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Agency
bonds tend to offer higher yields than Treasuries, but
lack the full faith and credit of the US government.
Many believe that, in the event of a default of a federal
agency, the government would act consistent with a moral
obligation to make lenders whole, but that is not assured.
Interest from certain agency securities, but not all,
is not taxable at the state and local level.
Short
duration agency bonds offer a premium over virtually
all other cash equivalents at the moment. The Federal
Home Loan Bank and the Federal Farm Credit Bank are
currently issuing 6-month to 1-year notes at par with
a coupon around 3.50%. Interest on notes issued
by these agencies as well as by TVA are state and local
tax exempt. Therefore, the fully taxible equivalent
rate for taxpayers in the highest tax brackets living
in high taxing states such as New York, California and
Pennsylvania may be greater than 4.00%.
Callable agencies can offer a significant premium on ordinary long-term agency bonds (essentially the purchaser is receiving a premium for "selling a call option"). For the last several years and until long term rates began declining in 2005, these bonds tended to be called at or shortly after the first call date (usually three or six months), thereby yielding an excellent rate over a short period of time (often in excess of 5.50%). Bonds issued at high rates are highly likely to be called as a result of recent Fed rate cuts (and therefore you should never purchase a currently callable bond at greater than par value).
For
example, a callable issue by the Federal Home Loan Bank
or the Federal Farm Credit Bank might offer over 5.50%
over 10 years. These bonds would be callable in three
months (and every month thereafter). Assuming the bond
is called at the first call date, the purchaser receives
a return of their principal plus 1.25% (5% on an annualized
basis) at that time. There is a risk that rates will
rise quickly and the bond is not called, and the purchaser
is left holding a bond that may be trading at a significant
discount to par. Therefore, callable agency securities
are an outstanding investment in stable or declining
interest rate environments. However, in rising interest
rate environments, these bonds are more appropriately
viewed as an alternative to long-dated Treasuries or
municipal securities.
The following agencies are issuers to consider:
Fannie Mae - Fannie Mae is the largest investor in home mortgage loans in the United States. Fannie Mae's main purpose is to provide liquidity to the mortgage market. Debt issued by Fannie Mae is explicitly guaranteed by Fannie Mae only and is fully taxable.
Federal Home Loan Mortgage Corporation (FHLMC), also known as Freddie Mac - Freddie Mac's goal is to increase the availability of mortgage credit for home financings and to stabilize the secondary mortgage market. Debt issued by Freddie Mac is explicitly guaranteed by FHLMC only and is fully taxable.
Federal Home Loan Bank System (FHLB), also known as Home Loan - The Federal Home Loan Bank was created out of legislation passed in 1932 to restore confidence in the thrift industry and improve the availability of funds to support home ownership. Debt issued by FHLB is explicitly guaranteed by FHLB only and is generally exempt from state and local taxation.
Federal Farm Credit Bank (FFCB), also known as Farm Credit - The Farm Credit system was created by Congress in 1916 to provide American agriculture with a source of sound, dependable credit at competitive rates of interest. Debt issued by FFCB is explicitly guaranteed by FFCB only and is generally exempt from state and local taxation.
Government National Mortgage Association (GNMA), also known as Ginnie Mae - GNMA is a wholly owned corporate agency operating within the U.S. Department of Housing and Urban Development (HUD). GNMA's primary goal is to channel funds to the primary mortgage market in order to increase the availability of capital for new mortgage loans. Debt issued and guaranteed by GNMA is backed by the full faith and credit of the U.S. government and is fully taxable.
Student Loan Marketing Association (SLMA), also known as Sallie Mae - Sallie Mae was established by the Higher Education Act of 1965 to provide liquidity for banks, thrifts and other lenders that originate Guaranteed Student Loans. Sallie Mae is expected to evolve into a state-chartered, privatized corporation. This move would allow Sallie Mae to expand into new lines of business, in light of the changing marketplace for student loans. All outstanding debt has been determined to be held under a GSE subsidiary, with no effect as to the status of the debt obligations, and is generally exempt from state and local taxation. Sallie Mae debt is known to be fully taxable in Pennsylvania, Massachusetts, Tennessee, and Mississippi.
Tennessee Valley Authority (TVA) - The TVA is a wholly owned corporate agency and instrumentality of the U.S. established by the 1933 Tennessee Valley Act. The objective of the TVA is to develop the resources of the Tennessee Valley region in order to strengthen the regional and national economy and the national defense. Debt issued by the TVA is explicitly guaranteed by the TVA only and is generally exempt from state and local taxation.
