What is “Loan Life Coverage Ratio”?
Loan Life Coverage Ratio (LLCR) is a commonly used metric in Project Finance that allows lenders to gauge the ability of a project to service its debt. It provides an indication of the number of times the Debt Outstanding on a project can be repaid by its Cash Flow Available for Debt Service (CFADS) over the Loan Life. The formula for LLCR is below:
LLCR = NPV (CFADS over the Loan Life)/ Debt Outstanding
While Debt Service Coverage Ratio (DSCR) is more commonly used for sculpting debt as it is at a point in time, LLCR is a longer term measure and is typically used for downside Break-Even analysis and frequently appears as a covenant in Project Finance transactions.
Key Learning Points
- LLCR is a forward-looking metric that indicates the ability of an asset to repay debt from its available Free Cash Flows
- It is frequently used by lenders in Break-even tests and also appears as a covenant in Project Financing Agreements
- LLCR < 1.0x means that the CFADS on a discounted basis are insufficient to support the outstanding debt
- While an LLCR = 1.0x signifies that the project will be able to service debt, it does not provide lenders enough headroom in case of any downsides, they would therefore look for LLCRs of 1.25x -1.50x
Calculation of NPV of CFADS
The first step is to determine the qualifying Cash Flow Available for Debt Service (CFADS) for LLCR. To do this start from the project CFADS and the Loan Tenor. Select the CFADS for the period upto the end of the Loan Tenor and disregard any CFADS for the period after as shown in the example below as the point of LLCR is only to calculate the debt coverage within the loan life.
The next step is to calculate the Net Present Value (NPV) of the qualifying CFADS. To do this start from the last period and calculate the NPV as CFADS/(1+ Discount Rate). For all the preceding years calculate the NPV as (CFADS + NPV of the next Period)/(1+ Discount Rate). The all-in cost of debt for a particular period should be used as the discount rate for that period in this calculation.
The opening Debt Balance for the period should be used. To get to the LLCR for a particular period divide the NPV of CFADS qualifying by the Debt Balance b/f of that period.
Significance of LLCR
LLCR < 1.0x: An LLCR that is less than 1.0x means that the project’s free cash flows are insufficient to support the amount of leverage that is being modeled and it will therefore be unable to service its loan within the Loan Life.
LLCR > 1.0x: This suggests that the project cash flows are sufficient to service debt. However, to be comfortable, lenders will look for atleast 1.25x LLCR at the start of the loan life and depending upon the riskiness of the project, this could go to 2.0x – 2.5x.
In the LLCR calculation example above, you will note that the LLCR for Years 1 to 4 is more than 1 signifying the debt can be repaid within its loan life, however in Year 5 it goes down to 0.95x meaning that it does not have enough free cash after paying interest. This trend in LLCRs is typical in case the debt has not been sculpted properly. As the cash flows in the previous years are higher, it could have easily been sculpted such that more of it was repaid in the earlier years allowing the LLCR in Year 5 to be higher.