Large U.S. banks defending themselves against a mass of state and federal mortgage probes face a difficult tactical decision following New York state's exit from settlement talks on Tuesday.

A settlement with the states remaining at the negotiating table and their partner federal agencies may be easier to strike, and could give skittish investors a sense of the size of banks' liability.

But a partial deal would leave open the question of whether the more aggressive attorneys general will be able to extract their own massive settlements, analysts and industry lawyers said.

The banks (have) got to be thinking what is the benefit of a deal with Iowa when New York and Massachusetts can still come after them, said a lawyer close to the process who asked not to be identified because of the sensitive nature of the talks.

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

States and the departments of Justice and Housing and Urban Development have been negotiating for months with Bank of America, JPMorgan Chase, Citigroup, Wells Fargo and Ally Financial.

The uncertainty over banks' mortgage-related exposures has weighed heavily on their stocks. The KBW Bank Index of stocks is down about 30 percent this year. Shares in Bank of America, the largest U.S. bank by assets, are down about 50 percent.

A focus of the settlement talks is what type of legal protections banks will get for agreeing to change their practices and for paying a combined penalty of possibly around $20 billion.

The contentious issue has caused fissures within the block of states dealing with the banks.

New York Attorney General Eric Schneiderman has insisted that any deal should not preclude states from pursuing further cases against the banks related to their mortgage practices.

Iowa Attorney General Tom Miller, the states' lead negotiator, announced on Tuesday that Schneiderman had been booted from the committee working on the deal.

Miller said in a statement that in recent weeks New York has actively worked to undermine the multi-state groups work because of differences with how to proceed.

Schneiderman's office said he will continue to pursue a comprehensive resolution to mortgage problems.

New York could still sign on to a final deal negotiated by Miller's team, although that seems unlikely at the moment.

Analysts said Schneiderman's departure shows the remaining states, along with their partner federal agencies, are eager to strike a deal. It also could mean the settlement figure would be lower because fewer states may take part in the agreement, although government negotiators will fight to prevent it from dropping too much.

Guggenheim Securities LLC analyst Marty Mosby said even a more limited deal would likely help the banks because it would provide more certainty about the size and scope of the liabilities they face. We go from guestimating to estimating, Mosby said. The range of possibilities begins to narrow and you can get more comfortable.

A partial settlement may also help banks in their dealings with aggressive AGs like Schneiderman.

Gilbert Schwartz, partner at Schwartz & Ballen LLP and a former Federal Reserve lawyer who is not involved in the negotiations, said lenders could point to the settlement as a precedent both during negotiations with Schneiderman and in court.

If he has to go his own way, the banks are just going to get their backs up and fight him, Schwartz said.

(Reporting by Dave Clarke; Editing by Tim Dobbyn)

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