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Appeal of Shared National Credit (SNC) (Third Quarter 2015)


A participant bank appealed the substandard rating assigned to a revolving credit during the 2015 Shared National Credit (SNC) examination.


The appeal argued with the SNC analysis that the borrowing base redetermination valued the reserves at 0.65 times total debt (secured and unsecured). The appeal stated that since the reserve-based lending (RBL) has a first lien secured position on the collateral, focusing on total debt coverage when assessing the RBL structure was inappropriate and negated the benefit of the revolver’s first lien structure. Given the revolver’s first lien position within the capital structure, the appeal asserted that the 2.44 times collateral coverage was adequate and reflective of a pass rating.

The appeal asserted that the “Oil and Gas Exploration and Production Lending” booklet of the Comptroller’s Handbook, dated March 2016 (OCC booklet), explains that a loan balance exceeding 65 percent of the present value of proved developed reserves may warrant a potential or well-defined weakness in the structure. A 2.44 times collateral coverage of the borrowing base is equivalent to a 41 percent advance rate against proved developed performing (PDP), which provides sufficient cushion per the OCC booklet. Further, this 2.44 times calculation pre-dated a debt raise and corresponding reduction of the borrowing base. Pro-forma for the debt raise results in coverage of the borrowing base increasing from 2.44 times to 4.40 times.

The appeal expressed that its position was consistent with the OCC booklet, which instructs lenders to assess the RBL facilities on a standalone basis, not total debt. The appeal noted that this facility merited its own treatment outside of the other debt in the capital structure due to the presence of strong protections provided by the RBL structure, such as semi-annual base re-determinations, borrowing base levels set below the net present value of the reserves, and the first lien claim on the collateral.


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

The SNC appeals panel agreed that the new debt issuance improved the borrower’s liquidity position. Well-defined weaknesses consistent with the regulatory definition of substandard remained, however, primarily centered in the borrower’s weak operating cash flow and high and escalating leverage position.

The appeals panel noted that the borrower projected the new liquidity will be exhausted by year-end 2017 with an aggregate deficit free cash flow over that period, driven by capital expenditures. While cash balances were forecasted to increase by year-end 2017, the appeal did not address the source and prospect of the capital raise.

The appeals panel concluded that the borrower reported a fixed charge coverage ratio (FCCR) below 1.0 times. Financial projections for fiscal year-end (FYE) 2015 reflected a slight improved but continued weak FCCR below 1.0 times. At FYE 2014, total leverage was expected to increase to a high level with the new debt on a pro-forma FYE 2015.

The appeals panel concluded that the lending group recognized the borrower’s financial difficulties by taking certain actions to ease several covenants.

Regulatory agencies recognize that unique attributes of oil and gas RBL result in risk inherent to the oil and gas industry requiring additional risk management practices and programs for oil and gas lending, including some controls that are similar to asset-based loans (ABL). For an ABL, however, the primary source of repayment is the conversion of working capital assets to cash, whereas for RBL, the primary source of repayment is cash flow generated from the sale of oil and gas over the life of the reserves.

The appeals panel concluded that the controls in place for a traditional ABL are more stringent than those typically found in an RBL. ABL controls include a first lien on account receivables and inventory which is not shared with any other lending group, dominion of cash through a lock box arrangement or a springing covenant, regular field audits, and periodic collateral valuations.

The appeals panel concluded that the primary source of repayment for an RBL is the cash flow generated from the future sale of encumbered oil or natural gas once it has been extracted. An RBL often shares the cash flow repayment “pari passu” with other debt, both secured and unsecured. In many cases, the other debt (term notes and bonds) requires no principal repayment until maturity. While the structures of RBL may vary, the facilities generally do not self-liquidate. Disbursements of proceeds, while generally not restricted, are primarily used for capital expenditures pertaining to the exploration, acquisition, development, and maintenance of oil and gas reserve interests. Oil and gas reserve interests tend to be longer term, depleting assets as opposed to accounts receivable and inventory.

The regulatory agencies believe RBL is subject to additional risks than traditional ABL and should be evaluated and risk rated through cash flow analysis, although consideration is given to each facility’s structure, controls, and collateral. The primary determinant for the regulatory risk rating is the ability of the borrower to service all debt from operating cash flow, the primary source of repayment.