CMO Market Update

July 12, 2021

The calendar has turned to July and the start of Q3 since our last CMO sector update. A link was included in last week’s overall update to a quarterly review yield and spread snapshot. Below you will find a condensed version limited to Treasurys and CMOs. Q2 saw yields for longer maturity Treasurys retrace some of their upward movement from Q1. Nominal CMO spreads were slightly tighter for the quarter, but largely unaffected by the volatility.

Once again, investors were focused on low coupon cuts last week. While 1.25% cuts saw the most activity, 1.00% and 2.00% coupon bonds, off both FGLMC and G2SF collateral, were in demand as well. It stands to reason that CMOs will continue to play an important role in depository institution portfolios as cash levels remain high and customers aim to structure cashflows in an appropriate manner for their respective balance sheets.

Monthly Trade Summary

While yields for longer maturity Treasurys declined during the quarter, yields for short- to intermediate-term government bonds were more resilient. Yields for 2- and 3-year Treasurys increased 9 and 11 basis points, respectively, while the yield for the 5-year Treasury declined 5 basis points. So, a bit of a mixed bag, but less drastic moves than were seen on the long end of the curve, where the 10- and 30-year yields decreased 27 and 32 basis points. Given the latter, one might have expected yields on new CMO purchases to decline month over month. But, as a reminder, our customers typically traffic in the 3 – 5 year portion of the curve when it comes to CMOs. So, as it turns out, projected yields on new investments were right in line with recent months at 1.17%.

While not a significant change month over month, customers did extend out on the curve with June purchases. This is evidenced by the increase in WAL from 3.9 in May to 4.2 in June. The last time we saw customers purchase bonds with a 4-year WAL or greater on average was in March of this year.

In terms of coupon types, fixed-rate bonds continue to make up the majority of purchases. However, floating-rate bonds accounted for just over 15% of trades in this sector for the second consecutive month. This is notable given the dropoff seen in March and April.

Lastly, customers were honed in on Sequential structures last month. As shown in the table below, PACs accounted for more than 50% of CMO trades in the prior 4 months, while activity in VADMs continues to be virtually non-existent.

Travis Nauert, CFA

Analyst, Investment Strategies

Vining Sparks IBG, LP