By Brett Esber
Anyone planning to build a vessel in a U.S. shipyard, and any U.S. shipyard planning a shipyard improvement project
, should consider using the Title XI program to finance the project. In a nutshell, the Title XI program is a loan guarantee program under which the U.S. Government guarantees bonds issued or a bank loan extended to finance the construction of a vessel in a U.S. shipyard or a U.S. shipyard improvement project. At first glance, the Title XI program looks very attractive. It enables the borrower to borrow more money at a significantly lower interest rate over a much longer period of time. There are, however, significant costs associated with using the Title XI program. So how does one determine whether it makes sense to use Title XI financing for a particular project?
Generally speaking, the Title XI program is right for a particular project if it saves the borrower money over the term of the loan. To make that determination, the borrower should compare the total cash payments (cash at closing plus cash over the life of the loan) under the Title XI financing option to the total cash payments under an alternative financing option (e.g., a conventional bank loan). This comparison should be made on a present value, after tax basis. This may sound complicated at first, but like any financial analysis, it is easier to understand if you first break it down to its component parts.
Breaking it Down
The benefits of the Title XI program as compared to a conventional bank loan are fairly straightforward. They are:
• Lower Interest Rate
The U.S. Government provides a full faith and credit guarantee of principal and interest, essentially removing all credit risk. The interest rate achieved on Title XI financing will vary depending upon the credit market generally at the time of closing, and will typically be priced at 80 to 120 basis points above a Treasury bill having the same average life to maturity. For example, Title XI bonds with a 20-year term and level principal amortization would typically be priced based upon the 10-year Treasury bill.
• Fixed Interest Rate
Title XI bonds offer the option of a fixed interest rate over the term of the bonds, which may be 15, 20 or even 25 years depending upon the economic useful life of the vessel or shipyard improvement to be financed. A commercial bank may offer a fixed rate through an interest rate swap product, but this product will likely not extend beyond a term of 10 years.
• Longer Amortization Period and Term of Loan
Even on long-lived assets such as ships, a commercial bank will typically not extend the term of the loan beyond 12 years. A longer amortization period may be offered, but the balloon resulting at the end of the loan term will need to be refinanced under circumstances that cannot be forecast at the time of the initial financing. In addition, at the time of refinancing, the vessel will be significantly aged, making the bank more conservative with respect to loan-to-value ratio.
• Greater Loan to Value Ratio
(i.e., Ability to Borrow More)
A bank will typically lend up to 80 percent of the fair market value of the vessel at the time of closing. In comparison, a borrower may finance up to 87.5 percent of the Actual Cost (a defined term that includes some costs that banks typically will not finance) of the vessel or shipyard improvement to be financed. For example, Actual Cost can include design and engineering costs, construction period interest, the guarantee fee charged for using the Title XI program (explained below), and other construction related costs.
Those are the benefits; now for the costs. The costs associated with the Title XI program are:
• Filing Fee
A Title XI application must be accompanied by a non-refundable filing fee of $5,000.
• Investigation Fee
The U.S. Maritime Administration ("MarAd"), which administers the Title XI program, charges a fee for reviewing the application. This review includes, among other things, an analysis of the creditworthiness of the borrower and the economic feasibility of the project. For this review, MarAd charges an "investigation fee" in the amount of $50,000 plus 0.125 percent of the amount of the guaranteed obligations (i.e., the amount borrowed) in excess of $10,000,000. On some projects, MarAd may also require a third party review of the application. The cost of this review may either be collected from the investigation fee or imposed as an additional cost on the borrower.
• Guarantee Fee
The guarantee fee is the most significant cost of using the Title XI program. It is essentially an annual fee calculated as a percentage (between ½ percent and 1 percent) of the outstanding principal balance of the guaranteed obligations. The guarantee fee over the life of the loan is calculated at closing based on the borrower's long-term debt to equity ratio at closing and the scheduled debt service on the bonds or loan, and is discounted back to present value using a prescribed discount rate. The resulting guarantee fee is then payable in full at closing, but can be financed (up to 87.5 percent) as part of the Actual Cost of the vessel or shipyard improvement.
• Bond Underwriting Fee
If the borrower issues bonds, an underwriting fee will be payable. The amount of this fee is typically between 0.5 and 1.0 percent of the principal amount of the bonds. The bond underwriting fee cannot be financed.
• Additional Legal and Accounting Fees
The legal and accounting fees associated with a Title XI financing will exceed the fees associated with a conventional bank loan. An estimate of the amount of additional legal and accounting fees must therefore be included in the analysis of the Title XI financing option.
Adding it Up
At this point we know that the Title XI program offers significant benefits but also imposes significant additional costs. The question is, "Do the benefits outweigh the costs?"
Although the fees associated with a Title XI financing are significant, because the most significant fee -- the guarantee fee -- can be financed, and because the borrower can finance more of the Actual Cost of the vessel or shipyard improvement project, the amount of cash required at the time of closing will likely be significantly less when Title XI is used. Consider the following example comparing a Title XI bond financing for a $10,000,000 project to a conventional bank loan for the same project:
Cash Required at or Before Closing
Title XI Bond Financing
Filing Fee $5,000
Investigation Fee 50,000
Non-Financed Portion of Guarantee Fee 81,250
Legal and Accounting Fees 100,000
Bond Underwriting Fee 100,000
Non-Financed Portion of Vessel Purchase Price
Total Cash Required at Closing
for Title XI Bonds $1,586,250
Conventional Bank Loan
Legal and Accounting Fees and Closing Costs 50,000
Non-Financed Portion of Vessel Purchase Price 2,000,000
Total Cash Required at Closing for Bank Loan $2,050,000
Cash Savings at Closing Under Title XI Option $463,750
So far, the Title XI program has saved the borrower $463,750 on a $10,000,000 project; at least as of the closing date. Although the Title XI loan amount will be larger than the conventional bank loan, the interest rate on the Title XI loan will be considerably lower and the term of the loan significantly longer. Will the lower interest rate and longer repayment term offset the higher principal amount? To answer this question, we must compare the aggregate debt service for each type of loan on a present value, after-tax basis.
To compare the debt service payments on the Title XI loan to those on a conventional bank loan on a present value, after-tax basis, the borrower will need to plug the following information into a basic financial model: principal amount, interest rate, amortization period and method (level principal or level debt), loan term, tax rate and discount rate. To make a realistic comparison, the borrower should obtain a term sheet (or at least indicative terms) from its bank indicating the amount and the terms upon which its bank will lend, including the interest rate, amortization period and loan term. As for the Title XI loan, if bonds will be issued, debt service will be paid semi-annually on either a level principal or level debt service basis. An indication of the Title XI interest rate that might be achieved can be obtained from underwriters or attorneys familiar with Title XI financing.
In many cases, the present value of the Title XI debt service after tax will be less than the present value of the debt service after tax on a conventional bank loan. This amount can then be added to the lower cash required at closing to determine the total cash benefit of using the Title XI program.
Considering the Finer Points
If the numbers add up, then it makes sense to consider some of the finer points, such as the affirmative and negative covenants that are imposed in connection with a Title XI financing. Timing is also a consideration. A Title XI application may take up to six months to review and approve, and not all applications are approved.
The Title XI program may offer significant advantages, even to a borrower with a high credit rating and a ready ability to finance a project through its existing bank. The loan to value ratio and ability to finance the guarantee fee and other costs of the project will typically result in considerably less cash required at closing. In many cases, the lower interest rate coupled with the longer loan term will also result in lower debt service payments on a present value after-tax basis over the life of the loan.
About the author
Brett M. Esber, currently a partner at Blank Rome LLP, practices in the areas of international and domestic commercial transactions, corporate law and finance. As a member of the Firm's Marine Transportation Group, Mr. Esber has specialized expertise and experience handling commercial transactions for companies involved in the shipping industry, including shipyards, shipowners and ship operators. He can be contacted at esber@BlankRome.com.