Applied Financial Technology Announces Free Access to the First "Dynamic" Prepayment Scores for the Mortgage Industry

Is the Mortgage Industry Making a $32 Billion Mistake?

San Francisco, July, 2002 -- Applied Financial Technology (formerly Espiel, Inc.) announced today that it will begin providing its Espiel Score for Prepayments (ESP) via the Web to all participants in the mortgage industry later this year at no charge.

Applied Financial Technology offers the Score to provide an additional methodology for more accurate estimation of prepayment risk in the market. Generally, the option to default for a mortgage borrower is worth about 3 to 15 basis points. The borrower's option to prepay is worth about 30 to 90 basis points. And yet the industry focuses many more resources on credit analysis than it does on prepayment risk analysis.

If we assume that the average error due to not taking into account all of the borrower and loan level characteristics in the calculation of prepayment risk is +/- 10 basis points, and the average spread duration of a loan is about 8 years, then the value of the error is $.80 per $100. In a $4 trillion market that equals an approximate $32 billion mistake in the valuation and hedging of prepayment risk.

Applied Financial's Espiel Prepayment Models represent the next generation of prepayment modeling and are used by the majority of top MBS dealers and top Mortgage Banks. Out of this more sophisticated process, Applied Financial Technology has developed a Prepayment Score that provides the user with a new language of communication to relate the intrinsic prepayment risk of a loan or a borrower. The Score provides the user with a simple method of comparing the underlying prepayment risk of externally similar loans. Unlike previous prepayment scores, the AFT Scores will also provide the user with the ability to value the prepayment option for hedging and valuation purposes, and a process to translate the Scores into differential prices, hedging ratios and short-term speed projections based on market interest rates and implied volatilities.

Michael Bykhovsky, CEO of Applied Financial Technology and a veteran of Wall Street, has spent more than 12 years developing prepayment models. He said, “While many have tried to meet the market demand for a prepayment score, none of the previous entries have answered the questions that the industry is asking. Questions like what is the relative value of two otherwise similar loans? What is the value of the embedded option to prepay? What hedge ratio should be used to hedge a specific set of loans? How much is a prepayment penalty worth? The AFT approach allows the user to rate loans and borrowers by their "propensity" to prepay. Propensity is not a function of ever-changing interest rates, but is an intrinsic property associated with a particular loan or borrower. This rate allows participants in different arenas of the mortgage process to communicate using simple numbers. Previous scores have had little or no value in that they have only provided prepayment projections for the next two to three months. The historical performance of such scores has been worse than the performance of the standard AFT Prepayment Model. We hope that by providing the Espiel Score for Prepayments to the market for free, we can help alleviate some the prepayment risk in the market and gain exposure for our analytics at the same time.

Applied Financial Technology, a privately held company headquartered in San Francisco, California, has been providing prepayment risk and other fixed income analytics to the mortgage industry since 1996.