It was one week ago that the mayor of Richmond, Calif., announced the adoption of a controversial plan to keep homeowners out of foreclosure by seizing underwater mortgages via eminent domain.
This move is credit negative for U.S. residential mortgage-backed securities, according to a bi-weekly report from Moody’s that provides comprehensive coverage of all sectors of the capital markets. If Richmond successfully implements its plan, other cities would be encouraged to adopt similar plans that would increase losses on RMBS.
Due to rising home prices, it is unlikely that Richmond and other cities will successfully put eminent domain into action that will deal with underwater mortgages, Moody’s said.
Mortgage Resolution Partners, the plan’s creator, has marketed the plan to cities and local governments for more than a year as a solution to stopping defaults and foreclosures. However, with home prices rising, borrowers will have less negative equity and thus be less likely to default.
The graphs above show loan-to-values falling, while home prices have continued improving since 2012 in Richmond and several other cities that the New York Times has reported have the plan under consideration.
Under the plan, Richmond would induce eminent domain, which would essentially allow the city to take private property for public use, to seize mortgages held by private-label RMBS trusts in exchange for significantly discounted prices. The city and MRP would both earn a fee. Initially, MRP planned to target only borrowers who are up-to-date on their loans.
According to Moody’s, cities would be likely to face effects from adopting the plan. Lenders concerned about future eminent domain action likely would restrict credit to borrowers in those cities, force lower LTVs as additional protection from loans becoming underwater or pass higher costs on to the borrowers.
Currently, no other city has moved forward with the plan; however, both San Bernardino County, Calif., and Chicago initially considered the plan before ultimately rejecting it.
Inevitably, the plan will face legal challenges. Industry groups have reassured that they would fight the legal basis for the plan on grounds that using eminent domain to apprehend mortgages is unconstitutional. These groups also contend that mortgages held outside the city are not within the city’s legal jurisdiction to seize.
Before seizing mortgages, Richmond also still needs city council approval.
Any city implementing the plan would increase losses on RMBS, said Moody’s. The price paid to RMBS trusts will be significantly less than the fair value of the home, according to MRP.
Without eminent domain, the expected recovery on those loans would be greater. Initially, many borrowers on underwater loans who remained current until now would continue to make their payments and there would be no losses. Additionally, as home prices continue rising, there will be less of a likelihood that borrowers will default and, even if they do, will reduce ultimate losses.
“If only Richmond and a handful of other cities implement the plan, overall losses to RMBS will be small. In the event that the plan becomes widespread, which we do not expect, losses would be significant,” said Moody’s.