[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
75-221 WASHINGTON : 2012
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20402-0001
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
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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
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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.
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\1\ Unless otherwise indicated, all years are Federal Fiscal Years.
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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.
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\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.
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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.
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\2\ Loan guarantees are legal obligations to pay off debt if an
applicant defaults on a loan.
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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.
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\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.
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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.
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\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.
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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.
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\9\ U.S. Department of Transportation, Office of Inspector General,
Maritime Administration Title XI Loan Guarantee Program (Washington,
D.C.: Mar. 27, 2003).
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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.
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\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.
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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.
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\11\ On June 25, 2001, AMCV restated losses from $6.1 million to
$9.1 million for the first quarter of 1999.
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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.
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\12\ The bids were for the purchase of the unfinished hull for
Project America I in seaworthy condition.
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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.
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\13\ The IG also recommended that MARAD impose compensating factors
for loan guarantees to mitigate risks.
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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).
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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.