Gross Revenue Pledge

What Is a Gross Revenue Pledge?

A gross revenue pledge, also known as "pledged revenue", is a stipulation in some municipal bond indentures that compels the issuer to use the bond's revenue to service the debt first. A gross revenue pledge reduces the risk for bondholders, thereby allowing the bonds to be issued at a higher credit rating and lower interest rate.

Key Takeaways

  • A gross revenue pledge is a promise that municipal bond issuers will use revenue to repay bondholders before paying other expenses.
  • Gross revenue pledges are used in revenue bonds, obligations that are repaid from a specific income source rather than the issuer's overall revenues.
  • A gross pledge is different from a net pledge, where revenue is used to cover operating expenses before repaying bondholders.
  • Credit agencies use a gross revenue pledge as a factor in calculating the rating and pricing of an issue.
  • A gross revenue pledge makes a debt issue safer for bondholders, giving the bond issue a lower interest rate.

Understanding Gross Revenue Pledge

When a bond has a gross revenue pledge, the issuer's first revenues must go towards paying down the bond's interest and principal. Operating and maintenance (O&M) costs are the second priority, though this can be funded from other revenue sources as well.

The presence or absence of a gross revenue pledge is a factor in calculating a bond's credit rating and the pricing of the issue. Like most restrictive provisions in a bond indenture, a gross revenue pledge makes the debt issue safer for bondholders by assuring that they will be repaid.

Gross Revenue Pledge vs. Net Revenue Pledge

A gross revenue pledge is different from a net revenue pledge, where the issuer's revenue is used to pay off operating and maintenance costs before repaying bondholders. This ensures that the bond facility has enough cash flow to continue operating, although it comes with additional risk to bondholders.

Generally, the added safety created by the gross revenue pledge is a cause for the bond issue to be offered at a lower interest rate, which saves money on interest expense for the issuer.

Example of Gross Revenue Pledge

In March 2018, the University of Connecticut sold $152 million of special obligation student fee revenue bonds to finance a student recreation center at the university's main campus. The bond indenture contains a pledged revenue clause.

The bonds are rated Aa3 by Moody's Investors Service, one notch higher than the ratings of the state of Connecticut's general obligation bonds. Moody's stated that its rating "reflects the scope of the university's operations as well as its solid results, the strength of pledged revenues and substantial state capital funding resulting in low direct debt obligations."

What Item Is Paid First in a Net Revenue Pledge?

When bonds are issued with a net revenue pledge, revenues from the bond facility are spent on operations and maintenance expenses first. Only after these expenses are met, the remaining ("net") revenues can be spent on paying the bond's interest and principal.

What Are Revenue Backed Bonds?

Revenue-backed bonds are municipal bonds that are backed by a specific revenue source, such as bridge tolls, bus fares, or income from public utilities. This is different from general obligation bonds, which are supported by the general revenue of the issuer. Interest payments from these bonds are exempt from federal income taxes, making them an attractive choice for income-seeking investors.

What Is a Special Tax Revenue Bond?

A special tax revenue bond is a bond that is repaid from taxes on a particular activity or product. For example, some local governments might issue a bond to finance the construction of a new school or hospital wing, servicing the bond with a special tax on tobacco or alcohol sales.

What Happens When a Revenue Bond Defaults?

A default occurs when the issuer of a bond is unable to make repayments in accordance with their debt obligation. Municipal bonds rarely default, and when they do, it is even rarer for the bondholders to lose their entire investment. The more likely outcome is that the issuer might suspend coupon repayments, causing the value and rating of the bonds to fall.

Article Sources
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  1. Moody's. "Moody's Assigns Aa3 to University of Connecticut's Series 2018A Student Fee Bonds."

  2. Charles Schwab. "Understanding Municipal Revenue Bonds."

  3. Bond View. "Municipal Bonds and Defaults."

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