Top 10 FAQ on Lender Policy Development
Risk managers at financial institutions are dealing with a slew of new regulations (with more to come), and increased attention from examiners on all aspects of risk management in property lending. As a result, risk management policies are receiving more scrutiny, and many lenders are updating their current environmental policies or creating their first ones. In doing so, they want to ensure that the policies are up to par with applicable guidance—and with industry benchmarks.
Below are the 10 most common questions (and answers) that lenders are asking as they create or update their environmental risk management policies.
1. What are other banks doing?
If you do not currently have an environmental policy or are just looking for guidance while updating, take a look at this sample policy matrix to get you started. It lays out the construct of a policy matrix that establishes different requirements for new originations (non-SBA), SBA loans and refis by property type and loan amount. It is common for institutions—particularly large institutions with long-standing policies–to use this type of a tiered approach to environmental due diligence that prescribes appropriate levels of investigation based on perceived risk.
2. Is my policy too stringent? Or too lax?
The right level of environmental due diligence for any given situation (i.e., origination, refi, foreclosure, bank property acquisition, etc.) will depend on a number of different factors, including risk tolerance, the size of the transaction/loan, your loan portfolio, property type, whether the loan will be sold to the secondary market, whether it is an SBA loan and perceived property risk based on former and current property uses.
3. Do you have a sample environmental policy?
We do! Based on the feedback EDR has received from many of the lenders we work with, we have created this sample Environmental Policy. Many risk managers have used this sample as a starting point for designing a policy that is in line with their own institution’s risk tolerance, experience, focus and asset size. In addition to this type of decision tree for determining the level of due diligence warranted, other common elements in lender policies include:
- sections that specifically address environmental professional qualifications,
- monitoring requirements over the course of a loan,
- whether to adopt the U.S. SBA’s policy for other types of loans,
- consideration of vapor migration risk, and
- training requirements.
4. What are some guidance documents that are valuable in building policy?
- A good starting point is the FDIC’s Guidelines for an Environmental Risk Program, which has implications for all types of commercial real estate lenders. In addition to recommending a tiered approach to environmental risk management, the FDIC also recommends that the lender’s environmental risk assessment extend over the life of the loan. Potential environmental concerns, such as changes in business activities at the property, should be monitored. This ties in with the U.S. EPA’s requirement that property owners comply with “continuing obligations” over the course of property ownership in order to preserve the ability to raise a defense under CERCLA.
- Another document that lenders today are using to ensure their policies contain the required elements to satisfy regulators is the August 2013 release from the Office of the Comptroller of the Currency (OCC). The OCC’s new “Commercial Real Estate Lending” booklet of the Comptroller’s Handbook brings the guidance more in line with the FDIC’s approach to risk management. For instance, the 2013 OCC recommendations prescribe 18 specific elements that should be in an effective policy, including a tiered approach to environmental due diligence that gives 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. It is important to note that headlines of late make it clear that the OCC is serious about ensuring that the institutions it regulates are adhering to sound risk management policies and practices in accordance with guidance.
- Lastly, for a good technical read on the basics of environmental risk management, a lender on the West Coast just recommended an OTS bulletin on Environmental Risk and Liability. Although it came out in 1989 and was later rescinded (by a “more vague 2009 replacement”), the bulletin contains a valuable soup-to-nuts discussion of the environmental risks that lenders face in extending credit on commercial properties. For any risk managers who are new to the environmental field (or even those looking for a refresher on the basics), this is a good go-to source not just on environmental risks and critical policy components, but also on the different types of environmental investigations available to a lender.
5. What are the industry NAICS code(s) for current or past property uses associated with high environmental risk?
NAICS codes are used by the U.S. SBA in its environmental guidelines (SOP 50 10 5(e)), which contain a list of environmentally sensitive industries. If you are conducting due diligence on a property for an SBA loan, and the property’s current/past uses are on this NAICS code list, the investigation must start with an AAI-compliant Phase I ESA. On the list are such high-environmental risk uses as oil/gas extraction, many types of manufacturing operations, laboratories and more. Note that the SBA also isolates gasoline stations and dry cleaning for more stringent environmental investigations given the property contamination commonly associated with these types of operations (see Appendix 5 of the SOP for Requirements Pertaining to Gasoline Station Loans and Section H, Special Use Facilities, for the SBA’s requirements for loans on properties used for dry cleaning operations). Also note that the SBA just adopted an updated version of its guidelines. Starting on January 1, 2014, SOP 50 10 5(f) supersedes the previous version (e).
6. What threshold are other lenders using to determine if they need a Phase I ESA?
Determining when to opt for a Phase I ESA depends on the loan type and other factors. Generally speaking, however, most lenders require Phase I ESAs on all loans over $1 million and on high risk properties. Depending on the former property use, your institution’s loan portfolio and your risk tolerance, you can assign different thresholds, or triggers, for Phase I ESAs in your institution’s policy. Likewise, these triggers may also be associated with “red flags” raised when less robust environmental investigations (e.g., transaction screens, desktop screens) reveal something about a property that may warrant further investigation.
7. Is an environmental policy needed for residential properties?
Residential transactions have been long ignored in the arena of environmental due diligence. Regulations regarding environmental screening on residential properties have been on the books for years, but have been ignored by most. Growing attention is now being devoted to consumer protection and this is bringing regulations designed to protect borrowers to the forefront. As such, lenders should review their environmental policies and make sure they are in line with applicable guidance. For a comprehensive source of information on the potential liabilities for various stakeholders and the agencies and organizations that require environmental screening specifically for residential properties, check out the Summary Report: Land Contamination and Residential Properties Summit. This landmark document was created from discussions initiated at the Land Contamination and Residential Properties Summit hosted by EDR in 2012 with attendees that included attorneys, appraisers, bankers and representatives from HUD, Freddie Mac and the U.S. EPA.
8. How do I know if my Environmental Professional is qualified?
When choosing an Environmental Professional (EP) to work with your institution, you want to be sure you are choosing a professional with the appropriate education, experience and training. The U.S. EPA’s All Appropriate Inquiries rule has established a widely-used set of specific requirements that are a good starting point to determine if your EP is qualified. In addition, you’ll want to verify that the consultant has relevant experience, reputable credentials, and can provide a sample and references.
9. How long are Phase I ESA reports good for?
The AAI rule assigns a one-year shelf life from the date of purchase to environmental investigations, although certain components (e.g., site visit, interviews, government records review, etc.) require an update after 180 days.
10. When does the new ASTM 1527-13 standard for Phase I ESAs take effect?
ASTM expects to publish the -13 revisions to the E 1527 standard in early November. Shortly thereafter, the U.S. EPA will issue its final rule recognizing the new current practice as an acceptable protocol for meeting AAI for the purposes of CERCLA liability protection. At this point, under ASTM bylaws, the E 1527-05 standard becomes a “historical standard,” and E 1527-13 becomes the most recent, active standard. For more on the latest status, read EDR’s blog on the five take-aways from our Oct. 1st webinar with Julie Kilgore and Bill Weissman. And for more on what lenders are doing to prepare for the transition over to E 1527-13, read our blog post: Five Things You Need to Know About the New ASTM Phase I ESA Standard (E 1527-13).