Lenders in the leveraged loan market are increasingly agreeing to looser terms that let companies load up on more debt with fewer protections.
In a report published Wednesday, Moody’s Investors Service warns that default risk is rising because of the loosening of credit pacts to allow unlimited future borrowings. About 80 percent of new loans include these incremental options that carry few conditions.
The Moody’s report is the latest warning that standards are being eroded in the market for riskier corporate credit as investors give up protections while seeking refuge from easy-money policies that have pushed yields on more than $11 trillion of debt below zero. Covenant research firm Xtract Research said last month that riskier companies are getting credit agreements that allow them to raise the amount of future cost savings to appear more creditworthy.
“Without significant investor pushback or continued regulatory focus, incremental facility structures will likely remain in their current weak state,” Enam Hoque, Moody’s vice president and senior covenant officer, said in the report. As well as increasing leverage and default risk, the looser structures also can dilute the claims of existing lenders in a bankruptcy.
The number of loans with weak incremental facility protections rose from 46 percent in 2013, according to the report. Nearly half of leveraged loans issued this year included incremental debt structures, according to Moody’s.
The structures are increasingly attracting the attention of regulators, according to Moody’s, which cited U.S. Comptroller of the Currency guidance that leverage levels above six times total debt to earnings before interest, taxes, depreciation and amortization, “raises concerns for most industries”.