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Prepayment Models for Sub-Prime Mortgages
by Sanjeeban Chatterjee
Over the last few years there has been a proliferation of sub-prime loan products in the marketplace. Andrew Davidson & Co., Inc., (AD&Co) a leader in prepayment modeling, has developed models for both fixed and adjustable-rate sub-prime mortgages. The fixed rate models cover 15 and 30 year maturities, whereas the adjustable-rate model can take any first and periodic reset as input, and can adjust for interest-only and loans with prepayment penalties. The new models incorporate AD&Co’s vision to provide a single framework for fixed and adjustable-rate mortgages, across collateral types.
It is important to note that for developing the prepayment models, we did not distinguish between voluntary and involuntary prepayments, but looked at total terminations. A termination is recorded whenever the outstanding balance becomes zero. However, defaults are becoming more and more important in the sub-prime world. The new AD&Co suite of credit models addresses issues faced by market participants while modeling defaults.
Data Issues
We define Sub-Prime loans as first lien non-revolving mortgages. These are not HELOC’s. Sub-prime borrowers typically have less than perfect credit and the loans usually have high Spread-At-Origination (SatO). All existing prepayment models have been developed using data from Intex.
The fixed rate 30 and 15 year models were developed using data from RFC. The adjustable-rate model was developed using data from 5 of the largest issuers (with largest balance outstanding as of December 2005). They are:
Countrywide
Residential Funding Corporation
Structured Asset Investment
Morgan Stanley
Long Beach
Trends
Spread-at-Origination (SatO) has a big impact on the level of prepayments as shown in the chart below. Speeds slow down as the SatO increases.
