By Alison Leckie | May 14, 2026
Course Overview
This video is the Introduction video of our online Leveraged Constraints Debt Sizing Online Mini Course
Leverage is central to project finance—used to enhance returns, but also a key source of risk. For lenders, the core challenge is ensuring that projects can sustain debt under both base case and downside scenarios.
This is where leverage constraints come into play. By limiting the amount of debt a project can support, lenders protect against cash flow volatility, construction risk, and operational uncertainty.
Understanding how and why these constraints are applied is fundamental to structuring bankable deals. It underpins the logic behind debt sizing, coverage ratios, and the trade-offs between maximizing leverage and maintaining resilience.
Video
Video Transcript
Haydn: Project finance often involves the use of two different loans. The construction loan used to cover construction costs and the term loan, which we repay from cash flows. The loans are typically the same amount. When construction is substantially complete, the construction loan is paid off by the drawdown of the term loan in an event called term conversion, effectively transferring debt from one loan to the other. In that sense, we can think about both loans working as one big loan. Money is drawn down during the construction period to cover the costs incurred then repaid during the term period with the cash flows generated by project operation. Project finance is cash flow based lending. The maximum amount that we can borrow and thus draw down during construction is directly tied to the amount that we can repay during operations. In other words, term cash flows dictate the maximum amount of debt a project can raise. Let’s bring in Dylan, our lender to elaborate. Welcome Dylan.
Dylan: Thanks, Haydn. Glad to be here. To be more specific. Debt is sized as the present value of us lenders cash flows in the term period discounted at the interest rate lenders cash flows or “debt service” are project CADs divided by our required minimum DSCR. If the present value of lender cash flows is 80 million. 80 million is the total debt quantum that cash flows can repay, which means that the maximum size for the term loan and the construction loan is also 80 million. After all, the amount of project drawdowns during construction can’t exceed the amount that cash flows can repay since the term loan pays off the construction loan.
Haydn: Why don’t we use just one loan then?
Dylan: Great question. The repayment or term period and the drawdown or construction period are two separate loans due to their different risk profiles. The risk in construction is that the project costs more, takes longer to complete or operates below specifications. The risk in the term period is that cash flows fall below forecast.
Haydn: That being said, increases or decreases in construction costs could be independent of project cash flows and the amount of debt that we can raise. Our cash flows may support. Say an $80 million construction loan by construction costs maybe 90, 100 or $180 million. Equity must fund the difference, and this is where a leverage percentage comes into play
Dylan: Right! The leverage or “gearing percentage” indicates the amount of the total project construction costs that are covered by the construction loan. It’s debt divided by cost, so it’s also called loan to cost or loan to value. For instance, if project costs are a hundred million, but the cash flows in the term period only support a term loan size of 80 million, the construction loan size is also 80 million, and the leverage is 80%, leaving 20% of costs to be funded by equity. However, we lenders may include a leverage or gearing constraint as a check or as the main driver of debt size, depending on the industry and the risk to cash flows issuing a hard cap on the leverage percentage. For example, if the leverage limit is 60% with the same 100 million in costs, the maximum amount the project can borrow is 60% times 100 million or 60 million. This is less than the 80 million that the project cash flows support. Haydn, what would happen if the lender’s leverage constraint were 90% instead?
Haydn: Hmm. The lender allows the loan to theoretically go up to 90 million, but the maximum amount cash flows can repay is only 80 million, so the original 80% leverage would be preserved, right?
Dylan: Right on the actual money Haydn, if lenders include a leverage ratio limit, the maximum debt during construction is the lesser of the term loan debt size, which is the present value of cash flows and the debt under the leverage constraint, which is the costs multiplied by the constraint percentage.
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