Jenna Fountain carries a bucket on Regency Drive in an attempt to retrieve items from her flooded home September 1, 2017 in Port Arthur, Texas.
Emily Kask | AFP | Getty Images
Record rains, floods and wildfires are examples of the growing risks to the US real estate market from climate change.
According to a new report from the Research Institute for Housing America, the Mortgage Bankers Association, mortgage lenders and investors are not prepared not only to hedge their risk, but also to mitigate that risk.
Sean Becketti, author of the report and former chief economist at Freddie Mac, said: “They are anxious to know what to do, but are unsure of where to go. They are not ready, but they are no longer clueless. ”
Housing finance has many stakeholders including consumers, homeowners, home builders, appraisers, mortgage originators and managers, insurance companies, mortgage investors, government agencies and businesses. government sponsored mortgage issuers (Fannie Mae and Freddie Mac). . This means that climate change will send significant pressure on a very long financial line.
Climate change is not only putting increased pressure on the national flood insurance program, but it may increase the risks of mortgage default and prepayment, triggering unfavorable selection in the types of loans sold to the GSE. and increase the volatility of house prices. can increase and produce an important climate. According to the report.
For example, lenders who guarantee their loans with GSE may face representative and guarantee insurance (that is, insurance covering breach of contracts or guarantees in large financial transactions) and higher risk. because GSE is changing their needs in response to climate. Switch.
Specifically, the GSE may require lenders to be very careful in determining the need for flood insurance and delay in updating official flood maps to allow lenders to include information. sources of additional information on flood risks. can force. As a result, GSEs may not be allowed to purchase loans against homes at high risk of flooding.
Additionally, the NFIP is in the midst of a major change, which will change pricing for homeowners. This will affect the value of the houses and, therefore, the values of the mortgages backed by those houses.
The biggest problem right now is uncertainty for mortgage stakeholders.
“They wonder what to do next. There have been no rule changes that affect businesses in the mortgage market, but these are under review, ”Becketti said.
A climate lockdown crisis?
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 risk and operational risk.
Sanjeev Das, CEO of Caliber Home Loans, said: “In terms of risk modeling, the mortgage industry still thinks primarily about protection in terms of asset risk and damage, which are underwritten and priced by mortgage companies. assurance. “The industry models climate risk less and relies mainly on models from FEMA or insurance companies.
But FEMA – the federal emergency management agency – is already under extreme stress due to the record number of natural disasters in recent years. If FEMA changes what it pays, mortgage lenders could suffer losses.
In addition, borrowers displaced by natural disasters can default on their home loans.
After Hurricane Harvey hit Houston in 2017, mortgage industry executives warned of a potential climate lockdown crisis as the storm flooded 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 generally not prone to flooding. According to CoreLogic, serious mortgage defaults on damaged homes have jumped more than 200%.
The estimated cost of default is central to evaluating profitability for banks, lenders, investors and mortgage services, as well as credit loss reserves and economic capital.
“If additional defaults become material to one or more of these stakeholders due to climate change, regulators and investors may need to measure the impact of these additional defaults and the sensitivity of these projections to key assumptions. Maybe, ”Becketti wrote in the report.
Flooded homes are shown near Lake Houston in the aftermath of Hurricane Harvey August 30, 2017 in Houston, Texas.
Win McNamee | Getty Images
Finally, mortgage bond investors, who are already seeking more information from lenders on climate risk, could pull out, leaving the mortgage market with low liquidity.
This week, the Securities and Exchange Commission released a copy of a letter it sent to state-owned companies asking them to give investors more information about their climate risk. The letter details the physical and financial risks associated with climate disasters, as well as risks ranging from climate-related changes to regulations or business models. Although it does not name the specific companies that have received it, the banking industry is a potential beneficiary.
The question is how to best measure such a risk? While there is now a new cottage industry of companies that measure all aspects of climate risk for US businesses as well as the housing market, there is no standard measure of risk for investors.
“Investors have sophisticated risk models for default and severity, 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 are more likely to use actuarial insurers than mortgage lenders to build risk models. More work will have to be done like the work of God, ”he said.