French corporates and banks account for around 20% of European credit indices, with an average rating of A3/Baa1, in line with the index’s average rating. French credit issuers thus have a significant weighting in European credit indices (namely the Bloomberg euro Aggregate Corporate index LECPTREU).
The political risk in France increased with the dissolution of the National Assembly in June 2024, followed by the government's motion of censure in December. This situation raises fears about the ability of France to reduce its deficit to converge towards the European Commission’s objectives. Uncertainty is still weighting on French debt French companies. The OAT / Bund spread, which widened a lot following the dissolution (from 48 bp to 78 bp) is now at 82 bp. As a reminder, during the peripheral debt crisis in 2011, which for some now became good students, the OAT/Bund spread widened to 130 bp in December 2011 for a deficit of more than 5% and a debt to GDP ratio of 90%.
In volume terms, French debt was 1800 billion euros at that time, compared with 3300 billion euros currently and a deficit of 6.1%.
In terms of valuation, France is lagging in terms of growth momentum, and all the so called ‘peripheral’ markets - apart from Italy and Greece - are refinanced better (ie at a lower rate). France (AA-/AA3) refinanced at 10 years at 3.13% while Greece (BBB-/Ba1) on this same maturity is at 3.17%, Spain (A/Baa1) at 3%, Portugal (A-/A3) at 2.77%, and Italy (BBB/Baa3) at 3.47%. In terms of spread, much information is already priced in by the markets, for a significant rating differential between these countries (stable outlook from Moody's to Aa3 for France).
To date, the French component of the European credit index has underperformed since the beginning of the year 2024. The European credit index posted a performance of +5.09% against +4.60% for its French component. This underperformance has also been noticeable since December with a performance of +0.66% for French credits vs +0.83% for euro credit.
This can be explained by risk premiums on French credit issuers which were, at the beginning of 2024, lower than the overall risk premiums of the European credit index. France's risk premium was 132 bp vs. 137 bp for the European credit index.
The good news is that, in this 2024 year which is positive for credit risk, premiums have fallen, but those of French corporates less than the others.
Thus, to date, the French credit premium is at 105bp of the German curve, a drop of 27 bp. This is compared to the premium of the European credit index, which also fell, but to a greater extent, to 100 bp, which represents a drop of 37 bp.
Consequently, French companies (banks and corporates) underperformed their European competitors with a widening of their risk premium of 10 bp.
With regards to the performance of the OAT vs. the Bund, whose spread went from 50bp to 80bp, a widening of +30bp, French companies resisted the mistrust on French debt.
How can we explain this resistance?
Some answers can be found on the fundamental characteristics of French corporates and banks.
Some corporates are directly linked to France by their shareholding structure and are therefore more likely to suffer a rating downgrade. Weak economic growth in France is already weighing on French companies. Those whose revenues come for more than +50% from France are necessarily the most exposed.
The sectors most sensitive to French risk are the banking and insurance sectors, due to their ownership and balance sheet structure. French banks offer solid credit fundamentals. The impact of spreads with spreads widening for French banks and France (OAT) is limited in the short term. Exposure to OAT bonds represents less than 5% of total assets on the balance sheets of French banks, which is manageable. Weak domestic growth is ultimately the biggest impact for French banks (decline in activity and volumes, deterioration in asset quality).
In terms of methodology, Moody's downgraded France to ‘Aa3 stable outlook’ last Friday, at level equivalent to S&P and Fitch which downgraded France to AA-. Moody's specific methodology resulted in the downgrade of senior preferred debt instruments rated Aa3 to A1. Although this downgrade is not good news, the market reaction has not been significant for the moment, this evolution resulting from a decline in sovereign debt rating and not the intrinsic deterioration of French banks. As investors are aware of the methodology and alignment of these ratings, the risk premiums of these bonds have deteriorated by widening by 10 bp in 2 days.
In terms of flows, buyers - mainly French - have repositioned themselves for purchase since Wednesday. In France, however, credit investors have been underweighted on French debt, especially since this summer. They are in a waiting position to take advantage of a very active primary market expected for January 2025, or a phase of volatility to reposition themselves on French bonds.
For French insurers, the increase in the French risk premium has resulted in a deterioration in their solvency ratio, especially for life insurers whose investments have long durations, and which are more exposed to France (the OAT represents 20% of their assets). However, their solvency ratios are currently more than comfortable, mostly above 200%.
Conclusion
The political crisis in France can spread over time, which could lead to volatility on the French markets and spreads, including the OAT. The ECB has tools at its disposal to ensure the stability of the European system. The activation of these tools could be conditional on commitments on the trajectory of French debt.
Highly impacted by this situation, French banks, however, benefit from strong fundamentals. The impact is mainly on market sentiment and technicals. Spread volatility can offer investment opportunities.
