Morgan Stanley 2014 Annual Report Download - page 178

MORGAN STANLEY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
• U.S. Agency Securities. U.S. agency securities are composed of three main categories consisting of
agency-issued debt, agency mortgage pass-through pool securities and collateralized mortgage
obligations. Non-callable agency-issued debt securities are generally valued using quoted market prices.
Callable agency-issued debt securities are valued by benchmarking model-derived prices to quoted
market prices and trade data for identical or comparable securities. The fair value of agency mortgage
pass-through pool securities is model-driven based on spreads of the comparable To-be-announced
security. Collateralized mortgage obligations are valued using quoted market prices and trade data
adjusted by subsequent changes in related indices for identical or comparable securities. Actively traded
non-callable agency-issued debt securities are generally categorized in Level 1 of the fair value hierarchy.
Callable agency-issued debt securities, agency mortgage pass-through pool securities and collateralized
mortgage obligations are generally categorized in Level 2 of the fair value hierarchy.
Other Sovereign Government Obligations.
• Foreign sovereign government obligations are valued using quoted prices in active markets when
available. These bonds are generally categorized in Level 1 of the fair value hierarchy. If the market is
less active or prices are dispersed, these bonds are categorized in Level 2 of the fair value hierarchy. In
instances where the inputs are unobservable, these bonds are categorized in Level 3 of the fair value
hierarchy.
Corporate and Other Debt.
• State and Municipal Securities. The fair value of state and municipal securities is determined using
recently executed transactions, market price quotations and pricing models that factor in, where
applicable, interest rates, bond or credit default swap spreads and volatility. These bonds are generally
categorized in Level 2 of the fair value hierarchy.
• Residential Mortgage-Backed Securities (“RMBS”), Commercial Mortgage-Backed Securities (“CMBS”)
and other Asset-Backed Securities (“ABS”). RMBS, CMBS and other ABS may be valued based on
price or spread data obtained from observed transactions or independent external parties such as vendors
or brokers. When position-specific external price data are not observable, the fair value determination
may require benchmarking to similar instruments, and/or analyzing expected credit losses, default and
recovery rates, and/or applying discounted cash flow techniques. In evaluating the fair value of each
security, the Company considers security collateral-specific attributes, including payment priority, credit
enhancement levels, type of collateral, delinquency rates and loss severity. In addition, for RMBS
borrowers, Fair Isaac Corporation (“FICO”) scores and the level of documentation for the loan are
considered. Market standard models, such as Intex, Trepp or others, may be deployed to model the
specific collateral composition and cash flow structure of each transaction. Key inputs to these models are
market spreads, forecasted credit losses, and default and prepayment rates for each asset category.
Valuation levels of RMBS and CMBS indices are used as an additional data point for benchmarking
purposes or to price outright index positions.
RMBS, CMBS and other ABS are generally categorized in Level 2 of the fair value hierarchy. If external
prices or significant spread inputs are unobservable or if the comparability assessment involves
significant subjectivity related to property type differences, cash flows, performance and other inputs,
then RMBS, CMBS and other ABS are categorized in Level 3 of the fair value hierarchy.
• Corporate Bonds. The fair value of corporate bonds is determined using recently executed transactions,
market price quotations (where observable), bond spreads, credit default swap spreads, at the money
volatility and/or volatility skew obtained from independent external parties such as vendors and brokers
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