Sallie Mae 2010 Annual Report Download - page 164

9. Derivative Financial Instruments (Continued)
Accounting for Derivative Instruments
Derivative instruments that are used as part of our 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 (prior to the
adoption of topic updates to new consolidation accounting guidance adopted on January 1, 2010, see Note 2,
“Significant Accounting Policies — Consolidation”). The accounting for derivative instruments requires that
every derivative instrument, including certain derivative instruments embedded in other contracts, be recorded
on 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 us 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 us to hedge the exposure to changes in fair value of a recognized
fixed rate asset or liability. We enter into interest rate swaps to economically convert fixed rate assets into
variable rate assets and fixed rate debt into variable rate debt. We also enter into cross-currency interest rate
swaps to economically convert foreign currency denominated fixed and floating debt to U.S. dollar denom-
inated variable debt. For fair value hedges, we generally consider all components of the derivative’s gain
and/or loss when assessing hedge effectiveness (in some cases we exclude time-value components) and
generally hedge changes in fair values due to interest rates or interest rates and foreign currency exchange
rates or the total change in fair values.
Cash Flow Hedges
We use cash flow hedges 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 recorded in 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 affects earnings. If we determine it is not probable that
the anticipated transaction will 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. We generally hedge exposure to changes in cash flows due to changes in interest rates or total
changes in cash flow.
Trading Activities
When derivative instruments do not qualify as hedges, they are accounted for as trading instruments
where all changes in fair value are recorded through earnings. We sell interest rate floors (Floor Income
Contracts) to hedge the Embedded Floor Income options in student loan assets. The Floor Income Contracts
are written options which have a more stringent hedge effectiveness hurdle to meet. Therefore, Floor Income
Contracts do not qualify for hedge accounting treatment, and are recorded as trading instruments. Regardless
of the accounting treatment, we consider these contracts to be economic hedges for risk management purposes.
We use this strategy to minimize our exposure to changes in interest rates.
F-61
SLM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts, unless otherwise stated)