Chelsea drops into the red on buy-to-lets fraud damage

Today the Chelsea building society, Britain's fifth largest, founded in 1875, revealed it had set aside £41 million to cover mortgage frauds, pushing it into the red.

It said the frauds took place between 2006 and 2008 and were mainly as a result of "third-party professionals" artificially inflating the values of properties on which it lent buy-to-let mortgages.

Stuart Bernau, who only joined Chelsea as chairman three weeks ago and is also acting chief executive, said: "Buy-to-let mortgage applications don't come in through branches, they come from mortgage brokers. Some of them, linking with valuers and in some cases solicitors, have produced inflated valuations for properties when they applied for mortgages. This is definitely criminal activity."

He admitted the society may also have been at fault. He said: "We should have had much stricter criteria, particularly in using independent valuers. But Chelsea was far from alone in expanding rapidly in the buy-let market between 2006 and 2008. No doubt further fraud provisions will emerge through other institutions' accounts."

Last week the taxpayer-owned Bradford & Bingley set aside another £100 million for potential losses from fraudulent or professionally negligent mortgages.

This month the Financial Services Authority banned mortgage broker Newcastle Home Loans and five of its executives, fining them a total of £255,000 for applying for mortgages "considerably higher than the purchase price of the property".

The FSA worked with Northumbria Police and the Solicitors Regulation Authority on the case and is believed to have dozens of other investigations under way. The Association of Chief Police Officers last year warned mortgage fraud in the UK could total £700 million. It said it was "attractive to criminals because of the low risk of detection and high profit opportunities." Bernau said the building society was "vigorously pursuing" methods of getting its money back and had insurance against mortgage fraud up to £10 million which it not claimed on.

He added: "KPMG have crawled over our entire mortgage book for suspected and proven fraud. We have now ring-fenced it" Chelsea said ordinary, legal mortgage arrears rose in the first half, leading to writedowns of £12 million. With the fraud, that pushed it from pre-tax profits of £23 million to £26 million losses.