What it means
These bodies sit in an awkward middle ground between public and private. They are owned by shareholders or members, run by commercial managers and expected to make a profit, but their purpose, permitted activities and often their governance are set out in the statute that created them.
That legal charter is what distinguishes them from any other financial company. Most operate in the secondary market rather than lending directly to the public.
They buy loans that banks have already made, pool them into securities, guarantee the payments on those securities and sell them to investors. The bank that made the original loan gets its cash back and can lend again, which is how the arrangement expands the supply of credit without the state putting up the money itself.
The economics rest on a spread. Because investors treat the enterprise's debt as almost sovereign in quality, it can borrow at yields close to government levels, well below what a similarly leveraged private financial firm would pay.
Part of that advantage funds the guarantee fees and operating costs, and part is intended to reach borrowers through lower mortgage or loan rates. The obvious criticism is moral hazard.
If profits go to private shareholders while the downside is implicitly carried by taxpayers, managers have an incentive to run more leverage and take more credit risk than they otherwise would. That is not a theoretical worry: several large housing enterprises required emergency public support during the financial crisis of 2007 to 2009, after which their capital and activity rules were tightened considerably.
For a business audience, the practical relevance is twofold. If you borrow to buy property or farm assets, the terms available to you are shaped by which loans these bodies will buy, since banks write products to match those criteria.
And if you invest, agency debt and agency mortgage-backed securities usually offer a small yield pickup over pure government securities in exchange for a slightly less certain guarantee.
In practice
Real-world examples.
Example
A regional bank sells a $75,000,000 pool of qualifying home loans to a housing enterprise. The cash returns to the bank's balance sheet within weeks, allowing it to write new mortgages without raising fresh deposits or capital.
Example
A farm supply cooperative borrows through a lender funded by an agricultural credit enterprise. The loan carries a rate roughly half a percentage point below what its local commercial bank quoted, reflecting the cheaper wholesale funding behind it.
Example
A corporate treasurer allocates $30,000,000 of a cash portfolio to short-dated agency debt rather than pure government bills, accepting a slightly less explicit guarantee in return for around 15 basis points of extra yield.
Formula
Calculation
Funding cost advantage = Yield on comparable private issuer debt - Yield on enterprise debt
Annual saving = Funding cost advantage x Debt outstanding
Suppose a housing finance enterprise issues five-year debt at a yield of 4.30%. A private financial company of similar size and leverage, without the statutory charter and the implied support, would have to pay 5.10% for the same maturity.
Funding cost advantage = 5.10% - 4.30% = 0.80%, or 80 basis points
With $5,000,000,000 of debt outstanding:
Annual saving = $5,000,000,000 x 0.80% = $40,000,000
That $40,000,000 a year is the value of the implied support. If roughly half is passed through to borrowers, it lowers the interest cost on the mortgages the enterprise funds by around 40 basis points, which on a $300,000 loan is about $1,200 a year of interest saved by the household.Case study
Seen in the real world.
Fernhall Home Finance is an entirely fictional enterprise used here to illustrate the model and its risks. Created by statute to widen home ownership, Fernhall bought conforming mortgages from banks, guaranteed the resulting securities for a fee of 25 basis points and funded itself with $50,000,000,000 of debt at yields only 0.30% above comparable government securities.
For years the model worked well. Fernhall earned guarantee fees, banks recycled capital into new lending and mortgage rates for qualifying borrowers ran below what the market would otherwise have set. Then Fernhall's board, under pressure to grow earnings, relaxed the loan criteria it would accept and let leverage rise well beyond the level its charter had anticipated.
In the illustrative downturn that followed, default rates on the newer loans tripled and guarantee payouts overwhelmed the fee income. Because Fernhall's securities were held throughout the financial system, the government intervened rather than allowing failure, converting an implied guarantee into a real one and confirming exactly the moral hazard critics had described.
Watch out
Common mistakes.
- Assuming the debt is formally guaranteed by the state. In most cases the guarantee is implied by market expectation rather than written into law, and the paperwork usually says so explicitly.
- Confusing these enterprises with government agencies. They are shareholder or member owned, run commercially, and their staff are not civil servants.
- Treating agency securities as identical to sovereign bonds when setting a treasury policy. They carry a small extra credit and liquidity risk, which is precisely why they pay a slightly higher yield.
Questions
People also ask.
How do they make money?
Mainly through guarantee fees on the loans they securitise and the spread between their low borrowing costs and the returns on assets they hold.
Do borrowers actually benefit?
Studies generally find part of the funding advantage reaches borrowers as lower rates, though a share is retained as profit and operating cost.
Are they only found in housing?
No, similar statutory bodies exist for agricultural credit, student lending and small business finance in various countries.
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