It is imperative to know the exact age to implement SATO; operating on an average or median can make the use of SATO misleading. Indeed, let us assume that two cohorts are candidates for delivery: the 1-yr old and the 5-yr old. The median age is, therefore, 3 years, but the market rates 3 years ago have nothing to do with either of the cohorts. Hence, we can’t use the SATO effect in such a case.

On the other hand, there are situations when the TBA age is certain, and pools originated at some positive SATO level are going to be delivered. It seems, at first glance, we are now facing this exact situation with FNCL 7.0. Assuming that the 8-mo median age, indeed, matches the origination of FNCL 7.0, and looking back at the mortgage rates in November of 2005, we conclude that TBA-deliverables were originated at a SATO exceeding 1.0%. Once the SATO effect is activated in our model prepay speeds drop and the valuation results line up with those of the brokers (Exhibit 1).

Exhibit 1. Comparative valuation of FN TBAs as of July 21, 2006



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