Appendix C— Making Financing Decisions in the U.S. Shipbuilding Industry

The committee recognizes that several factors could have a greater effect than technology on the competitiveness of the U.S. shipbuilding industry. These factors include financing, subsidies, international reputation, and the inherent difficulty of reentering into the international market. Although the assessment of these factors is beyond the scope of this study, given their importance, the committee has attempted to set this study within their larger context. This appendix briefly describes how financing decisions are made in the shipbuilding industry. This appendix is not intended to be more than an elementary presentation of shipbuilding finance. All shipyard managers certainly understand these basic financial principles and apply them on a daily basis. The important consideration is that a potential shipowner must consider much more than technology when purchasing a ship.

Financing

Terms of available ship financing are often a major factor considered by a potential ship buyer when determining where to place an order, especially when the terms are unique to a particular shipyard or shipbuilding country. In general, three factors define ship financing evaluation and selection: net present value (NPV), cash flow, and collateral requirements.

Net Present Value

To compare financing schemes, the shipowner performs NPV calculations for each alternative, discounting the cash outflow required to pay interest and



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--> Appendix C— Making Financing Decisions in the U.S. Shipbuilding Industry The committee recognizes that several factors could have a greater effect than technology on the competitiveness of the U.S. shipbuilding industry. These factors include financing, subsidies, international reputation, and the inherent difficulty of reentering into the international market. Although the assessment of these factors is beyond the scope of this study, given their importance, the committee has attempted to set this study within their larger context. This appendix briefly describes how financing decisions are made in the shipbuilding industry. This appendix is not intended to be more than an elementary presentation of shipbuilding finance. All shipyard managers certainly understand these basic financial principles and apply them on a daily basis. The important consideration is that a potential shipowner must consider much more than technology when purchasing a ship. Financing Terms of available ship financing are often a major factor considered by a potential ship buyer when determining where to place an order, especially when the terms are unique to a particular shipyard or shipbuilding country. In general, three factors define ship financing evaluation and selection: net present value (NPV), cash flow, and collateral requirements. Net Present Value To compare financing schemes, the shipowner performs NPV calculations for each alternative, discounting the cash outflow required to pay interest and

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--> debt amortization at a rate that reflects the cost of capital or opportunity costs (the rate of return available through other investments). The shipowner will usually consider the alternative with the lowest NPV to be the most favorable. Typically, the lowest NPV is associated with financing that allows the shipowner to borrow the greatest percentage of the price, to be repaid over the longest period of time, at the lowest available interest rate and origination cost. At this time, U.S. Title XI loan guarantees can offer the best terms available worldwide, with loans of up to 87.5 percent of acquisition cost for as long as 25 years at fixed interest rates closely approaching those of U.S. Treasury bonds. It is expected that this competitive advantage will disappear when the recently announced financing agreement of the Organization for Economic Cooperation and Development (OECD) is fully implemented. While at first glance the alternative with the lowest NPV is the best, there are other considerations. Beyond price and delivery, they include interest during construction, owner's supervision and plan review, attendant legal and underwriting costs, and other expenses included in the owner's total acquisition cost (capitalized cost). Cash Flows Cash flow considerations can lead a shipowner to select a financing scheme that does not have the lowest NPV. For example, if all debt repayments are delayed for three years, the shipowner may prefer this alternative (particularly if buying in a "down market"), even though total payments will be greater over time. The owner will consider manner of debt amortization, whether in equal annual principal amounts; "level debt" payments (like a typical home mortgage); or low amortization in the early years with a "balloon" payment at the end of the financing term. Collateral Requirements The collateral required of the shipowner by the lender will also be a major consideration in evaluating financing alternatives. One lender might require detailed financial information on all the owners of a vessel and personal as well as extensive corporate assurances or guarantees. Assignment of revenue streams from charters or other vessel-employment arrangements might also be required. Another lender may be satisfied simply with the ship as collateral for the loan, with few additional requirements. The potential variations and permutations are endless and play an important part in the shipowner's evaluation process. Concluding Comments This appendix has briefly considered a few aspects of ship financing. There are certainly more considerations, including the tax structure of ship financing,

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--> which may affect decisions of U.S. and foreign shipowners. The degree to which foreign governments offer tax incentives for financing ship construction is another consideration in international competitiveness. The ability to offer ship acquisition financing through the Title XI program may offer U.S. yards a significant competitive advantage until the new OECD financing agreement is implemented. Ratification of the OECD agreement is the subject of pending legislation in Congress. Title XI allows the financing of a greater part of the shipowner's capitalized cost for a longer period of time at fixed interest rates lower than are generally available through other international ship financing alternatives.