Review of Certain Aspects of the Federal Ship Financing Program--Title XI

Published by the Government Accountability Office on 1977-05-16.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                          COMPTROLLER     GENERAL        OF   THE    UNITED   STATES
                                        WASHINGTON.       D.C.   20548

B-118779                                                                      MAY 6 1977
The Honorable    Jack Brooks
Chairman,    Committee   on Government
House of Representatives
Dear Mr.       Chairman:
       In response      to your August 2, 1976, request           and subsequent
agreements    with your office,         we reviewed    certain    aspects    of the
Maritime    Administration's        (Agency's)    administration      of the
title    XI Federal     Ship Financing      Program.     This report     supple-
ments the information         provided    in the September       17, 1976, and
January    25, 1977, briefings         to your office.
       At the first        briefing         we addressed     the Agency's       guaran-
teed financing       of eight         liquified     natural     gas carriers       being
built   by General      Dynamics for use by various                 corporations       re-
lated   to Burmah Oil,          a British       corporation.       We informed        your
office    concerning       relationships         among the involved          parties
and the chronological             sequence of events pertinent               to the
guarantee     application         and approval        process.     We also advised
your office      that based on the Agency information                    we reviewed,
the legal     requirements          for title      XI financing      for the eight
vessels    appeared      to have been met.
      At the second briefing   we addressed    the following                                     spe-
cific    issues of concern by your office   regarding    the                                title     XI
       --The       role      of leverage              leasing.
       --Foreign           involvement.
       --The     cost        to the Government.
       --Benefits            to ship      owners.
We also     presented     the results    of our preliminary      work con-
cerning     the effectiveness       an'd administration     of the title   XI
         We informed     your office     that the Agency has been success-
ful in increasing         the amount of title        XI coverage     while     keep-
ing the number of defaults            at a minimum.         Its overall      adminis-
tration     of the program was generally            satisfactory,       although      we
identified       certain    management weaknesses          and other    aspects
needing     attention.       Your office     requested      that we further       -

                                                                                                       .   1
.   *


    examine these matters and provide   a written report on our-
    findings.   These matters are summarized below and presented
    in more detail   in the following sections.
          --Program income is being reduced because of late guar-
             antee fee collection  ($47,000 for the 12 month period
             ended January 31, 1977).
          --Required   annual recertifications   that vessels are
             owned and operated by U.S. citizens     are not being
             submitted  in all cases.
          --Because demand for guarantees       exceeds the authorized
             ceiling,     the Agency limits its refinancing     guarantees
             to only those applications     involving    a reasonable
             amount of new vessel construction        or where the appli-
             cants'    financial  viability depends directly     on the
          --Delays   in processing    applications   cause applicants
             to incur excess interest       costs and preclude   title         XI's
             full  contribution    to the Merchant Marine Act.
          --Title   XI documentation       requirements     could   be improved
             and are a disincentive        to applicants.
            Our review was limited       to an examination         of certain   man-
    agement weaknesses and other aspects of the program needing
    attention    which we identified        in our preliminary         survey work
    and presented      in our January 25, 1977, briefing.               Our work
    was performed at Agency headquarters,             Washington,       D.C. We
    examined policies,       procedures,      and practices;       reviewed agency
    records;    and interviewed     agency officials.            In addition,   we
    contacted     several attorneys      representing      title    XI apolicants.
          The Federal Ship Financing     Program was established    pur-
    suant to title    XI of the Merchant Marine Act of 1936
     (46 U.S.C. 1271-1281) as amended.       This program provides   for
    a full Government faith and credit       guarantee of debt obliga-
    tions issued by citizen    shipowners    for the purpose of financ-
    ing or refinancing    U.S. flag vessels.
            The primary purpose of       the program is to promote the
    growth and modernization       of    the U.S. merchant marine.          It en-
    ables eligible      vessel owners      to obtain long-term      financing    at
    interest     rates comparable to       those available    to financially
    strong,    -AM-rated corporations.          Title  XI applicants      pay an


        investigation   fee for the initial    guarantee    appr_oval and an
        annual guarantee   fee payable in advance.       The fees are depos-
        ited into an Agency-administered     revolving    fund and are used
        to pay the administrdtive    costs  of  the  program   and cover any
        losses due to defaults.
                As of December 31, 1976, the program had more than 400
        contracts     guaranteeing   over 4,500 vessels.       Outstanding
        commitments and guarantees         totaled  approximately    $5.3 billion.
        Title     XI has been self-supporting      because fee-and interest
        income to the revolving        fund have far exceeded program admin-
        istration     costs and losses from defaults.         To date there have
        been 10 defaults       under the program totaling      a net loss of
        $14.6 million.        As of December 31, 1976, the revolving        fund
        had a balance of about $115 million.
               Participants       in title  XI pay an annual fee into the
        Agency's revolving          fund in return for the Government's            financ-
        ing guarantee.        If the fee is not paid when due and remains
        unpaid for 5 days, the Agency can either                informally     remind
        the company of its nonpayment, or the Secretary                   of Commerce
        can issue a formal notice of default.                The latter     obliges    the
        Secretary      to repay bondholders        and take possession       of the
        vessel.      In the program's      39-year history,        this has never
        happened: moreover, because of the many cases of literal                      de-
        fault    (guarantee     fee payments 5 days overdue),           the Agency
        does not consider         this a practical     alternative.        We believe
        the present policy,          which consists    of both waiving security
        defaults     and not penalizing       companies for late payments, is
              For the period February 1976 through January 1977, we
        reviewed the timeliness     of all guarantee       fee payments.  We
        found that late payments were made for 199, or 46 percent,           of
        the 429 title  XI contracts     in force.     The length of the de-
        lays ranged from 1 to 99 days.         One hundred six, or 53 per-
        cent, of all delayed payments were more than 5 days late and
        could have been declared      security   defaults:    47 payments were
        a month or more late.
              Using a 6.77-percent    interest    rate (weighted average
        annual interest   rate on title     XI revolving     fund investments
        as of July 31, 1976), we calculated         interest    income of over
        $47,000 lost to the revolving       fund because of late payments
        during the 12-month period ended January 1977.



           In October 1976, the Agency's Divisicn           of Accounts set
    up a system for tracking        delinquent    payments.    Title   XI ad-
    ministrators      are now alerted     on the due date if the guarantee
    fee is not received;      they then call the delinquent          companies.
    If the payment is not received within            a week, it will appear
    on a weekly list      of delinquent      payments and weekly telephone
    reminders will be made to the delinquent            company until    the
    payment is received.        This new system is only a partial
    solution     to the problem because it merely reduces the length
    of the delay period,      not the number of such delays.           For ex-
    ample, of the 115 guarantee          fees paid during November 1976
    through January 1977, 55 percent were late compared to 46
    percent     for the year ending January 1977.
          As a possible    solution    to delinquent    guarantee  fee pay-
    ments, the Agency is considering         penalizing   late companies by
    increasing   the guarantee      fee rate to the maximum allowed.
    (The Secretary    is authorized      to charge an annual fee recom-
    puted annually    ranging from l/2 to 1 percent .of the outstand-
    ing mortgage balance;      the average is currently       about 6/10 of
    1 percent.)     A penalty of some form is needed to deter compa-
    nies from making late payments.
             We recommend that the Secretary of Commerce, within  the
    limits     of the act, have the Agency assess a penalty  on com-
    panies     when payments are overdue.
           To be eligible    for title     XI financing     guarantees,      ves-
    sels must be owned and operated by U.S. citizens.                   This re-
    quirement    enables the Federal Government to maintain                control
    over the vessel in case of a national            emergency or if needed
    for national    defense purposes.         To satisfy    this requirement
    the owners/operators      are required      to establish      their    U.S.
    citizenship,    which the Agency verifies,           at the time of the
    guarantee    and annually    thereafter     throughout     the life of the
    mortgage.     Failure  to satisfy      the citizenship       requirement       is
    cause for a title     XI guarantee default.
          Discussions     with officials        of the Agency's Office of
    General Counsel, and review of loan guarantee                files,   indicated
    that the Agency's initial         verifications     are satisfactory.
    However, our review of the loan guarantee              files     of 22 of the
    185 companies required      2s of September 30, 1976, to submit
    annual recertifications       showed that 11, or 50 percent,             did not
    do so for 1 or more years.           Although we did not find evidence

of foreign       ownership in these      11 companies, without   a
follow-up       system the potential      for foreign  ownership exists.
        h-e discussed     the lack of recertifications             with officials
of the Agency's General Counsel and Division                     of Ship Financing
Guarantees.        They told us that although they are aware some
companies are not submitting             the recertifications,           they do
not know the extent of the Droblem because they do not have a
systematic      method for monitoring          and reviewing       the recertifi-
cation requirement.           These officials        attribute     not having
such a system to lack of resources,                including      both personnel
and automatic       data crccessing        equipment.        The Assistant     Ad-
ministrator      for Maritime Aids advised us that since the
Agency's initial        efforts     in assuring      citizenship      requirements
are substantial,        he does not believe          a follow-up      system is
justified,      especially      considering     the resources        required.
       Without the recertification        process,    the Agency cannot
assure compliance with title        XI which requires         that owners
and operators     continue   to be U.S. citizens        throughout     the
life   of the mortgage guarantee.         For this reason we do not
believe    the Agency is authorized       to forgo the recertification
process unless they develo? some alternate              means of assuring
compliance with the citizenship          requirement.        Regarding the
resources     needed to establish     an effective      follow-up     system,
we could find no evidence that any study had been made to
determine what procedures        to follow and the types and quan-
tity   of resources     that would be needed.
        In view of the title        XI citizenship       requirements,        we
recommend that the Secretary           of Commerce direct         the Agency to
take appropriate       actions to comply with the citizenship                  veri-
fication     requirement     of title   XI.    'vv'ethink this is important
in view    Of   the growth of the title         XI program, the increasing
value of individual         vessels, ‘and the more frequent            use of
complex financial        arrangements,      such as leverage        leasing,
which involves       more parties     subject    to citizenship        certifica-


      The Merchant Marine Act of 1936 provides     for Agency
guarantees  of refinancing   for existing vessels.     Sectien
1104(a)(4)  of the act states,   in part,
      "* * * the Secretary       of Commerce * * * may guaran-
      tee * * * payment of the principal       of and interest
      on an obligation      which aids in * * * refinancing
      existing  obligations      * * *."
-Our review of the Agency refinancing          policy     showed that it,
despite      its refinancing   authority    under section     1104(a)(4),
limits     its apDrova1 of refinancing       guarantees     to only those
 applications     involving   a reasonable    amount of new vessel
 construction     or where the applicant's       financial    viability
depends directly        on the refinancing.
        According     to the Director,     Office of Subsidy Administra-
tion,    this policy      is being followed      because the Agency's
$7 billion       authorized   guarantee    ceiling    is less than the
total    demand for title       XI guarantees.       He  said that by guar-
anteeing      refinancing    having a reasonable        amount of new con-
struction,        the Agency can promote work for U.S. shipyards               and
enhance the capability         of the U.S. merchant fleet,           both major
objectives       of the act.     He also added that by adopting           this
policy     the Agency can maximize its promotion of the overall
goals of the act within          its statutory     guarantee    ceiling.
        During our review we confirmed            that the Agency's demand
for guarantees      has exceeded its authorized             $7 billion     ceiling.
For instance,      as of December 31, 1976, guarantees                committed
and applications       on file at the Agency totaled              approximately     .
$7.1 billion.       In addition,      we confirmed       that applications
(records     are not readily      available     to show how many) for re-
financing     have been denied because they did not include what
the Agency considers        to be a reasonable         amount of new con-
struction.      According     to Agency officials,          in addition      to the     .
refinancing     guarantees      denied, their policy          could have also
discouraged     other ship owners from submitting               applications
for refinancing       guarantees.       Therefore,     the exact effect         of
the Agency's policy        on the U.S. maritime          industry     is not
      It appears that the Agency's policy     of limiting  its
approval of refinancing  guarantees    to only those involving     a
reasonable  amount of new construction    or where the applicant's


financial     viability     depends directly          on the refinancing,        does
not permit it to exercise            the full      intent of its authority
under section 1104(a)(4)            of the act.        However, if all quali-
fied refinancing        applicaticns       are accepted and added to the
active    application     backlog,      the statutory        ceiling   for guaran-
tees would be approached more ranidly,                   thus precluding      the
acceptance      of applications        for financing        new construction.
Faced with this dilemma, the Agency, rather than requesting
an increase      in its authorized         ceiling,      chose to adopt its
limited    refinancing      policy.
      We recommend that the Secretary          of Commerce inform the
Congress that the authorized        $7 billion     ceiling    is inadequate
to cover all guarantee demands and therefore,              the Agency has
to place restrictions     on applications       for refinancing      guaran-
tees.   Further,    the Secretary    should recommend to the Con-
gress a legislative     ceiling   for title     XI guarantees      conpat-
ible with both industry       and Federal maritime policy          needs.
      According  to title    XI administrators,      the processing                .
time of a ship financing       guarantee    should ideally     be about
5 to 6 months.     To compare this standard with the Agency's
actual time to complete investigation           and documentation     of
its application    process,    we reviewed the status of the 48
pending title   XI applications       as of September 30, 1976.
 (Data was not readily     available    regarding   processing    time
for completed applications.)         We found that 24, or 50 per-
cent, of the applications        in process had already exceeded
the standard for completion        set by Agency officials.         The
time in process for these 24 applications           ranged from 6 to
over 18 months and averaged 10.4 mcnths.
Processing   delays mean increased
costs to title    XI applicants
       In a January 1977 study, the Agency estimated           the proc-
essing time from application         to issuance cf a guarantee        to
exceed 1 year.      Although the study did not identify          specific
causes of processing      delays,    it concluded that automating
the program would expedite        the process.      The study also
pointed out that, for the year reviewed (October 1975 to
September 1976), loan guarantee          applicants   in total   could
have saved almost $10 million          in interest   costs if the aver-
age processing    time had been reduced by 3 months.           Accord-
ing to the study:


      --Most shipowners applying             for Government guarantees
         require   financing while         their vessels are being con-
      --Most shi?owners   receive short-term, relatively               high
         interest rate loans to cover the period before                apgli-
         cation approval.
      --After   closing  the title      XI guarantee transaction,
         shipowners eliminate      their short-term    loans and sell
         Government guaranteed       mortgage bonds, thereby reducing
         their  interest   costs.
      The study concludes        that the shorter      the processing      time
at the Agency, the lower         the construction      period interest       ex-
pense to shipowners.
Reasons for     delays
      We discussed   the delays in processing       guarantee  applica-
tions with officials    of the Offices      of Subsidy Administration
and Ship Construction.      They attributed     the problem to
      --inccmplete     materials   submitted  by the a;?plicants neces-
          sitating  follow-up    at many stages during the investiga-
          tion phase of processing     and
      --the Agency's lack        of resources,   including    both     person-
          nel and automatic      data processing    equipment.
The officials      elaborated    on these    matters   as follows:
      Incomplete     materials
        Agency officials      stated that when applicants         submit in-
sufficient     or inadequate      materials   as part of their       guarantee
applications,      the Agency must request additional            data--a   time-
consuming communication          Frocess res?onsible.for        much of the
program's     processing     delays.    Of the 48 active pending ap-pli-
cations    on hand as of September 30, 1976, 33 had not com-
pleted the investigative          phase of processing.         We reviewed
the status of these 33 and found that 15 did not include                   ali
the necessary      information.       Agency officials      stated that the
types of information         needed to complete these applications
were evidence of (1) firm charters,             (2) completed financing
arrangements,      and (3) firm construction         contracts.


       Inadequate     resources    -
       The Chief, Division          of Ship Financing      Guarantees,    stated
that turnover        among his application        examiners,    combined with
the inflexible        personnel     ceiling,   contributed    to delays in
application       processing.       'yJe were also told by officials       of
the Division       of Trade Studies and Statistics           and the Office
of Ship Construction          that,    because of personnel      shortages    in
their    areas, certain       title    XI work had to be contracted        out
to private      firms.     The work involved       two of the most
important     technical      analyses made by the Agency--evaluations
of the. proposed vessel's           economic soundness and its construc-
tion.     In the past, these types of analyses were performed
in-house by the Agency.
      Program officials       told us that because of the increase
in the size of title       XI, with its considerable         administra-
tive workload,     manual recordkeeping       was inefficient      and was
having an adverse impact on the program's            ability    to process
new applications       in a timely manner.      They said much time
was being spent by clerical,         as well as professional,         per-
sonnel in maintaining       and using the manual systems.            This
time could be more productively          devoted to reviewing        and
processing    applications      and, according   to program officials,
delays could be avoided if an automated information                system
was implemented.
Processing   problems have been
a continuing    problem
      The factors     contributing       to delays in title         XI applica-
tion processing--     incomplete      materials     submitted     by applicants
and a lack of resources--- tJere equally            present 5 years ago.
In August 1972 a committee,           headed by a soecial         assistant     to
the Assistant     Secretary      for Karitime      Affairs,    was formed to
study these problems.          It found that a lack of staffoower               was
the greatest    single impediment.           Other factors      identified      by
the committee included         information      Frocessing     and the need
for providing     better    information      to title      XI applicants.

       The Merchant     Marine Act of 1536,        as amended, has been
described   as
          * * * a comprehensive  Congressional inactment
       designed to foster   the development and encourage
       the maintenance   of the United States %erchant

 Title    XI contributes     to the act's goals by providing       an
 incentive     to shipowners to register       their vessels in the
 United States.        To the extent delays in processing        applica-
 tions impede or discourage        U.S. shipowners     from building
 vessels,    or cause these shipowners       to incur excess interest
 charges,    the program is not making its fullest         contribution
 to the objectives       of the act.     We believe  the matters dis-
-cussed in this section of our report have had a negative
 effect    on the Agency's ability       to promote the goals of the
 act in an efficient       and effective    manner.
        We recommend that the Secretary          of Commerce direct       the
Agency to shorten        its inordinately     long application     process.
To accomplish      this will require,       at a minimum, an 2xamination
of (1) staffing       requirements,      (2) adequacy of written      in-
structions     to applicants,      and (3) applicability       and need for
automatic     data processing      equipment.     Shortening    the process
will better      enable the title      XI program to meet the intent          of
the act.
        Applications       for financing     guarantees     must go through
two processing         phases before they can be approved.             The first
is the investigation          phase in which the applicant's           proposal
is reviewed for economic soundness and conformity                    to vessel
cost, specification,           and operating     standards.      With an affirm-
ative finding        from this phase, the Secretary            sends the appli-
cant a letter        of commitment allowing         him to issue securities
to finance his vessel.            At this point the second, or documen-
tation,     phase begins.and       with it, according        to the Assistant
Secretary      for Maritime Affairs,         the generation      of a great
deal of burdensome and costly paperwork.
       A set of guarantee documents includes      many separate
agreements,    opinions,  consents,   and other legal instruments.
According   to the Chief, Ship Financing      Guarantee Division,  the
following    is a typical  set of title   XI commitment documents.


                                                                                   , .
1s       ,   .

     ’   3-118779

         Document                                                                     No. of
          number                                 Document                             pages
                 1      Commitment to Guarantee Obligations                              20
                 2          Schedule X-Schedule of Definitions                           10
                 3A     Appendix I&Underwriting            Agreement-Serial
                          2onds                                                          13
                  313                -Underwriting         Agreement-Sinking
                                          Fund Bonds                                     17
                 4      Appendix II-Trust        Indenture                                9
                 5          Schedule A-Schedule of Definitions                   to
                               Trust Indenture                                            4
                  6         Exhibit     l-General     Provisions        incorpo-
                               rated into the Trust Indenture                by-
                               Reference                                                 20
                  7A        Exhibit     2(a)-Forms       of Serial Bond,
                               Guarantee and Trustee's             Authentica-
                               tion Certificate                                           7
                  7B        Exhibit     2(b)-Forms       of Sinking Fund
                               Bond, Guarantee and Trustee's                Au-
                               thentication        Certificate                            7
                  8         Exhibit     3-Authorization          Agreement               24
                  9     Appendix III-Security         Agreement
                 10          Exhibit    l-General      Provisions       Incor-
                               porated into the Security              Agreement
                               by Reference                                              28
                 11         Exhibit     2-Form of Secretary's             Note            3
                 12          Exhibit     3-Form of First         Preferred
                               Fleet :{ortgage                                            6
                 13               Exhibit      A-Form of Supplement to
                                     First Preferred          Fleet Mortgage              5
                 14               Exhibit      B-Form of Opinion of
                                     Counsel                                              2
                 15          Exhibit     d-Construction        Contracts                 70
                 16          Exhibit     5-Form of Consent of Ship-
                               builder                                                     3
                 17          Exhibit     6-Title    XI Reserve Fund and
                               Financial       Agreement                                 23
                 18          Exhibit     7-Form of Management Agree-
                 19     Appendix IV-Depository           Agreement
                                         Total     pages of documentation               Z276

                    In May 1976 testimony  before the House Committee on
             Merchant Marine and Fisheries,     the Assistant Secretary for
             Maritime Affairs   said he is not happy with the paperwork


    process and believes         a better   job could be done.       He further
    stated that large and financially            sound companies can afford
    the expense of caperwork and the attorneys              required    to
    handle it, but when these costs are imposed on ap;?licants
    of financially       limited   resources,    they are discouraged      from
    participating      in the program.        The Assistant    Secretary   be-
    lieves     it will take a combined effort         by the Agency, ship-
    owners, and the financial          community to decrease the amount of
    this paperwork.
            Although our review did not determine         the extent of this      *
    problem, we discussed         its impact with several attorneys     who
    represent      title   XI applicants    and staff  members of the
    Agency's Ship Financing          Guarantee Division.     Their comments
    generally      confirmed   the statements    made by the Assistant   Sec-

          As your office  requested we have not obtained     written
    comments from the Agency regarding     this report.    Ve have,
    however, presented   program officials    with an oral statement
    of facts to which they expressed general agreement.
           This report contains      recommendations     to the Secretary
    of Commerce. As you know, section           236 of the Legislative
    Reorganization      Act of 1970 requires      the head of a Federal
    agency to submit a written         statement on actions      taken on our
    recommendations      to the Iiouse Committee on Government Opera-
    tions and the Senate Committee on Governmental Affairs              not
    later   than 60 days after the date of the report and to the
    Ilouse and Senate Committees on Appropriations            with the
    agency's    first   request for appropriations       made more than 60
    days after      the date of the report.       We will contact your
    office    in the near future to arrange for release of the re-
    port so that the requirements          of section   236 can be set in
                                         Sincerely   yours,

                                ACTING Comptroller  General
                                       of the United States