A revenue bond is a type of municipal bond issued by state or local governments, or their agencies, to finance specific public projects. Unlike other forms of municipal debt, the repayment of revenue bonds is secured solely by the income generated from the project they fund, rather than by the full faith and credit of the issuing governmental entity. This makes revenue bonds a distinct category within the broader field of fixed income securities. These bonds are frequently used for infrastructure projects that are expected to produce their own revenue streams, such as toll roads, bridges, airports, public utility systems, and hospitals36, 37.
History and Origin
Revenue bonds gained significant prominence in the United States, particularly during the Great Depression era of the 1930s. Before this period, state and local governments primarily relied on general obligation bonds, which were backed by the issuer's taxing power. However, with economic downturns limiting tax revenues and many municipalities facing debt limits, a new financing mechanism was needed to fund essential public works. Revenue bonds offered a solution by allowing governments to finance projects through future user fees or service charges, bypassing general tax revenue constraints35. This innovation provided a crucial means for continued public investment when traditional funding sources were strained. The National League of Cities highlights how such bonds became vital for funding public services and infrastructure, emphasizing their role in community well-being and growth throughout history.34
Key Takeaways
- Revenue bonds are a type of municipal bond used to finance self-supporting public projects.
- Their repayment is tied exclusively to the revenues generated by the funded project, such as tolls, fees, or utility charges.
- Unlike general obligation bonds, they are not backed by the general taxing power or full faith and credit of the issuing government.
- Revenue bonds often carry a higher yield than general obligation bonds due to their project-specific default risk32, 33.
- They are a key tool for public debt financing of airports, bridges, water systems, and other income-generating infrastructure.
Interpreting Revenue Bonds
Interpreting revenue bonds primarily involves assessing the financial viability and stability of the underlying project. Investors must evaluate the projected revenue streams, the legal structure of the bond issuance, and any bond covenants that outline how project revenues will be managed and prioritized for debt service. A thorough feasibility study is often conducted before issuance to gauge the likelihood of the project generating sufficient funds to cover interest payments and principal repayment.
Key factors to consider include the demand for the project's services, its operational efficiency, and the regulatory environment. For instance, a toll road revenue bond's performance depends on traffic volume, while a utility revenue bond relies on consistent service usage and pricing power. A strong credit rating for a revenue bond typically indicates confidence in the project's ability to generate reliable income, making it a more attractive, potentially investment-grade option for investors.
Hypothetical Example
Consider the city of Metropolis, which needs to build a new wastewater treatment plant to meet growing population demands. Instead of using its general tax revenues, the city's water and sewer authority decides to issue $100 million in revenue bonds. The proceeds from these bonds will finance the construction.
Once the plant is operational, the authority will collect fees from residents for water and sewer services. These fees constitute the dedicated revenue stream that will be used exclusively to pay back the principal and interest to the holders of the revenue bonds. If the wastewater plant performs as expected and collects sufficient service fees, bondholders receive their scheduled payments. However, if there are fewer users than anticipated, or if economic conditions reduce the ability of residents to pay their utility bills, the revenue stream might fall short, potentially impacting the bond's repayment ability. This highlights the importance of the project's success to the bond's performance.
Practical Applications
Revenue bonds are a cornerstone of public finance, enabling governments and public authorities to undertake large-scale infrastructure projects and essential services without burdening general taxpayers. Common practical applications include:
- Transportation Infrastructure: Funding for toll roads, bridges, airports, and mass transit systems, where tolls, fares, or airport fees provide the revenue30, 31.
- Public Utilities: Financing water and sewer systems, electric power plants, and gas distribution networks, repaid by utility service charges29.
- Healthcare Facilities: Developing hospitals, nursing homes, and medical centers, with repayment coming from patient fees and service charges28.
- Higher Education: Building university dormitories, student unions, and research facilities, backed by student tuition fees or housing charges.
- Housing Projects: Issuing mortgage revenue bonds to finance affordable housing, with repayment from mortgage payments27.
These bonds allow for targeted [debt financing], making them flexible for various public needs. The U.S. Securities and Exchange Commission (SEC) regulates the municipal securities market, providing oversight and resources for investors to understand these instruments, including disclosure requirements that aid in transparency.26 For more insights into how revenue bonds facilitate infrastructure development, resources from the SEC are available online.25 Furthermore, various states have utilized revenue bonds to fund significant infrastructure, as highlighted by publications such as Governing.com.24
Limitations and Criticisms
While revenue bonds offer flexibility in funding public projects, they come with specific limitations and criticisms. A primary concern is their reliance on the specific revenue-generating project. If the project underperforms—due to lower-than-expected usage, economic downturns, or poor management—the dedicated revenue stream may be insufficient to cover [interest payments] and principal repayment, increasing the [default risk] for bondholders. Un23like [general obligation bonds], revenue bonds typically lack the broader tax-backing of the issuing municipality, meaning investors generally have no claim on the issuer's general funds or taxing authority if the project revenue fails.
T21, 22his lack of full faith and credit pledge can lead to higher [yield] requirements from investors, as they demand greater compensation for the increased risk. Furthermore, the complexity of evaluating project-specific revenues often necessitates extensive [feasibility study] and ongoing monitoring, which can be challenging for individual investors. The Puerto Rico debt crisis is a notable example where various municipal bonds, including revenue bonds, faced significant financial distress due to economic challenges and unsustainable debt levels, illustrating the potential for severe consequences when revenue streams or economic conditions deteriorate. The19, 20 Brookings Institution provides detailed analysis of such crises and their implications for the broader municipal bond market.
##18 Revenue Bonds vs. General Obligation Bonds
The key distinction between revenue bonds and [general obligation bonds] lies in their source of [repayment] and underlying security.
| Feature | Revenue Bonds | General Obligation Bonds |
|---|---|---|
| Source of Repayment | Dedicated revenues generated by the specific project (e.g., tolls, fees, utility charges) | G17eneral taxing power of the issuer (e.g., property taxes, sales taxes, income taxes) |
| 15, 16 Security | Backed by project revenues and sometimes reserves or [bond covenants] | Backed by the "full faith and credit" of the issuing government 13, 14 |
| Voter Approval | Generally do not require voter approval, as they don't impact general tax revenues | Often require voter approval, as they pledge the government's general taxing power |
| 12 Risk & Yield | Typically carry higher [default risk] and offer higher [yield] due to project-specific nature | G10, 11enerally lower [default risk] and lower [yield] due to broader tax backing |
| 9 Project Type | Used for self-supporting projects (e.g., airports, utilities, toll roads) | 7, 8Used for general public purposes (e.g., schools, police departments, administrative buildings) |
6While revenue bonds enable [debt financing] for specific projects without burdening the general tax base, their performance is intrinsically linked to the success of that particular project. General obligation bonds, conversely, rely on the broader economic health and tax collection ability of the issuing entity.
FAQs
What types of projects are typically financed by revenue bonds?
Revenue bonds commonly finance projects that generate their own income. This includes [infrastructure projects] like toll roads, bridges, and airports (repaid by tolls and fees), public utility systems (water, sewer, electricity, repaid by user charges), hospitals (repaid by patient fees), and university dormitories (repaid by student housing fees).
#4, 5## Are revenue bonds tax-exempt?
Similar to most [municipal bonds], the interest income from revenue bonds is generally exempt from federal income tax. It may also be exempt from state and local taxes if the bondholder resides in the state or locality where the bond was issued. Th2, 3is tax-exempt status makes them attractive to certain investors, particularly those in higher tax brackets.
What happens if a project funded by revenue bonds does not generate enough revenue?
If a project fails to generate sufficient revenue, the issuer may face challenges in making scheduled [interest payments] and principal [repayment]. Since revenue bonds are typically not backed by the general taxing power of the government, bondholders may not have recourse to the municipality's other funds. Th1is can lead to delays in payments, restructuring of debt, or, in severe cases, default, highlighting the importance of a thorough [feasibility study] before investment.
How do investors assess the risk of revenue bonds?
Investors assess the risk of revenue bonds by conducting due diligence on the specific project's financial projections, management, and economic environment. Key considerations include the project's [credit rating], projected cash flows, the demand for its services, and the terms of the [bond covenants]. Understanding these factors helps evaluate the likelihood of consistent revenue generation and, consequently, the bond's [default risk].
Do revenue bonds require voter approval?
Typically, revenue bonds do not require voter approval. This is because their [repayment] is derived from the project's revenues, not from general tax revenues that would directly impact taxpayers. This contrasts with [general obligation bonds], which often require voter approval as they pledge the full faith and credit, and thus taxing power, of the issuing government.