Sallie Mae 2007 Annual Report Download - page 43

Off-Balance Sheet Student Loans
Estimate
Consolidating
Lender Effect on Estimate CPR Accounting Effect
Residual Interest. . Sallie Mae or other lenders Loan prepaid Increase • Reduction in fair market
value of Residual Interest
resulting in either an
impairment charge or
reduction in prior
unrealized market value
gains recorded in other
comprehensive income.
• Decrease in prospective
effective yield used to
recognize interest
income.
Derivative Accounting
We use interest rate swaps, cross-currency interest rate swaps, interest rate futures contracts, Floor Income
Contracts and interest rate cap contracts as an integral part of our overall risk management strategy to manage
interest rate and foreign currency risk arising from our fixed rate and floating rate financial instruments. In
addition, we use equity forward contracts (see Note 12, “Stockholders’ Equity,” to the financial statements for
further discussion) to lock-in our future purchase price of the Company’s stock to better manage share
repurchases. We account for these instruments 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. We determine the fair value for our derivative instruments primarily by using pricing models
that consider current market conditions and the contractual terms of the derivative contracts. Market inputs
into the model include interest rates, optionality, forward interest rate curves, volatility factors, forward foreign
exchange rates, and the closing price of the Company’s stock (related to our 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; the use of
different pricing models or assumptions could produce different financial results. As a matter of policy, we
compare the fair values of our derivatives that we calculate to those provided by our counterparties on a
monthly basis. Any significant differences are identified and resolved appropriately.
SFAS No. 133 requires that changes in the fair value of derivative instruments be recognized currently in
earnings unless specific hedge accounting criteria as specified by SFAS No. 133 are met. We believe that all
of our derivatives are effective economic hedges and are a critical element of our interest rate risk management
strategy. However, under SFAS No. 133, some of our derivatives, primarily Floor Income Contracts, certain
Eurodollar futures contracts, basis swaps and equity forwards, do not qualify for “hedge treatment” under
SFAS No. 133. Therefore, changes in market value along with the periodic net settlements must be recorded
through the “gains (losses) on derivative and hedging activities, net” line in the consolidated statement of
income with no consideration for the corresponding change in fair value of the hedged item. The derivative
market value adjustment is primarily caused by interest rate and foreign currency exchange rate volatility,
changing credit spreads during the period, and changes in our stock price (related to equity forwards) as well
as, the volume and term of derivatives not receiving hedge accounting treatment. See also “BUSINESS
SEGMENTS — Limitations of ‘Core Earnings’ — Pre-tax Differences between ‘Core Earnings’ and GAAP by
Business Segment — Derivative Accounting” for a detailed discussion of our accounting for derivatives.
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