[Senate Hearing 108-939]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 108-939
 
                        REFORM OF THE TITLE XI 
                    MARITIME LOAN GUARANTEE PROGRAM

=======================================================================


                                HEARING

                               before the

                         COMMITTEE ON COMMERCE,

                      SCIENCE, AND TRANSPORTATION

                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                              JUNE 5, 2003

                               __________

    Printed for the use of the Committee on Commerce, Science, and 
                             Transportation


       SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION

                      ONE HUNDRED EIGHTH CONGRESS




                  U.S. GOVERNMENT PRINTING OFFICE
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                             FIRST SESSION

                     JOHN McCAIN, Arizona, Chairman
TED STEVENS, Alaska                  ERNEST F. HOLLINGS, South 
CONRAD BURNS, Montana                    Carolina, Ranking
TRENT LOTT, Mississippi              DANIEL K. INOUYE, Hawaii
KAY BAILEY HUTCHISON, Texas          JOHN D. ROCKEFELLER IV, West 
OLYMPIA J. SNOWE, Maine                  Virginia
SAM BROWNBACK, Kansas                JOHN F. KERRY, Massachusetts
GORDON H. SMITH, Oregon              JOHN B. BREAUX, Louisiana
PETER G. FITZGERALD, Illinois        BYRON L. DORGAN, North Dakota
JOHN ENSIGN, Nevada                  RON WYDEN, Oregon
GEORGE ALLEN, Virginia               BARBARA BOXER, California
JOHN E. SUNUNU, New Hampshire        BILL NELSON, Florida
                                     MARIA CANTWELL, Washington
                                     FRANK R. LAUTENBERG, New Jersey
      Jeanne Bumpus, Republican Staff Director and General Counsel
             Robert W. Chamberlin, Republican Chief Counsel
      Kevin D. Kayes, Democratic Staff Director and Chief Counsel
                Gregg Elias, Democratic General Counsel


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on June 5, 2003.....................................     1
Statement of Senator Breaux......................................    40
Statement of Senator McCain......................................     1
Statement of Senator Stevens.....................................    38

                               Witnesses

McCool, Thomas J., Managing Director, Financial Markets and 
  Community Investment, U.S. General Accounting Office...........    16
    Prepared statement...........................................    19
Mead, Hon. Kenneth M., Inspector General, U.S. Department of 
  Transportation.................................................     6
    Prepared statement...........................................     9
Schubert, Hon. William G., Administrator, Maritime 
  Administration, U.S. Department of Transportation..............     2
    Prepared statement...........................................     4

                                Appendix

American Shipbuilding Association, prepared statement............    47
Letter, dated May 13, 2009, from Arthur Imperatore, Jr., 
  President, New York Waterway, to Hon. John McCain, Chairman and 
  Hon. Ernest F. Hollings, Ranking Member........................    50
Response to written questions submitted by Hon. John McCain to:
    Thomas McCool................................................    55
    Hon. Ken Mead................................................    51
Response to written questions submitted by Hon. Ernest F. 
  Hollings to 
  Thomas McCool..................................................    58


                        REFORM OF THE TITLE XI 
                    MARITIME LOAN GUARANTEE PROGRAM

                              ----------                              


                        THURSDAY, JUNE 5, 2003,

                                       U.S. Senate,
        Committee on Commerce, Science, and Transportation,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 2:30 p.m. in room 
SR-253, Russell Senate Office Building, Hon. John McCain, 
Chairman of the Committee, presiding.

            OPENING STATEMENT OF HON. JOHN McCAIN, 
                   U.S. SENATOR FROM ARIZONA

    The Chairman. Good afternoon. The Committee meets today to 
examine the management problems concerning the Title XI 
Maritime Loan Guarantee Program which have been identified by 
the Department of Transportation Inspector General and the 
General Accounting Office. Their findings make it clear that 
the Maritime Administration has failed to protect the interests 
of the American taxpayers in its administration of the program. 
Therefore, short of abolishing this special-interest subsidy 
program, which is highly unlikely given the congressional 
rebuke of the President's attempts to zero out program funding 
over the last 3 years, it's essential that we address the 
identified problems and institute fundamental programmatic 
reforms.
    Title XI of the Merchant Marine Act of 1936 authorizes the 
Secretary of Transportation to make loan guarantees to finance 
the construction, reconstruction, or reconditioning of eligible 
vessels, and the modernization and improvement of shipyards. 
While the program was halted in the late 1980s after suffering 
billions of dollars in defaults, the program was reinstituted 
in 1993, following the enactment of the Federal Credit Reform 
Act and the National Shipbuilding and Shipyard Conversion Act.
    Proponents of the Title XI program claim that the defaults 
that occurred in the 1980s were due to the heavy concentration 
of guarantees for projects supporting the offshore oil industry 
and the significant downturn in that industry. Even MARAD 
agreed that the concentration of guarantees in one sector of 
the economy had a significant impact on the program. Yet the 
agencies allowed a similar situation to occur again.
    As noted in the Department of Transportation IG's report, 
released March 22, when American Classic Voyages filed for 
bankruptcy protection in October 2001, its subsidiaries held a 
total of six loan guarantees that accounted for over 25 percent 
of the value of the entire Title XI portfolio.
    While the DOT IG notes that the defaults did not affect the 
overall solvency of the program, it did force MARAD to pay out 
almost $330 million, including $136 million from the U.S. 
Treasury, to AMCV's creditors. The report also states that this 
concentration of loans with AMCV was, quote, the largest amount 
of loan guarantees issued to an affiliated group of entities in 
the life of the program.
    While claims have been made that the AMCV defaults were the 
result of a significant downturn in the cruise industry just 
before and after September 11, the IG reports that there was 
clear evidence well in advance of the industry downturn that 
AMCV was in financial trouble. Yet MARAD took no action to 
secure additional collateral to further protect the taxpayers' 
interest. In fact, because the guaranteed projects were owned 
by subsidiaries, AMCV was completely insulated from financial 
responsibility for the loans. And, guess what? The American 
taxpayer was left holding the bag.
    Both the DOT IG and the GAO have found that MARAD has 
failed to provide effective oversight in receiving and 
approving loan guarantees, has failed to closely monitor the 
financial condition of borrowers during the term of the loan, 
and has failed to adequately monitor the condition of projects 
subject to guarantees. They also found that MARAD was flagrant 
in its use of authority in granting waivers to its own 
regulations governing the program without taking steps to 
better secure the taxpayer against defaults.
    I want to acknowledge that MARAD is not alone in its 
culpability for problems with guarantee approvals. At least two 
of the projects received direct and indirect intervention by 
Congress that influenced the approval of guarantees on loans 
that later defaulted. This Congress knows best practice in 
determining which projects which receive approval must stop. If 
it does not, no amount of reform will work to improve the 
program's management and protect the taxpayers' interest.
    While I've been no fan of the Title XI program, I hope we 
can work together in a bipartisan effort with input from the 
Administration to reform the Title XI program to ensure it 
works in a way that both promotes the U.S. maritime industry 
and protects the taxpayers' interest.
    I welcome our witnesses, thank them for being here today 
and share their views on the program and recommendations for 
reform.
    We'll begin with the Honorable William G. Schubert, 
Administrator, Maritime Administration, U.S. Department of 
Transportation, followed by the Honorable Ken Mead, Inspector 
General, U.S. Department of Transportation, and Thomas J. 
McCool, Managing Director, Financial Markets and Community 
Investment, U.S. General Accounting Office.
    Welcome, Mr. Schubert.

             STATEMENT OF HON. WILLIAM G. SCHUBERT

             ADMINISTRATOR, MARITIME ADMINISTRATION

               U.S. DEPARTMENT OF TRANSPORTATION

    Mr. Schubert. Good morning, Mr. Chairman. I welcome the 
opportunity to appear before you today to discuss the Title XI 
Loan Guarantee Program administered by the Maritime 
Administration.
    I would like to request that my formal statement be 
accepted into the record.
    As you know, MARAD administers a government program of 
guaranteed private sector obligations commonly referred to as 
the Title XI program. The President's budget for Fiscal Years 
2002 and 2003 did not seek any new funding for Title XI loan 
guarantees. The President's budget request for Fiscal Year 2004 
also does not seek funding for Title XI guarantees. However, 
the emergency wartime supplemental appropriations for Fiscal 
Year 2003 provided $25 million for the cost of new guaranteed 
obligations which could leverage up to $400 million in new loan 
guarantees.
    None of the new Title XI funds may be obligated until the 
Department of Transportation Inspector General certifies to 
Congress that the recommendations contained in the recent IG 
report on the Title XI program have been implemented by MARAD. 
Further, the Bush Administration insists that any Title XI loan 
guarantee fully meet the eligibility requirements for economic 
soundness that lie at the heart of our approval process.
    The Title XI program has been utilized in the construction 
of many types of vessels which are built throughout the 
country. As of March 31, 2003, MARAD's Title XI portfolio 
totaled approximately $4.6 billion, consisting of $3.4 billion 
in executed guarantees and $1.2 billion in guarantee 
commitments. The $3.4 billion in executed guarantees represents 
102 projects for 815 vessels and four shipyard modernizations.
    I believe it is critical that MARAD administer the program 
efficiently and effectively so as to provide the greatest value 
to the American taxpayer. This is a responsibility that I take 
seriously, and I look forward to the opportunity to improve 
this program.
    I will summarize the information contained in my formal 
testimony by stating that MARAD is actively implementing needed 
Title XI program management improvements that were outlined in 
the IG's Title XI audit report. Overall, MARAD is in complete 
agreement with the IG's recommendations, and we are working 
with the Office of the Inspector General to implement these 
recommendations and changes.
    Specifically, we are working to develop more effective 
program controls, such as imposing compensating measures such 
as liens on unencumbered collateral or requiring greater 
amounts of project equity as a consideration for modifying or 
waiving MARAD's standard financial criteria. Also, we agree 
with the IG that the use of outside financial advisors, in 
appropriate cases, would be beneficial. In MARAD's Fiscal Year 
2004 authorization proposal, we seek the authority to engage 
such financial advisors at the expense of prospective 
borrowers.
    Regardless of whether the program is provided additional 
funding by Congress, there are a number of changes that MARAD 
is making in the management of the outstanding portfolio. For 
example, we are enhancing the financial monitoring process in 
our current loan portfolio by transferring this responsibility 
to MARAD personnel that have the best financial skills and 
expertise. These employees now perform regular assessments of 
the financial health of each Title XI company. We have also 
instituted a credit watch report to identify those companies 
experiencing financial difficulties.
    Last, in order to establish a formal process for monitoring 
the physical condition of the guaranteed assets over the term 
of the loan guarantee, from vessel construction to active 
service, MARAD is developing a reporting system to obtain 
relevant information from the class society during the vessel 
construction period and from the Coast Guard class societies 
and insurance companies when the assets are completed and put 
into service. MARAD is also reviewing its procedures for the 
management, maintenance, and liquidation of defaulted assets to 
see what improvements can be made.
    The Committee has expressed interest in both the AMCV 
bankruptcy and the Quincy Massachusetts Heavy Industry Title XI 
defaults, which were also addressed in the IG's audit. The 
Project America and Quincy defaults and MARAD's subsequent 
actions are detailed in my formal testimony.
    Thank you for the opportunity to talk about the Maritime 
Administration and the Title XI program. This concludes my 
prepared statement, and I will be happy to answer questions at 
the appropriate time.
    [The prepared statement of Mr. Schubert follows:]

    Prepared Statement of Hon. William G. Schubert, Administrator, 
       Maritime Administration, U.S. Department of Transportation
    Good Afternoon, Mr. Chairman and Members of the Committee:
    I welcome the opportunity to appear before you today to discuss the 
Title XI Loan Guarantee Program administered by the Maritime 
Administration (MARAD). Much has happened in this area since my 
confirmation as Maritime Administrator just a year and a half ago.
    As you know, MARAD administers a Government program of guaranteed 
private sector obligations, commonly referred to as the Title XI 
program. Under Title XI of the Merchant Marine Act, 1936, the agency is 
authorized to assist private companies in obtaining financing for the 
U.S. construction of vessels or the modernization of U.S. shipyards. 
MARAD guarantees full payment to the lender of the unpaid principal and 
interest of an obligation in the event of default by a vessel owner or 
shipyard. The issuance and administration of Title XI loan guarantees 
are governed by regulations. Title XI loan guarantees enable vessel 
owners and shipyards to borrow private sector funds on more favorable 
terms than might otherwise be available, and thereby stimulate 
commercial shipbuilding in the United States.
    The President's budget for Fiscal Years 2002, 2003, and 2004 did 
not seek new funding for Title XI loan guarantees. Instead, the 
Administration proposed that MARAD continue to manage the existing 
guarantee portfolio and associated financial activity with funds 
requested for the administration of the program. However, P.L. 108-11, 
Making Emergency Wartime Supplemental Appropriations for the Fiscal 
Year Ending September 30, 2003, provided $25 million for the costs of 
new guaranteed obligations. Utilizing a risk factor of 6.21 percent, 
the $25 million appropriation could leverage up to $400 million in new 
loan guarantees.
    None of the new Title XI funds may be obligated or expended until 
the Department of Transportation Inspector General (DOT IG) certifies 
to Congress that the recommendations contained in a recent DOT IG 
Report on the Title XI Program have been implemented by MARAD.
    MARAD is already implementing needed Title XI program management 
improvements, which I will describe below. It is important to note that 
Congress has occasionally targeted Title XI funds for specific 
projects. In one instance, Congress directed MARAD to relax program 
eligibility requirements. A small number of loans that were targeted by 
Congress account for a large amount of recent Title XI default 
obligations. Details about several of them are contained in the IG's 
report and testimony.
    The Bush Administration has insisted that any Title XI loan 
guarantee fully meet the eligibility requirements for economic 
soundness that lie at the heart of our approval process. It is critical 
that MARAD administer the program efficiently and effectively so as to 
provide the greatest value to the American taxpayer. This is a 
responsibility that I take seriously and I look forward to the 
opportunity to improve this program.
    In the past, the Title XI Program has been utilized in the 
construction of many types of vessels, which are built throughout the 
country. As of March 31, 2003, MARAD's Title XI portfolio totaled 
approximately $4.6 billion, consisting of $3.4 billion in executed loan 
guarantees and $1.2 billion in loan guarantee commitments. The $3.4 
billion in executed loan guarantees represents 102 projects for 815 
vessels and 4 shipyard modernizations.
    The DOT IG recently issued a report on the audit of the Title XI 
Loan Guarantee Program. The DOT IG report made the following five 
recommendations, which are all based upon the assumption that Congress 
will continue to fund this program despite the Administration's 
request: (1) that MARAD require a rigorous analysis of risks from 
modifying any loan approval criteria and impose compensating provisions 
on the loan guarantee to mitigate those risks; (2) that MARAD formally 
establish an external review process as a check on MARAD's internal 
loan application review and as assistance in crafting loan conditions 
and covenants; (3) that MARAD establish a formal process for 
continuously monitoring the financial condition of borrowers, including 
requirements for financial reporting over the term of the guarantee as 
a condition of loan approval; (4) that MARAD establish a formal process 
to continuously monitor the physical condition of guaranteed assets 
over the term of the loan guarantee; and (5) that MARAD establish an 
improved process to monitoring the physical condition of foreclosed 
assets and for recovering the maximum amount of funds from their 
disposal.
    MARAD has been working closely with the IG to develop more 
effective program controls and we are in complete agreement with the 
report's overall recommendations. MARAD noted that more favorable terms 
are offered to the Title XI loan guarantee applicants than are offered 
by commercial lenders as a result of the statutory full faith and 
credit guarantee of the United States. MARAD's response also noted that 
in a number of instances where defaults have occurred, it has been due 
to high levels of political interest and pressure brought upon the 
agency to overlook underwriting requirements. For example, the default 
of the Quincy Shipyard project is directly attributed to the specific 
statutory direction of Congress for MARAD to approve the guarantee 
without regard to economic soundness.
    MARAD agreed with the DOT IG's suggestion that, as consideration 
for modifying or waiving financial criteria, MARAD could impose 
compensating measures such as liens on unencumbered collateral or 
requiring greater amounts of project equity. Because the program may be 
funded, we will continue to explore and implement these options.
    MARAD also agreed with the DOT IG that the use of outside financial 
advisors, in appropriate cases, would be beneficial. To that end, 
MARAD's Fiscal Year 2004 authorization proposal seeks the authority to 
engage such financial advisors, at the expense of the prospective 
borrower. The use of financial advisors would be most appropriate for 
uniquely complicated projects. Based on our experience, we believe that 
the assessment of a new market or a new type of service, including the 
use of new technology, is likely to be the area where a financial 
advisor would be warranted. The experience of the Export-Import Bank 
provides a useful model for the use of financial advisors as part of a 
project review.
    Regardless of whether the program is given additional funding by 
Congress, there are a number of changes MARAD will make in the 
management of the outstanding portfolio, as recommended by the DOT IG. 
For example, the financial monitoring process is being improved on 
those loan guarantees already in place. To that end, we have 
transferred the oversight responsibility to our Office of Ship 
Financing which now performs regular assessments of the financial 
health of each Title XI company. We will also institute a periodic 
``credit watch'' report for the use of senior agency management which 
will identify those Title XI companies experiencing financial 
difficulties. In addition, MARAD will implement within 3 months a 
formal process for review of these statements and, in addition to the 
``credit watch,'' will look to see what outside sources may be 
available to assist in this area.
    Lastly, in order to establish a formal process for monitoring the 
physical condition of guaranteed assets over the term of the loan 
guarantee, MARAD is developing a reporting system to obtain relevant 
information from the class society during the vessel construction 
period and from the Coast Guard, the class society and insurance 
companies over the term of the loan guarantee after the assets are 
completed and put into service. MARAD is also reviewing its procedures 
for maintaining defaulted assets to see where improvements can be made.
    The DOT IG report specifically addressed the AMCV bankruptcy, 
concluding that although it significantly affected the Title XI 
Program, it did not threaten its solvency. The AMCV project was the 
result of the U.S.-Flag Cruise Ship Pilot project statute enacted by 
Congress in October 1997. Under this legislation, a company that 
entered into a construction contract to build two new cruise vessels in 
a U.S. shipyard was given the right to operate a foreign-built cruise 
ship in the Hawaiian trade for up to 2 years following delivery of the 
second vessel. The legislation required that the construction contracts 
be entered into by April 8, 1999.
    In April 1999, MARAD issued a Title XI commitment for two cruise 
ships to be operated in Hawaii and owned by subsidiaries of Project 
America, Inc., which in turn was a subsidiary of AMCV. A Title XI 
closing was held in February 2000. Ingalls Shipbuilding, a subsidiary 
of Northrup Grumman Corporation, in Pascagoula, Mississippi was the 
shipyard. The projected cost for both vessels was approximately $1.2 
billion and a Title XI approval was issued for about $1.1 billion, 
representing 87.5 percent of the vessel's cost. Title XI obligations 
were not issued with respect to the second vessel.
    In October 2001, AMCV, the parent of the Project America Ship I 
(PASI) and Project America Ship II (PASII), the shipowners, filed for 
bankruptcy protection. Northrop Grumman Corporation, the parent of the 
shipyard, Ingalls Shipbuilding, requested approval of the issuance of 
an additional $915 million in Title XI indebtedness to the shipowners 
to complete the two vessels. MARAD declined. The shipowner defaulted on 
the entire Title XI debt on October 31, 2001 resulting in a demand 
under the Title XI guarantee. MARAD honored its guarantee and paid off 
$187 million on December 17, 2001.
    MARAD had a security interest in the partially completed PASI 
vessel. In May of 2002, MARAD authorized Ingalls to sell the hull and 
equipment and account to MARAD for the net profits. In May of 2002, 
Ingalls sold both the PASI hull and PASII equipment to Norwegian Cruise 
Lines for $23 million. Ingalls and MARAD agreed that $14 million of the 
sale were attributable to the PASI assets and that $12 million of those 
proceeds were necessary to complete the hull sufficiently to make it 
floatable and towable in international waters. Thus, MARAD retained $2 
million from the net sale proceeds of the PASI assets.
    The Committee also previously expressed interest in Massachusetts 
Heavy Industries, Inc. (MHI) default on a Title XI loan for the 
reactivation of the Fore River Shipyard in Quincy, Massachusetts. As 
you recall, the Coast Guard Authorization Act of 1996 contained a 
provision that directed MARAD to waive the primary statutory 
requirement for a finding of economic soundness for this project. I 
would like to update you on the status of the Government's efforts to 
recoup its funds.
    To date, MARAD has received about $35 million--a recovery of about 
55 percent of the approximately $64 million paid out by the agency in 
connection with this project. On January 16, 2003, MARAD auctioned the 
shipyard real estate and personal property for an aggregate of $11.8875 
million. Previously, MARAD had received approximately $23 million from 
an escrow account belonging to MHI, monies contributed by the 
Commonwealth of Massachusetts, and fees paid by MHI. In February of 
2000, MARAD honored its guarantee of MHI's financial obligations and 
paid bondholders $59.1 million in principal and accrued interest. 
Subsequently, as custodian of the shipyard, MARAD expended substantial 
funds in the custodial upkeep and security of the property, 
environmental clean up and environmental studies to prevent the 
commission of toxic torts from materials improperly marked and 
maintained by MHI, payments to a bankruptcy court approved post 
petition senior mortgagee, and other foreclosure expenses, which are 
included in the $64 million total. MARAD continues to be involved in 
litigation regarding the sale of the property.
    Thank you for the opportunity to talk about the Maritime 
Administration and the Title XI program. This concludes my prepared 
statement. I would be happy to answer any questions you may have at 
this time.

    The Chairman. Thank you.
    Mr. Mead?

  STATEMENT OF HON. KENNETH M. MEAD, INSPECTOR GENERAL, U.S. 
                  DEPARTMENT OF TRANSPORTATION

    Mr. Mead. Thank you, Mr. Chairman.
    Our work found that significant reforms are needed in 
nearly every phase of the Title XI program. I'd like to offer 
an overview of the four specific areas that are in need of 
reform and what we recommend be done.
    In a program like this, there's no reform that I can 
recommend that's going to be a panacea against defaults, but 
they'll go a long way, I think, toward better protecting the 
interests of the taxpayers who ultimately, of course, are going 
to foot the bill.
    I'd like to give you a quick overview of where these 
defaults occurred. The largest were by American Classic Voyages 
Company, AMCV for short. That was construction and renovation 
of five passenger cruise ships. Of $330 million in defaulted 
funds, MARAD was able to recover only $17 million. And, as you 
noted, the loan guarantees that went out to these people 
comprised about 25 percent of the total portfolio. That's a lot 
of eggs in one basket.
    If there's a silver lining in that, though, it's that 
things could have been much worse. And at the time of this 
bankruptcy, AMCV had an additional $895 million in committed 
but not yet disbursed funds. So when they went bankrupt, the 
fact that some of the money hadn't been disbursed was a good 
thing.
    The other ones, though, were Quincy Shipyards and Searex. 
And I think there are some similarities between all three of 
these. But Quincy Shipyard, that default was really not for 
construction of a boat or a ship; it was for the renovation of 
a shipyard in Quincy, Massachusetts. And the other one was for 
Searex. That was for four oil-drilling platforms. I guess these 
are vessels that help build the oil rigs. After the sale of 
assets, the combined cost to the taxpayers of both of those 
defaults was around $90 million.
    So let me turn to the specific reforms that need to be 
made. As Administrator Schubert mentioned, these reforms were 
recently incorporated into law, but that's just for this year's 
appropriation. And I would caution that if you want something 
more long term, that'll have to be done through authorizing 
legislation.
    So here are the reforms. First, when MARAD waives or 
modifies established loan criteria that are spelled right out 
in the Code of Federal Regulations, when they're going to waive 
or modify them, they need to put something in place, require 
some type of security in exchange for the assumption of the 
additional risk by the government. In every one of the nine 
loan guarantees that went into default since 1998, all of them 
were approved with waivers to one of the normal financial 
criteria without a sufficient compensating provision to protect 
the taxpayer.
    What do I mean by established normal financial criteria 
that was waived? Things like, that working capital be at least 
one dollar. That was waived in a number of cases. That the 
long-term debt not exceed two times the company's net worth was 
another one that was waived.
    As an example of a concrete example, of one, the guarantee 
for the Columbia Queen, which was an AMCV vessel, that waived 
the requirement for a minimum amount of equity. And MARAD did 
require a guarantee from the parent company, AMCV, for its 
shell company that it had created specifically to apply for the 
loan. But that guarantee wasn't backed by any unencumbered 
assets. So the parent was not really pledging any assets as 
collateral in the event of the shell company's default. And at 
the time of the default, the financial condition of the parent 
company was in a state of steady free-fall.
    Second, MARAD ought to establish an external loan-review 
process that's independent, and it would be very similar to the 
one that the Export-Import Bank of the United States has in 
place. Why is that necessary? Well, one, MARAD needs more 
technical expertise. It doesn't have as much in-house technical 
expertise as we would like to see. And, number two, from time 
to time, political pressures are brought to bear on MARAD, and 
I think MARAD needs to have an external review process in place 
so you have the credibility of an outside opinion that's going 
to come in and say, ``This is why this loan guarantee ought to 
be denied or approved, or here are the conditions that ought to 
be put in place.''
    And third is, we ought to proactively monitor the financial 
condition of both the borrowers and their parent companies over 
the term of the loan guarantee. We found that rather than 
proactive monitoring, MARAD tended to be reactive to loan 
problems after they occurred or while they were occurring. And 
yet firms rarely find themselves forced to default on loans 
without a lot of warning signs.
    AMCV stock price is a case in point. This was on a downward 
spiral for nearly 2 years before its bankruptcy. It dropped 
from $35 a share to something in the neighborhood of 50 cents a 
share. And during that same two-year period, three separate 
loan guarantees, totaling nearly a quarter of a billion 
dollars, were approved. And the last guarantee was approved in 
June 2001, just on the heels of a year where the company 
reported an annual loss of about 10 million.
    Also, when these warning signs start to appear, it's 
important that MARAD be in a position to trigger covenants in 
the agreements that it has with either the parent or the 
subsidiary to protect against--to protect the taxpayers' 
interest. And we refer to these as ``enhanced self-help 
measures.'' They might include MARAD prohibiting the payment of 
cash dividends and reducing executive compensation packages.
    Fourth, and finally, MARAD needs to pay close attention to 
the physical condition of secured assets, both during the loan 
guarantee and if there is a default. And that's so you can 
maximize the value of what is left for the taxpayers.
    In the Searex case, they entered Chapter 11 bankruptcy, and 
the uncompleted hulls of three of the Searex ships were chopped 
up by the shipyard in order to make room for them to build a 
series of luxury cruise ships. And the value of the dismantled 
hulls, of course, was significantly less than if MARAD had 
taken possession of the hulls in their original state.
    And then, finally, I would add that I do believe MARAD has 
been very responsive to our recommendations. It's going to take 
awhile to implement them, but they're moving forward. I think 
we have a good working relationship with them. And I only hope 
that they are permanent, and not just for the tenure of my 
colleague here, Administrator Schubert.
    Thank you, sir.
    [The prepared statement of Mr. Mead follows:]

    Prepared Statement of Hon. Kenneth M. Mead, Inspector General, 
                   U.S. Department of Transportation
    Mr. Chairman, Senator Hollings, and Members of the Committee:
    Thank you for the opportunity to share our views with you today on 
the Maritime Administration's Title XI Loan Guarantee Program 
(Program). Our comments reflect the findings and recommendations of the 
audit report we issued this past March. We undertook the audit as a 
result of the Chairman's request to perform a comprehensive review of 
the Title XI Program and to assess the impact of the American Classic 
Voyages Co. (AMCV) bankruptcy filing on it.
    Title XI of the Merchant Marine Act of 1936, as amended, 
established the Federal Ship Financing Guarantee Program to assist 
private companies in obtaining financing for the construction of ships 
or the modernization of U.S. shipyards. This Program authorizes the 
Federal Government to guarantee full payment to the lender of the 
unpaid principal and interest of a commercial debt obligation, with the 
Government holding a mortgage on the equipment or facilities financed.
    As you are aware, the demand for this audit was driven, in part, by 
the recent, unsettling increase in defaulted loans in the Program that, 
while not as severe, seemed to echo the problems of the late 1980s. 
Between 1985 and 1987, 129 defaults occurred in the Program, and the 
Maritime Administration (MARAD) paid out approximately $2 billion in 
guarantees.\1\ The Federal Credit Reform Act was enacted in 1990 to 
improve the performance of Federal credit programs. The Act required 
more accurate measurements of the costs of credit programs and 
established budgetary controls on loan programs, including requiring 
appropriations to cover the estimated credit costs of a project prior 
to the issuance of any approvals for financing. In the 5 years 
following implementation of this Act (1993 through 1997), only three 
MARAD loans defaulted, totaling approximately $12 million.
---------------------------------------------------------------------------
    \1\ Unless otherwise indicated, all years are Federal Fiscal Years.
---------------------------------------------------------------------------
    In the last 5 years (1998 to 2002), however, this improved 
performance has faltered. Nine MARAD loans have defaulted, six of which 
have occurred since December 2001, totaling approximately $490 million 
in payouts and $402 million in net payouts after recoveries. The 
biggest impact came from the bankruptcy of AMCV. Defaulted loans to 
AMCV represent 67 percent ($330 million) of the payouts and 78 percent 
($313 million) of the net payouts after recoveries. (See Table 1.)

                            Table 1--Recent Payouts and Recoveries on Defaulted Loans
----------------------------------------------------------------------------------------------------------------
                     Year of                          Project/Vessel     Guaranteed     Paid-Out      Recovered
 Date of  Default     Origin         Company               Name            Amount      Amount \2\    Amount \3\
----------------------------------------------------------------------------------------------------------------
2/1998                  1996   Surf Express, Inc.  FastCat Catamaran    $  1,701,000  $  1,788,854   $   100,000
2/2000                  1997   MHI, Inc.           Shipyard               55,000,000    59,071,658    24,108,619
                                                    Modernization
3/2001                  1995   SEAREX, Inc.        Moses-Class Vessels    77,269,000    78,099,782    25,405,708
12/2001                 1999   AMCV                Project America 1     185,000,000   187,317,445     7,425,416
                                                    Cruise Ship
12/2001                 2000   AMCV                Cape Cod Light         38,500,000    40,376,340     8,264,783
12/2001                 2000   AMCV                Cape May Light         37,900,000    39,769,997       703,947
1/2002                  1995   AMCV                SS Independence        33,334,000    25,185,531             0
1/2002                  2001   AMCV                Columbia Queen         35,471,000    37,007,570             0
3/2002                  1997   Friede Goldman      Shipyard               24,817,000    20,884,647    21,300,000
                                Offshore            Modernization
----------------------------------------------------------------------------------------------------------------
                     Totals through January 2003:                       $488,992,000  $489,501,824   $87,308,473
----------------------------------------------------------------------------------------------------------------
Source: MARAD

    At the time of its bankruptcy, AMCV accounted for $1.3 billion 
(over one-quarter) of MARAD's total $4.9 billion Title XI loan 
guarantee portfolio. This $4.9 billion consisted of $3.1 billion in 
executed loan guarantees and $1.8 billion of loan guarantee 
commitments.\4\ Of the $1.3 billion in loan guarantees and commitments 
to AMCV, $368 million (original amount) was for guarantees, which have 
since defaulted, and $895 million was for commitments.
---------------------------------------------------------------------------
    \2\ These amounts include accrued, unpaid interest as well as the 
outstanding principal.
    \3\ These amounts include recoveries from escrowed funds (as of 
January 2003).
    \4\ Executed loan guarantees are legal obligations (by MARAD) to 
pay off the debt if an applicant defaults on a loan. Loan guarantee 
commitments are legal agreements, stated in a commitment letter, 
stipulating that MARAD will issue a loan guarantee for the project if 
the applicant fulfills agreed-upon terms and there are no material 
changes in circumstances.


    These losses have generated both public and congressional concerns 
regarding whether the Program is adequately protecting the Government's 
financial interests. Concerns also exist regarding the potential for 
additional defaults and losses to the Government, given the uncertain 
financial status of some of the companies with guaranteed loans. Our 
audit identified a number of areas where MARAD could improve its 
Program practices, limit the risk of default, and reduce losses to the 
Government. We also identified steps that MARAD can take to 
significantly improve the Program, including the use of compensatory 
loan provisions to reduce risk, improved loan application review 
procedures, more rigorous financial oversight of borrowers during the 
term of loan guarantees, better monitoring and protection of vessels 
and shipyards while under a guarantee, and more effective stewardship 
of assets acquired through foreclosures.
    MARAD should require a rigorous analysis of the risks that arise 
from modifying loan approval criteria and, to mitigate those risks, 
should impose compensating provisions on the loan guarantee such as 
more collateral or higher equity contributions from the borrower. MARAD 
routinely modifies financial requirements in order to qualify 
applicants for loan guarantees. Such modifications increase the risk of 
the loan guarantee to the Government, and MARAD should impose stricter 
compensating loan provisions and covenants on borrowers to mitigate 
those risks. All nine of the loans that have gone into default since 
1998 were approved with modifications to some of the financial 
criteria. For example, the Project America loan guarantee included a 
waiver of the working capital requirement. MARAD secured a parent 
company guarantee from AMCV, but it was not backed by any unencumbered 
assets.
    MARAD should establish an external review process as a check on its 
internal loan application review and as assistance in crafting prudent 
loan conditions and covenants. MARAD currently assesses loan guarantee 
applications primarily with its own staff, but it would benefit from 
the use of an additional external review using contract resources that 
are fully reimbursed by the borrower. Such reviews would provide 
additional, credible information for loan guarantee approval or denial 
and would assist in devising loan packages that reduce the risks to the 
Government. These external reviews should include at least four 
elements: an assessment of the borrower's business plan, an evaluation 
of the borrower's credit risk, an assessment of the value of 
collateral, and a summary analysis that includes a recommendation on 
whether to approve the loan guarantee and on what terms. The Export-
Import Bank of the United States uses a similar approach in its loan 
guarantee program.
    MARAD should establish a formal process for continuously monitoring 
the financial condition of borrowers, including requirements for 
financial reporting over the term of the guarantee as a condition of 
loan approval. MARAD does not closely monitor the financial health of 
its borrowers; rather, it tends to be reactive to loan problems after 
they occur. Yet, firms rarely find themselves forced to default on 
loans without many preceding quarters of financial results that 
indicate developing financial distress. For example, AMCV's stock price 
was on a downward trend for nearly 2 years before its bankruptcy, and 
its net income declined continuously over 4 years from 1997 to 2000, 
from a positive $2.4 million to a negative $10.1 million. To become 
more proactive, MARAD loan guarantees should include stronger financial 
covenants on its borrowers' required financial performance and 
condition, and enhanced self-help measures should those covenants be 
violated. Most importantly, MARAD needs to maintain rigorous financial 
scrutiny of its borrowers to ensure these covenants are met and 
vigorous enforcement of its self-help prerogatives if they are not.
    MARAD should establish a formal process for continuously monitoring 
the physical condition of guaranteed assets over the terms of loan 
guarantees, and institute an improved process for monitoring the 
physical condition of foreclosed assets to ensure the Government 
recovers the maximum amount of funds from their disposal. MARAD does 
not closely monitor the physical condition of the vessels and property 
financed with guaranteed loans either during the loan period or after 
foreclosures. If borrowers experience financial difficulties, they may 
be inclined to under-maintain assets constructed with loan guarantees. 
MARAD staff conduct site visits on guaranteed vessels or property only 
on an episodic basis, usually in response to problems identified by 
borrowers or third parties. For example, at the time of AMCV's 
impending bankruptcy, MARAD officials we spoke with were not fully 
aware of the current condition and status of four of the five vessels 
whose loans ultimately defaulted. Regular, periodic inspections, 
particularly of those assets operated by firms in financial difficulty 
as identified by financial monitoring, would better ensure the value of 
assets to the Government.
    MARAD has acknowledged that it needs to improve administration and 
oversight in all phases of the Title XI loan process. MARAD agreed with 
our five recommendations for improving oversight and is working to put 
these recommendations into practice. Specifically, MARAD has committed 
to tightening the controls over the approval and monitoring of loan 
guarantees and to taking more timely action to recover the maximum 
amount possible from foreclosed assets in the event of loan defaults.
    MARAD's response to our audit report indicates that, in a number of 
instances where defaults have occurred, it has been due to political 
pressures to approve loan guarantees by overlooking underwriting 
requirements. Nevertheless, implementation of our recommendations 
regarding application review, both internal and external, should 
improve the credibility of MARAD's denial decisions when underwriting 
requirements are not met. In cases where the application is approved, 
our recommendations regarding protective covenants, financial 
monitoring, and asset monitoring should reduce the risk and size of 
losses to the Government.
    The Office of Inspector General must certify that our 
recommendations have been implemented. Public Law 108-11, Making 
Emergency Wartime Supplemental Appropriations for the Fiscal Year 
Ending September 30, 2003, appropriated $25 million to MARAD for new 
loan guarantees. According to MARAD, based on average risk premiums, 
these funds would likely guarantee loans with a face value of about 
$400 million and are available for obligation until September 30, 2005. 
Before these funds can be obligated, the law mandates that MARAD 
implement the recommendations in our report and that we certify to the 
Congress that our recommendations have been met.
    We are working with MARAD to analyze the new processes that it has 
proposed putting in place to meet the intent of our recommendations, 
and we will audit MARAD's compliance with the new processes once they 
are in use. We think it is important that these processes are not 
merely plans, but that they are in place, are being observed, and are 
working before we certify compliance. In this regard, some 
recommendations, such as those relating to compensating covenants in 
new guarantees, can only be verified after new loan guarantees are 
executed. Therefore, we may need to ``certify in principle'' that these 
recommendations have been implemented and then follow up with 
additional verification once the $25 million has been released.
Background
    Title XI of the Merchant Marine Act of 1936, as amended, 
established the Federal Ship Financing Guarantee Program to assist 
private companies in obtaining financing for the construction of ships 
or the modernization of U.S. shipyards. This Program authorizes the 
Federal Government to guarantee full payment to the lender of the 
unpaid principal and interest of a mortgage in the event of default by 
a vessel or shipyard owner. Title XI was amended in 1972 to provide 
Government guarantees to commercial debt obligations, with the 
Government holding a mortgage on the equipment or facilities financed.
    Regulations implementing the Merchant Marine Act of 1936 [Title 46 
Code of Federal Regulations (CFR) Section 298] outline the application 
process for Title XI loan guarantees and require MARAD to assess the 
economic feasibility and the financial viability of an applicant's 
project. Upon approval of an application, MARAD agrees to guarantee 
these obligations with the full faith and credit of the U.S. Government 
through a commitment letter to the applicant. The applicant must 
provide at least 12.5 percent to 25 percent (depending on project use) 
of the project's estimated cost as equity, and a commercial financial 
institution issues obligations for the remainder.\5\
---------------------------------------------------------------------------
    \5\ These are bonds, notes, debentures or other evidence of 
indebtedness.
---------------------------------------------------------------------------
    Applicants generally receive more favorable loan terms than are 
available in the commercial market without a guarantee. The Program has 
contributed to preserving a U.S. commercial fleet and modernizing U.S. 
shipyards. Vessels financed using loan guarantees include double-hull 
oil tankers, passenger ferries, cruise ships, and offshore drilling 
rigs. Shipyard modernizations have included capital improvement 
projects at shipyards located on the east, gulf, and west coasts.
    As of December 31, 2002, MARAD's Title XI portfolio totaled 
approximately $4.3 billion, consisting of $3.4 billion in executed loan 
guarantees (formal agreements to issue obligations) and $849 million of 
loan guarantee commitments (formal offers for guarantees). The $3.4 
billion in executed loan guarantees represents 103 projects for 818 
vessels and 4 shipyard modernizations. Included in the Title XI 
portfolio are eight projects totaling about $226 million in commitments 
that MARAD approved in 2002. As of December 31, 2002, MARAD had 26 
pending applications that requested about $5.7 billion of Title XI 
financing.
MARAD Could Reduce the Risk of Losses Through Compensatory Loan 
        Provisions Such as More Collateral and Higher Equity 
        Contributions
    MARAD currently assesses loan guarantee applications primarily with 
its own staff using financial criteria in regulations adopted from the 
Merchant Marine Act of 1936, as amended.\6\ Routinely, however, MARAD 
modifies these financial requirements to allow applicants to qualify 
for loan guarantees, and these modifications lead to increased risk of 
loss. All nine of the loans that have gone into default since 1998 were 
approved with modifications to some of the financial criteria. For 
example, the Project America loan guarantee included a waiver of the 
working capital requirement.\7\ Other applicants had long-term debt-to-
equity ratios of more than the 2 to 1 permitted in the regulations. In 
fact, one active project, approved for a loan guarantee of over $15 
million, had a debt-to-equity ratio of more than 4 to 1.
---------------------------------------------------------------------------
    \6\ 46 CFR 298.13
    \7\ Working capital is the difference between a company's short-
term assets (such as cash, marketable securities, accounts receivable, 
and inventories of raw materials and finished goods) and liabilities 
(accounts payable, short-term loans, and the current portion of long-
term debt). Working capital roughly measures a company's potential 
reservoir of cash to maintain its solvency if unforeseen circumstances 
arise.
---------------------------------------------------------------------------
    Although MARAD's regulations permit modifications and they may be 
appropriate in some cases, MARAD should impose compensating conditions 
on the borrower to offset the increased risk to the Government. This is 
particularly true because vessels under construction may have little or 
no value if the vessel is incomplete at the time of default. For 
example, the hull and materials for a vessel being built for Project 
America, Inc., a subsidiary of AMCV, and guaranteed by MARAD for $185 
million, were recently sold by the shipyard, with MARAD recovering only 
$2 million. This subsidiary had no assets beyond the guaranteed vessel, 
as in all six of the loans to AMCV subsidiaries.
    MARAD often accepts parent company guarantees of loan repayment for 
a subsidiary that either cannot qualify for a loan guarantee on its own 
or cannot qualify without modifications to the loan criteria. In 50 
percent of the projects we examined (21 of 42), the applicants could 
not independently qualify for a loan guarantee, had few or no assets to 
offer as collateral, and provided a parent company guarantee as the 
sole form of security. When these parent company guarantees are general 
pledges by the company to honor the loan commitment and do not 
specifically pledge unencumbered assets as collateral, these guarantees 
provide no real security if the parent company itself is not 
creditworthy or has few unencumbered assets, as was the case in six of 
nine recent defaults.
    MARAD can prevent this problem by requiring parent company pledges 
to be backed by liens on other unencumbered assets, requiring greater 
amounts of project equity from the applicants, or having a greater 
portion of the risk assumed by the applicant's lender. This approach 
should be feasible because many Title XI applicants are subsidiaries of 
parent companies that have other assets and financial resources. For 
example, MARAD approved a loan guarantee for over $150 million to a 
company for an oil-drilling unit without requiring a lien on other 
assets, yet the company had a number of other unencumbered assets it 
could have used to secure the guarantee.
MARAD Would Benefit From External Review of Applications
    MARAD primarily conducts in-house reviews of applications and does 
not routinely obtain independent assessments of proposed projects to 
determine if they are economically and financially sound. MARAD 
officials have acknowledged a lack of in-house expertise to review 
projects that employ new technologies, are financially complex, or are 
high-cost. Independent assessments of such projects would assist MARAD 
in its internal analysis and reduce the risk of default and loss to the 
Government. MARAD officials noted that a current application for about 
$750 million in loan guarantees for two high-speed container vessels is 
being reviewed by an outside firm due to the ships' cost, the use of 
new technology, and the start-up nature of the company.
    Independent external reviews should be paid for by borrowers and 
should encompass four elements: an assessment of the borrower's 
business plan; an evaluation of its credit risk; an independent 
assessor's analysis of the current market value of collateral and any 
encumbrances; and an independent summary analysis of the loan guarantee 
application that includes a recommendation on whether to approve the 
loan and on what terms.
    The Export-Import Bank of the United States (Bank), which operates 
a loan guarantee program, uses such external review. For projects with 
financial transactions that exceed $30 million, the Bank hires outside 
independent financial, legal, and technical advisors. After the Bank 
selects the advisor, the applicant is required to pay an evaluation fee 
and execute a contract with the advisor. The Bank uses the advisor's 
report as part of the evaluation package to determine if a loan 
guarantee will be made.
MARAD Could Better Protect Its Interests Through Improved Oversight of 
        Borrowers Over the Duration of Their Loans
    MARAD does not closely monitor the financial health of its 
borrowers over the term of its loan guarantees. Currently, borrowers 
submit annual audited financial statements to MARAD as well as selected 
financial information on a semi-annual basis. Although MARAD has the 
authority to require additional financial information, examine and 
audit the books and records pertaining to a project, and assess 
vessels, MARAD typically does not take these additional steps. MARAD 
does record loan payments, obtain documentation of insurance coverage, 
and monitor the portfolio for delinquent accounts. Although MARAD 
maintains communications with lenders, insurance companies, and loan 
guarantee recipients, MARAD has no established procedures or policies 
to perform periodic reviews of a company's financial well-being once a 
loan guarantee is approved.
    Firms rarely enter into bankruptcy or default on guaranteed loans 
without many preceding quarters or years of financial results that 
indicate developing financial distress. For example, AMCV's stock price 
fell from $35.00 a share in December 1999 to less than $0.50 before its 
bankruptcy filing in October 2001, as shown in Figure 2.


    Furthermore, AMCV's filings with the Securities and Exchange 
Commission show a marked decrease in net income from December 1997 to 
December 2000. In spite of AMCV's declining net income and stock 
valuation, MARAD continued to approve loan guarantees to AMCV for $76 
million for the two Cape Light ships, and over $35 million for the 
Columbia Queen. Just prior to AMCV's bankruptcy filing, MARAD was 
considering a disbursement from AMCV's Project America I escrow account 
to fund further construction of this vessel.
    Increased financial monitoring is only useful if MARAD also 
includes stronger financial covenants in its loan guarantee 
commitments. These covenants should prescribe the required financial 
performance and condition of its borrowers as well as enhanced self-
help measures to which MARAD is entitled should those provisions be 
violated. Performance targets could include higher minimum working 
capital levels, cash-flow requirements, minimum financial ratios, 
future capital spending constraints, and timely financial reporting. 
Self-help measures might include the ability to require additional 
reserves or collateral, declare defaults, take possession of existing 
collateral, and repossess the guaranteed asset. By having the right to 
invoke these measures earlier, when firms begin to experience financial 
distress, MARAD may be able to limit its losses by avoiding additional 
commitments and acquiring existing assets before they are dissipated by 
a failing firm.
MARAD Could Improve Its Return on Foreclosed Assets Through 
        Better Tracking of the Vessels and Property Constructed With 
        Loan Guarantees
    MARAD does not closely monitor the physical condition of the assets 
produced with the guaranteed loans over the term of its loan 
guarantees. MARAD relies on annual Coast Guard inspections and third-
party notices such as those from insurance underwriters. MARAD's field 
offices conducted site visits on guaranteed vessels or property only in 
response to problems or notices of potential problems from third 
parties or from borrowers. Third-party notices do not necessarily 
ensure that the value of the asset is maintained at a level 
commensurate with the remaining loan balance.
    MARAD also does not adequately monitor and protect assets after 
loan defaults occur. At the time of AMCV's impending bankruptcy, MARAD 
officials we spoke with were not fully aware of the current condition 
and status of several vessels whose loans ultimately defaulted 
(totaling about $330 million). Furthermore, MARAD does not adequately 
manage assets acquired from foreclosure. There are no set timeframes or 
procedures to maximize recovery of funds from defaulted loans. Thus, 
vessels and equipment may deteriorate due to exposure, vandalism, and 
neglect, diminishing their value and potential return.
    For example, in 1998, MARAD paid out approximately $1.8 million for 
a default on a vessel owned by Surf Express. The initial appraisal 
valued the 3-year-old vessel at only $793,000, and MARAD advertised it 
for sale several times, but rejected the bids in an attempt to recover 
more money. Meanwhile, MARAD stored the vessel in a wet-berth where it 
was exposed to the elements, including Hurricane Georges. When MARAD 
finally found a prospective buyer, the bidder rejected the vessel 
because of seized up engines and general deterioration due to exposure 
to tropical weather and the hurricane. As a result, MARAD recovered 
only $100,000 from the sale.
    To better protect the Government's interest in the assets that are 
collateral for its loan guarantees, MARAD needs to periodically inspect 
such assets, particularly those operated by firms that MARAD's 
financial monitoring identifies as experiencing financial difficulties. 
Likewise, when MARAD forecloses on assets after loan default, it could 
increase the return to the Government on them by better managing these 
assets to ensure they are maintained in good condition.
AMCV's Bankruptcy Significantly Affected the Title XI Program but Does 
        Not Threaten Its Solvency
    AMCV's bankruptcy affected over one-quarter of the value of MARAD's 
Title XI portfolio. With MARAD's approval of the last (sixth) guarantee 
application in May 2001, for the vessel Columbia Queen, AMCV had 
received loan commitments of about $1.3 billion covering seven 
vessels--potentially the largest amount of loan guarantees issued to an 
affiliated group of entities in the history of the Program. However, 
only $391 million in guarantees had actually been signed when AMCV 
filed for bankruptcy protection and ceased operations on October 19, 
2001. AMCV defaulted on five loans and cost the Government almost $330 
million in guaranteed payouts. See Table 2 for a description of the 
AMCV loan guarantees.

                         Table 2--MARAD's Liability for AMCV Vessels as of December 2002
----------------------------------------------------------------------------------------------------------------
                                                Project
Date  of   Date  of                 Parent        or        Cost of     Guaranteed     Paid-Out     Disposition/
  Origin   Default    Applicant   Company \8\   Vessel    Vessel  to      Amount        Amount      Recovery \9\
                                                 Name        Owner
----------------------------------------------------------------------------------------------------------------
May 2001  January    Great       Delta Queen   Columbia  $ 42,140,568  $ 35,471,000  $ 37,007,570  Maintained by
           2002       Pacific     Steamboat     Queen                                               MARAD
                      NW Cruise   Co.
                      Line,
                      L.L.C.
----------------------------------------------------------------------------------------------------------------
March     December   Coastal     Delta Queen   Cape May    44,950,728    37,900,000    39,769,997  Maintained by
 2000      2001       Queen       Coastal       Light                                               MARAD
                      West,       Voyages,
                      L.L.C.      L.L.C.
----------------------------------------------------------------------------------------------------------------
March     December   Coastal     Delta Queen   Cape Cod    44,582,720    38,500,000    40,376,340  Maintained by
 2000      2001       Queen       Coastal       Light                                               MARAD
                     East,        Voyages,
                      L.L.C.      L.L.C.
----------------------------------------------------------------------------------------------------------------
April     December   Project     Project       Project    610,797,578   185,000,000   187,317,445  Recovered
 1999      2001       America     America,      America                                            $2 million
                      Ship I,     Inc.          Vessel
                      Inc.                      I
----------------------------------------------------------------------------------------------------------------
April     n/a        Project     Project       Project    622,946,837             0             0  Part of the
 1999                 America     America,      America                                            $2 million
                      Ship II,    Inc.          Vessel                                             recovery
                      Inc.                      II                                                  above
----------------------------------------------------------------------------------------------------------------
November  January    Great       Great         S.S.        44,774,271    33,334,000    25,185,531  Maintained by
 1995      2002       Independe   Hawaiian     Independ                                             MARAD
                      nce Ship    Cruise        ence
                      Co.         Lines, Inc.
----------------------------------------------------------------------------------------------------------------
July      n/a        Great       Delta Queen   American    69,424,647    60,746,000             0  Full recovery-
 1995                 American    Steamboat     Queen
                      Queen       Co.                                                              refinanced to
                      Steamboat                                                                    new owner
                      , L.L.C.
----------------------------------------------------------------------------------------------------------------
                                   Totals:                             $390,951,000  $329,656,883
----------------------------------------------------------------------------------------------------------------
Source: MARAD

    The circumstances surrounding AMCV's loan approvals and defaults 
illustrate the problems identified above. Specifically, modifications 
to loan approval criteria were made without compensating collateral, 
and parent company guarantees were accepted without liens on specific 
assets of the parent companies. Close financial monitoring of AMCV did 
not occur over the terms of the loans before default, and neither did 
close monitoring of the foreclosed assets. Had our recommended Program 
revisions and protections been in place at the time of AMCV's loan 
application, the losses to the Government would likely have been much 
less.
---------------------------------------------------------------------------
    \8\ AMCV is the parent company to Delta Queen Steamboat Co. and 
AMCV Holdings, Inc. Delta Queen Steamboat Co., in turn, is the parent 
company of Delta Queen Coastal Voyages, L.L.C. AMCV Holdings, Inc., is 
the parent company of Project America, Inc., and Great Hawaiian Cruise 
Lines, Inc. Applicants are subsidiaries of Delta Queen Steamboat Co.; 
Delta Queen Coastal Voyages, L.L.C.; Project America, Inc.; and Great 
Hawaiian Cruise Lines, Inc.
    \9\ These amounts do not include recoveries from escrowed funds.
---------------------------------------------------------------------------
    For each of the six loan approvals, MARAD cited the Secretary of 
Transportation's authority to waive or modify the financial terms or 
requirements otherwise applicable, upon determining that there was 
adequate security for the Title XI guarantees. However, prudent 
financial analysis of AMCV as a whole would have highlighted the great 
risk of default and should have prompted MARAD to require more 
collateral or stricter covenants to protect the Government's interest. 
Of the 10 vessels owned and operated by, or under construction by, the 
AMCV group, 7 vessels were supported by loan guarantees. The other 
three vessels were encumbered with debt from commercial banking 
facilities. Thus the only collateral available to secure each vessel 
was the first mortgage from AMCV's subsidiary on the vessel itself.
    On their own, only one of the AMCV subsidiaries would have met all 
of the qualification requirements for a loan guarantee. By modifying 
the financial requirements for each of AMCV's consecutive loans, MARAD 
approved guarantees beyond AMCV's ability to service the debts, thereby 
creating a potential default situation--one that could not be cured 
with collateral. One practice that MARAD did employ effectively to 
limit losses was the use of incremental payments to control the 
disbursement of loan proceeds. This allowed MARAD to release funds to 
the borrower incrementally as construction on the project progressed, 
rather than releasing the entire loan proceeds up front.
    Better monitoring of the shipbuilding and financial operations of 
the AMCV subsidiaries would likely have alerted MARAD to AMCV's growing 
financial problems, allowing it to take action prior to the defaults. 
With the guarantee approval for the Columbia Queen, MARAD allowed 
AMCV's annual debt service to increase by $3 million even though the 
company's financial statements indicated a net loss for the previous 
year of over $10 million. AMCV's cumulative debt service was estimated 
to be $12 million every 6 months, yet no part of the approval package 
indicates MARAD reviewed the impact of this growing debt service on 
AMCV's ability to guarantee or pay its subsidiaries' debts.
    MARAD's loan guarantees with the AMCV subsidiaries had no 
established agreements, protocols, or requirements on how to secure and 
maintain the vessels after default. The loan guarantees did not specify 
which party in the guarantee security agreement was responsible for 
specific actions and the timeframes in which protective actions needed 
to be taken. Security of the onboard inventory from theft and pilferage 
was minimal for all the vessels MARAD acquired through the AMCV 
default. It was only after our audit inquiries that MARAD took action 
to ensure the security and the manner of laying-up the vessels.
    Mr. Chairman, this concludes my prepared statement. I would be 
happy to answer any questions you may have.

    The Chairman. Thank you.
    Mr. McCool, welcome.

  STATEMENT OF THOMAS J. McCOOL, MANAGING DIRECTOR, FINANCIAL 
   MARKETS AND COMMUNITY INVESTMENT, U.S. GENERAL ACCOUNTING 
                             OFFICE

    Mr. McCool. Thank you, Mr. Chairman, Members of the 
Committee. I'm pleased to be here today to discuss the results 
of our review of the Maritime Administration's Title XI Loan 
Guarantee Program.
    Mr. Chairman, because of concerns about the scale of recent 
defaults experienced by MARAD, you asked us to conduct a study 
of the Title XI Loan Guarantee Program. Specifically, you asked 
us to determine whether MARAD complied with key Title XI 
program requirements, describe how MARAD's practices for 
managing financial risks compare to those of the private-sector 
maritime lenders, and also to assess MARAD's implementation of 
credit reform as it relates to the Title XI program.
    I'm not going to spend too much time on the first 
objective, because our results parallel very closely the IG's 
testimony, and our written statement talks about the compliance 
issues in some detail. But I did want to spend some time 
talking about this issue of comparing MARAD's approach to 
monitoring loans to the private sector.
    First, I wanted to make a point that when we make this 
comparison, we're not saying that we think MARAD should be--
we're not trying to equate MARAD's responsibilities with those 
of a private-sector lender. We realize that MARAD is not in the 
business of making money. But what we think it needs to do is 
to do a very careful tradeoff between its policy goal of 
promoting the maritime industry, but also its alternative 
policy goal of protecting the government's financial interest, 
and we think that that tradeoff can be improved by some of the 
things that both the IG and we recommend for MARAD.
    One basic point that we did learn from private-sector 
lenders was that they manage financial risk by establishing a 
separation of duties to provide a system of checks and balances 
for important lending functions, such as approving loans, 
monitoring projects, and disposing of assets. In contrast, we 
found that the same office that promotes and markets the Title 
XI program at MARAD also has influence and authority over the 
office that approves and monitors the loans. It's also true 
that they're primarily responsible for underwriting and 
approving loan guarantees, as well as for program management, 
and they're also involved in the disposition of assets.
    Private-sector lenders told us that they rarely grant 
waivers or exceptions to underwriting requirements, or approve 
applications when borrowers do not meet key minimum 
requirements. Whereas, MARAD, as we just heard, often permits 
waivers or modifications of key financial requirements, often 
without a transparent or independent deliberative process.
    Private-sector lenders minimize financial risk by 
establishing loan monitoring and control mechanisms, such as 
periodically reviewing financial statements and assigning risk 
ratings on the basis of the current financial condition of the 
borrower. At MARAD, we found no evidence that staff routinely 
analyzed or evaluated financial statements or have changed risk 
categories after a loan was approved, even when a borrower's 
financial condition had changed.
    MARAD has guidance governing the disposition of defaulted 
assets, and we found that MARAD does not always adhere to it. 
MARAD officials cite the uniqueness of the vessels and projects 
as the reason for using guidelines instead of requirements for 
handling defaulted assets. However, certain practices for 
handling defaulted assets can be helpful regardless of the 
uniqueness of the project. Without a definitive strategy and 
clear requirements, defaulted assets may not always be secured, 
assessed, and disposed of in a manner that maximizes MARAD's 
recoveries, resulting in unnecessary costs and losses to the 
government.
    According to MARAD officials, the chief reason for the 
difference between private-sector and MARAD techniques for 
approving loans, monitoring project progress, and disposing of 
assets is the public purpose of the Title XI program. That is, 
MARAD's program purposely provides for greater flexibility in 
underwriting in order to meet the financing needs of shipowners 
and shipyards that otherwise might not be able to obtain 
financing.
    While program flexibility and financial and economic-
soundness standards may be necessary to help MARAD meet its 
mission objectives, the strict use of internal controls and 
management processes are also important. By not employing the 
limited internal controls it does possess and not taking 
advantage of basic internal controls like those private-sectors 
lenders employ, MARAD cannot ensure it is effectively utilizing 
its limited administrative resources or the government's 
limited financial resources.
    Now let me turn to the credit-subsidy estimates, this 
notion of credit reform. We think it's important--in fact, the 
Congress thinks it's important--to do credit-subsidy 
calculations in the correct way. We believe that without 
properly calculated credit-subsidy estimates and re-estimates, 
it's not possible to understand the cost of the Title XI 
program; and, therefore, the decisions relating benefits to 
cost, whether by Congress or the agency, will not be well 
informed.
    We think that MARAD uses a relatively simplistic cash-flow 
model, which contains five assumptions regarding the default 
amount, default timing, the recovery amount, recovery timing, 
and fees, to estimate the cost of the Title XI Loan Guarantee 
Program. Because MARAD has not evaluated its default and 
recovery-rate assumption since they were developed in 1995, the 
agency does not know whether its cash-flow model is reasonably 
predicting borrower behavior and whether its estimates of loan-
program costs are reasonable.
    The nature and characteristics of the Title XI program make 
it difficult to estimate subsidy costs. MARAD approves a small 
number of guarantees each year, leaving it with relatively 
little experience in which to base estimates for the future. In 
addition, each guarantee is for a large dollar amount. The 
projects have unique characteristics and cover several sectors 
of the market. Further, when defaults occur, they're usually 
for large amounts and may not take place during easily 
predicted timeframes. Recoveries may be equally difficult to 
predict and may be affected by the condition of the underlying 
collateral.
    We believe that an analysis of the past 5 years of actual 
default and recovery experience is meaningful and can provide 
management with valuable insight into how well its cash-flow 
models are predicting borrower behavior and how well its 
estimates are predicting the loan-guarantee program costs. We 
further believe that, while difficult, an analysis of its risk-
category system is meaningful for MARAD to ensure that it 
appropriately classified loan-guarantee projects into risk-
category subdivisions that are relatively homogeneous in cost.
    Further, MARAD's risk-category system is flawed because it 
does not consider concentrations of credit risk. For loans 
originated since 1996, we found that five of the eight defaults 
that occurred, totally 330 million, involved loan guarantees 
that had been made to one borrower, AMCV. Assessing 
concentration of credit risk is a standard practice in private-
sector lending.
    MARAD's ability to calculate reasonable re-estimates is 
seriously impacted by the same outdated assumptions it uses to 
calculate cost estimates, as well as by the fact it has not 
compared these estimates with actual default and recovery 
experience.
    Last, based on our analysis, we believe that OMB provided 
little review and oversight of MARAD's estimates and re-
estimates. OMB has final authority for approving estimates, in 
consultation with the agencies, and OMB approved each MARAD 
estimate and re-estimate, explaining to us that they defer to 
the expertise of MARAD program officials. However, MARAD has 
little expertise in the credit-reform area and has not devoted 
sufficient resources for developing this expertise.
    The Credit Reform Act of 1990 assigns responsibility to OMB 
for coordinating credit-subsidy estimates, developing 
estimation guidelines and regulations, and improving cost 
estimates, including coordinating the development of more 
accurate historical data and annually reviewing the performance 
of loan programs to improve cost estimates. Had OMB provided 
greater review and oversight of MARAD's estimates and re-
estimates, they would have realized the assumptions were 
outdated and did not track with actual recent experience.
    In conclusion, Mr. Chairman, MARAD does not operate the 
Title XI Loan Guarantee Program in a businesslike fashion. 
MARAD does not fully comply with its own requirements, does not 
have clear separation of duties for handling loan approval and 
fund disbursement functions, does not exercise sufficient 
diligence in considering and approving modifications and 
waivers, does not adequately secure and assess the value of 
defaulted assets, and does not know what its program costs. 
Because of these shortcomings, MARAD lacks assurance that it is 
effectively promoting growth and modernization of the U.S. 
Merchant Marine and U.S. shipyards or minimizing the risk of 
financial loss to the Federal Government.
    Finally, MARAD's questionable subsidy-cost estimates do not 
provide Congress a basis for knowing the true cost of the Title 
XI program, and Congress cannot make well-informed policy 
decisions when providing budget authority.
    Again, we have a report that is currently at the agency for 
comment which contains a number of recommendations and matters 
for Congressional consideration. In the area of 
recommendations, most of the recommendations follow from our 
findings to have MARAD improve its internal processes, both 
from the standpoint of approving and monitoring loans, as well 
as disposing of defaulted assets. In addition, we have 
recommendations to improve its credit-subsidy calculations. We 
have some potential recommendations for Congress, which I'll be 
glad to discuss, if you wish.
    That concludes my statement.
    [The prepared statement of Mr. McCool follows:]

 Prepared Statement of Thomas J. McCool, Managing Director, Financial 
    Markets and Community Investment, U.S. General Accounting Office
    Mr. Chairman and Members of the Committee:
    I am pleased to be here today to discuss the results of our review 
of the Maritime Administration's (MARAD) Title XI loan guarantee 
program. Title XI was created to help promote growth and modernization 
of the U.S. merchant marine and U.S. shipyards by enabling owners of 
eligible vessels and shipyards to obtain long-term financing on terms 
and conditions that might not otherwise be available. Under the 
program, MARAD guarantees the payment of principal and interest to 
purchasers of bonds issued by vessel and shipyard owners. These owners 
may obtain guaranteed financing for up to 87.5 percent of the total 
cost of buying or constructing a vessel or buying or modernizing a 
shipyard.
    Under Title XI, MARAD committed to guarantee more than $5.6 billion 
in shipyard modernization and ship construction projects over the last 
10 years. During this period, MARAD experienced nine defaults on these 
loan guarantee commitments totaling over $1.3 billion. The defaulted 
amounts associated with these nine loan guarantee commitments totaled 
$489 million.\1\ Five of these defaults were by subsidiaries of 
American Classic Voyages Company (AMCV), a shipowner. AMCV defaults 
represented 67 percent of all defaulted amounts experienced by MARAD 
during this period, with this borrower having defaulted on guaranteed 
loan projects in amounts totaling $330 million. The largest loan 
guarantee ever approved by MARAD, for over $1.1 billion, was for 
Project America, Inc., a subsidiary of AMCV. Project America, Inc., had 
entered into a contract in March 1999 with Northrup Grumman Corporation 
(formerly Litton Ingalls Shipbuilding) in Pascagoula, Mississippi, for 
the construction of two cruise ships. In October 2001, AMCV filed for 
bankruptcy, defaulting on $187 million in loan guarantees associated 
with Project America.
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    \1\ Defaulted amounts may include disbursed loan guarantee funds, 
interest accrued, and other costs.
---------------------------------------------------------------------------
    As of December 31, 2002, MARAD's portfolio included approximately 
$3.4 billion in executed loan guarantees, representing 103 projects for 
818 vessels and four shipyard modernizations.\2\ At the end of Fiscal 
Year 2002, MARAD had approximately $20 million in unexpended, 
unobligated budget authority that had been appropriated in prior years. 
In its 2004 budget, the administration requested no new funds for the 
Title XI program.
---------------------------------------------------------------------------
    \2\ Loan guarantees are legal obligations to pay off debt if an 
applicant defaults on a loan.
---------------------------------------------------------------------------
    While Title XI of the Merchant Marine Act of 1936, as amended, 
established the requirements of the loan guarantee program, the loan 
guarantees are also subject to the Federal Credit Reform Act of 1990 
(FCRA). Under the FCRA, Federal agencies must account for the estimated 
costs of direct and guaranteed loans on a net present value basis, over 
the full term of the credit, and agencies must receive appropriations 
for these costs before they disburse a loan or enter into loan 
guarantee commitments.
    Because of concerns about the scale of recent defaults experienced 
by MARAD, particularly those associated with AMCV, you asked us to 
conduct a study of the Title XI loan guarantee program. Specifically, 
you asked us to: (1) determine whether MARAD complied with key Title XI 
program requirements in approving initial and subsequent agreements, 
monitoring and controlling funds, and handling defaults; (2) describe 
how MARAD's practices for managing financial risk compare to those of 
selected private-sector maritime lenders; and (3) assess MARAD's 
implementation of credit reform as it relates to the Title XI program.
    To determine whether MARAD complied with key Title XI program 
requirements, we identified key program requirements and reviewed how 
these were applied to the management of five loan guarantee projects. 
To determine how MARAD's practices for managing financial risk compare 
to those of selected private-sector maritime lenders, we interviewed 
three maritime lenders to learn about lending practices, and compared 
these practices to MARAD's. To assess MARAD's implementation of credit 
reform, we analyzed MARAD's subsidy cost estimation and reestimation 
processes and examined how the assumptions MARAD uses to calculate 
subsidy cost estimates compare to MARAD's actual program experience. We 
conducted our work in Washington, D.C., and New York, N.Y., between 
September 2002 and April 2003 in accordance with generally accepted 
government auditing standards.
    In summary:

   MARAD has not fully complied with some key Title XI program 
        requirements. We found that MARAD generally complied with 
        requirements to assess an applicant's economic soundness before 
        issuing loan guarantees. However, MARAD used waivers or 
        modifications, which, although permitted by MARAD regulations, 
        allowed MARAD to approve some applications even though 
        borrowers had not met all financial requirements. MARAD did not 
        fully comply with regulations and established practices 
        pertaining to project monitoring and fund disbursement. 
        Finally, while MARAD has guidance governing the disposition of 
        defaulted assets, adherence to this guidance is not mandatory, 
        and MARAD did not always follow it in the defaulted cases we 
        reviewed.

   Private-sector maritime lenders we interviewed told us that 
        to manage financial risk, they among other things: (1) 
        establish a clear separation of duties for carrying out 
        different lending functions; (2) adhere to key lending 
        standards with few, if any, exceptions; (3) use a systematic 
        approach to monitoring the progress of projects; and (4) 
        primarily employ independent parties to survey and appraise 
        defaulted projects. They try to be very selective when 
        originating loans for the shipping industry. MARAD could 
        benefit from considering the internal control practices 
        employed by the private sector to more effectively utilize its 
        limited resources while maximizing its ability to accomplish 
        its mission.

   MARAD uses a relatively simplistic cash-flow model that is 
        based on outdated assumptions, which lack supporting 
        documentation, to prepare its estimates of defaults and 
        recoveries. While the nature and characteristics of the Title 
        XI program make it difficult to estimate subsidy costs, MARAD 
        has not performed the basic analyses necessary to assess and 
        improve its estimates, which differ significantly from recent 
        actual experience. Specifically, we found that in comparison 
        with recent actual experience, MARAD's default estimates have 
        significantly understated defaults, and its recovery estimates 
        have significantly overstated recoveries. Agencies should use 
        sufficient reliable historical data to estimate credit 
        subsidies and update--reestimate--these estimates annually 
        based on an analysis of actual program experience. However, 
        MARAD has never evaluated the performance of its loan guarantee 
        projects to determine if its subsidy cost reestimates were 
        comparable to actual costs. Finally, the Office of Management 
        and Budget (OMB) has provided little oversight of MARAD's 
        subsidy cost estimate and reestimate calculations.

    Because MARAD does not operate the Title XI loan guarantee program 
in a businesslike fashion, it lacks assurance that it is effectively 
promoting growth and modernization of the U.S. merchant marine and U.S. 
shipyards or minimizing the risk of financial loss to the Federal 
Government. Consequently, the Title XI program could be vulnerable to 
waste, fraud, abuse, and mismanagement. Also, MARAD's questionable 
subsidy cost estimates do not provide Congress a basis for knowing the 
true costs of the Title XI program and Congress cannot make well-
informed policy decisions when providing budget authority. If the 
pattern of recent experiences were to continue, MARAD would have 
significantly underestimated the costs of the program.
    To review our findings in more detail, let me start by describing 
MARAD's management of the Title XI program.
MARAD Has Not Fully Complied with Some Key Title XI Program 
        Requirements
    MARAD has not fully complied with some key Title XI program 
requirements. We found that MARAD generally complied with requirements 
to assess an applicant's economic soundness before issuing loan 
guarantees. However, MARAD used waivers or modifications, which, 
although permitted by MARAD regulations, allowed MARAD to approve some 
applications even though borrowers had not met all financial 
requirements. Additionally, MARAD did not fully comply with regulations 
and established practices pertaining to project monitoring and fund 
disbursement. Finally, while MARAD has guidance governing the 
disposition of defaulted assets, adherence to this guidance is not 
mandatory, and MARAD did not always follow it in the defaulted cases we 
reviewed. We looked at five MARAD-financed projects (see table 1).

 
 
 
------------------------------------------------------------------------
 


                Table 1.--Projects Included in Our Review
------------------------------------------------------------------------
                            Year loan    Original
         Project            committed     amount       Risk      Status
                                        (millions)   category
------------------------------------------------------------------------
 
(AMCV) Project America,----------1999-----$1,079.5----------2A---Default
 Inc.
------------------------------------------------------------------------
Searex                           1996        $77.3          2B   Default
------------------------------------------------------------------------
Massachusetts Heavy              1997        $55.0           3   Default
 Industries (MHI)
------------------------------------------------------------------------
Hvide Van Ommeran Tankers        1996        $43.2          2C    Active
 (HVIDE)
------------------------------------------------------------------------
Global Industries                1996        $20.3          1C    Active

    Source: MARAD data.
    Note: MARAD places projects into one of seven risk categories that, 
from lowest to highest, are 1A, 1 B, 1 C, 2A, 2B, 2C, and 3.
MARAD Used Waivers and Modifications to Approve Loans That Would 
        Otherwise Not Be Approved
    MARAD regulations do not permit MARAD to guarantee a loan unless 
the project is determined to be economically sound.\3\ MARAD generally 
complied with requirements to assess an applicant's economic soundness 
before approving loan guarantees, and we were able to find 
documentation addressing economic soundness criteria for the projects 
included in our review. Specifically, we were able to find 
documentation addressing supply and demand projections and other 
economic soundness criteria for the projects included in our review.\4\ 
In 2002, MARAD's Office of Statistical and Economic Analysis found a 
lack of a standardized approach for conducting market analyses. Because 
of this concern, in November 2002, it issued guidance for conducting 
market research on marine transportation services. However, adherence 
to these guidelines is not required. Finally, while MARAD may not waive 
economic soundness criteria, officials from the Office of Statistics 
and Economic Analysis expressed concern that their findings regarding 
economic soundness might not always be fully considered when MARAD 
approved loan guarantees.\5\ They cited a recent instance where they 
questioned the economic soundness of a project that was later approved 
without their concerns being addressed. According to the Associate 
Administrator for Shipbuilding, all concerns, including economic 
soundness concerns, are considered by the MARAD Administrator.
---------------------------------------------------------------------------
    \3\ All projects must be determined to be economically sound, and 
borrowers must have sufficient operating experience and the ability to 
operate the vessels or employ the technology on an economically sound 
basis. Particularly, MARAD regulations contain language stating that: 
(1) long-term demand must exceed supply; (2) documentation must be 
provided on the projections of supply and demand; (3) outside cash-flow 
should be shown, if in the short-term the borrower is unable to service 
indebtedness; and (4) operating cash-flow ratio must be greater than 
one (sufficient cash-flow to service the debt).
    \4\ Economic soundness analyses are prepared by the Office of 
Subsidy and Insurance and the Office of Statistical and Economic 
Analysis. It should be noted that we did not assess the substance of 
these economic analyses.
    \5\ In another case, Congress statutorily waived economic soundness 
criteria. Specifically, the Coast Guard Authorization Act of 1996 
contained a provision waiving the economic soundness requirement for 
reactivation and modernization of certain closed shipyards in the 
United States. Previously, MARAD had questioned the economic soundness 
of the MHI proposal and rejected the application.
---------------------------------------------------------------------------
    Shipowners and shipyard owners are also required to meet certain 
financial requirements during the loan approval process. However, MARAD 
used waivers or modifications, which, although permitted by Title XI 
regulations, allowed MARAD to approve some applications even though 
borrowers had not met all financial requirements that pertained to 
working capital, long-term debt, net worth, and owner-invested equity 
\6\ For example, AMCV's Project America, Inc., did not meet the 
qualifying requirements for working capital, among other things. 
Although MARAD typically requires companies to have positive working 
capital, an excess of current assets over current liabilities, the 
accounting requirements for unterminated passenger payments 
significantly affect this calculation because this deferred revenue is 
treated as a liability until earned.\7\ Because a cruise operator would 
maintain large balances of current liabilities, MARAD believed it would 
be virtually impossible for AMCV to meet a positive working capital 
requirement if sound cash management practices were followed.\8\ 
Subsequently, MARAD used cash-flow tests for Project America, Inc., in 
lieu of working capital requirements for purposes of liquidity testing.
---------------------------------------------------------------------------
    \6\ MARAD may waive or modify financial terms or requirements upon 
determining that there is adequate security for the guarantees.
    \7\ Unterminated passengers are individuals who pay for a cruise, 
but do not actually take the cruise, and the payment is not refunded. 
However, the passenger may take the trip at a later date.
    \8\ Cash management is a financial management technique used to 
accelerate the collection of debt, control payments to creditors, and 
efficiently manage cash.
---------------------------------------------------------------------------
    According to MARAD officials, waivers or modifications help them 
meet the congressional intent of the Title XI program, which is to 
promote the growth and modernization of the U.S. merchant marine 
industry. Further, they told us that the uniqueness of the Title XI 
projects and marine financing lends itself to the use of waivers and 
modifications. However, by waiving or modifying financial requirements, 
MARAD officials may be taking on greater risk in the loans they are 
guaranteeing. Consequently, the use of waivers or modifications could 
contribute to the number or severity of loan guarantee defaults and 
subsequent Federal payouts. In a recent review, the Department of 
Transportation Inspector General (IG) noted that the use of 
modifications increases the risk of the loan guarantee to the 
government and expressed concern about MARAD undertaking such 
modifications without taking steps to mitigate those risks.\9\ The IG 
recommended that MARAD require a rigorous analysis of the risks from 
modifying any loan approval criteria and impose compensating 
requirements on borrowers to mitigate these risks.
---------------------------------------------------------------------------
    \9\ U.S. Department of Transportation, Office of Inspector General, 
Maritime Administration Title XI Loan Guarantee Program (Washington, 
D.C.: Mar. 27, 2003).
---------------------------------------------------------------------------
MARAD Did Not Follow Requirements for Monitoring the Financial 
        Condition of Projects and for Controlling the Disbursement of 
        Loan Funds
    MARAD did not fully comply with requirements and its own 
established practices pertaining to project monitoring and fund 
disbursement. Program requirements specify periodic financial 
reporting, controls over the disbursement of loan funds, and 
documentation of amendments to loan agreements. MARAD could not always 
demonstrate that it had complied with financial reporting requirements. 
In addition, MARAD could not always demonstrate that it had determined 
that projects had made progress prior to disbursing loan funds. Also, 
MARAD broke with its own established practices for determining the 
amount of equity a shipowner must invest prior to MARAD making 
disbursements from the escrow fund.\10\ MARAD did so without 
documenting this change in the loan agreement. Ultimately, weaknesses 
in MARAD's monitoring practices could increase the risk of loss to the 
Federal Government.
---------------------------------------------------------------------------
    \10\ An escrow fund is an account in which the proceeds from sales 
of MARAD-guaranteed obligations are held until requested by the 
borrower to pay for activities related to the construction of a vessel 
or shipyard project or to pay interest on obligations.
---------------------------------------------------------------------------
    MARAD regulations specify that the financial statements of a 
company in receipt of a loan guarantee shall be audited at least 
annually by an independent certified public accountant. In addition, 
MARAD regulations require companies to provide semiannual financial 
statements. However, MARAD could not demonstrate that it had received 
required annual and semiannual statements. For example, MARAD could not 
locate several annual or semiannual financial statements for the 
Massachusetts Heavy Industries (MHI) project. Also, MARAD could not 
find the 1999 and 2000 semiannual financial reports for AMCV. The AMCV 
financial statements were later restated, as a result of a Securities 
and Exchange Commission (SEC) finding that AMCV had not complied with 
generally accepted accounting principles in preparing its financial 
statements.\11\ In addition, several financial statements were missing 
from MARAD records for Hvide Van Ommeran Tankers (HVIDE) and Global 
Industries Ltd. When MARAD could provide records of financial 
statements, it was unclear how the information was used. Further, the 
Department of Transportation IG in its review of the Title XI program 
found that MARAD had no established procedures or policies 
incorporating periodic reviews of a company's financial well-being once 
a loan guarantee was approved.
---------------------------------------------------------------------------
    \11\ On June 25, 2001, AMCV restated losses from $6.1 million to 
$9.1 million for the first quarter of 1999.
---------------------------------------------------------------------------
    An analysis of financial statements may have alerted MARAD to 
financial problems with companies and possibly given it a better chance 
to minimize losses from defaults. For example, between 1993 and 2000, 
AMCV had net income in only 3 years and lost a total of $33.3 million. 
Our analysis showed a significant decline in financial performance 
since 1997. Specifically, AMCV showed a net income of $2.4 million in 
1997, with losses for the next 3 years, and losses reaching $10.1 
million in 2000. Although AMCV's revenue increased steadily during this 
period by a total of 25 percent, or nearly $44 million, expenses far 
outpaced revenue during this period. For example, the cost of 
operations increased 29 percent, or $32.3 million, while sales and 
general and administrative costs increased over 82 percent or $33.7 
million. During this same period, AMCV's debt also increased over 300 
percent. This scenario combined with the decline in tourism after 
September 11, 2001, caused AMCV to file for bankruptcy. On May 22, 
2001, Ingalls notified AMCV that it was in default of its contract due 
to nonpayment. Between May 22 and August 23, 2001, MARAD received at 
least four letters from Ingalls, the shipbuilder, citing its concern 
about the shipowner's ability to pay construction costs. However, it 
was not until August 23 that MARAD prepared a financial analysis to 
help determine the likelihood of AMCV or its subsidiaries facing 
bankruptcy or another catastrophic event.
    MARAD could not always demonstrate that it had linked disbursement 
of funds to progress in ship construction, as MARAD requires. We were 
not always able to determine from available documents the extent of 
progress made on the projects included in our review. For example, a 
number of Project America, Inc.'s, disbursement requests did not 
include documentation that identified the extent of progress made on 
the project. Also, while MARAD requires periodic on-site visits to 
verify the progress on ship construction or shipyard refurbishment, we 
did not find evidence of systematic site visits and inspections. For 
Project America, Inc., MARAD did not have a construction representative 
committed onsite at Ingalls Shipyard, Inc., until May 2001, 2 months 
after the MARAD's Office of Ship Design and Engineering Services 
recommended a MARAD representative be located on-site. For the Searex 
Title XI loan guarantee, site visits were infrequent until MARAD became 
aware that Ingalls had cut the vessels into pieces to make room for 
other projects. For two projects rated low-risk, Hvide Van Ommeran 
Tankers and Global Industries, Ltd., we found MARAD conducted site 
visits semiannually and annually, respectively. We reviewed MHI's 
shipyard modernization project, which was assigned the highest risk 
rating, and found evidence that construction representatives conducted 
monthly site visits. However, in most instances, we found that a 
project's risk was not linked to the extent of project monitoring. 
Further, MARAD relied on the shipowner's certification of money spent 
in making decisions to approve disbursements from the escrow fund.
    We also found that, in a break with its own established practice, 
MARAD permitted a shipowner to define total costs in a way that 
permitted earlier disbursement of loan funds from the escrow fund. 
MARAD regulations require that shipowners expend from their own funds 
at least 12.5 percent or 25 percent, depending on the type of vessel or 
technology, of the actual cost of a vessel or shipyard project prior to 
receiving MARAD-guaranteed loan funds. In practice, MARAD has used the 
estimated total cost of the project to determine how much equity the 
shipowner should provide. In the case of Project America, Inc., the 
single largest loan guarantee in the history of the program, we found 
that MARAD permitted the shipowner to exclude certain costs in 
determining the estimated total costs of the ship at various points in 
time, thereby deferring owner-provided funding while receiving MARAD-
guaranteed loan funds. This was the first time MARAD used this method 
of determining equity payments, and MARAD did not document this 
agreement with the shipowner as required by its policy. In September 
2001, MARAD amended the loan commitment for this project, permitting 
the owner to further delay the payment of equity. By then, MARAD had 
disbursed $179 million in loan funds. Had MARAD followed its 
established practice for determining equity payments, the shipowner 
would have been required to provide an additional $18 million. Because 
MARAD had not documented its agreements with AMCV, the amount of equity 
the owner should have provided was not apparent during this period. 
Further, MARAD systems do not flag when the shipowner has provided the 
required equity payment for any of the projects it finances.
    MARAD officials cited several reasons for its limited monitoring of 
Title XI projects, including insufficient staff resources and travel 
budget restrictions. For example, officials of MARAD's Office of Ship 
Construction, which is responsible for inspection of vessels and 
shipyards, told us that they had only two persons available to conduct 
inspections, and that the office's travel budget was limited. The MARAD 
official with overall responsibility for the Title XI program told us 
that, at a minimum, the Title XI program needs three additional staff. 
The Office of Ship Financing needs two additional persons to enable a 
more through review of company financial statements and more 
comprehensive preparation of credit reform materials. Also, the 
official said that the Office of the Chief Counsel needs to fill a 
long-standing vacancy to enable more timely legal review. With regard 
to documenting the analysis of financial statements, MARAD officials 
said that, while they do require shipowners and shipyard owners to 
provide financial statements, they do not require MARAD staff to 
prepare a written analysis of the financial condition of the Title XI 
borrower.
    Inconsistent monitoring of a borrower's financial condition limits 
MARAD's ability to protect the Federal Government's financial 
interests. For example, MARAD would not know if a borrower's financial 
condition had changed so that it could take needed action to possibly 
avoid defaults or minimize losses. Further, MARAD's practices for 
assessing project progress limit its ability to link disbursement of 
funds to progress made by shipowners or shipyard owners. This could 
result in MARAD disbursing funds without a vessel or shipyard owner 
making sufficient progress in completing projects. Likewise, permitting 
project owners to minimize their investment in MARAD-financed projects 
increases the risk of loss to the Federal Government.
MARAD Does Not Have Requirements in Place to Govern the Handling of 
        Defaulted Assets
    MARAD has guidance governing the disposition of defaulted assets. 
However, MARAD is not required to follow this guidance, and we found 
that MARAD does not always adhere to it. MARAD guidelines state that an 
independent, competent marine surveyor or MARAD surveyor shall survey 
all vessels, except barges, as soon as practicable, after the assets 
are taken into custody. In the case of filed or expected bankruptcy, an 
independent marine surveyor should be used. In the case of Searex, 
MARAD conducted on-site inspections after the default. However, these 
inspections were not conducted in time to properly assess the condition 
of the assets. With funds no longer coming in from the project, Ingalls 
cut the vessels into pieces to make it easier to move the vessels from 
active work-in-process areas to other storage areas within the 
property. The Searex lift boat and hulls were cut before MARAD 
inspections were made. According to a MARAD official, the cutting of 
one Searex vessel and parts of the other two Searex vessels under 
construction reduced the value of the defaulted assets. The IG report 
on the Title XI program released in March 2003 noted that site visits 
were conducted on guaranteed vessels or property only in response to 
problems or notices of potential problems from third parties or from 
borrowers.
    The guidelines also state that sales and custodial activities shall 
be conducted in such a fashion as to maximize MARAD's overall recovery 
with respect to the asset and debtor. Market appraisals (valuations) of 
the assets shall be performed by an independent appraiser, as deemed 
appropriate, to assist in the marketing of the asset. Relying on an 
interested party in determining the value of defaulted assets may not 
have maximized MARAD's financial recovery. In the case of Project 
America I and II, MARAD relied on the shipbuilder, Ingalls, to provide 
an estimate of the cost of making the Project America I vessel 
seaworthy. According to MARAD officials, their only option was to rely 
on Ingalls to provide this estimate. Ingalls' initial estimate in April 
2002 was $16 million. Based on this estimate, MARAD rejected two bids 
to purchase the unfinished hull of Project America I ($2 million and 
$12 million respectively).\12\ Subsequently, on May 17, 2002, MARAD 
advised Ingalls that it should dispose of the assets of Project America 
I and remit the net savings, if any, to MARAD. In a June 28, 2002, 
agreement between Northrup Grumman Ship Systems, Inc. (formerly Litton 
Ingalls Shipbuilding), Northrup Grumman advised that it would cost 
between $9 and $12 million to preserve and make Project America I 
seaworthy for delivery to the prospective purchaser. Had the $9 to $12 
million estimate been made earlier in April 2002, MARAD would have 
accepted the $12 million dollar bid and would have disposed of the 
Project America I asset. By accepting Ingalls' original estimate of $16 
million to make the ship seaworthy, MARAD may have incurred several 
months of unnecessary preservation expenses and possibly lowered its 
recovery amount. According to MARAD officials, as of March 2003, MARAD 
had received $2 million from the sale of the Project America I and II 
vessels.
---------------------------------------------------------------------------
    \12\ The bids were for the purchase of the unfinished hull for 
Project America I in seaworthy condition.
---------------------------------------------------------------------------
    Rather than obtaining a market appraisal to assist in marketing the 
asset, MARAD hired the Defense Contract Audit Agency (DCAA) to verify 
the costs incurred by Northrop Grumman Ship Systems, Inc., since 
January 1, 2002, for preparing and delivering Project America I in a 
weather-tight condition suitable for ocean towing in international 
waters. A MARAD official said that the DCAA audit would allow MARAD to 
identify any unsupported costs and recover these amounts from the 
shipyard. The DCAA review was used to verify costs incurred, but not to 
make a judgment as to the reasonableness of the costs. DCAA verified 
costs of approximately $17 million.
    MARAD officials cite the uniqueness of the vessels and projects as 
the reason for using guidelines instead of requirements for handling 
defaulted assets. However, certain practices for handling defaulted 
assets can be helpful regardless of the uniqueness of a project. Among 
these are steps to immediately assess the value of the defaulted asset. 
Without a definitive strategy and clear requirements, defaulted assets 
may not always be secured, assessed, and disposed of in a manner that 
maximizes MARAD's recoveries--resulting in unnecessary costs and 
financial losses to the Federal Government.
MARAD Techniques to Manage Financial Risk Contrast to Techniques 
        of Selected Private-sector Maritime Lenders
    Private-sector maritime lenders we interviewed told us that it is 
imperative for lenders to manage the financial risk of maritime lending 
portfolios. In contrast to MARAD, they indicated that to manage 
financial risk, among other things, they: (1) establish a clear 
separation of duties for carrying out different lending functions; (2) 
adhere to key lending standards with few, if any, exceptions; (3) use a 
more systematic approach to monitoring the progress of projects; and 
(4) primarily employ independent parties to survey and appraise 
defaulted projects. The lenders try to be very selective when 
originating loans for the shipping industry. While realizing that MARAD 
does not operate for profit, it could benefit from the internal control 
practices employed by the private sector to more effectively utilize 
its limited resources and to enhance its ability to accomplish its 
mission. Table 2 describes the key differences in private-sector and 
MARAD maritime lending practices used during the application, 
monitoring, and default and disposition phases.

 
 
 
----------------------------------------------------------------------------------------------------------------
 


                   Table 2.--Comparison of Private-sector and MARAD Maritime Lending Practices
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
 
------------------------------------------Phases of the lending process-----------------------------------------
----------------------------------------------------------------------------------------------------------------
                                 Private-sector practices                           MARAD practices
----------------------------------------------------------------------------------------------------------------
                                                   Application
----------------------------------------------------------------------------------------------------------------
                 Permit few exceptions to key               Permit waivers of key financial
                          financial underwriting requirements                requirements
                          for maritime loans
                 Seek approval of exceptions or             Have no committee oversight
                          waivers from Audit Committee                       regarding the approval of
                                                                             exceptions or waivers of program
                                                                             requirements
                 Perform an in-depth analysis of a          Employ little variation in the depth
                          business plan for applications                     of review of business plans based
                          received for start-up businesses or                on type of vessel, size of loan
                          first-in-class shipyard vessels                    guarantee, or history of borrower
----------------------------------------------------------------------------------------------------------------
                                                   Monitoring
----------------------------------------------------------------------------------------------------------------
                 Set an initial risk rating at the          Assign one risk rating during the
                          time of approval and review rating                 application phase. No subsequent
                          annually to determine risk rating                  ratings assigned during the life of
                          of the loan                                        the loan
                 Use industry expertise for                 Use in-house staff to conduct
                          conducting periodic on-site                        periodic on-site inspections to
                          inspections to monitor progress on                 monitor progress of projects
                          projects and potential defaults
                 Perform monitoring that is dependent       Perform monitoring based on
                          on financial and technical risk,                   technical risk, familiarity with
                          familiarity with the shipyard, and                 shipyard, uniqueness of project,
                          uniqueness of the project                          and availability of travel funds
                 Analyze the borrower's financial           Have no documentation of analyses of
                          statements to identify significant                 borrowers' financial statements
                          changes in borrower's financial
                          condition and to determine
                          appropriate level and frequency of
                          continued monitoring at least
                          annually
----------------------------------------------------------------------------------------------------------------
                                             Default and disposition
----------------------------------------------------------------------------------------------------------------
                 Contract with an independent               Permit an interested party or MARAD
                          appraiser to prepare a valuation of                official to value assets
                          a defaulted project
                 Enlist a technical manager to review       Permit an interested party or MARAD
                          the ship after default to assist in                official to perform technical
                          determining structural integrity                   review of Title XI assets
                          and percentage of completion
----------------------------------------------------------------------------------------------------------------

    Sources: GAO analysis of MARAD and private-sector data.
Private-sector Lenders Separate Key Lending Functions
    Private-sector lenders manage financial risk by establishing a 
separation of duties to provide a system of checks and balances for 
important maritime lending functions. Two private-sector lenders 
indicated that there is a separation of duties for approving loans, 
monitoring projects financed, and disposing of assets in the event of 
default. For example, marketing executives from two private-sector 
maritime lending institutions stated that they do not have lending 
authority. Also, separate individuals are responsible for accepting 
applications and processing transactions for loan underwriting.
    In contrast, we found that the same office that promotes and 
markets the MARAD Title XI program also has influence and authority 
over the office that approves and monitors Title XI loans. In February 
1998, MARAD created the Office of Statistical and Economic Analysis in 
an attempt to obtain independent market analyses and initial 
recommendations on the impact of market factors on the economic 
soundness of projects. This office reports to the Associate 
Administrator for Policy and International Trade rather than the 
Associate Administrator for Shipbuilding. However, the Associate 
Administrator for Shipbuilding also is primarily responsible for 
overseeing the underwriting and approving of loan guarantees. Title XI 
program management is primarily handled by offices that report to the 
Associate Administrator for Shipbuilding. In addition, the same 
Associate Administrator controls, in collaboration with the Chief of 
the Division of Ship Financing Contracts within the Office of the Chief 
Counsel, the disposition of assets after a loan has defaulted. Most 
recently, MARAD has taken steps to consolidate responsibilities related 
to loan disbursements. In August 2002, the Maritime Administrator gave 
the Associate Administrator for Shipbuilding sole responsibility for 
reviewing and approving the disbursement of escrow funds. According to 
a senior official, prior to August 2002 this responsibility was shared 
with the Office of Financial and Rate Approvals under the supervision 
of the Associate Administrator for Financial Approvals and Cargo 
Preference. As a result of the consolidation, the same Associate 
Administrator who is responsible for underwriting and approving loan 
guarantees and disposing of defaulted assets is also responsible for 
approval of loan disbursements and monitoring financial condition. 
MARAD undertook this consolidation in an effort to improve performance 
of analyses related to the calculation of shipowner's equity 
contributions and monitoring of changes in financial condition. 
However, as mentioned earlier, MARAD does not have controls for clearly 
identifying the shipowner's required equity contribution. The 
consolidation of responsibilities for approval of loan disbursements 
does not address these weaknesses and precludes any potential benefit 
from separation of duties.
Private-sector Practices Employ Less Flexible Lending Standards
    The private-sector lenders we interviewed said they apply rigorous 
financial tests for underwriting maritime loans. They analyze financial 
statements such as balance sheets, income statements, and cash-flow 
statements, and use certain financial ratios such as liquidity and 
leverage ratios that indicate the borrower's ability to repay. Private-
sector maritime lenders told us they rarely grant waivers, or 
exceptions, to underwriting requirements or approve applications when 
borrowers do not meet key minimum requirements. Each lender we 
interviewed said any approved applicants were expected to demonstrate 
stability in terms of cash on hand, financial strength, and collateral. 
One lender told us that on the rare occasions when exceptions to the 
underwriting standards were granted, an audit committee had to approve 
any exception or waiver to the standards after reviewing the 
applicant's circumstances. In contrast, we found in the cases we 
reviewed that MARAD often permits waivers or modifications of key 
financial requirements, often without a deliberative process, according 
to a MARAD official. For example, MARAD waived the equity and working 
capital financial requirements at the time of the loan guarantee 
closing for MHI's shipyard modernization project. Also, a recent IG 
report found that MARAD routinely modifies financial requirements in 
order to qualify applicants for loan guarantees. Further, the IG noted 
that MARAD reviewed applications for loan guarantees primarily with in-
house staff and recommended that MARAD formally establish an external 
review process as a check on MARAD's internal loan application 
review.\13\ A MARAD official told us that MARAD is currently developing 
the procedures for an external review process.
---------------------------------------------------------------------------
    \13\ The IG also recommended that MARAD impose compensating factors 
for loan guarantees to mitigate risks.
---------------------------------------------------------------------------
    These private-sector lenders also indicated that preparing an 
economic analysis or an independent feasibility study assists in 
determining whether or not to approve funding based on review and 
discussion of the marketplace, competition, and project costs. Each 
private-sector lender we interviewed agreed that performance in the 
shipping industry was cyclical and timing of projects was important. In 
addition, reviewing historical data provided information on future 
prospects for a project. For example, one lender uses these economic 
analyses to evaluate how important the project will be to the overall 
growth of the shipping industry. Another lender uses the economic 
analyses and historical data to facilitate the sale of a financed 
vessel. In the area of economic soundness analysis, MARAD requirements 
appear closer to those of the private-sector lenders, in that external 
market studies are also used to help determine the overall economic 
soundness of a project. However, assessments of economic soundness 
prepared by the Office of Statistical and Economic Analysis may not be 
fully considered when MARAD approves loan guarantees.
Private-sector Lenders Use a More Systematic Approach to Loan 
        Monitoring
    Private-sector lenders minimized financial risk by establishing 
loan monitoring and control mechanisms such as analyzing financial 
statements and assigning risk ratings. Each private-sector lender we 
interviewed said that conducting periodic reviews of a borrower's 
financial statements helped to identify adverse changes in the 
financial condition of the borrower. For example, two lenders stated 
that they annually analyzed financial statements such as income 
statements and balance sheets. The third lender evaluated financial 
statements quarterly. Based on the results of these financial statement 
reviews, private-sector lenders then reviewed and evaluated the risk 
ratings that had been assigned at the time of approval. Two lenders 
commented that higher risk ratings indicated a need for closer 
supervision, and they then might require the borrower to submit monthly 
or quarterly financial statements. In addition, a borrower might be 
required to increase cash reserves or collateral to mitigate the risk 
of a loan. Further, the lender might accelerate the maturity date of 
the loan. Private-sector lenders used risk ratings in monitoring 
overall risk, which in turn helped to maintain a balanced maritime 
portfolio.
    At MARAD, we found no evidence that staff routinely analyzed or 
evaluated financial statements or changed risk categories after a loan 
was approved. For example, we found in our review that for at least two 
financial statement reporting periods, MARAD was unable to provide 
financial statements for the borrower, and, in one case, one financial 
statement was submitted after the commitment to guarantee funds. Our 
review of the selected Title XI projects indicated that risk categories 
were primarily assigned for purposes of estimating credit subsidy costs 
at the time of application, not for use in monitoring the project. 
Further, we found no evidence that MARAD changed a borrower's risk 
category when its financial condition changed. In addition, neither the 
support office that was initially responsible for reviewing and 
analyzing financial statements nor the office currently responsible 
maintained a centralized record of the financial statements they had 
received. Further, while one MARAD official stated that financial 
analyses were performed by staff and communicated verbally to top-level 
agency officials, MARAD did not prepare and maintain a record of these 
analyses.
    Private-sector lenders also manage financial risk by linking the 
disbursement of loan funds to the progress of the project. All the 
lenders we interviewed varied project monitoring based on financial and 
technical risk, familiarity with the shipyard, and uniqueness of the 
project. Two lenders thought that on-site monitoring was very important 
in determining the status of projects. Specifically, one lender hires 
an independent marine surveyor to visit the shipyard to monitor 
construction progress. This lender also requires signatures on loan 
disbursement requests from the shipowner, shipbuilder, and loan officer 
before disbursing any loan funds. This lender also relies on technical 
managers and classification society representatives who frequently 
visit the shipyard to monitor progress.\14\ Shipping executives of this 
lender make weekly, and many times daily, calls to shipowners to 
further monitor the project based on project size and complexity. This 
lender also requires shipowners to provide monthly progress reports so 
the progress of the project could be monitored.
---------------------------------------------------------------------------
    \14\ Classification society representatives are individuals who 
inspect the structural and mechanical fitness of ships and other marine 
vessels for their intended purpose.
---------------------------------------------------------------------------
    MARAD also relied onsite visits to verify construction progress. 
However, the linkage between the progress of the project and the 
disbursement of loan funds was not always clear. MARAD tried to adjust 
the number of site visits based on the amount of the loan guarantee, 
the uniqueness of project (for example, whether the ship is the first 
of its kind for the shipowner), the degree of technical and engineering 
risk, and familiarity with the shipyard. However, the frequency of site 
visits was often dependent upon the availability of travel funds, 
according to a MARAD official.
Private-sector Lenders Use Industry Expertise to Value Defaulted Assets
    Private-sector maritime lenders said they regularly use independent 
marine surveyors and technical managers to appraise and conduct 
technical inspections of defaulted assets. For example, two lenders 
hire independent marine surveyors who are knowledgeable about the 
shipbuilding industry and have commercial lending expertise to inspect 
the visible details of all accessible areas of the vessel, as well as 
its marine and electrical systems. In contrast, we found that MARAD did 
not always use independent surveyors. For example, we found that for 
Project America, the shipbuilder was allowed to survey and oversee the 
disposition of the defaulted asset. As mentioned earlier, MARAD hired 
DCAA to verify the costs incurred by the shipbuilder to make the 
defaulted asset ready for sale; however, MARAD did not verify whether 
the costs incurred were reasonable or necessary. For Searex, 
construction representatives and officials from the Offices of the 
Associate Administrator of Shipbuilding and the Chief of the Division 
of Ship Financing Contracts were actively involved in the disposition 
of the assets.
MARAD Cites Mission as the Difference in Management of Financial Risk 
        Compared to Private-sector Lenders
    According to top-level MARAD officials, the chief reason for the 
difference between private-sector and MARAD techniques for approving 
loans, monitoring project progress, and disposing of assets is the 
public purpose of the Title XI program, which is to promote growth and 
modernization of the U.S. merchant marine and U.S. shipyards. That is, 
MARAD's program purposefully provides for greater flexibility in 
underwriting in order to meet the financing needs of shipowners and 
shipyards that otherwise might not be able to obtain financing. MARAD 
is also more likely to work with borrowers that are experiencing 
financial difficulties once a project is under way. MARAD officials 
also cited limited resources in explaining the limited nature of 
project monitoring.
    While program flexibility in financial and economic soundness 
standards may be necessary to help MARAD meet its mission objectives, 
the strict use of internal controls and management processes is also 
important. Otherwise, resources that could have been used to further 
the program might be wasted. To aid agencies in improving internal 
controls, we have recommended that agencies identify the risks that 
could impede their ability to efficiently and effectively meet agency 
goals and objectives.\15\ Private-sector lenders employ internal 
controls such as a systematic review of waivers during the application 
phase and risk ratings of projects during the monitoring phase. 
However, MARAD does neither. Without a more systematic review of 
underwriting waivers, MARAD might not be giving sufficient 
consideration to the additional risk such decisions represent. 
Likewise, without a systematic process for assessing changes in payment 
risk, MARAD cannot use its limited monitoring resources most 
efficiently. Further, by relying on interested parties to estimate the 
value of defaulted loan assets, MARAD might not maximize the recovery 
on those assets. Overall, by not employing the limited internal 
controls it does possess, and not taking advantage of basic internal 
controls such as those private-sector lenders employ, MARAD cannot 
ensure it is effectively utilizing its limited administrative resources 
or the government's limited financial resources.
---------------------------------------------------------------------------
    \15\ U.S. General Accounting Office, Standards for Internal Control 
in the Federal Government, GAO/AIMD-00-21.3.1 (Washington, D.C.: 
November 1999) and Internal Control Management and Evaluation Tool, 
GAO-01-1008G (Washington, D.C.: August 2001).
---------------------------------------------------------------------------
MARAD's Credit Subsidy Estimates and Reestimates Are Questionable
    MARAD uses a relatively simplistic cash-flow model that is based on 
outdated assumptions, which lack supporting documentation, to prepare 
its estimates of defaults and recoveries. These estimates differ 
significantly from recent actual experience. Specifically, we found 
that in comparison with recent actual experience, MARAD's default 
estimates have significantly understated defaults, and its recovery 
estimates have significantly overstated recoveries. If the pattern of 
recent experience were to continue, MARAD would have significantly 
underestimated the costs of the program. Agencies should use sufficient 
reliable historical data to estimate credit subsidies and update--
reestimate--these estimates annually based on an analysis of actual 
program experience. While the nature and characteristics of the Title 
XI program make it difficult to estimate subsidy costs, MARAD has never 
performed the basic analyses necessary to determine if its default and 
recovery assumptions are reasonable. Finally, OMB has provided little 
oversight of MARAD's subsidy cost estimate and reestimate calculations.
MARAD's Credit Subsidy Estimates Are Questionable
    The Federal Credit Reform Act of 1990 (FCRA) was enacted, in part, 
to require that the Federal budget reflect a more accurate measurement 
of the government's subsidy costs for loan guarantees.\16\ To determine 
the expected cost of a credit program, agencies are required to predict 
or estimate the future performance of the program. For loan guarantees, 
this cost, known as the subsidy cost, is the present value of estimated 
cash-flows from the government, primarily to pay for loan defaults, 
minus estimated loan guarantee fees paid and recoveries to the 
government. Agency management is responsible for accumulating relevant, 
sufficient, and reliable data on which to base the estimate and for 
establishing and using reliable records of historical credit 
performance. In addition, agencies are supposed to use a systematic 
methodology to project expected cash-flows into the future. To 
accomplish this task, agencies are instructed to develop a cash-flow 
model, using historical information and various assumptions including 
defaults, prepayments, recoveries, and the timing of these events, to 
estimate future loan performance.
---------------------------------------------------------------------------
    \16\ The Federal Accounting Standards Advisory Board developed the 
accounting standard for credit programs, Statement of Federal Financial 
Accounting Standards No. 2, ``Accounting for Direct Loans and Loan 
Guarantees,'' which generally mirrors FCRA and which established 
guidance for estimating the cost of guaranteed loan programs.
---------------------------------------------------------------------------
    MARAD uses a relatively simplistic cash-flow model, which contains 
five assumptions--default amount, timing of defaults, recovery amount, 
timing of recoveries, and fees--to estimate the cost of the Title XI 
loan guarantee program. We found that relatively minor changes in these 
assumptions can significantly affect the estimated cost of the program 
and that, thus far, three of the five assumptions, default and recovery 
amounts and the timing of defaults, differed significantly from recent 
actual historical experience.\17\ According to MARAD officials, these 
assumptions were developed in 1995 based on actual loan guarantee 
experience of the previous 10 years and have not been evaluated or 
updated. MARAD could not provide us with supporting documentation to 
validate its estimates, and we found no evidence of any basis to 
support the assumptions used to calculate these estimates. MARAD also 
uses separate default and recovery assumptions for each of seven risk 
categories to differentiate between levels of risk and costs for 
different loan guarantee projects.
---------------------------------------------------------------------------
    \17\ MARAD's recovery assumption assumes a 50 percent recovery rate 
within 2 years of default. However, 2 years have not yet elapsed for 
several of the defaults and so we could not yet determine how the 
estimated timing of recoveries compares to the actual timing of 
recoveries.
---------------------------------------------------------------------------
    We attempted to analyze the reliability of the data supporting 
MARAD's key assumptions, but we were unable to do so because MARAD 
could not provide us with any supporting documentation for how the 
default and recovery assumptions were developed. Therefore, we believe 
MARAD's subsidy cost estimates to be questionable. Because MARAD has 
not evaluated its default and recovery rate assumptions since they were 
developed in 1995, the agency does not know whether its cash-flow model 
is reasonably predicting borrower behavior and whether its estimates of 
loan program costs are reasonable.
    The nature and characteristics of the Title XI program make it 
difficult to estimate subsidy costs. Specifically, MARAD approves a 
small number of guarantees each year, leaving it with relatively little 
experience on which to base estimates for the future. In addition, each 
guarantee is for a large dollar amount, and projects have unique 
characteristics and cover several sectors of the market. Further, when 
defaults occur, they are usually for large dollar amounts and may not 
take place during easily predicted timeframes. Recoveries may be 
equally difficult to predict and may be affected by the condition of 
the underlying collateral. This leaves MARAD with relatively limited 
information upon which to base its credit subsidy estimates. Also, 
MARAD may not have the resources to properly implement credit reform. 
MARAD officials expressed frustration that they do not have and, 
therefore, cannot devote, the necessary time and resources to 
adequately carry out their credit reform responsibilities.
    Notwithstanding these challenges, MARAD has not performed the basic 
analyses necessary to assess and improve its estimates. According to 
MARAD officials, they have not analyzed the default and recovery rates 
because most of their loan guarantees are in about year 7 out of the 
25-year term of the guarantee, and it is too early to assess the 
reasonableness of the estimates. We disagree with this assessment and 
believe that an analysis of the past 5 years of actual default and 
recovery experience is meaningful and could provide management with 
valuable insight into how well its cash-flow models are predicting 
borrower behavior and how well its estimates are predicting the loan 
guarantee program's costs. We further believe that, while difficult, an 
analysis of its risk category system is meaningful for MARAD to ensure 
that it appropriately classified loan guarantee projects into risk 
category subdivisions that are relatively homogenous in cost.
    Of loans originated in the past 10 years, nine have defaulted, 
totaling $489.5 million in defaulted amounts. Eight of these nine 
defaults, totaling $487.7 million, occurred since MARAD implemented its 
risk category system in 1996. Because these eight defaults represent 
the vast majority (99.6 percent) of MARAD's default experience, we 
compared the performance of all loans guaranteed between 1996-2002 with 
MARAD's estimates of loan performance for this period.\18\ We found 
that actual loan performance has differed significantly from agency 
estimates. For example, when defaults occurred, they took place much 
sooner than estimated. On average, defaults occurred 4 years after loan 
origination, while MARAD had estimated that, depending on the risk 
category, peak defaults would occur between years 10-18. Also, actual 
default costs thus far have been much greater than estimated. We 
estimated, based on MARAD data, that MARAD would experience $45.5 
million in defaults to date on loans originated since 1996. However, as 
illustrated by figure 1, MARAD has consistently underestimated the 
amount of defaults the Title XI program would experience. In total, 
$487.7 million has actually defaulted during this period--more than 10 
times greater than estimated. Even when we excluded AMCV, which 
represents about 68 percent of the defaulted amounts, from our 
analysis, we found that the amount of defaults MARAD experienced 
greatly exceeded what MARAD estimated it would experience by $114.6 
million (or over 260 percent).
---------------------------------------------------------------------------
    \18\ Our analysis focused on loans beginning in 1996 because: (1) 
this was the first year in which MARAD implemented its risk category 
system, and (2) MARAD could not provide us with any supporting data for 
its default and recovery assumptions for loans originating before 1996. 
Further, only one default occurred between 1993-1996, representing less 
than 1 percent of MARAD's total defaults between 1993-2002.


    Sources: MARAD (data); GAO (presentation).
    a We excluded estimates for risk categories 1A, 1B, and 
1C, because estimated defaults for these categories totaled only $1.5 
million or 3.4 percent of total estimated defaults.

    In addition, MARAD's estimated recovery rate of 50 percent of 
defaulted amounts within 2 years of default is greater than the actual 
recovery rate experienced since 1996, as can be seen in figure 2. 
Although actual recoveries on defaulted amounts since 1996 have taken 
place within 1-3 years of default, most of these recoveries were 
substantially less than estimated, and two defaulted loans have had no 
recoveries to date. For the actual defaults that have taken place since 
1996, MARAD would have estimated, using the 50 percent recovery rate 
assumption, that it would recover approximately $185.3 million dollars. 
However, MARAD has only recovered $78.2 million or about 42 percent of 
its estimated recovery amount. Even when we excluded AMCV, which 
represents about 68 percent of the defaulted amounts, from our 
analysis, we still found that MARAD has overestimated the amount it 
would recover on defaulted loans by $6.8 million (or about 10 percent). 
If this pattern of recent default and recovery experiences were to 
continue, MARAD would have significantly underestimated the costs of 
the program.


    Sources: MARAD (data); GAO (presentation).
    a Estimated recoveries are based on applying MARAD's 50 
percent recovery rate within 2 years to the actual default amounts. Our 
analysis of recovery estimates includes estimated recovery amounts for 
two of the five defaulted AMCV loans, even though 2 years have not 
elapsed, because, according to MARAD officials, no additional 
recoveries are expected on these two loans. Thus, our recovery 
calculation was based on $370.6 of the $487.7 million in defaulted 
loans, which includes defaults for which 2 years have elapsed, as well 
as the two AMCV defaults for which no additional recoveries are 
expected. With its 50 percent recovery assumption, MARAD would have 
estimated that, at this point, it should have recovered $185.3 million 
of these defaulted loans.
    b We calculated the actual recovery rate by comparing 
the total actual recoveries to the $370.6 million in relevant actual 
defaulted amounts. At the time of our review, MARAD had recovered $78.2 
out of this $370.6 million.

    We also attempted to analyze the process MARAD uses to designate 
risk categories for projects, but were unable to do so because the 
agency could not provide us with any documentation about how the risk 
categories and MARAD's related numerical weighting system originally 
were developed.\19\ According to OMB guidance, risk categories are 
subdivisions of a group of loans that are relatively homogeneous in 
cost, given the facts known at the time of designation. Risk categories 
combine all loan guarantees within these groups that share 
characteristics that are statistically predictive of defaults and other 
costs. OMB guidance states that agencies should develop statistical 
evidence based on historical analysis concerning the likely costs of 
expected defaults for loans in a given risk category. MARAD has not 
done any analysis of the risk category system since it was implemented 
in 1996 to determine whether loans in a given risk category share 
characteristics that are predictive of defaults and other costs and 
thereby comply with guidance. In addition, according to a MARAD 
official, MARAD's risk category system is partially based on outdated 
MARAD regulations and has not been updated to reflect changes to these 
regulations.
---------------------------------------------------------------------------
    \19\ MARAD's risk category system incorporates ten factors that are 
set out in Title XI, which specifies that MARAD is to establish a 
system of risk categories based on these factors. How MARAD weighs and 
interprets these factors is described in program guidance.
---------------------------------------------------------------------------
    Further, MARAD's risk category system is flawed because it does not 
consider concentrations of credit risk. To assess the impact of 
concentration risk on MARAD's loss experience, we analyzed the defaults 
for loans originated since 1996 and found that five of the eight 
defaults, totaling $330 million or 68 percent of total defaults, 
involved loan guarantees that had been made to one particular borrower, 
AMCV. Assessing concentration of credit risk is a standard practice in 
private-sector lending. According to the Federal Reserve Board's 
Commercial Bank Examination Manual, limitations imposed by various 
state and Federal legal lending limits are intended to prevent an 
individual or a relatively small group from borrowing an undue amount 
of a bank's resources and to safeguard the bank's depositors by 
spreading loans among a relatively large number of people engaged in 
different businesses. Had MARAD factored concentration of credit into 
its risk category system, it would likely have produced higher 
estimated losses for these loans.
MARAD's Credit Subsidy Reestimates Are Also Questionable
    After the end of each Fiscal Year, OMB generally requires agencies 
to update or ``reestimate'' loan program costs for differences among 
estimated loan performance and related cost, the actual program costs 
recorded in accounting records, and expected changes in future economic 
performance. The reestimates are to include all aspects of the original 
cost estimate such as prepayments, defaults, delinquencies, recoveries, 
and interest. Reestimates allow agency management to compare original 
budget estimates with actual costs to identify variances from the 
original estimates, assess the reasonableness of the original 
estimates, and adjust future program estimates, as appropriate. When 
significant differences between estimated and actual costs are 
identified, the agency should investigate to determine the reasons 
behind the differences, and adjust its assumptions, as necessary, for 
future estimates and reestimates.
    We attempted to analyze MARAD's reestimate process, but we were 
unable to do so because the agency could not provide us with any 
supporting data on how it determined whether a loan should have an 
upward or downward reestimate. According to agency management, each 
loan guarantee is reestimated separately based on several factors 
including the borrower's financial condition, a market analysis, and 
the remaining balance of the outstanding loans. However, without 
conducting our own independent analysis of these and other factors, we 
were unable to determine whether any of MARAD's reestimates were 
reasonable. Further, MARAD has reestimated the loans that were 
disbursed in Fiscal Years 1993, 1994, and 1995 downward so that they 
now have negative subsidy costs, indicating that MARAD expects these 
loans to be profitable. However, according to the default assumptions 
MARAD uses to calculate its subsidy cost estimates, these loans have 
not been through the period of peak default, which would occur in years 
10-18 depending on the risk category. MARAD officials told us that 
several of these loans were paid off early, and the risk of loss in the 
remaining loans is less than the estimated fees paid by the borrowers. 
However, MARAD officials were unable to provide us with any supporting 
information for its assessment of the borrowers' financial condition 
and how it determined the estimated default and recovery amounts to 
assess the reasonableness of these reestimates. Our analysis of MARAD's 
defaults and recoveries demonstrates that, when defaults occur, they 
occur sooner and are for far greater amounts than estimated, and that 
recoveries are smaller than estimated. As a result, we question the 
reasonableness of the negative subsidies for the loans that were 
disbursed in Fiscal Years 1993, 1994, and 1995.
    MARAD's ability to calculate reasonable reestimates is seriously 
impacted by the same outdated assumptions it uses to calculate cost 
estimates as well as by the fact that it has not compared these 
estimates with the actual default and recovery experience. As discussed 
earlier, our analysis shows that, since 1996, MARAD has significantly 
underestimated defaults and overestimated recoveries to date. Without 
performing this basic analysis, MARAD cannot determine whether its 
reestimates are reasonable and it is unable to improve these reestimate 
calculations over time and provide Congress with reliable cost 
information to make key funding decisions. In addition, and, again, as 
discussed earlier, MARAD's inability to devote sufficient resources to 
properly implement credit reform appears to limit its ability to 
adequately carry out these credit reform responsibilities.
OMB Has Provided Little Oversight of MARAD's Estimates and Reestimates
    Based on our analysis, we believe that OMB provided little review 
and oversight of MARAD's estimates and reestimates. OMB has final 
authority for approving estimates in consultation with agencies; OMB 
approved each MARAD estimate and reestimate, explaining to us that it 
delegates authority to agencies to calculate estimates and reestimates. 
However, MARAD has little expertise in the credit reform area and has 
not devoted sufficient resources to developing this expertise. The FCRA 
assigns responsibility to OMB for coordinating credit subsidy 
estimates, developing estimation guidelines and regulations, and 
improving cost estimates, including coordinating the development of 
more accurate historical data and annually reviewing the performance of 
loan programs to improve cost estimates. Had OMB provided greater 
review and oversight of MARAD's estimates and reestimates, it would 
have realized the assumptions were outdated and did not track with 
actual recent experience.
Conclusions
    In conclusion, Mr. Chairman, MARAD does not operate the Title XI 
loan guarantee program in a businesslike fashion. MARAD does not: (1) 
fully comply with its own requirements and guidelines, (2) have a clear 
separation of duties for handling loan approval and fund disbursement 
functions, (3) exercise diligence in considering and approving 
modifications and waivers, (4) adequately secure and assess the value 
of defaulted assets, and (5) know what its program costs. Because of 
these shortcomings, MARAD lacks assurance that it is effectively 
promoting growth and modernization of the U.S. merchant marine and U.S. 
shipyards or minimizing the risk of financial loss to the Federal 
Government. Consequently, the Title XI program could be vulnerable to 
waste, fraud, abuse, and mismanagement. Finally, MARAD's questionable 
subsidy cost estimates do not provide Congress a basis for knowing the 
true costs of the Title XI program, and Congress cannot make well-
informed policy decisions when providing budget authority. If the 
pattern of recent experiences were to continue, MARAD would have 
significantly underestimated the costs of the program.
Recommendations
    We are currently considering a number of recommendations to reform 
the Title XI program, including actions Congress could take to clarify 
borrower equity contribution requirements and incorporate concentration 
risk in the approval of loan guarantees, as well as actions MARAD could 
take to improve its processes for approving loan guarantees, monitoring 
and controlling funds, and managing and disposing of defaulted assets. 
In addition, we are considering recommendations to help MARAD better 
implement its responsibilities under FCRA. Because of the fundamental 
flaws we have identified, we question whether MARAD should approve new 
loan guarantees without first addressing these program weaknesses.
    This concludes my prepared statement. I will be happy to respond to 
any questions you or the other members of the Committee may have.

    The Chairman. Thank you, Mr. McCool. We'll look forward to 
those recommendations.
    Captain Schubert, you just heard Mr. McCool, who--those are 
some pretty strong criticisms. Do you have any response to 
those?
    Mr. Schubert. Yes, sir. Mr Chairman, first of all, I 
welcome a third-party review of the program to help improve the 
administration of the Title XI program, and it was one of the 
highest priorities that I had when I was sworn in, in December 
2001. So I welcome all impartial recommendations to improve the 
program.
    But that being said, as the GAO has testified, we did 
receive their draft report, which we're in the process of 
responding to. Since some of the recommendations also involve 
OMB, we're currently in the process of property vetting the 
response, a detailed response.
    But that being said, I would like to make some general 
comments in response to his testimony. First of all, the 
statement with regards to the private-sector lending practices, 
I don't believe that we agree that there is a ``universal 
trend,'' you might say, toward consolidation of the 
decisionmaking process or the monitoring process in the 
financial communities. I could say that my own experience in 
the private sector, in which I dealt with credit administration 
and shipping of over $7 billion in exports, but I dealt with 
many financial institutions during that timeframe, and I cannot 
say that I've observed that this statement is correct, that 
this is a standard practice. We will review this further and 
put it into our formal response.
    With regards to this, regarding the consolidation--my 
comment just referred to the consolidation issue, but in terms 
of the not following, or always following, our program 
requirements, I think we do follow our program--we have 
followed our program requirements, as per our regulations. The 
issues that were raised regarding the waiver of financial--
MARAD's financial requirements that had been done in the past, 
I will say that, as administrator, at least the $500 million 
that I've approved, that eight of the nine credits that I've 
approved have met all the financial requirements, and in only 
one case did we waive a provision, one of our provisions, for 
net worth on one of our projects. And we did get compensating 
provisions, as per the IG's recommendations.
    But I would like to see--and, as I mentioned in my opening 
statement--that the changes that we make, working together, 
will outlive me and will continue in the program to truly 
improve it.
    Now, with regards to the credit-risk model that we use to 
calculate the subsidy, I agree that we need to revisit that, 
and we need to work with the OMB to enhance and improve the 
current model. I believe that is something that we do agree 
with. But I would like to point out that, in the aggregate, the 
MARAD subsidy estimates, which includes the funds that are 
appropriated by Congress, plus the user fees, plus the 
recoveries that we have made, have provided adequate funds to 
cover all defaults to date. And so to say that it is has been 
totally inadequate might not be totally correct. But I do agree 
that we should make some improvements.
    The Chairman. Mr. Mead, you said that there have been nine 
loan-guarantee defaults since 1998. Is that right?
    Mr. Mead. Yes.
    The Chairman. And how much money was that?
    Mr. Mead. It was about--a little over $400 million, and 
they recovered, oh, I think about $80 million. My numbers might 
be a little bit off.
    The Chairman. Since 1998, there's been a $320 million cost 
to the taxpayers.
    Mr. Mead. Yes, sir. As I said, you know, we were fortunate 
that--over $800 million more hadn't been lost, and that was 
simply because they went bankrupt before the money could be 
disbursed.
    The Chairman. And those were AMCV, Quincy, Massachusetts, 
and the Searex platforms?
    Mr. Mead. Yes, sir. Well, and Quincy, of course, was the 
shipyard. And there were a couple of other minor ones. One was 
Surf Express. That was a catamaran undertaking in the Caribbean 
Islands.
    The Chairman. Captain Schubert, out of curiosity, Mr. Mead 
mentioned that the Searex ships were chopped up?
    Mr. Schubert. That's correct. There was one completed rig 
out of the four. Three of the four were not completed. And the 
shipyard did cut up the hulls that were on the property.
    The Chairman. Didn't that reduce the value?
    Mr. Schubert. I believe it did potentially reduce the 
value, but, to be quite honest, sir, it was probably worth 
scrap at that time, anyway.
    Mr. Mead. Well, you know----
    The Chairman. Go ahead.
    Mr. Mead.--I don't know what the predicate for that, for 
saying it's only worth scrap. I mean, they were at least hulls. 
They'd have been worth a little more. Also, that same shipyard, 
one of the reasons it chopped them up was to make room for some 
more ships that it was going to build under a loan guarantee.
    The Chairman. Now, just very briefly, the original AMCV 
deal was for five ships. Is that right? Or two ships?
    Mr. Schubert. Two ships, sir.
    The Chairman. Two ships. And they were never completed. And 
we know that $300-and-some million of the taxpayers' money was 
lost. But suppose that AMCV had not set up the subsidiary. 
Would we have gotten more money back if it had just been AMCV's 
responsibility?
    Mr. Schubert. Well, first of all, the parent company also 
went into bankruptcy, the parent company to AMCV----
    The Chairman. So we probably wouldn't have gotten any more 
money back even if they had not set up the subsidiary.
    Mr. Schubert. No, sir. I think there could have been 
stronger compensating controls, as recommended by the IG, that 
might have enhanced our recovery.
    The Chairman. And what's happened to those two hulks----
    Mr. Schubert. Well----
    The Chairman.--or shells or the uncompleted ships?
    Mr. Schubert. Uncompleted ships. Well, soon after I assumed 
the Maritime Administrator's position, I realized we had a very 
serious problem with what to do about the disposal of those 
assets. Really, there was only one hull, that was the first 
ship that was under construction. It was approximately 40-
percent complete at the time that the default occurred and also 
the--you know, there wasn't any more work--I mean, at that time 
there wasn't any work on the vessel. I, personally, went down 
to the ship to inspect the vessel. I have a ship-operating 
background. I took my staff with me to take a look at the 
vessel to see what could be done, and we determined, at that 
time, that the vessel was not going to be marketable in the 
current condition. It couldn't float at the time. So we began 
negotiations and discussions with the shipyard to make the 
vessel--to complete the hull of the vessel so it was floatable 
and towable.
    And we made good-faith attempts to advertise the vessel in 
its current condition. We were unsuccessful. In fact, the first 
offers we had would have meant that we would have had to get 
out the checkbook and write the buyer a $2 million check just 
to take the vessel. So, as you can see, we had a major problem 
here. We were trying to do everything possible to minimize the 
negative impact on the taxpayers to have to take on any more 
liability.
    We then found a buyer, or actually the shipyard found a 
buyer, for both the ship 1 and the parts for ship 2. As I 
should have mentioned, ship 2 was never actually--construction 
had never started on it. We received an offer for 22 million. 
The Maritime Administration was guaranteed a $2 million net 
recovery out of those proceeds, because the vessel had to be 
completed to where it was floatable.
    Now, the only other option we had was to probably spend 
anywhere from $20-$22 million additional of the taxpayers' 
dollars to finish the hull, to--it is a hurricane-prone area--
to make it hurricane-proof, and to possibly tow it into the 
Beaumont reserve fleet, which is nearby. That would cost the 
taxpayers $20-$22 million, with no guarantee of any recovery 
whatsoever.
    So we, under those circumstances, and also the fact that 
the shipyard space that they had the vessel sitting in was 
needed for a combatant program for the Navy, we agreed, as long 
as we could guarantee that we had net recovery of $2 million. 
And those vessels were sold--or the vessel, hull 1, plus the 
parts for hull 2, were sold to Norwegian Cruise Lines.
    The Chairman. And taken to where?
    Mr. Schubert. Germany.
    The Chairman. Germany. To where?
    Mr. Schubert. I don't remember the exact yard, sir.
    The Chairman. Construction. I mean, construction is 
continuing on----
    Mr. Schubert. The construction is continuing on both hull 
1, and they are going to commence construction on hull 2.
    The Chairman. Did you want to say anything, Mr. Mead, about 
that?
    Mr. Mead. Well, I don't know, the notion here bothers me 
that this is a program that is supposed to be designed to 
enhance U.S. shipyards, enhance U.S. shipbuilding. And here, we 
have a situation where a loan guarantee was made to build two 
ships in the United States. They go belly up, and they're 
ending up getting built overseas. There just seems something 
wrong--or something incongruous with that picture.
    The Chairman. Well, after they're finished, they may be the 
most expensive cruise ships, pound for pound, that ever has 
been worked on.
    I thank you both, Mr. Mead and Mr. McCool. I want to yield 
to Senator Stevens and then Senator Breaux.
    But, Captain Schubert, there are several changes, 
obviously, that Mr. Mead and Mr. McCool have recommended. Some 
of them may require legislative--and I'd like you to work with 
both Mr. Mead and Mr. McCool to see if we can't come up with 
whatever reforms are necessary, including if any legislative 
fixes are needed. I would appreciate that.
    Mr. Schubert. Well, can I just briefly comment, Mr. 
Chairman, that we have submitted legislation, cleared through 
OMB, that does just that. One is the ability to go out and get 
a third-party--to retain a third-party financial advisor. We 
believe that our legislation request accomplishes that.
    And I might also mention we have also asked for a provision 
in the title that the Secretary may make a determination that 
an application under this title requires additional equity 
because of the increased risk factors associated with the 
markets--technology, financial structures, and other risk 
factors identified by the Secretary. So we are also trying to 
address that, too.
    The Chairman. Thank you.
    Senator Stevens?

                STATEMENT OF HON. TED STEVENS, 
                    U.S. SENATOR FROM ALASKA

    Senator Stevens. Well, thank you very much, Mr. Chairman.
    I'm very much interested in this program, because living 
where I do, in an offshore state, we are subject to the Jones 
Act, and it seems that almost a hundred percent of our vessels 
have to have a Title XI guarantee in order to be economic with 
the foreign ships that come bring products directly from other 
countries.
    Mr. McCool, let me start with you, if I may. I'm told that, 
of the past 10 years, nine of the 108 Title XI loan guarantees 
have defaulted. Would you agree with that? Nine----
    Mr. McCool. That's correct, sir.
    Senator Stevens.--out of 108. And I'm told that the loan 
guarantees, per se, brought in $261 million of fees and 
interest charged to the loan recipients, but that defaults cost 
$490 million, meaning there's been a loss to the taxpayer of 
about $230 million. Is that correct?
    Mr. McCool. I'm not sure those are the exact numbers, but 
that's--the orders of magnitude seem right.
    Senator Stevens. Well, I'm further informed that because of 
this recent bankruptcy added to it, the AMCV, that the total 
now is $330 million in losses, that MARAD borrowed $136 million 
from the Treasury, and it has, from its own funds, repaid $124 
million. So the balance that is due is $12 million, and, when 
that's paid, the taxpayers haven't lost anything. Do you want 
to check that out?
    Mr. McCool. Well, we could check that out. The question 
is----
    Senator Stevens. If would, if I were you, because----
    Mr. McCool. The question is----
    Senator Stevens.--your report indicates that there's been a 
severe loss. And I'm told, because the financing, really, that 
when it's all added up, it's not a bad program. We've been 
through a period of time here now that has been--the whole 
economy's been in a severe slide. As a matter of fact, I'm told 
that five of the defaults took place since 9/11 of 2001.
    Mr. McCool. That's correct.
    Senator Stevens. So over half--half of the losses that have 
taken place have been taking place at a time of severe economic 
disruption in the overall economy. I would urge you to take a 
look at that.
    I'd like to go into another part, and that is that the 
assumption that the basis for a prediction of losses, default 
amount, timing of defaults, recovery amount, timing of 
resources--of recoveries and fees, that is used by MARAD to 
estimate losses, you refer to that as being simplistic. But if 
you look at the period prior to 9/11 of 2001, it was very 
accurate. It was overly accurate, as a matter of fact. Would 
you do that, please?
    Mr. McCool. We will look at that, sir, but I think it's 
also true that there were some indications even before 9/11 
that some of these projects were in trouble, so I'm not sure 
that you can attribute all the losses to 9/11.
    Senator Stevens. Well, but only four of them happened 
before that time.
    Mr. McCool. I understand. I understand. But, as I said, 
there are indications that some of the projects--and Project 
America, I think, was one of them--were potentially in deep 
trouble even before 9/11.
    But I think our sense, sir, is simply that it may be that 
there is currently enough funding to take care of what losses 
have taken place, but in order for the program to not operate 
at a loss, it would mean that the performance in the future is 
going to have to be better than expected and in sufficient 
amounts to compensate for the losses that have taken place----
    Senator Stevens. Your report----
    Mr. McCool.--in the last 6 years.
    Senator Stevens.--says eight of these nine defaults, 
totaling 487.7 million, occurred since MARAD implemented its 
risk-recovery system, in 1996. But five of them happened after 
9/11.
    Mr. McCool. That's right.
    Senator Stevens. So you're criticizing the system of 
estimating losses without taking into account the period that 
you're applying it to. It was a system that was based on a 10-
year rolling average, as I take it, and probably there will be 
a recalculation based on these five new losses, but I don't 
want to see the baby thrown out with the bath, you know. And it 
does seem to me that the period we're in right now of severe 
economic stress ought not to be used to judge a period of 
validity of a loan-guarantee program.
    Mr. McCool. Well, I think that the question is, you need to 
take it into account to some extent. You have to adjust for the 
fact that you think it's an anomaly, if you think it's an 
anomaly, but you also have to take into account the empirical 
facts in making these estimates. And that's all we're saying, 
that some adjustments based on empirical actuality have to be 
included in the estimates.
    Senator Stevens. Well, I'm sorry, Mr. Chairman, I'm going 
to move on, because I've got another--I know Senator Breaux has 
questions, too, and I have one more other comment to make.
    You say, on page 26 of the report, ``Consequently''--you've 
had, in conclusion, concept--it says, ``Consequently, the Title 
XI program could be vulnerable to waste, fraud, abuse, and 
mismanagement.'' Did your examination find waste, fraud, abuse, 
or mismanagement?
    Mr. McCool. Well, we certainly didn't find fraud. We did 
find--our problems with internal controls, I think, would 
qualify as areas where we think management could be improved. 
And----
    Senator Stevens. What about fraud?
    Mr. McCool.--in terms of waste, again, without good 
internal controls, it's hard to know whether money is being 
used efficiently. And that's, I think, what we mean by that.
    Senator Stevens. That ought to be seized by some of our 
brethren there in the news media, to say there's been an 
allegation that waste, fraud, abuse, and mismanagement. You're 
not making that allegation, are you?
    Mr. McCool. No, we're just saying that----
    Senator Stevens. There's a ``could'' in there, ``It could 
be.''
    Mr. McCool. That's what--we say ``could.'' We say 
``could.''
    Senator Stevens. You're not reporting that there's been any 
at all so far, right?
    Mr. McCool. That's correct.
    Senator Stevens. You've made questions about the 
management----
    Mr. McCool. That's correct.
    Senator Stevens.--and say that those questions ``might'' 
add up to mismanagement----
    Mr. McCool. Correct.
    Senator Stevens.--right?
    Mr. McCool. Correct, sir.
    Senator Stevens. Mr. Mead, would you care to comment on the 
waste, fraud, abuse, and mismanagement concept that could be 
applied to this program?
    Mr. Mead. I can't discuss, in this session, active 
investigations that we have underway. I would say that----
    Senator Stevens. Do you have any involving waste, fraud, 
abuse, or----
    Mr. Mead. Yes, we do.
    Senator Stevens. You do. All right. When will you decide 
those?
    Mr. Mead. That's something that would be done in concert 
with the Justice Department, and I can't predict exactly when.
    Senator Stevens. All right.
    Mr. Mead. But I would not--I think, in fairness, I don't 
want to characterize this program as ``riddled with fraud, 
waste, or abuse,'' but my comment is simply that I cannot 
categorically say, because of some investigations we have 
pending, that the program is totally free of it.
    Senator Stevens. Would it be improper to ask if they 
applied to the subjects reviewed by Mr. McCool in terms of 
these last severe losses?
    Mr. Mead. I think that I would not want to----
    Senator Stevens. All right. I thank----
    Mr. Mead.--respond to that.
    Senator Stevens. Well, I do thank you, Mr. Chairman, for 
holding the hearing. I, again, want to say, without this 
program, I don't think Alaskan trade could survive, so I have a 
deep interest in its preservation.
    Thank you very much.
    The Chairman. Thank you, Senator Stevens.
    I'd point out that the money that MARAD used to pay off the 
defaults were appropriated funds, so they are taxpayers' 
dollars. I don't know how you could--it's funny math when you 
say that we didn't cost taxpayers a whole lot of money.
    Senator Breaux?
    Senator Stevens. They had $124 million of earnings which 
were applied to that. That's not the taxpayers' money.

               STATEMENT OF HON. JOHN B. BREAUX, 
                  U.S. SENATOR FROM LOUISIANA

    Senator Breaux. Thank you, Mr. Chairman, and thank you the 
panel members----
    The Chairman. Any earnings, therefore----
    Senator Breaux.--for their----
    The Chairman.--any earnings would, therefore, 
counterbalance any cost to the American taxpayer.
    Please go ahead, Senator Breaux.
    Senator Breaux. Thank you, Mr. Chairman, for having the 
hearing, and thank our witnesses, as well.
    It's certainly not a newsworthy item that someone has found 
out that there's a Federal program in Washington that could be 
subject to waste, fraud, and abuse.
    [Laughter.]
    Senator Breaux. What an interesting and novel concept.
    [Laughter.]
    Senator Breaux. As one who deals with the $270-billion-a-
year Medicare program, as just one among many, waste, fraud, 
and abuse in many areas of our Federal Government is just 
incredibly--the amount that we have in so many of our programs 
is just incredible in comparison to this one.
    Trains, planes, and ships. When you look at what we spend 
in this country in Amtrak to keep the trains running on tax 
dollars and subsidies, when you look at how much this Congress 
has appropriated and authorized to keep bankrupt airlines out 
of getting into further difficult times, and you compare all of 
those other areas with what we do in this one area of 
shipbuilding to ensure a U.S. fleet, instead of looking at a 
black eye on this program, it should be getting a gold star 
when you compare it with everything else that we do.
    That is clearly not to say we can't do what we do better 
than we do, and I think that Captain Schubert has clearly 
indicated the department's willingness to try and look at ways 
to improve the program. But if we are going to look in the 
MARAD program for huge amounts of waste, fraud, and abuse 
compared to everything else, I would suggest that we're going 
to be spending a lot of time, with little results.
    But the fact of the matter is that the program, over the 
years, has been one of the more successful partnerships between 
the government--not in direct subsidies, but merely in allowing 
companies to go to the private sector to use private capital 
which the Federal Government guarantees. It's a perfect 
partnership with regard to government and private sector doing 
something that is important to this country. That is different 
from what we do with Amtrak. That is different from what we do 
with aviation.
    It is important to note that during the period between 1993 
and 2001, we've had three defaults and literally hundreds of 
loan guarantees. When the two twin towers came down, the cruise 
industry in this country collapsed, as well, and it sunk. And 
it's not surprising to find three or four ships that were 
destined for a cruise industry that, before 9/11, probably 
looked fairly decent, as far as the potential outcome. But 
after 9/11, whether you were in the cruise business or the 
hotel business or the airline business or the transportation 
business or the entertainment business, for a period of time, 
much of that literally collapsed. And I think the MARAD program 
is, obviously, adversely affected by it, just like all of these 
other areas.
    But prior to the bankruptcy and the default of the American 
Classic Voyage venture, the loan guarantee program in MARAD, I 
think, was in strong financial condition and actually 
collected, as I remember it, more in fees and interest than was 
lost to the default during that period. Is that correct, 
Captain?
    Mr. Schubert. That's correct, sir.
    Senator Breaux. There's not a lot of programs that we could 
say that the way we've run them we've actually made money while 
trying to help people by loaning them money. This happens to be 
an example. The increased default rate, I think, that we have 
in the ships since 9/11, is certainly, I think, not 
inconsistent with default rates that we have seen in other 
areas and bankruptcies that we've seen in other areas.
    I thank Mr. Mead and Mr. McCool for their work. I would 
hope that Captain Schubert is cooperative in what you all are 
trying to do and, out of this, we can produce a better 
administration, a better product for the services that we are 
trying to provide. I do not think that we need to wholesale 
change it. It's a good formula. It works. It's a good 
combination, private sector working with government.
    Are there problems? There's not a program that doesn't have 
problems. And I would hope that we'd be able to work something 
out that would be an improvement and would work with the 
Chairman to hopefully accomplish that.
    The Chairman. Thank you, Senator Breaux.
    Captain Schubert, the Justice Department filed suit against 
Newport News Shipbuilding alleging that the company knowingly 
mischarged the U.S. Navy on costs incurred for work under 
commercial contracts from 1994 to 1999. Do you have any 
evidence about that?
    Mr. Schubert. The Newport News--the investigation on 
Newport News, sir?
    The Chairman. Yes.
    Mr. Schubert. No, I don't.
    The Chairman. Have you heard that the Department of Justice 
filed suit against Newport News Shipbuilding?
    Mr. Schubert. To be honest, I have not heard that.
    The Chairman. Captain Schubert----
    Mr. Schubert. Can I add one----
    The Chairman. There is a loan guarantee before MARAD that 
seeks a $750 million loan guarantee for a project known as Fast 
Ship, which I understand would consist of four high-speed 
container vessels crossing the North Atlantic. It's my 
understanding the application has been pending since September 
1999. Does this project qualify for a loan guarantee under 
Title XI?
    Mr. Schubert. Mr. Chairman, this is a pending application. 
We are currently reviewing all the submittals. We've advised 
the applicant the areas that would need to be corrected for us 
to move forward. But since it is a pending application, I 
cannot go into, in a public forum--because much of the 
information is proprietary and confidential. But as the 
chairman of the committee with oversight, if you requested, in 
writing, some of these materials, we----
    The Chairman. It's somehow confidential to ask whether it 
qualifies for a loan guarantee under Title XI?
    Mr. Schubert. Well, since we have not made--Mr. Chairman, 
since we have not made a final determination, it is still a 
pending application.
    The Chairman. But my question is, does it qualify to be 
considered under Title XI?
    Mr. Schubert. Mr. Chairman, it qualifies to be considered 
under Title XI.
    The Chairman. Do you think so, Mr. Mead and Mr. McCool?
    Mr. Mead. I think that this--I'm familiar with the Fast 
Ship thing, and I don't want to breach any rules of 
confidentiality, certainly, in a session like this, but I do 
think this application is an excellent candidate for that 
second recommendation that we're offering, that they not 
approve these loan guarantees in the absence of independent 
third-party external review.
    Second, you need to make sure on this one that it's not 
just an R&D undertaking. The Department of Defense, I think, 
has some interest in this. I'd like to know a little bit more 
about why they have that interest.
    And, finally, I think if Mr. Schubert had a chance to 
respond to the record for you, that he would point out some 
things that still need to be completed in the application.
    The Chairman. Well, what I don't get is--my understanding 
is, it's been--the application has been pending since September 
1999. We're approaching 4 years here.
    Mr. Mead. Yes, well, it's not complete.
    The Chairman. Is that correct----
    Mr. Schubert. Mr. Chairman, that's correct.
    The Chairman.--Captain Schubert?
    Mr. Schubert. Mr. Chairman, that is----
    The Chairman. Is it normal for us to have an application in 
September 1999, and in June 2003 the application is not 
complete? Is that a normal, sort of, set of circumstances?
    Mr. Schubert. I would not say that this would be a normal 
circumstance, but I--since you've raised the issue of old 
applications, I would like to say, for the record, that we are 
undertaking----
    The Chairman. Well, I'm really talking about this 
particular issue, since it entails $750.5 million. I appreciate 
your policy toward it, but there's something wrong with this 
picture. Is there something that I should know about--that 
Congress should know about this?
    Mr. Schubert. Mr. Chairman, as the Chairman of the 
Committee that has the oversight over this program, we would be 
willing, if you request it in writing, to give you what items 
are outstanding for this application.
    The Chairman. Well, you know, I'm not often at a loss for 
words, but I don't think I've quite encountered anything quite 
like this, that you make an application, and 3-1/2 years later, 
more than 3-1/2 years later, the application is not complete. 
Obviously, I think we need to know more about this.
    Mr. Schubert. We have been----
    The Chairman. Mr. McCool or Mr. Mead, can you shed any 
light on this pending application which is not complete?
    Mr. Mead. I don't understand why it's been pending for so 
long, and I think--it's not uncommon, though, for applications 
at MARAD to be alive for an extended period of time. They 
probably need to scrub the portfolio of applications they have. 
And I've heard some estimates that they probably could cut that 
portfolio in half.
    The Chairman. Maybe, Captain Schubert, I've cut you short, 
then. Please go ahead.
    Mr. Schubert. I was going to testify, for the record, that 
we are in the process of cleansing--or, let's say, cleaning out 
old inventory of applications, and there is a substantial 
number of applications that we can, by our regulations, 
terminate. And we're in the process of doing that as one of the 
many areas that we're trying to improve the program.
    But I also was going to say, back to the Fast Ship 
application, that when I came in, in December 2001, that I 
pretty much asked the same question you asked, is, why is it so 
many years later, and how come we haven't moved on this? So I 
did begin a top-to-bottom review, you might say, of the 
application to really identify what it is that would need to be 
corrected for it to be considered a sound application.
    The Chairman. Well, here's what I'd like you to do, all 
three of you, if you don't mind. I'd like to know your 
recommendations, both in GAO and from the IG, and yours, 
Captain, that need to be changed in the rules and regulations 
and the way you do business, the statutory changes--you have 
referred to one, at least--that are recommended, and those, 
Captain Schubert, that Mr. McCool and Mr. Mead make that you 
would not actively support or you think are unnecessary or 
unwanted. And that way maybe we could sort out, one, what rules 
and regulations need to be changed, but, far more importantly, 
from the standpoint of our responsibilities, what legal and 
statutory changes need to be made. Is that agreeable to you, 
Captain?
    Mr. Schubert. Mr. Chairman, that's agreeable. I would like 
to add that we are implementing all five recommendations of the 
IG, and we're creating an audit trail so that it can be 
periodically verified that we are complying, and we're actively 
working with the staff to accomplish that very soon. And I 
believe that we have--the administration has proposed a couple 
of areas in legislation that would help implement the IG's 
recommendations.
    The Chairman. Just briefly, I'm told by staff that your 
request, right now, only addresses two of the five 
recommendations. Mr. Mead, are you--is that correct?
    Mr. Schubert . That's correct, Mr. Chairman. But the other 
areas that we're addressing in the recommendations are more of 
a process change, and we've been working very closely. I agree 
that we need more than just my word that we're going to 
implement it. We're actually creating forms and a way, a very 
systematic process change to the Title XI application and the 
review after we grant applications and approve applications, 
plus the areas that--what we'd need to do to improve monitoring 
in case of defaults. So all those things are--I believe most of 
them are process-type changes that we are actively implementing 
right now.
    The Chairman. That don't require statutory----
    Mr. Schubert. That don't require legislation.
    The Chairman. Is that your view, Mr. Mead?
    Mr. Mead. I think we've had some downs--we had some real 
downs in the 1980s in this program. I think that there are some 
similarities that existed in the 1980s that could have been 
corrected administratively that were--for a few years we 
backslided. And now Mr. Schubert is advancing the case that he 
could administratively implement them. I agree, you can. But 
sometimes you need the reinforcement of legislation, even on 
things that are process in nature.
    The Chairman. Mr. McCool, do you have any additional 
comments?
    Mr. McCool. No, I would actually agree with Mr. Mead, that 
a lot of these can be done through the regulations in the 
program, but there are probably some areas where legislation 
would be helpful to keep things consistent across 
administrators.
    The Chairman. Senator Breaux?
    Senator Breaux. I'll take it that on the application. I'm 
not familiar with--what the Chairman referred to, but it's 
taken 4 years. The type of vessels they're looking at are not 
yet a proven technology, and one of the obligations that MARAD 
would have to determine is that this new type of technology, 
which is not yet common technology, or accepted, in most terms, 
has to be proven to be economically viable in order for you to 
approve a loan. And it would seem to me, that is one of the 
difficult tasks that you have, and it seems to be one of the 
reasons why it's taken so long. You have to have some adequate 
proof that what this new technology can do is also commercially 
feasible. Is that part of the problem with the process?
    Mr. Schubert. Senator, that is correct. We have both a 
technical review of the application and the economic soundness 
test. But, obviously, one would relate to the other, in some 
cases. If you're selling a premium service on new technology, 
it's got to work.
    Mr. Mead. I think you've put your finger on it. The key 
here is, there's been application made of the Maritime 
Administration to approve this loan--this application for these 
things called Fast Ships. If this is really a Department of 
Defense initiative, query whether the Department of Defense 
ought to pony up the money for it.
    Senator Breaux. Yes, I take it that you cannot approve 
loans for research-type of projects. You can only approve loan 
guarantees for commercially feasible projects, not for research 
activities. Is that correct?
    Mr. Schubert. Senator, that's correct. This program, in 
particular, should never become a lender of last resort, which, 
in cases of research and technology, if you don't have a 
commercially viable vessel, it does, in my opinion, put the 
taxpayer at a high risk. But the program is not structured to 
be that.
    Senator Breaux. OK, thank you, Mr. Chairman.
    The Chairman. Captain Schubert, I take you at your word 
that you're trying to clean up these requests. I see you have 
one dating back to 1995. So----
    Senator Breaux. It's probably from one of my constituents.
    The Chairman. It is. Actually, it is. From Harvey, 
Louisiana.
    [Laughter.]
    Senator Breaux. What's taking so long on that one?
    The Chairman. Maybe fear.
    [Laughter.]
    The Chairman. So, you know, you ought to get----
    Mr. Schubert. But we have--under statutory authority now, 
we can terminate, at our discretion, any application that 
hasn't met the requirements. And then I would like to point out 
that the applicant, within a year, can reapply without paying 
any fees.
    The Chairman. I see.
    I want to thank the witnesses. This has been a very helpful 
hearing, and I have----
    Did you want to say something else, Mr. Mead?
    Mr. Mead. Yes, I've wanted to--I understood the line of 
questioning--some of the line of questioning was that the 
problems here surfaced post-9/11, and I wanted to clarify, for 
the record, that the systemic issues we're speaking of here 
were in existence before then, and the documentation I'd point 
to on that is AMCV. Before--in the early part of December, 
their stock had gone from about $35 to about 50 cents a share. 
And there also were eight of these defaults before 9/11. Quincy 
Shipyard did not happen after 9/11.
    So I'm sure, as with other industries, Mr. Chairman, that 
9/11 compounded an already difficult situation. It's the same 
thing in the airlines. The airlines came in here, and they 
said, well, we had all these problems after 9/11. But if you 
look back at the data, it goes back--their problems go back far 
before then.
    So, I'm sorry, I just wanted to clarify that for the 
record.
    The Chairman. No, you know, I think everybody is aware that 
the AMCV thing was one of the most incredible boondoggles in 
history, in recent history. $330 million of the taxpayers' 
money was incredibly wasted, a deal to cruise Hawaii, which 
would have then cost people who did cruise Hawaii a higher cost 
because of granting a monopoly. I mean, it was an outrageous 
rip-off of the taxpayers. And to blame it on 9/11, of course, 
flies in the face of the facts.
    I thank the witnesses.
    This hearing is adjourned.
    [Whereupon, at 3:40 p.m., the hearing was adjourned.]
                            A P P E N D I X

      Prepared Statement of the American Shipbuilding Association
    The American Shipbuilding Association (ASA), which is the national 
trade association for the six largest shipbuilders and 27 companies 
engaged in the manufacture of ship systems and equipment in the United 
States, is pleased to present this statement for the record in strong 
support of the Maritime Administration's (MARAD) Title XI Ship Loan 
Guarantee Program.
    In 1993, Congress amended and revived the Title XI Ship Loan 
Guarantee Program to bring it into compliance with the 1990 Credit 
Reform Act. The reformed program was designed to ensure that strong 
economic soundness criteria be met in order for ship owners to qualify 
for Title XI guarantees while carefully balancing the fact that some 
degree of risk always exists with the financing of major capital 
investments. Congress also amended the program to allow for guarantees 
of commercial loans for shipyard facility investments applying the same 
economic soundness criteria. As the Inspector General's report 
acknowledged, the program was performing very successfully until the 
2001 default by American Classic Voyages (AMCV). Until this tragic 
event, the program was experiencing a default rate of three (3) 
percent--one of the lowest of all Federal loan guarantee programs.
    Since 1993, the MARAD has guaranteed or formally agreed to 
guarantee more than $4.3 billion in commercial loans for the 
construction of approximately 820 vessels and the modernization of four 
shipyards. The 820 vessel construction programs financed have included 
six 45,000 DWT double hull clean product tankers built at Newport News 
Shipbuilding in Virginia; four 45,000 DWT double hull clean product 
tankers built at Avondale in Louisiana; one Roll-on/Roll-off ship built 
at National Steel and Shipbuilding Company (NASSCO) in California, with 
an application for the second ship of the class pending; four offshore 
oil supply vessels and two 2,000 passenger oceangoing cruise ships at 
Ingalls in Mississippi (which will be addressed later in this 
statement). Two ASA shipyards, Avondale and NASSCO, which at the time 
were employee-owned companies, received Title XI guarantees for 
facility investments in steel fabrication and pre-outfitting 
facilities, respectively.
    Title XI loan guarantees are essential to providing small and 
medium-sized ship owners with affordable financing to replace and 
expand their fleet of ships engaged in commerce. The financing rates 
facilitated by Title XI are comparable to the rates that large 
corporations have access to from commercial banks in the replacement of 
their vessels. The projects listed above, with the exception of the 
cruise ships, were for the construction of cargo ships moving refined 
oil and other cargo between ports in the United States, and all of the 
above referenced vessel guarantees went to small and medium-sized ship 
operating companies. The higher interest rates and conditions charged 
medium and smaller companies by commercial banks would have made the 
construction of these cargo ships unaffordable to these companies 
without the Title XI loan guarantee. Title XI guarantees 87.5 percent 
of a commercial loan over 25 years. The 25-year length of the loan 
guarantee is extremely important to ship owners financing a large 
capital investment such as ships. By analogy, the majority of American 
home buyers would probably not qualify for a home loan if they could 
not finance that loan over 30-years, thus making their monthly mortgage 
payments affordable.
    During Operation Iraqi Freedom, six of the clean product tankers 
referenced above were chartered by the Military Sealift Command to 
supply our forward deployed troops with jet fuel. These ships would not 
have been built, but for Title XI, and thus, would not have been 
available to our Nation in the war against Iraq. Terrorist attacks on 
New York and Washington, forward deployed troops in Saudi Arabia, and 
the USS Cole have underscored the need for American-built, owned, and 
manned ships to re-supply our forward deployed troops to mitigate, if 
not eliminate, the threat of terrorist attack. The Military Sealift 
Command chartered 25 clean product tankers for the Iraqi operation, but 
there were only six American-built, owned and crewed ships available 
for the mission. More clean product tankers need to built in the U.S. 
to address this security risk, and Title XI will be instrumental in 
this security objective.
    The other commercial ship types that the military desperately needs 
in times of war are Roll-on/Roll-off ships (RO/RO's), which can 
efficiently deliver Army jeeps, trucks, helicopters and other heavy 
equipment. The two RO/RO's NASSCO is building for Totem Ocean Trailer 
Express (TOTE) of Washington State, the construction of one, which has 
been guaranteed by Title XI, and the guarantee of the sister ship is 
awaiting application approval, will be critical to our military in the 
on-going war against terrorism. One of TOTE's older RO/RO ships, which 
was built with a Title XI guarantee, was also chartered by the Military 
Sealift Command in Operation Iraqi Freedom.
    Apart from the military usefulness of the ships constructed under 
Title XI Loan Guarantees, it is important to emphasize that we must 
have sufficient domestic shipping capacity to meet the commercial 
demands of all Americans in order to enable militarily useful ships to 
be diverted to the war zone from their domestic routes. These tankers 
and RO/RO's would not have been available to the Department of Defense 
if we did not have sufficient grain barges, oil barges, and other 
domestic oceangoing ships, financed by Title XI, to ensure that our 
domestic energy and commercial transportation needs were met to serve 
the U.S. economy.
    The U.S. Navy and Department of Defense further benefit from Title 
XI in the reduced cost of naval ships as a result of lower shipyard 
overhead costs charged to DOD; increased production throughput in our 
supplier base reducing the unit prices of hull, machinery and 
electrical equipment ordered for naval ships; and sustaining our highly 
skilled engineering and production work force, and thereby avoiding the 
high cost of firing to later hire and train a workforce at great 
expense and time to meet naval ship construction and repair 
requirements. It takes years to train the many specialized trades 
required to build the world's safest and most technologically advanced 
ships. The cost to train our workforce as a result of low and unstable 
rates of naval ship construction is reflected in our unit prices and 
the unit prices of our suppliers. Commercial shipbuilding, facilitated 
by Title XI, significantly reduces these costs, and more importantly 
helps to sustain the industrial and skill base essential to building 
warships that waged the war in Afghanistan, Iraq, and defended our 
homeland from additional terrorist attacks following September 11, 
2001.
    The American Shipbuilding Association has, and will continue, to 
oppose any and all efforts to waive the economic soundness criteria 
used by the Maritime Administration in determining qualified applicants 
for Title XI Loan Guarantees. The MARAD has done an excellent job in 
thoroughly reviewing and analyzing the economic soundness of each 
project brought before it. With the exception of one shipyard 
modernization guarantee, which MARAD was by law required to change the 
economic soundness criteria and approve the guarantee over its 
objection, MARAD has exercised good and sound judgment in its review 
and approval process.
    The solid administration of this program by the MARAD has been 
demonstrated by the low default rate prior to the end of 2001. In spite 
of this record, the MARAD has acknowledged that there is always room 
for improvement, and has moved to implement the recommendations of the 
Inspector General's (IG) report. This IG report was requested in the 
aftermath of the defaults in the program as a result of the bankruptcy 
of American Classic Voyages (AMCV). While the MARAD, maritime industry, 
and Title XI have been under attack as a result of these defaults, it 
is important to look at the guarantee applications from the cruise 
market perspective at the time they were approved.
    In 1997, AMCV solicited bids and proposals from all capable 
American shipbuilders for the design and construction of two 2,000 
passenger cruise ships. AMCV was an established American cruise company 
operating two American-built and crewed ships in the Hawaii trade and 
modern paddle wheel cruise vessels up and down the Mississippi. The 
ships in the Hawaii trade were old, out-dated, and in need of 
replacement. The cruise industry serving the American market, including 
Hawaii, had been experiencing a 20-year growth, and every projection 
was that this industry would continue to grow as more and more 
Americans sought cruise ships as their ultimate tourist destination. 
American shipbuilders viewed this as a promising commercial market in 
which to re-establish themselves after an absence of 40 years. They 
developed cruise ship designs and realized the ideal mix of skilled 
trades associated with the construction and integration of naval ships 
with that of cruise ships. Because of the promising growth in the 
cruise market coupled with the benefits of sustaining our companies and 
skilled workforce during the lowest rates of naval ship production 
since 1932, three ASA shipbuilders bid on the AMCV Project America 
Cruise Ship Project--Avondale, Ingalls, and NASSCO. In 1998, Ingalls 
was selected by AMCV to build two cruise ships with options for four 
additional ships.
    In March 1999, the MARAD approved the loan guarantee for Project 
America. Based on the past performance of the cruise market operating 
out of the United States, projections for continued growth in the 
market, and the growing market demand for AMCV cruises in Hawaii and 
its rising bookings, it is understandable why American shipbuilders and 
the MARAD found AMCV and its replacement and expansion plan to be 
economically sound. No one--AMCV, shipbuilders, or the MARAD--could 
have anticipated the economic downturn that began in late 1999 that 
took its toll on the Hawaii cruise market. The attacks of September 11, 
2001, shut down air travel and cruises in Hawaii. AMCV, as other cruise 
lines undergoing large capital investments and associated dept service, 
could not survive, and filed for bankruptcy at the end of October of 
2001.
    When AMCV filed for bankruptcy, Ingalls was forced to stop work on 
the construction of the first of two cruise ships--which was 
approximately 50 percent complete. It was forced to lay-off and re-
assign to other programs 1,250 people on the cruise ship project. 
Ingalls and MARAD both looked for alternative customers to assume 
ownership of the program so that the ships could be completed on 
schedule to protect the taxpayer from a default and to minimize 
disruption to the workforce and workload planning at the shipyard. 
There were no willing or able customers to assume the project in the 
months following the 9/11 disaster without the shipyard agreeing to 
support changes in U.S. law to allow the ships to be operated in Hawaii 
with foreign crews.
    This program was a tragedy for the taxpayer, the Title XI program, 
the MARAD, AMCV, and the shipbuilding industry. The default on Project 
America was $185 million to the taxpayer, a black eye for Title XI, a 
loss of $60 million to Ingalls for bills not paid by AMCV, and the 
displacement of hundreds of skilled taxpaying shipbuilders. The demise 
of AMCV also devastated the shipbuilding industry's momentum to 
recapture the cruise ship construction market serving American ports 
for the benefit of all taxpaying Americans--builders, owners, Crews, 
and tourists. As a result, the U.S. Treasury and the American worker 
will not see a return on investment in the foreign cruise industry 
operating from our shores, which pays no taxes to the U.S., but is 
supported by American tourists and American tax dollars in port 
infrastructure, channel dredging, and Coast Guard inspections and 
search and rescue.
    Hind sight is 20/20. MARAD, AMCV, and shipbuilders did not have a 
crystal ball to predict an economic downturn prior to the Title XI 
application approval of Project America in March 1999. And none of us 
predicted the terrorist attacks of 9/11, which brought AMCV to its 
knees as the cruise market in Hawaii collapsed. Following 9/11, 
Congress acted to establish a loan guarantee program to mitigate the 
financial collapse of the airline industry as a result of the economy 
and terrorist attacks. It would be devastating for the maritime 
industry if the Title XI program were to fall victim because of a 
default linked to the same economic factors and terrorist attack, which 
mobilized the country to come to the aid of the airline industry.
    In closing, ASA supports the recommendations made by the IG report 
on procedures MARAD could undertake to safeguard even further taxpayer 
dollars on Title XI Loan Guarantees--recommendations that MARAD is 
already implementing. ASA urges the Committee's continued support of 
Title XI to foster commercial ship construction, job creation, and the 
sustainment of America's defense shipbuilding industrial base. Thank 
you.
            Sincerely,
                                          Cynthia L. Brown,
                                                         President.
                                 ______
                                 
                                                NY Waterway
                                Weehawken, New Jersey, May 13, 2003
Hon. John McCain,
Chairman,
Committee on Commerce, Science, and Transportation,
Washington, DC.

Hon. Ernest F. Hollings,
Ranking Member,
Committee on Commerce, Science, and Transportation,
Washington DC.

                                Re: Title XI Reform Hearing

Dear Chairman McCain and Ranking Member Hollings:

    I am writing to request that my letter be included in the official 
record for your May 15, 2003 hearing on Title XI Reform.
Background
    My name is Arthur Imperatore, Jr. and I am President of New York 
Waterway, the largest private ferry company in the country. My father 
Arthur Sr. started our family owned business in 1986 at a time when it 
was widely referred to as ``Arthur's Folly". Today we have the largest 
ferry and excursion fleet in New York Harbor. Our company was 
recognized by Federal, state and local officials for its life-saving 
role in evacuating mid-town New York after the tragedy of September 
11th. New York Waterway operates commuter ferries between New York and 
New Jersey as well as harbor sightseeing cruises. Last year alone we 
carried more than 15 million commuters on our fleet of vessels.
    The success and growth of our company is due in large part to 
Marad's Title XI loan guarantee program. The Title XI program is the 
only Federal financing program available to private operators like New 
York Waterway to assist in the construction of ships. Over the past 6 
years our company has financed over $28,000,000 in the construction of 
eighteen new vessels through the Title XI program and we have a pending 
application for the financing of another five vessels. The favorable 
lending terms of the Title XI program have allowed us to accelerate our 
construction program to meet the needs of our customers. Since 
September 1lth. commuters as well as various government agencies have 
requested more frequent trips and additional destinations as they rely 
on our company to meet their transportation needs. In response to these 
needs, New York Waterway has built a significant marine transportation 
network providing essential transportation services to commuters and 
tourists. Our privately owned and operated ferries are the most 
significant form of non- subsidized public transit in the New York 
area.
    Because the individual cost of our ships is relatively small (about 
$1.5 million) and we have used the same shipyard, our Title XI projects 
have been straightforward and without controversy. Our eighteen newest 
ships have all been built in Sitka, Alaska and delivered on time and 
within budget. Nevertheless on every application Marad has required our 
company to undergo and comply with the same level of scrutiny used for 
much larger projects. In our experience the cost of the project 
financed is almost immaterial to the process and review employed by 
Marad.
    Those of us familiar with the Title XI program are aware of a few 
``problem'' projects. Frankly, it's not clear whether these problem 
projects are a result of inadequate financial resources of the 
applicant, incapable or inexperienced shipyards, poor project 
management or political interference. Whatever the reasons, I believe 
these projects represent a few exceptions to the norm and I would urge 
the Committee not to judge the effectiveness of the program on a few 
failed projects. In all the years dealing with Marad, New York Waterway 
has never defaulted on a loan guarantee and we've never missed a 
payment. We could not have expanded to meet the needs of our passengers 
without Title XI financing. I believe there are many other companies 
with a similar success record and these cases, not the few problem 
projects, are the testament to the success and importance of the 
program.
    Finally, some critics have called the Title XI program ``corporate 
welfare'' designed to provide subsidies to the maritime industry. From 
New York Waterway's perspective, nothing could be further from the 
truth. The program has provided essential financing for our company. In 
addition to the application fee, we pay a significant guarantee fee for 
the privilege of receiving the federally guaranteed loan. After the 
loan is paid off, I believe you will find that the government has 
actually made money from issuing the guarantee. As you may know, the 
National Marine Fisheries Service of the Department of Commerce 
administers the Title XI program for fishing vessels and fish 
processing facilities (under the same legal authority) and in the 
President's FY 04 proposed budget, the Office of Management and Budget 
scored that program as a negative cost to the government--meaning that 
the program has made money for the government. We believe that with a 
few minor reforms the Marad Title XI could achieve similar returns to 
the government.
Recommendations
    While the Title XI program has provided critical financing for New 
York Waterway, there are a few areas where we believe legislative and 
administrative reform could make the program even stronger.
    Acquisitions--Because the Title XI program was designed to promote 
construction in U.S. shipyards, only new vessels may be financed 
through the program. However, there are a number of recently built 
ferries that New York Waterway has wanted to buy. These purchases would 
have been less costly than new builds and satisfied our needs. We would 
also like to use the program to help finance maintenance related 
facilities and piers. We request that the Committee consider amending 
the program to allow for the financing of recently built U.S. vessels 
(less than 5 years old) as well as related marine facilities.
    Economic Soundness--Each project must meet Marad's economic 
soundness test. While we support the goal of only financing projects 
that are economically sound, the manner in which this test is currently 
applied may not be the best. For example, when New York Waterway 
submits an application for a new ferry we must show that that specific 
ferry will be economically sound. We are asked to submit projected 
ridership numbers and a market analysis. For new routes or when adding 
additional capacity to existing routes, this can be very difficult. For 
existing business we believe a better approach would be to look at the 
economic soundness of the company as a whole. In other words, is the 
applicant company--as opposed to a specific vessel--financially sound 
and capable of repaying a loan? Applying the economic soundness test in 
a broader context would in our view improve the program and possibly 
reduce the number of problem projects.
    Military Usefulness--The most recent congressional appropriation of 
funds for Title XI carried with it a directive to MARA to ``ensure that 
priority is given to vessels that not only provide commercial viability 
but also exhibit military utility,'' such as tank vessels or roll-on/
roll-off vessels. We are deeply concerned that this may eliminate 
ferries as eligible types of vessels as they are not generally 
militarily useful. We are also concerned that Title XI funding may be 
exhausted on other projects before ferries can be considered. New York 
Waterway has worked exceedingly hard to build a regional transportation 
network throughout the New York-New Jersey area. The benefits of marine 
transportation are well known and the success of our company and others 
like it means less congestion, less pollution and a savings in energy. 
Our vessels are also available in times of national disaster or 
emergency. We request that your Committee consider repealing this 
restriction or alternatively adding as priority projects those which 
expand and improve America's marine transportation network.
    Program Funding--As you can appreciate, the lead time needed to 
design, order, construct and deliver a new vessel is significant and at 
New York Waterway we attempt to plan for vessel purchases 2 years in 
advance. Unlike highway funds, Title XI Program funding is subject to 
annual appropriation which means that predicting whether funding will 
be available is a challenge. We ask that your Committee explore 
alternative funding mechanisms that would improve the predictability of 
the Title XI Program in terms of the availability of funds.
    I want to thank you in advance for your consideration of our views. 
New York Waterway is very appreciative of the support Congress has 
provided for the Title XI program and we hope our comments have been 
useful.
            Sincerely,
                                     Arthur Imperatore, Jr.
                                                         President.
                                 ______
                                 
    Response to Written Questions Submitted by Hon. John McCain to 
                             Hon. Ken Mead
    Question 1. Current practice allows applications for Title XI loan 
guarantees to linger for years without any formal action by MARAD. How 
long should an application be allowed to remain pending?
    Answer. MARAD does not have rules or policies governing the length 
of time an application for a Title XI Loan Guarantee can remain pending 
without MARAD taking formal action to reject or approve the guarantee. 
Although MARAD recently earmarked several pending applications for 
removal that did not appear to be making material progress toward 
meeting the requirements necessary for approval, there are still seven 
applications that have remained in ``pending'' status for more than 1 
year.
    Project applications may remain in an extended pending status for a 
variety of reasons and it is not necessarily inappropriate for a 
project to take more than one year to approve. Although MARAD would 
ideally prefer that every application be submitted fully complete, in 
reality, the applications and requisite supporting materials are 
extensive, and MARAD often requires additional information, 
documentation, explanation, and analyses.
    In some cases, however, applications are permitted to remain on the 
``pending'' list, despite the applicant's lack of progress toward 
demonstrating the viability of the project. In these cases, MARAD has 
neither acted to approve, nor formally reject, the applications. In 
some cases, applications are permitted to remain pending because the 
project may have strong political support or community backing.
    We would recommend that MARAD either remove all applications that 
remain in a ``pending'' status for more than one year or provide a 
written justification with the concurrence of the Office of the 
Secretary which includes the extraordinary circumstances that 
necessitate maintaining the specific application as active. The 
Committee's proposed MARAD reauthorization legislation, S. 1262, the 
Maritime Administration Authorization Act of 2003 (``S. 1262''), would 
require MARAD to act on an application within 270 days with an 
allowance of one 270 day extension upon the applicant's request. This 
would sufficiently address our concerns.
    It is relevant to note that the Title XI program currently has 7 
executed letter commitments for guarantees that MARAD has said will 
never close. We would recommend that similar requirements be 
established for letter commitments.

    Question 2. I have recently been made aware of alleged 
improprieties by MARAD in the disposal of defaulted assets. I know that 
both the DOT IG and the GAO, as part of their separate investigations, 
looked at what actions MARAD takes following a default to secure and 
maintain the associated assets, but I would like to know if you looked 
at MARAD's actions regarding the disposition of assets? If so, did you 
find any improprieties?
    Answer. Although we did not encounter any improprieties by MARAD in 
its efforts to dispose of assets acquired from foreclosure, we did find 
cases where MARAD did not adequately manage foreclosed assets. We have 
had several investigations in the past involving MARAD personnel, but 
not in regards to the disposition of assets. Last year, a MARAD 
employee was convicted of bribery and sentenced to serve 2 years in 
jail for bid rigging. In addition, we are currently investigating an 
entity for submitting false statements to MARAD concerning a Title XI 
loan guarantee.

    Question 3. Do you believe that by waiving or modifying statutory 
and regulatory requirements of the Title XI program that MARAD is 
taking on greater risks in the loans they are guaranteeing? If so, what 
changes need to be made to minimize the effect of waivers on risk?
    Answer. Waiving or modifying statutory and regulatory requirements 
of the Title XI program can result in greater risk to the taxpayers. 
However, that risk can be mitigated if appropriate steps are taken to 
gain adequate compensatory loan provisions for any waiver or 
modification of the financial requirements.
    We found that MARAD has been routinely modifying financial 
requirements in order to qualify applicants for loan guarantees without 
requiring stricter loan provisions and covenants on borrowers to 
mitigate those risks. In fact, all nine loans that have defaulted since 
1998 were approved with modifications to some of the financial 
criteria.
    In many cases, MARAD accepts parent company guarantees of loan 
repayment for a subsidiary that would not have been able to qualify for 
a loan guarantee, based on its own financial history. In 50 percent of 
the projects we examined during our audit (21 of 42), a parent company 
guarantee was the sole form of security aside from the ship or shipyard 
itself. When these guarantees are general pledges by the company and do 
not specifically pledge unencumbered assets as collateral, these 
guarantees provide no real security if the parent company, itself, is 
not creditworthy or has few unencumbered assets. MARAD can prevent this 
problem by monitoring the financial condition of the parent company as 
well and when warranted, requiring pledges to be backed by liens on 
other unencumbered assets or requiring greater amounts of project 
equity from the applicants. This is what we recommended in our March 
27, 2003 report. MARAD agreed with our recommendation, and the Office 
of the Secretary has directed MARAD to comply with it. Additionally, S. 
1262 directs the Secretary to promulgate regulations concerning 
circumstances under which waivers of financial conditions can be made 
so long as the economic soundness of the project remains in tact and 
compensating measures are imposed on the applicant.

    Question 4. Can MARAD effectively implement all of your 
recommendations for reform of the Title XI program without additional 
statutory requirements? If not, what specific action does Congress need 
to take to reform the program?
    Answer. With one exception, MARAD can effectively implement all of 
our recommendations for reform of the Title XI Loan Guarantee program 
without additional statutory requirements. We have recommended that 
MARAD establish an external review process as a check on its internal 
loan application review and as assistance in crafting prudent loan 
conditions and covenants. Such external reviews should be financed by 
the applicant, not taxpayers. Therefore, we concur with MARAD's request 
to modify the statute to give MARAD legislative authority to charge an 
applicant for the cost of obtaining independent financial and economic 
reviews as part of the application review process. This would allow 
MARAD to clearly place the burden of this cost on the applicant.
    Although a case could be made that MARAD already has this 
authority, we think that it is advisable to make this authority 
explicit and crystal clear. With regard to the rest of our 
recommendations (i.e., compensating provisions for financial waivers 
and/or modifications; financial monitoring; monitoring of the physical 
assets in and out of default), MARAD can manage the program to 
implement these changes under the current law, but our experience with 
the program suggests that they be institutionalized to survive from 
administration to administration and therefore may be appropriate to 
reinforce statutorily. S. 1262 effectively addresses two of our 
recommendations (compensating provisions for financial waivers and/or 
modifications and financial monitoring).

    Question 5. MARAD currently has discretionary authority to require 
an outside review and opinion of certain aspects of a project's merits 
and the sponsor's financial condition. Do you believe this authority is 
adequate? If not, what additional authority is needed?
    Answer. MARAD is in the process of developing and implementing a 
policy documenting the circumstances and procedures for conducting 
external reviews. The current authority to require an outside review is 
sufficient to enable MARAD to implement this policy; however, we agree 
with MARAD's request for a statutory change to enable MARAD to 
explicitly charge the cost of the reviews to the applicant. S. 1262 
provides this explicit authority for MARAD to impose this cost on the 
applicants.

    Question 6. Do you believe the use of external reviews of 
applicants should remain discretionary, or should all applications be 
subjected to such reviews?
    Answer. As a rule, all applicants should be subjected to external 
reviews. However, MARAD should retain some limited discretion to waive 
this requirement. Waivers should be extremely rare and must clearly 
state the extraordinary reasons for the waiver. An example of a 
potential waiver situation would include a recent repeat applicant with 
an extremely strong balance sheet requesting a second loan guarantee 
for a similar vessel that would clearly not suggest any potential 
overcapacity. In any event, the Office of the Secretary has directed 
MARAD to obtain independent reviews on all applications until further 
notice.

    Question 7. Do you agree with GAO's assertion that the processes 
for review and approving applications, monitoring project financial 
condition, and monitoring asset condition should be separated as it is 
in the private sector?
    Answer. Yes, ideally the functions for approving applications, 
monitoring financial conditions, and disbursing funds should all be 
performed through separate reporting lines. MARAD has a dual mission--
promoting the growth and financial health of the maritime industry and 
protecting the Government's interest--roles which may be in conflict at 
times. Vesting the responsibility for determining whether continued 
disbursements of funds on a troubled project are in the best interest 
of the Government with the same government officials who were 
responsible for approving the loan guarantee, places the official in a 
position where his or her objectivity or impartiality could be 
questioned.

    Question 8. How do you explain the lack of oversight, poor record-
keeping, unrealistic risk assessments, and generally poor management of 
the Title XI program?
    Answer. The Title XI program management has placed too much 
emphasis on disbursing loans and needs to be brought back into balance 
with a careful consideration of the risks imposed on the taxpayer. This 
return to balance is reflected in S. 1262.
    Title XI of the Merchant Marine Act (the ``Act'') was established 
in 1936 to assist private companies in obtaining financing for the 
construction of ships or the modernization of U.S. shipyards. 
Regulations implementing the Act outline the application process for 
Title XI loan guarantees and require MARAD to assess the economic 
feasibility and financial viability of an applicant's project.
    Between 1993 and December 2002, MARAD's portfolio of executed loan 
guarantees more than doubled, growing from $1.3 billion to $3.4 
billion, while the actual number of MARAD staff assigned to process the 
applications and monitor the loan guarantees decreased.
    In addition, MARAD has not developed the kinds of systematic 
policies and procedures for processing applications, approving loan 
guarantees, monitoring existing loan guarantees, and proactively 
intervening when signs of financial distress first emerge. Without 
these systematic policies and procedures, MARAD has not always been an 
effective custodian of taxpayer dollars.
    In line with our recommendations, MARAD is in the process of 
developing policies and procedures for improving program oversight, 
record-keeping, risk assessment, and management. As part of our 
Congressionally-mandated certification of MARAD's compliance with our 
recommendations, we will certify that these procedures are in place and 
being applied by MARAD staff to all new and existing loan guarantees.

    Question 9. Given the recent history of the Title XI program, 
should the required percentage of equity to be provided by the loan 
applicant be raised above 12.5 percent of project costs and if so, what 
level do you consider appropriate?
    Answer. MARAD regulations require that an applicant contribute a 
minimum of 12.5 percent of the project cost in equity. The interest and 
fees associated with the loan guarantee are included when calculating 
the project cost. The actual cost of the vessel can be considerably 
less than the total project cost. We believe that the 12.5 percent 
equity contribution is sufficient if the applicant is required to 
contribute 12.5 percent of the vessel cost as well as the interest and 
fees so that the guarantee is fully secured (the loan amount is for 
less than the cost of the vessel) at day one of the loan. Additionally, 
we agree with the provision included in S. 1262 that any application 
with increased risk factors should require additional equity.

    Question 10. Transportation Infrastructure Finance and Innovation 
Act or TIFIA loans are limited to 33 percent of project costs. Would a 
similar limit be appropriate for Title XI? Is there another Federal 
loan program that could serve as a model for MARAD to follow?
    Answer. The TIFIA program provides credit assistance to major 
transportation projects of critical national importance. The program 
provides loans, guarantees, or lines of credit to major infrastructure 
projects of at least $100 million. TIFIA-approved projects require 
substantial private co-investment. The project also must be supported 
in whole or part by user charges or other non-Federal dedicated funding 
sources and must be included in the State's transportation plan.
    The objectives of the TIFIA program and Title XI are very 
different. TIFIA is a direct loan program while the Title XI program 
provides loan guarantees. TIFIA projects are financed with a 
combination of other loans and bonding instruments in addition to the 
direct Federal funding. TIFIA projects are generally large projects for 
which a large private and public constituency exists, while Title XI 
projects may be of limited public and economic appeal and therefore not 
able to generate capital from private markets at attractive rates. If 
the Government's loan guarantee were capped at 33 percent for ship-
building or shipyard modernization, it is likely that either very few 
projects would be able to generate the additional private financing and 
equity to qualify or companies would not pursue these projects after 
considering the impact of the increased cost of capital, essentially 
undermining the goals of the Title XI program.
    Other Federal loan guarantee programs such as that administered by 
the Export-Import Bank, have similar Federal caps and equity 
contribution ratios as Title XI.

    Question 11. Does your office audit the Title XI program on a 
regular basis? Should Congress statutorily require periodic reviews?
    Answer. The OIG does not have a statutory requirement to audit 
MARAD's Title XI Loan Guarantee program on a regular basis, although we 
have reviewed several segments of the program in the past. Most 
recently, the Fiscal Year 2003 Emergency Wartime Supplemental Act 
required the OIG to certify that the recommendations included in our 
March 2003 report had been implemented. We are in the process of 
completing this work.
    Although we do not believe that Congress needs to statutorily 
require periodic reviews of the program, we intend to perform periodic 
reviews to gauge the success of the revisions now under way and to 
determine whether additional recommendations are required. We would 
have no objection to a statutory requirement for periodic reviews of 
the program although we are aware that S. 1262 does not include such a 
provision.
                                 ______
                                 
    Response to Written Questions Submitted by Hon. John McCain to 
                             Thomas McCool
    Question 1. What has the full and true cost of the Title XI program 
been to the taxpayer since it was revived in 1994?
    Answer. The total actual cost of Title XI loans originated since 
1994 will not be fully known until they have either paid off or 
defaulted. However, the Federal Credit Reform Act (FCRA) requires that 
agencies prepare estimates of the total subsidy cost of new lending 
activity at the time of budget formulation. When the budget is 
executed, this estimated long-term cost is a cost to the taxpayer. Over 
the life of the loan program, this estimated cost could increase or 
decrease, depending on the actual performance of the loans MARAD 
guarantees.

    Question 2. Current practice allows for applications for Title XI 
loan guarantees to linger for years without any formal action MARAD. 
How long should an application be allowed to remain pending?
    Answer. Our review did not address how long an application should 
be allowed to remain pending. However, MARAD should ensure that 
applicants continue to meet all program requirements when the 
application is finally approved.

    Question 3. I have recently been made aware of alleged 
improprieties by MARAD in the disposal of defaulted assets. I know that 
both the DOT IG and the GAO, as part of their separate investigations, 
looked at what actions MARAD takes following a default to secure and 
maintain the associated assets, but I would like to know if you looked 
at MARAD's actions regarding the disposition of assets? If so, did you 
find any improprieties?
    Answer. We did not assess the process for disposing of assets.

    Question 4. In your review of the Title XI program, did you find 
any evidence that MARAD has changed its processes as a result of the 
AMCV and other recent defaults?
    Answer. After the default of Project America, MARAD reorganized its 
Title XI offices in an attempt to gain better control of the 
disbursement of funds from the escrow account. However, the 
reorganization did little to correct disbursement concerns and raises 
additional concerns about consolidation of duties.

    Question 5. GAO found that MARAD has seriously underestimated 
defaults and overestimated recoveries from defaults. If risk is 
properly assessed, should the amount of funds set aside for defaults--
the loan cohorts--be sufficient to cover all expected losses from 
defaults?
    Answer. If risk were properly assessed, then the estimated cost of 
the program received through appropriations should be sufficient to 
cover all expected losses from defaults. The subsidy cost estimates are 
based on expected defaults and recoveries, and if MARAD were able to 
estimate these perfectly, then the subsidy costs would cover any 
defaults MARAD were to experience. However, we would not expect MARAD, 
or any other credit agency, to perfectly estimate the subsidy cost. We 
believe MARAD could do a better job calculating its subsidy cost 
estimates by updating its assumptions to take into account the 
differences between its estimated defaults and recoveries and recent 
actual defaults and recoveries, and by taking concentration of credit 
risk into consideration.

    Question 6. What impact would realistic risk estimates have had on 
the amount of loan guarantees MARAD could have committed to in the past 
10 years?
    Answer. Realistic risk estimates, based on documented analyses of 
estimated and actual defaults and recoveries, and annual updates of the 
assumptions used to calculate the subsidy cost estimates, would 
probably have caused MARAD to commit fewer loan guarantees over the 
past 10 years, as the estimated subsidy costs would most likely have 
been greater--all other things, such as level of appropriations, being 
equal--unless there were an equal reduction in the remaining years' 
estimated defaults and an increase in estimated recoveries.

    Question 7. In your written testimony, you pointed out that ``MARAD 
uses a relatively simplistic cash-flow model that is based on outdated 
assumptions, which lack supporting documentation, to prepare its 
estimates of defaults and recoveries.'' Further, you state ``MARAD's 
estimates have significantly understated defaults and its recovery 
estimates have significantly overstated recoveries.'' What is the 
effect of this poor estimation of defaults and recoveries and how does 
it impact what is known about the true cost of the program?
    Answer. The poor estimation of defaults and recoveries results in 
questionable subsidy cost estimates that do not provide Congress a 
basis for knowing the true costs of the Title XI Program. If MARAD were 
to continue to underestimate defaults and overestimate recoveries, and 
if the pattern of recent actual experience were to continue, then MARAD 
would have significantly underestimated the true costs of the program.

    Question 8. Who is responsible for ensuring that the assumptions 
used by agencies in their estimations, along with calculating risk and 
associated subsidy rates, is complete, accurate, and done in accordance 
with the Federal Credit Reform Act?
    Answer. The Federal Credit Reform Act assigns responsibility to the 
Office of Management and Budget (OMB) for coordinating credit subsidy 
estimates, developing estimation guidelines and regulations, and 
improving cost estimates, including coordinating the development of 
more accurate historical data and annually reviewing the performance of 
loan programs. OMB has final authority for approving estimates in 
consultation with agencies, but usually delegates authority to agencies 
to calculate estimates and reestimates.

    Question 9. Both GAO and the DOT IG found that MARAD had issued 
waivers or modifications to approve applications even though borrowers 
had not met all financial requirements. All nine of the applications 
that have gone into default since 1998 were approved with some form of 
modification to the financial criteria. Were waivers also issued for 
other active projects and from your analysis is it possible to conclude 
that there is a direct correlation between waivers and the likelihood 
of default.
    Answer. MARAD has approved waivers and modifications for both 
active and defaulted projects. We did not assess the correlation 
between the use of waivers and the likelihood of default. However, by 
waiving or modifying financial requirements, MARAD officials may be 
taking on greater risk in the loans they are guaranteeing. 
Consequently, the use of waivers or modifications could contribute to 
the number or severity of loan guarantee defaults and subsequent 
Federal payouts. For this reason the IG recommended that MARAD require 
a rigorous analysis of the risk of modifying any loan approval 
criteria.

    Question 10. Your written statement draws attention to the fact 
that MARAD has not used sound business practice in administering the 
Title XI program and that this lapse leaves the program vulnerable to 
fraud, waste, abuse, and mismanagement. Do you believe more 
investigative work is needed to determine that total extent of the 
program's problems?
    Answer. We believe that because of the programs vulnerability to 
fraud, waste, abuse and mismanagement, the program should continue to 
receive close oversight and MARAD should take steps to ensure that the 
recommendations made by GAO and the IG are implemented. Specifically, 
the IG needs to look periodically at the program.

    Question 11. What actions do you believe this Committee should take 
to address the vulnerabilities you have identified?
    Answer. This Committee should consider clarifying borrower equity 
contribution requirements. Specifically, the Committee should consider 
legislation requiring the entire equity down payment, based on the 
total cost of the project including total guarantee fees currently 
expected to be paid over the life of the project, be paid by the 
borrower before the proceeds of the guaranteed obligation are made 
available. Further, the Committee should consider legislation that 
requires MARAD to consider, in its risk category system, the risk 
associated with approving projects from a single borrower that would 
represent a large percentage of MARAD's portfolio.

    Question 12. In your written statement, you pointed out that MARAD 
has failed to ensure that it received, let alone reviewed, reports on 
the financial condition of companies holding loan guarantees which are 
required to be submitted semi-annually. Do you know of anything that 
would explain such flagrant disregard of the laws and regulations 
governing the program?
    Answer. MARAD officials told us that they did contact companies to 
obtain missing financial documents and that financial analysis was 
conducted. However, we saw no evidence of such analysis and, in the 
absence of financial information don't see how it could have been 
conducted.

    Question 13. In your written statement, you pointed out that 
``MARAD relied on the shipowner's certification of money spent in 
making decisions to approve the disbursements from the escrow fund.'' 
Does that mean MARAD was not independently verifying progress, and 
associated costs?
    Answer. For the projects we reviewed, we did not see evidence that 
MARAD routinely independently verified progress and associated costs. A 
limited number of disbursements from the escrow fund were actually 
verified by MARAD. MARAD has two headquarters staffers and one full-
time marine surveyor in the field that conduct site visits to Title XI 
projects.

    Question 14. If MARAD had been providing proper oversight of the 
progress and costs associated with projects under construction, is it 
reasonable to assume that MARAD should have been able to determine, in 
the case of the product tankers that where constructed at Newport News 
Shipyard and are now the subject of a DOJ suit against that yard, that 
costs that should have been annotated to the tankers, where, according 
to the DOJ, being passed onto the DOD in the form of mischarges to the 
Navy?
    Answer. We have no information about this project.

    Question 15. Your findings show that MARAD, in violation of its own 
rule, allowed AMCV to define the total costs of Project America in a 
way that allowed AMCV to exclude certain costs that previously had 
always been considered by MARAD. This meant a lower cost evaluation and 
MARAD then allowed for the early release of escrowed funds. In 
practice, this permitted AMCV to avoid expending the statutorily 
required 12.5 percent of the total cost of the project prior to 
receiving guaranteed funds. Can you explain further how this affected 
the guarantee?
    Answer. MARAD procedures and regulations require that borrowers pay 
12 1/2 percent of the actual cost of the vessel before proceeds of the 
guaranteed obligations are made available. The statute defines ``actual 
cost of a vessel'' as of any specified date as follows:

        ``. . . the aggregate, as determined by the Secretary, of (i) 
        all amounts paid by or for the account of the obligor on or 
        before that date, and (ii) all amounts which the obligor is 
        then obligated to pay from time to time thereafter, for the 
        construction, reconstruction, or reconditioning of the 
        vessel.'' 46 U.S.C. App. 1271(f).

    On February 1, 2000, MARAD and AMCV entered into a security 
agreement that defined the ``Actual Cost of the Vessel'' as 
$610,797,578. The security agreement also stated that the government 
would not disburse any funds until the obligor had paid 12 1 percent of 
the ``Actual Cost of the Vessel.'' While this amount was not stated in 
the agreement, this amounted to $76,349,697.
    However during the spring of 2000, both parties orally agreed to 
modify the Actual cost of the vessel for the purpose of computing 
AMCV's equity share by excluding the escalation fees and delaying 
inclusion of the guarantee fees until they were actually incurred. In 
addition to these exclusions, it is apparent that AMCV also excluded 
capitalization interest and owner furnished property from the equity 
share. These exclusions resulted in AMCV's equity share being reduced 
to $58,373,402.
    The reduction of AMCV's equity share resulted in the escrowed funds 
being disbursed earlier than they would have been had the original 
equity share been provided by AMCV, reducing AMCV's equity contribution 
by $17,976,295.

    Question 16. Was AMCV taking on less risk, while the taxpayers were 
taking on more?
    Answer. To the extent that the change in the equity requirement 
resulted in AMCV providing a smaller down payment, the government's 
potential exposure In the event of default was increased.

    Question 17. Do you think this practice was within the spirit and 
intent of the law?
    Answer. Because the law is unclear as to what constitutes actual 
costs, it is unclear if MARAD's practices were within the spirit and 
intent of the law. However, if the intent were to mitigate losses by 
requiring that owners provide a certain amount of equity in a project, 
then MARAD's practice would not meet this intent. This practice served 
to reduce owner equity and would appear to be in conflict with this 
intent. We therefore recommend that Congress consider clarifying the 
borrower's equity contribution requirements.

    Question 18. What other unique exemptions were granted AMCV? Should 
guidelines be established regarding the waiving of program 
requirements, or perhaps, there should be no waivers permitted at all?
    Answer. As mentioned in the report, MARAD modified the working 
capital requirement by using a cash-flow test. In addition, as 
mentioned above, MARAD orally agreed to define total cost in such a way 
as to limit borrower equity contributions. MARAD policy calls for such 
agreements to be made in writing. In September 2001, MARAD amended the 
loan commitment permitting the owner to further delay the payment of 
equity. Because of concern over the diligence that MARAD uses in 
considering approving modifications and waivers, we recommend MARAD 
establish a systematic process for considering and resolving findings 
when approving loan guarantees involving waivers and exceptions to 
program requirements.
                                 ______
                                 
 Response to Written Questions Submitted by Hon. Ernest F. Hollings to 
                             Thomas McCool
    Question 1. Analysis done by GAO was of a small sample size, five 
projects, of which three had defaulted, these numbers are not in line 
with the overall performance of the program. Why were these projects 
selected and can you explain the methods behind selecting the sample?
    Answer. We selected these five projects based on a number of 
factors, including the project size, risk category, status (defaulted, 
active and paid off), and type (e.g., barge, cruise line, shipyard). 
This judgmental sample is not representative of the universe.
    Our conclusions regarding the operations of the Title XI program 
are not based on the case studies alone, although these case studies 
did uncover policies and practices that do not effectively protect the 
government's interest. Our conclusions also draw on the work of the 
Department of Transportation Inspector General (IG), which looked at 
far more projects (42 projects), as well as our comparison with 
practices of selected private sector lenders. Finally, we also relied 
on our experience in analyzing other Federal loan guarantee programs.

    Question 1a. What analysis was done on the entire portfolio?
    Answer. In addition to the IG and other work referred to above, we 
conducted an analysis of MARAD's implementation of credit reform that 
examined the loan performance of the entire portfolio.

    Question 1b. What do you see as the current risk of the overall 
portfolio?
    Answer. The risk of the overall portfolio is uncertain. We found 
that in comparison with recent actual experience, MARAD's default 
estimates have significantly understated defaults, and its recovery 
estimates have significantly overstated recoveries. If this pattern of 
recent experience were to continue, MARAD would have significantly 
underestimated the costs of the program.

    Question 2. Who were the private sector lenders selected in the 
study? How were they selected?
    Answer. We spoke with maritime lending professionals from Bank One, 
JP Morgan Chase, and American Marine Advisors, Inc. We judgmentally 
selected the private sector lenders based on references from MARAD, as 
well as from banking experts, and on these lenders' publicly recognized 
expertise in the maritime industry and their willingness to meet with 
us. These lenders are not meant to represent the entire maritime 
industry; however, their practices are consistent with sound internal 
control mechanisms. Therefore, we believe that these practices have the 
potential to help MARAD to more efficiently meet its mission.

    Question 3. How many Federal loan guarantee programs are there?
    Answer. According to the Office of Management and Budget's (OMB) 
Fiscal Year 2004 Federal Credit Supplement, which summarizes 
information about Federal direct loan and loan guarantee programs 
subject to the Credit Reform Act of 1990, there are approximately 64 
different Federal loan guarantee programs.

    Question 3a. What is the percentage default rate on average for all 
these loan guarantee programs?
    Answer. Currently, there is not an average default rate published 
for all of these loan guarantee programs. However, according to OMB's 
Fiscal Year 2004 Federal Credit Supplement, estimated lifetime defaults 
as a percentage of disbursements range from a low of nearly 0 percent 
in the Government National Mortgage Association Guarantees of Mortgage-
Backed Securities program to a high of 45.6 percent in FHA Section 
221(d)(3) program. For those programs that reported estimated default 
rates in this publication, 12 programs had default rates less than 5 
percent, 13 programs had default rates of 5-10 percent, 18 programs had 
default rates of 10.01-15 percent, 11 programs had default rates of 
15.01-20 percent, 8 programs had default rates of 20.01-30 percent, and 
3 programs had default rates greater than 30 percent.

    Question 3b. How does Title XI compare, with and without the AMCV 
defaults?
    Answer. In contrast to the information presented above, MARAD's 
Title XI program had an estimated average default rate (including AMCV) 
of 37.85 percent in the Fiscal Year 2002 Federal Credit Supplement, the 
last year this program published default information. Because MARAD was 
unable to provide us with the necessary data to determine the estimated 
lifetime default rate, we are unable to calculate this rate excluding 
the AMCV loans.

    Question 4. In general, is it your experience that most of the 
Federal loan guarantee programs have a somewhat less stringent review 
and approval process than similar loan programs in the commercial 
market?
    Answer. It is difficult to generalize the levels of stringency used 
in the review and approval processes across Federal loan guarantee 
programs, since mechanisms for review and approval can vary by program. 
For example, the Small Business Administration (SBA) and the Federal 
Housing Administration (FHA) operate loan guarantee programs involving 
smaller and more standardized loans than MARAD guarantees. These 
agencies heavily rely on private sector lenders to underwrite loans 
with smaller loan amounts, and focus more on lender compliance with 
underwriting standards. However, other loan programs that deal with 
larger, unique loans may underwrite the loans directly, or are more 
involved in the underwriting. Because MARAD is providing guarantees on 
larger, unique loans, it is imperative that MARAD provide the highest 
level of stringency in its review and approval process. Private sector 
lenders are also more likely to increase the level of review for 
larger, unique types of loans, and MARAD should do the same. While 
program flexibility in financial and economic soundness standards may 
not be as stringent in order to help MARAD meet its public purpose, 
oversight and the strict use of internal controls are necessary to 
effectively use and guard the government's limited financial resources.

    Question 5. In general, how volatile is the maritime market, and is 
it a complex market in which to make financial assessments?
    Answer. The lenders we interviewed told us that timing is important 
in maritime lending and that it is a cyclical business. The lenders use 
a combination of historical performance, economic and market data to 
determine whether the loan is economically sound prior to approval. For 
this reason, MARAD should fully consider economic soundness analyses 
based on up to date information when considering applications for Title 
XI loan guarantees.

    Question 6. Do you think that the impact of September 11 could have 
been reasonably modeled or predicted?
    Answer. The events of September 11, 2001 were unprecedented and 
therefore could not be predicted. These events may have contributed to 
some Title XI loan defaults experienced by MARAD, including those 
associated with AMCV loans, however, AMCV had been experiencing 
financial difficulties prior to September 2001. Nonetheless, our 
analysis demonstrated that when the effects of the AMCV defaults are 
excluded, MARAD still underestimated the amount of defaults the program 
would experience between 1996 and 2002 by over 260 percent or $114.6 
million.

    Question 7. One of your conclusions is that too much of the 
guarantee portfolio was issued to one owner, AMCV. You state that the 
commercial lending industry does a better job of assessing the 
concentration of credit risk to one company. This practice of having 
``single issuer limits'' definitely seems to be a good concept. But, 
from what I understand this is a new practice at major banks that is 
the result of the Enron and WorldCom situations.
    Answer. Concentration of credit risk is not a new concept in 
banking. Bank regulators have imposed concentration limits and bank 
examiners have been assessing this aspect of risk when examining the 
safety and soundness of banks for many years.

    Question 7a. If these limits had been in place and the and there 
had been limits of concentrations to a single company, meaning that 
AMCV would not have been a part of the Title XI portfolio, how would 
the program have performed?
    Answer. As indicated in response to question 6, when we excluded 
defaults from AMCV loans from our analysis, MARAD still underestimated 
the amount of defaults the program would experience between 1996 and 
2002 by over 260 percent or $114.6 million.

                                  
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