Debt Service Reserve Account (DSRA)

DSRA Introduction

Debt Service Reserve Account (“DSRA”) 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 to cover future debt service. It is generally a deposit which is equal to a given number of months projected debt service obligations. Commonly the DSRA target is defined as six or 12 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.

The funds within the account are not expected to be used in the base case of your financial model however when testing downside scenarios, the DSRA may be required to fund cash shortfalls and thus will show how robust the project is. To learn more about scenario analysis find the link here.

Operations 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. The requirements will be defined in the term sheet and may include certain fees. The target is typically six to 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

Modelling DSRA in project finance model

DSRA Target

Target Balance is made depending on future debt service and is based on bank terms sheet. Deposits and withdrawals, to and from the DSRA are calculated by comparing the target balance and the opening balance.

• A deposit required when the Target Balance is in excess over DSRA opening Balance
• Target Withdrawal is excess of DSRA opening Balance over Target Balance

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 CASHFLOW)

• Initial funding of DSRA: Various ways of funding are discussed above
• Funding from cashflow: 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 CASHFLOW FROM DSRA)

• Release to cashflow (during distress): This is the cash flow release from the available balance in the DSRA to fund the shortfall in CFADS, this is when the DSCR is <1.00x. To find out more information on the DSCR please find the link here.
• Release to cashflow (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 balance of the DSRA, and recognised in the same way interest on cash balance is in the cashflow waterfall

Position of DSRA in the financial statements

The DSRA is cash balance owned by the borrower and thus sits on the current asset on the balance sheet.

In terms of positioning in the cashflow waterfall, the DSRA is ranked below the debt service, but takes precedence over equity, thus providing additional security for the lenders. The cash inflows to and outflows from DSRA are linked to the cashflow waterfall. Cash into the DSRA is cash out for the cashflow waterfall and cash out from the DSRA is a cash inflow for the cashflow waterfall.

Tips to keep in mind when modelling DSRA

The initial modelling of a DSRA is tricky however the good news is that there is not much variation between the DSRA calculations from project to project. You can therefore use our DSRA modelling template, which can be downloaded above, and be walked through the file with the accompanying webinar which can be found here.

Some key tips to consider while modelling the DSRA are as follow:

• Funding from the project’s cashflows 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 and 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

Circularities with DSRA

The DSRA can often cause circularities in the model and often a copy-paste macro will be required to break this circularity. The below diagram walks through a common circularity with the DSRA. Talk through the steps clockwise:

The DSRA target today, is based on future debt service. If the debt repayments are sculpted, then the repayments will be based on the cashflows available for debt service (CFADS). A component of the CFADS in the intertest income. To calculate the interest income, this is typically based on the cash balance brought forward. The cash balance brought forward, is the cash balance carried forward from the previous periods. The cash balance carried forward is dependent on the net cashflow for the period, which is dependent on the cash amount required for the DSRA.

Note this circularity only occurs when the principal repayment is sculpted, if the repayment method is an annuity (not dependent on CFADS), this circularity will be removed.

To learn about Mazars’s approach to breaking circularities in VBA, please see “Best Practice Approach to Copy-Paste Macros in Financial Models” tutorial here.