Up-in-coupon trades outperformed lately despite increased prepayment risk. The risk resulted from lower mortgage rates and the government's refinancing programs.
Barclays Capital analysts said that higher coupons outperformed Treasurys in March with 30-year 5.5s and 6s the best performers.
Trust IOs, however, have not participated in this outperformance and are looking very cheap on Bank of America/Merrill Lynch's model, the analysts said.
BoA/ML said that Trust IOs have widened significantly in terms of break-even prepayment model multiples, as well as, LOASs over the past few weeks. They acknowledged that these models are not the best indicators of relative value in the current environment considering the uncertainty regarding the government's intervention.
However, Trust IOs are trading at the cheap end of the past few months' trading range. Additonally, these securities offer attractive carry in the current range-bound mortgage rate environment that analysts expect to last through the end of the year.
Specifically, analysts recommended buying a benchmark Trust 5% IO with FNMA 4.5s (their hedge ratio is 1.8). They calculated that investors can pick up 15 to 16 ticks of positive carry per month assuming prepayment speeds average 40% CPR. (Speeds on this Trust were 19.6% CPR in March).
In the report, Barclays analysts also highlighted inverse IOs, which they said are even more attractive versus trust IOs.