CMO Market Update
January 19, 2021
Depending on maturity and structure, CMO spreads to Treasury yields were unchanged to 4 basis points tighter last week. As shown in the graphs below, CMO spreads and yields remain at the low end of their respective ranges over the past year. However, there is still high demand in this space as the spread pick-up over other investment alternatives remains attractive (see Investment Alternatives Matrix) and investors seek steady cashflows with prepay protection (low coupon cuts, low loan balance, 100% NY, etc.).
Activity last week was driven primarily by low coupon cuts. Premium averse investors should find value in bonds with coupons from 0.5% – 1.5% as they have been trading at slight discounts to 102 dollar price handles. For further analytical context on this sector, please see the below image from last week’s Investment Alternatives Matrix.
Monthly Trade Summary
Analytics on December CMO trades support what has been a noticable trend to close out the year: investors are willing to try something different. In relation to CMOs, customers are extending out on the curve. Typically, the average WAL purchased by customers is 2.5 years. In 2 of the last 3 months, the average WAL purchased as been closer to 3 years. Consequently, the average yield and effective duration purchased has increased to 0.79% and 3.6, respectively.
Low cut-coupons (1.0% – 1.5%, traditional and jumbo collateral) were the primary driver of activity in December. Investors continue to show an aversion to premiums and bonds with coupons in the 1.0% – 1.5% part of the stack have been trading in a range of par to 102 handles (see CMO section of Investment Alternatives Matrix). Activity in floating-rate bonds declined again in December, accounting for just 7% of CMO trades. This follows a string of strong tallies in the summer and fall months when floating-rate bonds were > 20% of CMO trades.
Breaking down trades by class-type, PACs outpaced Sequentials for the second consecutive month. PACs have accounted for more than 60% of trades in November and December.
Travis Nauert, CFA
Analyst, Investment Strategies
Vining Sparks IBG, LP