What Is Net Revenue Pledge?
A net revenue pledge requires the issuer of a municipal bond to use generated revenues to service debt costs (interest and principal payments) immediately after satisfying maintenance and operational expenses.
- A net revenue pledge requires the issuer of a municipal bond to use generated revenues to service debt costs (interest and principal payments) immediately after satisfying maintenance and operational expenses.
- Net revenue pledges lower the risk of default of a municipal bond. This results in the bond having a higher credit rating.
- Net revenue pledges are often seen in revenue bonds for public projects such as airports, universities, bridges, water and sewage facilities, hospitals, and subsidized housing.
Understanding Net Revenue Pledge
The "net" portion of a net revenue pledge refers to the amount of revenue left after all necessary expenses have been satisfied (revenues minus expenses). Once this is done, the issuer must use the remaining revenue to honor the municipal bond's periodic interest payment and principal before using it for any other purpose.
Net revenue pledges are included in the covenants of municipal bonds to make the issues less risky to potential bondholders. The intent is that the issuer must use the revenue from the financed project to pay debt services first, thereby lowering the risk of default. As a result, bonds with net revenue pledges often have higher credit ratings than those that do not.
Types of Municipal Bonds
There are two basic types of municipal bonds.
- General obligation bonds (GO) gain security from the credit and taxing authority of the jurisdiction. They have a basis in the belief that the issuing municipality will be able to repay its obligations solely through taxes.
- Revenue bonds have security in the profits derived from tolls, charges, or rents from the facility built with the bond's issue. A net revenue pledge is a way of governing the repayment priority of revenue bonds, and they have an impact on the flow of funds for the bond issuer.
The schedule of expenses and interested parties prioritizes the use of payments from the funds raised by a public-works, bond-financed project.
Net Revenue Pledge vs. Gross Revenue Pledge
In a gross revenue pledge, the payment of debt service is made before the payment of operating and maintenance expenses. This payment priority elevates debt service higher than that of a net revenue pledge. However, this isn't necessarily preferred by bondholders. Bondholders may want the financed facility maintained in good repair so people continue to use it (and it continues to generate revenue). In this case, a net revenue pledge may be the best system.
Pledged revenue—the money obligated for the payment of debt service and for the making of other deposits required by the bond contract—and the flow of funds are both of critical importance when analyzing revenue bonds. Municipal bond analysts take these factors into account when considering the financial viability of projects.
Example of Net Revenue Pledge
Public projects financed by revenue bonds that may include net revenue pledges include airports, universities, bridges, water and sewage facilities, hospitals, and subsidized housing.
For example, suppose that a bond issue for the construction of a new public toll road raises $10 million. However, the construction of the new public toll road costs just $8 million. In this example, the issuer would be required to use the remaining $2 million to pay back the debt from the bond.