There are two coverage ratios, which are typically part of the loan documentation. The first is the debt service coverage ratio, which is abbreviated to DSCR, and it is pretty straightforward. All it is doing is comparing the unlevered free cash flow, which is essentially all the cash available to service debt with the payment of interest and principle in one year. And it measures the cushion you have over and above the interest and debt repayments. So for example, a bank will say, we want a minimum DSCR of let's say 1.6. And what that means is, for $1 of interest and principle payment, you need $1.60 of cashflow, giving you a headroom of 0.6.

The other coverage ratio, which is a little more complex, is the loan life coverage ratio. And this is a point in time measure. So you have to start by taking the cashflow forecast over the maturity life of the debt.

So if the debt has a maturity of, let's say seven years, you will take seven years of the cashflow forecast and then compute its present value using the cost of debt. Then you will take that present value divided by the amount of the loan. And again, if the present value of the cashflows is equal to the loan amount, then the loan life coverage ratio will be one. In other words, it'll be just covered. Now clearly most banks want it to be covered with some headroom, so you would want the loan life coverage ratio to be greater than one, maybe 1.6, maybe two times, depending on what the bank wants.

So these are the two common coverage ratios used in project finance.