A rate covenant is a commitment in the bond ordinance or trust indenture that the utility will charge rates sufficient to produce net revenues equal to a stated multiple of the debt service falling due that year. Multiples between 1.10 and 1.25 are common on municipal water and sewer revenue debt; 1.20 is the one most often seen.
Why it binds the rate
The covenant is a continuing obligation measured every year against actual results, not a condition tested once at closing. A utility that meets its cost of service exactly and produces net revenue at 1.05 times debt service has covered its costs and broken its covenant. The rate has to clear the covenant, which means the covenant, and not the cost of service, is sometimes the number that sets the increase.
What happens when it is breached
Ordinances usually treat a coverage shortfall as an event requiring the utility to engage a consultant and adopt corrective rates, rather than as an immediate default accelerating the bonds. That distinction matters and it is specific to the document: the only reliable statement about a particular utility’s covenant is the one read out of its own ordinance or official statement.
Sources
Municipal Securities Rulemaking Board glossary of municipal securities terms, entry for rate covenant. California Debt and Investment Advisory Commission, Glossary of Municipal Debt Financing Terms. The governing text for any single utility is its own bond ordinance or trust indenture.