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


Related Articles
  1. Professionals

    Municipal Bonds

    FINRA Series 6 Exam Study Guide - Municipal Bonds. In this section Types of Municipal Bonds: 1) General Obligation 2) Revenue Bonds.
  2. Insurance

    Municipal Bond Tips For The Series 7 Exam

    Learn to distinguish between general obligation and revenue bonds to ace this test.
  3. Bonds & Fixed Income

    What is an Indenture?

    An indenture is a legal and binding contract between a bond issuer and the bondholders.
  4. Professionals

    Introduction To Bonds

    We look at what bonds are and how to buy and sell them.
  5. Financial Advisors

    Top 4 Ways to Avoid Muni Bond Mistakes

    Muni bonds are often perceived as safe investments. But it's important to do some thorough research before investing.
  6. Bonds & Fixed Income

    5 Reasons to Invest in Municipal Bonds When the Fed Hikes Rates

    Discover five reasons why investing in municipal bonds after the Fed hikes interest rates, and not before, can be a great way to boost investment income.
  7. Professionals

    Corporate Bonds

    FINRA Series 6 Exam Study Guide - Corporate Bonds. This section discusses corporate bonds in greater detail. Different types of corporate debt: secured, unsecured, junk and convertible bonds ...
  8. Professionals

    Special Munis

    FINRA Series 7 Online Study Guide
  9. Home & Auto

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  10. Mutual Funds & ETFs

    Why Muni Bonds and Bond Funds are Perfect Together

    Municipal bonds and bond funds differ in several ways, which is partly why they complement each other well.
RELATED TERMS
  1. Negative Pledge Clause

    A negative covenant in an indenture stating that the corporation ...
  2. Project Completion Restriction

    A type of clause, seen most often in municipal bond indentures, ...
  3. Indenture

    A legal and binding contract between a bond issuer and the bondholders. ...
  4. Net Revenue Pledge

    A provision in a municipal bond issue that requires the issuing ...
  5. Double Barreled

    A municipal general obligation bond in which the cash flows are ...
  6. Revenue Bond

    A municipal bond supported by the revenue from a specific project, ...
RELATED FAQS
  1. What is an indenture for a fixed income security?

    Learn about the indenture for a fixed-income security and its features, as well as the role of the trustee in administering ... Read Answer >>
  2. Who or what is backing municipal bonds?

    Learn about the basics of municipal bonds, including the various revenue sources that are utilized to back or secure municipal ... Read Answer >>
  3. What do cities do with the funds generated from municipal bonds?

    Learn more about municipal bonds, including the various types of bonds issued and the purposes of municipal bond funds, such ... Read Answer >>
  4. Why do companies issue debt and bonds? Can't they just borrow from the bank?

    Companies issue bonds to finance operations. Most companies can borrow from banks, but view direct borrowing from a bank ... Read Answer >>
  5. What forms of debt security are available for the average investor?

    Discover the various different types of debt securities, issued by government entities or corporations, that are available ... Read Answer >>
  6. How do the returns on municipal bonds compare to those of other bonds?

    Learn how tax-free municipal bonds may provide better returns than other types of bonds, and understand the risks of municipal ... Read Answer >>
Hot Definitions
  1. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  2. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  3. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  4. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  5. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  6. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
Trading Center