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Appeal of Shared National Credit (Third Quarter 2014)

Background

The agent bank appealed the substandard rating assigned to a revolving credit during the 2014 Shared National Credit (SNC) examination.

Discussion

The appeal argued that a special mention rating was appropriate for the facility. The appeal stated that the borrowing company’s leverage, while elevated, was acceptable at 4.39 times. While 2013 performance was lackluster, the company made a targeted pivot to horizontal development and away from a suboptimal vertical drilling program in late 2013 with positive results. Liquidity remained adequate to fund slated growth capital expenditures with cushion for unforeseen setbacks. The company had acceptable paying capacity, strong net worth, and collateral support.

Conclusion

An interagency appeals panel of three senior credit examiners agreed with the bank’s special mention rating. Although the borrower’s credit metrics have deteriorated, collateral coverage, the regulated borrowing nature, and the regular re-valuation of the underlying collateral fully support repayment of the facilities. The loan is structured as a traditional reserve-based borrowing base facility. Semiannual borrowing base redeterminations by third-party engineering firms govern availability under the revolver by calculating the net present value of future cash flows, the ultimate repayment source. The most recent valuation in spring 2014 provided 1.46 times coverage of the loan.

The appeals panel also noted that potential weaknesses were evident such as higher production costs due to capital overspend from accelerated drilling and cost overruns, lower than expected performance in certain wells leading to a shortfall in earnings, lower than expected proceeds from asset sales resulting in cash shortfalls, and lower than expected proceeds from an equity raise. In addition, acquisitions in 2013 increased leverage, leading to a leverage ratio of 4.3 times versus budgeted 3.7 times. This level of leverage exceeded the median leverage ratio of 3.6 times for the industry. Correspondingly, liquidity tightened as cash was depleted and availability on the revolver reduced substantially. The resulting balance sheet stress necessitated changes in the borrowing base and financial covenants in early 2014.