About 40 percent of all U.S. junk bonds outstanding in late 2008 will likely default by 2013 as government aid measures end and a wall of corporate debt comes due, Bank of America Merrill Lynch said on Thursday.
The worst recession since the 1930s has already pushed defaults to double-digit rates. According to Standard & Poor's, the default rate rose to 10.4 percent in August from less than 1 percent in 2007 as the recession and credit crunch left companies unable to pay off debt.
Deleveraging by consumers and financial institutions and fiscal problems at federal and state governments will slow the economic recovery, keeping defaults high, Bank of America said. Failure of the shadow banking system to reinvent itself will also contribute to high defaults, it said, referring to hedge funds and other non-bank institutions that fueled the last credit boom.
Defaults will also be triggered by hundreds of billions of dollars of debt coming due, especially in 2013 and 2014, Bank of America said. About $361 billion of high-yield loans come due in those two years alone, or 72 percent of the total outstanding, the bank estimated in an earlier report.
Bank of America in December had forecast that the junk bond default rate could peak at 17 percent in the second quarter of 2010, the worst since the Great Depression. Thanks to numerous government lifelines, including near-zero interest rates, it now expects the default rate to peak at 12.8 percent in the fourth quarter this year.
However, defaults will remain higher than normal and peak again at 8.5 percent in late 2012, the bank estimated. Even by 2013, the default rate will still be around 6 percent, much higher than the sub-4-percent levels usually seen at the end of a default cycle, Bank of America said.
Overall, we still expect this cycle to be more severe than either 1990-91 or 2001-02 experiences, and ultimately claim higher cumulative defaults, the bank said. The default cycle will also take longer than usual to heal, it said.
Many so-called distressed debt exchanges are only postponing defaults and will also contribute to the second wave, the bank said. In a distressed debt exchange, companies buy back debt at steep discounts, usually replacing it with longer-maturity debt. About 40 percent of distressed debt exchanges typically default anyway within three years, the bank said.
(Reporting by Dena Aubin; Editing by Dan Grebler)