The Securities Industry and Financial Markets Association (SIFMA) has reached a consensus on the issue of cities using their power of eminent domain to refinance underwater mortgages (using reducing principal reductions) that reside in private-label MBS, saying it will foul up the securitization process.

The association decided that loans to borrowers in municipalities that have initiated condemnation proceedings to seize mortgage loans “will not be deliverable into TBA-eligible securities on a going-forward basis,” SIFMA said on Thursday.

The association sets the ground rules of the “to be announced” market where most conventional loans are securitized.

The California cities of San Bernardino, Ontario and Fontana are considering a plan to use their powers to condemn underwater loans so the mortgages can be refinanced. The pooling and servicing agreements on most PLS bonds do not permit principal reductions.

Proponents of eminent domain claim it will enable municipalities to assist in the refinancing of loans that the bondholders themselves would like to see refinanced. Such refinancings will increase the value of the loans in places like San Bernardino where property values have fallen 40% to 50% since 2006.

However, critics such as SIFMA contend the use of eminent domain “creates a material and unquantifiable new risk factor” for investors and MBS issuers and it would “destroy the homogeneity” of loans in the TBA market.

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