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EX-32.1 - EXHIBIT 32.1 - Essent Group Ltd.a63017ex321.htm
EX-31.2 - EXHIBIT 31.2 - Essent Group Ltd.a63017ex312.htm
EX-31.1 - EXHIBIT 31.1 - Essent Group Ltd.a63017ex311.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
 
 
FORM 10-Q
 
 
 
 
(Mark One)
 
ý      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the period ended June 30, 2017
 
o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to             
 
Commission file number 001-36157 
 
  
ESSENT GROUP LTD.
(Exact name of registrant as specified in its charter)
 
  
Bermuda
 
Not Applicable
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
Clarendon House
2 Church Street
Hamilton HM11, Bermuda
(Address of principal executive offices and zip code)
 
(441) 297-9901
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232-405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)  Yes ý  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. 
Large accelerated filer
x
 
Accelerated filer
o
Non-accelerated filer
o
(Do not check if a smaller reporting company)
 
 
 
Smaller reporting company
o
 
 
 
Emerging growth company
o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý
The number of the registrant’s common shares outstanding as of August 1, 2017 was 93,423,101.



Essent Group Ltd. and Subsidiaries
 
Form 10-Q
 
Index
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


i


Unless the context otherwise indicates or requires, the terms “we,” “our,” “us,” “Essent,” and the “Company,” as used in this Quarterly Report on Form 10-Q, refer to Essent Group Ltd. and its directly and indirectly owned subsidiaries, including our primary operating subsidiaries, Essent Guaranty, Inc. and Essent Reinsurance Ltd., as a combined entity, except where otherwise stated or where it is clear that the terms mean only Essent Group Ltd. exclusive of its subsidiaries.
 
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This Quarterly Report on Form 10-Q, or Quarterly Report, includes forward-looking statements pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts or present facts or conditions, such as statements regarding our future financial condition or results of operations, our prospects and strategies for future growth, the introduction of new products and services, and the implementation of our marketing and branding strategies. In many cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or the negative of these terms or other comparable terminology.
 
The forward-looking statements contained in this Quarterly Report reflect our views as of the date of this Quarterly Report about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause events or our actual activities or results to differ significantly from those expressed in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future events, results, actions, levels of activity, performance or achievements. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements, including, but not limited to, those factors described below, in Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Quarterly Report, and in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission. These factors include, without limitation, the following:
 
changes in or to Fannie Mae and Freddie Mac, which we refer to collectively as the GSEs, whether through Federal legislation, restructurings or a shift in business practices;

failure to continue to meet the mortgage insurer eligibility requirements of the GSEs;

competition for our customers or the loss of a significant customer;
 
lenders or investors seeking alternatives to private mortgage insurance;

increase in the number of loans insured through Federal government mortgage insurance programs, including those offered by the Federal Housing Administration;

decline in the volume of low down payment mortgage originations;

uncertainty of loss reserve estimates;

decrease in the length of time our insurance policies are in force;

deteriorating economic conditions;

the definition of “Qualified Mortgage” reducing the size of the mortgage origination market or creating incentives to use government mortgage insurance programs;

the definition of “Qualified Residential Mortgage” reducing the number of low down payment loans or lenders and investors seeking alternatives to private mortgage insurance;

the implementation of the Basel III Capital Accord, which may discourage the use of private mortgage insurance;

management of risk in our investment portfolio;

fluctuations in interest rates;

inadequacy of the premiums we charge to compensate for our losses incurred;

ii



dependence on management team and qualified personnel;

disturbance to our information technology systems;

change in our customers’ capital requirements discouraging the use of mortgage insurance;

declines in the value of borrowers’ homes;

limited availability of capital;

unanticipated claims arise under and risks associated with our contract underwriting program;

industry practice that loss reserves are established only upon a loan default;

disruption in mortgage loan servicing;

risk of future legal proceedings;

customers’ technological demands;

our non-U.S. operations becoming subject to U.S. Federal income taxation;

becoming considered a passive foreign investment company for U.S. Federal income tax purposes; and

potential inability of our insurance subsidiaries to pay dividends.
 
Readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on these forward-looking statements. All of the forward-looking statements we have included in this Quarterly Report are based on information available to us on the date of this Quarterly Report. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as otherwise required by law.
 


iii


PART I — FINANCIAL INFORMATION
 
Item 1.   Financial Statements (Unaudited)
 
Essent Group Ltd. and Subsidiaries

Condensed Consolidated Balance Sheets (Unaudited)
 
 
 
June 30,
 
December 31,
(In thousands, except per share amounts)
 
2017
 
2016
Assets
 
 

 
 

Investments available for sale, at fair value
 
 

 
 

Fixed maturities (amortized cost: 2017 — $1,705,463; 2016 — $1,497,186)
 
$
1,710,057

 
$
1,482,754

Short-term investments (amortized cost: 2017 — $130,984; 2016 — $132,352)
 
130,984

 
132,348

Total investments
 
1,841,041

 
1,615,102

Cash
 
27,670

 
27,531

Accrued investment income
 
10,776

 
9,488

Accounts receivable
 
26,648

 
21,632

Deferred policy acquisition costs
 
14,037

 
13,400

Property and equipment (at cost, less accumulated depreciation of $48,513 in 2017 and $46,543 in 2016)
 
7,955

 
8,119

Prepaid federal income tax
 
215,357

 
181,272

Other assets
 
9,409

 
6,454

Total assets
 
$
2,152,893

 
$
1,882,998

 
 
 
 
 
Liabilities and Stockholders’ Equity
 
 

 
 

Liabilities
 
 

 
 

Reserve for losses and LAE
 
$
29,798

 
$
28,142

Unearned premium reserve
 
228,762

 
219,616

Net deferred tax liability
 
181,206

 
142,587

Credit facility borrowings (at carrying value, less unamortized deferred costs of $1,808 in 2017 and $0 in 2016)
 
173,192

 
100,000

Securities purchases payable
 
19,770

 
14,999

Other accrued liabilities
 
22,268

 
33,881

Total liabilities
 
654,996

 
539,225

Commitments and contingencies (see Note 6)
 


 


Stockholders’ Equity
 
 

 
 

Common shares, $0.015 par value:
 
 

 
 

Authorized - 233,333; issued and outstanding - 93,424 shares in 2017 and 93,105 shares in 2016
 
1,401

 
1,397

Additional paid-in capital
 
920,452

 
918,296

Accumulated other comprehensive income (loss)
 
1,065

 
(12,255
)
Retained earnings
 
574,979

 
436,335

Total stockholders’ equity
 
1,497,897

 
1,343,773

Total liabilities and stockholders’ equity
 
$
2,152,893

 
$
1,882,998

 
See accompanying notes to condensed consolidated financial statements.


1


Essent Group Ltd. and Subsidiaries
 
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands, except per share amounts)
 
2017
 
2016
 
2017

2016
Revenues:
 
 
 
 
 
 

 
 

Net premiums written
 
$
134,063

 
$
108,513

 
$
253,360

 
$
208,979

Increase in unearned premiums
 
(7,500
)
 
(7,802
)
 
(9,146
)
 
(13,865
)
Net premiums earned
 
126,563

 
100,711

 
244,214

 
195,114

Net investment income
 
9,400

 
6,701

 
17,835

 
12,884

Realized investment gains, net
 
544

 
583

 
1,199

 
1,054

Other income
 
1,099

 
170

 
1,950

 
1,579

Total revenues
 
137,606

 
108,165

 
265,198

 
210,631

 
 
 
 
 
 
 
 
 
Losses and expenses:
 
 

 
 

 
 

 
 

Provision for losses and LAE
 
1,770

 
2,964

 
5,463

 
6,695

Other underwriting and operating expenses
 
35,686

 
31,409

 
72,018

 
62,797

Interest expense
 
1,189

 

 
1,905

 

Total losses and expenses
 
38,645

 
34,373

 
79,386

 
69,492

 
 
 
 
 
 
 
 
 
Income before income taxes
 
98,961

 
73,792

 
185,812

 
141,139

Income tax expense
 
26,843

 
21,534

 
47,096

 
40,930

Net income
 
$
72,118

 
$
52,258

 
$
138,716

 
$
100,209

 
 
 
 
 
 
 
 
 
Earnings per share:
 
 

 
 

 
 

 
 

Basic
 
$
0.79

 
$
0.57

 
$
1.52

 
$
1.10

Diluted
 
0.77

 
0.57

 
1.49

 
1.09

 
 
 
 
 
 
 
 
 
Weighted average shares outstanding:
 
 

 
 

 
 

 
 

Basic
 
91,381

 
90,912

 
91,320

 
90,848

Diluted
 
93,162

 
92,138

 
93,093

 
91,999

 
 
 
 
 
 
 
 
 
Net income
 
$
72,118

 
$
52,258

 
$
138,716

 
$
100,209

 
 
 
 
 
 
 
 
 
Other comprehensive income (loss):
 
 

 
 

 
 

 
 

Change in unrealized appreciation of investments, net of tax expense of $3,649 and $5,049 in the three months ended June 30, 2017 and 2016 and $5,710 and $10,763 in the six months ended June 30, 2017 and 2016
 
8,470

 
10,702

 
13,320

 
24,061

Total other comprehensive income
 
8,470

 
10,702

 
13,320

 
24,061

Comprehensive income
 
$
80,588

 
$
62,960

 
$
152,036

 
$
124,270

 
See accompanying notes to condensed consolidated financial statements.


2


Essent Group Ltd. and Subsidiaries
 
Condensed Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
 
(In thousands)
 
Common
Shares
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Retained
Earnings
 
Treasury
Stock
 
Total
Stockholders’
Equity
Balance at January 1, 2016
 
$
1,390

 
$
904,221

 
$
(99
)
 
$
213,729

 
$

 
$
1,119,241

 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
 

 
 

 
 

 
222,606

 
 

 
222,606

Other comprehensive loss
 
 

 
 

 
(12,156
)
 
 

 
 

 
(12,156
)
Issuance of management incentive shares
 
10

 
(10
)
 
 

 
 

 
 

 

Forfeiture of management incentive shares
 

 

 
 

 
 

 
 

 

Stock-based compensation expense
 
 

 
16,881

 
 

 
 

 
 

 
16,881

Excess tax benefits from stock-based compensation expense
 
 

 
1,083

 
 

 
 

 
 

 
1,083

Treasury stock acquired
 
 

 
 

 
 

 
 

 
(4,024
)
 
(4,024
)
Cancellation of treasury stock
 
(3
)
 
(4,021
)
 
 

 
 

 
4,024

 

Other equity transactions
 
 
 
142

 
 
 
 
 
 
 
142

Balance at December 31, 2016
 
$
1,397

 
$
918,296

 
$
(12,255
)
 
$
436,335

 
$

 
$
1,343,773

 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
 

 
 

 
 

 
138,716

 
 

 
138,716

Other comprehensive income
 
 

 
 

 
13,320

 
 

 
 

 
13,320

Issuance of management incentive shares
 
8

 
(8
)
 
 

 
 

 
 

 

Stock-based compensation expense
 
 

 
9,288

 
 

 
 

 
 

 
9,288

Cumulative effect of ASU 2016-09 adoption
 
 
 
111

 
 
 
(72
)
 
 
 
39

Treasury stock acquired
 
 

 
 

 
 

 
 

 
(7,239
)
 
(7,239
)
Cancellation of treasury stock
 
(4
)
 
(7,235
)
 
 

 
 

 
7,239

 

Balance at June 30, 2017
 
$
1,401

 
$
920,452

 
$
1,065

 
$
574,979

 
$

 
$
1,497,897

 
See accompanying notes to condensed consolidated financial statements.


3


Essent Group Ltd. and Subsidiaries
 
Condensed Consolidated Statements of Cash Flows (Unaudited)
 
 
 
Six Months Ended June 30,
(In thousands)
 
2017
 
2016
Operating Activities
 
 

 
 

Net income
 
$
138,716

 
$
100,209

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Gain on the sale of investments, net
 
(1,199
)
 
(1,054
)
Depreciation and amortization
 
1,970

 
2,040

Stock-based compensation expense
 
9,288

 
7,949

Amortization of premium on investment securities
 
5,833

 
5,218

Deferred income tax provision
 
32,948

 
28,264

Change in:
 
 

 
 

Accrued investment income
 
(1,288
)
 
(712
)
Accounts receivable
 
(4,134
)
 
(2,478
)
Deferred policy acquisition costs
 
(637
)
 
(710
)
Prepaid federal income tax
 
(34,085
)
 
(30,360
)
Other assets
 
(1,877
)
 
(375
)
Reserve for losses and LAE
 
1,656

 
4,714

Unearned premium reserve
 
9,146

 
13,865

Other accrued liabilities
 
(11,934
)
 
(3,480
)
Net cash provided by operating activities
 
144,403

 
123,090

 
 
 
 
 
Investing Activities
 
 

 
 

Net change in short-term investments
 
1,364

 
(43,239
)
Purchase of investments available for sale
 
(396,919
)
 
(268,024
)
Proceeds from maturity of investments available for sale
 
36,318

 
9,043

Proceeds from sales of investments available for sale
 
151,583

 
178,719

Purchase of property and equipment
 
(1,806
)
 
(2,049
)
Net cash used in investing activities
 
(209,460
)
 
(125,550
)
 
 
 
 
 
Financing Activities
 
 

 
 

Credit facility borrowings
 
200,000

 

Credit facility repayments
 
(125,000
)
 

Treasury stock acquired
 
(7,239
)
 
(3,876
)
Payment of issuance costs for credit facility
 
(2,565
)
 
(2,098
)
Net cash provided by (used in) financing activities
 
65,196

 
(5,974
)
 
 
 
 
 
Net increase (decrease) in cash
 
139

 
(8,434
)
Cash at beginning of year
 
27,531

 
24,606

Cash at end of period
 
$
27,670

 
$
16,172

 
 
 
 
 
Supplemental Disclosure of Cash Flow Information
 
 
 
 
Income tax payments
 
$
(16,700
)
 
$
(10,800
)
Interest payments
 
(1,772
)
 

 
See accompanying notes to condensed consolidated financial statements.

4


Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
 
In these notes to condensed consolidated financial statements, “Essent”, “Company”, “we”, “us”, and “our” refer to Essent Group Ltd. and its subsidiaries, unless the context otherwise requires.
 
Note 1. Nature of Operations and Basis of Presentation
 
Essent Group Ltd. (“Essent Group”) is a Bermuda-based holding company, which, through its wholly-owned subsidiaries, offers private mortgage insurance and reinsurance for mortgages secured by residential properties located in the United States. Mortgage insurance facilitates the sale of low down payment (generally less than 20%) mortgage loans into the secondary mortgage market, primarily to two government-sponsored enterprises (“GSEs”), Fannie Mae and Freddie Mac.

The primary mortgage insurance operations are conducted through Essent Guaranty, Inc. (“Essent Guaranty”), a wholly-owned subsidiary approved as a qualified mortgage insurer by the GSEs and is licensed to write mortgage insurance in all 50 states and the District of Columbia. Essent Guaranty reinsures 25% of GSE-eligible new insurance written to Essent Reinsurance Ltd. (“Essent Re”), an affiliated Bermuda domiciled Class 3A Insurer licensed pursuant to Section 4 of the Bermuda Insurance Act 1978 that provides insurance and reinsurance coverage of mortgage credit risk. Essent Re also provides insurance and reinsurance to Freddie Mac and Fannie Mae. In 2016, Essent Re formed Essent Agency (Bermuda) Ltd., a wholly-owned subsidiary, which provides underwriting services to third-party reinsurers. In accordance with certain state law requirements, Essent Guaranty also reinsures that portion of the risk that is in excess of 25% of the mortgage balance with respect to any loan insured, after consideration of other reinsurance, to Essent Guaranty of PA, Inc. (“Essent PA”), an affiliate.
 
In addition to offering mortgage insurance, we provide contract underwriting services on a limited basis through CUW Solutions, LLC ("CUW Solutions"), a Delaware limited liability company, that provides, among other things, mortgage contract underwriting services to lenders and mortgage insurance underwriting services to affiliates.

We have prepared the condensed consolidated financial statements included herein pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). We have condensed or omitted certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) pursuant to such rules and regulations. In the opinion of management, the statements include all adjustments (which include normal recurring adjustments) required for a fair statement of financial position, results of operations and cash flows for the interim periods presented. These statements should be read in conjunction with the consolidated financial statements and notes thereto, including Note 1 and Note 2 to the consolidated financial statements, included in our Annual Report on Form 10-K for the year ended December 31, 2016, which discloses the principles of consolidation and a summary of significant accounting policies. The results of operations for the interim periods are not necessarily indicative of the results for the full year. We evaluated the need to recognize or disclose events that occurred subsequent to June 30, 2017 prior to the issuance of these condensed consolidated financial statements.

Certain amounts in prior years have been reclassified to conform to the current year presentation.
 
Note 2. Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This update is intended to provide a consistent approach in recognizing revenue. In accordance with the new standard, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, the new standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. In July 2015, the FASB delayed the effective date for this update to interim and annual periods beginning after December 15, 2017. In December 2016, the FASB clarified that all contracts that are within the scope of Topic 944, Financial Services-Insurance, are excluded from the scope of ASU 2014-09. Accordingly, this update will not impact the recognition of revenue related to insurance premiums or investments, which represent a significant portion of our total revenues. The adoption of this ASU is not expected to have a material effect on the Company's consolidated operating results or financial position.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This update requires certain equity investments (except those

5

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


accounted for under the equity method of accounting or result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. An entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. A qualitative assessment for impairment is required for equity investments without readily determinable fair values. This update also requires public entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. In addition, an entity is required to evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale investment securities in combination with the entity’s other deferred tax assets. The provisions of this update are effective for interim and annual periods beginning after December 15, 2017. The Company is evaluating the impact the adoption of this ASU will have on the consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This update will require organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. The new guidance will also require additional disclosures about the amount, timing and uncertainty of cash flows arising from leases. The provisions of this update are effective for annual and interim periods beginning after December 15, 2018. The Company expects a gross-up of its consolidated balance sheets as a result of recognizing lease liabilities and right of use assets. The Company is still evaluating the impact the adoption of this ASU will have on the consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (Topic 718). This update is intended to simplify several aspects of the accounting for share-based payment award transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The new guidance requires all excess tax benefits and tax deficiencies to be recognized as income tax expense or benefit in the income statement and treated as discrete items in the reporting period. In addition, excess tax benefits are required to be classified along with other income tax cash flows as an operating activity. Further, the new guidance allows for a policy election to account for forfeitures as they occur rather than on an estimated basis. The Company adopted this ASU on January 1, 2017 and recorded a charge of $0.1 million to retained earnings as of that date representing a cumulative-effect adjustment associated with our election to recognize forfeitures as they occur. The classification of excess tax benefits and tax deficiencies as income tax benefit or expense may result in net income volatility in reporting periods subsequent to 2016. Through December 31, 2016, excess tax benefits were recognized in additional paid-in-capital. In the three and six months ended June 30, 2017, the Company recorded excess tax benefits of $0.1 million and $3.1 million, respectively, as a reduction of income tax expense. The amount of excess tax benefits or tax deficiencies in future periods will vary based on the market value of the Company’s common stock at the vesting dates of nonvested common share and nonvested common share units.

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments (Topic 326). This update is intended to provide financial statement users with more information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The amendments in this ASU replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The new guidance requires financial assets measured at amortized cost to be presented at the net amount expected to be collected through the use of an allowance for credit losses. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance rather than as a write-down of the amortized cost of the securities. The provisions of this update are effective for annual and interim periods beginning after December 15, 2019. While the Company is still evaluating this ASU, we do not expect it to impact our accounting for insurance losses and loss adjustment expenses ("LAE") as these items are not within the scope of this ASU.


6

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


Note 3. Investments Available for Sale
 
Investments available for sale consist of the following:
 
June 30, 2017 (In thousands)
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
U.S. Treasury securities
 
$
205,023

 
$
87

 
$
(2,746
)
 
$
202,364

U.S. agency securities
 
26,599

 
8

 
(250
)
 
26,357

U.S. agency mortgage-backed securities
 
402,961

 
778

 
(6,137
)
 
397,602

Municipal debt securities(1)
 
362,363

 
8,551

 
(846
)
 
370,068

Corporate debt securities(2)
 
552,306

 
5,628

 
(1,969
)
 
555,965

Residential and commercial mortgage securities
 
68,421

 
1,524

 
(273
)
 
69,672

Asset-backed securities
 
135,266

 
451

 
(212
)
 
135,505

Money market funds
 
83,508

 

 

 
83,508

Total investments available for sale
 
$
1,836,447

 
$
17,027

 
$
(12,433
)
 
$
1,841,041


December 31, 2016 (In thousands)
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
U.S. Treasury securities
 
$
195,990

 
$
55

 
$
(4,497
)
 
$
191,548

U.S. agency securities
 
18,785

 

 
(344
)
 
18,441

U.S. agency mortgage-backed securities
 
324,654

 
335

 
(8,495
)
 
316,494

Municipal debt securities(1)
 
334,048

 
3,649

 
(3,373
)
 
334,324

Corporate debt securities(2)
 
457,842

 
2,343

 
(3,828
)
 
456,357

Residential and commercial mortgage securities
 
68,430

 
488

 
(582
)
 
68,336

Asset-backed securities
 
127,359

 
260

 
(447
)
 
127,172

Money market funds
 
102,430

 

 

 
102,430

Total investments available for sale
 
$
1,629,538

 
$
7,130

 
$
(21,566
)
 
$
1,615,102

 
 
 
June 30,
 
December 31,
(1) The following table summarizes municipal debt securities as of :
 
2017
 
2016
Special revenue bonds
 
62.0
%
 
63.6
%
General obligation bonds
 
32.2

 
29.7

Certificate of participation bonds
 
4.5

 
4.9

Tax allocation bonds
 
0.7

 
1.1

Special tax bonds
 
0.6

 
0.7

Total
 
100.0
%
 
100.0
%
 
 
June 30,
 
December 31,
(2) The following table summarizes corporate debt securities as of :
 
2017
 
2016
Financial
 
44.3
%
 
40.6
%
Consumer, non-cyclical
 
15.1

 
18.6

Energy
 
9.3

 
9.3

Communications
 
7.0

 
6.0

Utilities
 
6.4

 
6.0

Industrial
 
5.8

 
5.6

Consumer, cyclical
 
5.2

 
6.3

Technology
 
4.4

 
4.3

Basic materials
 
2.5

 
3.3

Total
 
100.0
%
 
100.0
%

7

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)



The amortized cost and fair value of investments available for sale at June 30, 2017, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Because most U.S. agency mortgage-backed securities, residential and commercial mortgage securities and asset-backed securities provide for periodic payments throughout their lives, they are listed below in separate categories.
 
(In thousands)
 
Amortized
Cost
 
Fair
Value
U.S. Treasury securities:
 
 

 
 

Due in 1 year
 
$
59,647

 
$
59,629

Due after 1 but within 5 years
 
47,536

 
47,379

Due after 5 but within 10 years
 
67,560

 
65,544

Due after 10 years
 
30,280

 
29,812

Subtotal
 
205,023

 
202,364

U.S. agency securities:
 
 

 
 

Due in 1 year
 

 

Due after 1 but within 5 years
 
26,599

 
26,357

Subtotal
 
26,599

 
26,357

Municipal debt securities:
 
 

 
 

Due in 1 year
 
13,933

 
13,949

Due after 1 but within 5 years
 
107,518

 
108,063

Due after 5 but within 10 years
 
141,366

 
146,278

Due after 10 years
 
99,546

 
101,778

Subtotal
 
362,363

 
370,068

Corporate debt securities:
 
 

 
 

Due in 1 year
 
62,114

 
62,132

Due after 1 but within 5 years
 
300,591

 
302,093

Due after 5 but within 10 years
 
186,284

 
188,435

Due after 10 years
 
3,317

 
3,305

Subtotal
 
552,306

 
555,965

U.S. agency mortgage-backed securities
 
402,961

 
397,602

Residential and commercial mortgage securities
 
68,421

 
69,672

Asset-backed securities
 
135,266

 
135,505

Money market funds
 
83,508

 
83,508

Total investments available for sale
 
$
1,836,447

 
$
1,841,041


Gross gains and losses realized on the sale of investments available for sale were as follows:
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands)
 
2017
 
2016
 
2017
 
2016
Realized gross gains
 
$
749

 
$
624

 
$
1,430

 
$
1,772

Realized gross losses
 
205

 
41

 
231

 
711

 

8

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


The fair value of investments in an unrealized loss position and the related unrealized losses were as follows:
 
 
 
Less than 12 months
 
12 months or more
 
Total
June 30, 2017 (In thousands)
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
U.S. Treasury securities
 
$
162,420

 
$
(2,746
)
 
$

 
$

 
$
162,420

 
$
(2,746
)
U.S. agency securities
 
20,232

 
(250
)
 

 

 
20,232

 
(250
)
U.S. agency mortgage-backed securities
 
310,680

 
(6,063
)
 
2,208

 
(74
)
 
312,888

 
(6,137
)
Municipal debt securities
 
70,885

 
(816
)
 
4,017

 
(30
)
 
74,902

 
(846
)
Corporate debt securities
 
192,204

 
(1,943
)
 
7,564

 
(26
)
 
199,768

 
(1,969
)
Residential and commercial mortgage securities
 
12,218

 
(264
)
 
1,547

 
(9
)
 
13,765

 
(273
)
Asset-backed securities
 
32,371

 
(108
)
 
19,080

 
(104
)
 
51,451

 
(212
)
Total
 
$
801,010

 
$
(12,190
)
 
$
34,416

 
$
(243
)
 
$
835,426

 
$
(12,433
)
 
 
 
Less than 12 months
 
12 months or more
 
Total
December 31, 2016 (In thousands)
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
U.S. Treasury securities
 
$
160,018

 
$
(4,497
)
 
$

 
$

 
$
160,018

 
$
(4,497
)
U.S. agency securities
 
18,441

 
(344
)
 

 

 
18,441

 
(344
)
U.S. agency mortgage-backed securities
 
289,282

 
(8,402
)
 
1,812

 
(93
)
 
291,094

 
(8,495
)
Municipal debt securities
 
149,368

 
(3,351
)
 
6,015

 
(22
)
 
155,383

 
(3,373
)
Corporate debt securities
 
213,965

 
(3,704
)
 
8,344

 
(124
)
 
222,309

 
(3,828
)
Residential and commercial mortgage securities
 
18,026

 
(434
)
 
14,014

 
(148
)
 
32,040

 
(582
)
Asset-backed securities
 
28,294

 
(57
)
 
47,597

 
(390
)
 
75,891

 
(447
)
Total
 
$
877,394

 
$
(20,789
)
 
$
77,782

 
$
(777
)
 
$
955,176

 
$
(21,566
)
 
The gross unrealized losses on these investment securities are principally associated with the changes in market interest rates and credit spreads subsequent to their purchase. Each issuer is current on its scheduled interest and principal payments. We assess our intent to sell these securities and whether we will be required to sell these securities before the recovery of their amortized cost basis when determining whether an impairment is other-than-temporary. There were no other-than-temporary impairments in the three and six months ended June 30, 2017. We recorded an other-than-temporary impairment of $7 thousand in the six months ended June 30, 2016 on a security in an unrealized loss position. The impairment resulted from our intent to sell the security subsequent to the reporting date.
 
The fair value of investments deposited with insurance regulatory authorities to meet statutory requirements was $8.6 million as of June 30, 2017 and $8.5 million as of December 31, 2016. In connection with its insurance and reinsurance activities, Essent Re is required to maintain assets in trusts for the benefit of its contractual counterparties. The fair value of the investments on deposit in these trusts was $487.4 million at June 30, 2017 and $349.6 million at December 31, 2016.

Net investment income consists of: 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands)
 
2017
 
2016
 
2017
 
2016
Fixed maturities
 
$
9,963

 
$
7,197

 
$
18,982

 
$
13,852

Short-term investments
 
74

 
30

 
133

 
63

Gross investment income
 
10,037

 
7,227

 
19,115

 
13,915

Investment expenses
 
(637
)
 
(526
)
 
(1,280
)
 
(1,031
)
Net investment income
 
$
9,400

 
$
6,701

 
$
17,835

 
$
12,884

 

9

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


Note 4. Reserve for Losses and Loss Adjustment Expenses
 
The following table provides a reconciliation of the beginning and ending reserve balances for losses and loss adjustment expenses (“LAE”) for the six months ended June 30:
 
($ in thousands)
 
2017
 
2016
Reserve for losses and LAE at beginning of period
 
$
28,142

 
$
17,760

Less: Reinsurance recoverables
 

 

Net reserve for losses and LAE at beginning of period
 
28,142

 
17,760

Add provision for losses and LAE, net of reinsurance, occurring in:
 
 

 
 

Current period
 
12,116

 
9,568

Prior years
 
(6,653
)
 
(2,873
)
Net incurred losses during the current period
 
5,463

 
6,695

Deduct payments for losses and LAE, net of reinsurance, occurring in:
 
 

 
 

Current period
 
97

 
112

Prior years
 
3,710

 
1,869

Net loss and LAE payments during the current period
 
3,807

 
1,981

Net reserve for losses and LAE at end of period
 
29,798

 
22,474

Plus: Reinsurance recoverables
 

 

Reserve for losses and LAE at end of period
 
$
29,798

 
$
22,474

 
 
 
 
 
Loans in default at end of period
 
1,776

 
1,174

 
For the six months ended June 30, 2017, $3.7 million was paid for incurred claims and claim adjustment expenses attributable to insured events of prior years. There has been a $6.7 million favorable prior year development during the six months ended June 30, 2017. Reserves remaining as of June 30, 2017 for prior years are $17.8 million as a result of re-estimation of unpaid losses and loss adjustment expenses. For the six months ended June 30, 2016, $1.9 million was paid for incurred claims and claim adjustment expenses attributable to insured events of prior years. There was a $2.9 million favorable prior year development during the six months ended June 30, 2016. Reserves remaining as of June 30, 2016 for prior years were $13.0 million as a result of re-estimation of unpaid losses and loss adjustment expenses. In both periods, the favorable prior years' loss development was the result of a re-estimation of amounts ultimately to be paid on prior year defaults in the default inventory, including the impact of previously identified defaults that cured. Original estimates are increased or decreased as additional information becomes known regarding individual claims.


10

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


Note 5. Debt Obligations
 
Revolving Credit Facility

On May 17, 2017, Essent Group and its subsidiaries, Essent Irish Intermediate Holdings Limited and Essent US Holdings, Inc. (collectively, the "Borrowers"), entered into an amended and restated four-year, secured credit facility with a committed capacity of $375 million (the “Credit Facility”). The Credit Facility amends and restates the three-year, secured revolving credit facility entered into on April 19, 2016, and provides for (i) an increase in the revolving credit facility from $200 million to $250 million, (ii) the issuance of term loans of $125 million, the proceeds of which were used at closing to pay down borrowings outstanding under the revolving credit facility, and (iii) a $75 million uncommitted line that may be exercised at the Borrowers’ option so long as the Borrowers receive commitments from the lenders. Borrowings under the Credit Facility may be used for working capital and general corporate purposes, including, without limitation, capital contributions to Essent’s insurance and reinsurance subsidiaries. Borrowings accrue interest at a floating rate tied to a standard short-term borrowing index, selected at the Company’s option, plus an applicable margin. A commitment fee is due quarterly on the average daily amount of the undrawn revolving commitment. The applicable margin and the commitment fee are based on the senior unsecured debt rating or long-term issuer rating of Essent Group to the extent available, or the insurer financial strength rating of Essent Guaranty. The current annual commitment fee rate is 0.35%. The obligations under the Credit Facility are secured by certain assets of the Borrowers, excluding the stock and assets of its insurance and reinsurance subsidiaries. The Credit Facility contains several covenants, including financial covenants relating to minimum net worth, capital and liquidity levels, maximum debt to capitalization level and Essent Guaranty's compliance with the PMIERS (see Note 11). The $125 million term loans contractually mature on May 17, 2021. This description is not intended to be complete in all respects and is qualified in its entirety by the terms of the Credit Facility, including its covenants. As of June 30, 2017, the Company was in compliance with the covenants and $175 million had been borrowed under the Credit Facility with a weighted average interest rate of 3.21%.

Note 6. Commitments and Contingencies
 
Obligations under Guarantees
 
Under the terms of CUW Solutions' contract underwriting agreements with lenders and subject to contractual limitations on liability, we agree to indemnify certain lenders against losses incurred in the event that we make an error in determining whether loans processed meet specified underwriting criteria, to the extent that such error materially restricts or impairs the salability of such loan, results in a material reduction in the value of such loan or results in the lender repurchasing the loan. The indemnification may be in the form of monetary or other remedies. We paid $68,018 and $42,173 related to remedies for the six months ended June 30, 2017 and 2016, respectively. As of June 30, 2017, management believes any potential claims for indemnification related to contract underwriting services through June 30, 2017 are not material to our consolidated financial position or results of operations.
 
In addition to the indemnifications discussed above, in the normal course of business, we enter into agreements or other relationships with third parties pursuant to which we may be obligated under specified circumstances to indemnify the counterparties with respect to certain matters. Our contractual indemnification obligations typically arise in the context of agreements entered into by us to, among other things, purchase or sell services, finance our business and business transactions, lease real property and license intellectual property. The agreements we enter into in the normal course of business generally require us to pay certain amounts to the other party associated with claims or losses if they result from our breach of the agreement, including the inaccuracy of representations or warranties. The agreements we enter into may also contain other indemnification provisions that obligate us to pay amounts upon the occurrence of certain events, such as the negligence or willful misconduct of our employees, infringement of third-party intellectual property rights or claims that performance of the agreement constitutes a violation of law. Generally, payment by us under an indemnification provision is conditioned upon the other party making a claim, and typically we can challenge the other party’s claims. Further, our indemnification obligations may be limited in time and/or amount, and in some instances, we may have recourse against third parties for certain payments made by us under an indemnification agreement or obligation. As of June 30, 2017, contingencies triggering material indemnification obligations or payments have not occurred historically and are not expected to occur. The nature of the indemnification provisions in the various types of agreements and relationships described above are believed to be low risk and pervasive, and we consider them to have a remote risk of loss or payment. We have not recorded any provisions on the condensed consolidated balance sheets related to indemnifications.
 

11

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


Note 7. Stock-Based Compensation
 
The following table summarizes nonvested common share and nonvested common share unit activity for the six months ended June 30, 2017:
 
 
 
Time and Performance-
Based Share Awards
 
Time-Based
Share Awards
 
Share Units
(Shares in thousands)
 
Number of
Shares
 
Weighted
Average
Grant Date
Fair Value
 
Number of
Shares
 
Weighted
Average
Grant Date
Fair Value
 
Number of
Share Units
 
Weighted
Average
Grant Date
Fair Value
Outstanding at beginning of year
 
1,503

 
$
15.41

 
605

 
$
16.32

 
493

 
$
19.24

Granted
 
140

 
36.29

 
91

 
36.29

 
387

 
33.40

Vested
 
(48
)
 
22.48

 
(272
)
 
16.06

 
(303
)
 
18.67

Forfeited
 

 
N/A

 

 
N/A

 
(18
)
 
30.24

Outstanding at June 30, 2017
 
1,595

 
$
17.03

 
424

 
$
20.75

 
559

 
$
28.98


In February 2017, certain members of senior management were granted nonvested common shares under the Essent Group Ltd. 2013 Long-Term Incentive Plan ("2013 Plan") that were subject to time-based and performance-based vesting. The time-based share awards granted in February 2017 vest in three equal installments on March 1, 2018, 2019 and 2020. The performance-based share awards granted in February 2017 vest based upon our compounded annual book value per share growth percentage during a three-year performance period that commenced on January 1, 2017 and vest on March 1, 2020. The portion of these nonvested performance-based share awards that will be earned based upon the achievement of compounded annual book value per share growth is as follows:
 
Performance level
 
 
Compounded Annual Book Value
Per Share Growth
 
Nonvested Common
Shares Earned
 
 
 
<16
%
 
0
%
Threshold
 
 
16
%
 
25
%
 
 
 
17
%
 
50
%
 
 
 
18
%
 
75
%
Maximum
 
 
≥19
%
 
100
%
 
 
 
 
 
 
 
In the event that the compounded annual book value per share growth falls between the performance levels shown above, the nonvested common shares earned will be determined on a straight-line basis between the respective levels shown.
 
In January 2017, time-based share units were issued to all vice president and staff level employees that vest in three equal installments in January 2018, 2019 and 2020. In connection with our incentive program covering bonus awards for performance year 2016, in February 2017, time-based share awards and share units were issued to certain employees that vest in three equal installments on March 1, 2018, 2019 and 2020. In May 2017, time-based share units were granted to non-employee directors that vest one year from the date of grant.

Amendments to our 2013 Plan were approved by shareholders and effective as of May 3, 2017. These amendments included a reduction in the maximum number of shares and share units available for issuance to 7.5 million under the Amended and Restated 2013 Plan (inclusive of approximately 2.6 million nonvested shares and share units outstanding as of May 3, 2017), down from the approximately 14.7 million shares and share units originally available for issuance under the 2013 Plan.

The total fair value on the vesting date of nonvested shares or share units that vested was $21.1 million and $14.2 million for the six months ended June 30, 2017 and 2016, respectively. As of June 30, 2017, there was $27.8 million of total unrecognized compensation expense related to nonvested shares or share units outstanding at June 30, 2017 and we expect to recognize the expense over a weighted average period of 2.0 years.
 

12

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


Employees have the option to tender shares to Essent Group to pay the minimum employee statutory withholding taxes associated with shares upon vesting. Common shares tendered by employees to pay employee withholding taxes totaled 214,474 in the six months ended June 30, 2017. The tendered shares were recorded at cost and included in treasury stock. All treasury stock has been cancelled as of June 30, 2017.
 
Compensation expense, net of forfeitures, and related tax effects recognized in connection with nonvested shares was as follows:
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands)
 
2017
 
2016
 
2017
 
2016
Compensation expense
 
$
4,669

 
$
4,167

 
$
9,288

 
$
7,949

Income tax benefit
 
1,502

 
1,346

 
2,985

 
2,558

 
Note 8. Earnings per Share (EPS)
 
The following table reconciles the net income and the weighted average common shares outstanding used in the computations of basic and diluted earnings per common share:
 
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
(In thousands, except per share amounts)
 
2017
 
2016
 
2017
 
2016
Net income
 
$
72,118

 
$
52,258

 
$
138,716

 
$
100,209

Less: dividends declared
 

 

 

 

Net income available to common shareholders
 
$
72,118


$
52,258


$
138,716


$
100,209

Basic earnings per share
 
$
0.79

 
$
0.57

 
$
1.52

 
$
1.10

Diluted earnings per share
 
$
0.77

 
$
0.57

 
$
1.49

 
$
1.09

Basic weighted average shares outstanding
 
91,381

 
90,912

 
91,320

 
90,848

Dilutive effect of nonvested shares
 
1,781


1,226


1,773


1,151

Diluted weighted average shares outstanding
 
93,162

 
92,138

 
93,093

 
91,999

 
There were 16,497 and 37,918 antidilutive shares for the three months ended June 30, 2017 and 2016, respectively and 89,309 and 192,765 antidilutive shares for the six months ended June 30, 2017 and 2016, respectively.
 
The nonvested performance-based share awards are considered contingently issuable for purposes of the EPS calculation. Based on the compounded annual book value per share growth as of June 30, 2017 and 2016, 100% of the dilutive performance-based share awards would be issuable under the terms of the arrangements at each date if June 30 was the end of the contingency period.


13

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


Note 9. Accumulated Other Comprehensive Income (Loss)
 
The following table presents the rollforward of accumulated other comprehensive income (loss) for the three and six months ended June 30, 2017 and 2016
 
 
Three Months Ended June 30, 2017
(In thousands)
 
Before Tax
 
Tax Effect
 
Net of Tax
Balance at beginning of period
 
$
(7,525
)
 
$
120

 
$
(7,405
)
Other comprehensive income (loss):
 
 

 
 

 
 

Unrealized holding gains arising during the period
 
12,663

 
(3,833
)
 
8,830

Less: Reclassification adjustment for gains included in net income (1)
 
(544
)
 
184

 
(360
)
Net unrealized gains on investments
 
12,119

 
(3,649
)
 
8,470

Other comprehensive income
 
12,119

 
(3,649
)
 
8,470

Balance at end of period
 
$
4,594

 
$
(3,529
)
 
$
1,065

 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2017
(In thousands)
 
Before Tax
 
Tax Effect
 
Net of Tax
Balance at beginning of year
 
$
(14,436
)
 
$
2,181

 
$
(12,255
)
Other comprehensive income (loss):
 
 

 
 

 
 

Unrealized holding gains arising during the period
 
20,229

 
(6,122
)
 
14,107

Less: Reclassification adjustment for gains included in net income (1)
 
(1,199
)
 
412

 
(787
)
Net unrealized gains on investments
 
19,030

 
(5,710
)
 
13,320

Other comprehensive income
 
19,030

 
(5,710
)
 
13,320

Balance at end of period
 
$
4,594

 
$
(3,529
)
 
$
1,065


 
 
Three Months Ended June 30, 2016
(In thousands)
 
Before Tax
 
Tax Effect
 
Net of Tax
Balance at beginning of period
 
$
19,734

 
$
(6,474
)
 
$
13,260

Other comprehensive income (loss):
 
 

 
 

 
 

Unrealized holding gains arising during the period
 
16,334

 
(5,185
)
 
11,149

Less: Reclassification adjustment for gains included in net income (1)
 
(583
)
 
136

 
(447
)
Net unrealized gains on investments
 
15,751

 
(5,049
)
 
10,702

Other comprehensive income
 
15,751

 
(5,049
)
 
10,702

Balance at end of period
 
$
35,485

 
$
(11,523
)
 
$
23,962

 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2016
(In thousands)
 
Before Tax
 
Tax Effect
 
Net of Tax
Balance at beginning of year
 
$
661

 
$
(760
)
 
$
(99
)
Other comprehensive income (loss):
 
 

 
 

 
 

Unrealized holding gains arising during the period
 
35,885

 
(11,030
)
 
24,855

Less: Reclassification adjustment for gains included in net income (1)
 
(1,061
)
 
267

 
(794
)
Net unrealized gains on investments
 
34,824

 
(10,763
)
 
24,061

Other comprehensive income
 
34,824

 
(10,763
)
 
24,061

Balance at end of period
 
$
35,485

 
$
(11,523
)
 
$
23,962

  
 
(1)
Included in net realized investment gains on our condensed consolidated statements of comprehensive income.

14

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


Note 10. Fair Value of Financial Instruments
 
We carry certain of our financial instruments at fair value. We define fair value as the current amount that would be exchanged to sell an asset or transfer a liability, other than in a forced liquidation.
  
Fair Value Hierarchy
 
ASC No. 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. The level within the fair value hierarchy to measure the financial instrument shall be determined based on the lowest level input that is significant to the fair value measurement. The three levels of the fair value hierarchy are as follows:

Level 1 — Quoted prices for identical instruments in active markets accessible at the measurement date.
 
Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and valuations in which all significant inputs are observable in active markets. Inputs are observable for substantially the full term of the financial instrument.

Level 3 — Valuations derived from one or more significant inputs that are unobservable.
 
Determination of Fair Value
 
When available, we generally use quoted market prices to determine fair value and classify the financial instrument in Level 1. In cases where quoted market prices for similar financial instruments are available, we utilize these inputs for valuation techniques and classify the financial instrument in Level 2. In cases where quoted market prices are not available, fair values are based on estimates using discounted cash flows, present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows and we classify the financial instrument in Level 3. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
 
We used the following methods and assumptions in estimating fair values of financial instruments:

Investments available for sale — Investments available for sale are valued using quoted market prices in active markets, when available, and those investments are classified as Level 1 of the fair value hierarchy. Level 1 investments available for sale include investments such as U.S. Treasury securities and money market funds. Investments available for sale are classified as Level 2 of the fair value hierarchy if quoted market prices are not available and fair values are estimated using quoted prices of similar securities or recently executed transactions for the securities. U.S. agency securities, U.S. agency mortgage-backed securities, municipal debt securities, corporate debt securities, residential and commercial mortgage securities and asset-backed securities are classified as Level 2 investments.
 
We use independent pricing sources to determine the fair value of securities available for sale in Level 1 and Level 2 of the fair value hierarchy. We use one primary pricing service to provide individual security pricing based on observable market data and receive one quote per security. To ensure securities are appropriately classified in the fair value hierarchy, we review the pricing techniques and methodologies of the independent pricing service 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. U.S. agency securities, U.S. agency residential and commercial mortgage securities, municipal and corporate debt securities are valued by our primary vendor using recently executed transactions and proprietary models based on observable inputs, such as interest rate spreads, yield curves and credit risk. Residential and commercial mortgage securities and asset-backed securities are valued by our primary vendor using proprietary models based on observable inputs, such as interest rate spreads, prepayment speeds and credit risk. As part of our evaluation of investment prices provided by our primary pricing service, we obtained and reviewed their pricing methodologies which include a description of how each security type is evaluated and priced. We review the reasonableness of prices received from our primary pricing

15

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


service by comparison to prices obtained from additional pricing sources. We have not made any adjustments to the prices obtained from our primary pricing service.
 
Derivative liabilities — Through June 30, 2016, certain of our Freddie Mac Agency Credit Insurance Structure ("ACIS") contracts were accounted for as derivatives. In determining an exit market, we considered the fact that there is not a principal market for these contracts. In the absence of a principal market, we valued these ACIS contracts in a hypothetical market where market participants, and potential counterparties, included other mortgage guaranty insurers or reinsurers with similar credit quality to us. We believed that in the absence of a principal market, this hypothetical market provides the most relevant information with respect to fair value estimates. These ACIS contracts were classified as Level 3 of the fair value hierarchy. During the quarter ended September 30, 2016, these contracts were amended and are now accounted for as insurance contracts rather than derivatives.
 
Through June 30, 2016, we determined the fair value of our derivative instruments primarily using internally-generated models. We utilized market observable inputs, such as the performance of the underlying pool of mortgages, mortgage prepayment speeds and pricing spreads on the reference STACR notes issued by Freddie Mac, whenever they were available. There was a high degree of uncertainty about our fair value estimates since our contracts were not traded or exchanged, which made external validation and corroboration of our estimates difficult. Considerable judgment was required to interpret market data to develop the estimates of fair value. Accordingly, the estimates may not have been indicative of amounts we could have realized in a market exchange or negotiated termination. The use of different market assumptions or estimation methodologies may have had a material effect on the estimated fair value amounts.
 
Assets and Liabilities Measured at Fair Value
 
All assets measured at fair value are categorized in the table below based upon the lowest level of significant input to the valuations. All fair value measurements at the reporting date were on a recurring basis.
 
June 30, 2017 (In thousands)
 
Quoted Prices
in Active 
Markets for
Identical
Instruments
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
Recurring fair value measurements
 
 

 
 

 
 

 
 

Financial Assets:
 
 

 
 

 
 

 
 

U.S. Treasury securities
 
$
202,364

 
$

 
$

 
$
202,364

U.S. agency securities
 

 
26,357

 

 
26,357

U.S. agency mortgage-backed securities
 

 
397,602

 

 
397,602

Municipal debt securities
 

 
370,068

 

 
370,068

Corporate debt securities
 

 
555,965

 

 
555,965

Residential and commercial mortgage securities
 

 
69,672

 

 
69,672

Asset-backed securities
 

 
135,505

 

 
135,505

Money market funds
 
83,508

 

 

 
83,508

Total assets at fair value
 
$
285,872

 
$
1,555,169

 
$

 
$
1,841,041

 

16

Essent Group Ltd. and Subsidiaries
 
Notes to Condensed Consolidated Financial Statements (Unaudited)


December 31, 2016 (In thousands)
 
Quoted Prices
in Active 
Markets for
Identical
Instruments
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
Recurring fair value measurements
 
 

 
 

 
 

 
 

Financial Assets:
 
 

 
 

 
 

 
 

U.S. Treasury securities
 
$
191,548

 
$

 
$

 
$
191,548

U.S. agency securities
 

 
18,441

 

 
18,441

U.S. agency mortgage-backed securities
 

 
316,494

 

 
316,494

Municipal debt securities
 

 
334,324

 

 
334,324

Corporate debt securities
 

 
456,357

 

 
456,357

Residential and commercial mortgage securities
 

 
68,336