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."