Water and Sewer Bonds
Water and sewer revenue bonds can be an essential building block of a municipal bond portfolio for most municipal bond investors. The water and sewer segment of the municipal bond market is a coveted one because of its essentiality. These bonds are used to construct or expand water and sewer lines for municipalities. Typically these securities carry strong bond ratings of A or above with many in the AA or AAA category.
The way that they work is that the municipality does not back the bond itself. Rather, the revenue from water bill collections is used to pay the bonds. Even during times of financial stress, ratepayers tend to continue to pay their water and sewer bills since we need water to live and to flush toilets in our modern world. They are considered essential services due to their importance for providing infrastructure and maintaining public health and safety.
The most common type of water revenue bond is a net revenue pledge bond. In such a case, the utility pays its operation and maintenance expenses first and covenants that it will structure its water and sewer rates so that they are sufficient to pay back bond holders their principal and interest. Most often there is just one choice for water and sewer services, a natural monopoly. Users of the system will continue to pay their water bills if rates need to be increased.
Factors to consider when analyzing essential service bonds are the financial health of the issuer, the quality of the utility’s management, the physical infrastructure of the water and sewer system and the characteristics of the ratepayers or customer base. In some instances, the service areas of a water system can extend beyond the boundaries of a city and for that reason some water and sewer bonds can be rated higher than the GO (general obligation) bonds of the municipality in which the water system is located.
The bottom line for investors is to carefully work with a trusted municipal bond portfolio manager that can help assess the financial health and default risk of a particular bond issuer to help make good decisions in building a muni bond portfolio.