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Economy and Finance

Economy and Finance

What is Debt restructuring?

10 Sep 2023 Zinkpot 148
What is Debt restructuring?
  1. Debt restructuring is a process in which a company or an entity that is experiencing financial distress and liquidity issues refinances its existing debt obligations in order to gain more flexibility in the short term and make its debt load more manageable, entirely.
  2. Companies can achieve debt restructuring by entering into direct negotiations with creditors to reorganize the terms of their debt payments. Sometimes, debt restructuring is imposed on a company by its creditors, if it cannot make its scheduled debt payments.
  3. Some of the ways in which a company can restructure its debts are:
    • Debt for equity swap: Creditors may agree to forgo a certain amount of outstanding debt in exchange for equity in the company.
    • Bondholder haircuts: Companies with outstanding bonds can negotiate with their bondholders to offer repayment at a discounted level. This can be achieved by reducing or omitting interest or principal payments.
    • Informal debt repayment agreements: Companies that are restructuring debt can ask for lenient repayment terms, and even ask to be allowed to write off some portions of their debt. This can be done by reaching out to the creditors directly and negotiating new terms of repayment. 
  4. In other terms, there are two main types of debt restructuring: depth rescheduling, and debt forgiveness. Debt rescheduling involves changing the payment schedule, interest rate, maturity date, or currency of the debt without reducing the principal amount.
  5. Debt forgiveness involves reducing or canceling part or all of the principal amount usually in exchange for some concessions from the debtor, such as equity, assets, or policy reforms.
  6. A company that is considering debt restructuring is likely experiencing financial difficulties that cannot be easily resolved. Under such circumstances, the company faces limited options - such as restructuring of its debts or filing for bankruptcy.
  7. Restructuring existing debts is obviously preferable and more cost-effective in the long term, as opposed to filing for bankruptcy.
  8. Bankruptcy is essentially a process through which a company that is facing financial difficulty is able to defer payments to creditors through a legally enforced pause. In this case, if the company is not able to honor the terms of the repayment plan, it must liquidate itself in order to repay its creditors. The repayment terms are then decided by the court.
  9. The debt restructuring process can be complex and time-consuming, involving multiple parties, interests, and issues. 
  10. It can entail some costs and risks for the creditors, such as lower interest income, higher administrative expenses, or exposure to currency fluctuations.
  11. Furthermore, it has some negative impacts on the debtors as well like lower credit rating, higher borrowing costs, or dilution of ownership.
  12. Lastly, it can create moral hazards or adverse selection problems by encouraging the debtor to over-borrow, underperform, or buy attracting opportunistic creditors.
     

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