Net revenue pledge

A net revenue pledge is a promise written into a revenue bond's trust indenture that establishes the order in which the facility's income gets spent. Under a net revenue pledge, the issuer pays operations and maintenance expenses first, and bondholders are paid out of the net revenue that remains. The competing structure, a gross revenue pledge, reverses the order and sends revenue to debt service before any operating costs are covered.

Consider a toll bridge that collects $10 million a year and spends $4 million keeping the bridge lit, staffed, and repaired. Under a net revenue pledge, the $4 million comes off the top and $6 million of net revenue flows to the bond's debt service account. Under a gross revenue pledge, the full $10 million would hit debt service first, with operating costs paid from whatever remained.

A gross revenue pledge looks better for bondholders on paper, but a net revenue pledge is far more common and is generally the more prudent structure. A facility that cannot afford maintenance stops generating revenue, so paying operating costs first protects the long-run source of repayment. Analysts measure the cushion with the debt service coverage ratio — net revenue divided by annual debt service — where a higher ratio signals a safer bond.

Because revenue bonds are backed only by a specific project's income and not by taxing power, the flow of funds is a core part of revenue bond analysis. The Series 7 exam expects you to know which expenses are paid first under each pledge, to recognize that the net revenue pledge is standard, and to compute or interpret a debt service coverage ratio from a facility's revenue and expense figures.