How the Credit Spread Adjustment Works on Your SOFR Loan

LIBOR was an unsecured rate, meaning it implicitly reflected some level of bank credit risk in the number itself, while SOFR is a secured, overnight, nearly risk-free rate that doesn't carry that same embedded credit component. Simply swapping SOFR in for LIBOR at the same spread would have quietly lowered every borrower's effective rate, since SOFR itself tends to run below where LIBOR sat. The credit spread adjustment is a fixed addition layered on top of SOFR specifically to make the transition roughly rate-neutral rather than an unplanned rate cut or increase for either side.

Rather than negotiating a spread adjustment loan by loan, the market largely adopted values recommended by the Alternative Reference Rates Committee, calculated from the historical spread between LIBOR and SOFR over a lookback period, with the adjustment varying by the loan's tenor, one month, three month, and so on. This is why two loans with the same nominal SOFR-plus-spread structure but different underlying tenors can end up with slightly different all-in rates once the credit spread adjustment is layered in.

For example, a treasury team reviewing two term loans, both priced at SOFR plus the same stated spread, finds that one payment is higher. The cause is usually mundane: one loan is tied to a three month tenor and the other to a one month tenor, so the adjustment differs, or one uses daily simple SOFR while the other uses a term rate. Before disputing anything, put the tenor, the adjustment value, the SOFR convention, and the stated spread for each loan side by side in one small table. If the components match the documents and the totals still don't reconcile, ask the lender for its calculation worksheet. The common mistake is comparing only the headline spread, which hides both the adjustment and the convention.

Loans handled the LIBOR transition two main ways: a hardwired approach that specified the replacement rate and spread adjustment directly in the original agreement, taking effect automatically on a set date, or an amendment approach requiring the borrower and lender to formally agree on new terms when LIBOR actually stopped being published. If your loan predates the transition and you're not sure which approach applies, pull the fallback language section of your credit agreement and confirm exactly which rate and adjustment are currently governing your payment, since the two approaches can land on different effective rates for what looks like the same underlying loan.

Confirm these points in your loan documents:

• Find out whether your agreement used a hardwired fallback that took effect automatically or an amendment you and the lender signed when LIBOR stopped being published.
• Confirm which replacement rate currently governs your payment, including whether it is term SOFR or daily simple SOFR.
• Check the credit spread adjustment applied for your loan's tenor, since one month and three month loans carry different adjustments.
• Compare your all-in rate with what the old LIBOR rate would have produced under the same market conditions.
• Raise any noticeable gap with your lender, since it may point to a calculation error or a spread that skipped the standard methodology.

Say a loan originally priced at LIBOR plus a stated spread transitions to SOFR plus the same stated spread plus the applicable credit spread adjustment for its tenor. In a rate-neutral transition, the resulting all-in rate should land close to where the LIBOR-based rate would have priced under similar market conditions, not meaningfully higher or lower. If your post-transition rate looks noticeably different from what your prior LIBOR rate would have produced under the same market conditions, that's worth raising directly with your lender, since it suggests either a calculation error or a spread that wasn't actually set using the standard adjustment methodology.

Term SOFR is a forward-looking rate set at the start of an interest period, similar in spirit to how LIBOR worked, which makes your payment for that period knowable in advance. Daily simple SOFR compounds the actual overnight rate day by day through the period, meaning your exact payment isn't fully known until the period ends. If your credit agreement uses daily simple SOFR, build your treasury forecasting around an estimate that gets refined as the period progresses, rather than assuming the payment is fixed the way a term rate would let you assume.

Some lenders offer a choice between the two conventions on the same facility, sometimes at a slightly different spread for each. If you have that choice, weigh the forecasting simplicity of a term rate against whatever pricing difference the lender is offering for daily simple SOFR, since the operational benefit of knowing your payment in advance has a real value even if it isn't the cheaper option on paper.