T-AOT 168 Sealift Pacific Build and Charter
Navy officials, since 1958, had requested procurement funds to purchase new tankers to replace the T-2 tankers. The requests were denied at higher budget review levels within the Navy or DOD because procurement funds were needed for higher priority combatant ship construction programs. The Build and Charter program was designed to meet the need for new tankers without spending procurement funds.
The program contemplated 20 years of fixed, biweekly charter payments (rent) for the exclusive use of nine tankers. Because the money is for rent payments and not for outright purchase, OFM funds can be used. Furthermore, because O&M funds were used, specific line-item congressional approval was not mandatory.
The Navy concluded that each new tanker needed to have a length not greater than 600 feet, a draft of 32 feet, a speed of 16 knots, and a displacement of 25,000 DWT. The specifications of the T-2 tankers scheduled for replacement were: a length of 523 feet, a draft of 30-l/2 feet, a speed of 14 knots, and a displacement of 16,600 DWT. The Navy's reason for this particular size of tanker is that fuel transportation services must be provided to ports too shallow to accommodate the larger size tankers (38,000 DWT and larger).
According to Navy officials, US-flag tankers with the specifications needed by the Navy were not available for long-term charter and, furthermore, new tankers with these specifications are not being built commercially in the United States. Commercial carriers of POL products prefer larger tankers, or super tankers (38,000 to 250,000 DWT), because of lower transportation costs. Tankers of the 25,000 DWT size are available under foreign flags, but the Cargo Preference Act of 1904 requires that all DOD material be shipped under the US flag, if available. If the Navy chartered foreign-flag vessels on a long-term basis, a problem would develop each time a US-flag vessel became available for charter hire. To obtain tankers meeting its specifications, the Navy concluded that new tankers must be built.
On February 12, 1969, after full advertisement and under competitive procedures, the Navy awarded the charter of nine 25,000 DWT tankers to Central Gulf Steamship Corp. The Navy presented the details of this proposed transaction on March 25, 1969, at hearings before the House Committee on Appropriations on fiscal year 1970 appropriations. During the hearings the Navy disclosed that the Central Gulf transaction had been terminated during the prior week because the company that was initially interested could not provide the money at the interest rate quoted in its bid. On February 4, 1971, the Navy again requested proposals for the construction of nine tankers for long-term charter. Fourteen competitors submitted bids, which were analyzed using competitive-award procedures, and the winner of that competition resulted in the Build and Charter agreements.
Before contract award, the prospective contractor and the Navy requested several key rulings from the General Accounting Office [GAO], the Department of Justice, and the Internal Revenue Service. By letter dated December 27, 1971, the prospective contractor's attorney requested GAO's opinion on whether the Navy had all the needed authority to proceed with the charters.
The Navy entered into the Build and Charter program to acquire the use of nine new tankers. On 20 June 1972 the Navy accepted an offer from Marine Transport Lines, Inc.; Citicorp Leasing, Inc. (formerly First National City Leasing, Inc.); and Salomon Brothers to arrange for building and financing nine new tankers to be constructed especially for chartering to the Navy. Private interests were to provide for their construction and financing, with a commitment from the Navy, that it would lease the tankers, with renewal provisions, for 20 years. By renting instead of purchasing, the Navy can apply Operation and Maintenance (OGM) funds which, unlike procurement funds, do not require specific authorization and approval by the Congress.
On June 20, 1972, the Navy entered into a series of principal financing documents for the construction and leasing of nine tankers. The Navy executed contracts with two special-purpose corporations, Marine Ship Leasing Corp. and Marine Vessel Leasing Corp. (Since Marine Transport Lines, Inc., acted as the fiscal agent for the two special-purpose corporations and to simplify discussion of this transaction, Marine Transport can be considered -- for purposes of discussion -- the owner of the tankers.) In essence, the Navy in these contracts, promised to lease the nine tankers when they are built, tested, and delivered. The lease period, with renewal options, was 20 years. The type of lease is called a bareboat charter, which means that only the ship is leased; the Navy is to bear other operating costs for such things as crew, fuel, maintenance, and insurance. The transaction can be divided into three phases: (1) construction (2) delivery and long-term financing, and (3) charter.
Marine Transport executed construction contracts simultaneously with Todd Shipyards Corporation for building four tankers and with Bath Iron Works Corporation for building five tankers. The Navy and the shipbuilders had no direct contractual arrangement. The fixed-price construction contracts' prices are shown in the following table.
Builder Unit Units Total price Bath $16,031,000 5 $ 80,155,OOO Todd $16,595,OOO 4 $ 66,380,OOO Total 9 $146,535,000Since Government progress payments were not available to finance the construction, Marine Transport obtained contruction loans from the interim lenders, the Chase Manhattan Bank (Todd's banker) and the First National City Bank (Bath's banker). The annual interest rate on the construction loans, which was not fixed, was 115 percent of the bank's base rate on 9O-day loans to substantial and responsible commercial borrowers in effect at the opening of the first business day of the calendar quarter when funds are made available.
From time to time, and as needed during the contruction period, Marine Transport borrowed money from the interim lenders and provided it to the shipbuilders as they progress on the construction of the tankers. The interim lenders obtained liens against the tankers until the loans, plus interest, are repaid.
After the construction phase is completed, the ships were delivered to Marine Transport and the previously agreed-to, long-term-financing arrangements become operative. Until the ships were delivered, the total cost cannot be determined. Capitalized costs are fundamental to determining (1) the amount of both borrowed and equity funds to be invested through selling bonds and ownership rights, (2) the amount of the Navy's charter payments, and (3) all other miscellaneous dollar flows related to the Build and Charter program.
When Marine Transport obtaind the tankers in the second half of 1974, it must pay back the money (principal plus interest) it borrowed to make progress payments during the construction phase. The bond purchasers were then called on for 75 percent, or $120 million, of the assumed $160 million capitalized cost and the owner participants are called on for 25 percent, or $40 million, of this amount. The bonds purchased bear 7-7/8 percent interest and are called "First Preferred Fleet Mortgage Bonds." The bond purchasers, 35 institutional investors, receive interest only during the first 10 years after bond purchase. During the second 10 years they will receive interest plus purchase price. In return the owner participants receive a paper loss for tax purposes during the first 13 years due primarily to the rapid depreciation of the ships. This loss, used to offset income from other sources, thereby reduces their tax liability in that year. The net effect is that the owner participants are buying a tax loss, or Marine Transport is selling depreciation expense. The transaction does not allow the companies to avoid paying taxes ; it defers payment of taxes to the later years of the contract. To the owner participant, as a 48-percent taxpayer, every dollar of tax deferral translates into 48 cents of interest-free money which can be reinvested.
When Marine Transport accepted the tankers, they were immediately chartered to the Navy. The Navy paid the charter hire on the fifteenth and last days of each month. The initial charter period was for 5 years with options to renew for three additional 5-year periods. At the end of the 20-year period, the tankers were to be returned. The terms of the contracts prohibit the Navy or any other Government agency from ever purchasing these tankers. This prohibition was needed so that, for income-tax purposes, the transaction could not be considered as a deferred sale to the Government. The Navy's charter payments were structured so that, during the first 10 years, the amount paid is exactly equal to the interest that the owners must pay to the bond purchasers. After the tenth year, the Navy's charter payments are more than double because, during the second lo-year period, principal and interest must be paid to the bond purchasers.
OMB Circular A-94 prescribes the discount rate for evaluating Government decisions concerning the initiation, renewal, or expansion of programs or projects. However, A-94 states that its provisions do not apply to the evaluation of Government decisions concerning the acquisition of commercial-type services. The circular states that guidance for making these decisions is contained in Circular A-76. Circular A-76 prescribes that the yield on long-term Department of the Treasury borrowings be used in evaluating lease-versus-purchase alternatives. This rate, at the time the transaction was entered into, was about 6 percent. Whether leasing or purchasing is the more economical alternative depends upon whether A-94 (10 percent) and A-76 (6 percent) criteria are applied. Under A-76 criteria (6 percent) purchasing would have been the more economical alternative by about $29.6 million. Under A-94 criteria (10 percent) leasing would have been the more economical alternative by about $10.4 million.
The Navy used Circular A-94 and evaluated the lease-versus-purchase decision using a discount rate of 10 percent. Under this criteria, the decision to lease appeared more economical than purchasing by $10.4 million. GAO believed that the A-94 criteria was not appropriate for evaluating the lease-versus-purchase decision and that criteria comparable to that contained in Circular A-76 would have been appropriate. Under A-76 criteria the decision would have been evaluated using the yield on long-term Treasury obligations which was about 6 percent at the time of the Navy's decision to lease, Using a discount rate of 6 percent, the decision to purchase would have been more economical by $29.6 million.
The Navy selected the Build and Charter program, not as the result of a lease versus purchase analysis, but because it could not obtain procurement funds to purchase new tankers and would rather conserve its procurement funds for combatant ships. The Navy analysis of charter payments does not reflect the total cost to the Government because it does not take into account the direct tax effects of this transaction. However, the tax shelter was a key factor in arranging this transaction. The Navy believed that a lease-versus-purchase analysis should not recognize the value of deferred payment of income taxes as a cost. Instead, the Navy considers the only true identifiable cost to the Government to be the charter hire payments.
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