The FDIC recently issued updated Guidelines for an Environmental Risk Program to reflect changes to the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) related to the Environmental Protection Agency’s All Appropriate Inquiry rule.
Recognizing that “the potential adverse effect of environmental contamination on the value of real property and the potential for liability under various environmental laws have become important factors in evaluating real estate transactions and making loans secured by real estate,” and responding to EPA’s new All Appropriate Inquiry rule, on November 13, 2006, the FDIC released the first update to its environmental guidelines in 13 years. The FDIC's Guidelines for an Environmental Risk Program has implications for all types of commercial real estate lenders. Most notably, the new guidance recommends not only that banks establish formal environmental due diligence policies, but also that they consider adopting the EPA's new AAI rule, where appropriate.
In defining an environmental risk program, the FDIC’s guidance recommends that banks include the following components:
- Staff training to ensure proper implementation of the program;
- Policies, manuals and written procedures that address environmental issues pertinent to specific lending activities;
- A tiered approach to conducting an Initial Environmental Risk Analysis during the application process and a more detailed Structured Environmental Risk Assessment, where appropriate;
- A process for monitoring the borrower and the real property collateral during the life of the loan for potential environmental concerns;
- 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.
Under item three above, the FDIC recommends a two-pronged approach to analyzing a commercial loan’s potential for environmental risk. First, during the application process for a loan on real property, the guidance states that “an initial environmental risk analysis needs to be conducted.” This step may “allow the institution to avoid loans that result in substantial losses or liability and provide the institution with information to minimize potential environmental liability on loans that are made.” In performing this preliminary analysis, helpful data will include present and past uses of the target property and its surrounding area, along with any actions involving environmental government agencies. Data can be obtained either by visiting various government offices, or—much more easily—by contacting an environmental information vendor. A site visit to look for obvious signs of contamination, such as stressed vegetation or industrial barrels, can supplement the government records research.
If environmental concerns are raised, a more detailed “structured environmental risk assessment” may be necessary. Within this second tier the FDIC envisions case-by-case decisions about the type of due diligence best suited to each investigation. This section of the guidance includes the recommendation that banks carefully consider whether AAI is “appropriate or necessary” for a particular extension of credit.
The FDIC also recommends that the lender’s environmental risk assessment extend over the life of the loan. Potential environmental concerns, such as changes in business activities at the property, should be monitored. This ties in with the AAI rule’s requirement that property owners comply with “continuing obligations” over the course of property ownership in order to preserve the ability to raise a defense under CERCLA as an innocent landowner, bona fide prospective purchaser or contiguous property owner.
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.”
How EDR Can Help
EDR’s new Collateral Screen service accomplishes several critical steps included in the FDIC’s guidance. The subscription-based service allows lenders to pre-screen all deals using findings from third-party government records, thereby providing information useful in making a determination as to whether the property should undergo an AAI-compliant Phase I ESA. By filling in questions raised by an environmental questionnaire or site visit, the information obtained from EDR’s Collateral Screen can also be used to enhance the usefulness of other environmental due diligence tools. EDR’s Collateral Screen also allows the lender to quickly and easily monitor the borrower and the real property collateral for environmental concerns during the life of the loan.
FDIC’s Guidelines for an Environmental Risk Program
Environmental Policy (Office of Thrift Supervision)