Moody's: junk defaults to triple

NEW YORK (AP) - Defaults among companies with speculative-grade credit are likely to triple over the next year, underscoring the recent weakness in the debt markets, Moody's Investors Service said Tuesday.

"We think the era of easy access to credit has ended," said Daniel Gates, Moody's chief credit officer for corporate finance in North America, in an interview.

The default rate is expected to climb from 1.4 percent in 2007 to 4.5 percent in 2008 and 5.6 percent in 2009, according to Moody's projections. Default rates would likely climb even higher if the economy were to go into recession, Gates said.

A 4 percent default rate is in line with historical averages. During the most recent downturn in the cycle, default rates reached 11 percent in January 2002.

Investor appetite for speculative-grade debt has all but disappeared in the past two months. The troubles began as delinquencies and defaults among subprime mortgages -- loans given to customers with poor credit history -- rose rapidly.

People became worried bonds backed by those loans would fail, and the problems would spread beyond that market. Now, buyers are avoiding nearly all low-grade investments for fear of default.

That stands in contrast to a period of "easy market access" in 2006 and the first half of 2007, which helped speculative-grade companies refinance or issue new debt at low rates and with looser standards than in the past, Gates said.

"The earlier period of easy market standards may have only postponed the day of reckoning for companies that have persistent negative cash flow or flawed business models," Gates said. Companies with little cash flow and that are highly leveraged are likely to fare the worst, he added.

Many of the defaults in the coming year may be triggered by companies simply running out of cash to sustain their business, because most took advantage of the relaxed financial covenants on their bank credit facilities, Gates said.

During the recent boom, some deals did not even include covenants that, in the past, would often trigger defaults. Such covenants often require specific levels of financial performance from the debt issuer.

Aside from receiving better rates, companies refinancing or issuing debt in 2006 and early 2007 were also able to lock in longer terms, meaning relatively little speculative-grade debt will mature soon. Only $26 billion of speculative-grade debt -- about 2 percent of the outstanding volume -- is scheduled to mature before the end of 2008.

Historically, peak defaults rates come three to four years after an issuance boom, meaning default rates are most likely to peak around 2010.

But they are unlikely to reach the heights of 2001 and 2002, Gates said, because historically low interest rates since then allowed companies to improve profitability and operating cash flow, giving them some flexibility to handle tightening standards.