Morgan Stanley 2009 Annual Report Download - page 73

were utilized for the fair value measurement of these instruments. For certain other debt, as the unobservable
inputs became insignificant in the overall valuation, the fair value of these instruments became highly correlated
with similar instruments in an observable market. For state and municipal securities, certain student loan auction
rate securities (“SLARS”) were reclassified from Level 3 to Level 2 as there was increased activity in the SLARS
market and restructuring activity of the underlying trusts.
During 2009, the Company also reclassified approximately $3.3 billion of certain Corporate and other debt from
Level 2 to Level 3. The reclassifications were primarily related to corporate loans and were generally due to a
reduction in market price quotations for these or comparable instruments, or a lack of available broker quotes,
such that unobservable inputs had to be utilized for the fair value measurement of these instruments. The key
unobservable inputs are assumptions to establish comparability to other instruments with observable spread
levels.
During 2009, the Company reclassified approximately $10.2 billion of certain Derivatives and other contracts
from Level 3 to Level 2, primarily related to single name subprime and CMBS credit default swaps as well as
tranche-indexed corporate credit default swaps. Certain single name subprime and CMBS credit default swaps
were reclassified primarily because the values associated with the unobservable inputs, such as correlation, were
no longer deemed significant to the fair value measurement of these derivative contracts due to market
deterioration. Increased availability of transaction data, broker quotes and/or consensus pricing resulted in the
reclassifications of certain tranche-indexed corporate credit default swaps. The Company reclassified
approximately $0.4 billion of certain Derivatives and other contracts from Level 2 to Level 3 as certain inputs
became unobservable.
Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis. Certain of the Company’s assets
were measured at fair value on a non-recurring basis. The Company incurs impairment charges for any
writedowns of these assets to fair value. A downturn in market conditions could result in impairment charges in
future periods.
For assets and liabilities measured at fair value on a non-recurring basis, fair value is determined by using
various valuation approaches. The same hierarchy as described above, which maximizes the use of observable
inputs and minimizes the use of unobservable inputs by generally requiring that the observable inputs be used
when available, is used in measuring fair value for these items.
For further information on financial assets and liabilities that are measured at fair value on a recurring and
non-recurring basis, see Note 4 to the consolidated financial statements.
Fair Value Control Processes. The Company employs control processes to validate the fair value of its
financial instruments, including those derived from pricing models. These control processes are designed to
assure that the values used for financial reporting are based on observable inputs wherever possible. In the event
that observable inputs are not available, the control processes are designed to assure that the valuation approach
utilized is appropriate and consistently applied and that the assumptions are reasonable. These control processes
include reviews of the pricing model’s theoretical soundness and appropriateness by Company personnel with
relevant expertise who are independent from the trading desks. Additionally, groups independent from
the trading divisions within the Financial Control, Market Risk and Credit Risk Management Department
(“Credit Risk Management”) participate in the review and validation of the fair values generated from pricing
models, as appropriate. Where a pricing model is used to determine fair value, recently executed comparable
transactions and other observable market data are considered for purposes of validating assumptions underlying
the model.
Consistent with market practice, the Company has individually negotiated agreements with certain counterparties
to exchange collateral (“margining”) based on the level of fair values of the derivative contracts they have
executed. Through this margining process, one party or each party to a derivative contract provides the other
party with information about the fair value of the derivative contract to calculate the amount of collateral
required. This sharing of fair value information provides additional support of the Company’s recorded fair value
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