Geography Affects Prepayment Risk.(Michael Bykhovsky- Applied Financial Technology)

SAN FRANCISCO -- With rates once again slipping in the third quarter, lenders - just recovering from the biggest refinancing boom in history - have seen prepayment rates rise again.

But in the mortgage secondary market, people are still failing to accurately price loans based on their propensity to refinance, according to a prepayment expert here. In part, that's because much of the mortgage investor and servicing marketplace lacks an understanding of the geographic variable behind a borrower's propensity to refinance.

Michael Bykhovsky, president and CEO of Applied Financial Technology, noted that some things have changed since the mid to late 1990s, which is the period of time on which many current models rely to make prepayment projection for the current housing market environment. For instance, existing home sales now run at a rate of about 6.2 million units per year, up from 4.5 million in 1996, with a very large increase even accounting for the increase in the housing stock.

"Just from that you would expect a higher rate of prepayments related to housing turnover than would be implied by the history - most models underestimate that," Mr. Bykhovsky said.

He also believes that the influences of geographic factors that are partially linked to the home price appreciation index are more nuanced than most people realize. Many states have experienced higher home price appreciation than others. At the same time, states also have differences in prepayment behaviors independent of the home price index. AFT has measured these separate effects, and calculated the "intrinsic" geography factors, independent from HPI and from other loan attributes, such as loan size, that also vary between states.

"If you compare prepay speeds on otherwise identical loans from regions that have had similar HPI, for instance, Wisconsin and Texas, expected prepayment speeds will differ due to intrinsic geographic factors," Mr. Bykhovsky said.

In fact, AFT's analysis has shown that ...