Do FHLB Bonds Seem Too Good to be True?

[MercyMe]

The current new issue of three-year FHLB bonds has a 5.35% expected yield. Since they are allegedly not state and locally taxable, the tax equivalent yield for me is 6.28%.

Of course they are callable and their guarantee is only "implied", but still these seem to be decent investments for some fixed income. The first bond I ever bought was just a few weeks ago and it was $100k in a 5 year FHLB bond yielding 5.5%.

I was thinking about buying more of these, but they seem too good to be true. What is the down side to FHLB bonds?

 

[VanWinkle]

If they seem too good to be true...... Federal Home Loan Bank bonds are not new, they just look better like every other type of bond out there today.

 

[MercyMe]

they just look better like every other type of bond out there today.

Right... but why?

 

[Spock]

Right... but why?

cuz interest rates have come up off the zero peg.
And there is a bit of a wave of people discovering individual bonds vs. bond funds lately.

 

[COcheesehead]

Right... but why?

Because mortgage rates are rising - that is what you are buying.

I just bought some at par yielding nearly 7%. It will eventually get called, but I will take an almost guaranteed 7% even if its for a year or two.

 

[MercyMe]

So I guess FHLB bonds are not too good to be true?

What's the dirt on these things? I guess what I'm asking is why aren't more people talking about these? They seem like a no-brainer for a bond investor. I feel like I must be missing something.

 

[Gotadimple]

So I guess FHLB bonds are not too good to be true?

What's the dirt on these things?

Read what COCheesehead said. That's the dirt.

 

[COcheesehead]

So I guess FHLB bonds are not too good to be true?

What's the dirt on these things? I guess what I'm asking is why aren't more people talking about these? They seem like a no-brainer for a bond investor. I feel like I must be missing something.

AAA rated, available across a variety of durations. I own a bunch. I don’t expect them to last for the full term. Just don’t buy above par and you should be OK.
As to why they aren’t talked about much? Too many folks love a bond fund more than an individual bond.

 

[erkevin]

On the subject of GSEs, Federal Farm Credit Banks has bonds at about 7%. 15 year callable

 

[CP Soon]

Because mortgage rates are rising - that is what you are buying.

I just bought some at par yielding nearly 7%. It will eventually get called, but I will take an almost guaranteed 7% even if its for a year or two.

How are these bonds searched on Fidelity platform? I am not seeing any bonds of this type nor any near the mentioned 7%. A little instruction would be helpful...

 

[COcheesehead]

How are these bonds searched on Fidelity platform? I am not seeing any bonds of this type nor any near the mentioned 7%. A little instruction would be helpful...

Search Products, then fixed income, then find investments, then new issues, then agency bonds. The 7% ones sold out a couple days back. There are some in the low to mid 6% range currently.

Edit, the 6% ones are gone now too. The only one showing right now a 4 year at 5.6%.

I think a lot of bonds came off the shelf in the last few days.

 

[CP Soon]

Search Products, then fixed income, then find investments, then new issues, then agency bonds. The 7% ones sold out a couple days back. There are some in the low to mid 6% range currently.

This helps, thanks. Not much different than searching Treasuries. Currently, I only see one Agency Bond @ 5.6%. Maybe I'm searching incorrectly, but I'm not seeing low to mid-6% bonds. Maybe user error?

FEDL FARM CREDIT BK BOND 5.60000% 11/16/2026 CUSIP 3133EN2G4

It appears that it is first callable 02/16/2023. Is this quick call typical for this type of Bond? For some reason, I was thinking they would be at least 1 year until callable. Regardless, it's still better rate than Treasury with same duration.

 

[COcheesehead]

This helps, thanks. Not much different than searching Treasuries. Currently, I only see one Agency Bond @ 5.6%. Maybe I'm searching incorrectly, but I'm not seeing low to mid-6% bonds. Maybe user error?

FEDL FARM CREDIT BK BOND 5.60000% 11/16/2026 CUSIP 3133EN2G4

It appears that it is first callable 02/16/2023. Is this quick call typical for this type of Bond? For some reason, I was thinking they would be at least 1 year until callable. Regardless, it's still better rate than Treasury with same rate.

I edited my post prior to your post. I said all the 6% ones are now gone and all that is left is the one you reference. A lot of bonds, a lot came off the shelf today.

 

[CP Soon]

Couple more questions on these FHLB's. Recent bond offerings are callable in Feb 2023.
Do these bonds often make it to maturity or are they usually called? There are a couple new bonds out there with decent yields with similar call structure starting Feb 2023. 2 year @ 5.15%, 10 year @ 6.12% and 15 year @ 6.49%. 10 & 15 year are a bit longer term than I was wanting, but the yields are nice. What is the secondary market like? Are they easily sold and fair market or will I take a hit? Just trying to fully understand my options to properly evaluate my risk and potential mitigations. Thanks.

 

[jldavid47]

Do these bonds often make it to maturity or are they usually called?

It’s pretty simple. If rates stay elevated then they won’t be called. If rates drop, they will. I purchased a FHLB 5 year callable bond recently yielding 6%. I look at it this way. If rates stay elevated I’m happy with 6%. If rates go down and it’s called then I still did better than if I had gone with a shorter maturity with a lower rate.

 

[COcheesehead]

Couple more questions on these FHLB's. Recent bond offerings are callable in Feb 2023.
Do these bonds often make it to maturity or are they usually called? There are a couple new bonds out there with decent yields with similar call structure starting Feb 2023. 2 year @ 5.15%, 10 year @ 6.12% and 15 year @ 6.49%. 10 & 15 year are a bit longer term than I was wanting, but the yields are nice. What is the secondary market like? Are they easily sold and fair market or will I take a hit? Just trying to fully understand my options to properly evaluate my risk and potential mitigations. Thanks.

Buy assuming you’ll hold to maturity or call. If you have to sell prior, the secondary market is just that, a market. It will depend on conditions at the time you sell. I figure worst case if rates take off, you collect a few coupons, get into the black and sell if you need to. Otherwise, buy to hold.

 

[coveredbridge]

If the market value exceeds par at any call date these bonds will be called away from you at par and you will need to find another place to invest your money at lower market rates.

 

[coveredbridge]

Most callables do not mature because as they roll down the curve the value of refinancing for the issuer increases. Also they very rarely, if ever, trade above par.

 

[swk7907]

This is something that I've been struggling with recently as I try to determine reinvestment risk.

We are just coming out of such a historic period with unusually low interest rates across the curve that it feels to us that the current opportunity in long term rates is a "once in a lifetime opportunity". Up until 6 months ago 10 year treasury yields were below 2% and 30 year yields were below 2.5% for the past 3 years. Other than a few blips though, they were never that low in history.

My personal feeling is that we won't see such low longer term interest rates for a prolonged time for quite a while. Right now we are concerned that if our 5-20 year bonds get called and we need to reinvest what type of a yield will we be able to get? I don't think many of us are overly concerned with our 5 year 5.6% bond being called in two years and needing to buy a new 5 year bond at 5.1%. Our PTSD is that we might need to buy a new 5 year bond at 1.5-2.0%. That makes these bonds being called seem very scary.

The market is not going to forget the severity of the current inflation we are going through. Even if there is a recession and short term rates get cut I just don't believe that mid and longer term rates will go as low as they had been. We all forgot how devastating inflation could be since it had been virtually non-existant for so long. That will no longer be the case so while we might have to sacrifice some yield if rates go down I have to believe there will still be opportunity to find yield when it is time to reinvest.

 

[COcheesehead]

I don’t worry about calls. You can always find yield. Heck, I found yield when rates were way below where they are now.

 

[money4wells]

After reading, I found this link very helpful for me to expand on the comments here. It seems to answer more specifically some of the OP questions. It also got me looking more closely at these types of bonds.
https://www.investopedia.com/articles/bonds/07/agency_bonds.asp

Fidelity has a Federal Farm GSE bond, 6.3%, callable, no state tax, till 2031.

 

[jazz4cash]

This is something that I've been struggling with recently as I try to determine reinvestment risk.

We are just coming out of such a historic period with unusually low interest rates across the curve that it feels to us that the current opportunity in long term rates is a "once in a lifetime opportunity". Up until 6 months ago 10 year treasury yields were below 2% and 30 year yields were below 2.5% for the past 3 years. Other than a few blips though, they were never that low in history.

My personal feeling is that we won't see such low longer term interest rates for a prolonged time for quite a while. Right now we are concerned that if our 5-20 year bonds get called and we need to reinvest what type of a yield will we be able to get? I don't think many of us are overly concerned with our 5 year 5.6% bond being called in two years and needing to buy a new 5 year bond at 5.1%. Our PTSD is that we might need to buy a new 5 year bond at 1.5-2.0%. That makes these bonds being called seem very scary.

The market is not going to forget the severity of the current inflation we are going through. Even if there is a recession and short term rates get cut I just don't believe that mid and longer term rates will go as low as they had been. We all forgot how devastating inflation could be since it had been virtually non-existant for so long. That will no longer be the case so while we might have to sacrifice some yield if rates go down I have to believe there will still be opportunity to find yield when it is time to reinvest.

Analysis paralysis. If you worry about call risk just add some 10 or 20 year treasuries which are at 3.83-4.23 right now. Not bad considering the pitiful rates of the past that you cited. Very liquid and non callable. If there is a wave of bonds being called because rates are dropping the treasuries will appreciate. Using the secondary market you can choose any maturity you prefer.

 

[swk7907]

Analysis paralysis. If you worry about call risk just add some 10 or 20 year treasuries which are at 3.83-4.23 right now. Not bad considering the pitiful rates of the past that you cited. Very liquid and non callable. If there is a wave of bonds being called because rates are dropping the treasuries will appreciate. Using the secondary market you can choose any maturity you prefer.

I guess my main point is that I feel less concerned about longer term rates dropping considerably even if short term rates do and thus my anxiety about reinvestment risk has been going down.

I think the bigger risk is locking too much money in 10-20 year debt and seeing long term rates continue to rise. A 20 year treasury at 4.1% might feel great now but I think it is very realistic five years from now we will see 15 year yields in the 5-6% range.

Best strategy in my opinion is laddering and keeping some money in cash since it is paying almost 4% and likely will continue to pay that or more for at least another 12-18 months.

 

[NomDeER]

It’s pretty simple. If rates stay elevated then they won’t be called. If rates drop, they will. I purchased a FHLB 5 year callable bond recently yielding 6%. I look at it this way. If rates stay elevated I’m happy with 6%. If rates go down and it’s called then I still did better than if I had gone with a shorter maturity with a lower rate.

If people are concerned about calls and reinvestment risk, can they avoid some of this buy buying an agency bond below par on the secondary market that has a much lower coupon? What are the drawbacks to this? Lower overall yield? Less income for the remaining duration of the bond compared to a recently issued agency bond that has a higher coupon (but presumably higher risk of being called?)

 

[COcheesehead]

If people are concerned about calls and reinvestment risk, can they avoid some of this buy buying an agency bond below par on the secondary market that has a much lower coupon? What are the drawbacks to this? Lower overall yield? Less income for the remaining duration of the bond compared to a recently issued agency bond that has a higher coupon (but presumably higher risk of being called?)

If rates continue to climb, you’re stuck with a below market coupon which will drive the value of the bond lower if you need to sell before maturity.
Also, as you said, your current income is diminished since some of your return is cap gains closer to the maturity date, rather than coupon payments over the duration.