California City Readies Controversial Loan-Seizure Program
City leaders in Richmond, Calif., said Tuesday that they would take the first steps towards potentially seizing underwater mortgages, becoming the first city to pilot an unorthodox use of eminent domain to tackle blight left by the housing bust.
Working with the investment firm Mortgage Resolution Partners, the city said it had begun sending letters to 32 lenders and other firms known as mortgage “servicers” that process loan payments on behalf of mortgage investors. The letters offer to buy some 624 mortgages at what MRP has concluded is the market price for those loans.
At issue are loans that were pooled together and sold to investors as mortgage-backed securities. These so-called “private-label” securities were issued by Wall Street firms and don’t have any government backing.
Tax and legal rules governing those securities make it difficult—downright impossible, say some investors—to sell individual loans out of the trusts. Of the loans that Richmond wants to buy more than two thirds, or 444, are current on their payments, while 180 are delinquent.
If banks and financial institutions refuse to sell the loans at prices offered by the city, then officials will consider using eminent domain. “It’s the responsibility of banks to fix this, and they haven’t, so we’re taking it into our hands,” said Richmond Mayor Gayle McLaughlin in a conference call with reporters on Tuesday.
Eminent domain allows a government to forcibly acquire property that is then reused in a way considered good for the public—new housing, roads, shopping centers and the like. Owners of the properties are entitled to compensation, often determined by a court.
Instead of acquiring houses, Richmond and other cities would buy the mortgages from investors at a price below the property’s current market value. They could cut the loan principal to around 97.75% of the property’s market value and then refinance the loan into a government-backed mortgage.
The proposal is backed by community activists that say it would help residents shed high debt loads and avoid foreclosures that are hurting property values and eroding the tax base. MRP, which would collect a fee for each loan, says it is focusing on loans on the private-label securities because these loans have generally been the most at risk of foreclosure. Loans backed by federally-supported entities could also be harder to condemn.
The eminent-domain approach is extremely unpopular with mortgage investors that hold those loans, and a court challenge is likely. Investors worry that cities will offer too low a price for loans, especially those where borrowers are current on their payments. They also say that seizing loans would upend their expectations of loan performance that is used to determine how much they pay for those bonds.
The upshot is that, going forward, investors say they would require significant down payments or higher rates in communities where the threat of loan-seizures exists—much the way a sovereign-debt default can raise borrowing costs for a country.
So how big is the market for this? Richmond, a working-class city of around 100,000 on the east side of San Francisco Bay, has around 18,700 owner occupied households. Analysts at RBS Securities reviewed data from monthly investor reports compiled by CoreLogic that provides greater detail on loans in private-label securities. Here’s what they found:
At the end of June, there were 1,099 loans on owner-occupied homes in private-label securities that were current on their payments. Of these around 42%, or 463 loans, had been modified.
- Roughly half of those modifications included some form or principal forgiveness or principal forbearance, where borrowers don’t have to make payments on a portion of the loan (even though it hasn’t been wiped out). On average, around 35% of the loan balances had been deferred or forgiven, representing $137,000 per loan. These modifications reduced average monthly payments by 37%, to $1,137, from $1,794.
- Other modifications included some kind of interest rate reduction or term extension, resulting in an average interest rate of 2.93%, from 6.12%, and average monthly payments that fell by one third, to $1,409 from $2,092.
- That leaves around 636 current loans that have not been modified. Of those, two thirds have never missed a payment over the life of the loan.
Investors have said that the data undercut the often-repeated argument by eminent-domain proponents that loans in private-label securities are the most difficult to modify.
What about loans that were current two years ago? The analysis shows that in June 2011 there were some 1,165 mortgages on owner-occupied homes.
- Today, some 895 of those loans, or 77%, are current and another 50, or 4%, have voluntarily paid off, often due to a refinance or sale of the home.
- Another 90 loans, or 8%, are one to two months delinquent, and 85, or 7%, are at least three months delinquent.
- Some 64 loans have been extinguished through a short sale, where the lender allows the homeowner to sell the home at a loss.
- The remaining 24 loans, or 2% of all loans that were current two years ago, have gone through foreclosure.
What about loans that were seriously delinquent two years ago?
- There were 496 of those, and more than a quarter of them—137 loans—have gone through foreclosure. Nearly as many loans have gone through short sales.
- Of those remaining, some 116 are behind on their payments.
- That leaves just 107 loans—or 22%—that are now current.
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