A revision of the collection periods for prepayments announced last week by Residential Funding Corporation (GMAC-RFC) is expected to protect investor's exposure to prepayment interest shortfalls, and is especially timely in light of the current interest-rate environment, sources said.
RFC is now including curtailments in the compensating interest calculation for all securities and is changing the collection period from the 16th of the previous month to the 15th of the current month with remittance to investors made on the 25th of the current month. In the past, if an investor is expecting a 7% coupon, for instance, and there is a 7% interest payment, the investor would not get that full coupon, so the company would take a portion of its master servicing fee income and allocate it to the coupon to make up for the shortfall.
"But in very high prepayment environments, there wasn't enough master servicing income to make up for that coupon," said Eric Scholtz, managing director of capital markets for GMAC-RFC's residential capital group. "On a 7% coupon, you'd receive only 6.95% or 6.90%. Now, with our change in collection periods, it gives us the ability to absorb the interest shortfall. We've come to feel that the majority of the investor community prefers it this way. This is expected to enhance the liquidity of our bonds even further."
Because a remittance cycle can not change on old deals, all these changes are effective for securities starting in Jan. 2001. "Investors do not have to deal with accounting issues of receiving less of a coupon," Scholtz said. "Perhaps they are not better off economically, but there will be more certainty on what the return will be month to month."
Scholtz added that in the past, these shortfalls would become apparent when prepayments reached 40 constant prepayment rate (CPR), and now they would only become apparent during extremely high prepayment scenarios, within the 80 CPR range.