How Evaluating Risk Can Prepare You for the Worst of Climate Change

Risk assessment in today’s economy means evaluating factors far outside the obvious. Moody's Analytics takes a broad-based view of commercial real estate by examining the world around it and using their vast data analytics capabilities to determine and quantify alternative dimensions of risk. Partner Insights spoke to Victor Calanog, Ph.D., the head of commercial real estate economics for Moody’s Analytics, to learn more about Moody’s Analytics’ risk evaluation capabilities.

Commercial Observer: What exactly do we mean when we discuss alternative dimensions of risk?

Victor Calanog: Alternative dimensions are factors that will likely have an impact on the commercial real estate market, but aren’t included or considered in traditional risk models. These can be factors that start by causing uncertainty in the market, but eventually elevate to the level of tangible risk.

Before COVID-19 hit, I would probably classify a global pandemic as belonging to the realm of uncertainty. But as it unfolded, industries and businesses needed to determine how the pandemic would impact their bottom line, or whether they would even survive. The “pandemic” then moved from uncertainty into the world of risk, where we needed to assign probabilities to possibilities. That’s where alternative sources of data, ways of analysis and newly available technologies became of much greater interest. This also applies to issues like climate change, or the impact of social upheaval on proper governance.

Is there a specific audience that should be most concerned with alternative dimensions of risk?

This used to be the traditional bailiwick of risk managers. But now, increasingly broader numbers of stakeholders are getting involved, not just because of regulatory pressure, but also because it’s becoming very clear that we need to think about commercial properties and the ecology of the built environment in a broader, more dynamic, and, frankly, more sustainable way.

One of these alternate risks is climate change. How could businesses account for the effects of climate change on their business dealings?

We can ask questions about specific geographies: What are the risks we can identify and quantify given modern science and technology? So, things like the risk of wildfires, flooding, earthquakes, etc. That’s why Moody’s has been investing in companies that have made this their business. It’s a science that’s evolving, and Moody’s aspires to be the global standard for holistic risk assessment. 

More specifically, how does Moody’s assist clients in determining some of these risks?

For specific categories of risk that were once very difficult to quantify, Moody’s brings the technology, the data, and analytics to bear to help you make the best decisions possible. Let’s talk about environment and climate. We have research teams dedicated to quantifying the effect of climate change on incomes and values, which directly impact your debt-service-coverage ratios, loan-to-value ratios and therefore your probabilities of default and expected losses for specific loan/property combinations. We can develop alternative scenarios — this is what’s likely to happen once you layer on climate risk. So, for example, we could find that flooding risk in Florida will knock a company’s net operating incomes down by X percent, far more than a similar loan in another state. We want to make it practical, giving you concrete information and analytics that will help you make good decisions.

Break this down into the positive effects Moody’s could have on lenders, and then on property owners.

On the lender side, we’re trying to determine whether loans issued will get paid back on your loan: What are the risks against that? It all boils down to what affects income and value. Climate risk could affect specific properties in different ways, depending on their location, even if they’re just a block or two apart. We want the most usable, granular level of decision-making, at the building, loan or even tenant level. It can’t just be market-level assessments anymore. For example, one of the things we’re trying to quantify from a climate risk point of view for property owners is the true transition cost of meeting new regulatory standards for environmental compliance. In New York City, Local Law 97 comes into effect over the next few years, and tough luck if you’re dealing with a much older building, because it might cost you quite a bit to overhaul all those HVAC units and piping. I know everyone wants to comply, but what if the cost of complying is so onerous? Maybe the decision is to pay the prescribed penalty.

How does Moody’s help protect lenders against possible damage from an ill-advised Know Your Customer (KYC) relationship?

Operating units from across Moody’s, including KYC, collaborate closely to bring the kind of intelligent analytics we have about specific businesses and individuals to bear. That’s really one of the fundamental value-drivers of our commercial real estate products and offerings; we can provide a broad and agile look at risk because of our expansive expertise, data, and tools. 

Our KYC group curates the world’s largest database of companies and individuals involved in financial crime and other controversies. They have datasets on companies and individuals who have been involved in unethical labor practices, for example. Using this data, we can work with lenders to identify borrowers they may want to take a closer look at. We’re building out our lending platform to make sure that our clients have this kind of analytical power at their disposal.

And how does this apply to property owners?

Think about how apartment landlords examine information like FICO credit scores and proofs of income for potential renters. Think about what we’re doing for commercial tenants as the analog to bringing business intelligence to bear for any new or existing tenant you might want to sign to a longer-term lease. We bring a lot of data resources, including alternative sources, to give property owners a more complete picture of who exactly they’re dealing with, and what kind of relationship is likely to evolve.

How can Moody’s help lenders limit the damage from supply chain delays?

Here’s a specific example related to new construction. We’ve always prided ourselves on the most accurate building level forecasts for when specific properties are going to come online. We get really deep into the data to provide a curated sense of which buildings are going up, which have broken ground, which have six months to go, which have three months to go, which are likely to be delayed, etc. Because of this database that we’ve maintained over the course of 15, 20, 25 years or so, we can also quantify the likelihood that specific developer projects will be delayed because of their track record. We have great relationships with the rating agency, which has a plethora of intelligence and research to assess the risks of certain types of debt. 

The different components that Moody’s can bring together give us a broad sense of whether there are parts of the system that are under stress because of supply chain issues. Then, we put it together and make projections about the future. We have an entire predictive analytics operating unit that studies what happened to the price of lumber, what’s happening to wages in the construction sector and what else might cause delivery delays. We can have that nuanced conversation about which drivers are really significant, and on the bright side, we can also make data-driven predictions about whether or not supply chain issues are easing.

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