Banks More Hesitant to Lend in Areas With Inaccurate Flood Maps

The federal maps are static and only periodically updated by the Federal Emergency Management Agency.

Climate change poses many problems for society as a whole, and for commercial real estate. Properties can face flooding or wildfires or heavy damage from winds. A building can be cut off from everything else. All the time while increasingly cut off new business lines in states that have been particularly hard hit by disasters.

At a time when insurance can’t be counted on as the rescue of last resort, lenders must consider the risk they could take on. The Federal Reserve Bank of New York emphasized this point in a recent blog post.

The observation started with a previous post about potential inaccuracies in flood maps. It wasn’t a nationally representative examination, but one still worth consideration because the issues aren’t only restricted to one part of the country.

The accuracy of federal flood maps is important for their part in setting insurance requirements for mortgage borrowers. But, as the NY Fed pointed out, there’s a mismatch. The maps are static, periodically updated by the Federal Emergency Management Agency. The conditions in any given area covered by a map aren’t static. “On the one hand, the climate continues to change, and the risks posed by a rising sea level, hurricanes, or even summer rains are constantly evolving,” they wrote. “On the other hand, many communities proactively manage flood risks through the construction of dams, floodways, or elevated dwellings to reduce the chance of catastrophic damage.”

The NY Fed went on to note that, through map updates, while the number of parcels deemed to face flood risks keeps increasing, more than a third get a lower risk designation than they previously had. Many maps remain decades old because the modeling and remapping processes are complex and tedious.

An area can be mapped incorrectly as at greater or lesser risk from flooding, which makes insurance requirements on lending uncertain and potentially misleading. It also causes banks to be more hesitant about lending in the area.

“We find that bank loans in areas that have inaccurate maps have a somewhat lower acceptance rate, all else equal,” they wrote. “Areas that have very inaccurate maps see a more pronounced reduction in acceptances. If we include borrower characteristics—especially borrower income and loan-to-value ratios—the relationship between the share of inaccurately mapped properties and loan acceptance rates becomes less negative among jumbo loans than in the raw correlation. This may be a reflection of the ability of these borrowers to make a larger down payment to help offset the bank’s perceived risk.”

It’s another, even if indirect, way that climate change has an impact on CRE.