Revenue bonds are a type of debt issued by a borrower to fund projects such as toll roads and bridges. A portion of the revenues generated from a revenue bond-funded project are pledged to repay the bondholders. Revenue bonds contain a Flow of Funds analysis that shows the bond investor how the revenue from the project is used prior to repaying the bonds, such as for operation and maintenance. The Flow of Funds gives the investor a sense of the creditworthiness of the bonds. If the revenues from the project do not meet the required debt service payments, the bonds go into default.
A gross revenue pledge requires the issuer to repay the bondholders out of their top-line revenue, as discussed in the Flow of Funds. In other words, the issuer must pay the bondholders first before covering operating and maintenance expenses.
A net revenue pledge requires the issuer to repay the bondholders after covering the operating and maintenance costs, as discussed in the Flow of Funds.
Example:
In a gross revenue pledge, a bond-funded project generates $100,000 in revenue and $40,000 in expenses. The issuer owes the investors $30,000 in annual interest cost, which must be paid first, leaving $70,000 left to cover expenses.
In a net revenue pledge, a bond-funded project generates $100,000 in revenue and $40,000 in expenses. The borrower owes the investors $30,000 in annual interest cost, but pays the $40,000 in expenses first. The borrower then has $60,000 remaining to pay the $30,000 in debt obligations.]
What’s important here?
In revenue bonds, the borrower pledges to use a portion of the revenues of the project to repay the bondholders. Net revenue pledges produce more risk to the investor getting their investment money back but keep the project well-maintained which can reduce the risk of default. Gross pledges reduce the risk to the investor but also do not guarantee good maintenance on the project in the future.
