The Pipeline

The yield curve has risen a fair amount since our last Pipeline, with further Fed easing no longer part of market narratives; indeed, small probabilities of a hike this year have emerged in Fed derivative markets as inflation diffuses out of energy into a broader swath of the economy. Additionally, mortgage rates have risen as the steep end of the curve has also reacted to those inflation concerns.

This article provides insight into how the composition of MBS pools from Fannie Mae and Freddie Mac have evolved over the last five years. The central story describes a clear shift from the low-rate origination environment of 2020¬–21 into a higher-rate, lower-volume, more purchase-oriented environment after 2022. The research data shows that pool composition, CPR behavior, property type, borrower purpose, and original WAC all changed together.

Andrew Davidson & Co., Inc. (AD&Co) has partnered with Cotality to provide model and performance coverage for origination and performance data for both home equity lines of credit (HELOCs) and closed-end home equity loans (HELs). The dataset covers home equity loans from January 2002 to present. The AD&Co model for HELOC takes a borrower-level approach to predicting borrower draw and balance/utilization of credit line during the revolving period.

This article provides a historical review of Andrew Davidson & Co., Inc. (AD&Co) risk-neutral prepayment modeling, a rigorous method of assessing the economics and risk of MBS investments. 

We first introduce the model’s design and demonstrate its calibration to TBA prices. We then demonstrate that, contrary to the common belief, the OAS method operating with an empirically designed prepayment model, fails to accurately predict interest-rate risk of MBS, but its modification that utilizes a risk-neutralized model trends closer to the empirically observed sensitivity.