AD&Co. Update - September '06

New ARM Prepayment Models for Agency, Jumbo and Sub-Prime Loans
by Rob Landauer

AD&Co is pleased to announce the availability of v5.2a of our prepayment model. This is the first release that combines all the enhanced fixed rate models released in v5.1 with these new ARM models into a single subroutine that uses a consistent functional form. This means that all loan types now model burnout using the active/passive (APD) form and generate more reasonable results across all credit, coupon, amortization and size loan variables originated in the mortgage market.

Of equal importance, v5.2a unveils our new suite of ARM models for Agency, Jumbo Prime and Sub-Prime loans that cover the full range of reset frequencies including 1-1, 3-3, 3-1, 5-1, 7-1 and 10-1’s. The Agency ARM models have been refit and recalibrated using the data through July of 2006, while the non-Agency models utilize data through the end of 2005 and provide several significant enhancements over the existing ARM suite of prepayment models. Some of these enhancements include:

1. For hybrids, prepayments after the initial reset are now modeled. In previous versions, the post reset prepayment speed was hard-coded based on the time to initial reset.

2. All of the new ARM models utilize the WAC forecasting module that provides the model with forecasted WACs for the next six months based on implied forward rates. As the reset approaches, the forward average of WAC’s begin to rise or fall, which affects the refinance incentive of the borrower. For example, a steep yield curves portends higher WACs for the borrower, which may lead to faster levels of refinancing back into teaser rate loans.

3. The impact of prepayment penalties and interest only (IO) amortization are now modeled through a WAC adjustment. For example, during the prepay penalty period, the WAC on the ARM is lowered to reduce the refinance incentive of the borrower.

4. Loan level models for jumbo and sub-prime consider LTV, loan size, and SATO effects.