Remove all the tile and all the drywall. Clean all the studs thouroughly with a heavy duty cleanser or at least bleach. Let everything dry thoroughly before rebuilding.
Re-Sheet the wall with cement board, not "blue board". Re-tile.
....And yes, I would say this is an excellent time to remodel the whole thing.
You definitely need to take care of this though. It'll eventually rot your sil plates and even through the floor.
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