BDCs

Floating-Rate Loans Explained

A floating-rate loan can raise BDC income and borrower stress at the same time. Here is the mechanism, the math and the investor test.

Drift Research Team

— 6 min read
Share
Colorful platforms rise and tilt at different heights on hydraulic columns across shifting terrain.

Last updated: September 22, 2026.

A floating-rate loan is a loan whose interest rate changes with a benchmark such as the Secured Overnight Financing Rate, or SOFR. The borrower usually pays the benchmark plus a fixed credit spread.

For a business development company, or BDC, higher rates can increase loan income while raising the borrower's interest bill. The extra income helps only if the borrower can keep paying and the BDC's own borrowing costs don't absorb it.

When rates fall, the same loan can earn less while leaving the borrower with more cash. That is why the floating-rate percentage alone cannot tell you whether a BDC's dividend is secure.

For the full balance-sheet effect, read what happens to BDCs when interest rates fall. To work through loan income, fees and losses yourself, try the Academy lesson on BDC loan returns.

Floating-rate loans in one screen

  • Formula: benchmark rate + credit spread.
  • Common benchmark: SOFR for many U.S. private-credit loans.
  • When rates rise: loan income can increase, but borrower interest expense rises too.
  • When rates fall: borrower pressure can ease, while BDC asset income may decline.
  • What a floor does: prevents the benchmark used in the formula from falling below a contractual minimum.
  • The investor test: compare loan income with borrowing costs, then check dividend coverage, cash collection and troubled loans.

The coupon is the contractual interest rate. It tells you what the borrower owes, not whether the borrower can pay.

How the loan rate is calculated

Suppose a private company borrows $10 million at:

Three-month SOFR + 5.00%, with a 1.00% SOFR floor

If SOFR is 3.85%

  • Benchmark: 3.85%
  • Credit spread: 5.00%
  • Contractual rate: 8.85%
  • Approximate annual cash interest: $885,000

If SOFR rises to 4.35%

  • Benchmark: 4.35%
  • Credit spread: 5.00%
  • Contractual rate: 9.35%
  • Approximate annual cash interest: $935,000

The lender earns about $50,000 more each year on the same $10 million principal. The borrower must find that same $50,000.

If SOFR falls to 0.50%

The 1.00% floor applies.

  • Contractual benchmark: 1.00%
  • Credit spread: 5.00%
  • Contractual rate: 6.00%
  • Approximate annual cash interest: $600,000

The floor protects part of the lender's income. It also keeps the borrower from receiving the full benefit of the lower benchmark.

These are hypothetical benchmark levels, not current market quotes. This educational example excludes fees, compounding conventions and day-count adjustments. It does not reproduce a specific loan agreement or forecast investment returns, and is not investment or tax advice.

Why BDC investors care

Many BDC portfolios contain a high proportion of floating-rate loans. When SOFR rises, those assets can reprice quickly. That can lift portfolio yield and net investment income coverage without requiring the BDC to deploy another dollar of principal.

But BDCs also borrow money. Their liabilities can include floating-rate credit facilities, fixed-rate unsecured notes and other funding arrangements. The right question is therefore not simply whether portfolio yield rose.

The right question is:

Did asset income rise faster than funding cost, without breaking borrower cash flow?

That is an asset-liability question and a credit question at once.

The September 2026 rate test

The Federal Reserve raised its target range to 3.75% to 4.00% on September 16, 2026. SOFR was 3.85% on September 18, while the 10-year Treasury yield was 5.01%.

Those figures affect different parts of the BDC machine:

Short rates reset loan income

SOFR helps determine the coupon on floating-rate assets and some floating-rate liabilities. A higher reset can increase lender income and borrower expense.

Long rates shape funding and valuation

Longer Treasury yields influence fixed-rate borrowing costs and the income yield investors demand from BDC shares. A BDC can earn more on its loans while its stock still falls because investors demand a higher return or anticipate future credit stress.

That is exactly why the September 18 market signal mattered. All ten BDC stocks in The Drift's completed-session sample fell, with an average one-day decline of 2.07%, even though higher short rates can support floating-rate asset income.

Read the full September 21 BDC Weekly for the rate, funding and market evidence.

Why a higher coupon is not automatically better

Imagine a borrower producing $2 million of annual cash flow before interest.

  • At $800,000 of annual interest, cash flow covers interest 2.5 times.
  • At $1.2 million of annual interest, coverage falls to about 1.7 times.
  • At $1.6 million, coverage falls to 1.25 times.

The lender is collecting more, but the margin for error is disappearing. A weaker quarter, lost customer or delayed project can turn an attractive coupon into a restructuring problem.

Private credit rarely jumps directly from healthy to default. Stress often appears in a sequence:

higher cash interest -> amendment -> PIK or deferred interest -> markdown -> non-accrual -> weaker NII

Payment-in-kind, or PIK, interest may preserve reported income while reducing current cash collection. A non-accrual is the later accounting signal that normal interest recognition no longer reflects collection confidence.

What happens when rates fall

Falling short-term rates reverse part of the mechanism.

  • Borrower interest expense may decline.
  • Floating-rate asset income may decline.
  • Contractual floors may slow the decline in lender income.
  • Credit stress may ease if borrowers retain more cash.
  • BDC funding costs may fall, but not always as quickly as asset yields.

Rate cuts are therefore not simply bad for BDCs. A lower coupon can be worthwhile if it improves borrower survival, supports repayment and reduces future losses.

The three-page investor test

Use this sequence when a BDC reports a high portfolio yield.

1. Understand the mechanism

How much of the portfolio is floating rate? What benchmark, spread and floor govern the loans? How quickly do assets and liabilities reset?

2. Test the dividend

Use the NII coverage ratio to determine whether reported net investment income covers distributions. Then test whether that income is recurring and collected in cash.

3. Test the credit consequence

Read What Are Non-Accruals? to see whether borrower pressure has begun removing loans from ordinary interest income. Compare non-accruals at cost and fair value with NAV, PIK and realized losses.

The three questions belong together. A high coupon without dividend quality or credit durability is not a complete investment case.

What to inspect in a BDC filing

  • Percentage of debt investments at floating rates.
  • Weighted-average portfolio yield.
  • Base-rate floors and reset timing.
  • Fixed-rate versus floating-rate borrowings.
  • Total funding cost, including unsecured notes and credit facilities.
  • Cash NII versus PIK and fee income.
  • Non-accruals at cost and fair value.
  • NAV per share and realized losses.
  • Management's sensitivity table for benchmark-rate changes.

The BDC Credit & Income Monitor brings several of these measures together across ten widely followed BDCs while preserving issuer-specific definitions.

Investor quick answers

What is a floating-rate loan?

It is a loan whose interest rate changes with a benchmark such as SOFR. The borrower usually pays the benchmark plus a fixed credit spread.

Are floating-rate loans good for BDCs?

They can support BDC income when short-term rates rise or remain elevated. The benefit can be offset by higher BDC funding costs, weaker borrower cash flow, PIK, restructurings and credit losses.

What is a SOFR floor?

It is the minimum benchmark rate used to calculate the loan coupon. If SOFR falls below the floor, the floor replaces SOFR in the formula.

Why can BDC stocks fall when rates rise?

Investors may expect more borrower stress, higher BDC funding costs or a higher required yield on the stock. Higher loan income does not eliminate those pressures.

What should I read after the floating-rate percentage?

Read the BDC's funding mix, NII coverage, PIK income, non-accruals, NAV trend and rate-sensitivity disclosure. Together they show whether the higher yield is durable.

Acronyms and terms

  • BDC: Business Development Company, a regulated investment company designed to provide capital to eligible businesses.
  • NAV: Net Asset Value, the value of a BDC's assets minus liabilities, usually reported per share.
  • NII: Net Investment Income, investment income minus operating and financing expenses.
  • PIK: Payment-in-Kind interest, interest added to principal rather than paid currently in cash.
  • SOFR: Secured Overnight Financing Rate, a benchmark based on overnight U.S. Treasury repurchase transactions.

Source notes

Disclosure

The Drift is published by Drift Research LLC for informational and educational purposes only. Nothing published by The Drift constitutes personalized investment advice, financial advice, tax advice, accounting advice, legal advice, or a recommendation to buy, sell, or hold any security. The Drift is not a registered investment adviser, broker-dealer, financial planner, or fiduciary. Data and calculations are derived from sources believed reliable and from methods described in the applicable source and calculation notes, but they may contain errors, estimates, rounding differences, or information that has become outdated. Readers should review the original sources and make their own assessment. All investments involve risk, including possible loss of principal. Past performance and hypothetical results do not guarantee future results. Consult qualified professionals before acting.

About, Methodology & Disclosures

Read more