CMO Market Update
August 17, 2020
Last week saw fixed-rate CMOs shed another 2 basis points in nominal spread to Treasury yields. This tightening trend has been playing out since early April and left spreads marginally above year-to-date lows.
Investors have been steadfast in seeking out call protection to shield their portfolios from prepayments. Most commonly, this has come in the form of cut-coupons and call-protected collateral, such as low-loan balance, 100% NY, or 100% investment property, that has historically experienced slower prepayments. One could layer protection as well by looking for cut coupons off one of the previously mentioned collateral types.
As discussed in our August Prepay Commentary (released 8/10/20), “there is a ‘pay-up’ associated with loan balance or 100% NY pools. However, given what we know coupled with historical evidence, the pay-up could be worthwhile as a form of insurance against prepayments.”
For those that missed it last week, please see the July Monthly Trade Summary included below.
Monthly Trade Summary
July was another active month for the CMO sector. The average purchased yield dropped month-over-month as demand for lower cut coupons, 1.25% – 2.00%, drove activity. Additionally, models continue to project elevated prepayments in this low rate environment. As shown in the table below, activity in floating-rate product was meaningful throughout the the second quarter and that continued in July as some investors are looking for upside in the event yields pop up from current levels. Sequentials edged PACs in terms of breakdown by class type, albeit by a slimmer margin than in June.
Travis Nauert, CFA
Analyst, Investment Strategies
Vining Sparks IBG, LP