After months of cutting quiet deals with banks in the high-stakes Manhattan state court litigation challenging its 2009 restructuring, MBIA Inc. reached a major settlement with Morgan Stanley on Tuesday. Under the agreement, Morgan Stanley will withdraw from the restructuring case and terminate outstanding credit default swap protection it bought from MBIA to guard against losses on commercial mortgage-backed securities. MBIA will drop claims it brought against Morgan Stanley in a separate New York state court suit related to the securities underlying those swaps.

In its announcement of the settlement, Morgan Stanley said it would record a $1.8 billion pre-tax loss as a result of the deal. (Through Sept. 30, Morgan Stanley had $2.7 billion in exposure to MBIA through credit default swaps, according to the bank’s most recent quarterly report.) But the settlement also includes a cash payment from MBIA to Morgan Stanley that sources peg at $1.1 billion.

In 2009, with approval from New York state insurance regulators, MBIA split its municipal bond insurance and structured finance groups into two companies. The restructuring left MBIA Insurance Corp. holding the insurer’s toxic financial products business while National Finance Public Guarantee Corp. kept the healthier muni bond chunk. A coalition of banks that originally numbered 18 sued in Manhattan state court, claiming MBIA had fraudulently transferred $5 billion in assets to National Finance, leaving MBIA Insurance insolvent and unable to honor its commitments to structured finance counterparts.

According to a person with knowledge of the settlement who requested anonymity, MBIA’s $1.1 billion payment to Morgan Stanley was made possible by a loan to MBIA Insurance from National Finance. And the notion that MBIA Insurance couldn’t fund the settlement itself has some of MBIA’s adversaries claiming vindication.

“What this settlement shows is what we’ve been saying is correct, and that MBIA [Insurance] does not have sufficient assets to pay all of their claims,” said David Ichel of Simpson Thacher & Bartlett, who represents the hedge fund Aurelius Capital Management in a putative class action against the insurer that closely parallels the banks’ case.

After Tuesday’s settlement with Morgan Stanley, just five banks remain in the suit against MBIA. The $1.1 billion sum Morgan Stanley will receive, which was confirmed by a person familiar with the settlement but not publicly disclosed Tuesday, appears to be the largest deal to date in the case. On Monday, HSBC withdrew from the case; the Wall Street Journal reports that it received $30 million. A spokesman for HSBC declined to comment on the report.

The banks that remain in the restructuring case are Bank of America Corp., Société Générale SA, UBS AG, BNP Paribas SA and Natixis SA. “The remaining plaintiff policyholders will continue to fight to restore the billions fraudulently taken from MBIA Insurance,” Robert Giuffra Jr. of Sullivan & Cromwell, the banks’ lawyer, said in a statement.

A trial over the New York Insurance Department’s allegedly unlawful approval of the restructuring, initially set for February, has been delayed until April amid settlement talks pushed by the new superintendent of the New York Department of Financial Services, according to a letter Giuffra sent the court last week. New York in October merged its banking and insurance departments. In a statement Benjamin Lawsky, the superintendent, applauded MBIA and Morgan Stanley’s “willingness to find common ground allowing both firms to put the time-consuming and expensive litigation behind them.”

“This settlement is good for Morgan Stanley, good for MBIA, and good for the markets and our financial system, allowing firms to move forward and rebuild,” he said. “With HSBC also settling this week, there are only five firms remaining in a litigation that began with 18. The Department of Financial Services will continue to work closely with the remaining firms and MBIA to seek fair resolutions of this litigation and we will work tirelessly to that end for the benefit of all involved and our financial system.”

Representatives of MBIA declined comment Tuesday. The company’s lawyers–Marc Kasowitz of Kasowitz Benson Torres & Friedman in the restructuring litigation and Robin Henry of Boies, Schiller & Flexner in MBIA’s mortgage-backed securities case against Morgan Stanley–either declined comment or did not respond to requests for comment.

Along with Bank of America, Morgan Stanley was the only bank remaining in the restructuring case that was facing mortgage-backed securities claims brought by MBIA. In May, MBIA’s lawyers at Boies Schiller landed a big win in the insurer’s MBS case against Morgan Stanley, when a state judge in White Plains, N.Y. denied the bank’s motion to dismiss fraud and breach of contract claims. Morgan Stanley’s lawyers at Davis Polk & Wardwell had filed a notice of appeal, though no brief had been submitted as of Tuesday. Morgan Stanley counsel James Rouhandeh of Davis Polk declined comment.