On January 19, 2021, the US Federal Housing Finance Agency (“FHFA”) became the latest federal government agency to recognize the potential impacts of climate change and natural disasters on the mortgage industry when it issued a Request for Input (“RFI”) on the risk of climate change and natural disasters to the national housing finance markets.1 The FHFA cited a number of reports and research on the risks of climate change to the housing market, including a Commodity Futures Trading Commission report issued last year,2 as part of the reason for issuing the RFI. Below, we summarize some of the risks previously identified by the entities regulated by the FHFA, Fannie Mae and Freddie Mac (“the Enterprises”) and the Federal Home Loan Banks (“FHLBanks”) pertaining to climate change and natural disasters and FHFA’s RFI on how to identify and mitigate these risks.
Impacts of Climate Change and Natural Disasters on the National Housing Finance Markets
In their annual reports for the fiscal year 2019 filed with the US Securities and Exchange Commission, the entities regulated by the FHFA, the Enterprises and the FHLBanks disclosed the risks natural disasters pose to their businesses. The Enterprises noted that natural disasters can adversely affect their businesses or financial results because of increased delinquency rates, default rates, credit losses, credit-related expenses, loan loss frequency and severity, lower origination volume, changes in property values and impacts to local economies.3 Although their financial exposure to natural disasters has been mitigated in the past,4 the Enterprises recognized that more geographically widespread weather events due to climate change pose a greater financial risk. In addition, the Enterprises are exposed to greater risk where insurance coverage is inadequate to cover damages from natural disasters and climate changes. Fannie Mae also disclosed that generally, its credit enhancement and risk transfer transactions are not designed to reduce weather and disaster-related losses that they incur. The FHLBanks similarly disclosed in their financial report for the fiscal year 2019 that natural disasters, among other unanticipated or catastrophic events, can reduce the demand for lending, increase the risk of credit losses and adversely affect their cost of and access to funding.5
As we detailed in our prior Legal Update, mortgage servicers generally bear the risk of loss in excess of hazard and flood insurance when government-insured or -guaranteed loans go into default due to natural disasters, particularly when the loans are pooled to back securities guaranteed by the Government National Mortgage Association (“Ginnie Mae”). This is in marked contrast to conforming conventional loans sold to or pooled with the Enterprises, where servicers in non-recourse transactions do not bear the risk of loss in excess of insurance due to a natural disaster or weather-related event.
Fannie Mae in particular noted in its annual report that the increasing unpredictability of major natural disasters makes it more difficult for it to forecast losses from those disasters, negatively impacting its ability to address the likelihood of such losses in guaranty fees. In addition, Fannie Mae stated that legal or regulatory responses to climate change concerns could also impact the housing markets. Fannie Mae also indicated in its annual report that it recognizes the risk that the increased frequency, severity and unpredictability of natural disasters poses for all stakeholders in the housing system and is exploring ways that it, along with FHFA and others, can mitigate those risks for all stakeholders.
FHFA’s Request for Input
In its RFI, the FHFA requested information on the current and future risk of climate change and natural disasters to the housing finance system, the Enterprises and the FHLBanks. The FHFA also requested input on strengthening its supervision and regulation of how the Enterprises and the FHLBanks manage risks arising from climate change and natural disasters. As the FHFA noted in the RFI, it does not have expertise in climate science and, through the RFI, seeks to gain further information about climate change risk exposure to the housing finance system and the entities it regulates. Comments on the RFI are due by April 19, 2021.
The RFI sets out a series of 25 questions for commenters to consider. These questions focus on identifying and assessing climate and natural disaster risk and enhancing FHFA’s supervisory and regulatory framework. The FHFA also requested any studies, research, data or other information supporting commenters’ responses or that is otherwise relevant to climate and natural disaster risks to Fannie Mae, Freddie Mac and the FHLBanks. The RFI does not address whether the risk of weather-related losses should be shifted to mortgage servicers, beyond a failure to follow servicing requirements. Among the questions, FHFA sought information on:
- How to define, measure and assess climate and natural disaster risk for the entities it regulates and for service providers;
- What risk management strategies are used by the industry to address climate change risks;
- How to evaluate the ability of the FHFA’s regulated entities to manage climate change risks;
- Whether the FHFA should implement stress testing or scenario analysis;
- Whether there are alternative risk mitigation strategies, such as insurance or insurance-based financial instruments, that could transfer risk from the regulated entities’ portfolios or products or assist with the market pricing of climate and natural disaster risks;
- Whether enough information is publicly available for stakeholders to exercise market discipline over the regulated entities’ appetites for and management of climate and natural disaster risk;
- What additional information would assist interested parties in assessing climate and natural disaster risks to the regulated entities;
- What additional reporting requirements the FHFA should impose on the regulated entities, if any, related to management of climate and natural disaster risk;
- How to tailor approaches to manage risks to the Enterprises versus the FHLBanks;
- Whether the FHFA can create policies for managing climate and natural disaster risk that do not adversely affect lower income households;
- What type of organizational structures the FHFA and the regulated entities should consider adopting to support management of climate and natural disaster risk;
- What issues or topics the FHFA should consider for further research on climate and natural disaster risk;
- What organizations, agencies or programs could the FHFA partner with to enhance supervision and regulation of climate and natural disaster risk and what factors the FHFA should consider when determining whether to engage in such partnerships;
- Whether the FHFA should support efforts to develop standards of classification and data reporting on climate and natural disaster risk to the financial performance of companies; and
- What other enhancements the FHFA should consider to supervise and regulate the climate and natural disaster risk to its regulated entities.
The FHFA’s RFI continues the trend of government agencies and other stakeholders recognizing the impacts that climate change and associated natural disasters have on financial services in the United States. The fact that the RFI was issued under FHFA Director Mark Calabria, who was appointed by former President Trump, reflects the reality that, regardless of the cause of natural disasters and climate change, these events are exposing the national housing finance markets to significant risk. Accordingly, the FHFA’s efforts to gather comments on these risks and develop management policies and strategies based on those comments is an important step towards mitigating climate change risk to the housing markets.
1 FHFA, Climate and Natural Disaster Risk Management at the Regulated Entities (Jan. 2021), https://www.fhfa.gov/Media/PublicAffairs/Documents/Climate-and-Natural-Disaster-RFI.pdf.
2 CFTC, “Managing Climate Risk in the U.S. Financial System” (Sept. 9, 2020), https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf.
3 Fannie Mae 2019 Form 10-K, Annual Report for the fiscal year ended December 31, 2019, pp. 36-37, 116-117; Freddie Mac 2019 Form 10-K, Annual Report for the fiscal year ended December 31, 2019, p. 144.
4 In its 2019 Annual Report, Fannie Mae indicated that its financial exposure from natural disasters is mitigated to the extent its business is geographically diverse.