Magazine article Journal of Commercial Lending

Environmental Risk Policies at Financial Institutions

Magazine article Journal of Commercial Lending

Environmental Risk Policies at Financial Institutions

Article excerpt

Beginning in the mid 1980s, legal liability for environmental contamination, as a result of owning or operating assets involving real estate, was the primary motivation for lenders to perform environmental due diligence. Such situations typically occurred in a relatively small number of transactions in which foreclosure or loan workout was contemplated. With the availability of standardized and economically priced environmental due diligence procedures and an increased ability to understand the financial implications of environmental contamination, lenders are expanding their due diligence efforts beyond this relatively limited number of transactions.

Lenders are widening their focus to include smaller real estate transactions and, increasingly, transactions not involving real estate. Any effect on the borrower's cash flow affecting the ability to service debt, such as fines or liability for shipping waste to a contaminated landfill, is of concern to the lender. As a result, the number of transactions now receiving at least a minimal level of environmental scrutiny is expanding significantly.

The Second Annual Financial Institution Environmental Survey, conducted by Dun & Bradstreet Information Services and Environmental Data Resources, Inc., found that all the institutions in the survey either have a formal, written environmental policy (88.5%) or are developing one (11.5%).(1)

The survey also found that a number of institutions are now routinely including residential real estate in their environmental risk policies. The dynamics behind the growing number of lenders reviewing residential properties are somewhat complicated. In general, exposure on any individual property represents an insignificant risk for most institutions. However, the negative publicity associated with facilitating transactions in a contaminated residential neighborhood can be quite damaging. This phenomenon, combined with increased environmental consciousness at the consumer level, is moving residential properties into the environmental due diligence mainstream. See Figure 1 for the survey results regarding the policy coverage of commercial versus residential real estate. Figure 2 shows how non-real-estate-secured transactions are being included in environmental policies as well.

Personnel

The survey found that most respondents (72%) have a designated environmental risk manager or policy coordinator as part of their staffs. An additional 5% noted that such a position will be filled within the next six to nine months. And 21% of the respondents noted that no such position exists in their institution.

The survey also asked those respondents with a designated environmental risk manager or policy coordinator to name the department to which this position was attached. A total of 34% of the respondents reported that this individual is a member of credit administration. Other departments associated with this title include real estate lending (11.5%), appraisal (11.5%), risk management (6.6%), and environmental services (5%).

Transaction Screening Procedures

The expansion of policy coverage to include a variety of transactions is being made possible, in part, through the use of a transaction screen. A transaction screen allows the lender to identify environmental "red flags" early in the transaction and at a nominal cost. …

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