A 7.8% Yielding Safer Alternative To American Capital Agency Corporation

| About: AGNC Investment (AGNC)

American Capital Agency Corporation (NASDAQ:AGNC) is the very well known mREIT that has seen its common shares pummeled (along with the rest of the industry) as a result of tapering from the Fed over the past eight months or so. While there is much debate regarding the common stock over where it is headed, book value of the company, and the sustainability of the company's ample dividend; in this article, we'll take a look at another, less volatile way to reap current income from AGNC without taking on undue risk. This piece will focus on AGNC's Series A Cumulative Preferred Stock (AGNCP, may differ depending on your broker) and what it could potentially do for your income portfolio.

AGNCP is a traditional preferred stock which means that it pays quarterly dividends, is not backed by any sort of debt issue and also has no stated maturity date. However, as preferred stock is essentially debt with no maturity date, you are still investing in the survival of AGNC. The best part of AGNCP, however, is that you can reap the huge dividend without having to bet on which way the common stock and its dividend will go. AGNCP has fixed payments that will accrue and be paid as long as AGNC is still in business and is not subject to earnings volatility as the common is.

Speaking of the dividend, AGNCP pays a 50 cent quarterly dividend, good for an 8% coupon on the $25 issue price. As shares are trading for a small premium to that at present, $25.50, the current yield is a touch lower but still strong at 7.8%. This represents a lower yield than the common stock of AGNC but keep in mind that AGNC's common dividend is subject to cuts and even suspension under extremely adverse conditions. AGNCP's dividends are cumulative which means they are guaranteed barring bankruptcy; it doesn't matter how bad things get for AGNC, if it is still operating, it must pay dividends on AGNC. The common stock, of course, has no such guarantee. And if you think the extra yield of the common is still attractive, see the chart below for the kind of gut-wrenching volatility you can avoid by simply owning the preferred:

AGNC has no stated maturity date but it does have a call date. Beginning in April of 2017 AGNC can call AGNCP at any time for the full $25 call price. As shares are currently trading at 2% above that amount, if you were to purchase today and then get called in 2017, you'd be subject to a 2% capital loss. I don't consider that much of a risk as many common stocks move that much in one day. Plus, between now and then you'll reap $2 per year in dividend payments, making it even more of a non-issue. Just know that AGNCP can be called and if that occurs, it will be at $25 per share regardless of where AGNCP is trading at that point.

Unfortunately, AGNCP is issued by a REIT, which means that even though it pays dividends and not interest payments, it is ineligible for the preferential tax treatment traditional dividends enjoy. Thus, if you hold AGNCP in a taxable account you must be aware of what the implications of this are for you before you pull the trigger. Depending on your tax rate, this could materially diminish the after-tax returns you net from AGNCP dividends. Of course, holding AGNCP in a retirement account makes this a non-issue but it is something to be aware of that is a specific issue for REIT preferreds.

In addition, AGNCP is subject to interest rate risk just like any other preferred. If interest rates move up violently we could see AGNCP and other income securities plummet in price in order to meet the new expectations for interest rates. As AGNCP pays a fixed coupon, a spike in rates is likely to send the price falling and that could cause investors to endure capital losses. However, if you are holding for the long term it could represent a buying opportunity. I'm also fully aware that "paper" losses are still losses and can be hard to stomach. If you are going to invest in income securities like AGNCP this is something you must be aware of and know that it is a real possibility. Just keep in mind AGNC must continue to pay the dividends on AGNCP regardless so you will always have the income.

AGNCP represents a great opportunity for investors who want exposure to an mREIT but don't want to endure the inherent volatility of owning AGNC common shares. The yield is lower than the common stock at present but so is the risk. If you are an income investor that cannot stomach the large moves we've seen in mREIT shares of late but still want some great current income, AGNCP may be the answer. It offers a terrific yield and less volatility than the common shares.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.