Sallie Mae 2009 Annual Report Download - page 190

9. Derivative Financial Instruments (Continued)
below a certain level. If the swap counterparty does not post the required collateral or is downgraded further,
the counterparty must find a suitable replacement counterparty or provide the trust with a letter of credit or a
guaranty from an entity that has the required credit ratings. In addition to the credit rating requirement, trusts
issued after November 2005 require the counterparty to post collateral due to a net positive exposure on cross-
currency interest rate swaps, irrespective of their counterparty rating. The trusts, however, are not required to
post collateral to the counterparty.
ASC 815
Derivative instruments that are used as part of the Company’s interest rate and foreign currency risk
management strategy include interest rate swaps, basis swaps, cross-currency interest rate swaps, interest rate
futures contracts, and interest rate floor and cap contracts with indices that relate to the pricing of specific
balance sheet assets and liabilities, including the Residual Interests from off-balance sheet securitizations. In
addition, prior to 2008, the Company used equity forward contracts based on the Company’s stock. The
Company accounts for its derivatives under ASC 815 which requires that every derivative instrument,
including certain derivative instruments embedded in other contracts, be recorded in the balance sheet as either
an asset or liability measured at its fair value. As more fully described below, if certain criteria are met,
derivative instruments are classified and accounted for by the Company as either fair value or cash flow
hedges. If these criteria are not met, the derivative financial instruments are accounted for as trading.
Fair Value Hedges
Fair value hedges are generally used by the Company to hedge the exposure to changes in fair value of a
recognized fixed rate asset or liability. The Company enters into interest rate swaps to convert fixed rate assets
into variable rate assets and fixed rate debt into variable rate debt. The Company also enters into cross-
currency interest rate swaps to convert foreign currency denominated fixed and floating debt to U.S. dollar
denominated variable debt. For fair value hedges, the Company generally considers all components of the
derivative’s gain and/or loss when assessing hedge effectiveness (in some cases the Company excludes time-
value components) and generally hedges changes in fair value due to interest rates or interest rates and foreign
currency exchange rates or the total change in fair value.
Cash Flow Hedges
Cash flow hedges are used by the Company to hedge the exposure to variability in cash flows for a
forecasted debt issuance and for exposure to variability in cash flows of floating rate debt. This strategy is
used primarily to minimize the exposure to volatility from future changes in interest rates. Gains and losses on
the effective portion of a qualifying hedge are accumulated in other comprehensive income and ineffectiveness
is recorded immediately to earnings. In the case of a forecasted debt issuance, gains and losses are reclassified
to earnings over the period which the stated hedged transaction impacts earnings. If the stated transaction is
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, 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
F-63
SLM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts, unless otherwise stated)