Moody’s Investors Service warns of risks associated with private equity’s use of large amounts of leverage.

“While much transformation activity continues, creditors are not participating in the potential “upside” available to private equity firms or original shareholders,” it says. “Future performance of current transactions will likely hinge on the economy remaining relatively stable and the credit markets remaining forgiving as many of these transactions will need to be re-financed over the coming years.”

Moody’s notes that many recent leveraged buyouts are in industries with high capital requirements, competition, or cyclicality, increasing risk. And, it has seen the equity component of private equity-owned issuers diminish, “making valuation more of a challenge, particularly as private equity firms increase dividend activity, sometimes completely eliminating the amount of contributed capital in their investments.”

In this environment, Moody’s says it is skeptical that plans to de-leverage or exit via the IPO market will actually be carried out.

Finally, it is concerned that debt holders have less rights given the prevalence of no or minimal financial maintenance covenants and modest amortization requirements among current transactions.