Revenue bonds are a type of municipal bond issued to finance public projects that generate revenue. These bonds are repaid through the income produced by the project—like tolls from a bridge or charges for hospital services—rather than from a general tax levy. Unlike general obligation bonds, revenue bonds are not backed by the full faith and credit of the issuing municipality.
Types of Revenue Bonds
Utility Revenue Bonds
These bonds are issued to fund projects such as water, sewer, or electric systems. The projects need to generate revenue from their users to pay off the bonds.
Transportation Revenue Bonds
Issued for projects like highways, toll bridges, and public transit systems, these bonds are repaid through tolls, fares, or other transportation-related fees.
Education Revenue Bonds
Funds construction and renovation of educational facilities, with repayment primarily from tuition fees or other educational service charges.
Health and Hospital Revenue Bonds
Issued for the development of hospitals and healthcare facilities, repaid from healthcare service fees and insurance reimbursements.
Economic Development Revenue Bonds
Supports infrastructure projects aimed at boosting local economies, like convention centers or sports stadiums, repaid from revenues generated by these facilities.
Characteristics of Revenue Bonds
Non-Tax Backed
One of the distinguishing features of revenue bonds is that they rely solely on the revenue generated by the funded project for repayment. They do not involve the taxing power of the municipality.
Risk and Credit Ratings
Because revenue bonds depend on a successful revenue-generating project, they tend to carry higher risk compared to general obligation bonds. This is reflected in their credit ratings, which are often lower without the backing of municipal tax revenue.
Special Considerations
Feasibility Study
Before issuing a revenue bond, a municipality often conducts a feasibility study to ensure that the projected revenue will be adequate for bond repayment.
Debt Service Coverage Ratio (DSCR)
This ratio measures the available revenue relative to debt service payments. Higher DSCR values indicate a greater ability to cover debt obligations.
Legal Covenants
Bonds often include covenants addressing matters such as maintaining the project, setting user fees, and preserving revenue streams, providing additional assurance to bondholders.
Examples of Revenue Bonds
An example of a revenue bond could be a municipality issuing bonds to construct a toll road. The revenue from the tolls collected from drivers using the road would be used to repay the bondholders. If the toll road attracts sufficient users, it generates the necessary revenue stream to fulfill bond obligations.
Historical Context
Revenue bonds have been a critical instrument for funding significant public infrastructure projects since the early 20th century. They gained prominence during the Great Depression when securing funds through traditional tax-backed bonds became challenging.
Applicability
Revenue bonds are particularly useful in circumstances where substantial capital is required for public benefits but where the municipality prefers or needs to avoid leveraging its tax base. They allow for the development of projects that directly benefit the public and generate necessary funds for bond repayment.
Comparisons
Revenue Bonds vs. General Obligation Bonds
Revenue bonds differ from general obligation bonds, which are backed by the municipality’s taxing power. General obligation bonds often hold lower risk and thus have a lower yield compared to revenue bonds.
Related Terms
- General Obligation Bond: A bond backed by the credit and taxing power of the issuing municipality.
- Municipal Bond: A bond issued by a local government or territory, or one of their agencies.
- Feasibility Study: An assessment of the practicality and financial viability of a proposed project.
FAQs
What is a revenue bond used for?
Are revenue bonds riskier than general obligation bonds?
How is a revenue bond repaid?
References
- “Revenue Bonds,” Investing in Bonds, Investopedia.
- “Municipal Bonds: An Investor’s Guide,” Securities Industry and Financial Markets Association (SIFMA), SIFMA.
- “Municipal Finance,” By George E. Peterson, Publications.
Summary
Revenue bonds are a vital financial tool for municipalities aiming to fund large-scale public projects without directly relying on tax revenues. By link repayment to the income generated by the project they finance, revenue bonds present both opportunities and risks to investors. Proper evaluation through feasibility studies, legal covenants, and a clear understanding of revenue streams are crucial for these bonds’ success.
