Understand the Prepayment Assumption Option

About the Absolute Prepayment Model (ABS)

ABS stands for the Absolute Prepayment Model. The ABS prepayment model defines an increasing sequence of prepayment rates. The ABS model is most commonly used for CARS (Certificates of Automobile Receivables) because prepayment of auto loans tend to have increasing prepayment as the loan ages or becomes seasoned.

The formula for ABS follows:

100 * SMM

ABS = ---------------------------

100 + SMM * (M-1)

Where M stands for the number of months after the loan origination. A definition of SMM follows.

The Absolute Prepayment Model (ABS') represents an assumed rate of prepayment each month relative to the original number of receivables in a pool of receivables. ABS further assumes that all the receivables in question are the same size and amortize at the same rate and that each receivable in each month of its life is either paid as scheduled or prepaid in full. For example, in a pool of receivables originally containing 10,000 receivables, a 1% ABS Rate means that 100 receivables prepay each month. ABS does not purport to be a historical description of prepayment experience or a prediction of the anticipated rate of prepayment of any pool of receivables, including the receivables.

Auto Loan ABS securities (or CARS), in general, use the ABS Prepayment Model to model the prepayment rates of CARS securities. The reason why CARS securities utilize the ABS Prepayment Model is that auto loans generally show an increasing prepayment rate as the loan ages (becomes seasoned), and the ABS Prepayment Model is able to calculate the increasing sequence of prepayment rates. Therefore, Eagle Accounting added the ABS Prepayment Model to its earnings code.

The following prepayment values are available for the ABS method when you create amortization rules.

About the Constant Prepayment Rate (CPR) and Single Month Mortality (SMM) Models

CPR stands for Constant Prepayment Rate or Conditional Prepayment Rate. CPR expresses the prepayment percentage as an annually compounded rate. The formula for CPR follows:

SMM stands for the Single Month Mortality. SMM is the fundamental measure of prepayment speeds that other prepayment speeds are based off of. The Single Monthly Mortality measures the amount of principal repayment. SMM is the percentage of remaining mortgage principal that will be repaid each month after the scheduled principal payment has been made.

CPR and SMM can each be converted to the other using the formulas:

The following prepayment values are available for the CPR and SMM methods when you create amortization rules.

About the Standard Prepayment Model (PSA)

PSA refers to the Standard Prepayment Model for the Bond Market Association (previously known as the Public Securities Association). The PSA prepayment method specifies a prepayment assumption for each month in the life of the underlying mortgages, expressed as an annual basis. The Bond Market Association prepayment formula assumes that new loans make very little additional prepayments in the first 30 months of the loan (see note).

More specifically, for a 100 PSA prepayment assumption, the Bond Market Association assumes that a home owner prepays an additional 0.2% of principal in the first month of the loan, and then an additional .2% CPR for each additional month, until the 30th month of the loan. In the 31st month of the loan, PSA assumes that 100% PSA is the equivalent of 6% of the loan.

The following prepayment values are available for the PSA method when you create amortization rules.

MBS purchased at a discount with a high prepayment assumption cause a higher amortization yield than normal. This is due to the quicker repayment of principal and thus shorter life span, of the security.

Subsequently, an MBS purchased at a premium with a high prepayment assumption has a lower amortization yield. This is due to quicker repayment of principal and shorter life span of the security.