No sooner has the lending sector begun to dust itself down after the credit market meltdown than it seems another crisis is waiting in the wings.
Recent discoveries of mammoth mortgage fraud at Chelsea Building Society and Bradford and Bingley (B&B) have suggested the sector may be facing a potentially widespread buy-to-let scandal.
Banks and building societies across the industry are feared to have been victims of criminal gangs inflating buy-to-let property prices during the boom years that could lead to losses totalling hundreds of millions of pounds.
Chelsea reported a £41million hit just days after B&B shocked the market with news of a £270.8million half-year provision for fraud and professional negligence, implying that lenders may be sitting on swathes of over-priced properties and dodgy applications.
Mortgage fraud is thought to have been on such a large scale in the UK and America that one expert believes it was ultimately responsible for the credit crunch that tipped the world into recession.
As cases begin to mount in the UK, the industry is yet again counting the cost of high-risk and aggressive lending during the property bubble in one huge hangover from a borrowing binge.
Chelsea’s provision was big enough to send the group into the red by £26million in the first half of the year.
For a firm already reportedly teetering on the brink of a rescue merger or a financial restructuring, the fraud revelation was a major blow.
It was only after the society’s losses came to light last year – and at the insistence of the Financial Services Authority – that it reviewed its mortgage book and as a result unearthed the fraud.
There are concerns many lenders are similarly unaware they may have fraud on their mortgage books that will only emerge as increasing numbers of properties are repossessed amid the recession.
According to Chelsea, it is “third-party professionals” who are to blame for artificially inflating buy-to-let property values, with unscrupulous mortgage brokers, solicitors and valuers colluding in an organised manner.
The cases are believed to have taken place during the heady days of the buy-to-let boom between 2006 and 2008. New-build homes and in particular city-centre flats are understood to be of prime concern.
Chelsea has said it has identified a few hundred cases of suspected fraud and has set up a 12 to 16-strong team to investigate.
Nationalised B&B, being wound down after its state rescue last year, confirmed in its half-year figures that fraud provisions had rocketed by nearly £100million since 2008 in a sign of the sheer scale of the problem.
The FSA has described mortgage fraud as serious and widespread in the UK and has been visiting 200 brokers under a crackdown to flush out bad practice.
It has already banned 60 mortgage brokers and levied fines of more than £1million in just three years for mortgage fraud, with a team of about 40 working on it.
KPMG, which helped to uncover Chelsea’s suspected fraud, estimated recently that there had been 18 cases with a combined value of £24million in the first half of 2009, compared with 25 cases worth £36million in the whole of 2008.
The buy-to-let fraud seen at Chelsea is thought to centre around a so-called practice where properties are sold and resold among a group of landlords, with the price inflated each time by a fraudulent valuation.
According to a paper on the subject by Clive Whitfield-Jones, head of mortgage recovery services at law firm Jeffrey Green Russell, mortgage fraud can be committed “on an industrial scale with potentially huge losses to lenders”.
He outlines how a mortgage fraud ring can be operated with new-build homes, where builders, valuers and conveyancers and even mortgage intermediaries can be in on the act to dupe lenders and often also innocent investors.
In one of his examples, a builder colludes with an organised ring to sell 250 flats, with property professionals and related parties also investing, at a substantial discount price of £180,000, off the market price of £200,000.
In the meantime, the builder sells three of the flats for £275,000 each to shell companies it has set up that appear not to be connected to the group. A dodgy conveyancer is used to inflate the value of the properties on these dummy sales, creating a false price bracket.
A broker, also involved in the scam, then arranges interim and long-term mortgage finance from a lender, using the conveyancer again on the valuations, who cites the dummy sales and overestimates the achievable rent. The lender agrees to advance a mortgage of £220,000 against each flat, giving the ring £40,000 profit for each property.
In other instances, fraudsters can use cashbacks and incentives to inflate property prices to obtain finance. In most cases, these deals are legitimate tools used by housebuilders to attract buyers but, if the lender is not informed, they achieve effective back-door price cuts that allow the additional loan advance to be pocketed.
The Council of Mortgage Lenders has introduced rules to ensure these incentives are disclosed amid its efforts to stamp out the growing fraud epidemic, however, lenders will often only become aware of the fraud upon repossession, after borrowers default on repayments.
The lender’s pain is then compounded by market price falls that further decrease the property value against the loan outstanding.
In his paper, Mr Whitfield-Jones concluded that the US sub-prime lending collapse that led to the credit crunch and subsequent recession was rooted in mortgage fraud, adding: “Without mortgage fraudsters we might have escaped the crash or at least such a serious downturn.”
While fraudsters can be expert at escaping detection, UK lenders have admitted their risk controls were perhaps not as tight as they should have been in the rush to advance cash as property prices soared. The lending frenzy led to mounting concerns over lax controls, with lenders reportedly accepting so-called “drive-by valuations” where properties were barely visited by valuers.
Self-certification mortgage business also came under fire, earning the nickname “liar’s loans” because they allowed borrowers to self-declare their salary, leaving them open to abuse.
Chelsea spokesman Jeremy Hicks said the group got carried away in the market forces of the time and it had since stopped writing new buy-to-let, self-certification and sub-prime business. The group has also conducted a review of its risk management, setting up several so-called “risk committees”.
The society is now combing through its suspected fraud cases and hopes to recoup cash lost by joining forces with other lenders to take legal action.
Mr Whitfield-Jones, whose firm represents lenders in such cases, said fraud could be difficult to prove against all parties, with victims rarely getting all their money back.
While it raises the issue once more of buy-to-let mortgage regulation – an area still not covered by the FSA – it has also revealed another damaging by-product of the credit boom, just when lenders thought the path was finally clearing.