Conventional wisdom — reflected in bond spreads throughout core Europe — suggests that the sovereign, as the largest and most liquid borrower in a country, should set the floor for covered bond spreads. For many investors, pricing through the sovereign is taboo.
But pressure on the OAT curve — thanks to renewed fears that France's government might fall (again) and its deficit is becoming ungovernable — is putting this notion under the microscope, setting pulses racing throughout La Défense.
French prime minister François Bayrou is expected to struggle to get his proposed 2026 budget through a divided parliament. Plans to freeze government and social funding and cut two public holidays have proven immediately unpopular.
If the Bayrou government falls, France could have its fourth prime minister in as many quarters very soon.
Naturally, this has not been great for the OAT curve. A year ago, 10 year OATs traded 60bp inside BTPs — as of Tuesday close, this gap has narrowed to below 17bp, according to Tradeweb data.
A rating downgrade would likely pile even more pressure on the OAT curve, hastening the spread tightening versus covered bonds.
France is — for now — rated Aa3/AA-/AA-, with negative outlooks from S&P and Fitch. The sovereign faces rating updates from all three agencies in the autumn — and there’s a risk it could finally lose its double-A rating.
French covered bonds, however, are for the most part rated several notches higher. In fact, every one of the benchmark-sized French covered bonds tracked by GlobalCapital’s Primary Market Monitor bears a triple A rating from one of the three major agencies.
When France was downgraded to Aa3 by Moody’s late last year, researchers at Natixis said French covered programmes were, for the most part, well-insulated as they “benefit from a [timely payment indicator] leeway of at least three notches”. As a result, French covered bond issuers have a lot of room to weather a downgrade.
Of course, from a pure rating perspective it makes sense for French covered bonds to trade inside the sovereign curve: the higher the rating, the better the credit and, therefore, the tighter the price.
This is nothing new. Italian covered bonds, for instance, trade and price far through BTPs and no one bats an eye. Sure, some picky investors have turned them down, but ultimately these deals have still been well bid.
Crédit Agricole Italia, for instance, landed a €1bn 3.25% February 2034 18bp inside of BTPs earlier this year. The tight price did not put off investors, who propelled the book to a peak size above €7bn, PMM data shows.
This deal is rated Aa3 by Moody’s, six notches above the Italian sovereign. As of Tuesday, the deal was trading roughly 2bp inside of BTPs, according to Tradeweb, following six months of rallying in the sovereign spread.
Of course, some French covered bonds already trade through OATs at the long end of the curve. But if the prospects for widening persist, the question for many in the market is whether OATs move above covered bond yields across the curve.
Investors have so far shown a willingness to accept Fremch covered bonds being priced through the OAT curve, at least at the long end. For instance, when Caffil priced the first covered bond through OATs since 2022 in January, investors still flung €5.25bn of orders towards the €1.25bn 3.125% July 2033 deal, which landed 8bp through the govvie curve, PMM data shows.
This pricing has not yet been tested at the short end but French covered issuers are probing.
No value relationship sacrosanct. Some taboos demand to be broken. And for an issuer, there is nothing transgressive about wanting the tightest possible spread.
It is only a matter of time before French covered bond spreads positive to OATs are as evocative a memory as Proust's madeleines.