Q. So these are a specific kind of municipal bond… how are they different than the “general obligation” bonds we discussed the other day?
A. General Obligation bonds are backed by the full taxing power of a municipality. Revenue bonds, on the other hand, are backed by the receipts of a specific revenue source… a good example is a recent offering by the New Jersey Turnpike authority, which is secured solely by the tolls it collects, but not by taxes or other income of the state.
Q. And I guess one benefit of Revenue Bonds is that a lot of the projects are essentially monopolies, not subject to a lot of competition.
A. Right. We won’t see a lot of competing turnpikes in NJ. So a revenue bond is often like investing in a protected, operating business… but again, without the backstop of the state or municipal taxes.
Q. Which is why these things are historically seen as less creditworthy than the “general obligation” variety. But given Detroit, I have to ask: how’s it actually work in a municipal bankruptcy?
A. This is an extremely interesting an important point. The bankruptcy code takes account of the differences between GO and revenue bonds, and essentially gives the revenue bondholders the benefit of their bargain: it preserves the liens on the assets, and allows payments from the assets to continue to bondholders. That’s not true for GO bonds issued by a city, for which payments stop on filing.
Q. Wait.. so Revenue Bond holders may actually do better than General Obligation bondholders in a municipal bankruptcy?
A. Yes. From that perspective, the common wisdom about GOs versus Revenue Bonds is overlooking something very important.