October 20, 2011

Mortgages don't like gas leases

The New York Times has an extended article today about conflicts between mortgages and gas drilling agreements - basically stating that by signing a gas lease (with surface rights), you're making the property ineligible for most mortgages, especially the "Uniform" mortgages used by Fannie Mae, Freddie Mac, and others:

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...

More generally, bankers are concerned because many leases allow drillers to operate in ways that violate rules in landowners' mortgages. These rulesalso require homeowners to get permission from their mortgage banker before they sign a lease -- a fact that most landowners do not know. ...

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.

I remember when I bought my house, my mortgage came with an entertaining flyer (which I now can't find) outlining the many things I couldn't do on my property. Nuclear experiments were the most memorable, disposing of gasoline and motor oil the most likely. Here's language from my 2003 mortgage:

21. Continuation of Borrower's Obligations to Maintain and Protect the Property. environmental protection are called "Environmental Law." Environmental Law classifies certain substances as toxic or hazardous. There are other substances that are considered hazardous for purposes of this Section 21. These substances are gasoline, kerosene, other flammable or toxic petroleum products, toxic pesticides and herbicides, volatile solvents, materials containing asbestos or formaldehyde, and radioactive materials. The substances defined as toxic or hazardous by Environmental Law and the substances considered hazardous for purposes of this Section 21 are called "Hazardous Substances." "Environmental Cleanup" includes any response action, remedial action, or removal action, as defined in Environmental Law.

An "Environmental Condition" means a condition that can cause, contribute to, or otherwise trigger an Environmental Cleanup.

I will not do anything affecting the Property that violates Environmental Law, and I will not allow anyone else to do so. I will not cause or permit Hazardous Substances to be present on the Property. I will not use or store Hazardous Substances on the Property. I also will not dispose of Hazardous Substances on the Property, or release any Hazardous Substance on the Property, and I will not allow anyone else to do so. I also will not do, nor allow anyone else to do, anything affecting the Property that: (a) is in violation of any Environmental Law; (b) creates an Environmental Condition; or (c) which, due to the presence, use, or release of a Hazardous Substance, creates a condition that adversely affects the value of the Property. The promises in this paragraph do not apply to the presence, use, or storage on the Property of small quantities of Hazardous Substances that are generally recognized as appropriate for normal residential use and maintenance of the Property (including, but not limited to, Hazardous Substances in consumer products). I may use or store these small quantities on the Property. In addition, unless Environmental Law requires removal or other action, the buildings, the improvements and the fixtures on the Property are permitted to contain asbestos and asbestos-containing materials if the asbestos and asbestos-containing materials are undisturbed and "non-friable" (that is, not easily crumbled by hand pressure).

I will promptly give Lender written notice of: (a) any investigation, claim, demand, lawsuit or other action by any governmental or regulatory agency or private party involving the Property and any Hazardous Substance or Environmental Law of which I have actual knowledge; (b) any Environmental Condition, including but not limited to, any spilling, leaking, discharge, release or threat of release of any Hazardous Substance; and (c) any condition caused by the presence, use or release of a Hazardous Substance which adversely affects the value of the Property. If I learn, or any governmental or regulatory authority, or any private party, notifies me that any removal or other remediation of any Hazardous Substance affecting the Property is necessary, I will promptly take all necessary remedial actions in accordance with Environmental Law.

Nothing in this Security Instrument creates an obligation on Lender for an Environmental Cleanup. (Form 3033, italics added)

Obviously this doesn't apply to places that don't have a mortgage, and language may vary from bank to bank, especially for banks that keep their mortgages in-house. Fannie Mae and Freddie Mac apparently don't (yet) have a formal policy on this.

The funniest - or saddest - piece in the article comes, as usual, from an industry attorney. These attorneys who insist that the absolute letter of the law as they interpret it must be followed just can't be bothered by someone else's agreements:

"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.

As always, the view from the oil and gas folks seems to be that you can do what you want with your property if and only if it's compatible with what the oil and gas companies want to do with it..

Update: WHCU has a podcast on this with Greg May, vice-president of residential mortgages at Tompkins Trust.

Posted by simon at October 20, 2011 12:23 PM in ,
Note on photos


Nathanael said:

Simon, this is slightly off-topic but closely related to the gas drilling topic, and I thought you might like to know.

It appears that the hydrofracking companies are operating what is essentially a pump-and-dump scheme. You may remember that the USGS announced not so long ago that the companies' estimates of the amount of gas they could get was far too high. You may remember that a number of fracked fields have run out of gas much more quickly than the companies predicted.

Well, if you look at Cheseapeake Energy's annual report, they explain that their business model is to develop a field (drill, get gas), advertise how much gas they're getting, and *sell it as soon as possible* to some other investor. This is an irrational business model if the fields actually are as rich in gas as they say they are -- but it's a very rational business model if the gas wells are barely economically viable, they know it, and the only way to make money is to hype them and sell them to suckers. In stock market terms, a pump-and-dump.

The supporters of gas drilling have probably been believing the claims from the gas drillers of large royalties coming for a long time. This isn't actually going to happen with hydrofracking. If I'm right, they are simply and plainly being scammed, as a side effect of a scam being run on investors.

I wonder if communicating this might change the views of some drilling "supporters". It's not just that fracking is an environmental disaster, it's actually part of a scam on investors.

Of course, when you realize that the companies are defrauding investors as a business model, the rest of their disregard for the law starts to make sense.