Portfolio Management - Revenue Bond Analysis

For revenue bonds, the muni analyst starts from the assumption that the tax base, so central to rating GO bonds, has far less impact in this realm. Revenue bonds are all about recovering money from specific projects. Like projects in the private sector, these public works will not be approved by municipal governments without compelling feasibility studies that demonstrate the technical and financial viability of the projects. If, by some quirk, the city should green-light a project without a feasibility study, the players in the bond market would make it very difficult for that project to get funding.

Feasibility Study
The feasibility study should, among other things, outline sources of revenue: user charges or tolls, concessions and fees, special taxes, and rental or lease payments. Another potential source of revenue is legislative appropriation, or tax dollars granted by the residents' elected representatives.

Protective Covenants
Revenue bonds often have protective covenants written into their indentures. These often require that sinking funds be established, that any future debt related to the project be subordinate to the issue in question or that the bondholders have recourse to the physical assets in case of default.

  • A rate covenant could specify user charges;

  • An insurance covenant could specify how both the physical asset and its cash flows are to be indemnified;

  • A maintenance covenant could specify that the asset be kept in good repair;

  • A nondiscrimination covenant could specify that all users of the facility must pay user fees except in times of emergency.

  • Other security features of revenue bonds include requirements for financial reports and outside audits, and restrictions on the issuance of additional bonds. These restrictions take three forms:
    • Open-end indenture: This permits additional bonds provided the prior year's revenue would have been adequate to cover the new issue.

    • Closed-end indenture: This subordinates all future bonds except those required to complete construction of the facility.

    • Project completion: This is similar to a closed-end indenture, but it actually requires issuing bonds required to complete construction - considered a measure to protect the current bondholders.

Pledged Revenue
Muni analysts are concerned with construction only insofar as it is associated with generating or protecting their clients' cash flows. Flow of funds is of critical importance when assessing revenue bonds. The money obligated for the payment of debt service and for the making of other deposits required by the bond contract is called pledged revenue.

  • Gross revenue pledge is a promise that all revenues received will be used for debt service prior to deductions for any expenses.

  • Net revenue pledge is a promise that net revenues, after expenses, will be used for payment of debt service.


Look Out!
Repayment priority for a flow of funds covenant in a trust indenture for a muni would be: Operations and maintenance, Debt Service, Debt Service Reserve and Maintenance Reserve.


  • One measure of the liquidity of the flow of funds is debt service coverage: the ratio of cash flow available to the issuer to the annual interest and principal payments.

Where is Credit Information Obtained?
Muni analysts do not rely exclusively on the issuer and rating services as sources of credit information. Other sources include commercial research services, industry trade journals and the general and financial press. Additionally, many states have advisory councils that serve as clearinghouses of information in an effort to promote underwriting of municipal bonds within their territory.

One last point to make about muni analysis is that sometimes an entity other than the one issuing the bond extends credit to cover the obligation; this added security is similar to a parent co-signing an auto loan for a newly independent adult child. In the muni world, the term credit enhancement usually refers to bond insurance, bank letters of credit, state school guarantees, and credit programs of federal and state agencies.

Sources of Information


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