Risk-Based Pricing is Adding A Wrinkle to Prepay Analysis.(Brief Article)

With the advent of risk-based pricing, investors in mortgage-backed securities have a new factor to consider when estimating prepayment risk.

That's the message that Anand Bhattacharya, executive vice president of Countrywide Securities Corp., delivered at a recent meeting with investors here.

"One thing we strongly believe is that the pricing in the mortgage market increasingly will become risk-based," he said.

Mr. Bhattacharya said that when investors evaluate the prepayment risk associated with loans at different coupon levels, they should compare the rate at loan origination with the prevailing rates for other loans originated at the same time. That's because seasoning will increasingly be "multidimensional," with prepayment behavior for loans at a given coupon rate varying according to the circumstances of loan origination.

In short, some loans with lower interest rates may prepay faster than loans with higher interest rates that were originated under risk-based pricing standards.

Without that loan level data, investors may be surprised to find that some loans at a given coupon rate perform much differently than others, he said.

For instance, an 8.5% loan originated today at above market rate might reflect a higher-risk borrower, and be much less likely to prepay than a loan originated at that same rate in May of 2000 to a low-risk borrower who has plenty of financing options.