At our new corporate headquarters, located at 1500 Market Street, in Philadelphia, Pennsylvania we currently lease approximately 174,000 square feet of office and storage space.
For periods beginning January 1, 2018, we expect the TCJA, excluding the impact of Discrete Items, to have a significant favorable impact on the Company’s net income, diluted earnings per share and cash flows, as compared to the tax laws in effect in 2017, primarily due to the reduction in the federal corporate tax rate from 35% to 21%. We are continuing to assess the potential effects of the TCJA on our future results. See “Item 1A. Risk Factors-The final impacts of the TCJA could be materially different from our current assessment,” “Results of Operations-Consolidated-Income Tax Provision” and Note 10 of Notes to Consolidated Financial Statements for additional information on the TCJA.
The following chart summarizes certain provisions of the TCJA and their impact on Radian.
Represents the remeasurement, upon enactment of the TCJA, of our net deferred tax assets at the enacted tax rates that are expected to apply to taxable income in the periods in which the deferred tax assets or liabilities are expected to be realized or settled.
Notwithstanding our current expectations, future guidance that may be issued or changes in policy or interpretations of the TCJA could have a positive or negative impact on our financial performance depending on how the changes would influence the economy, including business and consumer sentiment and the key factors influencing our performance.
Operating Environment. As a seller of mortgage credit protection and other credit risk management solutions, as well as mortgage and real estate services, our results are subject to macroeconomic conditions and specific events that impact the mortgage origination environment, the credit performance of our underlying insured assets and the business opportunities for our Services segment.
Lending laws and regulations that were enacted in response to the financial crisis of 2007-2008 resulted in increased regulation and regulatory scrutiny and a more restrictive credit environment that has limited the growth of the mortgage industry. Although this more restrictive credit environment resulted in overall improvement in credit quality, it also made it more challenging for many first-time home buyers to finance a home and has limited the number of loans available for private mortgage insurance. In response to first-time home buyer demand and affordability considerations, lenders and the GSEs recently have introduced new mortgage lending products, such as mortgage lending products that accommodate higher LTVs, including LTVs greater than 95%, as well as higher debt-to-income ratios. As a result, the private mortgage insurance industry, including Radian Guaranty, is experiencing a shift in the mix of mortgage lending products toward higher LTVs and higher debt-to-income ratios. See “Results of Operations-Mortgage Insurance-NIW, IIF, RIF” for additional information regarding our portfolio mix and the mortgage industry.
During the third quarter of 2017, Hurricanes Harvey and Irma caused extensive property damage to areas of Texas, Florida and Georgia, as well as other general disruptions including power outages and flooding. At December 31, 2017, our total primary mortgage insurance exposure to mortgages in counties affected by these storms and subsequently designated as FEMA Designated Areas is approximately $4.6 billion of RIF on approximately $17.4 billion of IIF. This exposure represents approximately 9% of our primary mortgage insurance RIF as of December 31, 2017. Although the mortgage insurance we write protects the lenders from a portion of losses resulting from loan defaults, it does not provide protection against property loss or physical damage. Our Master Policies contain an exclusion against physical damage, including damage caused by floods or other natural disasters. Depending on the policy form and circumstances, we may, among other things, deduct the cost to repair or remedy physical damage above a de minimis amount from a claim payment and/or, under certain circumstances, deny a claim where (i) the property underlying a mortgage in default is subject to unrestored physical damage or (ii) the physical damage is deemed to be the principal cause of default.
In order to be eligible to insure loans purchased by the GSEs, mortgage insurers such as Radian Guaranty must meet the GSEs’ eligibility requirements, or PMIERs. The PMIERs are comprehensive, covering virtually all aspects of the business and operations of a private mortgage insurer, including internal risk management and quality controls, the relationship between the GSEs and the approved insurer and the approved insurer’s financial condition. In addition, the GSEs have a broad range of consent rights under the PMIERs, and require private mortgage insurers to obtain the prior consent of the GSEs before taking certain actions, which may include paying dividends, entering into various intercompany agreements and commuting or reinsuring risk, among others. Radian Guaranty currently is an approved mortgage insurer under the PMIERs and is in compliance with the PMIERs financial requirements.
Seasoning factors are designed to adjust claim rate estimates for an expected loss pattern based on origination vintage.
While the overall improvements in the U.S. economy generally and, more specifically, the housing finance market have positively impacted the performance of our Mortgage Insurance business, this has not resulted in the business and growth opportunities for certain of our Services segment business lines that we had anticipated and forecasted. Among other things, highly competitive conditions and decreased demand for certain services have limited the volume of business for some of our Services segment business lines, as further discussed below. Additionally, the continued lack of a meaningful securitization market has significantly limited the growth opportunities for our Services segment.
We will only experience claims under these Front-end and Back-end credit risk transfer transactions if the borrower’s equity, any existing primary mortgage insurance and the GSEs’ retained risk are depleted. The GSEs retain the first losses on these credit risk transfer transactions, ranging from 35 to 50 basis points. Radian would then be responsible to cover the next layer of losses, which ranges in size from approximately 200 to 300 basis points.
As we reposition our Services business, we plan to continue to focus on using the services provided by our Services segment to 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 other mortgage insurance companies. Our current capabilities are illustrated by the graphic, “Product and Service Offerings” in “Item 1. Business-General.”
the settlement of our conversion obligations for the remaining aggregate principal amount of our Convertible Senior Notes due 2019 for $110.1 million in cash, resulting in an aggregate decrease as of the settlement date of 6.4 million diluted shares for the purpose of determining diluted net income per share; and
The purchases of our Senior Notes due 2019, 2020 and 2021 pursuant to the tender offers, together with the purchases of our Convertible Senior Notes due 2017 and the settlement of our remaining Convertible Senior Notes due 2019, resulted in an aggregate pretax charge of $51.5 million during 2017, recorded as a loss on induced conversion and debt extinguishment. The combination of these transactions is estimated to reduce our future annual cash interest payments by approximately $5.8 million and increased the weighted-average maturity of our senior notes by nearly two years. See “Liquidity and Capital Resources-Radian Group-Short-Term Liquidity Needs” and Note 12 of Notes to Consolidated Financial Statements for additional information about these transactions.
On August 9, 2017, Radian Group’s board of directors renewed its share repurchase program and authorized the Company to spend up to $50 million to repurchase Radian Group common stock in the open market or in privately negotiated transactions, based on market and business conditions, stock price and other factors. As of December 31, 2017, the full purchase authority of up to $50 million remained available under this program, which expires on July 31, 2018. See Note 14 of Notes to Consolidated Financial Statements for additional details.
Effective December 31, 2017, we increased the amount of risk ceded under the 2016 Single Premium QSR Transaction by amending the terms of the transaction to increase the amount of ceded risk on performing loans under the agreement from 35% to 65% for the 2015 through 2017 vintages. This amendment increases the amount of risk ceded as of its effective date, including for the purposes of calculating any future ceding commissions and profit commissions that Radian Guaranty will earn. See “Liquidity and Capital Resources-Radian Group-Short-Term Liquidity Needs” for more information, including the impact of the 2016 Single Premium QSR Transaction amendment on our PMIERs financial position.
IIF; Persistency Rate; Mix of Business. Our IIF is one of the primary drivers of our future premiums that will be earned over time. Based on the composition of our insurance portfolio, with Monthly Premium Policies comprising a larger proportion of our total portfolio than Single Premium Policies, an increase or decrease in IIF generally has 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. See “Results of Operations-Mortgage Insurance-NIW, IIF, RIF” for more information about the levels and characteristics of our NIW, IIF and RIF.
The ultimate profitability of our Mortgage Insurance business is affected by the impact of mortgage prepayment speeds on the mix of business we write. The measure for assessing the impact of policy cancellations on our IIF is our Persistency Rate, defined as the percentage of IIF that remains in force over a period of time. Assuming all other factors remain constant, over the life of the policies prepayment speeds have an inverse impact on IIF and the expected revenue from our Monthly Premium Policies. Slower loan prepayment speeds, demonstrated by a higher Persistency Rate, result in IIF remaining in place, providing increased revenue from Monthly Premium Policies over time as premium payments continue and we recover more of our policy acquisition costs. Earlier than anticipated loan prepayments, demonstrated by a lower Persistency Rate, reduce IIF and the revenue from our Monthly Premium Policies. Prepayment speeds may be affected by changes in interest rates, among other factors. An increasing interest rate environment generally will reduce refinancing activity and result in lower prepayments, whereas a declining interest rate environment generally will increase the level of refinancing activity and therefore increase prepayments.
In contrast to Monthly Premium 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. Although these cancellations reduce IIF, assuming all other factors remain constant, the profitability of our Single Premium business increases when Persistency Rates are lower.
Private mortgage insurance penetration in the insurable market tends to be significantly higher on new mortgages for purchased homes than on the refinance of existing mortgages, because average LTV ratios are typically higher on home purchases and therefore are more likely to require mortgage insurance. Radian Guaranty’s share of the private mortgage insurance market is influenced by competition in that market. See “Item 1. Business-Mortgage Insurance-Competition” and “Results of Operations-Mortgage Insurance-NIW, IIF, RIF.”
Based on actual dollars generated in the market, as reported by GSEs and company publicly reported information. Q4 2017 is based on most recent available industry and GSE estimates.
Rescissions, which are discussed in further detail below, result in a full refund of the inception-to-date premiums received, and therefore, premiums earned are negatively affected by any increases in our accrual for estimated Rescission refunds. Additionally, premiums ceded to third-party reinsurance counterparties decrease premiums written and earned.
Other Operating Expenses. Our other operating expenses are affected by the amount of our NIW, as well as the amount of RIF. Additionally, during 2015, our operating expenses were impacted significantly by compensation expense associated with changes in the estimated fair value of certain of our long-term equity-based incentive awards that were settled in cash. The fair value of these awards, and associated compensation expense, were dependent, in large part, on our stock price at any given point in time. Under the terms of our current awards, we do not expect expense volatility associated with our equity-based incentive awards in the future.
Third-Party Reinsurance. We use third-party reinsurance in our mortgage insurance business to manage capital and risk, including to balance our retained mix of Single Premium Policies and Monthly Premium Policies. See “- Mortgage Insurance-IIF.” 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. These arrangements have the impact of reducing our earned premiums but also reduce our net RIF, which provides capital relief, including under the PMIERs financial requirements. Our incurred losses are reduced by any incurred losses ceded in accordance with the reinsurance agreement, and 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.
Our Services segment is a fee-for-service business that offers a broad array of both mortgage and real estate services to market participants across the mortgage and real estate value chain. In connection with the restructuring of our Services business, we have refined our Services business strategy going forward to focus on our core mortgage and real estate services. These services provide mortgage lenders, financial institutions, mortgage and real estate investors and government entities, among others, with information and other resources and services that are used to originate, evaluate, acquire, securitize, service and monitor residential real estate and loans secured by residential real estate. Our mortgage services offerings include transaction management services such as loan review, RMBS securitization and distressed asset reviews, servicer and loan surveillance and underwriting. Our real estate services include REO asset management; review and valuation services related to single family rental properties; real estate valuation services; real estate brokerage services; and title and settlement services that include title search, settlement and closing services. See “Item 1. Business-Services-Customers” for additional information regarding the Services segment’s customers.
The services that we will no longer offer as a result of the restructuring of our Services business have not had a material impact on our consolidated cash flows or results of operations in recent periods. Therefore, as compared to our results in 2016 or 2017, we do not expect a material impact on our consolidated cash flows or results of operations from discontinuing these services. See “Overview-Operating Environment and Business Strategy” for more information. See Note 1 of Notes to Consolidated Financial Statements, “Item 1. Business-Services-Services Business Overview” and “Overview-Other 2017 Developments” for additional information regarding the Services segment.
Our Services revenue is generated under three basic types of contracts:
Fixed-Price Contracts. Under fixed-price contracts, we agree to perform the specified services and deliverables for a pre-determined per-unit or per-file price or day rate. To the extent our actual direct and allocated indirect costs decrease or increase from the estimates upon which the price was negotiated, we will generate more or less profit, respectively, or could incur a loss. We use fixed-price contracts in our real estate valuation and component services, our loan review, underwriting and due diligence services as well as our title and closing services. We also use fixed-price contracts in our surveillance business for our servicer oversight services and RMBS surveillance services, and in our REO management 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 our proprietary technology, property leads are sent to select clients. Upon the client’s successful closing on the property, we recognize revenue for these transactions based on a percentage of the sale.
Tax Cuts and Jobs Act. On December 22, 2017, the TCJA was signed into law. The TCJA significantly changes the U.S. tax system, and includes, among other things, a reduction of the federal corporate tax rate from 35% to 21%, effective January 1, 2018. Because deferred tax assets and liabilities are measured using the enacted tax rates that are expected to apply to taxable income in the periods in which the deferred tax assets or liabilities are expected to be realized or settled, the enactment of the TCJA resulted in a material reduction of our net deferred tax assets.
Based on our current understanding of the TCJA, we believe that our effective tax rate for 2018, excluding the impact of Discrete Items, will approximate the statutory rate of 21%. However, our effective tax rate may be affected by any return-to-provision adjustments for temporary differences recorded during 2018, because these adjustments will affect our current provision at a 35% rate while affecting our deferred provision at a 21% rate. Our return-to-provision adjustments are accounted for as Discrete Items and are generally recorded in the three-month period ending December 31. Because there may be future changes in interpretations of the TCJA and additional guidance issued, as well as changes in our assumptions or actions as a result of the TCJA, our actual future effective tax rate may differ from our initial estimates.
Notwithstanding our current expectations, future policy changes or interpretations could have a positive or negative impact on our financial performance depending on how the changes would influence the economy, including business and consumer sentiment and the key factors influencing our performance.
Net Income from Continuing Operations. As discussed in more detail below, our results for 2017 compared to 2016 primarily reflect: (i) the impairment of goodwill and other intangible assets related to the Services segment; (ii) additional tax expense related to the remeasurement of our net deferred tax assets as a result of the TCJA; (iii) a decrease in net gains on investments and other financial instruments; (iv) an increase in other operating expenses; and (v) restructuring and other exit costs associated with our plan to restructure the Services business. These items were partially offset by, among other things: (i) a decrease in provision for losses; (ii) a decrease in loss on induced conversion and debt extinguishment; and (iii) lower interest expense.
Income from Discontinued Operations, Net of Tax. In 2015, we recorded net income from discontinued operations due to the completion of the sale of Radian Asset Assurance to Assured on April 1, 2015. See Note 18 of Notes to Consolidated Financial Statements for more information.
Diluted Net Income Per Share. The change in diluted net income per share for 2017 was unfavorable compared to 2016, primarily due to the changes in net income, as discussed above, partially offset by the decrease in average diluted shares. The average diluted shares decreased from 229.3 million shares in 2016 to 220.4 million shares for 2017.
The $0.56 increase in book value per share resulting from our net income is net of the impact of a goodwill and other intangible assets impairment charge of $0.61 per share and an incremental tax provision of $0.48 per share related to the remeasurement of our net deferred tax assets as a result of the TCJA.
Services Revenue and Cost of Services. Services revenue and cost of services all relate to our Services segment. See “Results of Operations-Services” for more information.
Net gains on investments and other financial instruments decreased in 2016 as compared to 2015, primarily due to a decrease in net realized gains on investments in 2016 as compared to 2015. In 2015 we sold equity securities in our portfolio and reinvested the proceeds in assets that qualify as PMIERs-compliant Available Assets, recognizing pretax gains of $69.2 million. This decrease was partially offset by an increase in unrealized gains related to change in fair value of trading securities and other investments. The components of the net gains (losses) on investments and other financial instruments for the periods indicated are as follows:
Other Operating Expenses. Other operating expenses for 2017 increased as compared to 2016, primarily due to: (i) $6.6 million of expenses associated with retirement and consulting agreements entered into in February 2017 with our former Chief Executive Officer; (ii) increases in technology expenses associated with a significant investment in upgrading our systems; (iii) expenses accrued to defend and resolve certain outstanding legal matters; and (iv) a decrease in ceding commissions. The increase in other operating expenses for 2017 was partially offset by lower compensation expense in 2017, including variable incentive-based compensation.
Amortization and Impairment of Intangible Assets and Impairment of Goodwill. The amortization of intangible assets primarily reflects the amortization of intangible assets acquired as part of the Clayton acquisition. During the second quarter of 2017, we recorded a goodwill impairment charge of $184.4 million, as well as an impairment charge for other intangible assets of $15.8 million, in each case related to our Services segment. These charges were primarily due to changes in expectations regarding the future growth of certain Services business lines, resulting from changes in our business strategy, combined with market trends observed during the second quarter of 2017 that we expect to persist. As a result, as of December 31, 2017, the remaining balances of goodwill and other intangible assets reported in our consolidated balance sheet were $10.9 million and $53.3 million, respectively. See “-Overview-Operating Environment and Business Strategy-Business Strategy” and Note 7 of Notes to Consolidated Financial Statements for additional information.
Income Tax Provision. Our effective tax rate from continuing operations was 65.1% for 2017, compared to 36.3% for 2016 and 35.7% for 2015. The increase in our 2017 effective tax rate was primarily due to the impact of the TCJA, which resulted in a $102.6 million increase in our income tax provision, as discussed below.
On December 22, 2017, the TCJA was signed into law. The TCJA significantly changes the U.S. tax system, and includes, among other things, a reduction of the federal corporate tax rate from 35% to 21%, effective January 1, 2018. Because deferred tax assets and liabilities are measured using the enacted tax rates that are expected to apply to taxable income in the periods in which the deferred tax assets or liabilities are expected to be realized or settled, the enactment of the TCJA resulted in a $102.6 million reduction of our net deferred tax assets, recorded as additional income tax provision in 2017. In accordance with SAB 118, the measurement of certain of our deferred taxes was recorded provisionally, and may be adjusted within the next year.
As of December 31, 2017, our deferred tax balances for certain items, primarily including uncertain tax positions, NOLs expected to be utilized in carryback years and our inventory of tax credit carryforwards, did not require adjustment, as the value at which these amounts are expected to be realized was not affected by the enactment of the TCJA. As a result, approximately $78.4 million of our net deferred tax asset balance was not impacted by the corporate tax rate reduction.
Based on our current understanding of the TCJA, we believe that our effective tax rate for 2018, excluding the impact of Discrete Items, will approximate the statutory rate of 21%. However, our effective tax rate may be affected by any return-to-provision adjustments for temporary differences recorded during 2018, because these adjustments will affect our current provision at a 35% rate while affecting our deferred provision at a 21% rate. Our return-to-provision adjustments are accounted for as Discrete Items and are generally recorded annually in the three-month period ending December 31. Because there may be future changes in interpretations of the TCJA and additional guidance issued, as well as changes in our assumptions or actions as a result of the TCJA, our actual future effective tax rate may differ from our initial estimates.
Use of Non-GAAP Financial Measure. In addition to the traditional GAAP financial measures, we have presented “adjusted pretax operating income,” a non-GAAP financial measure for the consolidated company, among our key performance indicators to evaluate our fundamental financial performance. This non-GAAP financial measure aligns with the way our business performance is evaluated by both management and by our board of directors. This measure has been established in order to increase transparency for the purposes of evaluating our core operating trends and enabling more meaningful comparisons with our peers. Although on a consolidated basis “adjusted pretax operating income” is a non-GAAP financial measure, for the reasons discussed above we believe this measure aids in understanding the underlying performance of our operations. Our senior management, including our Chief Executive Officer (Radian’s chief operating decision maker), uses adjusted pretax operating income (loss) as our primary measure to evaluate the fundamental financial performance of each of the Company’s business segments and to allocate resources to the segments.
Net gains (losses) on investments and other financial instruments. The recognition of realized investment gains or losses can vary significantly across periods as the activity is highly discretionary based on the timing of individual securities sales due to such factors as market opportunities, our tax and capital profile and overall market cycles. Unrealized investment gains and losses arise primarily from changes in the market value of our investments that are classified as trading securities. These valuation adjustments may not necessarily result in realized economic gains or losses.
The following table summarizes our Mortgage Insurance segment’s results of operations for the years ended December 31, 2017, 2016 and 2015:
Our senior management uses adjusted pretax operating income (loss) as our primary measure to evaluate the fundamental financial performance of our business segments.
Includes allocation of corporate operating expenses of $55.4 million, $45.2 million and $46.4 million for 2017, 2016 and 2015, respectively.
Adjusted Pretax Operating Income. Our Mortgage Insurance segment’s adjusted pretax operating income for 2017 was $651.0 million, compared to $561.9 million for 2016 and $511.0 million for 2015. Our results for 2017 compared to 2016 primarily reflect a decrease in the provision for losses and to a lesser extent, a decrease in interest expense. The increase in the segment’s adjusted pretax operating income was partially offset by higher other operating expenses. 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 2016 Single Premium QSR Transaction.
The 7.0% increase in NIW for 2017 compared to 2016 is primarily attributable to an overall increase in purchase mortgage originations and an increase in our share of the mortgage insurance market, partially offset by decreased refinance originations.
Although it is difficult to project future volumes, industry sources expect the mortgage origination market in 2018 to decline approximately 5% compared to 2017, driven by a decline in refinance originations of approximately 26% as a result of higher anticipated interest rates, partially offset by an expected increase in purchase originations of approximately 7%. Given our expected penetration rates, we expect the private mortgage insurance market to be only modestly smaller in 2018 compared to 2017. Based on industry forecasts and our projections, we expect our NIW in 2018 to be approximately $50 billion.
The mortgage loans underlying our RIF originated after 2009 possess significantly improved credit characteristics compared to our portfolio originated before 2009. See “Characteristics of Mortgage Insurance Portfolio” below. For example, FICO scores for the borrowers of our current portfolio of insured mortgages are higher, and there are fewer loans with LTVs greater than 95%.
Recently, NIW on mortgage loans with LTVs greater than 95% has been increasing throughout the industry. In general, borrowers who purchase a home with mortgage insurance tend to have higher LTVs than borrowers who refinance with mortgage insurance. With purchase volume becoming a larger proportion of total originations and access to credit continuing to steadily expand, the proportion of higher-LTV lending in the market has increased. As further described below, additional primary factors contributing to an increase in the industry’s NIW on mortgage loans with LTVs greater than 95% include: (i) GSE program enhancements (as further discussed below) and guideline changes and (ii) recent lender response to market demands, particularly in light of increasing demand from first-time home buyers. These primary drivers have been further supported by FHA regulatory enforcement actions that may cause lenders to choose GSE execution over the FHA, as well as the widespread private mortgage insurance pricing changes that occurred in the first half of 2016.
Our expected future losses on our portfolios written after 2008, together with HARP refinancings, are significantly lower than those experienced on our NIW prior to 2009. The following charts illustrate the trends of our cumulative incurred loss ratios by year of origination and development year.
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. 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).
During the third quarter of 2017, the scheduled final settlement date under the Freddie Mac Agreement occurred, resulting in a negative impact on the Persistency Rate due to the removal from RIF and IIF of most of the loans subject to the Freddie Mac Agreement. The Persistency Rate was also reduced by an increase in cancellations of Single Premium Policies due to increased cancellations identified by our ongoing servicer monitoring process for Single Premium Policies.
The Persistency Rate annualized based on the quarter ended December 31, 2016 was less than in 2015, primarily due to the volume of Single Premium Policies that were cancelled during the fourth quarter of 2016, which were higher as compared to the same quarter in 2015.
Net Premiums Written and Earned. Net premiums written in 2017 increased compared to 2016, primarily due to a decrease in ceded premiums written, combined with the increase in our IIF. Net premiums written decreased in 2016 compared to 2015, primarily due to $233.2 million of ceded premiums written under the 2016 Single Premium QSR Transaction, partially offset by the increase in our IIF in 2016.
Ceded premiums written in all years included the cession of premiums from prior years’ vintages. Ceded premiums written in 2017 included a $145.7 million increase due to the amendment of the 2016 Single Premium QSR Transaction effective as of December 31, 2017, which increased the amount of ceded risk on performing loans for 2015 through 2017 vintages under the agreement from 35% to 65%. Ceded premiums written in 2016 included the implementation of the 2016 Single Premium QSR Transaction, effective as of January 1, 2016. At its initial implementation, the 2016 Single Premium QSR Transaction resulted in ceding certain Single Premium IIF written from January 1, 2012 to January 1, 2016, which negatively impacted net premiums written in 2016. See Note 8 of Notes to Consolidated Financial Statements for additional information regarding our reinsurance transactions.
Net premiums earned increased in 2017, compared to 2016, primarily as a result of increased IIF and decreased ceded premiums, net of profit commissions, partially offset by less accelerated revenue recognition due to fewer Single Premium Policy cancellations during 2017.
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 2016 Single Premium QSR Transaction. Net premiums earned were also impacted by our increased level of IIF in 2016, as compared to 2015.
We experienced a decrease in our total mix of Single Premium Policies to 23% of our NIW for 2017, as compared to 27% for 2016. We expect our production level for Single Premium Policies to vary over time based on various factors, which include risk-return and risk-mix considerations, as well as market conditions.
We enter into reinsurance transactions as a cost-effective strategy to efficiently manage our capital position and risk profile, including managing Radian Guaranty’s Risk-to-capital and its position under the PMIERs financial requirements. In the first quarter of 2016, Radian Guaranty entered into the 2016 Single Premium QSR Transaction in order to proactively manage the risk and return profile of Radian Guaranty’s insured portfolio and to manage its position under the PMIERs financial requirements. Radian Guaranty began ceding business under this agreement effective January 1, 2016.
The 2016 and 2018 Single Premium QSR Transactions are expected to increase Radian Guaranty’s return on required capital for its Single Premium Policies. In future periods, the impact of these transactions will vary depending on the level of ceded RIF, as well as the levels of prepayments and incurred losses on the reinsured portfolio, among other factors.
For all areas other than FEMA Designated Areas associated with Hurricanes Harvey and Irma, the number of total new primary mortgage insurance defaults in our insured portfolio decreased by 7.2%, as compared to 2016. Our gross Default to Claim Rate assumption for new primary defaults, excluding the new primary defaults in FEMA Designated Areas associated with Hurricanes Harvey and Irma received subsequent to those two natural disasters, was 10% as of December 31, 2017, compared to 12% as of December 31, 2016. This reduction in estimated gross Default to Claim Rate assumptions, which was based on observed trends, contributed to the reduction in the portion of our provision for losses related to new defaults in 2017, compared to 2016. In addition, the 2017 provision on current year defaults includes approximately $14 million related to pool commutations.
In addition to the positive trends in our provision for losses for current year defaults for 2017 and 2016, we experienced positive reserve development on prior year defaults, primarily due to reductions in certain Default to Claim Rate assumptions based on observed trends of higher Cures than were previously estimated on those prior year defaults.
The impact of the reductions in losses for current year defaults in 2016 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. The favorable development on prior year defaults observed in 2016 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. 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.
Excludes 100; 1,639; and 2,821 loans that are in default at December 31, 2017, 2016 and 2015, respectively, subject to the Freddie Mac Agreement, and for which we no longer have claims exposure. During the third quarter of 2017, the scheduled final settlement date under the Freddie Mac Agreement occurred. As of December 31, 2017, the remaining loans subject to the Freddie Mac Agreement were those with Loss Mitigation Activity and pending claims activity already in process but not yet finalized.
Included in this amount at December 31, 2017 are the defaults in the FEMA Designated Areas associated with Hurricanes Harvey and Irma, which occurred during the third quarter of 2017. At December 31, 2017, 2016 and 2015, defaults in these areas were 7,051; 3,321; and 4,214, respectively.
For all areas other than the FEMA Designated Areas associated with Hurricanes Harvey and Irma, we currently expect total new defaults for 2018 to continue to decrease, although the rate of decrease may moderate. This is due, in part, to the shift in our portfolio composition toward more recent vintages for which we expect increasing levels of new defaults, consistent with typical default seasoning patterns.
Includes those charged to a deductible or captive and, for 2015, claim payments related to the BofA Settlement Agreement.
Our mortgage insurance total loss reserve as a percentage of our mortgage insurance total RIF was 1.0% at December 31, 2017, compared to 1.6% at December 31, 2016 and 2.1% at December 31, 2015. 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.
Our primary reserve per default (calculated as primary reserve excluding IBNR and other reserves divided by the number of primary defaults) was $17,103, $22,503 and $24,019 at December 31, 2017, 2016 and 2015, respectively. The $17,103 primary reserve per default at December 31, 2017, includes the impact of reserves and defaults related to the FEMA Designated Areas associated with Hurricanes Harvey and Irma. Excluding the impact from new defaults received subsequent to Hurricanes Harvey and Irma in these FEMA Designated Areas, this amount would be approximately $20,500.
Total mortgage insurance claims paid in 2017 of $390.4 million have decreased from claims paid of $417.6 million in 2016, primarily due to the decline in the outstanding default inventory, partially offset by the payment of $54.8 million that, as expected, was made during 2017 in connection with the scheduled final settlement of the Freddie Mac Agreement. See “Liquidity and Capital Resources-Mortgage Insurance” for more information. Total mortgage insurance claims paid in 2016 of $417.6 million 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. Although expected claims are included in our reserve for losses, the timing of claims paid is subject to fluctuation from period to period, based on the rate that defaults cure and other factors (as described in “Item 1. Business-Mortgage Insurance-Defaults and Claims”) that make the timing of paid claims difficult to predict. Depending on those factors, we currently expect to pay claims of less than $300 million for the full year of 2018, excluding any payments negotiated under future commutation agreements.
Includes the impact of commutations and captive terminations. For 2017, includes payments that, as expected, were made in connection with the final settlement of the Freddie Mac Agreement, as well as payments to commute mortgage insurance coverage on certain performing and non-performing loans on which we had Pool Insurance risk. For 2015, includes the impact of the BofA Settlement Agreement from the February 1, 2015 implementation date.
Other operating expenses for 2016 decreased compared to 2015, primarily as a result of the benefit of ceding commissions from the 2016 Single Premium QSR Transaction, partially offset by increases in compensation-related expense and technology expenses associated with a significant investment in upgrading our systems.
Primarily includes employee severance and related benefit costs. Does not include impairment of long-lived assets and loss from the sale of a business line, which are not components of adjusted pretax operating income.
Adjusted pretax operating income (loss). Our Services segment’s adjusted pretax operating loss was $33.8 million in 2017 compared to adjusted pretax operating losses of $20.2 million in 2016 and $0.2 million in 2015. The increase in our adjusted pretax operating loss in 2017, as compared to 2016, was primarily driven by: (i) restructuring and other exit costs and (ii) decreased gross profit, as discussed further below. The increase in our adjusted pretax operating loss in 2016 as compared to 2015 was primarily driven by: (i) increases in other operating expenses and (ii) decreases in gross profit.
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 single family rental securitization market and slight decreases in loan review and surveillance services.
Other operating expenses also include other selling, general and administrative expenses, depreciation, and allocations of corporate general and administrative expenses. Other operating expenses for 2017 include allocations of corporate operating expenses of $14.3 million, compared to $8.5 million and $4.8 million for 2016 and 2015, respectively. The increase in 2017, as compared to 2016, is primarily due to: (i) an increase in total corporate expenses, primarily due to expenses associated with the retirement and consulting agreements entered into with our former Chief Executive Officer and (ii) an increase in the proportion of corporate expenses allocated to the Services segment. The increase in 2016, as compared to 2015, is primarily due to an increase in the portion of corporate expense allocated to the Services segment.
The following table summarizes certain of our contractual obligations and commitments, including our expected claim payments on insurance policies and interest payments on debt obligations, as of December 31, 2017, and the future periods in which such obligations are expected to be settled in cash. Additional details regarding these obligations are provided in the narrative following the table and in the Notes to Consolidated Financial Statements that are referenced in the table.
To the Board of Directors and Stockholders of Radian Group Inc.
We have audited the accompanying consolidated balance sheets of Radian Group Inc. and its subsidiaries as of December 31, 2017 and 2016, and the related consolidated statements of operations, comprehensive income, changes in common stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017, including the related notes and financial statement schedules listed in the index appearing under Item 15(a)(3) (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Our Mortgage Insurance segment provides credit-related insurance coverage, principally through private mortgage insurance, as well as other credit risk management solutions, to mortgage lending institutions nationwide. Private mortgage insurance plays an important role in the U.S. housing finance system because it promotes affordable home ownership and helps protect mortgage lenders, investors or other beneficiaries by mitigating default-related losses on residential mortgage loans. Generally, these loans are made to home buyers who make down payments of less than 20% of the purchase price for their home or, in the case of refinancings, have less than 20% equity in their homes. Private mortgage insurance also facilitates the sale of these low down payment loans in the secondary mortgage market, most of which are sold to the GSEs.
The PMIERs financial requirements require that a mortgage insurer’s Available Assets meet or exceed its Minimum Required Assets. The GSEs may amend the PMIERs at any time, and they have broad discretion to interpret the requirements, which could impact the calculation of Radian Guaranty’s Available Assets and/or Minimum Required Assets, and the PMIERs specifically provide that the factors that are applied to calculate and determine a mortgage insurer’s Minimum Required Assets may be updated every two years following a minimum of 180 days’ notice, or more frequently, as determined by the GSEs, to reflect changes in macroeconomic conditions or loan performance. On December 18, 2017, Radian Guaranty received, on a confidential basis, a summary of proposed changes to the PMIERs. Although it is reasonably likely that updates to the PMIERs could, among other things, result in a material increase to Radian Guaranty’s capital requirements under the PMIERs financial requirements, Radian expects to be able to fully comply with the proposed PMIERs as of the expected effective date in late 2018.
Our Services business is a fee-for-service business that offers a broad array of services to market participants across the mortgage and real estate value chain. These comprise mortgage services and real estate services that provide mortgage lenders, financial institutions, mortgage and real estate investors and government entities, among others, with information and other resources and services that are used to originate, evaluate, acquire, securitize, service and monitor residential real estate and loans secured by residential real estate.
Restructuring and Other Exit Costs. Based on our strategic assessment of the Services business, on September 5, 2017, the Company committed to a plan to restructure the Services business and incurred pretax restructuring charges of $17.3 million in 2017, including $6.8 million in cash payments. Additional pretax restructuring charges of approximately $3.8 million, including approximately $3.0 million in cash, are expected to be recognized within the next 12 months. The total restructuring charges of approximately $21.1 million are expected to consist of: (i) asset impairment charges (including the loss recognized on the sale of our EuroRisk business) of approximately $11.3 million; (ii) employee severance and benefit costs of approximately $7.1 million; (iii) facility and lease termination costs of approximately $1.8 million; and (iv) contract termination and other restructuring costs of approximately $0.9 million. See Note 7 for additional information, including the events that led to the restructuring decision.
Impairment of Goodwill and Other Intangible Assets. During the second quarter of 2017, we recorded a goodwill impairment charge and an impairment charge for other intangible assets. See Note 7 for additional information.
Reinsurance. During 2017, we entered into the 2018 Single Premium QSR Transaction with a panel of reinsurers and we amended the terms of the 2016 Single Premium QSR Transaction to increase the ceded risk on performing loans from 35% to 65% for the 2015 through 2017 vintages. See Note 8 for additional information about our reinsurance transactions.
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.
After estimating the Default to Claim Rate, we estimate Claim Severity based on the average of recently observed severity rates within product type, type of insurance, and Time in Default cohorts. These average severity estimates are then applied to individual loan coverage amounts to determine reserves. Similar to the Default to Claim Rate, Claim Severity also is impacted by the length of time that loans are in default and by our Loss Mitigation Activity. For claims under our primary mortgage insurance, the coverage percentage is applied to the claim amount, which consists of the unpaid loan principal, plus past due interest (for which our liability is contractually capped in accordance with the terms of our Master Policies) and certain expenses associated with the default, to determine our maximum liability. Therefore, Claim Severity generally increases the longer that a loan is in default. In addition, we estimate the impact that the amount that Claim Curtailments due to servicer noncompliance with our insurance policies and servicing guidelines have on the amount that we ultimately will have to pay with respect to claims. As part of our claims review process, we assess whether defaulted loans were serviced appropriately in accordance with our insurance policies and servicing guidelines. If a servicer failed to satisfy its servicing obligations, our insurance policies provide that we may curtail the claim payment for such default, and in some circumstances, cancel coverage or deny the claim.
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. During the third quarter of 2017, the scheduled final settlement date under the Freddie Mac Agreement occurred, although an immaterial amount remains outstanding due to Loss Mitigation Activity and pending claims activity already in process but not yet finalized. See Note 11 for additional information about the Freddie Mac Agreement.
Mortgage insurance premiums written on an annual or multi-year basis are initially recorded as unearned premiums and earned over time. Annual premiums are amortized on a monthly, straight-line basis. Multi-year premiums are amortized over the terms of the contracts in relation to the anticipated claim payment pattern based on historical industry experience. Premiums written on a monthly basis are earned over the period that coverage is provided. When we rescind insurance coverage on a loan, we refund all premiums received in connection with such coverage. Premium revenue is recognized net of our accrual for estimated premium refunds due to Rescissions or other factors. With respect to our reinsurance transactions, ceded premiums written are initially set up as prepaid reinsurance and are amortized in a manner consistent with the recognition of income on direct premiums.
The Services segment also provides certain services under multiple element arrangements, including valuations, title reviews and tax lien reviews. Contracts for these services include provisions requiring the client to pay a per-unit price for services that have been performed if the client cancels the contract. Each service qualifies as a separate unit of accounting on a per-unit basis, and we recognize revenue as each individual service is performed.
We are required to establish a valuation allowance against our deferred tax assets when it is more likely than not that all or some portion of our deferred tax assets 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 deferred tax assets will be realized in future periods.
On December 22, 2017, the TCJA was enacted into law. We are required to recognize the accounting effects of the TCJA in the period of enactment, such as remeasuring our deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. In December 2017, the SEC staff issued SAB 118, which provides guidance on accounting for the tax effects of the TCJA for which the accounting is incomplete. To the extent that a company’s accounting for certain income tax effects of the TCJA is incomplete but it is able to determine a reasonable estimate, it must record provisional estimates in the financial statements, during a measurement period not to extend beyond one year of the enactment date. Since the TCJA was passed late in the fourth quarter of 2017, and ongoing guidance and accounting interpretation is expected over the next 12 months, we have accounted for the tax effects of the TCJA on a provisional basis. Although our accounting for certain income tax effects is incomplete, we have determined reasonable estimates for those effects. Our reasonable estimates are included in our financial statements as of December 31, 2017 and we expect to complete our accounting during the one-year measurement period from the enactment date.
We record an other-than-temporary impairment adjustment on a security with an unrealized loss 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 accumulated other comprehensive income (loss), 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:
Accounts and notes receivable primarily consist of accrued premiums receivable due from our mortgage insurance customers, amounts billed and 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. Accounts and notes receivable exclude unbilled receivables totaling $22.3 million, which represent receivables for services performed that are not yet billed. Unbilled receivables are presented in other assets.
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 Radian’s market capitalization below book value if such decline is 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.
In performing the quantitative analysis for our goodwill impairment test as of June 30, 2017, we elected to early adopt the update to the accounting standard regarding goodwill and other intangibles, as discussed in “Recent Accounting Pronouncements-Accounting Standards Adopted During 2017, ” below. This update simplifies the subsequent measurement of goodwill by eliminating step two of the goodwill impairment test. Under the new guidance, if indicators for impairment are present, we perform a quantitative analysis to evaluate our long-lived assets for potential impairment, and then determine the amount of the goodwill impairment by comparing a reporting unit’s fair value to its carrying amount. After adjusting the carrying value for any impairment of other intangibles or long-lived assets, an impairment charge is recognized for any excess of the reporting unit’s carrying amount over the reporting unit’s estimated fair value, up to the full amount of the goodwill allocated to the reporting unit.
Restructuring and other exit costs include items such as asset impairment charges (including loss from the sale of a business line), employee severance and benefit costs, facility and lease termination costs, contract terminations and other costs of restructuring or exiting activities. The timing of the future expense and associated cash payments for restructuring and other exit costs is dependent on the type of exit cost and is expected to be completed within the next 12 months. We review assets for impairment in accordance with the accounting guidance for long-lived assets. The loss on sale of a business line is calculated by the excess of its carry amount over the sale price. Generally, our employee severance and benefit costs are part of the Company’s ongoing benefit arrangement and are recognized when probable and estimable. A liability for facility and lease contract termination costs is recognized at the date we cease the use of rights conveyed by the contract and is measured at its fair value, which is determined based on the remaining contractual lease rentals reduced by estimated sublease rentals. Other contract termination and exit costs include future costs that will be incurred, which are recognized in total when they no longer will benefit the Company. The liabilities for restructuring and other exit costs are recorded in other liabilities.
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 together represent the majority 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 for public companies 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 either the full retrospective or the modified retrospective transition method. We currently anticipate using the modified retrospective method of adoption, with the cumulative effect of initially applying the guidance recognized at the date of adoption. We have reviewed current accounting policies and key contracts that are representative of our various products and services within the Services segment and are in the process of comparing our historical accounting policies and practices to the requirements of the new guidance. We have identified immaterial differences resulting from applying the new requirements to our contracts which mainly affect timing of revenue recognition. Given that most of our contracts are short-term in nature, we do not expect the impact to be material to our financial statements. We have also identified appropriate changes to our business processes, systems and controls to support recognition and disclosure under the new guidance.
In October 2016, the FASB issued an update to the accounting standard regarding the accounting for income taxes. This update requires an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. This update will be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. 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 permitted, including adoption in the first interim period of the adoption year. We have concluded there is currently no impact to our financial statements and future disclosures as a result of this update.
In February 2018, the FASB issued an update to the accounting standard regarding income statement reporting of comprehensive income and reclassification of certain tax effects from accumulated other comprehensive income. The amendments in this update allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the TCJA. The provisions of this update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period, for reporting periods for which financial statements have not been available for issuance. We are currently evaluating the impact to our financial statements and future disclosures as a result of this update.
The calculation of the basic and diluted net income per share was as follows:
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 original issued amount of $300 million from the Senior Notes due 2019 that were used to fund our purchase of Clayton; and (iii) all corporate cash and investments.
Net gains (losses) on investments and other financial instruments. The recognition of realized investment gains or losses can vary significantly across periods as the activity is highly discretionary based on the timing of individual securities sales due to such factors as market opportunities, our tax and capital profile and overall market cycles. Unrealized investment gains and losses arise primarily from changes in the market value of our investments that are classified as trading securities. These valuation adjustments may not necessarily result in realized economic gains or losses. 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).
Net impairment losses recognized in earnings and losses from the sale of lines of business. The recognition of net impairment losses on investments and the impairment of other long-lived assets does not result in a cash payment and can vary significantly in both amount and frequency, depending on market credit cycles and other factors. Losses from the sale of lines of business are highly discretionary as a result of strategic restructuring decisions, and generally do not occur in the normal course of our business. We do not view these losses to be indicative of our fundamental operating activities. Therefore, whenever these losses occur, we exclude them from our calculation of adjusted pretax operating income (loss).
Net of ceded premiums written under the QSR Transactions and the 2016 Single Premium QSR Transaction. See Note 8 for additional information.
Primarily includes employee severance and related benefit costs. Does not include impairment of long-lived assets, which is not a component of adjusted pretax operating income.
Excludes net gains on investments and other financial instruments of $30.8 million, not included in adjusted pretax operating income.
Includes inter-segment expenses and revenues as listed in the notes to the preceding tables.
On a consolidated basis, “adjusted pretax operating income” is a measure not determined in accordance with GAAP. Total adjusted pretax operating income is not a measure of total profitability, and therefore should not be considered in isolation or viewed as a substitute for GAAP pretax income. Our definition of adjusted pretax operating income may not be comparable to similarly-named measures reported by other companies.
As of December 31, 2017, 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 both December 31, 2017 and December 31, 2016. California accounted for 14.1% of our Mortgage Insurance segment’s direct primary NIW for the year ended December 31, 2017, compared to 14.8% and 15.2% for the years ended December 31, 2016 and 2015, respectively.
The following is a list of those assets that are measured at fair value by hierarchy level as of December 31, 2017:
Includes $28.0 million of securities loaned to third-party Borrowers under securities lending agreements, classified as other assets in our consolidated balance sheets. See Note 6 for more information.
There were no investment transfers between Level I, Level II or Level III for the year ended December 31, 2016.
Although we had other securities in an unrealized loss position as of December 31, 2017, we did not consider those securities to be other-than-temporarily impaired as of such date. For all investment categories, the unrealized losses of 12 months or greater duration as of December 31, 2017, were generally caused by interest rate or credit spread movements since the purchase date, and as such, we expect the present value of cash flows to be collected from these securities to be sufficient to recover the amortized cost basis of these securities. As of December 31, 2017, we did not have the intent to sell any debt securities in an unrealized loss position and we determined that it is more likely than not that we will not be required to sell the securities before recovery of their cost basis, which may be at maturity; therefore, we did not consider these investments to be other-than-temporarily impaired at December 31, 2017.
During the third quarter of 2017, we commenced participation in a securities lending program whereby we loan certain securities in our investment portfolio to Borrowers for short periods of time. These securities lending agreements are collateralized financing arrangements whereby we transfer securities to third parties through an intermediary in exchange for cash or other securities. In all of our securities lending agreements, the securities we transfer to Borrowers (loaned securities) may be transferred or loaned by the Borrowers; however, we maintain effective control over all loaned securities, including: (i) retaining ownership of the securities; (ii) receiving the related investment or other income; and (iii) having the right to request the return of the loaned securities at any time. Although we report such securities at fair value within other assets on our consolidated balance sheets, the detailed information provided in this Note includes these securities. See Notes 2 and 9 for additional information.
There were no securities lending transactions outstanding at December 31, 2016.
Securities on deposit with various state insurance commissioners amounted to $11.8 million and $10.8 million at December 31, 2017 and 2016, respectively.
At December 31, 2016, Radian Guaranty had $63.9 million in a collateral account invested in and classified as part of our trading securities and pledged to cover Loss Mitigation Activity on the loans subject to the Freddie Mac Agreement. During the third quarter of 2017, the scheduled final settlement date under the Freddie Mac Agreement occurred. As of December 31, 2017, the remaining balance of $5.6 million in the collateral account was invested in and classified as short-term investments and pledged to cover Loss Mitigation Activity and pending claims activity already in process but not yet finalized. See Note 11 for additional information.
All of our goodwill and other intangible assets relate to our Services segment. The following table shows the changes in the carrying amount of goodwill as of and for the years ended December 31, 2017 and 2016:
In the second quarter of 2017, we elected to early adopt the update to the accounting standard regarding goodwill and other intangibles, as discussed in Note 2. In accordance with the updated standard, the fair value of the reporting unit is compared with its carrying amount, with any excess of the reporting unit’s carrying amount over its estimated fair value recognized as an impairment charge, up to the full amount of the goodwill allocated to the reporting unit, after adjusting the carrying value for any impairment of other intangibles or long-lived assets. For additional information on our accounting policies for goodwill and other intangible assets, see Note 2.
During the second quarter of 2017, the Services segment performed below forecasted levels. In combination with the recent underperformance of the Services segment, the anticipated business and growth opportunities for certain business lines in our Services segment have been impacted by: (i) market demand, which was lower than anticipated; (ii) increased competition, including with respect to product alternatives and pricing; and (iii) delays in the realization of efficiencies and margin improvements associated with certain technology initiatives. The demand for certain products and services has decreased due to several factors. Given the decreased volume of refinancings in the mortgage market that began in the first half of 2017, our customers have excess internal capacity which they are choosing to utilize and as a result they are less reliant on outsourcing to us. Additionally, due to market and competitive pressures, we renewed the contract terms with one of our largest customers during the second quarter of 2017, with lower pricing and volumes than expected in order to retain the engagement. We also experienced lower than expected customer acceptance for certain of our current and proposed products and services. The impact of these factors, partially offset by related future expense reductions, constituted a majority of the decline in the fair value of the Services segment since the previous annual impairment test.
Our quantitative valuation analysis, performed in connection with our annual goodwill impairment analysis in 2016, relied heavily on achieving the growth rates in our projected future cash flows. The impact of the market trends observed during the second quarter of 2017, which we currently expect to continue, together with our strategic decisions discussed above, resulted in changes to our expected product mix and the expected growth rates associated with various initiatives, which in turn generated material reductions to our forecasted net cash flows. Given the significant negative impact that the market trends and our strategic decisions would have on the timing and amount of our projected future cash flows in comparison to our original projections, we performed a quantitative analysis of the associated goodwill and other intangible assets as of June 30, 2017.
As a result of the quantitative goodwill analysis, we recorded an impairment charge of $184.4 million for the three months ended June 30, 2017, to reduce the carrying amount of the Services segment to its estimated fair value. As discussed further below, prior to finalizing this amount, we also evaluated the recoverability of the segment’s other intangible assets and recorded impairment charges of $15.8 million related to the Services segment’s other intangible assets. See “-Other Intangible Assets,” below. Substantially all of our goodwill and other intangible assets will continue to be deductible for tax purposes in accordance with the originally scheduled amortization period of approximately 15 years.
During the fourth quarter of 2017, we elected to perform a qualitative annual goodwill impairment analysis, which requires us to assess all relevant events and circumstances that could affect the significant inputs used to determine the fair value of the reporting unit. We considered factors such as: (i) the increase in and timing of revenues during the third and fourth quarters of 2017 (as compared to the forecasted amounts for the same periods); (ii) the impact to projected cash flows, a significant input used to determine the fair value of the reporting unit, associated with the TCJA enacted in the fourth quarter of 2017; (iii) our recent interim goodwill impairment test and recognition of impairment charges; and (iv) the recent sale of a business line. Based on our qualitative assessment in the fourth quarter of 2017, we concluded that it is not “more likely than not” that the fair value of the Services reporting unit is less than its carrying amount as of December 31, 2017.
In our mortgage insurance business, from time to time we use reinsurance as a strategy to manage our capital position and risk profile, including, among other things, managing Radian Guaranty’s regulatory Risk-to-capital and compliance with the PMIERs financial requirements. Premiums are ceded under the QSR Transactions, the 2016 Single Premium QSR Transaction and captive arrangements.
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.
The following tables show the amounts related to the QSR Transactions and the 2016 Single Premium QSR Transaction for the periods indicated:
All of our existing captive reinsurance arrangements are operating on a run-off basis, meaning that no new business is being placed in these captives. We have not entered into any new captives since 2007 and, pursuant to consent orders with the CFPB and the Minnesota Department of Commerce, we have agreed not to enter into any new captives until 2025. During 2017, our RIF ceded under captive reinsurance arrangements declined to $9.9 million as of December 31, 2017, compared to $12.7 million as of December 31, 2016, as we terminated several captive reinsurance arrangements during the year.
Although we use reinsurance as one of our risk management tools, 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 2016 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 2016 Single Premium QSR Transaction are expected to be realized from this account.
The reconciliation of taxes computed at the statutory tax rate of 35% to the provision for income taxes on continuing operations is as follows:
On December 22, 2017, H.R.1, the TCJA, was signed into law. In accordance with the provisions of the accounting standard regarding accounting for income taxes, changes in tax rates and tax law are accounted for in the period of enactment, which, for federal legislation, is the date the President signed the bill into law. Effective January 1, 2018, the TCJA, among other things, reduces the federal corporate income tax rate from 35% to 21%, repeals the corporate alternative minimum tax and modifies certain limitations on executive compensation. Under GAAP, the effect of tax rate changes on deferred tax balances is recorded as a component of the income tax provision related to continuing operations for the period in which the new tax law is enacted.
Because the TCJA was passed late in the fourth quarter of 2017, and ongoing guidance and accounting interpretation is expected over the next 12 months, as of December 31, 2017, we have not completed our accounting for the effects of the TCJA on certain deferred tax balances; however, we have made provisional estimates of those amounts in accordance with SAB 118. These provisional estimates primarily relate to NOLs, loss reserves, tax depreciation, share-based compensation and state taxes. We expect to complete our analysis of all deferred tax balances within the 12-month measurement period defined by SAB 118. Accordingly, we have recognized a non-cash, provisional income tax expense of $102.6 million, which is included as a component of the income tax provision for the year ended December 31, 2017. The ultimate impact of the TCJA may differ from our provisional estimates due to, among other things, future guidance that may be issued, changes in our interpretation or assumptions with respect to reversal periods, the outcome of our potential settlement of the IRS Matter and future actions that we may take as a result of the new tax law.
For periods beginning after December 31, 2017, we will realize a significant reduction in our annualized effective tax rate, before considering Discrete Items, primarily due to the reduction in the federal corporate tax rate from 35% to 21%. Typically, when the statutory tax rate is constant between periods, our return-to-provision adjustments for temporary differences do not impact our overall effective tax rate. However, with the change in the corporate tax rate, our return-to-provision adjustments recorded during 2018 may affect our current provision at a 35% tax rate while affecting our deferred provision at a 21% tax rate. Our return-to-provision adjustments are accounted for as Discrete Items and are generally recorded in the three-month period ending December 31.
As of December 31, 2017, we recorded a net current income tax payable of $95.6 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 $48.4 million. Before consideration of uncertain tax positions, we have approximately $124.4 million of U.S. NOL carryforwards, $57.1 million of alternative minimum tax credit carryforwards and $6.5 million of research and development tax credit carryforwards as of December 31, 2017. Our deferred tax asset relating to our U.S. NOL carryforward is reduced by the impact of uncertain tax positions in the above table of deferred tax assets and liabilities. To the extent not utilized, the U.S. NOL carryforwards will expire during tax years 2031 and 2032, and the research and development tax credit carryforwards will expire during tax years 2031 through 2037. We expect our alternative minimum tax credit carryforwards to be fully utilized or refunded in the near term. Certain entities within our consolidated group have also generated deferred tax assets of approximately $69.5 million, relating primarily to state and local NOL carryforwards which, if unutilized, will expire during various future tax periods.
As previously disclosed, we are contesting adjustments resulting from the examination by the IRS of our 2000 through 2007 consolidated federal income tax returns. The IRS opposes the recognition of certain tax losses and deductions that were generated through our investment in a portfolio of non-economic REMIC residual interests and has proposed denying the associated tax benefits of these items. We appealed these proposed adjustments to the Internal Revenue Service Office of Appeals and made “qualified deposits” with the U.S. Treasury of $85 million in June 2008 relating to the 2000 through 2004 tax years and $4 million in May 2010 relating to the 2005 through 2007 tax years in order to avoid the accrual of incremental above-market-rate interest with respect to the proposed adjustments.
We attempted to reach a compromised settlement with the Internal Revenue Service Office of Appeals, but in September 2014 we received Notices of Deficiency covering the 2000 through 2007 tax years that assert unpaid taxes and penalties of $157 million. The Deficiency Amount has not been reduced to reflect our NOL carryback ability. As of December 31, 2017, there also would be interest of approximately $149 million related to these matters. Depending on the outcome, additional state income taxes, penalties and interest (estimated in the aggregate to be approximately $37 million as of December 31, 2017) also may become due when a final resolution is reached. The Notices of Deficiency also reflected additional amounts due of $105 million, which are primarily associated with the disallowance of the previously filed carryback of our 2008 NOL to the 2006 and 2007 tax years. We currently believe that the disallowance of our 2008 NOL carryback is a precautionary position by the IRS and that we will ultimately maintain the benefit of this NOL carryback claim.
As discussed above, we believe we have reached a basis for a compromised settlement with the IRS on the issues present in our case. The resolution and computations of our adjusted tax liabilities for the 2000 through 2007 tax years have been presented to the JCT for review and cannot be finalized until the IRS considers the views, if any, expressed by the JCT about the matter. However, if we are able to achieve a compromised settlement with the IRS, then it is estimated that over the next 12 months approximately $70.0 million of unrecognized tax benefits in the above tabular reconciliation may be reversed pursuant to the accounting standard for uncertain tax positions.
In the event we are not successful in defense of our tax positions taken for U.S. federal income tax purposes, and for which we have recorded unrecognized tax benefits, then such adjustments originating in NOL or NOL carryback years may reduce our existing NOL.
Represents ceded losses on captive reinsurance transactions, the QSR Transactions and the 2016 Single Premium QSR Transaction.
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 mortgage loan PDR:
Our loss reserves at December 31, 2017 declined as compared to December 31, 2016, primarily as a result of the amount of paid claims and Cures continuing to outpace losses incurred related to new default notices reported in the current year. Reserves established for new default notices were the primary driver of our total incurred loss for 2017, and they were primarily impacted by the number of new primary default notices received in the period and our related gross Default to Claim Rate assumption applied to those new defaults, which, except as discussed below for FEMA Designated Areas associated with Hurricanes Harvey and Irma, declined from 12% at December 31, 2016 to 10% at December 31, 2017. The provision for losses during 2017 was positively impacted by favorable reserve development on prior year defaults, which was primarily driven by a reduction during the period in certain Default to Claim Rate assumptions for these prior year defaults compared to the assumptions used at December 31, 2016. The reductions in Default to Claim Rate assumptions resulted from observed trends, primarily higher Cures than were previously estimated.
Our loss reserves at December 31, 2016 declined as compared to December 31, 2015, primarily as a result of the amount of paid claims continuing to exceed losses incurred related to new default notices reported in the current year. Reserves established for new default notices were the primary driver of our total incurred loss for 2016, and they were impacted primarily by the number of new primary default notices received in the period and our related gross Default to Claim Rate assumption applied to those new defaults, which declined from 13% at December 31, 2015 to 12% as of December 31, 2016. The impact to incurred losses from reserve development on default notices reported in prior years was not significant during 2016.
Total claims paid decreased for 2016 compared to 2015, primarily due to the elevated claim payments in 2015 associated with the BofA Settlement Agreement (discussed below).
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. 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. Favorable reserve development on prior year defaults partially mitigated the provision for losses from new default notices received in 2015. 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 31% (29% excluding pending claims) at December 31, 2017 compared to 42% (40% excluding pending claims) at December 31, 2016. The change in our Default to Claim Rate in 2017 resulted primarily from: (i) the lower Default to Claim Rate of 3% on new primary defaults in FEMA Designated Areas associated with Hurricanes Harvey and Irma subsequent to those two natural disasters; (ii) a decrease in the proportion of pending claims, which have higher Default to Claim Rates; and (iii) a decrease in the assumed gross Default to Claim Rate for new primary defaults that were not located in FEMA Designated Areas associated with Hurricanes Harvey and Irma, from 12% to 10%, as of December 31, 2017. As of December 31, 2017, with the exception of new primary defaults in FEMA Designated Areas associated with Hurricanes Harvey and Irma, our gross Default to Claim Rates on our primary portfolio ranged from 10% for new defaults, to 62% for other defaults not in Foreclosure Stage, and 81% for Foreclosure Stage Defaults. As of December 31, 2016, these gross Default to Claim Rates ranged from 12% for new defaults, to 62% 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 our Legacy Portfolio has become a smaller percentage of our overall insured portfolio, we have undertaken a reduced amount of Loss Mitigation Activity with respect to the claims we receive, and we expect this trend to continue. As a result, our future Loss Mitigation Activity is not expected to mitigate our paid losses to the same extent as in recent years.
The BofA Settlement Agreement finalized claims decisions (including claims paid, coverage Rescissions, Claim Denials and Claim Curtailments) on certain loans covered by the agreement (communicated on or before certain dates prior to 2015), such that they are not subject to future challenge or adjustment. For claims decisions on certain other loans (communicated after those dates), the BofA Settlement Agreement limits both prior and future Rescissions, Claim Denials or Claim Curtailments. Radian Guaranty further agreed not to assert any right to cancel coverage on certain loans for failure to initiate certain proceedings (most commonly foreclosure proceedings) within the timelines set forth in the applicable Master Policies. We do not expect a material impact to our results of operations from this agreement in the future.
In August 2013, Radian Guaranty entered into the Freddie Mac Agreement, related to a group of first-lien mortgage loans guaranteed by Freddie Mac that were insured by Radian Guaranty and were in default as of December 31, 2011. At December 31, 2016, Radian Guaranty had $63.9 million in a collateral account invested in and classified as part of our trading securities and pledged to cover Loss Mitigation Activity on the loans subject to the Freddie Mac Agreement. During the third quarter of 2017, the scheduled final settlement date under the Freddie Mac Agreement occurred and, as expected, we paid $54.8 million to Freddie Mac, which reduced the remaining balance in the collateral account to $5.6 million at December 31, 2017. These amounts were invested in and classified as short-term investments and pledged to cover Loss Mitigation Activity and pending claims activity already in process but not yet finalized.
The information about net incurred losses and paid claims development for the years ended prior to 2017 is presented as supplementary information.
Represents reserves as of December 31, 2017 related to IBNR liabilities.
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 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. Included in this amount for the year ended December 31, 2017 and December 31, 2016 are 8,862 and 3,852 notices, respectively, of new primary defaults related to the FEMA Designated Areas associated with Hurricanes Harvey and Irma.
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, 2017:
In connection with our June 2015 purchases of our Convertible Senior Notes due 2017, we terminated a corresponding portion of the capped call transactions we had entered into in 2010 related to the initial issuance of the Convertible Senior Notes due 2017. As a result of this termination, we received total consideration of $54.9 million , consisting of 2.3 million shares of Radian Group common stock and $13.2 million in cash. In accordance with the accounting standards regarding equity and contracts in an entity’s own equity, the total consideration received was recorded as an increase to additional paid-in capital. 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.
Senior Notes due 2020. In June 2015, we issued $350 million aggregate principal amount of Senior Notes due 2020 and received net proceeds of $343.3 million. These notes mature on June 15, 2020 and bear interest at a rate of 5.250% per annum, payable semi-annually on June 15 and December 15 of each year, commencing on December 15, 2015.
On October 16, 2017, Radian Group entered into a three-year, $225 million unsecured revolving credit facility with a syndicate of bank lenders. Terms of the credit facility include an option to increase the amount during the term of the agreement, subject to our obtaining the necessary increased commitments from the lenders, up to a total of $300 million. Borrowings under the credit facility may be used for working capital and general corporate purposes, including, without limitation, capital contributions to Radian Group’s insurance and reinsurance subsidiaries as well as growth initiatives.
Any borrowings outstanding under the facility will accrue interest at a floating rate tied to a standard short-term borrowing index, selected at our option, plus an applicable margin. A commitment fee is due quarterly on the average daily amount of the undrawn commitment. The applicable margin and commitment fee vary based on the senior unsecured long-term debt rating of Radian Group.
The credit facility contains customary representations, warranties, covenants, terms and conditions. Our ability to borrow under the credit facility is conditioned on the satisfaction of certain financial and other covenants, including covenants related to minimum net worth and statutory surplus, a maximum debt-to-capitalization level, limits on certain types of indebtedness and liens, minimum liquidity levels and Radian Guaranty’s eligibility as a private mortgage insurer with the GSEs. At December 31, 2017, Radian Group was in compliance with all the covenants, although there were no amounts outstanding under this revolving credit facility.
Our Master Policies establish the timeline within which any suit or action arising from any right of an insured under the policy generally must be commenced. In general, any suit or action arising from any right of an insured under the policy must be commenced within two years after such right first arose for primary insurance and within three years for certain other policies, including certain Pool Insurance policies. Although we believe that our Loss Mitigation Activities are justified under our policies, we continue to face challenges from certain lender and servicer customers regarding our Loss Mitigation Activities, which have resulted in some reversals of our decisions regarding Rescissions, Claim Denials or Claim Curtailments. We are currently in discussions with these customers regarding Loss Mitigation Activities and our claim payment practices, which if not resolved, could result in arbitration or judicial proceedings and we may need to reassume the risk on, and increase loss reserves for, those policies or pay additional claims. See Note 11 for further information.
Securities regulations became effective in 2005 that impose enhanced disclosure requirements on issuers of ABS (including mortgage-backed securities). 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 $97.8 million of remaining credit exposure as of December 31, 2017.
At December 31, 2017, there were no future minimum receipts expected from sublease rental payments.
As partial consideration for our March 2016 privately negotiated purchases of a portion of our Convertible Senior Notes due 2017 and 2019, we issued to the sellers 17.0 million shares of Radian Group common stock. In addition, in connection with our termination of the corresponding portion of the related capped call transactions, we received consideration of 0.2 million shares of Radian Group common stock. See Note 12 for additional information regarding these transactions.
As partial consideration for our June 2015 privately negotiated purchases of a portion of our Convertible Senior Notes due 2017, we issued to the sellers 28.4 million shares of Radian Group common stock. In addition, in partial consideration for our termination of the corresponding portion of the related capped call transactions, we received 2.3 million shares of Radian Group common stock. See Note 12 for additional information regarding these transactions.
For purposes of calculating compensation cost recognized, we generally consider awards effectively vested (and we recognize the full compensation costs) when grantees become retirement eligible.
The vesting of performance-based RSU awards granted to executive officers and non-executives in 2015 is entirely dependent upon Radian Group’s TSR Measures, as described above.
The grant date fair value of the performance-based RSUs that are based on TSR Measures is determined using a Monte Carlo valuation model. The following are assumptions used in our calculation of the grant date fair value of performance-based RSUs to be settled in common stock:
Average volatility of peer companies is used in the calculation of the grant date fair value of the portion of the awards based on the Relative TSR Measure, as described above.
The time-vested RSU awards granted in 2016 and 2015 generally are subject to three-year cliff vesting.
Includes 262,694 time-vested awards granted on February 10, 2016 to convert the outstanding fully-vested 2009 and 2010 time-vested RSUs (to be settled in cash) awarded to our non-employee directors into time-vested RSUs to be settled in shares of our common stock on the conversion date (generally defined as a director’s termination of service with us).
Generally, the stock option awards have a four-year vesting period, with 50% of the award vesting on or after the third anniversary of the grant date and the remaining 50% of the award vesting on or after the fourth anniversary of the grant date, provided the applicable stock price performance hurdle is met, as described below. The fair value of stock options vested during the year ended December 31, 2017 was $3.3 million.
There were no stock options granted in 2017. For stock option awards granted in 2016 and 2015, in addition to the time-based vesting requirements, the options contain a performance hurdle whereby the options will only vest if the closing price of our common stock on the New York Stock Exchange exceeds approximately $15.20 and $23.03 (in each case, 125% of the option exercise price), respectively, for 10 consecutive trading days ending on or after the third anniversary of the date of grant.
The 2008 ESPP is designed to allow eligible employees to purchase shares of our common stock at a discount of 15% off the lower of the fair market value of our common stock at the beginning or end of a six month offering period (each period being the first and second six months in a calendar year).
As of December 31, 2017, 2016 and 2015, unrecognized compensation expense related to the unvested portion of all of our share-based awards was $16.3 million, $11.3 million and $11.7 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.
Less: Reclassification adjustment for net gains (losses) included in net income (1) (3)
In 2015, we recorded total net income from discontinued operations of $5.4 million related to this sale, including: (i) $34.3 million of total revenue, primarily due to the recognition of investment gains previously deferred and recorded in accumulated other comprehensive income (loss) and recognized as a result of the completion of the sale; (ii) an impairment charge of $14.3 million and (iii) taxes and adjustments to estimated transaction costs. The operating results of Radian Asset Assurance are classified as discontinued operations. No general corporate overhead or interest expense was allocated to discontinued operations.
The ability of Radian’s insurance subsidiaries to pay dividends on their common stock is restricted by certain provisions of the insurance laws of Pennsylvania, their state of domicile. Under Pennsylvania’s insurance laws, dividends and other distributions may only be paid out of an insurer’s positive unassigned surplus, measured as of the end of the prior fiscal year, unless the Pennsylvania Insurance Commissioner approves the payment of dividends or other distributions from another source. In 2015 we effectuated a reorganization of our mortgage insurance subsidiaries, which included a significant redistribution of assets and RIF among our legal entities. As a result of these actions, substantially all of the RIF and assets previously held by Radian Guaranty Reinsurance, Radian Mortgage Assurance, Radian Insurance and Radian Mortgage Insurance were transferred to Radian Guaranty and Radian Reinsurance. None of the distributions from these entities were retained by Radian Group, as all proceeds were distributed to either Radian Guaranty or Radian Reinsurance.
At December 31, 2017, Radian Guaranty had negative unassigned surplus of $765.0 million, compared to negative unassigned surplus of $691.3 million at December 31, 2016. Radian Reinsurance, which began operations in December 2015, had negative unassigned surplus of $112.1 million at December 31, 2017, compared to negative unassigned surplus of $118.4 million at December 31, 2016 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 2017, no dividends or other distributions can be paid from Radian Guaranty or Radian Reinsurance without approval from the Pennsylvania Insurance Commissioner. Other than the payment of the Extraordinary Dividend by Radian Guaranty, as described above, neither Radian Guaranty nor Radian Reinsurance paid dividends in 2017 or 2016.
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 a 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 2017 was primarily due to statutory capital growing faster than net RIF. Radian Guaranty’s statutory capital increased during 2017 due to statutory net income earned during the year and the issuance of the Surplus Note, partially offset by the reallocation of $175 million of capital from Radian Guaranty to Radian Reinsurance, as described above, and a net decrease in Radian Guaranty’s net admitted deferred tax assets. Radian Guaranty’s net RIF increased during the year due to strong growth in NIW and IIF, partially offset by the increased reinsurance benefit pursuant to the 2016 Single Premium QSR Transaction.
In December 2015, Radian Group transferred $325 million of cash and marketable securities to Radian Guaranty in exchange for a Surplus Note issued by Radian Guaranty. This Surplus Note had a 0% interest rate and was scheduled to mature on December 31, 2025. However, Radian Guaranty repaid the Surplus Note in full on June 30, 2016.
Under SAPP, certain assets, designated as non-admitted assets, are charged directly against statutory surplus. Such assets are reflected on our GAAP financial statements.
Prior to January 1, 2013, under SAPP, the accounting standard regarding share-based payments was not applicable, with regard to the recognition and measurement of stock option issuances. However, effective January 1, 2013, the NAIC adopted SSAP No. 104, Share-Based Payments (“SSAP 104”), on a prospective basis. Therefore, expenses related to stock options granted subsequent to the date of adoption of SSAP 104 are recognized under SAPP but expenses related to stock options granted prior to the date of adoption continue to not be recognized under SAPP. Expenses related to stock options, regardless of the date of grant, are reflected on our GAAP financial statements in accordance with this standard.
Under SAPP, capital contributions satisfied by receipt of cash or readily marketable securities subsequent to the balance sheet date but prior to the filing of the statutory financial statement are treated as a recognized subsequent event and, as such, are considered an admitted asset based on the evidence of collection and approval of the domiciliary commissioner. Under GAAP, such capital contributions are treated as a non-recognized subsequent event.
The fourth quarter of 2017 reflects an incremental tax provision related to the remeasurement of our net deferred tax assets as a result of the enactment of the TCJA.