DSCR - it can’t be any simpler - but it could be smarter.

By Nick Crawley on May 21 2009

A big part of my professional life has been spent calculated a very simple ratio, the Debt Service Cover Ratio (the “DSCR”) and I don’t think it could get much easier! Assuming that you are happy calculating this ratio and you understand its importance in the project finance world then how about we step it up a gear? Due to my mathematical grounding before switching to the dark side of the world of finance I am probably biased when I say so much more can be done with this ratio rather than just

plotting the profile over time
calculating the minimum (and - stop the press! - the date it occurs on….)
calculating the average

Any ideas how to leverage the DSCR calculations?

Well for example, I think that the Standard Deviation, or at least Variance would be really useful - and they are so easily calculated! Or what about a performing a weighted average rather than the arithmetic average? Weighted by what? Who knows - lets think about that! The beauty of project finance and its modelling is that each project is different and requires different analytical approaches, in many instances turning the analytical dial round a couple of notches would be really powerful and it can be done in Excel without confusing the matter with Monte Carlo simulation.

Here are just a few suggestions that sprang to mind to help us be just being a bit more advanced, but importantly without increasing complexity, what if we were to calculate:

a count of the number of instances the DSCR drops below any given hurdle (such as Equity Lock Up)
a frequency count for the DSCR population falling into different ranges
the overall Standard Deviation or Variance (for the entire population)
a running average (the average of all data up to period i)
a running standard deviation and using this data as error bars on the DSCR profile
the minimum LookForward DSCR at the date of the minimum DSCR

The last bullet point above translates to what is the most stressed period we can expect when we have passed the date of the overall minimum - that’s a mindbender - but pretty interesting!

“If it aint broke don’t fix it!”

The traditional system seems to work well so far (or does it?! the GFC was primarily driven by not analysing debt risk properly…..) but there are a few thoughts about seeing if there are any other simple steps which you could take to add a little more colour and depth into your next model without increasing the complexity.