(Bloomberg) — Money managers that buy sophisticated bonds backed by US corporate loans are increasingly finding they have to not just pay attention to how companies are performing, but also how the US residential mortgage debt market is doing.
Bonds tied to company debt, known as collateralized loan obligations, have started to look expensive relative to intricate bonds tied to home loans, known as collateralized mortgage obligations, or CMOs. Spreads on floating-rate CMOs backed by entities like Fannie Mae and Ginnie Mae were about as wide last month as those on top rated CLOs, with the two just a few basis points away from each other, according to data from
Since at least 2017, CLO spreads have usually been much wider, and investors holding the debt might not have paid as close attention to what was happening in CMOs. But now the structured mortgage securities are cheap enough that CLO investors are watching them more closely, according to strategists and investors.
Money managers including Columbia Threadneedle and TCW Group have looked at boosting their holdings of the mortgage debt. Investors are comparing the two instruments because both pay floating rates, are backed by loans, and have top credit ratings.
“The relative value across market sectors is always evolving and more recently it’s made perfect sense to increase agency CMO floater exposure while swapping out of some AAA CLOs,” said Liza Crawford, co-head of global securitized credit at TCW. “Bond markets live and breathe and if you remain in silos then you’ll miss out.”
Ankur Mehta, head of spread products research at
Since CLOs own roughly two-thirds of all risky corporate loans, any significant shift of buyers away from these products could translate into wider spreads on the underlying loans, too. That in turn would mean that it would be more expensive for private equity firms funding leveraged buyouts to borrow from the loan market.
TCW, the Los Angeles-based asset manager, has largely focused on floating-rate CMOs backed by the government finance agency Ginnie Mae, Crawford said. And asset manager Columbia Threadneedle has liked CMOs as a way to reduce exposure to other high-quality types of securities, including CLOs, according to Jason Callan, co-head of structured assets.
CLOs vs CMOs
Spreads of CLOs and CMOs have been converging for the last two years. On one side, risk premiums on AAA rated CLOs have tightened consistently alongside other credit products, especially as investors piled into exchange-traded funds tracking these obligations. That avenue of demand is expected to continue to boost CLOs.
On the other side, spreads on collateralized mortgage obligations have steadily widened. CMOs are bundles of agency mortgage bonds packaged together, and their increasing cheapness is largely a function of the fact that MBS spreads themselves are today at relatively wide levels. That’s due to a few different factors, such as the Federal Reserve’s pullback from the market as well as a long slowdown in demand from commercial banks.
“These two markets happened to run into each other,” said Walt Schmidt, a strategist at FHN Financial. “CLOs have been narrowing and narrowing while on the CMO side there was a confluence of cheapening underlying mortgage bonds just before the Fed started cutting rates late last year.”
CMOs are on money managers’ radar for another reason, too: they’re booming in their own right, with sales exceeding those of CLOs in 2023 and 2024.
Last year, roughly $140 billion of floating-rate agency CMOs were produced, compared with about $105 billion of AAA rated CLOs, according to
Banks in particular have been big buyers and issuers of CMOs. Their demand for the product picked up after the sharp rise in interest rates in 2022 pushed prices of fixed rate bonds dramatically lower, making them eager to shift money into floating-rate products instead.
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