A private loan's price is not a single number. It is a bundle of terms: a floating interest rate, a minimum on that rate, an upfront discount, fees, and rules about early repayment. Each piece shifts money between the borrower and the lender.
If you work in fund accounting, you will book these items. If you work in investor relations or on the LP side, you will see them in portfolio reports. If you are on a deal team, you will negotiate them. This lesson explains each piece in turn. Lesson 3.3 then puts them together into a single yield.
Base rate plus spread
Most private loans pay a floating rate: the interest rate resets regularly, usually every one or three months, in line with market rates. The rate has two parts.
The base rate. For US dollar loans this is SOFR, the Secured Overnight Financing Rate. SOFR is based on overnight borrowing secured by US Treasury securities. It replaced USD LIBOR, which stopped being published in its standard form in 2023. Loans usually use Term SOFR, a forward-looking version quoted for periods such as one or three months.
The spread (also called the margin). This is the fixed extra the lender charges for taking credit risk on this particular borrower. Spreads are quoted in basis points (bps). One basis point is 0.01%, so 100 bps = 1.00%.
Interest rate = base rate + spread
For example, a $50 million loan to Northfield Components prices at SOFR + 550 bps. If SOFR is 4.00%:
| Item | Rate |
|---|---|
| SOFR | 4.00% |
| Spread (550 bps) | 5.50% |
| Interest rate | 9.50% |
Annual interest is $50 million × 9.50% = $4.75 million, usually paid quarterly. (Real calculations use day counts and interest periods; PC303 covers these.)
Because the rate floats, the lender's income rises when rates rise and falls when they fall. The borrower carries the interest rate risk. The spread is what really reflects the borrower's credit risk, which is why deal teams usually talk about pricing in terms of spread.
Rate floors
A floor sets a minimum for the base rate. If a loan has a 1.00% SOFR floor and SOFR drops to 0.60%, interest is calculated as if SOFR were 1.00%.
| SOFR | Floor | Base rate used | + Spread (550 bps) | Interest rate |
|---|---|---|---|---|
| 4.00% | 1.00% | 4.00% | 5.50% | 9.50% |
| 1.50% | 1.00% | 1.50% | 5.50% | 7.00% |
| 0.60% | 1.00% | 1.00% | 5.50% | 6.50% |
The floor only matters ("binds") when SOFR is below it. It protects the lender's income when rates are very low, as they were for much of the 2010s. Note that the floor applies to the base rate, not the total rate, and it is never added on top of SOFR.
Original issue discount and upfront fees
Lenders also earn money at the start of a loan.
Original issue discount (OID) means the lender funds less than the face amount of the loan, but the borrower must repay the full face amount. Loan prices are quoted per 100 of face value. A loan "issued at 98" means the lender pays out $98 for every $100 the borrower owes. The 2-point difference is 2 points of OID. One point is 1% of face value.
On Northfield's $50 million loan issued at 98:
| Item | Amount |
|---|---|
| Face amount (borrower owes) | $50.0 million |
| Price | 98 |
| Cash funded by lender | $49.0 million |
| OID (2 points) | $1.0 million |
Upfront fees (also called closing fees or arrangement fees) do the same job in a different form. The lender funds the full $50 million and the borrower pays a 2% fee, $1 million, at closing. For the lender, 2 points of OID and a 2% upfront fee are roughly the same economics. Which form is used often depends on market convention, tax and accounting.
Why charge upfront at all? It rewards the lender for the work of arranging the deal. It also raises the lender's return without raising the ongoing interest rate the borrower has to pay in cash. In the accounts, OID and fees are usually recognized as income gradually over the life of the loan rather than all at once (PC303 covers this).
Call protection
The borrower usually has the right to repay the loan early, or prepay. Lenders don't always welcome this. If the company does well, it may refinance at a lower spread, and the lender loses the income it expected. Call protection makes early repayment costly, especially in the first years.
Two common forms:
- Non-call period: the loan cannot be repaid at all for a set time, such as the first year.
- Prepayment premium: the borrower may repay, but must pay extra. A "102/101" schedule means repaying in year one costs 102% of the amount repaid (a 2% premium), repaying in year two costs 101% (1%), and after that there is no premium (100%, known as "par").
| Repaid in | Price | Premium on $50 million |
|---|---|---|
| Year 1 | 102 | $1.0 million |
| Year 2 | 101 | $0.5 million |
| Year 3 onward | 100 | None |
Early repayment also speeds up the lender's OID: the discount is earned over a shorter time. Lesson 3.3 shows how both effects raise the lender's yield.
PIK interest
PIK stands for payment in kind. Instead of paying interest in cash, the borrower adds it to the loan balance. The lender receives it later, when the loan is repaid. Because the next period's interest is charged on the bigger balance, PIK interest compounds.
A $10 million loan paying 10% PIK, compounding annually:
| End of year | Interest added | Loan balance |
|---|---|---|
| 0 (start) | $10.00 million | |
| 1 | $1.00 million | $11.00 million |
| 2 | $1.10 million | $12.10 million |
| 3 | $1.21 million | $13.31 million |
PIK helps borrowers that need to keep cash in the business, such as fast-growing companies. It is common in mezzanine debt. The trade-off for the lender is risk: the lender gets no cash until the end, and the amount owed keeps growing.
Variations include:
- Split coupon: part of the interest is paid in cash and part is PIK.
- PIK toggle: the borrower may choose, period by period, to pay in cash or in kind, often at a higher rate if it chooses PIK.
Lenders and investors watch PIK closely. A loan that was agreed as all-cash but later switches to PIK can be an early sign that the borrower is short of cash.
Fees on undrawn money
Some facilities are commitments rather than cash handed over on day one:
- A revolver can be drawn and repaid as the company needs.
- A delayed-draw term loan (DDTL) can be drawn later, often to fund acquisitions.
The lender must keep this money available, so it charges a fee on the undrawn part, called a commitment fee or unused fee (on a DDTL it is sometimes called a ticking fee). The fee is a percentage of the undrawn amount, well below the full interest rate. Once money is drawn, it pays the normal rate of base rate plus spread.
Key terms
- Floating rate: an interest rate that resets regularly in line with a base rate.
- SOFR: the Secured Overnight Financing Rate, the standard base rate for US dollar loans since USD LIBOR ended.
- Spread (margin): the fixed amount added to the base rate to pay for credit risk.
- Basis point (bp): 0.01%; 100 bps = 1%.
- Floor: a minimum level for the base rate.
- Original issue discount (OID): the gap between a loan's face amount and the lower amount the lender actually funds.
- Point: 1% of a loan's face value.
- Upfront (closing) fee: a fee paid by the borrower to the lender at closing.
- Call protection: terms that restrict or add a cost to early repayment.
- Prepayment premium: an extra amount, as a percentage of the amount repaid, due on early repayment.
- PIK (payment in kind): interest added to the loan balance instead of paid in cash.
- PIK toggle: an option for the borrower to pay interest in cash or in kind.
- Commitment (unused) fee: a fee on the undrawn part of a revolver or delayed-draw term loan.
Key takeaways
- A floating-rate loan pays base rate (SOFR) plus a spread; the spread reflects credit risk.
- A floor sets a minimum base rate and only matters when SOFR falls below it.
- OID and upfront fees give the lender extra return at the start, spread over the loan's life.
- Call protection, such as a 102/101 premium schedule, compensates lenders for early repayment.
- PIK interest saves the borrower cash but compounds the debt and adds risk for the lender.
This lesson is for educational purposes only and is not investment advice.