A forthcoming cut in the interest rate paid by key savings products in France could help mitigate a shift away from French covered bonds by domestic investors as the former are able to compete on yield again, according to Crédit Agricole senior covered bond analyst Florian Eichert.

In the prevailing low yield environment investors are struggling to generate performance, he said in a note today (Monday), with the situation early this year considerably worse than in 2012 given significant spread and yield tightening over the course of last year.

In France asset managers and insurance companies face tough competition from Livret A and Livret de Développement Durable (LDD), said Eichert, tax-free savings products that have been very popular with French retail clients and pay an interest rate of 2.25%, which less than 10% of the French covered bond market can beat.

At the end of November French households had a total of Eu326bn invested in these savings products, he noted, with increases in the maximum allowance for deposits for private individuals in August and this January having attracted funds to the products – Eu24bn of inflows across October and November.

“At the same time, the average yield of French covered bonds has fallen significantly from 3.42% at the beginning of 2012 to 1.35% now, which is significantly below the Livret A rate,” said Eichert. “Not even 10% of the French covered bond market currently yields in excess of 2.25%.

“As a result, French investors that are either directly benchmarked against Livret A rates or that are in any case competing against this level find it very hard to beat or compete for these funds by investing in French covered bonds.”

However, the French government has announced that effective 1 February, the interest rate on Livret A will be cut from 2.25% to 1.75%, a move that Eichert said would mean that, at prevailing yield levels, around one-third of the French covered bond market will beat Livret A and LDD deposits, at least on a tax-free basis.

“This should in our view strengthen French demand for these bonds,” he said.

New benchmark covered bond supply from France has been limited to one deal so far this year, a Eu1bn 12 year issue for Caisse de Refinancement de l’Habitat (CRH), with factors such as deleveraging and attractive senior unsecured spreads seen contributing to lower issuance volumes – a syndicate official noted that residential mortgage lending dropped 26% last year.

Crédit Agricole’s Eichert said that in contrast to the previous two years, French investors have participated actively in peripheral new issuance, with more than 70% of the funds spent in the primary market so far by French accounts (based on 82% of this year’s issuance) allocated across Ireland, Italy, Portugal, and Spain.

The rise in the proportion of investments in the periphery is not merely due to increased issuance from the aforementioned countries, he said, but also because of an active overweighting of these markets by French investors.

Even if French covered bond supply increases over the course of 2013, domestic investors are likely to continue to focus more on peripheral markets than last year, said Eichert, given low carry and potentially negative total returns linked to investments in core jurisdictions.

“However, the rate reduction of the Livret A and LDD could mean that the shift in focus away from French covered bonds by domestic accounts is not going to be as pronounced as would otherwise have been the case,” he said. “As such, it should prove positive for French covered bond demand by domestic accounts during 2013.”