Sallie Mae's Lame Defense

Earlier this week, we wrote about a class action shareholder lawsuit that accuses Sallie Mae executives of having engaged in an elaborate scheme to hide the rapidly deteriorating state of the company's private student loan portfolio at a time when they were trying to complete a buy-out deal that would have brought them great riches.

At Higher Ed Watch, we find these allegations compelling. It was, after all, only a week after Sallie Mae's deal with J.C. Flowers & Co. collapsed that the company began to come clean about the huge amount of losses it was about to incur on the extremely risky private loans it had made to sub-prime borrowers at some of the largest chains of for-profit college companies in the country.

Unsurprisingly, Sallie Mae's lawyers tell a different story. Far from being conspirators, the student loan giant's leaders, they say, were "unsuspecting victims" of the financial turmoil that overtook the country during that period of time. "Although not recognized at the time, the second half of 2007 marked the start of what became the largest credit crisis since the Great Depression, described by former Federal Reserve Chairman, Alan Greenspan (who did not predict it), as a "once-in-a-century credit tsunami," the company's counsel wrote in their unsuccessful motion to get the case dismissed. "During this period SLM Corporation experienced unprecedented defaults by its student borrowers and its stock price declined substantially, on virtually the same downward trajectory as other consumer credit providers."

They concluded the motion by saying, "In sum, plaintiffs offer no contemporaneous, reliable evidence sufficient to support any inference other than that defendants were unsuspecting victims of a consumer credit tsunami that cause unprecedented numbers of its student borrowers to default."

This explanation could be convincing — but only if you ignore the numerous statements that Sallie Mae officials have made since that time acknowledging the part they played in creating the mess in which they find themselves. At Higher Ed Watch, we thought we'd provide the following chronology to remind our readers of what Sallie Mae executives had to say as the true condition of  the company's private loan portfolio became known:

The Truth Comes Out

Dec. 12, 2007: Sallie Mae announced that the merger deal with the Flowers group is officially dead.

Dec. 19, 2007: During a conference call with investors, Sallie Mae officials announced that they had significantly increased the company's provision for private loan losses and acknowledged that there were questions in the market about the credit quality of its private loan portfolio. Sallie Mae's chairman Al Lord, however, refused to go into any more detail and ended the call abruptly — closing with "There's no questions. Let's get the F*** out of here."

Jan. 4, 2008: Sallie Mae announced that it was going to be more selective in originating private loans and would use stricter underwriting standards.

Jan. 23, 2008: In a conference call with investors on the company's final 2007 financial results, Sallie Mae officials revealed that their provision for loan losses that year ultimately amounted to about $1 billion, an increase of 242 percent from the previous year. They also announced that they would no longer be making new sub-prime loans to financially needy students at some of the country's largest proprietary school chains. Lord, who was now the company's chief executive officer, acknowledged during the call that the company had erred by making such risky loans:

Sallie Mae has lent too much money to students who have gone to schools without very good graduation records. Such students at such schools are virtually singly responsible for 60% of the '07 credit losses ... The company has stopped making loans that were predictably not collectible [emphasis added]. You may have seen the announcements. I think three of our major customers and unfortunately what was bad news for us in this quarter has turned out to be very bad news for them as well. You may have seen the announcements that we've notified them that we're just not making those loans anymore.

Jack Remondi, the company's chief financial officer, provided more detail about the company's "nontraditional" lending:

This is really a segment of the schools that for one reason or another are bringing in students but not producing graduates. Or if they are producing graduates, their graduates haven't gained a sufficient economic benefit to generate the earnings to pay off and meet the debt obligations associated with their loan. And that's the business we will be exiting.

April 17, 2008: In a conference call on the company's 2008 first quarter earnings, Remondi acknowledged that the company's use of forbearances had increased significantly in 2007 and that the company was now going to be more selective in offering this option to financially distressed borrowers.

June 5, 2008: In an interview with The Wall Street Journal (for an article entitled "SLM's Headmaster on Lessons Learned"), Lord took responsibility for the company's irresponsible lending practices:
It was obviously a mistake and I'm not not going to step away from responsibility because I was either chairman or CEO when these loans were made [emphasis added]. We got a little too confident in our own view that credit scores are of limited meaning for undergraduates. Maybe as early as 2004, we stated lending with less selectivity.

Sept. 10, 2008: Speaking at a Lehman Brothers' financial analyst conference, Lord once again admitted that the company lent irresponsibly:
We shouldn't have non-traditional borrowers, but we do. In fact, 15% of our portfolio are what we call non-traditional borrowers ... It's basically kids and parents with poor credit risks who are at the wrong schools. The fact is that we put 15% of this — of our book on over the '04 to '07 period basically because we got a little sloppy and began to I think engage in some wishful thinking in our underwriting practices.

Oct. 23, 2008: In a conference call on the company's 2008 third-quarter earnings, Remondi acknowledged that the company had previously failed to adequately screen borrowers who were granted forbearance on their private loans:

On the forbearance side, for example, we are applying far more analysis [emphasis added] to requests that we receive to make sure that borrowers are both, one committed to serving their debt, and two, have the actual ability to benefit from a forbearance, and so we are working in those areas. And this whole effort is really being led by a new team of individuals who are doing far more segmentation of the areas and analytical approach to that space.

Jan. 22, 2009: In a conference call on the company's 2008 fourth-quarter earnings, Remondi admitted that the company's previous policy of indiscriminately providing forbearances had simply delayed inevitable delinquencies and defaults:

On the nontraditional side of the equation, and particularly on the forbearance changes, what we are looking at here is there are segments of the population who don't benefit from a forbearance ... So by ending that practice [emphasis added] and pushing those borrowers into repayment sooner, what you're doing is  accelerating charge-offs that would have occurred in future years ... I'm going to say it again, but it is not a forecast that our future default rates are going higher. It's just a shifting of the time of when they're recognized.

Now these quotes on their own obviously don't prove that Sallie Mae officials were engaged in a conspiracy. But they do show that these executives were not "unsuspecting victims" of an economic crisis. These officials acted incredibly irresponsibly (which, as we see here, they have readily admitted) and put extremely vulnerable borrowers in jeopardy. In future posts, we will take a closer look at the harm that was done.