Robert Szustakowski, The Lotis Engineering Group, PC
In August, 2013, the Office of the Comptroller of the Currency (OCC) issued their most recent Comptroller’s Handbook for Commercial Real Estate (CRE). Much attention has been paid to the changes made by the OCC related to environmental risk, construction risk, etc. However, a lesser discussed item has been the need for regular post-closing inspections of your commercial portfolio.
What does the OCC say?
In addition to discussions of inspections during construction, there are two relevant sections regarding post-closing inspections.
Monitoring Income Producing Property
Periodic property inspections should be performed to verify that the property is being adequately maintained and that tenants and vacancies have been accurately reported in the rent roll. Particular attention should be given to troubled properties and properties with troubled borrowers or guarantors. [Page 49]
Environmental Risk Management
[C]ollateral monitoring and periodic inspection requirements throughout the loan term for properties with higher environmental risk. [Page 71]
As noted above, the OCC is looking for inspections for two purposes, one is the overall condition of the collateral and the other specifically related to environmental concerns. Of note, the environmental risk recommends monitoring as well as inspections.
What do banks do?
In many instances, next to nothing. Experience suggests that many banks have no post-closing property inspections covered in their policies. And those that do have no clear tracking that the inspections are being completed and properly documented.
But it’s the RMs job
The RMs will suggest that they are visiting all of their customers on at least a yearly basis and inspecting the properties at that time. While this may be possible for a high-end CRE RM with a limited number of customers, the business banker may have tens if not hundreds of customers with lower end properties. It is these lower end properties tt create concern as there would typically be less money available for routine maintenance and environmental compliance. Further, an issue that can be readily addressed at a high value property may effectively sink a smaller property.
Lastly, shouldn’t the RM be out there bringing in more business as opposed to spending extra time with existing customers?
We can’t afford it
This is heard regularly. There are no monies to do this and you are right – sort of. No one has accounted for such inspections into their existing loan documents. So the need for subsequent regular inspections should be built into the closing costs, similarly to how you would build in costs for title work during the life of the loan.
The other consideration is – can you afford not to? If you are doing a five-year note, you are likely looking at only one or two inspections during the life of the loan, thus only adding a few hundred dollars to the loan. And if you are lending on environmentally risky properties (gasoline stations, dry cleaners, manufacturing facilities, etc.), inaction or bad action on the part of the customer and/or tenants can make your collateral worthless in a time period much less than five years.
But I know my borrowers; no worries
You can’t always trust them to do the right thing and keep you fully informed of changing conditions of your collateral. Doing regular inspections, I have found: significant vacancies not reported to the bank (including one where the single tenant was gone); deferred maintenance to the point of creating a hazardous situation; improper storage of hazardous wastes outside the on-site structures; spills reported on-site not identified to the bank; among others.
So, now what?
All CRE lenders should have a policy that includes some level of documented on-going monitoring and inspection consistent with your level of risk. Consider using strength/experience of a borrower and property type as triggers as opposed to monetary values. Borrowers with high end properties are typically not going to allow a situation to get out of hand; it’s the lower end deals that can create havoc very quickly and lose all value. Then devise a scope and schedule for the inspections. Do you need interior inspections on most properties? Likely not. Do you need more frequent inspections on environmentally risky properties? Likely. And those should include such things as review of tank monitoring reports at gasoline stations and disposal manifests at dry cleaners.
There are also other tools available. At least one regulatory database provider can monitor your collateral and inform you of environmental regulatory changes near your property, such as spills, a new generator of hazardous waste, etc. While required under most bank loan documents, experience suggests that such issues are not divulged to the bank until after identified by the bank.
The Lotis Engineering Group, PC, has experience with assessing a bank’s inspection needs and devising an appropriate program to meet those needs. High-volume clients can have exterior inspections, complete with photos and documentation, for minimal cost.
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.