Mobile Homes: A Prepayment Analysis Case Study

Wesley Phoa, Ph.D.

This paper illustrates the logic and the methods applied in prepayment analysis. This should help investors make informed judgments about the validity and usefulness of third party prepayment research.

Specifically, the paper analyses manufactured housing prepayments, based on published prospectus data, and using only spreadsheet-based analytics. It tracks the behavior of eleven mortgage pools, through periods of stable, falling and fluctuating interest rates.

The result is a prepayment model consisting of a baseline forecast, dependent on seasoning, and a model of interest rate sensitivity. This can be tested against out-of-sample data.

Uncertainty regarding defaults and interest rate sensitive prepayments gives rise to prepayment model risk. An examination of the data suggests ways to quantify this risk.

A full prepayment model would use more detailed data and more sophisticated methods. However, note that the value added by more detailed analysis is not primarily in generating more accurate forecasts, but in gaining greater insight into risk factors and quantifying their potential impact on security returns.