As recession talk swells, so do fears of a rising bankruptcy rate. It's anybody's guess how many more Chryslers are on the horizon -- but it seems unlikely that Uncle Sam will add to the nation's inflationary woes by anteing up big bucks to bail out other inept, inefficient corporate managements. If you believe that -- and it's not a difficult argument to buy -- then it follows that the investor ought to be doubly sensitive about where he puts his money in these volatile securities markets.
How'd you like to have bought Chryslerhs common stock at its 1968 high of 72.75 (now 6.5) or bankrupt W. T. Grant at 72 5/8?
To protect themselves from potential Chryslers, Grants and Penn Centrals, more than 125 of the nation's biggest institutional investors are paying $1,000 a month for the credit research work of a company little known to the public -- McCarthy, Reid, Crisanti and Maffei. Started in May of 1975, the New York-based company also does analyses of the money and capital markets. It's four principals -- all formerly with Paine Webber Mitchell Hutchins -- consist of two credit men, a money analyst and a research salesman.
Paul McCarthy, MRCM's soft-spoken, conservatively dressed president, sums up the current credit environment in frightening terms: "A cash crisis is coming; we're on the verge of a serious credit or liquidity squeeze."
What does it mean? As the 41-year-old McCarthy explains it: A crisis develops when a corporation's sources of cash are insufficient to cover day-to-day operations. "And for many corporations," McCarthy tells me, "that day is fast approaching . . . and not everybody's going to be able to get everything it needs to survive."
My next question was obvious and McCarthy was quick to anticipate it. "Even if the Federal Reserve eases credit, that's not going to be enough," he says. "You can't force banks to give bad loans. . ."
Considering the high interest rates, rising loan losses, weak earnings and Fed pressure aimed at keeping bank reserves higher, one could easily understand the banks' anxiety to tighten up.
McCarthy's implied message: Look for a rash of corporate failures, possibly including some biggies.
McCarthy offered some tough statistical data to back up his case. For starters, he points to the tremendous surge in short-term liabilities; these consist of short-term borrowings of roughly a year's duration, tax liabilities and tax credit. At year-end, these often crippling liabilities stood at a record $617.3 billion, up from 1978's $507.5 billion. Five years ago, they were just $347 billion -- meaning they've shot up a hefty 77 percent since then.
Another closely watched measurement of the viability of the corporate balance sheet is the ratio of highly liquid assets (demand deposits, currency in operation and U.S. securities) to short-term liabilities. Over the past five years, there's been rapid deterioration in this ration -- which has skidded from 19.7 percent in 1975 to 12.7 percent at year-end 1979.
In McCarthy's judgment, short-term liabilities will continue to go nowhere but up in the face of inflation and high interest rates (both of which eat up your cash) and slower customer payments.
"We also think we're going into a serious recession," says a grim-faced McCarthy. "And that means less favorable results, putting further strain on corporate liquidity."
Adds McCarthy: "You have hostile markets (a reference to poor stock and bond markets) and a federal government crowding out corporations with its own heavy financing needs. And while a corporation can defer capital requirements, it's difficult to defer current working capital requirements. Excluding cash flow, that leaves only the banks. It's clear that in the rush for funds, not all needs will be met immediately and in some cases the answer may be no."
McCarthy never said it in so many words, but what he's basically talking about is an agonizing corporate deathwatch . . . with nail-biting managements awaiting who does -- and doesn't -- get funds needed for survival.
The bid unknown: How many no's?
One of MRCM's chief service is its measurement of 544 companies (including banks) -- specifically their ability to meet short-term debt obligations. In assessing the borrower's ability to meet such debt, MRCM uses a variety of criteria. These include cash inflows and outflows, capital requirements, the quality of a company's receivables, the makeup of the total debt, an examination of industry fundamentals and financial policies (such as whether the company uses a disproportionate amount of short-term debt to finance long-term fixed assets).
The 544 companies are rated from 1 through 6. The higher the number, the riskier the debt. A shoddy 5 rating, for example, signifies MRCM's belief that the borrower has a low capacity to service debt on a timely basis; further, its debt-carrying capacity is subject to severe tests during periods of economic stress and (or) its need to carry short-term debt is deemed excessive. A 6 rating -- which would include Chrysler -- is deemed down-right speculative.
Phil Maffei, MRCM's executive vice president, tells me that under no circumstances would he own a 5- or 6-rated fixed-income security (or the common stock, for that matter because "there's a question mark about their financial viability."
In total, there are 43 fixed-income instrumments (a number of which represent subsidiaries of corporations) that fall in MRCM's 5- and 6-rated list. They appearl elsewhere in this column.
It should be kept in mind that this is strictly one rating service's view of the credit worthiness of fixed instruments. It's also worth noting through, that McCarthy, when he was at the brokerage firm of F. S. Smithers, as far back as 1971 named 55 electric utilities he thought were candidates for credit downgrading. In the next few years, 53 of the companies he named were downgraded by the major credit-rating services.
Kennecott Copper's inclusion on the 5-rated list surprised me. Maffei's explanation: deteriorating copper prices, a greatly weakened cash position as a result of the acquisition of Carborundum, a high level of capital spending, earning problems and a question of the firm's ability to go to the financial market for new short-term debt.
The tire industry was conspicuous with two 5-rated candidates -- Goodyear Tire & Rubber and Firestone Tire & Rubber. In a period in which the industry is suffering a severe profit squeeze because of the advent of longer-lasting radial tires, fears are voiced by MRCM that both companies are restoring to excessive use of short-term debt.
Sherwin-Williams, the big paint manufacturer, is also splashed with a 5-rating, chiefly reflecting poor cash flow relative to debt, a fundamental weak market position and poor profit margins.
The dominant group on the list -- the utilities -- comes as no surprise. Its problems -- from regulatory headaches and a poor bond market to rising short-term debt -- are well known.
The 6 group -- which includes banks and steel companies -- is aptly rated by the hardnosed McCarthy as "a crapshoot." That condemnation is about the best warning anyone can get. 5 RATING Alabama Power Appalachian Power Arkansas Power & Light Columbus & Southern Ohio Electric Dayton Power & Light Eastern Edison El Paso Electric Fidelity Bank Firestone Tire & Rubber First Atlantic Corp. Goodyear Tire & Rubber Kennecott Copper Long Island Lighting Louisiana Power & Light Marine Midland Bank Marine Midland Banks Inc. Ohio Edison Ohio Power Pennsylvania Power Piedmont Natural Gas Portland General Electric Potomac Edison Puget Sound Power & Light San Diego Gas & Electric Savannah Electric & Power Sherwin-Williams State Street Boston Corp. Transcontinental Gas Pipe Line United Gas Pipe Line United Illuminating Washington Natural Gas (Credit ratings by McCarthy, Reid, Crisanti & Mmaffei, Inc.) 6 RATING Chrysler Chrysler Financial Corp. Fidelcor Inc. First Pennsylvania Bank, N.A. First Pennsylvania Corp. Jersey Central Power & Light Metropolitan Edison Pennsylvania Electric Public Service Co. of New Hampshire Union Commerce Youngstown Sheet & Tube (Credit ratings by McCarthy, Reid, Crisanti & Maffei, Inc.)