Bonds are essential financial instruments used by governments and organizations to raise capital. Among the various types of bonds, the differentiation between Moral Obligation Bonds and Revenue Bonds is critical in understanding their backing, risk, and investment value.
What Is? Definition
Moral Obligation Bond
A Moral Obligation Bond is a municipal bond in which the state governments provide an assurance of repayment through a “moral obligation” rather than a legally binding contract. If the issuer cannot meet the debt service requirements, the state legislature may appropriate funds to cover the shortfall, drawing upon a moral commitment rather than a statutory obligation.
Revenue Bond
A Revenue Bond is a type of municipal bond that is secured by the revenue generated from a specific project or source. These do not rely on the general tax revenues for repayment. Common examples include bonds issued to fund toll roads, airports, or utility services, where the income generated by these projects is used to repay bondholders.
Types of Bonds
Types of Moral Obligation Bonds
- Project-Specific Moral Obligation Bonds: These bonds are issued for specific projects with a moral commitment from the state to cover any deficits.
- General Moral Obligation Bonds: These bonds support a wide range of municipal projects with a general moral obligation.
Types of Revenue Bonds
- Utility Revenue Bonds: Issued to finance utility services like water, sewage, and electric systems.
- Transportation Revenue Bonds: Issued for transportation infrastructure such as toll roads, bridges, and airports.
- Housing Revenue Bonds: Issued to fund public housing projects, where rental income supports the debt service.
Key Differences
Backing and Security
- Moral Obligation Bonds: Though primarily supported by project revenues, they have supplemental backing through a moral commitment from the state legislations.
- Revenue Bonds: Solely secured by the revenues generated from the funded projects.
Risk Profile
- Moral Obligation Bonds: Generally offer lower risk due to the secondary backing by the state’s moral commitment.
- Revenue Bonds: Depending on the project’s feasibility and revenue generation, these could have a higher risk profile.
Interest Rates
- Moral Obligation Bonds: Tend to offer lower interest rates due to the additional protection of state backing.
- Revenue Bonds: Typically provide higher interest rates as compensation for higher risk.
FAQs
What is the main distinguishing feature of a Moral Obligation Bond?
Are Moral Obligation Bonds legally binding?
Why do Revenue Bonds potentially offer higher interest rates?
Historical Context
Moral Obligation Bonds
Moral obligation bonds became more prominent in the 1970s as a way for municipalities to enhance the creditworthiness of projects without extending full state credit backing.
Revenue Bonds
Revenue bonds have been used throughout the 20th century to fund large-scale infrastructure projects like highways, bridges, and water treatment plants, fostering economic growth and public utility.
Special Considerations
Credit Ratings
Credit rating agencies evaluate both types of bonds differently, considering the state’s commitment in moral obligation bonds and the revenue-generating potential of projects for revenue bonds.
Legislative Appropriation
For moral obligation bonds, the appropriation of funds by the state legislature, while a moral commitment, can sometimes depend on political and budgetary considerations which may affect investor confidence.
Applicability
Investing
Investors seeking lower-risk municipal bonds might prefer Moral Obligation Bonds, considering the moral backing. In contrast, those looking for potentially higher returns and willing to assume more risk might explore Revenue Bonds.
Government Funding
Governments utilize these bonds to fund projects without affecting the general tax base, effectively distributing the financial impact across specific project revenues.
Related Terms
- Municipal Bond: A general term for bonds issued by a municipal entity.
- General Obligation Bond: A bond backed by the full faith and credit of the issuing municipality, typically supported by taxing power.
Summary
Understanding the distinction between Moral Obligation Bonds and Revenue Bonds is crucial for investors and public finance professionals. The state’s moral commitment in supporting moral obligation bonds provides a unique safety net absent in pure revenue bonds, offering different risk and return profiles tailored to varied investment appetites.
References
- Municipal Securities Rulemaking Board (MSRB). “Understanding Municipal Securities.”
- U.S. Securities and Exchange Commission (SEC). “Municipal Bonds: Understanding Credit Risk.”
- Moody’s Investors Service. “Rating Methodology for Moral Obligation Bonds.”
This comprehensive definition serves as a detailed resource on Moral Obligation Bonds and Revenue Bonds, aiding in the understanding of their financial and investment nuances.
