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

Highlights

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.

Recommendations

Matter for Congressional Consideration

Matter	Status	Comments
Congress may wish to consider discounting 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. Congress may also wish to consider rescinding the unobligated balances in MARAD's program account.	Closed – Implemented	Senate Report 108-841 accompanying S. 1262, the Maritime Administration Authorization Act of 2003, cited our report and our findings that that MARAD had failed to provide effective oversight in receiving and approving loan guarantees, had failed to closely monitor the financial condition of borrowers during the term of a loan; and has failed to adequately monitor the condition of projects subject to guarantees. Also, the bill cited that MARAD had been flagrant in its use of authority in granting waivers. S. 1262, as noted in the Senate Report 108-841, included a variety of provisions to address these issues: Sec. 105--Waivers of Program Requirements Under Title XI; Sec. 106--Project Monitoring Under Title XI; and Sec. 107--Defaults Under Title XI. These provisions were designed to reform how MARAD manages the Title XI Maritime Loan Guarantee Program through increased oversight diligence and a variety of administrative and financial mechanisms.
Congress may wish to consider clarifying borrower equity contribution requirements. Specifically, Congress may 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.	Closed – Implemented	Senate Report 108-841 accompanying S. 1262, the Maritime Administration Authorization Act of 2003, cited our report and our findings that that MARAD had failed to provide effective oversight in receiving and approving loan guarantees; had failed to closely monitor the financial condition of borrowers during the term of a loan; and has failed to adequately monitor the condition of projects subject to guarantees. S. 1262, as noted in the Senate Report 108-841, included a provision to address the issue of borrower equity contribution requirements: Sec. 104--Equity Payments By Obligor For Disbursement Prior TO Termination Of Escrow Agreeemnts Under Title XI. These provisions were designed to reform how MARAD manages the Title XI Maritime Loan Guarantee Program through increased oversight diligence and a variety of administrative and financial mechanisms.
Further Congress may wish to 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 portforlio.	Closed – Implemented	Senate Report 108-841 accompanying S. 1262, the Maritime Administration Authorization Act of 2003, cited our report and our findings that that MARAD had failed to provide effective oversight in receiving and approving loan guarantees and had failed to closely monitor the financial condition of borrowers during the term of a loan. S. 1262, as noted in the Senate Report 108-841, included a provision to address the issue of borrower risk: Sec. 109--Loan Guarantees Under Title XI. These provisions were designed to reform how MARAD manages the Title XI Maritime Loan Guarantee Program through increased oversight diligence and a variety of administrative and financial mechanisms.

Recommendations for Executive Action

Agency Affected	Recommendation	Status
Department of Transportation	The Secretary of Transportation should 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.	Closed – Implemented Jean Mckeever, MARAD Associate Administrator, informed us that MARAD organizational framework was being changed to address the separation of duties among loan application, project monitoring, and default management functions.
Maritime Administration	The Secretary of Transportation should 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.	Closed – Implemented Jean Mckeever, MARAD Associate Administrator, informed us that MARAD organizational framework was being changed to address the separation of duties among loan application, project monitoring, and default management functions.
Department of Transportation	The Secretary of Transportation should direct the Administrator of the Maritime Administration should 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 systematic process that ensures independent judgements of the technical, economic, and financial soundness of projects during loan guarantee approval.	Closed – Implemented MARAD informed us that it has identified the means to ensure that each project will receive independent review throughout its duration. New project applications must pass through an extensive review and concurrence process that includes multiple disciplines and management officials before a project is approved. MARAD initiated a process for detailed supplemental financial review of loan guarantees that are in-force. Both semi-annual and annual financial reports must be reviewed and approved not only by the primary analyst of the project, but also by a second analyst. Default management functions utilize a team approach combining the project and company expertise of the primary analyst, MARAD in-house technical expertise and MARAD attorneys.
Maritime Administration	The Secretary of Transportation should direct the Administrator of the Maritime Administration should 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 systematic process that ensures independent judgements of the technical, economic, and financial soundness of projects during loan guarantee approval.	Closed – Implemented MARAD informed us that it has identified the means to ensure that each project will receive independent review throughout its duration. New project applications must pass through an extensive review and concurrence process that includes multiple disciplines and management officials before a project is approved. MARAD initiated a process for detailed supplemental financial review of loan guarantees that are in-force. Both semi-annual and annual financial reports must be reviewed and approved not only by the primary analyst of the project, but also by a second analyst. Default management functions utilize a team approach combining the project and company expertise of the primary analyst, MARAD in-house technical expertise and MARAD attorneys.
Department of Transportation	The Secretary of Transportation should direct the Administrator of the Maritime Administration to take immediate action to improkve 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 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.	Closed – Implemented MARAD informed us that it has identified the means to ensure that each project will receive independent review throughout its duration. New project applications must pass through an extensive review and concurrence process that includes multiple disciplines and management officials before a project is approved. MARAD initiated a process for detailed supplemental financial review of loan guarantees that are in-force. Both semi-annual and annual financial reports must be reviewed and approved not only by the primary analyst of the project, but also by a second analyst. Default management functions utilize a team approach combining the project and company expertise of the primary analyst, MARAD in-house technical expertise and MARAD attorneys.
Maritime Administration	The Secretary of Transportation should direct the Administrator of the Maritime Administration to take immediate action to improkve 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 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.	Closed – Implemented MARAD informed us that it has identified the means to ensure that each project will receive independent review throughout its duration. New project applications must pass through an extensive review and concurrence process that includes multiple disciplines and management officials before a project is approved. MARAD initiated a process for detailed supplemental financial review of loan guarantees that are in-force. Both semi-annual and annual financial reports must be reviewed and approved not only by the primary analyst of the project, but also by a second analyst. Default management functions utilize a team approach combining the project and company expertise of the primary analyst, MARAD in-house technical expertise and MARAD attorneys.
Department of Transportation	The Secretary of Transportation should 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 systematically monitor and documentn the financial condition of borrowers and link the level of monitoring to the level of project risk.	Closed – Implemented MARAD developed a systematic procedure for monitoring and documenting a company's financial condition. If a borrower's financial condition deteriorates and the risk of lossto the Government increases, MARAD will increase the level of project monitoring.
Maritime Administration	The Secretary of Transportation should 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 systematically monitor and documentn the financial condition of borrowers and link the level of monitoring to the level of project risk.	Closed – Implemented MARAD developed a systematic procedure for monitoring and documenting a company's financial condition. If a borrower's financial condition deteriorates and the risk of lossto the Government increases, MARAD will increase the level of project monitoring.
Department of Transportation	The Secretary of Transportation should 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 management financial risk, MARAD should 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.	Closed – Not Implemented MARAD told us that its current practice is consistent with this recommendation although in certain rare instances MARAD permitted another approach that was considered reasonable. MARAD will continue to base equity down payment requirements on its best estimate of the project cost and will always include estimated total guarantee fees.
Maritime Administration	The Secretary of Transportation should 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 management financial risk, MARAD should 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.	Closed – Not Implemented MARAD told us that its current practice is consistent with this recommendation although in certain rare instances MARAD permitted another approach that was considered reasonable. MARAD will continue to base equity down payment requirements on its best estimate of the project cost and will always include estimated total guarantee fees.
Department of Transportation	The Secretary of Transportation should direct the Administrator of the Maritime Administration to take immediate action to improve the management of the Title XI loan guartantee program. Specifically, to better comply with Title XI loan guarantee program requirments and manage financial risk, MARAD should make apparent the amount of equity funds a shipowner or shipyard owner should provide.	Closed – Implemented MARAD said that all future MARAD approvals will specify the dollar amount of the required equity.
Maritime Administration	The Secretary of Transportation should direct the Administrator of the Maritime Administration to take immediate action to improve the management of the Title XI loan guartantee program. Specifically, to better comply with Title XI loan guarantee program requirments and manage financial risk, MARAD should make apparent the amount of equity funds a shipowner or shipyard owner should provide.	Closed – Implemented MARAD said that all future MARAD approvals will specify the dollar amount of the required equity.
Department of Transportation	The Secretary of Transportation should 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 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.	Closed – Implemented MARAD told us that its future disbursement records will indicate the required equity amount and disbursement will not be made until the obligor has paid this required amount.
Maritime Administration	The Secretary of Transportation should 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 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.	Closed – Implemented MARAD's future disbursement records will indicate the required equity amount and disbursement will not be made until the obligor has paid this required amount.
Department of Transportation	The Secretary of Transportation should 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 create a transparent, independent, and risk-based process for verifying and documenting the progress of projects under construction prior to disbursing guaranteed loan funds.	Closed – Not Implemented MARAD believes it has a transparent and risk-based process for verifying and documenting progress, which it will continue. (60-day letter)
Maritime Administration	The Secretary of Transportation should 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 create a transparent, independent, and risk-based process for verifying and documenting the progress of projects under construction prior to disbursing guaranteed loan funds.	Closed – Not Implemented MARAD believes it has a transparent and risk-based process for verifying and documenting progress, which it will continue. (60-day letter)
Department of Transportation	The Secretary of Transportation should 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 review risk ratings of loan guarantee projects at least annually.	Closed – Not Implemented MARAD stated that it already reviews all project risk annually as part of its subsidy re-estimation process. MARAD said that they will continue to perform this annual review.
Maritime Administration	The Secretary of Transportation should 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 review risk ratings of loan guarantee projects at least annually.	Closed – Not Implemented MARAD stated that it already reviews all project risk annually as part of its subsidy re-estimation process. MARAD said that they will continue to perform this annual review.
Department of Transportation	The Secretary of Transportation should 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 management financial risk, MARAD should establish minimum requirements for the management and disposition of defaulted assets, including a requirement for an independent evaluation of asset value.	Closed – Implemented MARAD modified its guidelines for actions to be taken in the event of a default to ensure that custodial and insurance arrangements commence immediately unless precluded by legal action. Also, MARAD will obtain appraisals of defaulted assets in appropriate cases.
Maritime Administration	The Secretary of Transportation should 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 management financial risk, MARAD should establish minimum requirements for the management and disposition of defaulted assets, including a requirement for an independent evaluation of asset value.	Closed – Implemented MARAD modified its guidelines for actions to be taken in the event of a default to ensure that custodial and insurance arrangements commence immediately unless precluded by legal action. Also, MARAD will obtain appraisals of defaulted assets in appropriate cases.
Maritime Administration	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.	Closed – Implemented MARAD informed us that this analysis and appropriate follow-on action will be performed as data becomes available. Due to the low number of project defaults, it is not expected that adequate data will be available on an annual basis.
Maritime Administration	To better implement federal credit reform, MARAD should 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.	Closed – Implemented MARAD worked with the OST Budget Office and the President's Office of Management and Budget to develop new elements for estimating each project's subsidy, which reflect historical results under Federal Credit Reform. MARAD will review and revise as necessary its documentation process for cash flow assumptions.
Maritime Administration	To better implement federal credit reform, MARAD should 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.	Closed – Implemented MARAD informed us that it will incorporate and document each project's latest financial review into the re-estimate process together with any changes in market condition.
Maritime Administration	To better implement federal credit reform, MARAD should review its risk category system to ensure that it appropriately classifies projects into subdivisions that are relatively homogenous in cost, give the facts known at the time of designation, and that risks and changes to risks are reflected in annual reestimates.	Closed – Implemented MARAD worked with the OST Budget Office and the President's Office of Management and Budget to develop new elements for estimating each project's subsidy, which reflect historical results under Federal Credit Reform. MARAD will review and revise as necessary its documentation process for cash flow assumptions. The elements developed include risk categorization.
Maritime Administration	To better implement federal credit reform, MARAD should 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.	Closed – Implemented MARAD worked with the OST Budget Office and OMB to develop new elements for estimating each project's subsidy, which reflect historical results under Federal Credit Reform. MARAD plans to review and revise as necessary its documentation process for cash flow assumptions. The elements developed include recognition of the concentration of guaranteed amounts with a single borrower.
Maritime Administration	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 consider the human capital needs to improve and strengthen credit reform data collection and analyses.	Closed – Not Implemented Jean Mckeever, Associate Administrator, MARAD, stated that they were working with a contrator on a MARAD-wide human capital effort. (March 8, 2004)
Office of Management and Budget	To assist and ensure that MARAD better implements credit reform, and given the questionableness of MARAD's estimates and reestimates, the Director of Office of Management and Budget should provide greater review and oversight of MARAD's subsidy cost estimates and reestimates.	Closed – Implemented OMB disagreed with GAO's finding that it provided little review and oversight of MARAD's subsidy cost estimates and reestimates. However, OMB stated that it plans to work with MARAD to review recovery expectations for high risk loan guarantees. The Associate Administrator said that MARAD was working with OMB and DOT/Budget on credit risk analysis. (March 8, 2004)

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Financial managementMerchant marineShipyardsNoncomplianceFederal lawRisk managementLoan guaranteesGovernment subsidiesPrivate sectorFinancial statements