In this article, we will be looking at the debt service reserve account (DSRA) in project finance.
The debt service reserve account is one of the most common control accounts in project finance.
Control accounts are the bank accounts, withdrawals from which, are controlled by the lenders.
A debt service reserve account is a cash reserve against shortages in cash to pay debt service.
These reserves are essentially put aside for a rainy day and it works as an additional security measure for the lender as it ensures that the borrower will always have funds available in case of default.
The typically required balance on the debt service reserve account is an amount equal to the aggregate of the anticipated principal repayments and interest payments over the next six months. So, DSRA provides relief for the lenders for temporary, short-term, and unexpected issues with the project.
Debt service reserve account is usually funded at the end of a construction period, once the loan becomes repayable, however, this may not always be the case. Sometimes, lenders may allow partial funding of the DRSA on the last construction day and fund the DSRA from the project’s operational cash flows.
The initial debt service reserve account funding can be provided entirely by lenders through a debt service facility.
Or, the debt service reserve account can be funded by lenders and project sponsors in the same proportion that lenders and sponsors fund the project’s CAPEX. In this case, the funding of the debt service reserve account will reduce the equity valuation and internal rate of return of the project.
Funding of the debt service reserve account at the construction completions is considered as a part of the financing costs in the project’s CAPEX, however, it is usually not included in the project’s fixed assets.
During the project’s operations, the funding of the debt service reserve account, if necessary, happens after the debt service. So, cash flow from which deposits are made into DSRA “cash flows available for the DSRA” are ranked after the debt service but above the payments related to equity in cash flow waterfall (shareholder loan interest and principal repayments, and dividends).
The cash can be withdrawn from the debt service reserve account by both lenders and the project company.
If the project company fails to make debt principal repayment or interest payment, in other words, the project is in default, the lenders will withdraw any cash available on the debt service reserve account to pay unpaid debt principal and interest payment amounts.
Typically, the project company may withdraw cash from the debt service reserve account if the cash in the reserve account exceeds the required cash balance, but this may not always be the case.
Sometimes, if the loan agreement allows, the project company may present a letter of credit from a reputable bank instead of funding the debt service reserve account.
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