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 (NYSE:F), Harrah's Entertainment, and Claire's Stores. The latter two were acquired in multibillion-dollar LBOs at the height of the buyout bonanza and piled high with debt -- no one should be surprised to find them in this lineup. Need I comment on 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:



Sprint Nextel (NYSE:S)


Verizon (NYSE:VZ)


Qwest Communications (NYSE:Q)


General Motors (NYSE:GM)


Ford (NYSE:F)


JDS Uniphase (NYSE:JDSU)


Advanced Micro Devices (NYSE:AMD)


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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Alex Dumortier, CFA has no beneficial interest in any of the companies mentioned in this article. Sprint Nextel is a Motley Fool Inside Value pick. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.