Boomtown Banks: The Boom-or-Bust Economies of Natural-Gas Towns Present Challenges for Community Banks

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When gas companies began negotiating leases with landowners around Mansfield, Pa., First Citizens Community Bank CEO Randall Black realized that education was crucial-both for him and his customers. The $875 million-assets bank sits smack within the huge Marcellus shale formation that extends from New York to Ohio and is estimated to be the world's second largest natural-gas reserve. Extracting the gas only became commercially viable with the development of modern hydraulic fracturing, the process of fracturing rock with pressurized water and chemicals combined with horizontal drilling, commonly known as "fracking." Now, wells are producing gas and money--in the Marcellus region and elsewhere--along with challenges for bankers as they navigate an economic boom that inevitably will run its course.

With many customers enjoying new-found wealth after signing lucrative oil and gas leases, Black, along with a neighboring bank CEO, a strategic partner, and a corporate attorney, spent a week in Texas--one of three trips that would be made to talk with bankers there about how gas drilling affected their world.

First Citizens held three seminars on wealth and tax planning for customers whose properties were gushing money. "When [land leasing] started, signing bonuses were about $100 an acre," says Black. "But as the play progressed, those numbers got closer to $7,000 an acre." Once the wells were in production, some individuals were earning more than $100,000 a month in leases and royalties. Realizing that many of them would not take into account the vengeance with which the tax man cometh, Black created a money-market product that was meant to entice customers to park their money until tax time.

The bank itself experienced approximately $200 million in growth with few problems over the past five years that drilling has been going on--in large part because it adopted policies that guarded profits while avoiding pitfalls. For instance, the influx of well-paid workers created such demand for housing that one-bedroom efficiency apartments normally renting for 8500 a month were fetching rents of $1,700 at the peak. Not surprisingly, many First Citizens customers wanted to borrow money to buy rental properties. "Realizing it was going to be a shorter demand, we shortened amortization to seven to ten years with aggressive payback," explains Black.

Indeed, with any loans related to Marcellus, the bank started with an LTV of 65% or less and shorter amortization--a policy that proved prescient. With the recent deterioration of natural-gas prices and better drilling potential in Ohio, many gas companies packed up and went west. Those that have remained are more strategic about leasing land, according to Bob Williams, director of mineral management services at First Citizens. A few years ago, several different companies would vie for any large land parcel. "Now, if one company is working it, others stay away," he says. "The only deal the customer has is what that one company puts in front of them."

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Royalties discounted 20%

Trying to determine the collateral value of gas-rich properties is a struggle. "If we had a mortgage on a property prior to this, it included the mineral and gas rights," Black explains. "But this whole play drives speculation, so we had customers and individuals buying properties, severing the oil and mineral rights, and selling them separately." Making sure that the bank has the mineral rights to a property and that they are valued fairly complicates due diligence.

First Citizens also must carefully assess customer assets that are dependent on Marcellus shale. "If we have a customer who's getting royalties, we look at those as part of their cash flow, but consider only about 20% of its value," says Chris Landis, senior commercial lending officer. …