When would a corporation want to refinance its debt?

By Jared Coulson AAA
A:

Favorable market conditions or the strengthening of a company's credit rating may lead to the refinancing of corporate debt. The two primary factors for influencing a company to refinance are decreases in the interest rate or improvements in the company's credit quality.

When a company issues debt, usually in the form of long-term bonds, it is agreeing to pay a periodic interest charge, known as a coupon, to the bondholders. The coupon rate reflects the current market interest rates and the company's credit rating.

When interest rates drop, the company will want to refinance its debt at the new rate. Because the debt was issued during a time of higher interest rates, the company is paying a larger interest rate than what current market conditions would specify. In this case, the company may refinance by issuing new bonds at the lower coupon rate and use the proceeds to buy back the older bonds. This allows the company to capitalize on the lower interest rate, which allows it to pay a smaller interest charge.

A company's credit rating is reflected in the coupon rate on newly issued debt. A risky company will need to offer lenders a larger return, to compensate them for the additional risk of investing in that company. When a company's credit quality improves, investors won't require such a high return because that company's bonds will be a safer investment. If lenders are requiring a lower return than before, a company will probably want to refinance its older debt at the new rate.

To learn more about corporate borrowing, read When Companies Borrow Money.

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