Sallie Mae 2007 Annual Report Download - page 137

2. Significant Accounting Policies (Continued)
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 primarily using pricing models that consider current
market conditions and the contractual terms of the derivative contract. These factors include interest rates, time
value, forward interest rate curve, volatility factors, forward foreign exchange rates, and the closing price of
the Company’s stock (related to its equity forward contracts). The fair values of some derivatives are
determined using counterparty valuations. 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. As a matter of policy, the Company
compares the fair values of its derivatives that it calculates to those provided by its counterparties. Any
significant differences are identified and resolved appropriately.
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, ineffectiveness is recognized for the full change
in value of the derivative with no offsetting mark-to-market of the hedged item for the current period. If it is also
determined the hedge will not be effective in the future, the Company discontinues the hedge accounting
prospectively, ceases recording changes in the fair value of the hedged item, and begins amortization of any
basis adjustments that exist related to the hedged item.
The Company also has a number of derivatives, primarily Floor Income Contracts, and certain basis
swaps that the Company believes are effective economic hedges but are not considered hedges under
SFAS No. 133. These derivatives are classified as “trading” for GAAP purposes and as a result they are
marked-to-market through GAAP earnings with no consideration for the price fluctuation of the economically
hedged item.
Under SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity,” equity forward contracts that allow a net settlement option either in cash or the
Company’s stock are required to be accounted for in accordance with SFAS No. 133 as derivatives. These
contracts lock-in the purchase price of the Company’s stock related to share repurchases. As a result, the
Company marks its equity forward contracts to market through earnings in the “gains (losses) on derivative
and hedging activities, net” line item in the consolidated statements of income along with the net settlement
expense on the contracts, see Note 12 “Stockholders’ Equity” for a discussion on the change in accounting
related to equity forward contracts as of December 31, 2007.
F-16
SLM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts, unless otherwise stated)