Debt Service Coverage Ratio
The debt service coverage ratio measures how well operating income or other pledged revenue of a project covers a revenue bond’s outstanding debt payments. This ratio is one of the most important aspects of revenue bond analysis.
The net operating income of a project is its total revenue minus operating expenses (including cost of goods sold), but it does not subtract tax liability or interest paid on debt.
Current debt service refers to any bond payments that are due within one year. A ratio of less than one indicates that cash flows from the project are insufficient to pay for the revenue bond’s annual principal and interest payments. A ratio of two or above is generally considered acceptable for an issuer of a revenue bond. For example, a debt service coverage ratio of 2.2 would mean that a project was a good candidate for a revenue bond.
Example:
Debt Service Coverage Calculation for Goodville Water Treatment Facility
Total Revenue: $273,000,000
Total Operating Expenses: $75,000,000
Net Operating Income: $198,000,000
Revenue Bond Service Payments: $90,000,000
Net Income: $108,000,000
Debt Service Coverage Ratio
Example Question 1
All of the following would suggest a high rating for a municipal GO bond except:
- A. Low overlapping debt
- B. A municipality with high property values that are growing
- C. A municipality that is not hostile to tax increases
- D. A high debt service coverage ratio
Answer: D
Explanation: Municipalities with high income and high property values and that are not hostile to tax increases would be municipalities that would probably receive a high rating for a GO bond issue. Low direct debt and low overlapping debt suggest a municipality that will be able to meet its interest payments. The debt service coverage ratio is a statistic used to analyze revenue bonds, not GO bonds.
Example Que