Moodys Warns: The "Last Line of Defense" for Junk Loans is Failing, Protective Covenants Exist in Name Only

Fierce competition is dismantling the last protective barrier of the Junk Loan market. As lenders compete to provide financing for M&A transactions, maintenance covenant terms continue to loosen, and credit risk exposure is quietly expanding.

According to Moodys, among a sample of over a hundred Leveraged Loans executed between 2024 and 2025, nearly half of the transactions with maintenance covenants for a Revolving Loan Facility set the leverage trigger threshold at over 8x EBITDA, with 26% exceeding 9x and 11% as high as 10x or more. By contrast, thresholds in pre-pandemic samples (2019-2020) generally ranged between 4x and 7.35x. This means borrowers can accumulate significant leverage without defaulting, making lender protection mechanisms effectively useless.

Moodys analysts warn that once such high leverage thresholds are breached, investors will likely be facing the borrower's "final curtain call"—by then, the company's financial condition may have severely deteriorated, and lenders will find it difficult to recover losses in a timely manner.

Thresholds Rise Significantly, Protection Mechanisms Become Hollow

Maintenance covenants are most common in a Revolving Loan Facility, and their core function is to allow lenders to intervene when borrowers show early signs of stress and to restrict excessive leveraging. However, the Moodys analyst team led by Derek Gluckman pointed out that these functions are being progressively weakened.

In addition to leverage thresholds, the trigger conditions for "springing covenants" have also been significantly relaxed. A springing covenant refers to financial protection terms that "spring" into effect only when the amount of the Revolving Loan Facility drawn by the borrower exceeds a certain percentage on a testing date. The market currently generally sets this trigger ratio at 40%, higher than the levels in the 2019-2020 sample. This means that borrowers can draw down the Revolving Loan Facility more heavily without undergoing financial testing or triggering protective terms.

From a historical perspective, "pro-rata" loans with maintenance covenants (including Class A term loans and Revolving Loan Facility) originally possessed a certain protective advantage compared to the vast majority of Class B term loans that have adopted "weak covenant" structures. However, as the covenant standards for pro-rata loans continue to weaken, the Moodys report notes that this "already limited" advantage is further shrinking, and the protective barrier for investors is narrowing.

Private Credit Competition Intensifies, Loose Covenants Become the Norm

Competition in the private credit market is even more aggressive, further dragging down overall market standards. Moodys analysts observed in the private credit sector that thresholds for maintenance covenants in weak covenant deals have reached as high as 15x EBITDA, with springing covenant trigger ratios set at 50%. The Moodys report stated: "This competition will continue to drive the broader syndicated loan market toward more relaxed maintenance covenant controls."

From the perspective of transaction types, deals with double-digit leverage thresholds in the Moodys sample are mainly concentrated in two categories: leveraged buyout financing and dividend recapitalization transactions. This means that as the leveraged buyout market accelerates its recovery, loose leverage terms will further become market practice, lowering creditor protection standards.

Moodys stated in the report: "We expect that once market risk appetite recovers and the leveraged buyout market (LBO transactions) fully rebounds, transactions adopting such loose covenant structures will become more common." For investor protection, which is already at historic lows, this means that risks may further accumulate.