'Hidden Brownfields' Could Lower Property Values
Murray, Michael, Mortgage Banking
Overlooked environmental issues from the past decade could add another burden to banks holding "underwater" commercial mortgages.
Derek Ezovski, president of Outsourced Risk Management Solutions LLC, West Hartford, Connecticut, described some environmental reports required in the commercial mortgage-backed securities (CMBS) market as "lackluster" and, for smaller banks, similar to "discretionary costs," he said.
"The difference between CMBS and commercial banking is that CMBS did have a requirement that [environmental reports] had to be done, but no one was really checking it," Ezovski said. "If it was done to the highest quality or lowest quality, it really was more of a checkbox."
In the past, lenders typically shared liability concerns on environmental issues if properties foreclosed. However, those laws started to change in the mid-1990s. Risk-based clean-up laws created more flexibility, based on laws in different states.
"There was a point in the late 1990s, early 2000s, where banks really went on this roll of becoming increasingly comfortable with environmental due diligence to the point where, frankly it was kind of checking a box," said Adam Meek, chief executive officer of Brownfield Management Associates, Chicago.
In 1990, the Court of Appeals for the 11th Circuit, in the United States vs. Fleet Factors Corp. decision, interpreted the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) to mean that a lender with the capacity to influence or control operations is liable as an operator.
However, safe-harbor initiatives started to take place in 1992 and in response to a 1994 decision in Kelly vs. the Environmental Protection Agency (EPA), Congress amended CERCLA in 1996 to expressly include a secured-creditor exemption equivalent to safe-harbor regulations.
Meek said the EPA created safe-harbor rules not making lenders liable as a responsible party or owner under CERCLA, or the Superfund, if lenders "did not effectively take part in the day-to-day operations of the business or have an inappropriate level of involvement over the business that [had an impact] on the disposal of waste and the environmental aspects of the property."
Meek added, "Chances are that if the due diligence was done in the last 10 years, it might have been a short-sheeted process."
Ezovski described the Phase I Environmental Site Assessment of the mid-2000s as not completely eliminated, but said, "It was definitely being skimped on."
He added, "On the CMBS side, if there were conditions that required further action, they did have to note those in the transaction and, typically, they had to be resolved before [the loans] were bundled into the portfolio. There have been plenty of stories I have heard from consultants as well as the industry in general that there was a very high incentive for the deal to go through and environmental was not expected to hold it up."
In some cases, environmental consultants were "strong-armed" by loan officers and transaction participants to "make issues disappear" and, in some cases, Ezovski said, environmental specialists with a reputation for pushing deals through were chosen for jobs above others who might have held up the process.
"There is a definite conflict of interest when you have a loan officer, a borrower and a seller of a property doing the environmental work," Ezovski said. "The loan officer is paid to produce deals, and does not get paid if the environmental knocks it back; a seller who clearly does not want to find any problems; and a borrower who, at the small level, particularly at the community bank level, deals with mom-and-pop shops and small businesses--they either do not know enough to question things or it is like buying a house where they fall in love with the property and they do not want anything to get in the way of that property. Very often, you get all three players who are invested in getting the deals done. …