Sierra Atlantic Volume 39 Fall 2012

 

Flawed natural gas leases raise risk of new mortgage meltdown

by Jurgen Wekerle and Andrew Lawrence

Natural gas leases throughout the New York Marcellus shale region, especially on properties with mortgages, are fatally flawed and may conceal reprehensible public and private risks.

The latest threat to real estate recovery across the country is the tens of thousands of mortgaged properties with defective gas leases. That’s because a lease without bank/thirdparty consent is subject to default, and the property may be precluded from resale, according to Elizabeth Radow, a New York attorney who has written a cover story about the topic for the New York State Bar Journal.

Further, each of these properties could be “fracked” and converted into a mini-Super Fund site affecting homes throughout the surrounding community. This is an unimagined toxic time bomb which could blow up the national housing market and drown the banking system yet again. The fear that fracking may someday be allowed in the Catskills is already undermining the second-home real estate market there, according to a recent article in The New York Times.

Dependent on fracking, gas leases are being signed without the required approval of banks holding the property mortgages. Anti-degradation stipulations in mortgages prohibit landowners from polluting or compromising the collateral value of the property, which guarantees the mortgage loan.

Deed recording is often shoddy, and contamination, health and financial liability risks are not disclosed. Moreover, lease sellers are being misled, zoning restrictions are ignored and the business community and public officials have not considered the consequences of property devaluation.

Gas drilling promoters promise astonishing wealth to landowners and often pay lease signing bonuses that are worth

Defective gas leases are putting the real estate industry at risk, threatening the banking system and the tax base upon which schools and municipalities depend.

more per acre than what the outright sale of that property could bring on the open market — land that could be contaminated and become an unmarketable public burden if ever abandoned. And, windfall tax revenue is promised to prop up government budgets staggered by the exploding real estate bubble and mortgage foreclosure meltdown. Rather than halt the slide in property prices, drilling would accelerate the downward spiral of property  assessments and tax revenue upon which municipalities and school districts depend.

News reports reveal that a growing number of lenders — most notably, Wells Fargo, the largest mortgage lender in the U.S. — have stopped issuing mortgages for refinancing or for the new purchase of homes with gas leases. Lenders are becoming skittish about the risk of losses caused by contamination and by the lease mechanism itself.

Not only must mortgage holders consent to the gas lease, so too must the home insurance companies who are obligated to evaluate new liability risks and adjust the terms and premium costs of policy coverage. Nationwide, one of the nation’s largest insurers, recently decided that it will no longer insure properties leased for gas drilling.

Home insurance is also required for a mortgage, and insurance policies routinely do not cover gas drilling or secondary risks related to fracking. Cancellation of a policy or lack of coverage also could trigger a mortgage default and a bank’s demand for instant repayment or foreclosure.

Gas leases have legal consequences just like aboveground subdivisions, which alter ownership relationships and property values. Significant changes require the written consent of all mortgage owners listed on the deed/title, such as the originating bank and all other parties with a financial interest, including a home equity loan or second mortgage, a mortgage derivative, or a lien or easement. That is why the lease must also be recorded with the deed in the office of the county clerk to satisfy title search and title insurance requirements upon which the transfer

and sale of real estate depend.

The value of a home’s assessment and mortgage is predicated on the value of the entire deeded property, including subsurface mineral assets, water resources, septic system performance, and aboveground buildings, which collectively become the collateral. The value of a home is also related to the value of neighborhood properties and to the community as a whole.

The gas lease, however, splits off the gas asset as part of the mortgage collateral. The lease further diminishes the value of the property, whether or not any pollution occurs, because it also controls the aboveground use of the property, including:

• construction of well pads, access roads, and collection pipes,

• frack fluid/sludge waste storage pits,

• gas compressors and processing facilities,

• easements, and,

• surface or underground storage facilities for gas and/or frack waste.

In fact, the potential for gas production makes the underground gas lease  exponentially more valuable than the surface land and structures, which become a shell to which the mortgage remains attached. Paradoxically, the mortgage holders may have the loan value sucked out from under them, but would receive no benefit, no signing bonus, or no shared royalty from the actual sale of the gas.

Should drilling take place and/or toxic contamination occur, the property would become unsaleable, and property tax revenue could decline to zero.

We do not know how much tax revenue gas production will generate for municipalities, or how the ad valorem tax—the only source of municipal frack revenue—will be implemented.

However, we do know that the “regulation” promised by the DEC draft Supplemental Generic Environmental Impact Statement (SGEIS) is deficient and unable to protect the public from fracking. The SGEIS is not even a law or a regulation having the full force and effect of law.

We know the SGEIS omitted both a health impact evaluation and a municipal cost/benefit study, including the impact of lost property taxes.

We know that New York has its own “Halliburton loophole” crafted by the DEC, which exempts toxic, cancer-causing frack chemicals and hazardous frack waste from regulation.

We know that the organic/biological process of municipal sewage treatment plants (STP) cannot remediate industrial frack waste chemicals or radioactive leachate which can nullify the ability to treat municipal sewage. Further, the highly corrosive frack waste brine can destroy the physical STP infrastructure by itself. Still, the DEC is considering municipal STPs for frack waste disposal.

The DEC cannot protect citizens from even fundamental regulatory problems such as the personal crisis faced by four Town of Goshen families whose well water has been contaminated by MTBE, which leaked from adjacent Orange County DPW gasoline tanks. The DEC identified the problem and the cause years ago, but families are still without water, they cannot sell their homes, and they cannot afford to move out. If the DEC cannot resolve or enforce a tiny but lethal MTBE spill in Goshen, how can it be trusted to regulate 70,000 frack wells located throughout the state?

The gas companies have insufficient insurance coverage to address liability and pollution cleanup costs, and performance bonds and landowner indemnification are pipe dreams. No amount of insurance or bonding or pooled remediation funds would be adequate to address an unexpected catastrophe such as the BP Deep Water Horizon explosion in the Gulf of Mexico during 2010, or the prospect of 70,000 leaking gas wells, pipelines and mini-spills throughout the Catskills, the Delaware and Susquehanna River Basins and the Southern Tier.

We know that the ultimate burden and costs of fracking will be shifted to local government, and municipalities, in turn, will shift the burden via escalating property taxes of homeowners who did not sign gas leases.

Gas companies are required to disclose the risks of fracking, including financial price risks, to corporate investors and shareholders. They, however, are not required to make those same downside disclosures to landowners or to the affected public when they solicit gas lease contracts. Withholding such material information misrepresents the gas lease contract obligations and consequences and sets the stage for massive consumer fraud, which would adversely affect lease sellers, municipalities and the real estate/financial industry at large.

Responding to the foreclosure crisis and alleging consumer fraud, New York State Attorney General Eric Schneiderman is currently suing bank/mortgage lenders who failed to disclose to home purchasers, agencies (such as Fannie Mae) and investors (such as the NYS Retirement System), the irregular details of the mortgage terms which led directly to foreclosure.

It is time for the attorney general to investigate the lack of full disclosure and the concealment of public and private risk associated with fracking leases, which mirror the same mortgage foreclosure fraud allegations.

Jurgen Wekerle and Andrew Lawrence co-chair the Chapter’s Sterling Forest-Highlands Committee. Wekerle is a member of the Ramapo-Catskill Group and vice chair of the Atlantic Chapter’s Executive Committee. Lawrence is a

member of the NYC Group and is a registered investment management  professional.