PREPAYMENT MODELING AN OVERVIEW

Feb 2017
Afshin Goodarzi
afshin@1010data.com
What is a mortgage?
A borrowers view

A contract between the Where:

A = periodic payment amount

lender and the borrower? P = amount of principal, net of initial payments, meaning "subtract any down-
payments"
i = periodic interest rate
n = total number of payments

Option to prepay in full or

in part!
Amortization
 Typical data

Credit score
Origination Loan Appraised Amort Reset Periodic Life
Loan # LTV Rate Product Purpose DTI Term Date upb amount Value FICO prop type PPT MI GOVT Period Period cap cap Ceiling Floor ppt term
1 80% 6%Fixed Purchase 42% 30 25-Jul-05 90000 90000 112,500.00 680SFR NO NO VA 360
2 8% 7%IO Refi-cash out 30% 15 25-Jul-04 75000 750000 900,000.00 780condo yes yes no 180 12 2% 6% 13% 4%3 years
3 90% 6.50%arm purchase 45% 30 15-Jan-05 123000 125000 136,666.67 6002-4 yes yes no 360 6 2% 5% 11.50% 3.50%4 ywars

Unpaid principal balance

Loan term
Debt to Income ratio

Loan Purpose GSE

Loan type
Annual Interest Rate Mortgage Insurance
Loan to value Prepayment penalty
What can we model?
Default <> foreclosure
Default is the inability to pay the mortgage
Foreclosure is the legal process by the lender to take ownership

Delinquency
Measured in 30 day increments, 30, 60, 90.
Prepayment or curtailment
Partial or full payment of principal prior to the term of the loan
 Transition Matrix
Our Focus
St
St-1
We will focus on the transition to zero or Prepayment.
( Option to payoff a mortgage at any time in the life of
the loan )

transition from 0->0 is not a prepayment

We will focus on the ABS data

We will model all prepayments available in the

CoreLogic ABS & MBS data

We used a 20% holdout (out of time and out of

sample) sample for each model

The foreground is the % transition by Count Time

The Background is the % of population in each row of from state
 Problem formulation

D- default I- Refinance : M- Autonomous :

Unemployment InterestRate Demographics

CPI HPI & AVMs Unemployment

HPI Burnout HPI

CCLTV Cost of Option InterestRates

Inventory Inventory
 http://www.freeusandworldmaps.com/html/US_Counties/US_Counties.html
http://www.tradingeconomics.com/united-states/unemployment-rate
http://www.fhfa.gov/
http://www.richmondfed.org/banking/markets_trends_and_statistics/trends/
pdf/delinquency_and_foreclosure_rates.pdf
All sources of Prepay as analyzed in 1989

Regional economy
Unemployment

Cost of option
Interest Rates
House prices

Loan Age
M
D

I
 What was considered prepay risk in 1989

Prepayment risk = D + R + M + I
D: Default Risk = 0 Backed by the full faith and credit of the US
government hence considered by market participants to be default-free
R: Interest rate risk substantial
M: Relocation (moving) risk 5% to 7% of home owners move per year
I: Idiosyncratic prepay complex

Sean Becketti, Federal Reserve bank of Kansas City, 1989,

The Prepayment Risk of Mortgage-backed Securities
Interest risk
What is
PMMS?
What is a

better
source?
 S curve
SMM single month mortality
smmi = 100 *
( FS Fi )
( Fi1 FS )

CPR Constant Prepayment

rate annualized smm
" " smm %12 %
CPR = 100 $$1 $1 ' ''
# # 100 & &

Cuspier with larger HPI and

larger mortgages
No incentive <> mover!
http://www.beyondbond.com/pdf/2.pdf
 Granularity ma,ers
The survey rates are o by up to 130 basis points on the na9onal average!
Regionally the dierence is even more start-220 basis points between FL and the PMMS.

Data source:
McDash Servicing & FHFA
 Interest rate paths: The Vasicek Model

Bounding the historical Interest rates by history

Adding probability of landing on any interest rate at time t

Mean
Variance
Age of loan
Prepayment Speed Assumptions
100% PSA assumes
n prepayment rates of 0.2% CPR
in the first month following
origination of the loans with a
constant 0.2% CPR in each
succeeding month until the 30th
month.
n On and after the 30th month,
100% PSA assumes a fixed
annual prepayment rate of
6.0% CPR
Assumption : early prepayment is
small Not always true! 100% PSA

http://www.beyondbond.com/pdf/2.pdf
House price index
Unemployment
Observations?
 Unemployment and foreclosure
Is this real?
Is it always true?
Underwriting effects of pre/post 1990
How should this effect be incorporated?

J. Lounsbury observes:
The unemployment rate for each state was for August, 2010.

The conclusion from this graph can be summarized as follows:

1. Below about 9% unemployment there may be a weak linear effect on foreclosure from the level of
unemployment. However the correlation is poor.

2. Above about 9% unemployment there is a greater than linear dependence of foreclosure rate on
unemployment. Although the correlation is good, just looking at the scatter evident on the graph raises the
question of whether there may be additional factors related to foreclosure activity. For example, the four
states with the biggest housing bubbles all fall in the group of states with the largest increase in foreclosure
rates. https://www.creditwritedowns.com/2010/10/unemployment-and-foreclosures.html
What is burnout?
If borrower has
been exposed n
times to low
rates an no refi
then they are
burnt out!
Are there better
measures?
http://www.beyondbond.com/pdf/2.pdf
Data Growth M by N matrix

N number of observations
M number of variables
Other data:
Servicer Text
Servicer Voice
Growth of both M and N is Faster Future

than Moores Law data?!

 Mortgage Loan Lifecycle- Lender Workflow

Mortgage Loan Originator

Order Services APPRAISAL TITLE INSURANCE INSPECTIONS
Mortgage Processor

Order Confirmed Order Confirmed Order Confirmed

The Mortgage life cycle

Obtain Documentation

Appraisal Commitment Inspection

Scheduled Received (5-10 Scheduled
days TAT)

Appraisal Deliver Info Inspection

Performed necessary to clear Performed
liens/judgments

Pull Credit Report, Receive Clear to Inspection

Run through AUS,
Appraisal Delivered
Close from Title Delivered Mortgage Service
PRINT AUS Providers
APPROVAL Obtain Final
Broker
Non- Agengy
Commitment
2 months Bank Channel
Statements
Originators/ Aggregators Direct Whole Loans Sales
Investors
2 Years Tax Returns CREATE UNDERWRITING
REVIEW PACKAGE Brokers
Paystubs/W2's/
Income Verification
BY FOLLOWING THE
UNDERWRITING STACKING
Internal
Top 30 Players
Wells Fargo Non-Agency Delivered Mortgages Non- Agency
ORDER AND INCLUDING ALL
Brokers/ About 50% of Total Originations CMOs
Chase
NECESSARY DOCUMENTS
Asset Verification
Referral
Initial Borrower
C Quicken Loans
Banks

o
Disclosure Packet

U.S.
WellsBancorp
Fargo WAMU
Agencies
UNDERWRITER REVIEW
n
IF counteroffer is
Bank of America Fannie Mae
Accept File From accepted (Change to
Fannie FNMA MBS
s
Int. Rate, Lower LTV, Mortgage Purchases
PennyMac Dealers
Queue
Correpondent
Approved with Conditions Review Approval
etc.) The mortgage
Company will Modify Channel
Mae Issued
PHH Corp.
The underwriter delivers and support docs DENIED/

u
the terms and
conditions that must be COUNTEROFFER
cleared before closing can
Verify Information Resubmit. Countrywide GMAC
is true and current
Citigroup
IF Denied with no
occur Lenders/
Use guidelines to
make decision m
counteroffer, the file
is considered Dead. Mortgage
Street and
Banks Flagstar Life Insurance
e Internet/ Bancorp Freddie Mac
Freddie
Non- Companies

Bank of FHLC MBS Street

r Brokers
loanDepot
National City Mortgage Purchases
Mac
CLEAR TO CLOSE

America Issued Broker/

Obtain Necessary information
from Borrower (Ex. Updated
Paystub). Do not Piece Mail
the underwriter. Wait until all
Resubmit Conditions To underwriting s Dealers
Pensions Funds
conditions have been received

Lender is notified and contacts the borrower to give them the good news, and find the correct Chase FNMC
time to close. The closing is scheduled with the title company and borrower
Retail
Channel Ginnie Mae Ginnie GNM MBS Savings & Loans
The Mortgage Lender delivers a Closing Instructions Fee Sheet with all final charges and
instructions on how to build the HUD-1 Settlement Statement. The title company creates the
Mortgage Purchases Mae Issued
final HUD, and submits it to the lender for review. ONCE APPROVED.

The Title Company prints the Entire closing package (Approximately 120 pages) with all
Branch
Network of Smaller Players
required documents and a copy package for the borrowers records. They review the docs for Retail
accuracy and prepare to close with the borrowers. A notary public is necessary to sign the
Lenders Other
documents. Many times, title agents or representatives have their notary license.

The Borrowers meet with the Title Agent/Notary

Public to sign all documents. On Purchase Deals,
the loan Funds at closing, or same day, the checks
are cut by the title company, and keys are
delivered. For Refinances, the borrower has a 3 day Held on
Right of Rescission, or ability to cancel the
transaction within that time. Once this time has Wholeloan Servicing Mortgage Balance Sheet
passed, the loan is considered officially closed and at smaller FNL
will move to Funding, where payoffs to existing Assets Assets Insurers Agencies
mortgages, invoices from other vendors, and
borrower funds will be distributed by the Title
Company. Efficiency
Different ways of improving models
More (horizontal or vertical) data
Better formulation of variables

Better algorithms

Hardware and software improvements

 Demographics
sfhg Use of Demographic variables are
Race Bias
protected by law in most cases!

Where is it permissible to use

Education demography?
Bias

Marital
Status bias

https://www.bls.gov/opub/btn/volume-2/patterns-of-homeownership.htm
Cost of Refinance

Upto 200 bp in
refi fees and
taxes in Queens
Typically not

modeled

http://ai.stanford.edu/~ronnyk/mortgage.pdf
CCLTV Comparison Charts

Sources:
Freddie Mac Loan Level Data
Equifax Credit Risk Insight Agency
FHFA HPI
 Different formulations
Refinance Incentive Measure
Spread..
Spread ratio.
Present Value Adjusted.....
Dollar equivalent...
Remaining $ Interest..
Where:
t is the date
C is the Coupon or Note rate
M is the Market rate as measured by the Freddie Mac Primary Mortgage Market Survey
T is the term of the loan measured in months
A is the age of the loan measured in months
Pic is the Principal and Interest as reported without any escrows.
Pim is the Principal and Interest as computed off of the fixed rate without any escrows.
 Confluence of Forces => Better Models?

New Data - Reconciliation of different data sets

Problem formulation ( Structural Change )
Modeling Techniques ( Algorithms )
Hardware and Software

Hoping to get rid of the Idiosyncratic risk!

Example Modeling approach
Used Ridge Regression inDatabase
Target = Refinance in the next 2 months
All time 1980s present
20% holdout set (Out of time and out of sample random)
All products over 2500 prepay models!!
Coarse models (7)
Fine modeling (2500 +)
Simulate Cash flows - Simulation
AUC definition
AUC Area Under the Curve as a measure of model quality
Coarse vs Fine models: AUC comparison
Fine Models
Coarse Models
AUC

count
 Coarse vs. Fine Models Refinance Incentive
Distribution of the Refi Incentive Beta is long tailed for the Fine
models case!
Average Beta for Refi Incentive is higher in the coarse model 2.0
as compared to the fine models 1.84. Suggesting that the Refi
incentive measure is more important and more positively
correlated in general. Which is simply not true.
Note that the classical s-curve is not as pronounced in this case

Beta
Prepay Rate

-1 Sigma

+1 Sigma

Refi Incentive
Refi Incentive
Fine vs. Coarse: Cash flows
Homework
Data source
https://www.consumerfinance.gov/data-
Download data for
2 states
research/hmda/explore.html
At least one year of data
Questions:
Are minorities discriminated against in lending?
n What metrics did you use in this data to prove or disprove?
n What factors did you control for?
n Did you use other data sets? Why?
n Should you use HMDA data to improve your prepay model? How would you do it?
n Is there a Geographic effect?
n Are there other trends in the data that you see? Are the effects you are describing getting worst or better
over time?
Q&A
Opportunities for expanding/extending the data
Horizontally
Better
formulations of drivers
New data sources

Vertically
More granularity in time
Sources
https://research.stlouisfed.org/wp/
2012/2012-017.pdf
 sfg Big data hype
is Over!
Big Data
When the coffee table book arrives the hype has peaked

Volume
i
Velocity M
 Big Data- A Definition IMHO
# of tables? 10s 1000s

Variety

Volume
Velocity
# of Rows? Millions - Trillions
# of bytes? Terabyte - Petabyte
Complexity of the ER?
Number of users? 100s 10,000s
How much history? Hours, days, months, years?
Granular? Raw? Filtered? Transformed?
History

Usage

Granularity
The Question
Coarse vs Fine modeling
Are the populations homogeneous or heterogeneous

Can we model each populations separately?

Why wouldnt every one do this already?

Are we dealing with big data?