Morgan Stanley 2010 Annual Report Download - page 113

Other. In addition to the activities noted above, there are other credit risks managed by the Credit Risk
Management Department and various business areas within the Institutional Securities business segment. The
Company incurs credit risk through margin and collateral transactions with clearing houses, clearing agencies,
exchanges, banks, securities firms and other financial counterparties. Certain risk management activities as they
pertain to establishing appropriate collateral amounts for the Company’s prime brokerage and securitized product
businesses are primarily monitored within those respective areas in that they determine the appropriate collateral
level for each strategy or position. In addition, a collateral management group monitors collateral levels against
requirements and oversees the administration of the collateral function.
Analyzing Credit Risk. Credit risk management takes place at the transaction, obligor and portfolio levels. In
order to protect the Company from losses resulting from these activities, the Credit Risk Management
Department ensures lending transactions and derivative exposures are analyzed, that the creditworthiness of the
Company’s counterparties and borrowers is reviewed regularly and that credit exposure is actively monitored and
managed. The Credit Risk Management Department assigns obligor credit ratings to the Company’s
counterparties and borrowers, which reflect an assessment of an obligor’s probability of default. Additionally, the
Credit Risk Management Department evaluates the relative position of the Company’s particular obligation in the
borrower’s capital structure and relative recovery prospects, as well as collateral (if applicable) and other
structural elements of the particular transaction.
Risk Mitigation. The Company may seek to mitigate credit risk from its lending and derivatives transactions in
multiple ways. At the transaction level, the Company seeks to mitigate risk through management of key risk
elements such as size, tenor, financial covenants, seniority and collateral. The Company actively hedges its
lending and derivatives exposure through various financial instruments that may include single name, portfolio
and structured credit derivatives. Additionally, the Company may sell, assign or sub-participate funded loans and
lending commitments to other financial institutions in the primary and secondary loan market. In connection with
its derivatives trading activities, the Company generally enters into master netting agreements and collateral
arrangements with counterparties. These agreements provide the Company with the ability to offset a
counterparty’s rights and obligations, request additional collateral when necessary or liquidate the collateral in
the event of counterparty default.
Credit Exposure—Corporate Lending. The following tables present information about the Company’s
corporate funded loans and lending commitments carried at fair value at December 31, 2010 and December 31,
2009. The “total corporate lending exposure” column includes both lending commitments and funded loans. Fair
value of corporate lending exposure represents the fair value of loans that have been drawn by the borrower and
lending commitments that were outstanding at December 31, 2010 and December 31, 2009. Lending
commitments represent legally binding obligations to provide funding to clients at December 31, 2010 and
December 31, 2009 for both “relationship-driven” and “event-driven” lending transactions. As discussed above,
these loans and lending commitments have varying terms, may be senior or subordinated, may be secured or
unsecured, are generally contingent upon representations, warranties and contractual conditions applicable to the
borrower, and may be syndicated, traded or hedged by the Company.
At December 31, 2010 and December 31, 2009, the aggregate amount of investment grade loans was $3.9 billion
and $6.5 billion, respectively, and the aggregate amount of non-investment grade loans was $6.8 billion and $9.5
billion, respectively. In connection with these corporate lending activities (which include corporate funded loans
and lending commitments), the Company had hedges (which include “single name,” “sector” and “index”
hedges) with a notional amount of $21.0 billion and $25.8 billion related to the total corporate lending exposure
of $69.2 billion and $64.0 billion at December 31, 2010 and December 31, 2009, respectively.
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