PSA Standard Prepayment Model is the presumed monthly prepayment rate annualized by the remaining principal amount of the mortgage loan. PSA Standard Prepayment Model is just one of many models utilized to estimate and manage the risk of prepayment that is specifically for Mortgage-backed Securities (MBS) along with collateralized mortgage obligation (CMO).
Understanding PSA
PSA Standard Prepayment Model recognizes that the prepayment assumptions can alter throughout the loan and can impact how much the securities yield. The model anticipates that prepayments will increase that peak gradually after 30 months. The standard model referred to as 100 percent PSA begins with an annualized rate of 0% for month zero. Then, it increases to 0.2 percent every month until it reaches 6.6% after 30 months.
The prepayment assumptions are based on homebuyers' data, which shows that during the first few years, an individual who is a borrower is less likely to be in a position to make a prepayment on the mortgage. This makes sense because a new homeowner will likely not move to a new residence or refinance immediately, as the cost of purchasing a house typically will not provide a large amount of money for the new owner to make further installments.
It is vital to understand that the PSA is not the only popular model for prepayment. Various models, including proprietary, can analyze and model prepayments in mortgage-backed investment. This model is called Public Securities Association Standard Prepayment Model, also known as "the" PSA model for prepayment.
Significance of the Standard Prepayment Model
If the annual mortality for a particular CMO or MBS is higher than anticipated according to the PSA, the security could decrease its life expectancy. This could result in the capital returning to investors earlier than originally expected. The return on capital received through prepayment is usually negative for investors since prepayment is more likely to rise in low-interest conditions, meaning investors get back capital that they need to reinvest in an environment with a lower yield. This has an adverse impact on the value of trading an MBS that is more than the PSA. However, the lifespan of an MBS could be extended if the prepayment rates are less than the PSA as long as the PSA was utilized for the development and marketing of the investment.
Background on the PSA
1985 saw the birth of PSA Standard Prepayment Model, established by the Public Securities Association. The Public Securities Association transitioned over time into the Bond Market Association, and in 2007, it amalgamated with the Securities Industry Association to become SIFMA.
The prepayment model is identified by its initial name; however, due to subsequent name changes to the organization, it is often referred to as Bond Market Associations PSA. It is also not uncommon to have the acronym that the model is misinterpreted with the acronym of the previously known as the Public Securities Association and acronym to describe the purpose of the model, which is offering a prepayment speed prepayment assumption (PSA).
PSA was the first association to exist prior to the formation of the Bond Market Associations, which is the organization that is responsible for representing the largest securities market in the world and the bond markets. The Public Securities Association was formally established in 1976, but in 1997 it decided to alter its name to the Bond Market Association in order to more accurately represent the organization's more diverse membership and constituent base.
The Bond Market Association represented a wide range of financial institutions and banks, ranging from large companies to niche specialists, with 70% of its members operating their base outside New York City. The association members collectively contributed to a large portion of U.S. municipal bonds trading and underwriting.
The Bond Market Association and the Securities Industry Association merged into a single organization in November 2006. The Securities Industry and Financial Markets Association, often known as SIFMA, was formed when the two associations merged to form a single entity. More than 13,000 individuals working in the banking and financial industries are now members of SIFMA, representing 75 percent of the income generated by the broker-dealer business in the United States. The Securities Industry and Financial Markets Association (SIFMA) is a key business group representing the securities brokerage industry, investment banking institutions, and other investment companies.
