Agency bonds are financial instruments issued by government-sponsored entities in the United States. These bonds are distinct from government-guaranteed securities, as they are created and issued by private companies. However, they carry an implicit backing from the United States government due to the nature and purpose of the issuing organizations.
These government-sponsored entities were established to provide more accessible and affordable financing options for specific groups of individuals, particularly first-time homebuyers and students. The most prominent and well-known issuers of Agency Bonds include Sallie Mae, Freddie Mac, and Fannie Mae.
Unlike government agencies, these issuers are not backed by the full faith and credit of the U.S. government but operate under government charters to support key policies. Instead, they operate as privately held and managed companies that have been granted government charters due to their crucial role in implementing government-directed policies.
Agency bonds are used to raise funds that enable these companies to offer various types of loans, including farm loans, home loans, student loans, and financing for international trade. The government’s decision to grant charters to these organizations reflects the significance of their activities in supporting national policies. As a result, financial markets generally assume that the Federal Government would intervene to prevent these chartered firms from failing.
This implied backing results in agency bonds having ratings and yields similar to government-issued debt. For instance, Private Export Funding Corporation bonds, which are backed by actual collateral of United States government securities, and Federal Farm Credit Banks’ bonds, which do not have such collateral backing but are still considered a government-sponsored entity. Despite these differences, the yield-to-maturity of these two bonds are remarkably similar at 4.753% and 4.760% respectively. This similarity in pricing demonstrates the market’s recognition of the implicit guarantee associated with government-sponsored entity securities.
All Agency bonds are subject to federal taxation. However, many of these bonds are exempt from state-level taxes, which can be a significant factor for investors residing in states with their own tax systems, though this varies by issuer. Interest payments from some of the most well-known organizations, such as Freddie Mac and Fannie Mae, may be subject to state-level taxation. In contrast, the majority of other Agency bonds avoid this state-level taxation, making them potentially more attractive to investors in high-tax states.
The Agency bond market is dominated by a small number of large issuers. In fact, more than ninety percent of all outstanding Agency bonds are issued by just four major government-sponsored entities. Listed in order of size, these are the Federal Home Loan Banks, Federal Home Loan Mortgage Corporation, Federal National Mortgage Association, and Federal Farm Credit Banks.
Agency bonds issued by the Federal Home Loan Banks and Federal Farm Credit Banks are not subject to state income tax, which can be an additional benefit for some investors.
