When Standard & Poor’s Ratings Services commented on the credit impact of eminent domain proposals to seize mortgages pledged to residential mortgage-backed securities (RMBS) last year, we considered the likelihood of implementation remote. However, recent developments suggest that the possibility of such eminent domain proceedings has increased, although only in a few jurisdictions. Because of the renewed interest in the plan and more specific discussions involving the City of Richmond, Calif., we are updating our views on the potential impact to outstanding securitization trusts, as well as the implications for ratings on future securitizations.
Standard & Poor’s believes that implementing eminent domain, which we view as a localized approach to an issue with far-reaching nationwide implications, may present inconsistencies in solving the root cause of the housing problem in the U.S., create unintended consequences for both borrowers and investors, and inadvertently limit mortgage lending activity. As we noted in our October 2012 report, “Assessing the Potential Impact of Eminent Domain on Private-Label RMBS,” the impact of such a proposal on the RMBS market could be significant, especially when the housing market is on a path to recovery and as private capital returns.
The City of Richmond’s proposal, which was developed, in part, by Mortgage Resolution Partners LLC (MRP), would relieve certain borrowers from potential future losses, which would be transferred to RMBS investors. The plan targets predominately performing home mortgages that have values that are less than their outstanding loan balances (“underwater mortgages”). Under the proposal, the City of Richmond would pay lenders approximately 75%-80% of a home’s fair market value, irrespective of the amount of money still owed on the related mortgage. For example, if a home is currently valued at $100,000 and the outstanding mortgage balance is $150,000, the city would pay the mortgage lender $80,000 as payment for the debt. The remaining $70,000 would be passed through as a loss to the RMBS holders.
The strategy has met many opponents, including Wells Fargo and Deutsche Bank, which have recently filed a lawsuit against the city, challenging the plan as unconstitutional and asking a federal court for an injunction preventing eminent domain proceedings. In addition, the Federal Housing Finance Agency has said in a statement on Aug. 8, 2013, that it may direct Fannie Mae and Freddie Mac to “limit, restrict, or cease business activities within the jurisdiction of any state or local authority employing eminent domain to restructure mortgage loan contracts.”
Standard & Poor’s believes the use of eminent domain by the City of Richmond could establish a precedent that other municipalities around the country may follow. While the overall exposure of outstanding Standard & Poor’s-rated non-agency RMBS transactions to particular jurisdictions is limited, the cumulative effect could be substantial. We used LoanPerformance data to determine the exposure that our rated transactions have to loans originated in Richmond, Calif. Of the 1,000-plus transactions identified as containing Richmond-originated loans, 98% had less than 1% exposure to these loans, and no transaction had greater than a 2.5% exposure. 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. While it is premature to gauge the full impact of such an analysis, we would inform the market as ratings are affected.
For newly issued RMBS, our analysis would likely differentiate jurisdictions where eminent domain has been implemented. In evaluating the likelihood of default, historical market data currently does not include defaults originating from eminent domain proceedings. As such, we would likely need to account for that additional risk of default in our baseline projections. In addition, Standard & Poor’s loss severity assumptions would also be affected, as the historical observations do not currently reflect the potential losses that the Richmond plan seems to contemplate. Thus, Standard & Poor’s would likely increase its request for credit support being provided to loans from affected jurisdictions. Moreover, the comparative decline in value for mortgages in jurisdictions that have employed eminent domain would likely make securitizations more speculative. We would expect this to translate into a higher mortgage rate and/or fewer credit opportunities for borrowers in those jurisdictions.
We will continue to evaluate the Richmond proposal and any others that are introduced, and provide additional insight into the effects that they might have on Standard & Poor’s rated RMBS universe.