For most in the US securitization market, environmental, social and governance issues are little but an afterthought. Whether they like it or not, this is going to change.
Sustainable finance has not flourished in US securitization, partly because the market is largely a strictly pragmatic, even clinical, way to borrow against financial assets. Recently, the political controversy
around the mere mention of ESG means that for many, it's easy to put the topic on the backburner.
The attitude, among many market participants, is that specifically labelled ESG bonds are costly and unnecessary.
After all, even in ESG-friendly Europe, the industry has struggled with how to integrate securitization structures into a green bond framework.
But climate risks are lurking in the residential mortgage-backed securities market. What's more, they are already beginning to surface, and soon market participants will have no choice but to face them.
Uneven risk
Most importantly, many RMBS are backed by non-qualified mortgages owed by non-standard borrowers, or single family rental loans. Large swathes of these pools are secured on houses in the Sun Belt states — particularly Florida, Texas and California.
These are critical geographies for RMBS. Amid the slump in mainstream first lien mortgage origination since interest rate rises began, non-QM volumes have increased significantly and have gone further than other asset classes in filling the supply gap.
Single family rental issuance, meanwhile, boomed in 2020 and 2021. These deals are backed by bank loans to property companies, secured on as many as hundreds of houses the company owns and rents out to tenants.
This sector benefitted from southward migration during the Covid pandemic, away from more expensive and more restrictive northern states.
After a slump in 2023, so far this year SFR-backed issuance has reached $5.5bn — pretty much double last year's whole volume.
Yet the Sun Belt region is the most sensitive to extreme heat, water scarcity, adverse weather events and rising sea levels.
For RMBS, at stake is not only direct impact on the performance of existing loans, but the pace of issuance of new mortgages. If this falls, it will not just affect securitization volume, but also credit quality, since properties will become harder to refinance.
Already, migration is slowing, and it is projected to reverse. Some people are adapting to emerging risks by avoiding the regions susceptible to the worst of climate change, and moving instead to more moderate zones such as the northeast.
Pressure on those who stay will also grow. Climate risks mean there has been a meteoric rise of tax and insurance rates in Sun Belt states, especially Florida, further constraining affordability and potentially pricing people out of homes.
Ultimately, the southern tier of the US will lose its luster, if it becomes dangerously hot, faces more frequent and intense droughts and has to deal with more weather events like hurricanes.
As taxes and insurance premiums rise, the cheaper cost of living in these states will be offset by an increasingly higher cost of housing.
Although these forces have not translated into loan delinquencies yet, this phenomenon is still in its early stages.
Wary investors
Inevitably, investors will become cautious. Some are already wary of investing in non-QM deals heavily exposed to areas like Florida, Texas and California, citing the uncertainty that rising costs pose to these housing markets.
Markets don’t like uncertainty, and less enthusiastic investor participation in deals concentrated in hot regions would translate into high costs of funding for non-agency mortgage originators issuing RMBS backed by properties there.
Today's assumptions about SFR — for instance that a lack of housing will continue to support rent growth — will be put at risk.
Reduced demand for housing in these areas, combined with investor caution, could damp rent growth and tenancy rates. It risks a vicious circle, in which rental companies struggle to get attractive financing on their portfolios.
For non-QM mortgages, higher taxes and insurance costs could trigger more delinquencies. But there is a graver risk: the uncertainty of how these region's housing markets, which have so far enjoyed strong price growth, will hold up under the climate-related pressure.
So far this year, the sun has shone brightly on non-QM and SFR-backed RMBS. But it is not clear that the Sun Belt can take much more heat.