Financial Institution Watch: Federal Government Focuses On Mortgage Loan Fraud

The problems that began in the subprime mortgage market have expanded exponentially and caused large losses throughout the financial services industry. As shareholders, mortgage investors, regulators and other government authorities review the turmoil resulting from the risks created or assumed by particular institutions, or in particular transactions, subsequent litigation, bank enforcement and internal investigations will analyze reasons for these losses and provide additional guidance on steps that particular institutions and market participants need to take in the future to protect against similar mortgage-related risks.

A principal focus of attention will be on the impact of (i) the relaxation of underwriting standards, (ii) weaknesses in documentation, and (iii) lax or non-existent verification of loan requirements.

Equally as important will be the existence of criminal activity in connection with mortgage loans. On April 16, 2008, FBI Director Mueller, testifying before a Senate subcommittee, stated that the FBI has had a tremendous surge in cases related to subprime lending. He noted that the FBI currently has almost 1,300 cases in this area. He also indicated that the FBI has 19 cases involving institutions themselves where mortgage fraud may have, among other things, contributed to corporate misstatements.

On April 3, 2008, the Treasury Department's Financial Crimes Enforcement Network ("FinCEN") issued a report on mortgage loan fraud based on an analysis of suspicious activity reports ("SARs"). The report shows a dramatic increase in the reports of mortgage fraud over a ten-year period. Remarkably, mortgage fraud, or more accurately, reports of mortgage fraud, were up 37% from the first quarter of 2006 to the first quarter of 2007.

FinCEN divides mortgage fraud into two broad categories: (i) fraud for housing, and (ii) fraud for profit. Fraud for housing involves material misrepresentation or omission of information with the intent to obtain credit and is generally committed by homebuyers attempting to purchase homes for their personal use. Fraud for profit involves the same misuse of information to obtain such credit, after which the perpetrator absconds with the loan proceeds and has little or no intention to purchase or actually occupy the house.

FinCEN reports that the mortgage loan fraud generally was accomplished through some combination of the following fraudulent activities: (i) misrepresentation of income/assets/debt, (ii) forged/fraudulent documents, (iii) occupancy fraud, (iv) appraisal fraud, (v) identity fraud, (vi) straw buyers, and (vii) flipping.

A growing number of SARs report that mortgage brokers initiated fraudulent loan applications. Increased reports of appraisal fraud, which include falsely conducted appraisals, as well as appraisals conducted through the theft of appraisers' identity and license information, are also noteworthy, as is a trend of increased suspected fraud involving cash-out refinance loans, stated income, low or no document loans, and home equity lines of credit. In what can only be categorized as a sign of the times, FinCEN also identified a trend of increased reports of suspected identity fraud and identity theft used to perpetrate mortgage fraud for housing.

Mortgage industry participants can expect close scrutiny of their lending practices as a consequence of the problems that have arisen in the mortgage sector. Regardless of prior practices, this is clearly the time to evaluate current strengths and weaknesses in an institution's processes. In addition to evaluating their loan underwriting standards, institutions should review and address their exposure to mortgage fraud by, among other things:

• Examining relationships with brokers,

• Determining how broker-originated loans are reviewed and monitored,

• Evaluating policies and procedures geared at detecting and investigating possible fraud prior to loan disbursement, and

• Identifying the types of mortgage fraud to which they are at greatest risk in order to be able to design responsive risk evaluation and control processes.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.