Takeaways
- Agency bonds are issued by GSEs, usually issued in $1,000 increments.
- Agency bonds have the implicit backing of the U.S. federal government.
- Agency bonds pay regular coupon payments and repay your principal investment.
- Callable agency bonds allow the issuer to redeem the bond before maturity.
- Fixed-income investors balance the pros and cons of agency bonds with CDs, corporate bonds, U.S Treasury Bills, and other interest-bearing investments.
What Are Agency Bonds?
Agency bonds, or “agencies,” are debt securities issued by government-affiliated organizations or government-sponsored enterprises, known as GSEs. These bonds generate capital for specific public projects like housing, farming, or infrastructure development. While they are not backed directly by the U.S. Treasury Department, most agency bonds are still considered a low-risk investment due to the government’s implicit backing.
Some of the biggest issuers of agency bonds include:
- Federal Home Loan Banks
- Federal Farm Credit Banks
- Federal National Mortgage Association (Fannie Mae)
- Federal Home Loan Mortgage Corporation (Freddie Mac)
The U.S. agency bond market is massive. In fact, over $980 billion in U.S. agency bond issuances were sold from January through September 2024.[1]
Agency bonds tend to offer higher yields than U.S. Treasury bonds, making them an attractive investment option for fixed-income, conservative, or retirement-focused investors trying to build a steady passive income.
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How Agency Bonds Work
Agency bonds are structured similarly to other types of bonds, like corporate bonds. A GSE first determines it needs to raise capital to fund a project, such as increasing homeownership, and then conducts a bond issuance.
Investors buy these newly issued debt securities from the issuing agency in a primary or secondary offering in exchange for the promise of regular coupon (interest) payments during the loan term and the repayment of the principal at maturity. Agency bonds are issued in $1,000 denominations, and most come with fixed interest rates, which means you will earn interest payments for the entire life of the bond.
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The issuing GSE uses the funds from bond sales to support initiatives with public mandates, like agriculture or housing. Although these bonds are not guaranteed by the U.S. federal government, like U.S. T Bills, many GSEs are still considered reliable because they receive direct government support.
Agency bonds can be short-term or long-term. Maturities range from just a couple of months to several years. Some agency bonds may also be “callable,” which means the issuer can repay the bond before it matures, saving them interest but lowering your return on the investment.
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What Agency Bonds Fund
Agency bonds fund a massive range of public-purpose projects. A large portion of capital raised through these bond issuances supports housing initiatives. For example, the bonds issued by Fannie Mae and Freddie Mac may create funding for more accessible mortgages or provide affordable mortgage credit, helping potential homeowners access more affordable options for housing.[2]
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Agency bonds also fund projects across other sectors, like agriculture and infrastructure. Organizations like the Federal Farm Credit Banks, the second-largest U.S. GSE based on outstanding debt, use the proceeds from bond purchases to financially support farmers and entire rural communities.[3] Other GSEs focus on sectors like education or engage in accessible small business lending.
How to Buy Agency Bonds
You can buy agency bonds through many different channels. Here is how to buy your first agency bond:
1. Open a Brokerage Account
The most common and arguably the easiest way to purchase an agency bond is through an online brokerage firm. They act as an intermediary between you and the issuer. Most major brokerages offer access to agency bonds, letting you buy newly issued bonds from the issuer or existing bonds on the secondary markets. (Read about the best online brokerage accounts).
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2. Research the Bond
Before purchasing any agency bonds, you should carefully consider the credit rating of the bond, which is a direct reflection of the financial stability and responsibility of the issuing agency. Moody’s or Standard & Poor’s provide bond ratings, and your online brokerage account should easily display the bond’s credit rating.
3. Review Your Portfolio
Even though agency bonds are largely considered safe, it is still critical to understand the risks and potential rewards if you consider adding them to your portfolio. Consult your investment portfolio to see how to titrate how large of an allocation you would like to make to agency bonds.
4. Purchase Your Bond
After determining how much of your portfolio you want to dedicate to agency bonds, you must fund your account. You can place a bond purchase order if you already have sufficient investment funds.
5. Monitor Your Bond’s Performance
After you purchase the agency bond, the next phase of the investment process is to monitor your agency bond’s performance. If you purchase a callable bond, you need to see if and when it is called. It can make sense to supplement your position during periods of rising interest rates (Read about how to automate your finances).
Another way to gain exposure to agency bonds is to invest in managed funds that focus on or specialize in agency bonds. These can be mutual funds or exchange-traded funds (ETFs), which can be passively or actively managed. This basket-style approach lets you invest in agency bonds without focusing on any one bond in particular. Investing in a mutual fund or ETF helps quickly diversify your agency bond investment across multiple issuances.
Pros of Agency Bonds
Agency bonds provide some substantial advantages for an array of investors. Whether you are looking to diversify your portfolio or pick up some passive income, here are several benefits of agency bonds to consider:
- Low Investment Risk: One of the most notable is the low level of risk investors assume. Since GSEs or other government-affiliated agencies issue most agency bonds, they are considered much safer than corporate bonds, though they lack the full backing of the U.S. Treasury Department.
- Modest Returns: Agency bonds also provide slightly higher returns than U.S. Treasury bonds. Investors looking for stable income and modest returns usually find agency bonds appealing additions to their portfolios.
- Tax-Advantaged Investments: Some agency bonds offer tax advantages. For instance, interest earned from FHLB, FFCB, and TVA bonds is exempt from state and local taxes, making them great investment options for high-income tax bracket earners. (Read more about HENRYs).
Cons of Agency Bonds
Agency bonds offer investors a pseudo-government-backed investment. Here, we explore a few relevant disadvantages to investing in agency bonds:
- Callable Bonds: Callable agency bonds allow the issuer to redeem the bond at any time before the maturity date. However, when you buy a callable bond, you know the potential call date and associated price in advance. Why would an issuer have a call option on their bond? If interest rates fall, these GSEs can reissue bonds at lower rates, saving the agency money in the form of future interest payments.
- Less Liquidity: As a rule of thumb, agency bonds have less liquidity than comparable U.S. Treasury bonds. While they are considered relatively safe, they may not be traded as quickly on the secondary market as other bonds, like corporate or green bonds.
- Opportunity Cost: Investing in fixed-income assets like agency bonds may yield lower returns than other asset classes, such as stocks or cryptocurrency. Alternatively, you could invest in high- yielding interest-bearing investments like certificates of deposits or U.S. Treasury Bills.
- Credit Risk: Agency bonds are rated by the credit rating agencies, Standard & Poor’s, Moody’s, and Fitch. Credit risk exists with agency bonds or the risk that the issue does not make on-time interest or principal payments. However, investors consider this risk relatively low because the U.S. federal government implicitly backs them.
Smart Summary
Agency bonds are debt securities issued by GSEs to fund their public-focused projects. These bonds offer higher yields than comparable U.S. Treasury bonds and offer some tax advantages. While the Treasury Department does not issue agency bonds, they are considered very low risk by institutional investors and Wall Street because of the high credit ratings and implicit backing from the federal government. Agency bonds can help supplement your fixed-income portfolio, help with retirement planning, and offer a form of passive income.
(1) SIFMA. US Agency Debt Statistics. Last Accessed January 13, 2025.
(2) Fannie Mae. Debt Securities Information. Last Accessed January 13, 2025.
(3) Federal Farm Credit Banks Funding Corporation. Investor Presentation. Last Accessed January 13, 2025.
