A debt service reserve account is when a borrower is required under their lending contract with the bank or whoever they have borrowed money from. They are required to set aside an amount of cash in advance of when that cash is going to be paid to the lender.

So for example, we might have a debt repayment coming up in six months time. We set aside the cash now six months ahead of time so that the lender is assured that in six months time, that money will actually be paid over to them. It's a way of getting extra security and extra assurance for the lenders. It's also quite expensive for the borrower because that cashflow could be used to repay the borrowing a bit earlier and save some interest or worse than that to be able to set aside enough cash to meet the payments before they become due. We might have to actually borrow more. So we are borrowing extra money to meet a debt payment that is due in six months time. We borrow that money, put it aside in a cash account, and we're paying interest on that money because it's been borrowed. It sits in a deposit account and probably earns a lot less interest out of that deposit account.

Usually a debt service reserve account is either used to keep debt payments going when the cash flow is low or even negative. So we're setting money aside in advance or more. Usually it's a constant amount throughout the loan life. So for example, the next six months worth of debt service must be present in a deposit account at all times throughout the loan life.

We can calculate, because we've done our debt modeling, we could calculate what six months worth of debt service will be at any point in time. We know what the total debt service is because that's what we built into our cashflow. And if we want say, six months worth, we just take 50% of that.

This can cause a circular reference because we are drawing down more debt than is immediately required. So we're borrowing money in order to meet a future repayment and the fact that we're borrowing money increases the debt service and therefore increases the amount that we need to set aside. So the debt service reserve account and the amount of future debt service are linked to one another. We could cause a circular reference there.

The debt services reserve account itself is just used to make those debt repayments as they fall due. As soon as the debt payment is made, then the reserve account falls below the necessary amount. It will need to be topped back up again for the next six months. Worth of debt service.

We can model that using a corkscrew. We work out what six months worth of debt service. If the amount in the reserve account is too low, we top it up. If the amount is too high, we can release some of those funds back to the project company.