Skip to main content
OCC Flag

An official website of the United States government

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


An agent bank appealed the nonaccrual treatment assigned to a revolving credit during the 2015 Shared National Credit (SNC) examination.


The appeal agreed with the substandard risk rating but argued that the nonaccrual designation was not appropriate due to strong collateral coverage and liquidity. The appeal stated that the “Oil and Gas Exploration and Production Lending” booklet of the Comptroller’s Handbook, dated March 2016 (OCC booklet) distinguishes between substandard accrual and nonaccrual assets by noting “the likelihood of full collection of principal and interest may be in doubt” for substandard nonaccrual assets. The appeal asserted that the inherent structure of this reserve-based loan (RBL), which is governed by a borrowing base with semi-annual redetermination mechanics, ensures adequate protection and full collection of principal and interest.

The appeal asserted that collateral was valued under both the present worth and existing asset value, of proved reserves discounted at 9 percent (PW9) and an engineered loan value (ELV). The proved PW9 reserve value exceeded the full first lien commitment by 1.56 times (64 percent loan-to-value). The ELV covered the first lien RBL facility by 0.98x, resulting in a modest deficiency of 2 percent to a fully conforming borrowing base. Due to the nature of these assets, the appeal also asserted that additional value above what was set as the ELV would be achieved in a liquidation process.

The appeal expressed that it was premature to place this RBL on nonaccrual, due to ongoing negotiations with creditors and an over-secured position of the first lien facility. Payment of full principal and interest was expected on this over-secured first lien RBL. The appeal argued that should the company file Chapter 11 with a prearranged bankruptcy plan, or utilize the bankruptcy court to facilitate a global restructure of the capital structure, the interest on the first lien RBL will remain current due to the over-secured position. The appeal also stated that the first lien RBL will eventually be repaid through a refinancing on market terms, or a sale of the assets.

The appeal asserted that reserve-based lending is a form of asset-based lending rather than as enterprise value cash flow lending. This risk grading approach, which had been employed by the agent bank on this and all oil and gas credit facilities for many years, was consistent with the OCC’s risk grading philosophy for oil and gas loans articulated on page 24 of the OCC booklet. As with other types of loans, oil and gas loans adequately protected by the current sound worth and debt service capacity of the borrower, guarantor, or underlying collateral generally should not be classified for supervisory purposes. The appeal stated that when risk rating oil and gas facilities, it is important to keep in mind that oil and gas lending is a borrowing-base, collateral-focused type of commercial lending. The loan is structured as a traditional reserve-based borrowing base facility. Semiannual borrowing base redeterminations by third-party engineering firms govern availability under the revolver by calculating the net present value of future cash flows, the ultimate repayment source. The appeal points out that the SNC write-up notes the borrower was in the process of raising additional debt, the proceeds of which were expected to pay off the existing RBL facility.


An interagency appeals panel of three senior credit examiners concurred with the SNC examination team’s originally assigned ratings of substandard and nonaccrual treatment based on the borrower’s insufficient cash flow, high leverage, and weak liquidity.

The appeals panel determined that the primary source of repayment for the RBL and term loan is the cash flow generated from the future sale of encumbered oil or natural gas once extracted. The RBL shares the cash flow repayment “pari-passu” with the term loan B. The nonaccrual accounting treatment should be consistent for both notes given the same primary source of repayment and equal sharing in the payment stream.

Regulatory agencies recognize that unique attributes of oil and gas RBLs 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 an 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. RBLs often share 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 RBLs may vary, the facilities generally do not self-liquidate. Disbursement 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 an RBL is subject to additional risks than a 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.