Morgan Stanley 2009 Annual Report Download - page 111

The Company trades in a variety of derivatives and may either purchase or write protection on a single name or
portfolio of referenced entities. The Company is an active market-maker in the credit derivatives markets. As a
market-maker, the Company works to earn a bid-offer spread on client flow business and manage any residual
credit or correlation risk on a portfolio basis. The Company also trades and takes credit risk in credit default swap
form on a proprietary basis. Further, the Company uses credit derivatives to manage its exposure to residential
and commercial mortgage loans and corporate lending exposures during the periods presented.
The Company actively monitors its counterparty credit risk related to credit derivatives. A majority of the
Company’s counterparties are banks, broker-dealers, insurance, and other financial institutions and Monolines.
Contracts with these counterparties do not include ratings-based termination events but do include counterparty
rating downgrades, which may result in additional collateral being required by the Company. For further
information on the Company’s exposure to Monolines, see “Certain Factors Affecting Results of Operations—
Monoline Insurers” herein. The master agreements with these Monoline counterparties are generally unsecured,
and the few ratings-based triggers (if any) generally provide the Company the ability to terminate only upon
significant downgrade. As with all derivative contracts, the Company considers counterparty credit risk in the
valuation of its positions and recognizes credit valuation adjustments as appropriate.
The following table summarizes the key characteristics of the Company’s credit derivative portfolio by
counterparty as of December 31, 2009. The fair values shown are before the application of any counterparty or
cash collateral netting:
At December 31, 2009
Fair Values(1) Notionals(2)
Receivable Payable Beneficiary Guarantor
(dollars in millions)
Banks and securities firms ............................ $125,352 $115,855 $2,294,658 $2,213,761
Insurance and other financial institutions ................. 15,422 9,310 194,353 229,630
Monolines ......................................... 4,903 — 22,886 —
Non-financial entities ................................ 387 69 3,990 3,634
Total ......................................... $146,064 $125,234 $2,515,887 $2,447,025
(1) Amounts shown are presented before the application of any counterparty or cash collateral netting. The Company’s credit default swaps
are classified in both Level 2 and Level 3 of the fair value hierarchy. Approximately 16% of receivable fair values and 11% of payable
fair values represent Level 3 amounts.
(2) As part of an industry-wide effort to reduce the total notional amount of outstanding offsetting credit derivative trades, the Company
participated in novating credit default swap contracts with external counterparties to a central clearinghouse during 2009.
Country Exposure. As of December 31, 2009 and December 31, 2008, primarily based on the domicile of the
counterparty, approximately 5% and 8%, respectively, of the Company’s credit exposure (for credit exposure
arising from corporate loans and lending commitments as discussed above and current exposure arising from the
Company’s OTC derivative contracts) was to emerging markets, and no one emerging market country accounted
for more than 1% and 2%, respectively, of the Company’s credit exposure.
The Company defines emerging markets to include generally all countries where the economic, legal and
political systems are transitional and in the process of developing into more transparent and accountable systems
that are consistent with advanced countries.
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