CMO Market Update

May 17, 2021

Spreads to Treasury yields for fixed-rate CMOs widened 2 basis points last week.

The trade desk continues to see a high concentration of activity in low coupon cuts, specifically 1.00% off 30-year, 3.00% Ginnie Mae collateral. Investors have gravitated towards this product type to maintain steady short to intermediate cashflow, while earning greater than a 1.00% projected yield, and avoiding high premiums in the process.

Two CMOs are highlighted in the image below of last week’s Investment Alternatives Matrix. This is to illustrate the kinds of tradeoffs investors are facing in this space when it comes to different coupon cuts. Assuming the same underlying collateral, the higher coupon will of course demand a higher price. And while the 1.50% coupon bond is projected to yield more in the base case, consider the +/- 100bps scenarios. The 1.25% coupon bond, at a slight discount, outperforms in a -100bps scenario. Price volatility and duration will also be a consideration, although the differences are not drastic in this example.

For data on collateral prepayments and performance, please see our monthly MBS Prepayment Commentary.

Monthly Trade Summary

Analytics on April CMO trades exhibited some mean reversion in terms of WAL and Effective Duration after investors extended out notably in March. Customer purchases of fixed-rate CMOs in March are projected to have a base-case WAL of about 5 years. In April, new investments averaged a 3.8-year WAL, which is more in line with historical averages for our depository institution customers. Similarly, effective duration fell to 3.4. But yields were steady month-over-month, with projected yields on April purchases averaging 1.20%.

In terms of product trends, investors continue to seek out discount-priced, low-coupon cuts, and it was the the 1.00% – 1.25% part of the stack that was in high demand during April. There was an increased appetite for traditional and jumbo Ginnie Mae collateral, and for G2SF 3 collateral in particular. Most trades with FNR or FHR issued bonds were 1.0% coupons off FNCI 1.5% collateral.

Activity in floating-rate CMOs has fallen off almost completely in the last two months after a decent run to start the year. Fixed-rate bonds accounted for the overwhelming majority of Agency CMO trades last month. When looking at trades by class type, PACs accounted for more than 50% of trades for the third month in a row. And a meaningful amount of TAC structures traded, accounting for most of the increase in the “Other” category by Class Type.

Travis Nauert, CFA

Analyst, Investment Strategies

Vining Sparks IBG, LP