US agency bonds: what you should know (2023)


24 maja 2023 r Martina Hill

Bonds issued by government-sponsored companies can offer slightly higher yields than US Treasuries without requiring investors to take more risk.

US agency bonds: what you should know (1)

US agency bonds are a type of high-rated bond investment that can help investors earn slightly higher yields than US Treasuries without taking on too much additional risk. We continue to suggest to investorsfocus on quality investments todayand agencies comply with these guidelines.

Agency bonds are issued by government sponsored companies (GSE). Some of the more common issuers of agency bonds include, but are not limited to:

  • Federal National Mortgage Association lub Fannie Mae (FNMA)
  • Federal Home Loan Mortgage Corporation lub Freddie Mac (FHLMC)
  • Federal Home Loan Bank (FHLB)
  • Federal Agricultural Credit Bank (FFCB)
  • Tennessee Valley Authority (TVA)1

In this article, we focus solely on agency-issued securities, not mortgage-backed securities. Fannie Mae, Freddie Mac, and the Government National Mortgage Association or Ginnie Mae (not named in this article) issue and withdraw mortgage-backed securities, but they are different from the traditional securities discussed in this article.

Government-sponsored companies have no explicit support from the US government. While GSEs are believed to have implicit government endorsement, they are not backed by the full faith and credit of the US government. Since agency bonds carry a greater credit risk (ie the risk of not paying interest on time or even, in the worst case, not paying the principal) than government bonds, they would generally carry more risk. is facing financial difficulties.

However, the current – ​​and historically recurring – debate over the debt ceiling and potential US default risk should not necessarily affect agency bonds. They are not considered direct liabilities of the U.S. government because the agencies and GSEs that issue them are generally self-funded. However, if one of the agencies needed help from the US while the US was insolvent - which we don't think is likely - this could pose a risk to investors investing in the agency's securities as the government would probably not be able to help in time. slick. ways.

Given this implicit support, agency bonds generally have the same credit rating as the US government, which is currently rated Aaa/AA+/AAA by Moody's Investors Service, Standard & Poor's and Fitch Ratings, respectively.2If one or more rating agencies downgraded the US government's rating as a result of political disputes over the debt ceiling, it would likely result in a downgrade of the agency's rating as well.

Agency Bonds have continued to pay interest and principal on time despite various concerns over the years. For example, Fannie Mae and Freddie Mac were placed in trust by the U.S. government in 2008. Both GSEs are public companies, and trusteeship means that the Federal Housing Finance Agency (their oversight body) "has authority over the management, boards, and shareholders Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac continue to operate as trading corporations."3

Here are some things you should know before considering agency bonds.

1. The advantage of yields over Treasuries is relatively low

Because the agencies are not explicitly backed by the U.S. government, they typically offer a yield advantage over U.S. Treasury bonds. This extra income is called the "spread" and varies according to market conditions.

Spreads widened sharply during the financial crisis of 2008-2009, especially when Fannie Mae and Freddie Mac were taken into custody. While agencies continued to pay principal and interest on time, this was unknown in 2008, and investors understandably became nervous, posting spreads as high as 1.75% on average. The spreads increased again in March 2020, but fell quickly due to the government's quick intervention.

The Bloomberg USA Agency Index has an average spread of just 29 basis points, or 0.29%, which means investors are not earning much more on Treasury bonds compared to history. The chart below shows that until recently, the average spread of the index rarely fell below 0.25%. Although above recent lows, the index's average spread is below its 20-year average of 0.42%.

However, this does not mean that investors should ignore the agencies. It may make more sense to focus on specific maturities where there is a more attractive yield advantage, as discussed below.

The yield advantage offered by agencies over government bonds is relatively low.

US agency bonds: what you should know (2)

Source: Bloomberg based on weekly data as of May 23, 2023

Bloomberg USA Index of agencies (index I09459). The option-adjusted spread (OAS) is a measure of the spread of a fixed-income bond with a risk-free return (for example, a U.S. Treasury corporate bond), which is then adjusted to take into account the embedded option.Past performance is not a guarantee of future results.

2. The relative attractiveness of agency bonds varies by maturity

Short-term branches offer yields relatively similar to Treasuries and do not start to offer a noticeable yield advantage until maturities of 2 years or more, as illustrated by the yield curve chart below.

Keep in mind that the agency earnings shown below are average. There are many different agency issuers, and all of them may have the same date of maturity - in other words, there is not necessarily a two-year or five-year "reference" agency note. On average, however, agencies with a maturity of less than two years do not appear to be of much value.

For investors considering very short-term investments, certificates of deposit (CDs) often offer higher yields than treasury and agency bonds. While the agencies are government-sponsored enterprises, they are not fully backed by the faith and credit of the US government. CDs are issued by banks but are covered by FDIC insurance (up to a certain limit, of course) and are therefore considered high quality.4

Agencies generally offer a more noticeable yield advantage for medium to long term maturities.

US agency bonds: what you should know (3)

Source: Bloomberg, May 23, 2023

US Treasuries Curve (YCGT0025 Index) and US BVAL Yield Curve (BVSC0131 Index). The treasury curve consists of active U.S. Treasury securities denominated in U.S. dollars. The curve is updated each auction day with the effective date of the next market day. The agency yield curve is constructed daily from bonds that have BVAL prices at market close. The BVAL curve is populated with USD-denominated senior unsecured fixed-rate bonds issued by US agencies.Past performance is not a guarantee of future results.

3. Callable agencies generally offer higher returns but come with call risk

A callable bond allows the issuer to "buy" or redeem it before a specified maturity date. Call date and price are generally known in advance, but may vary.

Publishers often include call features for flexibility. If yields fall after a bond issuance, this may allow the issuer to issue a new lower yield bond and use the proceeds to "catch" higher yield bonds.

Investors often face reinvestment risk if their demand bonds are repaid, as they will likely need to invest the funds in lower yield bonds. Callable agency bonds are typically issued with slightly higher yields than non-callable bonds to balance the risk of reinvestment and redemption.

Buyout agencies are typically issued in smaller transactions than non-buyout agencies, which often results in less liquidity. This can be a risk if an investor needs to sell a buyout agency before maturity as there may not be as many potential buyers as a larger non-call bond.

Callable bonds can have advantages such as higher yields that they usually offer. If the yield does not drop after you invest, you may find that you get a higher rate of return than if you invested in non-redeemable bonds. Moreover, even if the bond is redeemed early due to a decrease in interest rates, the yield achieved during this period may be higher than that available for other investments with the same short time horizon.

When considering a bond buyback, be prepared for any outcome. In other words, there is a possibility that it will be called and you will have to replace this announced title with a new investment. It is equally important to be prepared to hold callable bonds to maturity, as you do not know in advance if and when the issuer will be able to call them.

4. Consider taxes

Investing in some – but not all – agency bonds may have tax advantages. Agency bond income is subject to federal income tax when held in taxable accounts, but some agency income is exempt from state and local income taxes:

  • Not exempt from state and local taxes: Fannie Mae and Freddie Mac
  • Exempt from state and local taxes: FHLB, FFCB and TVA

Note that US Treasury bond interest is exempt from state and local taxes, so when considering Treasury bond agencies, US Treasury bonds may offer a higher after-tax yield, depending on agency issues and state and local tax rates. As always, we suggest that investors consult a tax expert when considering the tax implications of a particular investment.

what to consider now

US agency bonds may be considered by investors who want slightly higher yields without taking on too much additional credit risk. While the agencies are government-sponsored enterprises, they are not fully backed by the faith and credit of the US government.

Bought back branches may make sense for investors looking for even higher yields, but investors should always be aware of the risk of a call option before expiration, possibly resulting in reinvestment risk. Similarly, investors should not assume that an issue will be announced on the first redemption date - always consider the maturity date of an issue with a call option and be prepared to hold it for the duration of the redemption period.

Finally, consider the tax implications of agency bonds, as some may be more attractive than others after tax, especially for investors in high-tax states.

1The Tennessee Valley Authority is a federal agency, not a government sponsored corporation. However, its debt securities are not considered liabilities of the US government and are not guaranteed by the government. Source: Tennessee Valley Authority.

2Moody's investment rating scale is Aaa, Aa, A and Baa and sub-investment rating scale is Ba, B, Caa, Ca and C. Standard and Poor's investment rating scale is AAA, AA, A and BBB and the degree of underinvestment scale is BB, B , CCC, CC, and C. The AA to CCC ratings can be modified by adding a plus (+) or minus (-) sign to show relative standing in the major rating categories. Fitch's investment rating scale is AAA, AA, A, and BBB, and its sub-investment rating scale is BB, B, CCC, CC, and C.

3Fonte: Federal Housing Finance Agency, „History of Fannie Mae and Freddie Mac Conservatorships”, 17 grudnia 2022 r.

4The Federal Deposit Insurance Corporation (FDIC) is an independent agency that maintains the Deposit Insurance Fund, which is fully supported by the United States government. Its purpose is to protect depositors' funds deposited in banks and savings banks. The FDIC guarantees accounts held with member banks up to $250,000 per depositor per insured bank, based on ownership category. However, all deposits held at the same FDIC-insured bank under the same title of ownership are added together to determine the depositor's total FDIC coverage with that bank.

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The information provided here is for general information purposes only and should not be construed as an individualized recommendation or personalized investment advice. The investment strategies listed here may not be suitable for everyone. Each investor must analyze the investment strategy for his or her particular situation before making any investment decision.

All opinions expressed are subject to change without notice in response to changing market conditions. The data contained in this document from third-party providers comes from sources believed to be reliable. However, its accuracy, completeness, or reliability cannot be guaranteed.

The examples provided are for illustrative purposes only and are not intended to reflect the results that may be expected.

Investing involves risk, including loss of capital.

Past performance is not a guarantee of future results, and the opinions expressed should not be regarded as indicative of future results.

Indices are unmanaged, there are no management fees, costs or expenses and cannot be directly invested in. For more information on indexes,

Fixed income securities are subject to increased capital losses during periods of rising interest rates. Fixed income investments are subject to many other risks, including changes in credit quality, market valuations, liquidity, prepayments, early redemptions, corporate events, tax consequences and other factors. Lower rated securities are subject to greater credit, default and liquidity risk.

All company names and market data presented above are for illustrative purposes only and do not constitute a recommendation, offer to sell or solicitation of an offer to buy any securities.

The information provided here is for informational purposes only and is not intended to replace specific tax, legal or investment planning advice. When specific advice is needed or appropriate, consult a qualified tax advisor, CPA, financial planner or investment manager.

Mortgage-backed securities (MBS) may be more sensitive to changes in interest rates. They are subject to rollover risk, where borrowers extend the term of their mortgage as interest rates rise, and prepayment risk, where borrowers pay off their mortgages earlier when interest rates fall. These risks can reduce profits.

The Schwab Financial Research Center is a division of Charles Schwab & Co., Inc.

Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively, "Bloomberg"). Bloomberg or Bloomberg's licensors own all proprietary rights in the Bloomberg Indices. Neither Bloomberg nor its licensors endorse or endorse this material, nor guarantee the accuracy or completeness of any information contained therein, nor make any warranty, express or implied, as to the results that may be obtained from it and, to the fullest extent permitted by law, and assumes no liability for injury or damage resulting therefrom.



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