Fitch adds environmental risk metric to mortgage-backed securities ratings

June 5, 2019

By Kate Duguid

NEW YORK (Reuters) – Fitch Ratings will factor natural disaster and catastrophic risk into their ratings of residential mortgage-backed securities (RMBS), the firm announced Tuesday, the first of the three major U.S. credit ratings agencies to consider environmental risk explicitly for this asset class.

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.

“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. It is expected to better distinguish mortgage pools with high exposure to natural disaster risk, namely those with high concentrations in Florida and California, said Bailey.

Although the new penalty will apply to ratings which 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.

Fitch is soliciting feedback on the new methodology, so the adjustment will not go into effect immediately.

Neither Moody’s Investors Service nor Standard & Poor’s have explicit measures of climate risk in their assessments of RMBS, though both 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.

(Reporting by Kate Duguid; Editing by Jennifer Ablan and James Dalgleish)

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