Special to American Banker

Home lenders' first line of defense against loan losses - the nation's appraisal industry - may have holes in it, some regulators and industry professionals are warning.

Though hard numbers on appraisal fraud are hard to come by, industry professionals say all the ingredients are in place for a problem.

Competition among brokers for a dwindling pool of home loans means the incentive to inflate appraisals is high, regulators and appraisers themselves say. Reports of land-flipping schemes are on the rise.

Appraisers complain that interlopers - attracted by lucrative fees - have been stealing their credentials and passing themselves off as qualified experts. And though the housing market has grown quickly in the past decade, the number of certified appraisers has held steady at about 80,000, fueling worry that there are not enough legitimate appraisers to do the job.

"In the past year the total number of complaints we've received has increased," said Jerry Jolly, director of California's Office of Real Estate Appraisals in Sacramento. "Today we average between five and 10 complaints a month. Not all are related to fraud - some simply to the quality of work - but a good percentage of those do have to do with fraud."

As is often the case, regulators say abuses have started to come to light as a mortgage lending boom receded.

"Our real estate market is relatively flat," said Ted Boyer, who is director of the Utah State Division of Real Estate, in Salt Lake City and vice president of the Association of Appraiser Regulatory Officials, based in Ten Sleep, Wyo. "When there was a bull market, a lot of people got into the profession. Now with less business coming in and the [home refinance] business being flat, people are scrambling for work."

Adding to the concern is the use of automated valuation systems as a substitute for human eyes and judgment. Some in the appraisal business worry that lenders and others will stop demanding their services altogether.

At the very least, they are concerned that they will be cut out of the so-called cookie cutter appraisal business - that is, appraising units in developments such as tract housing where one condo or townhouse is pretty much like the rest. (Cookie cutter appraisals generally are handled with "drive-by" evaluations.)

More important, however, is the implication for the industry if automated appraisals are flawed.

"I think everyone agrees that technology benefits the industry; if it helps provide accurate values, that's a good thing," Mr. Jolly said. "Nevertheless, this is a worry for appraisers. If all these systems do is speed closings and the values are not accurate, there will be ramifications."

Industry executives worry further that in a stagnant mortgage market, lenders will put more pressure than ever on appraisers to provide a predetermined valuation number that will ensure a deal gets closed - an illegal but not uncommon practice, they say.

"One of the No. 1 complaints we receive is that lenders and mortgage companies are asking appraisers to reach a particular appraisal number as they take the assignment," Mr. Jolly said. "We've had situations where the lender says right on the order that he needs a $250,000 valuation."

Another problem that's vexing the appraisal community is the "stealing" of licenses by charlatans who hope to get on to lenders' approved-appraiser lists.

In California, some appraisers say they have faxed their credentials to lenders, only to have the forms swiped and other people's names substituted for their own.

"I'm not sure how big a problem misrepresentation is, but it is a problem," said David Rij, president of Feeapraiser.com, a service that has been on-line for about five months and is the largest Internet data base of real estate appraisal companies with confirmed licenses. The company claims to have 10,700 listings nationwide and says its Web site gets about 5,000 hits a month. (The appraisal subcommittee of the Federal Financial Institutions Examination Council also maintains a Web site that is said to identify every licensed and certified appraiser in the United States, at www.asc.gov.)

"I'm aware of someone in my office who had his license stolen, and [the case is] now in the hands of the local district attorney's office," Mr. Rij said. "As a result of stories like this, we had a point here in California where appraisers were not allowed to fax their licenses because unscrupulous people were taking those copies and whiting out the names." Today the state is once again allowing faxes to be used.

Those whose certificates are stolen suffer particularly because, once removed from a lender's approved list of appraisers, it's difficult to get back on. "This has happened to me twice, where someone used my name on an appraisal and my name was removed from this list, and the problem is that you have no recourse," said Jeff Turek, president of Choice Appraisals in Valencia, Calif. "I got an affidavit from one individual stating that I had nothing to do with the appraisal, and the lender still refused to put me back on the approved list."

What fraud schemes are appraisers involved in? The most frequently mentioned, of course, is "property flipping," in which the same parties buy and sell a house or building among themselves several times, using inflated appraisals, often within just a couple of weeks. Needless to say, the lender ends up holding the bag.

Far more insidious, however, is the problem of appraisers' giving inflated values for brokers. Mr. Boyer, whose agency also regulates Utah's brokers, blames brokers for many of the inflated appraisals being done.

"I distinguish between the brokers and lenders, who actually fund the loans," he says. "What the mortgage brokers are doing is requesting inflated appraisals, packaging the mortgage so it looks like it has equity in it. Take a $100,000 house: It's appraised at $120,000, and it looks like there's $20,000 in equity in the house, which there isn't. When it's sold it looks like there's an 80% loan-to-value ratio, but it's a phantom perception. You have the mortgage broker driving the bus, but the appraiser is in effect conspiring with him."

The problems can spiral. The lender takes on a loan that's riskier than originally thought; the borrower is more likely to default; the reported price is inflationary, pushing up prices on other properties and misleading appraisers who assess nearby properties.

"This is happening with greater frequency in Utah, [and] my counterparts are saying that it's happening in other states as well," Mr. Boyer said. "As a result, we're all seeing a marked increase in the number of foreclosures."

Regulators and other officials say a number of initiatives are in the works that may help eliminate fraud and poor appraisal work. Among these are education and a greater effort to share information among the FBI, local law enforcement agencies, and state real estate and appraisal regulatory authorities.

Today the Appraisal Foundation sets minimum qualifications and standards of conduct for appraisers working on federally regulated transactions. The federal government is recommending that states create different levels of licensure for appraisers, depending on their education and background.

"We're on the case," Mr. Boyer said. "We're instructing people, disciplining them, and the FBI is investigating fraud very seriously. People will be punished, and some will go to jail. As this happens, the tide will be stemmed."

Mr. Quinn is a freelance writer in Arlington, Va.

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