What are Revenue Bonds?
The term “revenue bonds” refers to the category of municipal bonds that fund the revenue-generating government projects, such as highways, toll gates, or stadiums. Typically, the revenue bonds are backed by the revenue from the particular project that they finance and thus they are largely considered to be secured revenue sources. These types of bonds are usually issued by government agencies for projects having both operating revenues and expenses.
Explanation
Besides direct and indirect taxes, the government agencies also use the sale of bonds, securities, and treasury bills to fund their projects. The government bodies are authorized to raise funds by selling developmental loans in the bond market. The revenue bond is one of the fundraising tools used by the municipal bodies and its repayment is primarily secured by the operating revenues of the underlying project.
Characteristics of Revenue Bonds
Generally, revenue bonds exhibit the following characteristics:
- Long Tenure: Since these bonds are used for funding long-term projects, the maturity period often falls in the ranges of 20 to 30 years. Hence, these bonds suit investors with a longer investment horizon.
- Higher Return: The payments of both principal and interest are made after meeting the operating expenses of the specific projects. However, if the operating revenue is not adequate to cover the expenses, then the payments can be deferred to a later date, which leads to a greater risk of non-payment or default. Hence, these bonds offer higher returns as compared to other municipal bonds to compensate the investors for the risk.
- No Claim on Operating Assets: The bondholders don’t have any claim on the assets of the funded projects. It means that if the projects fail to generate adequate revenue to meet the promised returns, then the bondholders don’t have the right to claim possession of the assets of the underlying project.
- Call Provision: These bonds are usually callable in nature, which means that the issuer can call back the bonds in the case of any catastrophic event.
- Insurance/ Guarantee: Since these bonds are exposed to the risk of default in case of unsuccessful projects, the issuing entities often provide insurance or federal guarantee on the bonds.
Examples of Revenue Bonds
Now, let us look at some of the real-life examples of revenue bonds.
Example #1
New York’sMetropolitan Transportation Authority (MTA) issued its first Climate bonds in February 2016. The proceeds from the bonds were allocated towards investments in the electrified rail assets and their related infrastructure.MTA had over $11 billion of eligible assets as part of the 2010-14 Capital Plan that were used to issue the bonds.
Source: Climate Bonds
Example #2
St. Louis of Missourioften uses tax-exempted revenue bonds for funding its infra-based projects and the maturity of these bonds is mostly in the range of 20 to 30 years. The interest earned on these bonds is tax-exempt from federal as well as many state taxes. The Airport Revenue Bond is an example of such a revenue bond used by this City and it is serviced with the revenues generated by the operation of the Airport. Currently, more than $550 million of the principal amount is outstanding across 11 series of Airport Revenue Bonds.
Source: St. Louis MO
How Are Revenue Bonds Paid?
The income generated from a municipal enterprise or project is put into a revenue fund. Now, the operating expenses of the project are paid from this revenue fund. If all the operating expenses are met and there is a surplus amount available in the revenue fund, only then the bondholders receive the principal and interest payments. This is how revenue bonds are paid.
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Types of Revenue Bonds
There are various types of revenue bonds available in the market and some of the major ones are as follows:
- Airport Revenue Bond: This type of municipal bond is issued by an airport authority and it is paid off using the revenue generated by the airport facility.
- Toll Revenue Bond: This type of municipal bond is used to fund public infrastructure projects, such as tunnels, expressways or bridges. Toll revenue bonds get paid off using the toll payments received from the users of the public facilities.
- Utility Revenue Bond: This type of municipal bond is used to fund essential public utility projects and is repaid using the project revenues.
- Hospital Revenue Bond: This type of municipal bond is issued to support the construction of new nursing homes, hospitals or related facilities. At times, the proceeds are used to purchase new hospital equipment or upgrading the existing facilities.
- Mortgage Revenue Bond: This type of bond is issued by the local or state Housing Finance Agencies and is also known as housing bonds. The proceeds are used to fund affordable mortgages for low to middle-income groups.
- Industrial Revenue Bond: Typically, a government agency issues this type of bond on behalf of a private sector company. The proceeds are used to acquire or build factories or other related equipment.
Structure of Revenue Bonds
The revenue bonds are typically issued in the increment of $5,000 and these bonds usually mature in 20 to 30 years.In some cases, the revenue bonds of a project are issued in a staggered manner such that all the bonds don’t mature at the same time and such bonds are popularly known as serial bonds.
Uses of Revenue Bonds
The proceeds from the revenue bonds are primarily used by government agencies to sponsor infrastructure projects. Some of the most common examples of these projects include the construction of bridges, highways, airports, sewer facilities, etc.
Advantages
Some of the major advantages of revenue bonds are as follows:
- The interest earned on these bonds is usually tax-exempted, which makes them attractive for the investors in the highest income tax bracket.
- These bonds are considered to be safer as compared to corporate bonds.
Disadvantages
Some of the major disadvantages of revenue bonds are as follows:
- These bonds are long-term in nature, which means the invested funds are blocked for a long time.
- They offer relatively lower interest rates as compared to corporate bonds of a similar investment horizon.
Conclusion
The revenue bonds make up almost two-thirds of the available municipal bonds. So, if investors are willing to invest in these bonds, then there are a lot of options available in the market. However, before investing the investors must assess the viability of the underlying project to avoid instances of credit default.
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