Sizing an interest reserve for a delayed development

Separate an allowance from available money

A budget can contain an interest allowance without a lender having committed that amount. A facility can contain an interest sublimit that cannot be used for construction. Record whether the reserve is cash already deposited, an undrawn part of the loan, or sponsor equity committed later. Those arrangements have different cash and interest consequences.

The OCC construction-lending guidance discusses interest reserves, project completion and the risks of replenishing reserves without addressing a project's underlying position. Apply the agreed loan terms rather than treating a reserve extension as automatic.

Sources: Office of the Comptroller of the Currency: Commercial Real Estate Lending, version 2.0

Calculate a transparent base case

Consider a hypothetical loan with opening principal of 6, 8 and 10 million over three consecutive quarters. Assume 2% quarterly interest on opening principal, paid from a separate 600,000 cash reserve at each quarter end. Cost draws create the next quarter's opening balance. The interest payments are 120,000, 160,000 and 200,000.

The base case uses 480,000 and leaves 120,000. This is a paid-interest example: reserve payments do not increase principal. If the reserve were funded by incremental loan draws, those draws would affect later interest and the complete loan schedule would need to be recalculated.

Extend the outstanding balance through the delay

Suppose the 10 million loan would have been repaid at the end of quarter three, but completion delays repayment by two quarters. At the same 2% quarterly rate, the extra interest is 400,000. Total interest becomes 880,000 and the original 600,000 reserve is short by 280,000.

In quarter four the reserve pays 120,000 of a 200,000 interest bill, requiring 80,000 from another source. Quarter five requires a further 200,000. A single total-shortfall cell is insufficient because the first additional cash is needed before the project produces exit receipts. If interest is capitalised instead, compounding raises the answer.

Separate delay, rate and balance effects

A rate stress to 2.5% for both delay quarters produces 500,000 of additional interest on unchanged principal. Keeping the original first three quarters unchanged, total interest becomes 980,000 and the reserve shortfall becomes 380,000. This is an incremental delay-period rate stress, not a claim that the base rate never changes.

Cost overruns may also increase debt, subject to availability. Calculate that separately from the timing extension. Refinancing fees, extension fees, hedging costs and penalties belong in identified rows with contractual support. Do not apply a generic percentage called finance contingency on top of explicit risks without explaining overlap.

Turn the result into a funding decision

Before approval, identify the reserve exhaustion date, the amount and date of sponsor support, the maturity date and any consent needed for an extension. A reserve that funds interest beyond contractual maturity does not itself extend the loan. Show a scenario in which the lender refuses additional funding.

The practical output is a dated reserve roll-forward alongside the ordinary debt roll-forward. Reconcile opening reserve plus additions less paid interest to closing reserve. Keep restricted reserve cash out of cash available for dividends or construction unless the agreement permits its release.