Transcript Low Risk - Appraisal Institute
Environmental Risk Management Trends and Best Practices for Lenders and Appraisers
Derek Ezovski
Outsourced Risk Management Solutions LLC
Eric Schwartz
Amegy Bank July 24, 2013
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Agenda
1.
Current Trends 2.
Regulatory Changes to the Environmental Due Diligence process 3.
Commercial Issues 4.
How Appraisals and Environmental Converge 5.
Q & A
Appraiser Poll
Question:
Are environmental issues typically not looked at because of ignorance or apathy?
Response:
We don’t know and we don’t care…
• • • • • •
How Appraisals and Environmental are similar for Lenders
Borrowers and lenders don’t “love” them They are both often considered commodities by the user Lots of people seem to think they cost too much There are many less than competent providers Report can differ based on who the user is Often the last thing necessary for loan approval
• • •
How Appraisals and Environmental are different for Lenders
Appraisals are regulated Environmental is often still considered discretionary Most regulators do not define the appropriate level of environmental due diligence
Risk Management Challenge
• “…data is old the minute that it is put in. Information is more available than it has ever been, but the ability to know what is pertinent and what is true is more challenging today.” – Martha Cummings – head of Risk, Banco Santander
Current Trends in Lending
• Pressure from regulators • Workouts/Foreclosures • SBA Lending on the Rise • Continuously trying to do more with less • Lenders updating environmental/appraisal policies to conduct: – More due diligence…on a greater % of loans
Current Status of Banking
• Bank closures have been occurring since 2007, most of which had unusually high commercial-mortgage exposure. • • • • • • • 2006 - 0 2007 – 4 2008 – 25 2009 – 140 2010 – 157 2011 – 92 2012 - 53 • EBA Survey 63% of lenders that had an examination over the last couple of years were asked about their environmental policy.
Former State of the Market
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CRE Lending
• While increasing bank leniency and improved fundamentals have helped revive the CRE market,
the high level of maturing debt remains a
significant barrier to recovery. • However, lenders’ focus on permanent loan resolutions through pre-foreclosure sales will likely provide opportunities for investors to acquire overleveraged properties at attractive prices.
- excerpt from Deloitte CRE Study
Banking Issues
• • • • • • • • Credit & Trust Risk Collateral Devaluation Direct Liability, Loan origination to foreclosure Reputational Risk (Brand and Image) Operational & Enterprise Risk Market & Interest Rate Risk Restructurings and Foreclosures Sustainable Development & Finance
Major Changes EPA’s All Appropriate Inquiry (AAI) ASTM 1527-05
EPA’s All Appropriate Inquiries (AAI) Rule
• For the first time, there was a federal statutory authority saying what is needed for a Phase I environmental site assessment (not just an ASTM standard) • Created by EPA under Brownfields Amendments to CERCLA in 2002.
• Biggest impact of AAI on lenders were the changes to FDIC guidelines – but there are other impacts of AAI including… Page 15
Key Changes to Phase I ESAs under AAI
1. Defined qualifications for environmental professionals (EPs); 2. Emphasized responsibilities of the “user” (person seeking liability protection); 3. New levels of Phase I research for consultant; 4. Shorter shelf life for Phase I reports.
Impact of AAI: Who Qualifies as an Environmental Professional?
Professional/Educational Qualifications Relevant Experience
3 years Professional engineer or professional geologist license/registration Federal or state license/certification to perform environmental inquiries B.A./B.S. degree or higher in any science or engineering field 3 years 5 years No B.A./B.S. degree 10 years Page 17
Changes to Phase I’s - 2013
Key Changes: Simplified “Recognized Environmental Condition” Definition • More closely aligned with the EPA’s All Appropriate Inquiries (AAI) “objective” • de minimis extracted as a stand-alone definition • Some instructional language added to historical and site visit sections
Key Changes:
De minimis
• A Recognized Environmental Condition includes the presence of a release • “de minimis” added to allow the Environmental Professional to immediately dismiss a minor spill • “de minimis” used by some to describe contamination left in place and accepted by an agency • E1527 Task Group (and EPA) concluded that the same term should not be used to describe both situations
Key Changes: Historical REC • Historical Recognized Environmental Condition definition originally developed pre-2002 – before the Bona Fide Prospective Purchaser landowner liability protection/continuing obligations requirements) • Conditionally-closed sites currently handled four different ways • Consistency needed
New: HREC Split • Redefined Historical Recognized Environmental Condition – Past releases addressed to unrestricted residential use – – Must consider current regulatory framework (rules change) HRECs are not RECs • Created new Controlled Recognized Environmental Condition term – Past releases addressed to non-residential standard, subject to some type of control – CRECs are RECs and must be included in the conclusions section of the report • de minimis” CAN be used to describe an HREC • de minimis” CAN NOT be used to describe a CREC
Agency File/Records Reviews • Some argued additional records review already required under current standard • Some argued additional records beyond a database report are not required under current standard • Clients thought it was already being done • Consistency needed • New language: – – Should be conducted for property and adjoining properties If not conducted, explain why – Alternate sources ok
“User” Responsibilities • The purpose of the “User Responsibilities” not previously explained – – Grounded in “Factors the Courts will Consider” CERCLA amendments Re-iterated in the 2002 amendments to CERCLA – 2002 amendments extended these responsibilities to include brownfield grantees • Loan officers/realtors/brokers/etc., not typically seeking CERCLA liability protections or brownfields grant • Some EPs asking the wrong people to the complete the “User” questionnaire • Clarification needed
Vapor • E1527 has been silent on vapor • EPA recommended the task group not ignore the vapor pathway • 2013 revision acknowledges the vapor pathway in “migration” definition • Proposed language acknowledges soil vapor in “Activity and Use Limitations” definition • Added discussion in Legal Appendix regarding vapor intrusion as it relates to CERCLA • Clarifies “Indoor Air” non-scope
Non-Scope Considerations and Appendices • Clarified “indoor air” exclusion – Added “unrelated to releases of hazardous substances or petroleum products into the environment • Revamped non-binding appendices – Revised Legal Appendix – Revised Report Table of Contents and Format – Developed a “Business Environmental Risk” Appendix to provide references and resource guidance
Recommendations • Task group split about 50/50 • Ultimately agreed that: – Recommendations are not required by the standard. – User should consider whether recommendations are desired.
– Recommendations are an additional service
Publication Timing • Anticipate ASTM/EPA process and publication completed sometime in 2013 • Can re-ballot existing E1527-05 as-is if necessary
Regulatory Issues
“New” FDIC Guidance • • FDIC updated its Guidelines in November 2006.
Other regulatory agencies also updated their guidelines: – NCUA (effective May 2008) – OCC – OTS – Federal Reserve • FDIC’s guidance set the standard; FDIC is regarded as a leader in terms of environmental requirements. • FFIEC implemented environmental policy training/education for examiners across all agencies (October 2007, May and June 2008) • A majority of banks have reconsidered and revised their environmental policies.
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NCUA Environmental Guidance
FDIC Focus
– FDIC emphasizes process and consistency.
– Ensures proper document management and records retention; – Document due diligence; – Track changes to policy and consistent application of policy.
– Banks must avoid “participating in management” of the business and thereby assuming liability under CERCLA.
– Many attorneys recommend a Phase I ESA in the event of foreclosure.
Small Business Administration Update
• • SBA updated its Environmental Policy Effective August 1, 2008 and updated five times since (most recently in June 2012).
• • • • Went from 1000 pages to 400 pages.
Especially important for institutions with preferred status who do SBA underwriting.
7A and 504 lenders must adhere to this policy.
Has become default policy for many lenders.
SBA Environmental Due Diligence Policy
2 levels of Environmental Due Diligence for SBA 1.
2.
• Phase I – for high risk properties If property type/use matches the list of NAICS codes for Environmentally Sensitive Conditions • • Records Search with Risk Assessment – low risk properties Includes a search of the government databases (compliant with AAI); A search of historical use records, and; •
A risk assessment by an environmental professional determining whether the site is “High”, “Elevated” or “Low” risk
• New Gas Station/Dry Cleaner Requirements 34
Sample SBA Policy Matrix
Minimum Due Diligence Requirements Real Estate Loan Type Low Risk Loans <$150K $150K < $2M
Questionnaire RSRA/TSA
High Risk* Loans – NAICS Codes Gas Station Dry Cleaners
Phase I Phase I + Evidence of UST Compliance Phase I
Dry Cleaner (older than 5 years old) Special Use Facilities (i.e. Daycare)
Phase I and Phase II More specific requirements (i.e. Lead Paint Testing, Lead in Drinking Water, etc) Phase I Phase I + Evidence of UST Compliance Phase I Phase I and Phase II More specific requirements (i.e. Lead Paint Testing, Lead in Drinking Water, etc) Page 35
Impact of Lender Size/Resources
Regional & National Lenders
• Resources in place to understand environmental issues on the property • Screen for lower-risk loans • Have staff/internal resources to manage environmental risk
Credit Unions/Community Banks
• No on-staff environmental expertise (typically) • Not as sophisticated with regard to environmental issues or due diligence options available • Often rely only on environmental questionnaires and/or proceed without accurate knowledge of environmental condition of property •
Rely on external guidance to dictate their practices
Types of Due Diligence
• Environmental questionnaire • Desktop due diligence • Transaction Screens • Phase I Environmental Site Assessments • Phase II, III, Remediation, etc. • Environmental insurance
Policy Matrix Becoming Common
Minimum Due Diligence Requirements Real Estate Loan Type Low Risk Loan new High Risk* Loans new Renewals -Low Risk Renewals -High Risk Multi-Family Outdated Phase I <$250K
Questionnaire/Desktop Phase I/Transaction Screen Questionnaire/Desktop Questionnaire/Desktop Questionnaire/Desktop Questionnaire/Desktop
$250K < $1M
Desktop/Transaction Screen Phase I/Transaction Screen Questionnaire/Desktop Questionnaire/Desktop Desktop/Transaction Screen Questionnaire/Desktop
>$1M
Phase I Phase I Questionnaire/Desktop Desktop/Transaction Screen Desktop/Transaction Screen Desktop/Phase I update Page 38
Common Residential Issues
• • • • • • • • Lead Based Paint Asbestos Radon Mold Neighboring properties Stormwater Runoff (for incomplete C&D) Heating Oil Tanks Meth Labs (emerging)
Common Commercial Issues
• UST’s • Gas Stations • Spills • Storage/disposal of Hazardous Waste • Superfund • Vapor Intrusion • Dry Cleaners • Mold, lead, asbestos, etc.
• Stormwater Runoff
Environmental Issues In Real Estate Valuation
– Contamination – Green/Sustainability
Environmental & Appraisals
Types of Contamination – Building Contamination • E.g., asbestos, lead paint, radon, formaldehyde – Encapsulate, Enclosure, Removal – Soil & Groundwater Contamination • E.g., hydrocarbons, solvents – Phase I (initial review) through III (remediation)
Environmental & Appraisals
Green/Sustainability – A development that meets the needs of the present without compromising the ability of future generations to meet own needs – Goal – merge the priorities of economic prosperity, environmental quality and social equity.
NET ZERO HOUSE
LEED PLATINUM 801 17 TH , NW, DC
Environmental & Appraisals
Green/Sustainability - Valuation Issues – Initial Costs are typically higher – Benefits both direct & indirect • Direct – Reduced operating expenses – – – – Reduced maintenance costs Increased occupancy rates Decreased tenant turnover Possible increased rental rates • Indirect – Appeal to tenants’ social conscience/image – Is it too new to measure value premium???
Examples of Environmental Concerns for Lenders
1. Foreclosures 2. “Boring” property that used to be auto shop… 3. Retail that used to be Gas Station 4. Removal of waste from a property by lender triggers possible action
What the seller sees…
What the buyer/lender should see…
•
Summary
Lenders have unique processes and reasons for conducting due diligence.
• • • • Market pressures have reinforced long-term trend to increased due diligence.
Regulators enforcing risk management due to a perceived over concentration of risk regarding commercial real estate.
Risk Management (Credit, Collateral, Environmental, etc.) is as critical as ever to lenders.
Environmental and appraisals are both pieces of the puzzle that are being revised under the current environment.
Contact Information: Derek Ezovski
860.838.5388
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How to Learn More?
Convergence of Appraisal and Environmental Services within Financial Institutions
Eric Schwartz, MAI, SRA Chief Appraiser Appraisal Review Department Amegy Bank of Texas July 2013 Disclaimer: The opinions expressed are solely those of the author and are not necessarily the opinions of the management or employees of Amegy Bank.
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Management of Environmental Services
• Vendor Pool – Qualifications – Who is “qualified”?
• Professional Credentials • Geographic competency • Property competency July 24, 2013 54
Management of Environmental Services
• Database Management – In-house • Pros – – – – Easily tailored to individual requirements Use of existing resources Customizable Integration into other databases July 24, 2013 55
Management of Environmental Services
• Database Management – In-house (continued) • Cons: – – – Reallocation of limited resources Functional requirements may not be understood by staff ASTM standards may seem “foreign” to appraisers/reviewers July 24, 2013 56
Management of Environmental Services
• On-line database management tools – Real Estate Management Information Service – RIMS • Web based project management system – – Procurement and tracking Vendor management – Performance • Pros: – – Reasonably low cost Automated credential monitoring – Secure report upload/download/storage July 24, 2013 57
Management of Environmental Services
• Features to look for – – Online service request – Ease of interface for vendor and management – Automated task and project tracking – Vendor Performance reports – Contact database management system – 24/7 accessibility July 24, 2013 58
Management of Environmental Services
• Synergies of task types – Appraisals and environmental reports must be tied to the same project. Requires a hierarchical management system similar to: • Project – Task » External » Internal – Reporting » » External Internal July 24, 2013 59
Management of Environmental Services
• • Environmental due diligence Least stringent to most stringent – ASTM Transaction Screen – Phase I “Lite” ESA – AAI/ASTM Phase I ESA July 24, 2013 60
•
Management of Environmental Services
Bank personnel and appraisers should possess some level of competency with: – ASTM E-1527-05: Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process (known as ESA) – ASTM E-1528-06: Standard Practice for Environmental Site Assessments: Transaction Screen Process » Reference: www.astm.org
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Management of Environmental Services
• Process Management – Within the appraisal/real estate unit?
• Maintain database of appropriate service providers • Understand qualifications of service providers • Internal reviews of Transaction Screens, Phase I “Lite” and Phase I – Recommendations may need to be outsourced to qualified environmental experts/attorneys July 24, 2013 62
Management of Environmental Services
• The appraiser’s role – Eyes, ears and nose of the lender • Recognize your limitations • You are likely not an environmental professional, but… • Tell us what you see/smell and hear (the contact say) • Why?.....................
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Management of Environmental Services
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Management of Environmental Services
• Some banks ask you to note if you observed any of the following: – Storage tanks – Collection Sites – Drums/containers and/or pesticides/chemicals – – Asbestos Miscellaneous • Soil contamination • Water leaks • Water damage • Mold July 24, 2013 65
Management of Environmental Services
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Management of Environmental Services
• • Exposure Draft of Proposed Revisions to Guide Note 6: Consideration of Hazardous Substances in the Appraisal Process (5/28/2013) Guide notes are not part of the standards of professional practice but instead provide guidance on how the standards may apply to specific issues.
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Management of Environmental Services
• Highlights of the proposed revisions to Guide Note 6 – Explains the differences between the existence of hazardous substance(s) and environmental contamination; – Consideration of the Competency Rule and Scope of Work Rule – Extraordinary assumptions and hypothetical conditions – Definitions – Basis of proper valuation July 24, 2013 68
Management of Environmental Services
– Guide Note 6-Consideration of hazardous substances
in the appraisal process is fundamental to the
appraisal of real property.
– Need for special consideration to the impact of hazardous substance on the valuation of real property.
– Hazardous substances are considered environmental contamination when their concentrations exceed appropriate regulatory standards. (see definitions in GN6) July 24, 2013 69
Management of Environmental Services
• • • Guide Note 6- Competency Competency rule in USPAP, Code of Professional Practice and the International Valuation Standards (IVS) Most appraisers do not have the knowledge, training and expertise required to detect the presence of hazardous substances or to measure the quantities of such material.
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Management of Environmental Services
• • • Guide Note 6- Competency (continued) If the assignment calls for the appraiser to take into account most appraisers rely on other professionals for assistance.
If the appraiser lacks the knowledge and expertise they have to disclose that lack of knowledge and experience prior to the acceptance of the assignment.
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Management of Environmental Services
• • • • Guide Note 6 – Scope of Work How and to what extent the appraisal problem will address known or suspected hazardous materials that may impact the property.
Assignment conditions cannot limit the scope of work such that the assignment results are not credible for the intended use.
Cannot allow the client’s objectives or the intended use to cause assignment results to be biased.
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• • • Guide Note 6 – Extraordinary Assumptions
and Hypothetical Conditions
Extraordinary assumptions would be employed when you are relying on the work of others.
Hypothetical conditions are used when the appraiser estimates the value of the property known to be contaminated in an unimpaired or uncontaminated condition. July 24, 2013 73
• • • • Guide Note 6 – Basis for Property Valuation Impaired value – The “as is” value of the property Unimpaired value – The market value developed of the contaminated property employing a hypothetical condition the property is not contaminated Diminution of value – Effects of costs to remediate plus use costs plus risk (stigma too).
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Management of Environmental Services
• What’s the appraiser to do?
– If you see it….report it.
• Call the client • Take photos and send them to the client • Write it up in your report • Calculate diminution in value if appropriate • Employ a hypothetical condition or extraordinary assumption if appropriate • Ensure your results are credible July 24, 2013 75
Management of Environmental Services
• What steps would you take if you saw this during the property inspection?
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Management of Environmental Services
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Management of Environmental Services
• • If FNMA, SBA, HUD and the bank are concerned about environmental conditions….shouldn’t you be?
What is your client’s policy?
– Do they require Transaction Screens based on loan amounts?
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Management of Environmental Services
• Resources – Guide Note 6 – Exposure Draft is out (5/28/13) –
Analyzing the Effects of Environmental
Contamination on Real Property (AI Seminar) – USPAP – Competency Rule; Advisory Opinion 9 – SBA SOP 50 10 5(C) Subpart B, Chapter 4 for 7A loans and Subpart C, Chapter 3 for 504 loans – NAICS Codes of Environmentally sensitive industries July 24, 2013 79
EBA 2010 www.envirobank.org
How it all started ...
• • • Lender liability issues in the early 1990s Environmental regulations Bankers wanted a place to share best practices and to learn additional skills EBA 2010 www.envirobank.org
Environmental Risk Management Issues
• • • • • • • Bank Risk Tolerance Business Environmental Risk Distressed Assets& Restructurings Loan modifications/renewals Workouts, Foreclosure, Bankruptcy Climate Change Risk Bank Failures EBA 2010 www.envirobank.org
Training
• • • • • • Environmental credit risk management Sustainable Financing (green buildings) Brownfield Redevelopment Sustainable development/carbon risk underwriting Management issues 2 Conferences per Year EBA 2010 www.envirobank.org