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

Background

A participant bank appealed the substandard ratings assigned to several credit facilities extended to affiliated companies during the August 2016 SNC examination. Because the obligors’ revenue streams were interrelated, the companies were assigned the same risk ratings based on the consolidated financial statements and condition of the parent corporation.

Discussion

The appeal asserted that the credits should be rated pass. The appeal argued that the company has maintained an adequate fixed charge coverage ratio over 1.0 times for the fiscal year ended December 31, 2015, and the trailing twelve month (TTM) period ending June 30, 2016. In addition, the company has significant liquidity and reasonable leverage. Finally, the appeal asserts that the borrowers have demonstrated their ability to adjust capital expenditures while maintaining production levels

Conclusion

An interagency appeals panel of three senior credit examiners concurred with the SNC examination team’s originally assigned risk rating of substandard.

The appeals panel concluded that the substandard rating is warranted based on well-defined weaknesses, including weak consolidated actual and projected financial results, operating losses, and inadequate repayment capacity. The company’s operating results for the TTM ending June 30, 2016, reflected a material decline in revenue compared to fiscal year-end 2014. Adjusted earnings before interest, taxes, depreciation, amortization, and exploration (EBITDAX) was insufficient to cover fixed charges (cash interest, cash taxes, and capital expenditures) for the TTM ending June 30, 2016. The appeals panel concluded that the appealing bank did not appropriately consider necessary capital expenditures in its fixed charge coverage calculation.

The appeals panel determined that base case projections, assuming future revenues based on second quarter 2016 New York Mercantile Exchange strip pricing and capital expenditures necessary to sustain a stable revenue stream, reflect that adjusted EBITDAX is insufficient to cover fixed charges for each year through 2020 and insufficient to reduce any debt over the seven-year projection period. The appeals panel concluded that the company’s liquidity, including cash balances and credit line availability, is necessary to sustain operations given prospects of continued depressed commodity prices.