Bill Tryon is GRS Group’s Director of Technical Quality
(707) 780-8187
[email protected]
In August, 2013, the OCC released a Comptroller’s Handbook to provide guidance to bank examiners and bankers concerning safety and soundness in commercial real estate lending. Among other things, the handbook provides details concerning the nature and extent of environmental due diligence and risk management programs that should be implemented by banks involved in commercial real estate lending.
“Environmental contamination may negatively affect the value of real property collateral as well as create potential liability for the bank under various environmental laws. Therefore, the 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.”
Lenders can be exempt from direct liabilities for contamination, but this exemption does not protect from a decline in the value of contaminated real estate, or assure repayment of the debt by the borrower.
“For these reasons, a bank should perform an evaluation of the borrower’s or tenant’s business activities and any property taken as collateral before funding a loan and before taking title in satisfaction of debt. The evaluation should be commensurate with the risk of loss that collateral contamination or borrower liability poses to the bank.”
The handbook identifies key elements which should be considered or included in adopting an environmental risk management program. I’ve re-grouped the elements below for the sake of clarity.
Overview
- Develop policies and procedures that reflect potential environmental risks associated with lending in markets and to industries served by the bank. Procedures should clearly specify the bank’s requirements for determining potential environmental concerns
- Consider cleanup liability as well as impacts on the value of collateral and the borrower’s ability to repay debt resulting from contamination or the presence of hazardous building material such as asbestos and lead-based paint
- Include an analysis of current applicable environmental laws and due diligence requirements for borrowers and the bank
- Reflect the level and nature of the bank’s real estate lending activities, its risk profile (that is, the liquidity and profitability of the bank)
- Reflect adequate consideration of the EPA’s AAI rule
- Be reviewed and approved with its lending policies annually by the bank’s board of directors or a designated committee of the board
- Provide a level of due diligence internally required in all real estate loan transactions
- Establish risk thresholds based on property type, use and loan amount for determining when and what type of due diligence is required
- Utilize varying due diligence methods depending on the type of loan, the amount of the loan and the risk category, including borrower questionnaire or screening, site visit, government records review, historical records review, testing or inspections using qualified professionals
- Describe criteria for determining the circumstances in which the bank would normally decline loan requests based on environmental factors
Procedures
- Provide a level of due diligence internally required in all real estate loan transactions
- Include guidelines that the lending staff should follow in conducting an initial analysis of potential environmental impact
- Specify the circumstances in which a more detailed environmental assessment, such as an AAI-compliant evaluation, should be conducted by a qualified professional
- Provide for the receipt and evaluation of environmental risk assessment reports before the bank’s final commitment to lend on a transaction
- Comply with appraisal requirements for disclosing and taking into consideration any environmental risk factors
Underwriting
- Specify requirements for determining potential environmental concerns; for example, include guidelines that the lending staff should follow in conducting an initial analysis of potential environmental impact
- Establish criteria for evaluating environmental risk factors and costs in the loan approval process
- Establish a means of evaluating potential environmental liability risk and environmental factors that could impact the ability to recover loan funds in the event of a foreclosure
Documentation
- Provide guidelines for loan documentation that protect the bank from environmental liability and related losses. Loan documentation should ensure that contractual provisions, including rights of access, are sufficient to facilitate AAI-compliant evaluations
- Assure the inclusion of environmental provisions for incorporation into transaction documentation
- for commitment letters: indicate the extent of due diligence required, borrower costs, approval contingencies, reporting obligations, documentation requirements, etc
- for loan documentation: include representations and warranties, inspection requirements, reporting requirements, lien covenants, indemnification provisions, and provisions allowing for the acceleration of the loan, refusal to extend funds under a line of credit, or exercise other remedies in the event of foreclosure
Controls
- Ensure that persons responsible for evaluating environmental risk possess relevant knowledge, skill, and competence
- Specify selection criteria to evaluate and monitor the performance of third-party professionals, such as environmental experts or legal counsel, who may be consulted to assess environmental risk
Servicing
- Guidelines for maintaining lender liability exemptions, avoiding owner/operator liability, and for qualifying for Landowner Liability Protections under CERCLA and AAI if the bank acquires ownership of the property
- Provide guidelines that the lending staff should follow for monitoring potential environmental concerns for the duration of loans held in the bank’s loan portfolio, focusing on business activities that might result in an increased risk of environmental contamination
- Collateral monitoring and periodic inspection requirements throughout the loan term for properties with higher environmental risk
- Establish procedures for assessing environmental concerns associated with assets before acquisition by the bank in workout or foreclosures as well as the bank’s investment in real estate assets for its own use*
* Note that this last provision extends environmental due diligence beyond lending activities.