Climate change is responsible for an increase in natural disasters, including hurricanes, tornados, flooding and wildfires, resulting in significant property damage. With the rising temperatures comes increased exposure and risk to financial institutions, mortgage lenders and servicers.
In advance of Earth Day 2020 on April 22, we examine lessons from Superstorm Sandy, Hurricane Harvey, and Hurricane Florence, among others, and explain why the mortgage industry should prepare now for increased litigation and regulatory scrutiny.
Lessons Learned Should Shape Response to Climate Change
The U.S. housing market is significantly underinsured against flood risk and flood maps are widely understood to be out of date. Increased flooding partnered with a lack of adequate insurance will likely lead to more defaults, decreased property values, requests from borrowers for assistance, and foreclosures.
Lenders should prepare to apply the lessons of the 2008 financial crisis, prior disasters, and even from the current Covid-19 crisis, to manage a potentially high volume of notices to customers, reviews and responses to loss mitigation requests and related litigation in a short period of time. This may require increased staffing, updating policies or procedures, additional training and quickly developing templates for customer communications.
Past litigation trends suggest increased property damage could prompt claims challenging lender placed insurance (LPI). LPI is authorized by federal law to ensure that mandated amounts of flood insurance are in place on properties located in “special flood hazard areas.”
Historically, plaintiffs’ suits over LPI have included class actions challenging servicers’ LPI practices. Disputes between property owners and neighbors over damage to property are common in the wake of natural disasters as well, and the lender or servicer is frequently named.
Finally, there may also be a resurgence of public nuisance claims that seek to require mortgage lenders to maintain damaged and abandoned properties and to seek to recover lost tax revenues and expenses related to vacant and abandoned properties, including hefty demolition costs.
The industry also must be prepared for supervisory actions and regulatory investigations. The U.S. Consumer Financial Protection Bureau (CFPB) recently explained in its Winter 2020 Supervisory Highlights that following a natural disaster, one or more mortgage servicer failed to comply with Regulation X (which details how and on what timeline servicers must provide loss mitigation notices) in part because the servicers failed “to handle an unexpected surge in applications due to natural disasters.”
Although the corrective action in these cases was limited to enhanced plans for surge staffing, servicers should be on notice that the CFPB will be examining whether they have adequate natural disaster plans.
Litigation Landscape and New Enforcement Risks
In addition to a surge of claims familiar to the mortgage industry, climate change and recent legislative and regulatory changes present new risks as well. First, some states have created new obligations on mortgagees, or their servicers, to maintain abandoned properties.
For example, as of April 2017, an Ohio law prohibits the use of plywood to secure real property that is deemed vacant and abandoned under Ohio law. And, New York law requires mortgagees and servicers to inspect, secure and maintain certain abandoned properties and to register such properties with the New York Department of Financial Services (DFS).
Compliance with these and other laws adopted after the 2008 financial crisis and recent storms may prove challenging if a large number of properties are damaged simultaneously, and they could thus subject servicers and lenders to substantial new fines and penalties in the wake of wide-spread property damage and foreclosures.
Importantly, the DFS has publicly stated that it wants to be a leader on climate change. We expect the DFS, and other regulators, to look carefully at supervised entities’ response to climate change and preparedness to respond to natural disasters.
The DFS has suggested it will be looking to initiatives taken abroad for guidance on climate change; those may foreshadow future regulations in the US. For example, the Bank of England has announced it will subject the largest banks and insurers to a climate change stress test beginning in 2021.
The U.S. Federal Reserve (the Fed) has not announced any plan to adopt a similar stress test, but Chairman Jerome Powell recently explained that the Fed takes “severe weather events” into account while exercising its banking supervisory function.
Foreign banking regulators are also paying attention to the exposure financial institutions have to climate-related risks and to their efforts to mitigate the impact of climate change by investments in “green” initiatives, or “impact financing.” Mandatory disclosures of climate-related business risk could be on the horizon. Financial institutions should therefore consider incorporating an analysis of their exposure to climate-change-related business risk into their strategic decisions.
Prepare Now to Address Climate-Related Risks
There is no doubt that there will be further natural disasters—and also no doubt that there will be further regulation, scrutiny and litigation. Financial institutions should prepare now to manage some known risks.
First, be prepared to address consumer complaints and thereby proactively avoid consumer lawsuits. An adequate claims department and good communications with customers paired with a system to elevate recurring complaints goes a long way.
Second, as recently advised by the CFPB, be prepared to increase staffing in the wake of a natural disaster.
Third, mortgage lenders and servicers should also ensure they are in compliance with the requirements of the National Flood Insurance Program, and take steps to minimize their exposure to future consumer claims challenging LPI.
Such steps might include: reviewing internal policies regarding the amount of flood insurance required (and placed) on collateralized properties in light of recent case law; scrutinizing relationships with LPI providers to understand any financial incentives your company or its affiliates are receiving and consider the litigation risk such incentives may pose; and reviewing notices that alert borrowers to the possibility of LPI, the expense of LPI in relation to policies a borrower could purchase directly, and to any commission earned on LPI policies to ensure compliance with all consumer protection laws.
Fourth, financial institutions should also monitor state and local legislative and regulatory activity to ensure awareness of new compliance obligations.
And, finally, financial services companies should watch what is happening abroad. Companies can get ahead of issues by monitoring climate-change regulations and litigation adopted outside the U.S. as well as litigation over corporate business practices and compliance with such regulatory standards.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Allison Schoenthal, a partner in Hogan Lovells’ New York office, is head of the firm’s Consumer Finance Litigation Practice. She has more than a decade of experience representing banks, trusts, lenders, servicers and others in the financial services industry in litigation, government investigations and enforcement actions.