10. Lenders' Concerns on PPP Funding
Banks play a crucial role in PPP arrangements. In a PPP, the private partner is highly incentivised to deliver the project on time and within the budget. In case the private partner fails to complete the project on time, it will need to request the banks to allow delayed repayment of debt, as revenues would be delayed. In case of cost overruns, the private partner would need to ask the bank to increase the loan. In such cases, the banks may impose penalties on these companies leading to a lower return on investment for the shareholder.
The amount of debt which could be raised by a project company is primarily determined by its ability to service its debt services from future cash flows with reasonable comfort. The lenders generally estimate this ability based on a set of ratios that are calculated on a periodic basis over the life of a project.
| Interpreting Debt Service Coverage Ratio Debt service refers to the principal and interest payments on all debt. The debt-service coverage ratio (DSCR) is the ratio of free cash flow to debt service. It indicates the capability of the project company (SPV/ private partner) to service debt through the margins in cash flow. DSCR = Net Operating Income/Total Debt Service DSCR must ideally be more than 1 DSCR > 1 means, the project is generating enough income to pay its debt obligations DSCR < 1 means that the project company has negative cash flows DSCR = 0.95 means there is only enough net operating income to cover 95 per cent of the annual debt payments In certain cases where DSCR is less than 1 for any year, the lenders ask the project company to maintain a Debt Service Reserve Account (DSRA) year on year to safeguard its debt service obligations. A financial model is not sustainable if the DSCR in any year of operations is less than 1.
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| Key Ratios that interest Lenders 1. Average Debt-Service Coverage Ratio • The ratio is defined as: • Average Cash Available for Debt Service (CADS)/Average Debt Service • This estimates the average cash available over the agreement period of the project against the average debt service requirement over the period. 2. Annual Debt Service Coverage ratio (ADSCR) • The ratio is defined as: • Cash Available for Debt Service (CADS) in a year/Debt Service in that year • This ratio is calculated for each year. This ratio is the primary determinant of the maximum loan that can be raised against the project. 3. Loan Life Cover Ratio (LLCR) • The ratio is defined as: • NPV of • The ratio is a useful measure for the initial assessment of the project company's ability to service its debt over the whole term. This ratio may not be useful if significant cash flow fluctuations are expected from year to year. 4. Project Life Cover Ratio (PLCR) • The ratio is defined as: • NPV of • The ratio is used to assess the capacity of the project company to make repayments with the tail period of the PPP contract after the original maturity date of the debt. This ratio would be a useful in cases where difficulties are expected in repaying all of the debt in time. |
