Companies owned by the 16 largest private equity firms have weaker credit than speculative-grade companies not owned by private equity firms, Moody's Investor Services states in a new report.
According to the report, 92% of 308 firms rated by Moody's since 2009 that were purchased through leveraged buyouts are rated B2 or below, compared with 40% of companies without a private equity sponsor.
The ratings of that 92% primarily were the results of downgrades by Moody's due to deteriorating credit metrics, a failure to improve financial performance or weakening liquidity.
"PE firms' focus on shareholder returns and high leverage has translated to a weaker rating distribution for their sponsored companies than for spec-grade debt issuers without such sponsorship," said Moody's analyst Julia Chursin in a news release on the report.
Among those 308 firms owned by the 16 largest private equity firms, 19% are on Moody's B3 negative or lower list — known as the distressed list, compared to 17% at other private-equity-owned companies and 8% at non-private-equity-owned companies.
The report also noted the 16 largest private equity firms further increase leverage by continuing to take debt-funded dividends, with 99 of the 308 firms paying those dividends to private equity shareholders. Because these LBOs occurred after the nadir of the financial crisis, all the dividends were taken "in a benign default environment," the report states, "when capital markets were willing to fund even risky transactions like dividend recaps."
The report also noted that in this environment, distressed exchanges have been prevalent. Among the 308 firms rated, there were 20 defaults and 60% of them were distressed exchanges. In a distressed exchange, debt holders take less principal in exchange for higher payment priority in the form of secured debt.
The "ratings of PE-backed companies do not bode well for them when the economy turns," the report said.