French Liquidity Support through the SFEF

Following a meeting of Group of Seven (G-7) industrialized nations on October 10, 2008, which focused on guiding principles for action during the financial crisis, the French government pursued a dual approach to aid their banking system that included the SFEF and Société de Prise de Participation de l’Etat (SPPE). The French government created the SPPE in October 2008 as a limited liability company to perform recapitalizations. Its first injection was €1 billion toward the international bailout of Dexia SA, a troubled Belgium-based bank with operations across Europe, in return for a 5.7% stake in the company. In December 2008, SPPE began a broad recapitalization scheme for French banks to ensure they continued lending to the economy.

The “loi de finances rectificative pour le financement de I’économie” was passed on October 13, 2008, and adopted on October 17, four days later. SFEF itself had actually existed as a company called Doumer Hyperion since 2003, but was given new guidelines for its future operations. The use of Doumer Hyperion was a convenience intended to avoid the delay involved in establishing a new entity. 

On October 28, 2008, French authorities notified the European Commission (EC) of the SFEF. On October 30, 2008 the EC determined that the SFEF was compatible with State aid requirements. The EC also approved a six-month extension of the program in May 2009. As discussed in more detail below, the need to structure the SFEF in such a way as to ensure EC approval significantly influenced the design of certain program features.

Documents establishing the SFEF did not disclose the specific motivation for this figure.

The creation of the SFEF was a unique aspect of the French rescue plan. Most European states decided to directly guarantee the issuances of their major banks. France chose to consolidate issuances and refinancing responsibility with the SFEF, creating a much more indirect form of intervention. Through the SFEF, French authorities were able to exercise control of the allocation of credit to eligible institutions, based on a formula tied to the size of an institution’s balance sheet in France and the amount of French loans it had outstanding. Moreover, with a single entity issuing bonds on the market, France was also able to avoid coordination problems when timing issuances (de Kergommeaux et al. 2008). If many banks are attempting to raise funds, their interactions on the market may result in less total funds being raised. Last, because investors would be buying guaranteed debt issued by an SPV making collateralized loans to a range of institutions rather than guaranteed debt issued by a single such institution, SFEF may have enabled banks to access funds at a lower rate than they would have through a direct guarantee (Cavalier 2010).

The SFEF had initial capital of €50 million and was jointly owned by a group of seven banks representing 80% of the balance sheet total of the French banking industry. The banks held a 66% ownership stake and the French state 34%. This ownership structure was driven by French authorities’ desire to exclude SFEF liabilities from the state’s public debt. A decision by Eurostat, the body responsible for harmonizing economic statistics across the EU, during the crisis held that the guaranteed liabilities of special purpose entities established on a temporary basis to address the crisis could be excluded from public debt if they were majority privately owned. 

Despite this private ownership, the French state bore the risk of the guarantee, and thus had significant control over the SFEF, which was governed by a board of directors composed of 10 members. The board included two representatives of the state, one of which acted as chairman of the board. The members of the board could execute duties only with the permission of the Minister of the Economy, bringing their actions under direct scrutiny of the government. Furthermore, board meetings were attended by a state commissioner with full veto power on decisions that could influence the French state’s interests in relation to its guarantee. These meetings were also attended by the governor of the Banque de France who was responsible for the smooth conduct of the SFEF’s affairs. On top of this, the SFEF, while not a credit institution, was supervised by the French Banking Commission. Thus, in spite of being a separate vehicle, the SFEF was tightly supervised by the state and its actions closely monitored (de Kergommeaux et al. 2008).

The bank shareholders of the SFEF could only earn a profit on their invested capital equivalent to the rate of return on a government bond. This was consistent with the shareholders’ being compensated for having their capital tied up rather than fully put at risk.

This was intended to limit the exposure of the SFEF. Eligible collateral included:

1. First-rate mortgages and real estate loans of equivalent security
2. Loans made for the financing of a real estate asset in France (in the form of a lease or guaranteed by some credit institution)
3. Loans to highly rated corporations
4. Loans to particular public entities
5. Credit export loans confirmed by particular credit export agencies

Collateral was subject to haircuts ranging from 10% to 40%, depending on the category of pledged assets.

According to the legislation establishing SFEF, beneficiary credit institutions owed the SFEF a claim for an amount equal to principal, interest, and ancillary rights of the loan granted by SFEF to such credit institution; in case of default, a direct right over any sums paid with respect to the underlying receivables together with the enforcement proceeds of any security rights attached to such receivables. Loans made by the SFEF were, thus, highly secure and the SFEF’s exposure very limited (de Kergommeaux 2008).

No more than 30% of guaranteed debt could have a maturity of greater than three years.

The government does not appear to have established minimum maturity requirements for debt issued by the SFEF or the loans it made with the proceeds.

Program documents do not appear to contain any restrictions on the currencies eligible to be used under the SFEF.

In allocating loans among eligible institutions, French used a formula tied to the size of an institution’s balance sheet in France and the amount of French loans it had outstanding.

The interest rate charged on loans from the SFEF was intended to cover SFEF’s financing costs plus an additional fee for the state guarantee. French authorities followed October 2008 guidance from the European Central Bank (ECB) in developing their approach to the guarantee fee. For loans of greater than one year, the guarantee fee was equal to the bank’s median value 5-year credit default swap (CDS) spread over the period from January 1, 2007, to August 31, 2008, plus an add-on fee. Banks without CDS spreads would use representative CDS spreads based on their credit ratings. For loans of one year or less, only the add-on fee would be charged. 

Under the ECB’s guidance, the add-on fee was set at 50 basis points (bps).  However, given the collateralized nature of the loans made by SFEF, the European Commission approved a lower add-on fee of 20 bps.

These fees were required to be paid up front.

Guidance issued by the European Commission in October 2008 on the creation of credit guarantee programs called for the inclusion in such programs of a set of safeguards to minimize distortions and avoid moral hazard. This guidance did not specify exactly what safeguards a program should include, but required “an adequate combination” of elements, including restrictions on advertising based on the guarantee, balance sheet growth, share buybacks, and executive compensation, some of which France adopted.

The specific commitments required of the institutions accessing funding from the SFEF included providing credit to individuals, households, small and medium-size companies, and local authorities. In particular, institutions had to maintain annual growth in loans to the French economy of 3% to 4% until December 31, 2009. Participating institutions had to submit monthly reports on loan volumes and could be excluded from the program for failure to meet targets. In addition, they agreed to seek ad hoc solutions for customers experiencing payment difficulties.

Banks also had to commit to following certain rules on executive compensation, severance arrangements, balance sheet growth, and advertising.

The plan was intended to be only a temporary measure. The SFEF was to issue bonds only until the end of 2009. Like many other design decisions, this measure may have been intended to ensure the banks were not excessively dependent on state assistance. The goal was to provide some aid to the institutions until market conditions improved. Also like many design decisions, this provision may have been possible only due to the subdued nature of the crisis in France.

Credit institutions were required to deposit funds owed to the SFEF in special accounts at the Banque de France pledged to the SFEF several days before payments were actually due. This requirement ensured that beneficiary credit institutions were prepared to repay borrowed funds on time or else provide the SFEF with advanced warning of inability to pay. If an institution was unable to deposit owed funds ahead of time, the SFEF would notify the government of an inability to pay. This would give the SFEF time to acquire funds from the state guarantee, and then repay its own debt holders on time. Through this strategy, the SFEF ensured its debt holders were repaid in a timely manner and thus maintained a positive reputation for the SFEF as a solid investment opportunity.