A revenue bond is a special type of municipal bond distinguished by its guarantee of repayment solely from revenues generated by a specified revenue-generating entity associated with the purpose of the bonds, rather than from a tax. Unlike general obligation bonds, only the revenues specified in the legal contract between the bond holder and bond issuer are required to be used for repayment of the principal and interest of the bonds; other revenues (notably tax revenues) and the general credit of the issuing agency are not so encumbered. Because the pledge of security is not as great as that of general obligation bonds, revenue bonds may carry a slightly higher interest rate than G.O. bonds; however, they are usually considered the second-most secure type of municipal bonds.
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Revenue bonds may be issued to construct or expand upon various revenue-generating entities, including:
Generally, any government agency or fund that is run like a business, generating operating revenues and expenses (sometimes known as an enterprise fund), can issue revenue bonds. An agency that provides a free service, such as a school, can not do so, as their only revenue is tax dollars.
The Supreme Court decision of Pollock v. Farmers' Loan & Trust Co. of 1895 initiated a wave or series of innovations for the financial services community in both tax-treatment and regulation from government. This specific case, according to a leading investment bank's research, resulted in the "intergovernmental tax immunity doctrine," ultimately leading to "tax-free status." Municipal bonds are generally exempt from federal tax on their interest payments (not capital gains). For taxpayers who purchase municipal bonds issued in the same state in which they reside, interest payments are generally exempt from state and local tax also. Municipal Bonds may be issued in one of two forms: (a) revenue bond, or (b) general obligation (GO) bond. Revenue bonds may be issued by an agency, commission, or authority created by legislation in order to construct a "facility," such as a toll bridge; turnpike; hospital; university dormitory; water; sewer, utilities and electric districts; or ports. The fees, taxes, or tolls charged for use of the facility ultimately pay off the debt.
Governments with the power to tax also issue revenue bonds, but restrict the debt service funds to only those funds from the governmental enterprise that generates these revenues. The government itself does not pledge its own credit to pay the bonds. When a municipality assumes liability for the debt service of the income from the project is insufficient it is considered to be double-barreled. In this case however, they are more like GO bonds.
Revenue bonds are most concerned with the repayment of interest to lenders who believe in financing a given public works project such as, bridges, tunnels, sewer systems, education (i.e. committed tolls for a bridge, college dorm and/or student loans, education). In the case of education or school systems, bonds issued for colleges and universities are from the state level are generally backed by income or progressive taxes. Bonds, which are issued by towns, cities, and counties, are backed by local property (ad valorem) regressive taxes and all other sources of revenue to the municipality. As a general rule, revenue bonds are backed by the revenue generated by the municipal facility the bond issues. A feasibility study should be conducted to compare one project's IRR (internal rate of return, or hurdle rate) to another proposed project, as it is most important to ensure the success of the municipality. For instance, local government and port authorities can propose construction for a given neighborhood, based on projects that have been successful previously, or it can create a nonprofit authority to issue revenue bonds to build a school district, for example.
In recent legislation, the Financial Services Modernization Act of 1999, the Municipal Securities Rulemaking Board (Securities Act Amendments of 1975), and now FINRA (the Financial Industry Regulation Authority) as of July 30, 2007, the industry overall has consolidated not only in sheer number but by undoing previous legislation such as the Securities Act of 1933. Municipal bonds traditionally were exempt from the filing requirements of the Glass–Steagall Act of 1933, however, like all other securities they are subject to the anti-fraud provisions of the Securities Exchange Act of 1934, and once again the newly formed FINRA.
Some examples of Revenue Bonds include: § IDRs and IDBs (Industrial Development Revenue Bonds) § Lease rental bonds § Special Assessment Bonds (or Special District Bonds § New Housing Authority Bonds § Moral Obligation Bonds
As a revenue bond is not backed by the full, faith, and credit of the U.S. government, it does not require voter approval. As of July 1, 1983 all municipal bonds must be registered. Two other important pieces of legislation are the Tax Reform Act of 1986 and the 39 General Regulations that govern the SRO (self-regulatory organization) of the MSRB. The MSRB, as mentioned above, governs the issuance and trade of municipal securities both general obligation and revenue bonds.
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