What it means
Project finance is the funding of a single large project, such as a toll road, solar farm or power plant, using loans that are repaid from that project's own cash flows. Because there is no wider business to fall back on, lenders watch the project's cash flow closely.
The LLCR gives them a single number that sums up whether the loan looks safe over its whole remaining term. The numerator is the net present value of cash flow available for debt service, often abbreviated CFADS, over the remaining life of the loan.
CFADS is the cash left after operating costs, taxes and capital spending but before paying interest and principal. Present value means each future amount is discounted back to today at the loan's interest rate, because a dollar received later is worth less than one received now.
The denominator is the debt outstanding at the measurement date, sometimes less any cash held in reserve accounts. Dividing one by the other shows how many times the project's future cash covers the debt.
Lenders set minimum LLCR levels in the loan agreement, and breaching them can trigger restrictions on dividends or even a default. LLCR differs from the debt service coverage ratio (DSCR), which looks at one period at a time, such as a single year.
LLCR looks at the whole remaining loan life, so it can smooth out a bad year but also hide a weak one. A related measure, the project life coverage ratio (PLCR), extends the cash flows beyond the loan's maturity.
Because LLCR depends on forecasts, small changes in assumptions such as prices, volumes or discount rates move it noticeably. Lenders therefore test it under downside cases, for example with revenue 10% lower than the base forecast.
In practice
Real-world examples.
Example
A wind farm company is refinancing its debt and the lender asks for an LLCR above 1.30x. The model shows 1.45x in the base case and 1.28x if wind speeds are 8% lower than forecast. The company agrees to build a larger cash reserve to give the lender comfort.
Example
A toll road operator faces lower traffic after nearby roadworks. Its LLCR falls from 1.35x to 1.12x, close to the loan covenant (a condition in the loan agreement) floor of 1.10x. The company stops paying dividends until the ratio recovers.
Example
An infrastructure investor evaluates a hospital project financed by availability payments from a public authority. The stable payments produce an LLCR of 1.15x, which the lender accepts because the revenue is highly predictable.
Formula
Calculation
LLCR = Net present value of CFADS over the loan life / Debt outstanding
A project has a loan with $50,000,000 outstanding and three years left. The loan interest rate is 10%, which is used as the discount rate. Forecast CFADS is $22,000,000 in year 1, $24,200,000 in year 2 and $26,620,000 in year 3. Present values are $22,000,000 / 1.10 = $20,000,000, then $24,200,000 / 1.21 = $20,000,000, then $26,620,000 / 1.331 = $20,000,000. The total present value is $60,000,000, so LLCR = $60,000,000 / $50,000,000 = 1.20x. The project's expected cash covers the debt with a 20% cushion.Case study
Seen in the real world.
Sunrise Valley Solar is an illustrative, fictional solar project that borrowed $80,000,000 to build a plant. At financial close, its model showed an LLCR of 1.40x, comfortably above the lender's minimum of 1.20x.
In year four, a power purchase contract was repriced and inverter repairs cost more than planned. Updated forecasts showed the present value of future CFADS falling from $90,000,000 to $72,000,000 against debt of $64,000,000, giving an LLCR of 1.125x.
Because 1.125x was below the 1.20x lock-up level (a trigger that stops cash being paid out to shareholders), distributions were frozen. The sponsors injected a small amount of equity and renegotiated the maintenance contract, and within two quarters the ratio climbed back above the threshold.
Watch out
Common mistakes.
- Using the wrong discount rate, which can make an ordinary project look safer or riskier than it is.
- Treating LLCR as a guarantee, when it is only as reliable as the forecast behind it.
- Confusing LLCR with DSCR and assuming that a healthy LLCR means every individual year is safe.
Questions
People also ask.
What is a good LLCR?
It depends on the sector and the certainty of cash flows, but lenders often look for something between 1.2x and 1.5x, with lower levels for very predictable projects.
What happens if the LLCR falls below the covenant level?
The loan agreement usually restricts dividends first, then may require remedies such as extra equity, and in serious cases allows the lender to demand repayment.
Is a higher LLCR always better?
A higher ratio means more safety for lenders, but a very high one can mean the project is under-borrowed and equity holders are not using debt efficiently.
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