What is an agency bond?
An agency bond (also called agency debt) is a fixed-income security issued either by a U.S. federal government department other than the Treasury or by a government-sponsored enterprise (GSE). These securities fund public-purpose activities (for example, housing or farm credit) and generally sit between Treasuries and corporate bonds in terms of credit risk and yield.
Core features (definitions)
– Coupon: the interest payment on the bond, typically paid semiannually.
– Par (face) value: the amount repaid at maturity (commonly $10,000 for agency bond blocks).
– Floating-rate bond: a bond whose coupon resets periodically based on a benchmark rate (historically LIBOR or similar).
– Callable: a bond feature that allows the issuer to redeem the bond before its scheduled maturity.
– Government-sponsored enterprise (GSE): a private corporation created to serve a public purpose (examples include Fannie Mae and Freddie Mac). GSE debt typically lacks the explicit “full faith and credit” guarantee of Treasury securities.
How agency bonds work (brief)
– Issuers sell bonds to raise capital for specific programs (housing finance, farmers’ lending, etc.).
– Most agency bonds pay a fixed coupon semiannually; some have floating coupons that reset with a benchmark.
– Typical minimums: first increment often $10,000; subsequent increments often $5,000. Ginnie Mae (GNMA) securities commonly come in $25,000 increments.
– Some federal agency bonds (issued by government departments such as GNMA or the FHA programs) are explicitly backed by the U.S. government; many GSE bonds are not, so they carry more credit risk than Treasuries.
Types of agency bonds
– Federal government agency bonds: issued by agencies or government departments (examples: Government National Mortgage Association – GNMA; Small Business Administration – SBA). GNMA securities are often issued as mortgage pass-throughs and, where indicated, can carry a government guarantee.
– Government-sponsored enterprise (GSE) bonds: issued by privately chartered entities serving public purposes (examples: Fannie Mae, Freddie Mac, Federal Home Loan Bank system, Federal Farm Credit Banks). These are typically subject to oversight but do not always have the same explicit government guarantee as Treasuries.
Tax treatment (summary)
Tax rules vary by issuer and by state/local law. Key points:
– Interest on many agency bonds is subject to federal income tax and may also be subject to state and local tax.
– Some issuers’ debt is exempt from state and local taxes (examples often cited: Tennessee Valley Authority, Federal Home Loan Banks, Federal Farm Credit Banks).
– Other agencies’ securities have fully taxable interest (examples often cited: Fannie Mae, Freddie Mac, Farmer Mac).
– Buying at a discount may create taxable capital gain when sold or redeemed; capital gains/losses are taxed under the same rules that apply to other securities.
Main risks
– Interest-rate risk: bond market prices fall when prevailing interest rates rise; longer maturities are generally more sensitive.
– Call risk: if the bond can be redeemed early, investors may have their higher-yield bonds called in a lower-rate environment and be forced to reinvest at lower rates (reinvestment risk).
– Credit/default risk: GSEs are not always explicitly guaranteed by the federal government, so default risk exists, albeit frequently low for many large agencies.
– Liquidity risk: some agency issues trade less frequently than Treasuries, which can make buying or selling at a fair price harder.
How to buy agency bonds (checklist)
1. Decide the issuer/type (federal agency vs. GSE) and confirm tax treatment for your state.
2. Choose a broker or dealer (many retail brokerages list agency bonds in their bond screeners).
3. Verify minimum denomination (commonly $10,000 initial, $5,000 increments; GNMA often $25,000).
4. Check the bond’s features: coupon type (fixed/floating), maturity date, call provisions, and liquidity.
5. Review current yield and compare to Treasury and corporate alternatives for similar maturity and risk.
6. Place an order through your broker (secondary market or new-issue offerings). Keep records for tax reporting.
Worked numeric example (illustrating interest-rate risk)
Suppose you buy a 5-year agency bond with:
– Par = $10,000
– Coupon = 3% annual, paid semiannually (so $150 every six months)
– You buy at par ($10,000).
If market rates rise to 4% annually, the bond’s price will fall because new issues pay higher coupons. Using a 4% market yield (2% per half-year) for discounting:
– Present value of coupons = 150 × [1 − 1/(1.02^10)] / 0.02 ≈ $1,347.38
– Present value of principal = 10,000 / 1.02^10 ≈ $8,203.50
– Bond price ≈ 1,347.38 + 8,203.50 = $9,550.88
Result: The bond’s market price falls to about $9,551, a loss of ≈ $449 (≈4.5% of par) because yields rose 1 percentage point. This example illustrates how rising interest rates reduce a bond’s market value.
Summary (the bottom line)
Agency bonds finance government-related programs and are generally viewed as conservative fixed-income investments. They sit between Treasury securities and corporate bonds on a risk–return spectrum: many agency bonds are very safe, but credit protection and tax treatment vary by issuer. Before buying, confirm the issuer’s backing, the bond’s call features, tax status for your state, and the minimum purchase size.
Selected reputable sources
– Investopedia — Agency Bond overview: https://www.investopedia.com/terms/a/agencybonds.asp
– Ginnie Mae (Government National Mortgage Association): https://www.ginniemae.gov
– Fannie Mae: https://www.fanniemae.com
– Freddie Mac: https://www.freddiemac.com
– Vanguard (investor education): https://www.vanguard.com
Educational disclaimer
This explainer is for educational purposes only. It is not personalized investment advice or a recommendation to buy or sell any security. Consider consulting a licensed financial professional and reviewing official prospectuses and tax guidance before making investment decisions.