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Rialto Investments Segment (Rialto Investments [Member])
9 Months Ended
Aug. 31, 2014
Rialto Investments [Member]
 
Segment Reporting Information [Line Items]  
Rialto Investments Segment
Rialto Investments Segment
The assets and liabilities related to the Rialto segment were as follows:
(In thousands)
August 31,
2014
 
November 30,
2013
Assets:
 
 
 
Cash and cash equivalents
$
211,030

 
201,496

Restricted cash (1)
31,636

 
2,593

Receivables, net (2)

 
111,833

Loans receivable, net
174,286

 
278,392

Loans held-for-sale (3)
164,923

 
44,228

Real estate owned - held-for-sale
194,339

 
197,851

Real estate owned - held-and-used, net
335,472

 
428,989

Investments in unconsolidated entities
176,132

 
154,573

Investments held-to-maturity
16,968

 
16,070

Other (4)
78,957

 
43,288

 
$
1,383,743

 
1,479,313

Liabilities:
 
 
 
Notes and other debts payable (5)
$
582,659

 
441,883

Other (6)
76,989

 
55,125

 
$
659,648

 
497,008


(1)
Restricted cash primarily consists of cash held in escrow by the Company's loan servicer provider on behalf of customers and lenders and is disbursed in accordance with agreements between the transacting parties.
(2)
Receivables, net primarily relate to loans sold but not settled as of November 30, 2013.
(3)
Loans held-for-sale relate to unsold loans originated by RMF carried at fair value.
(4)
Other assets include credit default swaps carried at fair value of $1.3 million and $0.8 million as of August 31, 2014 and November 30, 2013, respectively.
(5)
Notes and other debts payable include $352.0 million and $250.0 million related to the 7.00% Senior Notes due 2018 ("7.00% Senior Notes") as of August 31, 2014 and November 30, 2013, respectively, and also include $71.4 million and $76.0 million as of August 31, 2014 and November 30, 2013, respectively, related to the RMF warehouse repurchase financing agreements. As of August 31, 2014, notes and other debts payable also include $55.0 million related to notes issued through a structured note offering.
(6)
Other liabilities include interest rate swaps and swap futures carried at fair value of $1.4 million as of August 31, 2014 and credit default swaps carried at fair value of $1.6 million and $0.3 million as of August 31, 2014 and November 30, 2013, respectively.
Rialto’s operating earnings were as follows:
 
Three Months Ended
 
Nine Months Ended
 
August 31,
 
August 31,
(In thousands)
2014
 
2013
 
2014
 
2013
Revenues
$
40,848

 
27,808

 
142,196

 
79,114

Costs and expenses (1)
47,644

 
34,167

 
174,824

 
94,243

Rialto Investments equity in earnings from unconsolidated entities
19,973

 
5,199

 
43,266

 
15,877

Rialto Investments other income (expense), net
(5,342
)
 
1,837

 
(2,976
)
 
9,810

Operating earnings (2)
$
7,835

 
677

 
7,662

 
10,558

(1)
Costs and expenses for the three and nine months ended August 31, 2014 included loan impairments of $4.2 million and $44.7 million, respectively, primarily associated with the segment's FDIC loans portfolio (before noncontrolling interests). For the three and nine months ended August 31, 2013, costs and expenses included loan impairments of $3.5 million and $14.1 million, respectively, primarily associated with the segment's FDIC loans portfolio (before noncontrolling interests).
(2)
Operating earnings for the three and nine months ended August 31, 2014 included net loss attributable to noncontrolling interests of $4.5 million and $20.7 million, respectively. Operating earnings for the three and nine months ended August 31, 2013 included net earnings (loss) attributable to noncontrolling interests of ($0.8) million and $4.6 million, respectively.
The following is a detail of Rialto Investments other income (expense), net for the periods indicated:
 
Three Months Ended
 
Nine Months Ended
 
August 31,
 
August 31,
(In thousands)
2014
 
2013
 
2014
 
2013
Realized gains on REO sales, net
$
4,106

 
9,651

 
27,849

 
36,857

Unrealized gains (losses) on transfer of loans receivable to REO and impairments, net
(7,165
)
 
(2,373
)
 
(17,816
)
 
(8,683
)
REO and other expenses
(13,027
)
 
(10,267
)
 
(43,977
)
 
(33,171
)
Rental and other income
10,744

 
4,826

 
30,968

 
14,807

Rialto Investments other income (expense), net
$
(5,342
)
 
1,837

 
(2,976
)
 
9,810


Loans Receivable
In February 2010, the Rialto segment acquired indirectly 40% managing member equity interests in two limited liability companies (“LLCs”), in partnership with the FDIC ("FDIC Portfolios"), which retained 60% equity interests in the LLCs, for approximately $243 million (net of transaction costs and a $22 million working capital reserve). If the LLCs exceed expectations and meet certain internal rate of return and distribution thresholds, the Company’s equity interest in the LLCs could be reduced from 40% down to 30%, with a corresponding increase to the FDIC’s equity interest from 60% up to 70%. As these thresholds have not been met, distributions will continue being shared 60%/40% with the FDIC. During the nine months ended August 31, 2014, $146.7 million was distributed by the LLCs. The FDIC was distributed $88.0 million and Rialto, the parent company, was distributed $57.6 million.
The LLCs met the accounting definition of VIEs and since the Company was determined to be the primary beneficiary, the Company consolidated the LLCs. The Company was determined to be the primary beneficiary because it has the power to direct activities of the LLCs that most significantly impact the LLCs' performance through Rialto's management and servicer contracts. At August 31, 2014, these consolidated LLCs had total combined assets and liabilities of $551.2 million and $23.6 million, respectively. At November 30, 2013, these consolidated LLCs had total combined assets and liabilities of $727.1 million and $20.2 million, respectively.
In September 2010, the Rialto segment acquired approximately 400 distressed residential and commercial real estate loans (“Bank Portfolios”) and over 300 REO properties from three financial institutions. The Company paid $310 million for the distressed real estate and real estate related assets of which $124 million was financed through a 5-year senior unsecured note provided by one of the selling institutions. As of both August 31, 2014 and November 30, 2013, there was $90.9 million outstanding related to the 5-year senior unsecured note.
In May 2014, Rialto issued $73.8 million principal amount of notes through a structured note offering (the "Structured Notes") collateralized by certain assets originally acquired in the Bank Portfolios transaction at a price of 100%, with an annual coupon rate of 2.85%. Proceeds from the offering, after payment of expenses and hold backs for a cash reserve, were $69.1 million. The estimated final payment date of the Structured Notes is December 15, 2015. As of August 31, 2014, there was $55.0 million outstanding related to the Structured Notes.
The following table displays the loans receivable by aggregate collateral type:
(In thousands)
August 31,
2014
 
November 30,
2013
Land
$
101,047

 
166,950

Single family homes
28,698

 
59,647

Commercial properties
29,536

 
38,060

Other
15,005

 
13,735

Loans receivable, net
$
174,286

 
278,392


With regard to loans accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, (“ASC 310-30”), the Rialto segment estimated the cash flows, at acquisition, it expected to collect on the FDIC Portfolios and Bank Portfolios. In accordance with ASC 310-30, the difference between the contractually required payments and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. This difference is neither accreted into income nor recorded on the Company’s condensed consolidated balance sheets. The excess of cash flows expected to be collected over the cost of the loans acquired is referred to as the accretable yield and is recognized in interest income over the remaining life of the loans using the effective yield method.
The Rialto segment periodically evaluates its estimate of cash flows expected to be collected on its FDIC Portfolios and Bank Portfolios. These evaluations require the continued use of key assumptions and estimates, similar to those used in the initial estimate of fair value of the loans to allocate purchase price. Subsequent changes in the estimated cash flows expected to be collected may result in changes in the accretable yield and nonaccretable difference or reclassifications from nonaccretable yield to accretable yield. Increases in the cash flows expected to be collected will generally result in an increase in interest income over the remaining life of the loan or pool of loans. Decreases in expected cash flows due to further credit deterioration will generally result in an impairment charge recognized as a provision for loan losses, resulting in an increase to the allowance for loan losses but can be reversed if conditions improve.
The outstanding balance and carrying value of loans accounted for under ASC 310-30 were as follows:
(In thousands)
August 31,
2014
 
November 30,
2013
Outstanding principal balance
$
438,046

 
586,901

Carrying value
$
169,636

 
270,075


The activity in the accretable yield for the FDIC Portfolios and Bank Portfolios during the nine months ended August 31, 2014 and 2013 was as follows:
 
August 31,
(In thousands)
2014
 
2013
Accretable yield, beginning of period
$
73,144

 
112,899

Additions
8,785

 
53,652

Deletions
(25,621
)
 
(38,263
)
Accretions
(25,693
)
 
(38,455
)
Accretable yield, end of period
$
30,615

 
89,833


Additions primarily represent reclasses from nonaccretable yield to accretable yield on the portfolios. Deletions represent loan impairments, net of recoveries, and disposal of loans, which includes foreclosure of underlying collateral and result in the removal of the loans from the accretable yield portfolios.
When forecasted principal and interest cannot be reasonably estimated at the loan acquisition date, management classifies the loan as nonaccrual and accounts for these assets in accordance with ASC 310-10, Receivables (“ASC 310-10”). When a loan is classified as nonaccrual, any subsequent cash receipt is accounted for using the cost recovery method. In accordance with ASC 310-10, a loan is considered impaired when based on current information and events it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. Although these loans met the definition of ASC 310-10, these loans were not considered impaired relative to the Company’s recorded investment at the time of acquisition since they were acquired at a substantial discount to their unpaid principal balance. A provision for loan losses is recognized when the recorded investment in the loan is in excess of its fair value. The fair value of the loan is determined by using either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral less estimated costs to sell.
The following tables represent nonaccrual loans in the FDIC Portfolios and Bank Portfolios accounted for under ASC 310-10 aggregated by collateral type:
August 31, 2014
 
 
 
Recorded Investment
 
 
(In thousands)
Unpaid
Principal Balance
 
With
Allowance
 
Without
Allowance
 
Total  Recorded
Investment
Land
$
4,607

 

 
1,813

 
1,813

Single family homes
8,739

 
502

 
1,732

 
2,234

Commercial properties
1,500

 

 
603

 
603

Loans receivable
$
14,846

 
502

 
4,148

 
4,650

November 30, 2013
 
 
 
Recorded Investment
 
 
(In thousands)
Unpaid
Principal  Balance
 
With
Allowance
 
Without
Allowance
 
Total  Recorded
Investment
Land
$
6,791

 
249

 
2,304

 
2,553

Single family homes
15,125

 
519

 
4,119

 
4,638

Commercial properties
3,400

 
498

 
628

 
1,126

Loans receivable
$
25,316

 
1,266

 
7,051

 
8,317

The average recorded investment in impaired loans totaled approximately $6 million and $29 million for the nine months ended August 31, 2014 and 2013, respectively.
The loans receivable portfolios consist of loans acquired at a discount. Based on the nature of these loans, the portfolios are managed by assessing the risks related to the likelihood of collection of payments from borrowers and guarantors, as well as monitoring the value of the underlying collateral. The following are the risk categories for the loans receivable portfolios:
Accrual — Loans in which forecasted cash flows under the loan agreement, as it might be modified from time to time, can be reasonably estimated at the date of acquisition. The risk associated with loans in this category relates to the possible default by the borrower with respect to principal and interest payments and the possible decline in value of the underlying collateral and thus, both could cause a decline in the forecasted cash flows used to determine accretable yield income and the recognition of an impairment through an allowance for loan losses but can be reversed if conditions improve. The activity in the Company's allowance rollforward related to accrual loans was as follows:
 
Three Months Ended
 
Nine Months Ended
 
August 31,
 
August 31,
(In thousands)
2014
 
2013
 
2014
 
2013
Allowance on accrual loans, beginning of period
$
55,658

 
18,716

 
18,952

 
12,178

Provision for loan losses, net of recoveries
4,089

 
3,318

 
44,577

 
12,849

Charge-offs
(6,482
)
 
(1,940
)
 
(10,264
)
 
(4,933
)
Allowance on accrual loans, end of period
$
53,265

 
20,094

 
53,265

 
20,094


Nonaccrual — Loans in which forecasted principal and interest could not be reasonably estimated at the date of acquisition. The risk of nonaccrual loans relates to a decline in the value of the collateral securing the outstanding obligation and the recognition of an impairment through an allowance for loan losses if the recorded investment in the loan exceeds the fair value of the collateral less estimated cost to sell. As of August 31, 2014 and November 30, 2013, the Company had an allowance on these loans of $0.3 million and $1.2 million, respectively.
Accrual and nonaccrual loans receivable by risk categories were as follows:
August 31, 2014
(In thousands)
Accrual
 
Nonaccrual
 
Total
Land
$
99,234

 
1,813

 
101,047

Single family homes
26,464

 
2,234

 
28,698

Commercial properties
28,933

 
603

 
29,536

Other
15,005

 

 
15,005

Loans receivable
$
169,636

 
4,650

 
174,286

November 30, 2013
(In thousands)
Accrual
 
Nonaccrual
 
Total
Land
$
164,397

 
2,553

 
166,950

Single family homes
55,009

 
4,638

 
59,647

Commercial properties
36,934

 
1,126

 
38,060

Other
13,735

 

 
13,735

Loans receivable
$
270,075

 
8,317

 
278,392


In order to assess the risk associated with each risk category, the Rialto segment evaluates the forecasted cash flows and the value of the underlying collateral securing loans receivable on a quarterly basis or when an event occurs that suggests a decline in the collateral’s fair value.
Real Estate Owned
The acquisition of properties acquired through, or in lieu of, loan foreclosure are reported within the condensed consolidated balance sheets as REO held-and-used, net and REO held-for-sale. When a property is determined to be held-and-used, net, the asset is recorded at fair value and depreciated over its useful life using the straight line method. When certain criteria set forth in ASC 360, Property, Plant and Equipment, are met, the property is classified as held-for-sale. When a real estate asset is classified as held-for-sale, the property is recorded at the lower of its cost basis or fair value less estimated costs to sell. The fair value of REO held-for-sale are determined in part by placing reliance on third party appraisals of the properties and/or internally prepared analyses of recent offers or prices on comparable properties in the proximate vicinity.
The following tables represent the activity in REO:
 
Three Months Ended
 
Nine Months Ended
 
August 31,
 
August 31,
(In thousands)
2014

 
2013
 
2014

 
2013
REO - held-for-sale, beginning of period
$
192,829

 
204,385

 
197,851

 
134,161

Additions

 
14,833

 

 
16,166

Improvements
1,994

 
1,949

 
4,717

 
4,466

Sales
(52,431
)
 
(68,087
)
 
(141,097
)
 
(145,363
)
Impairments and unrealized losses
(6,087
)
 
(169
)
 
(8,910
)
 
(4,353
)
Transfers to Lennar Homebuilding

 
(430
)
 

 
(430
)
Transfers from held-and-used, net (1)
58,034

 
46,128

 
141,778

 
193,962

REO - held-for-sale, end of period
$
194,339

 
198,609

 
194,339

 
198,609

 
Three Months Ended
 
Nine Months Ended
 
August 31,
 
August 31,
(In thousands)
2014
 
2013
 
2014
 
2013
REO - held-and-used, net, beginning of period
$
379,069

 
478,314

 
428,989

 
601,022

Additions
14,530

 
14,154

 
48,657

 
38,882

Improvements
1,736

 
517

 
5,207

 
3,396

Impairments
(1,333
)
 
(5,126
)
 
(2,836
)
 
(5,529
)
Depreciation
(496
)
 
(1,075
)
 
(2,767
)
 
(3,153
)
Transfers to held-for-sale (1)
(58,034
)
 
(46,128
)
 
(141,778
)
 
(193,962
)
REO - held-and-used, net, end of period
$
335,472

 
440,656

 
335,472

 
440,656

(1)
During the three and nine months ended August 31, 2014 and 2013, the Rialto segment transferred certain properties from REO held-and-used, net to REO held-for-sale as a result of changes in the disposition strategy of the real estate assets.
For the three and nine months ended August 31, 2014, the Company recorded net losses of $0.2 million and $7.3 million, respectively, from acquisitions of REO through foreclosure. For the three and nine months ended August 31, 2013, the Company recorded net gains of $2.9 million and $1.2 million, respectively, from acquisitions of REO through foreclosure. These net gains (losses) are recorded in Rialto Investments other income (expense), net.
Rialto Mortgage Finance
In July 2013, RMF was formed to originate and sell into securitizations five, seven and ten year commercial first mortgage loans, generally with principal amounts between $2 million and $75 million, which are secured by income producing properties. During the nine months ended August 31, 2014, RMF originated loans with a total principal balance of $1.1 billion and sold $983.6 million of loans into five separate securitizations. As of August 31, 2014 and November 30, 2013, RMF had two warehouse repurchase financing agreements that mature in fiscal year 2015 with commitments totaling $650 million to help finance the loans it makes. Borrowings under these facilities were $71.4 million and $76.0 million as of August 31, 2014 and November 30, 2013, respectively.
In November 2013, the Rialto segment issued $250 million aggregate principal amount of the 7.00% senior notes due 2018 ("7.00% Senior Notes"), at a price of 100% in a private placement. Proceeds from the offering, after payment of expenses, were approximately $245 million. Rialto used a majority of the net proceeds of the sale of the 7.00% Senior Notes as working capital for RMF and used $100 million to repay sums that had been advanced to RMF from Lennar to enable it to begin originating and securitizing commercial mortgage loans. In March 2014, the Rialto segment issued an additional $100 million of the 7.00% Senior Notes, at a price of 102.25% of their face value in a private offering with no registration rights. Proceeds from the offering, after payment of expenses, were approximately $102 million. Rialto used the net proceeds of the offering to provide additional working capital for RMF, and to make investments in the funds that Rialto manages, as well as for general corporate purposes. Interest on the 7.00% Senior Notes is due semi-annually with the first interest payment made on June 1, 2014. At August 31, 2014 and November 30, 2013, the carrying amount of the 7.00% Senior Notes was $352.0 million and $250.0 million, respectively. Under the indenture, Rialto is subject to certain covenants limiting, among other things, Rialto’s ability to incur indebtedness, to make investments, to make distributions to, or enter into transactions with, Lennar or to create liens, subject to certain exceptions and qualifications. Rialto also has quarterly and annual reporting requirements, similar to an SEC registrant, to holders of the 7.00% Senior Notes. The Company believes it was in compliance with its debt covenants at August 31, 2014.
Investments
All of Rialto's investments in funds have the attributes of an investment company in accordance with ASC 946, Financial Services – Investment Companies, as amended by ASU 2013-08, Financial Services - Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements, the attributes of which are different from the attributes that would cause a company to be an investment company for purposes of the Investment Company Act of 1940. As a result, the assets and liabilities of Rialto's investments are recorded at fair value with increases/decreases in fair value recorded in their respective statements of operations and the Company’s share is recorded in Rialto Investments equity in earnings from unconsolidated entities in the Company's statement of operations.
The following table reflects Rialto's investments in funds that invest in and manage real estate related assets and other investments:
 
 
 
 
 
 
 
 
 
August 31,
2014
 
August 31,
2014
 
November 30,
2013
(Dollars in thousands)
Inception Year
 
Equity Commitments
 
Equity Commitments Called
 
Commitment to fund by the Company
 
Funds contributed by the Company
 
Investment
Rialto Real Estate Fund, LP
2010
 
$
700,006

 
$
700,006

 
$
75,000

 
$
75,000

 
$
80,741

 
75,729

Rialto Real Estate Fund II, LP
2012
 
1,305,000

 
660,058

 
100,000

 
50,579

 
57,528

 
53,103

Rialto Mezzanine Partners Fund
2013
 
168,600

 
145,267

 
27,299

 
23,521

 
23,397

 
16,724

Other investments
 
 
 
 
 
 
 
 
 
 
14,466

 
9,017

 
 
 
 
 
 
 
 
 
 
 
$
176,132

 
154,573


Rialto's share of earnings from unconsolidated entities was as follows:
 
Three Months Ended
 
Nine Months Ended
 
August 31,
 
August 31,
(In thousands)
2014
 
2013
 
2014
 
2013
Rialto Real Estate Fund, LP
$
10,291

 
3,685

 
22,524

 
14,827

Rialto Real Estate Fund II, LP
7,084

 
1,366

 
9,524

 
912

Rialto Mezzanine Partners Fund
591

 

 
1,373

 

Other investments
2,007

 
148

 
9,845

 
138

Rialto Investments equity in earnings from unconsolidated entities
$
19,973

 
5,199

 
43,266

 
15,877


Summarized condensed financial information on a combined 100% basis related to Rialto’s investments in unconsolidated entities that are accounted for by the equity method was as follows:
Balance Sheets
(In thousands)
August 31,
2014
 
November 30,
2013
Assets:
 
 
 
Cash and cash equivalents
$
200,878

 
332,968

Loans receivable
528,456

 
523,249

Real estate owned
388,284

 
285,565

Investment securities
611,381

 
381,555

Investments in partnerships
269,923

 
149,350

Other assets
37,315

 
191,624

 
$
2,036,237

 
1,864,311

Liabilities and equity:
 
 
 
Accounts payable and other liabilities
$
25,882

 
108,514

Notes payable
315,985

 
398,445

Partner loans

 
163,940

Equity
1,694,370

 
1,193,412

 
$
2,036,237

 
1,864,311


Statements of Operations
 
Three Months Ended
 
Nine Months Ended
 
August 31,
 
August 31,
(In thousands)
2014
 
2013
 
2014
 
2013
Revenues
$
39,401

 
69,856

 
104,005

 
189,155

Costs and expenses
22,552

 
65,357

 
71,965

 
190,066

Other income, net (1)
181,877

 
34,186

 
334,915

 
128,973

Net earnings of unconsolidated entities
$
198,726

 
38,685

 
366,955

 
128,062

Rialto Investments equity in earnings from unconsolidated entities
$
19,973

 
5,199

 
43,266

 
15,877


(1)
Other income, net, for the three and nine months ended August 31, 2014 and 2013 included Rialto Real Estate Fund, LP, Rialto Real Estate Fund II, LP and other investments realized and unrealized gains on investments.
In 2010, the Rialto segment invested in non-investment grade commercial mortgage-backed securities (“CMBS”) at a 55% discount to par value. The carrying value of the investment securities at August 31, 2014 and November 30, 2013 was $17.0 million and $16.1 million, respectively. These securities bear interest at a coupon rate of 4% and have a stated and assumed final distribution date of November 2020 and a stated maturity date of October 2057. The Rialto segment reviews changes in estimated cash flows periodically to determine if other-than-temporary impairment has occurred on its investment securities. Based on the Rialto segment’s assessment, no impairment charges were recorded during both the three and nine months ended August 31, 2014 and 2013. The Rialto segment classified these securities as held-to-maturity based on its intent and ability to hold the securities until maturity.
In January 2014, Rialto acquired 100% of the loan servicing business segment of a financial services company (the "Servicer Provider") in which a subsidiary of Rialto had an approximately 5% investment, in exchange for its investment interest. The Servicer Provider has a business segment that provides service and infrastructure to the residential home loan market, which provides loan servicing support for all of the Company's owned and managed portfolios and asset management services for Rialto's small balance loan program. At acquisition date, the fair value of the assets acquired was $20.8 million, the goodwill recorded was $5.1 million and the fair value of the liabilities assumed was $17.6 million. As of November 30, 2013, the carrying value of the Company’s investment in the Servicer Provider was $8.3 million.