*As of December 31, 2011, we had $1 in cash and cash equivalents, which is not identifiable in this schedule due to rounding.
MI protects mortgage lenders from all or a portion of default-related losses on residential mortgage loans made to home buyers who generally make down payments of less than 20% of the home's purchase price. By protecting lenders and investors from credit losses, we help facilitate the availability of mortgages to prospective, primarily first-time, U.S. home buyers, thus promoting homeownership while protecting lenders and investors against potential losses related to a borrower's default. MI also facilitates the sale of these mortgage loans in the secondary mortgage market, most of which are sold to the GSEs. We are one of seven companies in the United States who offer MI. Our business strategy is to continue to gain market share with our principal focus on writing insurance on high quality, low down payment residential mortgages in the U.S.
We began writing business in April 2013. We had 964 Master Policy holders by the end of 2015, compared to 735 at the end of 2014. Of those Master Policy holders, 51.9% were delivering business in 2015, compared to 37.7% delivering business in 2014. We had total IIF of $19.1 billion and total RIF of $3.7 billion as of December 31, 2015, compared to total IIF of $8.1 billion and total RIF of $894.7 million as of December 31, 2014. Of total IIF as of December 31, 2015, we had $14.8 billion of primary IIF and $4.2 billion of pool IIF, compared to $3.4 billion of primary IIF and $4.7 billion of pool IIF as of December 31, 2014. As of December 31, 2015, our primary RIF was $3.6 billion compared to primary RIF of $801.6 million as of December 31, 2014. Pool RIF was $93.1 million as of December 31, 2015 and December 31, 2014.
As discussed in Part I, Item 1, "Business - Customers," our sales and marketing strategy is focused on increasing market share from existing customers and attracting new mortgage originator customers in the U.S. that fall into two primary categories, which we refer to as "National Accounts" and "Regional Accounts."
Next 30, a combination of National and Regional Accounts, representing approximately 17% of the MI market; and
Approximately 1,500, primarily Regional Accounts, representing the remainder of the MI market.
Since April 2013, we have increased our customer base, and we expect to continue to acquire new customers. As of December 31, 2015, we had active customer relationships with 22 of the top 40 lenders and expect to develop additional active customer relationships. We believe our most significant growth opportunity is within the the large and fragmented market of Regional Accounts, which includes some of the top correspondent lenders. As of December 31, 2015, our active customer relationships give us access to over 83% of the correspondent origination market. In addition to adding new customers, we believe existing customers will begin to allocate more of their business to us for placement of our MI.
Our ability to continue to make progress attaining and retaining customers is primarily dependent on the following factors:
Maintain our connections and continue our progress in connecting with leading third-party loan origination systems utilized by Regional Accounts. This will allow the Regional Accounts who originate loans using these third-party loan origination systems to automatically select us as an MI provider within those platforms.
NMIC's primary insurance may be written on a flow basis, in which loans are insured in individual, loan-by-loan transactions, or on an aggregated basis, in which each loan in a portfolio of loans is individually insured in a single transaction.
MI may also be written in a pool policy, where a group of loans (or pool) are insured under one contract. Pool insurance may have a stated aggregate loss limit for a pool of loans and may also have a deductible under which no losses are paid by the insurer until losses on the pool of loans exceed the deductible.
We set premiums at the time a policy is issued based on our expectations regarding likely performance over the term of coverage. We offer BPMI and LPMI options. Premium rates are based on the risk characteristics of each insured loan and the capital required to support particular products. Capital charges are governed by the updated PMIERs and for LPMI policies, will increase in 2016. See "- GSE Oversight," below.
For the year ended December 31, 2015, we had net premiums written of $114.2 million and premiums earned of $45.5 million, compared to net premiums written of $34.0 million and premiums earned of $13.4 million for the year ended December 31, 2014. For the year ended December 31, 2013, we had net premiums written of $3.5 million and premiums earned of $2.1 million. Premiums written and earned in a year are generally influenced by:
cancellations, which reduce IIF. Upon cancellation of a policy, all premium that is non-refundable is immediately earned, and any refundable premium is returned to the policyholder. Cancellations due to refinancings are affected by the level of current mortgage interest rates compared to the mortgage rates on our IIF. Refinancings are also affected by current home values compared to values when the loans became insured and the terms on which mortgage credit is available. To a lesser extent, cancellations also result from claim payments, as we return any premium received from the servicer after the date the insured mortgage defaults. Finally, cancellations are affected by home price appreciation, which may give homeowners the right to cancel the MI on their loans. Based on current market conditions, we expect our MI policies to have a persistency rate of between 80% and 85%;
premiums ceded under reinsurance agreements. The only reinsurance agreements we currently have in place are between NMIC and Re One, and they are for the sole purpose of allowing NMIC to comply with certain statutory requirements regarding the amount of risk an MI company may retain on any single MI policy.
In our industry, a "book" is a group of loans that an MI company insures in a particular period, normally a calendar year. In general, the majority of any underwriting profit (i.e., the earned premium revenue minus claims and expenses, excluding investment income) that a book generates occurs in the early years of the book, with the largest portion of the underwriting profit for that book realized in the first year. This pattern generally occurs because relatively few of the claims that a book will ultimately experience typically occur in the first few years of the book, when premium revenue is highest, while subsequent years are affected by declining premium revenues, as the number of insured loans decreases (primarily due to loan prepayments), and by increasing losses. The earnings we record and the cash flow we receive vary based on the type of MI product and premium plan our customers select.
In recent years, the level of competition within the private MI industry has been intense and is not expected to diminish. Lenders have requested discounts from mortgage insurers with greater frequency, particularly with respect to LPMI single premium policies. A significant percentage of our total business to date has consisted of single premium policies, some of which has been written at a discounted rate, which may impact our premium yields in the near term. In the fourth quarter of 2015, we implemented new LPMI and BPMI rates, which we expect will improve premium yields on our future NIW and have the effect of increasing the amount of monthly NIW as a percentage of our total mix over time.
The table below shows primary NIW, IIF, RIF, policies in force, the weighted average coverage and loans in default, by quarter, for the last five quarters.
We utilize certain risk principles that form the basis of how we underwrite and originate primary NIW. We manage our portfolio credit risk by using several loan eligibility matrices which prescribe the maximum LTV, minimum borrower credit score, maximum loan size, property type and occupancy status of loans that we will insure. Our loan eligibility matrices, as well as all of our detailed underwriting guidelines, are contained in our Underwriting Guideline Manual that is publicly available on our website. Our eligibility criteria and underwriting guidelines are designed to mitigate the layered risk inherent in a single insurance policy. "Layered risk" refers to the accumulation of borrower, loan and property risk. For example, we have higher credit score and lower maximum allowed LTV requirements for riskier property types, such as investor properties, compared to owner-occupied properties.
The table below reflects a summary of the change in total primary IIF for the years ended December 31, 2015 and 2014.
Our persistency rate is the percentage of policies in force that remains on our books after any twelve-month period. Because our insurance premiums are earned over the life of a policy, changes in persistency rates can have a significant impact on our earnings. The persistency rate on our portfolio was 84.1% at December 31, 2015. In recent quarters, we have experienced high volumes of single premium policy cancellations driven by refinance activity, which has contributed to lower persistency than generally expected. We believe single premium policy cancellations will decrease if interest rates rise.
The following table reflects the percentage and policy count of our RIF by LTV. We calculate the LTV of a loan as a percentage of the original loan amount to the original value of the property securing the loan. In general, the lower the LTV the lower the likelihood of a default, and for loans that default, a lower LTV generally results in lower severity for a resulting claim, as the borrower has more equity in the property.
The following tables show the distribution by state of our IIF and RIF, for both primary and pool insurance. As of December 31, 2015, our IIF and RIF continues to be relatively more concentrated in California, primarily as a result of the location and timing of the acquisition of new customers. With the broadening of our customer base, the concentration of primary IIF and RIF in California has declined from over 16.0% for both as of the end of 2014, to 13.8% and 12.9%, respectively, as of December 31, 2015. The distribution of risk across the states as of December 31, 2015 is not necessarily representative of the geographic distribution we expect in the future. As we add new customers and receive greater allocations of business from our existing customers, we expect we will have increased flexibility to manage our state concentration levels.
the LTV ratio, with higher average LTV ratios tending to increase claims incurred;
the percentage of coverage on insured loans, with higher percentages of insurance coverage tending to result in higher incurred claim amounts than lower percentages of insurance coverage;
the distribution of claims over the life of a book. Historically, the first two to three years after loans are originated are a period of relatively low claims, with claims increasing substantially for several years subsequent and then declining. Factors, such as persistency of the book, the condition of the economy, including unemployment and housing prices, and others, can affect this pattern.
We expect that claims incurred for the early years of our operations will be relatively low for the following reasons:
In the second quarter of 2015, the FHFA published final updated PMIERs that went into effect on December 31, 2015 (Effective Date) for existing, GSE-approved private mortgage insurers, i.e., Approved Insurers. (Italicized terms have the same
meaning that such terms have in the PMIERs, as described below.) The PMIERs establish operational, business, remedial and financial requirements applicable to Approved Insurers. The new financial requirements prescribe a risk-based capital methodology whereby the amount of capital required to be held against each insured loan is determined based on certain risk characteristics, such as FICO, vintage (year of origination), performing vs. non-performing, LTV and other risk features. A capital charge is calculated for each insured loan based on its risk profile. In general, higher quality loans carry lower capital charges.
During the fourth quarter of 2015, NMIH raised additional capital by entering into the Credit Agreement to obtain the Term Loan in the amount of $150 million. Concurrently with the closing of the Credit Agreement, NMIH borrowed $150 million from the facility and subsequently made contributions to NMIC of $145.4 million of cash and securities during the fourth quarter to support growth in NMIC's RIF and meet the final PMIERs requirements as of the Effective Date. As a result, as of December 31, 2015, NMIC had sufficient assets to meet the PMIERs financial requirements and we expect to certify to the GSEs by March 1, 2016 that NMIC fully complies with the PMIERs.
State insurance regulators also have the authority to make changes to capital requirements. The NAIC has formed a working group to develop and recommend more robust regulations governing mortgage insurance, including, among other things, strengthened capital requirements, underwriting standards, claims practices and market conduct. We, along with other MI companies, are working with the Mortgage Guaranty Insurance Working Group of the Financial Condition (E) Committee of the NAIC (Working Group). The Working Group will determine and make a recommendation to the Financial Condition (E) Committee of the NAIC as to what changes the Working Group believes are necessary to the solvency and market practices regulation of MI companies, including changes to the Mortgage Guaranty Insurers Model Act (Model #630). We have provided feedback to the Working Group since early 2013. The Working Group's discussions are ongoing and the ultimate outcome of these discussions and any potential actions taken by the NAIC cannot be predicted at this time. If the Working Group proposes that the NAIC adopt more stringent capital requirements, this could ultimately lead to NMIC being obligated to hold more capital for its insured business than we are required to holder under PMIERs, which would reduce our profitability compared to the profitability we expect under the existing capital requirements.
In July 2015, Standard & Poor's (S&P) Ratings Services assigned its "BBB-" financial strength and long-term counter-party credit ratings to NMIC. At the same time, S&P assigned its "BB-" long-term counter-party credit rating to NMIH. S&P's outlook for both companies is "stable."
In recent years, the MI industry has been in a state of transition. There are now seven MI companies serving the mortgage market. Given this dynamic, we expect that the pressure for industry participants to grow or maintain their market share will continue in the coming years. Our competitors' respective shares of the private MI market at September 30, 2015 ranged from single percentage points penetration to a high of approximately 24%.
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, recent action by the current administration has made it difficult to predict whether the market share of governmental agencies such as the FHA and VA will recede to historical levels. On January 26, 2015, the FHA reduced some of its single-family annual mortgage insurance premiums. To date, we have not experienced any significant impact from this premium reduction on our business. It is difficult to predict what, if any, material impact this premium reduction will have in the future as there are factors beyond premium rate that influence a lender's decision to choose private MI over FHA insurance, including among others, the FHA's loan eligibility requirements and loan size limits and the relative ease of use of private MI products compared to FHA products. However, we believe our pricing continues to be more attractive than the FHA's pricing for a substantial majority of borrowers with credit and loan characteristics similar to those whose loans we insure.
For the year ended December 31, 2015, we had net premiums written of $114.2 million compared to net premiums written of $34.0 million for the year ended December 31, 2014 and $3.5 million for the year ended December 31, 2013. We had net premiums written for our primary mortgage insurance products of $109.3 million, $28.6 million, and $1.7 million for fiscal years 2015, 2014 and 2013, respectively. The principal driver of the increase in primary premiums written in 2014 and 2015 was the continued growth of our policies in force and the significant development of our customer base. As of December 31, 2015, we had 63,948 primary certificates in force and 18,955 pool certificates in force, compared to 14,603 primary certificates in force and 20,573 pool certificates in force as of December 31, 2014.
We had net single premiums written and earned of $34.8 million and $6.1 million, respectively, for the fourth quarter of 2015, compared to net single premiums written and earned of $26.9 million and $4.4 million, respectively, for the third quarter of 2015. Net single premiums earned increased as a result of an increase in single premiums written during the quarter ended December 31, 2015, as well as from cancellations on LPMI singles, which are non-refundable and fully earned upon cancellation. Net pool premiums written and earned of $1.2 million for both during the quarter ended December 31, 2015 was down slightly quarter over quarter due to the pay off of approximately 341 loans in the pool from September 30, 2015. We have not written significant annual premiums through December 31, 2015.
Insurance claims and claims expenses increased for the year ended December 31, 2015 compared to the year ended December 31, 2014, as a result of an increase in our NODs from December 31, 2014, in addition to our payment of two claims paid during the year ended December 31, 2015.
We recorded no income tax for the year ended December 31, 2015 compared to $2.4 million of income tax benefit for the year ended December 31, 2014. See Item 8, "Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 9, Income Taxes."
We have incurred significant net operating losses since our inception; however,we have seen our net losses decrease steadily as our business has grown. Our net losses were $27.8 million, $48.9 million and $55.2 million for the each of the years in the three-year period ended December 31, 2015, respectively. The primary driver of the decreases in net losses for the years ended December 31, 2015 and December 31, 2014 compared to the prior years was the significant increase in premiums earned as a result of the addition of new customers and higher allocations of business to us from existing customers, slightly offset by the continued hiring of management and staff personnel and external and professional costs.
Our software and equipment balance increased from $11.8 million at December 31, 2014 to $15.2 million at December 31, 2015, primarily due to the $6.1 million spent on the continued development of our technology platform to support the growth of our business.
Our other assets balance increased from $9.0 million at December 31, 2014 to $13.2 million as of December 31, 2015 primarily as a result of the increase in our premiums receivable balance related to our monthly policies.
In November 2015, we entered into the Credit Agreement and obtained the Term Loan. Our long-term debt balance under the Term Loan as of December 31, 2015 was $143.9 million.
Our unearned premiums balance increased from $22.1 million as of December 31, 2014 to $90.8 million as of December 31, 2015 due to single premiums written in 2015, offset by cancellations of LPMI policies previously discussed and earnings of existing unearned premiums in accordance with the expiration of risk in the related policies.
Our accounts payable and accrued expenses increased to $22.7 million as of December 31, 2015 from $10.6 million at December 31, 2014. The increase at December 31, 2015 was primarily the result of our increased headcount, accrued premium taxes, an increase in IT projects and expenses, as well as accrued interest expense related to the Term Loan. We also had an investment payable of $3.2 million as of December 31, 2015.
Operating activities generated positive cash flow for the year ended December 31, 2015, due primarily to the collection of premiums offset by the continued hiring of management and staff personnel and costs for contract and professional services.
As of December 31, 2015, NMIH had $100.2 million of cash and investments. NMIH's principal source of operating cash is investment income, and could include future dividends from NMIC, if available and permitted under law or our agreements with the GSEs and state regulators.
NMIH's future capital requirements depend on many factors, including NMIC's ability to successfully write new business, establish premium rates at levels sufficient to cover claims and operating costs and meet minimum required asset thresholds under the PMIERs. See "Conditions and Trends Impacting our Business - GSE Oversight," above. We expect NMIH may make additional capital contributions to its insurance subsidiaries to support their applicable capital adequacy requirements from time-to-time. To the extent that the funds generated by our ongoing operations and capitalization are insufficient to fund future operating requirements, we may need to raise additional funds through financing activities, reduce our RIF, including through reinsurance arrangements, or curtail our growth and reduce our expenses. We may choose to generate additional liquidity through the issuance of debt, equity, or a combination of both. Any such future capital raise would be conducted by means of a separate prospectus or other appropriate offering document and not by means of this report.
2015 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.
Our MI companies' principal operating sources of liquidity are premiums that we receive from policies and income generated by our investment portfolio. Our MI companies' primary liquidity needs include the payment of claims on our MI policies, operating expenses, investment expenses and other costs of our business. We anticipate that as our IIF grows, the premium revenue we receive will increase. We expect to manage our fixed operating expenses so that they grow at a slower rate than sales over the coming years.
Consistent with Wisconsin law, our investment policies emphasize preservation of capital, as well as total return. Based on our guidelines, our current investment portfolio is comprised almost entirely of cash and cash equivalents and fixed-income securities, all of which are investment grade. Prior to the third quarter of 2014, our investment portfolio consisted of A rated securities or better. During the third quarter of 2014, we changed our investment guidelines to allow 10-15% of the investment portfolio to be invested in BBB securities. As of December 31, 2015, approximately 13% of the investment portfolio was invested in BBB securities. Our policy guidelines contain limits on the amount of credit exposure to any one issue, issuer and type of instrument. We expect to preserve the liquidity of our portfolio through diversification and investment in publicly traded securities. We plan to maintain a level of liquidity commensurate with our perceived business outlook and the expected timing, direction and degree of changes in interest rates.
The pre-tax book yield on our portfolio, excluding unrealized gains and losses, was 1.8% for the year ended December 31, 2015 compared to 1.5% for the year ended December 31, 2014. The book yield is calculated on our year-to-date net investment income over our average portfolio book value at December 31, 2015. We believe that the yield on our investment portfolio likely will change over time based on potential changes to the interest rate environment, the duration or mix of our investment portfolio or other factors.
The sectors of our investment portfolio, including cash and cash equivalents appear in the table below:
We are a U.S. taxpayer and are subject to a statutory U.S. federal corporate income tax rate of approximately 35%. Our holding company files a consolidated U.S. federal and various state income tax returns on behalf of itself and its subsidiaries. Our effective income tax rate on our pre-tax loss was 0.0% , 4.7% and 0.0% for the years ended December 31, 2015, 2014 and 2013, respectively. 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 9, Income Taxes."
There is a tax sharing agreement between NMIH and its subsidiaries, dated August 23, 2012. Under this agreement, each of the parties mutually agreed to file a consolidated federal income tax return for 2012 and subsequent tax years, with NMIH as the direct tax filer. The tax liability of each subsidiary that is party to the agreement is limited to the amount of liability it would incur if it filed a separate tax return. Any settlements under the agreement between NMIH and a subsidiary will be made within 30 days of the filing of the applicable federal corporate income tax return with the IRS, including subsequent amended filings and IRS adjustments, except when a refund is due to a subsidiary, in which case payment shall be made to such subsidiary within 30 days after NMIH's receipt of the applicable tax refund.
*Long-term debt relates to our $150 million Credit Agreement and includes future interest payments using the minimum interest rate of 8.50%.
Level 1 - Unadjusted quoted prices for identical assets or liabilities in active markets that are accessible at the measurement date for identical assets or liabilities;
Level 2 - Prices or valuations based on observable inputs other than quoted prices in active markets for identical assets
We classify our entire investment portfolio as available-for-sale and report it at fair value. The related unrealized gains or losses, after considering the related tax expense or benefit, are reported as a component of accumulated other comprehensive income in stockholders' equity. We expect to hold short-term investments with maturities of greater than three and less than 12 months when purchased, and such investments will be carried at fair value. Any realized gains and losses on sales of investments are determined on a specific-identification basis. We expect that our investment income will consist primarily of interest. We recognize interest income on an accrual basis. Net investment income would represent interest income, net of investment expenses.
The guidance regarding the recognition and presentation of other-than temporary impairment (OTTI) requires that an OTTI of a debt security be separated into two components when there are credit-related losses associated with the impaired debt security for which we assert that we do not have the intent to sell the security and it is more likely than not that we will not be required to sell the security before recovery of our cost basis. Under this guidance, the amount of the OTTI related to a credit loss is recognized in earnings, and the amount of the OTTI related to other factors (such as changes in interest rates or market conditions) is recorded as a component of other comprehensive income (loss). In instances where no credit loss exists but it is more likely than not that we would have to sell the debt security prior to the anticipated recovery, the decline in fair value below amortized cost is recognized as an OTTI in earnings. In periods after recognition of an OTTI on debt securities, we account for such securities as if they had been purchased on the measurement date of the OTTI at an amortized cost basis equal to the previous amortized cost basis less the OTTI recognized in earnings. For debt securities for which OTTI are recognized in earnings, the difference between the new amortized cost basis and the cash flows expected to be collected would be accreted or amortized into net investment income.
We perform a premium deficiency calculation 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 related unearned premiums. The calculation of premium deficiency reserves requires the use of significant judgment and estimates to determine the present value of future premiums and present value of expected claims and expenses on our business. The present value of future premiums relies on, among other things, assumptions about persistency and repayment patterns on underlying loans. The present value of expected claims and expenses depends on assumptions relating to severity of claims, claim rates on current defaults and expected defaults in future periods. These assumptions may also include an estimate of expected rescission activity. Assumptions used in calculating premium deficiency reserves can be affected by volatility in the current housing and mortgage lending industries. To the extent premium patterns and actual claim experience differ from the assumptions used in calculating a premium deficiency reserve, the differences between the actual results and our estimate will affect future period earnings. In considering the potential sensitivity of the factors underlying our best estimate of premium deficiency reserves, it is possible that even a relatively small change in estimated claim rate or a relatively small percentage change in estimated claim amount could have a significant impact on establishing a premium deficiency reserve, should one be needed, and, correspondingly, on our operating results.
Costs directly associated with the successful acquisition of mortgage insurance policies, consisting of employee compensation and other policy issuance and underwriting expenses, are initially deferred and reported as deferred insurance policy acquisition costs. Deferred insurance policy acquisition costs arising from each book of business are charged against revenue in relation to the anticipated recognition of premiums.
If a premium deficiency exists, as described above, we reduce the related deferred insurance policy acquisition costs by the amount of the deficiency or to zero through a charge to current period earnings. If the deficiency is more than the deferred insurance policy acquisition costs balance, we then establish a premium deficiency reserve equal to the excess, by means of a charge to current period earnings.
We adopted ASC 718, Compensation - Stock Compensation (ASC 718). ASC 718 addresses accounting for share-based awards and recognizes compensation expense, measured using grant date fair value, over the requisite service or performance period of the award. Share-based payments include stock options and restricted stock unit (RSU) grants under the 2012 Stock Incentive Plan and the NMIH 2014 Omnibus Incentive Plan. The fair value of stock option grants issued are determined based on an option pricing model which takes into account various assumptions that are subjective. Key assumptions used in the stock option valuation include the fair value of the stock on the grant date, the expected term of the equity award taking into account the contractual term of the award, the effects of expected exercise and post-vesting termination behavior, expected volatility, expected dividends and the risk-free interest rate for the expected term of the award. RSU grants to certain employees contain a market and service condition. The fair value of RSU grants to employees prior to our IPO was determined using a Monte Carlo Simulation model at the date of grant. Following the IPO, fair value was determined based on closing price on the grant date. Restricted grants to non-employee directors are valued at our stock price on the date of grant less the present value of anticipated dividends. Expense is recognized over the required service period, which is generally a three-year vesting period for the options (vesting in one-third increments per year).
Expected Stock Price Volatility - is a measure of the amount by which a price has fluctuated or is expected to fluctuate. At the time of grants, our common shares trading history was not sufficient to calculate an expected volatility representative of the volatility over the expected lives of the options. As a substitute for such estimate, we used historical volatilities of a set of comparable companies in the industry in which we operate.
The estimated grant date fair values of the RSUs granted in 2012 that are subject to both a market and service condition were calculated using a Monte Carlo Simulation model based on the average outcome of 150,000 simulations using the following assumptions:
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedules. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NMI Holdings, Inc. at December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.
For the year ended December 31, 2015, one customer represented a material portion of our revenues. At December 31, 2015, approximately 13% of our total RIF was concentrated in California. We expect our RIF and state concentrations to lessen and align to industry averages as our insurance portfolio matures.
Consistent with industry accounting practices, for purposes of establishing claim reserves, we adhere to the general claim reserving principles contained in Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 944, Financial Services - Insurance (ASC 944), even though that standard expressly excludes mortgage insurance from its guidance. However, and consistent with our industry, we do not establish claim reserves for anticipated future claims on insured loans that are not currently in default. We do not consider a loan to be in default for claim reserve purposes until we receive notice from the servicer that a borrower has failed to make two consecutive regularly scheduled payments and is at least 60 days in default. In addition to reserves on reported defaults, we establish IBNR reserves for estimated claims incurred on loans that have been in default for at least 60 days that have not yet been reported to us by the servicers.
Our intangible assets consist of state licenses and GSE applications which have indefinite lives. We test indefinite-lived intangible assets for impairment during the fourth quarter of each year or more frequently if we believe indicators of impairment exist. We do not believe that the indefinite-lived intangible assets were impaired as of December 31, 2015.
In August 2014, the FASB issued an update that requires an entity's management to evaluate whether there is substantial doubt about that entity's ability to continue as a going concern and, if so, disclose that fact. An entity's management will also be required to evaluate and disclose whether its plans alleviate that doubt. The guidance is effective for annual periods ending after December 15, 2016 and for interim and annual periods thereafter. We do not expect the adoption of this update to have a material effect on the presentation of our financial statements and notes therein.
Certain items in the financial statements as of December 31, 2015 and for the periods ending December 31, 2014 and December 31, 2013 have been reclassified to conform to the current period's presentation. There was no effect on net income or shareholders' equity previously reported.
The amortized cost and fair values of available for sale securities at December 31, 2015 and 2014, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Because most asset-backed securities provide for periodic payments throughout their lives, they are listed below in separate categories.
At December 31, 2015, the investment portfolio had gross unrealized losses of $5.6 million, $0.5 million of which has been in an unrealized loss position for a period of twelve months or greater. We did not consider these securities to be other-than-temporarily impaired as of December 31, 2015. We based our conclusion that these investments were not other-than-temporarily impaired at December 31, 2015 on the following facts: (i) the unrealized losses were primarily caused by interest rate movements 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:
There were no credit losses recognized in earnings for which a portion of an OTTI loss was recognized in accumulated other comprehensive income (loss).
The following describes the valuation techniques used by us to determine the fair value of financial instruments held at December 31, 2015 and December 31, 2014:
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. There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the year ended December 31, 2015.
Securities classified as Level 2 assets include Federal Home, Farm and Agriculture agency obligations, municipal debt securities, corporate debt securities and asset-backed securities. Corporate securities are broadly diversified across industries and include $18.4 million of U.S. denominated foreign securities (Yankee Bonds) as of December 31, 2015. Asset-backed securities consist primarily of automobile and industrial industries and include $3.6 million of Yankee Bonds as of December 31, 2015.
ASC 825, Disclosures about Fair Value of Financial Instruments, requires all entities to disclose the fair value of their financial instruments, both assets and liabilities recognized and not recognized in the balance sheet, for which it is practicable to estimate fair value.
We revalue the warrant liability quarterly using a Black-Scholes option-pricing model, in combination with a binomial model. As of December 31, 2015, the assumptions used in the option pricing model were as follows: a common stock price as of December 31, 2015 of $6.77, risk free interest rate of 1.91%, expected life of 5.92 years , expected volatility of 32.70% and a dividend
NMIH is subject to certain quarterly covenants under the Credit Agreement. These covenants include, but are not limited to the following: a maximum debt-to-total capitalization ratio (as defined) of 35%, maximum RTC ratio of 22.0:1.0, liquidity (as defined) of $41 million, compliance with financial requirements of PMIERs, and equity requirements. This description is not intended to be complete in all respects and is qualified in its entirety by the terms of the Credit Agreement, including its covenants and events of default. We were in compliance with all covenants at December 31, 2015.
Future principal payments for the Company's Term Loan as of December 31, 2015 are as follows:
In 2013, we entered into a pool insurance transaction with Fannie Mae. We only establish claim or IBNR reserves for pool risk if we expect claims to exceed the deductible under the pool agreement, which represents the amount of claims absorbed by Fannie Mae before we are obligated to pay any claims. At December 31, 2015, forty-three loans in the pool were past due by sixty days or more. These forty-three loans represent approximately $2.6 million in RIF. Due to the size of the remaining deductible of$10.3 million, the low level of NODs reported through December 31, 2015 and the expected severity (all loans in the pool have LTVs under 80%), we have not established any pool reserves for claims or IBNR for the years ended December 31, 2015 and December 31, 2014. In connection with the settlement of pool claims, we applied $18 thousand to the pool deductible through December 31, 2015. We have not paid any pool claims to date.
There was a $49 thousand favorable prior year development for the year ended December 31, 2015, primarily attributable to NOD cures. Reserves of $30 thousand related to prior year defaults remained as of December 31, 2015. The decrease in the period is generally the result of ongoing analysis of recent loss development trends. We may increase or decrease our original estimates as we learn additional information about individual defaults and claims.
A summary of option activity in the plan during the years ended December 31, 2015 and December 31, 2014 is as follows:
In February 2013, the Board approved a modification to the vesting terms of approximately 400,000 granted and non-vested RSUs held by our employees. The modification to the vesting terms removed the market condition leaving the RSUs subject to a service condition only. The modification resulted in a change in the period over which compensation costs are recognized and prospective recognition of incremental compensation cost. Incremental compensation cost is measured as the excess of the fair value
of the modified award over the fair value of the original award immediately before its terms are modified using relevant valuation inputs as of the modification date.
At December 31, 2015, the 1.4 million shares of granted and non-vested RSUs consisted of 0.5 million shares that are subject to both a market and service condition and 0.9 million shares that are subject only to service conditions. The non-vested RSUs subject to both a market and service condition vest in one-half increments upon the achievement of certain market price goals and continued service. Non-vested RSUs subject only to a service condition vest over a service period ranging from one to three years. The fair value of RSUs subject to market and service conditions is determined based on a Monte Carlo simulation model at the date of grant. The fair value of RSUs subject only to service conditions are valued at our stock price on the date of grant less the present value of anticipated dividends.
The estimated grant date fair values of the RSUs granted in 2012 that are subject to both a market and service condition were calculated using a Monte Carlo simulation model based on the average outcome of 150,000 simulations using the following assumption:
The RSUs granted in 2015 were valued at our stock price on the date of grant less the present value of anticipated dividends, which is $0. As of December 31, 2015, there was $3.1 million of total unrecognized compensation cost related to non-vested RSUs compared to 3.0 million as of December 31, 2014.
At December 31, 2015, we had an income tax expense of $0.0. The income tax benefit of $2.4 million for the year ended December 31, 2014 was related to the tax effects of unrealized gains credited to other comprehensive income (OCI). Generally, the amount of tax expense or benefit allocated to continuing operations is determined without regard to the tax effects of other categories of income or loss, such as OCI. However, an exception to the general rule is provided in ASC 740-20-45-7 when there is a pre-tax loss from continuing operations and there are items charged or credited to other categories, including OCI. The intraperiod tax allocation rules related to items charged or credited directly to OCI can result in disproportionate tax effects that remain in OCI until certain events occur. As a result of a reduction in unrealized losses credited directly to OCI, $2.4 million of income tax expense was netted with prior year unrealized gains in OCI, and $2.4 million of income tax benefit was allocated to the income tax provision for continuing operations. As a result of net unrealized losses to OCI during the year ended December 31, 2015, the exception was not applicable.
The income tax benefit from income taxes was eliminated or reduced in each year by the recognition of a valuation allowance which was recorded to reflect the amount of the deferred taxes that may not be realized. As the Company has limited history, management has not yet concluded that it is more-likely-than-not that the results of future operations will generate sufficient taxable income. If we conclude the taxable income will be sufficient to release the valuation allowance, we would recognize an income tax benefit associated primarily with the carry forward of federal NOLs and future share-based compensation tax deductions.
At December 31, 2015 and 2014, we had a net deferred tax liability of $0.1 million as a result of the acquisition of indefinite-lived intangibles from the acquisition of our insurance subsidiaries for which no benefit had been reflected in the acquired net operating loss carry forwards. The tax liability incurred at the acquisition was recorded as an increase in goodwill.
Excluded from deferred tax assets were a gross $2.1 million of excess stock compensation as of December 31, 2015 and December 31, 2014, for which any benefit realized will be recorded to stockholders' equity.
As of December 31, 2015 and 2014, we have no reserve for unrecognized tax benefits, and have taken no material uncertain positions in its tax returns that would require measurement and recognition.
We file income tax returns with the U.S. federal government and various state jurisdictions which are subject to potential examination by tax authorities. We are not currently under examination, and 2012, 2013 and 2014 federal and state tax years remain open by statute.
Intangible assets and goodwill consist of identifiable intangible assets and goodwill we purchased in connection with the acquisition of our insurance subsidiaries, and at December 31, 2015 and December 31, 2014, were as follows for both years:
We test goodwill and intangibles for impairment in the third and fourth quarter, respectively, of every year, or more frequently if we believe indicators of impairment exist. No impairments of indefinite-lived intangibles or goodwill were identified as of December 31, 2015 and 2014.
By March 1, 2016, each Approved Insurer, including NMIC, must certify to the GSEs that it fully complies with the PMIERs as of the Effective Date. During the fourth quarter of 2015, NMIH raised additional capital by entering into the Credit Agreement to secure a term loan credit facility in the amount of $150 million. Concurrently with the closing of the Credit Agreement, NMIH borrowed $150 million from the facility and subsequently made contributions to NMIC. As a result, as of December 31, 2015, NMIC had sufficient assets to meet the PMIERs financial requirements and we expect to certify to the GSEs by March 1, 2016 that NMIC fully complies with the PMIERs. Going forward, by April 15th of each year, NMIC must certify it met all PMIERs requirements
The company leases office space under a facilities lease that expires in October 2017.
Under applicable Wisconsin law and 15 other states, a mortgage insurer must maintain a minimum amount of statutory capital relative to its RIF in order for the mortgage insurer to continue to write new business. While formulations of minimum capital may vary in each jurisdiction that has such a requirement, the most common measure applied 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. Our operation plan filed with the Wisconsin OCI and other state insurance departments in connection with NMIC's applications for licensure includes the expectation that NMIH will downstream additional capital if needed so that NMIC does not exceed RTC ratios agreed to with those states. NMIC may in the future seek state insurance department approvals, as needed, of an amendment to our business plan to increase this ratio to the Wisconsin regulatory minimum of 25:1.
Certain states limit the amount of risk a mortgage insurer may retain on a single loan to 25% of the indebtedness to the insured and, as a result, the portion of such insurance in excess of 25% must be reinsured. NMIC and Re One have entered into a primary excess share reinsurance agreement, effective August 1, 2012, and a facultative pool reinsurance agreement, effective September 1, 2013, under which NMIC cedes premiums, loss reserves and claims to Re One on an excess share basis for any primary or pool policy which offers coverage greater than 25% on any loan insured thereunder. NMIC will use reinsurance provided by Re One solely for purposes of compliance with these state statutory coverage limits. Currently, NMIC has no other reinsurance agreements.
Due to the use of weighted average shares outstanding when calculating earnings per share, the sum of quarterly per share data may not equal the per share data for the year.