There are different types of revenue municipal bonds designed to finance different projects. Revenue bonds are classified according to the facility a particular bond issue supports.
Industrial development revenue bonds finance either the construction of facilities or purchase of equipment for leasing back to a corporation. The municipal development authority uses the proceeds from lease payments to pay off interest and principal to the bondholders. The revenue stream to pay off the outstanding debt comes from the corporation leasing either the facility or equipment; and therefore, are rated the same as that corporation. All Industrial development bonds were tax exempt until the Tax Reform Act of 1986. This reform established that all bonds used for a public purpose are tax exempt unless when used for a non-public purpose. Non-public purpose bonds are a part of the alternative minimum tax.
A municipality constructing a building for either self-use or its community can issue lease-back municipal bonds. Lease-back municipal bonds, raise money for the construction; and thereafter, leasing of that building. This type of a financial transaction provides lease-back payments for covering debt service on the outstanding bonds.
A special tax bond is a revenue bond that finances numerous projects using specific excise taxes on gasoline, tobacco, and liquor. Other special tax bonds include, special assessment bonds which are issued to finance public improvements such as either sidewalks or sewers. The issuer assesses a levy on the property benefiting from the improvement; and then, uses the funds to pay principle and interest on the outstanding bonds.
Local housing authorities issue New Housing Authority bonds (NHAs); also called, Public Housing Authority bonds (PHAs) in order to develop and improve low-income housing. NHA bonds are backed by the full faith and credit of the US government. NHA bondholders receive payments from the lease payments collected. NHA bonds are often rated AAA because in case when lease payments are not sufficient to service the debt, the federal government makes up the difference. Interest from NHAs is exempt from federal income taxes, and may also be exempt from state or local taxes.
Local or state authorities issue Moral Obligation bonds to back an issue that may not have sufficient funds to service its debt. A state’s obligation to service its debt is not a legal obligation; however, it is a moral obligation. In the event of an unlikely default, a bondholder has the right to bring judgment in order to force a local or a state government to levy tax that will pay off the outstanding debt.
Municipal Notes are short-term debt instruments issued by municipalities that anticipate generating revenues in short order. Notes have maturities that range from 3 months to 3 years. Municipal Notes are redeemed when the municipality receives its anticipated revenue stream.
General Obligation bond issuers who anticipate future tax receipts, issue tax anticipation notes (TANs) in order to finance current expenditures. Revenue producing facilities issue revenue anticipation notes (RANs) in order to finance current expenditures. Tax and revenue anticipation notes can be combined into one note called TRANs or tax and revenue anticipation notes.
Bond anticipation notes (BANs) are short-term debt instruments issued by a municipality that is expected to be repaid from the proceeds of a long-term bond issue. Municipalities can issue tax-exempt commercial paper in place of BANs or TANs with maturities that are as long as 270 days.
Temporary financing for construction of housing projects is normally funded through issuance of construction loan notes (CLNs). When an issuer anticipates grant money from the federal government, issuing grant anticipation notes (GANs), provides for interim financing.
Variable rate municipal bonds and notes have a fluctuating interest rate that is tied to an interest rate index. The price of variable rate issues remains stable, at or near par, because of their changing coupon rate.
In order to stimulate a declining US economy, Build America Bonds (BABs) were introduced under the Economic Recovery and Reinvestment Act of 2009. The interest payments from BABs are taxable; however, a federal tax subsidy is paid back to the issuer of the bonds; thereby, enhancing the marketability of BABs. Build American Bonds cater mostly to investors in lower income tax brackets, foreigners, pension funds, and investors of retirement accounts where tax-exempt securities are not suitable. The Build America Bonds program expired on December 31, 2010. Thus far, billions of dollars of BABs have been raised for funding municipal projects, and many Build America Bond issues are still outstanding. Two types of BABs had been issued: tax credit BABs, and direct payment BABs. The tax credit BABs, provide a municipal issuer payments from the US Treasury equal to 35% of the coupon payment paid by the issuer. Direct payment BABs, provide bondholders federal income tax credit equal to 35% of the coupon payment paid on the bond in a single tax year. The tax credit may be carried forward to the following year when a bondholder does not fully use his or her current year’s credit.
Several taxing authorities can draw debt from the same community. This is called overlapping debt. For example, a school district can issue debt from the same political subdivision as the city or county draws debt from. Debt issued by states is not included when calculating overlapping debt. Municipalities that have overlapping boundaries are often described as coterminous, and their debt as coterminous debt.
[Source: Barclays Capital Municipal Bond Index components as proxy for the mix of the investment-grade muni market, as of April 26, 2011.]