Aussie mortgage bonds offer world's best value: Pimco

August 26, 2008
Aussie mortgage bonds offer world's best value: Pimco

(MELBOURNE) Australia's mortgage-backed bonds are one of the most
attractive buys 'on the planet', according to Rob Mead, head of Asia-
Pacific credit at Pacific Investment Management Co (Pimco) in Sydney.

Mr Mead, who manages the equivalent of US$17 billion, said he is
buying top AAA-rated US dollar- and euro-denominated bonds backed by
Australian home loans. The debt is being sold at fire-sale prices by
holders forced to close their businesses amid the collapse of the US
sub-prime mortgage market, he said.

The global investor exodus from mortgage debt markets has boosted
yields on Australia's home loan bonds about 10-fold in the last 12
months to at least two percentage points more than Australia's
benchmark swap rate. Even so, the credit quality of the debt,
supported by home loans to people with good repayment histories,
hasn't declined, said Mr Mead, who runs the Australian portfolio at
Pimco, the manager of the world's biggest bond fund.

'We think this paper in the non-Aussie dollar format is very, very
compelling,' Mr Mead said in a phone interview. 'Combined with the
absolute level of Australian swap rates, investors are able to
generate attractive real yields from very high-quality assets over
the next three to five years which are not available to almost any
other investor base on the planet.'

The yields have also increased because the bank bill swap rate, which
is the benchmark the nation's mortgage bonds are priced against, has
risen in line with the central bank's increases to official interest
rates.

The Reserve Bank of Australia increased its benchmark lending rate
four times since August to 7.25 per cent to cool the fastest
inflation in 17 years, even as central banks led by the Federal
Reserve and Bank of England cut borrowing costs to ease the fallout
of the global credit squeeze.

Australia's 90-day bank bill swap rate, the typical benchmark used to
price mortgage-backed bonds, rose to 7.3 per cent on Aug 22 from
6.847 per cent a year earlier.

The highest-rated US mortgage bonds backed by American fixed-rate
prime mortgages yield above 85 basis points more than the US dollar
London interbank offered rate, according to credit traders. A basis
point is 0.01 percentage point.

AAA-rated securities backed by US sub-prime or second mortgages yield
7.1 percentage points more than Treasuries with maturities similar to
their average lives, according to Lehman Brothers Holdings Inc index
data. Mr Mead said Australian mortgage bonds are yielding around 9.5
per cent.

More than 75 per cent of residential mortgage- backed securities sold
by Australian companies in 2007 were denominated in other currencies,
including the US dollar, euros and pounds, according to Standard &
Poor's (S&P).

That debt is being sold back to Australian investors by overseas-
based structured investment vehicles and conduits that have been
wound down because the seizure in credit markets has crippled their
funding sources.

'In this environment, investors feel much more comfortable investing
in their own backyard, where they understand everything,' Mr Mead
noted.

'The issues in US dollars or euros are coming back even cheaper than
the Aussie dollar equivalent,' he pointed out. 'There is not a lot of
supply and it has been quieter in the past two to three weeks, but
this is more reflective of the European summer lull than the fact the
paper will never appear again.'

The so-called seasoning, or time elapsed since the loan was
originated, of Australian mortgages that back existing bonds show the
debt is likely to 'perform well', Mr Mead said.

Seasoning also increases subordination in a transaction, which acts
as protection against mortgage arrears on top of the cover provided
by a lender's mortgage insurance. Subordinated notes absorb losses
and must be wiped out before holders of higher rated bonds lose their
money.

Payments more than 30 days late on prime loans backing Australia's
mortgage bonds increased for a sixth consecutive month in May,
gaining one basis point to a record high 1.49 per cent, S&P said on
July 23.

Default rates may increase as the biggest drop in Australian home
prices in five years, the highest borrowing costs in a decade and
slowing economic growth lead the nation towards a 'once-in-100-year
real-estate slump', according to Residex Ltd, a Sydney company that
tracks property prices.

Australian arrears trail the US, where delinquencies for sub-prime
loans in 2006 bonds climbed to 41.7 per cent in June from 34.2 per
cent in February, S&P said on Aug 22.

Late payments on so-called prime-jumbo loans increased to 4.5 per
cent from 2.9 per cent and Alt-A delinquencies rose to 21.5 per cent
from 15.2 per cent, S&P said on Aug 21 in statements.

In June, three US homeowners defaulted on insured mortgages for every
two who got out of arrears, according to the Mortgage Insurance
Companies of America.