As reported by NMIC under the PMIERs financial requirements, which took effect as of December 31, 2015.
The following analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and notes thereto included below in Item 8 of this report and the Risk Factors included above in Item 1A of this report. In addition, investors should review the "Cautionary Note Regarding Forward Looking Statements" above.
We provide private MI through our wholly owned insurance subsidiaries NMIC and Re One. NMIC and Re One are domiciled in Wisconsin and principally regulated by the Wisconsin OCI. NMIC is our primary insurance subsidiary, and is approved as an MI provider by the GSEs and is licensed to write coverage in all 50 states and D.C. Re One provides reinsurance to NMIC on insured loans with coverage levels in excess of 25% after giving effect to third-party reinsurance. Our subsidiary, NMIS, provides outsourced loan review services to mortgage loan originators.
We discuss below our results of operations for the periods presented, as well as the conditions and trends that have impacted or are expected to impact our business and results, including customer development, new insurance writings, the composition of our insurance portfolio, reinsurance among other factors.
Premiums are paid either by the borrower (BPMI) or the lender (LPMI) in a single payment at origination (single premium), on a monthly installment basis (monthly premium) or on an annual installment basis (annual premium). Our net premiums written will differ from our net premiums earned due to policy payment type. For single premiums, we receive a single premium payment at origination, which is earned over the estimated life of the policy. A majority of our single premium policies in force as of December
For the year ended December 31, 2018, monthly premium polices accounted for 88% of our NIW, compared to 81% and 67% for the years ended December 31, 2017 and 2016, respectively. As of December 31, 2018, monthly premium policies accounted for 75% of our primary IIF, compared to 69% at December 31, 2017 and 60% at December 31, 2016. We expect the break-down of monthly premium policies and single premium policies (which we refer to as "mix") in our primary IIF to continue to trend toward an increased monthly mix over time given the composition of our NIW. Our total IIF at December 31, 2018 increased 38% compared to December 31, 2017, which in turn increased 44% compared to December 31, 2016, primarily due to NIW generated between such measurement dates and the persistency of in force policies.
For the year ended December 31, 2017, net premiums written and earned increased 29% and 50%, respectively, compared to the year ended December 31, 2016. The increase in net premiums written is due to the growth of our IIF and increased monthly policy production, partially offset by a decrease in single premium NIW. The increase in net premiums earned is due to the growth of our IIF and increased monthly policy production, partially offset by decreases in our single premium NIW and earnings from cancellations, and the impact of cessions under the 2017 ILN transaction and 2016 QSR Transaction.
Pool premiums written and earned for the years ended December 31, 2018, 2017 and 2016, were $3.4 million, $3.8 million and $4.4 million, respectively, before giving effect to the 2016 QSR Transaction, under which all of our written and earned pool premiums have been ceded. A portion of our ceded pool premiums written and earned are recouped through profit commission under the 2016 QSR Transaction.
LTV ratios, with higher average LTV ratios tending to increase claims incurred;
Reserves for claims and allocated claims expenses are established for reported mortgage loan defaults, which we refer to as case reserves, when we are notified that a borrower has missed two or more mortgage payments (i.e., an NOD). We also make estimates of IBNR defaults, which are defaults that have been incurred but have not been reported by loan servicers, based on historical reporting trends, and establish IBNR reserves for those estimates. We also establish reserves for unallocated claims expenses not associated with a specific claim. The claims expenses consist of the estimated cost of the claim administration process, including legal and other fees, as well as other general expenses of administering the claims settlement process
Reserves are established by estimating the number of loans in default that will result in a claim payment, which is referred to as claim frequency, and the amount of the claim payment expected to be paid on each such loan in default, which is referred to as claim severity. Claim frequency and severity estimates are established based on historical observed experience regarding certain loan factors, such as age of the default, cure rates, size of the loan and estimated change in property value. Reserves are released the month in which a loan in default is brought current by the borrower, which is referred to as a cure. Adjustments to reserve estimates are reflected in the period in which the adjustment is made. Reserves are also ceded to reinsurers under the QSR Transactions. We will not cede claims to reinsurers under the ILN Transactions unless losses exceed the respective retained coverage layers. Reserves are not established for future claims on insured loans which are not currently in default.
We insure mortgages for homes in areas that have been impacted by recent natural disasters. We do not provide coverage for property or casualty claims related to physical damage of a home underpinning an insured mortgage. We experienced an increase in NODs on insured loans in areas impacted by such disasters in the fourth quarter of 2017, the first quarter of 2018 and the fourth quarter of 2018. Our ultimate claims exposure for loans in areas impacted by natural disasters will depend on the number of NODs received, proximate cause of each default, cure rate of the NOD population, and potential repair cost curtailment for appropriate claims on damaged properties as permitted under our Master Policy. Cure rates on loan defaults following natural disasters are influenced by the adequacy of homeowners and other hazard insurance carried on a related property, GSE-sponsored forbearance and other assistance programs, and a borrower's access to aid from government entities and private organizations, in addition to other factors which generally impact cure rates in unaffected areas. In 2018, we experienced higher cure rates on our NOD population in disaster-affected areas as compared to our NOD population in unaffected areas.
Related to ceded losses recoverable on the QSR Transactions, included in "Other Assets" on the Consolidated Balance Sheets. See Item 8, "Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 6, Reinsurance," for additional information.
Related to insured loans with their most recent defaults occurring in the current year. For example, if a loan had defaulted in a prior year and subsequently cured and later re-defaulted in the current year, that default would be included in the current year. Amounts are presented net of reinsurance.
Related to insured loans with defaults occurring in prior years, which have been continuously in default since that time. Amounts are presented net of reinsurance.
The "claims incurred" section of the table above shows claims and claim expenses incurred on NODs for current and prior years, including IBNR reserves and is presented net of reinsurance. The amount of claims incurred for current year NODs represents the estimated amount to be ultimately paid on such loans in default. The decreases during the periods presented in reserves held for prior year defaults represent favorable development and are generally the result of NOD cures and ongoing analysis of recent loss development trends. We may increase or decrease our original estimates as we gather additional information about individual defaults and claims, and continue to observe and analyze loss development trends in our portfolio. Gross reserves of $2.7 million related to prior year defaults remained as of December 31, 2018.
The following table provides details of our claims paid, before giving effect to claims ceded under the 2016 QSR Transaction, for the periods indicated. We did not cede any claims paid under the 2018 QSR Transaction during the periods indicated.
Severity represents the total amount of claims paid including claims expenses divided by the related RIF on the loan at the time the claim is perfected, and is calculated including claims settled without payment.
The increase in the number of claims paid for the year ended December 31, 2018 compared to the years ended December 31, 2017 and 2016, was due to the continued growth and seasoning of our insured portfolio. Over time, we expect the severity of claims paid to be between 85% and 95% of the coverage amount.
By April 15th of each year, NMIC must certify it met all PMIERs requirements as of December 31st of the prior year. We certified to the GSEs by April 15, 2018 that NMIC was in full compliance with the PMIERs as of December 31, 2017. NMIC also has an ongoing obligation to immediately notify the GSEs in writing upon discovery of a failure to meet one or more of the PMIERs requirements. We continuously monitor NMIC’s compliance with the PMIERs.
information security incidents, including breaches of our IT systems. Despite these safeguards, disruptions to and breaches of our IT systems are possible and may negatively impact our business.
The private MI industry overall competes more broadly with government MIs who significantly increased their presence in the MI market following the financial crisis. Although there has been broad policy consensus toward the need for private capital to play a larger role and government credit risk to be reduced in the U.S. housing finance system, it remains difficult to predict whether the combined market share of government MIs will recede to historical levels. A range of factors influence a lender's decision to choose private over government MI, including among others, premium rates and other charges, loan eligibility requirements, cancelability, loan size limits and the relative ease of use of private MI products compared to government MI alternatives.
Loss ratio is calculated by dividing the provision for insurance claims and claims expenses by net premiums earned.
We recognize insurance claims and claims expenses in connection with the loss experience of our insured portfolio and incur other underwriting and operating expenses, including employee compensation and benefits, policy acquisition costs, and technology, professional services and facilities expenses, in connection with the development and operation of our business.
Income tax expense was $28.0 million for the year ended December 31, 2018 compared to income tax expense of $30.7 million for the year ended December 31, 2017 and income tax benefit of $52.5 million for the year ended December 31, 2016. The decrease in income tax expense for the year ended December 31, 2018 relates to the TCJA. The TCJA, which took effect on December 22, 2017, lowered the statutory U.S. federal corporate income tax rate to 21% from 35%. As a U.S. taxpayer, our 2018 income tax expense benefited from the 21% federal corporate income tax rate as compared to the 35% rate applicable for all prior years through December 31, 2017. Additionally, our 2017 tax expense reflects a $13.6 million one-time non-cash charge related to the re-measurement of net deferred tax assets in connection with the enactment of the TCJA. For the year ended December 31, 2016, we recorded a one-time non-cash benefit of $58.5 million related to the release of the valuation allowance recorded against our federal and certain state net deferred tax assets. For further information regarding income taxes and their impact on our results of operations and financial position, see Item 8, "Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 11, Income Taxes."
Net income was $107.9 million for the year ended December 31, 2018, compared to $22.1 million and $64.0 million for the years ended December 31, 2017 and 2016, respectively. The increase in net income in 2018 compared to 2017 primarily relates to growth in total revenues, partially offset by an increase in total expenses. The decline in net income in 2017 compared to 2016 primarily relates to one-time non-cash tax items that impacted each period. 2017 net income reflects a $13.6 million one-time non-cash tax charge, compared to a $58.5 million one-time non-cash benefit realized in 2016. Partially offsetting the tax impact was growth in total revenues in 2017.
Net deferred policy acquisition costs (DAC) were $46.8 million as of December 31, 2018, compared to $37.9 million as of December 31, 2017. The increase was primarily driven by growth in the number of policies written during the year ended December 31, 2018 and the deferral of certain costs associated with the origination of those policies, partially offset by the amortization of previously deferred acquisition costs.
Prepaid reinsurance premiums were $30.4 million as of December 31, 2018, compared to $40.3 million as of December 31, 2017. Prepaid reinsurance premiums represent the unearned premiums reserve on single premium policies ceded under the 2016 QSR Transaction. The reinsurance coverage period of the 2016 QSR Transaction ended for new business written after December 31, 2017 and the coverage period for the 2018 QSR Transaction began for new business written on or after January 1, 2018. Under the 2018 QSR Transaction we cede premiums on singles policies on an earned basis, and consequently, we did not cede any unearned premiums reserve on singles policies in 2018. The decrease in prepaid reinsurance premiums reflects the amortization of the unearned premiums reserve on singles policies previously ceded under the 2016 QSR Transaction.
Warrant liability decreased to $7.3 million at December 31, 2018, compared to $7.5 million at December 31, 2017 primarily due to exercises of outstanding warrants. This was partially offset by an increase in fair value of the warrant liability due to an increase in our stock price in 2018 and changes in the Black-Scholes model inputs. For further information regarding the valuation of our warrant liability and its impact on our results of operations and financial position, see Item 8, "Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 4, Fair Value of Financial Instruments."
Net cash provided by operating activities was $145.9 million for the year ended December 31, 2018, compared to $67.8 million for the year ended December 31, 2017, and $71.9 million for the year ended December 31, 2016. The increase in cash generated from operating activities in 2018 compared to 2017 was primarily driven by growth in premiums written and investment income, partially offset by an increase in operating expenses and growth in claims paid tied to the growth and aging of our insured portfolio. The decrease in cash generated from operating activities in 2017 compared to 2016 was primarily caused by increased operating expenses in connection with employee compensation and benefits costs and higher claims paid, offset by growth in premiums written.
Cash used in investing activities for the periods presented was driven by the purchase of fixed and short-term maturities during those periods. Cash used in investing activities during 2018, reflects, in part, the investment of net proceeds raised in the common stock offering we completed in March 2018.
Cash provided by financing activities was $80.9 million for the year ended December 31, 2018 and relates to the $79.2 million of net cash proceeds raised in the common stock offering we completed in March 2018, as well as additional cash received in connection with the exercise of vested stock options and warrants, partially offset by net cash paid in connection with the extinguishment of the 2015 Term Loan and establishment of the 2018 Term Loan and 2018 Revolving Credit Facility. Cash used in financing activities was $3.2 million and $1.7 million for the years ended December 31, 2017 and 2016, respectively, and primarily relates to taxes paid on the net share settlement of equity awards for certain employees.
NMIH serves as the holding company for our insurance subsidiaries and does not have any significant operations of its own. NMIH's principal liquidity demands include funds for: (i) payment of certain corporate expenses; (ii) payment of certain reimbursable expenses of its insurance subsidiaries; (iii) payment of principal and interest related to the 2018 Term Loan and 2018 Revolving Credit Facility; (iv) tax payments to the Internal Revenue Service; (v) capital support for its subsidiaries; and (vi) payment of dividends, if any, on its common stock. NMIH is not subject to any limitations on its ability to pay dividends except those generally applicable to corporations that are incorporated in Delaware. Delaware law provides that dividends are only payable out of a corporation's surplus or recent net profits (subject to certain limitations).
As of December 31, 2018, NMIH had $64.3 million of cash and investments. NMIH's principal source of net cash is investment income. NMIH also has access to $85 million of undrawn revolving credit capacity under the 2018 Revolving Credit Facility and $2.7 million of ordinary course dividend capacity from Re One. In the future, NMIH could benefit from dividend capacity from NMIC, as available and permitted under law and by the GSEs.
In May 2018, NMIH entered into the 2018 Credit Agreement covering the 2018 Term Loan and 2018 Revolving Credit Facility. The 2018 Term Loan bears interest at the Eurodollar Rate, as defined in the 2018 Credit Agreement and subject to a 1.00% floor, plus an annual margin rate of 4.75%, payable monthly based on our current interest period election. Borrowings under the 2018 Revolving Credit Facility will accrue interest at a variable rate equal to, at our discretion, (i) a base rate (as defined in the 2018 Credit Agreement, subject to a floor of 1.00% per annum) plus a margin of 1.00% to 2.50% per annum, based on the applicable corporate credit rating at the time, or (ii) the Eurodollar Rate (subject to a floor of 0.00% per annum) plus a margin of 2.00% to 3.50% per annum, based on the applicable corporate credit rating at the time. The 2018 Revolving Credit Facility also requires a quarterly commitment fee on the average daily undrawn amount ranging from 0.30% to 0.60%, based on the applicable corporate credit rating at the time.
We are subject to certain covenants under the 2018 Term Loan and 2018 Revolving Credit Facility. Under the 2018 Term Loan (and as defined in the 2018 Credit Agreement), we are subject a maximum debt-to-total capitalization ratio of 35%. Under the 2018 Revolving Credit Facility (and as defined in the 2018 Credit Agreement), we are subject to a maximum debt-to-total capitalization ratio of 35%, a minimum liquidity requirement, compliance with the PMIERs financial requirements (subject to any GSE-approved waivers), and minimum consolidated net worth and statutory capital requirements. We were in compliance with all covenants as of December 31, 2018.
The following tables present a breakdown of our investment portfolio and cash and cash equivalents by investment type and credit rating:
Our effective income tax rate on pre-tax income was 20.6% for the year ended December 31, 2018. Our effective income tax rate on pre-tax income was 58.2% and (459.0)% for the years ended December 31, 2017 and 2016, respectively. The difference between our statutory tax rate and our effective tax rate for the year ended December 31, 2018 was primarily due to a tax benefit of $3.1 million from excess share-based compensation for vested RSUs and exercised stock options. The difference between our statutory
tax rate and our effective tax rate for the year ended December 31, 2017 was primarily due to a tax expense of $13.6 million associated with the enactment of the TCJA, partially offset by a tax benefit of $3.3 million from excess share-based compensation for vested RSUs and exercised stock options. The difference between our statutory tax rate and our effective tax rate for the year ended December 31, 2016 was due to the release of the valuation allowance in 2016.
our other deferred tax assets were based on known recognition schedules and our expectation was that the majority would either reverse in the next three years or were related to deferred tax liabilities;
our significant unearned premium balance, which represents future revenue to be earned over the policies' lives;
At December 31, 2018, we had a federal net operating loss carryforward of $2.6 million which expire in varying amounts in 2030 and 2031, and state net operating loss carryforwards of $93.3 million, which expire in varying amounts from 2031 to 2038. Our ability to utilize our remaining federal net operating loss carryforward is restricted by Section 382 of the Internal Revenue Code, which imposes annual limitations if there is an "ownership change." As a result of the acquisition of our insurance subsidiaries in 2012, $7.3 million of federal NOLs were subject to annual limitations of $0.8 million through 2016, and $0.3 million, thereafter. Our federal net operating loss carryforward balance is a result of this limitation.
Premiums for primary mortgage insurance policies may be paid in a single payment at origination (single premium), on a monthly installment basis (monthly premium) or on an annual installment basis (annual premium). Premiums written at origination for single premium policies are initially deferred as unearned premiums and amortized into earnings over the estimated policy life in accordance with the anticipated expiration of risk. Monthly premiums are recognized as revenue in the month billed as coverage is effective. Annual premiums are initially deferred and earned on a straight-line basis over the year of coverage. Upon cancellation of a policy, all remaining non-refundable deferred and unearned premium is immediately earned, and any refundable premium is returned to the policyholder. Premiums returned to policyholders are recorded as a reduction to written and earned premiums in the period paid.
Consistent with industry standards for mortgage insurers, we establish reserves for claims based on our best estimate of ultimate claim costs for defaulted loans using the general principles contained in ASC 944, Financial Services - Insurance (ASC 944). We establish case reserves when we are notified that a borrower has missed two or more mortgage payments (i.e., a default) and IBNR reserves based on an estimate of defaults which have been incurred by have not yet been reported to us by loan servicers. We also establish reserves for unallocated claims expenses not associated with specific claims. Claims expenses consist of the estimated cost of the claim administration process, including legal and other fees, as well as other general expenses of administering the claims settlement process.
We have designated our investment portfolio as available-for-sale and report it at fair value. The related unrealized gains and losses, after considering the related tax expense or benefit, are recognized as a component of accumulated other comprehensive income (loss) in shareholders' equity. Net realized investment gains and losses are reported in income based on specific identification of securities sold or other than temporarily impaired, and are reclassified out of accumulated other comprehensive income (loss).
current housing and mortgage lending industries. It is possible that even a relatively small change in estimated claim rates or a relatively small percentage change in estimated claim amounts could have a significant impact on our premium deficiency analysis. If we determine it is necessary and appropriate to establish a premium deficiency reserve, and actual premium patterns and claims experience differ from the assumptions used to establish the reserve, the differences between the actual results and our estimates will affect future period earnings.
We have audited the accompanying consolidated balance sheets of NMI Holdings, Inc. (the "Company") and subsidiaries as of December 31, 2018 and 2017, the related consolidated statements of operations and comprehensive income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2018, and the related notes and financial statement schedules included in the accompanying index(collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2018 and 2017, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.
In April 2012, we completed a private placement of our securities, through which we offered and sold an aggregate of 55 million of our Class A common stock resulting in net proceeds of approximately $510 million (the Private Placement), and we completed the acquisition of our insurance subsidiaries for $8.5 million in cash, common stock and warrants, plus the assumption of $1.3 million in liabilities. In November 2013, we completed an initial public offering of 2.4 million shares of our common stock, and our common stock began trading on the NASDAQ exchange on November 8, 2013, under the symbol "NMIH."
Premiums for primary mortgage insurance policies may be paid in a single payment at origination (single premium), on a monthly installment basis (monthly premium) or on an annual installment basis (annual premium), with such election and payment type fixed at policy inception. Premiums written at origination for single premium policies are initially deferred as unearned premiums and amortized into earnings over the estimated policy life, in accordance with the anticipated expiration of risk. Monthly premiums are recognized as revenue in the month billed and when the coverage is effective. Annual premiums are initially deferred and earned on a straight-line basis over the year of coverage. Upon cancellation of a policy, all remaining non-refundable deferred and unearned premium is immediately earned, and any refundable premium is returned to the policyholder. Premiums returned to policyholders are recorded as a reduction of written and earned premiums in the current period.
Costs directly associated with the successful acquisition of mortgage insurance policies, consisting of certain selling expenses and other policy issuance and underwriting expenses, are initially deferred and reported as DAC. DAC is reviewed periodically to determine that it does not exceed recoverable amounts. DAC is amortized to expense in proportion to estimated gross profits over the estimated life of the associated policies. We estimate the rate of amortization to reflect actual experience and any changes to persistency or loss development. Total amortization of DAC for the years ended December 31, 2018, 2017 and 2016, net of a portion of ceding commission related to the QSR Transactions (see "Reinsurance", below), was $8.1 million, $5.8 million and $4.3 million, respectively.
We consider whether a premium deficiency exists and premium deficiency reserve is required at each fiscal quarter using best estimate assumptions as of the testing date. Per ASC 944, a premium deficiency reserve shall be recognized if the sum of expected claim costs and claim adjustment expenses, expected dividends to policyholders, unamortized acquisition costs and maintenance costs exceeds future premiums, existing reserves and anticipated investment income. We have determined that no premium deficiency reserves were necessary for any of the years in the three year period ended December 31, 2018.
We account for income taxes using the liability method in accordance with ASC Topic 740, Income Taxes. The liability method measures the expected future tax effects of temporary differences at the enacted tax rates applicable for the period in which the deferred asset or liability is expected to be realized or settled. Temporary differences are differences between the tax basis of an asset or liability and its reported amount in the consolidated financial statements that would result in future increases or decreases in taxes owed on a cash basis compared to amounts already recognized as tax expense in the consolidated statement of operations.
We account for stock compensation in accordance with ASC 718, Compensation - Stock Compensation, which addresses accounting for share-based awards and recognition of compensation expense, measured using grant date fair value, over the requisite service or performance period of the award. Share-based compensation includes RSUs and stock option grants under our Stock Plans. We calculate the fair value of stock option grants using a Black-Scholes option pricing model, which takes into account various subjective assumptions. Key assumptions used in the model include the expected volatility of our stock price, dividend yield and the risk-free interest rate, as well as the expected option term, giving consideration to the contractual terms of any award. RSU grants may contain a service condition, or performance and service conditions. RSU grants are valued at our stock price on the date of grant less the present value of anticipated dividends. We account for stock option and RSU forfeitures as they occur.
beneficiary of a VIE is complex and requires management judgment regarding determinative factors, including the expected results of the VIE and how those results are absorbed by beneficial interest holders, as well as which party has the power to direct activities that most significantly impact the performance of the VIE.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This update is intended to provide a consistent approach in recognizing revenue. In December 2016, the FASB clarified that all contracts that are within the scope of Topic 944, Financial Services-Insurance, are excluded from the scope of ASU 2014-09. Accordingly, this update did not impact the recognition of revenue related to insurance premiums or investment income, which represent a majority of our total revenues. The update impacted our loan review services revenue, which is the only revenue stream in scope of the update. We adopted this update on January 1, 2018 using the modified-retrospective approach and the impact was immaterial to our consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825-10). This update requires certain equity investments to be measured at fair value with changes in fair value recognized in net income. This update also requires public entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. In addition, it requires entities to evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale investment securities in combination with the entities other deferred tax assets. We adopted this update effective January 1, 2018. The impact was immaterial to our consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230). This update is intended to reduce diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. We adopted this update effective January 1, 2018 and the adoption had no impact on our consolidated financial statements.
In March 2017, the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20). This update shortened the amortization period for the premium on certain purchased callable debt securities to the earliest call date. We adopted this update effective January 1, 2018 and the adoption had no impact on our consolidated financial statements.
In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (Topic 220). This update permits a company to reclassify the disproportionate income tax effects as a result of the TCJA on items within accumulated other comprehensive income (AOCI) to retained earnings. This standard will take effect for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. We adopted this update on January 1, 2018 and adjusted the disproportionate income tax effects, or "stranded tax effects," resulting in a $0.3 million reduction to our beginning retained earnings as of January 1, 2018.
related to the operating lease on our corporate headquarters. Adoption of this standard is not expected to have a material impact to our consolidated statements of operations or cash flows.
In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), and Derivatives and Hedging (Topic 815). This update is intended to simplify the accounting for certain equity-linked financial instruments. The standard will take effect for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The guidance must be applied using a full or modified retrospective approach. We adopted this ASU on January 1, 2019, and have determined that it has no impact on our consolidated financial statements.
In August 2018, the FASB issued ASU 2018-12, Targeted Improvements to the Accounting for Long-Duration Contracts. This update provides guidance to the existing recognition, measurement, presentation and disclosure requirements for long-duration contracts issued by an insurance entity. The standard will take effect for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. We are currently evaluating the impact the adoption of this ASU will have, if any, on our consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820). This update modifies the fair value measurement disclosure requirements of ASC 820. The standard will take effect for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. We are currently evaluating the impact the adoption of this ASU will have, if any, on our fair value of financial instruments disclosures.
As of December 31, 2018, the investment portfolio had gross unrealized losses of $15.5 million, $10.4 million of which has been in an unrealized loss position for a period of 12 months or greater. We did not consider these securities to be other-than-temporarily impaired as of December 31, 2018. We based our conclusion that these investments were not other-than-temporarily impaired as of December 31, 2018 on the following facts: (i) the unrealized losses were primarily caused by interest rate movements and market fluctuations in credit spreads since the purchase date, (ii) we do not intend to sell these investments; and (iii) we do not believe that it is more likely than not that we will be required to sell these investments before recovery of our amortized cost basis, which may not occur until maturity. For those securities in an unrealized loss position, the length of time the securities were in such a position is as follows:
The following table presents the components of net realized investment gains (losses):
Level 2 - Fair value measurements based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs other than quoted
prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
To determine the fair value of securities available-for-sale in Level 1 and Level 2 of the fair value hierarchy, independent pricing sources have been utilized. One price is provided per security based on observable market data. To ensure securities are appropriately classified in the fair value hierarchy, we review the pricing techniques and methodologies of the independent pricing sources and believe that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. A variety of inputs are utilized by the independent pricing sources including benchmark yields, reported trades, non-binding broker/dealer quotes, issuer spreads, two sided markets, benchmark securities, bids, offers and reference data including data published in market research publications. Inputs may be weighted differently for any security, and not all inputs are used for each security evaluation. Market indicators, industry and economic events are also considered. This information is evaluated using a multidimensional pricing model. Quality controls are performed by the independent pricing sources throughout this process, which include reviewing tolerance reports, trading information and data changes, and directional moves compared to market moves. This model combines all inputs to arrive at a value assigned to each security. We have not made any adjustments to the prices obtained from the independent pricing sources.
The following table outlines the key inputs and assumptions used to calculate the fair value of the warrant liability in the Black-Scholes option-pricing model as of the dates indicated.
At December 31, 2018 our 2018 Term Loan was carried at cost of $146.8 million, net of debt issuance costs of $2.5 million, and had a fair value of $146.3 million which is classified as a Level 2 instrument.
On May 24, 2018, we entered into the 2018 Credit Agreement, which provides for (i) the $150 million 2018 Term Loan that matures on May 24, 2023; and (ii) the $85 million 2018 Revolving Credit Facility that matures on May 24, 2021. Proceeds from the 2018 Term Loan were used to repay in full the outstanding amount due under the $150 million 2015 Term Loan, and to pay fees and expenses incurred in connection with the 2018 Credit Agreement.
We are subject to certain covenants under the 2018 Term Loan (as defined in the 2018 Credit Agreement), including (but not limited to) a maximum debt-to-total capitalization ratio (as defined in the 2018 Credit Agreement) of 35% under the 2018 Term Loan. We were in compliance with all covenants as of December 31, 2018.
Future principal payments due under the 2018 Term Loan as of December 31, 2018 are as follows:
We are required to pay a quarterly commitment fee on the average daily undrawn amount of the 2018 Revolving Credit Facility, which ranges from 0.30% to 0.60%, based on the applicable corporate credit rating at the time. As of December 31, 2018, the applicable commitment fee was 0.50%. For the year ended December 31, 2018, we recorded $0.3 million of commitment fees in interest expense.
We incurred issuance costs of $1.5 million in connection with the establishment of the 2018 Revolving Credit Facility, which were deferred and recorded within Other Assets. These costs will be amortized through interest expense over the three-year life of the 2018 Revolving Credit Facility on a straight line basis. For the year ended December 31, 2018, we recognized $0.3 million of interest expense from the amortization of deferred issuance costs. At December 31, 2018, the remaining issuance costs were $1.2 million, net of accumulated amortization.
In May 2017, NMIC entered into a reinsurance agreement with Oaktown Re, which provides for up to $211.3 million of aggregate excess-of-loss reinsurance coverage at inception for new delinquencies on an existing portfolio of mortgage insurance policies written from 2013 through December 31, 2016. For the reinsurance coverage period, NMIC retains the first layer of $126.8 million of aggregate losses, of which $125.2 million remained at December 31, 2018, and Oaktown Re then provides second layer coverage up to the outstanding reinsurance coverage amount. NMIC then retains losses in excess of the outstanding reinsurance coverage amount. The outstanding reinsurance coverage amount decreases from $211.3 million at inception over a ten-year period as the underlying covered mortgages are amortized or repaid, and/or the mortgage insurance coverage is canceled and was $131.1 million as of December 31, 2018. The outstanding reinsurance coverage amount will stop amortizing if certain credit enhancement or delinquency thresholds are triggered.
Under the reinsurance agreement, NMIC holds an optional termination right if certain events occur, including, among others, a clean-up call if the outstanding reinsurance coverage amount amortizes to 10% or less of the reinsurance coverage amount at inception or if NMIC reasonably determines that changes to GSE or rating agency asset requirements would cause a material and adverse effect on the capital treatment afforded to NMIC under the agreement. In addition, there are certain events that will result
in mandatory termination of the agreement, including NMIC's failure to pay premiums or consent to reductions in the trust account to make principal payments to noteholders, among others.
Oaktown Re II financed the coverage by issuing mortgage insurance-linked notes in an aggregate amount of $264.5 million to unaffiliated investors (the 2018 Notes). The 2018 Notes mature on July 25, 2028. All of the proceeds paid to Oaktown Re II from the sale of the 2018 Notes were deposited into a reinsurance trust to collateralize and fund the obligations of Oaktown Re II to NMIC under the reinsurance agreement. Funds in the reinsurance trust account are required to be invested in high credit quality money market funds at all times. We refer collectively to NMIC's reinsurance agreement with Oaktown Re II and the issuance of the 2018 Notes by Oaktown Re as the 2018 ILN Transaction. Under the terms of the 2018 ILN Transaction, NMIC makes risk premium payments for the applicable outstanding reinsurance coverage amount and pays Oaktown Re II for anticipated operating expenses (capped at $250 thousand per year). For the year ended December 31, 2018, NMIC ceded risk premiums of $3.3 million and did not cede any losses to Oaktown Re.
Effective September 1, 2016, NMIC entered into the 2016 QSR Transaction with a panel of third-party reinsurers. Each of the third-party reinsurers has an insurer financial strength rating of A- or better by S&P, AM Best or both.
Under the 2016 QSR Transaction, NMIC ceded premiums written related to:
Effective January 1, 2018, NMIC entered into the 2018 QSR Transaction with a panel of third-party reinsurers. Each of the third-party reinsurers has an insurer financial strength rating of A- or better by S&P, AM Best or both. Under the 2018 QSR Transaction, NMIC cedes premiums earned related to 25% of risk on eligible policies written in 2018 and will cede premiums earned related to 20% of risk on eligible policies written in 2019. The 2018 QSR Transaction is scheduled to terminate on December 31, 2029. However, NMIC has the option, based on certain conditions and subject to a termination fee, to terminate the agreement as of December 31, 2022, or at the end of any calendar quarter thereafter, which would result in NMIC reassuming the related risk.
NMIC may terminate either or both of the QSR Transactions without penalty if, due to a change in PMIERs requirements, it is no longer able to take full PMIERs asset credit for the RIF ceded under the respective agreements. NMIC has additional termination rights under the QSR Transactions, whereby it may elect to selectively terminate its engagement with individual reinsurers under the agreements on a run-off basis (i.e., reinsurers continue providing coverage on all risk ceded prior to the termination date, with no new cessions going forward) or cut-off basis (i.e., the reinsurance arrangement is completely terminated with NMIC recapturing all previously ceded risk) under certain circumstances. Such selective termination rights arise when, among other reasons, a reinsurer experiences a deterioration in its capital position below a prescribed threshold and/or a reinsurer breaches (and fails to cure) its collateral posting obligations under the relevant agreement.
Ceded premiums written under the 2016 QSR Transaction are recorded on the balance sheet as prepaid reinsurance premiums and amortized to ceded premiums earned in a manner consistent with the recognition of revenue on direct premiums. Under the 2018 QSR Transaction, premiums are ceded on an earned basis as defined in the agreement. NMIC receives a 20% ceding commission for premiums ceded under the QSR Transactions. NMIC also receives a profit commission, provided that the loss ratio on the loans covered under the 2016 QSR Transaction and 2018 QSR Transaction generally remains below 60% and 61%, respectively, as measured annually. Ceded claims and claim expenses under the QSR Transactions reduce NMIC's profit commission on a dollar-for-dollar basis.
In accordance with the terms of the 2016 QSR Transaction, rather than making a cash payment or transferring investments for ceded premiums written, NMIC established a funds withheld liability, which also includes amounts due to NMIC for ceding and profit commissions. Any loss recoveries and any potential profit commission to NMIC will be realized from this account until exhausted. NMIC's reinsurance recoverable balance is further supported by trust accounts established and maintained by each reinsurer in accordance with the PMIERs funding requirements for risk ceded to non-affiliates. The reinsurance recoverable on loss reserves related to our 2016 QSR Transaction was $2.8 million as of December 31, 2018.
In accordance with the terms of the 2018 QSR Transaction, cash payments for ceded premiums earned are settled on a quarterly basis, offset by amounts due to NMIC for ceding and profit commissions. Any loss recoveries and any potential profit commission to NMIC are also settled quarterly. NMIC's reinsurance recoverable balance is supported by trust accounts established and maintained by each reinsurer in accordance with the PMIERs funding requirements for risk ceded to non-affiliates. The reinsurance recoverable on loss reserves related to our 2018 QSR Transaction was $0.2 million as of December 31, 2018.
We establish reserves to recognize the estimated liability for insurance claims and claim expenses related to defaults on insured mortgage loans. Consistent with industry practice, we establish reserves for loans that have been reported to us by servicers as having been in default for at least 60 days, referred to as case reserves, and additional loans that we estimate (based on actuarial
review) have been in default for at least 60 days that have not yet been reported to us by servicers, referred to as IBNR reserves. We also establish claims expense reserves, which represent the estimated cost of the claim administration process, including legal and other fees, as well as other general expenses of administering the claims settlement process. As of December 31, 2018, we had reserves for insurance claims and claims expenses of $12.8 million for 877 primary loans in default. For the year ended December 31, 2018, we paid 89 claims totaling $3.2 million, including 70 claims ceded under the 2016 QSR Transaction representing $0.7 million of ceded claims and claims expenses. No claims were ceded under the 2018 QSR Transaction during the year ended December 31, 2018.
In 2013, we entered into a pool insurance transaction with Fannie Mae. The pool transaction includes a deductible, which represents the amount of claims to be absorbed by Fannie Mae before we are obligated to pay any claims. We only establish reserves for pool risk if we expect claims to exceed this deductible. At December 31, 2018, 55 loans in the pool were past due by 60 days or more. These 55 loans represented approximately $3.4 million of RIF. Due to the size of the remaining deductible, the low level of NODs reported on loans in the pool through December 31, 2018 and the expected severity (all loans in the pool have LTV ratios under 80%), we did not have any case or IBNR reserves for pool risks at December 31, 2018 or December 31, 2017. In connection with the settlement of pool claims, we applied $0.6 million to the pool deductible through December 31, 2018. At December 31, 2018, the remaining pool deductible was $9.7 million. We have not paid any pool claims to date. 100% of our pool RIF is reinsured under the 2016 QSR Transaction.
Related to ceded losses recoverable on the QSR Transactions, included in "Other Assets" on the Consolidated Balance Sheets. See Note 6, "Reinsurance" for additional information.
The following tables provide claim development data, by accident year and a reconciliation to the reserve for insurance claims and claims expenses.
The number of NODs outstanding as of December 31, 2018 is the total number of loans in default over 60 days for which we have established reserves.
Basic earnings per share is based on the weighted average number of shares of common stock outstanding. Diluted earnings per share is based on the weighted average number of shares of common stock outstanding and common stock equivalents that would be issuable upon the vesting of service based and performance and service based RSUs, and the exercise of vested and unvested stock options and outstanding warrants. The number of shares issuable for RSUs subject to performance and service based vesting requirements are only included in diluted shares if the relevant performance measurement period has commenced and results during such period meet the necessary performance criteria. The following table reconciles the net income and the weighted average shares of common stock outstanding used in the computations of basic and diluted earnings per share of common stock
We issued 992 thousand warrants in connection with our Private Placement. Each warrant gives the holder thereof the right to purchase one share of common stock at an exercise price equal to $10.00. The warrants were issued with an aggregate fair value of $5.1 million. During the years ended December 31, 2018 and 2017, 151 thousand and 55 thousand warrants were exercised, respectively, resulting in 91 thousand and 32 thousand common shares issued, respectively. Upon exercise, we reclassified approximately $1.6 million of warrant fair value from warrant liability to additional paid-in capital, of which $0.4 million related to changes in fair value in the current period for the twelve months ended December 31, 2018. No warrants were exercised during the year ended December 31, 2016.
Share-based compensation includes stock options and RSUs granted under our Stock Plans.
As of December 31, 2018, there was $1.5 million of total unrecognized compensation cost related to non-vested stock options. The weighted-average period over which total remaining compensation costs related to non-vested stock options will be recognized is 1.42 years.
Dividend yield - is calculated by dividing the expected annual dividend by our stock price at the valuation date.
A summary of RSU activity during the years ended December 31, 2018, 2017 and 2016 are as follows:
Non-vested RSUs subject to service condition vesting requirements vest over a service period ranging from one to five years. Non-vested RSUs subject to performance and service condition vesting requirements are scheduled to vest in 2019 and 2020, with the number of shares eligible for vesting in each period based on the achievement of return on equity goals. The fair value of non-vested RSUs is measured as the closing price of our common stock on the date of grant less the present value of anticipated dividends to be paid during the service period.
We offer our employees a 401(k) Savings Plan (401(k) Plan) that qualifies as a deferred salary arrangement under Section 401(k) of the IRC. Under the 401(k) Plan, we matched up to 100% of eligible employees' pre-tax contributions up to 4% of eligible compensation for the years ended December 31, 2018, 2017 and 2016. We contributed approximately$1.6 million for the year ended December 31, 2018, compared to $1.5 million for each of the years ended December 31, 2017 and 2016.
For the year ended December 31, 2018, we had income tax expense of $28.0 million, including amounts related to current year federal and state income taxes and changes to our net deferred tax liability.
For the year ended December 31, 2017, we had income tax expense of $30.7 million, including a one-time non-cash charge of $13.6 million primarily due to the re-measurement of our deferred tax assets and liabilities in connection with the enactment of the TCJA on December 22, 2017.
For the year ended December 31, 2016, we had income tax benefit of $52.5 million primarily related to the release of the valuation allowance previously recorded against our federal and certain state net deferred tax assets. At December 31, 2016, we determined that positive evidence of sufficient quantity and quality outweighed negative evidence, and supported a conclusion that it was more-likely-than-not that the Company would realize its federal and certain state net deferred tax assets. As a result, at December 31, 2016, we released the valuation allowance previously recorded against federal and certain state net deferred tax assets and recorded the effects of the change in income from continuing operations, generating financial statement benefits of $58.2 million and $0.3 million related to net federal and certain state net deferred tax assets, respectively.
At December 31, 2018, we had a federal net operating loss carryforward of $2.6 million which expires in varying amounts in 2030 and 2031, and state net operating loss carryforward of $93.3 million which expire in varying amounts from 2031 to 2038. Section 382 of the IRC imposes annual limitations on a corporation's ability to utilize its net operating loss carryforwards if it experiences an "ownership change." As a result of the acquisition of our insurance subsidiaries in 2012, $7.3 million of federal net operating losses were subject to annual limitations of $0.8 million through 2016, and $0.3 million, thereafter, through 2029. Our federal net operating loss carryforward arises from this limitation and the constraint on our ability to utilize the net operating loss carryforward in full during the current period.
At December 31, 2018 and 2017, we recorded valuation allowances of $8.1 million and $7.2 million, respectively against state net deferred tax assets that may not be realized in future periods. The valuation allowances for both years primarily relate to state net operating losses generated by NMIH, as NMIH operates at a loss and currently only generates revenue from its investment portfolio.
Under the PMIERs, approved insurers must maintain available assets that equal or exceed minimum required assets, which is an amount equal to the greater of (i) $400 million or (ii) a total risk-based required asset amount. The risk-based required asset amount is a function of the risk profile of an approved insurer's net RIF, assessed on a loan-by-loan basis and considered against certain risk-based factors derived from tables set out in the PMIERs to gross RIF, which is then adjusted on an aggregate basis for reinsurance transactions approved by the GSEs, such as with respect to our ILN Transactions and QSR Transactions. The risk-based required asset amount for performing, primary insurance is subject to a floor of 5.6% of performing, primary adjusted RIF, and the risk-based required asset amount for pool insurance considers both factors in the PMIERs tables and the net remaining stop loss for each pool insurance policy.
In March 2018, we completed the sale of 3.7 million shares of common stock and granted the underwriters on the transaction a 15% overallotment option to purchase additional shares. The overallotment option was exercised in full, resulting in a total of 4.3 million shares of common stock issued. The common stock offering generated total proceeds of approximately $79.2 million, net of underwriting discounts, commissions and other direct offering expenses.
Our insurance subsidiaries, NMIC and Re One, file financial statements in conformity with statutory accounting principles (SAP) prescribed or permitted by the Wisconsin OCI, NMIC's principal regulator. Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety of publications of the NAIC. The Wisconsin OCI recognizes only statutory accounting practices prescribed or permitted by the state of Wisconsin for determining and reporting the financial condition and results of operations of an insurance company and for determining its solvency under Wisconsin insurance laws.
NMIC and Re One's combined statutory net loss, statutory surplus, contingency reserve and RTC ratios as of and for the years ended December 31, 2018, 2017 and 2016 were as follows:
Under applicable law in Wisconsin and 15 other states, mortgage insurers must maintain minimum amounts of statutory capital relative to RIF to continue to write new business. While formulations of minimum statutory capital may vary in each state, the most common measure allows for a maximum permitted RTC ratio of 25:1. Wisconsin and certain other states, including California and Illinois, apply a substantially similar requirement referred to as minimum policyholders' position. A working group of the NAIC is currently developing a loan level capital model applicable to mortgage guaranty insurers that is expected to ultimately be incorporated into a revised NAIC Mortgage Guaranty Insurance Model Act. Following adoption by the NAIC, some or all of the 16 states that currently have minimum statutory capital requirements, and potentially others that do not, are expected to enact a portion or all of the revised Model Act, including the loan-level capital model.
As of December 31, 2018, NMIC's performing primary RIF, net of reinsurance, was approximately $10.0 billion and its RTC ratio was 13.7:1, significantly below applicable limits. As of December 31, 2017, NMIC's performing primary RIF, net of reinsurance, was approximately $7.3 billion and its RTC ratio was 14.0:1.
Prior to January 10, 2019, Ohio regulation limited the amount of risk a mortgage insurer was permitted to retain on a single loan to 25% of the borrower's indebtedness (after giving effect to third-party reinsurance) and, as a result, the portion of such insurance in excess of 25% was required to be reinsured. Ohio has repealed this requirement for future periods beginning January 10, 2019. Several other states previously imposed similar coverage restrictions and repealed these measures prior to 2018. To comply with these previous state coverage limits, NMIC and Re One have reinsurance agreements in place under which Re One provides reinsurance to NMIC on insured loans with coverage levels in excess of 25%, after giving effect to third-party reinsurance.
NMIC and Re One are subject to restrictions on their ability to pay dividends to NMIH without prior approval of the Wisconsin OCI. Under Wisconsin law, NMIC and Re One may pay dividends up to specified levels (i.e., "ordinary" dividends) with 30 days' prior notice to the Wisconsin OCI. Dividends in larger amount (i.e.,"extraordinary" dividends), are subject to the Wisconsin OCI's prior approval. Under Wisconsin law, an extraordinary dividend is defined as any payment or distribution that together with other dividends and distributions made within the preceding 12 months exceeds the lesser of (i) 10% of the insurer's statutory policyholders' surplus as of the preceding December 31 or (ii) adjusted statutory net income for the 12-month period ending the preceding December 31. NMIC and Re One have never paid any dividends to NMIH. NMIC reported a statutory net loss for the twelve months ended December 31, 2018 and cannot pay any dividends to NMIH through December 31, 2019 without the prior approval of the Wisconsin OCI. Certain other states in which NMIC is licensed also have statutes or regulations that restrict its ability to pay dividends. Re One currently has the capacity to pay ordinary dividends of $2.7 million to NMIH in 2019.
As of December 31, 2018, the amount of restricted net assets held by our consolidated insurance subsidiaries totaled approximately $766.2 million. The amount of restricted assets used to determine any dividend to NMIH, once all restrictions expire, would be computed under SAP which may differ from the amount of restricted assets computed under GAAP.
As an approved insurer under PMIERs, NMIC would be subject to additional restrictions on its ability to pay dividends to NMIH if it failed to meet the financial requirements prescribed by PMIERs. Approved insurers that fail to meet the PMIERs financial requirements are not permitted to pay dividends without prior approval of the GSEs.