Sallie Mae, the American student loan provider, sold $2.5 billion (£1.25 billion) of shares yesterday to settle a bet that it had made against its own stock.

The group had bought derivative contracts that let it fix the price at which it could purchase its own shares as part of its buyback programme.

The derivatives, known as equity forward contracts, were designed to make it cheaper for the lender to buy back its own stock, as long as its share price kept rising. However, in recent months, shares in Sallie Mae – officially the SLM Corporation – have slumped after Washington reduced federal subsidies on student loans and after JC Flowers, the private equity firm, pulled out of a bid for the group.

Late on Wednesday Sallie Mae issued a statement saying that it had appointed UBS and Citigroup to sell $2.5 billion of its shares so that it could settle the outstanding contracts.

The move will mean that Sallie Mae buys back 44 million shares for $2 billion, even though they are worth only $900 million at present market prices. The remaining $500 million is to be used for general corporate purposes. Last week Citigroup agreed to assume Sallie Mae’s outstanding equity forward contracts while the lender’s exposure was calculated. Yesterday’s announcement means that Sallie Mae will now repay Citigroup.

The transaction is the latest blow for Albert Lord, the lender’s recently appointed chief executive. Last week, he was criticised after a tense conference call with Wall Street analysts, during which he dismissed many of their questions about the group’s finances and about why the $25 billion buyout had failed. Mr Lord ended the call with an expletive as the shares sank to a five-year low.

Sallie Mae lends to students starting a college education and securitises the loans. It manages $160 billion, divided between about ten million borrowers. Although Sallie Mae operates as an ordinary financial services company, it benefits from measures giving it priority status if a borrower goes bust. In 2004, it ended its relationship with the Government, so that it could operate as a regular lender.

At the beginning of October, Washington cut billions of dollars of subsidies to student lenders. During the third quarter of the year Sallie Mae admitted that it had lost $344 million.

Investors are also eyeing Sallie Mae nervously because it is expected that the turmoil in America’s mortgage market will spill over into other types of credit, such as car loans and student borrowings.

Chris Whalen, of Institutional Risk Analytics, said: “This just highlights the idiocy of share repurchase programmes. Buying back your own shares does not increase shareholder value, it just means that the company has to pay a broker to buy your own stock. If a company wants to boost shareholder value, it is simple; pay a bigger dividend. The only people who benefit from these programmes are corporate financiers.”

Sallie Mae shares closed down by more than 11 per cent yesterday, at $19.65, having more than halved this year. Sallie Mae and Citigroup did not return calls yesterday.

11%
Fall in the value of Sallie Mae’s shares yesterday
Source: New York Stock Exchange

Times Recommends

• C&G axed - 1,660 jobs to be lost
• UK house prices rise 1.1% as buyers return
• Mixed reaction to US banks repaying bailouts