Shipyard Use of MARAD’s CCF Vessel Leasing & CCF Sinking Funds

1. ALL ABOUT MARINE Conference & Expo SHIPYARDS TRACK & JONES ACT TRACK SHIPYARD USE OF MARAD’s CCF VESSEL LEASING & CCF SINKING FUNDS September 4, 2014 Beau Rivage Resort & Casino Biloxi, MSH. Clayton Cook, Jr., Counsel Seward & Kissel LLP

2. SHIPYARD USE OF MARAD’s CCF VESSEL LEASING & CCF SINKING FUNDS INTRODUCTION & MARAD’s CCF ___________________________ SHIPYARD CCFs Vessel sale and lease profits and investment income use for working capital, construction financing and lease equity SHIPYARD CCFs Your shipyard, NASSCO, SUN Shipbuilding and AKER SHIPYARD CCFs Problems and solutions ____________________________ VESSEL LEASING & CCF SINKING FUNDS MERCHANT MARINE ACT of 1970 & Burmah LNG Transaction DUAL USE VESSELS & CCF SINKING FUNDS ____________________________ CONCLUDING THOUGHTS

3. INTRODUCTION & MARAD’s CCF The Merchant Marine Act of 1970 authorized a Capital Construction Fund tax deferral program (the CCF Program) administered by the Maritime Administration (MARAD) through contract agreements with U.S. citizen vessel owners.

4. INTRODUCTION & MARAD’s CCF The CCF Program allows a ship owner or operator, or a shipyard, to defer payment of federal (and in most instances state) income taxes on the profits from vessel operations or vessel sales and vessel leasing, and on associated investment income. 4

5. INTRODUCTION & MARAD’s CCF The CCF Program provides what is in effect an interest free loan of the money that would otherwise be paid to settle current taxes . . . in exchange for the promise to use this money for the construction of vessels for operation in . . . U.S. foreign, U.S. non-contiguous, Great Lakes, U.S. offshore, and since 2007, U.S. “short sea” qualifying trades.

6. INTRODUCTION & MARAD’s CCF MARAD opened the CCF Program for shipyard use in 1988 with the award of a MARAD CCF Program contract to National Steel & Shipbuilding Company (NASSCO). NASSCO is a CCF Program participant today with a significant CCF Program working capital fund of tax deferred monies for use by NASSCO in the construction of vessels for qualifying trades.

7. SHIPYARD CCFs The CCF tax deferral is accomplished under the terms of a CCF Program contract (CCF Agreement) between MARAD and the U.S. citizen shipyard participant (Participant).

8. SHIPYARD CCFs MARAD will approve a list of vessels that are under construction or are contemplated for construction (Agreement Vessels and Qualified Agreement Vessels) and the U.S. government will agree to defer the tax on the profit of the sale or lease of the approved vessels.

9. SHIPYARD CCFs The shipyard will then be able to use this money as working capital for the construction of Qualified Agreement Vessels for the shipyard’s account, or to provide customer construction period financing, or for shipyard equity for vessel leasing of new Qualified Agreement Vessels for service in qualifying trades.

10. SHIPYARD CCFs When a Qualified Agreement Vessel is built with CCF tax deferred money and is sold, the shipyard’s cost basis will be reduced by the measure of the CCF tax deferred money used, and the shipyard’s profit will be increased by this amount, but the shipyard’s tax on this this increased profit can be deferred by the deposit of this profit under the shipyard CCF Agreement. Let’s look at three examples of shipyard CCF use.

11. SHIPYARD CCFs YOUR SHIPYARD NASSCO SUN SHIPBUILDING & DRYDOCK AKER PHILDELPHIA

12. SHIPYARD CCFs PROBLEMS AND SOLUTIONS MARAD regulations that class OSV non-U.S. operations as nonqualified services subject to penalty charges, 46 CFR 390.5 (c)(7)(iii)(A) and (B) and (c)(8), can be addressed and resolved in a MARAD, DOT and ACUS assisted rulemaking.

13. SHIPYARD CCFs PROBLEMS AND SOLUTIONS The 1986 Code 26 U.S.C. 56 (c)(2) alternative minimum tax (AMT) treatment of CCF deposits and earnings as AMT preference items for “C” corporations must be addressed in a legislative initiative, possibly in combination with action on the harbor maintenance tax (HMT) and tonnage tax problems.

14. VESSEL LEASING & CCF SINKING FUNDS MERCHANT MARINE ACT of 1970 & BURMAH LNG DUAL USE VESSELS & CCF SINKING FUNDS

15. MERCHANT MARINE ACT of 1970 & BURMAH LNG MARAD’s 1970 Act program ushered in the most successful peacetime decade of U.S. shipyard vessel construction in U.S. history. Had there been a Blue Ribbon Award for the most precedent shattering project completed under the MARAD 1970 Act program, its recipients would almost certainly have been a U.S. citizen group who were the successful responders to a world-wide request for proposals for a 20 year services contract for the transportation of LNG from Indonesia to Japan.

16. MERCHANT MARINE ACT 1970 & BURMAH LNG However, no such award existed or was given. And there has never been a public explanation of how a little known U.S. operator could have been awarded such a $1.2 billion transportation agreement in an international competition, using vessels build in a U.S. shipyard without subsidy, to be operated without subsidy under U.S. flag by U.S. citizen maritime union crews, in what has come to be termed the MARAD “Burmah LNG“ transaction. How was this Burmah LNG transaction success achieved?

17. DUAL USE VESSELS & CCF SINKING FUNDS The concept of the dual use vessel is as old as the Republic itself and was incorporated in the Merchant Marine Acts of 1920, 1936 and 1970. “It is the policy of the United States that . . . the United States Navy and the merchant marine of the United States should work closely together to promote the maximum integration of the total seapower forces of the United States.” 46 U.S.C. 51101

18. DUAL USE VESSELS & CCF SINKING FUNDS DUAL USE VESSELS & AMERICA’S MARINE HIGHWAYS NATIONAL SHIPBUILDING RESEARCH PROGRAM 2007 & 2008 WORKSHOPS The Navy’s current Dual Use Vessel (DUV) program was initiated in 2005. Reacting to operator concerns about U.S. shipyard prices, the Navy held National Shipbuilding Research Program (NSRP) Workshops in 2007 and 2008 to address ways the shipyard costs of Jones Act DUVs could be reduced.

19. DUAL USE VESSELS & CCF SINKING FUNDS DUVs & AMERICAN’S MARINE HIGHWAYS NSRP 2007 & 2008 WORKSHOPS The 2007 Workshop examined methods for reducing shipyard costs and the anticipated follow-on reductions in shipyard sales prices. But, of course, it would be the vessel purchaser’s “fully financed cost”, rather than the shipyard sales price, that would be used to test the vessel owner’s business plan.

20. DUAL USE VESSELS & CCF SINKING FUNDS DUVs & AMERICA’S MARINE HIGHWAYS NSRP 2007 & 2008 WORKSHOPS A study of commercially available financing alternatives and of MARAD Title XI and CCF Program use was undertaken to provide a “cost-of-financing” presentation for the 2008 NSRP Workshop.

21. DUAL USE VESSELS & CCF SINKING FUNDS DUVS & AMERICA’S MARINE HIGHWAYS NSRP 2007 & 2008 WORKSHOPS The study examined the full range of commercially available Jones Act vessel financing options, and then turned to an analysis of the Burmah LNG transaction and a to variety of Title XI and CCF Program structures.

22. DUAL USE VESSELS & CCF SINKING FUNDS DUVS & AMERICA’S MARINE HIGHWAYS NSRP 2007 & 2008 WORKSHOPS The study confirmed that when the MARAD Title XI and CCF Programs were used together, additional equity could be deposited in the CCF program account, and when that equity was invested in high interest rate receivables, with income compounded tax sheltered over a 20 year term, the income produced, when combined with the additional equity, could be sufficient to retire the entire Title XI debt.

23. DUAL USE VESSELS & CCF SINKING FUNDS DUVs & AMERICA’S MARINE HIGHWAYS NSRP 2007 & 2008 WORKSHOPS The study suggested that the Burmah LNG owner-lessor CitiCorp Leasing had deposited additional CCF equity at the transaction inception, that was invested CitiBank consumer credit card high yield receivables, with income compounded tax sheltered over the Title XI 20 year term, and had created a pool of earnings, that when combined with this additional equity, had been sufficient to retire the entire CitiCorp Leasing Title XI debt.

24. DUV VESSELS & CCF SINKING FUNDS DUVs & AMERICA’S MARINE HIGHWAYS NSRP 2007 & 2008 WORKSHOPS So, because the Title XI debt was retired from this independent sinking fund source, there was no need for a debt component in the CitiCorp Leasing demise hire. And, the CitiCorp Leasing owner-lessor had thus been able to offer a discounted demise rate to the Energy Transportation Corporation U.S. operator, such that Energy was able to respond with a lowest cost winning figure for the Indonesia to Japan RFP.

25. DUV VESSELS & CCF SINKING FUNDS DUVs & AMERICA’S MARINE HIGHWAYS NSRP 2007 & 2008 WORKSHOPS So, perhaps the Burmah LNG success was explained in this fashion. Our Burmah LNG puzzle solved, the problem remained of how to apply this knowledge to resolve the our 2008 NSRP problem assignment of reducing Jones Act vessel costs for the DUV program.

26. DUAL USE VESSELS & CCF SINKING FUNDS DUVs & AMERICA’S MARINE HIGHWAYS NSRP 2007 & 2008 WORKSHOPS The next step was to develop a CCF software benefits model with sufficient sophistication and accuracy that could be used to make the computations necessary for use in DUV Jones Act vessel financing transactions.

27. DUAL USE VESSELS & CCF SINKING FUNDS DUVs & AMERICA’S MARINE HIGHWAYS NSRP 2007 & 2008 WORKSHOPS . While a variety of post Burmah LNG prior attempts, including one or more MARAD efforts, had apparently failed in creating such a CCF benefits model and providing examples of its application, we were successful. And we submitted our report and its examples to the DUV Program leadership on March 23, 2009.

28. DUAL USE VESSELS & CCF SINKING FUNDS DUVs & AMERICAN’S MARINE HIGHWAYS NSRP 2007 & 2008 WORKSHOPS The examples on the two slides that follow were done shortly after our March 2009 submission using our then NSRP CCF model. The DUV/AMH Ro/Ro being discussed had a shipyard price of $150 million.

29. DUAL USE VESSELS & CCF SINKING FUNDS DUVs & AMERICAN’S MARINE HIGHWAYS NSRP 2007 & 2008 WORKSHOPS The first slide shows a DUV/AMH Ro/Ro vessel with a $150 million shipyard price as financed with the MARAD Title XI Program alone, and the second slide shows this same Ro/Ro vessel as financed with the addition of the CCF Program sinking fund.

30. DUAL USE VESSELS & CCF SINKING FUNDS EXAMPLE NO. 1, TABLE 1, MARAD TITLE XI FINANCING 1. Shipyard Price $150,000,000 2. Total Title XI MARAD “Capitalized Cost” $159,631,891 3. Title XI Coupon Rate 3.01% 4. Effective Corporate Tax Rate 35.00% 5. Total Title XI Equity & Interest Payments $61,338,274 6. Total Title XI Fixed Principal Payments $134,885,432 7. Total Title XI Debt & Equity Cash Cost $198,773,706 Method of Debt Financing: Title XI, fixed principal, 80 percent of capitalized cost, 20 year term, level principal payments.

31. DUAL USE VESSELS & CCF SINKING FUNDS EXAMPLE No. 1, TABLE 2, TITLE XI & CCF FINANCING • Shipyard Price $150,000,000 2. Total Title XI Equity & Interest Payments $62,868,274 3. Total Title XI Fixed Principal Payments $134,885,432 4. Total Title XI Debt & Equity Cash Cost $198,773,706 5. Yield on CCF Investments 13.01% 6. Total Title XI Equity & Interest Payments $61,388,274 7. Total CCF Contributions & Taxes on Withdrawals $60,951,346 8. Total Cash Cost of Vessel with Title XI & CCF $123,939,620 9. CCF Savings over Title XI alone (37.55 percent) $74,634,086

32. DUAL USE VESSELS & CCF SINKING FUNDS DUVs & AMERICA’S MARINE HIGHWAY’S NSRP 2007 & 2008 Workshops You will see that for this $150 million Ro/Ro vessel, the fully financed cost would be $198.8 million with Title XI Program financing, and $123.9 million using Title XI with the addition of the CCF Program sinking fund. The next slide provides a graphical representation of the vessel owner’s CCF Program transaction sinking fund account deposits and withdrawals for a typical CCF sinking fund financing.

33. $40,000,000 $35,000,000 $30,000,000 $25,000,000 $20,000,000 $15,000,000 $10,000,000 $5,000,000 $0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Term of Debt Financing (Years) DUAL USE VESSELS & CCF SINKING FUNDS

34. DUAL USE VESSELS & CCF SINKING FUNDS We were required to develop our computer software for this 2008 NSRP work to complete our financing study comparisons and so that the CCF Program benefits could be measured with the precision necessary for use in the Navy’s DUV Program vessel financing. This 2008 NSRP software and its methodology were vetted and confirmed as satisfactory for DUV Program use by MIT Professor Henry C. Marcus in connection with his U.S. Navy DUV consultation contract.

35. DUAL USE VESSELS & CCF SINKING FUNDS While the 2008 NSRP software has not yet been commercially employed, it has obvious commercial applications. U.S. Patent No. US 8,010,431 B 1, “System and Method for Financing Vessels”, which protects this software usage, was issued on August 30, 2011.

36. DUAL USE VESSELS & CCF SINKING FUNDS 2008 NSRP FOLLOW ON FINANCING STUDIES In follow-on work with a U.S. shipyard in 2010, we were asked to run examples of a “fully financed cost” for a $300 million Turbine Installation Vessel (“TIV”) for use in U.S. East Coast offshore wind projects --- using this MARAD program financing structure that we had developed for the 2008 NSRP Workshop. 36

37. DUAL USE VESSELS & CCF SINKING FUNDS 2008 NSRP FOLLOW ON FINANCING STUDIES We found that by using this MARAD financing structure, the purchaser would have be able to reduce its TIV fully financed cost (equity+debt+interest) for the $300 million TIV from $438,370,562 (which it would have been in a simple Title XI financing) to $270,161,987 (which it would have been once CCF use was added) achieving a savings of $168,208,575 or 38.37 percent. 37

38. DUAL USE VESSELS & CCF SINKNG FUNDS EXAMPLE No. 2, TABLE 1, MARAD TITLE XI FINANCING 1. Shipyard Price $300,000,000 2. Total Title XI Capitalized Cost $315,740,839 3 Title XI Coupon Rate 4.16% 4. Effective Corporate Tax Rate 35.00% 5. Total Title XI Equity & Interest Payments $162,097,327 6. Total Title XI Fixed Principal Payments $276,273,234 7. Total Title XI Debt & Equity Cash Cost $438,370,562 Method of Debt Financing: Title XI, 80 percent of capitalized cost, fixed principal, 20 year term, level principal payments. 38

39. DUAL USE VESSELS & CCF SINKING FUNDS EXAMPLE No. 2, TABLE 2, MARAD TITLE XI & CCF FINANCING 1. Shipyard Price $300,000,000 2. Total Title XI Fixed Principal Payments $276,273,234 3. Total Title XI Debt & Equity Cash Cost $438,370,562 4. Total Title XI Equity & Interest Payments $162,097,327 5. Interest Rate on CCF portfolio investments 18.00% 6. Total CCF Contributions & Taxes on Withdrawals $108,064,660 7. Total Cash Cost of Vessel with Title XI & CCF $270,161,987 8. CCF Savings over Title XI alone (38.37%) $168,208,575 39

40. DUAL USE VESSELS & CCF SINKING FUNDS 2008 NSRP FOLLOW ON FINANCING STUDIES While the measure of CCF benefits will vary from one situation to another and depend upon factors that include the portfolio yields and tax situations of the individual vessel owner, we believe that cost reductions in excess of 40 per cent in vessel fully financed vessel costs can sometimes be achieved with these CCF sinking fund structures.

41. CONCLUDING THOUGHTS SHIPYARD USE OF MARAD’s CCF Any shipyard that has a substantial portion of its work in the construction of vessels for qualifying trades should analyze the benefits that would accompany the shipyard’s use of the CCF Program. Any shipyard that has enrolled in the CCF Program should analyze the benefits of employing CCF sinking fund leasing as a means of providing an alternative to its vessel sale offerings.

42. CONCLUDING THOUGHTS VESSEL LEASING & CCF SINKING FUNDS MARAD 46 CFR 390.8 regulations now authorize receivables investment programs similar to those used in the Burmah LNG transaction. Some number of U.S. vessel owners must be achieving these CCF sinking fund savings now. Shipyards, ship owners and actual and potential owner-lessors involved in the construction or ownership of CCF Program qualifying vessels should be investigating the use of the MARAD CCF program and CCF sinking funds in their operations.

43. SHIPYARD USE OF MARAD’s CCF VESSEL LEASING & CCF SINKING FUNDS Memorandum, “Shipyard CCF Program Use”, Seward & Kissel LLP, dated September 2014 United States Patent, Cook, Jr, et al. “System and Method for Financing Vessels”, US 8,010,431 B 1, dated August 30, 2011 MARINE MONEY International, “Financing Jones Act Vessel Assets”, H. C. Cook and P. E. Ogle, May 2010 Memorandum to Navy DUV Program Chair, Jonathan D. Kaskin, et al., “Reducing Vessel Costs with MARAD Program Financing”, from H. C. Cook and P. E. Ogle, dated March 23, 2008

44. SHIPYARD USE OF MARAD’s CCF VESSEL LEASING & CCF SINKING FUNDS THANK YOU ______________________________________________________ ADDITIONAL INFORMATION: For background and follow-on reading you may wish to refer to Mr. Cook’s “Financing With the Maritime Administration’s Capital Construction Fund,” MARINE MONEY International, October 2007, and his coauthored “Financing Jones Act Vessel Assets,” MARINE MONEY International, May 2010.