Morgan Stanley 1999 Annual Report Download - page 54

99 AR |page 52 interest rates over the 12-month period from its fiscal year-end, the
Company assumes that all interest rate sensitive assets and liabili-
ties will be impacted by a hypothetical, immediate 100-basis-point
increase in interest rates as of the beginning of the period.
Interest rate sensitive assets are assumed to be those for
which the stated interest rate is not contractually fixed for the next
12-month period. In fiscal 1999, a substantial portion of the
Company’s credit card receivables was repriced to a fixed interest
rate, although the Company has the right, with notice to cardmem-
bers, to reprice the receivables to a new fixed interest rate. The
Company considers such receivables to be interest rate sensitive,
consistent with its policy of matching the repricing of its credit card
receivables and the related financing. The Company measured the
earnings sensitivity for these assets from the expected repricing
date, which takes into consideration the required notice period and
billing cycles. In addition, assets which have a market-based index,
such as the prime rate, which will reset before the end of the
12-month period, or assets with rates that are fixed at fiscal year-
end but which will mature, or otherwise contractually reset to a
market-based indexed or other fixed rate prior to the end of the 12-
month period, are rate-sensitive. The latter category includes cer-
tain credit card loans which may be offered at below-market rates
for an introductory period, such as for balance transfers and spe-
cial promotional programs, after which the loans will contractually
reprice in accordance with the Company’s normal market-based
pricing structure. For purposes of measuring rate-sensitivity for
such loans, only the effect of the hypothetical 100-basis-point
change in the underlying market-based indexed or other fixed rate
has been considered rather than the full change in the rate to which
the loan would contractually reprice. For assets which have a fixed
rate at fiscal year-end but which contractually will, or are assumed
to, reset to a market-based indexed or other fixed rate during the
next 12 months, earnings sensitivity is measured from the expected
repricing date. In addition, for all interest rate sensitive assets,
earnings sensitivity is calculated net of expected loan losses.
Interest rate sensitive liabilities are assumed to be those
for which the stated interest rate is not contractually fixed for the
next 12-month period. Thus, liabilities which have a market-based
index, such as the prime, commercial paper, or LIBOR rates, which
will reset before the end of the 12-month period, or liabilities
whose rates are fixed at fiscal year-end but which will mature and
be replaced with a market-based indexed rate prior to the end of
the 12-month period, are rate-sensitive. For liabilities which have a
fixed rate at fiscal year-end, but which are assumed to reset to a
market-based index during the next 12 months, earnings sensitiv-
ity is measured from the expected repricing date.
Assuming a hypothetical, immediate 100-basis-point
increase in the interest rates affecting all interest rate sensitive
assets and liabilities as of November 30, 1999, it is estimated that
the pre-tax income of consumer lending and related activities over
the following 12-month period would be reduced by approximately
$10 million. The comparable reduction of pre-tax income for the
12-month period following November 30, 1998 was estimated to
be approximately $65 million. The decrease at November 30,
1999 as compared with the prior year was primarily the result of
the Company’s consumer loan repricing actions made during fiscal
1999 and the related impact of the funding supporting the
Company’s consumer loans.
The hypothetical model assumes that the balances of inter-
est rate sensitive assets and liabilities at fiscal year-end will remain
constant over the next 12-month period. It does not assume any
growth, strategic change in business focus, change in asset pricing
philosophy or change in asset/liability funding mix. Thus, this model
represents a static analysis which cannot adequately portray how the
Company would respond to significant changes in market condi-
tions. Furthermore, the analysis does not necessarily reflect the
Company’s expectations regarding the movement of interest rates in
the near term, including the likelihood of an immediate 100-basis-
point change in market interest rates nor necessarily the actual
effect on earnings if such rate changes were to occur.
CREDIT RISK
The Company’s exposure to credit risk arises from the possibility
that a customer or counterparty to a transaction might fail to per-
form under its contractual commitment, which could result in the
Company incurring losses. With respect to its institutional securi-
ties activities, the Company has credit guidelines which limit the
Company’s current and potential credit exposure to any one coun-
terparty and to each type of counterparty (by rating category). The
Credit Department that is responsible for the Company’s institu-
tional securities activities administers and monitors these credit
limits on a worldwide basis. In addition to monitoring credit limits,
the Company manages the credit exposure relating to its trading
activities by reviewing periodically counterparty financial sound-
ness, by entering into master netting agreements and collateral
arrangements with counterparties in appropriate circumstances,
and by limiting the duration of exposure. In certain cases, the
Company also may close out transactions, assign them to other