FDIC Responds to AAI Rule: First Chance to Agency’s Guidance in 13 Years

Monday, November 13, 2006 marked a historic day as the FDIC released one of the most significant reactions to the AAI rule to date. The new AAI rule provided a sufficiently strong impetus for the FDIC to issue the first update to its Guidelines for an Environmental Risk Program in 13 years. The new guidelines contain two critical components:

1. a recommendation that lending institutions set environmental policy guidelines and procedures, require an environmental review or analysis during the application process, and establish appropriate environmental risk assessment safeguards in loan workout situation and foreclosures; and;
2. more specifically, that "as part of its environmental risk analysis of any particular extension of credit, a lender should evaluate whether it is appropriate or necessary to require the borrower to perform an evaluation that meets [the AAI rule]."

In establishing a formal policy for environmental due diligence, the FDIC outlines a two-pronged approach. First, during the application process for a loan on real property, the guidance states that "an initial environmental risk analysis needs to be conducted." This step may "allow the institution to avoid loans that result in substantial losses or liability and provide the institution with information to minimize potential environmental liability on loans that are made." In performing this preliminary analysis, data may include the present and past uses of the target property, any actions involving environmental government agencies and, possibly, a site visit.

Then, if any possible environmental concerns are raised, a more detailed "structured environmental risk assessment" may be necessary. It is within this second tier that the FDIC envisions case-by-case decisions about what form of environmental due diligence may best be suited to each investigation. Also within this section of the guidance is the most noticeable change within the policy from the old 1993 version; namely, careful consideration about whether the AAI is "appropriate or necessary" for a particular extension of credit.

The FDIC also recommends that the lender’s environmental risk assessment continue beyond the purchase date of the property, to extend over the life of loan by monitoring for potential environmental concerns, such as changes in business activities at the property. This ties in closely with the AAI rule’s language about meeting continuing obligations over the course of property ownership in order to preserve the ability to raise a defense under CERCLA as an innocent landowner, bona fide prospective purchaser or contiguous property owner.

No matter how lenders choose to respond to the new guidance, one thing is clear: the FDIC has openly acknowledged the real danger of environmental liabilities within the newly revised guidance. The agency notes that bank examiners will review a lender’s environmental risk program. Specifically, a "failure to establish or comply with an appropriate environmental program will be criticized and corrective action required."

In light of the FDIC’s stance, bank regulators are getting tough on risk management at the same time that AAI is taking effect, putting lenders’ policies front and center. Prudent lenders will take time to review their policies and ensure they have a strategy in place that is aligned with their unique risk tolerance and FDIC’s guidelines. In its guidance, the FDIC took a flexible approach, allowing each bank to make its own decision regarding the level of environmental due diligence that is appropriate for their institution, rather than being prescriptive. This means that in crafting their response to the FDIC guidance and updating policies, lenders will likely need the input of qualified environmental professionals.

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