Avoiding circular references when modelling DSRA with sculpted principal repayments.

By Nick Crawley on December 10 2009

Hi all I generally don’t post the many questions that I respond to directly from readers but this one I think would an useful insight into something that causes so many model builders, auditors and managers sleepless nights. There is no rocket science (sorry!) just a healthy dose of experience and practicality.

Dear Nick,

First of all let me start this mail, by complimenting your wonderful website, both the navigator & your contributions on fimodo.

It is a great reference tool, also there is nothing new for me, since I am in this industry, for quite some time, but you present some great tutorials, that are very useful for beginner analyst, and provide a great education for them.

I was wondering what is your approach to modeling DSRA? To be more precise in the facility agreement of all the project I am familiar with, the cash available to fund the DSRA requirements is sub - ordinate to the debt service, sometime in models which use a target DSCR repayment profile, in order to optimize the repayment profile based on the project cash flow, the available cash flow to debt service (CFADS) is calculated after the allocation of the funds needed to fund the DSRA. The logic that stands behind this kind of modelling, is that when you want to optimize the repayment profile, you should first make sure you have the right amount for your DSRA, and only then you should be sculpting your repayment profile. On the other hand, in your DSRA tutorial, I see you are using the other method, where the cash available to fund the DSRA needs is after the debt service, but then again, you are using an annuity repayment profile, and not sculpting the repayment profile based on actual cash flow.

I would be really interested to hear your opinion.

Kind Regards,

Ziv Sade, CFO, EdelTech

My solution to the DSRA with sculpted repayment question

Dear Ziv,

Thank you for the compliments on the websites. We have taken time to ensure that they provide useful information relating to project finance and financial modelling.

To answer your question on the DSRA While there is no hard and fast rule to the modelling the DSRA, we do so to reflect the reality of how debt will be repaid considering the function of the DSRA.

We try to model as closely to the term sheet, which will outline the seniority of the DSRA. In the absence of a term sheet, we will model so that the DSRA is subordinated to debt service regardless of whether the debt repayments are sculpted or not.

There are a few reasons doing this and I will explain using the DSCR sculpted repayments as an example.

The DSRA is to be used if there is not enough CFADS for debt repayments. This is the main function of the DSRA and although we try to ensure that the DSRA target is met at all periods, it is not a strict requirement (but varies according to the term sheet). Also, it will not be fully funded if it needs to release for debt service. Therefore, the priority of the cashflows is to pay for debt service rather than the DSRA.
If debt repayments are sized on (CFADS - Cashflow used for DSRA), then the debt repayments will be lower than if they were to be sized on CFADS. To ensure that the DSCR correctly reflects the debt paying capacity of the project, then you need to ensure that the DSCR is calculated on (CFADS - cash used for DSRA)/Debt Service. If instead you then use CFADS/Debt service then your DSCR will be overstated as you are not measuring against the debt paying capacity of the project. The repayment sculpting exercise will be applying a false buffer if the debt service is sized after the DSRA obligations are met.
From experience, the majority of DSRA are subordinated to debt service, but every deal has the chance to be different so always check.

I hope this helps explain the approach to modelling a DSRA when there are sculpted payments.

Regards and good luck with your projects!

Nick