Terra Property Trust, Inc. 10-Q

Item 3. Quantitative and Qualitative Disclosures About Market Risk. We may be subject to financial market risks, including changes in interest rates. To the extent that we borrow money to make investments, our net investment income will be dependent upon the difference between the rate at which we borrow funds and the rate at which we invest these funds. In periods of rising interest rates, our cost of funds would increase, which may reduce our net investment income. As a result, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income. The following table summarizes the aggregate principal balance of variable rate investments and indebtedness as of: June 30, 2026 Variable rate investments $ 74,719,501 Variable rate debt $ 30,750,000 The following table summarizes estimated changes in net investment income on our variable rate investments and indebtedness as of June 30, 2026 assuming hypothetical increases or decreases in Term SOFR or SOFR: 1.00% Decrease 1.00% Increase Increase (decrease) in investment income from variable rate investments $ (554,183) $ 622,117 Decrease (increase) in interest expense from variable rate debt (1) — (58,095) Net increase (decrease) in investment income from variable rate instruments $ (554,183) $ 564,022 _______________ (1) A 1.00% decrease in Term SOFR or SOFR had no impact on interest expense because the interest rate on the debt is subject to a floor. 54 We may hedge against interest rate fluctuations by using standard hedging instruments, such as futures, options and forward contracts. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in benefits of lower interest rates with respect to our portfolio of investments with fixed interest rates. For the three and six months ended June 30, 2026 and 2025, we did not engage in interest rate hedging activities that qualify for hedge accounting. Prepayment Risks Prepayments can either positively or adversely affect the yields on our loans. Prepayments on debt instruments, where permitted under the debt documents, are influenced by changes in current interest rates and a variety of economic, geographic and other factors beyond our control, and consequently, such prepayment rates cannot be predicted with certainty. If we do not collect a prepayment fee in connection with a prepayment or are unable to invest the proceeds of such prepayments received, the yield on the portfolio will decline. In addition, we may acquire assets at a discount or premium and if the asset does not repay when expected, the anticipated yield may be impacted. Under certain interest rate and prepayment scenarios we may fail to recoup fully our cost of acquisition of certain loans. Extension Risk Extension risk is the risk that our assets will be repaid at a slower rate than anticipated and generally increases when interest rates rise. In which case, to the extent we have financed the acquisition of an asset, we may have to finance our asset at potentially higher costs without the ability to reinvest principal into higher yielding securities because borrowers prepay their mortgages at a slower pace than originally expected, adversely impacting our net interest spread, and thus our net interest income. Real Estate Risk The market values of commercial and residential mortgage assets are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions; changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; retroactive changes to building or similar codes; pandemics; natural disasters; and other Acts of God. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay the underlying loans, which could also cause us to suffer losses. Credit Risk We are subject to varying degrees of credit risk in connection with holding a portfolio of our target assets. With respect to our loan portfolio, we seek to manage credit risk by limiting exposure to any one individual borrower and any one asset class. Additionally, our Manager employs an asset management approach and monitors the portfolio of investments through, at a minimum, quarterly financial review of property performance including net operating income, loan-to-value, debt service coverage ratio and the debt yield. Our Manager also requires certain borrowers to establish a cash reserve, as a form of additional collateral, for the purpose of providing for future interest or property-related operating payments.