Sallie Mae 2007 Annual Report Download - page 104

due to, among other things, changes in student loan legislation. These commitments are not accounted for as
derivatives under SFAS No. 133 as they do not meet the definition of a derivative due to the lack of a fixed
and determinable purchase amount. As a result of the legislative changes effective October 1, 2007, we are
currently reviewing our forward purchase contracts. At December 31, 2007, there were $5.4 billion originated
loans (FFELP and Private Education Loans) in the pipeline that the Company is committed to purchase.
RISKS
Overview
Managing risks is an essential part of successfully operating a financial services company. Our most
prominent risk exposures are operational, market and interest rate, political and regulatory, liquidity, credit,
and Consolidation Loan refinancing risk. We discuss these and other risks in the “Risk Factors” section
(Item 1A) of this document. The discussion that follows enhances that disclosure by discussing the risk
management strategies that we employ to mitigate these risks.
Operational Risk
Operational risk can result from regulatory compliance errors, servicing errors (see further discussion
below), technology failures, breaches of the internal control system, and the risk of fraud or unauthorized
transactions by employees or persons outside the Company. This risk of loss also includes the potential legal
actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable
regulatory standards and contractual commitments, adverse business decisions or their implementation, and
customer attrition due to potential negative publicity. In addition, as described in “BUSINESS — Current
Business Strategy,” as a result of the CCRAA as well as the challenges we are facing in the capital markets,
we aim to reduce our operating expenses by up to 20 percent as compared to 2007 operating expenses by
year-end 2009, before adjusting for growth and other investments. To date we have reduced our work force by
approximately three percent.
The federal guarantee on our student loans is conditioned on compliance with origination and servicing
standards set by ED and guarantor agencies. A mitigating factor is our ability to cure servicing deficiencies
and historically our losses have been small. Should we experience a high rate of servicing deficiencies, the
cost of remedial servicing or the eventual losses on the student loans that are not cured could be material. Our
servicing and operating processes are highly dependent on our information system infrastructure, and we face
the risk of business disruption should there be extended failures of our information systems, any number of
which could have a material impact on our business. To mitigate these risks we have a number of back-up and
recovery plans in the event of systems failures, which are regularly tested and monitored.
We manage operational risk through our risk management and internal control processes, which involve
each business line including independent cost centers, such as servicing, as well as executive management.
The business lines have direct and primary responsibility and accountability for identifying, controlling, and
monitoring operational risk, and each business line manager maintains a system of controls with the objective
of providing proper transaction authorization and execution, proper system operations, safeguarding of assets
from misuse or theft, and ensuring the reliability of financial and other data. We have centralized certain staff
functions such as accounting, human resources and legal to further strengthen our operational controls. While
we believe that we have designed effective methods to minimize operational risks, our operations remain
vulnerable to natural disasters, human error, technology and communication system breakdowns and fraud.
Market and Interest Rate Risk
Market and interest rate risk is the risk of loss from adverse changes in market prices, interest rates,
and/or foreign currency exchange rates of our financial instruments. Our primary market risk is from changes
in interest rates and interest spreads. We have an active interest rate risk management program that is designed
to reduce our exposure to changes in interest rates and maintain consistent earning spreads in all interest rate
environments. We use derivative instruments extensively to hedge our interest rate exposure, but there still is a
risk that we are not hedging all potential interest rate exposures or that the hedges do not perform as designed.
We measure interest rate risk by calculating the variability of net interest income in future periods under
various interest rate scenarios using projected balances for interest earning assets, interest-bearing liabilities
and derivatives used to hedge interest rate risk. Many assumptions are utilized by management to calculate the
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