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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 asserted that the facility should be rated pass due to sufficient repayment ability and acceptable leverage position.

The appeal stated the SNC report indicated that since a spin-off transaction in March 2014, the borrower had not been able to meet revenue and earnings before interest, taxes, depreciation, and amortization (EBITDA) projections due to decline in a business line and location pricing pressure. The appeal explained, however, that over the past several years, the borrower had been transitioning its business model to one that delivers integrated solutions, supported by infrastructure, to improve revenues and reduce the capital intensity of the business. This transition was key to the financing in March 2014.

While performance had been slower than expected and revenue and EBITDA had fallen short of projections, the appeal argued that there are several positive trends, including (i) an improving win-rate in converting customers in the specific business line, (ii) growth in monthly recurring revenue, (iii) new customer growth, and (iv) revenue growth in 2014 and first quarter 2015 from one of the business lines.

The appeal also noted that the SNC report indicated the company’s fixed charge coverage ratio (FCCR) was below 1.0 times in fiscal year 2014. The appeal asserted, however, that the borrower is an “asset-heavy” business including gross property, plant and equipment, which represent over 80 percent of tangible assets (depreciated by approximately 75 percent at the time of transfer) which is not an accurate representation of the true value of the assets. In this context, analysis on a rent-adjusted basis was premature, although later on it may be appropriate if the company were to execute a sale-leaseback of substantial property down the line. The bank calculated EBITDA-based FCCR to be above 1.0 times for fiscal 2014 and trailing 12 months March 31, 2015.

The appeal disagreed with the examiner-calculation FCCR. The bank stated that its calculations were based on the industry standard FCCR definition in which cash taxes and capital expenditures (capex) are subtracted from the numerator to arrive at the cash flow available to cover fixed charges. The cash dividend paid in conjunction with the spin-off was also appropriately excluded from the calculation, as it was debt financed at origination. Total capex, instead of maintenance capex, was subtracted from the numerator, as the bank does not have a breakdown between growth and maintenance capex. Growth capex is viewed as discretionary, since it can be slowed or ceased by management depending on the company’s strategy.

The appeal stated that the SNC report noted the company’s projected free cash flow (FCF) for seven years showed the ability to repay 20 percent of the senior secured debt and 15 percent of total debt. While the appealing bank did not have access to the projections that were used in the repayment analysis cited in the SNC report, the appeal agreed that the company’s repayment capacity had diminished from that expected at origination, assuming the decline in EBITDA was to continue long term.

The appeal asserted that the SNC report stated total debt leverage would peak at year-end 2015, and would decline in the final year of the projection period. The appeal agreed that the larger than projected decline in EBITDA had caused leverage to increase since the original underwriting. Based on company-provided financial information, however, the borrower’s senior leverage and total leverage on a funded basis remained inside the guidelines.


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 noted that total revenue declined from 2013 to 2014. Projections provided to examiners showed a substantial decline in total revenue in 2015 and no significant improvement for several years. While one business line had exhibited growth, that growth continued to be more than offset by the significant decline in the company’s traditional businesses.

The appeals panel concluded that differences between the examiner-calculated FCCR versus the appeal calculation did not lead to significantly different results, as the company has a history of paying dividends, so those were included in the FCCR calculation. Excluding dividends from the 2014 calculation would yield a ratio that was 16 basis points higher but below 1.0 times, which still indicates the company was unable to cover its fixed expenses for the year. Projections do not show dividends in 2015 and beyond, so they are not included in the examiner calculations for those years.

The appeals panel concluded that SNC examiners consistently used the same method of calculating FCCR. Subtracting cash taxes and capex from the numerator instead of including them in the denominator yields a slightly different FCCR number, but does not lead to a different interpretation. For 2014, the ratio would be lower per the bank method.

The appeals panel concluded that revised projections generated significant differences between the bank calculations and examination findings. Projected EBITDA levels used by examiners in their FCF calculations for 2015 and subsequent years were substantially lower than 2014 results. The downward revision in EBITDA and resulting low level of FCF was the basis for the determination that the company will be unable to amortize debt within a reasonable time.

The appeals panel concluded that leverage ratios cited by the bank are consistent with examiner calculations for year-end 2014. As noted in the bank comment, examiners projected leverage to be substantially higher at year-end 2015 and subsequent years. This is due to the projected downward trend in EBITDA previously discussed.

The appeals panel concluded that the borrower was classified substandard due to weak operating performance and high leverage. Using the most recent projections available, examiners calculated repayment capacity as 20.4 percent of senior debt and 14.5 percent of total debt within seven years. The projected marginal FCCR of 1.0 to 1.1 times for 2015 to 2021 also indicates the company will not be able to pay down its debt significantly during that time.