Environmental Risk Management
Trends and Best Practices for Lenders
and Appraisers
Derek Ezovski
Outsourced Risk Management Solutions LLC
Eric Schwartz
Amegy Bank
July 24, 2013
Agenda
3
1.
Current Trends
2.
Regulatory Changes to the Environmental Due Diligence process
3.
Commercial Issues
4.
How Appraisals and Environmental Converge
5.
Q&A
Appraiser Poll
Question:
Are environmental issues typically not looked at
because of ignorance or apathy?
Response:
We don’t know and we don’t care…
How Appraisals and Environmental
are similar for Lenders
• Borrowers and lenders don’t “love” them
• They are both often considered commodities by
the user
• Lots of people seem to think they cost too much
• There are many less than competent providers
• Report can differ based on who the user is
• Often the last thing necessary for loan approval
How Appraisals and Environmental
are different for Lenders
• Appraisals are regulated
• Environmental is often still considered
discretionary
• Most regulators do not define the appropriate
level of environmental due diligence
Risk Management Challenge
• “…data is old the minute that it is put in.
Information is more available than it has ever
been, but the ability to know what is pertinent
and what is true is more challenging today.”
– Martha Cummings – head of Risk, Banco Santander
Current Trends in Lending
• Pressure from regulators
• Workouts/Foreclosures
• SBA Lending on the Rise
• Continuously trying to do more with less
• Lenders updating environmental/appraisal policies to conduct:
– More due diligence…on a greater % of loans
Current Status of Banking
• Bank closures have been occurring since 2007, most of which had
unusually high commercial-mortgage exposure.
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2006 - 0
2007 – 4
2008 – 25
2009 – 140
2010 – 157
2011 – 92
2012 - 53
• EBA Survey -
63% of lenders that had an examination over the
last couple of years were asked about their
environmental policy.
Former State of the Market
Page 10
CRE Lending
• While increasing bank leniency and improved
fundamentals have helped revive the CRE market,
the high level of maturing debt remains a
significant barrier to recovery.
• However, lenders’ focus on permanent loan
resolutions through pre-foreclosure sales will likely
provide opportunities for investors to acquire
overleveraged properties at attractive prices.
- excerpt from Deloitte CRE Study
Banking Issues
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Credit & Trust Risk
Collateral Devaluation
Direct Liability, Loan origination to foreclosure
Reputational Risk (Brand and Image)
Operational & Enterprise Risk
Market & Interest Rate Risk
Restructurings and Foreclosures
Sustainable Development & Finance
Major Changes
EPA’s All Appropriate Inquiry (AAI)
ASTM 1527-05
EPA’s All Appropriate Inquiries (AAI)
Rule
• For the first time, there was a federal statutory authority
saying what is needed for a Phase I environmental site
assessment (not just an ASTM standard)
• Created by EPA under Brownfields Amendments to CERCLA in
2002.
• Biggest impact of AAI on lenders were the changes to FDIC
guidelines – but there are other impacts of AAI including…
Page 15
Key Changes to Phase I ESAs under
AAI
1. Defined qualifications for environmental
professionals (EPs);
2. Emphasized responsibilities of the “user”
(person seeking liability protection);
3. New levels of Phase I research for consultant;
4. Shorter shelf life for Phase I reports.
Impact of AAI: Who Qualifies as an
Environmental Professional?
Professional/Educational
Qualifications
Relevant
Experience
Professional engineer or professional
geologist license/registration
3 years
Federal or state license/certification to
perform environmental inquiries
3 years
B.A./B.S. degree or higher in any
science or engineering field
5 years
No B.A./B.S. degree
10 years
Page 17
Changes to Phase I’s - 2013
Key Changes:
Simplified
“Recognized Environmental Condition”
Definition
•
More closely aligned with the EPA’s All Appropriate Inquiries (AAI)
“objective”
•
de minimis extracted as a stand-alone definition
•
Some instructional language added to historical and site visit sections
Key Changes:
De minimis
•
A Recognized Environmental Condition includes the presence of a release
•
“de minimis” added to allow the Environmental Professional to immediately
dismiss a minor spill
•
“de minimis” used by some to describe contamination left in place and accepted
by an agency
•
E1527 Task Group (and EPA) concluded that the same term should not be used to
describe both situations
Key Changes:
Historical REC
•
Historical Recognized Environmental Condition definition originally
developed pre-2002
–
before the Bona Fide Prospective Purchaser landowner liability
protection/continuing obligations requirements)
•
Conditionally-closed sites currently handled four different ways
•
Consistency needed
New: HREC Split
•
Redefined Historical Recognized Environmental Condition
– Past releases addressed to unrestricted residential use
– Must consider current regulatory framework (rules change)
– HRECs are not RECs
•
Created new Controlled Recognized Environmental Condition term
– Past releases addressed to non-residential standard, subject to some type of control
– CRECs are RECs and must be included in the conclusions section of the report
•
de minimis” CAN be used to describe an HREC
•
de minimis” CAN NOT be used to describe a CREC
Agency File/Records Reviews
•
Some argued additional records review already required under current
standard
•
Some argued additional records beyond a database report are not
required under current standard
•
Clients thought it was already being done
•
Consistency needed
•
New language:
– Should be conducted for property and adjoining properties
– If not conducted, explain why
– Alternate sources ok
“User” Responsibilities
•
The purpose of the “User Responsibilities” not previously explained
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–
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Grounded in “Factors the Courts will Consider” CERCLA amendments
Re-iterated in the 2002 amendments to CERCLA
2002 amendments extended these responsibilities to include brownfield grantees
•
Loan officers/realtors/brokers/etc., not typically seeking CERCLA liability
protections or brownfields grant
•
Some EPs asking the wrong people to the complete the “User” questionnaire
•
Clarification needed
Vapor
•
E1527 has been silent on vapor
•
EPA recommended the task group not ignore the vapor pathway
•
2013 revision acknowledges the vapor pathway in “migration”
definition
•
Proposed language acknowledges soil vapor in “Activity and Use
Limitations” definition
•
Added discussion in Legal Appendix regarding vapor intrusion as it
relates to CERCLA
•
Clarifies “Indoor Air” non-scope
Non-Scope Considerations
and Appendices
•
Clarified “indoor air” exclusion
– Added “unrelated to releases of hazardous substances or petroleum products
into the environment
•
Revamped non-binding appendices
– Revised Legal Appendix
– Revised Report Table of Contents and Format
– Developed a “Business Environmental Risk” Appendix to provide references and
resource guidance
Recommendations
•
Task group split about 50/50
•
Ultimately agreed that:
– Recommendations are not required by the standard.
– User should consider whether recommendations are desired.
– Recommendations are an additional service
Publication Timing
•
Anticipate ASTM/EPA process and publication completed sometime
in 2013
•
Can re-ballot existing E1527-05 as-is if necessary
Regulatory Issues
“New” FDIC Guidance
•
FDIC updated its Guidelines in November 2006.
•
Other regulatory agencies also updated their guidelines:
–
–
–
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NCUA (effective May 2008)
OCC
OTS
Federal Reserve
•
FDIC’s guidance set the standard; FDIC is regarded as a leader in terms of
environmental requirements.
•
FFIEC implemented environmental policy training/education for examiners across
all agencies (October 2007, May and June 2008)
•
A majority of banks have reconsidered and revised their environmental policies.
30
NCUA Environmental Guidance
FDIC Focus
– FDIC emphasizes process and consistency.
– Ensures proper document management and records
retention;
– Document due diligence;
– Track changes to policy and consistent application of policy.
– Banks must avoid “participating in management” of the
business and thereby assuming liability under CERCLA.
– Many attorneys recommend a Phase I ESA in the event of
foreclosure.
Small Business Administration Update
• SBA updated its Environmental Policy
• Effective August 1, 2008 and updated five times since
(most recently in June 2012).
• Went from 1000 pages to 400 pages.
• Especially important for institutions with preferred
status who do SBA underwriting.
• 7A and 504 lenders must adhere to this policy.
• Has become default policy for many lenders.
SBA Environmental Due Diligence
Policy
2 levels of Environmental Due Diligence for SBA
1.
Phase I – for high risk properties
•
2.
If property type/use matches the list of NAICS codes for Environmentally
Sensitive Conditions
Records Search with Risk Assessment – low risk properties
• Includes a search of the government databases (compliant with AAI);
• A search of historical use records, and;
• A risk assessment by an environmental professional determining
whether the site is “High”, “Elevated” or “Low” risk
• New Gas Station/Dry Cleaner Requirements
34
Sample SBA Policy Matrix
Minimum Due Diligence Requirements
Real Estate Loan
Type
<$150K
$150K < $2M
Questionnaire
RSRA/TSA
Phase I
Phase I
Phase I + Evidence of UST
Compliance
Phase I + Evidence of UST
Compliance
Phase I
Phase I
Dry Cleaner (older than 5
years old)
Phase I and Phase II
Phase I and Phase II
Special Use Facilities (i.e.
Daycare)
More specific requirements (i.e.
Lead Paint Testing, Lead in
Drinking Water, etc)
More specific requirements (i.e.
Lead Paint Testing, Lead in
Drinking Water, etc)
Low Risk Loans
High Risk* Loans – NAICS
Codes
Gas Station
Dry Cleaners
Page 35
Impact of Lender Size/Resources
Regional & National Lenders
• Resources in place to understand environmental issues on the property
• Screen for lower-risk loans
• Have staff/internal resources to manage environmental risk
Credit Unions/Community Banks
• No on-staff environmental expertise (typically)
• Not as sophisticated with regard to environmental issues or due diligence options
available
• Often rely only on environmental questionnaires and/or proceed without
accurate knowledge of environmental condition of property
• Rely on external guidance to dictate their practices
Types of Due Diligence
• Environmental questionnaire
• Desktop due diligence
• Transaction Screens
• Phase I Environmental Site Assessments
• Phase II, III, Remediation, etc.
• Environmental insurance
Policy Matrix Becoming Common
Minimum Due Diligence Requirements
Real Estate Loan
Type
<$250K
$250K < $1M
>$1M
Questionnaire/Desktop
Desktop/Transaction
Screen
Phase I
Phase I/Transaction
Screen
Phase I/Transaction
Screen
Phase I
Renewals -Low
Risk
Questionnaire/Desktop
Questionnaire/Desktop
Questionnaire/Desktop
Renewals -High
Risk
Questionnaire/Desktop
Questionnaire/Desktop
Desktop/Transaction
Screen
Multi-Family
Questionnaire/Desktop
Desktop/Transaction
Screen
Desktop/Transaction
Screen
Outdated Phase I
Questionnaire/Desktop
Questionnaire/Desktop
Desktop/Phase I update
Low Risk Loan new
High Risk* Loans new
Page 38
Common Residential Issues
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Lead Based Paint
Asbestos
Radon
Mold
Neighboring properties
Stormwater Runoff (for incomplete C&D)
Heating Oil Tanks
Meth Labs (emerging)
Common Commercial Issues
• UST’s
• Gas Stations
• Spills
• Dry Cleaners
• Storage/disposal of
Hazardous Waste
• Mold, lead, asbestos, etc.
• Superfund
• Vapor Intrusion
• Stormwater Runoff
Environmental Issues In Real Estate
Valuation
–Contamination
–Green/Sustainability
Environmental & Appraisals
Types of Contamination
– Building Contamination
• E.g., asbestos, lead paint, radon, formaldehyde
– Encapsulate, Enclosure, Removal
– Soil & Groundwater Contamination
• E.g., hydrocarbons, solvents
– Phase I (initial review) through III (remediation)
Environmental & Appraisals
Green/Sustainability
– A development that meets the needs of the
present without compromising the ability of
future generations to meet own needs
– Goal – merge the priorities of economic
prosperity, environmental quality and social
equity.
NET ZERO HOUSE
LEED PLATINUM
801 17TH, NW, DC
Environmental & Appraisals
Green/Sustainability - Valuation Issues
– Initial Costs are typically higher
– Benefits both direct & indirect
• Direct
– Reduced operating expenses
– Reduced maintenance costs
– Increased occupancy rates
– Decreased tenant turnover
– Possible increased rental rates
• Indirect
– Appeal to tenants’ social conscience/image
– Is it too new to measure value premium???
Examples of Environmental Concerns
for Lenders
1. Foreclosures
2. “Boring” property that used to be auto shop…
3. Retail that used to be Gas Station
4. Removal of waste from a property by lender triggers possible
action
What the seller sees…
What the buyer/lender should
see…
Summary
• Lenders have unique processes and reasons for conducting due
diligence.
• Market pressures have reinforced long-term trend to increased due
diligence.
• Regulators enforcing risk management due to a perceived overconcentration of risk regarding commercial real estate.
• Risk Management (Credit, Collateral, Environmental, etc.) is as
critical as ever to lenders.
• Environmental and appraisals are both pieces of the puzzle that are
being revised under the current environment.
Contact Information:
Derek Ezovski
860.838.5388
dezovski@orms.com
51
How to Learn More?
Convergence of Appraisal and
Environmental Services within
Financial Institutions
Eric Schwartz, MAI, SRA
Chief Appraiser
Appraisal Review Department
Amegy Bank of Texas
July 2013
Disclaimer: The opinions expressed are solely those of the author and are not
necessarily the opinions of the management or employees of Amegy Bank.
July 24, 2013
53
Management of Environmental
Services
• Vendor Pool
– Qualifications – Who is “qualified”?
• Professional Credentials
• Geographic competency
• Property competency
July 24, 2013
54
Management of Environmental
Services
• Database Management
– In-house
• Pros–
–
–
–
Easily tailored to individual requirements
Use of existing resources
Customizable
Integration into other databases
July 24, 2013
55
Management of Environmental
Services
• Database Management
– In-house (continued)
• Cons:
– Reallocation of limited resources
– Functional requirements may not be understood by staff
– ASTM standards may seem “foreign” to appraisers/reviewers
July 24, 2013
56
Management of Environmental
Services
• On-line database management tools
– Real Estate Management Information Service – RIMS
• Web based project management system
– Procurement and tracking
– Vendor management
– Performance
• Pros:
– Reasonably low cost
– Automated credential monitoring
– Secure report upload/download/storage
July 24, 2013
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Management of Environmental
Services
• Features to look for –
– Online service request
– Ease of interface for vendor and management
– Automated task and project tracking
– Vendor Performance reports
– Contact database management system
– 24/7 accessibility
July 24, 2013
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Management of Environmental
Services
• Synergies of task types
– Appraisals and environmental reports must be tied to the same
project. Requires a hierarchical management system similar to:
• Project
– Task
» External
» Internal
– Reporting
» External
» Internal
July 24, 2013
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Management of Environmental
Services
• Environmental due diligence
• Least stringent to most stringent
– ASTM Transaction Screen
– Phase I “Lite” ESA
– AAI/ASTM Phase I ESA
July 24, 2013
60
Management of Environmental
Services
• Bank personnel and appraisers should possess some level
of competency with:
– ASTM E-1527-05: Standard Practice for Environmental Site
Assessments: Phase I Environmental Site Assessment
Process (known as ESA)
– ASTM E-1528-06: Standard Practice for Environmental Site
Assessments: Transaction Screen Process
» Reference: www.astm.org
July 24, 2013
61
Management of Environmental
Services
• Process Management
– Within the appraisal/real estate unit?
• Maintain database of appropriate service providers
• Understand qualifications of service providers
• Internal reviews of Transaction Screens, Phase I “Lite”
and Phase I
– Recommendations may need to be outsourced to qualified
environmental experts/attorneys
July 24, 2013
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Management of Environmental
Services
• The appraiser’s role
– Eyes, ears and nose of the lender
•
•
•
•
Recognize your limitations
You are likely not an environmental professional, but…
Tell us what you see/smell and hear (the contact say)
Why?.....................
July 24, 2013
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Management of Environmental
Services
July 24, 2013
64
Management of Environmental
Services
• Some banks ask you to note if you observed
any of the following:
–
–
–
–
–
Storage tanks
Collection Sites
Drums/containers and/or pesticides/chemicals
Asbestos
Miscellaneous
•
•
•
•
Soil contamination
Water leaks
Water damage
Mold
July 24, 2013
65
Management of Environmental
Services
July 24, 2013
66
Management of Environmental
Services
• Exposure Draft of Proposed Revisions to Guide Note 6:
Consideration of Hazardous Substances in the Appraisal
Process (5/28/2013)
• Guide notes are not part of the standards of professional
practice but instead provide guidance on how the standards
may apply to specific issues.
July 24, 2013
67
Management of Environmental
Services
• Highlights of the proposed revisions to Guide
Note 6
– Explains the differences between the existence of
hazardous substance(s) and environmental
contamination;
– Consideration of the Competency Rule and Scope of
Work Rule
– Extraordinary assumptions and hypothetical
conditions
– Definitions
– Basis of proper valuation
July 24, 2013
68
Management of Environmental
Services
– Guide Note 6-Consideration of hazardous substances
in the appraisal process is fundamental to the
appraisal of real property.
– Need for special consideration to the impact of
hazardous substance on the valuation of real
property.
– Hazardous substances are considered
environmental contamination when their
concentrations exceed appropriate regulatory
standards. (see definitions in GN6)
July 24, 2013
69
Management of Environmental
Services
• Guide Note 6- Competency
• Competency rule in USPAP, Code of
Professional Practice and the International
Valuation Standards (IVS)
• Most appraisers do not have the knowledge,
training and expertise required to detect the
presence of hazardous substances or to
measure the quantities of such material.
July 24, 2013
70
Management of Environmental
Services
• Guide Note 6- Competency (continued)
• If the assignment calls for the appraiser to
take into account most appraisers rely on
other professionals for assistance.
• If the appraiser lacks the knowledge and
expertise they have to disclose that lack of
knowledge and experience prior to the
acceptance of the assignment.
July 24, 2013
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Management of Environmental Services
• Guide Note 6 – Scope of Work
• How and to what extent the appraisal problem
will address known or suspected hazardous
materials that may impact the property.
• Assignment conditions cannot limit the scope of
work such that the assignment results are not
credible for the intended use.
• Cannot allow the client’s objectives or the
intended use to cause assignment results to be
biased.
July 24, 2013
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• Guide Note 6 – Extraordinary Assumptions
and Hypothetical Conditions
• Extraordinary assumptions would be
employed when you are relying on the work of
others.
• Hypothetical conditions are used when the
appraiser estimates the value of the property
known to be contaminated in an unimpaired
or uncontaminated condition.
July 24, 2013
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• Guide Note 6 – Basis for Property Valuation
• Impaired value – The “as is” value of the
property
• Unimpaired value – The market value
developed of the contaminated property
employing a hypothetical condition the
property is not contaminated
• Diminution of value – Effects of costs to
remediate plus use costs plus risk (stigma too).
July 24, 2013
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Management of Environmental
Services
• What’s the appraiser to do?
– If you see it….report it.
•
•
•
•
•
Call the client
Take photos and send them to the client
Write it up in your report
Calculate diminution in value if appropriate
Employ a hypothetical condition or extraordinary
assumption if appropriate
• Ensure your results are credible
July 24, 2013
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Management of Environmental
Services
• What steps would you take if you saw this
during the property inspection?
July 24, 2013
76
Management of Environmental
Services
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77
Management of Environmental
Services
• If FNMA, SBA, HUD and the bank are
concerned about environmental
conditions….shouldn’t you be?
• What is your client’s policy?
– Do they require Transaction Screens based on loan
amounts?
July 24, 2013
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Management of Environmental
Services
• Resources
– Guide Note 6 – Exposure Draft is out (5/28/13)
– Analyzing the Effects of Environmental
Contamination on Real Property (AI Seminar)
– USPAP – Competency Rule; Advisory Opinion 9
– SBA SOP 50 10 5(C) Subpart B, Chapter 4 for 7A
loans and Subpart C, Chapter 3 for 504 loans
– NAICS Codes of Environmentally sensitive
industries
July 24, 2013
79
EBA 2010 www.envirobank.org
How it all started ...
• Lender liability issues in the early 1990s
• Environmental regulations
• Bankers wanted a place to share best practices
and to learn additional skills
EBA 2010 www.envirobank.org
Environmental Risk Management
Issues
• Bank Risk Tolerance
• Business Environmental Risk
• Distressed Assets&
Restructurings
• Loan modifications/renewals
• Workouts, Foreclosure,
Bankruptcy
• Climate Change Risk
• Bank Failures
EBA 2010 www.envirobank.org
Training
•
•
•
•
Environmental credit risk management
Sustainable Financing (green buildings)
Brownfield Redevelopment
Sustainable development/carbon risk
underwriting
• Management issues
• 2 Conferences per Year
EBA 2010 www.envirobank.org