Recent data indicates that private equity funds are pushing their portfolio companies to take on more debt through dividend recapitalizations, a strategy that has surged since 2022. This shift is largely due to a lack of viable exit options, such as IPOs or sales to other buyers, which have become scarce.
Moody's Ratings forecasts that private equity-owned companies in the EMEA region could incur an additional 41 billion euros ($46 billion) in debt before reaching levels that typically trigger a downgrade.
While this practice allows private equity sponsors to return cash to investors, it raises concerns about the long-term viability of these companies, as increased debt can limit their ability to invest and navigate future downturns.
Moody's analyst Mayank Mallik noted that the practice is currently confined to the strongest-performing companies, but the ongoing exit backlog means private equity firms may have to hold onto their investments longer than usual.
The decline in distributions to investors, which fell from over 30% of starting net asset value in 2022 to about 12% today, further underscores the pressure on private equity firms to find alternative ways to monetize their investments.
Although there is still capacity to fund these recapitalizations, the risks associated with increased leverage could lead to credit deterioration across portfolios if the exit environment does not improve