MBS Prepay Model Assumption
Q: What are the various behaviors for MBS prepay models and what
values are expected in MBS Assumption for each?
A: There are four possible MBS prepayment models:
- FHA - is based on real-world prepayment experience compiled by the Federal Housing Authority.
It is rarely used anymore, because it is not very helpful as a predictor of future mortgagee behavior, which is what
really matters with MBS.
- CPR - stands for Constant Prepayment Rate, is an estimate of how much principal -- above and beyond the amount included in the
homeowner's standard monthly mortgage payment -- will be prepaid. This is stated as a percentage of the remaining principal balance. In
general, it would be reasonable to expect this value to be less than 10 (or at most 20), although MBS pools with high coupons may prepay
faster if everyone refinances over a short period of time.
- SMM - stands for Single Monthly Mortality, effectively the same as CPR, but with the prepayment factor stated as a
monthly value. In general, this should be no more than 1 or 2, as even 2 implies an
annual prepayment rate of almost 25%.
- PSA - A model that describes prepayments on a gradually increasing scale from 0% to 6% CPR over the first thirty months, after which
prepayments are presumed to level out at 6% for the remaining life of the mortgage. Takes into account the real-world experience that most
people do not prepay mortgages during the first few years, since they are (1) less likely to move, (2) less likely to refinance, and (3)
usually too strapped to throw a little extra cash into their monthly mortgage payments. Since PSA is a model, the prepayment value is
stated as a percentage of the model's assumptions. Therefore, 100 PSA means
100 percent of the model, or CPR building from 0 to 6%; while 150
PSA means 150 percent of the model, or CPR building from 0% to 9%, where it levels out.