Ryland Group 10-Q 2011
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended March 31, 2011
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to .
Commission File Number: 001-08029
THE RYLAND GROUP, INC.
(Exact Name of Registrant as Specified in Its Charter)
24025 Park Sorrento, Suite 400
Calabasas, California 91302
(Address and Telephone Number of Principal Executive Offices)
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one:)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No
The number of shares of common stock of The Ryland Group, Inc., outstanding on May 5, 2011, was 44,377,848.
THE RYLAND GROUP, INC.
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
Note 1. Consolidated Financial Statements
The consolidated financial statements include the accounts of The Ryland Group, Inc. and its 100 percent-owned subsidiaries (the Company). Noncontrolling interest represents the selling entities ownership interests in land and lot option purchase contracts. (See Note 8, Variable Interest Entities (VIE).) Intercompany transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to the 2011 presentation. See Note A, Summary of Significant Accounting Policies, in the Companys 2010 Annual Report on Form 10-K for a description of its accounting policies.
The Consolidated Balance Sheet at March 31, 2011, and the Consolidated Statements of Earnings and Cash Flows for the three-month periods ended March 31, 2011 and 2010, have been prepared by the Company without audit. In the opinion of management, all adjustments, including normally recurring adjustments necessary to present fairly the Companys financial position, results of operations and cash flows at March 31, 2011, and for all periods presented, have been made. Certain information and footnote disclosures normally included in the financial statements have been condensed or omitted. These financial statements should be read in conjunction with the financial statements and related notes included in the Companys 2010 Annual Report on Form 10-K.
The Company has historically experienced, and expects to continue to experience, variability in quarterly results. Accordingly, the results of operations for the three months ended March 31, 2011, are not necessarily indicative of the operating results expected for the year ending December 31, 2011.
Note 2. Comprehensive Loss
Comprehensive loss consists of net earnings or losses and the increase or decrease in unrealized gains or losses on the Companys available-for-sale securities, as well as the decrease in unrealized gains associated with treasury locks, net of applicable taxes. Comprehensive loss totaled $19.8 million and $14.4 million for the three-month periods ended March 31, 2011 and 2010, respectively.
Note 3. Cash, Cash Equivalents and Restricted Cash
Cash and cash equivalents totaled $202.2 million and $226.6 million at March 31, 2011 and December 31, 2010, respectively. The Company considers all highly liquid short-term investments purchased with an original maturity of three months or less and cash held in escrow accounts to be cash equivalents.
At March 31, 2011 and December 31, 2010, the Company had restricted cash of $75.3 million and $74.8 million, respectively. The Company has various secured letter of credit agreements that require it to maintain cash deposits as collateral for outstanding letters of credit. Cash restricted under these agreements totaled $74.6 million at March 31, 2011, and $74.7 million at December 31, 2010. In addition, Ryland Mortgage Company and its subsidiaries and RMC Mortgage Corporation (collectively referred to as RMC) had restricted cash for funds held in trust for third parties of $668,000 and $100,000 at March 31, 2011 and December 31, 2010, respectively.
Note 4. Segment Information
The Company is a leading national homebuilder and mortgage-related financial services firm. As one of the largest single-family on-site homebuilders in the United States, it operates in 15 states and 19 homebuilding markets across the country. The Company consists of six segments: four geographically-determined homebuilding regions (North, Southeast, Texas and West); financial services; and corporate. The homebuilding segments specialize in the sale and construction of single-family attached and detached housing. The Companys financial services segment, which includes RMC, RH Insurance Company, Inc. (RHIC), LPS Holdings Corporation and its subsidiaries (LPS), and Columbia National Risk Retention Group, Inc. (CNRRG),
provides mortgage-related products and services, as well as title, escrow and insurance services, to its homebuyers. Corporate is a nonoperating business segment with the sole purpose of supporting operations. In order to best reflect the Companys financial position and results of operations, certain corporate expenses are allocated to the homebuilding and financial services segments, along with certain assets and liabilities relating to employee benefit plans.
The Company evaluates performance and allocates resources based on a number of factors, including segment pretax earnings and risk. The accounting policies of the segments are the same as those described in Note 1, Consolidated Financial Statements.
Note 5. Earnings Per Share Reconciliation
The following table sets forth the computation of basic and diluted earnings per share:
For the three months ended March 31, 2011 and 2010, the effects of outstanding restricted stock units and stock options were not included in the diluted earnings per share calculations as they would have been antidilutive due to the Companys net loss for the respective periods.
Note 6. Marketable Securities, Available-for-sale
The Companys investment portfolio includes U.S. Treasury securities; obligations of U.S. government and local government agencies; corporate debt backed by U.S. government/agency programs; corporate debt securities; asset-backed securities of U.S. government agencies and covered bonds; time deposits; and short-term pooled investments. These investments are primarily held in the custody of a single financial institution. Time deposits and short-term pooled investments, which are not considered cash equivalents, have original maturities in excess of 90 days. The Company considers its investment portfolio to be available-for-sale as defined by the Financial Accounting Standards Board (FASB) in its Accounting Standards Codification (ASC) No. 320 (ASC 320), InvestmentsDebt and Equity Securities. Accordingly, these investments are recorded at fair value. The cost of securities sold is based on an average-cost basis. Unrealized gains and losses on these investments were included in Accumulated other comprehensive income, net of tax, within the Consolidated Balance Sheets.
The Company periodically reviews its available-for-sale securities for other-than-temporary declines in fair values that are below their cost bases, and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. At March 31, 2011 and December 31, 2010, the Company believed that the cost bases for its available-for-sale securities were recoverable in all material respects.
For the three-month periods ended March 31, 2011 and 2010, net realized earnings totaled $1.3 million and $1.2 million, respectively, and were recorded in Gain from marketable securities, net within the Consolidated Statements of Earnings.
The following table sets forth, by type of security, the fair values of marketable securities, available-for-sale:
The primary objectives of the Companys investment portfolio are safety of principal and liquidity. Investments are made with the purpose of achieving the highest rate of return consistent with these two objectives. The Companys investment policy limits investments to debt rated investment grade or better, as well as to bank and money market instruments and to issues by the U.S. government, U.S. government agencies and municipal or other institutions primarily with investment-grade credit ratings. Policy restrictions are placed on maturities, as well as on concentration by type and issuer.
The following table sets forth, by contractual maturity, the fair values of marketable securities, available-for-sale:
Note 7. Housing Inventories
Housing inventories consist principally of homes under construction; land under development and improved lots; and inventory held-for-sale. Inventory includes land and development costs; direct construction costs; capitalized indirect construction costs; capitalized interest; and real estate taxes. The costs of acquiring and developing land and constructing certain related amenities are allocated to the parcels to which these costs relate. Interest and taxes are capitalized during active development and construction stages. Inventories to be held and used are stated at cost unless a community is determined to be impaired, in which case the impaired inventories are written down to their fair values. Inventories held-for-sale are stated at the lower of their costs or fair values, less cost to sell.
As required by ASC No. 360 (ASC 360), Property, Plant and Equipment, inventory is reviewed for potential write-downs on an ongoing basis. ASC 360 requires that, in the event that impairment indicators are present and undiscounted cash flows signify that the carrying amount of an asset is not recoverable, impairment charges must be recorded if the fair value of the asset is less than its carrying amount. The Company reviews all communities on a quarterly basis for changes in events or circumstances indicating signs of impairment. Examples of events or changes in circumstances include, but are not limited to: price declines resulting from sustained competitive pressures; a change in the manner in which the asset is being used; a change in assessments by a regulator or municipality; cost increases; the expectation that, more likely than not, an asset will be sold or disposed of significantly before the end of its previously estimated useful life; or the impact of local economic or macroeconomic conditions, such as employment or housing supply, on the market for a given product. Signs of impairment may include, but are not limited to: very low or negative profit margins; the absence of sales activity in an open community; and/or significant price differences for comparable parcels of land held-for-sale.
If it is determined that indicators of impairment exist in a community, undiscounted cash flows are prepared and analyzed at a community level based on expected pricing; sales rates; construction costs; local municipality fees; and warranty, closing, carrying, selling, overhead and other related costs; or on similar assets to determine if the realizable value of the assets held are less than their respective carrying amounts. In order to determine assumed sales prices included in cash flow models, the Company analyzes historical sales prices on homes delivered in the community and other communities in the geographic area, as well as sales prices included in its current backlog for such communities. In addition, it analyzes market studies and trends, which generally include statistics on sales prices in neighboring communities and sales prices of similar products in non-neighboring communities in the same geographic area. In order to estimate costs to build and deliver homes, the Company generally assumes cost structures reflecting contracts currently in place with vendors, adjusted for any anticipated cost-reduction initiatives or increases. The Companys analysis of each community generally assumes current pricing equal to current sales orders for a particular or comparable community. For a minority of communities that the Company does not intend to operate for an extended period or whose operating life extends beyond several years, slight increases over current sales prices are assumed in later years. Once a community is considered to be impaired, the Companys determinations of fair value and new cost basis are primarily based on discounting estimated cash flows at rates commensurate with inherent risks that are associated with the assets. Discount rates used generally vary from 19.0 percent to 30.0 percent, depending on market risk, the size or life of a community and development risk. Due to the fact that estimates and assumptions included in cash flow models are based on historical results and projected trends, unexpected changes in market conditions that may lead to additional impairment charges in the future cannot be anticipated.
Valuation adjustments are recorded against homes completed or under construction, land under development or improved lots when analyses indicate that the carrying values are greater than the fair values. Write-downs of impaired inventories to their fair values are recorded as adjustments to the cost basis of the respective inventory. At March 31, 2011 and December 31, 2010, valuation reserves related to impaired inventories amounted to $356.6
million and $361.4 million, respectively. The net carrying values of the related inventories amounted to $228.1 million and $236.3 million at March 31, 2011 and December 31, 2010, respectively.
The costs of acquiring and developing land and constructing certain related amenities are allocated to the parcels to which these costs relate.
Interest and taxes are capitalized during active development and construction stages. Capitalized interest is amortized as the related inventory is delivered to homebuyers. The following table is a summary of activity related to capitalized interest:
The following table summarizes each reporting segments total number of lots owned and lots controlled under option agreements:
Note 8. Variable Interest Entities (VIE)
As required by ASC No. 810, (ASC 810), Consolidation of Variable Interest Entities, a VIE is to be consolidated by a company if that company has the power to direct the VIEs activities and the obligation to absorb its losses or the right to receive its benefits, which are potentially significant to the VIE. ASC 810 also requires disclosures about VIEs that the company is not obligated to consolidate, but in which it has a significant, though not primary, variable interest.
The Company enters into joint ventures, from time to time, for the purpose of acquisition and co-development of land parcels and lots. Its investments in these joint ventures may create a variable interest in a VIE, depending on the contractual terms of the arrangement. Additionally, in the ordinary course of business, the Company enters into lot option purchase contracts in order to procure land for the construction of homes. Under such lot option purchase contracts, the Company funds stated deposits in consideration for the right to purchase lots at a future point in time, usually at predetermined prices. The Companys liability is generally limited to forfeiture of nonrefundable deposits, letters of credit and other nonrefundable amounts incurred. In accordance with the requirements of ASC 810, certain of the Companys lot option purchase contracts may result in the creation of a variable interest in a VIE.
In compliance with the provisions of ASC 810, the Company consolidated $74.4 million and $88.3 million of inventory not owned related to its land and lot option purchase contracts at March 31, 2011 and December 31, 2010, respectively. Although the Company may not have had legal title to the optioned land, under ASC 810, it had the primary variable interest and was required to consolidate the particular VIEs assets under option at fair value. To reflect the fair value of the inventory consolidated under ASC 810, the Company eliminated $19.4
million and $26.5 million of its related cash deposits for lot option purchase contracts at March 31, 2011 and December 31, 2010, respectively, which were included in Consolidated inventory not owned within the Consolidated Balance Sheets. Noncontrolling interest totaling $55.0 million and $61.8 million was recorded with respect to the consolidation of these contracts at March 31, 2011 and December 31, 2010, respectively, representing the selling entities ownership interests in these VIEs. Additionally, the Company had cash deposits and/or letters of credit totaling $13.5 million and $11.6 million at March 31, 2011 and December 31, 2010, respectively, that were associated with lot option purchase contracts having aggregate purchase prices of $160.5 million and $130.7 million, respectively. As the Company did not have the primary variable interest in these contracts, it was not required to consolidate them.
Note 9. Investments in Joint Ventures
The Company enters into joint ventures, from time to time, for the purpose of acquisition and co-development of land parcels and lots. Currently, the Company participates in six active homebuilding joint ventures in the Austin, Chicago, Dallas, Denver and Washington, D.C., markets. It participates in a number of joint ventures in which it has less than a controlling interest. The Company recognizes its share of the respective joint ventures earnings or losses from the sale of lots to other homebuilders. It does not, however, recognize earnings from lots that it purchases from the joint ventures. Instead, the Company reduces its cost basis in these lots by its share of the earnings from the lots.
The following table summarizes each reporting segments total estimated share of lots owned and controlled by the Company under its joint ventures:
At March 31, 2011 and December 31, 2010, the Companys investments in its unconsolidated joint ventures totaled $12.7 million and $13.4 million, respectively, and were classified in Other assets within the Consolidated Balance Sheets. For the three months ended March 31, 2011, the Companys equity in earnings from its unconsolidated joint ventures totaled $72,000, compared to $102,000 for the same period in 2010.
Note 10. Debt
Debt consisted of the following:
At March 31, 2011, the Company had outstanding (a) $186.2 million of 6.9 percent senior notes due June 2013; (b) $159.0 million of 5.4 percent senior notes due January 2015; (c) $230.0 million of 8.4 percent senior notes due May 2017; and (d) $300.0 million of 6.6 percent senior notes due May 2020. Each of the senior notes pays interest semiannually and may be redeemed at a stated redemption price, at the option of the Company, in whole or in part, at any time.
To provide letters of credit required in the ordinary course of its business, the Company has various secured letter of credit agreements that require it to maintain restricted cash deposits for outstanding letters of credit. Outstanding letters of credit totaled $74.3 million under these agreements at March 31, 2011 and December 31, 2010.
To finance its land purchases, the Company may also use seller-financed nonrecourse secured notes payable. At March 31, 2011 and December 31, 2010, outstanding seller-financed nonrecourse notes payable totaled $9.0 million.
Senior notes and indenture agreements are subject to certain covenants that include, among other things, restrictions on additional secured debt and the sale of assets. The Company was in compliance with these covenants at March 31, 2011.
Note 11. Fair Values of Financial and Nonfinancial Instruments
The Companys financial instruments are held for purposes other than trading. The fair values of these financial instruments are based on quoted market prices, where available, or are estimated using other valuation techniques. Estimated fair values are significantly affected by the assumptions used. As required by ASC No. 820 (ASC 820), Fair Value Measurements and Disclosures, fair value measurements of financial instruments are categorized as Level 1, Level 2 or Level 3, based on the types of inputs used in estimating fair values.
Level 1 fair values are those determined using quoted prices in active markets for identical assets or liabilities with no valuation adjustments applied. Level 2 fair values are those determined using directly or indirectly observable inputs in the marketplace that are other than Level 1 inputs. Level 3 fair values are those determined using unobservable inputs, including the use of internal assumptions, estimates or models. Valuation of these items is, therefore, sensitive to the assumptions used. Fair values represent the Companys best estimates as of
March 31, 2011, based on existing conditions and available information at the issuance date of these financial statements. Subsequent changes in conditions or available information may change assumptions and estimates.
The following table sets forth the values and measurement methods used for financial instruments that are measured at fair value on a recurring basis:
Marketable Securities, Available-for-sale
At March 31, 2011 and December 31, 2010, the Company had $408.3 million and $437.8 million, respectively, of marketable securities that were available-for-sale and comprised of U.S. Treasury securities; obligations of U.S. government and local government agencies; corporate debt backed by U.S. government/agency programs; corporate debt securities; asset-backed securities of U.S. government agencies and covered bonds; time deposits; and short-term pooled investments. (See Note 6, Marketable Securities, Available-for-sale.)
Other Financial Instruments
Options on futures contracts are exchange traded and based on quoted market prices (Level 1). Mortgage loans held-for-sale and forward-delivery contracts are based on quoted market prices of similar instruments (Level 2). At March 31, 2011, contractual principal amounts of loans held-for-sale totaled $6.8 million, compared to $9.6 million at December 31, 2010. Mortgage interest rate lock commitments (IRLCs) are valued at their aggregate market price premium or deficit, plus a servicing premium, multiplied by the projected close ratio (Level 3). The market price premium or deficit is based on quoted market prices of similar instruments; the servicing premium is based on contractual investor guidelines for each product; and the projected close ratio is determined utilizing an external modeling system, widely used within the industry, to estimate customer behavior at an individual loan level. Mortgage loans held-for-sale, options on futures contracts and IRLCs were included in Other assets within the Consolidated Balance Sheets, and forward-delivery contracts were included in Other assets and Accrued and other liabilities within the Consolidated Balance Sheets. Gains realized on the conversion of IRLCs to loans for the three-month periods ended March 31, 2011 and 2010, totaled $2.6 million and $4.5 million, respectively. Gains and losses related to forward-delivery contracts, options on futures contracts and IRLCs were included in Financial services revenues within the Consolidated Statements of Earnings.
At March 31, 2011, the excess of the aggregate fair value over the aggregate unpaid principal balance for mortgage loans held-for-sale measured at fair value totaled $72,000. At December 31, 2010, the excess of the aggregate unpaid principal balance over the aggregate fair value for mortgage loans held-for-sale measured at fair value totaled $86,000. These amounts were included in Financial services revenues within the Consolidated Statements of Earnings. At March 31, 2011, the Company held two loans with payments 90 days or more past due that had an
aggregate carrying value of $417,000 and an aggregate unpaid principal balance of $473,000. At December 31, 2010, the Company held two loans with payments 90 days or more past due that had an aggregate carrying value of $468,000 and an aggregate unpaid principal balance of $592,000.
While recorded fair values represent managements best estimates based on data currently available, future changes in interest rates or in market prices for mortgage loans, among other factors, could materially impact these fair values.
The following table represents a reconciliation of changes in the fair values of Level 3 items (IRLCs) included in Financial services revenues within the Consolidated Statements of Earnings:
In accordance with ASC 820, the Company measures certain nonfinancial homebuilding assets at their fair values on a nonrecurring basis. (See Note 7, Housing Inventories.)
The following table summarizes the fair values of the Companys nonfinancial assets that represent the fair values for communities and other homebuilding assets for which the Company recognized noncash impairment charges during the reporting periods:
Note 12. Postretirement Benefits
The Company has a supplemental nonqualified retirement plan, which generally vests over five-year periods beginning in 2003, pursuant to which it will pay supplemental pension benefits to key employees upon retirement. In connection with this plan, the Company has purchased cost-recovery life insurance on the lives of certain employees. Insurance contracts associated with the plan are held by trusts established as part of the plans to implement and carry out its provisions and finance its related benefits. The trusts are owners and beneficiaries of such contracts. The amount of coverage is designed to provide sufficient revenue to cover all costs of the plan if assumptions made as to employment term, mortality experience, policy earnings and other factors are realized. At March 31, 2011, the cash surrender value of these contracts was $12.0 million, compared to $10.1 million at December 31, 2010, and was included in Other assets. The net periodic benefit cost of the plan for the three months ended March 31, 2011, was $143,000, which included service costs of $262,000 and interest costs of $183,000, partially offset by an investment gain of $302,000. The net periodic benefit cost of the plan for the three months ended March 31, 2010, was $17,000, which included service costs of $43,000 and interest costs of $140,000, partially offset by an investment gain of $166,000. The $10.7 million and $10.3 million projected benefit obligations at March 31, 2011 and December 31, 2010, respectively, were equal to the net liabilities recognized in the Consolidated Balance Sheets at those dates. The discount rate used for the plan was 7.0 percent for the quarters ended March 31, 2011 and 2010.
Note 13. Income Taxes
Deferred tax assets are recognized for estimated tax effects that are attributable to deductible temporary differences and tax carryforwards related to tax credits and operating losses. They are realized when existing temporary differences are carried back to a profitable year(s) and/or carried forward to a future year(s) having taxable income. Deferred tax assets are reduced by a valuation allowance if an assessment of their components indicates that it is more likely than not that all or some portion of the deferred tax asset will not be realized. This assessment considers, among other things, cumulative losses; forecasts of future profitability; the duration of statutory carryforward periods; the Companys experience with loss carryforwards not expiring unused; and tax planning alternatives. The Company generated deferred tax assets for the first quarters of 2011 and 2010 primarily due to inventory impairments and net operating loss carryforwards. In light of these additional impairments, the unavailability of net operating loss carrybacks and the uncertainty as to the housing downturns duration, which limits the Companys ability to predict future taxable income, the Company determined that an allowance against its deferred tax assets was required. Therefore, in accordance with ASC No. 740 (ASC 740), Income Taxes, the Company recorded a net valuation allowance totaling $6.1 million against its deferred tax assets during the quarter ended March 31, 2011, which was reflected as a noncash charge to income tax expense. The balance of the deferred tax valuation allowance was $259.9 million and $253.8 million at March 31, 2011 and December 31, 2010, respectively. For federal purposes, net operating losses can be carried forward 20 years; for state purposes, they can generally be carried forward 10 to 20 years, depending on the taxing jurisdiction. To the extent that the Company generates sufficient taxable income in the future to utilize the tax benefits of related deferred tax assets, it expects to experience a reduction in its effective tax rate as the valuation allowance is reversed.
For the quarter ended March 31, 2011, the Companys effective income tax benefit rate was 10.9 percent due to a noncash charge of $6.1 million for the Companys deferred tax valuation allowance and to a $2.4 million benefit due to the settlement of a previously reserved unrecognized tax benefits. For the quarter ended March 31, 2010, the Companys effective income tax benefit rate was 0.0 percent due to a noncash charge of $5.0 million for the Companys deferred tax valuation allowance, which offsets the benefit generated during the quarter.
The Company made a $1.6 million settlement payment for income tax, interest and penalty to a state taxing authority during the quarter ended March 31, 2011. Additionally, it recorded a tax benefit of $2.4 million to reverse the excess reserve previously recorded for the tax position that related to this settlement. At March 31,
2011, the Companys liability for gross unrecognized tax benefits was $1.3 million, which reflected a decrease of $1.9 million from the balance of $3.2 million at December 31, 2010. The Company had $544,000 and $2.7 million in accrued interest and penalties at March 31, 2011 and December 31, 2010, respectively.
In 2009, the Worker, Homeownership and Business Assistance Act of 2009 (the Act) was enacted. The Act amended Section 172 of the Internal Revenue Code to allow net operating losses realized in a tax year ending after December 31, 2007, and beginning before January 1, 2010, to be carried back up to five years (such losses were previously limited to a two-year carryback). This change allowed the Company to carry back its 2009 taxable loss to prior years and receive a refund of previously paid federal income taxes during the first quarter of 2010.
Note 14. Stock-Based Compensation
The Company recorded stock-based compensation expense of $2.3 million and $3.1 million for the three months ended March 31, 2011 and 2010, respectively. Stock-based compensation expense has been allocated to the Companys business units and reported in Corporate, Financial services and Selling, general and administrative expenses.
A summary of stock option activity in accordance with the Companys equity incentive plans as of March 31, 2011 and 2010, and changes for the three-month periods then ended, follows:
The Company recorded stock-based compensation expense related to employee stock options of $1.1 million and $1.5 million for the three-month periods ended March 31, 2011 and 2010, respectively.
During the quarters ended March 31, 2011 and 2010, the total intrinsic values of stock options exercised were $256,000 and $1.3 million, respectively. The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option.
Compensation expense associated with restricted stock unit awards to senior executives totaled $1.1 million and $1.5 million for the three months ended March 31, 2011 and 2010, respectively.
The following is a summary of activity relating to restricted stock unit awards:
At March 31, 2011, the outstanding restricted shares are expected to vest as follows: 2011132,826; 2012338,827; 2013217,331; and 2014101,667.
The Company recorded stock-based compensation expense related to Director Plan stock awards in the amounts of $108,000 and $116,000 during the quarters ended March 31, 2011 and 2010, respectively. At March 31, 2011 and December 31, 2010, shares of common stock available for grant under the Director Plan totaled 21,975.
Note 15. Commitments and Contingencies
In the ordinary course of business, the Company acquires rights under option agreements to purchase land or lots for use in future homebuilding operations. At March 31, 2011 and December 31, 2010, it had cash deposits and letters of credit outstanding that totaled $44.5 million and $48.7 million, respectively, pertaining to land purchase contracts with aggregate purchase prices of $380.7 million and $374.6 million, respectively. At March 31, 2011 and December 31, 2010, the Company had $764,000 and $834,000, respectively, in commitments with respect to option contracts having specific performance provisions.
As an on-site housing producer, the Company is often required by some municipalities to obtain development or performance bonds and letters of credit in support of its contractual obligations. At March 31, 2011, development bonds totaled $103.1 million, while performance-related cash deposits and letters of credit totaled $43.0 million. At December 31, 2010, development bonds totaled $109.7 million, while performance-related cash deposits and letters of credit totaled $41.9 million. In the event that any such bonds or letters of credit are called, the Company would be required to reimburse the issuer; however, it does not believe that any currently outstanding bonds or letters of credit will be called.
In April 2009, a derivative complaint, City of Miami Police Relief and Pension Fund v. R. Chad Dreier, et al., was filed in the Superior Court for the State of California, County of Los Angeles, which named as defendants certain current and former directors and officers of the Company. The complaint alleged that these individual defendants breached their fiduciary duties to the Company from 2003 to 2008 by not adequately supervising Ryland business practices and by not ensuring that proper internal controls were instituted and followed. During the first quarter of 2011, the parties finalized a proposed settlement for this litigation, which was submitted to the court for approval. Final approval by the court is anticipated in the second quarter of 2011. As finalized, the resolution of this derivative action will not have a material adverse effect on the Companys financial condition.
IRLCs represent loan commitments with customers at market rates generally up to 180 days before settlement. The Company had outstanding IRLCs with notional amounts that totaled $116.8 million and $95.0 million at March 31, 2011 and December 31, 2010, respectively. Hedging instruments, including forward-delivery contracts, are utilized to hedge the risks associated with interest rate fluctuations on IRLCs.
The mortgage industry has experienced substantial increases in delinquencies, foreclosures and foreclosures-in-process in recent years. Under certain circumstances, RMC is required to indemnify loan investors for losses
incurred on sold loans. Once loans are sold, the ownership, credit risk and management, including servicing of the loans, passes to the third-party purchaser. RMC retains no role or interest other than industry standard representations and warranties. Reserves are created to address repurchase and indemnity claims made by these third-party investors or purchasers. Reserves are determined based on pending claims received that are associated with previously sold mortgage loans, industry foreclosure data, the Companys portfolio delinquency and foreclosure rates on sold loans made available by investors, as well as on historical loss payment patterns used to develop ultimate loss projections.
While the Companys access to delinquency information is limited subsequent to loan sale, based on a review of information provided voluntarily by certain investors and on government loan reports made available by the U.S. Department of Housing and Urban Development, the Company believes that the average delinquency rates of RMCs loans are generally in line with industry averages.
The following table summarizes the composition of the Companys mortgage loan types originated, its credit scores and its loan-to-value ratio:
Delinquency rates for loans originated in 2008 and subsequent years have significantly declined from those in 2005 through 2007. The Company primarily attributes this decrease in delinquency rates to the industrywide tightening of credit standards and the elimination of most nontraditional loan products.
Changes in the Companys loan loss reserves during the periods were as follows:
Subsequent changes in conditions or available information may change assumptions and estimates. Mortgage loan loss reserves were reflected in Accrued and other liabilities within the Consolidated Balance Sheets, and their associated expenses were included in Financial services expense within the Consolidated Statements of Earnings.
The Company provides product warranties covering workmanship and materials for one year, certain mechanical systems for two years and structural systems for ten years. The Company estimates and records warranty liabilities based upon historical experience and known risks at the time a home closes as a component of cost of sales, and in the case of unexpected claims, upon identification and quantification of the obligations. Actual future warranty costs could differ from current estimates.
Changes in the Companys product liability reserves during the periods were as follows:
The Company requires substantially all of its subcontractors to have workers compensation insurance and general liability insurance, including construction defect coverage. RHIC provided insurance services to the homebuilding segments subcontractors in certain markets until June 1, 2008. RHIC insurance reserves may have the effect of lowering the Companys product liability reserves, as collectibility of claims against subcontractors enrolled in the RHIC program is generally higher. At March 31, 2011 and December 31, 2010, RHIC had $21.1 million in subcontractor product liability reserves in Accrued and other liabilities within the Consolidated Balance Sheets. Reserves for loss and loss adjustment expense are based upon industry trends and the Companys annual actuarial projections of historical loss development.
Changes in RHICs insurance reserves during the periods were as follows:
Expense provisions or adjustments to RHICs insurance reserves have been included in Financial services expense within the Consolidated Statements of Earnings.
The Company is party to various legal proceedings generally incidental to its businesses. Litigation reserves have been established based on discussions with counsel and the Companys analysis of historical claims. The Company has, and requires its subcontractors to have, general liability insurance to protect it against a portion of its risk of loss and cover it against construction-related claims. The Company establishes reserves to cover its self-insured retentions and deductible amounts under those policies. Due to the high degree of judgment required in determining these estimated reserve amounts and to the inherent variability in predicting future settlements and judicial decisions, actual future litigation costs could differ from the Companys current estimates. The Company believes that adequate provisions have been made for the resolution of all known claims and pending litigation for probable losses. At March 31, 2011 and December 31, 2010, the Company had legal reserves of $7.5 million and $8.1 million, respectively. (See Part II, Item 1. Legal Proceedings.)
Note 16. New Accounting Pronouncements
ASU 2010-20 and ASU 2011-01
In July 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-20 (ASU 2010-20), Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. ASU 2010-20 amends Topic 310, Receivables, to provide additional disclosures related to credit risk inherent in an entitys portfolio of financing receivables. ASU 2010-20 was previously effective for interim and annual reporting periods ending after December 15, 2010. However, in January 2011, the FASB issued ASU No. 2011-01 (ASU 2011-01), Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20, to delay the effective date to interim or annual periods ending after June 15, 2011. The
Company does not anticipate that ASU 2010-20 will have a material impact on its consolidated financial statements.
Note 17. Supplemental Guarantor Information
The Companys obligations to pay principal, premium, if any, and interest under its 6.9 percent senior notes due June 2013; 5.4 percent senior notes due January 2015; 8.4 percent senior notes due May 2017; and 6.6 percent senior notes due May 2020 are guaranteed on a joint and several basis by substantially all of its 100 percent-owned homebuilding subsidiaries (the Guarantor Subsidiaries). Such guarantees are full and unconditional.
In lieu of providing separate financial statements for the Guarantor Subsidiaries, the accompanying condensed consolidating financial statements have been included. Management does not believe that separate financial statements for the Guarantor Subsidiaries are material to investors and are, therefore, not presented.
The following information presents the consolidating statements of earnings, financial position and cash flows for (a) the parent company and issuer, The Ryland Group, Inc. (TRG, Inc.); (b) the Guarantor Subsidiaries; (c) the non-Guarantor Subsidiaries; and (d) the consolidation eliminations used to arrive at the consolidated information for The Ryland Group, Inc. and subsidiaries.
CONSOLIDATING STATEMENTS OF EARNINGS