Morgan Stanley Settles Dispute With MBIA, Terminating Swaps

Morgan Stanley Sees Pretax Loss on MBIA Settlement $1.8b
Morgan Stanley signage is displayed at their headquarters in New York. Photographer: Peter Foley/Bloomberg

Morgan Stanley reached a settlement with MBIA Inc. over credit-default swaps that led to billions of dollars of losses for the bank, agreeing to terminate the contracts and drop a challenge to the insurer’s restructuring.

MBIA will make a $1.1 billion cash payment to Morgan Stanley as part of the settlement, according to a person familiar with the agreement who asked not to be named because the amount hasn’t been made public. Morgan Stanley will take a $1.2 billion loss this quarter related to the deal, the New York-based bank said today in a statement.

Morgan Stanley’s exposure to MBIA, and its attempts to hedge those risks, have resulted in losses of about $3 billion since the start of 2008, not including today’s announcement. The settlement will increase Morgan Stanley’s capital, boosting the Tier 1 common ratio under new rules by about 75 basis points, according to the statement.

“It’s critical that we reposition for the new regulatory environment and do so quickly,” Morgan Stanley Chief Executive Officer James Gorman said in the statement. “A top priority for 2011 was to address this large outstanding legacy exposure and this settlement is consistent with our efforts to build capital and de-risk the balance sheet.”

Morgan Stanley fell 21 cents, or 1.4 percent, to $15.17 at 4:15 p.m. in New York, after climbing as much as 7.6 percent. MBIA increased 0.7 percent to $11.48.

MBIA Hedges

The bank’s loss will come from writing down the value of the swap contracts with MBIA. Morgan Stanley had $4.9 billion of gross derivative counterparty risk to MBIA as of Sept. 30, and $2.7 billion after credit valuation adjustments, according to its quarterly filing with the SEC. The bank also had about $700 million of hedges against MBIA.

The agreement “removes a legal headache, and should give a boost to Morgan’s balance-sheet efficiency” Glenn Schorr, an analyst at Nomura Holdings Inc., said in a note to investors. The deal “could also cause the firm’s CDS spread to tighten as earnings volatility should decline,” Schorr said.

MBIA, based in Armonk, New York, will withdraw a suit against Morgan Stanley relating to $223 million of residential mortgage-backed securities. Morgan Stanley plans to end its participation in litigation challenging the split of the insurer’s business.

“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,” Benjamin Lawsky, New York state’s financial services superintendent, said in a separate statement.

Kevin Brown, a spokesman for MBIA, declined to comment.

Bank of America

The settlement “significantly” reduces Morgan Stanley’s risk-weighted assets under new rules from the Basel Committee on Banking Supervision, known as Basel III, according to the statement. Morgan Stanley had a Basel III Tier 1 common ratio of more than 7 percent as of Sept. 30, and the increase brings it closer to the range of 8 percent to 10 percent the firm said it planned to reach by the end of 2012.

Morgan Stanley’s MBIA exposure would have accounted for as much as 15 percent of the firm’s risk-weighted assets under Basel III, and the risk may have lasted for more than 10 years, Howard Chen, a Credit Suisse Group AG analyst, wrote in a note to investors.

Buyback Speculation

The deal increases the likelihood that Morgan Stanley will buy back shares or increase the dividend next year, according to Ed Najarian, an analyst at International Strategy & Investment Group Inc. Morgan Stanley has authorization for $1.6 billion of share repurchases. The firm hasn’t bought back any stock in the first nine months of this year, and would need regulatory approval to do so.

Bank of America Corp., the second-biggest U.S. lender by assets, made a preliminary offer to MBIA earlier this year aimed at settling their legal dispute tied to defective mortgages, two people briefed on discussions said in July. The companies were split on how much the Charlotte, North Carolina-based bank would have to pay to resolve the disagreement.

About two dozen banks and investment firms sued MBIA and regulators after the 2009 split of its main bond-insurance unit into two businesses. The division created a new company holding the state and municipal-bond guarantee business the insurer seeks to maintain, and left the old unit holding soured mortgage-backed debt that caused them to be shut out of the market. Lenders claimed the restructuring was a “fraudulent conveyance” that rendered the old insurer, MBIA Insurance Corp., insolvent.

Ending Lawsuits

Units of Wells Fargo & Co., Credit Agricole SA, KBC Groep NV, HSBC Holdings Plc, and Royal Bank of Scotland Group Plc have pulled out of the suits in the past four months, according to court papers. Funds run by New York-based Fir Tree Partners dropped out of a similar lawsuit by hedge funds and Third Avenue Trust, also based in New York, ended a separate case in October. Five of 18 banks that sued MBIA and the New York State Insurance Department including UBS AG, BNP Paribas SA, and Bank of America are still fighting the split.

“The remaining plaintiff policyholders will continue to fight to restore the billions fraudulently taken from MBIA Insurance,” Robert J. Giuffra, lead counsel for the banks and a partner at Sullivan & Cromwell LLP in New York, said in a separate statement.


Banks have discontinued litigation as MBIA negotiates settlements over the credit-default swaps it sold to the lenders to protect against losses on mortgage securities and other debt. MBIA said Nov. 10 that it had settled $10.6 billion of transactions since Sept. 30 at an undisclosed cost, bringing the amount of bets terminated this year to $23 billion.

The cost to protect against a default by the MBIA unit that sold the guarantees fell. Credit-default swaps eased 8 percentage points to a mid-price of 35 percent upfront as of 9:37 a.m. in New York, according to broker Phoenix Partners Group. That’s in addition to 5 percent a year, meaning it would cost $3.5 million initially and $500,000 annually to protect $10 million of MBIA’s debt.


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