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Debt Service Reserve Fund (DSRF)

When an Institution issues revenue bonds, it is mandated that a DSRF be established to provide a reserve source of payment for principal and interest in the event that revenues are unable to cover these obligations when due. The DSRF is to equal either 10 percent of the value of the bond issue, one year of debt service, or 125 percent of the average annual debt service. The DSRF can be funded in one of three ways: from proceeds of the bond issue, through an equity contribution from the issuer, or from revenues generated from the project that the bonds were issued to finance. Should the DSRF fall below its mandated level, the issuer is required to inject money in order to bring the fund to the required balance.

DSRF monies may be commingled from more than one bond issue; however, there are special rules for common reserve funds. One requires that investments be allocated to the various issues at least every three years. The methodology for allocation must be based on each issue's outstanding relative value, annual debt service requirements, or the original principal amounts.

DSRF monies may be invested in permissible interest-bearing instruments as specified in the trust indenture. Typically, these will include: US Treasury Bills, Notes, and Bonds; other obligations backed by the full faith and credit of the US Government; US Agency securities, including the Government National Housing Administration, Federal Home Loan Bank, Federal Farm Credit Bank, and Resolution Funding Corporation; obligations of the Federal Home Loan Mortgage Corporation (Freddie Mac), Federal National Mortgage Association (Fannie Mae), and Student Loan Marketing Association (Sallie Mae); and municipal obligations issued by any state or subdivision thereof. Typically, the trust indenture will also restrict the time to maturity for the investments.

Some common maturity restrictions are: DSRF investments shall not have maturities exceeding 5 years; DSRF investments shall not have maturities exceeding 10 years; one-half of the amount in the DSRF shall mature before 10 years and the remainder within 20 years; or investments in the DSRF shall mature no later than the final maturity of the bond issue itself.

The appropriate application of investment techniques to maximize non-rebatable income (see section on "Arbitrage") is a field of specialization within municipal finance that is usually beyond the scope of both bond attorneys and underwriters. Issues dated after August 16, 1986 and refunded in advance of maturity are particularly complicated, due to transferred proceed rules, inefficient escrows, and yield blending (see section on "Refunding").

Basic rules governing DSRFs are as follows:

  • For all tax-exempt revenue bonds issued before August 16th, 1986, DSRFs are not subject to Rebate.
  • For all tax-exempt revenue bonds issued after August 16th, 1986, DSRFs are always subject to rebate.
  • For refunding revenue bonds, "Transferred Proceeds Rules" apply.
  • Taxable revenue bonds are not subject to rebate.

DSRF Notes and Guidelines:

An issuer of revenue bonds is required to fund a Debt Service Reserve Fund (DSRF), which will be approximately 10% of the issue size. There are three ways to meet this requirement:

  • Purchase a Surety Bond/Letter of Credit in lieu of investments.
  • Use special investment products: Guaranteed Investment Contracts, Forward Purchase Agreements, and Repurchase Agreements.
  • Actively manage marketable securities (e.g., US Treasury Notes, US Government Agency Securities).

The trust documents will place the following restrictions on Debt Service Reserve Fund Investments:

  • Type of government securities that are permissible.
  • The maximum maturity of all DSRF investments.

NAM Recommendations for Active Management:

The maximum maturity for DSRF investment should be at least 10 years and preferably that of the final maturity date of the Revenue Bond issue.

All US Treasuries and common US government agencies and instrumentalities should be permitted including the following:

  • Treasury bills, notes, bonds, and zero coupon securities (strips).
 
  • The following agency and instrumentality bills, notes, bonds, and zero coupon securities:
 
  • FNMA
  • FHLB
  • FHLMC
  • FFCB
  • SBA
  • TVA
  • GNMA
  • REFCO
  • Municipal Securities AA or Higher should be permitted investments

Why NAM 

  • All investment strategies will comply with each bond indenture's definition of permitted investments and maturity restrictions.
  • All investment strategies are designed to aggressively recapture the negative arbitrage associated with each issue.
  • All investment strategies comply with existing and "proposed" SEC/IRS regulations pertaining to the investment of bond proceeds.
  • NAM's Disclosed Commissions for managing DSRFs are reasonable and comparable to the commissions charged to manage non-bond proceeds funds (e.g., discretionary money managers, no-load mutual funds).