Why quote over Prime vs SOFR/Treasury?

Based on previous WSO threads, here's what you need to know:

Rationale for Quoting Prime vs SOFR/Treasury

1. Prime Rate:

   • Definition: The Prime Rate is the interest rate that commercial banks charge their most creditworthy customers.
   • Usage: Often used by regional banks for quoting senior debt.
   • Flexibility: Prime can be used for both fixed-rate and floating-rate loans. When used for floating-rate loans, the rate adjusts as the Prime Rate changes.

2. SOFR (Secured Overnight Financing Rate):

   • Definition: SOFR is based on actual transactions and reflects the cost of borrowing cash overnight collateralized by Treasury securities.
   • Accuracy: Provides a more accurate reflection of supply and demand forces in the market compared to LIBOR.
   • Transition: With the end of LIBOR, SOFR is becoming a more common benchmark for loans.

3. Treasuries:

   • Definition: Treasury rates are the interest rates on U.S. government debt securities.
   • Stability: Often used for fixed-rate loans due to their stability and predictability.

Pros and Cons for Lender and Borrower

Prime Rate

• Pros for Lender:
  • Flexibility: Easier to adjust rates in response to market conditions.
  • Simplicity: Well-understood and widely accepted benchmark.

• Cons for Lender:

  • Volatility: Can be more volatile than other benchmarks like SOFR or Treasuries.

• Pros for Borrower:

  • Transparency: Borrowers are often familiar with the Prime Rate.
  • Potential for Lower Rates: In a low-interest environment, Prime-based loans can be cheaper.
• Cons for Borrower:
  • Uncertainty: Rates can increase if the Prime Rate rises.

SOFR

• Pros for Lender:
  • Accuracy: Reflects actual market transactions, providing a more accurate benchmark.
  • Stability: Less susceptible to manipulation compared to LIBOR.

• Cons for Lender:

  • Transition Costs: Costs associated with transitioning from LIBOR to SOFR.

• Pros for Borrower:

  • Fairness: More accurate reflection of market conditions.
  • Predictability: Less volatile than Prime in some cases.
• Cons for Borrower:
  • Complexity: May be less familiar to some borrowers.

Treasuries

• Pros for Lender:
  • Stability: Provides a stable and predictable benchmark for fixed-rate loans.

• Cons for Lender:

  • Lower Yields: Typically lower yields compared to Prime or SOFR-based loans.

• Pros for Borrower:

  • Predictability: Fixed rates provide certainty in loan payments.
• Cons for Borrower:
  • Potential for Higher Rates: In a rising interest rate environment, fixed rates can be higher than floating rates.

Example from WSO Threads

• Regional Banks Quoting Prime: Some regional banks quote loans using Prime plus or minus a certain number of basis points (e.g., Prime ± 100bps). This approach can be simpler for both the bank and the borrower, especially if they are more familiar with the Prime Rate.

For more detailed discussions, you might want to explore specific threads on Wall Street Oasis related to loan terms and benchmarks.

Sources: https://www.wallstreetoasis.com/forum/investment-banking/how-to-prepare-for-restructuring-technical-questions?customgpt=1, Pick Your Poison | The Daily Peel | 10/6/21, Loan Terms, Q&A: Non-Target School to Portfolio Manager at a Top Hedge Fund – 6 Years Out of Undergrad, Why do floating rate loans have more forgiving prepayment penalties? Understanding the mechanics behind securitization...