Agency bonds, also known as an agency debt, are not fully guaranteed the same way that U.S. Treasury and municipal bonds are. Agency bonds are issued by a government-sponsored enterprise or by a federal department that is not the U.S. Treasury. Most agency bonds are exempt from state and local taxes and like any bonds, they have interest rate risks.
Types of Agency Bonds
There are two types of agency bonds: federal government agency bonds and government-sponsored enterprise (GSE) bonds. Federal government agency bonds are issued by the Small Business Administration (SBA), Federal Housing Administration (FHA), and the Government National Mortgage Association (GNMA). While holding the bond, the investor will receive regular interest payments. The full-face value of the agency bond will be returned to the bondholder at the maturity date.
Government-Sponsored Enterprise (GSE) bonds are issues by entities such as the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage (Freddie Mac), Federal Home Loan Bank, and the Federal Farm Credit Banks Funding Corporation. These are private companies, not government agencies. They serve a public purpose and could be supported by the government and subjected to government oversight. GSE bonds do not have the same backing by the U.S. government as Treasury bonds. Because of that, there will be some credit and default risk, and the yield offered will typically be higher.
How Do Agency Bonds Work?
Agency bonds usually pay a semi-annual fixed coupon. Sold in a variety of increments, $10,000 is generally the minimum investment and increases in $5,000 increments. GNMA securities will come in $25,000 increments. Like all bonds, agency bonds have interest rate risks. An investor may buy agency bonds only to see that interest rates rise. The investor could have made more money by waiting for higher interest rates to kick in.
Tax Considerations
Most, but not all, agency bonds are exempt from local and state taxes. Freddie Mac, Fannie Mae, and Farmer Mac agency bonds are fully taxable. Investors may be subject to capital gains taxes when they sell or redeem an agency bond bought at a discount. Capital gains or losses are taxed at the same rates as stocks.
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This overview is for informational purposes only and is not a recommendation. It should not be the sole deciding factor in making an investment. Investing is a risk, and, as with all risks, a positive return is not guaranteed. Past performance does not indicate future results.