PREPAYMENT ANALYSIS OF RESIDENTIAL MORTGAGE BACKED

SECURITIES FOR INDIAN SECURITIZATION MARKET

Authors: K.C. Iyer and G.C. Tripathi

Submitted By,
Jessica Yvonne Varma, 1321250
MBA- IJK Finance (F1)

Submitted to,
Prof. T. S. Ramachandran
HOD. Finance

1


2

RESEARCH PAPER
Prepayment Analysis of Residential Mortgage Backed Securities for
Indian Securitization Market
By, K.C. I yer and G.C. Tripathi

Problem Statement:-
Residential Mortgage Backed securitization is faced by numerous risks like interest rate risk,
default risk, co-mingling risk, market risk and prepayment risk. These various risk elements
control the prices of products and prepayment is one of the most critical of them.
I ntroduction:-
(Bajaj, 2013) Securitization is the process through which an issuer or the originator pools
several types of financial assets and sells the aggregated instruments to Investors. These
instruments can be Bonds, Pass Through Certificates (PTCs), etc. These are consolidated by
pooling of contractual debts such as mortgages (residential and commercial), auto loans and
credit card debt obligations, etc.
The Securities backed by mortgages are known as Mortgage Backed Securities (MBS) while
the ones backed by other types of receivables are known as Asset Backed Securities (ABS).
(Bajaj, 2013) Looking at the securitization volume in 2013, the highest was for Asset Backed
Securities with volume of Rs.266.3 Billion and second highest was for Mortgage Backed
securities with volume of Rs.36.2 Billion.
Objectives of the Research:-
The research paper analyses two factors, seasonality and seasoning (Age) and their influence
on prepayment behaviour Residential Mortgage Backed Securitization instruments in India.
Hypothesis:-
Null

: Months of the year (i.e., seasonality) have no significant influence on

prepayments observed from mortgage pools.
3

Alternate

: Months of the year (i.e., seasonality) have no significant influence on

prepayments observed from mortgage pools.
Null

: Age (i.e., seasoning) of the pools has no significant influence on prepayments

of the pools.
Alternate

: Age (i.e., seasoning) of the pools has a significant influence on

prepayments of the pools.
Data Collection:-
A sample of 10 Residential Mortgage backed Securitization pools are collected and their basic
features like pool size, ratio of size of senior securitized instruments, the total size of the pool,
weighted average coupon rate of the pool and average seasoning or age of the pool before
Securitization, are summarized.
Statistical Tools used:-
One Way ANOVA, Two Way ANOVA and Regression Analysis was used in the study.
The Conditional Prepayment Rate was calculated for each pool using the following formula:

Where, SMM = Single Monthly Mortality, collected from the data.
For analysing the effect of seasoning of the pools on their prepayment behaviour, the
variations CPR with the age after Securitization were plotted for all the pools
individually. It was found that the prepayment rate of the pool increases as the age
increases, it attains a maximum value and then reduces.
The significance of these variations were tested by ANOVA.
The First ANOVA (One way) was conducted to analyse the significance of seananality
in Prepayment rates. It was found that the calculated F value was less than the critical F
value, also p value was greater than significance level of 5%, thus accepting the null
hypothesis, that there is no effect of seasonality on prepayment rates.
However with the second ANOVA test, it was found that there exists a statistically
significant impact of seasoning on the prepayments levels of the securitized pools. That
4

is, the null hypothesis was rejected. On further investigation, it is observed that the
average prepayments (CPR values) are reducing with respect to age.
A regression analysis of the data indicated that the goodness of fit, or the goodness of
the regression equation is very good with an

value of 92%.
Findings and Conclusion:-
The research paper investigated the influence of two factors, seasonality and seasoning (age) of
the pool on prepayment behaviour of residential mortgage backed securitization.
It was found that, unlike other developed countries, the seasonality of pools do not impact the
prepayment patterns. However, seasoning has a significant impact on the prepayment pattern of
the pools. Prepayment risk exists due to the option available for mortgages to either pay as
equal monthly instalments (EMI) or to pay off the mortgage in full at any point of time.
(Downing, Stanton and Wallace, 2001) According to Stantons literature review, prepayment
of mortgage contract can be considered as a call option which gives the holder a right but not
an obligation to exercise prepayment. There are three basic reasons for prepayment: moving,
refinancing, and default.
Reference:-
Iyer, K., & Tripathi, G. C. (2008, February 3). Prepayment Analysis of Residential
Mortgage Backed Securities for Indian Securitization Market. Social Science Research
Network. Retrieved July 28, 2014, from
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1090013
Bajaj, U. (2013, September). Securitization in India: A Bumpy Ride. Indian Journal of
Applied Research, 3(9).
Downing, C., Stanton, R. and Wallace, N. 2001. An Empirical Test of a Two-Factor
Mortgage Prepayment and Valuation Model: How Much Do House Prices Matter
Working paper, Carnegie-Mellon University.