Why Have an Environmental Risk Management Program?

Environmental analysis is an important yet frequently overlooked component of any risk management program and one that borrowers rarely understand. But with a few adjustments, you can reposition the environmental due diligence process as a service to enhance the borrower relationship and create lasting value over the long term.

There are several reasons why financial institutions involved in commercial real estate (CRE) lending should have a robust and well-considered environmental risk management program:

1. Lender Liability: The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA, also known as “Superfund”) was enacted in 1980 as the federal government’s solution to cleaning up sites contaminated by hazardous substances and pollutants. However, it really didn’t make an impact on the banking industry until a decade later, when the U.S. Court of Appeals for the Eleventh Circuit decided in the case of United States vs. Fleet Factors Corp (1990).

The court determined that, despite the statutory exemption for secured creditors, which was included in CERCLA, a lender may be held liable based simply on having the opportunity to influence a debtor’s business operations. With that decision, lenders were placed squarely in the crosshairs of liability for environmental contamination, forcing banks to be more aware of their role. This interpretation kick-started the development of environmental due diligence practices at commercial banks, a process that has trickled down over time to community banks and credit unions. 

2. Risk of Default: Environmental reviews may seem like a nuisance when trying to close a commercial real estate transaction in 60 days, but you will be glad for this piece of risk management if the worst-case scenario arises and the loan ends up going bad. When the bloom is still on the rose, it is hard to think about a loan going into default, but it does happen. And if you are forced to foreclose, a clean property will be worth a lot more on the market than one requiring remediation.

Additionally, good environmental reports include information about adjoining-property risks. Standard due diligence includes a history of past commercial use and remediation that can highlight potential risks of secondary contamination of the subject property. Although you or your borrowers may not technically be liable for contamination from surrounding commercial sites, you will still need to deal with it if the subject property goes into foreclosure and ends up on the market.

On balance, you and your borrowers are both better off conducting environmental due diligence up front on the subject property.

3. Impact on Reputation: Few crises are more media-ready than an environmental cleanup. If your institution has a loan on the property, or if you had to repossess a property due to a borrower default, your bank’s name will also be dragged through the mud. The public may very well question why your bank didn’t complete full due diligence at the time of the project’s initial funding or refinancing.              

The above is based on an excerpt from The RMA Journal, April 2016 article “Environmental Risk Management” by Derek Ezovski, president of ORMS in West Hartford, Connecticut. You can read the article in its entirety here.

Are You Prepared for the Next Recession?

Read More

Focus on RMA: New RMA Member Institutions

Read More

RMA Livestreaming Annual Risk Management Conference Keynote Speakers, October 28, on YouTube

Read More

comments powered by Disqus