Firms owned by PE more likely to default, says Moody's

Companies owned by private equity firms are landing in default more frequently than other speculative-grade borrowers, according to a report from Moody’s Ratings.

Private equity-backed companies defaulted at a rate of 17% between January 2022 and August of this year, twice the rate of non-private equity-backed companies, Moody’s said in the report released Thursday. Among the 12 largest private equity sponsors — as ranked by Moody’s — the default rate was slightly lower at around 14%.

Platinum Equity had the highest number and share of defaults, out of Moody’s ranking of the 12 largest sponsors, followed by Apollo Global Management and Clearlake Capital Group, according to the report. Both Platinum and Clearlake were cited as having the highest leverage ratios, while Apollo was near the average of the 12 sponsors at six times. 

“Leverage in Apollo’s private equity portfolio is among the lowest in the industry,” a spokesperson for Apollo said in a statement. “The Moody’s report characterizes normal course term loan extensions or opportunistic debt exchanges as ‘defaults’ for companies that are performing well and not in financial distress.”

A representative for Clearlake declined to comment, while Platinum Equity did not respond to requests for comment. 

Private equity-backed companies tend to have more debt and lower credit ratings than their peers, contributing to the higher default rate, Moody’s said. Higher interest rates has also weighed on corporate balance sheets, especially among borrowers with floating-rate debt, which many financial sponsors prefer for flexibility. 

Distressed debt exchanges accounted for most of the defaults, according to Moody’s. Private equity sponsors have favored these exchanges in recent years as a way to preserve their equity and exploit loose governing provisions to claw financing from some lenders at the expense of others. 

Private equity firms have borrowed against their funds’ combined assets, tapped private credit and utilized payment-in-kind features to manage diminishing cash flow, Moody’s said in the report.

Moody’s also highlighted how private equity has turned to tapping more debt to fund dividends, a strategy that allows them to return cash to shareholders as the market for traditional exits like mergers, acquisitions and initial public offerings has shriveled. 

That strategy hasn’t led to many defaults, because most of those deals by higher-rated portfolio companies, Moody’s said.

More sponsors are turning to private credit for rescue financing and greater flexibility. At least nine companies among the Moody’s sample of 257 borrowers refinanced publicly-rated debt with private placed deals and are no longer rated, according to the report. 

Firms like Vista Equity Partners, Carlyle Group and Thoma Bravo have “nearly disappeared and now appear more likely to borrow from direct lenders,” the report said.