Mortgage lenders that fund loans originated by third parties are becoming more vulnerable to fraud, industry observers are saying.
The alarms are being sounded in the wake of news that Walsh Holding Co., a subprime lender that Resource Bancshares Mortgage Group, Columbia, S.C., is acquiring, may have been involved in a real estate scam, either as a victim or as a participant.
An article in the Asbury Park Press last week alleged that during the last 12 months a New Jersey real estate company bought more than 70 properties at low prices and sold them to investors-sometimes on the same day as the purchase - at significantly higher prices.
Walsh, based in Parsippany, N.J., put up the money for the loans, all originated by one mortgage broker, National Home Funding, Freehold, N.J. The appraiser who inspected the properties was chosen from a list approved by Walsh.
Industry observers said cases of bloated appraisal values were not commonplace but do occur, especially when brokers are involved.
"The wholesale business is more susceptible to fraud because the relationship with the customer is one party removed," said Gareth Plank, an analyst with UBS Securities.
Steven F. Herbert, Resource's chief financial officer, said it was conducting its own investigation. Shareholders are scheduled to vote on the deal in August. Resource is planning to issue 21.4 million shares, worth about $390 million, to Walsh.
"We will react appropriately as the investigation develops further," Mr. Herbert said.
One concern is that the investors who bought the properties will not pay the mortgages, forcing Walsh to foreclose and take a loss. Another concern is whether Walsh knew the appraiser was padding the value of the properties and made the loans anyway.
John Oberdorf, a lawyer for Walsh, said the appraiser was eliminated from the company's approved list several months ago. He added that Walsh has ordered new appraisals of the 203 properties whose mortgages it bought from National Home in the last year. Walsh is no longer purchasing loans from the broker, he said.
Mr. Plank, one of only two analysts who follow Resource, said the company was unlikely to scrap its plans to buy Walsh unless it turns out that Walsh bought bad loans on a widespread basis.
"The most probable outcome is that Resource will set up a reserve to indemnify any losses from this," Mr. Plank said. The loans in question total $21.7 million.
Lenders generally perform background checks on brokers and appraisers, but the process is not foolproof.
"If the right people get together and produce an inflated appraisal and all the paperwork looks appropriate, there's not a lot you can do to stop it. We don't physically inspect the property," one large wholesale lender said.
One Wall Street mortgage trader said these types of scams were a more serious problem for smaller regional lenders.
"Is this something Chase and GE and Citibank should be worrying about? No," the trader said, referring to three of the nation's largest lenders.