Wild junk bond views pit S&P bear vs Moody's bull

NEW YORK Thu Aug 27, 2009 2:14pm EDT

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NEW YORK (Reuters) - Major credit rating companies hold diverging views on the state of the U.S. junk bond market in 2010.

Current forecasts for U.S. high-yield bonds show a wide gap between bearish calls from Standard & Poor's, which forecasts a 13.9 percent default rate, and Moody's Investors Service, which has scaled back its default rate forecast to 3.8 percent by the middle of next year.

In recent reports, S&P said it expects the U.S. speculative-grade default rate could even reach as high as 18 percent if economic conditions are worse than expected.

"You don't see a lot of places where there are huge divergences among the rating firms," said Martin Fridson, chief executive of Fridson Investment Advisors in New York. "Naturally, the S&P number is a sexy story and is probably influencing institutional investors to a fair degree."

Moody's Corp's (MCO.N) Moody's Investors Service, McGraw-Hill Co's MHP.N Standard & Poor's and Fimalac's (LBCP.PA) Fitch Ratings have been the targets of intense criticism over the past two years for their role in mis-rating highly complex mortgage bonds and other securities that contributed to credit markets freezing up.

Their views on the high-yield bond market could be a new test. That market is viewed as a key indicator for the health of credit markets, for corporations' access to capital and a harbinger of stability for global credit.

"Moody's and S&P may be incorporating very different economic scenarios into their rating decisions and default forecasts," Fridson said. "But I suspect many of those institutions' own economic outlooks are more optimistic than the very bearish case underlying the S&P forecast."

For example, S&P Chief Economist David Wyss expects the S&P 500 index to fall by 14 percent by the end of the year.

"We've generally been seeing expectations for defaults changing," said Matthew Tucker, head of U.S. fixed income investment strategy at Barclays Global Investors in San Francisco. "Most investors believe that defaults will not be as high as they thought even six months ago."

Tucker said he would not be surprised to see S&P and others begin to reduce their default forecasts if there are more signs of economic recovery.

At Moody's, Chief Economist John Lonski commented recently on the positive impact on the economy of the pickup in bond issuance. The company's Moody's Economy.com unit has issued reports forecasting positive GDP in the current quarter and noted signs of recovery in housing, retailing and manufacturing.

Moody's said in an August report that the global default rate has increased in every month since December 2007, when it bottomed at 1 percent. The current default rate is now higher than the peak of 10.4 percent reached in 2001, but below the 12.2 percent peak reached in 1991.

Looking ahead, Moody's predicts that the global default rate will peak at 12.2 percent in the fourth quarter before declining sharply to 4.4 percent by July 2010.

Moody's added that the default rate will not peak in Europe until 2010, when it reaches 12 percent in the first quarter.

Fitch Ratings has not published its forecast for next year, but said the U.S. high yield default rate may end this year between 15 percent to 18 percent.

"The volume of distressed debt and bond exchanges will likely weigh on default rates," Fitch analyst Eric Rosenthal said. "Distressed debt isn't going away."

For good measure, FIA's Fridson said he is splitting the difference for his June 2010 forecast. He sees a U.S. default rate of about 7.6 percent.

(Reporting by Walden Siew; Editing by Dan Grebler)

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