Leading private equity firms, including KKR & Co., Platinum Equity, and Clayton Dubilier & Rice, find themselves grappling with substantial financial losses due to an unexpected surge in interest rates.

These losses not only jeopardize the profitability of their owned companies but also push numerous enterprises to the brink of default.

“Not many folks were worrying about this and a lot of businesses have been burnt really badly,” said Chris Scott, Carlyle Group Inc.’s head of European capital markets.

Despite orchestrated increases in interest rates by central banks, many private equity firms failed to take precautionary measures to shield their companies from escalating costs. As a result, these firms now face an approximate $3 trillion burden of floating-rate debt, with costs doubling or even multiplying several times over. Hedging arrangements that were once affordable have become prohibitively expensive.

While industry insiders have been cautious in discussing the impact of rising interest rates on private equity-owned companies, recent analyses shed light on a significant portion of floating-rate debt taken on during the leveraged-buyout frenzy, lacking hedges in both the United States and Europe.

The consequences of rising rates could prove devastating for hundreds, if not thousands, of companies. Corporate defaults have the potential to disrupt the global economy, resulting in substantial losses for investors and significant job cuts for workers.

Experts underline the considerable risk posed by the abundance of unhedged debt. Companies caught off-guard by increasing rates may face dire consequences, as any decline in earnings could severely impact their financial stability.

During the extended period of low rates, private equity firms and the finance teams of acquired companies often viewed hedging as an unnecessary expense. This lack of a unified approach to hedging has left companies needlessly exposed to rising interest rates.

Prominent examples include Aventiv Technologies, a Platinum-owned company struggling to generate profits and burdened with high-interest expenses. Likewise, Wm Morrisons, acquired by CD&R, faced significant interest burdens despite eventually implementing some debt hedges. Moody’s downgraded Morrisons’ credit rating, signaling distress levels.

While some private equity firms took proactive measures and pursued hedging strategies, others were ill-prepared. Carlyle’s European buyout team, for instance, managed to save an estimated €200 million in interest for its portfolio companies through proactive hedging. Bain Capital also secured substantial savings via hedging.

Nevertheless, the lack of emphasis on hedging has left many companies vulnerable, with predictions of an impending wave of defaults among unhedged corporate borrowers. Over 300 mid-sized private companies in the US may struggle to meet their interest payments, necessitating debt renegotiations or financial assistance from private equity owners.

Even with significant rescue financing, Envision Healthcare, owned by KKR, filed for bankruptcy. The company’s financial woes were further compounded by various factors, including the absence of hedging for its floating-rate debt.

According to KKR, Envision had interest-rate hedges in place until 2021, but finding counterparties willing to assume the credit risk at an affordable price proved unfeasible at the time.