Chris Joles of Planet Home Lending: How Should Mortgage Bankers Measure Climate Risk?

Chris Joles is Senior Vice President and Enterprise Risk Officer with Planet Home Lending, Meriden, Conn.

Whether or not you personally believe climate change exists, the White House, federal regulators, states and even other countries are clearly signaling that mortgage companies need to measure climate risks.

The movement toward measurement has occurred within the larger framework of Environmental Social and Governance reporting. ESG reports seek to measure and report to investors non-financial data that influence a company’s financial results. Currently, the ESG reports appearing in the mortgage industry are coming from public companies and the government-sponsored entities, Fannie Mae and Freddie Mac. But, given the importance placed on ESG by large investors, even private companies will benefit from at least understanding their ESG performance.

The Opportunity to Define Falls on Everyone

Now is the time to not only begin measuring environmental risks, but to also get involved in discussions about what our industry decides to disclose. The Mortgage Bankers Association’s Mortgage Industry Standards Maintenance Organization (MISMO) group is currently working with members to hammer out ESG standards through their various Community of Practice workgroups, which are important to standards development.

Meanwhile, a good starting point for understanding the disclosure, benchmarking and company ESG performance measurement is the Sustainability Accounting Standards Board Mortgage Finance Standards. The environmental factors included in the standards are meaningful, quantifiable, and readily understood by our industry. In their most recent ESG reports, Fannie Mae, Freddie Mac and several public nonbanks have disclosed data responding to the SASB Mortgage Finance Standards.

Even if you’re not interested in seeking investor funding, looking at data for your own organization puts your company in a better position to respond when these types of disclosures become a routine part of annual regulator and business partner audits.

Current Guidance

The current SASB Mortgage Finance Standards ask lenders to measure the environmental risk to mortgage properties by disclosing data that answers two questions:

1. What is the company’s mortgage portfolio exposure to risks associated with weather-related natural catastrophes, and how does the company manage these risks?
2. How does the company integrate environmental and climate-related risk factors into its mortgage origination and underwriting process?

To be meaningful, the answers to those questions must be measurable, comparable and reliable over time. In the best possible scenario, the data also measures something we already routinely track and report on because it’s material to our business.

Fannie Mae and Freddie Mac responded to the two questions in their 2020 ESG reports by supplying data on the properties requiring flood insurance within their single-family and multifamily portfolios. Freddie Mac commented that weather-related natural catastrophes are not a significant contributor to default and delinquency.

Fannie Mae indirectly pointed out the difficulty of finding measurable, comparable, reliable climate change data relevant to mortgage bankers. “We are exploring the ability to estimate and communicate our exposure across a variety of natural catastrophes in a way that is both reasonable and consistent with industry best practices,” the Fannie Mae report said. As the mortgage industry works to define what data is relevant to environmental risk, the average mortgage company is left with far fewer resources than the GSEs to answer the two questions posed by SASB’s environmental standards.

Portfolio Influence

One method might be looking for ways climate change would influence credit and business lines covered in the company’s strategic plan. Do you have high exposure to properties in flood zones, wildfire areas or hurricane zones? Is your loan acquisition strategy driving your company to take on climate risk?

Within the realm of such questions, every mortgage company has the duty to be careful in making these judgments because climate risk often disproportionately occurs in predominately minority and underserved communities.

Building the Measurement Based on Scenarios

Modeling various scenarios can also provide estimates of climate risks. Most of the disaster scenarios right now measure flood risk. Further work needs to encompass temperature scenarios, wildfires (measured only in California right now), hurricanes, tsunamis and tornado outcomes.

The goal is to create a model to predict the outcome of losses based on a climate event. The variables going into the equation, such as home price, type of natural disaster and insurance coverage, can be adjusted.  Once that model is built, after research and justification, another model can be built to attempt to better predict the outcome from losses.

Once there is an actual event, the models can now be tested to see which is better. The one that wins becomes the new standard model for the organization to evaluate risk (the champion) and a different model is built to try to improve upon the outcome (the challenger).

Planet Home Lending has been testing such scenarios and the challenger/ champion model is the major tenet for any working group in the industry to capture relevant data and estimates.

It’s helpful to follow ongoing efforts within our industry and globally seeking to define climate hazard data and to consider how your company can build scenarios to measure climate risk at the loan and portfolio levels.

Offsetting Emissions

Along with measuring climate change’s influence on our portfolio, environmental reporting can also include actions taken to reduce emissions and your company’s environmental footprint, such as selecting LEED-certified offices, using green cleaning and pest control products or offering energy-efficiency mortgages. At Planet Home Lending, we also buy carbon offsets and have funded the planting a quarter-million trees in national forests over four years.

The most commonly used global standard for measuring a company’s overall emissions, the Greenhouse Gas Protocol (GHGP), creates three levels of greenhouse gas measurement, Scope 1, 2 and 3, which SEC-regulated companies follow:

• Scope 1 emissions come directly from sources the company controls or owns (fuel combustion in boilers, furnaces and vehicles).
• Scope 2 emissions are indirect emissions generated by the electricity, heating or cooling the company uses. Scope 2 emission happen primarily at utility companies but are attributed to company that uses the energy.
• Scope 3 measures emissions occurring from a company’s supply chain vendors, as well as employee travel and commuting.

The concept of Scope 3 emissions is greatly debated. What counts as one company’s Scope 3 could be another company’s Scope 1 or 2, creating a confusing accountability cycle. While it’s important to keep Scope 3 in mind, efforts to reduce Scope 3 will likely follow Scope 1 and 2 efforts.

Depending on what’s included in the calculation, Scope 3 calculations can place a heavy carbon offset burden on mortgage companies.

The Global GHG Accounting and Reporting Standard for the Financial Industry, which the SEC follows, would potentially have lenders take responsibility for offsetting the carbon emissions created by the homes they finance and hold as on-balance-sheet assets. Owned mortgage servicing rights are also often on-balance-sheet assets, should servicers also be expected to offset carbon emissions created by their homeowners?

Enterprise Approach

After working through some of the strategic items above, the next step is to share those learnings and work to align your organization. This includes informing everyone from risk, finance, leadership, vendor management and business continuity to third-party partners and vendors.

Take clues from the current trends. The conversations around environmental risk have become a part of the everyday conversation within a multitude of organizations and government entities. Therefore, environmental accomplishments and risks need to be a part of the decision-making of mortgage banking organizations.

While as individuals, we may not agree on the risks of climate change, as companies and as an industry, it’s wise to continually assess ways to measure environmental risks and carbon emissions. Those who ignore the issue run the risk of being caught flat-footed when today’s ESG options become tomorrow’s reporting requirements.

Views and opinions expressed in this article are those of the author and do not necessarily reflect or represent the views, policy, or position of Planet Home Lending, LLC.

(Views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA NewsLink welcomes your submissions. Inquiries can be sent to Mike Sorohan, editor, at msorohan@mba.org; or Michael Tucker, editorial manager, at mtucker@mba.org.)