How does the PSA prepayment model work for mortgage-backed securities, and what does '200 PSA' actually mean?
CFA Level II fixed income MBS section. I understand that homeowners can prepay their mortgages, which creates risk for MBS investors. But the PSA benchmark confuses me -- my notes mention '100 PSA' as the baseline and '200 PSA' as faster prepayment. What do these numbers represent and how do they affect MBS cash flows?
The PSA (Public Securities Association) prepayment model is the industry-standard benchmark for modeling mortgage prepayments. Understanding it is essential for CFA Level II securitization questions.
The PSA Benchmark (100 PSA)
The PSA model expresses prepayment speed as a CPR (Conditional Prepayment Rate) -- the annualized percentage of the remaining mortgage pool balance that prepays in a given month.
At 100 PSA (the baseline):
- Month 1: CPR = 0.2%
- Month 2: CPR = 0.4%
- Each subsequent month: CPR increases by 0.2%
- Month 30: CPR reaches 6.0%
- Month 31+: CPR stays flat at 6.0% for the remaining life
The monthly prepayment rate (SMM) is derived from CPR:
SMM = 1 - (1 - CPR)^(1/12)
What '200 PSA' Means
200 PSA simply means prepayments occur at twice the 100 PSA baseline rate:
- Month 1: CPR = 0.4% (2 x 0.2%)
- Month 15: CPR = 6.0% (2 x 3.0%)
- Month 30+: CPR = 12.0% (2 x 6.0%)
Similarly, 50 PSA means half the baseline speed, and 300 PSA means three times.
Impact on MBS Cash Flows: Collinswood Mortgage Trust Pool (fictional)
Consider a $100 million pool of 30-year mortgages at 5.5% coupon:
| PSA Speed | Weighted Avg Life | Total Interest Received | Principal Returned By Year 10 |
|---|---|---|---|
| 50 PSA | ~18 years | Higher | ~35% |
| 100 PSA | ~12 years | Moderate | ~55% |
| 200 PSA | ~7 years | Lower | ~80% |
| 300 PSA | ~5 years | Lowest | ~90% |
Why This Matters to Investors
Faster prepayments (higher PSA) create contraction risk -- principal comes back sooner, usually when rates have fallen (homeowners refinance). This means the MBS investor gets cash back when reinvestment rates are lower.
Slower prepayments (lower PSA) create extension risk -- principal stays out longer, typically when rates have risen. The investor is stuck in a below-market coupon bond.
The Seasoning Ramp Intuition
Why does prepayment speed ramp up over the first 30 months? New homeowners rarely move or refinance immediately after buying a house. As the mortgage ages ('seasons'), the likelihood of life events (job change, family growth, refinancing) increases. After about 2.5 years, the pool reaches a steady-state prepayment level.
Exam Tip: The CFA exam will give you a PSA speed and ask you to calculate the CPR at a specific month. Formula: CPR at month t = min(t x 0.2% x PSA/100, 6% x PSA/100). If the question says 150 PSA at month 20: CPR = min(20 x 0.2% x 1.5, 6% x 1.5) = min(6.0%, 9.0%) = 6.0%.
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