The alarm bell of a “climate subprime” in the face of finance, while insurance on real estate loans becomes delicate

Alarm bells are ringing about a looming subprime mortgage crisis that could see banks exposed to the elements and more borrowers shy away from home loans in areas prone to extreme weather.

Climate change is something many borrowers don’t consider when buying a property, but risk assessors say it should be a priority.

Ahmad Tabish and his young family have just moved to the Victorian regional town of Shepparton for their new job.

He likes the “beautiful city” but is aware of his vulnerability.

Flood waters in central Shepparton in 2010.(ABC News: Emma Williams)

Shepparton’s town center is along the Goulburn River. Nearby homes are prone to flooding.

Mr Ahmad plans to stay in Shepparton for the long term and buy a house there.

“Usually when people buy a house, especially young people, they do a lot of research in terms of cost,” he says.

“But I think now that there is [are] additional factors to consider: how is the topography of this area? The geography of this region?

“How vulnerable is this area to the effects of climate change, which could be bushfires, floods, droughts?”

This is something that banks that provide home loans are increasingly thinking about.

The ABC’s $31.2 billion exposure to extreme weather

Australia’s biggest lender released its first climate change report in August.

The Commonwealth Bank partnered with CSIRO to compile the report.

He noted that he currently has $31.2 billion in home loans on his books for properties in areas exposed to extreme weather risks, including cyclones, floods and bushfires.

three australia maps with weather events and numbers
The exposure of Commonwealth Bank home loans to extreme weather conditions, according to its recent climate change report.

The bank noted that it was using a severe physical risk scenario which assumes temperatures will rise by up to 4.8˚C by 2100.

He also noted that the $31.2 billion was just 3.1% of his home loans.

“However, we recognize that as Australia’s largest bank, our performance is strongly correlated to the Australian economy,” he said.

Another major lender, Westpac, has also looked into the matter.

It found a similar rate of CBA exposure across its mortgage portfolio, around 3.3-3.8% by 2050, depending on the temperature level projections used.

How do banks make these projections?

None of the big four banks would be questioned about it.

However, in its report, the ABC said its home loan risk assessment took into account “assumptions regarding insurance coverage, probability of default and real estate valuation impacts”.

Claire Ibrahim is an economist for Deloitte Access Economics who has insight into how the financial industry views climate risk.

“If you think about how people get mortgages today, part of that equation is [the property’s] ability to be insured,” says Ms. Ibrahim.

“The insurance obviously protects the owner of the home, but it also protects the bank, insofar as there is a natural disaster.”

a woman in front of a river
Claire Ibrahim works on the financial risks of climate change.(ABC News: Alice Pavlovic)

The problem for a bank is when it approves a home loan and then getting insurance on that property becomes a problem – say, because it’s considered more at risk from floods or fires.

Insurance premiums for zones are usually updated annually. They can easily skyrocket after a region has been hit by a major event such as a flood or cyclone.

How do you factor that into a 25 to 30 year home loan?

In a speech in August, Jonathan Kearns of the Reserve Bank of Australia highlighted this dilemma for banks.

“Loan contracts are much longer than insurance contracts,” the central bank economist said.

“Over these horizons, the effects of climate change are likely to be significant, but are also highly uncertain.

“The borrower may not keep insurance, either because insurers won’t cover it or because the cost of insurance has increased dramatically.

“If climate change means a home is uninsured, lenders may find that damage from floods, storms, or fires results in a significant drop in the value of collateral.”

Obviously, it depends on what the insurance industry is doing.

In a report released last month, his advocacy group, the Insurance Council of Australia, looked at this issue in relation to climate change.

“At this time, no area of ​​Australia is uninsurable. However, some areas may become increasingly difficult to insure as extreme weather risks increase,” the report said.

ICA chief operating officer Kylie McFarlane told The Business that the only real solution to this problem is to ensure that properties and communities are disaster proofed.

She said it was not possible for insurers to offer banks or homebuyers a longer-term outlook on premiums, and that people should do their research on insurance prospects on a property before buying it.

“That’s why we need to see substantial investments in resilience and mitigation,” she said.

What could this do to property values?

As the insurance industry becomes more open about the long-term risks of soaring premiums, a conversation is brewing about what this could mean for current and future home loans.

A person ABC News spoke to anonymously for this story who lives in an area just hit by a natural disaster told us his lender now sends him annual reminders saying he needs a insurance.

And another major bank confirmed to ABC News that it is standard policy after an area was hit by a severe weather event that people wishing to borrow for property there will need to receive a full on-site appraisal.

Some banks are already charging higher deposits, or interest rates, on loans deemed risky for various reasons.

It’s an indication of how lenders think about it.

“It’s very reasonable to start thinking about it, not as a future risk, but as a current risk,” says Ms Ibrahim.

“It will also affect property values…over time.”

Karl Mallon is the boss of a consulting firm that works with precision on insurance premium projections, climate risk and property values.

“Do you remember the GFC? The idea that was there [were] subprime [loans]. Well, now we are looking at climate subprime,” he says.

He also says there could be “property price corrections” for homes in high-risk locations in the coming years.

“Imagine trying to buy a house where the bank won’t give you a mortgage. That property won’t be worth much,” says Mallon.

It could also tragically lock people into houses that aren’t worth much and that they can’t sell or insure. It would leave them alone.

Mr Mallon’s company, Climate Valuation, released data earlier this year, with advocacy group the Climate Council, looking at high-risk areas across Australia.

Conclusions were based on a business as usual, high emissions perspective for climate change.

He claimed that one in 25 Australian households would be at high risk of becoming effectively uninsurable by 2030.

It also identified places across Australia where more than one in 10 households could face this risk, including parts of Brisbane.

This February marked the third major flood to hit Brisbane in 50 years.

Mrs. Ibrahim lives in the river town.

Two women walk by a house partially submerged by flood waters.
Women walk through knee-deep floodwater outside a house in the Brisbane suburb of Rocklea on February 27, 2022.(PAA: Jason O’Brien)

“People in Brisbane are particularly nervous [as we go into a] the summer where they report that we could see even more extreme weather events this year,” she says.

“What people did not take into account [the] The equation is what climate change will mean for the inherent and quite physical value of their property, particularly if it experiences frequent and more severe flooding.

“I don’t think people think like that right now.”

a man in front of a river
Ahmad Tabish is a scientist with an interest in climate change who has just moved to a city vulnerable to rising sea levels.(ABC News: Simon Tucci)

Another place identified on Climate Valuation’s list was Greater Shepparton, which brings us back to scientist Mr Ahmad.

He is aware of the risk assessment for Shepparton, which was reported by ABC News at the time with a focus on the regional city. Some locals believed the report and some didn’t.

“It’s still something [that] It may be too early to tell,” says Mr. Ahmad.

“But, sure, no one wants to risk your big investment on this. You have to think twice about it.”

Prior to moving to Shepparton, Mr Ahmad worked on nanotechnology which had applications for carbon capture and storage. This is why he is passionate about preventing the worst of climate change.

Like the Insurance Council of Australia, it believes the solution to this complex problem lies in building resilience and ensuring the impacts of climate change are mitigated.

He not only wants it for himself, but also for the next generation, including his young baby.

“We have to be prepared and we have to prepare our future generation,” he says.