Morgan Stanley has agreed to pay $2.6 billion to settle U.S. claims arising from the sale of mortgage bonds. This is the largest payout by the Wall Street firm from the financial crisis. The settlement ends a U.S. Justice Department investigation into claims that Morgan Stanley deceived investors by misrepresenting the quality of the home loans the firm packaged into bonds. It follows multibillion-dollar settlements the government reached with other big banks.

The agreement also resolves one of the last, and biggest, “legacy” issues that have weighed on the firm, its chief executive, James Gorman, and shareholders since the 2008 crisis. For Morgan Stanley, the price to move on is steep – wiping out a chunk of earnings – though it will be paid retroactively. In a regulatory filing that disclosed the deal, Morgan Stanley said it increased its legal reserves by about $2.8 billion, accounting for the costs in its 2014 results. The higher reserves will cut its income from continuing operations by $2.7 billion, or $1.35 a share, more than a third of its 2014 net income.

Last month, Morgan Stanley said it earned $6.2 billion, or $2.96 a share, from continuing operations in 2014. Large U.S. banks have now paid about $130 billion in settlements, fines and other costs related to the worst economic downturn in decades. On a January conference call with analysts, Mr. Gorman said his management team had worked hard during the past five years to “put the trouble from the financial crisis clearly in the rearview mirror.” The deal with the Justice Department won’t end once and for all of Morgan Stanley’s legal headaches.

The New York firm would still have to negotiate with the agency about other settlement terms, including what is included in a statement of facts that it must have to sign off on. The accord doesn’t cover other related probes by state litigators, helping to explain why the Wall Street firm had reserved $200 million above what it agreed to pay federal officials, said a person familiar with the matter. While Morgan Stanley was expected to settle the government probe, the large size of the penalty was still surprising. The company reached its agreement in principle with the Justice Department and U.S. Attorney’s Office for the Northern District of California.

The $2.6 billion settlement comes in the form of a cash penalty. Unlike some of the other bank settlements, Morgan Stanley’s deal with the government doesn’t include an agreement to provide aid to struggling homeowners.

The Morgan Stanley agreement was a fraction of the amount paid by other banks in mortgage-related settlements with the Justice Department: Bank of America Corp. paid $16.65 billion, J.P. Morgan Chase & Co. $13 billion and Citigroup Inc. $7 billion. The Morgan Stanley number was smaller in part because it wasn’t a major mortgage lender during the housing boom. Morgan Stanley’s archrival, Goldman Sachs Group Inc., is believed to be next in line with the government to potentially hammer out an agreement. Goldman has disclosed in a filing of its own that the U.S. Attorney’s Office for the Eastern District of California wrote to the company in December that the government had “preliminarily concluded” that it had violated federal law in connection the sale of mortgage bonds. The Morgan Stanley settlement comes as the Justice Department prepares for the departure of Attorney General Eric Holder. He will be replaced by Brooklyn U.S. Attorney Loretta Lynch once the Senate confirms her nomination.

Source: Wall Street Journal

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