Dominion Power 2001 Annual Report Download - page 64

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Securitization of Financial Assets
Securitization of Commercial Loans
During 2001 and 2000, Dominion sold commercial loans in
CLO and CDO-related securitization transactions. In those
transactions, Dominion retained servicing responsibilities and
interests which are subordinate to those of investors participat-
ing in the securitizations. The investors and the securitization
trusts have no recourse to Dominion’s other assets for failure of
debtors to pay when due. The majority of the loans sold are vari-
able rate loans. As a result, changes in interest rates will not
cause a material change in the performance of the loan portfo-
lios. Dominion receives annual servicing fees and rights to
future cash flows after the investors in the securitization trusts
have received their contracted return. The estimated fair value of
Dominion’s retained interests at the time of the 2001 securitiza-
tion was based on expected cash flow recoveries from the loan
portfolios, assuming a credit loss rate of 2 percent, and a dis-
count rate of 10 percent. The following table summarizes key
information about the securitizations of commercial loans
during 2001 and 2000:
Loans Cash Retained
(millions) Securitized Proceeds Interests Annual Servicing Fees
2001 $423 $227 $196 38 basis points of the
outstanding balance
2000 $646 $570 $ 76 38 basis points of the
outstanding balance
Securitization of Residential Mortgages
During 2001, 2000 and 1999, Dominion sold residential mort-
gage loans in securitization transactions. In each of those securi-
tizations, Dominion retained servicing responsibilities and
interests in the mortgage loans sold which are subordinate to the
interests of investors participating in the securitizations. The
investors and the securitization trusts have no recourse to
Dominion’s other assets for failure of debtors to pay when due.
Dominion’s retained interests in mortgage securitizations were
based on rights to annual servicing fees approximating 50 basis
points of the outstanding balance and rights to future cash flows
Note 13 from the performance of the loan portfolios after the investors in
the securitization trust have received their contracted return. In
addition, Dominion continues to receive future cash flows from
prepayment penalties on mortgage loans that prepay during the
contractual penalty period. The value of the retained interests is
subject to credit, prepayment and interest rate risks related to
the mortgage loans sold. In 2001, 2000 and 1999, Dominion
recognized pretax gains of $21 million, $85 million and $107
million, respectively, on the securitization of residential
mortgage loans.
The following table presents weighted-average rates
(per annum) for key economic assumptions used in measuring
the retained interests from securitizations completed
during 2001:
Retained
Interests
—
Retained
Mortgage Interests
—
Loans(1) CLO
Prepayment speed (2) N/A
Weighted-average life (in years) 3.28 2.2
Expected credit losses 3.22% 2%
Residual cash flows discounted at 17% 10%
(1) Dominion sold all of its servicing rights as part of its sale of Saxon Mortgage in 2001.
(2) Fixed rate loans ramp up to 26.25 Constant Prepayment Rate (CPR) over 16 months.
Adjustable rate loans ramp up to 67.275 CPR over 16 months, ramping down to 41.4
CPR over 12 months. Second liens ramp up to 36.75 CPR over 16 months, ramping
down to 23.1 CPR over 26 months. Two-year hybrid loans ramp up to 33.12 CPR over
14 months; ramping up to 67.275 CPR in month 25; ramping up to 32.085 CPR over 7
months. Three-year hybrid loans ramp up to 33.12 CPR over 14 months; ramping up to
62.1 CPR in month 37; ramping down to 32.085 CPR over 7 months.
As a result of an acceleration of prepayments and loan
defaults, Dominion recognized a loss of $21 million in the
fourth quarter of 2001 on its retained interests from securitiza-
tions of mortgage loans. During the first half of 2000, in
response to changes in market conditions, Dominion increased
the discount rate used to value the interest-only strips included
in its retained interests from 12 percent to 17 percent, and recog-
nized a loss of $106 million. In connection with the DCI exit
strategy, Dominion reclassified its retained interests from securi-
tizations of mortgage loans from available-for-sale to trading.
62