The bigger they are, the harder they fall. Well, the credit bubble that burst in 2007 was of gargantuan proportions, and we’re still falling. Standard & Poor's is now predicting that nearly 200 U.S. high-yield issuers are at risk of defaulting on their debt this year. The amounts involved are significant: almost $350 billion in debt.
S&P's hit parade of "at-risk" sectors? Restaurants, retail, automakers and their suppliers, gaming and lodging, media (including newspapers), and entertainment and printing. The ratings agency also fingered the largest companies that look shaky, including Ford
Public companies at risk
As a stock investor, you're probably wondering which public companies run the highest risk of default. The following table contains seven companies that are in the bottom decile of the S&P 500 in terms of their Z-score. Z-what? The Z-score, developed by NYU professor Edward Altman, is a statistical indicator of the risk of financial distress. The lower the score, the greater the risk of bankruptcy. It's not just an academic concept, either -- auditors and courts apply it to evaluating loans.
With a Z-score of 1.8 or below, a firm is thought to be distressed, with a significant risk of bankruptcy. As you can see, all companies in the table handily crawl under that hurdle:
Company |
Z-score |
---|---|
Sprint Nextel |
0.1 |
Verizon |
1.2 |
Qwest Communications |
(1.7) |
General Motors |
0.2 |
Ford |
1.0 |
JDS Uniphase |
(33.0) |
Advanced Micro Devices |
(0.7) |
If heightened risk of bankruptcy weren't bad enough, companies now face a greater risk that bankruptcy will lead to liquidation (as in the case of Circuit City) rather than simply reorganization. That's due to the fact that so-called "debtor-in-possession" (DIP) lending has dried up along with other forms of credit -- the number of lenders has shrunk from about 30-plus in 2006-7 to a single digit now. DIP loans are the lifeline that allows companies to continue operating as they navigate the Chapter 11 bankruptcy process.
A lesson on debt
As these conditions converge, highly leveraged companies will need to be quick on their feet to avoid defaults and/or bankruptcy. For stock investors, it's a stark reminder of the merits of investing in companies with an armor-plated balance sheet -- particularly during an economic downturn.
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