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Will the new interest rate of PEL (french housing savings plan) be a booster for the CMS spread market?

As the market of spreads on Constant Maturity Swaps (CMS) had been reducing to almost nothing since the crisis, the new valuation methodology of PEL could be a booster ...

Article also available in : English EN | français FR

Many interest rate desks, unable to hedge the movements of the CMS spread, mainly the "2-year vs 10-year", had surrendered during the crisis.

Since late 2008, this market remains confined to the management of existing products indexed on the slope. The reform of the calculation methodology of the PEL’s rate could change all that!

Christine Lagarde, French Minister of Economy, Finance and Industry has recently issued decree that alters the calculation methodology

Before this reform, it was a rate determined by order of the Ministers of Finance and Housing, and since August 1st, 2003, the rate was unchanged at 2.5%

Today, the formula is defined as follows:

rates of return = 70% * CMS5Y + 30%*(CMS10Y-CMS2Y)

The interest rate floor is 2.50%.

This change means that starting march 2011, banks will have such a liability in proportion of their newly created PEL.

From a asset-liability management view, this involves receiving 5-Year CMS and "steepeners!".

However, the new formula can also be viewed as a natural hedge of bank balance sheet. Indeed, the formula includes two components:
- The first reflects the cost of refinancing of banks on a maturity comparable to that of PEL
- The second reflects the expectations of rising interest rates, the slope facing the transformation and the risk of flattening of the yield curve

For investors, the change makes the PEL more attractive.

With the new formula, the rate of PEL would have been higher by 0.4 points on average per annum to what its observed level during the last 10 years. It will avoid situations where the rate of PEL is disconnected from the economic situation and do not provide enough returns for savings. The use of a floor rate also guarantees the investor a minimum return in accordance with the holding period of the product.

This will might be enough to stop the steady decline in number of PEL since 2004 and its assets under management. In 2009, there were 11.4 million opened PEL against 16 million in 2002 and 2003, and PEL’s assets under management were 176 billions € in 2009 against 227 billions € in 2005 (almost 22% decrease). These account for 23% of outstanding mortgages.

"With a more attractive remuneration, the PEL takes on a new lease of life in order to assist consumers in the preparation of a property purchase" said Christine Lagarde.

Next Finance January 2011

Article also available in : English EN | français FR



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