High Yield Market Flash

The objective of this flash is to assess the potential impact of the current conflict in Ukraine on the High Yield market and its implications on the La Française Rendement Global 2025 (LF RG 2025) and La Française Rendement Global 2028 (LF RG 2028) portfolios. In order to achieve this, as it was the case during the Covid crisis, we will try to:

1. Perform different scenarios and their impacts on the High Yield market (spreads and market default rates)
2. Transpose (in a second step) these scenarios to our portfolios in order to assess their impact on the performance of the LF RG 2025 and LF RG 2028 funds (in particular on the funds' NAVs at maturity).

THE DIFFERENT SCENARIOS AND THEIR IMPACT ON THE HIGH YIELD MARKET

At this stage and on the basis of the information available to us, we can envisage 3 scenarios.

The “Worst case" scenario, that of a stalemate in the ongoing conflict with an increase in human casualties. In this case, European countries and their allies will impose new economic sanctions on Russia and continue to support the Ukrainian army. President Putin reacts by deploying larger military forces and threatening other neighbouring countries. It is not excluded that President Putin will attack European countries economically, even interrupting the supply of gas and other raw materials to key partners (e.g. Germany).

The economic and financial impacts of this scenario would be as follows:

• A significant rise in commodity prices (oil, gas, agricultural products, etc.) for a prolonged period
• A default of Russia and the vast majority of Russian private or quasi-state companies with potentially significant contagion effects on the (global) banking and financial system.
• Risk of contagion to other neighbouring emerging countries (Turkey and others)
• Increase in High Yield spreads by +150-250bps from the current level (@ 415bps) to reflect the deterioration of the macroeconomic context. A stagflation scenario cannot be excluded in this case.
• Significant increase in global HY default rates to 6.5% by the end of 2022 and 6% in 2023 vs 2% at the end of 2021
• From a sectoral point of view, the most negatively impacted sectors would be industry (automotive, chemicals, etc.), consumer cyclicals, food, the financial sector (banks, insurance, and other financial services, etc.); the least exposed sectors would be TMT, healthcare, services, energy, and commodities.
• From a geographical point of view, the US and LATAM High Yield markets would be the main beneficiaries given the weight of the energy and commodities sectors in the indices (up to 70% in the LATAM HY indices). The European market would be much more affected than the US market given its geographical proximity to the ongoing conflict and given the negative impact of rising commodity prices on European economies. Finally, the European and Central Asian high yield markets would be the most damaged with a massive increase in defaults (remember that Russia, Turkey, and Ukraine are respectively the 1st, 3rd and 4th largest contributors to the high yield index in this area with a cumulative weight of around 50%).
• The only positive point that would result from this scenario would be the intervention of central banks (ECB and BOE) as a priority to limit contagion and a massive rise in default rates (our forecast of a default rate of 6.5% by the end of the year and 6% in 2023 takes into consideration this implicit "put" by central banks). Remember that the average default rate on the HY market over the last 10 years is 2%.

The « Best case » scenario is that of a rapid end to the conflict by diplomatic means, which could satisfy the various parties, at least in the short term, pending a more sustainable solution. In return, the sanctions against Russia would be reduced or even completely lifted.