A SOFR floor is a rate put the lender holds, and pricing it on the forward curve alone says it is worthless when it is not.
A SOFR floor pays the lender the gap between the floor and SOFR whenever SOFR falls below it, so its value is the present value of that payoff weighted across rate scenarios. On an illustrative $100 million five-year loan at S+575, a 1.00 per cent floor is worth $250,310, or 0.25 points, about 6.5 basis points a year, even though it pays nothing on the forward curve. A 3.00 per cent floor on the same loan is worth 45.9 basis points a year.
Worked in full in The Private Credit Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Floors were close to standard in direct lending when base rates sat near zero, and they remain a negotiated term now that rates are higher. Borrowers often concede them as costless because "SOFR will never get there". Lenders sometimes accept a lower floor in exchange for a few basis points of spread. Both sides need the same calculation: what is the floor worth as running spread?
| Input | Value |
|---|---|
| Loan amount, bullet | $100,000,000 |
| Spread over SOFR | 5.75% |
| Life assumed for valuation | 5 years |
| Discount rate | 9.50% |
| Annuity factor, 5 years at 9.50% | 3.8397 |
| Scenario | Probability | Y1 | Y2 | Y3 | Y4 | Y5 |
|---|---|---|---|---|---|---|
| Forward curve | 60% | 3.75% | 3.40% | 3.25% | 3.25% | 3.25% |
| Gradual easing | 25% | 3.25% | 2.50% | 2.25% | 2.25% | 2.25% |
| Crisis cuts | 15% | 2.00% | 0.50% | 0.25% | 0.25% | 0.75% |
Three scenarios are the simplest honest version of a rate distribution. A desk pricing floors for a book of loans would use an interest rate model with volatility; the logic is the same and the scenario version shows where the value comes from.
Floor payofft = max(0, floor − SOFRt) × balance
Value = Σ probabilitys × Σt payoffs,t ÷ (1 + discount rate)t
Running equivalent (bp a year) = value ÷ (balance × annuity factor)
In Excel, per scenario: =SUMPRODUCT((Floor>SOFR_Path)*(Floor-SOFR_Path)*Loan/(1+Disc)^Years), then weight by probability.
Take the 1.00 per cent floor. On the forward curve and the easing path, SOFR never falls below 1.00 per cent, so the payoff is zero. On the crisis path it pays in four of five years:
| Year | SOFR | Coupon without floor | Coupon with floor | Floor payoff, $ |
|---|---|---|---|---|
| 1 | 2.00% | 7.75% | 7.75% | 0 |
| 2 | 0.50% | 6.25% | 6.75% | 500,000 |
| 3 | 0.25% | 6.00% | 6.75% | 750,000 |
| 4 | 0.25% | 6.00% | 6.75% | 750,000 |
| 5 | 0.75% | 6.50% | 6.75% | 250,000 |
| Total | 2,250,000 |
| Floor | Forward | Easing | Crisis | Expected PV | Points | bp a year |
|---|---|---|---|---|---|---|
| 0.75% | 0 | 0 | 937,117 | 140,568 | 0.14 | 3.7 |
| 1.00% | 0 | 0 | 1,668,734 | 250,310 | 0.25 | 6.5 |
| 2.00% | 0 | 0 | 4,595,200 | 689,280 | 0.69 | 18.0 |
| 3.00% | 0 | 1,986,347 | 8,434,909 | 1,761,823 | 1.76 | 45.9 |
The value is convex in the strike. Moving the floor from 1.00 to 2.00 per cent nearly triples it; from 2.00 to 3.00 per cent, where the easing path starts to pay, multiplies it again by 2.6. A borrower asked to accept a floor near the current rate is giving away something closer to half a point of spread than a technicality.
| Crisis probability | Expected PV, $ | bp a year |
|---|---|---|
| 5% | 83,437 | 2.2 |
| 10% | 166,873 | 4.3 |
| 15% | 250,310 | 6.5 |
| 25% | 417,183 | 10.9 |
For a low floor the whole answer rests on the tail: the value is linear in the probability you put on a return to near-zero rates. That is a judgement, and it should be written down as one rather than buried in a spread negotiation.
For a lender comparing two term sheets, the conversion is the useful part. A borrower offering S+575 with a 1.00 per cent floor and a rival offering S+580 with a 0.75 per cent floor are, on these assumptions, within a couple of basis points of each other, because the difference in floors is worth 2.9 basis points a year against a 5 basis point difference in spread, which leaves the rival about two basis points ahead. Run the same arithmetic across a portfolio and the floors become a line in the fund's expected yield rather than a footnote in each credit agreement.
The common mistake is to value the floor on the forward curve. Every floor in the table, even the 3.00 per cent one, is worth exactly zero on that path, because the forward curve is a single expected path and a floor is an option that pays only away from it. The second mistake runs the other way: counting the full crisis value of 43.5 basis points a year as if the crisis were certain. A third is to forget that the loan may not be outstanding when the floor pays; in a low-rate world spreads often tighten and borrowers refinance, so the realised value of a floor depends on the same call protection that governs prepayment.
Price a floor as a rate put: payoff by scenario, discounted, probability-weighted, and converted to running spread with the same annuity factor used to turn OID into basis points. On these illustrative assumptions a 1.00 per cent floor is worth 6.5 basis points a year and a 3.00 per cent floor 45.9. The free workbooks for this book carry the lender's model and the fund bridge in which those basis points end up.
A minimum for the base rate used to set the coupon. If SOFR falls below the floor, the loan pays the floor plus the spread. On a loan at S+575 with a 1.00 per cent floor, a year with SOFR at 0.25 per cent pays 6.75 per cent instead of 6.00 per cent, 750,000 more on $100M.
Because rates can fall, and the floor only pays in the scenarios where they do. With SOFR projected above 3 per cent, a 1.00 per cent floor pays nothing on the forward curve. Give an illustrative 15 per cent probability to a crisis path that takes SOFR to 0.25 per cent and it is worth $250,310 on $100M, about 6.5 basis points a year.
Divide its present value by the loan amount and by the annuity factor of the loan's life at the discount rate. Here $250,310 over $100M is 0.25 points; divided by a five-year annuity factor of 3.8397 at 9.50 per cent, it is 6.5 basis points a year, the same conversion used for OID.
This article is one calculation from The Private Credit Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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