The loan life cover ratio (LLCR) is one of the most commonly used debt metrics in project finance. Unlike period-on-period measures such as the debt service cover ratio (DSCR), it provides an analyst with a measure of the number of times the cash flow over the scheduled life of the loan can repay the outstanding debt balance.
How many times more than the senior debt liability is the projects asset base (on a discounted basis), the operational cash flows?
Interpretation of the loan life cover ratio (LLCR) – example 1
An LLCR of 2.00x means that the cash flow available for debt service (“CFADS”), on a discounted basis, is double the amount of the outstanding debt balance.
Interpretation of the loan life cover ratio (LLCR) – example 2
An LLCR of 1.00x means that the CFADS, on a discounted basis, is exactly equal to the amount of the outstanding debt balance. The movement of a key variable to achieve an LLCR of 1.00x is an important measure of the strength of the project economics, often referred to as the ‘LLCR break-even’. A typical example is analysis of a toll road where the analysis could be ‘the project achieves a break-even LLCR at 38% reduction of patronage from the base case’. In comparison the DSCR breakeven might only be 20%.
Generally the LLCR is calculated as:
LLCR = NPV [CFADS over Loan Life] / Debt Balance b/f
The discount rate used in the NPV calculation is usually the cost of debt, also known as the weighted average cost of debt.
Variations in LLCR definition
From time to time borrowers request and Lenders allow other ‘assets’ to be either included in the numerator or excluded from the denominator to reflect instances where there will be other cash deposits available to the lender in the event of default rather than just the NPV of the cash flow.
For example it is not uncommon to find the balance of the project’s cash account, or the debt service reserve account (DSRA) added to the numerator or netted from the numerator. Extreme caution needs to be applied when assessing the economics of a project where the LLCR is supported with cash account balances.
When DSRA is included, the LLCR shall then be calculated as:
LLCR = (NPV [CFADS over Loan Life] + DSRA/c Balance b/f) / Debt Balance b/f
The LLCR does not pick up weak periods as it essentially represents a discounted average. For this reason, if the project has steady cash flows with credit foncier repayment, a good rule of thumb is that the LLCR should be roughly equal to the average DSCR. The example below illustrates a project with a steady CFADS and credit foncier repayment.
Screenshot 1: Example calculation of LLCR in a financial model
Common errors and oversights made when modelling the LLCR
Algebraically the LLCR is a simple calculation; however it is also a calculation which is prone to error. Below are some of the frequently encountered mistakes:
Incorrect use of the (X)NPV function in Excel
The discount rate has not been calculated as cost of debt, which includes interest and margin
The discount rate, which is usually the ‘average cost of debt’ is overcomplicated rather than calculated simply as
= Total Interest (for all tranches)/Total Debt Balance B/f (for all tranches)
The formulas are too complicated making them hard to edit if the definition requires variation or to validate
The definition of the LLCR in the model is not clear and has not been validated against the debt term sheet
LLCR covenants are used to trigger cash sweeps, while at the same time including interest on reserve accounts/cash balances in the model resulting in a circular model
The inclusion of CFADS has not been correctly capped at the end of the loan life
CFADS has not been clearly presented in the cash waterfall and the LLCR is incorrectly referring to some other line in the waterfall
The discounting of CFADS is calculated incorrectly by confusing compound/simple interest rates
Adjustment has not been made and an annual discount rate is being applied to quarterly cash flows, or vice versa
Caution needs to be applied when adding the DSRA/c Balance B/f into the numerator. Remember that the DSRA/c Balance shall be added to the NPV (CFADS) line, and not to be discounted as in CFADS. This clause must be carefully checked in the definition of LLCR in the term sheet.
Checking the calculation of LLCR
Some good rules of thumb to check if LLCR has been calculated correctly:
For steady cash flows with a credit foncier repayment the average DSCR should be very close to the LLCR. This is a good rule of thumb to cross-check the LLCR and/or the average DSCR. This is not always the case especially in highly sculpted or exotic repayment scenarios.
If CFADS is constant throughout and a credit foncier repayment is being adopted, then the calculated LLCR should also be constant. In the shot below you can see that a constant CFADS of USD 5.7 M throughout with a credit foncier repayment mechanism gives a constant LLCR of 1.76x throughout.
Screenshot 2: Financial modelling example of constant LLCR, Loan Life Coverage Ratio