By Karen Freifeld
(Reuters) - Bond insurer MBIA Inc <MBI.N> and Bank of America Corp <BAC.N> have reached a settlement in an ongoing legal dispute, and BofA will pay MBIA $1.6 billion, sources familiar with the matter said on Monday.
Bank of America will also provide MBIA with a $500 million credit line and receive a 4.9 percent stake in the company as part of the deal, said one of the sources.
MBIA shares, which were temporarily halted, rose 50 percent in afternoon trading to their highest since September 2008.
Representatives of the two companies were not immediately available to comment.
The agreement came together after MBIA's board hired Blackstone Group LP <BX.N> as an advisor and kept Chief Executive Jay Brown out of negotiations, one of the sources said. The sources were granted anonymity because they were not authorized to discuss the matter publicly.
The Bank of America litigation represented a major hurdle MBIA had to overcome to restructure itself after facing billions of dollars' in potential losses on residential mortgage securities it backed in the run-up to the financial crisis.
MBIA had sold credit default swaps to banks to protect them against losses on those securities. As the underlying loans went bad and the bonds lost value, banks argued MBIA was on the hook for losses. MBIA argued that the quality of the underlying loans had been misrepresented and litigation ensued.
In 2009, the insurer received approval to split itself into two separate businesses: a municipal bond insurer that would underwrite new deals and a guarantor of structured finance products that would handle old claims. A group of 18 banks objected to the restructuring, saying it would leave MBIA insolvent and unable to pay their mortgage-related claims.
All but two of the banks have since settled with MBIA. Bank of America and Societe Generale <SOGN.PA> sued MBIA and the state insurance department seeking to annul the restructuring. A judge dismissed the case and the banks appealed.
In its annual report on February 27, MBIA said its structured finance unit could be forced into liquidation or rehabilitation if litigation with Bank of America was not settled. The settlement avoids that risk.
Benjamin Lawsky, financial services superintendent for the state of New York, was involved in the Bank of America-MBIA settlement, with sides working through the weekend to reach a deal, one source said. Lawsky's office also worked on another big settlement between Morgan Stanley <MS.N> and MBIA in December 2011.
A spokesman for Lawsky's office declined to comment.
News of the Bank of America settlement was first reported by Dow Jones.
(Reporting by Karen Freifeld in New York.; Additional reporting by Lauren Tara LaCapra and Ben Berkowitz; Editing by Maureen Bavdek and Andre Grenon)