Loans with strong financial safeguards have largely disappeared from credit markets as borrowers backed by private equity are driving a surge of riskier loans that return less money in a default, according to a Moody’s Ratings report.
Lenders recovered an average of 57% on first-lien so-called cov-lite loans between 2023 and mid-2025, compared to 66% on a “small and shrinking” number of loans that include financial maintenance covenants, according to the Tuesday report.
Almost three-quarters of rated borrowers with cov-lite loans are private equity-backed, Moody’s wrote. Moody’s defines cov-lite loans as those that don’t require quarterly financial tests or those with one covenant that kicks in when the company borrows heavily on its revolving credit line.
“These covenants have traditionally served as red flag indicators when a borrower is experiencing financial stress,” the analysts wrote in the report.
But in light of inflation and higher interest rates, private equity-owned companies have been grappling with “overleveraged capital structures.” That’s led buyout firms to tap “the most flexible terms the market can bear,” according to the report.
The lack of safeguards generally allows weaker borrowers to delay or avoid bankruptcy in times of stress, according to the report.
However, this often results in a restructuring later on after a company experiences “significant deterioration” in value, according to the analysts. Weaker protections can also lead borrowers to transfer assets or increase leverage in a way that disadvantages existing lenders.
Fewer loans with strong lender protections have landed in default or distressed exchange scenarios than debt with limited safeguards. Only seven loans in Moody’s dataset of 31 resolved bankruptcies and 48 completed distressed exchange were considered “cov-heavy.”
Recoveries for both cov-lite and cov-heavy loans are down from long-term averages of 64% and 75%, respectively, according to Moody’s. The ratings firm has been tracking these metrics since the 2008 financial crisis.
There’s “little indication of improvement” for recovery rates tied to first-lien leveraged loans, Moody’s analysts wrote.
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