American Capital Agency (AGNC) recently announced the commencement of an underwritten public offering of shares of its Series A Cumulative Redeemable Preferred Stock (the “Series A Preferred Shares”) and this event was the catalyst for this article.

American Capital is a real estate investment trust (REIT) investing in residential mortgage pass-through securities and collateralized mortgage obligations for which the principal and interest payments are guaranteed by government-sponsored entities or by a United States government agency. In the case of American Capital, these government sponsored entities are Freddie Mac, Fannie Mae and Ginnie Mae.

Pass-through securities, as we all know, are basically a portfolio of mortgages from which investors receive payments at regular intervals consisting of principal and interest. At first blush, this may seem like a remarkably safe investment, given the government guarantees. However, this is not entirely the case. There are no guarantees in place to cover cash flow and volatility that can occur as a result of principal prepayments typically arising from mortgage rate drops triggering mortgage refinancing by homeowners. In other words, an investment in mortgage REITs of the type proffered by American Capital require the investor to be constantly alert to mortgage rate fluctuations in particular and the housing market in general. American Capital is currently favoring its investors with a dividend yielding 18.2%. That said, with risk comes reward. Normally a yield in the teens would suggest a substantial risk for the investor, but mortgage REITs are calculated to provide dividend yields at a rate that substantially exceeds utilities, telephone companies and investment-grade bonds.To continue reading, click here.