Moody’s Sees Tripling of U.S. Junk Default Rate

Its model shows the current 1.4-percent rate jumping to 4.5 percent in the next year; sharp rises globally, too.
Stephen TaubSeptember 11, 2007

A widening of the global credit crunch will cause a tripling of the current junk bond default rate in the U.S. over the next year, according to predictions by Moody’s Investors Service.

The default rate in the U.S. could climb to 4.5 percent in 12 months, according to a model used by the debt rating service. The default rate currently stands at 1.4 percent after a one-month dip from 1.5 percent in August. The U.S. rate was 1.7 percent at the beginning of this year and 2 percent a year ago.

Moody’s also projected that the issuer-weighted global speculative-grade default rate will reach 4.1 percent a year from now, and 5.1 percent by August 2009. Despite recent volatility in the financial markets, the global default rate, like that in the U.S., fell in August to 1.4 percent from 1.5 percent in the prior month, Moody’s said.

“Higher spreads and diminished liquidity are putting distressed issuers at increased risk of default,” according to Kenneth Emery, Moody’s Director of Corporate Default Research. “However, as long as the U.S. economy avoids recession, the default rate will likely remain below its long-run historical average of approximately 5 percent.”

The forecasting model used by Moody’s “shows future default rates varying significantly across regions,” although lower in Europe, where a 3 percent default rate is predicted over the next 12 months. In Europe, the default rate at the end of August was 2.9 percent, unchanged from the prior month and down slightly from 3 percent at the start of the year. A year ago, the European default rate stood at 0.8 percent.

Among U.S. speculative-grade issuers, the dollar-weighted bond default rate remained unchanged at 1 percent from July to August. This rate represents a sharp decline from a year ago, when it stood at 4.2 percent.

Meanwhile, new issuance of junk bonds is grinding to a halt due to lack of investor appetite. Moody’s pointed out that more than 50 planned high-yield and leveraged-loan transactions have been deferred.

In contrast, investment-grade issuance has resumed after what it calls “a brief period of reassessment.” It added that “even if the liquidity crunch eases, tighter credit standards are expected to linger.” And speculative-grade defaults are expected to rise.