Underwaterwriting: from theory to empiricism in regional mortgage markets in the U.S.

Abstract

This article provides the theoretical foundation for the concept of “Underwaterwriting,” which can be understood as various informational and institutional limitations related to environmental exposure and climate change impacts—specifically flooding and sea level rise inundation—shaping firm participation in mortgage markets. Underwaterwriting suggests that the unevenness of scientific knowledge and local soft information, as well as the institutional barriers for the utilization of that information, could result in determinations of risk that may not accurately reflect long-term asset performance or credit loss. These informational asymmetries may result in assignments of risk that reflect a degree of arbitrariness or inaccuracy that may operate to strand assets and shed or increase market share in ways that are inefficient and may otherwise lead to negative public externalities. Consistent with this theory, this article provides evidence that concentrated local lenders are transferring risk in high-risk coastal geographies in the Southeast Atlantic and Gulf Coasts (U.S.) through increased securitization of mortgages. These findings provide an impetus for supporting more robust analysis of climate-risk in light of forthcoming accounting rules that require an upfront accounting of forward-looking credit losses.