Should lenders be eco-worriers?

Article originally appeared in Mortgage Finance Gazette on 25th January 2023

According to two of the UK’s most respected energy sector forecasters, the unseasonably warm weather over December and early January suggests household energy bills could be lower than expected in 2023.  They might drop below the level of the government’s price guarantee in the second half of the year: from 1 April, government’s support for limiting the price per unit of energy that suppliers can charge customers will restrict a typical household bill to about £3,000 a year.

While the costs for British households would remain high compared with historic levels, the news means the personal finance pages were pleased to report some limited relief for households wrestling with rising living costs.

Was that milder weather good news for lenders, too? Surely, sky-high fuel bills make it harder for owner-occupiers to pay the mortgage.  More than three quarters of a million UK households are at risk of defaulting on their mortgage payments in the next two years, the FCA warned recently.  The figures underline the pressures being felt by ever more people as a result of the cost of living crisis.  An unseasonably warm winter should ease the pain, no?

Well, yes and no.  The Met Office has confirmed that last year was the UK’s warmest year on record. The average annual temperature in 2022 was more than 10°C for the first time and the mean temperature across the 12 months was 10.03°C, topping the previous all-time high of 9.88°C in 2014.  Of course, we need to be mindful that our weather is highly variable and we’ve had a couple of cold snaps — but on balance it’s been milder over more days than forecast.

But lenders should note that this warmer weather is the result of human-induced global warming (and that climate change is as much about violent swings in the weather as we have seen in the US and Europe as mild temperatures).  The fact that energy costs are not going to be as high as feared won’t help affordability in the future.  In fact, looking down the track, even high variable energy use costs could pale into comparison with loss of value from the impact on property values that climate change could inflict.

Specifically this means physical risks like subsidence, flooding, and coastal erosion.  By 2070, 98,000 homes will be at risk of coastal erosion while 3,000,000 homes will be at risk of flooding. 3,600,000 will be at risk from subsidence, up from 449,000 today.  Not only is the probability of incurring a loss growing; the scale of that loss is significant.

Eventually, lenders will find themselves exposed to those falling asset values, too.

Lenders should also consider the potential costs to retrofitting homes to make them more energy efficient or resilient to heat.  After all, we learned in a report from Downing Street’s net zero tsar that, as part of the drive to decarbonise property, the sale of homes that are not in energy efficiency band C could be banned by 2033. It is all well and good putting challenging targets out there, but it is simply not going to be possible to retrofit the 20 million homes that currently are D or less in time. By way of example, the Energy and Utilities Alliance says we’d need another 90,000 trained installers to hit government heat pump targets.  There are currently about 3,000 heat pump engineers in Britain.

There are things that homeowners can do.  Installing features such as airbrick covers, non return valves, flood gates, and lifting electrical sockets higher are lower cost and as effective for the homeowner to overcome more immediate environmental risks. 

Lenders can help to, possibly encouraging borrowers in the right direction as part of the conveyance process.  At the end of the day, solar panels, for example, will prove more expensive and the return on investment far longer term than most mortgage relationships on lenders’ books.  They can offer better rates through a revision of green mortgages that also accounts for improved resilience.

It’s certainly no good trying to ignore the problem.  In May 2022, the Bank of England completed a ‘climate stress test’ on the UK’s leading banks. It suggested that, if they fail to manage climate risk, banks face the risk of very significant financial impacts by 2050: up to £225bn in credit losses.

Climate change is not a fringe issue for mortgage lenders.

So how should lenders prepare for the future?  Well, a good place to start would be with some risk triage.  Lenders need to make sure they have the information at their fingertips, before they lend against a property.  That will require environmental searches capable of modelling climate data to see how vulnerable to climate change a  property will be.

This is why it is so important that lenders (and UK Finance) mandate climate change risk assessment as part of the conveyancing process.  Using the right tools, conveyancers can triage risk for their lender clients while improving the information flow back to lenders.

We are anticipating new guidance for lawyers on advice to clients about climate change in the early spring. It would be interesting to hear what UK Finance and their members think about how this information should be reported.