Salomon Smith Barney updated its prepayment model last week to reflect the impact of press coverage and publicity in the wave of refinancings that hit the mortgage market this year.
The "media effect"' kicks in, said Lakhbir Hayre, managing director for mortgage and asset-backed research at Salomon Smith Barney, when mortgage rates hit multiyear lows. The publicity prompts a "turbo-charging" of prepayment speeds because borrowers become more aware of refinancing opportunities and lenders become more competitive.
Mr. Hayre said the update made the model "more powerful and ... quicker."
The modification of the model, which is widely used to assess the value of mortgage-backed securities, reportedly had a noticeable impact on spreads last week.
Craig G. Ellinger, associate director for mortgage-backed securities at PPM America, Chicago, said the change would lower option-adjusted spreads, shorten the average duration of loans in portfolio, and lead to a slightly higher option cost associated with securities backed by agency mortgages.
Prepayment models "should be dynamic," said Mr. Ellinger, who manages $12 billion in mortgages using Salomon Smith Barney's prepayment model.
The media effect has been part of Wall Street's prepayment models for some time. Prepayment modelers tried to predict the media impact in 1986, 1993, and 1996, when refinancings were at high points, analysts said.
The effect is measured by comparing the coupon on all outstanding mortgages to the current coupon, and looking at a time component-the time since rates were at current levels, Mr. Hayre said.
If Salomon Smith Barney's prepayment model is wrong, then prepayments will be slower than projected, and most mortgage investors would benefit, Mr. Hayre said. But with well-informed borrowers and fast-paced electronic dissemination of information, Mr. Hayre said, he expects people to be very reactive if mortgage rates drop to new lows.
Every Wall Street firm tweaks its prepayment models monthly. Mortgage research departments are responsible for keeping them as accurate as possible.
"Any kind of media component is only going to affect prepayments in the short term; it can't be used to forecast prepayments in the long term," said Raymond Yee, vice president at Risk Monitors in White Plains, N.Y.
First Union Capital Markets and Lehman Brothers last week closed the second-largest, and the most geographically diverse, commercial mortgage securitization ever, a $3.4 billion offering.
The underlying portfolio included both the run-of-the-mill commercial mortgages traditionally originated by conduits, and loans of $50 million or more on top-class properties, which until recently were financed primarily by life insurance companies.
Such "fusion" deals are increasingly popular because they are less expensive than securitizing these different types of loans in separate deals, said Barry Reiner, managing director of First Union's commercial real estate finance group. -- Marc Hochstein