CMO Market Update
August 23, 2021
Last week, investors continued showing healthy demand for Agency CMOs. In terms of product types that traded, the main driver of activity was no surprise: 1.00% – 1.25% coupon, jumbo collateral bonds. Additionally, there was an uptick in CMO trades involving 100% NY collateral. The coupon levels varied, but last week saw the most activity for 100% NY collateral in this space during August. And lastly, some floating-rate bonds traded as well after a few quiet weeks.
When it comes to floating-rate CMOs, remember that there is a tradeoff between caps and yields. Generally speaking, yields on CMO floaters are so low that one might just barely exceed the rate they are earning on cash. But investors willing to trade away floating upside by accepting a lower lifetime cap can earn a meaningfully higher base case yield. This is something to keep in mind, especially for those looking to stay defensive with shorter duration investment options.
Last week’s Investment Alternatives Matrix was run using Yield Book’s prepay model V21.7. This is an upcoming update that will become their production model, scheduled for release later this week on August 26th. As it relates to CMOs, changes are more apparent (faster projected speeds) for early pay tranches collateralized with higher coupon 30-year MBS. Changes are less drastic for cut-coupon CMOs, which our customers have been most active in for some time now.
July Trade Summary
In the July 26 update, I expressed an expectation that the July trade summary would reveal a somewhat conservative approach from portfolio managers as it relates to extending out on the curve with new CMO purchases. That forecast was incorrect. The summary statistics show that investors did extend, albeit slightly, month over month compared to investments made in June.
July saw CMO investors purchased fixed-rate bonds with an average WAL of 4.3 years. This is the longest WAL we have seen since 4.9 years in March. Projected yields on July purchases even surpassed what was observed in March. While this may be surpising, it shows that investors still have some appetite for risk, whether it be exposure to prepayments in the short term or extension in the future, in the face of this low rate environment.
In terms of coupon type, fixed-rate investments dominated activity with floating-rate trades accounting for less than 1.00% of trades by current par. This is a stark contrast compared to May and June, months in which floating-rate activity was about 15.00% of trades. However, the lack of floating-rate activity in July is not too surprising given how rates fell during the month.
Looking at trades broken down by class type, PACs reclaimed the majority of activity after Sequentials were the more popular structure in June. As shown in the table below, customers have favored PACs for most of 2021. One development in July is that a handful of decent sized blocks traded involving TAC structures. These are accounted for in the “Other” category. At this point, it’s too early to say if this is a blip on the radar or a sign of things to come. As always, time will tell.
Travis Nauert, CFA
Analyst, Investment Strategies
Vining Sparks IBG, LP