Bad debt returns to bite Myrtle Beach area banks

A lawsuit filed against a former Myrtle Beach mortgage broker who has admitted to bank fraud illustrates a growing trend for banks that were duped by fraudulent loan applications during the real estate boom, and experts warn the fallout could put further pressure on banks already straining from real estate losses.

Rock Hill-based Coastal Mortgage Services Inc. is suing Darin Epps, the former owner of Myrtle Beach-based Dunes Mortgage, over a loan Epps arranged for a condominium buyer in the Carolina Forest subdivision.

The lawsuit is separate from a felony bank fraud charge that Epps pleaded guilty to in April. Epps has not yet been sentenced on the criminal charge.

Coastal Mortgage, in its civil lawsuit, claims it made the loan based on false information that Epps supplied in a loan application. Coastal Mortgage wants Epps to repurchase the $294,750 loan under a "buyback provision" in his contract to do business with the lender.

Such buyback provisions - called representations and warranties in banking jargon - are common in the mortgage industry, and they represent a huge liability for brokers who originated loans and the banks that sold them into the secondary market.

Bank of America, for example, announced last month that it spent $1.2 billion during the second quarter on mortgage buybacks. That was nearly double the amount spent during theprevious quarter.

Also last month, the federal agency that oversees mortgage giants Fannie Mae and Freddie Mac issued 64 subpoenas to banks seeking information that could help document fraud and other problems in the loans those government-sponsored enterprises purchased during the boom. That information could be used to force those banks and lenders to buy back the bad mortgages.

Fannie Mae and Freddie Mac hold about 30 percent of the nation's 5.2 million seriously delinquent mortgages - defined as at least 120 days late or in foreclosure - according to federal data.

All told, such buybacks eventually could cost banks up to $64.8 billion in the coming years, according to a study by Washington, D.C.-based investment firm Compass Point Research and Trading.

Inflated income numbers

The Epps case centers on a mortgage he and Dunes Mortgage arranged for Edward Croft, who purchased a condominium at the Ashley Park development in Carolina Forest in August 2008.

Croft's loan application included several false statements, according to court documents, including the amount of money Croft had in bank accounts, his income and his intent to occupy the condo instead of using it as an investment property. Coastal Mortgage said in court documents that Epps knew or should have known that the information was false, but submitted it anyway so Croft's loan would be approved.

Croft, whose last known address was in Duluth, Ga., could not be reached for comment. He has not yet filed a response to the lawsuit.

Coastal Mortgage foreclosed on the condominium in December.

Kenneth Raynor, a Charlotte lawyer who represents Coastal Mortgage Services, said there are indications that several of the loans Dunes Mortgage originated for clients included false information. So far, however, the Croft loan is the only one the mortgage company is trying to collect.

Raynor said the criminal charges have stalled Coastal Mortgage's attempts to make Epps pay for the bad loan.

"It appears at this point that Mr. Epps would plead the Fifth Amendment if we were to depose him, so it has interfered with the discovery process in our case," Raynor said, adding that once the criminal case is settled, Epps might be more willing to talk.

Epps has admitted in the criminal case that he provided a bank with false information so Tiffany Travis, a former Myrtle Beach area real estate agent, could get a mortgage loan for a condo. The false information, among other things, inflated the value of the property. Epps then split the excess loan proceeds with Tiffany Travis and business partner Jeff Shoup.

Travis and Shoup also are facing bank fraud charges. They have pleaded not guilty.

Epps has agreed to help the FBI in ongoing mortgage fraud cases as part of a plea agreement, but he still faces a maximum sentence of 30 years in prison.

"We are cooperating with the federal authorities, and I won't allow Mr. Epps to do anything that might interfere with their investigations," said William Monckton, a Myrtle Beach lawyer who represents Epps. "Where we can assist in the civil cases, we will, but only after getting approval from the FBI and U.S. attorney."

No sentencing date has been scheduled for Epps, according to Monckton.

Looking for who to blame

When a mortgage loan goes into default, it often comes under scrutiny by the investor who purchased it on the secondary market. It is at that point when fraudulent information on loan applications often is discovered.

But fraud is not the only reason that secondary-market investors are using to kick mortgages back to their originating banks or brokers. As the housing market continues to struggle, experts say many secondary-market investors are looking for any justification to hold the originator responsible.

Some buyback agreements included in mortgage assignments take effect if a homeowner stops making payments on the loan.

Secondary-market investors also are kicking back loans that were improperly underwritten - for example, not properly vetting a borrower's debt and income.

Two of the most common reasons today, according to an article in American Banker magazine, are the discovery that a borrower had debts that were not disclosed - such as a car loan that wasn't listed on the loan application - and appraisals that overvalued or misrepresented the property.

Coastal Mortgage alleges that the appraised value of Croft's condo "was greatly in excess of what any reasonable person" would have stated. Coastal Mortgage, in its lawsuit, accuses appraiser Roscoe Harless Jr. and his company, Pee Dee Consulting LLC of Florence, of negligence. Harless denied any wrongdoing in court documents.

Another common reason for buyback requests is that a buyer misstated that the property is a primary or secondary residence.

Such misstatements appear to have been common in the Myrtle Beach area during the mid-decade condo boom. A sampling by The Sun News of 252 condo loans made in 2005 showed that 80 percent were underwritten as second homes even though they should have been classified as investment properties.

In some cases, mortgage buybacks are a moot point because the loan originator has gone out of business or has insufficient assets to pay back a bad loan.

"If there has been fraud or misrepresentation in a loan, you can get a remedy assuming the person you sue has the financial wherewithal to buy it back," said Richard Lovelace, a Conway lawyer who specializes in banking law. "They rarely do."

For larger banks, the buybacks will affect earnings because more money will have to be set aside for losses. The banks also lose the fees they made when they originated the loans and typically have to repurchase the mortgages at a loss, both because the loans are in default and the property backing those loans has lost value.

That is why most banks are putting up a fight when asked to repurchase mortgages.

"We continue to fight the battle at a loan-by-loan level," Barbara Desoer, president of Bank of America's mortgage division, told The Wall Street Journal earlier this year.

Although the buybacks represent a liability for banks, they could prove to be a boon for taxpayers by reducing the amount of bailout money needed to rescue Fannie Mae and Freddie Mac.

Freddie Mac, for example, required lenders to repurchase $4.1 billion worth of mortgages last year and had an additional $4.8 million in repurchase requests pending at the end of the first quarter of this year. Fannie Mae does not disclose its mortgage buyback numbers.

Although the buybacks represent a fraction of the projected $150 billion taxpayer bailout that Fannie Mae and Freddie Mac will require, any mortgage that is kicked back to originating banks is one that won't fall to the public's tab.

"Freddie Mac is committed to being a good steward of taxpayer dollars," said Brad German, senior director of public relations for Freddie Mac. "As part of that commitment, we believe it's important that taxpayer dollars not go to loans that should not have been sold to us in the first place."