THE COMING DEFAULTS IN JUNK BONDS A FORTUNE study finds that many of these high-yield, low-quality securities face big trouble. The victims could range from huge institutions to countless small investors.
By Ford S. Worthy REPORTER ASSOCIATES Lorraine Carson, Christopher Knowlton, Terence Pare, Andrew Evan Serwer

(FORTUNE Magazine) – LEVINE. Boesky. Siegel. Wall Street's gallery of rogues keeps growing, with every indication of more to come. But while the financial community waits nervously for the next insider trading scandal to break, another kind of shocker is brewing. Not as dramatic, perhaps -- no one is likely to be led off in handcuffs -- but with effects that ultimately could prove more far- reaching. The threat: an unprecedented level of defaults by the companies issuing junk bonds. The fallout might rain down even on people who have never heard of these risky high-yield securities. Hundreds of institutions that have loaded up on the bonds could lose money, ranging from insurance companies to savings and loans. So could thousands of small-time investors who have bought shares in junk bond mutual funds. Undermine investors' confidence in junk bonds and you strike at the heart of Drexel Burnham Lambert, whose senior executive vice president, Michael Milken, pioneered their use and revolutionized corporate dealmaking in the process. Put a crimp in the ability of takeover artists to raise financing by selling junk bonds through Drexel or other investment banking firms, and the acquisition game slows down. Fewer companies will be menaced into restructuring, including some that still need to. True, critics of junk bonds have been prophesying an imminent, cataclysmic wave of defaults for years (the sky is falling, the sky is falling). And true, despite the predictions, this high-yield corporate bond market has merely steamed ahead, proving amazingly resilient when bumps did occur. It bounced back after two jolts in 1986. In July, LTV, the giant steelmaker, went into Chapter 11 and stopped payment on bonds with a face value of $2.1 billion, the biggest junk default ever. Then came the revelations last November that Ivan Boesky, a big Drexel customer, had connived in illegal insider trading and was now cooperating with government investigators in search of other malefactors. Prices of junk plummeted after each debacle, but rebounded impressively, enabling the overall market, as measured by a Drexel Burnham index, to sport a healthy 19% total return for the year. This time around it may be different. FORTUNE has made one of the first comprehensive attempts to find out how shaky the junk bond market really is. The answer: not as bad as some Chicken Littles have been saying, but much more worrisome than the defenders of junk would have us believe. The market for junk bonds won't collapse, but it could be rocked to its foundations. In an effort to gauge the potential problem, FORTUNE enlisted the help of Houlihan Lokey Howard & Zukin, a Los Angeles consulting firm nationally known for its work in analyzing the solvency of companies. The firm scrutinized a universe of about 500 companies that altogether had junk bonds with a face value of $72.5 billion outstanding at the end of 1986. Studying these, it identified 36 companies whose bonds, with a face value of $4 billion, seem particularly vulnerable. Looked at another way, some 5.5% of the junk bonds in our sample appear to be vulnerable. At first glance, 5.5% might not appear that threatening. Look again: It's over three times the historical rate of default for publicly traded junk bonds, around 1.5% a year, which Drexel and others have harped on in touting the securities. These atomic bonds, as Houlihan Lokey calls the riskiest of them, are not necessarily destined to blow up or melt down. Many of the companies that issued them will undoubtedly find ways to survive: by bringing in new management, selling assets to repay debt, winning concessions from lenders, or selling out to stronger companies. Indeed, Drexel officials, who have expressed disdain for FORTUNE's project, say that the prospects for many of the companies listed here are so good that savvy investors would do well to view them as buying -- not selling -- opportunities. Caveat emptor. To understand the danger that junk bonds present now, you have to understand the nature and history of the beast. The two major bond-rating agencies refer to junk securities -- those rated BB+ or below by Standard & Poor's, or Ba1 or less by Moody's Investors Service -- as ''speculative grade.'' Drexel prefers the appellation ''high yield.'' By any name this is the riskiest of all marketable corporate debt. But the spectrum of risk within the junk market is incredibly broad. For example, B.F. Goodrich Corp. junk bonds currently yield about 9% a year, an indication that investors regard them as much less risky than certain Bethlehem Steel bonds, which if bought today and held to maturity would, God willing, yield nearly 17%. Junk bonds represent about $145 billion of the $550-billion totality of all corporate bonds. Approximately $125 billion of junk is what's called straight debt, bonds whose holders receive regular fixed-interest payments, typically every six months, until maturity, when the principal is repaid. Holders of convertible debt (about $20 billion outstanding) have the option to exchange the bonds for other securities -- usually common stock. About a third of all junk bonds are ''fallen angels'' that began life with investment-grade status and grew riskier as the issuer's fortunes declined. The other two-thirds were junk from day one. The market for junk has grown wildly -- from about $1.5 billion worth of lesser-quality bonds issued in 1978 to $7.4 billion in 1983 to $48 billion last year -- largely because of the super-salesmanship of Drexel's Milken, the preeminent figure in corporate finance today. From his offices in Beverly Hills, Milken convinced investors that the expected yield on a diversified portfolio of junk bonds overcompensated them for the risks entailed. Such bonds are bought and sold mostly on the basis of the spread between their yield and the yield on risk-free government bonds. A typical junk bond portfolio yielding, say, 11%, currently enjoys a spread of about four percentage points over the 7% yield investors can earn on government bonds of similar maturity. In theory the spread owes to the likelihood that the junk portfolio will suffer losses over time, for instance as individual bonds default. MILKEN'S GENIUS was to recognize that in any year only a tiny percentage of companies issuing such bonds had failed to make an interest or principal payment on time. Moreover, bonds that do default lose only a portion of their value. As long as history repeated itself, an investor with a diversified portfolio of junk could expect his total return to be reduced by default losses of just one percentage point a year. Junk bonds seemed to promise free money, Milken and his fellow Drexel salesmen told their clients, because even & after subtracting expected default losses, total returns from junk would be far higher than risk-free Treasury bonds. Portfolio managers for insurance companies, pension funds, and mutual funds quickly caught on and poured money into the high-yield sector as never before. Everything else being equal, the flood of new money should have caused the interest rate spread between junk bonds and government bonds to narrow. Instead -- and ominously -- when interest rates on Treasuries and high-grade corporates began to fall a couple of years ago, yields on junk held steady. The wider spread was the market's way of saying that junk was getting trashier. In their rush to invest, some institutional money managers skipped the exhaustive research that they customarily perform before buying risky issues, relying instead on the strength of the underwriter's endorsement. Many simply didn't have a sufficient number of qualified analysts to thoroughly screen the hundreds of new issues coming onto the market or to closely monitor the scores of issues already in their portfolios. In addition, junk issuers and their bonds proved to be complex creatures that sometimes didn't lend themselves to analysis with traditional financial models. An executive at one rating service says that more than a third of the money managers he advises don't do any independent research on the bonds they buy. HAD THEY DONE their homework, they might have been wary of that low historical default rate. To begin with, the default rate for publicly traded junk debt -- which averaged 1.5% annually for the period 1974-86, according to New York University finance professor Edward Altman -- is based in part on years when the total amount of junk was paltry by today's standards. Nearly two-thirds of all outstanding junk bonds were issued in just the last three years, roughly half in the last two years. As Altman notes, it generally takes a few years for even the worst junk to spoil, so the most recently issued stuff hasn't had a real chance to affect default rates. Nor has the junk of recent vintage had to weather a downturn in the economy. More important, the nature of the bonds in the market appears to have changed significantly in the past few years. In 1986 an estimated $12 billion in new junk bonds -- roughly 25% of all the junk issued -- was sold in connection with leveraged buyouts, those extra-risky transactions where new owners essentially hock a company to buy it. In previous years LBO-related bonds represented such a small portion of the market that nobody bothered to keep statistics on them. It's not uncommon for LBOs to have nine parts debt for every one part equity, a recipe that few companies can live with for long. The people who do LBOs count on being able to swiftly pay down that debt by selling off some of the company's assets. ''Everybody in an LBO deal is going for a quick home run,'' says a New York banker. Lots of junk owners could go down swinging if a recession slows down that resale market. Most default statistics also fail to take into account instances where issuers come within an eyelash of bankruptcy before some sort of rescue mission saves them. Among the most common rescue operations is the exchange offer: A company gives its bondholders new securities in exchange for the old bonds. A company out of cash and on the brink might ask its bondholders to accept new bonds that carry a lower interest rate, or permit interest to be paid in stock rather than cash. Says Ray Minella, who runs Merrill Lynch's high-yield operations: ''Most such exchange offers are bankruptcies without the benefit of a judge.'' James A. Schneider, a Drexel executive and an expert on exchange offers, says that the idea is to give the ailing company enough time to get to a ''better doctor'' -- an outside investor, perhaps, who's willing to give the company a big infusion of equity. If the patient goes on to survive, the investors who hang on to the bonds can do quite well. But many investors choose to sell out, often at prices less than 50% of the face value of their bonds. That's so close to what bonds sell at just after defaulting -- typically around 40% of face value -- that some analysts refer to emergency exchange offers as ''soft defaults.'' But these soft defaults don't show up in the historical rate. The historical rate of default nonetheless continues to be the centerpiece of the case that Drexel and others make for junk bonds as a safe investment. Says Larry Post, Drexel's co-head of high-yield bond research: ''Unless you think the overall credit quality of the market has gone down, there is no reason to believe that default rates in the future won't be similar to those of the past.'' But that larger spread between junk and high-grade bonds suggests that the overall credit quality has gone down. Other evidence points the same way. For instance, the proportion of new junk bond issues landing in Standard & Poor's or Moody's lowest-rated categories or going unrated has increased from 6.3% of new issues in 1980 to over 40% last year, according to IDD Information Services, a research firm. No one has a perfect formula to measure the risk that a company will default on its debt. S&P and Moody's, in making their judgments, consider a broad range of financial data reflecting both the company's past performance and management's projections for the future. They also make more subjective assessments: How sound is management? How likely is potential litigation against the company? WHILE those judgments may be quite valuable, FORTUNE asked Houlihan Lokey to devise a more rigidly objective series of measures to spot especially vulnerable companies. The approach that resulted relies heavily on how the marketplace values a company's stock. Says Marko A. Budgyk, the Houlihan Lokey analyst who developed and managed the study: ''We believe that by looking at a company's stock price, you can get a very accurate reading of how investors perceive the company's prospects. In effect, you've got a million different investors telling you what they think of management, of that potential strike on the horizon, of that new product the company intends to conquer the world with.'' Houlihan Lokey combed through both Standard & Poor's and Moody's bond guides for January, identifying companies with at least one straight or convertible bond outstanding that either agency rated as junk. From that sample of 792 companies, representing $125 billion in junk, it eliminated firms whose $33 billion of junk bonds are publicly traded but whose common stock is not. The study also excluded electric utilities, representing $11 billion in bonds, and banks and other financial services companies, another $9 billion. Both have characteristics that make comparisons with industrial and nonfinancial service companies of little value. Finally, there was no way to assess junk bonds issued in private placements, a category that represented $23 billion in new issues over the past two years, according to Merrill Lynch. Houlihan Lokey next evaluated the remaining junk bond issuers in terms of three market-based criteria: the total market value of the company's stock and equity equivalents, the volatility of its stock price, and its leverage. The analysts calculated each company's leverage, dividing total debt by the market value of the equity. Total debt figures were based on the most recent quarterly financial statements. For the equity part of the ratio, Houlihan Lokey used the market value of each company's equity on January 30. FORTUNE subsequently asked each company to confirm its debt and equity figures; if a company reported significant changes on its balance sheet since its last financial statement, we used the fresher numbers. AS A COMPANY'S leverage increases, its ability to service its debts usually declines and the risk of default rises. In the view of Houlihan Lokey and most other experts, big companies, with more equity outstanding, are able to tolerate higher leverage than their smaller counterparts. Small companies -- those with equity of less than $100 million -- were considered vulnerable if their debt-to-equity ratio exceeded 2.5 to 1. Companies with between $100 million and $250 million in equity were considered vulnerable if their leverage was more than 3 to 1. For companies with equity of $250 million to $500 million, the cutoff point was 4 to 1; for companies larger than that, 5 to 1. To show up on the final lists, a company with that high leverage had to meet yet another test. Houlihan Lokey took a reading of the relative stability of each company by measuring the price volatility of its common stock over the preceding six months. The higher a company's volatility, the greater the daily changes in how investors expect it to perform in the future. In general, companies with high volatility are perceived to be riskier than companies with low volatility. What emerged from this sifting and resifting were 24 ''atomic'' companies whose junk bonds are highly vulnerable to default. Twelve others, either not so highly leveraged or not so volatile, were judged by Houlihan Lokey as slightly less risky, but sufficiently dicey to qualify as ''subatomic.'' Again, this does not necessarily mean that the companies are going to default. But they do appear to face substantially higher risks than their peers within the world of junk. Houlihan Lokey didn't estimate probabilities of default, nor did it predict when default might occur. The main strengths of the Houlihan Lokey approach stem from its reliance on the information captured in a company's stock price. Larry Post of Drexel has used a similar approach, in fact, in analyzing junk bond issuers for almost ten years. But as Post and others point out, the method has its limitations. For example, debt is sometimes structured so that the issuer can make interest payments in the form of shares of stock during troubled times, thus conserving precious cash. And companies don't make any cash payments on zero-coupon bonds until the bonds actually come due. In such cases, companies may find extraordinarily high leverage quite tolerable. Houlihan Lokey's method also fails to consider the amount of cash a company has in the bank -- ''Cash being one of the best ways I know of,'' Post observes, ''to make the interest payment on a bond.'' The towering pile of cash currently on the books of Revlon Group, a company that narrowly missed the cutoff for subatomics, is a big reason that the bond research firm McCarthy Crisanti & Maffei rates the company as having a mere 2% chance of default in the next two years. But, says Philip Maffei, noting that Revlon is controlled by the acquisitive Ronald Perelman, ''you can't assume that all that cash is just going to sit there for the benefit of bondholders.'' That's why his rating firm believes the possibility of a Revlon default in the next five years is closer to 10%. These important caveats aside, the companies on FORTUNE's list include some real prizes. Even as Houlihan Lokey was doing its initial sorting, Chapman Energy, a Dallas oil and gas company, defaulted on junk bonds with a face value of $22 million. Spendthrift Farm, a Kentucky horse-breeding operation that's an atomic, and subatomic Kaneb Services, an oil services company, both announced that they expect not to make interest payments due later this year. Says Kaneb's vice president, Robert Pando: ''That's why they call them high- risk bonds.'' NOT SURPRISINGLY, most of the companies listed as atomic or subatomic are working overtime to bolster their balance sheets. In the past year, several have exchanged some of their old bonds for new ones with terms more lenient to them. Others, including Westworld Community Healthcare, are planning exchange offers. Lear Petroleum paid off enough bank debt in early January to transform itself from an atomic company to a subatomic. Many executives at the listed companies took strong issue with Houlihan Lokey's methodology. Others argued that in going purely by the numbers the study failed to consider important mitigating factors. For example, Valero Energy, a subatomic, plans to spin off its natural gas pipeline operations into a limited partnership, a transaction that the company says will raise $700 million -- cash it will use to pay off enough debt to cut its borrowings - by more than half. Texas International has agreed to sell $120 million of assets for cash it can use to pay down its debt. An executive at Quanex, an atomic, emphasized that, unlike most junk bonds, its bonds are secured by a lien on two of its steel plants. ''At the first default,'' he says, ''the bondholders get the plants.'' Who owns the junk that's likely to show up on the next heap of defaults? High-yield mutual funds own about $26 billion in junk, according to Lipper Analytical Services. FORTUNE examined the portfolios of 35 of the 50 or so funds that invest mainly in junk bonds, using the most up-to-date quarterly reports available. Four were too old to consider. The remaining 31 dated from June to December of last year. If atomics and subatomics in a fund's portfolio represented the same proportion as they do of the entire junk universe -- including bonds FORTUNE excluded from its sample -- then each fund would have about 2.8% of its holdings allocated to these most vulnerable types. As a group, however, the funds appeared to have a slight predilection for the risky stuff. Twenty-four of the 31 funds had more than 2.8% of the total value of their bond holdings invested in atomics or subatomics. The percentage of risky junk varied considerably from fund to fund: In June, Bull and Bear High Yield Fund owned atomics and subatomics with a face value of $20 million, representing about 18% of its $111 million invested in bonds. At the other extreme, Vanguard's High Yield Bond Portfolio, with total bond holdings of $954 million last July, owned atomics and subatomics amounting to only 1.9% of its portfolio. Besides junk bond mutual funds, few buyers of junk disclose much about what they own. Pension funds, which own an estimated $15 billion in junk, must report their holdings only once a year, and only to the Internal Revenue Service, which doesn't make the information public. Insurance companies ($40 billion) open the kimonos on their portfolios only once a year, in publicly available statements they file with state insurance commissioners. While most statements currently available are too old to matter, FORTUNE checked the December 1985 portfolios of Executive Life of New York and Presidential Life, both well known for investing in junk. They seem to be particularly savvy junk collectors: Both had minuscule holdings of atomics and subatomics. ''I don't like the small deals,'' sniffed an investment officer at one of the companies as he was read the names on FORTUNE's lists. $ While a few institutional investors may have portfolios overloaded with the junkiest junk, it seems likely that the riskiest stuff is fairly evenly distributed. If the rest of a money manager's junk bonds perform as well as they have in the recent past, a default rate as high as 6% would knock down the total return on his portfolio by approximately 3.65 percentage points, an estimate based on Professor Altman's studies of how much value bonds typically retain after defaulting. In other words, the return would be reduced to about what he could earn on government bonds. But will the other 94% of junk bonds go on performing as well as always? A 6% default rate would probably shake investors' confidence in a far broader segment of the market. An exodus from junk to higher-quality investments -- or from low-grade junk to high-grade junk -- could send bond prices tumbling. Even investors perspicacious enough to have avoided the defaulted bonds could see the values of their portfolios shrink, at least until the market regained investors' faith. A RECESSION could have far more drastic consequences. Most economists say that as long as the economy keeps chugging along they won't worry too much about the junk bond market. But they add that even a modest downturn later this year, a scenario that few economists are predicting, could jeopardize junk issuers in already weak industries such as steel, construction, and restaurants. ''Massive failures of companies with junk bonds are a distinct possibility in a downturn,'' says Edward Yardeni, chief economist for Prudential-Bache Securities. A shakeout, he says, ''could feed on itself. Because there are so many companies financed this way, there could be sort of a domino effect.'' What seems more likely is the emergence of a two-tier market in junk bonds. Investors and rating agencies, more aware of the vastly different tiers of quality, probably will invent a new line to divide ''investment grade'' junk from the ''speculative'' stuff. Drexel's Post, for one, maintains that the amount of independent analysis performed by junk investors has increased ''substantially'' in the past year. Drexel's competitors, seeking to make a name in the business, are also committing more resources to credit analysis. There's quality -- of sorts -- to be had. Over the past two years, as Morgan Stanley's Martin Fridson notes, an impressive number of large, highly liquid junk issues have come onto the market, issued by the likes of BCI (formerly + Beatrice), Colt Industries, and Phillips Petroleum. Another encouraging sign: Some issuers are beginning to pay off their junk debt by selling stock. If the stock market stays strong, many companies will have an opportunity to convert some of their debt into equity. The emergence of big issuers along with scores of midsize but equally solid companies stands to encourage more investors to participate in the junk market. In fact, 15 large insurance companies surveyed recently by Morgan Stanley suggested that they ultimately plan to invest an additional $20 billion in high-yield bonds. That will presumably mean still more credit analysts crunching the numbers. As more investors join the chase for high yields, the market should grow more efficient. The interest-rate advantage that quality junk bonds have offered compared with high-grade corporates should narrow. Indeed, while more junk bonds than ever before are likely to live up to their name over the next few years, far more are apt to become known by a new, less pejorative label. Blue-chip junk, anyone?

BOX: BANKS, TOO, LIKE JUNKY COMPANIES Where there are junk bonds, there are often junk bank loans. Bankers generally don't like to talk about how inextricably connected to the junk bond market they have become. But contrary to the popular perception that companies that issue junk bonds aren't solid enough to borrow from banks, many issuers have apparently had no trouble lining up ample supplies of bank debt. Of course, they also pay a higher rate of interest on their loans than the average corporate customer. In addition to their junk bond borrowings, the companies on our atomic and subatomic lists owe another $5 billion -- much of it to banks. Houlihan Lokey estimates that all the junk bond issuers it evaluated in creating the lists together owe close to $200 billion in bank debt. Bankers insist that their loans are ''well protected,'' whatever other defaults may occur. While loans to junk issuers are not generally secured by specific collateral, banks almost always have first claim on a company's assets in the event it goes bankrupt and has to liquidate. The bankers also fill their loan agreements with myriad covenants that give them the right to step in if a borrower starts getting sickly. ''I've done deals where I knew my loan could be repaid no matter what kind of trouble the company eventually got into,'' says a top executive at a major New York bank. As for the bondholders, % he adds, ''I wasn't so sure they'd see their money back in a bankruptcy situation.'' For taking that extra risk, of course, junk bond investors earn a higher rate of interest than the banks do on their loans. There is little indication that banks will want out of the market any time soon. First Chicago, Drexel's lead bank, did catch the junk bond jitters shortly after the Boesky affair broke, telling Drexel that it would no longer accept junk securities as collateral for short-term loans to the same extent it once had. But most banks continue to look at high-risk companies with the same hungry eyes as investors who buy their bonds.


Allegheny Beverage Smith Barney 5.9 $192 $381

American Healthcare Management Drexel Burnham 12.8 $80 $435

Cannon Group Drexel Burnham 7.8 $243 $596

Care Enterprises Drexel Burnham 4.2 $68 $179

Compact Video Drexel Burnham 3.9 $80 $174

Consolidated Oil & Gas None 14.8 $42 $104

Consul Restaurant Piper Jaffray 3.7 $21 $26

Lifestyle Restaurant L.F. Rothschild 2.9 $12 $16

Michigan General Drexel Burnham 5.6 $110 $146

Pay 'N Save Drexel Burnham 3.5 $295 $343

Pennsylvania Engineering None 10.9 $12 $86

Penril Drexel Burnham 3.2 $18 $35

Po Folks Kidder Peabody 4.4 $16 $75

Pope Evans & Robbins Bear Stearns 2.8 $35 $39

Preway Drexel Burnham 10.3 $56 $60

Quanex Drexel Burnham 2.5 $103 $112

Reading & Bates Smith Barney 5.1 $60 $486

Spendthrift Farm Prudential-Bache 3.7 $30 $44

Texas International Drexel Burnham 2.8 $190 $298

Thousand Trails Prudential-Bache 6.9 $57 $188

Wean United None 3.6 $27 $37

Western Union Salomon Brothers 3.9 $526 $924

Westworld Community Healthcare Drexel Burnham 15.2 $65 $114

Winners Prudential-Bache 3.5 $25 $49

CREDIT: ILLUSTRATIONS BY STEVEN GUARNACCIA CAPTION: Too Hot to Handle? While these junk bond issuers are the shakiest in our sample, they aren't all going to default. Some will scrape by, perhaps with the sort of exchange offer Drexel Burnham has pioneered for clients. Total debt includes bank debt. DESCRIPTION: Man in radiation-proof suit holding bond with tongs.


Arrow Electronics Bear Stearns 2.2 $110 $164

Ducommun Donaldson Lufkin 2.8 $35 $160

Kaneb Services Smith Barney 2.0 $55 $185

Kay Bear Stearns 3.1 $101 $65

Lear Petroleum Drexel Burnham 6.5 $196 $266

MCO Holdings Drexel Burnham 4.5 $81 $327

Price Communications Morgan Stanley 3.4 $375 $447

Radice E.F. Hutton 3.3 $34 $168

Service Merchandise Merrill Lynch 3.6 $300 $904

Texstyrene Drexel Burnham 2.3 $50 $82

Universal Health Services Morgan Stanley 3.0 $853 $33

Valero Energy Shearson Lehman 3.4 $277 $897

CREDIT: ILLUSTRATIONS BY STEVEN GUARNACCIA CAPTION: Handle With Care A little less risky than atomics, the subatomic bonds of these companies still need to be approached with caution. Like the atomics, they're vulnerable, not necessarily doomed. Virtually all bonds outstanding are junk grade. DESCRIPTION: Man in radiation-proof suit waving Geiger counter over bond.


Argo Petroleum Shearson Lehman $25 $66

Chapman Energy Thomson McKinnon $22 $45

Digicon Paine Webber $55 $113

ICO Prudential-Bache $30 $45

Kenai Offerman $73 $77

LTV Merrill Lynch $2,100 $2,800

McLean Industries First Boston $243 $1,089

Smith International Morgan Stanley $75 $495

Texas American Oil E.F. Hutton $25 $38

Towle Salomon Brothers $25 $68

Wedtech Bear Stearns $115 $140

Western Co. of North America Smith Barney $58 $574

Zapata Shearson Lehman $78 $663

CREDIT: ILLUSTRATIONS BY STEVEN GUARNACCIA CAPTION: Sunken Junk The junk bonds of these companies have defaulted since January 1, 1986, and remain in default. Note the absence of Drexel Burnham among the underwriters; it rescues many clients before default. DESCRIPTION: Men in radiation-proof suits fall down from explosion.


Caesars World Drexel Burnham 0.8 $233 $495

Castle & Cooke Goldman Sachs 0.4 $173 $455

Circus Circus Drexel Burnham 0.2 $75 $180

Federal Paper Board First Boston 0.6 $144 $472

Fuqua Industries Shearson Lehman 0.5 $159 $311

GAF Drexel Burnham 0.3 $486 $486

GenCorp Kidder Peabody 0.1 $103 $208

B.F. Goodrich Goldman Sachs 0.4 $92 $489

Rorer Group First Boston 0.5 $326 $452

Tele-Communications Drexel Burnham 0.8 $505 $2,163

Telex Drexel Burnham 0.1 $21 $106

Texaco Salomon Brothers 1.0 $6,722 $9,394

United Brands Drexel Burnham 0.2 $96 $135

Whittaker Dominick & Dominick 1.0 $44 $268

CREDIT: ILLUSTRATIONS BY STEVEN GUARNACCIA CAPTION: Top of the Junk Heap More like investment-grade outfits than junk, these companies have low leverage, low stock-price volatility, and a lot of equity. Indeed, the junk bonds of some of these companies might end up being upgraded. DESCRIPTION: Man with safe bonds removes helmet of radiation-proof suit.

CHART: NOT AVAILABLE CREDIT: ILLUSTRATIONS BY STEVEN GUARNACCIA CAPTION: Where Will the Money Come From? These spiky graphs compare approximations of each company's operating cash flow over the past five years with the Houlihan Lokey firm's estimates of how much cash will be needed in the future to cover their fixed obligations. These include interest on their debt, the principal as it matures, and dividends on preferred stock. The case of Price Communications illustrates one shortcoming of this kind of analysis: According to its most recent available balance sheet, the broadcasting company has approximately $200 million of cash it could use to pay down debt. The graph doesn't reflect that. DESCRIPTION: Three line graphs showing cash flow and fixed obligations for Michigan General, Price Communications and Lear Petroleum, 1981-2000.