The Federal Deposit Insurance Corp., a recognized leader when it comes to addressing environmental issues, has updated its environmental guidance document for the first time in more than a decade. The document, FIL-98-2006, now references the U.S. Environmental Protection Agency’s new “All Appropriate Inquiries” protocol.
Eight months have passed since the U.S. Environmental Protection Agency’s new federal site assessment rule, All Appropriate Inquiries, and its equivalent, ASTM’s newly updated Phase I site assessment standard, E 1527-05, took effect. Today, anyone wishing to qualify for federal cleanup liability protection under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) must complete an AAI- or E 1527-05-compliant Phase I ESA, plus follow certain continuing obligations after taking title to a property, if they wish to maintain liability protection under any of CERCLA’s three defenses (innocent landowner, bona fide prospective purchaser or contiguous property owner). The AAI- and ASTM E 1527-05-compliant Phase I ESA represent a significant departure from the previously accepted site assessment protocol, ASTM’s E 1527-00 standard. Among the most notable changes are the qualifications required of the professional conducting the assessment, the information that must be gathered and the length of time the report is valid.
Lenders who haven’t already incorporated AAI into their environmental policies now have significant incentives to do so. For one, the uncertainty surrounding EPA’s new rule has eased; AAI has now become the standard of care in environmental due diligence. What’s more, lenders may come face to face with AAI due to competitive pressures – today there is a greater demand for information, which ironically comes with ever-shrinking deadlines – demands from real estate attorneys and brownfields redevelopment requirements. Add to the mix emerging environmental concerns such as vapor intrusion, an indoor air quality issue that affects potentially thousands of properties nationwide, and the need for sound environmental risk management intensifies.
Those changes in the environmental due diligence arena are coming on the heels of federal guidelines issued jointly last December by the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Federal Reserve, which, concerned with banks’ heavy concentrations in commercial real estate, are calling for tighter risk management practices. The document, entitled “Interagency Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices,” included controversial numerical thresholds designed to define metrics indicative of dangerously high concentrations of CRE loans that could act as triggers for increased regulatory scrutiny. FDIC recently announced that, as of the first quarter of 2007, approximately 2,500 banks have CRE concentrations above regulatory thresholds, a strong indication that the agency is keeping a close eye on the situation.
Regulators Respond
If the aforementioned scenarios aren’t incentive enough for banks to update environmental due diligence policies, they may soon need to in order to appease federal regulators, many of whom will revise their environmental requirements to acknowledge EPA’s rule. Most notably, as mentioned above, FDIC has updated its environmental guidance document, FIL-98-2006, to include EPA’s new protocol. In defining an environmental risk program, the agency’s guidance recommends that banks include the following components:
• Staff training to ensure proper implementation of the environmental due diligence program;
• Policies, manuals and written procedures that address environmental issues pertinent to specific lending activities;
• A tiered approach to an initial environmental risk analysis during the application process and a more structured risk assessment, where appropriate. (This section of the guidance includes the recommendation that banks consider whether AAI is “appropriate or necessary” for a particular extension of credit);
• A process for monitoring the borrower and the real property collateral during the life of the loan for potential environmental concerns. (A reflection of AAI’s ‘continuing obligations’ requirement, this stipulation recommends that lenders periodically monitor the property for new environmental concerns, such as reported spills or releases);
• Language in the loan documents to safeguard against potential environmental losses and liabilities; and
• Appropriate environmental risk assessment safeguards that apply in loan workout situations and foreclosures. (Here, according to several real estate attorneys, following AAI is the best bet because, although banks ultimately are protected at the federal level via secured creditor exemptions, the institution may still be sued by a third party or face liability at the state level. Also, if the property were to be taken back in foreclosure, its complete environmental status should be known before it is put back on the market.)
Follow the Leader
No matter how lenders choose to respond to the FDIC’s new guidelines, the agency notes that bank examiners will review a lender’s environmental risk program, and that a “failure to establish or comply with an appropriate environmental program will be criticized and corrective action required.”
As of early July, FDIC was the first and only regulatory body to formally respond to AAI. However, others have acknowledged they will follow suit: The OCC, while not likely to issue an independent environmental guidance, announced it is revising the environmental component of its Construction & Commercial Lending Handbook over the course of this year; the Office of Thrift Supervision (OTS), which released its current policy back in 1989, said it plans to formally respond to AAI by September; and the National Credit Union Administration (NCUA) confirmed that it will respond to AAI, likely through an independent guidance document. Even the Federal Reserve announced it will address the AAI rule, although likely not until late 2007 or early 2008.
The Small Business Administration recently issued a procedural notice requiring that “Â…7(a) lenders and Certified Development Companies comply with EPA’s AAI final rule as part of their prudent lending practicesÂ…when a Phase I is required pursuant to SOP 50 10.” At the time of this writing, SBA was in the process of revising the environmental component of its main loan processing standard operating procedure, SOP 50 10, an effort the agency says is nearly complete.
In the coming months, all regulatory agencies will undergo formal environmental training conducted by the Federal Financial Institutions Examination Council, which is attempting to establish a degree of consistency among examiners. With the first round of training expected to take place in October, lenders, who already are reporting increased questions from federal regulators regarding their environmental due diligence practices, likely will be under an even stronger microscope in the future.
Although commercial banks cannot ignore such significant developments, all of which mean they’ll face tighter scrutiny and a need for faster, more comprehensive environmental due diligence, they must also balance the need for sound risk management with the very real necessity of staying competitive. In some cases, lenders may decide not to require AAI compliance on every loan they underwrite. If so, loan size, the borrower’s profile, time and cost constraints, property type, and the bank’s risk tolerance should factor into the due diligence decision.
Today, thanks to improvements in environmental due diligence tools, commercial lenders have access to more options, with varying costs and turnaround times, than ever before. If the decision is made to forego a full AAI-compliant Phase I environmental site assessment, lenders can still manage business risk and demonstrate to regulators that they are addressing environmental concerns with other tools such as a Phase I update or a transaction screen. For a quick but thorough preliminary screen, lenders can even access property environmental reports via the Internet through environmental information vendors. These detailed yet cost-effective reports can highlight property concerns based on government records and historical data. If issues are raised, lenders can initiate a more thorough investigation. In this manner, the bank’s need to address business risk and work within competitive constraints, plus its obligation to demonstrate to regulators that appropriate safeguards are in place, can be managed quite effectively.
