What does the term "spread" refer to in leveraged finance?

In leveraged finance, the term "spread" specifically refers to the interest rate differential that lenders impose on the borrowed amount, which is often expressed in basis points over a benchmark rate, such as LIBOR or SOFR. This spread is critical because it accounts for the risk associated with lending to borrowers who may have higher debt levels or lower credit ratings.

When loan facilities are negotiated, lenders establish this spread to compensate for taking on the additional risk linked to leveraged companies, which typically have a higher likelihood of defaulting on their obligations. Therefore, the interest paid on the drawn amount of a loan directly reflects the spread applied, providing an essential metric for both borrowers and investors assessing the cost of debt.

Understanding the term "spread" in this context is fundamental in leveraged finance, as it influences the pricing structure of various debt instruments, the assessment of the company's leverage, and the overall return profile for lenders and investors.