Understanding Climate Risks in Commercial Real Estate Loans: Implications for Community and Regional Banks
As climate change continues to reshape our world, the implications for the commercial real estate (CRE) loan market cannot be ignored. Investors and lenders in the industry now face the imperative of enhancing risk management strategies to navigate the evolving landscape. Community and regional banks, in particular, are at the forefront of this challenge due to their significant exposure to CRE loans. In this conversation, Adam W. Sandback, a seasoned financial expert, and Andrew Eil delve into the impact of climate change on CRE loans, especially in high-risk areas such as California, Texas, and Florida.
Evaluating Climate Risk in Community and Regional Banks’ CRE Loan Portfolios
Adam W. Sandback, CFA, FRM, CPA, CMA: The threat of climate change looms large over California, Texas, and Florida, with rising sea levels and natural disasters impacting property values. Insurers are pulling back from these markets, creating further challenges. The shift to remote work and the heavy burden of CRE debt held by privately owned banks add to the risks highlighted by the US Federal Reserve in its recent reports.
Andrew Eil: Despite recent real estate activity indicating a strong market in Florida, Texas, and California, the growing frequency of extreme climate events raises concerns. Areas like Houston, Miami, and Norfolk are already showing signs of softening market values due to climate risks.
Adam W. Sandback: Smaller banks face unique challenges in managing climate risks due to their limited resources and expertise. Implementing climate-risk modeling and enhancing data management are crucial steps for these banks to mitigate potential losses.
Andrew Eil: Community and regional banks must align their risk management practices with climate realities to navigate the challenges posed by climate change. Overcoming regulatory and financial barriers to adopting climate-sensitive practices is essential for the long-term resilience of their portfolios.
Forecasting the Future of CRE Loans in a Changing Climate
Adam W. Sandback: The convergence of rising interest rates and climate risks poses a significant threat to the CRE loan market, especially for banks with large exposure to these loans. Climate-related discounts in the market remain elusive despite the looming threats.
Andrew Eil: The impact of climate change on CRE valuations may soon become more pronounced as extreme weather events become more common. Government policies and regulations will play a crucial role in shaping market dynamics, with a focus on climate-resilient infrastructure and disclosures.
Adam W. Sandback: Retrofitting buildings in climate-vulnerable states is essential but presents financial and regulatory challenges. The performance and attractiveness of buildings, driven by climate resilience and sustainability, will likely dictate future CRE values.
Navigating Insurmountable Challenges in the CRE Market
Adam W. Sandback: Soaring property insurance costs pose a significant challenge for CRE in states like California, Florida, and Texas, straining lenders and borrowers alike. Insurers are adapting to climate risks by adjusting premiums and underwriting techniques.
Andrew Eil: The retreat of insurers from high-risk areas could further exacerbate challenges for property owners and lenders. Climate-sensitive risk pricing and enhanced underwriting practices are essential to manage the evolving risks in the market.
Towards a Unified Approach to Climate Risk Management
Adam W. Sandback: Despite calls for standardized climate risk disclosures, many smaller banks struggle to comply due to limited resources. Implementing a unified international standard for climate risk management in the CRE market may take time but could help mitigate risks for smaller financial institutions.
Andrew Eil: The Fed’s recent guidelines on climate risk management underscore the need for stricter oversight in the banking sector. While challenges remain for smaller banks, voluntary approaches can pave the way for effective climate risk management.
Conclusion
As the commercial real estate market grapples with the complexities of climate change, community and regional banks must prioritize risk management strategies to safeguard their portfolios. Integrating climate risk into lending practices and embracing sustainable building practices are critical steps towards a more resilient future for the industry.
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Please note that the views expressed in this post are personal opinions and should not be construed as investment advice. The opinions presented do not necessarily reflect the views of CFA Institute or the author’s employer.
Image credit: ©Getty Images / Byba Sepit
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