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Appeal of Shared National Credit (SNC)-(Fourth Quarter 2016)

Background

A participant bank appealed the substandard (accrual) rating assigned to a credit facility during the August 2016 SNC examination.

Discussion

The appeal asserted that the credit should be rated special mention. The appeal acknowledged that the borrower’s cash flow from operations deteriorated significantly with the decline in oil and gas prices and required the company to seek bankruptcy protection and complete a reorganization. The appeal argued, however, that under the reorganization, the borrower was able to convert a significant amount of junior debt to equity and reduce its ongoing debt service obligations to levels supported by its reduced cash flow.

Conclusion

An interagency appeals panel of three senior credit examiners concurred with the SNC examination team’s originally assigned risk rating of substandard and also determined that the credit should be placed on nonaccrual.

The appeals panel concluded that the substandard rating is appropriate based on well-defined weaknesses, including marginal pro forma cash flow coverage, volatile revenue sources, a decline in contracted and actual rig count, and pricing pressures from lower demand for the borrower’s product. While emergence from bankruptcy provided an improved capital structure, revenues remain volatile and the borrower has a significant concentration to one customer also facing operating challenges. Given the potential collateral shortfall and the recent emergence from bankruptcy, there is doubt as to the full collectability of principal and interest, and the credit should be placed on nonaccrual. A period of sustained financial performance and well-supported financial projections that demonstrate the ability to retire debt in a reasonable time frame are needed before consideration for accrual status.

The appeals panel determined that projected earnings before interest, taxes, depreciation, and amortization (EBITDA) provides only marginal coverage of fixed charges (i.e., capital expenditures, interest, and required annual principal payments). However, projected EBITDA remains under substantial pressure, with industry rig counts down significantly and idle equipment causing extreme downward pricing pressure. The borrower’s current rig count had less than 10 percent of rigs operating, and contracted rigs for the future are down significantly. The significant customer concentration also presents elevated risk.

The appeals panel concluded that there is a potential collateral shortfall because the industry downturn has significantly impacted the demand and value of the company’s equipment.