CMO Market Update

November 12, 2019



CMO spreads to Treasurys tightened 2 basis points week-over-week. Not too bad considering the movement we saw in Treasury yields. The 3-year rose 15 basis points, while the 5-year (21 bps) and 10-year (23 bps) each rose greater than 20 basis points. CMO yields are approaching, although still below, their midpoint of 2019. Despite that, spreads are not far off their highs for the year.


In terms of activity last week, we saw several trades involving stripped down coupons, primarily 2.5% and below. We have written previously that in this elevated prepayment environment, CMO investors might want to consider cut-down coupons to lower the price and risk to underperforming yields. If you missed it, our November Prepay Commentary was released last week. The publication notes the broad-based increases in prepayments “save for a couple low-coupon (2.5 and 3.0) cohorts.”




If you missed it last week, please see the October Trade Summary below.


October Trade Summary

Last week’s update was not intentional foreshadowing. We referenced the increased VADM activity observed in September and questioned if the product would sustain interest during October. It not only sustained but accelerated. At 32%, VADMs accounted for nearly one-third of Agency CMO trades last month, by far the best month of 2019 for the class type. PAC-1s narrowly outpaced VADMs, making up 39% of trades.


Given the precipitous drop in rates this year, some investors could be anticipating a shift in market sentiment. One application of VADMs is to manage extension risk in the portfolio. While rising rates is still an unlikely scenario given the current outlook, it is less expensive to prepare for risk in advance, and before it is realized.


Other than the breakdown by Class Type, not much changed in terms of trade analytics. The average Projected Yield, Effective Duration and Convexity, and WAL was consistent with what we’ve seen throughout the second half of 2019. Customers tend to favor bonds in the 3-year space, which project to earn around a 2.25 yield. Fixed rate bonds continue to dominate activity by coupon type.






Travis Nauert, CFA

Analyst, Investment Strategies

Vining Sparks IBG, LP

INTENDED FOR INSTITUTIONAL INVESTORS ONLY.
The information included herein has been obtained from sources deemed reliable, but it is not in any way guaranteed, and it, together with any opinions expressed, is subject to change at any time. Any and all details offered in this publication are preliminary and are therefore subject to change at any time. This has been prepared for general information purposes only and does not consider the specific investment objectives, financial situation and particular needs of any individual or institution. This information is, by its very nature, incomplete and specifically lacks information critical to making final investment decisions. Investors should seek financial advice as to the appropriateness of investing in any securities or investment strategies mentioned or recommended. The accuracy of the financial projections is dependent on the occurrence of future events which cannot be assured; therefore, the actual results achieved during the projection period may vary from the projections. The firm may have positions, long or short, in any or all securities mentioned. Member FINRA/SIPC.
Copyright © 2021
Member FINRA/SIPC
This is a publication of Vining-Sparks IBG, L.P.
775 Ridge Lake Blvd., Memphis, TN 38120