A revenue pledge is a condition in a revenue bond that stipulates when the issuer must use project revenues to repay the bondholders.
In the case of municipalities…
Revenue bonds are a type of debt issued by state and local governments to fund projects, such as toll roads and bridges. The revenues generated from a revenue bond-funded project are used to repay the bondholders.
These are different from general obligation (GO) bonds, where the government can use any revenue source to repay the bond.
Revenue pledges stipulate when the bondholder must repay the bondholders — either before or after expenses.
Gross Revenue Pledges
A gross revenue pledge requires the issuer to repay the bondholders out of their top-line revenue. In other words, the issuer must pay the bondholders first before covering operating and maintenance expenses.
Net Revenue Pledges
Net revenue pledges require the issuer to repay the bondholders after covering the operating and maintenance costs.
Gross Revenue Pledge:A bond-funded project generates $100,000 in revenue and $40,000 in expenses. The issuer has a $30,000 interest bill. They must pay the $30,000 first, leaving them $70,000 left to cover their expenses.
Net Revenue Pledge:A bond-funded project generates $100,000 in revenue and $40,000 in expenses. The issuer has a $30,000 interest bill. They can pay the $40,000 first. Then, they have $60,000 left to pay their $30,000 in debt obligations.
What’s important here?
Net revenue pledges are more common because they make it easier for issuers to have the necessary funds for project operations and improvements.
This can ensure the project continues to generate and grow its revenue to repay bondholders. On the other hand, gross revenue pledges put more strain on the issuer to keep costs low, so they can afford their debt obligations.
However, net revenue pledges are riskier for bondholders since the chance they get paid is lower. As a result, net revenue pledges tend to pay higher interest rates than gross revenue pledges.