The housing market is poised for tremendous growth in 2014, witnessing positive momentum in home prices.
However, there are minor clogs in the market pipeline that are likely to cause minor headwinds that may cause investors to remain wary of all signs pointing to better days ahead — specifically eminent domain.
Before investors begin to sound the alarm on the program’s issues, market analysts expect eminent domain to remain an outlier risk, which, if widespread, could affect valuations drastically — although the likelihood is very low, according to Barclays (BCS).
"We are more wary of idiosyncratic servicing issues that could become widespread, especially as we see greater incidence of modified loans being written down to 10% to 15% of balance and severities much higher than 100% on large balance loans," explained Barclays analysts.
Various cities and local governments across the nation are considering whether they should use eminent domain to buy underwater borrowers out of nonagency deals.
Richmond, Calif., is the furthest along in this process given that the city council voted 4-3 to continue with the proposal by Mortgage Resolution Partners to buy underwater mortgages in September. The case remains at the center of much litigation.
Nonetheless, the city can only buy out mortgages if the trustees are willing to sell. At the moment, Richmond seems to lack the votes to pass a plan to use the program unless it can get MRP to buy insurance against potential liabilities the city may face from investor lawsuits.
"The concentrations in the give or so cities in California that are considering this are fairly miniscule," Barclays analysts noted.
They continued, “However, the risk is that a successful use of eminent domain in this context in even a single geography could quickly expand to other geographies, which would affect nonagency valuations adversely."
Other factors may continue to work in investors’ favor and reduce the threat of eminent domain expanding or ever being used.
As home prices increase broadly, fewer loans will be eligible for the program.
Additionally, MRP’s profits seem to be contingent on it being able to refinance these loans into some government-guaranteed loans shorty after buying them out.
The Federal Housing Finance Agency has already clarified that the GSEs will not guarantee any such loans.
In general, most originators will be afraid of making loans in these geographies — given the added uncertainty — which will increase borrowing costs more broadly in the area, Barclays argued.
"Overall, the likelihood that this becomes a big problem nationally seems small but the risk will remain as long as some local government continues to pursue this," analysts said.
They concluded, "As such, investors will have to be on the lookout for possible action by various local governments that could affect them adversely."