Whether due to a growing awareness that property contamination can have a detrimental impact on collateral value, an aversion to risk brought about by today’s uncertain market climate, increasing regulatory pressure or a combination of all three, financial institutions are paying more attention to environmental due diligence. As risk managers consider their institution’s own environmental policy, it is not uncommon for them to wonder:
“How complete is our environmental policy?”
“Is it consistent with what other institutions our size require?”
“Is it too stringent? Not stringent enough?”
“Does our environmental policy comply with regulators’ requirements and expectations?”
“Does our financial institution have a policy to screen for environmental risk on every property?”
1. Roles and Responsibilities
Does your policy clearly define the roles and responsibilities of key individuals? Policies often spell out which business units/groups at the bank must adhere to the policy, who will enforce it, who can approve exceptions (and under what circumstances) and who is responsible for reviewing environmental reports and communicating the results to loan officers and other stakeholders at the bank.
2. Qualifications for Environmental Professionals
Does your policy limit the outsourcing of Phase I environmental site assessments only to those who have the requisite experience, education and training? Many financial institutions adopted the definition of “environmental professional” included in the U.S. EPA All Appropriate Inquiries rule and the ASTM E 1527-05 Standard Practice for Phase I Environmental Site Assessments, while others established their own professional qualifications. The policy should also define who at the bank is responsible for approving individual vendors, and reviewing and maintaining the list over time.
3. Phase I ESA Thresholds
Does your policy define conditions that automatically trigger a Phase I environmental site assessment? In the past, bank policies typically did this by assigning a loan size threshold (“All loans above $1 million require a Phase I ESA.”). Today it is more common for Phase I ESA decisions to also define specific high-risk property uses (e.g., requiring any property once used as a gas station to get a Phase I ESA). The latter is consistent with the approach adopted by the U.S. Small Business Administration policy which requires Phase I ESAs for loans on properties associated with particular NAICS codes. (If your policy references the SBA policy, be sure it is the most recent version 50 10 5 (D) that was released in September 2011.)
4. Transaction Type
Does your policy define which specific transactions require different types of environmental investigations? Most bank policies clearly spell out environmental due diligence requirements for new originations. Others go a step further to define separate requirements that apply to refis, renewals/modifications, property purchases, foreclosures and special assets. Requirements for pre-foreclosure due diligence are often the most stringent, given the liability the bank may be exposed to when taking title to a property under a foreclosure proceeding.
5. Property Type
Does your policy account for differences by property type? Financial institutions often prescribe different levels of environmental investigation based on whether the loan involves an office building, apartment, retail center or industrial facility, and whether it is in an urban, suburban or rural location. Although all real estate, regardless of use, can be affected by environmental issues, an industrial site or manufacturing facility will likely require more environmental scrutiny than a residential home or an office building, especially if the property is in a heavily developed area or its past use is tied to a high-risk operation (e.g., gas station, dry cleaner, automotive shop, etc.).
6. Vapor Migration/Intrusion
Does your bank policy include a section on vapor migration/intrusion? The U.S. EPA defines the evolving pathway of vapor intrusion as the migration of volatile chemicals from the subsurface into overlying buildings. This pathway has been largely ignored for a long time at many sites, but there are a growing number of factors that are driving commercial real estate lenders to include screens of properties for potential vapor migration/intrusion risk in their policies. Lawsuits involving liability created by the migration of vapors from contaminated soil or groundwater are on the rise, more states are adopting vapor intrusion guidance and ASTM is considering revisions to its Phase I ESA standard to address vapor migration risk. Federal agencies, like the U.S. Department of Housing and Urban Development (HUD), now require vapor intrusion screens as part of their environmental policies. Due to these factors, an estimated 40 percent of financial institutions now have policies that address VI, up from 18 percent just three years ago.
7. Property Monitoring
Does your bank monitor the collateral behind commercial real estate loans over time? The latest FDIC guidance recommends that a lender’s environmental risk assessment extend over the life of the loan. This ties in with the requirement that property owners comply with continuing obligations over the course of property ownership to preserve the owner’s ability to qualify for CERCLA liability protections. Although many policies do not address monitoring directly, financial institutions routinely monitor certain properties, much like they do with flood determinations and credit checks. This practice is particularly common on properties behind troubled loans, and involves conducting regular site inspections for any changes in use that may create environmental issues for the financial institution.
8. Planned Property Use
Does your policy account for a borrower’s plans for the property? Environmental due diligence requirements may be more stringent for a property being purchased for redevelopment into a multifamily apartment or a day care facility or school than for a property with no planned change of use. Specific activity or land use limitations, engineering controls or institutional controls may also exist on a particular property that could limit its use.
9. Training Requirements
Does your policy require environmental staff at your institution to undergo routine training on environmental risk? If so, does the policy set the frequency of such training? Two out of every three respondents to EDR Insight’s most recent Benchmarking Survey of Financial Institutions work at financial institutions that do not provide any type of formal environmental risk training. It is much more common for national/international and regional banks to have training provisions in their policies than smaller community banks.
10. Schedule for Policy Updates
Is your policy required to be updated periodically? Most financial institutions review policies annually to ensure that it remains in line with the institution’s risk tolerance, changes in the real estate market and the institution’s own real estate lending practice. Others only require updates every two or three years or in response to some external factor (e.g., a new ASTM E 1527 standard, an update to the SBA’s environmental policy, etc.).
All of the elements and considerations above are vital to a successful environmental policy. However, decisions about each and whether to include individual components need to be tailored to a bank’s own objectives and risk tolerance. Lenders should also have their policies undergo technical review by a qualified environmental consultant and an environmental attorney to ensure that it is protective of the financial institutions’ own liability and current with relevant federal, state and local requirements.
Policies will only be effective if they have the support of senior management, including loan officers, senior credit risk officers and others. For more on how to communicate the value of an environmental policy internally at your financial institution, listen to a replay of our March 28th webinar titled Helping Risk Managers Communicate the Value of Environmental Due Diligence.
EDR Insight wishes to thank Don Grauer and Jon Walker for providing peer review of this Technical Brief.