There is a pressing demand for investment in transportation capital infrastructure improvements, which much outnumbers available funds. According to estimates, $51.6 billion per year will be required over the next 20 years to maintain the existing state and performance of the roadway system. This requirement compared to expected spending of $38.7 billion each year, resulting in an almost $13 billion investment shortfall. Furthermore, there is a $300 billion backlog in roadway and bridge infrastructure requirements.
Where will all of this money come from? Traditional resources, which have long been depleted, are clearly incapable of providing the kind of assistance required. The Intermodal Surface Transportation Act of 1991 (ISTEA) encouraged transportation decision makers to seek out and employ additional financing sources in awareness of this fact. As a result, decision-makers in the transportation sector are methodically considering all conceivable financing possibilities. One such possibility is the issue of bonds.
Highway Bonds: Basic Concepts
A bond is a written pledge to repay borrowed funds on a set timetable, usually at a fixed rate throughout the bond’s existence. Municipal bonds, which are issued by state and local governments to fund their numerous projects and expenses, account for nearly all highway bonds.
Highway projects have historically relied on bonds as a source of funding. Although the territory of Idaho issued “wagon road” bonds as early as 1890, Massachusetts was the first state to use bonds to borrow funds for highway needs in 1893. Except for Nebraska and Wyoming, all states have issued highway bonds since then. The quantity of municipal bonds issued, including highway bonds, has increased dramatically during the previous 20 years. At the end of 1992, state and local bond obligations totaled around $47 billion.
Interest income from municipal bonds, including highway bonds, is tax-free in the United States. State and local issuers benefit from the federal tax exemption because it allows them to borrow at a lower cost than other issuers.
Highway bonds are divided into three kinds for ease of understanding: general obligation bonds, revenue bonds, and hybrid bonds.
- General obligation bonds are backed by the issuing government’s full faith and credit. The majority of states rely on income taxes or sales taxes to fund their budgets. The full faith and credit backing implies that, unless otherwise specified, all sources of revenue will be used to pay debt service on this sort of bond.
- Revenue bonds are backed by a specific source of revenue, which is usually connected to the function for which the bond is being issued. As a result, revenue bonds backed by tolls, concessions, and direct fees may be used to fund highways and bridges. When a state or local government issues revenue bonds, the interest rate must be slightly higher to compensate for the additional risk to investors if revenues do not materialize.
- Hybrid bonds are ones that have both revenue and general obligation qualities. A moral obligation bond, for example, is a hybrid that is backed by revenues as well as a nonbinding commitment from the issuing state that it will consider making up any revenue shortfall. Other hybrids include double-barrel bonds, which are backed by both revenues and the issuing government’s full faith and credit.
Figure 1 depicts the movement of cash from investors to state and other governmental issuers of transportation bonds via the financial community.
Municipal bonds are typically issued in $5,000 denominations or multiples; this is the bond’s par, or face, value, which is paid when it matures. Bonds are often arranged so that the bond’s life is equivalent to the facility’s normal life. A very long-term project, such as a highway or bridge facility, usually has a financing duration of 20 or 30 years.
The coupon rate, which is the interest rate indicated on the bond and payable to the bondholder, is found on every bond. Most highway bonds include a semiannual interest payment. For example, a $10,000 bond with a 6% coupon rate would pay $600 per year in two $300 installments to the bondholder.
Bonds have a yield rate, which is the effective rate of return to the investor, which is determined by the bond’s price, coupon rate, and maturity date. For example, if the price of that identical bond was cut to $8,000, the present yield would rise to 7.5 percent ($600 divided by $8,000).
Highway bond prices and yields change dependent on activity in other credit markets, overall economic activity, inflation, and Federal Reserve policy, just like other bonds.
A credit rating is assigned to all bonds and serves as a standard for gauging investment risk. Every investment involves a risk-reward balance. A credit rating is a basic way of determining how hazardous a bond is. The credit rating also influences the interest rate levels at which the bond trades and dictates how much the issuer will have to pay for capital. In general, the higher the yield the issuer must offer, the lower the rating.
Three independent firms provide credit ratings for highway and other municipal debtors upon request. The ratings assess the issuer’s solvency and liquidity using objective assessment criteria such as the issuer’s current debt, economic foundation, finances, and management. The rating categories or grades range from the highest quality investment (Aaa or AAA) to defaulted bonds (D). (See illustration 2.)
By enhancing their credit position, state and municipal governments may usually enhance their access to money and lower their borrowing costs. A few mechanisms for doing so are listed below:
- Lenders and bondholders can get bond insurance and letters of credit to ensure that they will be reimbursed if the issuing government defaults.
- An institution that pools separate bond offers is known as a bond bank. Governments with low credit ratings or limited credit access can band together to issue a single large bond series, lowering both cost and risk.
- State revolving funds can help with credit by providing direct and indirect credit enhancement for state and municipal highway bonds. These revolving funds can function similarly to bond insurance or bond banks by providing support for bond or loan repayments.
Current Trends in Highway Bond Financing
In general, the tax-exempt market has developed to become a significant portion of the US investment industry over the last decade. Municipal bond volume surpassed $235 billion in 1992, compared to $83 billion in 1983. Transportation bond issuance climbed from $4.8 billion to $25.9 billion over the same 10-year period.
During this time, highway bond financing also increased significantly. State governments issued $6.4 billion in fresh issues (“new” funds see figure 3) in 1992, and refinanced another $3.1 billion. In 1983, new funds totaled $1.1 billion and refinancing totaled $1.3 billion. When local bonds are included, the total bond issue for highways and bridges in 1992 was $12.4 billion.
Why has the issuing of highway bonds surged so dramatically? Aside from the refinancing of previous debt, several factors are at play:
- Program requirements. While federal infrastructure investment has surged as a result of ISTEA and other laws approved in the 1980s, program demands have grown even faster. As previously stated, there is a $300 billion backlog in highway and bridge needs, with unfunded demands growing at a rate of around $13 billion per year. As a result, state and local governments have become increasingly reliant on finance markets.
- Interest rates have been reduced. Early in the 1990s, the low interest rate environment allowed for the issuance of new money bonds as well as the refinancing of debt issued in the 1980s.
- Financial products that are better. The types of bond and bond-related products available have increased dramatically in recent years, owing to program needs, degrees of investor and issuer sophistication, and competition in the bond business. For example, the number of state and municipal issuers using the highway bond market increased from 182 in 1988 to 263 in 1992, indicating that local governments are more prepared to employ all means at their disposal. (See illustration 3.)
Transportation decision-makers are becoming more conscious of the importance of utilizing all available revenue streams in order to acquire bond and other forms of funding. More than ever, state and local governments are diversifying their funding sources beyond traditional highway user fees and tolls to include transportation improvement districts (TIDs) and legislative support for bonds. TIDs are special units of local government organized to make transportation improvements and have the power to incur debt and levy taxes.
Bonds and Federal Legislation
ISTEA and other federal-aid legislation allow federal-aid transportation money to be used to support bond financing.
ISTEA Section 1012 removes many of the previous limits on toll financing. Because toll funding and toll authorities are frequently financed by bonds, ISTEA allows for additional bond financing options. Section 1012 allows for the initial construction, reconstruction, and conversion of some free facilities to tolls.
ISTEA Section 1044 allows the state to receive a credit for toll revenues. While bond issuance itself is not a credit, toll revenues generated by bonds are frequently connected with bond issuance.
Title 23, United States Code Highways, Sections 115 (Advance construction) and 122 (Bond retirement) provide for federal reimbursement for federal-aid highway projects that were initially financed using bonds issued by states and local governments. Under present law, a state that uses bond revenues to build major, interstate, urban extension, or interstate substitution projects is eligible for federal reimbursement on the portion of the bonds utilized to retire the bonds. Certain interstate interest charges may be eligible for reimbursement from the federal government.
Recent Proposed Legislation and Developments
Sen. Max Baucus (D-Mont.) and Rep. Robert A. Borski (D-Pa.) proposed measures in the 103rd Congress last year that would have allowed states more freedom in transportation finance and encouraged the sale of highway and transit bonds. Despite the fact that neither bill was passed by Congress, this attention demonstrates a growing interest in state bonds and other innovations as a means of expanding highway capital expenditure.
The Baucus bill, Senate Bill 1714, is the State Transportation Financing Improvement Act.
would have permitted states to create their own revolving funds using seed money from federal highway grants. These revolving funds may have been utilized to buy bond insurance or improve credit directly. According to recent study undertaken for the Federal Highway Administration (FHWA), if such legislation had been adopted in 1993, a $2 billion investment in state revolving fund credit enhancement operations may have resulted in over $6 billion in new bond issuance.
Borski proposed legislation that would have created an infrastructure reinvestment fund to provide current funding for ISTEA roadway and transit programs. H.R. 3489, the Infrastructure Reinvestment and Economic Revitalization Act, would have established a $30 billion infrastructure reinvestment fund financed over 30 years by five cents per gallon from the Highway Trust Fund and other taxes. The fund would have provided short-term funding for a substantial ISTEA program that would be repaid over a 30-year period. Despite the fact that H.R. 3489 was a federal bond rather than a state municipal bond scheme, it sought to solve the same underinvestment problem that state bonds do.
State Infrastructure Banks (SIBs) are included in the Department of Transportation’s (DOT) new program design as part of the department’s restructuring initiative. SIBs are designed to foster novel and user-fee methods of infrastructure financing, such as state bonds, in order to better leverage federal money and stimulate private investment. The DOT budget for fiscal year 1996 provided $2 billion in seed money to launch these banks. The SIBs’ program details and legislative language are still being finalized.
FHWA Innovative Financing Program
FHWA developed an Innovative Financing Test and Evaluation Project (TE-045) in March 1994 to help identify ways to stimulate higher transportation investment. The agency aimed to boost and improve highway and other surface transportation infrastructure investment. More than 60 innovative financial concepts were submitted by more than 25 states. Several projects were listed in these plans that supported highway bond financing either directly or indirectly. States presented plans to FHWA that included increased use of Section 1012, Section 1044 matching provisions, extended eligibility to include bond interest as an eligible cost, and post-ISTEA obligations. Several of these ideas were eventually accepted.
Conclusion: Evaluating Bonds as an Option
When it comes to the appropriateness of highway bond financing as a means of satisfying transportation infrastructure needs, there is no right or wrong answer. It’s a viable mechanism that state and local governments are increasingly relying on, and that federal efforts are supporting and encouraging. Bond financing, along with other alternative financing solutions, should be evaluated based on the application of particular financing criteria. A complete financing strategy should be established and assessed in terms of revenue potential (capacity to earn money), equity (fairness of cost-benefit ratio), efficiency (governments’ ability to collect these revenues), and political acceptability.
Choosing the right funding plan is only one aspect of highway construction. It is, nonetheless, a critical component. Bond financing may be the most suitable financing choice in various instances. When it is the most appropriate means of advancing needed highway and other surface transportation projects, transportation decision makers should choose this option.
Tom Howard works in the FHWA’s Office of Policy’s Legislation and Strategic Planning Division as a transportation specialist. He graduated from Fordham University with a bachelor’s degree in economics and master’s degrees in education and public administration from Fairfield University and George Washington University, respectively. He has more than 15 years of experience in the field of highway financing.
How do municipalities repay bonds?
Municipal bonds (also known as municipal debt) are a type of debt “State, city, county, and other local agencies issue debt securities to support day-to-day commitments as well as capital projects such as the construction of schools, roadways, and sewer systems. When you buy municipal bonds, you’re effectively lending money to the bond issuer in exchange for a promise of regular interest payments, usually semi-annually, and the return of the original investment, or a combination of the two “I am the principle.” The maturity date of a municipal bond (the day on which the bond’s issuer repays the principal) could be years away. Short-term bonds will mature in one to three years, whereas long-term bonds will take a decade or more to maturity.
Municipal bond interest is generally tax-free in the United States. If you live in the state where the bond was issued, the interest may be free from state and local taxes. Bond investors are often looking for a consistent stream of income payments and, when compared to stock investors, are more risk conservative and concerned with preserving rather than developing capital. Due to the tax benefits, tax-exempt municipal bonds typically have lower interest rates than taxable fixed-income assets such as corporate bonds with equal maturities, credit quality, and other characteristics.
- States, cities, and counties issue general obligation bonds that are not backed by any assets. General obligations, on the other hand, are backed by the government “the issuer’s “full faith and credit,” which includes the ability to tax inhabitants in order to pay bondholders.
- Revenue bonds are backed by earnings from a specific project or source, such as highway tolls or lease fees, rather by the government’s taxing power. Some revenue bonds are available “The term “non-recourse” refers to the fact that bondholders have no claim to the underlying revenue source if the revenue stream ceases to exist.
Municipal borrowers also occasionally issue bonds on behalf of private businesses such as non-profit universities and hospitals. The issuer, who pays the interest and principal on the bonds, often agrees to reimburse these “conduit” borrowers. The issuer is usually not compelled to pay the bonds if the conduit borrower fails to make a payment.
Where can investors find information about municipal bonds?
The Municipal Securities Rulemaking Board’s Electronic Municipal Market Access (EMMA) website makes municipal securities documentation and data available to the public for free. You will have access to:
- Economic reports and events that may have an influence on the municipal bond market are listed on this calendar.
It’s worth noting that many issuers have dedicated websites or webpages for municipal bond investors. Some issuers link to those pages from their EMMA main page. Learn how to use EMMA to locate issuer homepages.
In 2009, the Securities and Exchange Commission recognized EMMA as the official depository for municipal securities disclosures. The MSRB is supervised by the Securities and Exchange Commission (SEC). The MSRB is a self-regulatory body whose objective is to promote a fair and efficient municipal securities market in order to safeguard investors, state and local governments, and other municipal entities, as well as the public interest. The disclosure materials are not reviewed by the SEC or the MSRB before they are posted on EMMA.
What are some of the risks of investing in municipal bonds?
Municipal bonds, like any other investment, carry certain risk. Municipal bond investors are exposed to a number of dangers, including:
Call it a gamble. Call risk refers to the possibility of an issuer repaying a bond before its maturity date, which could happen if interest rates fall, similar to how a homeowner might refinance a mortgage loan to take advantage of reduced rates. When interest rates are constant or rising, bond calls are less likely. Many municipal bonds are “callable,” thus investors who plan to hold a bond to maturity should look into the bond’s call conditions before buying it.
There is a credit risk. This is the risk that the bond issuer will run into financial difficulties, making it difficult or impossible to pay interest and principal in full (the inability to do so is known as “default”). For many bonds, credit ratings are available. Credit ratings attempt to measure a bond’s relative credit risk in comparison to other bonds, yet a high grade does not imply that the bond would never default.
Interest rate risk is a concern. Bonds have a set face value, which is referred to as the “par” value. If bonds are held to maturity, the investor will get the face value of the bond plus interest, which might be fixed or variable. The market price of the bond will grow as interest rates fall and fall as interest rates rise, hence the market value of the bond may be greater or lesser than the par value. Interest rates in the United States have been historically low. If interest rates rise, investors who hold a cheap fixed-rate municipal bond and try to sell it before it matures may lose money due to the bond’s lower market value.
There is a chance of inflation. Inflation is defined as a widespread increase in prices. Inflation diminishes purchasing power, posing a risk to investors who are paid a fixed rate of interest. It may also result in higher interest rates and, as a result, a decrease in the market value of existing bonds.
There’s a danger of running out of cash. This refers to the possibility that investors may be unable to locate an active market for the municipal bond, prohibiting them from buying or selling the bond when they want and at a specific price. Because many investors purchase municipal bonds to hold rather than trade them, the market for a given bond may be less liquid, and quoted values for the same bond may range.
In addition to the risks, what other factors should you consider when investing in municipal bonds?
There are tax implications. Consult a tax specialist to learn more about the bond’s tax ramifications, such as whether it’s subject to the federal alternative minimum tax or qualified for state income tax benefits.
Brokerage commissions. The majority of brokers are compensated by a markup on the bond’s cost to the firm. It’s possible that this markup will be revealed on your confirmation statement. If you are charged a commission, it will appear on your confirmation statement. You should inquire about markups and commissions with your broker.
Do municipal bonds pay monthly interest?
Municipal bonds are debt instruments sold to bondholders by these organizations. This interest is normally paid every six months until the bond matures, at which point the bondholder receives the face value of the bond. The coupon is the annual rate of interest paid on the bond.
What is the procedure for repaying general obligation bonds?
These bonds are guaranteed by an issuer’s general revenues, which include taxes. They do not, however, have a specific tax pledged to repay them, unlike dedicated tax GOs. Instead, bondholders are compensated from general revenues, which, if insufficient to satisfy debt service, force the issuer to raise taxes.
What is the difference between a Section 38 agreement and a bond?
A Part 38 agreement (abbreviated as S38) is a section of the Highways Act 1980 that can be utilized when a developer wants to build a new estate road for residential, industrial, or general-purpose traffic that will be given to the Highway Authority for adoption as a public highway.
Under Section 37 of the Highways Act 1980, a developer may complete the construction of a road and then offer it to the Highway Authority Authority for adoption; however, S38 is preferable because the council has no power to require that a road be made up to an adoptable standard or that it be offered for adoption. If an S38 agreement is reached before construction begins, however, the council can ensure that it is built to the right standard, as well as illuminated and drained.
The Highway Authority (council) does not have the authority to compel a developer to sign an S38 agreement. Many developers, however, believe it is the preferable alternative because the adoption process can be lengthy, and if it occurs after a road has been built, the developer will be responsible for all upkeep until the road is adopted.
Following the signing of a section 38 agreement, the developer will be bound by a set of criteria, terms, and deadlines. It is backed by a bond or cash deposit determined by the Highway Authority and based on the anticipated works. This bond or cash deposit can be used if the developer goes bankrupt or otherwise fails to meet their obligations.
Our general enquiry form can be used to obtain information about existing assets and inventory.
How long does it take for bonds to mature?
Depending on the series you own, savings bonds mature at various intervals.
After 30 years, Series I savings bonds, also known as “I bonds,” reach their full maturity. You can, however, redeem them up to one year after purchase. If you pay them out early, you’ll forfeit the past three months of interest, so make sure you really need the money.
Series I bonds provide a fixed rate of interest that is adjusted for inflation. The I bond rate is 7.12 percent as of November 2021.
When a city sells bonds, what happens?
If you invest in city bonds, you will receive a tax credit from federal and some state income taxes, but your investment will not always be free of additional tax burdens, such as:
- State taxes are levied. If you invest in a bond issued by a state other than your own, you’ll usually have to pay taxes on the interest you earn. However, if you invest in a bond issued by your home state, the interest income you earn is normally exempt from state taxes. This isn’t always the case, though. For resident taxpayers, certain states levy taxes on certain types of bonds.
- Taxes on the federal level. Some municipal bonds are not tax-exempt at the federal level. A bond, for example, could be issued to assist fund a failing pension plan.
- De minimis taxes are taxes that are imposed on a small scale. You may owe taxes on the difference between the amount you paid and the bond’s market value, or par value, if you buy a bond at a discount.
- AMT stands for alternative minimum tax (AMT). Some municipal bond interest income is subject to the AMT liability. This calculation is frequently intricate and difficult to comprehend for the majority of taxpayers. A tax specialist can help you sort through the muck on this one.
- Social Security payouts are subject to a higher tax. Municipal bond interest income is included in your modified adjusted gross income (MAGI) by the IRS, which may increase your Social Security tax liability.
- Medicare rates are going up. Your MAGI may increase the amount you pay for Medicare Part B or Medicare prescription medication coverage as a result of your interest income from municipal bonds.
- There is a tax on capital gains. You must pay tax on the amount of gain realized if you sell a municipal bond before its maturity date and get a payment that is larger than your purchase price, adjusted for paid premiums and obtained discounts.
What impact do bonds have on taxpayers?
Putting “no tax increase” in front of “bonds” is designed to dampen opposition to increased taxes, as it is with many political words. But, to be clear, there is no category of bonds issued by school districts that does not result in an increase in your taxes. Bonds with no tax increase raise your taxes.
How? Bonds are frequently issued by school districts to fund capital projects such as the construction of new facilities or the renovation of existing infrastructure. The bonds are paid off over time by the taxpayers, usually through an increase in their property taxes. Bonds are issued for a set period of time, and when they are paid off, the tax payments of the taxpayers are reduced.
In 2020, are municipal bonds a decent investment?
- Municipal bond interest is tax-free in the United States, however there may be state or local taxes, or both.
- Be aware that if you receive Social Security, your bond interest will be recognized as income when determining your Social Security taxable amount. This could result in you owing more money.
- Municipal bond interest rates are often lower than corporate bond interest rates. You must decide which deal offers the best genuine return.
- On the bright side, compared to practically any other investment, highly-rated municipal bonds are often relatively safe. The default rate is quite low.
- Interest rate risk exists with any bond. You’ll be stuck with a bad performer if your money is locked up for 10 or 20 years and interest rates climb.