Skip navigation
Ensuring a Safe and Sound Federal Banking System for All Americans Site Map | Text Size: S M L

BankNet

BankNet
Resources for bankers

Appeal of Shared National Credit (First Quarter 2017)

Background

A participant bank appealed the special mention rating assigned to a revolving credit facility during the first-quarter 2017 Shared National Credit (SNC) examination.

Discussion

The appeal asserted that the facility should be rated pass due to on-plan operating performance, strong liquidity, satisfactory transaction structure, and a path to positive free cash flow even in a downside scenario. The appeal acknowledged the company’s negative free cash flow, but stated that the company has continued to monetize inventory since 2014. The company plans to maximize long-term growth through headcount and engineering investments. The appeal argued that the company had on-plan operating performance for fiscal year 2016 as revenues exceeded projections, resulting in on-plan earnings before interest, taxes, depreciation, and amortization (EBITDA). The appeal noted the company’s strong cash liquidity position, an enhanced transaction structure with a minimum liquidity covenant, and a path to achieve positive free cash flow even in a downside scenario that includes low capital expenditures (capex).

Conclusion

An interagency appeals panel of three senior credit examiners concurred with the SNC examination team’s originally assigned risk rating of special mention due to the borrower’s weak performance to plan, undemonstrated ability to manage growth, high execution risk, and weak transaction structure.

The company exceeded revenue projections, but spent more than anticipated on personnel expenses, research and development (R&D), and capital investments resulting in negative EBITDA and negative free cash flow. While new forecasts have not been completed, losses are expected to continue for several years. The appeals panel acknowledged that the company currently does not have large capex.

The appeals panel determined that execution risk remains high as company management plans to continue a high growth trajectory, but has not demonstrated an ability to manage expenses related to personnel and R&D. Although liquidity is currently satisfactory, future cash requirements are uncertain given the company’s pace of growth.

The appeals panel also concluded that the transaction structure is weak. The revolving facility is unsecured with a large incremental borrowing capacity, and does not have any financial covenants other than a minimum liquidity requirement.