Legal Definitions - agency security

An agency security is a type of debt instrument, similar to a bond, issued by a U.S. government agency or a government-sponsored enterprise (GSE). When an investor purchases an agency security, they are essentially lending money to that specific government-related entity. In return, the investor receives regular interest payments and the return of their principal investment at maturity.

These securities are generally considered to have a very low risk of default, though their backing by the U.S. government can vary; some are explicitly guaranteed, while others are implicitly backed by the government's support of the issuing agency. They are distinct from U.S. Treasury securities, which are direct obligations of the U.S. government.

• Example 1: A large university endowment fund seeks stable, low-risk investments to generate income for scholarships. It decides to invest a portion of its portfolio in mortgage-backed securities (MBS) issued by Freddie Mac.

  Explanation: Freddie Mac (Federal Home Loan Mortgage Corporation) is a government-sponsored enterprise. The mortgage-backed securities it issues, which represent interests in pools of residential mortgages, are therefore classified as agency securities. The endowment fund is lending money indirectly to homeowners, with Freddie Mac guaranteeing the timely payment of principal and interest, making it a relatively safe investment for the fund.

• Example 2: An individual investor nearing retirement wants to diversify their fixed-income portfolio with a secure asset that offers predictable returns. They purchase a bond issued by one of the Federal Home Loan Banks (FHLB).

  Explanation: The Federal Home Loan Banks are a system of government-sponsored enterprises that provide funding to financial institutions. The bonds they issue are considered agency securities because they are debt obligations of these government-sponsored entities. The investor receives regular interest payments, knowing the investment is backed by a robust, government-supported system, providing a sense of security for their retirement savings.

• Example 3: A state treasury department needs to invest surplus tax revenues for a short period, prioritizing safety and liquidity. It chooses to buy short-term notes issued by the Tennessee Valley Authority (TVA).

  Explanation: The TVA is a federally owned corporation that provides electricity and economic development in its service area. The notes it issues to finance its operations are agency securities because they are debt obligations of a U.S. government corporation. The state treasury chose this investment for its stability and predictable returns, relying on the TVA's government backing to safeguard public funds.