Risks of Eminent Domain in California: Fitch

In a commentary, Fitch stated the proposed uses of eminent domain in California could negatively affect private label RMBS performance.

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Recently, the board of supervisors of San Bernardino County voted to form a joint powers authority with California cities Fontana and Ontario to look into the option of using eminent domain to seize underwater mortgages. In previous cases, eminent domain has been used by the government to take over private properties for public interest, such as to expand highways.

But, San Bernardino County is considering the use of eminent domain to seize underwater homes and have them sold and repurchased at fair market value while allowing the homeowners to stay in their home with a new mortgage that reflects the current value of their home.

Fitch said one proposal, which is of particular concern, indicates that only current and delinquent mortgages, not those in foreclosure, would be eligible. Thus, borrowers who would have stayed current on their payments could have their mortgage seized by the local, state, or county government. If eminent domain was to be used in such a way, then holders of the seized homes could experience losses, Fitch said.

Between San Bernardino county, Fontana, and Ontario, there are about $14 billion worth of nonagency mortgages and more than 46,000 of the loans have mark-to-market combined loan-to-value (MTM CLTV) ratios of more than 100 percent, according to Fitch. About half of those underwater mortgages are current.

In addition to causing losses on performing loans, Fitch said the proposal could also have other unintended consequences, including negatively affecting mortgage interest rates and credit availability in affected areas.

""Likewise, the implementation of this program could further weigh on private investor confidence and appetite for private-label mortgage-backed securities going forward,"" Fitch warned.

Edward Pinto, resident fellow at the ""American Enterprise Institute"":http://www.aei.org/, raised concern over the issue of what fair market value will be defined as going forward.

""Are they actually going to be paying fair value? I don't think they are going to be paying fair value. The court may have decided the value is x, but the x might not be fair value relative to what the security holders are getting if these loans were not condemned,"" he said.

While opponents of the proposal find the debated use of eminent domain to be alarming, Fitch said due to the legal challenges involved, movement towards the proposed use of eminent domain will be slow and difficult.

As for who will lose the most, Rep. Brad Miller (D-North Carolina) wrote an article in the ""American Banker"":http://www.americanbanker.com/bankthink/eminent-domain-mortgage-seizures-terrify-wall-street-1050811-1.html and said the program would likely target homeowners with second liens, so it's the big banks and second lien holders who will come out with the biggest losses, not mortgage investors.

""Mortgage investors own most first mortgages, but the biggest banks own most second mortgages and home equity lines of credit,"" wrote Miller. ""So the real losers from the program would be the biggest banks, the holders of second liens, not investors in first mortgages. And even for the biggest banks, eminent domain would not cause losses but reveal losses.""