What is Net Revenue Pledge?
A net revenue pledge requires the issuer of a municipal bond to use the revenue generated to service debt costs (interest and principal payments) immediately after meeting maintenance and operating expenses.
- A net revenue pledge requires the issuer of a municipal bond to use the revenue generated to service debt costs (interest and principal payments) immediately after meeting maintenance and operating expenses.
- The net revenue pledge reduces the risk of default of municipal bonds. As a result, the credit rating of the bond is higher.
- Net revenue pledges are often seen in revenue bonds for public projects such as airports, universities, bridges, water and sewage facilities, hospitals and subsidized housing.
Understanding Net Revenue Pledge
The “net” portion of the net revenue pledge refers to the amount of revenue remaining after all necessary expenses have been satisfied (revenue minus expenses). Once this is done, the issuer must use the remaining revenue to honor the municipal bond’s periodic interest payments and principal before using it for any other purpose.
Municipal bond covenants include net revenue pledges to make the issues less risky for potential bondholders. The intention is that the issuer should use the revenue from the previously financed project to pay for debt services, thereby reducing the risk of default. As a result, bonds with net revenue pledged often have higher credit ratings than those that do not.
types of city bonds
There are two basic types of municipal bonds.
- General liability bonds (GOs) receive protection from the jurisdiction’s credit and tax authority. They have a basis for the belief that the issuing municipality will be able to meet its obligations only through taxes.
- Revenue bonds protect the benefits from tolls, fees or rent from the facility created with the issuance of the bond. A net revenue pledge is a way of controlling the repayment priority of revenue bonds, and the effect they have on the flow of funds to the bond issuer.
The schedule of expenditures and interested parties prioritizes the use of public works, payments from funds raised by the bond-financed project.
Net Revenue Pledge vs Gross Revenue Pledge
In gross revenue pledge, debt service is paid before operating and maintenance expenses are paid. This payment priority elevates debt service compared to a net revenue pledge. However, it is not necessarily preferred by bondholders. Bondholders want the financed facility to remain in good repair so that people can continue to use it (and it continues to generate revenue). In this case, a net revenue pledge may be the best method.
Mortgage income — money obligated to pay for debt service and other deposits required by the bond contract — and the flow of money are both of critical importance when analyzing revenue bonds. Municipal bond analysts take these factors into account when considering the financial viability of projects.
Example of Net Revenue Pledge
Public projects financed by revenue bonds that may include a net revenue pledge include airports, universities, bridges, water and sewage facilities, hospitals and subsidized housing.
For example, suppose $10 million is raised from the issuance of bonds to fund the construction of a new public toll road. However, the construction of the new public toll road cost just $8 million. In this example, the issuer must use the remaining $2 million to pay off the debt from the bond.