UPDATE: Pimco's Ivascyn Sees Value in Residential Mortgages

Pacific Investment Management Co., one of the world's largest bond managers, on Wednesday said reactions to Europe's fiscal crisis and a weak global economy have opened up opportunities in some of the riskiest mortgage bonds that have suffered for months.

Daniel Ivascyn, a senior portfolio manager at Pimco, said residential and commercial mortgage bonds have been a way to grab extra yield despite their exposure to the shaky U.S. real estate markets. They are among "dislocations" in markets created as the economic concerns rattled markets, he said.

Pimco, which is owned by Allianz SE (ALV.XE), is the latest and largest manager to underscore the value in private-label residential mortgage-backed securities, where some prices have fallen by 25% or more since early 2011.

On top of delinquency and rising foreclosure-related losses, the market for the non-guaranteed residential mortgage bonds has suffered as European crises and a teetering global economy led investors to broadly shun risky debt.

"Although we have a negative view on residential and commercial real estate fundamentals, and expect weakness in the U.S. economy going forward, we believe that current trading levels of these securities already incorporate negative views," Ivascyn said on a note drafted for the Pimco website.

Ivascyn, who manages the $6 billion Pimco Income Fund (PIMIX), also underscored the value in floating-rate bank loans and emerging-market debt as way to add income to the fund as policy makers keep interest rates low and increased economic uncertainty fuels a flight-to-quality bid away from risky assets.

The fund has returned 5.58% this year through Tuesday, placing it in the top 11% of the 254 funds in its category, according to Morningstar.

Prices on residential mortgage securities backed by prime adjustable-rate home loans have fallen by 18% since January, while riskier bonds supported by option-adjustable rate loans have lost 25%, according to Amherst Securities Group. Some subprime bond indexes have declined about 30%.

After accounting for expected losses, returns on RMBS now range from 4% to 15% on many senior bonds, Amherst said in a recent report. That makes them as cheap relative to other bonds as they have been since the financial crisis in 2008, the analysts said.

Even so, Ivascyn is stepping into a controversial market where many see losses accelerating as foreclosures continue, unemployment hovers around 9% and home prices drift lower. Despite some stability in other risky sectors--including commercial mortgage-backed securities--residential loan-backed securities have foundered because of low broker-dealer demand and possible selling by banks shedding risk from balance sheets, Amherst and FTN Financial analysts said in reports this week.

Some hedge funds since September have been ramping up bets against the bonds backed by prime quality loans with the PrimeX derivative index.

"It is possible for either fundamentals to be worse than expected, or technical selling to lead mark-to-market price declines even if the underlying fundamentals are in-line or better than expected," Ivascyn said.

But as prices languished, other buyers have emerged. Real estate investment trusts Two Harbors Investment Corp. (TWO) and Starwood Property Trust (STWD) both said they boosted holdings of residential mortgage securities last quarter. West Coast rival TCW Group has added to its residential mortgage holdings as prices fell.

In other high-yielding markets, floating-rate bank loans had been in favor earlier this year as investors sought a hedge that would benefit if interest-rates rose, Ivascyn said. Instead, rates dropped and the weaker economy raised the potential of corporate defaults, he said.

Redemptions by investors this year have forced managers to sell floating rate loans, as well as emerging market debt, increasing the appeal of those sectors, he said. Floating rate loans have "overshot to the downside," he said.

-By Al Yoon, Dow Jones Newswires; 212-416-3216; [e-mail]