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Debt sizing in project finance
Debt sizing refers to the project finance model mechanics for determining how much debt can be raised to support an infrastructure project.
The amount of debt that can be raised is defined in the debt term sheet and is usually expressed by a maximum gearing (leverage) ratio (e.g. maximum of 75% debt and 25% equity) and a minimum Debt Service Coverage Ratio (DSCR) (e.g. no less than 1.4x). The model then iterates (often using a debt sizing macro) to arrive at the implied debt size.
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Introduction to Debt Sizing in Project Finance
Firstly, it’s important to set the scene. A term sheet might have something like this:
This term sheet is for a renewables deal (you can tell from the “P50 energy output”). It gives us all the information we need for debt sizing – the gearing ratio of 75%, and the min DSCR of 1.40x (applied to a P50 revenue, in this case).
Let’s go through the 75% and the 1.40x separately.
Maximum gearing ratio
Most people are familiar with this. We’re gearing the project, yes, but 75% of what? Outside of project finance, this is typically thought of as Loan To Cost (LTC).
The Cost part is the total funding amount, for example:
Project Finance Cost:
Construction costs
(+) interest during construction (IDC)
(+) financing fees (FF)
(+) other items (e.g. the DSRA initial funding amount).
Minimum DSCR
In the term sheet above, at all points throughout the debt tenor, the DSCR must be greater than 1.40x. How can we rearrange the formula to calculate the debt size out of this?
Recalling our formula from our article on DSCR:
DSCR = CFADS / (Principal + Interest Payments)
Re-arranging the terms we get:
Principal + Interest (aka Debt Service) = CFADS/DSCR.
Rearranging again and summing these cash-flows over the debt tenor we get:
Principal Payments = CFADS / DSCR – Interest Payments
Now if we sum up all the principals, then we get back to what the maximum principal repayable is. Understand that we needed to run all the CFADS forecasts to arrive at this maximum debt size.
If you think about it, the maximum principal repayable, is really what your maximum debt size is. Because unpaid debt is a big no-no.
The project finance model screenshot below shows the maximum principal repayment, and the opening balance.
Note that linking these would result in a circularity. Why? Following the chain of logic here:
For the gearing ratio debt calculation, each subsequent debt amount must take into account the construction costs & interest & fees generated off that debt, thereby increasing the funding amount, thereby increasing the debt size (to retain the 75% of funding met by debt).
Both of these calculations can be solved iteratively, and Excel has this functionality through the Iterative calculation feature. However this is not recommended at all – firstly because it will massively slow your model down – imagine instead of doing 1 calculation every time you press enter, it does 100… and secondly because the answer risks not converging (i.e. iterative process incomplete) or converging on the wrong solution. We remain in control of this by using a debt sizing macro.
