Defaults Seen Below Crisis Levels in Next Cycle, Moody’s Says
The next wave of company defaults isn’t likely to reach the rate triggered by the financial crisis five years ago, according to a report from Moody’s Investors Service.
While the default cycle will last longer than the “short and severe” 21-month period that started in 2009 amid the worst recession since the Great Depression, the rate probably won’t surpass the 14.7 percent level reached in November 2009, Moody’s said in a report dated Oct. 28. The ratings firm didn’t forecast when the next wave of defaults may begin.
“We’ll get a longer default cycle, but not as sharp,” David Keisman, one of the authors of the report, said in a telephone interview yesterday. “No one is estimating a timeframe, but when it does, it can happen much more quickly than you thought it could.”
Prospects for a rise in defaults remain low with the New York-based credit grader expecting a 2.7 percent rate among U.S. speculative-grade issuers at the end of this year. The riskiest corporate borrowers have been buoyed by the Federal Reserve’s unprecedented monetary stimulus, which has pushed bond yields to the lowest ever.
Even as the default rate holds below a two-decade average of 4.5 percent, credit quality has started to decline, leading to an increase of downgrades to the B2 and B3 categories, five and six levels below investment grade. Companies have increased their ratios of debt to earnings, lowered interest coverage and issued more covenant-light securities that have fewer investor protections.
Energy Future Holdings Corp., taken private in 2007 for $48 billion, may file for bankruptcy as soon as this month. The buyout of the Dallas-based energy producer by KKR & Co., Goldman Sachs Capital Partners and TPG Capital was predicated on rising gas prices. Instead, they fell as the development of hydraulic fracturing created a surge in U.S. gas supplies.
In Brazil, OGX Petroleo & Gas Participacoes SA, former billionaire Eike Batista’s oil company, may seek bankruptcy protection that would put $3.6 billion of dollar bonds into default, the region’s largest on record.
The degree of losses on soured debt is poised to increase as recovery rates for defaulted companies decline amid fewer prepackaged bankruptcies and distressed debt exchanges that allow companies to reach agreements with creditors outside courts, Moody’s said in the report. More companies may declare Chapter 11 restructurings in the next period, which tend to lead to lower recovery values, the analysts said.
Yields on bonds issued by the riskiest U.S. companies fell to a record low of 5.98 percent in May, according to the Bank of America Merrill Lynch U.S. High Yield index. Borrowing costs have since risen to 6.44 percent, below the average of 9.05 percent during the past 10 years.