CANADIAN MORTGAGE INDUSTRY FRAUD WHITE PAPER PREPARED BY: CIMIBL MORTGAGE INDUSTRY FRAUD TASK FORCE OCTOBER 26, 2001 Introduction There is concern in the Canadian mortgage industry regarding the incidence and severity of mortgage loan fraud, specifically in relation to the increased number of multiple property frauds perpetrated by organized groups. Recent experience in the US has shown that fraud, ubiquitous within the mortgage insurance industry, is continuing to grow rapidly and create significant losses. Several US industry associations, such as the Mortgage Brokers Association of America (MBA) have taken a more aggressive approach to fraud prevention and awareness. In fact, it was recently proposed by the Bush Administration and the Federal Housing Authority (FHA), in an aggressive move to crackdown on property “flipping”, that FHA insurance would no longer be available on houses sold within six months of acquisition by the seller.1 1 Prohibition of Property Flipping in HUD ‘s Single FamilyMortgage Insurance Programs, docket number FR-4615 <www://wwwfha.~’ov> As in the US, the level of complexity within the Canadian mortgage industry has increased over time. The number of lenders in the market place, and the differentiation of mortgage products and delivery channels has lead to increased competition for new business, increased approval rates and reduced application processing time. For example, it is not always standard practice to meet borrowers face to face due to e-mail and faxed applications. While we do not believe that Canada currently incurs the level of fraud found in the US market, there is a concern that fraud trends may follow those experienced in the US. It is this concern that has resulted in the formation of a Mortgage Fraud Task Force co- ordinated by the Canadian Institute of Mortgage Brokers and Lenders (CIMBL) to ensure that, as the Canadian mortgage industry continues to evolve, adequate controls are put in place to protect originators, insurers and homeowners against fraud. CIMBL formed a new Mortgage Fraud Task Force (Task Force) in August, 2001. The Task Force contains executive representation from CIMBL, as well as representation from major originators (lenders and mortgage brokers), insurers, and other industry participants. The initial objective of the Task Force was to revise the CIMBL Code of Ethics and administrative procedures to more effectively manage complaints against CIMBL members, including fraud. This mandate was ultimately expanded to represent the broader issue of fraud management within the industry. An initial meeting was held on August 27 Self-Regulate (encourage self-regulation within the mortgage industry), and Protect (homeowners, lenders, insurers and other industry groups). Specific objectives include: Increase fraud awareness within the industry, the public, regulatory bodies and law enforcement. Develop industry-wide “best practices” to be adopted as professional standards of business conduct and subject to increased regulatory enforcement. Rewrite of CIMBL Code of Ethics. Establish administrative procedures, reporting and investigative protocol dealing with fraud, and establish penalties within CIMBL for noncompliance. Characterize, quantify and report on industry fraud losses on an ongoing basis. Investigate the accumulation and sharing of fraud-related information amongst impacted originators and other industry members. Develop ongoing liaison and dissemination of information with affiliated industry associations. Develop effective media and customer relations and make a commitment to protecting Canadian home buyers as well as lenders and insurers against financial loss. It is in the best interest of originators and insurers to work co-operatively to reduce fraud on an industry level. Fraud management has traditionally been an internal, proprietary function within each lending organization although, to avoid detection, it is well documented that fraudsters often employ multiple lenders. In addition, fraud awareness and training of all industry members - alerting them what to look for and how to protect themselves - plays an important role in the prevention of fraud. It is unrealistic to assume that each lender or insurer acting alone, will have sufficient information to effectively protect themselves against fraud. It is also unrealistic to assume that each should take individual responsibility for overall industry education. For these reasons, industry members will not be successful in reducing fraud losses unless they work cooperatively to improve fraud training and awareness within the mortgage community, and improve communication regarding fraud operators and schemes, amongst impacted organizations. Mortgage Loan Fraud Definition In order to perpetrate mortgage fraud, it is common to have the co-operation of an for incident reporting, investigation and enforcement of penalties for fraudulent or deceptive practices. In effect, increasing the probability of detection, and instituting penalties that directly affect the member’s future ability to conduct business in the industry will reduce the overall incidence of fraud For the purposes of the Task Force, a working definition of “Mortgage Loan Fraud” is: “Any deceit within the mortgage loan life cycle.” It is the assertion of the Task Force that the mortgage industry should adopt an attitude of: “Zero tolerance for deceit in any stage of the mortgage life cycle”. Fraud Types The following are classifications of mortgage fraud as determined by the Task Force. A fraudulent loan may contain characteristics relating to one or more categories: 1. Property Overvaluation - Flip, condo conversion - Inflated appraisal Misrepresentation of property characteristics or purpose - Forged or altered MLS listing to increase valuation - Commercial represented as residential - Multiple represented as fewer units or single Intent to reside - Rental represented as owner occupied Conditions not released at closing 2. Employment Forged or altered employment letter or employment reference Forged or altered pay stub, T4, Notice of Assessment Inflated income or tenure Misrepresentation regarding employment for self 3. Identification Providing forged or altered identification Use of “Straw” borrower or “True Name Fraud” Nonexistent individual, or alteration of personal information to avoid credit bureau purchase incentive Full or partial down payment paid directly to vendor 5. Title Fraudulent title transfer! fraudulent mortgage discharge Property not in name of seller Canadian Fraud Losses Exact industry fraud loss figures are unavailable due to the ambiguous nature of mortgage fraud, and the lack of consistent data collection over time. It is conservatively estimated that total exposure2 to the industry, including both conventional and insured loans, will be upwards of $150 - $300 million in 2001. This is almost double the exposure in 1999 and 2000, when exposure is estimated at $73 million and $75 million, respectively. There appears to have been a recent increase in fraud perpetrated by organized criminal groups involving multiple property schemes, which would lead us to believe that the actual losses will be higher for the remainder of 2001. The industry also believes that this trend will continue into 2002 and that, without direct intervention, mortgage fraud will continue to increase at an accelerated rate. US lenders and insurers have experienced similar difficulty in quantifying mortgage fraud losses. Published estimates have ranged between $5 billion and $30 billion annually in 1999/2000. All reports do agree however, that the incidence of mortgage fraud is increasing. In addition to the above, the figures quoted do not take into consideration legal, maintenance, repair, and disposal fees associated with foreclosure and resale of fraudulent properties. Legal fees associated with obtaining summary judgment, as well as civil and criminal prosecution of offenders are also assumed by industry members. Finally, fraud loss estimates do not represent the significant administrative and “brown dollar” cost of managing these loans. 2 “Exposure” includes the total amount advanced on the loan. While this does not portray actual dollar losses to Lenders and Insurers, which may be more or less than the total exposure given legal fees and other disposal costs, it is felt that this is the best available measurement of fraud in that it standardizes insured and conventional loans and is the number most readily available to all parties. • Industry commitment to reporting mortgage accounts and arrears on the credit bureaus. Fraud Awareness CMHC, supported by CIMBL, held fraud awareness sessions across Canada on behalf of the industry in 1999/2000. The sessions were extremely well received and the majority of participants indicated that they lacked sufficient knowledge about mortgage fraud and would welcome regular updates on current schemes and other events in the industry. The Task Force has stated its intention to continue holding regular fraud awareness sessions in the near future, and to further expand the scope, delivery mechanisms and potential audience. Of some concern is fraud awareness training and education to law enforcement agencies. It has been noted that the reluctance of many law enforcement officers to involve themselves in the investigation and prosecution of mortgage fraud stems, to a large extent, from their lack of knowledge and understanding of the mortgage industry in general, and mortgage fraud schemes in particular. Fraud awareness, including training sessions at the various police colleges may be considered going forward. Conclusion The mortgage industry in Canada has been evolving at a dramatic pace. In a competitive and automated world, it is becoming increasingly difficult to “Know Your Client”. This, and a lack of reporting mechanisms and enforceable penalties, has presented greater opportunities to perpetrate mortgage fraud in a relatively risk free environment. While the financial impact of increased mortgage loan fraud is borne primarily by lenders and insurers, mortgage fraud impacts the reputation of the industry as a whole. It is therefore in the best interest of the industry to act quickly, and to work collectively to enact changes that will reduce the incidence of mortgage fraud in Canada. CIMBL is well positioned to facilitate solutions on behalf of the industry, and it is via the CIMBL Mortgage Fraud Task Force that future initiatives will be launched.