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Single Monthly Mortality (SMM) & Conditional Prepayment Rate (CPR)

Category — Issue Parameters
One of the main risks for investors in securitized bonds is the risk of early repayment of mortgages included in the pool. This can often occur during periods of prolonged rate cuts due to the desire of borrowers to refinance existing debt on more favorable terms. The Annual Prepayment Rate in securitization analysis is the fraction of the existing credit pool that will be prepaid in a given year. Also, the Annual Prepayment Rate can be interpreted as the probability of prepayment in a given year.

Prepayments in mortgage pools are usually described in terms of the model created by the Public Securities Association (PSA). The Association has determined the values of the PSA Benchmark for the Prepayment Rate (PR): for 30 months of the existence of the loan, the PR becomes 6% and is constant for all subsequent periods. For all periods from 1 to 29 months, the PR is set at 0.2% for 1 month, 0.4% for 2 months, etc. Releases whose PR matches the PSA benchmark are called 100 PSA (in the value of 100% of the 6% benchmark). In the PSA Prepayment Rate model, the pool is named “Conditional Prepayment Rate” since the final prepayment rate will depend on the life year of the mortgages in the pool.

Thus, the Conditional Prepayment Rate (CPR) is the annual percentage of the main balance of the mortgage pool, which will be paid ahead of schedule for each period.

Single Monthly Mortality (SMM) can be interpreted in two ways: (1) the likelihood that the mortgage will be repaid in a given month; (2) the rate of early repayment of the mortgage pool in the given month. SMM is calculated using the following formula:

SMM = 1 - (1 - CPR)^1/12

Or by the following:

SMM = Prepayment / Beginning mortgage balance - Scheduled Principal Payment

Outside the securitization market in the United States, different terminology can be found; for example, in Canada, the monthly liquidation rate is used.
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