When capital expenditure is lumpy and/or large it is common to need to consider and model a major maintenance reserve account (MMRA). This tutorial describes the function of MMRA and how to code and link it to the financial statements.
During the operational phase of a project, capital investment is required to ensure that the project is able to continue operating as planned. Examples include, the resurfacing of runway, a planned lane widening on a toll road or the major overhaul of a generation set. Just like saving up for a rainy day, the MMRA is designed to accumulate funds to ensure the funds are there when they are needed, if not a little before.
A MMRA is typically required by lenders where the maintenance cycle of the project is such that there are large maintenance costs relative to the cash flow which incurred during the operational life of the project. Lenders would be concerned in these circumstances to ensure that cash was effectively put aside equal to the estimated maintenance costs in the year in which such costs are to be incurred.
From the lenders’ perspective, this is important because if that essential maintenance is not done when scheduled it may mean that the project’s ability to repay the outstanding loan on time is impaired.
Funding of MMRA in a project finance transaction environment
The major maintenance reserve account is usually funded up to certain target balance. The target balance for the MMRA might be set at six, 12, 18, or 24 months of future major maintenance capex. It may even be a fixed amount.
Similar to debt service reserve account (DSRA), the funding method for the establishment of the MMRA is usually stated in the term sheet which could be one of the following:
Funded in full on the last day of construction
Partially funded on the last day of construction, then built up from the project’s cash flow
Completely built up from the project’s cash flow
In terms of positioning in the cash flow waterfall, the cash available to fund MMRA is usually ranked after operational cash flow but takes precedence over debt service payment.
Modelling MMRA in a project finance model
The following points relate to the example used in the accompanied workbook:
The project has completed the construction
Product price for revenue calculation is cyclical from year to year
Product price dips by 20 percent in operational year two
There is a large major maintenance capex in year two
The project needs to maintain a MMRA during operations
The MMRA provides for the succeeding 24 months of capex
Partial funding of MMRA has taken place on the last day of construction
Screenshot 1: MMRA inputs in a financial model
Modelling the mechanics of a MMRA is similar to modelling a DSRA. Essentially, modelling the MMRA involves cash inflows and cash outflows as described below:
Cash inflows (i.e., additions to MMRA from project cash flows)
Funding from cash flow - this is funding from the project’s cash flow to top-up the MMRA to the required target balance
Cash outflows (i.e., releases to project cash flow from MMRA)
Release to cash flow - this is the cash flow release from the available balance in the MMRA to fund the shortfall in operational cash flow to meet the maintenance capex
Release to cash flow (excess cash released) - this is the release from the MMRA to reduce the balance down to the target balance
Screenshot 2 illustrates the elements and calculations of the MMRA. Note that the MMRA target balance is calculated as the sum of future expected maintenance capex. SUM (OFFSET) is used to calculate the dynamic target balance. Refer to our tutorial titled Offset Function Excel to learn more about this combination.
Generally, interest is earned on the opening balance of the major maintenance reserve account and is recognised in the same way interest on cash balance is in the cash flow waterfall.
Screenshot 2: MMRA calculation layout
Position the MMRA in financial statements
In screenshot 3, the cash inflows to/outflows from MMRA is linked into to the cash flow waterfall, and the closing balance of the MMRA forms part of the current assets in the balance sheet.
Note that in the first year the product price is expected to be higher and hence the revenue. Thus, the MMRA is built-up to the target balance in the first year of operations.
Then the prices start to dip in the second year and at the same time there is a large major maintenance capex in year two. However, as the balance in the MMRA could be used to fund such maintenance capex, the net major maintenance capex is constant (AUD 1.25 M).
By maintaining an MMRA, lenders could ensure the funds are set aside from ongoing operations in order to be able to service such capex at given intervals. This reduces the stress of lumpy cash flows on the project and therefore on debt service.
Screenshot 3: Financial modelling technique to Integrate the MMRA in the cash flow waterfall
MMRA – Points to keep in mind
As with the DSRA, care is to be taken modelling the MMRA to avoid circular references. This is particularly true if the initial balance is debt-funded. There is usually no real reason for a logical circular reference to occur due to the MMRA.
An issue frequently raised by lenders is the operation mechanism of MMRA in the event of a debt service payment shortfall. If there is cash available in the MRA and the project has no other funds with which to make a payment due to the lenders, can the lenders access the MMRA in this event? In this case, it is also required to restore the balance of the MMRA if it is drawn to pay debt service.
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