- By VIPAL MONGA
Senior Editor WSJ
Lenders beware: junk-rated companies that borrow with few strings attached are defaulting at higher-than-average rates.
Analysts at Moody’s Investors Service MCO -0.22% studied 423 U.S. companies that borrowed money on easy terms between 2005 through the first quarter of 2014. By tracking their default rates over three-year intervals, the analysts discovered that the average default rate totaled 18.8%, compared with a 13.4% rate for all high-yield loan borrowers.
More companies are getting access to those so-called covenant-lite loans. More than half of loans in the $750 billion junk loan market lacked financial covenants, according to a recent analysis by S&P Capital IQ.
Recently, pest-control and cleaning company Servicemaster Global Holdings Inc., borrowed $1.83 billion in a covenant-lite loan. Other recent borrowers included designer fashion house Kate Spade & Co. and nut specialist Diamond Foods Inc.DMND +0.29%
Covenants are triggers that could force borrowers to shore up their financial health. Those triggers usually involve periodic tests of overall debt levels and cash flow to cover scheduled interest payments.
Moody’s study also found that the covenant-lite loans are becoming a larger part of companies’ capital structures.
“It’s a worrisome trend,” said Moody’s analyst Julia Chursin. She noted that a smaller debt cushion means that lenders will take bigger losses in a default, because there are fewer lenders behind them in the capital structure to absorb losses.
Moody’s analysts found that covenant-lite lenders recovered less: 79 cents on the dollar versus 82 cents for all lenders in their database.
The growth in riskier loans is starting to concern regulators. The Office of the Comptroller of the Currency released a report on Wednesday, which cited the growth of risky high-yielding loans with looser underwriting standards as an area of “supervisory concern.”