NEW YORK (Reuters) - As part of a settlement with state attorneys general that could be worth as much as $8.6 billion, Bank of America Corp BAC.N said on Monday it would cut interest rates and principal on some troubled mortgages originated by Countrywide Financial Corp.

Bank of America, which bought Countrywide in July, reached a deal with attorneys general representing 11 states in which it will offer more affordable and sustainable mortgage payments for borrowers who had financed their homes with subprime loans or adjustable-rate mortgages serviced by Countrywide.

“This is good,” said Christopher Whalen, managing director at Institutional Risk Analytics, a provider of analysis and ratings for banks. “I hate to say we’ll need to see a lot more of this, but we will. Banks have no choice because the economy’s getting so flat. They’re going to become increasingly aggressive about keeping homeowners in their homes.”

The Countrywide settlement will likely become the largest predatory lending settlement in history, the California attorney general’s office said in a statement.

“With this settlement, homeowners will receive direct relief from the catastrophic damage caused by Countrywide,” said California Attorney General Edmund Brown in a statement.

“Countrywide’s lending practices turned the American dream into a nightmare for tens of thousands of families by putting them into loans they couldn’t understand and ultimately couldn’t afford,” he said.

States including West Virginia, California, Connecticut and Illinois had sued Countrywide over its business practices, alleging that the mortgage lender had made risky and costly loans to consumers who could not afford them.

ONCE NO. 1

Countrywide was once the largest U.S. mortgage lender before being acquired for about $4 billion in stock by Bank of America as its risky subprime mortgage loans began to fail.

“We have committed significant resources and developed innovative programs to help as many Countrywide customers as possible stay in their homes,” Barbara Desoer, president of Bank of America Mortgage, Home Equity and Insurance Services, said in a statement.

Bank of America shares fell $1.79, or 5.2 percent, to $32.69 in midday New York Stock Exchange trading. The KBW banks index .BKX was down 6.1 percent.

Whalen said Bank of America’s stock price decline was linked to general concern about the health of U.S. financial institutions rather than the settlement.

“Most people would probably view this (settlement) as a neutral to a positive,” said Whalen. It could cut profits, he said, but “one would hope that the loss rates would be lower and you’d keep more people in their homes and paying their mortgages.”

The deal will enable eligible subprime and pay-option mortgage borrowers to avoid foreclosure by obtaining a modified and more affordable loan. The loans covered by the settlement are among the riskiest and highest defaulting loans at the center of America’s foreclosure crisis.

Pay-option mortgages allowed borrowers to pay only a fraction of interest and principal owed each month, allowing the loan balance to increase.

400,000 ELIGIBLE

The deal applies to people who financed their homes with subprime loans or pay-option adjustable-rate mortgages serviced by Countrywide that originated before Dec. 31, 2007. Some 400,000 borrowers could be helped by the agreement.

The program centers around a loan modification process, valued up to $8.4 billion, aimed at providing relief to eligible borrowers who are “seriously delinquent” or are likely to become so due to loan features, such as rate resets or payment recasts.

About 12 percent of the eligible loans are held by Bank of America and the cost of restructuring these loans is “within the range of losses we estimated when we acquired Countrywide,” Bank of America said.

Under the program, eligible Countrywide-serviced customers who occupy the home as their primary residence will not be charged loan modification fees, and prepayment penalties for subprime and pay-option ARM loans will be waived, the bank said.

Some $150 million has been set aside for borrowers in certain states who suffered foreclosure or are at serious risk of foreclosure, the bank said.

An additional $70 million has been set aside for relocation assistance to borrowers unable to retain their homes.

Attorneys general in 11 states, including Arizona, California, Connecticut, Florida, Illinois, Iowa, Michigan, North Carolina, Ohio, Texas and Washington, are participating in the settlement.

The settlement does not include Angelo Mozilo, the former chairman and chief executive of Countrywide Financial Corporation or David Sambol, formerly the president of Countrywide Home Loans and president and chief operating officer of Countrywide Financial Corporation.