Veolia Environnement, the French utility, waste management and transport company, has gained permission from the Comité des Établissements de Crédit et des Entreprises d’Investissement (credit institutions and investment firms committee – CECEI) to set up a société de crédit foncier (SCF), the vehicle used under French law to issue obligations foncières.
Since 1999 a modest number of French financial institutions have used the obligation foncier structure to access the European covered bond market. But there is no precedent for corporates using this market. The process of setting up a SCF was "an extremely complicated procedure", according to a spokesperson from Veolia. "When the issue was first raised with the financial authorities, there was puzzlement, followed by a series of very interesting exchanges."
Some might suspect Veolia of formulating the issue purely for novelty’s sake. Sylvain de Forges, Veolia’s head of financial operations, became known during his time in France’s finance ministry for almost incessant innovation. However, it might just be that new accounting frameworks have allowed Veolia to reclassify its assets to make the issue of obligations foncières more plausible.
Veolia plans to use public sector assets as collateral. For example, contracts to provide water treatment services could be applicable, so long as they are of a long enough term. The quality of such contracts could also be improved by the provision of material assets, such as property and equipment. Veolia’s spokesperson pointed to an outstanding contract held by the company to provide waste management to a municipality that includes the construction, by Veolia, of an incinerator. Although there is a risk that, depending on Veolia’s performance, this contract could generate less revenue than originally expected, payments for the incinerator are guaranteed. Thus the quality of the asset is improved, as it is less dependent on the company’s performance and, consequently, its credit risk.
Over the past few years, covered bonds have increasingly become one of the most important bond segments in Europe for financial institutions. In 2006, €281 billion was issued, a 40% increase over five years, much of it backed by mortgages. There are now active covered bond markets in more than 20 European nations, with banks increasingly eager to make efficient use of the assets on their balance sheets.
This is the second particularly interesting event in the French covered bond market in recent months. In November, BNP Paribas launched the first issue of a €25 billion covered bond programme, comprising residential home loans. What made this issue especially memorable was that it was the first covered bond issued outside the obligations foncières framework. Despite this the BNP Paribas’ issue went down extremely well with investors. Veolia’s issue will be more conventional in that it will come via an SCF.
Leading the way
The implications of Veolia’s issue could be widespread. "Veolia has opened the door for any company holding public sector assets to consider issuing their own covered bonds," says Tim Skeet, head of covered bond origination at Merrill Lynch. "This is likely to have the biggest impact in nations with high public borrowing, such as America. Covered bonds are a way for companies with a modest rating that are sitting on assets that should have a higher rating to issue securities with that higher rating. Ratings for most securities are largely dependent on the quality of the parent, while covered bond ratings depend more on the quality of the cover pool."
Veolia is presently having its obligations foncières assessed by the ratings agencies. The company’s senior unsecured rating is A3/BBB+. Its €1 billion 10-year trades at Euribor plus 50 to 52 basis points. Although its covered bond might not quite achieve a triple-A rating, Veolia can still expect a significant saving on its funding costs. A triple A rated 10-year obligation foncier typically trades at sub-Euribor levels, meaning the firm’s saving might approach as much as 50 basis points.
So the performance of Veolia’s covered bond programme will be closely watched, and a significant success could well prompt copycat deals from other corporates.
However, the number of companies with suitable assets such as long-term government obligations or large mortgage portfolios might be relatively limited. But bankers offered such examples as GPAC of Canada, Germany’s Deutsche Post and French energy utility EDF.
As for Veolia, its upcoming obligation foncier will be something of a trial, and will certainly not be a jumbo issue. It is likely to amount to just a few hundred million euros.