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Appeal of Shared National Credit (SNC) (Third Quarter 2015)


An agent bank appealed the substandard rating assigned to a revolving credit during the 2015 Shared National Credit (SNC) examination.


The appeal asserted that a pass rating designation for this reserve-based loan (RBL) was appropriate because, consistent with the “Oil and Gas Exploration and Production Lending” booklet of the Comptroller’s Handbook, dated March 2016, RBLs should be viewed as a form of asset-based lending rather than as enterprise value cash flow lending. The booklet states, “As with other types of loans, oil and gas (O&G) loans adequately protected by the current sound worth and debt service capacity of the borrower, guarantor, or underlying collateral generally should not be classified for supervisory purposes. When risk rating O&G facilities, it is important to keep in mind that O&G lending is a borrowing base, collateral focused type of commercial lending.”

The appeal asserted that there was significant collateral coverage with a present worth of cash flows discounted at 9 percent reserve value that exceeded the full first lien commitment by 2.28 times (44 percent loan-to-value). The engineered loan value covered the first lien RBL facility by 1.13 times, resulting in a fully conforming borrowing base. Due to the nature of these assets, additional value above what was set as the engineered loan value would be achieved in a liquidation process.

The appeal asserted that the company’s March 31, 2015 liquidity, consisting primarily of unused borrowing base, provided 11.5 times coverage of management’s projected cash flow deficit for the remaining three quarters of 2015. Moreover, and as acknowledged in the examiner’s report, liquidity was more than sufficient to fund the projected cash flow deficit in 2016.

Furthermore, the appeal noted that two nationally recognized statistical rating organizations (NRSRO) provided pass ratings for the obligor, providing an important third-party validation of the obligor’s credit assessment.


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

Regulatory agencies recognize that unique attributes of O&G RBL result in risk inherent to the oil and gas industry requiring additional risk management practices and programs for O&G lending, including some controls that are similar to asset-based loans (ABL). For an ABL, the primary source of repayment is, however, the conversion of working capital assets to cash, whereas for an RBL, the primary source of repayment is cash flow generated from the sale of oil and gas over the life of the reserves.

The appeals panel concluded that the controls in place for a traditional ABL are more stringent than those typically found in an RBL. ABL controls include a first lien on account receivables and inventory which is not shared with any other lending group, dominion of cash through a lock box arrangement or a springing covenant, regular field audits, and periodic collateral valuations.

The appeals panel concluded that the primary source of repayment for an RBL is the cash flow generated from the future sale of encumbered oil or natural gas once it has been extracted. An RBL often shares the cash flow repayment “pari passu” with other debt, both secured and unsecured. In many cases, the other debt (term notes and bonds) requires no principal repayment until maturity. While the structures of RBLs may vary, the facilities generally do not self-liquidate. The Disbursements of proceeds, while generally not restricted, are primarily used for capital expenditures pertaining to the exploration, acquisition, development, and maintenance of oil and gas reserve interests. Oil and gas reserve interests tend to be longer term, depleting assets as opposed to accounts receivable and inventory.

The regulatory agencies believe an RBL is subject to additional risks than a traditional ABL and should be evaluated and risk rated through cash flow analysis, although consideration is given to each facility’s structure, controls, and collateral. The primary determinant for the regulatory risk rating is the ability of the borrower to service all debt from operating cash flow, the primary source of repayment.

The appeals panel concluded that the rational for the substandard classification was insufficient cash flow, increasing leverage, and inability to repay the debt within the half-life of the reserves. Cash flow through March 31, 2015, trailed projections with earnings before interest, taxes, depreciation, and amortization (EBITDA) producing negative free cash flow (FCF). Fiscal year-end (FYE) 2015 EBITDA was projected to produce a fixed charge coverage ratio below 1.0 times. Borrower leverage was moderate but projected to increase significantly due to declining EBITDA and increasing debt. Projected negative FCF for FYE 2015 and 2016 funded by incremental revolving credit usage would result in leverage exceeding 7 times by FYE 2016. Liquidity was sufficient to support cash burn through 2016.

The appeals panel noted that regulatory agencies do not consider NRSRO opinions when making a risk rating decision. Additionally, while the company was successful in obtaining additional capital in recent years, market conditions have deteriorated significantly since that time. Future ability to raise additional capital in the markets is speculative.