Morgan Stanley (NYSE:MS) settled its differences with insurer MBIA over credit default swaps linked to mortgage securities earlier this month.  The investment bank withdrew its 2009 lawsuit against MBIA in return for a $1.1 billion payment – allowing it to finally remove risky assets worth billions from its balance sheet. These assets contributed significantly to the volatility in Morgan Stanley’s earnings figures for nearly 4 years. There is, however, a price to pay as the bank will have to recognize pre-tax charges worth $1.8 billion for this quarter. This amounts to a $1.2 billion reduction in earnings – which can potentially drag its performance numbers for the quarter into the red. The settlement now leaves UBS (NYSE:UBS) and Bank of America (NYSE:BAC) in the legal tangle with MBIA
We have a $21 price estimate for Morgan Stanley’s stock and attribute the 32% premium to the current market price to the pessimistic outlook for banking stocks in the wake of economic slowdown and deteriorating European debt crisis.
The MBIA Lawsuit: History And Rationale
MBIA was a favorite among major investor banks before 2008 as an issuer of credit-default swaps (CDS). These CDS largely guaranteed mortgage-backed securities besides some other structured products. But when the housing bubble burst in 2008, MBIA ended up owing the banks a huge sum due to the CDS it issued and was forced to turn belly-up. Regulators had to step in, and approved a restructuring of MBIA into two units – a decision met with immediate opposition by 18 banks. The banks held that such a restructuring will severely impair MBIA’s ability to settle with them, and filed the lawsuit.
Morgan Stanley Throws in the Towel
After fighting it out for nearly 2 years, Morgan Stanley finally withdrew from the lawsuit following the settlement with MBIA. The settlement will bring in $1.1 billion in cash for the investment bank, besides freeing as much as $5 billion of capital.
The immediate impact of the settlement will be seen in this quarter’s performance figures – with Morgan Stanley taking a $1.8 billion charge. This amounts to a reduction in the 2011 margins of the bank’s bond trading business from our current estimate of 29% to just under 9%. While this represents a 1% decrease in our price estimate for the bank’s value – it could actually result in the bank reporting a loss for the quarter, as the bank had a pre-tax income of just around $1.5 billion in each of the two previous quarters, ignoring the effect of the gain due to the revaluation of its own debt.Notes:
- Morgan Stanley Capital Services Withdraws From MBIA Lawsuits, Bloomberg Businessweek, Dec 15 2011 [↩]