Sallie Mae 2007 Annual Report Download - page 172

10. Derivative Financial Instruments (Continued)
deemed probable not to occur, gains and losses are reclassified immediately to earnings. In assessing hedge
effectiveness, generally all components of each derivative’s gains or losses are included in the assessment. The
Company generally hedges exposure to changes in cash flows due to changes in interest rates or total changes
in cash flow.
Trading Activities
When instruments do not qualify as hedges under SFAS No. 133, they are accounted for as trading where
all changes in fair value of the derivatives are recorded through earnings. The Company sells interest rate
floors (Floor Income Contracts) to hedge the Embedded Floor Income options in student loan assets. The
Floor Income Contracts are written options which under SFAS No. 133 have a more stringent effectiveness
hurdle to meet. Therefore, these relationships do not satisfy hedging qualifications under SFAS No. 133, but
are considered economic hedges for risk management purposes. The Company uses this strategy to minimize
its exposure to changes in interest rates.
The Company also uses basis swaps to minimize earnings variability caused by having different reset
characteristics on the Company’s interest-earning assets and interest-bearing liabilities. These swaps usually
possess a term of up to 14 years with a pay rate indexed to 91-day Treasury bill, 3-month commercial paper,
52-week Treasury bill, LIBOR, Prime, or 1-year constant maturity Treasury rates. The specific terms and
notional amounts of the swaps are determined based on management’s review of its asset/liability structure, its
assessment of future interest rate relationships, and on other factors such as short-term strategic initiatives.
SFAS No. 133 requires that when using basis swaps, the change in the cash flows of the hedge effectively
offset both the change in the cash flows of the asset and the change in the cash flows of the liability. The
Company’s basis swaps hedge variable interest rate risk, however they generally do not meet this effectiveness
test because most of the Company’s FFELP student loans can earn at either a variable or a fixed interest rate
depending on market interest rates. The Company also has basis swaps that do not meet the SFAS No. 133
effectiveness test that economically hedge off-balance sheet instruments. As a result, under GAAP these swaps
are recorded at fair value with changes in fair value reflected currently in the income statement.
In addition, the Company enters into equity forward contracts (see Note 12, “Stockholders’ Equity,” for a
further discussion of equity forward contracts and the settlement of all equity forward contracts in January
2008). The Company utilizes the strategy to lock in the purchase price of the Company’s stock to better
manage the cost of its share repurchases. In order to qualify as a hedge under SFAS No. 133, the hedged item
must impact net income. In this case, the repurchase of the Company’s shares does not impact net income,
therefore, the equity forwards do not qualify as a SFAS No. 133 hedge. Prior to December 31, 2007, the
Company’s equity forward contracts provided for physical, net share or net cash settlement options. On
December 31, 2007, the terms of the contracts were changed to allow for physical settlement only. This
effectively changed the characteristics of the contracts so they no longer were derivatives accounted for under
SFAS No. 133 and SFAS No. 150 and instead were accounted for as a liability (recorded at the present value
of the repurchase price) under SFAS No. 150.
F-51
SLM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts, unless otherwise stated)