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Bond buyers seeking safety have traditionally bought U.S. Treasury securities. But the U.S. government’s efforts to reduce the national debt is shrinking the pool of Treasuries and forcing bond buyers to look elsewhere. Two alternatives recommended by many fixed-income experts are Fannie Maes and Ginnie Maes.
While they may sound like the names of two kindly aunts, Fannie and Ginnie Maes are long popular bond investments that traditionally have outperformed Treasury securities.
Fannie Mae is a shorthand for the Federal National Mortgage Association (FNMA). Originally this was a federally owned corporation designed to buy up home mortgages from lenders and then sell securities based on the mortgage pool. Buying up the mortgages freed the lenders to turn around and issue mortgages to new consumers. In 1968, the government converted FNMA to a private corporation whose stock trades on the New York Stock Exchange. Fannie Mae primarily buys mortgages issued by the Federal Housing Authority (FHA).
Fannie Mae issues securities in a variety of maturities and in denominations as small as $1,000. Unlike U.S. Treasuries, you can’t buy Fannie Mae bonds directly from Fannie Mae. You must buy them through a securities dealer. Historically, Fannie Maes yield better than comparable U.S. Treasuries. In mid-September, for example, 10-year Treasury notes yielded around 5.7 percent, while 10-year Fannie Maes yielded 6.84 percent
Although the U.S. government does not explicitly guarantee Fannie Mae issues as it does Treasury issues, FNMA’s federally charted mandate implies federal backing. Consequently, the credit rating of Fannie Maes generally is viewed as high or even higher than AAA corporate debt. Because of this implicit backing, Fannie Mae can borrow at a lower rate than other private competitors.
Fannie Mae’s special status has created some controversy that may change its credit risk in the future. Some members of Congress would like to sever the government’s close ties to Fannie Mae and another “government-sponsored enterprise” known as Freddie Mac.
Ginnie Maes are also mortgage-backed securities issued by the Government National Mortgage Association (GNMA). When the federal government spun off Fannie Mae as a separate private corporation, it split off a part of it and created GNMA, which is wholly owned by the U.S. government. GNMA creates a pool of mortgages from the Veterans Administration, FHA mortgages and the Farmers Home Administration guaranteed mortgages and issues what’s called “modified pass through certificates.” Ginnie Maes aren’t as easily accessible for smaller investors, unless they buy through bond funds. The minimum denomination for the certificates is $25,000.
Because Ginnie Maes are explicitly backed by the federal government, the credit risk isn’t an issue and the bonds thus yield a little less than Fannie Maes. In mid-September, a ten-year note was yielding around 6.75 percent. Understand that the yield is only an estimate at best. Prepayment of mortgages, such as often occurs when interest rates fall, reduces the actual yield.
Interest is paid monthly, but be very careful here. Payments include part of your original principal. Over time, the interest payment portion will grow smaller and the principal payment will grow larger. Also confusing is that the size of the payments vary month to month because of prepayments. Unlike interest from Treasury securities, Ginnie Mae and Fannie Mae interest payments are subject to state and local taxes.
Beyond the high minimum investment requirement of $25,000, smaller investors who don’t need the income find it difficult to keep the interest and principal payments reinvested in Ginnie Maes. Consequently, many investors use mutual funds that buy Ginnie Maes. Many government bond funds that buy Treasuries also hold a substantial stake in Fannie Maes and Ginnie Maes, and some funds focus mainly on these issues. Of course, the risks of buying Ginne and Fannie Maes through a bond fund carry many of the same risks any bond mutual fund buyer faces. Buying individual issues and holding them to maturity eliminates the risk of losing principal due to rising interest rates. Because there is no maturity date for bond mutual funds, investors run a greater risk of principal loss.
November 2000— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Rich Chambers, CFP, a local member in good standing of the FPA.
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