Resources / Glossary / Credit spread

Credit spread.

Aka. Spread · Margin · Credit margin

What is a credit spread?

A credit spread is the additional yield a borrower pays above a base or risk-free rate to compensate lenders for taking on credit risk. If a benchmark rate is the price of money to a riskless borrower, the spread is the premium charged for the chance that this particular borrower does not pay back in full and on time.

In a floating-rate loan, the spread is the margin quoted over the base rate — the all-in coupon is the base rate plus the spread. In a fixed-rate bond, the spread is the yield over a comparable government benchmark. Either way, the spread isolates the compensation for credit risk from the underlying cost of money.

Spreads move with both the borrower and the market. A weaker credit pays a wider spread; a stronger one pays less. And when markets turn risk-averse, spreads widen across the board even for unchanged borrowers — which is why spread levels are read as a barometer of credit conditions, not just individual risk.

How a credit spread actually works

The spread is set at pricing and then revalued continuously by the market.

Start from the base. Take the relevant base or risk-free rate as the floor — the cost of money before any credit risk.
Add the premium. Layer on the spread to reflect default risk, expected recovery, liquidity, and the instrument's structure and seniority.
Reflect the credit. Riskier borrowers and more junior positions command wider spreads; stronger credits and senior, secured positions command tighter ones.
Move with the market. Even after issuance, spreads widen and tighten in the secondary market as the borrower's risk and overall conditions change.

Frequently asked.

4 questions

01 What's the difference between the spread and the coupon?

The coupon is the total interest rate paid. The spread is the portion of that rate attributable to credit risk, sitting on top of a base or risk-free rate. On a floating-rate loan, coupon equals base rate plus spread; the spread is fixed in the contract while the base rate floats.

02 Why do credit spreads widen?

For two reasons. Specific to a borrower, a spread widens when its credit deteriorates and default looks more likely. Across the market, spreads widen when investors turn risk-averse and demand more compensation for any credit risk — even for borrowers whose own situation has not changed. Broad spread widening is a classic sign of stress in credit markets.

03 What does a credit spread compensate lenders for?

Chiefly the risk of default and the loss given default if the borrower fails to pay. It also embeds compensation for the instrument's liquidity, its seniority and security, and its term. A junior, illiquid, longer-dated claim commands a wider spread than a senior, liquid, short-dated one from the same borrower.

04 Why are credit spreads watched as a market indicator?

Because they aggregate the market's collective view of credit risk. When spreads compress, capital is plentiful and risk appetite is high; when they blow out, lenders are pulling back and financing is getting harder and dearer. That makes spread levels a real-time read on credit conditions and the cost of risk.

Related terms

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Second lien

Debt secured by a second-priority claim on the same collateral as the first lien — paid from that collateral only after the first-lien lenders are satisfied.

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Term loan B

An institutional first-lien term loan with light amortization and a bullet maturity, sold to funds and CLOs rather than held by banks.

Bcapital markets

Bridge loan

Short-term financing that funds a deal at close on the expectation it will be refinanced — the bridge <em>to</em> permanent capital, not the capital itself.

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BDC

A business development company — a regulated vehicle that lends to and invests in middle-market private companies, a major engine of private credit.

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Revolving credit facility

A committed line of credit a borrower can draw, repay, and redraw up to a limit — the flexible working-capital layer alongside term debt.

Dcapital markets

Delayed draw term loan

A committed term loan a borrower can draw in tranches over a defined window rather than all at once — pre-arranged capital for known future spending.

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