Following on from my recent post about the success of the Commonwealth Government's controversial and otherwise unprecedented investments in AAA-rated residential mortgage-backed securities, the largest fixed income investor in the world, PIMCO, has also come out and strongly backed the strategy. Even at current prices PIMCO has described these assets as "very attractive" and "as close to bullet-proof AAA as you can find." According to Bloomberg:
"Pimco Buying ‘Bullet-Proof’ Australian Mortgage-Backed Bonds
June 2 (Bloomberg) -- Bonds backed by Australian home loans offer value as returns outweigh the risk on notes that are “close to bullet-proof AAA,” according to Pacific Investment Management Co., manager of the world’s biggest debt fund.
Pimco’s Australian unit, which manages about A$28 billion ($23.4 billion) of assets, is buying the securities in its second-largest credit-market bet behind bank debt guaranteed by Australia’s government, head of portfolio management Robert Mead said in an interview in Sydney. Pimco, which manages $1 trillion worldwide, owns notes sold by lenders including Westpac Banking Corp. and Members Equity Bank Pty Ltd., he said.
The bonds are “as close to bullet-proof AAA as you can find, as long as you’re choosing the right securities,” Mead said. They are “very attractive” at current spreads, he added.
Pimco Australia is bulking up on mortgage bonds even as concern about the effects of Europe’s sovereign-debt crisis on demand for riskier assets prompts it to hold more cash and highly liquid assets such as U.S. government securities than required by the fund’s benchmarks. Investors shunned mortgage bonds worldwide after the U.S. subprime collapse sparked a global recession, pushing the margin on Australian securities to more than 400 basis points, from 15 basis points before the credit freeze, according to the Reserve Bank of Australia.
Spreads over the bank bill swap rate, which have since narrowed to about 130 basis points, widened even though no investor in the Australian bonds suffered losses, RBA Assistant Governor Guy Debelle said in a March 30 speech.
Fewer Delinquencies
Australian prime mortgage delinquencies of more than 30 days increased to 1.34 percent in the three months ended March from 1.10 percent in the previous quarter, Moody’s Investors Service said May 27. Foreclosures and mortgage delinquencies in the U.S. reached 14 percent in the same period, according to the Mortgage Bankers Association.
Buyers should look for mortgage bonds with large buffers of subordinated debt that is the first to suffer in the event of defaults, protecting investors in the top classes of notes from any losses, according to Mead. They should also seek notes that don’t rely on mortgage insurance for their credit ratings, he said.
Pimco has an overweight position on Australian residential mortgage-backed securities because the underlying loans are of high quality, John Wilson, head of Pimco Australia, said May 24.
Australian Banks
Pimco also has a “very positive” view on bonds sold by Australia’s banks and tends to buy notes denominated in euros or U.S. dollars as they offer more attractive returns once swapped back into Australian dollars, Mead said.
Australian financial debt handed investors a 1.5 percent return in May, a 14th consecutive month of gains, according to Bank of America Merrill Lynch indexes. Global financial bonds lost 1 percent, the indexes show.
Mead also sees “opportunities” after “excessive” increases in the pricing of credit-default swaps on nations including Australia, South Korea and Japan, he said.
Contagion can cause spreads on much higher-quality sovereigns to aggressively widen, “based on nothing more than risk aversion,” he said.
The cost of credit-default swaps linked to sovereign debt surged worldwide last month, led by Greece, on concern debt- laden European nations will struggle to finance budget shortfalls and efforts to curb spending will slow global growth.
Default Swaps
Market speculation that governments worldwide took on too much debt through the global financial crisis drove swaps linked to Japan to the highest in more than a year in May, while those for Australia climbed to their highest since February, according to CMA DataVision.
Swaps on Japan rose as high as 99.7 basis points on May 25 before falling to 90 on May 31, according to CMA DataVision. For Australia, they climbed to 67.3 basis points before ending the month at 52.6 basis points.
Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A basis point is 0.01 percentage point, and is equivalent to $1,000 a year on a credit-default swap contract protecting $10 million of debt from default for five years.
Pimco’s Australia unit is holding more highly-liquid assets and cash than required by the benchmark it tracks, including the debt of governments such as the U.S., Canada, Australia and Germany, according to Mead. Its holdings of Australian government-guaranteed bank debt are in U.S. and Australian dollar-denominated issues.
“You want to have enough liquidity available so you only use big credit rallies as a place to sell assets so you can then buy them again in the next risk-off trade,” he said. “It’s very much a cautious trade.”"
