Agency Bonds Offer Strong, Safe Yield

by: Rajiv Tarigopula

In these volatile times, recent events have seen bond yields soar as investors grow uncertain regarding the future of the global macroeconomy. Many investors are turning to safe streams of income such as U.S. Treasury bills, pushing yields on these securities to record lows. Still, investors seem to be overlooking another traditionally safer source of fixed income: debt securities issued by government-sponsored enterprises (GSEs). Because these agencies are not backed by the full faith and credit of the U.S. government, though, they offer a risk premium on yields for investors willing to take a gamble on these semiprivate entities. As one analyst puts it,

Government-sponsored enterprises (GSEs) are financing entities created by Congress to fund loans to certain groups of borrowers such as homeowners, farmers and students. Through the creation of GSEs, the government has sought to address various public policy concerns regarding the ability of members of these groups to borrow sufficient funds at affordable rates.

All GSE debt is not guaranteed by the federal government, whereas government agencies such as Government National Mortgage Association (Ginnie Mae) are divisions of the government whose securities are backed by the full faith and credit of the United States.

To conduct their lending business, GSEs have significant funding requirements. While many are stockholder-owned companies that can raise equity capital, most GSEs rely primarily on debt financing to fund their day-to-day operations. Among the most active issuers of debt securities are:

  • Federal Home Loan Banks

  • Freddie Mac

  • Fannie Mae

  • Federal Farm Credit Banks and

  • Tennessee Valley Authority (TVA).

Federal Farm Credit Banks lend to agricultural enterprises around the nation. Current bond offerings from the Federal Farm Credit Banks are worth investors' time and attention, and may be fantastic purchase opportunities for those seeking relatively safe (compared to some corporate debt) yields in the 3-4% range. Below are some offerings currently on the agency fixed-income securities market from Federal Farm Credit Banks.

CUSIP 31331K4L1, maturing on 12/23/2041 and offering 3.81% coupon with current yield 3.581% and YTM 3.461%, is non-callable, taxable, and rated Aaa/AA+/AAA. First coupon payment of these bonds dated December 23, 2011 was on June 23, 2012, with semi-annual payments in pay months June and December. 295 of these bonds are currently being sold at 106.405 cents on the dollar with minimum quantity of 5. For an individual investor seeking to purchase all 295 bonds in this lot, principal payment of $312,714.75 and accrued interest payment of $1,342.50 would come to a total cost of $314,057.25.

Examining the Moody's credit rating report for these particular bonds yields some illuminating results. Moody's, of course, has rated these bonds Aaa, "of the highest quality, with minimal credit risk." Credit strengths cited by the ratings agency include the following, of which investors should be aware:

- GSE status provides excellent market access and low funding costs
- U.S. Government consistently demonstrates strong support for agriculture
- Joint and several liability and the Farm Credit System Insurance Corporation Insurance Fund reduce default risk of Systemwide debt obligations
- MAA and CIPA enhance financial positions of constituent Banks

The Federal Farm Credit Banks system has demonstrated respectable and increasing ROAE over the last few years, reporting 9.4% in 2005, 10.0% in 2006, 10.4% in 2007, and 10.6% in 2008. Over this period, assets increased from $140 billion to $214 billion.

Potential investors may also want to check out the similar non-callable, taxable FFCB bonds with 5% coupon and semi-annual payments that are rated similarly, mature September 22, 2038, and are being quoted at a price of 127.893 cents on the dollar in an available quantity of 110. This comes to a YTM/YTW of 3.383%.

Investors should be sure to do full due diligence before pursuing one of these investments, especially given the volatile nature of the bond markets in recent weeks and months. Moreover, individuals seeking to potentially invest in FFCB bonds should be aware that investments in agency securities are subject to market risk, interest rate risk, and credit risk. Good luck!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.