Intelligence Solutions to Combat Short Sale Fraud

Data & Analytic Best Practices

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Overview
Contents
Introduction Best Practice #1 Best Practice #2 Best Practice #3 Best Practice #4 Best Practice #5 Conclusion Page 2 Page 3 Page 5 Page 6 Page 9 Page 10 Page 11

The market collapse brought with it an unprecedented number of distressed properties that in most cases require careful disposition planning to minimize losses. Short sales have become one of the most popular and effective strategies to achieve this objective providing borrowers a graceful exit and lenders, servicers and investors a least bad resolution. However, with the onslaught of short sales has also come a wave of fraudulent activity. As short sales have increased in number, so too have short sale fraudsters. In fact, the Financial Crimes Enforcement Network reported that in 2012, 10% of the 100,000 suspicious activity reports filed relating to mortgage fraud were classified as short sale fraud, up significantly from 2011. In addition, a recent DataQuick study found that 6.5% of all short sales had some type of suspicious activity. While no such suspicious activity was reported the previous year. There are, however, many strategies lenders, servicers, and investors can use to counter the efforts of fraudsters. Some of the most effective approaches leverage advanced data and analytics solutions to identify likely fraud hotbeds and more effectively target and respond to potentially fraudulent activity in real time. This best practices guide will focus on five intelligence solutions that can be deployed now to combat short sale fraud:  Understand activity levels to know markets with greatest fraud potential Know the fraudster profile Implement early warning triggers Know whats right before the offer is made Leverage technology to quickly evaluate the offer

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Understand Activity Levels to Know Markets with Greatest Fraud Potential

This is the most general of the five strategies, but it also provides the foundation for all of the other strategies you may deploy. Quite simply, its necessary to have a constant flow of market intelligence to understand where short sale fraud activity is most common. You must know where you have to be most vigilant. DataQuick utilized its RiskFinder Distress product to identify 205,177 short sales during the past two years in 14 of the largest U.S. counties to provide a general geographic activity roadmap. A variety of key base trends emerged from this analysis Figure 1 Short Sales as a Percentage of All Sales
40% 38%

30%

26% 20% 19% 19% 15% 15% 10%

20%

10%

0%

Wayne, MI

Los Angeles, CA Hennepin, MN Miami-Dade, FL San Diego, CA Maricopa, AZ Broward, FL Clark, NV

Source: DataQuicks RiskFinder Distress

Figure 1 indicates where short sale activity is most common (i.e. where a heightened sense of fraud awareness is required). Specifically, short sales are, by far, currently most common in Wayne County, MI. Of the remaining counties, short sales appear to be more concentrated in Western counties than those in the East, although the short sale craze has clearly subsided in Clark County, NV.

Source: DataQuick Neighborhood Level HPI

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Table 1 highlights other key trends to consider  Timing since peak activity helps explain the results described above. Specifically, the timing of peak activity has varied widely with some counties such as Miami-Dade, FL peaking more than 2 years ago while others, such as Los Angeles, CA, peaking within the last 2-3 quarters.  The timing naturally drives overall YOY and 24-month changes in short sale activity.  Short sales in Wayne County, MI are still on the rise which explains why theyre such a large percentage of all sales.  Activity in San Diego County, CA is up significantly over the past 2 years but only down slightly in the past year because the peak in this geography occurred just recently.  The peak is a distant memory in Broward County, FL which explains why 24-month and YOY activity are both down so significantly.

Table 1 Key Short Sale Metrics

Short Sale Peak YOY 24-Month
Wayne, MI San Diego, CA Los Angeles, CA Maricopa, AZ Hennepin, MN Broward, FL Miami-Dade, FL Clark, NV
Source: DataQuicks RiskFinder Distress

Change in Short Sales

4% 15% 5% -4% -22% -29% -34% -78%

Percent of all Distressed Sales

78% 43% 34% 31% 26% 18% 27% 22%

5% -2% -3% -24% 18% -18% 0% -78%

Apr-12 Aug-12 Oct-12 May-12 May-11 Jun-11 Apr-11 Aug-11

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Know the Fraudster Profile

Understanding where short sales activity is concentrated is a good start, but there is much more intelligence that can be utilized to help pinpoint where you face the greatest risk. To more precisely segment the market based on fraud potential, DataQuick leveraged its National Property Database to identify suspicious short sales during the past 2 years and then compared these sales to all short sales to determine a property-centric fraudster profile. The profile and comparison were defined as follows:  7,139 short sales were identified that took place between April 2011 and April 2013 that also were then re-sold within 6 months of the short sale.  516 of the 7,133 short sales were deemed suspicious because the (original) short sale price was less than 50% of market value at the time of sale and the subsequent sale was at least 200% higher than the short sale price.

When the 516 suspicious short sales were compared to the base 7,139 short sales, a definite profile emerged.

Geography: Beware of Maricopa County, AZ When the two groups are segmented by county, it becomes obvious that there is a greater concentration of suspicious activity in Maricopa County, AZ (Figure 2). Specifically, while Maricopa County, AZ accounted for only 41% of all short sale activity, but it accounted for 59% of all suspicious activity. Figure 2 Profiling Suspicious Short Sales-Geography
60% 50% 40% 30% 20% 10% 0% 10% 12% 59%

Suspicious All Short Sales

41%

27% 16% 7%

15%

Clark

Los Angeles

Mariposa

San Diego

Source: DataQuick National Property Database

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Like any property-related analysis, though, its important to realize that you cant stop at the county level as neighborhood/ zip-level trends will vary widely within a county, which will clearly impact how you respond to short sale activity on specific properties. Figure 3 uses Maricopa County, AZ as an example of how suspicious activity varies widely between zip codes in a specific geography. Some zip codes report lower than expected suspicious activity while others report higher than expected levels. Figure 3 Profiling Suspicious Short Sales-Zip Level View, Maricopa County, AZ
7% 6% 5% 4.3% 4% 3% 2% 1% 0% 0.7% 1.6% 1.6% 3.5% 3.5% 2.7% 1.8% 2.2% 1.6% 6.6%

Suspicious All Short Sales

4.6%

85225

85037

85035

85017

89009

85204

Source: DataQuick National Property Database

Property Value: Beware of Lower-Valued Properties A variety of real estate trends vary based on the property value and suspicious short sale activity is no exception. Figure 4 shows a much higher incidence of suspicious activity in lower-priced properties (less than $200,000), a lower than expected incidence in moderately- and high-priced properties ($250,000-$750,000), and as-expected activity with the most expensive properties. Figure 4 Profiling Suspicious Short Sales-Price Band
40% 39%

30% 25% 20%

28%

Suspicious All Short Sales

19% 16% 12%

19%

10%

10% 6%

9% 5%

7% 3% 2%

0%

< $100,000 $200,000-$299,999 $400,000-$499,999 $750,000+ $100,000-$199,999 $300,000-$399,999 $500,000-$749,999

Source: DataQuick National Property Database

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Property Type: Multi-Family Properties Could be a Problem While the discrepancy is not as great as the first two evaluations, Figure 5 does point to slightly higher than expected suspicious activity with multi-family properties.

Figure 5 Profiling Suspicious Short Sales-Property Type

90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 6% 9% 6% 84% 85%

Suspicious All Short Sales

3%

Condominium Multi Family Single Family Residence

Source: DataQuick National Property Database

These three analysis are a sample of the different types of evaluations that could be completed to profile the short sale fraudster. Specific approaches will vary based on your requirements and history with short sale fraud.

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Implement Early Warning Triggers

The first two best practices centered on advanced deployment of intelligence to anticipate where short sale fraud is likely to occur and who is more likely to perpetrate this fraud. This helps guide your overall strategy on where to deploy resources, but its also critical leverage tools to effectively and efficiently evaluate the risk of fraud on specific short sale offers. These tools certainly rely on comprehensive data, but they also utilize advanced analytics and decisioning to ensure a clear picture of potential fraud on every offer. Automation drives these types of solutions and delivers the benefit of a consistent, accurate, and fast analysis of all transactions. That said, the human element should never be taken out of the equation. Instead, the automated solution optimizes the deployment of precious human resources by flagging problem transactions that require the evaluation of an expert while at the same time freeing review teams from the drudgery of a full evaluation on the transactions thatbased on your business rulesconform to your standards. Figure 6 An Early Warning System for Short Sales Integrated, Automated Decisioning Solution

No

No Action

Warning

Daily Match

Portfolio

Nationwide Listings Database

Hit

Yes

Lien & Credit Analysis I  dentify all open liens, CLTV E  valuate payment performance A  ssess potential short fall

Apply Fraudster Profile Geography Value Property Type P  roperty Characteristics Agent

Figure 6 is an example of this type of integrated decisioning tool. The process leverages a variety of resources to highlight potential fraud very early in the short sale processimmediately after the property is listed. This solution is deployed as follows:  On a very regular basis, all loans within a portfolio are matched to a database of nationwide listings that are can be updated daily or weekly.

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Implement Early Warning Triggers

Loans flagged as a new listing are then subject to a thorough evaluation:  The first step in this evaluation is a Loan and Credit Analysis. The goal of the analysis is to identify loans in your portfolio that have a high likelihood of short sale by comparing the listing price to the current property price.  Next, a borrowers motivation to potentially bend the rules is evaluated by identifying all liens on the property, current loan-to-value, and the borrowers performance on all these liens as well as their other open tradelines. A comprehensive review of all tradelines also helps identify potential strategic defaulters. All of these evaluations are based on business rules/thresholds you establish that are automatically deployed in the process to ensure the results of the evaluation reflect your business requirements  Once potential short sale candidates are flagged, these loans are then profiled using criteria such as those discussed in the previous section to further refine short sales into segments of high or low likelihood of fraud. Again, this evaluation is automatic and consistently deployed across all loans based on specific business rules you build into the process.  Loans identified with both high likelihood of short sale and high likelihood of fraud can then be escalated and given to your higher-end review staff for special handling and borrower follow up.

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Know whats right before the offer is made

Even if youve decided where you have to be most vigilant, profiled the most common offenders, and flagged listings as having a high potential for fraud, you still need to make sure you have the right tools in place to evaluate every short sale offer to determine the likelihood of fraud. The last two best practices do just this. From a tactical standpoint, its critical to know the discount you should expect on a short sale in relation to an armslength transactionideally before any offers are made. Luckily, there are automated valuation models that have been designed specifically to calculate discounts expected at different stages of default. Figure 7 leverages this type of tool to provide specific discounts that can be expected for short sales in different regions of the country. Like many of the other analysis in this guide, there is significant variation across the country that must be accounted for when evaluating any offer. And also like most of the other analysis in this guide, Figure 8 illustrates that you cant rely on countylevel statistics. The discount rates for the different zip codes in Miami-Dade County, FL clearly show that zip-to-zip variation must be factored into any decision to accept or reject a short sale and, just as important, the effort to detect potential fraud as quickly and accurately as possible. Figure 7 Short Sale Discount Rates
Cuyahoga, OH Suffolk, NY Wayne, MI Hennepin, MN Broward, FL Maricopa, AZ King, WA Queens, NY Los Angeles, CA Miami-Dade, FL San Diego, CA Clark, NV Kings, NY Fairfax, VA
0% 5% 7% 10% 15% 20% 10% 10% 9% 9% 9% 9% 9% 0 12% 16% 10 8 6 21% 20% 19% 18% 20

Figure 8 Short Sale Discount Rate Distribution-MiamiDade County, FL

30 28

16

17

1-5%

6-10%

11-15%

16-20%

20+%

Source: DataQuick National Property Database

Source: DataQuick National Property Database

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Leverage technology to quickly evaluate the offer

The final best practice builds on the last to provide an automated, more comprehensive evaluation of the short sale offer and a more in-depth view of the potential for fraud. Utilizing a variety of valuation sources, lenders and investors benefit from both a more thorough interrogation of the offer, but also receive more defensible documentation to justify their decision to accept or reject an offera critical requirement give the increased incidence of buy back requests. As illustrated in Figure 9, the decision engine unfolds as follows:  A consensus value is determined for the specific property based on a custom expert panel that you select. The panel can consist of a variety of valuation sources as outlined in Figure 6 below (red panel).  Based on the distribution of values within the expert panel, a confidence score is developed for the consensus value to allow you understand the level of accuracy associated with the consensus value.  The offer price is compared to the consensus value and either accepted or rejected based on a tolerance level you define. The tolerance level can vary based on property type, geography, price band and a host of other variables.  In some cases, clients choose to adjust the consensus value (and ensuing comparison to the offer price) by applying the short sale discount percentage for the subject propertys specific location.

Like some of the other solutions discussed in this guide, this process is driven by an automated decisioning engine which provides the confidence that all short sale offers are quickly evaluated in a consistent, accurate fashion. Figure 9 Automated Short Sale Offer Validation
Confidence Score evaluates distribution of panel Compare short sale offer to Consensus Value and Expert Panel Rules-Driven Decision based on pre-established tolerance

Use Expert Panel to develop Consensus Value

Apply Short Sale Discount, if necessary

Expert Panel Appraisal Emulation Valuation Models MLS Valuation Model Freddie Mac HVE Tax Assessed Value HPI Index Value Hedonic Valuation

Consensus Value w/ Short Sale Discount MLS Valuation Model Tax Assessed Value Appraisal Emulation Valuation Model Freddie Mac HVE Consensus Value-Non Distressed Hedonic Valuation HPI Index Value
$60,000 $90,000 $120,000

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Summary
Short sales will be a significant piece of the real estate fabric for some time, and its highly likely that as long as there are short sales, there will be short sale fraud. The best practices outlined in this guide provide a strong foundation to combat fraud by profiling where the risk is greatest and outlining integrated solutions to quickly assess specific short sale offers as early in the process as possible. These solutions are, however, meant to be jumping off points. Its critical to integrate your own unique business requirements and the knowledge base youve gained from your own experience with short sale fraud into these types of solutions to ensure that youve deployed the most relevant, effective solutions possible.

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DataQuicks Associates are energized by the daily challenge of solving our clients unique business challenges. Three core values are at the center of how we manage our business:

Integrity
We deliver on the commitments we make to our Clients, Associates, and Investors.

Passion
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