Attached files

file filename
EX-32.1 - EXHIBIT 32.1 - ZAIS Group Holdings, Inc.tv478022_ex32-1.htm
EX-32.2 - EXHIBIT 32.2 - ZAIS Group Holdings, Inc.tv478022_ex32-2.htm
EX-31.2 - EXHIBIT 31.2 - ZAIS Group Holdings, Inc.tv478022_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - ZAIS Group Holdings, Inc.tv478022_ex31-1.htm

 

 

  

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2017

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

 

Commission file number: 001-35848

 

ZAIS GROUP HOLDINGS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware 46-1314400
(State or Other Jurisdiction of
Incorporation or Organization)

(I.R.S. Employer

Identification No.)

 

Two Bridge Avenue, Suite 322

Red Bank, NJ 07701-1106

(Address of Principal Executive Offices and Zip Code)

 

(732) 978-7518
(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨ Accelerated filer  ¨
   
Non-accelerated filer  ¨ Smaller reporting company  x
(Do not check if smaller reporting company)  
  Emerging growth company  x

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

 

As of November 13, 2017, 14,555,113 shares of Class A common stock, par value $0.0001 per share, and 20,000,000 shares of Class B Common Stock, par value $0.000001 per share, were issued and outstanding.

 

 

 

 

 

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION 3
   
Item 1. Financial Statements 3
   
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 52
   
Item 4. Controls and Procedures 81
   
PART II − OTHER INFORMATION 82
   
Item 1. Legal Proceedings 82
   
Item 1A. Risk Factors 82
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 82
   
Item 3. Defaults Upon Senior Securities 82
   
Item 4. Mine Safety Disclosures 82
   
Item 5. Other Information 83
   
Item 6. Exhibits 83
   
SIGNATURES 84

 

EXHIBIT 31.1  CERTIFICATIONS
 
EXHIBIT 31.2  CERTIFICATIONS
 
EXHIBIT 32.1  CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002, 18 U.S.C. SECTION 1350
 
EXHIBIT 32.2  CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002, 18 U.S.C. SECTION 1350

  

 2 

 

  

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Financial Condition (Unaudited)
(Dollars in thousands, except share amounts)

 

   September 30,
2017
   December 31,
2016
 
         
Assets          
Cash and cash equivalents  $16,241   $38,712 
Income and fees receivable   6,264    8,805 
Investments in affiliates, at fair value   10,153    5,273 
Due from related parties   958    734 
Property and equipment, net   222    274 
Prepaid expenses   1,457    906 
Other assets   371    348 
Assets of Consolidated Funds          
Cash and cash equivalents   37    37,080 
Investments, at fair value   63,607    404,365 
Due from broker       16,438 
Receivable for securities sold   38,700     
Other assets   1,620    1,210 
Total Assets  $139,630   $514,145 
           
Liabilities and Equity          
Liabilities          
Notes payable  $   $1,263 
Compensation payable   7,162    7,836 
Due to related parties   31    31 
Fees payable   61    2,439 
Other liabilities   1,251    1,127 
Liabilities of Consolidated Funds          
Notes payable of consolidated CLO, at fair value       384,901 
Payables for securities purchased   38,034     
Due to broker       24,462 
Other liabilities   236    2,121 
Total Liabilities   46,775    424,180 
           
Commitments and Contingencies (Note 12)          
           
Equity          
Preferred Stock, $0.0001 par value; 2,000,000 shares authorized; 0 shares issued and outstanding.        
Class A Common Stock, $0.0001 par value; 180,000,000 shares authorized; 14,480,782 and 13,900,917 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively.   1    1 
Class B Common Stock, $0.000001 par value; 20,000,000 shares authorized; 20,000,000 shares issued and outstanding.        
Additional paid-in capital   64,278    63,413 
Retained earnings (Accumulated deficit)   (23,376)   (18,965)
Accumulated other comprehensive income (loss)   (49)   (70)
Total stockholders’ equity, ZAIS Group Holdings, Inc.   40,854    44,379 
Non-controlling interests in ZAIS Group Parent, LLC   19,609    22,258 
Non-controlling interests in Consolidated Funds   32,392    23,328 
Total Equity   92,855    89,965 
Total Liabilities and Equity  $139,630   $514,145 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 3 

 

  

ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
(Dollars in thousands, except share and per share amounts)

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2017   2016   2017   2016 
Revenues                    
Management fee income  $4,223   $3,654   $11,019   $10,794 
Incentive income   4,559    3,614    7,740    3,909 
Reimbursement revenue   418        1,295     
Other revenues   77    79    247    238 
Income of Consolidated Funds   85        489     
Total Revenues   9,362    7,347    20,790    14,941 
Expenses                    
Compensation and benefits   5,775    6,908    18,808    23,914 
General, administrative and other   3,712    2,963    11,260    9,123 
Depreciation and amortization   118    79    229    206 
Expenses of Consolidated Funds   210    16    283    64 
Total Expenses   9,815    9,966    30,580    33,307 
Other income (loss)                    
Net gain (loss) on investments   81    46    195    83 
Other income (expense)   32    53    48    745 
Net gain (loss) of Consolidated Funds’ investments   1,304    4,115    4,018    7,808 
Net gain (loss) on beneficial interest of consolidated collateralized financing entity   620        2,118     
Total Other Income (Loss)   2,037    4,214    6,379    8,636 
Income (loss) before income taxes   1,584    1,595    (3,411)   (9,730)
Income tax (benefit) expense   9    (21)   19    (12)
Consolidated net income (loss), net of tax   1,575    1,616    (3,430)   (9,718)
Other comprehensive income (loss), net of tax:                    
Foreign currency translation adjustment   (8)   (61)   31    (262)
Total Comprehensive Income (Loss)  $1,567   $1,555   $(3,399)  $(9,980)
                     
Allocation of Consolidated Net Income (Loss), net of tax                    
Non-controlling interests in Consolidated Funds  $977   $1,902   $3,184   $3,688 
Stockholders’ equity, ZAIS Group Holdings, Inc.   403    (286)   (4,411)   (9,196)
Non-controlling interests in ZAIS Group Parent, LLC   195        (2,203)   (4,210)
 Total Allocation of Consolidated Net Income (Loss), net of tax  $1,575   $1,616   $(3,430)  $(9,718)
                     
Allocation of Total Comprehensive Income (Loss)                    
Non-controlling interests in Consolidated Funds  $977   $1,902   $3,184   $3,688 
Stockholders’ equity, ZAIS Group Holdings, Inc.   398    (326)   (4,390)   (9,370)
Non-controlling interests in ZAIS Group Parent, LLC   192    (21)   (2,193)   (4,298)
 Total Allocation of Total Comprehensive Income (Loss)  $1,567   $1,555   $(3,399)  $(9,980)
                     
Consolidated Net Income (Loss), net of tax per Class A common share applicable to ZAIS Group Holdings, Inc. – Basic  $0.03   $(0.02)  $(0.31)  $(0.66)
Consolidated Net Income (Loss), net of tax per Class A common share applicable to ZAIS Group Holdings, Inc. – Diluted  $0.03   $(0.02)  $(0.31)  $(0.66)
                     
Weighted average shares of Class A common stock outstanding:                    
Basic   14,480,782    13,900,917    14,315,387    13,887,997 
Diluted   21,480,782    20,900,917    21,315,387    20,887,997 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 4 

 

  

ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Changes in Equity and Non-controlling Interests (Unaudited)
(Dollars in thousands, except share amounts)

 

Nine Months Ended

September 30, 2017 

 

Class A

Common Stock

  

Class B

Common Stock

  

Additional

paid-in-capital

  

Retained
earnings

(Accumulated
deficit)

  

Accumulated

other

comprehensive

income

(loss)

  

Non-controlling

interests in

ZAIS Group
Parent, LLC

  

Non-controlling

interests in

Consolidated

Funds

   Total
Equity
 
   Shares   Amount   Shares   Amount                         
December 31, 2016   13,900,917   $1    20,000,000   $-   $63,413   $(18,965)  $(70)  $22,258   $23,328   $89,965 
Settlement of RSU awards   579,865    -    -    -    447    -    -    (447)   -    - 
Payment of employee taxes in connection with net settlement of RSUs   -    -    -    -    (801)   -    -    -    -    (801)
Modification of equity awards to liability awards   -    -    -    -    (17)   -    -    (9)   -    (26)
Capital
contributions
   -    -    -    -    -    -    -    -    5,880    5,880 
Equity-based
compensation
charges
   -    -    -    -    1,236    -    -    -    -    1,236 
Consolidated
net income
(loss)
   -    -    -    -    -    (4,411)   -    (2,203)   3,184    (3,430)
Other comprehensive income (loss)   -    -    -    -    -    -    21    10    -    31 
September 30, 2017   14,480,782   $1    20,000,000   $-   $64,278   $(23,376)  $(49)  $19,609   $32,392   $92,855 

 

Nine Months Ended
September 30, 2016
  Class A
Common Stock
   Class B
Common Stock
  

Additional

paid-in-capital

  

Retained
earnings

(Accumulated
deficit)

  

Accumulated

other

comprehensive

income

(loss)

  

Non-controlling

interests in

ZAIS Group
Parent, LLC

  

Non-controlling

interests in

Consolidated

Funds

   Total
Equity
 
   Shares   Amount   Shares   Amount                         
December 31, 2015   13,870,917   $1    20,000,000   $-   $60,817   $(13,805)  $158   $23,716   $14,916   $85,803 
                                                   
Settlement of RSU awards   30,000    -    -    -    30    -    -    (30)   -    - 
Capital contributions   -    -    -    -    -    -    -    -    4,907    4,907 
Capital distributions   -    -    -    -    -    -    -    (429)   -    (429)
Equity-based compensation charges   -    -    -    -    1,962    -    -    989    -    2,951 
Consolidated net income (loss)   -    -    -    -    -    (9,196)   -    (4,210)   3,688    (9,718)
Other comprehensive income (loss)   -    -    -    -    -    -    (174)   (88)   -    (262)
September 30, 2016   13,900,917   $1    20,000,000   $-   $62,809   $(23,001)  $(16)  $19,948   $23,511   $83,252 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 5 

 

  

ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows (Unaudited)
(Dollars in thousands)

 

   Nine Months Ended
September 30,
 
   2017   2016 
         
Cash Flows from Operating Activities          
Consolidated net income (loss)  $(3,430)  $(9,718)
Adjustments to reconcile consolidated net income (loss) to net cash provided by (used in) operating activities:          
Depreciation and amortization   229    206 
Net (gain) loss on investments   (32)   (83)
Non-cash stock-based compensation   1,236    2,951 
Interest expense on notes payable       6 
Operating cash flows due to changes in:          
Income and fees receivable   3,049    (2,781)
Due from related parties   (223)   (164)
Prepaid expenses   (551)   (669)
Other assets   7    (157)
Compensation payable   (701)   2,097 
Due to related parties       (31)
Fees payable   (2,378)   (756)
Other liabilities   123    (574)
Items related to Consolidated Funds:          
Purchases of investments and investments in affiliated securities   (366,960)   (30,348)
Proceeds from sale of investments   231,296     
Proceeds from sale of beneficial interest of collateralized financing entities   105,054    40,000 
Net (gain) loss on investments   6,637    509 
Net (gain) loss on beneficial interest of consolidated collateralized financing entity   (2,118)    
Net change in unrealized (gain) loss on notes payable of consolidated CLO   (8,362)    
Change in cash and cash equivalents   23,138    33 
Change in receivable for securities sold   (38,700)   (40,000)
Change in due from broker   12,563     
Change in other assets   (3,091)    
Change in dividend receivable   1,372    (8,317)
Change in payable for securities purchased   38,034    20,348 
Change in due to broker   (16,499)    
Change in other liabilities   (958)   (25)
Net Cash Provided by (Used in) Operating Activities   (21,265)   (27,473)
           
Cash Flows from Investing Activities          
Purchases of property and equipment   (178)   (17)
Distributions from investments in affiliates       165 
Purchases of investments in affiliates   (5,000)    
Purchases of investments, at fair value       (11)
Proceeds from sales of investments, at fair value   124    8,174 
Net Cash Provided by (Used in) Investing Activities   (5,054)   8,311 
           
Cash Flows from Financing Activities          
Contributions from non-controlling interests in Consolidated Funds   5,880    4,907 
Payment of employee taxes in connection with net settlement of RSUs   (801)    
Repayment of notes payable   (1,263)    
Distributions to non-controlling interests in ZGP       (429)
Net Cash Provided by (Used in) Financing Activities   3,816    4,478 
           
Net increase (decrease) in cash and cash equivalents denominated in foreign currency   32    (246)
Net increase (decrease) in cash and cash equivalents   (22,471)   (14,930)
Cash and cash equivalents, beginning of period   38,712    44,351 
Cash and cash equivalents, end of period  $16,241   $29,421 

  

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 6 

 

 

 ZAIS GROUP HOLDINGS, INC. AND SUBSIDIARIES

 

Notes to Condensed Consolidated Financial Statements

 

1.Organization

 

ZAIS Group Holdings, Inc. (“ZAIS”, and collectively with its consolidated subsidiaries, as the context may require, the “Company”) is a holding company conducting substantially all of its operations through ZAIS Group, LLC (“ZAIS Group”), an investment advisory and asset management firm focused on specialized credit which commenced operations in July 1997 and is headquartered in Red Bank, New Jersey. ZAIS Group also maintains an office in London. ZAIS Group is a wholly-owned consolidated subsidiary of ZAIS Group Parent, LLC (“ZGP”), a majority-owned consolidated subsidiary of ZAIS. ZAIS is the managing member of ZGP.

 

ZAIS Group is registered with the SEC under the Investment Advisors Act of 1940 and with the Commodity Futures Trading Commission as a Commodity Pool Operator and Commodity Trading Advisor. ZAIS Group provides investment advisory and asset management services to private funds, separately managed accounts, structured vehicles (collateralized debt obligation vehicles and collateralized loan obligation vehicles, together referred to as “CLOs”) and, through October 31, 2016, ZAIS Financial Corp. (“ZFC REIT”), a publicly traded mortgage real estate investment trust (collectively, the “ZAIS Managed Entities”).

 

Commencing in 2015, the Company’s management and its Board of Directors (the “Board”) have been conducting periodic strategic reviews of the Company’s business in order to enhance shareholder value. On February 15, 2017, the Board established a Special Committee of independent and disinterested directors (the “Special Committee of the Board of Directors”) to consider any proposals by management or third parties for strategic transactions. On September 5, 2017, Z Acquisition LLC entered into a share purchase agreement with Ramguard LLC pursuant to which Z Acquisition LLC will acquire 6,500,000 shares of Class A Common Stock (“Class A Common Stock”) of the Company at a purchase price of $4.00 per share for a combination of cash and a note (the “Ramguard Agreement”). After giving effect to the Ramguard Agreement, Christian Zugel would hold, directly or indirectly, 6,800,000 shares of the Class A Common Stock and 3,325,000 Class A Units of ZGP (“Class A Units”). Also, on September 5, 2017, the Special Committee of the Board of Directors received a letter (the “Letter”) from Christian Zugel seeking to pursue discussions with the Special Committee of the Board of Directors to take the Company private by acquiring through a merger the remaining issued and outstanding shares of Class A Common Stock of the Company, other than shares held by Christian Zugel and his affiliates, at $4.00 per share in an all cash transaction. The Company and Christian Zugel are negotiating the terms of an agreement for such a merger, which agreement will be subject to the approval of the Special Committee of the Board of Directors, the Board and the Company’s shareholders. If such merger is consummated, the Company expects to terminate the registration of ZAIS Class A Common Stock under the Securities Exchange Act of 1934, as amended, and to cease periodic and other public company compliance and reporting. There is no assurance that the discussions and negotiations between the Company and Christian Zugel which have taken place or may in the future take place will result in any agreement with respect to a merger. The Company intends to make a public announcement in the event, and at the time, of the approval of a merger agreement by the Board and the Special Committee of the Board.

 

The ZAIS Managed Entities predominantly invest in a variety of specialized credit instruments including corporate credit instruments such as CLOs, securities backed by residential mortgage loans, bank loans and various securities and instruments backed by these asset classes. ZAIS Group had the following assets under management (“AUM”):

 

Reporting Period  Approximately
(in billions)
 
As of September 30, 2017(1)  $4.144 
As of December 31, 2016  $3.444 

 

(1) In order to finance the purchase of the Company’s Class A Common Stock pursuant to the Ramguard Agreement, Christian Zugel and various trusts for which relatives of Christian Zugel are the beneficiaries have submitted a redemption request to redeem approximately $5.4 million (value date of September 30, 2017) of interests effective December 31, 2017, from ZAIS Opportunity Domestic Feeder Fund, LP, which serves as the feeder fund to ZAIS Opportunity Master Fund, Ltd, a ZAIS Managed Entity. The AUM presented has not been reduced to account for this redemption request.

 

 7 

 

 

ZAIS Group also serves as the general partner to certain ZAIS Managed Entities, which are generally organized as pass-through entities for U.S. federal income tax purposes.

 

  The Company’s primary sources of revenues are (i) management fee income, which is based predominantly on the net asset values of the ZAIS Managed Entities and (ii) incentive income, which is based on the investment performance of the ZAIS Managed Entities. Any management fee income and incentive income earned by ZAIS Group from the consolidated ZAIS Managed Entities (the “Consolidated Funds”) is eliminated in consolidation.

 

Additionally, a significant source of the Company’s revenues and other income is derived from income of Consolidated Funds, net gains of Consolidated Funds’ investments and net gains on beneficial interests of consolidated collateralized financing entities which invest in bank loans. A portion of income of Consolidated Funds and net gains of Consolidated Funds’ investments are allocated to non-controlling interests in Consolidated Funds.

 

2.Basis of Presentation and Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited, interim, consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") as contained within the Financial Accounting Standards Board’s ("FASB") Accounting Standards Codification ("ASC") and the rules and regulations of the SEC for interim reporting. In the opinion of management, all adjustments considered necessary for a fair statement of the Company's financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for the interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP as contained in the ASC have been condensed or omitted from the unaudited interim condensed consolidated financial statements according to the SEC rules and regulations. The information and disclosures contained in these unaudited interim condensed consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K. Certain comparative amounts in the consolidated financial statements have been reclassified to conform to the current period presentation.

 

Segment Reporting

 

The Company currently is comprised of one reportable segment, the investment management segment, and substantially all of the Company’s operations are conducted through this segment. The investment management segment provides investment advisory and asset management services to the ZAIS Managed Entities.

 

 Use of Estimates

 

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. While management believes that the estimates used in preparing the consolidated financial statements are reasonable and prudent, actual results may ultimately materially differ from those estimates.

 

Principles of Consolidation

 

The consolidated financial statements included herein are the financial statements of ZAIS, its subsidiaries and the Consolidated Funds. All intercompany balances and transactions are eliminated in consolidation, including ZAIS’s investment in ZGP and ZGP’s investment in ZAIS Group. The Company's fiscal year ends on December 31.

 

 8 

 

 

The consolidated financial statements include non-controlling interests in ZGP which is comprised of Class A Units held by Christian Zugel, the former managing member of ZGP and the founder and Chief Investment Officer of ZAIS Group, and certain related parties (collectively, the “ZGP Founder Members”).

 

The Company’s consolidated financial statements also include variable interest entities for which ZAIS Group is considered the primary beneficiary, and certain entities that are considered voting interest entities in which ZAIS Group has a controlling financial interest.

 

The Consolidated Funds include the following entities for the reporting periods presented:

 

    As of     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
Entity   September 30,
2017
    December 31,
2016
    2017     2016     2017     2016  
                                     
ZAIS Zephyr A-6, LP (“Zephyr A-6”)   ü     ü     ü     ü     ü     ü  
                                                 
ZAIS CLO 5, Limited (“ZAIS CLO 5” or “Consolidated CLO”)       ü         ü(1)           ü(1)      

 

(1) ZAIS CLO 5 is consolidated from the beginning of the period through August 10, 2017, the date which ZAIS CLO 5 was deconsolidated.

 

The Consolidated Funds, except for consolidated CLOs, are deemed to be investment companies under U.S. GAAP, and therefore, the Company has retained the specialized investment company accounting of these consolidated entities in its consolidated financial statements. The economic interests which are held by third-party investors are reflected as non-controlling interests in Consolidated Funds.

 

 The Company has elected the fair value option for the assets and liabilities held by the Consolidated Funds that otherwise would not have been carried at fair value. See Notes 4 and 5 for further disclosure on the assets and liabilities of the Consolidated Funds for which the fair value option has been elected.

 

For consolidated CLOs, the Company uses the measurement alternative included in the collateralized financing entity guidance (the “Measurement Alternative”). The Company measures both the financial assets and financial liabilities of the consolidated CLO in its consolidated financial statements using the fair value of the financial assets of the consolidated CLO, which are more observable than the fair value of the financial liabilities of the consolidated CLO. As a result, the financial assets of the consolidated CLO are measured at fair value and the financial liabilities are measured in consolidation as: the sum of the fair value of the financial assets and the carrying value of any non-financial assets that are incidental to the operations of the CLO less (ii) the sum of the fair value of any beneficial interests retained by the reporting entity (other than those that represent compensation for services) and the Company’s carrying value of any beneficial interests that represent compensation for services. The resulting amount is allocated to the individual financial liabilities (other than the beneficial interest retained by the Company) using a reasonable and consistent methodology. Under the Measurement Alternative, the Company’s consolidated net income reflects the Company’s own economic interests in the consolidated CLO including changes in the (i) fair value of the beneficial interests retained by the Company and (ii) beneficial interests that represent compensation for collateral management services. Such changes are presented in Net gain (loss) on beneficial interest of consolidated collateralized financing entity in the Consolidated Statements of Comprehensive Income (Loss).

 

The majority of the economic interests in the CLOs are held by outside parties, and are reported as notes payable of consolidated CLOs in the consolidated financial statements. The notes payable issued by the CLOs are backed by diversified collateral asset portfolios consisting primarily of loans or structured debt. In exchange for managing the collateral for the CLOs, ZAIS Group may earn investment management fees, including, in some cases, subordinated management fees and contingent incentive fees. All of the management fee income, incentive income and net gain (loss) on investments earned by ZAIS Group from the Consolidated Funds are eliminated in consolidation.

 

 9 

 

 

Reimbursement Revenue

 

ZAIS Group pays research and data services expenses relating to the management of the ZAIS Managed Entities directly to vendors and may allocate a portion of these costs to the respective ZAIS Managed Entities per the terms of the applicable related agreements (the “Research Costs”). Certain of these amounts may be reimbursable by the respective ZAIS Managed Entities and are recorded as Reimbursement revenue in the Consolidated Statements of Comprehensive Income (Loss) to the extent the Company is the primary obligor for such expenses and if the costs are charged back to the respective funds. The amounts for the three and nine months ended September 30, 2016 were not material and therefore were not separately reported in the Consolidated Statements of Comprehensive Income (Loss).

 

Income of Consolidated Funds

 

Income of Consolidated Funds reflects the interest income recognized by Zephyr A-6 related to its investments in unconsolidated CLOs. Any discounts and premiums on fixed income securities purchased are accreted or amortized into income or expense using the effective interest rate method over the lives of such securities. The effective interest rates are calculated using projected cash flows including the impact of paydowns on each of the aforementioned securities.

 

Non-Controlling Interests

 

The non-controlling interests within the Consolidated Statements of Financial Condition may be comprised of (i) redeemable non-controlling interests reported outside of the permanent capital section when investors have the right to redeem their interests from a Consolidated Fund or ZAIS Group, (ii) equity attributable to non-controlling interests in Consolidated Funds (excluding CLOs) reported inside the permanent capital section when the investors do not have the right to redeem their interests and (iii) equity attributable to non-controlling interests in ZGP inside the permanent capital section, if applicable.

 

The Company records non-controlling interests in the Consolidated Funds (excluding CLOs) to reflect the economic interests in those funds held by investors other than interests attributable to ZAIS Group. Income allocated to non-controlling interests in ZGP includes the portion of management fee income received from ZFC REIT that was payable to holders of Class B interests in ZAIS REIT Management, LLC (“ZAIS REIT Management”), a majority owned subsidiary of ZAIS Group which was the external adviser to ZFC REIT prior to October 31, 2016 (see Note 6 – “Management Fee Income and Incentive Income”).

 

Recent Accounting Pronouncements

 

Since May 2014, the FASB has issued ASU Nos. 2014-09, 2015-14, 2016-08, 2016-10 and 2016-12, Revenue from Contracts with Customers. The objective of the guidance is to clarify the principles for recognizing revenue and supersedes most current revenue recognition guidance, including industry-specific guidance. The guidance is to be applied retrospectively to all prior periods presented or through a cumulative adjustment in the year of adoption, for interim and annual periods beginning after December 15, 2017. However, a decision on the adoption method has not been made as of the date of this Report. The Company currently recognizes incentive income subject to contingent repayment once all contingencies have been resolved, whereas the new guidance requires an entity to recognize such revenue when it concludes that it is probable that a significant reversal in the cumulative amount of revenue recognized will not occur when the uncertainty is resolved. As such, the adoption of the new guidance may require the Company to recognize incentive income earlier than as prescribed under current guidance. The Company does not anticipate a significant change in the amount and timing of revenue recognition for management fee and reimbursement revenue. The Company continues to assess the impact of the rule changes on required disclosures.  The above includes the Company’s findings through the current report date.

 

 10 

 

  

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments─Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). The amendments, among other things, (i) requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (ii) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (iii) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) and (iv) eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. ASU 2016-01 is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The adoption of ASU 2016-01 is not expected to have a material effect on the Company’s consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). Under the new guidance, lessees are required to recognize lease assets and lease liabilities on the balance sheet for those leases previously classified as operating leases. The amendments in ASU No. 2016-02 are effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period with early adoption permitted. The Company is currently evaluating the impact of adopting this new standard. 

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). This ASU addresses the following eight specific cash flow issues: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early application is permitted, including adoption in an interim period. The adoption of ASU 2016-15 is not expected to have a material effect on the Company's consolidated financial statements.

  

In December 2016 the FASB issued ASU 2016-19, Technical Corrections and Improvements. As part of this guidance, ASU 2016-19 amends FASB ASC 820 to clarify the difference between a valuation approach and a valuation technique. The amendment also requires an entity to disclose when there has been a change in either or both a valuation approach and/or a valuation technique. ASU 2016-19 is effective on a prospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The Company has adopted ASU 2016-19 on its consolidated financial statements and disclosures. The adoption of ASU 2016-19 has not had a material impact on its consolidated financial statements.

 

Adopted Accounting Pronouncements

 

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payments Accounting ("ASU 2016-09").  ASU 2016-09 simplifies accounting for employee share-based payment transactions including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the consolidated statement of cash flows.  The Company adopted ASU 2016-09 as of January 1, 2017 with no significant impact on the consolidated financial statements.

 

3.Investments in Affiliates

 

In February 2017, ZAIS Group made a $5.0 million commitment to a ZAIS Managed Entity which focuses on investing in non-ZAIS managed CLOs, none of which has been called as of November 13, 2017.

 

In June 2017, ZAIS Group made a $5.0 million commitment to a ZAIS Managed Entity which carries first loss risk. ZAIS Group funded its entire $5.0 million commitment on June 29, 2017.

 

In July 2017, ZAIS liquidated the ZAIS Atlas Master Fund, LP and its feeder fund (together, the “Atlas Fund”), a ZAIS Managed Entity. ZAIS’s remaining amount due from the Atlas Fund was approximately $0.014 million at September 30, 2017. Such amount is included in Other assets in the Consolidated Statements of Financial Condition. At December 31, 2016, the Company’s investment in the Atlas Fund was $0.1 million. Such amount is included in Investments in affiliates in the Consolidated Statements of Financial Condition.

 

 11 

 

  

At September 30, 2017 and December 31, 2016, the Company held investments in four and five unconsolidated ZAIS Managed Entities (excluding an investment in a ZAIS Managed Entity for which no capital has been called as of November 13, 2017), respectively.

 

The Company applied the fair value option to its investments in the ZAIS Managed Entities that are not consolidated. The Company believes that reporting the fair value of these investments is more indicative of the Company’s financial position than the equity method of accounting.

 

The fair value of these investments was as follows:

 

September 30,
2017
   December 31,
2016
 
(Dollars in thousands)
        
$10,153   $5,273 

 

The Company recorded a change in unrealized gain (loss) associated with the investments still held at the end of each respective period as follows:

 

Three Months Ended   Nine Months Ended 

September 30,
2017

  

September 30,
2016

  

September 30,
2017

  

September 30,
2016

 
(Dollars in thousands)
                  
$2   $(32)  $12   $(55)

 

Such amounts are included in Net gain (loss) on investments in the Consolidated Statements of Comprehensive Income (Loss).

 

At September 30, 2017 and December 31, 2016, neither the Company’s equity investment, individually or in the aggregate, nor the Company’s proportionate share of the total assets of unconsolidated ZAIS Managed Entities in which the Company invested, exceeded 20% of the Company’s total consolidated assets. Additionally, the Company did not have any income related to these investments, individually or in the aggregate, which exceeded 20% of its total Consolidated net income, net of tax for the three or nine months ended September 30, 2017 and September 30, 2016. As such, the Company did not present separate or summarized financial statements for any of these investees.

 

4.Fair Value Measurements

 

ASC 820 Fair Value Measurements defines fair value, establishes a framework for measuring fair value, and requires certain disclosures about fair value measurements under U.S. GAAP. Specifically, this guidance defines fair value based on exit price, or the price that would be received upon the sale of an asset or the transfer of a liability in an orderly transaction between market participants at the measurement date. Fair value under U.S. GAAP represents an exit price in the normal course of business, not a forced liquidation price. If the Company was forced to sell assets in a short period to meet liquidity needs, the prices it receives could be substantially less than their recorded fair values.

 

The Company follows the fair value measurement and disclosure guidance under U.S. GAAP, which establishes a hierarchical disclosure framework. This framework prioritizes and ranks the level of market price observability used in measuring investments at fair value. Market price observability is affected by a number of factors, including the type of investment, the characteristics specific to the investment and the state of the marketplace including the existence and transparency of transactions between market participants. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices in an orderly market generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. In all cases, an instrument’s level within the hierarchy is based upon the market pricing transparency of the instrument and does not necessarily correspond to the Company’s perceived risk or liquidity of the instrument.

 

 12 

 

  

The Company considers observable data to be market data which is readily available, regularly distributed or updated, reliable and verifiable, not proprietary, and provided by independent sources that are actively involved in the relevant market. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the determination of which category within the fair value hierarchy is appropriate for any given investment is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires significant judgment and considers factors specific to the investment.

 

Assets and liabilities that are measured and reported at fair value are classified and disclosed in one of the following categories:

 

Level 1 — Fair value is determined based on quoted prices for identical assets or liabilities in an active market at measurement date. Assets and liabilities included in Level 1 include listed securities. As required in the fair value measurement and disclosure guidance under U.S. GAAP, the Company does not adjust the quoted price for these investments. The hierarchy gives highest priority to Level 1.

 

Level 2 — Fair value is determined based on inputs other than quoted prices that are observable for the asset or liability either directly or indirectly as of the reporting date. Assets and liabilities which are generally included in this category include corporate bonds and loans, less liquid and restricted equity securities and certain over-the-counter derivatives, including foreign exchange forward contracts whose values are based on the following:

 

Quoted prices for similar assets or liabilities in active markets.

 

Quoted prices for identical or similar assets or liabilities in non-active markets.

 

Pricing models whose inputs are observable for substantially the full term of the asset or liability.

 

Pricing models whose inputs are derived principally from or corroborated by observable market data for substantially the full term of the asset or liability.

 

Level 3 — Fair value is determined based on inputs that are unobservable for the investment and includes situations where there is little, if any, market activity for the asset or liability. The inputs into the determination of fair value require significant management judgment or estimation and the Company may use models or other valuation methodologies to arrive at fair value. Investments that are included in this category generally include distressed debt, less liquid corporate debt securities, non-investment grade residual interests in securitizations, collateralized debt obligations and certain derivative contracts. The hierarchy gives the lowest priority to Level 3.

 

The Company has established a valuation process that applies for all levels of investments in the valuation hierarchy to ensure that the valuation techniques are consistent and verifiable. The valuation process includes discussions between the valuation team, portfolio management team and the valuation committee (the “Valuation Committee”). The Valuation Committee consists of senior members of ZAIS Group and is chaired by the Chief Financial Officer of ZAIS Group. The Valuation Committee meets to review and approve the results of the valuation process which are used in connection with the preparation of quarterly and annual financial statements. The Valuation Committee is responsible for oversight and review of the written valuation policies and procedures and ensuring that they are applied consistently.

 

The lack of an established, liquid secondary market for some of the Company’s holdings may have an adverse effect on the fair value of those holdings and on the Company’s ability to dispose of them. Additionally, the public markets for the Company’s holdings may experience periods of volatility and periods of reduced liquidity and the Company’s holdings may be subject to certain other transfer restrictions that may further contribute to illiquidity. Such illiquidity may adversely affect the price and timing of liquidations of the Company’s holdings.

 

 13 

 

  

The following is a description of the valuation techniques used to measure fair value:

  

Investments in Bank Loans

 

The Company uses a nationally recognized pricing source to provide pricing information used to determine the price for the bank loans held by the consolidated CLOs.

 

Investments in CLOs

 

ZAIS determined the fair value of the investments in CLOs generally with input from a third party pricing source. ZAIS verifies that the quotes received from the valuation source are reflective of fair value as defined in U.S. GAAP, generally by comparing trading activity for similar asset classes, pricing research provided by banks and brokers, indicative broker quotes and results from an external cash flows analytics tool.

 

Collateralized Loan Obligation – Warehouses

 

A Collateralized Loan Obligation Warehouse ("CLO Warehouse") is an entity organized for the purpose of holding syndicated bank loans, also known as leveraged loans, prior to the issuance of securities from that same vehicle.  During the warehouse period, a CLO Warehouse will secure investments and build a portfolio of primarily leveraged loans and other debt obligations. The warehouse period terminates when the collateralized loan obligation vehicle issues various tranches of securities to the market. At this time, financing through the issuance of debt and equity securities is used to repay the bank financing.

 

The fair value of a CLO Warehouse is determined by adding the excess spread (accrued interest and delayed compensation plus interest received less financing cost, cost of carry and any applicable expenses) to the CLO Warehouse equity contribution made by the Consolidated Funds, unless ZAIS Group determines that the securitization will not be achieved, in which case, the fair value of a CLO Warehouse will be established based on the fair value of the underlying bank loan positions which are valued in a manner consistent with ZAIS Group’s valuation policy and procedures.  CLO warehouses can be exposed to credit events, mark to market changes, rating agency downgrades and financing cost changes. Changes in the fair value of a CLO Warehouse are reported in Net gain (loss) of Consolidated Funds’ investments in the Consolidated Statements of Comprehensive Income (Loss).

 

Investment in Affiliates

 

Under U.S. GAAP, the Company is permitted, as a practical expedient, to estimate the fair value of its investments in other investment companies using the net asset value (or its equivalent) of the related investment company. Accordingly, the Company utilizes the net asset value in valuing its investments in the unconsolidated ZAIS Managed Entities (excluding CLOs), which is an amount equal to the sum of the Company’s proportionate interest in the capital accounts of the affiliated entities at fair value. The fair value of the assets and liabilities of the ZAIS Managed Entities are determined by the Company in accordance with its valuation policies described above. Investments measured at fair value using the practical expedient are not required to be categorized within the fair value hierarchy. The resulting net gains or losses on investments are included in Net gain (loss) on investments in the Consolidated Statements of Comprehensive Income (Loss).

 

ZAIS Group has the ability to liquidate its investments according to the provisions of the respective entities’ operating agreements.

 

Notes payable of Consolidated CLO

 

The fair value of Notes payable of consolidated CLO is determined by applying the Measurement Alternative.

 

The following tables summarize the Company’s assets and liabilities measured at fair value on a recurring basis within the fair value hierarchy levels or based on net asset values, as applicable:

 

 14 

 

  

   September 30, 2017 
   (Dollars in thousands) 
   Level 1   Level 2   Level 3   Net Asset
 Value
   Total 
Assets, at fair value:                         
Cash equivalents  $14,870   $   $   $   $14,870 
                          
Investments in affiliates, at fair value               10,153    10,153 
                          
Assets of Consolidated Funds                         
Investments, at fair value:                         
CLOs:                         
Senior notes           36,604        36,604 
Mezzanine notes           21,971        21,971 
Subordinated notes           5,032        5,032 
Total – investments, at fair value           63,607        63,607 
Total assets, at fair value  $14,870   $   $63,607   $10,153   $88,630 

 

   December 31, 2016 
   (Dollars in thousands) 
   Level 1   Level 2   Level 3   Net Asset
Value
   Total 
Assets, at fair value:                         
Cash equivalents  $36,971   $   $   $   $36,971 
                          
Investments in affiliates, at fair value               5,273    5,273 
Assets of Consolidated Funds                         
Investments, at fair value:                         
Bank loans           389,329        389,329 
CLOs:                         
Warehouse           15,036        15,036 
Total – investments, at fair value           404,365        404,365 
Total assets, at fair value  $36,971   $   $404,365   $5,273   $446,609 
                          
Liabilities, at fair value:                         
Liabilities of Consolidated Funds                         
Notes payable of consolidated CLO, at fair value           384,901        384,901 
Total liabilities, at fair value  $   $   $384,901   $   $384,901 

 

The following tables summarize the changes in the Company’s Level 3 assets:

 

 15 

 

  

   Nine Months Ended September 30, 2017 
   (Dollars in thousands) 
   Beginning
Balance
January 1,
2017
   Purchases/
Issuances
   Sales/
Redemptions/
Settlements
   Total
Realized
and
Change in
Unrealized
Gains
(Losses)
   Amortization
of Discounts/
Premiums
   Effect of
Deconsolidation
   Transfers
to (from)
Level 3
   Ending
Balance
September
30, 2017
   Change in
Unrealized
Gains/Losses
Relating to
Assets and
Liabilities
Still Held at
September
30, 2017
 
Assets:                                             
Bank loans  $389,329   $231,203   $(231,296)  $(4,236)  $848   $(385,848)  $   $   $ 
CLOs:                                             
Senior notes       36,600        (265)   269            36,604    (265)
Mezzanine notes       21,916        (59)   114            21,971    (59)
Subordinated notes       8,541    (3,872)   257    106            5,032    140 
Warehouse   15,036    68,700    (87,820)   4,084                     
Total investments, at fair value  $404,365   $366,960   $(322,988)  $(219)  $1,337   $(385,848)  $   $63,607   $(184)
                                              
Liabilities:                                             
Notes payable of consolidated CLO, at fair value  $384,901            (8,362)       (376,539)            
Total liabilities, at fair value  $384,901   $   $   $(8,362)  $   $(376,539)  $   $   $ 

 

   Nine Months Ended September 30, 2016 
   ( Dollars in thousands ) 
   Beginning
Balance
January 1,
2016
   Purchases/
Issuances
   Sales/
Redemptions/
Settlements
   Total
Realized
and
Change in
Unrealized
Gains
(Losses)
   Transfers
to (from)
Level 3
   Ending
Balance
September
30, 2016
   Change in
Unrealized
Gains/Losses
Relating to
Assets and
Liabilities
Still Held at
September
30, 2016
 
CLOs:                                   
Warehouse  $30,509   $10,000   $(48,317)  $7,808   $   $   $ 
ZAIS CLO 5       20,348                20,348     
Total investments, at fair value  $30,509   $30,348   $(48,317)  $7,808   $   $20,348   $ 

 

The Company’s policy is to record transfers between Level 1, Level 2 and Level 3, if any, at the beginning of the period. There were no transfers between Level 1, Level 2 and Level 3 during the nine months ended September 30, 2017 or September 30, 2016.

 

 16 

 

  

The tables below summarize information about the significant unobservable inputs used in determining the fair value of the Level 3 assets and liabilities held by the Consolidated Funds:

 

Investment Type  Fair Value at
September 30,
2017
   Valuation
Technique
  Unobservable
Input
  Amount/
Percentage
  Min   Max   Weighted
Average
 
   (Dollars in
Thousands)
                      
Assets of Consolidated Funds:                             
CLOs:                             
Senior notes  $36,604   Third party pricing source  Not applicable  Not applicable            
Mezzanine notes   21,971   Third party pricing source  Not applicable  Not applicable            
Subordinated notes   5,032   Third party pricing source  Not applicable  Not applicable            
Total – Investments, at fair value  $63,607                         

 

Investment Type  Fair Value at
December 31,
 2016
   Valuation
Technique
  Unobservable
Input
  Amount/
Percentage
  Min   Max   Weighted
Average
 
   (Dollars in
Thousands)
                      
Assets of Consolidated Funds:                             
Bank loans  $389,329   Third party valuation source  Not applicable  Not applicable            
CLOs:                             
Warehouse   15,036   Cost plus excess spread  Excess spread  0.2%   0.2%   0.2%   0.2%
Total – Investments, at fair value  $404,365                         
                              
Liabilities of Consolidated Funds:                             
Notes payable of consolidated CLO, at fair value  $384,901   Measurement Alternative  Not applicable  Not applicable            
Total – Notes payable of consolidated CLO, at fair value  $384,901                         

 

 17 

 

  

5.Variable Interest Entities and Voting Interest Entities

 

In the ordinary course of business, ZAIS Group sponsors the formation of variable interest entities (“VIEs”) that can be broadly classified into the following categories: hedge funds, hybrid private equity funds and CLOs. ZAIS Group generally serves as the investment advisor or collateral manager with certain investment-related, decision-making authority for these entities. The Company has not recorded any liabilities with respect to VIEs that are not consolidated.

 

 Funds

 

The Company has determined that the fee it receives from several of the hedge funds and hybrid private equity funds ZAIS Group manages does not represent a variable interest, because ZAIS Group’s fee arrangements are commensurate with the level of effort performed and include only customary terms. The Company considered investments its related parties have in these entities when determining if ZAIS Group’s fee represented a variable interest.

 

ZAIS Group owns 51% of a majority-owned affiliate, Zephyr A-6, which was formed to invest in collateralized loan obligation vehicles, including during the related warehouse period of such vehicles. The Company has determined that ZAIS Group is the primary beneficiary of Zephyr A-6 and therefore has consolidated Zephyr A-6 in its consolidated financial statements at September 30, 2017 and December 31, 2016 and for the three and nine months ended September 30, 2017 and September 30, 2016. ZAIS Group is the primary beneficiary since it is deemed to have (i) the power to direct activities of the entity that most significantly impact its economic performance and (ii) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the entity.

 

ZAIS Group’s ownership interest in Zephyr A-6 was reduced on October 12, 2017 (see Note 17 – “Subsequent Events”).

 

Zephyr A-6’s investments are as follows:

 

ZAIS CLO 5

 

ZAIS CLO 5 was in the warehouse phase from June 29, 2016, its inception date, through October 26, 2016 (the “ZAIS CLO 5 Closing Date”). During this period (the “ZAIS CLO 5 Warehouse Period”), ZAIS CLO 5 financed the majority of its loan purchases using its warehouse facility. The Company was not required to consolidate ZAIS CLO 5 during the ZAIS CLO 5 Warehouse Period.

 

ZAIS CLO 5 which priced on September 23, 2016 and closed on the ZAIS CLO 5 Closing Date, invests primarily in first lien, senior secured bank loans and had a total capitalization of $408.5 million at the time of closing, which consisted of senior and mezzanine notes with an aggregate par amount of $368.0 million and subordinated notes of $40.5 million. The CLO matures in October 2028. In connection with the closing, Zephyr A-6 recognized a dividend of $8.8 million which represents gains that were realized under the terms of the CLO Warehouse agreement.

 

Zephyr A-6’s initial investment in ZAIS CLO 5 was $20.3 million ($20.5 million par), which represented approximately a 2.1% economic interest in the senior and mezzanine notes and approximately 31.8% economic interest in the subordinated notes. The Company determined that it was the primary beneficiary of ZAIS CLO 5 based on (i) its ability to impact the activities which most significantly impact ZAIS CLO 5’s economic performance as collateral manager and (ii) Zephyr A-6’s significant investment in the subordinated notes of ZAIS CLO 5. Therefore, the Company initially consolidated ZAIS CLO 5 in its financial statements on the ZAIS CLO 5 Closing Date.

 

 18 

 

  

In February 2017 Zephyr A-6 sold its interest in the Class A-1 tranche of ZAIS CLO 5 for a sales price of approximately $5.4 million and recognized a loss of approximately $81,000. Such amount is included in Net gain (loss) on beneficial interest of consolidated collateralized financing entity in the Consolidated Statements of Comprehensive Income (Loss).

 

On August 10, 2017 Zephyr A-6 sold all of its remaining interests in ZAIS CLO 5 for a sales price of approximately $12.1 million and recognized a loss of approximately $0.2 million. Such amount is included in Net gain (loss) on beneficial interest of consolidated collateralized financing entity in the Consolidated Statements of Comprehensive Income (Loss). The sale was not to a related party. Subsequent to the sale of its interests in ZAIS CLO 5, Zephyr A-6 did not have any investment in ZAIS CLO 5 and therefore the Company deconsolidated ZAIS CLO 5 as of August 10, 2017. A wholly owned subsidiary of ZAIS continued as the collateral manager for ZAIS CLO 5 subsequent to the deconsolidation.

 

The Company consolidated ZAIS CLO 5 in its financial statements for the period from October 26, 2016 through December 31, 2016 and for the period from January 1, 2017 through August 10, 2017 and as of December 31, 2016. Zephyr A-6 had an investment of $19.5 million in ZAIS CLO 5, at fair value, at December 31, 2016. This investment represents approximately a 2.1% economic interest in the senior and mezzanine notes and a 31.8% economic interest in the subordinated notes of ZAIS CLO 5 at December 31, 2016.

 

ZAIS CLO 6, Limited (“ZAIS CLO 6”)

 

ZAIS CLO 6 was in the warehouse phase from November 18, 2016, its inception date, through June 1, 2017 (the “ZAIS CLO 6 Closing Date”). During this period (the “ZAIS CLO 6 Warehouse Period”), ZAIS CLO 6 financed the majority of its loan purchases using its warehouse facility. ZAIS CLO 6 did not meet the consolidation criteria during the ZAIS CLO 6 Warehouse Period.

 

ZAIS CLO 6, which priced on May 3, 2017 and closed on the ZAIS CLO 6 Closing Date, invests primarily in first lien senior secured bank loans and had a total capitalization of $512.0 million on the ZAIS CLO 6 Closing Date, which consisted of senior and mezzanine notes with an aggregate par amount of $460.0 million and subordinated notes of $52.0 million. The CLO matures in July 2029. In connection with the closing, Zephyr A-6 recognized a dividend of $2.7 million which represents gains that were realized under the terms of the CLO Warehouse agreement. Zephyr A-6’s initial investment of $29.0 million in ZAIS CLO 6 represented approximately a 5.0% economic interest in the senior and mezzanine note tranches and approximately a 13.5% economic interest in the equity tranche.

 

 Prior to the ZAIS CLO 6 Closing Date, Zephyr A-6 sold a portion of its interest in the subordinated notes of ZAIS CLO 6 for a sales price of approximately $3.9 million and recognized a gain of approximately $0.2 million. Such amount is included in Net gain (loss) of Consolidated Funds’ investments in the Consolidated Statements of Comprehensive Income (Loss). This transaction reduced Zephyr A-6’s economic interest in the subordinated notes from 13.5% to 5.0%. The Company determined that it was not the primary beneficiary of ZAIS CLO 6 on the ZAIS CLO 6 Closing Date based on Zephyr A-6’s minimal investment in the subordinated notes of ZAIS CLO 6. Therefore, the Company was not required to consolidate ZAIS CLO 6 in its financial statements as of the ZAIS CLO 6 Closing Date.

 

 Zephyr A-6’s investment in ZAIS CLO 6 was $25.5 million at fair value, at September 30, 2017 ($25.6 million par), which represented approximately a 5.0% economic interest in the senior, mezzanine and subordinated notes based on notional value. The Company determined that it is not the primary beneficiary of ZAIS CLO 6 based on Zephyr A-6’s minimal investment in the subordinated notes of ZAIS CLO 6 at September 30, 2017. Therefore, the Company was not required to consolidate ZAIS CLO 6 in its financial statements at September 30, 2017 or for the three and nine months ended September 30, 2017.

 

ZAIS CLO 7, Limited (“ZAIS CLO 7”)

 

ZAIS CLO 7 was in the warehouse phase from June 12, 2017, its inception date, through September 30, 2017. During this period (the “ZAIS CLO 7 Warehouse Period”), ZAIS CLO 7 financed the majority of its loan purchases using its warehouse facility. ZAIS CLO 7 did not meet the consolidation criteria during the ZAIS CLO 7 Warehouse Period.

 

 19 

 

  

ZAIS CLO 7, which priced on September 11, 2017 (the “ZAIS CLO 7 Pricing Date”), invests primarily in first lien senior secured bank loans and has a total capitalization of $564.0 million, which consists of senior and mezzanine notes with an aggregate par amount of $506.0 million and subordinated notes of $58.0 million. The CLO matures in April 2030.

 

At the ZAIS CLO 7 Pricing Date, Zephyr A-6 had (i) an investment of approximately $35.5 million in the senior and mezzanine notes and an investment of approximately $2.5 million in the subordinated notes of ZAIS CLO 7 and a corresponding payable of $38.0 million for its obligation to purchase the securities and (ii) a receivable for securities sold of $38.7 million for the return of its initial investment in ZAIS CLO 7 while it was in the warehouse period.  Zephyr A-6’s investment of $38.1 million in ZAIS CLO 7, at fair value, represents approximately 5.0% economic interest in the senior note tranches, 16.4% economic interest in the mezzanine note tranches and 5.0% economic interest in the subordinated note tranches. In total, Zephyr A-6 held a 6.78% economic interest in the total capital structure of ZAIS CLO 7 on the ZAIS CLO 7 Pricing Date.

 

The Company determined that it was not the primary beneficiary of ZAIS CLO 7 at the ZAIS CLO 7 Pricing Date or at September 30, 2017 because ZAIS CLO 7 was still in the warehouse phase. Therefore, the Company was not required to consolidate ZAIS CLO 7 in its financial statements as of the ZAIS CLO 7 Pricing Date or at September 30, 2017.

 

ZAIS CLO 7 closed on October 19, 2017 (see Note 17 – “Subsequent Events”).

 

Net gain (loss) of Consolidated Funds’ Investments

 

Net gain (loss) related to Zephyr A-6’s investments in ZAIS CLO 5, ZAIS CLO 6 and ZAIS CLO 7 for the period which the investments were not consolidated by the Company includes the following: 

 

  

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
   2017   2016   2017   2016 
   (Dollars in thousands) 
ZAIS CLO 5:                    
Change in unrealized gain or loss  $   $4,115   $   $7,808 
                     
ZAIS CLO 6:                    
Change in unrealized gain or loss   (58)       (321)    
Realized gains   (106)       2,867     
Total – ZAIS CLO 6   (164)       2,546     
                     
ZAIS CLO 7:                    
Change in unrealized gain or loss   95        100     
Realized gains   1,373        1,372     
Total – ZAIS CLO 7   1,468        1,472     
                     
Total – Net gain (loss) of Consolidated Funds’ investments  $1,304   $4,115   $4,018   $7,808 

 

 Securitized Structures

 

ZAIS Group and certain of its wholly owned subsidiaries act as collateral manager for CLOs that are VIEs. These CLOs are entities that issue collateralized notes which offer investors the opportunity for returns that vary commensurately with the risks they assume. The notes issued by the CLOs are generally backed by asset portfolios consisting of loans, other debt or other derivatives. For acting as the collateral manager for these structures, ZAIS Group receives collateral management fees comprised of senior collateral management fees, subordinated collateral management fees and incentive collateral management fees (subject to hurdle rates). In some cases, all of the collateral management fees are waived as a result of certain ZAIS Managed Entities owning equity tranches of the related CLO.

 

 20 

 

  

For CLOs in which the Company has no economic interests other than ZAIS Group’s fee arrangement, the Company has determined that the fee it receives from the CLOs does not represent a variable interest because ZAIS Group’s fee arrangements are commensurate with the level of effort performed and include only customary terms. The Company considered investments its related parties have in the CLOs when determining if ZAIS Group’s fee represented a variable interest. The Company will continue to assess its investments in the CLOs to determine whether or not the Company is required to consolidate the CLOs in its financial statements.

 

The Dodd-Frank credit risk retention rules, which became effective on December 24, 2016, apply to any newly issued CLOs or certain cases in which an existing CLO is refinanced, issues additional securities or is otherwise materially amended. The risk retention rules specify that for each CLO, the relevant collateral manager must purchase and hold, unhedged, directly or through a majority-owned affiliate, either (i) 5% of the face amount of each tranche of the CLO’s securities, (ii) an amount of the CLO’s equity equal to 5% of the aggregate fair value of all of the CLO’s securities or (iii) a combination of the two for a total of 5%. The required risk must be retained until the latest of (i) the date that the CLO has paid down its securities to 33% of their original principal amount, (ii) the date that the CLO has sold down its assets to 33% of their original principal amount or (iii) the date that is two years after closing.

 

The Company determined that it is not the primary beneficiary of CLO Warehouses, which are VIEs, because the financing counterparty must approve all significant financing requests and, as a result, the Company does not have the power to direct activities of the entity that most significantly impacts its economic performance.

 

VIEs

 

 Consolidated VIEs 

 

At September 30, 2017 the Consolidated Funds consist of Zephyr A-6. At December 31, 2016 the Consolidated Funds consist of Zephyr A-6 and ZAIS CLO 5. Both Zephyr A-6 and ZAIS CLO 5 are VIEs.

 

The assets and liabilities of the consolidated VIEs are presented on a gross basis prior to eliminations in the tables in Note 16 – “Supplemental Financial Information” under the columns titled “Consolidated Funds.”

 

The assets presented belong to the investors in Zephyr A-6 and ZAIS CLO 5, are available for use only by the entity to which they belong and are not available for use by the Company. The Consolidated Funds have no recourse to the general credit of ZAIS Group with respect to any liability.

 

Unconsolidated VIEs

 

At September 30, 2017 and December 31, 2016, the Company’s unconsolidated VIEs consisted of the Company’s investments in certain ZAIS Managed Entities as well as the Consolidated Fund’s investments in certain collateralized financing entities.

 

The carrying amounts of the unconsolidated VIEs are as follows:

 

Investment In  Financial Statement Line Item  September 30,
2017
   December 31,
2016
 
      (Dollars in thousands) 
Certain ZAIS Managed Entities  Investment in affiliates, at fair value  $5,153   $272 
CLOs  Assets of Consolidated Funds – Investments at fair value   63,607     
CLO Warehouses  Assets of Consolidated Funds – Investments at fair value       15,036 
   Total  $68,760   $15,308 

 

 21 

 

  

Such amounts are included in the Consolidated Statements of Financial Condition.

 

ZAIS Group has a minimal direct ownership, if any, in the unconsolidated VIEs and its involvement is generally limited to providing asset management services. ZAIS Group’s exposure to loss from these entities is limited to a decrease in the management fee income and incentive income that has been earned and accrued, as well as any change in fair value of its direct equity ownership in the VIEs.

 

Zephyr A-6, one of the Consolidated Funds, contributed the following amounts to ZAIS CLO 5, ZAIS CLO 6 and ZAIS CLO 7 during the warehouse periods: 

 

  

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
   2017   2016   2017   2016 
   (Dollars in thousands) 
ZAIS CLO 5  $   $10,000   $   $10,000 
ZAIS CLO 6           30,000     
ZAIS CLO 7   13,700        38,700     
Total  $13,700   $10,000   $68,700   $10,000 

 

Notes Payable of consolidated CLO

 

The Company did not consolidate ZAIS CLO 5 at September 30, 2017. Therefore, there are no notes payable of consolidated CLOs at September 30, 2017.

 

Notes payable of ZAIS CLO 5, the consolidated CLO, are collateralized by the assets held by ZAIS CLO 5. As of December 31, 2016, this collateral primarily consists of bank loans. The fair value of the assets and liabilities of ZAIS CLO 5 and the eliminations for the Consolidated Fund’s investment in ZAIS CLO 5 is as follows:

  

   December 31,
2016
 
   (Dollars in
thousands)
 
     
Cash and cash equivalents  $23,987 
Investments, at fair value   389,329 
    413,316 
      
Other assets (liabilities), net   (8,909)
Notes payable of consolidated CLO, at fair value   404,407 
Elimination of Consolidated Funds’ investments in CLO   (19,506)
Notes payable of consolidated CLO, at fair value (net of eliminations)  $384,901 

 

The Company has elected to carry these notes at fair value in its Consolidated Statements of Financial Condition. Accordingly, the Company measured the fair value of the notes payable using the Measurement Alternative as described in Note 2.

 

 The table below presents information related to ZAIS CLO 5’s notes payable outstanding as of December 31, 2016. The subordinated notes have no stated interest rate, and are entitled to any excess cash flows after contractual payments are made to the senior notes. 

 

 22 

 

  

   December 31, 2016    
   (Dollars in thousands)    
        
   Unpaid 
Principal
Outstanding
   Fair
Value
   Weighted
Average
Interest
Rate
   Weighted
Average
Maturity
(in Years)
   Stated
Maturity
Dates
Senior and Mezzanine Secured Notes  $360,395   $357,489    2.97%   11.83   October 2028
Subordinated Notes   27,635    27,412    N/A    11.83   October 2028
Total  $388,030   $384,901              

 

Unconsolidated Voting Interest Entities (“VOEs”)

 

At September 30, 2017 and December 31, 2016, the Company’s unconsolidated VOEs consisted of the Company’s investment in one ZAIS Managed Entity which carries first loss risk.

 

The carrying amounts of the unconsolidated VOEs are as follows:

 

Investment In  Financial Statement Line Item  September 30,
2017
   December 31,
2016
 
      (Dollars in thousands) 
Certain ZAIS Managed Entities  Investment in affiliates, at fair value  $5,000   $5,000 

 

Such amounts are included in the Consolidated Statements of Financial Condition.

 

6.Management Fee Income and Incentive Income

 

ZAIS Group earns management fees for the funds and accounts which are generally based on (i) the net asset value of these funds and accounts prior to the accrual of incentive fees/allocations or (ii) drawn capital during the investment period. Management fees are generally collected on a monthly or quarterly basis.

 

Management fee income earned for the CLOs which ZAIS Group manages are generally based on the par value of the collateral and cash held in the CLOs. Additionally, subordinated management fees may be earned from CLOs for which ZAIS Group and certain of its wholly owned subsidiaries act as collateral manager. The subordinated management fee is an additional payment for the same collateral management service, but has a lower priority in the CLOs’ cash flows and is contingent upon the economic performance of the respective CLO. If the CLOs experience a certain level of asset defaults, these fees may not be paid. There is no recovery by the CLOs of previously paid subordinated fees.

 

Zephyr A-6 invests in certain CLOs managed by ZAIS Group. ZAIS Group earns fees from these CLOs. Any senior management fees in excess of 0.15%, the subordinate fee and the incentive fee (collectively, the “Rebated Fees”) paid to the Company by these CLOs are subsequently paid to Zephyr A-6 by ZAIS Group and allocated among the limited partners of Zephyr A-6 pro rata based on their percentage interests in Zephyr A-6. As a result of its interest in Zephyr A-6, ZAIS Group is allocated a portion of the Rebated Fees. The fee rebate income and related expense are eliminated in consolidation. The amounts allocable to the non-ZAIS partner of Zephyr A-6 are included in Non-controlling interest in Consolidated Funds in the Consolidated Statements of Comprehensive Income (Loss). The restructuring of Zephyr A-6 on October 12, 2017 modified the calculation of the Rebated Fees for the period subsequent to the restructuring (see Note 17 – “Subsequent Events”).

 

 23 

 

  

Prior to October 31, 2016, ZAIS Group earned management fee income from ZFC REIT, quarterly, based on ZFC REIT's stockholders' equity, as defined in the amended and restated investment advisory agreement between ZAIS REIT Management and ZFC REIT. Twenty percent of the management fee income received from ZFC REIT was paid to holders of Class B interests in ZAIS REIT Management. The payment to the Class B interests in ZAIS REIT Management was recorded as distributions to non-controlling interests in ZAIS Group Parent, LLC. The income was recorded as Management fee income in the Consolidated Statements of Comprehensive Income (Loss), and the portion of the management fees allocated to the holders of Class B interests in ZAIS REIT Management was included in the Allocation of Consolidated Net Income (Loss) to Non-controlling interests in ZAIS Group Parent, LLC. On October 31, 2016, the management agreement with ZFC REIT was terminated upon the completion of the merger between ZFC REIT and Sutherland Asset Management Corp (the “Termination Agreement”). Pursuant to the Termination Agreement, ZAIS REIT Management received a termination payment in the amount of $8.0 million in October 2016.

  

ZAIS Group manages certain ZAIS Managed Entities from which it may earn incentive income based on hedge fund-style and private equity-style fee arrangements. ZAIS Managed Entities with hedge fund-style fee arrangements are those that pay ZAIS Group, on an annual basis, an incentive fee/allocation based on a percentage of net realized and unrealized profits attributable to each investor, subject to a hurdle (if any) set forth in each respective entity’s operative agreements. Additionally, all ZAIS Managed Entities with hedge fund-style fee arrangements are subject to a perpetual loss carry forward, or a perpetual “high-water mark,” meaning that the relevant ZAIS Managed Entity will not pay incentive fees/allocations with respect to positive investment performance generated for an investor in any year following negative investment performance until that loss is recouped, at which point an investor’s capital balance surpasses the high-water mark. ZAIS Managed Entities with private equity-style fee arrangements are those that pay an incentive fee/allocation based on a priority of payments under which investor capital must be returned and a preferred return must be paid, as specified in each related ZAIS Managed Entity’s operative agreement, to the investor prior to any payments of incentive-based income to ZAIS Group. For CLOs, incentive income is earned based on a percentage of cumulative profits, subject to the return of contributed capital, payment of subordinate management fees (if any) and a preferred inception to date return as specified in the respective CLOs’ collateral management agreements. The advisory agreement between ZAIS REIT Management and ZFC REIT did not provide for incentive fees.

  

The following tables represent the gross amounts of management fee income and incentive income earned prior to eliminations due to consolidation of the Consolidated Funds and the net amount reported in the Company’s Consolidated Statements of Comprehensive Income (Loss):

 

     

Three Months Ended

September 30, 2017

 
      ( Dollars in thousands ) 
   Fee Range  Gross
Amount
   Elimination   Net
Amount
 
Management Fee Income (1)                  
Funds and accounts   0.50% - 1.25%  $2,748   $   $2,748 
CLOs   0.15% - 0.50%   1,653    (178)   1,475 
Total     $4,401   $(178)  $4,223 
                   
Incentive Income (1) (2)                  
Funds and accounts   10% - 20%  $4,548   $   $4,548 
CLOs  20%   11        11 
Total     $4,559   $   $4,559 

 

 24 

 

  

     

 Three Months Ended

September 30, 2016

 
      (Dollars in thousands) 
   Fee Range  Gross
Amount
   Elimination   Net
Amount
 
Management Fee Income (1)                  
Funds and accounts  0.50% - 1.25%  $2,669   $(218)  $2,451 
CLOs  0.15% - 0.50%   481        481 
ZFC REIT(3)  1.50%   722        722 
Total     $3,872   $(218)  $3,654 
                   
Incentive Income (1) (2)                  
Funds and accounts  10% - 20%  $3,614   $   $3,614 
Total     $3,614   $   $3,614 

 

     

Nine Months Ended

September 30, 2017

 
      ( Dollars in thousands ) 
   Fee Range  Gross
Amount
   Elimination   Net
Amount
 
Management Fee Income (1)                  
Funds and accounts  0.50% - 1.25%  $8,106   $   $8,106 
CLOs  0.15% - 0.50%   3,420    (507)   2,913 
Total     $11,526   $(507)  $11,019 
                   
Incentive Income (1) (2)                  
Funds and accounts  10% - 20%  $7,619   $   $7,619 
CLOs  20%   121        121 
Total     $7,740   $   $7,740 

 

     

Nine Months Ended

September 30, 2016

 
      (Dollars in thousands) 
   Fee Range  Gross
Amount
   Elimination   Net
Amount
 
Management Fee Income (1)                  
Funds and accounts  0.50% - 1.25%  $7,438   $(218)  $7,220 
CLOs  0.15% - 0.50%   1,311        1,311 
ZFC REIT(3)  1.50%   2,263        2,263 
Total     $11,012   $(218)  $10,794 
                   
Incentive Income (1) (2)                  
Funds and accounts  10% - 20%  $3,909   $   $3,909 
Total     $3,909   $   $3,909 

 

 25 

 

  

  (1) Certain management and incentive fees have been and may in the future be waived and therefore the actual fees rates may be lower than those reflected in the range.

 

  (2) Incentive income earned for certain of the ZAIS Managed entities is subject to a hurdle rate of return as specified in each respective ZAIS Managed Entity’s operative agreement.

 

  (3) On October 31, 2016, the management agreement with ZFC REIT was terminated pursuant to the Termination Agreement.

 

The Company may give credits for management fee income and/or incentive income to investors which invest in ZAIS Managed Entities that invest in other ZAIS Managed Entities where fees are also charged. The Company recorded all credits relating to management fee income and incentive income as Fees payable in the Consolidated Statements of Financial Condition and a reduction of either Management fee income or Incentive income in the Consolidated Statements of Comprehensive Income (Loss). The management fee income and incentive income amounts above are net of the following credits:

 

  

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
   2017   2016   2017   2016 
   (Dollars in thousands) 
Management fee income credit  $61   $52   $187   $156 
Total  $61   $52   $187   $156 

 

The following table presents the gross amount of the rebated fees prior to eliminations due to the consolidation of Zephyr A-6 and the net amount reported in the Company’s Consolidated Statements of Comprehensive Income (Loss): 

 

  

Three Months Ended

September 30, 2017

 
   ( Dollars in thousands ) 
   Gross
Amount
   Elimination   Net
Amount
 
Rebated Fees  $374   $(374)  $ 
Total  $374   $(374)  $ 

 

  

Nine Months Ended

September 30, 2017

 
   ( Dollars in thousands ) 
   Gross
Amount
   Elimination   Net
Amount
 
Rebated Fees  $664   $(664)  $ 
Total  $664   $(664)  $ 

 

There were no Rebated Fees for the three or nine months ended September 30, 2016.

 

 26 

 

  

Management fee income and incentive income which was accrued, but not received is as follows:

 

   September 30,
2017
   December 31,
2016
 
   (Dollars in thousands) 
         
Management fee income  $2,634   $1,284 
Incentive income   3,630    7,521 
Total  $6,264   $8,805 

 

Such amounts are included in Income and fees receivable in the Consolidated Statements of Financial Condition.  

 

The Company did not recognize any bad debt expense for the three and nine months ended September 30, 2017 or September 30, 2016. The Company believes all income and fees receivable balances are fully collectible.

 

7.Notes Payable

 

On March 17, 2015, in conjunction with the contribution of cash by HF2 Financial Management, Inc. to ZGP in exchange for newly issued Class A Units, representing a majority financial interest in ZGP (the “Business Combination”), ZAIS issued two promissory notes with an aggregate principal balance of $1.25 million to EarlyBirdCapital, Inc. and Sidoti & Company, LLC. The notes accrued interest at an annual rate equal to the annual applicable federal rate as published by the Internal Revenue Service (“AFR”) until the principal amount of, and all accrued interest on, the notes were paid in full. The notes matured on March 17, 2017 at which time the principal balance and accrued interest was paid in full. The notes were issued in lieu of paying certain underwriting costs at the closing of the Business Combination and, accordingly, treated as a direct cost attributable to the Business Combination and capitalized to equity.

 

The carrying amount of the Company’s notes payable approximates their fair value at December 31, 2016.

 

Total interest expense is included in Other income (expense) in the Consolidated Statements of Comprehensive Income (Loss) and was as follows:

 

Three Months Ended
September 30,

  

Nine Months Ended
September 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$   $2   $3   $6 

 

8.Compensation

 

The following table presents a detailed breakout of the Company’s compensation expense:

 

  

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
   2017   2016   2017   2016 
   (Dollars in thousands) 
                 
Salaries  $2,362   $2,497   $6,991   $8,370 
Bonus   3,068    2,808    9,211    10,208 
Severance       27    72    789 
Equity-Based Compensation   68    1,269    1,236    2,951 
Payroll taxes and benefits   277    307    1,298    1,593 
Commissions               3 
Total  $5,775   $6,908   $18,808   $23,914 

 

 27 

 

  

A summary of the Company’s compensation arrangements are as follows:

 

Bonus

 

Incentive Cash Compensation

 

Employees are eligible to receive discretionary incentive cash compensation (the “Bonus Award”) on an annual basis and certain employees may also be eligible to receive guaranteed incentive compensation (the “Guarantees”). The amount of the Bonus Award is based on, among other factors, both individual performance and the financial results of ZAIS Group. For certain employees, as documented in an underlying agreement (the “Bonus Agreements”), the Bonus Award may be further subject to a retention-based payout schedule that generally provides for 30% of the Bonus Award to vest and be paid incrementally over a three-year period. The Company expenses all current cash incentive compensation award payments ratably in the first year. All future payments are amortized equally over the required service period over the remaining term of the Bonus Award as defined in the Bonus Agreements. Any Guarantees that are paid upon an employee commencing employment are expensed immediately by the Company. All future payments related to Guarantees are amortized equally over the required service period over the remaining term as defined in the agreements for the Guarantees (“Guarantee Agreements”). In the event an award is forfeited pursuant to the terms of the Bonus Agreements or Guarantee Agreements, the corresponding accruals will be reversed.

 

Levels of incentive compensation will vary to the extent they are tied to the performance of certain ZAIS Managed Entities or the financial and operating performance of the Company. The compensation payable balance includes accrued incentive compensation and severance.

 

During the period from January 1, 2017 through September 30, 2017, the Company paid approximately $9.5 million related to year-end Bonus Awards issued in 2016, Bonus Awards and Guarantees that vested through February of 2017 pursuant to the Bonus Agreements and Guarantee Agreements related to a prior year and Guarantees pursuant to Guarantee Agreements related to the current year. A portion of these amounts had been accrued and recognized as an expense at December 31, 2016 and for the year ended December 31, 2016, respectively.

 

On May 9, 2017, the Board of Directors approved an amendment to the charter of the Compensation Committee of the Board of Directors of the Company (the “Compensation Committee”) to better enable the Company to retain its employees and to attract additional employees. The amendment removed the prior compensation guidelines set forth in the charter that by its terms applied to compensation paid through 2019. These compensation guidelines had provided that, subject to modification or waiver by the Compensation Committee, the Company’s total compensation expense on a consolidated basis calculated in accordance with U.S. GAAP for all cash and non-cash compensation paid to employees of the Company and its operating subsidiaries and affiliates for any given year would not exceed a certain percentage of the Company’s consolidated revenue for such year calculated in accordance with U.S. GAAP.

 

Retention Payment Plan

 

On March 29, 2016, the Compensation Committee adopted a retention payment plan for certain employees of ZAIS Group (the "Retention Payment Plan"). The Retention Payment Plan applied to approximately 60 employees of ZAIS Group all of whom had an annual base salary of less than $300,000. The purpose of the Retention Payment Plan was to enable ZAIS Group to retain the services of its employees in order to ensure that ZAIS Group was not disrupted or adversely affected by the possible loss of personnel or their commitment to ZAIS Group. Under the Retention Payment Plan, the participating employees were entitled to receive cash retention payments on each of April 15, 2016, August 15, 2016 and November 15, 2016, if the employee remained employed by ZAIS Group on such dates. The Company paid an aggregate amount of approximately $1.5 million and $3.0 million during the three and nine months ended September 30, 2016, respectively, to all participants pursuant to the Retention Payment Plan.

 

 28 

 

  

There were no amounts payable under the Retention Payment Plan at September 30, 2017 or December 31, 2016.

 

Other

 

On March 1, 2016, the Compensation Committee approved a retention payment of $900,000 to Howard Steinberg, the Company's former General Counsel, which was paid on March 15, 2016. This retention payment is included in Compensation and benefits in the Consolidated Statements of Comprehensive Income (Loss) for the nine months ended September 30, 2016.

 

Pursuant to the Legal Advisor Agreement, Mr. Steinberg also received a payment of $450,000 on February 28, 2017 (see Note 12 – “Commitments and Contingencies”). This payment is included in Compensation and benefits in the Consolidated Statements of Comprehensive Income (Loss) for the nine months ended September 30, 2017.

 

On April 5, 2017, the Company provided a retention award (the “Retention Award”) to Michael Szymanski, the Company’s Chief Executive Officer in recognition of the importance of retaining his services as the Chief Executive Officer of the Company and its operating subsidiary, ZAIS Group, and in connection with the Company’s review of strategic alternatives to enhance shareholder value. Under the Retention Award, which has been approved by the Compensation Committee, Mr. Szymanski is entitled to receive a cash retention payment of $500,000 on each of June 30, 2017, September 30, 2017 and a date within five business days following the closing date of a “Transaction” as defined in the Retention Award or otherwise as determined by the Board of Directors of the Company. On November 7, 2017, the Compensation Committee determined that Mr. Szymanski would receive the final $500,000 Retention Award payment on February 28, 2018. Mr. Szymanski would be entitled to such payments provided he remains employed by the Company on such dates, or if he has been removed as the Company’s Chief Executive Officer or his employment terminated for reasons other than for cause prior to such dates. The aggregate amount of retention payments that may be paid to Mr. Szymanski under the Retention Award is $1.5 million. For the three and nine months ended September 30, 2017, $0.5 million and $1.0 million, respectively have been paid and are included in Compensation and benefits in the Consolidated Statements of Comprehensive Income (Loss).

 

Points

 

ZAIS Group had entered into agreements with certain of its employees whereby certain current and former employees were granted rights to participate in a portion of the incentive income received from certain ZAIS Managed Entities (referred to as “Points Agreements”). There are currently outstanding Points Agreements relating to one ZAIS Managed Entity and ZAIS Group does not anticipate awarding additional Points Agreements. The Company did not incur any compensation expense relating to the Points Agreements for the three or nine months ended September 30, 2017 or September 30, 2016.

 

Severance

 

On March 8, 2016, the Company commenced a reduction in force which resulted in a decrease of 23 employees of ZAIS Group. The Company had incurred total severance charges of approximately $762,000 related to this reduction in force which was recognized and paid during the year ended December 31, 2016.

 

Equity-Based Compensation

 

Class B-0 Units

 

ZGP authorized 1,600,000 Class B-0 Units eligible to be granted to certain employees of ZAIS Group. The Class B-0 Units were subject to a two year cliff-vesting provision, whereby all Class B-0 Units granted to an employee would be forfeited if the employee resigned or was terminated prior to March 17, 2017. Subsequent to this date, an employee would only forfeit vested Class B-0 Units if the employee was terminated for cause. Until the time that such Class B Units became vested, the Class B-0 Units were not entitled to any distributions from ZGP (and thus would not participate in, or be allocated any, income or loss) or other material rights. Upon vesting, the Class B-0 Units would have had the same rights as Class A Units and were exchangeable on a one for one basis for shares of Class A Common Stock or cash (or a combination of shares and cash), at the Company’s election, subject to certain restrictions. This compensation expense was amortized equally over the two-year vesting period and was cumulatively adjusted for changes in estimated forfeitures at each reporting date.

 

 29 

 

  

On December 1, 2016, the Board of Directors authorized ZGP to offer the 28 employees holding unvested Class B-0 Units the right to receive in consideration for the cancellation of their Class B-0 Units, at the holder’s option, either (a) Restricted Stock Units (“RSUs”) of ZAIS, on a one-for-one basis, or (b) an amount of cash per Class B-0 Unit cancelled (the “Cash Amount”) equal to $1.92, which was the average of the daily closing prices of Class A Common Stock of ZAIS for the three calendar months ended November 30, 2016 (the “Proposal”). The RSUs and the Cash Amount were both subject to vesting requirements and, collectively, are referred to as the “Election Consideration”. The offer period expired on December 30, 2016.

 

All holders of Class B-0 Units accepted the Proposal to receive either RSUs or the Cash Amount. Upon the expiration of the offer period, the holders’ Class B-0 Units were cancelled. For those holders of Class B-0 Units who elected to receive RSUs, ZAIS granted the RSUs under the ZAIS 2015 Stock Incentive Plan (the “2015 Stock Plan”). The RSUs vested on March 17, 2017, the same date that the Class B-0 Units were scheduled to vest. The RSUs entitled the holders to receive ZAIS Class A Common Stock, which was issued, subject to applicable wage withholding requirements, immediately upon the vesting of the RSUs. In consideration of the issuance of such stock by ZAIS to the employees of ZGP’s subsidiary, ZAIS Group, ZGP issued a number of Class A Units to ZAIS equal to the number of shares of stock that were issued to the holders of RSUs. If the Class B-0 Unit holder elected to receive the Cash Amount, provided the holder remained employed by ZAIS Group or its subsidiaries through the date of vesting, the Cash Amount was paid by ZAIS Group to the holder, subject to applicable wage withholding requirements, on March 22, 2017. See disclosures below for additional information relating to cash payments and the issuance of RSUs in consideration for the cancellation of the B-0 Units.

 

The number of Class B-0 Units cancelled and Election Consideration provided as a result of the Proposal is as follows:  

 

Total number of Class B-0 Units cancelled in substitution for:     
RSUs   899,674 
Cash   133,559 
Total number of Class B-0 Units cancelled   1,033,233 
      
Class B-0 Units not cancelled    
      
Total Cash Amount paid in March 2017 (in thousands)  $256 

 

 The Company accounted for the cancellation of B-0 Units as follows:

 

RSUs Provided as a Replacement for the Cancellation of B-0 Units

 

The Company accounted for the issuance of RSUs as a modification of the award pursuant to ASC 718, “Compensation - Stock Compensation”, treating it as a cancellation of the limited liability company units accompanied by the concurrent grant of RSUs. The Company determined that the fair value of the RSUs and the Class B-0 Units at the modification date were equal and therefore there was no incremental compensation cost required to be recognized. ZAIS completed the amortization of the related compensation expense equally over the two-year vesting period subject to cumulative adjustment for changes in estimated forfeitures at each reporting date.

 

 Cash Provided as a Replacement for the Cancellation of Class B-0 Units

 

The Company accounted for the cash payment to be made in consideration for the cancellation of certain B-0 Units described above as a modification of the award pursuant to ASC 718, “Compensation - Stock Compensation”. However the modification of these awards changed the classification from equity awards to a liability awards. The fair value of the modified award at the time of the modification was approximately $256,000. The Company recognized a liability of approximately $230,000 at December 31, 2016 which reflects the vested amount of the modified award’s measurement date fair value. The remaining fair value of approximately $26,000 was amortized ratably over the remaining vesting period which ended on March 17, 2017.

 

 30 

 

  

  

Three Months Ended 

September 30,

 
   2017   2016 
   Number of
B-0 Units
   Weighted
Average
Grant Date
Fair Value
per Unit
   Number of
B-0 Units
   Weighted
Average
Grant Date
Fair Value
per Unit
 
Balance at beginning of period      $    1,132,213   $9.36 
Forfeited           (16,327)   9.70 
Balance at end of period      $    1,115,886   $9.36 

 

  

Nine Months Ended 

September 30,

 
   2017   2016 
   Number of
B-0 Units
   Weighted
Average
Grant Date
Fair Value
per Unit
   Number of
B-0 Units
   Weighted
Average
Grant Date
Fair Value
per Unit
 
Balance at beginning of period      $    1,337,486   $9.67 
Granted           100,000    6.34 
Forfeited           (321,600)   9.70 
Balance at end of period      $    1,115,886   $9.36 

 

The Company incurred compensation expense relating to the Class B-0 Units (including Class B-0 Units cancelled in consideration for the receipt of RSUs or cash) as follows:

 

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
(Dollars in thousands)   (Dollars in thousands) 
2017   2016   2017   2016 
                  
$   $1,310   $1,059   $2,876 

 

The estimated forfeiture rates of Class B-0 Units, including those cancelled in consideration of the issuance of RSUs, were as follows:

 

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
(Dollars in thousands)   (Dollars in thousands) 
2017   2016   2017   2016 
                  
 —%    29.6%   —%    29.6%

 

The expense relating to the Class B-0 Units, including those cancelled in consideration of the issuance of RSUs, is included in Compensation and benefits in the Consolidated Statements of Comprehensive Income (Loss).

 

 31 

 

  

RSUs

 

Non-employee directors of ZAIS receive RSUs pursuant to the 2015 Stock Plan as a component of annual compensation for their service as directors of ZAIS. The awards are unvested at the time they are granted and, as such, are not entitled to any dividends or distributions from ZAIS or other material rights until such RSUs vest. The RSUs vest in full on the one-year anniversary of the grant date. Upon vesting ZAIS will issue the recipient shares of Class A Common Stock equal to the number of vested RSUs. In accordance with ASC 718, “Compensation - Stock Compensation”, the Company is measuring the expense associated with these awards based on the fair value on the grant date adjusted for estimated forfeitures. This expense is being amortized equally over the one-year vesting period and adjusted on a cumulative basis for changes in estimated forfeitures at each reporting date. The weighted average grant date fair value of these RSUs is based on the market value of the Company’s shares on the grant date.

 

 The following table presents the RSU activity for non-employee directors during the three and nine months ended September 30, 2016 and September 30, 2017:

 

RSU Grant Date  Number of
RSUs Issued
  

Fair Value per
RSU on
Grant Date

   RSU Vesting Date
April 30, 2015   10,000   $9.85   April 21, 2016
April 30, 2015   20,000   $9.85   April 30, 2016
April 21, 2016   30,942   $3.22   April 21, 2017
November 1, 2016   74,331   $1.73   November 1, 2017
May 9, 2017   63,219   $2.19   May 9, 2018

 

Additionally, pursuant to the Proposal (see “Class B-0 Units” above), the Company issued 899,674 RSUs on December 30, 2016. The weighted average grant date fair value of these RSUs is equal to the fair value of the related B-0 Units at the time the units were issued.

 

On March 17, 2017, the 899,674 RSUs granted in connection with the Proposal vested. The fair value of the consideration was $2.1 million based on the closing stock price of the Company’s Class A Common Stock on March 17, 2017 and the gross amount of RSUs that vested. The Company issued 548,923 shares of its Class A Common Stock, on a net basis (to account for applicable wage withholding requirements), to the holders who elected to cancel their Class B-0 Units in substitution for RSUs. The applicable wage withholding requirement of approximately $0.8 million was recorded as a reduction of Additional paid-in-capital in the Consolidated Statements of Changes in Equity and Non-controlling Interests.

 

Additionally, ZAIS Group paid the Cash Amount of approximately $256,000 to the holders who elected the Cash Amount (subject to applicable wage withholding requirements) on March 22, 2017.

 

The following table presents the RSU activity for non-employees as well as employees that agreed to the cancellation of their Class B-0 Units:

 

  

Three Months Ended

September 30,

 
   2017   2016 
   Number of
RSUs
   Weighted
Average
Grant Date
Fair Value
per Unit
   Number of
RSUs
   Weighted
Average
Grant Date
Fair Value
per Unit
 
Balance at beginning of period:   137,550    1.94    30,942    3.22 
Grants during period to:                    
Non-employee directors                
Vested                
Balance at end of period   137,550    1.94    30,942    3.22 

 

 32 

 

  

  

Nine Months Ended

September 30,

 
   2017   2016 
   Number of
RSUs
   Weighted
Average
Grant Date
Fair Value
per Unit
   Number of
RSUs
   Weighted
Average
Grant Date
Fair Value
per Unit
 
Balance at beginning of period:   1,004,947   $8.60    30,000   $9.85 
Grants during period to:                    
Non-employee directors   63,219    2.19    30,942    3.22 
Vested   (930,616)   9.13    (30,000)   9.85 
Balance at end of period   137,550   $1.94    30,942   $3.22 

 

The Company incurred compensation expense relating to the non-employee RSUs as follows:

 

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$67   $(41)  $177   $75 

 

 The expense relating to these RSUs is included in Compensation and benefits on the Consolidated Statements of Comprehensive Income (Loss).

 

9.Income Taxes

 

ZAIS is taxable as a corporation for U.S. tax purposes while ZGP and its subsidiaries operate as pass-through entities for U.S. income tax purposes not subject to entity level taxes. Accordingly, the Company’s consolidated financial statements include U.S. federal, state and local income taxes on ZAIS’ allocable share of the consolidated results of operations, as well as taxes payable to jurisdictions outside the U.S related to the foreign subsidiaries.

 

The Company recorded an income tax expense of $9,000 and $19,000 for the three months and nine months ended September 30, 2017, respectively, related solely to foreign taxes payable to jurisdictions outside the U.S. related to Company’s foreign subsidiaries. The Company recorded income tax (benefit) of $(21,000) and $(12,000) for the three and nine months ended September 30, 2016, respectively, related solely to foreign taxes.

 

As a result of the variations each quarter in the relationship between pre-tax income and income tax expense, the Company utilizes the actual effective tax rate for each interim period being presented to calculate the tax (benefit) or expense. The following is a reconciliation of the U.S. statutory federal income tax to the Company’s effective tax:

 

 33 

 

  

   Three Months Ended
September 30,
  

Nine Months Ended

September 30,

 
   2017   2016   2017   2016 
       (Dollars in thousands)     
                 
Income tax (benefit) expense at the U.S. federal statutory income tax rate  $538   $542   $(1,160)  $(3,309)
                     
State and local income tax, net of federal benefit   23    13    (247)   (516)
Foreign tax   9    (21)   19    (12)
Effect of permanent differences   16        19    58 
Income attributable to non-controlling interests in Consolidated Funds not subject to tax   (333)   (647)   (1,083)   (1,254)
Income attributable to non-controlling interests in ZGP not subject to tax   (67)   2    747    1,433 
Provision to return adjustment   1    301    1    301 
Equity Compensation “Shortfall” DTA Adjustment   (2)       1,930     
Adjustment of tax rate used to value deferred taxes       42        42 
Valuation allowance   (176)   (253)   (207)   3,245 
Total  $9   $(21)  $19   $(12)

 

The Company’s effective tax for the periods presented above includes a rate benefit attributable to the fact that the Company’s subsidiaries operate as limited liability companies and limited partnerships which are treated as pass-through entities for U.S. federal and state income tax purposes. Accordingly, the Company’s consolidated financial statements include U.S. federal, state and local income taxes on the Company’s allocable share of the consolidated results of operations. The tax liability or benefit related to the partnership income or loss not allocable to the Company rests with the equity holders owning such non-controlling interests in ZAIS subsidiaries.

 

For the three and nine months ended September 30, 2017 and September 30, 2016, the net effective tax represents the taxes accrued related to the Company’s operations in jurisdictions outside the U.S. as a full valuation allowance has been established for the tax benefit related to U.S. federal, state and local income taxes on the Company’s allocable share of the consolidated results of operations as well as Company’s net operating losses and development stage start-up expenses incurred during the period from its inception and prior to the closing of the Business Combination with ZGP. Additionally, for the three and nine months ended September 30, 2017, the net effective tax is impacted due to a shortfall adjustment for equity compensation primarily related to the cancellation of the Class B-0 Units discussed in Note 8 – “Compensation”.

 

Deferred income taxes are provided for the effects of temporary differences between the tax basis of an asset or liability and are reported in the Consolidated Statements of Financial Condition. These temporary differences result in taxable or deductible amounts in future years.

 

As of September 30, 2017 and December 31, 2016, the Company had total deferred tax assets (“DTA”) of approximately $6.75 million and $7.0 million, respectively, related to net operating losses and other temporary differences related to the Company’s allocable share of the consolidated results of operations as well as Company’s net operating losses and development stage start-up expenses incurred during the period from its inception and prior to the closing of the Business Combination with ZGP. The Company has established a full valuation allowance on the DTA at September 30, 2017 and December 31, 2016.

 

As of September 30, 2017, the Company has estimated federal and state income tax net operating loss carryforwards of approximately $12.9 million which will expire as follows:

 

   (Dollars in
thousands)
 
2032  $1 
2033   83 
2034   122 
2035   5,990 
2036   1,703 
2037   5,033 
Total  $12,932 

 

 34 

 

  

As of each reporting date, management considers new evidence, both positive and negative, that could affect its view of the future realization of DTA. As of September 30, 2017, the Company has determined that the most recent management business forecasts do not support the realization of net DTA recorded for the Company. The Company has recorded a book loss for the three and nine months ended September 30, 2017 excluding income attributable to Consolidated Funds, and it is anticipated that expenses will continue to exceed revenues for the remainder of 2017. Although management intends to pursue various initiatives with potential to alter the operating loss trend, there is no specific plan that has been implemented at this point in time that will alter the negative earnings trend.

 

Accordingly, management continues to believe that it is not more likely than not that its DTA will be realized and the Company has continued to maintain full valuation allowance against the DTA at September 30, 2017. The Company has recorded a change in valuation allowance of approximately $(0.18) million and $(0.21) million in the Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2017, respectively, and approximately $(0.25) million and $3.2 million for the three and nine months ended September 30, 2016 respectively. The Company intends to continue maintaining a full valuation allowance on its deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances.

 

 The Company does not believe it has any significant uncertain tax positions. Accordingly, the Company did not record any adjustments or recognize interest expense for uncertain tax positions for the three and nine months ended September 30, 2017 and September 30, 2016, respectively. In the future, if uncertain tax positions arise, interest and penalties will be accrued and included in Income tax (benefit) expense in the Consolidated Statements of Comprehensive Income (Loss).

 

10.Related Party Transactions

 

ZAIS Managed Entities

 

ZAIS Group offers a range of alternative and traditional investment strategies through the ZAIS Managed Entities. ZAIS Group earns all of its management fee income and incentive income from the ZAIS Managed Entities, which are considered related parties as the Company manages the operations of, and makes investment decisions for, these entities. The Company considers ZAIS Group’s principals, executives, employees and all ZAIS Managed Entities to be affiliates and related parties.

 

ZAIS Group invests in its subsidiaries and some of the ZAIS Managed Entities. Investments in subsidiaries and certain ZAIS Managed Entities that are consolidated are eliminated. Investments in certain ZAIS Managed Entities that are not consolidated are further described in Note 3.

  

ZAIS Group did not charge management fees or earn incentive income on investments made in the ZAIS Managed Entities (excluding CLOs and ZFC REIT) by ZAIS Group’s principals, executives, employees and other related parties. The total amount of investors’ capital balances that are not being charged fees were approximately as follows:

 

September 30,
2017
   December 31,
2016
 
(Dollars in thousands)
        
$17,746(1)  $21,713 

 

(1) In order to finance the purchase of the Company’s Class A Common Stock pursuant to the Ramguard Agreement, Christian Zugel and various trusts for which relatives of Christian Zugel are the beneficiaries have submitted a redemption request to redeem approximately $5.4 million (value date of September 30, 2017) of interests effective December 31, 2017, from ZAIS Opportunity Domestic Feeder Fund, LP, which serves as the feeder fund to ZAIS Opportunity Master Fund, Ltd, a ZAIS Managed Entity. The capital balances presented have not been reduced to account for this redemption request.

 

Additionally, certain ZAIS Managed Entities, with existing fee arrangements, have investments representing 100% of the equity tranche of ZAIS CLO 2, Limited (“ZAIS CLO 2”) at September 30, 2017 and December 31, 2016 and ZAIS CLO 1, Limited (“ZAIS CLO 1”) for the period from January 1, 2017 through June 7, 2017 and at December 31, 2016. Therefore, ZAIS Group did not earn management fees or incentive fees from these ZAIS managed CLOs for the period which certain ZAIS Managed Entities with existing fee arrangements held investments representing 100% of the equity tranche of such CLOs. The total amounts of AUM that are not being charged fees were approximately as follows:

 

 35 

 

  

September 30,
2017
   December 31,
2016
 
(Dollars in thousands) 
        
$295,938   $560,272 

 

The amounts due from the ZAIS Managed Entities for Research Costs and other costs paid to vendors by ZAIS on behalf of the ZAIS Managed Entities (the “Other Direct Costs”) are as follows:

 

   September 30,
2017
  

December 31,

2016

 
   (Dollars in thousands) 
         
Research Costs  $685   $581 
Other Direct Costs   272    117 
Total  $957   $698 

 

These amounts are included in Due from related parties in the Consolidated Statements of Financial Condition.

 

Consulting Agreements 

 

RQSI, Ltd.

 

Certain affiliates of Mr. Neil Ramsey (“Mr. Ramsey”) are significant stockholders of ZAIS.

 

ZGP entered into a two-year Consulting Agreement (the “Consulting Agreement”) with Mr. Ramsey through RQSI, Ltd., an entity controlled by Mr. Ramsey. Under the terms of the Consulting Agreement, Mr. Ramsey provided consulting services to ZGP, ZAIS Group’s senior management team and ZAIS, from time to time during the 24-month period beginning on the closing of the Business Combination and ending on March 17, 2017. Mr. Ramsey agreed not to compete against ZGP during the term of the Consulting Agreement, and for two years following its termination. In consideration for his undertakings under the Consulting Agreement, ZGP agreed to pay Mr. Ramsey a consulting fee of $500,000 per annum payable in monthly installments. The Consulting Agreement terminated on March 17, 2017.

 

The Company has recorded the following expense related to the Consulting Agreement:

 

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$   $125   $105   $375 

 

The expense is included in General, administrative and other expenses in the Consolidated Statements of Comprehensive Income (Loss).

 

There were no amounts payable to Mr. Ramsey pursuant to the Consulting Agreement at September 30, 2017 or December 31, 2016. 

 

ZAIS Group had agreed to use certain statistical data generated by RQSI, Ltd. models. ZAIS Group had used this information for trading futures on behalf of the ZAIS Managed Entities through August 2017.

 

 36 

 

 

ZAIS Group entered into a month to month lease agreement with an affiliate of RQSI, Ltd dated February 1, 2016 to occupy space in the Company’s London office. The agreement was terminable upon 30 days’ notice. There was no charge to RQSI, Ltd. or its affiliate for use of the space prior to March 1, 2017. From March 1, 2017 through May 31, 2017, the date the lease was terminated, the monthly rate was 4,167 GBP.

 

Ms. Tracy Rohan

 

ZAIS Group is a party to a consulting agreement with Ms. Tracy Rohan (“Ms. Rohan”), Mr. Zugel’s sister-in-law, pursuant to which Ms. Rohan provides services to ZAIS Group relating to event planning, promotion, web and print branding and related services. Pursuant to the consulting agreement, Ms. Rohan earns 76,000 GBP annually. The Company recognized the following amounts for her services:  

 

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$24   $26   $72   $78 

 

The expense is included in General, administrative and other expenses in the Consolidated Statements of Comprehensive Income (Loss).

 

Amounts payable to Ms. Rohan pursuant to the consulting agreement are as follows:

 

September 30,
2017
  

December 31,

2016

 
(Dollars in thousands) 
$17   $16 

 

Such amounts are included in Other liabilities in the Consolidated Statements of Financial Condition.

 

11.Property and Equipment

 

Property and equipment consist of the following:

 

  

September 30,

2017

  

December 31,

2016

 
   (Dollars in thousands) 
         
Office equipment  $3,272   $3,098 
Leasehold improvements   695    684 
Furniture and fixtures   572    572 
Software   412    409 
    4,951    4,763 
Less accumulated depreciation and amortization   (4,729)   (4,489)
Total  $222   $274 

 

The Company recognized depreciation and amortization expense as follows:

 

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$118   $79   $229   $206 

 

 37 

 

  

12.Commitments and Contingencies

 

Engagement Agreement with Berkshire Capital

 

On April 22, 2016, the Company entered into an investment banking engagement agreement with Berkshire Capital Securities, LLC (“Berkshire Capital”), an affiliate of Mr. R. Bruce Cameron, a former director of the Company, pursuant to which Berkshire Capital will provide financial advisory services in connection with the Company’s strategic planning. Pursuant to the engagement letter, Berkshire Capital received a $100,000 retainer and is entitled to receive a monthly retainer of $15,000 beyond the initial three month term of the engagement, reimbursements for its expenses and a success fee in the event of covered transactions equal to no more than the greater of $750,000 and 2% of the total consideration paid. 

 

The Company incurred the following expenses pursuant to the engagement agreement:

 

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$47   $58   $138   $134 

 

The expense is included in General, administrative and other expenses in the Consolidated Statements of Comprehensive Income (Loss).

 

Legal Advisor Agreement

 

On February 27, 2017, ZAIS Group entered into an agreement (the “Legal Advisor Agreement”) with Howard Steinberg, the Company’s former General Counsel, pursuant to which Mr. Steinberg resigned as General Counsel effective March 31, 2017 and was retained as Senior Legal Advisor to the Company effective April 1, 2017. Under the Legal Advisor Agreement, which was approved by the Compensation Committee, Mr. Steinberg receives $150,000 per calendar quarter for his services, plus additional compensation of $900 per hour if he is requested to devote more than 20 hours during any week to advising the Company. In addition, under the Legal Advisor Agreement, Mr. Steinberg is entitled to reimbursement of reasonable out-of-pocket expenses incurred in connection with performing services for the Company, an allowance or reimbursement for the reasonable cost of suitable office space in Manhattan should Mr. Steinberg require it, 70% of the premiums for COBRA health and medical insurance coverage for Mr. Steinberg and his spouse paid for by the Company and, after COBRA coverage lapses, up to 70% of the costs of Medicare supplementary health insurance coverage for Mr. Steinberg and his spouse, for as long as he provides legal advisory services to the Company, capped at $3,450 per quarter. Pursuant to the Legal Advisor Agreement, Mr. Steinberg also received a payment of $450,000 on February 28, 2017 (the “February 2017 Payment”). The Legal Advisor Agreement is terminable by the Company or Mr. Steinberg on 30 days’ prior written notice. If the Legal Advisor Agreement is terminated by the Company other than due to Mr. Steinberg’s failure to perform services, Mr. Steinberg is entitled to a payment of $300,000.

 

The Company incurred the following expenses pursuant to the Legal Advisor Agreement:

 

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$171   $   $813   $ 

 

 38 

 

  

The expense, except for the February 2017 Payment, is included in General, administrative and other expenses in the Consolidated Statements of Comprehensive Income (Loss). The February 2017 Payment is included in Compensation and benefits in the Consolidated Statements of Comprehensive Income (Loss) for the nine months ended September 30, 2017.

 

Engagement Agreement with Houlihan Lokey Capital, Inc.

 

On September 27, 2017, the Company and the Special Committee of the Board of Directors entered into an investment banking engagement agreement with Houlihan Lokey, Inc. (“Houlihan Lokey”) pursuant to which the Special Committee of the Board of Directors retained Houlihan Lokey as its financial adviser in connection with a potential transaction between the Company and Christian Zugel. Pursuant to the engagement letter, Houlihan Lokey is entitled to receive a retainer payment in the amount of $250,000 (the “Houlihan Lokey Retainer”). Additionally, Houlihan Lokey is entitled to receive $350,000 at the time Houlihan Lokey renders its opinion on the potential transaction and $200,000 upon consummation of the potential transaction.

 

The Houlihan Lokey Retainer is included in Other liabilities in the Consolidated Statements of Financial Condition and General, administrative and other in the Consolidated Statements of Comprehensive Income (Loss).

 

Capital Commitments

 

At September 30, 2017 and December 31, 2016, the Company has committed $51.0 million of equity capital to Zephyr A-6, a Consolidated Fund, which has been established to invest in ZAIS Group managed CLOs and thereby satisfy the risk retention requirements of the Dodd-Frank Act. The Company’s cumulative contributions to Zephyr A-6 were as follows:

 

September 30,

2017

  

December 31,

2016

 
(Dollars in thousands)
        
$26,597   $20,477 

 

In connection with the restructuring of Zephyr A-6 on October 12, 2017 (see Note 17 – “Subsequent Events”), the partners’ capital commitments to Zephyr A-6 were amended.

 

There is no assurance that the full commitments will be required to be funded by ZAIS Group or as to the period of time during which these commitments may be required to be funded. ZAIS Group serves as the investment manager to these ZAIS Managed Entities and determines when, and to what extent, capital will be called.

 

In February 2017, ZAIS Group made a $5.0 million commitment to a ZAIS Managed Entity which focuses on investing in non-ZAIS managed CLOs, none of which has been called as of November 13, 2017.

 

Lease Obligations

 

ZAIS Group currently leases office space in New Jersey and London under operating lease agreements.

 

New Jersey

 

Effective September 30, 2016, the Company terminated a portion of its lease and reduced its office space in New Jersey by approximately 2,600 square feet. In connection with the lease termination, the Company paid a lease termination fee of approximately $20,000 pursuant to the terms of the lease. Such amount is included in General, administrative and other in the Consolidated Statements of Comprehensive Income (Loss).

 

On June 9, 2017, ZAIS Group extended its existing lease agreement for its office space in New Jersey until July 2018.

 

 39 

 

  

On August 31, 2017, ZAIS Group executed a lease for new office space in Holmdel, New Jersey (the “New Lease”). Rent will commence upon the day which the landlord delivers possession of the space to the Company and has an 84 month term. The lease provides for the Company to extend the lease term for one five year period commencing on the first day following the expiration of the lease. The fixed rent during the renewal period will be based on the fair market rent at the time of the renewal. The Company expects to take possession of the space in April 2018.

 

London

 

On June 5, 2017, ZAIS Group (UK) Limited, the Company’s London subsidiary, provided notice that the lease of its London office premises would terminate on September 7, 2017. On July 26, 2017, ZAIS Group (UK) Limited entered into an agreement to lease office space in London, commencing on September 11, 2017 and which may be cancelled on each anniversary subject to the provision of at least 3 months’ notice.

 

The Company recognizes rent expense related to its operating leases on a straight-line basis over the lease term and is included in General, administrative and other in the Consolidated Statements of Comprehensive Income (Loss). The Company incurred rent expense as follows:

 

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
2017   2016   2017   2016 
(Dollars in thousands) 
                  
$237   $270   $675   $777 

 

Aggregate future minimum annual rental payments for the period from October 1, 2017 to December 31, 2017 and the five years subsequent to December 31, 2017 and thereafter, including rental payments due under the New Lease, are approximately as follows:

 

Period  (Dollars in
thousands)
 
     
Three  months ended December 31, 2017   179 
      
Year Ending December 31,     
2018   472 
2019   327 
2020   399 
2021   406 
2022