What is a 'Utility Revenue Bond'

A utility revenue bonds are municipal debt securities which 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 utility revenue bond, also known as an essential service bond.

BREAKING DOWN 'Utility Revenue Bond'

A utility revenue bond is used to fund capital projects in areas considered essential to public services including hospitals, fire service, water and waste treatment facilities, or improvements to the electrical grid. These services generate revenue through customer fees which provide cash flows that can cover debt service obligations.

Revenue bonds have either a gross revenue pledge or a net revenue pledge debt structure.  Gross revenue debt gives bondholder payments priority over operational or maintenance costs incurred by the project. Net revenue pledge allows for the disbursement of administrative expenses and upkeep costs before satisfying obligations to bondholders.

Utilities deliver services considered essential to their customers such as water and electrical service. Due to the necessity of the service they provide, it is common for utility revenue bonds to feature a net revenue pledge. Since these facilities are essential to the community, upkeep must be implemented to maintain them in good working order.

It is also common for utilities to be required to maintain a specific revenue-to-expenditure ratio. The inclusion of debt repayment is as an expense, and the ratio is often used to support customer rate increases for public utilities.

Paying Back Utility Revenue Bonds

Municipal bonds repay bondholders through either municipal taxation, as in a general obligation bond (GO), or through revenue bonds. Revenue bonds derive income from the capital project. The issuer of general obligation bonds guarantees the repayment of debt via any means necessary. It can raise taxes, issue another round of bonds, or even sell physical assets to collect funds. The issuer of the debt is not constrained to a single stream of revenue to satisfy obligations. Investors should be aware of this distinction and can use it as they build a diversified, fixed-income portfolio. 

Other factors come into play when credit ratings agencies or investors evaluate utility revenue bonds and the projects they finance. The coverage ratio is used to determine expected revenues to principal and interest obligations. Population size and trends can provide an idea of future revenue growth or decline for a utility project. 

Customer concentration describes the mix of consumers whose usage fees support debt repayment. If a small number of consumers use a significant portion of a public utility’s service, that may lead to risk for the viability of that project’s revenues.

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