The Coupon Spread Increase: An Early Warning

Posted by David Diggins on Aug 21, 2018 2:06:02 PM

A quarter over quarter coupon spread increase can be an early warning sign for investors and restructuring advisors that the issuer may be facing financial troubles.

What do we mean by “coupon spread increase”? First, the coupon is simply the annual interest payment paid by the issuer relative to the loan or bond's face or par value. Coupon spreads compare the interest rate differential between two loans or bonds. Say the coupon rate is 5% in the first quarter of the year, and then changes to 7% the next quarter. This would cause a coupon spread increase between it and the coupon of a comparable loan or bond. [source]

An increased coupon spread from one quarter to another is an indicator that something happened – it does not mean there is imminent risk of default. If a company does not meet its obligation to its lenders, it may be required to take some sort of action to make good on its promises of repayment or otherwise remain in good faith. One such action could be an increase of the coupon payment.

Perhaps a stipulation of the loan was that the company was to expand to 500 new locations within a certain time period, and failed to deliver on that promise. Does that mean the company is in danger of defaulting on this loan? Maybe not, but it does show that the company’s financial situation was not what everyone had predicted.

There are many signs that a fixed-income security is in distress: markdowns, and credit rating downgrades just to name a few. Using coupon spread increases as an indicator of larger problems may give turnaround and restructuring experts a head start in their prospecting efforts. Get a leg up on your competition by looking for the first indicators of looming financial trouble. Start now, by downloading our list of recent BDC loan coupon spread increases.

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Topics: Loans, BDC, Distressed Debt, Restructuring, download

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