Mortgage Fraud: a Growing ThreatHigh-Profile Incidents Underscore Need for Secure Processes and 'Know Your Customer' Just last week a group of 19 mortgage fraudsters were indicted in a California federal court after a multi-year investigation by the FBI and IRS dubbed "Operation Homewrecker."
This group allegedly preyed on more than 100 desperate homeowners facing foreclosure, offering the homeowner options and money to avoid foreclosure -- then defrauding them of their homes, along with millions of dollars stolen through fraudulent loans and mortgages. (See: DOJ Indictments Announced In Major Mortgage Fraud Scheme)
This case, along with other recent mortgage fraud cases (See: http://losangeles.fbi.gov/dojpressrel/pressrel07/la022307usa.htm), brings to the forefront a growing threat: Mortgage fraud. And it underscores the need for accurate and consistent due diligence of loan applications by mortgage lenders and banks.
The Scary Numbers
FinCEN's own assessment of Suspicious Activity Reports (SARs) in 2006 (Mortgage Loan Fraud pdf) reveal that suspected mortgage loan fraud in the US continues to rise. It rose 35 percent between 2005 and 2006. Overall since the inclusion of mortgage loan fraud as a characterization of suspicious activity, the number of SARs related to mortgage loan fraud increased 1,411 percent from 1996 to 2005. (See: FinCEN Assessment Reveals Suspected Mortgage Loan Fraud Continues to Rise)
Should all financial institutions' loan officers and BSA compliance officers sit up and take note? The short answer is yes, says Rob Rowe, Senior Regulatory Counsel with the Independent Community Bankers of America (ICBA). It doesn't matter if the mortgage fraud attempted is "fraud to own" or "fraud for profit;" mortgage fraud is going to continue to happen, Rowe predicts. "We are going to see more and more fraud, I think it's the case that the horse is already out of the barn."
Is the higher number of SARs being reported mean there is more mortgage fraud happening, or does it mean people are more sensitized to look for warning signs? "The general consensus seems that it is a little of both," says Rowe. "In a lot of the cases, when the market was going up and the properties were going up in value, some of the fraud was not getting caught. Nobody cared because everyone was making money. Now it's like a game of musical chairs in the market."
While the real estate market was booming in the early 2000s, lenders couldn't stop lending, and churned out applications for mortgages and subprime mortgages. According to Alan Abel, CPA and Executive Global AML Practice Leader at Crowe Chizek and Company, there was a huge increase in mortgage fraud SARs filed by financial institutions. "Based on FinCEN's research with the craziness of the market and everything that's happened to date, this accounts for most of the mortgage loan fraud," says Abel, who also is on the FinCEN Bank Secrecy Act Advisory Group (BSAAG).
Money Laundering Connections
While the focus is on mortgage fraud, the defendants in the Operation Homewrecker case were also charged with attempted money laundering, which shows the insidious connections that the two can have, says Debra Geister, Director of Fraud Prevention and Compliance Solutions in LexisNexis' Risk and Information Analytics Group.
Until the case is tried, the details of the attempted money laundering won't be revealed, she says, but it will provide some interested compliance officers with another point to ponder when filing SARs.
The mortgage issues facing institutions because of the slumping market has caused increased scrutiny by the lending institutions on their mortgage portfolios, says Geister. One large lender she spoke with is now going through its mortgage portfolio to evaluate it from an anti-money laundering perspective. "I'm not sure this has been done in the past, and other banks should take note because some of the detection systems out there aren't necessarily geared to look at the mortgage issues," she adds.
She asks institutions, "Have you seen loan payoffs that would be suspected money laundering --not those in the foreclosure bucket, but those remaining loans? That is a real risk from a money laundering perspective." One point to pay attention to -- if there is no underlying lien, and it is paid off, it could it be money laundering. "It definitely would be something you would need to look into," she says.
Mortgage Fraud's Impact
What institutions are reporting as mortgage fraud on their SARs, and how well their institution does due diligence in processing loan applications is connected to the risk level of mortgage fraud, says Eva Weber, Regulatory and Compliance Analyst for the Aite Group, a Boston-based consultancy.
"Who is getting hit by mortgage fraud? Banks that were inundated with a large number of applications during the last few years will be hit," she says. "Those that had a large volume and didn't properly follow solid underwriting procedures carefully enough will also feel it."
She suspects those institutions that didn't have enough staff to properly check applications, and therefore didn't match personal information and verify information, were more prone to have bad applications slip through the cracks.
ICBA's Rowe sees the mortgage fraud problem happening more at large national banks. "Larger banks seem to be having more of a problem with mortgage fraud," he says. "With community banks, they know more about what's going on in their area."
Rowe also offers that the bigger institutions are more willing to go outside of their market area to lend. "Community banks tend to stick in their area. This way they know the properties they're lending on, they drive by them on the way to the office." He stresses where mortgage fraud has taken a real foothold is where loans are being made outside the area of the institution, citing the Indianapolis mortgage fraud case, where a Michigan bank made loans to buyers based in Indianapolis (See: Indianapolis Man Charged In Mortgage Fraud Scheme).
Allowing applicants to apply for mortgages via the Internet is cited by Rowe, Weber and Abel as an open invitation to fraud. "Loan forms being processed through the Internet has a higher risk," says Weber. The loan officer can't hold and compare government IDs or gauge the credibility of the person sitting in front of them. "Make sure that the procedures to authenticate that applicant are commensurate with the channel and the risk of the product, and make sure your staff is following those procedures," she advises. Abel adds that FinCEN has noted that a surprising percentage of mortgage loan frauds reported were a result of internet-based applications where there were "Know Your Customer" (KYC) deficiencies.
Rowe notes that community banks he's talked with report good news on the mortgage fraud front. "They're saying one of the reasons they didn't get into these problem loans in the first place was they know their customers, the properties, and they know what they're doing ,and they're paying close attention to what loans are being made in their community."
The community banks didn't "loosen their reins" on mortgage lending when other larger banks were churning out thousands of loans each week, he says. He compares the larger mortgage lenders are akin to the boiler rooms in the securities markets of the 1980s, where in cramped back offices the brokers were churning accounts. "I think the mortgage lending industry has gotten to that level in some respects in certain parts of the business - they weren't paying attention to the properties or the people they were lending to. There was a checklist mentality to close out loans as quickly as possible, and that's where the problems cropped up," he says.
The Buck Starts Here
Where does compliance and due diligence in underwriting start? With the loan officer. "The buck stops there; they are the key point of contact," says Rowe. The loan officer needs to know everyone who is involved in the transaction, not just the borrower, but also the appraiser - "The loan officer needs to know who the players are," he says.
Weber agrees and says the way to avoid mortgage fraud is the common sense of performing due diligence. "Everything they should be doing on any transaction, ID verification and authentication at the time the loan application is turned in, checking fraud databases and running the names through them, making sure the Social Security numbers match up with other personal information to reduce identity theft."
A careful risk assessment of the channel should also be performed on a regular basis, as well as keeping on top of geographic hot spots where mortgage fraud has already been spotted. In the end, Weber says "It all comes down to knowing their customer."