Pimco fund managers say markets are oversupplied; credit fundamentals remain intact

By Jennifer Lanning Drey

Portland, Ore., July 24 - Pimco Corp. managers of investment-grade, high-yield and bank loan-based portfolios each said that although the market is currently working through a supply and demand imbalance, the fundamentals of credit quality remain intact.

"We're going to see some choppy, volatile times as the supply and demand of loans imbalance works itself out over the next two to three, four months," said Cyrille Conseil, a portfolio manager for a Pimco fund invested in the bank loan sector, during a conference call about Pimco's corporate closed-end funds, held Tuesday.

Over the next three to six months, as the market works through a significant imbalance of new supply, deals are likely to be canceled, restructured or deferred, Mark Hudoff, who oversees Pimco's global high-yield products, also said Tuesday.

Reiterating a similar sentiment of other fund managers on the call, he added that default rates remain low and there is no evidence of an earnings recession.

And while technical pressure is expected to remain on the market for at least a few more months, the fund managers said the pressure is also leading to opportunities in each of the sectors.

Investment grade

Pimco's investments in the investment-grade market have been conservative in recent times as the bonds in the sector have lacked covenant protection, Mark Kiesel, senior member of the investment strategy and portfolio group at Pimco and portfolio manager for two investment grade funds, said Tuesday. Kiesel oversees the Pimco Corporate Income Fund and Pimco Corporate Opportunity Fund.

The fund manager also said the brokerage sector and banking sector have now widened, and the company expects to take advantage of opportunities as spreads begin to better reflect the risks in the marketplace.

With regard to the market going forward, Kiesel said, "Our view is that there's a significant amount of supply that needs to be digested in the marketplace, and we want to be selective."

Bank loan sector

Pimco portfolio manager Cyrille Conseil sees a similar situation in the bank loan market, where he said there is a pipeline of more than $200 billion of loans looking to go forward over the next six to eight months.

"Deals that are trying to come to market in this environment have to price at wider levels on a daily basis, which has a looping effect into the secondary market," he said.

Going forward, Conseil said there would be opportunity for Pimco to invest in better loans as they come with covenant-like structures or aggressive pricing.

"That environment where factors favored the private equity firm or the borrower has shifted to where lenders or investors such as ourselves have regained more of the balance of power," added Conseil, who manages the Pimco Floating Rate Income Fund and Pimco Floating Rate Strategy Fund.

High yield

The high-yield sector is also experiencing a supply glut that requires re-pricing, and in the last few months, banks and hedge funds have been forced into hedging mode, said Hudoff.

As hedgers go to the market to buy protection, they push the synthetic market wider, which in turn pushes the cash market wider, and investors feel the re-pricing on their books without having to sell cash bonds, he said.

Hudoff, manager of the Pimco High Income Fund, expects the factors to lead to some deals being cancelled, restructured or deferred over the next three to six months.

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