Gladstone Commercial Corporation Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

Mortgage Notes Payable and Credit Facility

Mortgage Notes Payable and Credit Facility

9 Months Ended

Sep. 30, 2018

Mortgage Notes Payable and Credit Facility

Our mortgage notes payable and Credit Facility as of September 30, 2018 and December 31, 2017 are summarized below (dollars in thousands):



	Encumbered properties at		Carrying Value at						Stated Interest Rates at	Scheduled Maturity Dates at
	September 30, 2018		September 30, 2018			December 31, 2017			September 30, 2018	September 30, 2018
Mortgage and other secured loans:
Fixed rate mortgage loans	49		$	380,620		$	383,189		(1)	(2)
Variable rate mortgage loans	18		61,115			69,302			(3)	(2)
Premiums and discounts, net	-		(318		)	(281		)	N/A	N/A
Deferred financing costs, mortgage loans, net	-		(4,271		)	(4,830		)	N/A	N/A
Total mortgage notes payable, net	67		$	437,146		$	447,380		(4)
Variable rate revolving credit facility	32	(6)	$	30,900		$	21,400		LIBOR + 1.75%	10/27/2021
Deferred financing costs, revolving credit facility	-		(566		)	(685		)	N/A	N/A
Total revolver, net	32		$	30,334		$	20,715
Variable rate term loan facility	-	(6)	$	75,000		$	75,000		LIBOR + 1.70%	10/27/2022
Deferred financing costs, term loan facility	-		(396		)	(468		)	N/A	N/A
Total term loan, net	N/A		$	74,604		$	74,532
Total mortgage notes payable and credit facility	99		$	542,084		$	542,627		(5)


(1)	Interest rates on our fixed rate mortgage notes payable vary from 3.55% to 6.63%.


(2)	We have 46 mortgage notes payable with maturity dates ranging from 12/1/2018 through 7/1/2045.


(3)	Interest rates on our variable rate mortgage notes payable vary from one month LIBOR + 2.25% to one month LIBOR + 2.75%. At September 30, 2018, one month LIBOR was approximately 2.26%.


(4)	The weighted average interest rate on the mortgage notes outstanding at September 30, 2018 was approximately 4.66%.


(5)	The weighted average interest rate on all debt outstanding at September 30, 2018 was approximately 4.52%.


(6)	The amount we may draw under our senior unsecured revolving credit facility and term loan facility is based on a percentage of the fair value of a combined pool of 32 unencumbered properties as of September 30, 2018.

N/A - Not Applicable

Mortgage Notes Payable

As of September 30, 2018, we had 46 mortgage notes payable, collateralized by a total of 67 properties with a net book value of $638.9 million. We have limited recourse liabilities that could result from any one or more of the following circumstances: a borrower voluntarily filing for bankruptcy, improper conveyance of a property, fraud or material misrepresentation, misapplication or misappropriation of rents, security deposits, insurance proceeds or condemnation proceeds, or physical waste or damage to the property resulting from a borrower’s gross negligence or willful misconduct. We have full recourse for $10.2 million of the mortgages notes payable, net, or 2.3% of the outstanding balance. We will also indemnify lenders against claims resulting from the presence of hazardous substances or activity involving hazardous substances in violation of environmental laws on a property.

During the nine months ended September 30, 2018, we repaid one mortgage collateralized by one property and partially repaid one mortgage collateralized by two properties, releasing one of the collateralized properties, which are summarized below (dollars in thousands):



Variable Rate Debt Repaid		Interest Rate on Variable Rate Debt Repaid		Fixed Rate Debt Repaid		Interest Rate on Fixed Rate Debt Repaid
$	6,738	LIBOR +	2.25%	$	9,444	5.75	%

During the nine months ended September 30, 2018, we issued two mortgages, collateralized by two properties, which are summarized in the table below (dollars in thousands):



Aggregate Fixed Rate Debt Issued			Weighted Average Interest Rate on Fixed Rate Debt
$	14,125	(1)	4.83%	(2)


(1)	We issued $14.1 million of swapped to fixed rate debt in connection with two properties with maturity dates of March 1, 2023 and November 1, 2028.


(2)	We entered into two interest rate swaps and will be paying an all in fixed rates of 4.58% and 5.32%, respectively.

On April 18, 2018, we extended the maturity dates on two existing variable rate mortgage notes totaling $13.0 million from July 2018 to July 2020.

On July 23, 2018, we extended the maturity date on one variable rate mortgage note totaling $4.0 million from September 2018 to September 2019.

On September 18, 2018, we extended the maturity date on one fixed rate mortgage note totaling $3.6 million from November 2018 to November 2021.

We made payments of $0.1 million and $0.3 million for deferred financing costs during the three and nine months ended September 30, 2018, respectively, and $0.6 million and $1.0 million for deferred financing costs during the three and nine months ended September 30, 2017, respectively.

Scheduled principal payments of mortgage notes payable for the three months ending December 31, 2018, and each of the five succeeding fiscal years and thereafter are as follows (dollars in thousands):



Year	Scheduled Principal Payments
Three Months Ending December 31, 2018	$	10,255
2019	52,262
2020	32,006
2021	36,917
2022	97,444
2023	69,342
Thereafter	143,509
Total	$	441,735	(1)


(1)	This figure does not include $0.3 million of premiums and discounts, net, and $4.3 million of deferred financing costs, which are reflected in mortgage notes payable, net on the condensed consolidated balance sheets.

We believe we will be able to address all mortgage notes payable maturing over the next 12 months through a combination of refinancing our existing indebtedness, cash from operations, proceeds from one or more equity offerings and availability on our Credit Facility.

Interest Rate Cap and Interest Rate Swap Agreements

We have entered into interest rate cap agreements that cap the interest rate on certain of our variable-rate debt and we have assumed or entered into interest rate swap agreements in which we hedged our exposure to variable interest rates by agreeing to pay fixed interest rates to our respective counterparty. We have adopted the fair value measurement provisions for our financial instruments recorded at fair value. The fair value guidance establishes a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. Generally, we will estimate the fair value of our interest rate caps and interest rate swaps, in the absence of observable market data, using estimates of value including estimated remaining life, counterparty credit risk, current market yield and interest rate spreads of similar securities as of the measurement date. At September 30, 2018 and December 31, 2017, our interest rate cap agreements and interest rate swap were valued using Level 2 inputs.

The fair value of the interest rate cap agreements is recorded in other assets on our accompanying condensed consolidated balance sheets. We record changes in the fair value of the interest rate cap agreements quarterly based on the current market valuations at quarter end. If the interest rate cap qualifies for hedge accounting, the change in the estimated fair value is recorded to accumulated other comprehensive income to the extent that it is effective, with any ineffective portion recorded to interest expense in our condensed consolidated statements of operations and comprehensive income. If the interest rate cap does not qualify for hedge accounting, or if it is determined the hedge is ineffective, any change in the fair value is recognized in interest expense in our consolidated statements of operations and comprehensive income. The following table summarizes the interest rate caps at September 30, 2018 and December 31, 2017 (dollars in thousands):



			September 30, 2018				December 31, 2017
Aggregate Cost			Aggregate Notional Amount		Aggregate Fair Value		Aggregate Notional Amount		Aggregate Fair Value
$	1,111	(1)	$	135,185	$	1,245	$	143,512	$	504


(1)	We have entered into various interest rate cap agreements on variable rate debt with LIBOR caps ranging from 2.25% to 3.25%.

We have assumed or entered into interest rate swap agreement in connection with certain of our acquisitions, whereby we will pay our counterparty a fixed rate interest rate on a monthly basis, and receive payments from our counterparty equivalent to the stipulated floating rate. The fair value of our interest rate swap agreements are recorded in other assets on our accompanying condensed consolidated balance sheets. We have designated our interest rate swaps as cash flow hedges, and we record changes in the fair value of the interest rate swap agreement to accumulated other comprehensive income on the condensed consolidated balance sheets. We record changes in fair value on a quarterly basis, using current market valuations at quarter end. The following table summarizes our interest rate swaps at September 30, 2018 and December 31, 2017 (dollars in thousands):



September 30, 2018				December 31, 2017
Aggregate Notional Amount		Aggregate Fair Value		Aggregate Notional Amount		Aggregate Fair Value
$	24,867	$	768	$	11,036	$	316

The following tables present the impact of our derivative instruments in the condensed consolidated financial statements (dollars in thousands):



	Amount of Gain (Loss), net recognized in Comprehensive Income
	Three Months Ended September 30,					Nine Months Ended September 30,
	2018		2017			2018		2017
Derivatives in cash flow hedging relationships
Interest rate caps	$	107	$	—		$	576	$	—
Interest rate swaps	138		(7		)	452		172

Total	$	245	$	(7	)	$	1,028	$	172

The following table sets forth certain information regarding our derivative instruments (dollars in thousands):



		Asset Derivatives Fair Value at
Derivatives Designated as Hedging Instruments	Balance Sheet Location	September 30, 2018		December 31, 2017
Interest rate caps	Other assets	$	1,036	$	450
Interest rate swaps	Other assets	768		316

Derivatives Not Designated as Hedging Instruments
Interest rate caps	Other assets	$	209	$	54

Total derivatives		$	2,013	$	820

The fair value of all mortgage notes payable outstanding as of September 30, 2018 was $435.9 million, as compared to the carrying value stated above of $441.7 million. The fair value is calculated based on a discounted cash flow analysis, using management’s estimate of market interest rates on long-term debt with comparable terms and loan to value ratios. The fair value was calculated using Level 3 inputs of the hierarchy established by ASC 820, “Fair Value Measurements and Disclosures.”

Credit Facility

On August 7, 2013, we procured our senior unsecured revolving credit facility (“Revolver”) with KeyBank National Association (“KeyBank”) (serving as revolving lender, a letter of credit issuer and an administrative agent). In October 2015, we expanded our Revolver to $85.0 million and entered into a term loan facility (“Term Loan”) whereby we added a $25.0 million, five-year Term Loan subject to the same leverage tiers as the Revolver, with the interest rate at each leverage tier being five basis points lower than that of the Revolver. We have the option to repay the Term Loan in full, or in part, at any time without penalty or premium prior to the maturity date. We refer to the Revolver and Term Loan collectively herein as the Credit Facility. On October 27, 2017, we amended this Credit Facility, increasing the Term Loan from $25.0 million, to $75.0 million, with the Revolver commitment remaining at $85.0 million. The Term Loan has a new five-year term, with a maturity date of October 27, 2022, and the Revolver has a new four-year term, with a maturity date of October 27, 2021. The interest rate for the Credit Facility was reduced by 25 basis points at each of the leverage tiers. We entered into multiple interest rate cap agreements on the amended Term Loan, which cap LIBOR at 2.75% in order to hedge our exposure to variable interest rates. We used the net proceeds of the amended Credit Facility to repay all previously existing borrowings under the Revolver. We incurred fees of approximately $0.9 million in connection with the Credit Facility amendment. The bank syndicate is now comprised of KeyBank, Fifth Third Bank, US Bank National Association and The Huntington National Bank.

As of September 30, 2018, there was $105.9 million outstanding under our Credit Facility at a weighted average interest rate of approximately 3.97% and $1.2 million outstanding under letters of credit at a weighted average interest rate of 1.75%. As of September 30, 2018, the maximum additional amount we could draw under the Revolver was $49.3 million. We were in compliance with all covenants under the Credit Facility as of September 30, 2018.

The amount outstanding under the Credit Facility approximates fair value as of September 30, 2018.