CMO Market Update
September 20, 2021
Investors were very engaged in the CMO space last week, with the trade desk seeing good two-way flow in activity. Buyers sought out a little bit of everything, including floating-rate bonds and prepay friction collateral. Current coupons for the CMO floaters averaged 0.40%, with bonds indexed to SOFR and 1-month LIBOR.
Fixed-rate buyers remain honed in on primarily 1.00% – 1.50% coupons. 1.50% bonds off low-loan balance or 100% NY collateral were popular last week. PACs are still favored by many when it comes to structure.
As readers are surely aware, markets are on the move this morning. Treasury yields have retreated back about halfway between where we were on Tuesday for last week’s Investment Alternatives Matrix and where the week ended on Friday.
We look forward to updated month-end pricing next week to close out September and the third quarter. This sets the stage for Q4 and execution of year-end planning. In case you missed it last week, the August trade summary is below.
August Trade Summary
Customer purchases in August project to have a shorter average life than purchases from prior, recent months. After 4 months of nearly a 4-year WAL for new purchases, bonds that traded last month averaged just over a 3-year WAL. With that came a drop in average duration from 3.3 in July to 2.5 in August. Overall, however, projected yields held up well at 1.13%. While a nice round number like 1.00% might seem like an arbitrary psychological hurdle to clear, investors shouldn’t be taking anything north of 1.00% for granted given the current rate environment. While more attractive yields can be achieved, that return will come with added risk, mainly extension risk and premium risk.
Floating-rate bonds accounted for nearly 23% of trades last month. This was primarily due to some larger sized blocks trading. So, while the numbers are up, it may not be fair to say that buying was widespread for CMO floaters. But, this is something we will continue to monitor in future trade summaries.
Investors continue to show a strong appetite for PAC structures, which has accounted for the most trades in terms of class type in 4 of the last 5 months. While VADMs showed up on the scoreboard, there hasn’t been much to speak of in terms of meaningful activity in 2021.
Generally speaking, investor focus remains on low coupon (1.00% – 1.50%) bonds off Jumbo collateral. But as alluded to in the discussion above, there is no one right answer. Some investors have found it prudent to stay short duration, whether it be in the form of a floating-rate bond, or shorter fixed-rate bonds. Others are in more of a risk seeking mode, searching for yield and willing to take on more uncertainty in cashflows. Ultimately, it’s about finding the appropriate fit for a given institution’s portfolio and balance sheet.
An important disclosure that has been mentioned in recent updates, we are now using Yield Book prepay model v21.7. This is Yield Book’s production model as of August 26th, 2021. As it relates to CMOs, changes are more apparent (faster projected speeds) for early pay tranches collateralized with higher coupon 30-year MBS. Changes are less drastic for cut-coupon CMOs, which our customers have been heavily focused on since last summer.
Travis Nauert, CFA
Analyst, Investment Strategies
Vining Sparks IBG, LP