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.
Most, but not all, project finance transactions have requirements for a DSRA (or DSRA/c). This topic is covered in detail in Corality's training course Advanced Project Finance Modelling if you are interested in learning more after reading this tutorial.
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 DSRA
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.
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.
A DSRA has two (2) modes of operation:
Modelling DSRA in a 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 (i.e., additions to DSRA from project’s cash flows)
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 (i.e., 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
Screenshot 1 below illustrates the elements and calculations of the debt service reserve account.
This example assumes that the initial DSRA is debt-funded on the last day of construction, and the target balance is equal to the next three (3) months of debt service. A binary flag is created to check if the DSRA is fully funded during the debt term. This flag is commonly linked to the equity distribution test. 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.
Screenshot 1: Elements and calculations of DSRA
Position of DSRA in the financial statements
As shown in screenshot 2, the cash inflows to outflows from DSRA is linked to the cash flow waterfall, and the closing balance of the DSRA forms part of the current assets in the balance sheet. As the initial DSRA is debt-funded in this example, it is positioned before debt funding in the cash flow waterfall.
Screenshot 2: Position of DSRA in the Financial Statements
Tips to keep in mind when modelling a DSRA
Care must be taken when modelling the DSRA to avoid circular references, particularly if the initial balance is debt-funded during the construction period. There is usually no reason for a circular reference to occur due to the DSRA/c. The core logic itself is not circular.
Calculating the target balance using the debt service for the next period could result in a circular reference, if interest on the DSRA is being considered. This can be solved using a macro or other modelling techniques, which are often a reasonable approximation.
It is important to check if the mechanics of the DSRA are sensible in the base case, as well as in other scenarios, especially in downside scenarios where the debt service coverage ratios (DSCRs) often fall below 1.0x. For example:
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
Corality Training Academy - SMART CAMPUS
There are numerous other tutorials and free resources related to financial modelling in Corality's SMART Campus. The DSRA is a common concept in project finance, and if you are more interested in valuations then you may be more interested in our 'Financial modelling for Valuations training course'.
Additional popular training courses that relate to this topic include:
Project Finance Theory: Concepts & Applications
Advanced Project Finance Modelling.
For related reading, see how debt service reserve accounts work in relation to Sculpted debt repayments without circular references and Avoiding circular references when modelling dsra sculpted principal repayments.