Natural disaster risk now considered in mortgage-backed securities ratings

by Kimberly Greene10 Jun 2019

Natural disasters and catastrophic risk will now be considered by Fitch Ratings as a part of their ratings for residential mortgage-backed securities (RMBS), the firm announced this week. Fitch Ratings is the first of the three major U.S. credit ratings agencies to consider environmental risk explicitly for this asset class.

“Over the last couple years, RMBS investors are increasingly focused on natural disaster risk. And we felt it would be helpful to try to quantify that for them,” said Grant Bailey, an analyst at Fitch who co-authored the report.

The adjustment would add a new penalty to existing risk metrics. The hope is that it will better distinguish mortgage pools with high exposure to natural disaster risk, particularly those with high concentrations in Florida and California, said Bailey.

Although the new penalty will apply to ratings that have already been issued, Fitch does not expect it to affect any ratings currently outstanding.

“Our current proposed adjustment is fairly modest. But our goal here was to develop a framework that would allow us to dial the adjustment as needed,” said Bailey.

The adjustment will not go into effect immediately, as Fitch is soliciting feedback on its new methodology.

Neither Moody’s Investors Service nor Standard & Poor’s have explicit measures of climate risk in their assessments of RMBS, though both firms noted that some of that risk is implicitly accounted for in existing metrics.

Investor demand for insight into environmental risk, however, has begun to shift credit assessments more broadly. Moody’s recently announced its intention to create a carbon transition assessment, a research tool separate from its ratings that would rank companies by the level of risk associated with a transition to a low-carbon future.

Last year, Hurricanes Florence and Michael caused a combined $49 billion in damage, according to the National Oceanic and Atmospheric Administration. Wildfires in California cost a record-breaking $24 billion, displacing the prior record for losses due to wildfires set in 2017.