What Is SOFR?
The Secured Overnight Financing Rate is calculated from actual transactions in the US Treasury repurchase agreement market, where banks and investors borrow cash overnight against Treasury securities. The Federal Reserve Bank of New York has published it every business day since April 2018, drawing on a transaction base that regularly exceeds a trillion dollars per day.
SOFR was selected by the Alternative Reference Rates Committee, a group convened by US regulators, as the replacement for US dollar LIBOR after the older benchmark was discredited by manipulation. Because SOFR is derived from observable trades rather than bank estimates, it is far harder to manipulate and better reflects real funding conditions.
How SOFR Works in Loans and Derivatives
The headline rate is a volume-weighted median of overnight repo transactions, so it captures where the bulk of the market actually cleared. Since most loans need a forward-looking rate for an interest period, CME Group publishes Term SOFR for one, three, six, and twelve months, derived from SOFR futures pricing. Derivatives markets more commonly use compounded averages of the daily rate calculated in arrears.
A leveraged loan today might be quoted at Term SOFR plus 350 basis points. Because SOFR is secured and nearly risk-free while LIBOR embedded bank credit risk, contracts that transitioned from LIBOR added a credit spread adjustment, roughly 26 basis points for the three-month tenor under the standard ISDA fallback methodology.
Why It Matters
SOFR is now the pricing backbone of US credit markets. Leveraged loans funding buyouts, revolving credit facilities, floating-rate notes, and hundreds of trillions of dollars of interest rate derivatives all reference it, so anyone modeling a company's interest expense or an LBO's debt schedule works from the SOFR curve.
The rate also behaves differently from its predecessor in a crisis. LIBOR spiked when banks distrusted each other, automatically raising borrowing costs at the worst moment, whereas SOFR tracks the Treasury repo market and stays anchored to Fed policy. That distinction, and occasional quarter-end repo volatility, comes up regularly in markets interviews and on trading desks.
