Agency Bonds vs. Treasuries

[GravitySucks]

I have been thinking of selling most of all of my bond fund holdings and buying 2 to 5 year Treasuries. However I see a slight advantage in Agency bond rates. For instance, Federal Farm BNK rates are about 0.3% better than a similar Treasury for a 2 year bond.
There's no such thing as a free lunch, but I can't imagine the Federal government would ever default on agency obligations. What am I missing here?

 

[GravitySucks]

Well here's one misunderstanding I had already. That Farm Bank is a GSE and is not backed by the full faith and credit of the U.S. government.
Stiil, Moody rates at AAA and pays better than a Corporate AAA. Is a federal farm bank really riskier than Proctor Gamble?

 

[WestwardBound]

GSEs are not guaranteed by the US government. The largest are Fannie, Freddie, Federal Home Loan Banks and Farm Credit. However, the market assigns them an "implicit" guarantee meaning that the government will not let them fail. Best recent examples are Fannie and Freddie.

The GSEs' Aaa/AA+ ratings are significantly achieved through this status that the rating agencies assign to them.

Thus they can borrow at spreads very close to treasuries.

 

[WestwardBound]

Not clear on your post but are you saying the a Farm Credit security yields more than P&G? For the same security structure?

 

[foxfirev5]

I would consider that most agency bonds are callable. Usually this means a higher coupon for accepting the risk of the bond being called in the event of falling interest rates.

 

[GravitySucks]

Not sure about things like callability but a P&G bond maturing in the same month of 2021 as the GSE had a lower yield.
I seem to have a mental block about learning about bonds, hence the thread. Trying to learn a bit more.

 

[foxfirev5]

Not sure about things like callability but a P&G bond maturing in the same month of 2021 as the GSE had a lower yield.
I seem to have a mental block about learning about bonds, hence the thread. Trying to learn a bit more.

Lower yield but they're obligated to pay until maturity. The GSE has a call schedule which allows them to leave you hanging if interest rates drop.

 

[WestwardBound]

A callable bond is the issuer purchasing an option to retire the bond before maturity. They pay you for the option through a higher coupon than they would if the bond had no call option. That may be why a P&G bond coupon of similar maturity is lower than a Farm Credit bond with a call.

Also, corporate debt spreads are historically narrow to treasury debt at this point. That could change significantly during a recession. They could devalue more quickly than a higher rated Farm Credit bond in that scenario.

As foxfire said, Farm Credit will likely repay the bond in a lower rate environment giving you reinvestment risk at lower rates.

 

[kaneohe]

I have been thinking of selling most of all of my bond fund holdings and buying 2 to 5 year Treasuries. However I see a slight advantage in Agency bond rates. For instance, Federal Farm BNK rates are about 0.3% better than a similar Treasury for a 2 year bond.
There's no such thing as a free lunch, but I can't imagine the Federal government would ever default on agency obligations. What am I missing here?

Another piece, if you have state taxes: https://personal.vanguard.com/us/content/Funds/FixIncAgencyBondsContent.jsp

"Taxability

The interest income on agency bonds generally is subject to federal and state taxes.

Interest on certain agency bonds, including securities issued by the FHLB and FFCB, is exempt from state taxes."

 

[Chuckanut]

Just in case people forgot:

The result is a mishmash. Aside from Treasury debt, state-tax free bonds include those from agencies such as the Federal Farm Credit Banks, Federal Home Loan Banks, Sallie Mae and the Tennessee Valley Authority. Yet interest on mortgage bonds from Ginnie Mae, Fannie Mae and Freddie Mac is subject to state taxes.

And

Income from Treasury repurchase agreements, often called repos, is also state taxable. This is especially important because many government money-market funds have been moving into these repos the past year.

And this

Recently, Fidelity’s Treasury Money Market Fund (trading under the ticker FZFXX) held about 20% of assets in Treasurys and 80% in state-taxable repos. By contrast, Fidelity’s Treasury-only Money Market Fund (FDLXX) recently held 100% in Treasurys and Treasury coupons.

At Charles Schwab, four exchange- traded or mutual funds with “Treasury” in their names had income that was 99% or more exempt from state taxes in 2022. But at another, the Treasury Obligations Money Fund (SNOXX), 2022 income was only 18.8% exempt from state taxes.

Above from the 9/10/23 WSJ