Leases and Lending Go Together

I have been in private practice as a real estate attorney in Northeastern Pennsylvania for more years that I’d like to admit.  My firm has offices in both Pike and Lackawanna Counties.  I also operated a real estate business for a number of years and serve as a Director of The Dime Bank, which is headquartered in Wayne County.  I have also served as local counsel to one of the major oil and gas companies operating in our area.  I offer you all this in the way of background for what I’m about to say – that Ian Urbina’s article in the New York Times this past week was seriously flawed.  I reached out to him when I heard he was doing a story on this subject.  Unfortunately, his deadline had already passed by the time I got his reply.  I wish we had been able to talk, because he got so much so wrong.

Let’s start with the obvious.  Who are these banks outside of Ithaca who aren’t lending to landowners with leases?  I don’t know of any lenders who are refusing mortgages in those areas of Pennsylvania where natural gas development is taking place.  Perhaps there are some for narrow reasons of special interest but all the banks I deal with, including the one where I serve as a Director, are more than pleased to write a mortgage on a property with the additional collateral a gas lease provides.

My experience is that gas lease bonus payment enabled a lot of our customers to resolve mortgage issues and pay off many of them.  What’s not to like about that?  Also, I am very puzzled about why some many of the sources cited in Mr. Urbina’s article are from the Ithaca, New York area.  Ithaca is hardly representative of the lending environment in those parts of the Marcellus Shale gas region where I’ve done business.  It tends to be one of those areas where you find enterprises whose motives are far removed from the mainstream business world where most operate – institutions such as the “Alternatives Federal Credit Union,” which apparently gets at least some of its capital from government grants issued through the Community Development Financial Institutions (CDFI) Fund.  That Fund prides itself on providing “loans, investments, financial services and technical assistance to underserved populations and communities” and examples like  the ShoreBank, which failed spectacularly.  These types of institutions are obviously motivated by factors having little to do with financial risk or the management of it.  They often make their decisions on non-financial factors and why Mr. Urbina would use them as examples is beyond me.

Lenders with whom I have been associated do have to evaluate financial risk, however, and that’s why they typically require assignments of gas lease revenues to themselves as a way of improving collateral.  A review of mortgages on file in any of our counties here in Northeastern Pennsylvania will reveal many associated with properties having gas leases and, in virtually, all those cases there are corollary assignments of leases to the lenders.

I have drafted such assignment forms.  These assignments permit the lender to reduce risk.  Title insurance companies typically except the gas leases from their insurance policies.  This means lenders, when they review the title insurance policy, are immediately informed of the existence of a gas lease.  This is why they require the assignments – to substitute for the lack of insurance on that aspect of the property value.  By taking an assignment they essentially self-insure.

All of this, of course, is slightly different than the normal mortgage procedure but it’s not complicated.  There is, to be sure, a learning curve for both landowners and lenders but that curve is not particularly steep and my experience suggests we’re well beyond the point in our area where any bank or other lender is hesitant to issue mortgages.  It’s just the opposite in fact.  Lenders see the value in the additional collateral and recognize the potential future income opportunities a gas lease offers both landowner and lender.  Royalty income is what I hear some of my clients refer as “mail money” – pleasant surprises that come each month in the mail and provide the receiver with extra financial security.

Let me add also that, from my experience in representing an oil and gas company and reviewing and assisting with the recording of hundreds of gas leases in Northeastern Pennsylvania, I have not seen what Mr. Urbina alleges – gas companies not bothering to secure the approvals of lenders prior to recording of lease documents.  The companies have the strongest possible incentive to secure those approvals – they risk losing all unvested lease rights in the event of a foreclosure because the mortgage takes precedent over the lease.

That’s the rule in Pennsylvania, anyway.  Perhaps, Mr. Urbina knows of some arcane rules in New York or elsewhere that work differently.  It certainly wouldn’t be the first time they did things differently there to their great disadvantage, but I doubt it.  No gas company I know of is going to skirt the rules to get a lease recorded that can be stricken in a foreclosure at the loss of hundreds of thousands of dollars.  It would be bizarre behavior and I notice Urbina doesn’t say it actually occurs.  He simply speculates it might.

Are the rules followed to the nth degree every single instance?  Probably not, but that’s true of every legal instrument.  The rules are voluminous and complying with all of them is a bit like completing a tax return – no one can be said to get everything correct 100% of the time.  Nonetheless, the vast majority of the time the rules ARE followed and as completely as possible, especially among the community and regional banks that serve those areas of Northeastern Pennsylvania where the bulk of the gas leasing has been taking place over the last 3-4 years.  If there are technical issues, they are extremely limited in number and not impacting the market.  As the Farmer Mac representative told Urbina, they do not represent a significant risk.  That’s the long and short of it.

Reflecting on the Urbina piece and considering the obvious incentives that both gas companies and lenders have to do things correctly, the lack of impacts on the market and the fact mortgages are being routinely issued for properties with gas leases, I have to wonder what the article was all about.  Is there something I am missing?  Is there a party who is damaged here?  Does anyone care what some “alternative lender” operating on the fringe of the Marcellus Shale region thinks about the impacts of gas leasing on mortgages?  Frankly, I am at a loss to understand what motivated this piece of writing.


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