Income Taxes

Valuation Allowance

We review the need to maintain the deferred tax asset valuation allowance on a quarterly basis. We analyze many factors, among which are the severity and frequency of operating losses, our capacity for the carryback or carryforward of any losses, the existence and current level of taxable operating income, operating results on a three year cumulative basis, the expected occurrence of future income or loss, the expiration dates of the loss carryforwards, the cyclical nature of our operating results, and available tax planning strategies. Based on our analysis, we reduced our benefit from income tax through the recognition of a valuation allowance from the first quarter of 2009 through the second quarter of 2015.

In the third quarter of 2015, based on our analysis, as described more fully below, we concluded that it was more likely than not that our deferred tax assets would be fully realizable and that the valuation allowance was no longer necessary. Therefore, we reversed the valuation allowance under the applicable accounting rules for a reversal in an interim period. Specifically, the portion of the valuation allowance release related to the deferred tax asset that is expected to be realized in the current year is included in the computation of the annual estimated effective tax rate. This amount, which totaled $124.4 million and $25.3 million for the first three quarters and the fourth quarter of 2015, respectively, is or will be applied to net income through a reduction of the tax provision. The portion of the valuation allowance release related to deferred tax assets that are expected to be realized in future years, totaling $758.9 million, is treated as a discrete period item and is recognized as a component of the tax provision in continuing operations in the period of the release. Furthermore, in determining the discrete period impact from the release, we removed the prior period disproportionate tax effects that had arisen in other comprehensive income because of the valuation allowance. This reduced the amount of tax benefit included in net income and resulted in an allocation of tax benefit of $60.8 million to components of other comprehensive income.

For each of the three and nine months ended September 30, 2015, the reversal of our valuation allowance against our net deferred tax assets resulted in a $698.1 million benefit in our provision for income taxes. In addition, we reversed $41.2 million and $124.4 million of our valuation allowance and reduced our tax provision on income for the three and nine months ended September 30, 2015, respectively. The change in valuation allowance that was included in other comprehensive income for the three and nine months ended September 30, 2015 was $70.0 million and $54.5 million, respectively. The total valuation allowance as of December 31, 2014 was $902.3 million.

The following table provides a roll forward of our deferred tax asset valuation allowance for the nine months ended September 30, 2015.



	For the nine months ended September 30, 2015 and period then ended
	(In millions)
Beginning Balance December 31, 2014	$	902.3

Reduction in tax provision for the nine months ended September 30, 2015	(124.4		)
Reduction in tax provision allocated to the three months ended December 31, 2015	(25.3		)
Amounts recorded in other comprehensive income for the nine months ended September 30, 2015	6.3
Change in valuation allowance for deferred tax assets in the current year	(143.4		)

Amounts related to the release of the deferred tax asset valuation allowance recorded in the three months ending September 30, 2015
Reduction in tax provision for amounts to be realized in future years	(698.1		)
Amounts recorded in other comprehensive income to be realized in future years	(60.8		)
Change in valuation allowance for deferred tax assets realizable in future years	(758.9		)

Ending Balance September 30, 2015	$	—

In our analysis we evaluated both subjective and objective evidence and assigned a weight to each one. Significant weight was given to our most recent operating results and our ability to sustain them. We have experienced a significant reduction in losses incurred as our level of default notices received and in inventory has declined, as the effects of the financial crisis continue to ebb. New insurance written in recent years has been of high quality and is expected to be profitable well into the future. Historically, the results of mortgage insurers have been cyclical, where periods of operating losses have been followed by significant amounts of income. All of these factors have had a positive effect on operating results. Our level of income for each of the first three quarters of 2015 exceeded $100 million. We viewed the recurring nature of our income as very important, objectively verifiable evidence and gave it great weight in our analysis. Based on the above, we believe that we will have significant sources of income which will allow for utilization of our deferred tax assets.

Generally, a significant component of any analysis for the recognition of deferred tax assets includes the objective observation of operating results for a period of time. In this regard, we considered the level of cumulative operating income, as adjusted for any permanent tax differences. There is no specific requirement that indicates the time span for this evaluation. In our evaluation, we used a three year period, which, based on our investigation, is commonly used by many publicly held entities. Prior to the third quarter of 2015, this three year cumulative total had been materially negative for an extended period of time, which we considered to be objective, negative evidence which would not support the release of the valuation allowance. In the third quarter, this amount became positive and totaled $194.1 million, which we believe provided additional objective evidence which supports the release of the valuation allowance.

In the fourth quarter of 2013, our net operating loss carryforward (“NOL”) for U.S. federal regular income tax purposes reached $2.6 billion, which was the highest amount it attained. As of September 30, 2015, the estimated remaining NOLs total $2.1 billion, a reduction of approximately $500 million in less than two years. At this rate, and without taking into account any improvement in earnings, we would utilize the NOL in approximately seven years. In addition to this history of the utilization of our NOLs, we considered that the amount of income that we have been generating has been increasing over time. In the first three quarters of 2015, we reduced our NOLs by an average of $120.4 million per quarter, whereas in 2014 that amount was $52.2 million per quarter. At the 2015 rate, we would utilize the NOLs on our return by the end of 2020. The earliest current expiration date for our NOLs is 2029. This recent history of positive earnings trends indicates that it is more likely than not that the NOLs would be utilized well before they expire. Further, we currently have no limitations under the change in control provisions of Internal Revenue Code Section 382, which would reduce our ability to utilize our NOLs. We have taken steps, primarily through our Amended and Restated Rights Agreement, to attempt to prevent any change in control which would limit the utilization of our NOLs.

The effect of the change in valuation allowance on the provision for income taxes was as follows:



	Three months ended September 30,						Nine months ended September 30,
	2015			2014			2015			2014
	(In thousands)
Provision for income tax	$	43,694		$	25,030		$	131,568		$	65,322
Change in valuation allowance	(739,298		)	(24,781		)	(822,465		)	(63,229		)

(Benefit from) provision for income taxes	$	(695,604	)	$	249		$	(690,897	)	$	2,093

The change in the valuation allowance that was included in other comprehensive income for the three months ended September 30, 2015 and 2014 was a decrease of $70.0 million and an increase of $6.6 million, respectively. The change in the valuation allowance that was included in other comprehensive income for the nine months ended September 30, 2015 and 2014 was a decrease of $54.5 million and a decrease of $21.3 million, respectively.

We have approximately $2.1 billion of NOL carryforwards on a regular tax basis and $1.2 billion of NOL carryforwards for computing the alternative minimum tax as of September 30, 2015. Any unutilized carryforwards are scheduled to expire at the end of tax years 2029 through 2033. In future years with taxable income and until such time as our NOL carryforwards are exhausted or expired, our provision for income tax would likely exceed the amount of cash tax payments.

Tax Contingencies

As previously disclosed, the Internal Revenue Service (“IRS”) completed examinations of our federal income tax returns for the years 2000 through 2007 and issued proposed assessments for taxes, interest and penalties related to our treatment of the flow-through income and loss from an investment in a portfolio of residual interests of Real Estate Mortgage Investment Conduits (“REMICs”). The IRS indicated that it did not believe that, for various reasons, we had established sufficient tax basis in the REMIC residual interests to deduct the losses from taxable income. We appealed these assessments within the IRS and in August 2010, we reached a tentative settlement agreement with the IRS which was not finalized.

On September 10, 2014, we received Notices of Deficiency (commonly referred to as “90 day letters”) covering the 2000-2007 tax years. The Notices of Deficiency reflect taxes and penalties related to the REMIC matters of $197.5 million and at September 30, 2015, there would also be interest related to these matters of approximately $179.2 million. In 2007, we made a payment of $65.2 million to the United States Department of the Treasury which will reduce any amounts we would ultimately owe. The Notices of Deficiency also reflect additional amounts due of $261.4 million, which are primarily associated with the disallowance of the carryback of the 2009 net operating loss to the 2004-2007 tax years. We believe the IRS included the carryback adjustments as a precaution to keep open the statute of limitations on collection of the tax that was refunded when this loss was carried back, and not because the IRS actually intends to disallow the carryback permanently.

We filed a petition with the U.S. Tax Court contesting most of the IRS' proposed adjustments reflected in the Notices of Deficiency and the IRS has filed an answer to our petition which continues to assert their claim. Litigation to resolve our dispute with the IRS could be lengthy and costly in terms of legal fees and related expenses. We can provide no assurance regarding the outcome of any such litigation or whether a compromised settlement with the IRS will ultimately be reached and finalized. Depending on the outcome of this matter, additional state income taxes and state interest may become due when a final resolution is reached. As of September 30, 2015, those state taxes and interest would approximate $48.4 million. In addition, there could also be state tax penalties. Our total amount of unrecognized tax benefits as of September 30, 2015 is $106.9 million, which represents the tax benefits generated by the REMIC portfolio included in our tax returns that we have not taken benefit for in our financial statements, including any related interest. We continue to believe that our previously recorded tax provisions and liabilities are appropriate. However, we would need to make appropriate adjustments, which could be material, to our tax provision and liabilities if our view of the probability of success in this matter changes, and the ultimate resolution of this matter could have a material negative impact on our effective tax rate, results of operations, cash flows, available assets and statutory capital. In this regard, see Note 1 – “Nature of Business – Capital-GSEs.”

In October 2014, we received a Revenue Agent’s Report from the IRS related to the examination of our federal income tax returns for the years 2011 and 2012. The result of the examination had no material effect on the financial statements.

The total amount of the unrecognized tax benefits, related to our aforementioned REMIC issue that would affect our effective tax rate is $93.7 million. We recognize interest accrued and penalties related to unrecognized tax benefits in income taxes. As of September 30, 2015 and December 31, 2014, we had accrued $27.6 million and $26.9 million, respectively, for the payment of interest.