UPDATE: MBIA Drops Mortgage Suit Against Bank of America

MBIA Inc. (MBI) agreed to drop a lawsuit against Bank of America Corp. (BAC) and Merrill Lynch over $5.7 billion in credit default protection the bond insurer underwrote for the bank's mortgage-backed securities.

The parties, according to a filing in New York state court, are voluntarily dismissing the claims and each is paying its own legal fees for the case.

The decision to dismiss the suit sent shares of MBIA higher Tuesday, up 7.8% to $9.12, as investors appeared to hope the filing was a signal for some other agreement between the two.

The dismissal follows a couple of setbacks in court for MBIA's suit.

MBIA had sued Merrill Lynch in April 2009, after Bank of America completed its purchase of the investment bank, alleging it had committed fraud while convincing the bond insurer to provide the credit default protection. MBIA alleged the bank hid that the supposed AAA-rated mortgage-backed securities were actually backed by poorly underwritten mortgages.

MBIA had said it was on the hook for several hundred million dollars in losses from the protection.

In 2010, a state judge tossed out part of the suit, and in February this year a New York appeals court ordered the entire case dismissed.

The appeals court decision said, in part, that MBIA's "level of sophistication" and the "undisputed fact" the bank did not hold information that MBIA could not have gotten, would prevent MBIA from proving fraud.

A state judge then ruled that MBIA should pay the bank the small sum of $340.

MBIA did make another attempt to appeal the dismissal, but no ruling had been made before the insurer dropped the case Monday.

A Bank of America spokesman said the bank had no comment on the filing. A MBIA spokeswoman said the insurer was not commenting.

Bank of America had previously paid a bond insurer to settle claims. The bank agreed in April to pay Assured Guaranty Ltd. (AGO) $1.6 billion, including a loss-share agreement, to settle claims with that bond insurer, a deal that at the time sent MBIA and other insurers climbing.

The bank has also reached in-court settlements over mortgage-related suits. It recently agreed to pay $8.5 billion to a group of investors in mortgage-backed securities. That settlement still requires a judge's approval.

Shares of other bond insurers also rose Tuesday, with PMI Group Inc. (PMI) up 6% to $1.42, Radian Group Inc. (RDN) up 2.3% to $4.38 and MGIC Investment Corp. (MTG) up 2.2% to $6.44. The group has moved higher each time Bank of America has announced a settlement with other parties.

Shares of Bank of America were flat at $10.35 in recent trading.

-By David Benoit, Dow Jones Newswires; 212-416-2458; david.benoit@dowjones.com

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