What is debt refinancing?

The corporate debt refinancing process typically involves changing the terms and conditions around existing company borrowing. For example, borrowers may be able to benefit from lower interest rates, or they could reduce ongoing costs by spreading the term of the financing over a longer period.

Other potential advantages include switching from variable to fixed interest rates (or vice versa, depending on market conditions), changing currencies, as well as renegotiating the terms relating to existing debt, such as lender covenants. Refinancing may also cover the reorganization of the company’s capital structure, for example altering the balance of debt and equity.

Why would a company refinance debt?

There are several incentives to consider when refinancing.

1. Change in interest rates: if a firm’s current financing arrangements were struck at a time when rates were particularly high, refinancing can significantly reduce repayment costs.
2. Changing the term on its debt: extending the term on a firm’s debt can also have cash flow benefits, or the borrower may be looking to match debt maturities to its long-term strategic goals.
3. Improving creditworthiness: thereby allowing a firm to access additional financing in the future.
4. Taking on additional borrowing: to fund specific projects or other strategic initiatives.
   
    

What happens when a company refinances its debt?

When undergoing a refinancing process, a firm must make several important decisions. Companies have to choose whether to opt for fixed or floating interest rates and how long the borrowing period should last. The source of capital also needs to be considered: financing can be obtained from banks, through public debt markets, via private placements – or through a combination of these options.

A private placement is a way for a business to raise money from sources other than banks or public offerings. Typically, institutional investors such as insurance companies offer private placements. The debt is usually fixed rate and is typically longer term. It is also normally ‘senior debt’, which means the lenders have the highest level of priority in terms of being repaid. Senior debt can be secured against specific assets to give lenders greater certainty. This is different to junior debt, also known as subordinated debt, where lenders sit behind the senior debt and have lower priority in a firm’s capital structure. Because of the different risk profiles, senior debt tends to have lower interest rates than junior debt.