Agency securities are debt obligations issued by federal agencies or federally sponsored agencies. Federal agencies are direct arms of the U.S. government; federally sponsored agencies are privately owned and publicly chartered organizations which were created by acts of Congress to support a specific public purpose (also referred to as government-sponsored entities or GSEs).
Federal agencies are arms of the federal government and generally do not issue securities directly in the marketplace. These agencies include the Government National Mortgage Association (GNMA), Export-Import Bank, Farmers Housing Administration (FHA), General Services Administration (GSA), Maritime Administration, Small Business Administration (SBA), the Tennessee Valley Authority, Commodity Credit Corporation, Rural Electrification Administration, Rural Telephone Bank, and the Washington Metropolitan Area Transit Authority. All federally related institutions are exempt from SEC registration. With the exception of securities of the Private Export Funding Corporation, and the Tennessee Valley Authority, the securities are backed by the full faith and credit of the U.S. government.
Government-sponsored entities include agencies in the following areas:
Housing (such as the Federal Home Loan Mortgage Corporation and Federal National Mortgage Association)
Farm credit (such as the Federal Farm Credit Bank System and Farm Credit System Financial Assistance Corporation)
Student loans (such as the Student Loan Marketing Association)
Small business (Small Business Administration)
Export funding (Export-Import Bank)
GSEs issue both discount and coupon notes and bonds. Discount notes are short-term obligations, with maturities ranging from overnight to 360 days. Coupon notes and bonds are sold with maturities greater than two years. The securities are not backed by the full faith and credit of the U.S. government. Consequently, investors purchasing GSEs are exposed to some potential credit risk. The yield spread between these securities and Treasury securities of comparable maturity reflects differences in perceived credit risk and liquidity.
GSEs issue direct debt obligations and guarantee various types of asset-backed securities. This section discusses only securities that represent direct obligations of federal and federally sponsored agencies. Mortgage-Backed Securities is a topic of securities issued or guaranteed by some of these agencies. Also, many GSEs are active in issuing structured notes.
CHARACTERISTICS AND FEATURES
Federal-agency securities such as those issued by the Government National Mortgage Association are backed by the full faith and credit of the U.S. government. However, government-sponsored agency securities are not guaranteed by the U.S. government, although market participants widely believe that the government would provide financial support to an agency if the need arose. This view has gained some credence as a result of the federal government’s operations to bolster the Farm Credit System in the mid-1980s. U.S. agency securities are also exempt from registration with the Securities and Exchange Commission (SEC.)
Agency securities are deemed suitable investments for banks, and they are frequently purchased by banks and held in their investment portfolios.
DESCRIPTION OF MARKETPLACE
In the primary market, government agencies and GSEs sell their securities to a select group of commercial banks, section 20 subsidiaries of commercial banks, and investment banks known as “selling groups.” Members of a selling group advise the agencies on issuing debt, placing the debt with end-users, and making markets in these securities.
Prices for the securities traded in the secondary market can be obtained from the “Money and Investing” of The Wall Street Journal or the financial section of local newspapers. Other media, such as Internet financial sites , provide over-the-counter quotes as well.
Federal agencies do not issue securities directly in the marketplace. Most have raised funds through the Federal Financing Bank since 1973, although many of these institutions have outstanding obligations from previous debt issues. Federal agencies include the following: the Export-Import Bank of the United States, Com-modity Credit Corporation, Farmers Housing Administration, General Services Administration, Government National Mortgage Association, Maritime Administration, Private Export Funding Corporation, Rural Electrification Administration, Rural Telephone Bank, Small Business Administration, Tennessee Valley Authority, and Washington Metropolitan Area Transit Authority (neither the Tennessee Valley Authority nor the Private Export Funding Corporation is backed by the full faith and credit of the U.S. government).
Federally Sponsored Agencies
Following is a summary of the main federally sponsored agencies and the types of obligations that they typically issue to the public. The Federal Farm Credit Bank System issues discount notes; short-term bonds with maturities of 3, 6, and 9 months; and long-term bonds with maturities of between 1 and 10 years. The Farm Credit Bank also issues medium-term notes which have maturities of between 1 and 30 years. The Federal Farm Credit System Financial Assistance Corporation issues 15-year notes, guaranteed by the federal government, which were issued to support the Farm Credit System in the mid-1980s.
The Federal Home Loan Bank System issues discount notes that mature in one year or less and noncallable bonds with maturities ranging from 1 to 10 years. These debts are consolidated obligations of the 12 regional Federal Home Loan Banks whose mandate is to provide funds to savings and other home-financing member organizations. As a result of the savings and loan crisis, the Financing Corporation (FICO) and the Resolution Funding Corporation (REFCO) were established in the late 1980s to recapitalize the Federal Savings and Loan Insurance Corporation (FSLIC) and to provide funding for the losses of insolvent thrift institutions, respectively.
The Federal National Mortgage Association (FannieMae) issues short-term discount notes and long-term bonds with maturities of up to 30 years. FannieMae has also issued indexed sinking-fund debentures which are callable and contain features of both mortgage-backed securities and callable corporate bonds. The Federal Home Loan Mortgage Corporation (Freddie Mac) issues discount notes and a limited number of bonds. The Student Loan Marketing Association (SallieMae) issues unsecured debt obligations in the form of discount notes to provide funds to support higher education.
Agency notes and bonds are quoted in terms of 32nds (a percentage of par plus 32nds of a point). Thus, an investor will be willing to pay 101.5 percent of par for an agency security that is quoted at 101:16. Short-term discount notes are issued on a discount basis similar to the way that U.S. Treasury bills are priced.
Agency securities trade at yields offering a positive spread over Treasury security yields because of slightly greater credit risk (due to the lack of an explicit government guarantee for most obligations) and somewhat lower liquidity.
The price risk of most agency securities is hedged in the cash market for Treasury securities or by using Treasury futures or options. As with all hedges, yield curve and basis risk must be monitored closely. In addition, dealers who are actively conducting arbitrage trades and other strategies should have the capability to monitor their positions effectively.
As with any security, much of the risk is a function of the type of trading strategy conducted by an institution.
Agency securities are subject to price fluctuations due to changes in interest rates. As with other types of securities, the longer the term of the security, the greater the fluctuation and level of interest-rate risk. Moreover, some agency securities are subject to greater interest-rate risk than others. Agencies that issue structured notes that are direct obligations, such asstep-up notes from a Federal Home Loan Bank, may have greater risk than other agency securities.
While the credit risk of agency securities is slightly higher than that of Treasury securities because they are not explicitly guaranteed by the U.S. government, their credit risk is still low due to the implied government guarantee.
Agency securities as a whole are not as liquid as U.S. Treasury securities, but liquidity varies widely within the agency market depending on the issuer and the specific debt obligation. In general, agency securities have large trading volumes on the secondary market that help to keep the liquidity risk low. However, various debt provisions and structured notes of different agency securities contribute to differing levels of liquidity risk within the agency market.
LEGAL LIMITATIONS FOR BANK INVESTMENT
General obligations of U.S. government agencies are type I securities, and are exempt from the limitations of 12 USC 24. Banks may purchase these securities for their own accounts without limitation, other than the exercise of prudent banking judgment (one exception is an obligation of the Tennessee Valley Authority, which is a type II security, and investments in which are limited to 10 percent of a bank’s capital stock and unimpaired surplus).