Credit Spread
Private Credit glossary · Documentation, Covenants & Terms
Definition
Yield premium above a risk-free rate compensating for default risk. Decomposed by the source into: E[y] = r_f + s_BSL + sum_i=1^4 π_i · P_i, i.e., risk-free rate + broadly-syndicated credit spread + four illiquidity/structural premia (size, illiquidity, complexity, covenant-strength). Actual middle-market spreads exceed Merton-predicted spreads because Merton omits illiquidity, the size premium, and asymmetric information.
Credit Spread in plain English
When you lend money to a shaky borrower, you want extra reward for the chance they never pay you back. The credit spread is exactly that extra reward — the slice of interest ABOVE what a super-safe loan (like lending to the U.S. government) pays. Think of two lemonade stands asking to borrow $100: the reliable one might pay you 5% interest, but the flaky one has to promise 9% to get anyone to lend — that extra 4% is the spread, your danger pay. In private credit the spread is even bigger than the raw risk of default alone, because these loans are hard to sell later, the companies are small, and the lender knows less about them than the borrower does — each of those worries adds its own little bump to the reward you demand.
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