UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to _________
1-12897
(Commission File Number)
PROVIDIAN FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
Delaware 94-2933952
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
201 Mission Street, San Francisco, California 94105
(Address of principal executive offices) (Zip Code)
(415) 543-0404
(Registrant's Telephone Number, Including Area Code)
Not Applicable
(Former name, former address and former fiscal year, if
changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
As of October 31, 2000, there were 142,933,381 shares of the registrant's
Common Stock, par value $0.01 per share, outstanding.
1
<PAGE>
PROVIDIAN FINANCIAL CORPORATION
FORM 10-Q
INDEX
September 30, 2000
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements (unaudited):
Condensed Consolidated Statements of Financial
Condition ........................................... 3
Condensed Consolidated Statements of Income ........... 4
Condensed Consolidated Statements of Changes in
Shareholders' Equity ................................ 5
Condensed Consolidated Statements of Cash Flows ....... 6
Notes to Condensed Consolidated Financial
Statements .......................................... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ................... 12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ...................................... 30
Item 6. Exhibits and Reports on Form 8-K ....................... 32
Signatures ............................................................. 33
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
PROVIDIAN FINANCIAL CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
(unaudited)
September 30 December 31
(dollars in thousands) 2000 1999
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 310,070 $ 182,915
Federal funds sold and securities
purchased under resale agreements 220,583 1,298,000
Investment securities:
Available-for-sale 1,932,581 455,238
Held-to-maturity 1,160,261 126,258
Loans held for securitization or sale 1,263,858 --
Loans receivable, less allowance for credit losses of $1,316,185
at September 30, 2000 and $1,028,377 at December 31, 1999 11,685,343 10,545,173
Premises and equipment, net 185,132 149,194
Interest receivable 161,999 108,087
Due from securitizations 624,580 614,217
Deferred taxes 701,168 571,040
Other assets 418,748 290,755
--------------------------------
Total assets $ 18,664,323 $ 14,340,877
================================
LIABILITIES
Deposits:
Non-interest bearing $ 67,105 $ 63,890
Interest bearing 13,752,718 10,474,233
--------------------------------
13,819,823 10,538,123
Short-term borrowings 300 126,289
Long-term borrowings 1,085,441 958,056
Deferred fee revenue 640,128 578,607
Accrued expenses and other liabilities 1,146,895 647,326
--------------------------------
Total liabilities 16,692,587 12,848,401
Company obligated mandatorily redeemable capital securities of subsidiary trust
holding solely junior subordinated deferrable
interest debentures of the Company (capital securities) 160,000 160,000
SHAREHOLDERS' EQUITY
Common stock, par value $0.01 per share (authorized: 800,000,000
shares; issued and outstanding: September 30, 2000--142,910,916
shares; December 31, 1999--142,066,407 shares) 1,431 954
Retained earnings 1,810,184 1,394,293
Cumulative other comprehensive income 9,236 (2,161)
Common stock held in treasury--at cost: (September 30, 2000--
197,064 shares; December 31, 1999--1,053,573 shares) (9,115) (60,610)
--------------------------------
Total shareholders' equity 1,811,736 1,332,476
--------------------------------
Total liabilities and shareholders' equity $ 18,664,323 $ 14,340,877
================================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
3
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
PROVIDIAN FINANCIAL CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
(dollars in thousands, except per share data) 2000 1999 2000 1999
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INTEREST INCOME
Loans $ 633,589 $ 424,597 $1,804,460 $1,062,171
Federal funds sold and securities
purchased under resale agreements 16,782 7,107 68,130 19,730
Other 40,954 7,544 100,213 21,892
-------------------------------------------------------------------
Total interest income 691,325 439,248 1,972,803 1,103,793
INTEREST EXPENSE
Deposits 211,312 89,073 598,624 227,302
Borrowings 13,459 28,546 47,676 71,088
-------------------------------------------------------------------
Total interest expense 224,771 117,619 646,300 298,390
Net interest income 466,554 321,629 1,326,503 805,403
Provision for credit losses 332,241 288,279 1,067,044 725,574
-------------------------------------------------------------------
Net interest income after provision
for credit losses 134,313 33,350 259,459 79,829
NON-INTEREST INCOME
Servicing and securitizations 242,893 157,802 550,099 437,776
Credit product fee income 479,063 484,153 1,600,849 1,240,782
Other 27,938 9,163 150,290 21,274
-------------------------------------------------------------------
749,894 651,118 2,301,238 1,699,832
NON-INTEREST EXPENSE
Salaries and employee benefits 179,056 132,579 527,371 350,350
Solicitation and advertising 138,821 115,972 369,963 317,650
Occupancy, furniture, and equipment 37,139 23,745 100,536 57,926
Data processing and communication 46,940 33,593 132,248 88,207
Other 147,792 127,299 700,992 314,001
-------------------------------------------------------------------
549,748 433,188 1,831,110 1,128,134
-------------------------------------------------------------------
Income before income taxes 334,459 251,280 729,587 651,527
Income tax expense 133,793 100,408 291,831 260,623
-------------------------------------------------------------------
Net Income $ 200,666 $ 150,872 $ 437,756 $ 390,904
===================================================================
Earnings per common share - basic $ 1.41 $ 1.07 $ 3.08 $ 2.77
===================================================================
Earnings per common share - assuming dilution $ 1.36 $ 1.04 $ 3.00 $ 2.69
===================================================================
Cash dividends paid per common share $ 0.05 $ 0.05 $ 0.15 $ 0.15
===================================================================
Weighted average common shares
outstanding - basic (000) 142,186 141,296 141,943 141,316
===================================================================
Weighted average common shares
outstanding - assuming dilution (000) 147,714 145,070 146,136 145,553
===================================================================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
4
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (unaudited)
PROVIDIAN FINANCIAL CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
Cumulative Common
Additional Other Stock
Common Paid-In Retained Comprehensive Held in
(dollars in thousands, except per share data) Stock Capital Earnings Income Treasury Total
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1998 $ 954 $ -- $ 866,005 $ (320) $ (63,452) $ 803,187
Comprehensive income:
Net Income 390,904 390,904
Other comprehensive income, net of income tax:
Unrealized loss on securities net of
income taxes of $205 (311) (311)
Foreign currency translation adjustments
net of income taxes of $33 (49) (49)
----------
Other comprehensive income (360)
----------
Comprehensive income 390,544
Cash dividend: Common - $0.15 per share (21,272) (21,272)
Purchase of 938,619 common shares for treasury 25,723 (97,572) (71,849)
Exercise of stock options and other awards (57,564) 4,917 74,919 22,272
Issuance of restricted and unrestricted stock less
forfeited shares (440) 8,833 8,393
Deferred compensation related to grant of
restricted and unrestricted stock less
amortization of $5,711 (2,682) (2,682)
Net tax effect from employee stock plans 34,963 34,963
----------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1999 $ 954 $ -- $ 1,240,554 $ (680) $ (77,272) $ 1,163,556
============================================================================
BALANCE AT DECEMBER 31, 1999 $ 954 $ -- $ 1,394,293 $ (2,161) $ (60,610) $ 1,332,476
Comprehensive income:
Net Income 437,756 437,756
Other comprehensive income, net of income tax:
Unrealized gain on securities net of
income taxes of ($7,867) 11,801 11,801
Foreign currency translation adjustments
net of income taxes of $269 (404) (404)
----------
Other comprehensive income 11,397
----------
Comprehensive income 449,153
Cash dividend: Common - $0.15 per share (21,396) (21,396)
Adjustment for stock dividend 477 (473) (4) --
Purchase of 592,182 common shares for treasury 25,786 (57,063) (31,277)
Exercise of stock options and other awards (47,558) (465) 80,730 32,707
Issuance of restricted and unrestricted stock less
forfeited shares (8,636) 27,828 19,192
Deferred compensation related to grant of
restricted and unrestricted stock less
amortization of $10,219 (8,973) (8,973)
Net tax effect from employee stock plans 39,854 39,854
----------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2000 $ 1,431 $ -- $ 1,810,184 $ 9,236 $ (9,115) $ 1,811,736
============================================================================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
5
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
PROVIDIAN FINANCIAL CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
Nine Months Ended
September 30
(dollars in thousands) 2000 1999
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net Income $ 437,756 $ 390,904
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses 1,067,044 725,574
Depreciation and amortization of premises and equipment 36,583 23,308
Amortization of net loan acquisition costs 24,831 41,182
Amortization of deferred compensation
related to restricted and unrestricted stock 10,219 5,711
Increase in deferred income tax benefit (137,507) (181,917)
Increase in net deferred fee revenue 61,521 188,995
Increase in interest receivable (53,912) (27,919)
Gain from sale of home loans (64,671) --
Net increase in other assets (153,511) (112,195)
Net increase in accrued expenses and other liabilities 539,423 190,688
--------------------------
Net cash provided by operating activities 1,767,776 1,244,331
INVESTING ACTIVITIES
Net (increase) decrease in money market instrument investments (1,034,003) 99,882
Net cash used for loan originations and principal
collections on loans receivable (5,821,634) (5,083,567)
Net increase in securitized loans 867,563 1,109,720
Net proceeds from sale of home loans 1,548,173 --
Portfolio acquisitions -- (127,119)
Increase in due from securitizations (10,363) (139,365)
Purchases of investment securities (1,568,774) (170,742)
Proceeds from maturities of investment securities 111,099 125,950
Decrease (increase) in federal funds sold and securities purchased under resale agreements 1,077,417 (640,295)
Net purchases of premises and equipment (73,229) (68,366)
--------------------------
Net cash used by investing activities (4,903,751) (4,893,902)
FINANCING ACTIVITIES
Net increase in deposits 3,281,700 2,681,263
Proceeds from issuance of term federal funds 995,000 1,718,000
Repayment of term federal funds (1,095,037) (1,712,000)
(Decrease) increase in other short-term borrowings (25,952) 480,938
Proceeds from issuance of convertible senior notes 402,500 -
(Decrease) Increase in other long-term borrowings (275,115) 629,603
Purchase of treasury stock (31,277) (71,849)
Dividends paid (21,396) (21,272)
Proceeds from exercise of stock options 32,707 22,272
--------------------------
Net cash provided by financing activities 3,263,130 3,726,955
--------------------------
Net increase in cash and cash equivalents 127,155 77,384
Cash and cash equivalents at beginning of period 182,915 176,348
--------------------------
Cash and cash equivalents at end of period $ 310,070 $ 253,732
==========================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
6
<PAGE>
PROVIDIAN FINANCIAL CORPORATION
Notes to Condensed Consolidated Financial Statements
September 30, 2000 (unaudited)
Note 1 - Basis of Presentation
The condensed consolidated financial statements include the accounts of
Providian Financial Corporation and its wholly owned subsidiaries (the
"Company"). The Company's subsidiaries offer a range of consumer lending
products, deposit products and membership products marketed through direct mail,
Internet and other channels. The principal operating subsidiaries of the Company
are Providian National Bank and Providian Bank, which are financial institutions
principally engaged in consumer lending activities. Providian Financial
Corporation also has a subsidiary, Providian Bancorp Services, which provides
administrative and customer services to its consumer lending affiliates.
The accompanying unaudited condensed consolidated financial statements of
the Company have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by generally accepted accounting
principles for complete consolidated financial statements. In the opinion of
management, all adjustments considered necessary to a fair statement of the
results for the interim period presented have been included. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates. Operating results for the three and nine
month periods ended September 30, 2000 are not necessarily indicative of the
results for the year ended December 31, 2000. The notes to the financial
statements contained in the Company's Annual Report on Form 10-K for the year
ended December 31, 1999 should be read in conjunction with these condensed
consolidated financial statements. All significant intercompany balances and
transactions have been eliminated. Certain prior period amounts have been
reclassified to conform to the 2000 presentation.
7
<PAGE>
Note 2 - Earnings Per Share
The following table sets forth the computation of both the basic and
assumed conversion methods of earnings per share.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
(dollars in thousands, except per share data) 2000 1999 2000 1999
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Basic
Net Income available to common stockholders $200,666 $150,872 $437,756 $390,904
=========================================
Weighted average common shares outstanding 142,186 141,296 141,943 141,316
=========================================
Earnings per common share--basic $ 1.41 $ 1.07 $ 3.08 $ 2.77
=========================================
Diluted
Net Income available to common stockholders $200,666 $150,872 $437,756 $390,904
Plus: Income impact of assumed conversions
Interest on 3.25% convertible senior notes
(net of tax) 807 -- 807 --
-----------------------------------------
Net Income available to common stockholders with
assumed conversions $201,473 $150,872 $438,563 $390,904
=========================================
Weighted average common shares outstanding 142,186 141,296 141,943 141,316
Plus: Incremental shares from assumed conversions
Restricted stock issued--non vested 622 549 596 551
Employee stock options(1) 3,671 3,088 3,128 3,686
3.25% convertible senior notes 1,204 -- 404 --
Forward purchase contracts 31 137 65 --
-----------------------------------------
Dilutive potential common shares 5,528 3,774 4,193 4,237
-----------------------------------------
Adjusted weighted average common shares 147,714 145,070 146,136 145,553
=========================================
Earnings per common share--assuming dilution $ 1.36 $ 1.04 $ 3.00 $ 2.69
=========================================
</TABLE>
(1) During the three and nine months ended September 30, 2000, options to
purchase 1,699,001 and 2,690,650 shares of the Company's common stock were not
included in the computation of diluted earnings per common share, because the
exercise price of the options was greater than the average market price of the
common shares and, therefore, the inclusion of such options would be
antidilutive.
Note 3 - Loans Receivable and Allowance for Credit Losses
The following is a summary of the Company's loans receivable at September
30, 2000 and December 31, 1999:
(dollars in thousands) September 30, 2000 December 31,1999
------------------------------------------------------------------------------
Credit cards $ 12,961,222 $ 10,075,185
Home loans 18,966 1,520,795
Other 21,340 13,974
--------------------------------
13,001,528 11,609,954
Allowance for credit losses (1,316,185) (1,028,377)
Net deferred origination fees -- (36,404)
--------------------------------
$ 11,685,343 $ 10,545,173
================================
The activity in the allowance for credit losses for the nine months ended
September 30, 2000 and 1999 was as follows:
Nine Months Ended September 30
(dollars in thousands) 2000 1999
-----------------------------------------------------------------------------
Balance at beginning of period $ 1,028,377 $ 451,245
Provision for credit losses 1,067,044 725,574
Allowance acquired/Other (22,617) 14,310
Foreign currency translation 37 --
Credit losses (841,246) (414,783)
Recoveries 84,590 56,437
--------------------------------
Net credit losses (756,656) (358,346)
--------------------------------
Balance at end of period $ 1,316,185 $ 832,783
================================
8
<PAGE>
Note 4 - Loans Held for Securitization or Sale
Loans held for securitization or sale are those loans eligible for
securitization which management has committed to securitize or sell, generally
within six months. These assets, which were securitized or sold during October
2000, are reported at the lower of cost or fair market value.
Note 5 - Sale of Home Loans
On February 29, 2000, the Company announced a realignment of resources
previously dedicated to its home loan business. The Company has transitioned
these resources, including employees and facilities, into its credit card and
e-commerce businesses, which have experienced rapid growth and have greater
potential returns. On June 16, 2000, the Company sold $1.5 billion of home
equity loans which resulted in a one-time pre-tax gain of $64.7 million which
was included in non-interest income -other on the Company's consolidated
statements of income.
Note 6 - Convertible Notes
On August 23, 2000, the Company issued $402,500,000 of 3.25% Convertible
Senior Notes due August 15, 2005 (the "Notes") with interest payable
semi-annually on February 15 and August 15 of each year, commencing on February
15, 2001. The Notes are initially convertible, at the option of the holders, at
the conversion rate of 7.2446 shares of the Company's common stock per $1,000 of
Note principal. The Company has the option to redeem the Notes on or after
August 20, 2003.
Note 7 - Credit Product Fee Income
During the third quarter of 2000, the Company recognized the estimated
uncollectible portion of accrued fees on certain delinquent accounts.
Previously, these accrued fees were reversed against current fee revenue upon
charge-off, which generally occurs no later than 180 days after an account
becomes delinquent. This change resulted from continued growth in credit product
fee income. The effect of adopting this change was to advance the timing of fee
income reversals, resulting in a decrease in loans receivable and non-interest
income of $95 million at the time of adoption.
Note 8 - Shareholders' Equity
In October 2000, the Company's Board of Directors approved a two-for-one
split of the Company's common stock, in the form of a stock dividend. For each
share of the Company's common stock held at the close of business on the record
date, one additional share will be issued. Distribution of the additional shares
will be made on November 30, 2000 to shareholders of record at the close of
business on November 15, 2000.
During the third quarter of 2000, the Company extended several agreements
to purchase, on a forward basis, shares of its common stock. At the Company's
election, the agreements may be settled on a physical basis or, subject to
certain conditions, on a net basis in shares of the Company's common stock or in
cash. As of September 30, 2000, the agreements covered 1,865,899 shares of the
Company's common stock at a weighted forward price of $99.3526 per share. The
agreements have terms of one year but may be settled earlier at the Company's
option. If the agreements had been settled on a net share basis at the September
30, 2000 market price of the Company's common stock ($127.00 per share), the
Company would have received approximately 406,199 shares of its common stock
from the counterparties. During the nine months ended September 30, 2000, the
Company received 390,714 shares of common stock from the settlement of forward
purchase agreements, which resulted in a $26.0 million increase in additional
paid in capital.
Note 9 - Cumulative Other Comprehensive Income
The components of cumulative other comprehensive income, net of related
tax, for the nine months ended September 30, 2000 and 1999 were as follows:
<TABLE>
<CAPTION>
Unrealized Foreign Cumulative Other
Gain/(Loss) Currency Comprehensive
(dollars in thousands) on Securities Translation Income
-------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, January 1, 1999 $ (320) $ -- $ (320)
Other comprehensive income (516) (82) (598)
Tax benefit (expense) 205 33 238
----------------------------------------------
Balance, September 30, 1999 $ (631) $ (49) $ (680)
==============================================
Balance, January 1, 2000 $ (2,207) $ 46 $ (2,161)
Other comprehensive income 19,668 (673) 18,995
Tax benefit (expense) (7,867) 269 (7,598)
----------------------------------------------
Balance, September 30, 2000 $ 9,594 $ (358) $ 9,236
==============================================
</TABLE>
9
<PAGE>
Note 10 - Segment Information
The operations of the Company are principally concentrated in its Credit
Card operating segment. All other operations of the Company have been included
in the segment titled "Other". Credit Card customer relationships are initiated
through direct marketing and other distribution channels or credit card
portfolio acquisitions from other financial institutions. The Other segment
includes First Select, which specializes in the purchase of delinquent loans for
collection, and the Company's e-commerce operations and international consumer
lending operations. Segment reporting has been reorganized as a result of the
Company's home loan portfolio sale and because it is no longer originating home
loans. Previously, home loan operations were combined with its First Select
business to form the reporting segment titled "Emerging Businesses". Prior
periods have been restated to reflect the change in segment reporting. Revenue
from cross-marketed products, which is derived from both the Credit Card segment
and the Other segment, is included in the respective segment summary financial
information.
It is the Company's practice to analyze its financial performance on a
managed basis. Segment information presented below is based on the Company's
managed loan portfolios. The Company securitizes certain loans and records such
securitizations as sales, which has the effect of removing such loans from the
Company's consolidated statements of financial condition.
The following is a summary of the Company's segment activity on a managed
basis for the three and nine months ended September 30, 2000 and 1999:
Credit
(dollars in thousands) Card Other Total
--------------------------------------------------------------------------------
Three Months Ended September 30, 2000
Revenue $ 1,285,165 75,037 $ 1,360,202
Profit or loss $ 455,004 (32,399) $ 422,605
Assets $23,595,742 1,092,405 $24,688,147
Three Months Ended September 30, 1999
Revenue $ 1,055,841 52,805 $ 1,108,646
Profit or loss $ 270,900 (13,842) $ 257,058
Assets $16,636,125 1,770,037 $18,406,162
Nine Months Ended September 30, 2000
Revenue $ 3,747,777 227,398 $ 3,975,175
Profit or loss $ 953,228 (32,811) $ 920,417
Assets $23,595,742 1,092,405 $24,688,147
Nine Months Ended September 30, 1999
Revenue $ 2,796,685 126,059 $ 2,922,744
Profit or loss $ 735,727 (42,490) $ 693,237
Assets $16,636,125 1,770,037 $18,406,162
The impact of securitizations on the Company's consolidated statements of
income is to reduce net interest income and the provision for credit losses, and
to increase non-interest income. The following is a reconciliation of the
Company's segment activity on a managed basis to the consolidated statements of
income of the Company for the periods ended September 30, 2000 and 1999:
10
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 30
(dollars in thousands) 2000 1999 2000 1999
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total segment profits $ 422,605 $ 257,058 $ 920,417 $ 693,237
Corporate and other (88,146) (5,778) (190,830) (41,710)
---------------------------------------------------------------------
Income before income taxes $ 334,459 $ 251,280 $ 729,587 $ 651,527
=====================================================================
</TABLE>
Note 11 - Commitments and Contingencies
On June 28, 2000, the Company announced that it had reached a final
settlement agreement with the Office of the Comptroller of the Currency, the San
Francisco District Attorney's office and the California Attorney General, ending
their inquiries into the Company's business practices. The Company agreed to
make certain business practice changes and to pay a one-time restitution to
affected customers. During the quarter ended June 30, 2000 the Company recorded
a net pre-tax charge of $272.6 million to non-interest expense on its
consolidated statements of income as a result of its obligations under the
settlement agreement. For more detailed information on legal proceedings
affecting the Company, see "Legal Proceedings" in Item 1 of Part II of this
Quarterly Report on Form 10-Q.
Note 12 - New Accounting Pronouncements
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS No. 133"), establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and hedging activities. In
June 1999, Statement of Financial Accounting Standards No. 137, "Accounting for
Derivative Instruments and Hedging Activities--Deferral of the Effective Date of
FASB Statement No. 133" ("SFAS No. 137"), was issued and extends the effective
date for SFAS No. 133 to all fiscal quarters of all fiscal years beginning after
June 15, 2000. In June 2000, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities - an amendment of FASB
Statement No. 133" ("SFAS No. 138"). SFAS No. 138 addresses a limited number of
issues causing implementation difficulties for entities that apply SFAS No. 133,
and amends the accounting and reporting standards of SFAS No. 133 for certain
derivative instruments and certain hedging activities. Based on the Company's
current level of derivative and hedging activities, the implementation of SFAS
No. 133, as amended by SFAS No. 137 and SFAS No. 138, should not have a material
impact on the Company's consolidated financial statements.
In September 2000, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities - a
replacement of FASB Statement No. 125" ("SFAS No. 140"). SFAS No. 140, which
replaces FASB Statement No. 125, revises the standards for accounting for
securitizations and other transfers of financial assets and requires certain
additional disclosures. SFAS 140 will be effective for all transfers and
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2001. The SFAS 140 disclosure requirements will be required for
financial statements for fiscal years ending after December 15, 2000. The
Company intends to adopt SFAS 140 on the required effective dates.
Implementation of SFAS 140 is not expected to have a material impact on the
Company's consolidated financial statements.
11
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Introduction
Providian Financial Corporation (the "Company") is a leading provider of
consumer finance products, including credit cards, deposits, and cross-marketed
products. The Company offers its lending and deposit products primarily through
its banking subsidiaries, Providian National Bank, a national bank, and
Providian Bank, a Utah industrial loan corporation. The Company's products are
offered to a broad spectrum of consumers in the United States, the United
Kingdom and in Argentina. Credit card products range from gold and platinum
cards with high credit lines to lower line classic and secured cards designed
for consumers underserved by traditional financial institutions. The primary
factors affecting the profitability of the Company's consumer lending business
are growth in the number of customer accounts and outstanding loan balances, net
interest spread on loans, fee revenue, credit usage, credit quality
(delinquencies and credit losses), level of solicitation and marketing expenses,
and account servicing efficiency. The Company's market focus is to seek out
profitable consumer segments and apply its risk adjusted, return driven approach
to customer segmentation and pricing. The Company believes this strategy has
been responsible for its continued overall strong performance. During the first
nine months of 2000 the Company incurred the following one-time events:
On June 28, 2000, the Company announced that it had reached a final
settlement agreement with the Office of the Comptroller of the Currency, the San
Francisco District Attorney's office and the California Attorney General, ending
their inquiries into the Company's business practices. The Company agreed to
make certain business practice changes and to pay a one-time restitution to
affected customers. During the quarter ended June 30, 2000 the Company recorded
a net pre-tax charge of $272.6 million to non-interest expense on its
consolidated statements of income as a result of its obligation under the
settlement agreement.
On February 29, 2000, the Company announced a realignment of resources
previously dedicated to its home loan business. The Company has transitioned
these resources, including employees and facilities, into its credit card and
e-commerce businesses, which have experienced rapid growth and have greater
potential returns. On June 16, 2000 the Company sold $1.5 billion of home equity
loans which resulted in a one-time pre-tax gain of $64.7 million.
Forward-Looking Information
Certain statements contained herein include forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, and are subject
to the "safe harbor" created by those sections. Forward-looking statements
include expressions of "belief," "anticipation," or "expectations" of
management, statements as to industry trends or future results of operations of
the Company, and other statements which are not historical fact. Forward-looking
statements are based on certain assumptions by management and are subject to
risks and uncertainties that could cause actual results to differ materially
from those in the forward-looking statements. These risks and uncertainties
include, but are not limited to, competitive pressures arising from aggressive
competition from other consumer lenders; factors that affect the delinquency
rate on the Company's consumer loans and the rate at which the Company's
consumer loans are charged off; changes in the cost and availability of funding
due to changes in the deposit market, credit market or securitization market, or
the way in which the Company is perceived in such markets; the effects of
government policy and regulation, including restrictions and /or limitations
arising from banking laws, regulations and examinations; legal proceedings; and
the ability to attract and retain key personnel. These and other risks and
12
<PAGE>
uncertainties are described in detail in the Company's 1999 Annual Report on
Form 10-K under the heading "Cautionary Statements," and in other filings made
by the Company with the Securities and Exchange Commission. Readers are
cautioned not to place undue reliance on forward-looking statements, which speak
only as of the date hereof. The Company undertakes no obligation to update any
forward-looking statements.
Earnings Summary
Net income for the three months ended September 30, 2000 was $200.7
million, an increase of 33% over net income of $150.9 million for the three
months ended September 30, 1999. Net income for the nine months ended September
30, 2000, before one-time adjustments for the settlement charge and the gain on
the sale of home equity loans in the second quarter, was $562.6 million, an
increase of 44% over net income of $390.9 million for the nine months ended
September 30, 1999. The key drivers to the third quarter and year-to-date
performance came from growth in outstanding loan balances and customer accounts
combined with improved customer retention. Net income for the nine months ended
September 30, 2000 was $437.8 million after the second quarter one-time
adjustments.
As of September 30, 2000, managed loans, which include reported and
securitized loans, were $24.5 billion. Managed credit card loans were $24.1
billion, an increase of $5.1 billion, or 26.7%, over the balance at December 31,
1999. This growth in managed credit card loans was achieved through increases in
the Company's loan originations, improved customer retention and increased
purchase activity from existing customers facilitated by the Company's ability
to upgrade proven customers to higher line products.
The Company's managed net interest margin on loans increased to 12.90% for
the third quarter of 2000 compared to 12.40% for the same period in 1999. The
managed net credit loss rate for the third quarter of 2000 increased to 7.61%
from 6.40% for the same period in 1999 and is up from 7.42% for the second
quarter of 2000. The increase quarter over quarter reflects account seasoning
within the managed portfolio and was less than expected. Consistent with the
Company's expectations, the 30+ day managed delinquency rate for the third
quarter of 2000 increased to 6.71% from 6.48% for the second quarter of 2000 and
5.20% for the third quarter of 1999. This account seasoning is expected to
result in a continued increase in the Company's managed net credit loss rate,
which is expected to rise to the 8% range in the fourth quarter of 2000. The
dollar contribution to managed revenue from non-interest income for the third
quarter of 2000 increased more than 10% over the same period in 1999 to $620.2
million, due primarily to increased revenue from cross-marketed products and
loan activity fees. The Company reinvested a portion of the increased revenue to
strengthen loan loss reserves, increase marketing investment and build
infrastructure, through the expansion of the employee base and product support
systems. Year over year, non-interest expense increased $116.6 million during
the third quarter of 2000 to $549.7 million, reflecting expenses associated with
servicing a greater number of customers and maintaining an employee base that
has grown by 27% over that period.
The Company's return on reported assets was 4.53% for the third quarter of
2000, down from 5.62% for the same period in 1999. The decrease is primarily the
result of the Company's decision to strengthen its balance sheet liquidity by
increasing its investment security portfolio. The return on average managed
assets for the third quarter of 2000 and 1999, was 2.92% and 3.20%,
respectively. Return on equity was 47.49% for the third quarter of 2000, down
from 54.89% for the same period in 1999.
13
<PAGE>
Managed Consumer Loan Portfolio and the Impact of Securitization
The Company securitizes consumer loan receivables. For additional
discussion of the Company's securitization activities, see "--Funding and
Liquidity." Securitized assets sold to external investors are not considered
assets of the Company and therefore are not shown on the Company's consolidated
statements of financial condition. It is, however, the Company's practice to
analyze its financial performance on a managed basis. To perform this analysis,
the Company uses an adjusted income statement and statement of financial
condition, which add back the effect of securitizations. The following table
summarizes the Company's managed loan portfolio:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
------------------------------ -----------------------------
(dollars in thousands) 2000 1999 2000 1999
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Period-End Balances:
Reported consumer loans $14,265,386 $ 9,520,735
Securitized consumer loans 10,284,140 8,835,433
----------- -----------
Total managed consumer loan portfolio $24,549,526 $18,356,168
=========== ===========
Average Balances:
Reported consumer loans $13,402,828 $ 8,994,243 $12,753,895 $ 7,697,174
Securitized consumer loans 9,992,190 8,268,226 9,776,064 7,773,717
----------- ----------- ----------- -----------
Total average managed consumer loan portfolio $23,395,018 $17,262,469 $22,529,959 $15,470,891
=========== =========== =========== ===========
Operating Data and Ratios:
Reported:
Average earning assets $16,807,971 $10,094,134 $16,208,824 $ 8,758,022
Return on average assets 4.53% 5.62% 3.41% 5.57%
Net interest margin (1) 11.10% 12.75% 10.91% 12.26%
Managed:
Average earning assets $26,800,161 $18,362,360 $25,984,888 $16,531,739
Return on average assets 2.92% 3.20% 2.17% 3.06%
Net interest margin (1) 11.36% 12.15% 10.82% 12.01%
</TABLE>
(1) Net interest margin is equal to net interest income divided by average
earning assets.
Financial Statement Impact
The Company's securitizations are treated as sales under generally accepted
accounting principles ("GAAP"). The Company receives the proceeds of the sale,
and the securitized loans are removed from the Company's consolidated statements
of financial condition. In certain cases, the Company has retained a
subordinated interest in the pool of assets included in a securitization, with a
right to receive collections allocated to such subordinated interest after
payment to investors. Such retained interests are recorded at fair value and are
included in "due from securitizations" on the Company's consolidated statements
of financial condition. At the time it enters into a securitization, the Company
recognizes an "interest-only strip receivable" asset, which is the present value
of the projected excess servicing income during the period the securitized loans
are projected to be outstanding. "Excess servicing income" refers to the excess
of the finance charge and fee revenue generated by the securitized loans over
the sum of the interest paid to investors, related credit losses, servicing
fees, and other transaction expenses. During the revolving period of a
securitization, an additional interest-only strip receivable is recognized each
month, as additional receivables are generated in the accounts that are in the
securitized pool to replenish the investors' share of principal collections on
the securitized loans. Revenue resulting from excess servicing income is
recognized each month first as a reduction of the interest-only strips
receivable and then, to the extent the amount received exceeds the related
component of the interest-only strips receivable, as servicing and
securitization income.
14
<PAGE>
When loans are securitized, the Company retains a "seller's interest"
generally equal to the total amount of the pool of assets included in the
securitization less the investors' portion of those assets and securitized
interests retained by the Company. As the amount of the loans in the securitized
pool fluctuates due to customer payments, purchases, cash advances, and credit
losses, the amount of the seller's interest will vary. The seller's interest is
classified on the Company's consolidated statements of financial condition as
loans receivable at par less the associated allowance for credit losses.
Periodically, the Company may transfer new loans receivable into a securitized
pool in order to maintain the seller's interest above an agreed-upon minimum.
The Company services the accounts underlying the securitized loans and
earns a monthly servicing fee, which is generally offset by the servicing costs
incurred by the Company. Accordingly, servicing assets have not been recognized
in connection with the Company's securitizations.
The effect of securitization accounting on the Company's consolidated
statements of income is to reduce net interest income and the provision for
credit losses, and to increase non-interest income. For the three months ended
September 30, 2000 and 1999, securitization accounting had the effect of:
reducing net interest income by $294.7 million and $236.2 million; reducing the
provision for credit losses by $165.1 million and $145.7 million; and increasing
non-interest income by $129.6 million and $90.5 million. For the nine months
ended September 30, 2000 and 1999, securitization accounting had the effect of:
reducing net interest income by $782.8 million and $683.5 million; reducing the
provision for credit losses by $495.3 million and $455.2 million; and increasing
non-interest income by $287.5 million and $228.3 million. Because credit losses
on the securitized loans are reflected as a reduction in servicing and
securitization income rather than a reduction of the allowance for credit
losses, the Company's provision for credit losses is lower than would be the
case had such loans not been securitized.
Risk Adjusted Revenue and Return
One measure of product profitability that incorporates revenue and the most
significant costs inherent in consumer loan risk analysis is risk adjusted
revenue, which is net interest income on loans plus non-interest income less net
credit losses. The Company uses risk adjusted revenue as a measure of loan
portfolio profitability, consistent with its goal of matching the revenue base
of customer accounts with the risk undertaken. Risk adjusted revenue may also be
expressed as a percentage of average consumer loans, in which case it is
referred to as risk adjusted return.
Managed risk adjusted revenue and return for the three months ended
September 30, 2000 were $929.5 million and 15.89% compared to $819 million and
18.99% for the same period in 1999. For the nine months ended September 30,
2000, managed risk adjusted revenue and return, before one-time second quarter
adjustments, were $2.79 billion and 16.50%, compared to $2.09 billion and 18.02%
for the same period in 1999. The decrease in managed risk adjusted return
reflects a decrease in the managed net interest margin on loans, which has
absorbed numerous rate increases by the Federal Reserve in the last year, and an
increase in the managed net credit loss rates, which reflects account seasoning
in the managed loan portfolio.
The components of risk adjusted revenue are discussed in more detail in
subsequent sections of this Management's Discussion and Analysis of Financial
Condition and Results of Operations.
Net Interest Income and Margin
Net interest income is interest earned from loan and investment portfolios
less interest expense on deposits and borrowings. Managed net interest income
includes net interest income and interest earned from securitized loans less
interest paid to securitization investors.
15
<PAGE>
Managed net interest income for the three months ended September 30, 2000
was $761.3 million, compared to $557.8 million for the same period in 1999,
representing an increase of $203.5 million, or 36%. Managed net interest margin
on average managed earning assets decreased to 11.36% for the three months ended
September 30, 2000, from 12.15% for the same period in 1999. For the nine months
ended September 30, 2000, managed net interest income was $2,109.3 million,
compared to $1,488.9 million for the same period in 1999, an increase of $620.4
million, or 42%. Managed net interest margin on average managed earning assets
decreased to 10.82% for the nine months ended September 30, 2000, from 12.35%
for the same period in 1999. The decrease was the result of the Company's
decision to increase liquidity utilizing its investment portfolio. Managed net
interest margin on average managed loans increased to 12.90% for the three
months ended September 30, 2000, from 12.40% for the same period in 1999.
Statement of Average Balances, Income and Expense, Yields and Rates
The following table provides an analysis of reported interest income,
interest expense, net interest spread, and average balances for the three and
nine months ended September 30, 2000 and 1999. Interest income and interest
expense margins are presented as a percentage of average earning assets, which
include interest-earning consumer loan portfolios and investments held for
liquidity purposes.
16
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended September 30
------------------------------------------------------------------------------
2000 1999
--------------------------------------- ------------------------------------
Average Income/ Yield/ Average Income/ Yield/
(dollars in thousands) Balance Expense Rate Balance Expense Rate
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning assets
Consumer loans $ 13,402,828 $ 633,589 18.91% $ 8,994,243 $ 424,597 18.88%
Interest-earning cash 151,473 2,454 6.48% 118,129 1,447 4.90%
Federal funds sold 1,014,041 16,782 6.62% 567,164 7,107 5.01%
Investment securities 2,239,629 38,500 6.88% 414,598 6,097 5.88%
------------ ------------ ----- ------------ ------------ -----
Total interest-earning assets 16,807,971 $ 691,325 16.45% 10,094,134 $ 439,248 17.41%
Allowance for loan losses (1,325,863) (738,282)
Other assets 2,225,373 1,373,961
------------ ------------
Total assets $ 17,707,481 $ 10,729,813
============ ============
LIABILITIES AND EQUITY:
Interest-bearing liabilities
Deposits $ 13,296,600 $ 211,312 6.36% $ 6,473,313 $ 89,073 5.50%
Borrowings 896,966 13,459 6.00% 1,920,960 28,546 5.94%
------------ ------------ ----- ---------- ------------ -----
Total interest-bearing liabilities 14,193,566 $ 224,771 6.33% 8,394,273 $ 117,619 5.60%
Other liabilities 1,663,614 1,076,182
------------ ------------
Total liabilities 15,857,180 9,470,455
Capital securities 160,000 160,000
Equity 1,690,301 1,099,358
------------ ------------
Total liabilities and equity $ 17,707,481 $ 10,729,813
============ ============
NET INTEREST SPREAD: 10.12% 11.81%
===== =====
Interest income to
average interest-earning assets 16.45% 17.41%
Interest expense to
average interest-earning assets 5.35% 4.66%
----- -----
Net interest margin 11.10% 12.75%
===== =====
</TABLE>
17
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended September 30
-------------------------------------------------------------------------------
2000 1999
----------------------------------------- ---------------------------------
Average Income/ Yield/ Average Income/ Yield/
(dollars in thousands) Balance Expense Rate Balance Expense Rate
----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning assets
Consumer loans $ 12,753,895 $ 1,804,460 18.86% $ 7,697,174 $ 1,062,171 18.40%
Interest-earning cash 135,156 6,170 6.09% 124,272 4,421 4.74%
Federal funds sold 1,475,452 68,130 6.16% 540,251 19,730 4.87%
Investment securities 1,844,321 94,043 6.80% 396,325 17,471 5.88%
------------ ------------ ----- ------------ ------------ -----
Total interest-earning assets 16,208,824 $ 1,972,803 16.23% 8,758,022 $ 1,103,793 16.80%
Allowance for loan losses (1,206,762) (622,901)
Other assets 2,122,283 1,229,452
------------ ------------
Total assets $ 17,124,345 $ 9,364,573
============ ============
LIABILITIES AND EQUITY:
Interest-bearing liabilities
Deposits $ 12,902,378 $ 598,624 6.19% $ 5,666,742 $ 227,302 5.35%
Borrowings 997,168 47,676 6.37% 1,611,164 71,088 5.88%
------------ ------------ ----- ------------ ------------ -----
Total interest-bearing liabilities 13,899,546 $ 646,300 6.20% 7,277,906 $ 298,390 5.47%
Other liabilities 1,492,092 944,750
------------ ------------
Total liabilities 15,391,638 8,222,656
Capital securities 160,000 160,000
Equity 1,572,707 981,917
------------ ------------
Total liabilities and equity $ 17,124,345 $ 9,364,573
============ ============
NET INTEREST SPREAD: 10.03% 11.33%
===== =====
Interest income to
average interest-earning assets 16.23% 16.80%
Interest expense to
average interest-earning assets 5.32% 4.54%
----- -----
Net interest margin 10.91% 12.26%
===== =====
</TABLE>
Interest Volume and Rate Variance Analysis
Net interest income is affected by changes in the average interest rate
earned on interest-earning assets and the average interest rate paid on
interest-bearing liabilities. Net interest income is also affected by changes in
the volume of interest-earning assets and interest-bearing liabilities. The
following table sets forth the dollar amount of the increase (decrease) in
interest income and interest expense resulting from changes in the volume and
rates:
18
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 30
2000 vs. 1999 2000 vs. 1999
----------------------------------------- -----------------------------------------
Change due to (1) Change due to (1)
Increase ------------------------- Increase -------------------------
(dollars in thousands) (Decrease) Volume Rate (Decrease) Volume Rate
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest Income:
Consumer loans $ 208,992 $ 208,316 $ 676 $ 742,289 $ 715,078 $ 27,211
Federal funds sold 9,675 6,872 2,803 48,400 41,977 6,423
Other securities 33,410 31,668 1,742 78,321 73,838 4,483
--------- --------- --------- --------- --------- ---------
Total interest income 252,077 246,856 5,221 869,010 830,893 38,117
Interest Expense:
Deposits 122,239 106,448 15,791 371,322 330,663 40,659
Borrowings (15,087) (15,372) 285 (23,412) (28,928) 5,516
--------- --------- --------- --------- --------- ---------
Total interest expense 107,152 91,076 16,076 347,910 301,735 46,175
--------- --------- --------- --------- --------- ---------
Net interest income $ 144,925 $ 155,780 $ (10,855) $ 521,100 $ 529,158 $ (8,058)
========= ========= ========= ========= ========= =========
</TABLE>
(1) The changes due to both volume and rates have been allocated in proportion
to the relationship of the absolute dollar amounts of the change in each. The
changes in interest income and expense are calculated independently for each
line in the schedule.
Non-Interest Income
Non-interest income, which consists primarily of servicing and
securitization income and credit product fee income, represented approximately
52% of gross reported revenues for the three months ended September 30, 2000.
Total non-interest income increased 15.2%, or $98.8 million, to $749.9 million
for the three months ended September 30, 2000, compared to $651.1 million for
the same period in 1999. For the nine months ended September 30, 2000, before
the one-time adjustment related to the second quarter sale of home loans, total
non-interest income increased 31.6%, or $536.7 million, to $2.24 billion,
compared to $1.70 billion for the same period in 1999. The increase is primarily
attributable to increased credit product fee income realized from cross-marketed
products and loan activity fees resulting from growth in the customer base.
After the one-time second quarter adjustment, total non-interest income was
$2.30 billion for the nine months ended September 30, 2000.
Servicing and Securitization Income
Servicing and securitization income relates directly to securitized loans.
It includes a servicing fee, which generally offsets the Company's cost of
servicing the securitized loans, excess servicing income, and gains or losses
from the transfer of financial assets (see "--Managed Consumer Loan Portfolio
and the Impact of Securitization"). To the extent subsequent cash flows for
excess servicing income exceed the projected amounts, which were recorded at
present value, the Company will recognize additional servicing and
securitization income during the period in which the servicing is provided.
As of September 30, 2000, securitizations outstanding provided $10.1
billion in funding, representing 37% of total managed funding, compared with
$8.6 billion, or 45%, as of September 30, 1999. The decrease in securitizations
outstanding as a percentage of total managed funding as of September 30, 2000
was due to the Company's efforts to increase deposit funding. Securitization,
however, remains a key element of the Company's funding strategy and, as market
conditions warrant, securitization as a component of total managed funding may
increase in future quarters. A more detailed discussion of the Company's funding
sources and the role of securitization activities is set forth under "--Funding
and Liquidity."
19
<PAGE>
Because excess servicing income on securitized loans essentially represents
a recharacterization of net interest income and credit product fee income less
the provision for loan losses and servicing expense, it will vary based upon the
same factors that affect those items. Thus, changes in net credit losses (see
"--Asset Quality, Net Credit Losses") and changes in interest rates (to the
extent that the receivables and interest payable to investors are based upon
floating rates) will cause excess servicing income to vary (see
"--Asset/Liability Risk Management").
For the three months ended September 30, 2000, servicing and securitization
income increased $85.1 million from the same period in 1999, to $242.9 million.
For the nine months ended September 30, 2000, servicing and securitization
income increased $112.3 million over the same period in 1999, to $550.1 million.
Excess servicing yields on securitized loans improved for the first nine months
of 2000 due to decreases in net credit loss rates which were partially offset by
decreased finance charge and fee yields on securitized loans.
Credit Product Fee Income
For the three months ended September 30, 2000, credit product fee income
decreased to $479.1 million from $484.2 million for the same period in 1999,
reflecting a reduction of late and overlimit fees resulting from the change in
the third quarter to accelerate the recognition of the estimated uncollectible
portion of accrued fees on certain delinquent accounts, described in Note 7 to
the condensed consolidated financial statements. For the nine months ended
September 30, 2000, credit product fee income increased 29% to $1,600.8 million,
compared to $1,240.8 million for the same period in 1999.
Credit product fee income includes loan performance fees, such as late,
overlimit and returned check charges, as well as certain account activity fees,
such as interchange income, annual membership income, and cash advance and
processing fees. Account activity fees also include other income (formerly
referred to as "membership services" income) arising primarily from fee products
cross-marketed to the Company's customer base, which increased to $187.2 million
and $597.3 million, or 13% and 54%, for the three and nine months ended
September 30, 2000, respectively, compared to $165.2 million and $387.1 million
for the same periods in the prior year. These increases are primarily attributed
to increased sales of cross-marketed products to a growing customer base. Income
on products cross-marketed to customers is recognized ratably over the term of
the product, net of an allowance for estimated refunds, beginning after the end
of the free or money-back guarantee period, if any. Certain fee revenue realized
from securitized loans is not included in credit product fee income but is
recorded as part of servicing and securitization income.
Non-Interest Expense
Non-interest expense includes employee salaries and benefits; loan
solicitation and advertising costs; occupancy, furniture, and equipment costs;
data processing and communication costs; and other non-interest expense. Loan
solicitation and advertising costs include printing, postage, telemarketing,
list processing, and credit bureau costs paid to third parties in connection
with account solicitation efforts. The Company also incurs advertising costs to
promote its consumer financial products. In accordance with GAAP, the Company
has capitalized only the direct nonsolicitation costs (loan origination costs)
associated with successful account acquisition efforts, after offsetting
up-front processing fees. Capitalized loan origination costs are amortized over
the privilege period (currently one year) for credit card loans, unless the
loans are securitized, in which case the costs are taken as an expense prior to
the securitization. The majority of loan origination costs are expensed as
incurred. For the three months ended September 30, 2000 and 1999, the Company
amortized loan origination costs of $9.7 million and $14.6 million. For the
three months ended September 30, 2000 and 1999, total loan solicitation costs,
including amortized loan origination costs, were $138.8 million and $116.0
million. The increase in loan solicitation costs reflects new marketing
initiatives, including television and Internet advertising campaigns. For the
nine months ended September 30, 2000 and 1999, total loan solicitation costs,
including amortized loan origination costs, were $370.0 million and $317.7
million.
20
<PAGE>
Non-interest expense also includes salary and benefit expenses, such as
staffing costs associated with marketing, customer service, collections, and
administration. Other non-interest expense includes third-party data processing
and communication costs, occupancy expenses, and other operational expenses,
such as collection costs, fraud losses, and bankcard association assessments,
and for the second quarter of 2000 includes a one-time adjustment related to the
previously mentioned settlement. The following table presents non-interest
expense for the three and nine months ended September 30, 2000 and 1999:
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 30
------------------------------- --------------------------------
(dollars in thousands) 2000 1999 2000 1999
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Non-interest expense
Salaries and employee benefits $ 179,056 $ 132,579 $ 527,371 $ 350,350
Solicitation and advertising 138,821 115,972 369,963 317,650
Occupancy, furniture, and equipment 37,139 23,745 100,536 57,926
Data processing and communication 46,940 33,593 132,248 88,207
Other (1) 147,792 127,299 700,992 314,001
----------------------------------------------------------------------
Total $ 549,748 $ 433,188 $1,831,110 $1,128,134
======================================================================
</TABLE>
(1) Year 2000 expenses include the $272.6 million one-time adjustment related to
the previously mentioned settlement.
Income Taxes
The Company recognized income tax expense of $133.8 million and $100.4
million for the three months ended September 30, 2000 and 1999. The Company's
effective tax rate was 40.0% for the three months ended September 30, 2000 and
1999.
Asset Quality
The Company's delinquencies and net credit losses reflect, among other
factors, the quality of loans, the average age of the Company's loans receivable
(generally referred to as "seasoning"), the success of the Company's collection
efforts, and general economic conditions. The quality of loans is subject to the
segmentation and underwriting criteria used, account management, seasoning, and
demographic and other factors.
The level of net credit losses directly affects earnings when reserves are
established through recognition of provisions for credit losses. Provisions for
credit losses generally depend on historical levels of net credit losses and
current trends. As new portfolios of consumer loans are originated or acquired,
management uses historical credit loss and delinquency analyses of similar, more
seasoned loan portfolios and other qualitative factors to establish an allowance
for credit losses inherent in the existing portfolio (see "--Allowance and
Provision for Credit Losses"). As net credit losses are experienced, the
previously established reserve is used to absorb the credit losses.
Additionally, the Company adjusts the allowance for credit losses to reflect the
sale of securitized loans and the removal of the related net book value from the
consolidated statements of financial condition.
The Company's policy is to recognize principal credit losses on all
delinquent unsecured loans (including the unsecured portion of any partially
secured credit card loans) no later than 180 days after the delinquency occurs,
unless the accountholder cures the default by making a partial payment that
qualifies under the Company's standards. Accounts of bankrupt credit card
customers are charged off upon notification of bankruptcy. Accounts of deceased
credit card customers are charged off upon determination of uncollectibility but
in no case later than 180 days after such loans become delinquent. At the time a
loan is charged off, accrued but unpaid finance charge income is reversed
against current earnings but is maintained on the customer's record in the event
of a future recovery. After a loan is charged off, the Company continues
collection activity, to the extent legally permissible. Any collections on
previously charged off loans are recognized as recoveries when realized.
21
<PAGE>
Delinquencies
An account is contractually delinquent if the minimum payment is not
received by the next billing date. Total 30+ day delinquencies on managed loans
increased to 6.71% as of September 30, 2000 from 5.66% as of December 31, 1999
and 5.20% as of September 30, 1999. This increase reflects the overall change in
the loan portfolio composition including the previously mentioned sale of home
loans, and account seasoning in lower line credit card asset classes. The
following table presents the delinquency trends of the Company's reported and
managed consumer loan portfolios as of September 30, 2000 and 1999:
<TABLE>
<CAPTION>
September 30
-------------------------------------------------------------------------
2000 1999
------------------------------ ------------------------------
% of % of
Total Total
(dollars in thousands) Loans Loans Loans Loans
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Reported:
Loans outstanding $14,265,386 100.00% $ 9,520,735 100.00%
Loans delinquent:
30 - 59 days 397,955 2.79% 186,547 1.96%
60 - 89 days 272,752 1.91% 133,714 1.40%
90 or more days 480,395 3.37% 257,821 2.71%
----------- ------ ----------- ------
Total $ 1,151,102 8.07% $ 578,082 6.07%
=========== ====== =========== ======
Managed:
Loans outstanding $24,549,526 100.00% $18,356,168 100.00%
Loans delinquent:
30 - 59 days 576,427 2.35% 319,267 1.74%
60 - 89 days 386,292 1.57% 219,201 1.19%
90 or more days 684,455 2.79% 415,887 2.27%
----------- ------ ----------- ------
Total $ 1,647,174 6.71% $ 954,355 5.20%
=========== ====== =========== ======
</TABLE>
Net Credit Losses
Net credit losses for consumer loans represent the principal amount of
losses from customers who have not paid their existing loan balances (including
charged-off bankrupt and deceased customer accounts) less current period
recoveries. The principal amounts of such losses include cash advances,
purchases, and certain financed cross-marketed product sales and exclude accrued
finance charge and fee income, and fraud losses.
The annualized managed net credit loss rate increased to 7.61% for the
three months ended September 30, 2000, compared to 6.40% for the same period in
1999. The increased managed net credit loss rate, which was less than expected,
reflects increases in credit loss rates on the Company's lower line credit card
asset classes due to account seasoning. The continued seasoning of the Company's
lower line asset classes is expected to result in an increase in the managed net
credit loss rate to the 8% range in the fourth quarter of 2000. The Company's
pricing for finance charge and fee income incorporates an expected higher credit
loss rate when appropriate, consistent with the Company's risk adjusted return
approach.
22
<PAGE>
The following table presents the Company's net credit losses for consumer
loans for the periods indicated and is presented both on a financial statement
reporting basis and a managed portfolio basis:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
------------------------------- -------------------------------
(dollars in thousands) 2000 1999 2000 1999
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Reported:
Average loans outstanding $13,402,828 $ 8,994,243 $12,753,895 $ 7,697,174
Net credit losses $ 280,066 $ 130,720 $ 756,656 $ 358,346
Net credit losses as a percentage
of average loans outstanding 8.36% 5.81% 7.91% 6.21%
Managed:
Average loans outstanding $23,395,018 $17,262,469 $22,529,959 $15,470,891
Net credit losses $ 445,140 $ 276,398 $ 1,251,934 $ 813,593
Net credit losses as a percentage
of average loans outstanding 7.61% 6.40% 7.41% 7.01%
</TABLE>
Allowance and Provision for Credit Losses
The Company maintains the allowance for credit losses at a level estimated
to be adequate to absorb credit losses, net of recoveries, inherent in the
existing reported loan portfolio. The allowance for credit losses is maintained
for reported loans only (see "--Managed Consumer Loan Portfolio and the Impact
of Securitization"). Accordingly, the entire allowance is allocated to
designated portfolios or pools of the Company's reported loans.
As part of the quantitative evaluation of the allowance for credit losses,
the Company segregates loans by portfolio type. These include portfolios of
various types of credit card products and acquired loan portfolios. The
quantitative factors the Company uses to establish portfolio-level reserves are
historical delinquencies, historical credit loss rates, level of security (if
applicable), customer characteristics, and other factors. Loan portfolios are
grouped into pools, and certain qualitative factors are applied to those pools,
consistent with applicable bank regulatory guidelines. In evaluating the need to
establish additional allowances on a pool or portfolio, the Company takes into
consideration qualitative factors, including general economic conditions, trends
in loan portfolio volume and seasoning, geographic concentrations, and recent
modifications to loan review and underwriting procedures. The Company compares
actual credit loss performance against estimated credit losses, and may modify
its loan loss allowance evaluation model accordingly.
23
<PAGE>
The following table sets forth the activity in the allowance for credit
losses for the three and nine months ended September 30, 2000 and 1999:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
------------------------------ -----------------------------
(dollars in thousands) 2000 1999 2000 1999
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at beginning of period $ 1,263,796 $ 675,224 $ 1,028,377 $ 451,245
Provision for credit losses 332,241 288,279 1,067,044 725,574
Reserve acquired / Other -- -- (22,617) 14,310
Foreign currency translation 214 -- 37 --
Credit losses (311,785) (148,995) (841,246) (414,783)
Recoveries 31,719 18,275 84,590 56,437
----------- ----------- ----------- -----------
Net credit losses (280,066) (130,720) (756,656) (358,346)
----------- ----------- ----------- -----------
Balance at end of period $ 1,316,185 $ 832,783 $ 1,316,185 $ 832,783
=========== =========== =========== ===========
Allowance for credit losses to loans at period-end 10.12% 8.75%
</TABLE>
The allowance for credit losses increased to $1.32 billion, or 10.12% of
reported loans, as of September 30, 2000, from $1.03 billion, or 8.86% of
reported loans, as of December 31, 1999 and $832.8 million, or 8.75% of reported
loans, as of September 30, 1999. The increase in the allowance for credit losses
as a percentage of reported loans reflects an increase in lower line credit card
loans, which are generally expected to experience higher credit loss rates (see
"--Risk Adjusted Revenue and Return").
Funding and Liquidity
The Company funds its assets through a diversified mix of funding products
designed to appeal to a broad range of investors, with the goal of generating
funding at the lowest cost possible while maintaining liquidity at prudent
levels and managing interest rate risk.
The primary goal of the Company's liquidity management is to ensure that
funding will be available to support Company operations in varying business
environments. The Company employs multiple strategies to maintain a strong
liquidity position, including diversification of funding sources, dispersion of
maturities, maintenance of a prudent investment portfolio and cash balances, and
maintenance of committed credit facilities.
Funding Sources and Maturities
The Company seeks to fund its assets by diversifying its distribution
channels and offering a variety of funding products. Among the products offered
are retail and institutional deposits, money market accounts, term federal
funds, public and private asset securitizations, and bank notes. Distribution
channels include direct phone and mail, brokerage and investment banking
relationships, and the Internet.
The Company offers maturity terms for its funding products that range from
one week to 30 years. Actual maturity distributions depend on several factors,
including expected asset duration, investor demand, relative costs, shape of the
yield curve, and anticipated issuances in the securitization and capital
markets. Maturities are managed by the types of funding sources utilized and by
the rates offered on different products. The Company seeks to maintain a
balanced distribution of maturities, avoiding undue concentration in any one
period. The Company monitors existing funding maturities and loan growth
projections with the goal of ensuring that liquidity levels are adequate to
support maturities.
24
<PAGE>
The following table summarizes the contractual maturities of deposits at
the Company as of September 30, 2000 and December 31, 1999:
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
--------------------------------------- ---------------------------------------
Direct Other Total Direct Other Total
(dollars in thousands) Deposits Deposits Deposits Deposits Deposits Deposits
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Three months or less $ 950,970 $ 1,525,597 $ 2,476,567 $ 675,158 $ 271,852 $ 947,010
Over three months through 12 months 2,120,142 2,325,202 4,445,344 2,080,048 2,084,568 4,164,616
Over one year through five years 1,937,348 3,384,661 5,322,009 1,426,006 2,609,582 4,035,588
Over five years -- 645,000 645,000 -- 330,000 330,000
Deposits without contractual maturity 893,691 37,212 930,903 999,753 61,156 1,060,909
--------------------------------------- ---------------------------------------
Total Deposits $ 5,902,151 $ 7,917,672 $13,819,823 $ 5,180,965 $ 5,357,158 $10,538,123
======================================= =======================================
</TABLE>
Deposits increased to $13.8 billion as of September 30, 2000 from $10.5
billion as of December 31, 1999. This increase is attributable to the Company's
continuing strategy to maintain a large deposit funding base and strong demand
for FDIC-insured deposits.
The Company securitizes loans in order to diversify funding sources and to
obtain an efficient all-in cost of funds, including the cost of capital. The
securitizations are diversified across the public and private securitization
markets and across maturity terms. Pools of securitized loans provide cash flow
for securities sold to investors under legal structures that generally provide
for an interest-only (revolving) period and a principal repayment (amortization
or accumulation) period. During an amortization or accumulation period, payments
on the securitized loans are distributed or accumulated for payment to the
securitization investors, and the portion of the securitized pool of assets
reported on the Company's statement of financial condition will increase.
Private securitizations may utilize commercial paper-based conduit
facilities and other variable funding programs to securitize loans receivable.
The conduit facilities and variable funding programs are generally renewable
annually. Balances securitized under conduit and variable funding facilities
totaled approximately $3.3 billion as of September 30, 2000.
During the first nine months of 2000, the Company completed three term
securitizations totaling approximately $1.9 billion. The Company securitized an
additional $1.3 billion in loans in October 2000.
The Company's term securitizations are expected to amortize over the
periods indicated below, based on currently outstanding securitized loans as of
September 30, 2000:
Amount
Amortizing
Year (dollars in millions)
--------------------------------------------------------------
2000 $ --
2001 945
2002 1,562
2003 1,403
2004 1,818
2005 865
The Company believes that it can attract deposits, borrow funds from other
sources, and issue additional asset-backed securities to replace the funding
reflected in the amortization schedule summarized above, although no assurances
can be given to that effect.
The Company, through one of its banking subsidiaries, maintains a program
for the issuance of senior and subordinated debt instruments. Under this
program, the Company from time to time may issue fixed or variable rate debt
instruments with maturities ranging from seven days to 15 years.
25
<PAGE>
On August 23, 2000, the Company issued $402,500,000 of 3.25% Convertible
Senior Notes due August 15, 2005 (the "Notes") with interest payable
semi-annually on February 15 and August 15 of each year, commencing on February
15, 2001. The Notes are initially convertible, at the option of the holders, at
the conversion rate of 7.2446 shares of the Company's common stock per $1,000 of
Note principal. The Company has the option to redeem the Notes on or after
August 20, 2003.
The following table shows the Company's unsecured funding availability and
outstandings as of September 30, 2000:
<TABLE>
<CAPTION>
September 30, 2000
------------------------------------------------------------
Effective/ Outstanding, Final
(dollars or dollar equivalents in thousands) Issue Date Availability(1) Net Maturity
-------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Senior and subordinated bank note program (2)(3) 2/98 $2,970,000 $ 731,721 2/13
Short-term credit facilities (three 364-day facilities) Various 250,000 -- Various
Short-term U.K. credit facility (364-day facility)(4) 4/99 37,853 -- 4/01
Revolving credit facility 1/99 750,000 -- 1/03
Providian Financial shelf registration 6/98 1,597,500 402,500 8/05
Capital Securities 2/97 -- 160,000 2/27
</TABLE>
(1) Short-term bank notes issued under the bank note program and short-term and
long-term credit facilities are revolving funding sources. Funding
availability is subject to market conditions and contractual provisions.
(2) Includes availability to issue up to $500 million of subordinated bank
notes, none outstanding as of September 30, 2000.
(3) Bank notes currently outstanding under the bank note program are
medium-term senior bank notes.
(4) (pound)25 million sterling facility in dollars using exchange rate as of
September 30, 2000.
Investments
The Company maintains cash reserves to provide adequate short-term
liquidity. The Company also maintains a portfolio of high-quality investment
securities such as U.S. government and agency obligations, mortgage-backed
securities, commercial paper, interest-earning deposits with other banks,
federal funds sold, and other cash equivalents. Investment securities increased
to $3,092.8 million as of September 30, 2000 from $581.5 million as of December
31, 1999, due to steps taken to enhance the Company's liquidity position, by
funding opportunistically at attractive rates in the deposit market. Federal
funds sold and securities purchased under resale agreements decreased to $220.6
million as of September 30, 2000 from $1,298.0 million as of December 31, 1999.
Credit Facilities
The Company has additional backup liquidity in the form of a $750 million
unsecured committed revolving credit facility from a group of financial
institutions, which is scheduled to expire in January 2003. Pursuant to this
credit facility, the Company's two banking subsidiaries, Providian National Bank
and Providian Bank, as borrowers, have access to revolving loans, which bear
interest determined by a competitive bid process or based on the federal funds
rate, the London Interbank Offered Rate (LIBOR), or the prime rate, plus a
spread. The Company guarantees the prompt and complete payment, when due, of the
borrowers' obligations under the credit facility. During the first nine months
of 2000, there were no borrowings under the credit facility. The Company is also
a party to three separate 364-day lines of credit totaling $250 million, under
which short-term borrowings are available for general corporate purposes. The
Company did not borrow funds under these 364-day lines of credit during the
first nine months of 2000. The United Kingdom branch of Providian National Bank
is a party to a sterling denominated 364-day line of credit in the amount of
(pound)25 million ($37.9 million equivalent based on the exchange rate at
September 30, 2000), under which short-term borrowings are available for general
corporate purposes. The Company guarantees the prompt and complete payment, when
due, of the borrower's obligations under the sterling facility.
26
<PAGE>
The Company follows a contingency funding plan that defines tests for
management to monitor the Company's liquidity position and prescribes
management's actions in response to various circumstances.
Capital Adequacy
Each of the Company's banking subsidiaries is subject to capital adequacy
guidelines as defined by its primary federal regulator. Core capital (Tier 1)
consists principally of shareholders' equity less goodwill. Total risk-based
capital (Tier 1 + Tier 2) includes a portion of the reserve for credit losses
and other capital components. Based on these classifications of capital, the
capital adequacy regulations establish three capital adequacy ratios that are
used to measure whether a financial institution is "well capitalized" or
"adequately capitalized":
<TABLE>
<CAPTION>
Well Adequately
Capitalized Capitalized
Capital Ratio Calculation Ratios Ratios
---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Total risk-based (Tier 1 + Tier 2)/Total risk-based assets => 10% => 8% < 10%
Tier 1 Tier 1/Total risk-based assets => 6% => 4% < 6%
Leverage Tier 1/Adjusted average assets => 5% => 4% < 5%
</TABLE>
At September 30, 2000, each of the Company's banking subsidiaries was "well
capitalized" in all regulatory capital ratio categories, as set forth below:
Providian
National Providian
Capital Ratio Bank Bank
--------------------------------------------------------------------------
Total risk-based 10.50% 14.71%
Tier 1 9.13% 13.42%
Leverage 10.89% 5.94%
The Company's banking subsidiaries' capital amounts and classifications are also
subject to qualitative judgments by the regulators with respect to components,
risk weightings, and other factors.
Asset/Liability Risk Management
The composition of the Company's consolidated statements of financial
condition consist primarily of investments in interest-earning assets (loans
receivable and investment securities) that are primarily funded by
interest-bearing liabilities (deposits and borrowings). As a result, the
Company's earnings are subject to risk resulting from interest rate fluctuations
to the extent that there is a difference between the amount of interest-earning
assets and the amount of interest-bearing liabilities that mature, reprice, or
prepay/withdraw in a specific period.
The Company's receivables generally have a fixed yield or float at a spread
above the prime rate. While the Company's fixed rate credit card receivables
have no stated maturity or repricing period, the Company may adjust the rate
charged after providing notice to the customer. Interest rates on the Company's
liabilities are generally indexed to LIBOR or bear a fixed rate until maturity.
This asset/liability structure exposes the Company to two types of interest rate
risk: (a) repricing risk, which results from differences between the timing of
rate changes and the timing of cash flows; and (b) basis risk, which arises from
changing spread relationships between yield curves and indexes.
27
<PAGE>
The principal objective of the Company's asset/liability risk management
activities is to monitor and control the Company's exposure to adverse effects
resulting from movements of interest rates over time. The Company measures and
manages interest rate risk individually for each banking subsidiary and on a
consolidated basis, including both reported and managed assets and liabilities
in its measurement and management. To measure exposure to interest rate changes,
the Company uses net interest income (NII) and market value of portfolio equity
(MVPE) simulation analysis.
The following table presents the estimated effects of positive and negative
parallel shifts in interest rates as calculated at September 30, 2000 and takes
into consideration the Company's current hedging activity:
September 30, 2000 (1)
----------------------------
Percentage Change In
Change in Interest Rates ----------------------------
(in basis points) NII(2) MVPE(3)
-------------------------------------------------------------------
+200 (1.4)% (6.5)%
Flat 0% 0%
-200 1.5% 7.3%
(1) The information shown is presented on a consolidated, managed
asset/liability basis, giving effect to securitizations and related funding.
(2) The percentage change in this column represents NII for 12 months in a
stable interest rate environment versus the NII in the specified rate scenarios.
(3) The percentage change in this column represents the MVPE in a stable
interest rate environment versus the MVPE in the specified rate scenarios. MVPE
is defined as the present value of expected net cash flows from existing assets,
minus the present value of expected net cash flows from existing liabilities,
plus the present value of expected net cash flows from existing off-balance
sheet transactions.
As part of its interest rate risk measurement process, the Company must
make reasonable estimates about how its customers and competitors will respond
to changes in market interest rates. In addition, the repricing of certain
categories of assets and liabilities is subject to competitive and other
pressures beyond the Company's control. As a result, certain assets and
liabilities assumed to mature or otherwise reprice within a certain period may
in fact mature or reprice at different times and at different volumes.
Therefore, the table above should be viewed as the Company's best estimate as to
the general effect of broad and sustained interest rate movements on the
Company's net income and portfolio value.
The Company generally seeks to mitigate earnings volatility associated with
interest rate movement by matching the repricing characteristics of reported and
managed assets and liabilities. When matching the repricing characteristics of
reported and managed assets and liabilities is not possible or efficient, the
Company uses derivative financial instruments, including swap and cap
agreements, to reduce interest rate risk.
Foreign currency exchange rate risk refers to the potential changes in
current and future earnings or capital arising from movements in foreign
exchange rates. The Company's foreign currency exchange rate risk is primarily
limited to the unhedged portion of the Company's net investment in its foreign
subsidiaries and branches. The Company uses forward exchange contracts to reduce
its exposure to foreign currency exchange rate risk.
28
<PAGE>
The Company does not trade in derivatives or use derivatives to speculate
on interest rates or foreign exchange rates or as an investment vehicle. The
following table presents the notional amounts of swap and cap agreements
purchased for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
------------------------------- -------------------------------
(dollars in thousands) 2000 1999 2000 1999
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Swap agreements:
Beginning balance $1,272,976 $ 635,500 $1,050,476 $ 635,500
Additions 82,500 115,000 315,000 130,000
Maturities -- 10,000 10,000 25,000
---------- ---------- ---------- ----------
Ending balance $1,355,476 $ 740,500 $1,355,476 $ 740,500
========== ========== ========== ==========
Interest rate caps:
Beginning balance $ 641,445 $ 647,709 $ 644,878 $ 670,960
Additions 149,179 96,750 360,155 159,000
Maturities 150,633 98,161 365,042 183,662
---------- ---------- ---------- ----------
Ending balance $ 639,991 $ 646,298 $ 639,991 $ 646,298
========== ========== ========== ==========
</TABLE>
Notional amounts of swaps outstanding have increased to offset, in part,
the growth of fixed rate deposits. As market conditions or the Company's
asset/liability mix change, the Company may increase or decrease the notional
amount of swaps and caps outstanding in order to manage the Company's interest
rate risk profile.
The Company manages credit risk arising from derivative transactions
through an ongoing credit review, approval, and monitoring process. "Credit
risk" for these derivative transactions is defined as the risk that a loss will
occur as the result of a derivative counterparty defaulting on a contract when
the contract is in a favorable economic position to the Company. The Company may
enter into master netting, market settlement, or collateralization agreements
with derivative counterparties to reduce the credit exposure arising from its
hedging transactions.
29
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
Beginning in May 1999, the Company was the subject of media coverage
concerning complaints made by some customers of the Company's banking
subsidiaries regarding certain sales and collections practices. Following the
initial media coverage, the San Francisco District Attorney's Office began an
investigation into the Company's sales and collections practices. In November
1999, the Connecticut Attorney General's Office began an inquiry into the
Company's sales and collections practices. On June 19, 2000, the Company reached
a settlement with the Connecticut Attorney General's Office in which it agreed
to pay $1.6 million to the State of Connecticut, to develop a process to
determine whether any individual Connecticut consumers are entitled to
restitution, and to modify certain business practices. On June 28, 2000 the
Company's national bank subsidiary, Providian National Bank (the "Bank"),
reached a settlement with the Office of the Comptroller of the Currency
following an examination that included an investigation of customer complaints,
and the Company reached a settlement with the San Francisco District Attorney
and the California Attorney General, in which the Bank and the Company and
certain subsidiaries of the Company agreed to make certain changes to their
business practices and to pay restitution to customers determined in accordance
with the procedures in the settlement agreement. The Company estimates that the
total restitution, which is subject to a floor of $300 million, will be
approximately $310 million. The Bank has begun mailing checks to persons
entitled to restitution and expects that substantially all the payments will be
made in the fourth quarter of 2000. As part of the settlement, the Bank
stipulated to the issuance by the Comptroller of a Consent Order obligating the
Bank to make such changes and to pay the aforementioned restitution, and the
Company and certain of its subsidiaries stipulated to the entry of a judgment
and the issuance of a permanent injunction effecting the terms of the
settlement. In addition, the Company agreed to pay $5.5 million in civil
penalties to the City and County of San Francisco.
Since May 1999, a number of lawsuits have been filed against the Company
and, in some cases, against certain of the Company's subsidiaries by current and
former customers of the Company's banking subsidiaries. A consolidated putative
class action lawsuit (In re Providian Credit Card Litigation) (the "Consolidated
Action") was filed in August 1999 in California state court in San Francisco
against the Company, the Bank, and certain other subsidiaries of the Company,
and seeks unspecified damages, including actual and punitive damages, attorneys'
fees and injunctive relief. The complaint alleges unfair and deceptive business
practices, including failure to credit payments in a timely fashion, adding
products and charging fees without customer authorization, changing rates and
terms without proper notice or authorization, and misleading or deceptive sales
practices. Similar actions filed in other California counties have been
transferred to San Francisco County and coordinated with the Consolidated
Action.
30
<PAGE>
As of November 14, 2000, three class actions were pending in state courts
in San Mateo County, California, Cook County, Illinois, and Bullock County,
Alabama. These actions have not been consolidated with the Consolidated Action
and are proceeding separately. A class consisting of a relatively small number
of California customers has been certified in the San Mateo County, California
action. No class has been certified in the Cook County, Illinois or Bullock
County, Alabama actions. A motion to dismiss the Cook County, Illinois action
has been granted with prejudice, and the plaintiff has filed an appeal. As of
November 14, 2000, one consolidated putative class action was pending in federal
court. The federal action (the "Multidistrict Action") is a consolidation of
several different actions that had been filed in various federal courts, and
transferred by the Federal Judicial Panel on Multidistrict Litigation to the
Eastern District of Pennsylvania. A consolidated complaint in the Multidistrict
Action was filed on February 4, 2000.
These other state and federal actions contain substantially the same
allegations as those alleged in the Consolidated Action. Certain of the actions
also allege one or more of the following: that the account agreement with
customers contained unconscionable or improper terms and fees, that statements
sent to customers failed to include credit protection and other add-on fees in
the calculation of the annual percentage rate disclosed in those statements,
refusal to honor cancellation requests, improper obtaining of credit reports,
breached promises to raise credit limits, and breached promises of high credit
limits.
A putative class action (In re Providian Securities Litigation), which is a
consolidation of complaints filed in the United States District Court for the
Eastern District of New York in June 1999, alleges, in general, that the Company
and certain of its officers made false and misleading statements concerning its
future prospects and financial results in violation of the federal securities
laws. The putative class, which is alleged to have acquired the Company's stock
between January 15, 1999 and May 26, 1999, seeks damages in an unspecified
amount, in addition to pre-judgment and post-judgment interest, costs and
attorneys' fees. By order dated February 8, 2000, the Federal Judicial Panel on
Multidistrict Litigation transferred the consolidated securities cases to the
Eastern District of Pennsylvania for inclusion with the Multidistrict Action
currently pending in that court. On June 9, 2000 an amended consolidated class
action complaint was filed, and on September 15, 2000 a second amended
consolidated class action complaint was filed. On September 30, 2000, a motion
to dismiss the second amended consolidated class action complaint was filed on
behalf of all defendants.
Two shareholder derivative actions, one filed on June 30, 2000 and one
filed on July 14, 2000, have been filed in California state court in San
Francisco. In addition, on September 14, 2000 a shareholder derivative lawsuit
was filed in Delaware chancery court. These actions seek redress against the
members of the Company's board of directors and certain executive officers for
breach of their fiduciary duties and for corporate waste arising out of their
approval of, or failure to prevent, the Company's alleged unfair business
practices, which allegedly resulted in a liability, or potential liability, for
restitution, penalties, and litigation costs. The unfair practices alleged in
these complaints are similar to the ones at issue in the Multidistrict Action
and the Consolidated Action, and many of them were covered by the Comptroller's
Consent Order described above. These complaints are at an early stage and no
response is yet due.
An informed assessment of the ultimate outcome or potential liability
associated with the lawsuits described above and other potential claims that
could arise out of the alleged unfair business practices is not feasible at this
time. Due to the uncertainties of litigation, there can be no assurance that the
Company will prevail on all the claims made against it in the lawsuits or that
similar proceedings will not be brought. However, management believes that the
Company has substantive defenses and intends to defend the actions vigorously.
31
<PAGE>
In addition, the Company is commonly subject to various other pending and
threatened legal actions arising in the ordinary course of business from the
conduct of its business activities. In the opinion of the Company, any liability
that is likely to arise with respect to these additional actions will not have a
material adverse effect on the consolidated financial condition or results of
operations of the Company.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits Required by Item 601 of Regulation S-K.
Exhibit 12.1 Computation of Earnings to Fixed Charges and Ratio of
Earnings to Combined Fixed Charges and Preferred Stock
Dividend Requirements.
Exhibit 27.1 Financial Data Schedule.
(b) Reports on Form 8-K.
The Company filed a report on Form 8-K on July 7, 2000, attaching its press
release dated June 28, 2000, announcing a final settlement agreement with
the Office of the Comptroller of the Currency, the San Francisco District
Attorney's Office and the California Attorney General.
The Company filed a report on Form 8-K on August 23, 2000 with respect to
its Registration Statement on Form S-3 and the issuance of its 3.25%
Convertible Senior Notes due August 15, 2005.
(e) Ratio of Earnings to Fixed Charges and Ratio of Earnings to Combined Fixed
Charges and Preferred Stock Dividend Requirements.
<TABLE>
<CAPTION>
Nine Months
Ended Year Ended December 31
September ---------------------------------------------
(dollars in thousands) 2000 1999 1998 1997 1996 1995
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
EARNINGS TO FIXED CHARGES:
Excluding interest on deposits 12.55 9.83 10.88 14.20 5.93 4.90
Including interest on deposits 2.10 2.99 2.93 2.66 2.34 2.34
EARNINGS TO COMBINED FIXED CHARGES AND
PREFERRED STOCK: (1)
Excluding interest on deposits 12.55 9.83 10.88 13.28 5.19 4.32
Including interest on deposits 2.10 2.99 2.93 2.63 2.25 2.24
</TABLE>
(1) Preferred stock dividend requirements are adjusted to represent a pretax
earnings equivalent.
32
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Providian Financial Corporation
-------------------------------
(Registrant)
Date: November 14, 2000 /s/ David J. Petrini
-------------------------------
David J. Petrini
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer and Duly
Authorized Signatory)
Date: November 14, 2000 /s/ Daniel Sanford
-------------------------------------
Daniel Sanford
Senior Vice President and Controller
(Chief Accounting Officer and Duly
Authorized Signatory)
33
