<PAGE>
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 June 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 July 31, 2000, there were 142,857,943 shares of the registrant's
Common Stock, par value $0.01 per share, outstanding.
1
<PAGE>
PROVIDIAN FINANCIAL CORPORATION
FORM 10-Q
INDEX
June 30, 2000
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page
----
<S> <C>
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............................... 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................... 28
Item 4. Submission of Matters to a Vote of Security Holders................. 29
Item 6. Exhibits and Reports on Form 8-K.................................... 30
Signatures............................................................................ 32
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
PROVIDIAN FINANCIAL CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
(unaudited)
June 30 December 31
(dollars in thousands) 2000 1999
----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 303,550 $ 182,915
Federal funds sold and securities
purchased under resale agreements 1,206,900 1,298,000
Investment securities:
Available-for-sale 1,905,785 455,238
Held-to-maturity 598,290 126,258
Loans receivable, less allowance for credit losses of $1,263,796
at June 30, 2000 and $1,028,377 at December 31, 1999 11,290,173 10,545,173
Premises and equipment, net 178,877 149,194
Interest receivable 129,742 108,087
Due from securitizations 609,986 614,217
Deferred taxes 649,104 571,040
Other assets 369,562 290,755
----------------------------
Total assets $ 17,241,969 $ 14,340,877
============================
LIABILITIES
Deposits:
Non-interest bearing $ 68,597 $ 63,890
Interest bearing 13,104,143 10,474,233
----------------------------
13,172,740 10,538,123
Short-term borrowings 50,310 126,289
Long-term borrowings 731,721 958,056
Deferred fee revenue 583,721 578,607
Accrued expenses and other liabilities 961,552 647,326
---------------------------
Total liabilities 15,500,044 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: June 30, 2000--142,722,722
shares; December 31, 1999--142,066,407 shares) 954 954
Retained earnings 1,590,641 1,394,293
Cumulative other comprehensive income 2,075 (2,161)
Common stock held in treasury--at cost: (June 30, 2000--
397,258 shares; December 31, 1999--1,053,573 shares) (11,745) (60,610)
----------------------------
Total shareholders' equity 1,581,925 1,332,476
----------------------------
Total liabilities and shareholders' equity $ 17,241,969 $ 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 Six Months Ended
June 30 June 30
(dollars in thousands, except per share data) 2000 1999 2000 1999
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INTEREST INCOME
Loans $ 594,145 $ 358,449 $1,170,871 $ 637,574
Federal funds sold and securities
purchased under resale agreements 19,613 6,920 51,348 12,623
Other 39,821 7,560 59,259 14,348
-------------------------------------------------
Total interest income 653,579 372,929 1,281,478 664,545
INTEREST EXPENSE
Deposits 201,425 73,790 387,312 138,229
Borrowings 15,446 26,480 34,217 42,542
-------------------------------------------------
Total interest expense 216,871 100,270 421,529 180,771
Net interest income 436,708 272,659 859,949 483,774
Provision for credit losses 373,590 255,222 734,803 437,295
-------------------------------------------------
Net interest income after provision
for credit losses 63,118 17,437 125,146 46,479
NON-INTEREST INCOME
Servicing and securitizations 153,123 148,763 307,206 279,974
Credit product fee income 575,368 414,819 1,121,786 756,629
Other 95,313 7,876 122,352 12,111
-------------------------------------------------
823,804 571,458 1,551,344 1,048,714
NON-INTEREST EXPENSE
Salaries and employee benefits 173,335 121,784 348,315 217,771
Solicitation and advertising 119,020 102,231 231,142 201,678
Occupancy, furniture, and equipment 32,798 18,877 63,397 34,181
Data processing and communication 44,690 29,852 85,308 54,614
Other 412,448 105,096 553,200 186,702
-------------------------------------------------
782,291 377,840 1,281,362 694,946
-------------------------------------------------
Income before income taxes 104,631 211,055 395,128 400,247
Income tax expense 41,859 84,569 158,038 160,215
-------------------------------------------------
Net Income $ 62,772 $ 126,486 $ 237,090 $ 240,032
=================================================
Earnings per common share - basic $ 0.44 $ 0.89 $ 1.67 $ 1.70
=================================================
Earnings per common share - assuming dilution $ 0.43 $ 0.87 $ 1.63 $ 1.65
=================================================
Cash dividends paid per common share $ 0.05 $ 0.05 $ 0.10 $ 0.10
=================================================
Weighted average common shares
outstanding - basic (000) 141,840 141,483 141,753 141,298
=================================================
Weighted average common shares
outstanding - assuming dilution (000) 145,791 145,546 145,491 145,623
=================================================
</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 240,032 240,032
Other comprehensive income, net of income tax:
Unrealized gain on securities, net of
income taxes of $123 (191) (191)
Foreign currency translation adjustments,
net of income taxes of ($6) 9 9
------------
Other comprehensive income (182)
------------
Comprehensive income 239,850
Cash dividend: Common - $0.10 per share (14,178) (14,178)
Purchase of 933,459 common shares for treasury 25,923 (97,120) (71,197)
Exercise of stock options and other awards (51,388) 8,466 62,515 19,593
Issuance of restricted and unrestricted stock less
forfeited shares (422) 9,029 8,607
Deferred compensation related to grant of
restricted and unrestricted stock less
amortization of $3,708 (4,896) (4,896)
Net tax effect from employee stock plans 31,729 31,729
-----------------------------------------------------------------------------------
BALANCE AT JUNE 30, 1999 $ 954 $ 946 $1,100,325 $ (502) $ (89,028) $ 1,012,695
===================================================================================
BALANCE AT DECEMBER 31, 1999 $ 954 $ - $1,394,293 $(2,161) $ (60,610) $ 1,332,476
Comprehensive income:
Net Income 237,090 237,090
Other comprehensive income, net of income tax:
Unrealized gain on securities, net of
income taxes of ($3,111) 4,666 4,666
Foreign currency translation adjustments,
net of income taxes of $286 (430) (430)
------------
Other comprehensive income 4,236
------------
Comprehensive income 241,326
Cash dividend: Common - $0.10 per share (14,252) (14,252)
Purchase of 70,234 common shares for treasury (5,937) (5,937)
Exercise of stock options and other awards 11,432 (26,490) 24,931 9,873
Issuance of restricted and unrestricted stock less
forfeited shares (8,603) 29,871 21,268
Deferred compensation related to grant of
restricted and unrestricted stock less
amortization of $7,229 (14,039) (14,039)
Net tax effect from employee stock plans 11,210 11,210
-----------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2000 $ 954 $ - $1,590,641 $ 2,075 $ (11,745) $ 1,581,925
===================================================================================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
5
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
PROVIDIAN FINANCIAL CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
Six Months Ended
June 30
(dollars in thousands) 2000 1999
------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net Income $ 237,090 $ 240,032
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses 734,803 437,295
Depreciation and amortization of premises and equipment 24,769 14,548
Amortization of net loan acquisition costs 15,134 26,604
Amortization of deferred compensation
related to restricted and unrestricted stock 7,229 3,708
Amortization of deferred fee revenue (438,938) (254,104)
Increase in deferred income tax benefit (80,888) (109,623)
Increase in deferred fee revenue 444,052 380,748
Increase in interest receivable (21,655) (20,262)
Gain from sale of home loans (64,671) --
Net increase in other assets (94,808) (72,578)
Net increase in accrued expenses and other liabilities 325,438 72,852
--------------------------
Net cash provided by operating activities 1,087,555 719,220
INVESTING ACTIVITIES
Net (increase) decrease in money market instrument investments (472,032) 74,894
Net cash used for loan originations and principal
collections on loans receivable (3,291,438) (3,066,363)
Net increase in securitized loans 328,636 569,163
Net proceeds from sale of home loans 1,548,173 --
Portfolio acquisitions -- (127,119)
Decrease in due from securitizations 4,231 88,763
Purchases of investment securities (1,495,821) (76,042)
Proceeds from maturities of investment securities 53,050 85,802
Decrease (increase) in federal funds sold and securities purchased under resale agreements 91,100 (471,256)
Net purchases of premises and equipment (54,806) (40,982)
--------------------------
Net cash used by investing activities (3,288,907) (2,963,140)
FINANCING ACTIVITIES
Net increase in deposits 2,634,617 1,325,282
Proceeds from issuance of term federal funds 1,445,000 1,258,778
Repayment of term federal funds (1,545,027) (872,500)
Increase in other short-term borrowings 24,048 --
(Decrease) increase in long-term borrowings (226,335) 629,548
Purchase of treasury stock (5,937) (71,197)
Dividends paid (14,252) (14,178)
Proceeds from exercise of stock options 9,873 19,593
--------------------------
Net cash provided by financing activities 2,321,987 2,275,326
--------------------------
Net increase in cash and cash equivalents 120,635 31,406
Cash and cash equivalents at beginning of period 182,915 176,348
--------------------------
Cash and cash equivalents at end of period $ 303,550 $ 207,754
==========================
</TABLE>
See notes to condensed consolidated financial statements.
6
<PAGE>
PROVIDIAN FINANCIAL CORPORATION
Notes to Condensed Consolidated Financial Statements
June 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 six month
periods ended June 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.
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 Six Months Ended
June 30 June 30
(dollars in thousands, except per share data) 2000 1999 2000 1999
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Income $ 62,772 $ 126,486 $ 237,090 $ 240,032
==========================================================================
Weighted average common shares outstanding--
basic 141,840 141,483 141,753 141,298
Effect of dilutive securities
Restricted stock issued--non vested 732 508 662 581
Employee stock options /(1)/ 3,046 3,555 2,864 3,744
Forward purchase contracts 173 -- 212 --
--------------------------------------------------------------------------
Dilutive potential common shares 3,951 4,063 3,738 4,325
--------------------------------------------------------------------------
Adjusted weighted average common shares and
assumed conversions 145,791 145,546 145,491 145,623
==========================================================================
Earnings per common share--basic $ 0.44 $ 0.89 $ 1.67 $ 1.70
==========================================================================
Earnings per common share--assuming dilution $ 0.43 $ 0.87 $ 1.63 $ 1.65
==========================================================================
</TABLE>
(1) During the three and six months ended June 30, 2000, options to purchase
2,630,750 and 2,699,650 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.
7
<PAGE>
Note 3 - Loans Receivable and Allowance for Credit Losses
The following is a summary of the Company's loans receivable at June 30, 2000
and December 31, 1999:
<TABLE>
<CAPTION>
(dollars in thousands) June 30, 2000 December 31,1999
----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Credit cards $ 12,458,784 $ 10,075,185
Home loans 79,646 1,520,795
Other 18,250 13,974
-------------------------------------------
12,556,680 11,609,954
Allowance for credit losses (1,263,796) (1,028,377)
Net deferred origination fees (2,711) (36,404)
-------------------------------------------
$ 11,290,173 $ 10,545,173
-------------------------------------------
</TABLE>
The activity in the allowance for credit losses for the six months ended
June 30, 2000 and 1999 was as follows:
<TABLE>
<CAPTION>
Six Months Ended June 30
(dollars in thousands) 2000 1999
--------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of period $ 1,028,377 $ 451,245
Provision for credit losses 734,803 437,295
Allowance acquired/Other (22,617) 14,310
Foreign currency translation (177) --
Credit losses (529,461) (265,788)
Recoveries 52,871 38,162
-----------------------------------
Net credit losses (476,590) (227,626)
-----------------------------------
Balance at end of period $ 1,263,796 $ 675,224
===================================
</TABLE>
Note 4 - Shareholders' Equity
The Company is party to 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 June 30, 2000, the
agreements covered 2,256,613 shares of the Company's common stock at a weighted
forward price of $85.2859 per share. The agreements have terms of one year but
may be settled earlier at the Company's option. During the three months ended
June 30, 2000, the Company did not make any settlements of the forward purchase
agreements. If the agreements had been settled on a net share basis at the June
30, 2000 market price of the Company's common stock ($90.00 per share), the
Company would have received approximately 118,199 shares of its common stock
from the counterparties.
Note 5 - Cumulative Other Comprehensive Income
The components of cumulative other comprehensive income, net of related
tax, for the six months ended June 30, 2000 and 1999 were as follows:
<TABLE>
<CAPTION>
Cumulative
Unrealized Foreign 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 (314) 15 (299)
Tax benefit (expense) 123 (6) 117
-------------------------------------------------------
Balance, June 30, 1999 $ (511) $ 9 $ (502)
=======================================================
Balance, January 1, 2000 $ (2,207) $ 46 $ (2,161)
Other comprehensive income 7,777 (716) 7,061
Tax benefit (expense) (3,111) 286 (2,825)
-------------------------------------------------------
Balance, June 30, 2000 $ 2,459 $ (384) $ 2,075
=======================================================
</TABLE>
8
<PAGE>
Note 6 - 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". The Credit Card operating segment includes credit
cards and secured credit cards. Credit Card customer relationships are initiated
through direct marketing and other distribution channels or credit card
portfolio acquisitions from other financial institutions. The operations in the
Other segment include the unsold portion of home loans, the operations related
to First Select, which specializes in the purchase of delinquent loans for
collection, and new business initiatives. Segment reporting has been reorganized
as a result of the Company's sale of a majority of its home loan portfolio 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. Membership services revenue, which is derived from
both the Credit Card segment and customers included in the Other category, 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 is presented below 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 six months ended June 30, 2000 and 1999:
<TABLE>
<CAPTION>
Credit
(dollars in thousands) Card Other Total
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Three Months Ended June 30, 2000
Revenue $ 1,258,997 86,642 $ 1,345,639
Profit or loss $ 100,877 47,304 $ 148,181
Assets $ 21,449,863 980,520 $ 22,430,383
Three Months Ended June 30, 1999
Revenue $ 913,855 44,020 $ 957,875
Profit or loss $ 233,781 (777) $ 233,004
Assets $ 14,825,101 1,441,066 $ 16,266,167
Six Months Ended June 30, 2000
Revenue $ 2,464,945 159,498 $ 2,624,443
Profit or loss $ 500,559 (2,748) $ 497,811
Assets $ 21,449,863 980,520 $ 22,430,383
Six Months Ended June 30, 1999
Revenue $ 1,722,201 72,447 $ 1,794,648
Profit or loss $ 464,827 (28,648) $ 436,179
Assets $ 14,825,101 1,441,066 $ 16,266,167
</TABLE>
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 June 30, 2000 and 1999:
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months Ended June 30
(dollars in thousands) 2000 1999 2000 1999
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total segment profits $ 148,181 $ 233,004 $ 497,811 $ 436,179
Corporate and other (43,550) (21,949) (102,683) (35,932)
-------------------------------------------------------------------------
Income before income taxes $ 104,631 $ 211,055 $ 395,128 $ 400,247
=========================================================================
</TABLE>
9
<PAGE>
Note 7 - 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 inquires 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 8 - 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 condensed consolidated
statements of income.
10
<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 membership
products. The Company through its subsidiary, GetSmart.com, Inc. offers an
online marketplace that provides consumer and business financial product
information and lender connections through proprietary search and application
technology. 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 and the Company
offers credit cards in the United Kingdom and 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 superior
financial performance. During the first six 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 inquires 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.
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 leaders; 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
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
11
<PAGE>
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, before one-time adjustments, for the three months ended
June 30, 2000 was $187.6 million, an increase of 48% over net income of $126.5
million for the three months ended June 30, 1999. Net income, before one-time
adjustments, for the six months ended June 30, 2000 was $361.9 million, an
increase of 51% over net income of $240.0 million for the six months ended June
30, 1999. The key drivers to the second quarter and year-to-date performance
came from growth in outstanding loan balances and customer accounts combined
with improved customer retention. After the one-time adjustments, net income for
the three and six months ended June 30, 2000 was $62.8 million and $237.1
million.
As of June 30, 2000, managed loans, which include reported and
securitized loans, after the sale of home equity loans, were $22.3 billion.
Managed credit card loans were $21.8 billion, an increase of $2.8 billion, or
14.7%, 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 remained relatively
stable at 12.05% for the second quarter of 2000 compared to 12.39% for the same
period in 1999. The managed net credit loss rate for the second quarter of 2000
increased to 7.42% from 7.16% for the same period in 1999 and is up from 7.18%
for the first quarter 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
second quarter of 2000 increased to 6.48% from 5.72% for the first quarter of
2000 and 4.70% for the second quarter of 1999. This account seasoning is
expected to result in a continued increase in the Company's managed net credit
loss rate, rising to an 8% range in the second half of 2000. The dollar
contribution to managed revenue from non-interest income, before the one-time
gain on the sale of home loans in the second quarter, increased more than 37%
over the same period in 1999 to $680.2 million, due to increased revenue from
membership 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 before one-
time adjustments increased $139.1 million during the second quarter of 2000 to
$509.7 million, reflecting expenses associated with servicing a greater number
of customers and maintaining an employee base that has grown by 42% over that
period.
The Company's return on reported assets before one-time adjustments was
4.33% for the second quarter of 2000, down from 5.36% 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 reported assets after one-time adjustments was 1.45%.
The Company continued to maintain the overall strength of its balance sheet
during the second quarter of 2000. Return on equity before one-time adjustments
was 47.23% for the second quarter of 2000, down from 52.19% for the same period
in 1999. Return on equity after one-time adjustments was 15.81% for the second
quarter of 2000.
Managed Consumer Loan Portfolio and the Impact of Securitization
The Company securitizes credit card, home loan and secured credit card
receivables. For additional discussion of the Company's securitization
activities, see "--Funding and Liquidity."
12
<PAGE>
Securitized assets sold to external investors are not considered assets of the
Company and therefore are not shown on the Company's consolidated statement 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 Six Months Ended
June 30 June 30
--------------------------------------------------------------------
(dollars in thousands) 2000 1999 2000 1999
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Period-End Balances:
Reported consumer loans $ 12,556,680 $ 8,164,979
Securitized consumer loans 9,745,044 8,074,956
--------------- ---------------
Total managed consumer loan portfolio $ 22,301,724 $ 16,239,935
=============== ===============
Average Balances:
Reported consumer loans $ 12,653,981 $ 7,785,664 $ 12,425,208 $ 7,038,259
Securitized consumer loans 9,949,681 7,542,062 9,666,813 7,522,365
--------------- --------------- --------------- ---------------
Total average managed consumer loan portfolio $ 22,603,662 $ 15,327,726 $ 22,092,021 $ 14,560,624
=============== =============== =============== ===============
Operating Data and Ratios:
Reported:
Average earning assets $ 16,186,718 $ 8,894,598 $ 15,902,449 $ 8,067,704
Return on average assets 1.45% 5.36% 2.81% 5.55%
Net interest margin (1) 10.79% 12.26% 10.82% 11.99%
Managed:
Average earning assets $ 26,136,399 $ 16,436,660 $ 25,569,262 $ 15,590,069
Return on average assets 0.91% 2.98% 1.78% 2.98%
Net interest margin (1) 10.53% 12.08% 10.54% 11.95%
</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 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 securitization" 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.
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. 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
13
<PAGE>
associated allowance for credit losses. Periodically, the Company transfers 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
June 30, 2000 and 1999 securitization accounting had the effect of: reducing net
interest income by $251.0 million and $223.6 million; reducing the provision for
credit losses by $172.1 million and $146.8 million; and increasing non-interest
income by $78.9 million and $76.8 million. For the six months ended June 30,
2000 and 1999 securitization accounting had the effect of: reducing net interest
income by $488.1 million and $447.4 million; reducing the provision for credit
losses by $330.2 million and $309.6 million; and increasing non-interest income
by $157.9 million and $137.8 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 June
30, 2000, before one-time adjustments, were $941.9 million and 16.67%, compared
to $695.2 million and 18.14% for the same period in 1999. For the six months
ended June 30, 2000 managed risk adjusted revenue and return, before one-time
adjustments, were $1.86 billion and 16.84%, compared to $1.27 billion and 17.46%
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 six 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 our 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.
Managed net interest income for the three months ended June 30, 2000 was
$687.8 million, compared to $496.2 million for the same period in 1999,
representing an increase of $191.6 million, or 39%. Managed net interest margin
on average managed earning assets decreased to 10.53% for the three months ended
June 30, 2000, from 12.08% for the same period in 1999. For the six months ended
June 30, 2000 managed net interest income was $1,348.1 million, compared to
$931.1 million for the same
14
<PAGE>
period in 1999, an increase of $417.0 million, or 45%. Managed net interest
margin on average managed earning assets decreased to 10.54% for the six months
ended June 30, 2000, from 11.95% 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
decreased to 12.05% for the three months ended June 30, 2000, from 12.39% for
the same period in 1999. The decrease in managed net interest margin was the
result of increased borrowing rates for the Company which were offset in part by
increases in finance charge yields. During the course of the past year, six rate
increases by the Federal Reserve have resulted in a 150 basis point increase in
the federal funds rate. The higher finance charge yields resulted from an
increase in the number of lower line credit card accounts, which generate higher
overall finance charge rates and fee income, consistent with the Company's risk
adjusted approach to pricing.
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
six months ended June 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.
<TABLE>
<CAPTION>
Three Months Ended June 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 $ 12,653,981 $ 594,145 18.78% $ 7,785,664 $ 358,449 18.42%
Interest-earning cash 123,850 1,908 6.16% 162,947 1,796 4.41%
Federal funds sold 1,224,569 19,614 6.41% 573,618 6,920 4.83%
Investment securities 2,184,318 37,913 6.94% 372,369 5,764 6.19%
--------------- ------------- ------- -------------- ------------ ---------
Total interest-earning assets 16,186,718 $ 653,580 16.15% 8,894,598 $ 372,929 16.77%
Allowance for loan losses (1,195,380) (617,980)
Other assets 2,343,863 1,153,420
--------------- --------------
Total assets $ 17,335,201 $ 9,430,038
=============== ==============
LIABILITIES AND EQUITY:
Interest-bearing liabilities
Deposits $ 13,068,820 201,426 6.17% $ 5,580,966 73,790 5.29%
Borrowings 940,512 15,446 6.57% 1,804,499 26,480 5.87%
--------------- ------------- ------- -------------- ------------ ---------
Total interest-bearing liabilities 14,009,332 $ 216,872 6.19% 7,385,465 $ 100,270 5.43%
Other liabilities 1,577,536 915,127
--------------- --------------
Total liabilities 15,586,868 8,300,592
Capital securities 160,000 160,000
Equity 1,588,333 969,446
--------------- --------------
Total liabilities and equity $ 17,335,201 $ 9,430,038
=============== ==============
NET INTEREST SPREAD: 9.96% 11.34%
======= =========
Interest income to
average interest-earning assets 16.15% 16.77%
Interest expense to
average interest-earning assets 5.36% 4.51%
------- ---------
Net interest margin 10.79% 12.26%
======= =========
</TABLE>
15
<PAGE>
<TABLE>
<CAPTION>
Six Months Ended June 30
-------------------------------------------------------------------------------
2000 1999
-------------------------------------- ---------------------------------------
Average Income/ Yield/ Average Income/ Yield/
(dollars in thousands) Balance Expense Rate Balance Expense Rate
--------------------------------------------------------------------------------------------------------------------
ASSETS:
Interest-earning assets
<S> <C> <C> <C> <C> <C> <C>
Consumer loans $ 12,425,208 $ 1,170,871 18.85% $ 7,038,259 $ 637,574 18.12%
Interest-earning cash 124,056 3,719 6.00% 129,522 2,971 4.59%
Federal funds sold 1,708,692 51,348 6.01% 526,572 12,623 4.79%
Investment securities 1,644,493 55,541 6.75% 373,351 11,377 6.09%
-------------- ----------- --------- ------------ ----------- ----------
Total interest-earning assets 15,902,449 $ 1,281,479 16.12% 8,067,704 $ 664,545 16.47%
Allowance for loan losses (1,146,853) (564,443)
Other assets 2,121,886 1,139,154
-------------- -------------
Total assets $ 16,877,482 $ 8,642,415
============== =============
LIABILITIES AND EQUITY:
Interest-bearing liabilities
Deposits $ 12,703,102 387,312 6.10% $ 5,256,773 138,229 5.26%
Borrowings 1,047,858 34,217 6.53% 1,445,954 42,542 5.88%
-------------- ----------- --------- ------------- ----------- ----------
Total interest-bearing liabilities 13,750,960 $ 421,529 6.13% 6,702,727 $ 180,771 5.39%
Other liabilities 1,459,696 860,484
-------------- -------------
Total liabilities 15,210,656 7,563,211
Capital securities 160,000 160,000
Equity 1,506,826 919,204
-------------- -------------
Total liabilities and equity $ 16,877,482 $ 8,642,415
============== =============
NET INTEREST SPREAD: 9.99% 11.08%
========= ==========
Interest income to
average interest-earning assets 16.12% 16.47%
Interest expense to
average interest-earning assets 5.30% 4.48%
--------- ----------
Net interest margin 10.82% 11.99%
========= ==========
</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:
16
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months Ended June 30
2000 vs. 1999 2000 vs. 1999
------------------------------------------- -------------------------------------------
---------------------------- ----------------------------
Increase Change due to (1) Increase Change due to (1)
---------------------------- ----------------------------
(dollars in thousands) (Decrease) Volume Rate (Decrease) Volume Rate
---------------------------------------------------------------------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Interest Income:
Consumer loans $ 235,696 $ 228,553 $ 7,143 $ 533,297 $ 506,629 $ 26,668
Federal funds sold 12,694 9,853 2,841 38,725 34,779 3,946
Other securities 32,261 30,873 1,388 44,912 42,672 2,240
----------- ----------- ---------- ----------- ----------- ----------
Total interest income 280,651 269,279 11,372 616,934 584,080 32,854
Interest Expense:
Deposits 127,636 113,557 14,079 249,083 223,847 25,236
Borrowings (11,034) (13,890) 2,856 (8,325) (12,646) 4,321
----------- ----------- ---------- ----------- ----------- ----------
Total interest expense 116,602 99,667 16,935 240,758 211,201 29,557
----------- ----------- ---------- ----------- ----------- ----------
Net interest income $ 164,049 $ 169,612 $ (5,563) $ 376,176 $ 372,879 $ 3,297
=========== =========== ========== =========== =========== ==========
</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
55% of gross reported revenues for the three months ended June 30, 2000. Total
non-interest income, before the one-time adjustment for the gain on the sale of
home loans, increased 32.8%, or $187.6 million, to $759.1 million for the three
months ended June 30, 2000, compared to $571.5 million for the same period in
1999. For the six months ended June 30, 2000, total non-interest income, before
the one-time adjustment, increased 41.8%, or $438.0 million, to $1.49 billion
compared to $1.05 billion for the same period in 1999. The increase is primarily
attributable to increased credit product fee income realized from membership
services revenue and loan activity fees resulting from growth in the customer
base. After the one-time adjustment, total non-interest income was $823.8
million and $1.55 billion for the three and six months ended June 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 June 30, 2000, securitizations outstanding provided $9.6 billion in
funding, representing 38% of total managed funding, compared with $8 billion, or
45%, as of June 30, 1999. The decrease in securitizations outstanding as a
percentage of total managed funding as of June 30, 2000 was due to the Company's
efforts to diversify its funding sources and increase deposit funding. A more
detailed discussion of the Company's funding sources and the role of
securitization activities is set forth under "--Funding and Liquidity."
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
17
<PAGE>
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 June 30, 2000, servicing and securitization
income increased $4.4 million from the same period in 1999, to $153.1 million.
For the six months ended June 30, 2000, servicing and securitization income
increased $27.2 million from the same period in 1999, to $307.2 million. Excess
servicing yields on securitized loans improved for the first six 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
Credit product fee income includes loan activity fees, loan performance
fees, and membership services revenue. For the three months ended June 30, 2000,
credit product fee income increased 38.7% to $575.4 million, compared to $414.8
million for the same period in 1999. For the six months ended June 30, 2000,
credit product fee income increased 48.3% to $1,121.8 million, compared to
$756.6 million for the same period in 1999. The Company expects credit product
fee income growth to continue to moderate in the second half of 2000. Certain
fee revenue realized from securitized loans is not included in credit product
fee income but instead is recorded as part of servicing and securitization
income.
Strong growth in new customers, customers that purchased membership
products, and rising loan activity fee volume contributed to the increase in
credit product fee income during the quarter ended June 30, 2000 over the second
quarter of 1999. For the three months ended June 30, 2000 and 1999, loan
activity fees, which include interchange income and cash advance, annual
membership, and processing fees, totaled $259.1 million and $199.9 million. For
the six months ended June 30, 2000 and 1999, loan activity fees totaled $501.8
million and $352.0 million. Loan activity fee income increased as account growth
resulted in increased annual membership fees, cash advance fees, and interchange
income. Loan performance fees include late fees, returned check fees, and
overlimit charges. For the three months ended June 30, 2000 and 1999, loan
performance fees totaled $103.3 million and $87.0 million, reflecting increased
overlimit income consistent with growth in the account base offset in part by a
decrease in late fee income. For the six months ended June 30, 2000 and 1999,
loan performance fees totaled $209.9 million and $182.8 million. Membership
services revenue results primarily from the sale of various proprietary
membership products that complement the Company's credit products. The Company
recognizes membership services revenue 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. For the three months ended June 30, 2000
and 1999, membership services revenue totaled $212.9 million and $127.9 million.
The increase reflects the overall increase in the Company's customer base and
increased sales of membership products to existing customers. For the six months
ended June 30, 2000 and 1999, membership services revenue totaled $410.1 million
and $221.8 million.
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 or the estimated
life of the loans for home loans, unless the loans are securitized, in which
case
18
<PAGE>
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 June
30, 2000 and 1999, the Company amortized loan origination costs of $7.7 million
and $15.4 million. For the three months ended June 30, 2000 and 1999, total loan
solicitation costs, including amortized loan origination costs, were $119.0
million and $102.2 million. The increase in loan solicitation costs reflects new
marketing initiatives, including television and Internet advertising campaigns.
For the six months ended June 30, 2000 and 1999, total loan solicitation costs,
including amortized loan origination costs, were $231.1 million and $201.7
million.
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 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 six months ended June 30, 2000 and 1999:
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months Ended June 30
---------------------------------------------------------------------
(dollars in thousands) 2000 1999 2000 1999
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Non-interest expense
Salaries and employee benefits $ 173,335 $ 121,784 $ 348,315 $ 217,771
Solicitation and advertising 119,020 102,231 231,142 201,678
Occupancy, furniture, and equipment 32,798 18,877 63,397 34,181
Data processing and communication 44,690 29,852 85,308 54,614
Other/(1)/ 412,448 105,096 553,200 186,702
---------------------------------------------------------------------
Total $ 782,291 $ 377,840 $ 1,281,362 $ 694,946
=====================================================================
</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 $41.9 million and $84.6
million for the three months ended June 30, 2000 and 1999. The Company's
effective tax rate was 40.0% for the three months ended June 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
19
<PAGE>
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 more 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. Home loans
are reviewed when a loss of all or part of the principal balance of the loan is
anticipated, and an allowance for credit losses is established in the amount by
which the book value of the loan exceeds the estimated net realizable value of
the underlying collateral. Anticipated losses on home loans are charged off no
later than 180 days after payments on such loans become delinquent. At the time
a loan is charged off, accrued but unpaid finance charge and fee 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.
Delinquencies
The following table presents the delinquency trends of the Company's
reported and managed consumer loan portfolios as of June 30, 2000 and 1999. 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
6.48% as of June 30, 2000 from 5.66% as of December 31, 1999 and 4.70% as of
June 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.
20
<PAGE>
<TABLE>
<CAPTION>
June 30
-------------------------------------------------------------------------
2000 1999
---------------------------------- ----------------------------------
% of % of
Total Total
(dollars in thousands) Loans Loans Loans Loans
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Reported:
Loans outstanding $ 12,556,680 100.00% $ 8,164,979 100.00%
Loans delinquent:
30 - 59 days 306,531 2.44% 158,234 1.94%
60 - 89 days 245,144 1.95% 101,321 1.24%
90 or more days 473,251 3.77% 186,591 2.28%
------------- ---------- ------------- ---------
Total $ 1,024,926 8.16% $ 446,146 5.46%
============= ========== ============= =========
Managed:
Loans outstanding $ 22,301,724 100.00% $ 16,239,935 100.00%
Loans delinquent:
30 - 59 days 452,653 2.03% 276,929 1.71%
60 - 89 days 340,635 1.53% 171,009 1.05%
90 or more days 651,608 2.92% 314,772 1.94%
------------- ---------- ------------- ---------
Total $ 1,444,896 6.48% $ 762,710 4.70%
============= ========== ============= =========
</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 membership product sales. The principal amounts
of such losses exclude accrued finance charge and other fee income, which is
charged against the related income at the time of credit loss recognition.
Losses for cardholder accounts related to fraudulent activity are included in
other non-interest expense.
The annualized managed net credit loss rate increased to 7.42% for the
three months ended June 30, 2000, compared to 7.16% 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
portfolios 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 second half 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.
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:
21
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
-------------------------------- --------------------------------
(dollars in thousands) 2000 1999 2000 1999
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Reported:
Average loans outstanding $ 12,653,981 $ 7,785,664 $ 12,425,208 $ 7,038,259
Net credit losses $ 247,371 $ 127,653 $ 476,590 $ 227,626
Net credit losses as a percentage
of average loans outstanding 7.82% 6.56% 7.67% 6.47%
Managed:
Average loans outstanding $ 22,603,662 $ 15,327,726 $ 22,092,021 $ 14,560,624
Net credit losses $ 419,527 $ 274,436 $ 806,794 $ 537,195
Net credit losses as a percentage
of average loans outstanding 7.42% 7.16% 7.30% 7.38%
</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 and home loan 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. Home
loans that are 90 or more days past due are also evaluated individually for
collectibility in order to establish an allowance for credit losses. Loan
portfolios are grouped into credit card and home loan 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.
The following table sets forth the activity in the allowance for credit
losses for the three and six months ended June 30, 2000 and 1999:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
-------------------------------- --------------------------------
(dollars in thousands) 2000 1999 2000 1999
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at beginning of period $ 1,160,360 $ 547,655 $ 1,028,377 $ 451,245
Provision for credit losses 373,590 255,222 734,803 437,295
Reserve acquired / Other (22,617) - (22,617) 14,310
Foreign currency translation (166) - (177) -
Credit losses (274,379) (150,282) (529,461) (265,788)
Recoveries 27,008 22,629 52,871 38,162
------------- ----------- ------------- -----------
Net credit losses (247,371) (127,653) (476,590) (227,626)
------------- ----------- ------------- -----------
Balance at end of period $ 1,263,796 $ 675,224 $ 1,263,796 $ 675,224
============= =========== ============= ===========
Allowance for credit losses to loans at period-end 10.06% 8.27%
</TABLE>
22
<PAGE>
The allowance for credit losses increased to $1.26 billion, or 10.06% of
reported loans, as of June 30, 2000, from $1.03 billion, or 8.86% of reported
loans, as of December 31, 1999 and $675.2 million, or 8.27% of reported loans,
as of June 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 issuance 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.
The following table summarizes the contractual maturities of deposits at
the Company as of June 30, 2000 and December 31, 1999:
<TABLE>
<CAPTION>
June 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 $ 882,567 $ 204,464 $ 1,087,031 $ 675,158 $ 271,852 $ 947,010
Over three months through 12 months 2,118,942 3,023,820 5,142,762 2,080,048 2,084,568 4,164,616
Over one year through five years 2,024,297 3,401,706 5,426,003 1,426,006 2,609,582 4,035,588
Over five years - 561,472 561,472 - 330,000 330,000
Deposits without contractual maturity 917,607 37,865 955,472 999,753 61,156 1,060,909
--------------------------------------------- -------------------------------------------
Total Deposits $5,943,413 $ 7,229,327 $ 13,172,740 $5,180,965 $5,357,158 $10,538,123
============================================= ===========================================
</TABLE>
Deposits increased to $13.2 billion as of June 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.
23
<PAGE>
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 generally 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 $3.1 billion as of June 30, 2000.
During the first six months of 2000, the Company completed two term
securitizations totaling approximately $1.4 billion.
The Company's term securitizations are expected to amortize over the
periods indicated below, based on currently outstanding securitized loans as of
June 30, 2000:
Amount
Amortizing
Year (dollars in millions)
----------------------------------------------------------------
2000 $ 79
2001 1,129
2002 1,714
2003 1,604
2004 1,454
2005 411
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 in the aggregate principal amount of up to $4.0 billion, with
maturities ranging from seven days to 15 years.
The following table shows the Company's unsecured funding availability and
outstandings as of June 30, 2000:
<TABLE>
<CAPTION>
June 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 $ 4,000,000 $ 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 2,000,000 -- --
Capital Securities 2/97 160,000 160,000 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.
24
<PAGE>
(2) Includes availability to issue up to $500 million of subordinated bank
notes, none outstanding as of June 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
June 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 $2,504.1 million as of June 30, 2000 from $581.5 million as of December 31,
1999, due to steps taken to enhance the Company's liquidity position, funding
opportunistically at attractive rates in the deposit market. Federal funds sold
and securities purchased under resale agreements decreased to $1.2 billion as of
June 30, 2000 from $1.3 billion 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 six 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 six 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 June
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.
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":
Well Adequately
Capitalized Capitalized
Capital Ratio Calculation Ratios Ratios
--------------------------------------------------------------------------------
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%
* Greater than or equal to
+ Less than
25
<PAGE>
At June 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 10.25% 15.40%
Tier 1 8.89% 14.10%
Leverage 9.68% 5.65%
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.
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 June 30, 2000 and takes into
consideration the Company's current hedging activity:
June 30, 2000 (1)
------------------------------
Change in Interest Rates Percentage Change In
------------------------------
(in basis points) NII (2) MVPE (3)
--------------------------------------------------------------------------------
+200 (0.9)% (8.6)%
Flat 0% 0%
-200 1.0% 10.1%
(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 off-balance
sheet transactions.
26
<PAGE>
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.
The Company does not trade in derivatives or use derivatives to
speculate on interest 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 Six Months Ended
June 30 June 30
--------------------------------------- ---------------------------------------
(dollars in thousands) 2000 1999 2000 1999
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Swap agreements:
Beginning Balance $ 1,150,476 $ 635,500 $ 1,050,476 $ 635,500
Additions 132,500 15,000 232,500 15,000
Maturities 10,000 15,000 10,000 15,000
----------------- ----------------- ----------------- -----------------
Ending Balance $ 1,272,976 $ 635,500 $ 1,272,976 $ 635,500
================= ================= ================= =================
Interest rate caps:
Beginning Balance $ 642,927 $ 669,099 $ 644,878 $ 670,960
Additions 114,226 12,250 210,976 62,250
Maturities 115,708 33,640 214,409 85,501
----------------- ----------------- ----------------- -----------------
Ending Balance $ 641,445 $ 647,709 $ 641,445 $ 647,709
================= ================= ================= =================
</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.
27
<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 agreed to
make certain changes to the Bank's business practices and to pay restitution to
customers determined in accordance with the procedures in the settlement
agreement, which the Company estimates will be approximately $300 million, and
which is subject to a floor of $300 million. 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 stipulated to the entry of a judgment against it 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, and seeks unspecified damages, including actual and punitive
damages, attorney's 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.
As of August 10, 2000, three other 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 August 10, 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
28
<PAGE>
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.
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. 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
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
actions 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 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.
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 4. Submission of Matters to a Vote of Security holders.
(a) The 2000 Annual Meeting of Stockholders was held on May 10, 2000.
(b) The following directors were elected at such meeting:
Shailesh J. Mehta
F. Warren McFarlan
Larry D. Thompson
The following directors continued their term of office after such meeting:
29
<PAGE>
Christina L. Darwall James V. Elliott
Ruth M. Owades Lyle Everingham
John L. Weinberg J. David Grissom
(c) The following matters were voted upon at such meeting:
Election of Directors Votes For Votes Withheld
--------------------- --------- --------------
Shailesh J. Mehta 123,511,742 1,180,025
F. Warren McFarlan 123,529,813 1,161,954
Larry D. Thompson 112,425,997 12,265,770
<TABLE>
<CAPTION>
Item Votes For Votes Against Abstain Broker Nonvotes
---- --------- ------------- ------- ---------------
<S> <C> <C> <C> <C>
Approval of the 68,668,600 34,227,429 566,233 21,229,505
combination of the
Company's 1997 Stock
Option Plan and Stock
Ownership Plan as the
Amended and Restated 2000
Stock Incentive Plan
<CAPTION>
Item Votes For Votes Against Abstain
---- --------- ------------- -------
<S> <C> <C> <C>
Approval of the material 118,100,834 5,955,745 635,188
terms of the Amended and
Restated 2000 Management
Incentive Plan
Ratification of the 124,250,738 66,902 374,127
selection of Ernst & Young
LLP as independent
auditors of the Company
for 1999
</TABLE>
There were no broker non-votes with respect to the election of directors,
the approval of the material terms of the Amended and Restated 2000
Management Incentive Plan, or the ratification of the selection of Ernst &
Young LLP as the Company's independent auditors.
No other matter was voted upon at such meeting.
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.
30
<PAGE>
Exhibit 27.1 Financial Data Schedule.
Exhibit 99.1 Office of the Comptroller of the Currency Consent Order and
Stipulation and Consent to the Issuance of a Consent Order,
each dated June 28, 2000 (In the Matter of Providian
National Bank, Tilton, New Hampshire)
Exhibit 99.2 Stipulated Final Judgment and Permanent Injunction and
Stipulation for Entry of Final Judgement and Permanent
Injunction (The People of the State of California vs.
Providian Financial Corporation, et al.), each dated June
28, 2000.
(b) Reports on Form 8-K.
The Company filed a report on Form 8-K on June 20, 2000, attaching its
press release dated June 20, 2000, revising its earnings guidance in light
of recent legal developments.
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.
(e) Ratio of Earnings to Fixed Charges and Ratio of Earnings to Combined Fixed
Charges and Preferred Stock Dividend Requirements.
<TABLE>
<CAPTION>
Six Months
Ended Year Ended December 31
June 30 ---------------------------------------------------------
(dollars in thousands) 2000 1999 1998 1997 1996 1995
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
EARNINGS TO FIXED CHARGES:
Excluding interest on deposits 9.99 9.83 10.88 14.20 5.93 4.90
Including interest on deposits 1.92 2.99 2.93 2.66 2.34 2.34
EARNINGS TO COMBINED FIXED CHARGES AND
PREFERRED STOCK: (1)
Excluding interest on deposits 9.99 9.83 10.88 13.28 5.19 4.32
Including interest on deposits 1.92 2.99 2.93 2.63 2.25 2.24
</TABLE>
(1) Preferred stock dividend requirements are adjusted to represent a pretax
earnings equivalent.
31
<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: August 14, 2000 /s/ David J. Petrini
--------------------
David J. Petrini
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer and Duly
Authorized Signatory)
Date: August 14, 2000 /s/ Daniel Sanford
------------------
Daniel Sanford
Senior Vice President and Controller
(Chief Accounting Officer and Duly
Authorized Signatory)
32
<PAGE>
EXHIBIT INDEX
Exhibit No.
-----------
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
Exhibit 99.1 Office of the Comptroller of the Currency Consent Order and
Stipulation and Consent to the Issuance of a Consent Order,
each dated June 28, 2000 (In the Matter of Providian
National Bank, Tilton, New Hampshire)
Exhibit 99.2 Stipulated Final Judgment and Permanent Injunction and
Stipulation for Entry of Final Judgement and Permanent
Injunction (The People of the State of California vs.
Providian Financial Corporation, et al.), each dated June
28, 2000.
33
