Water and Lending: Is Unsecured Water Secure?

6/29/2015 | NANCY ZALUTSKY

Water and Lending: Is Unsecured Water Secure?
Nancy Zalutsky

Nancy Zalutsky | Water Rights Specialist | Bio

Water is a crucial component of land value, yet has historically been overlooked in the appraisal and lending processes. As a result, lenders face exposure to a reduction in the value of collateralized land in the event of a foreclosure. In this post, Nancy Zalutsky explores the role of water in traditional ag lending and outlines approaches to mitigate risks.

When it comes to lending, surprises are seldom welcome, and unpleasant surprises are particularly to be avoided. Recently, I was at a banking association conference and was astonished to discover that banks rarely specifically include water rights as part of their security interest in farm and ranch land as well as land with planned subdivision and development. This was startling to me because water is central to the value of land, and by not specifically addressing water rights, bankers may be setting themselves up for a most unpleasant surprise.

Most lenders rely on the standard language in loan documents to protect water rights used on the land securing a mortgage. Historically, a lender could rely on those documents because deeds and mortgages drafted in the late nineteenth and early twentieth centuries often described a water right by decree, decree owner, priority date and number of inches of water. Consequently, the water rights transferred with a farm or ranch were easily tracked until the 1920s and 1930s, when farm foreclosures simply transferred the land with “appurtenances”. Because water rights were not specifically transferred in foreclosure deeds, a water right owner may have to go to great expense to find evidence outside the chain of title to prove ownership of a historic water right. Reducing the areas of use or amount of a water right is a simple process and usually doesn’t require public notice, so a landowner can reduce or eliminate water on collateralized land without a lender knowing, hence an unpleasant surprise.

As I discussed in a previous post, Need Land Value? Just Add Water, water adds substantial value to land, and water can be worth a substantial amount of money separate from the land. For these reasons, designating the water rights that add value to secured land is a fundamental way for lenders to reduce the risk of nasty surprises in the event of a foreclosure.

Boilerplate Security Isn’t Always Secure
How are water rights addressed in land security today?  Usually, a parcel is conveyed or secured, “Together with the tenements, hereditaments and appurtenances thereunto belonging.” This legal boilerplate means that the water rights, ditches and easements that overlap land parcels transfer with the land, so why worry about including specific water rights in security instruments? The reason: a borrower can sever water rights from land with or without realizing the water rights are part of the mortgaged property and without notifying the lender, who may not find out until the borrower defaults on the loan. Furthermore, a borrower can modify areas of use and even volume with no public notice whatsoever, as long as the modification has no adverse impact on other water rights owners. As a result, collateralized land that was historically irrigated (and valued accordingly) may be foreclosed upon as dry farmland, which is worth a fraction of the collateral value.

Severing Water Rights With No Notice
There are several different ways to sever or sell a water right from collateralized parcels without notice to the lender:

  • A borrower can file an Application for Change of an Appropriation Water Right to move the water right to a new place of use off the secured property. This entails public notice but not notice the lender.
  • File a Water Right Ownership Update and a deed severing a water right from its historic place of use.  This does not require public notice but is recorded and available to the public in miscellaneous filings that are not housed with land records. Again, notice to the lender is not mandatory.
  • In basins that do not yet have a Water Court decree, the owner can amend the place of use of a water right to use it off the secured property. Public notice does not occur until the basin decree is issued.
  • Owner can amend the place of use (remove collateralized parcels from the designated place of use) or reduce the amount of a water right and assign it to non-collateralized parcels within the designated place of use. Neither of these actions requires public notice nor notice to the lender.

Land ownership and water rights ownership records are maintained separately, so lenders can benefit greatly from Water Sage, which links them together through spatial queries.

Water used under contract from a state or federal project is even harder to track than water rights because the borrower can simply fail to renew the contract at the end of its term, usually 20 years. The ownership of shares in a water user’s association or irrigation district is a private agreement between the water user and the association to purchase water.  The place of use of water rights used under contract or on shares is a service area where water can legally be used.  A parcel might not be irrigated with purchased water even if it is located in the service area. The lender must obtain that information from the borrower or from the water supplier.

This Isn’t Just About Farms
While the risks of water rights being severed without lender knowledge are most obvious in Ag Lending, they also apply to land slated for development. In many places (not only in MT), cities and counties require subdivisions to submit water rights that will be retired or ceded to the municipal entity when development takes place. Failure to secure these water rights for transfer during permitting can jeopardize the entire development future of land and may result in additional costs and delays to purchase water on the open market.

How Can a Lender Protect Water Rights?
Before water rights can be secured, a lender must find out what water rights relate to the specific parcels that comprise the subject land) on the land.  Water Sage is uniquely helpful for this, as our Area Search (shown below) displays the place of use of all the water rights that may be used on a parcel, in this case including water from the Milk River Bureau of Reclamation Project.  If the land is irrigated from such a project, the lender may need to do more research or request additional information regarding water shares or water contracts from the borrower or water supplier.  Then, the lender can decide whether to include the private water rights in the loan documents and make some provision to preserve purchased water if necessary.


By turning off the Milk River Project water rights, the lender can identify a private water right used on land within the project service area.

Does It Matter?
Water is valuable with or without land, but ag land value is dependent upon water. The water market in Montana is new, but growing.  The statute authorizing changing water from other uses to water for marketing was enacted in 2011, so the market has only had 4 years to develop, but it’s growing. An online search returned two Montana water rights for sale.  Swan Land Company lists 1,212 acre-feet of decreed surface water rights for a seven-figure sum. A seller has offered 507 acre-feet of spring water in Beaverhead County, Montana on Georights. Water Right Exchange lists water rights for sale in Utah where prices range from $1,000 to $7,500 per acre-foot for well water and from $1,800 to a staggering $36,000 per share for contract water. Thus, the incentives to maneuver water away from historically irrigated parcels are growing, and with them the risks that lenders who do not incorporate water when taking security on land will wind up with a nasty surprise on their hands.

What Should a Lender Do?
Water adds to land value. Recurring droughts and thirsty cities are creating a market for this precious resource and incentives to sever water from historically irrigated land. Since water can be removed from property used to secure a loan, leaving dry land, lenders should get information about water used on property offered as collateral for a loan and take these steps to protect that water:

  • Search the water used on the property by drawing a box around the subject property in Water Sage. Use the owner filter to find all the water rights owned by the borrower. The list will include all versions of the owner name.
  • To get a list of water rights, export the index to a spreadsheet by clicking the index button.
  • Check to see if the subject property is located in the service area of any government project or water supplier as discussed above.
  • If the property appears to be within the boundaries of a service area, ask the borrower for a list of contracts for purchased water.
  • When all the information is collected and organized, consult with an attorney to draft provisions in the loan documents to include provisions that specifically list water rights by number; secure ditches, pipelines and other water conveyances; and require notice to lender regarding the expiration or termination of a contract, sale of shares in a water supply company or any administrative or judicial action involving the water rights.