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

Background

A participant bank appealed the split rating of pass/substandard assigned to a revolving credit during the 2015 Shared National Credit (SNC) examination.

Discussion

The appeal asserted that the facility should be rated pass/special mention based upon the parent company’s (parent) willingness and ability to support the borrower. The companies entered into a parent support agreement, with the parent agreeing to contribute funds to cure any borrowing base (BB) deficiency or provide additional collateral support in the event the BB was reduced below the outstanding balance. The borrower was the parent’s largest acquisition and remained strategically important to the parent’s ongoing profitability and market value.

The parent drew on its revolver and down-streamed the proceeds to the borrower, allowing repayment of the 2014 notes that were due. For the May 2015 BB redetermination, the parent provided a significant contribution. Base-case projections indicated the borrower had the ability to meet its debt service requirements and capital expenditures (capex) for 2015 with available cash flow.

Conclusion

The interagency appeals panel of three senior credit examiners concurred with the SNC examination team’s split rating of pass/substandard.

The appeal panel acknowledged that the parent company had supported the borrower. The parent’s ability and willingness to continue support beyond the requirements of the support agreement was, however, uncertain given the parent’s financial condition. The substantial drop in oil and natural gas prices in late 2014 and early 2015 negatively affected the valuation of the parent’s oil and gas reserves.

The parent’s debt level was excessive, as total debt exceeded the engineering valuation of total oil and gas reserves, exclusive of the borrower company’s reserves. Engineering valuations indicated that total debt could not be repaid from production of existing reserves and hedge revenue. To increase cash flow to repay total debt, the parent was heavily reliant on its ability to increase reserves through new exploration drilling, sale of assets, or participation in strategic partnership alliances to provide total debt repayment ability.

The appeals panel concluded that the parent company’s ability to strengthen operations through exploratory drilling was uncertain given future liquidity demands. The company had availability on its BB revolver, but BB availability was expected to decline as hedge revenue, which provides BB availability, rolls off and is not replaced by new hedges. Additionally, the parent was obligated to return money to the borrower from funds previously advanced by the borrower. Total debt was excessive as risk weighted reserves covered total funded debt only 1.2 times. Moreover, the company’s ability to realize future net revenues (FNR) projected to determine the risk adjusted engineering value was uncertain. Realization of projected FNR related to non-performing reserves depended upon the borrower’s ability to fund capex necessary to bring these reserves online. Engineering evaluations indicated that capex of $956 million was needed from October 2015 through 2019 to complete non-performing reserves.

The appeals panel noted that the borrower’s liquidity was negligible, the revolver was fully drawn, and the company reported minimal cash balances. Expected annual operating cash flow is insufficient to cover projected capex, leaving the company dependent upon the parent to supply remaining capex beyond the legally binding payable discussed earlier and other non-binding contributions.