Model behaviour

3 Jan 2008 By Simon Nixon

OK, people have been predicting gloom for years. But that may be because their models failed to take account of looser covenants. Citi has a new model that predicts US high yield defaults hitting 5.5% by 2009 even without a recession. Europe won’t be that different.

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US high yield bond defaults could hit 5.5% by the start of 2009 – up from 1.3% in 2007, according to Citigroup. The main driver of Citi's forecast is a sharp widening of spreads on new loans to large and medium firms, as shown in the Federal Reserve quarterly survey of lending conditions.

Recent predictions of higher default rates have proved wide of the mark. In 2006, Standard & Poor's forecast default rates would rise to 2.5% by the end of that year and 4% by the end of 2007. Moody's predicted defaults of 2.7% in 2005, 3.3% in 2006 and 2.6% in 2007. The actual outcome was only 1.9% in 2005, 1.3% in 2006 and 1.3% in the year to September 2007.

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