Defaults To Rise, But Remain Low by Historic Norms: Moody’s

  • Defaults now near all-time lows
  • Economy sluggish, profits revised down
  • Two views of high-yield spreads

The default rate on speculative grade U.S. issues stood at 2.9 percent at the end of the second quarter, according to Lenny Ajzenman, a senior vice president. That rate is likely to climb to 3.2 percent in November, Ajzenman said on a conference call with bond investors, but then to decline again to 2.6 percent by next June.

Those default rates compare to a historic average of 4.5 percent and 14 percent in 2009 when defaults peaked during the financial crisis.

Defaults have tumbled to near all-time lows as the Federal Reserve has pushed down interest rates in an attempt to boost economic activity. The economy is growing, if feebly: The Commerce Department reported second quarter gross domestic product growth of 1.7 percent, above the 1.0 percent expectation of economists, sister news service Reuters reported, while first-quarter growth was revised downward to 1.1 percent, from 1.8 percent reported earlier.

Current conditions are exhibiting “fairly top-of-the-market behavior,” with risky issues such as PIK toggles finding acceptance and a growing number of lower-rated new issuers, said Christina Padgett, a senior vice president. Among new issuers, almost 30 percent have ratings of B3, one notch above a distress rating in the Moody’s system. By contrast, B3 issuers represented 20 percent of the financing market at its 2007 peak, and only 13 percent in 2006.

With corporate revenue growth projected to be subpar and the profit outlook being revised downward, the conventional wisdom argues that high-yield spreads should be higher, said John Lonski, Moody’s chief capital market economist. But the metric called “expected default frequency” argues the other way, Lonski added. “According to the average high-yield EDF metric, the recent high-yield bond spread is too wide.”