Fracking Boom Gives Banks Mortgage Headaches

An East Coast oil boom has promised potential riches to lucky landowners. But the oil rush may cause big headaches for some unlucky banks.

At least three institutions — Tompkins Financial (TMP) in Ithaca, N.Y., Spain's Santander Bank and State Employees' Credit Union in Raleigh, N.C. — are refusing to make mortgages on land where oil or gas rights have been sold to an energy company.

Due to technological advances in hydraulic fracturing, or fracking, huge swaths of territory are potential sites for oil and natural gas, ranging from New York state and Pennsylvania to West Virginia and North Carolina.

But much of this land is occupied by single-family homes and farms. If oil or gas is beneath his property, a homeowner could sell the rights to an energy firm, potentially reaping millions of dollars. That transaction could also derail a mortgage.

The uniform New York state mortgage agreement, used by Fannie Mae and Freddie Mac, states that "you cannot cause or permit any hazardous materials to be on your property and it specifically references oil and gas," says Greg May, vice president of residential mortgage lending at Tompkins. "That alone would make it a problem."

The mortgage agreement says homeowners can sell an oil or gas lease to an energy firm with prior consent from a lender, but May says, "I don't know any lenders who are granting that right now."

If Fannie Mae owns the mortgage, it's unlikely it would approve such a transfer. Fannie Mae generally does not "allow surface instruments," such as an oil rig, on property it owns, says spokeswoman Callie Dosberg. A landowner could apply for prior approval, and there "may be a work-around, but generally the agency does not approve such requests," she says.

A greater concern for homeowners is that Fannie Mae or Freddie Mac could force the entire outstanding loan balance to become due immediately.

Freddie Mac is within its legal authority to exercise a mortgage's "due on sale" clause if a borrower enters into a mineral-rights agreement, says spokesman Brad German. He says no "public information" is available to show if that has ever happened.

An ability to exercise the "due on sale" clause is triggered if a landowner transfers a right attached to the property; or through language that bars "hazardous conditions" on the site, German says. A clause in Freddie Mac's standard security instrument bars "the borrower from taking any action that could cause the deterioration, damage or decrease in value of the subject property."

So "the borrower cannot enter into a mineral lease without express approval," German says.

Banks are in a bind, too, May says. On one hand, they must follow Fannie Mae and Freddie Mac policies, but they don't want to add dozens of foreclosed homes to their books.

"Lenders are trying really hard to play a neutral role in this," May says. "We're not in the market to own real estate. We want to make loans."

A lender could still make mortgage loans on property where oil fracking is occurring, but the bank would have to hold the mortgage to maturity, May says. "If someone came to us with significant dollars, a 50% loan-to-value ratio and great credit, we might make a portfolio loan," even if fracking is taking place on the land, he says.

State Employees' Credit Union said this year that it would stop making mortgages on properties that have mineral rights "severed," meaning the landowner sold the oil rights. About 80% of the credit union's $14.5 billion loan portfolio involves residential mortgages.

Oil rigs on a piece of land would affect the values of neighboring properties, says Jim Blaine, the $27 billion-asset credit union's president.

"You could end up where someone puts a drilling platform on that property," Blaine says. "We'd have to tell their neighbors, 'We're sorry, your property value just went down.'"

The credit union was one of several financial institutions that pushed North Carolina lawmakers to pass a law requiring it to be "very clearly stated" in a sales contract whether a property's mineral rights have been severed, Blaine says.

The $76 billion-asset Santander Bank, formerly Sovereign Bank, added a clause in September 2012 to mortgage agreements stating that it will not make loans where a property owner has severed the mineral rights.

"We include this clause as a means of reducing the bank's risk and protecting its financial strength, which benefits all of our customers," says Santander spokeswoman Siobhan O'Shea.

Santander has branches in the Marcellus Shale region of Pennsylvania, where oil and gas fracking is centered. Santander, "to the best of our knowledge," has not recalled a mortgage for any property financed before the new clause was added to legal agreements, O'Shea says.

The $4.9 billion-asset Tompkins has not changed its policy on mortgage loans, but is "just following the policy that's always been there," which says that an oil or gas lease is in "direct conflict" with the terms of a uniform mortgage loan, May says.

"I'm not pro- or con-drilling," May says. "My charge at Tompkins is to control the risk to the best of my ability."

Other big mortgage lenders with operations in fracking areas have yet to implement an outright ban. Wells Fargo (WFC) has "no blanket restrictions" on its lending policies on properties where there is oil or gas drilling, says spokesman Jim Hines.

Lending decisions are made independently and consider a variety of factors that are "property and transaction specific," Hines says. Wells Fargo has made loans on properties with oil wells, but those loans often require more research and documentation before approval, he says.

Northwest Bancshares (NWBI) in Warren, Pa., "has discussed and reviewed this topic at length" but has yet to change its procedures, says spokesman Jim Holding. Northwest in August added a royalty rights management unit to handle a rising number of landowners who have sold rights for oil drilling.

PNC Financial (PNC) in Pittsburgh has not made policy changes with respect to fracking, a spokeswoman says. A spokeswoman at F.N.B. Corp. (FNB) in Hermitage, Pa., declined to comment.

Severed mineral rights has not been an issue in the western United State, where homeowners have always assumed that their land had a mineral right that was separate from their mortgage, says Kent Siegrist, a Tulsa, Okla., lawyer. "In Oklahoma, it's virtually impossible to buy property with the minerals still attached to it," says Siegrist, who represents oil companies and landowners.

No bankers in western North Dakota, where the oil industry is centered, have raised concerns about fracking and mortgage lending, says Rick Clayburgh, president and CEO of the North Dakota Bankers Association.

There are also spots in the eastern United States where mortgage lending appears unaffected by fracking. In West Virginia, landowners who sell mineral rights typically receive such a large windfall that they are able to pay off the mortgage, says Joe Ellison, president and CEO of the West Virginia Bankers Association.

"I've heard there are tremendous sums [landowners] are getting up front," Ellison says.

Fracking could have a negative influence on property values, so it is an issue all mortgage lenders should review, says Steve Hvozdovich, Marcellus Campaign Coordinator for Clean Water Action. A potential problem is oil leaks, which can cause water pollution, he says.

"A lot of people in rural Pennsylvania rely on well water for their homes," Hvozdovich says. "If you have contaminated well water, you don't have a reliable drinking water source, which is going to make it almost impossible to resell the home."

Leaks have been problematic at some fracking sites. In September, a Tesoro pipeline reportedly leaked 20,600 barrels of oil onto farmland in western North Dakota. Still, many lenders are overreacting to the potential conflict between fracking and mortgage lending, Siegrist says.

"Some of the banks are scared, and I don't think it's justified," Siegrist says. "They see the propaganda that fracking has caused significant surface damage or damage to the water supply. But I can tell you the majority of these wells are ... checked to make sure problems like that don't exist."

The ultimate warning sign for banks may be insurance, May says. A borrower can't get a mortgage without homeowners' insurance. "We're actually seeing insurance companies cancel [insurance] renewals when they find a [gas or oil] lease on the property," May says.