On September 17, Citi Holdings, a division of Citigroup Inc., announced the sale of the indirect subsidiary The Student Loan Corp. (SLC) to Sallie Mae and Discover Financial Services.

As part of the transaction, the U.S. Department of Education also purchased a piece of SLC’s student loan portfolio, buying $4.7 billion in federally guaranteed student loans, and Citibank bought back approximately $8.7 billion in unguaranteed SLC assets for sale at a later date.

SLC is 80-percent owned by Citibank, with public shareholders owning the other 20 percent. SLC shareholders will receive about $30 per share in the buyout, a 42-percent increase on the stock’s closing price on September 16.

Prior to the sale, SLC was the second-largest servicer of federally guaranteed student loans behind Sallie Mae.

Sallie Mae paid $1.2 billion to assume servicing responsibility for $28 billion in securitized, federally guaranteed student loans, while Discover, which paid $600 million, will take over the servicing of $4.2 billion in private student loans. Citigroup says it lost about $500 million in the deal after taxes, which it will report in its third-quarter earnings statement. The transactions require regulatory and SLC shareholder approvals and are expected to close by the end of 2010.

Citi Ends Its Run as a Lender of Student Loans

The move means that Citigroup has officially exited both the private and federal student loan business. Citi, like other banks and private lenders, had already been forced to stop originating new federal college loans. Under the Student Aid and Fiscal Responsibility Act, legislation included in the Obama administration’s health care reconciliation bill and that went into effect on July 1, 2010, only the U.S. Department of Education may issue new federally guaranteed student loans. through the government’s student loan program.

Private lenders that were previously authorized to issue federally backed college loans (including Stafford, PLUS, Grad PLUS, and federal consolidation loans) under the third-party Federal Family Education Loan Program (FFELP) are still allowed to service their existing federal student loan portfolios , however, and can buy and sell the servicing rights to these government student loans among themselves.

Sallie Mae and Discover to Become Bigger Players in the Student Loan Market

Once the Citi deal is complete, Sallie Mae will service a portfolio of federal parent and student loans worth around $200 billion. Already the largest servicer of federal student loans, Sallie Mae is also the largest originator and servicer of non-federal private student loans, managing about $36 billion in private education loans.

With the purchase of Citbank’s federal student loans, Sallie Mae will take on about 1.3 million new customers. "This opportunity fits well with our servicing scale and expertise," said Sallie Mae CEO Albert Lord.

For its part, Discover gets a bigger share of the private student loan servicing pie and what the company believes will be a competitive entrée into the growing market for private student loans.

"The private student loan business is an important part of Discover’s direct banking strategy, and this acquisition will enhance our competitive position in private student loan originations," said David Nehms, Discover’s chairman and CEO, in the company’s press release.

Private student loans comprise a growing percentage of the overall student loan picture, as students look for more ways to cover the ever-increasing cost of a college education. While federal student loan legislation has closed one avenue for private lenders to issue student loans, the door is still open to private lenders who want to fill the widening difference between what students can borrow from Uncle Sam to cover college expenses and rising college costs.