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Appeal of Shared National Credit (SNC)-(Fourth Quarter 2016)

Background

A participant bank appealed the substandard rating assigned to a credit facility during the August 2016 SNC examination.

Discussion

The appeal asserted that the facility should be rated pass because the company is paying as agreed on an aggressive repayment program instituted before the decline in commodity prices. The appeal stated that collateral coverage is strong, liquidity is sufficient, and the borrower plans to further reduce debt by selling additional assets.

Conclusion

An interagency appeals panel of three senior credit examiners concurred with the SNC examination team’s originally assigned risk rating of substandard.

The appeals panel concluded that the substandard rating is appropriate due to the borrower’s well-defined weaknesses, including the inability to generate sufficient operating cash flow to service debt per contractual terms, as well as increasing leverage. While the borrower has been paying as agreed, the structure of the term loan has rendered free cash flow negative since 2014. The borrower has been able to supplement its operating cash flow to cover required principal amortization through asset sales. The “Rating Credit Risk” booklet of the Comptroller’s Handbook notes that the primary consideration in examiners’ credit risk assessment is the strength of the primaryrepayment source.  In this case, the borrower’s operating cash flow is insufficient.

Earnings before interest, taxes, depreciation, amortization, and exploration expenses (EBITDAX) have declined over the last several years and trailing 12 month EBITDAX is insufficient to cover fixed charges (e.g., capital expenditures, cash interest, and principal payments). Cash flow projections indicate that EBITDAX will be insufficient to cover fixed charges for the next several years. In addition, the borrower’s leverage is high and is expected to increase further in the near term.

The appeals panel concluded that future projected improvement in oil prices and the plan to divest another substantial amount of assets in the near term will likely improve the company’s financial condition going forward; however, these are future events and the subsequent effect on the borrower’s financial condition is uncertain.