Mortgage Reduction Deal 'Weeks' Away: Report (Update 1)

Updated with FHFA estimates of taxpayer costs for principal reduction in paragraph 15.

NEW YORK ( TheStreet) -- The draft of a $25 billion mortgage settlement between banks and U.S. states over deceptive foreclosure practices have been sent to state officials for review and could be adopted "within weeks", the Associated Press reported, citing anonymous officials familiar with the discussions.

According to the report, the settlement would bring significant relief to those at risk of losing their homes to foreclosure, with $17 billion likely to go towards reducing principals that struggling homeowners owe on their mortgages. An important caveat is that the settlement would apply only to privately held mortgages issued between 2008 and 2011 and not those controlled by Fannie Mae ( FNMA) and Freddie Mac ( FMCC), which own about half of all mortgages.

But the plan is still likely to benefit over 1 million homeowners.

About $5 billion of the settlement money would be placed in a reserve account for various federal and state programs. Checks of roughly $1,800 will be mailed to roughly 750,000 homeowners who were affected by wrongful foreclosure practices.

About $3 billion would go towards helping borrowers refinance at 5.25%, according to the report.

The nation's five largest banks- Bank of America ( BAC), JPMorgan Chase ( JPM), Wells Fargo ( WFC), Citigroup ( C) and Ally Financial have been in negotiations with State Attorneys General for more than a year over "robo-signing practices" followed by banks in the immediate aftermath of the housing bust.

Talks have frequently broken down over the past year, with California, New York, Nevada and lately Massachusetts pulling out of the negotiations on concerns that the proposed settlement was not enough and that the deal limited their ability to pursue suits against the banks independently.

It is unclear from recent reports whether the proposed settlement will include California. If the state is included, the settlement figures could increase. On the other hand, if the state is not part of the final settlement, banks remain exposed to lawsuits from California, which was at the epicenter of the housing bubble.

It is also yet unclear whether other regional banks will also be a part of the proposed settlement. US Bancorp ( USB), PNC Financial ( PNC), SunTrust ( STI) and HSBC ( HBC) have also been approached by states.

US Bancorp ( USB) took a $130 million fourth-quarter charge, while PNC Financial ( PNC) took a $240-million foreclosure-related charge. The settlement figure could be higher if the regional banks are involved, according to analysts.

Bank stocks have been rallying in 2012, with shares of Bank of America up nearly 30% in January. Hopes that the big banks will finally reach a mortgage settlement have fueled the rally, along with expectations of some sort of broad housing stimulus from the Obama Administration.

Some reports have said that President Obama might make an announcement about the mortgage settlement in his State of the Union Address on Tuesday.

"If a settlement is announced, we see it as a positive for the industry as banks can move on from lengthy litigation and most of the expense associated with a settlement is likely to come in the form of "soft dollars," which may already be charged off," FBR Capital Markets analyst Paul Miller wrote in a report Monday.

The deal might not be an end to banks mortgage woes however. Miller notes that mortgage putback claims increased in the fourth quarter after declining for three consecutive quarters.

The ultimate cost for taxpayers of principal reduction for homeowners "underwater" on their mortgage remains vague. On Monday the Federal Housing Finance Agency released a report saying that "forgiveness" on the estimated three million homes with outstanding balances greater than the value of the home would require $100 billion from Congress, in addition to the cost of credit losses banks would incur in such a scheme.

Bank of America recorded a $1.5 billion mortgage related litigation expense and set aside another $263 million for so-called representations and warranties--relating to investor challenges to mortgage bonds the bank sold leading up to the crisis.

--Written by Shanthi Bharatwaj in New York

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