In connection with our mortgage insurance operations, we lease office space in: Worthington, Ohio; Dayton, Ohio; Plano, Texas; St. Louis, Missouri; New York, New York; and Hong Kong. In addition, we lease office space for our Services operations in various cities in California, Colorado, Connecticut, Florida, Georgia, Pennsylvania and Utah, as well as in Bristol, England and Kolonaki, Greece.
We provide mortgage insurance on first-lien mortgage loans, and products and services to the real estate and mortgage finance industries. We have two business segments-Mortgage Insurance and Services. Our Mortgage Insurance segment provides credit-related insurance coverage, principally through private mortgage insurance, to mortgage lending institutions nationwide. We provide our mortgage insurance products mainly through our wholly-owned subsidiary, Radian Guaranty. Our Services segment provides outsourced services, information-based analytics, valuations and specialized consulting and surveillance services for buyers and sellers of, and investors in, mortgage- and real estate-related loans and securities as well as other consumer ABS. The primary lines of business in our Services segment include: (i) loan review, underwriting and due diligence; (ii) surveillance, including RMBS surveillance, loan servicer oversight, loan-level servicing compliance reviews and operational reviews of mortgage servicers and originators; (iii) real estate valuation and component services providing outsourcing and technology solutions for the SFR and residential real estate markets, as well as outsourced solutions for appraisal, title and closing services; (iv) REO management services; and (v) services for the United Kingdom and European mortgage markets through our EuroRisk operations. These services and solutions are provided primarily through Clayton and its subsidiaries, including Green River Capital, Red Bell and ValuAmerica.
As of December 31, 2016, our portfolio of business written in this improving Post-legacy credit environment, including HARP refinancings, represented 88% of our total primary RIF. The combination of improved portfolio mix and favorable credit trends has had a significant positive impact on our results of operations. The negative impact from losses in our Legacy Portfolio has been reduced and we have continued to write a high volume of insurance on high credit quality loans. The improving environment also has contributed to a reduction in our incurred losses and claims submitted and paid in our mortgage insurance business. The number of total new primary mortgage insurance defaults in our insured portfolio declined by 4.9% during the year ended December 31, 2016, compared to the same period of 2015. Similarly, our primary default rate of 3.2% at December 31, 2016 declined from 4.0% at December 31, 2015.
For our mortgage insurance business, our competitors include other private mortgage insurers and governmental agencies, principally the FHA and the VA. We currently compete with other private mortgage insurers that are eligible to write business for the GSEs on the basis of price, underwriting guidelines, customer relationships, reputation, perceived financial strength (including based on comparative credit ratings) and overall service, including services and products that complement our mortgage insurance products and that are offered through our Services business. We compete with the FHA and VA on the basis of loan limits, pricing, credit guidelines, terms of our insurance policies and loss mitigation practices. The FHA’s reduction of its annual mortgage insurance premiums in January 2015, combined with our premium changes in April 2016 to increase our pricing for borrowers with lower FICO scores, has negatively impacted our ability to compete with the FHA on certain high-LTV loans to borrowers with FICO scores below 720. However, we believe that our pricing changes made during the first half of 2016 enable us to more effectively compete with the FHA on certain high-LTV loans to borrowers with FICO scores above 720.
The positive macroeconomic and credit trends during the recovery from the financial crisis have encouraged new insurers to join the private mortgage insurance industry, although more recently there has also been consolidation among industry participants. Price competition continues as these newer entrants have sought to gain a greater presence in the market and more established industry participants seek to defend their market share and customer relationships. As a result of this competitive environment, recent pricing trends have included: (i) the use of a spectrum of filed rates to allow for formulaic, risk-based pricing (commonly referred to as “black-box” pricing); (ii) the use of customized (often discounted) rates on lender-paid, Single Premium Policies and to a limited extent, on borrower-paid Monthly Premium Policies; and (iii) overall reductions in standard filed rates on borrower-paid Monthly Premium Policies. In the recent past, the willingness of mortgage insurers to offer reduced pricing (whether through filed or customized rates) led to an increased demand from certain lenders for reduced rate products. This produced a marketplace where balancing both targeted returns on new business and an acceptable share of the insured market became more challenging for all participants. Although there can be no assurance that there will not be broad-based declines in mortgage insurance pricing in the future, following the widespread industry pricing changes for standard rates that occurred during the first half of 2016, pricing throughout the industry has been relatively stable with respect to borrower-paid Monthly Premium Policies. Further, in 2016 the California Department of Insurance issued guidance to the mortgage insurance industry stating that any approved discounting of a mortgage insurer’s rates must be provided to all similarly situated customers of the mortgage insurer. See “Item 1A. Risk Factors-Our insurance subsidiaries are subject to comprehensive state insurance regulations and other requirements, which we may fail to satisfy.” Although the impact of this guidance is uncertain, it is possible that this guidance will discourage the discounting of rates within the mortgage insurance industry.
Business Strategy. Radian is focused on a number of strategic objectives, as described in “Radian’s Long-Term Strategic Objectives” in “Item 1. Business-General.” With respect to our mortgage insurance business, we monitor various competitive and economic factors while seeking to balance both profitability and market share considerations in developing our pricing and origination strategies. We have taken a disciplined approach to establishing our premium rates and writing a mix of business that we expect to produce our targeted level of returns on a blended basis and an acceptable level of NIW. See “Results of Operations-Mortgage Insurance-NIW, IIF, RIF.” During 2016, in furtherance of our mortgage insurance strategy, we:
adjusted our borrower-paid, filed rates, effective on April 7, 2016, which generally had the effect of decreasing our standard rates on higher FICO business, and raising our standard rates on lower FICO business where the FHA is already very competitive;
continued to use the authority set forth in our rate filings to provide customized premiums for lender-paid, Single Premium mortgage insurance while maintaining our focus on our overall risk and return targets, and beginning in the third quarter of 2016, we elected to selectively participate in certain discounted Single Premium business that has been offered on an aggregated basis and is now priced at a level that is within our targeted returns; and
entered into the Single Premium QSR Transaction to proactively manage the risk and return profile of Radian Guaranty’s insured portfolio, which resulted in increasing our return on required capital for Single Premium Policies and decreasing the percentage of our Single Premium RIF, net of reinsurance ceded.
As part of our strategy to leverage our core expertise in credit risk management and expand our presence in the mortgage finance industry, during 2016 we participated in new front-end credit risk transfer pilot programs developed by Fannie Mae and Freddie Mac. These pilot programs involve participation as part of a panel of mortgage insurance company affiliates in writing credit insurance policies on loans that are to be purchased by the GSEs in the future (i.e., front-end), subject to certain pre-established credit parameters. Our current commitment level for both of these pilot programs will result in premiums and required capital that are immaterial. We may participate in other GSE credit risk transfer programs in the future.
Our strategy for future growth includes continuing to grow our Mortgage Insurance business and expanding our Services business. A key element of this business strategy is to use our Services segment to offer a range of mortgage and real estate-related products and services that complement our Mortgage Insurance business. This strategy is designed to satisfy demand in the market, grow our fee-based revenues, strengthen our existing mortgage insurance customer relationships, attract new customers and differentiate us from our mortgage insurance peers. Our current capabilities are illustrated by the graphic, “Existing Capabilities within Mortgage Finance Industry” in “Item 1. Business-General.”
During 2016, we completed a series of transactions to strengthen our financial position. The combination of these actions had the impact of decreasing our diluted shares, improving Radian Group’s debt maturity profile and improving Radian Guaranty’s position under the PMIERs Financial Requirements. This series of capital management transactions consists of:
the purchases of aggregate principal amounts of $30.1 million and $322.0 million, respectively, of our outstanding Convertible Senior Notes due 2017 and 2019;
the completion of the share repurchase program announced in January 2016, by purchasing an aggregate of 9.4 million shares of Radian Group common stock for $100.2 million, including commissions;
Following the purchases described above, $22.2 million and $68.0 million, respectively, of the principal amounts of the Convertible Senior Notes due 2017 and 2019 remained outstanding as of December 31, 2016. Subsequently, in January 2017, we satisfied our obligations with respect to the remaining outstanding Convertible Senior Notes due 2019. See “-Capital Management Developments Subsequent to 2016” below.
The 2016 transactions described above resulted in a net decrease in diluted shares (used for purposes of determining diluted net income per share), in each case as of the date of the completion of the respective transaction, of approximately 23.3 million. Although these transactions resulted in a net decrease in diluted shares outstanding, the actual shares outstanding increased at December 31, 2016 from December 31, 2015. See “Results of Operations-Consolidated-Diluted Net Income Per Share.”
a net decrease in available holding company liquidity of $204.6 million, before the repayment of the Surplus Note described below;
In addition, available holding company liquidity increased by $325 million at June 30, 2016 due to Radian Guaranty’s repayment of the Surplus Note to Radian Group. See “Liquidity and Capital Resources-Radian Group-Short-Term Liquidity Needs-Sources of Liquidity.”
In the first quarter of 2016, in order to proactively manage the risk and return profile of Radian Guaranty’s insured portfolio and continue managing its position under the PMIERs Financial Requirements in a cost-effective manner, Radian Guaranty entered into the Single Premium QSR Transaction with a panel of third-party reinsurers. Radian Guaranty began ceding business under this agreement effective January 1, 2016.
The Single Premium QSR Transaction increases the amount by which Radian Guaranty’s Available Assets exceeds its Minimum Required Assets under the PMIERs Financial Requirements. The Single Premium QSR Transaction also resulted in the following impacts, which are expected to continue over the term of the transaction:
reduction in other operating expenses by the amount of ceding commissions earned; and
improvement in Radian Guaranty’s return on required capital for its Single Premium mortgage insurance products as a result of the combination of the favorable impact to our PMIERs Financial Requirements and the expected ceded underwriting margin.
See Note 8 of Notes to Consolidated Financial Statements and “Liquidity and Capital Resources-Radian Group-Short-Term Liquidity Needs” for more information about the Single Premium QSR Transaction.
NIW. NIW is affected by the overall size of the mortgage origination market, the penetration percentage of private mortgage insurance into the overall mortgage origination market and our market share of the private mortgage insurance market. The overall mortgage origination market is influenced by macroeconomic factors such as household formation, household composition, home affordability, interest rates, housing markets in general, credit availability and the impact of various legislative and regulatory actions that may influence the housing and mortgage finance industries. The penetration percentage of private mortgage insurance is mainly influenced by the competitiveness of private mortgage insurance for GSE conforming loans compared to FHA and VA insured loans, and the relative percentage of mortgage originations that are for purchased homes versus refinances.
NIW increases our IIF and our premiums written and earned. Our IIF growth is expected to be one of our primary sources of increased future revenue over time. An increase or decrease in IIF will generally have a corresponding impact on premiums earned. Cancellations of our insurance policies as a result of prepayments and other reductions of IIF, such as rescissions of coverage and claims paid, generally have a negative effect on premiums earned. The measure for assessing the impact of policy cancellations on our IIF is our Persistency Rate, defined as the percentage of IIF that remains on our books over a period of time. Insurance premiums on our Monthly Premium insurance policies are paid and earned over time; therefore, higher Persistency Rates on Monthly Premium insurance policies enable us to earn more premiums and recover more of our policy acquisition costs, which generally would result in increased profitability from these monthly policies.
When Single Premium Policies are cancelled by the insured because the loan has been paid off or otherwise, we accelerate the recognition of any remaining unearned premiums. Therefore, assuming all other factors remain constant, profitability increases on our Single Premium business when Persistency Rates are lower. The ultimate profitability of our mortgage insurance business is affected by the impact of mortgage prepayment speeds on the mix of business we write. Because prepayment speeds are difficult to project, our strategy has been to write a mix of Single Premium Policies and Monthly Premium Policies, which we believe balances the overall impact on our results if actual prepayment speeds are significantly different from expectations. The Single Premium QSR Transaction is consistent with our strategy to balance our mix of Single Premium Policies and Monthly Premium Policies. The impact of all of our third-party QSR transactions reduced our Single Premium RIF from 30.2% at December 31, 2015 to 24.5% at December 31, 2016. See “Overview-Operating Environment and Business Strategy” for more information.
The product mix of our total direct RIF (loans with higher risk characteristics generally result in more delinquencies and claims).
The distribution of claims over the life cycle of a portfolio (historically, claims are relatively low during the first two years after a loan is originated and then increase over a period of several years before declining; however, several factors can impact and change this cycle, including the economic environment, the quality of the underwriting of the loan, characteristics of the mortgage loan, the credit profile of the borrower, housing prices and unemployment rates).
Our ability to mitigate potential losses through Rescissions, Claim Denials, cancellations and Claim Curtailments on claims submitted to us. These actions all reduce our incurred losses. However, if these Loss Mitigation Activities are successfully challenged at rates that are higher than expected or we agree to settle disputes related to our Loss Mitigation Activities at levels above our expected losses, our incurred losses will increase. As our Legacy Portfolio has become a smaller percentage of our overall insured portfolio, there has been a decrease in the amount of Loss Mitigation Activity with respect to the claims we receive, and we expect this trend to continue.
The Freddie Mac Agreement, which establishes certain terms for the treatment of the loans subject to that agreement, including claim payments, Loss Mitigation Activity and insurance coverage, and capped Radian Guaranty’s claim exposure on such loans. See Note 11 of Notes to Consolidated Financial Statements for additional information.
Third-Party Reinsurance. We use third-party reinsurance in our mortgage insurance business to manage capital and risk. When we enter into a reinsurance agreement, the reinsurer receives a premium and, in exchange, agrees to insure an agreed upon portion of incurred losses. This arrangement has the impact of reducing our earned premiums but also reduces our net RIF, which provides capital relief to the insurance subsidiary ceding the RIF and reduces our incurred losses by any incurred losses ceded in accordance with the reinsurance agreement. In addition, we often receive ceding commissions from the reinsurer as part of the transaction, which reduces our operating expenses. See Note 8 of Notes to Consolidated Financial Statements for more information about our reinsurance arrangements.
The Services segment’s principal customers include a wide range of financial institutions, the GSEs, securitization trusts, investors, regulators and other mortgage-related service providers, including mortgage originators, mortgage purchasers, MBS issuers, MBS investors and mortgage servicers. See “Item 1. Business-Services-Customers” for additional information regarding the Services segment’s customers.
The Services segment is dependent on a limited number of large customers that represent a significant portion of its revenues. Access to Radian Guaranty’s mortgage insurance customer base may provide additional opportunities to expand the segment’s existing customers. However, an unexpected loss of a major customer could significantly impact the level of Services revenue. Generally, our contracts do not contain volume commitments and may be terminated by clients at any time. Revenue for the Services segment also includes inter-segment revenues from services performed for our Mortgage Insurance segment. See Note 4 of Notes to Consolidated Financial Statements for additional information.
Time-and-Expense Contracts. Under a time-and-expense contract, we are paid a fixed hourly rate, and we are reimbursed for billable out-of-pocket expenses as work is performed. To the extent our actual direct labor costs decrease or increase in relation to the fixed hourly billing rates provided in the contract, we may generate more or less profit, respectively. However, since these contracts are generally short-term in nature, the risk is limited to the periods covered by the contracts. These contracts are used in our loan review, underwriting and due diligence and EuroRisk services offerings, as well as in the consulting services that we offer as part of our surveillance business.
Percentage-of-Sale Contracts. Under percentage-of-sale contracts, we are paid a contractual percentage of the sale proceeds upon the sale of each property. To the extent 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 a portion of our REO management services and our real estate brokerage services. In addition, through the use of proprietary technology, property leads are sent to select clients. Our Services segment recognizes revenue for these transactions based on a percentage of the sale, upon the client’s successful closing on the property.
In addition to the results of our operating segments, pretax income (loss) is also affected by “Other Factors Affecting Consolidated Results” described above. See “-Use of Non-GAAP Financial Measure” below for more information regarding items that are excluded from the operating results of our operating segments.
We allocate to our Mortgage Insurance segment: (i) corporate expenses based on an allocated percentage of time spent on the Mortgage Insurance segment; (ii) all interest expense except for interest expense related to the Senior Notes due 2019 that were issued to fund our purchase of Clayton; and (iii) all corporate cash and investments.
We allocate to our Services segment: (i) corporate expenses based on an allocated percentage of time spent on the Services segment and (ii) all interest expense related to the Senior Notes due 2019, the proceeds of which were used to fund our acquisition of Clayton. No corporate cash or investments are allocated to the Services segment. We have included Clayton’s results of operations from the June 30, 2014 date of acquisition.
For all periods presented, reflects changes to align our segment reporting structure with recent changes in personnel reporting lines and management oversight related to contract underwriting performed on behalf of third parties. Revenue and expenses for this business are now reflected in the Services segment. As a result, for all periods presented, Services revenue and cost of services have increased, with offsetting reductions in Mortgage Insurance other income and other operating expenses. See Notes 2 and 4 of Notes to Consolidated Financial Statements.
Includes the results of Clayton’s operations from the June 30, 2014 acquisition date.
Income (Loss) from Discontinued Operations, Net of Tax. There were no amounts recorded in 2016 related to discontinued operations. In 2015, we recorded total net income from discontinued operations of $5.4 million, consisting primarily of the recognition of investment gains previously deferred and recorded in AOCI and recognized as a result of the completion of the sale of Radian Asset Assurance to Assured on April 1, 2015, as well as adjustments to estimated transaction costs and taxes.
Based upon the Radian Asset Assurance Stock Purchase Agreement, Radian Asset Assurance was accounted for as held for sale and discontinued operations at December 31, 2014. As a result, in 2014, we recognized a $467.5 million pre-tax impairment charge reported as loss from discontinued operations. We have also reclassified the related operating results as discontinued operations for all periods presented in our consolidated statements of operations. No general corporate overhead or interest expense was allocated to discontinued operations in 2015 or 2014.
For additional information related to discontinued operations, see Note 18 of Notes to Consolidated Financial Statements.
Book Value Per Share. The increase in book value per share from $12.07 at December 31, 2015 to $13.39 at December 31, 2016 is primarily due to net income and the equity impact of the series of 2016 capital management transactions described above, partially offset by a net increase in the number of shares outstanding, as shown below.
All book value per share items above are calculated based on 206.9 million shares outstanding as of December 31, 2015, except for:
Includes the impact, net of related tax expense, of loss on induced conversion and debt extinguishment related to the series of capital management transactions completed in 2016, as further described in “-Overview-2016 and Other Recent Capital Management Developments.”
Reflects the combined net impact on equity and shares, respectively, from the series of capital management transactions completed in 2016, as further described in “-Overview-2016 and Other Recent Capital Management Developments.” The impact on equity shown above includes the impact of: (i) the extinguishment of Convertible Senior Notes due 2017 and 2019; (ii) the termination of the portion of the capped call transactions related to the purchased Convertible Senior Notes due 2017; and (iii) the shares repurchased under the completed share repurchase program, and excludes the loss on induced conversion and debt extinguishment, which is included in net income.
Other Operating Expenses. Other operating expenses for 2016, as compared to 2015, increased primarily due to operating expenses resulting from the acquisitions of Red Bell and ValuAmerica, which Clayton acquired in March 2015 and October 2015, respectively, and the increase in technology expenses associated with a significant investment in upgrading our systems. Compensation expense for 2016 also included severance costs of $5.3 million, which primarily relate to expense reduction initiatives. The increase in other operating expenses for 2016 was substantially offset by the increase in ceding commissions from the Single Premium QSR Transaction.
The decrease in other operating expenses in 2015 as compared to 2014 was also partially due to the settlement expenses that we incurred in 2014 on remedies related to contract underwriting services provided on our Legacy Portfolio for which we incurred no similar expenses in 2015. The decrease in other operating expenses in 2015 as compared to 2014 was partially offset by a full year of other operating expenses for Clayton in 2015 compared to six months in 2014.
Interest Expense. Interest expense for 2016 decreased compared to 2015. This decrease was primarily due to reductions in interest expense from: (i) the March 2016 and June 2015 purchases of aggregate principal amounts of $30.1 million and $389.1 million, respectively, of Convertible Senior Notes due 2017; (ii) the 2016 purchases of $322.0 million aggregate principal amount of Convertible Senior Notes due 2019; and (iii) the August 2016 redemption of the remaining $195.5 million aggregate principal amount of our Senior Notes due 2017. These reductions were partially offset by increased interest expense from the March 2016 issuance of $350 million aggregate principal amount of 7.000% Senior Notes due 2021 and the June 2015 issuance of $350 million aggregate principal amount of 5.250% Senior Notes due 2020.
Loss on induced conversion and debt extinguishment. During 2016, our purchases of Convertible Senior Notes due 2017 and 2019 and redemption of Senior Notes due 2017 resulted in a loss on induced conversion and debt extinguishment of $75.1 million consisting of: (i) a market premium of $41.8 million, representing the excess of the fair value of the total consideration delivered to the sellers of the Convertible Senior Notes due 2017 and 2019 over the fair value of the common stock issuable pursuant to the original conversion terms of the purchased notes; (ii) a loss on debt extinguishment of $17.2 million, representing the difference between the fair value and the carrying value, net of unamortized issuance costs, of the liability component of the purchased Convertible Senior Notes due 2017 and 2019; (iii) a loss on debt extinguishment of $15.0 million on the redemption of the Senior Notes due 2017; and (iv) expenses totaling $1.1 million for transaction costs.
The loss on induced conversion and debt extinguishment of $94.2 million for the year ended December 31, 2015 was primarily related to the purchases in the second quarter of 2015 of Convertible Senior Notes due 2017. See Note 12 of Notes to Consolidated Financial Statements for information on our extinguishment of debt.
Trends in the profitability of our fundamental operating activities can be more clearly identified without the fluctuations of these realized and unrealized gains or losses. We do not view them to be indicative of our fundamental operating activities. Therefore, these items are excluded from our calculation of adjusted pretax operating income (loss). However, we include the change in expected economic loss or recovery associated with our consolidated VIEs, if any, in the calculation of adjusted pretax operating income (loss).
The following table provides a reconciliation of the most comparable GAAP measure, consolidated pretax income from continuing operations, to our non-GAAP financial measure for the consolidated company, adjusted pretax operating income:
Acquisition-related expenses represent expenses incurred to effect the acquisition of a business, net of adjustments to accruals previously recorded for acquisition expenses.
Total adjusted pretax operating income consists of adjusted pretax operating income for each segment as follows:
Net of ceded premiums written under the QSR Transactions and the Single Premium QSR Transaction. See Note 8 of Notes to Consolidated Financial Statements for more information.
Adjusted Pretax Operating Income. Our Mortgage Insurance segment’s adjusted pretax operating income for 2016 was $561.9 million, compared to $511.0 million for 2015 and $347.8 million for 2014. Our results for 2016 compared to 2015 primarily reflect an increase in net investment income and a decrease in interest expense, partially offset by the net impact of the Single Premium QSR Transaction.
The improvement in the results for 2015 compared to 2014 primarily reflects: (i) an increase in net premiums earned; (ii) a reduction in provision for losses; and (iii) a reduction in other operating expenses.
The mortgage insurance industry is highly competitive and private mortgage insurers compete with each other and also with the FHA and VA, including with respect to price. In January 2015, the FHA reduced its annual mortgage insurance premium by 50 basis points to approximately 85 basis points per year. The FHA’s annual mortgage insurance premium reduction in 2015 made its pricing more competitive for certain high-LTV loans to borrowers with FICO scores below 720. Following this price reduction in 2015, the FHA’s share of the mortgage insurance market increased, relative to the combined market share of private mortgage insurers and the FHA (excluding VA), from approximately 43% in 2014 to approximately 52% in 2015. In February 2016, we announced updated premium rates for our mortgage insurance business to provide increased risk-based granularity to our pricing and to better align our pricing with the capital requirements under the PMIERs and with private mortgage insurance industry trends. Following our pricing change and similar changes from other private mortgage insurance companies in 2016, the private mortgage insurance industry has regained market share relative to the FHA, with the FHA’s market share decreasing, relative to the combined market share of private mortgage insurers and the FHA (excluding the VA), to approximately 49% in 2016. In addition, we believe that better execution for borrowers with higher FICO scores, lender preference and the inability to cancel FHA insurance for certain loans are factors that continue to provide a competitive advantage for private mortgage insurers. See “Key Factors Affecting Our Results-Mortgage Insurance-NIW.”
We expect price competition to continue throughout the mortgage insurance industry and future price reductions from private mortgage insurers or the FHA could impact our ability to compete. See “Item 1. Business-Mortgage Insurance-Competition” for more information about the current competitive environment and our pricing strategies.
We monitor competitive and economic factors while seeking to balance both profitability and market share considerations in developing our pricing and origination strategies. Although it is difficult to project future volumes, industry sources expect the mortgage origination market in 2017 to decline approximately 20% compared to 2016, driven by a decline in refinance originations of approximately 50% as a result of higher anticipated interest rates, partially offset by an expected increase in purchase originations of approximately 5%. With private mortgage insurance penetration on purchase originations three to four times higher than on refinance originations, we expect the private mortgage insurance market to be only modestly smaller in 2017 compared to 2016. As a result, we expect our NIW in 2017 to be comparable to our $50.5 billion of NIW written in 2016.
Although in our overall portfolio there are currently fewer loans with LTVs greater than 95% as compared to mortgages in our Legacy Portfolio, the percentage of recent NIW with LTVs greater than 95% is beginning to increase. For the years ended December 31, 2016 and 2015, the percentage of primary NIW with LTVs greater than 95% was 5.7% and 3.0%, respectively. Factors influencing the recent increases include: (i) GSE program enhancements and guideline changes; (ii) FHA regulatory enforcement actions that are causing lenders to choose GSE execution over the FHA; (iii) mortgage insurance pricing changes effective in the first half of 2016; and (iv) recent lender response to market demands and each lender’s appetite for mortgage origination volume.
Because our expected future losses on our Post-legacy Portfolio and our HARP refinancings are significantly lower than those experienced on our Legacy Portfolio, the improved credit quality of our overall mortgage insurance portfolio has led to improvement in our Mortgage Insurance segment’s operating profitability.
The improvement in the credit quality of our mortgage insurance portfolio is demonstrated by improved default trends for our Post-legacy mortgage insurance policies. Our expected future losses on our Post-legacy Portfolio, including HARP refinancings, are significantly lower than those experienced on our Legacy Portfolio. The following charts illustrate the improved trends of our cumulative incurred loss ratios by year of origination and development year.
In April 2016, the FHFA announced a new Principal Reduction Modification program, with the objective of benefiting borrowers whose mortgages were severely delinquent as of March 1, 2016. The program was a one-time offering, and the servicers of eligible mortgages were required to solicit eligible borrowers by October 15, 2016. This program did not affect a material number of our defaulted loans.
The following tables provide selected information as of and for the periods indicated related to mortgage insurance NIW, RIF and IIF. Policy years represent the original policy years, and have not been adjusted to reflect subsequent HARP refinancing activity. Primary RIF and IIF amounts at December 31, 2016 include $274 million and $1.09 billion, respectively, related to loans that are subject to the Freddie Mac Agreement. Although we no longer have future claim liability on these loans, we continue to receive premiums on the related loans and the insurance remains in force, and therefore these loans are included in our primary RIF and IIF. Throughout this report, unless otherwise noted, RIF is presented on a gross basis and includes the amount ceded under reinsurance. NIW, RIF and IIF for Direct Single Premiums include policies written on an individual basis (as each loan is originated) and on an aggregated basis (in which each individual loan in a group of loans is insured in a single transaction, typically after the loans have been originated).
The Persistency Rate for the 12 months ended December 31, 2016 decreased from 2015, primarily due to increased refinancing activity and the cancellations of Single Premium Policies. See “-Net Premiums Written and Earned,” below.
The Persistency Rate on a quarterly, annualized basis may be impacted by seasonality or other factors, and may not be indicative of full-year trends.
The Persistency Rate annualized based on the quarter ended December 31, 2016 decreased from 2015, primarily due to the volume of Single Premium Policies that were cancelled during the fourth quarter of 2016, which increased as compared to the same quarter in 2015.
Net premiums earned increased in 2016, compared to 2015, primarily as a result of the impact of the accelerated recognition of premiums earned on Single Premium Policies that were cancelled during the year, which was higher than in 2015. This increase was partially offset by increased ceded premiums, net of profit commission, primarily associated with the Single Premium QSR Transaction. Net premiums earned were also impacted by our increased level of IIF in 2016, as compared to 2015.
The Single Premium QSR Transaction had the following impact on Radian’s 2016 financial results:
A decrease to operating expenses of $14.6 million, related to the ceding commission;
A decrease to provision for losses and amortization of deferred acquisition costs totaling $3.0 million; and
Provision for Losses. The following table details the financial impact of the significant components of our provision for losses for the periods indicated (including amounts related to the change in PDR on Second-liens):
The impact of the reductions in losses for current year defaults in 2016 and 2015 was partially offset by a decline in the favorable reserve development from prior year defaults, which, although still positive, provided significantly less of a benefit to our provision for losses in 2016 as compared to 2015 and 2014. The favorable development on prior year defaults observed in all three years was driven primarily by a decrease in our actual and estimated Default to Claim Rate assumptions on prior year defaults, as a result of higher Cures than were previously estimated, partially offset by a decline in our estimates for future Rescissions and Claim Denials.
Our primary default rate at December 31, 2016 was 3.2% compared to 4.0% at December 31, 2015. Our primary defaulted inventory comprised 29,105 loans at December 31, 2016, compared to 35,303 loans at December 31, 2015, representing a 17.6% decrease. The reduction in our primary defaulted inventory is the result of the total number of defaulted loans: (i) that have cured; (ii) for which claim payments have been made; and (iii) that have resulted in net insurance Rescissions and Claim Denials, collectively exceeding the total number of new defaults on insured loans.
Insured loans subject to the Freddie Mac Agreement are included in the denominator for all periods, and loans in default subject to the Freddie Mac Agreement are excluded from the numerator beginning in 2013, because since that time we no longer have claims exposure on those loans.
Includes 5,850; 7,353; and 9,101 insured loans subject to the Freddie Mac Agreement at December 31, 2016, 2015 and 2014, respectively.
Includes Rescissions, Claim Denials and Reinstatements on the population of loans subject to the BofA Settlement Agreement. Rescissions and Claim Denials, net of (Reinstatements), related to the BofA Settlement Agreement prior to the Implementation Date represent such activities on loans that subsequently became subject to the BofA Settlement Agreement.
Our aggregate weighted average net Default to Claim Rate assumption for our primary loans used in estimating our reserve for losses, which is net of estimated Claim Denials and Rescissions, was approximately 42%, 46% and 52%, at December 31, 2016, 2015 and 2014, respectively. We develop our Default to Claim Rate estimates on defaulted loans based on models that use a variety of loan characteristics to determine the likelihood that a default will reach claim status. Our Default to Claim Rate estimates on defaulted loans are mainly developed based on the Stage of Default and Time in Default of the underlying defaulted loans, as measured by the progress toward foreclosure sale and the number of months in default. As of December 31, 2016, our gross Default to Claim Rate assumptions on our primary portfolio ranged from 12% for new defaults, up to 62% for other defaults not in foreclosure stage, and 81% for Foreclosure Stage Defaults. As of December 31, 2015, these gross Default to Claim Rate assumptions were 13% for new defaults, up to 65% for other defaults not in foreclosure stage, and 81% for Foreclosure Stage Defaults.
Our net Default to Claim Rate and loss reserve estimate incorporates our expectations with respect to future Rescissions, Claim Denials and Claim Curtailments. Our estimate of such net future Loss Mitigation Activities reduced our loss reserve as of December 31, 2016 and 2015 by approximately $39 million and $53 million, respectively. These expectations are based primarily on our recent experience with respect to the number of claims that have been denied due to the policyholder’s failure to submit sufficient documentation to perfect a claim within the time period permitted under our Master Policies and also our recent experience with respect to the number of insurance certificates that have been rescinded due to fraud, underwriter negligence or other factors. Our assumptions also reflect the estimated impact of the BofA Settlement Agreement. See Note 11 of Notes to Consolidated Financial Statements.
The impact to our mortgage insurance reserves due to estimated future Rescissions, Claim Denials and Claim Curtailments incorporates our expectations regarding the number of policies that we expect to reinstate as a result of our claims rebuttal process. The level of Loss Mitigation Activities has been declining in recent periods as our defaulted Legacy Portfolio continues to decline, and we expect this trend to continue.
On September 16, 2014, Radian Guaranty entered into the BofA Settlement Agreement in order to resolve various actual and potential claims or disputes related to the parties’ respective rights and duties as to mortgage insurance coverage on the Subject Loans. The consent of the GSEs required to implement the BofA Settlement Agreement was received in December 2014, and implementation of the agreement for Subject Loans owned by the GSEs or held in portfolio by the Insureds commenced on February 1, 2015. See Note 11 of Notes to Consolidated Financial Statements for additional information about the BofA Settlement Agreement.
Our mortgage insurance total loss reserve as a percentage of our mortgage insurance total RIF was 1.6% at December 31, 2016, compared to 2.1% at December 31, 2015 and 3.5% at December 31, 2014. See Note 11 of Notes to Consolidated Financial Statements for information regarding our reserves for losses by category and a reconciliation of our Mortgage Insurance segment’s beginning and ending reserves for losses and LAE.
Total mortgage insurance claims paid in 2016 of $417.6 million have decreased from claims paid of $764.7 million in 2015, primarily due to the completion of the reinstatement activities required by the BofA Settlement Agreement, which increased claims paid from February 2015 through December 31, 2015. Total mortgage insurance claims paid in 2015 of $764.7 million decreased from claims paid of $838.3 million in 2014, primarily due to the overall decline in defaulted loans and pending claims, partially offset by an increase in claims paid due to the BofA settlement agreement. We currently expect claims paid of approximately $325 million for the full year of 2017.
For 2015, includes the impact of the BofA Settlement Agreement from the Implementation Date.
Notwithstanding historical trends, our Legacy Portfolio experienced default and claim activity sooner and to a significantly greater extent than had been the case historically for our books of business prior to the financial crisis. For the periods indicated, the following tables show: (i) cumulative direct claims paid by us on our primary insured book of business at the end of each successive year after origination, expressed as a percentage of the cumulative premiums written by us in each year of origination and (ii) direct claims paid by policy origination year. Direct claims paid represent first-lien claims paid prior to reinsurance recoveries and captive termination payments, and exclude LAE expenses and settlement payments.
Our other operating expenses in 2015 as compared to 2014 decreased primarily as a result of the reduced impact from increases in the estimated fair value of cash-settled long-term incentive awards that were valued, in large part, based on the stock price of Radian Group’s common stock, combined with a decrease in other bonus compensation expense. This decrease in other operating expenses in 2015 as compared to 2014 was partially offset by the reduction in ceding commissions from the Initial and Second QSR Transactions.
Services Revenue. Revenue increased in 2016 as compared to 2015, primarily due to the inclusion of a full year of operations in 2016 for Red Bell and ValuAmerica, which were acquired in March 2015 and October 2015, respectively. This increase was partially offset by decreased activity in the SFR securitization market. Revenue for 2015 increased as compared to 2014 primarily due to (i) a full year of Clayton operations in 2015 compared to six months in 2014 and (ii) the acquisitions during 2015 of Red Bell and ValuAmerica.
Real estate valuation and component services revenue for the years ended December 31, 2016, 2015 and 2014 includes revenue from SFR securitizations as well as revenue from financial institutions that extend loans to institutional investors to fund purchases of homes. Approximately 14%, 18% and 20% of services revenue in 2016, 2015 and 2014 respectively, was related to the SFR market, including SFR securitizations. The overall decrease in activity related to the SFR market, compared to prior years, was driven by a decline in the pace of home purchases by institutional investors and a slowdown in SFR securitizations during 2015 and the first half of 2016, which negatively impacted our revenue in both years. We have since then experienced a modest increase in SFR securitization and related activity, and we expect this level of activity to continue through 2017.
For the year ended December 31, 2014, compensation-related costs represented 36% of the segment’s operating expenses. Other operating expenses in 2014 included losses related to contract underwriting remedies of $11.2 million related to settlement of remedies for services provided on legacy business. Excluding the expense related to the settlement, compensation-related costs as a percentage of the segment’s operating expenses were 55%. Other operating expenses for the year ended 2014 also included an allocation of corporate operating expenses of $1.1 million.
In addition to the contractual obligations set forth in the table above, we have the following material contractual obligations and commitments.
Radian Group and RGRI are parties to an Assumption and Indemnification Agreement with regard to RGRI’s portion of the Deficiency Amounts relating to the IRS litigation. This indemnification agreement was made in lieu of an immediate capital contribution to RGRI that otherwise would have been required for RGRI to maintain its minimum statutory policyholders’ surplus requirements in light of the remeasurement as of December 31, 2011 of uncertain tax positions related to the portfolio of REMIC residual interests. See Note 10 of Notes to Consolidated Financial Statements for additional information regarding the IRS matter. We can provide no assurance regarding the outcome of this IRS matter, which may take several years to resolve. As such, there remains significant uncertainty with regard to the amount and timing of any potential payments under the indemnity agreement described above. See “Item 1A. Risk Factors-Resolution of our dispute with the IRS could adversely affect us.”
In June 2016, Radian Guaranty repaid in full the $325 million Surplus Note due to Radian Group that was issued in December 2015. On June 29, 2016, Radian Group’s board of directors authorized a new share repurchase program to spend up to $125 million to repurchase Radian Group common stock. As of February 27, 2017, the full purchase authority remained available under this share repurchase program, which expires on June 30, 2017. See Notes 8, 12, and 14 of Notes to Consolidated Financial Statements for additional information on the individual transactions.
In November 2016, we announced our intent to exercise our redemption option for the remaining Convertible Senior Notes due 2019, of which $68.0 million aggregate principal was outstanding at December 31, 2016. The redemption was settled on January 27, 2017. Radian elected to redeem all of the notes surrendered for conversion or redemption with cash from available liquidity. The settlement of the obligation was funded with $110.1 million in cash. See Note 21 of Notes to Consolidated Financial Statements for additional details.
In addition to the potential use of up to $125 million to repurchase Radian Group common stock pursuant to the existing share repurchase program and the $110.1 million that we used in January 2017 to redeem the Convertible Senior Notes due 2019, Radian Group’s principal liquidity demands for the next 12 months are also expected to include the payment of $22.2 million principal amount to settle our obligations under our Convertible Senior Notes due 2017 (which must be settled in cash in November 2017, plus any related conversion premium which may, at our option, be settled in cash, common shares or a combination thereof) and the following items in the ordinary course of our business: (i) the payment of corporate expenses; (ii) interest payments on our outstanding long-term debt; and (iii) the payment of dividends on our common stock.
Radian Group’s liquidity demands for the next 12 months could also include: (i) additional conversion settlements, repurchases or early redemptions of portions of our long-term debt; (ii) potential investments to support our strategy of growing our businesses; and (iii) potential payments to the U.S. Treasury resulting from our ongoing dispute with the IRS relating to the examination of our 2000 through 2007 consolidated federal income tax returns, as discussed below. These items could result in liquidity demands in the next 12 months or in future periods.
Capital Support for Subsidiaries. Private mortgage insurers, including Radian Guaranty, are required to comply with the PMIERs to remain eligible insurers of loans purchased by the GSEs. The PMIERs became effective on December 31, 2015. See Note 1 in Notes to Consolidated Financial Statements and “Overview-Operating Environment and Business Strategy” for additional information.
In the first quarter of 2016, in order to proactively manage the risk and return profile of Radian Guaranty’s insured portfolio and continue managing its position under the PMIERs Financial Requirements in a cost-effective manner, Radian Guaranty entered into the Single Premium QSR Transaction with a panel of third-party reinsurers. The Single Premium QSR Transaction had the effect of increasing the amount of Radian Guaranty’s cushion under the PMIERs Financial Requirements.
The amount of credit that we receive under the PMIERs Financial Requirements for our third-party reinsurance transactions, including our QSR Transactions and our Single Premium QSR Transaction, is established by the GSEs at the time of each transaction based on terms generally prescribed in the PMIERs Financial Requirements as well as the GSEs’ view of the specific transaction. This credit is subject to periodic review by the GSEs. In December 2016, the GSEs issued interim guidance for the industry that negatively impacted the amount of credit that we receive for our Single Premium QSR Transaction, but also gave credit to certain liquid investments that are readily available to pay claims that previously were not permitted to be included in our Available Assets. This interim guidance did not affect Radian Guaranty’s compliance with the PMIERs Financial Requirements. The PMIERs also specifically provide for the factors that are applied to calculate and determine a mortgage insurer’s Minimum Required Assets to be updated every two years, with the next review scheduled to take place in 2017. See Note 1 of Notes to Consolidated Financial Statements for additional information.
Additional capital support may also be required for potential investments in new business initiatives by our subsidiaries to support our strategy of growing our businesses.
IRS Matter. In addition to the items discussed above, in the event a final judgment or compromised settlement agreement is reached in Radian Group’s ongoing dispute with the IRS related to the Deficiency Amount from the examination of our 2000 through 2007 consolidated federal income tax returns, Radian Group may be required to make a payment to the U.S. Treasury. During 2016, we held several meetings with the IRS in an attempt to reach a compromised settlement on the issues presented in our dispute. In January 2017, the parties informed the Tax Court that they believe they have reached a basis for a compromised settlement on the primary issues present in the case. The resolution must be reported to the JCT for review and cannot be finalized until the IRS considers the views, if any, expressed by the JCT about the matter. If we are unable to complete a compromised settlement, then the ongoing litigation could take several years to resolve and may result in substantial legal expenses. We can provide no assurance regarding the outcome of any such litigation or whether a compromised settlement with the IRS will ultimately be reached. As such, there remains significant uncertainty with regard to the amount and timing of any potential payments. See Note 10 of Notes to Consolidated Financial Statements for additional information regarding the IRS matter.
As of December 31, 2016, certain of our subsidiaries have incurred NOLs that could not be carried-back and utilized on a separate company tax return basis. As a result, we are not currently obligated under our tax-sharing agreement to reimburse these subsidiaries for their separate company NOL carryforward. However, if in a future period, our consolidated NOL is fully utilized before a subsidiary has utilized its share of NOL carryforward on a separate entity basis, then Radian Group may be obligated to fund such subsidiary’s share of our consolidated tax liability to the IRS. Certain subsidiaries, including Clayton, currently have NOLs on a separate entity basis that are available for future utilization. However, we do not expect to fund material obligations related to these subsidiary NOLs. See also “-Radian Group-Short-Term Liquidity Needs-Sources of Liquidity.”
We expect to meet the long-term liquidity needs of Radian Group with a combination of: (i) available cash and marketable securities; (ii) private or public issuances of debt or equity securities, which we may not be able to do on favorable terms, if at all; (iii) cash received under tax- and expense-sharing arrangements with our subsidiaries; and (iv) to the extent available, dividends from our subsidiaries.
At December 31, 2016 and December 31, 2015, Radian Guaranty had $63.9 million and $74.7 million, respectively, in a collateral account pursuant to the Freddie Mac Agreement. This collateral account, which contains investments primarily invested in and classified as part of our trading securities, is pledged to cover Loss Mitigation Activity on the loans subject to the Freddie Mac Agreement. Subject to certain conditions in the Freddie Mac Agreement, amounts in the collateral account may be released to Radian Guaranty over time to the extent that Loss Mitigation Activity becomes final in accordance with the terms of that agreement. In accordance with these provisions, Radian Guaranty withdrew $11.7 million from this account in October 2016 related to Loss Mitigation Activity that had become final as of August 31, 2016. Following this withdrawal, if, as of August 29, 2017, the amount of additional Loss Mitigation Activity that has become final in accordance with the Freddie Mac Agreement is less than $64 million, then any shortfall will be paid to Freddie Mac from the funds remaining in the collateral account, subject to certain adjustments designed to allow for any Loss Mitigation Activity that has not become final or any claims evaluation that has not been completed as of that date. As of December 31, 2016, we have $57.4 million recorded in reserve for losses that we expect to be paid to Freddie Mac from the funds expected to be remaining in the collateral account as of the August 29, 2017 measurement date.
As of December 31, 2016, our Services segment maintained cash and cash equivalents totaling $12.7 million, which included restricted cash of $3.8 million.
The Services segment did not generate sufficient cash flows to pay dividends to Radian Group in 2016. Additionally, while cash flow is expected to be sufficient to pay the Services segment’s direct operating expenses, it has not been sufficient to reimburse Radian Group for $35.3 million of its allocated operating expense and interest expense. We expect the Services segment will be able to bring its reimbursement obligations current in the next four to five years. In the event the cash flow from operations of the Services segment is not adequate to fund all of its needs, Radian Group may provide additional funds to the Services segment in the form of a capital contribution or an intercompany note.
Our most significant source of operating cash flows is from premiums received from our insurance policies, while our most significant uses of operating cash flows are generally for claims paid on our insured policies and our operating expenses. Net cash flows provided by operating activities increased for 2016 compared to 2015, primarily as a result of a significant reduction in total claims paid in 2016, compared to 2015.
Net cash used in financing activities increased for 2016, compared to net cash provided by financing activities for 2015, primarily due to: (i) purchases of aggregate principal amounts of $30.1 million and $322.0 million, respectively, of our outstanding Convertible Senior Notes due 2017 and 2019, which were partially settled in cash in the amount of $235.0 million and (ii) the redemption of the remaining $195.5 million aggregate principal amount of our Senior Notes due 2017, which we settled in cash in the amount of $211.3 million. The cash flow impact of these 2016 purchases and redemptions collectively exceeded the purchases and redemption of long-term debt for the same period of 2015 and was partially offset by a reduction in purchases of our common shares.
Radian Group, Radian Guaranty and Radian Reinsurance have been assigned the ratings set forth in the chart below. We believe that ratings often are considered by others in assessing our credit strength and the financial strength of our primary mortgage insurance subsidiary. See “Item 1A. Risk Factors-Radian Guaranty may fail to maintain its eligibility status with the GSEs.”
SEC guidance defines Critical Accounting Policies as those that require the application of management’s most difficult, subjective or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and that may change in subsequent periods. In preparing our consolidated financial statements in accordance with GAAP, management has made estimates, assumptions and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. In preparing these financial statements, management has utilized available information, including our past history, industry standards and the current and projected economic and housing environments, among other factors, in forming its estimates, assumptions and judgments, giving due consideration to materiality. Because the use of estimates is inherent in GAAP, actual results could differ from those estimates. In addition, other companies may utilize different estimates, which may impact comparability of our results of operations to those of companies in similar businesses. A summary of the accounting policies that management believes are critical to the preparation of our consolidated financial statements is set forth below.
We establish reserves to provide for losses and LAE, including the estimated costs of settling claims in our Mortgage Insurance segment, in accordance with the accounting standard regarding accounting and reporting by insurance enterprises. Although this standard specifically excludes mortgage insurance from its guidance relating to the reserve for losses, we establish reserves for mortgage insurance as described below, using the guidance contained in this standard supplemented with other accounting guidance, due to the lack of specific guidance for mortgage insurance.
Our aggregate weighted average Default to Claim Rate assumption (net of Claim Denials and Rescissions) used in estimating our primary reserve for losses was 42% (40% excluding pending claims) at December 31, 2016 and 46% (42% excluding pending claims) at December 31, 2015. Our Default to Claim Rate estimates on defaulted loans are mainly developed based on the Stage of Default and Time in Default of the underlying defaulted loans grouped according to the period in which the default occurred, as measured by the progress toward foreclosure sale and the number of months in default. During the year ended December 31, 2015, we reduced our gross Default to Claim Rate assumption for new primary defaults from 16% to 13% due to continued improvement in actual claim development trends. During the year ended December 31, 2016, this assumed rate was further reduced to 12%. Our estimates of gross Default to Claim Rates on our primary portfolio as of December 31, 2016 ranged from 12% for new defaults to 81% for Foreclosure Stage Defaults. Our estimate of expected Rescissions and Claim Denials (net of expected Reinstatements) embedded in our estimated Default to Claim Rate is generally based on our recent experience. Consideration is also given for differences in characteristics between those rescinded policies and denied claims and the loans remaining in our defaulted inventory, as well as the estimated impact of the BofA Settlement Agreement, as described below.
We also establish reserves for defaults that we estimate have been incurred but have not been reported to us on a timely basis by the servicer, as well as for previous Rescissions, Claim Denials and Claim Curtailments that we estimate will be reinstated and subsequently paid. We generally give the policyholder up to 30 days to challenge our decision to rescind coverage before we consider a policy to be rescinded and remove it from our defaulted inventory; therefore, we currently expect only a limited percentage of policies that were rescinded to be reinstated. We currently expect a significant percentage of claims that were denied to be resubmitted as a perfected claim and ultimately paid. Most often, a Claim Denial is the result of a servicer’s inability to provide the loan origination file or other servicing documents for review. Under the terms of our Master Policies with our lending customers, our policyholders have up to one year after the acquisition of borrower’s title to provide to us the necessary documents to perfect a claim. All estimates are periodically reviewed and adjustments are made as they become necessary.
For our Second-lien insurance business, we project future premiums and losses using historical results to help determine future performance for both prepayments and claims. An estimated expense factor is then applied, and the result is discounted using a rate of return that approximates our pre-tax investment yield. This net present value, less any existing reserves, is recorded as a premium deficiency and the reserve is updated at least quarterly based on actual results for that quarter, along with updated transaction level projections.
Corporate bonds and notes-The fair value of corporate bonds and notes is estimated using recent transaction activity, including market observations. Spread models are used that incorporate issuer and structure characteristics, such as credit risk and early redemption features, where applicable. These securities are generally categorized in Level II of the fair value hierarchy or in Level III when market-based transaction activity is unavailable.
RMBS, CMBS and Other ABS-The fair value of these instruments is estimated based on prices of comparable securities and spreads and observable prepayment speeds. These securities are generally categorized in Level II of the fair value hierarchy or in Level III when market-based transaction activity is unavailable. The fair value of any Level III securities is generally estimated by discounting estimated future cash flows.
Foreign government and agency securities-The fair value of foreign government and agency securities is estimated using observed market yields used to create a maturity curve and observed credit spreads from market makers and broker-dealers. These securities are categorized in Level II of the fair value hierarchy.
Equity securities-The fair value of these securities is generally estimated using observable market data in active markets or bid prices from market makers and broker-dealers. Generally, these securities are categorized in Level I or II of the fair value hierarchy, as observable market data are readily available. A small number of our equity securities, however, are categorized in Level III of the fair value hierarchy due to a lack of market-based transaction data or the use of model-based valuations.
Other investments-These securities primarily consist of commercial paper and short-term certificates of deposit, which are categorized in Level II of the fair value hierarchy. Other investments also contains convertible notes of non-reporting issuers, which are categorized in Level III of the fair value hierarchy due to a lack of market-based transaction data.
We record an other-than-temporary impairment adjustment on a security if we intend to sell the impaired security, if it is more likely than not that we will be required to sell the impaired security prior to recovery of its amortized cost basis, or if the present value of cash flows we expect to collect is less than the amortized cost basis of the security. If a sale is likely, the security is classified as other-than-temporarily impaired and the full amount of the impairment is recognized as a loss in the statement of operations. Otherwise, losses on securities that are other-than-temporarily impaired are separated into: (i) the portion of loss that represents the credit loss and (ii) the portion that is due to other factors. The credit loss portion is recognized as a loss in the statement of operations, while the loss due to other factors is recognized in AOCI, net of taxes. A credit loss is determined to exist if the present value of discounted cash flows expected to be collected from the security is less than the cost basis of the security. The present value of discounted cash flows is determined using the original yield of the security. In evaluating whether a decline in value is other-than-temporary, we consider several factors in addition to the above, including, but not limited to, the following:
Goodwill and other intangible assets were established primarily in connection with our acquisition of Clayton. Goodwill is an asset representing the estimated future economic benefits arising from the assets we have acquired that were not individually identified and separately recognized, and includes the value of discounted expected future cash flows of Clayton, Clayton’s workforce, expected synergies with our other affiliates and other unidentifiable intangible assets. Goodwill is deemed to have an indefinite useful life and is subject to review for impairment annually, or more frequently, whenever circumstances indicate potential impairment at the reporting unit level. A reporting unit represents a business for which discrete financial information is available; more than one reporting unit may be aggregated into a single reporting unit if they have similar economic characteristics. Events that could result in an interim assessment of goodwill impairment and/or a potential impairment charge include, but are not limited to: (i) significant under-performance relative to historical or projected future operating results; (ii) significant changes in the strategy for the Services segment; (iii) significant negative industry or economic trends; and (iv) a decline in market capitalization below book value attributable to the Services segment. Management regularly updates certain assumptions related to our projections, including the likelihood of achieving the assumed potential revenues from new initiatives and business strategies, and if these or other items have a significant negative impact on the reporting unit’s projections we may perform additional analysis to determine whether an impairment charge is needed. Lower earnings over sustained periods also can lead to impairment of goodwill, which could result in a charge to earnings. The value of goodwill is primarily supported by revenue projections, which are mostly driven by projected transaction volume and margins.
Intangible assets, other than goodwill, primarily consist of customer relationships, technology, trade name and trademarks, client backlog and non-competition agreements. Customer relationships represent the value of the specifically acquired customer relationships and are valued using the excess earnings approach using estimated client revenues, attrition rates, implied royalty rates and discount rates. The excess earnings approach estimates the present value of expected earnings in excess of a traditional return on business assets. Technology represents proprietary software used for loan review, underwriting and due diligence, managing the REO disposition process, performing surveillance of mortgage loan servicers, real estate valuations and client workflow solutions. Trade name and trademarks reflect the value inherent in the recognition of the “Clayton” name and its reputation. For purposes of our intangible assets, we use the term client backlog to refer to the estimated present value of fees to be earned for services performed on loans currently under surveillance or REO assets under management. The value of a non-competition agreement is an appraisal of potential lost revenues that would arise from an individual leaving to work for a competitor or initiating a competing enterprise. For financial reporting purposes, intangible assets with finite lives are amortized over their applicable estimated useful lives in a manner that approximates the pattern of expected economic benefit from each intangible asset.
In January 2016, the FASB issued an update that makes certain changes to the standard for the accounting of financial instruments. Among other things, the update requires: (i) equity investments to be measured at fair value with changes in fair value recognized in net income; (ii) the use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (iii) separate presentation of financial assets and financial liabilities by measurement category and form of financial asset; and (iv) separate presentation in other comprehensive income of the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk (also referred to as “own credit”) when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. The update also eliminates the requirement to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. This update is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is not permitted, with the exception of the “own credit” provision. We are currently evaluating the impact to our financial statements and future disclosures as a result of this update, but we do not expect the impact to be material due to the current amount of our investments in equity securities and our investment strategy.
Our Mortgage Insurance segment currently offers primary mortgage insurance coverage on residential first-lien mortgage loans, which comprised 98.0% of our $47.7 billion total direct RIF as of December 31, 2016. At December 31, 2016, Pool Insurance represented 2.0% of our total direct RIF. We provide our mortgage insurance products and services mainly through our wholly-owned subsidiary, Radian Guaranty.
PMIERs. Private mortgage insurers, including Radian Guaranty, are required to comply with the PMIERs to remain eligible insurers of loans purchased by the GSEs. At December 31, 2016, Radian Guaranty is an approved mortgage insurer under the PMIERs and is in compliance with the PMIERs Financial Requirements.
The PMIERs Financial Requirements require that a mortgage insurer’s Available Assets (as defined, these primarily include liquid assets and exclude premiums received but not yet earned) meet or exceed its Minimum Required Assets (a risk-based minimum required asset amount calculated based on net RIF, and which is intended to approximate the maximum loss exposure based on a variety of criteria which are indicative of credit quality). The GSEs may amend the PMIERs at any time, and they have broad discretion to interpret the requirements, which could impact the calculation of our Available Assets and/or Minimum Required Assets. The PMIERs specifically provide for the factors that are applied to calculate and determine a mortgage insurer’s Minimum Required Assets to be updated every two years following a minimum of 180 days’ notice (with the next review scheduled to take place in 2017), or more frequently, as determined by the GSEs, to reflect changes in macroeconomic conditions or loan performance. We have entered into reinsurance transactions as part of our capital and risk management activities, including to manage Radian Guaranty’s position under the PMIERs Financial Requirements, and the credit that we receive under the PMIERs Financial Requirements for these transactions is subject to the periodic review of the GSEs. In December 2016, the GSEs issued interim guidance for the industry that negatively impacted the amount of credit that we receive for our Single Premium QSR Transaction, but also gave credit to certain liquid investments that are readily available to pay claims that previously were not permitted to be included in our Available Assets. This interim guidance did not affect Radian Guaranty’s compliance with the PMIERs.
Our Services segment provides services and solutions to the real estate and mortgage finance industries. Our Services segment provides outsourced services, information-based analytics, valuations and specialized consulting and surveillance services for buyers and sellers of, and investors in, mortgage- and real estate-related loans and securities as well as other consumer ABS. The primary lines of business in our Services segment include:
Loan Review, Underwriting and Due Diligence-Loan-level due diligence for various asset classes and securitizations, with a primary focus on the mortgage and RMBS markets, utilizing skilled professionals and proprietary technology, with offerings focused on credit underwriting, regulatory compliance and collateral valuation;
Real Estate Valuation and Component Services-Outsourced solutions offered through Green River Capital, Red Bell and ValuAmerica, primarily focused on the SFR market, including valuations, property inspections, title reviews, lease reviews, tax lien reviews and due diligence reviews for SFR and residential real estate markets, as well as outsourced solutions for appraisal, title and closing services;
EuroRisk-Outsourced mortgage services in the United Kingdom and Europe, with offerings that include due diligence services, quality control reviews, valuation reviews and consulting services.
During the first quarter of 2015, Clayton expanded its service offerings by acquiring Red Bell, a real estate brokerage, valuation and technology company that provides products and services that include automated valuation models; broker price opinions used by investors, lenders and loan servicers; and advanced technology solutions for: (i) monitoring loan portfolio performance; (ii) tracking non-performing loans; (iii) managing REO assets; and (iv) valuing and selling residential real estate through a secure platform. In addition, in October 2015, Clayton acquired ValuAmerica, a national title agency and appraisal management company with a technology platform that helps mortgage lenders and their vendors streamline and manage their supply chains and operational workflow. Red Bell and ValuAmerica have been included in the Services segment since the dates of acquisition. See Note 7 for additional information.
Our consolidated financial statements are prepared in accordance with GAAP and include the accounts of all wholly-owned subsidiaries. All intercompany accounts and transactions, including intercompany profits and losses, have been eliminated. Certain prior period amounts have been reclassified to conform to current period presentation, including the reclassification to services revenue and cost of services from other income and other operating expense, respectively, of items related to certain contract underwriting activities that were previously reported in the Mortgage Insurance segment, as further described in Note 4 below. On a consolidated basis, the reclassifications increased services revenue, with a corresponding decrease in other income, by $3.4 million in 2015 and $1.3 million in 2014. The reclassifications also increased cost of services, with a corresponding decrease in other operating expenses, by $3.8 million in 2015 and $1.1 million in 2014. These reclassifications are not material to amounts we reported or disclosed in prior periods.
In our Mortgage Insurance business, the default and claim cycle begins with the receipt of a default notice from the loan servicer. Reserves for losses are established upon receipt of notification from servicers that a borrower has missed two monthly payments, which is when we consider a loan to be in default for financial statement and internal tracking purposes. We also establish reserves for associated LAE, consisting of the estimated cost of the claims administration process, including legal and other fees and expenses associated with administering the claims process. We maintain an extensive database of claim payment history, and use models based on a variety of loan characteristics to determine the likelihood that a default will reach claim status.
We do not establish reserves for loans that are in default if we believe that we will not be liable for the payment of a claim with respect to that default. We do not establish loss reserves for expected future claims on insured mortgages that are not in default. See “-Reserve for Premium Deficiency” below for an exception to this general principle.
The impact to our reserve due to estimated future Loss Mitigation Activities incorporates our expectations regarding the number of policies that we expect to be reinstated as a result of our claims rebuttal process. Rescissions, Claim Denials and Claim Curtailments may occur for various reasons, including, without limitation, underwriting negligence, fraudulent applications and appraisals, breach of representations and warranties and inadequate documentation, primarily related to our Legacy Portfolio. The level of Rescissions, Claim Denials and Claim Curtailments has been declining in recent periods as our defaulted Legacy Portfolio continues to decline, and we expect this trend to continue. In addition, with respect to claims decisions on the population of Future Legacy Loans covered under the BofA Settlement Agreement, Radian Guaranty has agreed, subject to certain limited exceptions and conditions, that it will limit Rescissions, Claim Denials or Claim Curtailments. See Note 11 for additional information about the BofA Settlement Agreement.
Included in our loss reserves is an estimate related to a potential additional payment to Freddie Mac under the Freddie Mac Agreement, which is dependent upon the Loss Mitigation Activity on the population of loans subject to that agreement. Our reserve related to this potential additional payment is based on the estimated Rescissions, Claim Denials, Claim Curtailments and cancellations for this population of loans, determined using assumptions that are consistent with those utilized to determine our overall loss reserves. See Note 11 for additional information about the Freddie Mac Agreement.
Available for sale securities, trading securities, and certain other assets are recorded at fair value as described in Note 5. All changes in fair value of trading securities and certain other assets are included in our consolidated statements of operations. All changes in the fair value of available for sale securities are recorded in AOCI.
Services revenue is recognized when pervasive evidence of an arrangement exists, the service has been performed, the fee is fixed and determinable and collection of the resulting receivable is reasonably assured.
The Services segment also generates additional revenue utilizing a percentage-of-sales contract. Through the use of Services’ proprietary technology, property leads are sent to select clients. Services recognizes revenue for these transactions based on a percentage of the sale, upon the client’s successful closing on the property.
We are required to establish a valuation allowance against our DTA when it is more likely than not that all or some portion of our DTA will not be realized. At each balance sheet date, we assess our need for a valuation allowance. Our assessment is based on all available evidence, both positive and negative. This requires management to exercise judgment and make assumptions regarding whether our DTA will be realized in future periods.
Our provision for income taxes for interim financial periods is based on an estimate of our annual effective tax rate for the full year of 2016 and 2015. When estimating our full year 2016 and 2015 effective tax rates, we adjust our forecasted pre-tax income for gains and losses on our investments, changes in the accounting for uncertainty in income taxes, changes in our beginning of year valuation allowance, and other adjustments. The impact of these items is accounted for discretely at the applicable federal tax rate.
We group assets in our investment portfolio into one of three main categories: held to maturity, available for sale or trading securities. Fixed-maturity securities for which we have the positive intent and ability to hold to maturity, if any, are classified as held to maturity and are reported at amortized cost. Investments in securities not classified as held to maturity or trading securities are classified as available for sale and are reported at fair value, with unrealized gains and losses (net of tax) reported as a separate component of stockholders’ equity as AOCI. Investments classified as trading securities are reported at fair value, with unrealized gains and losses reported as a separate component of income. Short-term investments consist of money market instruments, certificates of deposit and highly liquid, interest-bearing instruments with an original maturity of three months or less at the time of purchase. Amortization of premium and accretion of discount are calculated principally using the interest method over the term of the investment. Realized gains and losses on investments are recognized using the specific identification method. See Notes 5 and 6 for further discussion on the fair value of investments.
Accounts and notes receivable primarily consist of accrued premiums receivable due from our mortgage insurance customers, amounts due from our Services customers for services our Services segment has performed, and profit commission receivable, if any, related to our reinsurance transactions. See Note 8 for details. Accounts and notes receivable are carried at their estimated collectible amounts, net of any allowance for doubtful accounts, and are periodically evaluated for collectability based on past payment history and current economic conditions.
The calculation of the estimated fair value of goodwill and other intangibles is performed primarily using an income approach and requires the use of significant estimates and assumptions that are highly subjective in nature, such as attrition rates, discount rates, future expected cash flows and market conditions. The most significant assumptions relate to the valuation of goodwill and customer relationships. In particular, future expected cash flows include estimated transaction volumes that are not currently contracted, as well as volume projections associated with non-agency RMBS securitizations, for which current market conditions are not favorable. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable.
The stock-based compensation cost related to share-based liability awards is based on the fair value as of the measurement date. The compensation cost for equity instruments is measured based on the grant-date fair value at the date of issuance. Compensation cost is generally recognized over the periods that an employee provides service in exchange for the award. See Note 15 for further information.
In 2015, we had an ASR program that consisted of the combination of the purchase of Radian Group common stock from an investment bank and a forward contract with that investment bank indexed to Radian Group common stock. We accounted for the ASR program in accordance with the provisions of the accounting standards regarding derivatives and hedging for contracts indexed to an entity’s own stock, and the accounting standard regarding equity. The up-front payment to the investment bank as part of the ASR program was accounted for as a reduction to stockholders’ equity in our consolidated balance sheets in the second quarter of 2015, the period in which the payment was made. The shares of Radian Group common stock received were retired, resulting in a decrease in shares issued and outstanding and a corresponding increase in unissued shares in the periods delivered. We reflect the ASR program as a repurchase of common stock in the periods delivered for purposes of calculating earnings per share and as forward contracts indexed to the company’s own common stock. The ASR program met all of the applicable criteria for equity classification, and therefore, was not accounted for as a derivative instrument.
In April 2015, the FASB issued an update to the accounting standard for the accounting of internal-use software. The amendments in this update provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The provisions of this update are effective for interim and annual periods beginning after December 15, 2015. The implementation of this update, effective January 1, 2016, did not have a material impact to our financial position, results of operations or cash flows.
In May 2014, the FASB issued an update to the accounting standard regarding revenue recognition. In accordance with the new standard, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, the new standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. This update is not expected to change revenue recognition principles related to our investments and insurance products, which represent a significant portion of our total revenues. This update is primarily applicable to revenues from our Services segment. In July 2015, the FASB delayed the effective date for this updated standard to interim and annual periods beginning after December 15, 2017 and subsequently issued various clarifying updates. Early adoption is permitted. This standard permits the use of the retrospective or cumulative effective transition method. We are currently in the process of categorizing the Services revenues to evaluate the impact to our financial statements and future disclosures as a result of the updates.
The following number of shares of our common stock equivalents issued under our stock-based compensation arrangements and convertible debt, if any, were not included in the calculation of diluted net income per share because they were anti-dilutive:
We allocate to our Services segment: (i) corporate expenses based on an allocated percentage of time spent on the Services segment and (ii) as noted above, all interest expense related to the Senior Notes due 2019. No material corporate cash or investments are allocated to the Services segment. Inter-segment activities are recorded at market rates for segment reporting and eliminated in consolidation.
Although adjusted pretax operating income (loss) excludes certain items that have occurred in the past and are expected to occur in the future, the excluded items represent those that are: (i) not viewed as part of the operating performance of our primary activities or (ii) not expected to result in an economic impact equal to the amount reflected in consolidated pretax income (loss) from continuing operations. These adjustments, along with the reasons for their treatment, are described below.
Reflects changes to align our segment reporting structure with recent changes in personnel reporting lines and management oversight related to contract underwriting performed on behalf of third parties. Revenue and expenses for this business are now reflected in the Services segment. As a result, for all periods presented, Services revenue, cost of services and other operating expenses have increased, with offsetting reductions in Mortgage Insurance other income and other operating expenses.
As of December 31, 2016, California is the only state that accounted for more than 10% of our mortgage insurance business measured by primary RIF. California accounted for 12.4% of our Mortgage Insurance segment’s primary RIF at December 31, 2016, compared to 12.8% at December 31, 2015. California accounted for 14.8% of our Mortgage Insurance segment’s direct primary NIW for the year ended December 31, 2016, compared to 15.2% and 17.2% for the years ended December 31, 2015 and 2014, respectively.
At December 31, 2016, total Level III assets of $1.0 million accounted for less than 0.1% of total assets measured at fair value. Within other investments is a Level III investment which was purchased during the three months ended June 30, 2016, and there were no related gains or losses recorded during the year ended December 31, 2016. Within equity securities is a Level III investment that was purchased during the three months ended June 30, 2015, and there were no related gains or losses recorded during the year ended December 31, 2016. There were no Level III liabilities at December 31, 2016.
Does not include certain other invested assets ($1.7 million), primarily invested in limited partnerships, accounted for as cost-method investments and not measured at fair value.
At December 31, 2015, total Level III assets of $0.5 million accounted for less than 0.1% of total assets measured at fair value. This investment was purchased during the three months ended June 30, 2015, and there were no related gains or losses recorded during the year ended December 31, 2015. There were no Level III liabilities at December 31, 2015.
U.S. government and agency securities. The fair value of U.S. government and agency securities is estimated using observed market transactions, including broker-dealer quotes and actual trade activity as a basis for valuation. U.S. government and agency securities are categorized in either Level I or Level II of the fair value hierarchy.
Corporate bonds and notes. The fair value of corporate bonds and notes is estimated using recent transaction activity, including market observations. Spread models are used that incorporate issuer and structure characteristics, such as credit risk and early redemption features, where applicable. These securities are generally categorized in Level II of the fair value hierarchy or in Level III when market-based transaction activity is unavailable.
Long-Term Debt. The carrying amount of long-term debt is net of the equity component of our convertible notes, which is accounted for under the accounting standard for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement). The fair value is estimated based on the quoted market prices for the same or similar instruments. See Note 12 for further information.
For securities deemed “available for sale” and that are in an unrealized loss position, the following tables show the gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of the dates indicated:
For the years ended December 31, 2016, 2015 and 2014, we did not sell or transfer any fixed-maturity investments classified as held to maturity. For the years ended December 31, 2016, 2015 and 2014, we did not transfer any securities from the available for sale or trading categories.
Net realized gains (losses) on equities available for sale for the years ended December 31, 2016 and 2015 represent the gross amount of losses and gains, respectively, realized for those periods.
As of December 31, 2016, we did not have any investment in any person and its affiliates that exceeded 10% of our total stockholders’ equity.
At December 31, 2016 and 2015, Radian Guaranty had $63.9 million and $74.7 million, respectively, in a collateral account pursuant to the Freddie Mac Agreement. This collateral account, which contains investments primarily invested in trading securities, is pledged to cover Loss Mitigation Activity on the loans subject to the Freddie Mac Agreement. Subject to certain conditions in the Freddie Mac Agreement, amounts in the collateral account may be released to Radian Guaranty over time to the extent that Loss Mitigation Activity becomes final in accordance with the terms of that agreement. See Note 11 for additional information.
During the first quarter of 2015, Clayton expanded its service offerings by acquiring Red Bell, a real estate brokerage, valuation and technology company that provides products and services that include automated valuation models; broker price opinions used by investors, lenders and loan servicers; and advanced technology solutions for: (i) monitoring loan portfolio performance; (ii) tracking non-performing loans; (iii) managing REO assets; and (iv) valuing and selling residential real estate through a secure platform. The transaction was treated as a purchase for accounting purposes, with the excess of the acquisition price over the estimated fair value of the net assets acquired resulting in goodwill of $2.4 million. In addition, in October 2015, Clayton acquired ValuAmerica, a national title agency and appraisal management company with a technology platform that helps mortgage lenders and their vendors streamline and manage their supply chains and operational workflow. The transaction was treated as a purchase for accounting purposes, with the excess of the acquisition price over the estimated fair value of the net assets acquired resulting in goodwill of $0.8 million. Neither of these acquisitions met the criteria to be considered a material business combination. These acquisitions expand Clayton’s scope of services and are consistent with our strategy to be positioned to offer products and services throughout the entire mortgage value chain.
The goodwill in these acquisitions is an asset representing the estimated future economic benefits arising from the assets we have acquired that were not individually identified and separately recognized, and includes the value of the discounted expected future cash flows, the workforce, expected synergies with our other affiliates and other unidentifiable intangible assets. Goodwill is deemed to have an indefinite useful life and is subject to review for impairment annually, or more frequently, whenever circumstances indicate potential impairment. Events that could result in an interim assessment of goodwill impairment and/or a potential impairment loss include, but are not limited to: (i) significant under-performance relative to historical or projected future operating results; (ii) significant changes in the strategy for the Services segment; (iii) significant negative industry or economic trends; and (iv) a decline in market capitalization below book value attributable to the Services segment. Management regularly updates certain assumptions related to our projections, including the likelihood of achieving the assumed potential revenues from new initiatives and business strategies, and if these or other items have a significant negative impact on the reporting unit’s projections we may perform additional analysis to determine whether an impairment charge is needed. Lower earnings over sustained periods also can lead to impairment of goodwill, which could result in a charge to earnings. The value of goodwill is primarily supported by revenue projections which are driven primarily by projected transaction volume and margins.
We considered both positive and negative factors and concluded that, after considering all of the factors and evidence available, there is no impairment of goodwill as of December 31, 2016. The goodwill impairment test is a two-step process as required by the accounting standard related to intangible assets. Step one compares a reporting unit’s estimated fair value to its carrying value. If the carrying amount exceeds the estimated fair value, the second step must be completed to measure the amount of the reporting unit’s goodwill impairment loss, if any. In 2016, the estimated fair value of the reporting unit exceeded our carrying amount.
For the years ended December 31, 2016, 2015 and 2014, amortization expense was $13.2 million, $13.0 million and $8.6 million, respectively. The amortization expense for 2014 includes an impairment loss of $2.1 million, related to a small subsidiary within our Services segment that we acquired in 2013. The estimated aggregate amortization expense for 2017 and thereafter is as follows:
In the fourth quarter of 2012, Radian Guaranty and the same third-party reinsurance provider entered into the Second QSR Transaction, pursuant to which Radian Guaranty agreed to cede 20% of its NIW beginning with the business written in the fourth quarter of 2012. Effective April 1, 2013, Radian Guaranty amended the original terms of the Second QSR Transaction to reduce the percentage of all premiums and losses incurred on new business ceded to the reinsurer under this reinsurance agreement on a prospective basis from 20% to 5% with respect to NIW on conventional GSE loans. As of December 31, 2015, we had ceded the maximum of $1.6 billion of RIF under the Second QSR Transaction. As of December 31, 2016, RIF ceded under the Second QSR Transaction declined to $1.0 billion.
Similar to the Initial QSR Transaction, pursuant to the Second QSR Transaction Radian Guaranty had the ability, at its option, to recapture one-half of the reinsurance ceded as of December 31, 2015. Radian Guaranty chose not to recapture that risk and negotiated an amendment to the Second QSR Transaction pursuant to which we received a profit commission of $8.3 million based on performance through December 31, 2015, which increased net premiums earned during 2015. In addition, pursuant to the amendment, Radian Guaranty received an $8.5 million prepaid supplemental ceding commission, the recognition of which has been deferred and is expected to be amortized as a reduction to our other operating expenses over approximately five years. Pursuant to the original agreement and effective January 1, 2016, the ceding commission was reduced from 35% to 30% for one-half of the remaining reinsurance ceded under the Second QSR Transaction.
In the first quarter of 2016, in order to proactively manage the risk and return profile of Radian Guaranty’s insured portfolio and continue managing its position under the PMIERs Financial Requirements in a cost-effective manner, Radian Guaranty entered into the Single Premium QSR Transaction with a panel of third-party reinsurers. Under the Single Premium QSR Transaction, effective January 1, 2016, Radian Guaranty began ceding the following Single Premium IIF and NIW, subject to certain conditions:
Radian Guaranty receives a 25% ceding commission for premiums ceded pursuant to this transaction. Radian Guaranty also receives a profit commission, provided that the loss ratio on the loans covered under the agreement generally remains below 55%. Losses on the ceded risk above this level reduce Radian Guaranty’s profit commission on a dollar-for-dollar basis.
Notwithstanding the limitation on ceded premiums for Single Premium NIW written between January 1, 2016 and December 31, 2017, the parties may mutually agree to increase the amount of ceded risk on December 31, 2017. Radian Guaranty is entitled to discontinue ceding new policies under the agreement at the end of any calendar quarter. The agreement is scheduled to terminate on December 31, 2027; however, Radian Guaranty has the option, based on certain conditions and subject to a termination fee, to terminate the agreement as of January 1, 2020, or at the end of any calendar quarter thereafter, which would result in Radian Guaranty reassuming the related RIF in exchange for a net payment from the reinsurer calculated in accordance with the terms of the agreement. RIF ceded under the Single Premium QSR Transaction was $3.8 billion as of December 31, 2016.
The following tables show the amounts related to the QSR Transactions and the Single Premium QSR Transaction for the periods indicated:
Although we use reinsurance as a risk management tool, reinsurance does not relieve us of our obligations to our policyholders. In the event the reinsurers are unable to meet their obligations to us, our insurance subsidiaries would be liable for any defaulted amounts. However, in all of our reinsurance transactions, the reinsurers have established a trust to help secure our potential cash recoveries. In addition, for the Single Premium QSR Transaction, Radian Guaranty holds amounts received from ceded premiums written to collateralize the reinsurers’ obligations, which is reported in reinsurance funds withheld on the consolidated balance sheets. Any loss recoveries and profit commissions to Radian Guaranty related to the Single Premium QSR Transaction are expected to be realized from this account.
Includes $49.7 million and $35.9 million in 2016 and 2015, respectively, related to our technology upgrade project.
The components of our consolidated income tax provision (benefit) from continuing operations are as follows:
The reconciliation of taxes computed at the statutory tax rate of 35% to the provision (benefit) for income taxes on continuing operations is as follows:
As of December 31, 2016, we recorded a net current income tax payable of $130.9 million, which primarily consists of liabilities related to applying the standards of accounting for uncertainty in income taxes, and a current federal income tax recoverable of $3.5 million. Before consideration of uncertain tax positions, we have approximately $653.8 million of U.S. NOL carryforwards, $7.4 million of alternative minimum tax credit carryforwards and $5.6 million of research and development tax credit carryforwards as of December 31, 2016. To the extent not utilized, the U.S. NOL carryforwards will expire during tax years 2030 through 2032, the research and development tax credit carryforwards will expire during tax years 2031 through 2036 and the alternative minimum tax credit carryforwards have no expiration date. Certain entities within our consolidated group have also generated DTAs of approximately $52 million, relating primarily to state and local NOL carryforwards which, if unutilized, will expire during various future tax periods.
In evaluating negative evidence, consideration was given to the extensive U.S. NOL Carryforward period. Based on management’s projections, including adverse scenarios considered in our sensitivity analysis, we expect to fully utilize our U.S. NOL Carryforward over approximately the next two years. Additionally, we currently have no Section 382 or other limitations on our ability to utilize our existing NOL.
Our ability to fully use our tax assets such as NOLs and tax credit Carryforwards would be substantially limited if we experience an “ownership change” within the meaning of Section 382. Section 382 rules governing when a change in ownership occurs are complex and subject to interpretation; however, in general, an ownership change would occur if any “five-percent shareholders,” as defined under Section 382, collectively increase their ownership by more than 50 percentage points over a rolling three-year period. As of December 31, 2016, we have not experienced an ownership change under Section 382. However, if we were to experience a change in ownership under Section 382 in a future period, then we may be limited in our ability to fully utilize our NOL and tax credit Carryforwards in future periods.
On December 3, 2014, we petitioned the Tax Court to litigate the Deficiency Amount. On September 1, 2015, we received a notice that the case had been scheduled for trial. However, the parties jointly filed, and the Tax Court approved, motions for continuance in this matter to postpone the trial date. Also, in February 2016, the Tax Court approved a joint motion to consolidate for trial, briefing and opinion our case with a similar case involving MGIC Investment Corporation. During 2016, we held several meetings with the IRS in an attempt to reach a compromised settlement on the issues presented in our dispute. In January 2017, the parties informed the Tax Court that they believe they have reached a basis for a compromised settlement on the primary issues present in the case. The resolution must be reported to the JCT for review and cannot be finalized until the IRS considers the views, if any, expressed by the JCT about the matter. If we are unable to complete a compromised settlement, then the ongoing litigation could take several years to resolve and may result in substantial legal expenses. We can provide no assurance regarding the outcome of any such litigation or whether a compromised settlement with the IRS will ultimately be reached. We currently believe that an adequate provision for income taxes has been made for the potential liabilities that may result from this matter. However, if the ultimate resolution of this matter produces a result that differs materially from our current expectations, there could be a material impact on our effective tax rate, results of operations and cash flows.
As of December 31, 2016, we have $68.1 million of unrecognized tax benefits, including $63.5 million of interest and penalties, that would affect the effective tax rate, if recognized. Our policy for the recognition of interest and penalties associated with uncertain tax positions is to record such items as a component of our income tax provision (benefit), of which $1.8 million, $0.8 million and $2.5 million were recorded for the years ended December 31, 2016, 2015 and 2014, respectively.
California, Florida, Georgia, New York, Ohio, Pennsylvania and New York City.
For the periods indicated, the following table presents information relating to our reserve for losses, including our IBNR reserve and LAE, but excluding our Second-lien PDR:
Our loss reserve declined in 2015 from December 31, 2014, primarily as a result of the volume of paid claims, Cures and Rescissions and Claim Denials having exceeded new default notices received. Total incurred losses for 2015 decreased by $46.2 million as compared to 2014. This decrease was driven primarily by a continued decline in the number of new current year defaults and a decrease in the Default to Claim Rate assumptions applied to such defaults. During the year ended December 31, 2015, we reduced our gross Default to Claim Rate assumption for new primary defaults from 16% to 13%, based on continued improvement observed in actual claim development trends. This favorable impact to current year defaults was partially offset by a decline in the favorable reserve development from prior year defaults, which, although still positive, provided less of a benefit to our provision for losses in 2015 as compared to 2014. The $29.6 million favorable development on prior year defaults observed in 2015 was driven primarily by a decrease in our actual and estimated Default to Claim Rate assumptions on prior year defaults, as a result of higher Cures than were previously estimated, partially offset by a decline in our estimates for future Rescissions and Claim Denials.
Our aggregate weighted average Default to Claim Rate assumption (net of Claim Denials and Rescissions) used in estimating our primary reserve for losses was 42% (40% excluding pending claims) at December 31, 2016 compared to 46% (42% excluding pending claims) at December 31, 2015. The change in our Default to Claim Rate in 2016 resulted primarily from a decrease in the proportion of pending claims, which have higher Default to Claim Rates, and a decrease in the assumed gross Default to Claim Rate for new defaults from 13% to 12%, as of December 31, 2016 as well as a decrease in our estimated claim rate on aged defaults not in Foreclosure Stage. As of December 31, 2016, our gross Default to Claim Rates on our primary portfolio ranged from 12% for new defaults, to 62% for other defaults not in Foreclosure Stage, and 81% for Foreclosure Stage Defaults. As of December 31, 2015, these gross Default to Claim Rates ranged from 13% for new defaults, to 65% for other defaults not in Foreclosure Stage, and 81% for Foreclosure Stage Defaults. Our Default to Claim Rate estimates on defaulted loans are mainly developed based on the Stage of Default and Time in Default of the underlying defaulted loans grouped according to the period in which the default occurred, as measured by the progress toward foreclosure sale and the number of months in default. Our estimate of expected Rescissions and Claim Denials (net of expected Reinstatements) embedded in our estimated Default to Claim Rate is generally based on our recent experience. Consideration is also given for differences in characteristics between those rescinded policies and denied claims and the loans remaining in our defaulted inventory, as well as the estimated impact of the BofA Settlement Agreement, as described below.
Our reported Rescission, Claim Denial and Claim Curtailment activity in any given period is subject to challenge by our lender and servicer customers. We expect that a portion of previous Rescissions will be reinstated and previous Claim Denials will be resubmitted with the required documentation and ultimately paid; therefore, we have incorporated this expectation into our IBNR reserve estimate. Our IBNR reserve estimate of $14.3 million and $26.6 million at December 31, 2016 and 2015, respectively, includes reserves for this activity.
We also accrue for the premiums that we expect to refund to our lender customers in connection with our estimated Rescissions.
Represents total number of new default notices received in each calendar year as compiled monthly based on reports received from loan servicers. As reflected in our Default to Claim Rate assumptions, a significant portion of reported defaults generally do not result in a claim. In certain instances, a defaulted loan may cure, and then subsequently re-default in a later period. Consistent with our reserving practice, each new event of default is treated as a unique occurrence and therefore certain loans that cure and re-default may be included as a reported default in multiple periods.
The following table provides a reconciliation of the net incurred losses and paid claims development tables above to the reserve for losses and LAE in the consolidated balance sheet at December 31, 2016:
The carrying value of our long-term debt at December 31, 2016 and 2015 was as follows:
Announced Redemption of Convertible Senior Notes due 2019. In November 2016, we announced our intent to exercise our redemption option for the remaining Convertible Senior Notes due 2019, of which $68.0 million aggregate principal was outstanding at December 31, 2016. Our obligations in connection with this redemption were settled on January 27, 2017. See Note 21 for additional details.
Redemption Terms in Senior Notes. We have the option to redeem the Senior Notes due 2019, 2020 and 2021 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 or (ii) a “make-whole amount,” which is the sum of the present value of the remaining scheduled payments of principal and interest (excluding any portion of interest accrued to the redemption date) in respect of the notes, discounted at the applicable treasury rate plus 50 basis points, plus, in each case, accrued and unpaid interest thereon to, but excluding, the redemption date.
Covenants in Senior Notes. The Senior Notes due 2019, 2020 and 2021 have covenants customary for securities of this nature, including covenants related to the payments of the notes, reports, compliance certificates and modification of the covenants. Additionally, the indentures governing the Senior Notes due 2019, 2020 and 2021 include covenants restricting us from encumbering the capital stock of a designated subsidiary (as defined in the respective indentures for the notes) or disposing of any capital stock of any designated subsidiary unless either all of the stock is disposed of or we retain more than 80% of the stock.
During the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of the notes (for each trading day during that measurement period) was less than 98% of the product of the last reported sale price of the common stock and the applicable conversion rate on such trading day; or
In connection with the November 2010 offering of the convertible notes, we also entered into capped call transactions with an affiliate of Morgan Stanley, whose obligations have been guaranteed by Morgan Stanley. The capped call transactions are intended to offset the potential dilution to our common stock and/or any potential cash payments that may be required to be made by us upon conversion of the notes in excess of the principal amount of the notes, up to a stock price of approximately $14.11 per share, which is the initial cap on the counterparty’s share delivery obligation under the call options. If the market value per share of our common stock, as measured under the terms of the capped call transactions, exceeds the applicable cap price of the capped call transactions, the number of shares of our common stock and/or the amount of cash we expect to receive upon the exercise of the capped call transactions will be capped and the anti-dilutive and/or offsetting effect of the capped call transactions will be limited. We paid $46.1 million from the net proceeds from the issuance and sale of the convertible notes to purchase the capped call transactions.
Convertible Senior Notes due 2019. In March 2013, we issued $400 million principal amount of 2.25% Convertible Senior Notes due 2019 and received proceeds of $389.8 million, net of underwriting expenses. Interest was payable semi-annually on March 1 and September 1 of each year. The effective interest rate for the liability component of this debt was 6.25%.
Convertible Senior Notes due 2017 and 2019. The Convertible Senior Notes due 2017 and 2019 are both accounted for under the accounting standard for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement), which states that issuers of such instruments should separately account for the liability and equity components in a manner that reflects the entity’s nonconvertible debt borrowing rate when the interest cost is recognized in subsequent periods. Our convertible notes fall within the scope of this standard due to our ability to elect to repay the conversion premium in cash. We have determined that the embedded conversion options in the convertible notes are not required to be separately accounted for as derivatives under the accounting standard for derivatives and hedging.
Upon the original issuance of the Convertible Senior Notes due 2017 and 2019, in accordance with accounting standards related to convertible debt instruments that may be settled in cash upon conversion, the Company recorded a pretax equity component of $101.0 million and $77.0 million, respectively, net of the capped call transaction (with respect to the Convertible Senior Notes due 2017) and related issuance costs (with respect to the Convertible Senior Notes due 2017 and 2019). The pretax equity component is not subject to remeasurement, and therefore remains unchanged unless a reduction of outstanding principal occurs. As a result of our purchases during 2016, the remaining pretax equity component associated with the Convertible Senior Notes due 2017 and 2019 decreased from $11.3 million and $75.1 million, respectively, at December 31, 2015 to $5.0 million and $13.1 million, respectively, at December 31, 2016. See Note 10 for information on DTLs associated with our convertible and other long-term debt.
In any period when holders of the Convertible Senior Notes due 2017 are eligible to exercise their conversion option, the related equity component is reflected as mezzanine (temporary) equity rather than permanent equity, because we are required to settle the aggregate principal amount of the notes in cash. This equity component is the difference between: (i) the amount of cash deliverable upon conversion (i.e., par value of debt) and (ii) the carrying value of the debt.
Covenants in Convertible Senior Notes due 2017 and 2019. The Convertible Senior Notes due 2017 and 2019 have covenants generally customary for securities of this nature, including covenants related to payments of the notes, reports, compliance certificates, the modification of covenants and maintaining Radian Group’s corporate existence.
We are routinely involved in a number of legal actions, reviews and audits, as well as inquiries and investigations by various regulatory entities involving compliance with laws or other regulations, the outcome of which are uncertain. These legal proceedings could result in adverse judgments, settlements, fines, injunctions, restitutions or other relief that could require significant expenditures or have other effects on our business. In accordance with applicable accounting standards and guidance, we establish accruals only when we determine both that it is probable that a loss has been incurred and the amount of the loss is reasonably estimable. We accrue the amount that represents our best estimate of the probable loss; however, if we can only determine a range of estimated losses, we accrue an amount within the range that, in our judgment, reflects the most likely outcome, and if none of the estimates within the range is more likely, we accrue the minimum amount of the range.
As described in Note 10, on September 4, 2014 we received formal Notices of Deficiency from the IRS related to certain losses and deductions resulting from our investment in a portfolio of non-economic REMIC residual interest. We believe that an adequate provision for income taxes has been made for the potential liabilities that may result from this matter. However, if the ultimate resolution of this matter produces a result that differs materially from our current expectations, there could be a material impact on our effective tax rate, results of operations and cash flows.
Securities regulations became effective in 2005 that impose enhanced disclosure requirements on issuers of ABS (including MBS). To allow our customers to comply with these regulations at that time, we typically were required, depending on the amount of credit enhancement we were providing, to provide: (i) audited financial statements for the insurance subsidiary participating in the transaction or (ii) a full and unconditional holding company-level guarantee for our insurance subsidiaries’ obligations in such transactions. Radian Group has guaranteed two structured transactions for Radian Guaranty involving approximately $110.2 million of remaining credit exposure as of December 31, 2016.
We provide contract underwriting as an outsourced service to our customers. Under our current contract underwriting program the remedy we offer is limited indemnification to our contract underwriting customers only with respect to those loans that we simultaneously underwrite for both secondary market compliance and for potential mortgage insurance eligibility. In 2016, we did not pay any losses related to contract underwriting remedies. In 2016, our provision for contract underwriting expenses was $0.2 million and our reserve for contract underwriting obligations at December 31, 2016 was $0.5 million. We monitor this risk and negotiate our underwriting fee structure and recourse agreements on a client-by-client basis. We also routinely audit the performance of our contract underwriters.
We lease office space for use in our operations. The lease agreements, which expire periodically through August 2032, contain provisions for scheduled periodic rent increases. Net rental expense in connection with these leases totaled $5.0 million in 2016, $5.0 million in 2015 and $3.9 million in 2014, excluding the net rental expense related to discontinued operations. The commitment for non-cancelable operating leases in future years is as follows:
At December 31, 2016, there were no future minimum receipts expected from sublease rental payments.
All shares of Radian Group common stock that we received from the above transactions were retired, resulting in a decrease in shares issued and outstanding and a corresponding increase in unissued shares.
Awards granted under the Equity Plans provide for “double trigger” vesting in the event of a change of control, meaning that awards will vest in connection with a change of control only in the event the grantee’s employment is terminated by us without cause or the grantee terminates employment for “good reason,” in each case within 90 days before or one year after the change of control.
Generally, effective July 9, 2015, the performance RSUs granted to executive officers include a one-year post-vesting holding period, such that the vested awards will not be convertible into shares (other than shares withheld to pay taxes due at vesting) until the one-year anniversary following the vesting date of the awards, except in the event of death or disability.
In the event of a hypothetical change of control as of December 31, 2016, we estimate that the vesting of awards, assuming for purposes of this hypothetical that “double trigger” vesting occurred, would have resulted in a pretax accounting charge to us of approximately $11.3 million, representing the acceleration of compensation expense.
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 2016, 2015, and 2014, 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 2016, 2015, and 2014 provide that vesting remains dependent on the Company’s performance for the full term of the awards, notwithstanding the grantee’s earlier retirement.
Performance-Based RSUs- In 2012, a total of 2,211,640 performance-based RSUs (to be settled in cash) were granted to eligible officers under the 2008 Equity Plan. These performance-based RSUs entitled grantees to a cash amount equal to the fair market value of RSUs that vested at the end of a three-year performance period in 2015. There were no cash-settled performance-based RSUs granted after 2012.
Performance-Based RSUs-In 2016, 2015 and 2014, executive and non-executive officers were granted a total of 701,110; 499,740; and 702,180; respectively, of performance-based RSUs to be settled in common stock. The maximum payout at the end of the three-year performance period is 200% of a grantee’s target number of RSUs, subject to a maximum cap of six times the value of the grantee’s award on the grant date.
The vesting of 50% of the target awards granted to each executive officer in 2016 is dependent upon (i) Radian Group’s TSR compared to the median TSR of a designated peer group of companies as of the date of grant (the “Relative TSR Measure”) and (ii) Radian Group’s absolute TSR (“Absolute TSR Measure,” and together with the Relative TSR Measure, the “TSR Measures”), in each case measured over a three-year performance period and subject to certain conditions. The remaining 50% of each executive officer’s target award will vest based on the cumulative growth in Radian’s book value per share, adjusted for certain defined items, over a three-year performance period. The vesting of performance-based RSUs granted to non-executives in 2016 is entirely based on the Relative TSR Measures described above.
Time-Vested RSUs-In 2016, a total of 273,726 shares of time-vested RSUs to be settled in common stock were granted, including 180,380 shares awarded to certain executives and non-executive officers and 93,346 shares awarded to non-employee directors. In 2015, a total of 113,141 shares of time-vested RSUs to be settled in common stock were granted, including 56,970 shares awarded to non-executive officers and 56,171 shares awarded to non-employee directors. In 2014, a total of 170,176 shares of time-vested RSUs to be settled in common stock were granted, including 85,133 shares awarded to non-executive officers and 85,043 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 generally are subject to three-year cliff vesting.
The following table summarizes information concerning stock option activity for the periods indicated:
We elected to apply the short-cut method, under the accounting standard regarding share-based payment, to account for the windfall tax benefits that may result from the exercise of stock options. Effective January 1, 2017, upon the implementation of the update to the accounting standard regarding stock-based compensation, future windfalls and shortfalls resulting from cancellations, expirations or exercises of stock options will be reflected in the consolidated statements of operations as part of our income tax provision (benefit), as they occur. See Note 2.
We have an ESPP, the 2008 ESPP, under which 2,000,000 shares of our authorized but unissued common stock have been reserved for issuance. Under the 2008 ESPP, we sold 151,121; 94,676; and 67,743 shares to employees during the years ended December 31, 2016, 2015 and 2014, respectively.
As of December 31, 2016, 2015 and 2014, unrecognized compensation expense related to the unvested portion of all of our share-based awards was $11.3 million, $11.7 million and $17.5 million, respectively. Absent a change of control under the Equity Plans, this expense is expected to be recognized over a weighted average period of approximately 2.1 years.
The Radian Group Inc. Savings Incentive Plan (“Savings Plan”) covers substantially all of our full-time and our part-time employees. Participants can contribute up to 100% of their base earnings as pretax and/or after-tax (Roth IRA) contributions up to a maximum amount of $18,000 for 2016. The Plan also includes a catch-up contribution provision whereby participants who are or will be age 50 and above during the Plan year may contribute an additional contribution. The maximum catch-up contribution for Plan Year 2016 was $6,000. Effective January 1, 2016, we match up to 100% of the first 4.5% of base earnings contributed in any given year. Previously, the match was up to 100% of the first 6% of annual base earnings exclusive of Clayton, which had its own employee match of 25% of the first 6% of base earnings contributed in any given year. Beginning January 1, 2016, Clayton was merged into the Savings Plan. Our expense for matching funds for the years ended December 31, 2016, 2015 and 2014 was $4.9 million, $3.1 million and $3.1 million, respectively.
Radian Asset Assurance provided direct insurance and reinsurance on credit-based risks. The assets and liabilities associated with the discontinued operations had historically been a source of significant volatility to Radian’s results of operations, due to various factors including fluctuations in fair value and credit risk. The divestiture was intended to better position Radian Guaranty to comply with the PMIERs (which are discussed in Note 1) and to support Radian’s strategic focus on the mortgage and real estate industries. After closing costs and other adjustments, Radian Guaranty received net proceeds of $789 million.
Based upon the applicable terms of the Radian Asset Assurance Stock Purchase Agreement, we determined that Radian Asset Assurance met the criteria for held for sale and discontinued operations accounting at December 31, 2014. As a result, we recognized a pre-tax impairment charge of $467.5 million for the year ended December 31, 2014 and an additional pre-tax impairment charge of $14.3 million through April 1, 2015, when the sale was completed. We recorded total net income from discontinued operations of $5.4 million related to this sale in 2015, consisting primarily of the recognition of investment gains previously deferred and recorded in AOCI and recognized as a result of the completion of the sale of Radian Asset Assurance to Assured on April 1, 2015, as well as adjustments to estimated transaction costs and taxes. The operating results of Radian Asset Assurance are classified as discontinued operations for all periods presented in our consolidated statements of operations. No general corporate overhead or interest expense was allocated to discontinued operations.
The table below summarizes the components of income (loss) from discontinued operations, net of tax, for the periods indicated. There was no activity for discontinued operations in the year ended December 31, 2016.
Radian Group serves as the holding company for our insurance subsidiaries, through which we conduct our mortgage insurance business. These insurance subsidiaries are subject to comprehensive, detailed regulation by the insurance departments in the various states where our insurance subsidiaries are domiciled or licensed to transact business. Insurance laws vary from state to state, but generally grant broad supervisory powers to state agencies or officials to examine insurance companies and enforce rules or exercise discretion affecting almost every significant aspect of the insurance business, including the power to revoke or restrict an insurance company’s ability to write new business. The state insurance regulations include various capital requirements and dividend restrictions based on our insurance subsidiaries’ statutory financial position and results of operations, as described below. Our failure to maintain adequate levels of capital could lead to intervention by the various insurance regulatory authorities, which could materially and adversely affect our business, business prospects and financial condition. As of December 31, 2016, the amount of restricted net assets held by our consolidated insurance subsidiaries (which represents our equity investment in those insurance subsidiaries) totaled $3.0 billion of our consolidated net assets.
At December 31, 2016, Radian Guaranty had negative unassigned surplus of $691.3 million, compared to negative unassigned surplus of $679.9 million at December 31, 2015. Radian Reinsurance, which began operations in December 2015, had negative unassigned surplus of $118.4 million at December 31, 2016, compared to negative unassigned surplus of $127.3 million at December 31, 2015 as a result of the establishment of contingency reserves. If either of these insurers had positive unassigned surplus as of the end of the prior fiscal year, such insurer only may pay dividends or other distributions during any 12-month period in an aggregate amount less than or equal to the greater of: (i) 10% of the preceding year-end statutory policyholders’ surplus; or (ii) the preceding year’s statutory net income. Due to the negative unassigned surplus at the end of 2016, no dividends or other distributions can be paid from Radian Guaranty or Radian Reinsurance without approval from the Pennsylvania Insurance Commissioner. Neither Radian Guaranty nor Radian Reinsurance paid any dividends in 2016 or 2015.
Under state insurance regulations, Radian Guaranty is required to maintain minimum surplus levels and, in certain states, a minimum ratio of statutory capital relative to the level of net RIF, or Risk-to-capital. There are 16 RBC States that currently impose a Statutory RBC Requirement. The most common Statutory RBC Requirement is that a mortgage insurer’s Risk-to-capital may not exceed 25 to 1. In certain of the RBC States, a mortgage insurer must satisfy an MPP Requirement. The statutory capital requirements for the non-RBC States are de minimis (ranging from $1 million to $5 million); however, the insurance laws of these states generally grant broad supervisory powers to state agencies or officials to enforce rules or exercise discretion affecting almost every significant aspect of the insurance business, including the power to revoke or restrict an insurance company’s ability to write new business. Unless an RBC State grants a waiver or other form of relief, if a mortgage insurer, such as Radian Guaranty, is not in compliance with the Statutory RBC Requirement of that state, the mortgage insurer may be prohibited from writing new mortgage insurance business in that state. Radian Guaranty’s domiciliary state, Pennsylvania, is not one of the RBC States.
The net decrease in Radian Guaranty’s Risk-to-capital in 2016 was primarily due to a decrease in net RIF at Radian Guaranty, resulting from insurance ceded pursuant to the Single Premium QSR Transaction during 2016, combined with statutory net income, which had the effect of increasing statutory policyholders’ surplus. The effect of both of these items was mainly offset by the repayment of the $325 million Surplus Note on June 30, 2016.
We have actively managed Radian Guaranty’s capital position in various ways, including: (i) through internal and external reinsurance arrangements; (ii) by seeking opportunities to reduce our risk exposure through commutations and other negotiated transactions; and (iii) by contributing additional capital from Radian Group.
Effective December 2015, Radian Reinsurance is domiciled and licensed in Pennsylvania as a stock casualty insurance company authorized to carry on the business of credit insurance, which includes the authority to reinsure policies of mortgage guaranty insurance. Radian Reinsurance is only licensed or authorized to write direct mortgage guaranty insurance in Pennsylvania. Radian Reinsurance is required to maintain a minimum statutory surplus of $20 million to remain an authorized reinsurer in all states. Radian Reinsurance did not receive capital contributions from Radian Group in the year ended December 31, 2016. During 2015, Radian Reinsurance received cash capital contributions from Radian Group totaling $50 million.
Radian Reinsurance’s statutory net income, statutory policyholders’ surplus and contingency reserve as of and for the years ended December 31, 2016 and 2015 were as follows:
Under SAPP, insurance policy acquisition costs are charged against operations in the year incurred. Under GAAP, such costs, other than those incurred in connection with the origination of derivative contracts, are deferred and amortized.
Under SAPP, income tax expense is calculated on the basis of amounts currently payable. Generally, DTAs are recognized under both SAPP and GAAP when it is more likely than not that the DTA will be realized. However, SAPP standards impose additional admissibility requirements whereby DTAs are only recognized to the extent they are expected to be recovered within a one- to three-year period subject to a capital and surplus limitation. Changes in DTAs and DTLs are recognized as a direct benefit or charge to unassigned surplus, whereas under GAAP changes in DTAs and DTLs, except for changes in unrealized gains and losses on available-for-sale securities, are recorded as a component of income tax expense.
In November 2016, we announced our intent to exercise our redemption option for the remaining Convertible Senior Notes due 2019, of which $68.0 million aggregate principal was outstanding at December 31, 2016. Radian elected to redeem all of the notes surrendered for conversion or redemption with cash. We settled our obligations on January 27, 2017 with a$110.1 million cash payment. At the time of settlement, this transaction resulted in a pretax charge of $4.5 million and reduced Radian Group’s diluted shares by 6.4 million.