S&P Says Municipal Mortgage-Seizure Plan Would Hurt Bond Grades

Standard & Poor’s probably will demand greater protections for investors when mortgage bonds are backed by loans to homeowners in jurisdictions that use eminent domain to seize debt to help borrowers.

The use of eminent domain, such as contemplated by Richmond, California, would create an “additional risk of default,” as well as require different assumptions on the size of per-loan losses, S&P analysts James Taylor and Sharif Mahdavian said today in a report. The ratings firm would likely require more credit support, or protection such as some classes of deals taking losses before others, they wrote.

“The comparative decline in value for mortgages in jurisdictions that have employed eminent domain would likely make securitizations more speculative,” the New York-based analysts said. “We would expect this to translate into a higher mortgage rate and/or fewer credit opportunities for borrowers in those jurisdictions.”

Richmond is furthest along in considering using its eminent domain powers in such a way, which is being advocated by Mortgage Resolution Partners LLC and studied by about a dozen municipalities, according to data compiled by Bloomberg. S&P’s statement on its potential reaction if the effort progresses follows the ratings company’s response in 2003 to a predatory-lending law in Georgia with a refusal to grade bonds with home loans in the state.

Trustees Sue

Mortgage-bond trustees representing investors including BlackRock Inc. and Pacific Investment Management Co. sued Richmond on Aug. 7, alleging the proposal was unconstitutional and would cause more than $200 million in losses for bondholders as they sought a court order blocking any seizures.

The city, which is located north of Oakland and Berkeley, and Mortgage Resolution Partners, which is advising municipalities and lining up private funds that would profit as the buyer of the loans, said in an Aug. 22 court filing that the suit is premature and should be dismissed.

S&P rates more than 1,000 deals with mortgages from Richmond, according to its report. Of those, 98 percent had less than 1 percent exposure, with none having more than 2.5 percent, the firm said.

“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,” the analysts wrote.

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