Defaults by highly leveraged, illiquid firms will likely rise substantially as credit tightens and less cash is available to keep weak companies afloat, Moody's Investors Service said Monday.
The global junk bond default rate should jump from 1.5 percent currently to about 3.5 percent over the next 12 months and to 4.5 percent by July 2009, Moody's said in a report.
An increase of that magnitude would be the first sustained rise in defaults since 2002, when they peaked at nearly 11 percent.
Rating agencies have been predicting a rise in defaults for years, but buoyant financial markets and investors with healthy risk appetite kept pouring cash into weak companies, helping bankruptcies stay low.
The appetite for risk dried up this summer, however, amid growing losses in the U.S. subprime mortgage sector and a spate of failed financings for leveraged buyouts.
There are a few points that should be made here.
1.) Defaults have been really low for the last few years. So we're starting from a low point. That doesn't mean this won't be painful, but it does mean we have a long way to go before this becomes a credit rout.
2.) That being said, the change in the financial market's risk appetite is quite pronounced and incredibly quick. A mere several months ago it seemed as though no deal would be turned down. Now it seems as though all deals are getting turned down.
3.) This is a prediction, not a fact.