Fannie Finds Fraud in Multifamily Lending

Scorched by multiple instances of fraud in its multifamily lending program, it’s twice shy for Fannie Mae. The government-sponsored enterprise has quietly implemented changes in its underwriting requirements and is working to improve its processes to reduce risks from fraudulent activities.

These and other changes were revealed in Fannie Mae’s third quarter financial report to the Securities and Exchange Commission. The report outlines that the company has discovered possible or out-and-out fraud in some loans and is investigating other transactions in which fraud is suspected.

Gaps in processes

As of June 30, the latest date for which information is available, Fannie Mae owned or guaranteed an estimated 21 percent of all outstanding multifamily mortgage debt. While the company did not disclose any particular fraudulent case, the enterprise is known to have notified lenders in February that it would no longer accept loans from Riverside Abstract or Madison Title. The two Lakewood, N.J.,-based title outfits are allegedly linked to transactions with New York City investor Boruch Drillman, who admitted to fraud conspiracy in December 2023.

And in August of this year, three investors pleaded guilty to their part in a scheme involving a Fannie Mae loan. According to the Department of Justice, they paid $70 million for an apartment building but gave fake documents to their lender and Fannie Mae attesting that the cost was $96 million. Based on the false information, the lender originated and Fannie purchased a mortgage of $74 million on the property.

Normally, Fannie Mae does not independently verify most information reported by lenders, leaving it up to them to represent and warrant the accuracy of their loans’ characteristics. The company does spot checks to assess compliance with its underwriting and eligibility standards, but it relies heavily on lender-servicers to perform the legwork.

“This exposes us to the risk that one or more of the parties involved in a transaction (such as the borrower, borrower’s attorney, sponsor, seller, broker, appraiser, property inspector, title agent, lender or servicer) will engage in fraud by misrepresenting facts about a mortgage loan,” the GSE states in its SEC filing.

However, now that it has found fraud in at least several instances, it is taking steps to shore up what it calls “certain gaps…in our processes” for managing multifamily loan origination fraud risk and for overseeing seller-servicer counterparties.

Updated improvements on the way

Besides moving to reinforce and clarify its requirements, Fannie is updating its delegated underwriting and servicing guide and expanding its resources dedicated to overseeing its sellers and servicers. Loans serviced by DUS lenders and their affiliates account for almost all of the GSE’s multifamily guaranty book of business.

“We continue to pursue contractual remedies against multifamily lenders where we find breaches of the selling representations that lenders are required to provide on loans they sell to us as well as against multifamily borrowers and sponsors,” the company said in its latest quarterly report.

Despite these steps, Fannie admits its probably won’t catch every fraudulent loan: “Until we complete our work to improve our processes for managing multifamily loan origination fraud risk and oversight of multifamily seller/servicer counterparties, we may face a higher risk that we will be unable to detect or prevent fraudulent multifamily lending transactions.”

Even with the process improvements completed, Fannie’s mortgage fraud risk mitigation measures do not guarantee that financial losses due to mortgage fraud won’t occur.

In April, Fannie’s major secondary market competitor, Freddie Mac, implemented new policies to help detect fraud in the underwriting process. Among other things, Freddie now requires more frequent property inspections and a larger number of units in the sample audit. Lenders also are required to perform additional due diligence on first-time borrowers and those with limited multifamily experience, and all borrowers need additional liquidity.