Revenue Bonds
Revenue bonds are secured by the income generated from a specific project or facility, NOT by the taxing power of the issuer. The project must generate enough revenue to pay operating expenses and debt service.
Revenue Bond vs. GO Bond
| Feature | Revenue Bond | GO Bond |
|---|---|---|
| Security | Specific revenue source | Taxing power |
| Voter Approval | Usually not required | Often required (UTGO) |
| Risk | Generally higher | Generally lower |
| Yield | Usually higher | Usually lower |
| Tax backing | None | Ad valorem taxes |
Types of Revenue Bonds
| Type | Revenue Source |
|---|---|
| Toll Road/Bridge | Tolls from users |
| Airport | Landing fees, gate rentals, concessions |
| Water/Sewer | User fees and charges |
| Hospital | Patient fees, insurance payments |
| Electric Utility | Electricity sales |
| Stadium/Convention | Ticket sales, rentals, concessions |
| College/University | Tuition, fees, auxiliary revenue |
| Industrial Development (IDB) | Lease payments from private company |
Revenue Bond Covenants
Revenue bond indentures contain protective covenants that protect bondholders. These are legally binding promises by the issuer.
Rate Covenant
The issuer promises to set user fees high enough to cover:
- Operating and maintenance (O&M) expenses
- Debt service (principal and interest)
- Required reserve fund deposits
Coverage Ratio Example: If covenant requires 1.25x coverage:
- Net revenues must be at least 125% of debt service
- $1.25 million net revenue for every $1 million in debt payments
Flow of Funds
The flow of funds covenant specifies the priority of payments from collected revenues.
Net Revenue Pledge (Most Common)
| Priority | Payment |
|---|---|
| 1st | Operation & Maintenance |
| 2nd | Debt Service |
| 3rd | Debt Service Reserve |
| 4th | O&M Reserve |
| 5th | Renewal & Replacement Fund |
| 6th | Surplus (general fund) |
Key Point: In a net revenue pledge, O&M is paid FIRST, before bondholders.
Gross Revenue Pledge
| Priority | Payment |
|---|---|
| 1st | Debt Service |
| 2nd | Operation & Maintenance |
| 3rd | Reserves |
Key Point: In a gross revenue pledge, bondholders are paid FIRST.
Gross is better for bondholders because they get paid before O&M expenses.
Additional Bonds Test
Before issuing MORE bonds backed by the same revenue source, the issuer must prove:
- Current revenues cover existing AND new debt service
- Usually requires earnings coverage of 1.25x or higher
- Protects existing bondholders from dilution
Open-End vs. Closed-End Indentures
| Type | New Bonds Status |
|---|---|
| Open-End | New bonds have EQUAL claim (if earnings test passed) |
| Closed-End | New bonds are SUBORDINATE to original bonds |
Other Important Covenants
Insurance Covenant: Issuer must maintain adequate insurance on the facility.
Maintenance Covenant: Issuer must properly maintain the facility.
Catastrophe Clause: If the facility is destroyed, insurance proceeds are used to call bonds and repay bondholders.
Revenue Bond Analysis
When analyzing revenue bonds, consider:
| Factor | What to Look For |
|---|---|
| Coverage ratio | Higher is better (1.5x+ is strong) |
| Economic viability | Is the project essential? Demand trends? |
| Competition | Alternative facilities or services? |
| Rate flexibility | Can user fees be raised? |
| Management quality | Experience operating similar facilities? |
| Legal protections | Strong covenants? |
Under a net revenue pledge for a municipal revenue bond, what is paid FIRST from collected revenues?
The purpose of an additional bonds test in a revenue bond indenture is to:
Which type of revenue bond indenture is MORE favorable to bondholders?
A hospital revenue bond is backed by:
4.4 Municipal Bond Analysis
Continue learning