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Friday, May 31, 2019
 
MANAGING DIRECTOR:
Scott Carrithers
 
PORTFOLIO SALES AND SERVICE:
Steve Panknin • George Morris • Jeff Goble • Chris Thompson • Sean Doherty
Kevin Doyle • Lonnie Harris •  Mark Tranckino • Robert Schuyler • Tom Toburen • Josh Kiefer
 Nicole Burczyk • Kelley Frye • Natalie Regan • Aaron Stoffer • Chuck Honeywell
 
US Treasury Market
Date 1 mo 3 mo 6 mo 1 yr 2 yr 3 yr 5 yr 7 yr 10 yr 20 yr 30 yr
05/23/19 2.38 2.37 2.40 2.32 2.12 2.08 2.11 2.20 2.31 2.56 2.75
05/24/19 2.37 2.35 2.39 2.33 2.16 2.10 2.12 2.22 2.32 2.57 2.75
05/28/19 2.35 2.37 2.38 2.31 2.12 2.06 2.06 2.16 2.26 2.52 2.70
05/29/18 2.35 2.37 2.38 2.30 2.09 2.04 2.05 2.16 2.25 2.50 2.69
05/30/19 2.37 2.38 2.40 2.29 2.06 2.00 2.03 2.12 2.22 2.46 2.65
                                                                                                                                        Source: U.S. Department of the Treasury, as of 05/30/2019


                                                        CMOs – Count Me Out?

The Country Club Bank mortgage trading desk periodically reviews client MBS purchases and holdings throughout the year to spot possible problem bonds (or sometime winners that have run too far).  One common theme we have seen over the last several years is clients stretching for “yield” and/or “structure” in collateralized mortgage obligations “CMOs”.  When purchasing a CMO, we believe clients should consider a few stipulations to avoid potential future problems:
  1. Minimum Spread – We believe clients should determine an applicable minimum incremental spread over specified pools.  We generally recommend at least 15-25bps of incremental spread vs comparable coupon specified pools (assuming plain vanilla 15yr or 20yr collateral) to compensate for decreased liquidity / modeling risk (derivative of pools makes forecasting prepayment speeds harder) / structure risk .  Whatever your spread is, we recommend you not stretch for yield or violate this standard.
     
  2. Compare To Alternatives (Relative Value Analysis) – Always compare a CMO to similar specified pools.  We would recommend looking at the closest three specified pool coupons (for the below example we would compare the 3% coupon CMO to a 2.5% / 3% / 3.5% coupon pool with a similar base case WAL). This will help you gauge potential risk rewards.
     
  3. Size – We believe investors should consider purchasing larger par amounts vs specified pools.  CMOs have a much smaller audience that typically skews in favor of larger current face sizes (think 1mm+ current face fixed coupon or 5mm+ current face for floaters).  If you are a 1mm pool buyer, you need to do a 2-3x larger purchase to compensate for eventual pay down / liquidity down the road.  The lack of a TBA market in CMOs decreases liquidity vs a specified pool (that is why we think you should demand a higher spread). 
     
  4. Extension / Contraction Risk – Pay close attention to the shock scenarios.  We have seen numerous times where investors focus on the base case (which typically never happens), while negating to look at the possible range of outcomes.  Looking at the range of outcomes (compare this to similar WAL specified pool as well for relative value analysis) will help to identify undue risks you may be bearing. 
We have seen very little value in CMOs over the last several years (5+) as spreads remain incredibly tight.  The below example illustrates why we think CMOs remain rich.  The fixed rate 3% pool is 21 ticks cheaper, 18 bps higher yield, for only a minimal 0.1 WAL extension.  As one of our clients likes to say, CMOs stands for “Count Me Out” (in general we agree with them that most CMOs currently are not attractive).




 
                                                              


This information is intended for institutional investors only. The material provided in this document/presentation is for informational purposes only and is intended solely for private use. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.

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