Sallie Mae 2007 Annual Report Download - page 40

Securitization Accounting and Retained Interests
We regularly engage in securitization transactions as part of our financing strategy (see also “LIQUIDITY
AND CAPITAL RESOURCES — Securitization Activities”). In a securitization, we sell student loans to a
trust that issues bonds backed by the student loans as part of the transaction. When our securitizations meet
the sale criteria of SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities — a Replacement of SFAS No. 125,” we record a gain on the sale of the
student loans, which is the difference between the allocated cost basis of the assets sold and the relative fair
value of the assets received. The primary judgment in determining the fair value of the assets received is the
valuation of the Residual Interest.
The Residual Interests in each of our securitizations are treated as either (1) available-for-sale securities
in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and
therefore must be marked-to-market with temporary unrealized gains and losses recognized, net of tax, in
accumulated other comprehensive income in stockholders’ equity or (2) securities marked-to-market through
earnings under SFAS No. 155 “Accounting for Certain Hybrid Financial Instruments.” Since there are no
quoted market prices for our Residual Interests, we estimate their fair value both initially and each subsequent
quarter using the key assumptions listed below:
• the projected net interest yield from the underlying securitized loans, which can be impacted by the
forward yield curve, cost of funds for auction rate securities as well as the Repayment Borrower
Benefits program;
• the calculation of the Embedded Floor Income associated with the securitized loan portfolio;
• the CPR;
• the expected credit losses from the underlying securitized loan portfolio; and
• the discount rate used, which is intended to be commensurate with the risks involved.
We recognize interest income and periodically evaluate our Residual Interests for other than temporary
impairment in accordance with the Emerging Issues Task Force (“EITF”) Issue No. 99-20, “Recognition of
Interest Income and Impairment on Purchased and Residual Beneficial Interests in Securitized Financial
Assets.” Under this standard, each quarter we estimate the remaining cash flows to be received from our
Retained Interests and use these revised cash flows to prospectively calculate a yield for income recognition.
In cases where our estimate of future cash flows results in a lower yield from that used to recognize interest
income in 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, and the yield used to recognize subsequent income from the trust is negatively impacted.
We also receive income for servicing the loans in our securitization trusts. We assess 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.
Allowance for Loan Losses
We maintain an allowance for loan losses at an amount sufficient to absorb losses incurred in our FFELP
loan and Private Education Loan portfolios at the reporting date based on a projection of estimated probable
net credit losses. We analyze those portfolios to determine the effects that the various stages of delinquency
have on borrower default behavior and ultimate charge-off. We estimate the allowance for loan losses for our
Managed loan portfolio using a migration analysis of delinquent and current accounts. A migration analysis is
a technique used to estimate the likelihood that a loan receivable may progress through the various
delinquency stages and ultimately charge-off, and is a widely used reserving methodology in the consumer
finance industry. We also use the migration analysis to estimate the amount of uncollectible accrued interest
on Private Education Loans and write off that amount against current period interest income.
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