Gladstone Commercial Corporation Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Mortgage Notes Payable, Revolving Credit Facility, and Term Loan Facility

Aggregate Fixed Rate Debt Issued or Assumed

Weighted Average Interest Rate on Fixed Rate Debt

Mortgage Notes Payable, Revolving Credit Facility, and Term Loan Facility

12 Months Ended

Dec. 31, 2018

Mortgage Notes Payable, Revolving Credit Facility, and Term Loan Facility

Our revolving credit facility and term loan facility are collectively referred to herein as the Credit Facility.

Our mortgage notes payable and Credit Facility as of December 31, 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
	December 31, 2018		December 31, 2018			December 31, 2017			December 31, 2018	December 31, 2018
Mortgage and other secured loans:
Fixed rate mortgage loans	50		$	385,051		$	383,189		(1)	(2)
Variable rate mortgage loans	18		60,659			69,302			(3)	(2)
Premiums and discounts, net	-		(301		)	(281		)	N/A	N/A
Deferred financing costs, mortgage loans, net	-		(4,063		)	(4,830		)	N/A	N/A
Total mortgage notes payable, net	68		$	441,346		$	447,380		(4)
Variable rate revolving credit facility	32	(6)	$	50,600		$	21,400		LIBOR + 1.75%	10/27/2021
Deferred financing costs, revolving credit facility	-		(516		)	(685		)	N/A	N/A
Total revolver, net	32		$	50,084		$	20,715
Variable rate term loan facility	-		$	75,000		$	75,000		LIBOR + 1.70%	10/27/2022
Deferred financing costs, term loan facility	-		(371		)	(468		)	N/A	N/A
Total term loan, net	N/A		$	74,629		$	74,532
Total mortgage notes payable and credit facility	100		$	566,059		$	542,627		(5)


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


(2)	We have 47 mortgage notes payable with maturity dates ranging from 4/22/2019 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 December 31, 2018, one month LIBOR was approximately 2.52%.


(4)	The weighted average interest rate on the mortgage notes outstanding at December 31, 2018, was approximately 4.69%.


(5)	The weighted average interest rate on all debt outstanding at December 31, 2018, was approximately 4.59%.


(6)	The amount we may draw under our Credit Facility is based on a percentage of the fair value of a combined pool of 32 unencumbered properties as of December 31, 2018.

N/A - Not Applicable

Mortgage Notes Payable

As of December 31, 2018, we had 47 mortgage notes payable, collateralized by a total of 68 properties with a net book value of $643.3 million. Gladstone Commercial Corporation has 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 mortgage 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 year ended December 31, 2018, we repaid two mortgages collateralized by two properties, which are summarized below (dollars in thousands):



Fixed Rate Debt Repaid		Interest Rate on Fixed Rate Debt Repaid
$	9,444	5.75	%



Variable Rate Debt Repaid		Interest Rate on Variable Rate Debt Repaid
$	6,738	LIBOR +	2.25%

During the year ended December 31, 2018, we issued or assumed three mortgages, collateralized by three properties, which are summarized below (dollars in thousands):


(1)	We issued or assumed $21.0 million of fixed rate, or swapped to fixed rate, debt in connection with two of our five property acquisitions in 2018 and one of our property acquisitions in 2017, with maturity dates ranging from March 1, 2023 to August 1, 2037.


(2)	We entered into interest rate swaps in connection with two of the new mortgages and will be paying an all-in fixed rate of 4.58% and 5.32%, respectively. In addition, we assumed a fixed rate mortgage with an interest rate of 4.63%.

During the year ended December 31, 2018, we extended the maturity dates of four mortgages, collateralized by nine properties, which are summarized below (dollars in thousands):



Aggregate Fixed Rate Debt Extended		Weighted Average Interest Rate on Fixed Rate Debt Extended		Weighted Average Extension Term
$	3,598	4.92	%	3.0 years



Aggregate Variable Rate Debt Extended		Weighted Average Interest Rate on Variable Rate Debt Extended		Weighted Average Extension Term
$	24,832	LIBOR +	2.29%	1.5 years

Scheduled principal payments of mortgage notes payable for each of the five succeeding fiscal years and thereafter are as follows (dollars in thousands):



Year	Scheduled Principal Payments
2019	$	59,821
2020	32,256
2021	37,188
2022	97,718
2023	69,629
Thereafter	149,098
	$	445,710	(1)


(1)	This figure is does not include $(0.3) million premiums and (discounts), net, and $4.1 million of deferred financing costs, which are reflected in mortgage notes payable on the consolidated balance sheet.

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 Caps and Swaps

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 December 31, 2018 and 2017, our interest rate cap and interest rate swap agreements were valued using Level 2 inputs.

The fair value of the interest rate cap agreements is recorded in other assets on our accompanying 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 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 December 31, 2018 and 2017 (dollars in thousands):



			December 31, 2018				December 31, 2017
Aggregate Cost			Aggregate Notional Amount		Aggregate Fair Value		Aggregate Notional Amount		Aggregate Fair Value
$	1,105	(1)	$	134,678	$	622	$	143,512	$	504


(1)	We have entered into various interest rate cap agreements on new variable rate debt with LIBOR caps ranging from 2.50% to 3.25%.

We have assumed or entered into interest rate swap agreements in connection with certain of our acquisitions, whereby we will pay our counterparty a fixed 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 consolidated balance sheets. We have designated our interest rate swaps as cash flow hedges, and we record changes in the fair value of the respective interest rate swap agreement to accumulated other comprehensive income on the 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 December 31, 2018 and 2017 (dollars in thousands):



December 31, 2018							December 31, 2017
Aggregate Notional Amount		Aggregate Fair Value Asset		Aggregate Fair Value Liability			Aggregate Notional Amount		Aggregate Fair Value Asset
$	24,732	$	451	$	(396	)	$	11,036	$	316

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



	Amount of Gain (Loss), net recognized in Comprehensive Income
	2018			2017			2016
Derivatives in cash flow hedging relationships
Interest rate caps	$	77		$	(239	)	$	—
Interest rate swaps	(260		)	274			—
Total	$	(183	)	$	35		$	—

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	December 31, 2018			December 31, 2017
Interest rate caps	Other assets	$	552		$	450
Interest rate swaps	Other assets	451			316
Interest rate swaps	Other liabilities	(396		)	—

Derivatives Not Designated as Hedging Instruments
Interest rate caps	Other assets	$	70		54

Total derivatives		$	677		$	820

The fair value of all mortgage notes payable outstanding as of December 31, 2018 was $444.2 million, as compared to the carrying value stated above of $441.3 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. 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 five-year term, with a maturity date of October 27, 2022, and the Revolver has a 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% 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 December 31, 2018, there was $125.6 million outstanding under our Credit Facility at a weighted average interest rate of approximately 4.24% and $2.1 million outstanding under letters of credit at a weighted average interest rate of 1.75%. As of December 31, 2018, the maximum additional amount we could draw under the Credit Facility was $32.4 million. We were in compliance with all covenants under the Credit Facility as of December 31, 2018.

The amount outstanding under the Credit Facility approximates fair value as of December 31, 2018.