Sallie Discloses Billing Audit

Lender Also Expects Profit Reduction

Sallie Mae said yesterday that the Education Department is investigating its billing practices and that its business of issuing loans subsidized by the federal government will be significantly less profitable because of changes by Congress.

The disclosures were in a regulatory filing outlining the Reston student lender's plans to raise $3 billion to satisfy an agreement requiring it to buy back its own stock at above-market prices. Sallie Mae shares closed yesterday at their lowest price since 2001.

In its filing with the Securities and Exchange Commission, SLM Corp., as the company is officially known, also said it faces a federal lawsuit filed in Connecticut that seeks class-action status and alleges that Sallie Mae steered minority students toward more expensive loans. The company denied the charge in the filing.

The company has been on a roller coaster since the unraveling of a planned $25.3 billion buyout that would have given its stockholders $60 per share. Yesterday, the company's shares fell $2.48, or 11 percent, to close at $19.65. The stock is 66 percent off its 52-week high.

The collapse of Sallie Mae's months-long effort to sell itself to a group of investors led by private-equity firm J.C. Flowers has left the company with a host of problems. Since the deal was announced early this year, Sallie Mae's credit rating has deteriorated, and its borrowing costs have risen. Meanwhile, its bread-and-butter business, issuing student loans subsidized by the federal government, has become less profitable.

The Education Department's audit of Sallie Mae's billing practices comes as part of a nationwide investigation into the $85 billion student loan industry. Phone calls and messages left last night with Education Department representatives were not immediately returned.

In its SEC filing, Sallie Mae said that changes enacted this year in a federal student loan program "will significantly reduce and, combined with higher financing costs, could possibly eliminate the profitability of" issuing new loans through the program.

That statement struck a different note from arguments the company had made when it was fighting to keep the buyout on track. The buyers argued that they were entitled to walk away from the deal because the legislation cutting subsidies to lenders substantially changed the economics of Sallie Mae's business.

Sallie Mae argued that the buyers were obligated to complete the buyout or pay a $900 million penalty because the legislation wasn't materially worse than Sallie Mae had predicted in its most recent annual report. The two sides are battling over the fee in court.

Sallie Mae spokeswoman Martha Holler declined to comment yesterday, saying the company does not speak publicly during a stock offering.

Since the merger was negotiated, Sallie Mae has been relying on a credit line provided by some of the would-be buyers, Bank of America and J.P. Morgan Chase. Sallie Mae will not be able to borrow additional money through that arrangement after Feb. 15, and it must pay off the balance by May 16.

Replacing that credit line "will probably involve higher financing costs," Sallie Mae chief executive Albert L. Lord said in a recent conference call with investors. "This is not a great time to be financing," he said.

Sallie Mae also has a $6.5 billion credit line, but the decline in its share price could leave it out of compliance with the conditions of the credit line. Sallie Mae said it hopes to reduce the "risk of noncompliance" by selling new stock by Monday.

On Wednesday, the company said it would issue $2.5 billion in common and preferred stock. The offering is aimed at shoring up Sallie Mae's weakened financial condition and helping it avert a credit crunch. Most of the proceeds would be used to help Sallie Mae fulfill a contract to repurchase 44 million of its shares at $45.25 each.

Last night, the company increased the offering to $3 billion by expanding the number of common shares it planned to sell to nearly 102 million from 70 million. Sallie Mae priced those shares at $19.65 each.

A Lehman Brothers analyst's report yesterday said the stock offering may help boost Sallie Mae's credit rating to "A" from "BBB," enabling the company to borrow money at a lower cost to finance its business.

This month, the company reduced its earnings outlook for the current quarter and all of 2008 because the cost of borrowing money has increased. Sallie Mae, which relies on the debt markets to fund its student loans, expects its borrowing costs to be higher than normal through the middle of 2008.

Lord held a conference call last week in which he addressed shareholders for the first time since his effort to sell the student lender collapsed. The purpose of the call was to reacquaint Lord with shareholders after his return as chief executive, but the call was contentious and brief, ending with Lord uttering an expletive. The stock dropped 20 percent the next day.