Pressure to create climate change risk models in mortgage mounts

Increasing focus on climate change in Washington could create a demand for mortgage risk models that factor in the effects of global warming, according to the Research Institute for Housing America.

The task won’t be easy, according to a report released Thursday by the institute, a think tank affiliated with the Mortgage Bankers Association. The research finds that while some measures do exist, they aren’t on par with other industry risk models and won’t be easy to build out.

“At present, firms’ efforts to quantify climate risks are likely to fall short of the precision of existing models for disclosing interest rate and credit risk,” said author Sean Becketti in the report.

That could create challenges for the housing finance industry, which is facing more pressure to quantify climate change’s impact. Several policymakers are taking a harder look at housing-related exposures to environmental risks, particularly at government-related secondary market investors Fannie Mae and Freddie Mac, which buy a large percentage of the home loans made in the United States. Becketti previously was an economist at Freddie Mac.

The urgency at the governmental level is the result of the alarming degree to which extreme weather-related damage to homes has increased in recent years, something that has become problematic even when insurance coverage is available.

“Several studies have shown that due to insurance payouts and government relief, climate events such as fires and hurricanes do not produce significant losses for mortgage investors. In fact, in some cases there are even gains to property value as a result of these events. However, with the size and scope of these events increasing, investors may no longer benefit from these protections,” said Andrew Davidson, an industry consultant and analytics provider, during a virtual event his company hosted Wednesday.

The cost and number of weather and climate-related disasters has grown over time, according to a National Oceanic and Atmospheric Administration analysis of billion-dollar weather events published earlier this year. Between 2016 and 2020, annual averages for cost and the number of events were $121 billion and 16, respectively. In comparison, the equivalent numbers over a longer time period (2011 to 2020), were $89 billion and 13.5.

The Task Force on Climate Related Financial Disclosures has recommended some categorizations for risks, but RIHA’s report finds that, “Some of the impacts of climate change on housing and...finance might not fit neatly into the TCFD categories.”

Climate impacts can be broken down into categories that include some risks the mortgage industry already measures, such as property damage, defaults, prepayments and home prices, but a challenge lies in how climate risks would be quantified when added to these standard models, according to the report.

Some concerns, like flood risks, have been quantified in various ranges by different sources, while other climate concerns such as greenhouse gas emissions, heat waves or water availability may have impacts on housing that are more challenging to measure.

“It can be more difficult to connect these other risks to specific impacts on housing and...finance. Nonetheless, disruptions to human life of this magnitude will surely ripple through the housing system,” Becketti said in the report, which ultimately concludes that, “It is apparent that better and more standardized predictors of environmental risks will be needed.”