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Agency Bonds

Agency bonds are issued by either agencies of the U.S. government or government-sponsored enterprises (GSEs), which are federally chartered corporations but publicly owned by stockholders.

Reasons to consider agency bonds

Find agency bonds

Agency and GSE bonds are one way to create a more diversified portfolio without assuming excessive credit or inflation risk. The varying objectives of the individual government-sponsored entities, and their continuing demand for capital, usually enable customers to find a specific product to match their individual needs.

Bonds issued by GSEs
These include bonds such as the Federal Home Loan Mortgage Corporation (Freddie Mac), the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Banks and the Federal Farm Credit Banks. Because GSEs are owned by shareholders and not part of the federal government, these bonds are not backed by the government’s “full faith and credit” guarantee and are therefore subject to credit and default risk.

Bonds issued or guaranteed by U.S. federal government agencies
Federal agencies, such as the Government National Mortgage Association (Ginnie Mae), are part of the federal government; as such, they are backed by the “full faith and credit” of the U.S. government. Ginnie Mae, however, does not issue bonds directly; it insures or guarantees mortgage-backed securities originated by other lenders. Not all agencies have government backing; one example is the Tennessee Valley Authority (TVA). TVA bonds are not backed by the U.S. government. Instead, they’re backed by the revenues generated by the agencies’ projects.

New issue agency and GSE bonds
New issue bonds are typically sold through broker-dealers, who purchase them in large blocks, then make the securities available to other institutions and to individuals. Although most may have a minimum order quantity of one bond, others have minimum purchase sizes of 5 or 10 bonds, with 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.

Yields above Treasuries
GSE and agency bonds generally offer yields slightly higher than U.S. Treasuries of the same maturity. The extra yield is a reflection of the fact that their credit risk does not have the unconditional backing of the U.S. government, though they are considered to be high credit quality.

Credit quality
Agency and GSE bonds have historically been considered to be of high credit quality. However, investors should consider the balance sheets which may be highly leveraged and concentrated in real estate loans.

Variety of structures
Agencies and GSEs may offer zero-coupon notes, which are short-term obligations issued at a discount, with maturities ranging from overnight to 360 days, as well as bonds with maturities of greater than one year. While many bonds issued by agencies and GSEs are non-callable, they also issue callable bonds with "step-up" coupon rates, in which the coupon increases at regular intervals while the bond is outstanding.

Tax treatment
The tax treatment of agency and GSE bonds depends on the bond issuer and your own tax situation; it always makes sense to consult a professional.

Interest income from some agency bonds, such as those issued by Federal Farm Credit Banks Funding Corporation, Federal Home Loan Banks, and Tennessee Valley Authority (TVA), is exempt from state and local tax. The interest income from bonds backed by Fannie Mae and Freddie Mac, however, is not exempt from state and local tax. If you sell a bond before maturity for a profit, that profit will be subject to federal and state capital gains tax.

Liquidity
A relatively active secondary market exists for many agency and GSE bonds. The size of the market and features of each security affect liquidity. Note that many agency 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.

Call risk
Some agency or GSE bonds have call features, which means they can be redeemed or paid off at the issuer’s discretion prior to maturity. Typically an issuer will call a bond when interest rates fall, potentially leaving investors with a capital loss or loss in income and less favorable reinvestment options. For investors concerned about call risk, non-callable agency and GSE bonds are available in the marketplace.

Interest rate risk
Like all bonds, GSEs and agency bonds are susceptible to fluctuations in interest rates. If interest rates rise, bond prices will generally 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.

Credit and default risk
While GSE bonds have relatively low credit risk, there is some risk that the issuing GSE will default. Agency and GSE issued bonds are not an obligation of the U.S. government, with credit and default risk based on the individual issuer.

Inflation risk
While the yields on agency and GSE bonds are usually higher than those offered by Treasuries, there is a risk that the income generated may be lower than the rate of inflation. Inflation may diminish the purchasing power of a bond’s interest and principal.

Next steps

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Fidelity Learning Center

In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties.
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credit quality

a criteria used to evaluate the creditworthiness, or risk of default, of an individual fixed-income security; generally expressed through ratings provided by one of the credit ratings agencies

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Treasuries

debt obligations of the U.S. government that are issued at various intervals and with various maturities; revenue from these bonds is used to raise capital and/or refund outstanding debt; since Treasury securities are backed by the full faith and credit of the U.S. government, they are generally considered to be free from credit risk and thus typically carry lower yields than other securities; the interest paid by Treasuries is exempt from state and local tax, but is subject to federal taxes and may be subject to the federal Alternative Minimum Tax (AMT); U.S. Treasury securities include Treasury bills, Treasury notes, Treasury bonds, zero-coupon bonds, Treasury Inflation Protected Securities (TIPS), and Treasury Auctions

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yield

the percentage of return an investor receives based on the amount invested or on the current market value of holdings; it is expressed as an annual percentage rate; yield stated is the yield to worst — the yield if the worst possible bond repayment takes place, reflecting the lower of the yield to maturity or the yield to call based on the previous close

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inflation risk

the possibility that the value of assets or income will decrease as inflation shrinks the purchasing power of a currency; inflation causes money to decrease in value at some rate, and does so whether the money is invested or not

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maturity, maturity date(s)

the date on which the principal amount of a fixed income security is scheduled to become due and payable, typically along with any final coupon payment. It is also a list of the maturity dates on which individual bonds issued as part of a new issue municipal bond offering will mature

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credit risk

the risk that the issuer of a fixed-income security may not be able to make regularly scheduled interest payments or repay the principal at maturity

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callable

a bond or other security that may be redeemed by the issuer before the scheduled maturity; terms of this feature can be found in the bond's call schedule

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call protection

provision of a bond that makes it non‐callable or not subject to a scheduled call, even though other early redemption provisions may exist as specified in the prospectus or official statement

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step-up rate

see coupon

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issuer

a government, corporation, municipality, or agency that has issued a security (e.g., a bond) in order to raise capital or to repay other debt; the issuer goes to an underwriter to get their securities sold in the new issue market; for certificates of deposit (CDs), this is the bank that has issued the CD; in the case of fixed income securities, the issuer of the security is the primary determinant of the security's characteristics (e.g., coupon interest rate, maturity, call features, etc.)

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interest income

the dollar amount of all interest earned on government and corporate debt obligations and short-term certificates of deposit, as well as interest earned from cash in a brokerage account

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interest rate

the annual rate, expressed as a percentage of principal, payable for use of borrowed money

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call risk

the risk that a bond or other security may be redeemed by the issuer before the scheduled maturity, which may force the investor to reinvest at lower rates

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coupon

the interest rate a bond's issuer promises to pay to the bondholder until maturity, or other redemption event; generally expressed as an annual percentage of the bond's face value