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Avoiding circular references when modelling debt service reserve accounts (DSRA) with sculpted principal repayments

I generally don’t post the many questions that I respond to directly from readers; however, this will provide some useful insight into something that causes so many model builders, auditors and managers sleepless nights. There is no rocket science (sorry!) just a healthy dose of experience and practicality.

Dear Nick,

First of all let me start this mail, by complimenting your wonderful website, both the Navigator & your contributions on Fimodo.

It is a great reference tool, also there is nothing new for me, since I am in this industry, for quite some time, but you present some great tutorials, that are very useful for beginner analyst, and provide a great education for them.

It is a great reference tool, also there is nothing new for me, since I am in this industry, for quite some time, but you present some great tutorials, that are very useful for beginner analyst, and provide a great education for them.

I would be really interested to hear your opinion.

Kind Regards,

Ziv Sade, CFO, EdelTech

My solution to the DSRA with sculpted repayment question

Dear Ziv,

Thank you for the compliments on the websites. We have taken time to ensure that they provide useful information relating to project finance and financial modelling.

We aim to model closely to the term sheet, which outlines the seniority of the debt service reserve account (DSRA). In the absence of a term sheet, we will model so that the DSRA is subordinated to debt service, regardless of whether or not the debt repayments are sculpted. There are a few reasons for doing this. I will explain using the DSCR sculpted repayments as an example.

The DSRA is to be used if there is not enough cash flow available for debt service (CFADS) for debt repayments. This is the main function of the DSRA and although we try to ensure that the DSRA target is met at all periods, it is not a strict requirement (varies according to the term sheet). Also, it will not be fully funded if it needs to release for debt service. Therefore, the priority of the cash flows is to pay for debt service rather than the DSRA. When debt repayments are sized on CFADS (cash flow used for DSRA), the debt repayments will be lower than if they were to be sized on CFADS. To ensure that the DSCR correctly reflects the debt paying capacity of the project, you need to ensure that the DSCR is calculated on (CFADS – cash used for DSRA)/debt service. If, instead, you then use CFADS/debt service then your DSCR will be overstated as you are not measuring against the debt paying capacity of the project. The repayment sculpting exercise will be applying a false buffer if the debt service is sized after the DSRA obligations are met. From experience, the majority of DSRA are subordinated to debt service, but every deal has the chance to be different so always check.

I hope this helps explain the approach to modelling a DSRA when there are sculpted payments.

Regards and good luck with your projects!

Other resources available for understanding the DSRA and sculpting:

Tutorial on DSRA modelling, including a PDF

Blog posting on avoiding circulars with the DSRA

Tutorial on Sculpting without VBA to avoid circular references