10.7.10.2 Types of Prepayment Drivers

The prepayment drivers are designed to allow the calculation of prepayment rates at run time depending on the specific characteristics of the instruments for which cash flows are being generated. Although nine prepayment drivers are available, a particular prepayment model can contain only up to three prepayment drivers.

The prepayment drivers can be divided into the following two categories:

• Age/Term Drivers: The Age/Term drivers define term and repricing parameters in a Prepayment model. All such prepayment drivers are input in units of months. These drivers include:
  • Original Term: You can vary your prepayment assumptions based on the contractual term of the instrument. For example, you could model faster prepayment speeds for longer-term loans, such as a 10-year loan, than for short-term loans, such as a 5-year loan. You would then select the Original Term prepayment driver and specify two node values: 60 months and 120 months.
  • Repricing Frequency: You can vary your prepayment assumptions based on the repricing nature of the instrument being analyzed. Again, you could specify different prepayment speeds for different repricing frequencies and the system would decide which one to apply at run time on a record by record basis.
  • Remaining Term: You can specify prepayment speeds based on the remaining term to maturity. For example, loans with few months to go until maturity tend to experience faster prepayments than loans with longer remaining terms.
  • Expired Term: This is similar to the previous driver but instead of looking at the term to maturity, you base your assumptions on the elapsed time. Prepayments show some aging effects such as the loans originated recently experiencing more prepayments than older ones.
  • Term to Repricing: You can also define prepayment speeds based on the number of months until the next repricing of the instrument.
• Interest Rate Drivers: The Interest Rate drivers allow the forecasted interest rates to drive prepayment behavior to establish the rate-sensitive prepayment runoff. Interest Rate Drivers include:
  • Coupon Rate: You can base your prepayment assumptions on the current gross rate on the instrument.
  • Market Rate: This driver allows you to specify prepayment speeds based on the market rate prevalent at the time the cash flows occur. This way, you can incorporate your future expectations on the levels of interest rates in the prepayment rate estimation. For example, you can increase prepayment speeds during periods of decreasing rates and decrease prepayments when the rates go up.
  • Rate Difference: You can base your prepayments on the spread between the current gross rate and the market rate.
  • Rate Ratio: You can also base your prepayments on the ratio of current gross rate to market rate.

The following diagram illustrates a three-driver prepayment model:

Figure 10-1 Prepayment Model

The ~ signifies a point on the X-Y-Z plane. In this example, it is on the second node of the Z-plane. The Z -plane behaves like layers.

Oracle Balance Sheet Planning allows you to build prepayment models using the Prepayment Model rule. The Prepayment Model rule can then be referenced by a Prepayment Rule. See Prepayment Models.