Beware This New Hidden Risk in Your Portfolio: Goldman Sachs Group, Inc. (GS)

Deteriorating quality
Unfortunately, more companies are starting to negotiate weaker covenants and other unfavorable attributes that aren’t as generous to bondholders. For instance, Moody’s said earlier this week that bond quality in January hit an all-time low. The report noted that many new bonds, including issues from Netflix, Inc. (NASDAQ:NFLX) and aircraft manufacturer Lear Corporation (NYSE:LEA) , lack covenants governing certain restricted payments and incurring additional debt. Overall, more than half of bonds issued in January got a rating of Ba, which tend to have weaker covenants, compared to just over a quarter on average over the past two years.

Moreover, so-called payment-in-kind bonds are starting to get more popular as well. Last year, for instance, a unit of Goldman Sachs Group, Inc. (NYSE:GS) arranged to have bonds issued to finance its buyout of TransUnion that had a payment-in-kind toggle option. These securities don’t pay cash interest, instead issuing additional bonds. Obviously, these bonds have less-demanding cash-flow requirements for issuers, but they leave bondholders with increasing exposure to an issuer even if its credit condition erodes.

Be careful out there
When you’re desperate for income, you may be willing to accept conditions you wouldn’t ordinarily take. But with the risks already involved in lower-quality bonds, accepting weak covenants or payment in kind can leave you unprotected when things go wrong. By fully understanding what’s involved, you can better assess whether the higher income is worth the risk you take.

The article Beware This New Hidden Risk in Your Portfolio originally appeared on Fool.com and is written by Dan Caplinger.

Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends Goldman Sachs and Netflix. The Motley Fool owns shares of Netflix.

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