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Sector: Ports  |  Module 3: Tools and Resources

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A1 Financial viability and ratio analysis
Financial Structure Ratios

Financial structure ratios are used to determine an appropriate structure of liabilities of the Project Enterprise (SPV), i.e., the value of its equity and quasi-equity and the value of its debts. In project financing schemes, the structure of the SPV’s liabilities directly comes from the project’s ability to service its debts. These ratios enable the appraiser to assess from the outset the amount of the debt with limited recourse that is acceptable to the lenders. Thereafter the amount of equity and quasi-equity required to finance the project can be determined.

If the shareholders’ aim in financing the project is to enable the project to benefit from a non-recourse or limited recourse loan, then this means that the repayment ability of a project may be less than the amount of external finance that the shareholders wish to obtain. In this case, the loan will be split into several tranches differentiated according to the degree of recourse the lenders want to be granted with respect to the project shareholders. This is called subordinated debt or mezzanine debt. In this case, these financial resources are considered to be the same as the partners’ current accounts, namely quasi-equity.

Debt to Equity Ratio (DER)

This ratio signifies the proportion of debt to equity in a project. Higher the ratio means that there is more debt being used to finance the project. The most commonly used ratio to ascertain the financing structure is:

Debt to Equity Ratio = Total Long Term Liabilities / (Equity + Quasi-equity)

Notes:
Long Term Liabilities include all liabilities in the nature of loans and debts that the SPV undertakes. Please note that the Long Term Liabilities do not include share capital, reserves and surplus, and current liabilities.

Higher DER implies higher risks for lenders

The optimal DER depends on the project cash flows and the perceived comfort of the lenders. For unitary payments linked to strong credit-worthy clients, the lenders may be willing to consider a high DER. On the other hand, for projects where revenues are subject to demand or market risks and are not guaranteed by a strong credit worthy agency, the DER could be in the region of 1.5:1 to 2.33:1. However there is no absolute rule for the maximum DER, it would largely depend upon the lenders comfort and robustness of the project cash flows and the comforts thereof.

Annual Debt Service Cover Ratio (ADSCR)

This ratio signifies the ability of project’s cashflows to meet the annual debt service requirements. Of course, the annual debt service requirement is based on the terms of the loan that a lender is providing to the project.

ADSCR = Available Cashflow for Debt Service / (Principal + Interest Payment)

Notes:
Higher Debt Service Coverage Ratio reduces risks for lenders.

This ratio is calculated each year and therefore provides a continuous view of the project’s ability to service its debt.

It also enables the debt repayment profile to be changed if the values obtained reveal too high a disparity during the finance cycle.

The minimum ADSCR should ideally be above 1.3 times in all years of the loan period. An indication of the strength of different DSCR levels is shown below.

Strength DSCR assessment
Very Strong Very strong ability to pay interest and principal with Minimum DSCRs above 2x and remaining above 1.5x during periods of project stress (i.e. in sensitivity analysis).
Strong Strong ability to pay interest and principal with Minimum DSCRs above 1.5x throughout life of project and remaining above 1.3x during periods of project stress (i.e. in sensitivity analysis).
Modest Modest ability to pay interest and principal with minimum DSCRs above 1.3x throughout life of project and remaining above 1.1x during periods of project stress (i.e. in sensitivity analysis).
Poor Highly likely to miss scheduled debt service payments during some periods of project life with minimum DSCRs as low as 1.0x throughout life of project and falling below this if projects faces any financial stress (i.e. in sensitivity analysis).

 

Loan Life Coverage Ratio (LLCR)

This reflects the ability of the project to cover debt service over the entire period of loan. The LLCR enables an appraiser to understand that even if debt is not repaid in one period it could be recovered over the remaining life of the loan.

LLCR= NPV of Available Cashflow For Debt Service over the Debt Period / Total Debt

Notes:
The discount rate used in calculating the NPV is that of the average interest rates of the financial debts.

The period over which the NPV is calculated, is the length of the financing cycle, in other words the duration of the total loan period.

Although, technically a LLCR greater than 1 times means that the loan can be recovered. However, it is seldom that all assumptions hold good in real life. Therefore, private investors and lenders would need to keep a margin over and above. It is generally considered good to capital structure a project which will enable a LLCR above 1.7 times. However, there is no single rule for an optimum ratio.

Project Life Coverage Ratio (PLCR)

This reflects the ability of the project to cover debt service over the entire duration of project. The PLCR enables an appraiser to understand that even if debt is not repaid by the time the loan agreement expires then subsequent cash flows will be used to pay it off.

PLCR= NPV of Available Cashflow For Debt Service over the Project Period ÷  Total Debt

Notes:
The discount rate used in calculating the NPV is that of the average interest rates of the financial debts.

The period over which the NPV is calculated, is the entire life of the project, in other words the duration of the total project period.

Although, technically a PLCR greater than 1 times means that the loan can be recovered. However, it is seldom that all assumptions hold good in real life. Therefore, private investors and lenders would need to keep a margin over and above. It is generally considered good to capital structure a project which will enable a PLCR above 1.7 times. However, there is no single rule for an optimum ratio.

 
   
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