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Short sale fraud to cost banks $375 million in 2011

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Short sales increased rapidly over the last several quarters, but wherever there are home sales, there are home sales fraud. Sales of properties on the verge of foreclosure tripled over the last two years and will increase another 25% this year, according to analysis from CoreLogic (CLGX). Analysts found one in every 52 short sales conducted in the first half of 2010 were "suspicious," meaning the lender may have incurred unnecessary losses from fraud. Over the first six months of last year, banks showed $150 million in losses from these suspicious transactions. By the end of 2011, banks could face $375 million in losses from short sale fraud, according to CoreLogic. Short sales pose a suspicious risk in a variety of ways. One example occurs when the buyer flips the property for a 10% profit less than one month after the bank unloads it. Analysts also found any property flipped less than three months after the transaction for at least a 20% profit as suspicious. Even at six months after the transaction, a short sale can be suspicious if the buyer flips the property for 40% more than the short sale price. Flipped the same day Analysts said not all of these transactions were fraudulent. Buyers, often investors, can quickly rehabilitate the property, which poses no significant risk to the bank. However, as CoreLogic analysts looked through hundreds of thousands of short sales, some were resold on the very same day. Nearly one in six suspicious short sales are resold on the same day. On average, these transactions that were flipped within 24 hours showed a 34% profit between what the short sale went for and what the investor flipped the property for, CoreLogic said. "This same day turnaround of a short sale can be achieved by what is known as a 'back-to-back' closing," analysts said. In these deals, the investor has two separate contracts. One is the purchase contract with the lender. The other is a separate agreement the investor has with a third-party buyer. The two transactions are choreographed and presented to the title company on the same day with the short first executed, followed by the flip to the third-party buyer. Overall, roughly 65% of the resales after the originally short sale transaction were deemed "suspicious" and caused direct and unnecessary losses to the bank. Risk from certain states and buyers States with the highest short sale volume showed the most suspicious activity. Roughly 34% of the suspicious short sales found in the first half of 2010 occurred in California, followed by 17% in Florida and almost 10% in Arizona. The rest of the country accounted for about 38% of all suspicious short sales. Most of these occurred on properties that were sold to investment companies. Of the short sales conducted with investors, 28% were suspicious, compared to 1.9% for all short sales. Craig Focardi, senior research director of consumer lending at The TowerGroup, said the study validates an industry perception related to limited liability company buyers in a short sale transaction. "While they comprise only two percent of all buyers, they comprise more than 25% of buyers in suspicious short-sale transactions," Focardi said. Mitigate the risk CoreLogic provided some ways to mitigate the risk. Analysts recommended lenders review all short sale documentation, including any disclosures to resell the property at a higher price. They must ensure the short sale buyer is not aware of any other parties involved with the transaction, validate claims significant renovation was actually completed before the flip. But most importantly, banks should apply the proper due diligence in order to understand the current market value of the property, analysts said. "Identifying risk and monitoring distressed asset sale trends is absolutely essential for lenders to preempt potential losses," Focardi said. Write to Jon Prior. Follow him on Twitter @JonAPrior.

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