Environmental issues affecting securitization.

The national obsession with environmental contamination is starting to have a greater impact on business today than ever before. Not only has the Securities and Exchange Commission (SEC) now demanded that public companies disclose and clean up contaminated property, the bond rating agencies are now beginning to look at environmental exposure as a separate class of risk. And no where is this having a bigger dollars and cents impact than in the mortgage securitization industry, where rating delays or fears of any kind of risk can cost millions of dollars.

"Securitizations still are driving the real estate financing marketplace, and new, large commercial mortgage-backed securities transactions are originated every day," said Michael Murphy, president of The Stonebridge Group, a real estate advisory and investment firm that specializes in transactions involving real estate securities, and invests in the high risk, high yield real estate securities, known as B pieces. "The rating agencies are starting to ask themselves how the cost of remediating environmental contamination might adversely affect the cash flow of the securities they're rating. The answer is, they're unsure. That's a problem."

Murphy notes that growing fear over environmental contamination is causing delays in some securitization deals, and this can be expensive.

"We've started to see some of the rating agencies look favorably on deals where the environmental risk is transferred to a third party, usually using Environmental Site Assessment Insurance," said Murphy. "By mitigating the risk of relying solely on an environmental report, this type of insurance should help accelerate the rating process. In many ways this kind of coverage is analogous to title insurance, and very inexpensively transfers a whole category of risk out of the deal. As the various environmental agencies have turned up the heat on environmental compliance, potential environmental contamination and remediation is a serious cash flow issue."

Environmental Warranty, Inc., based in West Hartford, Connecticut, and one of the best known issuers of Environmental Site Assessment Insurance, agrees. According to the company's president, Charles Perry, the incidence of environmental contamination where none was thought to exist was far greater than the incidence of fire and casualty, or other risk real estate owners typically insure against.

"Lenders, both banks and life companies, are starting to demand the coverage, additionally, municipalities and state agencies now require the coverage when financing or bonding multi-family housing projects,' said Perry. "You only need to find contaminated ground water or asbestos once to realize what the cost can be."

Delays in the rating process, one of the biggest hurdles securitization deals typically face, can actually cost underwriters millions of dollars, particularly when deadlines for fiscal periods are missed because of the delay.

The Stonebridge Group, in addition to evaluating acquisition opportunities, is currently performing due diligence for a large institutional concern on a $300 million debt portfolio.