OCC Updates Lending Guidance for 1st Time in 18 Years, Expands ERM Policy Recommendations


Think about where you were 18 years ago. It was 1995—the year that Yahoo! surfaced as the first search engine service and eBay was founded. Bill Clinton was President, Toy Story was released on the big screen and Braveheart took home the Oscar for Best Picture. Much has happened since then—and the banking industry is certainly no exception.

Now, five years to the month since the financial crisis arrived with the implosion of Lehman Brothers—the list of regulations and guidance documents hitting lenders continues to grow. Tens of thousands of pages of regulations in the wake of the downturn have already been written with tens of thousands more still to come. The latest document released is from the Office of the Comptroller of the Currency (OCC). On August 20, 2013, the OCC issued the “Commercial Real Estate Lending” booklet of the Comptroller’s Handbook. The new document supersedes the OCC’s “Commercial Real Estate and Construction Lending” booklet issued in 1995. In several notable ways, the guidance on environmental risk, in particular, brings the OCC’s document more in line with the FDIC’s approach to risk management (The OCC also has a detailed section of the guidance dedicated to Appraisals and Evaluations that will be addressed in a future EDR Insight brief.) For instance, the approaches of both regulators now emphasize a tiered approach to environmental due diligence (giving special attention to the U.S. EPA’s All Appropriate Inquiries rule), a reliance on professionals with adequate training and experience in environmental risk, property monitoring over the course of a loan and maintaining adequate loan documentation. For a number of important reasons, this new OCC guidance is worth paying attention to—especially for risk managers at institutions that are under OCC supervision.

Scope of OCC’s Environmental Guidance Expands

When you consider the statutory and regulatory developments that have occurred in the past 18 years, it is not surprising that the 2013 document significantly expands the scope of the OCC’s 1995 guidance. One topic that expanded considerably is that of environmental risk management. The OCC now has a much more detailed and comprehensive approach for building a program that effectively addresses the risks posed by property contamination in commercial real estate lending.

“What I found interesting in this new publication is that it now contains specific language in a separate section pertaining to environmental risk management, whereas the previous 1995 document devoted much less attention to environmental due diligence,” says Andrew Luzod, Real Estate Risk Groups, Fifth Third Bank. “This clearly is another example of the added regulatory requirements that banks today are expected to comply with—and can expect to be audited for—going forward.” The document also includes an extensive questionnaire to be used by bank examiners in assessing the robustness of an institution’s policy for managing all types of risk, including environmental risk.

Mapping Out An Effective Environmental Program

After a detailed discussion of the financial and legal liability that environmental contamination may have on a bank extending credit on property loans, the OCC recommends that a “bank’s loan policy should establish a program for assessing the potential adverse effect of environmental contamination and ensure appropriate controls to limit the bank’s exposure to environmental liability associated with real estate taken as collateral.” How do banks do that? The OCC guidance tells banks they should address the 18 elements shown in the accompanying text box.

On the subject of a Phase I environmental site assessment, in particular, the OCC draws attention to the U.S. EPA’s All Appropriate Inquiry Final Rule (AAI), issued in 2006, which established standards for due diligence for the purposes of CERCLA liability protection.The AAI rule recognized as acceptable protocol the widely-used ASTM E 1527-05 Phase I ESA standard practice. Recognizing that lenders have an exemption from CERCLA liability, the OCC does acknowledge that “an AAI-compliant study can provide the best assessment of a property’s environmental condition, potential liability for a borrower, and disposition strategies upon foreclosure.”


It is worth noting that #12 in the list of elements that form an effective environmental policy, the OCC is expressly telling banks to include “appraisal requirements for disclosing and taking into consideration any environmental risk factors.” This requirement creates challenges, particularly at community banks that do not have appraisal expertise on staff. Environmental risk managers may not be comfortable putting appraisers in the position of taking property contamination into account when appraising a property, yet the new guidance is directing banks to incorporate an element into their policies that requires the appraisal process to account for any known environmental risk factors. This is just one of several developments that are ramping up the pressure on banks to strengthen their oversight of the appraisal process and how it relates to a bank’s overall risk management function. Ultimately, the end result could be more of an interaction between the environmental risk management and appraisal functions at institutions or at least more direction on how information about environmental risk should be treated by appraisers and communicated to the bank’s environmental experts.

How Will OCC Examiners Assess Compliance?

The entire document spans 128 pages, and in addition to environmental risk, the OCC provides guidance in the areas of appraisals/evaluations, real estate lending standards, development/construction lending, file documentation, CRE concentrations of credit and more. At the end of the document, the OCC lays out the structure of a 127-question Internal Control Questionnaire (ICQ) to be used by an examiner when assessing a bank’s internal controls.
Banks should ensure that their environmental policies are sufficient to stand up to the scrutiny of the following questions from the OCC ICQ regarding how the bank is addressing environmental concerns/considerations in its commercial real estate lending:


In addition to the ICQ, Appendix A of the OCC handbook contains a matrix titled “Quantity of Credit Risk Indicators” which gives examiners a tool for evaluating specific indicators when assessing the effect of CRE lending activities on a bank’s credit risk (low, medium or high risk). The indicators specific to environmental risk management are as follows:


Bottom Line

Since the release of the document in August, the OCC has been making clear its intent to ensure that banks meet their regulatory responsibilities in the aftermath of the financial crisis. At a regulatory symposium this week in Washington, DC, Comptroller of the Currency Thomas Curry announced plans to issue new “heightened expectations” guidelines, emphasizing the following:

“[The OCC is] “insisting that internal controls and audit be raised to the standard of ‘strong’ and we are making it clear that ‘satisfactory ratings’ are not acceptable.”(Comptroller Thomas Curry)

In the latest evidence of how seriously the OCC is taking its mission, it just shut down the largest institution to be closed in over three years—the $3.1 billion First National Bank (Edinburg, TX).


Safety and Soundness in Commercial Real Estate Lending. The cover of the updated OCC guidance says it all. And OCC headlines of late are making it clear that the regulators are serious about ensuring that the banks the OCC regulates are adhering to sound risk management policies and practices in accordance with guidance. Is your ERM policy keeping your institution as safe as it can be? Does your ERM policy reflect sound lending practices? Does the policy reflect the best practices of similar-size institutions?