I am interested in project finance and have seen some question statements like "a bank has agreed to lend at X% leverage to fund capex and other construction costs and financing is converted to a term loan with a DSCR of [some amount]". I haven't found any resources that go through a problem like this from start to finish, or at least a clear explanation, and would appreciate if someone could walk through how to approach this and/or provide any resources to this end.
The extent of debt sizing knowledge I have is the very basics - I can calculate debt service using DSCR and CFADS.
Thank you very much!
Hey, happy to help you in PM
These are two constraints on debt quantum - 1) LTC and 2) CFADS and debt sizing DSCR. Usually you use the lesser debt quantum of the two. When you include LTC as a constraint, it can be a bit trickier since you have to calculate all costs (construction and financing), and calculating financing costs is inherently circular. But the idea is fairly straightforward.
Would you be able to provide a high level walkthrough of the LTC method? From my (likely incorrect) understanding:
1) at the construction stage, your loan principal is (leverage% * construction costs) and this is your debt capacity. using this loan money, you need to pay off interest expenses so each period, you subtract the relevant interest expense from the relevant loan amount remaining.
2) for the operation stage, your debt capacity is the same amount of principal as in the construction stage. because you now have some revenue coming in, you can calculate CFADS. so you can calculate your minimum and average DSCR?
Where does the circularity come in?
As you size the debt during the construction stage, the financing costs will change slightly, I.E. Construction costs of $2B and assuming 80% LTC, that means $1.6B of debt. Now you have to factor in financing costs. Interest during construction, up front fees, structuring fees, underwriting fees, and commitment fees will all be circular. Assuming financing costs for $1.6B is $100MM, now you have total costs of $2.1B and with 80% LTC, your debt quantum is $1,680MM, but now debt moved up by $80MM, so financing costs (Interest during construction, up front fees, structuring fees, underwriting fees, and commitment fees) will all increase. This process is repeated until you zero in on a debt quantum.
Incredibly helpful, thank you!
Is my understanding of the operations side correct? tying in the construction vs operations side?
Hard to say. Your understanding could be correct, but I'll clarify. Operations period/tab is meant to show what the debt amortization, interest, CFADS, and debt service should look like during operations. So you use the active debt quantum (lesser of LTC vs CFADS vs LTV, etc) and then the sculpted amortization profile (% amortization for a specific period) and calculate the DSCR (CFADS / Debt Service). A lot of times, you'll also see a revenue build down to CFADS.
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