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


An agent bank appealed the nonaccrual treatment assigned to two revolving credits during the 2015 Shared National Credit (SNC) examination.


The appeal agreed with the substandard rating but asserted that the facilities should not be placed on nonaccrual due to the inherent structure of the two reserve-based loans (RBL). The RBLs are cross-collateralized and governed by a borrowing base, ensuring adequate collateral protection and full collection of principal and interest.

The appeal asserted that collateral consisted of proven present worth of the discounted cash flow at 9 percent (PW9) reserve value that exceeded the two facilities’ first lien commitment by 4.7 times. The engineering report indicated collateral values for first lien coverage of 2.8 times and proven developed performing (PDP) reserves for first lien coverage of 2.6 times. The borrower’s liquidity is adequate to meet cash needs during the bankruptcy proceeding.

The appeal stated that the credit facilities should not be placed on nonaccrual because of a well-secured position and the collection of interest through the bankruptcy proceeding. The appeal asserted that principal and interest would be repaid in full at the consummation of the bankruptcy or reinstated and paid in full by the original maturity in September 2016.

The appeal also stated that the agent bank views RBLs as a form of asset-based lending rather than as enterprise value cash flow lending. The bank’s risk grading approach, which has been employed on this and all of the bank’s oil and gas credit facilities for many years, is consistent with the guidance outlined on page 24 of the “Oil and Gas Exploration and Production Lending” booklet of the Comptroller’s Handbook, dated March 2016.


An appeals panel of three senior credit examiners concurred with the SNC examination team’s originally assigned risk ratings of substandard and nonaccrual treatment due to a bankruptcy reorganization plan that had not been filed, loans in default, and loan payment more than ninety days past due and not in process of collection.

The appeals panel concluded that RBLs’ inherent structure cannot ensure adequate protection and full collection of principal and interest under all business conditions. While adequate collateral controls and conservative discount rates can protect lenders from loss, they cannot guarantee against all conditions and situations that might result in loss from failed or deteriorating business ventures. While the collateral coverage appeared sufficient for the bank’s first lien position, the borrower had significant going concerns that may limit its ability to extract reserves, sell reserves, or obtain refinancing that would be necessary to fully repay the contractual principal and interest.

The appeals panel recognized that the first lien RBL facilities are fully secured by PDP and did not disagree with the bank’s borrowing base analysis. The appeals panel concluded that the outcome and reorganization plans from the Chapter 11 filing were not finalized and remained uncertain. The bank’s updated cash flow analysis reported 16 months of liquidity, but there was no plan for additional sources of liquidity after that period. The borrower must demonstrate continued liquidity beyond the depletion of the collateral protection payments or provide a formal plan for a new capital structure that includes a new liquidity source to support continued post-bankruptcy operations.

The appeals panel concluded that the reorganization plan reviewed during the SNC examination had no established timeline for emerging from the Chapter 11 bankruptcy, and the cash flow projections had to be revised at that time. Without a formal plan of reorganization, it was difficult to determine if the collateral protection payments would be sufficient to last throughout the bankruptcy proceeding. Further, the bank group entered into a forbearance agreement to restrain the bank group from exercising its rights and remedies in connection with specified defaults under the loan agreement. Nonaccrual status was appropriate given that the loans were in default and 90 days or more past due and not in the process of collection. The term “in the process of collection” requires that the timing and amount of repayment be reasonably certain, with evidence that collection in full of amounts due and unpaid will occur shortly. In this case, the timely collection in full of amounts due and unpaid was uncertain.

Regulatory agencies recognize that unique attributes of oil and gas RBL result in risk inherent to the oil and gas industry requiring additional risk management practices and programs for oil and gas lending, including some controls that are similar to asset-based loans (ABL). For an ABL, however, the primary source of repayment is the conversion of working capital assets to cash, whereas for an RBL, the primary source of repayment is cash flow generated from 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 RBL is the cash flow generated from the future sale of encumbered oil or natural gas once it has been extracted. RBL often share 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 RBL may vary, the facilities generally do not self-liquidate. 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 RBL is subject to additional risks than 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.