NMI Holdings, Inc. - 10-Q filing on 2017-08-01

Fair Value of Financial Instruments

6 Months Ended

Jun. 30, 2017

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 within which the fair value measurement in its entirety falls 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. There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the quarter ended June 30, 2017.

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.

The following tables present the level within the fair value hierarchy at which the Company’s 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, 2017	(In Thousands)
U.S. Treasury securities and obligations of U.S. government agencies	$	60,215	$	4,838	$	—	$	65,053
Municipal debt securities	—		79,622		—		79,622
Corporate debt securities	—		379,191		—		379,191
Asset-backed securities	—		104,248		—		104,248
Cash, cash equivalents and short-term investments	65,616		—		—		65,616
Total assets	$	125,831	$	567,899	$	—	$	693,730

Warrant liability	—		—		3,544		3,544
Total liabilities	$	—	$	—	$	3,544	$	3,544



	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, 2016	(In Thousands)
U.S. Treasury securities and obligations of U.S. government agencies	$	50,719	$	12,460	$	—	$	63,179
Municipal debt securities	—		40,269		—		40,269
Corporate debt securities	—		349,078		—		349,078
Asset-backed securities	—		114,661		—		114,661
Cash, cash equivalents and short-term investments	109,528		—		—		109,528
Total assets	$	160,247	$	516,468	$	—	$	676,715

Warrant liability	—		—		3,367		3,367
Total liabilities	$	—	$	—	$	3,367	$	3,367

There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the six months ended June 30, 2017 and the year-end December 31, 2016.

The following is a roll-forward of Level 3 liabilities measured at fair value:



	For the six months ended June 30,
Warrant Liability	2017		2016
	(In Thousands)
Balance, January 1	$	3,367	$	1,467
Change in fair value of warrant liability included in earnings	177		(611		)
Balance, June 30	$	3,544	$	856

We revalue the warrant liability quarterly using 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. As of June 30, 2017, the assumptions used in the option-pricing model were as follows: a common stock price as of June 30, 2017 of $11.45, risk free interest rate of 1.68%, expected life of 3.75 years, expected volatility of 30.6% and a dividend yield of 0%. The change in fair value is primarily attributable to an increase in the price of our common stock from December 31, 2016 to June 30, 2017.