Struggling Sallie Mae Turns to Private Loans and Stock Sale

December 28, 2007

By JOHN HECHINGER – Wall Street Journal
SLM Corp. cited potentially grim prospects for its main federally guaranteed student-loan business, and indicated it was accelerating its push into private loans that aren’t backed by the U.S. government.The biggest student lender, commonly known as Sallie Mae, also said that it faced a federal inquiry into its billing practices for high-return loans and a recent lawsuit from customers alleging racial discrimination. Sallie Mae disclosed both its strategy and the actions it faced in securities filings yesterday detailing two stock offerings. Late yesterday, Sallie said it raised $3 billion by selling common and convertible preferred stock, $500 million more than it had initially expected, amid strong demand. The company is using the proceeds to pay off a soured bet on its stock price and shore up its credit rating. Sallie Mae’s stock has plunged this year after Congress slashed subsidies to student lenders and a $25 billion takeover bid by a group of investors, led by private-equity firm J.C. Flowers & Co., fell through.
In 4 p.m. New York Stock Exchange composite trading, SLM shares were at $19.65, down 11%, as investors worried that the large new offerings would dilute the value of the company’s stock and might not be enough to improve the company’s credit rating, which is near junk-bond levels.
Sallie Mae said the subsidy cuts, as well as higher financing costs amid the current credit-market turmoil, will “significantly reduce” and “could ossibly eliminate the profitability” of making new federally-backed student loans. The Reston, Va., company said it would focus on more profitable private loans, which now make up about 17% of its $160 billion student loan portfolio.
Private loans, however, present their own set of problems. Investors are worried about rising default rates on these obligations, at a time of sharp tightening in the credit markets. Amid skyrocketing tuitions and scarce financial aid, students have increasingly been relying on private financing to pay for college. Earlier this year, in a hearing in Washington, New York Attorney General Andrew Cuomo and U.S. Sen. Christopher Dodd (D., Conn.), said they were looking at potentially discriminatory practices in the private student-loan market — particularly, whether students with comparable credit histories were paying higher rates at historically black colleges. Lenders have denied the allegations, saying they make loans based on borrowers’ credit history, not race.
Yesterday, Sallie Mae disclosed that two borrowers had filed a lawsuit seeking class-action status, alleging that the company’s underwriting practices steered racial minorities into more expensive loans. The suit, filed in U.S. District Court in Connecticut, alleges violations of civil-rights and truth-in-lending laws. The company said it intends “to vigorously defend this action.”
In the lawsuit, plaintiff Sasha Rodriguez, who is Hispanic and lives in Branford, Conn., said she took out 19,500 in private Sallie Mae loans to attend McIntosh College in New Hampshire. Her loans, carrying an 18.125% interest rate, now total more than $33,000, with payments of more than $500 a month, the suit says. Ms. Rodriguez, who makes $10.40 per hour as a pharmacy manager, says Sallie didn’t reveal the terms of the loan and has been calling her as many as 17 times a day to collect, according to the complaint.
Cathelyn Gregoire, who is African-American and lives in Tampa, Fla., claims she took out a $14,276 Sallie Mae loan to attend the International Academy of Design and Technology in Tampa. Including fees, the loan had an effective annual interest rate of 13.25%, the suit says. Ms. Gregoire, who claims she was told she would receive a loan with a 7% rate, says she can’t afford the $800-a-month payments. A Sallie Mae spokeswoman declined to comment on the allegations.
Sallie Mae also disclosed that the U.S. Department of Education’s inspector general planned an audit to determine whether the company properly billed the federal government under a controversial loan program. The program, which guaranteed a minimum 9.5% rate of return, was created as an incentive for lenders at a time when credit was scarce, and was meant to be phased out, but many lenders found a loophole that allowed it to continue, collecting hundreds of millions of dollars from the government. Sallie Mae, which didn’t say how much it collected under the program, said it stopped billing for it in 2006 and that its practice was “consistent with longstanding [Education Department]guidance.”