SALLIE MAE WARNINGS

Investors in SLM Corp., popularly known as Sallie Mae, are probably thanking their lucky stars that a quartet of buyers led by private equity powerhouse J.C. Flowers has a $60-per-share takeover bid on the table given the company’s sharp drop in first-quarter profit.

The company, which was embroiled in a student loan industry probe led by New York Attorney General Andrew Cuomo, reported a 24 percent drop in profit to $116 million, or 26 cents a share, compared with a year-earlier profit of $152 million, or 34 cents.

Despite the weak results, an eye-popping increase in the reserves set aside for loan losses and the withdrawal of earnings guidance, Sallie’s stock dropped only 61 cents to $53.74.

The key component of Sallie’s profit decline was skyrocketing private loan-loss provisions, a sign of an increasingly troubled loan portfolio. To counter declining student loan repayments, Sallie set aside $199 million to account for loans it believes will not be paid in full – a 125 percent increase from the $88 million set aside in last year’s fourth quarter.

The company’s highly coveted $5 billion private loan portfolio – bearing a much higher interest rate than the federally funded portfolio – saw an increase of 6.27 percent in loan charge-offs.

By way of explanation, Sallie Mae’s earnings release noted that much of the charge-off trouble stemmed from moving an operation responsible for handling delinquent loan collections to Indiana from Nevada in the fourth quarter, a move that previous filings did not indicate was in the works.

Also not helping Sallie were derivative losses of $357 million, versus $87 million in losses a year ago, most likely resulting from the cost of portfolio hedges.

Given all that bad news, the private-equity bid for Sallie not only provides a nice cushion for stockholders, but perhaps saved the company itself hundreds of millions of dollars it might have been obligated to pay out in “equity-forward” agreements. These deals, buried deep within its 10-K filing, obligate Sallie to buy back up to 48 million shares from Lehman Brothers at prices of $60 per share at points in 2008 and 2009.

These sorts of agreements are favorable if the company’s stock price is expected to increase, but can be painful if the stock drops because Sallie would have had to make up the difference between the $60 price and its stock price at the time.