Debt Service Reserves

These funds often get overlooked. It’s an unfortunate reality that we find very often when performing our analysis here at IBN. There are many reasons that the accounts seem to slip through the cracks; teams prioritize other tasks, issuers assume that trustees will invest the funds, we even find that many issuers are ill-informed about the options available to them. IBN has spent years working with bond issuers and trustees to create strategies that resolve these complications.

Debt Service Reserve funds are put in place as a security feature to be used to pay principal and interest payments in case an issuer cannot otherwise meet the obligation. If an Issuer needs to draw on the DSRF, a withdrawal is made to pay the bondholders in a timely manner. In most cases, however, these funds are deposited and stay in the account for the life of the bond. This creates an investment opportunity with often a very long time-horizon. 

Bond proceeds are required by law to be housed with a trustee for safekeeping. This trustee is chosen at the time of the bond issuance and is responsible for many things, including keeping and tracking debt service reserve accounts. Unless otherwise instructed, the trustee often invests these funds conservatively in a money market account per the bond’s indenture. According to the Tax Reform Act of 1986, issuers can invest these funds and earn up to the borrowing cost of the bond (often much higher than current rates) without incurring any negative tax consequences. 

All bond documents are unique, but most follow a general outline which includes a “permitted investments” section. This section lists exactly what instruments can be used to invest funds associated with the issue. All investment options are very conservative, which is why some issuers believe that there is little opportunity for gain. When in fact, often Issuers have multiple options available to them for investing their Debt Service Reserve Funds that will provide a benefit. 

IBN is very familiar with the opportunities available and the ‘legal-ese’ in these documents. Our analyses provide a high level of transparency into what options are available and the benefits of each.

As is seen in this graphic, even a change of .25 percent can provide great benefit in a portfolio of any size.

Although Debt Service Reserve Funds are often viewed as a small opportunity, this is often not the case. As shown in the graphic above, a seemingly small change can make a massive impact over the life of a bond. IBN encourages our colleagues to examine the options available to you and confirm that all funds are invested and working to their maximum potential. 

“Securities offered by Institutional Bond Network, LLC, member FINRA/SIPC.  Investment advisory services offered by IBN Asset Management, LLC.”