What Is a Revenue Bond?
A revenue bond is a category of municipal bond supported by the revenue from a specific project, such as a toll bridge, highway or local stadium. Revenue bonds that finance income-producing projects are thus secured by a specified revenue source. Typically, revenue bonds can be issued by any government agency or fund that is managed in the manner of a business, such as entities having both operating revenues and expenses.
Revenue bonds, which are also called municipal revenue bonds, differ from general obligation bonds (GO bonds) that can be repaid through a variety of tax sources.
- Revenue bonds are a class of municipal bond issued to fund public projects which then repay investors from the income created by that project.
- For instance, a toll road or utility can be financed with municipal bonds with creditors' interest and principal repaid from the tolls or fees collected.
- Revenue bonds, unlike GO bonds, are project-specific and are not funded by taxpayers.
Revenue Bonds Explained
A revenue bond repays creditors from income generated by the project that the bond itself is funding, such as a toll road or bridge. While a revenue bond is backed by a specific revenue stream, holders of GO bonds are relying on the full faith and credit of the issuing municipality. Typically, since holders of revenue bonds can only rely on the specific project's income, it has a higher risk than GO bonds and pays a higher rate of interest.
Broadly, several types of revenue bonds are commonly issued by state and local governments:
- An airport revenue bond is a type of municipal bond issued by a municipality or airport authority that uses the revenues of the airport facility to back the bond. In some cases, the airport revenue bond is a type of public purpose bond. However if more than 10% of the benefit from the airport will go to the private sector, the bond will be a private bond.
- A toll revenue bond is a type of municipal security used to build a public project such as a bridge, tunnel, or expressway. Revenues from tolls paid by users of the public project pay the principal and interest payments on the bond.
- Utility revenue bonds (essential services bonds) are municipal debt securities that are designed to finance public utility projects. The utility is required to repay bondholders directly from project revenues rather than a general tax fund.
- A hospital revenue bond is a type of municipal bond intended to support the construction of new hospitals, nursing homes, or related facilities. The bonds can also be used to purchase new equipment for these facilities or to finance upgrades for existing hospitals. The revenue created by the hospitals is then used to repay bondholders.
- Mortgage revenue bonds (MRBs) are bonds issued by local or state Housing Finance Agencies (HFAs). Also known as housing bonds, the HFA will issue the tax-free bonds to investors. Funding from the sale of these bonds is then used to finance affordable mortgages for low- and middle-income people.
- Industrial revenue bonds (IRBs) are municipal debt securities issued by a government agency on behalf of a private sector company and intended to build or acquire factories or other heavy equipment and tools.
Structure of Revenue Bonds
Typically, revenue bonds mature in 20 to 30 years and can be issued in various increments, including $1,000 and $5,000. The value of the bond is called the bond's face value, which is the amount paid to the investor or bondholder at the bond's maturity. Some revenue bonds have staggered maturity dates and do not mature at the same time. These are known as serial bonds.
Investors can purchase a revenue bond by paying the face value amount of the bond upfront and, in return, are paid interest over the life of the bond. At the bond's maturity, the face value amount is returned to the investor provided there was sufficient revenue from the project to pay back the bond. If there is insufficient revenue generated from the project, investors are at risk of losing their total investment.
For example, if a revenue bond is issued to build a new toll road, the tolls that are collected from motorists who drive on the road would be used to pay off the bond, after the building expenses have been paid. A primary reason for using revenue bonds is that they allow the municipality to avoid reaching legislated debt limits. An agency that is run solely on tax dollars, such as a public school, cannot issue revenue bonds, since these entities would be unable to pay off the bond using revenues from the specific project.
Real Life Examples
St. Louis, Missouri, engages in tax-exempt revenue bond financing. Typical projects funded this way are multi-family housing, in which a minimum of 20% of the units are set aside for households meeting income guidelines; publicly owned facilities; pollution control facilities; and various fixed assets such as land/buildings. The maturity of most of the issues is 20 to 30 years, and interest earned is generally tax-exempt from federal and most state income taxes. This also allows the issuer to pay a lower interest rate.
New York's Metropolitan Transportation Authority (MTA) decided to offer Green Bonds in February 2016. The MTA is using the $500 million of proceeds to pay for planned infrastructure renewal projects, including upgrades on its railroads. The bonds, issued under MTA's Transportation Revenue Bond, are backed by the agency's operating revenue and subsidies received from New York State.