Moody's: Third-party guarantees can lower cover pool credit risk for French covered bonds

Moody's Investors Service says that when provided by an independent and strong credit quality guarantor, the home loan guarantees are credit positive for covered bonds as they reduce cover pool credit risk, compared with cover pools where mortgages are the dominant collateral type. Third-party guarantors now provide guarantees for most new residential home loans rather than mortgages in France (Aa1 negative).

The new report "Strong Home Loan Guarantees Enhance Credit Quality of French Cover Pools", is now available on www.moodys.com. Moody's subscribers can access this report via the link provided at the end of this press release.

"Provided that the guarantors can meet their obligations, third-party guarantees offer stronger securities to lenders than mortgages because they cover for any incurred losses in a timely manner, if the borrower defaults. Third-party guarantees offer a cost-effective and flexible alternative to the traditional mortgage security both for borrowers and lenders, and provide lenders with a degree of hedging against possible decreases in house prices, whereas traditional mortgages do not," says Alix Faure, a Moody's Assistant Vice President - Analyst and author of the report.

Moody's says that the third-party guarantees also lessen the recovery lag of defaulted loans when the lenders can call the guarantee soon after the borrower's default. The guarantor's capacity to fulfil its obligations (even if the covered bond issuer defaults) will depend on its credit quality and its independence relative to the covered bond issuer.

"However, the guarantee's credit quality can be weaker than that of a traditional mortgage. This would usually be the case if we assess the guarantor's credit quality as weak, if we do not have enough information to determine its strength, or when its creditworthiness is highly linked to the covered bond issuer's credit quality. So, when we assess the credit quality of cover pools we distinguish loans depending on their security type, and for loans with a guarantee, depending on the credit strength and independency of the guarantor to the issuer's default," adds Ms Faure.