SPV October 2010 - Data Analysis of Fixed-to-Float Prepayment
Based on an investigation of data on outstanding nominal amounts of different loan types, we have established that borrowers switch between loan types over time. Our focus has primarily been on Fixed-to-Float prepayment, which directly affects the prepayment rates and thereby the value of fixed rate mortgage bonds. The data indicates that the primary trigger for Fixed-to-Float prepayment is the spread between short and medium term interest rates. This spread can be measured in various ways, the notions closest to what the borrower observes are the annual cost rate (ÅOP) and "yearly payment after tax". We observed that both these notions where correlated with Fixed-to-Float prepayment. We also investigate the effect of the "price 95 rule", but found it difficult to distinguish it from the interest rate spread effect. Comparing our findings of Fixed-to-Float prepayment with the estimated prepayment rates of the DMBS model on the 2009 July and 2010 October payment dates, we observe that the model is able to incorporates the Fixed-to-Float prepayment by reacting to the NPVGain variable and the pool factor. However all the payment dates with prepayments in the estimation window of the model exhibits Fixed-to-Float prepayment.
The true test of the prepayment model will thus be potential future payment dates without Fixed-to-Float prepayments. On the basis of the observations of this theme Scanrate will experiment with alternative specifications of the prepayment function including Fixed-to-Float prepayment.