What is a utility revenue bond?
A particular kind of municipal bond used to support a public utility that pays back creditors directly from project earnings instead of a general tax fund is called a utility revenue bond, often referred to as an essential service bond.
An Explanation of Utility Revenue Bonds
Utility revenue bonds fund capital projects in areas deemed necessary for public services, such as hospitals, fire departments, water and sewage treatment plants, and grid upgrades. Customer fees are how these services make money; those cash flows go toward paying the loan.
A gross or net revenue commitment is attached to revenue bonds. Bondholder payments are prioritized above project operating or maintenance expenditures when a commitment of gross income is made. A net revenue pledge permits maintenance and administrative expenditures to be paid before bondholder obligations are met.
Utilities provide essential services like power and water. Because these services are essential, utility revenue bonds often include a net revenue commitment because maintenance is required to keep them in good operating condition.
Utilities are often mandated to maintain a certain revenue-to-expenditure ratio. Debt repayment is included as an expenditure, and the ratio is often used to justify raising public utility user rates.
Repaying Bonds for Utility Revenue
Similar to those found in general obligation bonds, revenue bonds or municipal taxes are the two ways municipal bonds pay back their investors. The capital project generates income for revenue bonds. General obligation bond issuers pledge to repay debts by whatever means required. The issuer may increase taxes, liquidate tangible assets, or even issue more bonds to raise money. The issuer can use more than just one source of income to pay its debts. This difference is essential and may help investors create a diversified fixed-income portfolio.
When investors or credit rating agencies assess utility revenue bonds and the projects they fund, additional considerations are considered. The estimated revenues from principle and interest commitments are calculated using the coverage ratio. A utility project’s potential future income increase or decrease may be estimated using population size and patterns.
Customer concentration is the combination of customers whose use fees fund debt payments. A public utility’s financial viability may be in jeopardy if a small percentage of its customers utilize a significant portion of its services.
Conclusion
- A utility revenue bond is one kind of municipal bond used to fund a public utility project that pays back investors directly out of project profits.
- Due to the essential nature of their services, net income pledges are often seen in utility revenue bonds.
- Metrics like the coverage ratio are used by investors to assess utility revenue bonds and the projects they fund.
