Contents. Appendix * Listed in order of their size in the Lehman Brothers Index.

Transcription

1 Guide to Agency & Government-Related Securities

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3 Contents Introduction to the Agency Debt Market... 5 Table of Government Links to Issuers of Agency Debt Federal National Mortgage Association (FNMA) Federal Home Loan Mortgage Corporation (FHLMC) Federal Home Loan Bank (FHLB) Resolution Funding Corporation (REFCORP) Tennessee Valley Authority (TVA) Federal Farm Credit Banks (FFCB) Financing Corporation (FICO) Student Loan Marketing Corporation (SLMA) Private Export Funding Corporation (PEFCO) Government Trust Certificates (GTC) Agency for International Development (AID) Financial Assistance Corporation (FAC) General Services Administration (GSA) Small Business Administration (SBA) U.S. Postal Service (USPS) Appendix * Listed in order of their size in the Lehman Brothers Index. 3

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5 Introduction to the U.S. Agency Debt Market The agency debt market has grown in size and stature within the U.S. fixed income market over the past few years. Figure 1 highlights the growing size of agencies within the Lehman Brothers Aggregate and Government indices. With this dramatic increase in size, the agency market has also experienced increased liquidity and now plays a more central role in fixed income portfolios. A larger percentage of the Agency Index is now in large, liquid, bullet issues (Figure 2). Figure 1. Agency Index as a Share of the Lehman Brothers Aggregate Index Aggregate Index Government Index 1/31/96 6.5% 12.3% 1/31/ /31/ /31/ /31/ /31/ Figure 2. Agency Index Composition* % of Index Containing Issues That Are Over $1 billion Callable Jan Jan Jan Jan *Index inclusion rules changed in June

6 Lehman Brothers Guide to Agency & Government-Related Securities One of the fundamental aspects of the agency market is that the debt is issued by corporations, some of whose shares trade publicly. Yet agency debt is classified in the Government Index and trades at a narrow spread over U.S. Treasuries. This is due to the strong links between the agencies and the U.S. government. Agency market issuers, which comprise federal agencies and government sponsored enterprises (GSEs), were created by the U.S. Congress to fulfill specific public policy functions. Most of these public charters revolve around providing credit to important sectors of the economy, such as housing, agriculture, education, exports, and small businesses. IMPLIED GUARANTEE Although most agency and GSE debt is not backed by the full faith and credit of the federal government, investors generally treat agency securities as if they had negligible credit risk. Because of the importance of the agencies in promoting public policy, there is a widespread view that the federal government would prevent an agency or GSE from defaulting on its debt obligations. As a result, the agencies and GSEs enjoy what is commonly described as an implied guarantee. THE ISSUERS Agency and GSE issuers may be separated into three categories: frequent domestic issuers, other domestic agency issuers, and U.S. government-sponsored international development agency issuers. All of the frequent domestic issuers are GSEs: Federal Farm Credit Banks, Federal Home Loan Banks, Freddie Mac, Fannie Mae, and the Tennessee Valley Authority. These GSEs borrow in the capital markets and use the proceeds to support home, student, farm, and other types of loans. In the category of other domestic agency issuers, FICO, GSA, and SBA are federal agencies. Sallie Mae, REFCORP, and the U.S. Postal Service are GSEs. The category of U.S. government-sponsored international development agency issuers includes the Agency for International Development (AID), Government Trust Certificates (GTC), and the Private Export Funding Corporation (PEFCO). It also includes parts of the Foreign Military Sales Program, which is partially guaranteed by the Department of Defense. In this category, only AID is a federal agency. 6

7 Lehman Brothers Guide to Agency & Government-Related Securities The largest issuers in the agency market are the housing GSEs. As can be seen from Figure 3, Fannie Mae, Freddie Mac, and the Federal Home Loan Banks make up the bulk of the agency market. A large part of the recent growth in size of Fannie Mae and Freddie Mac has come through their Benchmark and Reference Note programs, respectively. These programs have focused on replicating the issuance pattern of the Treasury, with a scheduled calendar of issuance and large liquid issues at major maturity points along the curve. This has contributed greatly toward improving liquidity in the agency debt market. A complete breakdown of the share of the various issuers in the Lehman Brothers Agency Index is given in Figure 4. Figure 3. The Agency Market Is Dominated by the Housing GSEs FNMA 42% Others 13% FHLB 19% FHLMC 26% Figure 4. Issuers by Share in the Lehman Brothers Index Issuer Share of Index FNMA 42.42% FHLMC FHLB REFCORP 6.21 TVA 2.70 FFCB 1.60 FICO 1.51 SLMA 0.45 PEFCO 0.13 GTC 0.09 NARC 0.05 GLT (AID) 0.04 Others

8 Lehman Brothers Guide to Agency & Government-Related Securities BENEFITS OF AGENCY AND GSE STATUS Agency and GSE status provides advantages that are not available to other debt issuers. These include the ability to borrow funds more cheaply in the capital markets, the benefit of maintaining less capital in business processes, and certain exemptions from state and local taxes. There are other features of agency securities that lend support to their implied government backing. For example, they are acceptable as a security for the deposit of public monies under U.S. control. National banks and state chartered banks in the Federal Reserve System may deal in, underwrite, purchase, and hold agency securities for their own accounts without limitation. Agency securities can be used as collateral to secure advances to depository institutions from Federal Reserve Banks and as investments for federally chartered savings banks. Agency issues with remaining maturities of five years or less may be counted as liquidityqualifying investments under regulations prescribed by the Office of Thrift Supervision for savings associations. In addition, most are acceptable as purchases by the Federal Open Market Committee in its day-to-day implementation of monetary policy and as legal investments for federal credit unions. More recently, agency debt has been made acceptable as collateral in repo operations with the Federal Reserve. 8

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10 Lehman Brothers Guide to Agency & Government-Related Securities Issuers of Agency and Government-Related Securities FNMA FHLMC FHLB REFCORP TVA Chartered by act of Congress Yes Yes Yes Yes Yes Public stock outstanding Yes Yes No No Federal President or presidential appointees Yes Yes Yes Yes Yes appoint some board members Authority to borrow from the Treasury Yes Yes Yes Yes Yes Treasury approval of debt issuance Yes Yes Yes Yes Yes Eligible for Federal Reserve open Yes Yes Yes Yes Yes market purchases Use of Federal reserve as fiscal agent Yes Yes Yes Yes Yes Eligible to collaterize public deposits Yes Yes Yes Yes Yes (all U.S. Government; most state and local) Exempt from 1933 SEC registration Yes Yes Yes Yes Yes Government securities for purposes of Yes Yes Yes Yes Yes the Securities Exchange Act of 1934 Eligible for unlimited investment by national Yes Yes Yes Yes Yes and state bank Federal Reserve members Exemption of corporate earning from No No Yes Yes Yes federal income tax Exemption of corporate earning from Yes Yes Yes Yes Yes state and local income tax Coupon interest usually exempt from No No Yes Yes Yes state and local income tax Federal Regulator OFHEO OFHEO FHFB Yes None Explicit U.S. Government guarantee NoNoNoNoNo 10

11 Lehman Brothers Guide to Agency & Government-Related Securities FFCB FICO SLMA PEFCO GTC AID FAC GSA SBA USPS Yes Yes Yes NoYes Yes Yes Yes Yes Yes NoNoYes NoPrivate NoFederal Federal NoNo NoYes Yes NoN.A. Yes Yes NoYes No No NoYes NoN.A. Yes Yes No NoYes NoYes Yes NoYes N.A. Yes Yes NoYes Yes Yes Yes Yes Yes N.A. Yes Yes NoYes Yes Yes Yes NoNoNoYes Yes NoYes Yes Yes Yes NoNoYes Yes Yes Yes Yes Yes Yes Yes Yes NoYes Yes Yes Yes No Yes Yes Yes Yes Yes Yes Yes Yes Yes No Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes NoNoYes Yes Yes NoNoNo Yes Yes Yes NoYes Yes Yes Yes Yes Yes Yes Yes Yes NoNoNoYes Yes NoYes FCA FHFB None None None None FCA FCA None No No No NoYes NoYes Yes Yes Yes No 11

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13 FNMA Creation Purpose Use of Funds Issue Types Guarantee 1938 National Housing Act Provide support and liquidity to the U.S. mortgage market Purchase mortgages and mortgage-backed securities Discount notes, MTNs, Senior and Subordinated Benchmark Notes. None; obligations of FNMA The Federal National Mortgage Association was created by Congress in 1938 to provide supplemental liquidity in the mortgage market. It has historically fulfilled this objective by borrowing in the capital markets and using the proceeds to purchase mortgages from lenders who originated them. This approach attracts funds from investors who might not otherwise invest in mortgage loans, thereby expanding the pool of funds available for housing. Through its nationwide orientation, Fannie Mae also helps redistribute mortgage funds from capital-surplus to capital-deficient areas. Fannie Mae also issues mortgage-backed securities (MBS) based off the pools of mortgages it purchases from lenders. The issuance of MBS makes the secondary mortgage market more liquid, thereby lowering the cost of issuing mortgages. Fannie Mae is an active participant in the secondary MBS market as well, buying MBS and funding them with its debt issuance. In 1968, Fannie Mae was converted from government ownership to a federally chartered stockholder-owned, privately managed corporation. The new charter 13

14 Lehman Brothers Guide to Agency & Government-Related Securities gave Fannie Mae the ability to borrow in the world s capital markets at lower rates than those generally available to unrestricted private companies. This change enables Fannie Mae to fulfill its dual objectives: to provide liquidity to the residential mortgage market and a profit to its stockholders. In the 1970s, Fannie Mae s financial performance was reflective of its balance sheet. Its assets were predominantly long-term fixed-rate mortgages financed by borrowings of substantially shorter maturities, and as a result, earnings were subject to swings in interest rates. Fannie Mae s balance sheet still consists of mortgages and debt, but due to changes that began in the early 1980s, its earnings are far less affected by volatile interest rates. Fannie Mae now receives a portion of its income through the guarantee fees it earns on ensuring the timely payment of principal and interest on the MBS it issues. Fannie Mae also expanded its mortgage portfolio rapidly in the 1990s, which contributed to improved earnings. By 3Q00, Fannie Mae had close to $600 billion of mortgages outstanding in its portfolio. By matching the effective maturities of assets and liabilities, Fannie Mae has made interest income less sensitive to the level and volatility of interest rates. The agency issues callable debt and enters derivative transactions to obtain a closer match between its assets and liabilities. Fannie Mae has also shifted its long-term funding needs to its Benchmark program, which began in Under this program, Fannie Mae issues large liquid notes across various maturities on the curve based on a pre-announced calendar. This program has improved the liquidity in the agency market and lowered Fannie Mae s cost of funding. As of September 30, 2000, there was a total of $611 billion dollars in outstanding debt. Fannie Mae has come under closer scrutiny of late, with some members of Congress proposing to reform the housing GSEs. The role of the housing GSEs in the mortgage market and the cost and benefits of their preferential funding have come under closer examination. In response to this debate on greater regulation, Fannie Mae, along with Freddie Mac, announced a series of voluntary measures in October These include an increase in their capital base through the issuance of subordinated debt, independent third-party ratings, public disclosure of risk sensitivity analysis, and the maintenance of liquid assets to tide over a financial crisis. 14

15 FHLMC Creation Purpose Use of Funds Issue Types Guarantee 1970 Emergency Home Finance Act Provide support and liquidity to the U.S. mortgage market Purchase mortgages and mortgage-backed securities Discount notes, MTNs, Senior and Subordinated Reference Notes None; unsecured obligations of FHLMC The Federal Home Loan Mortgage Corporations, Freddie Mac, was created in 1970 as an instrumentality of the U.S. government with a mandate to increase the availability of mortgage credit to finance housing. To reflect the enormous changes in the country s mortgage and housing markets since 1970, FIRREA, enacted in 1989, restated Freddie Mac s purpose: the agency s goal is to stabilize the secondary market for home mortgages by helping to distribute investment capital available for financing home mortgages. Freddie Mac buys mortgage pools from lenders and securitizes them into guaranteed securities (called Mortgage Participation Certificates, or PCs). These securities are sold to investors in the secondary fixed income market. In this way, Freddie Mac links the mortgage markets to the capital markets. Freddie Mac is also an active investor in the secondary MBS market, repurchasing its own PCs. These purchases are financed by the issuance of its debt. As of the end of 3Q00, Freddie Mac had over $360 billion of mortgages as assets. 15

16 Lehman Brothers Guide to Agency & Government-Related Securities The bond and equity holder of most agencies that are privately owned but serve a public purpose have always assumed the risk that changing priorities required in fulfilling the agency s public debt charter might be detrimental to bondholders. The passage of FIRREA has generally helped with this problem: Freddie Mac was once considered a source of cash to help cover some of the cost of the thrift bailout, but under the new structure, it is virtually divorced from thrift industry problems. Although legislation may direct Freddie Mac to act in a way that a private corporation might not (i.e., providing mortgage credit for housing low- and moderate-income families), Congress also recognizes Freddie Mac s right to earn a reasonable economic return for doing so. As part of its risk management measures to better match its callable mortgage assets and predominantly bullet debt liabilities, Freddie Mac is an active participant in the fixed income derivatives market. Freddie Mac also issues callable debt to replicate the characteristics of its assets more closely. Being among the top global issuers, Freddie Mac issues debt securities that are unsecured obligations of the agency; they are not guaranteed by nor do they constitute debt obligations of the U.S. government. Beginning in 1998, Freddie Mac has been issuing a large portion of its debt under the Reference Note program. Under the program, Freddie Mac issues large liquid notes to the market on a scheduled calendar. The program has been extremely successful and improved the funding levels of Freddie Mac. Freddie Mac has also launched the Reference Note program in Europe, issuing debt in euros and tapping into a larger investor base. In another innovative move, Freddie Mac began auctioning its 2- and 3-year Reference Note in At the end of 3Q00, Freddie Mac had over $350 billion in outstanding long-term debt. Recently, Freddie Mac has come under some scrutiny from members of Congress, who have felt that the preferential funding received by Freddie Mac is unfair to private lenders and also creates systemic risk in the financial markets. A compromise deal was worked out in October 2000, whereby Freddie Mac, along with Fannie Mae, agreed to undertake certain voluntary measures to allay fears of systemic risk. Some of these measures included an increase in their capital base through the issuance of subordinated debt, independent third-party ratings, public disclosure of risk sensitivity analysis, and the maintenance of liquid assets to tide over a financial crisis. 16

17 FHLB Creation Purpose Use of Funds Issue Types Guarantee 1932 Federal Home Loan Bank Act Restore confidence in thrift industry Credit for deposits and mortgage funding for member institutions Consolidated bonds, discount notes, and MTNs None; joint and several obligations of FHLBs In 1932, Congress passed the Federal Home Loan Bank Act to revitalize the thrift industry ravaged by the Great Depression. Its primary goal was to restore confidence in the industry, to encourage savings, and, thereby, to provide for affordable home ownership through a stable supply of mortgage credit. The legislation created the Federal Home Loan Bank System, consisting of the Federal Home Loan Bank Board and twelve regional banks. The Federal Home Loan Banks do not directly fund mortgages, but make advances to thrift institutions, commercial banks, and credit unions that make new mortgage loans. In this way, the banks can closely match the duration of their assets and liabilities while prepayment risk remains with the thrift making the mortgage loan. More recently, the Home Loan Banks have embarked on an Mortgage Partnership Finance (MPF) program, in which the Home Loan Banks retain the mortgage loans on their books and manage interest rate and prepayment risk while passing off the credit risk to the members that originated the loan. For this, the Home Loan Bank pays the member institution a credit enhancement fee. 17

18 Lehman Brothers Guide to Agency & Government-Related Securities The Federal Home Loan Banks are instrumentalities chartered by the federal government but owned and capitalized by member institutions. For members, the benefits of ownership include access to FHLB credit and dividends on their capital stock. A regional FHLB, in its role as central bank to its members, provides deposit services, processing services, and securities safekeeping. Its most important role, however, is providing credit. Typically, the FHLB might help an institution meet seasonal deposit outflow through short-term credit or stimulate mortgage lending by providing longer-term credit. In either case, the primary means of raising necessary funds is through borrowing in the credit market. To provide funds to cover the losses incurred by the thrift industry in the 1980s, Congress enacted the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). FIRREA both directly and indirectly affected the FHLB. For example, FIRREA expanded the category of institutions eligible to become members of the FHLB to include both commercial banks and credit unions with at least 10% of their assets in home mortgages. The FHLB System Modernization Act was implemented in 1999 to achieve additional reform. Its main objectives were to expand membership and borrowing access, increase the autonomy of the Federal Home Loan Banks, and broaden the viable loan collateral. FHLB debt securities are not obligations of the United States and carry no government guarantee. They are joint and several obligations of the 12 Federal Home Loan Banks; each bank is responsible not only for repayment of its own participation in a debt issue but also for the indebtedness of the entire FHLB system. FHLB financing requirements are coordinated through the Office of Finance, which serves as fiscal agent for the 12 district banks. After canvassing the individual banks as to their financial requirements, the Office of Finance consolidates the debt, fulfilling the borrowing needs of several banks with fewer debt issues than would be necessary if each bank came to market independently. This coordinated debt market strategy improves the liquidity of FHLB securities and reduces financing costs to the FHLB system. The Office of Finance issues FHLB debt as consolidated bonds, discount notes, and MTNs. Consolidated bonds are issued with maturities ranging from one to ten years; discount notes mature in one year or less. MTNs are issued with maturities of one year and longer. FHLB is permitted to issue no more than 20 times the total capital of the bank system. In addition, the FHLB had $577 billion of consolidated debt obligations at the end of 3Q00. 18

19 REFCORP Creation Purpose Use of Funds Issue Types Guarantee 1989 FIRREA Provide funds to RTC Resolve thrift problems 30- and 40-year bonds Interest shortfall by Treasury; principal defeased with U.S. Treasuries The Resolution Funding Corporation was created by FIRREA to provide funds to the Resolution Trust Corporation (RTC) in order to help resolve the Savings and Loan failures. FIRREA authorized REFCORP to issue up to $30 billion in bonds, notes, debentures, and similar obligations. This authority was complete by January 1991, after REFCORP had brought to market two 40-year bond issues (totaling $10.5 billion) and four 30-year bond issues (totaling $19.5 billion). The bonds may be stripped and are eligible for reconstitution to the same extent as Treasury bonds. REFCORP operates as a Treasury agency under the direction of the RTC Oversight Board, whose chairman is the secretary of the Treasury. REFCORP bonds are attractive to investors because they are more like Treasury than agency securities; whereas most agency securities are distributed through selling groups, REFCORP bonds were sold through an auction process virtually identical to Treasury auctions. There is no explicit government guarantee on REFCORP bonds, more for budgetary reasons (i.e., keeping certain thrift resolution outlays off-budget to 19

20 Lehman Brothers Guide to Agency & Government-Related Securities avoid Gramm-Rudman law repercussions) than to divorce the government from its role in the REFCORP structure. FIRREA specified sources to repay interest and principal on REFCORP bonds, and all funds are ultimately backed by the U.S. government. REFCORP must hold Treasury zero-coupon bonds with face value equal to the aggregate amount of REFCORP bonds outstanding. Upon maturity, principal must be repaid with funds from the maturing zeros. According to FIRREA, REFCORP will obtain funds to pay interest on its obligations from the following sources: earnings on certain assets, proceeds from the RTC, payments from the FHLBs, and proceeds from the sale of assets. According to the Treasury backup statement, if the amounts available from these sources are insufficient to cover the interest payments, the secretary of the Treasury will pay the additional amount due. These funds are permanently appropriated and are not subject to sequestration under the balanced budget law. 20

21 TVA Creation Purpose Use of Funds Issue Types Guarantee 1933 Tennessee Valley Act Develop Tennessee Valley resources Meet current and finance capital expenditures Discount notes, power bonds with 5- to 50-year maturities None; obligations of TVA The Tennessee Valley Authority Act of 1933 established the TVA as both a corporation owned by the U.S. government and a government agency. Its purpose is to strengthen the regional economy and the national defense by controlling the Tennessee River and its tributaries, supplying electric power to an area of approximately 80,000 square miles with a population of about 7.0 million, and operating chemical plants for fertilizer development and national defense uses. TVA is a wholesaler of power to local distributors, federal agencies, and industries. It has the nation s largest electricity generating capacity. While TVA oversees both power and non-power programs, it can issue debt only in connection with its power program and has the authority to borrow up to $150 million from the U.S. Treasury. TVA s three board members are appointed by the president and confirmed by the Senate. Its borrowings are a part of the federal budget and the TVA Act guarantees it a line of credit with Treasury. TVA bonds are payable from net power proceeds and are not direct obligations of, or guaranteed by, the U.S. government. Net power proceeds are defined as gross revenues less the cost of operating, maintaining, and administering its 21

22 Lehman Brothers Guide to Agency & Government-Related Securities TVA power properties and state and local taxes. Amortization of capital expenditures is not deducted in the net power proceeds calculation. TVA is required by stature to charge rates that cover debt service. In fiscal year 1999, TVA had net power proceeds of $6.5 billion and interest expense of $1.8 billion. Interest on TVA securities is exempt from state and local taxes. These securities are eligible as collateral for Treasury tax and loan accounts and are exempt under the Securities Act of 1933 and the Securities Exchange Act of TVA has authority to borrow $30 billion; as of September 30, 2000, it had $25 billion in outstanding debt. Bonds have been issued with maturities from 5 to 50 years. Discount notes are also sold, with maturities of up to 360 days. 22

23 FFCB Creation Purpose Use of Funds Issue Types Guarantee 1971 Farm Credit Act Act as financial intermediary to provide credit to farmers Provide shortand long-term loans to farm and farm-affiliated businesses Consolidated systemwide notes and bonds, MTNs None; joint and several liabilities of FFCBs The Federal Farm Credit System is a network of cooperatively owned lending institutions that provides credit services to farmers and farmaffiliated businesses such as agricultural cooperatives and rural utilities. The Farm Credit Banks are not depository institutions, but financial intermediaries that borrow in the capital markets and use the proceeds to make loans and provide other assistance. Farm Credit institutions are chartered by the U.S. government and operate under the Farm Credit Act of 1971 and its amendments. The Farm Credit Administration (FCA), an independent agency in the executive branch of the federal government, has the task of regulation and oversight. The FCA is managed by a three-member board appointed by the president of the United States with the advice and consent of the Senate. When farmers borrowed aggressively in the 1970s to expand production, a growing farm-lending network was justified. However, the highly leveraged farmer of the 1970s helped contribute to the farm crisis in the mid-1980s. 23

24 Lehman Brothers Guide to Agency & Government-Related Securities Since then, farmers have begun to reduce debt. By passing the Agricultural Credit Act of 1987, Congress recognized the contraction that had taken place in farm lending and began to reduce overheads and streamline operations to revitalize the Farm Credit System. The act consolidated the FFC Banks and created the Financial Assistance Corporation (FAC) to provide capital to Farm Credit institutions experiencing financial difficulty. The system obtains funds for the lending operation primarily through the sale of notes and bonds. The banks maintain a fiscal agent, the FFC Banks Funding Corporation, to handle issuance and marketing of these securities. By sharing one fiscal agent, member banks determine their degree of participation in a debt issue while maintaining the marketability associated with consolidating the borrowing needs of many banks into a few issues. The consolidated system-wide notes and bonds of the FFC Banks are neither obligations of, nor guaranteed by the U.S. government. However, investors are protected in several ways. First, each bank must maintain eligible collateral at least equal in value to the total amount of its debt obligations outstanding. Second, while each bank determines its own participation in a debt sale, all of the banks are jointly and severally liable. This means that each bank can be held financially responsible for the notes and bonds issued by all other banks, making financial problems at one or two institutions less important than the health of the overall system. The Farm Credit Banks generally borrow by issuing either notes or bonds. The total amount of outstanding debt as of September 30, 2000, was $74 billion. 24

25 FICO Creation Purpose Use of Funds Issue Types Guarantee 1987 Competitive Equality Banking Act Recapitalize FSLIC Manage obligations of insolvent thrifts Long-term bonds (none issued since September 1989) Principal defeased with U.S. Treasuries In 1987, President Reagan signed a 12-title banking bill, part of which directed the Federal Home Loan Bank Board to create the Financing Corporation. FICO was given the authority to borrow $ billion for the purpose of recapitalizing the Federal Savings and Loan Insurance Corporation (FSLIC) through the transfer of proceeds from FICO debt to FSLIC. The legislation creating FICO explicitly states that interest and principal on its debt obligation are not backed by the full faith and credit of the U.S. government. FICO was the centerpiece of the 1987 plan to recapitalize FSLIC. The Financing Corporation is managed by a three-member directorate, including the director of the FHLB Office of Finance and two presidents of the 12 regional FHLBs. The 12 regional Federal Home Loan Banks were authorized to provide up to $3 billion in seed money for the Financing Corporation; however, most of its funds have been raised in the credit markets through the sale of long-term bonds. Net proceeds received by FICO were invested in FSLIC, which used the funds to manage certain insolvent and troubled thrifts. With the passage of FIRREA, the Resolution Funding Corporation became responsible for raising 25

26 Lehman Brothers Guide to Agency & Government-Related Securities money to manage problem thrifts. FICO last issued securities in 1989, and no future debt issuances are expected. FICO issued $8.2 billion of debt between October 1976 and September 1989 as 30-year coupon-bearing securities. More than half of these bonds ($4.68 billion) had been stripped and sold as zero-coupon bonds. To ensure payment of principal on the bonds, the Financing Corporation has purchased enough zero-coupon U.S. government-guaranteed securities to make total principal payable maturities approximately equal to the face value on FICO obligations. Interest payments on the bonds will be met through FICO s assessments on deposits insured by the Savings Association Insurance Fund (SAIF), exit fees charged to institutions transferring funds from SAIF to the Bank Insurance Fund, and investment income on FICO. The Financing Corporation has been granted authority to make a regular assessment of up to 1/12% of deposits. A special assessment of 1/8% may also be levied if the FHLB board and FICO directorate find it necessary to meet interest obligations. 26

27 SLMA Creation Purpose Use of Funds Issue Types Guarantee Amendments to 1965 Higher Education Act (1972) Provide liquidity to lenders for loans to students and educational institutions Facilitate loan purchases, warehousing, and forward commitments Debt securities, notes, and MTNs None; obligations of SLMA The Student Loan Marketing Association is a federally chartered, stockholderowned corporation established by the Higher Education Act of 1965 to provide liquidity for banks, thrifts, and other lenders that originate Guaranteed Student Loans (GSLs). Sallie Mae creates a national secondary market for GSLs by purchasing loans, or by using a warehousing advance program through which it advances funds to institutions that issue loans to students. Sallie Mae issues debt and equity securities to finance these activities. The GSL Program provides funds for higher education. While the program has evolved over the years, first into the Stafford Loan program and then into the Federal Family Education Loan Program (FFELP), loans are still originated primarily by commercial banks but are also offered by state agencies and educational institutions. The program provides that the government will pay interest on the loan while borrowers are in school; when the borrowers graduate or leave school, they become accountable for interest and principal payments. The government assures lenders a market rate of return on the notes. 27

28 Lehman Brothers Guide to Agency & Government-Related Securities With the government getting more directly involved in issuing student loans under the Clinton administration, the need for a GSE in the student loan market was reduced greatly. In an act passed in 1996, Sallie Mae was restructured to phase out its GSE status. The corporation currently consists of a GSE and a non- GSE subsidiary, with the GSE to be phased out by As of year-end 1998, there was $367 million outstanding in issues with maturities after These issues are to be defeased with Treasuries. The SLM Holding Corporation, which was created as part of the 1996 Act, has undergone a lot of organic growth since then. In July 1999, it purchased Nellie Mae, followed by the Loan Funding Resources Inc. in In the same year, it was renamed USA Education, Inc. after acquiring several divisions of the USA Group. As a consolidated fully privatized corporation, USA Education, Inc. is the largest U.S. supplier of education loans and financing. The largest asset on USA Education Inc. s balance sheet is the FFELP Program, which includes loans directly purchased or indirectly financed through the warehousing advance program. The advances are fully collateralized by GSLs, or by marketable government securities if the advances are to be used for financing future loans. USA Education Inc. has also accumulated a substantial investment portfolio, giving it liquidity and tax management flexibility. Total cash and investments have risen from $11.3 billion in 1990 to $45.6 billion at the end of 3Q00, with $35.9 billion worth of student loans. The outstanding debt as of September 2000 was $42.6 billion. 28

29 PEFCO Creation Purpose Use of Funds Issue Types Guarantee 1970, supported by U.S. Treasury and Eximbank Fund exports of U.S. goods and services Provide dollardenominated loans for foreign importers Secured notes with maturities of 5 years or longer Interest by Eximbank; princ. by obligations backed by full faith and credit of U.S. Government The Private Export Funding Corporation was created in 1970 with the support of the U.S. Department of Treasury, and the Export-Import Bank of the U.S. (Eximbank). The agency is owned by 44 commercial banks, seven industrial corporations, and one investment bank. PEFCO fulfills its purpose of increasing the funding available for financing exports of U.S. goods and services by making dollar-denominated loans to foreign importers. The timely payment of principal on PEFCO loans is backed by an equivalent principal amount of obligations, backed by the full faith and credit of the United States, that mature prior to the notes they collateralize. Interest payments are directly guaranteed by the Eximbank. The U.S. attorney general, in a 1966 opinion, stated that obligations of Eximbank constitute general obligations of the United States; thus, both principal and interest of PEFCO bonds are backed by the full faith and credit of the U.S. government. At September 30, 2000, the end of the fiscal year, PEFCO had total shareholder equity of $62.4 million and total assets of $4.6 million. Total securities 29

30 Lehman Brothers Guide to Agency & Government-Related Securities outstanding were $4.5. billion. Issues dated prior to 1985 have sinking fund schedules, while the more recent issues are noncallable. 30

31 GTC Creation Purpose Use of Funds Issue Types Guarantee 1987 Legislation on Foreign Military Sales Help foreign buyers of U.S. military equipment refinance purchases Facilitate financing of foreign military sales loans Current coupon bonds and zero coupon certificates with 3- to 20-year maturities Principal and interest: 90% guaranteed by the U.S. Government, 10% defeased by U.S. Treasuries As part of the Foreign Military Sales Program (FMS), the U.S. government lends money to key allies for the purchase of American military equipment. In late 1987, Congress passed legislation to authorize refinancing of MS loans through the public debt market. Several foreign governments, including El Salvador, Jordan, Israel, Morocco, Pakistan, Tunisia, and Turkey, have taken advantage of this legislation to reduce their debt service burdens by issuing securities. Government Trust Certificates securities are backed by the foreign country s obligation to make payments and a U.S. government guarantee covering 90% of principal and interest. The remaining 10% of payments is to be defeased with obligations of the U.S. Treasury. If the foreign country misses a payment, notice of default is given to the Department of Defense and payments of 90% of principal and interest due are made to the trust under the terms of the guarantee; the remaining 10% of 31

32 Lehman Brothers Guide to Agency & Government-Related Securities principal and interest comes from U.S. Treasury securities that pay on or before each trust payment date. Through this process, the certificate holders continue to receive 100% of each payment. GTC securities match payments on pools of loans. To replicate flows, both current-coupon bonds with set paydown schedules and zero-coupon certificates with maturities between 1990 and 2015 have been issued. Stated payments cannot be accelerated or slowed. Securities are issued through grantor trusts not subject to federal income tax; however holders of GTC issues are subject to federal, state, and local taxes where applicable. 32

33 AID Creation Purpose Use of Funds Issue Types Guarantee 1961 Foreign Assistance Act Promote housing in developing countries Guarantee loans for housing Debentures with maturities of 2 to 30 years Full faith and credit of the U.S. Government The U.S. Agency for International Development administers a Housing Guaranty Program, authorized by the Foreign Assistance Act of 1961, that promotes basic shelter for low-income families in developing countries. The program allows private lenders to securitize and sell the housing loans they make in developing countries into the secondary market. Housing Guaranty loans are secured by the full faith and credit of the U.S. government, making the securities attractive to secondary buyers and increasing liquidity. AID charges an initial fee of 1% of the principal balance plus an annual guarantee fee of 0.5% of the remaining balance for the life of the loan. The income from these fees pays operating expenses at AID and provides a reserve against adverse claims on the loan guarantee. Because AID does not prescribe a standard formula for Housing Guaranty Program loans, its guaranteed notes in the secondary market have a variety of structures. Most issues have sinking fund provisions starting after a given period, and some have premium call features. 33

34 Lehman Brothers Guide to Agency & Government-Related Securities Currently, about $1 billion in AID securities are outstanding. The maximum loan size under the AID Housing Guaranty Program without a special exemption from Congress is $25 million. Government Loan Trust (GLT) bonds issued in March 1991, in grantor trusts backed by the government, guaranteed loans to Israel. The GLT issuances divided the underlying loan collateral into three parts: $85 million of 4-year securities, $224 million of 12-year securities, and a series of zero-coupon bonds with maturities between 15 and 30 years. 34

35 FAC Creation Purpose Use of Funds Issue Types Guarantee 1987 Agricultural Credit Act Provide capital to Farm Credit System Institutions Capital infusion for Farm Credit institutions experiencing financial difficulty 15-year bonds Federal guarantee of timely payment of principal and interest The Financial Assistance Corporation was created by the Agricultural Credit Act of 1987 to assist members of the Farm Credit System experiencing financial difficulty. FAC s authority to purchase up to $4 billion of preferred stock of institutions requiring assistance expired in September FAC activities are directed by a board consisting of the secretaries of Treasury and agriculture and a director appointed by the president. Funds for capital infusion came from the sale of 15-year bonds explicitly guaranteed by the Treasury for the timely payment of principal and interest. The first bonds were issued in July The bonds were sold through a special limited selling group and on a competitive bidding basis. As of September 30, 2000, FAC had $775 million of outstanding debt. 35

36 Lehman Brothers Guide to Agency & Government-Related Securities 36

37 GSA Creation Purpose Use of Funds Issue Types Guarantee 1949 Federal Property and Administrative Services Act Manage government property and records Finance construction of federal buildings 30-year securities Full faith and credit of the U.S. Government The General Services Administration was established in 1949 by the Federal Property and Administrative Services Act to manage the property and records of the federal government. It oversees building construction and operations, procures and distributes supplies, disposes of surplus government property, and creates, preserves, and disposes of records. The GSA has issued Public Building Trust Participation Certificates to finance the construction of federal buildings. Since its last issue, Series J in 1976, GSA has financed projects by issuing securities directly to the Federal Financing Bank. In October 1972, the attorney general of the U.S. ruled that GSA securities constitutes an absolute and unconditional general obligation of the Unites States, guaranteed by the full faith and credit of the government. The trustee of the participation certificates also holds title to construction improvements and leasehold interest in project sites as security for the government s obligation to pay principal and interest. 37

38 Lehman Brothers Guide to Agency & Government-Related Securities In 1972, the GSA brought ten issues to market as 30-year securities with call provisions and sinking fund schedules. As of the end of fiscal year 1999, GSA had $2.6 billion in debt outstanding. 38

39 SBA Creation Purpose Use of Funds Issue Types Guarantee 1953 Facilitate financing for small business Guarantee of loans to facilitate securitization and sale into the secondary market Securities with maturities of 2 to 25 years U.S. Government guarantee through SBA The Small Business Administration was created in 1953 to facilitate financing in the small business sector. By bringing in capital from other regions, the small business community is allowed to flourish regardless of the financial situation of a particular area. The SBA-guaranteed portion of the loan is packaged for sale in the secondary market, providing liquidity for subsequent loans. In 1984, the Small Business Secondary Market Improvement Act established a single fiscal and transfer agent and approved the pooling of SBA loans. These steps made SBA loans available in large pools for institutional investors. Payment of principal and interest on SBA loans is guaranteed by the full faith and credit of the U.S. government through the SBA. This guarantee covers 75%-80% of the loan; the remaining amount must be retained by the originator. Total debt outstanding as of the end of October 2000 was $48.3 billion. 39

40 Lehman Brothers Guide to Agency & Government-Related Securities 40

41 USPS Creation Purpose Use of Funds Issue Types Guarantee 1970 Postal Reorganization Act Operating U.S. postal services Meet costs of providing effective and regular postal service nationwide Issues with maturities of 20 years or longer None; obligations of the U.S. Postal Service The U.S. Postal Service was created as an independent part of the executive branch by the Postal Reorganization Act in August 1970 and succeeded the operations of the Post Office Department in July The Postal Service provides mail processing and delivery services to individuals and businesses within the United States. The postmaster general is appointed by a board of governors made up of nine appointees of the president with the consent of the Senate. Revenues come from postal rates and feed, appropriations, reimbursement by Congress, proceeds from borrowing, and interest from investments. Debt issued by the Postal Service is not guaranteed by the U.S. government, although borrowing is authorized from the Treasury. Such authority also requires the Treasury, if necessary, to meet principal, premiums, and interest payments on these obligations as they come due. A total of $443 million of securities has been issued in two public issues of pro rata sinking fund debentures backed by sale/leaseback of the postal headquarters in Washington, DC. 41

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43 APPENDIX More information is available at the following web sites: This document is for information purposes only. No part of this document may be reproduced in any manner without the written permission of Lehman Brothers Inc. Under no circumstances should it be used or considered as an offer to sell or a solicitation of any offer to buy the securities or other instruments mentioned in it. We do not represent that this information is accurate or complete and it should not be relied upon as such. Opinions expressed herein are subject to change without notice. The products mentioned in this document may not be eligible for sale in some states or countries, nor suitable for all types of investors; their value and the income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates or other factors. Lehman Brothers Inc. and/or its affiliated companies may make a market or deal as principal in the securities mentioned in this document or in options or other derivative instruments based thereon. In addition, Lehman Brothers Inc., its affiliated companies, shareholders, directors, officers and/or employees, may from time to time have long or short positions in such securities or in options, futures or other derivative instruments based thereon. One or more directors, officers and/or employees of Lehman Brothers Inc. or its affiliated companies may be a director of the issuer of the securities mentioned in this document. Lehman Brothers Inc. or its predecessors and/or its affiliated companies may have managed or co-managed a public offering of or acted as initial purchaser or placement agent for a private placement of any of the securities of any issuer mentioned in this document within the last three years, or may, from time to time perform investment banking or other services for, or solicit investment banking or other business from any company mentioned in this document. This document has also been prepared on behalf of Lehman Brothers International (Europe), which is regulated by the SFA Lehman Brothers Inc. All rights reserved. Member SIPC.

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