Analyzing the Credit Quality of Revenue Municipal Bonds
- The rate of either increase or decrease of the General Obligation debt paid out as expenditures to bondholders.
- The implications of cutbacks in the intergovernmental aid from both the federal and state budgets to localities.
- The rate of either increase or decrease over three and five years in personal income.
- The viability, funding, quality, competitive landscape, and management of the project.
When a project is well run, and well funded to cater to a community that views it as an essential service; then, its dedicated stream of revenues should be enough to cover all operating expenses, and make interest and principal payments to bondholders.
- Hierarchy of Flow-of-Funds There are two types of flow-of-funds: A net revenue pledge, in this case, all bondholders are paid interest and principal second and right after revenues are used for operating and maintenance expenses. A gross revenue pledge; which on the other hand, means that bond holders are paid interest and principal first, before operating and maintenance expenses are paid. The latter improves the credit quality of a municipal revenue bond.
- Debt Service Coverage Covenants The credit quality of municipal revenue bonds increases if an issuer can legally raise rates without having to obtain prior governmental approval. In turn, the issuer can easily maintain stipulated debt-service coverage covenants such as 1.25 times net revenues; thereby, rendering better credit-quality support to bondholders.
- “Tap in Funding” Some municipalities are permitted by law to tap into the revenue stream of a project; such as an airport revenue bond, in order to use these fund for a city’s general operating budget. Naturally, this can lead to reduced debt-service coverage for bondholders.
- Additional Bond Test From time to time, projects need additional funding for capacity and quality improvements. An additional bond test indicates under what circumstances an enterprise can issue new bonds that share equal claims to prior bonds on an issuer’s revenues. A typical test calls for a maximum debt-service coverage to be maintained on all new and old outstanding bonds for not less than; say 1.30 times. These covenants tend to improve the credit quality of revenue municipal bonds.
- Reserve Fund All revenue municipal bonds should have a reserve fund to be used in rainy days for a period of not less than 1 year of net debt service payments to bondholders. In recent years, a lot of these reserve funds were replaced with surety bonds which had suffered credit rating downgrades. Reserve funds, which are funded with cash outlays as opposed to surety bonds, provide better backing for revenue municipal bonds.
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