Sallie Mae 2008 Annual Report Download - page 33

that should be recognized annually throughout the life of the loan. (See also “Allowance for Loan
Losses” above for the determination of default rates and the factors that may impact them.)
• The discount rate used (see “Fair Value Measurement” discussed above).
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.
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. 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, forward interest rate curves, volatility factors, forward foreign exchange rates, and the closing
price of our stock (related to our equity forward contracts). Inputs are generally from active financial markets;
however, as mentioned under “Fair Value Measurements” above, adjustments are made for inputs from illiquid
markets and to adjust for credit risk. In some instances, counterparty valuations are used in determining the
fair value of a derivative when deemed a more appropriate estimate of the fair value. Pricing models and their
underlying assumptions impact the amount and timing of unrealized gains and losses recognized and, as such,
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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