In November 2020, after a year marked by widespread property damage due to storms and flooding, the US Federal Reserve acknowledged climate change’s influence on the US financial system and mortgage market for the first time in its semi-annual Financial Stability Report.The report noted that properties will be increasingly “subject to acute hazards, such as storm surges associated with rising sea levels and more intense and frequent hurricanes.” This statement is aligned with a 2019 letter to the Federal Reserve bank of Chicago,which states that “climate scientists have expressed concerns that this recent wave of devastating storms is not an anomaly, but rather part of a long-term trend.”
The Federal Reserve’s report indicates that rising natural disaster rates could have an inverse relationship with property value, placing real estate loans, mortgage-backed securities, and their respective holders at risk. Natural disasters may also impact other participants in the financial market, such as banks that issue mortgages. Due to increasing climatic uncertainty, the US mortgage sector should pursue a risk-reduction solution to withstand market volatility.
Read on for a deeper look at the impact of natural disasters on the US mortgage industry and banking sector, along with an explanation of why mortgage support services might be the key to ensuring uninterrupted operational support, lowering costs, and improving threat perception.
Natural disasters can affect the mortgage industry along with key stakeholders, such as homeowners, landlords, builders, appraisers, mortgage originators and more, in three key ways:
Firstly, they can lead to increased mortgage default rates due to the disruption of livelihood faced by borrowers in disaster-affected areas. Several researchers, including Carolyn Kousky, AVP - Environment & Policy, Environment Defense Fund, have studied the effects of Hurricane Harvey (2017) and Hurricane Ida (2021), highlighting the link between property damage and mortgage delinquency in 2020 and 2021. respectively. In 2020, Kousky and Co. found that “loans on moderately to severely damaged homes were more likely to become 90 days delinquent after Harvey.” 2021’s study by Moody’s analytics expanded on this, revealing that regions “more exposed to storm risk are expected to suffer more than other regions when a hurricane hits.”
Secondly, if homes in affected areas have adequate insurance, this can increase prepayment rates. Homeowners with fixed-rate mortgages must make monthly payments to mortgage servicers, who retain a monthly “servicing strip”. These payments create a cash flow from mortgage servicers to Government-Sponsored Enterprises (GSEs) that purchase mortgages from lenders. From here, the revenue returns to lenders and the holders of Mortgage Backed Securities (MBS).
When prepayments are made, they reduce the mortgage value for MBS holders, as they cause an early return of the principal sum and a decrease in interest income. In addition, they also reduce the value of the servicing strip for mortgage servicers, leading to a dip in their revenue.
Research conducted by Fannie May economists and Carolyn Kousky underline the link between natural disasters and prepayment, showing that homeowners inside official at-risk zones use disaster insurance to prepay their mortgages faster than affected homeowners outside these areas.
Thirdly, frequent natural disasters can cause a fall in property value. The National Bureau of Economic Research has recorded this, showing that climate change has had an inverse relationship with real estate value and the annual volume of home-sale transactions in coastal regions for a decade.
A 2020 study by the University of Derby adds to these findings after conducting research on the impact of natural disasters on housing markets across 117 countries. It declares that “natural hazards are expected to increase in severity, and occur more frequently everywhere as a result of global climate change, thus, exerting severe impacts on house prices”, and calls upon national policymakers to adjust natural hazard insurance programs in relation to the housing sector.
The following are three major ways in which the US banking sector may be affected by natural disasters:
As discussed above, disaster-affected mortgage borrowers are more likely to default on their loans. While larger, multi-county banks can quickly mobilize debt collection and foreclosure proceedings, smaller banks that serve single counties may encounter difficulties in this regard, especially if defaulting occurs on a relatively large scale.
Economic disruptions incurred by bank clientele in affected areas can spill over to banks through loan losses, diminishing their income and capital.
Here, again, the operational scale of a bank determines the degree to which it will likely be affected. While multi-county banks have larger client bases, and, in such situations, may typically increase loan interest rates to mitigate losses, this is risky for single-county banks, as they may lose clientele.
Smaller banks will instead need to rely on their clientele making Federal Emergency Management Agency (FEMA) declarations to receive the financial aid necessary to pay their debts. However, as the Federal Reserve Bank of New York declared in a 2021 staff report, the benefits from FEMA-backed payments are not statistically significant for small banks.
Bank clientele may require more capital after a natural disaster for consumption and repairs, and this increases demand for loans, encompassing business, consumer, and mortgage loans. In addition, this allows banks to build back their diminished capital by raising loan interest rates, loan volume, or a combination of both.
The Federal Reserve Bank of New York’s findings suggest that loan interest rates tend to fall post-disaster, but an increase in volume makes up for lost capital.
The effects of natural disasters on the US banking sector underline the importance of the mortgage industry as a buffer to prevent disaster-related losses from spilling over to financial institutions. To better understand how the mortgage industry can brace itself for rising natural disaster rates, Gary Archambault - AVP, Sales and Key Accounts, IMS Datawise, weighs in on the topic.
“The challenges for mortgage industry that arise due to natural disasters are, to say, very complex. There are various questions that need their own solutions:
The solution here is that in times of natural disasters, we need to ensure that all vendors and internal staff teams are ready, and that all client reporting is completed in a timely manner. However, it is not possible every time. Especially, getting solutions to all the questions could be a complex scenario, given how multi-faceted the challenges could be. Therefore, a mortgage company needs a workforce solutions partner that can provide a centralized solution to the problems. It has been tried and tested that an external support partner, like IMS Datawise, can prove to be a cost-effective solution.”
Know more about why workforce solutions support is a prudent solution for organizations in the US mortgage sector.
Mortgage support services defend the US mortgage industry from climate phenomena and natural disasters in following key ways:
Climate phenomena and natural disaster rates are on the rise in the US. These can affect the US mortgage industry and banking sector by increasing mortgage default and prepayment rates, and lowering property values. However, the mortgage industry can prepare itself to withstand market volatility with mortgage support services, and act as a barrier that prevents greater financial upheaval.
Get in touch with IMS Datawise for a complete mortgage support service package. Be prepared to weather any storm, and handle hectic front and back-end mortgage-related tasks to disaster-proof your organization.