Despite the global credit crunch, defaults on high-yield corporate "junk" bonds fell in November to the lowest level since 1981 ...
Despite the global credit crunch, defaults on high-yield corporate “junk” bonds fell in November to the lowest level since 1981 — 1 percent.
But the rate could soon quadruple, predicts Moody’s Investors Service.
“Higher credit spreads and more discerning credit markets, along with slower economic growth in 2008, will put upward pressure on corporate default rates next year,” it argues in a report.
The bond rating agency’s forecast is harsher than many on Wall Street but not out of line with default rates in similar periods in the market’s history.
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“The numbers seem to be about right,” says Martin Fridson, publisher of Leverage World.
Based on the “spread,” or the difference in yield between junk bonds and Treasurys, “the risk premium points to a default rate in Moody’s ballpark,” he says.
As of Dec. 6, the Merrill Lynch High Yield Master II index yielded 5.49 percentage points more than Treasurys, a substantial widening over the first half of 2007, Fridson says. The 10-year Treasury now yields almost 4 percent.
“Assuming we don’t go into a recession, high-yield bonds are a potential opportunity. You’re going to see the news that default rates are going to quadruple. … At [current yields], that more than compensates you,” says Larry Adam, chief investment strategist of Deutsche Bank Private Wealth Management.
But while yields may look tempting, keep in mind that if there’s a recession, the default rate could reach almost 10 percent, Moody’s predicts.
In 2002, defaults peaked at 11 percent.
“If there’s a recession, we could go from trough to peak [defaults] in one to two years,” says Fridson. Many experts put the risk of recession at about 50-50.