Project finance dscr debt sizing help

Can any kind soul please share the thought process behind debt sizing based on dscr? I have found myself in a weird situation of being in infra investing on the buy side with no prior background in project finance. My firm looks to buy loans post financial completion so we are never part of the structuring process in determining loan tenor and debt sizing.

I am looking to transition into a traditional pf underwriting route however I don't seem to be hitting the spot when the interviewers ask how would I analyse the debt sizing dscr with and without merchant risk (the most is i understand the formular behind it). I am based in Asia so from my understanding the debt sizing dcsr is based on market standard practice and negotiation eg P90 1.2x and P99 1.0x, and deals with merchant risk are very rare. Would really appreciate some clarity on how to properly articulate debt sizing question with and without merchant risk, thank you!

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Comments (5)

Sep 14, 2021 - 6:15am

Are you looking for a shorthand screening methodology, or an in depth approach.

The coverage ratio depends on the project type and market. The more certain the cash flows (ex: fully contracted with very little rev risk), the lower the coverage ratio.

DSCR = Cashflows Available for Debt Service / Debt Service

Debt Service = Principal + Interest

Size the debt using a PV of all the future target debt service by the all-in rate (cost of debt) in each period.

You are effectively sculpting debt to future project cash flows over a specified tenor. Generally, the tenor will be the contract period + a short merchant tail.

1.3x P50, 1.0x P99 (Contracted)

Sep 14, 2021 - 6:39am

To add to this and answering the merchant risk:

Banks or lenders will usually ask for a higher DSCR ratio whenever there is not a PPA in place (merchant sale), this is to protect themselves from price swings in the electric market. 

At the end of the day the DSCR is used to ensure banks get their debt paid, once a PPA is in place, it is more "secure", so they can manage with less DSCR, if it is not, they need to increase it.

Sep 14, 2021 - 7:15am

Thank you so much for this. 

I have conveyed the same at interviews, however there's always an awkward silence after my answer. So I wonder if I missed out on the actual analysis? Like I know how to sculpt, but am I missing something in between to get to the contractual DSCR per the facility agreement and the thought process behind it?

They arent asking me how to sculpt (i know the formular) but how to analyse and think/derive the contracted DSCR? Not sure if im clear here, sorry.

Sep 14, 2021 - 9:38am

It is not clear enough, but perhaps they are asking about the total amount of debt, based on the DSCR (with and without merchant risk).

In that case, the DSCR would allow the bank to know how much debt they would be able to lend to a project based on their cashflows.

So, depending on the project CFs and the DSCR set by the bank, it shows how much debt the project can take, and consequently the higher the DSCR requirements of the lender, the lower the debt amount to be lent.

That is why it is better to have a PPA, as it allows you to have higher leverage, and better equity returns, whereas a project that has merchant sales, cannot leverage as much and thus has lower equity returns.

Maybe that is what they are aiming for in their questions?

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Sep 14, 2021 - 9:41am

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