**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 March 31, 2004**                                                                                                                                            |
|                                                                                                                                                                                              |   |                                                                                               |
| **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.) |

 

**201Mission Street, San Francisco, California 94105**(Address of principal executive offices) (Zip Code)

 

**(415)543-0404**(Registrant’s Telephone Number, Including Area Code)

 

**NotApplicable**(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 Actof 1934 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 April 30, 2004, there were 291,178,690 shares of theregistrant’s Common Stock, par value $0.01 per share, outstanding.

 

 

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**PROVIDIANFINANCIAL CORPORATIONFORM 10-Q**

 

**INDEX**

 

**March 31,2004**

 
| **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.**               | Changes in Securities, Use of Proceeds and  Issuer Purchases of Equity Securities           |   |
|              |                      |                                                                                        |   |
|              | **Item 6.**               | Exhibits and Reports on Form 8-K                                                            |   |
|              |                      |                                                                                        |   |
| **SIGNATURES**    |                      |
|              |                      |                                                                                        |   |
| **EXHIBIT INDEX** |                      |

 

2

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**PART I****.  FINANCIAL INFORMATION**

 

**Item 1****.  Financial Statements**

 

**ProvidianFinancial Corporation and Subsidiaries****ConsolidatedStatements of Financial Condition**

 
| **(dollars in thousands, except per share data)**                                                                                                                               |   | **March 31,  2004** |       | **December  31, 2003** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|------------------------|--------|
|                                                                                                                                                                            |   | **(unaudited)**          |       |                   |   |
| Assets                                                                                                                                                                          |   |                     |       |                   |   |
| Cash and cash equivalents                                                                                                                                                       |   | $                        | 771,399    |                   | $      | 544,554 |   |
| Federal funds sold and securities purchased  under resale agreements                                                                                                            |   | 1,439,315                |       | 3,235,189              |   |
| Investment securities:                                                                                                                                                          |   |                     |       |                   |   |
| Available-for-sale (at market value,  amortized cost of $2,761,950 at March 31, 2004 and $1,880,107 at  December 31, 2003)                                            |   | 2,755,439                |       | 1,859,150              |   |
| Loans receivable, less allowance for credit  losses of $568,810 at March 31, 2004 and $625,886 at December 31,  2003                                                  |   | 5,622,157                |       | 5,655,071              |   |
| Due from securitizations                                                                                                                                                        |   | 2,402,202                |       | 2,377,963              |   |
| Deferred taxes                                                                                                                                                                  |   | 167,667                  |       | 224,505                |   |
| Premises and equipment, net                                                                                                                                                     |   | 73,556                   |       | 84,198                 |   |
| Interest receivable                                                                                                                                                             |   | 41,955                   |       | 44,850                 |   |
| Other assets                                                                                                                                                                    |   | 213,182                  |       | 249,867                |   |
| Total assets                                                                                                                                                                    |   | $                        | 13,486,872 |                   | $      | 14,275,347 |   |
|                                                                                                                                                                            |   |                     |       |                   |   |
| Liabilities                                                                                                                                                                     |   |                     |       |                   |   |
| Deposits:                                                                                                                                                                       |   |                     |       |                   |   |
| Non-interest bearing                                                                                                                                                            |   | $                        | 55,373     |                   | $      | 63,016 |   |
| Interest bearing                                                                                                                                                                |   | 8,908,123                |       | 10,038,041             |   |
|                                                                                                                                                                            |   | 8,963,496                |       | 10,101,057             |   |
|                                                                                                                                                                            |   |                     |       |                   |   |
| Short-term borrowings                                                                                                                                                           |   | —                   |       | 108,828                |   |
| Long-term borrowings                                                                                                                                                            |   | 1,442,280                |       | 1,163,521              |   |
| Deferred fee revenue                                                                                                                                                            |   | 82,241                   |       | 100,416                |   |
| Accrued expenses and other liabilities                                                                                                                                          |   | 560,639                  |       | 476,076                |   |
| Total liabilities                                                                                                                                                               |   | 11,048,656               |       | 11,949,898             |   |
|                                                                                                                                                                            |   |                     |       |                   |   |
| Shareholders’ Equity                                                                                                                                                       |   |                     |       |                   |   |
| Common stock, par value $0.01 per share  (authorized: 800,000,000 shares; issued: March 31, 2004—291,453,540  shares; December 31, 2003—290,753,031 shares) |   | 2,915                    |       | 2,908                  |   |
| Retained earnings                                                                                                                                                               |   | 2,452,315                |       | 2,350,446              |   |
| Cumulative other comprehensive income                                                                                                                                           |   | (3,726                   | )          | (12,480                | )      |
| Common stock held in treasury—at cost  (March 31, 2004—294,333 shares; December 31, 2003—305,871 shares)                                               |   | (13,288                  | )          | (15,425                | )      |
| Total shareholders’ equity                                                                                                                                                 |   | 2,438,216                |       | 2,325,449              |   |
| Total liabilities and shareholders’ equity                                                                                                                                 |   | $                        | 13,486,872 |                   | $      | 14,275,347 |   |

 

See Notes to Consolidated Financial Statements.

 

3

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**ProvidianFinancial Corporation and SubsidiariesConsolidated Statements of Income**
|                                                                     |   | **Three months ended March 31,** |    |
|--------------------------------------------------------------------------|--------|---------------------------------------|---------|
| **(dollars in thousands, except per share  data)****(unaudited)**        |   | **2004**                              |    | **2003** |   |
|                                                                     |   |                                  |    |   |   |
| Interest Income                                                          |   |                                  |    |   |   |
| Loans                                                                    |   | $                                     | 217,900 |   | $ | 310,340 |   |
| Federal funds sold and securities purchased under  resale agreements     |   | 6,279                                 |    | 9,826 |   |
| Other                                                                    |   | 23,479                                |    | 32,033 |   |
| Total interest income                                                    |   | 247,658                               |    | 352,199 |   |
|                                                                     |   |                                  |    |   |   |
| Interest Expense                                                         |   |                                  |    |   |   |
| Deposits                                                                 |   | 114,896                               |    | 161,222 |   |
| Borrowings                                                               |   | 18,816                                |    | 10,623 |   |
| Total interest expense                                                   |   | 133,712                               |    | 171,845 |   |
|                                                                     |   |                                  |    |   |   |
| Net interest income                                                      |   | 113,946                               |    | 180,354 |   |
|                                                                     |   |                                  |    |   |   |
| Provision for credit losses                                              |   | 88,852                                |    | 261,815 |   |
|                                                                     |   |                                  |    |   |   |
| Net interest income (loss) after provision for  credit losses            |   | 25,094                                |    | (81,461 | ) |
|                                                                     |   |                                  |    |   |   |
| Non-Interest Income                                                      |   |                                  |    |   |   |
| Servicing and securitization                                             |   | 236,738                               |    | 190,588 |   |
| Credit product fee income                                                |   | 149,144                               |    | 200,193 |   |
| Other                                                                    |   | 11,544                                |    | 26,757 |   |
|                                                                     |   | 397,426                               |    | 417,538 |   |
| Non-Interest Expense                                                     |   |                                  |    |   |   |
| Salaries and employee benefits                                           |   | 81,480                                |    | 96,975 |   |
| Solicitation and advertising                                             |   | 52,571                                |    | 65,378 |   |
| Occupancy, furniture, and equipment                                      |   | 26,213                                |    | 28,683 |   |
| Data processing and communication                                        |   | 27,048                                |    | 30,670 |   |
| Other                                                                    |   | 78,694                                |    | 106,602 |   |
|                                                                     |   | 266,006                               |    | 328,308 |   |
| Income before income taxes                                               |   | 156,514                               |    | 7,769 |   |
| Income tax expense                                                       |   | 54,780                                |    | 3,069 |   |
| Net income                                                               |   | $                                     | 101,734 |   | $ | 4,700 |   |
|                                                                     |   |                                  |    |   |   |
| **Earnings per common share—basic**                                 |   | $                                     | 0.35    |   | $ | 0.02 |   |
|                                                                     |   |                                  |    |   |   |
| **Earnings per common share—assuming  dilution**                    |   | $                                     | 0.35    |   | $ | 0.02 |   |
|                                                                     |   |                                  |    |   |   |
| Weighted average common shares outstanding—basic  (000)             |   | 288,085                               |    | 286,187 |   |
|                                                                     |   |                                  |    |   |   |
| Weighted average common shares  outstanding—assuming dilution (000) |   | 298,345                               |    | 290,429 |   |

 

See Notes to Consolidated Financial Statements.

 

4

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**ProvidianFinancial Corporation and SubsidiariesConsolidated Statements of Changes in Shareholders’Equity**
| **(dollars in thousands, except  share data) (unaudited)**                                               |   | **Common  Stock** |      | **Additional  Paid-In  Capital** |   | **Retained  Earnings** |       | **Cumulative  Other  Comprehensive  Income** |          | **Common  Stock  Held  in Treasury** |   | **Total**   |       |
|----------------------------------------------------------------------------------------------------------|--------|-------------------|-----------|----------------------------------|--------|------------------------|------------|----------------------------------------------|---------------|--------------------------------------|--------|-------------|------------|
|                                                                                                     |   |              |      |                             |   |                   |       |                                         |          |                                 |   |        |       |
| **Balance at  December 31, 2002**                                                                   |   | **$**             | **2,909** | ** **                       | **$**  | **—**             | ** ** | **$**                                        | **2,202,960** | ** **                           | **$**  | **9,888**   | ** ** | **$** | **(76,685** | **)** | **$** | **2,139,072** | ** ** |
| Comprehensive income:                                                                                    |   |              |      |                             |   |                   |       |                                         |          |                                 |   |        |       |
| Net income                                                                                               |   |              |      |                             |   | 4,700                  |       |                                         |          |                                 |   | 4,700       |       |
| Change in unrealized loss on securities,  net of income tax benefit of $6,621                            |   |              |      |                             |   |                   |       | (10,141                                      | )             |                                 |   | (10,141     | )          |
| Total comprehensive loss                                                                                 |   |              |      |                             |   |                   |       |                                         |          |                                 |   | (5,441      | )          |
|                                                                                                     |   |              |      |                             |   |                   |       |                                         |          |                                 |   |        |       |
| Purchase of 108,587 common shares for  treasury                                                          |   |              |      |                             |   |                   |       |                                         |          | (649                                 | )      | (649        | )          |
| Exercise of stock options and other awards                                                               |   |              |      | 30,458                           |   | (31,192                | )          |                                         |          | 931                                  |   | 197         |       |
| Issuance of restricted and unrestricted  stock less forfeited shares                                     |   | (2                | )         | (28,679                          | )      |                   |       |                                         |          | 31,689                               |   | 3,008       |       |
| Deferred compensation related to grant of  restricted and unrestricted stock less amortization of $1,981 |   |              |      | (1,023                           | )      |                   |       |                                         |          |                                 |   | (1,023      | )          |
| Net tax effect from employee stock plans                                                                 |   |              |      | (756                             | )      |                   |       |                                         |          |                                 |   | (756        | )          |
| **Balance at  March 31, 2003**                                                                      |   | **$**             | **2,907** | ** **                       | **$**  | **—**             | ** ** | **$**                                        | **2,176,468** | ** **                           | **$**  | **(253**    | **)**      | **$** | **(44,714** | **)** | **$** | **2,134,408** | ** ** |
|                                                                                                     |   |              |      |                             |   |                   |       |                                         |          |                                 |   |        |       |
| **Balance at  December 31, 2003**                                                                   |   | **$**             | **2,908** | ** **                       | **$**  | **—**             | ** ** | **$**                                        | **2,350,446** | ** **                           | **$**  | **(12,480** | **)**      | **$** | **(15,425** | **)** | **$** | **2,325,449** | ** ** |
| Comprehensive income:                                                                                    |   |              |      |                             |   |                   |       |                                         |          |                                 |   |        |       |
| Net income                                                                                               |   |              |      |                             |   | 101,734                |       |                                         |          |                                 |   | 101,734     |       |
| Change in unrealized loss on securities,  net of income tax expense of $5,716                            |   |              |      |                             |   |                   |       | 8,754                                        |          |                                 |   | 8,754       |       |
| Total comprehensive income                                                                               |   |              |      |                             |   |                   |       |                                         |          |                                 |   | 110,488     |       |
|                                                                                                     |   |              |      |                             |   |                   |       |                                         |          |                                 |   |        |       |
| Purchase of 52,054 common shares for  treasury                                                           |   |              |      |                             |   |                   |       |                                         |          | (661                                 | )      | (661        | )          |
| Exercise of stock options and other awards                                                               |   |              |      | (2,489                           | )      | 135                    |       |                                         |          | 3,161                                |   | 807         |       |
| Issuance of restricted and unrestricted  stock less forfeited shares                                     |   | 7                 |      | 7,817                            |   |                   |       |                                         |          | (363                                 | )      | 7,461       |       |
| Deferred compensation related to grant of  restricted and unrestricted stock less amortization of $1,740 |   |              |      | (5,721                           | )      |                   |       |                                         |          |                                 |   | (5,721      | )          |
| Net tax effect from employee stock plans                                                                 |   |              |      | 393                              |   |                   |       |                                         |          |                                 |   | 393         |       |
| **Balance at  March 31, 2004**                                                                      |   | **$**             | **2,915** | ** **                       | **$**  | —                 | ** ** | **$**                                        | **2,452,315** | ** **                           | **$**  | **(3,726**  | **)**      | **$** | **(13,288** | **)** | **$** | **2,438,216** | ** ** |

 

See Notes to Consolidated Financial Statements.

 

5

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**ProvidianFinancial Corporation and Subsidiaries****ConsolidatedStatements of Cash Flows**

 
|                                                                                                                       |   | **Three  months ended March 31,** |    |
|----------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|---------|
| **(dollars in thousands) (unaudited)**                                                                                     |   | **2004**                               |    | **2003** |   |
|                                                                                                                       |   |                                   |    |   |   |
| **Operating Activities**                                                                                                   |   |                                   |    |   |   |
| Net income                                                                                                                 |   | $                                      | 101,734 |   | $ | 4,700 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:                                         |   |                                   |    |   |   |
| Provision for credit losses                                                                                                |   | 88,852                                 |    | 261,815 |   |
| Depreciation and amortization of premises  and equipment                                                                   |   | 11,350                                 |    | 9,892 |   |
| Amortization of net loan acquisition costs                                                                                 |   | 5,330                                  |    | 11,138 |   |
| Amortization of deferred compensation  related to restricted and unrestricted stock                                        |   | 1,740                                  |    | 1,981 |   |
| Decrease in deferred fee revenue                                                                                           |   | (18,175                                | )       | (41,373 | ) |
| Decrease in deferred income tax benefit                                                                                    |   | 51,157                                 |    | 68,201 |   |
| Decrease in interest receivable                                                                                            |   | 2,895                                  |    | 2,433 |   |
| Net decrease in other assets                                                                                               |   | 31,356                                 |    | 339,897 |   |
| Net increase in accrued expenses and other  liabilities                                                                    |   | 81,048                                 |    | 140,201 |   |
| Net cash provided by operating activities                                                                                  |   | 357,287                                |    | 798,885 |   |
|                                                                                                                       |   |                                   |    |   |   |
| **Investing  Activities**                                                                                                  |   |                                   |    |   |   |
| Net cash from loan originations and  principal collections on loans receivable                                             |   | 86,897                                 |    | 385,312 |   |
| Net decrease in securitized loans                                                                                          |   | (142,500                               | )       | (907,800 | ) |
| (Increase) decrease in due from  securitizations                                                                           |   | (24,239                                | )       | 707,751 |   |
| Purchases of available-for-sale investment  securities                                                                     |   | (2,366,185                             | )       | (890,859 | ) |
| Proceeds from maturities and sales of  available-for-sale investment securities                                            |   | 1,484,331                              |    | 880,654 |   |
| Decrease (increase) in federal funds sold  and securities purchased  under resale  agreements or similar arrangements |   | 1,795,874                              |    | (625,000 | ) |
| Net purchases of premises and equipment                                                                                    |   | (1,044                                 | )       | (4,052 | ) |
| Net cash provided (used) by investing  activities                                                                          |   | 833,134                                |    | (453,994 | ) |
|                                                                                                                       |   |                                   |    |   |   |
| **Financing  Activities**                                                                                                  |   |                                   |    |   |   |
| Net decrease in deposits                                                                                                   |   | (1,133,653                             | )       | (106,967 | ) |
| Repayment of short-term borrowings                                                                                         |   | (108,828                               | )       | (91,686 | ) |
| Proceeds from long-term borrowings                                                                                         |   | 278,759                                |    | — |   |
| Purchase of treasury stock                                                                                                 |   | (661                                   | )       | (649 | ) |
| Proceeds from exercise of stock options                                                                                    |   | 807                                    |    | 197 |   |
| Net cash used by financing activities                                                                                      |   | (963,576                               | )       | (199,105 | ) |
| **Net Increase in  Cash and Cash Equivalents**                                                                             |   | 226,845                                |    | 145,786 |   |
| Cash and cash equivalents at beginning of  period                                                                          |   | 544,554                                |    | 344,277 |   |
| Cash and cash equivalents at end of period                                                                                 |   | $                                      | 771,399 |   | $ | 490,063 |   |

 

See Notes to Consolidated Financial Statements.

 

6

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**ProvidianFinancial Corporation and Subsidiaries****Notes toConsolidated Financial Statements****March 31,2004 (unaudited)**

 

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

 

ProvidianFinancial Corporation (the “Company”) is a corporation incorporated under thelaws of Delaware. Through its wholly-owned banking subsidiary, ProvidianNational Bank (“PNB”), the Company offers credit card and deposit productsthroughout the United States. The Company markets consumer loans and depositsusing distribution channels such as mail, telephone and the Internet.

 

The accompanying unaudited consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States (“GAAP”) for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,we do not include all of the information and footnotes required by GAAP forcomplete consolidated financial statements. In the opinion of management, alladjustments considered necessary for a fair presentation of the results for theinterim periods presented have been included. All such adjustments are of anormal, recurring nature. The preparation of financial statements in conformitywith GAAP requires management to make estimates and assumptions that affectreported amounts in the financial statements and accompanying notes. Theseestimates are based on information available as of the date of the consolidatedfinancial statements. Therefore, actual results could differ from thoseestimates. Operating results for the three months ended March 31, 2004 arenot necessarily indicative of the results for the year ending December 31,2004. The notes to the consolidated financial statements contained in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2003should be read in conjunction with these consolidated financial statements. Allsignificant intercompany balances and transactions have been eliminated inconsolidation. For purposes of comparability, certain prior period amounts havebeen reclassified.

 

**Note 2.  Stock-Based Employee Compensation**

 

The Company has elected to account for its stock-based compensationplans in accordance with Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees” (“APB Opinion No. 25”), and relatedinterpretations, as permitted by Statement of Financial Accounting StandardsNo. 123, “Accounting for Stock Based Compensation” (“SFAS No. 123”).Accordingly, because the exercise price of the Company’s employee stock optionsis the fair market value of the underlying stock on the date of grant, theCompany recognizes no compensation expense at the time of the grant. For grantsof restricted shares of common stock, the market value of restricted shares atthe date of grant is amortized over the vesting period and classified asnon-interest expense. In addition, the Company does not recognize compensationexpense for its employee stock purchase plan since it qualifies as anon-compensatory plan under APB Opinion No. 25.

 

7

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The following table reflects, for the three months ended March 31,2004 and 2003, the stock-based employee compensation costs arising out of therestricted and nonrestricted stock programs 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 had been recorded based on the fair value at the date ofgrant under the Company’s stock-based compensation plans, consistent with theprovisions of SFAS No. 123. The pro forma compensation expense reflects thefair value of the stock options amortized to expense over the vesting period ofthe grant, which is generally three years.

 

**Stock-BasedEmployee Compensation Cost and****Pro FormaNet Income and Earnings Per Common Share**
|                                                                                                                |   | **Three  months ended March 31,** |   |
|---------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
| **(dollars in thousands, except per share data)**                                                                   |   | **2004**                               |   | **2003** |   |
| Restricted and unrestricted stock  amortization, net-of-taxes, included in net income,   as reported(1)        |   | $                                      | 1,053  |   | $ | 1,199 |   |
| Net income, as reported                                                                                             |   | 101,734                                |   | 4,700 |   |
| Deduct: Pro forma stock-based employee  compensation expense determined under fair value method, net-of-taxes(2)(3) |   | 5,320                                  |   | 7,078 |   |
| Pro forma net income(1)                                                                                             |   | $                                      | 96,414 |   | $ | (2,378 | ) |
| Net income per common share:                                                                                        |   |                                   |   |   |   |
| As reported—basic                                                                                              |   | $                                      | 0.35   |   | $ | 0.02 |   |
| As reported—assuming dilution                                                                                  |   | $                                      | 0.35   |   | $ | 0.02 |   |
| Net income per common share:                                                                                        |   |                                   |   |   |   |
| Pro forma—basic                                                                                                |   | $                                      | 0.33   |   | $ | (0.01 | ) |
| Pro forma—assuming dilution                                                                                    |   | $                                      | 0.33   |   | $ | (0.01 | ) |

 

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(1)          The Company uses the straight-line method forrecognizing compensation cost for fixed awards with pro rata vesting.

(2)          The pro forma stock-based compensationexpenses include the effects of an expense reduction for non-vested stockoptions that have been forfeited.

(3)          The pro forma stock-based compensationexpense for the three months ended March 31, 2004 reflects modification ofthe methodology used in estimating expected volatility of the Company’s stockprice. This modification resulted in the reduction of the pro forma stock-basedcompensation expense by $0.3 million, net-of-taxes. See discussion below forfurther information regarding this modification.

 

The fair values of the stock options granted under the Company’s stockincentive plans and the common stock offerings under the employee stockpurchase plan were estimated at the grant date using the Black-Scholes optionpricing model and based on assumptions for the risk-free weighted averageinterest rate, expected dividend yield, weighted average expected volatility,and the expected stock option life. The Black-Scholes option pricing model wasdeveloped for use in estimating the fair value of traded options, which have novesting restrictions, are fully transferable, and typically have shorter terms.In addition, option-pricing models require the input of highly subjectiveassumptions, including the option’s expected life and the expected pricevolatility of the underlying stock. Because the Company’s employee stockoptions have characteristics significantly different from those of tradedoptions, and because changes in the subjective model assumptions can materiallyaffect the estimate, the existing valuation models may not provide a reliablemeasure of the fair value of the Company’s employee stock options.

 

Expected volatility represents management’s estimate of the Company’sstock price changes expected to occur over the estimated life of the stockoptions and stock offerings. In prior periods, expected volatility wasestimated based upon the unadjusted historical volatility of the Company’scommon stock over a fixed period. During the fourth quarter of 2003, theCompany modified its methodology for estimating expected volatility. Themodification was based on the Company’s assessment that historical volatilitywas not representative of future expected experience as the historical volatilitydoes not reflect the impact of significant changes in the Company’s businessthat were implemented in late 2001 and 2002. The expected volatility is nowestimated giving consideration to the expected life of stock options and actualhistorical volatility of the price of the Company’s common stock adjusted forunusual, company-specific fluctuations in the Company’s stock price. Managementbelieves that the new method provides a better indicator of the expectedvolatility. The impact of the modification to volatility for options grantedduring the first quarter of 2004 was to reduce volatility from 90% to 46%. Thisresulted in an aggregate fair value of $7.2 million, which was 40% lower thanusing unadjusted historical volatility.

 

8

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**Note 3.  Consolidation of Variable Interest Entities**

 

In January 2003, theFinancial Accounting Standards Board (the “FASB”) issued Interpretation No. 46,“Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51”(“FIN 46”). FIN 46 provides guidance on how to identify a variable interestentity (“VIE”) and determine when the assets, liabilities, non-controllinginterests, and results of operations of a VIE must be included in a company’sconsolidated financial statements. A company that holds variable interests inan entity is required to consolidate the entity if its interest in the VIE issuch that it will absorb a majority of the VIE’s expected losses and/or receivea majority of the entity’s expected residual returns, if any.

 

In December 2003, theFASB issued a revision of FIN 46, which superseded the original guidance andrevised various aspects of the original guidance, including effective dates.Under the revised guidance, FIN 46 remains effective upon its issuance forinterests in VIEs acquired after January 31, 2003. For interests in VIEsacquired before February 1, 2003, the revised FIN 46 effective date wasdelayed to March 31, 2004, with the exception of special-purpose entities,for which the effective date was December 31, 2003. Effective July 1,2003, the Company applied the provisions of FIN 46 to Providian Capital I, itswholly-owned trust that issued preferred securities. See Note 9 to ConsolidatedFinancial Statements.

 

Because the Company’s securitizationsare structured using qualifying special-purpose entities, as defined inStatement of Financial Accounting Standards No. 140, “Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities—aReplacement of FASB Statement No. 125” (“SFAS No. 140”) and FIN 46, theCompany’s securitization trusts are not required to be consolidated. Inconnection with its Series 2000-A securitization, the Company has an equityinterest in a special-purpose entity that was acquired prior toFebruary 1, 2003. The Company previously determined that the entity is aVIE and that the Company is not the primary beneficiary, and therefore theentity does not meet the requirements for consolidation by the Company underFIN 46. As of March 31, 2004, the Company’s total investment in thisentity was $42.8 million, which represents the Company’s maximum loss exposure,and the estimated total assets of the entity were approximately $803.5 million.

 

TheCompany has also completed its analysis of certain VIEs that are notspecial-purpose entities and that were acquired before February 1, 2003,primarily with respect to the Company’s limited partnership interests thatqualify under the Community Reinvestment Act. Based on its review, the Companyhas determined that these limited partnerships are VIEs and that the Company isnot the primary beneficiary, and therefore these entities do not meet therequirements for consolidation by the Company under FIN 46. As ofMarch 31, 2004, the Company’s total investment in limited partnerships,including those acquired after January 31, 2003, was $22.9 million, which,combined with $20.2 million of remaining contractual funding commitments underthese investments, represents the Company’s maximum loss exposure, and theestimated total assets of these entities were approximately $269.3 million.

 

**Note 4.  Interest and Fee Income Recognition**

 

The Company recognizes interest and fee income using a suppressionmethodology. Under the suppression methodology, interest and fees thatwould otherwise accrue on reported loans and other assets, but that the Companyestimates will not be collected (the “suppressed amounts”), are not recognizedas interest income, credit product fee income, or servicing and securitizationincome on the Company’s statement of income and are not included in loansreceivable, interest receivable, or due from securitizations on the Company’sstatement of financial condition. Under the suppression methodology, theCompany analyzes projected credit loss rates, delinquency status, andhistorical loss experience to estimate the suppressed amounts.

 

The suppression impact on income includes adjustments to previousperiod estimates of uncollectible interest and fees. During the first quarterof 2004 and 2003, interest and fees not recognized as income as a result of theimpact of the suppression methodology were as follows:

 

**Suppressionof Interest and Fee Income**

 

|                                |   | **Three  months ended March 31,** |    |
|-------------------------------------|--------|----------------------------------------|---------|
| **(dollars in thousands)**          |   | **2004**                               |    | **2003** |   |
| Loan interest income                |   | $                                      | 17,236  |   | $ | 46,798 |   |
| Credit product fee income           |   | 27,603                                 |    | 58,963 |   |
| Servicing and securitization income |   | 108,506                                |    | 141,203 |   |
| Total                               |   | $                                      | 153,345 |   | $ | 246,964 |   |

 

9

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**Note5.  Investment Securities**

 

The Company’s investment securities portfolio is primarily comprised oftreasury obligations, government sponsored agency securities, mortgage-backedsecurities, and commercial paper. A large majority of the portfolio iscomprised of mortgage-backed securities issued by a government sponsored agencyor a fully government guaranteed agency. The mortgage-backed securities are inthe form of (a) fixed and floating rate collateralized mortgage obligations,(b) adjustable rate pass-through securities, and (c) fixed rate pass-throughsecurities. 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 security’sprice. The reduced value of these securities stems from changes in marketconditions, not necessarily from any intrinsic value deterioration. The Companyis able to hold those securities that currently have a loss on an ongoing basiswithout any detriment to the liquidity of the portfolio. At March 31,2004, the Company had an unrealized loss of $1.3 million on investments with anamortized cost of $156.5 million that were in a sustained unrealized lossposition for 12 months or more.

 

**Summaryof Available-for-Sale Investment Securities**

 
|                                             |   | **March 31, 2004** |      | **December 31, 2003**   |   |
|--------------------------------------------------|--------|-------------------------|-----------|------------------------------|--------|
| **(dollars in  thousands)**                      |   | **Amortized   Cost**    |      | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses  Less Than****12 Months** |   | **Gross  Unrealized****Losses  12 Months    or Longer** |   | **Market  Value** |   | **Amortized  Cost** |   | **Gross****Unrealized    Gains** |   | **Gross****Unrealized  Losses** |   | **Market  Value** |   |
| United States Treasury and  federal agency bonds |   | $                       | 278,042   |                         | $      | 1,090 |   | $ | — |   | $ | — |   | $ | 279,132 |   | $ | 118,098 |   | $ | 109 |   | $ | 184 |   | $ | 118,023 |   |
| Mortgage-backed securities                       |   | 871,099                 |      | 1,586                        |   | 7,233 |   | 1,298 |   | 864,154 |   | 1,010,943 |   | 638 |   | 20,413 |   | 991,168 |   |
| Commercial paper                                 |   | 1,583,209               |      | 89                           |   | 1,012 |   | — |   | 1,582,286 |   | 699,487 |   | — |   | 382 |   | 699,105 |   |
| Other                                            |   | 29,600                  |      | 271                          |   | — |   | 4 |   | 29,867 |   | 51,579 |   | 90 |   | 815 |   | 50,854 |   |
| Total investment securities  available-for-sale  |   | $                       | 2,761,950 |                         | $      | 3,036 |   | $ | 8,245 |   | $ | 1,302 |   | $ | 2,755,439 |   | $ | 1,880,107 |   | $ | 837 |   | $ | 21,794 |   | $ | 1,859,150 |   |

 

During the three months ended March 31, 2004, investmentsecurities with an amortized cost of $112.9 million were sold at a net realizedloss of $0.5 million, which includes gross gains of $0.1 million and grosslosses of $0.6 million. During the three months ended March 31, 2003,investment securities with an amortized cost of $387.4 million were sold at anet realized gain of $9.6 million, which includes gross gains of $10.3 millionand gross losses of $0.7 million. Realized gains and losses were calculatedusing the specific identification method.

 

**Note 6.  Loans Receivable**

 

The Company has credit risk on loans to the extent that borrowers failto repay amounts owed and such amounts are not recovered through collectionsprocedures. At March 31, 2004, the Company had no significant regionaldomestic or foreign concentrations of credit risk.

 

**Note 7.  Securitization or Sale of Receivables**

 

TheCompany periodically securitizes pools of its loans receivable and issuesasset-backed securities in underwritten offerings and private placementsthrough trusts that meet the requirements for sale treatment. At March 31,2004 and December 31, 2003, the Company’s securitization program had$10.20 billion and $10.33 billion of securityholders’ interests outstanding, ofwhich $8.78 billion and $8.92 billion were held by third parties. The Companyretains the remaining interests in the loans receivable transferred in itssecuritizations and includes them on its statement of financial condition.

 

TheCompany’s securitization transactions create undivided interests in the pool ofloans and establish securityholders’ interests (asset-backed securityholders’interests and notes), a seller’s interest, interest-only strips receivable, andspread accounts. Securityholders’ interests consist of senior and subordinatedinvestor interests. The senior securityholders’ interests are sold to thirdparty investors, supported with various forms of credit enhancement. When asecuritization transaction is entered into, the Company receives cash proceedsfrom the sale of securities to third parties, removes the securitized loans andrelated allowance for credit losses from its statement of financial condition,and records the retained interests in the transaction. The 

 

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Company typically recognizes a net gain on sale from thesecuritization, due primarily to the release of the related allowance for creditlosses and recognition of an interest-only strip receivable, which is partiallyoffset by discounts recognized for the retained subordinated interests.

 

Theseller’s interest is composed of senior and subordinated components. The seniorseller’s interest represents the seller’s undivided interest in the trust loansreceivable that are not allocated to the securityholders’ interests, and theprincipal, interest, and fees receivable included in the senior seller’sinterest are classified as loans receivable on the Company’s statement offinancial condition. The Company maintains an allowance for credit losses forthe principal amount of these loans. As the amount of the loans in thesecuritized pool fluctuates due to customer payments, purchases, cash advances,billed interest and fees, and credit losses, the amount of the senior seller’sinterest will vary. Periodically, the Company transfers new loans into thesecuritized pool in order to maintain the seller’s interest above the minimumrequired by the securitization documents or in anticipation of issuing newsecurityholders’ interests.

 

Thesubordinated component of the seller’s interest is the accrued interestreceivable (“AIR”), which represents the Company’s interest in outstandingaccrued interest and fees that are initially allocated to the securityholders’interests. The AIR is included as a financial component of the securitizationtransaction in computing the net gain on sale. It is valued at the lower of itsprevious carrying amount or allocated carrying value at the time of the saleand is recorded in due from securitizations on the Company’s statement offinancial condition.

 

Theretained securityholders’ interests are securities measured at fair value andincluded on the Company’s statement of financial condition in due fromsecuritizations. The retained subordinated securityholders’ interests consistprimarily of non-interest bearing beneficial interests that are repaid afterthe related senior classes. Upon 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 fair values at the time of origination is recorded innon-interest income—servicing and securitization. The Company measures fairvalue through estimated cash flows discounted at rates that reflect the levelof subordination, the projected repayment term, and the credit risk of thesecuritized loans.

 

Whenthe securityholders’ interests are reduced through amortization, termination,or a reduction in invested amounts in the Company’s variable funding series,the seller’s interest is increased, resulting in the recognition of an allowancefor credit losses related to the increase in reported loans receivable.Typically, this increase in allowance for credit losses is the only significantearnings impact resulting from the reduction in the securityholders’ investedinterests.

 

Duringthe three months ended March 31, 2004 and 2003, the Company securitized$914.6 million and $1.09 billion of loans receivable, offset by reductions insecuritized loans of $1.05 billion and $2.44 billion from the repayment ofcertain series and a reduction in the invested amount of the variable fundingseries. The Company recognized net losses of $14.1 million and $16.2 million inthe three months ended March 31, 2004 and 2003 from the initial sale ofinvestor interests to third party investors, the recognition of a gain from theinterest-only strip receivable and the loss from the discounts recognized onother retained interests. These amounts exclude the benefit realized from thereduction to the allowance for credit losses recognized at the time of sale.

 

Adjustmentsto record the allocated carrying value of new retained securityholders’interests at the time of sale during the three months ended March 31, 2004and 2003 reduced non-interest income—servicing and securitization by $53.2million and $84.2 million. These adjustments were partially offset by theallocated carrying value to fair value adjustments of $17.7 million and $61.4million.

 

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The following table presents key economic assumptions used in theinitial measurement of the retained subordinated interests for securitizationsentered into during the three months ended March 31, 2004 and 2003.

 

**SecuritizationInitial Measurement Assumptions**

 

|                                                       |   | **March 31,** |   |
|------------------------------------------------------------|--------|--------------------|--------|
|                                                       |   | **2004**           |   | **2003** |   |
| Payment rate(1)                                            |   | 6.1%               |   | 5.2% |   |
| Expected net credit loss rate                              |   | 17.3%              |   | 18.6% |   |
| Weighted average loans receivable life (in  years)(2)      |   | 0.90               |   | 1.0 |   |
| Discount rate(3)                                           |   | 6.8%-20.0%         |   | 6.3%-20.0% |   |
| Average interest rate margin for third  party investors(4) |   | 0.54%              |   | 0.86% |   |

 

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(1)          The monthly payment rate represents aforecast of principal collections for the month divided by a forecast of theaggregate amount of principal loans receivable at the beginning of the month.This rate is an average of forecasted monthly rates over the estimated life of theloans receivable.

(2)          The weighted average loans receivable life iscalculated by multiplying the principal collections expected in each futureperiod by the number of periods until the balance is paid, summing thoseproducts, and dividing by the initial principal balance.

(3)          Discount rate assumptions vary based on therelative risk of cash flows, which includes factors such as the level ofsubordination, the projected repayment term, and the credit risk of thesecuritized loans.

(4)          Theinterest rate paid to third party investors in a term securitization with avariable rate is based on this margin plus the London Interbank Offered Rate(LIBOR). The interest rate paid to conduit providers that participate in thevariable funding series is generally based on a commercial paper rate. Theaverage interest rate margin decreased in the three months ended March 31,2004 as a result of more favorable pricing included in the term securitizationissued by the Company in the first quarter of 2004.

 

Subsequentto the initial fair value recognition, the Company evaluates its retainedsecurityholders’ interests and recognizes changes in their fair market value innon-interest income—servicing and securitization. The fair market value changesreflect the Company’s revisions in estimated cash flows and discount rates,including the impact of the remaining term until repayment. As securityholders’interests approach their expected final payment date, their fair valuesgenerally approach their face values and the discounts are accreted, with theamount of such accretion realized in non-interest income—servicing andsecuritization. The following table summarizes the retained subordinatedsecurityholders’ interests in the Providian Gateway Master Trust as ofMarch 31, 2004 and December 31, 2003.

 

**Summary ofRetained Subordinated Securityholders’ Interests****in theProvidian Gateway Master Trust**

| **(dollars in thousands)**                             |   | **March 31,  2004** |      | **December 31,  2003** |   |
|--------------------------------------------------------|--------|--------------------------|-----------|-----------------------------|--------|
| Retained  subordinated securityholders’ interests |   |                     |      |                        |   |
| Face value                                             |   | $                        | 1,416,386 |                        | $      | 1,411,738 |   |
| Discount                                               |   | (193,954                 | )         | (235,422                    | )      |
| Fair market value                                      |   | $                        | 1,222,432 |                        | $      | 1,176,316 |   |
|                                                   |   |                     |      |                        |   |
| Weighted average remaining term (months)               |   | 22                       |      | 22                          |   |

 

For the three months ended March 31, 2004 and 2003, the changes innet unrealized gains on retained subordinated securityholders’ interestsincluded in earnings were $90.2 million and $118.6 million. These unrealizedgains are recognized in servicing and securitization income.

 

Theinterest-only strip receivable is a retained interest in the interest and feecollections allocated to the securityholders’ interests. This asset representsthe present value of estimated future excess servicing expected to be generatedby the securitized loans over the period the securitized loans are projected tobe outstanding. Excess servicing represents the net positive cash flow frominterest and fee collections allocated to the securityholders’ interests afterdeducting the interest paid on investor certificates, credit losses,contractual servicing fees, and other expenses. The interest-only stripreceivable is recorded at estimated fair value and included in due fromsecuritizations on the Company’s statement of financial condition. Subsequentto 

 

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theinitial sale, the Company’s securitizations impact its earnings through salesof retained interests, changes in the fair values of its retained interests,including the accretion of the retained interests’ discounts, the ongoingrecognition of interest-only strips receivable, and the difference in theactual excess servicing received as compared to the amount estimated incalculating the related interest-only strips receivable.

 

Spreadaccounts are cash reserve accounts that can be called upon to fund payments tosecuritization investors or credit enhancers. The cash in the spread account isreleased to the Company if certain conditions are met or the securitizationterminates with amounts remaining in the spread account. The spread accountsare recorded at estimated fair value in due from securitizations on theCompany’s statement of financial condition.

 

Duringthe revolving period of a securitization, no principal payments are made to theinvestors. Instead, monthly collections of principal allocated to investors,and other amounts treated as principal collections, are used to fund thepurchase of replacement loans receivable, and the Company recognizes additionalinterest-only strips receivable when this occurs. In addition, to the extentthe amount of the excess servicing cash flows received in a month differs fromthe amount estimated in establishing the related interest-only stripreceivable, the Company recognizes servicing and securitization income or loss.

 

Valuationsof retained subordinated securityholders’ interests, interest-only stripsreceivable, and spread accounts require the Company to use judgment inselecting discount rates, estimating future cash flows, assessing currenteconomic conditions, and assuming the outcome of future events. Retained subordinatedsecurityholders’ interests are discounted at rates that reflect the level ofsubordination, the projected repayment term, and the credit risk of thesecuritized loans. In valuing interest-only strips receivable, the Companyestimates the interest and fees that will be collected on the securitizedloans, credit losses, contractual servicing fees, and repayment trends of thesecuritized loans to project the amount of excess servicing to be received overthe period the securitized loans are projected to be outstanding. The spreadaccounts are recorded at fair value through a discounted cash flow analysisbased on projected repayments of spread account balances to the Company.

 

Atleast quarterly, the Company adjusts the valuations of the retained intereststo reflect changes in the amount of the securitized loans outstanding and anychanges to the initial assumptions, estimates, and discount rates. The Companyalso continues to refine the financial models used to obtain more accuratemeasures of the timing and amount of cash flows. These values can, and will,vary as a result of changes in the level and timing of the cash flows and theunderlying economic assumptions. Changes in the estimated fair value of theretained interests are reported as a component of non-interest income—servicingand securitization on the Company’s statement of income.

 

TheCompany continues to service the accounts included in the pool of securitizedloans and earns a monthly servicing fee, which is generally offset by the servicingcosts it incurs. The contractual servicing fee is representative of a marketrate and the Company therefore does not currently recognize a servicing assetor liability in connection with its securitizations.

 

The key economic assumptions used in valuing retained subordinatedinterests and the sensitivity of the current fair value of residual cash flowsto immediate 10% and 20% adverse changes in those assumptions at March 31,2004 are presented in the following table.

 

**SecuritizationSensitivities**

 

| **(dollars in thousands)** |   | **Discount  Rate** |    | **Expected  Net Credit  Loss Rate** |   | **Payment  Rate** |   |
|----------------------------|--------|--------------------|---------|-------------------------------------|--------|-------------------|--------|
| Current assumptions        |   | 5.10%–20%     |    | 17.33%                              |   | 6.14%             |   |
| Impact on fair value of:   |   |               |    |                                |   |              |   |
| 10% adverse change         |   | $                  | (24,732 | )                                   | $      | (112,479          | )      | $ | (10,571 | ) |
| 20% adverse change         |   | (47,380            | )       | (201,691                            | )      | (20,362           | )      |
|                            |        |                    |         |                                     |        |                   |        |  |  |  |

 

The adverse changes to these key economic assumptions are hypotheticaland are presented in accordance with SFAS No. 140. As the figures aboveindicate, changes in fair value based on a 10% variation in assumptionsgenerally cannot be extrapolated because the relationship of the change inassumption to the change in fair value may not be linear. In addition, theeffect of changing one assumption on the fair value of the retainedsubordinated interests is computed without allowing any other assumption tochange. In reality, changes in one assumption may result in changes in others.Furthermore, the sensitivities presented do not reflect actions that managementmight take to mitigate the impact of the adverse change. Accordingly, these sensitivitiesshould be used with caution.

 

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The following table summarizes certain cash flows from and paid inrespect of securitizations:

 

**SecuritizationCash Flows**

 
|                                                                       |   | **Three  months ended March 31,** |    |
|----------------------------------------------------------------------------|--------|----------------------------------------|---------|
| **(dollars in thousands)**                                                 |   | **2004**                               |    | **2003** |   |
| Proceeds from new securitizations(1)                                       |   | $                                      | 750,000 |   | $ | 815,000 |   |
| Proceeds from collections allocated to  securityholders’ interests(1) |   | 2,056,621                              |    | 1,969,763 |   |
| Servicing fees received                                                    |   | 75,987                                 |    | 86,644 |   |
| Net cash flows received on retained  interests                             |   | 220,671                                |    | 157,346 |   |
| Principal paid in respect of maturing  securitizations(1)                  |   | (892,500                               | )       | (1,722,800 | ) |
|                                                                            |        |                                        |         |  |  |  |  |

 

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(1)          Cash flows received or paid with respect tothird party securityholders’ interests.

 

**Note 8.  Commitments, Guarantees, and Contingencies**

 

**LoanCommitments.**A loancommitment is an agreement to lend to a customer up to a prescribed maximumamount subject to the customer’s compliance with the account agreement. TheCompany can reduce or cancel a credit card commitment by providing the requiredprior notice to the customer, or without notice if permitted by law. Theunfunded commitment represents the total unused portion of the line of creditavailable to the customer. Customers have not borrowed, and the Company doesnot anticipate that all of its customers will borrow, the entire line of creditavailable to them at the same time. Therefore, the total unfunded commitmentamounts do not necessarily represent future cash requirements. Total unfundedcommitments at March 31, 2004 and December 31, 2003 were $22.32billion and $20.34 billion.

 

**Guarantees.**In January 2003,the Company entered into a pledge agreement with an insurer with respect tocertain obligations owing to the insurer in connection with two series of theProvidian Gateway Master Trust. In exchange for the insurer agreeing to areduction in the base rate used for the purpose of calculating the excessspread early amortization event for those two series, the Company pledged $30.0million held in a deposit account as security for the payment to the insurer ofamounts owing to it in connection with these transactions. The pledge willcontinue in effect until the investor certificates and all amounts owing to theinsurer with respect to the two series are paid. In accordance with the pledgeagreement, the pledged collateral was reduced upon the repayment of one of theseries on September 15, 2003. The remaining amount of the pledgedcollateral at March 31, 2004 was $13.6 million. The remaining seriesrelated to the pledge has an expected final payment date of September 15,2005. The Company does not currently expect that performance under this pledgewill be required.

 

 In August 2002, the Company sold its interest in a limitedliability entity that constructed and operated an alternative energy plant.Through its interest in the entity, the Company had received certain taxcredits and tax deductions. In connection with the sale of the plant to a thirdparty, the Company guaranteed certain obligations of the limited liabilityentity under the purchase and sale agreement. The guarantee covers the seller’sobligation to indemnify the purchaser against losses arising out of theseller’s breach of the purchase and sale agreement and its failure torepurchase the assets if tax credits are not available to the purchaser. TheCompany’s guarantee is capped at $6.2 million plus the amounts of additionalcontingent future payments that may be made to the Company arising from fuelproduction from the plant. At March 31, 2004, the guaranteed amount was$13.7 million.

 

The Company enters intovarious agreements that contain general indemnification provisions, primarilyin connection with asset sale agreements and service contracts. Theseprovisions typically require the Company to make payments to another party toindemnify them against losses that may be incurred due to actions taken by theCompany prior to entering into the agreement, due to breach of representations,warranties and covenants made in connection with the agreement, and due topossible changes in or interpretations of tax law. The Company cannot estimatethe potential future impact of these indemnification provisions since thiswould require an assessment of future claims that may be made against theCompany. 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.

 

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**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 does not currently expect any of the actions affecting it to have amaterial adverse effect on its financial condition or results ofoperations, but it cannot give any assurance that they will not have such aneffect.

 

**Note 9.  Long-Term Borrowings**

 

Long-term borrowings consistof borrowings having an original maturity of one year or more.

 

**Summaryof Long-Term Borrowings**

 
| **(dollars in thousands)**                                                  |   | **March 31,  2004** |      | **December 31,  2003** |   |
|-----------------------------------------------------------------------------|--------|--------------------------|-----------|-----------------------------|--------|
|                                                                        |   |                     |      |                        |   |
| 3.25% convertible senior notes maturing in  2005                            |   | $                        | 343,302   |                        | $      | 343,302 |   |
| Zero coupon convertible senior notes maturing  in 2021(1)                   |   | 446,712                  |      | 442,310                     |   |
| 4.00% convertible senior notes maturing in  2008                            |   | 287,500                  |      | 287,500                     |   |
| 2.75% convertible cash to accreting senior  notes maturing in 2016          |   | 277,200                  |      | —                      |   |
| 9.525% junior subordinated deferrable  interest debentures maturing in 2027 |   | 109,281                  |      | 109,281                     |   |
|                                                                        |   | 1,463,995                |      | 1,182,393                   |   |
| Less unamortized issuance costs                                             |   | 21,715                   |      | 18,872                      |   |
| Total long-term borrowings                                                  |   | $                        | 1,442,280 |                        | $      | 1,163,521 |   |

 

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

 

**ConvertibleSenior Notes.**InAugust 2000, the Company issued $402.5 million of 3.25% convertible seniornotes due August 15, 2005 with interest payable semiannually onFebruary 15 and August 15 of each year, commencing onFebruary 15, 2001. These notes are convertible at the option of theholders, at any time prior to their maturity or their redemption or repurchaseby the Company, at the conversion rate of 14.4892 shares (split adjusted) ofthe Company’s common stock for each $1,000 of note principal (an initialconversion price of $69.02 per share of common stock). The Company will adjustthe conversion rate if certain events occur, as specified in the relatedindenture supplement, such as the issuance of dividends payable in theCompany’s common stock or the occurrence of a stock split or combination. TheCompany has the option to redeem these notes for cash on or afterAugust 20, 2003. During 2001, the Company repurchased $59.2 millionprincipal amount of the 3.25% convertible senior notes, resulting in a $20.5million gain, which was recorded as part of non-interest income—other in theCompany’s statement of income. There were no such repurchases during 2002,2003, or the three months ended March 31, 2004. Holders may require theCompany to purchase their notes for cash following a change of control, asdefined in the related indenture supplement.

 

In February 2001, theCompany issued $884.0 million principal amount at maturity of zero couponconvertible senior notes due February 15, 2021. The Company accretes theprincipal amount of the notes at a rate that provides holders with an aggregateannual yield to maturity of 4.00% per year, computed on a semiannual bondequivalent basis. These notes are convertible at any time prior to theirmaturity, at the option of the holders, into shares of the Company’s commonstock at a conversion rate of 6.2240 shares of common stock per note (aninitial conversion price of $72.77 per share of common stock, based on theoffering price of $452.89 per note). Conversion of the notes will be settled inshares of the Company’s common stock if the stock price exceeds a specifiedpercentage of the accreted conversion price for a given period of time prior tothe conversion, and in cash otherwise. In addition, conversion may be settledin cash, common stock, or other property upon the occurrence of certaincorporate events, as specified in the related indenture supplement. The Companywill adjust the conversion rate if certain events occur, as specified in therelated indenture supplement, such as the issuance of dividends payable in theCompany’s common stock or the occurrence of a stock split or combination. TheCompany may redeem all or a portion of the convertible notes for cash at anytime on or after February 15, 2006. During 2001, the Company repurchased$12.5 million principal amount at maturity of the zero coupon convertiblesenior notes, resulting in a $2.1 million gain, which was recorded as part ofnon-interest income—other in the Company’s statement of income. There were nosuch repurchases during 2002, 2003, or the three months ended March 31,2004. Holders may require the Company to purchase their notes at a price pernote on February 15, 2006 of $552.07, on February 15, 2011 of$672.97, and on February 15, 2016 of $820.35, which may be settled in cashor common stock, or a combination of both, at the option of the Company. 

 

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In addition, holders mayrequire the Company to purchase their notes for cash following a change ofcontrol, as defined in the related indenture supplement, on or beforeFebruary 15, 2006.

 

In May 2003, the Companyissued $287.5 million of 4.00% convertible senior notes due May 15, 2008 withinterest payable semiannually on May 15 and November 15 of each year,commencing on November 15, 2003. These notes are convertible at the optionof the holders at the conversion rate of 76.8758 shares of the Company’s commonstock for each $1,000 of note principal (an initial conversion price of $13.01per share of common stock), if specified conditions are met. These conditionsinclude the satisfaction of a market price condition, such that the price ofthe Company’s common stock exceeds a certain percentage of the conversion pricefor a given period of time; the satisfaction of a trading price condition, suchthat the trading price of the notes falls below a specified level; theoccurrence of certain corporate events, as specified in the related indenturesupplement; and the occurrence of a specified credit rating event, such thatthe ratings of the notes by certain rating agencies fall below specifiedlevels. Conversion of the notes will be settled in shares of the Company’scommon stock, except under certain circumstances related to the trading pricecondition, when conversion may be settled in cash, common stock, or acombination of both, and upon the occurrence of certain corporate events, asspecified in the related indenture supplement, when conversion may be settledin cash, common stock, or other property. The Company will adjust theconversion rate if certain events occur, as specified in the related indenturesupplement, such as the issuance of dividends payable in the Company’s commonstock or the occurrence of a stock split or combination. In addition,contingent interest is required to be paid to holders if certain conditions aremet. The Company may not redeem the notes prior to their maturity. Holders mayrequire the Company to purchase their notes for cash following a fundamentalchange, such as a change in control of the Company, as defined in the relatedindenture supplement.

 

On March 15, 2004, theCompany issued $277.2 million of 2.75% convertible cash to accreting seniornotes due March 15, 2016. After March 15, 2011, the Company will payinterest at a rate of 1.75% per year and will accrete the principal amount ofthe notes at a rate that provides holders with an aggregate annual yield tomaturity of 2.75% per year, computed on a semiannual bond equivalent yieldbasis. The notes are convertible at the option of the holders at a conversionrate of 58.7941 shares of the Company’s common stock for each $1,000 of noteprincipal (an initial conversion price of $17.01 per share of common stock), ifspecified conditions are met. These conditions include the satisfaction of amarket price condition, such that the price of the Company’s common stockexceeds a certain percentage of the conversion price for a given period oftime; the satisfaction of a trading price condition, such that the tradingprice of the notes falls below a specified level; the redemption of the notesby the Company, in which event holders will have the option to convert theirnotes prior to redemption; the occurrence of a specified credit rating event,such that the ratings of the notes by certain rating agencies fall belowspecified levels; the occurrence of specified corporate distributions, asdefined in the related indenture supplement; and the occurrence of afundamental change, as defined in the related indenture supplement. Conversionof the notes will be settled in shares of the Company’s common stock, exceptunder certain circumstances related to the trading price condition, whenconversion may be settled in cash, common stock, or a combination of both, andupon the occurrence of certain corporate events, as specified in the relatedindenture supplement, when conversion may be settled in cash, common stock, orother property. The Company will adjust the conversion rate if certain eventsoccur, as specified in the related indenture supplement, such as the issuanceof dividends payable in the Company’s common stock or the occurrence of a stocksplit or combination. In addition, contingent interest is required to be paidto holders if certain conditions are met. If a fundamental change, such as achange in control of the Company, as defined in the related indenturesupplement, occurs on or before March 15, 2011, the Company may also berequired to purchase the 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 fundamental change. The Company has theoption to redeem all or a portion of the notes for cash at any time on or afterMarch 31, 2011. Holders may require the Company to purchase all or aportion of their notes for cash on March 15, 2011 or March 15, 2014.

 

**Junior Subordinated Deferrable InterestDebentures.** In1997, through Providian Capital I, a wholly-owned subsidiary statutory trust,the Company issued mandatorily redeemable preferred securities, whichaccumulate accrued distributions that are payable semiannually. The Company hasthe right to defer payment of interest on the preferred securities at any timeand from time to time, for a period not exceeding 10 consecutive semiannualperiods with respect to each deferral period, provided that no extension periodmay extend beyond the stated maturity. During any such extension period, theCompany’s ability to pay dividends on its common stock would be restricted. TheCompany has the right to cause the redemption of the preferred securities on orafter February 1, 2007, or earlier in the event of certain regulatorychanges. The redemption price depends on several factors, including the date ofthe redemption, the present value of the principal and premium payable, and theaccumulated but unpaid distributions on the preferred securities. The soleassets of Providian Capital I are $109.3 million in aggregate principal amountof the Company’s 9.525% junior subordinated deferrable interest debentures dueFebruary 1, 2027 and the right to reimbursement of expenses under arelated expense agreement with the Company. The Company’s obligations undersuch debentures, together with its other obligations with respect to the preferred

 

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securities, constitute afull and unconditional guarantee. During 2001, the Company repurchased $6.7million principal amount of the preferred securities, and recorded a $3.1million gain as part of non-interest income—other in the Company’s statement ofincome. The Company did not repurchase any of the preferred securities during2002, 2003, or the three months ended March 31, 2004.

 

In accordance with FIN 46(see Note 3 to Consolidated Financial Statements), the Company has determinedthat Providian Capital I is a VIE and that the Company is not the primarybeneficiary, as the Company would not absorb a majority of the trust’s expectedlosses if they were to occur. The Company adopted the provisions of FIN 46 inrelation to the trust effective July 1, 2003. As a result, the Companydeconsolidated the trust and no longer reports the preferred securities on itsstatement of financial condition. In addition, effective July 1, 2003, theCompany began reporting the related interest as interest expense and its equityin the earnings of the nonconsolidated trust as non-interest income—other. AtMarch 31, 2004, the Company reported $109.3 million in junior subordinateddeferrable interest debentures related to the preferred securities in long-termborrowings and the Company’s equity investment in the trust of $5.0 million inother assets.

 

**Note 10.  Income Taxes**

 

TheCompany’s effective income tax rates for the three months ended March 31,2004 and 2003 were 35.0% and 39.5%. The decrease in the rate is due to taxcredits that the Company expects to utilize during 2004 as a result of currenttaxable income.  The tax credits aregenerated from an existing investment in a limited liability entity thatoperates an alternative energy plant. The Company was not able to utilize these credits in 2002 and 2003.

 

**Note 11.  Cumulative Other Comprehensive Income**

 

The components of cumulative other comprehensive income, net-of-taxes,for the three months ended March 31, 2004 and 2003 are presented in thefollowing table.

 

**CumulativeOther Comprehensive Income Components**

 

| **(dollars in thousands)**        |   | **Unrealized  Gain (Loss)  on Securities** |    | **Cumulative  Other  Comprehensive  Income** |   |
|-----------------------------------|--------|--------------------------------------------|---------|----------------------------------------------|--------|
| Balance at December 31, 2002 |   | $                                          | 9,888   |                                         | $      | 9,888 |   |
| Other comprehensive income        |   | (16,762                                    | )       | (16,762                                      | )      |
| Tax benefit                       |   | 6,621                                      |    | 6,621                                        |   |
| Balance at March 31, 2003    |   | $                                          | (253    | )                                            | $      | (253 | ) |
|                              |   |                                       |    |                                         |   |
| Balance at December 31, 2003 |   | $                                          | (12,480 | )                                            | $      | (12,480 | ) |
| Other comprehensive income        |   | 14,470                                     |    | 14,470                                       |   |
| Tax expense                       |   | (5,716                                     | )       | (5,716                                       | )      |
| Balance at March 31, 2004    |   | $                                          | (3,726  | )                                            | $      | (3,726 | ) |

 

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**Note 12.  Earnings per Common Share**

 

The following table sets forth the computation of both the basic anddiluted earnings per common share for the three months ended March 31,2004 and 2003.

 

**Computationof Earnings Per Common Share**

 
|                                                                       |   | **Three months  ended March 31,** |    |
|----------------------------------------------------------------------------|--------|----------------------------------------|---------|
| **(dollars and  number of shares in thousands, except per share data)**    |   | **2004**                               |    | **2003** |   |
|                                                                       |   |                                   |    |   |   |
| Income for computation of earnings per common share—basic             |   | $                                      | 101,734 |   | $ | 4,700 |   |
| Interest on 3.25% convertible senior notes, net-of-taxes(2)                |   | 1,688                                  |    | — | (1) |
| Income for computation of earnings per common share—assuming dilution |   | $                                      | 103,422 |   | $ | 4,700 |   |
|                                                                       |   |                                   |    |   |   |
| Weighted average common  shares outstanding—basic                     |   | 288,085                                |    | 286,187 |   |
|                                                                       |   |                                   |    |   |   |
| Restricted stock issued—non-vested                                    |   | 1,256                                  |    | 3,824 |   |
| Employee stock options                                                     |   | 4,030                                  |    | 418 |   |
| 3.25% convertible senior notes(2)                                          |   | 4,974                                  |    | — | (1) |
| Dilutive potential common  shares                                          |   | 10,260                                 |    | 4,242 |   |
|                                                                       |   |                                   |    |   |   |
| Weighted average common shares  outstanding—assuming dilution         |   | 298,345                                |    | 290,429 |   |
|                                                                       |   |                                   |    |   |   |
| Earnings per common share—basic                                       |   | $                                      | 0.35    |   | $ | 0.02 |   |
| Earnings per common share—assuming dilution                           |   | $                                      | 0.35    |   | $ | 0.02 |   |

 

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(1)          For the quarter ended March 31, 2003,the assumed conversion of the Company’s 3.25% convertible senior notes to4,974,000 shares and the related reduction of $1.7 million, net-of-taxes, ininterest expense on the Company’s 3.25% convertible senior notes wasantidilutive and therefore excluded from the calculation.

(2)          The Company’s other convertible notes havesignificant contingent conversion requirements that have not been met and aretherefore excluded from consideration in the computation of diluted earningsper common share.

 

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

 

This discussion is intended to further the reader’s understanding ofour consolidated financial condition and results of operations. It should beread in conjunction with our historical financial statements included in thisquarterly report and with the information in our Annual Report onForm 10-K for the year ended December 31, 2003 (the “2003 AnnualReport”). Our historical financial statements may not be indicative of ourfuture performance.

 

*Our Business*

 

We provide 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.

 

We generate income primarily through interest charged on outstandingloan balances and fees related to account usage and performance (such as late,overlimit, cash advance, and annual membership fees), and from the sale ofvarious cardholder service products. We receive interchange fees from bankcardassociations based on the purchase activity of our credit card customers. Inaddition, we earn income on our investments held for liquidity purposes andfrom servicing fees, excess servicing on securitized loans, and changes in thevalue of interests we retain in connection with our securitizations.

 

Our primary expenses are funding costs, including interest costsrelated to customer deposits and borrowings, credit losses, operating expenses,including salaries and employee benefits, advertising and solicitation costs,occupancy costs, data processing and communication costs, and income taxes.

 

We seek to fund our assets through a diversified mix of sources. Ourability to fund existing and future customer loans is currently dependent onfour primary sources: consumer deposits, securitizations, a portfolio of cashand liquid investment securities, and, to a lesser extent, debt. Securitizationis a process in which we segregate a pool of customer loans by transferringthem to a trust, which directly or through other special-purpose entitiesissues certificates or notes backed by the principal, interest, and fee cashflows generated by the pool of transferred loans. At the time the certificatesor notes are issued, we receive cash proceeds from the portion sold to thirdparties.

 

*Executive Overview*

 

Duringthe first quarter of 2004, we continued our efforts to strengthen our financialcondition and build a productive and sustainable portfolio of customer accountssupported by an appropriately sized and efficient infrastructure. Building offour progress over the past two years, we focused on four key areas of ourbusiness:

 

•                  Further strengthening our balance sheet andmanaging our liquidity position

 

•                  Implementing our “New Providian” andpartnership marketing strategies, with a focus on core earnings production

 

•                  Further improving credit performance

 

•                  Increasing operational efficiency and furtherreducing our operating expenses

 

*Balance Sheet and Liquidity.*  Ourprimary goals in this area were to further strengthen capital ratios and manageour liquidity portfolio in line with our growth expectations and PNB’s CapitalPlan. During the first quarter of 2004, our liquidity position decreased by$672.7 million, to $4.97 billion, while deposit levels decreased by $1.14billion. During the first quarter of 2004, we accessed the capital markets withissuances of convertible notes and asset-backed securities. These first quarterissuances consisted of $277.2 million of 2.75% convertible cash to accretingsenior notes and $750.0 million of three-year floating rate Providian GatewayOwner Trust 2004-A asset-backed notes that are backed by a certificate issuedby the Providian Gateway Master Trust. The first quarter 2004 asset-backedtransaction provided us with more favorable terms than other recent issuancesof asset-backed securities.

 

Ourcapital position strengthened during the quarter and at the end of the quarterwas $2.44 billion. At March 31, 2004, our shareholders’ equity andallowance for credit losses, on a combined basis, were equal to 48.6% of ourreported loans. PNB’s regulatory capital ratios improved during the firstquarter of 2004 due to the origination of higher credit quality loansreceivable, a reduction in the level of retained subordinated interests inconnection with the first quarter securitization transaction, and lower spreadaccount funding requirements. At March 31, 2004, PNB’s total risk-basedcapital ratio on a subprime basis, including the impact of the 

 

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accrued interest receivable, was 18.69%, well in excess of the 10% levelwe committed to achieve in our Capital Plan by June 2004.

 

*Marketing.*  In the first three months of2004, we added approximately 533,000 gross new accounts, with 81% originatedthrough our proprietary marketing program. We continued to implement our growthstrategy by focusing on our core “New Providian” marketing, which emphasizesdelivery of products, services, and rewards specifically designed formainstream American consumers, and entering into additional marketingarrangements with co-branding and affinity partners. The success of our “NewProvidian” and partnership marketing strategies will continue to be a criticalfactor in our future earnings.

 

*Credit.*  During the first quarter of2004, we continued to improve the credit mix of our loan portfolio byoriginating higher-quality loans receivable and we continued to benefit fromthe results of enhancements in our collections processes and changes in ourportfolio management strategies. These actions combined with the overallimprovement in the economy resulted in lower net credit losses in the firstquarter compared to the same period in 2003. Our net credit loss rates for thethree months ended March 31, 2004 were 9.02% on a reported basis and13.88% on a managed basis, compared to 15.79% and 17.61% for the same period in2003. Our earnings during the first quarter of 2004 benefited from a lowerallowance for credit losses and an increase in the level of interest and feeincome we estimate will become collectible, reflecting the improved risk outlookof our reported assets.

 

*Operational Efficiency.*  Inthe first quarter of 2004, we continued to streamline our organization byconsolidating the Louisville, Kentucky collections activity into other existingoperational sites and closing the Kentucky site. The resulting reduction in ourinfrastructure better aligns it with expected levels of customer accounts anddelinquency volumes. Reflecting these efforts, non-interest expense was $266.0million for the first quarter of 2004, a decrease of $62.3 million from thesame period in 2003.

 

Securitizationsremain a primary source of funding for our business. Securitizations have animpact on our earnings, because we record a gain or loss on the initial sale ofloans in a securitization transaction and we release the reserves associatedwith the securitized loans. In addition, we retain certain interests in thesecuritized loans, and we recognize changes in the fair value of these retainedinterests in current earnings. These impacts can contribute to volatility inour earnings. For example, in 2003 and in the first quarter of 2004, ourearnings benefited significantly from income recognized as a result ofincreases in the valuation of our retained interests caused by spreadcompression in the credit markets. In contrast, in 2002 the change in marketdiscount rates had a negative impact on our earnings related to decreases inthe valuation of these same interests. These fluctuations affect current periodearnings; however, discounts previously recognized on retained securityholders’interests will accrete through earnings over the duration of a securitizationtransaction, which may span a number of quarterly and annual reporting periods,as long as the transaction to which the interests relate progresses without defaultand all investors are fully repaid by the contractual final payment date.

 

*Overview of Critical AccountingPolicies*

 

Oursignificant accounting policies are described in Note 2 to ourConsolidated Financial Statements, “Summary of Significant Accounting Policies”in our 2003 Annual Report. Our financial statements are prepared in accordancewith accounting principles generally accepted in the United States (“GAAP”),which in some instances require us to use estimates and assumptions. GAAP alsorequires management to make judgments in valuing certain assets. Uncertaintiesare inherent in the use of estimates, assumptions, and judgments. The followingis an overview of our application of accounting policies that require us toexercise significant judgment and reach conclusions about future events basedon information currently available. Differences in judgment, and differencesbetween our estimates and assumptions and subsequent events, could have amaterial impact on our reported financial condition and results of operations.

 

*Securitization Accounting.*  Weaccount for our securitization transactions under Statement of FinancialAccounting Standards No. 140, “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities—a Replacement of FASBStatement No. 125” (“SFAS No. 140”). Our securitizations involve thetransfer of a pool of loans receivable to a securitization trust. The trust orother special-purpose entity through which asset-backed securities are issued meetsthe criteria under SFAS No. 140 for a qualifying special-purpose entitythat is not consolidated in our financial statements. When we enter into asecuritization, we receive cash proceeds from the sale of securities to thirdparties, remove the securitized loans allocated to securityholders’ interestsand the related allowance for credit losses from our balance sheet, and recordour retained interests in the transaction. We typically recognize a net gain onsale from the securitization, due primarily to the release of the relatedallowance for credit losses and recognition of an interest-only stripreceivable, which is partially offset by discounts recognized for the retainedsubordinated interests. We continue to service the securitized loans and wereceive 

 

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contractual servicing fees during the term of the transaction. Ourretained interests are generally reported at fair value with changes in theirfair value recognized in current period earnings.

 

Ourretained interests in the securitized loans, which consist of a seller’sinterest, subordinated securityholders’ interests, interest-only stripsreceivable, and spread accounts, are recorded on our balance sheet in loansreceivable, interest receivable, and due from securitizations. The seller’sinterest is composed of senior and subordinated components. The senior seller’sinterest in our securitizations represents an undivided interest in the pool ofloans receivable transferred to the securitization trust that are not allocatedto the securityholders’ interests. We retain the senior seller’s interest,which includes principal, interest and fees receivable, and classify them asloans receivable with an allowance for credit losses and interest receivable onour balance 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.

 

Weestimate the fair value of our retained subordinated securityholders’interests, interest-only strips receivable, and spread accounts using adiscounted cash flow valuation methodology that incorporates the repayment ofthese interests over time. Retained subordinated securityholders’ interests arediscounted at rates that reflect the level of subordination, the projectedrepayment term, and the credit risk of the securitized loans. For interest-onlystrips receivable, we estimate the interest and fees that will be charged onthe securitized loans, the interest payable to the securityholders, creditlosses, contractual servicing fees, and repayment trends of the securitizedloans to project the amount of excess servicing to be collected over the periodthe securitized loans are expected to be outstanding. For spread accounts, weestimate their fair value through a discounted cash flow analysis based onprojected repayments of existing spread account balances, typically at thematurity of the securitization. Typically, the fair value of our retainedsubordinated securityholders’ interests and spread accounts vary with themovement in market rates for comparable investments. Historically, we have notincurred a loss of invested principal on assets held until their final paymentdate and our valuations do not reflect such a loss of principal. The fairvalues of our interest-only strips receivable vary primarily with changes inour forecast of excess servicing. Estimated excess servicing fluctuates basedon the expected performance of the securitized loans.

 

Avariety of internal and external factors, including economic conditions,current account management strategies, and market perceptions regarding ourperformance can affect the expected net interest and fee income, coupon rates,net credit losses, and discount rates we use in our estimates. Changes in loanperformance expectations can have a material impact on the projected cash flowsand thus on our fair value estimates of our retained interests. Complexjudgment is required in the selection and use of these factors. Judgments andresults that differ from our projections can result in a material impact on ourbalance sheet and income statement. As an example of the sensitivity of oneassumption, at March 31, 2004, a 10% increase in the discount rates usedin valuing the cash flows from our retained subordinated interests would resultin a decrease in their fair value of approximately $24.7 million. The sensitivityof key assumptions used in valuing our retained subordinated interests isdiscussed in Note 7 to our Consolidated Financial Statements,“Securitization or Sale of Receivables.”

 

Atthe time of a securitization, we determine whether the retained subordinatedsecurityholders’ interests should be treated as held for trading oravailable-for-sale. This judgment is based on our intent and plans with respectto holding or selling the assets, and can vary among different securitizationsand different retained interests. Our existing retained subordinatedsecurityholders’ interests are securities measured as investments held fortrading. Unrealized gains and losses on investments held for trading areincluded in current period earnings. Unrealized gains and losses onavailable-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 servicing andsecuritization income. When realized, available-for-sale gains and losses areremoved from other comprehensive income and included in earnings. Designationof these assets as held for trading can have a material impact on the timing ofunrealized gains and losses recognized in earnings, but not shareholders’equity.

 

*Allowance for Credit Losses.*  Wemaintain an allowance for credit losses at a level that, in management’sjudgment, is adequate to absorb estimated credit losses inherent in theexisting loans receivable on our balance sheet. The amount of the allowance isdetermined based on an analysis of historical quantitative risk factors thatinclude customer risk scores, delinquency roll rates, principal credit lossrates, bankruptcies, and other customer characteristics.  The risk scores used in determining theallowance measure a customer’s credit risk based on a combination ofproprietary and external risk models. The delinquency roll rate measures the migration of loans receivablethrough the stages of delinquency. These factors are used to estimate thelikelihood that a loan receivable will charge off. In evaluating the adequacyof this quantitative analysis, management also takes into considerationenvironmental credit risk factors affecting the portfolio’s credit performance,including: the impact of general economic conditions on a customer’s ability topay, trends in loan portfolio volume, seasoning, geographic concentrations, andthe impact of recent modifications to loan review and underwriting procedureson the credit quality of the loans receivable portfolio and makes 

 

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appropriate adjustments to the allowance. We also validate the adequacyof the allowance by comparing coverage ratios to our actual loss experience andto that of other credit card lenders.

 

Establishingan allowance for credit losses that is adequate and not excessive requiressignificant judgment. We forecast multiple scenarios and use alternativemethods to establish and test the adequacy of the allowance. The coverageratios under these varying scenarios and methods create a range of reasonableoutcomes from which we record our allowance. The use of estimates is inherentin our assessment of the adequacy of the allowance for credit losses, andsignificant differences in these estimates could impact the adequacy of theallowance for credit losses.

 

Ifdifferent assumptions were made regarding estimated net credit losses, ourfinancial position and results of operations could differ materially. Forexample, a 10% increase in the projected net credit losses estimated atMarch 31, 2004 would result in an increase of approximately$56.9 million in the allowance for credit losses and the provision forcredit losses.

 

*Interest and Fee Income Recognition.*  Werecognize only the estimated collectible portion of accrued interest and fees.We use a suppression methodology in which the estimated uncollectible portionof accrued interest and fees on loans are not recognized as interest income,credit product fee income or servicing and securitization income on our incomestatement and are not included in loans receivable, interest receivable, or duefrom securitizations on our balance sheet. When loan principal amounts arecharged off, related accrued interest and fees included in loans receivable,interest receivable, and due from securitizations, to the extent not previouslysuppressed, are reversed against income.

 

Consistentwith our method of calculating the allowance for credit losses, we use multiplescenarios and alternative methods to establish a range of reasonable levels ofestimated uncollectible interest and fees, from which we determine thesuppressed amounts when we record estimated collectible interest and feeincome. We utilize historical charge-offs, delinquency roll rates, bankruptcyrates, behavioral risk-score models and loans receivable balance compositiondata to calculate the estimated uncollectible portion of accrued interest andfees. The delinquency roll rate measures the migration of loans receivablethrough the stages of delinquency.

 

Ifdifferent assumptions were made regarding estimated uncollectible interest andfees, our financial position and results of operations could differ materially.For example, a 10% increase in the projected uncollectible interest and feesestimated at March 31, 2004 would result in decreases of approximately$2.8 million to interest income and $18.5 million to non-interest income.

 

*Earnings Summary*

 

The following discussion provides a summary of our earnings for thethree months ended March 31, 2004, compared to the three months endedMarch 31, 2003. The significant components of our results of operationsare covered in further detail in subsequent sections of this discussion.

 

Net income was $101.7 million, or $0.35 per diluted share, for thethree months ended March 31, 2004, compared to $4.7 million, or $0.02 perdiluted share, in the same period of 2003.

 

For the three months ended March 31, 2004, net revenue (netinterest income plus non-interest income) was $511.4 million, compared to$597.9 million for the three months ended March 31, 2003, a decrease of$86.5 million. This decrease is comprised of a $66.4 million decrease in netinterest income and a $20.1 million decrease in non-interest income. Thedecrease in net interest income was primarily driven by a reduction in loansreceivable and a decrease in the yield on outstanding loans receivable as weshifted our marketing strategy to generating a larger proportion of highercredit quality loans receivable and to managing our existing portfolio throughselective, risk-based pricing. The decrease in non-interest income for thethree months ended March 31, 2004 was attributable to a $51.0 milliondecrease in credit product fee income as a result of lower average loansreceivable and our transition to higher-quality credit card accountoriginations and due to the inclusion in first quarter 2003 non-interest incomeof gains associated with the sale of investment securities and fee income fromloan referrals by GetSmart.com. The decrease in non-interest income waspartially offset by an increase in servicing and securitization income of $46.2million. The decrease in loans receivable in the first quarter of 2004 wasprimarily due to the sale of Providian Bank (“PB”) loans in the third quarterof 2003.

 

Our provision for credit losses was $88.9 million for the quarter endedMarch 31, 2004, a decrease of $173.0 million from the first quarter of2003 provision of $261.8 million. The provision for the three months endedMarch 31, 2004 reflects a lower reported loans receivable balance, andalso reflects a reduction in the loan loss coverage ratio from 13.69% to 9.19%related to the improved delinquency performance of our loans receivableresulting from changes in our portfolio management 

 

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and collections strategies and processes, higher-quality credit cardaccount originations, and an overall improvement in the U.S. economy.

 

For the quarter ended March 31, 2004, non-interest expensedecreased $62.3 million to $266.0 million, compared to $328.3 million for thequarter ended March 31, 2003. This reduction is primarily due to lowerpersonnel and related infrastructure costs associated with our workforcereductions and lower collection costs resulting from our lower average loansreceivable balance and certain new credit risk management operationsstrategies.

 

*Net Interest Income*

 

Net interest income is interest earned from loans receivable and ourinvestment portfolios less interest expense from deposits and borrowings.

 

Reported net interest income for the three months ended March 31,2004 was $113.9 million, compared to $180.4 million for the same period in2003, a decrease of $66.4 million. The decline in reported interest income yearover year reflects our continuing efforts to create a higher-quality loanportfolio and the sale of Providian Bank loans in the third quarter of 2003, whichresulted in reductions in loans receivable and decreases in the yield onoutstanding loans receivable. The average loans receivable decreased by $1.03billion from $7.50 billion in the three months ending March 31, 2003 to$6.47 billion in the three months ending March 31, 2004. In addition, theyield on our reported loans receivable decreased to 13.46% for the three monthsended March 31, 2004 from 16.55% for the three months ended March 31,2003, as the mix of our portfolio reflected a growing proportion ofhigher-quality accounts, which generally have lower annual percentage rates,including lower and longer introductory rates.

 

Partiallyoffsetting the negative impact to our yield from the change in the mix of ourloan portfolio was an increase in the level of interest income we estimate willbecome collectible (i.e., a reduction of the suppressed amounts). For the threemonths ended March 31, 2004 and 2003, reported interest income was reducedby $17.2 million and $46.8 million as a result of the impact of the suppressionmethodology.  The interest accrued onloans that we estimate to be uncollectible is not recognized as interest incomeon our income statement and is not included in loans receivable on our balancesheet. In addition, interest income is reduced by the reversal of accruedinterest included in loans receivable (to the extent not previouslysuppressed), when the principal amount of a loan is charged off.

 

For the three months ended March 31, 2004, interest expense was$133.7 million, compared to $171.8 million for the same period in 2003, adecrease of $38.1 million. Consistent with the decline in our average loanbalances and with our banking subsidiary’s Capital Plan, we decreased the levelof our deposit funding. The year over year decrease in interest expensereflects the lower average deposits and lower interest rates paid.

 

23

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*Statement of AverageBalances, Income and Expense, Yields and Rates*

 

The following table provides an analysis of reported interest income,interest expense, net interest spread, and average balances for the threemonths ended March 31, 2004 and 2003.

 

**Statement of Average Balances, Income andExpense, Yields and Rates**
|                                            |   | **Three  months ended March 31,** |       |
|-------------------------------------------------|--------|----------------------------------------|------------|
|                                            |   | **2004**                               |       | **2003** |   |
| **(dollars in thousands)**                      |   | **Average  Balance**                   | ** ** | **Income/  Expense** | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Income/  Expense** | ** ** | **Yield/  Rate** | ** ** |
| **Assets**                                      |   |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Interest-earning assets                         |   |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Loans receivable                                |   | $                                      | 6,473,312  |   | $ | 217,900 |   | 13.46 | % | $ | 7,500,339 |   | $ | 310,340 |   | 16.55 | % |
| Interest-earning cash and cash equivalents      |   | 424,793                                |       | 1,002 |   | 0.94 | % | 212,151 |   | 563 |   | 1.06 | % |
| Federal funds sold                              |   | 2,444,877                              |       | 6,279 |   | 1.03 | % | 3,219,077 |   | 9,826 |   | 1.22 | % |
| Investment securities                           |   | 1,836,398                              |       | 10,086 |   | 2.20 | % | 1,839,188 |   | 14,827 |   | 3.22 | % |
| Other                                           |   | 647,263                                |       | 12,391 |   | 7.66 | % | 833,216 |   | 16,643 |   | 7.99 | % |
| Total interest-earning assets                   |   | 11,826,643                             |       | $ | 247,658 |   | 8.38 | % | 13,603,971 |   | $ | 352,199 |   | 10.36 | % |
|                                            |   |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for credit losses                     |   | (645,519                               | )          |   |   |   |   | (1,104,594 | ) |   |   |   |   |
| Other assets                                    |   | 2,599,464                              |       |   |   |   |   | 4,018,847 |   |   |   |   |   |
|                                            |   |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                    |   | $                                      | 13,780,588 |   |   |   |   |   | $ | 16,518,224 |   |   |   |   |   |
|                                            |   |                                   |       |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and  Shareholders’ Equity**  |   |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities                    |   |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Deposits                                        |   | $                                      | 9,473,650  |   | $ | 114,896 |   | 4.85 | % | $ | 12,531,225 |   | $ | 161,222 |   | 5.15 | % |
| Borrowings                                      |   | 1,243,237                              |       | 18,816 |   | 6.05 | % | 942,036 |   | 10,623 |   | 4.51 | % |
| Total interest-bearing liabilities              |   | 10,716,887                             |       | $ | 133,712 |   | 4.99 | % | 13,473,261 |   | $ | 171,845 |   | 5.10 | % |
|                                            |   |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Other liabilities                               |   | 711,490                                |       |   |   |   |   | 852,962 |   |   |   |   |   |
| Total liabilities                               |   | 11,428,377                             |       |   |   |   |   | 14,326,223 |   |   |   |   |   |
|                                            |   |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Capital securities                              |   | —                                 |       |   |   |   |   | 104,332 |   |   |   |   |   |
|                                            |   |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Shareholders’ equity                       |   | 2,352,211                              |       |   |   |   |   | 2,087,669 |   |   |   |   |   |
|                                            |   |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Total liabilities and shareholders’ equity |   | $                                      | 13,780,588 |   |   |   |   |   | $ | 16,518,224 |   |   |   |   |   |
|                                            |   |                                   |       |   |   |   |   |   |   |   |   |   |   |
| **Net Interest Income  and Spread**             |   |                                   |       | $ | 113,946 |   | 3.39 | % |   |   | $ | 180,354 |   | 5.26 | % |

 

24

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*Interest Volume andRate Variance Analysis*

 

Net interest income is affected by changes in the average interest rateearned on interest-earning assets and the average interest rate paid oninterest-bearing liabilities. Net interest income is also affected by changesin the volume of interest-earning assets and interest-bearing liabilities. Thefollowing table sets forth the dollar amount of the increase (decrease) inreported interest income and expense resulting from changes in volumes and rates.

 

**Rate-VolumeVariance Analysis**

 
|                             |   | **Three  months ended March 31,** |    |
|----------------------------------|--------|----------------------------------------|---------|
|                             |   | **2004 vs.  2003**                     |    |
|                             |   |                                   |    | **Change due  to (1)** |   |
| **(dollars in thousands)**       |   | **Increase  (Decrease)**               |    | **Volume** |   | **Rate** |   |
|                             |   |                                   |    |   |   |   |   |
| **Interest Income**              |   |                                   |    |   |   |   |   |
| Loans receivable                 |   | $                                      | (92,440 | ) | $ | (39,111 | ) | $ | (53,329 | ) |
| Federal funds sold               |   | (3,547                                 | )       | (2,153 | ) | (1,394 | ) |
| Investments and other securities |   | (8,554                                 | )       | (3,101 | ) | (5,453 | ) |
| Total interest income            |   | (104,541                               | )       | (44,365 | ) | (60,176 | ) |
|                             |   |                                   |    |   |   |   |   |
| **Interest Expense**             |   |                                   |    |   |   |   |   |
| Interest-bearing deposits        |   | (46,326                                | )       | (37,398 | ) | (8,928 | ) |
| Borrowings                       |   | 8,193                                  |    | 3,962 |   | 4,231 |   |
| Total interest expense           |   | (38,133                                | )       | (33,436 | ) | (4,697 | ) |
|                             |   |                                   |    |   |   |   |   |
| **Net Interest Income**          |   | $                                      | (66,408 | ) | $ | (10,929 | ) | $ | (55,479 | ) |

 

----

(1)          The changes due to both volumes and rateshave been allocated in proportion to the relationship of the absolute dollaramounts of the change in each. The changes in interest income and interestexpense are calculated independently for each line in the table.

 

*Allowance andProvision for Credit Losses*

 

We maintain our allowance for credit losses at a level estimated to beadequate to absorb future principal charge-offs, net of recoveries, in theexisting reported loan portfolio. We maintain the allowance for credit lossesfor reported loans only.

 

We establish our allowance for credit losses by analyzing historicalrisk behavior and credit loss trends, and reviewing current loss expectationsthat incorporate general economic conditions that may impact future losses. Wesegregate loans into general risk classifications for each product type. Wecombine quantitative factors (including customer risk scores, historicaldelinquency roll rates, historical credit loss rates, and other customercharacteristics) with environmental credit risk factors to prepare comparativeevaluations of the allowance for credit losses.

 

25

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Theenvironmental credit risk factors are consistent with applicable bankregulatory guidelines and reflect our assessment of general macroeconomicconditions, trends in loan portfolio volume and seasoning, geographicconcentrations, and recent modifications to loan review and underwritingprocedures, among other factors. We compare allowances established in priorperiods 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.

 

**Allowance for CreditLosses**

 
|                                       |   | **Three months ended March 31,** |      |
|--------------------------------------------|--------|----------------------------------|-----------|
| **(dollars in thousands)**                 |   | **2004**                         |      | **2003** |   |
| Balance at beginning of period             |   | $                                | 625,886   |   | $ | 1,012,461 |   |
| Provision for credit losses                |   | 88,852                           |      | 261,815 |   |
| Credit losses                              |   | (188,818                         | )         | (341,338 | ) |
| Recoveries                                 |   | 42,890                           |      | 45,264 |   |
| Balance at end of period                   |   | $                                | 568,810   |   | $ | 978,202 |   |
|                                       |   |                             |      |   |   |
| Reported loans receivable at period end(1) |   | $                                | 6,191,078 |   | $ | 7,145,816 |   |
|                                       |   |                             |      |   |   |
| Coverage ratios at period end              |   | 9.19                             | %         | 13.69 | % |

 

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(1)          The three months ended March 31, 2004 and 2003 loansreceivable exclude market value adjustments of $(0.1) million and $0.8 millionunder Statement of Financial Accounting Standards No. 133, “Accounting forDerivative Instruments and Hedging Activities” (“SFAS No. 133”).

 

The decreasein both the dollar amount of the allowance for credit losses and the coverageratio (the allowance for credit losses as a percentage of reported loans receivable)as of March 31, 2004 compared to March 31, 2003 reflects the trend in our netcredit losses resulting from changes in our loan mix due to higher-qualityaccount originations, improvements in the U.S. economy, and changes in ourportfolio management and collections strategies and processes. As we continueto evaluate the allowance for credit losses in light of changes in assetquality, regulatory requirements, general economic trends, and the effect ofour new marketing strategy, we may further adjust the coverage ratio, whichwould impact our provision for credit losses.

*Non-Interest Income*

 

*Servicing and Securitization Income. *Servicing andsecuritization 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 March 31, 2004 and2003, the total principal amount of securitized loans outstanding was $10.20 billionand $10.98 billion. For the three months ended March 31, 2004, servicing andsecuritization income was $236.7 million, an increase of $46.2 millionfrom $190.6 million in the first quarter of 2003. Servicing andsecuritization income for the three months ended March 31, 2004 includes a$57.2 million benefit from an increase in the fair value recognized for ourretained subordinated securityholders’ interests and spread accounts due tofavorable changes in market discount rates. The improvement in the discountrates used to determine the fair value of these assets is primarily due tofactors not within the control of the Company, such as the improving U.S.economy, and due to continuing credit spread tightening in the asset-backedsecurities market. Additionally, servicing and securitization income increasedfor the first quarter of 2004 as compared to the same period of 2003 due tohigher levels of interest-only strips receivable recognized due to increases inforecasted excess servicing. The first quarter of 2003 servicing andsecuritization income was reduced by significant levels of discount recognitionassociated with the funding of spread accounts as compared to the same periodin 2004, when no further spread account funding was required. Partiallyoffsetting the positive income fluctuations described above, the servicing andsecuritization income in the first quarter of 2004 included lower discountaccretion related to decreased average retained subordinated securityholders’interests and spread account balances as compared to the same period in 2003. 

 

We do not recognizeincome associated with the interest and fees on securitized loans that we estimateto be uncollectible as servicing and securitization income on the incomestatement nor as due from securitizations on the balance sheet. 

26

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For the three months ended March 31, 2004 and 2003, theamount of servicing and securitization income not recognized as a result of theimpact of the suppression methodology was $108.5 million and $141.2 million.

 

*Credit Product Fee Income. *Credit product fee income includesperformance fees (late, overlimit, and returned check charges), annualmembership fees, and cash advance fees, which are charged in accordance withthe terms of the customer’s account agreement. Annual membership revenue isrecognized ratably over the customer privilege period (currently one year).Performance fees and cash advance fees are recognized when earned. Creditproduct fee income also includes revenue from products billed annually, whichis recognized ratably over the customer privilege period, revenue from productsbilled monthly, which is recognized in the month it is billed, and revenue frominterchange fees received from bankcard associations, which are based on thepurchase activity of our credit card customers.

 

For the three months endedMarch 31, 2004, credit product fee income was $149.1 million, a decrease from$200.2 million for the three months ended March 31, 2003. This decreasereflects lower average loans receivable, which resulted in lower late,overlimit, and interchange fees and lower cardholder service product and annualmembership fee revenue. The decrease in credit product fee income also reflectslower late and overlimit fee income associated with our transition tohigher-quality credit card account originations and lower overall delinquencylevels. 

 

In accordance with GAAP, wecapitalize direct loan origination costs associated with successful accountacquisition efforts. We amortize capitalized loan origination costs over thecustomer privilege period (currently one year) for credit card loans, unlessthe loans are securitized, in which case we recognize the remaining costs as anexpense upon securitization. Effective January 1, 2004, we began classifyingcapitalized loan origination costs as a reduction of credit product fee income.Previously, amortized loan origination costs were reported as non-interestexpense—solicitation and advertising. This reclassification of expenses did notmaterially impact our income statement. 

 

We do not recognize fees onloans that we estimate to be uncollectible as credit product fee income on ourincome statement or as loans receivable on our balance sheet. For the threemonths ended March 31, 2004 and 2003, the amount of credit product fee incomenot recognized as a result of the impact of the suppression methodology was $27.6 million and $59.0 million. Thedecrease in the suppression and reversal amount for the three months endedMarch 31, 2004 as compared to the three months ended March 31, 2003 isconsistent with the decrease in credit product fee income as discussed above.

 

*Other*.  Non-interestincome—other was $11.5 million and $26.8 million for the three months endedMarch 31, 2004 and 2003. This decrease is a result of decreases in realized netgains on investment securities, offset by installment payments received fromthe sale of a limited partnership investment and income related to limitedpartnership investments accounted for under the equity method. Additionally,non-interest income—other decreased in the first quarter of 2004 as compared tothe same period in 2003 due to the inclusion in 2003 of income from operationsthat were subsequently sold.

 

27

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*Non-Interest Expense*

 

Non-interest expenseincludes salary and employee benefits costs, loan solicitation and advertisingcosts, occupancy, furniture, and equipment costs, data processing andcommunication costs, and other non-interest expense. The following tablepresents non-interest expense for the three months ended March 31, 2004,December 31, 2003, and March 31, 2003. Overall, the decrease in non-interestexpense reflects our efforts to align our operations with the reduction in ourloans receivable portfolio.

 

**Summary ofNon-Interest Expense**

 
|                                |   | **Three months ended** |    |
|-------------------------------------|--------|------------------------|---------|
| **(dollars in thousands)**          |   | **March 31, 2004**     |    | **December 31, 2003** |   | **March 31, 2003** |   |
| Salaries and employee benefits      |   | $                      | 81,480  |   | $ | 76,815 |   | $ | 96,975 |   |
| Solicitation and advertising        |   | 52,571                 |    | 36,224 |   | 65,378 |   |
| Occupancy, furniture, and equipment |   | 26,213                 |    | 30,260 |   | 28,683 |   |
| Data processing and communication   |   | 27,048                 |    | 29,483 |   | 30,670 |   |
| Other                               |   | 78,694                 |    | 88,749 |   | 106,602 |   |
| Total non-interest expense          |   | $                      | 266,006 |   | $ | 261,531 |   | $ | 328,308 |   |

 

Salary and employee benefitscosts include staffing costs associated with marketing, customer service,collections, and administration. In the second half of 2003, as part of ourstrategy of enhancing operational efficiency, we entered into agreements tooutsource certain information technology functions. These include agreementswith Accenture, which provides the Company with technology applicationdevelopment and maintenance services, and Computer Sciences Corporation, whichprovides desktop, help desk, server, security administration, e-mail, andnetwork infrastructure services. We expect these outsourcing arrangements toreduce salaries and employee benefits expense with a partial offsettingincrease in other non-interest expense items during the remainder of 2004.While salary expense continues to decline consistent with our workforcereductions, total salaries and employee benefits in the first quarter of 2004include higher payroll taxes and benefits accruals compared to these costs inthe fourth quarter of 2003.

 

Solicitation and advertisingcosts include printing, postage, telemarketing, list processing, and creditbureau costs paid to third parties in connection with account solicitationefforts, and also include costs incurred to promote our products. Advertisingcosts and the majority of solicitation expenses are expensed as incurred. Firstquarter 2004 solicitation and advertising expense increased over fourth quarter2003 levels reflecting an increase in our marketing and account solicitationsactivity.

 

As discussed in"—Non-Interest Income—Credit Product Fee Income", effective January1, 2004, we began classifying capitalized loan origination costs as a reductionof non-interest income—credit product fee income. Prior to January 1, 2004,these costs were reported as non-interest expense—solicitation and advertising.This reclassification of expenses did not materially impact our incomestatement.

 

In connection with workforcereductions and the closure of certain facilities, we record charges related toemployee severance, premises, equipment, and furniture lease expenses, fixedasset write-downs, and disposition costs. At March 31, 2004, we had $9.9million accrued for remaining costs expected to be paid, primarily forpremises, equipment, and furniture lease costs associated with property nolonger in use. This amount included $2.4 million for costs associated with theclosure of our facilities in Louisville, Kentucky in January 2004. Inconnection with the closure of our Louisville facilities, we also recognized$3.4 million of severance and fixed asset write-down expense during the threemonths ended March 31, 2004. We closed our Louisville facilities to consolidateour collections functions and further enhance our operational efficiency.

 

Non-interest expense—otherincludes operational expenses such as collections costs, fraud losses, andbankcard association assessments. For the three months ended March 31, 2004 and2003, collections costs were $21.7 million and $54.7 million. The decrease incollections costs for the three months ended March 31, 2004 as compared to thethree months ended March 31, 2003 is primarily a result of our lower averageloans receivable balances and lower delinquencies due to certain credit riskmanagement operations strategies we implemented.

 

*Income Taxes*

 

We recognizedincome tax expense of $54.8 million and $3.1 million for the three monthsended March 31, 2004 and 2003. Our effective income tax rates for thethree months ended March 31, 2004 and 2003 were 35.0% and 39.5%. The decreasein the rate is due to tax credits that we expect to utilize during 2004 as aresult of current taxable income.  Thetax credits are generated from an existing investment in a limited liabilityentity that operates an alternative energy plant.  We were not able to utilize these credits in 2002 and 2003. 

 

28

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*Securitizationsof Loans Receivable*

 

Weaccount for our securitization transactions under SFAS No. 140. Oursecuritizations 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 for a qualifyingspecial-purpose entity that is not consolidated in our financial statements.

 

The securitizationtransactions create undivided interests in the pool of loans and establishsecurityholders’ interests (asset-backed securityholders’ interests and notes),a seller’s interest, interest-only strips receivable, and spread accounts.Securityholders’ interests consist of senior and subordinated investorinterests. The senior securityholders’ interests are sold to third partyinvestors, supported with various forms of credit enhancement. When asecuritization transaction is entered into, we receive cash proceeds from thesale of securities to third parties, remove the securitized loans and relatedallowance for credit losses from our balance sheet, and record the retainedinterests in the transaction. We typically recognize 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. See “—Overview of Critical Accounting Policies.”

 

During the three monthsended March 31, 2004 and 2003, we securitized $914.6 million and $1.09 billionof loans receivable, offset by reductions in securitized loans of $1.05 billionand $2.44 billion from the repayment of certain series and a reduction in theinvested amount of the variable funding series. We recognized net losses of$14.1 million and $16.2 million in the three months ended March 31, 2004 and2003 from the initial sale of investor interests to third party investors, therecognition of a gain from the interest-only strip receivable and the loss fromthe discounts recognized on other retained interests. These amounts exclude thebenefit realized from the reduction to the allowance for credit lossesrecognized at the time of sale. 

 

The total amounts of oursecuritized loans as of March 31, 2004 and December 31, 2003 were $10.20 billion and $10.33 billion. The following table presents the fair value(carrying value, net of any discounts) of our retained interests in the loansreceivable transferred in our securitizations and reported in due fromsecuritizations at March 31, 2004 and December 31, 2003. 

 

**Duefrom Securitizations**

 
| **(dollars in thousands)**                             |   | **March 31,  2004** |      | **December  31,  2003** |   |
|--------------------------------------------------------|--------|---------------------|-----------|-------------------------|--------|
| Retained subordinated securityholders’  interests |   | $                   | 1,222,432 |                    | $      | 1,176,316 |   |
| Interest-only strips receivable                        |   | 261,054             |      | 228,856                 |   |
| Spread accounts                                        |   | 359,317             |      | 403,802                 |   |
| Accrued interest receivable                            |   | 369,709             |      | 397,951                 |   |
| Other(1)                                               |   | 189,690             |      | 171,038                 |   |
| Total due from securitizations                         |   | $                   | 2,402,202 |                    | $      | 2,377,963 |   |

 

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(1)          Amountsconsist primarily of funds deposited in the trust collection account and notyet distributed.

 

*Non-GAAPManaged Financial Information*

* *

Loans thathave been securitized and sold to third party investors are not considered tobe 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“—Securitizations of Loans Receivable”). The performance of these loans canaffect the recorded values of our retained interests included in due fromsecuritizations and servicing and securitization income. We also continue toservice these loans.

 

Because ofthis continued exposure and involvement, we use managed financial informationto evaluate our historical performance, assess our current condition, and planour future operations. We believe that managed financial informationsupplements our GAAP information and is helpful to the reader’s understandingof our consolidated financial condition and results of operations. “Reported”financial information refers to GAAP financial information. “Managed” financialinformation is derived by adjusting the reported financial information to addback securitized loan balances and the related interest and fee income, creditlosses, and net interest costs.

 

29

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When makingdisclosures 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 derive comparable GAAP projections. Developing suchcomparable GAAP projections would be unreasonably burdensome and in the opinionof management such comparable GAAP projections would not provide to the usersof the financial information a significant benefit in understanding ourexpected future performance.

 

**Reconciliation ofSelected Reported Earningsto Selected Managed Earnings**

 
|                             |   | **Three  months ended March 31,** |    |
|----------------------------------|--------|-----------------------------------|---------|
| **(dollars in thousands)**       |   | **2004**                          |    | **2003** |   |
|                             |   |                              |    |   |   |
| **Adjusted Margin:**             |   |                              |    |   |   |
| Reported                         |   |                              |    |   |   |
| Interest income from loans       |   | $                                 | 217,900 |   | $ | 310,340 |   |
| Allocated interest expense       |   | (73,181                           | )       | (94,738 | ) |
| Credit product fee income        |   | 149,144                           |    | 200,193 |   |
| Net credit losses                |   | (145,928                          | )       | (296,074 | ) |
| Adjusted margin                  |   | 147,935                           |    | 119,721 |   |
|                             |   |                              |    |   |   |
| Securitization Adjustments       |   |                              |    |   |   |
| Interest income from loans       |   | $                                 | 505,055 |   | $ | 585,996 |   |
| Allocated interest expense       |   | (59,862                           | )       | (71,442 | ) |
| Credit product fee income        |   | 127,509                           |    | 159,878 |   |
| Net credit losses                |   | (433,644                          | )       | (538,468 | ) |
|                             |   |                              |    |   |   |
| Managed                          |   |                              |    |   |   |
| Interest income from loans       |   | $                                 | 722,955 |   | $ | 896,336 |   |
| Allocated interest expense       |   | (133,043                          | )       | (166,180 | ) |
| Credit product fee income        |   | 276,653                           |    | 360,071 |   |
| Net credit losses                |   | (579,572                          | )       | (834,542 | ) |
| Adjusted Margin                  |   | $                                 | 286,993 |   | $ | 255,685 |   |
|                             |   |                              |    |   |   |
| **Net Interest Income:**         |   |                              |    |   |   |
| Reported                         |   |                              |    |   |   |
| Interest income from loans       |   | $                                 | 217,900 |   | $ | 310,340 |   |
| Interest income from investments |   | 29,758                            |    | 41,859 |   |
| Interest expense                 |   | (133,712                          | )       | (171,845 | ) |
| Net interest income              |   | 113,946                           |    | 180,354 |   |
|                             |   |                              |    |   |   |
| Securitization Adjustments       |   |                              |    |   |   |
| Interest income from loans       |   | $                                 | 505,055 |   | $ | 585,996 |   |
| Interest income from investments |   | (11,062                           | )       | (13,010 | ) |
| Interest expense                 |   | (41,969                           | )  | (47,853 | ) |
|                             |   |                              |    |   |   |
| Managed                          |   |                              |    |   |   |
| Interest income from loans       |   | $                                 | 722,955 |   | $ | 896,336 |   |
| Interest income from investments |   | 18,696                            |    | 28,849 |   |
| Interest expense                 |   | (175,681                          | )       | (219,698 | ) |
| Net interest income              |   | $                                 | 565,970 |   | $ | 705,487 |   |

 

30

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**Reconciliation ofSelected Reported Financial Datato Selected Managed Financial Data**

 
| **(dollars in thousands)**   |   | **March 31,  2004** |       | **December  31,  2003** |   | **March 31,  2003** |   |
|------------------------------|--------|---------------------|------------|-------------------------|--------|---------------------|--------|
|                         |   |                |       |                    |   |                |   |
| **Selected Financial Data:** |   |                |       |                    |   |                |   |
| Reported                     |   |                |       |                    |   |                |   |
| Period End:                  |   |                |       |                    |   |                |   |
| Delinquent loans             |   | $                   | 325,241    |                    | $      | 417,131             |   | $ | 625,731 |   |
| Loans receivable(1)          |   | 6,191,078           |       | 6,281,403               |   | 7,145,817           |   |
| Total assets                 |   | 13,486,872          |       | 14,275,347              |   | 16,606,652          |   |
|                         |   |                |       |                    |   |                |   |
| Three-Month Average:         |   |                |       |                    |   |                |   |
| Loans receivable(1)          |   | $                   | 6,473,312  |                    | $      | 5,934,473           |   | $ | 7,500,339 |   |
| Earning assets               |   | 11,826,643          |       | 12,368,033              |   | 13,603,971          |   |
| Total assets                 |   | 13,780,588          |       | 14,815,957              |   | 16,518,224          |   |
|                         |   |                |       |                    |   |                |   |
| Securitization Adjustments   |   |                |       |                    |   |                |   |
| Period End:                  |   |                |       |                    |   |                |   |
| Delinquent loans             |   | $                   | 902,075    |                    | $      | 1,156,096           |   | $ | 1,278,505 |   |
| Loans receivable             |   | 10,485,261          |       | 10,653,351              |   | 11,323,170          |   |
| Total assets                 |   | 8,780,517           |       | 8,923,017               |   | 8,924,990           |   |
|                         |   |                |       |                    |   |                |   |
| Three-Month Average:         |   |                |       |                    |   |                |   |
| Loans receivable             |   | $                   | 10,231,416 |                    | $      | 10,732,942          |   | $ | 11,452,028 |   |
| Earning assets               |   | 10,231,416          |       | 10,732,942              |   | 11,452,028          |   |
| Total assets                 |   | 8,648,072           |       | 8,529,245               |   | 8,976,119           |   |
|                         |   |                |       |                    |   |                |   |
| Managed                      |   |                |       |                    |   |                |   |
| Period End:                  |   |                |       |                    |   |                |   |
| Delinquent loans             |   | $                   | 1,227,316  |                    | $      | 1,573,227           |   | $ | 1,904,236 |   |
| Loans receivable(1)          |   | 16,676,339          |       | 16,934,754              |   | 18,468,987          |   |
| Total assets                 |   | 22,267,389          |       | 23,198,364              |   | 25,531,642          |   |
|                         |   |                |       |                    |   |                |   |
| Three-Month Average:         |   |                |       |                    |   |                |   |
| Loans receivable(1)          |   | $                   | 16,704,728 |                    | $      | 16,667,415          |   | $ | 18,952,367 |   |
| Earning assets               |   | 22,058,059          |       | 23,100,975              |   | 25,055,999          |   |
| Total assets                 |   | 22,428,660          |       | 23,345,202              |   | 25,494,343          |   |

 

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(1)          Balancesexclude market value adjustments related to the fair value of designatedfinancial instruments.

 

31

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*Loan Performance Measures. *We present key loanperformance measures on a reported and a managed basis. Reported loans do notnecessarily have the same income or credit characteristics as securitized loansand can perform differently over time. Although managed loan performancemeasures include both reported and securitized loans, the securitized loanswill have a more significant impact on the managed loan performance numbersbecause our securitized receivables balance is substantially larger than ourreported receivables balance. In addition, when loans are securitized, there isa potentially significant impact on reported loan performance as loans areremoved from loans receivable on our balance sheet or reclassified to loansheld for securitization or sale, while there is generally no significant impacton managed loan performance.

 

**Loan PerformanceStatistics**

 
|                                           |   | **Three  months ended March 31,** |   |
|------------------------------------------------|--------|-----------------------------------|--------|
|                                           |   | **2004**                          |   | **2003** |   |
|                                           |   |                              |   |   |   |
| Reported                                       |   |                              |   |   |   |
| Net interest margin on average loans(1)        |   | 8.94                              | %      | 11.50 | % |
| Net interest margin on average earning  assets |   | 3.85                              | %      | 5.30 | % |
| Adjusted margin on average loans(2)            |   | 9.14                              | %      | 6.38 | % |
| Return on average assets                       |   | 2.95                              | %      | 0.11 | % |
|                                           |   |                              |   |   |   |
| Managed                                        |   |                              |   |   |   |
| Net interest margin on average loans(3)        |   | 14.12                             | %      | 15.41 | % |
| Net interest margin on average earning  assets |   | 10.26                             | %      | 11.26 | % |
| Adjusted margin on average loans(4)            |   | 6.86                              | %      | 5.40 | % |
| Return on average assets                       |   | 1.81                              | %      | 0.07 | % |

 

----

(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 interest expense and net creditlosses, plus credit product fee income on reported average loans receivable,expressed as a percentage of reported average loans receivable. Interestexpense is allocated to reported average loans receivable based on the ratio ofreported average loans receivable to reported average earning assets. 

(3)          Represents interest income, less interest expense, expressed as apercentage of managed average loans receivable. Interest expense is allocatedto managed average loans receivable based on the ratio of managed average loansreceivable to managed average earning assets. 

(4)          Represents interest income, less interest expense and net creditlosses, plus credit product fee income on managed average loans receivable,expressed as a percentage of managed average loans receivable. Interest expenseis allocated 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 on averageloans decreased to 8.94% for the first quarter of 2004, from 11.50% for thesame period in 2003. Managed net interest margin on average loans decreased to14.12% for the first quarter of 2004, from 15.41% for the same period in 2003.The yield on our reported loans receivable decreased to 13.46% for the firstquarter of 2004, from 16.55% for the same period in 2003. The yield on managedloans receivable decreased to 17.31% for the first quarter of 2004, from 18.92%for the same period in 2003. The lower yields in the three months ended March31, 2004 are primarily a result of the implementation of our strategy togenerate a higher-quality loan portfolio by increasing the percentage of highercredit quality accounts, which generally have lower interest rates.

 

Reportedearning assets include consumer loans, interest-earning cash, federal fundssold and securities purchased under resale agreements, investment securities,spread accounts, and interest-only strips receivable. Managed earning assetsinclude reported earning assets plus the loans receivable removed orreclassified from loans receivable on our balance sheet through oursecuritizations, less the retained interests from securitizations reported onour balance sheet. Net interest income expressed as a percentage of averageearning assets is referred to as net interest margin on average earning assets.The reported net interest margin on average earning assets declined from 5.30%for the quarter ended March 31, 2003 to 3.85% for the quarter ended March 31,2004. The managed net interest margin on average earning assets declined from11.26% for the quarter ended March 31, 2003 to 10.26% for the quarter endedMarch 31, 2004. In addition to the impact from the lower yields earned on ourearning assets, these decreases also reflect lower average reported and managedearning assets.

 

32

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*Adjusted Margin.*  One of the ways we measureloan portfolio profitability is by comparing the revenue generated by customeraccounts with the related funding costs and risk of loss. Adjusted marginconsists of interest income plus non-interest income—credit product fee incomeless interest expense allocated to loans and net credit losses. Adjusted marginexcludes non-interest income—servicing and securitization and non-interestincome—other. Adjusted margin provides an ongoing measure of loan portfolioprofitability by excluding fluctuations from changing retained interest fairvalues and non-recurring gains or losses included in non-interest income—other.Adjusted margin is expressed in dollars or as a percentage of average loansreceivable. 

 

Reportedadjusted margins for the quarter ended March 31, 2004 were $147.9 million and9.14%, compared to $119.7 million and 6.38% for the quarter ended March 31,2003. The adjusted margin for the three months ended March 31, 2004 increaseddue primarily to lower net credit losses, partially offset by lower yields andreduced fee income on reported loans outstanding.

 

Managedadjusted margins for the quarter ended March 31, 2004 were $287.0 million and6.86%, compared to $255.7 million and 5.40% for the quarter ended March 31,2003. The increases in the managed adjusted margins are primarily due to adecrease in net credit losses, partially offset by lower average managed loansand lower yields and lower 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, includingsales of charged-off assets, and general economic conditions. Initially, creditquality is primarily determined by the characteristics of the targeted marketsegment and the underwriting criteria utilized in the credit approval process.As an account ages, account management efforts, seasoning, and demographic andeconomic 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 5.25% as of March 31, 2004, compared to 6.64% as ofDecember 31, 2003 and 8.76% as of March 31, 2003. The 30+ day delinquency rateon managed loans was 7.36% as of March 31, 2004, compared to 9.29% as ofDecember 31, 2003 and 10.31% as of March 31, 2003. The reported net credit lossrate was 9.02% for the quarter ended March 31, 2004, compared to 15.79% for thequarter ended March 31, 2003. The managed net credit loss rate was 13.88% forthe quarter ended March 31, 2004, compared to 17.61% for the quarter endedMarch 31, 2003. 

 

The improved performanceover the past year in both our reported and managed 30+ day delinquency ratesand our reported and managed net credit loss rates reflect the impact ofhigher-quality credit card account originations, revised credit line andpricing strategies for existing customers, new collections and credit policiesand practices, and improving conditions in the U.S. economy. In addition, thereported net credit loss rate for the quarter ended March 31, 2004, includesthe favorable impact on such rate of the allocation of net credit losses to theProvidian Gateway Master Trust Series 2004-A as if the series was outstandingbeginning on March 1, 2004 rather than based on the March 31, 2004 seriesissuance date.

 

*Improvingthe Quality of Our Loan Portfolio.*Until the fourth quarter of 2001, we focused on three market segments:the standard market segment (higher-risk and generally underserved customerswho might not ordinarily qualify for credit cards, including customers withpast credit problems or limited credit history); the middle market segment(customers whose credit is typically superior to the standard market segmentbut inferior to platinum and prime market segment customers); and the platinummarket segment (customers with generally good credit history).

 

Subsequently, we changed ourmarketing strategies within both the new account acquisition and portfoliomanagement functions with the goal of generating a higher-quality loanportfolio with more stable earnings and lower, less volatile credit loss rates.As part of this shift in our strategy, we discontinued all new accountmarketing to the standard segment. In mid-2002, we introduced a balancedstrategy of originating new loans across the broad middle to prime marketsegments and, more recently, refined our strategy to focus on the parts of themiddle and prime segments that we expect to be most profitable. Under our newmarketing programs, we target higher credit quality prospects from these moreattractive segments of the market. We expect to generate higher credit qualityloans through our proprietary marketing program, which emphasizes the portion ofthe market we refer to as mainstream America, and through our new partnershipmarketing program, which uses highly targeted marketing criteria to market ourcredit card products to creditworthy individuals associated with variousgroups.

 

33

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Consistent with the changesin our strategy for new account acquisitions, we altered our portfoliomanagement strategy for existing customers. We selectively repriced loans andreduced credit lines for accounts that exhibited increased risk levels. Tostrengthen and extend our relationships with our best customers, we improvedour process to selectively provide product upgrades, improve pricing, andincrease credit lines when appropriate. In addition, on August 1, 2003 we sold$859.6 million in credit card balances owned by PB. Since the majority of PB’sloan portfolio consisted of higher-risk accounts, this transaction had theeffect of improving the credit quality mix of the assets remaining.

 

*Credit andCollections Strategies and Policies.*We employ a delinquency lifecycle strategy for the management ofdelinquent accounts. We initiated this strategy in the fourth quarter of 2002,and apply it in combination with certain event-driven actions, consumercounseling, and consumer debt management education. Under the delinquencylifecycle approach, we prioritize collections to focus on delinquency status,with attention to customer events within each stage of delinquency. We believethat this facilitates management and collector accountability for, andownership of, collection results.

 

We have also initiated anumber of risk management and credit and collections policies and practiceschanges consistent with regulatory guidance and industry practice, and madechanges within those parameters where necessary or appropriate. These changeshave had an impact on the age classification of delinquent account balances,the timing of principal charge-offs, and our procedures for investigating fraudlosses, as discussed in our 2003 Annual Report. Our continued review of riskmanagement and credit and collections operations could lead to furthermodifications in the future.

 

In the first quarter of2003, we modified our loan re-aging practice for reclassifying a delinquentaccount to current status based upon qualifying payments.  As modified, accounts are eligible for are-age not more than once in a twelve-month period and not more than twicewithin any 60-month period.  In March2004, we re-aged certain accounts of customers who had opened their accountsprior to February 16, 1999, but whose re-aging history had not been trackedprior to February 16, 1999. We estimate that this re-aging resulted in a 16basis point reduction to the reported 30+ day delinquency rate at March 31,2004. The impact to the reported net credit loss rate was not significant.

 

*Delinquencies. *Anaccount is contractually delinquent if the minimum payment is not received bythe next due date. Accountholders may cure account delinquencies by making apartial payment that qualifies under our re-aging practices and applicableregulatory requirements. The delinquency rate is derived by dividing loansreceivable that are 30 days or more past due at period end by loans receivableat period end.

 

34

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Reported 30+ day delinquencyrates are influenced by fluctuations in the composition of receivablestransferred to our securitization trust and by the amount of the seniorseller’s interest in the securitization trust from time to time. These amountsmay increase or decrease as a result of account additions, increases ordecreases in the balances 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 series. (See “—Securitizations of LoansReceivable.”) For example, during a month in which we designate additionalaccounts to the securitization trust or reduce the amount of an outstandingseries of 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 receivable in thesecuritization trust declines, will generally also increase our reported 30+day delinquency rate because we will have a larger undivided interest in thepool of loans receivable transferred to the securitization trust than beforethe increase and because the trust loans receivable currently have higherdelinquency rates than our reported loans receivable. As a result, short-termfluctuations in the reported 30+ day delinquency rate are not necessarily areliable indicator of trends in our asset quality.

 

**Delinquent Loans**

 
|                       |   | **March 31, 2004** |       | **December 31, 2003** |   |
|----------------------------|--------|--------------------|------------|-----------------------|--------|
| **(dollars in thousands)** |   | **Loans**          |       | **% of  Total Loans** |   | **Loans** |   | **% of  Total Loans** |   |
| **Reported**               |   |               |       |                  |   |   |   |   |   |
| Loans outstanding(1)       |   | $                  | 6,191,078  |                  | 100.00 | % | $ | 6,281,403 |   | 100.00 | % |
| Loans delinquent           |   |               |       |                  |   |   |   |   |   |
| 30-59 days                 |   | $                  | 91,581     |                  | 1.48   | % | $ | 128,467 |   | 2.05 | % |
| 60-89 days                 |   | 73,418             |       | 1.18                  | %      | 94,916 |   | 1.51 | % |
| 90 or more days            |   | 160,242            |       | 2.59                  | %      | 193,748 |   | 3.08 | % |
| Total loans delinquent     |   | $                  | 325,241    |                  | 5.25   | % | $ | 417,131 |   | 6.64 | % |
|                       |   |               |       |                  |   |   |   |   |   |
| **Securitized**            |   |               |       |                  |   |   |   |   |   |
| Loans outstanding(2)       |   | $                  | 10,485,261 |                  |   |   | $ | 10,653,351 |   |   |   |
| Loans delinquent           |   |               |       |                  |   |   |   |   |   |
| 30-59 days                 |   | $                  | 243,862    |                  |   |   | $ | 346,630 |   |   |   |
| 60-89 days                 |   | 206,633            |       |                  |   | 269,107 |   |   |   |
| 90 or more days            |   | 451,580            |       |                  |   | 540,359 |   |   |   |
| Total loans delinquent     |   | $                  | 902,075    |                  |   |   | $ | 1,156,096 |   |   |   |
|                       |   |               |       |                  |   |   |   |   |   |
| **Managed**                |   |               |       |                  |   |   |   |   |   |
| Loans outstanding(1)       |   | $                  | 16,676,339 |                  | 100.00 | % | $ | 16,934,754 |   | 100.00 | % |
| Loans delinquent           |   |               |       |                  |   |   |   |   |   |
| 30-59 days                 |   | $                  | 335,443    |                  | 2.01   | % | $ | 475,097 |   | 2.81 | % |
| 60-89 days                 |   | 280,051            |       | 1.68                  | %      | 364,023 |   | 2.15 | % |
| 90 or more days            |   | 611,822            |       | 3.67                  | %      | 734,107 |   | 4.33 | % |
| Total loans delinquent     |   | $                  | 1,227,316  |                  | 7.36   | % | $ | 1,573,227 |   | 9.29 | % |

 

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(1)          Balancesexclude market value adjustments related to the fair value of designatedfinancial instruments of $(0.1) million for the first quarter 2004 and $(0.4)million for the fourth quarter 2003.

(2)          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 the Company’s balancesheet.

 

35

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*Net CreditLosses.*We recognizecredit losses on accounts determined to be uncollectible by charging off theoutstanding principal balances, as described in “—Overview of CriticalAccounting Policies.” After a loan is charged off, we continue collectionactivity to the extent legally permissible. Net credit losses for consumerloans represent the principal amount of charged-off loan balances (includingcharged-off bankrupt and deceased customer accounts) less current periodprincipal recoveries. Net credit losses include purchases, including certainfinanced cardholder service product sales and cash advances, and excludeaccrued interest and fees and fraud losses. Recoveries include collections onthe principal portion of previously charged-off accounts and the proceeds fromthe sale of charged-off receivables. The amount of charged-off receivables soldwill vary from period to period and is influenced by charge-off trends, marketconditions, and credit loss performance targets for the period. The proceedsrecognized from these sales of charged-off receivables on a reported basis were$26.8 million for the three months ended March 31, 2004, as compared to $21.3million for the three months ended March 31, 2003. The proceeds recognized fromsuch sales on a managed basis were $68.3 million for the three months endedMarch 31, 2004, as compared to $48.1 million for the three months ended March31, 2003. Fraud losses (losses due to the unauthorized use of credit cards,including credit cards obtained through fraudulent applications) are charged tonon-interest expense after an investigation period of up to 90 days.

 

Credit loss rates arederived by dividing net credit losses by average loans receivable balances fora specified period.

While net credit losses exclude all accrued interest and feesassociated with charged-off loans, loans receivable balances include accruedinterest and fee balances estimated to be collectible. Managed net creditlosses 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 seniorseller’s interest in the securitization trust from time to time. These amountsmay increase or decrease as a result of account additions, increases ordecreases in the balances 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 series. (See “—Securitizations of LoansReceivable.”) For example, during a month in which we designate additionalaccounts to the securitization trust or reduce the amount of an outstandingseries of 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 receivable 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 trust loans receivable have currently 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 March 31,** |       |
|-----------------------------------------------------------------|--------|----------------------------------|------------|
| **(dollars in thousands)**                                      |   | **2004**                         |       | **2003** |   |
|                                                            |   |                             |       |   |   |
| **Reported**                                                    |   |                             |       |   |   |
| Average loans outstanding(1)                                    |   | $                                | 6,473,312  |   | $ | 7,500,339 |   |
| Net credit losses                                               |   | $                                | 145,928    |   | $ | 296,074 |   |
| Net credit losses as a percentage of  average loans outstanding |   | 9.02                             | %          | 15.79 | % |
|                                                            |   |                             |       |   |   |
| **Securitized**                                                 |   |                             |       |   |   |
| Average loans outstanding(2)                                    |   | $                                | 10,231,416 |   | $ | 11,452,028 |   |
| Net credit losses                                               |   | $                                | 433,644    |   | $ | 538,468 |   |
|                                                            |   |                             |       |   |   |
| **Managed**                                                     |   |                             |       |   |   |
| Average loans outstanding(1)                                    |   | $                                | 16,704,728 |   | $ | 18,952,367 |   |
| Net credit losses                                               |   | $                                | 579,572    |   | $ | 834,542 |   |
| Net credit losses as a percentage of  average loans outstanding |   | 13.88                            | %          | 17.61 | % |

 

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(1)          TheMarch 31, 2004 and 2003 balances exclude SFAS No. 133 market value adjustmentsof $(0.3) million and $6.2 million.

(2)          Excludesthe 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 the Company's balance sheet.

 

36

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*Interest Rate 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 ofinterest-bearing liabilities that mature or reprice in a specific period. Evenif earnings could be perfectly hedged, a change in the level of interest rateswill change the present 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 receivables accrue interest at ratesthat are either fixed or float at a spread above the prime rate. At March 31,2004, 71% of our reported loans receivable and 70% of our managed loansreceivable had interest rates that were floating. While our fixed rate creditcard receivables have no stated maturity or repricing period, we generally havethe right to adjust the rate charged after providing notice to the customer.Interest rates on our liabilities are generally indexed to LIBOR or bear afixed rate. This asset/liability structure exposes us to two types of interestrate risk: (a) repricing risk, which results from a mismatch between assets andliabilities that mature or reprice in specific periods; and (b) basis risk,which arises from changing spread relationships between indexes such as theprime 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 earnings andhedging the present value of earnings. To measure exposure to interest ratechanges, we use multiple complementary measures of risk to current earnings andthe present value of earnings under a number of scenarios and rate changes. Wetypically model the impact of rate changes on current earnings over athree-year period and the impact on the present value of earnings over a longerhorizon. When estimated risk exposure exceeds our guidelines, we seek tomitigate the risk through the use of matching and hedging techniques asdescribed below.

 

The following tableillustrates the estimated effects on managed net interest income of positiveand negative parallel

shifts in interest rates as calculated at March 31, 2004, using our interest rate risk model andtaking into consideration our current hedging activity as of March 31,2004.

 

**EstimatedEffects of Interest Rate Changes**

| **Change in Interest Rates** |   | **Percentage  Change in  Managed Net Interest Income(1)** |   |
|------------------------------|--------|--------------------------------------------------------------------------|--------|
| + 200 basis points           |   | 4.2                                                                      | %      |
| – 200 basis points      |   | (0.5                                                                     | )%     |

 

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(1)          The information shown is presented on a consolidated managedasset/liability basis, giving effect to derivatives, securitizations andrelated funding. It compares managed net interest income over twelve months ina stable interest rate environment to scenarios in which interest rates riseand fall by 200 basis points. We do not in the normal course of business derivecomparable interest rate sensitivity of net interest income on a reportedbasis. In the opinion of management, such comparable projections on a reportedbasis would not provide a significant benefit in understanding our expectedfuture performance.

 

Our interest rate risk modelincorporates certain assumptions regarding our ability to reprice our fixedrate credit card loans without otherwise impacting customer behavior. Theactual repricing sensitivity of these loans depends on how our customers andcompetitors respond to changes in market interest rates. As of March 31, 2004,we modeled the repricing maturity of our fixed rate credit card loans based onan average maturity of 15 months. The repricing of certain other categories ofassets and liabilities is subject to competitive and other pressures beyond ourcontrol. As a result, certain assets and liabilities assumed to mature orotherwise reprice within a certain period may in fact mature or reprice atdifferent times and at different volumes. The table above should be viewed asour estimate, subject to these uncertainties, of the general effect of theindicated interest rate movements on our managed net interest income.

 

37

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We generally seek tomitigate risks to earnings and capital arising from movements in interestrates. The main tools we use to manage our interest rate sensitivity areinvestment decisions, pricing decisions on our loans receivable, and whennecessary derivatives, including interest rate swap and cap agreements. We donot trade our derivative positions or use derivatives to speculate on interestrate movements, and we believe our use of such instruments is prudent andconsistent with industry standards.

 

**Notional Amounts ofInterest Rate Swap and Cap Agreements**

 
|                              |   | **Three  months ended March 31,** |    |
|-----------------------------------|--------|-----------------------------------|---------|
| **(dollars in thousands)**        |   | **2004**                          |    | **2003** |   |
| **Interest Rate Swap Agreements** |   |                              |    |   |   |
| Beginning balance                 |   | $                                 | 288,200 |   | $ | 918,200 |   |
| Maturities                        |   | —                            |    | 100,000 |   |
| Ending balance                    |   | $                                 | 288,200 |   | $ | 818,200 |   |
|                              |   |                              |    |   |   |
| **Interest Rate Cap Agreements**  |   |                              |    |   |   |
| Beginning balance                 |   | $                                 | —  |   | $ | 3,000 |   |
| Maturities                        |   | —                            |    | 3,000 |   |
| Ending balance                    |   | $                                 | —  |   | $ | — |   |

 

Notional amounts of interestrate swaps outstanding on March 31, 2004 decreased from March 31, 2003,primarily as the need for hedging declined in conjunction with a decrease inour fixed rate loans. As market conditions or our asset/liability mix change,we may increase or decrease the notional amounts of interest rate swaps andcaps outstanding in order to manage our interest rate risk within prudentlevels. As required by SFAS No. 133, we record the fair value of an interestrate derivative as an asset or liability (as appropriate) and offset thatamount with a change in the value of the item being hedged.

 

We manage credit riskarising from derivative transactions through an ongoing credit review,approval, and monitoring process. Credit risk for these derivative transactionsis defined as the risk that a loss will occur as the result of a derivativecounterparty defaulting on a contract when the contract is in a favorableeconomic position to us. We may enter into master netting, market settlement,or collateralization agreements with derivative counterparties to reduce thisrisk.

 

In 2002 we completed thesale of our operations in the United Kingdom and Argentina. At March 31, 2004,our foreign currency exposure had been reduced to small cash balances inBritish pounds sterling.

 

*Funding and Liquidity*

 

We seek to fund our assetsthrough a diversified mix of funding products designed to appeal to a broadrange of investors, with the goal of generating funding at the lowest costavailable to us while maintaining liquidity at appropriate levels and managinginterest rate risk. The primary goal of our liquidity management is to providefunding to support our operations in varying business environments. We employmultiple strategies, including diversification of funding sources, dispersionof maturities, and maintenance of liquid investments and cash balances.

 

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The following table reflectsour debt ratings and those of PNB as of March 31, 2004. Although previouslydowngraded, in September 2003, FitchRatings upgraded the ratings for seniorunsecured debt of Providian Financial Corporation from B to B+ and for seniorunsecured debt of Providian National Bank from B+ to BB–. In addition,FitchRatings revised our ratings outlook from stable to positive. However, wedo not expect any material change in our access to funding or in our fundingcosts as a result of the FitchRatings upgrades.

 

**Current Long-TermSenior Debt Ratings**

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

 

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(1)          Stableoutlook.

(2)          Positiveoutlook.

 

During the first quarter of2004, consistent with our Capital Plan, our liquidity position (federal fundssold and securities purchased under resale agreements, available-for-saleinvestment securities, and cash and cash equivalents) decreased byapproximately $672.7 million from $5.64 billion at December 31, 2003 to $4.97billion at March 31, 2004. We expect our liquidity position to continue todecrease over the remainder of 2004 due to the funding of growth in our loansreceivable. Our liquidity position at March 31, 2004 was approximately 37% ofour reported assets and 22% of our managed assets.

 

In addition, under thecapital assurances and liquidity maintenance agreement we entered into withPNB, we agreed to provide capital and liquidity support to it. Our agreementwith PNB to provide capital and liquidity support exempts certain of ournear-term cash obligations, including current interest obligations on our 3.25%convertible senior notes due August 15, 2005 and current payments on the 9.525%junior subordinated deferrable interest debentures due February 1, 2027. Inaddition, certain accrued deferred compensation, miscellaneous working capitalneeds not to exceed $25 million, and severance payments are generally exemptfrom the parent company’s obligations under the agreement. See “RegulatoryMatters” in our 2003 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“double leverage,” at March 31, 2004 was 127%. A double leverage ratio inexcess of 100% indicates the degree to which an investment in subsidiaries hasbeen funded with long-term borrowings and other liabilities of the parentcompany. The principal source of funds for us to make payments on our parent companydebt securities and to meet our other obligations is our cash investments anddividends from PNB. However, PNB has agreed not to pay any dividends to usduring the term of its regulatory agreement without first obtaining regulatoryconsent. It does not currently have any plans to seek such consent. Inaddition, if we are required to provide additional capital and liquiditysupport to PNB, our ability to service our debt obligations would be furtherlimited.

 

*Funding Sources and Maturities. *We seek to fund ourassets by diversifying our distribution channels and offering a variety offunding products. However, our ability to fund existing and future customerloans is currently dependent on four primary sources: customer deposits,securitizations, a portfolio of cash and liquid investment securities, and, toa lesser extent, debt.

 

We offermaturity terms for our funding products that range up to 30 years. Actualmaturity distributions depend on several factors, including expected assetduration, investor demand, relative costs, shape of the yield curve, andanticipated issuances in the securitization and capital markets. We seek tomaintain a balanced distribution of maturities and avoid undue concentration inany one period. We monitor existing funding maturities and loan growthprojections to prudently manage liquidity levels.

 

For theremainder of the year (April 1, 2004 through December 31, 2004), we havefunding requirements for maturing deposits of $2.36 billion, maturingsecuritizations of $2.33 billion, and no maturing short-term or long-term debt.Of the $2.33 billion of maturing securitizations, $1.43 billion represents theinvestor interests held by third parties of a variable funding series which isscheduled to begin amortizing in November 2004. We expect to extend therevolving period of this series for a period of approximately 12 months. If notrenewed, this series will begin to amortize during the fourth quarter of 2004.We anticipate that we will meet these funding requirements, along with anyincremental asset growth in 2004, by extending the revolving period on ourvariable funding series, issuing new securitization series, utilizing our 

 

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liquidity position, and accepting new deposits. We may also generateadditional funding by issuing common stock, including through a dividendreinvestment and direct stock purchase plan, or by issuing new debt securities.Although we have been successful in meeting our funding needs, future events orchanges affecting us or the markets in which we obtain our funding couldadversely affect our ability to fund our business.

 

*Deposits. *Deposits decreased to $8.96 billion as of March31, 2004 from $10.10 billion as of December 31, 2003. At March 31, 2004, PNB’sdeposits were covered by cash, liquid investments, and a risk-adjusted amountof on-balance sheet loans, as contemplated by its Capital Plan. We expect PNBto continue to maintain assets of sufficient quality on its balance sheet tofully cover its deposits. However, there can be no assurance that it will besuccessful in doing so.

 

The followingtable summarizes the contractual remaining maturities of our deposits,substantially all of which are retail deposits.

 

**Maturities ofDeposits**

 
|                                    |   | **March 31,  2004**  |      | **December  31, 2003** |   |
|-----------------------------------------|--------|----------------------|-----------|------------------------|--------|
| **(dollars in thousands)**              |   | **Direct  Deposits** |      | **Brokered  Deposits** |   | **Total  Deposits** |   | **Direct  Deposits** |   | **Brokered  Deposits** |   | **Total  Deposits** |   |
| Three months or less                    |   | $                    | 365,288   |                   | $      | 477,398 |   | $ | 842,686 |   | $ | 453,512 |   | $ | 631,682 |   | $ | 1,085,194 |   |
| Over three months through   one year(1) |   | 1,120,755            |      | 1,401,441              |   | 2,522,196 |   | 1,052,329 |   | 1,350,211 |   | 2,402,540 |   |
| Over one year through five years(2)     |   | 1,465,878            |      | 2,855,715              |   | 4,321,593 |   | 1,837,037 |   | 3,386,580 |   | 5,223,617 |   |
| Over five years                         |   | 1,586                |      | 706,942                |   | 708,528 |   | 322 |   | 708,152 |   | 708,474 |   |
| Deposits without contractual maturity   |   | 568,493              |      | —                 |   | 568,493 |   | 681,232 |   | — |   | 681,232 |   |
| Total deposits                          |   | $                    | 3,522,000 |                   | $      | 5,441,496 |   | $ | 8,963,496 |   | $ | 4,024,432 |   | $ | 6,076,625 |   | $ | 10,101,057 |   |

 

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(1)          Maturities of depositsover three months through one year by quarter are as follows: third quarter2004: $814.0 million; fourth quarter 2004: $705.7 million; first quarter 2005:$1.00 billion.

(2)          Maturities of depositsover one year through two years, $1.48 billion.

 

A bank that isbelow the well-capitalized levels as reported on its Call Reports is subject toceilings on rates paid for deposits and restrictions on accepting brokereddeposits. A bank that is adequately capitalized is restricted from acceptingbrokered deposits without a waiver from the FDIC and may not pay a rate on itsbrokered deposits that is more than 75 basis points higher than the prevailingrate in its market. As of March 31, 2004, capital ratios for PNB were above thewell-capitalized levels on a Call Report basis. PNB has exceeded thewell-capitalized level since March 31, 2002. Accordingly, the restrictions ondeposit taking activities described above do not currently apply to PNB andwill not apply to it so long as it remains well capitalized on a Call Reportbasis.

 

*Securitizations. *Securitizationof our loans receivable provides an important source of funding that is costeffective and beneficial in achieving the required levels of capitalestablished by our regulators. We seek a range of maturity terms in oursecuritizations.

 

Among our outstandingsecuritizations, we have a variable funding series that we expect to renewannually. Securitization funding under the variable funding series representsinvestor interests held by third parties, which totaled $1.43 billion as ofMarch 31, 2004 and $1.83 billion as of December 31, 2003. During November 2003,we extended the revolving period of the variable funding series for a period ofapproximately 12 months, and thus extended the beginning of the scheduled amortizationperiod for such series to November 2004. If the variable funding series is notrenewed or extended in November 2004 it will begin to amortize and we wouldexpect the amortization of investor interests held by third parties to continuefor a period of approximately two months, based on current assumptions andestimates. 

 

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Our term securitizationshave expected final payment dates of more than one year. In March 2004, PNBcompleted the sale of $750.0 million of three-year floating rate owner trustnotes, backed by a series certificate issued by the Providian Gateway MasterTrust. Our term securitizations are expected to amortize over the periodsindicated below, based on current projections and the amounts outstanding as ofMarch 31, 2004.

 

**Amortization of TermSecuritizations**

 

| **Year** |   | **Amount  Amortizing  (dollars in thousands)** |    |
|----------|--------|------------------------------------------------|---------|
| 2004     |   | $                                              | 900,000 |   |
| 2005     |   | 3,038,399                                      |    |
| 2006     |   | 1,932,149                                      |    |
| 2007     |   | 1,116,133                                      |    |
| 2008     |   | 361,336                                        |    |
|          |        |                                                |         |  |

 

 

The amount funded in ourspread accounts will change from time to time, depending on securitizationoutstandings and spread account funding triggers. These triggers are based, inpart, on PNB’s credit rating and the performance of the securitized loans. AtMarch 31, 2004, the funds on deposit in spread accounts totaled $397.7 million, of which $303.0 million wasrequired to be funded due to downgrades in our credit rating in 2001 and 2002,$55.0 million was required to be prefunded in a spread account associated withthe variable funding series, and $39.6 million was required to be funded basedon levels determined by the performance of our securitized loans. The spreadaccount funding requirements due to our credit rating downgrades have beenfully met. Currently, there are no additional spread account fundingrequirements relating to our credit ratings. As the performance of the loanstransferred to our securitization trust improves or deteriorates, spreadaccount funding levels based on the performance of the securitized loans will decreaseor increase.

 

*Unsecured Funding Facilities. *The following tablesummarizes the amounts outstanding under our unsecured funding facilities as ofMarch 31, 2004.

 

**Summary of UnsecuredFunding Facilities**

 
|                                                   |   | **March 31,  2004**        |   |
|--------------------------------------------------------|--------|----------------------------|--------|
| **(dollars in thousands)**                             |   | **Effective/  Issue Date** |   | **Facility  Amount(1)** |   | **Principal  Outstanding(2)** |   | **Maturity** |   |
| Providian Financial shelf registration(3)              |   | 6/98                       |   | $632,445 |   | $1,354,714 |   | Various |   |
| Junior subordinated deferrable interest  debentures(4) |   | 2/97                       |   | — |   | 109,281 |   | 2/27 |   |

 

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(1)          Funding availability and/or funding costs are subject to marketconditions and contractual provisions.

(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 9 to our ConsolidatedFinancial Statements for further discussion. 

(4)          In accordance with Financial Accounting Standards Board (“FASB”)Interpretation No. 46, “Consolidation of Variable Interest Entities, anInterpretation of ARB No. 51” (“FIN 46”), amounts previously reported ascapital securities are no longer included in our consolidated financialstatements. We now report junior subordinated deferrable interest debentures inlong-term borrowings. See Note 9 to our Consolidated Financial Statements forfurther discussion.

 

On March 15, 2004, we issued$277.2 million of 2.75% convertible cash to accreting senior notes due March15, 2016. The notes are convertible at the option of the holders at aconversion rate of 58.7941 shares of our common stock for each $1,000 of noteprincipal (an initial conversion price of $17.01 per share of common stock), ifspecified conditions are met. The proceeds from this issuance are available forgeneral corporate purposes, including the repurchase of outstanding debtobligations, capital contributions or extensions of credit to our bankingsubsidiary, investments in retained interests in the securitizations of ourbanking subsidiary, and other purposes consistent with PNB’s Capital Plan.After March 15, 2011, we will pay interest at a rate of 1.75% per year and willaccrete the principal amount of the notes at a rate that provides 

 

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holders with an aggregate annual yield to maturity of 2.75% per year,computed on a semiannual bond equivalent yield basis. In addition, contingentinterest is required to be paid to holders if certain conditions are met. If afundamental change, such as a change in control of the ownership of our commonstock, as defined in the related indenture supplement, occurs on or beforeMarch 15, 2011, we may also be required to purchase the notes for cash and payan additional make whole premium payable in our common stock upon therepurchase or conversion of the notes in connection with the fundamentalchange. We have the option to redeem all or a portion of the notes for cash atany time on or after March 31, 2011. Holders may require us to purchase all or aportion of their notes for cash on March 15, 2011 or March 15, 2014. Thesenotes also represent an additional contractual obligation for us as of March31, 2004. See “Funding and Liquidity—Contractual Obligations” in our 2003Annual Report for a discussion of our contractual obligations as of December31, 2003. See Note 9 to our Consolidated Financial Statements for furtherdiscussion of the notes. 

 

Our Board of Directors hassuspended the payment of quarterly cash dividends on our common stock. Theprincipal source of funds for the payment of dividends on our common stock isdividends received from PNB. However, PNB has agreed not to pay any dividendsto us during the term of its regulatory agreement without first obtaining priorregulatory consent. See “Regulatory Matters” in our 2003 Annual Report. PNBdoes not currently have any plans to seek such consent.

 

*Investments. *Wemaintain short-term liquidity through federal funds sold and securitiespurchased under resale agreements, available-for-sale investment securities andcash and cash equivalents. We also maintain a portfolio of high-qualityinvestment securities, such as U.S. government and agency obligations,mortgage-backed securities, and commercial paper. Investment securities were$2.76 billion as of March 31, 2004 and $1.86 billion as of December 31, 2003.Federal funds sold and securities purchased under resale agreements decreasedto $1.44 billion as of March 31, 2004 from $3.24 billion as of December 31,2003.

 

*Off-Balance Sheet Arrangements*

* *

*FinancialCommitments.*Significantcommitments at March 31, 2004 consisted of commitments to extend credit cardloans, which represent the total unused portions of the lines of creditavailable to customers. These amounts do not necessarily represent future cashrequirements as we do not anticipate that 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 8 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 7 toour 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 March 31, 2004, we had interest rate swap agreements with maturitiesranging from 2004 to 2016, and we had no interest rate cap agreements. See“—Interest Rate Sensitivity” for further discussion.

* *

*Guarantees.*In January 2003, weentered into a pledge agreement with an insurer with respect to certainobligations owing to the insurer in connection with two series of the ProvidianGateway Master Trust. The amount of the pledged collateral at March 31, 2004was $13.6 million, which is held in a deposit account as security for thepayment to the insurer of amounts owing to it in connection with the remainingseries (one of the series has already been repaid). See Note 8 to ourConsolidated Financial Statements for further discussion.

 

In August 2002, we sold ourinterest in a limited liability entity that constructed and operated analternative energy plant and we guaranteed certain obligations of the limitedliability entity under the purchase and sale agreement. The guarantee coversour obligation to indemnify the purchaser against losses arising out of abreach of the purchase and sale agreement and failure to repurchase the assetsif tax credits are not available to the purchaser. Our guarantee is capped at$6.2 million plus the amounts of additional contingent future payments that maybe made to us arising from fuel production from the plant. See Note 8 to ourConsolidated Financial Statements for further discussion.

 

We also are parties to andfrom time to time enter into various agreements that contain generalindemnification provisions. We cannot estimate the potential future impact ofthese indemnification provisions since this would require an assessment offuture claims that may be made against us. Based on historical experience, wedo not currently expect the risk of loss under these indemnification provisionsto have a material adverse effect on our financial condition or our results of 

 

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operations, but we cannot give any assurance that they will not havesuch an effect. See Note 8 to our Consolidated Financial Statements for furtherdiscussion.

 

*VariableInterest Entities.*InJanuary 2003, the FASB issued FIN 46, which provides guidance on how toidentify a variable interest entity (“VIE”) and determine when the assets,liabilities, non-controlling interests, and results of operations of a VIE mustbe included in a company’s consolidated financial statements. In December 2003,the FASB issued a revision of FIN 46 which superseded the original guidance andrevised various aspects of the original guidance, including effective dates.See Note 3 to our Consolidated Financial Statements for further discussion.

 

*Capital Adequacy*

 

We continue to manage ourcapital levels with the dual objectives of having sufficient capital to supportthe achievement of our business plan and to meet regulatory requirements.During the three months ended March 31, 2004, we continued to focus our capitalplanning on meeting or exceeding regulatory minimum levels of capital andsupporting anticipated growth. Our regulatory minimum levels of capital arederived from two primary sources: capital adequacy regulations that applygenerally to banks and the Capital Plan, which lays out capital goals for PNB.

 

The regulatory capitalratios are determined by comparing regulatory capital levels relative to totalassets as measured using a specified approach. Risk-weighted assets are derivedby adjusting asset levels based on the relative levels of risk as specified inthe capital adequacy regulations. Regulatory capital includes core capital(Tier 1 Capital), which consists primarily of shareholders’ equity, and totalrisk-based capital (Tier 1 Capital + Tier 2 Capital), which adds to corecapital a portion of the allowance for credit losses. Based on thesedefinitions of capital, the capital adequacy regulations establish thefollowing capital categories: well capitalized; adequately capitalized;undercapitalized; significantly undercapitalized; and criticallyundercapitalized. The capital ratios that correspond to well capitalized andadequately capitalized are set forth in the following table, along with PNB’sratios on a Call Report basis as of March 31, 2004.

 

**Capital AdequacyGuidelines**

 
| **Capital Ratio** |   | **Calculation**                                                |   | **PNB  Ratios** |   | **Well-  Capitalized  Ratios** |   | **Adequately  Capitalized  Ratios** |   |
|-------------------|--------|----------------------------------------------------------------|--------|-----------------|--------|--------------------------------|--------|-------------------------------------|--------|
| Total risk-based  |   | (Tier 1 + Tier 2/Total  risk-based assets) |   | 22.66           | %      | 10                             | %      | 8                                   | %      |
| Tier 1            |   | Tier 1/Total  risk-based assets                                |   | 20.24           | %      | 6                              | %      | 4                                   | %      |
| Leverage          |   | Tier  1/Adjusted average assets                                |   | 23.50           | %      | 5                              | %      | 4                                   | %      |

 

PNB’s capital ratios reflectthe application of regulatory guidance related to interests retained by PNB inits securitization transactions. Under the banking regulators’ low-levelrecourse rule, risk-based capital must be maintained for assets transferredwith recourse, in an amount no greater than the maximum amount of recourse forwhich a bank is contractually liable. This rule applies to transactionsaccounted for as sales under GAAP in which a bank contractually limits its riskof loss or recourse exposure to less than the full amount of regulatoryrisk-based capital that would be required if the low-level recourse rule didnot apply. Low-level recourse transactions include those in which a banksecuritizes assets and uses related retained interests as credit enhancements.PNB is required under this rule to hold risk-based capital equivalent to itsmaximum contractual recourse exposure on the assets transferred, not to exceedthe amount of risk-based capital that would be required if the low-levelrecourse rule did not apply.

 

In addition, PNB’s capitalratios reflect the application of banking regulations that, among other things,require the amount of credit-enhancing interest-only strips receivable thatexceed 25% of Tier 1 Capital (concentration limit) to be deducted from Tier 1Capital; and requiring “dollar-for-dollar” risk-based capital (as defined inthe regulations) for certain residual interests not deducted from Tier 1Capital. As of March 31, 2004, PNB’s interest-only strips receivablerepresented 8.41% Tier 1 Capital, which is below the 25% concentration limit inthe regulation. However, PNB does hold “dollar-for-dollar” risk-based capitalagainst approximately $1.75 billion in residual interests from itssecuritizations, which include the accrued interest receivable (“AIR”) relatedto securitized loans.

 

Under its Capital Plan,PNB’s capital ratios also reflect the application of the Expanded Guidance forSubprime

Lending Programs issued by the federal banking regulators (“SubprimeGuidance”) to a portion of its reported credit card account loans. Applicationof the Subprime Guidance results in higher-risk-weights than would otherwise berequired by the regulations being assigned to accounts that fall within thescope of the guidance. Under the methodology utilized in the Capital Plan fordetermining risk weights, PNB has segmented its standard and middle market portfoliosinto several categories according to their internal credit scores andhistorical and projected charge-off rates. As applied by PNB at 

 

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March 31, 2004, this methodology resulted in a weighted average riskweighting of 146% against PNB’s reported standard and middle market segmentloans receivable, which totaled approximately $3.76 billion on such date. Theserisk weightings are subject to change depending upon conditions of our loanportfolio and/or changes to regulatory guidance. Managed loans outstanding tocustomers in the standard and middle segments totaled approximately $14.24billion as of March 31, 2004.

 

PNB’s Capital Plan setscapital ratio goals that use the regulatory definitions of capital describedabove. The capital goals include total risk-based capital measures as shown onPNB’s Call Reports and after application of the Subprime Guidance. In addition,the impact of PNB’s adoption of the AIR guidance is factored into these goals (see“—Overview of Critical Accounting Policies—Securitization Accounting” fordiscussion regarding AIR). The Capital Plan sets goals of minimum capitalratios to be achieved by certain dates and thereafter maintained. PNB achievedits previous goals by the required dates and has maintained capital ratioshigher than the minimums specified. In addition, PNB has already achieved thegoals required to be met by June 30, 2004, as reflected in the following table.

 

**PNB Capital Ratios**

 

|                                                                                                      |   | **Capital  Plan  Goals** |   | **Actual**          |   |
|-----------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|---------------------|--------|
|                                                                                                      |   | **June 30,  2004**       |   | **March 31,  2004** |   |
| Total risk-based capital ratio, as reported  on PNB Call Report                                           |   | 10                       | %      | 22.66               | %      |
| Total risk-based capital ratio, after  application of Subprime Guidance, excluding impact of AIR guidance |   | 10                       | %      | 20.15               | %      |
| Total risk-based capital ratio, after  application of Subprime Guidance, including impact of AIR guidance |   | 10                       | %      | 18.69               | %      |

 

PNB’s capital ratiosimproved during 2003 and the first quarter of 2004, largely as a result ofdecreases in levels of retained subordinated interests due to sales of retainedsubordinated securityholders’ interests from PNB to the parent company and tothird parties, decreases in the level of spread accounts due to performanceimprovements of the relevant securitization transactions, and the addition ofcash and cash equivalents from the merger of PB into PNB. 

 

PNB’s future capital ratioswill depend on, among other things, the level of internally generated capitalas well as the level of loan growth, changes in loan mix, and the level ofretained subordinated interests related to our securitization activity. Growthin reported receivables, combined with changes in the levels and valuations ofspread accounts and other retained subordinated interests related to oursecuritizations, may result in changes in PNB’s risk-based capital ratios asreported on its Call Report and after applying the Subprime Guidance and theAIR guidance. Subject to the ongoing review and continuing update of itsCapital Plan and the potential impact of evolving regulatory standards, weexpect that PNB will continue to achieve the capital goals in its Capital Plan.

 

The capital requirements ofPNB are subject to qualitative judgments by its regulators with respect tocomponents, risk weightings, and other factors. Its banking regulators have theauthority to require PNB to adhere to higher capital requirements than thosespecified in the regulatory capital rules or its Capital Plan. This couldnecessitate increasing capital ratios by various means, including asset salesor equity issuances. In addition, the strategic initiatives that we have taken,and any that we may take in the future, could have an impact on the capitalratios and requirements of PNB.

 

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*Cautionary Statement Regarding Forward-LookingInformation*

 

This reportcontains certain 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. Forward-lookingstatements include, without limitation: expressions of the “belief,”“anticipation,” or “expectations” of management; statements as to industrytrends or future results of operations of the Company and our subsidiaries; andother statements that are not historical fact. Forward-looking statements arebased on certain assumptions by management and are subject to risks anduncertainties that could cause actual results to differ materially from thosein the forward-looking statements. These risks and uncertainties include, butare not limited to, competitive pressures; factors that affect liquidity,delinquency rates, credit loss rates, and charge-off rates; general economicconditions; consumer loan portfolio growth; changes in the cost and/oravailability of funding due to changes in the deposit, credit, orsecuritization 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,practices, and/or procedures; the success of product development efforts; legaland regulatory proceedings, including the impact of ongoing litigation;interest rates; one-time charges; extraordinary items; the ability to recruitor replace key personnel; and the impact of existing, modified, or newstrategic initiatives. These and other risks and uncertainties are described inour 2003 Annual Report under the heading “Risk Factors,” and are also describedin other parts of our 2003 Annual Report, including “Legal Proceedings” and“Management’s Discussion and Analysis of Financial Condition and Results ofOperations.” Readers are cautioned not to place undue reliance on anyforward-looking statement, which speaks only as of the date thereof. Weundertake no obligation to update any forward-looking statements.

 

**Item3****.****              Quantitative andQualitative Disclosures About Market Risk**

 

Informationconcerning quantitative and qualitative disclosures about market risk isprovided under the caption “Interest Rate Sensitivity” under “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inItem 2 of this Part I.

 

**Item4****.****           Controls and Procedures**

 

The Company’smanagement, with the participation of the Company’s Chief Executive Officer andChief 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, concluded that the Company’s disclosure controls and procedures,which have been designed to ensure that information required to be disclosed bythe Company in the reports it files or submits under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the rules and forms of the Securities and Exchange Commission, areeffective.

 

No change in theCompany’s internal control over financial reporting (as defined in Exchange ActRule 13a-15(f)) has occurred during the Company’s most recent fiscal quarterthat has materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

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**PART II.  OTHER INFORMATION**

 

**Item 1.****              LegalProceedings**

 

Following the announcementin October 2001 of our third quarter 2001 delinquency and credit lossexperience, a number of lawsuits were filed against us and certain of ourexecutive officers and/or directors. These included Rule 10b-5 securities classactions, shareholder derivative actions, and class actions relating to our401(k) plan. The class actions relating to our 401(k) plan were settled in June2003 on a classwide basis for $8.6 million, which was funded by our insurancecarriers.

 

The Rule 10b-5 securitiesclass actions were filed in the District Court for the Northern District ofCalifornia. These consolidated actions (In re Providian Financial SecuritiesLitigation) allege that we and certain of our officers made false andmisleading statements concerning our operations and prospects for the secondand third quarters of 2001, in violation of federal securities laws. Theactions seek damages, interest, costs, and attorneys’ fees. Our motion todismiss was denied in December 2002. The class was certified on January 15,2004 and comprises those persons or entities who acquired our stock betweenJune 6, 2001 and October 18, 2001. The case is in the discovery phase, andtrial is set for June 7, 2004.

 

The shareholder derivativeactions were filed in December 2001 and January 2002 in California state courtin San Francisco. These actions generally seek redress against members of ourBoard of Directors and certain executive officers and allege breach offiduciary duty, gross negligence, breach of contract, and violation of stateinsider trading law. The complaints seek damages (in the name of the Companyand to be awarded to the Company), attorneys’ fees, and other relief. Theseproceedings have been stayed by agreement of the parties.

 

Beginning in 1999, we werenamed as a defendant in a number of legal proceedings relating to allegedlyunfair and deceptive business practices by our banking subsidiaries in themarketing of cardholder service products and other practices.  In June 2000, we reached settlements withthe Comptroller, the San Francisco District Attorney, the California AttorneyGeneral, and the Connecticut Attorney General with respect to these consumerclaims. In November 2001, settlement of the consumer class action and otherlawsuits pending in state and federal court relating to such practices receivedfinal state court approval, and the federal court actions were dismissed in March2002. In connection with these settlements, we agreed to make certain businesspractice changes and to pay restitution to affected customers. Approximately6,400 class members opted out of participation in the class action settlementand approximately 60 of those class members have individual actions currentlypending against us. The parties have reached agreement to settle the opt outcases on a global basis.

 

In February 2001, we werenamed as a defendant in a putative consumer class action suit entitled *Ross v.Visa, U.S.A. Inc., et al.,* which was filed in the United StatesDistrict Court for the Eastern District of Pennsylvania against Visa,MasterCard, and a number of credit card issuing banks. The suit alleges thatuniform foreign currency surcharges allegedly imposed by the defendants are theresult of a conspiracy in restraint of trade and violate the federal antitrustlaws. The suit also alleges that the defendant banks violated theTruth-in-Lending Act by failing to separately identify these surcharges totheir customers on their monthly statements. Similar lawsuits were subsequentlyfiled in California and New York. In August 2001, the Federal Judicial Panel onMultidistrict Litigation transferred all of these cases to the SouthernDistrict of New York. In January 2002, plaintiffs filed an amended consolidatedcomplaint, which the defendants moved to dismiss. In July 2003 the courtgranted the motion to dismiss the plaintiffs’ claim for actual damages underthe Truth-in-Lending Act, and denied the motion to dismiss the plaintiffs’antitrust claims. The case is in the discovery phase.

 

In July 2002, we were namedas a defendant in a putative class action suit entitled *Shoars v. Providian Bancorp Services,Providian Financial Corporation, et al*. The suit was filed inCalifornia state court and alleges that our Paid Time Off (“PTO”) plan violatedCalifornia Labor Code section 227.3 because we capped the payout of PTObenefits for terminated employees at 40 hours. Following removal of the case tofederal court and the subsequent remand to state court, the case was settled ona classwide basis for $5.7 million.

 

In January 2004, a putativestate court class action, *Ventura v. Providian National Bank*, wasfiled in Orange County, California, alleging that PNB’s minimum paymentcalculation results in improper overlimit fees and that its payment postingpractices result in improper interest charges and late fees. The complaintalleges a single breach of contract claim and seeks damages, attorneys’ fees,and other relief. In February 2004, a putative state court class action, *Marotta v.Providian National Bank,* was filed in Orange County, Californiaalleging that plaintiffs’ APRs were increased improperly without proper notice.The complaint alleges a single breach of contract claim and seeks damages,attorneys’ fees, and other relief.

 

We have been advised that anindividual has made a claim against us and one of our vendors, alleging that weand/or the vendor received discounted bulk mail postage rates from the UnitedStates Postal Service on certain mailings between

 

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1997 and 2001 that were not eligible for the discounted rates. To thebest of our knowledge, the allegations involve claims that such mailings werenot eligible for bulk mail postage rates because requirements relating to theupdating of mailing lists were not satisfied. If we were not entitled toreceive the discounted rates, we could be subject to treble damages, penalties,and other relief. The Civil Division of the U.S. Department of Justice isworking with the U.S. Postal Service to investigate these allegations and todetermine whether to pursue the matter. We have received a subpoena from theU.S. Postal Service and have provided documents responsive thereto.

 

We have received a demand inarbitration from Credigy Receivables Inc. in connection with a disputeinvolving our subsidiary, First Select, Inc., arising out of the sale of aportfolio of certain charged-off, unsecured consumer credit card accounts.Credigy claims that First Select breached certain aspects of the PurchaseAgreement and Interim Servicing Agreement. Credigy is seeking contractualdamages, attorneys’ fees, and other relief.

 

Following the filing of aclaim in arbitration, we continue to have settlement discussions with ourformer Chief Executive Officer, Shailesh Mehta, concerning severance and otherbenefits alleged to be due under Mr. Mehta’s employment agreement in connectionwith the termination of his employment in November 2001.

 

In addition, we are commonlysubject to various other pending and threatened legal actions arising in theordinary course of business from the conduct of our activities. An informedassessment of the ultimate outcome or potential liability associated with ourpending lawsuits and other potential claims that could arise is not feasible atthis time.

 

Due to the uncertainties oflitigation, we can give no assurance that we will prevail on all claims madeagainst us in the lawsuits that we currently face or that additionalproceedings will not be brought. While we believe that we have substantivedefenses in the actions and claims described above and intend to defend thoseactions and claims vigorously, we cannot predict their ultimate outcome or theirpotential future impact on us. We do not presently expect any of these mattersto have a material adverse effect on our business, financial condition, orresults of operations, but can give no assurance that they will not have suchan effect.

 

**Item 2.****              Changesin Securities, Use of Proceeds and Issuer Purchases of Equity Securities**

 

The Companycurrently has no share repurchase programs in place. The following table setsforth information, on a monthly basis during the first quarter of 2004,regarding the Company’s acquisition of its Common Stock in connection withshares withheld to cover tax withholding requirements related to the vesting ofrestricted 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** |   |
|------------|--------|-----------------------------------------|--------|------------------------------------|--------|-------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------|--------|
| January    |   | 47,953                                  |   | 12.62                              |   | N/A                                                                                       |   | N/A                                                       |   |
| February   |   | 4,101                                   |   | 13.55                              |   | N/A                                                                                       |   | N/A                                                       |   |
| March      |   | —                                  |   | —                             |   | N/A                                                                                       |   | N/A                                                       |   |

 

 

**Item 6.****             ****Exhibits andReports on Form 8-K**

 

(a)                                  ExhibitsRequired by Item 601 of Regulation S-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. |
|--------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |                                                                                                                                           |
| 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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(b)                                 Reportson Form 8-K.

 

The Companyfiled or furnished the following reports on Form 8-K during the first quarterof 2004:

 

The Companyfiled a report on Form 8-K on January 15, 2004 with respect to the ProvidianGateway Master Trust’s net credit loss and 30+ day delinquency rates, and theProvidian Gateway Master Trust’s average excess spread rates, for the monthended December 31, 2003.

 

The Companyfurnished a report on Form 8-K on January 20, 2004 attaching its press releaseannouncing its financial results for the quarter and year ended December 31,2003.

 

The Companyfiled a report on Form 8-K on February 17, 2004 with respect to its and theProvidian Gateway Master Trust’s net credit loss and 30+ day delinquency rates,and the Providian Gateway Master Trust’s average excess spread rates, for themonth ended January 31, 2004.

 

The Companyfiled a report on Form 8-K on March 15, 2004 with respect to its and theProvidian Gateway Master Trust’s net credit loss and 30+ day delinquency rates,and the Providian Gateway Master Trust’s average excess spread rates, for themonth ended February 29, 2004.

 

The Company filed a reporton Form 8-K on March 19, 2004 attaching the Underwriting Agreement datedMarch 15, 2004 between the Company and Citigroup Global Markets, Inc.,Goldman, Sachs & Co., and Morgan Stanley & Co. Incorporated, the FourthSupplemental Indenture dated as of March 19, 2004 between the Company andJ.P. Morgan Trust Company, National Association, and the form of note in connectionwith the Company’s Registration Statement on Form S-3 (File No. 333-55937)and the issuance on March 19, 2004 of the Company’s 2.75% ConvertibleCash to Accreting Senior Notes due March 15, 2016.

 

(c)                                  Ratio of Earnings to Fixed Charges andRatio of Earnings to Combined Fixed Charges and Preferred Stock DividendRequirements.

 
|                                                                                  |   | **Three  months  ended  March 31,** |   | **Year ended  December 31,** |   |
|---------------------------------------------------------------------------------------|--------|-------------------------------------|--------|------------------------------|--------|
|                                                                                  |   | **2004**                            |   | **2003**                     |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
|                                                                                  |   |                                |   |                         |   |   |   |   |   |   |   |   |   |
| **Earnings to Fixed Charges**                                                         |   |                                |   |                         |   |   |   |   |   |   |   |   |   |
| Excluding interest on deposits                                                        |   | 8.30                                |   | 5.99                         |   | 3.83 |   | 3.68 |   | 14.91 |   | 10.05 |   |
| Including interest on deposits                                                        |   | 2.15                                |   | 1.50                         |   | 1.25 |   | 1.24 |   | 2.27 |   | 3.03 |   |
|                                                                                  |   |                                |   |                         |   |   |   |   |   |   |   |   |   |
| **Earnings to Combined Fixed Charges and  Preferred Stock Dividend Requirements (1)** |   |                                |   |                         |   |   |   |   |   |   |   |   |   |
| Excluding interest on deposits                                                        |   | 8.30                                |   | 5.99                         |   | 3.83 |   | 3.68 |   | 14.91 |   | 10.05 |   |
| Including interest on deposits                                                        |   | 2.15                                |   | 1.50                         |   | 1.25 |   | 1.24 |   | 2.27 |   | 3.03 |   |

 

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(1)          Preferredstock dividend requirements are adjusted to represent a pretax earningsequivalent.

 

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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:  May 10, 2004 |   | /s/ Anthony  F. Vuoto                                                                                                       |   |   |
|                     |   | Anthony F.  Vuoto  Vice Chairman and  Chief Financial Officer  (Principal Financial Officer and Duly Authorized  Signatory) |
|                     |   |                                                                                                                        |
| Date: May  10, 2004      |   | /s/ Daniel  Sanford                                                                                                         |   |   |
|                     |   | Daniel  Sanford  Executive Vice President and Controller  (Chief Accounting Officer and Duly  Authorized Signatory)         |

 

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**EXHIBIT INDEX**

 
| **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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