Bank of America Merrill Lynch points out that short PACs off premium 10/20s offer very attractive yield profiles currently. This is the result of concerns regarding the potential for higher prepayment speeds in 10/20 collateral through buyouts and loan modifications.

In an example, they note that 3-year 4% PACs off 6.5% coupon 10/20 collateral offer yields of 3.36% to 3.42% in their base case scenario that assumes a 30 CPR. This equates to +175bps over the Treasury curve.

Assuming speeds pick up to 50 CPR, an unlikely scenario in their view, the PACs offer yields of 2.85% to 2.90%. At a WAL of 1.8-years, this results in an attractive spread of around 200bps over the equivalent Treasury. Analysts also consider an unlikely slowing to 10 CPR, calculating a yield of about 3.6%, a WAL of 5.6- years, or 127bps over the 5-year Treasury.

Overall, BoA/ML said they "believe that short PACs off 10/20 collateral are very attractively priced for real money investors."

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