Private-equity firms showing strain

— -- Some of Wall Street's most private investors are beginning to have some public problems.

Private-equity firms, a revamped version of the leveraged buyout firms (LBOs) of the 1980s, are beginning to find that some of the companies they bought during the boom are showing serious signs of strain.

More than half — 25 — of the 42 companies that ratings agency Standard & Poor's says have the lowest credit ratings, and therefore the highest risk of default, are owned or controlled by private-equity firms. Many of the investments were made years ago, when it was easy to borrow money at low interest rates and buy companies.

Now, with the economy slowing and credit tight, companies are feeling the squeeze. "Some investments made by the private-equity firms are in big trouble," says Pavel Savor, finance professor at Wharton business school.

These problems have serious ramifications for investors, especially large pension plans and endowments, that invested heavily in private equity, says Bill Parish, financial adviser at Parish & Co. They can get hit twice if they invested in private-equity funds themselves and also bought bonds sold by companies backed by the private-equity firms.

Some private-equity-backed companies are now struggling because:

•Big debt loads are harder to handle. Consumer spending is slowing, so companies have less cash to service the debt the private-equity firms put on them, says Kim Noland of bond-rating service Gimme Credit. "Private-equity firms were the major force behind a number of LBOs that piled too much debt onto companies," Noland says.

•Leverage magnifies losses. Most private-equity firms use cheap borrowed money to amplify potential returns. But leverage accelerates the financial pain when companies they bought using debt stumble. If the value of a company falls 10.5%, the actual loss to the private-equity firm and its investors may be closer to 33% factoring in the effect of using debt, Savor says.