Morgan Stanley 2014 Annual Report Download - page 148

reference entity. The beneficiary typically pays a periodic premium over the life of the contract and is protected
for the period. If a credit event occurs, the guarantor is required to make payment to the beneficiary based on the
terms of the credit derivative contract. Credit events, as defined in the contract, may be one or more of the
following defined events: bankruptcy, dissolution or insolvency of the referenced entity, failure to pay, obligation
acceleration, repudiation, payment moratorium and restructurings.
The Company trades in a variety of credit derivatives and may either purchase or write protection on a single
name or portfolio of referenced entities. In transactions referencing a portfolio of entities or securities, protection
may be limited to a tranche of exposure or a single name within the portfolio. 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 manages 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 effectiveness of the Company’s credit default
swap (“CDS”) protection as a hedge of the Company’s exposures may vary depending upon a number of factors,
including the contractual terms of the CDS.
The Company actively monitors its counterparty credit risk related to credit derivatives. A majority of the
Company’s counterparties are composed of banks, broker-dealers, insurance and other financial institutions.
Contracts with these counterparties may include provisions related to counterparty rating downgrades, which
may result in additional collateral being required by the Company. 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 Trading revenues in the Company’s consolidated statements of income.
The following tables summarize the key characteristics of the Company’s credit derivative portfolio by
counterparty type at December 31, 2014 and December 31, 2013. The fair values shown are before the
application of contractual netting or collateral. For additional credit exposure information on the Company’s
credit derivative portfolio, see Note 12 to the Company’s consolidated financial statements in Item 8.
At December 31, 2014
Fair Values(1) Notionals
Receivable Payable Net Beneficiary Guarantor
(dollars in millions)
Banks and securities firms .......................... $25,452 $25,323 $129 $712,466 $687,155
Insurance and other financial institutions ............... 6,639 6,697 (58) 216,489 217,201
Non-financial entities .............................. 91 89 2 5,049 3,706
Total ....................................... $32,182 $32,109 $ 73 $934,004 $908,062
(1) The Company’s CDS are classified in either Level 2 or Level 3 of the fair value hierarchy. Approximately 4% of receivable fair values
and 7% of payable fair values represent Level 3 amounts (see Note 4 to the Company’s consolidated financial statements in Item 8).
At December 31, 2013
Fair Values(1) Notionals
Receivable Payable Net Beneficiary Guarantor
(dollars in millions)
Banks and securities firms ...................... $60,728 $57,399 $3,329 $1,620,774 $1,573,217
Insurance and other financial institutions ........... 7,313 6,908 405 278,705 313,897
Non-financial entities .......................... 226 187 39 7,922 6,078
Total ................................... $68,267 $64,494 $3,773 $1,907,401 $1,893,192
(1) The Company’s CDS are classified in either Level 2 or Level 3 of the fair value hierarchy. Approximately 7% of receivable fair values
and 5% of payable fair values represent Level 3 amounts (see Note 4 to the consolidated financial statements in Item 8).
144