A default wave is building, says Deutsche Bank. He
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Posted On: 05/31/2023 9:06:07 AM
A default wave is building, says Deutsche Bank. Here’s how bad it may get.
https://www.marketwatch.com/story/a-default-w...t-efe4a4d5
Deutsche Bank strategists Jim Reid and Steve Caprio just wrote the bank’s annual default study, now in its 25th year. Last year’s, correctly, called for the end of the ultra-low default era, though the current numbers are certainly not terrible. The U.S. high-yield bond default rate through April rose to 2.1% from 1.1%, and U.S. loan default rates rose to 3.1% from 1.4%. Over in Europe, speculative-grade default rates rose to 2.7% from 1.7%. According to Fitch, the average U.S. high-yield default rate is 3.6%.
But, the Deutsche Bank team say, “a default wave is imminent.” By the fourth quarter of 2024, they say the U.S. high-yield default rate will peak at 9%, and the U.S. loan default rate will reach 11.3%. The European speculative-default rate will rise too, though to a less steep 5.8%.
Why? “The tightest Fed and [European Central Bank] policy in 15 years is running into elevated corporate leverage built upon stretched profit margins. This is especially true in the leveraged loan market, where LBO leverage was juiced higher year after year (after year) by zero rates and central bank QE,” they say. LBO means leveraged buyouts, performed by the $5 trillion or so private-equity industry.
And don’t expect the Fed to run the rescue either, as the central bank continues to fight inflation. (Unmentioned by the analysts, but the debt-ceiling deal effectively kills any potential for U.S. fiscal support through the next election, barring an unusually nasty recession.)
Granted, Deutsche Bank is far from the only outfit calling for a recession. Isn’t a downturn, and ensuing defaults, built into prices? Maybe not. The Deutsche Bank strategists say investors might not be ready, given that high-yield bond index quality has improved this cycle, and global loan default rates have been tame for the past 15 years.
They quantify this by looking at the percentage of speculative-grade markets trading at distressed levels. Historically, distressed ratios lead default cycles by about 12 to 16 months. Regressing defaults by distressed ratios, they find the current U.S. high-yield market implying a 3.6% rate of defaults in the third quarter of next year, and European high-yield bonds projecting just over 2.2%.
https://www.marketwatch.com/story/a-default-w...t-efe4a4d5
Deutsche Bank strategists Jim Reid and Steve Caprio just wrote the bank’s annual default study, now in its 25th year. Last year’s, correctly, called for the end of the ultra-low default era, though the current numbers are certainly not terrible. The U.S. high-yield bond default rate through April rose to 2.1% from 1.1%, and U.S. loan default rates rose to 3.1% from 1.4%. Over in Europe, speculative-grade default rates rose to 2.7% from 1.7%. According to Fitch, the average U.S. high-yield default rate is 3.6%.
But, the Deutsche Bank team say, “a default wave is imminent.” By the fourth quarter of 2024, they say the U.S. high-yield default rate will peak at 9%, and the U.S. loan default rate will reach 11.3%. The European speculative-default rate will rise too, though to a less steep 5.8%.
Why? “The tightest Fed and [European Central Bank] policy in 15 years is running into elevated corporate leverage built upon stretched profit margins. This is especially true in the leveraged loan market, where LBO leverage was juiced higher year after year (after year) by zero rates and central bank QE,” they say. LBO means leveraged buyouts, performed by the $5 trillion or so private-equity industry.
And don’t expect the Fed to run the rescue either, as the central bank continues to fight inflation. (Unmentioned by the analysts, but the debt-ceiling deal effectively kills any potential for U.S. fiscal support through the next election, barring an unusually nasty recession.)
Granted, Deutsche Bank is far from the only outfit calling for a recession. Isn’t a downturn, and ensuing defaults, built into prices? Maybe not. The Deutsche Bank strategists say investors might not be ready, given that high-yield bond index quality has improved this cycle, and global loan default rates have been tame for the past 15 years.
They quantify this by looking at the percentage of speculative-grade markets trading at distressed levels. Historically, distressed ratios lead default cycles by about 12 to 16 months. Regressing defaults by distressed ratios, they find the current U.S. high-yield market implying a 3.6% rate of defaults in the third quarter of next year, and European high-yield bonds projecting just over 2.2%.
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