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Moody’s reports higher default rates among PE-backed firms

Companies owned by private equity (PE) firms are defaulting on their credit at a significantly higher rate compared to other speculative-grade borrowers, according to a report by Bloomberg citing a recent report from Moody’s Ratings.

From January 2022 to August 2023, private equity-backed companies had a default rate of 17%, nearly double the rate of non-PE-backed firms, Moody’s revealed in its report published on Thursday. Among the 12 largest private equity sponsors, the default rate was slightly lower, at approximately 14%.

Platinum Equity led the pack with the highest number and share of defaults among the top 12 private equity sponsors, followed by Apollo Global Management and Clearlake Capital Group. Both Platinum and Clearlake were noted for having the highest leverage ratios, while Apollo’s leverage was closer to the group’s average, standing at six times earnings.

A spokesperson for Apollo responded to the report, saying: “Leverage in Apollo’s private equity portfolio is among the lowest in the industry,” and also challenged Moody’s characterisation of term loan extensions and opportunistic debt exchanges as defaults, emphasising that the companies involved are performing well and not in financial distress.

Clearlake, meanwhile, declined to comment, and Platinum Equity did not respond to inquiries.

Moody’s pointed out that private equity-owned companies typically carry more debt and have lower credit ratings than their peers, which has contributed to their higher default rates. The rise in interest rates has further strained these companies, particularly those with floating-rate debt, a financing option favoured by many private equity sponsors for its flexibility.

Most of the defaults were due to distressed debt exchanges, a strategy that private equity sponsors have increasingly used to preserve their equity. These exchanges allow them to exploit lenient governance terms, enabling them to secure financing from certain lenders at the expense of others.

Moody’s also highlighted that many private equity firms have turned to leveraging their funds’ combined assets, utilising private credit, and adopting payment-in-kind features to manage shrinking cash flows.

The report noted that private equity firms have increasingly resorted to borrowing more debt to fund dividend payments, returning cash to shareholders. This strategy has been more common as traditional exit opportunities like mergers, acquisitions, and IPOs have dwindled. However, these dividend-related deals haven’t led to significant defaults, as they typically involve higher-rated portfolio companies.

More sponsors are turning to private credit for rescue financing and greater flexibility. At least nine companies in Moody’s sample of 257 borrowers have refinanced publicly rated debt with private deals and are no longer rated by Moody’s.

Some major firms, including Vista Equity Partners, Carlyle Group, and Thoma Bravo, have “nearly disappeared” from public debt markets and are now more likely to borrow from direct lenders, according to the report.

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