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Appeal of Shared National Credit (Third Quarter 2014)

Background

A participant bank appealed the special mention rating assigned to a term loan during the 2014 Shared National Credit (SNC) examination.

Discussion

The appeal argued that the loan should be rated pass. The appeal disagreed that the facility had a weak structure due to only one financial maintenance covenant, which required over 40 percent headroom in interest coverage and a back ended 1 percent amortization. The appeal stated that the transaction is favorable as it has an excess cash flow sweep based on specific targeted debt amounts, effectively requiring debt amortization. While the interest coverage covenant cushion of 40 percent is not ideal, the appeal stated that it is a true maintenance covenant rather than a covenant-lite or springing covenant. Actual interest coverage ratio was 2.21 times and 2.28 times at fiscal year ending 2013 and first quarter 2014, respectively, compared to the covenant of 1.60 times.

The appeal stated that the company’s variance in earnings performance to budget was acceptable. The company’s fiscal year end 2013 earnings before interest, tax, depreciation, and amortization expense (EBITDA) was off budget by only 2.8 percent on an adjusted EBITDA basis when including the major maintenance expense add-back that the company had mostly expected and budgeted. Excluding the major maintenance expense add-back on both the actual and budgeted results, the shortfall would have been 5.7 percent. A one-time outage at one of the plants caused most of the shortfall.

The appeal argued that the company’s leverage ratio, as calculated by total debt divided by EBITDA, was 7.5 times rather than 10.1 times, as determined by the SNC examination team, because the major maintenance expense was non-recurring. The appeal stated that the company’s projections demonstrate sufficient capacity to repay total debt over a 7-year period.

Conclusion

An interagency appeals panel of three senior credit examiners concurred with the bank’s pass rating.

While the facility’s structure is weak and the debt service coverage covenant has excessive headroom, the excess cash flow sweep supersedes the 1 percent amortization on the term loan.

The appeals panel agreed with the SNC examination team’s criticism of actual fiscal year 2013 EBITDA being 8 percent below plan. The appeals panel also recognized, however, that the EBITDA variance was a result of a one-time event temporarily interrupting revenue and determined that the 8 percent under performance of EBITDA is not likely to be repeated going forward.
Regarding the company’s leverage ratio, the appeals panel determined that leverage is 10 times and high for the industry. In addition, the SNC examination team calculated the fixed charge coverage (FCC) ratio as stated in the credit agreement and did not add back major maintenance expense for 2013, because it was determined to be a recurring expense. This resulted in a FCC ratio of 1.12 times, as compared to bank calculated FCC ratio of 1.33 times after adding back major maintenance expense.

Despite the high leverage, 82 percent of the obligor’s gross margin is contracted through the 2020 term loan maturity, providing stability of future cash flows. In addition, there is a 75 percent excess cash flow recapture provision subject to annual term loan debt levels. The company’s base-case projections show that 73 percent of total debt can be repaid within 7 years, which is well within the regulatory guidelines.