| GENERAL
DESCRIPTION
Agency securities
are debt obligations issued by federal agencies or federally sponsored
agencies. Federal agencies are direct arms of the U.S. government; federally
sponsored agencies are privately owned and publicly chartered organizations
which were created by acts of Congress to support a specific public purpose
(also referred to as government-sponsored entities or GSEs).
Federal agencies are arms of the federal government and
generally do not issue securities directly in the marketplace. These agencies
include the Government National Mortgage Association (GNMA),
Export-Import Bank,
Farmers Housing Administration (FHA), General Services Administration
(GSA), Maritime Administration, Small Business Administration (SBA), the
Tennessee Valley Authority, Commodity Credit Corporation, Rural Electrification
Administration, Rural Telephone Bank, and the Washington Metropolitan
Area Transit Authority. All federally related institutions are exempt
from SEC registration. With the exception of securities of the Private
Export Funding Corporation, and the Tennessee Valley Authority, the securities
are backed by the full faith and credit of the U.S. government.
Government-sponsored entities include agencies in the following
areas:
Housing (such as the
Federal Home Loan Mortgage Corporation and
Federal National Mortgage Association)
Farm credit (such as the
Federal Farm Credit Bank System and Farm Credit System Financial Assistance
Corporation)
Student loans (such as the Student Loan Marketing Association)
Small business (Small Business Administration)
Export funding (Export-Import
Bank)
GSEs issue both discount
and coupon notes and bonds. Discount notes are short-term obligations,
with maturities ranging from overnight to 360 days. Coupon notes and bonds
are sold with maturities greater than two years. The securities are not
backed by the full faith and credit of the U.S. government. Consequently,
investors purchasing GSEs are exposed to some potential credit risk. The
yield spread between these securities and Treasury securities of comparable
maturity reflects differences in perceived credit risk and liquidity.
GSEs issue direct debt obligations and guarantee various
types of asset-backed securities. This section discusses only securities
that represent direct obligations of federal and federally sponsored agencies.
Mortgage-Backed
Securities is a topic of securities issued or guaranteed by some of
these agencies. Also, many GSEs are active in issuing structured notes.
CHARACTERISTICS
AND FEATURES
Federal-agency securities such as those issued by the Government National
Mortgage Association are backed by the full faith and credit of the U.S.
government. However, government-sponsored agency securities are not guaranteed
by the U.S. government, although market participants widely believe that
the government would provide financial support to an agency if the need
arose. This view has gained some credence as a result of the federal government's
operations to bolster the Farm Credit System in the mid-1980s. U.S. agency
securities are also exempt from registration with the Securities and Exchange
Commission (SEC.)
USES
Agency securities are deemed suitable investments for banks, and they
are frequently purchased by banks and held in their investment portfolios.
DESCRIPTION
OF MARKETPLACE
In the primary market, government agencies and GSEs sell
their securities to a select group of commercial banks, section 20 subsidiaries
of commercial banks, and investment banks known as "selling groups."
Members of a selling group advise the agencies on issuing debt, placing
the debt with end-users, and making markets in these securities.
Prices for the securities traded in the secondary market
can be obtained from the "Money and Investing" of The Wall Street Journal
or the financial section of local newspapers. Other media, such as Internet
financial sites , provide over-the-counter quotes as well.
Federal Agencies
Federal agencies do not issue securities directly in the
marketplace. Most have raised funds through the Federal Financing Bank
since 1973, although many of these institutions have outstanding obligations
from previous debt issues. Federal agencies include the following: the
Export-Import Bank of the United States, Com-modity Credit Corporation,
Farmers Housing Administration, General Services Administration, Government
National Mortgage Association, Maritime Administration, Private Export
Funding Corporation, Rural Electrification Administration, Rural Telephone
Bank, Small Business Administration, Tennessee Valley Authority, and Washington
Metropolitan Area Transit Authority (neither the Tennessee Valley Authority
nor the Private Export Funding Corporation is backed by the full faith
and credit of the U.S. government).
Federally Sponsored Agencies
Following is a summary of the main federally sponsored
agencies and the types of obligations that they typically issue to the
public. The Federal Farm Credit Bank System issues discount notes; short-term
bonds with maturities of 3, 6, and 9 months; and long-term bonds with
maturities of between 1 and 10 years. The Farm Credit Bank also issues
medium-term notes which have maturities of between 1 and 30 years. The
Federal Farm Credit System Financial Assistance Corporation issues 15-year
notes, guaranteed by the federal government, which were issued to support
the Farm Credit System in the mid-1980s.
The Federal Home Loan Bank System issues discount notes
that mature in one year or less and noncallable bonds with maturities
ranging from 1 to 10 years. These debts are consolidated obligations of
the 12 regional Federal Home Loan Banks whose mandate is to provide funds
to savings and other home-financing member organizations. As a result
of the savings and loan crisis, the Financing Corporation (FICO) and the
Resolution Funding Corporation (REFCO) were established in the late 1980s
to recapitalize the Federal Savings and Loan Insurance Corporation (FSLIC)
and to provide funding for the losses of insolvent thrift institutions,
respectively.
The Federal National Mortgage Association (FannieMae) issues
short-term discount notes and long-term bonds with maturities of up to
30 years. FannieMae has also issued indexed sinking-fund debentures which
are callable and contain features of both mortgage-backed securities and
callable corporate bonds. The Federal Home Loan Mortgage Corporation (Freddie
Mac) issues discount notes and a limited number of bonds. The Student
Loan Marketing Association (SallieMae) issues unsecured debt obligations
in the form of discount notes to provide funds to support higher education.
PRICING
Agency notes and bonds are quoted in terms of 32nds (a percentage
of par plus 32nds of a point). Thus, an investor will be willing to pay
101.5 percent of par for an agency security that is quoted at 101:16.
Short-term discount notes are issued on a discount basis similar to the
way that U.S. Treasury bills are priced.
Agency securities trade at yields offering a positive spread
over Treasury security yields because of slightly greater credit risk
(due to the lack of an explicit government guarantee for most obligations)
and somewhat lower liquidity.
HEDGING
The price risk of most agency securities is hedged in the
cash market for Treasury
securities or by using Treasury futures or options. As with all hedges,
yield curve and
basis risk must be monitored closely. In addition,
dealers who are actively conducting arbitrage trades and other strategies
should have the capability to monitor their positions effectively.
RISKS
As with any security, much of the risk is a function of
the type of trading strategy conducted by an institution.
Interest-Rate Risk
Agency securities are subject to price fluctuations due
to changes in interest rates. As with other types of securities, the longer
the term of the security, the greater the fluctuation and level of interest-rate
risk. Moreover, some agency securities are subject to greater interest-rate
risk than others. Agencies that issue structured notes that are direct
obligations, such asstep-up
notes from a Federal Home Loan Bank, may have greater risk than other
agency securities.
Credit Risk
While the credit risk of agency securities is slightly higher
than that of Treasury securities because they are not explicitly guaranteed
by the U.S. government, their credit risk is still low due to the implied
government guarantee.
Liquidity Risk
Agency securities as a whole are not as liquid as U.S.
Treasury securities, but liquidity varies widely within the agency market
depending on the issuer and the specific debt obligation. In general,
agency securities have large trading volumes on the secondary market that
help to keep the liquidity risk low. However, various debt provisions
and structured notes of different agency securities contribute to differing
levels of liquidity risk within the agency market.
LEGAL LIMITATIONS FOR
BANK INVESTMENT
General obligations of U.S. government agencies are type
I securities, and are exempt from the limitations of 12 USC 24. Banks
may purchase these securities for their own accounts without limitation,
other than the exercise of prudent banking judgment (one exception is
an obligation of the Tennessee Valley Authority, which is a type II security,
and investments in which are limited to 10 percent of a bank's capital
stock and unimpaired surplus).
REFERENCES Commercial Bank
Examination Manual. Wash-ington, D.C.: Federal Reserve System. Fabozzi,
Frank J., ed. The Handbook of Fixed Income Securities. 4th ed. Burr Ridge,
Ill.: Irwin, 1991. The First Boston Corporation. Handbook of U.S. Government
and Federal Agency Securities. 34th ed. Chicago: Probus Publishing Com-pany,
1990. Stigum, Marcia L. The Money Market. 3d ed. Homewood, Ill.: Dow Jones-Irwin,
1990.
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