For an investor seeking a conservative product with a touch more risk than a government-backed bond, an agency bond is an option that offers a higher yield.
"You get a higher yield for the higher risk," said Louise Herrle, managing director of capital markets for Incapital, an underwriter of some agency bonds.
Incapital is the lead manager of Farmer Mac Notes, a new agency bond that it brought to the market in July. The company, which has offices in Chicago, Boca Raton, Fla., and London, is one of the top 15 distributors of U.S. agency bonds. It is an underwriter for the agency bond category, commonly called GSEs (government-sponsored enterprises), such as Fannie Mae, Federal Farm Credit Banks, Federal Home Loan Banks, Freddie Mac and Tennessee Valley Authority.
The risk with such bonds, unlike Treasureys or Ginnie Mae bonds, is that they are not backed by the "full faith and credit" of the U.S. government.
But up to now, they have been about as safe in practice—a distinction without a difference, Herrle said.
For example, when Fannie Mae and Freddie Mac struggled and went into conservatorship, they nonetheless continued to pay the interest and principal on their bonds, Herrle said, despite their losses. Their bond investors did not suffer.
But just because something has not happened, that does not mean it will never happen, noted Will Stith, senior portfolio manager for Wilmington Trust and co-manager of Wilmington Trust's Broad Market Bond Fund.
Unlike a Treasury note, an agency bond is not expressly guaranteed by the government, Stith said. The risk of default may be small but it does exist, he said. That is why agency bond investors get a higher yield than those who choose the safety of government-backed bonds, he said.
Stith currently only has about 2 percent of Wilmington's bond portfolio in agency bonds. That's not so much because he believes agencies are risky, though. He just believes investor-grade corporate bonds are a better choice these days. He said about 50 percent of Wilmington's bond portfolio is in that sector.
Agency bonds lately have provided about 10 basis points more than Treasuries for a 5-year, fixed-rate bond, 1.77 percent compared to 1.67 percent as of July 21, Herrle said.