Jenna Fountain carries a bucket down Regency Drive in an attempt to retrieve items from her flooded home in Port Arthur, Texas on September 1, 2017.
Emily Kask | AFP | Getty Images
Record rains, floods and forest fires are examples of the increasing risks to the US real estate market from climate change.
Mortgage lenders and investors are pitifully unprepared to not only mitigate but gauge their risk, according to a new report from the Mortgage Bankers Association’s Research Institute for Housing America.
“They are excited to see what to do but do not know where to go. They are unprepared but no longer ignorant,” said Sean Becketti, author of the report and former chief economist at Freddie Mac.
There are many stakeholders in home finance including consumers, landlords, builders, appraisers, mortgage lenders and service providers, insurance companies, mortgage investors, government agencies, and government sponsored companies that provide mortgages (Fannie Mae and Freddie Mac). That means that climate change will put significant stress on a very long financial line.
Not only is climate change putting a greater strain on the National Flood Insurance Program, it could increase the risk of mortgage defaults and early repayments, trigger negative selection in the types of loans sold to the GSEs, increase property price volatility, and create significant climate migration , so the report.
Lenders who securitize their loans with the GSEs could, for example, face additional costs for representative and guarantee insurance (d change.
Specifically, GSEs could require lenders to perform additional due diligence to determine flood insurance needs, and the delay in updating official flood maps may force lenders to include additional sources of information on flood risk. As a result, the GSEs may not be allowed to buy loans for homes at higher risk of flooding.
Additionally, the NFIP is in the midst of a major overhaul that will change pricing for homeowners. This will affect property values and, consequently, the values of the mortgages that back those homes.
The biggest problem right now is the uncertainty for those interested in mortgages.
“They are wondering, more than anything, what to do next. There have not been any rule changes affecting firms in the mortgage market, but they are being considered,” Becketti said.
A climate foreclosure crisis?
Today the mortgage market relies heavily on the insurance industry to gauge its risk.
Most mortgage industry risk models, however, focus on credit and operational risk.
“When it comes to risk modeling, the mortgage industry still primarily thinks of property and liability coverage underwritten and priced by insurance companies,” said Sanjiv Das, CEO of Caliber Home Loans. “The industry doesn’t model climate risk that much and mostly relies on models from FEMA or insurance companies.”
But FEMA – the Federal Emergency Management Agency – is already under severe stress due to the record number of natural disasters in recent years. If FEMA changes what it returns, mortgage lenders could face losses.
Additionally, borrowers displaced by natural disasters could default on their home loans.
After Hurricane Harvey in Houston in 2017, mortgage industry leaders warned of a potential climate crisis when the storm inundated nearly 100,000 homes in the Houston area. In Harvey’s state-declared disaster areas, 80% of homes had no flood insurance because they weren’t usually flood-prone. Major mortgage defaults on damaged homes increased more than 200%, according to CoreLogic.
Estimated Default Cost is at the heart of the business for banks, lenders, investors and mortgage service providers to assess profitability as well as credit risk reserves and economic capital.
“If incremental defaults due to climate change are found to be material to one or more of these stakeholders, regulators and investors will likely require those stakeholders to quantify the impact of these incremental defaults and measure the sensitivity of those estimates to key assumptions,” Becketti wrote in the report.
Flooded homes are shown near Lake Houston after Hurricane Harvey on August 30, 2017 in Houston, Texas.
Win McNamee | Getty Images
Finally, mortgage bond investors who are already demanding more climate risk information from lenders could also pull out, leaving the mortgage market with less liquidity.
This week the Securities and Exchange Commission released a copy of a letter it sent to publicly traded companies asking them to offer investors more information about their climate risk. The letter describes both physical and financial risks from climate disasters and risks from climate-related changes in regulations or business models. Although the specific companies they will receive are not named, the banking industry is a likely recipient.
The question is, how can we best measure such risks? While there is now a new home industry of corporations that measures all facets of climate risk for American businesses as well as the housing market, there is no standard risk measure for investors.
“Investors have developed sophisticated default and severity risk models, but are newcomers to force majeure analysis,” said Bill Dallas, president of Finance of America Mortgage.
“Today, investors avoid these potential risks by simply not buying credit. As fires, hurricanes, earthquakes, volcanic eruptions and torrential floods become more common, investors need to act as actuarial insurers rather than mortgage lenders to build risk models that deliberately “acts of God,” he added.