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Agency/Government Sponsored Enterprises (GSEs) Product Overview |
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| Product Overview |
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 Bonds which are sometimes referred to collectively as "agencies" or "agency bonds" are issued by two types of entities: (1) agencies of the U.S. federal government and (2) private agencies, called government sponsored enterprises (GSEs), which are federally chartered, but publicly owned by their stockholders. |
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| Bonds issued or guaranteed by U.S. federal government agencies, such as the Government National Mortgage Association (Ginnie Mae), Small Business Administration and Federal Housing Administration are backed by the "full faith and credit" of the U.S. federal government and guaranteed against default (but not other risks such interest rate risk or call or prepayment risk ). One exception to the "full faith and credit" guarantee is the Tennessee Valley Authority, which is a corporation owned by the U.S. government, but backed solely by the revenue generated by the Authority. It is also important to note that Ginnie Mae does not issue its own securities, but rather, guarantees the timely payment of principal and interest on the mortgage-backed securities (MBS) backed by federally insured or guaranteed loans. |
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| Bonds issued by GSEs, such as the Federal Home Loan Mortgage Association (Freddie Mac), the Federal Home Loan Mortgage Association (Fannie Mae) and the Federal Home Loan Banks are not backed by the same "full faith and credit" guarantee as bonds issued by U.S. federal government agencies. GSE issued bonds are therefore subject to credit and default risk. |
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| It is important for investors to understand who is issuing the bond and the extent to which the issuer is independent of the U.S. federal government. |
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New issue bonds are typically sold through broker-dealers. |
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Broker-dealers purchase large blocks, then make the securities available to other institutions and to individuals. |
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New issue bonds vary in their order minimums and increments. Although most may have a minimum order quantity of 1 bond, others have minimum purchase sizes of 5 or 10 bonds for minimum investment amounts of $5,000 or $10,000 respectively. Please check the Bond Details page of the issue you are considering when placing orders. |
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A relatively active secondary market exists (non-MBS) for many agency and GSE bonds. The size of the market and features of each security affect liquidity or ability to be bought and sold on the secondary market. |
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| Features and Benefits |
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Agency and GSE bonds are considered to be of high credit quality. |
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Agencies and GSEs may issue zero coupon discount notes, which are short-term obligations with maturities ranging from overnight to 360 days, and bonds, which have maturities greater than one year. |
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In addition to fixed-rate coupon bonds and non-callable bonds, agencies and GSEs also issue callable bonds with "step up" coupon rates. A "step up" bond has a coupon that increases at regular intervals while the bond is outstanding. "Step up" bonds are often called during periods of declining interest rates. |
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The tax status of Agency and GSE bonds varies. Interest income paid from some, but not all, Agency and GSE bonds is free from state and local income taxes. Interest from bonds issued by Freddie Mac and Fannie Mae is fully taxable. Interest income paid from GSE and Agency issued bonds is subject to federal income taxes. If you are subject to the federal alternative tax (AMT), it may also be includable in income for purposes of that tax. Capital gains and gains characterized as market discount recognized when bonds are sold or mature are generally taxable at both the state and federal level, although capital losses can usually be used to offset capital gains. Investors should consult a tax professional regarding their individual tax situation. |
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Because of the benefits they offer in credit quality and income, Agency and GSE bonds represent one way of diversifying beyond Treasuries, CDs, corporate bonds and other types of debt securities. Agency and GSE debt comprises over five percent of most fixed income indices. The varying objectives of the individual government entities and their continuing demand for capital, usually enables customers to find a specific product that matches their individual needs. |
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Active trading in the secondary market by dealers and investors means that many Agency and GSE bonds are easily bought and sold. It is important for investors to understand, however, that many Agnecy and GSE bonds are structured to meet the needs of a particular class of investor, often with the expectation that the bonds will be held until maturity. |
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Many issues carry call provisions which allow the bonds to be retired prior to stated maturity. These calls are clearly defined in the description and usually pay the holder a premium for exercising this right. |
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An issuer will typically call a bond when prevailing interest rates drop, making reinvestment less desirable for the buyer. For investors concerned about call risk, there are non-callable GSEs and Agency bonds available in the marketplace. |
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Like all bonds, GSEs and Agency bonds are susceptible to fluctuations in interest rates. If interest rates rise, bond prices will decline despite the lack of change in both the coupon and maturity. The degree of price volatility due to changes in interest rates is usually more pronounced for longer-term securities. |
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While GSEs and Agency bonds are generally considered to have relatively low credit risk, there is some risk that the issuing agency or GSE will default. However, by investing in the highest rated securities and/or carrying a diversified portfolio, the credit risks associated with a Agency or GSE bond investment can be reduced. Furthermore, it should be noted that their increased credit risk over Treasury securities is the main reason for the typically higher yields associated with GSEs and some Agencies. |
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The risk that the purchasing power of a bonds's future cash flows (interest and principal) will be reduced due to inflation. |
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