Wells Fargo & Co. and eight state attorneys general announced an agreement on Wednesday in which Wells will expand principal reductions and loan modifications for underwater homeowners.

The deal will resolve without litigation those states' inquiries into the marketing of the loans in the $120 billion pool of option adjustable-rate mortgages that Wells acquired through its 2008 purchase of Wachovia Corp. Wells will pay $24 million to the states for borrower outreach and assistance, and has committed to making more than $700 million in principal and interest rate reductions to pick-a-pay mortgages.

Home Affordable Modification Program assistance "will be offered first" to borrowers, said Franklin Codel, a Wells executive vice president who heads the San Francisco-based company's mortgage finance operations. "If they don't qualify for Hamp, we will attempt to qualify them for this modification program."

The eight states did not include California, where 60% of the option ARMs that Wells inherited were written. Wells said it could not address why California had not participated in the eight-state negotiations, but that it had contacted the state about Wednesday's agreement.

"We look forward to talking … about this agreement, and hopefully entering into similar agreements, with other states," Codel said. The eight-state agreement is in many ways an extension of mortgage modification work that Wells has already undertaken. Because the company took a $24 billion purchase-accounting writedown on the pick-a-pay portfolio at the time of Wachovia's purchase, Wells has been able to forgive more than $3.4 billion of debt without recognizing new losses.

Wednesday's agreement will add a new feature to the programs, however: earned principal forgiveness. For qualifying underwater borrowers, Codel said, Wells will be willing to trim loan-to-value ratios to 115% of a home's current value, assuming the borrower continues to make timely payments over the next several years. It will also consider taking such steps on mortgages outside of the eight states, Codel said.

By resolving the concerns of the eight attorneys general, Wells has sidestepped the potential cost and reputational damage of litigation over its predecessors' lending practices. Instead it will invest in mortgage modifications that should improve its ultimate recovery rates on the pick-a-pay portfolio.

Industry observers said Wednesday that Wells' bargain was a less painful way of resolving state investigations, comparing it favorably with a more onerous settlement that Bank of America Corp. agreed to earlier this year in order to resolve state predatory-lending litigation.

"A lot of the old Wachovia loans were probably heading toward this result anyway," said Greg Hebner, the president of MOS Group Inc., a mortgage-loss-mitigation company in Irvine, Calif. "Some of the principal that Wells is writing down is the [negative amortization] piece of the loan."

California's absence suggested to Hebner that Wells might still have some tough negotiating in front of it.

"You've got to believe [the eight AGs] called up [California Attorney General] Gerry Brown and Gerry Brown made a decision that he didn't want to be included," Hebner said. Brown's office did not return a call by press time.

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