How Financial Institutions Can Weather the Climate Risk Storm — Proactive Risk Management is Key

Climate change risks, particularly those related to flooding, pose a tangible threat to thousands of properties located in many communities across the United States. Based on a recent study, within 30 years, there will be 802,555 homes worth approximately $450 billion located in flood-risk zones. A 2019 study showed that even a modest sea-level rise of six feet would displace over 13 million people, including  2.5 million Miami residents alone. As underwriters, servicers, and investors, financial institutions should be keenly aware of the properties in their portfolio that are at risk and actively monitor the appropriateness of their risk mitigation activities.

In recent years, federal, state, and local governments have helped mitigate flood risks through subsidies or funding for flood prevention measures. However, the COVID-19 pandemic has exasperated budgets and financial institutions should not rely on or expect future government support to mitigate their risk. Therefore, financial institutions should proactively manage their risk exposure and take action now. This paper discusses key risks, explains why early adopters of climate risk monitoring will benefit, and describe how the current COVID-19 pandemic has elevated the level of attention climate risk has received on the mortgage market.

How Guidehouse Can Help

Despite the many risks, there is still time to act, but, as detailed above, it is prudent to act now to assess current risk and understand your monitoring capabilities. We are strategically positioned to help clients in a variety of ways. We can conduct:

1. Portfolio Review: Perform a portfolio review to analyze the processes that might be impacted to identify areas of exposure, decrease exposure, assist in rebalancing a portfolio, or identify risk mitigation strategies
2. Stress-Testing: Carry out stress tests to ensure lenders have appropriate capital allocation, monitoring, and response processes in place to prepare for, identify, and respond to high-impact climate events
3. Periodic Asset Monitoring: Conduct periodic reviews to ensure risk is within appropriate parameters and develop ongoing monitoring reports to track portfolio risk
4. Policy and Procedure Analysis: Define and document processes to identify risk, decrease exposure, and determine thresholds to offload/rebalance portfolios to support investor and regulatory inquiries

Climate change is an emerging threat with the potential to wreak havoc on markets throughout the country, including the housing market. It is easy to ignore a problem when the impact may not be truly felt for years; however, those organizations who take action now to identify and mitigate their exposure to climate risks will be well-positioned against the market.

Special thanks to Henry Darmstadter for contributions to this paper.