SOFR spreads question
Hey all quick question on S/L spreads,
Let’s say you had a company w a S+ 8% interest rate for a senior secured first lien loan. Is there any Methodology someone can use to determine their risk by purely looking at the bond?
Is there a way to think about credit ratings based on variable interest rates?
The higher the risk the wider the spread. You could use it to compare the perceived risk between two companies however you wouldn't know what is causing that risk to be perceived from just the spread alone (I.e. Poor business results or capital structure)
Also doesn’t consider market dynamics. Loan priced today at S + 8 May be less risky than something priced 18 months ago at S + 6
Latter would have traded down.
Yeah. You’re both right. Need to look at it from a DM perspective not coupon.
Look at comps to see how spreads compare given relative financial position and any qualitiaitve factors you deem spread. Also look at spreads as a turn of leverage to see how return expectations are priced relative to risk.
At least for bank debt, the spread is determined by the risk level of the company in terms of default on debt. So, I would imagine the same methodology would apply for bonds in regard to the level of risk the company would default on its debt. Usually firms/banks rate the company and based on the rating they already have pricing determined based on the rating of the company. Most follow the standard moody's, S&P, etc. ratings. The higher the rating, the lower the spread.
I think your response applies in the case of new issuance, but once a bond is trading/issued it trades to what the market believes is fair from a ytm/ytw scenario. Two identical credits currently outstanding are S+4 & S+8. If the credit is identical then the S+4 credit will simply trade at a lower price. The spread over sofr is really just a way to define coupon in name, but to make determinations about quality of the underlying you would need trading price at the very least.
Did not know this, thanks for the info. Don't usually see bonds in my role but very helpful.
I’m not sure I fully understand what you’re asking.
There is a floating rate leveraged loan at sofr plus 8, and you want to purely determine “their” risk by purely looking at the underlying bond?
What risk are you interested in? The company’s credit risk? The loan’s risk of default?
Then you ask if there is a way to think about credit ratings based on interest rates.
Are you asking for something more complex than just assuming the worse a credit, the higher the rate? I mean you can compare the ytw of a debt instrument to the requisite index and see how wide the spread is.
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