With all three rating agencies now officially supporting the use of secured creditor environmental insurance as a viable and increasingly popular alternative to traditional Phase I due diligence for CMBS deals, environmental broker Miller & Associates continues to penetrate new markets and add clients as market players become more aware of the lower-cost advantages of using insurance for securitizations.

In a span of less than three years, the company has placed coverage on more than 8000 properties throughout the United States and Canada, and as a testament to the growing popularity of environmental insurance, the firm's products were used as a replacement to due diligence for over 90% of those properties.

"We specialize in placing environmental insurance for various institutions including lenders, property owners, real estate investment trusts, franchisees, as well as traditional banks and investment banks," said William Havard, the chief operating officer of the firm, which has offices in Scottsdale, Los Angeles, Minneapolis and New York. "We also tailor our insurance products for borrowers, life insurance companies, and many franchisees and franchisors, including Pizza Hut, Burger King, Taco Bell and KFC, etc."

The company also works closely with the equity divisions of investment banks, especially when these departments foreclose on real estate, and with law firms and their clients involving mergers and acquisitions activity nationwide - a sector where environmental insurance activity is particularly hot nowadays.

"With mergers and acquisitions, whoever is selling a company doesn't want to keep any of the environmental liabilities on their balance sheet," Havard said. "So you can use these insurance products to insulate or get the deal done. You come in, provide protection to the buyer, whether for pre-existing or new conditions. The same concept of transferring risk and liability for deals is being used for M&A."

An Insurance Specialist

Miller & Associates' main goal is to provide insurance products to protect outstanding loan balances for lenders engaged in arranging loans secured by commercial real estate; additionally, it secures environmental coverage for buyers and operators of such properties.

While environmental insurance has been accepted for many years in the specialty-lending and asset-backed worlds, the CMBS community - known for its detail-oriented attention to minutiae when examining collateral pools - has been slower to employ it, and has only recently used insurance instead of traditional Phase I reports for small-balance and seasoned-loan pools.

However, the risk-reduction benefits of using environmental insurance have come to the fore recently, as the rating agencies have recently documented that a significant cost savings for the issuer can follow from the transfer or the capping of environmental liability - as opposed to just a "risk identification," a service which traditional due diligence provides.

As a specialist in Cleanup Cost Cap programs and Owner-Controlled Environmental Insurance programs (wrap-ups) for the remediation of contaminated sites, Miller & Associates protects the interests of everybody involved in a transaction, whether the properties end up being contaminated or not.

"If you have a million-dollar cleanup, for instance, you can use insurance products to cap that liability for the developers," Havard said. "For a premium, the insurance companies will come in and say, We'll attach our insurance at $1.2 million,' meaning that if the cleanup goes over the anticipated cleanup cost, you have insurance - so you're only on the hook for up to $1.2 million."

"Phase I, on the other hand, will not clean up the property, pay off the loan balance, protect the collateral or provide for third-party coverages for the lender," added David Krause, a managing director of the company. "Moreover, environmental insurance typically costs less than a Phase I depending on the lender's portfolio, volume, property types, loan amounts and coverages."

Surveying the CMBS Landscape

Though Havard says more larger lenders are currently looking to roll out environmental insurance programs, the CMBS world is still in the midst of getting its hands around the concept, though it has been accepted in ABS deals for quite awhile.

"For many years, Phase I due diligence was the norm, so we still are working to get over that hurdle," Havard noted. "Insurance hasn't penetrated CMBS markets like other markets; in fact, we have been working more on the ABS side, where there is higher acceptance."

According to Havard, more than 80% of lenders involved in ABS securitizations use these insurance products. "I think it was fastest to catch on with specialty lenders, then traditional banks, then the CMBS market, and then life insurance companies. That's the progression, in terms of phasing it in."

Part of the reason for that, in addition to the keen eye for assessing collateral which CMBS players are known for, is that many specialty lenders could not finance the convenience store industry without insurance products because of covenants made to their money sources which forbade them from lending on a piece of property that had any significant environmental contamination.

Krause and Havard noted that currently, the insurance is used for CMBS mainly on small-loan programs, where many investment banks utilize it to wrap the pools to get a credit pick-up.

Often, the pool already has existing due diligence on it, and the bank will just buy insurance on top of that.

Secondly, CMBS players are also using insurance if a borrower wants to remove an environmental indemnity. If loan documents, for instance, require a personal guarantee from the borrower where they are personally responsible for the indemnity, the insurance company or investment banks often make the borrower purchase an environmental insurance policy - whether the property is clean or dirty.

Finally, insurance is also being used on commercial properties that have already gone through due diligence but are having some trouble - be it from an on-site gas station or an adjoining property.

"In this way, it is used to further mitigate the risk, and our products are used on top of Phase I or Phase 2 due diligence," Krause explained.

As environmental insurance continues to catch on with the CMBS market, investment bankers are finally starting to comprehend the many benefits associated with it - especially from a cost perspective.

"We're beginning to find that banks are starting to say to themselves, Why are we even doing Phase 1's anymore?," Havard said.

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