Case 084Debt capacity and loan structuringCore

Size the maximum debt for a port under three limits: 5.0x leverage, 1.35x debt service cover over 12 years at 9%, and 60% loan to value. Which one binds?

The situation

Rethwik Ports runs a container terminal with EBITDA of Rs 300 crore. After tax and maintenance capex it generates about Rs 260 crore a year of cash available to service debt. An independent valuer puts the terminal's assets at Rs 2,200 crore.

A bank will lend on a twelve-year amortising loan at 9%, repaid in equal annual instalments, subject to three limits: debt no more than 5.0x EBITDA, cash available for debt service at least 1.35x the annual instalment, and debt no more than 60% of asset value.

Your task

What does each limit allow, which one sets the loan, and how much slack do the others leave?

Quick check

Which limit do you expect to bind?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Loan to value binds at Rs 1,320 crore. Leverage would allow Rs 1,500 crore and debt service cover about Rs 1,379 crore. At Rs 1,320 crore, leverage is 4.4x and cover 1.41x, so both have slack. The margin is thin, though: at a 10% rate the cover limit drops to Rs 1,312 crore and becomes the binding test.

Step 1What does each limit allow on its own?

Work each one out separately, then take the smallest. Leverage: 5.0 times Rs 300 crore is Rs 1,500 crore. Loan to value: 60% of Rs 2,200 crore is Rs 1,320 crore. Cover takes one more step: the most the port can pay each year is Rs 260 crore over 1.35, which is Rs 192.6 crore, and a twelve-year loan at 9% with that instalment is worth Rs 192.6 crore times the annuity factorThe present value of receiving one rupee a year for a set number of years at a given rate. At 9% for 12 years it is about 7.16. of 7.161, about Rs 1,379 crore.

The relationship
Dcover=2601.35×1−1.09−120.09=192.6×7.161≈1,379D_{\text{cover}} = \frac{260}{1.35} \times \frac{1 - 1.09^{-12}}{0.09} = 192.6 \times 7.161 \approx 1,379
260cash available for debt service each year, Rs crore
1.35required debt service cover
0.09, 12loan rate and term in years
What it says in wordsIf the port can spare Rs 192.6 crore a year for twelve years, a lender charging 9% can lend about Rs 1,379 crore against it.
Three limits, one loan: the lowest sets the size, Rs croreLeverage, 5.0x EBITDA1,500slack 180Cover, 1.35x over 12 yrs at 9%1,379slack 59Loan to value, 60%1,320loan: Rs 1,320 croredashed boxes: slack in the other two tests
Leverage allows Rs 1,500 crore, debt service cover Rs 1,379 crore and loan to value Rs 1,320 crore, so loan to value sets the loan, with Rs 59 crore of slack on cover and Rs 180 crore on leverage.
Step 2Why does the lowest limit win, and what does the slack tell you?

Each limit protects the lender against a different failure: leverage against earnings falling, cover against cash not arriving on time, loan to value against the asset being worth too little to repay the loan if it has to be sold. The loan has to pass every test, so the tightest one sets the size, and the slack on the others tells you which risk the loan is carrying least of. A family buying a flat faces the same thing: the bank checks the price, their salary and their other loans, and lends the smallest of the three answers. At Rs 1,320 crore, Rethwik's leverage is 4.4x and cover 1.41x.

Step 3How robust is that answer?

Less than it looks, because the cover limit is only Rs 59 crore above. If the rate rises from 9% to 10%, the same Rs 192.6 crore a year supports only Rs 1,312 crore, and cover becomes the binding test. Asset value also deserves a question: a port terminal has few buyers, and a valuer usually derives its value from the same cash flows, so loan to value and cover may be the same test counted twice. A lender would ask how the Rs 2,200 crore was reached before relying on it.

A one point rise in rates hands the binding role to the cover test1,2001,3001,4001,5001,6007%8%9%10%11%12%Interest rate on the loanLeverage limit 1,500Loan to value limit 1,320Cover limit9%: 1,37910%: 1,312, now binds
The leverage and loan to value limits do not depend on the interest rate, but the cover limit falls as rates rise, from Rs 1,379 crore at 9% to Rs 1,312 crore at 10%, where it drops below Rs 1,320 crore and becomes the limit that sets the loan.

Where candidates lose it

The most common slip is sizing the cover test on the whole Rs 260 crore instead of Rs 260 crore over 1.35, which overstates the limit by more than a third and makes cover look like it has the most room.

The second is reporting only the binding number. The interviewer wants the slack on the other two, because it shows which risk the structure is tight on and what would flip the answer.

What the interviewer asks next

  • What would a 10% fall in the valuation do to the loan size?
  • Would you rather have a longer tenor or a higher loan to value in this deal, and why?
  • How would a balloon repayment in year 12 change the cover limit?

Company names and figures are illustrative.