The aim of the loan life cover ratio (“LLCR”) is to measure how easily a loan can be repaid over the full life of the loan, rather than just in one period (such as with a DSCR). It is very common in project finance, but may also be used in leveraged finance or corporate transactions. At its simplest, the formula is:
LLCR = NPV of CFADS / Debt principal outstanding
Depending on how loan repayments are scheduled, and how steady the cashflow is, the LLCR may be very close to the average DSCR.
NPV of CFADS
An NPV needs two key inputs – the cashflow over time to be discounted, and a discount rate. The cashflow is simple – it is the CFADS for every period from the time of calculation until the loan is scheduled to be repaid.
The discount rate is usually the weighted average interest rate on the debt to compare apples with apples.
This should be the total debt outstanding across all debt that needs to be repaid. If you have subordinated debt as well as senior debt, then this may or may not be included depending on the different repayment and enforcement rights available to subordinated lenders.
Shown below is a simple example of an LLCR calculation. This example is detailed in the attached workbook.
You will notice that the LLCR is increasing over time. This is because
CFADS is increasing over time; and
Total debt service is decreasing.
Play around with the CFADS escalation rate and the debt repayment profile to see what happens to the DSCR and LLCR.
If you look at the workbook, you’ll also see that the last calculated LLCR is equal to the DSCR in the final period, which if all your inputs and calculations are correct, should always be the case. Unless you’re calculating interest based on an average loan balance rather than the opening balance.
Note also that by constructing the NPV calculation in the way we have, we are calculating the LLCR at the end of every period. See our posts on NPV and IRR and NPV by first principles for further guidance on this.
Variations, errors and complications
The simple version of LLCR we’ve used does not incorporate any mention of any cash the business has in the bank, whether in standard bank accounts or a special purpose Debt Service Reserve Account (“DSRA”). This comes up for discussion in nearly every debt negotiation I’ve had for a loan that includes an LLCR covenant. The three approaches to including the DSRA balance in the calculation are:
Add it to the numerator
Subtract it from the denominator (making this a “Net debt” calculation).
Version 1 will produce the lowest LLCR and version 3 the highest LLCR. It can be argued that all of these are the correct answer. Whichever one ends up being used, the most important thing is to adjust the covenant level to take the calculation method into account, e.g. recognising that an LLCR of 1.5 using method 3 is not the same as an LLCR of 1.5 using method 1. You can’t just compare the covenant level in one transaction directly to another without taking the calculation method into consideration.
You will also need to remember to add/subtract the balance of the accounts as the final step in the calculation, rather than adding it to the CFADS line (and therefore including the balance multiple times in the one calculation).
Your debt might have some bullet/balloon tranches rather than being fully repaid during the term of the loan. If you are intending (probably out of necessity) that the bullet tranches are refinanced with new debt rather than repaid, then you need to assume an appropriate repayment period for the new debt. There is very little point calculating an LLCR over 5 years (the contractual term of the current debt) if new debt has to be raised at the end of that 5 year period – you’ll likely just end up with a result that the LLCR is less than 1, indicating the loan can’t be repaid within 5 years. But you already knew that.
One of the most important elements of NPV calculations is ensuring that you know exactly when that NPV is being calculated – the start, middle or end of a period. For this reason, I usually calculate the NPV manually rather than using the built-in NPV function so I can easily see which time period is in place. This also has the advantage of having a faster calculation speed if you are calculating the LLCR in every period rather than just once.
Lockups and cash sweeps
In short, do not model cash lockups or sweeps based on a LLCR trigger level as you will cause a circular reference.
Usually you can use a simple copy/paste macro to break a circular reference, but that usually doesn’t work for an LLCR trigger (see the Unsolvable circular references section of our post on Circular references and breaking them for further details). You can end up with a model that ends up alternating between two binary states in at least one period. A possible solution is to adjust the looping macro so that it looks at each period’s LLCR trigger in isolation and locks it in place before moving on to the next period, but this will add significant calculation time. And if you have a debt service reserve account, particularly a forward looking one, it becomes even less likely to find a stable solution.
If you do have a LLCR covenant in your loan documents, the best modelling approach is usually to calculate the LLCR but not link it to the cash lockup/sweep calculations. If the business suffers a downturn and breaches the LLCR covenant in the future, apply the cash lockup/sweep provisions as they are documented, put in a manual debt repayment, and only calculate the LLCR for periods after the date of repayment.
This is the covenant that we most often see modelled incorrectly, so take care with your calculations. If in doubt, add another line to your calculation flow rather than trying to do it all in one long formula (a piece of advice that can apply to just about any section of your financial model).