Street analysts are noting the attractiveness of the 20-year sector that results from rolls currently trading near carry and some of the recent cheapening. In a recent report from Bear Stearns, analysts state that the ability to buy cheaper cashflows off 20-year collateral should be especially appealing to total return accounts and indexed benchmarked portfolios.
In the report, analysts pointed out that less liquid sectors that have languished due to the TBA roll bid - such as 20-year product - are expected to outperform as rolls remain weak, even though these have not seen a better bid. "With prepayment speeds on top of 15-year collateral and prices well behind, 20-year collateral is offering attractive relative value," wrote analysts.
In the report, Bear highlights the advantages of the trade. For one, 20-year paper does not share the same rich valuations as 15-year product. This is due, in part, to the lack of a liquid TBA market for this paper. Although it is hard to give up TBA liquidity, analysts said the lack of opportunities in the roll market makes specified- and 20-year pools seem like attractive alternatives in today's market.
Aside from this, 20-year collateral has less exposure to the housing market compared to 30-year pools. This is because these borrowers are actually more interested in reducing the term of their mortgage more than lowering their monthly payment. As a consequence, discount speeds are less likely to be adversely affected by a cooling housing market.
Another advantage is that the shorter amortization schedule that 20-year borrowers prefer increases borrower burnout, as they are reluctant to extend their term
by refinancing.
Bear Stearns analysts highlight 20-year 4.5s, which are currently trading $1.50 in back of 15-year paper. Aside from this, the bond offers a 24 basis point yield pick-up and 13 basis points in OAS without a significant convexity change. Bear analysts believe the pick-up compensation is more than appropriate given the flatness of the yield curve.
CMOs backed by 20-year collateral are also seen as attractive. In a separate report, Morgan Stanley analysts note that 5.5% 20-year PACs versus collateral look "remarkably cheap" at a 25 basis point spread pick-up in OAS. They add that the OAS pick-up is nearing one-year highs. Additionally, analysts say the structure has underperformed by over a point over the past three months.
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