Sallie Mae to sell $2.5 billion stock, convertibles

By Dan Wilchins

NEW YORK (Reuters) - Sallie Mae (SLM.N) said on Wednesday it plans to sell about $2.5 billion of stock and mandatory convertible securities to help pay off derivatives contracts that amounted to a bet that its share price would keep increasing.

The deal will boost the number of shares the student lender has outstanding, and the company's stock fell 7 percent in aftermarket trading to $20.56 from Wednesday's close of $22.13.

Sallie Mae will use about $2 billion of the proceeds from offering to buy back about 44 million shares now worth closer to about $900 million at current market prices.

The student loan company was tripped up by derivatives known as equity forward contracts that it used under its share buyback program for years.

The contracts allowed the company to reduce the cost of buying back its shares, as long as its stock price kept rising. But if Sallie Mae's share price fell enough, the company would have to buy back large number of shares at above-market prices.

Sallie Mae's shares have dropped by more than half this year as its efforts to sell itself to a group of buyout investors failed, and investors fretted that turmoil in the securitization market would lift its borrowing costs and crimp its profits.

That tripped up "triggers" under the equity forward contracts, forcing Sallie Mae to buy back shares at above-market prices.

Sallie Mae, legally known as SLM Corp, is issuing $2.5 billion of common stock and mandatory convertible preferred stock to help pay off its obligations under the derivatives. Whatever funds are left over after settling the contracts will be used for general corporate purposes, Sallie Mae said.

Sallie Mae said last week that banks it had equity forward contracts with had moved their contracts over to Citigroup (C.N) and that the terms of many of the contracts had been changed, in a move that signaled to many investors that the company was close to raising capital to settle the equity forwards.

Sallie Mae will receive shares of its stock as it buys them back from Citi, and the student loan company can retire those shares, offsetting some of the dilutive effects of issuing new stock.

The company's new chief executive, Albert Lord, last week held a conference call to talk to analysts and investors, but the conversation at times turned testy when participants did not feel they were receiving enough information from the company.

Toward the end of the call, Lord said he would take more questions at a meeting in January. He recommended that participants arrive early "because I can assure, you will be going through a metal detector."

(Reporting by Dan Wilchins, editing by Leslie Gevirtz, Richard Chang)