Yes, they can do that. They are holding the funds to insure that your building (THEIR collateral) is repaired as needed. You should be able to get a contractor with a letter from the mortgage firm indicating that the funds are available and will be released to the contractor and you when the work is completed as needed.

Ask the mortgage company if they’ll release the funds directly to your contractor.

OTOH, MOST contractors will do the work, and THEN let you pay . . .

But yes, they can do that.