May 14, 2009 / 1:18 PM / 10 years ago

Sallie Mae cut to junk by Moody's, slams decision

* Key student loan program may end under Obama plan

* Sallie Mae calls downgrade premature, unfortunate

* Shares fall 3.3 percent in premarket trade

By Jonathan Stempel

NEW YORK, May 14 (Reuters) - Sallie Mae was downgraded to “junk” status by Moody’s Investors Service, which cited concerns about the big U.S. student loan provider’s ability to generate earnings and cash flow after the Obama administration asked Congress to cut subsidies to lenders.

Sallie Mae, whose formal name is SLM Corp SLM.N, criticized the downgrade, calling it “unfortunate” and “premature.”

Students may obtain college loans by borrowing directly from the federal government or by taking out government-subsidized loans from private lenders.

In his 2010 federal budget proposal submitted in February, President Barack Obama called for shifting most of the nation’s $90 billion of student lending into the direct-loan program, hoping to save taxpayers more than $4 billion a year.

Moody’s late Wednesday lowered Reston, Virginia-based Sallie Mae’s senior unsecured debt rating two notches to “Ba1,” its highest junk grade, from “Baa2.”

It also cut Sallie Mae’s short-term rating to “Not Prime” from “Prime-2.” The rating outlook is negative, meaning another downgrade is possible within about two years.

Obama’s proposal would end by July 2010 the Federal Family Education Loan Program, which generated the vast majority of the $150 billion of loans on Sallie Mae’s balance sheet as of March 31, the company’s quarterly report shows.

Moody’s said abandoning the FFELP would end Sallie Mae’s traditional role as a lender in the federal student loan program, and turn the company into an originator and servicer, in competition with other vendors.

The rating agency said this could leave Sallie Mae with a lower earnings and cash flow stream that could persist “as profits from servicing loans for the U.S. government are likely to be heavily scrutinized.”

It said a Sallie Mae proposal for schools to choose vendors, and for vendors to get incentives, may fail because of strong support for the administration’s proposal.

Sallie Mae Chief Executive Albert Lord called the downgrade “unfortunate and surprising” given the company’s financial health and the fact that the FFELP remains in place. “This seems to us inappropriately speculative and very premature,” he said.

Last month, Sallie Mae posted a $47.8 million first-quarter net loss applicable to common shareholders as unsettled credit markets squeezed lending margins. Core profit, excluding changes in derivative values, totaled $13.9 million.

Standard & Poor’s, a McGraw-Hill Cos MHP.N unit, rates Sallie Mae’s long-term and short-term debt “BBB-minus” and “A-3,” respectively, its lowest investment grades, with a negative outlook.

Shares of Sallie Mae fell 18 cents to $5.24 in premarket trading. They had closed at $8.39 on Feb. 25 and fell to $5.80 the next day, when Obama released his budget plan. (Reporting by Jonathan Stempel; editing by John Wallace)

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