Agency Bond: Definition, Types, and Tax Rules
Agency bonds are issued by government-sponsored enterprises or federal departments other than the Treasury. U.S. Treasury and municipal bonds are fully guaranteed, while others are not. An agency bond is agency debt.
How Agency Bonds Work
Agency bonds typically pay semi-annual fixed coupons. Most increments require a $10,000 initial commitment and $5,000 for each subsequent step. The GNMA securities are $25,000 each.
Agency bonds can have floating or fixed coupon rates. Benchmark rates like LIBOR change floating rate agency bond interest rates.
Like other bonds, agency bonds contain interest rate concerns. Thus, a bond investor may buy bonds and see interest rates grow. Bond spending power has decreased. The investor may have made more by waiting for a higher interest rate. Naturally, long-term bond prices are riskier.
Types of Agency Bonds
Federal government agency bonds and GSE bonds exist.
Federal Agency Bonds
FHA, SBA, and GNMA issue federal government agency bonds. Most GNMAs are mortgage pass-through securities.
The U.S. government guarantees federal government agency bonds, like Treasury securities. Agency bond investors receive regular interest payments. Bondholders receive the full face value of agency bonds at maturity.
Less liquid federal agency bonds pay a higher interest rate than Treasury bonds. Callable agency bonds allow the issuing agency to redeem them before maturity.
Gov-sponsored enterprise bonds
Fannie Mae, Freddie Mac, Federal Farm Credit Banks Funding Corporation, and the Federal Home Loan Bank issue GSEs. Non-government agencies. Private firms serving a public purpose may receive government funding and oversight.
Treasury and government agency bonds are more U.S.-backed than GSE agency bonds. Due to credit and default risk, their yields are greater.
A discount to par no-coupon discount notes, or “discos,” are issued by various agencies for short-term financing. Discos mature in a day to a year, and selling them early may cost agency bond investors.
Most but not all agency bond interest is tax-exempt. Fannie Mae, Freddie Mac, and Farmer Mac agency bonds are taxable.
When sold or redeemed, discounted agency bonds may incur capital gains taxes. The sale of agency bonds is taxed like stock gains or losses. TVA, FHLB, and FFCB agency bonds are tax-exempt.
- Federal government agencies and GSE bonds pay significantly more than Treasury bonds.
- Some are exempt from state and local taxes.
- Interest rate concerns apply to all bonds.