Sallie Mae 2010 Annual Report Download - page 163

9. Derivative Financial Instruments (Continued)
sensitivity by modifying the repricing frequency and underlying index characteristics of certain balance sheet
assets and liabilities so the net interest margin is not, on a material basis, adversely affected by movements in
interest rates. We do not use derivative instruments to hedge credit risk associated with debt we issued. As a
result of interest rate fluctuations, hedged assets and liabilities will appreciate or depreciate in market value.
Income or loss on the derivative instruments that are linked to the hedged assets and liabilities will generally
offset the effect of this unrealized appreciation or depreciation for the period the item is being hedged. We
view this strategy as a prudent management of interest rate sensitivity. In addition, we utilize derivative
contracts to minimize the economic impact of changes in foreign currency exchange rates on certain debt
obligations that are denominated in foreign currencies. As foreign currency exchange rates fluctuate, these
liabilities will appreciate and depreciate in value. These fluctuations, to the extent the hedge relationship is
effective, are offset by changes in the value of the cross-currency interest rate swaps executed to hedge these
instruments. Management believes certain derivative transactions entered into as hedges, primarily Floor
Income Contracts, basis swaps and Eurodollar futures contracts, are economically effective; however, those
transactions generally do not qualify for hedge accounting under ASC 815 (as discussed below) and thus may
adversely impact earnings.
Although we use derivatives to offset (or minimize) the risk of interest rate and foreign currency changes,
the use of derivatives does expose us to both market and credit risk. Market risk is the chance of financial loss
resulting from changes in interest rates, foreign exchange rates and market liquidity. Credit risk is the risk that
a counterparty will not perform its obligations under a contract and it is limited to the loss of the fair value
gain in a derivative that the counterparty owes us. When the fair value of a derivative contract is negative, we
owe the counterparty and, therefore, have no credit risk exposure to the counterparty; however, the
counterparty has exposure to us. We minimize the credit risk in derivative instruments by entering into
transactions with highly rated counterparties that are reviewed regularly by our Credit Department. We also
maintain a policy of requiring that all derivative contracts be governed by an International Swaps and
Derivative Association Master Agreement. Depending on the nature of the derivative transaction, bilateral
collateral arrangements generally are required as well. When we have more than one outstanding derivative
transaction with the counterparty, and there exists legally enforceable netting provisions with the counterparty
(i.e., a legal right to offset receivable and payable derivative contracts), the “net” mark-to-market exposure,
less collateral the counterparty has posted to us, represents exposure with the counterparty. When there is a
net negative exposure, we consider our exposure to the counterparty to be zero. At December 31, 2010 and
2009, we had a net positive exposure (derivative gain positions to us less collateral which has been posted by
counterparties to us) related to SLM Corporation and the Bank derivatives of $296 million and $246 million,
respectively.
Our on-balance sheet securitization trusts have $13.8 billion of Euro and British Pound Sterling
denominated bonds outstanding as of December 31, 2010. To convert these non-U.S. dollar denominated
bonds into U.S. dollar liabilities, the trusts have entered into foreign-currency swaps with highly-rated
counterparties. At December 31, 2010, the net positive exposure on these swaps is $920 million. As previously
discussed, our corporate derivatives contain provisions which require collateral to be posted on a regular basis
for changes in market values. The on-balance sheet trusts’ derivatives are structured such that swap
counterparties are required to post collateral if their credit rating has been withdrawn or is 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.
F-60
SLM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts, unless otherwise stated)