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Taking notes: the eminent-domain controversy just keeps migrating to city after city. The latest stop on the tour: Richmond, California..

Earlier this year, the city of Richmond, California, held the dubious distinction of being particularly hard hit by the housing crisis. The city now has grabbed headlines for another reason: It has gone further than any other governmental body so far in considering eminent domain to take underwater mortgages out of securitized trusts. [paragraph] Mortgage Resolution Partners LLC (MRP), San Francisco, is the self-described community advisory firm that has made a name for itself nationwide by promoting not just the hot-button issue of principal reduction--but that and much more through eminent domain. [paragraph] MRP wants local governments to use eminent domain to take underwater but performing mortgages out of private-label securitized (PLS) trusts. The company then facilitates the payoff to current investors, restructuring of the loans to reduce homeowners' principal balances and selling the loans to new investors. [paragraph] Eminent domain typically involves a government "taking" of real property, such as homes or land, for urban renewal projects or highway construction. While it can and has been used to take intangible property, the notion of taking performing mortgages held in securitized trusts is innovative, to say the least. [paragraph] But Richmond means business. The city's momentum has grabbed the attention of Standard & Poor's (S&P), New York, which, it's worth noting, recently amped up its warning about the use of eminent domain because of Richmond's effort.

S&P "considered the likelihood of implementation remote" in its October 2012 RatingsDirecto report. But in August of this year, RatingsDirect stated, "Recent developments suggest that the possibility of such eminent-domain proceedings has increased, although only in a few jurisdictions."

It also was in August that the city became embroiled in lawsuits against some of the biggest banks over eminent domain. And they, too, voiced concern in their court filings that the city has taken big strides toward the use of eminent domain.

Richmond's predicament

Richmond describes itself in court filings as a diverse, working-class city hit harder by the housing crisis than most cities nationwide. Median sales prices for homes there dropped from a peak of $450,000 in January 2006 to currently about $220,000.

A bit more than half of homeowners are underwater on their mortgages and the average homeowner in that situation owes about 45 percent more than the home's value. For PLS trust loans that include ZIP codes from the city, 67 percent are underwater.

In the last three years, foreclosures have numbered about 2,000--roughly 16 percent of homeowners. The city's research indicates that a high percentage of underwater mortgages, especially those in PLS trusts, also will face foreclosure. That percentage was not disclosed in court filings.

According to arguments made in the city's court filings, the number of underwater mortgages depresses property values, which in turn reduces property tax revenues--and that means city service cutbacks. Between 2007 and 2012, property tax revenues dropped by more than 14.5 percent. City staffers number 786, down from 950 in 2009.

Richmond maintains it opted to target its eminent-domain effort on the most "risky and toxic loans" originated during the housing boom and included in PLS trusts, "which have exacerbated the crisis because they are especially likely to end up in foreclosure," according to court filings.

In July, the city sent letters to trustees and servicers of trusts holding 624 underwater mortgages, offering to pay about $126 million as just compensation and subject to the city council's approval.

The letters asked the recipients to identify who had the authority to sell the loans if the recipients didn't. If negotiations fail and the city opts to use eminent domain, the trustees and servicers have a right to just compensation determined in court, the city wrote.

The banks' lawsuit

Less than a month later, Wells Fargo Bank NA, Deutsche Bank National Trust Co. and Deutsche Bank Trust Co. Americas sued in what's called a motion for preliminary injunction to block Richmond and MRP from using eminent domain.

While the case--and a subsequent one filed by other banks discussed later in this article--turns on so-called ripeness for the lawsuits, court filings clearly describe the issues in the potential use of eminent domain to take mortgages.

The city and MRP intend to take mostly performing loans "hand-picked by MRP at steeply discounted prices"-80 percent or less of homes' current value--and MRP would then flip the loans to a new securitized trust for about 95 percent of the homes' values, according to the Wells Fargo suit.

"The substantial profit resulting from this eminent-domain arbitrage would be shared by MRP, MRP's investors and Richmond," the suit states. Richmond would get a flat payment of 5 percent of the refinancing price per loan. MRP and its investors would get the remainder. MRP also would get a per-loan fee of $4,500.

The Wells Fargo plaintiffs represent 350 trusts located outside of Richmond. The Richmond Seizure Program, as the banks call it, would result in tens of millions of dollars in losses to the trusts and their beneficiaries that own targeted loans. Add to that other trusts that hold Richmond loans and their beneficiaries, and the losses could be more than $200 million, according to the suit.

The trusts' investors include public and private pension funds, 401(k) plans, insurance companies, mutual funds, university endowments and individualinvestors and retirees.

If Richmond uses eminent domain and other local governments take similar action, the losses ultimately could be in the billions of dollars, according to the suit.

All told, the banks contend that the city's plan violates several provisions of the U.S. Constitution, and the California Constitution and statutes.

Here are the highlights of their argument:

* Taking loans located outside of the city violates state and federal due process requirements, and the state's eminent-domain law.

* Taking loans for private--rather than public--use violates the takings clause of the state and federal constitutions, and the state's eminent-domain law.

* By attempting to regulate interstate commerce, the plan violates the commerce clause of the federal Constitution by rewriting contracts between residents and out-of-area creditors.

* The city's plan violates the contracts clause of the federal Constitution by abolishing residents' debts at creditors' expense without any public purpose.

The suit also cites a caution by David Stevens, president and chief executive officer of the Mortgage Bankers Association (MBA), that lenders would require higher rates and down payments when making loans in Richmond to mitigate the risk of eminent domain. And if other cities use eminent domain, the impact of the risk "will ripple through the real estate market for years," says Stevens.

The city/MRP reply

The banks jumped the gun, say Richmond and MRP in their reply to the lawsuit.

The financial industry strongly opposes this type of principal reduction even though the city would have to pay just compensation for the loans, according to the city/MRP court filing. The industry's opposition is aimed at discrediting the plan on a broader scale, the city and MRP supporters maintain.

"This lawsuit is part of that campaign, intended to intimidate officials and community groups in the city and other localities considering similar proposals for addressing the underwater mortgage crisis," the city and MRP state.

In fact, at press time for this article, the city hadn't even adopted the required resolution of necessity to authorize the use of eminent domain. And that adoption must be by super-majority vote. The banks refused to drop their lawsuit even when the city advised them that no resolution was even on the agenda, according to the court filing.

Here are the highlights of the city/MRP argument:

* The banks' lawsuit is not "ripe" and does not meet the requirements for a preliminary injunction. The jurisdiction of the federal courts is limited to actual cases and, because the city has not adopted the required resolution yet, the court lacks what's called subject-matter jurisdiction.

* The banks can't establish the four criteria for getting a preliminary injunction: 1) the banks aren't likely to prevail on claims that can't be decided by a court; 2) the banks can't show likely irreparable harm if the injunction is denied; 3) city residents would face irreparable harm to their First Amendment rights and their right to self-government; and 4) an injunction would harm the public interest by entangling federal courts in local municipal decisions.

* The banks are wrong about the law in the four issues highlighted here.

* The U.S. Supreme Court already ruled that eminent domain does not violate the contract clause.

What's more, the city and MRP argue that the banks' lawsuit is a SLAPP suit--strategic lawsuit against public participation. Such suits are filed "because a well-funded plaintiff can achieve its goals by distracting, intimidating and wasting the resources of its adversary," say the city and MRP.

In September, U.S. District Court Judge Charles Breyer dismissed the banks' lawsuit for lack of ripeness and subject-matter jurisdiction.

NY Mellon, U.S. Bank companion case

Still pending, though, is a decision in a companion lawsuit--filed in August against the city, MRP and MRP's managing member, Gordian Sword LLC, by the Bank of New York Mellon and U.S. Bank NA--also seeking an injunction.

These banks make similar arguments as the Wells Fargo lawsuit did. MRP will raise the money to finance the takings, identify the loans to be taken and arrange for their refinancing, according to the lawsuit. MRP's investors would get the net profit margin between the acquisition price for the loan and new loan price sold to investors--after MRP and city fees, and any MRP expenses, are paid.

The city's plan would "cherry-pick" loans that aren't in default and likely would be repaid by homeowners, according to the banks' court filing.

Of the 624 loans that Richmond offered to buy, about 85 percent aren't in foreclosure and 81 percent have never had a default notice filed or are current. Of the 105 loans held by the Bank of New York Mellon as trustee, more than 90 percent aren't in any stage of foreclosure, the lawsuit states.

The city's program targets performing loans that will be most profitable to restructure and sell, and is designed to create profits for MRP and its investors, according to the suit.

"MRP has included a small percentage of loans in default or foreclosure for optics only, in a thinly veiled attempt to justify its scheme under the guise of public good," the suit states.

Several days after Judge Breyer's dismissal of the Wells Fargo lawsuit, Richmond and MRP filed a motion to dismiss the New York Mellon case for lack of jurisdiction. At press time for this article, a hearing was scheduled for Nov. 1 before Judge Breyer.

Attorneys involved in the two lawsuits did not respond to interview requests.

The fallout

In what's called an amid curiae filing in support of the city/MRP position against the Wells Fargo group, the National Housing Law Project (NHLP), Housing and Economic Rights Advocates (HERA), Bay Area Legal Aid, California Reinvestment Coalition and the Law Foundation of Silicon Valley contend that the banks' public-interest argument in their effort to quell eminent domain is disingenuous.

The filing from this group contends that the securitization industry already has announced its intent to make loans difficult, expensive or impossible in communities with high proportions of minority residents like Richmond if eminent domain is used. And that violates the Fair Housing Act and other federal and state anti-discriminatory laws, the filing maintains.

The National Housing Law Project's group contends that the Securities Industries and Financial Markets Association (SIFMA) has already announced its plans. In July, SIFMA said that loans to borrowers in areas using eminent domain to take mortgage loans won't be eligible for TBA (to be announced) securities. If Richmond borrowers don't have access to the TBA market, loan costs will rise, according to court filings.

In March, Timothy Cameron, managing director of SIFMA's asset management group, wrote Richmond Mayor Gayle McLaughlin that "we believe the execution of these plans to use eminent domain will result in a serious contraction of credit availability as lenders and secondary market sources of funding react with defensive, very stringent underwriting criteria."

SIFMA did not respond to an interview request.

The next step

At press time for this article, Richmond Mayor McLaughlin told Mortgage Banking that the city was considering a joint powers agreement (JPA). It would allow other local governments to join the city to expand the numbers of underwater loans that could be acquired, share strategies and attorneys in litigation, and prepare resolutions of necessity for any eminent-domain action.

But eminent domain is not a foregone conclusion. In fact, at press time, the city council did not have enough members in favor of eminent domain for the required super-majority vote. The alternative? "We are asking [the banks] to come to the table, tell us what they think is a fair price for these loans and [saying] let's negotiate," McLaughlin says.

Patrick Lynch, the city's director of housing and community development, says the JPA is viewed differently by eminent-domain opponents and proponents. The latter believe the JPA could provide more of a legal shield in eminent-domain challenges. Opponents view the JPA as a means to bring cities and counties together to forge a relationship with the capital markets and provide workout agreements with homeowners.

Lynch declines to take a stand on eminent domain. "At the end of the day, I want to end up in a place that assists families with their notes," he says.

In the meantime, all the talk has brought plenty of drama to the little city about 18 miles northeast of San Francisco.

Beatrice Robinson, who ran for city council two years ago and is treasurer of the Richmond Neighborhood Coordinating Council, says at least 85 percent of the residents don't want eminent domain.

"The people in the city are not interested in this--the outsiders are," she told Mortgage Banking.

And the plan isn't helping low-income homeowners either, Robinson says. "Most of the homes of the 624 loans [that the city approached the banks about acquiring] are in the most affluent areas. They are not ghettos," she says.

Lynch says that view has been "keenly expressed" by a consortium of Realtors[R] and mortgage lenders who have done community surveys.

The mayor acknowledges that a small but vocal group of residents is opposed but says the vast majority of residents favor the city's effort. "The number of emails, phone calls and hardcopy mail in support of this program is really quite astounding," she says. "The few negative communications are so negligible--hardly worth mentioning in the face of such support."

Terry Sheridan is a North Conway, New Hampshire-based independent journalist who has covered real estate, mortgage finance and real estate legal issues for 22 years. Her June 2011 article for Mortgage Banking, "Short on Results," won a Best in Business Award in the category of feature article for magazines with less than 75,000 circulation from the Society of American Business Editors and Writers (SABEW). She can be reached at
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Comment:Taking notes: the eminent-domain controversy just keeps migrating to city after city.
Author:Sheridan, Terry
Publication:Mortgage Banking
Geographic Code:1U9CA
Date:Nov 1, 2013
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