A new study from Moody’s Investors Service suggests that reports of the junk bond market’s rapid demise — even the debt-rating company’s own reports — are premature.
In an unusual announcement, Moody’s tempered its earlier projections, asserting that several factors unique to the current corporate credit environment now suggest that corporate default rates may not increase as rapidly in 2008 as being forecast by Moody’s Investors Service’s formal forecasting model.
The model currently projects a 5-percent global speculative-grade default rate by year-end. However, Moody’s now expects the default rate will end 2008 in the 3-4 percent range.
To be sure, this is still up sharply from its current level of 1.5 percent. Still, the back-pedaling is rather surprising. According to Moody’s, there were 15 defaulters in the first quarter of 2008. It explained that the 5-percent forecast for year-end implies that there will be about 90 additional defaulters by the end of 2008, or about 10 per month on average.
However, Moody’s senior vice president Kenneth Emery said in the later published report that a downside scenario of six to eight defaults per month, resulting in a rate in the 3 percent to 4 percent range, is more likely.
Moody’s did stress that it expects continued upward pressure on default rates in 2009, as refunding risks increase and as balance sheets grow more stressed. However, again it pulled back a bit, asserting that the magnitude of further increases in default rates in 2009 depends in large part on the strength of the U.S. economy next year.
Over the near term, however, Moody’s said that refunding risks are relatively low, and balance sheets of U.S. non-financial corporations appear to be in good shape relative to their condition entering past recessions.
Another reason it now expects fewer defaults than previously forecast is that the currently high spreads on speculative-grade debt — a major factor in the credit transition model’s predictions — may reflect investor concerns beyond increased defaults.
“In contrast to previous credit crises, the current credit market dislocations did not originate from the non-financial corporate sector,” Emery said. “As a result recent increases in high-yield bond spreads may more proportionally reflect increases in liquidity and risk premiums, rather than increases in expected corporate credit losses.”