NMI Holdings, Inc. 10-Q

Item 1. Financial Statements INDEX TO FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets as of June 30, 2020 (Unaudited) and December 31, 2019 6 Condensed Consolidated Statements of Operations and Comprehensive Income for the three and six months ended June 30, 2020 and 2019 (Unaudited) 7 Condensed Consolidated Statements of Changes in Shareholders' Equity for the six months ended June 30, 2020 and 2019 (Unaudited) 8 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2020 and 2019 (Unaudited) 10 Notes to Condensed Consolidated Financial Statements (Unaudited) 11 5 NMI HOLDINGS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) June 30, 2020 December 31, 2019 Assets (In Thousands, except for share data) Fixed maturities, available-for-sale, at fair value (amortized cost of $1,286,803 and $1,113,779 as of June 30, 2020 and December 31, 2019, respectively) $ 1,339,771 $ 1,140,940 Cash and cash equivalents (including restricted cash of $2,068 and $2,662 as of June 30, 2020 and December 31, 2019, respectively) 515,450 41,089 Premiums receivable 46,408 46,085 Accrued investment income 7,909 6,831 Prepaid expenses 3,416 3,512 Deferred policy acquisition costs, net 63,619 59,972 Software and equipment, net 26,105 26,096 Intangible assets and goodwill 3,634 3,634 Prepaid reinsurance premiums 10,263 15,488 Reinsurance recoverable (1) 14,307 4,939 Other assets (1) 16,049 16,232 Total assets $ 2,046,931 $ 1,364,818 Liabilities Debt $ 392,773 $ 145,764 Unearned premiums 115,236 136,642 Accounts payable and accrued expenses 104,777 39,904 Reserve for insurance claims and claim expenses 69,903 23,752 Reinsurance funds withheld 12,205 14,310 Warrant liability, at fair value 2,698 7,641 Deferred tax liability, net 83,785 56,360 Other liabilities 8,517 10,025 Total liabilities 789,894 434,398 Commitments and contingencies Shareholders' equity Common stock - class A shares, $0.01 par value; 84,804,766 and 68,358,074 shares issued and outstanding as of June 30, 2020 and December 31, 2019, respectively (250,000,000 shares authorized) 848 684 Additional paid-in capital 927,950 707,003 Accumulated other comprehensive income, net of tax 37,675 17,288 Retained earnings 290,564 205,445 Total shareholders' equity 1,257,037 930,420 Total liabilities and shareholders' equity $ 2,046,931 $ 1,364,818 (1) Reinsurance recoverable has been reclassified from "Other assets" in the prior period. See accompanying notes to condensed consolidated financial statements (unaudited). 6 NMI HOLDINGS, INC. C ONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (UNAUDITED) For the three months ended June 30, For the six months ended June 30, 2020 2019 2020 2019 Revenues (In Thousands, except for per share data) Net premiums earned $ 98,944 $ 83,249 $ 197,661 $ 157,118 Net investment income 7,070 7,629 15,174 15,012 Net realized investment gains (losses) 711 ( 113 ) 639 ( 300 ) Other revenues 1,223 415 2,123 456 Total revenues 107,948 91,180 215,597 172,286 Expenses Insurance claims and claim expenses 34,334 2,923 40,031 5,666 Underwriting and operating expenses (1) 30,370 32,190 62,647 62,990 Service expenses (1) 1,090 353 1,824 402 Interest expense 5,941 3,071 8,685 6,132 Loss (gain) from change in fair value of warrant liability 1,236 1,685 ( 4,723 ) 7,164 Total expenses 72,971 40,222 108,464 82,354 Income before income taxes 34,977 50,958 107,133 89,932 Income tax expense 8,129 11,858 22,014 17,933 Net income $ 26,848 $ 39,100 $ 85,119 $ 71,999 Earnings per share Basic $ 0.36 $ 0.58 $ 1.20 $ 1.07 Diluted $ 0.36 $ 0.56 $ 1.11 $ 1.04 Weighted average common shares outstanding Basic 73,617 67,590 71,090 67,143 Diluted 74,174 69,590 72,407 69,348 Net income $ 26,848 $ 39,100 $ 85,119 $ 71,999 Other comprehensive income, net of tax: Unrealized gains in accumulated other comprehensive income, net of tax expense of $8,978 and $3,662 for the three months ended June 30, 2020 and 2019, and $5,162 and $7,615 for the six months ended June 30, 2020 and 2019, respectively 33,773 13,779 19,418 28,647 Reclassification adjustment for realized (gains) losses included in net income, net of tax expense (benefit) of $149 and ($24) for the three months ended June 30, 2020 and 2019, and ($258) and ($63) for the six months ended June 30, 2020 and 2019, respectively ( 562 ) 89 969 237 Other comprehensive income, net of tax 33,211 13,868 20,387 28,884 Comprehensive income $ 60,059 $ 52,968 $ 105,506 $ 100,883 (1) Certain "Underwriting and operating expenses" have been reclassified as "Service expenses" in prior periods. See accompanying notes to condensed consolidated financial statements (unaudited). 7 NMI HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) Common Stock - Class A Additional Paid-in Capital Accumulated Other Comprehensive Income Retained Earnings Total Shares Amount (In Thousands) Balances, December 31, 2019 68,358 $ 684 $ 707,003 $ 17,288 $ 205,445 $ 930,420 Common stock: class A shares issued related to warrant exercises 6 * 221 — — 221 Common stock: class A shares issued under stock plans, net of shares withheld for employee taxes 510 5 ( 3,755 ) — — ( 3,750 ) Share-based compensation expense — — 2,552 — — 2,552 Change in unrealized investment gains/losses, net of tax benefit of $3,409 — — — ( 12,824 ) — ( 12,824 ) Net income — — — — 58,271 58,271 Balances, March 31, 2020 68,874 $ 689 $ 706,021 $ 4,464 $ 263,716 $ 974,890 Common stock: class A shares issued related to public offering 15,870 159 219,528 — — 219,687 Common stock: class A shares issued under stock plans, net of shares withheld for employee taxes 61 * ( 321 ) — — ( 321 ) Share-based compensation expense — — 2,722 — — 2,722 Change in unrealized investment gains, net of tax expense of $8,829 — — — 33,211 — 33,211 Net income — — — — 26,848 26,848 Balances, June 30, 2020 84,805 $ 848 $ 927,950 $ 37,675 $ 290,564 $ 1,257,037 * During the three months ended March 31, 2020, we issued 6,474 common shares, with a par value of $ 0.01 in connection with the exercise of warrants, which is not identifiable in this schedule due to rounding. During three months ended June 30, 2020, we issued 61,226 common shares, with a par value of $ 0.01 in connection with shares issued under stock plan, which is not identifiable in this schedule due to rounding. 8 NMI HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) Common Stock - Class A Additional Paid-in Capital Accumulated Other Comprehensive Income Retained Earnings Total Shares Amount (In Thousands) Balances, December 31, 2018 66,319 $ 663 $ 682,181 $ ( 14,832 ) $ 33,488 $ 701,500 Common stock: class A shares issued related to warrant exercises 39 * 944 — — 944 Common stock: class A shares issued under stock plans, net of shares withheld for employee taxes 1,144 12 ( 1,471 ) — — ( 1,459 ) Share-based compensation expense — — 2,981 — — 2,981 Change in unrealized investment gains/losses, net of tax expense of $3,992 — — — 15,016 — 15,016 Net income — — — — 32,899 32,899 Balances, March 31, 2019 67,502 $ 675 $ 684,635 $ 184 $ 66,387 $ 751,881 Common stock: class A shares issued related to warrants 128 $ 1 3,835 — — 3,836 Common stock: class A shares issued under stock plans, net of shares withheld for employee taxes 138 1 218 — — 219 Share-based compensation expense — — 3,475 — — 3,475 Change in unrealized investment gains/losses, net of tax expense of $3,686 — — — 13,868 — 13,868 Net income — — — — 39,100 39,100 Balances, June 30, 2019 67,768 $ 677 $ 692,163 $ 14,052 $ 105,487 $ 812,379 * During the three months ended March 31, 2019, we issued 39,195 common shares with a par value of $ 0.01 in connection with the exercise of warrants, which is not identifiable in this schedule due to rounding. See accompanying notes to condensed consolidated financial statements (unaudited). 9 NMI HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) For the six months ended June 30, 2020 2019 Cash flows from operating activities (In Thousands) Net income $ 85,119 $ 71,999 Adjustments to reconcile net income to net cash provided by operating activities: Net realized investment (gains) losses ( 639 ) 300 (Gain) loss from change in fair value of warrant liability ( 4,723 ) 7,164 Depreciation and amortization 4,914 4,339 Net amortization of premium on investment securities 629 622 Amortization of debt discount and debt issuance costs 3,267 499 Deferred income taxes 22,006 17,840 Share-based compensation expense 5,274 6,456 Changes in operating assets and liabilities: Premiums receivable ( 323 ) ( 6,218 ) Accrued investment income ( 1,078 ) ( 607 ) Prepaid expenses 96 ( 312 ) Deferred policy acquisition costs, net ( 3,647 ) ( 5,767 ) Other assets ( 328 ) ( 260 ) Unearned premiums ( 21,406 ) ( 7,535 ) Reserve for insurance claims and claim expenses 46,151 5,621 Reinsurance recoverable ( 9,368 ) ( 774 ) Reinsurance balances, net 2,658 336 Accounts payable and accrued expenses ( 1,247 ) ( 6,379 ) Net cash provided by operating activities 127,355 87,324 Cash flows from investing activities Purchase of short-term investments ( 41,872 ) ( 113,276 ) Purchase of fixed-maturity investments, available-for-sale ( 451,462 ) ( 126,179 ) Proceeds from maturity of short-term investments 85,689 119,748 Proceeds from redemptions, maturities and sale of fixed-maturity investments, available-for-sale 297,977 49,229 Software and equipment ( 4,638 ) ( 4,491 ) Net cash (used in) investing activities ( 114,306 ) ( 74,969 ) Cash flows from financing activities Proceeds from issuance of common stock related to public offering, net of issuance costs 220,284 — Proceeds from issuance of common stock related to employee equity plans 3,391 12,374 Taxes paid related to net share settlement of equity awards ( 7,462 ) ( 13,538 ) Proceeds from senior secured notes 400,000 — Repayments of term loan ( 147,750 ) ( 750 ) Payments of debt issuance costs ( 7,151 ) — Net cash provided by (used in) financing activities 461,312 ( 1,914 ) Net increase in cash, cash equivalents and restricted cash 474,361 10,441 Cash, cash equivalents and restricted cash, beginning of period 41,089 25,294 Cash, cash equivalents and restricted cash, end of period $ 515,450 $ 35,735 Supplemental disclosures of cash flow information Interest paid $ 4,286 $ 5,365 Income taxes refunded $ 76 $ 134 (1) Reinsurance recoverable have been reclassified from "Reinsurance balance, net" in the prior period. See accompanying notes to condensed consolidated financial statements (unaudited). 10 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. Organization, Basis of Presentation and Summary of Accounting Principles NMI Holdings, Inc. (NMIH) is a Delaware corporation, incorporated in May 2011, to provide private mortgage guaranty insurance (which we refer to as mortgage insurance or MI) through its wholly-owned insurance subsidiaries, National Mortgage Insurance Corporation (NMIC) and National Mortgage Reinsurance Inc One (Re One). Our common stock is listed on the NASDAQ exchange under the ticker symbol "NMIH." In April 2013, NMIC, our primary insurance subsidiary, issued its first mortgage insurance policy. NMIC is licensed to write mortgage insurance in all 50 states and D.C. In August 2015, NMIH capitalized a wholly-owned subsidiary, NMI Services, Inc. (NMIS), through which we offer outsourced loan review services to mortgage loan originators. Basis of Presentation The accompanying unaudited condensed consolidated financial statements, which include the results of NMIH and its wholly-owned subsidiaries, have been prepared in accordance with the instructions to Form 10-Q as prescribed by the SEC for interim reporting and include other information and disclosures required by accounting principles generally accepted in the U.S. (GAAP). Our accounts are maintained in U.S. dollars. These statements should be read in conjunction with our consolidated financial statements and notes thereto for the year ended December 31, 2019, included in our 2019 10-K. All intercompany transactions have been eliminated. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect reported amounts of assets and liabilities, as well as disclosure of contingent assets and liabilities as of the balance sheet date. Estimates also affect the reported amounts of income and expenses for the reporting period. Actual results could differ from those estimates. Certain reclassifications to previously reported financial information have been made to conform to current period presentation. The results of operations for the interim period may not be indicative of the results that may be expected for the full year ending December 31, 2020. COVID-19 Developments On January 30, 2020, the World Health Organization (WHO) declared the outbreak of COVID-19 a global health emergency and characterized the outbreak as a global pandemic on March 11, 2020. In an effort to stem contagion and control the COVID-19 pandemic, the population at large has severely curtailed day-to-day activity and local, state and federal regulators have imposed a broad set of restrictions on personal and business conduct nationwide. The COVID-19 pandemic, along with the widespread public and regulatory response, has caused a dramatic slowdown in U.S. and global economic activity and a record number of Americans have been furloughed or laid-off. The global dislocation caused by COVID-19 is unprecedented and, while there is broad hope for medical advances that might relieve the crisis and provide for a near-term return to normalized activity, it is not known how long the dislocation will persist and if or when any such medical advances may be developed or made available. In response to the COVID-19 outbreak and continuing uncertainties, we activated our business continuity program to ensure our employees are safe and able to continue serving our customers and their borrowers without interruption. We have also sought to broadly assess the impact that the COVID-19 outbreak has had and may continue to have on the U.S economy and housing market, and the implications for the mortgage insurance market, and our business performance and financial position, including our new business production, default and claims experience, and investment portfolio results. Given the uncertainty that remains, we cannot fully assess or estimate the ultimate impact of COVID-19. Significant Accounting Principles There have been no changes to our significant accounting principles as described in Item 8, " Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - Note 2 - Summary of Accounting Principles " of our 2019 10-K, other than as noted in " Investments, " " Premium Receivables, " " Reinsurance " and " Recent Accounting Pronouncements - Adopted " below. Investments We hold all investments on an available-for-sale basis and evaluate each position quarterly for impairment. We recognize an impairment on a security through the statement of operations if (i) we intend to sell the impaired security; or (ii) it is more likely than not that we will be required to sell the impaired security prior to recovery of its amortized cost basis. If a sale is intended or likely to be required, we write down the amortized cost basis of the security to fair value and recognize the full amount of the impairment through the statement of operations as a " Realized Investment Loss ." 11 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) For securities in an unrealized loss position where a sale is not intended or likely to be required, we further assess if the decline in fair value below amortized cost is driven by a credit related impairment, considering several items including, but not limited to: • the severity of the decline in fair value; • the financial condition of the issuer; • the failure of the issuer to make scheduled interest or principal payments; • recent rating downgrades of the applicable security or issuer by one or more nationally recognized statistical ratings organization; and • other adverse conditions related to or impacting the security or issuer. To the extent we determine that a security impairment is credit-related, an impairment loss is recognized through the statement of operations as a provision for credit loss expense, and presented as a "Realized Investment Loss." We recognize an allowance for credit losses for the difference between the amortized cost and present value of future expected cash flows, limited by the amount the fair value of the security is below its amortized cost. Subsequent changes (favorable and unfavorable) in credit losses are recognized through the statement of operations as a provision for or a reversal of credit loss expense, and presented as a "Realized Investment Gain or Loss." The portion of a security impairment attributed to other non-credit related factors is recognized in other comprehensive income, net of taxes. We have elected to present accrued interest receivable separately from available for sale securities on our consolidated balance sheet. Accrued interest receivable was $ 7.9 million as of June 30, 2020 and is included in " Accrued Investment Income. " We have elected not to measure an allowance for credit losses for accrued interest receivable on available for sale securities. Accrued interest for available for sale securities is written off against interest income when the receivable has aged 90 days past due. We did not write off any accrued interest receivable during the three or six months ended June 30, 2020. Premiums Receivable Premiums receivable consists of premiums due on our mortgage insurance policies. If a mortgage insurance premium is unpaid for more than 120 days, the associated receivable is written off against earned premium and the related insurance policy is canceled. We recognize an allowance for credit losses for premiums receivable based on credit losses expected to arise over the life of the receivable. Due to the nature of our insurance policies (a necessary precondition for access to mortgage credit for covered borrowers) and the short duration of the related receivables, we do not typically experience credit losses against our premium receivables and did not establish an allowance for credit loss at June 30, 2020. Premiums receivable may be written off prior to 120 days in the ordinary course of business for non-credit events including, but not limited to, the modification or refinancing of an underlying insured loan. We have established a reserve for premium write-offs based on historical experience; such reserve was deemed to be immaterial at June 30, 2020. Reinsurance We account for premiums, claims and claim expenses that are ceded to reinsurers on a basis consistent with that which we use to account for the original policies we issue and pursuant to the terms of our reinsurance contracts. We account for premiums ceded or otherwise paid to reinsurers as a reduction to premium revenue. NMIC has entered into quota share reinsurance treaties effective September 1, 2016 (the 2016 QSR Transaction) , January 1, 2018 (the 2018 QSR Transaction) and April 1, 2020 (the 2020 QSR Transaction) , which we refer to collectively as the QSR Transactions. W e earn profit and ceding commissions in connection with the QSR Transactions. Profit commissions represent a percentage of the profits recognized by reinsurers that are returned to us, based on the level of claims and claim expenses that we cede. We recognize any profit commissions we earn as increases to premium revenue. Ceding commissions are calculated as a percentage of ceded written premiums under the 2016 QSR Transaction and as a percentage of ceded earned premiums under the 2018 and 2020 QSR Transactions, and are intended to cover our costs of acquiring and servicing direct policies. We recognize any ceding commissions we earn in a manner consistent with our recognition of earnings on the underlying insurance policies, over the terms of the policies reinsured. We account for ceding commissions earned as a reduction to underwriting and operating expenses. 12 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Under the QSR Transactions, we cede a portion of claims and claim expense reserves to our reinsurers, and account for such ceded reserves as " Reinsurance Recoverables " on the consolidated balance sheets and such ceded claims as reductions to claims expenses on the consolidated statements of operations. As of June 30, 2020, we had $ 14.3 million of reinsurance recoverables under the QSR Transaction s. We remain directly liable for all claim payments if we are unable to collect the recoverables due from our reinsurers and, as such, we actively monitor and manage our counterparty credit exposure to our reinsurance providers. We establish an allowance for expected credit loss against our reinsurance recoverables if we do not expect to recover amounts due from one or more of our reinsurance counterparties, and report our reinsurance recoverables net of such allowance, if any. We actively monitor the counterparty credit profiles of our reinsurers and each is required to partially collateralize its obligations under the terms of our QSR Transactions. As of June 30, 2020, we did not recognize any allowance for credit loss with respect to our reinsurance recoverables. Recent Accounting Pronouncements - Adopted In June 2016, the Financial Accounting Standard Board (FASB) issued Accounting Standards Update (ASU) 2016-13, Financial Instruments-Credit Losses (Topic 326) and subsequently issued amendments to the initial guidance: ASU 2019-04, Codification Improvements to Topic 326 , Financial Instruments-Credit Losses (Topic 815) , Derivatives and Hedging , and Topic 825, Financial Instruments , ASU 2019-05, Financial Instruments-Credit Losses: Targeted Transition Relief , and ASU 2019-11, C odification Improvements to Topic 326, Financial Instruments-Credit Losses . These updates will require companies to measure and establish reserves for lifetime expected credit losses on many financial assets held at a given reporting date. Under the guidance, the methodology for measuring lifetime credit losses shifts from an incurred loss model, whereby losses are only recognized once probable and estimable, to a current expected credit loss (CECL) model, whereby losses are recognized upfront based on a future economic forecast. Credit losses relating to available-for-sale fixed maturity securities are recorded through an allowance for credit losses, rather than a write-down of the asset as was required, with the amount of the allowance limited to the amount by which fair value is less than amortized cost. The length of time an available-for sale fixed maturity security has been held in an unrealized loss position will no longer impact its credit loss determination. We adopted these updates on January 1, 2020. Adoption of the updated standards did not have a material impact on our consolidated financial statements, and had no impact on our accounting for insurance claims and claim expenses as these items are not in scope of the guidance. 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. We adopted this ASU on January 1, 2020 and determined it did not have a material impact on our consolidated financial statements. In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) . This update applies to cloud computing arrangements structured as service contracts, and provides companies with guidance on the criteria for capitalizing implementation, set-up and other up-front costs incurred in association with these arrangements. We adopted this ASU on January 1, 2020 and applied it on a prospective basis for eligible costs incurred after the effective date. The adoption of this ASU did not have a material impact on our consolidated financial statements. Recent Accounting Pronouncements - Not Yet Adopted 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 FASB subsequently issued ASU 2019-09 in November 2019, which amended the effective date for this standard. The standard will now take effect for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2021. We are currently evaluating the impact the adoption of this ASU will have, if any, on our consolidated financial statements. In November 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740) . This update eliminates certain exceptions for recognizing deferred taxes for investments, performing intra-period allocations and calculating income taxes in interim periods. The ASU also includes guidance to reduce complexity in certain income tax areas, including recognizing deferred taxes for tax goodwill and allocating taxes to members of a consolidated group. 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 March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848) . This update provides optional guidance to ease the potential burden in accounting for reference rate reform on financial reporting. Reference rate reform refers to the global transition away from referencing the London Interbank Offered Rate (LIBOR) in financial contracts, which is expected to be discontinued in 2021. The ASU includes optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions affected by reference rate reform if certain criteria are met. The standard is effective 13 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) immediately through December 31, 2022 for all entities that have contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. We are currently evaluating the impact the adoption of this ASU would have, if any, to our contract modifications that are affected by the discontinuation of LIBOR. 2. Investments We hold all investments on an available-for-sale basis and evaluate each position quarterly for impairment. We recognize an impairment on a security through the statement of operations if (i) we intend to sell the impaired security; or (ii) it is more likely than not that we will be required to sell the impaired security prior to recovery of its amortized cost basis. If a sale is intended or likely to be required, we write down the amortized cost basis of the security to fair value and recognize the full amount of the impairment through the statement of operations as a " Realized Investment Loss ." To the extent we determine that a security impairment is credit-related, an impairment loss is recognized through the statement of operations as a provision for credit loss expense. The portion of a security impairment attributed to other non-credit related factors is recognized in other comprehensive income, net of taxes. Fair Values and Gross Unrealized Gains and Losses on Investments Amortized Cost Gross Unrealized Fair Value Gains Losses As of June 30, 2020 (In Thousands) U.S. Treasury securities and obligations of U.S. government agencies $ 31,196 $ 2,484 $ — $ 33,680 Municipal debt securities 175,035 7,743 — 182,778 Corporate debt securities 987,938 42,964 ( 984 ) 1,029,918 Asset-backed securities 92,278 1,071 ( 310 ) 93,039 Total bonds 1,286,447 54,262 ( 1,294 ) 1,339,415 Short-term investments 356 — — 356 Total investments $ 1,286,803 $ 54,262 $ ( 1,294 ) $ 1,339,771 Amortized Cost Gross Unrealized Fair Value Gains Losses As of December 31, 2019 (In Thousands) U.S. Treasury securities and obligations of U.S. government agencies $ 48,203 $ 784 $ ( 58 ) $ 48,929 Municipal debt securities 189,530 1,721 ( 1,035 ) 190,216 Corporate debt securities 661,719 23,373 ( 211 ) 684,881 Asset-backed securities 170,153 2,603 ( 114 ) 172,642 Total bonds 1,069,605 28,481 ( 1,418 ) 1,096,668 Short-term investments 44,174 98 — 44,272 Total investments $ 1,113,779 $ 28,579 $ ( 1,418 ) $ 1,140,940 We did not own any mortgage-backed securities in our asset-backed securities portfolio at June 30, 2020 o r December 31, 2019. We periodically recognize unsettled trades payable or receivable in connection with our investing activity. Unsettled trades payable represent funds due for investments purchased at period end. Unsettled trades receivable represent funds due for investments sold at period end. Included in "Accounts Payable and Accrued Expenses" are $ 68.9 million and $ 5.6 million of unsettled trade payables from the purchase of investment securities at June 30, 2020 and December 31, 2019, respectively. The following table presents a breakdown of the fair value of our corporate debt securities by issuer industry group as of June 30, 2020 and December 31, 2019: 14 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) June 30, 2020 December 31, 2019 Financial 37 % 38 % Consumer 23 26 Utilities 13 9 Communications 10 10 Technology 10 7 Industrial 7 8 Energy — 2 Total 100 % 100 % As of June 30, 2020 and December 31, 2019, approximately $ 5.7 million and $ 5.5 million, respectively, of our cash and investments were held in the form of U.S. Treasury securities on deposit with various state insurance departments to satisfy regulatory requirements. Scheduled Maturities The amortized cost and fair value of available-for-sale securities as of June 30, 2020 and December 31, 2019, 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 a separate category. As of June 30, 2020 Amortized Cost Fair Value (In Thousands) Due in one year or less $ 72,505 $ 73,072 Due after one through five years 387,886 410,176 Due after five through ten years 716,261 744,725 Due after ten years 17,873 18,759 Asset-backed securities 92,278 93,039 Total investments $ 1,286,803 $ 1,339,771 As of December 31, 2019 Amortized Cost Fair Value (In Thousands) Due in one year or less $ 138,776 $ 139,113 Due after one through five years 406,986 417,208 Due after five through ten years 380,737 394,180 Due after ten years 17,127 17,797 Asset-backed securities 170,153 172,642 Total investments $ 1,113,779 $ 1,140,940 Aging of Unrealized Losses As of June 30, 2020, the investment portfolio had gross unrealized losses of $ 1.3 million, of which $ 0.1 million had been in an unrealized loss position for a period of 12 months or longer. For those securities in an unrealized loss position, the length of time the length of time the securities were in such a position is as follows: 15 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Less Than 12 Months 12 Months or Greater Total # of Securities Fair Value Unrealized Losses # of Securities Fair Value Unrealized Losses # of Securities Fair Value Unrealized Losses As of June 30, 2020 (Dollars in Thousands) Corporate debt securities 39 194,885 ( 982 ) 2 553 ( 2 ) 41 195,438 ( 984 ) Asset-backed securities 16 32,683 ( 227 ) 1 2,913 ( 83 ) 17 35,596 ( 310 ) Total 55 $ 227,568 $ ( 1,209 ) 3 $ 3,466 $ ( 85 ) 58 $ 231,034 $ ( 1,294 ) Less Than 12 Months 12 Months or Greater Total # of Securities Fair Value Unrealized Losses # of Securities Fair Value Unrealized Losses # of Securities Fair Value Unrealized Losses As of December 31, 2019 (Dollars in Thousands) U.S. Treasury securities and obligations of U.S. government agencies 4 $ 12,001 $ ( 58 ) — $ — $ — 4 $ 12,001 $ ( 58 ) Municipal debt securities 26 92,844 ( 1,034 ) 1 999 ( 1 ) 27 93,843 ( 1,035 ) Corporate debt securities 10 30,481 ( 140 ) 14 23,976 ( 71 ) 24 54,457 ( 211 ) Asset-backed securities 9 19,236 ( 102 ) 1 2,988 ( 12 ) 10 22,224 ( 114 ) Total 49 $ 154,562 $ ( 1,334 ) 16 $ 27,963 $ ( 84 ) 65 $ 182,525 $ ( 1,418 ) Allowance for credit losses As of June 30, 2020, we did not recognize an allowance for credit loss for any security in the investment portfolio and we did record any provision for credit loss for investment securities during the three or six months ended June 30, 2020. Based on current facts and circumstances, we believe the unrealized losses as of June 30, 2020 are not indicative of the ultimate collectability of the current amortized cost of the securities. We believe the gross unrealized losses are primarily attributable to widening credit spreads as a result of uncertainties arising from the COVID-19 pandemic. During the six months ended June 30, 2019, we recognized $ 0.4 million other-than-temporarily impaired (OTTI) losses in connection with the planned sale of a security that was disposed of in April 2019. Net Investment Income The following table presents the components of net investment income: For the three months ended June 30, For the six months ended June 30, 2020 2019 2020 2019 (In Thousands) Investment income $ 7,320 $ 7,741 $ 15,669 $ 15,237 Investment expenses ( 250 ) ( 112 ) ( 495 ) ( 225 ) Net investment income $ 7,070 $ 7,629 $ 15,174 $ 15,012 The following table presents the components of net realized investment gains (losses): For the three months ended June 30, For the six months ended June 30, 2020 2019 2020 2019 (In Thousands) Gross realized investment gains $ 4,586 $ 22 $ 5,126 $ 217 Gross realized investment losses ( 3,875 ) ( 135 ) ( 4,487 ) ( 517 ) Net realized investment gains (losses) $ 711 $ ( 113 ) $ 639 $ ( 300 ) 16 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 3. Fair Value of Financial Instruments The following describes the valuation techniques used by us to determine the fair value of our financial instruments: We established a fair value hierarchy by prioritizing the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under this standard are described below: Level 1 - Fair value measurements based on quoted prices in active markets that we have the ability to access for identical assets or liabilities. Market price data generally is obtained from exchange or dealer markets. We do not adjust the quoted price for such instruments. 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. Level 3 - Fair value measurements based on valuation techniques that use significant inputs that are unobservable. Both observable and unobservable inputs may be used to determine the fair values of positions classified in Level 3. The circumstances for using these measurements include those in which there is little, if any, market activity for the asset or liability. Therefore, we must make certain assumptions, which require significant management judgment or estimation about the inputs a hypothetical market participant would use to value that asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy is determined based on the lowest level input that is significant to the fair value measurement in its entirety. Assets classified as Level 1 and Level 2 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. Liabilities classified as Level 3 We calculate the fair value of outstanding warrants utilizing Level 3 inputs, including a Black-Scholes option-pricing model, in combination with a binomial model, and we value the pricing protection features within the warrants using a Monte-Carlo simulation model. Variables in the model include the risk-free rate of return, dividend yield, expected life and expected volatility of our stock price. 17 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The following tables present the level within the fair value hierarchy at which our financial instruments were measured: Fair Value Measurements Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value As of June 30, 2020 (In Thousands) U.S. Treasury securities and obligations of U.S. government agencies $ 33,680 $ — $ — $ 33,680 Municipal debt securities — 182,778 — 182,778 Corporate debt securities — 1,029,918 — 1,029,918 Asset-backed securities — 93,039 — 93,039 Cash, cash equivalents and short-term investments 515,806 — — 515,806 Total assets $ 549,486 $ 1,305,735 $ — $ 1,855,221 Warrant liability — — 2,698 2,698 Total liabilities $ — $ — $ 2,698 $ 2,698 Fair Value Measurements Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value As of December 31, 2019 (In Thousands) U.S. Treasury securities and obligations of U.S. government agencies $ 48,929 $ — $ — $ 48,929 Municipal debt securities — 190,216 — 190,216 Corporate debt securities — 684,881 — 684,881 Asset-backed securities — 172,642 — 172,642 Cash, cash equivalents and short-term investments 85,361 — — 85,361 Total assets $ 134,290 $ 1,047,739 $ — $ 1,182,029 Warrant liability — — 7,641 7,641 Total liabilities $ — $ — $ 7,641 $ 7,641 There were no transfers between Level 2 and Level 3 of the fair value hierarchy during the six months ended June 30, 2020, or the year ended December 31, 2019. The following is a roll-forward of Level 3 liabilities measured at fair value: For the six months ended June 30, Warrant Liability 2020 2019 (In Thousands) Balance, January 1 $ 7,641 $ 7,296 Change in fair value of warrant liability included in earnings ( 4,723 ) 7,164 Issuance of common stock on warrant exercise ( 220 ) ( 4,781 ) Balance, June 30 $ 2,698 $ 9,679 18 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) T he 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. As of June 30, 2020 2019 Common stock price $ 16.08 $ 28.39 Risk free interest rate 0.16 % 1.72 - 1.95 % Expected life 1.81 years 0.92 - 2.81 years Expected volatility 71.6 % 33.8 - 40.0 % Dividend yield 0 % 0 % The changes in fair value of the warrant liability for the six months ended June 30, 2020 and 2019 are primarily attributable to changes in the price of our common stock during the respective periods, with additional impact related to changes in other Black-Scholes model inputs. The change in fair value of the warrant liability for the six months ended June 30, 2019 also reflects the impact of the exercises of outstanding warrants. Financial Instruments not Measured at Fair Value On June 19, 2020, we issued $ 400 million aggregate principal amount of senior secured notes that mature on June 1, 2025 (the Notes). At June 30, 2020, the Notes were carried at a cost of $ 392.8 million, net of unamortized debt issuance costs of $ 7.2 million, and had a fair value of $ 418.4 million as assessed under our Level 2 hierarchy. At December 31, 2019, our 2018 Term Loan was carried at a cost of $ 145.8 million, net of unamortized debt issuance costs of $ 2.0 million, and had a fair value of $ 147.8 million. 4. Debt Senior Secured Notes At June 30, 2020, we had $ 400 million aggregate principal amount of senior secured notes outstanding. The Notes were issued pursuant to an indenture dated June 19, 2020 (the Indenture) and bear interest at a rate of 7.375 %, payable semi-annually on June 1 and December 1. A portion of the proceeds from the Notes offering were used to repay the outstanding amount due under our $ 150 million term loan (2018 Term Loan) and to pay underwriting fees incurred in connection with the offering. Remaining proceeds of $ 244.4 million are available for general corporate purposes, including to support the growth of our new business production and operations. The Notes mature on June 1, 2025. At any time, or from time to time, prior to March 1, 2025, we may elect to redeem the Notes in whole or in part at a price based on 100 % of the aggregate principal amount of any Notes redeemed plus the "Applicable Premium," plus accrued and unpaid interest thereon. Applicable Premium is defined as the greater of (1) 1.0 % of the principal amount of the Note, or (2) the principal value of the Note plus the present value of all future interest payments. At any time on or after March 1, 2025, we may elect to redeem the Notes in whole or in part at a price equal to 100 % of the aggregate principal amount of the Notes to be redeemed plus accrued and unpaid interest thereon. From time to time prior to June 1, 2022, we may also elect to use proceeds raised from one or more equity offerings to redeem up to 40 % of the aggregate principal amount of the Notes at a price equal to 107.375 % of the aggregate principal amount thereof plus accrued and unpaid interest thereon, subject to certain exceptions. Interest expense for the Notes includes interest and the amortization of capitalized debt issuance costs. In connection with the Notes offering, we recorded capitalized debt issuance costs of $ 7.4 million. Such amounts will be amortized over the contractual life of the Notes using the effective interest method. At June 30, 2020, $ 7.2 million of unamortized debt issuance costs remained. Interest expense for the three and six months ended June 30, 2020 includes $ 2.6 million of costs related to the extinguishment of the 2018 Term Loan and issuance of the Notes. We are subject to certain covenants under the Notes (as defined in the Indenture), including, but not limited to, a maximum debt-to-total capitalization ratio of 35 %. We were in compliance with all Notes covenants as of June 30, 2020. 19 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 2020 Revolving Credit Facility On March 20, 2020, we amended our $ 85 million three-year secured revolving credit facility (the 2018 Revolving Credit Facility), increasing borrowing capacity under the facility to $ 100 million, extending its maturity date from May 24, 2021 to February 22, 2023, and reducing the interest cost related to both undrawn commitments and drawn borrowings under the facility (as amended, the 2020 Revolving Credit Facility). Borrowings under the 2020 Revolving Credit Facility may be used for general corporate purposes, including to support the growth of our new business production and operations, and accrue interest at a variable rate equal to, at our discretion, (i) a base rate (as defined in our existing credit agreement (the Credit Agreement), subject to a floor of 1.00 % per annum) plus a margin of 0.375 % to 1.875 % per annum or (ii) the Eurodollar Rate (subject to a floor of — % per annum) plus a margin of 1.375 % to 2.875 % per annum, based on the applicable corporate credit rating at the time. As of June 30, 2020, no borrowings were drawn under the 2020 Revolving Credit Facility. Under the 2020 Revolving Credit Facility, we are required to pay a quarterly commitment fee on the average daily undrawn amount of 0.175 % to 0.525 %, based on the applicable corporate credit rating at the time. As of June 30, 2020, the applicable commitment fee was 0.35 %. For the three and six months ended June 30, 2020, we recorded $ 0.1 million and $ 0.2 million of commitment fees in interest expense, respectively. We incurred debt issuance costs of $ 0.8 million in connection with the 2020 Revolving Credit Facility and had $ 0.6 million of unamortized debt issuance costs associated with the 2018 Revolving Credit Facility remaining at the time of its amendment and replacement. Combined unamortized debt issuance will be amortized through interest expense on a straight-line basis over the contractual life of the 2020 Revolving Credit Facility. At June 30, 2020, remaining unamortized deferred debt issuance costs were $ 1.2 million. We are subject to certain covenants under the 2020 Revolving Credit Facility, including, but not limited to, the following: 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 (respectively, as defined therein). We were in compliance with all covenants at June 30, 2020. 5. Reinsurance We enter into third-party reinsurance transactions to actively manage our risk, ensure compliance with PMIERs, state regulatory and other applicable capital requirements (respectively, as defined therein), and support the growth of our business. The Wisconsin Office of the Commissioner of Insurance (Wisconsin OCI) has approved and the GSEs have indicated their non-objection to all such transactions (subject to certain conditions and ongoing review, including levels of approved capital credit). The effect of our reinsurance agreements on premiums written and earned is as follows: For the three months ended For the six months ended June 30, 2020 June 30, 2019 June 30, 2020 June 30, 2019 (In Thousands) Net premiums written Direct $ 108,478 $ 92,213 $ 211,931 $ 173,943 Ceded (1) ( 18,369 ) ( 9,604 ) ( 30,451 ) ( 19,411 ) Net premiums written $ 90,109 $ 82,609 $ 181,480 $ 154,532 Net premiums earned Direct $ 120,150 $ 95,180 $ 233,337 $ 181,478 Ceded (1) ( 21,206 ) ( 11,931 ) ( 35,676 ) ( 24,360 ) Net premiums earned $ 98,944 $ 83,249 $ 197,661 $ 157,118 (1) Net of profit commission. Excess-of-loss reinsurance NMIC entered into excess-of-loss reinsurance agreements with Oaktown Re Ltd., Oaktown Re II Ltd. and Oaktown Re III Ltd. (special purpose reinsurance entities collectively referred to as the Oaktown Re Vehicles) effective May 2, 2017, July 25, 2018 and July 30, 2019, respectively. Each agreement provides NMIC with aggregate excess-of-loss reinsurance coverage on a defined portfolio of mortgage insurance policies written during a discrete period. Under each agreement, NMIC retains a first 20 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) layer of aggregate loss exposure on covered policies and the respective Oaktown Re Vehicle then provides second layer loss protection up to a defined reinsurance coverage amount. NMIC then retains losses in excess of the respective reinsurance coverage amounts. NMIC makes risk premium payments to the Oaktown Re Vehicles for the applicable outstanding reinsurance coverage amount and pays an additional amount for anticipated operating expenses (capped at $ 300 thousand per year to Oaktown Re Ltd. and $ 250 thousand per year to Oaktown Re II, Ltd. and Oaktown Re III, Ltd.). NMIC ceded aggregate premiums to the Oaktown Re Vehicles of $ 3.3 million and $ 7.1 million during the three and six months ended June 30, 2020 and $ 2.9 million and $ 5.9 million during the three and six months ended June 30, 2019, respectively. NMIC applies claims paid on covered policies against its first layer aggregate retained loss exposure under each excess-of-loss agreement. NMIC did not cede any incurred losses on covered policies to the Oaktown Re Vehicles during the three and six months ended June 30, 2020 and 2019, as the aggregate first layer risk retention was not exhausted for each applicable agreement during such periods. Under the terms of each excess-of-loss reinsurance agreement, the Oaktown Re Vehicles are required to fully collateralize their outstanding reinsurance coverage amount to NMIC with funds deposited into segregated reinsurance trusts. Such trust funds are required to be invested in short-term U.S. Treasury money market funds at all times. Each Oaktown Re Vehicle financed its respective collateral requirement through the issuance of mortgage insurance-linked notes to unaffiliated investors. Such insurance-linked notes mature ten years from the inception date of each reinsurance agreement. We refer to NMIC's reinsurance agreements with and the insurance-linked note issuances by Oaktown Re Ltd., Oaktown Re II, Ltd. and Oaktown Re III, Ltd. individually as the 2017 ILN Transaction, 2018 ILN Transaction and 2019 ILN Transaction, and collectively as the ILN Transactions. The respective reinsurance coverage amounts provided by the Oaktown Re Vehicles decrease from the inception of each agreement over a ten -year period as the underlying insured mortgages are amortized or repaid, and/or the mortgage insurance coverage is canceled. As the reinsurance coverage decreases, a prescribed amount of collateral held in trust by the Oaktown Re Vehicles is distributed to ILN Transaction noteholders as amortization of the outstanding insurance-linked note principal balances. The outstanding reinsurance coverage amounts stop amortizing, and the collateral distribution to ILN Transaction noteholders and amortization of insurance-linked note principal is suspended if certain credit enhancement or delinquency thresholds, as defined in each agreement, are triggered (each, a Lock-Out Event). Effective June 25, 2020, a Lock-Out Event was deemed to have occurred for each of the 2017, 2018 and 2019 ILN Transactions and the amortization of reinsurance coverage, and distribution of collateral assets and amortization of insurance-linked notes was suspended for each ILN Transaction. The amortization of reinsurance coverage, distribution of collateral assets and amortization of insurance-linked notes will remain suspended for the duration of the Lock-Out Event for each ILN Transaction, and during such period assets will be preserved in the applicable reinsurance trust account to collateralize the excess-of-loss reinsurance coverage provided to NMIC. The following table presents the inception date, covered production p eriod, initial and current reinsurance coverage amount, and initial and current first layer retained aggregate loss under each of the ILN Transactions. Current amounts are presented as of June 30, 2020. ( $ values in thousands) Inception Date Covered Production Initial Reinsurance Coverage Current Reinsurance Coverage Initial First Layer Retained Loss Current First Layer Retained Loss (1) 2017 ILN Transaction May 2, 2017 1/1/2013 - 12/31/2016 $ 211,320 $ 40,226 $ 126,793 $ 122,034 2018 ILN Transaction July 25, 2018 1/1/2017 - 5/31/2018 264,545 158,489 125,312 123,694 2019 ILN Transaction July 30, 2019 6/1/2018 - 6/30/2019 326,905 231,877 123,424 123,345 (1) NMIC applies claims paid on covered policies against its first layer aggregate retained loss exposure and cedes reserves for incurred claims and claims expenses to each applicable ILN Transaction and recognizes a reinsurance recoverable if such incurred claims and claims expenses exceed its current first layer retained loss. NMIC holds optional termination rights under each ILN Transaction, including, among others , an optional call feature which provides NMIC the discretion to terminate the transaction on or after a prescribed date, and 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 a given agreement. In addition, there are certain events that trigger mandatory termination of an agreement, including NMIC's failure to pay premiums or consent to reductions in a trust account to make principal payments to noteholders, among others. 21 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Under the terms of the 2018 ILN Transaction and the 2019 ILN Transaction, we are required to maintain a certain level of restricted funds in premium deposit accounts with Bank of New York Mellon until the respective notes have been redeemed in full. "Cash and cash equivalents" on our condensed consolidated balance sheet includes restricted amounts of $ 2.1 million as of June 30, 2020. We are not required to deposit additional funds into the premium deposit accounts in the future and the restricted balances required under these transactions. Quota share reinsurance NMIC is a party to three outstanding quota share reinsurance treaties – the 2016 QSR Transaction, effective September 1, 2016, the 2018 QSR Transaction, effective January 1, 2018 and the 2020 QSR Transaction, effective April 1, 2020. Under each of the QSR Transactions, NMIC cedes a proportional share of its risk on eligible policies written during a discrete period to panels of third-party reinsurance providers. Each of the third-party reinsurance providers has an insurer financial strength rating of A- or better by Standard & Poor's Rating Service (S&P), A.M. Best Company, Inc. (A.M. Best) or both. Under the terms of the 2016 QSR Transaction, NMIC cedes premiums written related to 25 % of the risk on eligible primary policies written for all periods through December 31, 2017 and 100 % of the risk under our pool agreement with Fannie Mae. The 2016 QSR Transaction is scheduled to terminate on December 31, 2027, except with respect to the ceded pool risk, which is scheduled to terminate on August 31, 2023. NMIC has the option, based on certain conditions and subject to a termination fee, to terminate the agreement as of December 31, 2020, or at the end of any calendar quarter thereafter, which would result in NMIC re-assuming the related risk. Under the terms of the 2018 QSR Transaction, NMIC cedes premiums earned related to 25 % of the risk on eligible policies written in 2018 and 20 % of the risk on eligible policies written in 2019. The 2018 QSR Transaction is scheduled to terminate on December 31, 2029. 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 re-assuming the related risk. Under the terms of the 2020 QSR Transaction, NMIC cedes premiums earned related to eligible policies written from April 1, 2020 to December 31, 2020 (Eligible Policies). At the time the 2020 QSR Transaction agreement was executed, NMIC ceded premiums earned related to 10.5 % of the risk on the Eligible Policies, and subsequent to the execution of the agreement, we engaged additional reinsurance counterparties and increased the cession under the 2020 QSR Transaction to 21.0 % of the risk on the Eligible Policies, subject in all respects to the terms of the agreement. Financial results for the three and six months ended June 30, 2020 , reflect the initial 10.5 % cession rate under the 2020 QSR Transaction. The 2020 QSR Transaction is scheduled to terminate on December 31, 2031. NMIC has the option, based on certain conditions and subject to a termination fee, to terminate the agreement as of December 31, 2024, or at the end of any calendar quarter thereafter, which would result in NMIC re-assuming the related risk. NMIC may terminate any or all 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 risk-in-force (RIF) ceded under the respective agreements. Additionally, under the terms of the QSR Transactions, NMIC may elect to selectively terminate its engagement with individual reinsurers 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. Effective April 1, 2019, NMIC elected to terminate its engagement with one reinsurer under the 2016 QSR Transaction on a cut-off basis. In connection with the termination, NMIC recaptured approximately $ 500 million of previously ceded primary RIF and stopped ceding new premiums earned or written with respect to the recaptured risk. With the termination, ceded premiums written under the 2016 QSR Transaction decreased from 25 % to 20.5 % on eligible policies. The termination has no effect on the cession of pool risk under the 2016 QSR Transaction. 22 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) T he following table shows amounts related to the QSR Transactions: For the three months ended For the six months ended June 30, 2020 June 30, 2019 June 30, 2020 June 30, 2019 (In Thousands) Ceded risk-in-force $ 4,563,676 $ 4,558,862 $ 4,563,676 $ 4,558,862 Ceded premiums earned ( 23,210 ) ( 20,919 ) ( 46,221 ) ( 42,387 ) Ceded claims and claim expenses 8,669 770 10,201 1,669 Ceding commission earned 4,428 4,171 8,941 8,377 Profit commission 5,271 11,884 17,684 23,945 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 and 2020 QSR Transactions, 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 under each of the QSR Transactions, provided that the loss ratios on loans covered under the 2016 QSR Transaction, 2018 QSR Transaction and 2020 QSR Transaction, generally remain below 60 %, 61 % and 50 %, respectively, as measured annually. Ceded claims and claim expenses under each of the QSR Transactions reduce the respective profit commission received by NMIC 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 the 2016 QSR Transaction was $ 4.9 million as of June 30, 2020. In accordance with the terms of the 2018 and 2020 QSR Transactions, 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 the 2018 QSR Transaction was $ 9.4 million as of June 30, 2020. The reinsurance recoverable on loss reserves related to the 2020 QSR Transaction were immaterial as of June 30, 2020. 6. Reserves for Insurance Claims and Claim Expenses We hold gross reserves in an amount equal to the estimated liability for insurance claims and claim expenses related to defaults on insured mortgage loans. A loan is considered to be in "default" as of the payment date at which a borrower has missed the preceding two or more consecutive monthly payments. We establish reserves for loans that have been reported to us in default by servicers, referred to as case reserves, and additional loans that we estimate (based on actuarial review and other factors) to be in default that have not yet been reported to us by servicers, referred to as incurred but not reported (IBNR) reserves. We also establish reserves for claim expenses, which represent the estimated cost of the claim administration process, including legal and other fees, as well as other general expenses of administering the claim settlement process. As of June 30, 2020, we had 10,816 primary loans in default and held gross reserves for insurance claims and claim expenses of $ 69.9 million. During the six months ended June 30, 2020, we paid 83 claims totaling $ 4.1 million, including 78 claims covered under the QSR Transactions representing $ 0.8 million of ceded claims and claim expenses. 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 June 30, 2020, 231 loans in the pool were in default. These 231 loans represented approximately $ 19.6 million of RIF. Due to the size of the remaining deductible, the low level of defaults reported to us on loans in the pool through June 30, 2020 and the expected severity (all loans in the pool have loan-to-value (LTV) ratios under 80 %), we did not establish any case or IBNR reserves for pool risk at June 30, 2020. In connection with the settlement of pool claims, we applied $ 0.9 million to the pool deductible through June 30, 2020. At June 30, 2020, the remaining pool deductible was $ 9.5 million. We have not paid any pool claims to date. 100 % of our pool RIF is reinsured under the 2016 QSR Transaction. We had 10,816 loans in default in our primary insured portfolio as of June 30, 2020, which represented a 2.90 % default 23 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) rate against 372,934 to tal policies in-force. We had 1,028 loans in default in our primary insured portfolio as of June 30, 2019, which represented a 0.32 % default rate against 324,876 total policies in-force. The increase in our default population is primarily due to challenges borrowers are facing related to the COVID-19 outbreak and their decision to access the forbearance program for federally backed loans codified under the Coronavirus Aid, Relief and Economic Security (CARES) Act or similar programs made available by private lenders. The size of the reserve we establish for each defaulted loan (and by extension our aggregate reserve for claims and claim expenses) reflects our best estimate of the future claim payment to be made for each individual loan in default. Our future claims exposure is a function of the number of defaulted loans that progress to claim payment (which we refer to as frequency) and the amount to be paid to settle such claims (which we refer to as severity). Our estimates of claims frequency and severity are not formulaic, rather they are broadly synthesized based on historical observed experience for similarly situated loans and assumptions about future macroeconomic factors. We generally observe that forbearance programs are an effective tool to bridge dislocated borrowers from a time of acute stress to a future date when they can resume timely payment of their mortgage obligations. The effectiveness of forbearance programs is enhanced by the availability of various repayment and loan modification options which allow borrowers to amortize or, in certain instances, outright defer payments otherwise due during the forbearance period over an extended length of time. In response to the COVID-19 outbreak, the FHFA and GSEs have introduced new repayment and loan modification options to further assist borrowers with their transition out of forbearance programs and default status. Our reserve setting process considers the beneficial impact of forbearance, foreclosure moratorium and other assistance programs available to defaulted borrowers. We generally observe that forbearance programs are an effective tool to bridge dislocated borrowers from a time of acute stress to a future date when they can resume timely payment of their mortgage obligations. The effectiveness of forbearance programs is enhanced by the availability of various repayment and loan modification options which allow borrowers to amortize or, in certain instances, outright defer payments otherwise due during the forbearance period over an extended length of time. At June 30, 2020, we established lower reserves for defaults that we consider to be connected to the COVID-19 outbreak given our expectation that forbearance, repayment and modification, and other assistance programs will aid affected borrowers and drive higher cure rates on such defaults than we would otherwise expect to experience on similarly situated loans that did not benefit from broad-based assistance programs. While we established lower reserves per defaulted loan at June 30, 2020, our total reserve position and claims and claims expenses increased substantially as of and during the period ended June 30, 2020 due to the significant increase in the size of our default population. 24 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The following table provides a reconciliation of the beginning and ending gross reserve balances for primary insurance claims and claim expenses: For the six months ended June 30, 2020 2019 (In Thousands) Beginning balance $ 23,752 $ 12,811 Less reinsurance recoverables (1) ( 4,939 ) ( 3,001 ) Beginning balance, net of reinsurance recoverables 18,813 9,810 Add claims incurred: Claims and claim expenses incurred: Current year (2) 42,516 7,401 Prior years (3) ( 2,485 ) ( 1,735 ) Total claims and claim expenses incurred 40,031 5,666 Less claims paid: Claims and claim expenses paid: Current year (2) 39 — Prior years (3) 3,209 1,368 Reinsurance terminations (4) — ( 549 ) Total claims and claim expenses paid 3,248 819 Reserve at end of period, net of reinsurance recoverables 55,596 14,657 Add reinsurance recoverables (1) 14,307 3,775 Ending balance $ 69,903 $ 18,432 (1) Related to ceded losses recoverable under the QSR Transactions. See Note 5, " Reinsurance " for additional information. (2) Related to insured loans with their most recent defaults occurring in the current year. For example, if a loan defaulted in a prior year and subsequently cured and later re-defaulted in the current year, the default would be included in the current year. Amounts are presented net of reinsurance. (3) Related to insured loans with defaults occurring in prior years, which have been continuously in default before the start of the current year. Amounts are presented net of reinsurance. (4) Represents the settlement of reinsurance recoverables in conjunction with the termination of one reinsurer under the 2016 QSR Transaction on a cut-off basis. See Note 5, "Reinsurance" for additional information. The "claims incurred" section of the table above shows claims and claim expenses incurred on defaults occurring in current and prior years, including IBNR reserves and is presented net of reinsurance. The amount of claims incurred relating to current year defaults represents the estimated amount of claims and claim expenses to ultimately be paid on such loans. We recognized $ 2.5 million and $ 1.7 million of favorable prior year development during the six months ended June 30, 2020 and 2019, respectively, primarily due to the curing of previously reported defaults. We may increase or decrease our claim estimates and reserves as we learn additional information about individual defaulted loans, and continue to observe and analyze loss development trends in our portfolio. Gross reserves of $ 16.5 million related to prior year defaults remained as of June 30, 2020. 7. Earnings per Share (EPS) Basic EPS is based on the weighted average number of shares of common stock outstanding. Diluted EPS 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 restricted stock units (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 EPS of common stock. 25 NMI HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) For the three months ended June 30, For the six months ended June 30, 2020 2019 2020 2019 (In Thousands, except for per share data) Net income $ 26,848 $ 39,100 $ 85,119 $ 71,999 Basic weighted average shares outstanding 73,617 67,590 71,090 67,143 Basic earnings per share $ 0.36 $ 0.58 $ 1.20 $ 1.07 Net income $ 26,848 $ 39,100 $ 85,119 $ 71,999 Gain from change in fair value of warrant liability — — ( 4,723 ) — Diluted net income $ 26,848 $ 39,100 $ 80,396 $ 71,999 Basic weighted average shares outstanding 73,617 67,590 71,090 67,143 Dilutive effect of issuable shares 557 2,000 1,317 2,205 Diluted weighted average shares outstanding 74,174 69,590 72,407 69,348 Diluted earnings per share $ 0.36 $ 0.56 $ 1.11 $ 1.04 Anti-dilutive shares 609 705 78 748 8. Warrants We issued 992 thousand warrants in connection with a private placement of our common stock in April 2012. 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 three months ended June 30, 2020, no warrants were exercised. During the six months ended June 30, 2020, nine thousand warrants were exercised resulting in the issuance of six thousand shares of common stock. Upon exercise, we reclassified approximately $ 0.2 million of warrant fair value from warrant liability to additional paid-in capital. During the three months ended June 30, 2019, 193 thousand warrants were exercised resulting in the issuance of 129 thousand shares of common stock. Upon exercise, we reclassified approximately $ 3.9 million of warrant fair value from warrant liability to additional paid-in capital, of which $ 2.0 million related to changes in fair value during the three months ended June 30, 2019. During the six months ended June 30, 2019, 260 thousand warrants were exercised resulting in the issuance of 168 thousand shares of common stock. Upon exercise, we reclassified approximately $ 4.8 million of warrant fair value from warrant liability to additional paid-in capital, of which $ 2.3 million related to changes in fair value during the six months ended June 30, 2019. 9. Income Taxes We are a U.S. taxpayer and are subject to a statutory U.S. federal corporate income tax rate of 21%. NMIH files a consolidated U.S. federal and various state income tax returns on behalf of itself and its subsidiaries. Our effective tax rate on our pre-tax income was 23.2 % and 20.5 % for the three and six months ended June 30, 2020, respectively, compared to 23.3 % and 19.9 % for the three and six months ended June 30, 2019, respectively. Our provision for income taxes for interim reporting periods is established based on our estimated annual effective tax rate for a given year. Our effective tax rate may fluctuate between interim periods due to the impact of discrete items not included in our estimated annual effective tax rate, including the tax effects associated with the vesting of RSUs and exercise of options, and the change in fair value of our warrant liability. Such items are treated on a discrete basis in the reporting period in which they occur. As a mortgage guaranty insurance company, we are eligible to claim a tax deduction for our statutory contingency reserve balance, subject to certain limitations outlined under IRC Section 832(e), and only to the extent we acquire tax and loss bonds in an amount equal to the tax benefit derived from the claimed deduction, which is our intent. As a result, our interim provision for income taxes for the three and six months ended June 30, 2020 represents a change in our net deferred tax liability. As of June 30, 2020, we held $ 7.6 million of tax and loss bonds in "Other assets" in our condensed consolidated balance sheet. 26 10. Common Stock As of June 30, 2020, we had 84.8 million outstanding shares of common stock. Holders of our common stock have no preemptive or conversion rights or other subscription rights, and there are no redemption or sinking fund provisions applicable to the common stock. Each holder of our common stock is entitled to one vote per share on all matters to be voted upon by stockholders, and there are no cumulative voting rights. Holders of common stock are entitled to receive dividends ratably if any are declared. On June 8, 2020, we completed the sale of 13.8 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 15.9 million shares of common stock issued. The common stock offering generated proceeds of $ 219.7 million, net of underwriting discounts, commissions and other direct offering expenses. 11. Regulatory Information Statutory Requirements 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 National Association of Insurance Commissioners. 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 income (loss) was as follows: For the three months ended June 30, For the six months ended June 30, 2020 2019 2020 2019 (In Thousands) Statutory net (loss) gain $ ( 24,705 ) $ 6,466 $ ( 17,014 ) $ 5,539 NMIC and Re One's combined statutory surplus, contingency reserve and risk-to-capital (RTC) ratio were as follows: June 30, 2020 December 31, 2019 (In Thousands) Statutory surplus $ 892,160 $ 449,602 Contingency reserve 648,493 531,825 RTC ratio 13 .0:1 15.8 :1 In June 2020, NMIH contributed approximately $ 445 million of capital to NMIC following completion of its respective Notes and common stock offerings. 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 corporate law provides that dividends are only payable out of a corporation's capital surplus or, subject to certain limitations, recent net profits. NMIC and Re One are subject to certain rules and regulations prescribed by jurisdictions in which they are authorized to operate and the GSEs that may restrict their ability to pay dividends to NMIH. Since inception, NMIC and Re One have not paid any dividends to NMIH. NMIC and Re One have the capacity to pay aggregate ordinary dividends as calculated under Wisconsin law of $ 16.1 million to NMIH during the 12-month period ending December 31, 2020. The Wisconsin OCI has approved the allocation of interest expense on the $ 400 million Notes and $ 100 million 2020 Revolving Credit Facility to NMIC, to the extent proceeds from such offering and facility are distributed to NMIC or used to repay, redeem or otherwise defease amounts raised by NMIC under prior credit arrangements that have previously been distributed to NMIC. 12. Subsequent Event On July 30, 2020, NMIC entered into a reinsurance agreement with Oaktown Re IV Ltd. (Oaktown Re IV), a Bermuda domiciled special purpose reinsurer, that provides for up to $ 322.1 million of aggregate excess-of-loss reinsurance coverage at inception for new delinquencies on an existing portfolio of mortgage insurance policies written between July 1, 2019 and March 27 31, 2020. For the reinsurance coverage period, NMIC will retain the first layer of $ 169.5 million of aggregate losses and Oaktown Re IV will then provide second layer coverage up to the outstanding reinsurance coverage amount. NMIC will then retain losses in excess of the outstanding reinsurance coverage amount. Oaktown Re IV financed the coverage by issuing mortgage insurance-linked notes in an aggregate principal amount of $ 322.1 million to unaffiliated investors. The notes issued by Oaktown Re IV mature on July 25, 2030; all proceeds raised were deposited into a reinsurance trust to collateralize and fund the obligations of Oaktown Re IV 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 to NMIC's reinsurance agreement with and the insurance-linked notes issued by Oaktown Re IV as the 2020 ILN Transaction. Under the terms of the 2020 ILN Transaction, NMIC makes risk premium payments for the applicable outstanding reinsurance coverage amount and pays Oaktown Re IV for anticipated operating expenses (capped at $ 250,000 per year). 28