Bank of America Corp. to pay MBIA Inc. $1.7 billion to settle a dispute over soured mortgage securities issued during the U.S. housing boom, eliminating major legal uncertainties for both companies.
The pact comes as MBIA faced a rise in mortgage-related claims, and it will keep the Armonk, N.Y., company's insurance unit from being taken over by the New York state financial regulator, said people familiar with the deal.
Shares of both companies rose on the news. MBIA rocketed 38% and Bank of America advanced 4.6%.
A Bank of America spokesman declined to comment. "While work remains to be done, today's announcement represents a significant milestone in MBIA's transformation for the future and toward our goal of resuming growth in shareholder value," Jay Brown, MBIA's chief executive officer, said in a statement.
Bank of America will pay MBIA $1.6 billion in cash, along with some other compensation, and provide MBIA with a credit line of $500 million. BofA will also get stock-purchase warrants in MBIA's holding company that could give it a stake of about 4.9%.
Isaac Gradman, an attorney specializing in mortgage-backed-securities litigation at the firm Perry Johnson Anderson Miller & Moskowitz LLP, in Santa Rosa, Calif., said he had never come across a settlement in this area where one party takes a stake in the other. "It ties the state of these two companies together and gives MBIA an anchor in one of the big-four banks," he said.
The agreement follows intermittent settlement talks over the past six months, said people familiar with the matter. The two sides worked through the weekend, as did Benjamin Lawsky, the New York Department of Financial Services superintendent, to bring about the deal.
The pact comes a little more than a week after the MBIA unit, known as MBIA Insurance Corp., hired law firm Weil Gotshal & Manges LLP. The MBIA unit had faced running out of money as early as this month, when cash payments on billions of dollars of insurance claims tied to commercial-mortgage-backed securities start coming due.
The agreement eliminates one of the last overhangs for MBIA, which was sued by more than a dozen banks over its split during the financial crisis into one healthier bond insurer that focuses on guaranteeing municipal-bond payments and another, MBIA Insurance Corp., that insured complex financial instruments and mortgage securities that soured during the crisis. The banks argued the split unfairly limited their potential recoveries in actions against MBIA Insurance Corp. by diverting much of its resources to a separate entity.
Mr. Lawsky inherited the matter when he took over as New York's superintendent of financial regulation in October 2011, and he has pushed for more than a dozen deals with banks and MBIA to try to keep the state from taking the insurance unit over in a process known as receivership.
One such pact was a $1.1 billion deal in December 2011 with Morgan Stanley MS +2.28% . That settlement was facilitated by an intercompany loan of more than a billion dollars from MBIA's healthier municipal-bond insurer.
Some hedge funds have staked out aggressive positions on the MBIA litigation. Manal Mehta, a partner at the hedge fund Sunesis Capital, said his firm bet on MBIA, wagering the big banks would end up having to pay for questionable, pre-financial-crisis underwriting practices.
"The question came up: Who is going to be the beneficiary of recoveries by suing the banks?" he said.
Bank of America is working to put its legal troubles behind it but continues to spend heavily on resolving legal disputes. It took an $881 million charge in the first quarter to cover matters that included a $500 million settlement of three class-action lawsuits that arose from mortgage-backed securities sold to investors by Countrywide, a lender Bank of America acquired during the financial crisis.
The company faces a May 30 hearing in which a New York state judge could decide whether to approve an $8.5 billion settlement with investors in mortgage-backed-securities. Some analysts say the bank's legal costs could skyrocket if the settlement, which was struck almost two years ago, isn't approved.
Paul Miller, an analyst with FBR Capital Markets, called the MBIA settlement a "mild positive" for Bank of America since the settlement shows the bank is making progress in putting its legal troubles in the past.
"BofA did a great job convincing people that a lot of this legacy stuff is behind them," he said. "So far, they've been more right than wrong, and they're getting these things slowly behind them."
Whether a judge will approve the $8.5 billion settlement with investors is far more worrisome for the firm, Mr. Miller said.
"That's an overhang that's still very real," he said, adding that the judge could take months to rule. Mr. Miller also noted the bank continues to struggle to increase earnings. Because of that, he said he still doesn't think "there's a lot of upside to the company at this point."
Other developments Monday highlight how the bank remains vulnerable to legal action.
New York State Attorney General Eric Schneiderman said Monday he plans to sue Bank of America and Wells Fargo & Co. over alleged violations of a landmark $25 billion settlement aimed at providing aid to homeowners struggling to pay their mortgages.
Mr. Schneiderman said the banks violated standards they promised to adhere to when they settled with 49 states' attorneys general last year. Part of the settlement included rules over how to conduct fair and timely service to homeowners. Mr. Schneiderman said his office found 339 violations of those rules by the two banks.
"Through March we have provided relief for more than 10,000 New York homeowners through the National Mortgage Settlement, totaling more than $1 billion," Bank of America said in a statement. "Attorney General Schneiderman has referenced 129 customer servicing problems which we take seriously and will work quickly to address."
Wells Fargo didn't immediately respond to a request for comment.