SOFR Breakage Cost Calculation in ABL and Term Loan Credit Agreements: How Funding-Loss Recovery Actually Works

Breakage cost is a small line item that becomes surprisingly consequential when the timing of a refinancing, restructuring, or prepayment is wrong. It is the amount a Term SOFR borrower is obligated to reimburse the lender group for funding losses when a loan is prepaid, converted, or otherwise terminated mid-period. In a matched-funded world it would be a mechanical calculation; in the actual world of SOFR loans it is a legal fiction anchored to a specific formula in the credit agreement, and it is calculated even where the lender has no actual funding cost to unwind. Understanding the mechanic is essential to timing any refinancing or restructuring event correctly.

This piece is a practitioner walk-through of the SOFR breakage architecture in middle-market ABL and companion term-loan credit agreements — the funding-cost fiction, the calculation formula, the standard trigger catalog, how it interacts with prepayment premiums and yield protection, and where the negotiating room is.

The funding-cost fiction and why it survives

Under the LIBOR regime that governed most syndicated lending for four decades, breakage was intuitive. A lender that made a three-month LIBOR loan was assumed to have matched-funded that loan with a corresponding three-month interbank deposit. If the borrower prepaid at day 45 of the period, the lender was left with a deposit obligation for another 45 days at the original LIBOR rate and had to redeploy the returned principal at whatever rate was then available in the market. If rates had fallen, the lender took a loss on the redeployment; breakage reimbursed that loss. The formula was standard, the calculation was mechanical, and both sides understood the economics.

Term SOFR is a different animal. It is a forward-looking rate derived from the SOFR futures market, but SOFR itself is an overnight rate reflecting Treasury repo transactions. There is no interbank deposit market for Term SOFR the way there was for LIBOR. Lenders funding Term SOFR loans typically do not have a specific matched deposit to unwind. The "funding loss" that breakage compensates is largely a fiction — a contractual construct that survived the LIBOR-to-SOFR transition rather than an actual economic loss the lender is incurring.

Nonetheless, breakage clauses survived the transition largely unchanged. The market convention preserved the LIBOR-era language and formula, adapted to reference Term SOFR instead of LIBOR. Lenders defend this on the basis that they still incur real costs when a loan is unexpectedly returned — funding-desk operational cost, redeployment friction, and the general principle that the borrower committed to a defined interest period and should compensate the lender when it breaks that commitment. Borrowers accept this because the alternative — eliminating breakage entirely — is not a market outcome available in the current syndicated lending environment.

The standard breakage formula

The mechanical formula in most middle-market credit agreements calculates breakage as follows:

Breakage = Principal Amount × (Applicable Term SOFR at loan origination − Current Term SOFR for the remaining period) × (Days Remaining in Interest Period / 360)

Read carefully, this formula has three critical characteristics.

It is asymmetric

Breakage is due only when the current rate is lower than the original rate — that is, when the lender would have to redeploy the returned principal at a lower rate. If current rates are higher than the loan's original rate, breakage is zero. The lender does not owe the borrower anything for the "profit" the lender would realize on redeployment at a higher rate. Standard breakage clauses include a "not less than zero" floor for exactly this reason.

It scales with days remaining

Breakage on a loan prepaid at day 1 of a 90-day period is roughly 30× larger than breakage on the same loan prepaid at day 87. Timing the prepayment to coincide with the end of the interest period eliminates breakage almost entirely. This is the single most important practical takeaway of the breakage architecture.

It uses a matched-fund assumption

The formula assumes the lender funded the loan with a matched deposit or reserve at the applicable Term SOFR at origination, and that the redeployment occurs at the current Term SOFR for the remaining term. Neither assumption typically reflects the actual funding stack. The formula is what it is because it survived from LIBOR; it does not need to be economically accurate to be enforceable.

Standard trigger catalog

The breakage clause typically applies to a defined list of events that end a Term SOFR interest period other than at its scheduled end date.

Prepayment during an interest period

Voluntary or mandatory prepayment of a Term SOFR loan before the end of its current interest period triggers breakage on the prepaid amount. This is the most common trigger, especially in a refinancing or M&A closing scenario where the borrower prepays outside of a natural SOFR period end.

Conversion during an interest period

Conversion of a Term SOFR loan to a Base Rate loan (or vice versa) during an interest period triggers breakage on the converted amount. This is less common but occurs in unusual situations — for example, a lender exercising Base Rate replacement rights under a yield-protection or illegality provision.

Failure to draw a requested loan

If the borrower requests a Term SOFR loan, the lenders reserve funding capacity for that loan, and the borrower then fails to draw for any reason other than the lenders' default, breakage is due on the un-drawn amount. This is a rare trigger in practice, but it is important in scenarios where a borrower requests a loan and then a condition precedent fails after the reservation period begins.

Failure to make a scheduled repayment

Where a scheduled repayment is required at the end of an interest period, failure to make that payment (before it becomes an EoD, given any grace period) can technically trigger breakage on the amount that should have been repaid, though this rarely comes up in practice because the borrower is either paying on time or is in default territory.

Assignment or transfer to a different lender

Where a loan is assigned or transferred during an interest period, the credit agreement typically preserves the interest period rather than triggering breakage. Some agreements treat certain assignments as prepayment-and-redraw events, but this is not market standard.

Interaction with prepayment premiums and yield protection

Breakage sits alongside two other lender-protection concepts in the credit agreement, and understanding the interaction matters for stack calculation.

Prepayment premium (make-whole and soft call)

Term loans often carry a prepayment premium — typically a make-whole premium in the first year or two, stepping down to a soft call (1-2% premium) in years 2-3, and then par prepayment thereafter. Breakage is separate from and additive to the prepayment premium. On a mid-period prepayment of a Term SOFR term loan in year 1, the borrower typically owes make-whole plus breakage — not one or the other.

Yield protection

Yield protection provisions (increased-cost claims, reserve requirements, illegality) are a different lender-recovery mechanism triggered by regulatory or market events, not by borrower action. They rarely interact directly with breakage.

SOFR fallback and market disruption

Where a SOFR-related market disruption or fallback event occurs, the credit agreement typically permits the lender to convert Term SOFR loans to Base Rate. Whether this conversion triggers breakage depends on the specific fallback language. Well-drafted fallback provisions carve out lender-initiated Base Rate conversions from the breakage catalog.

Where the negotiating room is

Breakage is one of the more heavily-market-standardized provisions in a credit agreement, but there is real room on several sub-issues.

The "not less than zero" floor

Every well-drafted breakage clause should include an explicit "not less than zero" floor. Absent this, an argument could theoretically be made in a rising-rate environment that the lender should reimburse the borrower for the redeployment upside. This is not a real risk in practice, but the floor should be there for clarity.

Certification requirement

The credit agreement typically requires the lender to deliver a certificate calculating the breakage cost. Borrowers should push for the certificate to include the specific inputs to the calculation — the applicable original rate, the applicable current rate, the days remaining, and the reference source for the current rate. Vague "conclusive absent manifest error" certifications with no shown calculation are worth pushing back on.

Prepayment at end of period

The credit agreement should make explicit that prepayment on the last day of an interest period incurs no breakage. This is market standard but is occasionally omitted; when it is omitted, the omission is worth flagging.

Reasonable-lender standard

Some borrowers negotiate a "reasonable lender" or "actual funding cost" standard on the breakage calculation — essentially, that the lender may claim only the amount that a reasonably-hedged lender would actually incur, not the full formula amount. This is a stretch in the middle market and is more common in higher-rated corporate credits.

Notice period for prepayment

The prepayment notice period (typically 3 business days for Term SOFR loans) matters for breakage planning. Some agreements require longer notice; shorter notice typically means less lender flexibility to unwind funding, and lenders resist notice periods below 3 business days. Ensuring the notice period is workable for the borrower's realistic closing timelines avoids a scramble at the end of a refinancing.

Partial-prepayment allocation

On a partial prepayment of a Term SOFR loan, the allocation of the payment across outstanding SOFR tranches (of different original rates and maturities) affects the aggregate breakage. Well-drafted agreements let the borrower choose the allocation to minimize breakage; less-well-drafted agreements let the agent make the allocation. Borrower choice is worth negotiating for.

Practical considerations for the closing timeline

Understanding breakage mechanics changes how a refinancing or restructuring closing should be sequenced.

Time payoffs to interest-period end

The single most impactful practical action is timing the payoff to coincide with the end of a Term SOFR period. Most middle-market ABLs use one-month interest periods; term-loan tranches often use one-month or three-month periods. On a $50M SOFR term loan at 8% versus a 4% redeployment rate, the difference between paying off on day 15 of a 30-day period versus day 30 is roughly $85,000. A two-week delay to align with the period end is virtually always worth it.

Coordinate agent notice with prepayment funding

The 3-business-day prepayment notice needs to be given before the funds are wired. Borrowers frequently arrange the payoff funding first and then discover the notice window has been missed, requiring an additional day or two of interest accrual. Building the notice period into the closing timeline is elementary but frequently overlooked.

Understand the breakage on the payoff letter

The payoff letter delivered by the agent will include a specific breakage number. This should be tested against the credit agreement formula — not just accepted. Occasional errors in breakage calculation are corrected on request; systematic errors, if any, warrant escalation.

SOFR mid-period conversions during workouts

In a workout, forbearance, or restructuring, lenders sometimes exercise the right to convert Term SOFR loans to Base Rate — typically at the ABR rate, which is often higher than the SOFR rate. This is a lever the lender group uses to increase current-period interest cost during a stressed period. Whether the conversion triggers breakage depends on the specific credit agreement; borrower-side counsel should confirm the mechanic before signing any forbearance agreement.

Where DCE fits

Don Clarke — SFNet Hall of Fame 2021, Lifetime Achievement Award, author of "Asset Based Lending Disciplines" (the first ABL textbook), and trainer of more than 5,000 professionals at GE Capital, JP Morgan Chase, Lloyds, and Barclays — has watched borrowers pay unnecessary breakage costs during refinancings and restructurings across decades. The pattern is almost always the same: the deal team focuses on the headline economics of the new facility and forgets that the payoff timing on the old facility carries a mechanical cost that could have been avoided with a two-week schedule shift. Breakage is not usually a strategically significant number in the overall economics of a refinancing, but on a large payoff it can easily be a six-figure item.

DCE advises borrowers preparing for refinancings, restructurings, and material prepayment events. We help CFOs and their counsel think through the payoff-timing decision and confirm that the breakage calculation on the payoff letter matches the credit agreement. We do not act as counsel — lending or restructuring counsel drafts the actual language and confirms enforceability — and we do not underwrite or make credit decisions. See also our practitioner deep-dives on yield protection and SOFR fallback and make-whole prepayment premiums on term-loan tranches.

ABLC (ablc.net) is DCE's sister firm serving lenders with due diligence, field examination, and training services — including yield-protection and breakage training for lender operations teams.

Educational only; not legal, tax, or investment advice. Breakage-cost mechanics and the applicable formula are specific to the credit agreement. Borrowers should engage qualified lending or restructuring counsel for any material refinancing or restructuring event.