Should proposals being considered in some California areas to seize underwater mortgages be adopted nationwide, mortgage bond investors could see defaults rise by more than 30%, according to new Moody's Investors Service analysis, leading to losses.

Earlier in the month, officials in San Bernardino County, Calif. met to discuss using eminent domain to confiscate current underwater mortgages at "fair market" value using private capital. The borrower would likely get a principal reduction and refinanced into a new mortgage backed by the Federal Housing Administration.

"Other jurisdictions are unlikely to adopt the program; however, if all 50 states were to adopt it, losses for prime jumbo (residential mortgage-backed securities) pools would increase by around 30% over our current projections," Moody's analysts said in a report released Monday.

They added investment grade RMBS would receive on average three-notch downgrades and estimated losses on a variety of scenarios depending on the program expansion elsewhere (click the graph below to expand).

The current proposal affects roughly a very small percentage of mortgages securitized into private bonds in the area, but investors are concerned the idea will spread. Such volatile new loans could even throw off the steady "To Be Announced" market for agency-backed mortgages.

Moody's analysts concluded many of the mortgages seized would have stayed current without the assistance. Just 1% of jumbo mortgages with loan-to-value ratios up to 140% turned newly delinquent per month. Should the rates hold, half of today's still performing jumbo loans will still be current in five years.

Investors wouldn't fair-market value for the loans, as well. According to a fact sheet provided by the private capital provider for the program, Mortgage Resolution Partners, compensation would be what the property was worth but minus the foreclosure expenses and unpaid servicer advances on the loan.

Moody's estimated investors would get 15% to 20% below market prices.

"Servicers would likely contest the seizures by challenging loan valuation," analysts said, based on pooling and servicing agreements requiring protection against any litigation on the mortgage.