SAN FRANCISCO, Sept 20 (Reuters) - Richmond, California's plan to use eminent domain to seize "underwater" mortgages and make them more affordable could backfire on its finances, Moody's Investors Service said on Friday, adding the plan is a "credit negative" for the city.
Eminent domain allows governments to acquire property for public purposes such as building roads, but Richmond's city council last week voted to potentially use it to acquire mortgages to prevent more foreclosures.
"The eminent domain program is credit negative for the city because it will likely lead banks to raise mortgage interest rates and reduce mortgage availability, which will in turn limit the growth of property values and related taxes," Moody's said in a report.
Moody's has an 'A1' issuer rating on Richmond, one of the San Francisco region's poorest cities and the first one in the United States to embrace eminent domain to acquire underwater mortgages.
Supporters of the plan in Richmond say roughly half of mortgage borrowers in the city of about 105,000 residents have underwater mortgages, or owe more on the loans than their property is worth.
Richmond's plan, crafted by investor group Mortgage Resolution Partners, provides for the city to use eminent domain to acquire mortgages if investors holding them turn down its offers to buy homes at a deep discount to the value of the loans.
The city has already made offers for more than 600 delinquent and performing mortgages. Critics say that shows the city is lending its eminent domain power to Mortgage Resolution Partners to split profits from refinancings with it.
The plan's supporters say it would help keep more borrowers in their homes, averting defaults and blight from foreclosures. That should help Richmond's housing market and by extension the city's finances, they add.
Moody's view of the potential effect on Richmond's housing market reflects the mortgage industry's view. Moody's predicted "Lenders will factor in the additional risk by raising mortgage interest rates or decreasing their availability."
That would reduce demand for housing in Richmond and slow its rising home values, Moody's said.
Mortgage brokers warn that forcing mortgage investors to take a loss so Richmond can modify home loans could also scare lenders out of the city. "If you give lenders a lose-lose proposition, they're gone," said Lou Barnes, a mortgage broker tracking Richmond's plan from Boulder, Colorado.
Richmond risks becoming "toxic" for lenders, said Rick Sharga, an executive vice president at online real estate marketplace Auction.com. "It adds an element of risk that's never been factored into a mortgage contract before," he said.
Richmond's city council voted 4-3 last week to approve the plan but would need to vote 5-2 for eminent domain actions. If there are no willing sellers, courts could set prices exceeding offers by Richmond, potentially undermining its program's financial rationale, Moody's said.
Investors holding mortgages targeted by Richmond show no sign of accepting its offers to buy homes financed by the loans. The investors, through their trustees, tried to block Richmond in U.S. District court in San Francisco, but a judge there on Monday dismissed the case, saying their suit was premature.