FDIC Calls for Consideration of Junior Liens
The Federal Deposit Insurance Corp. on Monday issued a letter to banks calling for new considerations when estimating credit losses on junior liens on one- to four-family homes. The letter calls for quarterly adjustment of loan loss allowances related to these estimated losses, indicating banks may soon have to beef up reserves if heavy losses are expected on junior liens. The FDIC is urging a historical perspective in estimating losses on these loans, including history of a borrower's repayment status regarding first liens and any delinquencies or modifications. The letter also asks banks to consider changes in the value of underlying real estate collateral. A significant item of inspection included in the letter is the collectibility of junior lien loans and whether underlying collateral is sufficient to protect the junior lien position in a foreclosure proceeding initiated by a senior lien holder. "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 refinancings," the FDIC said in the letter. "Examiners will continue to evaluate the effectiveness of an institution's loss mitigation strategies for loans as part of their assessment of the institution's overall financial condition." The letter arrives on the heels of a push from lawmakers to reconsider the value of junior and second liens held on banks' balance sheets. Without accurately estimated loan losses, some second lien holders resist modification efforts, the lawmakers said in a letter. Senate Banking Committee chairman Chris Dodd, D-Conn., and House Financial Services Committee chairman Barney Frank, D-Mass., in mid-July dispatched a letter to the heads of bank regulators, calling for action on the issue of second liens. “Carrying these loans at potentially inflated values may contribute to resistance on the part of servicers to negotiate the disposition of these liens, and thus may stand in the way of increasing participation" in certain modification programs, the letter said. “Inadequate reserving would also overstate the capital position of these institutions at a time when an accurate picture of the capital adequacy of the banking system is crucial.” Write to Diana Golobay.