Talks between the Arizona Department of Housing and Wells Fargo (WFC) to reduce the principal on more distressed mortgages are "progressing," according to a source familiar with the negotiations. Arizona received $268 million of the more than $7.6 billion in Hardest Hit Fund dollars disbursed by the Treasury Department last summer. It will put some of this money to pay participating banks incentives for writing down the principal on these loans. Wells began talks with the Arizona Department of Housing earlier in the year to possibly provide principal reduction assistance. Bank of America (BAC) began notifying its Arizona borrowers in March of possible principal writedowns, targeting roughly 8,000 homeowners. But talks with other large institutions continue to linger. Wells told the Arizona Department of Housing that it was already committed to principal reduction as a nationwide option, according to the source. From January 2009 through March 2011, Wells forgave more than $3.9 billion principal, according to its first quarter financial supplement. A spokesperson at the bank said Wells is not participating in principal writedowns through HHF now but is providing unemployment, reinstatement and transition assistance. "We continue to discuss the Hardest Hit Fund principal reduction program in Arizona and in other states," the spokesperson said. A principal reduction program is still an option under the ongoing negotiations between mortgage servicers and the 50 state attorneys general. James Frischling, president and co-founder of financial advisory firm NewOak Capital said using taxpayer funds to reduce principal requires a delicate balance. "The perception that certain borrowers are being bailed-out would send the wrong message to the vast majority of borrowers who are doing everything possible to stay current on their obligations, so the relief needs to be provided in a fair and equitable manner, and much more needs to be done," Frischling said. Write to Jon Prior. Follow him on Twitter @JonAPrior.