In previous posts, I have covered CPR, PSA, and a spreadsheet that allows for any prepayment vector you might want to create. There have been many attempts to describe what the prepayment pattern for MBS will look like in the future. One of the models that has been used extensively, particularly with ALM (Asset / Liability Management) models, is the 4-Factor prepayment model. Some models have more than four factors, but I am hoping this spreadsheet with four factors, will give the user an idea of how the 4-Factor model might work. The model relies on historic data, but can be adjusted for the user’s personal expectations. The four factors I will consider are:
1. Refinance Incentive: This is the difference between the weighted average coupon (WAC) of the loans, and the current market yield that is an alternative for refinancing the loans. This is the base factor that determines what will happen to the CPR, under various changes in market yields.
2. Burnout: After the loans have gone through one or more interest rate cycles, and for various reasons still have not refinanced, the expectation is that the remaining loans might be less likely to refinance in the future.
3. Seasoning: Like the PSA model, it is assumed that newer loans are less likely to prepay than more seasoned loans. The PSA model assumes the CPR will start at 1/30th if the CPR, ramps up until it peaks at 30 months, and then assumes the full CPR for the rest of the life of the loans. This seasoning factor takes into consideration the base model to determine in what month the ramping of the expected CPR will peak. Unlike PSA, the seasoning factor is not dependent on only one CPR (6%).
Seasonality: Run virtually any data set and you will find that, for various reasons, people tend to sell or refinance their homes more often during certain months of the year. For this reason, the amortization schedule used to run the model, needs a starting date.
The Excel functions looks like this for 7/1/2017:
Base Factor (CPR)
Assuming the spread is -2.00% (WAC – Market Rate)
Base Factor = .006924
*CPR = Base Factor Table
Assuming a pool factor of 1.0
Burnout = 1.000
*CPB = Current Principal Balance
*OSB = Original Starting Balance
*Burnout = Burnout Table
Assuming the spread is -2.00% (WAC – Market Rate) & the payment number is 19
Seasoning = 0.39583
*Seasoning = Seasoning Table
Assuming the payment date is 7/1/17
Seasonality = 1.10
*Seasonality = Seasonality Table
SMM (Single Monthly Mortality Rate)
SMM = .006924 *1.00* .39583* 1.10
SMM for the 7/1/2017 payment = .003015
On the right hand side of the amortization sheet I show the calculations for each factor, and for each payment:
Change the Market Yield (use the drop down box) to see how it effects the prepayment chart. Note the change of scale on the Y axis: