The following article is reprinted from the Quarter 3, 2007 issue
of On the Edge, the Interactive Data Fixed Income Analytics Quarterly newsletter.

Hybrid ARM Prepayments

Teri Geske
Senior Vice President, Business & Product Development

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Issuance of Hybrid ARMs remains strong well into 2007. As versus 2002-2003, when the yield curve displayed 200-300 bps of steepness (as measured by the Treasury 2Y-10Y spread), through 2006-2007 when the curve was flat to inverted, ARM issuance has continued to climb. As the table below shows, Hybrid ARMs account for 11.4% of the outstanding mortgage market as of mid 2007, up from just 3.3% in 2002. This has largely come at the cost of GNMA issuance, Balloons, and Traditional ARMS.

With the Treasury curve set to steepen yet again, and housing prices remaining somewhat firm, Hybrid-ARM programs promise to remain an enticing financing option for borrowers.

As with any mortgage product, one of the largest sources of risk inherent in Hybrids lies with prepayments. Hybrid borrowers tend to behave like balloon borrowers, since at the end of the fixed-rate period, they tend to reassess their borrowing costs and options. The BondEdge Hybrid ARM prepayment model captures this enhanced sensitivity to refinancing at the end of the fixed-rate period.

However, the BondEdge Hybrid ARM model tended to produce base prepayment speeds during the fixed-rate period that outpaced actual reported prepayments. Consequently, as of the end of July 2007, the BondEdge Hybrid ARM prepayment model will benefit from a modest recalibration to recent historical speeds. The affect on the prepayments for typical Hybrid ARMs will be to slow prepayments down slightly thus lengthening durations by approximately 0.10. The table below illustrates the general affect for various segments of the Hybrid ARM index.