1 Creating an Integrated Real Estate Risk Function: Development of Synergies Between Appraisal, Environmental, Construction, & Flood Insurance
2 PRESENTATION SUMMARY As part of a commercial real estate transaction, lenders and borrowers often consider real estate appraisals, environmental reviews, construction monitoring, & flood insurance as separate and distinct steps in the process Working collaboratively, the various components of an integrated real estate risk function ensure that the Bank makes prudent lending decisions while ensuring compliance with regulatory requirements (e.g., FIRREA, Interagency Guidelines and OCC CRE Handbook) Most lenders focus on the value there are multiple issues and concerns that can impact the value that is reported in the appraisal The goal of this panel is provide considerations and resultant strategies that can reduce unanticipated risks and result in an improved bank and customer experience
GOALS OF THE REAL ESTATE RISK FUNCTION Independent oversight of the valuation, environmental risk, construction monitoring, and flood insurance functions Compliance with federal regulations and associated guidance servicing various parts of the financial institution including lending units, workout group, REO, and corporate facilities Provide an ordering and review function Work collaboratively to ensure that all facets of real estate risk (real estate valuation, environmental due diligence, construction monitoring, and flood insurance) result in a well-reasoned and supported conclusion taking into consideration geographic nuances (appraisal), potential environmental liabilities, and regulatory compliance 3
4 GENERAL RESPONSIBILITIES OF THE REAL ESTATE RISK FUNCTION Ordering, reviewing and accepting reports and transactional due diligence completed by external third-party vendors; Updating internal policies and procedures in response to regulatory changes; Quality assurance/quality control of third-party reports; Manage pre-approved vendor lists and contractual agreements for external third-party appraisers/environmental/construction consultants; Identifying and applying industry best practices to increase efficiencies; Providing market research and advisory services; and, Periodic training of lending teams.
5 STATUTORY & REGULATORY REQUIREMENTS Valuation: Dodd-Frank Wall Street Financial Reform and Consumer Protection Act (12 USC 5301) Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) (12 USC 3331) Federal Deposit Insurance Corporation Improvement Act (FDICIA) (12 USC 1828) Revised Interagency Appraisal and Evaluation Guidelines - December 2010 FAQs on the Regulatory Capital Rule - May 2015 (FIL-16-2015) Interagency FAQs on Residential Tract Development Lending - Sept. 2005 (FIL-90-2005) FAQs on the Appraisal Regulations - March 2005 (FIL-20-2005) Environmental: Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) (42 USC 9600) CERCLA Lender Liability Exemption: Updated Questions and Answers - July 2007 Environmental Liability - Updated Guidelines for an Environmental Risk Program - November 2006 (FIL-98-2006) Effect of Superfund on Lenders That Hold Security Interests in Contaminated Property - July 2002 (EC-G-2002-155) Guidelines for an Environmental Risk Program - February 1993 (FIL-14-93) Environmental Liability - Final Rule - July 1992 (OCC-BB-92-38) Environmental Liability - October 1991 (SR 91-20 (FIS))
6 STATUTORY & REGULATORY REQUIREMENTS Flood Insurance: National Flood Insurance Reform Act (42 USC 4001) - as amended by: Biggert-Waters Flood Insurance Reform Act of 2012 Homeowners Flood Insurance Affordability Act of 2014 Final Rule to Implement Requirements of the Biggert-Waters Flood Insurance Reform & Homeowners Flood Insurance Affordability - May 2015 (FIL-32-2015) Flood Disaster Protection January 2014 (FDIC Compliance Manual Section V) Updates to Interagency Questions & Answers Regarding Flood Insurance - October 2011 (OCC 2011-42) Revised Interagency Questions & Answers Regarding Flood Insurance - July 2009 (FIL- 42-2009) Mandatory Purchase of Flood Insurance Guidelines - September 2007 (rescinded) Flood Insurance; Limits on Amount of Coverage Required to be Purchased - Massachusetts General Laws Chapter 183, 69 An Act Concerning Municipal Flood Zone Maps and the Prohibition of Flood Insurance as Prerequisites for Mortgage Loan for Certain Properties - Connecticut General Assembly Public Act No. 678 Construction: Commercial Real Estate Lending - August 2013 (OCC Comptroller s Handbook)
7 ISSUES THAT IMPACT MULTIPLE PIECES OF THE REAL ESTATE RISK PROCESS The structure of the transaction may complicate the ability of the Bank to mitigate/manage the environmental risk due to lack of privity between the Bank and the property owner/responsible 3 rd party: If the Site is a leasehold interest, often the responsible party for the remediation is the property owner and not the borrower. If the bank is providing acquisition financing, the responsible party for the remediation may be the seller pursuant to P&S. For long-term remedial projects, the responsible party may not have owned the property for 10+ years. Special use properties (such as automotive dealerships and gasoline stations) often present more significant environmental concerns and more complex allocations of liability amongst various parties resulting in a more complex environmental review process. While historic industrial use may not have an impact on appraisal valuation methodology, such use may result in a higher level of environmental review and remediation prior to redevelopment (especially if redeveloped as residential).
8 MORE ISSUES THAT IMPACT MULTIPLE PIECES OF THE REAL ESTATE RISK PROCESS Recorded activity and use limitations (AUL) and/or deed restrictions that may impact highest and best use of the Site or prohibit future redevelopment of a portion of a Site due to residual contamination Significant environmental remediation costs and on-going long-term monitoring that may adversely impact value of the Site Environmental remediation conducted as a component of redevelopment: Has the estimated remedial cost been integrated into the construction budget? Is the amount reasonable? Is the responsible party for the remediation the same party undertaking the construction project? Is the bank funding the remediation? What is the sequence and will construction impede the remediation or increase its cost?
9 EVEN MORE ISSUES THAT IMPACT MULTIPLE PIECES OF THE REAL ESTATE RISK PROCESS Significant on-site contamination may impede the redevelopment timeframe and the final as complete valuation will delay cause project to miss the market? If appraisal identifies significant deferred maintenance, such as leaking roof or other structure damage, it is possible that these conditions may result in an environmental issue related to microbial matter/mold or poorly maintained lead-based painted surfaces. The identification of deferred maintenance by either an appraisal or environmental vendor may implicate the need for a Property Condition Assessment (PCA). When has construction project progressed to the point where flood insurance is required? Rely on construction inspections to provide notice to the bank?
10 HOW TO PROMOTE SYNERGIES BETWEEN THE GROUPS Understand the loan structure to ensure that an appraisal, environmental, and/or flood insurance are actually needed: Some transaction do NOT require appraisal/environmental (abundance of caution, negative pledge, unsecured transaction, etc.) BUT you may still need flood insurance Leverage historic appraisal and environmental information to ensure that the appropriate level of valuation, environmental due diligence and flood review is completed and is completed on the appropriate collateral. Obtain accurate and detailed property addresses and descriptions to ensure understanding of the collateral, appropriate scoping of the assignment and vendor selection: An inconsequential building that does not provide any contributory value in the appraisal may nevertheless require flood insurance Leverage a single vendor to provide answers to multiple questions: Leveraging appraisal vendor to provide an insurable value for flood purposes or provide periodic construction inspections
11 STRATEGIES THAT CREATE SYNERGIES BETWEEN THE GROUPS CROSS-TRAINING: force people out of their comfort zone and silo mentality; there is no reason why people cannot be cross-trained (e.g., appraisal or construction completing flood reviews) Expand skill set & provide an opportunity for people to become more valuable asset to the organization Need to be a specialist but also good to be real estate generalist VENDOR MANAGEMENT: engage vendors who can fill multiple needs; create an integrated vendor pool (especially in consideration of increased regulatory scrutiny of third-party vendor relationships). COMMUNICATE: foster an atmosphere of open dialogue where people are encouraged to discuss real estate issues with real estate colleagues regardless of area of expertise establish a semi-centralized group. INTEGRATED SYSTEMS: communication and dialogue are enhanced and better decisions are ultimately made if real estate risk records are housed in an integrated system which provides a one-stop shop for business units. REPORTING LINES: communication and dialogue may also be enhanced if various facets of the real estate risk function share a common reporting line.