Mortgage lenders need to have a robust transition plan and climate targets in place.
This is vital both for their own internal risk management processes – especially to ensure a full understanding of transition risk and associated business costs across different legislative scenarios – and to meet heightening climate disclosure requirements.
But, there are many challenges for lenders when producing a rigorous and credible transition plan.
Two of the key challenges are:
- Data. Environmental data for properties is incomplete and unreliable which makes it difficult to produce transition plans and targets that you feel confident in.
- Best practice. What’s included in a transition plan can vary across different lenders so it’s hard to know what best practice looks like – especially in terms of the actions needed to meet climate targets.
That’s why we recently held a discussion on ways to overcome these challenges in our webinar: ‘The Lender Path to Net Zero’, with expert speakers from across the industry:
- Joe Webb, Chief Growth Officer at Kamma
- Tom Kenny, Group Property and Credit Risk Director at Just Group
- Heather Buchanan, CEO and Co-founder of Bankers for Net Zero.
If you missed the webinar, you can find the full video recording is below, as well as a written summary of the discussion.
Part 1: 4 key steps for a best practice transition plan
The webinar kicked off with Joe Webb from Kamma, who highlighted 4 vital steps for mortgage lenders to take when producing or updating their transition plan – with a particular focus on the need for better data.
- Upgrade your data acquisition approach. It’s difficult to create a credible transition plan when you’re reliant on incomplete information. Data is a particular problem when it comes to the energy efficiency and carbon emissions of properties in a mortgage book (vital for understanding and mitigating transition risk) – EPC data is the primary source, but is incomplete, unvalidated, and often misleading. On the physical risk side, flood risk data is also incomplete – with 3.3% of UK mortgages containing hidden flood risk. It’s possible to acquire better data through providers like Kamma, who are able to validate property data for your mortgage book, improve accuracy, and fill any missing data gaps with predictive modelling.
- Close blind spots. Once you have a more accurate dataset for your mortgage book, you can assess and quantify the real extent of transition risk and opportunity for a more accurate and credible transition plan, free from blind spots.
- Apply scenario analysis and stress testing before setting climate targets. Joe advises modelling at least two scenarios for your mortgage book to give a full picture of business impact: a) expected emissions reductions at your current rate of progress, and b) emissions reductions needed if new legislation was introduced e.g. minimum EPC C for a mortgage portfolio. For stress tests, Joe recommends assessing the cost to EPC C (as this is the most likely legislative driver) across your portfolio under two analyses: a) the proportion of properties where the retrofit cost to EPC C cannot be absorbed into the current mortgage loan without crossing an LTV threshold, b) the proportion of properties where the retrofit cost to EPC C is more than 5% of the asset value – this is our approach for our climate risk and net zero reports at Kamma.
- Assess customer needs. Retrofit is always going to be a vital element of emissions reductions for mortgage lenders’ transition plans. Joe shared research conducted by the Kamma team as part of a GHFA-funded project. The key finding was that most home retrofit planning tools recommend a max retrofit package to homeowners which averages £10,000-15,000, which is out of budget for 70-90% of homeowners. But, optimising the cost of the retrofit package a homeowner receives can bring retrofit in-budget for the majority of homeowners – highlighting the importance of understanding customer barriers and needs when it comes to retrofit, and providing the right messaging and financing opportunities.
Part 2: A behind-the-scenes look a Just Group’s data-driven transition plan
Tom Kenny is Group Property and Credit Risk Director at Just Group, where he is responsible for setting the lending policy and risk appetite for the company’s lifetime mortgages – including climate risk.
Tom explained his key learnings from leading on Just Group’s sustainability strategy and transition plan:
- It’s worth investing a lot of time to understand climate risk exposure. Like Joe, Tom emphasised the importance of scenario analysis to gain an in-depth understanding of how climate risk could impact your business, especially in different legislative scenarios. For Just Group, scenario analysis highlighted that transition risk was likely to have a much bigger influence than physical risks such as flooding.
- You have to feel comfortable with the credibility of your own emissions calculations. Because the data on property emissions is so incomplete and unreliable, it’s also important to invest time in gathering and cleaning the data for your mortgage book, and then finding ways to fill the gaps in the dataset (Just Group have partnered with Kamma to fill their gaps via our predictive modelling). Ultimately, if you’re responsible for your company’s transition plan, you have to feel comfortable with the data being included, and with the credibility of that data. One way to improve data confidence is to target a low PCAF score – PCAF scores are on a scale from 1-5, with representing high data quality –this is another reason that Just Group chose to partner with Kamma for their reporting, to increase data quality.
- Set proactive targets related to scenario analysis. Just Group modelled the two key scenarios when setting climate targets – their current rate of emissions reductions vs the rate of reduction needed if the government introduced minimum EPC C legislation – and found there was a 9% gap between the two. So, they’ve set targets based on the need to proactively close that 9% gap to reduce transition risk by being well prepared for future legislation.
- The mortgage industry needs better best practice standards. Just Group’s focus is on lifetime mortgages, and Tom’s work has seen first-hand that there is a lack of standardisation in terms of approaches within the industry. Tom is the Chair of the Funders’ Forum for the Equity Release Council, and is working with the council on principles and guidance for later life lenders on transition planning to ensure all organisations are working to the same standards.
- There’s no magic bullet to increase retrofits, but there are three key initiatives. Tom highlighted the need for many different approaches to driving retrofit uptake to meet different customer needs. Some customers simply need education on small energy efficiency improvements that could move them from an EPC D to an EPC C, or get them started on a retrofit journey. Other customers need more in-depth advice on a best practice approach for retrofit. And others need finance to help them overcome the barrier of upfront costs – for Just Group this includes exploring the option of lifetime mortgages as a way to take equity from the home and spend it on retrofit improvements.
Part 3: The role of innovative financing models
Heather Buchanan is CEO of Bankers for Net Zero, an initiative that brings together banks, businesses, and regulators to support the UK financial sector’s transition to net zero.
Linking with Tom’s final point, Heather explained that the need to drive customer retrofit is the biggest challenge that the members of Bankers for Net Zero face.
There’s currently low customer demand for retrofit due to the upfront costs – which means the previous emphasis on offering new green mortgage products is not an effective approach to driving decarbonisation for lenders.
Heather highlighted three innovative financing models which are currently being developed within the industry, which could be much more effective:
- Property linked finance. Financing for retrofit is associated with the property instead of the property owner. This would help to overcome the barrier for many homeowners who are reluctant to spend a lot of their savings on a home that they have no intentions of owning in the long-term.
- Digital logbook. In the same way that many vehicles now have an electronic logbook that automatically logs data relating to journeys and mileage, properties could have a digital logbook that contains dynamically updated information on the property’s energy performance and progress on its bespoke retrofit pathway.
- Development banks and Private Finance Initiatives (PFIs). A blended finance approach could be used to mobilise additional private financing for retrofitting.
Finally, to return to the common theme of the webinar, Heather also emphasised that more accurate and up-to-date property data is needed to unlock any of these retrofit financing routes.
📣 Want to join the discussion for our next webinar?
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