Last week, in part one of this series, we examined how fracking and oil and gas shale development is likely driving down home values for the millions of Americans living near wells, production platforms, pipelines and other industrial paraphernalia belonging to the oil and gas industry as a result of its current drilling boom.
As we noted, the problem is a large one. More than 15 million people now live within one mile of an oil and gas well that has been drilled and fracked just since the year 2000. And it is predicted that we are only in the beginning stages of the current drilling boom, which will eventually extend into 34 of the lower 48 states.
When a shale play and a population center collide, the results are staggering. For example, a recent examination by The Wall Street Journal found that in Johnson County, Texas — an area sitting atop the Barnett Shale on the southern edge of Fort Worth with a population of 150,000 — 99.5 percent of county residents live within a mile of one or more of the 3,900 wells that now blanket the county. This is particularly startling when you consider that in the year 2000, there were less than 20 wells in the entire county.
Also as reported last week in BW, research into the impact of oil and gas extraction on real estate values has found that homes near wells or even as far away as 2.48 miles from production activity can lose between 4 percent and 15 percent of their market value. Researchers also claim that home values in places like Boulder County, where environmental awareness is particularly high, could drop by 20 percent or, in worst-case scenarios, be rendered nearly worthless because no one will buy them due to their proximity to oil and gas activity.
These losses in real estate value are also being exacerbated by the impact that fracking and oil and gas shale development is having on the primary and secondary mortgage markets.
When a homeowner attempts to sell, chances are, whomever is going to buy your house will need a mortgage to do so. Approximately 90 percent of all home purchases in the U.S. are made using money loaned to the buyer by a bank, credit union or government entity in the form of a mortgage against the property being purchased.
To secure a mortgage using the property as collateral, an appraisal of the property must be done and the buyer must be able to secure adequate homeowners and title insurance.
This part of the mortgage transaction is a function of the primary mortgage market. If this were the only mortgage market, then qualifying for a home loan would be quite difficult for most Americans because it wouldn’t take long for most lending institutions to loan out all their available funds.
That being the case, the federal government sponsors the secondary mortgage market to provide ongoing liquidity to the housing market. The purpose of government-sponsored institutions Fannie Mae and Freddie Mac is to purchase the home mortgages issued by banks and other lending institutions and then package those home loans into mortgaged-backed financial instruments that can then be sold to investors.
Buying mortgages from the banks that originated them ensures that those banks have a constantly renewing source of money to loan the next round of homebuyers.
In 2008, thanks to the mortgage crisis and the increasing insolvency of certain financial institutions, the Federal Housing Finance Agency (FHFA) was formed. The primary purpose of the FHFA is to provide oversight to Fannie Mae, Freddie Mac and the Federal Home Loan Banks. According to attorney Elisabeth Radow, writing for the New York Bar Association Journal, Fannie Mae and Freddie Mac have purchased or guaranteed more than 65 percent of all new home mortgages in this country. Which means that these entities hold more than $6.7 trillion dollars worth of home loans that they have packaged and pushed to mostly institutional investors such as pension funds or investment banks and their clients. Because of their fiduciary role in secondary mortgage market investing, it is in the interest of Fannie Mae and Freddie Mac to establish certain guidelines for home mortgages that decrease the risk for future lost value and/or default, and they have done so.
It is here, at the secondary market’s intersection of home mortgages and downstream investor interests, that fracking and the shale oil/gas boom become a substantial threat to the entire system as it’s currently built.
In laymen’s terms, in order to control risk for its investors, Fannie Mae and Freddie Mac have established rules that do not allow them to purchase home mortgages on properties that are engaged in industrial activities that deal with, among other things, the transport or storage of toxic substances such as chemicals, oil and gas products or radioactive materials. Nor do they allow for the transportation of such materials on their properties. In addition, all mortgages have a standard clause that does not allow homeowners to sell or lease any part of the property without permission from the mortgage holder. To sum it up, property owners can’t do anything that risks decreasing the value of their property without the permission of the mortgage holder.
All of these mortgage “don’ts” are, to one degree or another, encompassed within the current conflict between oil and gas shale development and the mortgage markets.
Fracking horizontal wells in shale formations entails pumping millions of gallons of water, toxic chemicals and sand into and under properties that have mortgages likely owned by the secondary market. Holding ponds on the surface contain millions of gallons of chemical slurries during the drilling process. Produced water that flows to the surface along with the gas and oil is briny, radioactive and contains some fracking chemicals and other contaminants. Once wells are producing, permanent easements for pipelines, truck transport and production platforms with their storage tanks to hold oil and other produced liquids are put in place. Spills happen, accidents occur.
In short, all of these oil and gas activities, if conducted on or even near a mortgaged property, have the potential to put the mortgage into technical default.
At this time, the primary markets have no incentive to start calling in loans. The last thing these banks need is to become the owner of large quantities of real estate that has lost much of its value due to oil and gas extraction activity. But depending on what happens in the secondary mortgage market, local lenders may have little choice.
The potential actions of the secondary market are far less predictable than those in the primary market. Fannie Mae and Freddie Mac have an obligation to protect the quality of the mortgage packages they have sold to investors. They also have the right to demand that the originating bank buy back any mortgages that were sold into the secondary market that did not meet Fannie Mae and Freddie Mac’s stated requirements concerning hazardous activity.
At this point, it is impossible to know just how many of the mortgages in the secondary market are in potential technical default due to oil and gas shale development and fracking. That’s because until fairly recently, no one in either mortgage market was paying much attention to how the shale boom was negatively affecting property values or how it might be causing technical defaults on tens of thousands of mortgages.
While we don’t know an exact number of endangered mortgages, we do know that the number is going up rapidly, as illustrated by what has happened in Johnson County, Texas, and other population centers where fracking has taken hold. If it’s 20 percent of the mortgages in the secondary market that are at risk, then $1.2 trillion worth of real estate mortgages could be in trouble. If it’s 5 percent, then $335 billion could be in technical default. Whatever the percentage, these are serious numbers for the federal government and the banks.
Any mortgage on a property where the homeowner has signed an oil and gas lease without first gaining the mortgage holder’s permission could be called, forcing the homeowner to pay off the loan or vacate the property.
Most homeowners are unaware that they need their mortgage holder’s permission before they can execute leases on their own property. Most oil and gas companies don’t tell potential lessors about the mortgage requirement because they know that mortgage holders are more likely than not these days to say “no” to an oil and gas lease that lenders understand is most likely going to lower the value of the property that serves as their collateral.
Even if a homeowner refuses to sign an oil and gas lease on her property, in most states the company doing the drilling can “force pool” the landowner into a well’s spaced unit as long as they pay them the oil and gas royalties that would have been due to them had they signed a lease. Even being force pooled against their will can put a homeowner into technical default of their mortgage and therefore at the mercy of the lender.
These are only some of the conflicts that now exist for homeowners who already have a mortgage on their property.
The larger concern for the real estate market going forward in at least 34 states is that many lenders may simply stop lending in many places due to oil and gas activity — or just the fear it may come.
Not only are banks starting to refuse to make mortgage loans near oil and gas shale plays, title insurance companies are also starting to exempt any potential losses stemming from unforeseen problems rising from oil and gas development, and that leaves the lenders at greater risk.
And homeowner’s insurance, which is also a requirement for getting a mortgage, is likewise getting harder to buy in shale gas plays where spills, small earthquakes, contaminated water and other potentially disastrous things are causing insurers to think twice.
Local banks and credit unions are just now realizing the exposure they have already inadvertently taken on due to the oil and gas industry’s encroachment into populated areas where they have previously made loans now mostly controlled by the secondary mortgage market. They are also just beginning to grasp the potential exposure they could still incur should they make loans in any area where oil and gas shale drilling activity is now taking place or could take place in the future. This is no longer a hypothetical problem for the real estate market.
Homeowners across the nation are starting to report that banks are refusing to offer mortgages on their property even if the property doesn’t have an oil and gas lease on it. They are being turned down simply because there is drilling activity in their area.
Some lending institutions are taking it a step further, refusing to make loans on any property where the mineral ownership has been severed from the surface ownership and is now owned by a third party outside the lender’s control, and this is even happening in areas with no history of oil and gas development. Some homeowners have even been rejected when they tried to refinance existing loans in areas near properties with drilling activity.
In writing for the New York State Bar Association Journal, Radow, who has brought many of these mortgage-market concerns to the attention of federal regulators, described what has happened of late in her neck of the woods near the Marcellus Shale.
“Bank of America, Wells Fargo, Provident Funding, GMAC, FNCB, Fidelity and First Liberty, First Place Bank, Solvay Bank, Tompkins Trust Company, CFCU Community Credit Union and others are either imposing large buffer zones (too large for many borrowers) around the home as a condition to the loan or not granting a mortgage at all,” she wrote.
“Once lenders connect the ‘no hazardous activity’ clause in the mortgage with the mounting uptick in uninsurable events from residential fracking, this policy can be expected to expand. Originating lenders with gas industry business relationships may decide to assume the risk, make mortgage loans to homeowners with gas leases and keep the non-conforming loans in their own loan portfolio. However, there is a limit to what an originating bank can keep in its own loan portfolio. Eventually, cash infusions from the secondary mortgage market will become a necessity, and secondary mortgage market lending guidelines will be a reality. If homeowners with gas leases can’t mortgage their property, they probably can’t sell their property either (this assumes the purchaser will need mortgage financing to fund the purchase). The inability to sell one’s home may represent the most pervasive adverse impact of residential fracking.”
Boulder County and the entire Front Range of Colorado are in the middle of today’s fracking/real estate conundrum. But unlike many other regions, Front Range citizens are fortunate enough to have taken steps in the form of passing fracking moratoriums and bans that are currently protecting them from the economic disaster of lost home values. Hopefully, the time that has been bought by these measures will be used to find permanent solutions to the conundrum, before the flood of drilling rigs just waiting to be unleashed has the opportunity to strip away potentially billions of dollars in wealth from area homeowners — families that currently have no recourse to force the party that has damaged them to pay one penny of their loss.