Utility Revenue Bond Definition

What is the Utilities Tax Liability?

A utility revenue obligation, also known as an essential service obligation, is a type of municipal bond issued to finance a public service that reimburses bondholders directly from project revenues rather than from a general tax fund.

Key points to remember

  • A utility revenue bond is a type of municipal bond issued to fund a utility project that repays investors directly from project revenues.
  • Due to the necessity of the services they provide, it is common for utility revenue bonds to include a net income pledge.
  • Investors rely on metrics such as coverage ratio to value utility revenue bonds and the projects they finance.

Understanding Utilities Tax Liability

A utility revenue bond is used to fund capital projects in areas considered essential to public services, including hospitals, fire departments, water and waste treatment facilities, and improvements of the electrical network. These services generate revenue through fees charged to customers, which provide cash flow that can service the debt.

Revenue bonds are accompanied either by a gross revenue or one net revenue pledge. A gross revenue pledge prioritizes payments from bondholders over operating or maintenance costs incurred by the project. A net income pledge allows for the disbursement of administrative expenses and maintenance costs before meeting obligations to bondholders.

Utilities provide essential services such as water and electricity. Due to the need for these services, it is common for utility revenue bonds to carry a pledge of net income, as maintenance must be implemented to keep them in good working order.

It is also common for utilities to be required to maintain a specific revenue to expense ratio. The inclusion of debt repayment is considered an expense, and the ratio is often used to support increases in customer rates for utilities.

Reimbursement of utility revenue bonds

Municipal bonds repay bondholders either through municipal taxation, as in a general bond bondor by revenue bonds. Revenue bonds derive revenue from the capital project. The general bond issuer guarantees repayment of the debt by any means necessary. To raise funds, the issuer can raise taxes, issue another series of bonds, or even sell physical assets. The issuer is not constrained to a single revenue stream to meet its obligations. Investors should be aware of this distinction and can use it when constructing a diversified portfolio of fixed income securities.

Other factors come into play when credit rating agencies or investors assess utility revenue bonds and the projects they fund. The The coverage ratio is used to determine expected income against principal and interest obligations. Population size and trends can provide an idea of ​​future revenue growth or decline for a utility project.

Customer concentration describes the mix of consumers whose user fees support debt repayment. If a small number of consumers use a significant portion of a utility’s service, this can pose a risk to the revenue viability of that project.

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