Eminent domain plan may have spooked investors
By Carolyn Said
August 30, 2013
Just days after Richmond became the first city in the country to use the threat of eminent domain to obtain underwater mortgages, Wall Street spurned its efforts to refinance its highly rated municipal bonds, an unusual snub that cost the city nearly $4 million in lost savings.
"There just was not interest in the market in purchasing the city's bonds," said Bill Lindsay, Richmond's city manager. "The underwriter indicated this is something the market is usually very interested in, and this time it was not."
Bonds are a crucial funding mechanism for local governments, which depend on them to finance public projects like roads, schools and utilities. Being unable to sell or refinance bonds to lower interest rates could hurt a city's ability to meet its long-term obligations. In late July, Richmond sent letters to 32 banks and other mortgage holders offering to buy 624 underwater mortgages at discounts to the homes' current values. It said if the offers were rebuffed it would consider invoking its eminent domain powers to seize the mortgages and resell the homes back to their owners at a more affordable price.
The city's goal is to help underwater homeowners refinance into affordable mortgages, thus preventing foreclosures and stabilizing neighborhoods. But banks and mortgage lenders vehemently opposed the move, saying it would make it harder and more expensive to obtain a mortgage in the city.
No banks or mortgage lenders agreed to sell the underwater mortgages to Richmond by its self-imposed deadline, and the city is weighing its next steps. A supermajority of the City Council - five out of its seven members - would have to agree before it could invoke eminent domain.
Meanwhile, a coalition of banks, bondholders, securities firms and other financial institutions filed a lawsuit this month in federal court seeking to block Richmond's plan on the grounds that it is unconstitutional. A hearing is scheduled for Sept. 13 on the suit.
Over the first two weeks of August, the successor to Richmond's redevelopment agency tried to refinance $34 million worth of bonds. Richmond disclosed the eminent domain plan as part of the official offering statement but said it wasn't material.
Despite the bonds' A-minus rating, there were no takers from investors. Meanwhile, bonds issued by other cities with lower credit ratings found buyers.
While Lindsay downplayed the idea that the eminent domain controversy influenced investors' rejection, Councilman Nat Bates begged to differ. Richmond's plan to seize underwater mortgages forcibly "is exactly the reason the bonds were rejected," said Bates, who opposes the city's use of eminent domain. "We need to get back in good graces with financial institutions."
In an effort to reassure Wall Street, Bates said he plans to introduce a motion at the City Council's Sept. 10 meeting that would withdraw the city's offers to purchase underwater mortgages and specify that future offers require advance approval by the council.
Outside experts involved in the refinancing effort said Richmond's involvement in a story that grabbed national headlines may have spooked the traders who buy municipal bonds on behalf of big institutional investors. Such traders have hundreds of such bond issues to choose from daily.
Faced with what the market calls "a story bond" - something with unusual characteristics that are difficult to understand - traders prefer to make their lives easier by buying an equivalent issue that doesn't carry such baggage.
Richard Larkin, director of credit analysis at investment firm HJ Sims, who was not involved in the offering, said he can't say why the bonds failed to find buyers, but it seemed surprising.
"Not getting any bids on a $38 million deal with an A-minus rating - that is unusual even during a slow time like August," he said.
If Richmond had been able to sell new bonds at the lower rate, the city would have saved $3.985 million. Instead Richmond pulled the bonds from the market.
This week, ratings agency Standard & Poor's said it would probably lower grades for mortgage bonds in cities that use eminent domain in the unusual way Richmond is contemplating.
"The comparative decline in value for mortgages in jurisdictions that have employed eminent domain would likely make securitizations more speculative," S&P analysts James Taylor and Sharif Mahdavian wrote in a report. "We would expect this to translate into a higher mortgage rate and/or fewer credit opportunities for borrowers in those jurisdictions."
The city has no plans to give up on the bond market. In October, Richmond will return to Wall Street to sell the annual tax-revenue anticipation bonds it issues to provide cash flow for regular operations.
Carolyn Said is a San Francisco Chronicle staff writer. E-mail: email@example.com Twitter: @csaid
Statement from City Manager Bill Lindsay
Mayor and Member of the City Council:
This is to provide some background information on a recently proposed Successor Agency bond refinancing that staff pulled from the market last week.
The proposed $34 million bond issue was a fairly standard refunding of tax increment bonds that had been issued by the former Redevelopment Agency. Bond payments were to be secured by property tax increment (i.e., the growth in assessed values in the former Redevelopment Agency project area). The interest rate on the current outstanding bonds is 5.23%, and the approximate anticipated interest rate on the refunding bonds was 3.82%, providing a present value savings over the life of the bond issue of $3,984,781. The underwriter attempted to market the bonds on August 14th and 15th, but was unsuccessful in terms of getting orders. As a result, several days later, staff determined, together with the finance team (underwriter, bond counsel, financial advisor), that the bonds should be pulled from the market temporarily.
The speculation among the staff and the finance team was that Richmond’s mortgage acquisition strategy was impacting the underwriter’s ability to sell the bonds. The fact that there was a national story regarding the mortgage acquisition program was thought to be a contributing factor; when investors have choices in the market regarding the purchase of municipal bonds, they tend to choose the safe, plain vanilla option rather than an option that requires them to research and fully understand a story. It is, however, impossible to know why investors were not willing to bid on the bonds because they did not inform us as to their reasons.
Management at the underwriter’s firm did apparently receive an inquiry from a “higher up” representative of the Securities Industry and Financial Markets Association (SIFMA) indicating that they thought that the disclosure language in the Preliminary Official Statement for the bond issue was inadequate. I have provided to you this disclosure language in its entirety below, in part because I think that is an excellent summary of the actions taken by the City of Richmond to date (“As of the date of this Official Statement, the City Council has not taken any action to approve the described loan acquisition program nor has the City Council taken any action to approve commencement of any eminent domain proceedings.”), and also because I think it provides a reasonable conclusion regarding the effect of the mortgage program on the creditworthiness of the bonds (“the Fiscal Consultant estimates that the impact on the assessed value would be immaterial.”)
Nonetheless, the possibility that the mortgage acquisition program may impair Richmond’s ability to access the credit markets is a very real concern, of which the Council should be aware.
We will continue to keep you informed as we get more information.
Excerpt from Preliminary Official Statement for Successor Agency Refunding Bonds:
Recent Developments Regarding Possible Eminent Domain Proceedings
On April 2, 2013, the City Council approved the execution of an advisory services agreement (the “Advisory Agreement”) with Mortgage Resolution Partners, LLC (“MRP”), a community advisory firm, to assist the City in designing and implementing a program to ease the impacts of the mortgage crisis on the residents, including identifying and arranging acquisition financing of private label securities mortgages (i.e. loans in mortgage-backed securities pools) for the purpose of achieving mortgage principal reduction for property owners that are underwater on their mortgages. Pursuant to the Advisory Agreement, the City will pay MRP a fee for each loan acquired and MRP agrees to indemnify, protect, defend and hold the City and its representatives harmless for any liability, penalties, costs, losses, damages, expenses, causes of action, claims or judgments, including attorney’s fees and other defense costs arising out of or in any way related directly or indirectly from the Advisory Agreement, the programs or tasks implemented under the Advisory Agreement, any failure to comply with applicable law ,and any default or breach by MRP in the performance of its obligations under the Advisory Agreement.
In June 2013, Mortgage Industry Advisory Corporation appraised the value of all of the underwater mortgages to determine the fair market value of the loans to be purchased. Of the 624 mortgage loans appraised, only 85 of the loans are associated with property located within the Merged Project Areas.
On July 29, 2013, the City Manager’s Office sent letters to the lender trustees of 624 mortgage loans informing them that the City was investigating the acquisition of mortgage loans as part of a public program to modify underwater mortgage loans to reduce principal and avoid foreclosure. Based upon the appraisals completed by Mortgage Industry Advisory Corporation, the City made an offer (collectively, the “Offer”) to each lender trustee to purchase the loans (free and clear of any encumbrances to title or other interests that the City, in its discretion, deems unacceptable) for the fair market values set forth in the related loan appraisals. Consummation of each Offer is subject to approval by the City Council, including approval of final conditions for the implementation of the loan acquisition program. If any lender trustee deems its Offer unacceptable or fails to accept the Offer by August 13, 2013, the City may decide to proceed with the acquisition of the loans through eminent domain, in which case the owner of the loans would have the right to have the amount of just compensation to be paid by the City for such loans fixed by a court of law.
The loan appraisals are not real estate appraisals of the market value of the related properties. Rather, the loan appraisals are appraisals solely of the mortgage loans. In order to estimate the value of a given mortgage loan, Mortgage Industry Advisory Corporation uses an automated property valuation methodology known as ABSNet Loan Home/Val that incorporates a number of demographic and market analysis parameters into the analysis of a given loan, including an estimate of the value of the related property when it was first placed in the mortgage-backed securities pool.
Although the loan appraisals are not real estate appraisals and are not based on current assessed valuation data, the Fiscal Consultant (defined below) determined that the current aggregate assessed valuation of the 85 properties located in the Merged Project Areas was a combined $17,520,450 compared to the $17,128,207 aggregate loan value estimated by Mortgage Industry Advisory Corporation. Thus, the current aggregate assessed valuation of the 85 properties is $392,243 higher than the aggregated estimated value of the mortgage loans. Even if all of the mortgage loans within the Merged Project Areas were to be acquired, the Fiscal Consultant estimates that the impact on the assessed value would be immaterial.
As of the date of this Official Statement, the City Council has not taken any action to approve the described loan acquisition program nor has the City Council taken any action to approve commencement of any eminent domain proceedings.
City of Richmond
450 Civic Center Plaza
Richmond, California 94804