The reasons why companies refinance their obligations are various – it can be the deterioration of the company’s financial situation or the desire to improve loan's conditions. However, for a refinancing transaction with a new creditor to be profitable, some aspects need to be considered.
It has its benefits
Refinancing can take place in different cases, i.e., in situations when the burden of debt becomes too heavy, or the borrower observes that better loan conditions could be obtained from another lender. It is also possible to receive loans from several lenders, but the more advantageous option is to combine these loans into one.
Inese Rendeniece, a senior associate at Law at BDO Law, explains that refinancing can always be used to get a better financing offer, as there is an opportunity to make one’s own claims, such as a lower interest rate or fewer restrictions on the borrower's commercial activity, and the potential new financier will most likely agree to them, notes the expert.
Refinancing can also be used to secure the release of collateral, i.e., property pledged to the bank, which is intended to be sold or used for commercial activity without being subject to any restrictions imposed by the bank. Refinancing can also be a solution when it is necessary to extend the term of the loan or receive additional financing, but the current creditor does not agree to it, says the expert.
Another reason for refinancing may be a situation when the borrower has loans in several different banks or several credit products (such as a loan and a credit line) in the same bank and wishes to combine them into one, adds Rendeniece.
The interviewed bank representatives say that they face several cases daily when entrepreneurs want to refinance their obligations.
"Refinancing is a common practice used by bank customers during the relevant business life cycle," describes Guntis Mincis, Head of Medium Business Services at Citadele Bank, who has observed that in about 90% of the cases refinancing of obligations is linked to the company's development plans. For example, when a major new project is being planned or additional funds are needed, and the current partner cannot fully meet the requirements, or also - the company uses the chance to see what is happening in the market and how the credit conditions can be improved.
"Of course, it should be taken into account that the current cooperation partner will always be a priority, as it is easier to receive money from the current partner from an administrative point of view, especially if the client has good cooperation," adds Mincis. The remaining 10% of refinancing cases are based on other reasons, i.e., the partners’ values do not match, so the client is looking for a new financial partner.
Refinancing is a relatively simple process for the customer – the new creditor sends a notice to the previous one and takes over the obligations. Of course, commission fees and other costs associated with the registration of mortgages should be taken into account, Mincis reminds.
Roberts Idelsons, Chairman of the Board of JSC Signet Bank, has noticed that more companies are considering bond issues as one of loan refinancing alternatives, as they have a more flexible collateral structure and the possibility to repay the loan at the end of the term. Also, bonds do not have as strict collateral requirements as bank loans, allowing the company to attract more funding. The possibility to repay the principal amount of the loan at the end of the term can be beneficial to the cash flow for a certain period, which is especially relevant during the active investment period.
"We also see that bonds are considered as an alternative by companies that have a relatively complex liability structure – different types of loans from different lenders," told Idelsons. In such cases, bonds can be used to combine several loans under one "frame", making the company's liability and collateral structure more transparent and simpler.
When assessing the company's predisposition to issue bonds, similar to the credit assessment process, the bank considers the company's ability to service and repay its debts, Idelsons says. Additionally, the credit institution assesses the overall structure of the transaction and the compliance of the company's expected funding rate with common market conditions – whether the company can raise funds from investors, and whether the company is willing to raise funds in the capital market, which is determined by various factors such as the quality of the financial statements, orderliness and transparency of the company group structure, quality of the management team. If the company meets the given requirements, the bond issue project can be carried out within 2-3 months.
What is the most efficient way to refinance?
For the refinancing deal with the new creditor to be profitable, Rendeniece recommends paying attention to these ten aspects.
1. Grace period
In most cases, the reason behind refinancing is a better interest rate which means that eventually, there are fewer costs associated with the borrowed amount. Nevertheless, the transfer to the new creditor will entail quite significant immediate costs (refinancing fee, commitment/ disbursement fee for the new loan, state duties for registration of the pledges, etc.), therefore it is recommended to ask for a grace period. For example, the borrower can be allowed to begin repayment of the principal amount (or both, the principal amount and the interest) only on the third or fourth month following disbursement of the new loan.
2. Interest on the deposit
Sometimes banks require a financial pledge in the form of a deposit as one of the loan repayment guarantees. For example, the borrower is required to deposit a particular amount of money, which is then blocked and from which the bank has the right to subtract overdue payments, if necessary. As a result, the borrower should not simply freeze these funds, but also agree that the deposit is paid interest at the bank's standard interest rates.
3. Exceptions to restrictions
Standard loan agreements always set out a number of restrictions that will apply to the borrower and/or the borrower's commercial activity, such as a restriction on borrowing or lending loans without the bank's consent, paying dividends to members, etc. It is worth mentioning, when requested, banks generally agree to exceptions to these restrictions in standard contracts. The bank may allow loans from related parties to be borrowed without a prior approval, or, for example, loans in the form of a lease, which do not exceed certain amounts in a certain time period. The payment of dividends is generally permitted provided that the financial indicators in the agreement are met.
4. Mitigation of the termination regulations
In the same way as it is possible to agree on exceptions for activities that require prior consent of the bank, it is possible to mitigate the standard termination events included in the loan agreement. For example, if the agreement provides that each and every litigation involving the borrower qualifies as a termination event, it is possible to negotiate that only an entered-into-force judgement of a certain minimum amount against the borrower entitles the bank to terminate.
5. Remedy period
It is recommended to agree on remedy periods for eliminating the circumstances that qualify as breaches of the agreement. For instance, if a borrower has not submitted the financial statements that are required under a credit agreement, there may be a variety of reasons, that's why the borrower should be given a certain number of days to remedy this default before the bank is entitled to impose a penalty or terminate the agreement.
6. Possibility of partial refinancing
If in the process of refinancing the new bank is not willing to issue a loan corresponding the total amount of the existing obligations you can agree that part of the existing loan is repaid from your (your company’s) own funds and a part is refinanced by the new loan.
7. Acceptable cooperation partners
Depending on the composition of the collateral and the type of business of the borrower, it will be necessary to involve various third parties – service providers – in the execution of the credit agreement. It is advised to agree on third party cooperation partners and service providers (insurers, valuators, lessors, suppliers etc.) acceptable to the bank already in the pre-signing stage in order to avoid encountering the bank’s bureaucracy related to obtaining the approval as well as any potential unpleasant surprises later.
8. Watch out for double penalties
Given that in the recent years there has been a growing tendency for banks to include provisions in standard contracts providing for the imposition of contractual penalties for a variety of breaches, before signing contracts drawn up by a new creditor make sure that the agreements do not provide for the bank’s right to impose a penalty for the same breach several times, for example, for both the borrower and the pledgor (if the pledgor is a different person than the borrower).
9. Subordination of existing loans
The bank will most likely want you to subordinate existing loans. It means, that if the company which is granted the loan, previously borrowed some money from its shareholder, it will not be allowed to repay the shareholder’s loan until all the obligations against the bank are settled. However, it is a normal practice to agree that interest payments on the subordinated loans are still allowed.
10. Special procedure for sale of mortgages
Enforcement of collateral or the sale of the mortgaged property is, of course, the worst-case scenario in the process of fulfilling any credit obligations. However, even in this case, it is possible to find a "silver lining of the cloud", provided that the borrower has already agreed in advance with the bank in the contract. For a certain time, the borrower may be granted the right to recommend the buyer of the pledged property, as well as negotiate a certain sequence of enforcement of the collateral. For example, the bank first has to sell the pledged real estate, and only in case the proceeds from the sale of the real estate are not sufficient, the bank can sell the fixed assets or the company OR the bank first has to sell all assets and only then it can enforce the shareholders’ guarantee.
"The recommendations above only cover some of the aspects that are important when refinancing a liability or borrowing a new loan, but I hope that this article has given you an insight into both the significant benefits of transferring to another creditor, and the fact that borrow can also have “voting rights” and there are many options for what the contracts between you and the bank may look like in the end" – adds Rendeniece.