What is a Net Revenue Pledge?
A net revenue pledge requires issuers of municipal bonds to use their net revenues (revenue minus expenses) to pay the principal and interest of the municipal bonds before any other use.
How Does a Net Revenue Pledge Work?
Let's assume City XYZ issues $10 million of municipal bonds to build a toll road. The toll road is expected to generate $500,000 of revenue per year and cost $450,000 per year to operate. The net revenue is $50,000 per year. The principal and interest payments are $40,000 per year.
If the municipal bonds contain a net revenue pledge, City XYZ is required to use the $50,000 of net revenues per year to pay the $40,000 of principal and interest first. Only then can City XYZ use the remainder ($10,000) for other purposes.
Why Does a Net Revenue Pledge Matter?
Net revenue pledges are restrictive covenants intended to mitigate risk for bondholders. The idea is that the issuer has to use the revenues from the financed project to pay debt service costs first, thereby lowering the risk of default. As a result, bonds that have net revenue pledges often have higher debt ratings than those that do not.