Private Investors to Buy Sallie Mae for $25 Billion

By David S. Hilzenrath and Amit R. Paley
Washington Post Staff Writers
Tuesday, April 17, 2007

Sallie Mae, the nation's largest student loan company, announced yesterday that it would be bought by a group of private investors in a $25 billion deal that could reduce public scrutiny of the lender at a time when the student loan industry is under siege.

The enormous deal underscores the potential for profit that Wall Street sees in the $85 billion-a-year student loan industry, even as Congress considers slashing billions of dollars in federal loan subsidies and an expanding nationwide probe reveals fresh conflicts of interest in the student lending world.

The buyers of the Reston company include J.P. Morgan Chase, the third-largest originator of federal student loans, and Bank of America, the fourth-largest. Together with Sallie Mae, they control up to 40 percent of the market, analysts said.

The sale -- which could triple the value of the chief executive's stock options, to more than $120 million -- is the latest transformation for a 35-year-old company that began as a congressionally chartered quasi-governmental entity. Sallie Mae has capitalized on rising tuition costs and increased enrollments at colleges and universities to become a financial powerhouse and one of the largest public companies in the Washington area.

Sallie Mae's bread and butter has been issuing loans that carry federal interest rate subsidies and government guarantees, which minimize the potential losses if borrowers default.

Tom Joyce, a spokesman for Sallie Mae, said the deal would not affect the company's nearly 10 million student loan customers, who owe a total of $142 billion. He also said Sallie Mae, Bank of America and J.P. Morgan Chase would continue to compete with one another in the student loan business.

But some analysts said the buyout could reduce options for consumers. "This deal is going to hurt students because there aren't going to be as many competitive rates out there," said Stuart Plesser, an analyst at Standard & Poor's.

News of the deal prompted concern from Democratic lawmakers who have opened investigations into the financial relationships and conflicts of interest among private lenders, universities and government officials. Government probes have already resulted in the suspension of financial aid directors at six universities, a senior official at the Department of Education and three top lending company executives.

"Clearly, banks and investors see student loans as a very profitable business," Edward M. Kennedy (D-Mass.), chairman of the Senate Education Committee, said in a statement. "It's more urgent than ever to enact reforms to our student loan system to ensure that students, not profits, are our top priority."

Critics of Sallie Mae have for years pored over the lender's Securities and Exchange Commission filings to discover details about compensation packages for top executives and the company's profit margins. Some of those disclosures have galvanized efforts to overhaul the student loan industry.

Much of that information could became secret once the company goes private.

"They are trying to turn student loans into a black box," said Luke Swarthout, an advocate for the U.S. Public Interest Research Group Higher Education Project. "That will further stymie and undermine appropriate regulations and appropriate protection of taxpayer subsidies."

But some student advocates said it was unclear that the deal would have any effect on students. "I think this is more about changes in corporate America than it is about changes in student loans," said Robert Shireman, president of the Institute for College Access and Success and executive director of the Project on Student Debt.

And Sallie Mae disputed the notion that the sale would cloak its operations in secrecy. "Sallie Mae will continue to have publicly traded debt securities and as a result will continue comprehensive financial reporting about its business, financial condition and results of operations," spokesman Joyce said in an e-mail.

After the buyout, which remains subject to shareholder and regulatory approval, Sallie Mae's management team would stay on the job, and the company would remain based in Reston, Sallie Mae said in a news release. No layoffs are planned, Joyce said. The company employs 11,456 people, including 763 in the Washington area.

At a price of $60 per share, the buyout would boost the value of Sallie Mae's stock by almost 50 percent compared with the price last week before the possibility of such a deal was first reported.

Chief executive Thomas J. Fitzpatrick's stock options would be worth $123.1 million; as of last week, he could have cashed in options worth $39.4 million, based on data from the company's most recent compensation disclosure. Fitzpatrick also owned more than 2 million shares that would be worth another $122.2 million.

As a group, Sallie Mae's officers and directors held more than 5 million shares as of Feb. 28 that would be worth more than $300 million at the buyout price.

"This transaction . . . recognizes the value in the company for shareholders," Sallie's Joyce said. "The marketplace, you could say, [had] not rewarded our shareholders for the earnings power of the company."

Sallie Mae's shares closed at $55.05 yesterday, up 17.7 percent from Friday's close, which already reflected news of a potential deal.

The sale of the company, which had been in the works for several weeks, was signed Sunday night after Sallie Mae's board met over the weekend, Joyce said.

By pooling their resources -- the student loan marketing dominance of Sallie Mae and the banking power and reach of Bank of America and J.P. Morgan Chase -- the three firms could position themselves to better withstand the threats from Congress, analysts said. The two other buyers are New York investment firms: J.C. Flowers & Co. and Friedman Fleischer & Lowe.

The change to private ownership reflects Sallie Mae's desire to shift from restrictive federal loans into the booming private loan business, where higher interest rates and fees can double the cost to borrowers, analysts said. The company also has been expanding into debt collection and the marketing of college savings plans.

"The fact that we have investors now who can bring significant resources to the table . . . will allow us to continue to diversify the business away from being wholly reliant on guaranteed student loans," Joyce said.

The cuts the government is considering in student loan subsidies "will result in less lenders, higher prices and less choice for students," Joyce said.

The debt Sallie Mae would take on as a result of the deal was raising eyebrows. Almost two-thirds of the $25 billion purchase price would be borrowed. The three major credit ratings agencies put Sallie Mae on watch yesterday for a possible downgrade in its investment ratings. A downgrade, which acts as an alert to the financial markets, could make it more difficult for Sallie Mae to get low-interest funds that back its student loans.

Staff writer David Cho, graphics editor Karen Yourish and staff writer Tomoeh Murakami Tse in New York contributed to this report.