Moody's warning: The "last line of defense" for junk loans is being breached, and protective covenants are virtually nonexistent.

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Intense competition is dismantling the last line of defense in the junk loan market. As lenders race to provide financing for mergers and acquisitions, maintenance covenant terms continue to loosen, and credit risk exposure is quietly expanding.

According to Moody’s Analytics, among over a hundred leveraged loan samples executed between 2024 and 2025, nearly half of the transactions with revolving loan maintenance covenants set the leverage trigger threshold at more than 8 times EBITDA; 26% exceed 9 times, and 11% reach 10 times or higher. In contrast, pre-pandemic samples (2019-2020) generally had thresholds between 4 and 7.35 times. This means borrowers can accumulate leverage significantly without defaulting, rendering lender protection mechanisms ineffective.

Moody’s analysts warn: Once such high leverage thresholds are breached, investors may already be facing the borrower’s “final curtain”—by then, corporate finances may have severely deteriorated, making losses difficult for lenders to promptly recover.

Thresholds Rise Sharply, Protection Mechanisms Become Hollow

Maintenance covenants are most common in revolving loans; their core function is to enable lenders to intervene when early signs of borrower stress appear, and to restrain excessive leverage. However, the Moody’s analyst team led by Derek Gluckman points out this function is being steadily weakened.

Besides leverage thresholds, the trigger conditions for "springing covenants" have also been significantly relaxed. A springing covenant refers to financial protection clauses that "spring into effect" only when the borrower uses a certain proportion of the revolving loan line on a testing date. Currently, this trigger ratio is commonly set at 40%, higher than the 2019-2020 sample level. This means borrowers can draw more from revolving loans without facing financial tests or triggering protection clauses.

Historically, "pro rata" loans with maintenance covenants (including term loan A and revolving loans) originally had some protective advantage over most type B term loans with "looser covenant" structures. But as pro rata loan covenant standards continue to weaken, Moody’s reports that this "already limited" advantage is further shrinking, and investor protection barriers are narrowing.

Intensified Private Debt Competition, Loose Covenants Become the Norm

The competitive dynamics of the private credit market are even more aggressive, further dragging down overall market standards. Moody’s analysts observed that in the private credit sector, the covenant threshold for weak covenant transactions in revolving credit has risen to 15 times EBITDA, with the springing covenant trigger ratio set at 50%. Moody’s report states: “This competition will continue to push the syndicated loan market in general toward looser maintenance covenant controls.”

In terms of transaction types, Moody’s sample shows double-digit leverage threshold transactions are mainly concentrated in two categories: leveraged buyout financing and dividend recapitalization transactions. This means as the leveraged buyout market accelerates its recovery, loose leverage terms will further become market practice, lowering creditor protection standards.

Moody’s states in the report: “We expect that once market risk appetite rebounds and the leveraged buyout market (LBO transactions) fully recovers, deals with such relaxed covenant structures will become even more common.” For investor protection, already at historic lows, this implies risk may further accumulate.

Risk warning and disclaimerMarkets have risks, investments need caution. This article does not constitute personal investment advice, nor does it take into account individual users’ specific investment goals, financial conditions, or needs. Users should consider whether any opinions, views, or conclusions in this article fit their specific situation. Investment based on this is at your own risk. ```