IRWA Annual Education Conference Hartford, Connecticut June 23, 2014

1. The Condemnation of Underwater Mortgages: The Law & Economics IRWA Annual Education Conference Hartford, Connecticut June 23, 2014 Presented by: Rick Rayl and Kevin Donahue

2. The Problem

3. Underwater Mortgages: 4th Qtr. 2000

4. Underwater Mortgages: 4th Qtr. 2009

5. Underwater Mortgages: 2nd Qtr. 2012

6. Corelogic Trends

7. 1st Quarter 2014 State Analysis • Compare these figures to Texas, Montana, Alaska, North Dakota, and Hawaii, each of which have negative equity of less than 4.5% • Connecticut is at 11.%

8. But What About a More Local Look? * Source: Haas Institute for a Fair and Inclusive Society (December 31, 2013 Data)

9. CoreLogic – 1st Quarter 2014 • Homes with positive equity suffered a default rate of .6% • Homes with negative equity suffered a default rate of 3.5% • 1,200,000 properties would return to positive equity if prices rise another 5% (projected to occur over the next 12 months)

10. What Does it Mean? • According to some, the historic rate of underwater loans creates fundamental flaws in the housing market • Issues: • Tightens credit market • Narrows the pool of potential buyers • Creates unprecedented foreclosure rate • Reduces housing starts • Impacts unemployment rate • Vandalism/ Crime/ Tax Defaults • Emergency Services

11. The Proposal:Mortgage Resolution Partners’ Plan

12. The Basics – the Loans • Identify residential properties with underwater mortgages • Local government agency will condemn the loans • NOTE: Condemnation of the LOANS, not the properties themselves • Only privately-held loans eligible • Initially, only performing loans eligible

13. The Basics – From MRPs Website Q: Who will choose the mortgages? A: Local governments will choose. They will determine which loans to acquire and in which areas in order to make a meaningful difference to their communities. We will partner with these committed local governments to screen loans for eligibility and inclusion in their programs.

14. The Basics – Acquisition Costs • Funding comes from a private equity group • Condemning agency does not pay the acquisition costs or the transaction costs • This includes the costs of any legal challenges to the program

15. The Basics – the Fees • Mortgage Resolution Partners earns a fee of $4,500 per loan • Private equity fund gets interest and the arbitrage in the deal

16. Is this plan even legal?? • Critics say it will violate the Public Use Clause, Contracts Clause, Due Process Clause, among other things

17. Illegal Invalid Public Use – How will this be used by the public? Benefit the public? Improper transfer of private property from one individual to another to benefit a third individual Acquisition by Eminent Domain not Necessary Competing Views: Illegal

18. Competing Views: Legal Legal • The definition of Public Use is Broad • Valid public use: Would help fix the housing market to benefit the community • It would prevent foreclosures, increase taxes, halt blight • Within purview of eminent domain powers to address economic considerations

19. Federal Law • The Takings Clause. The Fifth Amendment of the United States Constitution Provides: “No person shall be … [other important rights omitted] …nor shall private property be taken for public use, without just compensation.” • The real question is – What is a public use?

20. Federal Law • The Contracts Clause. Article I of the United States Constitution Provides: “No state shall . . . Pass any . . . Law impairing the Obligations of Contracts.”

21. How is “Public Use” Defined? • Is it: • (A) Government ownership of property for use by the public, or • (B) Condemnation for a public purpose, regardless of the final ownership of the property, or • (C) Both? • Eminent Domain can be employed as a means of achieving a public purpose, or as the court ruled in 1837 in Charles River Bridge v. Warren Bridge, to promote “the public interest and convenience.”

22. Federal Case Law Berman v. Parker(1954) 348 U.S. 26 Court approved condemnation of private property for redevelopment by private developers. Reasoning: • The power of eminent domain is merely the means to the end. • The means of executing the project are for legislative determination once the public purpose has been established. • The public may be better served through private enterprise. • Public ownership is not the sole method of promoting the public purposes.

23. Supreme Court’s Broad Public Use Definition Hawaii Housing Authority v. Midkiff(1984) 467 U.S. 229 Court approved condemnation used to break up the concentration of land ownership among a few owners in Hawaii by transferring it to lessees. Reasoning: • The land oligopoly skewed the market and created a malfunctioning land market. • No literal requirement that condemned property be put into use for the general public. • Public purpose is achieved even when the without the State's taking actual possession of the land. • Government does not itself have to use property to legitimate the taking; it is only the taking's purpose, and not its mechanics, that must pass scrutiny under the Public Use Clause.

24. Broad Public Use, Cont. Kelo v. City of New London, (2005) 545 U.S. 469 • Court ruled it was permissible when the City of New London designated a redevelopment area and acquired property by condemnation so a private developer could construct hotel, restaurants, retail and parks. • Reasoning: “Quite simply, the government's pursuit of a public purpose will often benefit individual private parties.” (Kelo v. City of New London, (2005) 545 U.S. 469, 485.) • Similar to redevelopment here in CA.

25. Federal Conclusion • Overall: Appears Legal on a Federal Level • AND, something on point: • If the public interest requires, and permits, the taking of property of individual mortgagees in order to relieve the necessities of individual mortgagors, resort must be had to proceedings by eminent domain; so that, through taxation, the burden of the relief afforded in the public interest may be borne by the public. (Louisville Joint Stock Land Bank v. Radford, (1935) 295 U.S. 555, 60.)

26. The Economics

27. Does the Plan “Pencil” Economically? • Idea is the use equity funds to purchase loans at 80% of the property’s fair market value • New loan will be set at 95% of FMV • The 15% difference will be used for: • MRP’s $4,500 fee • Transaction costs, including attorneys’ fees • The return on investment to the equity group funding the plan (estimated 20-30% return)

28. Looking at a Hypothetical Acquisition

29. Allocating the Remaining $ 25,500 • Pay for an appraisal(s) • Pay attorneys to file and prosecute eminent domain action • Pay court costs for both sides • Pay lender’s attorneys’ fees? • Severance damages (Larger Parcel)? • Query: What is a realistic assessment of transaction costs?

30. What is the Loan Really Worth- Hartford? • $190,000 loan on $154,000 property • 5.5% fixed interest rate • Loan performing since it originated in 2008 • At what value will it be appraised? • Who appraises it?

31. Loan Value, according to MRP “Similar sales of troubled loans in the secondary market exist and are good evidence of fair value. These sales occur at a significant discount to the fair value of the home because of the “foreclosure discount” -- the market's recognition of the cost in time, money and effort to foreclose on the homeowner and thereafter to maintain and sell the property.”

32. Analyzing the Acquisition Estimate • Loans are, by definition, performing (not necessarily true based on recent changes) • Loans likely at higher than market rate of interest • Loans difficult to refinance • Arguably the most valued assets of the loan pool • NOTE: A 2011 report found that the loans were trading at 106% of par value

33. Looking at a Hartford Acquisition

34. Will it Fix the Problem? • Approximately 90% of all mortgages held by Fannie Mae or Freddie Mac • Ineligible for Program • Of the privately-held loans, many are not performing • Ineligible for Program? • Some borrowers may reject the plan • Ineligible for Program

35. What does this mean for MRP? • Remember, for playing Robin Hood, all MRP wants is a modest, $4,500 fee • In San Bernardino County alone (the location many view as the first to seriously consider the proposal), MRP could have earned almost $190,000,000 • MRP quietly reported that if plan proceeds nationwide, it could make billions

36. Probability Of This Plan Actually Happening

37. A Federal Legislative Barrier? • “Defending American Taxpayers from Abusive Government Takings Act” – H.R. 2733 • Seeks to stop local governments from seizing distressed home loans and funding unconventional loan modifications • BUT: Referred to Congressional Committee on July 18, 2013, and has not been heard from since • GovTrack.us predicts only a 2% chance that the bill will ever be enacted

38. A Quick Case Study • To date, Richmond, California has progressed closest towards implementation • When San Bernardino County backed away from the plan, most of the nationwide attention shifted to Richmond – viewed as a national test case by many • At the depth of the recession, homes in Richmond had lost two-thirds of their value • About 16 percent of Richmond’s homes went through a foreclosure

39. A Quick Case Study • When it became clear Richmond was taking the idea seriously, representatives of Securities Industry and Financial Markets Association (SIFMA) flew out from Washington to meet with City officials, warning the City of potential negative consequences • Despite the warnings, City voted to proceed to acquire 624 loans, appraised them, and made offers to buy them

40. A Quick Case Study • Lenders responded with a vengeance, filing preemptive lawsuits seeking to challenge Richmond’s “right to take” before Richmond had even adopted a Resolution of Necessity • In September 2013, Lawsuits dismissed as unripe, but they did appear to have the desired chilling effect • Richmond has been unable to secure the necessary super-majority vote to adopt a Resolution of Necessity, and it appears to have given up on the idea

41. Does the Death of the Plan in Richmond Signal its Death Nationwide? • Many jurisdictions were waiting to see if Richmond succeeded, and many have backed off after watching what happened there • But not every jurisdiction as been scared away • As recently as June 10, 2014, articles appeared discussing the progress several New Jersey cities were making towards implementation • Irvington, NJ plan appears farthest along, with approximately 200 loans targeted for acquisition

42. Does the Death of the Plan in Richmond Signal its Death Nationwide? • On June 17, at the confirmation hearing for proposed HUD Secretary Julian Castro, the only tough issue during the entire hearing involved questions about Mr. Castro’s position on using eminent domain to acquire underwater mortgages • On June 24, recently elected Newark, NJ Mayor Ras Baraka announced a plan to condemn 1,000 underwater mortgages

43. A Few Other Issues • Might the lenders go after the borrowers for the deficiency? • For purchase money loans, borrowers protected • But for other loans, lender may have recourse • What about the holder of second/third position loans? • What about people who want new loans in these areas? • Tax Consequences of Loan Forgiveness?

44. Other Possible Solutions? “As tyme hem hurt, a tyme doth hem cure” -- Chaucer, Troilus & Criseyde, 1385

45. Other Possible Solutions? Package up the most delinquent loans and conduct a “rigged” auction with a bidder who has already committed to assist owners in creative solutions that avoid foreclosure. San Bernardino is conducting just such an auction TODAY, with the help of HUD

46. Questions? Rick E. Rayl rrayl@nossaman.com Kevin Donahue kdonahue@opcservices.com Nossaman LLP 18101 Von Karman Ave., Suite 1800 Irvine, CA 92612 949.833.7800 Overland, Pacific & Cutler, Inc. 1 Jenner, Suite 200 Irvine CA 92618 949.951-5263 CaliforniaEminentDomainReport.com