Sallie Mae Tells Buyout Consortium to Put Up or Pay Up $900 Million Breakup Fee

Implications: Students borrow approximately $85 billion annually to finance the costs to attend college and the demand for private education loans has surged by 27% over the last six years, while Sallie Mae has diversified its portfolio to offer college-savings plans and private student loans in the last 10 years to meet the demands. Guaranteed borrowing accounts for 40% of SLM's revenue and student lending 23% of their revenue, which is why investors was attracted to Sallie Mae due to the growth in student lending, which has increased an average of 6% annually from 1989-2006. However, Sallie Mae's share price has closed below the $60 a share offered by the Consortium, which has led the Consortium to revise the terms of the deal to $50 a share, however, Sallie Mae wants the buyers to put up or pay up the $900 million breakup fee. In the revised deal the buyers have established their own benchmarks and if met or exceeded by Sallie Mae it could result in a payout of up to $10 per share.

Analysis: The Sallie Mae buyout by the Consortium (J.C. Flowers & Co., Friedman Fleischer & Lowe, LLC (50.2% stake), JPMorgan Chase & Bank of America (each has a 24.9% stake) has hit a snag with both sides crying foul. The buyout of Sallie Mae comes on the hills of allegations of improprieties among student loan lenders and financial aid directors at major institutions in the U.S.  Allegedly, student loan lenders wooed financial aid directors with trips, gifts and payouts to encourage them to direct students applying for student loans to specific lenders and Sallie Mae paid a settlement of $2 million to NY Attorney General, who launched a probe of deceptive loan practices and as a result Sallie Mae agreed to adopt a new code of conduct.

1.  In February 2007, President Bush requested in his budget proposal to cut federal subsidies for student lenders by more than $16 billion, while the Democrats wanted to cut subsidies by as much as $22 billion. The Consortium's concern about the potential long-term profit loss and the terms of the proposed buyout allows the buyers to cancel the deal if Congress cuts federal subsidies for lenders by more than $16 billion and the buyers could walk away from the deal or opt to restructure the proposed deal

2.  As the buyout Consortium and Sallie Mae litigate over the fate of the $25 billion deal, student groups and consumer advocate groups have launched bus tours and meetings to turn a spotlight on key issues facing student borrowers and sought out J.C. Flowers, Bank of America and JPMorgan Chase to agree to place a cap on interest rates, provide additional money for debt forgiveness, offer clear and concise information to students and forgo aggressive debt collection practices

The potential failure of the Sallie Mae buyout deal may be just another casualty amongst a list of proposed LBOs to falter as a result of the meltdown aftermath in credit markets over the last couple of months. On September 27, 2007, President Bush passed legislation to cut federal subsidies by approximately $20 billion to student lenders and Sallie Mae is the largest student lender and a a result of the cut in federal subsidies and a downturn in economic conditions the buyout Consortium is proposing changes to its original deal with Sallie Mae.