Appeal of Shared National Credit (Third Quarter 2019)
Two participant banks appealed facilities agented by a national bank and reviewed during the third quarter 2019 Shared National Credit (SNC) examination. One participant bank appealed the split risk rating of substandard, doubtful, and loss assigned to a term loan and the other participant bank appealed the accounting treatment for the asset-based revolving credit.
The appeal of the term loan asserted that a substandard and doubtful split risk rating was more appropriate. The appeal agreed that the debt structure was not sustainable given the decline in earnings and collection of full principal and interest in doubt. The appeal disagreed that the facility was uncollectible and of such little value that its continuance as a bankable asset was no longer warranted, because the obligor had not defaulted, was not delinquent, and did not consider bankruptcy protection. In addition, the appeal noted that sponsor support of near-term liquidity needs allowed the obligor time to implement turnaround plans. The appeal also acknowledged uncertainty regarding the potential success of those initiatives. The appeal questioned the calculation of collateral support, noting that examiners did not accurately account for excess collateral availability under a revolving credit or priority lien assignments. The appeal asserted that uncertainty regarding turnaround plans, collateral support, and enterprise value were more reflective of a doubtful disposition than loss.
The appeal of the asset-based facility disagreed with the nonaccrual accounting treatment stating that the facility was well-secured and full collection of principal and interest was not in doubt. The appeal acknowledged concerns regarding leverage and cash flow supporting the substandard rating but asserted that liquidity, a priority position in the collateral, and strong asset-based lending controls mitigated concerns regarding the collateral. The appeal contended that the loan balance was fully secured by appropriately margined collateral and subject to reasonable advance rates. The appeal noted strong asset-based controls such as monthly borrowing base certificates, annual audit and inventory appraisals, and triggers and covenants that support more frequent reporting and line control in case of deterioration. The appeal also noted strong collateral cushion if the line was fully funded and sufficient liquidity available under other revolving facilities.
The interagency appeals panel conducted a comprehensive review of the information submitted by the banks, and relied on the supervisory standards outlined below:
- OCC Bulletin 2013-9, "Guidance on Leveraged Lending"
- OCC Bulletin 2014-55, "Frequently Asked Questions for Implementing March 2013 Interagency Guidance on Leveraged Lending"
- Comptroller's Handbook, "Asset-Based Lending" (January 2017)
- Comptroller's Handbook, "Commercial Loans" (Narrative—March 1990, Procedures—March 1998)
- Comptroller's Handbook, "Leveraged Lending" (February 2008)
- Comptroller's Handbook, "Rating Credit Risk" (April 2001, updated June 2017)
An interagency appeals panel of three senior credit examiners concurred with both banks and assigned a split rating of substandard and doubtful to the term loan and accrual accounting treatment to the asset-based facility.
Regarding the term loan, the appeals panel agreed that projected financial performance was insufficient to repay total debt and reliant on an uncertain turnaround strategy. In addition, negative cash flow was projected to deplete available liquidity within a short period. As a result, the obligor was highly reliant on continued sponsor liquidity support or a distressed debt restructure to remain a going concern. These issues also highlight the reliance on secondary sources of repayment from collateral and enterprise valuation. The appeals panel concluded that the estimated liquidation value of long-term assets supported the substandard portion of the term loan while a range of enterprise values supported the portion rated doubtful. Nonaccrual treatment is warranted because full repayment of principal and interest is in doubt.
For the asset-based loan, the appeals panel concluded that full repayment of principal and interest on the asset-based revolving credit was not currently in doubt. Therefore, accrual accounting treatment was appropriate for the asset-based facility.