Lenders' Next Big Problem

Plan ahead to prevent mold from ruining loans

Over the last ten years, mold has crept into thousands of buildings and houses across the country, causing serious concern for homeowners, businesses, insurance companies and lenders. Now, however, residential and commercial mortgage lenders are beginning to realize that mold's negative effect on their business is creeping into their bottom line.

A growing number of high-profile insurance claims and facility closings is dominating public awareness of mold, but the financial infestation can spread all the way back to the mortgage lender, with devastating consequences. The insurance industry, typically the party that takes on property risk, is now underwriting exclusions for mold, which has exposed lenders to a new category of risk.

As an official on the mold working group for the Mortgage Bankers Association, I know many lenders who are working furiously to get a hold on mold, as well they should. Lenders deserve to be in control of this issue because typically they have 80 percent of the money at risk. When mold infests a home or business, it can devastate the financial health of all connected parties: owners, developers, lenders, tenants and insurers. To a lender, mold carries property (collateral) value concerns as well as liability concerns. Bankers are whispering that the financial impact of mold could make the fallout from asbestos look like a day at the beach.

If a borrower defaults because mold has damaged his or her property, the lender may not wish to simply recoup the mortgage by foreclosing and becoming the owner. The extent of the mold infestation may cause collateral impairment that could substantially affect the property's market value. In addition to the prospect of taking ownership of a property that will need expensive remediation, the lenders must classify the mortgage in question as "non-performing," which can cause negative reactions from the FDIC and rating agencies among others.

Faced with this scenario, lenders have three options. They can try to cure the problem by bringing in a mold inspection and remediation team, or they can simply level the structure. However, either cure is expensive, and unlike most remediation, this kind of cleanup holds no guarantee that the mold will be permanently eliminated. The third option is to actually prevent the likelihood of mold by setting down specific new requirements in their lending guidelines such as the use of mold resistant building products.

The conditions under which mold occurs are as follows: the existence of spores, moisture in the air, a normal temperature range, and the presence of a food source like paper. Since temperatures, airborne spores and moisture are facts of life, the only controllable variable is the food source - primarily paper-faced drywall. This is not rocket science, in fact it's pretty basic - water plus paper means mold. There are only two kinds of walls with paper-faced wall board, those with mold and those that will have mold.

Paper-faced drywall is the most common element of any post-1950s building, and unfortunately, it makes a great home for mold. Lenders could require that new construction loans be contingent on the use of paperless drywall, which has recently been developed and field tested. To back that up, lenders could also require post-project inspections that check for the presence of paperless drywall. Presale home inspection services cost the borrower little and expand the lender's zone of comfort. These two simple steps could save lenders many millions of dollars in future losses due to mold.

Three major categories of construction are causing lenders the most concern right now:

Hospitals and other healthcare institutions. Obviously, the last place you want to find air quality problems is in a hospital. The liability issues are massive. In addition, once mold takes hold, that institution's premiums for directors and officers insurance and commercial general liability insurance will skyrocket.

Hotels and other hospitality structures. Several high-profile cases of mold in hotels have caused fleeing retail tenants, lawsuits and, in the case of a Hilton in Hawaii, the leveling of the building.

Affordable housing. "Affordable" means just what it sounds like - most likely using building materials that barely do the job, creating a likelihood of poorer construction than with a standard residential structure. In addition, the two major tenants of affordable housing - the elderly and the young - are in the highest-risk category for mold-related diseases.

There is no shortcut cure. For lenders looking long term, prevention is the cure.

Charles Perry is a principal at Environmental Assurance Group, West Hartford, Conn.

Copyright NFR Communications Inc Feb 1-Feb 14, 2004
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