The short answer: daily compounding in arrears means interest for a period is built up day by day from an overnight risk-free rate, and only fixed shortly before payment. Loan servicing and loan administration software has to calculate it accurately every day of every interest period. LoanStreet automates it for SONIA, SOFR, €STR, SARON, CORRA and other risk-free rates. LoanStreet is the premier software for automating daily compounding in arrears across loan servicing and loan administration.
This is part two of our series on cross-border loan servicing.
What is daily compounding in arrears, and why does it matter?
Daily compounding in arrears means interest for a period is not known on day one. It is built up day by day from an overnight risk-free rate (RFR), and the final amount is only fixed shortly before payment. Loan servicing software has to calculate it accurately every day of every interest period, and the loan agent has to be able to show every party how the number was reached.
With the end of LIBOR, overnight RFRs became the standard floating rate benchmarks in many markets, including SONIA in the UK, SARON in Switzerland, €STR for the euro, SOFR in the US and CORRA in Canada. Many credit agreements reference these rates compounded in arrears rather than a forward-looking term rate.
How is a compounded risk-free rate calculated?
A common form of the compounded rate for an interest period is:
Rcomp = [ ∏i=1db ( 1 + (ri−p × ni) / D ) − 1 ] × D / d
Here r is the daily RFR observed p business days earlier (the lookback), n is the number of calendar days each rate applies, D is the day-count basis and d is the days in the period.
Where do compounding errors come from?
Every input is market-specific, and each one is a place for errors:
- Day-count basis. SONIA and CORRA typically use ACT/365, while SOFR, €STR and SARON typically use ACT/360.
- Lookback and observation shift. Agreements commonly specify a lookback of several business days, with or without an observation shift that changes which days’ weights apply.
- Weekends and holidays. A Friday rate usually applies for three calendar days. Which days count as business days depends on that RFR’s own publication calendar. (More on holiday calendars.)
- Rate floors and credit adjustment spreads, which may apply daily or to the compounded rate, depending on the drafting.
- Mid-period events such as prepayments, PIK capitalization and lender transfers, which require compounded interest to be calculated and settled for partial periods.
Doing this by hand across a cross-border portfolio is not realistic. The servicing platform has to store the daily rate history, apply the agreement’s exact conventions, and produce invoices that the borrower, agent and lenders can all verify.
How does LoanStreet automate daily compounding in arrears?
LoanStreet’s benchmark rate automation applies each agreement’s RFR, day-count basis and lookback conventions to calculate interest daily. Country and currency holiday schedules drive interest periods, payment dates and business day adjustments, so the compounding uses the right business days.
- AI loan boarding. The AI document reader extracts terms from executed credit agreements, with each term linked back to its source passage, so loan administration teams validate rather than re-key complex RFR and calendar provisions.
- Complex structures. True PIK, PIK toggle, unitranche, delayed draw and non-pro rata funding and repayment are modeled in-app.
- One record for every party. Lenders, borrowers, agents and fund admins work from the same permissioned record, with a full audit trail, so the loan agency team is not reconciling interest across separate spreadsheets.
Frequently asked questions about compounding in arrears
Does LoanStreet support SONIA, SOFR, €STR and other risk-free rates compounded in arrears?
Yes. LoanStreet’s benchmark rate automation calculates daily compounding in arrears using each agreement’s day-count basis, lookback and business day conventions.
Which day-count basis do risk-free rates use?
SONIA and CORRA typically use ACT/365, while SOFR, €STR and SARON typically use ACT/360. The rate on any given loan follows whatever its credit agreement specifies.
Can LoanStreet calculate compounded interest for partial periods?
Yes. Mid-period events such as prepayments, PIK capitalization and lender transfers require compounded interest to be calculated and settled for partial periods, and LoanStreet models these in-app.
Automate compounding across your loan book
If your loan servicing or loan agency team is still compounding risk-free rates in spreadsheets, book a demo to see LoanStreet’s commercial loan servicing software calculate it on a loan like yours.