Detection and prevention of mortgage loan fraud

RMA Journal, The, Sept, 2004 by Vernon Martin

Bogus construction plans. As another example, a real estate developer wished to acquire and hold a piece of land on which he would eventually build an industrial park. The developer admitted in a newspaper interview that he would use the site for airport parking until such time that industrial park development became feasible again. Wishing to purchase the land for $24 million, he persuaded a bank to lend $30 million to build a permanent, state-of-the-art airport parking lot, with ground leases to McDonalds, Denny's, Hertz, Budget Rent-a-Car, Chevron, and a national taco chain. Colluding with an inside loan officer, he obtained an appraisal that was made to order, valuing the completed parking lot at more than $67 million. The appraisal assumed parking rates of $14 to $20 per day in a market where most daily rates were $9, even though the proposed lot would increase parking inventory. by more than 40% at an airport already at maximum legal flight capacity. Although the parking lot was completed, none of the ground leases were executed. Because the oversupply of parking created a price war, daily rates at this parking lot are now only $7 uncovered to $10 covered, and the property is presumably operating at a loss after debt service on a $30 million loan. This loan was then sold to other financial institutions tinder the misrepresentation that the airport itself planned to lease the parking lot, although the airport had been suing the developer for two years and had erected a fence around the parking lot to prevent pedestrian access to terminals.

This $30 million loan fraud could have been prevented with the following policies:

1. Commissioned loan agents should not be allowed to order appraisals. A noncommissioned party, such as a chief appraiser or chief credit officer, should do the ordering.

2. The bank should have insisted that only appraisers from its approved list be used. This appraiser was not approved and was also linked to a $225 million loan default at another institution.

3. The date of the inspection, the date of the appraisal order, and the date of the report should be compared. In this case, the inspection had been performed before the appraisal was ordered, suggesting that the appraisal had already been done for another party, possibly the developer. Also suspect was the delivery of the appraisal of such a complex property only one week after it had been ordered. Most commercial appraisals of for less complicated properties arrive in three to four weeks.

Bogus offers to lease. Nothing substitutes for signed leases with real tenants. Letters of intent are generally nonbinding, and to be assigned any credibility they should come from recognized credit tenants on company letterhead. Despite these intuitively obvious precautions, a vacant former Costco warehouse was purchased for $1.62 million in 2001 and was appraised one year later for $21.5 million, resulting in a $14 million funded loan, with the assumption that Federal Express, Walgreens, AutoZone, El Pollo Loco, and Global Terratransit would be leasing it, although there was no documented interest from any of these tenants. Federal Express, which was to occupy 40% of the space, had chosen a nearby building instead. Two years later, the only tenant is an ethnic supermarket. A lending institution's appraisal policy should insist the property be valued based on market rents, market vacancy rates, and market absorption rates until a bona fide lease can be produced.