CMO Market Update
May 18, 2020
One persistent theme in the CMO space has been the level of dollar prices. Lately, investors in this sector have seen bonds with attractive yield and average life profiles, only to be faced with a sizeable premium. For many, that is a deterrent. But let’s remember, the price is what it is for a reason. Bonds that project to perform well and have desirable structures should be in high demand.
In the wake of the coronavirus pandemic and subsequent Fed easing, more specifically the Central Bank’s purchases of Mortgage Backed Securities, investors re-allocated into a variety of other products. With rates at historic lows, investors are seeking further protection from calls and prepayments. CMOs have participated as investors seek to build consistent cashflow from their portfolio, and certain collateral types work toward achieving that goal.
For example, the Trade Desk continues to see interest in bonds backed by loans with low original max loan sizes. All else equal, it should not be economically favorable for these borrows 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.
For those uncomfortable with the premium, don’t forget the other side of the trade. The Desk, as always, is seeking bid wanted lists. Holders of CMOs can look to harvest gains and go into other products like CMBS or Munis where attractive spreads are also present.
Travis Nauert, CFA
Analyst, Investment Strategies
Vining Sparks IBG, LP