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The debt service reserve account (DSRA) works as an additional security measure for lenders. It is generally a deposit which is equal to a given number of months projected debt service obligations.

This tutorial explains how to code a transparent and efficient DSRA, and how it is linked to the financial statements without circular references.

Key learnings:

  • Modelling DSRA in a project finance model
  • Position of DSRA in the financial statements

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DSRA Introduction

Debt Service Reserve Account is a cash reserve which works as an additional security measure for the lender as it ensures that the borrower will always have funds deposited for the next x months of debt service. It is generally a deposit which is equal to a given number of months projected debt service obligations. Commonly the Debt Service Reserve Account target is defined as six or twelve months of debt service.

The purpose of a DSRA is to provide a cash buffer during periods where cash available for debt service (CFADS) is less than the scheduled payments. This buffer allows some breathing room for operational issues to be resolved and/or, in more extreme situations, the debt to be restructured before the borrower defaults on the debt.

Operation and funding of debt service reserve account

The DSRA is usually funded up to a dynamic target balance. The target balance for the DSRA includes both the interest and principal repayment amounts. This might be set at three (3), six (6), nine (9) or 12 months, or may even be a fixed amount.

The funding method for the establishment of the DSRA (initial funding of DSRA) 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 flows; or,
  • Completely built-up from the project’s cash flows

DSRA Target

Target Balance is made depending on future debt service and is based on bank terms. Target Deposits / (Withdrawals) are calculated by comparing the target balance and the DSRA Opening Balance.

  • Target Deposit is excess of Target Balance over DSRA opening Balance
  • Target Withdrawal is excess of DSRA opening Balance over Target Balance

Modelling DSRA in project finance model

Modelling the mechanics of a DSRA involves linking up the formula within various components of the project’s cash flows and the DSRA itself. Essentially, modelling the DSRA involves cash inflows and cash outflows as described below:

Cash inflows (ADDITIONS TO DSRA FROM PROJECT’S CASH FLOW)

  • Initial funding of DSRA: Various ways of funding are discussed above
  • Funding from cash flow: This is funding from the project’s cash flow (using cash available to fund DSRA) to top-up the DSRA to the target balance

Cash Outflows (RELEASES to PROJECT’S CASH FLOW FROM DSRA)

  • Release to cash flow (during distress): This is the cash flow release from the available balance in the DSRA to fund the shortfall in CFADS
  • Release to cash flow (excess cash released): This is the release from the DSRA to reduce the balance down to its target balance, including the release on final maturity

Generally, interest is earned on the opening balance of the DSRA, and recognised in the same way interest on cash balance is in the cash flow waterfall

Position of DSRA in the financial statements

In terms of positioning in the cash flow waterfall, the cash available to fund DSRA is ranked after debt service, but takes precedence over any payments to equity, thus providing additional security for the lenders. The cash inflows to and outflows from DSRA are linked to the cash flow waterfall, and the closing balance of the DSRA forms part of the current assets in the balance sheet.

  • For cash flow into the DSRA we would debit the DSRA and credit cash.
  • For cash flow out of the DSRA we would credit the DSRA and debit cash.

DSCR Considerations

When DSCR >= 1.00x, the cash flows are the ‘top – up to’ and ‘release from the DSRA’ to maintain the ongoing target balance

When DSCR < 1.00x, release from the DSRA to the project’s cash flows to fund the shortfall in order to keep the debt whole

DSRA balance breach

Actual DSRA balance is less than the Target DSRA balance.

The illustration above shows periods (with green markers) in which Actual DSRA balance is less than the Target DSRA balance.

Tips to keep in mind when modelling DSRA

  • Funding from the project’s cash flows to top up the DSRA/c should not exceed the cash available to fund DSRA
  • The balance of the DSRA should never be negative
  • The ‘addition to’ and ‘release from’ the DSRA should not occur concurrently
  • In the base case, besides the initial funding and the final release, all other DSRA movements should be minimal
  • The sum of all cash movements + initial funding should equal zero
  • The DSRA balance should be zero at the end of the loan life, and should gradually decline in the periods leading up to that time
  • The release from the DSRA during a period of distress should only be sufficient to preserve a DSCR of 1.00x