Cades. Heard of it? You will have soon. By the middle of this year, Cades is set to become one of the biggest French issuers of international bonds. “It’s going to be the best credit in France after the government,” reckons Arnaud Gremont, an executive director at Morgan Stanley.
For an organization that plans to raise up to Ffr140 billion ($27 billion) in syndicated loans and bonds this year, Cades has a remarkably low profile. Standard & Poor’s has no rating for it; Moody’s has never heard of it. The switchboard at the French treasury says it doesn’t exist, even though the treasury is responsible for setting it up.
The Caisse d’Amortissement de la Dette Sociale (Cades – pronounced Kad-ess) is part of a package of measures introduced by the French government to eradicate the increasingly unwieldy social security debt. Spending cuts will reduce future borrowing and Cades will take on what has already been spent: the deficit accumulated since 1994 (approximately Ffr60 billion a year) and that projected for 1996 (Ffr17 billion). It aims to pay this off within 13 years. So far the money has been raised in the form of a Ffr140 billion loan from the Caisse des Dépôts et Consignations, due June 28. This month, Cades is expected to announce the timetable for refinancing this debt through a combination of syndicated loans and bond issues.
A corollary of Cades is a new tax, the remboursement de la dette sociale. Pegged at 0.5% of virtually all revenues, it will be levied alongside current social security contributions until the debt is repaid. Half the revenues from the tax will be used to meet Cades’s interest and redemption payments over the next 13 years. The other half will repay the debt accrued between 1990 and 1993.
Cades will not have an explicit guarantee from the state. Instead, its financial situation will be regulated by parliament, though it is unclear precisely what responsibility the legislature will have. Cades’s board of six is appointed by decree, five of the members being acting civil servants from the ministries of finance and social security. The board’s president is to be a “professional” – “a person with a track record in bond issues,” says an adviser at the French treasury. Even though there is no formal guarantee, this degree of official supervision should make it easier for Cades to raise money. “The relationship and the strong links between Cades and the state are attractive to investors,” says Henri Kuppers, head of new issues at the Caisse Nationale de Crédit Agricole. “The fact that parliament is charged with maintaining its financial stability is a big plus.” The government has been careful to make the guarantee issue implicit. As one banker says: “Whether it is written or carved in stone doesn’t really matter – the issue is associated with the government.” The lack of guarantee means that Cades will have to offer wider spreads. This, together with the strong state backing, Kuppers says, is likely to ensure that investors regard Cades bonds almost as “OATs [French government bonds] with a small margin”.
However, there are potential problems. Finding the large amounts Cades requires may not be easy this year. There are already a large number of French triple-A issuers and the government itself will be looking for Ffr520 billion for its OAT and BTAN [short-term government bond] programmes. Some are cautious, one banker says that while the market “can absorb Ffr30 billion to Ffr40 billion, anything above that is more difficult”. Others are more optimistic but stress that timing will be crucial. “The domestic market could absorb between Ffr50 billion and Ffr70 billion,” says Arnaud Gremont at Morgan Stanley, “but only spread over the year, not in one shot.” Should the bond issues run into problems, the amount raised through syndicated loans (which many estimate at between Ffr50 billion and Ffr75 billion) will probably rise.
It is hard to predict Cades’s precise impact. Repeated delays in the announcement of the Cades timetable have done nothing to reduce uncertainty. For example, board members were still unnamed at the end of March. Indeed, until the formal decree is published, Cades does not even technically exist – the money raised so far has been borrowed in the name of Acoss, an agency of the French social security system. The French treasury has been secretive throughout, making an accurate assessment difficult. “We still know practically nothing,” says Bruno de Pamplone, head of debt at Merrill Lynch in Paris. “We have so little information – we don’t know the proportion of bonds, the proportion of loans, whether there will be a lot of foreign currency or none at all.”
Why has the announcement of the programme been so delayed? The treasury’s indecisiveness has clearly frustrated many observers. It informally consulted around 25 banks and primary dealers (SVTs) at the start of February, asking for suggestions. “Since then,” says Morgan Stanley’s Gremont, “the French treasury has essentially kept very quiet”. The flow of opinions would appear to be strictly one-way. “The treasury is now just thinking it over and over,” says Christophe Duval Kieffer, economist at Banque Indosuez, “they are not keen on answering questions.”
Most observers – and the treasury – ascribe the delay to bureaucratic procedure. “It’s nothing to do with the market,” says de Pamplone of Merrill Lynch. “This is a complex dossier with many political implications. A big reform takes a bit of time.”
Crédit Agricole’s Kuppers agrees, noting that “securing the agreement of parliament has taken a little longer [than expected]”. Most of the paperwork is now complete and a senior treasury adviser confirms that “things will now happen as quickly as possible – very quickly indeed”. One possible timetable is as follows. Assuming the board is named at the beginning of this month and has its first meeting a couple of weeks later, as many expect, “they may even come to the market as soon as the end of the month [April]”, Gremont says. The situation is still very uncertain though. Jean Arthuis, French finance minister, announced just last month that the first issue would be “very soon”, only to have his remarks clarified by the treasury the next day. “Soon”, it seems, does not mean the same for bureaucrats as it does for politicians.
Whatever its origins, the delay has not been to Cades’s advantage. Left so long in the dark, some bankers are beginning to have doubts. “Three or four months ago I would have said it was going to be a great success,” says Duval Kieffer. Now, however, “people seem less confident in French Eurobonds”. The decline in confidence is partly because of the turbulence in the market over the last couple of months which has seen many spreads suffer.
Foreign disenchantment
The underlying trend may be even more worrying. Foreign investors are relatively uninterested in French franc bonds at present levels. “The spread [over German Bunds] is too narrow in any paper,” explains one portfolio manager at Deutsche Bank. “Many international funds would sell, but they can’t.” Some international funds are finding the French franc market as a whole expensive. “Foreign investors are currently holding very few French bonds in their portfolios,” says Eric Muller, chief economist at Crédit Commercial de France. He estimates that the foreign share of French government debt (OATs and BTANs) may be as low as 18%. Foreign portfolios are generally underexposed in other state-backed and public-sector securities. “Most international funds preferred liquidity in 1995, especially with the tightening of spreads,” Muller says. Many found the Bund/OAT spread tight even at 40bp or 50bp. At 20bp as Euromoney went to press, it is tighter still. Demand in the market has been almost entirely sustained by domestic investors, in particular insurance companies.
Other concerns, more specific to Cades, are perhaps more damaging in the long term. Many are unhappy that the government has not given Cades an explicit guarantee. It has instead chosen to hand over the debt to a separate agency, albeit one with implicit state backing. “This kind of funny accounting,” says a foreign banker, “is very much the typical French way of doing things.” But why set up a separate body to deal with the debt in the first place? Several reasons have been put forward, the most cynical that the government wishes to get Ffr140 billion off its hands. However, as Morgan Stanley’s Gremont points out, “the social security system has never been a French state problem. It has always been managed outside the state.” A useful technicality when the sums involved are so large.
Another reason has more to do with the politics of taxation. By separating out the debt in this way the government is drawing attention to the problems in welfare funding and making the repayment of the social security debt an issue of collective responsibility. The existence of Cades means taxpayers will see exactly where their money goes. “It is important in order to justify the new taxes,” says Olivier Rousseau, head of origination for French issuers at BNP. The government wants the problem to be self-regulating. In this context the lack of guarantee is intended as “a strong signal to the social security organizations”, says Duval Kieffer at Indosuez, a signal warning them to “avoid future deficits”. In market terms, though, the lack of a guarantee makes the paper “much less interesting to investors”, says Marc Schaeffer, a portfolio manager at Crédit Mutuel.
With only an implicit guarantee, Cades may also suffer from investors’ wider disenchantment with French quasi-state and public-sector securities. According to a portfolio manager at Deutsche Bank, international investors “have been left with a bad image, a suspicion of quasi-state [issuers]” after Crédit Foncier had its rating downgraded and the spreads on its debt of over Ffr200 billion widened from 20bp over OATs to as much as 200bp. “Important funds that were long in Crédit Foncier” have had their fingers burnt, says the fund manager, and are “now careful with state-associated names. Even in other currencies it might be very difficult to place abroad”. The portfolio manager stresses that the connection between Cades and Crédit Foncier is “illogical” given their different set-ups, but he argues that it is a connection that buyers may perceive. Cades is an establishment of public administration, while Crédit Foncier is a specialized finance institution, a private bank whose governors are appointed by the state. However the distinction for those not completely au fait with the arcane legal niceties of French public finance may be a slender one. As one banker acknowledges, for foreigners the state and semi-state sector “can seem at times like French porridge”.
Gremont believes that “investors who understand [how Cades works] feel extremely comfortable”. Cades is unlikely to face the same problems as Crédit Foncier or Crédit Lyonnais for example. It is not involved in business or property, the root of the current banking crisis. It will simply collect taxes and service debt. “From the investors’ standpoint it is simple to understand, much simpler than business, it is just a cashflow,” believes Gremont. Nevertheless confusion does exist. “There is a problem with the transparency of the name,” says an international portfolio manager. If the issue is to be a success with international investors the government will have to do a better job on publicity than it has managed up to now. The role of the bookrunners will be important, believes Crédit Agricole’s Kuppers. “They will have to roadshow it,” says Gremont.
However, even domestic investors may be concerned by recent economic indicators which suggest the new tax may prove a less secure financial base for Cades than expected. The treasury estimates that revenues will be around Ffr25 billion this year. Some believe this target will not be reached. Duval Kieffer of Indosuez considers that “investors in general are doubtful about the amount budgeted and with reason”. With projected GDP growth “slower than expected” and potentially as low as 1% to 1.3%, what the treasury believes will be raised looks “generous, if not optimistic”. Others point out that there is still some room for manoeuvre; Cades will take priority over other borrowing when tax revenue is shared out.
There are also concerns that Cades may have to borrow more. The Ffr17 billion budgeted for this year’s social security deficit will be “substantially surpassed”, believes Indosuez’s Duval Kieffer. This means that the current estimate of borrowing, Ffr147 billion, “will have to be revised upwards”, possibly by as much as Ffr8 billion to Ffr10 billion. This raises the question of what will happen if future deficits continue to be large. The treasury has not given any clear indications to the market. “They didn’t really talk about that, I don’t think anything clear has been decided,” says a banker, “I think they are aiming for close to a wipe-out.” A treasury adviser says that Cades is “ring-fenced”, the government will deal with deficits after 1996 if and when they occur. However, some investors are clearly worried, one fears that financing welfare debt could prove a “bottomless cup”, though concedes this is unlikely. A lot will hinge on the credibility of the government’s austerity measures. Investors will be looking carefully for evidence of a dramatic reduction in spending. A Cades 2 is a prospect the market does not relish.
In general, though, the investment community is optimistic. International demand may be doubtful, but many domestic investors are looking forward to the issue. “The market is ready,” confirms Arnaud Serougne, head of the long-term desk at Compagnie Bancaire. “We have known the sums involved for some time now”. The delays do not appear to have dampened enthusiasm too much. Crédit Agricole’s Kuppers considers that “the market will welcome [Cades], it has been waiting for it for some time – almost six months”.
All about the spread
The way Cades is received will ultimately depend on its pricing. Duval Kieffer acknowledges that the market has sufficient depth to absorb the volumes Cades is seeking but emphasizes that this must be in the right context, with “the right maturities and the right interest rates – a spread more generous than OATs”, possibly by as much as 25bp. One fund manager said that while some of his clients “believe 12bp to 15bp is good, others think that over 20bp is not enough”. They may be disappointed. Straight government-guaranteed bonds generally trade at between 3bp and 8bp above OATs, public-sector company bonds (EDF or SNCF, for example) at between 10bp and 20bp. Cades will probably fall in between, even without a government guarantee. As Muller of Crédit Commercial de France points out, “the fact that it is backed [by a tax] offers enormous security”. In some ways its future is more secure than that of the utilities, it is in no danger of being privatized, for instance.
The numbers involved may force the spread higher than this though. “The size of the transactions are maybe a little too much for the market,” says Gremont of Morgan Stanley, “so the Cades may have to pay a little bit more than the theoretical rate.” On the other hand the size of the issues may actually count in Cades’s favour when it comes to pricing. The liquidity they guarantee will be attractive to investors.
Patrick Artus, head of economic studies at Caisse des Dépôts et Consignations, believes that banks that already have large holdings of OATs and BTANs are likely to show a strong interest. He thinks Cades is likely to issue what the market wants, pointing out that “life assurers and savings funds are currently looking for longer maturities. They are buying nothing but bonds.” Cades is likely to ensure that “the issues match demand”. Indeed, the treasury is understood to have already “prepared” the main buyers in the insurance market in order to find out. A senior treasury adviser has no doubt that demand will be high – “the SVTs [primary dealers] have all responded positively, the demand is there”. Treasury studies have indicated that the “issue is eagerly awaited”.
The arrival of Cades will certainly have an important effect on state and public-sector securities. “It will accentuate the selective side of the market” says Serougne, “competition will be sharper”. Cades may attract investment that would otherwise have gone elsewhere. Bruno Lescoeur, deputy head of finance at EDF, one of the largest triple A public borrowers, concedes that “Cades will represent a competitor” but is largely unworried, French franc issues represent only a fifth of total borrowing. The public-sector issuers’ perspective is “vigilant rather than worried”, confirms Jacques Gibert, head of finance at SNCF. He acknowledges though that “we will have to be flexible and reactive”.
The prospect of competition may already have jolted some into action. Kuppers believes that “we have seen a number of issuers hurry to get in ahead of Cades”. Crédit Local, for instance, by far the largest French issuer, has already floated Ffr2 billion. An official there thinks it “unlikely” that it will come back to francs for the rest of the year.
Should Cades paper prove popular, the treasury may find it has established a rival to its OAT programme. Serougne suggests there is a possibility that Cades paper “will be preferred to OATs”. In portfolios with a set percentage allocated to state-backed debt, managers may choose to drop government bonds in favour of the wider spread Cades is expected to offer. This situation could arise if investors consider that Cades bonds “are practically OATs”, says Schaeffer, the portfolio manager at Crédit Mutuel.
This possibility can, however, be overstated. Investors may well take Cades paper in addition to their current positions, rather than switching. “I am not sure we will see an eviction effect,” says Muller, “investors may see this as an opportunity to add a name with a high level of security.”
The success of Cades will be decided by how flexible it is. Given the amount to be raised, most observers expect a blend of currencies and maturities, with around half the total funded through syndicated loans. Cades may well prefer to borrow short rather than risk overloading the issue programme. “They will not be hurried, the issues will reflect the position of the market,” believes Rousseau at BNP.
However, political considerations may restrict its options and make it difficult for Cades to finance the debt as cheaply as it would like. Some people are uncomfortable with the use of foreign-currency issues to settle what they consider a domestic problem. While the Ecu market may offer some possibilities, other choices may prove more controversial. “It would look a bit strange if they issued in Deutschmarks or yen to fund the social security deficit,” comments an analyst at one investment bank. Others are more sanguine and see the currency issue as “neutral”.
The Juppé government has a lot invested (both financially and symbolically) in the success of its social security debt programme. Last November the prime minister declared that the establishment of Cades and its tax would bring “a new legitimacy to our welfare system”.
Domestic demand is probably assured, international investors will no doubt wait a while longer before committing themselves. Whatever the outcome, further delays in the programme will be unlikely to increase investor confidence. When the sums involved are so large, bankers want details, and soon. “It is effectively a very large sum – announced as a straight figure, Ffr140 billion can seem alarming,” concedes Muller of Crédit Commercial de France. “However, the multiplicity of tools and options available to finance the debt means that it will be far more easily absorbed than foreign investors fear.”
Some bankers, such as de Pamplone at Merrill Lynch, are even more confident. “It’s only Ffr140 billion,” he points out laconically, “it’s not difficult to raise that kind of money internationally.”
