Transportation debt is unique in the way that it’s often issued for projects that can take a long time to complete, involve multiple jurisdictions and may span across a vast region. These initiatives include: bridges, highways, public transit system (including rail and buses), ports and airports. And because these projects are rarely unique to one local government, you will often see a large metropolitan area consisting of many cities and counties taking part in these projects by creating special districts, electing a board with a unanimous consensus and funding these initiatives.
Contrary to popular belief, transportation bonds aren’t limited to the big infrastructure projects mentioned above or only issued by larger jurisdictions. In 2016, Kenmore, Washington (population 22,460), passed its first bond measure in the city’s history: a Walkways and Waterways bond that supports new sidewalks and buffered bike lanes along two streets in the city. The bond is tied to the city’s Target Zero goal, which strives for zero fatalities of people walking and bicycling by 2025.
In this article, we will take a closer look at the transportation debt market, revenues that back up this form of obligation and how it fits in your portfolio as an investor.
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Public Transit System and Transportation Debt
Bonds are one of the main sources of funding that many local governments use to pay for infrastructure projects. For public transit agencies, the complex part of the transaction is often identifying and pledging the right source that’s secured by revenues coming from multiple jurisdictions. For example: a train authority that services ten different jurisdictions in a metropolitan area, which means that the funding source includes a revenue pledge that’s proportional to all ten jurisdictions. In some cases, you might see a sales tax pledge that extends to multiple jurisdictions and revenues that are managed by a central transit agency, which runs the operations of the public transit system. This debt structure is very similar to the revenue-backed debt structure used by an individual city or county.
Let’s examine the difference between GO bond structure, issued primarily by a single entity, and revenue-backed debt, issued by an authority that covers multiple jurisdictions, in a transportation debt issuance.
General obligation bonds are backed by the “full faith and credit” of the issuing government, which means that governments will be required to use any means to pay back these debt obligations, including raising taxes. Projects financed by GO bonds do not need to generate revenue-like revenue bonds, and there is no collateral needed to secure the funding. The issuing government pledges to pay back the debt from its general fund, which acquires revenue from property taxes, income taxes, sales taxes and more.
Revenue bonds are loans that fund projects that generate income to pay back the loan. An example is a bridge toll service: a city or state needs funding to build a bridge and collect toll fees that will be used to pay back the initial investment. Revenue bonds are often used for transportation projects with a secured pledge on the revenues. It’s important to note that if there is uncertainty or delay for the revenues to materialize, from the transportation projects, the issuer will need to look for other revenue pledges to secure the financing.
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Seeing Beyond the Revenue Pledge
As mentioned earlier, the public transit debt includes a number of jurisdictions benefiting from the services and they are responsible for contributing to the revenue stream for the agency to run its operations. In most cases, these revenues are coming from sales tax measures enacted in these cities exclusively to pay for transportation-related projects.
An investor must consider a downturn in the economic cycle and its impact on the sales tax revenue pledge. It’s also critical to note that almost all sales tax revenues are typically generated via purchases made in the brick-and-mortar stores in any given jurisdiction. Up until recently, the state couldn’t require a business to collect sales taxes or use taxes on goods sold if the business didn’t have a substantial presence in the state (Supreme Court case Bellas Hess in Quill v. North Dakota) or if the business’s only contact with the customer was via remote sales sent by common carrier or mail (Supreme Court case: Bellas Hess v. Department of Revenue).
In most cases, an e-commerce company meets both requirements and the states couldn’t require them to collect sales tax on purchases made on their e-commerce channels, which resulted in huge uncollected sales tax revenues by state and local governments.
Key Considerations for Transportation Debt Investors
Fare revenue Declines
Some bus and train agencies throughout the United States rely on the fare revenue collection to run its operations. Given the rapid decline in ridership for bus and trains over the years, these agencies are frantically looking for other revenue measures to make ends meet.
This type of risk is directly attributed to the issuer of municipal debt, and alludes to its inability to pay back the borrowed debt or make scheduled coupon payments to its debt holders – also known as default. Although municipal default rates are extremely low, it’s still a cause of concern.
Sustainable Tax Base
The main basis for repaying debt is the strength and ability of the local economy – which includes the size, diversity of employers and strong tax base – to meet its financial obligations.
For a transportation debt issuer and any other local government that borrows money, the organizational style and financial preparedness determine its ability to withstand any potential downturns and debt repayment capacity. This preparedness isn’t limited to its reliance on general fund revenues, but it also takes into account the potential policies in place for an unforeseen event, including reserve fund policy, access, and management of liquid resources, and feasibility of long-range financial plans.
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The Bottom Line
As more and more transportation agencies look for more permanent and fixed revenue sources, like sales tax, the future looks reliable for these agencies to raise the capital to revamp the public transportation in the United States. This also presents some lucrative opportunities for investors.
Investors must consult with their financial advisors and tax consultants on their holdings, and it’s important to understand the tax status of any fixed-income instrument that you buy in the future, as it may have changed.
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Disclaimer: The opinions and statements expressed in this article are for informational purposes only and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned. Opinions and statements expressed reflect only the view or judgement of the author(s) at the time of publication and are subject to change without notice. Information has been derived from sources deemed to be reliable, the reliability of which is not guaranteed. Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professionals and advisers prior to making any investment decisions.