Dominion Power 2001 Annual Report Download - page 56

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
54
or other securities issued by the trust or interests in the loans sold.
Cash proceeds are determined based on the difference between
interest rates to be received on the loans sold and the interest rate
to be paid to investors participating in the securitizations. The
determination of cash proceeds is also affected by estimates of pre-
payments, credit losses, servicing costs, and non-refundable fees
and premiums. Gains and losses realized on the sale of loans are
recognized based on the difference between the carrying amount
of the loans sold and the sum of the cash proceeds received and
the fair value of interests retained in the securitization on the set-
tlement date. Fair value is based on the present value of estimated
cash flows, adjusted to reflect the effects of credit losses, prepay-
ments and other factors appropriate in each securitization.
Dominion securitized commercial loans receivable in collateral-
ized loan obligation (CLO) and collateralized debt obligation
(CDO) transactions. Retained interests in CLO and CDO trans-
actions are reported as available for sale securities. In addition,
Dominion securitized residential mortgage loans. Dominion clas-
sifies its retained interests from securitizations of mortgage loans as
investment securities-trading.
Retained interests from the securitization of mortgage loans
include interest-only strips which are recorded based on the net
present value of projected cash flows, using management’s best
estimates of key assumptions. These assumptions include credit
losses, prepayment speeds, forward yield curves, and discount
rates commensurate with the risks involved. Interest-only strips
are amortized in proportion to the estimated income received.
They are analyzed quarterly to determine whether prepayment
experience, losses and changes in the interest rate environment
have had an impact on the valuation. Expected cash flows of the
underlying loans sold are reviewed based upon current economic
conditions and the type of loans originated and are revised as
necessary. See Notes 8 and 13 for more information about
Dominion’s investments in retained interests, including the
recognition of impairments in 2001 and 2000.
Derivatives
Dominion uses derivatives such as futures, swaps, forwards and
options to manage the commodity, currency exchange and
financial market risks of its business operations. Dominion also
manages a portfolio of commodity contracts held for trading
purposes as part of its strategy to market energy and to manage
related risks. Effective January 1, 2001, upon adoption of SFAS
No. 133, Accounting for Derivative Instruments and Hedging
Activities, derivatives are generally recognized on the consoli-
dated balance sheets at fair value. See Note 15 for further discus-
sion of Dominion’s use of derivatives and energy trading
contracts, including its risk management policy, its accounting
policy for derivatives under SFAS No. 133 and the results of its
hedging activities for the year ended December 31, 2001.
Prior to January 1, 2001, Dominion considered derivative
instruments to be effective hedges when the item being hedged
and the underlying financial or commodity instrument showed
strong historical correlation. Dominion used deferral accounting
to account for futures, forwards and other derivative instru-
ments that were designated as hedges. Under this method, real-
ized gains and losses (including the payment of any premium)
related to effective hedges of existing assets and liabilities were
recognized in earnings in conjunction with earnings of the des-
ignated asset or liability. Gains and losses related to effective
hedges of firm commitments and anticipated transactions were
included in the measurement of the subsequent transaction.
Goodwill, Net
Goodwill arising from acquisitions completed before July 1,
2001 was amortized on a straight-line basis over periods up to
40 years. As of December 31, 2001 and 2000, Dominion had
amortized $173 million and $83 million of goodwill, respec-
tively. In accordance with SFAS No. 142, Goodwill and Other
Intangible Assets, Dominion has not amortized goodwill arising
from acquisitions initiated after June 30, 2001 and will cease
amortization of all goodwill effective January 1, 2002. See Note
4 for further discussion of the adoption of SFAS 142 effective
January 1, 2002. See Note 5 for discussion of Dominion’s acqui-
sitions during 2001.
Regulatory Assets and Liabilities
Methods of allocating costs to accounting periods for operations
subject to federal or state cost-of-service rate regulation may dif-
fer from accounting methods generally applied by nonregulated
companies. The economic effects of allocations prescribed
by regulatory authorities for rate-making purposes must be
considered in the application of generally accepted accounting
principles. See Notes 9 and 18 for the impact of legislation on
continued application of SFAS No. 71, Accounting for the Effects
of Certain Types of Regulation, and additional information on
regulatory assets and liabilities.
Amortization of Debt Issuance Costs
Dominion defers and amortizes debt issuance costs and debt
premiums or discounts over the lives of the respective debt
issues. As permitted by regulatory commissions, gains or losses
resulting from the refinancing of debt allocable to utility opera-
tions subject to cost-based regulation have also been deferred
and amortized over the lives of the new issues.