Morgan Stanley and municipal bond insurer MBIA Inc. have settled a series of lawsuits.
“The comprehensive settlement terminates outstanding credit default swap protection purchased from MBIA on commercial mortgage-backed securities and resolves pending litigation between the two parties for consideration of a net cash payment to Morgan Stanley,” the bank said in a press release.
MBIA is paying Morgan Stanley $1.1 billion, according to a source familiar with the deal.
The settlement was announced Tuesday morning. As part of the settlement, Morgan Stanley will withdraw from litigation that challenges MBIA’s spin-off of its municipal bond insurance portfolio and MBIA will drop its suit alleging Morgan misrepresented the risks of the securities it insured.
MBIA’s problems stemmed from the busted real estate bubble, during which many banks made dubious loans and securitized them. MBIA and other companies insured these securities through issuing credit default swaps to Morgan Stanley and other banks.
When the recession hit in 2008, real estate values plunged, unemployment spiked, and many homeowners stopped making payments on their mortgages. The securities turned out to be worth far less than promised.
After the securities failed, Morgan Stanley and other banks asked MBIA to make good on their pledge to insure them.
In 2009, MBIA decided to place its financially healthier municipal insurance business in a new unit. It left MBIA Insurance Corp. to insure structured finance products including mortgage-backed securities and non-US public finance. This unit, which included some weaker performing parts, would pay claims on the mortgage-backed securities that MBIA had guaranteed before the crisis. In response, Morgan Stanley and many other banks sued parent company.
For its part, MBIA sued Morgan Stanley and other firms for misrepresenting the soundness of the mortgage loans that the banks had MBIA insure.
However, MBIA had insured $4 billion in mortgage securities before the financial crisis, according to the Wall Street Journal. By accepting the settlement, Morgan Stanley is acknowledging that it will never receive the full amount. There can be incentives for policy holders to commute a policy early, said MBIA spokesman Kevin Brown.
“The pre-tax loss on the settlement will approximate $1.8 billion ($1.2 billion after tax) in the current quarter,” Morgan Stanley said.
“The settlement has the effect of significantly reducing risk-weighted assets and releasing the equivalent of approximately $5 billion of capital under the Basel Committee’s proposed Basel III framework, thereby increasing the pro forma Tier I Common ratio under Basel III by approximately 75 basis points by the end of 2012,” Morgan Stanley said.
As of the close of the stock market onTuesday, MBIA’s shares were up 0.7% for the day. Morgan Stanley’s shares were down 1.4%.
The Royal Bank of Scotland reached a separate settlement with MBIA in mid-November.
On Monday HSBC Holdings PLC settled with MBIA. MBIA agreed to pay HSBC $30 million, said Manal Mehta, co-founder of hedge fund Branch Hill Capital, which owns MBIA stock.
Responding to the much larger settlement with Morgan Stanley, Mehta said, “This news comes as a surprise. The fact that they could resolve it is fantastic news for MBIA.”
Morgan Stanley was one of the three large counterparties suing MBIA, Mehta said. One was Royal Bank of Scotland, which has settled.
MBIA’s claim against Morgan Stanley was small and Morgan Stanley had a large claim against it. So this settlement was likely to be a difficult one to reach for MBIA, he said.
While the remaining large counterparty Bank of America and its subsidiary, Merrill Lynch, remain in the suits against MBIA, on an overall basis the Bank of America companies owe MBIA $2 billion, Mehta said. So the painful part of resolving the suits is behind MBIA.
“It puts them in a trajectory to settle all outstanding litigation and return [its bond insuring subsidiary National Public Finance Guarantee Corp.] to a position where it can start writing new policies,” Mehta said.
Mark Palmer, managing director of BTIG LLC, was less effusively positive about the settlement. “It’s certainly a step forward for MBIA in the litigation,” he said.
“It may well presage a settlement with Bank of America.” It is in Bank of America’s interest to settle, he said.
MBIA now has “momentum.”
The remaining plaintiffs against MBIA are BNP Paribas, Merrill Lynch International, Bank of America NA, Natixis, Natixis Financial Products LLC, Societe Generale, and the London branch of UBS AG.
