Loan Dynamics Model™
by Kyle Lundstedt, Ph.D.

The risks inherent in credit-sensitive mortgages and related securities require market participants to gain a solid understanding of prepayment, delinquency, default and loss severity on mortgage loans. In response to this challenge, we have extended our current prepayment model subroutines to address the needs of those who are exposed to these risks by producing probability outputs of these exact required performance metrics, given loan characteristics and a scenario for interest rate and house price indices. Meet the Loan Dynamics Model™.

The Loan Dynamics Model™ is the culmination of a 2-year company-wide development effort. As a starting point, we examined historical data, including roughly 8 million loans from 144 issuers from 1990 to 2005. Over the course of our analysis, we found that borrower behavior can be described realistically yet parsimoniously using 4 categories of payment status:

Current (0-59 days past due)
Delinquent (60-179 days past due)
Seriously Delinquent (180+ days past due)
Terminated (default or prepay)

Our team built a set of economic models to explain the motivation for borrowers to transition from one payment status to the others given a wide variety of economic scenarios and loan characteristics. The model is estimated using observed historical data to provide a probabilistic assessment of how a loan will behave in the future.