Loan Life Coverage Ratio (LLCR) should be used by Workout teams to assess the viability of a given amount of debt and consequently to evaluate the risk profile and the related costs. Unlike Debt Service Coverage Ratio (DSCR) which captures just a single point in time, LLCR allows for several time periods more suitable for understanding liquidity available for loans of medium to long time horizons. Thus, given its long-term nature, this ratio should be used for project finance and other multi-year loans, where long term viability needs to be assessed.
The LLCR is a financial ratio used to estimate the solvency of a firm, or the ability of a borrowing company to repay an outstanding loan. LLCR is calculated by dividing the net present value (NPV) of the money available for debt repayment by the amount of outstanding debt.
The Formula for the computation is as follows:
Present value of total available cash flow (ACF) during the loan life period (including interest and principal) + cash reserve available to repay the debt (the debt reserve)
Where, CFt= cash - flows available for debt service at year t
t = the time period (year)
s = the number of years expected to pay the debt back
i = the weighted average cost of capital (WACC) expressed as an interest rate
In this calculation, the weighted average cost of debt is the discount rate for the NPV calculation and the project "cash flows" are more specifically the cash flows available for debt service. The loan life coverage ratio is a measure of the number of times over the cash flows of a project can repay an outstanding debt over the life of a loan. The higher the ratio, the less potential risk there is for the bank.
