"Four months and seven weeks ago (more or less), Moody's brought forth upon the debt markets a new survey, conceived in logic, and dedicated to the proposition that a whole lot of companies are about to go bankrupt."
-- with apologies to Abraham Lincoln
When Moody's released a survey of companies most at risk of default back in March, its original name was "Bottom Rung." The survey's name has since changed to the less judgmental "B3 Negative and Lower Corporate Ratings List." But whatever its title, the survey's conclusion hasn't changed: Nearly 300 of the nation's best-known corporate titans are in danger of going bankrupt.
Burdened by debt and strangled by a consumer-driven recession, 283 companies populated Moody's inaugural edition of the report back in March. And since its publication, Moody's says "the list has been an accurate indicator of defaults, capturing all but two of the 50-plus defaults of rated non-financial corporate defaults" during the first half of 2009:
- The twin bankruptcies at Chrysler and GM? Moody's called 'em.
- Six Flags? Moody's waved the red flag before it happened.
- It also accurately predicted the "limited defaults" (essentially, distressed debt restructurings) at Ford (NYSE:F) and Fairpoint Communications.
Here's the really scary part: The inaugural edition of "Bottom Rung" contained 283 companies that were rated "B3 Negative or Lower" and at risk of further downgrade. The ensuing months have seen some five dozen of these companies default, removing them from the list. But now that Warren Buffett has declared the recession over, things are looking up, right? How many companies could remain at risk today?
Oh, just 280.
Round up the usual suspects
Three-quarters of the way through 2009, the list now includes all the names you'd expect to find:
- Airlines such as AMR (NYSE: AMR) and JetBlue
- Homebuilders, including Hovnanian (NYSE:HOV) and Beazer Homes
But we've also got more than a few names from industries you wouldn't expect. Mining firms rode high on the commodities boom, but now, miners like Stillwater Mining (NYSE:SWC) and James River Coal (NASDAQ:JRCC) have dug themselves deep into debt. And while some considered the casino industry essentially recession-proof, according to Moody's, both MGM Mirage (NYSE:MGM) and Las Vegas Sands (NYSE:LVS) are now deep in the hole and in danger of folding.
What's it mean to you?
Moody's estimates that about 45% of the companies on its list will "default" within 12 months. However, whether that hurts you, the individual investor, depends to a large extent on what particular flavor of "default" occurs. We could be talking about a mere "limited" default -- the sort that Ford incurred when it offered creditors the chance to trade in risky loans for Ford common stock back in March -- which can actually be beneficial to common shareholders. Since Ford made its exchange offer, for example, the stock has quintupled.
But what if we get the other kind of default? You know, the sort of massive corporate failure that struck Chrysler or GM? Restructuring debts at these two companies left common stockholders like you and me with nothing. Sometimes, defaults can wipe you out, too.
Um, I'll take the first kind, please
Yeah, me too. But we can't always have our druthers. And to my mind, the combination of 1) a 45% probability that something bad will happen to any given company on the list, and 2) any percentage chance, no matter how small, that a company could go kaput and entirely wipe out your investment equals the following conclusion: Keep your eye on the Bottom Rung.
After all, Moody's makes the list freely available to the public four times a year. While only paying customers get to see updates as they're issued each month, you can view the quarterly reports the Moody's website simply by registering.
There be dragons
One final word of warning: Disasters come in all sizes, but small companies with weak balance sheets can succumb to economic downturns even more quickly than big firms with worse balance sheets. Small shops just don't have as many options available to "keep the game running" -- but this fear can also depress their stock prices inordinately, creating even greater upside potential.
That's one reason why we love investing in small caps here at Motley Fool Hidden Gems. But you should also know that we're hip to the risk of debt disasters here at the Fool. As the scale of the current crisis became apparent last year, we undertook a full-scale review of every stock we recommend, aiming to measure their ability to withstand a prolonged economic downturn by assigning each one a Defense Rating. You can even see them free of charge, just by signing up for a free 30-day trial to the service.
Recent reports of economic green shoots notwithstanding, we think the rising tide of bankruptcies justifies an extra dose of caution. Until the economy really improves, keeping watch for struggling companies could prevent a major meltdown in your portfolio.
