Nykredit Markets’ mortgage prepayment model

Most mortgage bonds in Denmark are pass-through securities where borrowers have an option to prepay their loans at par. The bonds offer attractive spreads to investors, but relative value strategies and risk assessment require a prepayment model that takes this option into account. Nykredit Markets uses an in-house prepayment model, which has been developed by its quantitative research team. In this article, Jesper Lund presents the main features of the model

Danish callable mortgage bonds are pass-through securities with quarterly payments. The underlying loans are annuities with the same coupon rate and only a small variation in time-to-maturity. Currently, most new loans have maturities of either 20 or 30 years. Borrowers have an option to prepay their loans at par with a notice period of two months. Since borrowers can also redeem their loans with bonds from the underlying series (called buybacks), we only see prepayments for bonds trading above