Moody's Sees Surge in High-Yield Defaults

Global default rates by speculative-grade companies are expected to quadruple to 4.2% next year, Moody's says in a new report, offering a fresh sign that easy credit fueled excessive borrowing by risky companies over the past two years.

To date this year, defaults remain low, at just 1% in November, the ratings agency says. This is the lowest level since December 1981, when it stood at 0.7%. A year ago, the rate was 1.9%.

"Our baseline forecast incorporates a slowing U.S. economy in 2008 but no recession," says Kenneth Emery, Moody's director of corporate default research. "If a recession were to materialize, default rates could increase to near double-digit levels."

The last time default rates hit double digits was in 2002, when they were around 11%.

Numerous factors are contributing to the rising levels of distressed situations. The environment has been very forgiving for debtors in recent years, but credit markets have quickly tightened. A large chunk of lower-quality debt was issued by LBO firms for buyout deals of public companies.

"The main reason for the big increase [in expected defaults] is the very poor quality of new issues in the high-yield market in 2006 and the first half of 2007," says Edward Altman, professor of finance at New York University Stern School of Business and an expert on corporate bankruptcy. Altman had forecast earlier this year that default rates would rise to around 4% in 2008.