Bond insurer MBIA Inc. will pay Morgan Stanley $1.1 billion to settle a two-year-old legal clash over guarantees tied to commercial and residential real estate, according to a person familiar with the matter.
Talks that spanned the past two months between Morgan Stanley, MBIA and New York's top financial regulator, Benjamin M. Lawsky, culminated late Monday night in a settlement that resolves $4.9 billion worth of insurance contracts Morgan Stanley bought from MBIA before the financial crisis, said the person. Under the agreement, the insurance contracts Morgan Stanley bought from MBIA will disappear, ending the New York securities firm's costly entanglement with the insurer.
As part of the settlement, Morgan Stanley will drop its lawsuit against MBIA and against New York's Department of Financial Services. MBIA also has agreed to drop a lawsuit that claimed Morgan Stanley misrepresented tens of millions of dollars' worth of mortgages backing loans it insured.
Shares of both firms rose in trading Tuesday on news of the settlement. Morgan Stanley rose 42 cents, or 2.7%, to $15.80, while MBIA added 21 cents, or 1.8%, to $11.61.
The settlement with Morgan Stanley is a crucial piece of resolving the litigious puzzle that MBIA has been mired in since the financial crisis, when bond defaults rose, straining its finances. The New York Department of Financial Services has been working on resolving related disputes since Mr. Lawsky took the reins in October.
For Morgan Stanley, the deal will help build capital under international regulatory standards being phased in over coming years, because the settlement reduces the amount of risky assets the firm must hold a cushion against, according to a statement released by Morgan Stanley. The settlement frees up about $5 billion of capital under pending global regulatory requirements, said the statement.
But because Morgan Stanley is tearing up the insurance contracts as part of the settlement, the firm is taking a $1.8 billion charge to fourth-quarter earnings, reflecting the difference between the cash the firm received in the settlement and the contracts' market value.
Chief Executive James Gorman has made a point of unwinding headaches that stemmed from the financial crisis, including selling off unwanted real estate, restructuring ties with Mitsubishi UFJ Financial Group Inc., and spinning off a stake in the hedge fund FrontPoint Partners.
"It is critical that we reposition for the new regulatory environment and do so quickly," said Mr. Gorman.
MBIA hasn't returned a call for comment.
Morgan Stanley and 17 other banks sued the Armonk, N.Y., bond insurer in 2009, arguing it would be unable to make good on its insurance contracts after a restructuring, blessed by New York's insurance department, that split its insurance unit in two. The banks argued the split left them relying on future payments to be made by a financially stretched segment that guarantees souring mortgage securities and other complicated bonds, rather than the healthier piece that guarantees municipal bond payments. MBIA has paid out all of its claims tied to the bonds and disputes those allegations.
The settlement will be paid to Morgan Stanley by MBIA Insurance Corp., with a loan for the $1.1 billion from the municipal insurer, known as National Finance Public Guarantee Corp. The loan was approved by Mr. Lawsky, said a person familiar with the matter.
This settlement is "good for Morgan Stanley, good for MBIA, and good for the markets and our financial system, allowing firms to move forward and rebuild," said Mr. Lawsky in a statement.
Morgan has lost over $3 billion since 2007 from its financial exposure to bond-insurance companies, including MBIA, according to company filings. The bank's hedges on these exposures caused quarterly swings of hundreds of millions of dollars in its earnings, which some analysts have said hurt its stock price since the financial crisis.
For the bond insurance company, the agreement clears it of obligations to guarantee regular principal and interest payments on billions of dollars' worth of commercial real estate related bonds, which could sour in the current market environment. The legal overhang has hurt MBIA, one of the nation's largest bond insurers, in its efforts to win business guaranteeing new municipal bonds.
Morgan Stanley posted profits of $2.17 billion for the third quarter ended Sept. 30, $1.19 billion for the second quarter ended June 30 and $966 million for the first quarter ended March 31. Analysts expect Morgan's fourth-quarter earnings, due out next month, to suffer from soft trading volumes in the fixed-income and commodities markets, as investors retrench amid fears about Europe's debt crisis. Morgan Stanley shares have dropped more than 40% this year.
MBIA has reached settlements with 13 of the 18 companies that together sued MBIA and the New York regulator. The bond insurer hasn't disclosed how much money, if any, it paid in those agreements.
MBIA last month settled with HSBC Holdings PLC, agreeing to pay the bank $30 million, said a person familiar with the matter. A group of five banks remain in the multibank lawsuit against MBIA, including Bank of America Corp., which is separately being sued by MBIA for misrepresenting the mortgages backing the loans the bond insurer guaranteed.
