In its Covered Bond Market Insights report, S&P Global Ratings presents the local covered bond market, summarizes how the relevant legal framework works, compares key characteristics of existing programs, and provides an overview on the current local mortgage market and recent market developments.

Overview: France Is A Market Leader

French investor-placed covered bond benchmark issuance in 2024 remains strong, with volumes as of Aug. 31, 2024, accounting for about 80% of the 2023 issuance and the largest European benchmark issuance share.

As of June 2024, the French covered bond market is the largest globally, with over €481 billion of investor-placed and retained bonds outstanding, according to the Harmonised Transparency Template (HTT) reporting of French issuers. There are 19 French covered bond programs issued by 13 banks and one corporate entity. Since 2023, retained issuance has significantly increased as issuers are turning to covered bonds to access liquidity, primarily because home loans are no longer accepted as collateral under the Eurosystem. The primary collateral types backing these programs are residential loans (mortgage and guaranteed), and--to a lesser extent--public sector exposures, with the latter accounting for about 18% of total cover pool assets as of June 2024. The large outstanding volume and ongoing issuance indicate covered bonds continue to be a primary funding source for French banks.

Chart 1

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High Council for Financial Stability's legally binding guidelines remain largely unchanged and contribute to constrained home loan origination

The French High Council for Financial Stability's (HCSF) legally binding guidelines on all new home loan origination in France have remained broadly unchanged. The debt service-to-income (DTI) ratio is limited at 35%, a maximum loan term equal to 25 years applies, and allows for up to 20% of residential loan origination to deviate from these limits. Deviations are now assessed over the last three quarters, rather than annually. Out of the allowed deviation, 70% is reserved for primary residence acquisition, with at least 30% allocated for first-time buyers and 30% for nonprimary residence, leaving up to a 6% possible deviation for buy-to-let (BTL) loans. In addition, the maximum loan term can be extended to 27 years for property construction loans and for loans where renovation costs exceed 10% of the property acquisition cost.

The guidelines continue to restrain new home loan origination as French banks must strictly adhere to them. The share of loans originated within the 20% allowed deviation is 14.9% as of the first quarter of 2024, in line with the levels observed during the last two years.

Chart 3

Home loan offer recovers as lending rate cap no longer limits origination

The usury rate, set by Banque de France, represents the maximum allowable interest rate for all new loans in France and caps the interest rate that lenders can charge borrowers, with all costs included. The interest rate is calculated based on the average level of interest rates applied by credit institutions during a predetermined period (usually a quarter) and can exceed this level by one third only.

In 2022 and the first half of 2023, the usury rate lagged market conditions and led to profitability challenges for certain banks, as well as reduced mortgage application acceptances, thereby excluding potential borrowers from contracting new loans.

In 2024, the usury rate has caught up with the market rate level and no longer constrains home loan origination in France. High interest rates, however, have limited the demand for home loans, which has continued to decline throughout 2023 and the beginning of 2024. At the end of 2023, average interest rates on newly originated home loans--excluding fees and insurance and renegotiation--increased to 4.17%. Since then, rates have started to decline, reaching 3.65% in July 2024, which is similar to the eurozone average. We expect that after the two 25 basis points (bps) cuts in June and September, the ECB will proceed with one more cut of 25 bps in 2024, and three more 25 bps cuts in 2025 (Credit Conditions Europe Q3 2024: Keep Calm, Carry On, June 25, 2024).

In the past, French banks' business model kept average interest rates in France below the eurozone average. However, given the current unstable political situation, it is unclear if interest rates on housing loans in France will follow the downward trend over the next year and a half or if they will stabilize at a higher level due to increased funding costs.

Seasonally adjusted home loan origination volumes (excluding renegotiation) leveled off at the beginning of 2024 and have even started to recover--with May, June, and July volumes hitting €8.1 billion, €8.6 billion, and €11.3 billion, respectively (representing a 21% increase since February-April 2024). We expect this trend to continue this year, supporting covered bond issuances in 2024.

Evolving incentives limit BTL loan demand

Old BTL loan tax incentives that are applicable on properties rented out at maximum predetermined levels depending on geographical location and conditioned on renting tenor are being progressively phased out in 2023 and 2024. New tax incentives, introduced in 2023, are similar to the old ones but follow stricter limits related to energy performance, minimal living space, and quality of life conditions. Therefore, limiting the demand for BTL loans.

Climate and resilience law driving price differentiation among different levels of energy-efficient properties

The Aug. 24, 2022, law limits renting out properties according to their energy performance certificate (EPC). Under the law, energy consumption and CO2 emission limits extend progressively over the coming years. This means that properties without the minimum energy performance level will be gradually excluded from the rental market (see table 1).

Table 1

Price differentiation has been increasing between properties with the G and F EPC--which are set to be excluded from the rental market as of 2025 and 2028, respectively--and properties with better EPC ratings. The EPC calculation for small apartments has recently been amended, thereby reclassifying tens of thousands of properties from F and G levels to better EPC levels. We expect that overall, properties backing new BTL loans will be more energy-efficient in the future and less exposed to market value decline. Currently, we apply a 20% overvaluation assumption for all French residential properties.

The Legal Framework: A Well-Balanced System

The French covered bond legislation encompasses two main legal frameworks: "société de financement de l'habitat" (SFH) and "société de crédit foncier" (SCF). An additional framework is exclusively dedicated to one issuer, the Caisse de Refinancement de l'Habitat. The SFH framework restricts eligible collateral to residential loans and is dedicated to the issuance of "obligations de financement de l'habitat". The SCF framework can accommodate multiple collateral types, including public sector exposures, residential loans, and commercial real estate loans. Covered bonds issued under this framework are named "obligations foncières". Both give credit to a loan-to-value (LTV) ratio below an 80% threshold for standard residential loans and prescribe a 15% cap to the share of cover pool substitute assets--in the form of exposures to credit institutions.

SFHs and SCFs--the covered bond issuers--are specialized credit institutions licensed and supervised by the "Autorité de Contrôle Prudentiel et de Résolution", the French banking regulator. They are created as a wholly owned affiliate of a bank, for refinancing the banking group to which they belong, and are remote from the bankruptcy of their parent. SFHs and SCFs have usually no employees or other resources and are managed by their parent. As regulated entities, SFHs and SCFs are subject to regular compliance audits with legal covenants from the specific controller, a cover pool monitor.

Bondholders have dual recourse to the SFH/SCF's parent bank, and to the cover pool assets if the parent bank becomes insolvent.

Assets can be segregated within the SFH/SCF by way of a transfer of security to a loan granted by the SFH/SCF to the parent bank (secured loan structure) or through a true sale where they are sold outright to the SFH/SCF.

In our view, these frameworks strike a good balance between effective protection of covered bondholders, flexibility to include multiple asset types, and clear program management thresholds for minimum overcollateralization, liquidity coverage, and maturity-mismatch requirements.

For a more detailed description of the French Legal Covered Bond Framework, please refer to "The French Covered Bond Legal Framework: A Closer Look", April 3, 2023.

Table 2  |  View Expanded Table

Features Of French Covered Bond Programs

Home loans.  As of the end of June 2024, home loans comprise about 80% of all French cover pool assets.

A fixed-rate lending market.   The fixed-for-life nature of French residential loans makes them less sensitive to rising interest rates. So far, we haven't observed deteriorating loan performance. However, higher interest rates have driven new home loan origination volume down since its peak during 2021-2022. As of July 31, 2024, year-to-date new home loan origination volume (excluding renegotiated loans) stands at €58.6 billion, versus €83.8 billion during the same period in 2023, a decrease of about 30% (see chart 3).

Due to the prevalence of fixed-for-life residential loans in the French market, SFH covered bond programs mainly issue fixed-rate notes and rely on a natural hedge with no ad hoc interest rate swaps. We assess the extent to which these natural hedges affect overcollateralization requirements through our cash flow analysis.

An emphasis on DTI.   The main borrower eligibility criterion under French banks' credit underwriting policies is the DTI ratio. This contrasts to other mortgage markets such as the U.S. or the U.K. where more importance is given to LTV ratios. Underwriting standards are generally conservative, and the maximum DTI is typically between 33% and 35%. As a result, French residential loan performance is less linked to house prices than in the U.S. or the U.K. Alongside a strong social benefit support system, this means portfolio performance tends to be less cyclical. Our credit analysis also relies on this metric, increasing the weighted average foreclosure frequency (WAFF) for DTI levels above 30%.

Guaranteed loans as market standard.   French residential loans are secured either by a traditional mortgage deed or a guarantee (known as caution) provided by an insurer or a credit institution. France is a full recourse market, meaning there is a full recourse on the borrower's possessions that goes beyond the secured property. The recovery process differs depending on the guarantor, as it can intervene either at the beginning or at the end of the process. In the first case, the lender recovers the guaranteed amount from the guarantor, which then manages the recovery and, if applicable, the eventual property foreclosure. In the second case, the recourse to the guarantee is triggered only when all other recovery options are exhausted with the guarantee covering only the final loss. Loans guaranteed by cautions are a unique feature of the French market. Cautions represent over 65% of outstanding home loans. We consider guaranteed loans credit losses to be dependent on the guarantor credit quality, and typically these losses are higher than those for mortgage loans.

Public sector exposures

Public sector underlying collateral types are relatively diverse, comprising loans to French local and regional governments (LRGs), public hospitals, other public entities, and export finance loans guaranteed by export credit agencies (ECAs) in France and abroad. Our credit analysis includes an assessment of the creditworthiness of the various obligors and guarantors.

As of June 2024, according to issuers' HTT templates, public sector underlying collateral account for approximately 18% of the total cover pool assets in French covered bond programs.

Following our May 31, 2024, downgrade of France, we lowered our long-term ratings on BpiAssurance France (an ECA acting on behalf of the French government), several government-related entities, and two LRGs. The degree of impact on credit risk of French public sector programs exposed to these entities depends on the magnitude of their exposures. This, in turn, limits our required level of credit enhancement for these programs.

Currently, all French public sector covered bond programs are considered to be exposed to multiple jurisdictions. This means that the two-notch maximum rating differential with the French sovereign rating that we apply for single jurisdiction public sector programs according to our sovereign risk criteria does not cap the covered bond ratings for these programs. However, our supplemental largest sovereign test (LST) defaults all exposures to assets in the highest represented country rated 'A+' and below. So far, the result from the LST has not affected the required credit enhancement for any of the French public sector programs that we rate, but this would change if France were downgraded by an extra notch.

Chart 4

An important reform related to ECAs framework supports export credits business

Governments support domestic exporters by backing export credits through their domestic export agencies (ECAs). Several French issuers provide refinancing for ECA-guaranteed exposures (see chart 4). We anticipate that the amount of export credit in these cover pools will increase.

In July 2023, following an agreement in principle reached by OECD countries, the OCED Arrangement on officially supported export credits underwent a major reform. The reform aimed to modernize export credit rules by standardizing and simplifying government-supported export credit conditions, as well as expanding the scope of green and sustainable projects, with maximum repayment terms extended for such projects. This will allow ECAs to offer more flexible terms for their supported credits and encourage climate-friendly investments.

In our rated programs, in the total amount of export finance loans guaranteed by ECAs has increased by about 13% since 2023. We view these reforms will incentivize more ECA-backed projects. The extension of maximum repayment terms of supported export credits may increase the overall average maturity of public sector assets and affect asset-liability mismatches and refinancing risk in our rated public sector covered bond programs.

Mortgage Market Overview: Housing Market Cooled Off Significantly

On May 31, 2024, we lowered the long-term sovereign rating on France to 'AA-' from 'AA', reflecting our expectation that general government debt as a share of GDP will be at 112% by 2027, up from about 109% in 2023, due to larger-than-expected budget deficits. We expect that budget deficits will reach 3.5% of GDP in 2027, exceeding the government's revised deficit target of 2.9% (France Long-Term Rating Lowered To 'AA-' From 'AA' On Deterioration Of Budgetary Position; Outlook Stable, May 31, 2024).

We project that the French economy will begin to recover from the second half of 2024 and expand by 0.8% in 2024, followed by 1.4% on an average during 2025-2027. This rebound will likely be driven by further disinflation, a gradual decline in accumulated savings during the COVID-19 pandemic, and the resilient labor market supporting private consumption.

The French labor market remains resilient, with the unemployment rate reaching 7.5% in first-quarter 2024, well below the pre-pandemic level of 9.4% on average over 2015-2019, narrowing the gap with other European economies.

Table 3

Property market outlook: House prices are expected to rebound

Following record levels of real estate transactions in 2021 and 2022 and continued house price growth, higher interest rates significantly slowed the market in 2023. This has changed the characteristics of the newly originated home loans. Additionally, average home loan amounts have been decreasing due to higher levels of down payments, resulting in a decrease in the LTV ratio on newly originated loans to 78.8% in 2023 from 83.1% in 2022. The price-to-income and price-to-rent ratios have both improved, decreasing from their peaks in the second and third quarters of 2023, respectively. The demand for home loans has cooled down, pressuring home prices. After a sharp increase in 2022 and early 2023, home loan terms have leveled off, averaging nearly 22 years in 2023 and early 2024.

In 2024, house prices of new builds remain high, while they continue to decline for existing homes. This discrepancy is largely due to stricter quality standards and increased construction costs, driven by high material and labor expenses (European Housing Markets: Better Days Ahead, July 17, 2024).

In 2024, we expect house prices to decrease further by 2.5%, given the higher interest rates on home loans and increased cost-of-living pressures. We expect this downward trend to reverse, with a projected modest house price growth of 1.5% in 2025 and 2% in 2026.

We currently view the French housing market as being overvalued by roughly 20%, which we adjust for in our credit analysis by decreasing house price decline assumption in a stressed environment.

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LRG Lending: Deleveraging Underway

We expect French LRGs to continue deleveraging, forecasting a debt-to-operating revenue ratio of 72% in 2025 from 77% in 2022. The gradual consumption recovery will support value-added tax (VAT) growth proceeds, while decelerating inflation will ease pressure on operating expenditures. Higher operating surpluses will allow French LRGs to finance their investment projects while limiting additional borrowing.

During 2024-2025, we expect French LRGs to limit capital expenditure growth due to weakening economic conditions and still high, albeit decelerating inflation. Financing costs are likely to remain modest. French LRGs' average debt maturity exceeds 10 years and 75% of debt has a fixed interest rate, thereby moderating the effect of rising interest rates on French LRGs' debt positions.

Overall, we expect French LRGs' creditworthiness to remain resilient ("Subnational Debt 2024: France, Adaptability will remain key amid sluggish growth", March 4, 2024).

Comparison Of French Covered Bond Programs

French covered bonds benefit from the support of highly rated issuers. In our analysis of French covered bond programs, the parent bank is the first recourse for bondholders. Therefore, strong issuers benefit the programs' creditworthiness. A highly rated parent can translate into unused notches of ratings uplift, offering some buffer against the deteriorating credit and cash flow environment.

Due to the high issuer credit ratings on French banks, the downgrade of France did not affect French covered bond ratings and the required credit enhancement for most French covered bond programs. The required credit enhancement of only two residential covered bond programs remains negatively affected by the recent sovereign downgrade. The programs that were affected had RRLs equal to the level of the long-term French sovereign rating and were required to compensate for an extra notch of collateral-based uplift for the notch of RRL lost.

Even though French covered bonds tend to perform strongly on average, some of their program characteristics and credit and cash flow results differ. Below we present and compare the key characteristics of the French covered bond programs that we rate.

Table 4a  |  View Expanded Table

Table 4b  |  View Expanded Table

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Ratings Outlook: High Issuer Credit Ratings And Unused Notches Underpin Stable Ratings

Most French covered bond programs are rated 'AAA' (see charts below).

Table 5 shows our average credit enhancement calculations across programs. The target credit enhancement is the overcollateralization required to achieve the maximum potential collateral-based uplift. It covers asset default risk (or credit risk) and market value risk, which is the credit enhancement that we expect to be required to refinance the cover pool in a stressed environment.

In 2023 and the first half of 2024, most French mortgage covered bond programs' credit and market risk continued to increase, albeit less than the previous year. This increase is primarily due to the impact of rising interest rates affecting the cost of new issuances, among other factors. Their excess spreads, which represent the difference between the interest gained on the assets and the coupon due on the covered bonds, continued to compress--a trend prevailing in the previous year. With residential loans having mostly fixed-for-life interest rates and with loan terms increasing, along with a limited increase in new loan origination due to higher interest rates, the weighted-average interest rate on these assets has not increased as quickly as the weighted-average cost on the newly issued covered bonds, thereby reducing the excess spread of French covered bond programs. Since early 2024, thanks to the stability of ECB policy rates, the interest due on new bond issuances has started to decrease, and the excess spread stabilized.

2024 has seen the return to longer maturities than 2023, when new investor-placed benchmark issuances were concentrated in shorter maturities. During the first 8 months of this year, over 25% of new investor-placed benchmark issuances in France had a 10-year tenor or longer and more than 50% had tenors exceeding seven years. This increases the overall weighted-average life of French covered bond issuances, reducing asset-liability mismatches and refinancing risk and therefore, target credit enhancement.

Uncertain political environment may prevent funding costs from decreasing

The recent parliament elections have contributed to an uncertain business climate in France. It is unclear how funding costs will respond as covered bond issuance in France has remained limited since the elections, but widening covered bond spreads may increase funding costs therefore, contributing to higher required credit enhancement levels for French covered bond programs.

However, French covered bond programs still have sufficient available credit enhancement to cover higher requirements.

Table 5

On average, French programs present relatively low credit and market risk than peer countries. Consequently, the available credit enhancement is also lower see here (under "Country Focus").

The available and target credit enhancement by country can be found here (under "Country Distribution/Rating Outlook").

Related Criteria

• Global Methodology And Assumptions: Assessing Pools Of Residential Loans--Europe Supplement, April 4, 2024
• Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities, Dec. 22, 2020
• Global Methodology And Assumptions: Assessing Pools Of Residential Loans, Jan. 25, 2019
• Covered Bond Ratings Framework: Methodology And Assumptions, June 30, 2015
• Covered Bonds Criteria, Dec. 9, 2014
• Methodology And Assumptions For Assessing Portfolios Of International Public Sector And Other Debt Obligations Backing Covered Bonds And Structured Finance Securities, Dec. 9, 2014
• Principles Of Credit Ratings, Feb. 16, 2011

Related Research

• European Housing Markets: Better Days Ahead, July 17, 2024
• French Banks Face Increased Volatility Amid Policy Uncertainty, July 10, 2024
• France's Hung Parliament Is Likely To Complicate Policymaking, July 8, 2024
• European Banks: Covered Bonds Are A Cheap, Stable Funding Source With Limited Side Effects, July 4, 2024
• Credit Conditions Europe Q3 2024 : Keep Calm, Carry On , June 25, 2024
• Global Covered Bond Insights Q3 2024, June 18, 2024
• Your Three Minutes In Covered Bonds: How The Downgrade Of France Affects French Covered Bonds, June 7, 2024
• France Long-Term Rating Lowered To 'AA-' From 'AA' On Deterioration Of Budgetary Position; Outlook Stable, May 31, 2024
• Covered Bonds Outlook Midyear 2024: Rising Interest Rates Will Test Asset Performance, July 19, 2023
• The French Covered Bond Legal Framework: A Closer Look, April 3, 2023
• S&P Global Ratings' Covered Bonds Primer, June 20, 2019
• Glossary Of Covered Bond Terms, April 27, 2018