Refinancing risk is the possibility that a borrower will not be able to replace an existing debt obligation with new debt resulting in financial losses. It is common for a business, organization or individual to require new debt to replace debt that is coming due. If new sources of debt can't be found this can result in financial losses such as a need to shutdown a profitable business. The following are a few examples of refinancing risk.
1. Short Term DebtA house builder takes on large amounts of short term debt to fund its projects. The company must regularly replace this debt with new debt. This strategy works for several years until credit markets suddenly tighten and banks become unwilling to offer new debt to the company. As a result, the builder needs to sell some of its properties at a large discount in order to quickly raise money to cover its short term debt obligations. This results in a sizable financial loss.
2. Long Term DebtAn electronics company makes a large offering of 5 year bonds. The bonds are structured with small payments in the first four years followed by large balloon payments in the last year. The company assumes that it will be able to make these balloon payments with new bond issues. When the balloon payments come due the company has a failed product launch that damages its profitability and financial condition. The company is unable to find financing to cover the balloon payments and must issue new equity at a discount to market prices. Its stock price plunges dramatically as existing shareholders are diluted by the issuance of new shares.
The risk you will not be able to refinance to repay existing debt.
A company has $2 million dollars in short term debt that they need to roll into a new loan. However, credit markets seize up due to a banking crisis and loans become difficult to find.
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