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How Strong Is Your Environmental Risk Policy?
As if there were not enough compliance issues to tackle during these trying times, here is one more: Is your bank’s environmental policy for commercial real estate up to date and does it meet your risk tolerances and the bank’s potential risks due to environmental issues?
The FDIC says, “The potential adverse effect of environmental contamination on the value of real property and the potential for liability under various environmental laws have become important factors in evaluating real estate transactions and making loans secured by real estate. Environmental contamination and liability associated with it may have a significant adverse effect on the value of real estate collateral, which may in certain circumstances cause an insured institution to abandon its right to the collateral.”
“As the economic landscape slowly comes out of the woods, banks have recently seen a rise in loan demand for real estate purchases; there are many buying opportunities for business owners as well as investors,” according to Marianne Plant, vice president-credit administration, senior credit officer at Tradition Bank in Houston, Texas. “As one of the many healthy community banks that made it through the recession, we do not want to make the same mistakes of the banks that are experiencing long, slow recoveries.
“Accordingly, many lenders, such as our community bank, have a much lower risk tolerance and are tightening our due diligence policies to ensure that high-risk contaminated properties do not end up in our loan portfolios,” Plant continued. “We are considering environmental assessments and associated environmental liabilities in the credit and collateral risk evaluations, and providing additional environmental risk training for our lending staff to ensure that we truly understand the environmental issues and risks in the reports that we order, and that risks could be inherent in all property types.”
Many lending institutions have environmental policies but are not sure how to implement their policies effectively. According to the FDIC, “Institutions need to implement an environmental risk program in order to evaluate the potential adverse effect of environmental contamination on the value of real property and the potential environmental liability associated with the real property.”
The main components of a lender’s environmental risk policy should include purpose, policy statement, identification of environmentally sensitive industries, and the environmental evaluation process, including existing loans with environmental exposure, questionnaires and vendor qualifications. Be aware that loan amounts may dictate that your internal policy be more stringent than what a government entity requires or what another lender’s risk policy entails. Therefore, knowing your bank’s risk tolerances and following your policy should result in fewer headaches and trouble-free audits.
“I think in today’s environment, younger bankers do not realize that past uses of properties can also have had historically environmentally sensitive businesses that may not be evident when looking at the property today,” said Buzz Stagg, executive vice president and chief credit officer for Green Bank in Houston. Old buildings may have lead-based paint that could result in liability depending on the property’s use, or asbestos products that may affect remodeling or require a management plan. While these activities with toxic chemicals or products may not have been used in many years, the liability may still be lurking for lenders and their customers.”
As surprising as it seems, not all environmental reports are created equal. Why is this so important? The FDIC says this: “The failure of an institution to evaluate potential environmental risks associated with real property may contribute to an institution’s inability to collect on its loans and affect the institution’s financial condition. It is also possible for an institution to be held directly liable for the environmental cleanup of real property collateral acquired by the institution. The cost of such a cleanup may exceed by many times the amount of the loan made to the borrower.”
Before accepting a report by an environmental consultant that has not been qualified by your institution, it is recommended that, at a minimum, any examinations are conducted by an environmental professional by the EPA’s definition 40 CFR 312 and the reports follow the current ASTM standards and EPA All Appropriate Inquiries rule.
“Over the past several years in banking, I have seen controversies concerning environmental risk topics, such as unimproved land,” according to Plant. “Some lenders do not perceive unimproved land as an environmental risk.
Nevertheless, I have seen environmental issues pertaining to a potential purchase on unimproved acreage in a rural area outside the Houston city limits. The environmental assessment revealed that there was a shooting range adjacent to the subject property that had contaminated a section of the proposed raw land to be purchased, thus requiring a site cleanup.
“Additionally, there were potential stormwater issues and wetland concerns. The present owner of the property was unaware of these circumstances,” said Plant. “Consequently, without an environmental assessment, these risks would not have been identified and the potential owner and customer could have inherited these issues. Going forward, the banking industry should see an increase in environmental due diligence for all types of properties.”
In a big hurry? Heed caution; the EPA is allowed 20 calendar days (per the ASTM standard) to complete the Phase I report and buried somewhere in the fine print from the consultant may be a disclaimer stating that you did not give him enough time to complete proper due diligence. Also, ASTM non-scope considerations (i.e., asbestos, lead based paint) may be erroneously included in the Phase I report and many times without the required licensed/certified individuals making those statements.
“A significant number of loans became troubled during the recession largely due to hard economic times for our borrowers,’’ said Aaron Sessions, environmental officer at Zions First National in Salt Lake City. “We have learned the hard way on a few loans when we didn’t really understand the environmental risk prior to making the loan, but we got the opportunity to understand it very well after making the loan. Environmental risk is a costly and time-consuming problem for financial institutions that we are working hard to minimize in the future.”
Points to Remember
- Know your consultants’ qualifications; review their current licenses, certifications and insurance policies.
- Phase I/Phase II reports should meet or exceed the current ASTM standard and EPA AAI Rule.
- Keep current; understand and follow the bank’s policy for conventional and government-guaranteed loans, foreclosures, etc.
Melanie Edmundson is principal, co-owner, Phase Engineering Inc., environmental consultants based in Houston, Texas. Contact her at melanie(at)phaseengineering.com.
Copyright (c) June 2012 by BankNews Media