Legal Definitions - refunding

Refunding refers to the process of replacing an existing financial obligation, such as a bond or a loan, with a new one. This is typically done to secure more favorable terms, such as lower interest rates, an extended maturity period, or different covenant conditions, thereby reducing the cost of debt or improving financial flexibility.

Here are some examples illustrating refunding:

• Corporate Bond Refunding: A major technology company had issued corporate bonds five years ago with an interest rate of 6.5%. With current market interest rates significantly lower, the company decides to issue new bonds at a 3.8% interest rate. The proceeds from the sale of these new bonds are then used to pay off and retire the older, higher-interest 6.5% bonds. This action is a refunding because the company replaced its existing debt with new debt to take advantage of lower borrowing costs.

• Municipal Bond Refunding: A city government had previously issued municipal bonds to finance the construction of a new public library, carrying a 5% interest rate over 20 years. Ten years into the bond's term, the city's financial advisors note that prevailing interest rates for municipal debt have dropped to 2.5%. The city council approves issuing new municipal bonds at this lower rate. The funds generated from the new bond issuance are then used to redeem the outstanding 5% library bonds. This is an example of refunding, as the city replaced its existing debt to achieve substantial savings for taxpayers over the remaining life of the debt.

• Institutional Loan Refunding: A large university took out a substantial loan from a consortium of banks to fund a new research facility. The original loan had a variable interest rate that was tied to a benchmark, which was projected to increase significantly in the coming years. To mitigate this risk and secure more predictable payments, the university negotiates a new, fixed-rate loan with a different financial institution. The proceeds from this new fixed-rate loan are then used to pay off the original variable-rate loan in its entirety. This constitutes refunding because the university replaced its existing debt with a new one to secure more stable and potentially lower long-term financing costs.