Environmental Risk Management plays a key role in the Office of the Comptroller of the Currency (OCC)’s revised Commercial Real Estate Lending Booklet, which contains guidelines for commercial real estate loan concentrations and sound risk management practices for banks.
The new OCC guidelines comprehensively incorporate environmental risk management into the larger commercial real estate context. How will these new guidelines impact the environmental risk management programs of lenders, and what is the relationship of the revised OCC handbook to the All Appropriate Inquiry (AAI) process?
The 2013 Update
The OCC’s new Commercial Real Estate Lending Booklet replaces the booklet issued in 1995, which only briefly addressed environmental risk by stating that banks should have policies or procedures in place to protect the bank from liability associated with potential environmental hazards. In the event that the bank did hold contaminated property as collateral, the 1995 booklet recommend banks should take steps to minimize potential liability and seek the advice of environmental professionals if the environmental problems were considered severe, particularly in default situations.
This Commercial Real Estate Lending Booklet was revised in August 2013, raising the prominence of environmental risk management by identifying environmental liability as one of five credit risks that can affect the ability of the borrower to repay a loan.
What does the OCC consider to be an appropriate environmental risk program?
The OCC states that real estate lending policies should be appropriate for the bank’s size and the nature and scope of its operations and should reflect the level of risk that is acceptable to its board of directors. The guidelines recommend that the bank’s board of directors, or a dedicated committee, should regularly review and approve the policy.
To satisfy the revised guidelines, the OCC states that banks should:
- develop policies and procedures that reflect potential environmental risks associated with lending in markets and to industries served by the bank. Procedures should clearly specify the bank’s requirements for determining potential environmental concerns. For example, procedures should include guidelines that the lending staff should follow in conducting an initial analysis of potential environmental impact. Procedures should also specify the circumstances in which a more detailed environmental assessment, such as an AAI-compliant evaluation, should be conducted by a qualified professional.
- provide for the receipt and evaluation of environmental risk assessment reports before the bank’s final commitment to lend on a transaction.
- establish procedures for assessing environmental concerns associated with assets before acquisition by the bank in workout or foreclosures as well as the bank’s investment in real estate assets for its own use.
- ensure that persons responsible for evaluating environmental risk possess relevant knowledge, skill, and competence. The bank’s program should specify selection criteria to evaluate and monitor the performance of third-party professionals, such as environmental experts or legal counsel, who may be consulted to assess environmental risk.
- provide guidelines that the lending staff should follow for monitoring potential environmental concerns for the duration of loans held in the bank’s loan portfolio. These guidelines should focus on changes in business activities that might result in an increased risk of environmental contamination associated with the property, thus adversely affecting the value of the collateral.
- maintain guidelines for loan documentation that protect the bank from environmental liability and related losses. Loan documentation should ensure that contractual provisions, including rights of access, are sufficient to facilitate AAI-compliant evaluations. A bank’s policies and procedures should reflect adequate consideration of the EPA’s AAI rule.
Such a policy should incorporate certain key elements, including:
- an analysis of current environmental laws and due diligence requirements for borrowers and the bank.
- a level of due diligence internally required in all real estate loan transactions.
- risk thresholds based on property type, use and loan amount for determining when and what type of due diligence is required.
- varying due diligence methods depending on the type of loan, the amount of the loan and the risk category, including borrower questionnaire or screening, site visit, government records review, historical records review, testing or inspections using qualified professionals.
- the potential for significant impact resulting from the presence of hazardous building material such as asbestos and lead-based paint.
- appraisal requirements for disclosing and taking into consideration any environmental risk factors.
- criteria for evaluating environmental risk factors and costs in the loan approval process.
- criteria for determining the circumstances in which the bank would normally decline loan requests based on environmental factors.
- environmental provisions for incorporation into transaction documentation:
- for commitment letters: extent of due diligence required, borrower costs, approval contingencies, reporting obligations, documentation requirements, etc.
- for loan documentation: representations and warranties, inspection requirements, reporting requirements, lien covenants, indemnification provisions, and provisions allowing for the acceleration of the loan, refusal to extend funds under a line of credit, or exercise other remedies in the event of foreclosure
- collateral monitoring and periodic inspection requirements throughout the loan term for properties with higher environmental risk.
- a means of evaluating potential environmental liability risk and environmental factors that could impact the ability to recover loan funds in the event of a foreclosure.
- guidelines for maintaining lender liability exemptions, avoiding owner/operator liability, and for qualifying for Landowner Liability Protections under CERCLA and AAI if the bank acquires ownership of the property.
The OCC and All Appropriate Inquiries
According to the 2013 Commercial Real Estate Lending Booklet, banks do not need to comply with the All Appropriate Inquiry rule to qualify for the secured creditor exemption during loan origination; however, it suggests that an AAI-compliant investigation can be useful in assessing a property’s environmental condition, the potential liability for a borrower, and disposition strategies upon foreclosure.
The OCC further states that banks must employ policies and procedures that reflect adequate consideration of the Environmental Protection Agency’s AAI rule and specifically states that procedures should specify the circumstances in which a more detailed environmental assessment, such as an AAI compliant evaluation should be conducted.