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Appeal of Shared National Credit (Third Quarter 2014)

Background

A participant bank appealed the special mention rating assigned to an asset-based loan (ABL) during the 2014 Shared National Credit (SNC) examination.

Discussion

The appeal argued for a pass rating based on the covenants as well as a 22 percent loan-to-value ratio and $941 million in excess availability on the line that is projected to remain stable. The bank stated that covenants for the ABL are similar to those offered in the current syndicated lending market for other ABLs and that the borrower has a strong market position and diversification of products and geographies.  In addition, the company has adequate liquidity consisting of cash flow from operations, cash, and availability under the ABL.

Conclusion

An interagency appeals panel of three senior credit examiners concurred with the SNC examination team’s special mention rating.

Although borrowings under an ABL structure typically have an additional layer of strength given the priority collateral and controls involved, this ABL warrants a special mention risk rating due to the weak and deteriorating financial condition of the borrowing entity. The weaknesses include inadequate ability to cover fixed charges, negative free cash flow for fiscal year 2013, high leverage, and the inability to amortize a sizable percentage of senior and total debt in a reasonable time frame. While sufficient liquidity resources are available at the borrowing and parent company to absorb short-term needs, shortfalls are projected to continue and will strain remaining liquidity resources. Increased usage of this facility may be necessary, particularly if the parent company is unable to continue to supply the borrower with further extensions of debt, as experienced in 2013.

Regarding the covenants, the appeals panel determined that the similarity of the facility structure to other syndicated loans in the market is not a factor that affects this borrower’s financial condition or ability to repay debt, which is a primary factor when evaluating the facility’s rating. The facility’s covenants, such as minimum excess availability and advance rates, may mirror market standards, but these elements offer limited lender control. The minimum excess availability covenant is low at 7 percent of the total committed amount of the line, cash dominion is springing and triggered at a low level of line availability, and the transition from receipt of monthly to weekly borrowing base certificates is at a minimal level of line availability (12.5 percent). In addition, a 90 percent advance rate on collateral is relatively high and has increased compared with previous years,

Regarding collateral coverage, while the 22 percent loan-to-value ratio appears relatively strong, the company’s business is highly seasonal and the ratio is subject to significant swings. Furthermore, the parent provides some working capital via short-term loans, which, if included in advances, would result in a higher loan-to-value. Although the company projects line usage will be commensurate with historical patterns, the company has not achieved financial projections in recent years.

The appeals panel also determined that while the company has had a large market share and diversification of products and geographies for the past several years, these characteristics have not prevented material declines in revenue; operating income; earnings before interest, tax, depreciation, and amortization expense (EBITDA); and free cash flow generation for the 2014 fiscal year end.

Regarding the company’s liquidity position, the appeals panel determined that while the liquidity position of the borrower is adequate based on current circumstances, the weak financial condition of both companies has the potential to lessen liquidity resources. For the 2014 fiscal year end, the borrower’s cash flow from operations was insufficient to fund investing and financing activities. The company received a new loan advance from the parent company to fund the shortfall in lieu of reducing cash or drawing on the ABL. Ongoing liquidity support from the parent company is uncertain due to the parent company’s need to fund operational shortfalls through cash. In addition, both the parent company and the borrower have significant debt facilities that mature prior to the subject loan maturity of March 2019. The subject ABL has a springing maturity covenant intended to mitigate the refinancing risk associated with the other debt facilities. Given the weak performance of the operating company, however, the impact on liquidity as a result of the maturities is uncertain.