Community Banks engaged in financing non-residential property transactions are familiar with the importance of having thorough due diligence procedures. Your loan officers are experienced in evaluating the potential risks associated with a prospective borrower, and your institution has developed detailed guidelines for evaluating credit worthiness. However, does your bank have an outlined environmental risk management policy that guides your loan officers in evaluating the risks associated with loans for agricultural, commercial and industrial properties? How does a loan officer determine when a Phase I Environmental Site Assessment (ESA) should be performed? Developing a defined environmental policy for your community bank offers guidance for your team members in evaluating the risks associated with certain loans and helps manage your environmental risk while satisfying regulatory requirements.
Since the promulgation of the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) in 1980, the regulatory framework for non-residential real estate loans has allowed for lending institutions to take advantage of the limitation of liability defenses by completing environmental due diligence activities. Banks understand that through the Phase I ESA process, the All Appropriate Inquiries (AAI) requirements can be satisfied and a lender can qualify for liability protections in the event of foreclosure. While a Phase I is an instrument for determining the potential for environmental impairment at a property, the Phase I ESA is not specifically outlined within any regulatory framework. Additionally, protections against liability in the eyes of a regulator do not always translate into protection of the market value of a property. The presence of an environmental concern on a property is generally considered to be a negative stigma that may hinder the sale of the property. Furthermore, long term remediation and monitoring of a property would hinder the use and redevelopment of the property until the environmental concerns are resolved. This encumbrance may also negatively affect the potential sale of the property.
The regulatory climate that has developed during the past few years is a continuing burden to the community banking industry. Regulations promulgated by the FDIC and the Office of the Comptroller of the Currency (OCC) have included detailed guidance to banks, outlining specific elements needed for an operational environmental risk management policy. The OCC has also published a questionnaire that lenders can use to perform an internal evaluation of their environmental policies. Elements of the questionnaire include appraising whether your environmental policy:
• Establishes a process to define the amount of due diligence necessary to be reasonably protective;
• Ensures that the bank recognizes and assesses potential environmental risks associated with the lending services offered;
• Quantifies the potential negative effect of actual environmental contamination on the property value and how that is to be managed in the event of a foreclosure.
Point to Point Environmental has had many discussions with members of the CBA about their concerns surrounding this important issue and would like to provide some suggestions that can assist you with drafting or refining your environmental policy and effectively manage your environmental risk.
A lending institution’s environmental policy needs to be tailored for the types of lending that occurs at the individual bank. The policy framework can begin with a matrix, table or narrative for evaluating the potential risk for the different types of loans. A risk matrix alleviates the need to negotiate the terms of due diligence of every proposed deal, standardizes the practices using a tiered approach, and simplifies communication regarding the phases involved. By using a standardized risk matrix or written narrative you are also eliminating any potential ‘favoritism’ in a simple but direct manner.
An environmental policy should include a Borrower Checklist, Questionnaire or Disclosure Statement. Agricultural, commercial and industrial properties should all have different procedures specifically tailored to those types of properties. Ideally the current owner of the property would complete these checklists so that you are provided with historical information. However, though it is more common that the borrower is willing to assist, it is important that some historical knowledge of the property is provided. Additionally, it is best practice that a loan officer personally visit a property. However, digital photographs which thoroughly cover a property can be sufficient.
Even if you are rarely in need of their services, developing a list of trusted consultants will save time and money when their advice or services are needed. The consultants on your list should be ones that you can trust, having been referred to you by peer bankers who can vouch for the quality of their work. The consultants on your list will preferably have similar approaches to risk management as your bank. Caution should be exercised against choosing the low-price leaders in the consulting industry as the costs savings is often realized in lost quality and lack of attention to detail. There does not need to be any formal arrangement or even a face-to-face relationship in determining which consultants to include on your list. However, you should have a list of reliable consultants so that you are not unduly pressured to work with a firm that is preferred by the parties involved or a ‘friend of the deal’.
An environmental policy should be written in clear and succinct terms so that it can easily be read and understood by others including the Board of Directors, junior loan officers and others that may have no experience with these types of issues. The language utilized in crafting the environmental policy should embody a practical and common sense approach, while also having enough ‘wiggle room’ so that it allows you to follow the spirit of the law rather than the letter of the law. An operable environmental policy should have an escape hatch, trap door or some other process for moving away from a strict interpretation of the environmental requirements. This flexibility should not be confused with a waiver policy. There may not need to be a formal waiver in every instance as frequent waivers can also be perceived as an undue red flag. However, waiver policy language should be crafted so that there is a strict way of identifying a situation when a waiver should be considered, while also requiring an explanation as to the reasons for the waiver.
Especially during our current financial climate that fosters refinancing projects, an environmental policy should codify some methodology for updating prior environmental reports. A Phase I ESA report is generally considered to be effective for up to six months after which it can be simply updated, and wholly redone after one year. However, this does not necessarily need to include performing a fully updated or new Phase I ESA report. A policy that includes utilization of older environmental due diligence measures with a specified update can allow for streamlining the due diligence process while also reducing costs. An environmental professional can perform a Records Search with Risk Assessment (RSRA) for an older Phase I ESA that includes a search of specific government databases and a designation of potential risk. The RSRA also satisfies the SBA loan requirements. In every case, an environmental professional should be consulted as to the risks associated with the reuse of older environmental due diligence investigation report.
A complete environmental policy should be a living document so that it can change with both the regulatory and business climates. As the real estate market continues to mature, there will be more and more challenging properties being evaluated for transactions. Formal written policies can be an effective tool for communicating expectations with your staff, limiting the bank’s liability as well as managing regulatory requirements while adopting industry best practices. An environmental policy should be tailored for the types lending services your bank offers.
Point to Point Environmental can assist you with the analysis of the liabilities associated with your lending services and support the development of your environmental policy. Please call Mark Faas of Point to Point Environmental at (678) 565-4435 to discuss your particular situation.