“Only when the tide goes out do you discover who’s been swimming naked,” is a famous quote from US super investor Warren Buffett about the problems that arise when markets go from boom to bust.
And no where has that been more true in the UK mortgage market than with fraud. Pre-2008 standards among some lenders slackened. Increasing house prices papered over a multitude of sins and they only became apparent, and a problem, when funding declined and house prices started to slide.
Overnight, dodgy loans, bent surveyors, solicitors and mortgage brokers became a threat to many lenders’ businesses and the industry took radical steps to correct the problem.
Mortgage Strategy has been filled to bursting with tales of both the FSA and lenders taking corrective action – brokers banned for fraud, brokers kicked off panels, solicitors kicked off conveyancing panels, etc.
So after five long years, is the industry now winning the battle on fraud?
Not according to credit reference agency Experion.
The company markets a fraud detection system to lenders called Hunter which enables them to detect, investigate and record fraud at the point of application.
It has warned lenders to brace themselves for a for a surge in fraudulent applications this year.
The credit reference agency believes that fraud attempts will rise by 13 per cent this year to 43 in every 10,000 applications.
But some in the industry have responded with anger and frustration at the forecast as they feel it does not take enough account of the work that companies are doing to tackle fraud.
PMS executive chairman John Malone disputes Experian’s prediction that mortgage fraud will see a significant increase this year, as he believes initiatives like the National Fraud Authority’s Fraud Forum, on which he sits as the Association of Mortgage Intermediaries’ representative, are bearing fruit.
“My contacts at the major lenders are telling me that fraud is well down on the levels seen before the Fraud Forum was set up.”
Malone says it has never been possible to put an exact monetary value on mortgage fraud levels, but that in 2006-7 it was probably worth around £5bn per year and now he believes it is more like £500m.
“At that time, lenders believed that property prices would keep rising and that would prevent major losses even if there was some fraud getting through,” he says.
“They were just passing the parcel to another lender as loans were sold on.
“Then in 2008 the music stopped. Since then, the FSA has worked so hard to manage fraud and lenders have tightened up their systems.”
Malone also argues that it is unfair for Experian to talk about fraud being on the rise when it is trying to sell its own services – the Hunter fraud detection system – to lenders.
“It has a commercial interest,” he says.
“We haven’t cracked the fraud issue yet, there is still a lot of bad practice, but significant progress has been made.”
Malone feels the credit reference agencies also need to do more in the fraud fight. “We do not want to give the FSA reason to go storming back into lenders and saying that their fraud prevention systems are not up-to-date when we would like Experian’s own systems to be in a better position,” he says.
One example he gives is where people are renting and they move around and as a result their credit history will be months behind.
Experian says it relies on financial companies to pass on information promptly when people move address, but that sometimes customers do not update their bank or other providers, either because they do not get around to it, or on occasion, because they do not want bad debts to follow them.
It says it does recognise the work being done by the industry to tackle fraud, and that instances might have been even higher without these efforts.
Xit2 managing director Mark Blackwell is also sceptical of the Experian forecast.
“The ‘blight’ of mortgage fraud is over-sold,” he says.
“Actually, the industry is making progress. Fraud is creeping up – but only on the back of increased volumes.
“The rate of fraud is actually being pruned back. 2013 certainly won’t be a vintage year for the fraudsters. The figures from Experian don’t tell the whole story.”
Putting its money where its mouth is
Yet Experian remains confident in its forecast. It made its 2013 prediction on the back of data from the third quarter of 2012, when 38 in every 10,000 home loan applications were deemed fraudulent, an increase from 36 during the same quarter of 2011.
Since then it has received data for the final quarter of 2012, during which 39 in every 10,000 applications were fraudulent, which has affirmed its view.
Experian director of identity and fraud services Nick Mothershaw says the increase in the number of attempts does not necessarily mean that more fraud will get through, as lenders are getting better at detecting these cases.
“Mortgage fraud is still on the rise as we predicted, borne out by the latest statistics,” he says.
“The lion’s share of mortgage fraud is first party, so people misrepresenting their own circumstances. The overall increase in first party fraud would suggest factors such as personal financial stress are at play – intermediaries have a role to play here in checking applications and using all the tools available.”
Mothershaw says that the one of the most common types of first-party fraud is where borrowers lie about their past addresses or make omissions in order to try to leave a bad credit past behind them.
Over-stating income, commission or bonuses also accounts for a large proportion of attempted fraud. Experian’s Hunter system should pick up cases where the borrower has made another mortgage or credit application using a different income recently.
If the lender has grounds for suspicion, it can also check the borrower’s stated income against HM Revenue & Customs records.
The difficulty of obtaining mortgages for borrowers who are self-employed or contractors, can result in some applicants providing false employment details.
Mothershaw says that in most of these instances the borrower genuinely intends to repay their mortgage, however the misleading information that they provide could leave a mortgage lender with much greater exposure to risk than it realises.
Threats still lurking
But while Malone disputes Experian’s predictions about fraud, he says that despite the mortgage industry’s efforts and significant progress, there are still corners of the market where threats lurk.
One of his main concerns is the use of unregulated introducers.
They work in collaboration with someone who is genuinely authorised, channelling business their way.
“These are people who are going around and seeing clients – they may be ex-mortgage packagers or people who did not complete their exams to become qualified brokers,” he says.
“They are working through a regulated broker, giving advice, forging the adviser’s signature and putting their FSA number on the forms.
“The regulated broker then takes half the procuration fee.”
Malone says this type of fraud is a real worry, though he finds it hard to comprehend why regulated brokers are willing to take such high risks by allowing others to use their credentials in this way.
“It really frightens me,” he says. “It is especially an issue in the buy-to-let market, because it is unregulated, which is why lenders are asking brokers to treat buy-to-let as regulated. “There are a number of rogue letting agents in less affluent areas which provide potential leads and offer to put clients in touch with ‘finance introducers’ who can get them mortgages.”
Another scam which has not gone away is the market for fake documents.
Websites offering so-called replacement bank statements, P45s, P60s, utilities bills, payslips still proliferate, long since Mortgage Strategy revealed how easy it was for fraudsters to obtain these counterfeits in a 2007 investigation.
The websites offer farcical reasons why customers might want to purchase replica documents for non-fraudulent use, such as for novelty purposes. Yet they also offer assurances that applicants’ details will be deleted from their files immediately after the documents have been supplied, which suggests their customers are not the practical jokers they imply.
“The hardest kind of fraud to spot is where a fake document is used to procure a real one,” says Malone.
“The police can close down UK based sites, but not the ones based abroad – it is a losing battle.”
Even UK-based websites seem to manage to remain under the radar for some time.
At the time of writing, there were a number of fake document websites registered in the UK. Some of these even publish their postal addresses. Internet history archives suggest they have been up and running for a year or more.
The FSA warned in June 2011 that some brokers were misusing buy-to-let mortgages as an alternative to defunct self-certification mortgages, because some lenders only look at rental income and do not ask for proof of the borrower’s earnings.
Malone believes this issue has largely been resolved now.
“Most of the lenders are now asking for proof of income – apart from The Mortgage Works and Precise Mortgages – but they both have good systems,” he says.
There still appear to be a number of websites claiming that they can obtain mortgages for customers without proof of income.
It is not clear whether they are simply out-of-date with pages that were written when self-cert loans were still available that have been left up because they still drive traffic, or whether these companies are continuing to abuse the buy-to-let loophole.
Perhaps they have found another method to game lenders’ systems.
The challenge that first-time buyers face in trying to raise a deposit has created further potential for fraud around distorted valuations.
“We are seeing cases where the prices of houses are inflated so a deposit is either reduced or unnecessary,” says Regulatory Legal Solicitors director Gareth Fatchett .
“This is fraud if the mortgage lender is misled. Any lawyer acting in these cases would be struck off if they knowingly became involved in these activities.”
A recent warning from the FSA highlighted the risk posed by properties marketed as below market value – in these cases both the buyer and the seller might be encouraged to commit fraud. Some companies offering quick property sales to borrowers in financial difficulty may ask the seller to state on the documentation that the buyer paid the full price for the property when in fact it was heavily discounted.
The seller is more likely to agree to doing so because they are in a desperate situation and are looking for a quick way out. They may not even realise that they are committing fraud if they put their trust in a rogue professional who tells them it is ok.
The scam is designed to help the buyer who cannot raise an adequate deposit and needs to borrow 100 per cent of the purchase price from a mortgage lender.
If a property sells for £120,000, but the lender is told it actually sold for £150,000, it may agree to lend up to £120,000 in the belief that it is maintaining a relatively conservative loan-to-value (LTV) ratio of 80 per cent.
In reality, the lender has taken on a much greater exposure to risk at 100 per cent LTV.
The borrower has not had to fund any of the deposit from their own money.
This generally requires a circle of complicit professionals, including a valuer, solicitor and broker. Lenders may spot a fraud like this if they see that the same individuals’ names are appearing on a number of suspicious cases.
The Hunter system can flag up professionals with a dubious record.
Cracking down on solicitors
Some lenders have tried to reduce the risk of fraud by reducing the panel of solicitors and conveyancers that they work with in order to implement more thorough checks, but this can lead to frustration for borrowers.
HSBC reversed a decision to cut its panel of conveyancers from many thousands to fewer than 50 after complaints that its policy was resulting in higher costs and delays for home buyers. It increased the panel back up to 1,400 solicitors who are monitored as part of the Law Society’s Conveyancing Quality Scheme six months after its original cull.
The FSA has made it clear that it expects lenders to carry out regular checks on the property professionals they work with as part of their anti-fraud strategy.
In a Thematic Review published in June 2011, the regulator hinted that a panel which is too large might be a risk, if it meant the lender was unable to carry out the required due diligence. Small firms with low volumes of conveyancing business are seen as high risk.
Blackwell argues that valuation fraud is much less of a problem than it was in the past thanks to improvements by lenders.
“At the valuation stage, rogue surveyors have always been a problem,” he says.
“But we’ve seen a fall in valuation fraud over the last year which is mainly thanks to improved due diligence.”
Better panel management is shutting the crooks out from the valuation process. Equally, fraudulent solicitors are still a threat and they still make the news – but Blackwell says his firm has seen a gradual fall in those as corrupt conveyancers are shut out of the process.
“Of course, none of that means the problem will go away entirely and we certainly can’t afford a return to the overconfidence of 2007,” he says.
“Fraud will always pop up – no industry in the world has the resources to entirely eradicate every criminal. But the financial crisis has forced a re-think in the mortgage sector. Slowly but surely, that is paying dividends.”
Case study – Britain’s biggest ever mortgage fraud
In January 2013, two businessmen were jailed after using forged documents to borrow more than £740m and acquire a portfolio of 16 properties
Achilleas Kallakis, 44, was sentenced to seven years in prison and Alexander Williams, also 44, was handed a five-year sentence at Southwark Crown Court . The jury returned a unanimous guilty verdict on two counts of conspiracy to defraud.
The events occurred between 2003 and 2008, when Kallakis and Williams conspired to defraud Allied Irish Banks to obtain finance for their commercial property portfolio, in the largest mortgage fraud Britain has ever seen. They had properties in Knightsbridge, Mayfair, Croydon and even bought the headquarters of The Daily Telegraph and a building used by the Home Office.
They used guarantees from a Hong Kong company called Sun Hung Kai Properties in order to convince the bank to lend them more than the purchase price of the properties, however, this company had no knowledge of the guarantees, which proved worthless. The value of lending by Allied Irish Banks exceeded the combined value of the portfolio by £60m.
In 2007 and 2008, Kallakis obtained a loan from Bank of Scotland for €29m which he used to convert a former passenger ferry into his own super-yacht. He provided a false guarantee from Oregon Finance Group, based on forged documents and fake accounting.
The loans exceeded the purchase price of the properties through guarantees by Hong Kong property company Sun Hung Kai Properties, but the company had no knowledge of the transactions. The loans advanced by AIB were £60m in excess of the cost of the properties.
The ferry on which the loan was secured proved to be worthless, but by the time the bank grew suspicious it had already advanced €5.7m of the total loan.
The jury heard that Kallakis used the cash he obtained to live a super-rich lifestyle with a fleet of chauffeur-driven Bentleys, a private jet, a helicopter, a luxury yacht moored in Monaco and a valuable art collection.
The pair were previously convicted of selling bogus peerages to wealthy Americans in the 1990s.