skip navigation
Build America Transportation Investment Center (BATIC) Institute: An AASHTO Center for Excellence
Build America Transportation Investment Center (BATIC) Institute: An AASHTO Center for Excellence


A final update to this content was completed in March 2022.

Bonding and Debt Instruments

Municipal/Public Bond Issues

Revenue Bonds

Revenue bonds are used to finance municipal projects that generate revenue (a toll road or bridge, for example). This revenue is used to make interest and principal payments to the bond holders. Often, states and their subdivisions create certain agencies and authorities to perform specific tasks. Many times, the agency or authority has the ability to levy charges and fees for its services. These bonds are analyzed in terms of historical or potential earnings compared with the bond requirements. Usually, the yield is higher than that of a general obligation bond due to greater risk. Taxes that would back a general obligation bond are more secure than most project-backed revenue sources.


Toll-backed Revenue Bonds

Most toll roads are financed by borrowing debt backed by future toll revenues. Toll-based finance is straightforward and very much akin to the municipal finance model. First, a public authority needs to be vested with the responsibility of developing toll roads within its given jurisdiction. After completing the appropriate feasibility studies, the authority issues bonds against anticipated toll revenues and uses the proceeds to fund the construction of the toll road. Once the toll road is open to traffic, the authority pays back its debt and interest costs using toll revenues collected on the facility. This model is attractive to investors as the interest they make on their holdings is exempt from federal and state income taxes. The toll-based finance model may also be used in conjunction with public-private partnerships. In this case, a private sector partner would arrange financing for the project and then repay the debt from toll revenues. Private activity debt for toll projects can be issued on a tax exempt basis using private activity bonds.

Reliance on toll-backed financing necessitates detailed financial feasibility assessments along with financial planning to evaluate the role of equity versus debt and repayment structuring. It also demands rigorous traffic and revenue forecasts, subject to multiple sensitivity tests and some form of risk analysis. Such financing requires a variety of additional institutional arrangements, including debt issuing authority and a bond rating process.

FareBox Revenue Bonds

Farebox revenue bonds involve the issuance of debt by a transit agency, secured by pledging revenues collected from transit system operation. Farebox revenue bonds are rare because most transit systems operate at substantial deficits. Transit riders on average pay less than 40 percent of transit operating costs. Federal, state, and local subsidies are necessary to maintain operations.

For a traditional revenue bond, such as one for a water or sewer system, an issuer covenants to charge rates that will produce revenues sufficient to cover operating and maintenance costs and debt service. Such a covenant is called a "rate covenant". A "coverage factor" is also commonly desired in which the issuer will covenant to maintain revenues in excess of operations and maintenance expenses by a certain multiple of the annual debt service owed on its outstanding obligations. Factors of 1.10, 1.25, 1.5, or 2 times the coverage have all been used to seek investment grade ratings on revenue debt.

However, because a transit system does not produce sufficient net farebox revenues to cover debt service, a gross revenue pledge is employed. A gross revenue pledge measures gross revenues to debt service and requires substantial coverage (typically 3 or 4 times debt service).

To evaluate the potential transaction, the viability of the system is analyzed to determine how creditworthy it is. How essential the system is to the local economy may be more important to a credit analysis than an impractical rate covenant. For example, it would not be desirable to require an increase in rates by way of a rate covenant if the result would be fewer riders and ultimately less revenue. Rate increases may also lead to less public and political support for subsidy payments.

Large metropolitan systems with well-developed routes and consistent ridership levels are most appropriate for farebox revenue borrowing. Even with such a transit system, other dedicated subsidy sources such as sales taxes or bridge tolls may be essential to obtain an investment grade rating on debt. Overall employing farebox revenue bonds requires determining if they represent sufficient security for financing. Additionally, the authority for a transit agency to issue them is a legal issue governed by state law.