This page addresses how to incorporate debt fees and in particular fees on a DSRA letter of credit when you are sculpting debt repayments and structuring debt. Fees paid on debt, including fees paid on a letter of credit, may or may not be defined as part of debt service and must be incorporated in developing sculpted repayment analysis. The discussion on this webpage demonstrates how the fundamental sculpting formulas that define debt at commercial operation as the present value of debt service can be adjusted to account for the debt fees by subtracting the present value of the fees from the fundamental debt sizing formulas. If the L/C fees are included as an operating expense, there are circular reference problems, but the debt fees do not have the NPV of fee adjustment. The amount of debt fees reduces the amount of debt that can be supported by cash flow — if you have the same cash flow and more fees, then the debt size from DSCR analysis will be reduced. As the size of the DSRA is affected by the fees and the fees depend on debt, a nasty circular reference arises.

There are a couple of key files where I put the financial formulas, modelling examples and the VBA code for cases where you run into circular references. I have also made a file with some very simple examples that illustrate the formulas in cases where the interest rate is zero. You can file these file on the google drive in the Project Finance Section under exercises and then Section D for the Sculpting course. The second file is the circular reference resolution file attached to a model that deals with the DSRA as an L/C and includes provision for debt fees.

## Mechanics of Adjusting Debt Sizing for Fees with Debt Sizing from DSCR

To include the fees in the sculpting equations, you should subtract the present value of fees that are included in the defined debt service when you compute the net present value of debt. To illustrate this, assume that the interest rate is zero and there are only fees on debt (note that sometimes the fees that are included on a DSRA facility may not be included in debt service). If you pretend that the interest rate is zero and there are no fees, then the present value of the debt payment would be the sum of the repayments. If there are either interest payments or fees, less debt service can support the same amount of cash flow to meet the DSCR constraint. This is illustrated in the very simple two period example below. If there were no fees in the example, the debt would be 800 rather than 700 for the DSCR target of 1.5 — the cash flow is 600 and the allow debt service per year is then 600/1.5 = 400 which would pay off 800 of debt over two periods. But with 50 of fees, the amount of the debt service for repayment is only 350 because 50 of fees are paid in the two periods. That is why the target debt service at the bottom of the simple example is less — 350 per year. As the interest rate is zero, this represents the debt repayment and the total debt sums to 700. The 700 could be derived by first dividing the cash flow by the DSCR to arrive at 400 debt service per year or 800. Then, the PV of the fees (again at a zero interest rate) of 100 would yield total debt of 800 – 100 or 700. The thing to remember is to subtract the PV of the fees.

When computing the NPV of debt service and reduce the debt service for fees, the NPV of debt service computed without fees must be lowered for the fees. Fees reduce the amount of debt service that can be supported by cash flow. This is just the same as deducting the interest to come up with the repayment. The fees reduce the amount of debt associated with CFADS compared to a situation without fees. Because the PV of debt service uses the debt interest rate without the effective rate that accounts for fees (which would be a higher interest rate), you can deduct the PV of fees at the debt interest rate and the debt schedule will work. To make the sculpting work you should also make the repayment lower by the fees as shown below:

**DSCR = CFADS/Debt Service**

**DSCR = CFADS/(Repayment + Interest + Fees)**

**Repayment = CFADS/DSCR – Interest – Fees**

**Debt = NPV(Interest Rate, P&I – fees) = NPV(rate, Debt Service) – NPV(rate, Fees)**

**where the discount rate used in NPV is the interest rate (i.e. not adjusted for fees)**

## Theory of Debt Fees after COD on an Letter of Credit that Replaces the Funded DSRA Account

It may be useful to review general some ideas of how debt fees fit into financial analysis. The fundamental point about fees is that debt fees are just like interest from the standpoint of a lender — money is earned by the lender on the basis of the amount of debt outstanding. To evaluate the profitability of debt from the standpoint of a lender, you can compute the IRR earned. As with calculation of any IRR, the debt IRR is computed on the basis of cash flow coming out of your pocket compared to cash flow coming in. The cash flow going out is the debt draws. The cash flow coming in is the cash interest expense, plus the repayment and plus any debt fees before or after construction. The debt IRR which can also be called the all-in interest rate.

As debt fees that are paid after COD can be substituted for interest payments, it should be easy to see that debt fees should be included in debt service. This means that debt fees should be included in the denominator of the DSCR. You could even make an argument that the LLCR should be adjusted for debt fees as demonstrated in the formulas below:

**Without Fees: LLCR = NPV(CFADS)/NPV(Debt Service) = NPV(CFADS)/Debt**

**With Fees: LLCR = NPV(CFADS)/NPV(Interest + Fees + Repayment) = NPV(CFADS)/(Debt + NPV(Fees)**

## Mechanics of Sculpting with Fees when the Debt is Fixed

The bottom of the simple case below demonstrates the LLCR or the adjusted target DSCR can be adjusted. The PV of CFADS divided by the Debt plus the PV of Fees instead of just dividing the CFADS divided by the debt. As with the case above, after you have computed the adjusted LLCR to compute the target debt service, the repayment is computed by subtracting the both fees and interest from debt service.

**LLCR = PV CFADS/(Debt + PV Fees)**

**Debt Service = CFADS/LLCR**

**Repayment = Debt Service – Interest – Fees**

## Analysis of Fees in Sculpting Exercise

A simple case with zero interest rate and a five percent interest rate is illustrated in the two screen shots below. The first screen shot shows that you can just add up the required debt service, then subtract the sum of the fees and the target DSCR of 1.5 will be achieved.

The second screen shot demonstrates the case with a 10% interest rate. There is lower debt in this case because of interest being paid, but the ideas are the same (the total debt amount falls from 480 to 332.

Very often in sculpting, the debt is given and the repayments must be sculpted. When the debt is given, the fees affect the synthetic LLCR that is used to compute the debt service from the CFADS. In this case, the amount of repayment must be reduced because of the fees and the synthetic LLCR should be reduced. The sculpting analyses include calculation of the LLCR to evaluate whether the debt to capital constraint is driving the constraint. In this case the PV of CFADS is not the correct numerator for the analysis. Instead, the PV of the LC fees should be added to the denominator of the LLCR as follows:

**LLCR = PV(CFADS)/(Debt + PV of LC Fees), where**

**Debt = Project Cost x Debt to Capital**

A problem here is that the NPV of the debt depends on the fees, but the LC fees depend on the DSRA, which in turn depends on the size of the debt and the NPV. This is a clear circular reference. Note Debt Service in the above equation means debt service without fees and debt is reduced by PV of fees.

## Code with Adjustments for Debt Fees in Circular Reference Template

The code below is part of the circular reference template model. Even if you are a basic old copier and paster, the code can demonstrate the kinds of adjustments you should make in your project finance model. The first excerpt shows the adjustments you should make in sizing the debt.

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Select Case debt_sizing_option ' Define the amount of senior debt depending on the option choosen Case 1: senior_debt = senior_fixed_total Case 2: senior_debt = senior_percent_input * total_project_cost Case 3: senior_debt = pv_debt_service - pv_fees + total_non_sculpt + DSRA_pv_adjustment Case 4: senior_debt_pct = senior_percent_input * total_project_cost senior_debt_dscr = pv_debt_service_target_dscr - pv_fees + total_non_sculpt + DSRA_pv_adjustment ' Add other debt because PV debt service not includes senior_debt = WorksheetFunction.Min(senior_debt_pct, senior_debt_dscr) End Select

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The next excerpt shows how the LLCR computed for sculpting when the debt service constraint applies or multiple sculpting issues are implemented.

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'------------------------------------------------------------------------------------------------------------------------------- ' INITIAL DEBT SIZING SECTION: DETERMINE THE LLCR FOR USE IN SCULPTING WITH FIXED DEBT ' ' Determine what DSCR should be applied for sculpting ' Section for determining DSCR to use in sculpting when the debt balance is given ' The adjusted DSCR applied is used in computing the PV of debt service from CFADS '------------------------------------------------------------------------------------------------------------------------------- llcr = 0 ' This is the sculpting LLCR LLCR_denominator = senior_debt + pv_fees - pv_non_sculpt LLCR_numerator = pv_cfads Select Case DSRA_Sculpting_Option Case 1: LLCR_numerator = pv_cfads Case 2: LLCR_numerator = pv_cfads + pv_DSRA_flows Case 3: LLCR_numerator = pv_cfads + 0 LLCR_denominator = senior_debt + pv_fees - pv_non_sculpt - pv_DSRA_flows Case 4: LLCR_numerator = pv_cfads + pv_DSRA_flows ' This is like case 2 LLCR_denominator = senior_debt + pv_fees - pv_non_sculpt End Select Select Case debt_sizing_option ' Take the LLCR or DSCR from the last iteration -- in the first iteration LLCR is 1 Case 1: ' This is the fixed debt case, for sculpting you need a DSCR senior_debt = senior_debt_input If LLCR_denominator > 0.1 And LLCR_numerator > 0.1 Then llcr = LLCR_numerator / LLCR_denominator Else llcr = 1 End If DSCR_Applied = llcr Case 2: ' This is the case of debt to capital senior_debt = senior_percent_input * total_project_cost If LLCR_denominator <> 0 Then llcr = LLCR_numerator / LLCR_denominator DSCR_Applied = llcr Case 3: ' Where sculpting defines the debt senior_debt = pv_debt_service - pv_fees + total_non_sculpt DSCR_Applied = dscr_input ' If repayments are fixed, then must come up with debt size differently Case 4: ' Optimise the repayment If LLCR_denominator <> 0 Then llcr = LLCR_numerator / LLCR_denominator DSCR_Applied = WorksheetFunction.Max(llcr, dscr_input) DSCR_Applied = dscr_input End Select

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