The substantial increase over the past six years of first-lien debt with little or no subordinated debt to absorb losses will lower recovery rates for senior leveraged loan investors in the next downturn, said Moody's Investors Service.

The prevalence of speculative-grade deals with covenant-lite structures over the same timeframe means that many investors now hold debt with skimpy credit protection, just as a number of factors will constrain market access for these issuers when their debt maturities peak in 2020.

"First-lien debt typically has priority claim when a loan becomes distressed, but that cushion has been eroded by the lack of subordinated debt beneath the first-lien tranche," said Christina Padgett, a Moody's Senior Vice President. "Distressed investors are unlikely to find the relief in the next downturn offered by the rounds of quantitative easing that helped fund the last round of debt financing. Recent improvements in credit quality alongside less low-rated issuance won't offset the past several years of aggressive lending."

In addition, more stringent regulatory guidelines for leveraged lending and investors' flight to higher-quality investments in response to market volatility will make it more difficult for speculative-grade issuers to tap the markets when they need to refinance, according to the report "US Leveraged Finance: First Lien with Less to Lean On: Riskier Credits, Weaker Protection Will Hasten Distress."

Moody's notes that many investors may think they are protected from losses by the presence of maintenance covenants in the revolving credit facility, but that these "springing" covenants offer little real protection because the borrower can often avoid triggering the maintenance covenant..

However, the lack of meaningful maturities through 2017 gives leveraged finance issuers time to refinance. Thus far, liquidity conditions for US speculative-grade issuers outside of the commodities sectors has been fairly stable.

Moody's expects that issuers lacking covenants will continue to consider distressed exchanges, which tend to have higher recoveries and preserve equity.

"Although recoveries are typically higher in distressed exchanges because they preserve value by avoiding bankruptcy proceedings, the decline in junior debt capital means that first-lien lenders will absorb a greater proportion of the loss."