By Oleg Blokhin

As inflation eats away at margins and interest rates rise, borrowers will look for cheaper financing. To stay competitive, banks will need better ways to determine which properties are truly at the greatest risk of default on their mortgages and charge them accordingly. Climate change brings more frequent extreme weather events, making businesses significantly more likely to experience downtimes, lose revenue and subsequently default on their mortgages. Even worse: Most lenders have no easy way to quantify that risk.

Banks that can calculate a borrower’s true climate risk exposure gain a major advantage over their competitors. 

Using One Concern DNA™ banks could quantify the climate change-related default risk on a business in a coastal area seeking a 30-year fixed mortgage for $50 million. The borrower wants an interest rate of 4.5% — but One Concern shows its actual climate risk exposure supports a rate of 4.6%. Charging a premium of 0.1% may not look like much, but over the term of the loan, it allows the lender to book more than $1 million of additional revenue.

Our hypothetical mortgage data shows direct building damage increases mortgage default rates by 1.0% on average over a five-year horizon, and damage to essential infrastructure increases it by another 3.8% on average over a five-year horizon.

Like business lending of all kinds, commercial mortgage banking has long relied on models that estimate the probability of default based on how properties produce revenue. How much could a hurricane reduce a building’s utility, for instance, and impair a borrower’s cash flow?

As we’ve learned in the past two years, some businesses can absorb tremendous disruptions by allowing their employees to work remotely. Many others, however, do not have that luxury: When concert venues, factories, meat-packing plants, grocery distributors and patient care facilities shut down for significant periods, it can take an immediate and dramatic toll on their revenues. 

And a chain is only as strong as its weakest link, so it’s not just the risk that a facility will shut down due to flooding or damage on the premises — it’s also the risk that related events will knock out the infrastructure on which it depends.

Typical risk models that rely on zip codes or GIS data do not incorporate the probabilities of prolonged downtime that disrupt a property’s dependencies, including electricity, transportation networks and community. 

Sometimes two buildings will be located in the same zip code, in the same neighborhood, and even on the same street — but one depends on electric power from a substation resting on a geological fault line, which would fail in the event of an earthquake. As a result, that property presents a substantially greater risk of default, and without One Concern, lenders might have no idea until the borrower begins missing payments. 

Using One Concern DNA™,  banks can add probability-adjusted downtimes and their resulting impacts into their existing default or credit risk models, calculating downtime-conditional losses for tenants and property owners. This allows banks to estimate resilience-adjusted probabilities of default and incorporate them directly into their credit and pricing models. 

One Concern Domino and One Concern DNA™ allow lenders to address the impact of climate change, natural disasters and other complex hazards and plug them all into their bank’s risk management systems, loan origination systems, loan review, stress tests, and scenario analyses.

As climate change risk disclosures become a regulatory requirement, One Concern’s products will enable banks to produce resilience-adjusted risk reports for direct real estate holdings, commercial mortgage portfolios, and commercial lending of all kinds. 

Think again of how much an interest rate difference of just 0.1% compounds over three decades. So whether lenders are more concerned with cutting losses on properties or realizing gains before they originate a loan, One Concern DNA™ can help them understand their true risk exposure.