With the lack of refinancing response considering current level of rates, analysts are weighing whether its burnout or the lack of media effect that is causing the lackluster borrower reaction.

JPMorgan Securities analysts report that although burnout and the media effect have similar effects, these have very different results. A major difference is that while burnout is specific to a pool and only impacts seasoned collateral, the media effect is supposed to influence the entire market - which means new as well as seasoned product - explained JPMorgan.

In other words, the media effect, unlike burnout, has nothing to do with the pool's factors - it has do with the percentage of borrowers refinancing for every incremental change in rates, as when mortgage rates either reach new lows or retrace previous lows.

Other analysts added that there is currently a lack of media effect because the market has not seen the lows in rates that were seen throughout the first quarter of this year.

For instance, as of last Wednesday's close, the Fannie Mae current coupon was at 5.07% compared to the 4.81% seen in late March, which is a difference of 26 basis points. The market has not retraced the low rates that were seen before the backup last April 2.

UBS prepayment analyst Glenn Boyd said that current prepayment behavior is completely consistent based on the media effect. Since rates have not revisited previous lows seen earlier this year, it's not surprising that the Mortgage Bankers Association Refinancing Index has not increased by much. Boyd added that with less of the market in the money right now, even the same low rates seen earlier this year and last year would not necessarily generate a comparable response. Considering these two factors, UBS expects the Refinancing Index to top 2100 in a couple of weeks, given the current level of rates and provided that a selloff does not occur during this time frame.

In the most recent Mortgage Strategist, Boyd explained the importance of media effect in determining refinancing response curves. "To project speeds, it's not sufficient to know the economic refi incentive of a pool - you also need to know something about the rate environment." The firm's main media effect variable is Rate Attractiveness (RA), which is the difference between the three-year average Freddie Mac mortgage and the current rate.

Currently, Boyd said that in order to attain a stronger refinancing response typical of a moderate refinancing environment, rates have to rally by 30 basis points. He added that for another refinancing frenzy to occur, a rally of 70 basis points is needed.

Burnout argument

In a recent report, JPMorgan noted that the recent lack of refinancing reactivity is not due to the media effect since information distribution does not seem to be an issue here.

It is noteworthy that the data has been consistent with prepayment models that have no media effect, similar to the JPMorgan model. Analysts explained that models incorporating a media effect usually significantly increase the refinancing reactivity when rates hit new lows. Because of this, such models would show low reactivity in the current environment.

JPMorgan theorizes that burnout has similar consequences, explaining the lower reactivity on the same pool of mortgages as a result of high previous reactivity. In other words, as the factor declines because of refinancing, the prepayment reactivity dips, as less callable loans then represent a larger share of the remaining balance.

This has an observable consequence in the current environment, JPM said. JPMorgan's model has the 2002 vintage - most 6s and higher coupons - considerably burned out as their factors have dropped sharply following the 2003 refinancing wave. For instance, the 2002 vintage FNMA 6.5s are prepaying slower than the 2003 6.5s, even though the latter are primarily Alt-A originations. However, without the media effect, analysts would expect similar reactivity from new originations as seen in 2003. In particular, 2003 5.5s in 2004 were expected to be as callable as the 2002 cohort (in 2003). Because FNMA 5.5s have barely been in-the-money in 2004, researchers said there is little data on the vintage's refinanceability.

The 2003 cohort is somewhat unique due to its size and high refinancing share, representing new loans from homeowners that have considerable prior home tenure, of about over four years, and is consequently already prepaying much faster than the 2002 cohort did in 2003. If this turns out to be true, then analysts hope this would put an end to, "the myth of the media effect."

In a related report, Citigroup Global Markets said that the current environment is a classic time period when burnout is present. Citigroup analysts added that although mortgage rates are significantly less today than in May, they are still 75 basis points higher than the rates seen in June last year. These rates are also higher than the vast majority of 2003. Because of this, in-the-money mortgages are showing signs of less prepay reactivity to lower mortgage rates. Analysts expect this to be disrupted only if there is a rally of about 50 basis points.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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