mdc20140630_10q.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2014

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File No. 1-8951

 

M.D.C. HOLDINGS, INC.

(Exact name of Registrant as specified in its charter)

 

Delaware

 

84-0622967

(State or other jurisdiction

 

(I.R.S. employer

of incorporation or organization)

 

identification no.)

 

4350 South Monaco Street, Suite 500

 

80237

Denver, Colorado

 

(Zip code)

(Address of principal executive offices)

   

 

(303) 773-1100

(Registrant's telephone number, including area code)

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes    No  

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes    No  

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer

Accelerated Filer

Non-Accelerated Filer

  (Do not check if a smaller reporting company)

Smaller Reporting Company

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes    No  

 

As of July 25, 2014, 48,816,639 shares of M.D.C. Holdings, Inc. common stock were outstanding.

 

 
 

 

 

M.D.C. HOLDINGS, INC. AND SUBSIDIARIES

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2014

 

INDEX

 

Page
No.

PartI. Financial Information:

 
         

Item1.

Unaudited Consolidated Financial Statements:

 
         

Consolidated Balance Sheets at June 30, 2014 and December 31,2013

1

 
         

Consolidated Statements of Operations and Comprehensive Income for the three and six months ended June 30, 2014 and 2013

2

 
         

Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013

3

 
         

Notes to Unaudited Consolidated Financial Statements

4

 
         

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

25

 
         

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

40

 
         

Item 4.

Controls and Procedures

41

 
     

Part II. Other Information:

 
         

Item 1.

Legal Proceedings

42

 
         

Item1A.

Risk Factors

42

 
         

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

43

 
         
 

Item 3.

Defaults Upon Senior Securities

43

 
         
 

Item 4.

Mine Safety Disclosures

43

 
         

Item 5.

Other Information

43

 
         

Item 6.

Exhibits

44

 
       

Signature

44

 

 

 
(i) 

 

 

ITEM 1.     Unaudited Consolidated Financial Statements

 

M.D.C. HOLDINGS, INC.

Consolidated Balance Sheets.

 

   

June 30,

2014

   

December 31,

2013

 
   

(Dollars in thousands, except

per share amounts)

 
   

(Unaudited)

         
ASSETS                
Homebuilding:                

Cash and cash equivalents

  $ 100,150     $ 148,634  

Marketable securities

    492,498       569,021  

Restricted cash

    2,188       2,195  

Trade and other receivables

    27,250       23,407  

Inventories:

               

Housing completed or under construction

    758,392       636,700  

Land and land under development

    837,889       774,961  

Total inventories

    1,596,281       1,411,661  

Property and equipment, net

    30,765       31,248  

Deferred tax asset, net

    160,872       176,262  

Metropolitan district bond securities (related party)

    14,291       12,729  

Prepaid and other assets

    65,374       53,525  

Total homebuilding assets

    2,489,669       2,428,682  

Financial Services:

               

Cash and cash equivalents

    29,881       50,704  

Marketable securities

    13,390       19,046  

Mortgage loans held-for-sale, net

    58,377       92,578  

Other assets

    5,244       4,439  

Total financial services assets

    106,892       166,767  

Total Assets

  $ 2,596,561     $ 2,595,449  

LIABILITIES AND EQUITY

               

Homebuilding:

               

Accounts payable

  $ 34,266     $ 15,046  

Accrued liabilities

    145,290       152,821  

Revolving credit facility

    10,000       -  

Senior notes, net

    1,096,112       1,095,620  

Total homebuilding liabilities

    1,285,668       1,263,487  

Financial Services:

               

Accounts payable and accrued liabilities

    56,086       55,639  

Mortgage repurchase facility

    32,198       63,074  

Total financial services liabilities

    88,284       118,713  

Total Liabilities

    1,373,952       1,382,200  

Stockholders' Equity

               

Preferred stock, $0.01 par value; 25,000,000 shares authorized; none issued or outstanding

    -       -  

Common stock, $0.01 par value; 250,000,000 shares authorized; 48,816,639 and 48,788,887 issued and outstanding at June 30, 2014 and December 31, 2013, respectively

    488       488  

Additional paid-in-capital

    910,535       908,090  

Retained earnings

    301,730       293,096  

Accumulated other comprehensive income

    9,856       11,575  

Total Stockholders' Equity

    1,222,609       1,213,249  

Total Liabilities and Stockholders' Equity

  $ 2,596,561     $ 2,595,449  

 

The accompanying Notes are an integral part of these Unaudited Consolidated Financial Statements.

 

 
- 1 -

 

 

M.D.C. HOLDINGS, INC.

Consolidated Statements of Operations and Comprehensive Income

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
   

2014

   

2013

   

2014

   

2013

 
   

(Dollars in thousands, except per share amounts)

 
   

(Unaudited)

 

Homebuilding:

                               

Home sale revenues

  $ 430,743     $ 400,327     $ 749,277     $ 732,075  

Land sale revenues

    518       1,807       518       1,807  

Total home and land sale revenues

    431,261       402,134       749,795       733,882  

Home cost of sales

    (356,175 )     (327,927 )     (615,653 )     (602,003 )

Land cost of sales

    (522 )     (1,435 )     (522 )     (1,435 )

Inventory impairments

    (850 )     -       (850 )     -  

Total cost of sales

    (357,547 )     (329,362 )     (617,025 )     (603,438 )

Gross margin

    73,714       72,772       132,770       130,444  

Selling, general and administrative expenses

    (49,798 )     (51,908 )     (98,140 )     (100,109 )

Interest and other income

    4,613       10,200       18,162       16,749  

Interest expense

    -       (909 )     (685 )     (1,726 )

Other expense

    (1,080 )     (366 )     (1,693 )     (722 )

Loss on early extinguishment of debt

    -       -       (9,412 )     -  

Homebuilding pretax income

    27,449       29,789       41,002       44,636  
                                 

Financial Services:

                               

Revenues

    11,491       13,884       20,714       26,390  

Expenses

    (5,615 )     (6,581 )     (10,539 )     (12,223 )

Interest and other income

    701       920       1,489       1,795  

Financial services pretax income

    6,577       8,223       11,664       15,962  
                                 

Income before income taxes

    34,026       38,012       52,666       60,598  

Benefit from (provision for) income taxes

    (12,484 )     186,897       (19,620 )     186,827  

Net income

  $ 21,542     $ 224,909     $ 33,046     $ 247,425  
                                 

Other comprehensive income (loss) related to available for sale securities, net of tax

    2,327       (1,995 )     (1,719 )     540  

Comprehensive income

  $ 23,869     $ 222,914     $ 31,327     $ 247,965  
                                 

Earnings per share:

                               

Basic

  $ 0.44     $ 4.60     $ 0.68     $ 5.06  

Diluted

  $ 0.44     $ 4.55     $ 0.67     $ 5.01  
                                 

Weighted average common shares outstanding

                               

Basic

    48,640,979       48,478,076       48,613,521       48,410,486  

Diluted

    48,852,696       48,946,055       48,842,527       48,916,988  
                                 

Dividends declared per share

  $ 0.25     $ -     $ 0.50     $ -  

 

 

The accompanying Notes are an integral part of these Unaudited Consolidated Financial Statements. 

 

 
- 2 -

 

 

M.D.C. HOLDINGS, INC.

Consolidated Statements of Cash Flows

 

 

   

Six Months Ended

June 30,

 
   

2014

   

2013

 
   

(Dollars in thousands)

 
   

(Unaudited)

 

Operating Activities:

               

Net income

  $ 33,046     $ 247,425  

Adjustments to reconcile net income to net cash used in operating activities:

               

Loss on early extinguishment of debt

    9,412       -  

Stock-based compensation expense

    2,550       5,214  

Depreciation and amortization

    1,933       2,072  

Loss (gain) on sale of marketable securities

    (6,356 )     -  

Amortization of discount / premiums on marketable debt securities

    422       1,423  

Deferred income tax expense (benefit)

    19,554       (187,643 )

Net changes in assets and liabilities:

               

Restricted cash

    7       (820 )

Trade and other receivables

    (8,409 )     (8,566 )

Mortgage loans held-for-sale

    34,201       27,490  

Housing completed or under construction

    (122,368 )     (56,087 )

Land and land under development

    (62,746 )     (138,509 )

Prepaid expenses and other assets

    (9,615 )     (7,884 )

Accounts payable and accrued liabilities

    12,097       (30,358 )

Net cash used in operating activities

    (96,272 )     (146,243 )
                 

Investing Activities:

               

Purchases of marketable securities

    (382,279 )     (312,095 )

Maturities of marketable securities

    159,789       87,015  

Sales of marketable securities

    306,769       137,067  

Purchases of property and equipment

    (1,354 )     (998 )

Net cash provided by (used in) investing activities

    82,925       (89,011 )
                 

Financing Activities:

               

Payments on mortgage repurchase facility, net

    (30,876 )     (27,479 )

Proceeds from issuance of senior notes

    248,375       346,938  

Repayment of senior notes

    (259,118 )     -  

Advances on revolving credit facility, net

    10,000       -  

Dividend payments

    (24,412 )     -  

Proceeds from exercise of stock options

    71       5,118  

Net cash provided by (used in) financing activities

    (55,960 )     324,577  
                 

Net increase (decrease) in cash and cash equivalents

    (69,307 )     89,323  

Cash and cash equivalents:

               

Beginning of period

    199,338       160,095  

End of period

  $ 130,031     $ 249,418  

 

The accompanying Notes are an integral part of these Unaudited Consolidated Financial Statements. 

 

 
- 3 -

 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

1.

Basis of Presentation

 

The Unaudited Consolidated Financial Statements of M.D.C. Holdings, Inc. ("MDC," “the Company," “we,” “us,” or “our” which refers to M.D.C. Holdings, Inc. and its subsidiaries) have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Accordingly, they do not include all information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. These statements reflect all normal and recurring adjustments which, in the opinion of management, are necessary to present fairly the financial position, results of operations and cash flows of MDC at June 30, 2014 and for all periods presented. These statements should be read in conjunction with MDC’s Consolidated Financial Statements and Notes thereto included in MDC’s Annual Report on Form 10-K for the year ended December 31, 2013. Certain prior year amounts have been reclassified to conform to the current year’s presentation.

 

2.

Recently Adopted Accounting Standards

 

In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU 2013-11"). This update will require companies to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, unless certain conditions exist. ASU 2013-11 was effective for our interim and annual periods beginning January 1, 2014. The adoption of ASU 2013-11 did not have a material impact on our consolidated financial position or results of operations.

 

3.

Segment Reporting

 

Our operating segments are defined as a component of an enterprise for which discrete financial information is available and is reviewed regularly by the chief operating decision-maker, or decision-making group, to evaluate performance and make operating decisions. We have identified our chief operating decision-maker as two key executives— our Chief Executive Officer and Chief Operating Officer.

 

We have identified each homebuilding division as an operating segment. Our operating segments have been aggregated into the reportable segments noted below because they are similar in the following regards: (1) economic characteristics; (2) housing products; (3) class of homebuyer; (4) regulatory environments; and (5) methods used to construct and sell homes. Our homebuilding reportable segments are as follows:

 

 

West (Arizona, California, Nevada and Washington)

 

Mountain (Colorado and Utah)

 

East (Virginia, Florida and Maryland, which includes Pennsylvania, Delaware and New Jersey)

 

Our financial services business consists of the operations of the following operating segments: (1) HomeAmerican Mortgage Corporation (“HomeAmerican”); (2) Allegiant Insurance Company, Inc., A Risk Retention Group (“Allegiant”); (3) StarAmerican Insurance Ltd. (“StarAmerican”); (4) American Home Insurance Agency, Inc.; and (5) American Home Title and Escrow Company. Due to its contributions to consolidated pretax income we consider HomeAmerican to be a reportable segment (“Mortgage operations”). The remaining operating segments have been aggregated into one reportable segment (“Other”) because they do not individually exceed 10 percent of: (1) consolidated revenue; (2) the greater of (A) the combined reported profit of all operating segments that did not report a loss or (B) the positive value of the combined reported loss of all operating segments that reported losses; or (3) consolidated assets.

 

Corporate is a non-operating segment that develops and implements strategic initiatives and supports our operating divisions by centralizing key administrative functions such as finance and treasury, information technology, insurance and risk management, litigation and human resources. Corporate also provides the necessary administrative functions to support MDC as a publicly traded company. A portion of the expenses incurred by Corporate are allocated to the homebuilding operating segments based on their respective percentages of assets, and to a lesser degree, a portion of Corporate expenses are allocated to the financial services segments. A majority of Corporate’s personnel and resources are primarily dedicated to activities relating to the homebuilding segments, and, therefore, the balance of any unallocated Corporate expenses is included in the homebuilding segment.

 

 
- 4 -

 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

The table set forth below summarizes home sale revenues for our homebuilding operations and revenues for our financial services operations.

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2014

   

2013

   

2014

   

2013

 
   

(Dollars in thousands)

 
Homebuilding                                

West

  $ 189,661     $ 164,514     $ 326,083     $ 299,493  

Mountain

    146,665       133,768       247,610       267,145  

East

    94,935       103,852       176,102       167,244  

Total home and land sale revenues

  $ 431,261     $ 402,134     $ 749,795     $ 733,882  
                                 

Financial Services

                               

Mortgage operations

  $ 7,352     $ 10,494     $ 12,471     $ 19,538  

Other

    4,139       3,390       8,243       6,852  

Total financial services revenues

  $ 11,491     $ 13,884     $ 20,714     $ 26,390  

 

The following table summarizes pretax income for our homebuilding and financial services operations. 

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2014

   

2013

   

2014

   

2013

 
   

(Dollars in thousands)

 
Homebuilding                                

West

  $ 16,695     $ 16,779     $ 29,345     $ 27,390  

Mountain

    12,182       14,142       19,541       27,138  

East

    5,296       4,523       7,957       6,051  

Corporate

    (6,724 )     (5,655 )     (15,841 )     (15,943 )

Total homebuilding pretax income

  $ 27,449     $ 29,789     $ 41,002     $ 44,636  
                                 

Financial Services

                               

Mortgage operations

  $ 4,501     $ 6,855     $ 7,060     $ 12,854  

Other

    2,076       1,368       4,604       3,108  

Total financial services pretax income

  $ 6,577     $ 8,223     $ 11,664     $ 15,962  
                                 

Total pretax income

  $ 34,026     $ 38,012     $ 52,666     $ 60,598  

 

The table set forth below summarizes total assets for our homebuilding and financial services operations. The assets in our West, Mountain and East segments consist primarily of inventory while the assets in our Corporate segment consist primarily of cash and cash equivalents, marketable securities and our deferred tax asset. The assets in our financial services segment consist mostly of cash and cash equivalents, marketable securities and mortgage loans held-for-sale.

 

 
- 5 -

 

  

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

 

   

June 30,

   

December 31,

 
   

2014

   

2013

 

Homebuilding assets

 

(Dollars in thousands)

 

West

  $ 846,832     $ 760,450  

Mountain

    500,365       418,796  

East

    333,174       297,627  

Corporate

    809,298       951,809  

Total homebuilding assets

  $ 2,489,669     $ 2,428,682  
                 

Financial services assets

               

Mortgage operations

  $ 66,206     $ 99,065  

Other

    40,686       67,702  

Total financial services assets

  $ 106,892     $ 166,767  
                 

Total assets

  $ 2,596,561     $ 2,595,449  

 

4.

Earnings Per Share     

 

A company that has participating securities (for example, holders of unvested restricted stock that has nonforfeitable dividend rights) is required to utilize the two-class method to calculate earnings per share (“EPS”) unless the treasury stock method results in lower EPS. The two-class method is an allocation of earnings/(loss) between the holders of common stock and a company’s participating security holders. Under the two-class method, earnings/(loss) for the reporting period are allocated between common shareholders and other security holders based on their respective rights to receive distributed earnings (i.e., dividends) and undistributed earnings (i.e., net income/(loss)). Currently, we have one class of security and we have participating security holders consisting of shareholders of unvested restricted stock. Basic EPS is calculated by dividing income or loss attributable to common stockholders by the weighted average number of shares of common stock outstanding. To calculate diluted EPS, basic EPS is further adjusted to include the effect of potential dilutive stock options outstanding. The following table shows basic and diluted EPS calculations:

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2014

   

2013

   

2014

   

2013

 
   

(Dollars in thousands, except per share amounts)

 

Numerator

                               

Net income

  $ 21,542     $ 224,909     $ 33,046     $ 247,425  

Less: distributed earnings allocated to participating securities

    (49 )     -       (101 )     -  

Less: undistributed earnings allocated to participating securities

    (37 )     (2,069 )     (39 )     (2,310 )

Net income attributable to common stockholders (numerator for basic earnings per share)

    21,456       222,840       32,906       245,115  

Add back: undistributed earnings allocated to participating securities

    37       2,069       39       2,310  

Less: undistributed earnings reallocated to participating securities

    (37 )     (2,049 )     (38 )     (2,286 )

Numerator for diluted earnings per share under two class method

  $ 21,456     $ 222,860     $ 32,907     $ 245,139  
                                 

Denominator

                               

Weighted-average common shares outstanding

    48,640,979       48,478,076       48,613,521       48,410,486  

Add: dilutive effect of stock options

    211,717       467,979       229,006       506,502  

Denominator for diluted earnings per share under two class method

    48,852,696       48,946,055       48,842,527       48,916,988  
                                 

Basic Earnings Per Common Share

  $ 0.44     $ 4.60     $ 0.68     $ 5.06  

Diluted Earnings Per Common Share

  $ 0.44     $ 4.55     $ 0.67     $ 5.01  

 

 
- 6 -

 

  

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

Diluted EPS for the three and six months ended June 30, 2014 excluded options to purchase approximately 4.2 million and 4.0 million shares, respectively, of common stock because the effect of their inclusion would be anti-dilutive. For the same periods in 2013, diluted EPS excluded options to purchase approximately 3.2 million and 3.1 million shares, respectively.

 

5.

Accumulated Other Comprehensive Income

 

The following table sets forth our changes in accumulated other comprehensive income:

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2014

   

2013

   

2014

   

2013

 
   

(Dollars in thousands)

 

Unrealized gains (losses) on available-for-sale marketable securities 1 :

                               

Beginning balance

  $ 3,609     $ 7,373     $ 7,655     $ 4,838  

Other comprehensive income before reclassifications

    1,633       (5,274 )     1,600       (3,053 )

Amounts reclassified from accumulated other comprehensive income 2

    104       (1,215 )     (3,909 )     (901 )

Ending balance

  $ 5,346     $ 884     $ 5,346     $ 884  
                                 

Unrealized gains on available-for-sale metropolitan district bond securities 1 :

                               

Beginning balance

  $ 3,920     $ -     $ 3,920     $ -  

Other comprehensive income before reclassifications

    590       4,494       590       4,494  

Amounts reclassified from accumulated other comprehensive income

    -       -       -       -  

Ending balance

  $ 4,510     $ 4,494     $ 4,510     $ 4,494  
                                 

Total ending accumulated other comprehensive income

  $ 9,856     $ 5,378     $ 9,856     $ 5,378  

 

 

1.

All amounts net-of-tax.

 

2.

See separate table below for details about these reclassifications.

 

The following table sets forth the activity related to reclassifications out of accumulated other comprehensive income (loss) related to available for sale securities:

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 

Affected Line Item in the Statements of Operations

 

2014

   

2013

   

2014

   

2013

 
   

(Dollars in thousands)

 

Homebuilding interest and other income

  $ (176 )   $ 1,166     $ 6,361     $ 871  

Financial services interest and other income

    7       49       (5 )     30  

Income before income taxes

    (169 )     1,215       6,356       901  

Benefit from (provision for) income taxes

    65       -       (2,447 )     -  

Net income

  $ (104 )   $ 1,215     $ 3,909     $ 901  

 

6.

Fair Value Measurements

 

Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements (“ASC 820”), defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.

 

 
- 7 -

 

  

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

The following table sets forth the fair values and methods used for measuring the fair values of financial instruments on a recurring basis:

 

           

Fair Value

 

Financial Instrument

 

Hierarchy

   

June 30, 2014

   

December 31, 2013

 
           

(Dollars in thousands)

 

Marketable securities (available-for-sale)

                       

Equity securities

 

Level 1

    $ 465,115     $ 389,323  

Debt securities - maturity less than 1 year

 

Level 2

      2,079       72,577  

Debt securities - maturity 1 to 5 years

 

Level 2

      21,723       106,566  

Debt securities - maturity greater than 5 years

 

Level 2

      16,971       19,601  

Total available-for-sale securities

          $ 505,888     $ 588,067  
                         

Mortgage loans held-for-sale, net

 

Level 2

    $ 58,377     $ 92,578  
                         

Metropolitan district bond securities (related party) (available-for-sale)

 

Level 3

    $ 14,291     $ 12,729  

 

The following methods and assumptions were used to estimate the fair value of each class of financial instruments.

 

The fair value of our cash and cash equivalents, restricted cash, trade and other receivables, inventories, prepaid and other assets, accounts payable, and accrued liabilities approximate their carrying value.

 

Marketable Securities.  We have marketable debt and equity securities.  Our equity securities consist primarily of holdings in mutual fund securities, which invest mostly in debt securities. The remaining equity securities in our investment portfolio are holdings in corporate equities. Our debt securities consist primarily of fixed and floating rate interest earning debt securities, which may include, among others, United States government and government agency debt and corporate debt. We measure the fair value of our debt securities using a third party pricing service that either provides quoted market prices in active markets for identical or similar securities, which are level 1 inputs, or uses observable inputs for their pricing, which are level 2 inputs. As of June 30, 2014 and December 31, 2013, all of our marketable securities were treated as available-for-sale investments and, as such, we have recorded all of our marketable securities at fair value with changes in fair value being recorded as a component of accumulated other comprehensive income.

 

The following table sets forth the amortized cost and estimated fair value of our available-for-sale marketable securities.

 

   

June 30, 2014

   

December 31, 2013

 
   

Amortized
Cost

   

Fair Value

   

Amortized
Cost

   

Fair Value

 
   

(Dollars in thousands)

 
Homebuilding:                                

Equity securities

  $ 453,152     $ 460,925     $ 375,142     $ 385,303  

Debt securities

    31,051       31,573       181,635       183,718  

Total homebuilding available-for-sale securities

  $ 484,203     $ 492,498     $ 556,777     $ 569,021  
                                 

Financial Services:

                               

Equity securities

  $ 4,000     $ 4,190     $ 4,000     $ 4,020  

Debt securities

    8,950       9,200       14,721       15,026  

Total financial services available-for-sale debt securities

  $ 12,950     $ 13,390     $ 18,721     $ 19,046  
                                 

Total available-for-sale marketable securities

  $ 497,153     $ 505,888     $ 575,498     $ 588,067  

 

As of June 30, 2014 and December 31, 2013, our marketable securities were in net unrealized gain positions totaling $8.7 million and $12.6 million, respectively. Our marketable securities that were in unrealized loss positions aggregated to unrealized losses of $0.7 million and $1.1 million as of June 30, 2014 and December 31, 2013, respectively. The table below sets forth the debt and equity securities that were in an aggregate loss position. We do not believe that the aggregate unrealized loss related to our debt or equity securities as of June 30, 2014 is material to our operations.

 

 
- 8 -

 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

   

June 30, 2014

   

December 31, 2013

 
   

Number of Securities in Loss Position

   

Aggregate Loss Position

   

Aggregate Fair Value of Securities in a Loss Position

   

Number of Securities in Loss Position

   

Aggregate Loss Position

   

Aggregate Fair Value of Securities in a Loss Position

 

Type of Investment

 

(Dollars in thousands)

 

Debt

    40     $ (221 )   $ 12,509       72     $ (430 )   $ 46,440  

Equity

    3       (480 )     108,403       7       (713 )     14,174  

Total

    43     $ (701 )   $ 120,912       79     $ (1,143 )   $ 60,614  

 

The following tables set forth gross realized gains and losses from the sale of available-for-sale marketable securities, which were included in either interest and other income in the homebuilding section or interest and other income in the financial services section of our consolidated statements of operations.

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2014

   

2013

   

2014

   

2013

 
   

(Dollars in thousands)

 

Gross realized gains on sales of available-for-sale securities

                               

Equity securities

  $ -     $ 216     $ 5,518     $ 216  

Debt securities

    100       128       1,920       260  

Total

  $ 100     $ 344     $ 7,438     $ 476  
                                 

Gross realized losses on sales of available-for-sale securities

                               

Equity securities

  $ (467 )   $ -     $ (709 )   $ -  

Debt securities

    (182 )     (1,006 )     (373 )     (1,225 )

Total

  $ (649 )   $ (1,006 )   $ (1,082 )   $ (1,225 )
                                 

Net realized gain (loss) on sales of available-for-sale securities

  $ (549 )   $ (662 )   $ 6,356     $ (749 )

 

Mortgage Loans Held-for-Sale, Net.  As of June 30, 2014, the primary components of our mortgage loans held-for-sale that are measured at fair value on a recurring basis are: (1) mortgage loans held-for-sale under commitments to sell; and (2) mortgage loans held-for-sale not under commitments to sell. At June 30, 2014 and December 31, 2013, we had $48.9 million and $66.1 million, respectively, of mortgage loans held-for-sale under commitments to sell for which fair value was based upon Level 2 inputs, which were the quoted market prices for those mortgage loans. At June 30, 2014 and December 31, 2013, we had $9.5 million and $26.5 million, respectively, of mortgage loans held-for-sale that were not under commitments to sell. The fair value for those loans was primarily based upon the estimated market price received from an outside party, which is a Level 2 fair value input.

 

Metropolitan District Bond Securities (Related Party).  The Metropolitan district bond securities (the “Metro Bonds”) are included in the homebuilding section of our accompanying consolidated balance sheets. We acquired the Metro Bonds from a quasi-municipal corporation in the state of Colorado (the “Metro District”), which was formed to help fund and maintain the infrastructure associated with a master-planned community being developed by our Company. Cash flows received by the Company from these securities reflect principal and interest payments from the Metro District that are supported by an annual levy on the taxable value of real estate and personal property within the Metro District’s boundaries and a one-time fee assessed on permits obtained by MDC in the Metro District. The stated year of maturity for the Metro Bonds is 2037. However, if the unpaid principal and all accrued interest are not paid off by the year 2037, the Company will continue to receive principal and interest payments in perpetuity until the unpaid principal and accrued interest is paid in full. Since 2007 and through the first quarter of 2013, we accounted for these securities under the cost recovery method and they were not carried at fair value in accordance with ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”).

 

 
- 9 -

 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

In the second quarter of 2013, we determined that these securities no longer were required to be accounted for under the cost recovery method due to an increase in the number of new homes delivered in the community coupled with improvements in property values within the Metro District. In accordance with ASC 310-30, we will adjust the bond principal balance on a prospective basis using an interest accretion model that utilizes future cash flows expected to be collected. Furthermore, as this investment is accounted for as an available-for-sale asset, we will update its fair value on a quarterly basis, with the adjustment being recorded through other comprehensive income. The fair value is based upon a discounted future cash flow model, which uses Level 3 inputs. The two primary unobservable inputs used in our discounted cash flow model are the forecasted number of homes to be closed, as they drive any increases to the tax base for the Metro District, and the discount rate. The table below provides quantitative data, as of June 30, 2014, regarding each unobservable input and the sensitivity of fair value to potential changes in those unobservable inputs.

 

    Quantitative Data     Sensitivity Analysis  

Unobservable Input

 

Range

   

Weighted Average

   

Movement in
Fair Value from
Increase in Input

   

Movement in
Fair Value from
Decrease in Input

 

Number of homes closed per year

 

0 to 120

   

93

   

Increase

   

Decrease

 

Discount rate

 

6% to 16%

   

11.9%

   

Decrease

   

Increase

 

 

The table set forth below summarizes the activity for our Metro Bonds:

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2014

   

2013

   

2014

   

2013

 
   

(Dollars in thousands)

 

Balance at beginning of period

  $ 13,027     $ 5,818     $ 12,729     $ 5,818  

Increase in fair value (recorded in other comprehensive income)

    959       7,354       959       7,354  

Change due to accretion of principal

    305       663       603       663  

Cash receipts

    -       -       -       -  

Balance at end of period

  $ 14,291     $ 13,835     $ 14,291     $ 13,835  

 

Mortgage Repurchase Facility. The debt associated with our Mortgage Repurchase Facility is at floating rates or at fixed rates that approximate current market rates and have relatively short-term maturities, generally within 30 days. The fair value approximates carrying value and is based on Level 2 inputs.

 

Senior Notes. The estimated values of the senior notes in the following table are based on Level 2 inputs, including market prices of other homebuilder bonds.

 

   

June 30, 2014

   

December 31, 2013

 
   

Carrying
Amount

   

Fair Value

   

Carrying
Amount

   

Fair Value

 
   

(Dollars in thousands)

 

5⅜% Senior Notes due December 2014, net

  $ -     $ -     $ 249,814     $ 258,750  

5⅜% Senior Notes due July 2015, net

    249,956       259,850       249,935       262,562  

5⅝% Senior Notes due February 2020, net

    246,156       270,938       245,871       259,688  

5½% Senior Notes due January 2024, net

    250,000       258,250       -       -  

6% Senior Notes due January 2043

    350,000       329,613       350,000       305,083  

Total

  $ 1,096,112     $ 1,118,651     $ 1,095,620     $ 1,086,083  

 

 
- 10 -

 

  

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

7.

Inventories

 

The following table sets forth, by reportable segment, information relating to our homebuilding inventories:

 

   

June 30,

   

December 31,

 
   

2014

   

2013

 
   

(Dollars in thousands)

 

Housing Completed or Under Construction:

               

West

  $ 349,850     $ 270,778  

Mountain

    236,784       194,101  

East

    171,758       171,821  

Subtotal

    758,392       636,700  

Land and Land Under Development:

               

West

    458,490       459,512  

Mountain

    244,853       211,526  

East

    134,546       103,923  

Subtotal

    837,889       774,961  

Total Inventories

  $ 1,596,281     $ 1,411,661  

 

Our inventories are primarily associated with communities where we intend to construct and sell homes on the land, including models and unsold started homes. Costs capitalized to land and land under development primarily include: (1) land costs; (2) land development costs; (3) entitlement costs; (4) capitalized interest; (5) engineering fees; and (6) title insurance, real property taxes and closing costs directly related to the purchase of the land parcel. Components of housing completed or under construction primarily include: (1) land costs transferred from land and land under development; (2) direct construction costs associated with a house; (3) real property taxes, engineering fees, permits and other fees; (4) capitalized interest; and (5) indirect construction costs, which include field construction management salaries and benefits, utilities and other construction related costs. Land costs are transferred from land and land under development to housing completed or under construction at the point in time that construction of a home on an owned lot begins.

 

In accordance with ASC 360, Property, Plant, and Equipment (“ASC 360”), homebuilding inventories are carried at cost unless events and circumstances indicate that the carrying value of the underlying subdivision may not be recoverable. We evaluate inventories for impairment at each quarter end on a subdivision level basis as each such subdivision represents the lowest level of identifiable cash flows. In making this determination, we review, among other things, the following for each subdivision:

 

 

actual and trending “Operating Margin” (which is defined as home sale revenues less home cost of sales and all direct incremental costs associated with the home closing, including sales commissions) for homes closed;

 

estimated future undiscounted cash flows and Operating Margin;

 

forecasted Operating Margin for homes in backlog;

 

actual and trending net and gross home orders;

 

base sales price and home sales incentive information for homes closed, homes in backlog and homes available for sale;

 

market information for each sub-market, including competition levels, home foreclosure levels, the size and style of homes currently being offered for sale and lot size; and

 

known or probable events indicating that the carrying value may not be recoverable.

 

If events or circumstances indicate that the carrying value of our inventory may not be recoverable, assets are reviewed for impairment by comparing the undiscounted estimated future cash flows from an individual subdivision to its carrying value. If the undiscounted future cash flows are less than the subdivision’s carrying value, the carrying value of the subdivision is written down to its then estimated fair value. We generally determine the estimated fair value of each subdivision by determining the present value of the estimated future cash flows at discount rates that are commensurate with the risk of the subdivision under evaluation. For the three and six months ended June 30, 2014, we recorded $0.9 million of inventory impairment charges related to two projects in our East segment. No such charges were recorded during the three and six months ended June 30, 2013.

 

 
- 11 -

 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

8.

Capitalization of Interest

 

We capitalize interest to inventories during the period of development in accordance with ASC Topic 835, Interest (“ASC 835”). Homebuilding interest capitalized as a cost of inventories is included in cost of sales as related units or lots are sold. To the extent our homebuilding debt exceeds our qualified assets, as defined in ASC 835, we expense a portion of interest incurred. Qualified homebuilding assets consist of all lots and homes, excluding finished unsold homes or finished models, within projects that are actively selling or under development. The table set forth below summarizes homebuilding interest activity.

 

The homebuilding interest expensed in the table below relates to the portion of interest incurred where our homebuilding debt exceeded our qualified inventory for such periods in accordance with ASC 835.

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2014

   

2013

   

2014

   

2013

 
   

(Dollars in thousands)

 

Homebuilding interest incurred

  $ 16,530     $ 15,345     $ 35,712     $ 29,684  

Less: Interest capitalized

    (16,530 )     (14,436 )     (35,027 )     (27,958 )

Homebuilding interest expensed

  $ -     $ 909     $ 685     $ 1,726  
                                 

Interest capitalized, beginning of period

  $ 80,928     $ 72,791     $ 74,155     $ 69,143  

Interest capitalized during period

    16,530       14,436       35,027       27,958  

Less: Previously capitalized interest included in home cost of sales

    (16,522 )     (12,680 )     (28,246 )     (22,554 )

Interest capitalized, end of period

  $ 80,936     $ 74,547     $ 80,936     $ 74,547  

 

9.

Homebuilding Prepaid Expenses and Other Assets

 

The following table sets forth the components of homebuilding prepaid expenses and other assets.

 

   

June 30,

   

December 31,

 
   

2014

   

2013

 
   

(Dollars in thousands)

 

Land option deposits

  $ 18,907     $ 15,221  

Deferred marketing costs

    23,818       15,830  

Prepaid expenses

    3,648       4,349  

Goodwill

    6,008       6,008  

Deferred debt issuance costs, net

    12,601       11,527  

Other

    392       590  

Total

  $ 65,374     $ 53,525  

 

 
- 12 -

 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

10.

Homebuilding Accrued Liabilities and Financial Services Accounts Payable and Accrued Liabilities

 

The following table sets forth information relating to homebuilding accrued liabilities.

 

   

June 30,

   

December 31,

 
   

2014

   

2013

 
   

(Dollars in thousands)

 

Accrued compensation and related expenses

  $ 20,677     $ 35,990  

Accrued executive deferred compensation

    30,796       30,796  

Accrued interest

    29,953       24,198  

Warranty reserves

    20,178       22,238  

Customer and escrow deposits

    14,685       10,759  

Land development and home construction accruals

    7,875       9,592  

Other accrued liabilities

    21,126       19,248  

Total accrued liabilities

  $ 145,290     $ 152,821  

 

The following table sets forth information relating to financial services accounts payable and accrued liabilities.

 

   

June 30,

   

December 31,

 
   

2014

   

2013

 
   

(Dollars in thousands)

 

Insurance reserves

  $ 49,363     $ 49,637  

Accounts payable and other accrued liabilities

    6,723       6,002  

Total accounts payable and accrued liabilities

  $ 56,086     $ 55,639  

 

11.

Warranty Reserves

 

Our homes are sold with limited third-party warranties. We record accruals for general and structural warranty claims, as well as accruals for known, unusual warranty-related expenditures. Warranty accruals are recorded based upon historical payment experience in an amount estimated to be adequate to cover expected costs of materials and outside labor during warranty periods. The determination of the warranty accrual rate for closed homes and the evaluation of our warranty reserve balance at period end are based on an internally developed analysis that includes known facts and interpretations of circumstances, including, among other things, our trends in historical warranty payment levels and warranty payments for claims not considered to be normal and recurring.

 

Our warranty reserves are included in accrued liabilities in the homebuilding section of our consolidated balance sheets and adjustments to our warranty reserves are recorded as an increase or reduction to home cost of sales in the homebuilding section of our consolidated statements of operations.

 

The table set forth below summarizes accrual, adjustment and payment activity related to our warranty reserve for the three and six months ended June 30, 2014 and 2013. As a result of favorable warranty payment experience relative to our estimates at the time of home closing, we reduced our warranty reserve by $1.3 million and $2.1 million for the three and six months ended June 30, 2014, respectively, compared to no adjustments during the three months ended June 30, 2013 and $0.3 million in adjustments for the six months ended June 30, 2013.

 

The impact of the change in our warranty accrual rates from the three months ended June 30, 2014, as compared to three months ended June 30, 2013, and the six months ended June 30, 2014, as compared to six months ended June 30, 2014, did not materially affect our warranty expense or gross margin from home sales for the three and six months ended June 30, 2014.

 

 
- 13 -

 

  

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2014

   

2013

   

2014

   

2013

 
   

(Dollars in thousands)

 

Balance at beginning of period

  $ 21,447     $ 23,098     $ 22,238     $ 23,151  

Expense provisions

    1,243       1,154       2,157       2,276  

Cash payments

    (1,237 )     (1,527 )     (2,142 )     (3,002 )

Adjustments

    (1,275 )     -       (2,075 )     300  

Balance at end of period

  $ 20,178     $ 22,725     $ 20,178     $ 22,725  

 

12.

Insurance Reserves

 

The establishment of reserves for estimated losses associated with insurance policies issued by Allegiant and re-insurance agreements issued by StarAmerican are based on actuarially developed studies that include known facts and interpretations of circumstances, including our experience with similar cases and historical trends involving claim payment patterns, pending levels of unpaid claims, product mix or concentration, claim severity, frequency patterns depending on the business conducted, and changing regulatory and legal environments.

 

The table set forth below summarizes the insurance reserve activity for the three and six months ended June 30, 2014 and 2013. The insurance reserve is included as a component of accrued liabilities in the financial services section of the accompanying consolidated balance sheets.

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2014

   

2013

   

2014

   

2013

 
   

(Dollars in thousands)

 

Balance at beginning of period

  $ 49,076     $ 48,949     $ 49,637     $ 47,852  

Expense provisions

    1,737       1,775       3,047       3,302  

Cash payments, net of recoveries

    (1,450 )     (2,890 )     (3,321 )     (3,320 )

Balance at end of period

  $ 49,363     $ 47,834     $ 49,363     $ 47,834  

 

In the ordinary course of business, we make payments from our insurance reserves to settle litigation claims arising primarily from our homebuilding activities. These payments are irregular in both their timing and their magnitude. As a result, the cash payments, net of recoveries shown for the three and six months ended June 30, 2014 and 2013 are not necessarily indicative of what future cash payments will be for subsequent periods.

 

13.

Deferred Compensation Retirement Plans

 

Effective August 1, 2008, the Company entered into amended and restated employment agreements (as amended on March 8, 2012, the “Employment Agreements”) with Larry A. Mizel, Chairman of the Board and Chief Executive Officer, and David D. Mandarich, President and Chief Operating Officer (collectively, the “Executive Officers”), which provided certain annual post-retirement pension benefits (the “Retirement Benefits”) depending on the year of retirement. In response to concerns expressed by significant institutional investors, and in accordance with the recommendation of an independent compensation consultant to the Company’s Compensation Committee, the Company announced that it had reached agreements (collectively, the “Second Amendments”) with the Executive Officers for the early termination, effective on October 18, 2013, of the Retirement Benefits contained in their respective Employment Agreements. Pursuant to the Second Amendments, the Company will pay each of Mr. Mizel and Mr. Mandarich a deferred lump sum in the amount of $14.8 million and $16.0 million, respectively, in full satisfaction of their past, present and future Retirement Benefits. The Company’s termination of the Retirement Benefits is irrevocable. These payments, which equal the amounts accrued on the books of the Company as of June 30, 2013 with respect to the Company’s estimated liability to pay Retirement Benefits, will be made to the Executive Officers on October 20, 2014. As a result of the termination of the Retirement Benefits, the Company no longer accrues additional expenses relating to Retirement Benefits.

 

 
- 14 -

 

  

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

14.

Income Taxes

 

At the end of each interim period, we are required to estimate our annual effective tax rate for the fiscal year and use that rate to provide for income taxes for the current year-to-date reporting period. As a result, we recorded income tax expense of $12.5 million and $19.6 million for the three and six months ended June 30, 2014, respectively, compared to a benefit of $186.9 million and $186.8 million for the same respective periods in 2013. Our overall effective income tax rates were 36.7% and 37.3% for the three and six months ended June 30, 2014, respectively, while our effective tax rates for the same periods in 2013 were not meaningful as the income tax benefit was not directly correlated to the amount of pretax income in such periods due to a $187.6 million benefit from the reversal of our deferred tax asset valuation allowance in the 2013 second quarter.

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The tax effects of significant temporary differences that give rise to our net deferred tax asset are as follows:

 

   

June 30,

   

December 31,

 
   

2014

   

2013

 
   

(Dollars in thousands)

 
Deferred tax assets:                

Federal net operating loss carryforwards

  $ 60,887     $ 70,770  

State net operating loss carryforwards

    41,625       40,012  

Alternative minimum tax and other tax credit carryforwards

    24,772       24,196  

Stock-based compensation expense

    25,923       26,651  

Warranty, litigation and other reserves

    14,186       15,543  
Receivables from related party     12,081       12,132  

Deferred compensation retirement plans and accrued compensation

    4,313       11,136  

Asset impairment charges

    4,099       5,496  

Inventory, additional costs capitalized for tax purposes

    1,914       1,700  

Other, net

    4,070       3,446  

Total deferred tax assets

    193,870       211,082  

Valuation allowance

    (14,988 )     (14,669 )

Total deferred tax assets, net of valuation allowance

    178,882       196,413  
                 

Deferred tax liabilities:

               

Property, equipment and other assets

    5,242       5,512  

Discount on notes receivable

    4,204       4,204  

Deferred revenue

    3,715       3,985  

Unrealized gain on marketable securities

    3,388       4,915  

Other, net

    1,461       1,535  

Total deferred tax liabilities

    18,010       20,151  

Net deferred tax asset

  $ 160,872     $ 176,262  

 

 
- 15 -

 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

15.

Senior Notes

 

The following table sets forth the carrying amount of our senior notes as of June 30, 2014 and December 31, 2013, net of applicable discounts:

 

   

June 30,

   

December 31,

 
   

2014

   

2013

 
   

(Dollars in thousands)

 

5⅜% Senior Notes due December 2014, net

  $ -     $ 249,814  

5⅜% Senior Notes due July 2015, net

    249,956       249,935  

5⅝% Senior Notes due February 2020, net

    246,156       245,871  

5½% Senior Notes due January 2024, net

    250,000       -  

6% Senior Notes due January 2043

    350,000       350,000  

Total

  $ 1,096,112     $ 1,095,620  

 

On January 15, 2014, we issued $250 million of 5½% Senior Notes due 2024 (the “5½% Notes”). The 5½% Notes, which pay interest semi-annually in arrears on January 15 and July 15 of each year, with payments commencing July 15, 2014, are general unsecured obligations of MDC and rank equally and ratably with our other general unsecured and unsubordinated indebtedness. We received proceeds of $248.4 million, net of underwriting fees of $1.6 million.

 

During the first quarter 2014, we redeemed our 5% Senior Notes due December 2014.  As a result of this transaction, we paid $259.1 million to extinguish $250 million in debt principal with a carrying value, including unamortized deferred financing costs, of $249.7 million and recorded a $9.4 million expense for loss on extinguishment of debt.

 

Our senior notes are not secured and, while the senior note indentures contain some restrictions on secured debt and other transactions, they do not contain financial covenants. Our senior notes are fully and unconditionally guaranteed on an unsecured basis, jointly and severally, by substantially all of our homebuilding segment subsidiaries.

 

16.

Stock Based Compensation

 

We account for share-based awards in accordance with ASC 718, Compensation-Stock Compensation, which requires the fair value of stock-based compensation awards to be amortized as an expense over the vesting period. Stock-based compensation awards are valued at fair value on the date of grant.

 

During the three and six months ended June 30, 2014, we expensed $0.6 million and $1.2 million, respectively, for stock option grants, compared to $0.8 million and $2.8 million, respectively, during the same periods in 2013. We expensed $0.6 million and $1.3 million for restricted stock awards during the three and six months ended June 30, 2014, respectively, compared to $1.0 million and $2.4 million, respectively, during the same periods in 2013.

 

17.

Commitments and Contingencies

 

Surety Bonds and Letters of Credit. We are required to obtain surety bonds and letters of credit in support of our obligations for land development and subdivision improvements, homeowner association dues, warranty work, contractor license fees and earnest money deposits. At June 30, 2014, we had issued and outstanding surety bonds and letters of credit totaling $116.5 million and $37.2 million, respectively, including $21.2 million in letters of credit issued by HomeAmerican. The estimated cost to complete obligations related to these bonds and letters of credit was approximately $47.1 million and $7.1 million, respectively. The letters of credit as of June 30, 2014, excluding those issued by HomeAmerican, were outstanding under our unsecured revolving credit facility (see Note 19 for further discussion of the revolving credit facility). We expect that the obligations secured by these performance bonds and letters of credit generally will be performed in the ordinary course of business and in accordance with the applicable contractual terms. To the extent that the obligations are performed, the related performance bonds and letters of credit should be released and we should not have any continuing obligations. However, in the event any such performance bonds or letters of credit are called, our indemnity obligations could require us to reimburse the issuer of the performance bond or letter of credit.

 

We have made no material guarantees with respect to third-party obligations.

 

 
- 16 -

 

 

M.D.C. HOLDINGS, INC.

Notes to Unaudited Consolidated Financial Statements

 

Mortgage Loan Loss Reserves. In the normal course of business, we establish reserves for potential losses associated with HomeAmerican’s sale of mortgage loans to third-parties. These reserves are created to address repurchase and indemnity claims by third-party purchasers of the mortgage loans, which claims arise primarily out of allegations of homebuyer fraud at the time of origination of the loan. These reserves are based upon, among other matters: (1) pending claims received from third-party purchasers associated with previously sold mortgage loans; (2) a current assessment of the potential exposure associated with future claims of homebuyer fraud in mortgage loans originated in prior periods; and (3) historical loss experience. In addition to reserves established for mortgage loans previously sold to third-parties, we establish reserves for loans that we have repurchased if we believe the loss is likely and estimable. Our mortgage loan reserves are reflected as a component of accrued liabilities in the financial services section of the accompanying consolidated balance sheets, and the associated expenses are included in expenses in the financial services section of the accompanying consolidated statements of operations.

 

The following table summarizes the mortgage loan loss reserve activity.

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2014

   

2013

   

2014

   

2013

 
   

(Dollars in thousands)

 

Balance at beginning of period

  $ 873     $ 1,140     $ 1,370     $ 976  

Expense provisions

    -       378       -       628  

Cash payments

    -       (70 )     -       (156 )

Adjustments

    (159 )     (98     (656 )     (98 )

Balance at end of period

  $ 714     $ 1,350     $ 714     $ 1,350  

 

Legal Reserves. Because of the nature of the homebuilding business, we have been named as defendants in various claims, complaints and other legal actions arising in the ordinary course of business, including product liability claims and claims associated with the sale and financing of homes. In the opinion of management, the outcome of these ordinary course matters will not have a material adverse effect upon our financial condition, results of operations or cash flows.

 

Lot Option Contracts. In the normal course of business, we enter into lot option purchase contracts (“Option Contracts”), generally through a deposit of cash or a letter of cred