By Dan Mikes
Throughout my 27 years of providing financing for religious institutions, I have seen a number of instances in which all the financial and other factors were right, but the loan could not be made because the collateral (the land and buildings) was unacceptable due to environmental contamination.
While this is a fairly rare occurrence, it is not uncommon for a loan closing to be delayed due to the need for additional environmental testing — even in instances where the current lender deemed a previous environmental study to be sufficient to support the existing mortgage. Your leadership team should be aware of this risk, and, when seeking refinancing, should provide prospective lenders with copies of old environmental studies early in the process.
Against the backdrop of another round of headlines about rising interest rates, many religious institutions (RIs) have reached out to lenders to assess whether now might be a good time to refinance. Even if you have a year or two remaining on your current note, it might make sense to seek a longer-term fixed rate now rather than take your chances with where rates might be when your loan matures. It typically takes about 90 days to go through the loan review and decision process, which includes securing a property appraisal, a title insurance commitment, etc. Ninety days might seem like a long time if you are concerned about rising rates. Vetting the environmental condition of your property early in the process can help you avoid unnecessary delays.
Prior to funding a loan, lenders require that a certain level of due diligence is performed on the property being offered as collateral for the loan. These contingencies are typically listed in the financing offer letter. Most borrowers anticipate that the loan will be contingent upon a current Market Value Appraisal evidencing that the loan does not exceed the lender’s maximum Loan-to-Value limit, typically 75 percent. However, many borrowers don’t realize that a great appraisal valuation doesn’t mean that the bank will accept your property as collateral. Appraisals are typically based upon an assumption that the property is free of any contamination. The following disclaimer language, or language similar to it, commonly appears in property appraisals: “No studies have been provided to us indicating the presence or absence of hazardous materials on the subject property or in the improvements, and our valuation is predicated upon the assumption that the subject property is free and clear of any environment hazards including, without limitation, hazardous wastes, toxic substances and mold. No representations or warranties are made regarding the environmental condition of the subject property.”
In addition to the Market Value Appraisal, lenders typically require a clean “Phase I” environmental site assessment as a condition of the loan. The Phase I identifies potential or known environmental contamination liabilities associated with both the underlying land as well as the physical improvements to the property. The lender needs to be confident that if the property ever had to be sold to satisfy the loan, the value and marketability of the property would not be adversely impacted by environmental contamination.
Quite naturally, RIs with existing debt might assume that if their property has met the hurdles set by their current lender, there should be nothing to worry about upon refinancing. After all, the prior lender required a “Phase I” before closing the existing loan. However, environmental standards can change, and sensitivities can also vary from one lender to the next. As an example of a fairly common scenario, a dated Phase I study references the past removal of a heating oil underground storage tank (UST), yet fails to reference any removal and closure documentation, or sample analytical results. Upon reviewing the old Phase I report, the new lender might require a ground-penetrating radar survey to confirm whether the storage tank remains on-site. In a worst-case scenario, a leaking UST is identified and, consequently, the piping, and any significantly contaminated soil, must be removed and disposed of off-site. Further, a “Phase II” will then likely be required whereby soil samples of the surrounding area are taken and analyzed. If your RI ever finds itself in this situation, prior to authorizing the Phase II work, ask your lender to review and approve your environmental consultant’s qualifications, as well as a map of the proposed sampling locations. This will limit the risk of having to go back for additional sampling.
Also, whenever your RI is in the market to purchase land or buildings, be sure to require the seller to provide an environmental study. If one is not made available up front, any purchase agreement should be contingent upon the receipt and acceptable review of a clean study prior to the purchase. If a report is offered by the seller, be sure to have your lender look at it as early in the process as possible. I have seen instances where lenders have spotted issues like the one outlined in the preceding paragraph, yet the seller refused to undertake any further analysis of the property for fear of “opening a can of worms.” No buyer — particularly a RI — should be willing take on the reputational or financial risk of proceeding past such a red flag only to later find their leaking UST is contaminating a nearby water supply.
The Federal Reserve has increased its key interest rates recently, and now might prove to be a good time to consider refinancing your debt. Upon engaging prospective lenders, be sure to share copies of any existing environmental studies early in the process. A qualified commercial lender can provide you with prompt feedback about what, if any, additional precautionary analysis you might need to initiate.
Dan Mikes is Executive Vice President and National Manager of the Religious Institution Division, Bank of the West, San Ramon, CA. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of Bank of the West.