Morgan Stanley, MBIA Settle Legal Battle

Morgan Stanley (NYSE:MS) and MBIA have agreed to terminate credit default swaps on commercial mortgage-backed securities and drop litigation against one another in a settlement that will cost Morgan Stanley $1.8 billion pre-tax in the fourth quarter.

Under the terms of the deal, bond insurer MBIA (NYSE:MBI) will withdraw its residential mortgage-backed securities-related suit against Morgan Stanley, and the bank will withdraw from suits challenging MBIA’s restructuring.

Morgan Stanley said the agreement will help it significantly reduce risk-weighted assets, thus releasing about $5 billion worth of capital and strengthening its balance sheet ahead of looming international regulations that call for higher capital levels.

“It's critical that we reposition for the new regulatory environment and do so quickly,” Morgan Stanley CEO James Gorman said. The deal increases the firm’s Basel III Tier 1 Common ratio by about 75 basis points by the end of 2012.

Shares of Morgan Stanley shot up nearly 5% on the news to $16.12, while shares of MBIA climbed nearly 8% to $12.22.

Meanwhile, The Wall Street Journal, citing sources close to the matter, reported that MBIA is paying Morgan Stanley $1.1 billion to settle the two-year-old clash related to about $4 billion in insurance contracts Morgan Stanley bought from MBIA before the financial crisis.

That $1.1 billion charge was not disclosed on Tuesday by either Morgan Stanley or MBIA.