CMO Market Update
June 1, 2020
Agency CMO spreads were steady in May, ending the month within a basis point of where they started. Year-to-date, spreads have settled into the midpoint of their 2020 range. Remember, spreads started the year at the low end of this range before reaching historically-wide levels in the midst of the pandemic and subsequent expansion of the Fed’s balance sheet.
As investors continue to assess their portfolios, CMOs remain an attractive alternative to traditional MBS. With interest rates at low absolute levels, portfolio managers are seeking collateral and structure that are less susceptible to prepayments. Cashflow stability becomes even more important when considering current pricing levels. As market participants turned to products like CMOs, CMBS, and Municipals in light of the dislocation in the MBS space, prices have risen in response to robust demand. We have seen healthy interest in bonds with characteristics like low loan balance collateral and cut coupons. Basically, those willing to pay a premium are doing their best to make sure that cost is spread out over the life of the bond.
For those uncomfortable with mid to high premiums, or willing to take a stance on future rate increases, floating-rate CMOs can provide value. There will certainly be a trade off in yield and spread as compared to fixed-rate bonds, but that comes with the added benefit of reduced price volatility and increased yield in rising rate scenarios. Additionally, investors should be able to find floating-rate bonds offered at a slight discount to par. If the yield doesn’t look quite attractive enough, consider a bond with a lower rate cap to increase projected return.
As always, the trade desk is seeking to bid paper for inventory. So, while some investors are uneasy about purchasing at current levels, they should be able to clean up some positions and potentially book a gain in the process.
Travis Nauert, CFA
Analyst, Investment Strategies
Vining Sparks IBG, LP