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entitled 'Maritime Administration: Weaknesses Identified in Management 
of the Title XI Loan Guarantee Program' which was released on June 30, 
2003.

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Report to the Chairman, Committee on Commerce, Science, and 
Transportation, U.S. Senate:

United States General Accounting Office:

GAO:

June 2003:

Maritime Administration:

Weaknesses Identified in Management of the Title XI Loan Guarantee 
Program:

GAO-03-657:

GAO Highlights:

Highlights of GAO-03-657, a report to the Chairman, Senate Committee 
on Commerce, Science, and Transportation 

Why GAO Did This Study:

Title XI of the Merchant Marine Act of 1936, as amended, is intended 
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 financing at attractive terms. The program has 
committed to guarantee more than $5.6 billion in ship construction and 
shipyard modernization costs since 1993, but it has experienced 
several large-scale defaults over the past few years. Because of 
concerns about the scale of recent defaults, GAO was asked to (1) 
determine whether MARAD complied with key program requirements, (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.

What GAO Found:

The Maritime Administration (MARAD) has not fully complied with some 
key Title XI program requirements. While MARAD generally complied with 
requirements to assess an applicant’s economic soundness before 
issuing loan guarantees, MARAD did not ensure that shipowners and 
shipyard owners provided required financial statements, and it 
disbursed funds without sufficient documentation of project progress. 
Overall, MARAD did not employ procedures that would help it adequately 
manage the financial risk of the program. 

MARAD could benefit from following the practices of selected private 
sector maritime lenders. These lenders separate key lending functions, 
offer less flexibility on key lending standards, use a more systematic 
approach to loan monitoring, and rely on experts to estimate the value 
of defaulted assets.

With regard to credit reform implementation, MARAD uses a simplistic 
cash flow model to calculate cost estimates, which have not reflected 
recent experience. If this pattern of recent experience were to 
continue, MARAD would have significantly underestimated the cost of 
the program.

MARAD does not operate the program in a businesslike fashion. 
Consequently, MARAD cannot maximize the use of its limited resources 
to achieve its mission, and the program is vulnerable to fraud, waste, 
abuse, and mismanagement. Also, because MARAD’s subsidy estimates are 
questionable, Congress cannot know the true costs of the program.

What GAO Recommends:

GAO recommends that Congress consider providing no new funds for new 
loan guarantees under the Title XI program until certain controls have 
been instituted and MARAD has updated its default and recovery 
assumptions to more accurately reflect costs. GAO also recommends that 
MARAD undertake several reforms to help improve program management.

In written comments, the Department of Transportation disagreed with 
some report findings, however, recognized that program improvements 
were needed. 

www.gao.gov/cgi-bin/getrpt?GAO-03-657.

To view the full product, including the scope and methodology, click 
on the link above. For more information, contact Tom McCool at (202) 
512-8678 or mccoolt@gao.gov.

[End of section]

Contents:

Letter:

Results in Brief:

Background:

MARAD Has Not Fully Complied with Some Key Title XI Program 
Requirements:

MARAD Techniques to Manage Financial Risk Contrast to Techniques of 
Selected Private-sector Maritime Lenders:

MARAD's Credit Subsidy Estimates and Reestimates Are Questionable:

Conclusions:

Matters for Congressional Consideration:

Recommendations for Executive Action:

Agency Comments:

Appendix I: Scope and Methodology:

Appendix II: Comments from the Department of Transportation:

Appendix III: Comments from the Office of Management and Budget:

Appendix IV: GAO Contacts and Staff Acknowledgments:

GAO Contacts:

Staff Acknowledgments:

Tables:

Table 1: Projects Included in Our Review:

Table 2: Comparison of Private-sector and MARAD Maritime Lending 
Practices:

Table 3: Projects Selected for Our Review:

Figures:

Figure 1: MARAD's Defaulted Projects (1993-2002):

Figure 2: Estimated and Actual Defaults of Title XI Loan Guarantees 
(1996-2002):

Figure 3: Estimated and Actual Recoveries on Title XI Loan Defaults 
(1996-2002):

Abbreviations:

AMCV: American Classic Voyages, Co. 
DCAA: Defense Contract Audit Agency 
DOT: Department of Transportation 
FCRA: Federal Credit Reform Act 
IG: Department of Transportation Inspector General 
MARAD: Maritime Administration 
MHI: Massachusetts Heavy Industries, Inc. 
OMB: Office of Management and Budget 
SEC: Securities and Exchange Commission:

United States General Accounting Office:

Washington, DC 20548:

June 30, 2003:

The Honorable John McCain 
Chairman 
Committee on Commerce, Science, and Transportation 
United States Senate:

Dear Mr. Chairman:

Under the Title XI Loan Guarantee Program, the Maritime Administration 
(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 associated with 
these loan guarantee commitments totaling over $1.3 billion. The 
defaulted amounts associated with these nine loan guarantee commitments 
totaled $489 million.[Footnote 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.[Footnote 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.

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. Appendix I contains a full description 
of our scope and methodology.

Results in Brief:

MARAD has not fully complied with some key Title XI program 
requirements. In approving loan guarantees, MARAD generally complied 
with requirements to assess an applicant's economic soundness. MARAD 
used waivers or modifications, which, although permitted by Title XI 
regulations, allowed MARAD to approve applications where borrowers did 
not meet all financial requirements. In monitoring projects it 
financed, MARAD did not ensure that shipowners and shipyard owners 
provided required financial statements. Overall, we could not always 
track financial reporting because of missing or incomplete 
documentation. Without a systematic analysis of changes in the 
financial condition of its borrowers, MARAD cannot take the appropriate 
steps to minimize losses. Further, MARAD disbursed loan funds without 
sufficient documentation of project progress. MARAD also permitted a 
shipowner to minimize its investment in a project before receiving 
guaranteed loan funds. With respect to the disposition of assets, MARAD 
has guidelines, but no requirements, in place to ensure that it 
maximizes recoveries.

Selected private-sector maritime lenders told us that they manage 
financial risk by (1) establishing a clear separation of duties for key 
lending functions; (2) permitting few, if any, exceptions to key 
underwriting standards; (3) using a more systematic approach to 
monitoring the progress of projects; and (4) employing independent 
parties to survey and appraise defaulted assets. Private-sector 
representatives we interviewed stated that they were very selective 
when originating loans for the shipping industry. While MARAD cites its 
mission as an explanation as to why it does not employ these practices, 
these controls would actually help it to accomplish its mission while 
managing financial risk.

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. While the nature and 
characteristics of the Title XI program make it difficult to estimate 
subsidy costs and may affect MARAD's ability to produce reliable cost 
estimates, 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 significantly 
understate defaults, and its recovery estimates significantly overstate 
recoveries. If this pattern of recent experiences 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. 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, while the Office of Management and Budget (OMB) 
approved each MARAD estimate and reestimate, its review was not 
sufficient since it did not identify that MARAD's assumptions were 
outdated and lacked adequate support.

This report makes several recommendations to help MARAD improve its 
management of the Title XI loan guarantee program, including its 
processes for approving loan guarantees, monitoring and controlling 
funds, and managing and disposing of defaulted assets, and better 
implementing its responsibilities under the Federal Credit Reform Act 
(FCRA). We also recommend that Congress consider legislation to clarify 
borrower equity contribution requirements and incorporate 
concentration risk in the approval of loan guarantees. Because of the 
fundamental flaws we have identified, we question whether MARAD should 
approve new loan guarantees without first addressing these program 
weaknesses.

We provided a draft of this report to the Department of Transportation 
for its review and comment. MARAD noted that it has already begun to 
take steps to improve the operations of the Title XI program, 
consistent with several of our recommendations. MARAD disagreed with 
the manner in which we characterized some report findings, and provided 
additional information and data that we have incorporated into our 
analyses and report as appropriate. We also provided a copy of the 
draft report to OMB for its review and comment. OMB agreed that recent 
recovery expectations should be incorporated into future reestimates, 
but disagreed that it had provided little or no oversight over the 
program's subsidy cost estimates. However, we believe that had OMB 
provided greater review and oversight of MARAD's estimates and 
reestimates, it would have realized that MARAD did not have adequate 
support for its default and recovery assumptions.

Background:

Title XI of the Merchant Marine Act of 1936, as amended, authorizes the 
Secretary of Transportation to guarantee debt issued for the purpose of 
financing or refinancing the construction, reconstruction, or 
reconditioning of U.S.-flag vessels or eligible export vessels built in 
U.S. shipyards and the construction of advanced and modern shipbuilding 
technology of general shipyard facilities located in the United 
States.[Footnote 3] Title XI guarantees are backed by the full faith 
and credit of the United States. Title XI was created to help promote 
growth and modernization of the U.S. merchant marine and U.S. shipyards 
by enabling owners of eligible vessels and shipyards to obtain long-
term financing on terms and conditions that might not otherwise be 
available. Under the program, MARAD guarantees the payment of principal 
and interest to purchasers of bonds issued by vessel and shipyard 
owners. These owners may obtain guaranteed financing for up to 87.5 
percent of the total cost of constructing a vessel or modernizing a 
shipyard. Borrowers obtain funding for guaranteed debt obligations in 
the private sector, primarily from banks, pension funds, life insurance 
companies, and the general public. MARAD loan guarantees represent 
about 10 percent of the U.S.-flagged maritime financing market, 
according to MARAD officials. However, MARAD plays a greater role in 
certain segments of the maritime finance market. For example, according 
to a private-sector maritime lender, MARAD guarantees financing on 
about 15 percent of the country's inland barge market.

Over the last 10 years, MARAD experienced defaults in amounts that 
totaled $489 million. One borrower, AMCV, defaulted on five loan 
guarantee projects in amounts totaling $330 million, 67 percent of the 
total defaulted amounts. Figure 1 shows the nine defaults experienced 
by MARAD over the past 10 years, five of which were associated with 
AMCV and which are shown in gray.

Figure 1: MARAD's Defaulted Projects (1993-2002):

[See PDF for image]

[End of figure]

Once an applicant submits a Title XI application to MARAD, and prior to 
execution of a guarantee, MARAD must determine the economic soundness 
of the project, as well as the applicant's capability to construct or 
operate the ship or shipyard. For example, the shipowner or shipyard 
must have sufficient operating experience and the ability to operate 
the vessels or employ the technology on an economically sound basis. 
The shipowner or shipyard must also meet certain financial requirements 
with respect to working capital and net worth.

The amount of the obligations that MARAD may guarantee for a project is 
based on the ship or shipyard costs. Title XI permits guarantees not 
exceeding 87.5 percent of the actual cost of the ship or shipyard, with 
certain projects limited to 75 percent financing. The interest rate of 
the guaranteed obligations is determined by the private 
sector.[Footnote 4] MARAD also levies certain fees associated with the 
Title XI program. For example, applicants must pay a nonrefundable 
filing fee of $5,000. In addition, prior to issuance of the commitment 
letter, the applicant must pay an investigation fee against which the 
filing fee is then credited. Participants must also pay a guarantee 
fee, which is calculated by determining the amount of obligations 
expected to be outstanding and disbursed to the shipowner or shipyard 
during each year of financing.

The Title XI program is also subject to the Federal Credit Reform Act 
(FCRA) of 1990, which was enacted to require that agency budgets 
reflect a more accurate measurement of the government's subsidy costs 
for direct loans and loan guarantees. FCRA is intended to provide 
better cost comparisons both among credit programs and between credit 
and noncredit programs. The credit subsidy cost is the government's 
estimated net cost, in present value terms, of direct or guaranteed 
loans over the entire period the loans are outstanding. Credit reform 
was intended to ensure that the full cost of credit programs would be 
reflected in the budget so that the executive branch and Congress might 
consider these costs when making budget decisions. Each year, as part 
of the President's Budget, agencies prepare estimates of the expected 
subsidy costs of new lending activity for the upcoming year. Unless OMB 
approves an alternative proposal, agencies are also required to 
reestimate this cost annually. OMB has oversight responsibility for 
federal loan program compliance with FCRA requirements and has 
responsibility for approving subsidy estimates and reestimates.

All credit programs automatically receive any additional budget 
authority that may be needed to fund reestimates.[Footnote 5] For 
discretionary programs this means there is a difference in the budget 
treatment of the original subsidy cost estimates and of subsidy cost 
reestimates. The original estimated subsidy cost must be appropriated 
as part of the annual appropriation process and is counted under any 
existing discretionary funding caps. However, any additional 
appropriation for upward reestimates of subsidy cost is not constrained 
by any budget caps. This design could result in a tendency to 
underestimate the initial subsidy costs of a discretionary program. 
Portraying a loan program as less costly than it really is when 
competing for funds means more or larger loans or loan guarantees could 
be made with a given appropriation because the program then could rely 
on a permanent appropriation for subsequent reestimates to cover any 
shortfalls. This built-in incentive is one reason to monitor subsidy 
reestimates. Monitoring reestimates is a key control over tendencies to 
underestimate costs as well as a barometer of the quality of agencies' 
estimation processes.

When credit reform was enacted, it generally was recognized that 
agencies did not have the capacity to implement fully the needed 
changes in their accounting systems in the short-term and that the 
transition to budgeting and accounting on a present-value basis would 
be difficult. However, policy makers expected that once agencies 
established a systematic approach to subsidy estimation based on 
auditable assumptions, present value-based budgeting for credit would 
provide them with significantly better information.

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. 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. We looked at five MARAD-financed projects (see table 1).

Table 1: Projects Included in Our Review:

Dollars in millions.

(AMCV) Project America, Inc.; Year loan committed: 1999; 
Original amount: $1,079.5; Risk category: 2A; Status: Default.

Searex; Year loan committed: 1996; Original amount: $77.3; 
Risk category: 2B; Status: Default.

Massachusetts Heavy Industries (MHI); Year loan committed: 1997; 
Original amount: $55.0; Risk category: 3; Status: 
Default.

Hvide Van Ommeran Tankers (HVIDE); Year loan committed: 1996; 
Original amount: $43.2; Risk category: 2C; Status: Active.

Global Industries; Year loan committed: 1996; Original amount: 
$20.3; Risk category: 1C; Status: Active.

Source: MARAD.

Note: MARAD places projects into one of seven risk categories that, 
from lowest to highest, are 1A, 1B, 1C, 2A, 2B, 2C, and 3.

[End of table]

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.[Footnote 6] 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.[Footnote 7] 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. According to 
the Department of Transportation (DOT) Assistant Secretary for 
Administration, the market research guidelines developed by the Office 
of Statistical and Economic Analysis were neither requested nor 
approved by Title XI program management. Finally, while MARAD may not 
waive economic soundness criteria, officials from the Office of 
Statistics and Economic Analysis which is responsible for providing 
independent assessment of the market impact on economic soundness 
expressed concern that their findings regarding economic soundness 
might not always be fully considered when MARAD approved loan 
guarantees.[Footnote 8] 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 owner-invested 
equity.[Footnote 9] 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.[Footnote 10] 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.[Footnote 11] Subsequently, MARAD used cash flow tests for 
Project America, Inc., in lieu of working capital requirements for 
purposes of liquidity testing. According to the Assistant Secretary for 
Administration, one of the major cruise lines uses cash flow tests as a 
measure of its liquidity.

According to MARAD officials, waivers or modifications help them meet 
the congressional intent of the Title XI program, which is to promote 
the growth and modernization of the U. S. merchant marine industry. 
Further, they told us that the uniqueness of the Title XI projects and 
marine financing lends itself to the use of waivers and modifications. 
However, by waiving or modifying financial requirements, MARAD 
officials may be taking on greater risk in the loans they are 
guaranteeing. Consequently, the use of waivers or modifications could 
contribute to the number or severity of loan guarantee defaults and 
subsequent federal payouts. In a recent review, the Department of 
Transportation Inspector General (IG) noted that the use of 
modifications increases the risk of the loan guarantee to the 
government and expressed concern about MARAD undertaking such 
modifications without taking steps to mitigate those risks.[Footnote 
12] 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.[Footnote 13] 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.[Footnote 14] 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 Inspector General (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 Litton Ingalls 
Shipbuilding 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., disbursement requests did not include 
documentation that identified the extent of progress made on the 
project. Also, while MARAD requires periodic on-site visits to verify 
the progress on ship construction or shipyard refurbishment, we did not 
find evidence of systematic site visits and inspections. For Project 
America, Inc., MARAD did not have a construction representative 
committed on-site 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 routinely linked to the extent of project 
monitoring. Further, without a systematic approach to on-site visits, 
MARAD relied principally on the shipowner's certification and 
documentation 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, travel 
budget restrictions and limited enforcement tools. 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 thorough 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. MARAD Assistant Secretary for 
Administration noted that if financial documents were not submitted 
after a request for missing documents was made, MARAD's only legal 
recourse was to call the loan in default, pay off the Title XI debt and 
then seek recovery against the borrower.

He said that MARAD tries to avoid takings these steps. We found no 
evidence that MARAD routinely requested missing financial statements or 
did any analysis. Also, the IG report on the Title XI program released 
in March 2003 noted that MARAD does not closely monitor the financial 
health of its borrowers over the term of their loans. We recognize that 
MARAD has limited enforcement resources, however, for such publicly 
traded companies as AMCV, financial statements filed with the 
Securities and Exchange Commission could be used. However, we found no 
evidence that MARAD attempted to use SEC filings.

Inconsistent monitoring of a borrower's financial condition limits 
MARAD's ability to protect the federal government's financial 
interests. For example, MARAD would not know if a borrower's financial 
condition had changed so that it could take needed action to possibly 
avoid defaults or minimize losses. Further, MARAD's practices for 
assessing project progress limit its ability to link disbursement of 
funds to progress made by shipowners or shipyard owners. This could 
result in MARAD disbursing funds without a vessel or shipyard owner 
making sufficient progress in completing projects. Likewise, permitting 
project owners to minimize their investment in MARAD-financed projects 
increases the risk of loss to the federal government.

MARAD Does Not Have Requirements in Place to Govern the Handling of 
Defaulted Assets:

MARAD has guidance governing the disposition of defaulted assets. 
However, MARAD is not required to follow this guidance, and we found 
that MARAD does not always adhere to it. MARAD guidelines state that an 
independent, competent marine surveyor or MARAD surveyor shall survey 
all vessels, except barges, as soon as practicable after the assets are 
taken into custody. In the case of filed or expected bankruptcy, an 
independent marine surveyor should be used. In the case of Searex, 
MARAD conducted on-site inspections after the default. However, these 
inspections were not conducted in time to properly assess the condition 
of the assets. With funds no longer coming in from the project, Ingalls 
cut the vessels into pieces to make it easier to move the vessels from 
active work-in-process areas to other storage areas within the 
property. The Searex lift boat and hulls were cut before MARAD 
inspections were made. According to a MARAD official, the cutting of 
one Searex vessel and parts of the other two Searex vessels under 
construction reduced the value of the defaulted assets. The IG report 
on the Title XI program released in March 2003 noted that site visits 
were conducted on guaranteed vessels or property only in response to 
problems or notices of potential problems from third parties or from 
borrowers.

The guidelines also state that sales and custodial activities shall be 
conducted in such a fashion as to maximize MARAD's overall recovery 
with respect to the asset and debtor. Market appraisals (valuations) of 
the assets shall be performed by an independent appraiser, as deemed 
appropriate, to assist in the marketing of the asset. MARAD did not 
have a market appraisal for the defaulted Project America assets. Also, 
MARAD relied on an interested party to determine the cost of making 
Project America I seaworthy. An appraisal of Project America assets 
immediately after default would have assisted MARAD in preparing a 
strategy for offering the hull of Project America I and the parts of 
Project America II for sale. According to MARAD officials, as of March 
2003, MARAD had received $2 million from the sale of the Project 
America I and II vessels.[Footnote 15] Without a market appraisal, it 
is unclear whether this was the maximum recovery MARAD could have 
received.

MARAD hired the Defense Contract Audit Agency (DCAA) to verify the 
costs incurred by Northrop Grumman Ship Systems, Inc., since January 1, 
2002, for preparing and delivering Project America I in a weather-tight 
condition suitable for ocean towing in international waters. A MARAD 
official said that the DCAA audit would allow MARAD to identify any 
unsupported costs and recover these amounts from the shipyard. The DCAA 
review was used to verify costs incurred, but not to make a judgment as 
to the reasonableness of the costs. DCAA verified costs of 
approximately $17 million.

MARAD officials cite the uniqueness of the vessels and projects as the 
reason for using guidelines instead of requirements for handling 
defaulted assets. However, certain practices for handling defaulted 
assets can be helpful regardless of the uniqueness of a project. Among 
these are steps to immediately assess the value of the defaulted asset. 
Without a definitive strategy and clear requirements, defaulted assets 
may not always be secured, assessed, and disposed of in a manner that 
maximizes MARAD's recoveries--resulting in unnecessary costs and 
financial losses to the federal government.

MARAD Techniques to Manage Financial Risk Contrast to Techniques of 
Selected Private-sector Maritime Lenders:

Private-sector maritime lenders we interviewed told us that it is 
imperative for lenders to manage the financial risk of maritime lending 
portfolios. In contrast to MARAD, they indicated that to manage 
financial risk, among other things, they (1) establish a clear 
separation of duties for carrying out different lending functions; (2) 
adhere to key lending standards with few, if any, exceptions; (3) use a 
more systematic approach to monitoring the progress of projects; and 
(4) primarily employ independent parties to survey and appraise 
defaulted projects. The lenders try to be very selective when 
originating loans for the shipping industry. While realizing that MARAD 
does not operate for profit, it could benefit from the internal control 
practices employed by the private sector to more effectively utilize 
its limited resources and to enhance its ability to accomplish its 
mission. Table 2 describes the key differences in private-sector and 
MARAD maritime lending practices used during the application, 
monitoring, and default and disposition phases.

Table 2: Comparison of Private-sector and MARAD Maritime Lending 
Practices:

[See PDF for image]

Sources: GAO analysis of MARAD and private-sector data.

[End of table]

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. Today, 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 is primarily responsible for overseeing 
the underwriting and approving of loan guarantees. Title XI program 
management is primarily handled by offices that report to the Associate 
Administrator for Shipbuilding. In addition, the same Associate 
Administrator controls, in collaboration with the Chief of the Division 
of Ship Financing Contracts within the Office of the Chief Counsel, the 
disposition of assets after a loan has defaulted. Most recently, MARAD 
has taken steps to consolidate responsibilities related to loan 
disbursements. In August 2002, the Maritime Administrator gave the 
Associate Administrator for Shipbuilding sole responsibility for 
reviewing and approving the disbursement of escrow funds. According to 
a senior official, prior to August 2002 this responsibility was shared 
with the Office of Financial and Rate Approvals under the supervision 
of the Associate Administrator for Financial Approvals and Cargo 
Preference. As a result of the consolidation, the same Associate 
Administrator who is responsible for underwriting and approving loan 
guarantees and disposing of defaulted assets is also responsible for 
approval of loan disbursements and monitoring financial condition. 
MARAD undertook this consolidation in an effort to improve performance 
of analyses related to the calculation of shipowner's equity 
contributions and monitoring of changes in financial condition. 
However, as mentioned earlier, MARAD does not have controls for clearly 
identifying the shipowner's required equity contribution. The 
consolidation of responsibilities for approval of loan disbursements 
does not address these weaknesses and precludes any potential benefit 
from separation of duties.

Private-sector Practices Employ Less Flexible Lending Standards:

The private-sector lenders we interviewed said they apply rigorous 
financial tests for underwriting maritime loans. They analyze financial 
statements such as balance sheets, income statements, and cash flow 
statements, and use certain financial ratios such as liquidity and 
leverage ratios that indicate the borrower's ability to repay. Private-
sector maritime lenders told us they rarely grant waivers, or 
exceptions, to underwriting requirements or approve applications when 
borrowers do not meet key minimum requirements. Each lender we 
interviewed said any approved applicants were expected to demonstrate 
stability in terms of cash on hand, financial strength, and collateral. 
One lender told us that on the rare occasions when exceptions to the 
underwriting standards were granted, an audit committee had to approve 
any exception or waiver to the standards after reviewing the 
applicant's circumstances. However, according to one MARAD official the 
waivers are often made without a deliberative process. Nonetheless, 
MARAD points to its concurrence system as a deliberative process for 
key agency officials to concur on loan guarantees and major waivers and 
modifications. However, as mentioned earlier, the official responsible 
for performing a macro analysis of the market is not always included in 
the concurrence process. We found in the cases we reviewed that MARAD 
often permits waivers or modifications of key financial requirements. 
Also, a recent IG report found that MARAD routinely modified 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.[Footnote 16] A MARAD official told us 
that MARAD is currently developing the procedures for an external 
review process of waivers and modifications.

These private-sector lenders also indicated that preparing an economic 
analysis or an independent feasibility study assists in determining 
whether or not to approve funding based on review and discussion of the 
marketplace, competition, and project costs. Each private-sector lender 
we interviewed agreed that performance in the shipping industry was 
cyclical and timing of projects was important. In addition, reviewing 
historical data provided information on future prospects for a project. 
For example, one lender uses these economic analyses to evaluate how 
important the project will be to the overall growth of the shipping 
industry. Another lender uses the economic analyses and historical data 
to facilitate the sale of a financed vessel. In the area of economic 
soundness analysis, MARAD requirements appear closer to those of the 
private-sector lenders, in that external market studies are also used 
to help determine the overall economic soundness of a project. However, 
assessments of economic soundness prepared by the Office of Statistical 
and Economic Analysis may not be fully considered when MARAD approves 
loan guarantees.

Private-sector Lenders Use a More Systematic Approach to Loan 
Monitoring:

Private-sector lenders minimized financial risk by establishing loan 
monitoring and control mechanisms such as analyzing financial 
statements and assigning risk ratings. Each private-sector lender we 
interviewed said that conducting periodic reviews of a borrower's 
financial statements helped to identify adverse changes in the 
financial condition of the borrower. For example, two lenders stated 
that they annually analyzed financial statements such as income 
statements and balance sheets. The third lender evaluated financial 
statements quarterly. Based on the results of these financial statement 
reviews, private-sector lenders then reviewed and evaluated the risk 
ratings that had been assigned at the time of approval. Two lenders 
commented that higher risk ratings indicated a need for closer 
supervision, and they then might require the borrower to submit monthly 
or quarterly financial statements. In addition, a borrower might be 
required to increase cash reserves or collateral to mitigate the risk 
of a loan. Further, the lender might accelerate the maturity date of 
the loan. MARAD notes that in certain cases, such as a loan guarantee 
to a subsidiary of Enron, it already uses such requirements. The DOT IG 
noted that MARAD should place covenants in its loan guarantees 
concerning the required financial performance and condition of its 
borrowers, as well as measures to which MARAD is entitled should these 
provisions be violated. However, the IG expressed concern that MARAD's 
minimum monitoring approach would not provide financial information in 
a timely and sufficient manner. Private-sector lenders use 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.[Footnote 17] 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 on site visits to verify construction progress. 
However, the linkage between the progress of the project and the 
disbursement of loan funds was not always clear. MARAD tried to adjust 
the number of site visits based on the amount of the loan guarantee, 
the uniqueness of project (for example, whether the ship is the first 
of its kind for the shipowner), the degree of technical and engineering 
risk, and familiarity with the shipyard. However, the frequency of site 
visits was often dependent upon the availability of travel funds, 
according to a MARAD official.

Private-sector Lenders Use Industry Expertise to Value Defaulted 
Assets:

Private-sector maritime lenders said they regularly use independent 
marine surveyors and technical managers to appraise and conduct 
technical inspections of defaulted assets. For example, two lenders 
hire independent marine surveyors who are knowledgeable about the 
shipbuilding industry and have commercial lending expertise to inspect 
the visible details of all accessible areas of the vessel, as well as 
its marine and electrical systems. In contrast, we found that MARAD did 
not always use independent surveyors. For example, we found that for 
Project America, the shipbuilder was allowed to survey and oversee the 
disposition of the defaulted asset. As mentioned earlier, MARAD hired 
DCAA to verify the costs incurred by the shipbuilder to make the 
defaulted asset ready for sale; however, MARAD did not verify whether 
the costs incurred were reasonable or necessary. For Searex, 
construction representatives and officials from the Offices of the 
Associate Administrator of Shipbuilding and the Chief of the Division 
of Ship Financing Contracts were actively involved in the disposition 
of the assets.

MARAD Cites Mission as the Difference in Management of Financial Risk 
Compared to Private-sector Lenders:

According to top-level MARAD officials, the chief reason for the 
difference between private-sector and MARAD techniques for approving 
loans, monitoring project progress, and disposing of assets is the 
public purpose of the Title XI program, which is to promote growth and 
modernization of the U.S. merchant marine and U.S. shipyards. That is, 
MARAD's program purposefully provides for greater flexibility in 
underwriting in order to meet the financing needs of shipowners and 
shipyards that otherwise might not be able to obtain financing. MARAD 
is also more likely to work with borrowers that are experiencing 
financial difficulties once a project is under way. MARAD officials 
also cited limited resources in explaining the limited nature of 
project monitoring.

While program flexibility in financial and economic soundness standards 
may be necessary to help MARAD meet its mission objectives, the strict 
use of internal controls and management processes is also important. 
Otherwise, resources that could have been used to further the program 
might be wasted. To aid agencies in improving internal controls, we 
have recommended that agencies identify the risks that could impede 
their ability to efficiently and effectively meet agency goals and 
objectives.[Footnote 18] 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:

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.[Footnote 19] 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 
actual historical experience.[Footnote 20] 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 time frames. 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.[Footnote 21] 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 2, MARAD has consistently underestimated the 
amount of defaults the Title XI program would experience. In total, 
$487.7 million has actually defaulted during this period--more than 10 
times greater than estimated. Even when we excluded AMCV, which 
represents about 68 percent of the defaulted amounts, from our 
analysis, we found that the amount of defaults MARAD experienced 
greatly exceeded what MARAD estimated it would experience by $114.6 
million (or over 260 percent).

Figure 2: Estimated and Actual Defaults of Title XI Loan Guarantees 
(1996-2002):

[See PDF for image]

[A] We excluded estimates for risk categories 1A, 1B, and 1C, because 
estimated defaults for these categories totaled only $1.5 million or 
3.4 percent of total estimated defaults.

[End of figure]

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 3. 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 $94.9 million or about 51 percent of 
its estimated recovery amount. When we excluded AMCV, which represents 
about 68 percent of the defaulted amounts, from our analysis, we found 
that MARAD has more accurately estimated the amount it would recover on 
defaulted loans, and in fact, has underestimated the actual amount by 
about $10 million (or about 15 percent). If the overall pattern of 
recent default and recovery experiences were to continue, MARAD would 
have significantly underestimated the costs of the program.

Figure 3: Estimated and Actual Recoveries on Title XI Loan Defaults 
(1996-2002):

[See PDF for image]

[A] Estimated recoveries are based on applying MARAD's 50 percent 
recovery rate within 2 years to the actual default amounts. Our 
analysis of recovery estimates includes estimated recovery amounts for 
two of the five defaulted AMCV loans, even though 2 years have not 
elapsed, because, according to MARAD officials, no additional 
recoveries are expected on these two loans. Thus, our recovery 
calculation was based on $370.6 of the $487.7 million in defaulted 
loans, which includes defaults for which 2 years have elapsed, as well 
as the two AMCV defaults for which no additional recoveries are 
expected. With its 50 percent recovery assumption, MARAD would have 
estimated that, at this point, it should have recovered $185.3 million 
of these defaulted loans.

[B] We calculated the actual recovery rate by comparing the total 
actual recoveries to the $370.6 million in relevant actual defaulted 
amounts. At the time of our review, MARAD had recovered $94.9 out of 
this $370.6 million.

[End of figure]

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.[Footnote 22] 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 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 adequate 
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 adequate 
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. FCRA assigns 
responsibility to OMB for coordinating credit subsidy estimates, 
developing estimation guidelines and regulations, and improving cost 
estimates, including coordinating the development of more accurate 
historical data and annually reviewing the performance of loan programs 
to improve cost estimates. Had OMB provided greater review and 
oversight of MARAD's estimates and reestimates, it would have realized 
that MARAD did not have adequate support for the default and recovery 
assumptions it uses to calculate subsidy cost estimates.

Conclusions:

MARAD does not operate the Title XI loan guarantee program in a 
businesslike fashion to minimize the federal government's fiscal 
exposure. 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.

Matters for Congressional Consideration:

We recommend that Congress consider discontinuing future appropriations 
for new loan guarantees under the Title XI program until adequate 
internal controls have been instituted to manage risks associated with 
the program and MARAD has updated its default and recovery assumptions 
to more accurately reflect the actual costs associated with the program 
and that Congress consider rescinding the unobligated balances in 
MARAD's program account. We also recommend that Congress consider 
clarifying borrower equity contribution requirements. Specifically, we 
recommend that Congress 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, we recommend that Congress 
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.

Recommendations for Executive Action:

We recommend that the Secretary of Transportation direct the 
Administrator of the Maritime Administration to take immediate action 
to improve the management of the Title XI loan guarantee program. 
Specifically, to better comply with Title XI loan guarantee program 
requirements and manage financial risk, MARAD should:

* establish a clear separation of duties among the loan application, 
project monitoring, and default management functions;

* establish a systematic process that ensures independent judgments of 
the technical, economic, and financial soundness of projects during 
loan guarantee approval;

* establish a systematic process that ensures the findings of each 
contributing office are considered and resolved prior to approval of 
loan guarantee applications involving waivers and exceptions made to 
program requirements;

* systematically monitor and document the financial condition of 
borrowers and link the level of monitoring to the level of project 
risk;

* base the borrower's equity down payment requirement on a reasonable 
estimate of the total cost of the project, including total guarantee 
fees expected to be incurred over the life of the project;

* make apparent the amount of equity funds a shipowner or shipyard 
owner should provide;

* establish a system of controls, including automated controls, to 
ensure that disbursements of loan funds are not made prior to a 
shipowner or shipyard owner meeting the equity fund requirement;

* create a transparent, independent, and risk-based process for 
verifying and documenting the progress of projects under construction 
prior to disbursing guaranteed loan funds;

* review risk ratings of loan guarantee projects at least annually; 
and:

* establish minimum requirements for the management and disposition of 
defaulted assets, including a requirement for an independent evaluation 
of asset value.

To better implement federal credit reform, MARAD should:

* establish and implement a process to annually compare estimated to 
actual defaults and recoveries by risk category, investigate any 
material differences that are identified, and incorporate the results 
of these analyses in its estimates and reestimates;

* establish and implement a process to document the basis for each key 
cash flow assumption--such as defaults, recoveries, and fees--and 
retain this documentation in accordance with applicable records 
retention requirements;

* establish and implement a process to document the basis for each 
reestimate, including an analysis of a borrower's financial condition 
and a market analysis;

* review its risk category system to ensure that it appropriately 
classifies projects into subdivisions that are relatively homogenous in 
cost, given the facts known at the time of designation, and that risks 
and changes to risks are reflected in annual reestimates; and:

* 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.

To ensure that the reformed Title XI program is carried out effectively 
and in conformity with program and statutory requirements, MARAD should 
conduct a comprehensive assessment of its human capital and other 
resource needs. Such analysis should also consider the human capital 
needs to improve and strengthen credit reform data collection and 
analyses.

To assist and ensure that MARAD better implements credit reform, and 
given the questionableness of MARAD's estimates and reestimates, we 
also recommend that the Director of OMB provide greater review and 
oversight of MARAD's subsidy cost estimates and reestimates.

Agency Comments:

We provided a draft of this report to DOT for its review and comment. 
We received comments from the department's Assistant Secretary for 
Administration, who noted that MARAD has already begun to take steps to 
improve the operations of the Title XI program consistent with several 
of our recommendations. The department disagreed with the manner in 
which we characterized some report findings and provided additional 
information and data that we have incorporated into our analyses and 
report as appropriate. We also provided a copy of the draft report to 
OMB for its review and comment. We received comments from OMB's Program 
Associate Director for General Government Programs, and its Assistant 
Director for Budget, who agreed that recent recovery expectations 
should be incorporated into future reestimates, but disagreed that OMB 
had provided little or no oversight over the program's subsidy cost 
estimates.

The department noted that its Office of Inspector General recently 
identified a number of issues raised in our report and that MARAD is 
already addressing these issues. MARAD recognized that aspects of the 
program's operation need improvement and said it is working to fine 
tune program operations and create additional safeguards. Specifically, 
MARAD has agreed to improve procedures for financial review, seek 
authorization for outside assistance in cases of unusual complexity, 
and expand, within resource constraints, its processes for monitoring 
company financial condition and the condition of assets.

The department pointed out that MARAD is permitted, under Title XI 
regulations, to modify or waive financial criteria for loan guarantees. 
Before issuing waivers in the future, DOT reported that MARAD will 
identify any needed compensatory measures to mitigate associated risks. 
MARAD also agreed to consider using outside financial advisors to 
review uniquely complicated cases. In addition, DOT reported that MARAD 
is working to improve its financial monitoring processes by developing 
procedures to better document its regular assessments of each company's 
financial health. The department stated that MARAD plans to highlight 
the results of these assessments to top agency management for any Title 
XI companies experiencing financial difficulties.

The department also reported that MARAD is developing a system that 
leverages limited staff resources for providing more extensive 
monitoring of Title XI vessel condition. In this regard, DOT said MARAD 
is establishing a documentation process for each vessel that would 
include improved record keeping of annual certificates from the U.S. 
Coast Guard, vessel classification societies, and insurance 
underwriters. MARAD hopes to use this system, together with company 
financial condition assessments, to determine whether additional 
inspections are necessary.

In addition, DOT indicated that MARAD has begun an analysis of the 
program's results covering the full 10-year period since FCRA was 
implemented to improve the accuracy of subsidy cost estimates. We agree 
that MARAD should conduct this analysis as part of its annual 
reestimate process to determine if estimated loan performance is 
reasonably close to actual performance and are encouraged that MARAD 
has been able to obtain the historical data to conduct such an 
analysis. We had attempted to perform a similar analysis to assess the 
basis MARAD used for its default and recovery assumptions, but MARAD 
was unable to provide us with this data.

The department believes that our analysis may provide results that do 
not accurately reflect the management of the program as a whole, and 
that the results we report are affected by our sample selection. It 
points out that the report is based on an analysis of only 5 projects, 
representing a minute segment of the Title XI program's universe, 3 of 
which are defaulted projects, even though the program experienced only 
9 defaults out of 104 projects financed over the last 10 years. We do 
not contend that this sample is representative of all of the projects 
MARAD finances. However, we do believe that these case studies uncover 
policies that permeate the program and do not provide for adequate 
controls or for the most effective methods for protecting the 
government's interest. In addition, our conclusions also draw on the 
work of a recent IG review, which looked at 42 Title XI projects, as 
well as a comparison with practices of selected private sector lenders 
and our own experience in analyzing loan guarantee programs throughout 
the federal government.

The department also believes that as a result of our emphasis on 
projects involving construction financing, a significant portion of the 
report is directed at issues associated solely with that type of 
financing, which only accounts for about 30 percent of Title XI 
projects since 1993. The department believes it is important for us to 
recognize that most projects (70 percent) have been for mortgage period 
financing because there are no disbursements made from an escrow fund 
for these types of projects, and there is virtually no need for agency 
monitoring of the construction process for these types of projects 
because the ship owner does not receive any Title XI funds until the 
vessel has been delivered and certified by the regulatory authorities 
as seaworthy. We believe that projects involving construction financing 
are at greater risk of fraud, waste, abuse, and mismanagement, and 
therefore require a greater level of oversight compared to projects 
involving only mortgage period financing. Again, as mentioned above, 
our overall conclusions are based on more than the cases we reviewed.

DOT asserts that the report's portrayal of events and the rationale 
behind our description of the assessment of defaulted Searex assets and 
the verification of the cost for completing Project America I are 
inaccurate. In the case of Searex, the department believes that we 
implied that had the program officials rigorously adhered to program 
guidelines, the vessels would not have been dismantled. We believe that 
while the use of rigorous program guidelines may not have prevented 
Ingalls from dismantling the vessels, adherence to existing program 
guidelines would have provided evidence of the value and condition of 
the assets at the time of default. This documentary evidence would be 
advantageous if legal action occurred. In the case of Project America, 
DOT believes that the report incorrectly asserts that MARAD relied on 
an interested party, Ingalls Shipbuilding, Inc., to determine the value 
of the Project America I assets. The department believes that MARAD 
relied on the shipbuilder only to provide an estimate of the cost of 
making Project America seaworthy. We revised the report to reflect that 
MARAD did not obtain a market appraisal of the assets, and that it 
relied on Ingalls to estimate the cost of making the vessel seaworthy. 
We believe that in order to market the Project America assets, MARAD 
needs to know the costs of the available options including the cost of 
making the hull seaworthy.

The department also believes that the report does not convey a clear 
understanding of DCCA's role in the handling of Project America assets 
after default. We disagree with this assertion, and believe that the 
report appropriately reflects DCCA's role as outlined in its report 
entitled the Application of Agreed-Upon Procedures Incurred on Project 
America.

DOT believes that the report uses a number of examples to show that 
granting waivers or "other occurrences" related to program guidelines 
somehow contributed to the three defaults among the cases studied and 
expresses concern that the report concludes that weak program oversight 
contributed to the defaults examined in the draft. First, the report 
correctly notes that MARAD is permitted to approve waivers under 
certain circumstances. Nonetheless, waiving financial requirements 
increases the risk borne by the federal government. MARAD is now 
recognizing this by agreeing to implement the IG recommendations 
calling for compensating provisions to mitigate risk when approving 
waivers. Second, the program's vulnerability to fraud, waste, abuse and 
mismanagement is not only due to MARAD not complying with program 
requirements, but also because MARAD lacks requirements for the 
management of defaulted assets, does not utilize basic internal control 
practices, such as separation of duties, and cannot reasonably estimate 
the program's cost.

With regard to the private sector comparison, DOT does not agree that 
MARAD lacks a deliberative process for loan approvals. The department 
believes that, in each written loan guarantee analysis, MARAD discusses 
the basis for granting major modifications or waivers. Also, DOT 
believes MARAD has a deliberative process through its written 
concurrence system whereby key agency offices have to concur on actions 
authorizing waivers or modifications. We revised the report to reflect 
the differing opinions of MARAD officials regarding the process for 
approving loan guarantees and waivers or modifications. We believe that 
it is not clear that MARAD uses a deliberative process and our review 
of the project files showed that key agency offices were not always 
included in the concurrence process.

DOT believes that the report should acknowledge that MARAD maintains 
separation of duties for disbursement. The report correctly notes that 
the ultimate decision to disburse funds is made by the same office that 
approves and monitors the Title XI loans. We added the name of the 
office that it then instructs to disburse funds.

DOT noted that certain lenders consolidate rather than separate 
approval and monitoring functions in order to improve efficiencies. The 
lenders we spoke to, who are major marine lenders, do not combine these 
functions. They also separate approval and monitoring functions from 
marketing and disposition functions. Further, we do not believe that 
efficiencies achieved through consolidating these functions outweigh 
the greater vulnerability to fraud, waste, abuse, and mismanagement 
associated with consolidation.

The department believes that MARAD's determination of subsidy costs is 
in accordance with OMB guidance. While we did not assess MARAD's 
compliance with OMB guidance, MARAD did not comply with other 
applicable, more specific guidance, which states that estimated cash 
flows should be compared to actuals, and estimates should be based on 
the best available data. The guidance is in the Accounting and Auditing 
Policy Committee's Technical Release 3, Preparing and Auditing Direct 
Loan and Loan Guarantee Subsidies Under the Federal Credit Reform Act. 
This guidance was developed by an interagency group including members 
from OMB, Treasury, GAO, and various credit agencies to provide 
detailed implementation guidance on how to prepare reasonable credit 
subsidies. Regardless of whether MARAD complied with all applicable 
guidance, because MARAD did not conduct this fundamental analysis to 
assess whether its cash flow model was reasonably predicting borrower 
behavior, it did not know that for the past 5 years, defaults were 
occurring at a much higher rate and costing significantly more than 
estimated, and recoveries were significantly less than expected. In 
addition, MARAD did not appropriately incorporate these higher default 
rates and lower recovery rates into its cash flow models.

The department also stated that the report should recognize that, as a 
result of its full compliance with FCRA, MARAD set aside adequate funds 
for all defaults to date. While MARAD may have complied with some of 
the broad requirements of FCRA in preparing estimates and reestimates, 
these estimates were based on outdated assumptions and MARAD could not 
demonstrate that the estimates were based on historical data or other 
meaningful analyses. Further, DOT's response does not recognize that 
the appropriated funds are to cover expected losses over the life of 
the loan guarantee program. Because actual losses for the last 5 years 
have been significantly more and recoveries significantly less than 
expected, in the future actual losses will need to be significantly 
less and recoveries significantly more than estimated for MARAD not to 
require additional funding.

In addition, DOT believes that our analysis of MARAD's subsidy 
estimates was inaccurate and based on incomplete or incorrect data, and 
that we underreported actual recoveries from one of the defaulted 
projects (MHI). We disagree and believe our analysis was accurate, 
based on the information MARAD had provided. In its comments, the 
department provided new information on recoveries for the MHI project. 
We have now incorporated this new data, as appropriate, into our 
analysis. We did not include data provided on guarantee fees because 
these are paid upfront and should not be included in estimates of 
recoveries.

The department also provided technical comments, which we have 
incorporated as appropriate. The department's comments appear in 
appendix II.

OMB agreed that recent recovery expectations on certain defaulted 
guarantees cited in our report should be incorporated into future 
reestimates, and plans to ensure that these expectations are reflected 
in next year's budget. Further, OMB plans to work with MARAD to review 
recovery expectations for other similar loan guarantees. In addition, 
OMB has been working with DOT and MARAD staff to implement 
recommendations contained in the IG report, and expects that resulting 
changes will also address many of the concerns raised in our report.

OMB disagreed with our finding that it provided little review and 
oversight of MARAD's subsidy cost estimates and reestimates and points 
to the substantial amount of staff time it devotes to working with 
agencies on subsidy cost estimates. OMB claims that the data used in 
our report does not seem to support our assertion of a lack of OMB 
oversight and disagrees with our implication that the overall subsidy 
rates would be higher if it had provided oversight. We clarified our 
report to convey the message that if OMB had provided greater 
oversight, it would have realized that MARAD did not have adequate 
support for the default and recovery assumptions it uses to calculate 
subsidy cost estimates. While OMB asserts that the number of default 
claims made between 1992 and 1999 is substantially in line with the 
assumptions underlying the estimated subsidy costs, we could not verify 
the magnitude and timing of defaults prior to the period included in 
our review (1996-2002) because MARAD could not provide data on 
historical default experience. Because MARAD could not provide adequate 
support for its default and recovery assumptions, we question the basis 
for the estimates and whether OMB had provided sufficient oversight. We 
continue to believe that MARAD's recent actual experience was 
significantly different than what MARAD had estimated and OMB had 
approved. Even when we exclude all of the AMCV projects, as well as the 
MHI project, from our analysis, we found that the amount of defaults 
MARAD experienced exceeded what MARAD estimated it would experience by 
$63.3 million (or about 177 percent). Should the program receive new 
funding in the future, the subsidy rate estimates should be calculated 
using updated default and recovery assumptions to incorporate recent 
actual experience.

OMB also took issue with our use of data on the eight defaults, 
particularly those involving AMCV and MHI, in questioning MARAD's most 
recent reestimates of the costs of loans guaranteed between 1992 and 
1995. However, we continue to question the reasonableness of the 
negative subsidies for the loans that were disbursed in fiscal years 
1993, 1994, and 1995. First, the loans in these cohorts have not been 
through what MARAD considers the period of peak default--years 10-18 
depending on the risk category. Second, MARAD was unable to provide us 
with adequate supporting information for how it determined the 
estimated default and recovery amounts. OMB agrees that recent 
experience should be used to calculate reestimates and states in its 
comments that it generally requires agencies to use all historical data 
as a benchmark for future cost estimates and agreed that recent 
recovery experience should be incorporated into future reestimates.

OMB's comments appear in appendix III.

We are sending copies of this report to the Secretary of 
Transportation. We also will make copies available to others upon 
request. In addition, the report will be available at no charge on the 
GAO web site at http://www.gao.gov.

If you or your staff have any questions about this report or need 
additional information, please contact me, or Mathew Scirè at 202-512-
6794. Major contributors to this report are listed in appendix IV.

Sincerely yours,

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

Signed by Thomas J. McCool: 

[End of section]

Appendix I: Scope and Methodology:

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. 
We judgmentally selected 5 projects from a universe of 83 projects 
approved between 1996 and 2002. The selected projects represent active 
and defaulted loans and five of the six risk categories assigned during 
the 1996-2002 period. The projects selected include barges, lift boats, 
cruise ships, and tankers. (See table 3.) Two of the selected 
shipowners had multiple Title XI loan guarantees during 1996-2002 
(HVIDE, five guarantees; and AMCV, the parent company of Project 
America, Inc., five).

Table 3: Projects Selected for Our Review:

Project: (AMCV) Project America, Inc.; Year loan committed: 1999; 
Type of project: Cruise ships.

Project: Searex; Year loan committed: 1996; Type of project: 
Lift boats.

Project: Massachusetts Heavy Industries (MHI); Year loan committed: 
1997; Type of project: Shipyard modernization.

Project: Hvide Van Ommeran Tankers (HVIDE); Year loan committed: 1996; 
Type of project: Tanker.

Project: Global Industries; Year loan committed: 1996; Type of 
project: Barge.

Source: GAO.

[End of table]

We interviewed agency officials and reviewed provisions of existing 
federal regulations set forth in Title 46, Part 298 of the Code of 
Federal Regulations to identify the key program requirements that 
influence the approval or denial of a Title XI loan guarantee. We 
reviewed internal correspondence and other documentation related to the 
compliance with program requirements for the approval of the loan 
guarantee, ongoing monitoring of the project, and disposition of assets 
for loans resulting in default. We interviewed agency officials and 
staff members from the Title XI support offices that contribute to the 
approval and monitoring of loans and disposal of a loan resulting in 
default. Also, we interviewed a retired MARAD employee involved in one 
of the projects.

In addition, we interviewed officials that represented AMCV/Project 
America, Inc., including the former Vice President and General Counsel 
and former outside counsel.

To determine how MARAD's practices of managing financial risk compare 
to those of selected private-sector maritime lenders, we interviewed 
two leading worldwide maritime lenders, and one leading maritime lender 
in the Gulf Coast region. We interviewed these lenders to become 
familiar with private-sector lending policies, procedures, and 
practices in the shipping industry. Among the individuals we 
interviewed were those responsible for portfolio management and asset 
disposition. We did not verify that the lenders followed the practices 
described to us.

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 first identified the key cash 
flow assumptions MARAD uses to calculate its subsidy cost estimates. 
Once we identified these assumptions, we determined whether MARAD had a 
reliable basis--whether MARAD had gathered sufficient, relevant, and 
reliable supporting data--for the estimates of program cost and for 
their estimates of loan performance. We compared estimated program 
performance to actual program performance to determine whether 
variances between the estimates and actual performance existed. 
Further, we interviewed those MARAD officials who are responsible for 
implementing credit reform and compared the practices MARAD uses to 
implement credit reform to the practices identified in OMB and other 
applicable credit reform implementation guidance.

We performed 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.

[End of section]

Appendix II: Comments from the Department of Transportation:

U.S.Department of Transportation 
Assistant Secretary for Administration	
400 Seventh St., S.W.

Washington, D.C. 20590:

JUN 12 2003:

Mr. Thomas J. McCool:

Managing Director, Financial Markets and Community Investment Issues:

U.S. General Accounting Office 441 G Street, N.W. Washington, D.C. 
20548:

Dear Mr. McCool:

Thank you for the opportunity to review and comment on the GAO draft 
report, "Maritime Administration: Weaknesses Identified in Management 
of the Title XI Loan Guarantee Program." We offer the following 
comments for your consideration as the report is finalized. The 
comments are organized to provide an overall perspective on the draft 
report, followed by a section with specific and detailed comments.	If 
you have any questions concerning our reply, please contact Martin 
Gertel on 366-5145.

Sincerely,

Vincent T. Taylor:

Signed for Vincent T. Taylor:

U.S. Department of Transportation Comments on U.S. General Accounting 
Office Draft Report, "Maritime Administration: Weaknesses Identified in 
the Management of the Title XI Loan Guarantee Program" GAO-03-657:

Title XI Program Management Improvements Underway:

A number of issues raised in the draft report were previously 
identified by the Department's Office of Inspector General (OIG) in its 
recently issued report on the Title XI program, and MARAD is already 
addressing those issues. MARAD recognized that aspects of the Title XI 
program's operation need improvement, and it is working closely with 
OIG to fine tune program operation and create additional safeguards. 
Specifically, MARAD has agreed to improve procedures for financial 
review, seek authorization for outside assistance in cases of unusual 
complexity, and expand, within resource constraints, its processes for 
monitoring company financial condition and the condition of assets.

MARAD is permitted under the Title XI regulations to modify or waive 
financial criteria for a loan guarantee. Before issuing a waiver in the 
future, MARAD will identify any needed compensatory measures to 
mitigate associated risks. These compensatory measures could include 
requirements for liens on unencumbered collateral or greater amounts of 
project equity. MARAD also agreed to consider using outside financial 
advisors to review uniquely complicated cases. Its fiscal year 2004 
authorization seeks authority to engage such financial advisors, at the 
expense of the prospective borrower.

MARAD is working to improve its financial monitoring processes by 
developing procedures to better document its regular assessments of 
each Title XI company's financial health. The results of these 
assessments will be highlighted to top agency management for any Title 
XI companies experiencing financial difficulties.

Finally, MARAD is developing a system that leverages its limited staff 
resources for providing more extensive monitoring of Title XI vessel 
condition. In this regard, MARAD is establishing a documentation 
process for each Title XI vessel which will include improved 
recordkeeping of annual certificates from the U.S. Coast Guard, vessel 
classification societies, and insurance underwriters. MARAD will use 
this system together with company financial condition assessments to 
determine whether additional inspections by MARAD are necessary.

Draft Report Results Affected By Sample Selection:

The GAO draft report is based on analysis of only five projects, 
representing a minute segment of the Title XI program's universe. These 
five projects included three defaults even though MARAD has financed 
104 Title XI projects over the last 10 years and experienced only nine 
defaults in total. Thus, while 60 percent of the projects in GAO's 
sample were defaults, the program has experienced less than a 9 percent 
default rate 
over the last 10 years. It should also be noted that one of the 
projects analyzed by GAO, the shipyard reactivation project for MHI 
Shipbuilding, was approved only as the result of special legislation 
that has no applicability to any other Title XI project. This project 
has already been the subject of three separate OIG audits. The draft 
report's analytical focus on defaults, including a unique case with no 
parallels in the program, may provide results that do not accurately 
reflect the management of the program as a whole.

Another aspect of sample selection also affected the draft report's 
analysis. Two distinct types of financing are offered through the Title 
XI program, "Mortgage Period" and "Construction Period." Since 1993, 
mortgage period financing accounts for about 70 percent of the 
projects. This type of financing provides funds only after vessel 
construction has been satisfactorily completed as compared to 
construction period financing, which provides funding during the 
construction period as well. Despite the program's preponderance of 
mortgage period loans, only one of five cases considered by GAO was of 
this type. Recognizing most Title XI financings are mortgage period 
loans is significant for two key reasons. First, there are no 
disbursements from an escrow fund for mortgage period financing. 
Second, there is virtually no need for agency monitoring of the 
construction process because the ship owner does not receive any Title 
XI funds until the vessel has been delivered and certified by the 
regulatory authorities as seaworthy. As a result of the draft report's 
emphasis on projects involving construction financing, a significant 
portion of the report is directed at issues associated solely with that 
type of financing that accounts for only about 30 percent of Title XI 
projects. For example, all of the discussion in the draft report's 
section "Controlling the Disbursements of Loan Funds" addresses issues 
that are pertinent only to construction period financing.

Finally, it would have been useful to include a drill rig project in 
the sample, since these projects represent the largest market segment 
in the Title XI portfolio. MARAD has approved drill rig projects 
totaling $1.6 billion in outstanding loan guarantees and commitments 
out of a total portfolio of $4.6 billion. All of these projects to date 
have been successful.

Clear Understanding of Events Necessary to Avoid Erroneous Conclusions:

In some cases, the draft report's portrayal of events and the rationale 
behind them is inaccurate. For example, the draft report cites certain 
issues that arose during Title XI funded projects to assert that 
reliance on flexible guidelines for handling defaulted assets is 
insufficient and that specific and rigorous requirements could save 
funds. As stated earlier, while we agree that the program will benefit 
from certain procedural modifications, some of the examples cited are 
misconstrued.

Assessing Assets in Custody:

The draft report implies that had program officials rigorously adhered 
to program guidelines, the SEAREX vessels would not have been 
dismantled. MARAD's guidelines 
for the disposition of defaulted assets state that a marine surveyor 
"shall survey all vessels as soon as practicable after the assets are 
taken into custody." The draft report states that MARAD did not timely 
conduct such a survey before Ingalls dismantled the SEAREX vessels, 
implying that had this action occurred, the vessels would not have been 
dismantled. There are several flaws in this logic. First, MARAD did not 
have custody of the vessels, Ingalls did. As a result, the guideline 
provisions, even if they had been inflexible requirements, would not 
have applied. Secondly, MARAD conducted oversight visits to Ingalls 
prior to the vessels being dismantled. However, it is unclear how a 
marine surveyor's assessment, or oversight visits by MARAD, could have 
prevented Ingalls from dismantling the vessels.

MARAD and SEAREX were both entitled to rely on the duty of Ingalls, as 
a secured party in possession of the vessels, to take reasonable care 
of the vessels and preserve them. Instead, Ingalls cut up the vessels 
because they were in its way and, in so doing, failed to carry out its 
legal obligations imposed by the State of Mississippi, and also Federal 
Bankruptcy law, which forbids such actions without a Bankruptcy Court 
order. SEAREX has commenced a civil action against Ingalls for the 
damage and MARAD will claim against any proceeds. MARAD does not have 
an independent right to bring a civil action against Ingalls for damage 
to its collateral.

Verifying Cost for Completion versus Estimates of Assessed Value:

The draft report incorrectly asserts that, in the case of Project 
America, MARAD relied on an interested party, Ingalls Shipbuilding, to 
determine the value of the Project America I assets. In fact, MARAD 
relied on the shipbuilder only to provide an estimate of the cost of 
making the Project America I vessel seaworthy. In places, the draft 
report incorrectly interprets this as a request for Ingalls to perform 
an appraisal for the purpose of marketing the asset. MARAD did not ask 
Ingalls to appraise the hull's market value; rather, MARAD wanted to 
know how much it would cost to make the vessel towable. The draft 
report should note the fact that the incomplete vessel, more than 800 
feet long and 200 feet high, could only be removed from the shipyard by 
partially completing it or allowing Ingalls to cut the vessel up. It 
was MARAD's independent conclusion, based on its shipbuilding 
expertise, that it would cost more and return less money to dismantle 
the vessel than it would to partially complete it. MARAD opted to 
partially complete the vessel for no more than $12 million - not the 
$16 million the cited in the draft report. Subsequently, of the $14 
million attributable to the sale of Hull 1, after deducting the $12 
million used to partially complete the vessel, MARAD recovered $2 
million. Had MARAD adopted the alternative course of action described 
in the draft report, it would have fared worse.

The draft report also does not convey a clear understanding of DCAA's 
role in this project. On page 18, the draft report states that "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 [Ingalls]." MARAD hired the DCAA to protect its 
rights under its contract with Ingalls. Had Ingalls spent less than $12 
million in preserving and completing the vessel, MARAD would have been 
entitled to each dollar:

under the $12 million cap. MARAD's hiring of DCAA was unrelated to 
assessing the asset's market value, and represents standard and 
appropriate practice for ensuring charges related to a contract were in 
fact incurred. Further, the draft report states that DCAA did not 
review the reasonableness of the costs charged by Ingalls. DCAA does 
not provide that service. Instead, MARAD is performing a reasonableness 
review. Prior to entering into its agreement to pay $12 million of the 
sales proceeds to Ingalls for partially completing the hull, MARAD 
performed a preliminary review of the reasonableness of such costs and 
concluded that they were likely to be reasonable. Now that DCAA has 
submitted its report, MARAD is completing its review of the 
reasonableness of Ingalls' charges.

MARAD Compliance with Program Management Requirements:

The draft report uses a number of examples to show that granting 
waivers or other occurrences related to program guidelines somehow 
contributed to the three defaults among the cases studied. While MARAD 
agrees, as stated earlier, that some increased program controls may be 
useful in managing future projects, the draft report does not make a 
convincing case that cited instances materially contributed to these 
defaults. For example, MARAD recognizes that certain ship owner 
financial statements could not be located; however, in each case MARAD 
was aware of the ongoing financial difficulties, and was working with 
those tools available to address the situation.

The draft report comments extensively on waivers and modifications of 
financial requirements, but acknowledges that these are permitted under 
the Title XI regulations. While MARAD acknowledges that in the future, 
compensatory measures will be used to provide additional risk 
mitigation, it should be noted that MARAD has frequently required such 
compensatory measures in the past. It should also be noted that MARAD 
could not have approved many of its successful and desirable projects 
without having waived or modified financial requirements. Examples 
include the double hull tankers that MARAD financed for American Heavy 
Lift and Hvide Van Ommeren. These tankers were necessary to meet the 
requirements of the Oil Pollution Act and could not have been built 
without MARAD financing, which included the judicious use of waivers.

MARAD also disagrees with the draft report's conclusion, based on the 
small number of examples studied, that its Title XI oversight is weak, 
or somehow contributed to the defaults examined by the draft. While 
MARAD recognizes there are opportunities to improve oversight, some of 
the assertions in the report lack firm basis. For example, the draft 
report asserts that MARAD could not always demonstrate linkage between 
fund disbursement and construction progress. MARAD has supporting 
documentation of construction progress for Project America which is the 
example cited in the draft report, and has made it available to GAO.

MARAD Practice Compared to Private Lenders:

While comparisons between Title XI practices and those of the private 
sector offer some useful insights, MARAD does not agree with all of the 
characterizations of its processes:

in the draft report. For example, while MARAD agrees that some of the 
financial analysis documentation practices of the private sector offer 
useful insights for improving the program's practices, MARAD does not 
agree that it lacks a deliberative process for loan approvals. In each 
written loan guarantee analysis, MARAD discusses the basis for granting 
major modifications or waivers. MARAD has a deliberative process 
through its written concurrence system whereby key agency offices have 
to concur on actions authorizing waivers or modifications. Also, 
certain lenders consolidate rather than separate approval and 
monitoring functions to achieve greater efficiencies, as MARAD has 
recently done. The draft report recognizes that MARAD consolidated 
certain functions in order to correct the very issues GAO and the OIG 
have identified, yet the draft asserts MARAD's organizational structure 
offers too little separation of duties for the Title XI program. The 
GAO report should note that MARAD does maintain separation of duties 
for disbursement.

Credit Subsidy:

MARAD's determination of subsidy costs is in accordance with guidance 
from the Office of Management and Budget. The draft report should 
recognize that as a result of its full compliance with the Federal 
Credit Reform Act (FCRA), MARAD set aside adequate funds for all 
defaults to date. The draft report is critical of MARAD's subsidy 
estimates on the basis that, even if the AMCV recoveries were excluded, 
MARAD's estimates of its other recoveries were inaccurate. 
Unfortunately, the draft report's analysis was based on incomplete or 
incorrect data (see the Specific and Technical comments section), since 
it underestimated MARAD's recovery from MHI. If the draft report's 
analysis had been accurate in this case, it would have recognized that 
MARAD recovered more funds than anticipated, and it would have reached 
a different overall conclusion.

Finally, we agree with the draft report's suggestion to conduct long-
term, retrospective analyses of program results to improve the accuracy 
of FCRA estimates. However, the draft report's recommendation of 
conducting analyses covering the last 5 year period could provide an 
insufficient time-span to achieve worthwhile results. For example, if 
such an analysis had been done after the first five years after 
implementation of FCRA, it would have demonstrated that MARAD 
overestimated program costs, since no defaults occurred during this 
period. A longer term perspective offers greater assurance that we 
capture a complete and accurate record of the program's results. 
Therefore, MARAD has begun an analysis of the program's results 
covering the full 10-year period since FCRA was implemented.

[End of section]

Appendix III: Comments from the Office of Management and Budget:

EXECUTIVE OFFICE OF THE PRESIDENT OFFICE OF MANAGEMENT AND BUDGET:
WASHINGTON, D. C. 20503:

June 23, 2003:

Thomas J. McCool Managing Director Financial Markets and Community 
Investment General Accounting Office:

Washington, DC 20548:

Dear Mr. McCool:

We have been asked to respond on the Acting Director's behalf to your 
request for comment from the Office of Management and Budget on your 
draft report "Maritime Administration: Weaknesses Identified in 
Management of the Title XI Loan Guarantee Program.":

We agree with GAO that recent recovery expectations on certain 
defaulted guarantees cited in the report should be incorporated into 
future reestimates; since these data were received after publication of 
the 2004 President's Budget, we will ensure that they are reflected in 
next year's Budget, and will work with the Maritime Administration 
(MARAD) to review recovery expectations for other similar loan 
guarantees.

In addition, we commend GAO on recognizing many of the same program 
management issues raised in the Department of Transportation's Office 
of the Inspector General (OIG) report on the Title XI program, issued 
in March 2003. We have been working with the Department and MARAD staff 
to implement recommendations contained in the OIG report, and expect 
that resulting changes will also address many of the concerns raised in 
the GAO report.

However, we disagree with GAO's assertion that OMB provided little or 
no oversight over the MARAD Title XI subsidy cost estimates. To support 
this assertion, GAO cites several defaults on loans originated between 
1996-2002, and implies that the overall subsidy rates would be higher 
if OMB had provided oversight.

First, OMB devotes a substantial amount of staff time to working with 
all agencies, including DoT staff, on subsidy cost estimates: we work 
with agencies on revisions and refinements to their models throughout 
the year, review cash flows for all agency subsidy cost estimates and 
reestimates in preparation for the President's Budget, provide a 
variety of tools to aid agencies in making calculations in support of 
these estimates, and provide comprehensive annual training in credit 
budgeting guidance and procedures for all interested Federal government 
staff, as well as respond to ad hoc requests for guidance and training.

Second, the data used in the report does not seem to support GAO's 
assertion of a lack of OMB oversight. In general, OMB requires that 
agencies use their program's historical experience as a benchmark for 
future cost estimates. As GAO outlined, the:

large majority of MARAD's default experience is attributable to six 
loan guarantees: Massachusetts Heavy Industries (MHI), and the five 
made for American Classic Voyages (AMCV). At the time of making the 
AMCV loan guarantees in 1999, MARAD had experienced, at most, only four 
default claims since 1992. GAO acknowledges that MHI was an atypical 
project because P.L. 104-324 waived MARAD's economic soundness 
criterion. Therefore, on the more than 70 standard loan guarantees 
issued between 1992-1999, MARAD had experienced only three default 
claims. This figure is substantially in line with the assumptions 
underlying the estimated subsidy costs for guarantees made under 
conditions permitted by law and regulations, such as those to AMCV. As 
a result, OMB would not have questioned the estimates since they were 
in line with historical experience.

Finally, GAO also uses the data on the eight defaults to call into 
question NIARAD's most recent estimates of the cost of loans guaranteed 
between 1992-1995, primarily because the MHI and AMCV defaults occurred 
earlier, and in larger amounts, than originally estimated. As GAO 
wrote, MARAD estimates that most defaults will occur during years 10-18 
of the loans. Since the loans from those earlier years now have between 
eight and eleven years of experience behind them, with only one 
default, it is not clear how the MHI and AMCV experience would change 
the default estimates on the earlier loan guarantees.

Sincerely,


Stephen McMillin
Program Associate Director,
General Government Programs:	

Richard P. Emery
Assistant Director for Budget 

Signed by Stephen McMillin and Richard P. Emery:

[End of section]

Appendix IV: GAO Contacts and Staff Acknowledgments:

GAO Contacts:

Thomas J. McCool (202) 512-8678 Mathew J. Scirè (202) 512-6794:

Staff Acknowledgments:

In addition to those individuals named above, Kord Basnight, Daniel 
Blair, Rachel DeMarcus, Eric Diamant, Donald Fulwider, Grace Haskins, 
Rachelle Hunt, Carolyn Litsinger, Marc Molino, and Barbara Roesmann 
made key contributions to this report.

FOOTNOTES

[1] Defaulted amounts may include disbursed loan guarantee funds, 
interest accrued, and other costs.

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

[3] Vessels eligible for Title XI assistance generally include 
commercial vessels such as passenger, bulk, container, cargo and 
oceanographic research; also eligible tankers, tugs, towboats, barges, 
dredges, floating power barges, offshore oil rigs and support vessels, 
and floating dry docks. Eligible technology generally includes proven 
technology, techniques, and processes to enhance the productivity and 
quality of shipyards; novel techniques and processes designed to 
improve shipbuilding; and related industrial production that advances 
U.S. shipbuilding. 

[4] MARAD must determine that the interest rate is reasonable.

[5] Congress recognized that data were limited or unreliable in the 
early years of credit reform and that this could impede the ability of 
agencies to make reliable estimates. Thus, Congress provided for 
permanent, indefinite budget authority for upward reestimates of 
subsidy costs. Agencies with discretionary credit programs then could 
reestimate subsidy costs as required without being limited by the 
constraints of budgetary spending limits.

[6] 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). 

[7] Economic soundness analyses are prepared by the Office of Insurance 
and Shipping Analysis which is responsible for recommending approval or 
disapproval of loans from an economic soundness perspective, and the 
Office of Statistical and Economic Analysis. It should be noted that we 
did not assess the substance of these economic analyses. 

[8] 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.

[9] MARAD may waive or modify financial terms or requirements upon 
determining that there is adequate security for the guarantees.

[10] 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. 

[11] Cash management is a financial management technique used to 
accelerate the collection of debt, control payments to creditors, and 
efficiently manage cash. 

[12] U.S. Department of Transportation, Office of Inspector General, 
Maritime Administration Title XI Loan Guarantee Program (Washington, 
D.C.: March 27, 2003). 

[13] 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.

[14] On June 25, 2001, AMCV restated losses from $6.1 million to $9.1 
million for the first quarter of 1999. 

[15] MARAD has no financial interest in the equipment purchased for 
Project America II , and therefore has no right to sale proceeds for 
this vessel.

[16] The IG also recommended that MARAD impose compensating factors for 
loan guarantees to mitigate risks.

[17] Classification society representatives are individuals who inspect 
the structural and mechanical fitness of ships and other marine vessels 
for their intended purpose.

[18] 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).

[19] The Federal Accounting Standards Advisory Board developed the 
accounting standard for credit programs in 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.

[20] MARAD's recovery assumption assumes a 50 percent recovery rate 
within 2 years of default. However, 2 years have not yet elapsed for 
several of the defaults and so we could not yet determine how the 
estimated timing of recoveries compares to the actual timing of 
recoveries.

[21] Our analysis focused on loans beginning in 1996 because (1) this 
was the first year in which MARAD implemented its risk category system, 
and (2) MARAD could not provide us with any supporting data for its 
default and recovery assumptions for loans originating before 1996. 
Further, only one default occurred between 1993-1996, representing less 
than 1 percent of MARAD's total defaults between 1993-2002.

[22] MARAD's risk category system incorporates ten factors that are set 
out in Title XI, which specifies that MARAD is to establish a system of 
risk categories based on these factors. How MARAD weighs and interprets 
these factors is described in program guidance.

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