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Appeal of Shared National Credit (SNC) (Fourth Quarter 2011)
A bank appealed to the ombudsman the decision by the SNC appeal panel to rate an asset-based lending (ABL) revolving credit facility as substandard, nonaccrual. The appeal specifically disagrees with the nonaccrual designation.
In its appeal, the bank states nonaccrual treatment is not warranted because full repayment of principal and interest is expected and the ABL revolving credit facility is well secured by collateral consisting of liquid retail inventory and accounts receivable, thus providing adequate margin. The liquidation value of the collateral has a longstanding and proven reputation for predictability. In addition, the bank asserts the facility is governed by adequate controls. The appeal emphasizes that availability under the borrowing base and collateral are the key factors in making this determination.
The appeal also asserts the SNC panel’s criticism of the company’s use of the revolving line to make interest and other payments is unwarranted. The bank states lenders automatically make an advance under the borrowing base to pay interest, and as long as the company retains availability, interest should continue to be paid. Furthermore, the company has the right to use loan proceeds to pay debt service and other charges.
The appeal asserts that if the credit deteriorates or the company is unable to restructure its debt, the most likely scenario would be the company files for bankruptcy and the ABL revolving credit is rolled into a Debtor-in-Possession facility with the company sold shortly thereafter in a court-approved “363 Sale.” In a worst-case scenario, the company would be liquidated in a “going out of business” sale. The bank claims the ABL would be paid in full based on an ample enterprise value and low loan-to-value percentage.
The original SNC voting team supported a substandard, nonaccrual classification of this ABL facility based upon continued net losses, inadequate cash flow to service debt and other fixed charges, high leverage, borrowing base shrinkage, and liquidity concerns. Insufficient cash flow and the absence of additional capital injections by the sponsor indicate the borrower will need to rely on availability under the ABL to pay interest. The examiners state projections reflect continuing cash flow and availability problems.
The SNC voting team also found the credit has adequate collateral protection and is governed by controls, including full cash dominion and regular borrowing base certificate submissions, cash flow projections, field audits, and appraisals. Collateral and controls were found to be adequate to preclude a more severe classification (i.e., doubtful) but nonaccrual treatment was deemed appropriate.
The SNC appeals panel also supports a substandard, nonaccrual classification based on similar reasons. In addition, the panel found that advance rates on accounts receivables and inventory were liberal and inconsistent with collateral for a well-secured credit, there was significant reliance on potentially illiquid collateral, and collateral was only marginally adequate. The panel agreed that the existing controls, lack of fixed assets in the borrowing base, lack of over-advances, addition of a sponsor’s letter of credit, and the standalone nature of the ABL credit with a senior secured position are positive features. However, those features were insufficient to preclude a nonaccrual designation.
The ombudsman conducted a comprehensive review of information submitted by the bank and the SNC appeal panel. The definition of nonaccrual as defined in the glossary of the Call Report instructions and the Comptroller’s Handbooks for “Rating Credit Risk” and “Accounts Receivable and Inventory Financing (ARIF)” were the standards for his analysis.
The ARIF Handbook states the primary source of repayment of an ABL credit is the conversion of current assets. Therefore, lenders must closely monitor credit availability, collateral, and controls. Collateral consists predominantly of accounts receivable and inventory. Because greater emphasis is on collateral (than in cash flow lending), an ABL facility is structured so that collateral will be readily available if the loan must be liquidated.
Further, nonaccrual treatment is required on any asset which is maintained on a cash basis due to financial condition deterioration, for which payment in full of principal or interest is not expected, or upon which principal or interest has been in default for 90 days or more unless the asset is both well secured and in the process of collection. However, there is no requirement that a loan must be delinquent for 90 days. Once reasonable doubt exists about a loan’s collectability, the loan should be placed on nonaccrual.
Concerning this facility, examiner documentation acknowledged adequate collateral protection and controls. Collateral provided a sufficient margin based on advance rates on the accounts receivable and inventory and were within OCC policy guidelines. In addition, controls included regular borrowing base certificate submissions, 13-week cash flow projections, field audits and appraisals and cash dominion over the accounts receivables. Furthermore, the facility is buoyed by a letter of credit from the sponsor, which can be drawn if availability falls below established minimums. While there are valid concerns regarding the nature of luxury goods and credit card receivables in the event of liquidation, those were not quantified to support doubtful collection. Lastly, the facility was contractually current with no payment defaults projected, and there had been no over-advances.
Based on the above information, the ombudsman found that while sufficient well-defined weaknesses existed to support the substandard rating, there was insufficient evidence to support doubt as to full collection of principal and interest based upon the realizable value of the collateral. The collateral and controls of this ABL facility were consistent with OCC guidelines and were sufficient to maintain accrual status at the time of review. Therefore, the appropriate rating on this facility was substandard/accrual.