Robert Szustakowski, The Lotis Engineering Group, PC
Recently at the request of a bank client, I summarized guidance documents published by various banking regulators, that is, the Office of the Comptroller of the Currency (OCC), the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and the Small Business Administration (SBA). Appreciate that I have read and re-read all of these documents numerous times over the years but this was the first time that I had completed some compare and contrast. Further, I found some items that I was not fully aware of in that review.
Here is what I deduced.
Which Ones Apply to My Bank?
All of them? As banks are aware, it is common for items from one agency to be adopted, officially or unofficially, at another agency. My advice is to pay attention to all of the various guidance documents on this subject.
Further, even if you don’t make SBA-secured loans, you should review their guidance document. Unlike the other documents, which are essentially “big picture” ideas, the SBA guidance document is “process.” It provides detailed instruction on how to meet the overarching goals noted in the other documents. And, as you read it, you will likely see many ideas that are within your bank’s environmental SOPs – or should be.
The Federal Reserve published their “Supervisory Letter” on October 11, 1991. [No, this is not a mis-print; the Federal Reserve still references a 25-year-old document.] I don’t know we would consider this the best guidance out there, but they packed a lot in just a few pages of text published two years before the first ASTM Phase I standard. The most important take-aways are likely the following.
Risk Beyond Real Estate – This is likely one of the most common items missing from even the best bank environmental policies. Potential environmental liability goes beyond real estate and the risk can include lending on “manufacturing or transportation equipment” without real property. A great example of this was years ago when I was the environmental risk officer at a very large bank that wanted to take a fleet of truck and associated trailers as collateral. Their business? Transportation of hazardous wastes. My thought is that in the event of the business going under, our collateral would be tanker trailers filled with hazardous wastes; the cost to disposal of their contents would exceed the value of the trailer. Take the trucks, I suggested, but not the trailers.
Varying Levels of Due Diligence – This makes the Federal Reserve one of the earliest entities to recognize that not all properties should be assessed with the same level of due diligence. [See my recent article on this topic posted on LinkedIn.] This was not adopted by the SBA until much later (see below). While the terms did not exist at that time, this was the pre-cursor to such things as Transaction Screens and Desktops. [While this pre-dates the ASTM standards, “Phase I” was already common vernacular in the consulting world at that time.] The document even references in-house reviews of some sort.
Foreclosure Concerns – This guidance post-dates the Fleet Factors case but before the Lender Safe Harbor changes to CERCLA (you “youngins” can look those up) so there was significant concern over lenders acquiring liabilities from your collateral. It was clear that the lender could not manage the borrower’s operations and in-depth environmental review was required prior to foreclosure.
Training and On-Going Monitoring – Again issues overlooked by many lenders. The guidance states that training is required to assure that bank staff understand environmental risks and the bank’s policies to address them. [At my last employer, I developed an on-line course that reviewed the regulations and the bank’s policy requirements. It was a required training of all new RMs and others.] The guidance also discussed monitoring your existing portfolio. [See another recent article I posted on LinkedIn.]
Office of the Comptroller of the Currency
Much has been made within the environmental banking world of the OCC’s “Comptroller’s Handbook, Commercial Real Estate Lending” published in August 2013. The OCC went from a few paragraphs of environmental guidance for lenders in their prior guidance to two full pages of information. It also recognized numerous changes in the industry and regulations since the last guidance.
Bank Policy – The bank must have an environmental policy but the details of the policy are up to the bank. While the guidance references the ASTM and USEPA requirements for a Phase I and All Appropriate Inquiry (AAI), it also allows the level of due diligence to vary based on the nature of the property, including use of in-house assessments. Further, it states that the policy must be consistent with the lending practices of the bank; the OCC would not expect a national lender to have the same policy as a community bank. The OCC states that the policy must be reviewed by the bank’s board of directors (or designated committed) annually, an item often overlooked.
Consultants and Report Reviews – The bank can complete due diligence through a combination of both in-house staff and outside consultants. Third party consultants are to be monitored (I interpret as grading consultant’s reports and confirmation that liability insurance remains in-place). It also states that reports prepared for the bank must be “evaluated” and the person evaluating the report must “possess relevant knowledge, skill competence” to do so. That would suggest that an RM would typically not be the one to “evaluate” a report. [Like an appraiser reviewing an appraisal, a environmental professional reviewing a Phase I will see many things that an RM will not.] Also, guidance states that these reports should be provided to the appraiser if there may be an item that can impact value.
Monitoring and Foreclosure – Again, properties must be monitored during life of loan, you cannot participate in the management of the property and due diligence is required prior to foreclosure.
Non-ASTM Issues – The definition of a recognized environmental condition (REC) is limited by ASTM. Two items, asbestos and lead-based paint, are specifically identified by the OCC as items that should be considered in your reports. Depending on the nature of the property, this may have to be expanded to include wetlands, vapor intrusion and other items.
Federal Deposit Insurance Corporation
The FDIC issued a “Financial Institution Letter” in November 2006 that summarized what they feel is appropriate for a lender’s environmental program. You will note many similarities with the OCC guidance, including its focus on real estate.
Policy – Again, the board of directors must approve the environmental policy. That policy must include training and must be consistent with the lending practices of the lender. [For example, if you provide oil and gas (O&G) lending, your policy should address the unique environmental liabilities associated with that industry. You should consider whether such an operation should be subject to a regulatory compliance audit, to assess the risk of other liabilities to your borrower other than CERCLA.]
Staff -The guidance states that the board must designate a “senior officer knowledgeable in environmental matters responsible for program implementation.” This is often the chief appraiser, who likely is not “knowledgeable” in environmental matters.
Level of Effort – While acknowledging the use of ASTM Phase I reports and EPA’s AAI, the text is clear that use of outside staff is not required on every deal.
Monitoring – Again, you have to monitor your collateral.
Small Business Administration
The SBA provides the most regular updates to their policies, and just updated their “Lender and Development Company Loan Programs” (SOP 50 10 5(I)) on January 1, 2017. As noted above, this is an SOP, not a policy document. However, some of the same themes as above can be seen in this document.
Level of Effort – This document goes beyond suggesting the need for varying level of effort for varying property types. It specifically outlines what that level of effort should be [in their opinion for SBA-backed deals] based on the North American Industry Classification System (NAICS) code of the property. [While I find their process a bit short sighted, it’s a good start and most lenders’ programs start the same way.]
Consultants – The document discusses further choosing consultants and the need for professional liability insurance.
Dealing with Contamination – Methods of how you can close on an environmentally impacted property are detailed. While the SBA does not have a reputation for allowing such closings on a regular basis, their discussion can provide a bank direction and suggestions for their own policies.
All summed up, from the lenders’ perspective, here are likely the most significant points to consider for your environmental process.
Policy – You must have a written policy specific to your organization’s lending practices, it must be approved and annually reviewed by the board of directors, and there must be a knowledgeable “senior officer” responsible for its implementation. You must be able to document that you followed your policy, whatever it says, during an examination.
Level of Effort – You should vary your level of effort for environmental due diligence based on the specifics of the transaction. You can use both in-house staff and third parties to complete the due diligence but the third parties must be monitored and their products evaluated by a knowledgeable person before making a lending decision based upon them.
Beyond the Standard – Beyond ASTM and AAI, you should consider other liabilities associated with real estate not included in the standards. Further, you should look at potential environmental issues unrelated to real estate when devising your environmental policy.
Pre-Foreclosure – Don’t participate in management or foreclose without appropriate environmental due diligence.
Monitoring – You must monitor your portfolio, especially those environmentally risky properties.
About the Author
Bob Szustakowski has been completed environmental due diligence for lenders, as a consultant and an in-house environmental risk manager, for 30 years. He has devised and implemented environmental programs for various lenders, including one of the largest banks in the world.