Disasters strike areas, but they also strike people and families. To start the recovery process when your home is damaged or destroyed in a disaster, you call your insurance company to file a claim, apply for aid from government organizations, and contact your mortgage servicer to let them know what happened. If you can’t make your payments, this is the time to ask for options to help you adjust your payments, so you don’t fall behind and incur fees or face foreclosure. Which leads to the question, “What are lenders and servicers doing about the increased number, and severity, of storms impacting borrowers and property values?”
First, some context. An unprecedented number of billion-dollar disasters (28 in total) struck the United States in 2023, as the remarkably warm year wrapped up with a record-warm December. The total cost for these 28 disasters was $92.9 billion. National Oceanic and Atmospheric Administration (NOAA) Chief Scientist Sarah Kapnick stated, “Record warm U.S. temperatures in December, a record-setting number of U.S. billion-dollar disasters in 2023, and potentially the warmest year on record for the planet are just the latest examples of the extremes we now face that will continue to worsen due to climate change.”
Economist Dr. Elliot Eisenberg observed, “In 2013 and 2014, the number of weather/climate disasters exceeding $1 billion inflation-adjusted was 10. In 2017, the number hit 19, in 2020 it was 22, and after declining to 20 in 2021 and 18 in 2022, the number reached a record 28 in 2023. The years 2020-2023 have been four of the worst five years with 2017 also in the top five. A home insurance rate respite seems unlikely.”
Catastrophe and climate risk modeling is becoming more important for lenders and servicers. It is something that every lender and servicer should be aware of, since it will, if it hasn’t already, impact the pricing of loans and servicing across the nation. There is a difference between climate and catastrophes when it comes to evaluating risk. Modeling the financial impact of climate change is relatively new, whereas catastrophe modeling began development in 1992. Gradually rising sea levels are different than forest fires, earthquakes, volcanoes, and tornadoes, although the argument can be made that they are linked.
Investors, loan servicers, insurance companies and others are looking at this subject in terms of “what may happen” versus “what has happened.” Climate change can drive longer-term changes, versus the instant damage that can occur in a catastrophe, such as the recent tornadoes that hit the central U.S.
Throughout history, insurance companies have tended to focus on modeling catastrophes. And every homeowner, and LO, has seen insurance rates increase, if policies can even be set in place. Insurance companies have continued to be ahead of lenders and servicers in evaluating risk over time (one can think of insurance like a one-year ARM that re-adjusts based on changes in interest rates every year) as they monetize perils. These companies can react more quickly.
Mortgage rates are a combination of several factors, such as mortgage-backed security prices, prepayment speeds, servicing values, credit risk, and the competitive landscape. Generally speaking, these rates currently do not directly incorporate the risk of catastrophes.
Insurance premiums are also a combination of many factors, not the least of which are the probability of an event, assessing the risk of damage to a given asset, and the cost of repairs. All of these can impact lenders and mortgage servicers as well. For example, the Lahaina fire in Hawai’i was not anticipated in terms of the combination of factors: non-native species combined with high winds combined with old wooden structures built very close to one another. Despite those factors, lenders were only too happy to extend home loans, and mortgage servicers own those servicing rights.
And now, in Hawai’i, where will the labor and materials come from to rebuild? Does the community want to rebuild what was there without regard for zoning? The wildfires in California in recent years have eliminated 25,000 structures. How do insurance companies model that? Or do they just stop issuing policies? As of this writing, the damage from recent tornadoes is still being assessed, but insurance rates have already gone up, impacting the monthly payments owners, and borrowers, make.
Few will argue that building codes have kept pace with climate or catastrophe risk. In coastal areas, insurance carriers are asking questions that lenders and servicers have not. Have barriers been built? What are flood control measures like? In fire-prone areas, how have forest management techniques changed, if at all? Do zoning regulations incorporate disasters of any sort? What is density like? Many major U.S. cities are in coastal areas. People are going to live, and establish communities, where they want to be, like California or Florida. And lenders are happy to have the business.
Lenders and servicers should be analyzing how risk will be calculated and reported. How is the industry valuing the impact, potential or actual, of climate change or catastrophes? What is the strain on borrowers, and what are the potential changes in loan-to-value or overall debt service amounts? How do servicers model risk and pass this quantitative information onto mortgage servicing rights (MSR) values? How is this information being reported, if at all, to the parties involved, and how is this information being used?
The questions continue. How will borrowers with different types of loans react? Will delinquencies and defaults vary based on Agency, non-QM, bond loans, and so on? As noted above, people are where they are for a reason. But different states have different hazard zones that insurance companies have developed less tolerance for ignoring.
Companies servicing mortgages, although there are economies of scale, have seen the cost of servicing going higher. If a disaster occurs, is the cost of servicing a loan greater than the income earned by servicing that loan? If so, there is a negative net present value: how do you value servicing when income is less than the expenses?
The catastrophe models used by insurance companies and loan servicers must be dynamic. How are yours updated if you have them at all? The scope of a given disaster is rarely priced into the value of a pool of loans, or even one loan. In California, for example, the lack of supply is masking the potential climate price hit. (Put another way, what buyers want to live in areas prone to earthquakes or forest fires, even when prices do not reflect it?)
Lenders should be aware that borrowers’ rates will be impacted by these changes. Servicers are probably not calculating MSR values based on state and area code and flood zone and zip code. But in the future, there is no reason not to, as the data exists. The amount of capital that needs to be held by banks, credit unions, and other servicers will matter even more given the climate risk to the assets. One can expect Freddie Mac, Fannie Mae, and investors to focus on this, as no servicer wants to buy assets from geographic areas or property types that were “bid back” by others.
Interestingly, given the constant change, historical records almost don’t matter. Hurricane or tornado patterns from 1960 don’t matter in 2024. Lenders, and borrowers, should expect more comprehensive disclosures to incorporate more granular climate and catastrophe information. Affordable housing advocates are quick to point out that there are higher costs to certain segments of the population as many are in low-lying areas. The U.S. Government has money available to help disaster victims, with various forms of assistance.
Whether or not you believe in climate change, or that the severity of storm damage has increased, is of no consequence. What is of consequence is that insurance companies have already moved to incorporate this data into both their premiums and where they issue policies, and this impacts homeowners. Government agencies, including Freddie Mac and Fannie Mae, correspondent investors, purchasers of mortgage servicing rights, and the rating agencies are moving in that direction, which will also impact your borrowers. Nature always bats last, and originators should know which way the tide is going.
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