Authority Bond: What It is, How it Works

What Is an Authority Bond?

An authority bond is a debt security issued by an authority—such as a government agency or a corporation—formed to manage a public enterprise. A public enterprise is a business organization that is either wholly or partly owned by the state and controlled through a public authority. Authority bonds are also referred to as local authority bonds.

The purpose of an authority bond is to finance the operations of a revenue-generating public business. Investors buy into authority bonds for a stated period, which allows the financed project to be completed and begin earning revenue; after this period, the bond will pay interest at a specified rate. Buyers of authority bonds have a claim to the business's revenue, which serves as the bond's yield. (Yield refers to the earnings generated and realized on an investment over a particular period of time.)

Understanding Authority Bonds

Authority bonds are issued by an authority, such as a government agency, public organization, or a company. The bond's security is from the proceeds of the project it finances.

While bonds, in general, are issued in order to finance governmental and civic agencies and infrastructure, the funds from an authority bond are applied to fund one specific project.

Authority bonds are generally considered low-risk investments, although the risk varies by the issuer. The risk of an authority bond correlates with the risk of the specific project it finances.

While municipal bonds tend to finance low-risk infrastructure projects for the community at large, authority bonds may fund projects that have varying degrees of appeal and may not earn the projected revenue.

Authority Bonds vs. Municipal Bonds vs. General Obligation (GO) Bonds

Authority bonds are similar to municipal bonds. Both of these types of bonds are issued by related entities for the same purposes. And while there is some overlap in the types of projects they finance, there are fundamental differences as well. 

Municipal bonds tend to be issued for infrastructure projects, while authority bonds are typically issued for community organizations or expansions of organizations. 

For example, a municipal bond might be issued in order to help fund the building of a new bridge, and bondholders might be paid using the tolls from the new bridge. An authority bond might be issued for a new wing on a community recreation center, and the bondholders for this project might be paid with funds generated by membership fees or day-pass fees.

Another critical difference is authority bonds incorporate margin protections. Margin protections mean bondholders have a guarantee they haven't overpaid for the bonds. This warranty reduces bondholders' risk because the lower price means the project does not have to earn as much revenue to pay back the bondholders.

Authority bonds are a type of revenue bond. Revenue bonds that finance income-producing projects are thus secured by a specified revenue source. Typically, revenue bonds can be issued by any government agency or fund that is managed in the manner of a business, such as entities having both operating revenues and expenses.

Revenue bonds can be compared to general obligation (GO) bonds. A GO bond is a municipal bond backed solely by the credit and taxing power of the issuing jurisdiction (rather than the revenue from a given project). GO bonds can be repaid through a variety of tax sources. Municipal bonds are sometimes revenue bonds (but not always).