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Charts

Covered bond spreads in France: en route to Italy?

Lukas Kühne

Lukas Kühne

Nord/LB

In recent months, the spreads of French covered bonds have widened significantly compared to German Pfandbriefe.

This trend can be observed across all maturity segments, but it is discreetly stronger in the medium maturity segments of five- and seven-year covered bonds. While the lows in the spread difference from February 2024 are due to the increased risk premiums of individual German Pfandbrief issuers with higher CRE exposures, the development at the current margin is dominated by the tense budgetary situation in France and the associated widening of OAT spreads.

 

For the rating experts at Fitch, the forecast increase in government debt in the coming years and the fragmented political landscape were two decisive factors in changing the outlook for France’s sovereign rating from “Stable” to “Negative” in October 2024. The rating classification (AA-) was not affected. OAT spreads widened noticeably and are currently around 40 basis points higher than at the end of 2023. In line with the tense sentiment, the spreads of French covered bonds rose more sharply than those of their German peers. Compared to sovereigns, however, French covered bonds are more robust, meaning that in the longer maturity range (10y generic) the “covered” bonds are quoted within the “govies”.

Compared to German Pfandbriefe, French covered bonds are currently showing a pick-up of around three basis points in up to three years maturities and up to 14 basis points for seven-year covered bonds. We see this development as being driven by sentiment, rather than by fundamental criteria such as credit quality and over-collateralisation ratios of French covered bonds that have not changed. In fact, we still expect a modest spread widening for both markets until the end of the year. This should be stronger in the longer maturities than in shorter ones. In our view, the spread difference between German Pfandbriefe and French covered bonds should have almost reached its peak, so we do not expect the spread levels to drift further apart. From a relative value point of view, French covered bonds are currently much less attractive than French government sovereign bonds in selected maturit buckets or appear too expensive to many investors. In our view, some of these relative spread observations are more of an episodic nature. In particular, the observation that French government bonds are trading above covered bonds in some maturity buckets is unlikely to become entrenched in the long term. Accordingly, we do not expect Italian conditions for French covered bonds.