This time of year many are loosening their belts and fitting in a second serving of turkey, and many lenders are doing end of year reevaluations of policy, including risk management policies. This is a perfect time to evaluate whether your physical due diligence policies are protecting you from a double helping of risk in your portfolio.
During our recent Globe Street webinar on Probable Maximum Loss (PML) Seismic Risk Assessments, I discussed a situation that I see very commonly: brokers call me and ask which “Where should I take this deal? I’m concern this property might not pass a PML, so which bank does not have a seismic policy?” Those lenders who do not have a formal seismic risk management policy often get a double dose of seismic risk:
- High risk properties are not screened out by Seismic PMLs
- And, more subtly, brokers know that they can take potentially more risky deals to these lenders!
So, in a very real way, lenders without seismic risk management policies are likely subject to much greater risk of loss during a major seismic event. There is a lot more discussion in the webinar on how lenders can better understand and use PMLs / Seismic Risk Assessments. It is available to view on demand until January 31, click here to sign up.
Similarly, I served on a panel earlier this year in which environmental risk managers from three major lending institutions discussed how they end up having contaminated properties in their REO portfolios. Several causes were identified, including:
- Consultant errors, where an environmental concern was missed during the Phase 1 Environmental Site Assessment. Maintaining a solid “approved list” of quality environmental consultants can minimize these errors.
- The bank accepted a borrower supplied report, rather than a report from one of the bank’s approved environmental consultants. There are two main problems here: the bank may not know the quality of that particular consultant’s work, and the borrower often just wants the deal to get done with no issues being found (so this could influence their consultant’s determination of the environmental risk of the property).
- Bank staff not following environmental risk policy. Sometimes the appropriate level of due diligence was not done, or a waiver was made after a Phase 1 ESA identified an environmental concern, for of business reasons (often because of the strength of the borrower). There are always reasonable exceptions to policies, but the risk managers noted that this was sometimes abused.
- Legacy loans – Acquisition of another bank or purchase of a portfolio, where the previous bank had a looser environmental due diligence policy; or older loans where due diligence was less stringent.
- Less than a Phase 1 ESA was done. It is not feasible that a Phase 1 Environmental Report be done on every loan (especially small loans or “low risk” properties), so often lower-tier products like Records Search and Risk Assessments and other Desktop Environmental Reviews are used to do an initial risk screen. These products do have an important place in a risk management strategy, and they are better than doing no due diligence at all, but without the level of scrutiny of a Phase 1 ESA it is foreseeable that some polluted properties will slip through the screen.
So for lenders who may have experienced some of these issues, how well are your risk management policies working for you? How are you avoiding excessive seismic and environmental risk exposure? Are there some risks that are inevitable and acceptable? Are there some that you can avoid by tightening up your risk policy?
This is a good time of year to revisit these questions, and think about some New Year’s resolutions.