Resources / Glossary / SOFR

SOFR.

Aka. Secured Overnight Financing Rate · Term SOFR
All terms

What is SOFR?

SOFR — the Secured Overnight Financing Rate — is the benchmark interest rate that floating-rate dollar debt prices over. It measures the cost of borrowing cash overnight collateralized by U.S. Treasury securities, computed from actual transactions in the repo market rather than from bank estimates.

It replaced USD LIBOR, which was phased out after a manipulation scandal and the thinning of the unsecured interbank lending it was supposed to reflect. Since mid-2023, essentially all new leveraged loans, many bonds, and most floating-rate derivatives reference SOFR instead of LIBOR.

The headline distinction: SOFR is secured and nearly risk-free, because it is backed by Treasury collateral. LIBOR carried bank credit risk. That difference is why loans add a small credit spread adjustment when converting legacy LIBOR documents to SOFR — to keep the all-in economics roughly unchanged.

How SOFR is used in a loan

A leveraged loan does not quote a fixed rate. It quotes a spread over a base rate, and SOFR is that base rate.

  1. Pick the base. Most loans use Term SOFR — a forward-looking rate published for 1-, 3-, and 6-month tenors — so the rate is known at the start of each interest period rather than compounded in arrears.
  2. Add the margin. The credit agreement sets a spread, e.g. SOFR + 450 basis points, that compensates the lender for the borrower's credit risk.
  3. Apply the floor. Many deals include a SOFR floor (commonly around 0.50% to 1.00%) so the base rate cannot fall below a set level, protecting lender yield in a low-rate environment.
  4. Reset each period. At each rollover the borrower picks a tenor, SOFR is observed, and the new coupon is locked for that period.

Why it matters to a sponsor

Because nearly all LBO debt floats over SOFR, a portfolio company's interest expense moves directly with the benchmark. When SOFR rises, cash interest rises, debt service coverage tightens, and free cash flow available for amortization and dividends shrinks — without any change in the business itself.

This is why sponsors hedge. Interest-rate caps or swaps fix or cap the SOFR component for some portion of the debt, converting an uncertain floating cost into a budgetable one. The hedge does not touch the credit margin or the SOFR floor; it only addresses movement in the underlying benchmark.

Frequently asked.

5 questions
01 What is the difference between SOFR and LIBOR?

LIBOR was an unsecured rate derived from banks' estimated borrowing costs and carried bank credit risk. SOFR is a secured rate computed from actual overnight Treasury repo transactions, making it nearly risk-free and far harder to manipulate. Because SOFR sits structurally below LIBOR, legacy contracts add a credit spread adjustment when they transition so the all-in cost stays roughly the same.

02 What is Term SOFR versus overnight SOFR?

Overnight SOFR is the raw daily rate. Term SOFR is a forward-looking rate published for set tenors — typically 1, 3, and 6 months — derived from SOFR futures. Loans almost always use Term SOFR because borrowers want to know their coupon at the start of an interest period rather than only after it has compounded.

03 What is a SOFR floor?

A SOFR floor is a contractual minimum applied to the base rate before the margin is added. If a loan has a 1.00% floor and SOFR falls to 0.30%, the borrower still pays as if SOFR were 1.00%. Floors protect lender yield when benchmark rates are very low and are negotiated alongside the margin.

04 Why do floating rates matter in an LBO?

Leveraged buyouts are funded largely with floating-rate debt priced over SOFR, so interest expense rises and falls with the benchmark. A jump in SOFR can erode coverage ratios and free cash flow even when revenue and EBITDA are flat, which is why sponsors often hedge a portion of the exposure with caps or swaps.

05 How is the all-in rate on a SOFR loan calculated?

Take the greater of current Term SOFR or the SOFR floor, then add the credit margin set in the credit agreement. A loan quoted at SOFR + 450 with a 1.00% floor, when SOFR is 5.00%, carries an all-in coupon of 9.50%. Tracking these inputs over the life of the loan keeps interest forecasts accurate as the benchmark moves.

Related terms

Scapital markets

Sponsor finance

Lending specifically to private-equity-owned companies to fund buyouts and their growth — a distinct, relationship-driven corner of leveraged finance.

Open
Scapital markets

Second lien

Debt secured by a second-priority claim on the same collateral as the first lien — paid from that collateral only after the first-lien lenders are satisfied.

Open
Ccapital markets

Credit spread

The extra yield a borrower pays over a risk-free or base rate to compensate lenders for credit risk — the price of the risk, not the underlying rate.

Open
Icapital markets

Incremental facility

Pre-agreed capacity in a credit agreement to raise additional debt later on the same terms — the accordion that lets a borrower add leverage without a new deal.

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Fcapital markets

First lien

Debt holding a first-priority security interest in collateral — paid first from those assets, the senior-most secured claim in the capital structure.

Open
Ecapital markets

Excess cash flow sweep

A covenant that forces a borrower to use a share of leftover free cash to <em>prepay</em> debt — automatic deleveraging.

Open
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