MBA RIHA Climate Change Report: Mortgage Industry Needs to Improve Risk Management Measurements

Climate change triggered by global warming will continue at an unpredictable pace and will add stress to the complex system of allocating risks across housing and housing finance stakeholders, according to a new research report released Thursday by the Mortgage Bankers Association’s Research Institute for Housing America.

“The mortgage industry will not be spared by the growing impact climate change is having on the environment, governments, and individuals,” said Sean Becketti, author of the report and an industry veteran with more than four decades of mortgage finance experience. “The physical destruction caused by flooding and other extreme weather events will continue to influence the behavior of portfolio lenders, the GSEs, the federal government’s FHA/VA programs and mortgage investors. Climate mitigation efforts are necessary to slow the adverse effects of global warming, and better and more standardized predictors of environmental risks are needed to make housing and housing finance more resilient.”

Becketti said projecting future climate change and its impacts remains challenging primarily because the outcome depends crucially on the actions chosen by governments, industries and households. “Given the uncertainty over those actions, the future path of climate change could continue to get much worse,” he said.

The study, The Impact of Climate Change on Housing and Housing Finance, is divided into four sections: what is known so far about climate change; the likely impacts to housing and housing finance; strategies that can mitigate climate change or adapt to the part of climate change that cannot be averted; and the ways firms in housing and housing finance can articulate and measure their exposure to climate change.

“RIHA’s study underscores the need for the mortgage industry to better address the growing impacts of climate change and prepare for increased reporting to regulators and investors on the quantitative estimates of climate-related risks,” said Edward Seiler, Executive Director of RIHA and MBA Associate Vice President, Housing Economics.

Key Highlights of The Impact of Climate Change on Housing and Housing Finance:

• Global warming – the source of climate change – is certain and is backed by 150 years of measurements to document it.
  • There is convincing scientific evidence that global warming is contributing to sea-level rise, more storm surges and reductions in glaciers and snow coverage. Recent studies also draw links to increased droughts and inland flooding events.
  • The actions chosen by governments, industries and households will influence climate change’s future impacts on all aspects of life.
• Climate change will place increasing stress on housing and housing finance’s sophisticated system of distributing risk across multiple stakeholders, including consumers, landlords, home builders, appraisers, originators, servicers, insurance companies, government agencies and the GSEs and mortgage investors. 
  • The Financial Stability Board’s Task Force on Climate-Related Financial Disclosures recommends firms divide climate-related risks into physical risks – adverse weather events and natural disasters, for example – and transition risks that firms face in a lower-carbon economy. Transition risks include policy and legal, technology, market and reputation risks.
  • Climate change may alter the nature of flood risk and exacerbate the current challenges of the National Flood Insurance Program (NFIP).
  • Along with increased flood risk and residential property damage, climate change may increase mortgage default and prepayment risks, trigger adverse selection in the types of loans that are sold to the GSEs, increase the volatility of house prices and even produce significant climate migration.
• In addition to climate mitigation efforts to limit global warming, adaptation strategies are needed to make housing and housing finance more resilient.
  • These strategies include incorporating building modifications into new construction (easier) and existing buildings (more difficult and more expensive) and increasing the resiliency of communities through infrastructure improvements and standards.
  • Housing finance is likely to face increasing stress as the consequences of global warming mount and influence the behavior of portfolio lenders, the GSEs, the federal government’s FHA/VA programs and mortgage investors.
  • The costs of mitigation and adaptation strategies pose significant challenges to their adoption.
• Firms in housing and housing finance face increased pressure to quantify the expected costs of future climate events, their climate change mitigation activities and the burden of future regulations and laws.
  • The report identifies three obstacles to quantifying the risk of climate-induced mortgage defaults: the choice of climate scenario, the lack of a recognized measure of climate risk and the lack of a sufficient historical record of available climate risk metrics.
  • 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.

RIHA is a 501(c)(3) trust fund. RIHA’s chief purpose is to encourage and assist – through grants to distinguished scholars and subject matter experts, educational institutions, research facilities and government organizations – establishment of a broader-based knowledge of mortgage banking and real estate finance. You can find additional studies on RIHA’s website: http://www.housingamerica.org.