Moody’s Investors Service warns that several recent developments point to a sharp increase in defaults among vulnerable issuers of U.S. speculative-grade debt. In a new report, the credit rating company forecasts that the U.S. junk bond default rate will rise to 4 percent at the end of 2008, quadruple the rate from the end of 2007, when the default rate stood at roughly 1 percent.

Moody’s explains that low rated issuers face increasing refinancing risk and liquidity pressures. Further, a persistently tight lending environment is narrowing options for these issuers as debt matures and available credit lines dwindle.

At the same time, covenant cushions are thinning for issuers whose earnings are under pressure amid deteriorating economic conditions in the U.S., or because of scheduled tightening under credit-agreement terms. “These risk factors often function in combination, and the default risk is particularly acute for issuers facing multiple pressures simultaneously,” Moody’s warns.

For example, deteriorating cash flow is likely to put pressure on covenants, which can further reduce liquidity and make refinancing more difficult, says the report. The upshot: Credit quality has declined for five consecutive quarters, as measured by the ratios of rating downgrades to upgrades and negative outlooks to positive outlooks. “The decline in credit quality increased in severity in the first quarter of 2008,” the report asserts, pointing to the fact that downgrades exceeded upgrades by 2.9 times in the first three months of 2008, compared with 1.9 times in the fourth quarter.

The negative trend in ratings is most pronounced among speculative-grade companies. Examining first quarter results, Moody’s reported that more than four times as many junk bond issuers were downgraded than were upgraded. By comparison, this multiple was less than two times for investment-grade issuers.

Rating outlooks also signal a negative credit trend, according to Moody’s Negative outlooks currently exceed positive outlooks by 3 times, compared with 2.1 times at year-end 2007, and 1.9 times at the end of the third quarter. “The change in this ratio was affected as much by a reduction in the number of positive outlooks as an increase in the number of negative outlook,” Moody’s explained. What’s more, the credit rater said that downward revisions of rating outlooks have been particularly likely for issuers that are sensitive to reduced consumer spending or tighter lending conditions.

As a result, Moody’s currently forecasts that the U.S. speculative-grade default rate will rise to 5.7 percent at the end of 2008. However, Moody’s believes that the year-end default rate will likely be lower than the model suggests, rising to around 4 percent.

In all, 13 non-financial corporate issuers defaulted in the first quarter of 2008, compared with 19 in all of 2007. Key factors in 11 of the 2008 defaults included weakness in consumer discretionary spending, companies’ difficulty passing through higher commodity costs, and/or the slowing economy. “We expect these factors will precipitate more defaults of low-rated issuers over the next few quarters,” added Moody’s.