The sentiment at last week’s Mortgage Bankers Association Convention in San Diego was one of looking forward to growth in lending on commercial properties, much more than looking backwards as was the case at the events of the past few years. Lender panels at EDR’s Due Diligence at Dawn workshops in 11 cities this fall and winter echoed the same mindset of transitioning from workouts and foreclosures to organic growth in new originations. As loan activity slowly ramps up, what are some of the top challenges that environmental risk managers face? The results might surprise you.
EDR Insight’s 4Q12 Quarterly Benchmarking Survey of Financial Institutions asked risk managers at financial institutions across the country this question:
On a scale of 1 to 5, indicate how challenging each of the following is to risk management at your institution (1=not a challenge to 5=very challenging):
- Balancing risk management with pressure to stay competitive
- Doing more with smaller risk management staff
- Pressure to cut costs
- Complying with changing environmental regulations
- Stringent pressure from bank regulators
- Meeting fast turnaround time pressures internally
- Lack of education on environmental risk internally in the context of overall lending process
- Understanding environmental reports and making decisions based on findings
Staying Competitive and Efficient
As shown in the accompanying graph, at the top of the ranking with a weighted average score of 3.3 is “balancing risk management with pressure to stay competitive,” followed closely by “meeting fast turnaround time pressures internally” (3.0). These two challenges are closely related.
Competitive pressures among lenders are heating up with higher demand for property loans. Banks are competing for a limited pool of creditworthy buyers on low-risk properties. It can be a real problem if a national bank is requiring a Phase I ESA on a loan application while the community bank up the street does not. Being able to effectively justify those costs with customers is critical.
As competition for loans intensifies, financial institutions are challenged to manage environmental risk exposure without adding significantly to the time and cost of the loan origination process. As one respondent noted, “Our risk management division is very conservative so they love asking for more information. This is a huge challenge as it often delays the process and creates frustration.” Getting environmental due diligence completed quickly (challenge #2) therefore becomes that much more important.
Financial institutions need to demonstrate to regulators and other stakeholders that they are managing risk and doing thorough environmental investigations, but efficiency is also critical. In today’s market of high risk aversion/high competition for new loans, lenders cannot always allow more time for a higher level of investigation. One issue raised by a risk manager panelist at EDR’s Boston DDD workshop last week is that “Back in 2007 and before, the environmental and appraisal would typically be ordered together. Now, the bank is not always comfortable with where values are and comparables are not always reliable, so the appraisal is getting pushed forward first to help get our hands around the value. This can compress the timeframe for getting the environmental element completed—sometimes to as short as 2 weeks—so we can close.”
Doing More With Less
Challenge number 3, doing more with smaller risk management staff (2.9), is another theme that surfaced consistently with the lender panels at the 11 DDDs EDR held during the fall/winter. At institutions large and small, risk management staff reductions during the downturn have not been replaced, or may have been replaced with less experience staff. Now, their volume of work is increasing as originations tick back up, but the staff has not yet been built up. For some, this means a greater reliance on outside environmental professionals to meet due diligence needs. As one survey respondent commented: “It gets more and more challenging to maintain our superior level of environmental risk management for the corporation with only 2 full time risk analysts. In the last 4 years more and more of our R/E collateral analysis has led to additional due diligence which requires even more time to analyze. We are maxed out with personnel.”
Regulations and Education
Challenges 4 and 5 relate to the need to stay current on the changing landscape of environmental regulations, and a lack of awareness about environmental risk management in the context of lending internally at the bank. It is critical for there to be an institution-wide understanding of the importance of environmental due diligence, the types of issues that come up, how they might impact bank liability, how to communicate the value of due diligence up the chain and ultimately, minimize the institution’s liability exposure. The reality is that environmental due diligence is important, but only in the context of getting loans done, so it becomes important—and challenging—to bridge the gap between the borrower and credit or loan officers to explain why due diligence is important but need not hold up the business of lending. To meet this challenge, some risk managers are focused on internal education efforts to help foster a better understanding of technical environmental issues and to ensure that loan officers understand the value and its importance in the lending process.
Pressure to Cut Costs
Ranking 6th is pressure to cut costs, which is key today. Small community banks are under intense pressure from investors to cut costs. The situation is not all that different at larger banks. As one environmental risk manager from one of the largest institutions in the country told a DDD audience last fall, “If I go back to my higher ups to show I got the job done, but cut costs, I look like a hero.”
So although the market’s improving, the challenges are significant: stay competitive, meet aggressive lending goals, do more with less staff and manage environmental risk in a cautious and fragile market. In 2013, competition, as one respondent observed, “will be keen, making it difficult to balance with risk management with the need to stay competitive.” Challenging times, indeed.