Revenue Bonds

Summary

Revenue bonds, also referred to as limited obligation bonds, are legally secured only by a specified revenue source. If that specified revenue source is insufficient to make debt service payments, the state is not legally obligated to appropriate other revenues for debt repayment.

Advantages

• Revenue bonds are not subject to the constitutional prohibition against debt and therefore do not require a constitutional amendment to be approved by voters.
• Beneficiaries of the projects are often the ones paying for the debt service on the bonds if the bonds are repaid with a revenue source associated with the program or project that is being financed.

Disadvantages

• Revenue bonds generally carry higher interest rates than general obligation bonds because the risk of default is greater.
• Revenue bonds are typically more complex than general obligation bonds, thus resulting in higher administrative costs

Revenue Bonds

Revenue bonds, also referred to as limited obligation bonds, are legally secured only by a specified revenue source, not the full faith and credit of the state. If that specified revenue source is insufficient to make debt service payments, the state is not legally obligated to appropriate other revenues for debt repayment. In Texas, the issuance of revenue bonds requires legislative, but not voter, approval. Bond issuing authority is either granted by the Legislature for a specific instance or by general statutory authority for the agency to issue revenue bonds.

Revenue bonds are not legally considered a financial obligation of the state; therefore, the bonds are not subject to the constitutional prohibition of debt and do not require a constitutional amendment.

Revenue bonds may be either self-supporting or not self-supporting. Self-supporting bonds are repaid from revenues generated from the financed project or program. Not self-supporting revenue bonds are repaid with general revenues subject to biennial appropriation by the Legislature.

Advantages

There are several advantages to using revenue bonds. Unlike general obligation bonds, financing is not delayed by the need to seek voter approval in a bond referendum.

Also, self-supporting revenue bonds are not counted toward the debt limit. (However, not self-supporting revenue bonds do count towards that limit.) Additionally, self-supporting revenue bonds may be the more appropriate way to finance a public project because the responsibility for repaying the debt is distributed only among the users of the project.

Disadvantages

Among the disadvantages of using revenue bonds is their higher costs when compared to general obligation bonds. Because the source of repayment is not as legally secure as that of general obligation bonds and the risk of default is considered greater, revenue bonds usually carry higher interest rates. If the bonds are defaulted, the governmental agency is not legally responsible.

Realistically, however, if a government is not willing to make the appropriations necessary to meet debt service requirements on revenue bonds, despite having no legal obligation to do so, there will be a negative reaction by the bond market toward the issuing government.

Revenue bonds also may incur higher costs due to their more complex nature. Not only is more preparation and administration of the issue needed, but revenue bond issues are more likely to be negotiated, often incurring higher underwriting costs.

Since the bonds do not require a bond referendum, citizens do not have an opportunity to approve or disapprove of them. In general, the issuance of revenue bonds occurs out of the public spotlight. Nevertheless, as the use of general obligation bonds is usually restricted, revenue bonds may provide the only real alternative for financing necessary government projects.