**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WashingtonD.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  September 30, 2002** |
|                                                   |   |                                                                                          |
| **OR**                                                 |
|                                                   |   |                                                                                          |
| o                                                      |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**For thetransition periodfrom             to             **

 

**1-12897**

**(CommissionFile Number)**

 

**PROVIDIAN FINANCIAL CORPORATION**

(Exact Name of Registrantas Specified in Its Charter)

 

| **Delaware**                                                                        |   | **94-2933952**                        |
|-------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  Jurisdiction of  Incorporation or Organization)                    |   | (I.R.S. Employer  Identification No.) |
|                                                                                |   |                                  |
| **201 Mission Street, San Francisco,  California 94105**                            |
| (Address of principal  executive offices) (Zip Code)                                |
|                                                                                |   |                                  |
| **(415) 543-0404**                                                                  |
| (Registrant’s Telephone  Number, Including Area Code)                          |
|                                                                                |   |                                  |
| **Not Applicable**                                                                  |
| (Former name, former  address and former fiscal year, if changed since last report) |

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

**Yes**  ý     **No  **o

 

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

 

Yes  ý     No  o

 

As of October 31, 2002, there were 289,044,075 sharesof the registrant’s Common Stock, par value $0.01 per share, outstanding.

 

 

----

 

**PROVIDIANFINANCIAL CORPORATION**

**FORM10-Q**

 

**INDEX**

 

**September30, 2002**

 
| **PART I.**    | **FINANCIAL  INFORMATION** | 3                                                                                           |
|----------------|----------------------------|---------------------------------------------------------------------------------------------|
|           |                       |                                                                                        |   |
|           | **Item 1.**                | Financial  Statements (unaudited):                                                          | 3 |
|           |                       | Condensed  Consolidated Statements of Financial Condition                                   | 3 |
|           |                       | Condensed  Consolidated Statements of Income                                                | 4 |
|           |                       | Condensed  Consolidated Statements of Changes in Shareholders’ Equity                  | 5 |
|           |                       | Condensed  Consolidated Statements of Cash Flows                                            | 6 |
|           |                       | Notes  to Condensed Consolidated Financial Statements                                       | 7 |
|           |                       |                                                                                        |   |
|           | **Item  2.**               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 18 |
|           |                       |                                                                                        |   |
|           | **Item 4.**                | Controls and Procedures                                                                     | 46 |
|           |                       |                                                                                        |   |
| **PART II.**   | **OTHER INFORMATION**      | 47                                                                                          |
|           |                       |                                                                                        |   |
|           | **Item 1.**                | Legal Proceedings                                                                           | 47 |
|           |                       |                                                                                        |   |
|           | **Item 5.**                | Other Information                                                                           | 49 |
|           |                       |                                                                                        |   |
|           | **Item 6.**                | Exhibits and  Reports on Form 8-K                                                           | 49 |
|           |                       |                                                                                        |   |
| **SIGNATURES** |                       | 51                                                                                          |

 

2

----

 

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

**Item 1.  FinancialStatements.**

** **

**Condensed Consolidated Statements ofFinancial Condition**

Providian Financial Corporation and Subsidiaries

 
| **(dollars in thousands, except per share data)**                                                                                                                                       |   | **September 30,  2002** |       | **December 31,  2001** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|------------------------|--------|
|                                                                                                                                                                                    |   | **(unaudited)**         |       |                   |   |
| Assets                                                                                                                                                                                  |   |                    |       |                   |   |
| Cash and cash equivalents                                                                                                                                                               |   | $                       | 407,579    |                   | $      | 449,586 |   |
| Federal funds sold and securities purchased under resale agreements                                                                                                                     |   | 4,141,000               |       | 1,611,000              |   |
| Investment securities:                                                                                                                                                                  |   |                    |       |                   |   |
| Available-for-sale (at market value, amortized cost of $1,700,266 at  September 30, 2002 and $1,302,435 at December 31, 2001)                                                           |   | 1,718,144               |       | 1,324,465              |   |
| Loans held for securitization or sale                                                                                                                                                   |   | 500,000                 |       | 1,410,603              |   |
| Loans receivable, less allowance for credit losses of $1,172,838 at September  30, 2002 and $1,932,833 at December 31, 2001                                                             |   | 6,524,938               |       | 9,626,307              |   |
| Premises and equipment, net                                                                                                                                                             |   | 137,970                 |       | 183,829                |   |
| Interest receivable                                                                                                                                                                     |   | 73,180                  |       | 116,053                |   |
| Due from securitizations                                                                                                                                                                |   | 2,472,182               |       | 2,926,181              |   |
| Deferred taxes                                                                                                                                                                          |   | 759,087                 |       | 1,030,340              |   |
| Other assets                                                                                                                                                                            |   | 483,431                 |       | 521,159                |   |
| Assets of discontinued operations                                                                                                                                                       |   | —                  |       | 738,643                |   |
| Total assets                                                                                                                                                                            |   | $                       | 17,217,511 |                   | $      | 19,938,166 |   |
|                                                                                                                                                                                    |   |                    |       |                   |   |
| Liabilities                                                                                                                                                                             |   |                    |       |                   |   |
| Deposits:                                                                                                                                                                               |   |                    |       |                   |   |
| Non-interest bearing                                                                                                                                                                    |   | $                       | 50,037     |                   | $      | 71,232 |   |
| Interest bearing                                                                                                                                                                        |   | 13,060,163              |       | 15,246,933             |   |
|                                                                                                                                                                                    |   | 13,110,200              |       | 15,318,165             |   |
|                                                                                                                                                                                    |   |                    |       |                   |   |
| Short-term borrowings                                                                                                                                                                   |   | 91,557                  |       | 117,176                |   |
| Long-term borrowings                                                                                                                                                                    |   | 873,042                 |       | 959,281                |   |
| Deferred fee revenue                                                                                                                                                                    |   | 252,926                 |       | 468,310                |   |
| Accrued expenses and other liabilities                                                                                                                                                  |   | 654,690                 |       | 885,780                |   |
| Liabilities of discontinued operations                                                                                                                                                  |   | —                  |       | 177,611                |   |
| Total liabilities                                                                                                                                                                       |   | 14,982,415              |       | 17,926,323             |   |
|                                                                                                                                                                                    |   |                    |       |                   |   |
| Company obligated mandatorily redeemable capital securities of  subsidiary trust holding solely junior subordinated deferrable interest  debentures of the Company (Capital Securities) |   | 104,332                 |       | 104,332                |   |
|                                                                                                                                                                                    |   |                    |       |                   |   |
| Shareholders’ equity                                                                                                                                                               |   |                    |       |                   |   |
| Common stock, par value $0.01 per share (authorized: 800,000,000  shares; issued: September 30, 2002—291,053,830 shares; December 31,  2001—286,209,960 shares)               |   | 2,911                   |       | 2,862                  |   |
| Retained earnings                                                                                                                                                                       |   | 2,196,807               |       | 1,971,359              |   |
| Cumulative other comprehensive income                                                                                                                                                   |   | 10,437                  |       | 9,807                  |   |
| Common stock held in treasury—at cost: (September 30, 2002—1,897,297  shares; December 31, 2001—1,383,562 shares)                                                        |   | (79,391                 | )          | (76,517                | )      |
| Total shareholders’ equity                                                                                                                                                         |   | 2,130,764               |       | 1,907,511              |   |
| Total  liabilities and shareholders’ equity                                                                                                                                        |   | $                       | 17,217,511 |                   | $      | 19,938,166 |   |

 

See Notes to Condensed Consolidated Financial Statements.

 

3

----

 

**Condensed Consolidated Statements ofIncome (unaudited)**

Providian Financial Corporation and Subsidiaries

 
|                                                                                           |   | **Three months ended September 30,** |    | **Nine months ended September 30,** |   |
|------------------------------------------------------------------------------------------------|--------|--------------------------------------|---------|-------------------------------------|--------|
| **(dollars in thousands, except per share data)**                                              |   | **2002**                             |    | **2001**                            |   | **2002** |   | **2001** |   |
|                                                                                           |   |                                 |    |                                |   |   |   |   |   |
| Interest Income                                                                                |   |                                 |    |                                |   |   |   |   |   |
| Loans                                                                                          |   | $                                    | 328,240 |                                | $      | 586,677 |   | $ | 1,166,807 |   | $ | 1,899,448 |   |
| Federal funds sold and securities purchased under resale agreements                            |   | 13,334                               |    | 19,489                              |   | 26,041 |   | 35,519 |   |
| Other                                                                                          |   | 46,902                               |    | 38,723                              |   | 132,356 |   | 113,073 |   |
| Total interest income                                                                          |   | 388,476                              |    | 644,889                             |   | 1,325,204 |   | 2,048,040 |   |
|                                                                                           |   |                                 |    |                                |   |   |   |   |   |
| Interest Expense                                                                               |   |                                 |    |                                |   |   |   |   |   |
| Deposits                                                                                       |   | 178,705                              |    | 232,505                             |   | 559,746 |   | 655,101 |   |
| Borrowings                                                                                     |   | 10,306                               |    | 13,700                              |   | 32,338 |   | 48,760 |   |
| Total interest expense                                                                         |   | 189,011                              |    | 246,205                             |   | 592,084 |   | 703,861 |   |
| Net interest income                                                                            |   | 199,465                              |    | 398,684                             |   | 733,120 |   | 1,344,179 |   |
|                                                                                           |   |                                 |    |                                |   |   |   |   |   |
| Provision for credit losses                                                                    |   | 192,366                              |    | 549,923                             |   | 1,152,830 |   | 1,330,834 |   |
| Net interest  income after provision for credit losses                                         |   | 7,099                                |    | (151,239                            | )      | (419,710 | ) | 13,345 |   |
| Non-Interest Income                                                                            |   |                                 |    |                                |   |   |   |   |   |
| Servicing and securitizations                                                                  |   | 125,057                              |    | 351,203                             |   | 570,247 |   | 865,606 |   |
| Credit product fee income                                                                      |   | 273,548                              |    | 459,433                             |   | 904,675 |   | 1,607,947 |   |
| Other                                                                                          |   | 66,503                               |    | 46,761                              |   | 613,355 |   | 151,099 |   |
|                                                                                           |   | 465,108                              |    | 857,397                             |   | 2,088,277 |   | 2,624,652 |   |
|                                                                                           |   |                                 |    |                                |   |   |   |   |   |
| Non-Interest Expense                                                                           |   |                                 |    |                                |   |   |   |   |   |
| Salaries and employee benefits                                                                 |   | 129,341                              |    | 174,131                             |   | 433,219 |   | 525,652 |   |
| Solicitation and advertising                                                                   |   | 126,404                              |    | 168,303                             |   | 339,275 |   | 447,677 |   |
| Occupancy, furniture, and equipment                                                            |   | 43,765                               |    | 52,385                              |   | 179,520 |   | 156,621 |   |
| Data processing and communication                                                              |   | 39,621                               |    | 48,119                              |   | 133,615 |   | 155,583 |   |
| Other                                                                                          |   | 113,035                              |    | 167,135                             |   | 402,955 |   | 465,406 |   |
|                                                                                           |   | 452,166                              |    | 610,073                             |   | 1,488,584 |   | 1,750,939 |   |
|                                                                                           |   |                                 |    |                                |   |   |   |   |   |
| Income from continuing operations before income taxes                                          |   | 20,041                               |    | 96,085                              |   | 179,983 |   | 887,058 |   |
| Income tax (benefit) expense                                                                   |   | (22,084                              | )       | 37,955                              |   | 41,093 |   | 350,389 |   |
|                                                                                           |   |                                 |    |                                |   |   |   |   |   |
| Income from continuing operations                                                              |   | 42,125                               |    | 58,130                              |   | 138,890 |   | 536,669 |   |
| Income (loss) from discontinued operations—net of related taxes                           |   | —                               |    | (14,792                             | )      | 67,156 |   | (32,353 | ) |
| Extraordinary item, extinguishment of debt—net of related taxes                           |   | —                               |    | 13,905                              |   | — |   | 13,905 |   |
| Cumulative effect of change in accounting principle—net of $1.3 million  of related taxes |   | —                               |    | —                              |   | — |   | 1,846 |   |
| Net Income                                                                                     |   | $                                    | 42,125  |                                | $      | 57,243 |   | $ | 206,046 |   | $ | 520,067 |   |
|                                                                                           |   |                                 |    |                                |   |   |   |   |   |
| **Earnings per  common share**—**basic**                                                  |   |                                 |    |                                |   |   |   |   |   |
| Income from continuing operations                                                              |   | $                                    | 0.15    |                                | $      | 0.20 |   | $ | 0.49 |   | $ | 1.89 |   |
| Income (loss) from discontinued operations—net of related taxes                           |   | —                               |    | (0.05                               | )      | 0.23 |   | (0.12 | ) |
| Extraordinary item, extinguishment of debt—net of related taxes                           |   | —                               |    | 0.05                                |   | — |   | 0.05 |   |
| Cumulative effect of change in accounting principle—net of related  taxes                 |   | —                               |    | —                              |   | — |   | 0.01 |   |
| Net Income                                                                                     |   | $                                    | 0.15    |                                | $      | 0.20 |   | $ | 0.72 |   | $ | 1.83 |   |
|                                                                                           |   |                                 |    |                                |   |   |   |   |   |
| **Earnings per  common share**—**assuming  dilution**                                     |   |                                 |    |                                |   |   |   |   |   |
| Income from continuing operations                                                              |   | $                                    | 0.15    |                                | $      | 0.20 |   | $ | 0.49 |   | $ | 1.83 |   |
| Income (loss) from discontinued operations—net of related taxes                           |   | —                               |    | (0.05                               | )      | 0.23 |   | (0.12 | ) |
| Extraordinary item, extinguishment of debt—net of related taxes                           |   | —                               |    | 0.05                                |   | — |   | 0.05 |   |
| Cumulative effect of change in accounting principle—net of related  taxes                 |   | —                               |    | —                              |   | — |   | 0.01 |   |
| Net Income                                                                                     |   | $                                    | 0.15    |                                | $      | 0.20 |   | $ | 0.72 |   | $ | 1.77 |   |
|                                                                                           |   |                                 |    |                                |   |   |   |   |   |
| Weighted average common shares outstanding—basic                                          |   | 285,323                              |    | 283,864                             |   | 284,649 |   | 284,542 |   |
|                                                                                           |   |                                 |    |                                |   |   |   |   |   |
| Weighted average common shares outstanding—assuming dilution                              |   | 294,094                              |    | 294,965                             |   | 293,935 |   | 297,076 |   |

 

See Notes to Condensed Consolidated Financial Statements.

 

4

----

 

**Condensed Consolidated Statements ofChanges in Shareholders’ Equity (unaudited)**

Providian Financial Corporation and Subsidiaries

 
| **(dollars  in thousands, except per share data)**                                                         |   | **Common  Stock** |      | **Additional  Paid-In  Capital** |       | **Retained  Earnings** |       | **Cumulative  Other  Comprehensive  Income** |          | **Common  Stock  Held in  Treasury** |       | **Total**  |       |
|------------------------------------------------------------------------------------------------------------|--------|-------------------|-----------|----------------------------------|------------|------------------------|------------|----------------------------------------------|---------------|--------------------------------------|------------|------------|------------|
| **Balance at December 31, 2000**                                                                           |   | **$**             | **2,862** | ** **                       | **$**      | **—**             | ** ** | **$**                                        | **2,014,205** | ** **                           | **$**      | **21,092** | ** ** | **$** | **(5,976** | **)** | **$** | **2,032,183** | ** ** |
| Comprehensive income:                                                                                      |   |              |      |                             |       |                   |       |                                         |          |                                 |       |       |       |
| Net Income                                                                                                 |   |              |      |                             |       | 520,067                |       |                                         |          |                                 |       | 520,067    |       |
| Other comprehensive  income:                                                                               |   |              |      |                             |       |                   |       |                                         |          |                                 |       |       |       |
| Unrealized loss  on securities, net of income tax benefit of $4,776                                        |   |              |      |                             |       |                   |       | (6,689                                       | )             |                                 |       | (6,689     | )          |
| Foreign currency  translation adjustments, net of income tax benefit of $1,455                             |   |              |      |                             |       |                   |       | (2,243                                       | )             |                                 |       | (2,243     | )          |
| Other comprehensive  income                                                                                |   |              |      |                             |       |                   |       |                                         |          |                                 |       | (8,932     | )          |
| Comprehensive income                                                                                       |   |              |      |                             |       |                   |       |                                         |          |                                 |       | 511,135    |       |
|                                                                                                       |   |              |      |                             |       |                   |       |                                         |          |                                 |       |       |       |
| Cash dividend:  Common—$0.09 per share                                                                |   |              |      |                             |       | (25,685                | )          |                                         |          |                                 |       | (25,685    | )          |
| Purchase of  4,425,415 common shares for treasury                                                          |   |              |      | (959                             | )          |                   |       |                                         |          | (221,672                             | )          | (222,631   | )          |
| Exercise of  stock options and other awards                                                                |   |              |      | (38,705                          | )          | (29,640                | )          |                                         |          | 116,459                              |       | 48,114     |       |
| Issuance of  restricted and unrestricted stock less forfeited shares                                       |   |              |      | 5,406                            |       |                   |       |                                         |          | 6,968                                |       | 12,374     |       |
| Deferred  compensation related to grant of restricted and unrestricted stock less  amortization of $10,303 |   |              |      | (2,071                           | )          |                   |       |                                         |          |                                 |       | (2,071     | )          |
| Net tax effect  from employee stock plans                                                                  |   |              |      | 36,329                           |       |                   |       |                                         |          |                                 |       | 36,329     |       |
| **Balance at September 30, 2001**                                                                          |   | **$**             | **2,862** | ** **                       | **$**      | **—**             | ** ** | **$**                                        | **2,478,947** | ** **                           | **$**      | **12,160** | ** ** | **$** | **(104,221** | **)** | **$** | **2,389,748** | ** ** |
|                                                                                                       |   |              |      |                             |       |                   |       |                                         |          |                                 |       |       |       |
| **Balance at December 31, 2001**                                                                           |   | **$**             | **2,862** | ** **                       | **$**      | **—**             | ** ** | **$**                                        | **1,971,359** | ** **                           | **$**      | **9,807**  | ** ** | **$** | **(76,517** | **)** | **$** | **1,907,511** | ** ** |
| Comprehensive income:                                                                                      |   |              |      |                             |       |                   |       |                                         |          |                                 |       |       |       |
| Net Income                                                                                                 |   |              |      |                             |       | 206,046                |       |                                         |          |                                 |       | 206,046    |       |
| Other comprehensive  income:                                                                               |   |              |      |                             |       |                   |       |                                         |          |                                 |       |       |       |
| Unrealized loss  on securities, net of income tax benefit of $288                                          |   |              |      |                             |       |                   |       | (441                                         | )             |                                 |       | (441       | )          |
| Foreign currency  translation adjustments, net of income tax expense of $700                               |   |              |      |                             |       |                   |       | 1,071                                        |          |                                 |       | 1,071      |       |
| Other comprehensive  income                                                                                |   |              |      |                             |       |                   |       |                                         |          |                                 |       | 630        |       |
| Comprehensive income                                                                                       |   |              |      |                             |       |                   |       |                                         |          |                                 |       | 206,676    |       |
| Purchase of  666,714 common shares for treasury                                                            |   |              |      |                             |       |                   |       |                                         |          | (3,402                               | )          | (3,402     | )          |
| Exercise of  stock options and other awards                                                                |   |              |      | (20,236                          | )          | 19,402                 |       |                                         |          | 1,922                                |       | 1,088      |       |
| Issuance of  restricted and unrestricted stock less forfeited shares                                       |   | 49                |      | 16,933                           |       |                   |       |                                         |          | (1,394                               | )          | 15,588     |       |
| Deferred  compensation related to grant of restricted and unrestricted stock less  amortization of $15,643 |   |              |      | 55                               |       |                   |       |                                         |          |                                 |       | 55         |       |
| Net tax effect  from employee stock plans                                                                  |   |              |      | 3,248                            | ** ** |                   | ** ** |                                         | ** **    |                                 | ** ** | 3,248      | ** ** |
| **Balance at September 30, 2002**                                                                          |   | **$**             | **2,911** | ** **                       | **$**      | **—**             | ** ** | **$**                                        | **2,196,807** | ** **                           | **$**      | **10,437** | ** ** | **$** | **(79,391** | **)** | **$** | **2,130,764** | ** ** |

 

See Notes to Condensed Consolidated Financial Statements.

 

5

----

 

**Condensed Consolidated Statements ofCash Flows (unaudited)**

Providian Financial Corporation and Subsidiaries

 
|                                                                                                       |   | **Nine  months ended  September 30,** |    |
|------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|---------|
| **(dollars  in thousands)**                                                                                |   | **2002**                              |    | **2001** |   |
| **Operating Activities**                                                                                   |   |                                  |    |   |   |
| Net Income                                                                                                 |   | $                                     | 206,046 |   | $ | 520,067 |   |
| (Income) loss  from discontinued operations, net of related taxes                                          |   | (67,156                               | )       | 32,353 |   |
| Extraordinary  item – extinguishment of debt, net of related taxes                                    |   | —                                |    | (13,905 | ) |
| Cumulative  effect of change in accounting principle, net of related taxes                                 |   | —                                |    | (1,846 | ) |
| Income from  continuing operations                                                                         |   | 138,890                               |    | 536,669 |   |
| Adjustments to  reconcile income from continuing operations to net cash provided by operating  activities: |   |                                  |    |   |   |
| Provision for  credit losses                                                                               |   | 1,152,830                             |    | 1,330,834 |   |
| Depreciation and  amortization of premises and equipment                                                   |   | 38,255                                |    | 54,079 |   |
| Amortization of  net loan acquisition costs                                                                |   | 31,657                                |    | 44,057 |   |
| Amortization of  deferred compensation related to restricted and unrestricted stock                        |   | 15,643                                |    | 10,303 |   |
| Decrease in  deferred fee revenue                                                                          |   | (215,384                              | )       | (161,247 | ) |
| Decrease in  deferred income tax benefit                                                                   |   | 272,914                               |    | 25,514 |   |
| Decrease in  interest receivable                                                                           |   | 42,873                                |    | 1,721 |   |
| Gain from sale  of interests in Providian Master Trust                                                     |   | (401,903                              | )       | — |   |
| Net decrease  (increase) in other assets                                                                   |   | 34,610                                |    | (306,629 | ) |
| Net (decrease)  increase in accrued expenses and other liabilities                                         |   | (215,262                              | )       | 199,803 |   |
| Net cash  provided by operating activities                                                                 |   | 895,123                               |    | 1,735,104 |   |
|                                                                                                       |   |                                  |    |   |   |
| **Investing Activities**                                                                                   |   |                                  |    |   |   |
| Net cash from  (used for) loan originations and principal collections on loans receivable                  |   | 5,110,684                             |    | (5,844,635 | ) |
| Net (decrease)  increase in securitized loans                                                              |   | (1,867,453                            | )       | 4,587,523 |   |
| Net decrease in  held-to-maturity investment                                                               |   | —                                |    | 686,214 |   |
| Decrease  (increase) in due from securitizations                                                           |   | 453,999                               |    | (792,653 | ) |
| Purchases of  available-for-sale investment securities                                                     |   | (4,506,909                            | )       | (22,916,705 | ) |
| Proceeds from  maturities and sales of investment securities                                               |   | 4,109,078                             |    | 23,123,191 |   |
| Increase in  federal funds sold and securities purchased under resale agreements or  similar arrangements  |   | (2,530,000                            | )       | (2,344,894 | ) |
| Net purchases of  premises and equipment                                                                   |   | —                                |    | (54,883 | ) |
| Net cash  provided (used) by investing activities                                                          |   | 769,399                               |    | (3,556,842 | ) |
|                                                                                                       |   |                                  |    |   |   |
| **Financing Activities**                                                                                   |   |                                  |    |   |   |
| Net (decrease)  increase in deposits                                                                       |   | (2,220,545                            | )       | 2,598,037 |   |
| Proceeds from  issuance of term federal funds                                                              |   | 405,670                               |    | 357,890 |   |
| Repayment of  term federal funds                                                                           |   | (411,339                              | )       | (372,889 | ) |
| Increase in  other short-term borrowings                                                                   |   | —                                |    | 774 |   |
| Repayment of  short-term borrowings                                                                        |   | (111,513                              | )       | — |   |
| Proceeds from  long-term borrowings                                                                        |   | 12,321                                |    | 400,354 |   |
| Repayment of  long-term borrowings                                                                         |   | (6,997                                | )       | (283,954 | ) |
| Purchase of  treasury stock                                                                                |   | (3,402                                | )       | (222,631 | ) |
| Dividends paid                                                                                             |   | —                                |    | (25,685 | ) |
| Proceeds from  exercise of stock options                                                                   |   | 1,088                                 |    | 48,114 |   |
| Net cash (used)  provided by financing activities                                                          |   | (2,334,717                            | )       | 2,500,010 |   |
|                                                                                                       |   |                                  |    |   |   |
| Net cash related  to discontinued operations                                                               |   | 628,188                               |    | (68,888 | ) |
|                                                                                                       |   |                                  |    |   |   |
| **Net (Decrease) Increase in Cash and  Cash Equivalents**                                                  |   | (42,007                               | )       | 609,384 |   |
| Cash and cash  equivalents at beginning of period                                                          |   | 449,586                               |    | 430,554 |   |
| Cash and cash  equivalents at end of period                                                                |   | $                                     | 407,579 |   | $ | 1,039,938 |   |

 

See Notes to Condensed Consolidated Financial Statements.

 

6

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**PROVIDIAN FINANCIAL CORPORATION**

**Notes to Condensed ConsolidatedFinancial Statements**

**September 30, 2002 (unaudited)**

 

**Note 1.  Organization andBasis of Presentation**

 

ProvidianFinancial Corporation (the “Company”) is incorporated under the laws ofDelaware. The Company’s principal wholly owned banking subsidiaries areProvidian National Bank (“PNB”) and Providian Bank (“PB”). Through its bankingsubsidiaries, the Company provides credit card and deposit products in theUnited States. The Company markets consumer loans and deposits usingdistribution channels such as mail, telephone, and the Internet.

 

InNovember 2001, the Company announced that it would discontinue itsoperations in the United Kingdom and Argentina. Accordingly, the assets,liabilities, and operations of these foreign subsidiaries and branches arereflected as discontinued operations on the Company’s condensed consolidatedfinancial statements. The Company completed the sale of its United Kingdomoperations in April 2002 and the sale of its Argentina operations inMay 2002.

 

Theaccompanying unaudited condensed 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 byGAAP for complete consolidated financial statements. In the opinion ofmanagement, all adjustments considered necessary for a fair presentation of theresults for the interim period presented have been included. The preparation offinancial statements in conformity with GAAP requires management to makeestimates and assumptions that affect reported amounts in the financialstatements and accompanying notes. These estimates are based on informationavailable as of the date of the condensed consolidated financial statements.Therefore, actual results could differ from those estimates. Operating resultsfor the three and nine month periods ending September 30, 2002 are notnecessarily indicative of the results for the year ending December 31,2002. The notes to the financial statements contained in our Annual Report onForm 10-K for the year ended December 31, 2001 should be read inconjunction with these condensed consolidated financial statements. Allsignificant intercompany balances and transactions have been eliminated.Certain prior period amounts have been reclassified to conform to the 2002presentation.

 

**Note2.  Finance Charge and Fee Income Recognition**

 

Loans receivable are comprised of amounts duefrom customers for purchase activities, cash advances and finance charges andfees receivable. Estimated uncollectible principal amounts arising frompurchase activities and cash advances are provided for in the allowance forloan losses on the Company's balance sheet. The Company has provided for the estimated uncollectible finance chargesand fees receivable as described in this Note 2.  Historically, the Company’s practice was to recognize income fromfinance charges and fees receivable during the period when the finance chargesand fees accrued as revenue.  Financecharges and fees would continue to be posted to a customer’s account until thecustomer’s account was charged off.  Atthe time an account was charged off, any accrued but unpaid finance charges andfees, including finance charges and fees accrued in prior periods, would berecorded as a reduction to finance charge and fee income in the period in whichthe account was charged off.

 

7

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*Creation of a ValuationAllowance for Estimated Uncollectible Fees on Certain Past Due Loans*

 

In the third quarter of 2000, due to an increasein the Company’s portfolio mix of higher risk loans that carried higherbalances of fees combined with higher loss experience, the Company establisheda valuation allowance for the estimated uncollectible portion of fees posted tocustomer accounts in its reported loans. The valuation allowance for estimated uncollectible fees was establishedfor reported loans in the higher risk standard and middle segments of thereported loan portfolio that were 90 or more days delinquent.  Upon adoption at the beginning of the thirdquarter of 2000, the amount of this allowance was set at $95.2 million for feesposted to customer accounts prior to the beginning of the quarter.  By the end of the third quarter of 2000, theCompany added $12.3 million to the allowance for fees posted during thequarter, bringing the total allowance for estimated uncollectible fees to$107.5 million at the end of the third quarter of 2000.  When the estimated uncollectible fees wererecorded as a valuation allowance, loans receivable on the balance sheet andcredit product fee income on the income statement were each reduced by $107.5million for the third quarter of 2000.

 

From the end of the third quarter of 2000 throughthe end of the second quarter of 2001, the Company maintained the valuationallowance for estimated uncollectible fees on the standard and middle segmentsof the reported loan portfolio that were 90 or more days delinquent at levelscommensurate with the Company’s evaluation of the risk of the uncollectibilityof such fees, ending the second quarter of 2001 with a valuation allowance forestimated uncollectible fees of $103.1 million.

 

*Expansion of Valuation Allowance to Include EstimatedUncollectible Fees, and Creation of Valuation Allowance for EstimatedUncollectible Finance Charges, on All Loans 90 or More Days Past Due*

 

During the third quarter of 2001, due todeterioration in the underlying credit characteristics of the loan portfolioand increased loss experience, combined with an increase in the portion ofincome represented by fees and the change in the portfolio loan mix towardloans that generated higher levels of fees, the Company expanded the valuationallowance for estimated uncollectible fees to include all segments of thereported loan portfolio that were 90 or more days delinquent.  In addition, the Company established avaluation allowance for the estimated uncollectible portion of accrued financecharges on all reported loans that were 90 or more days delinquent.

 

As a result of the change during the third quarter of 2001 to includeall reported loan segments that were 90 or more days delinquent in thevaluation allowance for estimated uncollectible fees, the Company increased thevaluation allowance for estimated uncollectible fees by $21.3 million.  In addition, the Company increased the valuation allowance foruncollectible fees by an additional $4.9 million at the end of the thirdquarter of 2001 to reflect changes in the loan portfolio during the quarter,bringing the total increase during the quarter to $26.2 million, and ended thequarter with a total valuation allowance for estimated uncollectible fees of$129.4 million.  As a result of theseincreases in the valuation allowance for estimated uncollectible fees, loansreceivable on the balance sheet and credit product fee income on the incomestatement were each reduced by $26.2 million during the third quarter of 2001.

 

Upon creation during the third quarter of 2001 of the valuationallowance for the estimated uncollectible portion of accrued finance charges onreported loans that were 90 or more days delinquent, the amount of theallowance was established at $63.7 million. This resulted in a

 

8

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$63.7 million reduction in loans receivable on the balance sheet and ininterest**income—loanson the income statement for the third quarter of 2001.

 

*Expansion of Finance Charge and Fee Valuation Allowances toCover All Loans*

 

During the fourth quarter of 2001, the Company increased the valuationallowances for estimated uncollectible finance charges and fees to include allreported loans, including those that were less than 90 days delinquent.  This expansion of the valuation allowancesresulted from the Company’s assessment of an increased risk of uncollectibilitybased on further changes in the composition of and deterioration in the loanportfolio and continued weakening of the economic environment, and was madeafter discussions between the Company’s banking subsidiaries and theirregulators and in conjunction with the development of their Capital Plans.  See “—Our Capital Plan and Other RegulatoryMatters” in the Company’s 2001 Annual Shareholders Report.

 

As a result of the change to include the estimated uncollectibleportion of accrued finance charges on all reported loans, the Company increasedthe valuation allowance for estimated uncollectible finance charges by $122.4million during the fourth quarter of 2001. In addition, the Company reduced the valuation allowance foruncollectible finance charges by $0.7 million at the end of the fourth quarterof 2001 to reflect changes in the loan portfolio during the quarter, bringingthe total net increase during the quarter to $121.7 million, and ended thequarter with a total valuation allowance for estimated uncollectible financecharges of $185.4 million.  As a result,loans receivable on the balance sheet was reduced by $94.8 million, interestreceivable on the balance sheet was reduced by $26.9 million and interestincome—loans on the income statement was reduced by $121.7 million during thefourth quarter of 2001.

 

As a result of the change to include the estimated uncollectible portionof accrued fees on all reported loans, the Company increased the valuationallowance for estimated uncollectible fees by $189.7 million during the fourthquarter of 2001.  In addition, theCompany reduced the valuation allowance for uncollectible fees by $8.4 millionat the end of the fourth quarter of 2001 to reflect changes in the loanportfolio during the quarter, bringing the total net increase during thequarter to $181.3 million, and ended the quarter with a total valuationallowance for estimated uncollectible fees of $310.7 million.  As a result, loans receivable on the balancesheet and credit product fee income on the income statement were each reducedby $181.3 million during the fourth quarter of 2001.

* *

*Change in Methodology from Valuation Allowances forEstimated Uncollectible Finance Charges and Fees to Accrual of Only EstimatedCollectible Finance Charges and Fees*

 

Beginning on January 1, 2002, the Companymodified the accounting entries made so that, rather than maintaining valuationallowances for the estimated uncollectible portion of finance charges and feeson its reported loans, it would instead recognize only those finance chargesand fees that it estimates will be collectible.  This change, which was made after discussions between theCompany’s banking subsidiaries and their regulators and in conjunction with thedevelopment of their Capital Plans, was based on the Company’s evaluation ofits loan portfolio.  See “—Our CapitalPlan and Other Regulatory Matters” in the Company’s 2001 Annual ShareholdersReport.  As a result of this change, thepreviously established valuation allowances for uncollectible finance chargesand fees were depleted during the first two quarters of 2002 as the

 

9

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Company experienced charge-offs of the loans forwhich the valuation allowances were established.

 

Under the new methodology instituted at thebeginning of 2002 (the “suppression methodology”), finance charges and feesthat would otherwise accrue on reported loans, but that the Company estimateswill not be collected (the “suppressed amounts”), are not recognized as interestincome—loans or credit product fee incomeon the income statement and are not included in interest receivable or loansreceivable on the balance sheet.

 

With the suppression methodology, the Companycontinues to use the same types of analyses (based on projected credit lossrates, delinquency status and historical loss experience) to estimate thesuppressed amounts as it previously did to estimate uncollectible amounts underthe valuation allowance methodology. Accordingly, the change from a valuation methodology to a suppressionmethodology is not expected to materially impact the Company’s income.

 

As a result of this change in methodology, at theend of the first quarter of 2002, $126.3 million of finance charges that wouldhave accrued during the quarter had the Company not estimated them to beuncollectible were suppressed and therefore were not recognized as interestincome—loans on the income statement and were not included in loans receivableor interest receivable on the balance sheet. Similarly, at the end of the first quarter of 2002, $155.9 million offees that would have accrued during the quarter had the Company not estimatedthem to be uncollectible were suppressed and therefore were not recognized ascredit product fee income on the income statement and were not included inloans receivable on the balance sheet. Under the valuation allowance methodology, the amounts included in thevaluation allowances for estimated uncollectible finance charges and fees wouldhave been substantially the same.

 

*Expansion of Suppression Methodology to Include AmountsExpected to Become Uncollectible Due to Customer Bankruptcies*

 

During the second quarter of 2002, due to thecontinuation of high levels of customer bankruptcies and the impact of suchbankruptcies on the collectibility of finance charges and fees, the Companybegan to include in its estimated uncollectible finance charges and fees anestimate for amounts expected to charge off due to customer bankruptcies,regardless of delinquency status. Beginning on June 30, 2002, the additional estimated amounts associatedwith customer bankruptcies were included in the suppressed amounts.  Prior to the second quarter of 2002, theCompany’s estimates focused on delinquency roll rates (the percentage ofcustomers whose delinquency status worsens from month to month) and the Companydid not include separate amounts in its estimates based on loansexpected to charge off due to bankruptcy.

 

As a result of the change during the second quarter of 2002 to includeexpected customer bankruptcies in the estimate used for suppressing financecharges, the Company increased the amount of suppressed finance charges by$22.0 million.  In addition, the Companyincreased the amount of suppressed finance charges by an additional $16.2million at the end of the second quarter of 2002 to reflect changes in the loanportfolio during the quarter, including changes in asset mix. This brought thetotal increase in the amount of suppressed finance charges during the quarterto $38.2 million, and the Company ended the quarter with total suppressedfinance charges of $164.5 million.  As aresult of changes affecting the suppressed amount of finance charges, loansreceivable on the balance sheet was reduced by $43.5 million, interestreceivable on the balance sheet was reduced by $5.3 million, and interestincome—loans on the income

10

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statement was reduced by $38.2 million during the second quarter of2002. The negative impact of the increase in suppressed amounts was, however,offset by the positive impact of reductions in our previously establishedvaluation allowances, as shown in the table below.

 

As a result of the change during the second quarter of 2002 to includeexpected customer bankruptcies in the estimate used for suppressing fees, theCompany increased the amount of suppressed fees by $34.9 million.  In addition, the Company increased theamount of suppressed fees by an additional $7.2 million at the end of thesecond quarter of 2002 to reflect changes in the loan portfolio during thequarter, including changes in asset mix. This brought the total increase in theamount of suppressed fees during the quarter to $42.1 million, and the Companyended the quarter with total suppressed fees of $198.0 million.  As a result of the changes affecting thesuppressed amount of fees, loans receivable on the balance sheet and creditproduct fee income on the income statement were each reduced by $42.1 millionduring the second quarter of 2002. The negative impact of the increase insuppressed amounts was, however, offset by the positive impact of reductions inour previously established valuation allowances, as shown in the table below.

 

The following tables set forth (a) the allowancesfor uncollectible finance charges and fees for the Company’s reported loanportfolio beginning with the third quarter of 2000 through the second quarterof 2002 and (b) the total amounts of finance charges and fees suppressed fromloans receivable and interest receivable as of each quarter end beginning withthe first quarter of 2002.  For thefirst half of 2002, the Company maintained both valuation allowances forfinance charges and fees accrued through December 31, 2001 and suppressedamounts for finance charges and fees accrued after that date.  During the period when the Companymaintained both methodologies, the total amount of finance charges and feesestimated to be uncollectible each quarter is equal to the sum of the valuationallowance plus the suppressed amount. Accordingly, the impact of changes inestimates on the Company’s income is equal to the net change in the combinedvaluation allowance and suppressed amount from quarter to quarter, as shownbelow.

 

**Estimated Uncollectible Finance Chargeand Fee Valuation Allowances(dollars in millions)**

 

|               |   | **Finance Charge  Valuation  Allowance** |   | **Fee  Valuation  Allowance** |   | **Total  Valuation  Allowance** |   |
|--------------------|--------|------------------------------------------|--------|-------------------------------|--------|---------------------------------|--------|
| July 1, 2000       |   | $                                        | — |                          | $      | 95.2                            |   | $ | 95.2 |   |
| September 30, 2000 |   | —                                   |   | 107.5                         |   | 107.5                           |   |
| December 31, 2000  |   | —                                   |   | 112.5                         |   | 112.5                           |   |
| March 31, 2001     |   | —                                   |   | 119.1                         |   | 119.1                           |   |
| June 30, 2001      |   | —                                   |   | 103.1                         |   | 103.1                           |   |
| September 30, 2001 |   | 63.7                                     |   | 129.4                         |   | 193.1                           |   |
| December 31, 2001  |   | 185.4                                    |   | 310.7                         |   | 496.1                           |   |
| March 31, 2002     |   | 45.9                                     |   | 71.3                          |   | 117.2                           |   |
| June 30, 2002      |   | —                                   |   | —                        |   | —                          |   |
|                    |        |                                          |        |                               |        |                                 |        |  |  |  |

 

**EstimatedUncollectible Finance Charge and Fee Suppressions**

**(dollars in millions)**

 
|               |   | **Finance Charge  Suppression** |   | **Fee  Suppression** |   | **Total  Suppression** |   |
|--------------------|--------|---------------------------------|--------|----------------------|--------|------------------------|--------|
| December 31, 2001  |   | $                               | — |                 | $      | —                 |   | $ | — |   |
| March 31, 2002     |   | 126.3                           |   | 155.9                |   | 282.2                  |   |
| June 30, 2002      |   | 164.5                           |   | 198.0                |   | 362.5                  |   |
| September 30, 2002 |   | 177.0                           |   | 205.6                |   | 382.6                  |   |
|                    |        |                                 |        |                      |        |                        |        |  |  |  |

 

The following table summarizes the finance charges and fees that wouldhave accrued during the nine months ended September 30, 2002 had the Companynot estimated them to be uncollectible and therefore suppressed them fromincome:

 

**EstimatedUncollectible Finance Charge and Fee Suppressions from Income**

**(dollarsin millions)**

 
| **Three months ending** |   | **Finance  Charge  Suppression** |   | **Fee  Suppression** |   | **Total  Suppression** |   |
|-------------------------|--------|----------------------------------|--------|----------------------|--------|------------------------|--------|
| March 31, 2002          |   | $                                | 157.4  |                 | $      | 184.0                  |   | $ | 341.4 |   |
| June 30, 2002           |   | 145.9                            |   | 193.2                |   | 339.1                  |   |
| September 30, 2002      |   | 147.9                            |   | 188.4                |   | 336.3                  |   |
|                    |   | $                                | 451.2  |                 | $      | 565.6                  |   | 1,016.8 |   |
|                         |        |                                  |        |                      |        |                        |        |  |  |  |  |

 

 

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**Note 3.  Loans Receivableand Allowance for Credit Losses**

 

The following is a summary of loans receivable at September 30, 2002and December 31, 2001:

 

| **(dollars  in thousands)**  |   | **September  30,  2002** |      | **December  31,  2001** |   |
|------------------------------|--------|--------------------------|-----------|-------------------------|--------|
| Credit cards                 |   | $                        | 7,678,314 |                    | $      | 11,498,974 |   |
| Other                        |   | 19,462                   |      | 60,166                  |   |
| Allowance for  credit losses |   | (1,172,838               | )         | (1,932,833              | )      |
|                         |   | $                        | 6,524,938 |                    | $      | 9,626,307 |   |

 

The activity in the allowance for credit losses for the three and ninemonths ended September 30, 2002 and 2001 is as follows:

 
|                                                   |   | **Three months ended September 30,** |      | **Nine months ended September 30,** |   |
|--------------------------------------------------------|--------|--------------------------------------|-----------|-------------------------------------|--------|
| **(dollars in thousands)**                             |   | **2002**                             |      | **2001**                            |   | **2002** |   | **2001** |   |
|                                                   |   |                                 |      |                                |   |   |   |   |   |
| Balance  at beginning of period                        |   | $                                    | 1,224,901 |                                | $      | 1,507,118 |   | $ | 1,932,833 |   | $ | 1,436,004 |   |
| Provision  for credit losses                           |   | 192,366                              |      | 549,923                             |   | 764,600 |   | 1,330,834 |   |
| Fair  value adjustment – loans available for sale |   | —                               |      | —                              |   | 388,230 |   | — |   |
| Credit  losses                                         |   | (278,437                             | )         | (408,918                            | )      | (1,035,763 | ) | (1,191,567 | ) |
| Recoveries                                             |   | 34,008                               |      | 32,724                              |   | 108,881 |   | 105,572 |   |
| Transfer  of loans to available for sale               |   | —                               |      | —                              |   | (985,943 | ) | — |   |
| Other                                                  |   | —                               |      | —                              |   | — |   | 4 |   |
| Balance  at end of period                              |   | $                                    | 1,172,838 |                                | $      | 1,680,847 |   | $ | 1,172,838 |   | $ | 1,680,847 |   |

 

The Company in the past charged off loans no later than 180 days afterthey became contractually past due.  Inthe first quarter of 2002, the Company accelerated its recognition ofcharge-offs for loans that are restructured under its consumer debt managementprogram, substantially all of which are loans under consumer credit counselingservice programs through which customers establish a plan to repay theiroutstanding balances under agreed upon-terms. These loans are subsequentlycharged off no later than 120 days after they become contractually past due. Asa result of this change, the Company recorded a provision for credit losses andan offsetting decrease to loans receivable of approximately $2.9 million duringthe first quarter of 2002.  In addition,in the third quarter of 2002, the Company accelerated its recognition of charge-offsfor certain customers who had activated Credit Protection due to death.  As a result, the Company charged offbalances of approximately $3.6 million relating to these accounts.

 

Beginning in the fourth quarter of 2002, the Company began to recognizeprincipal charge-offs by the end of the calendar month in which the relatedaccount became 180 days contractually past due.  However, for deceased customers, including customers who haveactivated Credit Protection, the Company has adopted a change to recognizecharge-offs within 60 days of verification of death.  This policy is being implemented with respect to verifications ofdeath received on or after November 1, 2002. For verifications received prior to November 1, 2002, the Company willbe recognizing charge-offs during the remainder of 2002 and the first quarterof 2003, in no event later than the month in which the account becomes 180 dayscontractually delinquent.  While thesechanges to the timing of charge-off recognition may modestly affect the levelof charge-offs, we do not currently expect the impact of these changes tomaterially affect our financial results.

 

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**Note 4.  Asset Sales**

 

On February 5, 2002, the Company sold its interests in the ProvidianMaster Trust, which primarily consisted of $1.4 billion of loans receivable and$472 million of retained subordinated interests held by PNB. As of the date ofsale, the Providian Master Trust contained nearly $8 billion of loansreceivable arising from approximately 3.3 million active credit card accounts.This transaction resulted in cash proceeds of approximately $2.8 billion and afirst quarter after-tax gain of approximately $242 million included innon-interest income.  Under an interimservicing agreement entered into at the time of the sale, the Company continuedto service this portfolio, receiving servicing revenue and incurring servicingexpense, until the transfer of servicing in August 2002.  In the third quarter of 2002, in connection withthe final settlement of the interim servicing agreement, the Company recognized$6.8 million in servicing revenue due to termination of the interim servicingearlier than anticipated.

 

On February 28, 2002, the Company agreed with investors to terminate asecuritization transaction that funded approximately $410 million ofreceivables arising from a portfolio of accounts acquired in 1998.Substantially all of these receivables were included in the structured sale ofthe $2.4 billion higher risk asset portfolio that was completed on June 25, 2002.

 

On April 19, 2002, the Company completed the sale of its United Kingdomoperations. The sale included facilities in London and Crawley, England. Thissale generated a second quarter 2002 gain of $95.6 million on proceeds of over$600 million.

 

On May 10, 2002, the Company completed the sale of its Argentinaoperations, including Providian Financial S.A. and Providian Bank S.A. Theconsummation of this transaction resulted in a gain of $8.0 million during thesecond quarter of 2002. During the fourth quarter of 2001, we had recognized$133 million in charges primarily related to the estimated losses from thedevaluation of the Argentine Peso and the reclassification of the Argentineoperations as a discontinued operation.

 

On June 25, 2002, the Company completed the structured sale of the $2.4billion higher risk asset portfolio transferred to loans held for sale duringthe first quarter of 2002. In addition to a provision for loan losses of $388million to adjust the portfolio to fair value and $15 million in relatedtransaction expenses during the first quarter of 2002, the Company recognized aloss in the second quarter of 2002 of $4.5 million related to the reduction incarrying value of the receivables and related transaction costs. In October2002, $11.0 million in original face amount of the BB-/Ba2 rated certificatesoriginally held by a limited liability subsidiary of PNB was sold at par to athird party. In October 2002, servicing for this portfolio was transferred fromPNB to Cardholder Management Services, LLP, an affiliate of Cardworks, Inc.,and CompuCredit Corporation.

 

**Note 5.  Decommissioning ofFacilities**

 

In a continuation of its efforts to align itsoperations infrastructure with its ongoing business, on July 30, 2002 theCompany announced the closure of its facilities in Sacramento, California,Fairfield, California and Salt Lake City, Utah.  In the third quarter of 2002, the Company completed the closureof its Sacramento facility, and the closures of its Fairfield and Salt LakeCity facilities are scheduled to be completed in the fourth quarter of2002.  During the second quarter of

 

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2002, the Company recognized a $37.9 millioncharge related to the decommissioning of facility equipment and furniture leaseexpenses, fixed asset write–downs, and disposal costs. In addition to the$16.7 million workforce reduction charge taken during the first quarter of2002, the Company recognized approximately $9.6 million in severance andbenefit expenses during the third quarter of 2002.

 

**Note 6.  Income Taxes**

 

On September 11, 2002, California enacted a law requiring large banks(those with average assets in excess of $500 million) to conform to federal taxlaw with respect to accounting for bad debts. Before the change, all banks,regardless of size, were eligible to use the reserve method of accounting forbad debts, which enabled them to take deductions for California tax purposes atthe time the bad debt reserves were established. As a result of the change,large banks may now deduct only the actual charge-offs, net of recoveries, indetermining their California taxable income, and must include in taxable income50% of the bad debt reserves existing as of the end of the prior tax year.  As a concession to the banks that aresubject to the new law, the State of California has waived recapture of theremaining 50% of the reserves.  Theeffect of this concession was to create a non-recurring tax benefit for theCompany in the amount of $30.0 million, which has been reflected in theCompany’s income tax expense for the quarter ended September 30, 2002.

 

**Note 7.  DiscontinuedOperations**

 

Pursuantto Statement of Financial Accounting Standards (“SFAS”) No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets,” which theCompany early adopted in the fourth quarter of 2001, the Company reclassifiedthe balances relating to its United Kingdom and Argentina operations on itscondensed consolidated financial statements to reflect the anticipateddisposition of these operations. The revenues, costs and expenses, assets andliabilities, and cash flows of these operations have been segregated in thecondensed consolidated statements of income, statements of financial condition,and statements of cash flows for all periods presented and have been separatelyreported as “discontinued operations.”

 

Sales of our discontinued operations in the UnitedKingdom and Argentina were finalized during the second quarter of 2002, andthere were no results from discontinued operations in the third quarter of2002. The loss from discontinued operations in the third quarter of 2001 was$14.8 million. For the nine months ended September 30, 2002, income fromdiscontinued operations was $67.2 million, compared to a loss of$32.4 million for the first nine months of 2001. The increase during 2002is primarily due to a pre-tax gain of $95.6 million from the sale of theUnited Kingdom operations and a pre-tax gain of $8.0 million from the saleof our Argentina operations during the second quarter of 2002.

 

The following is a summary of the income (loss) from discontinuedoperations:

 

14

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|                                                             |   | **Three months ended September 30,** |   | **Nine months ended September 30,** |   |
|------------------------------------------------------------------|--------|--------------------------------------|--------|-------------------------------------|--------|
| **(dollars in thousands)**                                       |   | **2002**                             |   | **2001**                            |   | **2002** |   | **2001** |   |
| Income  (loss) from discontinued operations before related taxes |   | $                                    | — |                                | $      | (24,450 | ) | $ | 111,002 |   | $ | (53,476 | ) |
| Less  related tax expense (benefit)                              |   | —                               |   | (9,658                              | )      | 43,846 |   | (21,123 | ) |
| Income  (loss) from discontinued operations net of related taxes |   | $                                    | — |                                | $      | (14,792 | ) | $ | 67,156 |   | $ | (32,353 | ) |

 

**Note 8.  Extraordinary Item– Extinguishment of Debt**

 

During the nine months ended September 30, 2002,the Company did not record any extraordinary items. In the third quarter of2001, the Company repurchased and retired $57.2 million in principal amount ofits 3.25% convertible senior notes due August 15, 2005, $12.5 million inprincipal amount at maturity of its zero coupon convertible notes due February15, 2021, and $4.6 million in principal amount of its capital securities. Thesenotes and securities were purchased at an aggregate price of $44.5 million plusaccrued interest, or $23.0 million below their aggregate carrying values. Thegain related to these repurchases was recorded, net of taxes, as anextraordinary item in the Company’s consolidated statements of income.  The Company will adopt the provisions ofSFAS 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASBStatement No. 13, and Technical Corrections,” related to the rescission of SFAS4, “Reporting Gains and Losses from Extinguishment of Debt, an Amendment of APBOpinion No. 30,” in its December 31, 2002 financial statements, and thegain on extinguishment of debt that has been classified as an extraordinary itemwill be reclassified to non-interest income.

 

**Note 9.  Cumulative Effectof Change in Accounting Principle – Derivative Instruments**

 

OnJanuary 1, 2001, the Company adopted SFAS No. 133, “Accounting forDerivative Instruments and Hedging Activities,” as amended. SFAS No. 133requires that all derivative instruments be reported in the statement offinancial condition at fair value and establishes criteria for designatingvarious types of hedging activities. In accordance with SFAS No. 133, theCompany reported a transition adjustment upon the adoption of the standard torecognize its derivatives at fair value and to recognize the difference(attributable to hedged risks) between the carrying values and the fair valuesof related hedged assets and liabilities. The effect of this transitionadjustment was to increase reported income during the first quarter of 2001 by$1.8 million, net of related taxes.

 

**Note 10.  Earnings perCommon Share**

 

The following table sets forth the computation of both basic anddiluted earnings per common share: 

 

15

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|                                                                          |   | **Three months ended September 30,** |   | **Nine months ended September 30,** |   |
|-------------------------------------------------------------------------------|--------|--------------------------------------|--------|-------------------------------------|--------|
| **(in thousands, except per share  data)**                                    |   | **2002**                             |   | **2001**                            |   | **2002** |   | **2001** |   |
| **Basic**                                                                     |   |                                 |   |                                |   |   |   |   |   |
| Income from continuing  operations                                            |   | $                                    | 42,125 |                                | $      | 58,130 |   | $ | 138,890 |   | $ | 536,669 |   |
| Income (loss) from  discontinued operations - net of related taxes            |   | —                               |   | (14,792                             | )      | 67,156 |   | (32,353 | ) |
| Extraordinary item  extinguishment of debt - net of related taxes             |   | —                               |   | 13,905                              |   | — |   | 13,905 |   |
| Cumulative effect of  change in accounting principle - net of related taxes   |   | —                               |   | —                              |   | — |   | 1,846 |   |
| Net income  available to common shareholders                                  |   | $                                    | 42,125 |                                | $      | 57,243 |   | $ | 206,046 |   | $ | 520,067 |   |
|                                                                          |   |                                 |   |                                |   |   |   |   |   |
| Weighted average  common shares outstanding                                   |   | 285,323                              |   | 283,864                             |   | 284,649 |   | 284,542 |   |
| Earnings per  common share:                                                   |   |                                 |   |                                |   |   |   |   |   |
| Income from  continuing operations                                            |   | $                                    | 0.15   |                                | $      | 0.20 |   | $ | 0.49 |   | $ | 1.89 |   |
| Income (loss)  from discontinued operations - net of related taxes            |   | —                               |   | (0.05                               | )      | 0.23 |   | (0.12 | ) |
| Extraordinary  item extinguishment of debt - net of related taxes             |   | —                               |   | 0.05                                |   | — |   | 0.05 |   |
| Cumulative  effect of change in accounting principle - net of related taxes   |   | —                               |   | —                              |   | — |   | 0.01 |   |
| Net income per  common share                                                  |   | $                                    | 0.15   |                                | $      | 0.20 |   | $ | 0.72 |   | $ | 1.83 |   |
|                                                                          |   |                                 |   |                                |   |   |   |   |   |
| **Diluted**                                                                   |   |                                 |   |                                |   |   |   |   |   |
| Income from  continuing operations                                            |   | $                                    | 42,125 |                                | $      | 58,130 |   | $ | 138,890 |   | $ | 536,669 |   |
| Plus:    Income impact of dilutive assumed  conversions        |   |                                 |   |                                |   |   |   |   |   |
| Interest on  3.25% convertible senior notes - net of related taxes            |   | 1,688                                |   | 1,966                               |   | 5,063 |   | 5,923 |   |
| Income from  continuing operations with assumed conversions                   |   | 43,813                               |   | 60,096                              |   | 143,953 |   | 542,592 |   |
| Income (loss)  from discontinued operations - net of related taxes            |   | —                               |   | (14,792                             | )      | 67,156 |   | (32,353 | ) |
| Extraordinary  item extinguishment of debt - net of related taxes             |   | —                               |   | 13,905                              |   | — |   | 13,905 |   |
| Cumulative  effect of change in accounting principle - net of related taxes   |   | —                               |   | —                              |   | — |   | 1,846 |   |
| Net income  available to common shareholders - with assumed conversions       |   | $                                    | 43,813 |                                | $      | 59,209 |   | $ | 211,109 |   | $ | 525,990 |   |
| Weighted average  common shares outstanding                                   |   | 285,323                              |   | 283,864                             |   | 284,649 |   | 284,542 |   |
| Plus:    Incremental shares from dilutive assumed  conversions |   |                                 |   |                                |   |   |   |   |   |
| Restricted stock  issued – non vested                                    |   | 3,647                                |   | 875                                 |   | 4,103 |   | 764 |   |
| Employee stock  options                                                       |   | 150                                  |   | 4,439                               |   | 209 |   | 5,953 |   |
| 3.25%  convertible senior notes                                               |   | 4,974                                |   | 5,787                               |   | 4,974 |   | 5,817 |   |
| Dilutive  potential common shares                                             |   | 8,771                                |   | 11,101                              |   | 9,286 |   | 12,534 |   |
| Adjusted  weighted average common shares                                      |   | 294,094                              |   | 294,965                             |   | 293,935 |   | 297,076 |   |
| Earnings per  common share:                                                   |   |                                 |   |                                |   |   |   |   |   |
| Income from  continuing operations                                            |   | $                                    | 0.15   |                                | $      | 0.20 |   | $ | 0.49 |   | $ | 1.83 |   |
| Income (loss)  from discontinued operations - net of related taxes            |   | —                               |   | (0.05                               | )      | 0.23 |   | (0.12 | ) |
| Extraordinary  item extinguishment of debt - net of related taxes             |   | —                               |   | 0.05                                |   | — |   | 0.05 |   |
| Cumulative  effect of change in accounting principle - net of related taxes   |   | —                               |   | —                              |   | — |   | 0.01 |   |
| Net income per  common share                                                  |   | $                                    | 0.15   |                                | $      | 0.20 |   | $ | 0.72 |   | $ | 1.77 |   |

 

**Note 11.  Cumulative OtherComprehensive Income**

 

The components of cumulative other comprehensive income for the ninemonths ended September 30, 2002 and 2001 are as follows:

 
| **(dollars  in thousands)**    |   | **Unrealized    Gain (Loss)  on Securities** |   | **Foreign   Currency  Translation** |   | **Cumulative  Other  Comprehensive  Income** |   |
|--------------------------------|--------|----------------------------------------------|--------|-------------------------------------|--------|----------------------------------------------|--------|
| Balance at  December 31, 2000  |   | $                                            | 21,513 |                                | $      | (421                                         | )      | $ | 21,092 |   |
| Other  comprehensive income    |   | (11,465                                      | )      | (3,698                              | )      | (15,163                                      | )      |
| Tax benefit  (expense)         |   | 4,776                                        |   | 1,455                               |   | 6,231                                        |   |
| Balance at  September 30, 2001 |   | $                                            | 14,824 |                                | $      | (2,664                                       | )      | $ | 12,160 |   |
|                           |   |                                         |   |                                |   |                                         |   |
| Balance at  December 31, 2001  |   | $                                            | 10,878 |                                | $      | (1,071                                       | )      | $ | 9,807 |   |
| Other  comprehensive income    |   | (729                                         | )      | 1,771                               |   | 1,042                                        |   |
| Tax benefit  (expense)         |   | 288                                          |   | (700                                | )      | (412                                         | )      |
| Balance at  September 30, 2002 |   | $                                            | 10,437 |                                | $      | —                                       |   | $ | 10,437 |   |

 

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**Note 12.  Loans Held ForSecuritization or Sale**

 

On September 30, 2002, the Company transferred $500 million of loans,at the lower of cost or fair value, to loans held for securitization or sale.On October 30, 2002, the transferred loans were sold, in connection with a newconduit securitization in the Providian Gateway Master Trust, and removedentirely from the Company’s condensed consolidated statements of financialcondition.

 

**Note 13.  Commitments andContingencies**

 

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 Companybelieves that it has substantive defenses and intends to defend the actionsvigorously, it cannot predict the ultimate outcome or the potential futureimpact on the Company of such actions. The Company does not presently expect any of the actions affecting it tohave a material adverse effect on its financial condition or results ofoperations, but it cannot give any assurance that they will not have such aneffect.  For more detailed informationon legal proceedings affecting the Company, see “Legal Proceedings” in Item 1of Part II of this Quarterly Report on Form 10-Q.

 

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**Item 2.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

This discussion is intended tofurther the reader’s understanding of the consolidated financial condition andresults of operations of our company. It should be read in conjunction with ourhistorical financial statements included in this Quarterly Report and with theinformation in our Annual Report on Form 10-K for the year endedDecember 31, 2001. Our historical financial statements may not beindicative of our future performance. Certain prior period amounts included inthe tables herein have been reclassified to conform to the 2002 presentation,which excludes our discontinued operations in the United Kingdom and Argentina.

 

*Introduction and Recent Developments*

 

Through our subsidiaries weprovide credit card and deposit products to customers throughout the UnitedStates. Our lending and deposit taking activities are conducted primarilythrough Providian National Bank (“PNB”) and Providian Bank (“PB”). ProvidianBancorp Services (“PBS”) performs a variety of servicing activities in supportof PNB, PB and other affiliates.

 

We generate revenue primarilythrough finance charges assessed on outstanding loan balances, through feespaid by customers related to account usage and performance (such as late,overlimit, cash advance, processing, and annual membership fees), and from thesale of various cardholder service products. We receive interchange fees frombankcard associations based on the purchase activity of our credit cardcustomers. In addition, we earn revenue on our investments held for liquiditypurposes and servicing fees and excess servicing on securitized loans.

 

Our primary expenses are assetfunding costs (including interest), credit losses, operating expenses(including salary and employee benefit costs, advertising and solicitationcosts, and data processing and communication costs), and income taxes.

 

*Accounting Policies.*  Ourfinancial statements are prepared in accordance with GAAP. Our key accountingpolicies are summarized in “Overview of Significant Accounting Policies” in ourannual report to shareholders included in Exhibit 13 of our 2001 AnnualReport on Form 10-K for the year ended December 31, 2001 (the “2001Annual Shareholders Report”). In addition, our accounting policies regardingthe recognition of finance charges and fees, and the changes that have occurredwith respect thereto, are further clarified in Note 2 of the Notes to CondensedConsolidated Financial Statements in Item 1 of Part I of this Quarterly Reporton Form 10-Q.

 

*Managed Financial Information.*  Weservice (or manage) the loans that we own and the loans that we have soldthrough our securitizations. Loans that have been securitized are notconsidered to be our assets under GAAP and, therefore, are not shown on ourbalance sheet. However, we typically retain interests in the securitized loanpools, and thus we still have a financial interest in and exposure to theperformance of the securitized loans. These retained interests include a“seller’s interest” (which is generally equal to the total amount of loansincluded in the securitization less all investor securities issued),subordinated investor securities retained by us, and “interest-only strips” thatare subordinate to the interests of investors. Interest-only strips representthe present value of the estimated cash flow from finance charge and feerevenue less amounts paid to investors, related credit losses, servicing feesand other transaction expenses. See “—Managed Consumer Loan Portfolio and theImpact of Securitization—Financial Statement Impact.” To the extent actualcredit losses on a securitized portfolio exceed the estimates used to

 

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calculate the present value of the relatedinterest-only strip or other retained subordinated interest, the value of suchinterest-only strip or other retained subordinated interest would be adjusteddownward to reflect the reduced present value of the expected cash flows, and acharge against earnings would be taken. Conversely, to the extent actual creditlosses are less than the estimates, the values would be adjusted upward.

 

Because the securitized loanscontinue to affect future cash flows, it is our practice to analyze ourfinancial performance on a “managed” basis. “Managed” financial information isadjusted financial information that includes the impact of securitized loanbalances, credit losses related to those securitized loans, and the relatedfinance charge and fee income on key aspects of our GAAP-basis financialinformation, such as net interest income and credit losses. To analyze ourbusiness on a managed basis, we use key performance measures such as themanaged delinquency rate, managed credit loss rate and managed net interestmargin. Managed financial information is not GAAP compliant, does not reverseall of the changes in our financial statements that result from securitizations(for example, gain on sale and allowance for credit losses), and is not meantto be a comprehensive restatement of our financial statements.

 

Managed loan performance will notalways coincide with reported loan performance, because the relative portionsof total managed loans represented by reported and securitized loans will varyover time, and reported and securitized loans may have different creditcharacteristics and perform differently over time. For example, during thefirst quarter of 2002, we sold our interests in the Providian Master Trust andin connection with such sale transferred our interests in the related loans.Because substantially all of the loans included in the Providian Master Trustwere securitized, the sale of our interests in the Providian Master Trust had agreater effect on managed loan performance. In contrast, the sale of the higherrisk asset portfolio in the second quarter of 2002 had a greater effect onreported loan performance, because we had owned those assets and included themin reported loans.

 

*Funding.*  We fund our business through avariety of funding sources. The majority of our funding is provided bydeposits, securitizations and debt issuances. The deterioration of ourfinancial performance and asset quality and downgrades by credit ratingagencies since our third quarter 2001 earnings announcement have adverselyaffected our ability to obtain additional securitization funding and borrowfunds from other sources, and our Capital Plan contemplates a reduction ininsured deposits. These developments have resulted in an increase in our costof funds relative to our historical levels. For a more detailed discussion ofour funding program, see “—Funding and Liquidity.”

 

*Capital Plans and Related Regulatory Matters.*  Ourbanking subsidiaries have entered into written agreements with theirregulators, we have entered into written agreements with our bankingsubsidiaries, and our banking subsidiaries have submitted Capital Plansaccepted by their regulators, as described under “Our Capital Plan and OtherRegulatory Matters” in our 2001 Annual Shareholders Report. As ofSeptember 30, 2002, our banking subsidiaries met their commitments underthese Capital Plans to achieve the capital ratio goals for that date set forthin the Capital Plans. See “—Capital Adequacy.”

 

On June 4, 2002, we contributed the stock of PBS toPNB, as planned, and on September 27, 2002, we made a cash contribution to PNBof $100 million, which represented proceeds from the partial repayment of aninvestment security related to certain subordinated notes held by the Company.The remaining repayment, in the amount of $70 million, is expected to bereceived in the fourth quarter of 2002 and contributed to our bankingsubsidiaries. The contributions to date have resulted in an aggregate increaseto capital at PNB of $116.4 million.  Our banking subsidiaries have submitted to theOffice of the Comptroller of the Currency (“Comptroller”) an application forpermission to merge PB into PNB. The application is awaiting

 

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approval from the Comptroller, and we expect tocomplete the merger as and when that approval is received.

 

On May 17, 2002, the federalbanking agencies issued an interagency advisory with respect to the risk-basedcapital treatment for banking institutions that record an asset commonlyreferred to as Accrued Interest Receivable (“AIR”) in connection with theircredit card receivables securitizations. The AIR represents fees and financecharges that have been accrued on receivables that an institution has securitizedand sold to third party investors and may include finance charges billed butnot yet collected and finance charges accrued but not yet billed on thesecuritized receivables. Pursuant to this advisory, an AIR may be considered aretained subordinated interest for regulatory capital purposes, andinstitutions are expected to hold risk-based capital in an amount consistentwith its subordinated nature. We treat an AIR for fees and finance chargesaccrued but not yet billed as a residual interest subject to the residualinterest rule, which our banking subsidiaries elected to early adopt as ofJanuary 1, 2002 (see “—Capital Adequacy”). Our practice with respect tofees and finance charges billed but not yet collected has been to hold capitalon the same basis as other loans, including loans subject to increased subprimerisk weightings. We are in discussions with our regulators to establish anagreed upon application of the advisory to our banking subsidiaries by December31, 2002. If it is determined that the fees and finance charges billed but notyet collected meet the definition of recourse exposure for risk-based capitalpurposes, we could be required to hold more capital against this component ofthe AIR.  In that event, we would takesuch steps as necessary to accommodate the effect of the advisory. However, wedo not currently expect that the implementation of the advisory will affect ourability to meet the capital goals set forth in our Capital Plan.

 

On July 22, 2002, thefederal banking agencies issued their draft guidance (the “Guidance”) onaccount management and loss allowances for credit card lending, which setsforth the agencies’ expectations in the areas of credit card accountmanagement, risk management, and loss allowance practices. The Guidanceaddresses credit line management, overlimit, and workout and forbearancepractices, as well as income recognition and loss allowance practices,including practices related to accrued interest and fees and loan lossallowances. The principles set forth in the Guidance are generally applicableto all institutions subject to the agencies’ supervision that offer credit cardprograms. Certain practices, such as negative amortization for overlimitaccounts (which occurs when the required minimum payment is insufficient tocover fees and finance charges assessed in the current billing cycle), would besubject to increased regulatory scrutiny in the management of subprime lendingprograms. Institutions are expected to work with their primary regulators toensure implementation of the Guidance as promptly as possible. We believe thatPNB is in substantial compliance with the income recognition and loss allowanceprinciples included in the Guidance as proposed, and we are taking appropriatesteps to implement the remaining practices set forth in the draft Guidance.However, the final Guidance has not yet been released, and although we continueto believe that we should be able to implement the Guidance without majorimpact to our business model, we are unable to predict its effect withcertainty at this time.

 

*Recent Developments.*  In thethird quarter of 2002, we took the following actions in connection with variousinitiatives previously announced:

 

•              Completed the closure of theSacramento, California facility.

 

•                                          Achieved a workforce reduction of approximately1,100 during the quarter, to end the quarter at approximately 7,300 employees.

 

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•                                          Further strengthened our executive management teamby hiring Chaomei Chen as Vice Chairman, Credit and Collections, and promotingJim Jones to Vice Chairman, Enterprise Risk Management.

 

Inaddition, in October 2002, servicing for the higher risk portfolio, which wetransferred in a structured sale in the second quarter of 2002, was transferredfrom PNB to Cardholder Management Services, LLP, an affiliate of CardWorks,Inc., and CompuCredit Corporation.  Alsoin October 2002, we completed the initial funding, totaling $500million, of a conduit securitization in our Providian Gateway Master Trust.

 

*Earnings Summary*

 

The following discussion providesa summary of results for the three and nine month periods endedSeptember 30, 2002, compared to the results for the three and nine monthperiods ended September 30, 2001. During 2001, we announced our intentionto discontinue our operations in the United Kingdom and Argentina, and duringthe second quarter of 2002 we completed the sale of our operations in bothlocations. The following tables exclude all discontinued operations. Each componentof the results is covered in further detail in subsequent sections of thisdiscussion.

 

Income from continuing operationsfor the three months ended September 30, 2002 was $42.1 million,compared to $58.1 million for the three months ended September 30,2001. Income from continuing operations for the nine months endedSeptember 30, 2002 was $138.9 million, compared to $536.7 million forthe nine months ended September 30, 2001. The reasons for the decrease inincome from continuing operations for the three-month and nine-month periodsended September 30, 2002 are lower average loans and higher average loss rates.For the three months ended September 30, 2002, reported net interestincome decreased 50% to $199.5 million, compared to $398.7 million forthe third quarter of 2001. Non-interest income for the quarter endedSeptember 30, 2002 was $465.1 million, a decrease of$392.3 million from $857.4 million during the third quarter of 2001.The decreases in net interest income and in non-interest income areattributable primarily to reductions in reported and securitized loan balancesdue to our asset sales as well as the expansion of finance charge and feevaluation allowances to cover all loans. See “Finance Charge and Fee Income Recognition” in Note 2 of the Notesto Condensed Consolidated Financial Statements in Item 1 of Part I of thisQuarterly Report on Form 10-Q.

 

During the quarter ended September 30, 2002 there wereno results from discontinued operations because the sales of our discontinued operationsin the United Kingdom and Argentina were finalized during the second quarter of2002. The loss from discontinued operations in the third quarter of 2001 was$14.8 million. For the nine months ended September 30, 2002, income fromdiscontinued operations was $67.2 million, compared to a loss of$32.4 million for the first nine months of 2001. The increase during 2002is primarily due to a pre-tax gain of $95.6 million from the sale of theUnited Kingdom credit card operations and a pre-tax gain of $8.0 millionfrom the sale of our Argentina operations.

 

During the nine months ended September 30, 2002 we didnot record any extraordinary items. During the third quarter of 2001, werepurchased and retired $57.2 million in principal amount of our 3.25%convertible senior notes due August 15, 2005, $12.5 million in principal amountat maturity of our zero coupon convertible notes due February 15, 2021, and$4.6 million in principal amount of our capital securities. These notes andsecurities were purchased at an aggregate price of $44.5 million plus accruedinterest, or $23.0 million below their aggregate carrying values. The gainrelated to these repurchases was recorded, net of taxes, as an extraordinaryitem in the Company’s consolidated statements of income.

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As of September 30, 2002,managed credit card loans, which included $7.70 billion of reported loansand $500 million of loans held for securitization, was $19.45 billion, adecrease of $12.25 billion, or 39%, from the balance at September 30,2001. This decline in managed credit card loans was primarily due to thetransfer of nearly $8 billion in managed loans receivable included in theProvidian Master Trust in February 2002 and the sale of $2.4 billionof higher risk credit card receivables in June 2002.

 

For the three months ended September 30, 2002,reported net interest income decreased 50% to $199.5 million, from$398.7 million for the same period in 2001. For the nine months endedSeptember 30, 2002, reported net interest income was $733.1 million,compared to $1.34 billion for the same period in 2001, attributableprimarily to reductions in reported and securitized loan balances due to ourasset sales as well as the expansion of finance charge and fee valuationallowances to cover all loans.  See“Finance Charge and Fee Income Recognition” in Note 2 of the Notes to CondensedConsolidated Financial Statements in Item 1 of Part I of this Quarterly Reporton Form 10-Q. Our reported net interest margin on loans increased to 12.93% forthe third quarter of 2002, from 11.26% for the same period in 2001. For thethird quarter of 2002, the reported net credit loss rate was 13.38%, comparedto 14.21% for the second quarter of 2002 and 10.47% for the third quarter of2001. The 30+ day reported delinquency rate as of September 30, 2002 was8.14%, an increase from 7.29% as of June 30, 2002 and a decrease from9.11% as of September 30, 2001. The increase in the net interest marginand the net credit loss rate year over year reflects the change in loan mix dueto the sale of our interests in the Providian Master Trust, which includedloans with generally lower yields and credit loss rates than other loans in ourmanaged portfolio, as well as continued weakness in the economy and thedeterioration in the credit quality of our loans. The improvement in thereported delinquency rate year over year is primarily the result of an increasein the estimate of uncollectible finance charges and fees subsequent to September30, 2001.

 

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For the three months endedSeptember 30, 2002, managed net interest income was $779.8 million,compared to $996.5 million for the third quarter of 2001. For the ninemonths ended September 30, 2002, managed net interest income was$2.53 billion, compared to $2.83 billion for the same period in 2001.Our managed net interest margin on loans increased to 16.73% for the thirdquarter of 2002 from 12.94% for the same period in 2001. For the third quarterof 2002, the managed net credit loss rate was 16.71%, compared to 17.53% forthe second quarter of 2002 and 10.43% for the third quarter of 2001. The 30+day managed delinquency rate as of September 30, 2002 increased to 11.23%from 10.16% as of June 30, 2002, and from 8.71% as of September 30,2001. The increase in yields, the net credit loss rate, and the delinquencyrate reflects the change in loan mix due to the sale of our interests in theProvidian Master Trust, which included loans with generally lower yields andcredit loss rates than other loans in our managed portfolio, as well ascontinued weakness in the economy and the deterioration in the credit qualityof our loans.

 

Non-interest income for the quarter endedSeptember 30, 2002 was $465.1 million, a decrease of$392.3 million from $857.4 million for the same period in 2001.Non-interest income for the nine months ended September 30, 2002 was$2.09 billion, a decrease of $938.3 million from $2.62 billionfor the same period in 2001, after excluding the $401.9 million gain fromthe sale of our interests in the Providian Master Trust during the firstquarter of 2002. This decrease reflects lower credit product fee and servicingand securitization income. Non-interest expense decreased $157.9 millionto $452.2 million for the third quarter of 2002, compared to$610.1 million for the same period in 2001. For the nine months endedSeptember 30, 2002, non-interest expense decreased $262.4 million to$1.49 billion, compared to $1.75 billion for the same period in 2001.The reductions in non-interest expense are primarily due to lower solicitationand advertising expenses as we transitioned to our new marketing strategy andto lower salary and employee benefits expenses related to our workforce reduction.

 

Our return on reported assets was0.97% for the third quarter of 2002, down from 1.07% for the same period in2001. Our return on managed assets was 0.61% and 0.62% for the third quartersof 2002 and 2001. The return on equity of 8.00% for the third quarter of 2002was down from 9.40% for the same period in 2001.  Decreases in return on assets and equity were primarily

 

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driven by increased credit losses due to thedeterioration in the credit quality of our loans and continued weakness in theeconomy.

 

*Managed Consumer Loan Portfolio and theImpact of Securitization*

 

We securitize consumer loans inorder to diversify funding sources and to manage our cost of funds. Foradditional discussion of our securitization activities, see “—Funding andLiquidity.” Securitized loans sold to investors are not considered our assetsand therefore are not shown on our balance sheet. Because we typically retainan interest in the loans we have securitized, and the impact of securitizedloans continues to affect future cash flows, it is our practice to analyze ourfinancial performance on a managed basis. To perform this analysis, we use anadjusted income statement and adjusted statements of financial condition, whichadd back the effect of securitizations.

 

The following table summarizes our reported loanportfolio:

 
|                                                            |   | **Three  months ended September 30,** |       | **Nine  months ended September 30,** |   |
|-----------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|--------|
| **(dollars  in thousands)**                                     |   | **2002**                              |       | **2001**                             |   | **2002** |   | **2001** |   |
| **Period  - End Balances**                                      |   |                                  |       |                                 |   |   |   |   |   |
| Consumer loans                                                  |   | $                                     | 8,197,776  |                                 | $      | 13,763,839 |   | $ | 8,197,776 |   | $ | 13,763,839 |   |
|                                                            |   |                                  |       |                                 |   |   |   |   |   |
| **Average  Balances**                                           |   |                                  |       |                                 |   |   |   |   |   |
| Average Consumer  loans                                         |   | $                                     | 7,305,075  |                                 | $      | 14,365,767 |   | $ | 9,354,255 |   | $ | 14,213,248 |   |
| Average earning  assets                                         |   | $                                     | 15,010,648 |                                 | $      | 19,384,469 |   | $ | 15,739,038 |   | $ | 18,018,452 |   |
|                                                            |   |                                  |       |                                 |   |   |   |   |   |
| **Operating  Data and Ratios**                                  |   |                                  |       |                                 |   |   |   |   |   |
| Return on  average loans                                        |   | 2.31                                  | %          | 1.59                                 | %      | 2.94 | % | 4.88 | % |
| Net interest  margin(1)                                         |   | 12.93                                 | %          | 11.26                                | %      | 11.61 | % | 9.59 | % |
|                                                            |   |                                  |       |                                 |   |   |   |   |   |
| Return on  average assets                                       |   | 0.97                                  | %          | 1.07                                 | %      | 1.51 | % | 3.40 | % |
| Net interest  margin(2)                                         |   | 5.32                                  | %          | 8.23                                 | %      | 6.21 | % | 9.95 | % |
|                                                            |   |                                  |       |                                 |   |   |   |   |   |
| Net credit  losses as a percentage of average loans outstanding |   | 13.38                                 | %          | 10.47                                | %      | 13.21 | % | 10.19 | % |
|                                                            |   |                                  |       |                                 |   |   |   |   |   |
| Total  delinquency trends(3):                                   |   |                                  |       |                                 |   | 8.14 | % | 9.11 | % |
|                                                            |   |                                  |       |                                 |   |   |   |   |   |

 

----

(1) Net interest margin is equal to net interestincome divided by average loans.

(2) Net interestmargin is equal to net interest income divided by average earning assets.

(3) Loansoutstanding include loans held for sale at par, and exclude SFAS No. 133 marketvalue adjustments.

 

The following table summarizes our managed loanportfolio:

 
|                                                            |   | **Three  months ended September 30,** |       | **Nine  months ended September 30,** |   |
|-----------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|--------|
| **(dollars  in thousands)**                                     |   | **2002**                              |       | **2001**                             |   | **2002** |   | **2001** |   |
| **Period-End  Balances**                                        |   |                                  |       |                                 |   |   |   |   |   |
| Reported  consumer loans                                        |   | $                                     | 8,197,776  |                                 | $      | 13,763,839 |   | $ | 8,197,776 |   | $ | 13,763,839 |   |
| Securitized  consumer loans                                     |   | 11,255,146                            |       | 17,940,181                           |   | 11,255,146 |   | 17,940,181 |   |
| Total managed  consumer loan portfolio                          |   | $                                     | 19,452,922 |                                 | $      | 31,704,020 |   | $ | 19,452,922 |   | $ | 31,704,020 |   |
|                                                            |   |                                  |       |                                 |   |   |   |   |   |
| **Average  Balances**                                           |   |                                  |       |                                 |   |   |   |   |   |
| Reported  consumer loans                                        |   | $                                     | 7,305,075  |                                 | $      | 14,365,767 |   | $ | 9,354,255 |   | $ | 14,213,248 |   |
| Securitized  consumer loans                                     |   | 11,931,675                            |       | 16,456,636                           |   | 13,074,858 |   | 14,852,833 |   |
| Total average  managed consumer loan portfolio                  |   | $                                     | 19,236,750 |                                 | $      | 30,822,403 |   | $ | 22,429,113 |   | $ | 29,066,081 |   |
|                                                            |   |                                  |       |                                 |   |   |   |   |   |
| Average earning  assets                                         |   | $                                     | 26,942,323 |                                 | $      | 35,841,105 |   | $ | 28,813,896 |   | $ | 32,871,285 |   |
|                                                            |   |                                  |       |                                 |   |   |   |   |   |
| **Operating  Data and Ratios**                                  |   |                                  |       |                                 |   |   |   |   |   |
| Return on  average loans                                        |   | 0.88                                  | %          | 0.74                                 | %      | 1.22 | % | 2.39 | % |
| Net interest  margin(1)                                         |   | 16.73                                 | %          | 12.94                                | %      | 15.38 | % | 9.47 | % |
|                                                            |   |                                  |       |                                 |   |   |   |   |   |
| Return on  average assets                                       |   | 0.61                                  | %          | 0.62                                 | %      | 0.94 | % | 2.01 | % |
| Net interest  margin(2)                                         |   | 11.58                                 | %          | 11.12                                | %      | 11.69 | % | 11.47 | % |
|                                                            |   |                                  |       |                                 |   |   |   |   |   |
| Net credit  losses as a percentage of average loans outstanding |   | 16.71                                 | %          | 10.43                                | %      | 15.97 | % | 10.08 | % |
|                                                            |   |                                  |       |                                 |   |   |   |   |   |
| Total  delinquency trends(3):                                   |   |                                  |       |                                 |   | 11.23 | % | 8.71 | % |

 

----

(1) Net interest marginis equal to net interest income divided by average loans.

(2) Net interest marginis equal to net interest income divided by average earning assets.

(3) Loans outstandinginclude loans held for sale at par, and exclude SFAS No. 133 market valueadjustments.

 

*FinancialStatement Impact*.  Ouroutstanding securitizations are treated as sales under GAAP.  We receive the proceeds of the sale, and thesecuritized loans and related allowances are removed from our balancesheet.  In certain cases, we haveretained an interest in the securitized pool of assets that is subordinate tothe interests of third party investors. As the holder of a subordinated interest, we retain a right to receivecollections allocated to the subordinated interest after payments to seniorinvestors.  Certain events result in theexcess cash flow being used to fund spread accounts, in which we also retain aninterest.  Subordinated retainedinterests and spread accounts are recorded at estimated fair value, which isless than the face amount, and are included in “due from securitizations” onour balance sheet.  Each quarter, weadjust the valuation of our retained interests to reflect changes in the amountof the securitized loans outstanding and any changes to key estimates that wemake.  These adjustments are reflectedin servicing and securitization income.

 

At the time we enter into a securitization, werecognize an “interest-only strip receivable” asset, which is the present valueof the estimated excess servicing income during the period the securitizedloans are projected to be outstanding. “Excess servicing income” refers to the net positive cash flow fromfinance charge and fee revenues generated by the securitized loans less the sumof the interest paid to investors, related credit losses, servicing fees, andother transaction expenses.

 

We recognize a net gain or loss on our income statementwhen we enter into a securitization, based on: the income recognized from therelease of reserves related to the securitized loans; the value of theinterest-only strip recorded at the time of the securitization; the discountrecognized at the time of the securitization in recording the fair value of anyretained subordinated interests; and the expenses related to the consummationof the securitization transaction.

 

During the revolving period of a securitization, noprincipal payments are made to the investors. Instead, monthly principal payments received on the loans are used topurchase replacement loans receivable, and we recognize additionalinterest-only strips receivable.  Excessservicing revenue is recognized each month, through the accretion ofinterest-only strips receivable and, to the extent the amounts received exceedthe related interest-only strip receivable, as servicing and securitizationincome.  During the amortization oraccumulation period of a securitization, principal payments are either made toinvestors or are held in an account for accumulation and later distribution toinvestors.

 

24

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When loans are securitized, we retain a “seller’sinterest” generally equal to the total amount of the pool of loans included inthe securitization less the investors’ portion and our subordinated retainedinterests in those loans.  As the amountof the loans in the securitized pool fluctuates due to customer payments,purchases, cash advances, and credit losses, the amount of the seller’sinterest will vary.  The seller’sinterest is classified as loans receivable at par on our balance sheet.  At September 30, 2002, we maintained anallowance for credit losses and suppressed estimated uncollectible financecharges and fees with respect to the seller’s interest.  Periodically, we may be required to transfernew loans into a securitized pool in order to maintain the seller’s interestabove a minimum required by the securitization documents.

 

We continue to service the accounts included in thepool of securitized loans and earn a monthly servicing fee, which is generallyoffset by the servicing costs we incur. Accordingly, servicing assets or liabilities have not been recognized inconnection with our securitizations.

 

The ongoing effect of securitization accounting on ourincome statement includes a reduction in net interest income and the provisionfor credit losses, and an adjustment to non-interest income.  For the three months ended September 30, 2002and 2001, securitization accounting had the effect of reducing net interestincome by $580.4 million and $597.8 million; reducing the provision for creditlosses by $559.3 million and $427.6 million; and increasing non-interest incomeby $21.1 million and $170.2 million. For the nine months ended September 30,2002 and 2001, securitization accounting had the effect of reducing netinterest income by $1.79 billion and $1.48 billion; reducing the provision forcredit losses by $1.76 billion and $1.11 billion; and increasing non-interestincome by $32.4 million and $371.9 million. Unamortized loan acquisition costsare expensed upon securitization. Credit losses on securitized loans are reflected as a reduction of servicingand securitization income rather than a reduction of the allowance for creditlosses.  Therefore, our provision forcredit losses is lower than if the loans had not been securitized.

 

If certain early amortization events specified in thesecuritization documents were to occur, principal collections from thesecuritized receivables would be applied to repay the related securitizationfunding earlier than would be the case if the scheduled amortization periodwere to commence. Early amortization of a securitization transaction increasesthe seller’s interest and could thereby require us to maintain additionalregulatory capital and establish credit loss reserves, which could negativelyimpact our financial results and liquidity.

 

Early amortization events include excess spreadtriggers (based on a formula that takes into account finance charge and feeyield, interest, servicing and other administrative costs and credit lossesallocated to a particular series), certain breaches of representations,warranties or covenants, insolvency or receivership, servicer defaults, andearly amortization events relating to credit ratings, regulatory capital, andearly amortization with respect to our other securitization transactions. Forexample, in the Providian Gateway Master Trust Series 2000-D and Series 2001-Jsecuritizations, early amortization can be triggered by: a downgrade in PNB’scredit rating below BB-/Ba3 unless PNB has entered into a back-up servicingagreement with a back-up servicer satisfactory to the investors within 60 daysof the downgrade; the failure of PNB to be “well capitalized” as shown on itsCall Report beginning with the quarter ending June 30, 2002; or an earlyamortization with respect to any of our other Providian Gateway Master Trustsecuritizations. In addition, under the securitization documents as currentlyin effect, early amortization of the Series 2000-D securitization can betriggered by a downgrade of the Class B certificates below A-/A3 if a specifiedpercentage of the investors declare the downgrade to be an amortization event.

 

As of the date of this report, none of the triggerevents has occured.  Although the ClassB Certificates in the Series 2000-D securitization were downgraded from A to A-by Standard & Poors on November 6, 2002, which would have triggered an amortizationevent if two-thirds of the Class A or Class B certificateholders had declaredit to be an amortization event, effective as of November 6, 2002, the Series2000-D securitization documents were amended to provide that no trigger eventwill occur unless the Class B Certificates are downgraded below A-/A3.  In addition, we have taken steps that weexpect will help prevent the occurrence of a trigger event in the event adowngrade in PNB’s credit rating should occur, by entering into a back-upservicing agreement with a back-up servicer. We have also converted asubstantial portion of the receivables in the Providian Gateway Master Trustfrom fixed to variable rates. Since all the outstanding securitizations in theProvidian Gateway Master Trust bear interest at floating rates of interest,this conversion reduces the risk that excess servicing could be adverselyaffected should interest rates rise. There was an improvement in average excess spread during the thirdquarter of 2002.  In addition, in October2002 we designated additional accounts to the Providian Gateway MasterTrust.  This addition, which included$800 million in receivables and consisted only of loans that were not more than30 days past due, is expected to improve the Trust net credit loss rate and theexcess spread over a five-month period beginning in October 2002.  However, there continues to be risk that anearly amortization event based on excess spread triggers could occur withrespect to some of the series of the Providian Gateway Master Trust.

 

25

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*CashFlow Impact*.  Whenloans are securitized, we receive cash proceeds from investors net of up-fronttransaction fees and expenses.  We usethese proceeds to reduce alternative funding liabilities, fund related spreadaccounts when required, invest in short-term liquid investments, and for othergeneral corporate purposes.  Theinvestors’ share of finance charges and fees received from the securitizedloans is collected each month and used to pay investors for interest and creditlosses, to pay us for servicing fees and to pay other third parties for creditenhancement costs, and for other transaction expenses.  Any finance charge and fee cash flowremaining after such payments is treated as excess servicing income and isgenerally retained by or remitted back to us. Our right to receive excessfinance charges and fees and principal collections allocated to a series ofinvestor securities is, in some cases, subject to the prior right of otherinvestors in other series of a master trust to use such collections to covershortfalls.

 

Certain negative events, such as deterioration ofexcess servicing below certain specified levels, result in the excess cash flowbeing retained in the securitization through the funding of spread accounts asadditional credit enhancement rather than remitted back to us.  As a consequence of our credit ratingdowngrades in late 2001 and projected increases in spread account fundingrequirements, approximately $640 million of Providian Gateway Master Trustcollections constituting excess servicing is currently expected to be used tofund spread accounts during 2002.  Ofthis amount, approximately $520 million was funded in these spread accountsduring the first nine months of 2002. Additional amounts from the proceeds of the Series 2002-A securitizationare expected to be used to fund spread accounts in the fourth quarter of 2002;approximately $31 million was funded in October 2002 when Series 2002-A wasfunded.  The amount expected to befunded will change from time to time, depending on securitization amounts andmaturities and the performance of the securitized loans.

 

During the revolving period of a securitization, theinvestors’ share of monthly principal collections and certain finance chargeand fee collections are used to purchase replacement loans receivable fromus.  During the amortization oraccumulation period of a securitization, the investors’ share of principalcollections (in certain cases, up to a specified amount each month) is

 

26

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either distributed each month to the investors or held in an accountfor accumulation and later distribution to the investors.

 

*Risk Adjusted Revenue and Return.*

 

We use risk adjusted revenue (net interest income onloans plus non-interest income less net credit losses) as a measure of loanportfolio profitability, consistent with our goal of matching the revenuegenerated by customer accounts with the risks undertaken.  Risk adjusted revenue may also be expressedas a percentage of average consumer loans, in which case it is referred to asrisk adjusted return.

 

Reported risk adjusted revenue and return on loans forthe three months ended September 30, 2002 were $456.9 million and 25.02%,compared to $885.4 million and 24.66% for the same period in 2001.  The decrease in reported risk adjustedrevenue is primarily the result of lower interest income and non-interestincome resulting from decreased reported loan balances and high credit lossrates.  The increase in the reportedrisk adjusted return resulted primarily from smaller increases in our estimatesof uncollectible finance charges and fees, and from increases in othernon-interest income, in the third quarter of 2002 compared to the same periodin 2001.

 

Managed risk adjusted revenue and return on loans forthe three months ended September 30, 2002 were $445.1 million and 9.25%,compared to $904.1 million and 11.43% for the same period in 2001. The decreasein managed risk adjusted return is primarily the result of lower interestincome and non-interest income resulting from decreased managed loan balancesdue to asset sales and high credit loss rates. In addition, the decline in themanaged risk adjusted return resulted from an increase in the managed creditloss rate due to deterioration in the credit quality of our loans and continuedweakness in the economy.

 

*Net Interest Income and Margin*

 

Net interest income is interest earned from loan andinvestment portfolios less interest expense on deposits and borrowings.  Managed net interest income also includesinterest earned from securitized loans less securitization funding costs.

 

Reported net interest income for the three monthsended September 30, 2002 was $199.5 million, compared to $398.7 million for thesame period in 2001, representing a decrease of $199.2 million, or 50%.Reported net interest income for the nine months ended September 30, 2002 was$733.1 million, compared to $1.34 billion for the same period in 2001,representing a decrease of $611.1 million, or 46%.  The decrease in reported net interest income is primarilyattributable to lower loan balances resulting from the sale of our interests inthe Providian Master Trust and our higher risk asset portfolio as well as theexpansion of finance charge and fee valuation allowances to cover allloans.  See “Finance Charge and FeeIncome Recognition” in Note 2 of the Notes to Condensed Consolidated FinancialStatements in Item 1 of Part I of this Quarterly Report on Form 10-Q.

 

Managed net interest income for the three months endedSeptember 30, 2002 was $779.8 million, compared to $996.5 million for the sameperiod in 2001, representing a decrease of $216.7 million, or 22%. Managed netinterest income for the nine months ended September 30, 2002 was $2.53 billion,compared to $2.83 billion for the same period in 2001. The decrease in managednet interest income is primarily attributable to the decrease in loan balancesresulting from the sale of our interests in the Providian Master Trust and ourhigher risk asset portfolio.  Managednet interest margin on average managed earning assets increased to 11.58% forthe three months ended September 30, 2002, from 11.12% for the same period in2001.

 

27

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The reported interest yield on total interest earningassets declined to 10.35% and 11.23% for the three and nine months endedSeptember 30, 2002, from 13.31% and 15.16% for the same periods in 2001. Theprimary cause for the decline in reported yield on interest earning assets isthe large lower-yielding liquidity position we have maintained during 2002.These lower yields have been partially offset by lower funding costs onliabilities resulting from interest rate declines over the last year.

 

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

 

The following tables provide an analysis of reportedinterest income, interest expense, net interest spread, and average balancesfor the three and nine months ended September 30, 2002 and 2001 (interestincome and interest expense margins are presented as a percentage of averageearning assets, which include interest-earning consumer loan portfolios andinvestments held for liquidity purposes):

* *
|                                                 |   | **Three  months ended September 30,** |       |
|------------------------------------------------------|--------|---------------------------------------|------------|
|                                                 |   | **2002**                              |       | **2001** |   |
| **(dollars  in thousands)**                          |   | **Average  Balance**                  |       | **Income/  Expense** |   | **Yield/  Rate** |   | **Average  Balance** |   | **Income/  Expense** |   | **Yield/  Rate** |   |
| **Assets**                                           |   |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Interest-earnings  assets                            |   |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Consumer loans                                       |   | $                                     | 7,305,075  |   | $ | 328,240 |   | 17.97 | % | $ | 14,365,767 |   | $ | 586,677 |   | 16.34 | % |
| Interest-earning  cash                               |   | 2,640,564                             |       | 11,786 |   | 1.79 | % | 759,722 |   | 6,948 |   | 3.66 | % |
| Federal funds  sold                                  |   | 2,927,351                             |       | 13,334 |   | 1.82 | % | 2,170,051 |   | 19,489 |   | 3.59 | % |
| Investment  securities                               |   | 1,453,358                             |       | 17,364 |   | 4.78 | % | 1,787,221 |   | 23,367 |   | 5.23 | % |
| Other                                                |   | 684,300                               |       | 17,752 |   | 10.38 | % | 301,708 |   | 8,408 |   | 11.15 | % |
| Total  interest-earning assets                       |   | 15,010,648                            |       | $ | 388,476 |   | 10.35 | % | 19,384,469 |   | $ | 644,889 |   | 13.31 | % |
| Allowance for  loan losses                           |   | (1,196,616                            | )          |   |   |   |   | (1,505,741 | ) |   |   |   |   |
| Other assets                                         |   | 3,569,704                             |       |   |   |   |   | 3,450,869 |   |   |   |   |   |
| Total assets                                         |   | $                                     | 17,383,736 |   |   |   |   |   | $ | 21,329,597 |   |   |   |   |   |
|                                                 |   |                                  |       |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and Equity**                           |   |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities                        |   |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Deposits                                             |   | $                                     | 13,421,112 |   | $ | 178,705 |   | 5.33 | % | $ | 15,817,236 |   | $ | 232,505 |   | 5.88 | % |
| Borrowings                                           |   | 962,280                               |       | 10,306 |   | 4.28 | % | 1,187,672 |   | 13,700 |   | 4.61 | % |
| Total  interest-bearing liabilities                  |   | 14,383,392                            |       | $ | 189,011 |   | 5.26 | % | 17,004,908 |   | $ | 246,205 |   | 5.79 | % |
| Other  liabilities                                   |   | 789,145                               |       |   |   |   |   | 1,778,269 |   |   |   |   |   |
| Total  liabilities                                   |   | 15,172,537                            |       |   |   |   |   | 18,783,177 |   |   |   |   |   |
| Capital  securities                                  |   | 104,332                               |       |   |   |   |   | 109,900 |   |   |   |   |   |
| Equity                                               |   | 2,106,867                             |       |   |   |   |   | 2,436,520 |   |   |   |   |   |
| Total  liabilities and equity                        |   | $                                     | 17,383,736 |   |   |   |   |   | $ | 21,329,597 |   |   |   |   |   |
|                                                 |   |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Net Interest  Spread                                 |   |                                  |       |   |   | 5.09 | % |   |   |   |   | 7.52 | % |
| Interest income  to average interest-earning assets  |   |                                  |       |   |   | 10.35 | % |   |   |   |   | 13.31 | % |
| Interest expense  to average interest-earning assets |   |                                  |       |   |   | 5.04 | % |   |   |   |   | 5.08 | % |
| Net interest  margin                                 |   |                                  |       |   |   | 5.31 | % |   |   |   |   | 8.23 | % |

 

28

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|                                                 |   | **Nine  months ended September 30,** |       |
|------------------------------------------------------|--------|--------------------------------------|------------|
|                                                 |   | **2002**                             |       | **2001** |   |
| **(dollars  in thousands)**                          |   | **Average  Balance**                 |       | **Income/  Expense** |   | **Yield/  Rate** |   | **Average  Balance** |   | **Income/  Expense** |   | **Yield/  Rate** |   |
| **Assets**                                           |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest-earnings  assets                            |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Consumer loans                                       |   | $                                    | 9,354,255  |   | $ | 1,166,807 |   | 16.63 | % | $ | 14,213,248 |   | $ | 1,899,448 |   | 17.82 | % |
| Interest-earning  cash                               |   | 2,446,890                            |       | 32,165 |   | 1.75 | % | 487,530 |   | 15,076 |   | 4.12 | % |
| Federal funds  sold                                  |   | 1,954,953                            |       | 26,041 |   | 1.78 | % | 1,171,698 |   | 35,519 |   | 4.04 | % |
| Investment  securities                               |   | 1,421,837                            |       | 52,879 |   | 4.96 | % | 2,045,407 |   | 89,589 |   | 5.84 | % |
| Other                                                |   | 561,103                              |       | 47,312 |   | 11.24 | % | 100,569 |   | 8,408 |   | 11.15 | % |
| Total  interest-earning assets                       |   | 15,739,038                           |       | $ | 1,325,204 |   | 11.23 | % | 18,018,452 |   | $ | 2,048,040 |   | 15.16 | % |
|                                                 |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for  loan losses                           |   | (1,473,305                           | )          |   |   |   |   | (1,488,916 | ) |   |   |   |   |
|                                                 |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Other assets                                         |   | 3,909,983                            |       |   |   |   |   | 3,884,711 |   |   |   |   |   |
| Total assets                                         |   | $                                    | 18,175,716 |   |   |   |   |   | $ | 20,414,247 |   |   |   |   |   |
|                                                 |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Liabilities and Equity**                           |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities                        |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Deposits                                             |   | $                                    | 14,074,383 |   | $ | 559,746 |   | 5.30 | % | $ | 14,446,358 |   | $ | 655,102 |   | 6.05 | % |
| Borrowings                                           |   | 991,742                              |       | 32,338 |   | 4.35 | % | 1,329,407 |   | 48,760 |   | 4.89 | % |
| Total  interest-bearing liabilities                  |   | 15,066,125                           |       | $ | 592,084 |   | 5.24 | % | 15,775,765 |   | $ | 703,862 |   | 5.95 | % |
| Other  liabilities                                   |   | 958,249                              |       |   |   |   |   | 2,213,557 |   |   |   |   |   |
| Total  liabilities                                   |   | 16,024,374                           |       |   |   |   |   | 17,989,322 |   |   |   |   |   |
| Capital  securities                                  |   | 104,332                              |       |   |   |   |   | 110,548 |   |   |   |   |   |
| Equity                                               |   | 2,047,010                            |       |   |   |   |   | 2,314,377 |   |   |   |   |   |
| Total  liabilities and equity                        |   | $                                    | 18,175,716 |   |   |   |   |   | $ | 20,414,247 |   |   |   |   |   |
|                                                 |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| **Net Interest Spread**                              |   |                                 |       |   |   | 5.99 | % |   |   |   |   | 9.21 | % |
| Interest income  to average interest-earning assets  |   |                                 |       |   |   | 11.23 | % |   |   |   |   | 15.16 | % |
| Interest expense  to average interest-earning assets |   |                                 |       |   |   | 5.02 | % |   |   |   |   | 5.21 | % |
| Net interest  margin                                 |   |                                 |       |   |   | 6.21 | % |   |   |   |   | 9.95 | % |

 

*Interest Volume And Rate VarianceAnalysis*

 

Net interest income is affected by changes in theaverage interest rate earned on interest-earning assets and the averageinterest rate paid on interest-bearing liabilities.  Net interest income is also affected by changes in the volume ofinterest-earning assets and interest-bearing liabilities.  The following table sets forth the dollaramount of the increase (decrease) in reported interest income and expenseresulting from changes in volume and rates:

 

29

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|                        |   | **Three  months ended September 30,** |     | **Nine  months ended September 30,** |   |
|-----------------------------|--------|---------------------------------------|----------|--------------------------------------|--------|
|                        |   | **2002 vs.  2001**                    |     | **2002 vs.  2001**                   |   |
|                        |   |                                  |     | **Change due  to(1)**                |   |   |   | **Change due  to(1)** |   |
| **(dollars  in thousands)** |   | **Increase  (Decrease)**              |     | **Volume**                           |   | **Rate** |   | **Increase  (Decrease)** |   | **Volume** |   | **Rate** |   |
|                        |   |                                  |     |                                 |   |   |   |   |   |   |   |   |   |
| **Interest Income**         |   |                                  |     |                                 |   |   |   |   |   |   |   |   |   |
| Consumer loans              |   | $                                     | (258,437 | )                                    | $      | (312,161 | ) | $ | 53,724 |   | $ | (732,641 | ) | $ | (612,916 | ) | $ | (119,725 | ) |
| Federal funds  sold         |   | (6,155                                | )        | 5,409                                |   | (11,564 | ) | (9,478 | ) | 16,464 |   | (25,942 | ) |
|                        |   |                                  |     |                                 |   |   |   |   |   |   |   |   |   |
| Other securities            |   | 8,179                                 |     | 14,507                               |   | (6,328 | ) | 19,283 |   | 41,629 |   | (22,346 | ) |
| Total interest  income      |   | (256,413                              | )        | (292,245                             | )      | 35,832 |   | (722,836 | ) | (554,823 | ) | (168,013 | ) |
|                        |   |                                  |     |                                 |   |   |   |   |   |   |   |   |   |
| **Interest Expense**        |   |                                  |     |                                 |   |   |   |   |   |   |   |   |   |
| Deposits                    |   | (53,800                               | )        | (33,262                              | )      | (20,538 | ) | (95,355 | ) | (16,399 | ) | (78,956 | ) |
| Borrowings                  |   | (3,394                                | )        | (2,464                               | )      | (930 | ) | (16,422 | ) | (11,446 | ) | (4,976 | ) |
| Total interest  expense     |   | (57,194                               | )        | (35,726                              | )      | (21,468 | ) | (111,777 | ) | (27,845 | ) | (83,932 | ) |
| Net interest  income        |   | $                                     | (199,219 | )                                    | $      | (256,519 | ) | $ | 57,300 |   | $ | (611,059 | ) | $ | (526,978 | ) | $ | (84,081 | ) |

 

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(1)               The changes due toboth volume and rates have been allocated in proportion to the relationship ofthe absolute dollar amounts of the change in each.  The changes in interest income and expense are calculatedindependently for each line in the table.

 

*Non-Interest Income*

* *

Non-interest income during thethird quarter of 2002 consisted primarily of servicing and securitizationincome and credit product fee income. Total non-interest income decreased 46%,or $392.3 million, to $465.1 million for the three months endedSeptember 30, 2002, compared to $857.4 million for the same period in2001. This decrease in non-interest income reflects decreases in both servicingand securitization income and credit product fee income and was offset in partby a $10.8 million gain on the sale of investment securities and a $6.8 millionbenefit related to the termination of the interim servicing agreement for theProvidian Master Trust earlier than anticipated.

 

*Servicing and Securitization Income.*  Servicingand securitization income relates primarily to securitized loans. It includes aservicing fee, which generally offsets our cost of servicing the securitizedloans, excess servicing income, and gains or losses from the securitization offinancial assets (see “—Managed Consumer Loan Portfolio and the Impact ofSecuritization”).

 

As of September 30, 2002,securitizations outstanding provided $9.68 billion in funding,representing 41% of total managed funding, compared with $16.79 billion,or 50%, as of September 30, 2001. A more detailed discussion of ourfunding sources and the role of securitization activities is set forth in “—Fundingand Liquidity.”

 

Because excess servicing incomeon securitized loans essentially represents a recharacterization of netinterest income and credit product fee income less the provision for creditlosses and servicing expense, it will vary based upon the same factors thataffect those items. Thus, changes in net credit losses (see “—Asset Quality—NetCredit Losses”) and changes in interest rates will cause excess servicingincome to vary (see “ —Asset/Liability Risk Management”).

 

For the three months endedSeptember 30, 2002, servicing and securitization income was$125.1 million, a decrease of $226.1 million from $351.2 millionfor the same period in 2001. For the nine months ended September 30, 2002,servicing and securitization income was $570.2 million, compared to$865.6 million for the same period in 2001. Lower average securitizedloans outstanding and higher credit loss rates resulted in lower servicing andsecuritization income during 2002. In addition, asset quality trends andthe widening of spreads for asset backed

 

30

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securities affected the valuation of residual securitization interests,resulting in charges totaling $77.1 million to servicing and securitizationincome during the third quarter of 2002.

 

*Credit ProductFee Income.*  Credit product fee income includesperformance fees (late, overlimit and returned check charges), annualmembership fees, cash advance fees, line management fees, and processing fees,all of which are generally recorded as fees receivable. Credit product feeincome also includes revenue from cardholder service products, which aregenerally recorded as fee revenue if billed monthly and as customer purchasesif billed annually or semi-annually. Cardholder service product and annualmembership revenue is recognized ratably over the customer privilege period.Credit product fee income also includes interchange fees received from bankcardassociations.

 

For the three months ended September 30, 2002 and2001, credit product fee income was $273.5 million and$459.4 million. For the nine months ended September 30, 2002 and2001, credit product fee income was $904.7 million and $1.61 billion.The decrease for the three-month and nine-month periods endedSeptember 30, 2002 primarily reflects the change of our marketing focusaway from the standard segment, the sale of our interests in the ProvidianMaster Trust in the first quarter of 2002, which resulted in lower interchangefees, and lower cardholder service product and annual membership revenue. Thedecrease was also attributable to an increase in estimated uncollectiblefinance charges and fees for credit losses due to bankruptcy, which was offsetby a reduction in such estimate due to the sale of the higher risk portfolio inJune 2002.

 

For the three months endedSeptember 30, 2002 and 2001, managed credit product fee income was$422.4 million and $652.7 million. For the nine months endedSeptember 30, 2002 and 2001, managed credit product fee income was$1.43 billion and $2.09 billion. The decrease for the three-month andnine-month periods ended September 30, 2002 primarily reflects the changeof our marketing focus away from the standard segment, the sale of ourinterests in the Providian Master Trust in the first quarter of 2002, whichresulted in lower interchange fees, and lower cardholder service product andannual membership revenue. The decrease was also attributable to an increase inestimated uncollectible finance charges and fees for credit losses due tobankruptcy, which was offset by a reduction in such estimate due to the sale ofthe higher risk portfolio in June 2002.

 

*Non-Interest Expense*

 

Non-interest expense includes salary and employeebenefit costs, loan solicitation and advertising costs, occupancy, furniture,and equipment costs, data processing and communication costs, and othernon-interest expense.  Salary andbenefit costs include staffing costs associated with marketing, customerservice, collections, and administration. Loan soliciatation and advertising costs include printing, postage,telemarketing, list processing, credit bureau costs paid to third parties inconnection with account solicitation efforts, and costs incurred to promote ourproducts, and also include acquisition costs relating to purchased charged-offreceivables.  Advertising costs and themajority of solicitation expenses are expensed as incurred.  In accordance with GAAP, we capitalizeacquisition costs relating to purchased charged-off receivables and the directloan origination costs associated with successful account acquisition efforts,after they are reduced by up-front processing fees.  Capitalized loan origination costs are amortized over thecustomer privilege period (currently one year) for credit card loans unless theloans are securitized, in which case the costs are taken as an expense uponsecuritization.  Acquisition costsrelated to purchased charged off receivables are amortized over the periodduring which the receivables are expected to be collected.

 

Total loan solicitation and advertising costs were$126.4 million and $168.3 million for the three months ended September 30, 2002and 2001.  For the three months endedSeptember 30, 2002 and 2001, we amortized loan origination costs of $8.7million and $16.3 million and acquisition costs related to purchased chargedoff receivables of $42.3 million and $18.2 million.  For the nine months ended September 30, 2002 and 2001, total loansolicitation and advertising costs, including amortized loan origination costs,were $339.3 million and $447.7 million. The decrease in loan solicitation costs for the three-month andnine-month periods ended September 30, 2002 reflects a reduction in the volumeof customer mailings as we changed our marketing strategy to focus on themiddle and prime market segments and began testing new product offerings,partially offset by an increase in the amortization of acquisition costsrelated to the purchase of charged-off receivables.

 

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Other non-interest expense includes operationalexpenses such as collection costs, fraud losses, and bankcard associationassessments.  The following tablepresents non-interest expense for the three and nine months ended September 30,2002 and 2001:

 
|                                 |   | **Three  months ended  September 30,** |    | **Nine  months ended  September 30,** |   |
|--------------------------------------|--------|----------------------------------------|---------|---------------------------------------|--------|
| **(dollars  in thousands)**          |   | **2002**                               |    | **2001**                              |   | **2002** |   | **2001** |   |
| **Non-Interest Expense**             |   |                                   |    |                                  |   |   |   |   |   |
| Salaries and  employee benefits      |   | $                                      | 129,341 |                                  | $      | 174,131 |   | $ | 433,219 |   | $ | 525,652 |   |
| Solicitation and  advertising        |   | 126,404                                |    | 168,303                               |   | 339,275 |   | 447,677 |   |
| Occupancy,  furniture, and equipment |   | 43,765                                 |    | 52,385                                |   | 179,520 |   | 156,621 |   |
| Data processing  and communication   |   | 39,621                                 |    | 48,119                                |   | 133,615 |   | 155,583 |   |
| Other                                |   | 113,035                                |    | 167,135                               |   | 402,955 |   | 465,406 |   |
| Total                                |   | $                                      | 452,166 |                                  | $      | 610,073 |   | $ | 1,488,584 |   | $ | 1,750,939 |   |

 

In a continuation of our effortsto align our operations infrastructure with our ongoing business, onJuly 30, 2002 we announced the closure of our facilities in Sacramento,California, Fairfield, California and Salt Lake City, Utah. In the thirdquarter of 2002, we completed the closure of the Sacramento facility, and theclosures of the Fairfield and Salt Lake City facilities are scheduled to becompleted in the fourth quarter of 2002. At the end of the third quarter of 2002, we had approximately 7,300employees, and we expect the number of employees to decrease to below 7,000 bythe end of 2002. During the second quarter of 2002, we recognized a$37.9 million charge related to the decommissioning of facility equipmentand furniture lease expenses, fixed asset write-downs, and disposal costs. Inaddition to the $16.7 million workforce reduction charge taken during thefirst quarter of 2002, we recognized approximately $9.6 million in severanceand benefit expenses during the third quarter 2002.

 

*Income Taxes*

 

On September 11, 2002, California enacted a lawrequiring large banks (those with average assets in excess of $500 million) toconform to federal law with respect to accounting for bad debts. Before thechange, all banks, regardless of size, were eligible to use the reserve methodof accounting for bad debts, which enabled them to take deductions forCalifornia tax purposes at the time the bad debt reserves wereestablished.  As a result of the change,large banks may now deduct only the actual charge-offs, net of recoveries, indetermining their California taxable income, and must include in taxable income50 percent of the bad debt reserves existing as of the end of the prior taxyear.  As a concession to the banks thatare subject to the new law, the State of California has waived recapture of theremaining 50 percent of the reserves. The effect of this concession was to create a non-recurring tax benefitfor us in the amount of $30.0 million, which has been reflected in our incometax expense for the quarter ended September 30, 2002.

 

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We recognized a net income taxbenefit of $22.1 million and income tax expense of $38.0 million forthe three months ended September 30, 2002 and 2001 from continuingoperations. For the nine months ended September 30, 2002 and 2001, werecognized $41.1 million and $350.4 million in income tax expensefrom continuing operations. Excluding the one-time tax benefit described in thepreceding paragraph, our effective tax rate was 39.5% for the three and ninemonths ended September 30, 2002 and 2001.

 

*Asset Quality*

 

Our delinquencies and net creditlosses reflect, among other factors, the credit quality of loans, the averageage of our loans receivable (generally referred to as “seasoning”), the successof our collection efforts, and general economic conditions. Initially, creditquality is primarily determined by the characteristics of the targeted segmentand the underwriting criteria utilized during the credit approval process.Subsequently, account management efforts, seasoning, demographic, and economicconditions will impact credit quality.

 

Except for loans that arerestructured under our consumer debt management program, which are charged offno more than 120 days after they become contractually past due, ourpolicy, prior to implementation of the changes described below, was torecognize principal charge-offs on loans no more than 180 days after theybecame contractually past due, unless the accountholder cured the accountdelinquency by making a partial payment that qualified under our standards andapplicable regulatory requirements. We batch process notifications of customerswho have declared bankruptcy or died and charge off the related amounts once amonth.

 

At the time a loan is chargedoff, any accrued but unpaid finance charge and fee income is removed from ourloan balances but is maintained on the customer’s record in the event of afuture recovery. After a loan is charged off, we continue collection activityto the extent legally permissible. Any collections on, or proceeds from thesale of, charged off loans are recognized as recoveries, and are offset againstcurrent period charged off balances to determine net credit losses.

 

During the third quarter of 2002, we undertook astrategic review of our risk management and collections operations. As aresult, we are in the process of implementing a series of changes to ouroperating strategies and policies.  Themost significant outcome of our review was the adoption of a delinquencylifecycle strategy for the management of delinquent accounts.  In October 2002 we began to implement thisstrategy in combination with event-driven approaches, consumer counseling, andconsumer debt management education. Under the delinquency lifecycle approach, we prioritize collections tofocus on delinquency status, with attention to customer events within eachstage of delinquency.  We believe thatthis facilitates management and collector accountability for, and ownership of,results.

 

We have also begun a process of re-examining ouroperational policies and procedures for consistency with regulatory guidanceand industry practice, and we expect to make changes within those parameterswhere necessary or appropriate for improved performance.  As a result of this review:

 

 

•                                        Weare changing our procedures for investigating fraud losses (losses due to theunauthorized use of credit cards), which are charged against non-interestexpense after an investigation period during which we verify whether a fraudhas occurred.  Beginning with fraudsdiscovered in November 2002, we expect to increase the investigation periodfrom a maximum of 60 to a maximum of 90 days, which will permit a more thoroughinvestigation.  As a result, fraudlosses will be recognized up to 90 days after initial discovery.

 

•                                        EffectiveOctober 1, 2002, we began recognizing principal charge-offs no later than thelast day of the calendar month in which the related account becomes 180 dayscontractually past due, instead of on the day the account becomes 180 days pastdue.

 

•                                        Weare changing our policies for recognizing charge-offs for accounts of deceasedcustomers, including customers who have activated Credit Protection.  Beginning with verifications of deathreceived in November 2002, we are recognizing the charge-off within 60 daysafter verification of death.  Forverifications received prior to November 2002, we will be recognizing the charge-offsduring the remainder of 2002 and the first quarter of 2003, in no event laterthan the month in which the account becomes 180 days past due.

 

Although the changes to the timing of charge-offrecognition may modestly affect the level of charge-offs, and the changes toprocedures for fraud investigation may modestly affect fraud loss levels, we donot currently expect the impact of these changes on our financial results to bematerial.  We do expect these changes toresult in operational expense reductions and performance improvements over thelong term.  Our continued review of riskmanagement and collections operations could lead to further modifications inthe future.  For example, we arecontemplating a modification to our loan re-aging policy to permit re-aging ofeligible accounts once in any 12-month period (but not more than twice in 60months), as opposed to our current policy of re-aging no more than once in any30-month period.

 

*Delinquencies*.  An account is contractually delinquent ifthe minimum payment is not received by the next billing date.  The 30+ day delinquency rate on reportedloans was 8.14% as of September 30, 2002, compared to 7.29% as of June 30, 2002and 9.11% as of September 30, 2001.  Theincrease from June 30, 2002 to September 30, 2002 reflects increases in delinquentbalances during the quarter due primarily to economic and seasonal trends.  The decrease in the reported delinquencyrate year over year is primarily the result of an increase in the estimate ofuncollectible finance charges and fees subsequent to September 30, 2001.

 

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The 30+ day delinquency rate onmanaged loans was 11.23% as of September 30, 2002, compared to 8.81% as ofDecember 31, 2001 and 8.71% as of September 30, 2001. In addition tooverall loan seasoning and a decline in the economy, the increase in manageddelinquency rates reflect the deterioration of the credit quality of our loanportfolio and the sale of our interests in the Providian Master Trust, whichincreased the percentage of our customers in the standard and middle marketsegments.

 

The following table presents the delinquency trends ofour reported and managed consumer loan portfolios as of September 30, 2002 and2001:

 

|                        |   | **September  30,** |       |
|-----------------------------|--------|--------------------|------------|
|                        |   | **2002**           |       | **2001** |   |
| **(dollars  in thousands)** |   | **Loans**          |       | **% of   Total  Loans** |   | **Loans** |   | **% of   Total  Loans** |   |
|                        |   |               |       |   |   |   |   |   |   |
| **Reported**                |   |               |       |   |   |   |   |   |   |
| Loans  outstanding(1)       |   | $                  | 8,185,724  |   | 100.00 | % | $ | 13,731,841 |   | 100.00 | % |
| Loans delinquent            |   |               |       |   |   |   |   |   |   |
| 30 – 59 days           |   | $                  | 243,298    |   | 2.97 | % | $ | 406,229 |   | 2.96 | % |
| 60 – 89 days           |   | 166,733            |       | 2.04 | % | 306,442 |   | 2.23 | % |
| 90 or more days             |   | 256,676            |       | 3.13 | % | 538,787 |   | 3.92 | % |
| Total                       |   | $                  | 666,707    |   | 8.14 | % | $ | 1,251,458 |   | 9.11 | % |
|                        |   |               |       |   |   |   |   |   |   |
| **Managed**                 |   |               |       |   |   |   |   |   |   |
| Loans  outstanding(1)       |   | $                  | 19,440,870 |   | 100.00 | % | $ | 31,672,022 |   | 100.00 | % |
| Loans delinquent            |   |               |       |   |   |   |   |   |   |
| 30 – 59 days           |   | $                  | 676,255    |   | 3.48 | % | $ | 854,718 |   | 2.70 | % |
| 60 – 89 days           |   | 502,445            |       | 2.58 | % | 634,758 |   | 2.00 | % |
| 90 or more days             |   | 1,004,435          |       | 5.17 | % | 1,268,485 |   | 4.01 | % |
| Total                       |   | $                  | 2,183,135  |   | 11.23 | % | $ | 2,757,961 |   | 8.71 | % |

 

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(1)          Loans outstanding includeloans held for sale at par, and exclude SFAS No. 133 market value adjustments.

 

*Net Credit Losses.* Net credit losses for consumer loans representthe principal amount of losses from customers who have not paid their existingloan balances (including charged-off bankrupt and deceased customer accounts)less current period recoveries (i.e., collections on previously charged offaccounts and the proceeds from the sale of charged-off receivables). Theprincipal amounts of such losses include cash advances, purchases, and certainfinanced cardholder service product sales, and exclude accrued finance chargeincome, fee income, and fraud losses. Fraud losses (losses due to theunauthorized use of credit cards, including credit cards obtained throughfraudulent applications) are charged to non-interest expense after aninvestigation period of

 

34

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up to 60 days or a shorter period, dependingon the amount (up to 90 days, beginning in the fourth quarter of 2002). See“—Asset Quality” for a discussion of changes in fraud loss recognitionbeginning in the fourth quarter of 2002.

 

The reported net credit loss ratewas 13.38% for the three months ended September 30, 2002, compared to10.47% for the same period in 2001. The managed net credit loss rate was 16.71%for the three months ended September 30, 2002, compared to 10.43% for thesame period in 2001. The loss rate in September 2002 was negatively impacted bya temporary suspension in the sale of charged-off assets; the loss rate inOctober 2002 is expected to decline as sales of charged-off assets resumed.  We believe that losses will remainrelatively high throughout the remainder of 2002 and the first quarter of 2003.

 

The following table presents our net credit losses forconsumer loans for the periods indicated and is presented both on a financialstatement reporting basis and a managed portfolio basis:

 
|                                                            |   | **Three  months ended September 30,** |       | **Nine  months ended September 30,** |     |
|-----------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|----------|
| **(dollars  in thousands)**                                     |   | **2002**                              |       | **2001**                             |     | **2002(1)** |   | **2001** |   |
| **Reported**                                                    |   |                                  | * *   |                                 | * * |   | * * |   | * * |
| Average loans  outstanding                                      |   | $                                     | 7,305,075  |                                 | $        | 14,365,767 |   | $ | 9,354,255 |   | $ | 14,213,248 |   |
|                                                            |   |                                  |       |                                 |     |   |   |   |   |
| Net credit  losses                                              |   | $                                     | 244,429    |                                 | $        | 376,194 |   | $ | 926,882 |   | $ | 1,085,991 |   |
| Net credit  losses as a percentage of average loans outstanding |   | 13.38                                 | %          | 10.47                                | %        | 13.21 | % | 10.19 | % |
|                                                            |   |                                  |       |                                 |     |   |   |   | * * |
| **Managed**                                                     |   |                                  |       |                                 |     |   |   |   | * * |
| Average loans  outstanding                                      |   | $                                     | 19,236,750 |                                 | $        | 30,822,403 |   | $ | 22,429,113 |   | $ | 29,066,081 |   |
|                                                            |   |                                  |       |                                 |     |   |   |   |   |
| Net credit  losses                                              |   | $                                     | 803,739    |                                 | $        | 803,753 |   | $ | 2,686,732 |   | $ | 2,196,815 |   |
|                                                            |   |                                  |       |                                 |     |   |   |   |   |
| Net credit  losses as a percentage of average loans outstanding |   | 16.71                                 | %          | 10.43                                | %        | 15.97 | % | 10.08 | % |

 

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(1)          Average loansoutstanding and net credit losses for the nine months ended September 30, 2002included the higher risk loan portfolio balances at par and related creditlosses through March 31, 2002.  On March31, 2002, the higher risk asset portfolio was transferred to loans held forsale and recorded at fair value.

 

*Allowance and Provision for Credit Losses.*  Wemaintain our allowance for credit losses at a level estimated to be adequate toabsorb future principal charge–offs, net of recoveries, inherent in theexisting reported loan portfolio.  Theallowance for credit losses is maintained for reported loans only (see“—Managed Consumer Loan Portfolio and the Impact of Securitization”).Accordingly, the entire allowance is allocated to designated portfolios orpools of our reported loans.

 

The allowance for credit lossesis established through analysis of historical credit loss trends and reviews ofcurrent loss expectations that incorporate general economic conditions that mayimpact future losses. Loans are segregated by product type into general riskclassifications by market segment. Quantitative factors (including historicaldelinquency roll rates, historical credit loss rates, customer characteristics,such as risk scores, and other data) are combined with environmental factorsaffecting credit risk to prepare comparative evaluations of the allowance forcredit losses.

 

The environmental credit riskfactors are consistent with applicable bank regulatory guidelines and includeassessment of general macroeconomic conditions, trends in loan portfolio volumeand seasoning, geographic concentrations, and recent modifications to loanreview and underwriting procedures, among other factors. Also, we compareallowances established in prior

 

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periods with subsequent actual credit losses andperform a peer group comparative analysis of lagged loss rates to coverageratios.

 

The following table sets forth the activity in theallowance for credit losses for the periods indicated:

 
|                                                   |   | **Three months ended September 30,** |      | **Nine months ended September 30,** |   |
|--------------------------------------------------------|--------|--------------------------------------|-----------|-------------------------------------|--------|
| **(dollars in thousands)**                             |   | **2002**                             |      | **2001**                            |   | **2002** |   | **2001** |   |
|                                                   |   |                                 |      |                                |   |   |   |   |   |
| Balance  at beginning of period                        |   | $                                    | 1,224,901 |                                | $      | 1,507,118 |   | $ | 1,932,833 |   | $ | 1,436,004 |   |
| Provision  for credit losses                           |   | 192,366                              |      | 549,923                             |   | 764,600 |   | 1,330,834 |   |
| Fair  value adjustment – loans available for sale |   | —                               |      | —                              |   | 388,230 |   | — |   |
| Credit  losses                                         |   | (278,437                             | )         | (408,918                            | )      | (1,035,763 | ) | (1,191,567 | ) |
| Recoveries                                             |   | 34,008                               |      | 32,724                              |   | 108,881 |   | 105,572 |   |
| Transfer  of loans to available for sale               |   | —                               |      | —                              |   | (985,943 | ) | — |   |
| Other                                                  |   | —                               |      | —                              |   | — |   | 4 |   |
| Balance  at end of period                              |   | $                                    | 1,172,838 |                                | $      | 1,680,847 |   | $ | 1,172,838 |   | $ | 1,680,847 |   |
|                                                   |   |                                 |      |                                |   |   |   |   |   |
| Allowance  for credit losses to loans at period-end    |   |                                 |      |                                |   | 15.26 | % | 12.24 | % |
|                                                   |   |                                 |      |                                |   |   |   |   |   |
| Reported  loan balance(1)                              |   | $                                    | 7,685,724 |                                | $      | 13,731,841 |   | $ | 7,685,724 |   | $ | 13,731,841 |   |

 

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(1) Loan balances exclude SFAS No. 133 market value adjustments of $12million and $32 million for 2002 and 2001, respectively.  The 2002 loan balance excludes loans heldfor sale of $500 million.

 

The allowance for credit losseswas $1.17 billion, or 15.26% of reported loans, as of September 30,2002, a decrease from $1.93 billion, or 16.76% of reported loans, as ofDecember 31, 2001 and a decrease on a dollar basis from $1.68 billionand an increase on a percentage basis from 12.24% of reported loans as ofSeptember 30, 2001. The year over year increase in the allowance forcredit losses as a percentage of reported loans reflects the expected trend incredit losses after adjusting our loan mix for the sales of our interests inthe Providian Master Trust and the higher risk asset portfolio. The overall decreasein the allowance for credit losses as a dollar amount reflects the sale of ourinterests in the Providian Master Trust and the transfer to loans held forsale, and the subsequent sale, of the higher risk asset portfolio, whichresulted in a decrease of $66.6 million in the allowance for credit losses(see “—Risk Adjusted Return and Revenue”). As we continue to evaluate theallowance for credit losses in light of changes in asset quality, regulatoryrequirements, general economic trends, and the effects of our middle and primemarketing strategy, the amount of the allowance and the ratio of the allowancefor credit losses to loans may be adjusted.

 

*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 prudent levels and managinginterest rate risk.  The primary goal ofour liquidity management is to provide funding to support our operations invarying business environments. We employ multiple strategies, includingdiversification of funding sources, dispersion of maturities, and maintenanceof a prudent investment portfolio and cash balances.

 

Since our third quarter 2001earnings announcement, our debt ratings and those of PNB have been downgraded.These downgrades have had and, together with any future downgrades,

 

36

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may continue to have a negative effect on our abilityto obtain funding. In addition, access to funding has been and may continue tobe at a higher cost and on terms less favorable to us than those previouslyavailable to us, as we continue to experience the effects of the deteriorationin our financial performance and asset quality.

 

Our current long-term senior debt ratings are asfollows:

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

 

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(1)     Stable outlook.

 

During the third quarter of 2002,our liquidity position (cash and cash equivalents, federal funds sold andsecurities purchased under resale agreements, and available-for-sale investmentsecurities) decreased by approximately $1.59 billion from the secondquarter of 2002 to end the third quarter at $6.27 billion. This decreasewas primarily attributable to a reduction in deposits of approximately $800million, consistent with our goal of reducing reliance on insured deposits as asource of funding, as set forth in our Capital Plan, and to the scheduledamortization of maturing securitizations of $985 million, offset by loanattrition of approximately $145 million.

 

In addition, under the capitalassurances and liquidity maintenance agreements we entered into with ourbanking subsidiaries, which we described in our 2001 Annual ShareholdersReport, we have agreed to provide liquidity support to them. Our agreementswith the banks to provide capital and liquidity support exempt certainnear-term cash obligations of the parent, including current interestobligations on our 3.25% convertible senior notes due August 15, 2005 andcurrent payments on the Providian Capital I 9.525% capital securities. Inaddition, certain accrued deferred compensation, miscellaneous working capitalneeds not to exceed $25 million, and severance payments are generallyexempt from our obligations under the agreements.

 

*Funding Sources and Maturities.*  We seekto fund our assets by diversifying our distribution channels and offering avariety of funding products. Among the products we have historically used aredirect and brokered deposits, money market accounts, asset–backedsecurities, term federal funds, and debt issuances. Distribution channels forthese products include direct phone and mail, brokerage and investment bankingrelationships, and the Internet.

 

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

 

Given the downgrades in ourcredit ratings and deterioration in our financial performance and assetquality, our ability to attract deposits, borrow funds from other sources, andissue additional asset–backed securities has been adversely impacted andour cost of funds has risen relative to our historical levels.

 

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For the remainder of the year(October 1, 2002 through December 31, 2002), we have fundingrequirements for maturing deposits of $1.1 billion, maturingsecuritizations of $1.0 billion, and no debt maturities. We anticipatethat we will meet these funding requirements, along with any incremental assetgrowth, with securitization issuances, our liquidity position, and newdeposits.

 

*Deposits.*  Deposits decreased to$13.11 billion as of September 30, 2002 from $15.32 billion asof December 31, 2001. The decrease in deposits during the first ninemonths of 2002 is primarily due to maturities of brokered deposits that werenot replaced. Our ability to attract retail deposits through the broker channeldiminished after our third quarter 2001 earnings announcement. While stillproviding a substantial source of funding, we anticipate that during theremainder of 2002, and consistent with the Capital Plan, deposit issuances willbe at lower levels than those we have experienced historically. We did notoffer new brokered deposits during the period from January throughApril 2002, and from May 1, 2002 through September 30, 2002, raised $104million in brokered deposits. During the remainder of 2002, we expect to raisemodest amounts of new brokered deposits while continuing to reduce our overallreliance on deposit funding.

 

The following table summarizes the contractualmaturities of our deposits, substantially all of which are retail deposits:

 
|                                        |   | **September  30, 2002** |      | **December  31, 2001** |   |
|---------------------------------------------|--------|-------------------------|-----------|------------------------|--------|
| **(dollars  in thousands)**                 |   | **Direct  Deposits**    |      | **Brokered  Deposits** |   | **Total  Deposits** |   | **Direct  Deposits** |   | **Brokered  Deposits** |   | **Total  Deposits** |   |
|                                        |   |                    |      |                   |   |   |   |   |   |   |   |   |   |
| Three months or  less                       |   | $                       | 661,339   |                   | $      | 463,798 |   | $ | 1,125,137 |   | $ | 672,361 |   | $ | 961,046 |   | $ | 1,633,407 |   |
| Over three  months through twelve months(1) |   | 1,299,564               |      | 1,237,135              |   | $ | 2,536,699 |   | 1,935,051 |   | 1,281,858 |   | $ | 3,216,909 |   |
| Over one year  through five years           |   | 2,442,936               |      | 4,404,185              |   | $ | 6,847,121 |   | 2,265,691 |   | 5,399,250 |   | $ | 7,664,941 |   |
| Over five years                             |   | 38,067                  |      | 1,530,693              |   | $ | 1,568,760 |   | 29,433 |   | 1,687,232 |   | $ | 1,716,665 |   |
| Deposits without  contractual maturity      |   | 1,032,483               |      | —                 |   | $ | 1,032,483 |   | 1,086,204 |   | 39 |   | $ | 1,086,243 |   |
| Total Deposits                              |   | $                       | 5,474,389 |                   | $      | 7,635,811 |   | $ | 13,110,200 |   | $ | 5,988,740 |   | $ | 9,329,425 |   | $ | 15,318,165 |   |

 

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(1)                                  Maturities of deposits over three months throughtwelve months by quarter is as follows: first quarter 2003: $1.17 billion;second quarter 2003: $617.6 million; third quarter 2003: $746.2 million.

 

As of September 30, 2002, capital ratios for both PNBand PB were both above the “well capitalized” levels on a Call Report basis,and we have maintained those levels since March 31, 2002.  Accordingly, the restrictions on deposittaking activities described below do not currently apply to PNB and will notapply to either PNB or PB so long as they remain “well capitalized” on a CallReport basis.

 

As of December 31, 2001, capital ratios for PNB werebelow the “well capitalized” levels as reported on its Call Report. PNB wasonly “adequately capitalized” and was therefore subject to ceilings on ratespaid for deposits (limited to not more than 75 basis points higher than theprevailing rate in its market) and was restricted from taking brokered depositswithout a waiver from the FDIC.  PNBapplied for and received the required waiver. As of December 31, 2001, capital ratios for PB were above the “wellcapitalized” levels on a Call Report basis and PB was therefore not subject tosuch restrictions regarding deposit rates and brokered deposits.  See “—Our Capital Plan and Other RegulatoryMatters,” “—Supervision and Regulation Generally—Federal Deposit InsuranceCorporation Improvement Act of 1991” in our 2001 Annual Shareholders Report and“—Capital Adequacy” herein

 

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*Securitizations*.  We securitize loans in order to diversifyfunding sources and to obtain efficient all-in cost of funds, including thecost of capital.  Our securitizationshave a widely dispersed range of maturity terms.  During the third quarter of 2002, we issued no newsecuritizations.  In October 2002, wecompleted a $500 million funding of a conduit securitization in our GatewayMaster Trust.  The loans securitized inthis transaction are reflected on our balance sheet for the period endingSeptember 30, 2002 as loans held for securitization or sale.  We are working to expand this facility to anaggregate amount of $1.5 billion to $2.0 billion and to fund additionaltranches in December 2002 and the first quarter of 2003.

 

Securitizations may utilize commercial paper basedconduit and other variable funding facilities that allow the funded amount tofluctuate.  Conduit and other variablefunding facilities are generally renewable annually if the relevant conditionsfor such renewal are satisfied. Securitized funding under these facilities totaled $2.32 billionand $4.12 billion as of September 30, 2002 and 2001. The following tablepresents the amounts of these conduit and variable funding facilities expectedto amortize or otherwise become payable, based on current projections and theamounts outstanding as of September 30, 2002, during the following quarters ifthe facilities are not renewed:

 

| **During the  Quarter Ending** |   | **Amount  (dollars in millions)** |   |
|--------------------------------|--------|-----------------------------------|--------|
| December  31, 2002             |   | $                                 | 764    |   |
| March 31, 2003                 |   | 1,286                             |   |
| June  30, 2003                 |   | 271                               |   |
| September  30, 2003            |   | —                            |   |
| December  31, 2003             |   | —                            |   |
|                                |        |                                   |        |  |

 

Term securitizations are issued with expectedmaturities of one year or more.  Ourterm securitizations are expected to amortize over the periods indicated below,based on current projections and the amounts outstanding as of September 30,2002:

 

| **Year** |   | **Amount Amortizing(dollars in millions)** |   |
|----------|--------|--------------------------------------------|--------|
| 2002     |   | $                                          | 228    |   |
| 2003(1)  |   | 703                                        |   |
| 2004     |   | 1,914                                      |   |
| 2005     |   | 1,925                                      |   |
| 2006     |   | 943                                        |   |
| 2007     |   | 565                                        |   |
| 2008     |   | 224                                        |   |
|          |        |                                            |        |  |

 

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(1) Amountamortizing during:  first quarter 2003:$0; second quarter 2003: $19; third quarter 2003: $556; fourth quarter 2003:$128.

 

Given the deterioration in our financial performanceand liquidity position since our third quarter 2001 earnings announcement,there has been increased pressure on our ability to attract deposits, borrow fundsfrom other sources, and issue additional asset-backed securities as existingfunding amortizes.

 

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*UnsecuredFunding Facilities*. The following table shows our unsecured funding facilities and correspondingoutstanding amounts as of September 30, 2002:

 
|                                          |   | **September 30, 2002**     |   |
|-----------------------------------------------|--------|----------------------------|--------|
| **(dollars in thousands)**                    |   | **Effective/  Issue Date** |   | **Facility  Amount(1)** |   | **Outstanding** |   | **Maturity** |   |
| Senior  and subordinated bank note program(2) |   | 2/98                       |   | $ | 2,970,000 |   | $ | 200,347 |   | Various |   |
| Providian  Financial shelf registration(3)    |   | 6/98                       |   | 1,197,145 |   | 764,252 |   | Various |   |
| Capital  Securities                           |   | 2/97                       |   | — |   | 104,332 |   | 2/27 |   |
|                                               |        |                            |        |  |  |  |  |  |  |  |  |

 

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(1)          Funding availabilityand/or funding costs are subject to market conditions and contractualprovisions.

(2)          Available for newissuances only if debt is rated investment grade.  Facility Amount includes a sub-limit of $500 million forsubordinated bank notes.  Bank notescurrently outstanding under this program are all medium-term senior bank notes.

(3)          Outstanding securitiesissued under the shelf registration consist of two convertible debt offeringswith earliest possible required principal payment dates beginning in August2005 and February 2006.

 

The senior and subordinated bank note program wasestablished by PNB and includes potential fixed or variable rate debt withmaturities ranging from seven days to 15 years.  However, this program is available only for debt that is ratedinvestment grade at the time of issuance and is therefore not currentlyavailable to us.  There can be noassurance that we will be able to successfully utilize this program in thefuture.

 

The principal source of funds for payment of dividendson our common stock is dividends received from our banking subsidiaries.  However, our banking subsidiaries haveagreed not to pay any dividends to us during the term of their regulatoryagreements without first obtaining regulatory consent.  See “Our Capital Plan and Other RegulatoryMatters” in our 2001 Annual Shareholders Report.  Our banking subsidiaries do not currently have any plans to seeksuch approval.  In addition, our boardof directors has suspended for an indefinite period the payment of quarterlycash dividends on our common stock.

* *

*Investments*.  We maintain short-term liquidity throughinterest earning deposits with other banks, federal funds sold, money marketmutual funds, securities purchased under resale agreements and similararrangements, and other cash equivalents. We also maintain a portfolio of high-quality investment securities, suchas U.S. government and agency obligations, mortgage-backed securities, andcommercial paper.  Investment securitiesincreased to $1.72 billion as of September 30, 2002 from $1.32 billion as ofDecember 31, 2001.  Federal funds soldand securities purchased under resale agreements or similar arrangementsincreased to $4.14 billion as of September 30, 2002 from $1.61 billion as ofDecember 31, 2001.

 

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Capital Adequacy

 

Each of our banking subsidiaries is subject to capitaladequacy guidelines as defined by its primary federal regulator.  Core capital (Tier 1) consists principallyof shareholders’ equity less goodwill. Total risk-based capital (Tier 1 + Tier 2) includes a portion of thereserve for credit losses and other capital components.  Based on these classifications of capital,the capital adequacy regulations establish three capital adequacy ratios thatare used to measure whether a financial institution is “well capitalized” or“adequately capitalized,” as set forth below:

 

| **Capital Ratio** |   | **Calculation**                           |   | **Well  Capitalized  Ratios**    |   | **Adequately  Capitalized  Ratios**                                     |   |
|-------------------|--------|-------------------------------------------|--------|----------------------------------|--------|-------------------------------------------------------------------------|--------|
| Total risk-based  |   | (Tier 1 + Tier 2/Total risk-based assets) |   | 3   10            | %      | 3    8%   <    10            | %      |
| Tier 1            |   | Tier 1/Total risk-based assets            |   | 3     6 | %      | 3   4%   <      6  | %      |
| Leverage          |   | Tier 1/Adjusted average assets            |   | 3     5 | %      | 3    4%   <      5 | %      |

 

See “Our Capital Plan and Other Regulatory Matters” and “Our CapitalPlan and Other Regulatory Matters—Capital Requirements”****in our 2001 Annual Shareholders Report.  As of September 30, 2002,our banking subsidiaries’ capital ratios, as reported on their Call Reports,were as follows:

 

Capital Ratios

(Call Report Basis)

 

| **Capital Ratio** |   | **Providian  National  Bank** |   | **Providian  Bank** |   |
|-------------------|--------|-------------------------------|--------|---------------------|--------|
| Total  risk-based |   | 16.82                         | %      | 15.92               | %      |
| Tier  1           |   | 14.86                         | %      | 14.43               | %      |
| Leverage          |   | 16.63                         | %      | 7.18                | %      |

 

Pursuant to the Capital Plan, ourcapital is also evaluated under the Expanded Guidance for Subprime LendingPrograms (“Subprime Guidance”). Application of the Subprime Guidance in theCapital Plan results in a higher overall risk weighting on the loan portfolioas a whole than would otherwise be required by the regulations. Under themethodology utilized under the Capital Plan for determining risk weightings,our banking subsidiaries have segmented their standard and middle market loanportfolios into several categories differentiated by the banks’ internal creditscores and historical and projected dollar charge-off rates. As applied by thebanks as of September 30, 2002, this methodology resulted in a weightedaverage risk weighting of approximately 171% against reported standard andmiddle segment loans of approximately $6.03 billion as ofSeptember 30, 2002. Managed loans outstanding to customers in the standardand middle segments totaled approximately $17.28 billion as ofSeptember 30, 2002. See “Our Capital Plan and Other Regulatory Matters”and “Our Capital Plan and Other Regulatory Matters—Capital Requirements” in our2001 Annual Shareholders Report.

 

The resulting capital ratios,after applying the Subprime Guidance, as of September 30, 2002, were asfollows:

 

Capital Ratios

(Applying SubprimeGuidance)

 

| **Capital Ratio** |   | **Providian  National  Bank** | ** ** | **Providian  Bank** |   |
|-------------------|--------|-------------------------------|------------|---------------------|--------|
| Total  risk-based |   | 12.31                         | %          | 9.58                | %      |
| Tier  1           |   | 10.71                         | %          | 8.20                | %      |
| Leverage          |   | 16.63                         | %          | 7.18                | %      |

 

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PNB individually, and PNB and PB, on a combined basis,have met the commitment in the Capital Plan to achieve, by March 31, 2002, atotal risk-based capital ratio of at least 8% after applying the Subprime Guidancerisk weightings. PNB and PB, on a combined basis, have committed to achieve, byJune 30, 2003, a total risk-based capital ratio of at least 10% after applyingthe Subprime Guidance risk weightings. As of September 30, 2002, PNB and PB, individually and on a combinedbasis, had total risk-based capital ratios exceeding 8% after applying theSubprime Guidance risk weightings. Future capital ratios will depend on the level of internally generatedcapital as well as the level of loan growth, changes in loan mix, and the levelof other residual assets related to our securitization activity.  Growth in on-balance sheet receivables,combined with the growth in spread accounts and other subordinated retainedinterests relating to our securitizations, may result in the fluctuation of thebanks’ total risk-based capital ratios, as reported in their Call Reports andtotal risk-based capital ratios after applying the Subprime Guidance.  In addition, the outcome of discussions withour regulators concerning capital treatment of the AIR advisory (see “ —Capital Plan and Related Matters”) may affect future capital ratios.  However, with the completion of our assetdispositions and the implementation of other strategic initiatives, as well asthe generation of internal capital through the recognition of net income, andsubject to the ongoing review and update of our Capital Plan (see “Our CapitalPlan and Other Regulatory Matters” in our 2001 Annual Shareholders Report), weexpect that our banking subsidiaries will be able to achieve the capital goalsin our Capital Plan as required.

 

The capital requirements and classifications of ourbanking subsidiaries are also subject to qualitative judgments by theirregulators with respect to components, risk weightings, and other factors.  The banking regulators have the authority torequire us to adhere to higher capital requirements.  This would necessitate increasing capital ratios by various means,including asset sales or equity issuances. In addition, the strategic initiatives that we have taken, and any thatwe are in the process of taking or may take in the future, could have an impacton the capital requirements of our banking subsidiaries.

 

In accordance with the banking regulators’ risk-basedcapital standards, risk-based capital must be maintained for assets transferredwith recourse, in an amount no greater than the maximum amount of recourse forwhich a regulated entity is contractually liable.  This rule, known as the low-level recourse rule, applies totransactions accounted for as sales under GAAP in which a bank contractuallylimits its risk of loss or recourse exposure to less than the full effectiveminimum risk-based capital requirement for the assets transferred.  Low-level recourse transactions arise when abank securitizes assets and uses contractual cash flows, retained subordinatedinterests, or other assets as credit enhancements.  Accordingly, our banking subsidiaries are required to holdrisk-based capital equivalent to the maximum recourse exposure on the assetstransferred, not to exceed the amount of risk-based capital that would berequired if the low-level recourse rule did not apply.

 

In November 2001, the federal banking agenciespublished a final rule to revise the agencies’ regulatory capital standards toaddress the treatment of recourse obligations, residual interests and directcredit substitutes that expose banks to credit risk (the “residual interestrule”).  The residual interest rule addsnew standards for the treatment of residual interests, including aconcentration limit for credit-enhancing interest-only strips.  This rule is intended to result in moreconsistent regulatory capital treatment for certain transactions involvingsimilar risk, and capital requirements that more closely reflect a bankingorganization’s relative exposure to credit risk.  The final rule was effective January 1, 2002 for anytransaction covered under the rule that settles on or after the effective date.  Banks that entered into transactions beforethe effective date may elect early adoption of any provision of the final ruleor may delay application of the rule to those transactions until December 31,2002.  Our banking subsidiaries electedearly adoption of the residual interest rule, effective January 1, 2002.

 

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Specifically, the final rule amends the currentcapital standards by: providing a more consistent risk-based capital treatmentfor recourse obligations and direct credit substitutes; applying a ratings-basedapproach that sets capital requirements for positions in securitizedtransactions; deducting from Tier 1 capital the amount of credit-enhancinginterest-only strips that exceeds 25% of Tier 1 capital (concentration limit);and requiring “dollar-for-dollar” risk based capital for certain residualinterests not deducted from Tier 1 capital (dollar-for-dollar capitalrequirement).  As of September 30, 2002,PNB’s interest-only strips represented 6.4% of its Tier 1 capital, which isbelow the 25% concentration limit, and PB had no interest-only strips.

 

*Asset/Liability Risk Management*

 

Our assets and liabilities consist primarily ofinvestments in interest-earning assets (loans receivable and investmentsecurities) that are primarily funded by interest-bearing liabilities (depositsand borrowings).  As a result, ourearnings are subject to risk resulting from interest rate fluctuations to theextent that there is a difference between the amount of interest-earning assetsand the amount of interest-bearing liabilities that mature, reprice, prepay orwithdraw in a specific period.

 

Our receivables accrue finance charges at rates thatare either fixed or float at a spread above the prime rate.  While our fixed rate credit card receivableshave no stated maturity or repricing period, we generally may adjust the ratecharged after providing the required notice to the customer.  Interest rates on our liabilities aregenerally indexed to LIBOR or bear a fixed rate until maturity.  This asset/liability structure exposes us totwo types of interest rate risk:  (a)repricing risk, which results from differences between the timing of ratechanges and the timing of cash flows; and (b) basis risk, which arisesfrom changing spread relationships between yield curves and indexes.

 

The principal objective of our asset/liability riskmanagement activities is to monitor and control our exposure to adverse effectsresulting from movements of interest rates over time.  We measure and manage interest rate risk individually for eachbanking subsidiary and on a consolidated basis, including both reported andmanaged assets and liabilities.  Tomeasure exposure to interest rate changes, we use net interest income (NII) andmarket value of portfolio equity (MVPE) simulation analysis.

 

The following table presents the estimated effects ofpositive and negative parallel shifts in interest rates as calculated atSeptember 30, 2002 using our interest rate risk model and takes intoconsideration our current hedging activity:

 
|                                           |   | **Percentage Change In(1)** |   |
|------------------------------------------------|--------|-----------------------------|--------|
| **Change in Interest Rates (in basis points)** |   | **NII(2)**                  |   | **MVPE(3)** |   |
| +200                                           |   | 1.8                         | %      | (0.6 | )% |
| Flat                                           |   | 0                           | %      | 0 | % |
| -200                                           |   | (1.5                        | )%     | 0.1 | % |

 

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(1)                                  Theinformation shown is presented on a consolidated managed asset/liability basis,giving effect to securitizations and related funding.

(2)                                  Thiscolumn compares NII over twelve months in a stable interest rate environment toscenarios in which interest rates rise and fall by 200 basis points.

(3)                                  Thiscolumn compares MVPE in a stable interest rate environment to scenarios inwhich interest rates rise and fall by 200 basis points.  MVPE is defined as the present value ofexpected net cash flows from existing assets, liabilities, and off-balancesheet transactions.

 

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As part of our interest rate riskmeasurement process, we estimate the repricing sensitivity of our fixed ratecredit card loans. The actual repricing sensitivity of these loans depends onhow our customers and competitors respond to changes in market interest rates.In addition, the repricing of certain categories of assets and liabilities issubject to competitive and other pressures beyond our control. As a result,certain assets and liabilities assumed to mature or otherwise reprice within acertain period may in fact mature or reprice at different times and atdifferent volumes. As of September 30, 2002, we modeled the repricingmaturity of our fixed rate credit card loans based on an average maturity of15 months. The table above should be viewed as our estimate of the generaleffect of broad and sustained interest rate movements on our net income andportfolio value, calculated as of September 30, 2002.

 

We generally seek to mitigateearnings volatility associated with interest rate movement by matching themodeled repricing characteristics of reported and managed assets andliabilities. When matching the repricing characteristics of assets andliabilities is not possible or efficient, we generally seek to use derivativefinancial instruments, including interest rate swap and cap agreements, toreduce interest rate risk. We do not trade derivatives or use derivatives tospeculate on interest rates and we believe our use of such instruments isprudent and consistent with industry standards.

 

Foreign currency exchange raterisk refers to the potential changes in current and future earnings or capitalarising from movements in foreign exchange rates. At September 30, 2002,our foreign currency exposure has been reduced to small cash balances inBritish pounds sterling. The following table presents the notionalamounts of interest rate swap and cap agreements in the periods indicated:

 
|                               |   | **Three months ended September 30,** |      | **Nine months ended September 30,** |   |
|------------------------------------|--------|--------------------------------------|-----------|-------------------------------------|--------|
| **(dollars in thousands)**         |   | **2002**                             |      | **2001**                            |   | **2002** |   | **2001** |   |
|                               |   |                                 |      |                                |   |   |   |   |   |
| **Interest  Rate Swap Agreements** |   |                                 |      |                                |   |   |   |   |   |
| Beginning  balance                 |   | $                                    | 1,163,200 |                                | $      | 1,990,476 |   | $ | 1,293,200 |   | $ | 1,375,476 |   |
| Additions                          |   | —                               |      | 633,000                             |   | — |   | 1,815,500 |   |
| Maturities                         |   | 150,000                              |      | 577,500                             |   | 280,000 |   | 1,145,000 |   |
| Ending balance                     |   | $                                    | 1,013,200 |                                | $      | 2,045,976 |   | $ | 1,013,200 |   | $ | 2,045,976 |   |
|                               |   |                                 |      |                                |   |   |   |   |   |
| **Interest  Rate Cap Agreements**  |   |                                 |      |                                |   |   |   |   |   |
| Beginning  balance                 |   | $                                    | 4,871     |                                | $      | 10,306 |   | $ | 7,883 |   | $ | 13,625 |   |
| Additions                          |   | —                               |      | —                              |   | — |   | — |   |
| Maturities                         |   | 1,871                                |      | 1,327                               |   | 4,883 |   | 4,646 |   |
| Ending balance                     |   | $                                    | 3,000     |                                | $      | 8,979 |   | $ | 3,000 |   | $ | 8,979 |   |

 

Notional amounts of interest rateswaps outstanding have decreased from the prior year, primarily as the need forhedging requirements declined in conjunction with the decrease in fixed rateloans. As market conditions or our asset/liability mix change, we may increaseor decrease the notional amount of interest rate swaps and caps outstanding inorder to manage our interest rate risk within prudent levels.

 

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We manage credit risk arisingfrom derivative transactions through an ongoing credit review, approval, andmonitoring process. “Credit risk” for these derivative transactions is definedas the risk that a loss will occur as the result of a derivative counterpartydefaulting on a contract when the contract is in a favorable economic positionto us. We may enter into master netting, market settlement, orcollateralization agreements with derivative counterparties to further reducethe credit exposure arising from our hedging transactions.

 

*Cautionary Statement Regarding Forward–LookingInformation*

 

This report contains certainforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended, which are subject to the “safe harbor”created by those sections. Forward-looking statements include, withoutlimitation: expressions of the “belief,” “anticipation,” or “expectations” ofmanagement; statements as to industry trends or future results of operations ofour company and our subsidiaries; and other statements that are not historicalfact. Forward-looking statements are based on certain assumptions by managementand are subject to risks and uncertainties that could cause actual results todiffer materially from those in the forward-looking statements. These risks anduncertainties include, but are not limited to, competitive pressures; factorsthat affect delinquency rates, credit loss rates and charge-off rates; generaleconomic conditions; consumer loan portfolio growth; changes in the cost and/oravailability of funding due to changes in the deposit, credit or securitizationmarkets; changes in the way we are perceived in such markets and/or conditionsrelating to existing or future financing commitments; the effect of governmentpolicy and regulation, whether of general applicability or specific to us,including restrictions and/or limitations relating to our minimum capitalrequirements, deposit taking abilities, reserving methodologies, dividendpolicies and payments, growth, and/or underwriting criteria; changes inaccounting rules, policies, practices and/or procedures; product development;legal and regulatory proceedings, including the impact of ongoing litigation; interestrates; acquisitions; one-time charges; extraordinary items; the ability toattract and retain key personnel; the impact of existing, modified, or newstrategic initiatives; and international factors. These and other risks anduncertainties are described in our annual report to shareholders included inExhibit 13 of our Annual Report on Form 10-K for the year endedDecember 31, 2001 under the heading “Risk Factors,” and are also describedin other parts of our 2001 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 any forward–lookingstatement, which speaks only as of the date thereof. We undertake no obligationto update any forward-looking statements.

 

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**Item4.  Controls and Procedures.**

 

Within the 90 days prior to the date of this report,the Company’s management, under the supervision and with the participation ofthe Company’s Chief Executive Officer and Chief Financial Officer, conducted anevaluation of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures (as defined in Exchange Act Rule 13a-14(c)).  The Chief Executive Officer and the ChiefFinancial Officer concluded that the Company’s disclosure controls andprocedures, which have been designed to ensure that information required to bedisclosed by the Company in the periodic reports it files under the Exchange Actis recorded, processed, summarized and reported in a timely manner, areeffective based on such evaluation. There have been no significant changes in internal controls or in otherfactors that could significantly affect internal controls subsequent to thedate of such evaluation.

 

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**PARTII.  OTHER INFORMATION**

 

**Item1.  Legal Proceedings.**

 

Following the Company’s third quarter earningsannouncements in October 2001, a number of lawsuits were filed.  These include Rule 10b-5 securities classactions filed in the District Court for the Northern District of Californiaagainst the Company and certain of its executive officers and/ordirectors.  These consolidated actionsallege that the Company and certain of its officers made false and misleadingstatements concerning the Company’s operations and prospects for the second andthird quarters of 2001, in violation of federal securities laws.  The actions define the putative class as those persons or entities who acquired theCompany’s stock between June 6 and October 18, 2001, and they seek damages,interest, costs and attorneys’ fees. The Company’s motion to dismiss the actions was heard on June 21, 2002,and the parties are awaiting a ruling by the court.

 

In addition, two shareholder derivative actions datedDecember 2001 and January 2002 were filed in California state court in SanFrancisco.  These actions generally seekredress against the members of the Company’s board of directors and certainexecutive officers and allege breach of fiduciary duty, gross negligence,breach of contract and violation of state insider trading law.  The complaints seek damages (in the name ofthe Company and to be awarded to the Company), attorneys’ fees and otherrelief.  The parties have agreed totemporarily suspend the proceedings in their cases.

 

Beginning in December 2001, several class actioncomplaints were filed in the District Court for the Northern District ofCalifornia against the Company and/or certain of its executive officers anddirectors regarding the Company’s 401(k) plan (the “Plan”).  The purported class  comprises all persons who were participantsor beneficiaries of the Plan since July 17, 2001.  These consolidated actions allege, among other things, that the defendants breached their fiduciaryduties under the Employee Retirement Income Security Act by encouragingparticipants to invest in the Company’s common stock, and restricting sales ofthe common stock held under the Plan, at a time when the common stock was anunsuitable Plan investment.  Thecomplaints seek compensatory and punitive damages, attorneys’ fees and otherrelief.  The Company’s motion to dismissthese actions was heard on October 11, 2002, and the parties are awaiting aruling by the court.

 

In other matters, in June 2000 the Company reachedsettlements with the San Francisco District Attorney, the California AttorneyGeneral and the Connecticut Attorney General, and Providian National Bankreached a settlement with the Office of the Comptroller of the Currency,regarding alleged unfair and deceptive business practices.  Under these settlements, the Company andcertain subsidiaries of the Company, including Providian National Bank, agreedto make certain changes to their business practices and to pay restitution tocustomers, which resulted in a charge to earnings in 2000.  As part of the settlements, ProvidianNational Bank stipulated to the issuance by the Comptroller of a Consent Orderobligating Providian National Bank to make such changes, and the Company andcertain of its subsidiaries stipulated to the entry of a judgment and theissuance of a permanent injunction effecting the terms of the settlement.

 

In December 2000, the Company reached an agreement tosettle state and federal lawsuits alleging unfair and deceptive businesspractices that had been filed against the Company and

 

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certain of its subsidiaries, beginning in May 1999, by current andformer customers of the Company’s banking subsidiaries.  Under the settlement, the Company andcertain of its subsidiaries, including Providian National Bank, agreed to makepayments to customers, which resulted in a charge to the Company’s 2000 earnings,and agreed to injunctive relief incorporating the same business practicechanges included in the Company’s settlements with the Comptroller, the SanFrancisco District Attorney and the California and Connecticut AttorneysGeneral.  The lawsuits covered by thesettlement consist of: a consolidated putative class action lawsuit (In reProvidian Credit Card Litigation) (the “Consolidated Action”) that was filed inAugust 1999 in California state court in San Francisco against the Company,Providian National Bank, and certain other subsidiaries of the Company; similaractions filed in other California counties that were transferred to SanFrancisco County and coordinated with the Consolidated Action; and severalputative class actions, containing substantially the same allegations as thosealleged in the Consolidated Action, that were filed in federal courts(the”Multidistrict Action”) and transferred to the Eastern District ofPennsylvania.  The settlement receivedfinal state court approval in November 2001, and the Multidistrict Action wasdismissed on March 14, 2002. Approximately 6,400 class members opted out of participation in thesettlement, approximately 1,500 of whom have filed individual actions againstthe Company.

 

Another purported class action, containingsubstantially similar claims as those alleged in the Consolidated Action, wasproceeding in state court in Bullock County, Alabama. After a class wascertified by the trial court, the Alabama Supreme Court decertified the classon appeal.

 

In February 2002, the Company agreed to settle aputative class action (In re Providian Securities Litigation), which was aconsolidation of complaints filed in the United States District Court for theEastern District of New York in June 1999 and transferred to the EasternDistrict of Pennsylvania.  Thecomplaints alleged, in general, that the Company and certain of its executiveofficers made false and misleading statements in violation of the federalsecurities laws concerning its future prospects and financial results andsought damages in an unspecified amount, in addition to pre-judgment andpost-judgment interest, costs and attorneys’ fees.  The settlement class acquired the Company’s stock between January15, 1999 and May 26, 1999.  Thesettlement, which was approved by the court, totaled $38 million and was fundedby the Company’s insurance carriers.

 

Two shareholder derivative actions were filed in Juneand July 2000 in California state court in San Francisco and, in December 2000,a shareholder derivative lawsuit was filed in Delaware state court.  These actions seek redress against themembers of the Company’s board of directors and certain executive officers andallege breach of fiduciary duty and corporate waste arising out of allegedunfair business practices similar to the ones that were at issue in theMultidistrict Action and the Consolidated Action. An agreement to settle theseactions received court approval on October 23, 2002.  The settlement requires the Company to adopt certain corporate governancemeasures and includes a payment of $1.75 million in attorneys’ fees, which willbe funded by the Company’s insurers.

 

In February 2001, the Company was named as a defendantin a consumer class action suit entitled Ross v. VISA, U.S.A., Inc., et al.,which was filed in the United States District Court for the Eastern District ofPennsylvania against VISA, MasterCard and a number of credit card issuingbanks.  The suit alleges that uniformforeign currency surcharges allegedly imposed by the defendants are the resultof a conspiracy in restraint of trade and violate the federal antitrust laws,and that the defendant banks failed to separately identify these surcharges totheir

 

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customers on their monthly statements in violation of the federalTruth-in-Lending Act.  A number ofsimilar lawsuits have since been filed in California and New York.  In August 2001, the Federal Judicial Panelon Multidistrict Litigation transferred all of these cases to the SouthernDistrict of New York.  In January 2001,plaintiffs filed an amended consolidated complaint.  On March 21, 2002, the Company moved to dismiss the amendedconsolidated complaint.  The parties areawaiting a ruling by the court.

 

On July 3, 2002, a state court class action complaintwas filed against the Company alleging that the Company’s Paid-Time-Off (“PTO”)plan violates California Labor Code section 227.3 because the Company caps thepayout of PTO benefits for terminated employees at forty (40) hours.  The Company removed the case to federalcourt on the grounds that federal ERISA law governs the PTO plan and thereforepre-empts California law. Plaintiffs intend to file a motion to remand afterdiscovery relating to jurisdiction is complete.

 

The Company continues to engage in discussions withits former Cheif Executive Officer, Shailesh Mehta, concerning severance andother benefits alleged to be due under Mr. Mehta’s employment agreement inconnection with the termination of his employment in November 2001, subject toapplicable regulatory constraints. During the third quarter of 2002, Mr. Mehta filed a claim in arbitrationseeking damages for breach of his employment agreement.  There have been no proceedings with respectto the claim since it was filed.  In themeantime, the Company is continuing to negotiate the extent of the obligationsof the Company to Mr. Mehta.

 

In addition, the Company is commonly subject tovarious other pending and threatened legal actions arising in the ordinarycourse of business from the conduct of its activities.  An informed assessment of the ultimateoutcome or potential liability associated with the Company’s pending lawsuitsand other potential claims that could arise is not feasible at this time.

 

Due to the uncertainties of litigation, the Company cangive no assurance that it will prevail on all claims made against it in thelawsuits that it currently faces or that additional proceedings will not bebrought.  While the Company believesthat it has substantive defenses in the actions described above and intends todefend those actions vigorously, we cannot predict the ultimate outcome or thepotential future impact on the Company of such actions.  The Company does not presently expect any ofthese actions to have a material adverse effect on its financial condition orresults of operations, but can give no assurance that they will not have suchan effect.

 

**Item 5.**  Other Information.

 

Pre-Approval of Non-Audit Services:

 

In accordance with Section 10A(i) of the SecuritiesExchange Act of 1934, in October 2002 the Audit and Compliance Committee of ourBoard of Directors pre-approved the engagement of our audit firm, Ernst &Young LLP, to perform certain non-audit, tax-related services.

 

**Item6.** Exhibits andReports on Form 8-K.

 

(a)           ExhibitsRequired by Item 601 of Regulation S-K.

 
| Exhibit 12.1 | Computation of Earnings to Fixed Charges and Ratio  of Earnings to Combined Fixed Charges and Preferred Stock Dividend  Requirements. |
|--------------|---------------------------------------------------------------------------------------------------------------------------------------|
|         |                                                                                                                                  |
| Exhibit 99.1 | Certification of Periodic Report                                                                                                      |
|         |                                                                                                                                  |
| Exhibit 99.2 | Certification of Periodic Report                                                                                                      |

 

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(b)           Reports on Form 8-K.

 

The Company filed the following reports on Form 8-Kduring the third quarter of 2002:

 

The Company filed a report on Form 8-K (dated July 9,2002) on July 10, 2002 with respect to the completion on June 25, 2002 of thestructured sale of a portfolio of higher risk credit card receivables, whichwas effected through PACCT, LLC, a limited liability company subsidiary ofProvidian National Bank.

 

The Company filed a report on Form 8-K (dated July 15,2002) on July 15, 2002 with respect to its managed net credit loss rate for themonth ended June 30, 2002 and its 30+ day managed delinquency rate as of June30, 2002.

 

The Company filed a report on Form 8-K (dated August14, 2002) on August 14, 2002, attaching copies of the sworn statement by eachof the Principal Executive Officer, Joseph Saunders, and Principal FinancialOfficer, Anthony F. Vuoto, of the Company submitted on August 14, 2002 to theSecurities Exchange Commission pursuant to Securities and Exchange CommissionOrder No. 4-460.

 

The Company filed a report on Form 8-K (dated August15, 2002) on August 15, 2002 with respect to its managed net credit loss ratefor the month ended July 31, 2002 and its 30+ day managed delinquency rate asof July 31, 2002.

 

The Company filed a report on Form 8-K (datedSeptember 16, 2002) on September 17, 2002 with respect to its managed netcredit loss rate for the month ended August 31, 2002 and its 30+ day managed delinquency rate as of August 31, 2002,including results from both reported and securitized loans, including loanssecuritized in the Providian Gateway Master Trust.

 

(e)           Ratio of Earnings toFixed Charges and Ratio of Earnings to Combined Fixed Charges and PreferredStock Dividend Requirements.

 
|                                        |   | **Nine  Months  Ended  September 30  2002** |                        |   |     |   |     |   |     |   |     |   |   |
|---------------------------------------------|--------|---------------------------------------------|-----------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|--------|
|                                        |   |                                        |                        |   |     |   |     |   |     |   |     |   |
|                                        |   |                                        | **Year  Ended December 31** |   |
|                                        |   |                                        | **2001**                    |   | **2000** |   | **1999** |   | **1998** |   | **1997** |   |
|                                        |   |                                        |                        |   |     |   |     |   |     |   |     |   |   |
| **Earnings  to Fixed Charges**              |   |                                        |                        |   |     |   |     |   |     |   |     |   |   |
| Excluding interest on deposits              |   | 4.18                                        |                        | 3.68   |     | 14.91  |     | 10.05  |     | 10.88  |     | 14.20  |   |
| Including interest on deposits              |   | 1.29                                        |                        | 1.24   |     | 2.27   |     | 3.03   |     | 2.93   |     | 2.66   |   |
|                                        |   |                                        |                        |   |     |   |     |   |     |   |     |   |   |
| **Earnings  to Combined Fixed Charges and** |   |                                        |                        |   |     |   |     |   |     |   |     |   |   |
| **Preferred  Stock(1)**                     |   |                                        |                        |   |     |   |     |   |     |   |     |   |   |
| Excluding interest on deposits              |   | 4.18                                        |                        | 3.68   |     | 14.91  |     | 10.05  |     | 10.88  |     | 13.28  |   |
| Including interest on deposits              |   | 1.29                                        |                        | 1.24   |     | 2.27   |     | 3.03   |     | 2.93   |     | 2.63   |   |

 

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(1)  Preferred stock dividend requirements areadjusted to represent a pretax earnings equivalent.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                           |   | Providian Financial Corporation                                                                                            |
|--------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------|
|                           |   | (Registrant)                                                                                                               |
|                           |   |                                                                                                                       |
| Date:   November 14, 2002 |   | /s/ Anthony F. Vuoto                                                                                                       |   |
|                           |   | Anthony F. Vuoto  Vice Chairman and  Chief Financial Officer  (Principal Financial Officer and Duly  Authorized Signatory) |   |
|                           |   |                                                                                                                       |   |
| Date:   November 14, 2002 |   | /s/ Daniel Sanford                                                                                                         |   |
|                           |   | Daniel Sanford  Executive Vice President and Controller  (Chief Accounting Officer and Duly  Authorized Signatory)         |

 

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**CERTIFICATION**

 

I, Joseph Saunders, the President and Chief ExecutiveOfficer of Providian Financial Corporation (the “Company”), certify that:

 

1. I have reviewed this quarterly report on Form 10-Qof the Company;

 

2. Based on my knowledge, this quarterly report doesnot contain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3. Based on my knowledge, the financial statements,and other financial information included in this quarterly report, fairlypresent in all material respects the financial condition, results of operationsand cash flows of the registrant as of, and for, the periods presented in thisquarterly report;

 

4. The registrant’s other certifying officers and Iare responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a) designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is being prepared;

 

b) evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

 

c) presented in this quarterly report our conclusionsabout the effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officers and Ihave disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

a) all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b) any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6. The registrant’s other certifying officers and Ihave indicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent

 

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evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
|   | Date: November 14, 2002 |   |   |   |                                  |   |   |
|--------|-------------------------|--------|--------|--------|---------------------------------------|--------|--------|
|   |                    |   |   |   |                                  |   |   |
|   |                    |   |   |   | /s/ Joseph Saunders                   |   |
|   |                    |   |   |   | Joseph Saunders                       |
|   |                    |   |   |   | President and Chief Executive Officer |
|        |                         |        |        |        |                                       |        |        |  |

 

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**CERTIFICATION**

 

I, Anthony F. Vuoto, the Chief Financial Officer ofProvidian Financial Corporation (the “Company”), certify that:

 

1. I have reviewed this quarterly report on Form 10-Qof the Company;

 

2. Based on my knowledge, this quarterly report doesnot contain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3. Based on my knowledge, the financial statements,and other financial information included in this quarterly report, fairlypresent in all material respects the financial condition, results of operationsand cash flows of the registrant as of, and for, the periods presented in thisquarterly report;

 

4. The registrant’s other certifying officers and Iare responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a) designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;

 

b) evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

 

c) presented in this quarterly report our conclusionsabout the effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officers and Ihave disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

a) all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and have identifiedfor the registrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6. The registrant’s other certifying officers and Ihave indicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent

 

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evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date: November  14, 2002 |   |   |   |   |                    |   |
|--------------------------|--------|--------|--------|--------|-------------------------|--------|
|                     |   |   |   |   |                    |   |   |
|                     |   |   |   |   | /s/ Anthony F. Vuoto    |   |
|                     |   |   |   |   | Anthony F. Vuoto        |
|                     |   |   |   |   | Chief Financial Officer |
|                          |        |        |        |        |                         |        |  |  |

 

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