Tuesday, September 11, 2007

Rise forecast in company default rates

By David Oakley, Financial Times

Published: September 11 2007 22:51 | Last updated: September 11 2007 22:51

Company default rates are forecast to rise nearly 300 per cent as the credit squeeze hits the wider economy and raises the prospect of a global recession.

Moody’s Investors Service warned that default rates among high-yield-rated companies – one of the best indicators of the health of the world economy – will rise sharply because of the turmoil in the money markets.

Mark Zandi, chief economist from Moody’s economy.com, said: “We may be in a recession in the US right now, although not in a technical sense as the downturn would have to last a few months. And if we aren’t in recession, the risks are as high as they have ever been since the last recession in 2001,” he said. “The subprime and money market problems have been a major blow to the US economy, undermining the already very fragile housing market.

“The risk is that this will hit consumer spending and business confidence.”

Moody’s predicts that the global speculative-grade default rate will rise from 1.4 per cent – meaning only 1.4 per cent of the companies rated have defaulted in the past year – to 4.1 per cent in a year’s time and 5.1 per in two years’ time.

Moody’s said Wednesday’s figure of 1.4 per cent was a 20-year low and showed that companies had so far stood up well to the recent volatility.

However, if the US slipped into recession, this figure could approach the all-time highs of about 12 per cent, last seen in 2001 after the dotcom crash and in the early 1990s when inflation spiralled out of control in both Europe and the US, economists said.

Willem Sels, head of credit strategy at Dresdner Kleinwort, said: “We believe there is roughly a 40 per cent probability that the US will go into a recession, so it is essential that the money market problems are solved quickly. If they aren’t, the probability of recession could rise further, with negative implications for the markets.” Although US and European companies had weathered the storms so far in the money markets, default rates are certain to rise as it becomes more expensive to refinance debt in a tougher market place where investors are demanding higher interest rates or returns to buy debt.

Andrea Zazzarelli, associate director of European default research at Moody’s, said: “The problems in the money markets will put companies at risk as they are facing higher costs to refinance debt. Those with strong balance sheets can still do so, but the weaker companies may be forced to default.” In Europe, the default rate stands at 2.9 per cent, compared with the US default rate of 1.4 per cent.

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