NEW YORK (Reuters)—Morgan Stanley agreed to give up insurance claims against MBIA Inc. in exchange for a $1.1 billion payment from the ailing insurer, ending a two-year legal fight over guarantees on mortgage bonds.

As the result the settlement, announced by Morgan Stanley on Tuesday and confirmed by MBIA, Morgan Stanley will take a pretax $1.8 billion charge in the fourth quarter for the deal. After accounting for tax benefits, the deal will reduce Morgan Stanley's bottom line by $1.2 billion.

Morgan Stanley bought protection against bond defaults from MBIA, an insurer that guarantees bonds. MBIA historically focused on municipal bonds but in last decade sold large numbers of credit default swaps (CDS), or insurance contracts, that guaranteed mortgage-backed securities and other structured finance bonds.

MBIA's bets on CDS started souring as the financial crisis ramped up, forcing regulators to split the insurer into a municipal guarantee business and a structured finance unit.

A group of 18 banks, including Morgan Stanley, objected to the restructuring in court, arguing that it might leave the insurer unable to pay out its structured finance obligations. Morgan Stanley's settlement Tuesday includes its ending its legal objections to MBIA's restructuring.

Many of the banks suing MBIA have settled recently, including HSBC Holdings P.L.C., Royal Bank of Scotland P.L.C. and Wells Fargo & Co. Five are still pursuing claims, including Bank of America Corp. and UBS A.G.

"We are continuing to work toward resolving all the litigation," said Kevin Brown, a spokesman for MBIA. "We're talking to most, but not all, the parties."

Robert J. Giuffra Jr., a partner at Sullivan & Cromwell and lead counsel for banks that are still suing MBIA, said the plaintiffs will continue to fight its restructuring.

Manal Mehta, a founding partner of the hedge fund Branch Hill Capital, which owns MBIA shares, called the settlement a win for the bond insurer.

Wiping away the Morgan Stanley exposure will help MBIA get on more stable ground, Mehta said, because the bank represented one of its biggest legal challenges and because the underlying bonds were big money losers.

"This is a fantastic deal for MBIA," said Mehta.

Tuesday's agreement will also free up $5 billion worth of capital for Morgan Stanley and lift the bank's Tier 1 common ratio by 75 basis points under new, tougher capital rules. Under existing rules, its Tier 1 common ratio will decline 30 basis points.

With Morgan Stanley ending its credit default contracts with MBIA, the investment bank will no longer have to record gains and losses in the market value of the contracts, which had been a source of swings in the bank's income.

MBIA will drop a lawsuit over the quality of mortgage bonds underlying the contracts, Morgan Stanley said. MBIA had said that Morgan Stanley misrepresented the quality of the mortgage bonds that the insurer was guaranteeing.

MBIA's structured finance division, known as MBIA Insurance, will pay the settlement using a loan from its municipal bond division called National Finance, according to another person familiar with the deal.

Shares of MBIA were up 2.9% at $11.3 in recent trading, while Morgan Stanley gained 1.8% to $15.65.