Agency securities are debt instruments issued by U.S. federal agencies and government-sponsored enterprises (GSEs). True federal agency securities — such as those issued by Ginnie Mae (GNMA) — carry the full faith and credit guarantee of the U.S. government, making them equivalent in credit quality to Treasuries. GSE securities — such as those from Fannie Mae (FNMA), Freddie Mac (FHLMC), Federal Home Loan Banks (FHLB), and Farm Credit System — have an implied (but not explicit) government backing; they were placed into conservatorship in 2008.
Agency securities include non-mortgage agency debt (debentures issued by the FHLB, Farm Credit, etc.) and mortgage-backed securities (MBS) — the most common being mortgage pass-through certificates (Ginnie Mae, Fannie Mae, Freddie Mac pools). Mortgage pass-throughs distribute monthly principal and interest payments from pooled mortgages to investors, passing through both scheduled and prepaid principal.
The primary risk unique to agency MBS is prepayment risk — when homeowners refinance or sell, principal is returned to investors earlier than expected. In a falling rate environment, prepayment speeds accelerate (negative convexity), and investors receive principal back just when reinvestment rates are lowest (reinvestment risk).
Agency securities generally offer yields slightly above comparable Treasuries (an "agency spread") to compensate for the lack of explicit government guarantee and the prepayment risk in MBS.
> Exam tip: On the Series 7, know that GNMA is the only agency with an explicit U.S. government guarantee. FNMA and FHLMC have implied support. All agency securities are exempt from state and local income taxes (like Treasuries) but are subject to federal tax. Mortgage pass-throughs carry prepayment risk — know how rising prepayments affect investors in a falling rate environment.