Streamlining and Simplifying US Government Guaranteed Vessel Financing
The Maritime Administration (MARAD) has taken several steps to streamline and simplify the Federal Ship Financing Program under Chapter 537 of Title 46 of the U.S. Code (commonly referred to as Title XI). The Title XI program provides for a full faith and credit guarantee by the United States government to promote the growth and modernization of the U.S. merchant marine and U.S. shipyards. The Title XI Program supports U.S. shipowners obtaining new vessels from, or reconstructing and reconditioning vessels in, U.S. shipyards. It also aids U.S. shipyards in modernizing their facilities, including floating drydocks, barges or vessels used for vessel construction, reconstruction or repair. The Title XI Program offers longer repayment terms and lower interest rates than those offered by banks and private credit markets.
The most significant change is that Title XI financing is now provided by the Federal Financing Bank (FFB), a body corporate and instrumentality of the United States. The FFB is authorized, under the Federal Financing Bank Act of 1973 (12 U.S.C. § 2281 et seq.), to purchase any obligation that is issued, sold, or guaranteed by an agency of the United States. FFB and the Maritime Administrator have entered into a Program Financing Agreement setting forth the commitment of FFB to enter into agreements to purchase Notes issued by shipowners and shipyards when those Notes have been guaranteed by the United States. Each Note is issued pursuant to a Note Purchase Agreement and is a future advance promissory note payable to the FFB.
A tremendous benefit of the FFB is that the bank makes funds available to guaranteed borrowers at a rate lower than what the borrower would likely receive in private credit markets. The basic interest rate applicable to each advance of funds made by the FFB under a particular Note (Advance) is established at the time that the respective Advance is made and is equal to a spread over the current average yield on outstanding marketable obligations of the United States of comparable maturity, as determined by the Treasury. At the request of a guarantor agency, the FFB may charge a fixed spread if doing so will provide significant benefits to the guarantee program. In most Title XI cases, the interest rate is fixed. However, with restrictions, MARAD has occasionally approved floating interest rates. In no case will a rate be less than a comparable Treasury rate.
For each Advance, a borrower must select the level debt service payments method (equal payments of principal and interest) or the equal principal payments method. MARAD usually requires amortization in equal payments of principal. However, level debt payments may be allowed if MARAD finds that there is sufficient security.
The FFB also offers borrowers a choice of prepayment privileges on terms consistent with the protection of the bank and the Treasury from financial loss. Funds advanced by FFB are subject to elective prepayments in whole or in part based upon the Market Value/Prepayment Refinancing Privilege and the Par Prepayment/Refinancing Privilege in accordance the Note and the Note Purchase Agreement. The choice of prepayment privileges is selected at the time of each Advance, subject to terms acceptable to the Administrator.
The Market Value/Prepayment Refinancing Privilege will allow a borrower to repurchase its loan at any time at a price equal to the market value (as determined by the Treasury) of the unpaid payment obligations on the loan through its maturity. The Par Prepayment/Refinancing Privilege will allow a borrower to prepay its loan after an agreed-upon no call period (No-Call Period), with no premium. The No-Call Period may be either a 5-year No-Call Period or a 10-year No-Call Period. In the event that the borrower selects the Par Prepayment/Refinancing Privilege, the interest rate for the Advance shall also include a fee (expressed in terms of a basis point increment to the applicable basic interest rate).
The allowance of any refinancing of Advances is at the sole discretion of the Administrator. Any such elective prepayments or refinancing of Advances shall result in a corresponding reduction or refinancing of the outstanding amount of the Administrator’s Note.
If allowed by the Administrator, the borrower may elect to refinance the entire principal amount of any Advance or to refinance the Note in its entirety. The refinancing price is determined as follows:
(A) the installment (if any) of principal that is due on the particular payment date that the borrower specified to be the intended refinancing date;
(B) all unpaid interest (and late charges, if any) accrued on such Advance through the intended refinancing date; and
(C) the amount of the premium (if any) that is required under the particular prepayment/refinancing privilege that applies to such Advance.
Additional refinancing may be made as set forth in the Note Purchase Agreement. The opportunity to refinance is a departure from the prior Title XI structure where bondholder consent was required and often difficult to obtain. One major roadblock was often the inability to even identify the ultimate holders of the Title XI debt due to the use of Cede & Co. as the holder of global obligation(s).
With the involvement of the FFB, the role of the indenture trustee in Title XI transactions has been eliminated. Thus, there is no longer a requirement for a Trust Indenture where the trustee’s primary roles are to collect and forward payments and to make a demand under the Government’s guarantee in the event of a payment default. Similarly, the role of the Depository Trust Company (DTC) has been eliminated as there are no longer global obligations.
Another benefit of the FFB is the impact on the calculation of the amount of subsidy that MARAD must set aside from available funds for each guarantee under the Federal Credit Reform Act (FCRA). Under the FCRA, appropriations to cover the estimated costs of a project must be obtained prior to the issuance of any letter commitments for debt guarantees. According to the MARAD website as last updated September 15, 2020:
The approximate subsidy available for Title XI is $35.4 million, as of June 2020. As of June 2020, loan guarantees based on the average risk for projects MARAD previously guaranteed could support approximately $432 million in loan guarantees. This guarantee estimate is based on the following assumptions: (i) financing provided by the Federal Financing Bank (FFB), (ii) 25-year maturity, (iii) MARAD’s historical recovery rate, (iv) the interest rate set at the Treasury rate which achieves a zero-financing subsidy, and (v) MARAD’s historical average upfront fee.
The above amount could be impacted, however, if the President’s Fiscal Year (FY) 2021 budget proposal is enacted. The President’s budget proposes to rescind $27.9 million in MARAD’s Title XI budget authority. Similar Title XI rescission proposals have failed in the past, including as recently as FY 2017, and it is reasonable to anticipate that Congressional appropriators will not support the President’s proposal.
Use of the FFB lowers the government’s risk by eliminating private bondholders. In addition, it changes the manner in which loan guarantees are scored by the Office of Management and Budget for budgetary purposes. The aggregate result is that – depending on the borrower’s profile – significantly less (or even zero) subsidy may be required for the issuance of a loan guarantee. Accordingly, MARAD’s available subsidy may support far more loan guarantees than would have been previously possible.
In addition to these changes, MARAD has made an effort to decrease the historically voluminous documentation of a Title XI transaction by working with outside legal counsel to establish documentation that aligns (somewhat) more closely to commercial lending practices. The new form of Consolidated Agreement includes Annex A (Information Specific to the Shipowner, the Affiliate Guarantor and the Guarantee Transaction) and Annex C (General Terms and Conditions). Annex A, as its name suggests, sets forth requirements specific to the transaction (e.g., Qualifying Financial Covenants, the Late Charges Reserve Subfund Deposit, Interest Escrow Fund Deposit, and Mandatory Progress Payment Threshold (discussed below)). Annex C sets forth general terms and combines the prior forms of the Commitment to Guarantee, the Security Agreement, the Escrow Agreement, the Chapter 537 Reserve Fund and Financial Agreement, and the Depository Agreement into one document. As mentioned above, the Trust Indenture has been eliminated. Many concepts of the Trust Indenture are now in the Note Payment Agreement. Provisions have also been added to allow documents to be executed electronically, which will hopefully remove the necessity of in-person closings.
While the program’s standard requirements remain in place (e.g., qualifying financial covenants, negative covenants, security requirements (including mortgages, and assignments of earnings and insurance), shipyard consents, affiliate guarantees, equity interest subordination agreements, financial reporting requirements, legal opinions, etc.), there are also a few new features. For example, in addition to the Chapter 537 Reserve Fund, the Maritime Administration has provided specific provisions for the Late Charges Reserve Subfund, the No-Call Prepayment Fund, and the Interest Escrow Fund. While these funds are described below, MARAD may tailor them depending on the financial strength of the borrower.
The Chapter 537 Reserve Fund is the equivalent of the old Title XI Reserve Fund and Financial Agreement. A deposit is required into the Chapter 537 Reserve Fund unless the shipowner is, at the close of its fiscal year, in compliance with all of its Qualifying Financial Covenants (i.e., working capital, net worth, and long term debt to net worth ratio as set forth in Annex A of the Consolidated Agreement) or the amount in the Chapter 537 Reserve Fund is equal to or in excess of fifty percent (50%) of the outstanding advance of funds by FFB. As with past practice, a deposit is still required if there is an existing default. A shipowner can still use a Capital Construction Fund (CCF) in lieu of Chapter 537 Reserve Fund if the shipowner agrees that the CCF will be added as security to the United States. Notably, CCF withdrawals may be applied only for the acquisition, construction or reconstruction of vessels operated in the U.S. foreign, Great Lakes, noncontiguous domestic, or short sea transportation trade, so this may not be a viable option for some Jones Act operators.
The Late Charges Reserve Subfund is a subfund of the Chapter 537 Reserve Fund and the shipowner must deposit a set Late Charges Reserve Subfund Deposit into this fund which is held and disbursed by the Administrator to pay any late charges (e.g., interest, default interest or late payment premiums or penalties). At any time that the amount in the Late Charges Reserve Subfund is less than the greater of (a) the Late Charges Reserve Subfund Deposit required by Annex A of the Consolidated Agreement, or (b) an amount determined by the Administrator to be sufficient to cover thirty (30) days of hypothetical late charges based upon a daily rate selected by the Administrator, then, upon notice of such deficiency, the shipowner must immediately make any additional deposit of cash into the Late Charges Reserve Subfund.
The “No-Call Prepayment Fund” means the account to be utilized by the Administrator to pay scheduled debt payments with respect to Prepaid No-Call Advances. A “No-Call Advance” means any outstanding Advance that may not be prepaid in full without premium or penalty until the end of the “No-Call Period”. This fund will be used in cases where the principal amount of the outstanding Advances is in excess of the amount eligible for guarantee by the United States (usually 75% to 87½% of the project’s actual cost), there is a loss event for a vessel financed with outstanding No-Call Advances, or where a vessel subject to a No-Call Advance is sold.
The Interest Escrow Fund is the account utilized by the Administrator to pay interest on the Note. The Shipowner must deposit into the Interest Escrow Fund an amount equal to the Interest Escrow Fund Deposit, which will be an amount equal to six months’ interest on the Note, assuming the maximum principal amount of the Note has been advanced by FFB, unless such requirement is waived by the Administrator.
If at the end of any fiscal year, the shipowner’s net income attributable to the operation of the Vessels for such year calculated in accordance with Annex C of the Consolidated Agreement (Reserve Fund Net Income) exceeds the Mandatory Progress Prepayment Threshold set forth in Annex A of the Consolidated Agreement, then the shipowner must on demand from the Administrator immediately prepare and deliver to FFB and the Administrator a Mandatory Prepayment Election Notice (indicating the shipowner’s irrevocable intent to prepay the Advances or any portion of the Advances in an amount equal to the Mandatory Progress Prepayment Amount on the intended payment date. If a Mandatory Progress Prepayment is required: (a) the shipowner shall only apply such prepayment to those Unrestricted Advances (i.e., an Advance not subject to a No-Call Period) that will not result in the incurrence of a prepayment penalty or premium upon prepayment of such Advance; and (b) if such Mandatory Progress Prepayment Amount exceeds the amount of those outstanding Unrestricted Advances that will not result in the incurrence of a prepayment penalty or premium upon prepayment of such Advances, then the Mandatory Progress Prepayment Amount will be reduced to the amount of such outstanding Unrestricted Advances. The obligations of the shipowner to make a Mandatory Progress Prepayment (unless waived) are in addition to its obligations under the Chapter 537 Reserve Fund (including the Late Charges Subfund).
While the application process is still onerous and program fees remain (including application, investigation, independent analysis and guarantee fees) and while MARAD has added many provisions to strengthen its security position, it appears that the agency has made a substantial effort to streamline the process and documentation for a Title XI closing once an application is approved. The use of the FFB also has the benefit of avoiding private credit markets, eliminating the Indenture Trustee (and DTC), making the holder easy to identify, and, finally, obtaining an interest rate set at the Treasury rate which hopefully will continue to achieve a zero-financing subsidy. Finally, as a recent Title XI transaction shows, many of the provisions described above may be tailored (or even waived) to fit the particular circumstances of the borrower as long as MARAD determines that the agency is adequately protected.