What are Revenue Bonds?
Revenue bonds are municipal bonds issued by a government, but unlike general obligation bonds, they are repaid through income from a specific project or source instead of the government’s credit. Revenue bonds are frequently used to fund and finance public sector projects such as toll roads, bridges, or utilities, where the revenues generated from the project will pay the bondholder. Revenue poses a different risk since the bond relies on the revenue-generating capabilities of the funded project. In this article, you will learn more about how revenue bonds work, examples of revenue bonds, and more.
Key Highlights
- Revenue bonds are municipal bonds repaid based on project-generated income, such as tolls or utilities.
- Unlike general obligation bonds, revenue bonds are not supported by taxes but by the revenue being generated from the project they fund; hence, these are relatively more risky.
- Revenue bonds usually offer relatively higher interest rates, compensating for the extra risk involved with repaying the bondholders.
- Real-life examples of revenue bonds are toll roads, water utilities, and airports, where the funds generated by the users are used to repay bondholders.
Table of Contents
Understanding Revenue Bonds
Revenue bonds are different from all the other types of bonds because they are directly related to the financial performance of a specific project or operation. This means that the bond’s interest and principal payments can be financed by the income from the asset financed, such as toll fees or utility payments. In case the revenue is not sufficient, there is a chance that the bondholders might not be paid the full amount, and hence revenue bonds are a little more prone to risk. Conversely, in general obligation bonds, bondholders are insured by tax revenues generated by the issuing government.
Eligibility Criteria for Issue of Revenue Bonds
Municipal authorities in India have certain criteria before they issue revenue bonds, they are as follows:
- No Default in Loan Payments: The authority issuing revenue bonds should not have defaulted on any loan payment in the last few years.
- Positive Net Worth: The net worth of the municipalities should be positive for the last three years.
- Not Present in the RBI’s Wilful Defaulter List: Neither the issuing entity nor any of the directors, promoters, or related companies must be present in the list published by the Reserve Bank of India of defaulting parties. This requirement seeks to eliminate organisations that are loan defaulters and delay payment from the bond market.
Regulatory Framework
The issuing authority for municipal revenue bonds in India is the Securities and Exchange Board of India (SEBI). SEBI set clear guidelines in 2015 that helped to re-establish municipal bond markets by dispelling any confusion about the guiding framework local bodies were supposed to follow while raising funds through these bonds.
Real-Life Examples
In February 2023, the Indore Municipal Corporation (IMC) took a groundbreaking step by introducing in India the first municipal bonds specifically for retail investors. This development represents a major milestone in municipal bond financing, as municipal bonds have historically only been available to institutional investors. IMC’s green municipal bonds are rated, listed, taxable, secured, redeemable, and non-convertible with a face value of ₹1,000. A minimum application of ₹10,000 permitted individual investors to join a changed approach to fund urban infrastructure.
The bonds had tenors of three, five, seven, and nine years, allowing for flexibility in maturity based on investor goals. Raising funds through this approach was intended for essential city infrastructure (such as roads/public utilities). This new opportunity also gave municipalities additional options for financing and local investment in urban infrastructure development.
Conclusion
Revenue bonds offer an excellent opportunity to raise funds for public infrastructure, providing investors with an opportunity to yield returns from project-specific income. However, revenue bonds also pose a higher level of risk because their repayment is solely dependent on the success of the funded project. For the investor willing to include revenue bonds in diversified portfolios, it is necessary to be aware of the structure, characteristics, and risks involved with revenue bonds.
FAQs on Revenue Bonds
Revenue bonds repay investors from the revenue generated by the project they finance; however, if the issuer defaults or the project fails to generate sufficient income, investors risk losing their money.
Investing in bonds is generally safer than stocks, but it comes with risks: Interest Rate Risk, Default Risk, Inflation Risk, Reinvestment Risk and Liquidity Risk. While bonds can provide stable income, it's important to understand these risks before investing.
If the bond's issuer defaults on payments or if you sell it before its maturity date for less than you paid, you could lose money on the bond.