The issue of credit spreads is a very key one with respect to debt, debt capital markets, and the in many ways the overall market climate. First, a few basics: Nearly all debt is quoted based on a spread against an existing, usually risk free investment (this is known as the benchmark). For most debt, that benchmark can be a US Treasury issue of similar maturity, LIBOR (the London Interbank Offering Rate), or the Prime Rate. Spreads are quoted in “basis points” (or, in Wall Street slang, “bips”), which are 1/100 of a percentage point (or 100 basis points is equal to 1%). So, for example, a company called Operating Co. issues 10 year bond that is tied to the US Treasury and sold at a spread of 100 basis points above the US Treasury yield. Therefore, if the yield on the 10 year Treasury is 4.5%, then the yield on the 10 year Operating Co bond is 5.5% (4.5% + 1%) The spread becomes the numerical indicator of the credit risk of that particular offering; the greater the spread, the riskier the debt instrument (with time to maturity factored in as well).
In many cases, the credit spread can change or fluctuate depending on the terms established by the lender, or the covenants inherent in the issue. Many lenders want to guarantee that the yield on the debt they write will not change wildly if interest rates change or other market conditions arise. They want to ensure that there is a “floor” or lowest possible yield that will become locked in. Provisions and Covenants can get creative on this matter, with any number of triggers, market conditions, or other company events that could force an adjustment to a credit spread on outstanding debt-
The point made about credit spreads increasing is a direct indication that the debt marketing is “tightening”; i.e. lenders are asking for a higher return on new debt issues. This is consistent with the discussion, both on this site and the business press in general, that easy access to credit and the tremendous debt commitments that drove the LBO and PE booms are ending and lenders are requiring a much greater premium for any new debt they underwrite. With regards to the movement of the underlying benchmarks, and how that affects that debt that is tied to it, this is really 2 separate processes. The Treasury department, through its own internal methodologies, will determine what yields US Government securities should be priced and sold at, and banks and other financial institutions determine, for the debt they will potentially issue on behalf of clients, which level of risk they are willing to accept and establish those spreads accordingly