In this blog, we review the concept of loan refinancing, using a real-world example of a public corporate action by Centum, which restructured a Sh3.1 billion dual-currency loan to mitigate exchange rate risks. This move, announced on September 27, 2024, is a good example of how companies can strategically refinance their loans to improve financial stability. You can read more about Centum’s refinancing action here.

Refinancing a loan is replacing an existing loan with a new one, usually with better terms. This financial maneuver is common for individuals and businesses as they seek to adjust loan conditions, often to secure lower interest rates, reduce currency risk, or improve cash flow. When done correctly, refinancing can provide significant financial relief and offer more control over debt management.

One notable case of refinancing is Centum’s recent move to restructure a Sh3.1 billion dual-currency loan, converting it into a shilling-denominated facility to mitigate exchange rate risks. This serves as a practical example of why and when a company might consider refinancing as a valuable financial tool.

Why Refinancing is Done

The primary reason for refinancing is to secure better loan terms. This could involve reducing interest rates, extending the loan term to lower monthly repayments, or switching from variable to fixed interest rates for predictability. In Centum’s case, the company sought to protect itself from exchange rate volatility by converting a loan that was subject to fluctuating foreign exchange rates into a more stable, shilling-based loan.

For businesses with international exposure, currency risks can eat into profits, especially when foreign-denominated debt becomes more expensive due to unfavourable exchange rates. By refinancing into local currency, Centum took a strategic step to safeguard its financial position.

When Should a Company Consider Refinancing?

A company should consider refinancing when current market conditions present an opportunity for better loan terms. For example, when interest rates drop significantly, companies with older, high-interest loans can refinance at a lower rate to reduce costs. Additionally, when a firm’s debt is denominated in a foreign currency that poses a substantial exchange rate risk—as was the case with Centum—it makes sense to convert the loan to a local currency.

Another opportune moment for refinancing is when a company’s credit rating improves. A stronger credit profile can open doors to more favourable terms that weren’t available when the original loan was taken out.

How is Refinancing Done?

The process of refinancing involves several steps. First, the company assesses the existing loan terms and compares them with potential new options. After identifying the new loan terms that meet the company’s objectives, it negotiates with lenders to either modify the current loan or take on a new loan to pay off the old one.

Centum’s approach in this regard involved restructuring its loan, which likely required negotiating with the lender to change the currency denomination from foreign to local. This type of refinancing not only protects against currency risk but may also involve reviewing other loan terms such as the interest rate and repayment period.

What Makes for a Successful Refinancing Deal?

A successful refinancing deal typically hinges on timing and a clear understanding of the company’s financial goals. It’s crucial to seize refinancing opportunities when market conditions favour the borrower—whether through lower interest rates or advantageous currency positions. Additionally, thorough due diligence is essential. Companies need to analyze how the new loan structure will impact their cash flow, balance sheet, and overall financial health.

In Centum’s case, success was measured by reducing exposure to currency fluctuations that could have a direct impact on its financial performance. By shifting to a shilling-denominated loan, Centum locked in predictability, which is a key success factor for businesses operating in volatile economic environments.

Pitfalls to Watch Out for When Refinancing

Refinancing, while beneficial, is not without its risks. One major pitfall is the cost associated with the process, which can include penalties for early loan repayment, processing fees, and legal costs. If these costs outweigh the savings from better loan terms, refinancing could prove counterproductive.

Additionally, companies must carefully assess market conditions before making any moves. Refinancing into a different currency, for example, may not always shield a business from risk. If interest rates rise, the company could find itself in a less favourable financial position than before. Companies should also ensure that new loan terms don’t create unmanageable long-term obligations, such as balloon payments or restrictive covenants.

Centum’s restructuring of its loan demonstrates careful consideration of these factors. The firm mitigated the exchange rate risk, but likely also weighed the associated costs of switching loans and decided that the long-term benefits outweighed the short-term costs.

Conclusion

Loan refinancing is a powerful financial tool that can help companies optimize their debt, manage risk, and improve financial stability. Centum’s strategic decision to switch from a dual-currency loan to a shilling-based loan is a textbook example of using refinancing to reduce exposure to external risks, in this case, volatile exchange rates. For any business considering refinancing, the key is to thoroughly assess the current loan structure, potential market conditions, and the broader financial implications to ensure that refinancing brings the desired benefits.