Helping clients through the process starts with understanding lenders' approach

Dianne Crocker, senior economist and managing director, EDR Market Research Group

As published in Scotsman Guide's Commercial Edition, March 2010.

Amid today's shaky business climate and declining property values, mortgage lenders are finding it more important than ever to protect their bottom line. A disciplined due-diligence process helps them do that.

When it comes to financing commercial real estate, environmental contamination is a risk that can impair -- or even kill -- a deal.

Contaminated property securing a loan transaction can expose a lender to direct liability for cleanup costs as well as probable litigation. It also can cause buyers to default if they're forced to divert cash flow to pay for remediation. And in the case of foreclosure, it can leave the bank with property that may be difficult to sell.

To help protect themselves from unnecessary exposure, most commercial lenders conduct some type of environmental due diligence before extending credit -- usually tailored to the specifics of the deal, such as loan size, past use, planned use of the property or another factor.

It's important for commercial mortgage brokers to know not only why environmental contamination can be detrimental to borrowers and lenders but also how lenders' best practices in environmental risk management have evolved to where they are today. Armed with this knowledge, brokers can better determine whether a property will make a good deal for their clients and lending partners.

Although no two banks manage environmental risk quite the same way, the following six distinct trends have emerged in the past few years obligating lenders to address environmental due diligence proactively.

1. Regulatory pressure

In November 2006, the Federal Deposit Insurance Corp. (FDIC) updated its environmental guidelines for the first time in 13 years. It urged banks to address commercial real estate risk exposure proactively. Other agencies, including the Office of Thrift Supervision, the Office of the Comptroller of the Currency and the Federal Reserve Board, quickly followed suit.

This past September, after scrutinizing risk at the nation's largest banks, regulators expanded the net to include smaller banks. A month later, the FDIC issued guidance to assist banks with nonperforming loans. All of this adds up to a new normal: more government involvement in commercial real estate lending.

Challenged to demonstrate to examiners and regulators that they are complying with policy guidance, lenders are staying abreast of the latest regulatory changes and tools for assessing a property's environmental risk. Lenders that have not yet developed formal environmental policies are doing so. Others are updating existing policies to bring them in line with regulatory guidelines.

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