The saga around second liens continued on Thursday as regulators issued a letter to financial institutions, aiming to end part of the dispute on conflicts of interest present in modifying first liens on a property also secured by a second lien in a subordinate position. The Federal Financial Institutions Examination Council sent a letter to Federal Deposit Insurance Corp. (FDIC)-supervised banks, saying they should modify first liens when it’s in the best interest of investors and owners, despite any ownership of the second lien by the bank. “A servicer’s decision to modify the first lien mortgage should not be influenced by the modification’s potential impact on the subordinate lien loan and vice versa,” the FDIC said. “Any ownership interest in the subordinate lien cannot be a consideration.” The council includes of FDIC chairman Sheila Bair, Office of Thrift Supervision acting director John Bowman, Office of the Comptroller of the Currency chairman John Dugan and Board of Governors of the Federal Reserve System member Daniel Tarullo. The letter said servicers must act on behalf of owners/investors of serviced residential mortgage loans and should modify the first lien mortgage when doing so would produce a greater anticipated recovery than inaction. The council said the servicer should modify the first lien loan “regardless of any potential effect” on the subordinate lien. The opposite, the letter said, is also necessary — that servicers must modify subordinate liens when it is in the best interest of the owners/investors. The letter arrives in the midst of discussions between lawmakers, regulators and lenders on how best to address the different investment positions. Lawmakers in July called for bank regulators to amend the way banks account for subordinate second liens on residential properties in terms of loan loss reserves. They argued banks holding the liens at potentially inflated values — without allowing for greater loss reserves — puts second lien holders on the defense when it comes to modification of first liens. The FDIC also issued a letter to banks, urging more comprehensive consideration of subordinate liens in calculating for loan loss reserves. Write to Diana Golobay.