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What Is a Revenue Bond?

Revenue bonds are a debt obligation issued by the U.S. government. They provide interest income to bondholders who invest in them.

The interest is unconnected to the success of an underlying asset such as a physical or financial asset or equity position. This type of bond can be backed by anticipated revenue sources.

It is often paired with stocks that provide good investment returns, but are considered too risky for fixed income obligations. We will review how these types of bonds work, the different types and features associated with them.

How Do Revenue Bonds Work?

A revenue bond is an obligation of the government that provides annual interest payments to investors. This or any other type of asset backed security has its own characteristics, which will be discussed in detail. 

What Is an Example of a Revenue Bond?

The example below illustrates the type of revenue bonds issued by the state of Virginia. This particular bond is backed by taxes from the commonwealth’s revenues and will be repaid with those same resources.

It was issued based on an estimate of $100 million in annual revenues from this source, which works out to $10 million per year. The state will make interest payments on this debt obligation based on the revenues derived from the “asset” held, in this case, the tax collections.

The interest payments are unconnected to the profitability of the underlying asset, which is a positive for investors looking for potentially higher returns. Because of its nature as a debt obligation, revenue bonds are given a very high rating by rating agencies such as Standard and Poor’s, Moody’s and Fitch.

Where Do the Payments of Revenue Bonds Come From?

Revenue bonds are backed by an anticipated revenue stream from a particular type of revenue. It comes from sources such as taxation, tolls, and fees.

For the case of this bond, it is backed by taxes collected on real property in the commonwealth. The projected $10 million per year will be paid to investors over 20 years in an interest-only obligation.

As long as taxes come into the state’s coffers for this purpose, investors will receive their payments.

Do Revenue Bonds Require Voter Approval?

It is very important to understand that only general revenue bonds, and not tax-increment financing bonds, require voter approval. General revenue bonds are considered the “back door” to funding for city and county governments.

They do not require voter approval. 

What Are Typical Interest Rates With Revenue Bonds?

The interest rate for most revenue bonds is determined through competitive bidding. Bidding can be done either with a single bidder or multiple bidders. 

If you are looking for a high-volume bond the interest rates tend to be higher than if you are looking at a small amount of bonds. The bid-winner is chosen based on who can provide the best rate that meets the minimum required interest rate and fee specified by the issuer.

What Are Tax Implications With Revenue Bonds?

Because the interest payments related to this type of debt obligation are unconnected to the profitability of the underlying asset, investors receive tax-exempt income. In other words, there is little risk for investors who do not want to take a chance on fluctuating interest rates. 

Types of Revenue Bonds

There are several types of revenue bonds, which include:

Municipal Revenue Bonds

Municipal revenue bonds are tax-exempt bonds issued by states and local governments, providing investors with revenue streams based on how much income is brought in through specific assets held by the issuer. For example, these bonds fund public projects like building highways.

The revenue made from the project funded, will go towards repaying investors.

Utility Revenue Bonds

Utility revenue bonds are considered a form of revenue bond because they make use of a particular type of asset that the issuer has under its control. This asset is usually related to public utility needs that are considered to be essential to the public.

For example, services like the fire department and waste management.

Industrial Revenue Bonds

Industrial revenue bonds are government-issued debt obligation with payment streams based on the volume that a particular type of industrial product, such as metal or oil, is purchased by the issuer.

Toll Revenue Bonds

Toll revenue bonds are bonds that have payment streams linked to the volume of the activity of traveling on a particular type of transportation, such as highways.

Hospital Revenue Bonds

Hospital revenue bonds are financial obligations that have their payments linked to the revenues that an issuer receives from funding the construction of new medical structures or from renovating an already existing medical facility.

Education Revenue Bonds

Education revenue bonds are debt obligations issued by state and local governments that get their payment streams from a specific type of activity, such as tuition fees paid by students. 

This is typically issued through a school or educational institution, such as a university or college. These types of institutions have tax exempt status related to the debt obligation they issue.

Airport Revenue Bonds

Airport revenue bonds are sold by local governments and have the payment stream tied to the fees incentivized for people who use airport facilities. The bonds issued go towards funding new airports or expanding and renovating existing airports.

Entertainment Revenue Bonds

Entertainment revenue bonds are debt obligations sold by state or local governments that make money through amusement or entertainment activities. They receive a payment stream from things such as arena events, concerts, theaters and other similar activities.

Mortgage Revenue Bonds

Mortgage revenue bonds are debt obligations that get their payment streams from mortgage fees from specific types of properties held by the issuer. 

Features of Revenue Bonds

There are several features that make revenue bonds more appealing to investors than traditional bonds. These features are:

Call Provision

A call provision is a type of debt covenant that allows the issuer to call back the debt obligation before it matures. This means that the issuer may repurchase the bond before it reaches maturity.

The issuer buys back the bonds at a discount and pays off any interest payments still outstanding. This is very common with revenue bonds because issuers want to use these instruments as a way to manage their cash flow in times of low sales or if they are anticipating future capital needs.

Issuers typically use this as an additional source of capital.

High Returns

In order to compensate investors for the lack of a guarantee that they will receive interest payments as outlined in the indenture, revenue bonds can promise a much higher return than traditional bonds.

Revenue bonds offer higher returns because investors are taking a slight risk with these types of instruments. The risks come from the fact that there is a chance the issuer won’t be able to use future tax revenue streams for their payment obligation.

Long Maturity Date

Revenue bonds typically have a long maturity date. That is because issuers often use these bonds as a way to manage their cash flow in times of low sales or if they are anticipating future capital needs. 

Issuers typically issue revenue bonds to finance large projects, which can range anywhere from building a new airport to financing the development of new technologies and equipment. These debt obligations are then repaid over time with the revenues that they receive from taxpayers, fees, or other sources of income within their control.

Why Do Revenue Bonds Matter?

Revenue bonds are one of the most important forms of debt obligations that investors can purchase. They are used to finance major capital projects and can help resolve local budget issues. 

Investors see bond documents because they want to ensure that their investment is protected if a government backs out on its commitment. If there is no guarantee, then the bond will suffer a significant devaluation in price.

This means that investors will receive less than the face value of their investment, which they have already pre-paid for upfront.

Revenue Bonds vs General Obligation Bonds

The main difference between revenue bonds and general obligation bonds is that revenue bonds don’t have the same type of government-guarantee. The payments to bondholders come from taxpayers, fees, or other sources of income within the control of the issuing government. 

General obligation bonds are backed by the taxing power of a government. This means that the government promises to pay bondholders before any other kind of creditor, including citizens.

The Name’s Bond, Revenue Bond

Revenue bonds are one of the most important forms of debt obligations that investors can purchase. They are used to finance major capital projects and can help resolve local budget issues. 

Investors see bond documents because they want to ensure that their investment is protected if a government backs out on its commitment. If there is no guarantee, then the bond will suffer a significant devaluation in price.

If you are considering investing in a revenue bond and want to know if this is the right investment for you, consider reaching out to a financial advisor for further guidance.

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