PES has been a leader in Environmental Due Diligence studies for over seventeen years, primarily in Virginia, Maryland, and Washington, D.C. and secondarily in the broader Mid-Atlantic Region.   Please call us (703-938-5050) or email us (propertyinc@cox.net) anytime for advice on the level or type of study needed to fit your particular loan or circumstances.

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Steve Butler of ButlerBank Consulting this past year shared his ideas and thoughts on environmental due diligence for the banking industry.  Mr. Butler has spent just over forty years in the banking industry as a lender, manager, CEO, and as a consultant.  In this discussion Mr. Butler was asked why bankers need to worry about environmental due diligence.

“Bank lending officers have to be concerned with the repayment of the loans they extend because they extend loans utilizing their depositors’ funds, which in turn is insured by an agency of the U.S. Government, the FDIC.  Hence each loan made must have, among other concerns, both a primary (cash flow) and secondary (collateral) source of repayment.  Whenever a bank takes real estate as collateral, it must concern itself with the environmental issues that can accompany real property.”

On a basic level I know that acquiring a piece of property through foreclosure, and in some instances, simply collateralizing a loan with potentially contaminated property, can result in some instances of the bank paying for a considerable and costly clean up/remediation.   There are three additional risks that bankers face with contaminated property: 1) reputational risk, 2) the risk of litigation involving the bank, and 3) risk of loan default if the borrower discovers environmental risks on his property subsequent to obtaining a bank loan secured by that property.  The clean-up costs could put a dent in the borrower’s cash flow and potentially in that borrower’s ability to repay the loan.

Finally, on this point, banks are facing an ever-increasing burden from their regulators, and regulatory criticism is the last thing a bank wants to worry about, especially when properly devised and implemented environmental due diligence policies and procedures can prevent the problem.   Having a loan classified by examiners as “Special Mention”, “Substandard”, or “Doubtful” can impact a bank’s business.   Reputational problems can wreck havoc for the bank.  For these reasons, bankers need to worry about environmental due diligence.”

Diane Crocker, of EDR, Inc., recently stated in the Scotsman Guide that in response to a mix of regulatory and economic forces a higher percentage of lenders are viewing more of their property loans through the lens of environmental risk to protect the bank from the liability that contamination can cause.   PES is available to help our clients navigate through the ever changing world of environmental risk management.

Much of the time the risk of environmental contamination does not work against the collateral as established by the borrower. However when it does there can many unwanted repercussions:

• Loan defaults from financial obligations with cleanup costs and government fines
• Compromised building and redevelopment plans from property use limitations
• Legal claims from occupants of collateral or adjoining properties
• Irreparable damage to your bank’s reputation, brand and image
• Environmental issues can reduce the value of a property below the loan amount
• If the case of foreclosure, it can delay the bank’s sale of the property while the extent of the contamination is determined and an appropriate remedial action is identified

An environmental assessment helps to ensure that real estate used as collateral has the value the bank expects, since standard appraisals do not factor in environmental risk, and also elicits information on whether the borrower’s ability to make loan payments could be compromised by a large environmental expenditure.

Just recently PES conducted a Phase I Environmental Assessment where an underground storage tank (UST) was not registered with the Virginia Department of Environmental Quality (DEQ).  The previous owner of the property never bothered with this notification. The subsequent/current owner and borrower became responsible for properly registering this tank prior to loan clearance. This registration helps protect the bank as the Commonwealth of Virginia has financial programs in place to protect the bank’s collateral from spills and contamination caused by a leaking tank. Banks should not lose perspective that they are largely exempt from exposure due to federal and state lender liability laws, provided they do not take over environmental operations beyond protection of their security interest. It makes sense for the lender to require the borrower to obtain a pollution legal liability insurance policy naming the bank as an additional insured to protect the bank’s interest if liability arises out of unknown conditions (i.e. those not discovered in a Phase I or even a Phase II study).

In addition to setting due diligence thresholds, most banks require the borrower to sign 1) a Hold Harmless Agreement to indemnify from environmental liability for the subject property, and 2) a hazardous Substances Indemnity Agreement to address hazardous materials and spills on the subject property.

If liability protection for the borrower under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) is important, only an EPA AAI or ASTM E1527 compliant Phase I ESA will suffice. To take advantage of any of the three liability defenses to CERCLA – 1) the innocent landowner, 2) the bona fide prospective purchaser or 3) the contiguous property owner – property purchasers or their lenders must have a Phase I (AAI or ASTM standard) ESA prepared by a qualified environmental professional.

Never be reluctant to reach out to PES by phone: 703-938-5050, or email: propertyinc@cox.net with any questions or thoughts you may have pertaining to environmental concerns or studies needed.

The Small Business Administration (SBA) issued their latest guidance criteria on March 1, 2013 with Standard Operating Procedure (SOP) 50 57.  Specifically this SOP applies to Section 7(a) Loan Servicing and Liquidation.  SOP 50 57 outlines the expanded risks associated for secured creditors with contaminated collateral.  In response to this SOP lenders are requiring more pre-loan and post-default environmental investigations to minimize risks from institutional liability.   Additionally any property to serve as collateral that has ever had a gasoline service station or dry cleaning business must receive additional scrutiny to qualify for meeting the liability protections as outlined in the SOP.  The SBA’s environmental policies have been adopted by many financial institutions for their internal organizational policy standard.  As federal regulatory pressures have increased and with the growing amount  of liable responsible parties there have been enforcement actions against over 1,300 banks in the last few years.

The revised ASTM Phase I Environmental Site Assessment standard (E-1527-13) will soon be universally accepted within the industry.   One of the key changes over the ASTM 2005 standard version is the expanded definition and clarification of Recognized Environmental Conditions (REC).   A REC in the summary or conclusion of a due diligence report refers to the presence or likely presence of any hazardous substance or petroleum products in, on, or at the subject property under conditions indicative of a past release, present release, or posing a material threat of a future release to the environment.   The new standard has introduced the “Historical REC” and the “Controlled REC”.  A Historical REC refers to a past release that has been addressed to the satisfaction of the applicable regulatory authority or that meets unrestricted residential use criteria.   The Controlled REC refers to a past release that has been addressed to the satisfaction of the applicable regulatory authority with hazardous substances or petroleum products allowed to remain in place subject to required controls such as activity or use restrictions, institutional limitations, or engineering controls.   Read more here …

On the upside, capital markets are in much better shape than in recent years.  Cash flush investors, REITS, pension funds, hedge funds, institutions, and private equity investors, are out shopping assets to acquire.  As confidence increases, so does loan volume.  Commercial property sales in the first two quarters of this year were up about 30% from a year earlier.  Also, stronger real estate pricing has invigorated loan dispositions particularly by small banks.  Banks are moving commercial loans off their balance sheets at a faster pace and at higher prices than at any time since the beginning of the financial crisis in 2008.

On the downside, time will tell on the degree of reduced and altered lending volume resulting from the Dodd-Frank Act.  Many view this act as an overreaction to the recession that started in 2008 leading a significant number of investors to be less inclined to be as active as they normally would.  For the majority of lending institutions, the Act burdens banks with cumbersome rules and compliance that leads to restrict overall economic growth.  Many moderate to large banks are putting plans in place to deal with the Volcker Rule – prohibiting banks from owning, investing, or sponsoring hedge funds, private equity funds, or any proprietary trading operations for their own profit – to minimize their exposure to regulatory correction.   The increased cost of compliance will have the long term effect of raising the cost of credit to borrowers and investors.