As the climate crisis accelerates, its impact on financial stability, particularly in the mortgage lending sector, is becoming undeniable. Traditionally, mortgage lenders have leaned on homeowners insurance as a safeguard against natural disaster-related defaults. But with the rising frequency and intensity of extreme weather, that safety net is unraveling. A new report by First Street Foundation introduces a critical addition to the traditional credit risk framework: Climate, the Sixth “C” of Credit.
Why Climate Risk Now Belongs in Credit Analysis
Lenders have historically relied on the five Cs of credit — character, capacity, capital, collateral, and conditions—as time-tested metrics to evaluate a borrower’s risk. However, climate change is disrupting the assumptions baked into these models. First Street’s 13th National Risk Assessment reveals how disasters like flooding, hurricanes, and wildfires are producing “hidden credit losses” that lenders’ conventional models fail to anticipate.
For example, lenders misjudged the foreclosure risk of affected properties after Hurricane Sandy, underestimating losses by up to $68 million. These weren’t just errors — they were costly blind spots. The report shows that foreclosures tied to climate events, particularly floods outside FEMA-designated flood zones, are significantly higher, by more than 50 percentage points, than those inside zones where flood insurance is mandatory.
The Insurance Crisis and Its Ripple Effects
As the insurance industry grapples with record-breaking losses — $546.2 billion in 2023 alone — insurers are retreating from high-risk areas or drastically increasing premiums. That leaves more homeowners exposed and financially vulnerable. And when the cost of coverage rises, so do defaults. According to the report, every 1 percentage-point increase in homeowners insurance premiums correlates with a 1.05 percentage-point increase in foreclosure rates.
While wind and wildfire damages are generally covered and directly reimbursed to lenders, floods continue to present the greatest threat. NFIP limits haven’t kept pace with real property values or reconstruction costs, driving a widening protection gap.
Billions at Stake in the Decade Ahead
First Street projects that climate-driven credit losses could reach $1.2 billion by the end of 2025, roughly 6.7% of all foreclosure credit losses. If trends continue without changes in lending standards or climate mitigation, that number could balloon to $5.4 billion annually by 2035.
What’s driving this surge? The combination of:
- Uninsured or underinsured properties in flood-prone areas
- Stagnant home-price growth in climate-vulnerable regions
- Macroeconomic volatility, including inflation and recession risks
- Increased borrower exposure due to shifting insurance burdens
Integrating Climate Data into Lending Decisions
The report urges lenders to incorporate high-resolution climate data into risk models. Tools like First Street’s Flood Model (FS-FM) and Macroeconomic Implications Model (FS-MIM) allow for better forecasting of long-term foreclosure risk tied to climate pressures.
Failing to adapt comes with steep costs. Not only do foreclosures strain borrowers, but they also expose banks and mortgage investors to unrecognized losses, jeopardizing broader financial system stability.
Redefining Creditworthiness
Climate risk is no longer a hypothetical threat — it’s a measurable, material factor that influences borrower resilience, property value, and portfolio performance. As such, it deserves a formal place in credit risk assessment. Lenders, insurers, and investors must evolve their models and strategies now, or risk being blindsided by the rising tide of climate-driven losses.
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