After a lull, eminent domain has burst back onto the mortgage scene. Bolstered by the financial backing and guidance of San Francisco-based investment advisor Mortgage Resolution Partners (MRP), the California city of Richmond has launched a renewed ground attack and accompanying threats to pursue and liberalize the taking of private property (in this case mortgages) for greater public good through the powers of eminent domain. Essentially, Richmond is moving forward with a game plan that initially emerged, but was subsequently not pursued, by a handful of other California municipalities early in 2012. The plan is to purchase underwater, but current paying loans, secured by properties in Richmond that are pledged to repay private label securities (PLS). While limited in its initial scope, should this practice gain traction in the market, it could quickly be adopted by other municipalities and pursued for similar loans backing both Agency Mortgage Backed Securities (MBS) as well as mortgages held on the balance sheet of financial institutions.
While an intriguing twist on the legal concept and an idea with good intentions of helping the hardest hit housing markets, in our view, it is a bad business and financial decision for the City on many fronts. In addition, in due process, Richmond’s plan could very well be found unconstitutional on many grounds including: unjust compensation, violation of the commerce clause, targeting mortgages purely for private use, et. al…
In summary, the City of Richmond recently submitted to the trustees (Wells Fargo, Deutsche Bank, among others) an offer to purchase 624 loans from various PLS. The offers are at values substantially below the existing loan balance and fair market value of the loan (e.g. 80% of the property’s current market value). Should the Trustees decline their offer (which they have), Richmond has signaled their intent to pursue the taking of these loans under the powers of eminent domain. With the help of MRP, the ultimate plan is to write down the balance of the loans to 95% of the market value of the property and use the Federal Housing Administration’s (FHA) short refinance program to refinance the borrower into a new FHA-insured loan which would then be securitized into new Ginnie Mae MBS pools. The difference between the balance of the new loan and the price paid would be split between MRP and the municipality.
To block Richmond from exercising a “quick take” under California’s eminent domain laws, the trustees, at the direction of a coalition of bondholders, filed suit in federal court requesting an injunction to prevent the seizing of the mortgage loans.
We believe the use of eminent domain as contemplated by Richmond will ultimately be struck down by the courts as unconstitutional. However, should the proposal somehow make it through the court system, we believe it would not only severely impact prices in the non-agency and agency mortgage backed securities markets, it would also substantially change the availability and terms of new mortgage financing for any individual residing within a city that utilizes eminent domain to seize mortgage loans. This does not even begin to account for the law of unintended consequences that will likely occur in other debt markets involving assets secured by mortgages or other contracts that could potentially fall under these new and expanded powers of eminent domain. Institutional investors, including the FHFA (conservator of Fannie Mae and Freddie Mac and regulator of the FHLBanks) have made it clear they intend to initiate all necessary legal actions to block this movement and fully protect their legal rights. Additionally, FHFA issued a public statement that they may direct Fannie and Freddie to stop doing business in communities that seize mortgages through eminent domain. Finally, HUD could also easily halt this movement by issuing a statement that any mortgage seized through eminent domain will not be eligible for FHA insurance.