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

Background

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

Discussion

The appeal asserted that the facility should be rated pass because the borrower’s leverage was within acceptable limits and the industry norm, liquidity was sufficient to continue to fund capital expenditures (capex), and cash flow was acceptable to fund debt service. In addition, the company is not reliant on capital market issuance or further distribution cuts to fund its business in the near to mid-term. Collateral coverage was satisfactory as of the last review and had further improved since that time based on an updated engineering report.

Conclusion

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

While the increased leverage ratio was within industry norms, current and projected increases in leverage would place additional pressure on earnings, which are insufficient to support operations.

The appeals panel recognized that after a significant capital injection from a second lien loan and capital issuance, there was sufficient liquidity for the near term. With a cash flow shortfall as discussed in the next paragraph, however, the projections provided during the examination estimated a small funding surplus for fiscal year-end (FYE) 2016, which resulted in insufficient liquidity to fund a substantial level of future growth capex.

The panel disagreed with the appeal’s assertion that the borrower was not reliant on capital market issuances or further distribution cuts to fund its business in the near to mid-term. Growth capex would be dependent on outside sources of capital, which may not be feasible if commodity prices remain depressed. FYE 2014 earnings before interest, taxes, depreciation, and amortization were short to cover interest, maintenance capex, and distributions. Furthermore, the fixed charge coverage ratio was well below 1.0 times for FY 2014 after cash distributions to partners with the shortfall covered by borrowing on the revolver. Without capital issuances in 2016 and beyond, the obligor’s projections indicated funding deficits and an inability to cover growth capex, which may limit additional distributions. The appeals panel considered the cash flow shortfall a well-defined weakness and indicative of a substandard classification. The collateral value was not a deciding factor in risk rating this credit.