Higher real estate investment trust purchases of Fannie Mae and Freddie Mac mortgage bonds kept yields higher for the market over the past year.
REITs, which are special investment vehicles that enjoy certain tax advantages, purchased $52 billion in agency mortgage-backed securities in the first quarter. Only banks bought more at $58 billion.
"Despite the 10-year Treasury closing at its lowest yield ever this past week, mortgages managed to outperform Treasuries by several ticks," according to a report from JPMorgan Chase (JPM) analysts. "In fact, this is a pattern that has been in place for much of the past year."
The analysts said higher demand from REITs along with softer refinances kept yields higher.
American Capital Agency (AGNC), a Maryland REIT, invests only in agency MBS. It bought $25 billion worth over the first three months of the year, more than any other REIT.
According to its most recent financial filing, AGNC holds $80.5 billion in these securities, and it's targeting lower coupon stacks out of fear of prepayment risks.
As of March 31, the AGNC portfolio had an average coupon of 3.99%, down from 4.23% at the end of last year.
Should the artificially low rate environment begin to rise and more borrowers refinance, it could mean losses not just for AGNC but for the entire REIT sector.
"This situation may also cause the market value of our agency securities collateralized by fixed rate mortgages or hybrid ARMs to decline by more than otherwise would be the case while most of our hedging instruments would not receive any incremental offsetting gains," AGNC warned in its filing. "In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur realized losses."
But with signs from the Federal Reserve pointing to lower rates for the foreseeable future, demand should remain elevated. JPMorgan Chase analysts said the larger REITs could be issuing more equity to buy even more agency bonds.
On May 9, the largest REIT, Annaly Capital (ALY) said it would issue and sell $750 million in senior notes due in 2015. It expects to use the proceeds to acquire more securities.
"REITs issued $4 billion in equity in the first quarter, corresponding to the $50 billion in MBS purchases. A sell-off would clearly be painful for REITs given the duration gap, but we don't expect much selling of MBS in that scenario," analysts said.