Prudential 2012 Annual Report Download - page 115

PRUDENTIAL FINANCIAL, INC.
Notes to Consolidated Financial Statements
2. SIGNIFICANT ACCOUNTING POLICIES AND PRONOUNCEMENTS (continued)
Equity securities available-for-sale are comprised of common stock, mutual fund shares, non-redeemable preferred stock, and certain
perpetual preferred stock, and are carried at fair value. The associated unrealized gains and losses, net of tax, and the effect on deferred policy
acquisition costs, value of business acquired, deferred sales inducements, future policy benefits and policyholders’ dividends that would
result from the realization of unrealized gains and losses, are included in AOCI. The cost of equity securities is written down to fair value
when a decline in value is considered to be other-than-temporary. See the discussion below on realized investment gains and losses for a
description of the accounting for impairments. Dividends from these investments are recognized in “Net investment income” when earned.
Commercial mortgage and other loans consist of commercial mortgage loans, agricultural loans, loans backed by residential
properties, as well as certain other collateralized and uncollateralized loans. Loans backed by residential properties primarily include
recourse loans held by the Company’s international insurance businesses. Other collateralized loans primarily include senior loans made by
the Company’s international insurance businesses and loans made to the Company’s former real estate franchisees. Uncollateralized loans
primarily represent reverse dual currency loans and corporate loans held by the Company’s international insurance businesses.
Commercial mortgage and other loans originated and held for investment are generally carried at unpaid principal balance, net of
unamortized deferred loan origination fees and expenses, and net of an allowance for losses. Commercial mortgage loans originated within
the Company’s commercial mortgage operations include loans held for sale which are reported at the lower of cost or fair value; loans held
for investment which are reported at amortized cost net of unamortized deferred loan origination fees and expenses, and net of an
allowance for losses; and loans reported at fair value under the fair value option. Commercial mortgage and other loans acquired, including
those related to the acquisition of a business, are recorded at fair value when purchased, reflecting any premiums or discounts to unpaid
principal balances.
Interest income, as well as prepayment fees and the amortization of the related premiums or discounts, related to commercial
mortgage and other loans, are included in “Net investment income.”
Impaired loans include those loans for which it is probable that amounts due will not all be collected according to the contractual terms
of the loan agreement. The Company defines “past due” as principal or interest not collected at least 30 days past the scheduled contractual
due date. Interest received on loans that are past due, including impaired and non-impaired loans as well as loans that were previously
modified in a troubled debt restructuring, is either applied against the principal or reported as net investment income based on the Company’s
assessment as to the collectability of the principal. See Note 4 for additional information about the Company’s past due loans.
The Company discontinues accruing interest on loans after the loans become 90 days delinquent as to principal or interest payments,
or earlier when the Company has doubts about collectability. When the Company discontinues accruing interest on a loan, any accrued but
uncollectible interest on the loan and other loans backed by the same collateral, if any, is charged to interest income in the same period.
Generally, a loan is restored to accrual status only after all delinquent interest and principal are brought current and, in the case of loans
where the payment of interest has been interrupted for a substantial period, or the loan has been modified, a regular payment performance
has been established.
The Company reviews the performance and credit quality of the commercial mortgage and other loan portfolio on an on-going basis.
Loans are placed on watch list status based on a predefined set of criteria and are assigned one of three categories. Loans are placed on “early
warning” status in cases where, based on the Company’s analysis of the loan’s collateral, the financial situation of the borrower or tenants or
other market factors, it is believed a loss of principal or interest could occur. Loans are classified as “closely monitored” when it is
determined that there is a collateral deficiency or other credit events that may lead to a potential loss of principal or interest. Loans “not in
good standing” are those loans where the Company has concluded that there is a high probability of loss of principal, such as when the loan is
delinquent or in the process of foreclosure. As described below, in determining the allowance for losses, the Company evaluates each loan on
the watch list to determine if it is probable that amounts due will not be collected according to the contractual terms of the loan agreement.
Loan-to-value and debt service coverage ratios are measures commonly used to assess the quality of commercial mortgage loans. The
loan-to-value ratio compares the amount of the loan to the fair value of the underlying property collateralizing the loan, and is commonly
expressed as a percentage. Loan-to-value ratios greater than 100% indicate that the loan amount exceeds the collateral value. A smaller loan-
to-value ratio indicates a greater excess of collateral value over the loan amount. The debt service coverage ratio compares a property’s net
operating income to its debt service payments. Debt service coverage ratios less than 1.0 times indicate that property operations do not
generate enough income to cover the loan’s current debt payments. A larger debt service coverage ratio indicates a greater excess of net
operating income over the debt service payments. The values utilized in calculating these ratios are developed as part of the Company’s
periodic review of the commercial mortgage loan and agricultural loan portfolio, which includes an internal appraisal of the underlying
collateral value. The Company’s periodic review also includes a quality re-rating process, whereby the internal quality rating originally
assigned at underwriting is updated based on current loan, property and market information using a proprietary quality rating system. The
loan-to-value ratio is the most significant of several inputs used to establish the internal credit rating of a loan which in turn drives the
allowance for losses. Other key factors considered in determining the internal credit rating include debt service coverage ratios, amortization,
loan term, estimated market value growth rate and volatility for the property type and region. See Note 4 for additional information related to
the loan-to-value ratios and debt service coverage ratios related to the Company’s commercial mortgage and agricultural loan portfolios.
Loans backed by residential properties, other collateralized loans, and uncollateralized loans are also reviewed periodically. Each loan
is assigned an internal or external credit rating. Internal credit ratings take into consideration various factors including financial ratios and
qualitative assessments based on non-financial information. In cases where there are personal or third party guarantors, the credit quality of
the guarantor is also reviewed. These factors are used in developing the allowance for losses. Based on the diversity of the loans in these
categories and their immateriality, the Company has not disclosed the credit quality indicators related to these loans in Note 4.
Prudential Financial, Inc. 2012 Annual Report 113