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75–221 PDF 2012

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 

( 

(II) 

SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION 

ONE HUNDRED EIGHTH CONGRESS 

FIRST SESSION 

JOHN MCCAIN, Arizona, Chairman 

TED STEVENS, Alaska 

CONRAD BURNS, Montana 

TRENT LOTT, Mississippi 

KAY BAILEY HUTCHISON, Texas 

OLYMPIA J. SNOWE, Maine 

SAM BROWNBACK, Kansas 

GORDON H. SMITH, Oregon 

PETER G. FITZGERALD, Illinois 

JOHN ENSIGN, Nevada 

GEORGE ALLEN, Virginia 

JOHN E. SUNUNU, New Hampshire 

ERNEST F. HOLLINGS, South Carolina, 

Ranking 

DANIEL K. INOUYE, Hawaii 

JOHN D. ROCKEFELLER IV, West Virginia 

JOHN F. KERRY, Massachusetts 

JOHN B. BREAUX, Louisiana 

BYRON L. DORGAN, North Dakota 

RON WYDEN, Oregon 

BARBARA BOXER, California 

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 

(III) 

C O N T E N T S 

Page 

Hearing held on June 5, 2003 ................................................................................. 1 

Statement of Senator Breaux ................................................................................. 40 

Statement of Senator McCain ................................................................................. 1 

Statement of Senator Stevens ................................................................................ 38 

WITNESSES

McCool, Thomas J., Managing Director, Financial Markets and Community 

Investment, U.S. General Accounting Office ..................................................... 16 

Prepared statement .......................................................................................... 19 

Mead, Hon. Kenneth M., Inspector General, U.S. Department of Transportation ..................................................................................................................... 6 

Prepared statement .......................................................................................... 9 

Schubert, Hon. William G., Administrator, Maritime Administration, U.S. 

Department of Transportation ............................................................................ 2 

Prepared statement .......................................................................................... 4 

APPENDIX

American Shipbuilding Association, prepared statement .................................... 47 

Letter, dated May 13, 2009, from Arthur Imperatore, Jr., President, New 

York Waterway, to Hon. John McCain, Chairman and Hon. Ernest F. 

Hollings, Ranking Member .................................................................................. 50 

Response to written questions submitted by Hon. John McCain to: 

Thomas McCool ................................................................................................. 55 

Hon. Ken Mead ................................................................................................. 51 

Response to written questions submitted by Hon. Ernest F. Hollings to 

Thomas McCool .................................................................................................... 58 

(1) 

REFORM OF THE TITLE XI 

MARITIME LOAN GUARANTEE PROGRAM 

THURSDAY, JUNE 5, 2003, 

U.S. SENATE, COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION, Washington, DC. 

The Committee met, pursuant to notice, at 2:30 p.m. in room 

SR–253, Russell Senate Office Building, Hon. John McCain, Chairman of the Committee, presiding. 

OPENING STATEMENT OF HON. JOHN MCCAIN, 

U.S. SENATOR FROM ARIZONA 

The CHAIRMAN. Good afternoon. The Committee meets today to 

examine the management problems concerning the Title XI Maritime Loan Guarantee Program which have been identified by the 

Department of Transportation Inspector General and the General 

Accounting Office. Their findings make it clear that the Maritime 

Administration has failed to protect the interests of the American 

taxpayers in its administration of the program. Therefore, short of 

abolishing this special-interest subsidy program, which is highly 

unlikely given the congressional rebuke of the President’s attempts 

to zero out program funding over the last 3 years, it’s essential that 

we address the identified problems and institute fundamental programmatic reforms. 

Title XI of the Merchant Marine Act of 1936 authorizes the Secretary of Transportation to make loan guarantees to finance the 

construction, reconstruction, or reconditioning of eligible vessels, 

and the modernization and improvement of shipyards. While the 

program was halted in the late 1980s after suffering billions of dollars in defaults, the program was reinstituted in 1993, following 

the enactment of the Federal Credit Reform Act and the National 

Shipbuilding and Shipyard Conversion Act. 

Proponents of the Title XI program claim that the defaults that 

occurred in the 1980s were due to the heavy concentration of guarantees for projects supporting the offshore oil industry and the significant downturn in that industry. Even MARAD agreed that the 

concentration of guarantees in one sector of the economy had a significant impact on the program. Yet the agencies allowed a similar 

situation to occur again. 

As noted in the Department of Transportation IG’s report, released March 22, when American Classic Voyages filed for bankruptcy protection in October 2001, its subsidiaries held a total of 

six loan guarantees that accounted for over 25 percent of the value 

of the entire Title XI portfolio. 

2 

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. 

3 

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 

4 

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 apVerDate Nov 24 2008 11:42 Jul 25, 2012 Jkt 052754 PO 00000 Frm 00008 Fmt 6633 Sfmt 6621 S:\GPO\DOCS\75221.TXT SCOM1 PsN: JACKIE
5 

proval 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. 

6 

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 

7 

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 

8 

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:] 

9 

1 Unless otherwise indicated, all years are Federal Fiscal Years. 

2These amounts include accrued, unpaid interest as well as the outstanding principal. 

3These 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. 

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. 

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 

Date of 

Default 

Year of 

Origin Company Project/Vessel Name 

Guaranteed 

Amount 

Paid-Out 

Amount 2

Recovered 

Amount 3

2/1998 1996 Surf Express, Inc. FastCat Catamaran $ 1,701,000 $ 1,788,854 $ 100,000 

2/2000 1997 MHI, Inc. Shipyard Modernization 55,000,000 59,071,658 24,108,619 

3/2001 1995 SEAREX, Inc. Moses-Class Vessels 77,269,000 78,099,782 25,405,708 

12/2001 1999 AMCV Project America 1 

Cruise Ship 

185,000,000 187,317,445 7,425,416 

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 

Offshore 

Shipyard Modernization 24,817,000 20,884,647 21,300,000 

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. 

10 

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 


605MEAD1.eps
11 

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. 

12 

5These are bonds, notes, debentures or other evidence of indebtedness. 

6 46 CFR 298.13 

7Working 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. 

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

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. 

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 

13 

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. 

14 

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 


605MEAD2.eps
15 

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. 9These amounts do not include recoveries from escrowed funds. 

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 

Date 

of 

Origin 

Date 

of 

Default 

Applicant Parent 

Company 8

Project or 

Vessel 

Name 

Cost of 

Vessel 

to Owner 

Guaranteed 

Amount 

Paid-Out 

Amount 

Disposition/ 

Recovery 9

May 2001 January 

2002 

Great Pacific NW 

Cruise Line, 

L.L.C. 

Delta Queen 

Steamboat 

Co. 

Columbia 

Queen 

$ 42,140,568 $ 35,471,000 $ 37,007,570 Maintained by 

MARAD 

March 

2000 

December 

2001 

Coastal 

Queen West, 

L.L.C. 

Delta Queen 

Coastal Voyages, L.L.C. 

Cape May 

Light 

44,950,728 37,900,000 39,769,997 Maintained by 

MARAD 

March 

2000 

December 

2001 

Coastal 

Queen 

East, L.L.C. 

Delta Queen 

Coastal Voyages, L.L.C. 

Cape Cod 

Light 

44,582,720 38,500,000 40,376,340 Maintained by 

MARAD 

April 1999 December 

2001 

Project 

America 

Ship I, Inc. 

Project 

America, 

Inc. 

Project 

America 

Vessel I 

610,797,578 185,000,000 187,317,445 Recovered 

$2 million 

April 1999 n/a Project 

America 

Ship II, Inc. 

Project 

America, 

Inc. 

Project 

America 

Vessel II 

622,946,837 0 0 Part of the 

$2 million 

recovery above 

November 

1995 

January 

2002 

Great Independence 

Ship Co. 

Great Hawaiian 

Cruise 

Lines, Inc. 

S.S. 

Independence 

44,774,271 33,334,000 25,185,531 Maintained by 

MARAD 

July 1995 n/a Great American Queen 

Steamboat, 

L.L.C. 

Delta Queen 

Steamboat 

Co. 

American 

Queen 

69,424,647 60,746,000 0 Full recoveryrefinanced to 

new owner 

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 reviVerDate Nov 24 2008 11:42 Jul 25, 2012 Jkt 052754 PO 00000 Frm 00019 Fmt 6633 Sfmt 6621 S:\GPO\DOCS\75221.TXT SCOM1 PsN: JACKIE
16 

sions and protections been in place at the time of AMCV’s loan application, the 

losses to the Government would likely have been much less. 

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. 

17 

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 privatesector 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. 

18 

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. 

19 

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 guaranVerDate Nov 24 2008 11:42 Jul 25, 2012 Jkt 052754 PO 00000 Frm 00023 Fmt 6633 Sfmt 6621 S:\GPO\DOCS\75221.TXT SCOM1 PsN: JACKIE
20 

1Defaulted amounts may include disbursed loan guarantee funds, interest accrued, and other 

costs. 2Loan guarantees are legal obligations to pay off debt if an applicant defaults on a loan. 

teed 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. 

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. 

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 

21 

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 

Project 

Year loan 

committed 

Original 

amount 

(millions) 

Risk 

category Status 

(AMCV) Project America, Inc. 1999 $1,079.5 2A Default 

Searex 1996 $77.3 2B Default 

Massachusetts Heavy Industries (MHI) 1997 $55.0 3 Default 

Hvide Van Ommeran Tankers (HVIDE) 1996 $43.2 2C Active 

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. 

22 

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. 6MARAD 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. 

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. 

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 ownerinvested 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. 

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 

23 

9 U.S. Department of Transportation, Office of Inspector General, Maritime Administration 

Title XI Loan Guarantee Program (Washington, D.C.: Mar. 27, 2003). 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. 11On June 25, 2001, AMCV restated losses from $6.1 million to $9.1 million for the first quarter of 1999. 

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. 

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. 

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. 

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 

24 

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 

25 

12The bids were for the purchase of the unfinished hull for Project America I in seaworthy 

condition. 

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. 

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 

26 

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 financial underwriting requirements for maritime loans • Permit waivers of key financial requirements 

• Seek approval of exceptions or waivers from Audit 

Committee 

• Have no committee oversight regarding the approval of exceptions or waivers of program requirements 

• Perform an in-depth analysis of a business plan 

for applications received for start-up businesses or 

first-in-class shipyard vessels 

• Employ little variation in the depth of review of 

business plans based on type of vessel, size of loan 

guarantee, or history of borrower 

Monitoring 

• Set an initial risk rating at the time of approval 

and review rating annually to determine risk rating of the loan 

• Assign one risk rating during the application 

phase. No subsequent ratings assigned during the 

life of the loan 

• Use industry expertise for conducting periodic onsite inspections to monitor progress on projects 

and potential defaults 

• Use in-house staff to conduct periodic on-site inspections to monitor progress of projects 

• Perform monitoring that is dependent on financial 

and technical risk, familiarity with the shipyard, 

and uniqueness of the project 

• Perform monitoring based on technical risk, familiarity with shipyard, uniqueness of project, and 

availability of travel funds 

• Analyze the borrower’s financial statements to 

identify significant changes in borrower’s financial 

condition and to determine appropriate level and 

frequency of continued monitoring at least annually 

• Have no documentation of analyses of borrowers’ 

financial statements 

Default and disposition 

• Contract with an independent appraiser to prepare a valuation of a defaulted project • Permit an interested party or MARAD official to 

value assets 

• Enlist a technical manager to review the ship 

after default to assist in determining structural 

integrity and percentage of completion 

• Permit an interested party or MARAD official to 

perform technical review of Title XI assets 

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 disVerDate Nov 24 2008 11:42 Jul 25, 2012 Jkt 052754 PO 00000 Frm 00030 Fmt 6633 Sfmt 6621 S:\GPO\DOCS\75221.TXT SCOM1 PsN: JACKIE
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13The IG also recommended that MARAD impose compensating factors for loan guarantees 

to mitigate risks. 

bursement 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. 

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 collatVerDate Nov 24 2008 11:42 Jul 25, 2012 Jkt 052754 PO 00000 Frm 00031 Fmt 6633 Sfmt 6621 S:\GPO\DOCS\75221.TXT SCOM1 PsN: JACKIE
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14 Classification society representatives are individuals who inspect the structural and mechanical fitness of ships and other marine vessels for their intended purpose. 

eral 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. 

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 shipVerDate Nov 24 2008 11:42 Jul 25, 2012 Jkt 052754 PO 00000 Frm 00032 Fmt 6633 Sfmt 6621 S:\GPO\DOCS\75221.TXT SCOM1 PsN: JACKIE
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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). 16The 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. 

yards 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. 

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. 

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 

30 

17MARAD’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. 18Our 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. 

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. 

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 

31 

the amount of defaults MARAD experienced greatly exceeded what MARAD estimated it would experience by $114.6 million (or over 260 percent). 

Sources: MARAD (data); GAO (presentation). 

aWe 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. 


605GAO1.eps
32 

19MARAD’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. 

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. bWe 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. 

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 


605GAO2.eps
33 

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, inVerDate Nov 24 2008 11:42 Jul 25, 2012 Jkt 052754 PO 00000 Frm 00037 Fmt 6633 Sfmt 6621 S:\GPO\DOCS\75221.TXT SCOM1 PsN: JACKIE
34 

cluding 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. 

35 

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. 

36 

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 

37 

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? 

38 

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. 

39 

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? 

40 

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. 

41 

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 

42 

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. 

43 

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. 

44 

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. 

45 

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—— 

46 

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.] 

(47) 

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 

48 

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. 

49 

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. 

50 

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 

51 

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 

52 

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 

53 

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 applicaVerDate Nov 24 2008 11:42 Jul 25, 2012 Jkt 052754 PO 00000 Frm 00057 Fmt 6601 Sfmt 6621 S:\GPO\DOCS\75221.TXT SCOM1 PsN: JACKIE
54 

tion 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 guaran- tees 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 ExportImport 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. 

55 

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 

56 

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. 

57 

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. 

58 

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? 

59 

Answer. It is difficult to generalize the levels of stringency used in the review and 

approval processes across Federal loan guarantee programs, since mechanisms for 

review and approval can vary by program. For example, the Small Business Administration (SBA) and the Federal Housing Administration (FHA) operate loan guarantee programs involving smaller and more standardized loans than MARAD guarantees. These agencies heavily rely on private sector lenders to underwrite loans 

with smaller loan amounts, and focus more on lender compliance with underwriting 

standards. However, other loan programs that deal with larger, unique loans may 

underwrite the loans directly, or are more involved in the underwriting. Because 

MARAD is providing guarantees on larger, unique loans, it is imperative that 

MARAD provide the highest level of stringency in its review and approval process. 

Private sector lenders are also more likely to increase the level of review for larger, 

unique types of loans, and MARAD should do the same. While program flexibility 

in financial and economic soundness standards may not be as stringent in order to 

help MARAD meet its public purpose, oversight and the strict use of internal controls are necessary to effectively use and guard the government’s limited financial 

resources. 

Question 5. In general, how volatile is the maritime market, and is it a complex 

market in which to make financial assessments? 

Answer. The lenders we interviewed told us that timing is important in maritime 

lending and that it is a cyclical business. The lenders use a combination of historical 

performance, economic and market data to determine whether the loan is economically sound prior to approval. For this reason, MARAD should fully consider economic soundness analyses based on up to date information when considering applications for Title XI loan guarantees. 

Question 6. Do you think that the impact of September 11 could have been reasonably modeled or predicted? 

Answer. The events of September 11, 2001 were unprecedented and therefore 

could not be predicted. These events may have contributed to some Title XI loan 

defaults experienced by MARAD, including those associated with AMCV loans, however, AMCV had been experiencing financial difficulties prior to September 2001. 

Nonetheless, our analysis demonstrated that when the effects of the AMCV defaults 

are excluded, MARAD still underestimated the amount of defaults the program 

would experience between 1996 and 2002 by over 260 percent or $114.6 million. 

Question 7. One of your conclusions is that too much of the guarantee portfolio 

was issued to one owner, AMCV. You state that the commercial lending industry 

does a better job of assessing the concentration of credit risk to one company. This 

practice of having ‘‘single issuer limits’’ definitely seems to be a good concept. But, 

from what I understand this is a new practice at major banks that is the result of 

the Enron and WorldCom situations. 

Answer. Concentration of credit risk is not a new concept in banking. Bank regulators have imposed concentration limits and bank examiners have been assessing 

this aspect of risk when examining the safety and soundness of banks for many 

years. 

Question 7a. If these limits had been in place and the and there had been limits 

of concentrations to a single company, meaning that AMCV would not have been 

a part of the Title XI portfolio, how would the program have performed? 

Answer. As indicated in response to question 6, when we excluded defaults from 

AMCV loans from our analysis, MARAD still underestimated the amount of defaults 

the program would experience between 1996 and 2002 by over 260 percent or $114.6 

million. 

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