In this article, we will be looking at the loan life cover ratio ( LLCR ) which is a typical debt metric in project finance transactions. LLCR provides an analyst with a measure of the net present value of the cash flow during the loan’s life over the outstanding loan balance.
Let’s take a look at LLCR definition:
LLCR is a ratio of the present value of CFADS ( Cash Flow Available for the Debt Service) over the term of the loan to present value of debt service. Debt service is the sum of the interest payment and debt principal repayments.
The discount rate used in calculating the present value of CFADS and debt service is the cost of the debt.
Note that the present value of the debt service discounted at the cost of the debt is equal to the initial debt balance, therefore, in calculations, we do not have to discount the debt service.
Let’s review how LLCR is calculated.
Our timeline is a 6 months periods timeline, which is a typical timeline for project finance models at the operations stage when debt repayment happens every 6 months.
So, the first ingredient in the LLCR calculation is CFADS over the debt repayment term.
Then, we have to come up with a discount factor based on the debt’s interest rate per period. In this simple example, we used 3% periodic interest rate to calculate these discount factors.
The next step is to discount our CFADS over the debt repayment term by multiplying CFADS by the discount factor.
Then, we have to sum up all our discounted CFADS to come up with a present value of CFADS.
Next, is the present value of the debt service, which is the same as the initial loan balance at 3% discount rate.
Project’s LLCR is the net present value of CFADS divided by the initial loan balance, which is equal to 1.67 in this case.
And, finally, we have to compare the project’s LLCR to the lender’s required LLCR.
If the project’s LLCR is greater than lenders' required LLCR, then the project meets the lenders requirement.
Remember, it is up to lenders to decide how these project cover ratios such as LLCR are calculated. So, the loan term sheet will include exact project cover ratio formulas, that you as a financial modeler should use in your financial model.
Errors that you may encounter when modeling the LLCR:
- The NPV in the numerator has been calculated with the wrong timeline so the LLCR values are all on different ‘time basis’.
- Incorrect use of the (X)NPV function in Excel
- The Discount Rate, where ‘Cost of Debt’ is overcomplicated.
- The definition of the LLCR in the model is not clear and has not been validated against the debt term sheet.
- The inclusion of CFADS has not been correctly calculated and includes all of the project’s CFADS (when in fact, it has to include only those CFADS happening during the loan’s life).
- The discount rate used to calculate the CFADS is different from the cost of debt.
A good rule of thumb to check if the LLCR calculations are correct is to replace the CFADS with debt service, which shall give the LLCR of one, if it is different from one, than LLCR calculations have to be revised.
In this article, we learned about the LLCR calculation in project finance. To learn about financial modeling for project finance please enroll in one of our courses.
Learn more about LLCR by watching this short video