2. The RMA Journal September 2008 69
Recent revisions in environmental due dili-
gence requirements have left many lenders
wondering whether their environmental poli-
cies are adequate. Specifically, they want an-
swers to these questions:
• Is it necessary to conduct, for every transac-
tion, a Phase I environmental site assessment
in accordance with the U.S. Environmental
Protection Agency’s All Appropriate Inquiry
(AAI) rule?
• If not, which quick screens are available to
assess lower-dollar loans for environmental
problems?
• Does a transaction screen assessment protect
the borrower from federal cleanup liability?
• Does the “secured creditor” exemption still
protect the bank from liability?
Bankers tasked with updating their bank’s
Phase I and Beyond
By Jamie Haberlen
and Derek P. Pollard
environmental policy should be familiar with
current environmental issues, laws, regula-
tions, and possible remedies as they review and
revise their own risk management policies.
Options for Mitigating Environmental Risk
The goal of an environmental investigation is
to determine the level of impact environmen-
tal contamination may have on real estate val-
ues. Bankers have explicit direction from the
regulatory community on real estate valuation
requirements—except when it comes to envi-
ronmental risk. As a result, environmental due
diligence alternatives range from doing noth-
ing to hiring an environmental professional to
conduct a full-scale Phase I environmental site
assessment in accordance with the EPA’s AAI
regulation or its equivalent, ASTM standard E
A contaminated property securing a loan
exposes the lender to a direct liability for cleanup
costs as well as probable litigation. A borrower
forced to divert cash flow to pay for an unexpected
cleanup is at greater risk of defaulting on a loan.
Accordingly, most banks engaged in commercial
real estate lending manage environmental risk with
appropriate policies and procedures.
Due Diligence Tools
3. September 2008 The RMA Journal70
1527-05. In general, lenders require an AAI-compliant
Phase I environmental site assessment for large loans
(typically those over $1 million) collateralized by com-
mercial real estate. For
the smaller loans, lend-
ers have a wide range of
environmental options
at their fingertips.
Most lenders rely
on one or more of five
commonly used envi-
ronmental risk manage-
ment tools to mitigate environmental risk. Each of the fol-
lowing options has a place in a sound risk management
program.
1. Phase I environmental site assessment. Prepared by
an environmental professional, a Phase I environmental
site assessment includes a review of available records
for a target property and its surrounding area, a review
of historical records, a site visit, and interviews with
past and present owners, operators, and occupants.
The final report contains documentation of all records
reviewed, observations made during the site visit, re-
sults of the interviews, an explanation of any gaps in
data, and any recognized environmental conditions un-
covered along with conclusions and recommendations.
Average cost: $2,700. Turnaround: generally 10 to 15
business days.
2. Transaction screen assessment. Prepared by an environ-
mental professional or bank officer, the transaction screen
assessment consists of three parts: 1) a questionnaire for
property owners or occupants (the most commonly used
is found in a document entitled ASTM E 1528 Standard
Practice for Limited Environmental Due Diligence: Transac-
tion Screen Process), 2) a site visit to observe property con-
ditions, and 3) a limited environmental records review. If
an environmental professional prepares the transaction
screen assessment, the average turnaround is 10 business
days. Average cost: between $800 and $1,000, depend-
ing on what’s included.
3. Desktop review. Environmental data companies com-
pile, map, and continually update millions of federal,
state, local, and tribal environmental records culled
from publicly available databases. Lenders can order
and retrieve the reports, which help identify environ-
mental concerns on the target property and its sur-
rounding area for any U.S. location from any desktop
computer. Both current and historical information is
available, and reports are typically delivered within a
day or two. The reports cost between $150 and $500,
depending on the type and quantity of information or-
dered. A newly available product, the collateral screen, is
even faster and more cost effective than the government
records check report. This subscription-based service
allows lenders with Internet access to tap into a central
database as many times as they wish to instantly retrieve
property records.
4. Environmental questionnaire. The property question-
naire is a simple document that contains anywhere from
10 to 25 questions designed to determine whether the
property in question has any environmental conditions.
The bank lender typically submits the document to the
borrower or seller for completion. As a result, this envi-
ronmental screening tool represents the no-cost, intimate
approach to environmental due diligence. The drawback
to this method is that it lacks outside verification.
5. Environmental Indemnification Agreement (EIA). The
EIA is a legal document that protects the lender against
future lawsuits, losses, and claims for environmental
contamination that either was preexisting or occurred
during the life of a loan secured by real estate. A loan
transaction’s borrowers, collateral owners, and guaran-
tors are required to sign and execute the agreement as
part of the pre-closing loan documentation process. By
signing the EIA, the borrower, collateral owner, and/or
the guarantor agree to indemnify, defend, and hold the
lender harmless if environmental contamination is dis-
covered. The EIA can either be embedded in security
documents or stand alone as a separate document.
Banks should have clear guidelines for underwriters to
follow when faced with the decision of which environ-
mental due diligence tool to use. Many lenders use a mon-
etary threshold as the deciding factor. For example, some
banks require a Phase I environmental site assessment for
all loans valued over $1 million, a transaction screen as-
sessment or a desktop review of government and histori-
cal records for loans ranging from $250,000 to $1 million,
and a transaction screen assessment or an online database
screen of the property along with an environmental ques-
tionnaire for loans valued under $250,000.
Regardless of the criteria used, the bank should spell
out its guidelines in an environmental due diligence poli-
cy. Consulting with environmental experts, real estate at-
torneys, or both prior to updating the policy is a good
idea. These professionals can help ensure that the bank’s
environmental due diligence guidelines are in line with its
overall risk management goals. To help ensure consisten-
cy, it is important to consider the following environmental
risk criteria:
• The size of the loan transaction.
• The transaction’s perceived risk.
• The type of property in question.
• The bank’s risk tolerance.
• The level of environmental expertise at the bank.
• Customary industry practices.
• The borrower’s relationship with the bank.
Regardless of the criteria
used, the bank should
spell out its guidelines
in an environmental
due diligence policy.
4. Advanced Operational
Risk Management
www.rmahq.org
800-677-7621
Understand, assess, and manage your institution’s operational risk exposures
September 15–16, 2008
New York City
MassMutual at
OppenheimerFunds
Course Overview
Advanced Operational Risk Management
provides a detailed analysis of best practice
operational risk management, covering
management processes, policies, methodologies,
and risk mitigation. It will cover not just theory
but also practice: how to build the tools described
and how to use them.
Who Should Attend?
Practitioners with existing knowledge and
experience of operational risk who are moving
into a broader or more senior operational risk
management role, including business line
operational risk managers.
You will learn to:
• Assess and manage your banks’ operational risk
exposures.
• Deliver the appropriate level of policies and
procedures to your firm.
• Obtain better buy-in from the businesses
regarding operational risk.
• Understand the capital implications of
operational risk exposures.
To register, or for more information, please contact Kathy Vitale,
215-446-4003, kvitale@rmahq.org
5. September 2008 The RMA Journal72
• Whether there has been any environmental spill or other
concern on the subject property or adjacent properties.
• The planned use of the property.
• Whether protection from federal cleanup liability under
the Comprehensive Environmental Response, Compen-
sation, and Liability Act (CERCLA) is a concern.
• Whether the loan will be sold in the secondary market.
It is important to remember that environmental risk is
a function of a site’s current and past use and may not
be reflected in its current value. For this reason, the de-
gree of environmental due diligence should be based on
the bank’s transaction exposure, although there is a de
minimis point where extensive environmental investiga-
tion exceeds the bank’s potential return. Lenders should
always proceed with caution, however, as cleanup costs
have been known to exceed property values.
Pros and Cons of Environmental Due Diligence Tools
In revising the environmental policy, the lender must first
resolve whether it is important for the bank if the borrow-
er has liability protection under CERCLA. If so, a Phase I
environmental site assessment conducted in accordance
with EPA’s AAI rule will suffice; EPA also recognized the
ASTM E 1527-05 standard as sufficient protocol for meet-
ing AAI. Put another way, if a property purchaser wishes
to take advantage of any of the three liability defenses to
CERCLA (innocent landowner, bona fide prospective pur-
chaser, or contiguous property owner), he or she has no
choice but to have an AAI- or E 1527-05-compliant Phase
I environmental site assessment prepared by a qualified
environmental professional for the property in question.
If CERCLA liability isn’t a concern and the user has
no reason to suspect that an environmental problem will
arise, a less expensive and faster Phase I, conducted in ac-
cordance with E 1527-00, can be used. If suspicions are
raised or problems are discovered during the assessment
process, the consultant can always modify the work to
comply with the E 1527-05 standard.
While a Phase I environmental site assessment pre-
pared to either stan-
dard is a comprehen-
sive environmental due
diligence tool, it is not
meant to be an exhaus-
tive screen of every en-
vironmental concern
that can materially
impact a property. The
original purpose of the
Phase I was to set up a
defense to CERCLA li-
ability, not to evaluate business risk. Therefore, issues not
specified as considerations under CERCLA—including
vapor intrusion, mold, lead-based paint, and asbestos—
lie outside the scope of the inquiry. If the Phase I is being
used to evaluate business risk, and the borrower will be
repositioning the asset in any way and may have to ex-
cavate soil or renovate, lenders should consider asking
their environmental consultant to screen for these and
possibly other non-scope items, as their presence may
create a significant cost to the user during renovation or
redevelopment.
Beyond the Phase I
Many lenders choose to skip environmental due diligence
when a property appears to be low risk or if a deal can’t
support the time or cost required to perform a Phase I
environmental site assessment. This practice is risky, be-
cause lenders who ignore new FDIC guidelines to perform
an initial risk analysis on all commercial real estate loans
could incur penalties. An alternate, cheaper, and faster
due diligence option is available. Under the FDIC’s up-
dated environmental guidelines, banks are free to choose
the method they use to conduct the initial environmental
screen. Many lenders find that a transaction screen as-
sessment strikes a cost-effective balance between the dual
goals of obtaining enough information to assess business
risk while conserving time and money.
Yet lenders should note that the passage of the 2002
Brownfield Amendments stripped the transaction screen
assessment of its ability to set up a defense to CERCLA
liability. Nevertheless, transaction screens are still popular
due diligence tools, so rather than doing away with the
transaction screen assessment standard, ASTM Interna-
tional revised it for the purpose of “identifying any cur-
rent or past potential environmental concerns at low risk
sites or other sites for which CERCLA liability immunity
is not a concern.” Today, lenders who rely on transaction
screen assessments generally use the updated standard,
ASTM E 1528-06 Standard Practice for Limited Environmen-
tal Due Diligence: Transaction Screen Process, as a starting
point, modifying the process to suit their purposes. Un-
like the Phase I environmental site assessment, a transac-
tion screen assessment does not require the expertise of
a qualified environmental professional, although a bank
without in-house expertise can benefit from hiring a con-
sultant to provide the service. Then, if an environmental
concern arises, the environmental professional can easily
raise the inquiry to the next level.
While a transaction screen assessment’s results are less
conclusive than a Phase I’s, they are generally adequate
for assessing business risk. As long as the bank meets cer-
tain criteria, it typically can rely on this due diligence tool
because of CERCLA’s secured-creditor exemptions. These
exemptions offer lenders who hold ownership in a facility
(“primarily to protect their security interest”) protection
While a transaction
screen assessment’s
results are less
conclusive than a
Phase I’s, they are
generally adequate for
assessing business risk.
6. The RMA Journal September 2008
from CERCLA liability, as long as the lender does not “par-
ticipate in the management of the facility.” Regardless, the
process should be restricted to non-suspect operations,
because while CERCLA’s secured-creditor exemptions
shield lenders from EPA enforcement actions, lenders can
still be held liable under certain state laws.
Some due diligence experts believe transaction screens
will eventually be phased out as desktop due diligence op-
tions become more sophisticated. Desktop due diligence
reports, also known as government records check reports,
are detailed, competitively priced, and delivered quickly
thanks to the Internet. When paired with available histori-
cal reports, this type of screen is an economical and quick
environmental due diligence alternative that can be used
to screen lower-dollar, non-suspect operations, to update
an old report, or as an initial step in the property screen-
ing process.
Desktop due diligence reports detail such issues as leak-
ing underground storage tanks, landfills, or former high-
risk operations (for example, dry cleaners or industrial
facilities) on the subject property or operations of concern
on adjacent properties. Some companies even assign a risk
code to the reports—a feature that is especially beneficial
to lenders without in-house environmental experts and
those who must comply with the Small Business Admin-
istration’s new environmental policy. SBA’s environmental
policy requires that a qualified environmental professional
make the risk determination; if you’re relying on a records
search company to provide the risk code, make sure it uses
qualified environmental professionals to provide the risk
analysis. If potential risks are disclosed, the lender can ad-
dress them early in the transaction by taking due diligence
to the next level, either by pairing the report with a site
visit and questionnaire, or by hiring an environmental pro-
fessional to conduct a Phase I.
Beware the Questionnaire
According to a straw poll conducted by a national envi-
ronmental information firm at RMA’s New Orleans confer-
ence last October, 70 percent of lenders rely on a prop-
erty questionnaire when a Phase I is not performed. The
questionnaire does have marginal value when paired with
other forms of environmental due diligence, but it should
never be relied on as the sole source of information, pri-
marily because the responses are not always reliable.
The seller has a vested interest in disposing of the
property and is unlikely to raise any issues that may
hamper the deal. The borrower, on the other hand, typi-
cally is unaware of environmental problems onsite and
cannot be expected to respond accurately to such ques-
tions as, Have there ever been any spills or releases on the
property? Occasionally, the results of the questionnaire
will shed light on the site’s past operations and use, but
a prudent credit underwriter will complement the ques-
tionnaire with another screening tool, such as a desktop
report or site visit.
Guidelines for Environmental Due Diligence
To ensure that its risk appetite matches its environmental
policy, a bank should take the following actions:
• Review the thresh-
olds for when certain
types of environmen-
tal due diligence are
required.
• Ensure that access to
in-house or outside
environmental due
diligence experts is
available.
• Employ an environ-
mental screen before
or during the underwriting process to address environ-
mental concerns for every transaction.
• Ensure that borrowers are educated about CERCLA and
AAI/ASTM E 1527-05.
Post-AAI, many banks have incorporated a weighted
approach that takes into account both the exposure of the
loan and the perceived risk of the real estate. For high-risk
operations, a higher level of environmental due diligence
should begin at a lower dollar threshold. Therefore, a bank
in the process of updating its environmental policy should
first define its risk appetite (the level of risk the bank is
willing to accept should be defined by management) and
then consult with an environmental attorney or other ex-
pert to customize a program to fit its needs.
Bottom Line
Environmental risk management is growing in importance
in the due diligence process for loan transactions related
to commercial real estate. No longer is environmental risk
management restricted solely to big deals. Properly con-
ducted early in the transaction, environmental risk man-
agement helps protect the bank against a loss of collat-
eral and reduces the potential for loan default. Measured,
incremental environmental due diligence should be an
integral part of the risk management process for all com-
mercial loans collateralized by real estate. v
••
Jamie Haberlen is the national account manager in the Lender Services group at
Environmental Data Resources. Contact him by e-mail at jhaberlen@edrnet.com.
Derek P. Pollard is first vice president and commercial real estate credit policy officer,
Credit Risk Management, at SunTrust Banks, Inc., Atlanta, Georgia. Contact him by
e-mail at derek.p.pollard@suntrust.com.
73
A prudent credit
underwriter will
complement the
questionnaire with
another screening
tool, such as a desktop
report or site visit.
