Robert Szustakowski, The Lotis Engineering Group, PC

Virtually every commercial lender has their own policy regarding environmental due diligence. While there are some basic guidelines provided by the SBA, the FDIC, the OCC, etc., each lender is to determine the appropriate level of environmental due diligence based on their risk tolerance, nature of their lending, etc. However, it is apparent that many lenders, especially those without on-staff environmental professionals, lean toward the “one size fits all” kind of approach.

After 30 years of working with banks on policy, due diligence, vendor management, etc., I’d like to share some thoughts to consider for your environmental due diligence (EDD) program.

The Low End Cutoff

Most lenders have a “low end,” below which no environmental due diligence is required. Typically, the larger the bank, the higher the cutoff. Large banks often do nothing below a $1MM mortgage; some go even higher.

My advice is don’t set this any lower than what you are willing to walk away from. That is to say, if you set your cutoff at $500M, be prepared to walk away from that $500M collateral. There are literally thousands of properties out there valued under $500M where on-site environmental issues exceed value. It’s amazing the number of former automotive repair facilities, gasoline stations, printers, dry cleaners and other environmentally sensitive operations are out there valued at under $100M. And if your environmental policy does not assess low value properties, you just brought into portfolio a property that you would not foreclose upon. In other words, you have no collateral.

This is not to say that you need to do ASTM Phase I environmental site assessments on every property. No; that’s a waste. But you should do SOMETHING beyond an environmental questionnaire (EQ); these are often completed by people who know nothing of the historical use of the site. All an EQ does is make the bank feel better but provides next to no information.

Determining Level of Effort for EDD

Most banks have a two-pronged system for assessing level of effort for EDD – loan amount and current site use (often identified by the NAICS code). This is actually based on the Small Business Administration’s system for determining the required level of effort for SBA loans. If the value is low and the current use is not environmentally sensitive, do an EQ. As values go up, maybe go to a Desktop, then a Transaction Screen and at some value, a Phase I. If it’s environmentally sensitive, start with the Transaction Screen or Phase I. For some uses (i.e., dry cleaners and gasoline stations), the SBA automatically requires further assessment immediately.

My suggestion is to re-think all of this. That $150M apartment building had a gasoline station in its parking lot. That $300M strip plaza had a dry cleaner in it for years. The dental office was a gasoline station. The vacant lot was an industrial operation. These are not fictitious events but based on my three decades of work in this industry. Experience suggests an old gasoline station cleanup can easily go into the hundreds of thousands of dollars; the dry cleaner cleanup can go into the millions. If these properties make their way to Special Assets, and you then do your appropriate due diligence, you learn that what you thought was collateral has a negative worth.
On the other extreme are the high value properties. Appreciate that an ASTM Phase I environmental site assessment is unlikely to identify any more issues at an apartment building than a consultant-prepared thorough Transaction Screen will. [Note that I said a consultant prepared Transaction Screen; the basic screen provides minimal information.] It does not matter whether you are lending $500M or $5MM. Again, it’s current and historic use, not value, that should control level of effort.
Now, before I hear about “what about AAI and my protections?” You are a bank, not a purchaser. Heading to foreclosure? YES! Do a full Phase I; you want all of the protections you can get. But until that time, the purpose of your due diligence is not purchase but lending. Collect sufficient information to make a lending decision. Your needs are different from that of a purchaser and at that time, you are not looking for AAI protections.

Lastly, remember the law of diminishing returns. You get a LOT of good information on the Desktop or Transaction Screen level. You do a Phase I and you get a little bit more. A Phase II may provide more but of a very specific nature. But keep the property value, strength of the borrower, the LTV, etc., in mind as you continue to spend the borrower’s money. Case in point. Large regional health care borrower looking at $45MM for one of many owned senior housing facilities, a 40-acre property. Phase I comes back with a “ghost” tank, a 550-gallon fuel oil tank was installed. No idea on location; no idea on status. I suggested that we make the borrower aware of it and understand that when/if ever found, it has to be addressed but holding up a $45MM deal for a potential $50M problem made no sense.

In comes a co-lender with their own outside consultant. The sky is falling. The tank could have leaked. Contamination possible. We need a geophysical survey. We need a Phase II. After spending $17M of the borrower’s money, and finding nothing, we finally close. One unhappy borrower. And he still must address the tank when/if encountered in the future.

What are the Levels of Effort?

Most banks use Transaction Screens and Phase I assessments. You need to assess when you use each. If you are a national bank that does not touch anything below $5MM and you require a Phase I on every project, that’s fine and it makes sense in your lending environment. If you are a community bank making many sub-$1MM deals, such an EDD program would price you out of the market as the borrower “competitively bids” their banking needs.

Many banks also use some sort of “Desktop” studies, similar to the SBA’s Record Search and Risk Assessment (RSRA), for low-end deals that are not believed to be environmentally sensitive. This level of study generally consists of a regulatory database search consistent with an ASTM Phase I, plus some level of historical research. [The SBA does not stipulate the extent of the historical research but leaves that up to the author of the RSRA.] This information is then reviewed by an Environmental Professional (EP) and a report provided. The level of information obtained by a good Desktop (which should include an EQ, more than one historical source and an on-line search of municipal records) is amazing. But, even at $350 or so, in some deals and in some geographic areas, this may not be acceptable.

What about the $100M commercial mortgage? We recommend what we call a “Limited Environmental Review” which includes review of an EQ and a review of limited regulatory information. Review of on-line historic sources may also be included with a brief report authored by an EP. It is amazing the number of gasoline stations, dry cleaners, repair facilities, etc., that are identified in this level of study. While it certainly will not identify every potential issue, it is a far cry better than just an EQ. And at about $150, you don’t get the “borrower backlash” when you require it.

Avoiding Perceived Conflicts of Interest

I have completed such a variety of studies for numerous banks, either as a bank employee or their consultant, for my 30 years. And there is always one complaint by the borrowers as well as the RMs: it would appear that it is in the best interest of the consultant completing a Desktop-level study to say it must be “elevated” to a Transaction Screen or Phase I. After all, why wouldn’t the consultant want to complete the more complex, and expensive, study? Further, many banks do not have the internal staff qualified to make their own judgement on the true necessity to pursue further study and must rely on that outside consultant.

My solution? The firm doing your “internal” stuff (i.e., Desktops and the like) does NOT do any Transaction Screen, Phase I or Phase II work for you. While you may want to contract that firm to review reports provided by other firms (federal banking guidelines state that an experienced person review environmental reports being used in a lending decision), there is no longer that perceived conflict of interest.


If you are a bank that makes smaller commercial mortgages, don’t overlook your environmental due diligence. There are inexpensive ways to provide significant more information than an EQ. Consider that if you cannot foreclose and must walk away from a single $100M property due environmental issues, that lost money would have funded to over 650 low level studies to avoid ever taking that property as collateral.

About the Author

Bob has been completing environmental due diligence for lenders for 30 years. He has developed and managed environmental programs, as a consultant and bank employee, for some of the largest and smallest banks in the country. He has also devised bank programs for construction monitoring and routine property inspections.