Aversion to environmental risk by commercial real estate lenders continues to be elevated in today’s highly uncertain economic climate, although the recent tightening of environmental due diligence standards eased in the latest quarter. The EDR Insight Environmental Risk Aversion Index, a measure of the extent to which financial institutions are tightening or relaxing environmental due diligence, normalized in the latest quarter after several quarters of steady tightening. In periods of high risk aversion, lenders are asking more questions about what specific environmental issues mean and, in a growing number of cases, requiring more investigation or even testing to eliminate unknowns.
Ernst & Young: Make Risk Management “Everyone’s Business”
A stronger emphasis on risk management coincides with a recent Ernst & Young survey of major financial institutions. Their study concluded that the lending industry is still responding to the financial crisis, noting that improving risk management policies is a “work in progress.” Perhaps not surprisingly, their latest survey, Ernst & Young’s 3rd since the start of the financial crisis, showed that attention to building a strong risk culture has remained high for those financial institutions most affected by the downturn with 53% of respondents reporting a “significant increase in attention” to risk over the past 12 months.
EDR Insight Risk Aversion Index
Like the Ernst & Young study, the EDR Insight Environmental Risk Aversion Index tracks how lenders’ attitudes toward risk are changing in response to market conditions. Based on quarterly survey data from lenders, as well as from the environmental consultants who serve them, the index has historically correlated very well with broader market trends. For instance, hope in late 2010 turned into optimism by the start of 2011 as a number of key economic indicators signaled that the general economy and commercial real estate were finding a foothold from which to build a recovery. Amidst signs that the market was finally improving, lenders and investors were bullish about deal making in the new year and risk aversion relaxed, as reflected in a downturn in the index. Then, mid-2011 market unrest, debt problems in Europe, disappointing economic barometers here in U.S. and problems in the CMBS market injected a lack of confidence into the market and resulted in many industry players scaling back their forecast for the remainder of 2011. Wary lenders responded by tightening their environmental underwriting, a trend that continued through 1Q12.