Continuing its innovation in prepayment models for a variety of asset classes, Andrew Davidson & Co. has developed a model to determine prepayments for adjustable-rate home-equity loans.

ARMs are becoming a hot sector in the market, and the company decided to pursue constructing a model that would be of particular interest to issuers and investors. The new model sets itself apart from other prepayment models by obtaining data from a variety of issuers, rather than just one.

Because the prepayment model is available directly to users, investors do not have to go to their dealer to use the dealer's model or read a report.

"What that allows us to do is capture effects that are true across the collateral class as opposed to being driven by effects that are issuer-specific," said Andrew Davidson, president of the company. "In the past it wasn't that crucial because these issuers all had their own niche and their own way of originating loans, but there's been so much turmoil in this industry, not all of these issuers continue to exist. You do have this change in who the players are, and so having a model that's driven largely by issuer information no longer becomes as valuable, so what we really want to understand is the behavior of the borrower directly."

The model uses data from 30-year non-convertible Libor ARMs that are secured by single-family residencies with first reset dates of six, 12, 24 or 36 months, with periodic resets every six months thereafter.

"What's very important in these adjustable-rate home-equity loans are these reset periods, because the borrowers seem to be driven very much by what their initial choice of reset period was and what happens when these loans come out of their fixed period into their adjustable period," Davidson said. The model also is able to differentiate borrowers with different credit margins.

The model will soon be available to users, providing statistical analysis and in-depth analysis of loans. A dynamic-linked library, or subroutine, was also created, which can be plugged into a variety of analytical tools so that there's a wide range of methods by which investors can use the model in order to do whatever analysis they think is appropriate, according to Davidson.

The factors currently incorporated in the new model are aging, coupon rate, margin, loan-to-value ratio and Initial Libor Rate. "I think we were able to capture what I think most analysts would consider to be the major factors that drive these kinds of prepayments," Davidson said.

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