What Is an Agency Bond?
An agency bond is a security issued by a government-sponsored enterprise or by a federal government department other than the U.S. Treasury. Some are not fully guaranteed similarly that U.S. Treasury and municipal bonds are. An agency bond is otherwise called agency debt.
How Agency Bonds Work
Most agency bonds pay a semi-annual fixed coupon. They are sold in different augmentations, generally with a base investment level of $10,000 for the principal increase and $5,000 for extra additions. GNMA securities, in any case, come in $25,000 increases.
Some agency bonds have fixed coupon rates while others have floating rates. The interest rates on floating rate agency bonds are intermittently adjusted by the movement of a benchmark rate, like LIBOR.
Like all bonds, agency bonds have interest rate risks. That is, a bond investor might buy bonds just to find that interest rates rise. The real spending power of the bond is short of what it was. The investor might have gotten more cash-flow by waiting for a higher interest rate to kick in. Normally, this risk is greater at long-term bond costs.
Types of Agency Bonds
There are two types of agency bonds, including federal government agency bonds and government-sponsored enterprise (GSE) bonds.
Federal Government Agency Bonds
Federal government agency bonds are issued by the Federal Housing Administration (FHA), Small Business Administration (SBA), and the Government National Mortgage Association (GNMA). GNMAs are regularly issued as mortgage pass-through securities.
Like Treasury securities, federal government agency bonds are backed by the full faith and credit of the U.S. government. An investor gets ordinary interest payments while holding this agency bond. At its maturity date, the full face value of the agency bond is returned to the bondholder.
Federal agency bonds offer a marginally higher interest rate than Treasury bonds since they are less liquid. Also, agency bonds might be callable, and that means that the agency that issued them might choose to reclaim them before their scheduled maturity date.
Government-Sponsored Enterprise Bonds
A GSE is issued by elements like the Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage (Freddie Mac), Federal Farm Credit Banks Funding Corporation, and the Federal Home Loan Bank.
These are not government agencies. They are private companies that fill a public need, and hence might be upheld by the government and subject to government oversight.
GSE agency bonds don't have a similar degree of backing by the U.S. government as Treasury bonds and government agency bonds. Thusly, there is some credit risk and default risk, and the yield offered on them normally higher.
To meet short-term financing needs, a few agencies issue no-coupon discount notes, or "discos," at a discount to par. Discos have maturities going from a day to a year and, whenever sold before maturity, may bring about a loss for the agency bond investor.
Government-sponsored enterprise bonds don't have a similar degree of backing by the U.S. government as Treasury bonds and other agency bonds.
The interest from the overwhelming majority agency bonds is exempt from nearby and state taxes. Farmer Mac, Freddie Mac, and Fannie Mae agency bonds are fully taxable.
Agency bonds, when bought at a discount, may subject investors to capital gains taxes when they are sold or recovered. Capital gains or losses while selling agency bonds are taxed at similar rates as stocks.
Tennessee Valley Authority (TVA), Federal Home Loan Banks, and Federal Farm Credit Banks agency bonds are exempt from nearby and state taxes.
- The vast majority are exempt from state and neighborhood taxes.
- Federal government agency bonds and government-sponsored enterprise bonds pay marginally higher interest than U.S. Treasury bonds.
- Like any bonds, they have interest rate risks.