Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Investment Portfolio Net Interest Income
Generally, our business model is such that rising interest rates will increase our net income, while declining interest rates will decrease net income. As of December 31, 2020, 98% of our investments by total investment exposure earned a floating rate of interest and were financed with liabilities that pay interest at floating rates, which resulted in an amount of net equity that is positively correlated to rising interest rates, subject to the impact of interest rate floors on certain of our floating rate loans. As of December 31, 2020, the remaining 2% of our investments by total investment exposure earned a fixed rate of interest, but are financed with liabilities that pay interest at floating rates, which resulted in a negative correlation to rising interest rates to the extent of our financing. In certain instances where we have financed fixed rate assets with floating rate liabilities, we have purchased interest rate caps to limit our exposure to increases in interest rates on such liabilities.
LIBOR and certain other floating rate benchmark indices to which our floating rate loans and other loan agreements are tied, including, without limitation, the Euro Interbank Offered Rate, the Canadian Dollar Offered Rate and the Australian Bank Bill Swap Reference Rate, or collectively, IBORs, are the subject of recent national, international and regulatory guidance and proposals for reform. On November 30, 2020, the Financial Conduct Authority of the U.K., or FCA, which has statutory powers to require panel banks to contribute to LIBOR where necessary, announced that subject to confirmation following its consultation with the administrator of LIBOR, it would cease publication of the one-week and two-month USD LIBOR immediately after December 31, 2021 and cease publication of the remaining tenors immediately after June 30, 2023. Additionally, the Federal Reserve Board has advised banks to stop entering into new USD LIBOR based contracts. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, has identified the Secured Overnight Financing Rate, or SOFR, a new index calculated by short-term repurchase agreements, backed by Treasury securities, as its preferred alternative rate for LIBOR. At this time, it is not possible to predict how markets will respond to SOFR or other alternative reference rates as the transition away from the IBOR benchmarks is anticipated in coming years. Refer to “Part I. Item 1A. Risk Factors—Risks Related to Our Lending and Investment Activities—The expected discontinuation of currently used financial reference rates and use of alternative replacement reference rates may adversely affect net interest income related to our loans and investments or otherwise adversely affect our results of operations, cash flows and the market value of our investments.” of this Annual Report on Form 10-K.
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The following table projects the impact on our interest income and expense, net of incentive fees, for the twelve-month period following December 31, 2020, assuming an immediate increase or decrease of both 25 and 50 basis points in the applicable interest rate benchmark by currency ($ in thousands):
Assets (Liabilities)
Sensitive to Changes
in Interest Rates (1)(2)(3)
Interest Rate Sensitivity as of December 31, 2020
Increase in Rates
Decrease in Rates (4)
Currency
25 Basis Points
50 Basis Points
25 Basis Points
50 Basis Points
USD
$
12,516,341
Income
$
7,871
$
16,569
$
(4,272
)
$
(4,272
)
(9,087,879
)
Expense
(15,261
)
(30,869
)
8,783
8,783
$
3,428,462
Net interest
$
(7,390
)
$
(14,300
)
$
4,511
$
4,511
EUR (5)
$
3,420,351
Income
$
—
$
—
$
—
$
—
(2,498,055
)
Expense
—
—
—
—
$
922,296
Net interest
$
—
$
—
$
—
$
—
GBP
$
1,578,932
Income
$
1,439
$
3,333
$
(142
)
$
(142
)
(1,124,222
)
Expense
(2,248
)
(4,497
)
229
229
$
454,710
Net interest
$
(809
)
$
(1,164
)
$
87
$
87
AUD
$
259,788
Income
$
—
$
—
$
—
$
—
(188,420
)
Expense
(377
)
(754
)
90
90
$
71,368
Net interest
$
(377
)
$
(754
)
$
90
$
90
CAD
$
45,649
Income
$
3
$
6
$
(3
)
$
(6
)
(62,760
)
Expense
(126
)
(251
)
126
231
$
(17,111
)
Net interest
$
(123
)
$
(245
)
$
123
$
225
Total net interest
$
(8,699
)
$
(16,463
)
$
4,811
$
4,913
(1)
Our floating rate loans and related liabilities are indexed to the various benchmark rates relevant in each case in terms of currency and payment frequency. Therefore the net exposure to each benchmark rate is in direct proportion to our net assets indexed to that rate. Increases (decreases) in interest income and expense are presented net of incentive fees. In addition, $14.2 billion of our loans earned interest based on floors that are above the applicable index as of December 31, 2020. Refer to Note 12 to our consolidated financial statements for additional details of our incentive fee calculation.
(2)
Includes investment exposure to the 2018 Single Asset Securitization. Refer to Notes 4 and 16 to our consolidated financial statements for details of the subordinate position we own in the 2018 Single Asset Securitization.
(3)
Includes amounts outstanding under secured debt agreements, securitizations, asset-specific financings, and secured term loans.
(4)
Decrease in rates assumes the applicable benchmark rate for each currency does not decrease below 0%.
(5)
Assets balance includes a loan denominated in British Pound Sterling, with an outstanding principal balance of £146.2 million as of December 31, 2020, that is hedged to Euro exposure through a foreign currency forward contract. Refer to Note 10 to our consolidated financial statements for additional discussion of our foreign currency derivatives.
Investment Portfolio Value
As of December 31, 2020, 2% of our investments by total investment exposure earned a fixed rate of interest and as such, the values of such investments are sensitive to changes in interest rates. We generally hold all of our investments to maturity and so do not expect to realize gains or losses on our fixed rate investment portfolio as a result of movements in market interest rates.
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Risk of Non-Performance
In addition to the risks related to fluctuations in cash flows and asset values associated with movements in interest rates, there is also the risk of non-performance
on floating rate assets. In the case of a significant increase in interest rates, the additional debt service payments due from our borrowers may strain the operating cash flows of the collateral real estate assets and, potentially, contribute to non-performance
or, in severe cases, default. This risk is partially mitigated by various facts we consider during our underwriting process, which in certain cases include a requirement for our borrower to purchase an interest rate cap contract.
Credit Risks
Our loans and investments are also subject to credit risk. The performance and value of our loans and investments depend upon the sponsors’ ability to operate the properties that serve as our collateral so that they produce cash flows adequate to pay interest and principal due to us. To monitor this risk, our Manager’s asset management team reviews our investment portfolios and in certain instances is in regular contact with our borrowers, monitoring performance of the collateral and enforcing our rights as necessary.
In addition, we are exposed to the risks generally associated with the commercial real estate market, including variances in occupancy rates, capitalization rates, absorption rates, and other macroeconomic factors beyond our control. We seek to manage these risks through our underwriting and asset management processes.
The COVID-19
pandemic has significantly impacted the commercial real estate markets, causing reduced occupancy, requests from tenants for rent deferral or abatement, and delays in construction and development projects currently planned or underway. These negative conditions have persisted, and in the future may continue to persist and impair our borrowers’ ability to pay principal and interest due to us under our loan agreements. We maintain a robust asset management relationship with our borrowers and have utilized these relationships to address the potential impacts of the COVID-19
pandemic on our loans secured by properties experiencing cash flow pressure, most significantly hospitality assets. Some of our borrowers have indicated that due to the impact of the COVID-19
pandemic, they will be unable to timely execute their business plans, have had to temporarily close their businesses, or have experienced other negative business consequences and have requested temporary interest deferral or forbearance, or other modifications of their loans. During the three months ended December 31, 2020, we closed 18 loan modifications, representing an aggregate principal balance of $2.5 billion, as of December 31, 2020.
During the year ended December 31, 2020, we closed 49 loan modifications, representing an aggregate principal balance of $6.5 billion, as of December 31, 2020. The loan modifications primarily included term extensions, interest rate changes, repurposing of reserves, and performance test or covenant waivers, many of which were coupled with additional equity commitments from sponsors, with virtually no interest deferrals.
We are generally encouraged by our borrowers’ initial response to the COVID-19
pandemic’s impacts on their properties. With limited exceptions, we believe our loan sponsors are committed to supporting assets collateralizing our loans through additional equity investments, and that we will benefit from our long-standing core business model of originating senior loans collateralized by large assets in major markets with experienced, well-capitalized institutional sponsors. Our investment portfolio’s low origination weighted-average LTV of 64.0% as of December 31, 2020, reflects significant equity value that our sponsors are motivated to protect through periods of cyclical disruption. While we believe the principal amounts of our loans are generally adequately protected by underlying collateral value, there is a risk that we will not realize the entire principal value of certain investments.
Our Manager’s portfolio monitoring and asset management operations benefit from the deep knowledge, experience, and information advantages derived from its position as part of Blackstone’s real estate platform. Blackstone Real Estate is one of the largest owners and operators of real estate in the world, with a proven track record of successfully navigating market cycles and emerging stronger through periods of volatility. The market-leading real estate expertise derived from the strength of the Blackstone platform deeply informs our credit and underwriting process, and we believe gives us the tools to expertly manage our asset portfolio and work with our borrowers throughout periods of economic stress and uncertainty.
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Capital Market Risks
We are exposed to risks related to the equity capital markets, and our related ability to raise capital through the issuance of our class A common stock or other equity instruments. We are also exposed to risks related to the debt capital markets, and our related ability to finance our business through borrowings under credit facilities or other debt instruments. As a REIT, we are required to distribute a significant portion of our taxable income annually, which constrains our ability to accumulate operating cash flow and therefore requires us to utilize debt or equity capital to finance our business. We seek to mitigate these risks by monitoring the debt and equity capital markets to inform our decisions on the amount, timing, and terms of capital we raise.
Margin call provisions under our credit facilities do not permit valuation adjustments based on capital markets events, and are limited to collateral-specific credit marks generally determined on a commercially reasonable basis. During the three months ended June 30, 2020, we entered into agreements with our seven largest secured credit facility lenders, representing an aggregate $7.9 billion of our secured credit facilities as of June 30, 2020, to temporarily suspend credit mark provisions and pre-approve
certain loan modifications to certain of their portfolio assets, primarily in exchange for cash repayments and pledging additional loan collateral. During the three months ended December 31, 2020, we extended the credit facility modification agreements with the seven lenders without any further deleveraging or increased cost.
Counterparty Risk
The nature of our business requires us to hold our cash and cash equivalents and obtain financing from various financial institutions. This exposes us to the risk that these financial institutions may not fulfill their obligations to us under these various contractual arrangements. We mitigate this exposure by depositing our cash and cash equivalents and entering into financing agreements with high credit-quality institutions.
The nature of our loans and investments also exposes us to the risk that our counterparties do not make required interest and principal payments on scheduled due dates. We seek to manage this risk through a comprehensive credit analysis prior to making an investment and active monitoring of the asset portfolios that serve as our collateral.
Currency Risk
Our loans and investments that are denominated in a foreign currency are also subject to risks related to fluctuations in currency rates. We generally mitigate this exposure by matching the currency of our foreign currency assets to the currency of the borrowings that finance those assets. As a result, we substantially reduce our exposure to changes in portfolio value related to changes in foreign currency rates.
The following tables outline our assets and liabilities that are denominated in a foreign currency (€/£/C$/A$ in thousands):
December 31, 2020
Foreign currency assets (1)(2)
€
2,817,831
£
1,400,798
C$
107,888
A$
343,141
Foreign currency liabilities (1)
(2,044,299
)
(1,023,437
)
(79,944
)
(245,522
)
Foreign currency contracts – notional
(763,132
)
(372,487
)
(26,200
)
(92,800
)
Net exposure to exchange rate fluctuations
€
10,400
£
4,874
C$
1,744
A$
4,819
(1)
Balances include non-consolidated
senior interests of £198.8 million.
(2)
Euro balance includes a loan denominated in British Pound Sterling, with an outstanding principal balance of £146.2 million as of December 31, 2020, that is hedged to Euro exposure through a foreign currency forward contract. Refer to Note 10 to our consolidated financial statements for additional discussion of our foreign currency derivatives.
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December 31, 2019
Foreign currency assets (1)
€
2,736,673
£
1,639,881
C$
105,273
A$
518,315
Foreign currency liabilities (1)
(2,122,767
)
(1,017,239
)
(77,550
)
(379,968
)
Foreign currency contracts – notional
(525,600
)
(527,100
)
(23,200
)
(135,600
)
Net exposure to exchange rate fluctuations
€
88,306
£
95,542
C$
4,523
A$
2,747
(1)
Balances include non-consolidated
senior interests of £302.0 million.
Substantially all of our net asset exposure to the Euro, the British Pound Sterling, the Australian Dollar, and the Canadian Dollar has been hedged with foreign currency forward contracts as of December 31, 2020.