Debt service reserve accounts

A debt service reserve account (“DSRA”) is a special purpose bank account set up to provide additional security and is usually only contained in project finance transactions. Borrowers are required to maintain a minimum target balance within the account, with the target balance usually set as a fixed number of months of debt servicing costs (commonly 3, 6 or 12 months). As the target balance is based on projected costs (i.e. costs in future periods), the modelling of DSRAs can result in circular references. Borrowers can usually only withdraw money from the DSRA if funds are required to meet their debt obligations (i.e. DSCR is less than 1), or if the actual balance of the account is greater than the target balance.

Dealing with circular references

You actually have quite a few approaches to dealing with circular references in a DSRA. For more detail, see our article on Circular references and breaking them.

1. Ignore them – just let Excel iterate until it (hopefully) finds a stable solution for the model.
2. Put in a copy/paste macro – if the only circular reference you have in the model is from the DSRA, this will usually work (although does add calculation time, sometimes significantly).
3. Solve it mathematically – when you do it properly, this can be the best solution; but don’t mess up your algebra!
4. Set the target based on the current period rather than the future – if you have a quarterly model and a 6 month target balance, just make the target balance equal to 2x the current period’s debt service requirements, or the sum of the last two quarters. You won’t have a circular reference, and the modelled amount should be pretty close to reality unless your debt servicing changes markedly from period to period.
5. Use a fixed target – particularly if debt servicing is reasonably constant, then making the target balance a fixed dollar value will be a reasonable approximation. And if you have volatile debt servicing (perhaps because debt repayments are sculpted to better match the project’s cashflows), then this may be a better approach to have in your loan documents anyway.

Which method you use is up to you, but my typical approach is to use option 4 as a good balance of accuracy and speed.
This is a very light review of modelling DSRAs, so we’ll go into further detail in a future article.