Due to a renewed interest in using the power of eminent domain to seize and restructure underwater home loans — and specific discussions involving the City of Richmond, Calif. — the securitization market and investors remain a bit shaken, analysts claim.

The potential use of eminent domain may present various after effects that harm investors and the entire RMBS landscape.

More importantly, the implementation of the program could negatively impact residential mortgage-backed securities and future lending activity, according to both Standard & Poor’s and Fitch Ratings.

"We also believe these programs could further weigh on private investor confidence and appetite for private-label mortgage-backed securities going forward," explained Fitch Ratings directors.

Richmond’s proposal would relieve certain borrowers from potential future losses, which would then be transferred to RMBS investors. The plan targets performing home mortgages that have values that are less than their outstanding loan balances — underwater mortgages.

Under the program, the municipality would pay lenders between 75% and 80% of a home’s fair market value, regardless of the amount of money still due on the related mortgage.

Many market opponents have voiced opposition to Richmond’s proposal, including Wells Fargo (WFC) and Deutsche Bank (DB), which recently filed a lawsuit against the city – challenging that the plan is unconstitutional and asking a federal court for an injunction to prevent eminent domain proceedings.

Additionally, the Federal Housing Finance Agency could direct Fannie Mae and Freddie Mac to cease business activities within communities adopting eminent domain.

In general, S&P believes the use of eminent domain by the City of Richmond could establish a benchmark for other municipalities around the country. Consequently, the overall exposure of private-label RMBS transactions in these particular jurisdictions could be ‘substantial.’

On a similar note, Moody's Investors Service firmly believes successful implementation of Richmond's plan and widespread adoption by other cities is unlikely, due to rising home prices and the legal challenges the municipalities will face -- turning market participants away from the proposal. 

"Nevertheless, the move is credit negative for US RMBS because if the city successfully executes the program, it would encourage other cities to adopt similar plans that would increase losses on RMBS," stated Moody's vice president and senior credit officer Yehudah Forster.

In recent research, the credit ratings agency used LoanPerformance data to determine the exposure of loans originated in Richmond, Calif.

Of the 1,000 transactions identified as Richmond-originated loans, 98% had less than 1% exposure to these loans, and no transaction had greater than a 2.5% exposure, S&P pointed out.

"However, once such proceedings are instituted, we would consider the potential effect of similar claims, particularly from other jurisdictions with significant populations of underwater performing mortgages," said S&P primary credit analysts James Taylor and Sharif Mahdavian.

Additionally, the use of eminent domain could have other unintended consequences, including increasing mortgage interest rates and decreasing credit availability in affected areas, according to Fitch.

"Eminent domain provides a mechanism for local, county or state governments to seize mortgages at discounted values, potentially resulting in losses for the holders of those seized," Fitch directors stated.

They concluded, "Several of these plans focus on borrowers who are current on their existing mortgage obligations."