Sallie Mae 2013 Annual Report Download - page 188

SLM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. Derivative Financial Instruments (Continued)
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 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. Specifically, our Floor Income Contracts do not
qualify for hedge accounting treatment because the pay down of principal of the student loans underlying the
Floor Income embedded in those student loans does not exactly match the change in the notional amount of our
written Floor Income Contracts. Additionally, the term, the interest rate index and the interest rate index reset
frequency of the Floor Income Contracts are different from that of the student loans. 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.
We use basis swaps to minimize earnings variability caused by having different reset characteristics on our
interest-earning assets and interest-bearing liabilities. These swaps possess a term of up to 13 years and are
primarily indexed to LIBOR or Prime rates. The specific terms and notional amounts of the swaps are determined
based on a review of our asset/liability structure, our assessment of future interest rate relationships, and on other
factors such as short-term strategic initiatives. Hedge accounting requires that when using basis swaps, the
change in the cash flows of the hedge effectively offset both the change in the cash flows of the asset and the
change in the cash flows of the liability. Our basis swaps hedge variable interest rate risk; however, they
generally do not meet this effectiveness criterion because the index of the swap does not exactly match the index
of the hedged assets. Additionally, some of our FFELP Loans can earn at either a variable or a fixed interest rate
depending on market interest rates and, therefore, swaps economically hedging these FFELP Loans do not meet
the criteria for hedge accounting treatment. As a result, these swaps are recorded at fair value with changes in fair
value reflected currently in the statement of income.
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