There are two types of municipal revenue bonds -- enterprise revenue bonds and tax revenue bonds. Each is different from the other, but they share the distinction of being secured by non-property tax revenue.
States, state corporations, aka authorities, agencies, commissions, municipalities, and municipal corporations issue enterprise-revenue and tax-revenue bonds
Tax-revenue bond issuers secure payment of P&I with a lien on non-property taxes such as sales, income, hotel occupancy, gasoline and utility taxes.
Whatever tax is pledged, in whole or part, the issuer has no obligation to increase the rate of taxation or allocation of the tax in the event pledged revenue is insufficient to pay P&I.
Enterprise revenue bond issuers, on the other hand, are obligated to raise rates and charges to a level sufficient to pay annual P&I
Enterprise revenue bond issuers charge rates, fees, and tolls in exchange for delivery of services such as water, electric, highway access, parking facilities, tunnels, bridges airport terminals
These kinds of enterprise activities are the most commonly employed to secure payment of P&I.
Key credit quality indicators for tax revenue bonds include:
Population trend and size, employment and economic diversity of the taxed economy
Tax rate (low, average, high, the lower the better), and whether it is broad-based such as sales or income taxes or narrowly based such as a hotel occupancy tax.
Customer concentration, meaning do one or more commercial tax payers account for a large share of tax revenue. Sales tax revenue bonds, where size and diversity are lacking, can be at risk when the taxing jurisdiction, for example, includes a large concentration of auto dealers.
Coverage is stated as a ratio of available pledged tax revenue to either current annual P&I, or future maximum annual P&I, including any proposed additional debt calculated in the same manner. For example, if pledged revenue equals $110 and P&I equals $100, coverage is 1.10 times, or revenue exceeds P&I by 9%. The higher the better.
Additional bond tests provide tax-revenue bond investors protection against over-leveraging, i.e., issuing large amounts of additional parity bonds, thereby reducing coverage to the bare minimum.
Tax-revenue bond proceeds are used to fund a wide variety of public infrastructure projects, whereas proceeds from enterprise revenue bonds can be only be used for maintenance, improvement or expansion of the revenue generating enterprise.
Key credit quality indicators for enterprise-revenue bonds include:
Population trend and size, employment and economic diversity of the service area's economy. Big size is not always a positive, but small size, less than 3,000 customers, all else being equal, is generally riskier and more prone to volatility.
Pro forma debt service (P&I) coverage of the future maximum annual amount on all outstanding parity bonds and any proposed additional bonds of around 90%, or .9 to 1 ratio of current net revenue to future maximum annual P&I is a positive. Equally important is current coverage, the ratio of current net revenue to current P&I. A 1.25% to 1 ratio is simply stated as 1.25x coverage, a positive for creditworthiness, the higher the better.
Rates and charges (low, average, high, the lower the better), and whether revenues are collected on a broad base of captive customers, such as those of government-owned electric and water utilities.
Narrower customer bases such as those supporting toll roads and bridges and other government enterprise services such as airports, public colleges, public transit and parking can display a range of monopolistic power from little to nearly complete, with pricing nearly inelastic to very elastic.
Customer concentration is generally a negative, meaning having one or two heavy industrial customers accounting for a large share of electric revenue, or one airline dominating traffic to and from the airport.
As common sense would suggest, bonds secured by non-essential use revenue enterprises are riskier than both tax revenue and captive customer essential-service enterprise revenue bonds. There are always exceptions.
The latter kind of bond typically requires analysis of feasibility studies provided by consultants who specialize in toll traffic or airline passenger projections. The data they provide is essential, but the key question is how much of the forecast do you discount because they are usually too optimistic. Competition, private and public, and price elasticity judgments with respect to rates and charges come into play as well.
Always assume a reasonable worst future scenario in your analysis because credit strengths can still outweigh negatives with room to spare. Reasonableness can only be judged in the context of the specific enterprise and whose point of view is taken, the investors or issuers who pay the rating agencies fees.
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Municipal Credit Insights, LP and Benchmark Bond Ratings®, LP Garden City, NY