Our MRES segment provides services and solutions to the mortgage and real estate industries. The MRES segment’s results primarily reflect the operations and offerings of Clayton from the acquisition date of June 30, 2014, along with other services and activities we offer that are complementary to our mortgage insurance business. In contrast to the mortgage insurance segment, the MRES segment is a fee-for-service business without significant balance sheet risk.
Percentage-of-Sale Contracts. A portion of REO management services are provided under percentage-of-sale contracts, in which we are paid a contractual percentage of the sale proceeds upon the sale of each property. To the extent the timing of the sale of a property is delayed or not consummated, or the sales proceeds are significantly less than originally estimated, we may generate less profit than anticipated, or could incur a loss. These contracts are only used for our REO management services.
For additional information related to discontinued operations, see Note 3 of Notes to Consolidated Financial Statements.
Acquisition-related expenses. Acquisition-related expenses represent the costs incurred to effect an acquisition of a business (i.e., a business combination). Because we pursue acquisitions on a limited and selective basis and not in the ordinary course of our business, we do not view acquisition-related expenses as a consequence of a primary business activity. Therefore, we do not consider these expenses to be part of our operating performance and they are excluded from our calculation of adjusted pretax operating income (loss).
The following table shows information regarding our average loss reserves per default:
Our senior management uses adjusted pretax operating income (loss) as our primary measure to evaluate the fundamental financial performance of the Company’s business segments.
The public comment period for the proposed PMIERs ended on September 8, 2014. The FHFA is currently reviewing and considering input before adopting the final PMIERs. All aspects of the final PMIERs are expected to become effective 180 days after their final publication. It is anticipated that approved insurers who fail to meet the PMIERs Financial Requirements when they become effective would, at the discretion of the GSEs, be permitted to operate under a transition plan during an extended transition period of up to two years from the final publication date, and would continue to be eligible insurers during that period. We expect the final PMIERs to be published during the first half of 2015 and to be effective by December 31, 2015. Based on an assumed final publication date of June 30, 2015, with an effective date of December 31, 2015, Radian Guaranty’s estimated net shortfall in Available Assets would be approximately $350 million as of December 31, 2015 and no shortfall as of June 30, 2017 (the projected end of the two-year transition period), in each case after giving consideration to existing holding company cash balances of $670 million and approximately $790 million in anticipated proceeds from the pending sale of Radian Asset Assurance.
Historically, dividends from Radian Asset Assurance were also one of the principal sources of liquidity in our mortgage insurance business. In July 2014, following approval from the NYSDFS, Radian Asset Assurance paid a $150 million Extraordinary Dividend to Radian Guaranty. In addition, in light of the proposed PMIERs, which in their current form would not provide Radian Guaranty with any credit for its investment in Radian Asset Assurance, on December 22, 2014, Radian Guaranty entered into the Radian Asset Assurance Stock Purchase Agreement to sell Radian Asset Assurance, our principal financial guaranty subsidiary, to Assured for a purchase price of approximately $810 million, subject to certain adjustments. After closing costs and other adjustments, we expect net cash proceeds of approximately $790 million. Radian expects to complete the sale of Radian Asset Assurance to Assured in the first half of 2015, subject to satisfaction of customary closing conditions, including regulatory approvals. See Note 1 and Note 3 of Notes to Consolidated Financial Statements for more information regarding PMIERs and the Radian Asset Assurance Stock Purchase Agreement, respectively.
As of the filing date of this report, there were no additional accounting pronouncements issued but not yet effective that are expected to have an impact on the Company’s consolidated financial statements.
Mortgage insurance premiums written on an annual and multi-year basis are initially recorded as unearned premiums and earned over time. Annual premiums are amortized on a monthly, straight-line basis. Multi-year premiums are amortized over the terms of the contracts in relation to the anticipated claim payment pattern based on historical industry experience. Premiums written on a monthly basis are earned over the period that coverage is provided. When we rescind insurance coverage on a loan, we refund all premiums received in connection with such coverage. Premium revenue is recognized net of our accrual for estimated rescission refunds. With respect to our reinsurance transactions, ceded premiums written are initially set up as prepaid reinsurance and are amortized in a manner consistent with the recognition of income on direct premiums. Premiums on certain Structured Transactions in our mortgage insurance business are recognized over the period that coverage is provided.
The loss from discontinued operations consisted of the following components for the periods indicated:
Includes corporate income and expenses that have been reallocated to the mortgage insurance segment that were previously allocated to the financial guaranty segment, but were not reclassified to discontinued operations. These items include net investment income of $4.8 million, other income of $0.3 million, interest expense of $53.3 million and corporate overhead expenses of $13.5 million for the year ended December 31, 2014.
Other income of $0.2 million has been reallocated to the mortgage insurance segment for each of the years ended December 31, 2013 and 2012.
During the financial crisis and downturn in the housing and related credit markets in which losses have increased significantly, most all captive reinsurance arrangements have attached, requiring our captive reinsurers to make payments to us. In all cases, the captive reinsurer established a trust to secure our potential cash recoveries. We generally are the sole beneficiary under these trusts, and therefore, have the ability to initiate disbursements under the trusts in accordance with the terms of our captive reinsurance agreements. All of our existing captive reinsurance arrangements are operating on a run-off basis, meaning that no new business is being placed in these captives.
In some instances, we anticipate that the ultimate losses ceded to the captive reinsurers will be greater than the assets currently held by the segregated trusts established for each captive reinsurer. Recorded recoverables, however, are limited to the current trust balances. We expect that most of the actual cash recoveries from those captives that have not yet been terminated on a cut-off basis will be received over the next few years.
Senior Notes due 2019. In May 2014, in anticipation of the Clayton acquisition, we issued $300 million principal amount of Senior Notes due 2019 and received net proceeds of approximately $293.8 million. The notes bear interest at a rate of 5.500% per annum, payable semi-annually on June 1 and December 1 of each year, commencing on December 1, 2014. These notes mature on June 1, 2019. We have the option to redeem these notes, in whole or in part, at any time or from time to time prior to maturity at a redemption price equal to the greater of: (i) 100% of the aggregate principal amount of the notes to be redeemed; and (ii) the make-whole amount, which is the present value of the notes discounted at the applicable treasury rate plus 50 basis points, plus, in each case, accrued interest thereon to the redemption date.
We prepare our statutory financial statements in accordance with the accounting practices required or permitted, if applicable, by the insurance departments of the respective states of domicile of our insurance subsidiaries. Required statutory accounting practices include a variety of publications of the NAIC as well as state laws, regulations and general administrative rules. In addition, insurance departments have the right to permit other specific practices that may deviate from prescribed practices. As of December 31, 2014, our use of any prescribed or permitted statutory accounting practices did not result in reported statutory surplus or risk-based capital being significantly different from what would have been reported had NAIC statutory accounting practices been followed.
Radian Guaranty’s statutory net income (loss), statutory policyholders’ surplus and contingency reserve as of or for the years ended December 31, 2014, 2013 and 2012 were as follows:
As a Pennsylvania domiciled insurer, RMAI is required to maintain statutory-basis capital and surplus of $1.125 million. Radian Group and RMAI are parties to a guaranty agreement, which provides that Radian Group will make sufficient funds available to RMAI to ensure that RMAI has a minimum of $5 million of statutory policyholders’ surplus evaluated quarterly. RMAI’s statutory net (loss) income and statutory policyholders’ surplus as of and for the years ended December 31, 2014, 2013 and 2012 were as follows:
Radian Asset Assurance is domiciled and licensed in New York as a monoline financial guaranty insurer. It is also licensed under the New York insurance laws to write some types of surety insurance and credit insurance. On December 22, 2014, Radian Guaranty entered into the Radian Asset Assurance Stock Purchase Agreement to sell Radian Asset Assurance. See Note 3 for additional information related to discontinued operations.
New York insurance law also establishes aggregate risk limits on the basis of aggregate net liability as compared with statutory capital. “Aggregate net liability” is a risk-based calculation based on outstanding principal and interest of guaranteed obligations insured, net of qualifying reinsurance and collateral. Under these limits, statutory policyholders’ surplus and contingency reserves must not be less than a percentage of aggregate net liability equal to the sum of various percentages of aggregate net liability for various categories of specified obligations. The percentage varies from 0.33% for certain municipal obligations to 4% for certain non-investment grade obligations. As of December 31, 2014, the aggregate net liability of Radian Asset Assurance was significantly below the applicable limit.
Radian Asset Assurance’s statutory net income, statutory policyholders’ surplus and contingency reserve as of and for the years ended December 31, 2014, 2013 and 2012 were as follows:
Awards granted prior to May 13, 2009 generally vest upon a change of control, defined as: (i) the acquisition by any third party of the beneficial ownership of 40% or more of our outstanding common stock (20% or more of our outstanding common stock for awards under the 1995 Equity Plan); (ii) the purchase by any third party of substantially all of our assets; or (iii) during any 24-month period, a change in 75% of the members of the Board with 75% of the prior members of the Board not approving such change.
We use the Monte Carlo valuation model to determine the fair value of all cash-settled awards where stock price is a factor in determining the vesting, as well as for cash- or equity-settled performance awards where there exists a similar stock price-based market condition (we refer to these awards as “Market Condition Awards”). The Monte Carlo valuation model incorporates multiple input variables, including expected life, volatility, risk-free rate of return and dividend yield for each award to estimate the probability that a vesting condition will be achieved. In determining these assumptions for the Monte Carlo valuations, we consider historic and observable market data.
For purposes of calculating compensation cost recognized, we generally consider time-vested awards effectively vested (and we recognize the full compensation costs) when grantees become retirement eligible. However, under the terms of our stock option awards granted in 2014, 2013, and 2012, legal vesting for retirement occurs when the grantee actually separates from service, with the exception of certain senior executives for whom vesting remains dependent on the stock price hurdle being met regardless of when the executive separates from service. Performance-based RSU awards granted in 2014, 2013, and 2012 provide that vesting remains dependent on the Company’s performance for the full term of the awards notwithstanding the grantee’s earlier retirement.
The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant.
We elected to apply the short-cut method in accounting for the windfall tax benefits under the accounting standard regarding share-based payment. Should future offsets to the windfall resulting from cancellations, expirations or exercise shortfalls exceed the balance of $17.3 million at December 31, 2014, the excess would be reflected in the consolidated statements of operations.
Time-Vested RSUs-In 2014, the Compensation Committee granted a total of 170,176 shares of time-vested RSUs to be settled in common stock, including 85,133 shares awarded to non-executive officers and 85,043 shares awarded to non-employee directors. In 2013, the Compensation Committee granted a total of 102,618 shares of time-vested RSUs to be settled in common stock, including 13,260 shares awarded to non-executive officers and 89,358 shares awarded to non-employee directors. In 2012, the Compensation Committee granted a total of 558,216 shares of time-vested RSUs to be settled in common stock, including 7,812 shares awarded to non-executive officers and 550,404 shares awarded to non-employee directors. The grant date fair value of the time-vested RSUs was calculated based on the closing price of our common stock on the NYSE on the date of grant and is recognized as compensation expense over the vesting period. All of these awards are subject to three-year cliff vesting.
We have been named as a defendant in a number of putative class action lawsuits alleging, among other things, that our captive reinsurance agreements violate RESPA. On December 9, 2011, an action titled Samp v. JPMorgan (the “JPMorgan Case”) was filed in the U.S. District Court for the Central District of California. The defendants were JPMorgan and several mortgage insurers, including Radian Guaranty. The plaintiffs purported to represent a class of borrowers whose loans allegedly were referred to mortgage insurers by JPMorgan in exchange for reinsurance agreements between the mortgage insurers and JPMorgan’s captive reinsurer. Plaintiffs asserted violations of RESPA. On October 4, 2012, Radian Guaranty filed a motion to dismiss on a number of grounds, and on May 7, 2013, the court granted the motion and dismissed the plaintiffs’ claims with prejudice. The court ruled that the plaintiffs could not state a claim against Radian Guaranty because it did not insure their loans, and, in addition, ruled that their claims were barred by the statute of limitations. On June 5, 2013, plaintiffs appealed these rulings to the U.S. Court of Appeals for the Ninth Circuit. On November 9, 2013, plaintiffs voluntarily dismissed their appeal.