WASHINGTON (Business-Insider) -The impact of a recession and a credit crunch in U.S. could be that $1 trillion worth of corporate debt ends up defaulting, Bank of America credit strategists said in a note.
“It has been a long time since we had a proper credit cycle,” Oleg Melentyev wrote to clients, pointing to the credit cycles beginning in 1981, 2000, and 2007. Those cycles were upended by a dramatic tightening of credit conditions, leading the three-year default rate on US corporate default debt to soar to around 15%.
Melentyev said that a 15% default rate on corporate debt was a “distinct risk” as the U.S. approaches a recession and credit gets tighter, though he believed a coming credit crunch will likely be less severe than what was seen during the Great Financial Crisis.
“We think it is reasonable to argue that that the next-3yr default cycle, whenever it starts, should add up to a lower peak,” he said. That would still amount to an 8% corporate default default rate in a full-blown recession, which could translate into $920 billion of corporate debt defaults.
That’s largely because banks have already started to pull back on credit conditions since the collapse of Silicon Valley Bank. U.S. debt growth has also pulled back in recent years, and a “full-scale” recession hasn’t been officially declared yet, though Bank of America strategists have said a mild downturn could start this quarter.
“If a full-scale recession doesn’t arrive in the next year or two, the cycle will get delayed, but not canceled. For now, we continue to think that a mild/short recession is a more likely outcome than a full-scale one for the foreseeable future. Therefore, we assume a moderate pace of loss-gathering is already underway, but it has not yet reached a point of a lift-off to take us to 8% aggregate across all credit,” he added.
Markets are growing jittery over the prospect of a future downturn, with the New York Fed’s U.S. Recession Probability Index predicting a 68% chance that a recession will arrive by April 2024. The risk stems from the Fed aggressively raising interest rates over the past year to tame inflation.
That risk has been amplified with recent banking turmoil, as lenders weather losses on their bond portfolios and steep deposit flight, causing them to tighten up on new lending.