Morgan Stanley 2014 Annual Report Download - page 141

whose membership includes individuals from the Company’s Credit Risk Management Department. A
comprehensive and global Credit Limits Framework is utilized to manage credit risk levels across the Company.
The Credit Limits Framework is calibrated within the Company’s risk tolerance and includes single-name limits
and portfolio concentration limits by country, industry and product type. The Company’s Credit Risk
Management Department ensures transparency of material credit risks, compliance with established limits and
escalation of risk concentrations to appropriate senior management. The Company’s Credit Risk Management
Department also works closely with the Company’s Market Risk Department and applicable business units to
monitor risk exposures and to perform stress tests to identify, analyze and control credit risk concentrations
arising in the Company’s lending and trading activities. The stress tests shock market factors (e.g., interest rates,
commodity prices, credit spreads), risk parameters (e.g., default probabilities and loss given default), recovery
rates and expected losses in order to assess the impact of stresses on exposures, profit and loss, and the
Company’s capital position. Stress and scenario tests are conducted in accordance with established Company
policies and procedures.
Credit Evaluation.The evaluation of corporate and institutional counterparties and certain high net worth
borrowers includes assigning obligor credit ratings, which reflect an assessment of an obligor’s probability of
default and loss given default. Credit evaluations typically involve the assessment of financial statements;
leverage; liquidity; capital strength; asset composition and quality; market capitalization; access to capital
markets; adequacy of collateral, if applicable; and in the case of certain loans, cash flow projections and debt
service requirements. The Company’s Credit Risk Management Department also evaluates strategy, market
position, industry dynamics, management and other factors that could affect the obligor’s risk profile.
Additionally, the Company’s Credit Risk Management Department evaluates the relative position of the
Company’s exposure in the borrower’s capital structure and relative recovery prospects, as well as adequacy of
collateral (if applicable) and other structural elements of the particular transaction.
The evaluation of consumer borrowers is tailored to the specific type of lending. Margin and securities-based
loans are evaluated based on factors that include, but are not limited to, the amount of the loan, the degree of
leverage and the quality, diversification, price volatility and liquidity of the collateral. The underwriting of
residential real estate loans includes, but is not limited to, review of the obligor’s income, net worth, liquidity,
collateral, loan-to-value ratio and credit bureau information. Subsequent credit monitoring for residential real
estate loans is performed at the portfolio level, and for consumer loans, collateral values are monitored on an
ongoing basis.
Credit risk metrics assigned to the Company’s borrowers during the evaluation process are incorporated into the
Company’s Credit Risk Management Department’s maintenance of the allowance for loan losses for the loans
held for investment portfolio. Such allowance serves as a reserve for probable inherent losses as well as probable
losses related to loans identified for impairment. For more information on the Company’s allowance for loan
losses, see Notes 2 and 8 to the Company’s consolidated financial statements in Item 8.
Risk Mitigation. The Company may seek to mitigate credit risk from its lending and trading activities in
multiple ways, including collateral provisions, guarantees and hedges. 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 syndicate 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 demand collateral, as well as to liquidate collateral and offset receivables and
payables covered under the same master agreement in the event of a counterparty default.
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