Prepayable NHA MBS - Securitization.Net

More documents

Recommendations

Info

10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 For this study, we have eliminated pools with economically motivated refinancings in order to examine core prepayment patterns For this study, in order to analyze the level of prepayments due exclusively to seasoning, those open pools have been identified that offer no incentive for mortgagors to refinance. Put another way, the pools examined in this study are out of the money. The prepayable MBS included in this study have been selected on the basis of having a weighted average mortgage rate (WAM) minus the prevailing five-year mortgage rate of less than 50 basis points. Using these parameters we can be certain there are few economically motivated refinancings because it is not financially beneficial to refinance mortgages under these conditions. Mortgagors in these pools are deterred by the penalties and inconveniences associated with refinancing. By eliminating refinancings that may be motivated by economic considerations, the pattern of core prepayments over time can be examined. Core prepayments are comprised of liquidations due to defaults, substitutions and relocation, and are generally insensitive to interest rate changes. Figure #1 graphs the monthly annualized liquidation rate (LQR) of out of the money, fiveyear, open pool MBS as the pools season from the interest adjustment date (IAD), which is the date that a mortgage in a pool is originated or renewed. The liquidation rate refers to the percentage of mortgages on which the entire principal balance is repaid. Figure #1 illustrates that as securitized pools of mortgages season, liquidations tend to increase regardless of whether or not economic incentives to refinance exist. Over time, up to a point, liquidations increase, returning unscheduled amounts of principal to MBS investors at increasing rates. Increasing prepayments translate into quicker principal repayment for investors, which can be desirable, particularly in a rising interest rate environment. 21% Figure #1 Monthly Annualized Liquidation Rate (LQR) (includes all out of the money NHA MBS pools) 18% Liquidations (%) 15% 12% 9% 6% 3% 0% 1 4 7 Months after IAD MBS prices are standardized across dealers using the Canadian Liquidation Vector model Prepayments are expected in prepayable pools and are factored into MBS pricing by analyzing the propensity to refinance at prevailing mortgage rates. To ensure accurate and comparable pricing across dealers and to use prepayment assumptions which reflected historical data, the Canadian Liquidation Vector (CLV) model was developed in June of 1998 for the NHA MBS market and subsequently adopted by the IDA. It is important to note that the model is designed to estimate prepayments and is more effective than constant prepayment assumptions, but is not intended as a completely predictive model. Figure #2 (following page) shows the Standard Canadian Curve (SCC). It is a key component of the CLV and its shape is based on a composite of 10 years of prepayment history. 2 CIBC World Markets October 24, 2000
10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 Figure #2 Canadian Standard Liquidation Vector (CLV) produces the Standard Canadian Curve (SCC) 15% Liquidations (%) 12% 9% 6% 3% 0% 1 4 7 Month The SCC curve is made pool specific by applying the standard multiplier to the Standard Canadian Curve Prepayments return principal to investors, which is then invested at current interest rates Opportunity exists when the CLV differs from the actual data The SCC is the core of the CLV and it is used to price MBS, in conjunction with a standard multiplier formula which takes into account the average mortgage rate in the pool and the current refinancing rate. The multiplier formula is as follows: (40*(average rate in pool-refinancing rate)) Multiplier=.85*e The multiplier standardizes prepayment expectations, which is necessary for comparable pricing across dealers. The formula computes the level of prepayments expected at any given difference between the average mortgage rate in the pool and the current refinancing rate. As the refinancing rate decreases, expected prepayments increase and vice versa. It is worthwhile to note that in the event that the rate differential is zero, prepayments are expected to occur at a lower rate than the SCC. Expected prepayments track the SCC curve at an interest rate differential of about 40.5 basis points. The prepayment option, in a decreasing interest rate environment, is beneficial to borrowers as they can refinance their mortgages at lower prevailing rates, but a detriment to investors. As interest rates decrease, investors receive unscheduled principal payments and are forced to reinvest these proceeds at lower interest rates. Conversely, in an increasing interest rate environment, it is the mortgagors who have no incentive to refinance as new mortgages would be written at higher rates than those currently contracted. Prepayments occurring in conjunction with rising rates, particularly if they are greater than expected using the CLV, can increase returns to investors. The opportunity for investors, as demonstrated by our data, lies in the fact that core prepayments increase as pools of mortgages become more seasoned, regardless of economic incentives. In an increasing interest rate environment, liquidations in pools trading at a discount can become a significant advantage for investors in open pool MBS. In a bear bond market, rising interest rates decrease the value of the multiplier and produce a liquidation vector that is below the SCC, indicating lower expected prepayments. Seasoning has the effect of increasing core prepayments over time because they are insensitive to the prevailing interest rate environment. Comparing specific seasoned pool data against the CLV may indicate that prepayments have been underestimated during certain months, which could result in underpriced securities. 3 CIBC World Markets October 24, 2000
Page 1: Canadian ABS/MBS Research www.cibcw
Page 5 and 6: Table #2-Pools Meeting Analysis Cri

Prepayable NHA MBS - Securitization.Net

You also want an ePaper? Increase the reach of your titles

Delete template?

Save as template?