(FORTUNE Magazine) – In the movie The Deer Hunter, the lead character plays a game of Russian roulette, with tragic consequences. Many investors are unknowingly making a similar gamble, thanks to the advent of so-called debt triggers, which are usually hidden from sight--until they explode. These devices, also known as rating triggers, are essentially insurance clauses that skittish corporate lenders are increasingly demanding to lessen their risk should a company's credit quality deteriorate below investment grade. The mere existence of such mechanisms should tell you something about how optimistic banks are about the borrower's ability to generate future cash flow. (Hint: Not very.) And if the triggers go off, they can take a fatal toll on companies and their shareholders.

The most lethal kind of trigger forces a company to pay off its debt as soon as a rating downgrade occurs--precisely when a company is least likely to have enough cash to do so and is at high risk of defaulting on its obligations. When that happens, shareholders are lucky to get back even a fraction of their initial investment. Such was the case with--surprise--Enron, which spiraled into bankruptcy less than a week after its credit rating was cut to sub-investment-grade (or junk) status. Similar triggers knocked California utility Pacific Gas & Electric into Chapter 11 and almost took Southern California Edison down the same path.

But even in cases where a trigger's penalty is less severe--such as requiring a company to pay more interest, pledge collateral, or sell assets--the damage can be significant. "The structural risks that come with such triggers can have a very real impact on a company's ability to execute its strategy," warns Glenn Reynolds, CEO of research firm CreditSights. "When a company has to sell assets or limit capital spending, it can take the stock totally off its growth trajectory."

What makes all of this most vexing for investors is the fact that rating triggers are usually buried deep within the covenants of financing arrangements, in arcane explanations that often don't have to be publicly disclosed. Ratings agencies Moody's and Standard & Poor's have recently begun surveying companies in an attempt to ferret out these troublesome clauses, which both agencies believe are on the rise. But that's cold comfort to analysts and investors, who for now can only grope in the dark. So far even the professionals haven't had much luck finding triggers. "If the ratings agencies are throwing up their hands and saying that they don't have a good grasp on it, how am I ever going to find it?" asks Carol Levenson, an analyst with credit research firm Gimme Credit.

Lately a trickle of companies have come clean on their rating triggers, but they're mostly power producers desperate to distance themselves from Enron. With its stock trading at a 52-week low of $39, Texas energy company El Paso announced in December that it was taking steps to remove the triggers associated with some $2 billion in off-balance-sheet debt. In this case, the triggers enable debt holders to automatically demand payment if El Paso's credit rating is downgraded to junk and its share price falls below certain levels. "That's got to be the most self-destructive financial structure ever invented," remarks Levenson. "Your stock price and your bond ratings have to fall an incredible amount--and then you have an extra obligation added to your plate? What genius invented that?" So far, El Paso's revelation has done little to help its stock price. (It's still trading for $39.) For one thing, the company hasn't been able to escape the post-Enron cloud hanging over the entire energy sector. Second, if the triggers were removed, the debt would go on the balance sheet. That prospect doesn't thrill investors.

Then, in January, another power producer, Williams Cos., disclosed a trigger that could leave it on the hook for $1.4 billion. That debt is currently on the books of a beleaguered former subsidiary it spun off in April 2001, Williams Communications. In this case, if Williams Cos.' rating gets downgraded to junk and its stock trades below $30.22 a share for ten days, the trigger goes off--and the company must come up with $1.4 billion immediately. The credit rating remains a few notches above there now, but the stock has dropped from $25 to $15. Like El Paso, Williams says it is working to shed the onerous trigger, safeguarding it from a balloon payment should its rating be downgraded. But removing the trigger could still prove damaging. Says Reynolds: "The price of eliminating this trigger may be that Williams has to take that debt back on its books." Servicing that debt would add to the company's interest expense and take a whack out of earnings. A Williams spokesperson says the company will outline its plans for restructuring the debt in early March.

Oil-field-services company Halliburton also has a trigger that could cost it down the line. If its rating falls below investment grade, it loses the right to draw upon its $700 million line of credit. Hanging over it are thousands of asbestos-related lawsuits associated with a subsidiary--one of the factors that prompted Moody's to downgrade Halliburton's credit rating in January to just two notches above junk. (S&P, on the other hand, rates the company two levels above that.) Doug Foshee, Halliburton's CFO, points out that the company has never had to draw on the line of credit, has a low debt-to-capital ratio, and is generating plenty of cash. Still, the rating trigger means that the company could face more expensive financing costs down the road if, as many analysts expect, it replaces the line of credit with one that contains no triggers. "This could make funding more difficult and expensive," points out Reynolds. "Their bonds are already trading like junk."

Triggers can also limit a company's ability to grow. AT&T, for instance, issued $10 billion in debt this past November after announcing its broadband unit was for sale. Subsequently it agreed to sell it to Comcast. To get the money, the company not only paid generous interest, it also assured lenders that its credit rating would still be investment grade when the Comcast deal is finalized. But if its rating is junk at that time, AT&T will be forced to pay back the entire $10 billion. While Moody's analyst Robert Ray says the broadband sale will go a long way toward strengthening AT&T's balance sheet, the existence of the trigger means that until the split takes place, the company is in no position to add to its debt load. That will prevent it from, say, using debt to acquire another company.

Rating triggers crop up in all kinds of nooks and crannies. For instance, many companies obtain financing by securitizing--in essence, selling--their accounts receivable to outside investors. But more and more often, these investors are demanding that the companies buy back or refinance the receivables if their credit rating is downgraded to junk. (Collection then becomes riskier.) That could create a real cash crunch. Papermaker Georgia Pacific, another company plagued with asbestos-related lawsuits (in this case stemming from its long-since shuttered gypsum business), has such a trigger associated with $1.4 billion in receivables. Both Moody's and S&P currently rate the company one notch above junk. Any misstep, though, and the company would have to refinance $1.4 billion, probably at a higher cost.

AT&T Canada has a similar trigger in place and in February spent $100 million repurchasing all the outstanding receivables it had securitized--just days before its debt was downgraded to junk. But now the company, which has a host of other problems, has to finance that $100 million all over again--and pay interest it can ill afford.

For investors, the real problem with triggers remains the utter lack of disclosure. The SEC requires companies to reveal them only when it becomes "material"--that is, when the trigger is on the verge of being pulled. By that time it's often too late. Some observers expect companies to start fessing up more readily to all the intricacies of their financing, given the white-hot spotlight now shining on balance sheets. Bondholders and shareholders alike are well advised to stay vigilant. As Reynolds puts it: "Sometimes people look so hard for the bomb that they miss the series of bullets that can wear them down."

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