Government agency bonds are fixed-income securities issued by entities tied to the federal government but separate from the U.S. Treasury. They come in two flavors: bonds from federal agencies, which carry the same full-faith-and-credit guarantee as Treasuries, and bonds from government-sponsored enterprises (GSEs), which do not. Together they make up roughly a $2 trillion market and typically pay a bit more than Treasuries of similar maturity in exchange for slightly higher credit risk, weaker liquidity, and, in many cases, a call feature that lets the issuer redeem the bond early.
Who Issues Agency Bonds
The issuer determines almost everything that matters about an agency bond: the strength of the guarantee, the tax treatment of your interest, and the yield you can expect.
Federal Agencies
Federal agencies are part of the government. The best-known issuer is the Government National Mortgage Association (Ginnie Mae), which guarantees mortgage-backed securities issued by private lenders. Federal law pledges the full faith and credit of the United States behind Ginnie Mae’s guarantees, so payments are backed the same way Treasury payments are.1Office of the Law Revision Counsel. 12 U.S. Code 1721 – Management and Liquidation Functions of Government National Mortgage Association The Tennessee Valley Authority, a government-owned corporation financing power infrastructure, also issues bonds with explicit federal backing.2GovInfo. 16 U.S. Code 831n-4 – Bonds for Financing Power Program
Because the guarantee is legally identical to a Treasury’s, these bonds trade at yields close to Treasury rates, and you give up much of the extra yield that makes agency bonds attractive.
Government-Sponsored Enterprises
GSEs are federally chartered but privately structured corporations set up to channel credit into housing and agriculture. The major ones are the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), the Federal Home Loan Banks, and the Federal Farm Credit Banks.
GSE bonds are the obligation of the issuing enterprise, not the government. They do not carry a full faith and credit guarantee.3Fidelity. Agency Bonds – Section: Types The market has long assumed the government would step in before letting a major GSE fail, an “implicit guarantee” that was tested in 2008 when the Federal Housing Finance Agency placed Fannie Mae and Freddie Mac into conservatorship.4Federal Housing Finance Agency. History of Fannie Mae and Freddie Mac Conservatorships Treasury backstopped both companies through Preferred Stock Purchase Agreements, and both remain in conservatorship today.5Congressional Research Service. Fannie Mae and Freddie Mac in Conservatorship: Frequently Asked Questions So the market’s assumption was correct. But no statute requires the government to bail out GSE bondholders, and if conservatorship ever ends, the nature of the guarantee could shift.
Common Bond Structures
The structure of an agency bond decides how your coupons behave and whether the issuer can end the bond early.
- Bullet bonds. A fixed coupon (usually paid semiannually) until maturity, when you get your principal back. Non-callable. Most agency bonds fall into this category.
- Callable bonds. The issuer can redeem the bond before maturity, typically after a lockout period. Issuers call when rates drop and they can refinance cheaper. You get a higher coupon to compensate.
- Step-up bonds. The coupon rises on a preset schedule. Almost always callable, so the issuer can pull the bond before the step-up kicks in.
- Discount notes. Short-term instruments, usually under a year, sold below face value with no coupon. Your return is the difference between purchase price and face value at maturity, similar to Treasury bills.
Callable bonds deserve careful attention because they shift reinvestment risk onto you. When rates fall, the bond gets called and you have cash to redeploy at lower rates. When rates rise, nobody calls anything and you sit with a below-market coupon. That asymmetry is why callable agency bonds pay more than bullets of similar maturity. For any callable bond, look at yield-to-call, which assumes redemption at the earliest call date, alongside yield-to-maturity.
Tax Treatment by Issuer
Interest tax rules vary enough by issuer to change which bond is the better deal on an after-tax basis. Treasuries set the baseline: federally taxable, but exempt from state and local income taxes by statute.6Office of the Law Revision Counsel. 31 U.S. Code 3124 – Exemption from Taxation In a high-tax state, that exemption is worth real money and sets the bar every agency bond has to clear.
Fannie Mae and Freddie Mac
Interest is fully taxable at the federal, state, and local levels. There is no state or local exemption. For a high-tax-state investor, this erodes the yield advantage over Treasuries, so always compare on an after-tax basis.
Federal Home Loan Banks and Federal Farm Credit Banks
These two GSEs get more favorable treatment. FHLB interest is exempt from state and local income taxes.7Office of the Law Revision Counsel. 12 U.S. Code 1433 – Exemption from Taxation Farm Credit Bank interest receives the same exemption under a parallel provision.8Office of the Law Revision Counsel. 12 U.S. Code 2023 – Taxation If you owe state income tax, FHLB and Farm Credit bonds often beat Fannie or Freddie bonds with similar coupons after taxes.
Tennessee Valley Authority
TVA bonds are exempt from state and local taxes on both principal and interest, except for estate and gift taxes.2GovInfo. 16 U.S. Code 831n-4 – Bonds for Financing Power Program Combined with explicit federal backing, TVA bonds offer government-guaranteed credit and state-tax-exempt income.
Selling Before Maturity
If you sell any agency bond for more than you paid, the profit is a capital gain. Held longer than a year, it qualifies for long-term rates, which top out at 20% for most investors. Held a year or less, it is taxed as ordinary income.9Internal Revenue Service. Topic No. 409 Capital Gains and Losses One wrinkle: if you buy an agency bond on the secondary market at a discount to face value, the discount portion is generally taxed as ordinary interest income when you sell or redeem, not as capital gain, subject to a small de minimis exception.
How to Buy Them
You have two paths: individual bonds or a fund.
Individual Bonds
Agency bonds trade over the counter through broker-dealers rather than on a centralized exchange. You place orders through a brokerage account, and the broker either sells from inventory or sources the bond from another dealer. Minimum purchase amounts vary. Some bonds are available in $1,000 increments; others require $10,000 or more.
Transaction costs are usually embedded as a markup in the price rather than shown as a separate commission. Online brokerages have narrowed this, with some charging as little as $1 per bond on online orders. Compare the quoted price against recent trade data before you buy.
Before buying any individual bond, check whether it is callable and note the first call date. A bond trading above face value with a call date six months out is a very different investment than the same coupon in a bullet.
Bond Funds and ETFs
Mutual funds and ETFs specializing in agency debt give you diversification without having to evaluate individual bonds. They also remove the minimum-investment barrier: you buy shares rather than committing $10,000 to one bond.
The tradeoffs are cost and control. Expenses typically run from 0.10% to 0.50% annually for passively managed products, cutting into the modest yield edge agency bonds offer. You also lose the ability to hold to maturity and guarantee your return of principal, because the fund is continuously trading. Look at the holdings breakdown before you buy: a fund heavy in Fannie Mae and Freddie Mac debt will generate fully state-taxable income, while one tilted toward FHLB or Farm Credit bonds may preserve the state exemption.
The Main Risks
Call Risk
This is the risk most specific to agency bonds. When rates decline, issuers call and refinance. You get your principal back and have to reinvest at lower rates. The bonds most likely to be called are the ones you would most want to keep, because they pay above-market coupons. Step-ups are especially vulnerable, since the issuer has every incentive to call before the coupon ratchets up.
Interest Rate Risk
Like all fixed-rate bonds, agency bonds lose market value when rates rise. A 10-year agency bond’s price will drop if comparable new bonds start offering higher coupons. Hold to maturity and this is irrelevant. If you might sell early, longer maturities carry more of this risk than shorter ones, and discount notes under a year carry almost none.
Credit Risk
For federal agency bonds backed by full faith and credit, credit risk is effectively the same as Treasury debt. For GSE bonds, credit risk is technically higher because the guarantee is implicit rather than legal. In practice, the conservatorship of Fannie Mae and Freddie Mac and the Treasury’s backstop have kept that risk theoretical for over 15 years. Theoretical risks can become real under conditions nobody anticipated, and the implicit guarantee’s future depends on political decisions about housing finance reform.