What Does Single Monthly Mortality Mean?
Single monthly mortality (SMM) is a measure of the prepayment rate of a mortgage-backed security (MBS). As the term suggests, the single monthly mortality measures prepayment in a given month and is expressed as a percentage. For investors of mortgage-backed securities, prepayment of mortgages is usually undesirable since future interest is foregone; investors prefer a lower or declining single monthly mortality on an MBS.
Understanding Single Monthly Mortality (SMM)
Single monthly mortality is sometimes confused with the scheduled principal prepayments. The servicer records for an MBS usually provide the scheduled principal repayments that are set for the pool when the MBS is created. Single monthly mortality refers to the principal prepayments that occur over that amount, essentially taking the total principal paid, subtracting the scheduled principal payments, and dividing by the outstanding balance that was scheduled for the month (as opposed to the actual) to get a percentage of prepayment.
Single Monthly Mortality and Prepayment Risk
The single monthly mortality will fluctuate from month to month according to borrower refinancing, accelerated payments, and so on. Prepayment hinders the returns for MBS investors because mortgages are normally prepaid using a refinancing loan, and this happens primarily when interest rates have fallen. So while an investor in an MBS believes they have locked in a higher yielding investment in a low rate environment, they may, in fact, have the carpet pulled out from under them. As a result, investors in mortgage-backed securities are always concerned about the prepayment risk on their investment, and single monthly mortality provides them a metric to show whether risks are going up, going down, or leveling off.
SMM, Constant Prepayment Rate, and Prepayment Ramps
Single monthly mortality can be annualized into the constant prepayment rate (CPR), which gives the annual percentage rather than a monthly snapshot. MBS investors can switch between the two during important points in their holding’s life span. For example, if interest rates decline over a period of time, an MBS investor will usually watch the SMM to see whether or not burnout is setting in.
Similarly, there are the first 30 months of a mortgage-backed security’s life where it is considered “on the ramp” and during which SMM and CPR are expected to increase before leveling off once the MBS is “off the ramp” after 30 months. The caveat with the prepayment ramps is that they are based on the PSA model from the 1980s. Although the broad outline of this model holds up—mainly that there are two phases to an MBS lifespan—the mortgage market is a different place now, and public awareness of refinancing and interest rates is more ubiquitous than when the PSA model was created. The length of the ramps is believed to be much shorter now, as people are more likely to refinance when rates go down.