Disputes over insurers' cancellations of mortgage insurance policies because they were obtained through various types of fraud will be on the increase, a legal expert is forecasting.

Rescinding of policies that were procured by fraud "will become more common as mortgage insurers take steps to protect their rights under mortgage insurance policies," predicted Vineet Bhatia, a partner in the Washington office of Susman Godfrey law firm.

"A lot of these cases are going to end up in arbitration because companies will typically have arbitration included in master policy or commitment documents," Mr. Bhatia said.

The cancellations will come about, he said, as banks and mortgage companies face a rising tide of mortgage delinquencies and file insurance claims to offset a large portion of their losses. "In many cases, they [the banks] will be disappointed," according to Mr. Bhatia.

Mortgage insurers, facing a flood of claims, he said, are rejecting those involving fraudulent loan practices and underwriting "that ran rampant as the housing bubble inflated..."

Mr. Bhatia noted that an insurer can rescind a policy if it can demonstrate that the policy was issued under false premises, i.e., that the policyholder materially misrepresented its business, its risks or its underwriting practices.

According to Susman Godfrey, grounds for rescission cited by mortgage insurers include cases where loan originators and underwriters approved loans using grossly inflated statements of borrower income and assets, fraudulent employment and occupancy information, and false debt-to-income ratios.

There are also cases where banks and other entities created pools of bad loans, and then shifted losses to mortgage insurers by lying about the quality of the loans, the firm noted.

Susman Godfrey said that banks and other originators also used sham appraisers to inflate property valuations that were used to underwrite increasingly risky loans, and that appraisers who refused to participate in the fraud were blacklisted by banks.

The firm also said that banks and other entities had sometimes claimed that the loans they sought to insure were originated according to established underwriting guidelines, even though they knew that the loans failed to meet underwriting guidelines. Mr. Bhatia said his firm currently has a large mortgage insurance case in arbitration that involves hundreds of millions of dollars and he is aware of others that are all sizeable cases.

As an example of the resistance by insurers, Mr. Bhatia, noted that mortgage insurer MBIA had brought a case against Countrywide seeking to recover monies it had paid.

Banks such as Washington Mutual and IndyMac Federal Bank and others, he noted, have significant numbers of bad loans.

But Mr. Bhatia said actual public litigation may not be involved because the companies are most likely to end up in arbitration.

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Mortgage Insurance Fraud Seen Spurring Policy Cancellations

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