A lawsuit filed on behalf of investors in private-label residential mortgage-backed securities has made its way to a federal court in California. Defendants include the company that has been peddling the use of eminent domain to seize performing loans and a California city that has already started offering discounted prices for securitized loans. The first batch of offers are discounted by as much as 89 percent of the current balances.
The lawsuit was filed Wednesday by The Bank of New York Mellon in U.S. District Court for the Northern District of California, according to a copy of the filed complaint provided by plaintiff’s counsel, Mayer Brown LLP.
Named as defendants are the city of Richmond, Calif., and Mortgage Resolution Partners LLC — the company that has been promoting the scheme. A third defendant is Gordian Sword LLC, which is the managing member that controls Mortgage Resolution.
BNY Mellon filed the action as trustee of RMBS issued between 2004 and 2007. Among 82 transactions at issue are CWALT, CWL and FHAMS. Among the RMBS investors are 401(k) plans and municipal and private pension plans.
According to the complaint, Mortgage Resolution “stands to profit handsomely” from an agreement approved by the city to use its power of eminent domain to seize negative-equity mortgages — including performing loans — in order to modify loan principal at the expense of investors. Mortgage Resolution would earn $4,500 per seized loan plus a portion of the difference between the seized value and the subsequent sale amount. The loans would be refinanced and re-securitized.
In addition to Mortgage Resolution, Richmond would also profit from such transactions.
RMBS investors, however, would lose “tens of millions of dollars in loan principal.”
The city has already identified 624 loans to be seized from the trusts and offered to purchase the loans for a nominal amount on behalf of Mortgage Resolution, according to the complaint. Richmond’s mayor has reportedly said that this is only the first batch of loans under the scheme, and she hopes to expand it to more loans.
A letter has already been received by BNY Mellon on 100 loans. Offers on those loans range from 11 percent of the outstanding balance to 92 percent.
But the method used to value the loans ignores the value derived from as-agreed payment histories, the complaint alleges.
“The low offers are no accident, nor are they the beginning of constructive negotiation,” the complaint says. “Defendants cannot simply purchase the loans consensually from their owners (i.e., the trusts), because the seizure program does not work if the city actually pays fair value.”
The program is called “pure financial engineering.”
In addition, Mortgage Resolution has already publicly stated that federal law doesn’t allow the trusts to sell the loans through the voluntary purchase proposal offered by the defendants, the lawsuit says.
The plaintiff claims that the city, Mortgage Resolution and its investors will be doing nothing to enhance the loans’ values.
The plaintiff also alleges that the city’s use of eminent domain to seize and refinance mortgages would violate the constitutions of both the state of California and the United States. This is because the program won’t work if the loans are based on market value, the seizure won’t be for public use, and some of the loans already selected are beyond eminent domain power because the properties are outside of the city’s limits.
Another issue raised in the complaint is the coercion of crossing state lines and threatening massive disruption to the mortgage and securitization markets — which would conflict with federal power under the Commerce Clause.
“The city seeks to abrogate debts that its citizens owe to out-of-town entities and permit a local speculator to reap the profits,” the complaint states.
In addition, several California laws would allegedly be violated in the process.
The lawsuit cites previous concerns raised by the Federal Housing Finance Agency including how the scheme would have a “chilling effect” on mortgage lending. FHFA regulates Fannie Mae and Freddie Mac — both which hold private-label RMBS in their investment portfolios.
FHFA issued a statement today indicating that, following public comment on a previous notice it published in the Federal Register, it continues to have “serious concerns” about the use of eminent domain to restructure existing financial contracts.
“In response to an eminent domain action to restructure mortgage loans, FHFA may take any of the following steps: initiate legal challenges to any local or state action that sanctions the use of eminent domain to restructure mortgage loan contracts that affect FHFA’s regulated entities; act by order or by regulation to direct the regulated entities to limit, restrict or cease business activities within the jurisdiction of any state or local authority employing eminent domain to restructure mortgage loan contracts; or take such other actions as may be appropriate to respond to market uncertainty or increased costs created by any movement to put in place such programs,” FHFA stated.
An injunction is sought to prevent Richmond from using California’s “quick take” procedure that would allow condemnation of the property first followed by the court’s determination of fair compensation.
“Once each loan is taken, MRP will destroy it through refinancing; a new loan would then be imposed on each borrower, and those new loans would be hastily sold to other investors,” the complaint states. “If the seizure program is found unconstitutional afterwards, that egg may prove impossible to unscramble.”
Another reason for the injunction is the potential inability for the city to compensate the trusts in the event seizures are determined to be unconstitutional.
The plaintiffs also pointed to years of uncertainty if litigation against other cities, some in other states, that have already entered into agreements with Mortgage Resolution is fought individually in state courts.
