** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington D.C.  20549**

 

**FORM 10-Q**

 

**(Mark One)**
| **ý**                                                                                                                                                                                        | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                              |
| **For the quarterly period ended June 30,  2005**                                                                                                                                            |
|                                                                                                                                                                                              |
| **OR**                                                                                                                                                                                            |
|                                                                                                                                                                                              |
| **o**                                                                                                                                                                                             | ** ** | **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)

 

**PROVIDIANFINANCIAL CORPORATION**

(Exact Name of Registrant as Specified in ItsCharter)
| **Delaware**                                                    | **94-2933952**                        |
|-----------------------------------------------------------------|---------------------------------------|
| (State or other Jurisdiction of  Incorporation or Organization) | (I.R.S. Employer  Identification No.) |

 

**201 Mission Street, San Francisco, California94105**(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 reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes  ý     No  o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).

 

Yes  ý     No  o

 

As of July 31, 2005, there were 294,793,109 shares of the registrant’sCommon Stock, par value $0.01 per share, outstanding.

 

 

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**PROVIDIAN FINANCIAL CORPORATIONFORM 10-Q**

 

**INDEX**

**June 30, 2005**
| **PART I.**       | **FINANCIAL INFORMATION** | ** **                                                                                  |
|-------------------|---------------------------|---------------------------------------------------------------------------------------------|
| ** **        | ** **                | ** **                                                                                  | ** ** |
| ** **        | **Item 1.**               | Financial Statements (unaudited):                                                           |   |
|              |                      | Consolidated Statements of Financial Condition                                              |   |
|              |                      | Consolidated Statements of Income                                                           |   |
|              |                      | Consolidated Statements of Changes in Shareholders’ Equity                             |   |
|              |                      | Consolidated Statements of Cash Flows                                                       |   |
|              |                      | Notes to Consolidated Financial Statements                                                  |   |
|              |                      |                                                                                        |   |
| ** **        | **Item 2.**               | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
|              |                      |                                                                                        |   |
| ** **        | **Item 3.**               | Quantitative and Qualitative Disclosures  About Market Risk                                 |   |
|              |                      |                                                                                        |   |
| ** **        | **Item 4.**               | Controls and Procedures                                                                     |   |
|              |                      |                                                                                        |   |
| **PART  II.**     | **OTHER  INFORMATION**    | ** **                                                                                  |
|              |                      |                                                                                        |   |
| ** **        | **Item  1.**              | Legal Proceedings                                                                           |   |
|              |                      |                                                                                        |   |
| ** **        | **Item 2.**               | Unregistered Sales of Equity Securities and  Use of Proceeds                                |   |
|              |                      |                                                                                        |   |
| ** **        | **Item 6.**               | Exhibits                                                                                    |   |
|              |                      |                                                                                        |   |
| **SIGNATURES**    |                      |                                                                                        |
|              |                      |                                                                                        |   |
| **EXHIBIT INDEX** |                      |                                                                                        |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**Providian Financial Corporation andSubsidiaries****ConsolidatedStatements of Financial Condition**

 
| **(dollars in thousands, except per share data)**                                                                                                                              | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                     | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| Assets                                                                                                                                                                         |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                                      |       | $                       | 208,406    |                        | $          | 272,397 |   |
| Federal funds sold and securities purchased  under resale agreements                                                                                                           |       | 1,297,965               |       | 440,351                     |       |
| Investment securities:                                                                                                                                                         |       |                    |       |                        |       |
| Available-for-sale, at market value  (amortized cost of $3,414,517 at June 30, 2005 and $4,083,634 at December 31, 2004)                                             |       | 3,405,749               |       | 4,072,695                   |       |
| Loans receivable                                                                                                                                                               |       | 6,866,451               |       | 7,522,401                   |       |
| Less allowance for credit losses                                                                                                                                               |       | (421,537                | )          | (599,703                    | )          |
| Loans receivable, net                                                                                                                                                          |       | 6,444,914               |       | 6,922,698                   |       |
|                                                                                                                                                                           |       |                    |       |                        |       |
| Due from securitizations                                                                                                                                                       |       | 2,409,731               |       | 2,266,314                   |       |
| Deferred taxes                                                                                                                                                                 | ** ** | **—**              |       | 30,185                      |       |
| Premises and equipment, net                                                                                                                                                    |       | 46,116                  |       | 52,640                      |       |
| Interest receivable                                                                                                                                                            |       | 53,164                  |       | 57,807                      |       |
| Other assets                                                                                                                                                                   |       | 212,982                 |       | 229,452                     |       |
| Total assets                                                                                                                                                                   |       | $                       | 14,079,027 |                        | $          | 14,344,539 |   |
|                                                                                                                                                                           |       |                    |       |                        |       |
| Liabilities                                                                                                                                                                    |       |                    |       |                        |       |
| Deposits:                                                                                                                                                                      |       |                    |       |                        |       |
| Non-interest bearing                                                                                                                                                           |       | $                       | 43,525     |                        | $          | 53,398 |   |
| Interest bearing                                                                                                                                                               |       | 8,761,279               |       | 9,417,606                   |       |
|                                                                                                                                                                           |       | 8,804,804               |       | 9,471,004                   |       |
|                                                                                                                                                                           |       |                    |       |                        |       |
| Short-term borrowings                                                                                                                                                          |       | 343,058                 |       | 342,080                     |       |
| Long-term borrowings                                                                                                                                                           |       | 1,130,623               |       | 1,119,278                   |       |
| Accrued expenses and other liabilities                                                                                                                                         |       | 720,131                 |       | 702,648                     |       |
| Total liabilities                                                                                                                                                              |       | 10,998,616              |       | 11,635,010                  |       |
|                                                                                                                                                                           |       |                    |       |                        |       |
| Shareholders’ Equity                                                                                                                                                      |       |                    |       |                        |       |
| Common stock, par value $0.01 per share  (authorized: 800,000,000 shares; issued: June 30, 2005—295,656,876  shares; December 31, 2004—293,980,878 shares) |       | 2,957                   |       | 2,940                       |       |
| Retained earnings                                                                                                                                                              |       | 3,112,408               |       | 2,735,223                   |       |
| Cumulative other comprehensive income                                                                                                                                          |       | (5,477                  | )          | (6,833                      | )          |
| Common stock held in treasury—at cost (June 30,  2005—921,680 shares; December 31, 2004—479,464 shares)                                               |       | (29,477                 | )          | (21,801                     | )          |
| Total shareholders’ equity                                                                                                                                                |       | 3,080,411               |       | 2,709,529                   |       |
| Total liabilities and shareholders’ equity                                                                                                                                |       | $                       | 14,079,027 |                        | $          | 14,344,539 |   |

 

See Notes to Consolidated Financial Statements.

 

3

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**Providian Financial Corporation andSubsidiariesConsolidated Statements ofIncome**
| ** **                                                               | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(dollars  in thousands, except per share data) (unaudited)**           | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                               | ** ** | ** **                           | ** ** | **As Restated**                    | ** ** | ** ** | ** ** | **As Restated** | ** ** |
| Interest Income                                                          | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans                                                                    |       | $                                    | 231,841    |                               | $          | 209,621 |   | $ | 435,244 |   | $ | 427,521 |   |
| Federal funds sold and securities purchased under resale agreements |       | 3,773                                |       | 1,826                              |       | 6,571 |   | 8,105 |   |
| Other                                                                    |       | 41,312                               |       | 26,962                             |       | 81,812 |   | 48,174 |   |
| Total interest income                                                    |       | 276,926                              |       | 238,409                            |       | 523,627 |   | 483,800 |   |
|                                                                     |       |                                 |       |                               |       |   |   |   |   |
| Interest Expense                                                         |       |                                 |       |                               |       |   |   |   |   |
| Deposits                                                                 |       | 96,415                               |       | 106,746                            |       | 192,304 |   | 221,642 |   |
| Borrowings                                                               |       | 16,407                               |       | 16,257                             |       | 32,887 |   | 35,073 |   |
| Total interest expense                                                   |       | 112,822                              |       | 123,003                            |       | 225,191 |   | 256,715 |   |
|                                                                     |       |                                 |       |                               |       |   |   |   |   |
| Net interest income                                                      |       | 164,104                              |       | 115,406                            |       | 298,436 |   | 227,085 |   |
|                                                                     |       |                                 |       |                               |       |   |   |   |   |
| Provision for credit losses                                              |       | 96,386                               |       | 182,017                            |       | 157,231 |   | 270,869 |   |
|                                                                     |       |                                 |       |                               |       |   |   |   |   |
| Net interest income (loss) after provision  for credit losses            |       | 67,718                               |       | (66,611                            | )          | 141,205 |   | (43,784 | ) |
|                                                                     |       |                                 |       |                               |       |   |   |   |   |
| Non-Interest Income                                                      |       |                                 |       |                               |       |   |   |   |   |
| Servicing and securitization                                             |       | 308,076                              |       | 259,834                            |       | 533,662 |   | 485,925 |   |
| Credit product fee income                                                |       | 129,565                              |       | 137,064                            |       | 254,471 |   | 286,208 |   |
| Other                                                                    |       | 8,530                                |       | 4,360                              |       | 48,850 |   | 15,904 |   |
|                                                                     |       | 446,171                              |       | 401,258                            |       | 836,983 |   | 788,037 |   |
| Non-Interest Expense                                                     |       |                                 |       |                               |       |   |   |   |   |
| Salaries and employee benefits                                           |       | 67,125                               |       | 70,048                             |       | 131,148 |   | 151,528 |   |
| Solicitation and advertising                                             |       | 64,312                               |       | 65,410                             |       | 127,749 |   | 117,981 |   |
| Occupancy, furniture, and equipment                                      |       | 16,724                               |       | 22,026                             |       | 34,223 |   | 48,239 |   |
| Data processing and communication                                        |       | 29,505                               |       | 27,050                             |       | 59,443 |   | 54,098 |   |
| Other                                                                    |       | 46,564                               |       | 74,559                             |       | 132,655 |   | 153,253 |   |
|                                                                     |       | 224,230                              |       | 259,093                            |       | 485,218 |   | 525,099 |   |
| Income before income taxes                                               |       | 289,659                              |       | 75,554                             |       | 492,970 |   | 219,154 |   |
| Income tax expense                                                       |       | 64,348                               |       | 25,640                             |       | 134,638 |   | 75,573 |   |
| Net income                                                               |       | $                                    | 225,311    |                               | $          | 49,914 |   | $ | 358,332 |   | $ | 143,581 |   |
|                                                                     |       |                                 |       |                               |       |   |   |   |   |
| **Earnings per common share—basic**                                 |       | $                                    | 0.77       |                               | $          | 0.17 |   | $ | 1.23 |   | $ | 0.50 |   |
|                                                                     |       |                                 |       |                               |       |   |   |   |   |
| **Earnings per common share—assuming dilution**                     |       | $                                    | 0.67       |                               | $          | 0.16 |   | $ | 1.08 |   | $ | 0.46 |   |
|                                                                     |       |                                 |       |                               |       |   |   |   |   |
| Weighted average common shares  outstanding—basic (000)             |       | 291,381                              |       | 288,355                            |       | 291,291 |   | 288,246 |   |
|                                                                     |       |                                 |       |                               |       |   |   |   |   |
| Weighted average common shares  outstanding—assuming dilution (000) |       | 346,467                              |       | 332,647                            |       | 346,310 |   | 325,230 |   |

 

See Notes to Consolidated Financial Statements.

 

4

----

 

**Providian Financial Corporation andSubsidiariesConsolidated Statementsof Changes in Shareholders’ Equity**
| **(dollars in thousands) (unaudited)**                                                                   | ** ** | **Common Stock** | ** ** | **Additional Paid-In Capital** | ** ** | **Retained Earnings** | ** ** | **Cumulative Other Comprehensive Income** | ** **    | **Common Stock Held in Treasury** | ** ** | **Total**   | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------------|------------|--------------------------------|------------|-----------------------|------------|-------------------------------------------|---------------|-----------------------------------|------------|-------------|------------|
| ** **                                                                                               | ** ** | ** **       | ** ** | ** **                     | ** ** | ** **            | ** ** | ** **                                | ** **    | ** **                        | ** ** | ** **  | ** ** |
| **Balance at December 31, 2003 (See Note 4)**                                             | ** ** | **$**            | **2,908**  | ** **                     | **$**      | **—**            | ** ** | **$**                                     | **2,321,414** | ** **                        | **$**      | **(12,480** | **)**      | **$** | **(15,425** | **)** | **$** | **2,296,417** | ** ** |
| Comprehensive income:                                                                                    |       |             |       |                           |       |                  |       |                                      |          |                              |       |        |       |
| Net income, as restated                                                                                  |       |             |       |                           |       | 143,581               |       |                                      |          |                              |       | 143,581     |       |
| Change in unrealized gain (loss) on  securities, net of income tax benefit of $5,749                     |       |             |       |                           |       |                  |       | (8,806                                    | )             |                              |       | (8,806      | )          |
| Total comprehensive income, as restated                                                                  |       |             |       |                           |       |                  |       |                                      |          |                              |       | 134,775     |       |
|                                                                                                     |       |             |       |                           |       |                  |       |                                      |          |                              |       |        |       |
| Purchase of 52,244 common shares for  treasury                                                           |       |             |       |                           |       |                  |       |                                      |          | (663                              | )          | (663        | )          |
| Exercise of stock options and other awards                                                               |       | 7                |       | (5,611                         | )          | 8,590                 |       |                                      |          | 3,161                             |       | 6,147       |       |
| Issuance of restricted and unrestricted  stock less forfeited shares                                     |       | 6                |       | 7,775                          |       |                  |       |                                      |          | (90                               | )          | 7,691       |       |
| Deferred compensation related to grant of  restricted and unrestricted stock less amortization of $3,856 |       |             |       | (3,835                         | )          |                  |       |                                      |          |                              |       | (3,835      | )          |
| Net tax effect from employee stock plans                                                                 |       |             |       | 1,671                          |       |                  |       |                                      |          |                              |       | 1,671       |       |
| **Balance at June 30, 2004, as restated**                                                           | ** ** | **$**            | **2,921**  | ** **                     | **$**      | **—**            | ** ** | **$**                                     | **2,473,585** | ** **                        | **$**      | **(21,286** | **)**      | **$** | **(13,017** | **)** | **$** | **2,442,203** | ** ** |
|                                                                                                     |       |             |       |                           |       |                  |       |                                      |          |                              |       |        |       |
| **Balance at December 31, 2004**                                                                    | ** ** | **$**            | **2,940**  | ** **                     | **$**      | **—**            | ** ** | **$**                                     | **2,735,223** | ** **                        | **$**      | **(6,833**  | **)**      | **$** | **(21,801** | **)** | **$** | **2,709,529** | ** ** |
| Comprehensive income:                                                                                    |       |             |       |                           |       |                  |       |                                      |          |                              |       |        |       |
| Net income                                                                                               |       |             |       |                           |       | 358,332               |       |                                      |          |                              |       | 358,332     |       |
| Change in unrealized gain (loss) on  securities, net of income tax expense of $815                       |       |             |       |                           |       |                  |       | 1,356                                     |          |                              |       | 1,356       |       |
| Total comprehensive income                                                                               |       |             |       |                           |       |                  |       |                                      |          |                              |       | 359,688     |       |
|                                                                                                     |       |             |       |                           |       |                  |       |                                      |          |                              |       |        |       |
| Purchase of 503,591 common shares for treasury                                                      |       |             |       |                           |       |                  |       |                                      |          | (8,627                            | )          | (8,627      | )          |
| Exercise of stock options and other awards  and conversion of convertible senior notes                   |       | 11               |       | (8,905                         | )          | 18,853                |       |                                      |          |                              |       | 9,959       |       |
| Issuance of restricted and unrestricted  stock less forfeited shares                                     |       | 6                |       | 8,368                          |       |                  |       |                                      |          | 951                               |       | 9,325       |       |
| Deferred compensation related to grant of  restricted and unrestricted stock less amortization of $5,895 |       |             |       | (3,429                         | )          |                  |       |                                      |          |                              |       | (3,429      | )          |
| Net tax effect from employee stock plans                                                                 |       |             |       | 3,966                          |       |                  |       |                                      |          |                              |       | 3,966       |       |
| **Balance at June 30, 2005**                                                                        | ** ** | **$**            | **2,957**  | ** **                     | **$**      | **—**            | ** ** | **$**                                     | **3,112,408** | ** **                        | **$**      | **(5,477**  | **)**      | **$** | **(29,477** | **)** | **$** | **3,080,411** | ** ** |

 

See Notes to Consolidated Financial Statements.

 

5

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**Providian Financial Corporation andSubsidiaries****ConsolidatedStatements of Cash Flows**

 
| ** **                                                                                                          | ** ** | **Six months ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(dollars in thousands)  (unaudited)**                                                                             | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| ** **                                                                                                          | ** ** | ** **                         | ** ** | **As  Restated** | ** ** |
| **Operating  Activities**                                                                                           |       |                               |       |   |   |
| Net income                                                                                                          |       | $                                  | 358,332    |   | $ | 143,581 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:                                  |       |                               |       |   |   |
| Provision for credit losses                                                                                         |       | 157,231                            |       | 270,869 |   |
| Depreciation and amortization of premises  and equipment                                                            |       | 9,374                              |       | 19,267 |   |
| Amortization of net loan acquisition costs                                                                          |       | 12,672                             |       | 10,640 |   |
| Amortization of prepaid broker fees                                                                                 |       | 11,933                             |       | 14,452 |   |
| Amortization of deferred compensation  related to restricted and unrestricted stock                                 |       | 5,895                              |       | 3,856 |   |
| Decrease in deferred income tax benefit                                                                             |       | 33,542                             |       | 68,327 |   |
| Increase in deferred income tax liability                                                                           |       | 78,102                             |       | — |   |
| Decrease (increase) in interest receivable                                                                          |       | 4,643                              |       | (6,617 | ) |
| Gain on sale of higher risk loan portfolio                                                                          |       | (36,846                            | )          | — |   |
| Net decrease in other assets                                                                                        |       | 3,798                              |       | 11,360 |   |
| Net (decrease) increase in accrued expenses  and other liabilities                                                  |       | (61,317                            | )          | 63,918 |   |
| Net cash provided by operating activities                                                                           |       | 577,359                            |       | 599,653 |   |
|                                                                                                                |       |                               |       |   |   |
| **Investing  Activities**                                                                                           |       |                               |       |   |   |
| Net cash used for loan originations and  principal collections on loans receivable                                  |       | (562,678                           | )          | (636,581 | ) |
| Net increase (decrease) in securitized  loans                                                                       |       | 614,184                            |       | (262,234 | ) |
| Net proceeds from sale of higher risk loan  portfolio                                                               |       | 305,893                            |       | — |   |
| Increase in due from securitizations                                                                                |       | (143,417                           | )          | (2,616 | ) |
| Purchases of available-for-sale investment  securities                                                              |       | (4,834,108                         | )          | (5,790,600 | ) |
| Proceeds from maturities and sales of  available-for-sale investment securities                                     |       | 5,499,053                          |       | 4,386,238 |   |
| (Increase) decrease in federal funds sold  and securities purchased under resale agreements or similar arrangements |       | (857,614                           | )          | 2,681,190 |   |
| Net purchases of premises and equipment                                                                             |       | (2,850                             | )          | (1,751 | ) |
| Net cash provided by investing activities                                                                           |       | 18,463                             |       | 373,646 |   |
|                                                                                                                |       |                               |       |   |   |
| **Financing  Activities**                                                                                           |       |                               |       |   |   |
| Net decrease in deposits                                                                                            |       | (670,266                           | )          | (1,102,612 | ) |
| Repayment of short-term borrowings                                                                                  |       | —                             |       | (108,828 | ) |
| Proceeds from and accretion on long-term  borrowings                                                                |       | 9,121                              |       | 278,020 |   |
| Purchase of treasury stock                                                                                          |       | (8,627                             | )          | (663 | ) |
| Proceeds from exercise of stock options and  conversion of convertible senior notes                                 |       | 9,959                              |       | 6,147 |   |
| Net cash used by financing activities                                                                               |       | (659,813                           | )          | (927,936 | ) |
|                                                                                                                |       |                               |       |   |   |
| **Net  (Decrease) Increase in Cash and Cash Equivalents**                                                           |       | (63,991                            | )          | 45,363 |   |
| Cash and  cash equivalents at beginning of period                                                                   |       | 272,397                            |       | 544,554 |   |
| Cash and  cash equivalents at end of period                                                                         |       | $                                  | 208,406    |   | $ | 589,917 |   |

 

See Notes to Consolidated Financial Statements.

 

6

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**Providian Financial Corporation andSubsidiaries****Notes toConsolidated Financial Statements****June 30, 2005 (unaudited)**

 

**Note 1.  Organization and Basis of Presentation**

 

Providian Financial Corporation (the “Company”) is acorporation incorporated under the laws of Delaware. Through its wholly ownedbanking subsidiary, Providian National Bank (“PNB”), the Company offers creditcard and deposit products throughout the United States. The Company marketsconsumer loans and deposits using distribution channels such as mail,telephone, and the Internet.

 

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United States (“GAAP”)for interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, the Company does notinclude all of the information and footnotes required by GAAP forcomplete consolidated financial statements. The unaudited consolidatedfinancial statements for the three and six months ended June 30, 2004 havebeen restated. All information in the notes to the consolidated financialstatements affected by the restatement give effect to the restatement. See Note 4to Consolidated Financial Statements, “Restatement of Prior Periods Presented.”In the opinion of management, all adjustments considered necessary for a fairpresentation of the results for the interim periods presented have beenincluded. All such adjustments are of a normal, recurring nature. Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect reported amounts in the financialstatements and accompanying notes. These estimates are based on informationavailable as of the date of the consolidated financial statements. Actualresults could differ from those estimates. Operating results for the three andsix months ended June 30, 2005 are not necessarily indicative of theresults for the year ending December 31, 2005. The notes to the consolidatedfinancial statements contained in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004 should be read in conjunction withthese consolidated financial statements. All significant intercompany balancesand transactions have been eliminated in consolidation. For purposes of comparability, certain prior periodamounts have been reclassified.

 

**Note 2.  Pending Merger**

 

On June 6,2005, the Company announced that it had entered into an agreement to merge withWashington Mutual, Inc., in a stock and cash transaction valued atapproximately $6.45 billion. In the proposed merger, the Company wouldmerge with and into Washington Mutual, with Washington Mutual continuing as thesurviving corporation. Washington Mutual is a retailer of financial servicesthat provides a diversified line of products and services to consumers andcommercial clients and currently operates more than 2,400 retail banking,mortgage lending, commercial banking and financial services offices throughoutthe nation.

 

Subject to theterms and conditions of the merger agreement, shareholders of the Company willreceive consideration based on a fixed exchange ratio of 0.45 Washington Mutualcommon shares (the “Exchange Ratio”) for each Providian common share. The mergerconsideration will be paid 89 percent in stock and 11 percent in cash. Thestock consideration will be determined by multiplying the Exchange Ratio by0.89, and the cash consideration will be determined by multiplying the ExchangeRatio by the product of 0.11 and the average closing price of Washington Mutualcommon stock for the 10 trading days immediately preceding completion of themerger.

 

The merger isexpected to be completed in the fourth quarter of 2005 and is subject toapproval by the Company’s shareholders and regulatory approvals. Shareholdersof record as of August 1, 2005 will be eligible to vote on the Company’sproposed merger with Washington Mutual at a special meeting of shareholderscalled for that purpose, scheduled to occur on August 31, 2005.

 

In connectionwith the proposed merger transaction, Washington Mutual has filed aregistration statement on Form S-4 with the Securities and Exchange Commission(“SEC”) containing the definitive proxy statement/prospectus for theshareholders of Providian.

 

**Note 3.  Stock-BasedEmployee Compensation**

 

The Company has elected toaccount for its stock-based employee compensation plans in accordance withAccounting Principles Board Opinion No. 25, “Accounting for Stock Issued toEmployees” (“APB Opinion No. 25”), and related interpretations, as permitted byStatement of Financial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation” (“SFAS No. 123”). Because the exercise price of the Company’semployee stock options is the fair market value of the underlying stock on thegrant date, the Company recognizes no compensation expense at the time of thegrant. For grants of restricted shares of common stock, the market value of therestricted shares at the grant date is amortized over the vesting period andclassified as non-interest expense. For grants of unrestricted shares of commonstock, the market value of the unrestricted shares at the grant date isrecognized in the period the shares are granted and classified as non-interest 

 

7

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expense. The Company does not recognizecompensation expense related to its employee stock purchase plan (the “ESPP”),because the plan qualifies as a non-compensatory plan under APB Opinion No. 25.

 

Thefollowing table reflects, for the three and six months ended June 30, 2005and 2004, the stock-based employee compensation costs arising out of therestricted and unrestricted stock grants that are included in reported netincome. It also reflects on a pro forma basis the Company’s net income andearnings per common share with and without dilution, as if compensation costsfor stock options (including rights to purchase common stock under the ESPP foroffering periods beginning prior to January 1, 2005) had been recorded based ontheir fair value at the grant date under the Company’s stock-based employeecompensation plans, consistent with the provisions of SFAS No. 123. The proforma compensation expense reflects the fair value of the stock optionsamortized to expense over the vesting period of the grant, which is generallythree years.

 

EffectiveJanuary 1, 2005, the Company modified the terms of its offerings under theESPP, so that the duration of each offering period is six months and thepurchase price of the common stock is 95% of the fair market value of the stockon the last day of the offering period. As a result of these changes, therights to purchase common stock under the ESPP for offering periods beginningon or after January 1, 2005 are not required to be, and have not been, includedin the pro forma compensation expense calculation. Prior to these changes, eachESPP offering period had a duration of 12 months, and the purchase priceof the common stock was the lesser of 85% of the fair market value of the stockon the first day of the offering period and 85% of the fair market value of thestock on the last day of the offering period.

 

**Stock-BasedEmployee Compensation Cost and****Pro Forma Net Income and Earnings Per Common Share**
| ** **                                                                                                       | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(dollars in thousands, except per share data)**                                                                | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                       | ** ** | ** **                           | ** ** | **As Restated**                    | ** ** | ** ** | ** ** | **As Restated** | ** ** |
| ** **                                                                                                       | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Restricted and unrestricted stock  amortization, net-of-taxes, included in net income, as reported(1)       |       | $                                    | 1,848      |                               | $          | 1,280 |   | $ | 3,682 |   | $ | 2,333 |   |
| Net income, as reported                                                                                          |       | 225,311                              |       | 49,914                             |       | 358,332 |   | 143,581 |   |
| Deduct: Pro forma stock-based employee  compensation expense determined under fair value method, net-of-taxes(2) |       | 3,117                                |       | 3,974                              |       | 6,604 |   | 9,294 |   |
| Pro forma net income(1)                                                                                          |       | $                                    | 222,194    |                               | $          | 45,940 |   | $ | 351,728 |   | $ | 134,287 |   |
| Net income per common share:                                                                                     |       |                                 |       |                               |       |   |   |   |   |
| As reported—basic                                                                                           |       | $                                    | 0.77       |                               | $          | 0.17 |   | $ | 1.23 |   | $ | 0.50 |   |
| As reported—assuming dilution(3)                                                                            |       | $                                    | 0.67       |                               | $          | 0.16 |   | $ | 1.08 |   | $ | 0.46 |   |
| Net income per common share:                                                                                     |       |                                 |       |                               |       |   |   |   |   |
| Pro forma—basic                                                                                             |       | $                                    | 0.76       |                               | $          | 0.16 |   | $ | 1.21 |   | $ | 0.47 |   |
| Pro forma—assuming dilution(3)                                                                              |       | $                                    | 0.66       |                               | $          | 0.15 |   | $ | 1.06 |   | $ | 0.43 |   |

 

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| (1) | The Company uses the straight-line method for recognizing  compensation cost for fixed awards with pro rata vesting.                                                                                                                                                         |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | The pro forma stock-based employee compensation expenses include the  effects of an expense reduction for unvested stock options that have been  forfeited.                                                                                                                  |
| (3) | Amounts reflect the effect of adopting EITF Issue No. 04-8, “The  Effect of Contingently Convertible Instruments on Diluted Earnings per Share”  (“EITF 04-8”) in the third quarter of 2004. See Note 17 to  Consolidated Financial Statements |

 

Thefair values of the stock options granted under the Company’s stock incentiveplans and, for offering periods beginning prior to January 1, 2005, the rightsto purchase common stock under the ESPP have been estimated at the grant dateor purchase date using the Black-Scholes option pricing model. TheBlack-Scholes option pricing model was developed for use in estimating the fairvalue of traded options, which, unlike employee stock options, have no vestingrestrictions, are fully transferable, and generally have shorter terms. TheBlack-Scholes option pricing model requires the use of assumptions, includingestimates with respect to the risk-free interest rate, expected dividend yield,expected stock option life, and expected price volatility of the underlyingstock. Because the Company’s employee stock-based awards have characteristicssignificantly different from those of traded options, and because changes inthe assumptions used can materially affect their valuation, the valuationsderived under the Black-Scholes option pricing model are only estimates of fairvalue and are not intended to predict values ultimately realized by theemployees who received the stock-based awards.

 

8

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During the first quarter of2005, the Company refined its methodology for estimating the expectedvolatility assumption used in determining the fair values of its employee stockoptions. Expected volatility represents management’s estimate of expectedfluctuations in the Company’s stock price over the estimated life of the stockoptions. Prior to 2005, the Company estimated expected volatility by takinginto account the expected life of its stock options and the historicalvolatility of its stock price, as adjusted for unusual, Company-specificfluctuations. As a result of the modification in the first quarter of 2005, theCompany now takes into account the expected life of its stock options and bothhistorical and implied volatility (the volatility assumption inherent in themarket prices of a company’s traded options); specifically, the historicalvolatility of the Company’s stock price, as adjusted for unusual,Company-specific fluctuations, and the implied volatility of the stock price,determined from the market prices of the Company’s traded options. The impactof this modification for options granted during the second quarter of 2005 wasto reduce expected volatility from 38% to 22%, which resulted in a lower fairvalue than if the Company’s previous estimation methodology had been used. Thisreduction did not have a material impact on the Company’s pro forma financialresults presented in the table above.

 

Duringthe first quarter of 2005, the Company also updated its expected stock optionlife assumption from 4 years to 4.5 years, based on changes to the estimatedweighted average term between the option grant date and the estimated optionexercise date, and giving consideration to the vesting period of the award andthe effect of employees’ historical exercise and post-vesting employmenttermination behavior. This change in the expected stock option life assumptiondid not have a material impact on the Company’s pro forma financial resultspresented in the table above.

 

**Note 4. Restatement of Prior Periods Presented**

 

In February 2005, theCompany determined that it would restate its consolidated financial statementsfor the years ended December 31, 2000 to December 31, 2003 and eachof the quarters of 2003 and the first three quarters of 2004. The determinationto restate these financial statements was made in connection with the Company’sanalysis and correction of the methodology and assumptions relating to thevaluation of the Company’s interest-only strips. The Company changed itsinterest-only strips valuation methodology and assumptions to correct sucherrors, and the Company’s financial statements for the years ended December 31,2000 to December 31, 2003 and its quarterly financial statements for 2003and the first three quarters of 2004 were restated in its 2004 Annual Report. See Note 3to Consolidated Financial Statements in the Company’s Annual Report on Form10-K for the year ended December 31, 2004.

 

The following table presentsthe effects of the restatement for the correction of these errors on theCompany’s consolidated statements of income for the three and six months ended June 30,2004.

 

**RestatementAdjustments (Unaudited)**

** **

| **(dollars in thousands, except per share data)**                      | ** ** | **Three months ended June 30, 2004** | ** ** | **Six months ended June 30, 2004** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                             | ** ** | ** **                                     | ** ** | ** **                                   | ** ** |
| Interest income—other                                             |       | $                                              | (3,300     | )                                            | $          | (5,567 | ) |
| Net interest income                                                    |       | (3,300                                         | )          | (5,567                                       | )          |
|                                                                   |       |                                           |       |                                         |       |
| Servicing and securitization income                                    |       | (28,382                                        | )          | (39,029                                      | )          |
| Total non-interest income                                              |       | (28,382                                        | )          | (39,029                                      | )          |
|                                                                   |       |                                           |       |                                         |       |
| Net decrease in income from continuing  operations before income taxes |       | (31,682                                        | )          | (44,596                                      | )          |
| Income tax expense                                                     |       | (11,892                                        | )          | (16,739                                      | )          |
|                                                                   |       |                                           |       |                                         |       |
| Net decrease in net income                                             |       | $                                              | (19,790    | )                                            | $          | (27,857 | ) |
|                                                                   |       |                                           |       |                                         |       |
| Net decrease in earnings per common share—basic                   |       | $                                              | (0.07      | )                                            | $          | (0.10 | ) |
|                                                                   |       |                                           |       |                                         |       |
| Net decrease in earnings per common share—assuming  dilution      |       | $                                              | (0.06      | )                                            | $          | (0.08 | ) |
|                                                                   |       |                                           |       |                                         |       |

 

9

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**Note 5.  Recently IssuedAccounting Pronouncements**

 

**Stock-Based Compensation.**   In December 2004, the FinancialAccounting Standards Board (the “FASB”) issued Statement of FinancialAccounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS No.123(R)”), which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.”SFAS No. 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued toEmployees.” Generally, the approach to accounting for stock-based compensationin SFAS No. 123(R) is similar to the approach described in SFAS No. 123.However, SFAS No. 123(R) requires**allcosts related to stock-based compensation to employees, including grants ofemployee stock options, to be recognized in the financial statements based onthe fair value of such compensation, so that pro forma disclosure is no longeran alternative to financial statement recognition. In April 2005, the SECdelayed the compliance date for SFAS No. 123(R) so that the effective date ofSFAS No. 123(R) for the Company is now January 1, 2006. As permitted by SFASNo. 123(R) for companies transitioning to the new standard, the Company intendsto apply the provisions of SFAS No. 123(R) as of January 1, 2006 on a modifiedprospective basis to both new awards and the unvested portions of past awardsbased on their grant date fair values. The Company is in the process ofassessing the impact of the adoption of SFAS No. 123(R).

 

**The Effect of Contingently Convertible Debt on DilutedEarnings per Share.  **In October 2004, the FASB ratified the consensus of the Emerging IssuesTask Force with respect to Issue No. 04-8, “The Effect of ContingentlyConvertible Debt on Diluted Earnings per Share” (“EITF 04-8”), which statesthat contingently convertible debt instruments should be included in dilutedearnings per share computations if dilutive, regardless of whether the marketprice trigger or other contingent conversion features have been met. During thethird quarter of 2004, the Company elected to adopt the provisions of EITF 04-8and included the dilutive effect of its contingently convertible notes in itsdiluted earnings per share calculation from the time of issuance of the notes,in accordance with the if-converted methodology under Statement of FinancialAccounting Standards No. 128, “Earnings per Share” (“SFAS No. 128”), in itsQuarterly Report on Form 10-Q for the quarter ended September 30, 2004. At thesame time, as required by EITF 04-8, the Company restated its diluted earningsper share for prior periods.

 

**Earnings per Share****—an Amendment of FASB StatementNo. 128****.  **In its effort to converge with internationalaccounting standards, the FASB has issued an Exposure Draft, “Earnings perShare—an Amendment of FASB Statement No. 128,” which, if adopted, would requirethat contracts containing an option to settle in cash or stock be assumed tosettle in stock for purposes of calculating diluted earnings per share. TheCompany understands that the FASB plans to issue a final statement on thisproposal during the first quarter of 2006. The Company’s zero couponconvertible senior notes provide such an option to the Company in the eventthat holders of the notes exercise certain rights to require the Company torepurchase their notes. See Note 13 to Consolidated FinancialStatements for further discussion. The Company has the unilateral right toamend the indenture supplement governing the zero coupon notes to eliminate theCompany’s right to settle note repurchases in stock and currently intendsto enter into such an****amendment if the proposal becomes effective.If the proposal in its current form had been in effect in the second quarter of2005, it would have impacted the Company’s diluted earnings per sharecalculation for the six months ended June 30, 2005 by requiring theinclusion of an additional 27,529,968 shares related to these notes, and wouldhave also required that the Company restate its diluted earnings per share forprior periods for purposes of comparability. The impact on diluted earnings pershare would be partially offset by the add-back of related debt interestexpense to net income under the if-converted method. If the proposal becomeseffective, the Company intends to amend the indenture supplement governing thezero coupon notes so that, under the terms of the current Exposure Draft, theCompany would not be required to include the additional shares in its dilutedearnings per share calculation.

 

**Note 6.  Interest and FeeIncome Recognition**

 

Interest on loans is chargedon each customer’s billing cycle date based on the amount of loans outstandingand their contractual annual percentage rates. The Company recognizes only theestimated collectible portion of accrued interest and fees—see discussionregarding its suppression methodology below. Interest income recognized by theCompany that has been billed to the customer is included in loans receivable orin due from securitizations on the Company’s consolidated statements offinancial condition. Accrued interest income recognized by the Company that hasnot yet been billed to the customer is reported in interest receivable or indue from securitizations on the Company’s consolidated statements of financialcondition. The Company estimates the unbilled portion of interest on customeraccounts for the month from the customer’s billing cycle date to the end of themonth. During the first quarter of 2005, the Company refined its interestaccrual estimation process for the unbilled portion of interest on customeraccounts by calculating the daily interest at the account level based onaccount balances segmented by annual percentage rate and billing cycle date.The one-time impact of this change was to reduce, in the first quarter of 2005,reported and managed interest revenue by $4.4 million and $16.6 millionand reported and managed net interest margins by 25 basis points and 37 basispoints.

 

10

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The Company recognizesinterest and fee income using a suppression methodology. Under thesuppression methodology, interest and fees that would otherwise accrue onreported loans and other assets, but that the Company estimates will not becollected (the “suppressed amounts”), are neither recognized as interestincome, credit product fee income, or servicing and securitization income onthe Company’s consolidated statement of income nor included in loansreceivable, interest receivable, or due from securitizations on the Company’sconsolidated statement of financial condition. In addition, interest and feeincome is reduced by the reversal of accrued interest and fees included in loansreceivable, interest receivable, and due from securitizations (to the extentnot previously suppressed) when the principal amount of a loan is charged off.

 

During the first quarter of2005, the Company enhanced the estimation process used in its suppressionmethodology by using portfolio segmentation that gives greater weight tocustomer risk scores and other risk factors, such as Fair Isaac Corporation(FICO®) credit scores. The Company continues to use other historicalquantitative risk factors for its analysis, such as interest and fee reversalrates, delinquency roll rates, payment performance, and loans receivablebalance composition data.  The change in estimation process did not have amaterial impact on the Company’s financial results or condition.  Whenestimating uncollectible interest and fee amounts, the Company may give greateror lesser weight from time to time to these and other factors that it may usein the estimation process.

 

During the three and sixmonths ended June 30, 2005 and 2004, the amount of interest and fees notrecognized as income as a result of the suppression of estimated uncollectibleinterest and fees and interest and fee income reversals was as follows:

 

**Suppression of Interest and Fee Income**

** **

| ** **                           | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(dollars in thousands)**           | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Loan  interest income                |       | $                                    | 16,197     |                               | $          | 20,174 |   | $ | 32,160 |   | $ | 37,410 |   |
| Credit  product fee income           |       | 16,992                               |       | 28,757                             |       | 37,168 |   | 56,360 |   |
| Servicing  and securitization income |       | 89,612                               |       | 103,766                            |       | 185,014 |   | 212,272 |   |
| Total                                |       | $                                    | 122,801    |                               | $          | 152,697 |   | $ | 254,342 |   | $ | 306,042 |   |

** **

**Note 7.  Investment Securities**

 

TheCompany maintains short-term liquidity through federal funds sold andsecurities purchased under resale agreements, available-for-sale investmentsecurities, and cash and cash equivalents.

 

Federalfunds sold totaled $1.30 billion at June 30, 2005 and $440.4 millionat December 31, 2004. There were no securities purchased under resaleagreements outstanding at June 30, 2005 or December 31, 2004.

 

TheCompany’s available-for-sale investment securities portfolio is composed oftreasury obligations, government sponsored agency securities, mortgage-backedsecurities, commercial paper, auction rate securities, and other securitiesconsisting primarily of asset-backed securities. A significant portion of theportfolio is either issued or backed by a government sponsored agency or afully government guaranteed agency. The mortgage-backed securities are in theform of floating rate collateralized mortgage obligations, adjustable ratepass-through securities, or fixed rate pass-through securities. The auctionrate securities are in the form of taxable student loan backed debt securitiesand money market preferred equity securities eligible for dividends receiveddeductions. All of the securities in the portfolio have an investment gradecredit rating, with a large majority having an AAA/Aaa rating. Fluctuations ingeneral market conditions will translate into fluctuations in the price of thesecurities. Reductions in the value of these securities stem from changes inmarket conditions, and not necessarily from any intrinsic value deterioration.The Company has the ability to hold those securities that currently have a losson an ongoing basis until recovery or maturity without any material detrimentto the liquidity of the portfolio. At June 30, 2005, the Company had anunrealized loss of $8.6 million on investments with an amortized cost of$890.0 million that had a continuous unrealized loss position for 12months or more. At December 31, 2004, the Company had an unrealized lossof $2.4 million on investments with an amortized cost of $215.0 millionthat had a continuous unrealized loss position for 12 months or more.

 

11

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** **

**Summary of Available-for-Sale Investment Securities**

 

| ** **                                       | ** ** | **June 30, 2005**     | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|
| **(dollars in thousands)**                       | ** ** | **Amortized Cost**         | ** ** | **Gross Unrealized Gains** | ** ** | **Gross**** Unrealized Losses  Less Than  12 Months** | ** ** | **Gross**** Unrealized  Losses  12 Months  or Longer** | ** ** | **Market**** Value** | ** ** |
| United States Treasury and  federal agency bonds |       | $                          | 970,006    |   | $ | — |   | $ | 1,468 |   | $ | 6,254 |   | $ | 962,284 |   |
| Mortgage-backed securities                       |       | 385,967                    |       | 731 |   | 189 |   | 2,346 |   | 384,163 |   |
| Commercial paper                                 |       | 506,726                    |       | — |   | 491 |   | — |   | 506,235 |   |
| Auction rate securities                          |       | 704,150                    |       | 874 |   | 18 |   | — |   | 705,006 |   |
| Other                                            |       | 847,668                    |       | 872 |   | 478 |   | 1 |   | 848,061 |   |
| Total investment securities  available-for-sale  |       | $                          | 3,414,517  |   | $ | 2,477 |   | $ | 2,644 |   | $ | 8,601 |   | $ | 3,405,749 |   |
|                                             |       |                       |       |   |   |   |   |   |   |   |   |
| ** **                                       | ** ** | **December 31, 2004** | ** ** |
| **(dollars in thousands)**                       | ** ** | **Amortized Cost**         | ** ** | **Gross Unrealized Gains** | ** ** | **Gross**** Unrealized Losses  Less Than  12 Months** | ** ** | **Gross**** Unrealized  Losses  12 Months  or Longer** | ** ** | **Market**** Value** | ** ** |
| United States Treasury and  federal agency bonds |       | $                          | 975,004    |   | $ | — |   | $ | 7,750 |   | $ | — |   | $ | 967,254 |   |
| Mortgage-backed securities                       |       | 444,066                    |       | 1,213 |   | 11 |   | 2,447 |   | 442,821 |   |
| Commercial paper                                 |       | 1,210,152                  |       | — |   | 1,815 |   | — |   | 1,208,337 |   |
| Auction rate securities                          |       | 645,800                    |       | 536 |   | — |   | — |   | 646,336 |   |
| Other                                            |       | 808,612                    |       | 307 |   | 972 |   | — |   | 807,947 |   |
| Total investment securities  available-for-sale  |       | $                          | 4,083,634  |   | $ | 2,056 |   | $ | 10,548 |   | $ | 2,447 |   | $ | 4,072,695 |   |

 

Noinvestment securities were sold during the three and six months ended June 30,2005 and the three months ended June 30, 2004. During the six months endedJune 30, 2004, investment securities with an amortized cost of $112.9 millionwere sold at a net realized loss of $0.5 million, which includes grossgains of $0.1 million and gross losses of $0.6 million. Realizedgains and losses were calculated using the specific identification method.

 

**Note 8.  Loans Receivable**

 

TheCompany has credit risk on loans to the extent that borrowers fail to repayamounts owed and such amounts are not recovered through collections procedures.At June 30, 2005, the Company had no significant regional domestic or foreignconcentrations of credit risk.

 

**Note 9.  Asset Sales**

 

OnMarch 1, 2005, the Company completed the sale of a portfolio of non-core,higher risk credit card loans held by PNB with a carrying value ofapproximately $400 million at the date of sale, which resulted in therecognition of a $36.8 million gain reported in non-interest income—otherduring the first quarter of 2005. The related loans receivable and interestreceivable were reclassified to loans held for securitization or sale inJanuary 2005 in anticipation of the sale. At that time, the related loansreceivable and interest receivable were reduced to their respective fair valuesbased on the estimated net realizable value of the portfolio and estimatedsales costs at the time of the reclassification, with an offsetting reductionto the allowance for credit losses.

 

12

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**Note 10.  Securitization orSale of Receivables**

 

The Company periodically securitizes pools of its loansreceivable and issues asset-backed securities in underwritten offeringsand private placements through trusts or other special-purpose entities thatmeet the requirements for sale treatment. At June 30, 2005 and December 31,2004, the Company’s securitization program had $11.42 billion and $10.73 billion of securityholders’ interests outstanding, of which $9.91 billionand $9.29 billion were held by third parties. The Company retains theremaining interests in the loans receivable transferred in its securitizationsand includes them on its statement of financial condition.

 

The Company’s securitization transactions createundivided interests in the pool of loans and establish securityholders’interests (asset-backed investor securities), a seller’s interest,interest-only strips receivable, and spread accounts. Securityholders’interests consist of various classes of investor interests ranked by seniority.Certain classes of securityholders’ interests, which are supported by variousforms of credit enhancement and generally include the senior classes, are soldto third party investors. When the Company enters into a securitizationtransaction, it receives cash proceeds from the sale of securities to thirdparties, removes the securitized loans and related allowance for credit lossesfrom its statement of financial condition, and records the retained interestsin the transaction. The Company typically recognizes a net gain on sale fromthe securitization, due primarily to the release of the related allowance forcredit losses and recognition of an interest-only strip receivable, which ispartially offset by discounts recognized for the retained subordinatedinterests.

 

The seller’s interest is composed of senior andsubordinated components. The senior seller’s interest represents the seller’sundivided interest in the trust loans receivable that are not allocated to thesecurityholders’ interests. The principal, interest, and fees receivableincluded in the senior seller’s interest are classified on the Company’sstatement of financial condition as loans receivable, with a related allowancefor credit losses, and as interest receivable. As the amount of the loans inthe securitized pool fluctuates due to customer payments, purchases, cashadvances, billed interest and fees, and credit losses, the amount of the seniorseller’s interest will vary. Periodically, the Company transfers new loans intothe securitized pool in order to maintain the seller’s interest above theminimum required by the securitization documents or in anticipation of issuingnew securityholders’ interests.

 

The subordinated component of the seller’s interest isthe accrued interest receivable (“AIR”), which represents the Company’sinterest in outstanding accrued interest and fees that are initially allocatedto the securityholders’ interests. The AIR is included as a financial componentof the securitization transaction in computing the net gain on sale. It isvalued at the lower of its previous carrying amount or allocated carrying valueat the time of the sale and is recorded in due from securitizations on theCompany’s statement of financial condition.

 

The interest-only strip receivable is a retained interestin the interest and fee collections allocated to the securityholders’interests. This asset represents the present value of estimated future excessservicing expected to be generated during the period the securitized loans areprojected to be outstanding. In order to give effect to the gain recognitionrequirements of SFAS No. 140, this period is determined by an accounting methodthat assumes the investor securities will not be in their revolving periodsafter the date of valuation and, therefore, that all available future principalcollections will be applied to repay the investor securities. Under thismethod, which applies only to interest-only strips receivable valuation and isnot used to determine repayment periods for retained subordinatedsecurityholders’ interests or spread accounts, the Company applies an estimatedpayment rate to the initial securitized receivables balance in order to derivethe dollar amount by which the securitized receivables balance is estimated tobe reduced in future periods. This corresponds to the contractual rights thesecurityholders have to a fixed percentage of principal collections during theperiod in which principal collections must be applied to repay the investorsecurities. Excess servicing represents the net positive cash flow frominterest and fee collections allocated to the securityholders’ interests afterdeducting the interest paid on investor securities, credit losses, contractualservicing fees, and other expenses. The interest-only strip receivable isrecorded at estimated fair value, and is included in due from securitizationson the Company’s statement of financial condition.

 

Spread accounts are cash reserve accounts that can becalled upon to fund payments to securitization investors and credit enhancersin the event their share of cash flows is insufficient to cover the requiredamounts due. Spread accounts are generally funded through excess cash flows ifcash flows fall below specified levels or other trigger events occur during theterm of a securitization. The cash in a spread account is released to theCompany if the investor securities enhanced by the spread account are repaid orthere are otherwise excess amounts in the spread account. The spread accountsare recorded at estimated fair value in due from securitizations on the Company’sstatement of financial condition.

 

13

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The retained securityholders’ interests are securitiesmeasured at fair value and included on the Company’s statement of financialcondition in due from securitizations. The retained subordinatedsecurityholders’ interests consist primarily of non-interest bearing beneficialinterests that are repaid when no longer required to provide credit enhancementfor senior classes. At the origination of a securitization, the Companyrecognizes these assets at their allocated carrying value. Generally, theallocated carrying value is less than the face value of the security, and thedifference is recorded as a reduction to non-interest income—servicing andsecuritization. At the same time, the Company recognizes the fair value ofthese assets. The Company’s existing retained securityholders’ interests havebeen classified as held for trading, and the difference between their allocatedcarrying values and their fair values at the time of origination is recorded innon-interest income—servicing and securitization. The Company measures fairvalue by estimating cash flows that are discounted at rates that reflect thelevel of subordination, the projected repayment term, and the credit risk ofthe securitized loans.

 

When the securityholders’ interests are reduced throughamortization or termination, or through a reduction in the invested amount ofthe Company’s variable funding conduit facilities, the seller’s interest isincreased. This results in the recognition of an allowance for credit lossesrelated to the increase in reported loans receivable. Typically, this increasein the allowance for credit losses is the only significant earnings impactresulting from such reductions in securityholders’ invested interests.

 

The Company typically recognizes a net gain from theinitial sale of investor interests to third parties, due primarily to therelease of the related allowance for credit losses and recognition of a gainfrom the interest-only strip receivable, which is partially offset by therecognition of a loss from discounts recognized in establishing the fair valueof the retained subordinated interests. During the three and six months ended June 30,2005, the Company securitized loans receivable by increasing the investedamounts of its variable funding conduit facilities by $1.43 billion and$1.63 billion, which were offset by reductions of $691.7 million and$939.3 million from the repayment of certain term series and reductions inthe invested amounts of its variable funding conduit facilities. Excluding thebenefit realized from the reduction to the allowance for credit losses, theCompany recognized gains of $18.2 million and $21.3 million relatedto such increases in the invested amount during the three and six months ended June 30,2005. During the three and six months ended June 30, 2004, the Companysecuritized $802.5 million and $1.72 billion of loans receivable,which were offset by $920.8 million and $1.97 billion from therepayment of certain term series and a reduction in the invested amount of itsvariable funding conduit facilities. Excluding the benefit realized from thereduction to the allowance for credit losses recognized at the time of sale,the Company recognized a gain of $7.6 million and a loss of $6.5 millionrelated to new securitizations during the three and six months ended June 30,2004.

 

Adjustmentsto record the allocated carrying value of new retained securityholders’interests at the time of sale during the three months ended June 30, 2005and 2004 reduced non-interest income—servicing and securitization by $26.7 million and $44.2 million. The impact of further adjusting these assetsfrom allocated carrying value to fair value increased non-interestincome—servicing and securitization by $17.9 million and $19.9 millionduring the three months ended June 30, 2005 and 2004. Adjustments to record the allocated carrying value of new retainedsecurityholders’ interests at the time of sale during the six months ended June 30,2005 and 2004 reduced non-interest income—servicing and securitization by $27.4 millionand $97.5 million. The impact offurther adjusting these assets from allocated carrying value to fair valueincreased non-interest income—servicing and securitization by $18.4 millionand $37.6 million during the six months ended June 30, 2005 and 2004.

 

14

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Thefollowing table presents key economic assumptions used in the initialmeasurement of the fair values of the retained subordinated interests forsecuritizations entered into during the six months ended June 30, 2005 and2004.

 

**Securitization Initial MeasurementAssumptions**

 

| ** **                                                 | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| ** **                                                 | ** ** | ** **                         | ** ** | **As Restated** | ** ** |
| Payment  rate(1)                                           |       | 8.4                                | %          | 6.5 | % |
| Expected net  credit loss rate                             |       | 11.1                               | %          | 16.2 | % |
| Weighted  average loans receivable life (in years)(2)      |       | 0.5                                |       | 0.6 |   |
| Discount  rate(3)                                          |       | 6.2%-20.0                          | %          | 6.8%-20.0 | % |
| Average  interest rate margin for third party investors(4) |       | 0.81                               | %          | 0.50 | % |

 

----

| (1) | This rate is an average of forecasted monthly payment rates for loans  receivable in the securitized pool. The monthly payment rate represents a  forecast of principal collections for the month divided by a forecast of the  aggregate amount of principal loans receivable at the beginning of the month.                                                                                                                                                                                                                                                                                                                                                                             |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | The weighted average loans receivable life is used only in the  initial measurement of the fair value of the interest-only strip receivable.  It is calculated by multiplying the principal collections expected in each  future period by the number of periods until the balance is paid, summing those  products, and dividing by the initial principal balance. Estimated principal  collections are based on the accounting method used in valuing interest-only  strips, which applies the estimated monthly payment rate to the initial  securitized receivables balance in order to derive the dollar amount by which  such balance is estimated to be reduced in future periods. |
| (3) | Discount rate assumptions vary based on the relative risk of cash  flows, which includes factors such as the level of subordination, the projected  repayment term, and the credit risk of the securitized loans. The discount  rate assumption used for retained securityholders’ interests ranged from 6.2%  to 8.0% and 6.8% to 10.0% during the six months ended June 30, 2005 and  2004. The discount rate assumption used for interest-only strips receivable  was 20.0% during the six months ended June 30, 2005 and 2004.                                                                                                                                         |
| (4) | The interest rates paid to third party investors in a term  securitization with variable rates is based on this margin plus the London  Interbank Offered Rate (LIBOR). The interest rates paid to third party  investors in the Company’s fixed rate term securitizations are based on this margin plus the relevant term swap rate at the  time of pricing. The interest rates paid to conduit asset-backed investors  that participate in the variable funding conduit facilities are generally  based on a commercial paper rate.                                                                                                                                                |

 

After the initial sale, the Company’s securitizationsimpact its earnings through sales of retained interests, changes in the fairvalues of its retained interests, including the accretion of discounts onretained interests, the ongoing recognition of interest-only strips receivable,and the difference in the actual excess servicing received as compared to theamount estimated in calculating the related interest-only strips receivable.

 

During the revolving period of a securitization, noprincipal payments are made to the investors. Instead, monthly collections ofprincipal allocated to investors, and other amounts treated as principal collections,to the extent not used to fund principal amounts due other investors, are usedto fund the purchase of replacement loans receivable, and the Companyrecognizes additional interest-only strips receivable when this occurs. Inaddition, to the extent the amount of the excess servicing cash flows receivedin a month differs from the amount estimated in establishing the relatedinterest-only strip receivable, the Company recognizes servicing andsecuritization income or loss.

 

The Company continues to service the accounts included inthe pool of securitized loans and earns a monthly servicing fee, which isgenerally offset by the servicing costs it incurs. The Company has determinedthat the contractual servicing fee represents adequate compensation and theCompany therefore does not currently recognize a servicing asset or liabilityin connection with its securitizations.

 

At least quarterly, the Company adjusts the valuations ofthe retained interests to reflect changes in the amount of the securitizedloans outstanding and any changes to the initial assumptions, estimates, anddiscount rates. The Company also continues to refine the financial models usedto obtain more accurate measures of the timing and amount of cash flows. Thesevalues can, and will, vary as a result of changes in the level and timing ofthe cash flows, financial models, and underlying economic assumptions. Changesin the estimated fair values of the retained interests are reported as acomponent of non-interest income—servicing and securitization on the Company’sstatement of income.

 

15

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Afterthe initial fair value recognition, the Company evaluates its retainedsecurityholders’ interests and recognizes changes in their fair value in non-interestincome—servicing and securitization. The fair value changes reflect the Company’schanges to estimated cash flows and discount rates, including the impact ofchanges in the remaining term until repayment. As securityholders’ interestsapproach their expected final payment date, their fair values generallyapproach their face values and the discounts are accreted, with the amount ofsuch accretion realized in non-interest income—servicing and securitization.

 

The following table summarizes the retained subordinatedsecurityholders’ interests in the Providian Gateway Master Trust as of June 30,2005 and December 31, 2004.

 

**Summary of Retained Subordinated Securityholders’ Interests**

**in the Providian Gateway Master Trust**

** **

| **(dollars in thousands)**                             | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| Retained  subordinated securityholders’ interests |       |                   |       |                       |       |
| Face value                                             |       | $                      | 1,515,919  |                       | $          | 1,437,806 |   |
| Discount                                               |       | (149,293               | )          | (186,552                   | )          |
| Fair value                                             |       | $                      | 1,366,626  |                       | $          | 1,251,254 |   |
|                                                   |       |                   |       |                       |       |
| Weighted average remaining term (months)               |       | 16                     |       | 25                         |       |

** **

The changes in netunrealized gains or losses on retained subordinated securityholders’ interestsincluded in earnings consisted of gains of $46.5 million and $22.6 millionfor the three months ended June 30, 2005 and 2004. For the six months endedJune 30, 2005 and 2004, the changes in net unrealized gains or losses onretained subordinated securityholders’ interests included in earnings consistedof gains of $58.8 million and $104.9 million. These unrealized gainsor losses are recognized in non-interest income—servicing and securitization.

 

Valuations of retained subordinated securityholders’interests, interest-only strips receivable, and spread accounts require theCompany to use judgment in selecting discount rates, estimating future cash flows,assessing current economic conditions, and assuming the outcome of futureevents. Generally, the Company discounts retained subordinated securityholders’interests and spread accounts using a defined methodology that, to the extentpossible, is based on observable market interest rates and credit spreads thatapproximate rates on other investments. Retained subordinated securityholders’interests are discounted at rates that reflect the level of subordination, theprojected repayment term (which in the case of interest-only strips receivableis determined under the accounting method described above), and the credit riskof the securitized loans. Spread account valuations are determined through adiscounted cash flow analysis based on projected repayments of spread accountbalances to the Company.

 

The following table presents the fair value (carryingvalue, net of any discounts) of the Company’s retained interests in thesecuritized loans, which retained interests were reported in due fromsecuritizations at June 30, 2005 and December 31, 2004.

 

**Duefrom Securitizations**

| ** **                                              | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(dollars in thousands)**                              | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| Retained  subordinated securityholders’  interests |       | $                 | 1,366,626  |                  | $          | 1,251,254 |   |
| Interest-only  strips receivable                        |       | 299,862           |       | 299,830               |       |
| Spread  accounts                                        |       | 251,697           |       | 246,195               |       |
| Accrued  interest receivable                            |       | 324,905           |       | 352,817               |       |
| Other(1)                                                |       | 166,641           |       | 116,218               |       |
| Total due from securitizations                          |       | $                 | 2,409,731  |                  | $          | 2,266,314 |   |

----

(1)          Amounts consist primarily of funds deposited in the trust collectionaccount and not yet distributed.

 

16

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The key economic assumptions used in valuing retainedinterests and the sensitivity of the current fair value of residual cash flowsto immediate 10% and 20% adverse changes in those assumptions at June 30,2005 are presented in the following table.

 

**SecuritizationSensitivities**

** **

| **(dollars in thousands)** | ** ** | **Discount**** Rate** | ** ** | **Expected Net Credit Loss Rate** | ** ** | **Payment Rate** | ** ** |
|----------------------------|------------|----------------------------|------------|----------------------------------------|------------|------------------|------------|
| Current assumptions        |       | 6.2%-20.0                  | %          | 10.9                                   | %          | 8.5              | %          |
| Impact on fair value of:   |       |                       |       |                                   |       |             |       |
| 10% adverse change         |       | $                          | (17,473    | )                                      | $          | (50,166          | )          | $ | (17,026 | ) |
| 20% adverse change         |       | $                          | (34,707    | )                                      | $          | (99,811          | )          | $ | (31,839 | ) |

 

The adversechanges to these key economic assumptions are hypothetical and are presented inaccordance with SFAS No. 140. As the figures above indicate, changes infair value based on a 10% variation in assumptions generally cannot beextrapolated because the relationship of the change in assumption to the changein fair value may not be linear. In addition, the effect of changing oneassumption on the fair value of the retained interests is computed withoutallowing any other assumption to change. In reality, changes in one assumptionmay be accompanied by changes in others. Furthermore, the sensitivities presenteddo not reflect actions that management might take to mitigate the impact of theadverse change. Accordingly, these sensitivities should be used with caution.

 

The following table summarizes certain cashflows received from or paid in respect of securitizations:

 

**Securitization CashFlows**

** **
| ** **                                                                | ** ** | **Six months ended June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(dollars in  thousands)**                                               | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| Proceeds from new securitizations(1)                                      |       | $                                  | 1,505,844  |   | $ | 1,400,000 |   |
| Proceeds from collections allocated to securityholders’ interests(1) |       | 5,035,308                          |       | 4,416,718 |   |
| Servicing fees received                                                   |       | 156,087                            |       | 147,960 |   |
| Net cash flows received on retained interests                             |       | 455,335                            |       | 435,108 |   |
| Principal paid in respect of maturing securitizations(1)                  |       | (891,660                           | )          | (1,662,234 | ) |
|                                                                           |            |                                    |            |  |  |  |  |

----

(1)          Cash flows received from or paid in respectof third party securityholders’ interests. Amounts include increases anddecreases in invested amounts of variable funding conduit facilities.

 

**Note 11. Consolidation of Variable Interest Entities**

 

In December 2003, theFASB issued a revision of Interpretation No. 46, “Consolidation of VariableInterest Entities, an Interpretation of ARB No. 51” (“FIN 46”), whichsuperseded the original guidance issued in January 2003. Under FIN 46, acompany is required to consolidate a variable interest entity (“VIE”) if itsinterest in the VIE is such that it will absorb a majority of the VIE’sexpected losses and/or receive a majority of the VIE’s expected residualreturns, if any. The Company has applied FIN 46 to Providian Capital I, itswholly owned trust that issued preferred securities. See Note 13 toConsolidated Financial Statements for further discussion.

 

Because the Company’ssecuritizations are structured using qualifying special-purpose entities, asdefined in SFAS No. 140 and FIN 46, the Company’s securitization trustsare not required to be consolidated under FIN 46. The Company has an equityinterest in a special-purpose entity related to one of its securitizationtransactions and has determined that the entity is a VIE and that the Companyis not the primary beneficiary. As such, the entity does not meet therequirements for consolidation by the Company under FIN 46. As of June 30,2005, the Company’s total investment in this entity was $30.1 million,which represents the Company’s maximum loss exposure, and the estimated totalassets of the entity were approximately $51.0 million.

 

The Company also has equityinterests in various limited partnerships. The Company has determined that thelimited partnerships are VIEs and that the Company is not the primary beneficiary.As such, these entities do not meet the requirements for consolidation by theCompany under FIN 46. As of June 30, 2005, the Company’s total investmentin limited partnerships was $24.3 million, which, combined with $4.8 millionof remaining contractual funding commitments under these investments,represents the Company’s maximum loss exposure, and the estimated total assetsof these entities were approximately $439.8 million.

 

17

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**Note 12.  Commitments,Guarantees, and Contingencies**

 

**Commitments.  **A loan commitment is an agreement to lend to a customer up to aprescribed maximum amount, subject to the customer’s compliance with theaccount agreement. The Company can reduce or cancel a credit card commitment byproviding the required prior notice to the customer, or without notice ifpermitted by law. The unfunded commitment represents the total unused portionof the line of credit available to the customer. The Company has notexperienced, and does not expect that it will experience, circumstances underwhich all of its customers will borrow the entire line of credit available tothem at the same time. Therefore, the total unfunded commitment amounts do notnecessarily represent future cash requirements. Total unfunded commitments at June 30,2005 and December 31, 2004 were $29.63 billion and $29.10 billion.

The Company is also a partyto and from time to time enters into agreements that contain provisionsregarding minimum payment commitments, including agreements in connection withtechnology maintenance, consulting, outsourcing, and co-marketing services.These provisions typically require the Company to make minimum payments toother parties, as specified in the agreements, which are not necessarilycontingent upon the amounts or levels of services provided to the Company underthe agreements. The Company does not currently expect any of these minimumpayment commitments to have a material impact on its consolidated financialstatements, but it cannot give any assurance that they will not have such aneffect.

**Guarantees.  **In January 2003, the Company entered into apledge agreement with an insurer with respect to certain obligations owing tothe insurer in connection with two series of the Providian Gateway MasterTrust. In exchange for the insurer agreeing to a reduction in the base rateused for calculating the excess spread early amortization event for the twoseries, the Company pledged $30.0 million to be held in a deposit accountas security for the payment to the insurer of amounts owing to it in connectionwith these transactions. The pledge agreement remains in effect until theinvestor securities and all amounts owing to the insurer with respect to thetwo series are paid. In accordance with the pledge agreement, the pledgedcollateral was reduced when one of the series was repaid in September 2003. Theremaining amount of the pledged collateral at June 30, 2005 was $13.6 million.The remaining series related to the pledge has an expected final payment datein September 2005. The Company does not currently expect that performance underthis pledge will be required.

In addition, the Company hasentered into interest rate swap arrangements to manage its interest rate riskexposure. See Note 15 to Consolidated Financial Statements forfurther discussion. In connection with these agreements, the Company pledgedcollateral to interest rate swap counterparties totaling $34.4 million at June 30,2005.

 

In August 2002, the Company,through a wholly owned limited liability entity, sold its investment in analternative energy plant. Through the limited liability entity, the Company hadreceived certain tax credits and tax deductions. In connection with the sale ofthe plant to a third party, the Company guaranteed certain obligations of thelimited liability entity under a purchase and sale agreement. The guaranteecovers the limited liability entity’s obligation to indemnify the purchaseragainst losses arising out of a breach of the purchase and sale agreement andfailure to repurchase the assets if tax credits are not available to thepurchaser. The Company’s guarantee is capped at the amount of payments made tothe limited liability entity at the time of sale, plus the amounts ofadditional payments made, and contingent future payments that may be made, tothe limited liability entity and its affiliates arising from fuel productionfrom the plant. At June 30, 2005, the maximum guaranteed amount was $31.0 million,based on actual payments made.

 

The Company is a party toand from time to time enters into agreements that contain generalindemnification provisions, primarily in connection with asset sale agreementsand service contracts, including the purchase and sale agreement referred to inthe preceding paragraph. These provisions typically require the Company to makepayments to other parties to indemnify them against losses that may be incurreddue to actions taken by the Company prior to entering into the agreement or dueto a breach of representations, warranties, and covenants made in connectionwith the agreement or possible changes in or interpretations of tax law. TheCompany cannot estimate the potential future impact of these indemnificationprovisions, since such an estimate would require an assessment of claims notyet made. Based on historical experience, the Company does not currently expectthe risk of loss under these indemnification provisions to have a materialadverse effect on its financial condition or results of operations, but itcannot give any assurance that they will not have such an effect.

 

**Litigation.  **The Company is subject to various pending and threatened legal actions,including actions arising in the ordinary course of business from the conductof its activities. While the Company believes that it has substantive defensesand intends to defend the actions vigorously, it cannot predict the ultimateoutcome or the potential future impact on the Company of such actions. TheCompany establishes reserves for expected future litigation exposures that areboth probable 

 

18

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and reasonably estimable. The Company doesnot currently expect any of the actions pending or threatened against it tohave a material adverse effect on its financial condition or results ofoperations, but it cannot give any assurance that they will not have such aneffect.

 

**Note 13.  Long-TermBorrowings**

 

Long-termborrowings consist of borrowings having a remaining maturity of one year ormore. The following table summarizes the Company’s long-term borrowings at June 30,2005 and December 31, 2004.

 

**Summary of Long-Term Borrowings**

** **
| **(dollars in thousands)**                                                  | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| Zero coupon  convertible senior notes maturing in 2021(1)                   |       | $                      | 469,383    |                       | $          | 460,180 |   |
| 4.00%  convertible senior notes maturing in 2008                            |       | 287,392                |       | 287,500                    |       |
| 2.75% convertible cash to accreting senior notes maturing in 2016           |       | 277,200                |       | 277,200                    |       |
| 9.525%  junior subordinated deferrable interest debentures maturing in 2027 |       | 109,281                |       | 109,281                    |       |
|                                                                        |       | 1,143,256              |       | 1,134,161                  |       |
| Less  unamortized issuance costs                                            |       | 12,633                 |       | 14,883                     |       |
| Total long-term borrowings                                                  |       | $                      | 1,130,623  |                       | $          | 1,119,278 |   |

----

(1)            Amounts include the accreted portion of ayield to maturity of 4.00% per year.

 

*Convertible Senior Notes*

 

During the second quarter of 2005, the specifiedmarket price condition for conversion of the Company’s 4.00% convertible seniornotes was satisfied, as the Company’s common stock price exceeded theconversion trigger price of $14.31 per share for at least 20 of the last 30trading days of the second quarter of 2005. As a result, the 4.00% convertiblesenior notes are convertible during the third quarter of 2005. See furtherdiscussion of the notes below.

 

The following summarizes theterms of the Company’s convertible senior notes outstanding at June 30,2005:

 

**Summary of Convertible Senior Notes**

** **
| ** **                                             | ** ** | **3.25%(1)**                                | ** ** | **Zero Coupon(2)**                          | ** ** | **4.00%**                                   | ** ** | **2.75%**                                   | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| Original issuance amount                               |       | $402.5 million                         |       | $884.0 million                         |       | $287.5 million                         |       | $277.2 million                         |       |
| Issuance date                                          |       | August 2000                                 |       | February  2001                              |       | May 2003                                    |       | March 2004                                  |       |
| Maturity date                                          |       | August 15, 2005                             |       | February  15, 2021                          |       | May  15, 2008                               |       | March 15, 2016                              |       |
| Conversion rate(3)                                     |       | 14.4892  shares/ $1,000 note principal |       | 6.2240  shares/ $1,000 note principal  |       | 76.8758  shares/ $1,000 note principal |       | 58.7941  shares/ $1,000 note principal |       |
| Conversion price (per share of common stock)           |       | $69.02                                      |       | $85.66 (accreted conversion price)          |       | $13.01                                      |       | $17.01                                      |       |
| Conversion trigger price under market price  condition |       | N/A                                         |       | $94.23  (110% of accreted conversion price) |       | $14.31 (110% of conversion price            | )          | $20.41 (120% of conversion price)           |       |

----

(1)          At June 30, 2005, the amount of 3.25% convertible senior notesoutstanding of $343.3 million is due in one year or less and has beenclassified as a short-term borrowing.

(2)          At time of issuance, the original principal amount at maturity was $884.0 million.The conversion rate is based on principal amount at maturity of the zero couponconvertible senior notes.

 

19

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(3)          The Company may adjust the conversion rate if certain events occur, asspecified in the related indenture supplement, such as the issuance ofdividends payable in the Company’s common stock or the occurrence of a stocksplit or combination.

 

The Company’s 3.25%convertible senior notes are convertible into shares of the Company’s commonstock at the option of the holders, at the conversion rate noted above, at anytime prior to their maturity or their redemption or repurchase by the Company.The Company’s zero coupon, 4.00%, and 2.75% convertible senior notes areconvertible into shares of the Company’s common stock at the option of theholders, at the conversion rates noted above, under circumstances specified inthe respective indenture supplements, including the following:

 

•                  Satisfaction of a market price condition,such that the price of the Company’s common stock equals or exceeds a certainpercentage of the conversion price (or accreted conversion price, in the caseof the zero coupon convertible senior notes) for at least 20 of the last 30trading days of the preceding calendar quarter (at least 20 of the 30 tradingdays prior to conversion, in the case of the zero coupon convertible seniornotes) *(applicable to zero coupon, 4.00%,and 2.75% convertible senior notes)*;

 

•                  Satisfaction of a trading price condition,such that the trading price of the notes falls below a specified level *(applicable to 4.00% and 2.75% convertible seniornotes)*;

 

•                  The occurrence of a specified credit ratingevent, such that the ratings of the notes by certain rating agencies fall belowspecified levels*(applicable to 4.00% and2.75% convertible senior notes)*;

 

•                  The occurrence of certain corporate events *(applicable to zero coupon and 4.00% convertiblesenior notes)*; and

 

•                  The occurrence of specified corporatedistributions or the occurrence of a fundamental change, as defined in therelated indenture supplement, or the announcement of a redemption of the notesby the Company *(applicable to 2.75%convertible senior notes)*.

 

Holders of the zero couponconvertible senior notes may surrender their notes for conversion at any timeprior to maturity, but (except in certain specified circumstances) if theconditions for conversion into common stock have not been met, conversion willinstead be settled in cash, in an amount determined based on the formulas specifiedin the related indenture supplement. Holders of the zero coupon notes may alsorequire the Company to purchase their notes on February 15, 2006 at a price pernote of $552.07, on February 15, 2011 at a price per note of $672.97,and on February 15, 2016 at a price per note of $820.35, based on $1,000principal amount payable at maturity. The Company has the option to settlethese purchases in cash (at the then current accreted value of the notes) orcommon stock (at the then current market price of the Company’s common stock),or using a combination of both.

 

Conversions of the 4.00% and2.75% convertible senior notes will be settled in shares of the Company’scommon stock, except under certain circumstances related to the trading pricecondition, when conversions may be settled in cash, common stock, or acombination of both. Conversions of the zero coupon, 4.00%, and 2.75%convertible senior notes may also be settled in cash, common stock, or otherproperty upon the occurrence of certain corporate events, as specified in therelated indenture supplements. The Company may also be required to purchase the2.75% convertible senior notes for cash and pay an additional make wholepremium payable in the Company’s common stock upon the repurchase or conversionof the notes in connection with the occurrence of a fundamental change, asdefined in the related indenture supplement. In addition, contingent interestis required to be paid to holders of the 4.00% and 2.75% convertible seniornotes if certain conditions are met.

* *

*Junior Subordinated DeferrableInterest Debentures*

 

In 1997, through ProvidianCapital I, a wholly owned subsidiary statutory trust, the Company issuedmandatorily redeemable preferred securities, which accumulate accrueddistributions that are payable semiannually. The Company has the right to deferpayment of interest on the preferred securities at any time and from time totime, for a period not exceeding 10 consecutive semiannual periods with respectto each deferral period, provided that no extension period may extend beyondthe stated maturity. During any such extension period, the Company’s ability topay dividends on its common stock would be restricted. The Company has theright to cause the redemption of the preferred securities on or after February1, 2007, or earlier in the event of certain regulatory changes. The redemptionprice depends on several factors, including the date of the redemption, thepresent value of the principal and premium payable, and the accumulated butunpaid distributions on the 

 

20

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preferred securities. The sole assets ofProvidian Capital I are $109.3 million in aggregate principal amount ofthe Company’s 9.525% junior subordinated deferrable interest debentures dueFebruary 1, 2027 and the right to reimbursement of expenses under a relatedexpense agreement with the Company. The Company’s obligations under suchdebentures, together with its other obligations with respect to the preferredsecurities, constitute a full and unconditional guarantee.

 

In accordance with FIN 46 (see Note 11to Consolidated Financial Statements), the Company has determined that theProvidian Capital I trust is a VIE and that the Company is not the primarybeneficiary. The Company adopted the provisions of FIN 46 with respect to thistrust and deconsolidated it effective July 1, 2003. At June 30, 2005, theCompany reported $109.3 million in junior subordinated deferrable interestdebentures related to the preferred securities in long-term borrowings and theCompany’s equity investment in the trust of $5.0 million in other assets.

 

**Note 14.  Income Taxes**

 

The Company has taxexposures relating to its assessment of tax liabilities in the ordinary courseof business. The Company periodically assesses its liabilities andcontingencies for all years subject to potential tax audit based on the latestinformation available. For those matters where it is probable that anadjustment will be asserted, the Company has recorded its best estimate of theentire amount of the tax liability (including related interest charges for suchtax liabilities) related to such matters in its consolidated financialstatements. Subsequent events that result in an increase or decrease to theCompany’s total assessment of its tax exposures for such tax liabilities arereflected in current period earnings.

 

The Company’s effectiveincome tax rates for the three and six months ended June 30, 2005 were22.21% and 27.31%, and for the three and six months ended June 30, 2004were 33.94% and 34.48%, as restated. The effective income tax rates includefederal and state components and the utilization of tax credits generated froman existing investment in a limited liability entity that operates analternative energy plant.

 

Thedecrease in the effective tax rates for the three and six months ended June 30,2005 is primarily due to net reductions of previously established taxliabilities. During the three months ended June 30, 2005, the Companyrecorded a reduction of $40.2 million of previously accrued income taxexpense and a reversal of $31.7 million of interest expense related topreviously established tax liabilities, which had the effect of increasing netincome by $60.6 million in the second quarter of 2005, or $0.18 per dilutedshare. These net reversals resulted from the finalization of various tax auditsthat were more favorably resolved than previously anticipated and fromreassessment of tax exposures covering the years 1997 through 2005. Althoughthe final resolution of remaining tax exposures is uncertain, in the opinion ofthe Company’s management, based on current information, the ultimatedisposition of these open tax matters is not expected to have a materialadverse effect on the Company’s financial condition or results of operations.

 

**Note 15.  Derivative Financial Instruments**

 

TheCompany’s principal objective in entering into derivative financial instrumentsis to reduce interest rate risk by more closely aligning the repricingcharacteristics of the Company’s assets and liabilities. The operations of theCompany are subject to the risk of interest rate fluctuations to the extentthat there is a difference in repricing characteristics as betweeninterest-earning assets and interest-bearing deposits and other liabilities.The goal is to maintain levels of net interest income while reducing interestrate risk and facilitating the satisfaction of the Company’s funding needs. Toachieve that goal, the Company uses a combination of interest rate riskmanagement instruments, including interest rate swap agreements, withmaturities ranging from 2005 to 2016 as of June 30, 2005.

 

Inaccordance with Statement of Financial Accounting Standards No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” as amended (“SFASNo. 133”), the Company designates and documents each derivative contractas one of the following at the time the contract is executed: a hedge of arecognized asset or liability or an unrecognized firm commitment (a fair valuehedge); a hedge of a forecasted transaction or of the variability of cash flowsto be received or paid related to a recognized asset or liability (a cash flowhedge); a hedge of a net investment in a foreign operation (a net investmenthedge); or a derivative instrument not designated as a hedging instrument whosechange in fair value is recognized as a benefit for protection against changinginterest rates (an undesignated hedge).

 

Duringthe three and six months ended June 30, 2005 and 2004, all of the Company’sderivatives contracts were designated as fair value hedges. For fair valuehedges, both the effective and ineffective portions of the change in the fairvalue of the derivative, together with the change in fair value of the hedgeditem that is attributable to the hedged risk, are reported in earnings. Theeffective portion of a change in fair value of a fair value hedge 

 

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is recognized on the sameline in the consolidated statements of income as the hedged item. The ineffectiveportion of a change in fair value of a fair value hedge is recognized innon-interest income—other. If a hedge designation is discontinued, previousadjustments to the carrying value of the hedged item are recognized in earningsto match the earnings recognition pattern of the hedged item. If the underlyingitem being hedged is removed from hedge designation, the derivative willsubsequently be accounted for as an undesignated hedge instrument.

 

TheCompany documents its hedge relationships, including identification of thehedging instruments and the hedged items, as well as its risk managementobjectives and strategies for undertaking the hedge transaction, at the timethe derivative contract is executed. Derivatives are reported in the consolidatedstatements of financial condition at fair value in other assets and accruedexpenses and other liabilities. The fair value of the Company’s derivativefinancial instruments is represented by the estimated unrealized gains orlosses as determined by quoted market prices or dealer quotes and generallyapproximates the amounts the Company would receive or pay to terminate theinstruments at the reporting date.

 

Bothat inception and at least quarterly thereafter, the Company assesses whetherthe derivatives used in hedging transactions are highly effective in offsettingchanges in either the fair value or cash flows of the hedged item. If it isdetermined that a derivative has ceased to be a highly effective hedge, theCompany will discontinue hedge accounting for such transaction.

 

Wheninterest rate risk management instruments are used to hedge reported assets andliabilities, the net receipts or payments are recognized as an adjustment tointerest income or interest expense. The following table presents the notionalvalue of the Company’s interest rate swap agreements that are designated asfair value hedges and the specific assets or liabilities to which they arelinked.  Interest rate swap agreements have the effect of convertingassets or liabilities from a fixed rate to a floating rate or from a floatingrate to a fixed rate.

 

**Notional Value of Fair ValueHedge Swaps**

 

| ** **                             | ** ** | **June 30, 2005**      | ** ** |
|----------------------------------------|------------|-----------------------------|------------|
| **(dollars in thousands)**             | ** ** | **Receive Fixed**           | ** ** | **Pay Fixed** | ** ** | **Total** | ** ** |
| Swaps  hedging certificates of deposit |       | $                           | 2,693,500  |   | $ | — |   | $ | 2,693,500 |   |
| Total  notional value of swaps         |       | $                           | 2,693,500  |   | $ | — |   | $ | 2,693,500 |   |
|                                   |       |                        |       |   |   |   |   |
| ** **                             |       | **December 31,  2004** |       |
| **(dollars in thousands)**             | ** ** | **Receive  Fixed**          | ** ** | **Pay  Fixed** | ** ** | **Total** | ** ** |
| Swaps  hedging certificates of deposit |       | $                           | 2,369,800  |   | $ | — |   | $ | 2,369,800 |   |
| Total notional  value of swaps         |       | $                           | 2,369,800  |   | $ | — |   | $ | 2,369,800 |   |

 

TheCompany is exposed to market and credit risk associated with its interest raterisk management instruments. The Company’s exposure to market risk isassociated with changes in interest rates, and the Company’s exposure to creditrisk is the risk of loss from a counterparty failing to perform according tothe terms of an agreement. This credit risk is measured as the gross unrealizedgain on the interest rate risk management instruments. The Company controlscredit risk in these instruments by entering into interest rate risk managementagreements with nationally recognized financial institutions and dealers thatcarry at least investment grade ratings. In addition, the Company’s policy isto diversify its credit risk exposure across a number of counterparties. On anindividual counterparty basis, the Company determines the need for collateralor other security to support financial instruments with credit risk. TheCompany does not currently anticipate default by any of its counterparties.

 

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**Note 16.  Cumulative Other Comprehensive Income**

 

The components of cumulativeother comprehensive income, net-of-taxes, for the six months ended June 30,2005 and 2004 are presented in the following table.

 

**Cumulative Other Comprehensive IncomeComponents**

** **

| **(dollars in thousands)**        | ** ** | **Unrealized Gain (Loss) on Securities** | ** ** | **Cumulative Other Comprehensive Income** | ** ** |
|-----------------------------------|------------|------------------------------------------|------------|-------------------------------------------|------------|
| Balance at December 31, 2003 |       | $                                        | (12,480    | )                                         | $          | (12,480 | ) |
| Other comprehensive income        |       | (14,555                                  | )          | (14,555                                   | )          |
| Tax benefit                       |       | 5,749                                    |       | 5,749                                     |       |
| Balance at June 30, 2004     |       | $                                        | (21,286    | )                                         | $          | (21,286 | ) |
|                              |       |                                     |       |                                      |       |
| Balance at December 31, 2004 |       | $                                        | (6,833     | )                                         | $          | (6,833 | ) |
| Other comprehensive income        |       | 2,171                                    |       | 2,171                                     |       |
| Tax expense                       |       | (815                                     | )          | (815                                      | )          |
| Balance at June 30, 2005     |       | $                                        | (5,477     | )                                         | $          | (5,477 | ) |

 

**Note 17.  Earnings perCommon Share**

 

The following table setsforth the computation of both basic and diluted earnings per common share forthe three and six months ended June 30, 2005 and 2004.

 

**Computation of Earnings Per Common Share**

** **
| ** **                                                                  | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(dollars and number of shares in thousands, except per share data)**      | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                  | ** ** | ** **                           | ** ** | **As Restated**                    | ** ** | ** ** | ** ** | **As Restated** | ** ** |
| Income for computation of earnings per  common share—basic             |       | $                                    | 225,311    |                               | $          | 49,914 |   | $ | 358,332 |   | $ | 143,581 |   |
| Interest on convertible senior notes,  net-of-taxes(1)                      |       | 7,616                                |       | 2,892                              |       | 15,205 |   | 4,773 |   |
| Income for computation of earnings per  common share—assuming dilution |       | $                                    | 232,927    |                               | $          | 52,806 |   | $ | 373,537 |   | $ | 148,354 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Weighted average common shares  outstanding—basic                      |       | 291,381                              |       | 288,355                            |       | 291,291 |   | 288,246 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Employee stock options                                                      |       | 5,036                                |       | 4,295                              |       | 5,159 |   | 4,181 |   |
| Restricted stock  issued—unvested                                      |       | 1,259                                |       | 1,598                              |       | 1,067 |   | 1,477 |   |
| Convertible senior notes(1)                                                 |       | 48,791                               |       | 38,399                             |       | 48,793 |   | 31,326 |   |
| Dilutive potential common shares                                            |       | 55,086                               |       | 44,292                             |       | 55,019 |   | 36,984 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Weighted average common shares  outstanding—assuming dilution          |       | 346,467                              |       | 332,647                            |       | 346,310 |   | 325,230 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Earnings per common share—basic                                        |       | $                                    | 0.77       |                               | $          | 0.17 |   | $ | 1.23 |   | $ | 0.50 |   |
| Earnings per common share—assuming  dilution(1)                        |       | $                                    | 0.67       |                               | $          | 0.16 |   | $ | 1.08 |   | $ | 0.46 |   |

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(1)          Amountsrelated to convertible senior notes reflect the effect of adopting EITF 04-8 inthe third quarter of 2004. The adoption of EITF 04-8 had the effect of reducingthe Company’s diluted earnings per common share by $0.03 and $0.01 for thethree months ended June 30, 2005 and 2004, and $0.05 and $0.03 for the sixmonths ended June 30, 2005 and 2004.

 

The Company’s convertiblesenior notes consist of its 2.75%, 4.00%, and zero coupon notes, which arecontingently convertible notes, and its 3.25% notes. See Note 13 toConsolidated Financial Statements for further discussion. During the thirdquarter of 2004, the Company elected to adopt the provisions of EITF 04-8, andas a result included the dilutive effect 

 

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of its contingently convertible notes in its dilutedearnings per share calculation from the time of issuance of the notes, inaccordance with the if-converted methodology under SFAS No. 128. As required byEITF 04-8, the Company also restated its diluted earnings per share for priorperiods.

 

The amounts presentedabove for the three and six months ended June 30, 2005 reflect the assumedconversions to common shares of the Company’s 2.75%, 4.00%, 3.25%, and zerocoupon convertible senior notes, and for the three and six months ended June 30,2004 reflect the assumed conversions to common shares of the Company’s 2.75%and 4.00% convertible senior notes, the impact of which was partially offset bythe add-back of related debt interest expense to net income in accordance withthe if-converted methodology. The Company’s 3.25% and zero coupon convertiblesenior notes were excluded from the calculation for the three and six monthsended June 30, 2004 because the effect of including them would have beenantidilutive. The interest expense and dilutive potential common sharesincluded in the diluted earnings per share calculations presented above are asfollows:

 
| ** **                                       | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(dollars and number of shares  in thousands)** | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| **2.75%  convertible senior notes**              |       |                                 |       |                               |       |   |   |   |   |
| Interest on notes, net-of-taxes                  |       | $                                    | 1,190      |                               | $          | 1,153 |   | $ | 2,381 |   | $ | 1,294 |   |
| Dilutive potential common shares                 |       | 16,298                               |       | 16,297                             |       | 16,298 |   | 9,224 |   |
| **4.00%  convertible senior notes**              |       |                                 |       |                               |       |   |   |   |   |
| Interest on notes, net-of-taxes                  |       | $                                    | 1,795      |                               | $          | 1,739 |   | $ | 3,590 |   | $ | 3,479 |   |
| Dilutive potential common shares                 |       | 22,095                               |       | 22,102                             |       | 22,097 |   | 22,102 |   |
| **3.25%  convertible senior notes**              |       |                                 |       |                               |       |   |   |   |   |
| Interest on notes, net-of-taxes                  |       | $                                    | 1,742      |                               | $          | — |   | $ | 3,485 |   | $ | — |   |
| Dilutive potential common shares                 |       | 4,974                                |       | —                             |       | 4,974 |   | — |   |
| **Zero  coupon convertible senior notes**        |       |                                 |       |                               |       |   |   |   |   |
| Interest on notes, net-of-taxes                  |       | $                                    | 2,889      |                               | $          | — |   | $ | 5,749 |   | $ | — |   |
| Dilutive potential common shares                 |       | 5,424                                |       | —                             |       | 5,424 |   | — |   |

 

TheFASB has issued an Exposure Draft, “Earnings per Share—an Amendment of FASBStatement No. 128,” which would require that contracts containing an option tosettle in cash or stock be assumed to settle in stock for purposes ofcalculating diluted earnings per share. See Note 5 to ConsolidatedFinancial Statements for further discussion.

 

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**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

Thisdiscussion is intended to further the reader’s understanding of ourconsolidated financial condition and results of operations. It should be readin conjunction with our historical financial statements included in thisquarterly report and with the information in our Annual Report on Form 10-K forthe year ended December 31, 2004 (the “2004 Annual Report”). Results forprior periods have been restated for various correcting adjustments, to theextent applicable. These adjustments are discussed in Note 4 to ourConsolidated Financial Statements, “Restatement of Prior Periods Presented.”Our historical financial statements may not be indicative of our futureperformance.

 

*Our Business*

 

Weprovide credit card and deposit products to customers throughoutthe United States. Our lending and deposit taking activities are conductedthrough Providian National Bank (“PNB”), a wholly owned banking subsidiary. Wemarket consumer loans and deposits using distribution channels such as mail,telephone, and the Internet.

 

Wegenerate income primarily through interest charged on outstanding loan balancesand fees related to account usage and performance (such as late, overlimit,cash advance, balance transfer, and annual membership fees), and from the saleof various cardholder service products. We receive interchange fees frombankcard associations based on the purchase activity of our credit cardcustomers. In addition, we earn income on our investments held for liquiditypurposes and from servicing fees, excess servicing on securitized loans, andchanges in the value of interests we retain in connection with our securitizations.

 

Ourprimary expenses are funding costs, including interest costs related tocustomer deposits and borrowings; credit losses; operating expenses, includingsalaries and employee benefits, advertising and solicitation costs, occupancycosts, data processing and communication costs; and income taxes.

 

Weseek to fund our assets through a diversified mix of sources and may vary theuse of any one source over time. Our ability to fund existing and futurecustomer loans is currently dependent on four primary sources: deposits,securitizations, a portfolio of cash and liquid investment securities, and debtissuances. Securitization is a process in which we segregate a pool of customerloans by transferring them to a trust, which directly or through otherspecial-purpose entities issues investor securities backed by the principal,interest, and fee cash flows generated by the pool of transferred loans. At thetime the investor securities are issued, we receive cash proceeds from theportion sold to third parties.

 

*ExecutiveOverview*

 

On June 6, 2005, we announced that we had entered into anagreement to merge with and into Washington Mutual, Inc., in a stock and cashtransaction valued at approximately $6.45 billion. The merger is expectedto be completed in the fourth quarter of 2005 and is subject to approval of ourshareholders and regulatory approvals. See Note 2 to ourConsolidated Financial Statements for further discussion.

 

Duringthe second quarter of 2005, we continued our efforts to maintain a strongfinancial condition and build a productive and sustainable portfolio ofcustomer accounts supported by an appropriately sized and efficientinfrastructure. Building on our progress over the previous three years, wecontinued to focus on the following key areas of our business.

 

*Maintaining a Strong Balance Sheet and Managing OurLiquidity Position.*   Ourprimary goals in this area have been to maintain strong capital ratios andmanage our liquidity portfolio in line with our growth expectations and PNB’sCapital Plan developed pursuant to its written agreement with its primaryregulator.  During the second quarter of2005, consistent with PNB's Capital Plan, our liquidity position increased by$159.3 million, ending at $4.91 billion, while deposit levels decreasedby $263.4 million, ending the period at $8.80 billion.

 

Ourcapital position increased during the quarter and at the end of the secondquarter of 2005 was $3.08 billion. At June 30, 2005, our shareholders’equity and allowance for credit losses, on a combined basis, were equal to51.0% of our reported loans. PNB continued to maintain strong levels of capitalratios throughout the period, ending the quarter with a total risk-basedcapital ratio on a subprime basis of 23.69%.

 

*Building on Our “New Providian” and Partnership MarketingStrategies.*   Inthe second quarter of 2005, we added approximately 550,000 gross new accounts,of which about 74% were originated through our proprietary marketing program.We continued to implement our growth strategy by focusing on our “New Providian”marketing, which emphasizes delivery 

 

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ofproducts, services, and rewards specifically designed for mainstream Americanconsumers, and entering into additional marketing arrangements with co-brandingand affinity partners. During the second quarter of 2005, we launched severalmarketing partnership programs that we had entered into previously. The successof our “New Providian” and partnership marketing strategies will continue to bea critical factor in our future earnings.

 

*Further Improving Our Credit Performance.*   During the second quarter of 2005, wecontinued to improve the credit mix of our loan portfolio by originatinghigher-quality loans receivable. We continued to benefit from the results ofenhancements in our collections processes and changes in our portfoliomanagement strategies as well as from the sale of higher risk credit card loanscompleted in the first quarter of 2005. These actions resulted in lowerdelinquencies and net credit losses in the second quarter of 2005 as comparedto the same period in 2004. Our net credit loss rates for the three monthsended June 30, 2005 were 5.95% on a reported basis and 8.31% on a managedbasis, compared to 9.10% and 12.53% for the same period in 2004. Our 30+ daydelinquency rates at June 30, 2005 were 3.23% on a reported basis and4.84% on a managed basis, compared to 4.61% and 6.16% at December 31, 2004and 4.74% and 6.44% at June 30, 2004. Our earnings during the secondquarter benefited from a $17.5 million reduction in the allowance forcredit losses, reflecting the improved risk composition of our reported assets.

 

*Further Improving Our Operational Efficiency.*   Reflecting our efforts over the pastseveral years to streamline our organization and reduce our operating costs,non-interest expense for the three months ended June 30, 2005 was $224.2 million,compared to $259.1 million for the same period in 2004. Non-interestexpense for the second quarter of 2005 included a reversal of $31.7 million of interest expenseassociated with previously established tax liabilities, resultingprimarily from the finalization of various tax audits that were more favorablyresolved than previously anticipated. Non-interestexpense, excluding solicitation and advertising, was $159.9 million forthe three months ended June 30, 2005, a decrease of $33.8 millionfrom the same period in 2004.

 

*Other KeyAreas*.   Securitizationshave remained a primary source of funding for our business. Securitizationshave an impact on our earnings because we record a gain or loss on the initialsale of loans in a securitization transaction and we release the allowance forcredit losses associated with the securitized loans. In addition, we retaincertain interests in the securitized loans, and we recognize changes in thefair value of these retained interests in current earnings. These impacts cancontribute to volatility in our earnings, specifically non-interestincome—servicing and securitization, from period to period. For example, duringthe second and third quarters of 2004, our earnings benefited from increases inthe valuation of interest-only strips receivable recognized from increases inforecasted excess servicing, primarily due to lower forecasted credit losses.Additionally, in 2003 and 2004, our earnings benefited significantly fromincome recognized as a result of decreased discount rates and the resultingincrease in the valuation of our retained interests caused by spreadcompression in the credit markets. In contrast, in 2002 our earnings werenegatively impacted by increased discount rates and the resulting decrease inthe valuation of these interests due to the deterioration at that time in theunderlying credit characteristics of the securitized loan portfolio. Thesefluctuations affect current period earnings; however, discounts previouslyrecognized on retained interests will accrete through earnings over the durationof a securitization transaction, which may span a number of quarterly andannual reporting periods. We continue to work on ways to reduce the level ofthese retained interests, in order to reduce the volatility of our earningsfrom period to period.

 

*Restatement.*   In February 2005, we determined thatwe would restate our consolidated financial statements for the years ended December 31,2000 to December 31, 2003 and each of the quarters of 2003 and the firstthree quarters of 2004. This determination was made in connection with thepreparation of our financial statements for the year ended December 31,2004 and the related review and resulting correction of the methodology andassumptions used to value our interest-only strips. The restated results, whichare audited for the years ended December 31, 2002, 2003, and 2004 andunaudited in prior and interim periods, were presented in our 2004 AnnualReport.  See Note 4 to our Consolidated Financial Statements forfurther discussion.

 

*Overviewof Critical Accounting Policies*

 

Our significant accounting policies aredescribed in Note 2 to our Consolidated Financial Statements, “Summary ofSignificant Accounting Policies,” in our 2004 Annual Report. Our financialstatements are prepared in accordance with accounting principles generallyaccepted in the United States (“GAAP”), which in some instances require us touse estimates and assumptions. GAAP also requires management to make judgmentsin valuing certain assets. Uncertainties are inherent in the use of estimates,assumptions, and judgments. The following is an overview of our application ofaccounting policies that require us to exercise significant judgment and reachconclusions about future events based on information currently 

 

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available. Differences in judgment, anddifferences between our estimates and assumptions and subsequent events, couldhave a material impact on our reported financial condition and results ofoperations.

 

*Securitization Accounting.*   We account for our securitizationtransactions under Statement of Financial Accounting Standards No. 140, “Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities—a Replacement of FASB Statement No. 125” (“SFAS No. 140”).Our securitizations involve the transfer of a pool of loans receivable to asecuritization trust. The trust or other special-purpose entity through whichasset-backed securities are issued meets the criteria under SFAS No. 140for a qualifying special-purpose entity that is not consolidated in ourfinancial statements. When we enter into a securitization, we receive cashproceeds from the sale of securities to third parties, remove from our balancesheet the securitized loans allocated to securityholders’ interests and therelated allowance for credit losses, and record our retained interests in thetransaction. We typically recognize a net gain on sale from the securitization,due primarily to the release of the related allowance for credit losses andrecognition of an interest-only strip receivable, which is partially offset bydiscounts recognized for the retained subordinated interests. We continue toservice the securitized loans and we receive contractual servicing fees duringthe term of the transaction. Our retained interests are generally reported atfair value, and changes in their fair values are recognized in current periodearnings.

 

Our retained interests inthe securitized loans consist of a seller’s interest, subordinated securityholders’interests, interest-only strips receivable, and spread accounts. These retainedinterests are recorded on our balance sheet in loans receivable, interestreceivable, and due from securitizations. The seller’s interest is composed ofsenior and subordinated components. The senior seller’s interest in oursecuritizations represents an undivided interest in the pool of loansreceivable transferred to the securitization trust that are not allocated tothe securityholders’ interests. The senior seller’s interest includesprincipal, interest and fees receivable, and is classified as loans receivable,with a related allowance for credit losses, and as interest receivable on ourbalance sheet. The seller’s interest subordinated component is the accruedinterest receivable asset (“AIR”), which represents our interest in outstandingaccrued interest and fees that are initially allocated to the securityholders’interests. The AIR is recorded in due from securitizations on our balancesheet.

 

We record an interest-onlystrip receivable at the inception of a securitization and on an ongoing basisthereafter during the revolving period of the transaction. We estimate thefair value of our interest-only strips receivable using a discounted cash flowvaluation methodology that incorporates the estimated repayment of theseinterests over time. For interest-only strips receivable, we estimate theinterest and fees that will be charged on the securitized loans, the interestpayable to the securityholders, credit losses, contractual servicing fees, andrepayment trends of the securitized loans to project the amount of excessservicing to be collected over the period the securitized loans are projectedto be outstanding. In order to give effect to the gain recognition requirementsof SFAS No. 140, this period is determined by an accounting method that assumesthe investor securities will not be in their revolving periods after the dateof valuation and, therefore, that all available future principal collectionswill be applied to repay the investor securities. We apply an estimated paymentrate to the initial securitized receivables balance in order to derive thedollar amount by which the securitized receivables balance is estimated to bereduced in future periods. This corresponds to the contractual rights thesecurityholders have to a fixed percentage of principal collections during theperiod in which principal collections must be applied to repay the investorsecurities. This methodology, which applies only to interest-only stripsvaluation, was adopted in connection with the restatement and has beenreflected in our financial statements for the year ended December 31, 2004and in our restated prior period financial statements. See Note 4 toour Consolidated Financial Statements, “Restatement of Prior Periods Presented,”for further discussion. The fair value of our interest-only strips receivablevaries primarily with changes in our forecast of excess servicing. Estimatedexcess servicing is impacted by the terms of the securityholders’ interests,and fluctuates primarily based on the expected performance of the securitizedloans, including the amount and timing of credit losses as well as principalrepayment rates.

 

We estimate the fair valueof our retained subordinated securityholders’ interests and spread accountsusing a discounted cash flow valuation methodology that incorporates theestimated repayment of these interests over time. Generally, we discountretained subordinated securityholders’ interests and spread accounts using adefined methodology that, to the extent possible, is based on observable marketinterest rates and credit spreads that approximate rates on other investments.We discount retained subordinated securityholders’ interests at rates thatreflect the level of subordination, the projected repayment term, and thecredit risk of the securitized loans. For spread accounts, we use a discountedcash flow analysis based on projected repayments of existing spread accountbalances, which generally are repaid when the investor securities enhanced bythe spread account are repaid or there are otherwise excess amounts in thespread account. The discount rates on retained subordinated securityholders’interests and spread accounts are significantly impacted both by changes inmarket interest rates as well as changes in the estimated duration of theassets, with shorter durations decreasing the estimated discount rate. Forpurposes of estimating repayment of these assets, we assume the investorsecurities will remain outstanding through their projected maturities,including any revolving period. Historically, we have not incurred a 

 

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loss of invested principal on assets heldthrough their final payment date, and our valuations do not reflect such a lossof principal.

 

A variety of internal andexternal factors, including economic conditions, current account managementstrategies, and market perceptions regarding our performance can affect theexpected net interest and fee income, coupon rates, net credit losses, anddiscount rates we use in our estimates. Changes in loan performanceexpectations can have a material impact on the projected cash flows and thus onour fair value estimates of our retained interests. Changes in the methodologyused to estimate, and assumptions regarding the level of receivables thatgenerate, cash flows can also have a material impact on the projected cashflows. Significant judgment is required in the selection and use of thesefactors. Results that differ from our projections canresult in a material impact on our balancesheet and income statement. As an example of the sensitivity of one assumption,at June 30, 2005, a 10% increase in the discount rates used in valuing thecash flows from our retained subordinated interests would have resulted in adecrease in their fair value of approximately $17.5 million. Thesensitivity of key assumptions used in valuing our retained subordinatedinterests is discussed in Note 10 to our Consolidated FinancialStatements, “Securitization or Sale of Receivables.”

 

At the time of asecuritization, we determine whether the retained subordinated securityholders’interests should be treated as held for trading or available-for-sale. Thisjudgment is based on our intent and plans with respect to holding or sellingthe assets, and could potentially vary among different securitizations anddifferent retained interests. All of our existing retained subordinatedsecurityholders’ interests are securities measured as investments held fortrading. Changes to unrealized gains and losses on investments held for tradingare included in current period earnings. Changes to unrealized gains and losseson available-for-sale assets are excluded from earnings and reported as a netamount in a separate component of shareholders’ equity, as other comprehensiveincome. If there is a determination that such available-for-sale assets havebeen permanently impaired, unrealized losses are reported as a reduction toservicing and securitization income. When realized, available-for-sale gainsand losses are removed from other comprehensive income and included inearnings. Designation of these assets as held for trading can have a materialimpact on the timing of unrealized gains and losses recognized in earnings, butnot on shareholders’ equity.

 

*Allowance for Credit Losses.*   We maintain an allowance for creditlosses at a level that, in management’s judgment, is adequate to absorbestimated credit losses inherent in the existing loans receivable on ourbalance sheet. The amount of the allowance is determined based on an analysisof historical quantitative risk factors. During 2004, we enhanced ourestimation process by including segmentation that gives greater weight tocustomer risk scores and age of accounts, as well as other risk factors, suchas Fair Isaac Corporation (FICO®) credit scores. Additionally, wecontinue to use other historical quantitative risk factors in our analysis,such as delinquency roll rates, principal credit loss rates, bankruptcies, andother customer characteristics. The delinquency roll rate measures themigration of loans receivable through the stages of delinquency. These factorsare used to estimate the likelihood that a loan receivable will charge off.When evaluating the adequacy of this quantitative analysis, management alsotakes into account environmental credit risk factors affecting the portfolio’scredit performance and makes appropriate adjustments to the allowance. Theseinclude such factors as the impact of general economic conditions on a customer’sability to pay, trends in loan portfolio volume, seasoning, geographicconcentrations, and the impact of modifications to loan review and underwritingprocedures on the credit quality of the loans receivable portfolio. Whenestimating future credit losses, we may give greater or lesser priority fromtime to time to these and other factors we may use in the estimation process.We also validate the adequacy of the allowance by comparing coverage ratios toour actual loss experience and to that of other credit card lenders.

 

Establishing an allowancefor credit losses that is adequate but not excessive requires significantjudgment. We forecast multiple scenarios and use alternative methods toestablish and test the adequacy of the allowance. The coverage ratios underthese varying scenarios and methods create a range of reasonable outcomes fromwhich we record our allowance. The use of estimates is inherent in ourassessment of the adequacy of the allowance for credit losses, and significantdifferences in these estimates could affect the adequacy of the allowance forcredit losses.

 

Different assumptionsregarding estimated net credit losses could materially affect our financialposition and results of operations. For example, a 10% increase in theprojected net credit losses estimated at June 30, 2005 would have resultedin an increase of approximately $42.2 million in the allowance for creditlosses and the provision for credit losses.

 

*Interest and Fee Income Recognition.*   Interest on loans is charged on eachcustomer’s billing cycle date based on the amount of loans outstanding andtheir contractual annual percentage rates. We recognize only the estimatedcollectible portion of accrued interest and fees (see discussion regardingour suppression methodology below). Interest income that we recognize that hasbeen billed to the customer is included in loans receivable or in due fromsecuritizations on the balance sheet. Accrued interest income that we recognizethat has not yet been billed to the customer is reported in interest receivableor in due from securitizations on the balance sheet. We estimate the unbilledportion of interest on customer accounts for the 

 

28

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month from the customer’s billing cycle dateto the end of the month. During the first quarter of 2005, we refined ourinterest accrual estimation process for the unbilled portion of interest oncustomer accounts by calculating the daily interest at the account level basedon account balances segmented by annual percentage rate and billing cycle date.The one-time impact of this change was to reduce, in the first quarter of 2005,reported and managed interest revenue by $4.4 million and $16.6 millionand reported and managed net interest margins by 25 basis points and 37 basispoints.

 

Under our suppressionmethodology, we do not recognize the estimated uncollectible portion of accruedinterest and fees on loans as interest income, creditproduct fee income, or servicing andsecuritization income on our income statement and do not include them in loansreceivable, interest receivable, or due from securitizations on our balancesheet. When loan principal amounts are charged off, related accrued interestand fees included in loans receivable, interest receivable, and due fromsecuritizations, to the extent not previously suppressed, are reversed againstincome.

 

We use multiple scenarios toestablish a range of reasonable levels of estimated uncollectible interest andfees, from which we determine the suppressed amounts when we record estimatedcollectible interest and fee income.  During the first quarter of 2005, weenhanced the estimation process used in our suppression methodology by usingportfolio segmentation that gives greater weight to customer risk scores andother risk factors, such as Fair Isaac Corporation (FICO®) creditscores. We continue to use other historical quantitative risk factors in ouranalysis, such as interest and fee reversal rates, delinquency roll rates,payment performance, and loans receivable balance composition data. The changein the estimation process has not have a material impact on our financialresults or condition.  When estimating uncollectible interest and feeamounts, we may give greater or lesser weight from time to time to these andother factors that we may use in the estimation process.

 

Different assumptionsregarding estimated uncollectible interest and fees could materially affect ourfinancial position and results of operations. For example, a 10% increase inthe projected uncollectible interest and fees estimated at June 30, 2005would have resulted in decreases of approximately $1.9 million to interestincome and $13.8 million to non-interest income.

 

*Earnings Summary*

 

Thefollowing discussion provides a summary of our earnings for the three and sixmonths ended June 30, 2005, compared to the three and six months ended June 30,2004. The significant components of our results of operations are covered infurther detail in subsequent sections.

 

Net income was$225.3 million, or $0.67 per diluted share, for the three months ended June 30,2005, compared to $49.9 million, or $0.16 per diluted share, for the sameperiod in 2004. Net income for the second quarter of 2005 included a benefit of$60.6 million, or $0.18 per diluted share, resulting primarily from thefinalization of various tax audits that were more favorably resolved thanpreviously anticipated. Net income was $358.3 million, or $1.08 perdiluted share, for the six months ended June 30, 2005, compared to $143.6 million,or $0.46 per diluted share, for the same period in 2004. Earnings per dilutedshare amounts include the dilutive effects of our contingently convertiblenotes resulting from our adoption of EITF Issue No. 04-8, “The Effect ofContingently Convertible Instruments on Diluted Earnings per Share” (“EITF 04-8”),in the third quarter of 2004. See Note 5 to our ConsolidatedFinancial Statements for further discussion.

 

Netrevenue (net interest income plus non-interest income) for the three monthsended June 30, 2005 was $610.3 million, compared to $516.7 millionfor the same period in 2004, an increase of $93.6 million. Net revenue forthe six months ended June 30, 2005 was $1.14 billion, compared to $1.02 billionfor the same period in 2004, an increase of $120.3 million. The increasesin net revenue for the three and six months ended June 30, 2005 reflectincreases in both net interest income and non-interest income.

 

Netinterest income increased by $48.7 million for the second quarter of 2005compared to the same period in 2004, and increased by $71.4 million forthe six months ended June 30, 2005 compared to the same period in 2004,primarily due to increases in interest income on loans and other interestincome and decreases in interest expense on deposits. The increases in interestincome on loans were primarily driven by increases in our reported loansreceivable, and the increases in other interest income were primarily driven byincreases in the average volume and yields of our investment securitiesportfolio. The decreases in interest expense resulted primarily from lowerinterest rates paid on our deposits.

 

Non-interestincome increased by $44.9 million for the second quarter of 2005 comparedto the same period in 2004, due primarily to an increase in servicing andsecuritization income of $48.2 million. The increase in servicing andsecuritization income resulted primarily from an increase in the fair valuesrecognized for our retained subordinated securityholders’ interests and spreadaccounts due to a reduction in market discount rates, higher discount accretionon 

 

29

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retained subordinatedsecurityholders’ interests and spread account balances, and net gainsrecognized from increases in the invested amounts of our variable fundingconduit facilities.

 

Non-interestincome increased by $48.9 million for the six months ended June 30,2005 compared to the same period in 2004, due to an increase in servicing andsecuritization income of $47.7 million, primarily resulting from net gainsrecognized from increases in the invested amounts of our variable fundingconduit facilities and an increase in the valuation of our interest-only stripsreceivable due to higher rates of improvement in excess servicing as comparedto the prior year. The increase in non-interest income for the six months endedJune 30, 2005 also reflects an increase in non-interest income3⁄4otherof $32.9 million due primarily to the gain recognized on the sale ofnon-core, higher risk loans in the first quarter of 2005, which was partiallyoffset by a decrease in credit product fee income of $31.7 million dueprimarily to our transition to higher-quality credit card account originations.

 

Our provisionfor credit losses was $96.4 million for the second quarter of 2005, adecrease of $85.6 million from the second quarter 2004 provision of $182.0 million.For the six months ended June 30, 2005, our provision for credit losseswas $157.2 million, a decrease of $113.6 million from the provisionof $270.9 million for the six months ended June 30, 2004. Thesedecreases, and the reduction in our loan loss coverage ratio from 8.72% at June 30,2004 to 6.14% at June 30, 2005, reflect the improving trend in our netcredit losses resulting from changes in our loan mix due to higher-qualityaccount originations and the sale of a portfolio of non-core, higher risk loansin the first quarter of 2005.

 

Forthe three months ended June 30, 2005, non-interest expense was $224.2 million,a $34.9 million decrease compared to non-interest expense of $259.1 millionfor the three months ended June 30, 2004. For the six months ended June 30,2005, non-interest expense was $485.2 million, a $39.9 milliondecrease compared to non-interest expense of $525.1 million for the sixmonths ended June 30, 2004. These reductions are primarily a result oflower personnel and related infrastructure costs associated with our workforcereductions in 2004 and the reversal in the second quarter of 2005 of interestexpense associated with previously established tax reserves. See “3⁄4Non-Interest Expense” for further discussion.

 

*Net Interest Income*

 

Netinterest income is interest earned from loans receivable and our investmentportfolios less interest expense from deposits and borrowings.

 

Reportednet interest income for the three months ended June 30, 2005 was $164.1 million,compared to $115.4 million for the three months ended June 30, 2004,an increase of $48.7 million. For the six months ended June 30, 2005,reported net interest income was $298.4 million, compared to $227.1 millionfor the six months ended June 30, 2004, an increase of $71.4 million.The increases in reported net interest income for the three and six monthsended June 30, 2005 were primarily driven by an increase in our reportedloans receivable during these periods and a decrease in our interest expense ondeposits. Additionally, other interest income increased for the three and sixmonths ended June 30, 2005 as a result of increases in the average volumeand yields of our investment securities portfolio.

 

Underthe suppression methodology, the interest accrued on loans that we estimate tobe uncollectible is not recognized as interest income on our income statementand is not included in loans receivable on our balance sheet. In addition,interest income is reduced by the reversal of accrued interest included inloans receivable (to the extent not previously suppressed) when the principalamount of a loan is charged off. For the three months ended June 30, 2005and 2004, reported interest income was reduced by $16.2 million and $20.2 milliondue to the suppression of estimated uncollectible interest and interest incomereversals. For the six months ended June 30, 2005 and 2004, reportedinterest income was reduced by $32.2 million and $37.4 million due tothe suppression of estimated uncollectible interest and interest incomereversals.

 

For the three months ended June 30,2005, interest expense was $112.8 million, compared to $123.0 millionfor the same period in 2004, a decrease of $10.2 million. For the sixmonths ended June 30, 2005, interest expense was $225.2 million,compared to $256.7 million for the same period in 2004, a decrease of$31.5 million. The decreases in interest expense for the three and sixmonths ended June 30, 2005 primarily reflect the lower interest rates paidon our deposits.

 

30

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*Statementof Average Balances, Income and Expense, Yields and Rates*

 

The following table providesan analysis of reported interest income, interest expense, net interest spread,and average balances for the three and six months ended June 30, 2005 and2004.

 

**Statement of Average Balances, Income andExpense, Yields and Rates**

** **
| ** **                                      | ** ** | **Three months ended June 30,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                      | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| **(dollars in thousands)**                      | ** ** | **Average Balance**                  | ** ** | **Income/ Expense** | ** ** | **Yield/ Rate** | ** ** | **Average Balance** | ** ** | **Income/ Expense** | ** ** | **Yield/ Rate** | ** ** |
| ** **                                      | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** |   | **As  Restated** | ** ** | **As  Restated** | ** ** | **As  Restated** |   |
| **Assets**                                      | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |   |
| Interest-earning assets                         |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Loans receivable                                |       | $                                    | 7,655,117  |   | $ | 231,841 |   | 12.11 | % | $ | 6,610,851 |   | $ | 209,621 |   | 12.68 | % |
| Interest-earning cash and cash equivalents      |       | 149,277                              |       | 1,111 |   | 2.98 | % | 524,252 |   | 1,187 |   | 0.91 | % |
| Federal funds sold                              |       | 506,615                              |       | 3,773 |   | 2.98 | % | 715,993 |   | 1,826 |   | 1.02 | % |
| Investment securities                           |       | 3,422,078                            |       | 23,916 |   | 2.80 | % | 3,075,349 |   | 13,730 |   | 1.79 | % |
| Other                                           |       | 564,132                              |       | 16,285 |   | 11.55 | % | 552,970 |   | 12,045 |   | 8.71 | % |
| Total interest-earning assets                   |       | 12,297,219                           |       | $ | 276,926 |   | 9.01 | % | 11,479,415 |   | $ | 238,409 |   | 8.31 | % |
|                                            |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for credit losses                     |       | (493,037                             | )          |   |   |   |   | (602,809 | ) |   |   |   |   |
| Other assets                                    |       | 2,232,896                            |       |   |   |   |   | 2,555,881 |   |   |   |   |   |
|                                            |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                    |       | $                                    | 14,037,078 |   |   |   |   |   | $ | 13,432,487 |   |   |   |   |   |
|                                            |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity**   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities                    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Deposits                                        |       | $                                    | 8,954,021  |   | $ | 96,415 |   | 4.31 | % | $ | 8,854,802 |   | $ | 106,746 |   | 4.82 | % |
| Borrowings                                      |       | 1,469,601                            |       | 16,407 |   | 4.47 | % | 1,444,375 |   | 16,257 |   | 4.50 | % |
| Total interest-bearing liabilities              |       | 10,423,622                           |       | $ | 112,822 |   | 4.33 | % | 10,299,177 |   | $ | 123,003 |   | 4.78 | % |
|                                            |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Other liabilities                               |       | 699,034                              |       |   |   |   |   | 740,350 |   |   |   |   |   |
| Total liabilities                               |       | 11,122,656                           |       |   |   |   |   | 11,039,527 |   |   |   |   |   |
|                                            |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Shareholders’ equity                       |       | 2,914,422                            |       |   |   |   |   | 2,392,960 |   |   |   |   |   |
|                                            |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Total liabilities and shareholders’ equity |       | $                                    | 14,037,078 |   |   |   |   |   | $ | 13,432,487 |   |   |   |   |   |
|                                            |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Net Interest Income and Spread**              |       |                                 |       | $ | 164,104 |   | 4.68 | % |   |   | $ | 115,406 |   | 3.53 | % |

 

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** **

**Statement of Average Balances, Income and Expense, Yields and Rates**

 
| ** **                                      | ** ** | **Six  months ended June 30,** | ** ** |
|-------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                      | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| **(dollars  in thousands)**                     | ** ** | **Average  Balance**                | ** ** | **Income/  Expense** | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Income/  Expense** | ** ** | **Yield/  Rate** | ** ** |
| ** **                                      | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** |   | **As  Restated** | ** ** | **As  Restated** | ** ** | **As  Restated** |   |
| **Assets**                                      | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** |   |   |   |   |   |   |   |
| Interest-earning assets                         |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Loans receivable                                |       | $                                   | 7,502,025  |   | $ | 435,244 |   | 11.60 | % | $ | 6,542,084 |   | $ | 427,521 |   | 13.07 | % |
| Interest-earning cash and cash equivalents      |       | 158,532                             |       | 2,042 |   | 2.58 | % | 474,523 |   | 2,189 |   | 0.92 | % |
| Federal funds sold                              |       | 481,500                             |       | 6,571 |   | 2.73 | % | 1,580,435 |   | 8,105 |   | 1.03 | % |
| Investment securities                           |       | 3,578,157                           |       | 47,277 |   | 2.64 | % | 2,455,871 |   | 23,816 |   | 1.94 | % |
| Other                                           |       | 586,623                             |       | 32,493 |   | 11.08 | % | 575,840 |   | 22,169 |   | 7.70 | % |
| Total interest-earning assets                   |       | 12,306,837                          |       | $ | 523,627 |   | 8.51 | % | 11,628,753 |   | $ | 483,800 |   | 8.32 | % |
|                                            |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for credit losses                     |       | (472,574                            | )          |   |   |   |   | (624,165 | ) |   |   |   |   |
| Other assets                                    |       | 2,183,378                           |       |   |   |   |   | 2,504,776 |   |   |   |   |   |
|                                            |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                    |       | $                                   | 14,017,641 |   |   |   |   |   | $ | 13,509,364 |   |   |   |   |   |
|                                            |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and Shareholders’ Equity**   |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities                    |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Deposits                                        |       | $                                   | 9,011,541  |   | $ | 192,304 |   | 4.27 | % | $ | 9,164,226 |   | $ | 221,642 |   | 4.84 | % |
| Borrowings                                      |       | 1,476,482                           |       | 32,887 |   | 4.45 | % | 1,343,806 |   | 35,073 |   | 5.22 | % |
| Total interest-bearing liabilities              |       | 10,488,023                          |       | $ | 225,191 |   | 4.29 | % | 10,508,032 |   | $ | 256,715 |   | 4.89 | % |
|                                            |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Other liabilities                               |       | 673,876                             |       |   |   |   |   | 639,009 |   |   |   |   |   |
| Total liabilities                               |       | 11,161,899                          |       |   |   |   |   | 11,147,041 |   |   |   |   |   |
|                                            |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Shareholders’ equity                       |       | 2,855,742                           |       |   |   |   |   | 2,362,323 |   |   |   |   |   |
|                                            |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| Total liabilities and shareholders’ equity |       | $                                   | 14,017,641 |   |   |   |   |   | $ | 13,509,364 |   |   |   |   |   |
|                                            |       |                                |       |   |   |   |   |   |   |   |   |   |   |
| **Net Interest Income and Spread**              |       |                                |       | $ | 298,436 |   | 4.22 | % |   |   | $ | 227,085 |   | 3.43 | % |

 

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*Interest Volume and Rate Variance Analysis*

 

Netinterest income is affected by changes in the average interest rate earned oninterest-earning assets and the average interest rate paid on interest-bearingliabilities. Net interest income is also affected by changes in the volume ofinterest-earning assets and interest-bearing liabilities. The following tablesets forth the dollar amount of the increase (decrease) in reported interestincome and expense resulting from changes in volumes and rates.

 

**Rate-Volume Variance Analysis**

 
| ** **                        | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                        | ** ** | **2005 vs. 2004**                    | ** ** | **2005 vs. 2004**                  | ** ** |
| ** **                        | ** ** | **Increase**                         | ** ** | **Change due to(1)**               | ** ** | **Increase** | ** ** | **Change due to(1)** | ** ** |
| **(dollars in thousands)**        | ** ** | **(Decrease)**                       | ** ** | **Volume**                         | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** | **Volume** | ** ** | **Rate** | ** ** |
| ** **                        | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Interest  Income**              |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |
| Loans  receivable                 |       | $                                    | 22,220     |                               | $          | 31,964 |   | $ | (9,744 | ) | $ | 7,723 |   | $ | 58,812 |   | $ | (51,089 | ) |
| Federal  funds sold               |       | 1,947                                |       | (670                               | )          | 2,617 |   | (1,534 | ) | (8,419 | ) | 6,885 |   |
| Investments  and other securities |       | 14,350                               |       | 628                                |       | 13,722 |   | 33,638 |   | 14,280 |   | 19,358 |   |
| Total interest income             |       | 38,517                               |       | 31,922                             |       | 6,595 |   | 39,827 |   | 64,673 |   | (24,846 | ) |
|                              |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |
| **Interest  Expense**             |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |
| Interest-bearing  deposits        |       | (10,331                              | )          | 1,173                              |       | (11,504 | ) | (29,338 | ) | (3,636 | ) | (25,702 | ) |
| Borrowings                        |       | 150                                  |       | 265                                |       | (115 | ) | (2,186 | ) | 3,273 |   | (5,459 | ) |
| Total interest expense            |       | (10,181                              | )          | 1,438                              |       | (11,619 | ) | (31,524 | ) | (363 | ) | (31,161 | ) |
|                              |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |
| **Net Interest Income**           |       | $                                    | 48,698     |                               | $          | 30,484 |   | $ | 18,214 |   | $ | 71,351 |   | $ | 65,036 |   | $ | 6,315 |   |

----

(1)          The changes due to both volumes and rateshave been allocated in proportion to the relationship of the absolute dollar amountsof the change in each. The changes in interest income and interest expense arecalculated independently for each line in the table.

 

 

*Allowanceand Provision for Credit Losses*

 

             We maintain our allowance for credit lossesat a level estimated to be adequate to absorb future principal charge-offs, netof recoveries, in the existing reported loan portfolio. We maintain theallowance for credit losses for reported loans only.

 

             We establish our allowance for credit lossesby analyzing historical risk behavior and credit loss trends and reviewingcurrent loss expectations that incorporate general economic conditions that mayimpact future losses. We combine quantitative factors (including customer riskscores, historical delinquency roll rates, historical credit loss rates, andother customer characteristics) with environmental credit risk factors toprepare comparative evaluations of the allowance for credit losses. During2004, we enhanced our estimation process by including segmentation that givesgreater weight to customer risk scores and age of accounts, as well as otherrisk factors, such as FICO® credit scores. This change in process has not had amaterial impact on our financial results or condition. When estimating futurecredit losses, we may give greater or lesser weight from time to time to theseand other factors that we may use in the estimation process.

 

             The environmental credit risk factors areconsistent with applicable bank regulatory guidelines and reflect ourassessment of general macroeconomic conditions, trends in loan portfolio volumeand seasoning, geographic concentrations, and modifications to loan review andunderwriting procedures, among other factors. We compare allowances establishedin prior periods with subsequent actual credit losses and perform a peer groupcomparative analysis of lagged loss rates to coverage ratios. We derive ourcoverage ratios by dividing the allowance for credit losses by the reportedloans outstanding at period end.

 

             We recognize credit losses by charging offthe principal balance no later than the last day of the calendar month in whichthe account becomes 180 days past due under the terms of the account agreement.Loans that have been restructured under our consumer debt management programare charged off no later than 120 days or 180 days after they becomecontractually past due, depending on an account’s delinquency status at thetime it entered the consumer debt management program and its subsequent paymenthistory. We recognize charge-offs for accounts of bankrupt and deceasedcustomers generally within 30 days after notification of bankruptcy and 60 daysafter verification of death. We record current period 

 

 

33

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principal recoveries on previously charged-offloans and proceeds from the sale of previously charged-off loans as a reductionto net credit losses.

**Allowance for Credit Losses**
| ** **                                                 | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(dollars in thousands)**                                 | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                 | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at  beginning of period                            |       | $                                    | 439,008    |                               | $          | 568,810 |   | $ | 599,703 |   | $ | 625,886 |   |
| Provision  for credit losses                               |       | 96,386                               |       | 182,017                            |       | 157,231 |   | 270,869 |   |
| Credit  losses                                             |       | (138,710                             | )          | (178,622                           | )          | (236,852 | ) | (367,440 | ) |
| Recoveries                                                 |       | 24,853                               |       | 28,274                             |       | 42,555 |   | 71,164 |   |
| Credit  losses on loans held for securitization or sale(1) |       | —                               |       | —                             |       | (141,100 | ) | — |   |
| Balance at  end of period                                  |       | $                                    | 421,537    |                               | $          | 600,479 |   | $ | 421,537 |   | $ | 600,479 |   |
|                                                       |       |                                 |       |                               |       |   |   |   |   |
| Reported  loans receivable at period end                   |       | $                                    | 6,866,451  |                               | $          | 6,883,942 |   |   |   |   |   |
|                                                       |       |                                 |       |                               |       |   |   |   |   |
| Coverage  ratios at period end                             |       | 6.14                                 | %          | 8.72                               | %          |   |   |   |   |

----

(1)          The decrease in allowance for credit losses of $141.1 millionin the six months ended June 30, 2005 represents the allowance for creditlosses that, together with the outstanding balances of the non-core, higherrisk loans, was transferred to loans held for securitization or sale as part ofthe adjustment to the fair value of approximately $309.3 million.

 

             The decrease in both the dollar amount of theallowance for credit losses and the coverage ratio (the allowance for creditlosses as a percentage of reported loans receivable) as of June 30, 2005compared to June 30, 2004 reflects the trend in our net credit losses resultingfrom changes in our loan mix due to higher-quality account originations and thesale of a portfolio of non-core, higher risk loans in the first quarter of2005. As we continue to evaluate the allowance for credit losses in light ofchanges in asset quality, regulatory requirements, general economic trends, andthe effect of our marketing strategy, we may make adjustments that would resultin further changes to the coverage ratio, which would impact our provision forcredit losses.

 

*Non-InterestIncome*

 

             *Servicing and Securitization Income*.   Servicingand securitization income relates primarily to securitized loans. It includesservicing fees, primarily relating to loans receivable transferred in oursecuritizations, excess servicing income, gains or losses related to thesecuritization of our loans receivable, and changes in the fair value of ourretained interests (see “—Securitizations of Loans Receivable”).

 

             As of June 30, 2005 and 2004, the totalprincipal amount of securitized loans outstanding was $11.42 billion and $10.08billion. For the three months ended June 30, 2005, servicing and securitizationincome was $308.1 million, an increase of $48.2 million from $259.8 million forthe three months ended June 30, 2004. Servicing and securitization income forthe three months ended June 30, 2005 includes a $3.8 million benefit from anincrease in the fair value recognized for our retained subordinatedsecurityholders’ interests and spread accounts due to a reduction in marketdiscount rates. The second quarter 2005 benefit compares to a $35.3 millioncharge in the same period of 2004 from a decrease in the fair value recognizedfor our retained subordinated securityholders’ interests and spread accounts.Changes in market discount rates are generally due to factors not within ourcontrol, such as changes in the U.S. economy, the current interest rateenvironment, and credit spread levels. In addition, the increase in servicingand securitization income for the second quarter of 2005 compared to the sameperiod in 2004 reflects higher discount accretion on retained subordinatedsecurityholders’ interests and spread account balances and net gains recognizedfrom increases in the invested amounts of our variable funding conduitfacilities. Offsetting these positive trends was a reduction in the rate ofimprovement to forecasted excess servicing, which impacts the valuation of ourinterest-only strips receivable.

 

             For the six months ended June 30, 2005,servicing and securitization income was $533.7 million, an increase of $47.7million from $485.9 million for the same period in 2004. The increase inservicing and securitization income for the six months ended June 30, 2005 isdue to net gains recognized from increases in the invested amounts of ourvariable funding conduit facilities and due to increases in the valuation ofour interest-only strips receivable resulting from higher rates of improvementin excess servicing as compared to the prior year, partially offset by adecrease in the fair value recognized for our retained subordinated securityholders’interests and spread accounts due to an increase in market 

 

 

 

34

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discount rates as compared to the six months ended June 30, 2004.

 

             Under thesuppression methodology, we do not recognize income associated with theinterest and fees on securitized loans that we estimate to be uncollectible asservicing and securitization income on the income statement or as due fromsecuritizations on the balance sheet. In addition, servicing and securitizationincome is reduced by the reversal of accrued interest and fees included in duefrom securitizations (to the extent not previously suppressed) when theprincipal amount of a securitized loan is charged off. For the three monthsended June 30, 2005 and 2004, the amounts of servicing and securitizationincome not recognized as a result of the suppression of estimated uncollectibleinterest and fees and interest and fee income reversals were $89.6 million and$103.8 million. For the six months ended June 30, 2005 and 2004, the amounts ofservicing and securitization income not recognized as a result of thesuppression of estimated uncollectible interest and fees and interest and feeincome reversals were $185.0 million and $212.3 million.

 

             In January 2005,we ceased serving as interim accounts owner of the portfolio of higher riskassets we sold in 2002, when we transferred ownership of such accounts to athird party accounts owner. Prior to January 2005, we served as interimaccounts owner of such higher risk assets and recorded the related compensationreceived as servicing and securitization income. The termination of thecompensation we were receiving as interim accounts owner has not had a materialimpact on our earnings.

 

             *Credit Product Fee Income*.   Creditproduct fee income includes performance fees (late, overlimit, and returnedcheck charges), annual membership fees, and cash advance and balance transferfees, which are assessed in accordance with the terms of the customer’s accountagreement. Annual membership and balance transfer fee revenue are recognizedratably over the customer privilege period, which is currently one year.Performance fees and cash advance fees are recognized when earned. Creditproduct fee income also includes revenue from cardholder service productsbilled annually, which is recognized ratably over the customer privilegeperiod, revenue from cardholder service products billed monthly, which isrecognized in the month it is billed, and revenue from interchange fees receivedfrom bankcard associations, which is based on the purchase activity of ourcredit card customers.

 

             For the threemonths ended June 30, 2005, credit product fee income was $129.6 million, adecrease from $137.1 million for the same period in 2004. For the six monthsended June 30, 2005, credit product fee income was $254.5 million, a decreasefrom $286.2 million for the same period in 2004. These decreases primarilyreflect our transition to higher-quality credit card account originations,which resulted in lower late and overlimit fees and lower cardholder serviceproduct and annual membership fee revenue.

 

             In accordancewith GAAP, we capitalize direct loan origination costs associated withsuccessful account acquisition efforts. We amortize capitalized loanorigination costs over the customer privilege period for credit card loans,unless the loans are securitized, in which case we recognize the remainingcosts as an expense at the time we enter into the securitization. Theamortization of capitalized loan origination costs, which is classified as areduction to credit product fee income, totaled $6.5 million and $5.3 millionfor the three months ended June 30, 2005 and 2004, and $12.7 million and $10.6million for the six months ended June 30, 2005 and 2004.

 

             Under thesuppression methodology, we do not recognize fees on loans that we estimate tobe uncollectible as credit product fee income on our income statement or asloans receivable on our balance sheet. In addition, credit product fee incomeis reduced by the reversal of accrued fees included in loans receivable (to theextent not previously suppressed), when the principal amount of a loan ischarged off. For the three months ended June 30, 2005 and 2004, the amounts ofcredit product fee income not recognized as a result of the suppression ofestimated uncollectible fees and fee income reversals were $17.0 million and$28.8 million. For the six months ended June 30, 2005 and 2004, the amounts ofcredit product fee income not recognized as a result of the suppression ofestimated uncollectible fees and fee income reversals were $37.2 million and$56.4 million. The decreases in the amount of suppressed credit product feeincome for the three and six months ended June 30, 2005 as compared to the sameperiods in 2004 are in line with the decreases in credit product fee incomediscussed above.

 

             *Other*.   Non-interestincome—other was $8.5 million and $4.4 million for the three months ended June30, 2005 and 2004. For the six months ended June 30, 2005 and 2004,non-interest income—other was $48.9 million and $15.9 million. The increase of$32.9 million in non-interest income—other for the six months ended June 30,2005 over the same period in 2004 was primarily due to the gain recognized onthe sale of a portfolio of non-core, higher risk loans in the first quarter of2005. See Note 9 to our Consolidated Financial Statements for furtherdiscussion.

 

 

 

35

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*Non-Interest Expense*

 

             Non-interestexpense includes salary and employee benefits costs; solicitation andadvertising costs; occupancy, furniture, and equipment costs; data processingand communication costs; and other non-interest expense. The following tablepresents non-interest expense for the three and six months ended June 30, 2005and 2004. Overall, the decreases in non-interest expense reflect our efforts toincrease operational efficiency and reduce our infrastructure to an appropriatelevel.

**Summary of Non-Interest Expense**

 
| ** **                                                          | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(dollars in thousands)**                                          | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Salaries and employee benefits                                      |       | $                                    | 67,125     |                               | $          | 70,048 |   | $ | 131,148 |   | $ | 151,528 |   |
| Solicitation and advertising                                        |       | 64,312                               |       | 65,410                             |       | 127,749 |   | 117,981 |   |
| Occupancy, furniture, and equipment                                 |       | 16,724                               |       | 22,026                             |       | 34,223 |   | 48,239 |   |
| Data processing and communication                                   |       | 29,505                               |       | 27,050                             |       | 59,443 |   | 54,098 |   |
| Other                                                               |       | 46,564                               |       | 74,559                             |       | 132,655 |   | 153,253 |   |
| Total non-interest expense                                          |       | $                                    | 224,230    |                               | $          | 259,093 |   | $ | 485,218 |   | $ | 525,099 |   |
| Less: solicitation and advertising                                  |       | (64,312                              | )          | (65,410                            | )          | (127,749 | ) | (117,981 | ) |
| Total non-interest expense, excluding  solicitation and advertising |       | $                                    | 159,918    |                               | $          | 193,683 |   | $ | 357,469 |   | $ | 407,118 |   |

 

Salary andemployee benefits costs include staffing costs associated with marketing,customer service, collections, and administration. Since the second half of2003, our outsourcing arrangements with Accenture, Computer SciencesCorporation and other service providers have contributed to a reduction insalaries and employee benefits expense, which has been partially offset by anincrease in other non-interest expense.

 

Solicitationand advertising costs include printing, postage, telemarketing, listprocessing, and credit bureau costs paid to third parties in connection withaccount solicitation efforts and also include costs incurred to promote ourproducts. Solicitation and advertising costs are expensed as incurred.Solicitation and advertising expense remained relatively flat for the quarterended June 30, 2005 compared to the same period in 2004 and increased by$9.8 million for the six months ended June 30, 2005 compared to thesame period in 2004, reflecting increases in our marketing and accountsolicitation activity and increased use of third party marketing serviceproviders.

 

In connectionwith workforce reductions and the closure of facilities from time to time, werecord charges related to employee severance, premises, equipment, andfurniture lease expenses, fixed asset write-downs, and disposition costs. At June 30,2005, we had remaining accruals of $8.6 million for costs expected to bepaid in the future, primarily for premises, equipment, and furniture leasecosts associated with property no longer in use. This amount included $0.8 millionfor accrued but unpaid costs associated with the closure of our facilities inLouisville, Kentucky in the first quarter of 2004 and $1.0 million and$4.7 million for costs associated with the closures of our San Antonio,Texas and Oakland, California facilities in the fourth quarter of 2004. Inconnection with the closure of our Louisville facilities, we also recognized$3.4 million of severance and fixed asset write-down expense during thefirst quarter of 2004. 

 

Non-interest expense—otherincludes operational expenses such as collection costs, outsourcing servicescosts, fraud losses, and bankcard association assessments. Non-interestexpense—other decreased by $28.0 million for the three months ended June 30,2005, compared to the same period in 2004, and decreased by $20.6 millionfor the six months ended June 30, 2005, compared to the same period in2004, due primarily to a reversal in the second quarter of 2005 of $31.7 millionof interest expense associated with previously established tax liabilities.This reversal resulted from the finalization of various tax audits that weremore favorably resolved than previously anticipated and from reassessment oftax exposures covering the years 1997 through 2005. See further discussionof tax expense in “—Income Taxes.”

*Income Taxes*

 

We have tax exposuresrelating to our assessment of tax liabilities in the ordinary course ofbusiness. We periodically assess our liabilities and contingencies for allyears subject to potential tax audit based on the latest information available.For those matters where it is probable that an adjustment will be asserted, wehave recorded our best estimate of the entire amount of the tax liability(including related interest charges for such tax liabilities) related to suchmatters in our consolidated financial statements. Subsequent events that resultin an increase or decrease to our total assessment of tax exposures for suchtax liabilities are reflected in current period earnings.

 

We recognizedincome tax expense of $64.3 million and $25.6 million for the three monthsended June 30, 2005 and 

 

36

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2004. For the six monthsended June 30, 2005 and 2004, we recognized income tax expense of $134.6 millionand $75.6 million. Our effective income tax rates for the three and sixmonths ended June 30, 2005 were 22.21% and 27.31%, and for the three andsix months ended June 30, 2004 were 33.94% and 34.48%, as restated. Theeffective income tax rates include federal and state components and theutilization of tax credits generated from an existing investment in a limitedliability entity that operates an alternative energy plant.

             The decrease in the effective tax rates for the threeand six months ended June 30, 2005 is primarily due to net reductions ofpreviously established tax liabilities. During the three months ended June 30,2005, we recorded a reduction of $40.2 million of previously accruedincome tax expense and a reversal of $31.7 million of interest expenserelated to previously established tax liabilities, which had the effect ofincreasing net income by $60.6 million in the second quarter of 2005, or$0.18 per diluted share. These net reversals resulted from the finalization ofvarious tax audits that were more favorably resolved than previouslyanticipated and from reassessment of tax exposures covering the years 1997through 2005. Although the final resolution of remaining tax exposures isuncertain, in the opinion of management, based on current information, theultimate disposition of these open tax matters is not expected to have amaterial adverse effect on our financial condition or results of operations.

 

Without the benefit of the reduction of previouslyaccrued income tax expense, the effective tax rate for the three and six monthsended June 30, 2005 would have been 35.7%.

 

*Securitizations of LoansReceivable*

 

A securitization is a financingtransaction that provides liquidity and capital through the transfer offinancial assets. Our securitizations involve the transfer of a pool of loansreceivable to a securitization trust. The trust or other special-purpose entitythrough which asset-backed securities are issued meets the criteria under SFASNo. 140 for a qualifying special-purpose entity that is not consolidatedin our financial statements. Our transactions qualify for sale treatment underGAAP and the loans receivable are removed from our balance sheet.

 

In a securitization, weauthorize the trust to issue, directly or through other special-purposeentities, investor securities, called securityholders’ interests, backed by theloans receivable transferred to the trust. These securities represent undividedinterests in the pool of loans receivable and the right to receive futurecollections of principal, interest, and fees on the receivables. We sellcertain classes of these securities to third party investors, using variousforms of credit enhancement so that these classes will receive credit ratingsthat allow them to be sold in underwritten offerings or private placements. Inaddition to the securityholders’ interests, the structure of the securitizationcreates certain other interests in the securitized pool of loans, which weretain, including a seller’s interest, interest-only strips receivable, spreadaccounts, and an accrued interest receivable. We also retain thesecurityholders’ interests not sold to investors and include them on our balancesheet.

 

We typically recognize a net gain from the initialsale of investor interests to third parties, due primarily to the release ofthe related allowance for credit losses and recognition of a gain from theinterest-only strip receivable, which is partially offset by the recognition ofa loss from discounts recognized in establishing the fair value of the retainedsubordinated interests. See “—Overview of Critical Accounting Policies.” During the three and six months ended June 30,2005, we securitized loans receivable by increasing the invested amount of ourvariable funding conduit facilities by $1.43 billion and $1.63 billion,which were offset by reductions of $691.7 million and $939.3 millionfrom the repayment of certain term series and reductions in the investedamounts of our variable funding conduit facilities.****Excludingthe benefit realized from the reduction to the allowance for credit losses, werecognized gains of $18.2 million and $21.3 million related to suchincreases in the invested amount during the three and six months ended June 30,2005.****Duringthe three and six months ended June 30, 2004, we securitized $802.5 millionand $1.72 billion of loans receivable, which were offset by $920.8 millionand $1.97 billion from the repayment of certain term series and areduction in the invested amount of our variable funding conduit facilities. Excludingthe benefit realized from the reduction to the allowance for credit lossesrecognized at the time of sale, we recognized a gain of $7.6 million and a loss of $6.5 million related to newsecuritizations during the three and six months ended June 30, 2004.

 

37

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The total amount of securitizedloans as of June 30, 2005 and December 31, 2004 was $11.42 billionand $10.73 billion. The following table presents the fair value (carryingvalue, net of any discounts) of our retained interests in the securitized loansreceivable, which retained interests were reported in due from securitizationsat June 30, 2005 and December 31, 2004.

**Due from Securitizations**
| **(dollars in thousands)**                             | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| Retained  subordinated securityholders’ interests |       | $                      | 1,366,626  |                       | $          | 1,251,254 | ** ** |
| Interest-only  strips receivable                       |       | 299,862                |       | 299,830                    |       |
| Spread  accounts                                       |       | 251,697                |       | 246,195                    |       |
| Accrued  interest receivable                           |       | 324,905                |       | 352,817                    |       |
| Other(1)                                               |       | 166,641                |       | 116,218                    |       |
| Total due from securitizations                         |       | $                      | 2,409,731  |                       | $          | 2,266,314 |   |

----

(1)          Amountsconsist primarily of funds deposited in the trust collection account and not yetdistributed.

 

*Non-GAAPManaged Financial Information*

* *

Loansthat have been securitized and sold to third party investors are not consideredto be our assets under GAAP and therefore are not shown on our balance sheet.However, the interests we retain in the securitized loan pools create financialexposure to the current and expected cash flows of the securitized loans (see “—Securitizationsof Loans Receivable”). The performance of these loans can affect the recordedvalues of our retained interests included in due from securitizations andservicing and securitization income. We also continue to service these loans.

 

Becauseof this continued exposure and involvement, we use managed financialinformation to evaluate our historical performance, assess our currentcondition, and plan our future operations. We believe that managed financialinformation supplements our GAAP information and is helpful to the reader’sunderstanding of our consolidated financial condition and results ofoperations. “Reported” financial information refers to GAAP financialinformation. “Managed” financial information is derived by adjusting thereported financial information to add back securitized loan balances and therelated interest and fee income, credit losses, and net interest costs.

 

Whenmaking disclosures regarding our expected future performance, including thosecontained in this report, we disclose certain projected financial measuresrelating to expected performance on a managed basis. We develop suchprojections on a managed basis using managed financial information and do notin the normal course of business derive comparable GAAP projections. Developingsuch comparable GAAP projections would be unreasonably burdensome and, in theopinion of management, such comparable GAAP projections would not provide tothe users of the financial information a significant benefit in understandingour expected future performance.

 

38

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**Reconciliation of Selected Reported Earnings**

**to Selected Managed Earnings**

 
| ** **                              | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(dollars in thousands)**              | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                              | ** ** | ** **                           | ** ** | **As Restated**                    | ** ** | ** ** | ** ** | **As Restated** | ** ** |
| **Adjusted and Risk Adjusted Margins:** |       |                                 |       |                               |       |   |   |   |   |
| **Reported**                            |       |                                 |       |                               |       |   |   |   |   |
| Interest income from loans              |       | $                                    | 231,841    |                               | $          | 209,621 |   | $ | 435,244 |   | $ | 427,521 |   |
| Allocated interest expense              |       | (70,232                              | )          | (70,837                            | )          | (137,276 | ) | (144,428 | ) |
| Credit product fee income               |       | 129,565                              |       | 137,064                            |       | 254,471 |   | 286,208 |   |
| Net credit losses                       |       | (113,857                             | )          | (150,348                           | )          | (194,297 | ) | (296,276 | ) |
| Adjusted margin                         |       | 177,317                              |       | 125,500                            |       | 358,142 |   | 273,025 |   |
| Servicing and securitization income     |       | 308,076                              |       | 259,834                            |       | 533,662 |   | 485,925 |   |
| Other non-interest income               |       | 8,530                                |       | 4,360                              |       | 48,850 |   | 15,904 |   |
| Risk adjusted margin(1)                 |       | 493,923                              |       | 389,694                            |       | 940,654 |   | 774,854 |   |
|                                    |       |                                 |       |                               |       |   |   |   |   |
| **Securitization Adjustments**          |       |                                 |       |                               |       |   |   |   |   |
| Interest income from loans              |       | $                                    | 501,030    |                               | $          | 493,677 |   | $ | 997,909 |   | $ | 998,732 |   |
| Allocated interest expense              |       | (85,480                              | )          | (56,229                            | )          | (165,611 | ) | (116,058 | ) |
| Credit product fee income               |       | 114,403                              |       | 124,242                            |       | 243,019 |   | 251,751 |   |
| Net credit losses                       |       | (263,364                             | )          | (375,057                           | )          | (561,730 | ) | (808,701 | ) |
| Servicing and securitization income     |       | (255,447                             | )          | (191,129                           | )          | (493,208 | ) | (339,286 | ) |
|                                    |       |                                 |       |                               |       |   |   |   |   |
| **Managed**                             |       |                                 |       |                               |       |   |   |   |   |
| Interest income from loans              |       | $                                    | 732,871    |                               | $          | 703,298 |   | $ | 1,433,153 |   | $ | 1,426,253 |   |
| Allocated interest expense              |       | (155,712                             | )          | (127,066                           | )          | (302,887 | ) | (260,486 | ) |
| Credit product fee income               |       | 243,968                              |       | 261,306                            |       | 497,490 |   | 537,959 |   |
| Net credit losses                       |       | (377,221                             | )          | (525,405                           | )          | (756,027 | ) | (1,104,977 | ) |
| Adjusted margin                         |       | 443,906                              |       | 312,133                            |       | 871,729 |   | 598,749 |   |
| Servicing and securitization income     |       | 52,629                               |       | 68,705                             |       | 40,454 |   | 146,639 |   |
| Other non-interest income               |       | 8,530                                |       | 4,360                              |       | 48,850 |   | 15,904 |   |
| Risk adjusted margin(1)                 |       | $                                    | 505,065    |                               | $          | 385,198 |   | $ | 961,033 |   | $ | 761,292 |   |
|                                    |       |                                 |       |                               |       |   |   |   |   |
| **Net Interest Income:**                |       |                                 |       |                               |       |   |   |   |   |
| **Reported**                            |       |                                 |       |                               |       |   |   |   |   |
| Interest income from loans              |       | $                                    | 231,841    |                               | $          | 209,621 |   | $ | 435,244 |   | $ | 427,521 |   |
| Interest income from investments        |       | 45,085                               |       | 28,788                             |       | 88,383 |   | 56,279 |   |
| Interest expense                        |       | (112,822                             | )          | (123,003                           | )          | (225,191 | ) | (256,715 | ) |
| Net interest income                     |       | 164,104                              |       | 115,406                            |       | 298,436 |   | 227,085 |   |
|                                    |       |                                 |       |                               |       |   |   |   |   |
| **Securitization Adjustments**          |       |                                 |       |                               |       |   |   |   |   |
| Interest income from loans              |       | $                                    | 501,030    |                               | $          | 493,677 |   | $ | 997,909 |   | $ | 998,732 |   |
| Interest income from investments        |       | (13,924                              | )          | (10,803                            | )          | (28,166 | ) | (19,598 | ) |
| Interest expense                        |       | (82,698                              | )          | (40,932                            | )          | (157,822 | ) | (82,901 | ) |
|                                    |       |                                 |       |                               |       |   |   |   |   |
| **Managed**                             |       |                                 |       |                               |       |   |   |   |   |
| Interest income from loans              |       | $                                    | 732,871    |                               | $          | 703,298 |   | $ | 1,433,153 |   | $ | 1,426,253 |   |
| Interest income from investments        |       | 31,161                               |       | 17,985                             |       | 60,217 |   | 36,681 |   |
| Interest expense                        |       | (195,520                             | )          | (163,935                           | )          | (383,013 | ) | (339,616 | ) |
| Net interest income                     |       | $                                    | 568,512    |                               | $          | 557,348 |   | $ | 1,110,357 |   | $ | 1,123,318 |   |

----

(1)          Risk adjusted margin measures loan portfolioprofitability by comparing the revenue generated by customer accounts with therelated funding costs and risk of loss. Risk adjusted margin consists ofinterest income plus non-interest income (including non-interestincome—servicing and securitization and non-interest income—other) less interestexpense allocated to loans and net credit losses. Therefore, this measureincludes fluctuations from changes in the fair values of retained interests andnon-recurring gains or losses included in non-interest income—other. To providean ongoing measure of loan profitability that is not subject to suchfluctuations we use adjusted margin.

 

39

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**Reconciliation of Selected Reported Financial Data**

**to Selected Managed Financial Data**

 
| ** **                     | ** ** | **June 30,** | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|--------------------------------|------------|-------------------|------------|---------------|------------|-----------------------|------------|-------------------|------------|
| **(dollars in thousands)**     | ** ** | **2005**          | ** ** | **2005**      | ** ** | **2004**              | ** ** | **2004**          | ** ** |
| ** **                     | ** ** | ** **        | ** ** | ** **    | ** ** | ** **            | ** ** | **As Restated**   | ** ** |
| **Selected Financial Data:**   |       |              |       |          |       |                  |       |              |       |
| **Reported**                   |       |              |       |          |       |                  |       |              |       |
| Period End:                    |       |              |       |          |       |                  |       |              |       |
| Delinquent loans               |       | $                 | 221,792    |          | $          | 224,632               |       | $                 | 346,942    |   | $ | 326,011 |   |
| Loans receivable               |       | 6,866,451         |       | 7,127,214     |       | 7,522,401             |       | 6,883,942         |       |
| Total assets                   |       | 14,079,027        |       | 14,046,732    |       | 14,344,539            |       | 13,535,380        |       |
|                           |       |              |       |          |       |                  |       |              |       |
| Three-Month Average:           |       |              |       |          |       |                  |       |              |       |
| Loans receivable               |       | $                 | 7,655,117  |          | $          | 7,164,104             |       | $                 | 6,935,564  |   | $ | 6,610,851 |   |
| Earning assets                 |       | 12,297,219        |       | 12,026,887    |       | 12,371,406            |       | 11,479,415        |       |
| Total assets                   |       | 14,037,078        |       | 14,104,663    |       | 14,340,248            |       | 13,432,487        |       |
|                           |       |              |       |          |       |                  |       |              |       |
| **Securitization Adjustments** |       |              |       |          |       |                  |       |              |       |
| Period End:                    |       |              |       |          |       |                  |       |              |       |
| Delinquent loans               |       | $                 | 677,246    |          | $          | 708,784               |       | $                 | 794,535    |   | $ | 784,147 |   |
| Loans receivable               |       | 11,699,467        |       | 10,961,605    |       | 11,013,352            |       | 10,361,415        |       |
| Total assets                   |       | 9,907,015         |       | 9,292,832     |       | 9,292,832             |       | 8,660,783         |       |
|                           |       |              |       |          |       |                  |       |              |       |
| Three-Month Average:           |       |              |       |          |       |                  |       |              |       |
| Loans receivable               |       | $                 | 10,506,512 |          | $          | 10,814,902            |       | $                 | 10,928,190 |   | $ | 10,167,072 |   |
| Earning assets                 |       | 10,506,512        |       | 10,814,902    |       | 10,928,190            |       | 10,167,072        |       |
| Total assets                   |       | 8,882,120         |       | 9,139,498     |       | 9,134,339             |       | 8,599,879         |       |
|                           |       |              |       |          |       |                  |       |              |       |
| **Managed**                    |       |              |       |          |       |                  |       |              |       |
| Period End:                    |       |              |       |          |       |                  |       |              |       |
| Delinquent loans               |       | $                 | 899,038    |          | $          | 933,416               |       | $                 | 1,141,477  |   | $ | 1,110,158 |   |
| Loans receivable               |       | 18,565,918        |       | 18,088,819    |       | 18,535,753            |       | 17,245,357        |       |
| Total assets                   |       | 23,986,042        |       | 23,339,564    |       | 23,637,371            |       | 22,196,163        |       |
|                           |       |              |       |          |       |                  |       |              |       |
| Three-Month Average:           |       |              |       |          |       |                  |       |              |       |
| Loans receivable               |       | $                 | 18,161,629 |          | $          | 17,979,006            |       | $                 | 17,863,754 |   | $ | 16,777,923 |   |
| Earning assets                 |       | 22,803,731        |       | 22,841,789    |       | 23,299,596            |       | 21,646,487        |       |
| Total assets                   |       | 22,919,198        |       | 23,244,161    |       | 23,474,587            |       | 22,032,366        |       |

 

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*LoanPerformance Measures.  *We present key loan performance measures on a reported and a managedbasis. Reported loans do not necessarily have the same income or creditcharacteristics as securitized loans and can perform differently over time.Although managed loan performance measures include both reported andsecuritized loans, the securitized loans will have a more significant impact onthe managed loan performance numbers because our securitized receivablesbalance is substantially larger than our reported receivables balance. Inaddition, when loans are securitized, there is a potentially significant impacton reported loan performance as loans are removed from loans receivable on ourbalance sheet or reclassified to loans held for securitization or sale, whilethere is generally no significant impact on managed loan performance.

 

**Loan Performance Statistics**

** **
| ** **                                     | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                     | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                     | ** ** | ** **                           | ** ** | **As Restated**                    | ** ** | ** ** | ** ** | **As Restated** | ** ** |
| **Reported**                                   |       |                                 |       |                               |       |   |   |   |   |
| Net interest margin on average loans(1)        |       | 8.44                                 | %          | 8.39                               | %          | 7.94 | % | 8.65 | % |
| Net interest margin on average earning  assets |       | 5.34                                 | %          | 4.02                               | %          | 4.85 | % | 3.91 | % |
| Adjusted margin on average loans(2)            |       | 9.26                                 | %          | 7.58                               | %          | 9.54 | % | 8.34 | % |
| Risk adjusted margin on average loans(3)(4)    |       | 25.80                                | %          | 23.57                              | %          | 25.07 | % | 23.68 | % |
| Return on average assets                       |       | 6.42                                 | %          | 1.49                               | %          | 5.11 | % | 2.13 | % |
|                                           |       |                                 |       |                               |       |   |   |   |   |
| **Managed**                                    |       |                                 |       |                               |       |   |   |   |   |
| Net interest margin on average loans(5)        |       | 12.71                                | %          | 13.74                              | %          | 12.44 | % | 13.93 | % |
| Net interest margin on average earning  assets |       | 9.97                                 | %          | 10.30                              | %          | 9.67 | % | 10.29 | % |
| Adjusted margin on average loans(6)            |       | 9.77                                 | %          | 7.44                               | %          | 9.59 | % | 7.16 | % |
| Risk adjusted margin on average loans(4)(7)    |       | 11.12                                | %          | 9.18                               | %          | 10.57 | % | 9.10 | % |
| Return on average assets                       |       | 3.93                                 | %          | 0.91                               | %          | 3.11 | % | 1.30 | % |

----

(1)          Represents interest income, less interestexpense, expressed as a percentage of reported average loans receivable.Interest expense is allocated to reported average loans receivable based on theratio of reported average loans receivable to reported average earning assets.

(2)          Represents interest income, less interestexpense and net credit losses, plus credit product fee income on reportedaverage loans receivable, expressed as a percentage of reported average loansreceivable. Interest expense is allocated to reported average loans receivablebased on the ratio of reported average loans receivable to reported averageearning assets.

(3)          Represents interest income, less interestexpense and net credit losses, plus non-interest income, expressed as apercentage of reported average loans receivable.  Interest expense isallocated to reported average loans receivable based on the ratio of reportedaverage loans receivable to reported average earning assets.

(4)          Risk adjusted margin measures loan portfolioprofitability by comparing the revenue generated by customer accounts with therelated funding costs and risk of loss. Risk adjusted margin consists ofinterest income plus non-interest income (including non-interestincome—servicing and securitization and non-interest income—other) lessinterest expense allocated to loans and net credit losses. Therefore, thismeasure includes fluctuations from changes in the fair values of retainedinterests and non-recurring gains or losses included in non-interestincome—other. To provide an ongoing measure of loan profitability that is notsubject to such fluctuations, we use adjusted margin.

(5)          Represents interest income, less interestexpense, expressed as a percentage of managed average loans receivable.Interest expense is allocated to managed average loans receivable based on theratio of managed average loans receivable to managed average earning assets.

(6)          Represents interest income, less interestexpense and net credit losses, plus credit product fee income on managedaverage loans receivable, expressed as a percentage of managed average loansreceivable. Interest expense is allocated to managed average loans receivablebased on the ratio of managed average loans receivable to managed averageearning assets.

(7)          Represents interest income, less interestexpense and net credit losses, plus non-interest income, expressed as apercentage of managed average loans receivable.  Interest expense isallocated to managed average loans receivable based on the ratio of managedaverage loans receivable to managed average earning assets.

 

*Net Interest Margin*.   Our reported net interest margin onaverage loans increased to 8.44% for the second quarter of 2005, from 8.39% forthe same period in 2004. Managed net interest margin on average loans decreasedto 12.71% for the second quarter of 2005, from 13.74% for the same period in2004. The increase in the reported net interest margin for the 

 

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second quarter of 2005 was primarily drivenby the increase in our reported loans receivable during the quarter and thedecrease in our interest expense on deposits. The decrease in the managed netinterest margin for the second quarter of 2005 was primarily driven by thedecrease in the yield on managed loans receivable. The yield on our reportedloans receivable decreased to 12.11% for the second quarter of 2005, from12.68% for the same period in 2004. The yield on our managed loans receivabledecreased to 16.14% for the second quarter of 2005, from 16.77% for the sameperiod in 2004. The lower yields in the second quarter of 2005 are primarily aresult of our continuing efforts to generate a higher-quality loan portfolio byincreasing the percentage of higher credit quality accounts, which generallyhave lower annual percentage rates, including lower and longer introductoryrates.

 

Reported earning assetsinclude consumer loans, interest-earning cash, federal funds sold andsecurities purchased under resale agreements, investment securities, spreadaccounts, and interest-only strips receivable. Managed earning assets includereported earning assets plus the loans receivable removed or reclassified fromloans receivable on our balance sheet through our securitizations, less theretained interests from securitizations reported on our balance sheet. Net interestincome expressed as a percentage of average earning assets is referred to asnet interest margin on average earning assets. The reported net interest marginon average earning assets increased to 5.34% for the second quarter of 2005from 4.02% for the same period in 2004, primarily due to the increase in ourreported loans receivable during the quarter and the decrease in our interestexpense on deposits. The managed net interest margin on average earning assetsdecreased to 9.97% for the second quarter of 2005 from 10.30% for the sameperiod in 2004. This decrease primarily reflects the lower yields earned on ourmanaged earning assets.

 

*Adjusted Margin.*   One of the ways we measure loan portfolio profitability is by comparingthe revenue generated by customer accounts with the related funding costs andrisk of loss. Adjusted margin consists of interest income plus non-interestincome—credit product fee income less interest expense allocated to loans andnet credit losses. This measure excludes non-interest income—servicing andsecuritization and non-interest income—other to provide an ongoing measure ofloan profitability that excludes fluctuations from changes in the fair valuesof retained interests and non-recurring gains or losses. Adjusted margin is expressedin dollars or as a percentage of average loans receivable.

 

Reportedadjusted margins for the second quarter of 2005 were $177.3 million and9.26%, compared to $125.5 million and 7.58% for the second quarter of2004. Reported adjusted margins for the six months ended June 30, 2005were $358.1 million and 9.54%, compared to $273.0 million and 8.34%for the same period in 2004.

 

Managedadjusted margins for the second quarter of 2005 were $443.9 million and9.77%, compared to $312.1 million and 7.44% for the second quarter of2004. Managed adjusted margins for the six months ended June 30, 2005 were$871.7 million and 9.59%, compared to $598.8 million and 7.16% forthe same period in 2004. The increases in the reported and managed adjustedmargins for the three and six months ended June 30, 2005 are primarily dueto decreases in net credit losses and increases in interest income from loans,partially offset by reduced fee income associated with our transition tohigher-quality accounts.

 

*Asset Quality*

 

Our delinquencies and netcredit losses reflect, among other factors, the credit quality of our loansreceivable, the average age of our loans receivable (generally referred to as “seasoning”),the success of our collection and recovery efforts, including sales ofcharged-off assets, and general economic conditions. Initially, credit qualityis primarily determined by the characteristics of the targeted market segmentand the underwriting and line assignment criteria utilized in the creditapproval process. As an account ages, account management efforts, seasoning,and demographic and economic conditions will affect overall credit quality.

 

We measure the creditperformance of our portfolio of loans receivable through two key rates, the 30+day delinquency rate and the net credit loss rate. The 30+ day delinquency rateon reported loans was 3.23% as of June 30,2005, compared to 4.61% as of December 31, 2004 and 4.74% as of June 30,2004. The 30+ day delinquency rate on managed loans was 4.84% as of June 30,2005, compared to 6.16% as of December 31, 2004 and 6.44% as of June 30,2004. The reported net credit loss rate was 5.95% for the three months ended June 30,2005, compared to 9.10% for the three months ended June 30, 2004. Themanaged net credit loss rate was 8.31% for the three months ended June 30,2005, compared to 12.53% for the three months ended June 30, 2004.

 

The improved performanceover the past year in both our reported and managed 30+ day delinquency ratesand our reported and managed net credit loss rates primarily reflects theimpact of higher quality account originations and the sale of a portfolio ofnon-core, higher risk loans during the first quarter of 2005.

 

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*Improving the Quality of Our Loan Portfolio.  *Our strategy is to originate new loans acrossthe broad middle to prime market segments, focusing on the parts of thesesegments that we expect to be most profitable and creditworthy, with the goalof generating a higher-quality loan portfolio with more stable earnings andlower, less volatile credit loss rates. We no longer market new accounts tohigher risk segments of the market, which means that, consistent with PNB’sCapital Plan, we do not originate accounts for consumers with FICO® creditscores below 600, as derived from information available on credit bureaureports. As a result, we have generated higher credit quality loans through ourproprietary marketing program, which emphasizes the portion of the market werefer to as mainstream America, and through our partnership and co-brandingmarketing programs, which use highly targeted criteria to market our creditcard products to creditworthy individuals associated with various groups andorganizations.

 

To strengthen and extend ourrelationships with our best customers, we selectively provide product upgrades,improve pricing, and increase credit lines when appropriate. In addition, inMarch 2005 we sold a portfolio of non-core, higher risk credit card loans heldby PNB with a carrying value of approximately $400 million at the date ofsale, which had the effect of improving the credit quality mix of our remainingassets.

 

*Credit and Collections Strategies and Policies.*We employ a delinquency lifecycle strategy tomanage delinquent accounts. This approach allows for targeted collectiontreatment based on the stage of delinquency of the account. This strategy isapplied in combination with certain event-driven actions, consumer counseling,and consumer debt management education. We believe this facilitates managementand collector accountability for, and ownership of, collection results.

 

We have also initiated anumber of changes in risk management and credit and collections policies andpractices that are consistent with regulatory guidance and industry practice.These changes have had an impact on the age classification of delinquentaccount balances, the timing of principal charge-offs, and our procedures forinvestigating fraud losses, as discussed in our 2004 Annual Report. Ourcontinuing review of risk management and credit and collections operationscould lead to further modifications.

 

*Delinquencies.  *An account is contractually delinquent if therequired minimum payment is not received by the next due date. Accountholdersmay cure account delinquencies by making a partial payment that qualifies underour re-aging practices and applicable regulatory requirements. The delinquencyrate is derived by dividing loans receivable that are 30 days or more past dueat period end by loans receivable at period end.

 

Reported 30+ day delinquencyrates are influenced by fluctuations in the composition of receivablestransferred to our securitization trust and by the amount of the senior seller’sinterest in the securitization trust from time to time. These amounts mayincrease or decrease as a result of account additions, increases or decreasesin the balance of the pool of loans receivable transferred to thesecuritization trust, and increases or decreases in the level ofsecurityholders’ interests due to new issuances and amortization oraccumulation of outstanding securityholders’ interests. (See “—Securitizationsof Loans Receivable.”) For example, during a month in which we designateadditional accounts to the securitization trust or reduce the amount of outstandingsecurityholders’ interests, the amount of our senior seller’s interest willincrease. This increase, which may continue until new securityholders’interests are issued or the amount of loans in the securitization trustdeclines, will generally also increase our reported 30+ day delinquency ratebecause we will have a larger undivided interest in the pool of loansreceivable transferred to the securitization trust than before the increase andbecause the securitized loans currently have higher delinquency rates than ourreported loans receivable. As a result, short-term fluctuations in the reported30+ day delinquency rate are not necessarily a reliable indicator of trends inour asset quality.

 

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** **

**Delinquent Loans**

 
| ** **                 | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|----------------------------|------------|------------------------|------------|----------------------------|------------|
| **(dollars in thousands)** | ** ** | **Loans**              | ** ** | **% of  Total Loans**      | ** ** | **Loans** | ** ** | **% of  Total Loans** | ** ** |
| **Reported**               |       |                   |       |                       |       |   |   |   |   |
| Loans outstanding          |       | $                      | 6,866,451  |                       | 100.00     | % | $ | 7,522,401 |   | 100.00 | % |
| Loans delinquent           |       |                   |       |                       |       |   |   |   |   |
| 30-59 days                 |       | $                      | 76,647     |                       | 1.12       | % | $ | 109,014 |   | 1.45 | % |
| 60-89 days                 |       | 51,595                 |       | 0.75                       | %          | 80,152 |   | 1.06 | % |
| 90 or more days            |       | 93,550                 |       | 1.36                       | %          | 157,776 |   | 2.10 | % |
| Total loans delinquent     |       | $                      | 221,792    |                       | 3.23       | % | $ | 346,942 |   | 4.61 | % |
|                       |       |                   |       |                       |       |   |   |   |   |
| **Securitized**            |       |                   |       |                       |       |   |   |   |   |
| Loans outstanding(1)       |       | $                      | 11,699,467 |                       |       |   | $ | 11,013,352 |   |   |   |
| Loans delinquent           |       |                   |       |                       |       |   |   |   |   |
| 30-59 days                 |       | $                      | 220,466    |                       |       |   | $ | 244,041 |   |   |   |
| 60-89 days                 |       | 155,441                |       |                       |       | 182,531 |   |   |   |
| 90 or more days            |       | 301,339                |       |                       |       | 367,963 |   |   |   |
| Total loans delinquent     |       | $                      | 677,246    |                       |       |   | $ | 794,535 |   |   |   |
|                       |       |                   |       |                       |       |   |   |   |   |
| **Managed**                |       |                   |       |                       |       |   |   |   |   |
| Loans outstanding          |       | $                      | 18,565,918 |                       | 100.00     | % | $ | 18,535,753 |   | 100.00 | % |
| Loans delinquent           |       |                   |       |                       |       |   |   |   |   |
| 30-59 days                 |       | $                      | 297,113    |                       | 1.60       | % | $ | 353,055 |   | 1.90 | % |
| 60-89 days                 |       | 207,036                |       | 1.11                       | %          | 262,683 |   | 1.42 | % |
| 90 or more days            |       | 394,889                |       | 2.13                       | %          | 525,739 |   | 2.84 | % |
| Total loans delinquent     |       | $                      | 899,038    |                       | 4.84       | % | $ | 1,141,477 |   | 6.16 | % |

----

(1)          Excludes the senior seller’s interest in the loans receivable transferred insecuritizations, which is included in reported loans receivable. Includes theseller’s interest subordinated component, or AIR, which is reported in due fromsecuritizations on our balance sheet.

 

*Net CreditLosses.  *Werecognize credit losses on accounts determined to be uncollectible by chargingoff the outstanding principal balances, as described in “—Allowance andProvision for Credit Losses.” After a loan is charged off, we continuecollection activity to the extent legally permissible. Net credit losses forconsumer loans represent the principal amount of charged-off loan balances(including charged-off bankrupt and deceased customer accounts) less currentperiod principal recoveries. Net credit losses include purchases, includingcertain financed cardholder service product sales and cash advances, andexclude accrued interest and fees and fraud losses. Recoveries includecollections on the principal portion of previously charged-off accounts and theproceeds from the sale of charged-off receivables. The amount of charged-offreceivables sold will vary from period to period and is influenced bycharge-off trends, market conditions, and credit loss performance targets forthe period. The proceeds recognized from such sales of charged-off receivableson a reported basis were $18.0 million and $23.9 million for thethree and six months ended June 30, 2005, as compared to $13.0 millionand $39.8 million for the three and six months ended June 30, 2004.The proceeds recognized from such sales of charged-off receivables on a managedbasis were $55.3 million and $74.7 million for the three and sixmonths ended June 30, 2005, as compared to $43.5 million and $111.8 millionfor the three and six months ended June 30, 2004. Fraud losses (losses dueto the unauthorized use of credit cards, including credit cards obtainedthrough fraudulent applications) are charged to non-interest expense no laterthan the last day of the calendar month in which 90 days have elapsed after thefraud notification.

 

Net credit loss rates arederived by dividing net credit losses by average loans receivable balances fora specified period. While net credit losses include only the principal balanceassociated with charged-off loans, loans receivable balances include accruedinterest and fee balances estimated to be collectible as well as principalbalances. This results in a lower net credit loss rate than would be determinedif loans receivable balances included only principal balances. Managed netcredit losses include reported net credit losses plus the principal amount ofsecuritized loans charged off less principal recoveries (including proceedsfrom the sale of charged-off receivables) related to securitized loans.

 

Reported net credit lossrates are influenced by fluctuations in the composition of receivablestransferred to our securitization trust and by the amount of the senior seller’sinterest in the securitization trust from time to time. These amounts mayincrease or decrease as a result of account additions, increases or decreasesin the balance of the pool of loans

 

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receivable transferred to the securitizationtrust, and increases or decreases in the level of securityholders’ interestsdue tonew issuances andamortization or accumulation of outstanding securityholders’ interests. (See “—Securitizationsof Loans Receivable.”) For example, during a month in which we designateadditional accounts to the securitization trust or reduce the amount ofoutstanding securityholders’ interests, the amount of our senior seller’sinterest will increase. This increase, which may continue until newsecurityholders’ interests are issued or the amount of loans in thesecuritization trust declines, will generally also increase our reported netcredit loss rate because we will have a larger undivided interest in the poolof loans receivable transferred to the securitization trust than before theincrease and because the securitized loans currently have higher net creditloss rates than our reported loans receivable. As a result, short-termfluctuations in the reported net credit loss rate are not necessarily areliable indicator of trends in our asset quality.

** **

**Net Credit Losses**
| ** **                                                      | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(dollars  in thousands)**                                     | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Reported**                                                    |       |                                 |       |                               |       |   |   |   |   |
| Average loans outstanding                                       |       | $                                    | 7,655,117  |                               | $          | 6,610,851 |   | $ | 7,502,025 |   | $ | 6,542,084 |   |
| Net credit losses                                               |       | $                                    | 113,857    |                               | $          | 150,348 |   | $ | 194,297 |   | $ | 296,276 |   |
| Net credit losses as a percentage of  average loans outstanding |       | 5.95                                 | %          | 9.10                               | %          | 5.18 | % | 9.06 | % |
|                                                            |       |                                 |       |                               |       |   |   |   |   |
| **Securitized**                                                 |       |                                 |       |                               |       |   |   |   |   |
| Average loans outstanding(1)                                    |       | $                                    | 10,506,512 |                               | $          | 10,167,072 |   | $ | 10,659,856 |   | $ | 10,199,244 |   |
| Net credit losses                                               |       | $                                    | 263,364    |                               | $          | 375,057 |   | $ | 561,730 |   | $ | 808,701 |   |
|                                                            |       |                                 |       |                               |       |   |   |   |   |
| **Managed**                                                     |       |                                 |       |                               |       |   |   |   |   |
| Average loans outstanding                                       |       | $                                    | 18,161,629 |                               | $          | 16,777,923 |   | $ | 18,161,881 |   | $ | 16,741,328 |   |
| Net credit losses                                               |       | $                                    | 377,221    |                               | $          | 525,405 |   | $ | 756,027 |   | $ | 1,104,977 |   |
| Net credit losses as a percentage of  average loans outstanding |       | 8.31                                 | %          | 12.53                              | %          | 8.33 | % | 13.20 | % |

----

(1)          Excludes the senior seller’s interest in theloans receivable transferred in securitizations, which is included in reportedloans receivable. Includes the seller’s interest subordinated component, orAIR, which is reported in due from securitizations on our balance sheet.

 

*InterestRate Sensitivity*

 

Interest rate sensitivityrefers to the change in earnings or value resulting from fluctuations ininterest rates. Our earnings are subject to risk to the extent that there is adifference between the amount of interest-earning assets and the amount of interest-bearingliabilities that mature or reprice in a specific period. Even if earnings couldbe perfectly hedged, a change in the level of interest rates will change thepresent value of the hedged earnings stream.

 

Our assets and liabilitiesconsist primarily of investments in interest-earning assets (loans receivableand investment securities), which are primarily funded by interest-bearingliabilities (deposits and borrowings). Our loans receivable accrue interest atrates that are either fixed or float at a spread above the prime rate. At June 30,2005, 50.5% of our reported loans receivable and 64.7% of our managed loansreceivable had interest rates that were floating. In calculating suchpercentages, we do not include balances subject to a promotional offer thatbear fixed rates during the term of the promotional offer. While ournon-promotionally priced fixed rate credit card receivables have no statedmaturity or repricing period, we generally have the right to adjust the ratecharged after providing notice to the customer. Repricing of our fixed andfloating rate credit card receivables may be limited by competitive and otherpressures beyond our control and by credit risk considerations. Interest rateson our liabilities are generally indexed to the London Interbank Offered Rate (“LIBOR”)or bear a fixed rate. This asset/liability structure exposes us to two types ofinterest rate risk: (a) repricing risk, which results from a mismatch betweenassets and liabilities that mature or reprice in specific periods; and (b)basis risk, which arises from changing spread relationships between indexessuch as the prime rate and LIBOR.

 

The principal objective ofour interest rate risk management activities is to monitor and control ourexposure to adverse effects resulting from movements of interest rates overtime. We generally seek to strike a balance between hedging net interest incomeand hedging the present value of net interest income. To measure exposure tointerest rate changes, we use multiple complementary measures of risk to netinterest income under a number of scenarios and rate changes. We 

 

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typically model the impact of rate changes oncurrent net interest income over a three-year period and the impact on thepresent value of net interest income over a longer horizon. When estimated riskexposure exceeds our guidelines, we seek to mitigate the risk through the useof matching and hedging techniques as described below.

 

The following tableillustrates the estimated effects on managed net interest income of positiveand negative parallel shifts in interest rates as calculated at June 30,2005, using our interest rate risk model and taking into consideration ourcurrent hedging activity as of June 30, 2005. Our analysis comparesestimated managed net interest income over 12 months in a stable interest rateenvironment to scenarios in which interest rates rise and fall by 200 basispoints. Our interest rate risk model incorporates certain assumptions regardingour ability to reprice our fixed and floating rate credit card loans withoutotherwise impacting customer behavior. The actual repricing sensitivity ofthese loans depends on how our customers and competitors respond to changes inmarket interest rates. As of June 30, 2005, we modeled the repricingbehavior of our fixed rate credit card loans based on an amortization schedulewhich results in approximately 50% of the original balance being repriced bythe 15th month. The repricing of certain assets and liabilities may be limitedby competitive and other pressures beyond our control and by credit riskconsiderations. As a result, certain assets and liabilities assumed to matureor otherwise reprice within a certain period may in fact mature or reprice atdifferent times and at different volumes. The table below should be viewed asour estimate, subject to these uncertainties, of the general effect of theindicated interest rate movements on our managed net interest income.

 

**Estimated Effects of Interest Rate Changes**

| **Change in Interest Rates** | ** ** | **Percentage Change in Managed Net Interest Income** | ** ** |
|------------------------------|------------|---------------------------------------------------------------------|------------|
| + 200 basis  points          |       | 2.9                                                                 | %          |
| - 200 basis  points          |       | (3.8                                                                | )%         |

 

Theinformation shown above is presented on a consolidated managed asset/liabilitybasis, which includes the interest rate sensitivity of net interest income fromsecuritized loans and the impact of derivative instruments. We do not in thenormal course of business derive comparable interest rate sensitivity of netinterest income on a reported basis. In the opinion of management, suchcomparable projections on a reported basis would not provide a significantbenefit in understanding our expected future performance. In addition, theprojections above do not include the impact of interest rate changes onnon-interest income. Non-interest income—servicing and securitization can besubject to significant impacts to the extent that interest rate changes affectthe market discount rate assumptions used in valuing our retained interests insecuritizations. Sensitivities of the current fair value of our retainedsecuritization interests to changes in key securitization assumptions,including the market discount rate, are presented in Note 10 of ourConsolidated Financial Statements.

 

Wegenerally seek to mitigate risks to net interest income and capital arisingfrom movements in interest rates. The main tools we use to manage our interestrate sensitivity are investment decisions, pricing decisions on our loansreceivable, and, when deemed appropriate, derivatives, including interest rateswap and cap agreements. We do not trade our derivative positions or usederivatives to speculate on interest rate movements, and we believe our use ofsuch instruments is prudent and consistent with industry standards.

 

**Notional Amounts of Interest Rate SwapAgreements**

 
| ** **                 | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(dollars in thousands)** | ** ** | **2005**                             | ** ** | **2004**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Beginning  balance         |       | $                                    | 2,757,300  |                               | $          | 288,200 |   | $ | 2,369,800 |   | $ | 288,200 |   |
| Additions                  |       | 113,700                              |       | 720,900                            |       | 501,200 |   | 720,900 |   |
| Maturities                 |       | (177,500                             | )          | (10,000                            | )          | (177,500 | ) | (10,000 | ) |
| Ending  balance            |       | $                                    | 2,693,500  |                               | $          | 999,100 |   | $ | 2,693,500 |   | $ | 999,100 |   |

 

Notionalamounts of interest rate swaps outstanding on June 30, 2005 increased fromJune 30, 2004, primarily as the need for hedging increased due to thecontinued trend toward more loans priced at floating rates, while depositfunding remained at fixed rates. As market conditions or our asset/liabilitymix change, we may increase or decrease the notional amounts of interest rateswaps and caps outstanding in order to manage our interest rate risk withinprudent levels. As required by SFAS No. 133, we record the fair value of aninterest rate derivative as an asset or liability (as appropriate) and offsetthat amount with a change in the value of the item being hedged.

 

Wemanage credit risk arising from derivative transactions through an ongoingcredit review, approval, and monitoring process. Credit risk for thesederivative transactions is defined as the risk that a loss will occur as theresult of a 

 

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derivative counterpartydefaulting on a contract when the contract is in a favorable economic positionto us. We may enter into master netting, market settlement, or collateralizationagreements with derivative counterparties to reduce this risk.

 

*Funding andLiquidity*

 

Weseek to fund our assets by diversifying our distribution channels and offeringa variety of funding products, with the goal of generating funding at the lowestcost available to us while maintaining liquidity at appropriate levels andmanaging interest rate risk. The primary goal of our liquidity management is toprovide funding to support our operations in varying business environments. Weemploy multiple strategies, including diversification of funding sources,dispersion of maturities, and maintenance of liquid investments and cashbalances.

 

Thefollowing table reflects our current debt ratings and those of PNB. In January2005, Moody’s Investors Service upgraded its ratings outlook for our debtratings (Providian Financial Corporation) from stable to positive.

 

**Current Long-Term Senior Debt Ratings**

| ** **                       | ** ** | **Standard & Poor’s(1)** | ** ** | **Moody’s Investors Service** | ** ** | **FitchRatings(1)** | ** ** |
|----------------------------------|------------|-----------------------------------|------------|-----------------------------------------|------------|---------------------|------------|
| Providian  Financial Corporation |       | B                                 |       | B2 (1)                                  |       | B+                  |       |
| Providian  National Bank         |       | BB-                               |       | Ba3 (2)                                 |       | BB-                 |       |

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(1)          Positive outlook.

(2)          Stable outlook.

 

During the second quarter of2005, consistent with PNB’s Capital Plan, our liquidity position (federal fundssold and securities purchased under resale agreements, available-for-saleinvestment securities, and cash and cash equivalents) increased by $159.3 millionfrom $4.75 billion at March 31, 2005 to $4.91 billion at June 30,2005.****Our liquidity position at June 30,2005 was approximately 35% of our reported assets and 21% of our managedassets.

 

Under the capital assurancesand liquidity maintenance agreement we entered into with PNB, we agreed toprovide capital and liquidity support to PNB. Our agreement with PNB to providecapital and liquidity support exempts certain of our near-term cashobligations, including current interest obligations on our 3.25% convertiblesenior notes due August 15, 2005 and current payments on the 9.525% juniorsubordinated deferrable interest debentures due February 1, 2027. In addition,certain accrued deferred compensation, miscellaneous working capital needs notto exceed $25 million, and severance payments are generally exempt fromthe parent company’s obligations under the agreement. See “RegulatoryMatters” in our 2004 Annual Report for a description of the capital assurancesand liquidity maintenance agreement.

 

Our investment insubsidiaries as a percentage of our total equity, which is referred to as our “doubleleverage,” at June 30, 2005 was 113%. A double leverage ratio in excess of100% indicates the degree to which an investment in subsidiaries has beenfunded with long-term borrowings and other liabilities of the parent company.The principal source of funds for us to make payments on our parent companydebt securities and to meet our other obligations is our cash and liquidinvestments and dividends from PNB. In December 2004, PNB sought andreceived approval from its primary regulator to make an in-kind dividend to usof certain retained interests, which had a carrying value of $230.6 million,in PNB’s securitizations. If PNB seeks to make future dividends it must firstobtain regulatory consent. There can be no assurance that such consent, ifsought, will be obtained. In addition, if we are required to provide additionalcapital and liquidity support to PNB, our ability to service our parent companydebt obligations would be further limited.

 

*Funding Sources and Maturities.  *We seek to fund our assets by diversifyingour distribution channels and offering a variety of funding products. However,our ability to fund existing and future customer loans is currently dependenton four primary sources: customer deposits, securitizations, a portfolio ofcash and liquid investment securities, and debt issuances.

 

We offer maturity terms forour funding products that range up to 30 years. Actual maturity distributionsdepend on several factors, including expected asset duration, investor demand,relative costs, shape of the yield curve, and anticipated issuances in thesecuritization and capital markets. We seek to maintain a balanced distributionof maturities and avoid undue concentration in any one period. We monitorexisting funding maturities and loan growth projections to prudently manageliquidity levels.

 

For the remainder of theyear (July 1, 2005 through December 31, 2005), we have fundingrequirements for maturing deposits of $1.30 billion, maturing third partysecurityholder interests in securitizations of $2.98 billion, and 

 

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maturing debt of $343.3 million. Of the$2.98 billion of maturing securitizations, $1.40 billion representsthe third partysecurityholders’interests in a variable funding conduit facility that is scheduled to beginamortizing in November 2005, unless the revolving period of the conduitfacility is extended. We expect to extend the revolving period of such variablefunding conduit facility for a period of approximately 12 months in November2005. We anticipate that we will meet our funding requirements for theremainder of the year, along with any incremental asset growth in 2005, byextending the revolving period of such variable funding conduit facility,issuing new securitization securityholders’ interests, utilizing our liquidityposition, and accepting new deposits. We may also generate additional fundingby issuing common stock, including issuances under a dividend reinvestment anddirect stock purchase plan, or by issuing new debt securities. Although we havebeen successful in meeting our funding needs, future events or changesaffecting us or the markets in which we obtain our funding could adverselyaffect our ability to continue to fund our business.

 

*Deposits.  *Deposits decreased to $8.80 billion asof June 30, 2005 from $9.47 billion as of December 31, 2004. At June 30,2005, PNB’s deposits were covered by cash, liquid investments, and arisk-adjusted portion of on-balance sheet loans, as contemplated by its CapitalPlan developed pursuant to its written agreement with its primary regulator. Weexpect PNB to continue to maintain assets of sufficient quality on its balancesheet to fully cover its deposits. However, there can be no assurance that itwill be successful in doing so.

 

The following tablesummarizes the remaining contractual maturities of our deposits, substantiallyall of which are retail deposits.

 

**Maturities of Deposits**
| ** **                            | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|---------------------------------------|------------|------------------------|------------|----------------------------|------------|
| **(dollars in thousands)**            | ** ** | **Direct Deposits**    | ** ** | **Brokered Deposits**      | ** ** | **Total Deposits** | ** ** | **Direct Deposits** | ** ** | **Brokered Deposits** | ** ** | **Total Deposits** | ** ** |
| Three months or less                  |       | $                      | 196,852    |                       | $          | 472,294 |   | $ | 669,146 |   | $ | 426,487 |   | $ | 535,562 |   | $ | 962,049 |   |
| Over three months through one year(1) |       | 737,493                |       | 1,633,510                  |       | 2,371,003 |   | 691,961 |   | 1,379,516 |   | 2,071,477 |   |
| Over one year through five years(2)   |       | 1,500,434              |       | 3,412,396                  |       | 4,912,830 |   | 1,566,844 |   | 3,942,294 |   | 5,509,138 |   |
| Over five years                       |       | 430                    |       | 565,444                    |       | 565,874 |   | 7,568 |   | 526,000 |   | 533,568 |   |
| Deposits without contractual maturity |       | 285,951                |       | —                     |       | 285,951 |   | 394,772 |   | — |   | 394,772 |   |
| Total deposits                        |       | $                      | 2,721,160  |                       | $          | 6,083,644 |   | $ | 8,804,804 |   | $ | 3,087,632 |   | $ | 6,383,372 |   | $ | 9,471,004 |   |

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(1)          At June 30, 2005,maturities of total deposits over three months through one year by quarter wereas follows: fourth quarter 2005: $632.5 million; first quarter 2006:$680.9 million; second quarter 2006: $1.06 billion.

(2)          At June 30, 2005,maturities of total deposits over one year through two years were $2.29 billion.

 

A bank that is below thewell-capitalized levels as reported on its Call Reports is subject to ceilingson rates paid for deposits and restrictions on accepting brokered deposits. Abank that is adequately capitalized is restricted from accepting brokereddeposits without a waiver from the Federal Deposit Insurance Corporation andmay not pay a rate on its deposits that is more than 75 basis points higherthan the prevailing rate in its market. As of June 30, 2005, capitalratios for PNB were above the well-capitalized levels on a Call Report basis.PNB has exceeded the well-capitalized level since March 31, 2002. Accordingly,these restrictions on deposit taking activities do not currently apply to PNB.

 

*Securitizations*.*  *Securitization of our loans receivable provides an important source offunding that is cost effective and beneficial in achieving the required levelsof capital established by our regulators. We seek a range of maturity terms inour securitizations.

 

Among our outstandingsecuritizations we have two variable funding conduit facilities, one with atwo-year revolving period, and one with a one-year revolving period. Thetwo-year revolving variable funding conduit facility, which has a commitmentamount of $500.0 million, was issued in August 2004. The one-year revolvingvariable funding conduit facility, which was issued in November 2004 andreplaced a previous variable funding conduit facility, has a commitment amountof $1.00 billion. Securitization funding from third party securityholdersunder our variable funding conduit facilities totaled $1.90 billion and$630.0 million as of June 30, 2005 and December 31, 2004. Weexpect to extend the revolving period of our one-year revolving variablefunding conduit facility for another 12 months in November 2005. If the revolvingperiod of such conduit facility is not extended in November 2005, it will beginto amortize and we would expect the amortization of investor interests held bythird parties to take approximately three months, based on current assumptionsand estimates. Similarly, we expect to extend the revolving period for ourtwo-year revolving variable funding conduit facility in August 2006. If therevolving period of such conduit facility is not extended, it will begin toamortize in August 2006 and we 

 

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would expect the amortization of investorinterests held by third parties to take approximately two months, based oncurrent assumptions and estimates.

 

Our term securitizationshave expected final payment dates ranging from two to seven years from the timeof original issuance. No new term securitizations were issued in the first halfof 2005. Our term securitizations are expected to amortize over the periodsindicated below, based on current projections and the amounts outstanding as ofJune 30, 2005.

 

**Amortization of TermSecuritizations**

 

| **(dollars in thousands)** | ** ** | **Amount Amortizing** | ** ** |
|----------------------------|------------|-----------------------|------------|
| 2005                       |       | $                     | 1,581,357  |   |
| 2006                       |       | 3,424,202             |       |
| 2007                       |       | 2,495,580             |       |
| 2008                       |       | 505,876               |       |
|                            |            |                       |            |  |

 

The amount funded in oursecuritization spread accounts may change from time to time, depending onsecuritizations outstanding and spread account funding triggers. The level ofspread account funding required by these triggers is generally determined bythe performance of the securitized loans, although certain of our outstandingtransactions have a spread account trigger based on PNB’s credit rating. At June 30,2005, the funds on deposit in spread accounts totaled $261.5 million, allof which was required to be funded based on levels resulting from downgrades inPNB’s credit rating in 2001 and 2002. The spread account funding requirementsbased on such PNB credit rating downgrades have been fully met. Currently,there are no additional spread account funding requirements relating to ourcredit ratings. If the performance of the loans transferred to oursecuritization trust were to deteriorate, spread account funding requirementscould be triggered based on the performance of the securitized loans, resultingin an overall increase in spread account funding.

 

*Long-Term Borrowings.*   The following table summarizes ourlong-term borrowings at June 30, 2005, a portion of which consists ofconvertible notes issued under our shelf registration statement filed with theSecurities and Exchange Commission.

 

**Summaryof Long-Term Borrowings**

** **
| ** **                                          | ** ** | **June 30, 2005**    | ** ** |
|-----------------------------------------------------|------------|---------------------------|------------|
| **(dollars in thousands)**                          | ** ** | **Effective/ Issue Date** | ** ** | **Unused Registered Amount(1)** | ** ** | **Principal Outstanding(2)(3)** | ** ** | **Maturity** | ** ** |
| Providian  Financial shelf registration             |       | 6/98                      |       | $ | 632,445 |   | $ | 1,377,277 |   | Various | ** ** |
| Junior  subordinated deferrable interest debentures |       | 2/97                      |       | — |   | 109,281 |   | 2/27 | ** ** |
|                                                     |            |                           |            |  |  |  |  |  |  |  |  |

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(1)          Represents remaining unused registered amount on the shelfregistration. Funding availability and/or funding costs and ability to issuesecurities using the shelf registration are subject to market conditions, contractualprovisions and other factors.

(2)          Amounts presented do not include related discount and/or issuancecosts.

(3)          Outstanding securities issued under the shelf registration consist offour issuances of convertible senior notes with earliest possible requiredprincipal payment dates beginning in August 2005, February 2006, May 2008, andMarch 2011. In addition, we may be required to redeem these notes prior totheir maturity following a change of control or a fundamental change, asdefined in the related indenture supplements. See Note 13 to ourConsolidated Financial Statements for further discussion.

 

Our 4.00% convertible seniornotes totaling $287.4 million due May 15, 2008 are convertible at theoption of the holders at the conversion rate of 76.8758 shares of our commonstock for each $1,000 of note principal (an initial conversion price of$13.01 per share of common stock) if specified conditions are met. During thesecond quarter of 2005, the specified market price condition for conversion of our4.00% convertible senior notes was satisfied, as our common stock priceexceeded the conversion trigger price of $14.31 per share for at least 20 ofthe last 30 trading days of the quarter. As a result, the 4.00% convertiblesenior notes are convertible during the third quarter of 2005. See Note 13to our Consolidated Financial Statements for further discussion.

 

The principal source offunds for the payment of any dividends on our common stock is dividendsreceived from PNB. However, our Board of Directors has suspended the payment ofquarterly cash dividends on our common stock, and PNB has agreed with itsprimary regulator that it will not declare or pay any dividends without suchregulator’s consent. In December 2004, PNB sought and received approvalfrom its primary regulator to make an in-kind dividend to us of certain

 

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retained interests, which had a carryingvalue of $230.6 million, in PNB’s securitizations. If PNB seeks to makefuture dividends it must first obtain regulatory consent. There can be noassurance that such consent, if sought, will be obtained. See “RegulatoryMatters” in our 2004 Annual Report.

 

*Investments.  *We maintain short-term liquidity throughfederal funds sold and securities purchased under resale agreements,available-for-sale investment securities, and cash and cash equivalents. Wealso maintain a portfolio of high-quality investment securities, such as U.S.government and agency obligations, mortgage-backed securities, and commercialpaper. Investment securities decreased by $732.7 million during the secondquarter of 2005 to $3.41 billion as of June 30, 2005, with acorresponding increase in federal funds sold and securities purchased underresale agreements of $900.6 million, from $397.4 million as of March31, 2005 to $1.30 billion as of June 30, 2005, as we elected tomaintain a larger investment in federal funds sold and securities purchasedunder resale agreements.

 

*Off-Balance Sheet Arrangements*

 

*FinancialCommitments. *Significantcommitments at June 30, 2005consisted of commitments to extend credit card loans, which represent the totalunused portions of the lines of credit available to customers. These amounts donot necessarily represent future cash requirements, as we do not expect toexperience circumstances under which all of our customers will borrow theentire line of credit available to them at the same time. Further discussion ofthese commitments is included in Note 12 to our Consolidated FinancialStatements.

 

Our securitizationsrepresent off-balance sheet arrangements. We use qualifying special-purposeentities as defined by SFAS No. 140 for our securitizations and account for thetransactions as sales. See “—Securitizations of Loans Receivable” and Note 10to our Consolidated Financial Statements for further discussion.

 

We enter into derivativefinancial instruments to reduce the risk of interest rate fluctuations that mayresult from differences in repricing characteristics between interest-earningassets and interest-bearing liabilities. We use interest rate risk managementinstruments, including interest rate swap and cap agreements, for this purpose.As of June 30, 2005, we hadinterest rate swap agreements with maturities ranging from 2005 to 2016, and wehad no interest rate cap agreements. See “—Interest Rate Sensitivity” and Note 15to our Consolidated Financial Statements for further discussion.

 

We are also a party to andfrom time to time enter into agreements that contain provisions regarding minimumpayment commitments, including agreements in connection with technologymaintenance, consulting, outsourcing and co-marketing services. Theseprovisions typically require us to make minimum payments to other parties, asspecified in the agreements, which are not necessarily contingent upon theamounts or levels of services provided to us under the agreements. We do notcurrently expect any of these minimum payment commitments to have a materialimpact on our consolidated financial statements, but we cannot give anyassurance that they will not have such an effect.

 

*Guarantees.  *In January 2003, we entered into a pledgeagreement with an insurer with respect to certain obligations owing to theinsurer in connection with two series of the Providian Gateway Master Trust.One of the series has since been repaid. The amount of the pledged collateralat June 30, 2005 was $13.6 million,which is held in a deposit account as security for the payment to the insurerof amounts owing to it in connection with the remaining series.

 

In connection with theinterest rate swap agreements discussed above in “—Financial Commitments,” wepledged collateral to interest rate swap counterparties totaling $34.4 millionat June 30, 2005.

 

In August 2002, through awholly owned limited liability entity, we sold our investment in an alternativeenergy plant. In connection with the sale, we guaranteed certain obligations ofthe limited liability entity under a purchase and sale agreement. The guaranteecovers the limited liability entity’s obligation to indemnify the purchaseragainst losses arising out of a breach of the purchase and sale agreement andfailure to repurchase the assets if tax credits are not available to thepurchaser. Our guarantee is capped at the amount of payments made to thelimited liability entity at the time of sale, plus the amounts of additionalpayments made, and contingent future payments that may be made, to the limitedliability entity and its affiliates arising from fuel production from theplant. At June 30, 2005, the maximum guaranteed amount was $31.0 million,based on actual payments made.

 

We are also a party to andfrom time to time enter into agreements that contain general indemnificationprovisions, primarily in connection with asset sale agreements and servicecontracts, including the purchase and sale agreement referred to in thepreceding paragraph. We cannot estimate the potential future impact of theseindemnification provisions, since that would require an assessment of claimsnot yet made. Based on historical experience, we do not currently expect therisk of 

 

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loss under these indemnification provisionsto have a material adverse effect on our financial condition or our results ofoperations, but we cannot give any assurance that they will not have such aneffect.

 

See Note 12to our Consolidated Financial Statements for further discussion of ourguarantee obligations.

 

*Variable Interest Entities.*   In December 2003, the FASB issueda revision of FIN 46, which superseded the original guidance issued in January2003. Under FIN 46, a company is required to consolidate a variable interestentity (“VIE”) if its interest in the VIE is such that it will absorb amajority of the VIE’s expected losses and/or receive a majority of the VIE’sexpected residual returns, if any.  See Note 11 to ourConsolidated Financial Statements for further discussion.

 

*Capital Adequacy*

 

Wecontinue to manage our capital levels with the dual objectives of havingsufficient capital to support the achievement of our business plan and meetingregulatory capital requirements. During the three months ended June 30,2005, we continued to focus our capital planning on meeting or exceedingregulatory minimum levels of capital and supporting anticipated growth. Wedetermine our regulatory minimum levels of capital from two primary sources:capital adequacy regulations that apply generally to banks, and the PNB CapitalPlan developed pursuant to its written agreement with its primary regulator,which lays out capital goals for PNB.

 

PNB’scapital ratios on a Call Report basis as of June 30, 2005 are set forth inthe following table:

 

**PNBCapital Ratios on Call Report Basis**

** **

| **Capital Ratio** | ** ** | **Calculation**                                                | ** ** | **PNB  Ratios** |
|-------------------|------------|----------------------------------------------------------------|------------|-----------------|
| Total  risk-based |       | (Tier 1 + Tier 2/Total  risk-based assets) |       | 26.72           | % |
| Tier 1       |       | Tier 1/Total  risk-based assets                           |       | 24.37           | % |
| Leverage          |       | Tier 1/Adjusted  average assets                           |       | 26.64           | % |

 

PNB’scapital ratios reflect the application of banking regulations that, among otherthings, require the amount of credit-enhancing interest-only strips receivablethat exceed 25% of Tier 1 Capital (concentration limit) to be deductedfrom Tier 1 Capital; and requiring “dollar-for-dollar” risk-based capital(as defined in the regulations) for certain residual interests not deductedfrom Tier 1 Capital. As of June 30, 2005, PNB’s interest-only stripsreceivable represented 8.64% of Tier 1 Capital, which is below the 25%concentration limit in the regulation. However, PNB does hold “dollar-for-dollar”risk-based capital against approximately $1.43 billion in residualinterests from its securitizations, which include the accrued interestreceivable related to securitized loans.

 

Further,applying PNB’s methodology for implementing the Expanded Guidance for SubprimeLending Programs (“Subprime Guidance”), as of June 30, 2005, this methodologyresulted in a weighted average risk weighting of 132% against PNB’s reportedstandard and middle market segment loans receivable, which totaledapproximately $3.73 billion on such date. These risk weightings aresubject to change depending on conditions in our loan portfolio and/or changesin regulatory guidance. Managed loans outstanding in the standard and middlemarket segment portfolios totaled approximately $15.26 billion as of June 30,2005.

 

Thefollowing table summarizes PNB’s capital ratios and goals under its CapitalPlan.

 

**PNB Capital Ratios**

**Under PNB Capital Plan**

 
| ** **                                                              | ** ** | ** **             | ** ** | **Actual**             | ** ** |
|-------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                              | ** ** | **Capital Plan Goals** | ** ** | **June 30, 2005** | ** ** | **March 31, 2005** | ** ** | **December 31, 2004** | ** ** |
| Total risk-based capital ratio, as reported  on PNB Call Report         |       | 10                     | %          | 26.72                  | %          | 25.25 | % | 22.72 | % |
|                                                                    |       |                   |       |                   |       |   |   |   |   |
| Total risk-based capital ratio, after  application of Subprime Guidance |       | 10                     | %          | 23.69                  | %          | 22.22 | % | 19.47 | % |

 

PNB’scapital ratios improved during the second quarter of 2005 primarily as a resultof the increase in net income for the quarter ended June 30, 2005 comparedto the quarter ended March 31, 2005.

 

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PNB’sfuture capital ratios will depend on, among other things, the level ofinternally generated capital as well as the level of loan growth, changes inloan mix, and the level of retained subordinated interests related to oursecuritization activity. Growth in reported receivables, combined with changesin the levels and valuations of spread accounts and other retained subordinatedinterests related to our securitizations, may result in changes in PNB’srisk-based capital ratios as reported on its Call Report and after applying theSubprime Guidance. PNB continues to work to reduce the level of its retainedsubordinated interests in its securitizations. Subject to ongoing review andupdates of its Capital Plan and the potential impact of evolving regulatorystandards, we expect that PNB will continue to achieve the capital goals in itsCapital Plan. PNB will be updating its Capital Plan on a rolling two-year basispursuant to the terms of PNB’s written agreement with its primary regulator. Weexpect the updated plan to be consistent with our strategic objectives ofmeasured and profitable receivables growth and improving credit quality, whilecontinuing our focus on maintaining strong capital and liquidity.

 

PNB’scapital requirements are subject to qualitative judgments by its regulatorswith respect to components, risk weightings, and other factors. Its bankingregulators have the authority to require PNB to adhere to higher capitalrequirements than those specified in the regulatory capital rules or itsCapital Plan. This could necessitate increasing capital ratios by variousmeans, including asset sales or equity issuances. In addition, the strategicinitiatives that we have taken, and any that we may take in the future, couldhave an impact on PNB’s capital ratios and requirements.

 

*Cautionary Statement Regarding Forward-Looking Information*

 

Thisreport contains forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended, which aresubject to the “safe harbor” created by those sections. We also make written ororal forward-looking statements in our periodic reports to the Securities andExchange Commission on Forms 10-K, 10-Q, and 8-K, in our proxy statements, inour offering circulars and prospectuses, in press releases and other writtenmaterials and in oral statements made by our officers, directors, or employeesto third parties. Forward-looking statements include, without limitation:expressions of the “belief,” “anticipation,” or “expectations” of management;statements as to industry trends or future results of operations of our companyand our subsidiaries; and other statements that are not historical fact.Forward-looking statements are based on certain assumptions by management andare subject to risks and uncertainties that could cause actual results todiffer materially from those in the forward-looking statements. These risks anduncertainties include, but are not limited to, competitive pressures; factorsthat affect liquidity, delinquency rates, credit loss rates, and charge-offrates; general economic conditions; consumer loan portfolio growth; changes inthe cost and/or availability of funding due to changes in the deposit, credit,or securitization markets; changes in the way we are perceived in such marketsand/or conditions relating to existing or future financing commitments; theeffect of government policy and regulation, whether of general applicability orspecific to us, including restrictions and/or limitations relating to ourminimum capital requirements, deposit-taking abilities, reservingmethodologies, dividend policies and payments, growth, and/or underwritingcriteria; year-end adjustments; changes in accounting rules, policies, orassumptions or in the interpretation or application of such rules, policies, orassumptions; changes to or the restatement of prior period financial statementsor results as the result of accounting errors or other circumstances; thesuccess of product development efforts; legal and regulatory proceedings,including the impact of ongoing litigation; interest rates; one-time charges;extraordinary items; the ability to recruit or replace key personnel; and theimpact of existing, modified, or new strategic initiatives. These and otherrisks and uncertainties are described in our 2004 Annual Report under theheading “Risk Factors” and are also described in other parts of our 2004 AnnualReport, including “Legal Proceedings” and “Management’s Discussion and Analysisof Financial Condition and Results of Operations.” Other risks anduncertainties include matters related to the proposed merger of our companywith Washington Mutual, Inc. (including, among others, risks related toshareholder and regulatory approvals, integration issues, and the realizationof expected growth opportunities and cost savings from the merger). Readers arecautioned not to place undue reliance on any forward-looking statement, whichspeaks only as of the date thereof. We undertake no obligation to update anyforward-looking statements.

 

**Item 3.  Quantitative andQualitative Disclosures About Market Risk**

 

Information concerningquantitative and qualitative disclosures about market risk is provided underthe caption “Interest Rate Sensitivity” under “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” in Item 2 of thisPart I.

 

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**Item 4.  Controls and Procedures**

 

TheCompany’s management, with the participation of the Company’s Chief ExecutiveOfficer and Chief Financial Officer, evaluated the effectiveness of the Company’sdisclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e))as of the end of the period covered by this report and, based on thisevaluation, the Company’s Chief Executive Officer and Chief Financial Officerconcluded that the Company’s disclosure controls and procedures are effective.

 

Nochange in the Company’s internal control over financial reporting (as definedin Exchange Act Rule 13a-15(f)) has occurred during the Company’s most recentfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 

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**PART II.  OTHER INFORMATION**

 

**Item1.  Legal Proceedings**

 

Followingthe announcement in October 2001 of our third quarter 2001 delinquency andcredit loss experience, two shareholder derivative actions were filed, in December 2001and January 2002, in California state court in San Francisco. Theseactions generally sought redress against members of our Board of Directors andcertain executive officers and alleged breach of fiduciary duty, grossnegligence, breach of contract, and violation of state insider trading law.These actions were settled for $1 million, which was funded under ourinsurance policies, and the settlement was approved by the Court in January2005. However, coverage of these actions by the affected insurer is subject toa reservation of rights by such insurer to contest coverage, and thereservations of rights claim has not yet been resolved.

 

InFebruary 2001, we were named as a defendant in a putative consumer classaction suit entitled *Ross v. Visa U.S.A.Inc., et al*., which was filed in the United States District Court forthe Eastern District of Pennsylvania against Visa, MasterCard and a number ofcredit card issuing banks. The suit alleges that uniform foreign currencysurcharges allegedly imposed by the defendants are the result of a conspiracyin restraint of trade and violate the federal antitrust laws. The suit alsoalleges that the defendant banks violated the Truth-in-Lending Act by failingto separately identify these surcharges to their customers on their monthlystatements. Similar lawsuits were subsequently filed in California and NewYork. In August 2001, the Federal Judicial Panel on MultidistrictLitigation transferred all of these cases to the Southern District of New York.In January 2002, plaintiffs filed an amended consolidated complaint, whichthe defendants moved to dismiss. In July 2003, the court granted themotion to dismiss the plaintiffs’ claim for actual damages under theTruth-in-Lending Act, and denied the motion to dismiss the plaintiffs’antitrust claims. The plaintiffs’ motion for class certification was granted inOctober 2004. Various motions challenging this order and others are pendingbefore the court. This case remains in the discovery phase.

 

InJanuary 2004, a state court putative class action,*Ventura v. Providian National Bank*, was filed in OrangeCounty, California, alleging that PNB’s minimum payment calculation results inimproper overlimit fees and that its payment posting practices result inimproper interest charges and late fees.  The complaint alleges a singlebreach of contract claim and seeks damages, attorneys’ fees, and other relief.In February 2004, a state court putative class action, *Marotta v. Providian National Bank*, wasfiled in Orange County, California, alleging that plaintiffs’ annual percentagerates were improperly increased without proper notice. The complaint alleges asingle breach of contract claim and seeks damages, attorneys’ fees, and otherrelief. Both cases are in the preliminary discovery phase.

 

InNovember 2004, we, along with seven other banks, Visa, and MasterCard, werenamed as defendants in an antitrust lawsuit alleging anti-competitivepractices, *American Express Travel RelatedServices Company, Inc. v. Visa U.S.A. Inc., et al*., filed in theU.S. District Court for the Southern District of New York. The litigationarises from the Department of Justice’s successful antitrust suit against Visaand MasterCard challenging the associations’ rules prohibiting member banksfrom issuing American Express or Discover cards. All defendants filed motionsto dismiss the complaint. In April 2005 the court denied some portions of thesemotions but reserved rulings on other portions.

 

Wehave been advised that an individual has made a claim against us and one of ourvendors, alleging that we and/or the vendor received discounted bulk mailpostage rates from the U.S. Postal Service on certain mailings between 1997 and2001 that were not eligible for the discounted rates.  The allegationsinvolve claims that such mailings were not eligible for bulk mail postage ratesbecause requirements relating to the updating of mailing lists were notsatisfied.  If we were not entitled to receive the discounted rates, wecould be subject to treble damages, penalties, and other relief.  In July2005, we reached a settlement with the Civil Division of the Department ofJustice, which had been investigating these allegations with the U.S. PostalService, and the law firm representing the private plaintiff.  The settlement requires court approval.

 

InFebruary 2005, PNB was named as a defendant in *Koskeyv. CompuCredit Corporation and Providian National Bank, et al.*, aputative class action filed in Los Angeles Superior Court which arises out ofcertain changes in the terms of customer account agreements, includingincreases to interest rates, relating to certain higher risk loans that weresold by PNB in 2002 and thereafter serviced by CompuCredit.  Theplaintiffs allege that the changes were not adequately disclosed and thatcustomers were not given the opportunity to reject the increased interestrates. The putative class is purported to consist of all accountholders whosebalances plaintiffs allege were transferred from PNB to CompuCredit. We havenot yet answered the complaint.

 

In May 2005,we and PNB were named as defendants in *Wanek v. ProvidianFinancial Corporation and Providian National Bank*. The lawsuit, aputative class action filed in the U.S. District Court for the NorthernDistrict of Illinois on behalf of Illinois residents, alleges that defendantsimproperly accessed plaintiffs’ consumer reports without their consent or a 

 

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“permissible purpose,” inviolation of the Fair Credit Reporting Act (“FCRA”).  Plaintiffs also assert that our pre-screensolicitations did not constitute “firm offers of credit” under FCRA due, inpart, to inadequate disclosures.  Thematter is in the discovery phase.

 

Also in June 2005,a putative class action, *Photos Etc. Corporation v.Providian Financial Corporation et al.,* was filed in the U.S. DistrictCourt for the District of Connecticut on behalf of retailers in several states,naming us, Visa, MasterCard, and over two dozen member banks, includingPNB.  The lawsuit alleges antitrustviolations, including price-fixing, collusion and conspiracy in the setting ofinterchange fees and the “tying” of products and services. PNB has not yetanswered the complaint.

 

Inaddition, we are commonly subject to various other pending and threatened legalactions arising in the ordinary course of business from the conduct of ouractivities.

 

Dueto the uncertainties of litigation, we can give no assurance that we willprevail on claims made against us in the legal proceedings that we currentlyface or that additional proceedings will not be brought. We believe that wehave substantive defenses in the actions and claims described above, and weintend to defend those actions and claims vigorously. We also establishreserves for expected future litigation exposures that we determine to be bothprobable and reasonably estimable. However, an informed assessment of theultimate outcome of pending lawsuits and potential claims is not feasible inmany cases, and we cannot predict the potential future impact of pendinglawsuits and potential claims on us. While we do not presently expect thesematters to have a material adverse effect on our business, financial condition,or results of operations, we can give no assurance that they will not have suchan effect.

 

**Item 2.  Unregistered Sales of Equity Securities andUse of Proceeds**

 

The Company currently hasno share repurchase program in place. The following table sets forthinformation for the second quarter of 2005 regarding the Company’s acquisitionof its Common Stock in connection with shares withheld to cover tax withholdingrequirements related to the vesting of restricted stock:

 
| **Period**     | ** ** | **Total Number of Shares Purchased** | ** ** | **Average Price Paid per Share** | ** ** | **Total Number of Shares Purchased as Part of Publicly Announced Plans  or Programs** | ** ** | **Maximum Number of Shares That May Yet Be Purchased** | ** ** |
|----------------|------------|-------------------------------------------|------------|----------------------------------|------------|---------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| April 1-30     |       | N/A                                       |       | N/A                              |       | N/A                                                                                   |       | N/A                                                    |       |
| May 1-31       |       | N/A                                       |       | N/A                              |       | N/A                                                                                   |       | N/A                                                    |       |
| June 1-30 |       | 170,801                                   |       | 17.685                           |       | N/A                                                                                   |       | N/A                                                    |       |

 

**Item 6.  Exhibits**

 

Exhibits Required by Item 601 of RegulationS-K.

 
| Exhibit 12.1 |   | Computation of Ratio of  Earnings to Fixed Charges and Ratio of Earnings to Combined Fixed Charges and  Preferred Stock Dividend Requirements.                                                                                                                                                                                                                                                                                                      |
|--------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   | (For the six months ended June 30,  2005, the ratio of earnings to fixed charges and the ratio of earnings to  combined fixed charges and preferred stock dividend requirements, in each  case excluding interest on deposits, was 15.42; and the ratio of earnings to  fixed charges and the ratio of earnings to combined fixed charges and  preferred stock dividend requirements, in each case including interest on  deposits, was 3.18.) |
|         |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| Exhibit 31.1 |   | Section 302 Certification  of Chief Executive Officer.                                                                                                                                                                                                                                                                                                                                                                                              |
|         |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| Exhibit 31.2 |   | Section 302 Certification  of Chief Financial Officer.                                                                                                                                                                                                                                                                                                                                                                                              |
|         |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| Exhibit 32.1 |   | Section 906 Certifications  of Chief Executive Officer and Chief Financial Officer.                                                                                                                                                                                                                                                                                                                                                                 |

 

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**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                  |   | Providian  Financial Corporation                                                                                           |   |   |
|-----------------------|--------|----------------------------------------------------------------------------------------------------------------------------|--------|--------|
|                  |   | (Registrant)                                                                                                               |   |
|                  |   |                                                                                                                       |   |
| Date: August  9, 2005 |   | /s/ Anthony  F. Vuoto                                                                                                      |   |
|                  |   | Anthony F.  Vuoto  Vice Chairman and  Chief Financial Officer  (Principal Financial Officer and Duly Authorized Signatory) |   |
|                  |   |                                                                                                                       |   |
| Date: August  9, 2005 |   | /s/ Daniel  Sanford                                                                                                        |   |
|                  |   | Daniel  Sanford Executive  Vice President and Controller  (Chief Accounting Officer and Duly Authorized Signatory)         |   |

 

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**EXHIBITINDEX**

** **
| **Exhibit** | ** ** | **Description**                                                                                                                               |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                          |
| 12.1        |       | Computation of Ratio of Earnings to Fixed Charges and Ratio of  Earnings to Combined Fixed Charges and Preferred Stock Dividend Requirements. |
|        |       |                                                                                                                                          |
| 31.1        |       | Section 302 Certification of Chief Executive Officer.                                                                                         |
|        |       |                                                                                                                                          |
| 31.2        |       | Section 302 Certification of Chief Financial Officer.                                                                                         |
|        |       |                                                                                                                                          |
| 32.1        |       | Section 906 Certifications of Chief Executive Officer and Chief  Financial Officer.                                                           |

 

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