Ratings

Because obligations foncières are secured bonds, rather than the product of a true securitization, the rating analysis has to evaluate the consequences of the insolvency of the sociétés de crédit foncier. The new law clearly states that, in such a situation, obligations foncières benefit from a statutory privilege, such that they would not be accelerated and cash flow from the underlying loans would be used to service obligations foncières in priority to any other indebtedness, including employee wages and taxes. A government decree defining the specific parameters of the sociétés de crédit foncier—such as the level of due diligence the issuer must perform on the underlying properties and the loan-to-value (LTV) ratios a loan must have to be included in the asset pool—is expected shortly. Even in a carefully constructed secured bond structure, however, the possibility of default exists, and raises the question of full and timely payment on the bonds.

Another difference between the obligations foncières and asset-backed transactions is that sociétés de crédit foncier are operating entities. The assets of the sociétés de crédit foncier secure at all times all issuances of obligations foncières. Therefore, liquidity and interest rate risks will be much more central to the rating analysis than is the case for typical ABS.

Although sociétés de crédit foncier may be subject to the risk of failure, Standard & Poor's believes that the holders of certain obligations foncières will continue to receive full and timely payments in the case of the issuer's insolvency or default on other obligations. In the rating analysis, analysts will assume the insolvency of the société de crédit foncier and will look to determine if the cash flows from the assets of the société de crédit foncier, when subjected to default, restructuring, or prepayment assumptions, are sufficient to repay the obligations foncières holders on time and in full.

The eligibility criteria limiting the sphere of assets that can be originated by or transferred to a société de crédit foncier certainly contribute to limiting the credit risk of the collateral. However, Standard & Poor's will review the composition of each pool on a regular basis and a certain level of losses will be assumed on the collateral, depending on the rating assigned to the obligations foncières.

Furthermore, assets and liabilities of a société de crédit foncier may be mismatched in terms of maturity, leading to cash surpluses in certain periods, followed by cash deficits in others. Cash surpluses may be caused by higher-than-anticipated prepayments, especially in the residential mortgage sector, where prepayment penalties are limited by law. Standard & Poor's assumes that any cash surplus will be conservatively reinvested for the benefit of the noteholders, unless hedging instruments, such as floors or guaranteed investment contracts, are in place to cover the issuer against reinvestment risk. To assess whether temporary deficits can be financed by a liquidity facility or bridge loan, Standard & Poor's will look at the incentives that may exist for providing such a loan and, notably, whether the finance provider can expect to benefit from the statutory privilege, even in an insolvency of the société de crédit foncier.

The overall asset base in France, on the basis of outstandings at year-end 1998, is estimated at around 100 billion euros for loans to French local governments, and Eur250 billion for French residential loans. The scope of eligible loans is actually wider, however, since the obligor may be located in any EU country. Furthermore, these figures do not include commercial property outstandings.

Although France this year celebrated the tenth anniversary of the legislation on fonds communs de créances, making it the second-oldest market for securitization in Europe after the U.K., the potential of this market has remained largely untapped. Cumulative MBS securitizations stand at about Eur10 billion, and only one approximately Eur1 billion securitization of loans to local authorities was completed, by Credit Foncier de France.

Obligations foncières and true securitizations complement each other more than they compete with each other. The société de crédit foncier will probably appeal to high volume originators in the limited eligible asset types. Fonds communs de créances likely will continue to be used by originators with lower market shares or for other asset types. Fonds communs de créances are an eligible asset for sociétés de crédit foncier, so this reformed legislative environment may actually, although somewhat counterintuitively, be the source of increased fonds communs de créances issuance.

Before the legislative change, only two issuers offered mortgage-backed bonds: Credit Foncier de France and Credit Foncier et Communal d'Alsace Lorraine. Credit Foncier de France and Credit Foncier et Communal d'Alsace Lorraine will have six months to set up sociétés de crédit foncier and convert their existing mortgage bonds into obligations foncières. Besides these two banks, other institutions have expressed keen interest in establishing sociétés de crédit foncier. Most notable among these is Credit Local Dexia, the dominant player in public sector lending, with a 40% market share in France.

Although obligations foncières bear many similarities to pfandbriefe, the two differ in some key ways. First, because of their hundred-year history and the larger eligible asset base in Germany , pfandbriefe are expected to outpace obligations foncières in total issuance over the next few years. As of Dec. 31, 1998, outstanding pfandbriefe totalled Eur1.4 trillion, of which approximately 80% were secured by loans to public sector entities, and 20% by mortgage loans. In contrast, Credit Foncier de France initially is expected to transfer Eur30 billion into its société de crédit foncier, and Credit Local Dexia is expected to issue Eur10 billion per year out of its new subsidiary. Obligations foncières will probably suffer at first from a relative lack of liquidity because of this relatively smaller size. This initial handicap may not last long, however, because both markets should become more European in terms of their underlying asset bases, as allowed by their respective legal frameworks.

A second difference is that obligations foncières are backed by all assets of the société de crédit foncier. With Pfandbriefe, public sector loans and mortgage loans are allocated to two separate cover registers, called Deckungsstock. Any given Pfandbriefe issuance is backed by either the public sector or the mortgage Deckungsstock.

Another difference between the French and German mortgage bonds is the amount of prepayment risk each experiences. Mortgage loans in particular exhibit significantly higher prepayment risk in France than in Germany, and a société de crédit foncier will need to demonstrate that it is covered against the reinvestment risk resulting from the inability of the sociétés de crédit foncier to amortize a related amount of debt with prepayment proceeds.

In addition, unlike Germany, hedge counterparties benefit from statutory privilege, according to the new French law. This feature of the law creates all the incentives for a hedge counterparty to stay in place, even in a wind-down scenario. Standard & Poor's will review all hedging agreements to ensure that any interest rate or currency risks are fully covered by appropriately rated counterparties.

The first issuance of obligations foncières is expected in fall 1999, and should provide a good test of the viability and future prospects of that market. Observers believe that the depth of the secondary market early on will be critical to the future development of the product. It is widely expected that the regulation applicable to sociétés de crédit foncier will impose requirements, in terms of disclosure of ongoing performance of the underlying loans and interest rate or prepayment risks, which should help prop up secondary trading. Standard & Poor's is looking forward to the development of a stronger mortgage bond market in France, and to working with potential issuers to develop and refine criteria for rating those instruments.