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Appeal of Shared National Credit (Third Quarter 2014)


A participant bank appealed the substandard ratings assigned to a term loan and revolving credit facilities during the 2014 Shared National Credit (SNC) examination. The appeal also disagreed with the troubled debt restructuring (TDR) treatment for the two facilities.


The appeal argued that a special mention rating was appropriate based on an error in earnings calculation when determining the company’s leverage ratio, the declining level and trend of leverage, sufficient fixed charge coverage (FCC) ratio and the borrower’s ability to repay 54 percent of total debt within seven years. The appeal also disagreed with the TDR treatment stating that no concessions were granted to the borrower at the time of the extension other than extending the maturity 90 days.

The appeal disagreed that the FCC ratio of 1.1 times was marginal. The bank stated that the FCC ratio was more than adequate and indicated excess free cash flow from operations given the company’s balance sheet debt reductions in 2012 and 2013.

The appeal stated that the determination that the company’s leverage ratio was high at 5.0 times as of fiscal year 2013 was based on an incorrect calculation for earnings that deducted rent expense and lack of consideration to the overall trend in leverage. The leverage ratio would be 25 percent lower without the deduction of rent expense. In addition, leverage at 5.0 times is at its lowest level in three years having declined from 5.2 times in 2013 and 5.3 times in 2012 and the company is within the leverage covenant of 5.25 times.


An interagency appeals panel of three senior credit examiners agreed with the SNC examination team’s originally assigned risk rating of substandard for the two facilities. The appeals panel agreed with the bank that the loans did not meet the definition of a TDR.

Regarding the company’s repayment capacity, the appeals panel stated that OCC Bulletin 2013 9, “Guidance on Leveraged Lending,” provides direction on assessing a borrower’s ability to de-lever to a sustainable level within a reasonable period. While the company’s repayment ability is above the thresholds noted in the guidance, the company exhibits well-defined weaknesses such as negative performance trends and covenant defaults. Earnings before interest, taxes, depreciation, and amortization expense (EBITDA) declined from $54 million in 2009 to $45.4 million in 2013 and the EBITDA margin declined from a high of 10.6 percent in 2009 to 8.8 percent in 2013. Lower margins have resulted in reduced FCC and covenant breaches in three consecutive quarters in 2013. Despite the declining trend, bank projections assume a 2 percent to 3 percent annual growth in EBITDA. Given the decline in EBITDA during the past two years, the inability of the company to meet projections, and the company’s poor financial performance, the appeals panel determined zero EBITDA growth as a more realistic scenario. This assumption decreases repayment capacity from 54 percent to 44 percent of total debt over seven years.

Regarding the earnings calculation for the leverage ratio, the appeals panel determined that the deduction of rent expense from earnings was not an error. The regulatory agencies have a standard practice of treating significant volumes of operating leases as debt-like obligations in estimating the financial leverage of the lessee and accordingly included those leases in the leverage calculation. While the borrower’s leverage declined a small degree in 2013, leverage remains high at 5.0 times and compares unfavorably to industry averages of between 2.4 times and 3.1 times. The high leverage also left the company vulnerable to market disruptions as evidenced by a year-over-year revenue decline in 2013 due to a much higher rainfall in its markets. In addition, declining earnings trends in the past two years that fell short of projections cast doubt on the reliability of future earnings and revenue projections.

Regarding the FCC ratio, the appeals panel stated that in recent years the company has only been able to achieve near break-even coverage of fixed charges with fiscal years 2012 and 2013 ratios resulting in 0.87 times and 1.1 times, respectively. In addition, the company was in default of the FCC covenant three consecutive quarters during 2013 due to the ratio falling below 1.0 times, resulting in the banks amending the covenant definition and lowering the minimum in 2012. Without the covenant definition amendment, the FCC ratio would be materially lower.

Regarding the TDR treatment, the appeals panel concurred that the two facilities would not qualify as TDRs due to the short 90-day duration of the loan extensions and the insignificant effect on the cash flows to the notes. ASC 310-40-15-17 provides the applicable guidance that states in part, “A restructuring that results in only a delay in payment that is insignificant is not a concession. The following factors, when considered together, may indicate that a restructuring results in a delay in payment that is insignificant. The amount of the restructured payments subject to the delay is insignificant relative to the unpaid principal or collateral value of the debt and will result in an insignificant shortfall in the contractual amount due.”