Although distressed debt hedge funds have yet to benefit from the credit crisis, they undoubtedly will in the coming year, Reuters reports.

“You ain’t seen nothing yet,” said a hedge fund-of-funds executive speaking on the condition of anonymity. “It’s going to be huge. The tea leaves are not difficult to read. It will come in all sorts of forms—banks having to offload stuff. It’s not just the debt of distressed companies. The time must come [for banks to sell assets], having got themselves into a tremendous hole.”

Distressed funds buy the debt of firms that have defaulted on debt payments, but get them at discount. The reason such funds haven’t benefited from the subprime meltdown is that the junk bond default rate is only at 1% because many banks are hesitant to sell debt at distressed prices.

“As it stands, it’s a bit precipitous to suggest there are lots of opportunities,” said Tim Gascoigne, a manager of hedge funds-of-funds at HSBC Alternative Investments. However, Gascoigne is bracing for defaults in the second half of next year.

As to why banks are sitting on distressed debt, Ken Kinsey-Quick, a manager of a hedge fund-of-funds at Thames River Capital, explained that many banks are “in a denial phase. Nobody wants to be the first one out. Nobody’s doing anything right now. I would have expected it [the bursting of the credit bubble] to be far faster and more brutal.” However, as corporate refinancing continues to dry up and the threat of a recession looms, many expect default rates to increase.

Through the end of November, distressed hedge funds have risen 8.29%, trailing the Credit Suisse/Tremont Hedge Fund Index’s 12.04% gain.

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