By Bill Alpert

Wildfire risk could cloud future mortgage lending in California.

The wildfires around Los Angeles have killed two dozen people and destroyed the homes of thousands. Within hours of the first sparks, home insurer stocks sank, and estimates soon forecast $20 billion or more in insured losses.

There has been relatively little volatility in a sector with a comparable interest in those scorched homes -- that is, the residential mortgage industry. The reason is because houses with a mortgage typically carry home insurance, so the banks aren't on the hook.

But if the insurance industry refuses to write new policies in fire-prone California, it will eventually hurt the mortgage business there.

In 2023 alone, there were $13 billion in mortgage loans made on homes in the ZIP Codes burned or evacuated by the current fires, according to a Barron's analysis of the latest figures. The nine fire-prone counties of Southern California are one of the nation's richest mortgage markets, accounting for $170 billion in originations that same year, or some 10% of the U.S. total. Big lenders there include JPMorgan Chase and Citigroup, as well as nonbank firms like UWM Holdings, Rocket Cos., and the Los Angeles-based Vista Point Mortgage. The homes securing thousands of those loans just went up in smoke.

Yet even in a catastrophe as large as the Southern California fires, it is hard to pinpoint where and when the embers will eventually fall in the mortgage industry. None of the big mortgage lenders would talk to Barron's about the business impact of the Los Angeles catastrophe.

"Our focus is on the safety and support of our employees and customers in the affected areas," said a Wells Fargo spokeswoman.

JPMorgan's Chase unit is the largest home mortgage lender in Southern California. Including its First Republic Bank unit, JPMorgan made more than $30 billion in loans there in 2023 alone -- some 18% of its national total -- according to federal data tallied by the Englewood, Colo.-based consultants Richey May. About $4.5 billion of the JPMorgan loans were for homes in the ZIP Codes affected by the still-burning Pacific Palisades and Eaton fires.

Vista Point, which lends to those who don't qualify for standard mortgages, and UWM Holdings, a big, publicly held originator known as United Wholesale Mortgage, had the next largest Southern California volumes in 2023, at $28 billion and $11 billion, respectively.

But the mortgage loans didn't remain on the lenders' books.

"The actual credit risk for most of the loans are not sitting with the lenders," says Eric Hagen, who follows the nonbank mortgage firms for BTIG. Most home mortgages quickly move off the books of the originating lender and into huge, geographically diversified pools of mortgage-backed securities. Those, in turn, end up in the portfolios of the government-sponsored Fannie Mae and Freddie Mac, along with some banks, life insurers, and private investors.

To keep mortgage bankers mindful of risks, the Dodd Frank Act requires lenders to retain 5% of the credit risk on loans they originate. But banks and nonbank firms like Rocket can satisfy the rule by holding a 5% slice of the securitized pool that buys the loans. So, their credit exposure to local catastrophes remains diffuse.

While the lenders pass the loans on to securitized pools, they usually keep their hands in the profitable business of servicing the loan. Los Angeles homeowners still owe mortgage payments on their burned homes, and there is no statutory requirement that mortgage companies agree to forbear collection, by allowing deferred payment, as a federal law required during the Covid pandemic.

Still, most mortgage servicers are voluntarily offering disaster forbearance to the Los Angeles fire victims. Chase Home Lending will grant three months' forbearance initially, which it will extend up to a year, depending on the homeowner's circumstances.

"Our thoughts are with everyone impacted by the devastating wildfires in Southern California, and the heroic first responders working to contain them," said Chase Home Lending in a statement to Barron's.

The insurance recoveries on wildfire losses also protect the mortgage companies. "In most cases when you take out a mortgage, the lender makes you buy insurance," says Hagen. "You can't even come to the closing table without insurance."

And when insurers send checks to rebuild a burned home -- or to settle with homeowners who don't want to rebuild -- the checks require the mortgage company's endorsement.

"The losers in these fires are the insurance companies and the homeowners," says Harley Bassman, a mortgage investing veteran at Simplify Asset Management. "I think the banks are fine; I think the mortgage holders are fine."

The midsize bank Axos Financial provides large mortgages to the wealthy. Five of those properties were destroyed in the Los Angeles fires, said chief executive Greg Garrabrants at a Needham conference Thursday. Axos has insurance to supplement the homeowners' coverage. "They are going to be rebuilt," he said.

Yet the catastrophe could actually spur new business, Garrabrants said. A rush for homes in safer parts of Los Angeles has suddenly made doubtful construction projects viable.

That doesn't mean there will be enough insurance coverage for all future mortgage lending. Private insurers have avoided writing homeowner's policies in California, and the state's last-resort coverage program will probably be exhausted by the Palisades and Eaton fires. Over 40% of the single-family homes in Southern California -- worth above $40 billion -- face a high risk of wildfire, according to the latest figures from the Federal Housing Finance Agency. The same goes for 50% of the area's multifamily housing.

And wildfire losses, in California and the rest of the nation, have been smaller than other climate-driven risks like hurricanes and flooding. As climate catastrophes increase, insurance costs nationally will need to increase. Rising insurance premiums will limit who qualifies for mortgages, as lenders factor those costs into their calculations of housing-expense-to-income ratios.

"We definitely expect some of the major lenders are going to be less active in lending to borrowers with more risk," says Hagen.

The 2008-09 financial crisis put the mortgage giants Fannie Mae and Freddie Mac into government conservatorship. Stockholders like Bill Ackman hope those government-sponsored entities can get released from conservatorship. An obstacle, warns Hagen, is whether their mortgage portfolios can get adequate insurance coverage for climate catastrophes like floods and fires.

"Climate risk is super relevant to privatization of those government-sponsored entities," says Hagen.

Write to Bill Alpert at william.alpert@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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January 17, 2025 12:20 ET (17:20 GMT)

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