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updated on 29 November 2022
QuestionWhat’s debt refinancing and why do businesses use it?
In the past few years, the markets have seen all-time lowest interest rates, economic downturns, a pandemic, lockdowns and most recently, the Ukraine-Russia war and the high inflation rates that came with it. But, through thick and thin, rain or shine, companies have continued to seek solutions in one particular corporate finance strategy to manage their debts – ‘debt refinancing’. Debt refinancing is used as a tool to benefit from the favourable terms in good times and to weather, with some cushion, the bad times in the economy.
In very brief terms, ‘debt refinancing’ is an exercise of taking out a new loan to repay and replace an existing debt. You can think of it as a periodic house-cleaning of corporate debts or airing a company’s dusted financing agreements to bring them to fresh terms compatible with the market terms and meeting the company’s needs. And we, lawyers, have been busy helping them implement their corporate finance strategy and achieve refreshed terms for their debt obligations. For example, when the markets were running on low interest rates last year, we helped companies to replace their existing loans with new loans ‘locking-in’ such low interest rates and the markets terms that had become increasingly borrower-friendly over time in the days of a booming economy. To give an example closer to everyone’s homes and hearts, consider mortgages; comparing the interest rates for people who took out a mortgage before the inflation rates started rising – say, before last summer – with the current mortgage rates on offer highlights the economy’s volatile state. Those who were lucky enough to ‘lock-in’ their mortgage on low-interest terms are now breathing a sigh of relief. It’s the same for those companies. Those that did their homework on time and proactively sought to bring their loans in line with lower-interest terms now have more cushion to weather the current rates.
But, clearly, in these past few years, it’s not been all sunshine and roses for businesses. When covid hit, it meant that most businesses had to keep a watchful eye on their financings as they faced liquidity constraints due to lockdowns. Take the entertainment industry, for example. Many companies in the sector ended up with underscoring loans following halted or suspended productions due to health concerns. For some other industries, the impact wasn’t as severe but almost all businesses shared the same sentiment – that those were times to be mindful of potential risks of tripping over their obligations in a loan agreement which could then create a domino effect. And for us, those were the times we helped our clients understand their options to bring their loan arrangements into arrangements on more patient terms. For example, for some companies, this meant consolidating their existing loans to talk to a smaller number of lenders when they had to negotiate a new term, or taking ‘holidays’ from their obligations to maintain certain financial ratios to have some breathing room, or extending the term of their loan agreements to remove uncertainty about availability of capital.
These days, we’re all trying to navigate through the impacts of the recent economic policies, the Ukraine-Russia war, and energy and supply shortages in our daily lives. And the companies are, again, going through their corporate finance strategies and deciding on the best strategy to keep their businesses operating on solid grounds. Factors they might be considering include whether to:
But there’s one thing to keep in mind – a company doesn’t need to be in dire financial conditions to consider refinancing. A debt refinancing doesn’t necessarily mean that a company is facing a significant economic downturn or is under pressure. Debt refinancing can be used as a periodic exercise to manage a company’s financings. It can be the right strategy for a company to take advantage of the market trends on sunny days or to proactively address any potential, or actual, financial problems while they’re small snowballs before they start to roll down a cliff.
Inci Aydogdu is an associate in the banking and finance team at Weil, Gotshal & Manges (London) LLP.