filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Financial Data” and our audited consolidated financial statements and accompanying notes included elsewhere in this Report.
Special Note Regarding Forward-Looking Statements
This annual report on Form 10-K contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements concern expectations, beliefs, projections, plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. The forward-looking statements in this annual report include statements regarding: our belief that the housing market will continue its steady and slow recovery, and our belief regarding the drivers of such recovery; our belief that we will continue to see lower margins in 2016 compared to 2015; our belief that we are currently positioned to deliver between 26,500 and 27,000 homes in fiscal 2016; our expectation that we will continue to identify and invest in unique and enticing land opportunities that we expect will drive our future growth and profitability; our expectation that our ancillary business will provide opportunities to enhance shareholder value; our belief that our main driver of earnings will continue to be our homebuilding and Financial Services operations; our belief that Lennar Multifamily's revenues will continue to grow in the future and our expectation that the Multifamily business will be profitable in 2016; our belief that we are on track to achieve another year of substantial profitability in fiscal 2016; our intent to settle the face value of the 2.75% convertible senior notes due 2020 in cash; our expectation regarding our variability in our quarterly results; our expectations regarding the renewal or replacement of our warehouse facilities; our belief regarding draws upon our bonds or letters of credit, and our belief regarding the impact to the Company if there were such a draw; our expectation that substantially all homes currently in backlog will be delivered in fiscal year 2016; our belief that our operations and borrowing resources will provide for our current and long-term capital requirements at our anticipated levels of activity; our belief regarding legal proceedings in which we are involved, and, in particular, our belief that the Court’s decision in the Settlers Crossing case is contrary to applicable law; and our estimates regarding certain tax and accounting matters, including our expectations regarding the result of anticipated settlements with various taxing authorities.
These forward-looking statements reflect our current views about future events and are subject to risks, uncertainties and assumptions. We wish to caution readers that certain important factors may have affected and could in the future affect our actual results and could cause actual results to differ significantly from those expressed in any forward-looking statement. The most important factors that could prevent us from achieving our goals, and cause the assumptions underlying forward-looking statements and the actual results to differ materially from those expressed in or implied by those forward-looking statements include, but are not limited to, the following: our ability to acquire land and pursue real estate opportunities at anticipated prices; increases in operating costs, including costs related to real estate taxes, construction materials, labor and insurance, and our ability to manage our cost structure, both in our Homebuilding and Lennar Multifamily businesses; unfavorable outcomes in legal proceedings that substantially exceed our expectations, including an unfavorable outcome in the Settlers Crossing case; a slowdown in the recovery of real estate markets across the nation, or any downturn in such markets; changes in general economic and financial conditions, and demographic trends, in the U.S. leading to decreased demand for our services and homes, lower profit margins and reduced access to credit; the possibility that we will incur nonrecurring costs that may not have a material adverse effect on our business or financial condition, but may have a material adverse effect on our condensed financial statements for a particular reporting period; decreased demand for our Lennar Multifamily rental properties, and our ability to successfully sell our rental properties once rents and occupancies have stabilized; the ability of our Financial Services segment to maintain or increase its capture rate and benefit from Lennar home deliveries; increased competition for home sales from other sellers of new and resale homes; conditions in the capital, credit and financial markets, including mortgage lending standards, the availability of mortgage financing and mortgage foreclosure rates; changes in interest and unemployment rates, and inflation; a decline in the value of the land and home inventories we maintain or possible future write-downs of the carrying value of our real estate assets; our ability to successfully develop multifamily assets in the Multifamily Venture; our inability to maintain anticipated pricing levels and our inability to predict the effect of interest rates on demand; the ability and willingness of the participants in various joint ventures to honor their commitments; our ability to successfully and timely obtain land-use entitlements and construction financing, and address issues that arise in connection with the use and development of our land; natural disasters and other unforeseen damage for which our insurance may not provide adequate coverage; our inability to successfully grow our ancillary businesses; potential liability under environmental or construction laws, or other laws or regulations affecting our business; regulatory changes that adversely affect the profitability of our businesses; our ability to comply with the terms of our debt instruments, our ability to refinance our debt on terms that are acceptable to us; and our ability to successfully estimate the impact of certain regulatory, accounting and tax matters.
Please see “Item 1A-Risk Factors” of this Annual Report for a further discussion of these and other risks and uncertainties which could affect our future results. We undertake no obligation to revise any forward-looking statements to reflect events or circumstances after the date of those statements or to reflect the occurrence of anticipated or unanticipated events, except to the extent we are legally required to disclose certain matters in SEC filings or otherwise.
Outlook
We believe that the housing market will continue its slow and steady recovery driven by lower unemployment, sustained wage growth and growing consumer confidence, despite the first increase in interest rates in nine years announced by the Federal Reserve, which stated that the increase was a sign of confidence in the economy.
Fiscal 2015 was another excellent year for Lennar, with revenues and net earnings attributable to Lennar increasing 22% and 26%, respectively, from 2014. Our core homebuilding business continued to produce strong operating results as gross margins and operating margins were 24.0% and 14.1%, respectively. During 2015, we were able to meet our delivery schedule, amid a tight labor market and despite the impact of the TILA-RESPA Integrated Disclosure regulations. Our home deliveries and new orders increased 16% and 14% compared to fiscal 2014. Our efficient Everything’s Included® manufacturing model helped mitigate the impact of a tight labor market and our focus on digital marketing helped to improve our S,G&A leverage. In addition, we ended the year with a strong sales backlog, up 14% in homes and 25% in dollar value, which gives us a strong start for fiscal 2016.
Complementing our homebuilding business, we also had strong performances from our other businesses during fiscal 2015. Our Financial Services segment produced $127.8 million of pretax earnings compared to $80.1 million in 2014. The increase in profitability was primarily due to an increase in volume, which benefited both our mortgage and title operations.
Rialto generated $28.8 million of operating earnings net of earnings attributable to noncontrolling interests benefiting from its commercial lending business and its fund investments. Rialto continues to emerge as a best-in-class asset manager. In addition, in November 2015, Rialto completed the first closing of over $510 million in commitments from investors in its third real estate investment fund ("Fund III") including $100 million committed by Rialto.
Our Multifamily rental business continued to grow during fiscal 2015, as it sold two completed rental properties and formed the Lennar Multifamily Venture, a co-investment equity venture with global sovereign and institutional investors. This venture gives us the ability to recognize current development earnings and to continue to own a portfolio of income producing properties. We anticipate a profitable year in 2016 for our Multifamily business.
While our homebuilding business continues to produce strong results, we believe we are also in an excellent position across our multiple platforms. In fiscal 2016, our principal focus in our homebuilding operations will continue to be on generating strong operating margins on the homes we sell by delivering homes from what we believe are favorable land positions. We expect to continue to see lower margins in 2016 compared to 2015 due to cost increases outpacing sales price increases, competitive pressures and the start of development of some additional previously inactive land assets. In addition to our soft-pivot strategy, we plan to continue to identify and invest in unique and enticing land opportunities that we expect will drive our future growth and profitability.
We expect that our Company’s main driver of earnings will continue to be our homebuilding and financial services operations as we believe we are currently positioned to deliver between 26,500 and 27,000 homes in fiscal 2016. We are also focused on our multiple platforms including Rialto, Multifamily, and FivePoint, as such ancillary businesses continue to mature and expand their franchises providing opportunities that we expect will enhance shareholder value. Overall, we believe we are on track to achieve another year of substantial profitability in fiscal 2016.
Results of Operations
Overview
Our net earnings attributable to Lennar in 2015 were $802.9 million, or $3.46 per diluted share ($3.87 per basic share), compared to $638.9 million, or $2.80 per diluted share ($3.12 per basic share), in 2014.
The following table sets forth financial and operational information for the years indicated related to our operations.
| Years Ended November 30, | |||||||||
| (Dollars in thousands) | 2015 | 2014 | 2013 | ||||||
| Lennar Homebuilding revenues: | |||||||||
| Sales of homes | $ | 8,335,904 | 6,839,642 | 5,292,072 | |||||
| Sales of land | 131,041 | 185,488 | 62,875 | ||||||
| Total Lennar Homebuilding revenues | 8,466,945 | 7,025,130 | 5,354,947 | ||||||
| Lennar Homebuilding costs and expenses: | |||||||||
| Cost of homes sold | 6,332,850 | 5,103,409 | 3,973,812 | ||||||
| Cost of land sold | 100,939 | 143,797 | 45,834 | ||||||
| Selling, general and administrative | 831,050 | 714,823 | 559,462 | ||||||
| Total Lennar Homebuilding costs and expenses | 7,264,839 | 5,962,029 | 4,579,108 | ||||||
| Lennar Homebuilding operating margins | 1,202,106 | 1,063,101 | 775,839 | ||||||
| Lennar Homebuilding equity in earnings (loss) from unconsolidated entities | 63,373 | (355 | ) | 23,803 | |||||
| Lennar Homebuilding other income, net | 18,616 | 7,526 | 27,346 | ||||||
| Other interest expense | (12,454 | ) | (36,551 | ) | (93,913 | ) | |||
| Lennar Homebuilding operating earnings | $ | 1,271,641 | 1,033,721 | 733,075 | |||||
| Lennar Financial Services revenues | $ | 620,527 | 454,381 | 427,342 | |||||
| Lennar Financial Services costs and expenses | 492,732 | 374,243 | 341,556 | ||||||
| Lennar Financial Services operating earnings | $ | 127,795 | 80,138 | 85,786 | |||||
| Rialto revenues | $ | 221,923 | 230,521 | 138,060 | |||||
| Rialto costs and expenses | 222,875 | 249,114 | 151,072 | ||||||
| Rialto equity in earnings from unconsolidated entities | 22,293 | 59,277 | 22,353 | ||||||
| Rialto other income, net | 12,254 | 3,395 | 16,787 | ||||||
| Rialto operating earnings | $ | 33,595 | 44,079 | 26,128 | |||||
| Lennar Multifamily revenues | 164,613 | 69,780 | 14,746 | ||||||
| Lennar Multifamily costs and expenses | 191,302 | 95,227 | 31,463 | ||||||
| Lennar Multifamily equity in earnings (loss) from unconsolidated entities | 19,518 | 14,454 | (271 | ) | |||||
| Lennar Multifamily operating loss | $ | (7,171 | ) | (10,993 | ) | (16,988 | ) | ||
| Total operating earnings | $ | 1,425,860 | 1,146,945 | 828,001 | |||||
| Corporate general administrative expenses | 216,244 | 177,161 | 146,060 | ||||||
| Earnings before income taxes | $ | 1,209,616 | 969,784 | 681,941 | |||||
| Net earnings attributable to Lennar | $ | 802,894 | 638,916 | 479,674 | |||||
| Gross margin as a % of revenue from home sales | 24.0 | % | 25.4 | % | 24.9 | % | |||
| S,G&A expenses as a % of revenues from home sales | 10.0 | % | 10.5 | % | 10.6 | % | |||
| Operating margin as a % of revenues from home sales | 14.1 | % | 14.9 | % | 14.3 | % | |||
| Average sales price | $ | 344,000 | 326,000 | 290,000 |
2015 versus 2014
Revenues from home sales increased 22% in the year ended November 30, 2015 to $8.3 billion from $6.8 billion in 2014. Revenues were higher primarily due to a 15% increase in the number of home deliveries, excluding unconsolidated entities, and a 6% increase in the average sales price of homes delivered. New home deliveries, excluding unconsolidated entities, increased to 24,209 homes in the year ended November 30, 2015 from 20,971 homes last year. There was an increase in home deliveries in all of our Homebuilding segments and Homebuilding Other, except in Houston. The slight decrease in home deliveries in Houston was primarily due to less demand driven by volatility in the energy sector. The average sales price of homes delivered increased to $344,000 in the year ended November 30, 2015 from $326,000 in the year ended November 30, 2014, primarily due to increased pricing in many of our markets due to favorable market conditions. Sales incentives offered to homebuyers were $21,400 per home delivered in the year ended November 30, 2015, or 5.9% as a percentage of home sales revenue, compared to $21,400 per home delivered in the year ended November 30, 2014, or 6.2% as a percentage of home sales revenue. Currently, our biggest competition is from the sales of existing homes. We differentiate our new homes from those existing homes by issuing new home warranties, updated floor plans, our Everything's Included® marketing program, community amenities and in certain markets by emphasizing energy efficiency and new technologies.
Gross margins on home sales were $2.0 billion, or 24.0%, in the year ended November 30, 2015, compared to $1.7 billion, or 25.4%, in the year ended November 30, 2014. Gross margin percentage on home sales decreased compared to the year ended November 30, 2014, primarily due to an increase in land costs, partially offset by an increase in the average sales price of homes delivered and a decrease in sales incentives offered to homebuyers as a percentage of revenue from home sales. Gross profits on land sales were $30.1 million in the year ended November 30, 2015, compared to $41.7 million in the year ended November 30, 2014.
Selling, general and administrative expenses were $831.1 million in the year ended November 30, 2015, compared to $714.8 million in the year ended November 30, 2014. As a percentage of revenues from home sales, selling, general and administrative expenses improved to 10.0% in the year ended November 30, 2015, from 10.5% in the year ended November 30, 2014 primarily due to improved operating leverage as a result of an increase in home deliveries.
Lennar Homebuilding equity in earnings (loss) from unconsolidated entities was $63.4 million in the year ended November 30, 2015, compared to ($0.4) million in the year ended November 30, 2014. In the year ended November 30, 2015, Lennar Homebuilding equity in earnings from unconsolidated entities primarily related to $82.8 million of equity in earnings from Heritage Fields El Toro, one of our unconsolidated entities ("El Toro"), due to the sale of approximately 700 homesites and a commercial property to third parties, the sale of approximately 800 homesites to a joint venture in which we have a 50% investment, and a gain on debt extinguishment. In the year ended November 30, 2014, Lennar Homebuilding equity in loss from unconsolidated entities primarily related to our share of net operating losses from various Lennar Homebuilding unconsolidated entities, which included $4.6 million of our share of valuation adjustments related to assets of Lennar Homebuilding's unconsolidated entities.
Lennar Homebuilding other income, net, totaled $18.6 million in the year ended November 30, 2015, compared to $7.5 million in the year ended November 30, 2014. In the year ended November 30, 2015, other income, net included $10.2 million aggregate gains on sales of an operating property and a clubhouse.
Lennar Homebuilding interest expense was $220.1 million in the year ended November 30, 2015 ($205.2 million was included in cost of homes sold, $2.5 million in cost of land sold and $12.5 million in other interest expense), compared to $201.5 million in the year ended November 30, 2014 ($161.4 million was included in cost of homes sold, $3.6 million in cost of land sold and $36.6 million in other interest expense). Interest expense increased primarily due to an increase in our outstanding debt and home deliveries, partially offset by an increase in qualifying assets eligible for interest capitalization and lower borrowing costs.
Operating earnings for our Lennar Financial Services segment were $127.8 million in the year ended November 30, 2015, compared to operating earnings of $80.1 million in the year ended November 30, 2014. The increase in profitability was primarily due to an increase in mortgage originations driven by a stronger refinance market and an increase in purchase volume for both Lennar and non-Lennar homebuyers, and an increase in capture rate. The increase in volume also benefited the title operations.
Operating earnings for our Rialto segment were $28.8 million in the year ended November 30, 2015 (which included $33.6 million of operating earnings, partially offset by $4.8 million of net earnings attributable to noncontrolling interests), compared to operating earnings of $66.6 million in the year ended November 30, 2014 (which included $44.1 million of operating earnings and an add back of $22.5 million of net loss attributable to noncontrolling interests).
Rialto revenues were $221.9 million in the year ended November 30, 2015, compared to $230.5 million in the year ended November 30, 2014. Revenues decreased primarily due to a decrease in interest income as a result of a decrease in the portfolio of loans Rialto owns because of loan collections, resolutions and real estate owned ("REO") foreclosures and because
Rialto no longer recognizes interest income under the accretable yield method. Instead, interest income is recognized to the extent that loan collections exceed their carrying value. This decrease was partially offset by an increase in securitization revenue and interest income from Rialto Mortgage Finance ("RMF"). In addition, in the years ended November 30, 2015 and 2014, revenues included $20.0 million and $34.7 million, respectively, of advance distributions with regard to Rialto's carried interests in the Rialto real estate funds in order to cover income tax obligations resulting from the allocations of taxable income to Rialto’s carried interests in these funds.
Rialto expenses were $222.9 million in the year ended November 30, 2015, compared to $249.1 million in the year ended November 30, 2014. Expenses decreased primarily due to a $46.8 million decrease in loan impairments, partially offset by an increase in RMF securitization expenses, general and administrative expenses and interest expense.
Rialto equity in earnings from unconsolidated entities was $22.3 million and $59.3 million in the years ended November 30, 2015 and 2014, respectively, primarily related to the segment's share of net earnings from its real estate funds. The decrease in equity in earnings was primarily related to smaller net increases in the fair value of certain assets in the Rialto real estate funds in the year ended November 30, 2015 than in the prior year.
In the year ended November 30, 2015, Rialto other income, net was $12.3 million, which consisted primarily of $35.2 million of net realized gains on the sale of REO and rental income, net, partially offset by expenses related to owning and maintaining REO and $12.4 million of impairments on REO. In the year ended November 30, 2014, Rialto other income, net was $3.4 million, which consisted primarily of $43.7 million of net realized gains on the sale of REO and rental income, net, partially offset by expenses related to owning and maintaining REO and $19.3 million of impairments on REO.
Operating loss for our Lennar Multifamily segment was $7.2 million in the year ended November 30, 2015, compared to $11.0 million in the year ended November 30, 2014. In the year ended November 30, 2015, the operating loss in Lennar Multifamily primarily related to general and administrative expenses, partially offset by the segment's $22.2 million share of gains as a result of the sale of two operating properties by Lennar Multifamily's unconsolidated entities, management fee income and general contractor income, net. In the year ended November 30, 2014, the operating loss primarily related to general and administrative expenses, partially offset by the segment's $14.7 million share of gains as a result of the sale of two operating properties by Lennar Multifamily unconsolidated entities and management fee income.
Corporate general and administrative expenses were $216.2 million, or 2.3% as a percentage of total revenues, in the year ended November 30, 2015, compared to $177.2 million, or 2.3% as a percentage of total revenues, in the year ended November 30, 2014.
Net earnings (loss) attributable to noncontrolling interests were $16.3 million and ($10.2) million in the years ended November 30, 2015 and 2014, respectively. Net earnings attributable to noncontrolling interests in the year ended November 30, 2015 were primarily attributable to earnings related to Lennar Homebuilding consolidated joint ventures and the FDIC's interest in the portfolio of real estate loans that we acquired in partnership with the FDIC. Net loss attributable to noncontrolling interests in the year ended November 30, 2014 was primarily due to a net loss related to the FDIC's interest in the portfolio of real estate loans that we acquired in partnership with the FDIC, partially offset by a strategic transaction by one of Lennar Homebuilding's consolidated joint ventures that impacted noncontrolling interests by $5.6 million.
During the years ended November 30, 2015 and 2014, we had a tax provision of $390.4 million and $341.1 million, respectively. Our overall effective tax rates were 32.72% and 34.80% for the years ended November 30, 2015 and 2014, respectively. The effective tax rate for the year ended November 30, 2015 included tax benefits for the domestic production activities deduction and energy tax credits, offset primarily by state income tax expense and accruals for uncertain tax positions.
2014 versus 2013
Revenues from home sales increased 29% in the year ended November 30, 2014 to $6.8 billion from $5.3 billion in 2013. Revenues were higher primarily due to a 15% increase in the number of home deliveries, excluding unconsolidated entities, and a 12% increase in the average sales price of homes delivered. New home deliveries, excluding unconsolidated entities, increased to 20,971 homes in the year ended November 30, 2014 from 18,234 homes in the year ended November 30, 2013. There was an increase in home deliveries in all of our Homebuilding segments and Homebuilding Other, which was primarily driven by an increase in active communities over the year ended November 30, 2013. The average sales price of homes delivered increased to $326,000 in the year ended November 30, 2014 from $290,000 in the year ended November 30, 2013, primarily due to increased pricing in many of our markets as the market recovery continues. Sales incentives offered to homebuyers were $21,400 per home delivered in the year ended November 30, 2014, or 6.2% as a percentage of home sales revenue, compared to $20,500 per home delivered in the year ended November 30, 2013, or 6.6% as a percentage of home sales revenue.
Gross margins on home sales were $1.7 billion, or 25.4%, in the year ended November 30, 2014, compared to gross margins on home sales of $1.3 billion, or 24.9%, in the year ended November 30, 2013. Gross margin percentage on home sales improved compared to the year ended November 30, 2013, primarily due to an increase in the average sales price of homes delivered, a decrease in sales incentives offered to homebuyers as a percentage of revenue from home sales and $20.9 million of insurance recoveries and other nonrecurring items, partially offset by an increase in materials, labor and land costs.
Gross profits on land sales totaled $41.7 million in the year ended November 30, 2014, compared to $17.0 million in the year ended November 30, 2013. Gross profits on land sales in the year ended November 30, 2013 included a $4.8 million recovery of an option deposit previously written-off.
Selling, general and administrative expenses were $714.8 million in the year ended November 30, 2014, compared to $559.5 million in the year ended November 30, 2013. As a percentage of revenues from home sales, selling, general and administrative expenses improved to 10.5% in the year ended November 30, 2014, from 10.6% in the year ended November 30, 2013.
Lennar Homebuilding equity in earnings (loss) from unconsolidated entities was ($0.4) million in the year ended November 30, 2014, compared to $23.8 million in the year ended November 30, 2013. In the year ended November 30, 2014, Lennar Homebuilding equity in loss from unconsolidated entities related to our share of operating losses from various Lennar Homebuilding unconsolidated entities, which included $4.6 million of valuation adjustments related to assets of Lennar Homebuilding unconsolidated entities, partially offset by $4.7 million of equity in earnings related to third-party land sales by one unconsolidated entity. In the year ended November 30, 2013, Lennar Homebuilding equity in earnings from unconsolidated entities included $19.8 million of equity in earnings primarily as a result of sales of homesites to third parties by one unconsolidated entity for approximately $204 million resulting in a gross profit of approximately $67 million.
Lennar Homebuilding other income, net, totaled $7.5 million in the year ended November 30, 2014, compared to $27.3 million in the year ended November 30, 2013. In the year ended November 30, 2013, Lennar Homebuilding other income, net was primarily due to management fees and the sale of a rental operating property by one of our consolidated joint ventures that resulted in a gain of $14.4 million (the transaction resulted in a net loss of $3.2 million after considering the impact of noncontrolling interests totaling $17.6 million), partially offset by other expenses.
Lennar Homebuilding interest expense was $201.5 million in the year ended November 30, 2014 ($161.4 million was included in cost of homes sold, $3.6 million in cost of land sold and $36.6 million in other interest expense), compared to $214.3 million in the year ended November 30, 2013 ($117.8 million was included in cost of homes sold, $2.6 million in cost of land sold and $93.9 million in other interest expense). Interest expense decreased due to an increase in qualifying assets eligible for interest capitalization, partially offset by an increase in our outstanding debt and home deliveries.
Operating earnings for our Lennar Financial Services segment were $80.1 million in the year ended November 30, 2014, compared to operating earnings of $85.8 million in the year ended November 30, 2013. The decrease in profitability was primarily due to a more competitive environment as a result of a significant decrease in refinance transactions, which resulted in lower profit per transaction in the segment's mortgage operations.
Operating earnings for our Rialto segment were $66.6 million in the year ended November 30, 2014 (which included $44.1 million of operating earnings and an add back of $22.5 million of net loss attributable to noncontrolling interests), compared to operating earnings of $19.9 million in the year ended November 30, 2013 (which included $26.1 million of operating earnings, partially offset by $6.2 million of net earnings attributable to noncontrolling interests).
Rialto revenues were $230.5 million in the year ended November 30, 2014, compared to $138.1 million in the year ended November 30, 2013. Revenues increased primarily due to the receipt of a $34.7 million advanced distribution with regard to Rialto's carried interest in Rialto Real Estate Fund, LP (“Fund I”) in order to cover the income tax obligation which resulted from allocations of taxable income due to Rialto’s general partner interest in Fund I. In addition, revenues increased due to an
increase in securitization revenue and interest income from RMF, partially offset by a decrease in interest income associated with Rialto’s portfolio of real estate loans.
Rialto expenses were $249.1 million in the year ended November 30, 2014, compared to $151.1 million in the year ended November 30, 2013. Expenses increased primarily due to a $41.0 million increase in loan impairments as a result of changes in estimated cash flows expected to be collected on the segment’s loan portfolios and the change from the accretable yield income method to a cost recovery basis method in the fourth quarter of 2014. We made this determination in order to better reflect the performance of the loan portfolios due to the uncertainty in estimating the timing and amount of future cash flows. In addition, expenses increased due to an increase in interest expense and other general administrative expenses.
Rialto equity in earnings from unconsolidated entities was $59.3 million and $22.4 million in the years ended November 30, 2014 and 2013, respectively, primarily related to the segment's share of earnings from its real estate funds. The higher equity in earnings related to increases in fair value and recognition of gains related to certain assets in the Rialto real estate funds.
In the year ended November 30, 2014, Rialto other income, net was $3.4 million, which consisted primarily of $43.7 million of net realized gains on the sale of REO and rental and other income, partially offset by expenses related to owning and maintaining REO, $19.3 million of impairments on REO and other expenses. In the year ended November 30, 2013, Rialto other income, net, was $16.8 million, which consisted primarily of $48.8 million of net realized gains on the sale of REO, a gain of $8.5 million related to a bargain purchase acquisition, which included cash and a loan receivable as consideration, and rental income, partially offset by expenses related to owning and maintaining REO and $16.1 million of impairments on REO.
Operating loss for our Lennar Multifamily segment was $11.0 million in the year ended November 30, 2014, compared to $17.0 million in the year ended November 30, 2013. In the year ended November 30, 2014, the operating loss in Lennar Multifamily primarily related to general and administrative expenses, partially offset by the segment's $14.7 million share of gains as a result of the sale of two operating properties by Lennar Multifamily unconsolidated entities and management fee income. In the year ended November 30, 2013, the operating loss in Lennar Multifamily primarily related to general and administrative expenses, partially offset by gross profit on a land sale and management fee income.
Corporate general and administrative expenses were $177.2 million, or 2.3% as a percentage of total revenues, in the year ended November 30, 2014, compared to $146.1 million, or 2.5% as a percentage of total revenues, in the year ended November 30, 2013. As a percentage of total revenues, corporate general and administrative expenses improved due to increased operating leverage.
Net earnings (loss) attributable to noncontrolling interests were ($10.2) million and $25.3 million in the years ended November 30, 2014 and 2013, respectively. Net loss attributable to noncontrolling interests in the year ended November 30, 2014 was primarily due to a net loss related to the FDIC's interest in the portfolio of real estate loans that we acquired in partnership with the FDIC, partially offset by a strategic transaction by one of Lennar Homebuilding's consolidated joint ventures that impacted noncontrolling interests by $5.6 million. In the year ended November 30, 2013, net earnings attributable to noncontrolling interests were primarily attributable to a transaction by one of Lennar Homebuilding's consolidated joint ventures that decreased noncontrolling interests by $17.6 million.
During the year ended November 30, 2014, we had a $341.1 million tax provision related to pre-tax earnings of the period, compared to a $177.0 million net tax provision in the year ended November 30, 2013, which included a tax benefit of $67.1 million for a valuation allowance reversal. Our overall effective tax rates were 34.80% and 26.96% for the years ended November 30, 2014 and 2013, respectively. The difference in effective tax rates was primarily related to the reversal of our valuation allowance in the year ended November 30, 2013.
Homebuilding Segments
Our Homebuilding operations construct and sell homes primarily for first-time, move-up and active adult homebuyers primarily under the Lennar brand name. In addition, our homebuilding operations purchase, develop and sell land to third parties. In certain circumstances, we diversify our operations through strategic alliances and attempt to minimize our risks by investing with third parties in joint ventures.
As of and for the year ended November 30, 2015, we have grouped our homebuilding activities into five reportable segments, which we refer to as Homebuilding East, Homebuilding Central, Homebuilding West, Homebuilding Southeast Florida and Homebuilding Houston. Information about homebuilding activities in states in which our homebuilding activities are not economically similar to other states in the same geographic area is grouped under “Homebuilding Other,” which is not considered a reportable segment. Reference in this Management’s Discussion and Analysis of Financial Condition and Results of Operations to homebuilding segments are to those reportable segments.
At November 30, 2015, our reportable homebuilding segments and Homebuilding Other consisted of homebuilding divisions located in:
East: Florida(1), Georgia, Maryland, New Jersey, North Carolina, South Carolina and Virginia
Central: Arizona, Colorado and Texas(2)
West: California and Nevada
Southeast Florida: Southeast Florida
Houston: Houston, Texas
Other: Illinois, Minnesota, Oregon, Tennessee and Washington
| (1) | Florida in the East reportable segment excludes Southeast Florida, which is its own reportable segment. |
| (2) | Texas in the Central reportable segment excludes Houston, Texas, which is its own reportable segment. |
The following tables set forth selected financial and operational information related to our homebuilding operations for the years indicated:
Selected Financial and Operational Data
| Years Ended November 30, | |||||||||
| (In thousands) | 2015 | 2014 | 2013 | ||||||
| Revenues: | |||||||||
| East: | |||||||||
| Sales of homes | $ | 2,734,687 | 2,228,469 | 1,828,543 | |||||
| Sales of land | 27,137 | 19,212 | 13,619 | ||||||
| Total East | 2,761,824 | 2,247,681 | 1,842,162 | ||||||
| Central: | |||||||||
| Sales of homes | 1,191,456 | 908,195 | 736,557 | ||||||
| Sales of land | 22,144 | 28,745 | 6,918 | ||||||
| Total Central | 1,213,600 | 936,940 | 743,475 | ||||||
| West: | |||||||||
| Sales of homes | 2,338,652 | 1,761,762 | 1,160,842 | ||||||
| Sales of land | 26,867 | 34,613 | 490 | ||||||
| Total West | 2,365,519 | 1,796,375 | 1,161,332 | ||||||
| Southeast Florida: | |||||||||
| Sales of homes | 790,004 | 686,994 | 502,175 | ||||||
| Sales of land | 11,850 | 5,904 | — | ||||||
| Total Southeast Florida | 801,854 | 692,898 | 502,175 | ||||||
| Houston: | |||||||||
| Sales of homes | 696,670 | 675,927 | 604,212 | ||||||
| Sales of land | 34,042 | 37,186 | 36,949 | ||||||
| Total Houston | 730,712 | 713,113 | 641,161 | ||||||
| Other: | |||||||||
| Sales of homes | 584,435 | 578,295 | 459,743 | ||||||
| Sales of land | 9,001 | 59,828 | 4,899 | ||||||
| Total Other | 593,436 | 638,123 | 464,642 | ||||||
| Total homebuilding revenues | $ | 8,466,945 | 7,025,130 | 5,354,947 |
| Years Ended November 30, | |||||||||
| (In thousands) | 2015 | 2014 | 2013 | ||||||
| Operating earnings (loss): | |||||||||
| East: | |||||||||
| Sales of homes | $ | 405,629 | 341,461 | 279,561 | |||||
| Sales of land | 10,516 | 5,193 | 1,255 | ||||||
| Equity in earnings from unconsolidated entities | 532 | 2,254 | 678 | ||||||
| Other income (expense), net | (1,739 | ) | 2,867 | (5,354 | ) | ||||
| Other interest expense | (5,753 | ) | (11,667 | ) | (25,023 | ) | |||
| Total East | 409,185 | 340,108 | 251,117 | ||||||
| Central: | |||||||||
| Sales of homes | 112,714 | 81,182 | 68,743 | ||||||
| Sales of land | 2,714 | 6,911 | 773 | ||||||
| Equity in earnings (loss) from unconsolidated entities | 57 | (131 | ) | (87 | ) | ||||
| Other expense, net | (997 | ) | (6,971 | ) | (1,809 | ) | |||
| Other interest expense | (1,736 | ) | (5,406 | ) | (12,417 | ) | |||
| Total Central | 112,752 | 75,585 | 55,203 | ||||||
| West: | |||||||||
| Sales of homes | 358,054 | 286,393 | 190,582 | ||||||
| Sales of land | 446 | 11,851 | 3,442 | ||||||
| Equity in earnings (loss) from unconsolidated entities (1) | 62,960 | (1,647 | ) | 22,039 | |||||
| Other income, net (2) | 17,564 | 7,652 | 27,832 | ||||||
| Other interest expense | (3,206 | ) | (11,530 | ) | (32,740 | ) | |||
| Total West | 435,818 | 292,719 | 211,155 | ||||||
| Southeast Florida: | |||||||||
| Sales of homes | 172,556 | 158,951 | 107,733 | ||||||
| Sales of land | (68 | ) | 3,967 | (188 | ) | ||||
| Equity in loss from unconsolidated entities | (414 | ) | (576 | ) | (152 | ) | |||
| Other income, net | 124 | 2,318 | 7,778 | ||||||
| Other interest expense | (520 | ) | (2,697 | ) | (8,282 | ) | |||
| Total Southeast Florida | 171,678 | 161,963 | 106,889 | ||||||
| Houston: | |||||||||
| Sales of homes (3) | 83,658 | 99,066 | 73,024 | ||||||
| Sales of land | 10,881 | 10,202 | 10,749 | ||||||
| Equity in earnings from unconsolidated entities | 18 | 121 | 2,079 | ||||||
| Other income (expense), net | 1,772 | (201 | ) | (503 | ) | ||||
| Other interest expense | (383 | ) | (1,566 | ) | (4,530 | ) | |||
| Total Houston | 95,946 | 107,622 | 80,819 | ||||||
| Other: | |||||||||
| Sales of homes | 39,393 | 54,357 | 39,155 | ||||||
| Sales of land | 5,613 | 3,567 | 1,010 | ||||||
| Equity in earnings (loss) from unconsolidated entities | 220 | (376 | ) | (754 | ) | ||||
| Other income (expense), net | 1,892 | 1,861 | (598 | ) | |||||
| Other interest expense | (856 | ) | (3,685 | ) | (10,921 | ) | |||
| Total Other | 46,262 | 55,724 | 27,892 | ||||||
| Total homebuilding operating earnings | $ | 1,271,641 | 1,033,721 | 733,075 |
| (1) | Lennar Homebuilding equity in earnings from unconsolidated entities for the year ended November 30, 2015 included $82.8 million of equity in earnings from El Toro, for details refer to Note 4 of the Notes to Consolidated Financial Statements. Lennar Homebuilding equity in loss for the year ended November 30, 2014 included our share of operating losses from various Lennar Homebuilding unconsolidated entities, which included $4.3 million of valuation adjustments related to assets of Lennar Homebuilding's unconsolidated entities, partially offset by $4.7 million of equity in earnings as a result of third-party land sales by one unconsolidated entity. For the |
year ended November 30, 2013, Lennar Homebuilding equity in earnings from unconsolidated entities included $19.8 million of equity in earnings primarily as a result of sales of homesites to third parties by one unconsolidated entity for approximately $204 million, resulting in a gross profit of approximately $67 million. Equity in earnings recognized by us related to the sale of land by our unconsolidated entities may vary significantly from period to period depending on the timing of those land sales and other transactions entered into by our unconsolidated entities in which we have investments.
| (2) | Other income, net for the years ended November 30, 2015 and 2013 included a $6.5 million and a $14.4 million gain on the sale of an operating property each year, respectively. |
| (3) | Sales of homes for the year ended November 30, 2014 included a $5.5 million insurance recovery. |
Summary of Homebuilding Data
Deliveries:
| Years Ended November 30, | ||||||||
| Homes | ||||||||
| 2015 | 2014 | 2013 | ||||||
| East | 9,251 | 7,824 | 6,941 | |||||
| Central | 3,719 | 3,156 | 2,814 | |||||
| West | 5,245 | 4,141 | 3,323 | |||||
| Southeast Florida | 2,264 | 2,086 | 1,741 | |||||
| Houston | 2,452 | 2,482 | 2,266 | |||||
| Other | 1,361 | 1,314 | 1,205 | |||||
| Total | 24,292 | 21,003 | 18,290 |
Of the total home deliveries above, 83, 32 and 56 represent deliveries from unconsolidated entities for the years ended November 30, 2015, 2014 and 2013, respectively.
| Years Ended November 30, | |||||||||||||||||||
| Dollar Value (In thousands) | Average Sales Price | ||||||||||||||||||
| 2015 | 2014 | 2013 | 2015 | 2014 | 2013 | ||||||||||||||
| East | $ | 2,737,608 | 2,234,086 | 1,834,794 | $ | 296,000 | 286,000 | 264,000 | |||||||||||
| Central | 1,191,456 | 908,195 | 736,558 | 320,000 | 288,000 | 262,000 | |||||||||||||
| West | 2,383,432 | 1,775,587 | 1,190,385 | 454,000 | 429,000 | 358,000 | |||||||||||||
| Southeast Florida | 790,004 | 686,994 | 502,175 | 349,000 | 329,000 | 288,000 | |||||||||||||
| Houston | 696,671 | 675,927 | 604,212 | 284,000 | 272,000 | 267,000 | |||||||||||||
| Other | 584,435 | 578,295 | 459,743 | 429,000 | 440,000 | 382,000 | |||||||||||||
| Total | $ | 8,383,606 | 6,859,084 | 5,327,867 | $ | 345,000 | 327,000 | 291,000 |
Of the total dollar value of home deliveries above, $47.7 million, $19.4 million and $35.8 million represent the dollar value of home deliveries from unconsolidated entities for the years ended November 30, 2015, 2014 and 2013, respectively. The home deliveries from unconsolidated entities had an average sales price of $575,000, $608,000 and $639,000 for the years ended November 30, 2015, 2014 and 2013, respectively.
Sales Incentives (1):
| Years Ended November 30, | |||||||||
| (In thousands) | |||||||||
| 2015 | 2014 | 2013 | |||||||
| East | $ | 200,460 | 176,726 | 163,039 | |||||
| Central | 84,266 | 71,533 | 51,557 | ||||||
| West | 80,617 | 59,148 | 29,542 | ||||||
| Southeast Florida | 58,134 | 54,529 | 47,504 | ||||||
| Houston | 68,907 | 62,935 | 64,216 | ||||||
| Other | 25,679 | 24,286 | 17,230 | ||||||
| Total | $ | 518,063 | 449,157 | 373,088 |
| Years Ended November 30, | ||||||||||||||||||
| Average Sales Incentives Per Home Delivered | Sales Incentives as a % of Revenue | |||||||||||||||||
| 2015 | 2014 | 2013 | 2015 | 2014 | 2013 | |||||||||||||
| East | $ | 21,700 | 22,600 | 23,600 | 6.8 | % | 7.4 | % | 8.2 | % | ||||||||
| Central | 22,700 | 22,700 | 18,300 | 6.6 | % | 7.3 | % | 6.5 | % | |||||||||
| West | 15,600 | 14,300 | 9,000 | 3.3 | % | 3.2 | % | 2.5 | % | |||||||||
| Southeast Florida | 25,700 | 26,100 | 27,300 | 6.9 | % | 7.4 | % | 8.6 | % | |||||||||
| Houston | 28,100 | 25,400 | 28,300 | 9.0 | % | 8.5 | % | 9.6 | % | |||||||||
| Other | 18,900 | 18,500 | 14,300 | 4.2 | % | 4.0 | % | 3.6 | % | |||||||||
| Total | $ | 21,400 | 21,400 | 20,500 | 5.9 | % | 6.2 | % | 6.6 | % |
| (1) | Sales incentives relate to home deliveries during the period, excluding deliveries by unconsolidated entities. |
New Orders (2):
| Years Ended November 30, | ||||||||
| Homes | ||||||||
| 2015 | 2014 | 2013 | ||||||
| East | 9,347 | 8,068 | 7,533 | |||||
| Central | 4,128 | 3,473 | 2,805 | |||||
| West | 5,608 | 4,516 | 3,231 | |||||
| Southeast Florida | 2,232 | 2,055 | 1,879 | |||||
| Houston (3) | 2,320 | 2,643 | 2,419 | |||||
| Other | 1,471 | 1,274 | 1,176 | |||||
| Total | 25,106 | 22,029 | 19,043 |
Of the new orders above, 105, 95 and 55 represent new orders from unconsolidated entities for the years ended November 30, 2015, 2014 and 2013, respectively.
| Years Ended November 30, | |||||||||||||||||||
| Dollar Value (In thousands) | Average Sales Price | ||||||||||||||||||
| 2015 | 2014 | 2013 | 2015 | 2014 | 2013 | ||||||||||||||
| East | $ | 2,808,537 | 2,303,916 | 2,066,065 | $ | 300,000 | 286,000 | 274,000 | |||||||||||
| Central | 1,358,374 | 1,021,839 | 763,895 | 329,000 | 294,000 | 272,000 | |||||||||||||
| West | 2,617,393 | 1,956,157 | 1,243,831 | 467,000 | 433,000 | 385,000 | |||||||||||||
| Southeast Florida | 761,959 | 685,536 | 576,781 | 341,000 | 334,000 | 307,000 | |||||||||||||
| Houston (3) | 678,965 | 720,453 | 649,472 | 293,000 | 273,000 | 268,000 | |||||||||||||
| Other | 663,247 | 522,411 | 485,699 | 451,000 | 410,000 | 413,000 | |||||||||||||
| Total | $ | 8,888,475 | 7,210,312 | 5,785,743 | $ | 354,000 | 327,000 | 304,000 |
Of the total dollar value of new orders above, $70.2 million, $56.8 million and $34.8 million represent the dollar value of new orders from unconsolidated entities for the years ended November 30, 2015, 2014 and 2013, respectively. The new orders from
unconsolidated entities had an average sales price of $669,000, $598,000 and $632,000 for the years ended November 30, 2015, 2014 and 2013, respectively.
| (2) | New orders represent the number of new sales contracts executed by homebuyers, net of cancellations, during the years ended November 30, 2015, 2014 and 2013. |
| (3) | The decrease in new orders in Homebuilding Houston was primarily due to less demand driven by volatility in the energy sector during the year ended November 30, 2015. |
Backlog:
| November 30, | ||||||||
| Homes | ||||||||
| 2015 | 2014 | 2013 | ||||||
| East | 2,308 | 2,212 | 1,968 | |||||
| Central | 1,370 | 961 | 644 | |||||
| West | 1,354 | 991 | 616 | |||||
| Southeast Florida | 544 | 576 | 607 | |||||
| Houston | 698 | 830 | 669 | |||||
| Other | 372 | 262 | 302 | |||||
| Total | 6,646 | 5,832 | 4,806 |
Of the total homes in backlog above, 89, 67 and 4 represent homes in backlog from unconsolidated entities at November 30, 2015, 2014 and 2013, respectively.
| November 30, | |||||||||||||||||||
| Dollar Value (In thousands) | Average Sales Price | ||||||||||||||||||
| 2015 | 2014 | 2013 | 2015 | 2014 | 2013 | ||||||||||||||
| East | $ | 741,528 | 672,204 | 600,257 | $ | 321,000 | 304,000 | 305,000 | |||||||||||
| Central | 477,674 | 310,726 | 195,762 | 349,000 | 323,000 | 304,000 | |||||||||||||
| West | 671,524 | 437,492 | 257,498 | 496,000 | 441,000 | 418,000 | |||||||||||||
| Southeast Florida | 186,570 | 214,606 | 215,988 | 343,000 | 373,000 | 356,000 | |||||||||||||
| Houston | 208,076 | 225,737 | 180,665 | 298,000 | 272,000 | 270,000 | |||||||||||||
| Other | 192,379 | 113,563 | 169,431 | 517,000 | 433,000 | 561,000 | |||||||||||||
| Total | $ | 2,477,751 | 1,974,328 | 1,619,601 | $ | 373,000 | 339,000 | 337,000 |
Of the total dollar value of homes in backlog above, $62.4 million, $39.8 million and $2.5 million represent the dollar value of homes in backlog from unconsolidated entities at November 30, 2015, 2014 and 2013, respectively. The homes in backlog from unconsolidated entities had an average sales price of $701,000, $595,000 and $624,000 at November 30, 2015, 2014 and 2013, respectively.
Backlog represents the number of homes under sales contracts. Homes are sold using sales contracts, which are generally accompanied by sales deposits. In some instances, purchasers are permitted to cancel sales if they fail to qualify for financing or under certain other circumstances. We do not recognize revenue on homes under sales contracts until the sales are closed and title passes to the new homeowners.
We experienced cancellation rates in our homebuilding segments and Homebuilding Other as follows:
| Years Ended November 30, | ||||||||
| 2015 | 2014 | 2013 | ||||||
| East | 16 | % | 17 | % | 16 | % | ||
| Central | 18 | % | 20 | % | 18 | % | ||
| West | 13 | % | 14 | % | 15 | % | ||
| Southeast Florida | 13 | % | 13 | % | 12 | % | ||
| Houston (1) | 26 | % | 24 | % | 21 | % | ||
| Other | 11 | % | 13 | % | 13 | % | ||
| Total | 16 | % | 17 | % | 16 | % |
| (1) | The cancellation rate in Homebuilding Houston increased during the year ended November 30, 2015 due to volatility in the energy sector, while cancellation rates decreased or remained flat in all the other Homebuilding segments and Homebuilding Other. |
Active Communities:
| November 30, | ||||||||
| 2015 | 2014 | 2013 | ||||||
| East | 245 | 233 | 197 | |||||
| Central | 128 | 117 | 101 | |||||
| West | 119 | 111 | 80 | |||||
| Southeast Florida | 39 | 32 | 30 | |||||
| Houston | 78 | 78 | 79 | |||||
| Other | 56 | 54 | 50 | |||||
| Total | 665 | 625 | 537 |
Of the total active communities listed above, 3 communities represent active communities being constructed by unconsolidated entities as of both November 30, 2015 and 2014. Of the total active communities listed above, 2 communities represent active communities being constructed by unconsolidated entities as of November 30, 2013.
The following table details our gross margins on home sales for the years ended November 30, 2015, 2014 and 2013 for each of our reportable homebuilding segments and Homebuilding Other:
| Years Ended November 30, | ||||||||||
| (In thousands) | 2015 | 2014 | 2013 | |||||||
| East: | ||||||||||
| Sales of homes | $ | 2,734,687 | 2,228,469 | 1,828,543 | ||||||
| Cost of homes sold | 2,048,217 | 1,639,328 | 1,353,048 | |||||||
| Gross margins on home sales | 686,470 | 25.1% | 589,141 | 26.4% | 475,495 | 26.0% | ||||
| Central: | ||||||||||
| Sales of homes | 1,191,456 | 908,195 | 736,557 | |||||||
| Cost of homes sold | 949,814 | 721,494 | 591,611 | |||||||
| Gross margins on home sales | 241,642 | 20.3% | 186,701 | 20.6% | 144,946 | 19.7% | ||||
| West: | ||||||||||
| Sales of homes | 2,338,652 | 1,761,762 | 1,160,842 | |||||||
| Cost of homes sold | 1,773,651 | 1,305,208 | 840,619 | |||||||
| Gross margins on home sales | 565,001 | 24.2% | 456,554 | 25.9% | 320,223 | 27.6% | ||||
| Southeast Florida: | ||||||||||
| Sales of homes | 790,004 | 686,994 | 502,175 | |||||||
| Cost of homes sold | 551,638 | 473,146 | 352,684 | |||||||
| Gross margins on home sales | 238,366 | 30.2% | 213,848 | 31.1% | 149,491 | 29.8% | ||||
| Houston: | ||||||||||
| Sales of homes | 696,670 | 675,927 | 604,212 | |||||||
| Cost of homes sold | 535,429 | 504,144 | 464,612 | |||||||
| Gross margins on home sales | 161,241 | 23.1% | 171,783 | 25.4% | 139,600 | 23.1% | ||||
| Other | ||||||||||
| Sales of homes | 584,435 | 578,295 | 459,743 | |||||||
| Cost of homes sold | 474,101 | 460,089 | 371,238 | |||||||
| Gross margins on home sales | 110,334 | 18.9% | 118,206 | 20.4% | 88,505 | 19.3% | ||||
| Total gross margins on home sales | $ | 2,003,054 | 24.0% | 1,736,233 | 25.4% | 1,318,260 | 24.9% |
2015 versus 2014
East: Revenues from home sales increased in 2015 compared to 2014 primarily due to an increase in the number of home deliveries and average sales price of homes delivered in all the states of the segment. The increase in the number of deliveries was primarily driven by an increase in active communities over the last year and/or driven by higher demand as the number of deliveries per active community increased. The increase in the average sales price of homes delivered was primarily because we have been able to increase the sales price of homes delivered and/or reduce sales incentives in certain of our communities due to favorable market conditions. Gross margin percentage on homes decreased compared to last year primarily due to an increase in direct construction and land costs per home, partially offset by an increase in the average sales price of homes delivered and a decrease in sales incentives offered to homebuyers as a percentage of revenues from home sales.
Central: Revenues from home sales increased in 2015 compared to 2014 primarily due to an increase in the number of home deliveries in all the states of the segment, except Arizona, and an increase in the average sales price of homes delivered in all the states of the segment. The increase in the number of deliveries was primarily driven by an increase in active communities over the last year and/or driven by higher demand as the number of deliveries per active community increased in all the states of the segment, except Arizona. The decrease in the number of homes delivered in Arizona was primarily due to the timing of deliveries in certain of our communities. The increase in the average sales price of homes delivered was primarily because we have been able to increase the sales price of homes delivered and/or reduce sales incentives in certain of our communities due to favorable market conditions. Gross margin percentage on homes decreased compared to last year as 2014 included $6.4 million of insurance recoveries and other nonrecurring items, which increased the gross margin percentage in 2014 by 80 basis points.
West: Revenues from home sales increased in 2015 compared to 2014 primarily due to an increase in the number of home deliveries and in the average sales price of homes delivered in all the states of the segment. The increase in the number of deliveries was primarily driven by an increase in active communities over the last year and/or driven by higher demand as the number of deliveries per active community increased. The increase in the average sales price of homes delivered was primarily because we have been able to increase the sales price of homes delivered in certain of our communities due to favorable market conditions. Gross margin percentage on homes decreased compared to last year primarily due to an increase in land costs per home, which included a valuation adjustment of $5.8 million in California, partially offset by an increase in the average sales price of homes delivered.
Southeast Florida: Revenues from home sales increased in 2015 compared to 2014 primarily due to an increase in the number of home deliveries and in the average sales price of homes delivered in this segment. The increase in the number of deliveries was primarily driven by an increase in active communities over the last year. The increase in the average sales price of homes delivered was primarily because we have been able to increase the sales price of homes delivered and/or reduce sales incentives in certain of our communities due to favorable market conditions. Gross margin percentage on homes sales decreased compared to last year primarily due to an increase in direct construction and land costs per home, partially offset by an increase in the average sales price of homes delivered and a decrease in sales incentives offered to homebuyers as a percentage of revenues from home sales.
Houston: Revenues from home sales increased in 2015 compared to 2014 primarily due to an increase in the average sales price of homes delivered in this segment. The increase in the average sales price of homes delivered was primarily related to product mix due to the timing of deliveries of the segment's high-end homes in certain communities. Home deliveries in this segment slightly decreased in 2015 compared to 2014 primarily due to less demand driven by volatility in the energy sector. Gross margin percentage on homes sales decreased compared to last year primarily due to an increase in direct construction costs per home and an increase in sales incentives offered to homebuyers as a percentage of revenues from home sales, partially offset by an increase in the average sales price of homes delivered. In addition, gross margin percentage on home sales for 2014 included a $5.5 million insurance recovery, which increased the gross margin percentage in 2014 by 80 basis points.
Other: Revenues from home sales increased in 2015 compared to 2014 primarily due to an increase in the number of homes delivered in Tennessee, Oregon and Washington driven by higher demand as the number of deliveries per active community increased. This was partially offset by a decrease in the average sales price of homes delivered in Tennessee and in our Northeast Urban operations primarily as a result of a change in product mix due to timing of deliveries in certain communities. Gross margin percentage on homes sales decreased compared to last year primarily due to an increase in land costs per home, which included a valuation adjustment of $9.6 million in our Northeast Urban operations primarily related to a strategic decision to move forward on an inactive asset and an increase in sales incentives offered to homebuyers as a percentage of revenues from home sales.
2014 versus 2013
East: Revenues from home sales increased in 2014 compared to 2013 primarily due to an increase in the number of home deliveries in all the states of the segment, except New Jersey and an increase in the average sales price of homes delivered in all the states of the segment, except Georgia. The increase in the number of deliveries was primarily driven by an increase in active communities during 2014. The decrease in home deliveries in New Jersey was primarily due to the timing of deliveries in certain communities. The increase in the average sales price of homes delivered was primarily because we were able to increase the sales price of homes delivered and/or reduce sales incentives in certain of our communities as the market recovery continued. The decrease in the average sales price of homes delivered in Georgia was primarily driven by a change in product mix due to the timing of deliveries in certain of our communities. Gross margin percentage on homes increased compared to 2013 primarily due to an increase in the average sales price of homes delivered and a decrease in sales incentives offered to homebuyers as a percentage of revenues from home sales, partially offset by an increase in direct construction and land costs per home due to increases in labor, material and land costs.
Central: Revenues from home sales increased in 2014 compared to 2013 primarily due to an increase in the number of home deliveries and in the average sales price of homes delivered in all the states of the segment. The increase in the number of deliveries was primarily driven by an increase in active communities during 2014. The increase in the average sales price of homes delivered was primarily because we were able to increase the sales price of homes delivered as the market recovery continued. Gross margin percentage on homes increased compared to 2013 primarily due to an increase in the average sales price of homes delivered and $6.4 million of insurance recoveries and other nonrecurring items, partially offset by an increase in sales incentives offered to homebuyers as a percentage of revenues from home sales and an increase in direct construction and land costs per home due to increases in labor, material and land costs.
West: Revenues from home sales increased in 2014 compared to 2013 primarily due to an increase in the number of home deliveries and in the average sales price of homes delivered in all the states of the segment. The increase in the number of deliveries was primarily driven by an increase in active communities during 2014. The increase in the average sales price of homes delivered was primarily a result of a change in product mix due to the timing of deliveries and because we were able to increase the sales price of homes delivered as the market recovery continued. Gross margin percentage on homes decreased compared to 2013 primarily due to an increase in direct construction costs per home as a result of a change in product mix due to the timing of deliveries and increases in labor, material and land costs, and an increase in sales incentives offered to homebuyers as a percentage of revenues from home sales. This was partially offset by an increase in the average sales price of homes delivered.
Southeast Florida: Revenues from home sales increased in 2014 compared to 2013 primarily due to an increase in the number of home deliveries and in the average sales price of homes delivered in this segment. The increase in the number of deliveries was primarily driven by a lower mix of start-up communities, which are earlier in the life cycle of delivering homes than non start-up communities. The increase in the average sales price of homes delivered was primarily because we were able to increase the sales price of homes delivered and/or reduce sales incentives in certain of our communities as the market recovery continued. Gross margin percentage on homes sales increased compared to 2013 primarily due to an increase in the average sales price of homes delivered and a decrease in sales incentives offered to homebuyers as a percentage of revenues from home sales, partially offset by an increase in direct construction and land costs per home due to increases in labor, material and land costs.
Houston: Revenues from home sales increased in 2014 compared to 2013 primarily due to an increase in the number of home deliveries in this segment driven by higher demand as the number of deliveries per active community increased. Gross margin percentage on homes sales increased compared to 2013 primarily due to a decrease in sales incentives offered to homebuyers as a percentage of revenues from home sales and a $5.5 million insurance recovery, partially offset by an increase in direct construction and land costs per home due to increases in labor, material and land costs.
Other: Revenues from home sales increased in 2014 compared to 2013 primarily due to an increase in the number of home deliveries in Oregon and Tennessee, which the latter was a new operation, partially offset by a decrease in the number of home deliveries in Washington. Homebuilding revenues also increased due to an increase in the average sales price of homes delivered in all the states of Homebuilding Other. The increase in the number of home deliveries in Oregon was primarily driven by higher demand as the number of home deliveries per active community increased. The decrease in the number of home deliveries in Washington was primarily due to a higher mix of start-up communities, which are earlier in the life cycle of delivering homes than non start-up communities. The increase in the average sales price of homes delivered was primarily because we were able to increase the sales price of homes delivered in certain of our communities as the market recovery continued. Gross margin percentage on homes sales increased compared to 2013 primarily due to an increase in the average sales price of homes delivered, partially offset by an increase in sales incentives offered to homebuyers as a percentage of revenues from home sales and an increase in direct construction and land costs per home due to increases in labor, material and land costs.
Lennar Financial Services Segment
Our Lennar Financial Services reportable segment provides mortgage financing, title insurance and closing services for both buyers of our homes and others. Our Lennar Financial Services segment sells substantially all of the loans it originates within a short period in the secondary mortgage market, the majority of which are sold on a servicing released, non-recourse basis. After the loans are sold, we retain potential liability for possible claims by purchasers that we breached certain limited industry-standard representations and warranties in the loan sale agreements.
The following table sets forth selected financial and operational information relating to our Lennar Financial Services segment:
| Years Ended November 30, | |||||||||
| (Dollars in thousands) | 2015 | 2014 | 2013 | ||||||
| Revenues | $ | 620,527 | 454,381 | 427,342 | |||||
| Costs and expenses | 492,732 | 374,243 | 341,556 | ||||||
| Operating earnings | $ | 127,795 | 80,138 | 85,786 | |||||
| Dollar value of mortgages originated | $ | 8,877,000 | 5,950,000 | 5,282,000 | |||||
| Number of mortgages originated | 32,600 | 23,300 | 22,300 | ||||||
| Mortgage capture rate of Lennar homebuyers | 82 | % | 78 | % | 77 | % | |||
| Number of title and closing service transactions | 108,600 | 90,700 | 101,200 | ||||||
| Number of title policies issued | 263,500 | 220,400 | 192,400 |
Rialto Segment
Our Rialto reportable segment is a commercial real estate investment, investment management, and finance company focused on raising, investing and managing third-party capital, originating and selling into securitizations commercial mortgage loans as well as investing our own capital in real estate related mortgage loans, properties and related securities. Rialto utilizes its vertically-integrated investment and operating platform to underwrite, diligence, acquire, manage, workout and add value to diverse portfolios of real estate loans, properties and securities as well as providing strategic real estate capital. Rialto's primary focus is to manage third-party capital and to originate and sell into securitizations commercial mortgage loans. Rialto has commenced the workout and/or oversight of billions of dollars of real estate assets across the United States, including commercial and residential real estate loans and properties as well as mortgage backed securities with the objective of generating superior, risk-adjusted returns. To date, many of the investment and management opportunities have arisen from the dislocation in the United States real estate markets and the restructuring and recapitalization of those markets.
Rialto's operating earnings were as follows:
| Years Ended November 30, | |||||||||
| (In thousands) | 2015 | 2014 | 2013 | ||||||
| Revenues | $ | 221,923 | 230,521 | 138,060 | |||||
| Costs and expenses (1) | 222,875 | 249,114 | 151,072 | ||||||
| Rialto equity in earnings from unconsolidated entities | 22,293 | 59,277 | 22,353 | ||||||
| Rialto other income, net | 12,254 | 3,395 | 16,787 | ||||||
| Operating earnings (2) | $ | 33,595 | 44,079 | 26,128 |
| (1) | Costs and expenses included loan impairments of $10.4 million, $57.1 million and $16.1 million for the years ended November 30, 2015, 2014 and 2013, respectively, primarily associated with the segment's FDIC loans portfolio (before noncontrolling interests). |
| (2) | Operating earnings for the years ended November 30, 2015, 2014 and 2013 included net earnings (loss) attributable to noncontrolling interests of $4.8 million, ($22.5) million and $6.2 million, respectively. |
The following is a detail of Rialto other income, net:
| Years Ended November 30, | |||||||||
| (In thousands) | 2015 | 2014 | 2013 | ||||||
| Realized gains on REO sales, net | $ | 35,242 | 43,671 | 48,785 | |||||
| Unrealized losses on transfer of loans receivable to REO and impairments, net | (13,678 | ) | (26,107 | ) | (16,517 | ) | |||
| REO and other expenses | (57,740 | ) | (58,067 | ) | (44,282 | ) | |||
| Rental and other income | 48,430 | 43,898 | 20,269 | ||||||
| Gain on bargain purchase acquisition | — | — | 8,532 | ||||||
| Rialto other income, net | $ | 12,254 | 3,395 | 16,787 |
Rialto Mortgage Finance
RMF originates and sells into securitizations five, seven and ten year commercial first mortgage loans, generally with principal amounts between $2 million and $75 million, which are secured by income producing properties. This business has become a significant contributor to the Rialto segment's revenues.
During the year ended November 30, 2015, RMF originated loans with a total principal balance of $2.6 billion and sold $2.4 billion of loans into twelve separate securitizations. During the year ended November 30, 2014, RMF originated loans with a principal balance of $1.6 billion and sold $1.3 billion of loans into eight separate securitizations. As of November 30, 2015 and 2014, $151.8 million and $147.2 million, respectively, of these originated loans were sold into a securitization trust but not settled and thus were included as Rialto's receivables, net.
Loans Receivable
In 2010, our Rialto segment acquired indirectly 40% managing member equity interests in two limited liability companies (“LLCs”), in partnership with the FDIC, which retained 60% equity interests in the LLCs, for approximately $243 million (net of transaction costs and a $22 million working capital reserve). The LLCs hold performing and non-performing loans formerly owned by 22 failed financial institutions and when our Rialto segment acquired its interests in the LLCs, the two portfolios consisted of approximately 5,500 distressed residential and commercial real estate loans. If the LLCs exceed expectations and meet certain internal rate of return and distribution thresholds, our equity interest in the LLCs could be reduced from 40% down to 30%, with a corresponding increase to the FDIC’s equity interest from 60% up to 70%. As these thresholds have not been met, distributions continue being shared 60% / 40% with the FDIC. During the years ended November 30, 2015 and 2014, the LLCs distributed $149.7 million and $184.9 million, respectively, of which $89.8 million and $110.9 million, respectively, was distributed to the FDIC and $59.9 million and $74.0 million, respectively, was distributed to Rialto, the parent company.
The LLCs meet the accounting definition of variable interest entities ("VIEs") and since we were determined to be the primary beneficiary, we consolidated the LLCs. We were determined to be the primary beneficiary because we have the power to direct the activities of the LLCs that most significantly impact the LLCs’ performance through Rialto's management and servicer contracts. At November 30, 2015, these consolidated LLCs had total combined assets and liabilities of $355.2 million and $11.3 million, respectively. At November 30, 2014, these consolidated LLCs had total combined assets and liabilities of $508.4 million and $21.5 million, respectively.
Also, in 2010, our Rialto segment acquired approximately 400 distressed residential and commercial real estate loans and over 300 REO properties from three financial institutions. We paid $310 million for the distressed real estate and real estate related assets of which $124 million was financed through a 5-year senior unsecured note provided by one of the selling institutions for which the maturity was subsequently extended. The remaining balance is due in December 2016. As of November 30, 2015 and 2014, the outstanding amount related to the 5-year senior unsecured note was $30.3 million and $60.6 million, respectively.
Investments
Rialto is the sponsor of and an investor in private equity vehicles, listed in the table below, that invest in and manage real estate related assets and other related investments.
| Private Equity Vehicle | Inception Year | Purpose | Commitment |
| Rialto Real Estate Fund, LP | 2010 | Invest in distressed real estate assets and other related investments | $700 million (including $75 million by us) |
| Rialto Real Estate Fund II, LP | 2012 | Invest in distressed real estate assets and other related investments | $1.3 billion (including $100 million by us) |
| Rialto Mezzanine Partners Fund, LP | 2013 | Invest in performing mezzanine commercial loans that have expected durations of one to two years and are secured by equity interests in the borrowing entity owning the real estate assets | $300 million (including $34 million by us) |
| Rialto Capital CMBS Fund, LP | 2014 | Invest in commercial mortgage-backed securities B-pieces with some portion of the collateral being originated by our loan and securitization business. | $71 million (including $24 million by us) |
| Rialto Real Estate Fund III | 2015 | Invest in commercial real estate related debt and preferred equity opportunities of all types, as well as value add real estate acquisitions and real estate property requiring repositioning | $510 million (including $100 million by us) |
Rialto also earns fees for its role as a manager of these vehicles and for providing asset management and other services to those vehicles and other third parties.
Rialto's share of earnings (loss) from unconsolidated entities was as follows:
| Years Ended November 30, | |||||||||
| (In thousands) | 2015 | 2014 | 2013 | ||||||
| Rialto Real Estate Fund, LP | $ | 9,676 | 30,612 | 19,391 | |||||
| Rialto Real Estate Fund II, LP | 7,440 | 15,929 | 2,523 | ||||||
| Rialto Mezzanine Partners Fund, LP | 2,194 | 1,913 | 354 | ||||||
| Rialto Capital CMBS Fund, LP | 3,013 | 10,823 | — | ||||||
| Rialto Real Estate Fund III (1) | (78 | ) | — | — | |||||
| Other investments | 48 | — | 85 | ||||||
| Rialto equity in earnings from unconsolidated entities | $ | 22,293 | 59,277 | 22,353 |
| (1) | Equity in loss from Fund III for the year ended November 30, 2015 relates to formation costs incurred in November 2015. |
In 2010, our Rialto segment invested in non-investment grade commercial mortgage-backed securities ("CMBS") at a 55% discount to par value with a coupon rate of 4%, a stated and assumed final distribution date of November 2020 and a stated maturity date of October 2057. In September 2015, our Rialto segment made a net investment of $7.1 million in another CMBS bond at a 39% discount to par value with a coupon rate of 3.4%, a stated and assumed final distribution date of September 2025 and a stated maturity date of September 2058. The aggregate carrying value of these investment securities at November 30, 2015 and 2014 was $25.6 million and $17.3 million, respectively. The Rialto segment classified these securities as held-to-maturity based on its intent and ability to hold the securities until maturity.
In December 2014, the Rialto segment invested $18 million in a private commercial real estate services company. The investment is carried at cost at November 30, 2015 and is included in Rialto's other assets.
Lennar Multifamily Segment
We have been actively involved, primarily through unconsolidated entities, in the development, construction and property management of multifamily rental properties. Our Lennar Multifamily segment focuses on developing a geographically diversified portfolio of institutional quality multifamily rental properties in select U.S. markets.
As of November 30, 2015 and 2014, our balance sheet had $415.4 million and $268.0 million, respectively, of assets related to our Lennar Multifamily segment, which includes investments in unconsolidated entities of $250.9 million and $105.7 million, respectively. Our net investment in the Lennar Multifamily segment as of November 30, 2015 and 2014 was $348.4 million and $203.7 million, respectively. During each of the years ended November 30, 2015 and 2014, our Lennar Multifamily segment sold two operating properties through unconsolidated entities resulting in the segment's $22.2 million and $14.7
million share of gains, respectively, which are included in Lennar Multifamily equity in earnings (loss) from unconsolidated entities.
Our Lennar Multifamily segment had equity investments in 29 unconsolidated entities (including the Lennar Multifamily Venture, the "Venture") and 26 unconsolidated entities as of November 30, 2015 and 2014, respectively. As of November 30, 2015, our Lennar Multifamily segment had interests in 46 communities with development costs of approximately $4.0 billion, of which five communities were completed and operating, four communities were partially completed and leasing, 23 communities were under construction and the remaining communities were either owned or under contract. As of November 30, 2015, our Lennar Multifamily segment had a pipeline of future projects totaling $2.5 billion in assets across a number of states that will be developed primarily by unconsolidated entities.
In July 2015, our Lennar Multifamily segment completed the first closing of the Venture for the development, construction and property management of class-A multifamily assets. The Venture has approximately $1.1 billion of equity commitments, including a $504 million co-investment commitment by us comprised of cash, undeveloped land and preacquisition costs.
Financial Condition and Capital Resources
At November 30, 2015, we had cash and cash equivalents related to our homebuilding, financial services, Rialto and multifamily operations of $1.2 billion, compared to $1.3 billion and $970.5 million at November 30, 2014 and 2013, respectively.
We finance all of our activities including Homebuilding, financial services, Rialto, multifamily and general operating needs primarily with cash generated from our operations, debt issuances and equity offerings as well as cash borrowed under our warehouse lines of credit and our credit facility.
Operating Cash Flow Activities
During 2015, 2014 and 2013, cash used in operating activities totaled $419.6 million, $788.5 million and $807.7 million, respectively. During 2015, cash used in operating activities was impacted by an increase in inventories due to strategic land purchases and land development costs, an increase of $213.5 million in Rialto loans held-for-sale related to RMF and an increase of $105.2 million in Lennar Financial Services loans held-for-sale, partially offset by our net earnings and an increase in accounts payable and other liabilities. For the year ended November 30, 2015, distribution of earnings were (1) $26.3 million from Lennar Homebuilding unconsolidated entities, (2) $13.3 million from Rialto unconsolidated entities, and (3) $21.1 million from Lennar Multifamily unconsolidated entities.
During 2014, cash used in operating activities was impacted by an increase in inventories due to strategic land purchases and land development costs, an increase of $326.1 million in Lennar Financial Services loans held-for-sale due to increased home deliveries towards the end of 2014 compared to 2013 and an increase in receivables, partially offset by our net earnings and an increase in accounts payable and other liabilities. For the year ended November 30, 2014, distribution of earnings were (1) $5.3 million from Lennar Homebuilding unconsolidated entities, (2) $2.5 million from Rialto unconsolidated entities, and (3) $14.5 million from Lennar Multifamily unconsolidated entities.
During 2013, cash used in operating activities was impacted by an increase in inventories due to strategic land purchases and an increase of $44.0 million in Rialto loans held-for-sale related to RMF, partially offset by our increased revenues, an increase in accounts payable and other liabilities and a decrease of $86.1 million in Lennar Financial Services loans held-for-sale. For the year ended November 30, 2013, distribution of earnings were (1) $3.4 million from Lennar Homebuilding unconsolidated entities, and (2) $0.6 million from Rialto unconsolidated entities.
Investing Cash Flow Activities
During 2015, 2014 and 2013, cash provided by (used in) investing activities totaled ($98.4) million, $438.4 million and $689.2 million, respectively. During 2015, our cash used in investing activities was primarily impacted by cash contributions of (1) $210.7 million to Lennar Homebuilding unconsolidated entities primarily for working capital, (2) $63.0 million to Rialto unconsolidated entities comprised of $41.7 million contributed to Fund II, $13.3 million contributed to the Mezzanine Fund and $8.0 million contributed to the CMBS Fund, and (3) $41.3 million to Lennar Multifamily unconsolidated entities primarily for working capital. In addition, cash used in investing activities was impacted by purchases of investment securities and loans held-for-investments. This was partially offset by the receipt of $73.7 million of proceeds from the sale of a Lennar Homebuilding operating property, $155.3 million of proceeds from the sales of REO and by distributions of capital of (1) $118.0 from Lennar Homebuilding unconsolidated entities, (2) $78.1 million from Lennar Multifamily unconsolidated entities, of which $55.3 million was distributed by the Venture, and (3) $22.9 million from Rialto unconsolidated entities comprised of $16.9 million distributed by Fund II, $3.4 million distributed by the Mezzanine Fund and $2.6 million distributed by the CMBS Fund.
During 2014, our cash provided by investing activities was primarily related to the receipt of $269.7 million of proceeds from the sale of REO, $43.9 million of proceeds from the sale of a Lennar Homebuilding operating property and $51.9 million of proceeds from the sale of Lennar Homebuilding investments available-for-sale. In addition, cash provided by investing activities increased due to distributions of capital of (1) $143.5 million from Lennar Homebuilding unconsolidated entities, $66.9 million from Lennar Multifamily unconsolidated entities, and (3) $68.9 million from Rialto unconsolidated entities comprised of $32.5 million distributed by Fund I, $9.0 million distributed by Fund II, $16.5 million distributed by the Mezzanine Fund and $10.9 million distributed by the CMBS Fund. This was partially offset by $21.3 million for purchases of Lennar Homebuilding investments available-for-sale and by cash contributions of (1) $87.5 million to Lennar Homebuilding unconsolidated entities primarily for working capital, (2) $41.5 million to Rialto unconsolidated entities comprised of $7.6 million contributed to Fund II, $18.1 million contributed to the Mezzanine Fund and $15.8 million contributed to the CMBS Fund, and (3) $30.8 million to Lennar Multifamily unconsolidated entities primarily for working capital.
During 2013, our cash provided by investing activities was primarily related to the receipt of $239.2 million of proceeds from the sale of REO, $140.6 million of proceeds from the sale of a Lennar Homebuilding operating property, $66.8 million of principal payments on Rialto loans receivable and a decrease of $223.8 million in Rialto's defeasance cash by two consolidated minority-owned LLCs to repay a loan from the FDIC. In addition, cash provided by investing activities was impacted by distributions of capital of (1) $158.1 million from Lennar Homebuilding unconsolidated entities, primarily related to a distribution from a new unconsolidated joint venture, (2) $42.6 million from Rialto unconsolidated entities, primarily related to Fund I, and (3) $38.9 million from Lennar Multifamily unconsolidated entities. This was partially offset by cash contributions of (1) $57.1 million to Lennar Homebuilding unconsolidated entities primarily for working capital and (2) $67.0 million to Rialto unconsolidated entities comprised of $50.6 million contributed to Fund II and $16.4 million contributed to the Mezzanine Fund, and (3) $22.7 million to Lennar Multifamily unconsolidated entities primarily for working capital.
Financing Cash Flow Activities
During 2015, 2014 and 2013, our cash provided by (used in) financing activities totaled $394.7 million, $661.4 million and ($221.8) million, respectively. During 2015, our cash provided by financing activities was primarily attributed to the receipt of proceeds related to the sale of (1) $400 million aggregate principal amount of 4.875% senior notes due 2023, (2) an additional $250 million aggregate principal amount of 4.50% senior notes due November 2019, and (3) $500 million aggregate principal amount of 4.750% senior notes due 2025; proceeds of $101.6 million from other borrowings; and net borrowings of $366.3 million under our Lennar Financial Services and Rialto warehouse repurchase facilities. This cash provided by financing activities was partially offset by the redemption of $500 million principal amount of our 5.60% senior notes due 2015, exchanges and conversions of $212.1 million principal amount of our 2.75% convertible senior notes due 2020 (the "2.75% Convertible Senior Notes"), principal payments of $258.1 million on other borrowings, and payments of $133.4 million related to noncontrolling interests.
During 2014, our cash provided by financing activities was primarily attributed to the receipt of proceeds related to the sale of (1) $500 million aggregate principal amount of 4.500% senior notes due June 2019, (2) $350 million aggregate principal amount of 4.50% senior notes due November 2019, and (3) an additional $100 million aggregate principal amount of Rialto's 7.00% senior notes due 2018 (the "7.00% Senior Notes"); proceeds of $94.4 million related to the issuance of Rialto's structured note offerings (the "Structured Notes"); and net borrowings of $389.5 million under our Lennar Financial Services and Rialto warehouse repurchase facilities. The cash provided by financing activities was partially offset by the redemption of $250 million principal amount of our 5.50% senior notes due 2014, principal payments of $299.7 million on other borrowings, and payments of $155.6 million related to noncontrolling interests.
During 2013, our cash used in financing activities was attributed to principal payments of $471.3 million related to Rialto notes payable, net repayments of $83.8 million under our Lennar Financial Services warehouse repurchase facilities, principal payments of $287.4 million on other borrowings, the redemption of $63.8 million principal amount of our 5.95% senior notes due 2013, and payments of $201.7 million related to buyouts of our partners' noncontrolling interests, primarily related to two of our consolidated joint ventures. This was partially offset by the receipt of proceeds related to the sale of (1) $275 million aggregate principal amount of our 4.125% senior notes due 2018, (2) $225 million additional aggregate principal amount of our 4.750% senior notes due 2022, and (3) $250 million aggregate principal amount of Rialto's 7.00% Senior Notes; net borrowings of $76.0 million under Rialto's warehouse repurchase facilities related to RMF; and proceeds of $92.6 million from other borrowings.
Debt to total capital ratios are financial measures commonly used in the homebuilding industry and are presented to assist in understanding the leverage of our Lennar Homebuilding operations. Lennar Homebuilding debt to total capital and net Lennar Homebuilding debt to total capital were calculated as follows:
| November 30, | ||||||
| (Dollars in thousands) | 2015 | 2014 | ||||
| Lennar Homebuilding debt | $ | 5,025,130 | 4,661,266 | |||
| Stockholders’ equity | 5,648,944 | 4,827,020 | ||||
| Total capital | $ | 10,674,074 | 9,488,286 | |||
| Lennar Homebuilding debt to total capital | 47.1 | % | 49.1 | % | ||
| Lennar Homebuilding debt | $ | 5,025,130 | 4,661,266 | |||
| Less: Lennar Homebuilding cash and cash equivalents | 893,408 | 885,729 | ||||
| Net Lennar Homebuilding debt | $ | 4,131,722 | 3,775,537 | |||
| Net Lennar Homebuilding debt to total capital (1) | 42.2 | % | 43.9 | % |
| (1) | Net Lennar Homebuilding debt to total capital is a non-GAAP financial measure defined as net Lennar Homebuilding debt (Lennar Homebuilding debt less Lennar Homebuilding cash and cash equivalents) divided by total capital (net Lennar Homebuilding debt plus stockholders' equity). We believe the ratio of net Lennar Homebuilding debt to total capital is a relevant and a useful financial measure to investors in understanding the leverage employed in our Lennar Homebuilding operations. However, because net Lennar Homebuilding debt to total capital is not calculated in accordance with GAAP, this financial measure should not be considered in isolation or as an alternative to financial measures prescribed by GAAP. Rather, this non-GAAP financial measure should be used to supplement our GAAP results. |
At November 30, 2015, Lennar Homebuilding debt to total capital was lower compared to the prior year period, primarily as a result of an increase in stockholders’ equity primarily related to our net earnings, partially offset by an increase in Lennar Homebuilding debt due to the issuance of senior notes.
We are continually exploring various types of transactions to manage our leverage and liquidity positions, take advantage of market opportunities and increase our revenues and earnings. These transactions may include the issuance of additional indebtedness, the repurchase of our outstanding indebtedness for cash or equity, the acquisition of homebuilders and other companies, the purchase or sale of assets or lines of business, the issuance of common stock or securities convertible into shares of common stock, and/or pursuing other financing alternatives. In connection with some of our more recently formed businesses, such as Rialto and Lennar Multifamily, we may also consider other types of transactions such as restructurings, joint ventures, spin-offs or initial public offerings. If any of these transactions are implemented, they could materially impact the amount and composition of our indebtedness outstanding, increase our interest expense, dilute our existing stockholders and/or affect the net book value of our assets. On July 2, 2015, we, through our wholly-owned subsidiaries, entered into a Contribution Agreement, as amended on December 17, 2015, pursuant to which the entities that own the Newhall Ranch, Great Park Neighborhoods, and The San Francisco Shipyard and Candlestick Point (the “Shipyard Venture”) master planned mixed-used developments in California will be combined under a single holding company, together with the existing FivePoint Communities management company. A portion of the assets in the Shipyard Venture will be retained by us and our Shipyard Venture partner. The transactions under the Contribution Agreement are conditioned upon the holding company completing an initial public offering. At November 30, 2015, we had no agreements or understandings regarding any significant transactions that have not been previously disclosed.
The following table summarizes our Lennar Homebuilding senior notes and other debts payable:
| November 30, | ||||||
| (Dollars in thousands) | 2015 | 2014 | ||||
| 6.50% senior notes due 2016 | $ | 249,905 | 249,735 | |||
| 12.25% senior notes due 2017 | 396,252 | 394,415 | ||||
| 4.75% senior notes due 2017 | 397,736 | 396,994 | ||||
| 6.95% senior notes due 2018 | 247,632 | 246,816 | ||||
| 4.125% senior notes due 2018 | 273,319 | 272,747 | ||||
| 4.500% senior notes due 2019 | 497,210 | 496,419 | ||||
| 4.50% senior notes due 2019 | 596,622 | 347,027 | ||||
| 2.75% convertible senior notes due 2020 | 233,225 | 429,005 | ||||
| 3.25% convertible senior notes due 2021 | 398,194 | 393,721 | ||||
| 4.750% senior notes due 2022 | 567,325 | 566,243 | ||||
| 4.875% senior notes due 2023 | 393,545 | — | ||||
| 4.750% senior notes due 2025 | 495,784 | — | ||||
| 5.60% senior notes due 2015 | — | 500,092 | ||||
| Mortgages notes on land and other debt | 278,381 | 368,052 | ||||
| $ | 5,025,130 | 4,661,266 |
Our Lennar Homebuilding average debt outstanding was $5.2 billion with an average rate for interest incurred of 4.9% for the year ended November 30, 2015, compared to $4.7 billion with an average rate for interest incurred of 5.2% for the year ended November 30, 2014. Interest incurred related to Lennar Homebuilding debt for the year ended November 30, 2015 was $288.5 million, compared to $273.4 million in 2014. The majority of our short-term financing needs, including financings for land acquisition and development activities and general operating needs, are met with cash generated from operations, proceeds from debt, as well as borrowings under our unsecured revolving credit facility (the "Credit Facility").
The terms of each of our senior and convertible senior notes outstanding at November 30, 2015 were as follows:
| Senior and Convertible Senior Notes Outstanding (1) | Principal Amount | Net Proceeds (2) | Price | Dates Issued | |||||||||
| (Dollars in thousands) | |||||||||||||
| 6.50% senior notes due 2016 | $ | 250,000 | $ | 248,900 | 99.873 | % | April 2006 | ||||||
| 12.25% senior notes due 2017 | 400,000 | 386,700 | 98.098 | % | April 2009 | ||||||||
| 4.75% senior notes due 2017 | 400,000 | 395,900 | 100 | % | July 2012, August 2012 | ||||||||
| 6.95% senior notes due 2018 | 250,000 | 243,900 | 98.929 | % | May 2010 | ||||||||
| 4.125% senior notes due 2018 (3) | 275,000 | 271,718 | 99.998 | % | February 2013 | ||||||||
| 4.500% senior notes due 2019 | 500,000 | 495,725 | (4) | February 2014 | |||||||||
| 4.50% senior notes due 2019 | 600,000 | 595,801 | (5) | November 2014, February 2015 | |||||||||
| 2.75% convertible senior notes due 2020 (6) | 446,000 | 436,400 | 100 | % | November 2010 | ||||||||
| 3.25% convertible senior notes due 2021 | 400,000 | 391,600 | 100 | % | November 2011, December 2011 | ||||||||
| 4.750% senior notes due 2022 (3) | 575,000 | 567,585 | (7) | October 2012, February 2013, April 2013 | |||||||||
| 4.875% senior notes due 2023 | 400,000 | 393,622 | 99.169 | % | November 2015 | ||||||||
| 4.750% senior notes due 2025 | 500,000 | 495,528 | 100 | % | April 2015 |
| (1) | Interest is payable semi-annually for each of the series of senior and convertible senior notes. The senior and convertible senior notes are unsecured and unsubordinated, but are guaranteed by substantially all of our 100% owned homebuilding subsidiaries. |
| (2) | We generally use the net proceeds for working capital and general corporate purposes, which can include the repayment or repurchase of other outstanding senior notes. |
| (3) | During 2013, we incurred additional interest with respect to the 4.125% senior notes due 2018 and the 4.750% senior notes due 2022 because the registration statements relating to the notes did not become effective by, and the exchange offers were not consummated by, the dates specified in the Registration Rights Agreement related to such notes. |
| (4) | We issued $400 million aggregate principal amount at a price of 100% and $100 million aggregate principal amount at a price of 100.5%. |
| (5) | We issued $350 million aggregate principal amount at a price of 100% and $250 million aggregate principal amount at a price of 100.25%. |
| (6) | As of November 30, 2015, the principal amount outstanding for the 2.75% convertible senior notes was $233.9 million. |
| (7) | We issued $350 million aggregate principal amount at a price of 100%, $175 million aggregate principal amount at a price of 98.073% and $50 million aggregate principal amount at a price of 98.250%. |
In April 2015, we retired our 5.60% senior notes due May 2015 (the "5.60% Senior Notes") for 100% of the $500 million outstanding principal amount, plus accrued and unpaid interest. At November 30, 2014, the carrying value of the 5.60% Senior Notes was $500.1 million.
The 3.25% convertible senior notes due 2021 (the "3.25% Convertible Senior Notes") are convertible into shares of Class A common stock at any time prior to maturity or redemption at the initial conversion rate of 42.5555 shares of Class A common stock per $1,000 principal amount of the 3.25% Convertible Senior Notes or 17,022,200 shares of Class A common stock if all the 3.25% Convertible Senior Notes are converted, which is equivalent to an initial conversion price of approximately $23.50 per share of Class A common stock, subject to anti-dilution adjustments. The shares are included in the calculation of diluted earnings per share. Holders of the 3.25% Convertible Senior Notes have the right to require us to repurchase them for cash equal to 100% of their principal amount, plus accrued but unpaid interest on November 15, 2016. We have the right to redeem the 3.25% Convertible Senior Notes at any time on or after November 20, 2016 for 100% of their principal amount, plus accrued but unpaid interest.
The 2.75% Convertible Senior Notes are convertible into cash, shares of Class A common stock or a combination of both, at our election. However, it is our intent to settle the face value of the 2.75% Convertible Senior Notes in cash. Shares are included in the calculation of diluted earnings per share because even though it is our intent to settle the face value of the 2.75% Convertible Senior Notes in cash, our volume weighted average stock price exceeded the conversion price. For the years ended November 30, 2015, 2014 and 2013, our volume weighted average stock price was $48.61, $39.96 and $37.06, respectively, which exceeded the conversion price, thus 8.6 million shares, 9.0 million shares and 8.2 million shares, respectively, were included in the calculation of diluted earnings per share.
At November 30, 2015, holders may convert the 2.75% Convertible Senior Notes at the initial conversion rate of 45.1794 shares of Class A common stock per $1,000 principal amount or 10,567 shares of Class A common stock if all the 2.75% Convertible Senior Notes are converted, which is equivalent to an initial conversion price of approximately $22.13 per share of Class A common stock, subject to anti-dilution adjustments. Holders of the 2.75% Convertible Senior Notes have the right to convert them during any fiscal quarter (and only during such fiscal quarter, except if they are called for redemption or about to mature), if the last reported sale price of our Class A common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price on each applicable trading day. Holders of the 2.75% Convertible Senior Notes had the right to require us to repurchase them for cash equal to 100% of their principal amount, plus accrued but unpaid interest, on December 15, 2015, but none of them elected to do so. We have the right to redeem the 2.75% Convertible Senior Notes at any time on or after December 20, 2015 for 100% of their principal amount, plus accrued but unpaid interest.
During the year ended November 30, 2015, we exchanged and converted approximately $212 million in aggregate principal amount of the 2.75% Convertible Senior Notes for approximately $213 million in cash and 5.2 million shares of Class A common stock, including accrued and unpaid interest through the dates of completion of the exchanges and conversions. Subsequent to November 30, 2015, we exchanged and converted approximately $89 million in aggregate principal amount of the 2.75% Convertible Senior Notes for approximately $89 million in cash and 2.1 million shares of Class A common stock, including accrued and unpaid interest through the dates of completion of the conversion.
For our 2.75% Convertible Senior Notes, we will be required to pay contingent interest with regard to any interest period beginning with the interest period commencing December 20, 2015 and ending June 14, 2016, and for each subsequent six-month period commencing on an interest payment date to, but excluding, the next interest payment date, if the average trading price of the 2.75% Convertible Senior Notes during the five consecutive trading days ending on the second trading day immediately preceding the first day of the applicable interest period exceeds 120% of the principal amount of the 2.75% Convertible Senior Notes. The amount of contingent interest payable per $1,000 principal amount of notes during the applicable interest period will equal 0.75% per year of the average trading price of such $1,000 principal amount of 2.75% Convertible Senior Notes during the five trading day reference period.
Certain provisions under Accounting Standards Codification (“ASC”) 470, Debt, require the issuer of certain convertible debt instruments that may be settled in cash on conversion to separately account for the liability and equity components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate. We have applied these provisions to our 2.75% Convertible Senior Notes. At issuance, we estimated the fair value of the 2.75% Convertible Senior Notes using similar debt instruments that did not have a conversion feature and allocated the residual value to an equity component that represented the estimated fair value of the conversion feature at issuance. The debt discount of the 2.75%
Convertible Senior Notes was amortized over the five years ended November 30, 2015 and the annual effective interest rate was 7.1% after giving effect to the amortization of the discount and deferred financing costs. At November 30, 2015 and 2014, the principal amount of the 2.75% Convertible Senior Notes was $233.9 million and $446.0 million, respectively. At November 30, 2015 and 2014, the carrying amount of the equity component included in stockholders’ equity was $0.6 million and $15.0 million, respectively, and the net carrying amount of the 2.75% Convertible Senior Notes included in Lennar Homebuilding senior notes and other debts payable was $233.2 million and $429.0 million, respectively. During the years ended November 30, 2015 and 2014, the amount of interest incurred relating to both the contractual interest and amortization of the discount was $21.2 million and $27.3 million, respectively.
Currently, substantially all of our 100% owned homebuilding subsidiaries are guaranteeing all our senior notes (the “Guaranteed Notes”). The guarantees are full and unconditional. The principal reason our 100% owned homebuilding subsidiaries are guaranteeing the Guaranteed Notes is so holders of the Guaranteed Notes will have rights at least as great with regard to our subsidiaries as any other holders of a material amount of our unsecured debt. Therefore, the guarantees of the Guaranteed Notes will remain in effect with regard to a guarantor subsidiary only while it guarantees a material amount of the debt of Lennar Corporation, as a separate entity, to others. At any time when a guarantor subsidiary is no longer guaranteeing at least $75 million of Lennar Corporation’s debt other than the Guaranteed Notes, either directly or by guaranteeing other subsidiaries’ obligations as guarantors of Lennar Corporation’s debt, the guarantor subsidiary’s guarantee of the Guaranteed Notes will be suspended. Therefore, if the guarantor subsidiaries cease guaranteeing Lennar Corporation’s obligations under our Credit Facility and our letter of credit facilities and are not guarantors of any new debt, the guarantor subsidiaries’ guarantees of the Guaranteed Notes will be suspended until such time, if any, as they again are guaranteeing at least $75 million of Lennar Corporation’s debt other than the Guaranteed Notes.
If our guarantor subsidiaries are guaranteeing revolving credit lines totaling at least $75 million, we will treat the guarantees of the Guaranteed Notes as remaining in effect even during periods when Lennar Corporation’s borrowings under the revolving credit lines are less than $75 million. A subsidiary will be released from its guarantee and any other obligations it may have regarding the senior notes if all or substantially all its assets, or all of its capital stock, are sold or otherwise disposed of.
In April 2015, we amended our Credit Facility to reduce the interest rate and increase the maximum potential borrowing capacity. At November 30, 2015, we had a $1.6 billion Credit Facility, which includes a $163 million accordion feature, subject to additional commitments with certain financial institutions. The maturity for $1.3 billion of the Credit Facility is in June 2019, with the remainder maturing in June 2018. The proceeds available under the Credit Facility, which are subject to specified conditions for borrowing, may be used for working capital and general corporate purposes. The Credit Facility agreement also provides that up to $500 million in commitments may be used for letters of credit. As of both November 30, 2015 and 2014, we had no outstanding borrowings under the Credit Facility. We may from time to time, borrow and repay amounts under the Credit Facility. Consequently, the amount outstanding under the Credit Facility at the end of the period may not be reflective of the total amounts outstanding during the period. We believe that we were in compliance with our debt covenants at November 30, 2015. In addition, we had $315 million letter of credit facilities with different financial institutions.
Our performance letters of credit outstanding were $236.5 million and $234.1 million at November 30, 2015 and 2014, respectively. Our financial letters of credit outstanding were $216.7 million and $190.4 million at November 30, 2015 and 2014, respectively. Performance letters of credit are generally posted with regulatory bodies to guarantee the performance of certain development and construction activities. Financial letters of credit are generally posted in lieu of cash deposits on option contracts, for insurance risks, credit enhancements and as other collateral. Additionally, at November 30, 2015, we had outstanding performance and surety bonds related to site improvements at various projects (including certain projects of our joint ventures) of $1.3 billion, which includes $223.4 million related to a pending litigation case.
Under the amended Credit Facility agreement executed in April 2015 (the “Credit Agreement”), as of the end of each fiscal quarter, we are required to maintain a minimum consolidated tangible net worth of approximately $1.5 billion plus the sum of 50% of the cumulative consolidated net income from February 29, 2012, if positive, and 50% of the net cash proceeds from any equity offerings from and after February 29, 2012. We are required to maintain a leverage ratio that shall not exceed 65% and may be reduced by 2.5% per quarter if our interest coverage ratio is less than 2.25:1.00 for two consecutive fiscal calendar quarters. The leverage ratio will have a floor of 60%. If our interest coverage ratio subsequently exceeds 2.25:1.00 for two consecutive fiscal calendar quarters, the leverage ratio we will be required to maintain will be increased by 2.5% per quarter to a maximum of 65%. As of the end of each fiscal quarter, we are also required to maintain either (1) liquidity in an amount equal to or greater than 1.00x consolidated interest incurred for the last twelve months then ended or (2) an interest coverage ratio equal to or greater than 1.50:1.00 for the last twelve months then ended.
The following are computations of our compliance with the minimum net worth test, maximum leverage ratio, and liquidity test, as calculated per the Credit Agreement as of November 30, 2015:
| (Dollars in thousands) | Covenant Level | Level Achieved as of November 30, 2015 | ||||
| Minimum net worth test (1) | $ | 2,610,488 | 4,552,230 | |||
| Maximum leverage ratio (2) | 65.0 | % | 44.4 | % | ||
| Liquidity test (3) | 1.00 | 3.19 |
The terms of the minimum net worth test, maximum leverage ratio and liquidity test used in the Credit Agreement are specifically calculated per the Credit Agreement and differ in specified ways from comparable GAAP or common usage terms. Our minimum net worth test, maximum leverage ratio and liquidity test were calculated for purposes of the Credit Agreement as of November 30, 2015 as follows:
| (1) | The minimum consolidated tangible net worth and the consolidated tangible net worth as calculated per the Credit Agreement were as follows: |
| Minimum consolidated tangible net worth | |||
| (In thousands) | As of November 30, 2015 | ||
| Stated minimum consolidated tangible net worth per the Credit Agreement | $ | 1,459,657 | |
| Plus: 50% of cumulative consolidated net income as calculated per the Credit Agreement, if positive | 1,150,831 | ||
| Required minimum consolidated tangible net worth per the Credit Agreement | $ | 2,610,488 |
| Consolidated tangible net worth | |||
| (In thousands) | As of November 30, 2015 | ||
| Total equity | $ | 5,950,072 | |
| Less: Intangible assets (a) | (51,246 | ) | |
| Tangible net worth as calculated per the Credit Agreement | 5,898,826 | ||
| Less: Consolidated equity of mortgage banking, Rialto and other designated subsidiaries, and, from and after March 1, 2015, equity of Lennar Commercial, Lennar Multifamily and Sunstreet subsidiaries (b) | (1,258,948 | ) | |
| Less: Lennar Homebuilding noncontrolling interests | (87,648 | ) | |
| Consolidated tangible net worth as calculated per the Credit Agreement | $ | 4,552,230 |
(a)Intangible assets represent the Lennar Financial Services segment's title operations goodwill and title plant assets.
| (b) | Consolidated equity of mortgage banking subsidiaries represents the equity of the Lennar Financial Services segment's mortgage banking operations. The consolidated equity of Rialto, as calculated per the Credit Agreement, represents Rialto's total assets minus Rialto's total liabilities as disclosed in Note 8 of the notes to our consolidated financial statements as of November 30, 2015. Consolidated equity of other designated subsidiaries represents the equity of certain subsidiaries included within the Lennar Financial Services segment's title operations that are prohibited from being guarantors under the Credit Agreement. The consolidated equity of Lennar Commercial subsidiaries represents the equity of certain subsidiaries within Lennar Homebuilding that engage in activities related to commercial properties. The consolidated equity of Lennar Multifamily represents Lennar Multifamily’s total assets minus Lennar Multifamily’s total liabilities disclosed in Note 9 of the notes to our consolidated financial statements as of November 30, 2015. The consolidated equity of Sunstreet subsidiaries represents the equity of certain subsidiaries within Lennar Homebuilding that engage in activities related to solar power systems. The consolidated equity of mortgage banking, Rialto, Lennar Commercial, Lennar Multifamily, Sunstreet subsidiaries and other designated subsidiaries are included in equity in our consolidated balance sheet as of November 30, 2015. |
| (2) | The leverage ratio as calculated per the Credit Agreement was as follows: |
| Leverage ratio: | |||
| (Dollars in thousands) | As of November 30, 2015 | ||
| Lennar Homebuilding senior notes and other debts payable | $ | 5,025,130 | |
| Plus: Lennar Homebuilding debt issuance costs | 26,417 | ||
| Less: Debt of Lennar Homebuilding consolidated entities (a) | (10,850 | ) | |
| Funded debt as calculated per the Credit Agreement | 5,040,697 | ||
| Plus: Financial letters of credit (b) | 216,703 | ||
| Plus: Lennar's recourse exposure related to Lennar Homebuilding unconsolidated/consolidated entities, net (c) | 21,831 | ||
| Consolidated indebtedness as calculated per the Credit Agreement | 5,279,231 | ||
| Less: Unrestricted cash and cash equivalents in excess of required liquidity per the Credit Agreement (d) | (915,318 | ) | |
| Numerator as calculated per the Credit Agreement | $ | 4,363,913 | |
| Denominator as calculated per the Credit Agreement | $ | 9,831,461 | |
| Leverage ratio (e) | 44.4 | % |
| (a) | Debt of our Lennar Homebuilding consolidated joint ventures is included in Lennar Homebuilding senior notes and other debts payable in our consolidated balance sheet as of November 30, 2015. |
| (b) | As of November 30, 2015, our financial letters of credit outstanding include $216.7 million as disclosed in Note 6 of the notes to our consolidated financial statements and $0.1 million of financial letters of credit related to the Lennar Financial Services segment's title operations. |
| (c) | Lennar's recourse exposure related to the Lennar Homebuilding unconsolidated and consolidated entities, net includes $11.0 million of net recourse exposure related to Lennar Homebuilding unconsolidated entities and $10.9 million of recourse exposure related to Lennar Homebuilding consolidated entities, which is included in Lennar Homebuilding senior notes and other debts payable in our consolidated balance sheet as of November 30, 2015. |
| (d) | As of November 30, 2015, unrestricted cash and cash equivalents includes $892.5 million of Lennar Homebuilding cash and cash equivalents, excluding cash and cash equivalents from Lennar Commercial and Sunstreet subsidiaries within Lennar Homebuilding, and $32.8 million of Lennar Financial Services cash and cash equivalents, excluding cash and cash equivalents from mortgage banking subsidiaries and other designated subsidiaries within the Lennar Financial Services segment. |
| (e) | Leverage ratio consists of the numerator as calculated per the Credit Agreement divided by the denominator as calculated per the Credit Agreement (consolidated indebtedness as calculated per the Credit Agreement, plus consolidated tangible net worth as calculated per the Credit Agreement). |
| (3) | Liquidity as calculated per the Credit Agreement was as follows: |
| Liquidity test | |||
| (Dollars in thousands) | As of November 30, 2015 | ||
| Unrestricted cash and cash equivalents as calculated per the Credit Agreement (a) | $ | 915,716 | |
| Consolidated interest incurred as calculated per the Credit Agreement (b) | $ | 286,718 | |
| Liquidity (c) | 3.19 |
| (a) | Unrestricted cash and cash and cash equivalents at November 30, 2015 for the liquidity test calculation includes $892.5 million of Lennar Homebuilding cash and cash equivalents, excluding cash and cash equivalents from Lennar Commercial and Sunstreet subsidiaries within Lennar Homebuilding, plus $32.8 million of Lennar Financial Services cash and cash equivalents, excluding cash and cash equivalents from mortgage banking subsidiaries and other designated subsidiaries within the Lennar Financial Services segment, minus $9.6 million of cash and cash equivalents of Lennar Homebuilding consolidated joint ventures. |
| (b) | Consolidated interest incurred as calculated per the Credit Agreement for the twelve months ended November 30, 2015 includes Lennar Homebuilding interest incurred of $288.5 million, plus Lennar Financial Services interest incurred excluding interest incurred from mortgage banking subsidiaries and other designated subsidiaries within the Lennar Financial Services operations, minus (1) interest incurred related to our partner's share of Lennar Homebuilding consolidated joint ventures included within Lennar Homebuilding interest incurred, (2) Lennar Homebuilding interest income included within Lennar Homebuilding other income (expense), net, and (3) Lennar Financial Services interest income, excluding interest income from mortgage banking subsidiaries and other designated subsidiaries within the Lennar Financial Services operations. |
| (c) | We are only required to maintain either (1) liquidity in an amount equal to or greater than 1.00x consolidated interest incurred for the last twelve months then ended or (2) an interest coverage ratio of equal to or greater than 1.50:1.00 for the last twelve months then ended. Although we are in compliance with our debt covenants for both calculations, we have only disclosed the detailed calculation of our liquidity test. |
Our Lennar Financial Services segment's warehouse facilities at November 30, 2015 were as follows:
| (In thousands) | Maximum Aggregate Commitment | ||
| 364-day warehouse repurchase facility that matures August 2016 (1) | $ | 600,000 | |
| 364-day warehouse repurchase facility that matures August 2016 | 300,000 | ||
| 364-day warehouse repurchase facility that matures October 2016 (2) | 450,000 | ||
| Total | $ | 1,350,000 |
| (1) | In accordance with the amended warehouse repurchase facility agreement, the maximum aggregate commitment will be decreased to $400 million in the first quarter of fiscal 2016 and will be increased to $600 million in the second quarter of fiscal 2016. |
| (2) | Maximum aggregate commitment includes an uncommitted amount of $250 million. |
Our Lennar Financial Services segment uses these facilities to finance its lending activities until the mortgage loans are sold to investors and the proceeds are collected. The facilities are expected to be renewed or replaced with other facilities when they mature. Borrowings under the facilities and their prior year predecessors were $858.3 million and $698.4 million, at November 30, 2015 and 2014, respectively, and were collateralized by mortgage loans and receivables on loans sold to investors but not yet paid for with outstanding principal balances of $916.9 million and $732.1 million, at November 30, 2015 and 2014, respectively. The combined effective interest rate on the facilities at November 30, 2015 was 2.5%. Without the facilities, our Lennar Financial Services segment would have to use cash from operations and other funding sources to finance its lending activities. Since our Lennar Financial Services segment’s borrowings under the warehouse repurchase facilities are generally repaid with the proceeds from the sale of mortgage loans and receivables on loans that secure those borrowings, the facilities are not likely to be a call on our current cash or future cash resources. If the facilities are not renewed or replaced, the borrowings under the lines of credit will be paid off by selling mortgage loans held-for-sale to investors and by collecting on receivables on loans sold but not yet paid.
At November 30, 2015, RMF warehouse facilities were as follows:
| (In thousands) | Maximum Aggregate Commitment | ||
| 364-day warehouse repurchase facility that matures March 2016 (1) | $ | 250,000 | |
| 364-day warehouse repurchase facility that matures August 2016 (1) | 250,000 | ||
| 364-day warehouse repurchase facility that matures October 2016 (one year extension) (1) | 400,000 | ||
| Warehouse repurchase facility that matures August 2018 (two - one year extensions) (2) | 100,000 | ||
| Totals | $ | 1,000,000 |
| (1) | RMF uses these facilities to finance its loan origination and securitization business. |
| (2) | In August 2015, Rialto entered into a separate repurchase facility to finance the origination of floating rate accrual loans. Loans financed under this new facility will be held as accrual loans within loans receivable, net. Borrowings under this facility were $36.3 million as of November 30, 2015. |
In December 2015, RMF entered into an additional warehouse repurchase facility with commitments totaling $100 million that matures in December 2017.
Borrowings under the facilities that finance RMF's loan originations and securitization activities were $317.1 million and $141.3 million as of November 30, 2015 and 2014, respectively and were secured by a 75% interest in the originated commercial loans financed. The facilities require immediate repayment of the 75% interest in the secured commercial loans when the loans are sold in a securitization and the proceeds are collected. These warehouse repurchase facilities are non-recourse to the Company and are expected to be renewed or replaced with other facilities when they mature.
In November 2013, the Rialto segment originally issued $250 million aggregate principal amount of the 7.00% Senior Notes, at a price of 100% in a private placement. In March 2014, the Rialto segment issued an additional $100 million of the 7.00% Senior Notes at a price of 102.25% of their face value in a private placement. Proceeds from the offerings, after payment of expenses, were approximately $347 million. Rialto used the net proceeds of the sale of the 7.00% Senior Notes to provide additional working capital for RMF, to make investments in the funds that Rialto manages, as well as for general corporate purposes. In addition, Rialto used $100 million of the net proceeds to repay sums that had been advanced to RMF from Lennar to enable it to begin originating and securitizing commercial mortgage loans. Interest on the 7.00% Senior Notes is due semi-annually. As of November 30, 2015 and 2014, the carrying amount, net of debt issuance costs, of the 7.00% Senior Notes was $347.9 million and $347.1 million, respectively. Under the indenture, Rialto is subject to certain covenants limiting, among other things, Rialto’s ability to incur indebtedness, to make investments, to make distributions to, or enter into transactions with Lennar or to create liens, subject to certain exceptions and qualifications. Rialto also has quarterly and annual reporting requirements, similar to an SEC registrant, to holders of the 7.00% Senior Notes. We believe Rialto was in compliance with its debt covenants at November 30, 2015.
As of November 30, 2015 and 2014, the outstanding amount, net of debt issuance costs, related to the Structured Notes was $31.3 million and $56.6 million, respectively.
As of November 30, 2015 and 2014, the outstanding amount related to the 5-year senior unsecured note due December 2016 was $30.3 million and $60.6 million, respectively.
Changes in Capital Structure
We have a stock repurchase program adopted in 2001, which originally authorized us to purchase up to 20 million shares of our outstanding common stock. During the years ended November 30, 2015, 2014 and 2013, there were no share repurchases of common stock under the stock repurchase program. As of November 30, 2015, the remaining authorized shares that can be purchased under the stock repurchase program were 6.2 million shares of common stock.
During the year ended November 30, 2015, treasury stock increased by 0.3 million shares of Class A common stock due to activity related to our equity compensation plan. During the year ended November 30, 2014, treasury stock decreased by 11.6 million shares of Class A common stock primarily due to the retirement of 11.7 million shares of Class A common stock authorized by our Board of Directors, partially offset by activity related to our equity compensation plan.
During the years ended November 30, 2015, 2014 and 2013, our Class A and Class B common stockholders received a per share annual dividend of $0.16.
Based on our current financial condition and credit relationships, we believe that our operations and borrowing resources will provide for our current and long-term capital requirements at our anticipated levels of activity.
Off-Balance Sheet Arrangements
Lennar Homebuilding - Investments in Unconsolidated Entities
At November 30, 2015, we had equity investments in 34 homebuilding and land unconsolidated entities (of which 3 had recourse debt, 7 had non-recourse debt and 24 had no debt), compared to 35 homebuilding and land unconsolidated entities at November 30, 2014. Historically, we have invested in unconsolidated entities that acquired and developed land (1) for our homebuilding operations or for sale to third parties or (2) for the construction of homes for sale to third-party homebuyers. Through these entities, we have primarily sought to reduce and share our risk by limiting the amount of our capital invested in land, while obtaining access to potential future homesites and allowing us to participate in strategic ventures. The use of these entities also, in some instances, has enabled us to acquire land to which we could not otherwise obtain access, or could not obtain access on as favorable terms, without the participation of a strategic partner. Participants in these joint ventures have been land owners/developers, other homebuilders and financial or strategic partners. Joint ventures with land owners/developers have given us access to homesites owned or controlled by our partners. Joint ventures with other homebuilders have provided us with the ability to bid jointly with our partners for large land parcels. Joint ventures with financial partners have allowed us to combine our homebuilding expertise with access to our partners’ capital. Joint ventures with strategic partners have allowed us to combine our homebuilding expertise with the specific expertise (e.g. commercial or infill experience) of our partner. Each joint venture is governed by an executive committee consisting of members from the partners.
Although the strategic purposes of our joint ventures and the nature of our joint ventures partners vary, the joint ventures are generally designed to acquire, develop and/or sell specific assets during a limited life-time. The joint ventures are typically structured through non-corporate entities in which control is shared with our venture partners. Each joint venture is unique in terms of its funding requirements and liquidity needs. We and the other joint venture participants typically make pro-rata cash contributions to the joint venture. In many cases, our risk is limited to our equity contribution and potential future capital contributions. Additionally, most joint ventures obtain third-party debt to fund a portion of the acquisition, development and construction costs of their communities. The joint venture agreements usually permit, but do not require, the joint ventures to make additional capital calls in the future. However, capital calls relating to the repayment of joint venture debt under payment or maintenance guarantees generally is required.
Under the terms of our joint venture agreements, we generally have the right to share in earnings and distributions of the entities on a pro-rata basis based on our ownership percentage. Some joint venture agreements provide for a different allocation of profit and cash distributions if and when the cumulative results of the joint venture exceed specified targets (such as a specified internal rate of return). Lennar Homebuilding equity in earnings (loss) from unconsolidated entities excludes our pro-rata share of joint ventures’ earnings resulting from land sales to our homebuilding divisions. Instead, we account for those earnings as a reduction of our costs of purchasing the land from the joint ventures or reduce the investment in certain cost sharing unconsolidated entities. This in effect defers recognition of our share of the joint ventures’ earnings related to these sales until we deliver a home and title passes to a third-party homebuyer.
In many instances, we are designated as the manager of a venture under the direction of a management committee that has shared power among the partners of the unconsolidated entity and we receive fees for such services. In addition, we often enter into option and purchase contracts to acquire properties from our joint ventures, generally for market prices at specified dates in the future. Option contracts generally require us to make deposits using cash or irrevocable letters of credit toward the exercise price. These option deposits are generally negotiated on a case by case basis.
We regularly monitor the results of our unconsolidated joint ventures and any trends that may affect their future liquidity or results of operations. Joint ventures in which we have investments may be subject to a variety of financial and non-financial debt covenants related primarily to equity maintenance, fair value of collateral and minimum homesite takedown or sale requirements. We monitor the performance of joint ventures in which we have investments on a regular basis to assess compliance with debt covenants. For those joint ventures not in compliance with the debt covenants, we evaluate and assess possible impairment of our investment.
Our arrangements with joint ventures generally do not restrict our activities or those of the other participants. However, in certain instances, we agree not to engage in some types of activities that may be viewed as competitive with the activities of these ventures in the localities where the joint ventures do business.
As discussed above, the joint ventures in which we invest generally supplement equity contributions with third-party debt to finance their activities. In some instances, the debt financing is non-recourse, thus neither we nor the other equity partners are a party to the debt instruments. In other cases, we and the other partners agree to provide credit support in the form of repayment guarantees.
Material contractual obligations of our unconsolidated joint ventures primarily relate to the debt obligations described above. The joint ventures generally do not enter into lease commitments because the entities are managed either by us, or another of the joint venture participants, who supply the necessary facilities and employee services in exchange for market-based management fees. However, they do enter into management contracts with the participants who manage them. Some joint ventures also enter into agreements with developers, which may be us or other joint venture participants, to develop raw land into finished homesites or to build homes.
The joint ventures often enter into option or purchase agreements with buyers, which may include us or other joint venture participants, to deliver homesites or parcels in the future at market prices. Option deposits are recorded by the joint ventures as liabilities until the exercise dates at which time the deposit and remaining exercise proceeds are recorded as revenue. Any forfeited deposit is recognized as revenue at the time of forfeiture. Our unconsolidated joint ventures generally do not enter into off-balance sheet arrangements.
As described above, the liquidity needs of joint ventures in which we have investments vary on an entity-by-entity basis depending on each entity’s purpose and the stage in its life cycle. During formation and development activities, the entities generally require cash, which is provided through a combination of equity contributions and debt financing, to fund acquisition and development of properties. As the properties are completed and sold, cash generated is available to repay debt and for distribution to the joint venture’s members. Thus, the amount of cash available for a joint venture to distribute at any given time is primarily a function of the scope of the joint venture’s activities and the stage in the joint venture’s life cycle.
We track our share of cumulative earnings and cumulative distributions of our joint ventures. For purposes of classifying distributions received from joint ventures in our statements of cash flows, cumulative distributions are treated as returns on capital to the extent of cumulative earnings and included in our consolidated statements of cash flows as cash flow from operating activities. Cumulative distributions in excess of our share of cumulative earnings are treated as returns of capital and included in our consolidated statements of cash flows as cash flows from investing activities.
Summarized financial information on a combined 100% basis related to Lennar Homebuilding’s unconsolidated entities that are accounted for by the equity method was as follows:
Statement of Operation and Selected Information
| Years Ended November 30, | |||||||||
| (Dollars in thousands) | 2015 | 2014 | 2013 | ||||||
| Revenues | $ | 1,309,517 | 263,395 | 570,910 | |||||
| Costs and expenses | 969,509 | 291,993 | 425,282 | ||||||
| Other income | 49,343 | — | 14,602 | ||||||
| Net earnings (loss) of unconsolidated entities | $ | 389,351 | (28,598 | ) | 160,230 | ||||
| Our share of net earnings (loss) | $ | 95,901 | (1,323 | ) | 32,815 | ||||
| Lennar Homebuilding equity in earnings (loss) from unconsolidated entities | $ | 63,373 | (355 | ) | 23,803 | ||||
| Our cumulative share of net earnings - deferred at November 30 | $ | 42,651 | 6,593 | 13,191 | |||||
| Our investments in unconsolidated entities | $ | 741,551 | 656,837 | 716,949 | |||||
| Equity of the unconsolidated entities | $ | 2,692,360 | 2,278,941 | 2,513,329 | |||||
| Our investment % in the unconsolidated entities (1) | 28 | % | 29 | % | 29 | % |
| (1) | Our share of profit and cash distributions from the sales of land could be higher compared to our ownership interest in unconsolidated entities if certain specified internal rate of return or cash flow milestones are achieved. |
For the year ended November 30, 2015, net earnings of unconsolidated entities included the sale of approximately 1,800 homesites and a commercial property by El Toro for $1.1 billion that resulted in $373.2 million of gross profit, of which (1) approximately 300 homesites were sold to us for $139.6 million that resulted in $49.3 million of gross profit, of which our portion was deferred, (2) approximately 800 homesites were sold to a joint venture in which we have a 50% investment and for which our portion of the gross profit from the sale was deferred, and (3) approximately 700 homesites and a commercial property were sold to third parties. In addition, net earnings for the year ended November 30, 2015 included a gain on debt extinguishment related to a debt paydown by El Toro. These transactions primarily resulted in the recognition of $82.8 million of Lennar Homebuilding equity in earnings for the year ended November 30, 2015.
For the year ended November 30, 2014, Lennar Homebuilding equity in loss from unconsolidated entities related primarily to our share of operating losses from various Lennar Homebuilding unconsolidated entities, which included $4.6 million of valuation adjustments related to assets of Lennar Homebuilding's unconsolidated entities, partially offset by $4.7 million of equity in earnings as a result of third-party land sales by one unconsolidated entity. For the year ended November 30, 2013, Lennar Homebuilding equity in earnings from unconsolidated entities included $19.8 million of equity in earnings primarily as a result of sales of homesites to third parties by one unconsolidated entity.
Balance Sheet
| November 30, | ||||||
| (In thousands) | 2015 | 2014 | ||||
| Assets: | ||||||
| Cash and cash equivalents | $ | 248,980 | 243,597 | |||
| Inventories | 3,059,054 | 2,889,267 | ||||
| Other assets | 465,404 | 155,470 | ||||
| $ | 3,773,438 | 3,288,334 | ||||
| Liabilities and equity: | ||||||
| Accounts payable and other liabilities | $ | 288,192 | 271,638 | |||
| Debt | 792,886 | 737,755 | ||||
| Equity | 2,692,360 | 2,278,941 | ||||
| $ | 3,773,438 | 3,288,334 |
As of November 30, 2015 and 2014, our recorded investments in Lennar Homebuilding unconsolidated entities were $741.6 million and $656.8 million, respectively, while the underlying equity in Lennar Homebuilding unconsolidated entities partners’ net assets as of November 30, 2015 and 2014 was $839.5 million and $722.6 million, respectively. The basis difference is primarily as a result of us buying an interest in a partner's equity in a Lennar Homebuilding unconsolidated entity at a discount to book value, contributing non-monetary assets to an unconsolidated entity with a higher fair value than book value and deferring equity in earnings on land sales.
During the year ended November 30, 2015, we bought out the partner of one of our unconsolidated entities for approximately $10 million of which $7 million was paid in cash and the remainder was financed with a short-term note. As a result, our $70 million investment in the unconsolidated entity was reclassified primarily to inventory.
During the year ended November 30, 2015, El Toro sold approximately 800 homesites to a joint venture, in which we have a 50% investment, for $472.0 million of which $320 million was financed through a non-recourse note. This transaction resulted in $157.4 million of gross profit, of which our portion was deferred. In addition, this transaction resulted in an increase in inventory, other assets and debt of the Lennar Homebuilding unconsolidated entities reflected in the summarized condensed financial information presented in the previous table.
The Lennar Homebuilding unconsolidated entities in which we have investments usually finance their activities with a combination of partner equity and debt financing. In some instances, we and our partners have guaranteed debt of certain unconsolidated entities.
Debt to total capital of the Lennar Homebuilding unconsolidated entities in which we have investments was calculated as follows:
| November 30, | ||||||
| (Dollars in thousands) | 2015 | 2014 | ||||
| Debt | $ | 792,886 | 737,755 | |||
| Equity | 2,692,360 | 2,278,941 | ||||
| Total capital | $ | 3,485,246 | 3,016,696 | |||
| Debt to total capital of our unconsolidated entities | 22.7 | % | 24.5 | % |
Our investments in Lennar Homebuilding unconsolidated entities by type of venture were as follows:
| November 30, | ||||||
| (In thousands) | 2015 | 2014 | ||||
| Land development | $ | 691,850 | 535,960 | |||
| Homebuilding | 49,701 | 120,877 | ||||
| Total investments | $ | 741,551 | 656,837 |
Indebtedness of an unconsolidated entity is secured by its own assets. Some unconsolidated entities own multiple properties and other assets. There is no cross collateralization of debt of different unconsolidated entities. We also do not use our investment in one unconsolidated entity as collateral for the debt in another unconsolidated entity or commingle funds among Lennar Homebuilding unconsolidated entities.
In connection with loans to a Lennar Homebuilding unconsolidated entity, we and our partners often guarantee to a lender, either jointly and severally or on a several basis, any or all of the following: (i) the completion of the development, in whole or in part, (ii) indemnification of the lender from environmental issues, (iii) indemnification of the lender from “bad boy acts” of the unconsolidated entity (or full recourse liability in the event of an unauthorized transfer or bankruptcy) and (iv) that the loan to value and/or loan to cost will not exceed a certain percentage (maintenance or remargining guarantee) or that a percentage of the outstanding loan will be repaid (repayment guarantee).
In connection with loans to an unconsolidated entity where there is a joint and several guarantee, we sometimes have a reimbursement agreement with our partner. The reimbursement agreement provides that neither party is responsible for more than its proportionate share of the guarantee. However, if our joint venture partner does not have adequate financial resources to meet its obligations under the reimbursement agreement, we may be liable for more than our proportionate share, up to our maximum exposure, which is the full amount covered by the joint and several guarantee.
The total debt of Lennar Homebuilding unconsolidated entities in which we have investments, including Lennar's maximum recourse exposure, were as follows:
| November 30, | ||||||
| (Dollars in thousands) | 2015 | 2014 | ||||
| Non-recourse bank debt and other debt (partner’s share of several recourse) | $ | 50,411 | 56,573 | |||
| Non-recourse land seller debt and other debt (1) | 324,000 | 4,022 | ||||
| Non-recourse debt with completion guarantees (2) | 146,760 | 442,854 | ||||
| Non-recourse debt without completion guarantees | 260,734 | 209,825 | ||||
| Non-recourse debt to the Company | 781,905 | 713,274 | ||||
| The Company’s maximum recourse exposure | 10,981 | 24,481 | ||||
| Total debt | $ | 792,886 | 737,755 | |||
| The Company’s maximum recourse exposure as a % of total JV debt | 1 | % | 3 | % |
| (1) | Non-recourse land seller debt and other debt as of November 30, 2015 included a $320 million non-recourse note related to a transaction between El Toro and an unconsolidated joint venture, described previously. |
| (2) | The decrease in non-recourse debt with completion guarantees was primarily related to a debt paydown by El Toro as a result of sales of homesites and debt extinguishment. |
During the year ended November 30, 2015, our maximum recourse exposure related to indebtedness of Lennar Homebuilding unconsolidated entities decreased by $13.5 million, as a result of $0.2 million paid by us primarily through capital contributions to unconsolidated entities and $13.3 million primarily related to the joint ventures selling assets and other transactions.
The recourse debt exposure in the previous table represents our maximum exposure to loss from guarantees and does not take into account the underlying value of the collateral or the other assets of the borrowers that are available to repay debt or to reimburse us for any payments on our guarantees. The Lennar Homebuilding unconsolidated entities that have recourse debt have a significant amount of assets and equity. The summarized balance sheets of the Lennar Homebuilding unconsolidated entities with recourse debt were as follows:
| November 30, | ||||||
| (In thousands) | 2015 | 2014 | ||||
| Assets (1) | $ | 139,389 | 1,669,285 | |||
| Liabilities (1) | $ | 45,214 | 557,261 | |||
| Equity (1) | $ | 94,175 | 1,112,024 |
| (1) | During 2015, El Toro paid down a portion of its debt for which we had a repayment guarantee, thus reducing our maximum recourse exposure and subsequently reducing assets, liabilities and equity of Lennar Homebuilding unconsolidated entities that have recourse debt. |
In addition, in most instances in which we have guaranteed debt of a Lennar Homebuilding unconsolidated entity, our partners have also guaranteed that debt and are required to contribute their share of the guarantee payment. Historically, we have had repayment guarantees and maintenance guarantees. In a repayment guarantee, we and our venture partners guarantee repayment of a portion or all of the debt in the event of a default before the lender would have to exercise its rights against the collateral. In the event of default, if our venture partner does not have adequate financial resources to meet its obligation under our reimbursement agreement, we may be liable for more than our proportionate share, up to our maximum recourse exposure, which is the full amount covered by the joint and several guarantee. The maintenance guarantees only apply if the value of the collateral (generally land and improvements) is less than a specified percentage of the loan balance. As of both November 30, 2015 and 2014, we did not have any maintenance guarantees related to our Lennar Homebuilding unconsolidated entities.
In connection with many of the loans to Lennar Homebuilding unconsolidated entities, we and our joint venture partners (or entities related to them) have been required to give guarantees of completion to the lenders. Those completion guarantees may require that the guarantors complete the construction of the improvements for which the financing was obtained. If the construction is to be done in phases, the guarantee generally is limited to completing only the phases as to which construction has already commenced and for which loan proceeds were used.
If we are required to make a payment under any guarantee, the payment would generally constitute a capital contribution or loan to the Lennar Homebuilding unconsolidated entity and increase our share of any funds the unconsolidated entity distributes.
As of November 30, 2015 and 2014, the fair values of the repayment guarantees and completion guarantees were not material. We believe that as of November 30, 2015, in the event we become legally obligated to perform under a guarantee of an obligation of a Lennar Homebuilding unconsolidated entity due to a triggering event under a guarantee, most of the time the collateral should be sufficient to repay at least a significant portion of the obligation or we and our partners would contribute additional capital into the venture. In certain instances, we placed performance letters of credit and surety bonds with municipalities for our joint ventures (see Note 6 of the notes to our consolidated financial statements).
In view of credit market conditions during the past several years, it is not uncommon for lenders to real estate developers, including joint ventures in which we have interests, to assert non-monetary defaults (such as failure to meet construction completion deadlines or declines in the market value of collateral below required amounts) or technical monetary defaults against the real estate developers. In most instances, those asserted defaults are resolved by modifications of the loan terms, additional equity investments or other concessions by the borrowers. In addition, in some instances, real estate developers, including joint ventures in which we have interests, are forced to request temporary waivers of covenants in loan documents or modifications of loan terms, which are often, but not always obtained. However, in some instances developers, including joint ventures in which we have interests, are not able to meet their monetary obligations to lenders, and are thus declared in default. Because we sometimes guarantee all or portions of the obligations to lenders of joint ventures in which we have interests, when these joint ventures default on their obligations, lenders may or may not have claims against us. Normally, we do not make payments with regard to guarantees of joint venture obligations while the joint ventures are contesting assertions regarding sums due to their lenders. When it is determined that a joint venture is obligated to make a payment that we have guaranteed and the joint venture will not be able to make that payment, we accrue the amounts probable to be paid by us as a liability. Although we generally fulfill our guarantee obligations within a reasonable time after we determine that we are obligated with regard to them, at any point in time it is likely that we will have some balance of unpaid guarantee liability. At both November 30, 2015 and 2014, we had no liabilities accrued for unpaid guarantees of joint venture indebtedness on our consolidated balance sheets.
The following table summarizes the principal maturities of our Lennar Homebuilding unconsolidated entities (“JVs”) debt as per current debt arrangements as of November 30, 2015 and does not necessarily reflect estimates of future cash payments that will be made to reduce debt balances. Many JV loans have extension options in the loan agreements that would allow the loans to be extended into future years.
| Principal Maturities of Unconsolidated JVs by Period | |||||||||||||||||||
| (In thousands) | Total JV Debt | 2016 | 2017 | 2018 | Thereafter | Other Debt (1) | |||||||||||||
| Maximum recourse debt exposure to Lennar | $ | 10,981 | 966 | 10,015 | — | — | — | ||||||||||||
| Debt without recourse to Lennar | 781,905 | 98,535 | 60,317 | 63,003 | 236,050 | 324,000 | |||||||||||||
| Total | $ | 792,886 | 99,501 | 70,332 | 63,003 | 236,050 | 324,000 |
| (1) | Represents land seller debt and other debt of which $320 million is due in December 2016. |
The table below indicates the assets, debt and equity of our 10 largest Lennar Homebuilding unconsolidated joint venture investments as of November 30, 2015:
| (Dollars in thousands) | Lennar’s Investment | Total JV Assets | Maximum Recourse Debt Exposure to Lennar | Total Debt Without Recourse to Lennar | Total JV Debt | Total JV Equity | JV Debt to Total Capital Ratio | ||||||||||||||
| Top Ten JVs (1): | |||||||||||||||||||||
| Heritage Fields El Toro | $ | 274,070 | 1,433,960 | — | 10,797 | 10,797 | 1,314,552 | 1 | % | ||||||||||||
| Newhall Land Development | 60,479 | 456,170 | — | 257 | 257 | 359,995 | — | ||||||||||||||
| Heritage Hills Irvine | 54,179 | 477,788 | — | — | — | 153,835 | — | ||||||||||||||
| Runkle Canyon | 50,334 | 138,378 | — | 35,745 | 35,745 | 100,668 | 26 | % | |||||||||||||
| Ballpark Village | 41,818 | 122,771 | — | 25,235 | 25,235 | 85,637 | 23 | % | |||||||||||||
| Treasure Island Community Development | 40,718 | 88,193 | — | — | — | 81,467 | — | ||||||||||||||
| Shipyard Communities (Hunters Point) | 37,508 | 508,466 | — | 328,181 | 328,181 | 134,083 | 71 | % | |||||||||||||
| LS Terracina | 22,187 | 38,610 | — | — | — | 38,528 | — | ||||||||||||||
| MS Rialto Residential Holdings | 21,581 | 89,646 | — | — | — | 87,309 | — | ||||||||||||||
| Krome Grove Land Trust | 21,354 | 89,644 | 9,015 | 19,240 | 28,255 | 58,944 | 32 | % | |||||||||||||
| 10 largest JV investments | 624,228 | 3,443,626 | 9,015 | 419,455 | 428,470 | 2,415,018 | 15 | % | |||||||||||||
| Other JVs | 117,323 | 329,812 | 1,966 | 38,450 | 40,416 | 277,342 | 13 | % | |||||||||||||
| Total | $ | 741,551 | 3,773,438 | 10,981 | 457,905 | 468,886 | 2,692,360 | 15 | % | ||||||||||||
| Land seller debt and other debt | — | 324,000 | 324,000 | ||||||||||||||||||
| Total JV debt | 10,981 | 781,905 | 792,886 |
(1)The 10 largest joint ventures presented above represent approximately 90% of total JVs assets, debt and equity. In addition, all of the joint ventures presented in the table above operate in our Homebuilding West segment except for Krome Groves Land Trust, which operates in our Homebuilding Southeast Florida segment.
Rialto - Investments in Unconsolidated Entities
The following table reflects Rialto's investments in funds that invest in and manage real estate related assets and other investments:
| November 30, 2015 | November 30, 2015 | November 30, 2014 | ||||||||||||||||||||||
| (In thousands) | Inception Year | Equity Commitments | Equity Commitments Called | Commitment to fund by the Company | Funds contributed by the Company | Investment | ||||||||||||||||||
| Rialto Real Estate Fund, LP | 2010 | $ | 700,006 | $ | 700,006 | $ | 75,000 | $ | 75,000 | $ | 68,570 | 71,831 | ||||||||||||
| Rialto Real Estate Fund II, LP | 2012 | 1,305,000 | 1,305,000 | 100,000 | 100,000 | 99,947 | 67,652 | |||||||||||||||||
| Rialto Mezzanine Partners Fund, LP | 2013 | 300,000 | 300,000 | 33,799 | 33,799 | 32,344 | 20,226 | |||||||||||||||||
| Rialto Capital CMBS Fund, LP | 2014 | 70,660 | 70,660 | 23,735 | 23,735 | 23,233 | 15,266 | |||||||||||||||||
| Rialto Real Estate Fund III (1) | 2015 | 510,233 | — | 100,000 | — | — | — | |||||||||||||||||
| Other investments | 775 | 725 | ||||||||||||||||||||||
| $ | 224,869 | 175,700 |
| (1) | In November 2015, Rialto completed the first closing of commitments from the entities that comprise Rialto Real Estate Fund III ("Fund III"). Fund III's objective is to invest in commercial real estate related debt and preferred equity opportunities of all types, as well as value add real estate acquisitions and real estate property requiring repositioning. |
Rialto's share of earnings (loss) from unconsolidated entities was as follows:
| Years Ended November 30, | |||||||||
| (In thousands) | 2015 | 2014 | 2013 | ||||||
| Rialto Real Estate Fund, LP | $ | 9,676 | 30,612 | 19,391 | |||||
| Rialto Real Estate Fund II, LP | 7,440 | 15,929 | 2,523 | ||||||
| Rialto Mezzanine Partners Fund, LP | 2,194 | 1,913 | 354 | ||||||
| Rialto Capital CMBS Fund, LP | 3,013 | 10,823 | — | ||||||
| Rialto Real Estate Fund III (1) | (78 | ) | — | — | |||||
| Other investments | 48 | — | 85 | ||||||
| Rialto equity in earnings from unconsolidated entities | $ | 22,293 | 59,277 | 22,353 |
| (1) | Equity in loss from Fund III for the year ended November 30, 2015 relates to formation costs incurred in November 2015. |
As manager of real estate funds, we are entitled to receive additional revenue through carried interest if they meet certain performance thresholds. The amounts presented in the table below are advance distributions received related to Rialto's carried interests in order to cover income tax obligations resulting from allocations of taxable income to its carried interests in the funds. These advance distributions are not subject to clawbacks but will reduce future carried interest payments to which Rialto becomes entitled from the applicable funds and have been recorded as revenues.
| Years Ended November 30, | ||||||
| (In thousands) | 2015 | 2014 | ||||
| Rialto Real Estate Fund, LP | $ | 9,588 | 34,693 | |||
| Rialto Real Estate Fund II, LP | 9,383 | — | ||||
| Rialto Mezzanine Partners Fund, LP | 513 | — | ||||
| Rialto Capital CMBS Fund, LP | 516 | — | ||||
| $ | 20,000 | 34,693 |
The following table represents amounts Rialto would have received had the funds ceased operations and hypothetically liquidated all its investments at their estimated fair values on November 30, 2015, both gross and net of amounts received as advanced tax distributions.
| Hypothetical Carried Interest | Paid as Advanced Tax Distribution | Hypothetical Carried Interest, Net | |||||||
| (In thousands) | |||||||||
| Rialto Real Estate Fund, LP | $ | 159,285 | 44,283 | 115,002 | |||||
| Rialto Real Estate Fund II, LP (1) | 39,980 | 9,383 | 30,597 | ||||||
| $ | 199,265 | 53,666 | 145,599 |
| (1) | Net of incentive participations of some employees (refer to paragraph below). |
Rialto adopted a Carried Interest Incentive Plan (“Plan”) which provides participants in the Plan an equity interest in a Rialto subsidiary that entitles them to a specified percentages of distributions made to a Rialto subsidiary from funds or other investment vehicles managed by the Rialto subsidiary. Some Rialto employees may receive up to 40% of the distributions received by the Rialto subsidiary. During the year ended November 30, 2015, Rialto recorded $3.0 million related to the amortization of compensation expense of the Plan over the vesting period.
Summarized condensed financial information on a combined 100% basis related to Rialto’s investments in unconsolidated entities that are accounted for by the equity method was as follows:
Balance Sheet
| November 30, | ||||||
| (In thousands) | 2015 | 2014 | ||||
| Assets: | ||||||
| Cash and cash equivalents | $ | 188,147 | 141,609 | |||
| Loans receivable | 473,997 | 512,034 | ||||
| Real estate owned | 506,609 | 378,702 | ||||
| Investment securities | 1,092,476 | 795,306 | ||||
| Investments in partnerships | 429,979 | 311,037 | ||||
| Other assets | 30,340 | 45,451 | ||||
| $ | 2,721,548 | 2,184,139 | ||||
| Liabilities and equity: | ||||||
| Accounts payable and other liabilities | $ | 29,462 | 20,573 | |||
| Notes payable | 374,498 | 395,654 | ||||
| Equity | 2,317,588 | 1,767,912 | ||||
| $ | 2,721,548 | 2,184,139 |
Statements of Operations and Selected Information
| Years Ended November 30, | |||||||||
| (In thousands) | 2015 | 2014 | 2013 | ||||||
| Revenues | $ | 170,921 | 150,452 | 251,533 | |||||
| Costs and expenses | 97,162 | 95,629 | 252,563 | ||||||
| Other income, net (1) | 144,941 | 479,929 | 187,446 | ||||||
| Net earnings of unconsolidated entities | $ | 218,700 | 534,752 | 186,416 | |||||
| Rialto equity in earnings from unconsolidated entities | $ | 22,293 | 59,277 | 22,353 | |||||
| Rialto's investments in unconsolidated entities | $ | 224,869 | 175,700 | 154,573 | |||||
| Equity of the unconsolidated entities | $ | 2,317,588 | 1,767,912 | 1,193,412 | |||||
| Rialto's investment % in the unconsolidated entities | 10 | % | 10 | % | 13 | % |
| (1) | Other income, net included realized and unrealized gains (losses) on investments. |
Lennar Multifamily - Investments in Unconsolidated Entities
At November 30, 2015 and 2014, we had equity investments in 29 and 26 unconsolidated entities, respectively, that are engaged in multifamily residential developments (of which 22 had non-recourse debt and 7 had no debt). We invest in unconsolidated entities that acquire and develop land to construct multifamily rental properties. Through these entities, we are focusing on developing a geographically diversified portfolio of institutional quality multifamily rental properties in select U.S. markets. Participants in these joint ventures have been financial partners. Joint ventures with financial partners have allowed us to combine our development and construction expertise with access to our partners’ capital. Each joint venture is governed by an operating agreement that provides significant substantive participating voting rights on major decisions to our partners.
In July 2015, the Lennar Multifamily segment completed the first closing of the Venture for the development, construction and property management of class-A multifamily assets. The Venture has approximately $1.1 billion of equity commitments, including a $504 million co-investment commitment by us comprised of cash, undeveloped land and preacquisition costs. It will be seeded with 22 undeveloped multifamily assets that were previously purchased or under contract by the Lennar Multifamily segment totaling approximately 7,100 apartments with projected project costs of $2.4 billion as of November 30, 2015. During the year ended November 30, 2015, $275.5 million of the $1.1 billion in equity commitments were called, of which we contributed our portion of $125.7 million, resulting in a remaining equity commitment of $378.3 million. As of November 30, 2015, the carrying value of our investment in the Venture was $122.5 million.
The joint ventures are typically structured through non-corporate entities in which control is shared with our venture partners. Each joint venture is unique in terms of its funding requirements and liquidity needs. We and the other joint venture participants typically make pro-rata cash contributions to the joint venture except for cost overruns relating to the construction
of the project. In all cases, we have been required to provide guarantees of completion and cost overruns to the lenders and partners. These completion guarantees may require us to complete the improvements for which the financing was obtained. Therefore, our risk is limited to our equity contribution, draws on letters of credit and potential future payments under the guarantees of completion and cost over-runs. In certain instances, payments made under a cost over-run guarantee are considered capital contributions.
Additionally, the joint ventures obtain third-party debt to fund a portion of the acquisition, development and construction costs of the rental projects. The joint venture agreements usually permit, but do not require, the joint ventures to make additional capital calls in the future. However, the joint venture debt does not have payment or maintenance guarantees. Neither we nor the other equity partners are a party to the debt instruments. In some cases, we agree to provide credit support in the form of a letter of credit provided to the bank.
We regularly monitor the results of our unconsolidated joint ventures and any trends that may affect their future liquidity or results of operations. We also monitor the performance of joint ventures in which we have investments on a regular basis to assess compliance with debt covenants. For those joint ventures not in compliance with the debt covenants, we evaluate and assess possible impairment of our investment. We believe all of the joint ventures were in compliance with their debt covenants at November 30, 2015.
Under the terms of our joint venture agreements, we generally have the right to share in earnings and distributions of the entities on a pro-rata basis based on our ownership percentages. Most joint venture agreements provide for a different allocation of profit and cash distributions if and when the cumulative results of the joint venture exceed specified targets (such as a specified internal rate of return).
In many instances, we are designated as the development manager and/or the general contractor and/or the property manager of the unconsolidated entity and receive fees for such services. In addition, we do not plan to enter into option and purchase contracts to acquire properties from our joint ventures.
Our arrangements with joint ventures generally do not restrict our activities or those of the other participants. However, in certain instances, we agree not to engage in some types of activities that may be viewed as competitive with the activities of these ventures in the localities where the joint ventures do business.
Material contractual obligations of our unconsolidated joint ventures primarily relate to the debt obligations described above. The joint ventures generally do not enter into lease commitments because the entities are managed either by us or the other partners, who supply the necessary facilities and employee services in exchange for market-based management fees. However, they do enter into management contracts with the participants who manage them.
As described above, the liquidity needs of joint ventures in which we have investments vary on an entity-by-entity basis depending on each entity’s purpose and the stage in its life cycle. During formation and development activities, the entities generally require cash, which is provided through a combination of equity contributions and debt financing, to fund acquisition, development and construction of multifamily rental properties. As the properties are completed and sold, cash generated will be available to repay debt and for distribution to the joint venture’s members. Thus, the amount of cash available for a joint venture to distribute at any given time is primarily a function of the scope of the joint venture’s activities and the stage in the joint venture’s life cycle.
Summarized financial information on a combined 100% basis related to Lennar Multifamily’s unconsolidated entities that are accounted for by the equity method was as follows:
Balance Sheet
| November 30, | ||||||
| (In thousands) | 2015 | 2014 | ||||
| Assets: | ||||||
| Cash and cash equivalents | $ | 39,579 | 25,319 | |||
| Operating properties and equipment | 1,398,244 | 637,259 | ||||
| Other assets | 25,925 | 14,742 | ||||
| $ | 1,463,748 | 677,320 | ||||
| Liabilities and equity: | ||||||
| Accounts payable and other liabilities | $ | 179,551 | 87,151 | |||
| Notes payable | 466,724 | 163,376 | ||||
| Equity | 817,473 | 426,793 | ||||
| $ | 1,463,748 | 677,320 |
Statements of Operations and Selected Information
| Years Ended November 30, | |||||||||
| (In thousands) | 2015 | 2014 | 2013 | ||||||
| Revenues | $ | 16,309 | 4,855 | — | |||||
| Costs and expenses | 27,190 | 7,435 | 1,493 | ||||||
| Other income, net | 43,340 | 35,068 | — | ||||||
| Net earnings (loss) of unconsolidated entities | $ | 32,459 | 32,488 | (1,493 | ) | ||||
| Lennar Multifamily equity in earnings (loss) from unconsolidated entities (1) | $ | 19,518 | 14,454 | (271 | ) | ||||
| Our investments in unconsolidated entities | $ | 250,876 | 105,674 | 46,301 | |||||
| Equity of the unconsolidated entities | $ | 817,473 | 426,793 | 183,037 | |||||
| Our investment % in the unconsolidated entities (2) | 31 | % | 25 | % | 25 | % |
| (1) | During each of the years ended November 30, 2015 and 2014, our Lennar Multifamily segment sold two operating properties through unconsolidated entities resulting in the segment's $22.2 million and $14.7 million share of gains, respectively. |
| (2) | Our share of profit and cash distributions from sales of operating properties could be higher compared to our ownership interest in unconsolidated entities if certain specified internal rate of return milestones are achieved. |
Option Contracts
We have access to land through option contracts, which generally enables us to control portions of properties owned by third parties (including land funds) and unconsolidated entities until we have determined whether to exercise the option.
The table below indicates the number of homesites owned and homesites to which we had access through option contracts with third parties (“optioned”) or unconsolidated JVs (collectively, controlled homesites) at November 30, 2015 and 2014:
| Controlled Homesites | ||||||||||||||
| November 30, 2015 | Optioned | JVs | Total | Owned Homesites | Total Homesites | |||||||||
| East | 17,815 | 48 | 17,863 | 42,350 | 60,213 | |||||||||
| Central | 5,683 | 1,135 | 6,818 | 19,543 | 26,361 | |||||||||
| West | 2,172 | 4,829 | 7,001 | 37,934 | 44,935 | |||||||||
| Southeast Florida | 4,107 | 446 | 4,553 | 7,862 | 12,415 | |||||||||
| Houston | 2,140 | — | 2,140 | 11,758 | 13,898 | |||||||||
| Other | 1,574 | — | 1,574 | 6,467 | 8,041 | |||||||||
| Total homesites | 33,491 | 6,458 | 39,949 | 125,914 | 165,863 |
| Controlled Homesites | ||||||||||||||
| November 30, 2014 | Optioned | JVs | Total | Owned Homesites | Total Homesites | |||||||||
| East | 9,649 | 93 | 9,742 | 45,489 | 55,231 | |||||||||
| Central | 5,582 | 1,135 | 6,717 | 20,704 | 27,421 | |||||||||
| West | 2,867 | 5,358 | 8,225 | 38,222 | 46,447 | |||||||||
| Southeast Florida | 2,860 | 446 | 3,306 | 9,507 | 12,813 | |||||||||
| Houston | 1,746 | 3 | 1,749 | 11,788 | 13,537 | |||||||||
| Other | 2,151 | — | 2,151 | 6,969 | 9,120 | |||||||||
| Total homesites | 24,855 | 7,035 | 31,890 | 132,679 | 164,569 |
We evaluate all option contracts for land to determine whether they are VIEs and, if so, whether we are the primary beneficiary of certain of these option contracts. Although we do not have legal title to the optioned land, if we are deemed to be the primary beneficiary or make a significant deposit for optioned land, we may need to consolidate the land under option at the purchase price of the optioned land.
During the year ended November 30, 2015, consolidated inventory not owned increased by $6.4 million with a corresponding increase to liabilities related to consolidated inventory not owned in the accompanying consolidated balance sheet as of November 30, 2015. The increase was primarily due to more construction started on homesites not owned than homesite takedowns. To reflect the purchase price of the inventory consolidated, we had a net reclass related to option deposits from consolidated inventory not owned to land under development in the accompanying consolidated balance sheet as of November 30, 2015. The liabilities related to consolidated inventory not owned primarily represent the difference between the option exercise prices for the optioned land and our cash deposits.
Our exposure to loss related to our option contracts with third parties and unconsolidated entities consisted of our non-refundable option deposits and pre-acquisition costs totaling $89.2 million and $85.6 million at November 30, 2015 and 2014, respectively. Additionally, we had posted $70.4 million and $34.5 million of letters of credit in lieu of cash deposits under certain land and option contracts as of November 30, 2015 and 2014, respectively.
Contractual Obligations and Commercial Commitments
The following table summarizes certain of our contractual obligations at November 30, 2015:
| Payments Due by Period | |||||||||||||||
| (In thousands) | Total | Less than 1 year | 1 to 3 years | 3 to 5 years | More than 5 years | ||||||||||
| Lennar Homebuilding - Senior notes and other debts payable (1) | $ | 5,061,514 | 374,665 | 1,145,109 | 1,380,714 | 2,161,026 | |||||||||
| Lennar Financial Services - Notes and other debts payable | 858,300 | 858,300 | — | — | — | ||||||||||
| Rialto - Notes and other debts payable (2) | 775,395 | 391,250 | 32,645 | 351,500 | — | ||||||||||
| Interest commitments under interest bearing debt (3) | 1,185,293 | 279,131 | 428,228 | 235,132 | 242,802 | ||||||||||
| Operating leases | 159,817 | 38,275 | 61,253 | 35,541 | 24,748 | ||||||||||
| Other contractual obligations (4) | 486,538 | 407,278 | 79,260 | — | — | ||||||||||
| Total contractual obligations (5) | $ | 8,526,857 | 2,348,899 | 1,746,495 | 2,002,887 | 2,428,576 |
| (1) | Some of the senior notes and other debts payable are convertible senior notes, which have been included in this table based on maturity dates, but they are putable to, or callable by, us at earlier dates than the maturity dates disclosed in this table. The puts are described in the detail description of each of the convertible senior notes in the financial condition and capital resources section of this M,D&A. The amounts presented in the table above exclude debt issuance costs. |
| (2) | Amount includes notes payable and other debts payable of $351.5 million related to Rialto's 7.00% Senior Notes, $30.3 million related to Rialto's 5-year senior unsecured note, $353.4 million related to the RMF warehouse repurchase financing agreements and $31.4 million related to Rialto's Structured Notes with an estimated final payment date of April 15, 2017. These amounts exclude debt issuance costs. |
| (3) | Interest commitments on variable interest-bearing debt are determined based on the interest rate as of November 30, 2015. |
| (4) | Amount includes $378.3 million remaining equity commitment to fund the Venture for future expenditures related to the construction and development of the projects, $8.3 million of remaining commitment to fund a homebuilding unconsolidated entity for further expenses up until the unconsolidated entity obtains permanent financing and $100.0 million of commitments to fund Rialto's Fund III. |
| (5) | Total contractual obligations excludes our gross unrecognized tax benefits and accrued interest and penalties totaling $77.4 million as of November 30, 2015, because we are unable to make reasonable estimates as to the period of cash settlement with the respective taxing authorities. |
We are subject to the usual obligations associated with entering into contracts (including option contracts) for the purchase, development and sale of real estate in the routine conduct of our business. Option contracts for the purchase of land generally enable us to defer acquiring portions of properties owned by third parties and unconsolidated entities until we have determined whether to exercise our options. This reduces our financial risk associated with land holdings. At November 30, 2015, we had access to 39,949 homesites through option contracts with third parties and unconsolidated entities in which we have investments. At November 30, 2015, we had $89.2 million of non-refundable option deposits and pre-acquisition costs related to certain of these homesites and had posted $70.4 million of letters of credit in lieu of cash deposits under certain land and option contracts.
At November 30, 2015, we had letters of credit outstanding in the amount of $453.2 million (which included the $70.4 million of letters of credit discussed above). These letters of credit are generally posted either with regulatory bodies to guarantee our performance of certain development and construction activities, or in lieu of cash deposits on option contracts, for insurance risks, credit enhancements and as other collateral. Additionally, at November 30, 2015, we had outstanding performance and surety bonds related to site improvements at various projects (including certain projects of our joint ventures) of $1.3 billion, which includes $223.4 million related to a pending litigation case. Although significant development and construction activities have been completed related to these site improvements, these bonds are generally not released until all of the development and construction activities are completed. As of November 30, 2015, there were approximately $490.0 million, or 38%, of costs to complete related to these site improvements. We do not presently anticipate any draws upon these bonds, but if any such draws occur, we do not believe they would have a material effect on our financial position, results of operations or cash flows.
Our Lennar Financial Services segment had a pipeline of loan applications in process of $2.0 billion at November 30, 2015. Loans in process for which interest rates were committed to the borrowers totaled approximately $487.5 million as of November 30, 2015. Substantially all of these commitments were for periods of 60 days or less. Since a portion of these commitments is expected to expire without being exercised by the borrowers or borrowers may not meet certain criteria at the time of closing, the total commitments do not necessarily represent future cash requirements.
Our Lennar Financial Services segment uses mandatory mortgage-backed securities (“MBS”) forward commitments, option contracts, future contracts and investor commitments to hedge our mortgage-related interest rate exposure. These instruments involve, to varying degrees, elements of credit and interest rate risk. Credit risk associated with MBS forward commitments, option contracts, future contracts and loan sales transactions is managed by limiting our counterparties to
investment banks, federally regulated bank affiliates and other investors meeting our credit standards. Our risk, in the event of default by the purchaser, is the difference between the contract price and fair value of the MBS forward commitments and option contracts. At November 30, 2015, we had open commitments amounting to $1.0 billion to sell MBS with varying settlement dates through February 2016 and open future contracts in the amount of $708.0 million with the settlement dates through September 2022.
The following sections discuss market and financing risk, seasonality and interest rates and changing prices that may have an impact on our business:
Market and Financing Risk
We finance our contributions to JVs, land acquisition and development activities, construction activities, financial services activities, Rialto activities, Lennar Multifamily activities and general operating needs primarily with cash generated from operations, debt and equity issuances, as well as borrowings under our Credit Facility and warehouse repurchase facilities. We also purchase land under option agreements, which enables us to control homesites until we have determined whether to exercise the option. We try to manage the financial risks of adverse market conditions associated with land holdings by what we believe to be prudent underwriting of land purchases in areas we view as desirable growth markets, careful management of the land development process and, until recent years, limitation of risks by using partners to share the costs of purchasing and developing land as well as obtaining access to land through option contracts. Although we believed our land underwriting standards were conservative, we did not anticipate the severe decline in land values and the sharply reduced demand for new homes encountered in the prior economic downturn.
Seasonality
We historically have experienced, and expect to continue to experience, variability in quarterly results. Our homebuilding business is seasonal in nature and generally reflects higher levels of new home order activity in our second fiscal quarter and increased deliveries in the second half of our fiscal year. However, periods of economic downturn in the industry can alter seasonal patterns.
Interest Rates and Changing Prices
Inflation can have a long-term impact on us because increasing costs of land, materials and labor result in a need to increase the sales prices of homes. In addition, inflation is often accompanied by higher interest rates, which can have a negative impact on housing demand and the costs of financing land development activities and housing construction. Rising interest rates as well as increased material and labor costs, may reduce gross margins. An increase in material and labor costs is particularly a problem during a period of declining home prices. Conversely, deflation can impact the value of real estate and make it difficult for us to recover our land costs. Therefore, either inflation or deflation could adversely impact our future results of operations.
New Accounting Pronouncements
See Note 1 of the notes to our consolidated financial statements for a comprehensive list of new accounting pronouncements.
Critical Accounting Policies and Estimates
Our accounting policies are more fully described in Note 1 of the notes to our consolidated financial statements included in Item 8 of this document. As discussed in Note 1, the preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and such differences may be material to our consolidated financial statements. Listed below are those policies and estimates that we believe are critical and require the use of significant judgment in their application.
Valuation of Deferred Tax Assets
We record income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized based on the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and attributable to operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which the temporary differences are expected to be recovered or paid. The effect on deferred tax assets and liabilities of a change in tax rates is
recognized in earnings in the period when the changes are enacted. Interest related to unrecognized tax benefits is recognized in the financial statements as a component of income tax expense.
A reduction of the carrying amounts of deferred tax assets by a valuation allowance is required if, based on the available evidence, it is more likely than not that such assets will not be realized. Accordingly, the need to establish valuation allowances for deferred tax assets is assessed each reporting period by us based on the consolidation of all available positive and negative evidence using a "more-likely-than-not" standard with respect to whether deferred tax assets will be realized. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, actual earnings, forecasts of future profitability, the duration of statutory carryforward periods, our experience with loss carryforwards not expiring unused and tax planning alternatives.
We believe that the accounting estimate for the valuation of deferred tax assets is a critical accounting estimate because of the judgment required in assessing the likely future tax consequences of events that have been recognized in our financial statements or tax returns. We base our estimate of deferred tax assets and liabilities on current tax laws and rates and, in certain cases, business plans and other expectations about future outcomes. Changes in existing tax laws or rates could affect actual tax results and future business results, which may affect the amount of deferred tax liabilities or the valuation of deferred tax assets over time. Our accounting for deferred tax consequences represents our best estimate of future events.
Lennar Homebuilding and Lennar Multifamily Operations
Lennar Homebuilding Revenue Recognition
Revenues from sales of homes are recognized when the sales are closed and title passes to the new homeowner, the new homeowner’s initial and continuing investment is adequate to demonstrate a commitment to pay for the home, the new homeowner’s receivable is not subject to future subordination and we do not have a substantial continuing involvement with the new home. Revenues from sales of land are recognized when a significant down payment is received, the earnings process is complete, title passes and collectability of the receivable is reasonably assured. We believe that the accounting policy related to revenue recognition is a critical accounting policy because of the significance of revenue.
Lennar Multifamily Revenue Recognition
Our Lennar Multifamily segment provides management services with respect to the development, construction and property management of rental projects in joint ventures in which we have investments. As a result, our Lennar Multifamily segment earns and receives fees, which are generally based upon a stated percentage of development and construction costs and a percentage of gross rental collections. These fees are included in Lennar Multifamily revenue and are recorded over the period in which the services are performed, fees are determinable and collectability is reasonably assured. In addition, our Lennar Multifamily segment provides general contractor services for the construction of some of its rental projects and recognizes the revenue over the period in which the services are performed under the percentage of completion method. We believe that the accounting policy related to Lennar Multifamily revenue recognition is a critical accounting policy because it represents a significant portion of our Lennar Multifamily's revenues and is expected to continue to grow in the future as the segment builds more rental properties.
Inventories
Inventories are stated at cost unless the inventory within a community is determined to be impaired, in which case the impaired inventory is written down to fair value. Inventory costs include land, land development and home construction costs, real estate taxes, deposits on land purchase contracts and interest related to development and construction. We review our inventory for indicators of impairment by evaluating each community during each reporting period. The inventory within each community is categorized as finished homes and construction in progress or land under development based on the development state of the community. There were 662 and 622 active communities, excluding unconsolidated entities, as of November 30, 2015 and 2014, respectively. If the undiscounted cash flows expected to be generated by a community are less than its carrying amount, an impairment charge is recorded to write down the carrying amount of such community to its estimated fair value.
In conducting our review for indicators of impairment on a community level, we evaluate, among other things, the margins on homes that have been delivered, margins on homes under sales contracts in backlog, projected margins with regard to future home sales over the life of the community, projected margins with regard to future land sales, and the estimated fair value of the land itself. We pay particular attention to communities in which inventory is moving at a slower than anticipated absorption pace and communities whose average sales price and/or margins are trending downward and are anticipated to continue to trend downward. From this review, we identify communities whose carrying values exceed their undiscounted cash flows. Although gross margin percentages for the year ended November 30, 2015 have decreased compared to the year ended November 30, 2014 primarily due to an increase in land costs, revenues have increased for all of our homebuilding segments and Homebuilding Other, compared to the year ended November 30, 2014, primarily due to an increase in home deliveries and an increase in the average sales price of homes delivered.
We estimate the fair value of our communities using a discounted cash flow model. The projected cash flows for each community are significantly impacted by estimates related to market supply and demand, product type by community, homesite sizes, sales pace, sales prices, sales incentives, construction costs, sales and marketing expenses, the local economy, competitive conditions, labor costs, costs of materials and other factors for that particular community. Every division evaluates the historical performance of each of its communities as well as current trends in the market and economy impacting the community and its surrounding areas. These trends are analyzed for each of the estimates listed above. For example, during the downturn in the housing market, we found ways to reduce our construction costs in many communities, and this reduction in construction costs in addition to changes in product type in many communities impacted future estimated cash flows.
Each of the homebuilding markets in which we operate is unique, as homebuilding has historically been a local business driven by local market conditions and demographics. Each of our homebuilding markets has specific supply and demand relationships reflective of local economic conditions. Our projected cash flows are impacted by many assumptions. Some of the most critical assumptions in our cash flow models are our projected absorption pace for home sales, sales prices and costs to build and deliver our homes on a community by community basis.
In order to arrive at the assumed absorption pace for home sales included in our cash flow models, we analyze our historical absorption pace in the community as well as other comparable communities in the geographical area. In addition, we consider internal and external market studies and trends, which generally include, but are not limited to, statistics on population demographics, unemployment rates and availability of competing product in the geographic area where the community is located. When analyzing our historical absorption pace for home sales and corresponding internal and external market studies, we place greater emphasis on more current metrics and trends such as the absorption pace realized in our most recent quarters as well as forecasted population demographics, unemployment rates and availability of competing product. Generally, if we notice a variation from historical results over a span of two fiscal quarters, we consider such variation to be the establishment of a trend and adjust our historical information accordingly in order to develop assumptions on the projected absorption pace in the cash flow model for a community.
In order to determine the assumed sales prices included in our cash flow models, we analyze the historical sales prices realized on homes we delivered in the community and other comparable communities in the geographical area as well as the sales prices included in our current backlog for such communities. In addition, we consider internal and external market studies and trends, which generally include, but are not limited to, statistics on sales prices in neighboring communities and sales prices on similar products in non-neighboring communities in the geographic area where the community is located. When analyzing our historical sales prices and corresponding market studies, we also place greater emphasis on more current metrics and trends such as future forecasted sales prices in neighboring communities as well as future forecasted sales prices for similar product in non-neighboring communities. Generally, if we notice a variation from historical results over a span of two fiscal quarters, we consider such variation to be the establishment of a trend and adjust our historical information accordingly in order to develop assumptions on the projected sales prices in the cash flow model for a community.
In order to arrive at our assumed costs to build and deliver our homes, we generally assume a cost structure reflecting contracts currently in place with our vendors adjusted for any anticipated cost reduction initiatives or increases in cost structure. Those costs assumed are used in our cash flow models for our communities.
Since the estimates and assumptions included in our cash flow models are based upon historical results and projected trends, they do not anticipate unexpected changes in market conditions or strategies that may lead to us incurring additional impairment charges in the future.
Using all the available information, we calculate our best estimate of projected cash flows for each community. While many of the estimates are calculated based on historical and projected trends, all estimates are subjective and change from market to market and community to community as market and economic conditions change. The determination of fair value also requires discounting the estimated cash flows at a rate we believe a market participant would determine to be commensurate with the inherent risks associated with the assets and related estimated cash flow streams. The discount rate used in determining each asset’s fair value depends on the community’s projected life and development stage. We generally use a discount rate of approximately 20%, subject to the perceived risks associated with the community’s cash flow streams relative to its inventory.
We estimate the fair value of inventory evaluated for impairment based on market conditions and assumptions made by management at the time the inventory is evaluated, which may differ materially from actual results if market conditions or our assumptions change. For example, changes in market conditions and other specific developments or changes in assumptions may cause us to re-evaluate our strategy regarding previously impaired inventory, as well as inventory not currently impaired but for which indicators of impairment may arise if market deterioration occurs, and certain other assets that could result in further valuation adjustments and/or additional write-offs of option deposits and pre-acquisition costs due to abandonment of those options contracts.
We also have access to land inventory through option contracts, which generally enables us to defer acquiring portions of properties owned by third parties and unconsolidated entities until we have determined whether to exercise our option. A majority of our option contracts require a non-refundable cash deposit or irrevocable letter of credit based on a percentage of the purchase price of the land. Our option contracts are recorded at cost. In determining whether to walk-away from an option contract, we evaluate the option primarily based upon the expected cash flows from the property under option. If we intend to walk-away from an option contract, we record a charge to earnings in the period such decision is made for the deposit amount and any related pre-acquisition costs associated with the option contract.
We believe that the accounting related to inventory valuation and impairment is a critical accounting policy because: (1) assumptions inherent in the valuation of our inventory are highly subjective and susceptible to change and (2) the impact of recognizing impairments on our inventory has been and could continue to be material to our consolidated financial statements. Our evaluation of inventory impairment, as discussed above, includes many assumptions. The critical assumptions include the timing of the home sales within a community, management’s projections of selling prices and costs and the discount rate applied to estimate the fair value of the homesites within a community on the balance sheet date. Our assumptions on the timing of home sales are critical because the homebuilding industry has historically been cyclical and sensitive to changes in economic conditions such as interest rates, credit availability, unemployment levels and consumer sentiment. Changes in these economic conditions could materially affect the projected sales price, costs to develop the homesites and/or absorption rate in a community. Our assumptions on discount rates are critical because the selection of a discount rate affects the estimated fair value of the homesites within a community. A higher discount rate reduces the estimated fair value of the homesites within the community, while a lower discount rate increases the estimated fair value of the homesites within a community. Because of changes in economic and market conditions and assumptions and estimates required of management in valuing inventory during changing market conditions, actual results could differ materially from management’s assumptions and may require material inventory impairment charges to be recorded in the future.
Product Warranty
Although we subcontract virtually all aspects of construction to others and our contracts call for the subcontractors to repair or replace any deficient items related to their trades, we are primarily responsible to homebuyers to correct any deficiencies. Additionally, in some instances, we may be held responsible for the actions of or losses incurred by subcontractors. Warranty and similar reserves for homes are established at an amount estimated to be adequate to cover potential costs for materials and labor with regard to warranty-type claims expected to be incurred subsequent to the delivery of a home. Reserves are determined based upon historical data and trends with respect to similar product types and geographical areas. We believe the accounting estimate related to the reserve for warranty costs is a critical accounting estimate because the estimate requires a large degree of judgment.
At November 30, 2015, the reserve for warranty costs was $130.9 million, which included $11.5 million of adjustments to pre-existing warranties from changes in estimates during the current year primarily related to specific claims related to certain of our homebuilding communities and other adjustments. While we believe that the reserve for warranty costs is adequate, there can be no assurances that historical data and trends will accurately predict our actual warranty costs. Additionally, there can be no assurances that future economic or financial developments might not lead to a significant change in the reserve.
Lennar Homebuilding and Lennar Multifamily Investments in Unconsolidated Entities
We strategically invest in unconsolidated entities that acquire and develop land (1) for our homebuilding operations or for sale to third parties, (2) for construction of homes for sale to third-party homebuyers or (3) for the construction and sale of multifamily rental properties. Our Lennar Homebuilding partners generally are unrelated homebuilders, land owners/developers and financial or other strategic partners. Our Lennar Multifamily partners are all financial partners.
Most of the unconsolidated entities through which we acquire and develop land are accounted for by the equity method of accounting because we are not the primary beneficiary or a de facto agent, and we have a significant, but less than controlling, interest in the entities. We record our investments in these entities in our consolidated balance sheets as “Lennar Homebuilding or Lennar Multifamily Investments in Unconsolidated Entities” and our pro-rata share of the entities’ earnings or losses in our consolidated statements of operations as “Lennar Homebuilding or Lennar Multifamily Equity in Earnings (Loss) from Unconsolidated Entities,” as described in Note 4 and Note 9 of the notes to our consolidated financial statements. For most unconsolidated entities, we generally have the right to share in earnings and distributions on a pro-rata basis based upon ownership percentages. However, certain Lennar Homebuilding unconsolidated entities and all of our Lennar Multifamily unconsolidated entities provide for a different allocation of profit and cash distributions if and when cumulative results of the joint venture exceed specified targets (such as a specified internal rate of return). Advances to these entities are included in the investment balance.
Management looks at specific criteria and uses its judgment when determining if we are the primary beneficiary of, or have a controlling interest in, an unconsolidated entity. Factors considered in determining whether we have significant influence or we have control include risk and reward sharing, experience and financial condition of the other partners, voting rights, involvement in day-to-day capital and operating decisions and continuing involvement. The accounting policy relating to the use of the equity method of accounting is a critical accounting policy due to the judgment required in determining whether we are the primary beneficiary or have control or significant influence.
As of November 30, 2015, we believe that the equity method of accounting is appropriate for our investments in unconsolidated entities where we are not the primary beneficiary and we do not have a controlling interest, but rather share control with our partners. At November 30, 2015, the Lennar Homebuilding unconsolidated entities in which we had investments had total assets of $3.8 billion and total liabilities of $1.1 billion. At November 30, 2015, the Lennar Multifamily unconsolidated entities in which we had investments had total assets of $1.5 billion and total liabilities of $0.6 billion.
We evaluate the long-lived assets in unconsolidated entities for indicators of impairment during each reporting period. A series of operating losses of an investee or other factors may indicate that a decrease in the fair value of our investment in the unconsolidated entity below its carrying amount has occurred which is other-than-temporary. The amount of impairment recognized is the excess of the investment’s carrying amount over its estimated fair value.
The evaluation of our investment in unconsolidated entities includes certain critical assumptions: (1) projected future distributions from the unconsolidated entities, (2) discount rates applied to the future distributions and (3) various other factors.
Our assumptions on the projected future distributions from unconsolidated entities are dependent on market conditions. Specifically, distributions are dependent on cash to be generated from the sale of inventory by the Lennar Homebuilding unconsolidated entities or operating assets by the Lennar Multifamily unconsolidated entities. Such long-lived assets are also reviewed for potential impairment by the unconsolidated entities. The unconsolidated entities generally also use a discount rate of between 10% and 20% in their reviews for impairment, subject to the perceived risks associated with the community’s cash flow streams relative to its inventory. If a valuation adjustment is recorded by an unconsolidated entity related to its assets, our proportionate share is reflected in our Lennar Homebuilding or Lennar Multifamily equity in earnings (loss) from unconsolidated entities with a corresponding decrease to our Lennar Homebuilding or Lennar Multifamily investment in unconsolidated entities. We believe our assumptions on the projected future distributions from the unconsolidated entities are critical because the operating results of the unconsolidated entities from which the projected distributions are derived are dependent on the status of the homebuilding industry, which has historically been cyclical and sensitive to changes in economic conditions such as interest rates, credit availability, unemployment levels and consumer sentiment. Changes in these economic conditions could materially affect the projected operational results of the unconsolidated entities from which the distributions are derived.
Additionally, we evaluate if a decease in the value of an investment is other than-temporary. This evaluation includes certain critical assumptions made by management and other factors such as age of the venture, intent and ability for us to recover our investment in the entity, financial condition and long-term prospects of the unconsolidated entity, short-term liquidity needs of the unconsolidated entity, trends in the general economic environment of the land, entitlement status of the land held by the unconsolidated entity, overall projected returns on investments, defaults under contracts with third parties (including bank debt), recoverability of the investment through future cash flows and relationships with the other partners and banks. If the decline in the fair value of the investment is other-than-temporary, then these losses are included in Lennar Homebuilding other income, net or Lennar Multifamily costs and expenses.
In addition, we believe our assumptions on discount rates are critical accounting policies because the selection of the discount rates affects the estimated fair value of our investments in unconsolidated entities. A higher discount rate reduces the estimated fair value of our investments in unconsolidated entities, while a lower discount rate increases the estimated fair value of our investments in unconsolidated entities. Because of changes in economic conditions, actual results could differ materially from management’s assumptions and may require material valuation adjustments to our investments in unconsolidated entities to be recorded in the future.
Consolidation of Variable Interest Entities
GAAP requires the consolidation of VIEs in which an enterprise has a controlling financial interest. A controlling financial interest will have both of the following characteristics: (a) the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and (b) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.
Our variable interest in VIEs may be in the form of (1) equity ownership, (2) contracts to purchase assets, (3) management services and development agreements between us and a VIE, (4) loans provided by us to a VIE or other partner and/or (5) guarantees provided by members to banks and other third parties. We examine specific criteria and use our judgment when determining if we are the primary beneficiary of a VIE. Factors considered in determining whether we are the primary
beneficiary include risk and reward sharing, experience and financial condition of other partner(s), voting rights, involvement in day-to-day capital and operating decisions, representation on a VIE’s executive committee, existence of unilateral kick-out rights or voting rights, level of economic disproportionality between us and the other partner(s) and contracts to purchase assets from VIEs.
Generally, all major decision making in our joint ventures is shared among all partners. In particular, business plans and budgets are generally required to be unanimously approved by all partners. Usually, management and other fees earned by us are nominal and believed to be at market and there is no significant economic disproportionality between us and other partners. Generally, we purchase less than a majority of the JV’s assets and the purchase prices under our option contracts are believed to be at market.
Generally, our unconsolidated entities become VIEs and consolidate when the other partner(s) lack the intent and financial wherewithal to remain in the entity. As a result, we continue to fund operations and debt paydowns through partner loans or substituted capital contributions. The accounting policy relating to variable interest entities is a critical accounting policy because the determination of whether an entity is a VIE and, if so, whether we are primary beneficiary may require us to exercise significant judgment.
Lennar Financial Services Operations
Revenue Recognition
Title premiums on policies issued directly by us are recognized as revenue on the effective date of the title policies and escrow fees and loan origination revenues are recognized at the time the related real estate transactions are completed, usually upon the close of escrow. Revenues from title policies issued by independent agents are recognized as revenue when notice of issuance is received from the agent, which is generally when cash payment is received by us. Expected gains and losses from the sale of loans and their related servicing rights are included in the measurement of all written loan commitments that are accounted for at fair value through earnings at the time of commitment. Interest income on loans held-for-sale and loans held-for-investment is recognized as earned over the terms of the mortgage loans based on the contractual interest rates. We believe that the accounting policy related to revenue recognition is a critical accounting policy because of the significance of revenue.
Loan Origination Liabilities
Substantially all of the loans our Lennar Financial Services segment originates are sold within a short period in the secondary mortgage market on a servicing released, non-recourse basis. After the loans are sold, we retain potential liability for possible claims by purchasers that we breached certain limited industry-standard representations and warranties related to loan sales. Over the last several years there has been an industry-wide effort by purchasers to defray their losses by purporting to have found inaccuracies related to sellers’ representations and warranties in particular loan sale agreements.
Our mortgage operations have established reserves for possible losses associated with mortgage loans previously originated and sold to investors. We establish reserves for such possible losses based upon, among other things, an analysis of repurchase requests received, an estimate of potential repurchase claims not yet received and actual past repurchases and losses through the disposition of affected loans, as well as previous settlements. While we believe that we have adequately reserved for known losses and projected repurchase requests, given the volatility in the mortgage industry and the uncertainty regarding the ultimate resolution of these claims, if either actual repurchases or the losses incurred resolving those repurchases exceed our expectations, additional recourse expense may be incurred. This allowance requires management’s judgment and estimate. For these reasons, we believe that the accounting estimate related to the loan origination losses is a critical accounting estimate.
Rialto Operations
Management Fee Revenue
Our Rialto segment provides services to a variety of legal entities and investment vehicles such as funds, joint ventures, co-invests, and other private equity structures to manage their respective investments. As a result, Rialto earns and receives management fees, underwriting fees and due diligence fees. These fees are included in Rialto revenues and are recorded over the period in which the services are performed, fees are determinable and collectability is reasonably assured. Rialto receives investment management fees from investment vehicles based on 1) a percentage of committed capital during the commitment period and after the commitment period ends and 2) a percentage of invested capital less the portion of such invested capital utilized to acquire investments that have been sold (in whole or in part) or liquidated. Fees earned for underwriting and due diligence services are based on actual costs incurred. In certain situations, Rialto may earn additional fees when the return on assets managed exceeds contractually established thresholds. Such revenue is only booked when the contract terms are met, the contract is at, or near, completion and the amounts are known and collectability is reasonably assured. Since such revenue is recognized during the latter half of the life of the investment vehicle, after substantially all of the assets have been sold and investment gains and losses realized, the possibility of claw backs is limited. In addition, Rialto may also receive tax
distributions in order to cover income tax obligations resulting from allocations of taxable income due to Rialto's carried interests in the funds. These distributions are not subject to clawbacks and therefore are recorded as revenue when received.
We believe the way we record Rialto management fee revenue is a significant accounting policy because it represents a significant portion of our Rialto segment's revenues and is expected to continue to grow in the future as the segment manages more assets.
Rialto Mortgage Finance - Loans Held-for Sale
The originated mortgage loans are classified as loans held-for-sale and are recorded at fair value. We elected the fair value option for RMF's loans held-for-sale in accordance with ASC 825, Financial Instruments, which permits entities to measure various financial instruments and certain other items at fair value on a contract-by-contract basis. Changes in fair values of the loans are reflected in Rialto revenues in the accompanying consolidated statements of operations. Interest income on these loans is calculated based on the interest rate of the loan and is recorded in Rialto revenues in the accompanying consolidated statements of operations. Substantially all of the mortgage loans originated are sold within a short period of time in securitizations on a servicing released, non-recourse basis; although, we remain liable for certain limited industry-standard representations and warranties related to loan sales. We recognize revenue on the sale of loans into securitization trusts when control of the loans has been relinquished.
We believe this is a critical accounting policy due to the significant judgment involved in estimating the fair values of loans held-for-sale during the period between when the loans are originated and the time the loans are sold and because of its significance to our Rialto segment.
Nonaccrual Loans - Revenue Recognition and Impairment
For loans in which forecasted principal and interest could not be reasonably estimated at the loan acquisition date or subsequently, management classifies these loans as nonaccrual and accounts for these assets in accordance with ASC 310-10, Receivables, (“ASC 310-10”). When a loan is classified as nonaccrual, any subsequent cash receipt is accounted for using the recovery method. In accordance with ASC 310-10, a loan is considered impaired when based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected.
A provision for loan losses is recognized when the recorded investments in the loan is in excess of its fair value. The fair value of the loan is determined by using either the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral less estimated costs to sell.
We believe that the accounting for nonaccrual loans is a critical accounting estimate due to the significant judgment involved.
Real Estate Owned
REO represents real estate that our Rialto segment has taken control, or has effective control of, in partial or full satisfaction of loans receivable. At the time of acquisition of a property through foreclosure of a loan, REO is recorded at fair value less estimated costs to sell if classified as held-for-sale or at fair value if classified as held-and-used, which becomes the property’s new basis. The fair values of these assets are determined in part by placing reliance on third-party appraisals of the properties and/or internally prepared analyses of recent offers or prices on comparable properties in the proximate vicinity. The third-party appraisals and internally developed analyses are significantly impacted by the local market economy, market supply and demand, competitive conditions and prices on comparable properties, adjusted for anticipated date of sale, location, property size, and other factors. Each REO is unique and is analyzed in the context of the particular market where the property is located. In order to establish the significant assumptions for a particular REO, we analyze historical trends, including trends achieved by our local homebuilding operations, if applicable, and current trends in the market and economy impacting the REO. Using available trend information, we then calculate our best estimate of fair value, which can include projected cash flows discounted at a rate we believe a market participant would determine to be commensurate with the inherent risks associated with the assets and related estimated cash flow streams.
Changes in economic factors, consumer demand and market conditions, among other things, could materially impact estimates used in the third-party appraisals and/or internally prepared analyses of recent offers or prices on comparable properties. Thus, estimates can differ significantly from the amounts ultimately realized by our Rialto segment from disposition of these assets. The amount by which the recorded investment in the loan is less than the REO’s fair value (net of estimated cost to sell if held-for-sale), is recorded as an unrealized gain on foreclosure in our consolidated statement of operations. The amount by which the recorded investment in the loan is greater than the REO’s fair value (net of estimated cost to sell if held-for-sale) is initially recorded as an impairment in our consolidated statement of operations.
Subsequent to obtaining REO via foreclosure or directly from a financial institution, management periodically performs valuations using the methodologies described above such that the real estate is carried at the lower of its carrying
value or current fair value, less estimated costs to sell if classified as held-for-sale. Held-and-used assets are tested for recoverability whenever changes in circumstances indicate that the carrying value may not be recoverable, and impairment losses are recorded for any amount by which the carrying value exceeds its fair value. Any subsequent impairment losses, operating expenses or income, and gains and losses on disposition of such properties are also recognized in Rialto other income (expense), net. REO assets classified as held-and-used are depreciated using a useful life of forty years for commercial properties and twenty seven and a half years for residential properties. REO assets classified as held-for-sale are not depreciated. Occasionally, an asset will require certain improvements to yield a higher return. Construction costs incurred prior to acquisition or during development of the asset may be capitalized.
We believe that the accounting related to REO is a critical accounting policy because of the significant judgment required in the third-party appraisals and/or internally prepared analyses of recent offers or prices of comparable properties in the proximate vicinity used to estimate the fair value of REOs.
Consolidations of Variable Interest Entities
In 2010, our Rialto segment acquired indirectly 40% managing member equity interests in two LLCs, in partnership with the FDIC. We determined that each of the LLCs met the definition of a VIE and we were the primary beneficiary. In accordance with ASC 810-10-65-2, Consolidations, (“ASC 810-10-65-2”), we identified the activities that most significantly impact the LLCs’ economic performance and determined that we have the power to direct those activities. The economic performance of the LLCs is most significantly impacted by the performance of the LLCs’ portfolios of assets, which consist primarily of distressed residential and commercial mortgage loans. Thus, the activities that most significantly impact the LLCs’ economic performance are the servicing and disposition of mortgage loans and real estate obtained through foreclosure of loans, restructuring of loans, or other planned activities associated with the monetizing of loans.
The FDIC does not have the unilateral power to terminate our role in managing the LLCs and servicing the loan portfolios. While the FDIC has the right to prevent certain types of transactions (i.e., bulk sales, selling assets with recourse back to the selling entity, selling assets with representations and warranties and financing the sales of assets without the FDIC’s approval), the FDIC does not have full voting or blocking rights over the LLCs’ activities, making their voting rights protective in nature, not substantive participating voting rights. Other than as described in the preceding sentence, which are not the primary activities of the LLCs, we can cause the LLCs to enter into both the disposition and restructuring of loans without any involvement of the FDIC. Additionally, the FDIC has no voting rights with regard to the operation/management of the operating properties that are acquired upon foreclosure of loans (e.g. REO) and no voting rights over the business plans of the LLCs. The FDIC can make suggestions regarding the business plans, but we can decide not to follow the FDIC’s suggestions and not to incorporate them in the business plans. Since the FDIC’s voting rights are protective in nature and not substantive participating voting rights, we have the power to direct the activities that most significantly impact the LLCs’ economic performance.
In accordance with ASC 810-10-65-2, we determined that we had an obligation to absorb losses of the LLCs that could potentially be significant to the LLCs or the right to receive benefits from the LLCs that could potentially be significant to the LLCs based on the following factors:
| • | Rialto/Lennar owns 40% of the equity of the LLCs and has the power to direct the activities of the LLCs that most significantly impact their economic performance through loan resolutions and the sale of REO. |
| • | Rialto/Lennar has a management/servicer contract under which we earn a 0.5% servicing fee. |
| • | Rialto/Lennar has guaranteed, as the servicer, its obligations under the servicing agreement up to $10 million. |
We are aware that the FDIC, as the owner of 60% of the equity of each of the LLCs, may also have an obligation to absorb losses of the LLCs that could potentially be significant to the LLCs. However, in accordance with ASC 810-10-25-38A, only one enterprise, if any, is expected to be identified as the primary beneficiary of a VIE.
Since both criteria for consolidation in ASC 810-10-65-2 are met, we consolidated the LLCs. We believe that our assessment that we are the primary beneficiary of the LLCs is a critical accounting policy because of the significant judgment required in evaluating all of the key factors and circumstances in determining the primary beneficiary.
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