August capped a three-month holiday from leveraged loan defaults. And, if ratings agencies' 2011 forecasts -- at 0.13% by dollar amount and 0.7% by number, by Standard & Poor's count -- are to be believed, we're looking at default rates below historical averages.

But the numbers belie deepening strains in credit markets. The wilting economy and Europe's debt crisis have given creditors pause. For buyout shops, the recent failure of NewPage Corp., Cerberus Capital Management LP's long-suffering paper-making company, to refinance its debt underscored the fragility of businesses on the margin.

Are we headed for another cycle of distress? Deteriorating economic reports have cast a pall not only on buyout deals but on portfolio companies that have skirted insolvency so long as debt markets were loose. Banks are unlikely to lend as freely this time, and it's even less likely that buyout firms will dig in to still-sizable caches of uninvested capital for equity fixes, say observers.

"Over the past two years, many PE firms moved away from operating issues to focus on amending or extending loan maturities," says AlixPartners LLP restructuring expert John Castellano. "I think that's going to change over the next six to 18 months, where I don't believe there will be liquidity."

Southfield, Mich.-based AlixPartners is "certainly seeing more work on operational turnarounds" in a bid to avert Chapter 11 than in the past two years, says Castellano. "We're facing some serious economic headwinds. I don't anticipate unemployment fundamentals improving, regardless of any short-term stimulus," he says. Gridlock in Washington and an upcoming presidential election will only feed uncertainty.

Default rates spiked in 2008 to 2010, including 120 loans totaling $85 billion, or about 15% of loans outstanding at the end of 2007, according to S&P. That means, says S&P Leveraged Commentary & Data managing director Steve Miller, that many of the weakest companies in the most troubled sectors had already fallen to the Great Recession.

Still, notwithstanding record numbers of failed PE-backed businesses after the crisis, covenant-lite financing saved many. As liquidity returned, covenants were amended or loan maturities extended.

Castellano believes the reckoning has arrived. Whatever tools were available to PE-backed companies to repair short-term liquidity issues or debt covenants are no longer available, he says.

There was a significant amount of high-yield debt raised that coincided with the Federal Reserve's two quantitative easing programs. Those ended, with few hints of a third. "I just don't see liquidity returning at the same speed," says Castellano. "A lot has to do with market sentiment at this point."

To be sure, many PE-backed businesses that survived the last bloodbath have posted strong cash flow growth. Year-over-year Ebitda growth averaged 16% between the third quarter of 2009 and the second quarter of 2011, according to S&P, citing Capital IQ data. Thus, these companies' average cash-flow-coverage ratio, the strongest benchmark of default risk, grew to an all-time high, and the companies on credit watch shrank.

In recent weeks, however, there was a noticeable spurt of downgrades, including Global Aviation Holdings Inc., a passenger and cargo air transport services company controlled by MatlinPatterson Global Advisers LLC, whose debt rating was knocked down several notches. Hurt by weak demand from its government and commercial customers, the Peachtree, Ga.-based company deferred an interest payment and seeks relief from a debt covenant.

Moody's Investors Service also dropped the ratings of PE-backed window maker Atrium Cos., which Golden Gate Capital and Kenner & Co. bought from bankruptcy in April 2010. And Medi­Media USA Inc., a healthcare IT services provider backed by Vestar Capital Partners, took a one-notch downgrade. "There was some mismanagement of an acquisition that led to quality issues, and resulted in increased expenses that caused Ebitda to fall," says S&P credit analyst Jeanne Shoesmith. MediMedia breached its maximum leverage covenant and now needs an amendment or waiver.

Debt-burdened companies are susceptible to higher financing costs and leverage ratios while the unencumbered collateral declines. As Castellano says: "You have the combined effect of higher leverage and lower valuation on assets while operating in sectors vulnerable to weak general economic conditions and consumer sentiment." He adds: "There aren't many options other than to fix operations. And sometimes that would require true restructuring."

Vyvyan Tenorio writes about private equity for The Deal magazine.