Resilience Under Adversity: Quantifying Physical Risk for U.S. Commercial Real Estate Lending

This white paper examines the quantification of physical risks associated with U.S. commercial real estate (CRE) lending, particularly in the context of increasing natural disasters such as wildfires and floods. It outlines the significant impact of these risks on lending portfolios, noting that CRE loans have become a larger portion of bank portfolios amid rising demand. The document details the modeling inputs used to assess climate damage and the CRE credit risk framework employed to evaluate the effects of physical risks on portfolio performance. The analysis reveals that incorporating physical risk into credit assessments leads to a notable increase in the probability of default and expected loss, emphasizing the need for lenders to integrate climate analytics into their portfolio management strategies. The paper also discusses the methodologies used to select a representative loan portfolio and the characteristics that distinguish more resilient assets from those vulnerable to climate-related risks, highlighting the importance of understanding these dynamics in the financial sector.