Mortgage Asset Research Institute

White Paper Mortgage Asset Research Institute Eighth Periodic Mortgage Fraud Case Report to Mortgage Bankers Association By: Merle Sharick Erin E. Omba Nick Larson D. James Croft This report was combined and published before the acquisition of LexisNexis and ChoicePoint.

May 24, 2006 Dear MBA Member: Mortgage fraud against lenders continues to receive much attention throughout the real estate finance industry. Through education, research and advocacy, the Mortgage Bankers Association (MBA) strives to equip our members with the knowledge and tools necessary to catch and avoid fraud in their operations. One such tool is the cooperative databases of the Mortgage Asset Research Institute, Inc. (MARI). The most prominent of these is the Mortgage Industry Data Exchange (MIDEX), which is a database system where lenders, insurers and agencies exchange information about companies and parties that have originated loans containing fraud. Enclosed you will find the Eighth Periodic Case Report to the Mortgage Bankers Association produced by MARI. MARI provides MBA members these annual reports as well as discounted fees to participate in MARI s database. Mortgage fraud is a burgeoning crime that is affecting more and more companies and communities. The most recent statistics from the FBI indicate that there was a seven fold increase in reports of mortgage fraud from over 3,000 in FY 1999 to almost 22,000 in FY 2005. The FBI also reports that Federally-regulated institutions alone reported over one billion dollars in losses due to mortgage fraud in FY 2005. MBA continues to be at the forefront of efforts to help lenders detect, investigate and prevent mortgage fraud. This year, we held our first annual National Fraud Issues Conference in Chicago. The goal of the conference was to teach companies how to protect themselves from being victimized by fraud, by gaining insight into how to move beyond learning about schemes and red flags, and look at issues that cut across departments and industries. We were very excited about the turnout for this conference, which sold out months before it actually took place. While the conference attendance shows us that the mortgage industry is willing to come together to combat the crime of mortgage fraud against lenders, it also shows us that mortgage fraud continues to increase and that more work must be done. In order to increase resources in the fight, MBA submitted written requests this past April to the House and Senate Appropriations Committees advocating for $31.25 million

over a five year period in dedicated funding for the FBI and the Department of Justice to combat mortgage fraud. We believe this funding could provide 30 new FBI field investigators, two new prosecutors at the Department of Justice to coordinate prosecution efforts of mortgage fraud cases and $750,000 to support the operations of Interagency Task Forces in targeted areas with concentrations of mortgage fraud. MBA has also reached out to member companies requesting they identify a person within their company who can serve as the primary contact for law enforcement to contact as they seek information in investigating and prosecuting mortgage fraud cases. Law enforcement has indicated that often, significant resources are expended just trying to locate the right person within a mortgage banking company. MBA has recently submitted to the FBI a list of primary law enforcement contacts at 52 member companies. These companies have made this a tangible sign of their commitment to work with law enforcement to combat mortgage fraud. If your company has not identified a primary law enforcement contact, I encourage you to do so by contacting Rachel Voss by phone at (202) 557-2865 or by email at rvoss@mortgagebankers.org. We will continue to keep you apprised of our efforts in the fight against mortgage fraud. Most sincerely, Jonathan L. Kempner President and Chief Executive Officer 2

12030 Sunrise Valley Drive Suite 200 Reston, Virginia 20191 Tel: (703) 620-6262 Fax: (703) 620-9587 EIGHTH PERIODIC MORTGAGE FRAUD CASE REPORT TO MORTGAGE BANKERS ASSOCIATION By Merle Sharick Erin E. Omba Nick Larson D. James Croft Mortgage Asset Research Institute, Inc. A ChoicePoint Service

EIGHTH PERIODIC REPORT TO MORTGAGE BANKERS ASSOCIATION Executive Summary Mortgage originations continued to be strong in 2005. Although the 2005 numbers on residential mortgage fraud and misrepresentation are still preliminary, it appears that problems of loan application misrepresentation remain high. The Financial Crimes Enforcement Network (FinCEN) recently reported that the number of mortgagerelated Suspicious Activity Reports (SARs) in the first half of 2005 were 33% higher than in the first six months of 2004. 1 And 2004 SAR submissions were 150% higher than 2003. If rising interest rates produce a significant reduction in originations for 2006, additional cases could surface in the future at a rapid rate as some originators press to maintain high origination levels. This is the eighth annual report by the Mortgage Asset Research Institute, Inc. (MARI) to the Mortgage Bankers Association (MBA) members. These annual reports examine the current composition of residential mortgage fraud and misrepresentation in the United States. (See Appendix I at the end of this report for information about MARI and the methods it uses to collect data on mortgage fraud.) The highlights of this report are as follows: Dramatic increases in the submission of mortgage-related SARs have significantly increased awareness of and attention on fraud. But not all of the increases in SAR submissions can be attributed to increased levels of fraud. Although 2005 statistics are still preliminary, it appears that Florida, Utah and Georgia are leading the mortgage fraud pack. Georgia s problems appear to be abating in response to authorities strong anti-fraud activities. Colorado and Illinois show steadily increasing problems over the past five years. South Carolina shows the greatest improvement in its MARI Fraud Index over the past five years. Reported fraud in California is lower than it has been in many years, but a significant number of its problems are likely being masked by high real estate appreciation. The industry s competitive forces are pressuring lenders to adopt new products, some of which have significantly more opportunities for fraud, due to their structure. The body of this report presents the data behind the conclusions cited above. 2006 Mortgage Asset Research Institute, Inc. Page 1

High Levels of Reported Mortgage Fraud The mortgage industry s interest in fraud increased dramatically in 2005 and continues to be very high in early 2006. The heightened interest is shared by the press and regulators of financial institutions. Federal and state legislation has been proposed due to the perception that mortgage fraud is rampant. The Mortgage Bankers Association is giving anti-fraud initiatives high priority. It recently announced that it will urge Congress to increase funding for new FBI agents and federal prosecutors devoted to pursuing mortgage fraud. It appears that this high level of attention has been sparked, to a large extent, by the latest information about mortgage fraud coming from the FinCEN, the agency that collects Suspicious Activity Reports from all federally insured financial institutions. Table 1 below shows almost 22,000 mortgage-related SARs were filed in fiscal 2005, compared to slightly fewer than 7,000 only two years earlier. Table 1 Mortgage Fraud SARs 2 Fiscal Year SAR Submissions 2005 23,018 (est) 3 2004 18.391 2003 9,539 2002 5,387 2001 4,696 2000 3,515 1999 2,934 These changes in SAR figures, however, are not entirely reflective of increased fraud activity. There are factors beyond simple increases in mortgage fraud that contribute significantly to the dramatic figures shown above. First, SAR submissions are currently required of only federally insured financial institutions and their affiliates. The fraud experiences of independent mortgage banking companies are not reflected in Table 1. An FBI Special Agent working in the area of financial fraud was recently quoted as saying, We think that there is a large number of mortgage fraud situations that are not covered by the statistics that we report, based [only] on SARs. That said, however, the number of mortgage originators covered by the SAR submission requirement has been growing significantly in recent years. Commercial banks and thrifts (which are required to make SAR reports) acquired almost 150 independent mortgage banks between 1997 and 2005. Many of the acquired companies were among the largest originators in the country. 2006 Mortgage Asset Research Institute, Inc. Page 2

Therefore, some of the increased activity in mortgage-related SARs is due to the increased numbers of mortgage originators that submit SAR reports. Also, many companies don t discover fraud until a loan has seasoned one to four years. By the time an incident of fraud gets fully investigated and reported in a SAR, it may be two to five years old. So the large numbers of SAR reports in 2004 and 2005 can be attributed, in part, to both the increased numbers of originators now submitting SARs and the record-setting origination volumes that took place in the 2001-2003 period. Not all of the increase in SAR submissions, however, can be attributed to these statistical anomalies. Likewise not all mortgage fraud is caught in SAR reports. There are several other factors contributing to both perceived and reported fraud cases. These include: Recent high origination volumes that strained quality control processes originators had in place processes which were adequate for more normal periods Concentration of companies resources on managing production demands Need to assign newer, less-well-trained staff to points in the production process where seasoned employees might more readily detect fraud Introduction of non-traditional loans for which lenders have fewer quality checks in place, and through which fraud is more easily perpetrated There are other factors, of course, but fraud reports MARI receives and discussions with customers suggest statistically and anecdotally that incidents of fraud have risen recently. An FBI report on the subject concluded that despite the limitations of SARs, Based on various industry reports and FBI analysis, mortgage fraud is pervasive and growing. Much of what follows in this report contains data that confirm this assertion. Data and Information Sources Over the last decade, major mortgage lenders, agencies and insurers have been submitting information describing incidents of alleged fraud and material misrepresentation to a central database. The database is MARI s Mortgage Industry Data Exchange (MIDEX ). MARI mines this database to obtain statistics on a wide range of mortgage fraud characteristics. Many findings from this research are presented in this Case Report. In addition, LoanPerformance, Inc. 4, a subsidiary of First American Financial Services, collects monthly payment data on more than 40 million active residential loans. Over the past several years, LoanPerformance has graciously provided MARI with information about serious early payment defaults for use in our annual Periodic Case Report to the MBA. Early payment defaults closely track fraud trends reported to MARI and often precede them by a year or more. Therefore, this report provides the latest available information about where early payment problems are occurring. 2006 Mortgage Asset Research Institute, Inc. Page 3

Geographical Distribution of Mortgage Fraud Table 2 below was developed from fraud cases submitted to MARI by MIDEX subscribers. The first three columns of the table show the rankings of states with the most serious mortgage fraud problems in loans originated 5 during 2005. The remaining columns of the table show the rankings and a numerical measure of the same 10 states (or 11 states if we count No. 19, South Carolina) in the years from 2004 back to 2001. In Table 2, the numerical measure of each state s fraud problem is represented by the MARI Fraud Index (MFI). An MFI of 0 would indicate no reported fraud from a state. An MFI of 100 would indicate that the reported fraud for a state is exactly what one would expect in terms of fraud rates, given the level of loan originations in that state. That is, a state with an MFI of 100 is average. Appendix II at the end of this report explains in detail how the MFI is calculated. The first row of numbers in the table should be read as follows. Based on fraud reports submitted to MARI by its customers, Florida ranked first in the nation for loans originated in 2005 that contained alleged fraud or serious misrepresentation. The reported fraud rate was approximately two and one-quarter times (MFI FL/2005 = 224) what we would expect, based solely on its origination volume. For loans originated in 2004, Florida had a reported fraud rate almost two and one half times what it should have had (MFI FL/2004 = 244) and ranked second to Georgia, which had almost three times (MFI GA/2004 = 294) its expected fraud rate that year. Finally, Florida s 2001 fraud rate was 1.62 times the average, and that figure gave it a ranking of sixth among all states in 2001. (Figure 1 on the following page is a map indicating the Top Ten states in 2005.) Table 2 MARI Fraud Index (MFI) 6 By State (2001-2005 All Originations) 2005 2004 2003 2002 2001 State Rank MFI Rank MFI Rank MFI Rank MFI Rank MFI Florida 1 224 2 244 2 165 10 146 6 162 Utah 2 209 4 142 3 161 3 215 3 183 Georgia 3 193 1 294 1 436 1 304 2 233 Colorado 4 175 3 169 5 156 18 82 21 77 Illinois 5 163 6 122 9 140 11 120 11 130 Missouri 6 135 10 111 4 157 6 175 5 165 Texas 7 126 8 115 6 148 9 149 15 111 California 8 122 17 90 18 75 23 63 18 79 Michigan 9 117 5 135 8 141 12 115 12 117 Ohio 10 112 15 95 15 106 5 194 4 181.*** *** *** *** *** *** *** *** *** *** *** So. Carolina 19 71 11 106 7 145 2 275 1 479 2006 Mortgage Asset Research Institute, Inc. Page 4

Figure 1 We can draw a number of interesting conclusions from Table 2 and this map. Georgia, the leader in fraud rates from 2002 through 2004, has dropped to third position for fraud reported to date on its 2005 book of business. For 2005 it is a little less than twice the national average (MFI GA/2005 = 193), which is a far cry from its 2003 position when it far outstripped every other state (MFI GA/2003 = 436). This drop may be due to the aggressive legislation and enforcement Georgia officials have recently put in place. Utah s fraud problems have given it a consistently high ranking despite increased requirements for professional licensing and education, and more rigorous enforcement. Colorado shows the greatest degradation over the past five years. It moved from the 21 st ranking for loans originated in 2001 to fourth for loans in 2005 and added almost 100 points to its MFI. Illinois five-year climb toward higher ranks in the fraud list, though not as dramatic as Colorado s, is a steady trend. The greatest improvement in the last five years can be found in South Carolina. In 2001 it had one of the highest scores (MFI 2001/SC = 479) MARI has ever recorded. But its 2005 score ranked the state at 19 th and have an MFI at only 71% of the national average. Does Spotty Real Estate Inflation Have an Impact? Several areas of the country have seen substantial residential property inflation rates. California has experienced exceptional price increases. 2006 Mortgage Asset Research Institute, Inc. Page 5

Therefore, California s low MFI 2005 score may be somewhat deceptive. Many lenders are concerned that fraud is still very high in California loan applications, but much of that fraud is being masked by unusually high property appreciation, especially in Southern California and the San Francisco Bay area. In addition, these rapidly rising property values may be adding to the fraud problem. Some potential homeowners in hot real estate markets feel panicky about ever being able to afford a home. This leads to problems where borrowers, often with the help of loan originators, misrepresent their circumstances in an effort to get into homes before they are further priced out of the market. In the past two years, lenders in California have reported cases where multiple families have purchased a home together. However, the loan application is made in the name of the family that has the best credit score. The income shown on the application is really the combined income of all the families. Lenders that find such situations are in a quandary about whether to report the application as fraudulent since often these mortgages show timely payments. Many of these fraud for housing cases are quite different from the fraud for profit cases that lenders are reporting in other parts of the country. Of course, many areas in Florida have experienced substantial real estate inflation, but the state has still had the first or second highest MFI in the past three years of MIDEX data. There are clearly forces operating in Florida beyond the inflation factor. Other States Along with Florida and Utah, the states of Georgia, Colorado and Illinois comprise the top five states for fraud in the 2001-2005 period. Each has an MFI that is more than 150% of what we would expect, based on each state s origination volumes. The problems, as one would anticipate, occur primarily in these states larger cities. The Midwestern cities of Detroit and Chicago continue to have problems, and generally, the states of Colorado, Illinois and Texas have been climbing in the MFI rankings over the last five years. Their numbers are consistent with anecdotal reports that have been circulating among quality control and fraud investigation departments during that period. Prime v. Subprime Fraud Levels Subprime lending has been growing strongly in recent years. Many mortgage lenders that once paid little attention to this market have become quite active originators. Therefore, it seems appropriate to look at the geographic distribution of fraud found in subprime loans to determine if it follows the same pattern found in loans taken as a whole. 2006 Mortgage Asset Research Institute, Inc. Page 6

Table 3 below shows the subprime MARI Fraud Indices of the top 10 states over the past five years. Just as in Table 2, the states are ranked by their 2005 MFI values. Those states MFI ranks and values for 2001 through 2005 are also listed. Table 3 MARI Fraud Index (MFI) By State (2001-2005 Subprime Originations) 2005 2004 2003 2002 2001 State Rank MFI Rank MFI Rank MFI Rank MFI Rank MFI Florida 1 301 1 323 2 245 3 175 9 153 Utah 2 281 3 160 3 182 6 151 3 212 Missouri 3 261 26 52 12 93 20 80 11 144 Illinois 4 179 15 86 14 89 9 127 6 173 Georgia 5 172 2 280 1 600 1 445 2 223 Colorado 6 161 4 142 6 137 16 94 18 114 Texas 7 145 9 109 11 104 12 105 27 62 Rhode Island 8 133 37 29 41 22 8 132 33 31 Arkansas 9 115 30 42 4 159 41 1 40 1 Ohio 10 109 16 74 19 66 15 98 8 154.*** *** *** *** *** *** *** *** *** *** *** So. Carolina 22 50 12 92 13 91 2 184 1 253 The preliminary data in this table reveal a number of interesting patterns. For the most part, the states that report difficulty with subprime fraud are the same ones that have problems listed in the more comprehensive Table 2. Georgia, while still among the top five states in subprime fraud loan reports, has dropped in dramatic fashion from 2002 and 2003, when its MFI rates were four to six times the national average. Rhode Island s presence among the top ten states with subprime problems is clearly a statistical anomaly based on the fact that the increase of a few fraud cases in a very small state can create a large percentage change. Its present 2005 MFI is simply an aberration. South Carolina again shows the most improvement over the past five years. Types of Fraud Reported MARI s MIDEX system classifies the types of alleged fraud involved in each incident reported by its cooperating subscribers. These classifications are shown in Table 4 for loans originated in the four-year period from 2002 through 2005. The numbers on 2006 Mortgage Asset Research Institute, Inc. Page 7

2005 loans, of course, are very preliminary since fraud perpetrated in 2005 will continue to surface for another two years or more. Table 4 shows each type of fraud as a percentage of all fraud cases submitted to the MIDEX database. For instance, 59% of the fraud incidents reported to the database for mortgages originated in 2005 contained application fraud. (This is not surprising given the comprehensive nature of the application form.) Table 4 Mortgage Fraud Types Mortgage Origination Year Fraud Classification 2005 2004 2003 2002 Applications 59% 61% 63% 60% Tax and Financial Statements 22% 27% 22% 18% Verifications of Deposit 16% 17% 18% 15% Appraisals/Valuations 14% 16% 26% 40% Verifications of Employment 13% 14% 15% 13% Escrow/Closing 7% 7% 14% 18% Credit Reports 4% 8% 7% 5% Source: Case submissions to the MIDEX system It should be noted that the total percentage for each year (the sum of each column in Table 4) exceeds 100%. This is because most reported incidents involve more than one type of fraud. Many of the percentage figures shown in the table above are similar to those MARI has reported for several years. There are two exceptions, however. First, compared to MBA/MARI Case Reports in past years, the level of reported appraisal fraud found in loans originated in the one-to-four year period prior to the report has increased. (The next section of this report presents more information about the appraisal figures.) Second, the 2003-2005 problems found in credit reports, while still few in number, are much higher than the 1% to 2% historical figures. 2006 Mortgage Asset Research Institute, Inc. Page 8

Appraisal Fraud Even casual observation of Table 4 indicates that the amount of appraisal fraud reported is somewhat lower than one might expect in each of the years, especially in 2004 and 2005. The low levels of reporting are due, in large part, to the fact that, typically, reported incidents involve more than one type of fraud. If the reporting lender finds misrepresentation in the verification of employment and in occupancy status, that lender is not likely to pay for the review appraisal that would be necessary to verify appraisal fraud, even if the appraisal appears to be inflated. In addition, it should be noted that the appraisal fraud rates reported in the data for 2004 and 2005 are lower than those reported for earlier years. But these numbers will increase over time as more misrepresentations are found in the 2004 and 2005 books of business and as the sometimes lengthy process of reappraisal and value verification is completed in many investigations. Many MIDEX subscribers indicate that attempts at appraisal fraud are much higher than Table 4 shows. Some loans are not closed due to faulty appraisals comparisons to the values produced by automated valuation models (AVMs). However, lenders express concerns about using AVM results in some markets. In particular, they are finding cases where such models have difficulty establishing realistic values in major urban areas where the same neighborhood may contain diverse housing types. Nearby comparables may not really be comparable. Appraisals in these neighborhoods are far more accurate when reviewed by experienced appraisers who are familiar with the market. Some lenders are also concerned about the accuracy of AVMs in areas hit by property flipping. The comparables found by such models may be influenced by transactions not recognized as flips. Early Serious Delinquencies Indicate Possible Fraud Loans that become delinquent by more than ninety days or go into foreclosure in the first 6 to 18 months, Serious Early Defaults (SEDs), do not necessarily involve fraud. However, many such loans contain some form of misrepresentation and should not have been made. LoanPerformance, Inc. collects monthly payment data on more than 40 million loans. An analysis prime payment histories prepared by the LoanPerformance staff is presented in Table 5. It shows prime loan SED scores for various metropolitan statistical areas (MSAs) around the country. (These scores are based on the dollar volume of the problem loans, and an SED score of 100 indicates an area has an SED score that is average for the United States.) The years designated by columns in Table 5 refer to the origination years. The 13 MSAs listed in the first column of the table are those that have SED rates at least 50% above the national average for the 2005 book of prime business. 2006 Mortgage Asset Research Institute, Inc. Page 9

As noted previously, California was the country s most serious mortgage fraud hot spot during the 1990s. But the 2005 prime loan SED rates for the Los Angeles and San Francisco MSAs do not appear in Table 5 because they are so low. Their 2005 prime lending SED scores were only 62 and 85, respectively. That is, both MSAs were significantly below the national average of 100. Again, unusually high real estate price appreciation may be masking fraud problems, even early in the life of a loan. Table 5 LoanPerformance, Inc. Data on Prime Loans Serious Early Defaults 2002-2005 2005 Rank 2005 2004 2003 2002 MSA New Orleans 1 9,347 225 194 155 Miami 2 347 100 147 155 Houston 3 311 192 188 164 Indianapolis 4 263 267 235 236 Newark 5 200 229 153 127 Dallas-Ft. Worth 6 195 263 271 233 Detroit 7 (tie) 174 158 135 124 West Palm Beach 7 (tie) 174 83 76 39 Atlanta 9 (tie) 163 300 271 239 Memphis 9 (tie) 163 217 224 170 Columbus 11 (tie) 158 271 194 176 San Antonio 11 (tie) 158 213 282 252 Orange 13 153 83 141 82 Source: LoanPerformance, Inc. New Orleans SED is, of course, far above any reasonable range due to the effects of Hurricane Katrina. However, the figures for years prior to 2005 also show that the city is no stranger to Serious Early Defaults. The other cities that rank high in 2005 early defaults have all been on this list in the past. However, it is notable that Atlanta s rate has dropped significantly from levels reported in MARI annual reports for past years. The Table 5 figures confirm the concerns expressed by industry professionals over the past two years. Many report seeing much of their fraud problems shifting from the larger metropolitan areas to cities of more moderate size. Indianapolis, West Palm Beach, Memphis, Columbus, San Antonio, and Orange have only recently shown up as potential fraud hot spots. 2006 Mortgage Asset Research Institute, Inc. Page 10

Table 6 below shows LoanPerformance SED scores for subprime loans. The LoanPerformance information for subprime loans is not sufficiently robust to be statistically valid for all MSAs. Therefore, it is aggregated by state. The 10 states with LoanPerformance 2005 subprime SED scores above 150 are shown below. The table again reflects the impact of Hurricane Katrina on the performance of recently originated loans. Lenders and mortgage servicing companies with large numbers of loans secured by homes in the path of that storm will be working through its effects for several years. Table 6 LoanPerformance, Inc. Data on Subprime Loans Serious Early Defaults 2002-2005 2005 State Rank 2005 2004 2003 2002 Louisiana 1 836 152 147 127 Mississippi 2 451 190 176 199 Georgia 3 184 183 175 175 Michigan 4 173 161 155 129 Colorado 5 171 157 179 160 Ohio 6 168 216 185 160 Alabama 7 162 125 118 111 Oklahoma 8 161 203 185 185 Minnesota 9 159 164 149 114 Indiana 10 155 197 162 147 Source: LoanPerformance, Inc. Table 6 shows that some states in the Midwest are experiencing early payment problems among subprime loans. Outside of Louisiana and Mississippi, there do not appear to be any states that have experienced dramatic changes in their SEDs over the past four years. While SED scores do not necessarily indicate fraud, the conclusions that can be drawn from the LoanPerformance data are consistent with, and tend to lead, by approximately a year, the results reported by MARI s database subscribers. Related Issues Two exacerbating factors have combined over the past few years to pressure the industry into non-traditional practices that will contribute to future fraud reports. Those factors are: 1) the ever-present drive to speed up the mortgage approval process, and 2) escalating home prices in many markets. 2006 Mortgage Asset Research Institute, Inc. Page 11

Stated income and reduced documentation loans speed up the approval process, but they are open invitations to fraudsters. It appears that many members of the industry have little historical appreciation for the havoc created by low-doc/no-doc products that were the rage in the early 1990s. Those loans produced hundreds of millions of dollars in losses for their users. One of MARI s customers recently reviewed a sample of 100 stated income loans upon which they had IRS Forms 4506. When the stated incomes were compared to the IRS figures, the resulting differences were dramatic. Ninety percent of the stated incomes were exaggerated by 5% or more. More disturbingly, almost 60% of the stated amounts were exaggerated by more than 50%. These results suggest that the stated income loan deserves the nickname used by many in the industry, the liar s loan. When these loans were introduced, they made sense, given the relatively strict requirements borrows had to meet before qualifying. However, competitive pressures have caused many lenders to loosen these requirements to a point that makes many risk managers squirm. Federal regulators of insured financial institutions have expressed safety and soundness concerns over these loans with lower documentation requirements and other nontraditional loans. There are significant differences of opinion about the advantages and disadvantages to these types of loans. However, when some of these loans go into default, it is inevitable that investigations will find that innovative fraudsters have perpetrated new types of misrepresentations that the product designers did not anticipate. The fraud-proof loan has yet to be developed. Future case reports in this series will assess the level of creativity being used to exploit today s changes in mortgage offerings. 2006 Mortgage Asset Research Institute, Inc. Page 12

Appendix I Source and Analysis of MARI s Mortgage Fraud Data The data presented in Tables 2, 3 and 4 of this report was taken from a cooperative mortgage fraud database operated by the Mortgage Asset Research Institute, Inc. (MARI). 7 MARI has designed and offered various mortgage industry databases for the past sixteen years. Its most recognized database system is the Mortgage Industry Data Exchange (MIDEX ) that contains information about licensing, public sanctions and incidents of alleged fraud reported to MARI by MIDEX subscribers. The MIDEX data discussed in this document were taken from the incidents that MIDEX subscribers describe in reports to MARI. (Agreeing to submit reports describing their fraud investigation findings to the non-public section of MARI s MIDEX system is required for those who wish to access other subscribers non-public reports.) Only material misrepresentations are included in these reports. That is, companies only submit reports to MIDEX in those cases where, knowing what they know after their thorough investigations, they would not have originated, bought or insured the loans in question. The reports submitted to MARI include the following information about each incident: Location of the collateral (state, city and address, to the extent known) Names of the originating entity and the loan officer who took the application Date the misrepresentation took place The method used to verify the existence of the reported misrepresentation(s) A short narrative description of the misrepresentation(s) found during the MIDEX subscriber s investigation Names of any other professionals that appear to be in a position to influence the accuracy of the information found to be misrepresented, e.g. the name of the appraiser and appraisal firm in cases where the property value is found to be significantly inflated A certification from an authorized individual at the submitting mortgage entity that the report is, to the best of his/her knowledge, complete and accurate 2006 Mortgage Asset Research Institute, Inc. Page 13

MARI staff reviews the reports to assure they meet submission standards for severity and consistency. Submissions are input directly by MIDEX subscribers via an online form, or data entry staffers convert hard copy submissions to a standard, searchable format for inclusion in the MIDEX system. After reading the report s narrative description, a MARI staffer will classify the incident as involving one or more of the types of misrepresentations listed in Table 4. If MARI makes any changes to the submitted reports, they are returned to the submitting subscriber for review prior to their being entered into the system. The subscribers participating in the MIDEX system represent a wide range of mortgage entities. They include secondary market agencies, all of the major private mortgage insurance companies, and lenders that account for more than 80% of wholesale lending in the country. To access a MIDEX Client List, go to www.mari-inc.com and click on About MARI. 2006 Mortgage Asset Research Institute, Inc. Page 14

Appendix II Computation of the MARI Fraud Index (MFI) The MARI Fraud Index, or MFI, is an indication of the amount of mortgage fraud found through MIDEX subscriber fraud investigations in various geographical areas. It involves very straightforward calculations. To come up with Table 2 s 2005 MFI for loans in a state such as Florida, MARI staff determines the percentage of all U.S. MIDEX fraud reports that were submitted for Florida-originated loans in 2005. They determined that 14.02% of MIDEX reports submitted from across the country by subscribers for originations in 2005 involved loans on Florida properties. But according to HMDA data, Florida had approximately 6.25% of the nation s total mortgage originations over the last four years. If mortgage fraud were distributed throughout the country like originations, then we would expect 6.25% of mortgage fraud to occur in Florida. But 14.02% for the Florida 2005 fraud figure was more than double its origination figure. Therefore, the 2005 MARI Fraud Index for Florida, as of this report s date, is: MFI FL/2005 = (14.02/6.25) x 100 = 224 This is, of course, a dynamic figure. Often, a fraud investigation is not completed until a year or two after the loan was originated. MARI will continue to receive Florida fraud reports for another two to three years from its MIDEX subscribers that find misrepresentations in their 2001-2005 book of business. Therefore, the Florida s (and all other states ) MFI figures will continue to change somewhat in future MBA/MARI Periodic Reports, especially those containing recent years like 2004 and 2005. It should be noted that the MFI is based on the number of fraud incidents reported for each state, and not the dollar amounts of those mortgages. Therefore, a fraud on a $120,000 loan in Des Moines, Iowa, is counted the same as a fraud on a $720,000 loan in Los Angeles, California. Also, there is currently no distinction made between purchases, refinances or home improvement loans in these figures. 2006 Mortgage Asset Research Institute, Inc. Page 15

Endnotes 1 Financial Crimes Enforcement Network, The SAR Activity Review: By the Numbers, Issue 5, February, 2006. 2 Data as of February 10, 2006, found at www.fincen.gov/sars/depository_insitution_sars, Exhibit 5. 3 Assumes the 11,509 reported SAR submissions as of June 30, 2005, double by the end of the year. 4 Formerly Mortgage Information Corporation, aka MIC. 5 The dates used in MARI s Fraud Index are when the fraud occurred, which are typically the loan origination dates. Subscribers to the MIDEX system may not discover that a loan involved fraud for several months, or even one or two years after it was originated. So numbers for recent years are dynamic. 6 Readers that compare the MFI figures in Table 2 for the same states to those found in previous Reports in this series will find that the rates have changed. This is due to the fact that MIDEX subscribers in 2005 continued to uncover and report fraud findings from 2001 through 2004. Therefore all numbers in this Report are dynamic and will undergo some changes as time passes. 7 MARI was purchased by ChoicePoint Services, Inc. in June of 2003. Prior to that, it was privately held. 2006 Mortgage Asset Research Institute, Inc. Page 16

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