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Wide search for strategic alternatives led ZAIS Financial to Sutherland deal

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Wide search for strategic alternatives led ZAIS Financial to Sutherland deal

Facing difficulty in raising equity capital to achieve scale,ZAIS Financial Corp inearly 2015 began exploring strategic alternatives that eventually led it to inkinga deal to combine withSutherland Asset Management Corp.

As ZAIS and other publicly traded residential mortgage REITssaw their stocks begin to trade at a significant discount to book value, the companybegan looking into various potential strategic alternatives.

The company initially looked into a possible transaction withZAIS Group Holdings Inc., the ultimate parent of its adviser ZAIS REIT ManagementLLC. The ZAIS Group board, however, later determined not to propose a transactionwith ZAIS.

As the independent directors of the ZIAS board had scheduledmeetings with several investment banks given a potential ZAIS Group transaction,the company decided that those meetings push through anyway. ZAIS later engagedHoulihan Lokey Capital Inc. to serve as financial adviser to identify strategicalternatives available to ZAIS and to act as financial adviser in connection withany related transactions.

In October 2015, the ZAIS board had determined that the companyshould commence a process to evaluate potential strategic alternatives. The boardthen approved a process whereby Houlihan Lokey would contact a targeted group ofpotential strategic and financial buyers to ascertain their interest in a strategictransaction involving ZAIS.

Houlihan Lokey then contacted a targeted group of 63 buyers,and ZAIS eventually entered into confidentiality agreements with 44 potential buyers.

As part of the initial contact with potential strategic and financialbuyers, Thomas Buttacavoli, managing director and portfolio manager of andchief investment officer of Sutherland, was contacted by representatives of ZAISand Houlihan Lokey. Waterfall and Buttacavoli had previously dealt with ZAIS inconnection with ZAIS's acquisitionof GMFS LLC in 2014. ZAIS eventually entered into a confidentiality agreement withWaterfall acting on behalf of Sutherland.

In November 2015, the Sutherland board met with a representativeof Bank of America Merrill Lynch, its financial adviser. The Sutherland board approvedthe submission of an initial nonbinding indication of interest proposing that ZAISacquire Sutherland in a stock-for-stock merger.

ZAIS in the same month received proposals from 12 other partiesoffering various transactions for all or a part of the company, including a proposalfrom a publicly traded residential mortgage REIT to acquire ZAIS in an all-cashtransaction. ZAIS also received an initial indication of interest from a credit-focusedinvestor.

The ZAIS board authorized Houlihan Lokey to invite Sutherlandand the two other entities to conduct additional due diligence. Throughout lateDecember 2015 and early January 2016, representatives of Houlihan Lokey and Alston& Bird LLP, outside counsel to ZAIS, held numerous conversations with representativesof the three entities with regard to various due diligence and transaction structuringmatters.

In light of certain potential claims related to ZAIS's GMFS business,the Sutherland board approved the submission of a revised nonbinding indicationof interest proposing that ZAIS acquire Sutherland in a stock-for-stock merger.

ZAIS later received revised nonbinding indications of interestfrom the three entities.

Following a ZAIS board meeting, representatives of Houlihan Lokeycontacted Sutherland and BofA Merrill Lynch to inform them of the ZAIS board's decisionto move forward with Sutherland and to discuss next steps. Throughout late January,representatives of Houlihan Lokey and Alston held numerous conversations with representativesof Sutherland, BofA Merrill Lynch and Sidley Austin LLP, Sutherland's legal adviser,with regard to various due diligence and transaction structuring matters.

After Thomas Capasse, Sutherland's CEO, and Frederick Herbst,Sutherland's CFO, and other members of Sutherland's management met with membersof ZAIS's board and management, ZAIS and Sutherland entered into an exclusivityagreement providing Sutherland with a 21-day period of exclusivity.

On Feb. 2, Sidley provided a revised draft of the merger agreement,which provided for a stock-for-stock merger between ZAIS and Sutherland. This wasfollowed by numerous discussions about financial and other terms of the proposedtransaction, as a result of which the parties tentatively agreed, among other terms,to a $15 million reduction in ZAIS's book value for purposes of determining theexchange ratio.

Between March 21 to March 30, Sutherland and its counsel continuedto negotiate the terms of a definitive merger agreement and the exhibits to themerger agreement with ZAIS and its counsel, with the parties exchanging multipledrafts of the merger agreement and its various exhibits. Between April 1 and April6, the parties and their respective advisers finalized the merger agreement andits various exhibits and the parties' respective disclosure schedules.

Later on April 6, ZAIS, Sutherland and the other entities partyto the agreement executed and delivered the merger agreement. On the morning ofApril 7, ZAIS and Sutherland issued a joint press release announcing the executionof the merger agreement.