Morgan Stanley 2010 Annual Report Download - page 119

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. 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 “Management’s Discussion and Analysis of Financial
Condition and Results of Operations—Significant Items—Monoline Insurers” in Part II, Item 7 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 within Principal transactions—Trading.
The following tables summarize the key characteristics of the Company’s credit derivative portfolio by
counterparty at December 31, 2010 and December 31, 2009. The fair values shown are before the application of
any counterparty or cash collateral netting:
At December 31, 2010
Fair Values(1) Notionals
Receivable Payable Beneficiary Guarantor
(dollars in millions)
Banks and securities firms ............................. $ 96,551 $86,574 $2,037,326 $2,032,824
Insurance and other financial institutions .................. 10,954 8,679 277,714 257,180
Monolines(2) ........................................ 2,370 — 25,676 —
Non-financial entities ................................. 259 373 2,920 4,247
Total .......................................... $110,134 $95,626 $2,343,636 $2,294,251
(1) The Company’s credit default swaps are classified in both Level 2 and Level 3 of the fair value hierarchy. Approximately 13% of
receivable fair values and 8% of payable fair values represent Level 3 amounts.
(2) Amounts do not include the effect of hedges of Monoline derivative counterparty exposure.
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) 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 certain credit default swap contracts with external counterparties to a central clearinghouse during 2009.
Country Exposure. At both December 31, 2010 and December 31, 2009, primarily based on the domicile of the
counterparty, approximately 5% of the Company’s credit exposure (for credit exposure arising from corporate
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