Understanding Revenue Bonds

Understanding Revenue Bonds

4 Min.

Revenue bonds are a type of municipal bond that finance specific income-generating projects like toll roads, airports, or hospitals. The revenue generated from the project is used to pay back bondholders, making these bonds different from general obligation bonds, which are secured by tax revenues. This guide will explore the definition, types, and examples of revenue bonds, including their structure and potential risks for investors.

Basics

Revenue bonds are specialized municipal bonds issued to support specific projects or services that generate their revenues. These may include infrastructure such as toll bridges and highways, local utilities, and facilities like stadiums. Unlike general obligation bonds, which are secured by a municipality’s taxing power, revenue bonds are solely backed by the income from the project they fund.

Key Differences Compared to General Obligation Bonds

While general obligation bonds rely on the issuer's credit and taxing power, revenue bonds carry a higher risk due to their dependency on project-specific revenue, often resulting in higher interest rates for investors.

Types of Revenue Bonds

Airport Revenue Bonds

Issued by cities or airport authorities, these bonds are backed by the financial activities of airports. If an airport's services provide over 10% of their benefits to the private sector, these bonds are classified as private, otherwise, they are public-purpose bonds.

Toll Revenue Bonds

These bonds finance public transportation projects such as bridges or tunnels, with toll collections directly repaying the bond's principal and interest.

Utility Revenue Bonds

These are issued to fund essential public services, like water and power utilities. The revenue from the services provided by these utilities is used to repay the bondholders.

Hospital Revenue Bonds

These bonds support the construction and upgrading of medical facilities, with repayment sourced from the revenue these institutions generate.

Mortgage Revenue Bonds

Local or state Housing Finance Agencies issue these bonds to finance home loans for low- and middle-income individuals. The interest from these bonds is typically exempt from federal taxes, offering an attractive investment.

Industrial Revenue Bonds

Issued on behalf of private sector companies, IRBs are used for the construction or acquisition of industrial facilities and heavy equipment.

Revenue Bonds Structure and Investment

Maturity and Value

Revenue bonds generally have a long-term maturity of 20 to 30 years and can be purchased in increments like $1,000 and $5,000. The bond's face value is what the investor will receive at maturity.

Payment and Risk to Investors

Investors pay the face value upfront and receive interest over the bond's life. At maturity, they are paid back with the project's revenue, assuming it's sufficient. If not, there's a risk of investment loss.

For instance, a toll road-funded revenue bond uses toll collections to repay investors after construction costs are covered. Revenue bonds are a tool for municipalities to finance projects without impacting debt limits. Entities reliant on tax revenue, such as public schools, cannot issue revenue bonds due to their inability to generate project-specific revenue.

Examples of Revenue Bonds in Real-World

St. Louis Revenue Bonds

St. Louis utilizes revenue bonds for projects like multi-family housing, public facilities, and pollution control, with a usual maturity of 20-30 years. The tax-exempt status of these bonds allows for lower interest rates.

New York's Green Bonds

The MTA issued Green Bonds in February 2016, raising $500 million for infrastructure projects. These bonds are backed by the MTA's operating revenue and state subsidies, highlighting the use of revenue bonds for environmental and infrastructure upgrades.

Conclusion

Revenue bonds serve as a crucial financial instrument for municipalities to fund projects without taxing residents directly. While they offer higher yields due to their riskier nature compared to general obligation bonds, they play a pivotal role in financing important public works and services. Each type of revenue bond serves a unique purpose and carries specific benefits and risks. For investors, understanding these nuances is vital in assessing potential investments in municipal bonds.

Bond
Municipal Bond
Revenue Bond
Industrial Revenue Bonds (IRBs)
Metropolitan Transportation Authority (MTA)
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