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


An agent bank appealed the 65 percent substandard and 35 percent doubtful split rating and the nonaccrual treatment assigned to a revolving credit during the 2015 Shared National Credit (SNC) examination.


The appeal asserted that a substandard rating and accrual status was appropriate based on updated financial projections and reserve valuations. The revised projections used a bank-provided price deck and lower capital expenditures to reflect the borrower's new field development plans. The appeal argued the following:

  • This SNC facility is a troubled debt restructuring (TDR), but the collateral value precludes placement on nonaccrual.
  • Under the revised June 9, 2015 projections, the borrower has sufficient liquidity under its committed credit facilities to cover cumulative negative free cash flow and free cash flow becomes positive in 2019.
  • Funding another facility is an option of the borrower that can only be exercised after 24 months and may never occur.


An interagency panel of three senior credit examiners adjusted the ratings to 87 percent substandard and 13 percent doubtful. The panel upheld the nonaccrual treatment.

The appeals panel noted that the revised projections continued to show negative free cash flow through 2018, high total debt leverage, and a significant decline in collateral values. Capital expenditures were cut aggressively to accommodate the decline in gas prices. Additionally, the TDR facility further weakened lenders' protection due to poor credit structuring and weak collateral coverage.

The appeals panel concluded that the SNC voting team did not diverge from the credit risk rating guidance contained on pages 25 and 26 of the "Oil and Gas Exploration and Production Lending" booklet of the Comptroller's Handbook (OCC booklet), dated March 2016, which each agency has generally adopted for use by its examiners. The SNC voting team applied the loan's collateral values to the classification amounts in a manner fully consistent with that guidance. While the guidance allows consideration of proved developed non-performing (PDNP) and proved undeveloped (PUD) values in determining bankable classification amounts, the voting team decided in this case not to include such values in the risk rating decision based on its analysis of that part of the collateral pool. The booklet does give examiners that judgmental discretion if supported by appropriate documentation.

During the SNC appeals process, and only for purposes of the 2015 SNC examination, the interagency SNC management group, working in coordination with regulatory agencies' credit policy groups, agreed to make the following adjustments to the booklet's risk rating criteria for loans where repayment is entirely dependent on the value or cash flow generated by the collateral.

Proved developed performing (PDP) reserves 100%—Substandard
Hedges 100%—Substandard
PDNP reserves 70%—Substandard
PDNP reserves 30%—Doubtful
PUD 50%—Doubtful

The interagency decision to apply the revised risk rating criteria to reserve-based loans reflects the agencies' understanding that engineering valuation techniques and reliability have significantly improved over the past 30 years (since the existing examiner risk rating guidance was actually developed) from advancements in industry technology and market efficiency. In addition, the risk adjustments to the various reserve value categories are consistent with industry practice.

Using above percent allocations and the most recent engineering study, the appeals panel adjusted the ratings to 87 percent substandard and 13 percent doubtful.

The appeals panel noted that although the bank did not provide sensitized revised projections, the revised base-case projections continued to show the company not achieving positive free cash flow until 2019. The revised projections assume average gas price of $3.00 per million BTU in 2015, gradually rising to $3.83 per million BTU in 2021. The bank also aggressively cuts capital expenditures by 27 percent. These capital expenditure reductions do not appear realistic given that 62 percent of the company's present value of future cash flows discounted at 9 percent (PV9) reserves are proved undeveloped (PUD), and need to be developed to meet cash flow needs and debt repayments.

The appeals panel also concluded that leverage was very high, with revised projections indicating total debt to adjusted earnings before interest, taxes, depreciation, and amortization of 14.6 times and 11 times in 2015 and 2016, respectively.

The appeals panel determined that from inception, this facility did not conform to reserve-based lending guidance. The bank designated 80 percent of the borrowing base PUD. This is in direct contravention to the OCC booklet, which states, "proved undeveloped reserves should not be attributable to the borrowing base under any circumstances, unless actual tests in the same reservoir confirm the likelihood of reserves."

The appeals panel also concluded there was no evidence that the bank updated the engineering report in conjunction with determining that this facility was a TDR. It was updated in the spring of 2015 at the request of the OCC examiners. This precluded the bank from having an updated estimate of the collateral values.

The appeals panel noted that covenants were further weakened by allowing the additional facility and the increase in the term loan A to be excluded from the leverage test. The borrowing base was also lenient, allowing advances on 100 percent of reserve values that are not predicated on the probability of gas in the reserves. While the financial sponsor does not guarantee the facilities, they agreed to inject additional funds into the project after obtaining a discount on their term loan C participation.