15 Jul 2011

Environmental Due Diligence – Damned If You Don’t

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Many of your competitors won’t require any environmental due diligence on the loan that you are considering. Why? The reasons are many. National banks have huge loan loss reserves. They can absorb large numbers of small hits that may result from a lack of environmental due diligence. Any loan under $250,000 (Huge Bank #1) or under $500,000 (Huge Bank #2) require only that the Borrower fill out a questionnaire. If there are no red flags in the answers, no further inquiry is made. On the other hand, your small competitors just don’t want to perform environmental due diligence. They don’t want to require the fee of the member and, in many cases, they feel that they know the surrounding communities well. Then there is the question of enforcement. Who knows of a property where the regulators swooped in and required cleanup? Many younger loan officers have just never seen environmental enforcement.

What does the NCUA require? There’s not much guidance, “All credit unions granting real estate secured loans need to be aware of this issue [environmental risk] and credit unions granting member business loans secured by real estate should establish policies and procedures to help ensure liability in this regard is minimized.” Essentially, the regulators will check to see that you have a policy and follow it.

So what should you require? You must have a policy, but how should it read? If you are very conservative and require in depth environmental due diligence for every commercial loan, your members may just go to a competitor. If you do not require environmental due diligence, what risk is there?

To answer this question, we recommend that you ask another question, “how much money can I lose for the credit union without jeopardizing the credit union (and my job)”? National banks who perform no environmental due diligence at loan origination will perform due diligence, generally a Phase I environmental site assessment for approximately $2,000, prior to foreclosure. If at foreclosure the property is found to be contaminated, then in many cases in Michigan, for an additional $10,000 to $20,000, the bank can obtain protections of a baseline environmental assessment, foreclose and sell the property at a discount. Assume an average $50,000 loss. This the banks routinely take in stride.

Can your institution take one or more $50,000 losses per year in stride? If so, you may adopt a lax policy. Naturally this may not happen, or any individual loss could exceed $50,000, but this is a good measuring stick. If the board of directors or management indicate that such potential losses are not acceptable, then a more conservative policy is wise. The key is to consider the issue, confront the realities and to structure your policy to reflect your risk tolerance. Unfortunately, many of your small competitors have simply ignored the issue and heads may roll with their first major loss.

Two other institutions offer guidance. Cencorp Business solutions offers a boilerplate, fill-in-the-blank policy that allows the credit union to decide what loan amount will trigger environmental due diligence and then to structure the level of due diligence. Again, the regulations require only that you have a policy and follow it. The US Small Business Administration has a more detailed policy that is becoming an industry standard. They first look at the type of collateral property to assess generic environmental risk associated with the property use and then the SBA differentiates the level of due diligence by the amount of the loan. All properties require at least a questionnaire filled out the by current property owner. Higher loan amounts and higher risk properties require more assessment.

Protect the credit union and protect your job. Ensure that management and the board of directors consider and establish their expectations and their risk tolerance and create a policy that will fulfill their expectations. All members who seek a loan should expect to pay at least a small fee for this purpose, and the bulk of your loans will require environmental due diligence that costs on the order of $300. Yeoman Group will advise, offer a sample policy template and assist with policy implementation and training at no fee.

You do not want to confront this issue for the first time when the credit union is staring at a large unexpected loss for failure to understand environmental due diligence. If you are not fully comfortable with your credit unions environmental procedures, stop what you are doing, pick up the phone and call Yeoman Group today.

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