The Federal Reserve increased agency mortgage-backed securities holdings by $165 billion in 2012, bringing the total to $1 trillion as of year-end, according to the Federal Reserve Bank of New York’s latest open market operations report.

The significant jump was due to the Federal Open Market Committee’s decision to continue providing additional policy accommodation through agency MBS puchases at a pace of $40 billion per month, the report said.

Throughout the year, the central bank’s ongoing reinvestment of principal payments from agency debt and agency MBS also contributed to the rise in holdings. 

Similar to purchases of Treasury securities, agency MBS purchases remove duration risk from the market and also remove prepayment risk – the risk associated with uncertainty around the timing of cash flows due to the fact that homeowners can prepay their mortgages at any time, the NY Fed stated.

"The removal of a considerable amount of these risks through the SOMA’s purchases of agency MBS should, all else equal, lower MBS rates by lowering risk premiums, thereby helping to reduce primary mortgage rates, stimulate demand for housing, and promote increased refinancing activity," the report said. 

Furthermore, policy actions supported historically low mortgage rates, which contributed to a pickup in refinancing activity and new issuance of agency MBS. 

Meanwhile, additional purchases and reinvestments shifted the distribution of agency MBS holdings into lower coupons and longer-durations securities last year, the report explained.

As of 2012, agency MBS holdings were mostly in 30-year securities and holdings were spread across three issuers including Fannie Mae, Freddie Mac and Ginnie Mae.

In total, at the end of the 2012, the Fed held 19% of outstanding fixed-rate agency MBS, up from 18% at the start of last year, the NY Fed concluded.