UPDATE 2-U.S. banks and states meeting on foreclosure probe

Wed May 11, 2011 7:06pm EDT

* Talks expected to last all week

* Banks propose $5 billion settlement figure - source

* Two sides "still far apart" -- Connecticut AG (Changes sourcing on $5 billion proposal)

By Dave Clarke

WASHINGTON, May 11 (Reuters) - U.S. state attorneys general are pressing five large banks to reduce loan balances for troubled borrowers as part of a settlement over mortgage servicers' foreclosure practices.

The two sides -- which include Bank of America Corp (BAC.N), JP Morgan Chase & Co (JPM.N), Citigroup Inc (C.N), Wells Fargo & Co (WFC.N) and Ally Financial -- began meeting on Tuesday and the talks are expected to last most of the week.

"We are still far apart on some issues," Connecticut Attorney General George Jepsen said on Wednesday.

The negotiations have been going on for months and to kick off this round the states and their partner federal agencies, which include the departments of Justice and Housing and Urban Development, revised an earlier 27-page settlement proposal sent to banks in March.

The revised termsheet includes a proposal for how states and the federal government would use whatever penalty banks agree to pay, as well as earlier proposals for overhauling how servicers deal with troubled homeowners.

A spokesman for Iowa Attorney General Tom Miller, leader of the states' investigation, said the proposal includes using the funds for reducing the balance of troubled homeowners' loans, but the funds would also be used for other programs.

"Principal reduction is still very much on the table, but it would not be accurate to characterize it as a principal reduction fund," said Geoff Greenwood, Miller's spokesman. "That would just be one component."

Greenwood said the funds could go toward such things as mediation programs and state hotlines that borrowers could call when they need help.

How much banks should pay to settle with the states and federal agencies remains the key issue.

The agencies involved in the talks earlier this year had discussed making the banks pay in the range of $20 billion as part of the settlement. The banks floated the idea this week of settling for $5 billion, according to a source familiar with the negotiations.

Greenwood said the states and federal agencies involved did not propose a settlement amount going into negotiations this week. Jepsen said the states are "hopeful" about reaching an agreement.

Federal regulators and state attorneys general have been investigating bank mortgage practices that came to light last year, including the use of "robo-signers" to sign hundreds of unread foreclosure documents a day.

Last month, 14 mortgage servicers, including those involved in talks with the states, separately reached a settlement with federal banking regulators.

That deal requires them to overhaul their mortgage servicing practice, compensate borrowers who were wrongly foreclosed upon and undergo an independent review of their 2009 and 2010 foreclosures. [ID:nN13259474]

Money penalties have still to be decided.

Under this agreement banks have to come up with a plan by next month on how they will overhaul their servicing standards.

It is possible that an agreement with the states could be coordinated and incorporated into these plans.

The banking regulators involved in last month's settlement are the Office of the Comptroller of the Currency, the Federal Reserve and the Office of Thrift Supervision. (Additional reporting by Dan Levine in San Francisco; editing by Richard Chang and Andre Grenon)