MBS Prepayment Cash Flow Measurements

Aside from changes in interest rates, advances in mortgage lending and other market factors have contributed to the number of refinancings and impacted the pace of prepayments:

-Competition: Historically, individuals would not refinance until interest rates fell by at least two percent (200 basis points). In recent years, competition has resulted in favorable changes such as no points on new loans, so that individuals have been induced to refinance for as little as ½ of a percent (50 basis points).

-Efficiency: A streamlined origination process has led to quicker turnaround times for refinancing.

-Home Price Appreciation: Turnover of homes, spurred by higher home sale prices, was a driver of prepayments for mortgages that already had lower interest rates.

-Burnout: Burnout occurs when mortgages within a pool have already refinanced, causing prepayment speeds to slow. In 2001, many pools experienced no such slow down, due in part to homeowners refinancing more than once.

The complexity and variety of MBS securities require a detailed understanding of their characteristics, and the market factors that impact them. At the heart of this complexity is determining prepayment cash flows. The industry generally relies on two key measures that reflect the rate at which a particular security is likely to prepay:

-Conditional Prepayment Rate (CPR): The CPR measures (as a fraction or percentage of the remaining balance) the amount expected to be prepaid annually.

-PSA Speed: This measure, which was introduced by the Public Securities Association, applies mainly to pass-thrus, but can also be used for CMOs. PSA speeds differ from CPR in that the model accounts for an increasing rate of prepayments during the first 30 months of the pool's life. PSA speeds can be for any number of periods (e.g., one month, three months, six months, etc.)

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