Feltus sees great value in junk debt

NEW YORK (Reuters) - U.S. high-yield bonds are great buys as spreads are trading at "ridiculous levels," Andrew Feltus, senior vice president and portfolio manager at Pioneer Investments, told the Reuters 2008 Restructuring Summit.

Feltus, who oversees about $8 billion in high-yield assets, said default rates of between 13 percent and 16 percent are "baked in the cake" for high-yield bonds. "The market is at very extreme valuations," Feltus said, adding securities are the cheapest ever.

The extra yield, known as the spread, that investors demand to hold risky junk bonds over U.S. Treasuries widened to a record 983 basis points on September 18. Spreads narrowed to 921 basis points on Friday, according to Merrill Lynch & Co data, on optimism over the federal mortgage bailout plan.

Feltus is also bullish on beaten-down mortgage-backed securities, or MBS.

"We have been long the Ginnie Maes, the Fannie Maes (FNM.N) and Freddie Macs (FRE.N) throughout this. You know, the 'Bill Gross' trade, for lack of a better term," Feltus said.

Bill Gross, chief investment officer of Pimco, the world's biggest bond fund manager, had been making big investments in Fannie and Freddie mortgage-backed securities, betting that the government would not let them go under.

Mortgage-backed securities issued by Fannie Mae and Freddie Mac rallied to their best levels since May after the Treasury's bailout of the companies promised bigger purchases. Yield spread premiums on Fannie Mae mortgage bonds paying 5 percent interest have declined to 1.51 percentage points more than benchmark 10-year Treasuries as of Monday from 1.83 percentage points before the September 7 Treasury action. The spread was as wide as 2.1 percentage points in mid-August.

The Treasury could also help heal the rest of the frozen credit markets. The Treasury Department has proposed buying as much as $700 billion in troubled assets from banks. Lawmakers hope to hammer out the details this week.

Feltus said it is "guaranteed" the government will overpay for illiquid, battered mortgage loans in its $700 billion bailout plan.

That said, the good news is that at this point the plan is "more of a backstop -- a bailout," Feltus said. "The government's plan will get the economy going and credit actually improving."

Feltus also said the government's decision not to extend loans to Lehman Brothers Holdings Inc. (LEHMQ.PK) was a prudent one. "I thought it was a good decision to let Lehman Brothers fail because it reduced the moral hazard issue," he said.

(For summit blog: summitnotebook.reuters.com/)

(Reporting by Walden Siew, Jennifer Ablan and Al Yoon; editing by Dave Zimmerman)