The mortgage industry has experienced an alarming rise in fraud over the past few years. According to the Financial Crimes Enforcement Network, the number of suspected mortgage fraud reports filed with the Treasury Department skyrocketed 31% in 2011 compared with the previous year.

It's a costly problem. According to the FBI, it took a $3 billion toll on the industry. This upward trend is continuing as the FBI has projected a record mortgage fraud caseload in 2012.

Fraud isn't a new threat to the mortgage industry, but current market conditions are acting as a magnet for perpetrators. In the past, fraud largely occurred in the loan origination process. Companies responded by putting detection methods and controls in place. But the current market's high delinquency and foreclosure rates have resulted in a new wave of scams that target foreclosure rescue, loan modifications and short sales. Fraudsters are increasingly preying on the default servicing end of the mortgage lifecycle, where traditional detection methods have not been deployed. 

Today's mortgage companies are increasingly vulnerable to financial, regulatory and reputational risk. Once fraud is committed, lenders risk losses on short sales and face post-foreclosure issues, including repurchase demands from investors.

From a regulation standpoint, changes have required lenders to institute fraud prevention controls. Failure to meet these requirements can result in sanctions and penalties. In some cases, lenders could be subject to lawsuits that include punitive damages in excess of actual losses.

Reputational damage also takes a significant toll. A history of fraud incidents can lead to punitive conditions from vendors. In some cases, investors may stop purchasing loans altogether, and customers might file class action lawsuits.

As fraud continues to spread, companies are at a crossroads. Lenders and servicers are taking action, but turning to a different set of tools in the toolkit. This newest wave of mortgage fraud calls for a renewed focus on detection and prevention.

For fraud prevention to be effective, it should be a strategic priority that's championed by executive management. Leading companies have instituted communication plans reinforcing the company's commitment to fraud prevention and reinforcing the authority for the fraud department to effectively implement fraud prevention initiatives. 

A companywide fraud unit should underpin the fraud prevention program. Assessed across the company, fraud data can flag patterns that may otherwise be overlooked. In addition, a dedicated team within the mortgage unit should acts as the hub for mortgage fraud prevention.

There are many emerging practices to detect and prevent fraud in default servicing. For short sales and modifications, compare information the borrower supplied during the originations process to the same information they're supplying now, such as income and occupation, in order to confirm that the borrower can't afford to make payments on the current loan.

Another developing practice is to look for pricing patterns with realtors. One red flag is when certain Realtors are consistently involved in transactions for properties that sell well below market value. This can indicate that the realtor is providing below-market-value BPOs to influence the asking price.

Lately, industry service providers have begun to analyze the behavioral patterns of applicants, brokers, loan officers, lenders and appraisers, combined with historical patterns for fraudulent and non-fraudulent loans. Analytics can also be used to detect cases of collusion, for instance, by identifying data that indicates Realtors, buyers, appraisers and homeowners who are working together to manipulate a short sale or REO sale.

Employees remain a company's strongest line of defense for spotting and reporting suspicious activity. Employees don't need to be experts in mortgage fraud, but they should be able to recognize potential fraud and know how to report suspicious transactions for further investigation. Most importantly, training should be mandatory and ongoing to reinforce the emphasis that executive leadership places on fraud prevention.

Fraudsters are professional chameleons. They go to painstaking lengths to develop new methods to commit fraud as economic conditions, operating environments and market factors change. Yesterday's detection and prevention programs weren't built to combat these new threats. With the industry exposed to billions in losses each year, companies should take steps to evolve their fraud detection and prevention methods, protecting themselves against this growing problem.

Peter Pollini and Martin Touhey are principals in PwC's Banking and Capital Markets sector. They work closely with clients in the mortgage banking industry.