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June 5, 2003 Senate holds Title XI hearing The Senate Committee on Science, Commerce and Transportation was today scheduled to hold a full committee hearing on the Title XI maritime loan guarantee program with Committee Chairman Senator John McCain, a long time critic of the program, presiding. "The Committee meets today to examine management problems concerning the Title XI maritime loan guarantee program, which have been identified by the Department of Transportation Inspector General (DOT IG) and the General Accounting Office (GAO)," said Senator McCain in his prepared testimony. "Their findings make it clear that the Maritime Administration (MARAD) has failed to protect the interest 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 three years, it is essential that we address the identified problems and institute fundamental programmatic reforms." After recalling some of the program's shortcomings, Senator McCain declared "While I have been no fan of the Title XI program, I hope we can work 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 taxpayer’s interest." MRITIME ADMINISTRATOR TESTIFIES In his prepared statement, U.S. Maritime Administrator, Captain William Schubert, revealed some interesting information about past Title XI debacles and about MARAD's plans to correct the faults. "The President's budget for Fiscal Years 2002, 2003, and 2004 did not seek new funding for Title XI loan guarantees," noted Captain Schubert. "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 funds, said Schubert, 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 program have been implemented. MARAD is already implementing needed Title XI program management improvements, said Schubert, adding that "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." "As of March 31, 2003," said Schubert, "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. He noted that the DOT IG report made the following five recommendations (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," said Schubert. MARAD, he said, 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. MARAD also agreed with the DOT IG that the use of outside financial advisors, in appropriate cases, would be beneficial. "To that end," said Schubert, "MARAD's FY 2004 authorization proposal seeks the authority to engage such financial advisors, at the expense of the prospective borrower." "The use of financial advisors," continued Schubert, "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." There are a number of changes MARAD will make in the management of the outstanding portfolio, as recommended by the DOT IG, noted Schubert. "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 three 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. 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," said Schubert. "The AMCV project," he noted, "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 two 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 Norweigan 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. Turning to the Heavy Industries, Inc. (MHI) default on a Title XI loan for the reactivation of the Fore River Shipyard in Quincy, Massachusetts, Schubert recalled that 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. "To date," said Schubert, "MARAD has received about $35 million -- a recovery of about 55% 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. " DOT INSPECTOR GENERAL Also testifying was DOT Inspector General Ken Mead. His prepared statement can be read here. Among other things, the Inspector General noted MARAD’s response that, in a number of instances defaults had been due to political pressures to approve loan guarantees by overlooking underwriting requirements. "Nevertheless," he said, "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. " He noted that the Office of Inspector General must certify that its recommendations have been implemented before the $25 million appropriated for new loans in FY 2003 can be obligated. "We are working with MARAD to analyze the new processes that it has proposed putting in place to meet the intent of our recommendations," the Inspector General said, "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." GAO TESTIMONY Also testifying was Thomas J. McCool, Managing Director, Financial Markets and Community Investment, U.S. General Accounting Office. His testimony was sharply critical of MARAD's management of Title XI and concluded: "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 [The Federal Credit Reform Act]. Because of the fundamental flaws we have identified, we question whether MARAD should approve new loan guarantees without first addressing these program weaknesses." You can download the full text here. Tell a friend: