Sallie Mae 2006 Annual Report Download - page 135

2. Significant Accounting Policies (Continued)
where the Company’s estimate of future cash flows results in a decrease in the yield used to recognize interest
income compared to the prior quarter, the Residual Interest is written down to fair value, first to the extent of
any unrealized gain in accumulated other comprehensive income, then through earnings as an other than
temporary impairment.
The Company also receives income for servicing the loans in its securitization trusts which is recognized
as earned. The Company assesses the amounts received as compensation for these activities at inception and
on an ongoing basis to determine if the amounts received are adequate compensation as defined in
SFAS No. 140. To the extent such compensation is determined to be no more or less than adequate
compensation, no servicing asset or obligation is recorded at the time of securitization. Servicing rights are
subsequently carried at the lower of cost or market. At December 31, 2006 and 2005, the Company did not
have servicing assets or liabilities recorded on the balance sheet.
Derivative Accounting
The Company accounts for its derivatives, which include interest rate swaps, cross-currency interest rate
swaps, interest rate futures contracts, interest rate cap contracts, Floor Income Contracts and equity forward
contracts in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,”
which requires that every derivative instrument, including certain derivative instruments embedded in other
contracts, be recorded at fair value on the balance sheet as either an asset or liability. The Company
determines the fair value for its derivative contracts using either (i) pricing models that consider current market
conditions and the contractual terms of the derivative contract or (ii) counterparty valuations. These factors
include interest rates, time value, forward interest rate curve and volatility factors, as well as foreign exchange
rates. Pricing models and their underlying assumptions impact the amount and timing of unrealized gains and
losses recognized with regard to derivatives, and the use of different pricing models or assumptions could
produce different financial results.
Many of the Company’s derivatives, mainly interest rate swaps hedging the fair value of fixed rate assets
and liabilities, cross-currency interest rate swaps, and certain Eurodollar futures contracts, qualify as effective
hedges under SFAS No. 133. For these derivatives, the relationship between the hedging instrument and the
hedged items (including the hedged risk and method for assessing effectiveness), as well as the risk
management objective and strategy for undertaking various hedge transactions at the inception of the hedging
relationship is documented. Each derivative is designated to either a specific asset or liability on the balance
sheet or expected future cash flows, and designated as either a fair value or a cash flow hedge. Fair value
hedges are designed to hedge the Company’s exposure to changes in fair value of a fixed rate or foreign
denominated asset or liability (“fair value” hedge), while cash flow hedges are designed to hedge the
Company’s exposure to variability of either a floating rate asset’s or liability’s cash flows or an expected fixed
rate debt issuance (“cash flow” hedge). For effective fair value hedges, both the hedge and the hedged item
(for the risk being hedged) are marked-to-market with any difference reflecting ineffectiveness and recorded
immediately in the income statement. For effective cash flow hedges, the change in the fair value of the
derivative is recorded in other comprehensive income, net of tax, and recognized in earnings in the same
period as the earnings effects of the hedged item. The ineffective portion of a cash flow hedge is recorded
immediately through earnings. The assessment of the hedge’s effectiveness is performed at inception and on
an ongoing basis, generally using regression testing. When it is determined that a derivative is not currently an
effective hedge or it will not be one in the future, the Company discontinues the hedge accounting
prospectively and ceases recording changes in the fair value of the hedged item.
The Company also has a number of derivatives, primarily Floor Income Contracts, certain basis swaps
and equity forwards, that the Company believes are effective economic hedges but are not considered hedges
F-16
SLM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts, unless otherwise stated)