Mortgage market unprepared for climate risk, industry report says

Record rains, floods and wildfires are examples of the growing risks to the US real estate market from climate change.

Mortgage lenders and investors are unfortunately not prepared to not only mitigate their risk, but even assess that risk, according to a new report from the Mortgage Bankers Association’s Research Institute for Housing America.

“They are anxious to know what to do but don’t know where to go to find it out. They are not prepared but no longer know it,” said Sean Becketti, author of the report and former chief economist at Freddie Mac.

There are many stakeholders in housing finance including consumers, landlords, home builders, appraisers, mortgage originators and services, insurance companies, mortgage investors, agencies. government and government sponsored companies that issue mortgages (Fannie Mae and Freddie Mac). This means that climate change will send significant pressure on a long financial line.

Not only will climate change put more emphasis on the national flood insurance program, but it could increase the risks of default and prepayment of mortgages, triggering unfavorable selection in the types of loans sold to consumers. GSE, increase the volatility of house prices and produce an important climate. migration, according to the report.

For example, lenders who securitize their loans with GSEs might face additional costs for collateral representation and insurance, which covers breach of contracts or guarantees in large financial transactions, and higher risk when GSEs are reviewing their requirements in response to climate change.

Specifically, GSEs could require lenders to perform additional due diligence to determine the need for flood insurance, and delay in updating official flood maps may require lenders to incorporate sources of additional information on flood risks. As a result, GSEs may not be allowed to purchase loans on homes with higher flood risk.

Additionally, the National Flood Insurance Program is in the midst of a major overhaul, which will change prices for homeowners. This will affect the value of the homes and, therefore, the values ​​of the mortgages that support those homes.

The biggest problem right now is uncertainty for mortgage stakeholders.

“They ask themselves what to do next more than anything else. There has been no rule change that affects businesses in the mortgage market, but they are being considered,” Becketti said.

Today, the mortgage market relies heavily on the insurance industry to assess its risk.

But most risk models in the mortgage industry focus on credit and operational risk.

“In the case of risk modeling, the mortgage industry still thinks primarily about protection in terms of damage risk, which is underwritten and priced by insurance companies,” said Sanjiv Das, CEO of Caliber Home Loans. “The industry does not model climate risk as much and relies primarily on models from FEMA or insurance companies.”

But the Federal Emergency Management Agency is already in heavy demand due to the record volume of natural disasters in recent years. If FEMA changes what it supports, mortgage lenders could suffer losses.

In addition, borrowers displaced by natural disasters could default on their home loans.

In the aftermath of Hurricane Harvey in Houston in 2017, mortgage industry executives warned of a possible climate lockdown crisis as the storm flooded nearly 100,000 homes in the Houston area. In the federally declared disaster areas of Harvey, 80% of homes did not have flood insurance because they were not normally prone to flooding. Serious defaults on damaged homes have jumped more than 200%, according to CoreLogic.

Estimated default costs are the centerpiece for banks, lenders, investors and mortgage services to assess profitability, as well as loan loss reserves and economic capital.

“If additional defaults due to climate change prove to be significant to one or more of these stakeholders, regulators and investors are likely to ask these stakeholders to quantify the impact of these additional defaults and assess the sensitivity from those estimates to key assumptions, ”Becketti said in the report.

Finally, mortgage bond investors, who are already asking lenders for more information on climate risk, could also pull out, leaving the mortgage market with less liquidity.

This week, the Securities and Exchange Commission published a letter it sent to state-owned companies asking them to offer more information to investors about their climate risk. The letter details the physical and financial risks associated with climate disasters, as well as risks associated with changes in climate-related regulations or business models. While it does not name the specific companies that receive it, the banking industry is a likely beneficiary.

The question is how to best measure such a risk? While there is now a new cottage industry of companies measuring all facets of climate risk for US businesses, as well as the housing market, there is no standard measure of risk for investors.

“Investors have built sophisticated risk models for default and gravity, but are new to natural disaster analysis,” said Bill Dallas, president of Finance of America Mortgage.

“Today’s investors avoid these potential risks by simply not buying loans. As fires, hurricanes, earthquakes, volcanic eruptions and torrential floods become more common, investors will need to act more as actuarial insurers than mortgage lenders in order to build risk models that contemplate acts of God, ”he added.