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AGNC INVESTMENT CORP. filed this Form 10-Q on 05/05/2016
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unemployment rates, general economic conditions, government participation in the mortgage market and evolving regulations or legal settlements that impact servicing practices or other mortgage related activities.
Our Risk Management Strategy  
We use a variety of strategies to hedge a portion of our exposure to market risks, including interest rate, prepayment and extension risks, to the extent that our Manager believes is prudent, taking into account our investment strategy, the cost of the hedging transactions and our intention to qualify as a REIT. Consequently, while we use interest rate swaps and other hedges to attempt to protect our net book value against moves in interest rates, we may not hedge certain interest rate, prepayment or extension risks if our Manager believes that bearing such risks enhances our return relative to our risk/return profile, or the hedging transaction would negatively impact our REIT status.
The risk management actions we take may lower our earnings and dividends in the short term to further our objective of maintaining attractive levels of earnings and dividends over the long term. In addition, some of our hedges are intended to provide protection against larger rate moves and as a result may be relatively ineffective for smaller changes in interest rates. There can also be no certainty that our Manager's projections of our exposures to interest rates, prepayments, extension or other risks will be accurate or that our hedging activities will be effective and, therefore, actual results could differ materially. Furthermore, since our hedging strategies are generally not designed to protect our net book value from spread risk, wider spreads between the market yield on our investment securities and benchmark interests underlying our interest rate hedges will typically cause our net book value to decline and can occur independent of changes in benchmark interest rates. For further discussion of our market risks and risk management strategy, please refer to “Quantitative and Qualitative Disclosures about Market Risk” under Item 3 of this Quarterly Report on Form 10-Q.
Trends and Recent Market Impacts
Following the Federal Reserve's (the "Fed") first Federal Funds Rate increase in nearly ten years in December 2015, interest rates across much of the yield curve fell materially during the first quarter of 2016 as concerns regarding global economic weakness dampened the market’s expectations with respect to U.S. economic growth, inflation and the pace of monetary policy normalization. Consistent with this weaker outlook, at its March meeting, the Fed significantly reduced its expectations for short term interest rate increases and explicitly acknowledged the potential downside risk to the U.S. economy associated with the deteriorating global landscape. This weaker global growth also led to significant additional easing measures by the European Central Bank and the Bank of Japan, with the latter instituting negative interest rates for the first time.
Against this backdrop, the 10 year swap rate in the U.S. moved significantly during the first quarter, declining 70 basis points from 2.19% at the beginning of the quarter to a low of 1.49% in early February, ultimately closing the quarter at 1.64%, a 55 basis point decline for the quarter. The 10 year U.S. Treasury rate performed slightly better, closing the quarter down 49 basis points. The aggregate spread differential between the market yield on agency MBS and benchmark interest rates underlying our interest rate hedges widened modestly during the quarter and was the primary driver of the -2.2% decline in our net book value per common share to $22.09 per common share as of March 31, 2016, from $22.59 per common share as of December 31, 2015. Taking into account the $0.60 per common share of dividends declared during the first quarter, our economic return was 0.4% for the quarter, or 1.8% on an annualized basis.
We continue to believe that rates in the U.S. will remain "lower for longer." This more benign interest rate environment, when coupled with increasingly attractive investment opportunities in agency MBS, should be supportive of improved economic returns for our stockholders. Given this view, we chose to increase our "at risk" leverage level again during the first quarter to 7.3x as of March 31, 2016, compared to 6.8x as of December 31, 2015 and a low of 6.1x as of June 30, 2015. We also repurchased 6.5 million shares, or 1.9%, of our common stock during the quarter.
Our weighted average net interest margin declined during the first quarter due to the combination of (i) lower asset yields, due to higher prepayment expectations following the decline in interest rates and the resultant "catch-up" premium amortization expense recognized during the quarter, and (ii) an increase in our average funding costs, largely due to higher repo costs following the Fed's December rate increase and timing differences between the rate reset on our repo positions and the rate reset on the receive-floating rate leg of our pay-fixed interest rate swaps.
The outstanding balance of our hedge portfolio declined to 83% from 87% of our repo, FHLB advances, other debt and net TBA position as of March 31, 2016 and December 31, 2015, respectively. In addition, the composition of our hedges shifted slightly toward a greater portion of U.S. Treasury hedges in our overall hedge mix, as we favored using a greater share of U.S. Treasury-based hedges in the current environment given the heightened risk associated with swap spreads. The significant drop in interest rates during the quarter also led to a reduction in our net duration gap from 0.8 years as of December 31, 2015 to a zero net duration gap as of the end of the first quarter. During periods of low interest rate levels where the risk is skewed towards higher interest rates, we will generally operate with a smaller, or even negative, net duration gap. For the estimated impact of


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