Sometimes you have to take a step back to take two steps forward, which is what Morgan Stanley appears to be doing Tuesday in a settlement with bond insurance firm MBIA that will result in a $1.8 billion charge but allow the bank to release about $5 billion of capital thanks to a significant reduction in risk-weighted assets.
Tuesday’s agreement comes after Morgan Stanley and MBIA had sued each other over insurance sold on mortgage-backed securities. MBIA, and its peers like Ambac Financial Group, traditionally operated in the somewhat routine business of insuring municipal bonds but expanded into the mortgage market as the housing boom swelled and began writing insurance on mortgage-related instruments that turned sour en masse when the bubble burst.
The settlement terminates credit default swaps Morgan Stanley purchased from MBIA to protect holdings of commercial mortgage-backed securities and resolves the pending litigation between the two and will see an undisclosed cash payment from the bond insurer to the bank. Morgan Stanley had been challenging MBIA’s restructuring, while MBIA had an ongoing suit tied to residential mortgage-backed securities packaged by Morgan Stanley.
The bank will take a $1.8 billion pre-tax fourth-quarter charge tied to the settlement ($1.2 billion after tax), but the agreement also ups its capital ratios thanks to the release of about $5 billion of capital held against the assets involved, which increases the firm’s Basel III Tier 1 Common ratio by about 75 basis points by the end of 2012, Morgan Stanley said.
Chief Executive James Gorman said “It's critical that we reposition for the new regulatory environment and do so quickly. 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. Putting this behind us removes earnings volatility and meaningfully improves our pro forma Tier 1 Common ratio under Basel III.”
Shares of Morgan Stanley, under pressure for months on concerns over the firm’s exposure to European debt, rallied 4.3% in the first hour of trading Tuesday. The gain came amid a wider bounce following Monday’s slide, but Morgan Stanley was a clear outperformer. Rival Goldman Sachs was up just 0.7%, while the broader market gained about 1%.