Revenue Bond

The credit risk bulletin reaches the same division. According to the bulletin, the type of municipal bond issued affects both the risk of default and the value of the municipal bond, repayment may come from the issuer, an obligor, or from a single tax or revenue source, and revenue bonds are backed by revenues from a specific project or source. There is a wide diversity of types of revenue bonds, each with unique credit characteristics.

According to the MSRB's infrastructure primer, revenue bonds typically rely on revenues from a specific project or system, such as a water or electric utility, and repay investors from a dedicated revenue stream, such as tolls collected for a road, airport user fees, the sale of electricity from a municipal facility or college and university tuition payments.

Pledged Revenues and the Limit on Repayment

According to the MSRB's page on sources of repayment, the issuer of a revenue bond is not obligated to pay principal and interest on its bonds using any source other than the sources specifically pledged to the bond. Revenue bonds are payable from identified sources of revenue and do not permit the bondholders to compel taxation or legislative appropriation of funds not pledged for payment of debt service.

Pledged revenues may be derived from operation of the financed project, grants or excise or other specified non-ad-valorem taxes. Generally, no voter approval is required before such obligations are issued. If the specified sources of revenue become inadequate, a default in payment of principal or interest may occur.

Various types of pledges of revenue may be used to secure interest and principal payments on revenue bonds, and the nature of these pledges may differ widely based on the type of issuer, type of revenue stream and other factors. Some revenue bonds are issued by governmental agencies to fund facilities for essential public services. A bond issued by a municipal water and sewer authority, for example, typically would involve revenues obtained through local water and sewer assessments. The pledge of revenue would identify specific assessments that can be used to pay principal and interest on the bonds, the authority's responsibility and ability, if any, to raise water and sewer assessments, and any superior claim on the assessments.

Revenue Bonds and General Obligation Bonds

According to the MSRB, general obligation bonds typically are issued by a state or local government that pledges its full faith, credit and taxing power to pay principal and interest. They may be payable from general funds including income taxes or property taxes of the issuer, although the precise source and priority of payment may vary considerably from issuer to issuer depending on applicable state or local law. General obligation bonds issued by local units of government often are payable from, and in some cases solely from, the issuer's ad valorem taxes, while those issued by states often are payable from appropriations made by the state legislature. General obligation bonds may require approval by voters before issuance. In the event of default in required payments of interest or principal, general obligation bondholders typically have certain rights to compel a tax levy or a legislative appropriation.

The SEC's investor bulletin Municipal Bonds: An Overview describes general obligation bonds as not secured by any assets of the municipal issuer and as backed by the full faith and credit of the municipal issuer, which has the power to tax residents to pay bondholders. The credit risk bulletin describes them as not backed by revenues from a specific project or source. Some are backed by dedicated taxes on real property and, on occasion, other taxes. While in many instances general obligation means that the issuer or other governmental entity responsible for repaying the bonds has the unlimited authority to tax residents to pay bondholders, in other cases the issuer or other governmental entity may have limited or no taxing authority.

Conduit Revenue Bonds and Private Activity Bonds

The MSRB describes another type of revenue bond as one that may be issued by a governmental issuer acting as conduit for the benefit of a private sector entity or a 501(c)(3) organization. In these cases the governmental issuer is seeking to advance specific public purposes within its mission, and conduit bonds are commonly issued for not-for-profit hospitals, single and multi-family housing, industrial or economic development, student loan programs or waste disposal facilities. Principal and interest on such bonds normally are paid exclusively from revenues pledged by the entity receiving financing, called the obligor. Unless otherwise specified under the terms of the bonds, the issuer is not required to make payments of principal or interest if the obligor defaults.

The MSRB glossary defines the underlying transaction. A conduit financing is the issuance of municipal securities by a governmental unit, referred to as the issuer or conduit issuer, to finance a project to be used primarily by a third party, which may be a for-profit entity engaged in private enterprise, a 501(c)(3) organization, or another governmental entity, referred to as the conduit borrower. In a conduit financing, the conduit borrower is liable for making debt service payments on the bonds. The glossary names industrial development bonds, multi-family housing revenue bonds and qualified 501(c)(3) bonds as common types of conduit financings. It defines a conduit borrower as a borrower of bond proceeds in a conduit financing and a conduit issuer as an issuer of municipal securities that issues securities on behalf of another entity.

The MSRB's municipal bond basics page connects conduit issuers to private activity bonds. It states that municipal issuers sometimes issue a type of revenue bond, known as private activity bonds, on behalf of private entities that are unable to issue tax-exempt debt on their own to finance certain types of projects such as healthcare facilities, affordable housing and educational facilities. In these cases the public entity acts as a conduit issuer on behalf of the borrower but does not take responsibility to pay or guarantee the payment of the bonds. Instead, the borrower, known as the obligor, is ultimately responsible to pay interest and return the principal on the bond.

The SEC's investor bulletin Municipal Bonds: An Overview describes the same arrangement. Conduit revenue bonds are issued by a municipal issuer on behalf of a private entity such as a non-profit college or hospital, and these conduit borrowers typically agree to repay the municipal issuer, who pays the interest and principal on the bonds. The credit risk bulletin adds that the issuer pays the interest and principal on the securities solely from the revenue provided by the conduit borrower.

Non-Recourse Revenue Bonds

The SEC's bulletins use the term non-recourse for some revenue bonds. A non-recourse revenue bond is one where, if the revenue stream dries up, or if payments on the bonds are otherwise not paid, the bondholders do not have a claim on the underlying revenue source or against the conduit borrower, according to the credit risk bulletin. In instances where a conduit borrower fails to make a payment to the municipal issuer, the issuer is usually not required to pay the bondholders. The bulletin adds that for these reasons it is essential to understand the source of the revenues that will be used to repay the bonds.

Double-Barreled and Moral Obligation Bonds

The MSRB also describes two other pledge structures. A double-barreled bond is secured by a defined revenue source as well as the full faith and credit of an issuer that has taxing power, so it has both general obligation and revenue pledges.

A moral obligation bond is usually issued by a state or agency and is secured by a non-binding covenant that any amount necessary to make up any deficiency in pledged revenues available for debt service will be included in the budget recommendation made to the state legislature or other legislative body, which may appropriate funds to make up the shortfall. The legislature or other legislative body is not legally obligated to make such an appropriation. Unlike a general obligation pledge, the moral obligation bond does not require voter approval and does not have the state official pledge of its full faith and credit.

The Bond Contract and the Pledged Revenues

The MSRB glossary defines a bond contract as an agreement outlining the obligations of the issuer with respect to the issuance and repayment of bonds. The terms of the agreement may be determined by reference to specified documents associated with the bond issue. Typically, the bond resolution or trust indenture, together with any other security agreements, constitute parts of the contract, as do those laws in force at the time of issuance, and the documents that form the bond contract vary according to the terms of each issue.

The glossary defines the bond resolution as the document or documents in which the issuer authorizes the issuance and sale of municipal securities. Read together, the resolutions describe the nature of the obligation, the issuer's duties to the bondholders, the issuer's rights with respect to the obligations and the security for the obligations. In certain jurisdictions the governing body acts by means of an ordinance rather than by resolution.

Covenants in the bond contract govern how pledged revenues are protected. The glossary defines a covenant, or bond covenant, as a contractual obligation set forth in a bond contract. Covenants commonly made in connection with a bond issue may include covenants to charge fees sufficient to provide required pledged revenues, called a rate covenant; to maintain casualty insurance on the project; to complete, maintain and operate the project; not to sell or encumber the project; not to issue parity bonds or other indebtedness unless certain tests are met, called an additional bonds or additional indebtedness covenant; and not to take actions that would cause tax-exempt interest on the bonds to become taxable or otherwise become arbitrage bonds, called tax covenants. A covenant whereby a party is affirmatively obligated to undertake a duty to protect the interests of bondholders is referred to as an affirmative or protective covenant. A covenant whereby the issuer obligates itself to refrain from performing certain actions is referred to as a negative covenant.

The glossary also defines the revenues available to pay debt service. Available revenues are the funds obligated for the payment of debt service and the making of other deposits required by the bond. A gross revenue pledge, or gross pledge, is a pledge that all revenues received will be used for debt service prior to deductions for any other costs or expenses, and many bond contracts with gross revenue pledges have provisions permitting the bond trustee to use gross revenues to pay operating expenses prior to debt service. A net revenue pledge, or net pledge, is a pledge that revenues less deductions for specified costs and expenses will be used for payment of debt service.

Additional Bonds, Coverage and Debt Service

The glossary defines additional bonds as an issue of bonds having a lien on the same revenues or other security pledged to outstanding bonds. Additional bonds may be issued on a parity with the outstanding bonds, although in some cases additional bonds may have either a junior lien or a senior lien on pledged revenues or other security. They are generally issued under the same bond contract.

The additional bonds covenant or test is the financial test, sometimes referred to as a parity test, that must be satisfied under the bond contract securing outstanding revenue bonds or other types of bonds as a condition to issuing additional bonds. Typically, the test would require that historical revenues, plus in some cases future estimated revenues, exceed projected debt service requirements for both the outstanding issue and the proposed issue by a certain ratio.

Debt service is the amount of money necessary to pay interest on outstanding bonds, the principal of maturing or redeemed bonds and any required contributions to a sinking fund for term bonds, also known as the debt service requirement. Coverage is the ratio of the revenues available annually to pay debt service to the annual debt service requirement, often referred to as debt service coverage or the coverage ratio. The ratio is one indication of the availability of revenues for payment of debt service.

Credit Enhancement

According to the MSRB, some municipal securities are backed by a third-party credit enhancement, which backstops the primary pledge to pay principal and interest. Forms of credit enhancement include bond insurance, bank letters of credit, state school guarantees and credit programs of federal or state governments or federal agencies. Credit enhancement serves as a secondary source of payment if the primary source of payment is insufficient.

The MSRB's page adds that investors should take care to note the current credit quality of the guaranty or letter of credit bank, but should also consider carefully the credit of the issuer or the obligor, since the financial strength of credit enhancers can change over time and in some cases could decline. Insured bonds and bonds backed by letters of credit often carry two separate ratings, one based on the financial strength of the insurer or bank and the other, the underlying rating, based on the financial strength of the issuer or obligor making the primary pledge for payment of principal and interest. In other cases a guarantee may be provided by a different type of related third party, such as another unit of government, or in the case of conduit revenue bonds, a parent corporation or other entity related to the private beneficiary of the bonds.

Tax Treatment of Revenue Bond Interest

According to the MSRB's municipal bond basics page, municipal bonds are generally referred to as tax-exempt bonds because the interest earned on the bonds often is excluded from gross income for federal income tax purposes and, in some cases, is also exempt from state and local income taxes. Given the tax benefits, the interest rate for tax-exempt municipal bonds is typically lower than that on taxable fixed-income securities, such as corporate bonds and even Treasury bonds.

Not all municipal bonds are tax-exempt. For interest on a municipal bond to be exempt from federal income tax, the issuer must meet several requirements in the federal income tax code. Municipal issuers sometimes issue taxable bonds if the purpose of the issuer's financing does not meet certain purpose or public use tests under federal tax rules. Certain municipal bonds, such as private activity bonds, are subject to the federal alternative minimum tax, which means an investor's interest income could be included in the calculation of the investor's alternative minimum tax. The yields on bonds subject to the alternative minimum tax are higher, reflecting the risk that they could become taxable to some investors at some point in time.

Credit Risk Factors for Revenue Bonds

The SEC's credit risk bulletin lists five factors for investors to consider: the type of municipal bond, whether the financing is non-recourse, the purpose of the financing, the financial condition of the issuer or other obligor, and other sources of funds to pay principal and interest.

On the purpose of the financing, the bulletin explains that municipal bond default rates vary considerably depending on a variety of factors, including the types of bonds issued and whether the ultimate obligor is a municipal entity or a non-municipal entity, such as a conduit borrower. An investor considering municipal securities that finance speculative projects, including those involving for-profit businesses, should pay close attention to the potential risks involved. The official statement for this kind of offering usually will include a feasibility study showing the key assumptions made in evaluating the project.

On the financial condition of the issuer or other obligor, a key concern is whether the issuer or other obligor will be able to pay interest and principal in full. The bulletin lists debt and other longer-term liabilities payable from or impacting the same source of revenue as the bonds, including, if applicable, pension and other postemployment benefit obligations of the municipal bond issuer; the underlying local economy, including employment, income, wealth, and tax burden; and the audited financial statements of the issuer or obligor, including both revenues and expenses.

On other sources of funds, the bulletin notes that while some municipal bonds are general obligation bonds, others are repaid not by an issuer or other obligor but from a specific payment stream, and that an investor should evaluate the viability of the sources of revenue to be used to make these payments. In evaluating the source of payment, it lists economic or social trends that may limit demand for particular goods or services, such as gasoline or cigarettes, when those goods or services are being taxed to fund the repayment of the securities, and statutory limits on raising revenues, such as the need for voter approval.

The bulletin also addresses credit ratings. Investors should not rely solely on credit ratings when deciding whether to purchase municipal bonds. Credit ratings are assessments of municipal bonds' credit risk at a particular point in time, and because they may change over time, the credit rating found on the official statement may not be the credit rating of the municipal bonds if the investor purchases them on a subsequent date. In general, credit rating agencies are paid by the issuer whose municipal bonds they are rating, and credit ratings are not investment advice, guarantees of credit quality or of future credit risk, or indications that an investment is suitable.

Where Information on a Revenue Bond Is Found

According to the credit risk bulletin, in most cases official statements, as well as updated information regarding the issuer and the municipal bonds, can be found on the Electronic Municipal Market Access website, known as EMMA. The issuer's financial information is often updated each year, and many municipal bond issuers provide material event notices that contain information concerning, among other things, delinquent principal and interest payments, other types of defaults, rating changes, events impacting the tax status of the securities, and bond redemptions or calls.

Often, the official statement contains a section titled investment risk factors or investment considerations, which provides information relevant to the investment decision, and pertinent financial information regarding the issuer generally may be found in an appendix attached to the official statement. The bulletin also tells investors to read the official statement describing the revenue bond and to understand both the identity of the conduit borrower, if any, and what revenues are actually pledged to back the bonds before making an investment decision.

Revenue Bonds in FINRA's Examination Outline

FINRA's Securities Industry Essentials examination content outline carries a 2025 copyright. Section 2 of the outline, Understanding Products and Their Risks, includes topic 2.1.2, Debt Instruments. That topic lists municipal securities, general obligation bonds, revenue bonds, and others, such as special type bonds, taxable municipal securities and short-term obligations. Candidates should check the current outline before the examination.

Common Misunderstandings

A revenue bond is not backed by the issuer's taxing power. The MSRB states that revenue bond is the term used generally for a bond payable from a specific source of revenue and to which the full faith and credit of an issuer with taxing power is not pledged.

Revenue bondholders cannot compel taxation or appropriation of funds that were not pledged. The MSRB states that revenue bonds do not permit the bondholders to compel taxation or legislative appropriation of funds not pledged for payment of debt service, while general obligation bondholders typically have certain rights to compel a tax levy or a legislative appropriation.

A governmental issuer is not always the party responsible for repayment. In a conduit financing, the conduit borrower is liable for making debt service payments, and the issuer is not required to make payments of principal or interest if the obligor defaults unless the terms of the bonds say otherwise.

A revenue bond is not always free of a taxing power pledge. A double-barreled bond is secured by a defined revenue source as well as the full faith and credit of an issuer that has taxing power.

A moral obligation pledge is not a legal obligation to appropriate. The legislature or other legislative body is not legally obligated to make the appropriation.

Pledged revenues are not always gross revenues. The MSRB glossary distinguishes a gross revenue pledge, under which all revenues received will be used for debt service prior to deductions for any other costs or expenses, from a net revenue pledge, under which revenues less deductions for specified costs and expenses will be used for payment of debt service.

Interest on a municipal bond is not always tax-exempt. The MSRB states that not all municipal bonds are tax-exempt and that certain municipal bonds, such as private activity bonds, are subject to the federal alternative minimum tax.

A credit rating is not a guarantee. The SEC's credit risk bulletin states that credit ratings are not investment advice, guarantees of credit quality or of future credit risk, or indications that an investment is suitable.

Key Points

A revenue bond is a municipal bond not backed by the government's taxing power but by revenues from a specific project or source, such as highway tolls or lease fees, according to Investor.gov.

According to the MSRB, the issuer of a revenue bond is not obligated to pay principal and interest using any source other than the sources specifically pledged to the bond, and revenue bonds do not permit the bondholders to compel taxation or legislative appropriation of funds not pledged for payment of debt service.

Generally, no voter approval is required before revenue bonds are issued, according to the MSRB.

In a conduit revenue bond, the conduit borrower is liable for making debt service payments, and where the borrower fails to pay, the municipal issuer usually is not required to pay the bondholders, according to the SEC.

The MSRB glossary describes the rate covenant, the additional bonds test, gross and net revenue pledges, and coverage as terms that concern pledged revenues.

FINRA's outline for the Securities Industry Essentials examination lists revenue bonds in the debt instruments topic.