In a typical project finance transaction, various accounts will be set up prior to financial close between the borrowers and the lenders to ensure that project cashflows are appropriately managed. this means that  the SPV (Special Purpose Vehicle) can only open specified accounts which can be monitored by the lenders.

Here are some of the typical accounts required by lenders:-

  • the Revenues Account
  • the Disbursement Account;
  • the Equity Account;
  • the Compensation and Insurance Proceeds Account;
  • the Debt Service Account; and
  • the Debt Service Reserve Account

In this blog post, I want to go deeper in the Debt Service Reserve Account or DSRA. You can download my manual and template on DSRA from my Eloquens channel:

Debt Service Reserve Account (Manual & Excel Template)

What is a DSRA?

As we said earlier, lenders require a Debt service Reserve Account to be set up at commercial operation date and containing sufficient funds to cover for the upcoming (next period) debt service.

The DSRA requirement in each period is one of the covenants and will be monitor by lenders. The target DSRA in each period is set out in the term sheet and is typically required to contain 6-months of debt service (both interest and principal).

In terms of funding of DSRA, this account is either fully or partially funded at the last construction period.

Why Lenders require a DSRA?

In a project finance type of transaction, the future project cash flows are the primary source of debt repayment and lenders have no or limited recourse to sponsors for the repayment of the loan. You can not start paying back the loan until the project is operational.  that is why making sure that the future cash flows under the base case are sufficient and there’s reasonable buffer in case of temporarily problems. The funding of DSRA is a tangible security for lenders and is just a way to secure liquidity for lenders and funds from DSRA can be used to deal with possible problems in debt payments.

Loan Term sheet discussions around DSRA:

  • Is the DSRA required?

Typically in a project finance it is required but if you have to check with all lenders and ask if they require a DSRA. For example if you have a mezzanine/junior debt, they might or might not require a DSRA. So in terms of the financial model inputs, you can include a flag and provide flexibility to include or exclude any of the lenders in the DSRA.

  • Should the DSRA be pre-funded or can be backed-up by an LC? who pays for the LC, Project or Equity?

The DSRA needs to be established at commercial operation date but depending on lenders requirements, it can be either funded:

– in the last construction period and therefore the pre-funding will be included in the project budget and be funded with debt and equity.

– it is funded from cash from operation and build-up periodically from cashflows.

– funded with a letter of credit and the cost of LC can be paid out by the SPV or directly by sponsors.

So in your financial models, you need to provide flexibility for pre-funding the DSRA as part of the project cost and also the option to fund it with an LC and model the LC fee as either SPV cost (included in the cash flow waterfall) or sponsor cost (affects only equity return).

  • If DSRA is pre-funded, then by how much?

If the lenders require a pre-funding of DSRA, then the next question is by how much should it be pre-funded:

– it can be funded up to maximum of periodic debt service over life of the loan.

– It can be funded equal to the debt service in the first repayment (interest and principal)

– It can be partially pre-funded and a portion to be funded from cash from operation

  • What is a DSRA requirement in each period?

-Typically lenders require the DSRA to contain funds sufficient enough to cover the next debt service (interest and principal). For example if the repayment is done on semi-annual basis, at each payment periods lenders require the 6 months worth of upcoming debt service to be available in the DSRA. They might even ask for 12 months worth of debt service but it’s not common however if you don’t have any visibility on what lenders might require, then you might want to built in that flexibility in your financial models.

  • Does the lender allow release from DSRA during the loan life?

The DSRA is typically structured in a way that if in a period the funds available in the DSRA exceeds the required amount, the excess funds can be released in the cash flow waterfall. However, it might be the case that lenders do not allow any release from the DSRA. In these cases, typically lender also require the DSRA to be funded up to maximum of debt service in each repayment period and only allow release of funds after the loan is fully repaid. So you need to allow this flexibility in your financial models.

  • Position of DSRA cash inflows and outflows in the cashflow waterfall

The cash flow available for funding the DSRA is subordinated to debt service, meaning that funds will be first used to pay for interest and principal and any fees then any available funds will be used to fund the DSRA up to the required amount.

Regarding the release from the DSRA in case of excess funds, we discussed earlier that the lenders might or might not allow any release from DSRA during the loan life. Another question that need to be discussed during the loan term sheet negotiation is regarding the definition of cashflow available for debt service and whether the release from DSRA can be included as an inflow in the definition of CFADS. That’s an important issue especially if the debt is sized based on cashflow rather than gearing.

I hope that you find this blog post useful and you understand the importance of the financial model when you are negotiating contract. I have a blog post on the importance of finance model and financial modeler in loan term sheet negations. You can read it here.

Why you need your financial modeler at your side when you are negotiating the loan term sheet

You might also be interest to read and download my cash waterfall template and manual:

Typical Cash Flow Waterfall (Excel Template and PDF manual)

I am thinking about a good topic for my next blog post. If you have any suggestion, please let me know.

Stay in !$touch$!

Hedieh