Sallie Mae 2012 Annual Report Download - page 86

their job prospects after graduation and therefore affects their ability to make payments. Credit scores are an
indicator of the credit worthiness of a customer and the higher the credit score the more likely it is the customer
will be able to make all of their contractual payments. Loan status affects the credit risk because a past due loan
is more likely to result in a credit loss than an up-to-date loan. Additionally, loans in a deferred payment status
have different credit risk profiles compared with those in current pay status. Loan seasoning affects credit risk
because a loan with a history of making payments generally has a lower incidence of default than a loan with a
history of making infrequent or no payments. The existence of a cosigner lowers the likelihood of default. We
monitor and update these credit quality indicators in the analysis of the adequacy of our allowance for loan losses
on a quarterly basis.
To estimate the probable credit losses incurred in the loan portfolio at the reporting date, we use historical
experience of customer payment behavior in connection with the key credit quality indicators and incorporate
management expectations regarding macroeconomic and collection procedure factors. Our model is based upon
the most recent six months of actual collection experience, adjusted for seasonality, as the starting point and
applies expected macroeconomic changes and collection procedure changes to estimate expected losses caused
by loss events incurred as of the balance sheet date. Our model places a greater emphasis on the more recent
default experience rather than the default experience for older historical periods, as we believe the recent default
experience is more indicative of the probable losses incurred in the loan portfolio today. Similar to estimating
defaults, we use historical customer payment behavior to estimate the timing and amount of future recoveries on
charged-off loans. We use judgment in determining whether historical performance is representative of what we
expect to collect in the future. We then apply the default and collection rate projections to each category of loans.
Once the quantitative calculation is performed, we review the adequacy of the allowance for loan losses and
determine if qualitative adjustments need to be considered. Additionally, we consider changes in laws and
regulations that could potentially impact the allowance for loan losses. More judgment has been required over the
last several years, compared with years prior, in light of the U.S. economy and its effect on our customers’ ability
to pay their obligations. We believe that our model reflects recent customer behavior, loan performance, and
collection performance, as well as expectations about economic factors.
Similar to the rules governing FFELP payment requirements, our collection policies allow for periods of
nonpayment for customers requesting additional payment grace periods upon leaving school or experiencing
temporary difficulty meeting payment obligations. This is referred to as forbearance status and is considered
separately in our allowance for loan losses. The loss confirmation period is in alignment with our typical
collection cycle and takes into account these periods of nonpayment.
On July 1, 2011, we adopted new guidance that clarified when a loan restructuring constitutes a TDR. In
applying the new guidance we determined that certain Private Education Loans for which we grant forbearance
of greater than three months should be classified as troubled debt restructurings. If a loan meets the criteria for
troubled debt accounting then an allowance for loan losses is established which represents the present value of
the losses that are expected to occur over the remaining life of the loan. This accounting results in a higher
allowance for loan losses than our previously established allowance for these loans as our previous allowance for
these loans represented an estimate of charge-offs expected to occur over the next two years (two years being our
loss confirmation period). The new accounting guidance was effective as of July 1, 2011 but was required to be
applied retrospectively to January 1, 2011. This resulted in $124 million of additional provision for loan losses in
the third quarter of 2011 from approximately $3.8 billion of student loans being classified as troubled debt
restructurings. This new accounting guidance is only applied to certain customers who use their fourth or greater
month of forbearance during the time period this new guidance is effective. This new accounting guidance has
the effect of accelerating the recognition of expected losses related to our Private Education Loan portfolio. The
increase in the provision for losses as a result of this new accounting guidance does not reflect a decrease in
credit expectations of the portfolio or an increase in the expected life-of-loan losses related to this portfolio. We
believe forbearance is an accepted and effective collections and risk management tool for Private Education
Loans. We plan to continue to use forbearance and as a result, we expect to have additional loans classified as
troubled debt restructurings in the future (see “Note 4 — Allowance for Loan Losses” for a further discussion on
the use of forbearance as a collection tool).
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