A revenue bond is a type of municipal bond that is secured by the revenues generated from a specific project or source, rather than by general taxation.
A Revenue Bond is a municipal bond backed by the income generated from a dedicated revenue source, such as tolls from a toll road, fees from a public utility, or rents from a public building. Unlike general obligation bonds, which are backed by the full faith and credit of the issuing government entity and funded through taxation, revenue bonds rely solely on the cash flows produced by the specific project or asset they finance. This means the repayment of principal and interest on revenue bonds comes from the net revenues collected, making them a project-specific financing tool. In finance and wealth management, revenue bonds offer an investment opportunity linked directly to the performance of the underlying revenue-generating entity. They can provide higher yields than general obligation bonds due to their potential higher risk, mainly if project revenues fall short. Investors analyze the revenue streams, operational risks, and legal provisions around these bonds to assess their security and expected returns. Revenue bonds are commonly used in infrastructure financing and public utility expansions, offering diversification in fixed income portfolios.
Understanding revenue bonds is critical for investors managing fixed-income allocations, particularly within family offices that prioritize risk-adjusted returns and tax efficiency. Since revenue bonds are backed by specific revenue streams, they introduce unique risk factors tied to the performance of projects, such as changes in usage levels, regulatory actions, or operational disruptions. This can affect the bond’s risk profile and yield, influencing strategic portfolio construction and income forecasting. Furthermore, revenue bonds often come with particular covenants and legal structures that impact repayment priority and default risk, making due diligence essential. In tax planning, many revenue bonds are tax-exempt at the federal level and sometimes at state and local levels, providing a tax-efficient income stream. Properly integrating revenue bonds into a diversified bond portfolio can enhance income diversification while balancing credit and project-specific risks, influencing governance policies around investment selection and monitoring.
A city issues a $10 million revenue bond to finance the construction of a toll bridge. The bond’s repayment schedule depends on the toll revenues collected from drivers. If the bridge collects $1.2 million a year in net tolls, this revenue services the bond interest and principal repayments. Assuming an interest rate of 5% and a 10-year maturity, the bondholders receive payments funded entirely from these toll collections, not from city taxes.
General Obligation Bond
General Obligation Bonds are municipal bonds backed by the full taxing power of the issuing government, typically considered more secure with tax-based repayment, whereas Revenue Bonds are repaid from specific project revenues and carry different risk and return profiles.
How does a revenue bond differ from a general obligation bond?
A revenue bond is repaid through revenues generated by a specific project, such as tolls or fees, while a general obligation bond is backed by the taxing authority of the issuer. This makes GOs generally less risky but potentially lower yielding.
Are revenue bond interests taxable?
Typically, interest earned on revenue bonds is exempt from federal income tax and may also be exempt from state and local taxes, especially if issued by entities within the investor’s state of residence, enhancing tax efficiency.
What risks should investors consider with revenue bonds?
Investors should evaluate the stability and sufficiency of the dedicated revenue stream, operational risks of the project, legal covenants, and potential for revenue shortfalls which can affect timely payment of bond interest and principal.
