Sallie Mae 2008 Annual Report Download - page 29

quantitative calculation. Once the quantitative calculation is performed, management reviews the adequacy of
the allowance for loan losses and determines if qualitative adjustments need to be considered.
The 2007 FFELP provision included one-time adjustments for the repeal of the Exceptional Performer
program (and the resulting increase in our Risk Sharing percentage) due to the passage of the CCRAA, which
was effective October 1, 2007, as well as increased provision related to the increase in our default expectations
due to an increase in recent delinquencies and claim filings. The provision in 2008 increased due to an
increase in delinquencies and claim filings from the weakening of the U.S. economy, as well as the portfolio
transitioning to FFELP loans, which are subject to more Risk Sharing. Since we are impacted by changes in
the laws and regulations of the FFELP, any changes made to the Risk Sharing levels could have a material
impact on our FFELP allowance for loan losses. Also, if the economy continues to weaken beyond our
expectations, the losses embedded in the FFELP allowance for loan losses could continue to increase.
Premium and Discount Amortization
For both federally insured and Private Education Loans, we account for premiums paid, discounts
received, and capitalized direct origination costs incurred on the origination of student loans in accordance
with the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standard
(“SFAS”) No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring
Loans and Initial Direct Costs of Leases.” The unamortized portion of the premiums and the discounts is
included in the carrying value of the student loans on the consolidated balance sheet. We recognize income on
our student loan portfolio based on the expected yield over the estimated life of the student loan after giving
effect to the amortization of purchase premiums and accretion of student loan discounts. In arriving at the
expected yield, we make a number of estimates that when changed are reflected as a cumulative adjustment to
interest income in the current period. The most critical estimates for premium and discount amortization are
incorporated in the Constant Prepayment Rate (“CPR”), which measures the rate at which loans in the
portfolio pay down principal compared to their stated terms. The CPR estimate is based on historical
prepayments due to consolidation activity, defaults, and term extensions from the utilization of forbearance, as
well as, management’s qualitative expectation of future prepayments and term extensions.
In the development of the CPR estimates, the effect of consolidation activity can be a significant
assumption. Between 2003 and 2006, we experienced a surge in FFELP Stafford loan consolidation activity as
a result of aggressive marketing and historically low interest rates. This, in turn, has had a significant effect on
premium and discount amortization in our financial statements. More recently, as a result of the CCRAA and
the current U.S. economic and credit environment, we, as well as many other industry competitors, have
suspended our FFELP consolidation program. In lieu of consolidation, we may offer a term extension option
for FFELP loans based on the borrower’s total indebtedness.
Based upon these market factors, we have updated our CPR assumptions that are affected by consolida-
tion activity, and we have updated the estimates used in developing the cash flows and effective yield
calculations as they relate to the amortization of student loan premium and discount amortization.
Consolidation activity affects estimates differently depending on whether the original loans being
consolidated were on-balance sheet or off-balance sheet and whether the resulting consolidation is retained by
us or consolidated with a third party. When we consolidate a loan that was in our portfolio, the term of that
loan is generally extended and the term of the amortization of associated student loan premiums and discounts
is likewise extended to match the new term of the loan. In that process, the unamortized premium balance
must be adjusted to reflect the new expected term of the consolidated loan as if it had been in place from
inception.
At the beginning of 2008, when we evaluated our estimates by taking into consideration the suspension of
our FFELP consolidation program, there was an expectation of increased external consolidations to third
parties, but an overall decrease in total consolidation activity (when taking into account both internal
consolidations and consolidations to third parties) due to a lack of financial incentive for lenders to continue
offering a consolidation product. External consolidations did not significantly increase as expected; therefore,
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