RMBS Comeback

Mortgage Resolution Partners (MRP) is the latest in a long list of challenges to a broader recovery in the market for private label residential mortgage-backed securities (RMBS), which, five years after the financial crisis, is finally gaining traction.  

Describing itself as a “community advisory firm,” the alternative investment manager has shopped around a plan it finances to several cities in California that were hit hard by the housing crisis and still have numerous residents whose underwater mortgages put them at risk of foreclosure.

Richmond, a small city in the San Francisco Bay area, is the first municipality to decide to pursue the program. It gave servicers until Aug. 13 to agree to sell more than 600 loans at steeply discounted prices, but there were no takers. So the mayor has begun the process of getting approval to compensate lenders for the loans that the city plans to confiscate using eminent domain. The intent is to replace them with financing that borrowers can more easily afford.

The scheme is attractive to homeowners, who stand to see their principal reduced significantly. And the city argues that it will reduce the potential for falling home values and blight that often accompany a slew of foreclosures. That of course is a boon for any political leaders deciding whether to pursue the strategy.
But it unnerves current and potential future investors in mortgage bonds at a time when a consensus has emerged across political party lines that the federal government’s 90% share of the mortgage financing market must be significantly reduced and replaced by private capital.

The concern is apparent by the array of prominent institutions already lining up against the initiative by Richmond, a city with just over 100,000 and a median household income of under $52,000. On Aug. 8, bond giants Pacific Investment Management Co. (Pimco), Blackrock and Doubleline joined Fannie Mae and Freddie Mac in a lawsuit seeking an injunction against the city and MRP, claiming the plan could result in investors losing as much as $200 million. 

On the same day, the Federal Housing Finance Agency said it would order Fannie and Freddie, which it regulates, to limit or stop buying loans from any jurisdiction using eminent domain to cease mortgages. And in a separate court, BNY Mellon sued Richmond and MRP.

The urgency for bondholders stems from the unique California provision called “quick take,” which allows for MRP and Richmond to seize and restructure the loans immediately, before the case is litigated and ruled on in the courts

“The notion that I have assets on the books that can be called away—at a discount to par no less—and they can actually be premium assets, is very troubling,” said Kevin Chavers, managing director specializing in mortgages at Blackrock and a member of the asset manager’s government relations team.

The eminent domain issue is only the latest in a list of developments since the housing bubble deflated that raise concerns among major investors, whose reliable participation will be necessary to bolster private-label RMBS volume sufficiently to replace government involvement in the mortgage market. Much of their dismay stems from the lack of standardization in today’s market, requiring investors to perform burdensome due diligence or demand higher pricing that may stymie issuers. Those issues include the securities’ widely varying representations (reps) and warranties, the current parity between first-lien and second-lien debt, and the uncertainty around which mortgages will be classified as qualified residential mortgages (QRMs), and therefore avoid yet-to-be-finalized requirements for retaining risk.

“In our view, the major issue is the fact that there’s no standardization in the industry, and in some cases it’s worse than before the crisis,” said Andrew McCormick, head of T. Rowe Price’s active taxable bond team
In the near-term, there are also market-driven challenges, such as volatile pricing and the chicken vs. egg dilemma faced by a market that remains too small to draw major sources of capital on a regular basis.

As an issue, eminent domain falls under the lack-of-standardization umbrella—governments have traditionally applied eminent domain to properties, not loans—and its legality has yet to be tested. Further complicating matters is the fact that, while under-water mortgages are more prone to defaults, more than 70% of the Richmond borrowers are current in their payments. 

“If successful, MRP’s loan seizure program would remove predominantly-performing mortgage loans from trusts, forcing a loss on millions of savers and retirees nationwide,” noted law firm Ropes & Gray in a statement regarding the Richmond proceedings.