1. 1 Environmental Risk Management and Best Practices for Lenders and Appraisers 2014 Appraisal Institute Annual Meeting August 5, 2014

2. Current Trends in Lending/Financing of Commercial Real Estate Pressure from regulators New ASTM Standard for Phase I’s New Transaction Screen Assessment (TSA) Standard SBA Lending Lenders updating environmental/appraisal policies More levels/forms of due diligence than ever before on more loans Seems to be a big push in the CRE market again… 2

3. Other Fire Sales Happening

4. How Environmental Issues Often Seem

5. Environmental & Appraisals Types of Contamination  Building Contamination  E.g., asbestos, lead paint, radon, formaldehyde  Encapsulate, Enclosure, Removal  Soil & Groundwater Contamination  E.g., hydrocarbons, solvents  Phase I (initial review) through III (remediation)

6. Appraiser Poll Question: Are environmental issues typically not looked at because of ignorance or apathy? Response: We don’t know and we don’t care…

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8. Comments from LinkedIn by Appraisers I agree that hardly anyone outside the appraisal world reads USPAP. That includes AMC's and Lender's that often make requests to appraisers which are not compliant with USPAP. This leads to both appraiser and lender frustration. If USPAP is the governing document for appraisers, you would think at a minimum that underwriters would be required to understand the document. I dread taking the refresher every 2 years. It's definitely the most boring CE class. It usually turns into 8 hours of complaining about the profession. What is USPAP? Does any lender really care about USPAP anymore? Basically, lender guidelines appear to always over rule USPAP. Professor Warren, your last comment it sooooo true. We all need to wake up to what is really happening vs debating appraisal methods among ourselves, as if the typical big boy lenders really care about appraisal methods or quality. That being said, it seems a bit ridiculous that we create and enforce rules that many lenders could care less about.

9. Comments from LinkedIn by Environmental Consultants You will always have a problem until lenders start rejecting sub-standard Phase I ESA's. When lenders are accepting Phase I's that have zero historical research and records reviews that cost $1200 and were done in five days, it will not matter who does the site visit. Unfortunately, a significant part of the industry has a product mentality rather than one of service. The result is a business solely driven by price, thus tempting the industry shortcomings. Professor Warren, your last comment it sooooo true. We all need to wake up to what is really happening vs debating appraisal methods among ourselves, as if the typical big boy lenders really care about appraisal methods or quality. That being said, it seems a bit ridiculous that we create and enforce rules that many lenders could care less about.

10. Appraisal Institute Survey - 2013

11. CRE Appraiser Concerns  Fee pressure & expanding scope of work  Formulary approach (forms, checklists, ratios, indices) gaining more prominence  Greater liability  Increasing barriers to direct communication with lenders resulting in appraisal report acceptance and/or perceived report quality issues  Over regulation of appraisal profession 11

12. Concerns of Appraiser Clients  Long turnaround times  Cost of appraisals  Misunderstandings concerning the scope of work in engagement letters  Compliance with standards/regulation  Sufficiently supported value conclusions  Quality work product  Shortage of qualified appraisers  Concise valuations (do not want lengthy reports) 12

13. Hottest Topics for Staff Appraisers  Inadequate market analyses  Appraisal compliance with bank regulations  Not recognizing or appreciating clients’ needs  Insufficient details on market conditions and trends affecting real property  Going concern valuations (different methodologies causing confusion)  Reluctance to interact with client out of fear of violating appraiser/client “firewall” 13

14. Appraiser Challenges

15. Take Aways  Communication Breakdowns  Tough and uncertain regulatory environment  Unsatisfied clients and frustrated service providers  Clear need (and opportunity) to bridge the gap 15

16. Moving Forward Higher risk transactions –Commission appraisal and environmental together –Appraisal prepared for as-is market value –Environmental assessment returned to bank and information provided to appraiser to determine value as-impaired –“As is impaired” may not = “as-is clean” – cost to cure because of potential market resistance

17. Challenges that Appraisers Face Challenges –Pressure on bank appraisal/environmental departments –Cost to cure calculations –Not all appraisers are competent to assess environmental impacts (might have to call one in) –Bidding process – appraisers would need to know this upfront because the as-is impaired is a different kind of assignment –Potential project delay/cost increase

18. Lenders’ Reaction to Environmental Issues…

19. Issues Important to Lenders Collateral Devaluation Direct Liability - Loan origination to foreclosure Reputational Risk (Brand and Image) Operational & Enterprise Risk Credit & Trust Risk … but at the end of the day, the primary issue for lenders is Business Risk

20. Risk Management Challenge “…Information is more available than it has ever been, but the ability to know what is pertinent and what is true is more challenging today.”  Martha Cummings – head of Risk, Banco Santander

21. Key Changes to Phase I’s - 2013

22. Who Qualifies as an Environmental Professional? Professional/Educational Qualifications Relevant Experience Professional engineer or professional geologist license/registration 3 years Federal or state license/certification to perform environmental inquiries 3 years B.A./B.S. degree or higher in any science or engineering field 5 years No B.A./B.S. degree10 years Page 22

23. Key Changes: Simplified “Recognized Environmental Condition” Definition More closely aligned with the EPA’s All Appropriate Inquiries (AAI) “objective” de minimis extracted as a stand-alone definition Some instructional language added to historical and site visit sections

24. New: HREC Split Redefined Historical Recognized Environmental Condition Past releases addressed to unrestricted residential use Must consider current regulatory framework (rules change) HRECs are not RECs Created new Controlled Recognized Environmental Condition term Past releases addressed to non-residential standard, subject to some type of control CRECs are RECs and must be included in the conclusions section of the report de minimis” CAN be used to describe an HREC de minimis” CAN NOT be used to describe a CREC

25. Agency File/Records Reviews Clients thought it was already being done Consistency needed New language: Should be conducted for property and adjoining properties If not conducted, explain why Alternate sources ok

26.  E1527 has been silent on vapor  EPA recommended the task group not ignore the vapor pathway  2013 revision acknowledges the vapor pathway in “migration” definition  Clarifies “Indoor Air” non-scope Vapor

27. Vapor Intrusion

28.  Task group split about 50/50  Ultimately agreed that:  Recommendations are not required by the standard.  User should consider whether recommendations are desired.  Recommendations are an additional service  REALLY?? Recommendations

29. How Did AAI Affect Lenders For the first time, there was a federal statutory authority saying what is needed for a Phase I environmental site assessment Biggest impact of AAI on lenders were the changes to regulatory and government agencies – specifically FDIC guidelines and the SBA

30. Regulators Are Now Talking About Environmental http://www.occ.gov/publications/publications-by- type/comptrollers-handbook/cre.pdf

31. NCUA Environmental Guidance

32. FDIC Highlights FDIC emphasizes process and consistency. Training Policies and Procedures should be established; Environmental Risk Analysis should be conducted; Document due diligence; Track changes to policy and consistent application of policy. Monitoring Lenders must avoid “participating in management” of the business and thereby assuming liability under CERCLA. Most attorneys recommend a Phase I ESA in the event of foreclosure.

33. OCC Updates Develop policies and procedures that reflect potential environmental risks associated with lending Provide for receipt and evaluation of environmental reports prior to making final commitment. Ensure that persons responsible for evaluating environmental risk possess relevant knowledge, skill and competence. A bank’s policy should reflect the EPA’s AAI rule.

34. OCC Updates The policy should include: Analysis of current laws and due diligence requirements; A level of due diligence internally required on all real estate transactions Risk thresholds based on property type, use and loan amount for determining when and what type of due diligence is used; Varying due diligence methods depending on the type of loan, the loan amount and the risk category, including questionnaire or screening, site visit, government records review, historical records review, etc.

35. OCC Updates The policy should include: The potential for impacts from asbestos and lead based paint; Appraisal requirements for disclosing and taking into consideration any environmental risk factors; Criteria for evaluating environmental risk factors and costs in the loan approval process; Environmental documentation for commitment letters, reps and warranty, etc. A means of evaluating potential environmental liabilities for foreclosures.

36. Small Business Administration Update SBA updated its Environmental Policy Effective August 1, 2008 and updated six times since (most recently in January 2014). Especially important for institutions with preferred status who do SBA underwriting. 7A and 504 lenders must adhere to this policy. Has become default policy for many lenders.

37. SBA Environmental Due Diligence Policy 2 levels of Environmental Due Diligence for SBA 1. Phase I – for high risk properties If property type/use matches the list of NAICS codes for Environmentally Sensitive Conditions 2. Records Search with Risk Assessment – low risk properties Includes a search of the government databases (compliant with AAI); A search of historical use records, and; A risk assessment by an environmental professional determining whether the site is “High”, “Elevated” or “Low” risk New Gas Station/Dry Cleaner Requirements

38. Sample SBA Policy Matrix Minimum Due Diligence Requirements Real Estate Loan Type <$150K$150K < $5MM Low Risk Loans QuestionnaireRSRA/TSA High Risk* Loans – NAICS Codes Phase I Gas Station Phase I + Evidence of UST Compliance Dry Cleaners Phase I Dry Cleaner (older than 5 years old) Phase I and Phase II Special Use Facilities (i.e. Daycare) More specific requirements (i.e. Lead Paint Testing, Lead in Drinking Water, etc)

39. Dry Cleaners

40. The Trouble with Dry Cleaners

41. Size has Mattered (but that doesn’t have to be the case) Regional & National Lenders Resources in place to understand environmental issues on the property Screen all loans by an EP Have staff/internal resources to manage environmental risk Credit Unions/Regional & Community Banks No on-staff environmental expertise (typically) Not as sophisticated with regard to environmental issues or due diligence options available Often rely only on environmental questionnaires and/or proceed without accurate knowledge of environmental condition of property Rely on external guidance to dictate their practices

42. Environmental Due Diligence Options Environmental questionnaire (EQ) Desktop due diligence (various levels) Transaction Screen Assessment (TSA) Phase I Environmental Site Assessments Phase II, III, Remediation, etc. Storm water Issues Sustainability/Green Issues Environmental Insurance Others

43. Policy Matrix Page 43 Minimum Due Diligence Requirements Real Estate Loan Type <$250K$250K < $1M>$1M Low Risk Loan - new Questionnaire/DesktopDesktop/Transaction Screen Phase I High Risk* Loans - new Phase I/Transaction Screen Phase I Renewals -Low Risk Questionnaire/Desktop Renewals -High Risk Questionnaire/Desktop Desktop/Transaction Screen Multi-Family Questionnaire/DesktopDesktop/Transaction Screen Outdated Phase I Questionnaire/Desktop Desktop/Phase I update

44. Common Commercial Issues USTs Fuel Oil Tanks Spills Storage/disposal of Hazardous Waste Vapor Intrusion Mold Gas Stations Dry Cleaners Lead, asbestos Radon Storm water Runoff Superfund

45. What the Seller Sees

46. What the Buyer/Lender Should See

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49. Best Practices/Takeaways  Create and follow environmental policies and procedures;  Use commitment fees from borrowers to cover the costs of the due diligence;  At a minimum, obtain an environmental questionnaire and some form of government environmental records for each commercial transaction;  Different types of properties require different levels of due diligence;  Start the process as early as possible to allow enough time for evaluation and follow-up work that may be required.  Work with a company or expert that has experience in this area and consider outsourcing the review process similar to other functions that are not “core-competencies” of the bank.

50. Summary Lenders have unique processes and reasons for conducting due diligence. Market pressures have reinforced long-term trend to increased due diligence. Regulators enforcing risk management due to a perceived over-concentration of risk regarding commercial real state. Risk Management (Credit, Collateral, Environmental, etc.) is as critical as ever to lenders. Environmental and appraisals are both pieces of the puzzle that are being revised under the current environment.

51. How Much and How Long??

52. ORMS Overview  ORMS was founded with credit unions, community and regional banks as its primary focus;  ORMS serves as natural extension of our lender clients;  ORMS helps lenders develop and execute environmental policies and procedures;  ORMS helps lenders focus on the low level due diligence needs;  ORMS helps lenders review and make decisions on existing environmental reports and information;  ORMS helps lenders do more risk management in a cost-effective manner by outsourcing the environmental risk management process.

53. ORMS helps with the 5 Steps of Risk Management  Identify Risk  Assess Risk  Develop Controls or Risk Strategy  Implement policy/controls  Evaluate policy/controls

54. Product and Services  ORMS EnviroFlash™ – current data review and opinion designed for low risk loans  ORMS Desktop Review (RSRA) – current data + historical research + opinion  ORMS Property File Review  3 rd Party Reviews/Phase I Updates  Assistance with selection of environmental consultants on behalf of clients  Policy Development and Evaluation  Training Programs

55. How ORMS is Different  ORMS doesn’t do Phase I’s/Phase II’s (although we can help you manage through the process).  ORMS is set up to be a business advisor with our clients, not a data driven product. We evaluate each situation and help select the most effective solution.  ORMS makes sense of the issues so that you can make a informed risk-based decisions.  ORMS provides services nationwide.

56. How ORMS is Different  ORMS provides solutions/strategies to resolve environmental issues;  We do more research:  Property cards  Internet Search  We utilize environmental risk management professionals  We provide follow up help  Our program includes data + so much more.  WE CAN WORK WITH YOU AND YOUR BORROWERS TO HELP FIGURE OUT SOLUTIONS TO THE ISSUES

57. Upcoming EBA Meetings January 2015 – Charleston, SC June 2015 – Denver, CO January 2016 – Long Beach, CA June 2016 – Fort Worth, TX

58. Convergence of Appraisal and Environmental Services within Financial Institutions Eric Schwartz, MAI, SRA Chief Appraiser Appraisal Review Department Amegy Bank of Texas August 2014 Disclaimer: The opinions expressed are solely those of the author and are not necessarily the opinions of the management or employees of Amegy Bank. August 5, 2014 58

59. Vendor Pool  Qualifications – Who is “qualified”?  Professional Credentials  Geographic competency  Property competency August 5, 2014 59 Management of Environmental Services

60. Database Management  In-house  Pros-  Easily tailored to individual requirements  Use of existing resources  Customizable  Integration into other databases August 5, 2014 60 Management of Environmental Services

61. Database Management  In-house (continued)  Cons:  Reallocation of limited resources  Functional requirements may not be understood by staff  ASTM standards may seem “foreign” to appraisers/reviewers August 5, 2014 61 Management of Environmental Services

62. On-line database management tools  Real Estate Management Information Service – (eg. RIMS)  Web based project management system  Procurement and tracking  Vendor management  Performance  Pros:  Reasonably low cost  Automated credential monitoring  Secure report upload/download/storage August 5, 2014 62 Management of Environmental Services

63. Features to look for:  Online service request  Ease of interface for vendor and management  Automated task and project tracking  Vendor Performance reports  Contact database management system  24/7 accessibility August 5, 2014 63 Management of Environmental Services

64. Synergies of task types  Appraisals and environmental reports must be tied to the same project. Requires a hierarchical management system similar to:  Project  Task External Internal  Reporting External Internal August 5, 2014 64 Management of Environmental Services

65. Environmental due diligence Least stringent to most stringent  Environmental Questionnaire  Desktop Due Diligence/Screening  ASTM Transaction Screen  AAI/ASTM Phase I ESA  Phase I “Plus” August 5, 2014 65 Management of Environmental Services

66. Bank personnel and appraisers should possess some level of competency with:  ASTM E-1527-13: Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process (known as ESA)  ASTM E-1528-14: Standard Practice for Environmental Site Assessments: Transaction Screen Process Reference: www.astm.org August 5, 2014 66 Management of Environmental Services

67. Process Management  Within the appraisal/real estate unit?  Maintain database of appropriate service providers  Understand qualifications of service providers  Internal reviews of Desktop Reports, Transaction Screens, and Phase I  Recommendations may need to be outsourced to qualified environmental experts/attorneys August 5, 2014 67 Management of Environmental Services

68. The appraiser’s role  Eyes, ears and nose of the lender  Recognize your limitations  You are likely not an environmental professional, but…  Tell us what you see/smell and hear (the contact say)  Why?..................... August 5, 2014 68 Management of Environmental Services

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70. August 5, 2014 70 Management of Environmental Services Tell the client what you observed. If you don’t tell the client early the assignment process, you might get a reaction like the following from the Chief Appraiser.

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72. Some banks ask you to note if you observed any of the following:  Storage tanks  Collection Sites  Drums/containers and/or pesticides/chemicals  Asbestos  Miscellaneous  Soil contamination  Water leaks  Water damage  Mold August 5, 2014 72 Management of Environmental Services

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74. August 5, 2014 74 Management of Environmental Services Scope of Work - The appraiser is to contact the Client in cases of extraordinary assignment or limitations (e.g., restricted subject access, lack of lease information for known key tenants, discovery of significant environmental impairment, etc.) to consider possible adjustments to the scope of work. In such cases, while the bank account officer’s input may be useful, adjustments to the scope of work for any appraisal assignment must approved by the Client. Environmental Issues - It is recognized that appraisers are not qualified to detect hazardous waste and toxic materials. Moreover, it is recognized that any comments made that may suggest the possibility of the presence of such substance is not confirmation of the presence of hazardous waste and/or toxic materials. Such determination would require investigation by a qualified expert in the field of environmental assessment. The appraiser observation is important in revealing the possibility of “red flag” environmental situations or conditions. For this reason, the appraiser is required to complete the Environmental Site Inspection form.

75. Appraisal Institute Guide Note 6: Consideration of Hazardous Substances in the Appraisal Process Guide notes are not part of the standards of professional practice but instead provide guidance on how the standards may apply to specific issues. August 5, 2014 75 Management of Environmental Services

76. Highlights of Guide Note 6  Explains the differences between the existence of hazardous substance(s) and environmental contamination;  Consideration of the Competency Rule and Scope of Work Rule  Extraordinary assumptions and hypothetical conditions  Definitions  Basis of proper valuation August 5, 2014 76 Management of Environmental Services

77.  Guide Note 6-Consideration of environmental conditions along with social, economic and governmental conditions is fundamental to the appraisal of real property. (Introduction to Guide Note 6).  Need for special consideration to the impact of hazardous substance on the valuation of real property.  Hazardous substances are considered environmental contamination when their concentrations exceed appropriate regulatory standards. (see definitions in GN6) August 5, 2014 77 Management of Environmental Services

78. Guide Note 6- Competency Competency rule in USPAP  Properly identify the problem to be addressed and have the knowledge and experience necessary to complete the assignment; or  Disclose the appraiser’s lack of knowledge or experience to the client before accepting the assignment….take all steps necessary…and describe the steps take; or  Withdraw from the assignment August 5, 2014 78 Management of Environmental Services

79. Guide Note 6- Competency (continued) If the assignment calls for the appraiser to take into account the effects on value of hazardous substances, most appraisers rely on other professionals for assistance. If the appraiser lacks the knowledge and expertise they have to disclose that lack of knowledge and experience prior to the acceptance of the assignment. August 5, 2014 79 Management of Environmental Services

80. Guide Note 6 – Scope of Work How and to what extent the appraisal problem will address known or suspected hazardous materials that may impact the property. Assignment conditions cannot limit the scope of work such that the assignment results are not credible for the intended use. Cannot allow the client’s objectives or the intended use to cause assignment results to be biased. August 5, 2014 80 Management of Environmental Services

81. Guide Note 6 – Extraordinary Assumptions and Hypothetical Conditions Extraordinary assumptions would be employed when you are relying on the work of others. Hypothetical conditions are used when the appraiser estimates the value of the property known to be contaminated in an unimpaired or uncontaminated condition. August 5, 2014 81 Management of Environmental Services

82. Guide Note 6 – Basis for Property Valuation Impaired value – The “as is” value of the property Unimpaired value – The market value developed of the contaminated property employing a hypothetical condition the property is not contaminated Diminution of value – Effects of costs to remediate plus use costs plus risk (stigma too). August 5, 2014 82 Management of Environmental Services

83. What’s the appraiser to do?  If you see it….report it.  Call the client/email the client  Take photos and send them to the client  Write it up in your report/Put it in the letter of transmittal  Calculate diminution in value if appropriate  Employ a hypothetical condition or extraordinary assumption if appropriate  Ensure your results are credible August 5, 2014 83 Management of Environmental Services

84. August 5, 2014 84 Management of Environmental Services What steps would you take if you saw this during the property inspection?

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90. Appraisal Report Language Ace Appraisal Services is not qualified to detect the existence of potentially hazardous material or underground storage tanks (USTs) which may be present or, or near, the subject site. The existence of hazardous materials or USTs may affect the value and marketability of the subject property. For the purposes of this appraisal assignment, Ace Appraisal Services has assumed that the subject property is not affected by hazardous materials which may be present on or in proximity to the subject property. Unless otherwise stated in this report, any value conclusions are predicated on the assumption that the subject property is free of contamination, environmental impairment or hazardous materials. Unless otherwise stated in the appraisal report, the existence of hazardous material was not observed by the appraiser(s) and the appraiser(s) has no knowledge of the existence of such materials on or in the property. The appraiser(s), however, is/are not qualified to detect such substances. The presence of substances such as asbestos, urea-formaldehyde foam insulation or other potentially hazardous materials may affect the value of the property. No responsibility is assumed for any such conditions, or for any expertise or engineering knowledge required for discovery. The client is urged to retain an expert in this field, if desired. August 5, 2014 90

91. Appraisal Report Language Unless otherwise stated in this report, the existence of hazardous material, which may or may not be present on the property was not observed by the appraisers. Ace Appraisal Services has no knowledge of the existence of such materials on or in the property. Ace Appraisal Services, however, is not qualified to detect such substances. The presence of substances such as asbestos, urea formaldehyde foam insulation, contaminated groundwater or other potentially hazardous materials may affect the value of the property. The value estimate is predicated on the assumption that there is no such material on or in the property that would cause a loss in value. No responsibility is assumed for any such conditions, or for any expertise or engineering knowledge required to discover them. The client is urged to retain an expert in this field, if desired. We have inspected, as thoroughly as possible by observation, the land; however, it was impossible to personally inspect conditions beneath the soil. Therefore, no representation is made as to these matters unless specifically considered in the appraisal. August 5, 2014 91

92. Appraisal Report Language Sample of Extraordinary Assumptions when appraising convenience stores, auto dealerships and similar property types. REALLY ACE APPRAISAL SERVICES has not observed, yet is not qualified to detect, the existence of potentially hazardous material or underground storage tanks, which may be present on or near the site. The existence of hazardous materials or underground storage tanks may have an effect on the value of the property. For this appraisal, REALLY ACE APPRAISAL SERVICES has specifically assumed that the property is not affected by any hazardous materials and/or underground storage tanks that may be present on or near the property. It is an extraordinary assumption of this report that the subject property is environmentally clean August 5, 2014 92

93. If FNMA, SBA, HUD and the bank are concerned about environmental conditions….shouldn’t you be? What is your client’s policy?  Do they determine what level of due diligence based on transaction amount and/or property type? August 5, 2014 93 Management of Environmental Services

94. Resources  Guide Note 6  Analyzing the Effects of Environmental Contamination on Real Property (AI Seminar)  USPAP – Competency Rule; Advisory Opinion 9  SBA SOP 50 10 5(F) Subpart B, Chapter 4 for 7A loans and Subpart C, Chapter 3 for 504 loans  NAICS Codes of Environmentally sensitive industries August 5, 2014 94 Management of Environmental Services

95. Q&A 95

96. Contact Info: Derek Ezovski 860.838.5388 dezovski@orms.com