LOS ANGELES -- The use of eminent domain to seize underwater mortgages, as proposed by Richmond, Calif., could have negative consequences on the U.S. housing market, according to Standard & Poor’s.

Analysts James Taylor and Sharif Mahdavian called the plan a “localized approach to an issue with far-reaching nationwide implications” in a report released Monday.

“[Implementing eminent domain] may present inconsistencies in solving the root cause of the housing problem in the U.S., create unintended consequences for both borrowers and investors, and inadvertently limit mortgage lending activity,” the report said.

Richmond’s eminent domain plan, a concept created by Mortgage Resolution Partners, would relieve borrowers by invoking the power to take private property for public use to seize loans that have a higher balance than the value of the home. The San Francisco-area city, with a population of about 100,000, would pay lenders approximately 75% to 80% of a home’s fair market value, regardless of the amount of money still owed on the related mortgage.

For example, if a home is currently valued at $100,000 and the outstanding mortgage balance is $150,000, the city would pay the mortgage lender $80,000 as payment for the debt. The RMBS holders would incur the $70,000 loss.

Standard & Poor’s first commented on the credit impact of eminent domain proposals in October 2012, saying the impact on the residential mortgage-backed securities market could be significant, especially when the housing market is on a path to recovery and as private capital returns.

At the time, the ratings agency considered the likelihood of implementation remote but it updated the report following Richmond’s July announcement it would proceed with such a plan.

“Standard & Poor’s believes the use of eminent domain by the City of Richmond could establish a precedent that other municipalities around the country may follow,” Standard & Poor’s analysts wrote. “While the overall exposure of outstanding Standard & Poor’s-rated non-agency RMBS transactions to particular jurisdictions is limited, the cumulative effect could be substantial.”

Using LoanPerformance data to determine exposure of its rated transactions, Standard & Poor’s found that of the 1,000-plus transactions identified as containing Richmond-originated loans, 98% had less than 1% exposure to these loans. No transaction had greater than 2.5% exposure.

Analysts said that once the eminent domain plans are implemented, they will consider the potential effect of similar claims.

“While it is premature to gauge the full impact of such an analysis, we would inform the market as ratings are affected,” analysts said.

The plan has met many opponents, including Wells Fargo and Deutsche Bank, which recently filed a lawsuit against the city. The banks challenged the plan as unconstitutional and asked a federal court for an injunction preventing eminent domain proceedings.

The Federal Housing Finance Agency has also said that it may direct Fannie Mae and Freddie Mac to limit or restrict business activity within any jurisdiction that employs eminent domain to restructure mortgage loan contracts.

Standard & Poor’s said that if such plans are implemented, it would likely increase its request for credit support being provided to loans from affected jurisdictions.

In addition, the comparative decline in value for mortgages would likely make securitizations more speculative, which would translate into a higher mortgage rate and fewer credit opportunities for borrowers in those jurisdictions, analysts said.

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