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.
(dollars in thousands, except per share data)
Results of Operations
This section of this Form 10-K generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.
Overview
Business Environment and the Impact of COVID-19
The pandemic, caused by the novel strain of coronavirus ("COVID-19"), has had a significant impact on all facets of our business. Our primary focus as we face this challenge is to do everything we can to ensure the safety and well-being of our employees, customers and trade partners. Residential construction has been deemed an essential business in each of our markets since the beginning of the pandemic, except Pennsylvania and New York, where we faced closures into May 2020. In each of our markets, we continue to operate in accordance with the guidelines issued by the Centers for Disease Control and Prevention as well as state and local guidelines, which has resulted in significant changes to the way we conduct business.
We experienced elevated sales cancellations and decreased new orders during March and April; however, the demand for new homes began to strengthen in May and remained strong through December. Despite high unemployment rates attributable to the COVID-19 pandemic, demand has increased primarily as a result of historically low mortgage interest rates coupled with low resale inventory levels.
From March through May, there were significant disruptions in the mortgage market as investors tightened their credit standards or exited the market, which resulted in significantly lower values for mortgage servicing rights and fewer customers able to qualify for a mortgage. During the second half of 2020, the mortgage market stabilized as mortgage demand increased.
Although current demand for new homes is strong, there is uncertainty regarding the extent and timing of disruption to our business that may result from COVID-19 and related governmental actions. There is also uncertainty as to the effects of the pandemic and related economic relief efforts on the U.S. economy, unemployment, consumer confidence, demand for our homes and the mortgage market, including lending standards and secondary mortgage markets. We are unable to predict the extent to which this will impact our operational and financial performance, including the impact of future developments such as the duration and spread of COVID-19, corresponding governmental actions, and the impact of such on our employees, customers and trade partners.
We expect to continue to face gross profit margin pressure which will be impacted by our ability to manage land and construction costs as well as balancing sales pace and pricing. We also expect to face pressure on mortgage banking profit due to the competitive pricing pressures in the mortgage market. We believe that we are well positioned to take advantage of opportunities that may arise from future economic and homebuilding market volatility due to the strength of our balance sheet.
Business
Our primary business is the construction and sale of single-family detached homes, townhomes and condominium buildings, all of which are primarily constructed on a pre-sold basis. To fully serve customers of our homebuilding operations, we also operate a mortgage banking and title services business. We primarily conduct our operations in mature markets. Additionally, we generally grow our business through market share gains in our existing markets and by expanding into markets contiguous to our current active markets. Our four homebuilding reportable segments consist of the following regions:
| Mid Atlantic: | Maryland, Virginia, West Virginia, Delaware and Washington, D.C. | |||||||
| North East: | New Jersey and Eastern Pennsylvania | |||||||
| Mid East: | New York, Ohio, Western Pennsylvania, Indiana and Illinois | |||||||
| South East: | North Carolina, South Carolina, Florida and Tennessee |
Our lot acquisition strategy is predicated upon avoiding the financial risks associated with direct land ownership and development. We generally do not engage in land development (see discussion below of our land development activities). Instead, we typically acquire finished lots from various third party land developers pursuant to LPAs. These LPAs require deposits, typically ranging up to 10% of the aggregate purchase price of the finished lots, in the form of cash or letters of credit that may be forfeited if we fail to perform under the LPA. This strategy has allowed us to maximize inventory turnover, which we believe enables us to minimize market risk and to operate with less capital, thereby enhancing rates of return on equity and total capital.
In addition to constructing homes primarily on a pre-sold basis and utilizing what we believe is a conservative lot acquisition strategy, we focus on obtaining and maintaining a leading market position in each market we serve. This strategy allows us to gain valuable efficiencies and competitive advantages in our markets, which we believe contributes to minimizing the adverse effects of
regional economic cycles and provides growth opportunities within these markets. Our continued success is contingent upon our ability to control an adequate supply of finished lots on which to build.
In limited specific strategic circumstances, we deviate from our historical lot acquisition strategy and engage in joint venture arrangements with land developers or directly acquire raw ground already zoned for its intended use for development. Once we acquire control of raw ground, we determine whether to sell the raw parcel to a developer and enter into an LPA with the developer to purchase the finished lots or to hire a developer to develop the land on our behalf. While joint venture arrangements and direct land development activity are not our preferred method of acquiring finished building lots, we may enter into additional transactions in the future on a limited basis where there exists a compelling strategic or prudent financial reason to do so. We expect, however, to continue to acquire substantially all of our finished lot inventory using LPAs with forfeitable deposits.
As of December 31, 2020, we controlled lots as described below.
Lot Purchase Agreements ("LPAs")
We controlled approximately 103,000 lots under LPAs with third parties through deposits in cash and letters of credit totaling approximately $438,500 and $8,100, respectively. Included in the number of controlled lots are approximately 7,700 lots for which we have recorded a contract land deposit impairment reserve of approximately $52,200 as of December 31, 2020.
Joint Venture Limited Liability Corporations (“JVs”)
We had an aggregate investment totaling approximately $23,600 in four JVs, expected to produce approximately 5,200 lots. Of the lots to be produced by the JVs, approximately 2,200 lots were controlled by us and approximately 3,000 lots were either under contract with unrelated parties or currently not under contract.
Land Under Development
We directly owned three separate raw land parcels, zoned for their intended use, with a current cost basis, including development costs, of approximately $62,800 that we intend to develop into approximately 500 finished lots. We had additional funding commitments of approximately $5,100 under a joint development agreement related to one parcel, a portion of which we expect will be offset by development credits of approximately $2,600.
See Notes 3, 4 and 5 to the consolidated financial statements included herein for additional information regarding LPAs, JVs and land under development, respectively.
Raw Land Purchase Agreements
In addition to the lots we currently control as discussed above, we have certain properties under contract with land owners that are expected to yield approximately 6,100 lots. Some of these properties may require rezoning or other approvals to achieve the expected yield. These properties are controlled with cash deposits and letters of credit totaling approximately $1,300 and $100, respectively, as of December 31, 2020, of which approximately $1,000 is refundable if we do not perform under the contract. We generally expect to assign the raw land contracts to a land developer and simultaneously enter into an LPA with the assignee if the project is determined to be feasible.
Key Financial Results
Our consolidated revenues for the year ended December 31, 2020 totaled $7,536,923, an increase of 2% from $7,388,664 in 2019. Our net income for 2020 was $901,248, or $230.11 per diluted share, increases of 3% and 4% compared to 2019 net income and diluted earnings per share, respectively. Our homebuilding gross profit margin percentage was 19.0% in both 2020 and 2019. New orders, net of cancellations (“New Orders”) during 2020 were 23,082, an increase of 18% from 2019 while our average New Order sales price increased 3% to $380.1 in 2020. Our backlog of homes sold but not yet settled with the customer as of December 31, 2020 increased on a unit basis by 40% to 11,549 units and increased on a dollar basis by 46% to $4,575,899 when compared to December 31, 2019. Income before tax from our mortgage banking segment totaled $140,073 in 2020, an increase of 37% when compared to $101,916 in 2019 due primarily to an increase in secondary marketing gains on sales of loans.
Homebuilding Operations
The following table summarizes the results of our consolidated homebuilding operations and certain operating activity for each of the last three years:
| Year Ended December 31, | ||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Financial data: | ||||||||||||||||||||
| Revenues | $ | 7,328,889 | $ | 7,220,844 | $ | 7,004,304 | ||||||||||||||
| Cost of sales | $ | 5,937,401 | $ | 5,849,862 | $ | 5,692,127 | ||||||||||||||
| Gross profit margin percentage | 19.0 | % | 19.0 | % | 18.7 | % | ||||||||||||||
| Selling, general and administrative expenses | $ | 431,008 | $ | 447,547 | $ | 428,874 | ||||||||||||||
| Operating data: | ||||||||||||||||||||
| New orders (units) | 23,082 | 19,536 | 18,281 | |||||||||||||||||
| Average new order price | $ | 380.1 | $ | 368.4 | $ | 376.3 | ||||||||||||||
| Settlements (units) | 19,766 | 19,668 | 18,447 | |||||||||||||||||
| Average settlement price | $ | 370.8 | $ | 367.1 | $ | 379.7 | ||||||||||||||
| Backlog (units) | 11,549 | 8,233 | 8,365 | |||||||||||||||||
| Average backlog price | $ | 396.2 | $ | 380.2 | $ | 376.9 | ||||||||||||||
| New order cancellation rate | 14.9 | % | 14.6 | % | 14.5 | % |
Consolidated Homebuilding
Homebuilding revenues increased 2% in 2020 compared to 2019, as a result of a 1% increase in the average settlement price coupled with a slight increase in the number of units settled year over year. Settlements in 2020 were negatively impacted by the COVID-19 pandemic primarily during the first and second quarters of 2020. Gross profit margin percentage in 2020 remained flat year over year at 19.0%.
The number of New Orders and the average sales price of New Orders increased 18% and 3%, respectively, in 2020 when compared to 2019. The increase in New Orders was favorably impacted by increased demand in the second half of 2020 due to favorable market conditions driven by historically low mortgage interest rates coupled with low resale home inventory levels. New Orders were higher in each of our reportable segments in both the third and fourth quarters of 2020 compared to the same periods of 2019, due to these favorable market conditions. The increase in the average sales price of New Orders was primarily attributable to improved pricing power in each of our markets.
Selling, general and administrative ("SG&A") expenses in 2020 decreased by 4% compared to 2019, and as a percentage of revenue decreased to 5.9% in 2020 from 6.2% in 2019. SG&A expenses were lower primarily due to an approximate $26,800 decrease in equity-based compensation expense due primarily to the stock options granted in 2014 under the 2014 Equity Incentive Plan becoming fully vested in 2019, offset partially by an increase in personnel costs attributable to an increase of approximately $11,200 in management incentive expense based on an increase in eligible employees and improved results.
Our backlog represents homes sold but not yet settled with our customers. Backlog units and dollars were 11,549 units and $4,575,899, respectively, as of December 31, 2020 compared to 8,233 units and $3,130,282, respectively, as of December 31, 2019. The increases in backlog units and dollars is attributable to the increases in New Orders and the average sales price of New Orders as discussed above, coupled with a lower backlog turnover rate year over year.
In addition to the impact of the COVID-19 pandemic, our backlog may be impacted by customer cancellations for various reasons that are beyond our control, such as failure to obtain mortgage financing, inability to sell an existing home, job loss, or a variety of other reasons. In any period, a portion of the cancellations that we experience are related to New Orders that occurred during the same period, and a portion are related to New Orders that occurred in prior periods and therefore appeared in the beginning backlog for the current period. Additionally, a substantial majority of our cancellations occur prior to starting construction on a home. Expressed as the total of all cancellations during the period as a percentage of gross New Orders during the period, our cancellation rate was 14.9%, 14.6% and 14.5% in 2020, 2019, and 2018, respectively. Additionally, approximately 6% in both 2020 and 2019 and 5% in 2018, of a reporting quarter’s opening backlog cancelled during the quarter. We can provide no assurance that our historical cancellation rates are indicative of the actual cancellation rate that may occur in future years. Other than those units that are cancelled, and subject to potential construction delays resulting from COVID-19 related restrictions, we expect to settle substantially all of our December 31, 2020 backlog during 2021. See “Risk Factors” in Item 1A of this Form 10-K.
The backlog turnover rate is impacted by various factors, including, but not limited to, changes in New Order activity, internal production capacity, external subcontractor capacity and other external factors over which we do not exercise control, such as the impact of government orders to cease or limit construction activities as a result of COVID-19.
Reportable Homebuilding Segments
Homebuilding segment profit includes all revenues and income generated from the sale of homes, less the cost of homes sold, SG&A expenses, and a corporate capital allocation charge determined by corporate management. The corporate capital allocation charge eliminates in consolidation and is based on the segment’s average net assets employed. The corporate capital allocation charged to the operating segment allows the Chief Operating Decision Maker to determine whether the operating segment is providing the desired rate of return after covering our cost of capital.
We record impairment charges on contract land deposits when we determine that it is probable that recovery of the deposit is impaired. For segment reporting purposes, impairments on contract land deposits are generally charged to the operating segment upon the termination of an LPA with the developer, or the restructuring of an LPA resulting in the forfeiture of the deposit. We evaluate our entire net contract land deposit portfolio for impairment each quarter. For presentation purposes below, the contract land deposit reserve at December 31, 2020 and 2019 has been allocated to the reportable segments for the respective years to show contract land deposits on a net basis. The net contract land deposit balances below also include approximately $8,100 and $5,500 at December 31, 2020 and 2019, respectively, of letters of credit issued as deposits in lieu of cash.
The following tables summarize certain homebuilding operating activity by reportable segment for each of the last three years:
Selected Segment Financial Data:
| Year Ended December 31, | ||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Revenues: | ||||||||||||||||||||
| Mid Atlantic | $ | 3,668,542 | $ | 3,901,573 | $ | 3,893,358 | ||||||||||||||
| North East | 538,772 | 514,804 | 580,726 | |||||||||||||||||
| Mid East | 1,524,667 | 1,501,139 | 1,455,834 | |||||||||||||||||
| South East | 1,596,908 | 1,303,328 | 1,074,386 |
| Year Ended December 31, | ||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Gross profit margin: | ||||||||||||||||||||
| Mid Atlantic | $ | 690,058 | $ | 734,017 | $ | 726,655 | ||||||||||||||
| North East | 102,621 | 100,520 | 115,169 | |||||||||||||||||
| Mid East | 282,443 | 285,091 | 279,050 | |||||||||||||||||
| South East | 327,483 | 260,804 | 211,870 |
| Year Ended December 31, | ||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Gross profit margin percentage: | ||||||||||||||||||||
| Mid Atlantic | 18.8 | % | 18.8 | % | 18.7 | % | ||||||||||||||
| North East | 19.0 | % | 19.5 | % | 19.8 | % | ||||||||||||||
| Mid East | 18.5 | % | 19.0 | % | 19.2 | % | ||||||||||||||
| South East | 20.5 | % | 20.0 | % | 19.7 | % |
| Year Ended December 31, | ||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Segment profit: | ||||||||||||||||||||
| Mid Atlantic | $ | 437,849 | $ | 478,537 | $ | 462,178 | ||||||||||||||
| North East | 50,677 | 51,728 | 69,789 | |||||||||||||||||
| Mid East | 168,605 | 173,374 | 175,134 | |||||||||||||||||
| South East | 205,029 | 155,144 | 118,296 |
Segment Operating Activity:
| Year Ended December 31, | ||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||||||||||||||||||||
| Units | Average Price | Units | Average Price | Units | Average Price | |||||||||||||||||||||||||||||||||
| New orders, net of cancellations: | ||||||||||||||||||||||||||||||||||||||
| Mid Atlantic | 9,230 | $ | 453.8 | 8,799 | $ | 424.4 | 8,906 | $ | 429.4 | |||||||||||||||||||||||||||||
| North East | 1,738 | $ | 416.6 | 1,349 | $ | 390.8 | 1,296 | $ | 400.4 | |||||||||||||||||||||||||||||
| Mid East | 5,780 | $ | 330.9 | 4,628 | $ | 323.2 | 4,314 | $ | 328.0 | |||||||||||||||||||||||||||||
| South East | 6,334 | $ | 307.7 | 4,760 | $ | 302.6 | 3,765 | $ | 297.7 | |||||||||||||||||||||||||||||
| Total | 23,082 | $ | 380.1 | 19,536 | $ | 368.4 | 18,281 | $ | 376.3 |
| Year Ended December 31, | ||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||||||||||||||||||||
| Units | Average Price | Units | Average Price | Units | Average Price | |||||||||||||||||||||||||||||||||
| Settlements: | ||||||||||||||||||||||||||||||||||||||
| Mid Atlantic | 8,363 | $ | 438.6 | 9,335 | $ | 417.9 | 8,982 | $ | 433.4 | |||||||||||||||||||||||||||||
| North East | 1,375 | $ | 391.8 | 1,325 | $ | 388.5 | 1,415 | $ | 410.4 | |||||||||||||||||||||||||||||
| Mid East | 4,719 | $ | 323.1 | 4,621 | $ | 324.8 | 4,406 | $ | 330.4 | |||||||||||||||||||||||||||||
| South East | 5,309 | $ | 300.8 | 4,387 | $ | 297.1 | 3,644 | $ | 294.8 | |||||||||||||||||||||||||||||
| Total | 19,766 | $ | 370.8 | 19,668 | $ | 367.1 | 18,447 | $ | 379.7 |
| Year Ended December 31, | ||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||||||||||||||||||||
| Units | Average Price | Units | Average Price | Units | Average Price | |||||||||||||||||||||||||||||||||
| Backlog: | ||||||||||||||||||||||||||||||||||||||
| Mid Atlantic | 4,479 | $ | 470.9 | 3,612 | $ | 440.1 | 4,148 | $ | 423.4 | |||||||||||||||||||||||||||||
| North East | 950 | $ | 447.8 | 587 | $ | 408.8 | 563 | $ | 404.1 | |||||||||||||||||||||||||||||
| Mid East | 2,874 | $ | 344.5 | 1,813 | $ | 332.0 | 1,806 | $ | 336.2 | |||||||||||||||||||||||||||||
| South East | 3,246 | $ | 323.7 | 2,221 | $ | 314.6 | 1,848 | $ | 304.1 | |||||||||||||||||||||||||||||
| Total | 11,549 | $ | 396.2 | 8,233 | $ | 380.2 | 8,365 | $ | 376.9 |
Operating Data:
| Year Ended December 31, | ||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||
| New order cancellation rate: | ||||||||||||||||||||
| Mid Atlantic | 14.9 | % | 15.0 | % | 15.2 | % | ||||||||||||||
| North East | 13.1 | % | 13.0 | % | 12.5 | % | ||||||||||||||
| Mid East | 14.5 | % | 14.1 | % | 12.9 | % | ||||||||||||||
| South East | 15.8 | % | 14.9 | % | 15.5 | % |
| Year Ended December 31, | ||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Average active communities: | ||||||||||||||||||||
| Mid Atlantic | 177 | 206 | 234 | |||||||||||||||||
| North East | 40 | 33 | 36 | |||||||||||||||||
| Mid East | 138 | 134 | 119 | |||||||||||||||||
| South East | 112 | 97 | 88 | |||||||||||||||||
| Total | 467 | 470 | 477 |
Homebuilding Inventory:
| As of December 31, | ||||||||||||||
| 2020 | 2019 | |||||||||||||
| Sold inventory: | ||||||||||||||
| Mid Atlantic | $ | 704,595 | $ | 575,216 | ||||||||||
| North East | 140,461 | 77,965 | ||||||||||||
| Mid East | 278,510 | 190,700 | ||||||||||||
| South East | 336,902 | 230,640 | ||||||||||||
| Total (1) | $ | 1,460,468 | $ | 1,074,521 |
| As of December 31, | ||||||||||||||
| 2020 | 2019 | |||||||||||||
| Unsold lots and housing units inventory: | ||||||||||||||
| Mid Atlantic | $ | 76,690 | $ | 104,459 | ||||||||||
| North East | 7,941 | 28,331 | ||||||||||||
| Mid East | 13,252 | 15,333 | ||||||||||||
| South East | 23,220 | 35,420 | ||||||||||||
| Total (1) | $ | 121,103 | $ | 183,543 |
(1)Total segment inventory differs from consolidated inventory due to certain consolidation adjustments necessary to convert the reportable segments’ results, which are predominantly maintained on a cash basis, to a full accrual basis for external financial statement presentation purposes. These consolidation adjustments are not allocated to our operating segments.
Lots Controlled and Land Deposits:
| As of December 31, | ||||||||||||||
| 2020 | 2019 | |||||||||||||
| Total lots controlled: | ||||||||||||||
| Mid Atlantic | 42,100 | 42,400 | ||||||||||||
| North East | 10,500 | 9,900 | ||||||||||||
| Mid East | 22,000 | 24,200 | ||||||||||||
| South East | 31,100 | 28,400 | ||||||||||||
| Total | 105,700 | 104,900 |
| As of December 31, | ||||||||||||||
| 2020 | 2019 | |||||||||||||
| Contract land deposits, net: | ||||||||||||||
| Mid Atlantic | $ | 212,742 | $ | 205,433 | ||||||||||
| North East | 32,949 | 50,348 | ||||||||||||
| Mid East | 49,222 | 57,053 | ||||||||||||
| South East | 100,864 | 106,523 | ||||||||||||
| Total | $ | 395,777 | $ | 419,357 |
| Year Ended December 31, | ||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Contract land deposit impairments (recoveries), net: | ||||||||||||||||||||
| Mid Atlantic | $ | 114 | $ | (141) | $ | 2,743 | ||||||||||||||
| North East | 60 | 1,050 | 1,033 | |||||||||||||||||
| Mid East | 293 | 175 | 211 | |||||||||||||||||
| South East | 1,045 | 21 | 1,911 | |||||||||||||||||
| Total | $ | 1,512 | $ | 1,105 | $ | 5,898 |
Mid Atlantic
The Mid Atlantic segment had an approximate $40,700, or 9%, decrease in segment profit in 2020 compared to 2019, driven by a decrease in segment revenues of approximately $233,000, or 6%, year over year. Segment revenues decreased due to a 10% decrease in the number of units settled, offset partially by a 5% increase in the average settlement price year over year. The decrease in the number of units settled was impacted by a 13% lower backlog unit balance entering 2020 compared to the backlog unit balance entering 2019, coupled with a lower backlog turnover rate year over year. The increase in the average settlement price was primarily attributable to a 4% higher average sales price of units in backlog entering 2020 compared to backlog entering 2019. The Mid Atlantic segment’s gross profit margin percentage remained flat at 18.8% in both 2020 and 2019.
Segment New Orders and the average sales price of New Orders increased 5% and 7%, respectively, in 2020 compared to 2019. New Orders increased despite a 14% decrease in the average number of active communities year over year, due to higher absorption rates attributable to favorable market conditions in the second half of 2020, driven primarily by historically low mortgage interest rates and low resale inventory levels. The increase in the average sales price of New Orders was primarily attributable to improved pricing power in the segment.
North East
The North East segment had an approximate $1,100, or 2%, decrease in segment profit in 2020 compared to 2019, despite an increase in segment revenues of approximately $24,000, or 5%, year over year. The increase in segment revenues was attributable to a 4% increase in the number of units settled and a 1% increase in the average settlement price year over year. The increase in the number of units settled was attributable to a 4% higher backlog unit balance entering 2020 compared to the backlog unit balance entering 2019, coupled with a 27% increase in New Orders in the first nine months of 2020 compared to the same period in 2019. The segment’s gross profit margin percentage decreased to 19.0% in 2020 from 19.5% in 2019 due primarily to increases in lumber and certain other commodity prices year over year.
Segment New Orders and the average sales price of New Orders increased 29% and 7%, respectively, in 2020 compared to 2019. New Orders increased due to a 19% increase in the average number of active communities year over year and favorable market conditions in the second half of 2020, driven primarily by historically low mortgage interest rates and low resale inventory levels. The average sales price of New Orders was favorably impacted by the previously mentioned favorable market conditions which provided us some pricing power, as well as to a relative market shift in New Orders to higher priced communities within certain markets in the segment.
Mid East
The Mid East segment had an approximate $4,800, or 3%, decrease in segment profit in 2020 compared to 2019, despite an increase in segment revenues of approximately $23,500, or 2%, year over year. Segment revenues increased primarily due to a 2% increase in the number of units settled year over year. The increase in units settled was largely attributable to a 24% increase in settlements in the fourth quarter of 2020 compared to the same period in 2019 as settlements in the first half of 2020 were delayed in our Western Pennsylvania and New York markets due to the state and local governments in those markets issuing various orders that prohibited residential construction from the end of March through April 2020 as a result of the COVID-19 pandemic. The segment’s gross profit margin percentage decreased to 18.5% in 2020 from 19.0% in 2019 due to increases in lumber and certain other commodity prices year over year.
Segment New Orders and the average sales price of New Orders increased 25% and 2%, respectively, in 2020 compared to 2019. New Orders increased primarily due to higher absorption rates attributable to favorable market conditions driven primarily by historically low mortgage interest rates and low resale inventory levels.
South East
The South East segment had an approximate $49,900, or 32%, increase in segment profit in 2020 compared to 2019. The increase in segment profit was primarily driven by an increase in segment revenues of approximately $293,600, or 23%, coupled with improved gross profit margins year over year. The increase in revenues was attributable to a 21% increase in the number of units settled and a 1% increase in the average settlement price year over year. The number of units settled were favorably impacted by a 20% higher backlog unit balance entering 2020 compared to the same period in 2019, coupled with a 21% increase in New Orders in the first six months of 2020 compared to the same period in 2019. The segment’s gross profit margin percentage increased to 20.5% in 2020 from 20.0% in 2019 due to a relative shift in settlements to higher margin communities.
Segment New Orders and the average sales price of New Orders increased 33% and 2%, respectively, in 2020 compared to 2019. New Orders increased due to to a 15% increase in the average number of active communities year over year, coupled with higher absorption rates attributable to favorable market conditions in the second half of 2020, driven primarily by historically low mortgage interest rates and low resale inventory levels.
Homebuilding Segment Reconciliations to Consolidated Homebuilding Operations
In addition to the corporate capital allocation and contract land deposit impairments discussed above, the other reconciling items between homebuilding segment profit and homebuilding consolidated profit before tax include unallocated corporate overhead (which includes all management incentive compensation), equity-based compensation expense, consolidation adjustments and external corporate interest expense. Our overhead functions, such as accounting, treasury and human resources, are centrally performed and the costs are not allocated to our operating segments. Consolidation adjustments consist of such items to convert the reportable segments’ results, which are predominantly maintained on a cash basis, to a full accrual basis for external financial statement presentation purposes, and are not allocated to our operating segments. External corporate interest expense is primarily comprised of interest charges on our 3.95% Senior Notes due 2022 and 3.00% Senior Notes due 2030, and is not charged to the operating segments because the charges are included in the corporate capital allocation discussed above.
| Year Ended December 31, | ||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Homebuilding consolidated gross profit: | ||||||||||||||||||||
| Mid Atlantic | $ | 690,058 | $ | 734,017 | $ | 726,655 | ||||||||||||||
| North East | 102,621 | 100,520 | 115,169 | |||||||||||||||||
| Mid East | 282,443 | 285,091 | 279,050 | |||||||||||||||||
| South East | 327,483 | 260,804 | 211,870 | |||||||||||||||||
| Consolidation adjustments and other | (11,117) | (9,450) | (20,567) | |||||||||||||||||
| Homebuilding consolidated gross profit | $ | 1,391,488 | $ | 1,370,982 | $ | 1,312,177 |
| Year Ended December 31, | ||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Homebuilding consolidated profit before taxes: | ||||||||||||||||||||
| Mid Atlantic | $ | 437,849 | $ | 478,537 | $ | 462,178 | ||||||||||||||
| North East | 50,677 | 51,728 | 69,789 | |||||||||||||||||
| Mid East | 168,605 | 173,374 | 175,134 | |||||||||||||||||
| South East | 205,029 | 155,144 | 118,296 | |||||||||||||||||
| Reconciling items: | ||||||||||||||||||||
| Contract land deposit impairment reserve (1) | (24,633) | 1,644 | 783 | |||||||||||||||||
| Equity-based compensation expense (2) | (47,548) | (75,156) | (70,865) | |||||||||||||||||
| Corporate capital allocation (4) | 239,233 | 224,468 | 213,903 | |||||||||||||||||
| Unallocated corporate overhead | (114,921) | (105,125) | (89,973) | |||||||||||||||||
| Consolidation adjustments and other (3) | 63,025 | 43,486 | 15,829 | |||||||||||||||||
| Corporate interest expense | (39,356) | (24,221) | (23,968) | |||||||||||||||||
| Reconciling items sub-total | 75,800 | 65,096 | 45,709 | |||||||||||||||||
| Homebuilding consolidated profit before taxes | $ | 937,960 | $ | 923,879 | $ | 871,106 |
(1)This item represents changes to the contract land deposit impairment reserve, which are not allocated to the reportable segments. See further discussion of contract land deposit impairment charges in Note 3 in the accompanying consolidated financial statements.
(2)The decrease in equity-based compensation expense in 2020 was primarily attributable to stock options issued in 2014 under the 2014 Equity Incentive Plan becoming fully vested in 2019. In addition, there were higher stock option forfeitures in 2020 compared to 2019.
(3)The increase in 2020 relates primarily to the significant increase in lumber prices during the second half of 2020. Our reportable segments' results include intercompany profits of our production facilities, which were negatively impacted by the increase in lumber costs. The increase in lumber costs related to homes not yet settled is eliminated through the consolidation adjustment. As these homes currently in inventory are settled in subsequent quarters, our consolidated homebuilding margins will be negatively impacted by the higher lumber costs.
(4)This item represents the elimination of the corporate capital allocation charge included in the respective homebuilding reportable segments. The corporate capital allocation charge is based on the segment’s monthly average asset balance and is as follows for the years presented:
| Year Ended December 31, | ||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Corporate capital allocation charge: | ||||||||||||||||||||
| Mid Atlantic | $ | 124,426 | $ | 123,130 | $ | 123,855 | ||||||||||||||
| North East | 22,850 | 19,755 | 17,893 | |||||||||||||||||
| Mid East | 40,256 | 37,263 | 35,803 | |||||||||||||||||
| South East | 51,701 | 44,320 | 36,352 | |||||||||||||||||
| Total corporate capital allocation charge | $ | 239,233 | $ | 224,468 | $ | 213,903 |
Mortgage Banking Segment
We conduct our mortgage banking activity through NVRM, a wholly owned subsidiary. NVRM focuses almost exclusively on serving the homebuilding segment customer base. The following table summarizes the results of our mortgage banking operations and certain statistical data for each of the last three years:
| Year Ended December 31, | ||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||
| Loan closing volume: | ||||||||||||||||||||
| Total principal | $ | 5,317,811 | $ | 5,164,725 | $ | 4,829,406 | ||||||||||||||
| Loan volume mix: | ||||||||||||||||||||
| Adjustable rate mortgages | 2 | % | 8 | % | 10 | % | ||||||||||||||
| Fixed-rate mortgages | 98 | % | 92 | % | 90 | % | ||||||||||||||
| Operating profit: | ||||||||||||||||||||
| Segment profit | $ | 143,319 | $ | 105,292 | $ | 93,462 | ||||||||||||||
| Equity-based compensation expense | (3,246) | (3,376) | (4,836) | |||||||||||||||||
| Mortgage banking income | $ | 140,073 | $ | 101,916 | $ | 88,626 | ||||||||||||||
| Capture rate: | 90 | % | 90 | % | 88 | % | ||||||||||||||
| Mortgage banking fees: | ||||||||||||||||||||
| Net gain on sale of loans | $ | 168,720 | $ | 128,642 | $ | 122,755 | ||||||||||||||
| Title services | 38,554 | 38,537 | 36,001 | |||||||||||||||||
| Servicing fees | 760 | 641 | 614 | |||||||||||||||||
| $ | 208,034 | $ | 167,820 | $ | 159,370 |
Loan closing volume in 2020 increased by approximately $153,100, or 3%, from 2019. The increase was primarily attributable to a 1% increase in the number of loans closed year over year due primarily to the aforementioned increase in the homebuilding segment’s number of settlements in 2020 as compared to 2019 and a 2% increase in the average loan amount in 2020 compared to 2019.
Segment profit in 2020 increased by approximately $38,000, or 36%, from 2019. The increase in segment profit was primarily attributable to an increase in mortgage banking fees. Mortgage banking fees increased by approximately $40,200, or 24%, resulting from the aforementioned increase in loan closing volume and an increase in secondary marketing gains on sales of loans.
Mortgage Banking – Other
We sell all of the loans we originate into the secondary mortgage market. Insofar as we underwrite our originated loans to the standards and specifications of the ultimate investor, we have no further financial obligations from the issuance of loans, except in certain limited instances where repurchases or early payment default occur. Those underwriting standards are typically equal to or more stringent than the underwriting standards required by FNMA, GNMA, FHLMC, VA and FHA. Because we sell all of our loans and do not service them, there is often a substantial delay between the time that a loan goes into default and the time that the investor
requests us to reimburse them for losses incurred because of the default. We believe that all of the loans that we originate are underwritten to the standards and specifications of the ultimate investor to whom we sell our originated loans. We employ a quality control department to ensure that our underwriting controls are effective, and further assess the underwriting function as part of our assessment of internal controls over financial reporting.
We maintain a reserve for losses on mortgage loans originated that reflects our judgment of the present loss exposure from the loans that we have originated and sold. At December 31, 2020 and 2019, we had repurchase reserves of approximately $20,500 and $18,500, respectively.
NVRM is dependent on our homebuilding operation’s customers for business. If new orders and selling prices of the homebuilding segment decline, NVRM’s operations will also be adversely affected. In addition, NVRM’s operating results may be adversely affected in future periods due to tightening and volatility of the credit markets, changes in investor funding times, increased regulation of mortgage lending practices and increased competition in the mortgage market.
Seasonality
We generally have higher New Order activity in the first half of the year and higher home settlements, revenues and net income in the second half of the year, however, COVID-19 related restrictions negatively impacted our New Order activity in March and April, affecting our typical seasonal New Order trend.
Effective Tax Rate
Our consolidated effective tax rate in 2020, 2019 and 2018 was 16.40%, 14.36% and 16.94%, respectively. The higher effective tax rate in 2020 compared to 2019 was attributable primarily to the retroactive reinstatement of certain expired energy tax credits under The Further Consolidated Appropriations Act in 2019, which resulted in the recognition of a tax benefit of approximately $15,100 in 2019 related to homes settled in 2018 and 2019. For the year ended December 31, 2020, we recognized approximately $10,200 in energy tax credits.
Additionally, our effective tax rates in 2020, 2019 and 2018 were favorably impacted by the recognition of an income tax benefit related to excess tax benefits from stock option exercises of $92,234, $101,466 and $77,478, respectively. We expect continued tax rate volatility in future years attributable to the recognition of excess tax benefits from equity plan activity and distributions from the deferred compensation plans.
Recent Accounting Pronouncements Pending Adoption
See Note 1 to the accompanying consolidated financial statements for discussion of recently issued accounting pronouncements applicable to us.
Liquidity and Capital Resources
Lines of Credit and Notes Payable
We had a very strong liquidity position as of December 31, 2020, with approximately $2,8 billion in cash and cash equivalents, approximately $187,200 in unused committed capacity under our revolving credit facility and $150,000 in unused committed capacity under our revolving mortgage repurchase facility.
Our homebuilding segment funds its operations from cash flows provided by operating activities, a short-term unsecured working capital revolving credit facility and capital raised in the public debt and equity markets.
Senior Notes
On September 10, 2012, we completed an offering for $600,000 aggregate principal amount of 3.95% Senior Notes due 2022 (the "2022 Senior Notes"). The 2022 Senior Notes were issued at a discount to yield 3.97% and have been reflected net of the unamortized discount in the accompanying consolidated balance sheet. The 2022 Senior Notes mature on September 15, 2022 and bear interest at 3.95%, payable semi-annually in arrears on March 15 and September 15.
On May 4, 2020, we issued $600,000 of 3.00% Senior Notes due 2030 (the "2030 Senior Notes"). The 2030 Senior Notes were issued at a discount to yield 3.02% and have been reflected net of the unamortized discount and unamortized debt issuance costs in the accompanying consolidated balance sheet. The offering of the 2030 Senior Notes resulted in aggregate net proceeds of approximately $595,200, after deducting underwriting discount and offering expenses. The 2030 Senior Notes mature on May 15, 2030 and bear interest at 3.00%, payable semi-annually in arrears on May 15 and November 15.
On September 9 and September 17, 2020, we issued an additional $250,000 and $50,000, respectively, of 3.00% 2030 Senior Notes (the "2030 Additional Notes" and together with the 2030 Senior Notes and the 2022 Senior Notes, the "Senior Notes"). The
2030 Additional Notes were issued at a premium to yield 2.00% and have been reflected net of the unamortized premium and unamortized debt issuance costs in the accompanying consolidated balance sheet. The offering of the 2030 Additional Notes resulted in aggregate net proceeds of approximately $323,600, including the underwriting premium, less offering expenses. The 2030 Additional Notes form a single series with the 2030 Senior Notes and have substantially identical terms as the 2030 Senior Notes.
The Senior Notes are senior unsecured obligations and rank equally in right of payment with any of our existing and future unsecured senior indebtedness, will rank senior in right of payment to any of our future indebtedness that is by its terms expressly subordinated to the Senior Notes and will be effectively subordinated to any of our existing and future secured indebtedness to the extent of the value of the collateral securing such indebtedness. The indenture governing the Senior Notes does not contain any financial covenants; however, it does contain, among other items, and subject to certain exceptions, covenants that restrict our ability to create, incur, assume or guarantee secured debt, enter into sale and leaseback transactions and conditions related to mergers and/or the sale of assets. We were in compliance with all covenants under the Senior Notes at December 31, 2020.
Credit Agreement
On July 15, 2016, we entered into an unsecured Credit Agreement (the “Credit Agreement”) with Bank of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer, Merrill Lynch, Pierce, Fenner & Smith Incorporated as Sole Lead Arranger and Sole Book Runner, and the other lenders party thereto, which provides for aggregate revolving loan commitments of $200,000 (the “Facility”). Proceeds of the borrowings under the Facility will be used for working capital and general corporate purposes. Under the Credit Agreement, we may request increases of up to $300,000 to the Facility in the form of revolving loan commitments or term loans to the extent that new or existing lenders agree to provide additional revolving loan or term loan commitments.
The Credit Agreement provides for a $100,000 sublimit for the issuance of letters of credit of which there was approximately $12,800 outstanding at December 31, 2020, and a $25,000 sublimit for a swing line commitment. Borrowings under the Credit Agreement generally bear interest for Base Rate Loans at a Base Rate equal to the highest of (i) a Federal Funds Rate plus one-half of one percent, (ii) Bank of America’s publicly announced “prime rate,” and (iii) the Eurodollar Rate plus one percent, plus the Applicable Rate which is based on our debt rating, or for Eurodollar Rate Loans, at the Eurodollar Rate equal to LIBOR plus the Applicable Rate.
The Credit Agreement contains various representations and affirmative and negative covenants that are generally customary for credit facilities of this type. Such covenants include, among others, the following financial maintenance covenants: (i) minimum consolidated tangible net worth, (ii) minimum interest coverage ratio or minimum liquidity and (iii) a maximum leverage ratio. The negative covenants include, among others, certain limitations on liens, investments and fundamental changes. The Credit Agreement termination date is July 15, 2021. We were in compliance with all covenants under the Credit Agreement at December 31, 2020. There were no borrowings outstanding under the Credit Agreement as of December 31, 2020.
On February 12, 2021, we entered into The Amended and Restated Credit Agreement with Bank of America, N.A., as Administrative Agent, BOFA Securities, Inc. as Sole Lead Arranger and Sole Bookrunner, and other lenders party thereto (the "Amended Credit Agreement"). The Amended Credit Agreement amends and restates the Credit Agreement, discussed above, which was scheduled to expire on July 15, 2021. The Amended Credit Agreement provides for aggregate revolving loan commitments of $300,000 (the "New Facility") and terminates on February 12, 2026. Under the Amended Credit Agreement, we may request increases of up to $300,000 to the New Facility in the form of revolving loan commitments or term loans to the extent that new or existing lenders agree to provide additional revolving loan or term loan commitments. In addition, the Amended Credit Agreement provides for a $100,000 sublimit for the issuance of letters of credit. All other terms of the Amended Credit Agreement, including interest on borrowings and affirmative and negative covenants, are materially consistent with the Credit Agreement it replaces. The Amended Credit Agreement is filed as Exhibit 10.48 in this Form 10-K. The above summary of the material terms of the Amended Credit Agreement is qualified in its entirety by reference to Exhibit 10.48.
Repurchase Agreement
Our mortgage banking subsidiary, NVRM, provides for its mortgage origination and other operating activities using cash generated from operations, borrowings from its parent company, NVR, as well as a revolving mortgage repurchase facility, which is non-recourse to NVR. In July 2020, NVRM entered into the Twelfth Amendment (the “Amendment”) to its Amended and Restated Master Repurchase Agreement dated August 2, 2011 with U.S. Bank National Association (as amended by the Amendment and ten earlier amendments, the “Repurchase Agreement”). The Repurchase Agreement provides borrowing capacity up to $150,000, subject to certain sublimits. The purpose of the Repurchase Agreement is to finance the origination of mortgage loans by NVRM. The Repurchase Agreement expires on July 21, 2021. Advances under the Repurchase Agreement carry a Pricing Rate based on the LIBOR Rate plus the LIBOR Margin, as determined under the Repurchase Agreement, provided that the Pricing Rate shall not be less than 1.75%. There are several restrictions on purchased loans, including that they cannot be sold to others, they cannot be pledged to anyone other than the agent, and they cannot support any other borrowing or repurchase agreement.
The Repurchase Agreement contains various affirmative and negative covenants. The negative covenants include among others, certain limitations on transactions involving acquisitions, mergers, the incurrence of debt, sale of assets and creation of liens upon any of its Mortgage Notes. Additional covenants include (i) a tangible net worth requirement, (ii) a minimum liquidity requirement, (iii) a
minimum net income requirement, and (iv) a maximum leverage ratio requirement. NVRM was in compliance with all covenants under the Repurchase Agreement at December 31, 2020. At December 31, 2020, there was no debt outstanding under the Repurchase Agreement and there were no borrowing base limitations.
Common Stock Repurchases
In addition to funding growth in our homebuilding and mortgage banking operations, we historically have used a substantial portion of our excess liquidity to repurchase outstanding shares of our common stock in open market and privately negotiated transactions. This ongoing repurchase activity is conducted pursuant to publicly announced Board authorizations, and is typically executed in accordance with the safe-harbor provisions of Rule 10b-18 promulgated under the Securities Exchange Act of 1934, as amended. In addition, the Board resolutions authorizing us to repurchase shares of our common stock specifically prohibit us from purchasing shares from our officers, directors, Profit Sharing Plan Trust or Employee Stock Ownership Plan Trust. The repurchase program assists us in accomplishing our primary objective, creating increases in shareholder value. See “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in Item 5 of this Form 10-K for disclosure of amounts repurchased during the fourth quarter of 2020. For the year ended December 31, 2020, we repurchased 93,346 shares of our common stock at an aggregate purchase price of $371,078. As of December 31, 2020, we had $546,062 available under Board approved repurchase authorizations.
Cash Flows
For the year ended December 31, 2020, cash, restricted cash and cash equivalents increased by $1,648,978. Net cash provided by operating activities was $925,269, due primarily to cash provided by earnings in 2020 and net proceeds of $212,636 from mortgage loan activity. Additionally, cash was provided by an increase in customer deposits attributable to the increase in our ending backlog year over year. Cash was primarily used to fund the increase in inventory of $362,384, attributable to an increase in units under construction at December 31, 2020 compared to December 31, 2019.
Net cash used in investing activities in 2020 was $3,933. Cash was used for purchases of property, plant and equipment of $16,119, offset partially by the receipt of capital distributions from our unconsolidated JVs totaling $11,625.
Net cash provided by financing activities in 2020 was $727,642, due primarily to the net proceeds received from the issuance of the 2030 Senior Notes, as discussed above, and by $180,866 in proceeds from stock option exercises in 2020. Cash was used during the period to repurchase shares of our common stock under our ongoing common stock repurchase program as discussed above.
For the year ended December 31, 2019, cash, restricted cash and cash equivalents increased by $428,556. Net cash provided by operating activities was $866,535, due primarily to cash provided by earnings in 2019 and net proceeds of $91,178 from mortgage loan activity. Cash was primarily used to fund the increase in inventory of $94,178, attributable to an increase in units under construction at December 31, 2019 compared to December 31, 2018. Net cash used in investing activities in 2019 of $13,284 was attributable primarily to cash used for purchases of property, plant and equipment of $22,699, offset partially by the receipt of capital distributions from our unconsolidated JVs totaling $8,247. Net cash used in financing activities of $424,695 resulted primarily from our repurchase of 220,965 shares of our common stock for an aggregate purchase price of $698,417 under our ongoing common stock repurchase program as discussed above, offset partially by $274,028 in proceeds from stock option exercises.
At December 31, 2020 and 2019, the homebuilding segment had restricted cash of $28,912 and $17,943, respectively. Restricted cash in each year was attributable to customer deposits for certain home sales.
We believe that our current cash holdings, cash generated from operations, and cash available under our short-term unsecured credit agreement, revolving mortgage repurchase facility and the public debt and equity markets will be sufficient to satisfy near and long term cash requirements for working capital and debt service in both our homebuilding and mortgage banking operations.
Off-Balance Sheet Arrangements
Lot Acquisition Strategy
We generally do not engage in land development. Instead, we typically acquire finished building lots from various land developers under LPAs that require deposits that may be forfeited if we fail to perform under the agreement. The deposits required under the LPAs are in the form of cash or letters of credit in varying amounts and represent a percentage, typically ranging up to 10%, of the aggregate purchase price of the finished lots.
We believe that our lot acquisition strategy reduces the financial risks associated with direct land ownership and land development. We may, at our option, choose for any reason and at any time not to perform under these LPAs by delivering notice of our intent not to acquire the finished lots under contract. Our sole legal obligation and economic loss for failure to perform under these purchase agreements is limited to the amount of the deposit pursuant to the liquidated damage provision contained in the LPAs. We do not have any financial guarantees or completion obligations and we typically do not guarantee lot purchases on a specific performance basis under these LPAs.
At December 31, 2020, we controlled approximately 105,700 lots through LPAs, JVs and land under development, with an aggregate purchase price of approximately $10,300,000. These lots are controlled by making or committing to make deposits of approximately $661,600 in the form of cash and letters of credit. Our entire risk of loss pertaining to the aggregate purchase price contractual commitment resulting from our non-performance under the contracts is limited to $438,500 in deposits paid and $8,100 in letters of credit issued as of December 31, 2020, plus approximately $215,000 related to deposits to be paid subsequent to December 31, 2020 assuming that contractual development milestones are met by the developers and we exercise our option. As of December 31, 2020, we had recorded an impairment valuation allowance of approximately $52,200 related to certain cash deposits currently outstanding. Additionally, as of December 31, 2020, we had funding commitments totaling $3,100 to one of our JVs and approximately $5,100 under a joint development agreement related to our land under development, a portion of which we expect will be offset by development credits of approximately $2,600.
In addition, we have certain properties under contract with land owners that are expected to yield approximately 6,100 lots, which are not included in our number of total lots controlled above. Some of these properties may require rezoning or other approvals to achieve the expected yield. These properties are controlled with cash deposits and letters of credit of approximately $1,300 and $100, respectively, as of December 31, 2020, of which approximately $1,000 is refundable if we do not perform under the contract and the remainder is at risk of loss. We generally expect to assign the raw land contracts to a land developer and simultaneously enter into an LPA with the assignee if the project is determined to be feasible. Please refer to Note 1 in the accompanying consolidated financial statements for a further discussion of the contract land deposits and Note 3 in the accompanying consolidated financial statements for a description of our lot acquisition strategy in relation to our accounting for variable interest entities.
Bonds and Letters of Credit
We enter into bond or letter of credit arrangements with local municipalities, government agencies, or land developers to collateralize our obligations under various contracts. We had approximately $40,600 of contingent obligations under such agreements as of December 31, 2020, inclusive of the $8,100 of lot acquisition deposits in the form of letters of credit discussed above. We believe we will fulfill our obligations under the related contracts and do not anticipate any material losses under these bonds or letters of credit.
Mortgage Commitments and Forward Sales
In the normal course of business, NVRM enters into contractual commitments to extend credit to our homebuyers with fixed expiration dates. The commitments become effective when the borrowers “lock-in” a specified interest rate within time frames established by us. All mortgagors are evaluated for credit worthiness prior to the extension of the commitment. Market risk arises if interest rates move adversely between the time of the “lock-in” of rates by the borrower and the sale date of the loan to an investor. To mitigate the effect of the interest rate risk inherent in providing rate lock commitments to borrowers, we enter into optional or mandatory delivery forward sale contracts to sell whole loans and mortgage-backed securities to investors. The forward sale contracts lock in a range of interest rates and prices for the sale of loans similar to the specific rate lock commitments. We do not engage in speculative or trading derivative activities. Both the rate lock commitments to borrowers and the forward sale contracts to investors are undesignated derivatives, and, accordingly, are marked to fair value through earnings. At December 31, 2020, we had contractual commitments to extend credit to borrowers aggregating $617,308 and open forward delivery contracts aggregating $916,588, which hedge both the rate lock commitments and closed loans held for sale (see Note 15 in the accompanying consolidated financial statements for a description of our fair value accounting).
Contractual Obligations
Our fixed, non-cancelable obligations as of December 31, 2020, were as follows:
| Payments due by year | ||||||||||||||||||||||||||||||||
| Total | 2021 | 2022 to 2023 | 2024 to 2025 | 2026 and Later | ||||||||||||||||||||||||||||
| Debt (1) | $ | 1,500,000 | $ | — | $ | 600,000 | $ | — | $ | 900,000 | ||||||||||||||||||||||
| Interest on debt (1) | 293,472 | 50,700 | 70,722 | 54,000 | 118,050 | |||||||||||||||||||||||||||
| Finance leases (2) | 19,512 | 1,744 | 3,503 | 3,523 | 10,742 | |||||||||||||||||||||||||||
| Operating leases (2) | 84,965 | 30,111 | 34,418 | 13,795 | 6,641 | |||||||||||||||||||||||||||
| Purchase obligations (3) | 220,104 | * | * | * | * | |||||||||||||||||||||||||||
| Uncertain tax positions (4) | 29,085 | * | * | * | * | |||||||||||||||||||||||||||
| Total | $ | 2,147,138 | $ | 82,555 | $ | 708,643 | $ | 71,318 | $ | 1,035,433 |
(1)See Note 9 in the accompanying consolidated financial statements for additional information regarding the Senior Notes.
(2)See Note 13 in the accompanying consolidated financial statements for additional information regarding our finance and operating leases.
(3)Amount represents expected payments of forfeitable deposits with land developers under existing LPAs assuming that contractual development milestones are met by the developers and we exercise our option, and estimated contractual obligations for land development agreements. We expect to make the majority of payments of the deposits with land developers within the next three years, but due to the nature of the contractual development milestones that must be met we are unable to accurately estimate the portion of the deposit obligation that will be made within one year and that portion that will be made within one to three years.
(4)Due to the nature of the uncertain tax positions, we are unable to make a reasonable estimate as to the period of settlement with the respective taxing authorities.
Critical Accounting Policies
General
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. We continually evaluate the estimates we use to prepare the consolidated financial statements and update those estimates as necessary. In general, our estimates are based on historical experience, on information from third party professionals, and other various assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ materially from those estimates made by management.
Homebuilding Inventory
The carrying value of inventory is stated at the lower of cost or market value. Cost of lots and completed and uncompleted housing units represent the accumulated actual cost of the units. Field construction supervisors’ salaries and related direct overhead expenses are included in inventory costs. Interest costs are not capitalized into inventory, with the exception of land under development and joint venture investments, as applicable (see below). Upon settlement, the cost of the unit is expensed on a specific identification basis. Cost of building materials is determined on a first-in, first-out basis.
Sold inventory is evaluated for impairment based on the contractual selling price compared to the total estimated cost to construct. Unsold inventory is evaluated for impairment by analyzing recent comparable sale prices within the applicable community compared to the costs incurred to date plus the expected costs to complete. Any calculated impairments are recorded immediately in cost of sales.
Contract Land Deposits and Land Under Development
Contract Land Deposits
We purchase finished lots under LPAs that require deposits that may be forfeited if we fail to perform under the contract. The deposits are in the form of cash or letters of credit in varying amounts and represent a percentage of the aggregate purchase price of the finished lots.
We maintain an allowance for losses on contract land deposits that reflects our judgment of the present loss exposure in the existing contract land deposit portfolio at the end of the reporting period. To analyze contract land deposit impairments, we conduct a loss contingency analysis each quarter. In addition to considering market and economic conditions, we assess contract land deposit impairments on a community-by-community basis pursuant to the purchase contract terms, analyzing quantitative and qualitative information including, as applicable, current sales absorption levels, recent sales’ profit margin, the dollar differential between the contractual purchase price and the current market price for lots, a developer’s performance, a developer’s financial ability or willingness to reduce lot prices to current market prices, if necessary, and the contract’s default status by either us or the developer along with an analysis of the expected outcome of any such default.
Our analysis is focused on whether we can sell houses at an acceptable margin and sales pace in a particular community in the current market with which we are faced. Because we do not own the finished lots on which we had placed a contract land deposit, if the above analysis leads to a determination that we cannot sell homes at an acceptable margin and sales pace at the current contractual lot price, we then determine whether we will elect to default under the contract, forfeit our deposit and terminate the contract, or whether we will attempt to restructure the lot purchase contract, which may require us to forfeit the deposit to obtain contract concessions from a developer. We also assess whether an impairment is present due to collectability issues resulting from a developer’s non-performance because of financial or other conditions.
Although we consider the allowance for losses on contract land deposits reflected on the December 31, 2020 consolidated balance sheet to be adequate (see Note 1 to the accompanying consolidated financial statements included herein), there can be no assurance that this allowance will prove to be adequate over time to cover losses due to unanticipated adverse changes in the economy or other events adversely affecting specific markets or the homebuilding industry.
Land Under Development
On a limited basis, we directly acquire raw parcels of land already zoned for its intended use to develop into finished lots. Land under development includes the land acquisition costs, direct improvement costs, capitalized interest, where applicable, and real estate taxes.
Land under development, including the land under development held by our unconsolidated JVs and the related joint venture investments, is reviewed for potential write-downs when impairment indicators are present. In addition to considering market and economic conditions, we assess land under development impairments on a community-by-community basis, analyzing, as applicable, current sales absorption levels, recent sales’ profit margin, and the dollar differential between the projected fully-developed cost of the lots and the current market price for lots. If indicators of impairment are present for a community, we perform an analysis to determine if the undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts, and if so, impairment charges are required to be recorded in an amount by which the carrying amount of the assets exceeds the fair value of such assets. Our determination of fair value is primarily based on discounting the estimated future cash flows at a rate commensurate with the inherent risks associated with the assets and related estimated cash flow streams.
At December 31, 2020, we had approximately $62,800 in land under development in three separate communities. In addition, at December 31, 2020, we had an aggregate investment totaling approximately $23,600 in four separate JVs that controlled land under development. During 2020, we recognized an impairment of approximately $1,800 related to one of our JVs. None of the communities classified as land under development nor any of the undeveloped land held by the JVs had any indicators of impairment at December 31, 2020. As such, we do not believe that any of the land under development is impaired at this time. However, there can be no assurance that we will not incur impairment charges in the future due to unanticipated adverse changes in the economy or other events adversely affecting specific markets or the homebuilding industry.
Warranty/Product Liability Accruals
We establish warranty and product liability reserves to provide for estimated future expenses as a result of construction and product defects, product recalls and litigation incidental to our homebuilding business. Liability estimates are determined based on our judgment considering such factors as historical experience, the likely current cost of corrective action, manufacturers’ and subcontractors’ participation in sharing the cost of corrective action, consultations with third party experts such as engineers, and discussions with our General Counsel and outside counsel retained to handle specific product liability cases. Although we consider the warranty and product liability accrual reflected on the December 31, 2020 consolidated balance sheet to be adequate (see Note 14 to the accompanying consolidated financial statements included herein), there can be no assurance that this accrual will prove to be adequate over time to cover losses due to increased costs for material and labor, the inability or refusal of manufacturers or subcontractors to financially participate in corrective action, unanticipated adverse legal settlements, or other unanticipated changes to the assumptions used to estimate the warranty and product liability accrual.
Equity-Based Compensation Expense
We recognize equity-based compensation expense within our income statement for all share-based payment arrangements, which include non-qualified stock options to purchase shares of NVR common stock ("Options") and restricted share units ("RSUs"). Compensation expense is based on the grant-date fair value of the Options and RSUs granted, and is recognized on a straight-line basis over the requisite service period for the entire award (from the date of grant through the period of the last separately vesting portion of the grant). Options and RSUs which are subject to a performance condition are treated as a separate award from the “service-only” Options and RSUs, and compensation expense is recognized when it becomes probable that the stated performance target will be achieved. We calculate the fair value of our Options, which are non-publicly traded, using the Black-Scholes option-pricing model. The grant date fair value of the RSUs is the closing price of our common stock on the day immediately preceding the date of grant. The reversal of compensation expense previously recognized for grants forfeited is recorded in the period in which the forfeiture occurs.
As noted above, we calculate the fair value of our Options, which are non-publicly traded, using the Black-Scholes option-pricing model. While the Black-Scholes model is a widely accepted method to calculate the fair value of options, its results are dependent on input variables, two of which, expected term and expected volatility, are significantly dependent on management’s judgment. We have concluded that our historical exercise experience is the best estimate of future exercise patterns to determine an Option’s expected term. To estimate expected volatility, we analyze the historical volatility of our common stock over a period equal to the Option’s expected term. Changes in management’s judgment of the expected term and the expected volatility could have a material effect on the grant-date fair value calculated and expensed within the income statement.
In addition, when recognizing equity-based compensation cost related to “performance condition” Option and RSU grants, we are required to make a determination as to whether the performance conditions will be met prior to the completion of the actual performance period. The performance metric is based on our return on capital performance during a specified three year period based on the date of Option grant. While we currently believe that this performance condition will be satisfied at the target level and are recognizing compensation expense related to such Options and RSUs accordingly, our future expected activity levels could cause us to
make a different determination, resulting in a change to the compensation expense to be recognized related to performance condition Option and RSU grants that would otherwise have been recognized to date.
Although we believe that the compensation costs recognized in 2020 are representative of the cumulative ratable amortization of the grant-date fair value of unvested Options and RSUs outstanding, changes to the estimated input values such as expected term and expected volatility and changes to the determination of whether performance condition grants will vest, could produce widely different expense valuations and recognition.
Mortgage Repurchase Reserve
We originate several different loan products to our customers to finance the purchase of their home. We sell all of the loans we originate into the secondary mortgage market, on a servicing released basis, typically within 30 days from closing. All of the loans that we originate are underwritten to the standards and specifications of the ultimate investor. Those underwriting standards are typically equal to or more stringent than the underwriting standards required by FNMA, GNMA, FHLMC, VA and FHA. Insofar as we underwrite our originated loans to those standards, we bear no increased concentration of credit risk from the issuance of loans, except in certain limited instances where repurchases or early payment default occur. We employ a quality control department to ensure that our underwriting controls are effectively operating, and further assess the underwriting function as part of our assessment of internal controls over financial reporting. We maintain a reserve for losses on mortgage loans originated that reflects our judgment of the present loss exposure in the loans that we have originated and sold. The reserve is calculated based on an analysis of historical experience and exposure. Although we consider the mortgage repurchase reserve reflected on the December 31, 2020 consolidated balance sheet to be adequate (see Note 16 to the accompanying consolidated financial statements included herein), there can be no assurance that this reserve will prove to be adequate over time to cover losses due to unanticipated changes to the assumptions used to estimate the mortgage repurchase reserve.
Impact of Inflation, Changing Prices and Economic Conditions
See “Risk Factors” included in Item 1A of this Form 10-K for a description of the impact of inflation, changing prices and economic conditions on our business and our financial results. See also the discussion of the current business environment in the Overview section above.
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