CMO Market Update
May 11, 2020
CMO spreads to Treasurys dropped 2 basis points across the curve last week, continuing a tightening trend that started in early April. While relative value is present in the form of historically wide nominal spreads, investors active in the CMO space know this comes at a cost, as in a high dollar price. Our customers are typically most active in CMOs with a WAL of around 3 years. Investors looking to this part of the curve could face anywhere from a high 102 to 104 dollar price, depending on coupon and collateral type. If extending out to 5 years and beyond, one very well could find a 106 handle or higher.
Given the high dollar prices in this space, customers have been looking to different collateral or structure types in hopes of attaining more stable cashflows. For example, the Trade Desk has seen interest in bonds backed by loans with low original max loan sizes. All else equal, it should not be economically favorable for these borrowers to refinance, providing the stable cashflow that investors seek. While supply is not super abundant, we have seen some “85k max” bonds, that is bonds collateralized by loans with a max original balance of $85,000. Other investors have looked to VADMs which usually limit extension risk.
While CMOs remain an attractive alternative to MBS, investors might also find value in the opposite side of the trade. High dollar prices might deter some from adding to their CMO holdings, but they can also sell positions and likely harvest some gains in the process.
Travis Nauert, CFA
Analyst, Investment Strategies
Vining Sparks IBG, LP