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

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

12 Months Ended

Dec. 31, 2017

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, 2017 and December 31, 2016 are summarized below (dollars in thousands):



	Encumbered properties at		Carrying Value at						Stated Interest Rates at	Scheduled Maturity Dates at
	December 31, 2017		December 31, 2017			December 31, 2016			December 31, 2017	December 31, 2017
Mortgage and other secured loans:
Fixed rate mortgage loans	48		$	383,189		$	378,477		(1)	(2)
Variable rate mortgage loans	19		69,302			71,707			(3)	(2)
Premiums and discounts, net	-		(281		)	217			N/A	N/A
Deferred financing costs, mortgage loans, net	-		(4,830		)	(5,123		)	N/A	N/A
Total mortgage notes payable, net	67		$	447,380		$	445,278		(4)
Variable rate revolving credit facility	29	(6)	$	21,400		$	39,700		LIBOR + 1.75%	10/27/2021
Deferred financing costs, revolving credit facility	-		(685		)	(475		)	N/A	N/A
Total revolver, net	29		$	20,715		$	39,225
Variable rate term loan facility	-		$	75,000		$	25,000		LIBOR + 1.70%	10/27/2022
Deferred financing costs, term loan facility	-		(468		)	(108		)	N/A	N/A
Total term loan, net	N/A		$	74,532		$	24,892
Total mortgage notes payable and credit facility	96		$	542,627		$	509,395		(5)


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


(2)	We have 45 mortgage notes payable with maturity dates ranging from 7/1/2018 through 7/1/2045.


(3)	Interest rates on our variable rate mortgage notes payable vary from one month LIBOR + 2.15% to one month LIBOR +2.75%. At December 31, 2017, one month LIBOR was approximately 1.56%.


(4)	The weighted average interest rate on the mortgage notes outstanding at December 31, 2017, was approximately 4.56%.


(5)	The weighted average interest rate on all debt outstanding at December 31, 2017, was approximately 4.42%.


(6)	The amount we may draw under our Credit Facility is based on a percentage of the fair value of a combined pool of 29 unencumbered properties as of December 31, 2017.

N/A - Not Applicable

Mortgage Notes Payable

As of December 31, 2017, we had 45 mortgage notes payable, collateralized by a total of 67 properties with a net book value of $654.9 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. Gladstone Commercial Corporation has full recourse for $11.7 million of the mortgage notes payable, net or 2.6% 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, 2017, we repaid four mortgages collateralized by 10 properties, which are summarized below (dollars in thousands):



Aggregate Fixed Rate Debt Repaid		Weighted Average Interest Rate on Fixed Rate Debt Repaid
$	41,077	6.25	%



Aggregate Variable Rate Debt Repaid		Weighted Average Interest Rate on Variable Rate Debt Repaid
$	8,163	LIBOR +	2.50%

During the year ended December 31, 2017, we issued or assumed four mortgages, collateralized by seven properties, and drew an additional advance on an existing mortgage note, collateralized by one property, which are summarized below (dollars in thousands):



Aggregate Fixed Rate Debt Issued or Assumed			Weighted Average Interest Rate on Fixed Rate Debt			Aggregate Variable Rate Debt Issued or Assumed
$	54,887	(1)	3.78	%	(2)	$	7,500	(3)


(1)	We issued or assumed $54.9 million of fixed rate, or swapped to fixed rate, debt in connection with five of our seven property acquisitions in 2017, with maturity dates ranging from April 1, 2026 to August 10, 2027.


(2)	We assumed an interest rate swap in connection with one property acquisition and will be paying an all-in fixed rate of 3.55%. The newly issued fixed rate mortgages have rates ranging from 3.75% to 3.89%.

(3)

The interest rate for our newly issued variable rate mortgage debt is equal to one month LIBOR plus a spread of 2.75%. The maturity date on this new variable rate debt is May 15, 2020. We have entered into a rate cap agreement on our new variable rate debt and will record all fair value changes into interest expense on the consolidated statement of operations and comprehensive income. The interest rate for our additional advance on the existing mortgage note is equal to one month LIBOR plus a spread of 2.50% and the maturity date is December 1, 2021.

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
2018	$	55,267
2019	47,447
2020	19,357
2021	33,337
2022	97,156
Thereafter	199,927
	$	452,491	(1)


(1)	This figure is does not include $(0.3) million premiums and (discounts), net, and $4.8 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 refinancings, cash from operations, equity proceeds and availability on our Credit Agreement.

Interest Rate Caps

We have entered into interest rate cap agreements that cap the interest rate on certain of our variable-rate debt and we have assumed an interest rate swap agreement in which we hedged our exposure to variable interest rates by agreeing to pay fixed interest rates to our 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 swap, 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, 2017 and 2016, our interest rate cap 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, 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 for the year ended December 31, 2017 and 2016 (dollars in thousands):



			December 31, 2017				December 31, 2016
Aggregate Cost			Aggregate Notional Amount		Aggregate Fair Value		Aggregate Notional Amount		Aggregate Fair Value
$	1,171	(1)	$	143,512	$	504	$	71,721	$	101


(1)	We have entered into various interest rate cap agreements on new variable rate debt with LIBOR caps ranging from 2.50% to 3.00%.

We assumed an interest rate swap agreement in connection with our June 22, 2017 acquisition of a property in Conshohocken, Pennsylvania, whereby we will pay our counterparty an interest rate equivalent to 1.80% on a monthly basis, and receive payments from our counterparty equivalent to one month LIBOR. The fair value of our interest rate swap agreement is recorded in other assets on our accompanying consolidated balance sheets. We have designated our interest rate swap as a cash flow hedge, and we record changes in the fair value of the 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. We assumed our interest rate swap with a value of $0.04 million on the date of assumption, and the fair market value increased to $0.3 million at December 31, 2017. The swap has a notional value equal to the debt we assumed of $11.2 million, and has a termination date of April 1, 2026, which is also the maturity date of the assumed debt.

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



	Amount of Gain (Loss) recognized in Comprehensive Income
	2017			2016		2015
Derivatives in cash flow hedging relationships
Interest rate caps	$	(239	)	$	—	$	—
Interest rate swap	274

Total	$	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, 2017		December 31, 2016
Interest rate caps	Other assets	$	450	$	—

Derivatives Not Designated as Hedging Instruments
Interest rate caps	Other assets	$	54	101

Total derivatives		$	504	$	101

The fair value of all mortgage notes payable outstanding as of December 31, 2017 was $455.1 million, as compared to the carrying value stated above of $447.4 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 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, 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. 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 our existing Credit Facility. The Term Loan component of the Credit Facility was increased 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 interest rate cap agreements on the amended Term Loan, which cap LIBOR at 2.75%. 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, 2017, there was $96.4 million outstanding under our Credit Facility at a weighted average interest rate of approximately 3.28% and $1.0 million outstanding under letters of credit at a weighted average interest rate of 1.75%. As of February 14, 2018, the maximum additional amount we could draw under the Credit Facility was $43.2 million. We were in compliance with all covenants under the Credit Facility as of December 31, 2017.

The amount outstanding under the Credit Facility approximates fair value as of December 31, 2017.