Selling Sallie Mae

Sallie Mae announced a deal Monday under which the gargantuan student loan provider would be sold to two private equity firms and two banks for $25 billion, completing a remarkably swift (and in some quarters controversial) transformation from government entity to privately held company.

The sale of Sallie Mae, which had been rumored in recent days, comes at a time of great agitation and uncertainty in the student loan industry, given sprawling state and federal investigations into possible lender wrongdoing (Sallie Mae paid $2 million last week to settle claims made about the company's practices by New York Attorney General Andrew M. Cuomo) as well as expected Congressional and White House efforts to cut further into lender profits.

Cuomo’s investigation expanded further Monday with the announcement of a settlement with another lender and the announcement that the attorney general and legislative leaders have reached agreement on a bill that would require all colleges in New York to abide by a student loan code of conduct that he is promulgating (see below).

Those developments might seem to make the industry's most visible player and potential regulatory target an odd and potentially risky investment target, and members of Congress indicated that they would scrutinize the deal closely. But several observers of the loan industry said they believed that the sale would ultimately go through and that the investors' interest indicated that Sallie Mae would emerge from the current period of controversy perhaps battered and bruised, but fundamentally intact as the 800-pound gorilla in the industry (it manages $142 billion in student loans for 10 million borrowers).

Under the terms of the deal, JC Flowers & Co. and Friedman Fleischer & Lowe LLC together would own 50.2 percent of Sallie Mae, and JPMorgan Chase & Co. and Bank of America would each own a shade less than a quarter of the company. The purchase price, which includes $8.8 billion in cash and about $16 billion in debt, equates to a per-share stock price of $60. That is significantly higher than the $44 a share that Sallie Mae was trading at last week week ago when news of a possible sale first broke, but in line with the stock's yearly high of $58, which it hit in early 2006. (On news of the deal, Sallie Mae’s stock rose to $55 a share Monday, but three ratings agencies put the company on their “watch” lists, suggesting they anticipated downturns in its credit ratings.)

Sallie Mae officials said the sale, which would require the approval of Sallie Mae stock holders as well as government regulators, would allow the company both to fulfill its existing business model and to continue to diversify its offerings, perhaps expanding its roles in the private loan market, in state 529 plans, and the like. Sallie Mae officials also said that the company's management team would remain in place, although most experts on the industry said they expected turnover at the top, including Timothy Fitzpatrick, the chief executive officer.

Company officials also pointed out that the two banks in the deal would commit to providing $200 billion in backup financing for Sallie Mae in case the increased debt load it accumulates through the deal limits its access to the traditional financing markets.

The proposed sale of Sallie Mae into private hands would represent the final stage in a process in which it evolved from a "government-sponsored enterprise" (buying existing student loans from banks using low-cost debt guaranteed by the federal government) into an independent, publicly traded company into, if this deal goes through, a privately held one.

That is among the facets of the proposed transaction that could draw more than the usual scrutiny from government regulators who might be in a position to review, if not hamstring, the deal. Some of Sallie Mae's many critics contend that the company profited enormously from the many years when it was government backed, and may try to question the sale of the company into private hands, or at least get something from taxpayers from the deal. But even loan experts who are no fans of Sallie Mae questioned, as one put it, "what legal basis there would be to do that."

More likely, Congressional critics of the lending industry and Sallie Mae in particular are likely to raise questions about whether the company's move is likely to shield it from the scrutiny and review to which publicly traded companies are susceptible. In fact, that is one of the two major reasons -- the other being to give companies more protection from the quarterly profitability demands of Wall Street -- that a growing number of publicly traded companies are seeking private equity and other investment.

Rep. George Miller (D-Calif.), chairman of the House of Representatives Committee on Education and Labor, signaled his concerns along those lines in a statement last week when news of a possible deal for Sallie Mae first broke. And he weighed in Monday, too, after the deal was announced, saying: "At a time when the integrity of our nation's student loan system has been called into question for many reasons, and given the checkered past of Sallie Mae, I will be interested -- and the Congress will be interested -- in learning more about how this new ownership will change their operations, and whether this is truly in the best interests of student borrowers and families who are working extremely hard to pay these loans back."

Sen. Edward M. Kennedy (D-Mass.), who heads the Senate's education committee, said the deal was a sign that the student loan industry remained enormously profitable, and that it would encourage him to pursue plans to further rein in lender profits and use the proceeds to help students pay for college.

Sallie Mae officials said Monday that the company would still face significant public scrutiny and disclosure. They said that the company would remain subject to state and federal laws, to all Education Department regulations, and to Congressional oversight, and that it would continue to file reports with the Securities and Exchange Commission because it would continue to participate in the public debt markets (buying and selling loan debt). In addition, he noted, the company just agreed to abide by the code of conduct promulgated by Attorney General Cuomo, subjecting it to "unprecedented disclosure and transparency," as one official put it.

"The notion that we're going to be somehow not transparent is just not accurate," a Sallie Mae official said. ''We'll continue to have the same oversight post-closing that we have today."

That view was challenged by some student loan officials, though, who noted that Sallie Mae would no longer have to submit many of the reports that it now does as a publicly traded company.

In other developments in the unfolding loan scandal Monday:

• Attorney General Cuomo and legislative leaders in New York said they would introduce legislation that would codify in state law (and require all colleges to adopt) the code of conduct that Cuomo has been instituting college by college and lender by lender to date. In introducing the Student Lending Accountability, Transparency and Enforcement Act of 2007, lawmakers adopted some of the highly critical language that Cuomo has used at time in explaining the need for cracking down on dubious behavior by lenders and financial aid officers alike. “It is deeply troubling that college and university financial aid officers and lenders would look to benefit from the need and willingness of working families and students to take on enormous debt to gain the education needed to compete in the 21st Century economy," Assembly Speaker Sheldon S. Silver said. "The Assembly will hold a public hearing April 23 on the SLATE legislation as part of our efforts to move aggressively to end this scandal and restore confidence in our higher education system.”
• Cuomo also announced that he had reached a settlement with a third lender, Education Finance Partners, which agreed to pay $2.5 million and to end its revenue sharing arrangements with colleges, among other changes, in adopting the attorney general's code of conduct. Education Finance Partners had been the attorney general's first announced target, and company officials reacted defiantly to his plan to sue the company. But they adopted a very different tone Monday. "We are proud of our legacy of helping students obtain the resources they need to continue their education," Tamera Briones, Education Finance's founder and chief executive, said in a prepared statement. "This agreement removes the appearance of any impropriety and supports our company’s goal of raising the level of education and transparency around private loan programs."
• Sen. Edward M. Kennedy (D-Mass.) sent a letter to the Education Department asking its officials to cut off lenders' access to the National Student Loan Data System, amid reports that some of them may have used it to find confidential information about student borrowers to market their products.