Aug. 21 (Bloomberg) -- Chelsea Building Society, the 134 year-old customer-owned U.K. lender, said it posted a loss after the discovery of 41 million pounds ($67.6 million) in proven or suspected mortgage fraud.

Chelsea was “vigorously” seeking the return of its money, the firm said today in a statement. Fraud sent provisions for bad loans soaring to 53 million pounds in the six months to June 30, up from 4 million pounds a year earlier, as it recorded a 19 million-pound net loss in the period. That compared with a net profit of 16 million pounds in the first half of 2008.

Many of the suspect transactions involved “buy-to-let,” or landlord loans, in northern English cities, Chelsea said.

“Hopefully all the skeletons are out of the cupboard,” Chairman and interim Chief Executive Officer Stuart Bernau, who was appointed Aug. 1, said in a telephone interview. “Chelsea has identified this early enough and it’s got the opportunity to remain independent so long as it builds sensibly in the future.”

Britain’s building societies, which provide home loans to about 3 million people, have been hit by the credit crunch with several, including Dunfermline, Cheshire and Derbyshire, taken over following financial problems. Former building societies, including Northern Rock Plc and Alliance & Leicester Plc, made “reckless” mortgage loans that helped inflate the housing bubble, the Institute for Public Policy Research, a policy research group with ties to the government, said in May.

Fraud Provisions

Bradford & Bingley Plc, the U.K.’s largest buy-to-let lender before it was nationalized in 2008, last week increased its provisions for fraudulent activity by 56 percent to 271 million pounds. Almost two thirds of the former building society’s mortgage book was composed of loans to landlords.

The extent of mortgage fraud “is probably not known or appreciated by many lenders, as in many instances the accounts are still performing and interest rates are low,” Jonathan Richards, partner at London-based law firm Eversheds LLP, said in an e-mailed statement. “It is reasonable to expect to see many more announcements of this nature” over the next year.

“External consultants have completed a review of the entire mortgage book for suspected or proven fraud,” the company said. A large proportion of the dubious deals were uncovered in newly built apartment blocks in the northern and central English cities of Manchester, Leeds, Birmingham, and Liverpool, Bernau said.

“If you get collusion between an intermediary, a local valuer and perhaps a solicitor, they can start to inflate up property prices,” he said. “When you come to sell the property, it’s worth nothing like what you thought.”

Risk Controls

Chelsea, the U.K.’s fifth-biggest building society, halted buy-to-let lending at the end of 2008, together with commercial, sub-prime and so-called self-certification loans, where borrowers estimated their own incomes. The company also sought to “further improve” its risk controls, the statement said.

Richard Hornbrook, Chelsea’s chief executive officer, will leave the company “by mutual agreement” at the end of this month after four years in the role and Finance Director Andrew Parsons has resigned, the statement said. Bernau will take the CEO job while a replacement is found.

The Financial Services Authority has been cracking down on mortgage fraud since subprime mortgages sparked the credit crisis two years ago. The regulator has banned 60 mortgage brokers since then, the latest occurring two days ago.

Cheltenham, England-based Chelsea’s arrears rose in the first six months of the year, as U.K. unemployment reached 7.8 percent, the most since 1996. The building society didn’t provide detailed figures for its arrears rate, while saying that there were signs that the number of souring loans had been “leveling off” since last month, Chelsea said.

Ratings Downgrades

Bradford & Bingley last week said the proportion of mortgages more than three months in arrears rose to 5.88 percent at June 30.

Fitch Ratings downgraded the debt ratings on five U.K. building societies, including Chelsea, in May citing rising bad loans and difficulties in accessing funding from the wholesale money markets.

West Bromwich, Newcastle, Principality and Yorkshire building societies also had their long-term issuer default ratings reduced. Three weeks later, West Bromwich Building Society was forced into 185 million-pound debt-for-equity swap by the FSA to prevent its breakup.

Chelsea reduced its reliance on wholesale funding in the first half so that its mortgage assets are wholly financed by deposits, the building society said. “Chelsea as focused on returning to the more traditional funding source of retail savings,” the lender said.

To contact the reporter on this story: Kevin Crowley in London at kcrowley1@bloomberg.net

Last Updated: August 21, 2009 11:09 EDT