Federal regulators are starting to put pressure on banks to recognize losses on second liens in markets where the first mortgage is underwater due to declining house values.

"Failure to timely recognize estimated credit losses could delay appropriate loss mitigation activity, such as restructuring junior lien loans to more affordable payments or reducing principal on such loans to facilitate refinancing," the Federal Deposit Insurance Corp. says in a letter to banks.

House Financial Services Committee chairman Barney Frank, D-Mass., and Senate Banking Committee chairman Christopher Dodd, D-Conn., recently urged the regulators to stop allowing banks to carry home equity loans at inflated values. "Carrying these loans at potentially inflated values may contribute to resistance on the part of servicers to negotiate the disposition of these second liens," the chairmen say in a July 10 letter.

The FDIC Financial Institution Letter reminds banks of 2006 interagency guidance that says delaying recognition of losses on second liens in declining markets is an "inappropriate" accounting practice.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.