Sallie Mae Shifts $1.6 Billion in Derivatives to Citi

Sallie Mae said Thursday that banks have transferred a series of its derivative contracts to Citigroup signaling that the student loan company is close to paying off an estimated $1.6 billion obligation linked to the derivatives.

Sallie Mae could raise new capital to help pay off the contracts known as equity forwards, said Sameer Gokhale, analyst at Keefe, Bruyette & Woods. On Wednesday, Morgan Stanley said it was selling a $5 billion stake to China.

Under the equity forward contracts, Sallie Mae may have had to soon buy back more than a billion dollars of its shares at higher-than-market levels because the company's share price has fallen so much in recent months.

The steep share decline -- Sallie Mae's shares fell another 9 percent Thursday to their lowest since 2001 -- follows a failed leveraged buyout attempt that has ended up in court and turmoil in the securitization markets that Sallie uses for funding.

Sallie Mae, legally known as SLM Corp , had equity forward contracts with about nine different banks and uses the derivatives essentially as a means of financing its share buyback program.

Sallie Mae and the banks have moved all the contracts to Citigroup unit Citibank N.A. The contracts now expire Feb. 22, 2008.

Citi and Sallie Mae removed the triggers from the contracts, meaning the student lender will not have to immediately pay back its obligations under the contracts as its share price falls. The triggers had been close to being tripped, a source familiar with the situation said.

Citi would not likely take on all those obligations and give up the protection that triggers offer unless it were close to paying them off, analysts said.

Under equity forward contracts, a bank would buy a large block of shares and then sell the shares to Sallie Mae in the future at the bank's historical cost plus a financing fee. But if shares fell below a particular level, Sallie Mae would have to buy back the shares at a higher-than-market level.

In Legal Fight

Sallie Mae said in its most recent quarterly filing that it has access to about $45 billion of funds between cash, liquid investments and borrowing capacity.

Stripping out borrowing capacity that may fall away in the future, Sallie Mae conservatively has about $10 billion to $15 billion of available funds, Gokhale said.

The extent to which the company taps those funds to pay back the estimated $1.6 billion, or instead raises new capital, depends on whether the company is looking for a higher credit rating than it has, Gokhale said.

Last week, Sallie Mae said it was lowering its 2008 core earnings per share forecast to a range of $2.60 to $2.80 from $3.25, which it said at the time was due primarily to increased costs from replacing an interim funding facility.

Sallie Mae, slugging it out in a legal fight with a private equity group over a failed $25 billion takeover of the company, saw its shares drop 21 percent Wednesday on concerns about its finances. The shares were down about 10 percent at $20.68 in afternoon trading on Thursday.

Credit rating agency Moody's Investors Service said it was considering cutting Sallie Mae's ratings because Sallie Mae could have more trouble financing itself at reasonable rates.