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Agency/Government Sponsored Enterprises (GSEs) Product Overview |
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| Product Overview |
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 Government Sponsored Enterprises (GSEs) are lenders created by an act of Congress to assist groups of borrowers such as farmers, ranchers, homeowners and mortgage lenders to gain access to appropriate capital markets. |
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| GSEs are among the most creditworthy fixed income investments available today. GSEs traditionally offer a yield advantage over Treasuries and CDs, while the association with the U.S. government makes them attractive to investors who value quality. |
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| GSEs vs. Agency Securities |
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GSEs are independent organizations that are in part sponsored by the
federal government. Interest income from some examples of government sponsored enterprises are the Federal Farm Credit Banks, the Federal Home Loan Bank System, the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae). |
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Agencies, such as the Government National Mortgage Association (Ginnie Mae), as their name implies, are issued by official government bodies. |
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| Features and Benefits |
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Government Sponsored Enterprises carry an implicit guarantee. This means that the federal government acknowledges an interest in the issuing organization and thus implies an interest in the securities it issues. This differs from the explicit guarantee for U.S. Treasury securities, which states that the securities are backed by the full faith and credit of the U.S. government. While an implied guarantee is not considered as safe as an explicit guarantee, the government historically has taken action if the financial status of a GSE appears threatened. |
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The government also grants special privileges to GSEs, designed to help ensure the organizations' financial strength. This includes access to large credit lines from the Treasury, typically between $1.0 billion and $4.0 billion, and important exemptions from tax and securities laws. |
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The government has the power to regulate GSEs in various ways, including, in some cases, the power to appoint directors to an organization's board. |
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New issue GSEs are typically sold through broker-dealers on an as-needed basis. |
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Broker-dealers purchase large blocks, then make the securities available to other institutions and to individuals. |
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GSEs are generally available in minimum denominations of $5,000, with subsequent investments in increments of $1,000. |
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| While GSEs are not backed by the full faith and credit of the U.S. Government, most possess good credit quality. |
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Because of GSEs' close relationships with the federal government and exemptions from certain tax and securities laws, they are generally perceived as offering a higher level of low-risk than corporate bonds and many other investments. |
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GSEs issue discount notes, which are short-term obligations with maturities ranging from overnight to 360 days, and bonds, which have maturities greater than one year. GSEs use the same price quotation convention as Treasuries. Bid and offer prices are given in 32nds, so a stated price of 988 stands for 98 8/32 or 98.25. |
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Due to the slightly increased credit and liquidity risks, GSEs typically provide investors with higher yields than US Treasury securities or CDs of similar maturities |
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Interest income from some GSEs, such as Federal Farm Credit Bank and Federal Home Loan Bank, are free from state and local income taxes. Interest income from GSEs/Agencies is subject to federal income taxes. If you are subject to the federal alternative tax (AMT), it is also includable in income for purposes of that tax. Capital gains and gains characterized as market discount recognized when bonds are sold or mature are generally taxable at both the state and federal level, although capital losses can usually be used to offset capital gains. Investors should consult a tax professional regarding their individual tax situation. |
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When added to a varied investment portfolio, GSEs can increase average yield while maintaining low-risk. Because of the benefits they offer in safety and income, GSEs represent one way of diversifying beyond Treasuries, CDs, corporate bonds and other types of debt securities. Agency debt comprises over five percent of most fixed income indices. The varying objectives of the individual government entities and their continuing demand for capital, usually enables customers to find a specific product that matches their individual needs. |
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In the fixed income marketplace the liquidity of GSEs is surpassed only by that of Treasury obligations. Active trading in the secondary market by dealers and investors means that most GSEs are easily bought and sold. |
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Many issues carry call provisions which allow the bonds to be retired prior to stated maturity. These calls are clearly defined in the description and usually pay the holder a premium for exercising this right. |
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An issuer will typically call when prevailing interest rates drop, making reinvestment less desirable for the buyer. For investors concerned about call risk, there are also bullet or non-callable GSEs available in the marketplace. |
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Like all bonds, GSEs are susceptible to fluctuations in interest rates. If interest rates rise, bond prices will decline despite the lack of change in both the coupon and maturity. The degree of price volatility tends to increase with the length of the maturity and decrease as the size of the coupon decreases. |
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While GSEs are generally considered to be a low-risk investment, there is some risk that the issuing agency will default. However, by investing in the highest rated securities and/or carrying a diversified portfolio, the credit risks associated with a GSE investment can be reduced. Furthermore, it should be noted that their increased credit risk over Treasury securities is the main reason for the typically higher yields associated with GSEs. |
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The risk that the rate of the yield to call or maturity of the investment may not provide a positive return over the rate of inflation
for the period of the investment. |
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