Moody's Sees Rise in Defaults as Credit Tightens

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.

"In the coming months we expect more defaults among the weaker corporate credits that have been kept afloat in recent years on a pool of market liquidity that is now drying up," Kenneth Emery, Moody's director of corporate default research, said in the report.

A recent spike in yields on junk bonds relative to those on safe Treasuries underscores the declining availability of credit to low-rated companies, Moody's said. According to Merrill Lynch data, yields on junk bonds rose to 419 basis points over Treasuries in July, a jump of 121 basis points.

Defaults will rise faster in the United States than in Europe, with the U.S rate expected to reach 4.0 percent over the next 12 months compared with 2.5 percent in Europe, Moody's said.