Pacific Investment Management Co., which manages the world’s biggest bond fund, is buying Australian notes backed by home loans in the secondary market to profit from higher yields as European investors dump the bonds.
Pimco’s Australian unit, which manages about A$32 billion ($31.9 billion), bought AAA rated residential mortgage-backed securities this month yielding as much as 165 basis points more than the bank bill swap rate, Robert Mead, Sydney-based head of portfolio management, said in an interview. New bond sales pay about 110 basis points, or 1.1 percentage points, he said.
“We think the cheapest asset across Australian fixed-income is secondary market RMBS,” Mead said. “Distressed areas of Europe are now net sellers of Australian RMBS, which we are benefiting from.”
As much as a quarter of the RMBS sold annually by Australian lenders between 2002 and 2007 was denominated in euros to attract European investors, according to data from Standard & Poor’s. The region is now battling a sovereign debt crisis that’s seen Greece and Ireland accept financial bailouts and forced the European Union to create a 750 billion euro ($988 billion) emergency fund.
Moody’s Investors Service lowered Ireland’s credit rating five levels to Baa1 from Aa2 on Dec. 17, with further downgrades possible, as the government struggles to contain losses in the country’s banking system. Moody’s said last week it may lower Spain from Aa1 and also placed Greece’s Ba1 rating on review for a possible downgrade.
When institutions are undercapitalized and don’t have access to new sources of funding, they “need to sell assets to reduce their balance sheet size,” Mead said. “They often focus on high dollar price, liquid assets as selling priorities.”
Many offshore structured investment vehicles, which made up a “sizable share of the international investor base” for Australian RMBS before the 2007 credit freeze, were forced to liquidate their portfolios during the crisis and sell the notes on the secondary market, Reserve Bank of Australia Assistant Governor Guy Debelle said in a Nov. 30 speech.
Secondary market RMBS spreads widened to as much as 450 basis points amid the financial crisis, from 20 basis points before the U.S. subprime collapse roiled markets, according to the speech.
Wide Bay Australia Ltd., a non-bank lender, paid 105 basis points more than the bank bill swap rate on A$138 million of AAA rated RMBS, with a weighted average life of 1.5 years, according to an e-mailed statement last week from Australia & New Zealand Banking Group Ltd., which helped manage the sale.
ANZ Bank, Australia’s third-largest bank by market value, paid a 70 basis-point spread to sell A$100 million of three-year bonds last month, according to data compiled by Bloomberg.
Pimco bought Australian mortgage bonds denominated in U.S. and local dollars and the euro, Mead said. The bond investor prefers to buy RMBS in the secondary market because home owners who borrowed the underlying mortgages which back the notes have proven they can meet repayments, he said.
“The nice thing about those securities is that house prices have gone up since, so already conservatively structured loan to valuation ratios have become even more conservative,” he said. “Our strong preference is the seasoned secondary market opportunities.”
House prices in Australia have risen 20 percent since the start of 2009, according to the statistics bureau.
Even as Gerard Minack, a Sydney-based developed markets strategist at Morgan Stanley, warned in August that homes are about 40 percent overvalued, the Reserve Bank of Australia said in a June report no rated portions of the nation’s mortgage bonds have suffered a default.
Prices in the established housing market have “cooled” and tracked “broadly sideways” since June, the RBA said in minutes of its Dec. 7 meeting, released today.
Pimco also sees Australian financial bonds as attractive, and maintains an overweight position to the nation’s dollar, Mead said.
The currency has gained 11 percent against the greenback this year, the second-best performer of 16 major currencies tracked by Bloomberg. Financial debt has returned 7.2 percent this year, according to a Bank of America Merrill Lynch index. The benchmark S&P/ASX 200 Index of stocks has returned 2 percent including reinvested dividends, according to data compiled by Bloomberg.
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