The government's growing role is cutting out private lenders from much of the business of financing higher education, prompting lenders to decide whether to exit the business entirely or scale back.
On Friday, Citigroup said it is selling its 80 percent stake in Student Loan Corp., its student loan business, and about $32 billion in related assets to Discover Financial Services and the student lender Sallie Mae.
The combined transactions will bring Citigroup $1.8 billion in cash, but Citi said it will take a loss of about $500 million in this year's third quarter because of the deals.
The move is the latest by Citi to shed some of its smaller businesses and focus on its core consumer banking operations, as it tries to recover from the recession and credit crisis.
"This is a byproduct of the government basically nationalizing the student loan business," said analyst Matt Snowling of FBR Capital Markets.
Back in March, President Obama signed a law to make the government the primary lender to students, rather than a guarantor backing private loans. This essentially means that private lenders can continue to service their exisiting loans, but the potential for growth in making new loans is cut off. Private lenders still can make student loans that are not backed by the government, although that market is shrinking.
The changes have hit Citi's student loan business and Sallie Mae harder than the industry as a whole, said Tim Ranzetta, founder of the independent research firm Student Lending Analytics. He estimates industrywide the number of new private loans was down 24 percent in the 2009-2010 academic year compared with the previous year, while Citi and Sallie Mae have seen their new loan business cut by roughly half.
"There is a reordering of the industry going on," Ranzetta said, noting that Discover Financial and Wells Fargo & Co. are gaining market share.
In Friday's transactions, Sallie Mae, the largest student lender, and Discover Financial, provider of the Discover payment cards, will fill the void from Citi's private student loan exit.
Discover has agreed to pay Citi $600 million, or $30 per share, for Student Loan Corp. Discover also will acquire $4.2 billion of private student loans from Student Loan Corp.
By expanding its student loan business, the deal gives Discover the opportunity to drum up more credit-card business. It will be able to introduce the Discover brand to a new pool of clients.
Sallie Mae, based in Reston, Va., is the nation's largest student lender, formally known as SLM Corp. It has been restructuring, including slashing jobs, as it responds to the new law and increasingly emphasizes its servicing business for federal loans. With the Citigroup deal, Sallie Mae will acquire $28 billion in federal loans, adding another 1.3 million new customers, for $1.2 billion.
After the transaction, Sallie Mae will manage or service about $200 billion in federal student loans.
Citi has been looking for a buyer for its 80 percent stake in the Student Loan Corp. for several months as it refocuses it operations. The indirect Citi subsidiary is 20 percent owned by holders of Student Loan Corp.'s publicly traded shares.
Citi has been unraveling the one-stop financial services marketplace model it created in the late 1990s. Citi split itself into two parts last year Citicorp and Citi Holdings. The latter division holds riskier assets including the mortgage-backed securities that undermined the bank and other financial institutions.
In afternoon trading, Student Loan Corp. shares surged $8.72, or 41 percent, to close at $29.87 slightly below the $30 price per share that Discover is paying in the transaction.