An agency bond is a bond issued by a government agency. These bonds do not include those issued by the U.S. Treasury or municipalities and are not fully guaranteed in the same way as U.S. Treasury and municipal bonds.

Agency bond is also known as agency debt.

Breaking Down Agency Bond

There are two types of agency bonds—federal government agency bond and GSE bond. Federal government agency bonds are issued by the Federal Housing Administration (FHA), Small Business Administration (SBA), and Government National Mortgage Association (GNMA). GNMAs are commonly 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 expects to receive regular interest payments from holding this agency bond. At maturity, the full face value of the agency bond is remitted to the bondholder. Because federal agency bonds are less liquid than Treasury bonds, they offer a slightly higher rate of interest than Treasury bonds. In addition, federal government agency bonds may be callable, which means that investors are exposed to the risk that the issuer may redeem the bonds before their scheduled maturity date.

A Government-Sponsored Enterprise (GSE) bond is an agency bond issued by such agencies as Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage (Freddie Mac), Federal Farm Credit Banks Funding Corporation, and the Federal Home Loan Bank. The same guarantee does not back GSE agency bonds as federal government agencies and, hence, have credit risk and default risk. For this reason, the yield on these bonds is typically higher than the yield on Treasury bonds.

Most agency bonds pay a semi-annual fixed coupon and are sold in a variety of increments, though the minimum investment level is generally $10,000 for the first increment and $5,000 increments after that. GNMA securities come in $25,000 increments. Some agency bonds have fixed coupon rates while others have floating rates affixed to the bonds. Floating rate agency bonds have their interested rates periodically adjusted to the movement of a benchmark rate, such as LIBOR. To meet short-term financing needs, some agencies may issue no-coupon discount notes, or “discos,” at a discount to par. Discos have maturities ranging from a day to a year and, if sold before maturity, may result in a loss for the agency bond investor.

The interest from most, but not all, agency bonds is exempt from local 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 redeemed. Capital gains or losses when selling agency bonds are taxed at the same rates as stocks. Tennessee Valley Authority (TVA), Federal Home Loan Banks, and Federal Farm Credit Banks agency bonds are exempt from local and state taxes.

Like all bonds, agency bonds have interest rate risks. The inverse relationship between interest rates and bond prices means that the value of an agency bond held by an investor will fall in times of rising interest rates in the economy. Interest rate changes generally have a greater effect on long-term bond prices.