Rush to Drill for Natural Gas Creates Conflicts With Mortgages
New York Times
19 October 2011
By Ian Urbina
As natural gas drilling has spread across the country, energy
industry representatives have sat down at kitchen tables in states
like Texas, Pennsylvania and New York to offer homeowners leases
that give companies the right to drill on their land.
And over the past 10 years, as natural gas has become increasingly
important to the nation’s energy future, Americans have signed
more than a million of these leases.
But bankers and real estate executives, especially in New York,
are starting to pay closer attention to the fine print and are
raising provocative questions, such as: What happens if they lend
money for a piece of land that ends up storing the equivalent of
an Olympic-size swimming pool filled with toxic wastewater from
drilling?
Fearful of just such a possibility, some banks have become
reluctant to grant mortgages on properties leased for gas
drilling. At least eight local or national banks do not typically
issue mortgages on such properties, lenders say.
A credit union in upstate New York has started requiring gas
companies to promise to pay for any damage caused by drilling that
may lead to devaluation of its mortgaged properties. Another will
make home loans only to people who expressly agree not to sign a
gas lease as long as they hold the mortgage.
More generally, bankers are concerned because many leases allow
drillers to operate in ways that violate rules in landowners’
mortgages. These rules also require homeowners to get permission
from their mortgage banker before they sign a lease — a fact that
most landowners do not know.
Last year, Jack and Carol Pyhtila spent several weeks working to
refinance the mortgage on their roughly 30 acres in Tompkins
County, N.Y. But when they arrived to sign the mortgage, the
lender, Visions Federal Credit Union, had taken a closer look at
the lease on their land and revoked its offer, said Mr. Pyhtila,
72.
“They told us there was not enough information yet to know how the
lease would affect the property value and they were not sure if it
followed the mortgage rules,” he said. Another bank agreed to
refinance their loan several months later.
Lenders predict that the conflicts between leases and mortgage
rules are not likely to cause foreclosures, nor have they resulted
in broad litigation or legislation. But many of the leases do
constitute “technical defaults” on the mortgages, lenders say, and
will likely result in new rules from local banks and additional
hurdles to getting a home loan or refinancing a mortgage.
Some real estate agents have started raising red flags.
“When you decide to sell your house you may find it difficult to
do so because many banks, here and elsewhere, will not mortgage
properties with gas leases, which, in turn, limits the number of
buyers willing and able to buy your property,” wrote Linda
Hirvonen, an agent in Ithaca, N.Y., in a newsletter last month.
Banks establish rules for how mortgaged properties can be used, to
help ensure that they will hold their value. Banks also need to
guarantee that their mortgages meet certain standards so that they
can sell them to institutions like Fannie Mae and Freddie Mac,
which bundle and sell these mortgages to investors.
“In terms of litigation, there is a real potential for a domino
effect here if lenders at each step of the way made guarantees
that are invalid,” said Greg May, vice president of residential
mortgage lending at Tompkins Trust Company, headquartered in
Ithaca.
Banks resell more than 90 percent of new residential mortgages in
the United States to institutions like Fannie Mae, Freddie Mac and
Ginnie Mae. It is not clear how many mortgages held by major
secondary lenders or investors have oil or gas leases on them that
do not comply with mortgage rules.
But if even a small percentage do, tens of billions of dollars in
mortgages might be affected, raising new concerns for an industry
that has suffered in recent years from home loans that proved much
riskier than expected.
Some lawyers who specialize in oil and gas leases said they were
not worried.
“The leases have not created any practical conflict or issue with
mortgages,” said Adam J. Schultz, a lawyer in Syracuse, adding
that there are thousands of gas leases on mortgaged properties in
New York and Pennsylvania and that state environmental regulations
helped protect property values.
Most of the bankers and mortgage experts interviewed also
emphasized that they were not opposed to expanded drilling. The
surge in such drilling has created thousands of jobs, bolstered
American energy supplies and turned some landowners into
millionaires, they said.
However, the banking industry is only starting to appreciate the
complexity and possible consequences, they added.
“It’s truly Pandora’s box,” said Cosimo Manzo, a vice president of
First Heritage Financial, a mortgage services company in
Philadelphia, during a presentation to Pennsylvania lenders posted
online in July by a state credit union association. He also
compared getting leases to comply with mortgage rules to solving a
Rubik’s Cube.
If local banks do not require that leases comport with mortgage
rules, Fannie Mae and Freddie Mac may stop buying mortgages from
these banks, Mr. Manzo said. Other experts warned that the two
institutions, or investors who bought mortgage-backed securities,
may also force local lenders to buy back noncompliant mortgages.
Real estate experts said the chances for conflicts between leases
and mortgages were growing as drilling increased in more populated
areas. The issue has garnered the most attention among lawmakers
and lenders in New York, partly because the state’s rules for how
close to homes drilling may be undertaken are more lax than in
some Western states where there has been drilling for years.
Attention From Lawmakers
Lawmakers have started asking more questions about the
interplay of leases and mortgages.
In September, after The New York Times asked them about the issue,
two Democratic congressmen, Edward J. Markey of Massachusetts and
Maurice D. Hinchey of New York, asked Fannie Mae and Freddie Mac
how they intended to rectify any breaches of their standards
caused by drilling leases. State legislators from New York, Ohio
and Maryland have also sent letters to regulators seeking more
information.
In October, Mr. May published a report after a Tompkins County
legislator, Carol Chock, asked him to look into the issue. The
report described various conflicts between leases and mortgages
over such things as minimum distances between gas wells and homes
and the construction of wastewater ponds.
Mr. May said the issue was causing “a high level of concern for
prudent banks and lenders.” He and other bankers have also
questioned how the growing grid of buried pipelines that carry
natural gas from wells to consumers will comply with mortgage
rules. A separate report from the Congressional Research Service,
the research arm of Congress, said signing a drilling lease
without prior approval on a property with a mortgage owned or
guaranteed by Fannie Mae or Freddie Mac “generally will be
considered an act of default under the mortgage.”
That could give either of the federally run companies the right to
demand immediate payment of the full loan and even foreclose on
the property if the owner cannot pay, the report said.
Representatives for Freddie Mac, Fannie Mae and the Federal
Housing Finance Agency, which oversees Fannie Mae and Freddie Mac,
declined to comment.
Other officials at Fannie Mae, who were not authorized to speak to
reporters, said it was unclear how many mortgaged properties with
noncompliant leases Fannie Mae owned or had unwittingly sold to
investors. Since drilling leases are frequently on farms and
Farmer Mac, which purchases farm, ranch and rural homeowner
mortgages, has many of the same rules as Fannie Mae and Freddie
Mac, potential conflicts between mortgages and leases exist there,
too.
A spokesman for Farmer Mac said he did not believe leases posed a
significant financial risk.
Some bankers have emphasized that the conflicts between mortgages
and leases can be resolved. But that first requires more guidance
from Fannie Mae, Freddie Mac and other secondary lenders about
what types of appraisals and title insurance are appropriate for
mortgaged properties with leases, and whether the risks and values
of these properties need to be reassessed, said Bill Crane, a
senior vice president of CFCU Community Credit Union in Ithaca.
Other lenders said they needed mortgage rules relating to leased
properties to be followed uniformly so that bankers who enforced
these higher hurdles were not left at a competitive disadvantage.
In New York, these lenders added, regulators need to change
regulations to require a larger buffer zone between homes and
wells so that drilling complies with mortgage rules.
“New York needs the drilling jobs,” said Ralph Kelsey, a senior
vice president of Tioga State Bank in Tioga County, N.Y. “We also
need a lot more answers to these questions.”
Last year, Mr. Kelsey gave a presentation warning that since
intensive drilling is relatively new in New York and Pennsylvania,
there is a lack of historical data about how drilling affects
property values, which in turn raises questions about whether
appraisals will meet mortgage guidelines.
Rare Requests for Clearance
Data is scarce on how often landowners or drilling companies
are getting written permission from lenders before putting leases
on mortgaged properties. Most mortgage experts said the requests
were rare.
Bank of America receives roughly 100 requests per month
nationwide, a company spokesman said. Fewer than a dozen such
requests are sent directly to Fannie Mae each year, according to
Fannie Mae officials.
Wells Fargo, Bank of America, Citigroup, JPMorgan Chase, HSBC,
GMAC Mortgage and the Mortgage Bankers Association declined to
comment beyond saying they decided mortgages case by case and
noting that the landowner or the gas company is responsible for
ensuring leases do not violate mortgages.
In private e-mails, some lenders said drilling leases could create
problems for getting a mortgage.
It is “very difficult to obtain financing due to the potential
hazard” as well as “unknowns,” an official at Wells Fargo wrote to
a mortgage broker in northeastern Pennsylvania in April 2010.
Drilling officials offered a different view. They said that the
income from lease bonuses and gas royalties actually enhanced
property values, and that mortgage lenders welcomed gas drilling
because it provided borrowers with extra income that could be used
to pay off their mortgages.
New York environmental regulators recently published a report
indicating that property values go up regionally with an influx of
drilling jobs. But the report also said research showed the value
of properties closest to drilling would likely decrease.
Chesapeake Energy, a major natural gas producer, does not seek
approval from lenders before finalizing leases on mortgaged
properties but asks permission later for properties where wells
will be drilled and withholds royalties until consent is obtained,
said Jim Gipson, a company spokesman.
However, lenders warned that mortgage rules required approvals
from lenders before drilling leases were signed.
They also noted that such approvals were required on all leases,
not just those where wells are drilled.
Landowners said they were unaware of the rules set by their
mortgages.
“It never even dawned on me to talk to the bank before I signed my
lease,” said Marie McRae, 67, who raises horses in Freeville,
N.Y., outside Ithaca. She leased 13 acres of her farm in 2008, but
came to regret her decision and has publicly criticized drilling.
Asked by The Times to review the mortgage regulations and a
collection of leases, Shaun Goho, a lecturer at Harvard Law School
and co-author of a guide to natural gas leasing, said he was
alarmed by various potential conflicts between leases and
mortgages. He added that he planned to revise the guide this fall
to include a discussion of these conflicts.
Officials from Exxon Mobil, the largest natural gas producer in
the United States, and America’s Natural Gas Alliance, a trade
association, declined to comment.
This is not the first time that questions have been raised about
whether mortgages comply with standards set by major lenders.
The assembly-line way that mortgages are sold and resold makes it
difficult to track liability and risk and to ensure that
guidelines are being followed, said Eric Forster, a real estate
and mortgage expert who is the managing principal in Forster
Realty Advisors of Los Angeles, which often consults on real
estate litigation.
“The subprime mortgage mess was the first symptom of this larger
problem,” he said. “And these leasing issues represent a second
symptom.”
Kitty Bennett contributed research.