One of Canada's biggest banks has emerged as enemy No. 1 in a new battle between mortgage funds and the banks that give them financing

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• Two real estate investment funds have sued Royal Bank of Canada, alleging that it moved to "unlawfully seize" securities the funds had pledged as collateral for short-term loans known as repurchase agreements.
• The funds sought an injunction to prevent RBC from selling some of the collateral at an auction today, though a judge allowed the sale to go through because the paperwork wasn't filed in time, according to a person briefed on the case.
• RBC is "hitting the accelerator to unlawfully seize and unload a large portfolio of plaintiffs' assets at fire-sale prices," the lawsuit claimed.
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Two real estate investment funds have sued Royal Bank of Canada, saying it unlawfully seized their assets during a downturn that has frozen the market for commercial mortgage-backed securities.

The lawsuit shows just how much of a disconnect is emerging between investment firms and lenders as the coronavirus upends the massive US mortgage market. As financial markets break down, security values become increasingly hard to determine and lead to disputes between counterparties.

The funds, affiliated with investment firm Angelo Gordon & Co, say RBC moved too quickly to mark down the value of their securities during a market swoon in which the coronavirus pandemic has essentially frozen the market for securitized products. RBC made margin calls on the funds and seized their collateral.

An RBC spokesman declined to comment.

The problem, according to the investment funds, is that the market has frozen so thick that it's impossible to determine the value of their securities. According to the lawsuit, "because the 'Market' is temporarily frozen, there currently is no objective means of calculating 'Market Value.'"

Investment funds like these, called mortgage real estate investment trusts, borrow money from banks like RBC and pledge collateral in return. When the value of the collateral declines, lenders typically ask clients to put up more cash or collateral, in what's known as a margin call. If clients can't meet those new demands, lenders typically have the right to seize the collateral.

The funds said in the lawsuit that RBC's actions violated the documents governing their financing relationship. The funds said they received margin calls from RBC on March 23.

The turmoil in markets that's seen US stocks plunge 30% from their highs has migrated to the US mortgage industry, forcing valuations on residential and commercial mortgage-backed securities to plunge in value. In recent days, according to reports, investment funds have flooded the market with billions of dollars in securities to raise cash.

In the face of such value declines, the funds said "virtually every major money-center bank" has agreed to enter talks to delay margin calls or work out forbearance agreements. RBC has so far refused, according to the lawsuit.

RBC is "hitting the accelerator to unlawfully seize and unload a large portfolio of plaintiffs' assets at fire-sale prices into the seized markets which will have a cascading effect in the market for mortgage-based assets," according to the lawsuit.

RBC was selling $600 million in CMBS in an auction today after seizing them from clients over recent days, according to the Wall Street Journal. At least $11 million of that was seized from the Angelo Gordon funds, according to the lawsuit.

The funds sought an injunction to prevent the auction from going forward. A judge allowed the sale to go through because the paperwork was filed too late, according to a person briefed on the proceeding.

The funds aren't the only RBC clients to take issue in recent days with the bank's actions.

Earlier Wednesday, Exantas Capital Corp, another mortgage investment firm, said RBC had sent notices of default that it disputed, and that it intended to defend itself against them. Exantas said as of March 23, it had not been able to meet some margin calls.

The company "intends to vigorously assert its rights and defenses against any wrongful conduct by its CMBS repo financing counterparties," according to the press release.

The turmoil in the mortgage market is bringing echoes of the 2008 financial crisis, when credit markets froze in the face of plunging values on mortgage securities. On Monday, in an effort to support the market, the Federal Reserve instituted an emergency lending program that will allow it to purchase some types of mortgage-backed securities.

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