What is a Net Revenue Pledge
A net revenue pledge is a provision that requires issuers of municipal bonds to use their net revenues to pay the principal and interest of the municipal bond before using them for other purposes. The calculation of net revenues is revenues minus expenses. Additional fees the city must pay relating to the bond issue are operating, and maintenance costs of the public works project funded by the municipal bond.
BREAKING DOWN Net Revenue Pledge
Net revenue pledges are restrictive covenants intended to mitigate risk for bondholders. The intent is that the issuer has to use the revenues from the financed product to pay debt services first, thereby lowering the risk of default. As a result, bonds with net revenue pledges often have higher debt ratings than those that do not.
There are two basic types of municipal bonds.
- General obligation bonds (GOs) 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 through taxes and no other collateral.
- 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.
In a Gross Revenue Pledge, the payment of debt service is before the payment of operating and maintenance expenses. This payment priority elevates debt service higher than it is in 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 is the better system.
Pledged revenue, or 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 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 can include net revenue pledges include airports, universities, bridges, water and sewage facilities, hospitals, and subsidized housing. An example of a net revenue pledge in action would be if a bond issue raises $10 million. However, the construction of the new public toll road only costs $8 million. In this example, the issuer would be required to use the remaining $2 million to pay back the debt from the bond.