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Single Monthly Mortality (SMM)

Contents

  1. Demystifying Single Monthly Mortality (SMM) in Mortgage-Backed Securities
  2. Exploring Single Monthly Mortality (SMM)
  3. Understanding SMM Calculation
  4. Navigating Prepayment Risk
  5. Relationship with Constant Prepayment Rate (CPR) and Prepayment Ramps
  6. Evolving Dynamics in Mortgage Markets

Demystifying Single Monthly Mortality (SMM) in Mortgage-Backed Securities

Exploring Single Monthly Mortality (SMM)

Single Monthly Mortality (SMM) serves as a crucial metric for investors in mortgage-backed securities (MBS), providing insights into the prepayment risk associated with these financial instruments. In this comprehensive guide, we delve into the intricacies of SMM, its calculation, and its implications for MBS investors.

Understanding SMM Calculation

SMM is expressed as a percentage and represents the rate of prepayment of mortgages within a given MBS pool during a specific month. It is calculated by subtracting the scheduled principal repayments from the total principal paid and dividing the result by the outstanding balance scheduled for the month. This metric allows investors to gauge the pace at which mortgages are being paid off prematurely, impacting future interest earnings.

Navigating Prepayment Risk

Prepayment risk is a primary concern for investors in MBS, as it affects the duration and yield of these securities. Factors such as borrower refinancing and accelerated payments contribute to fluctuations in SMM from month to month. Investors monitor SMM closely to assess whether prepayment risks are increasing, decreasing, or stabilizing over time, thereby influencing their investment strategies and decisions.

Relationship with Constant Prepayment Rate (CPR) and Prepayment Ramps

SMM can be annualized into the Constant Prepayment Rate (CPR), providing investors with an annualized perspective on prepayment activity. Additionally, SMM and CPR are particularly significant during the first 30 months of an MBS's lifespan, known as the prepayment ramp period. During this phase, prepayment rates typically increase before leveling off, impacting investor expectations and strategies.

Evolving Dynamics in Mortgage Markets

While prepayment ramps were originally modeled based on historical data from the 1980s, the modern mortgage market exhibits different dynamics. Increased public awareness of refinancing opportunities and interest rate fluctuations has led to shorter prepayment ramp periods. Investors must adapt their strategies accordingly, considering the evolving landscape of mortgage-backed securities.