Dominion Power 2002 Annual Report Download - page 61

reported at fair value with realized gains and losses included in
earnings and unrealized gains and losses reported as a compo-
nent of accumulated other comprehensive income, net of tax.
Loans Receivable, Net
Loans receivable are stated at their outstanding principal bal-
ance, net of the allowance for credit losses and any deferred fees
or costs. Origination fees, net of certain direct origination costs,
are deferred and recognized as an adjustment of the yield of
loans receivable. Each loan is evaluated for impairment by dis-
counting estimated future cash flows at the loan’s original con-
tractual rate. In assessing the recoverability of future cash flows,
Dominion management considers the debtor’s financial strength
and market position, general economic conditions and other
factors. If it is determined that a loan has become impaired, an
additional allowance for credit losses is established through pro-
visions for credit losses and is charged against income. Loans
receivable deemed to be uncollectible are charged against the
allowance for credit losses, and subsequent recoveries, if any,
are credited to the allowance. At December 31, 2002 and 2001,
the carrying amount of loans receivable was $87 million and
$106 million, respectively, net of the allowance for credit losses
of $69 million and $79 million, respectively.
Securitizations by Financial Services Businesses
Prior to being divested, Dominion’s financial services businesses
would periodically securitize mortgages and loans. Securitiza-
tions resulted from the process of selling loans to unconsoli-
dated special purpose trusts in exchange for cash and certain
retained interests. Retained interests include subordinated
bonds or other securities issued by the trusts or interests in the
loans sold. Cash proceeds were determined based on the differ-
ence between interest rates to be received on the loans sold and
the interest rate to be paid to investors participating in the secu-
ritizations. The determination of cash proceeds was also affected
by estimates of prepayments, credit losses, servicing costs and
non-refundable fees and premiums. Gains and losses realized
on the sale of loans were recognized based on the difference
between 1) the carrying amount of the loans sold and 2) the
sum of the cash proceeds received and the fair value of interests
retained in the securitization on the settlement date. Fair value
was based on the present value of estimated cash flows, adjusted
to reflect the effects of credit losses, prepayments and other fac-
tors appropriate in each securitization. Dominion securitized
commercial loans receivable in collateralized loan obligation
(CLO) and collateralized debt obligation (CDO) transactions.
Retained interests in CLO and CDO transactions are reported
as available-for-sale securities. In addition, before selling its resi-
dential mortgage business, Dominion securitized residential
mortgage loans.
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 dis-
count 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 pre-
payment experience, losses and changes in the interest rate envi-
ronment have had an impact on the valuation. Expected cash
flows of the underlying loans sold are reviewed based on current
economic conditions and the types of loans originated and are
revised as necessary. See Notes 9 and 13 for more information
about Dominion’s investments in retained interests, including
the recognition of impairments in 2002, 2001 and 2000.
Derivative Instruments
Dominion uses derivative instruments 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. Derivative instruments are gener-
ally recognized on the Consolidated Balance Sheets at fair value.
See Note 15 for further discussion of Dominion’s use of deriva-
tive instruments 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
years ended December 31, 2002 and 2001.
Prior to January 1, 2001, Dominion considered derivative
instruments to be effective hedges when the item being hedged
and the underlying financial instrument or commodity contract
showed strong historical correlation. Dominion used deferral
accounting to account for futures, forwards and other derivative
instruments that were designated as hedges. Under this method,
realized gains and losses (including the payment of any pre-
mium) related to effective hedges of existing assets and liabilities
were recognized in earnings in conjunction with the designated
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
Prior to the adoption of SFAS No. 142, Goodwill and Other
Intangible Assets, on January 1, 2002, goodwill arising from
acquisitions completed before July 1, 2001 was amortized on a
straight-line basis over periods up to 40 years. In accordance
with SFAS No. 142, Dominion did not amortize goodwill aris-
ing from acquisitions initiated after June 30, 2001 and ceased
amortization of all goodwill upon adoption of the standard.
Dominion evaluates goodwill for impairment on at least an
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Dominion ’02 Annual Report