Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is designed to provide a reader of our consolidated financial statements with a narrative from the perspective of management, and should be read in conjunction with the consolidated financial statements and accompanying notes included in this Annual Report on Form 10-K. Our MD&A is presented in eight sections:
Summary of Critical Accounting Estimates
Liquidity and Capital Resources
Off-Balance Sheet Arrangements
Aggregate Contractual Obligations
Our principal objective is to provide our stockholders with attractive risk-adjusted returns through a combination of monthly dividends and tangible net book value accretion. We generate income from the interest earned on our investments, net of associated borrowing and hedging costs, and net realized gains and losses on our investment and hedging activities. We fund our investments primarily through borrowings structured as repurchase agreements.
The size and composition of our investment portfolio depends on the investment strategies we implement, availability of attractively priced investments, suitable financing to appropriately leverage our investment portfolio and overall market conditions. Market conditions are influenced by interest rates, prepayment expectations, liquidity, housing prices, unemployment rates, general economic conditions, government participation in the mortgage market, regulations, relative returns on other assets and other factors.
Trends and Recent Market Impacts
Economic conditions in the U.S. and abroad continued to improve throughout 2017 and long-term interest rates remained remarkably stable. Investors generally favored higher risk assets, as evidenced by the strong performance of equities and tighter credit spreads throughout much of the fixed income market. Agency RMBS spreads, on the other hand, widened modestly during the first three quarters of the year versus benchmark interest rates in anticipation of the Fed's reduction of its Agency RMBS holdings. In September 2017, the Fed announced the details of its plan to gradually reduce the reinvestment of proceeds from its RMBS holdings beginning in October 2017. Following the announcement, the price of our Agency RMBS appreciated relative to our hedge instruments, as Agency spreads narrowed somewhat in the fourth quarter. The overall strong performance of Agency RMBS, as well as CRT securities, over the course of the year was a key driver of the increase in our tangible net book value to $19.69 per common share as of December 31, 2017, from $19.50 per common share as of December 31, 2016. The $0.19 per common share improvement in our tangible net book value and the $2.16 per common share of dividends paid for the year resulted in an economic return on our tangible common equity of 12.1% for 2017.
Throughout 2017, the Fed continued to gradually increase short-term interest rates, raising the federal funds rate three times for a total increase of 75 basis points. Over the same period, the yield on the 10-year U.S. Treasury note declined 2 basis points. As a result, the yield differential between short and long-term U.S. Treasury rates narrowed, or flattened, significantly. Despite this flattening, our average net interest margin (including our TBA dollar roll funded assets and interest rate swap hedges and excluding "catch-up" premium amortization cost due to changes in CPR forecasts) increased to 1.45% for 2017, compared to 1.41% for 2016. Our net interest margin benefited from a relative increase in our holdings of higher yielding 30-year fixed rate Agency RMBS, versus 15-year holdings, and favorable funding conditions for both our repo and TBA dollar roll funded assets. Additionally, we increased the portion of our funding raised through our captive broker-dealer subsidiary, BES, which was generally at more favorable terms than traditional bilateral repo. As of December 31, 2017, 33% of our Agency repo funding was sourced through BES, up from 12% as of the year prior. These conditions provided a favorable investment landscape against which we increased our "at risk" leverage ratio during 2017 to 8.1x our tangible equity as of December 31, 2017, from 7.7x as of December 31, 2016.
During 2017, we generally believed interest rates were biased higher given improving underlying economic fundamentals and a reduction of quantitative easing measures by central banks. As such, we reduced our exposure to higher rates and maintained a relatively large interest rate hedge position. As of December 31, 2017, the notional balance of our interest rate hedges totaled 97% of our Agency repo and TBA position, up from 90% as of December 31, 2016, providing significant protection to our net