**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington D.C.  20549**

 

**FORM 10-Q**

 

**(MarkOne)**
| ý                                             |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|----------------------------------------------------|--------|-----------------------------------------------------------------------------------------------|
|                                               |   |                                                                                          |
| **For the quarterly period ended  March 31, 2003** |
|                                               |   |                                                                                          |
| **OR**                                             |
|                                               |   |                                                                                          |
| o                                                  |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**For thetransition periodfrom             to             **

 

**1-12897**

**(Commission File 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 ofprincipal executive offices) (Zip Code)

 

**(415) 543-0404**

(Registrant’sTelephone 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 April 30, 2003, there were 289,842,603 shares ofthe registrant’s Common Stock, par value $0.01 per share, outstanding.

 

 

----

 

**PROVIDIAN FINANCIAL CORPORATION**

**FORM10-Q**

 

**INDEX**

 

**March 31, 2003**

 
| **PART I.**        | **FINANCIAL INFORMATION** | **Page**                                                                                    |   |
|--------------------|---------------------------|---------------------------------------------------------------------------------------------|--------|
|               |                      |                                                                                        |   |
|               | **Item 1.**               | Financial Statements  (unaudited):                                                          |   |
|               |                      | Consolidated  Statements of Financial Condition                                             | 3      |
|               |                      | Consolidated  Statements of Income                                                          | 4      |
|               |                      | Consolidated  Statements of Changes in Shareholders’ Equity                            | 5      |
|               |                      | Consolidated  Statements of Cash Flows                                                      | 6      |
|               |                      | Notes  to Consolidated Financial Statements                                                 | 7      |
|               |                      |                                                                                        |   |
|               | **Item 2.**               | Management’s Discussion and Analysis  of Financial Condition and Results of Operations | 16     |
|               |                      |                                                                                        |   |
|               | **Item 3.**               | Quantitative and Qualitative  Disclosures About Market Risk                                 | 33     |
|               |                      |                                                                                        |   |
|               | **Item 4.**               | Controls and Procedures                                                                     | 33     |
|               |                      |                                                                                        |   |
| **PART  II.**      | **OTHER  INFORMATION**    |                                                                                        |   |
|               |                      |                                                                                        |   |
|               | **Item 1.**               | Legal Proceedings                                                                           | 34     |
|               |                      |                                                                                        |   |
|               | **Item 4.**               | Submission of Matters to a  Vote of Security Holders                                        | 35     |
|               |                      |                                                                                        |   |
|               | **Item 6.**               | Exhibits and Reports on Form 8-K                                                            | 36     |
|               |                      |                                                                                        |   |
| **SIGNATURES**     |                      | 37                                                                                          |
|               |                      |                                                                                        |   |
| **CERTIFICATIONS** |                      | 38                                                                                          |
|                    |                           |                                                                                             |        |  |  |  |  |

 

 

2

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**PARTI.  FINANCIAL INFORMATION**

 

**Item1.  Financial Statements.**

 

**Providian Financial Corporation and Subsidiaries****Consolidated State****ments of Financial Condition**

 
| **(dollars  in thousands, except per share data)**                                                                                                                                       |   | **March 31,  2003** |       | **December  31,  2002** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|-------------------------|--------|
|                                                                                                                                                                                     |   | **(unaudited)**     |       |                    |   |
| Assets                                                                                                                                                                                   |   |                |       |                    |   |
| Cash and cash  equivalents                                                                                                                                                               |   | $                   | 490,063    |                    | $      | 344,277 | ** ** |
| Federal funds  sold and securities purchased under resale agreements                                                                                                                     |   | 4,226,000           |       | 3,601,000               |   |
| Investment  securities:                                                                                                                                                                  |   |                |       |                    |   |
| Available-for-sale  (at market value, amortized cost of $1,850,059 at March 31, 2003 and  $1,839,854 at December 31, 2002)                                                     |   | 1,849,754           |       | 1,856,607               |   |
| Loans  receivable, less allowance for credit losses of $978,202 at March 31,  2003 and $1,012,461 at December 31, 2002                                                         |   | 6,168,418           |       | 5,895,296               |   |
| Premises and  equipment, net                                                                                                                                                             |   | 108,891             |       | 119,260                 |   |
| Interest  receivable                                                                                                                                                                     |   | 58,408              |       | 60,841                  |   |
| Due from  securitizations                                                                                                                                                                |   | 3,015,631           |       | 3,723,382               |   |
| Deferred taxes                                                                                                                                                                           |   | 425,949             |       | 487,529                 |   |
| Other assets                                                                                                                                                                             |   | 263,538             |       | 622,197                 |   |
| Total assets                                                                                                                                                                             |   | $                   | 16,606,652 |                    | $      | 16,710,389 | ** ** |
|                                                                                                                                                                                     |   |                |       |                    |   |
| Liabilities                                                                                                                                                                              |   |                |       |                    |   |
| Deposits:                                                                                                                                                                                |   |                |       |                    |   |
| Non-interest  bearing                                                                                                                                                                    |   | $                   | 47,896     |                    | $      | 56,724 | ** ** |
| Interest bearing                                                                                                                                                                         |   | 12,544,817          |       | 12,651,591              |   |
|                                                                                                                                                                                     |   | 12,592,713          |       | 12,708,315              |   |
|                                                                                                                                                                                     |   |                |       |                    |   |
| Short-term  borrowings                                                                                                                                                                   |   | 108,722             |       | 91,560                  |   |
| Long-term  borrowings                                                                                                                                                                    |   | 760,167             |       | 877,238                 |   |
| Deferred fee  revenue                                                                                                                                                                    |   | 170,605             |       | 211,978                 |   |
| Accrued expenses  and other liabilities                                                                                                                                                  |   | 735,705             |       | 577,894                 |   |
| Total  liabilities                                                                                                                                                                       |   | 14,367,912          |       | 14,466,985              |   |
|                                                                                                                                                                                     |   |                |       |                    |   |
| 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:  March 31, 2003—290,715,884 shares; December 31, 2002— 290,880,218  shares)        |   | 2,907               |       | 2,909                   |   |
| Retained  earnings                                                                                                                                                                       |   | 2,176,468           |       | 2,202,960               |   |
| Cumulative other  comprehensive income                                                                                                                                                   |   | (253                | )          | 9,888                   |   |
| Common stock  held in treasury—at cost: (March 31, 2003—871,419 shares;  December 31, 2002—1,498,398 shares)                                                    |   | (44,714             | )          | (76,685                 | )      |
| Total  shareholders’ equity                                                                                                                                                         |   | 2,134,408           |       | 2,139,072               |   |
| Total  liabilities and shareholders’ equity                                                                                                                                         |   | $                   | 16,606,652 | ** **              | $      | 16,710,389 | ** ** |

 

See Notes to Consolidated Financial Statements.

 

3

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**Providian Financial Corporation and Subsidiaries****Consolidated Statements****of Income(unaudited)**

 
|                                                                 |   | **Three  months ended March 31,** |    |
|----------------------------------------------------------------------|--------|----------------------------------------|---------|
| **(dollars  in thousands, except per share data)**                   |   | **2003**                               |    | **2002** |   |
|                                                                 |   |                                   |    |   |   |
| Interest Income                                                      |   |                                   |    |   |   |
| Loans                                                                |   | $                                      | 310,340 |   | $ | 488,085 |   |
| Federal funds  sold and securities purchased under resale agreements |   | 9,826                                  |    | 5,609 |   |
| Other                                                                |   | 32,033                                 |    | 38,641 |   |
| Total interest  income                                               |   | 352,199                                |    | 532,335 |   |
|                                                                 |   |                                   |    |   |   |
| Interest Expense                                                     |   |                                   |    |   |   |
| Deposits                                                             |   | 161,222                                |    | 195,303 |   |
| Borrowings                                                           |   | 10,623                                 |    | 11,752 |   |
| Total interest  expense                                              |   | 171,845                                |    | 207,055 |   |
|                                                                 |   |                                   |    |   |   |
| Net interest  income                                                 |   | 180,354                                |    | 325,280 |   |
|                                                                 |   |                                   |    |   |   |
| Provision for  credit losses                                         |   | 261,815                                |    | 880,079 |   |
|                                                                 |   |                                   |    |   |   |
| Net interest  loss after provision for credit losses                 |   | (81,461                                | )       | (554,799 | ) |
|                                                                 |   |                                   |    |   |   |
| Non-Interest  Income                                                 |   |                                   |    |   |   |
| Servicing and  securitizations                                       |   | 190,588                                |    | 320,360 |   |
| Credit product  fee income                                           |   | 200,193                                |    | 344,927 |   |
| Other                                                                |   | 26,757                                 |    | 447,893 |   |
|                                                                 |   | 417,538                                |    | 1,113,180 |   |
| Non-Interest  Expense                                                |   |                                   |    |   |   |
| Salaries and  employee benefits                                      |   | 96,975                                 |    | 165,018 |   |
| Solicitation and  advertising                                        |   | 65,378                                 |    | 108,682 |   |
| Occupancy,  furniture, and equipment                                 |   | 28,683                                 |    | 53,232 |   |
| Data processing  and communication                                   |   | 30,670                                 |    | 49,286 |   |
| Other                                                                |   | 106,602                                |    | 170,866 |   |
|                                                                 |   | 328,308                                |    | 547,084 |   |
| Income from  continuing operations before income taxes               |   | 7,769                                  |    | 11,297 |   |
| Income tax  expense                                                  |   | 3,069                                  |    | 4,462 |   |
| Income from  continuing operations                                   |   | 4,700                                  |    | 6,835 |   |
| Income from  discontinued operations (net of taxes)                  |   | —                                 |    | 3,184 |   |
| Net Income                                                           |   | $                                      | 4,700   |   | $ | 10,019 |   |
|                                                                 |   |                                   |    |   |   |
| **Earnings per common share-basic**                                  |   |                                   |    |   |   |
| Income from  continuing operations                                   |   | $                                      | 0.02    |   | $ | 0.02 |   |
| Income from  discontinued operations-net of taxes                    |   | —                                 |    | 0.01 |   |
| Net Income                                                           |   | $                                      | 0.02    |   | $ | 0.03 |   |
|                                                                 |   |                                   |    |   |   |
| **Earnings per common share-assuming  dilution**                     |   |                                   |    |   |   |
| Income from  continuing operations                                   |   | $                                      | 0.02    |   | $ | 0.02 |   |
| Income from  discontinued operations-net of taxes                    |   | —                                 |    | 0.01 |   |
| Net Income                                                           |   | $                                      | 0.02    |   | $ | 0.03 |   |
|                                                                 |   |                                   |    |   |   |
| Weighted average  common shares outstanding-basic (000)              |   | 286,187                                |    | 283,893 |   |
|                                                                 |   |                                   |    |   |   |
| Weighted average  common shares outstanding-assuming dilution (000)  |   | 290,429                                |    | 288,540 |   |

 

See Notes to Consolidated Financial Statements.

 

4

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**Providian Financial Corporation and Subsidiaries****ConsolidatedStatements of Changes in Shareholders’ Equity(unaudited)**
| **(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, 2001**                                                                          |   | **$**             | **2,862** | ** **                       | **$**  | **—**             | ** ** | **$**                                        | **1,971,359** | ** **                           | **$**  | **9,807**   | ** ** | **$** | **(76,517** | **)** | **$** | **1,907,511** | ** ** |
| Comprehensive  income:                                                                                    |   |              |      |                             |   |                   |       |                                         |          |                                 |   |        |       |
| Net Income                                                                                                |   |              |      |                             |   | 10,019                 |       |                                         |          |                                 |   | 10,019      |       |
| Unrealized loss  on securities, net of income tax benefit of $3,225                                       |   |              |      |                             |   |                   |       | (4,939                                       | )             |                                 |   | (4,939      | )          |
| Foreign currency  translation adjustments, net of income tax benefit of $16,597                           |   |              |      |                             |   |                   |       | (25,421                                      | )             |                                 |   | (25,421     | )          |
| Total  comprehensive income                                                                               |   |              |      |                             |   |                   |       |                                         |          |                                 |   | (20,341     | )          |
|                                                                                                      |   |              |      |                             |   |                   |       |                                         |          |                                 |   |        |       |
| Purchase of  180,874 common shares for treasury                                                           |   |              |      |                             |   |                   |       |                                         |          | (719                                 | )      | (719        | )          |
| Exercise of  stock options and other awards                                                               |   |              |      | (3,640                           | )      | 3,662                  |       |                                         |          |                                 |   | 22          |       |
| Issuance of  restricted and unrestricted stock less forfeited shares                                      |   | 42                |      | 14,092                           |   |                   |       |                                         |          | (33                                  | )      | 14,101      |       |
| Deferred  compensation related to grant of restricted and unrestricted stock less  amortization of $6,120 |   |              |      | (7,981                           | )      |                   |       |                                         |          |                                 |   | (7,981      | )          |
| Net tax effect  from employee stock plans                                                                 |   |              |      | (2,471                           | )      |                   |       |                                         |          |                                 |   | (2,471      | )          |
| **Balance at March 31, 2002**                                                                             |   | **$**             | **2,904** | ** **                       | **$**  | **—**             | ** ** | **$**                                        | **1,985,040** | ** **                           | **$**  | **(20,553** | **)**      | **$** | **(77,269** | **)** | **$** | **1,890,122** | ** ** |
|                                                                                                      |   |              |      |                             |   |                   |       |                                         |          |                                 |   |        |       |
| **Balance at December 31, 2002**                                                                          |   | **$**             | **2,909** | ** **                       | **$**  | **—**             | ** ** | **$**                                        | **2,202,960** | ** **                           | **$**  | **9,888**   | ** ** | **$** | **(76,685** | **)** | **$** | **2,139,072** | ** ** |
| Comprehensive  income:                                                                                    |   |              |      |                             |   |                   |       |                                         |          |                                 |   |        |       |
| Net Income                                                                                                |   |              |      |                             |   | 4,700                  |       |                                         |          |                                 |   | 4,700       |       |
| Unrealized loss  on securities, net of income tax benefit of $6,621                                       |   |              |      |                             |   |                   |       | (10,141                                      | )             |                                 |   | (10,141     | )          |
| Total  comprehensive income                                                                               |   |              |      |                             |   |                   |       |                                         |          |                                 |   | (5,441      | )          |
|                                                                                                      |   |              |      |                             |   |                   |       |                                         |          |                                 |   |        |       |
| Purchase of  108,587 common shares for treasury                                                           |   |              |      |                             |   |                   |       |                                         |          | (649                                 | )      | (649        | )          |
| Exercise of  stock options and other awards                                                               |   |              |      | 30,458                           |   | (31,192                | )          |                                         |          | 931                                  |   | 197         |       |
| Issuance of  restricted and unrestricted stock less forfeited shares                                      |   | (2                | )         | (28,679                          | )      |                   |       |                                         |          | 31,689                               |   | 3,008       |       |
| Deferred  compensation related to grant of restricted and unrestricted stock less  amortization of $1,981 |   |              |      | (1,023                           | )      |                   |       |                                         |          |                                 |   | (1,023      | )          |
| Net tax effect  from employee stock plans                                                                 |   |              |      | (756                             | )      |                   |       |                                         |          |                                 |   | (756        | )          |
| **Balance at March 31, 2003**                                                                             |   | **$**             | **2,907** | ** **                       | **$**  | **—**             | ** ** | **$**                                        | **2,176,468** | ** **                           | **$**  | **(253**    | **)**      | **$** | **(44,714** | **)** | **$** | **2,134,408** | ** ** |

 

See Notes to Consolidated Financial Statements.

 

5

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**Providian Financial Corporation and Subsidiaries****ConsolidatedStatements of Cash Flows (unaudited)**
|                                                                                                       |   | **Three  months ended March 31,** |    |
|------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|---------|
| **(dollars in  thousands)**                                                                                |   | **2003**                          |    | **2002** |   |
| **Operating Activities**                                                                                   |   |                              |    |   |   |
| Net Income                                                                                                 |   | $                                 | 4,700   |   | $ | 10,019 |   |
| Income from  discontinued operations                                                                       |   | —                            |    | (3,184 | ) |
| Income from  continuing operations                                                                         |   | 4,700                             |    | 6,835 |   |
| Adjustments to  reconcile income from continuing operations to net cash provided by operating  activities: |   |                              |    |   |   |
| Provision for  credit losses                                                                               |   | 261,815                           |    | 880,079 |   |
| Depreciation and  amortization of premises and equipment                                                   |   | 9,892                             |    | 16,042 |   |
| Amortization of  net loan acquisition costs                                                                |   | 11,138                            |    | 13,148 |   |
| Amortization of  deferred compensation related to restricted and unrestricted stock                        |   | 1,981                             |    | 6,120 |   |
| Decrease in  deferred fee revenue                                                                          |   | (41,373                           | )       | (73,344 | ) |
| Decrease  (increase) in deferred income tax benefit                                                        |   | 68,201                            |    | (32,438 | ) |
| Decrease in  interest receivable                                                                           |   | 2,433                             |    | 10,234 |   |
| Gain from sale  of interests in Providian Master Trust                                                     |   | —                            |    | (401,903 | ) |
| Net decrease in  other assets                                                                              |   | 339,897                           |    | 98,407 |   |
| Net increase in  accrued expenses and other liabilities                                                    |   | 140,201                           |    | 44,178 |   |
| Net cash  provided by operating activities                                                                 |   | 798,885                           |    | 567,358 |   |
|                                                                                                       |   |                              |    |   |   |
| **Investing Activities**                                                                                   |   |                              |    |   |   |
| Net cash from  loan originations and principal collections on loans receivable                             |   | 385,312                           |    | (18,628 | ) |
| Net decrease in  securitized loans                                                                         |   | (907,800                          | )       | (711,620 | ) |
| Net proceeds  from sale of Providian Master Trust                                                          |   | —                            |    | 2,777,559 |   |
| Decrease in due  from securitizations                                                                      |   | 707,751                           |    | 648,728 |   |
| Purchases of  available-for-sale investment securities                                                     |   | (890,859                          | )       | (919,174 | ) |
| Proceeds from  maturities and sales of available-for-sale investment securities                            |   | 880,654                           |    | 525,763 |   |
| Increase in  federal funds sold and securities purchased under resale agreements or  similar arrangements  |   | (625,000                          | )       | (1,924,500 | ) |
| Net purchases of  premises and equipment                                                                   |   | (4,052                            | )       | (667 | ) |
| Net cash (used)  provided by investing activities                                                          |   | (453,994                          | )       | 377,461 |   |
|                                                                                                       |   |                              |    |   |   |
| **Financing Activities**                                                                                   |   |                              |    |   |   |
| Net decrease in  deposits                                                                                  |   | (106,967                          | )       | (886,147 | ) |
| Proceeds from  issuance of term federal funds                                                              |   | —                            |    | 200,000 |   |
| Repayment of  term federal funds                                                                           |   | —                            |    | (200,000 | ) |
| Repayment of  short-term borrowings                                                                        |   | (91,686                           | )       | (117,189 | ) |
| Repayment of  long-term borrowings                                                                         |   | —                            |    | (4,970 | ) |
| Purchase of  treasury stock                                                                                |   | (649                              | )       | (719 | ) |
| Proceeds from  exercise of stock options                                                                   |   | 197                               |    | 22 |   |
| Net cash used by  financing activities                                                                     |   | (199,105                          | )       | (1,009,003 | ) |
| Net cash  provided by discontinued operations                                                              |   | —                            |    | 2,606 |   |
| **Net Increase (Decrease) in Cash and  Cash Equivalents**                                                  |   | 145,786                           |    | (61,578 | ) |
| Cash and cash  equivalents at beginning of period                                                          |   | 344,277                           |    | 449,586 |   |
| Cash and cash  equivalents at end of period                                                                |   | $                                 | 490,063 |   | $ | 388,008 |   |

 

See Notes to Consolidated Financial Statements.

 

6

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**Providian Financial Corporation and Subsidiaries****Notes to Consolidate****d FinancialStatements****March 31,2003 (unaudited)**

 

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

 

Providian Financial Corporation (the “Company”) is acorporation incorporated under the laws of Delaware. The Company’s wholly ownedbanking subsidiaries are Providian National Bank (“PNB”) and Providian Bank(“PB”). Through its banking subsidiaries, the Company offers credit card anddeposit products throughout the United States. The Company markets consumerloans and deposits using distribution channels such as mail, telephone, and theInternet.

 

In November 2001, the Company announced that it woulddiscontinue its operations in Argentina and the United Kingdom, and the Companysold those operations in 2002. Accordingly, the operations of the Company’ssubsidiaries and branches in those locations are reflected as discontinuedoperations on the Company’s statements of income.

 

The accompanying unaudited consolidated financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States (“GAAP”) for interim financialinformation and with the instructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly, we do not include all of the information andfootnotes required by GAAP for complete consolidated financial statements. Inthe opinion of management, all adjustments considered necessary for a fair presentationof the results for the interim period presented have been included.  All such adjustments are of a normal,recurring nature.  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 consolidated financial statements. Therefore,actual results could differ from those estimates. Operating results for thethree month period ended March 31, 2003 are not necessarily indicative ofthe results for the year ending December 31, 2003. The notes to theconsolidated financial statements contained in the Company's Annual Report onForm 10-K for the year ended December 31, 2002 should be read inconjunction with these consolidated financial statements. All significantintercompany balances and transactions have been eliminated in consolidation.For purposes of comparability, certain prior period amounts have beenreclassified.

 

**Note2.  Stock-Based Employee Compensation**

 

The Company has elected to account for its stock-basedcompensation plans in accordance with Accounting Principles Board (“APB”)Opinion No. 25, “Accounting for Stock Issued to Employees” and relatedinterpretations, as permitted by Statement of Financial Accounting Standards(“SFAS”) No. 123, “Accounting for Stock-Based Compensation.” Accordingly,because the exercise price of the Company’s employee stock options is the fairmarket value of the underlying stock on the date of grant, the Companyrecognizes no compensation expense at the time of the grant. In addition, theCompany does not recognize compensation expense for its employee stock purchaseplan, since it qualifies as a non-compensatory plan under APB OpinionNo. 25.

 

In December 2002, the Financial Accounting StandardsBoard (“FASB”) issued SFAS No. 148, ‘‘Accounting for Stock-BasedCompensation—Transition and Disclosure—An Amendment of FASB Statement No.123.’’ SFAS No. 148 amended the disclosure requirements of SFAS No. 123 torequire disclosures in the notes to both annual and interim financialstatements about the method of accounting for stock-based employee compensationand the effect of the method used on reported results. The stock-basedcompensation plan disclosures required by SFAS No. 123 and SFAS No. 148are provided in this Note and in the Company's Annual Report on Form 10-Kfor the year ended December 31, 2002 in Note 21 to ConsolidatedFinancial Statements.

 

The following table reflects, for the quarter endedMarch 31, 2003 and 2002, the stock-based employee compensation costs arisingout of the restricted and unrestricted stock programs that are included inreported net income. It also reflects on a pro forma basis the Company’s netincome and earnings per common share with and without dilution, as ifcompensation costs for stock options had been recorded based on the fair valueat the date of grant under the Company’s stock-based compensation plans,consistent with the provisions of SFAS No. 123. The pro forma compensationexpense reflects compensation expense over the vesting period of the grant,which is generally three years.

 

7

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**Stock-Based Employee Compensation Cost and****Pro FormaNet Income and Earnings Per Common Share**
|                                                                                                              |   | **Three  months ended March 31,** |   |
|-------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
| **(dollars in thousands, except per share data)**                                                                 |   | **2003**                               |   | **2002** |   |
|                                                                                                              |   |                                   |   |   |   |
| Restricted and  unrestricted stock amortization, net of taxes, included in net income, as  reported               |   | $                                      | 1,199  |   | $ | 3,703 |   |
| Net income, as  reported                                                                                          |   | 4,700                                  |   | 10,019 |   |
| Deduct: Pro  forma stock-based employee compensation expense determined under fair value  method, net of taxes(1) |   | 7,078                                  |   | 12,425 |   |
| Pro forma net  income                                                                                             |   | $                                      | (2,378 | ) | $ | (2,406 | ) |
| Net income per  common share:                                                                                     |   |                                   |   |   |   |
| As  reported-basic                                                                                                |   | $                                      | 0.02   |   | $ | 0.03 |   |
| As  reported-assuming dilution                                                                                    |   | $                                      | 0.02   |   | $ | 0.03 |   |
| Net income per  common share:                                                                                     |   |                                   |   |   |   |
| Pro forma-basic                                                                                                   |   | $                                      | (0.01  | ) | $ | (0.01 | ) |
| Pro  forma-assuming dilution                                                                                      |   | $                                      | (0.01  | ) | $ | (0.01 | ) |

----

| (1) |   | The pro forma stock-based compensation expense for  the three months ended March 31, 2003 and 2002 includes the effect of an  expense reduction for non-vested stock options that have been forfeited in  the relevant period. |
|-----|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

The fair value of the stock options granted by the Companywas estimated at the grant date using the Black-Scholes modeling technique withthe following assumptions: for grants during the quarter ended March 31,2003, risk-free weighted average interest rate of 1.89%, no dividend yield,weighted average expected volatility of 93%, and expected stock option life offour years; and for grants during the quarter ended March 31, 2002,risk-free weighted average interest rate of 3.65%, no dividend yield, weightedaverage expected volatility of 90%, and expected stock option life of fouryears. Assumptions made for offerings under the Company’s 1997 Employee StockPurchase Plan were, for the quarter ended March 31, 2003, risk-free weightedaverage interest rate of 1.26%, no dividend yield, weighted average expected volatilityof 135%, and expected life of one year; and were, for the quarter ended March31, 2002, risk-free weighted average interest rate of 2.16%, no dividend yield,weighted average expected volatility of 86%, and expected life of one year.

 

The weighted average fairvalues of the stock options granted by the Company during the first quarter of2003 and 2002 were $3.92 and $2.95 per common share. The weighted average fairvalues of the offerings under the Company’s 1997 Employee Stock Purchase Planfor the quarters ended March 31, 2003 and 2002 were $3.74 and $1.55 per commonshare, respectively.  The exercise priceof each stock option is the market price of the Company’s common stock on thedate of the grant. Expiration dates range from August 4, 2003 to March 6,2013 for options outstanding at March 31, 2003.

 

**Note3.  Consolidation of Variable InterestEntities**

 

In January 2003, theFASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of VariableInterest Entities, an Interpretation of ARB No. 51.” FIN 46 providesguidance on how to identify a variable interest entity (“VIE”) and determinewhen the assets, liabilities, non-controlling interests, and results ofoperations of a VIE must be included in a company’s consolidated financialstatements. A company that holds variable interests in an entity is required toconsolidate the entity if the company’s interest in the VIE is such that thecompany will absorb a majority of the VIE’s expected losses and/or receive amajority of the entity’s expected residual returns, if any. FIN 46 becameeffective upon its issuance for interests in a VIE acquired afterJanuary 31, 2003, and will become effective beginning in the third quarterof 2003 for VIEs acquired on or before February 1, 2003. Because the Company’ssecuritizations are structured as qualifying special purpose entities, asdefined in SFAS No. 140, “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities” and FIN 46, the Company’ssecuritization trusts are not required to be consolidated.

 

Since January 31, 2003, the Company has notacquired an interest in a VIE. The Company is currently evaluating VIEsacquired before February 1, 2003 to determine whether they meet thecriteria for consolidation under FIN 46. The Company has identified oneVIE that may require consolidation. This entity has assets of $10 million.Based on its preliminary evaluation, the Company does not expect FIN 46 to havea material impact on its consolidated financial statements.

 

**Note4.  Finance Charge and Fee IncomeRecognition**

 

Beginning onJanuary 1, 2002, the Company adopted a new methodology (the “suppressionmethodology”) for recognizing finance charge and fee income. Under thesuppression methodology, finance charges and fees that would

 

8

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otherwise accrue on reported loans, but that the Company estimates willnot be collected (the “suppressed amounts”), are not recognized as interestincome, servicing and securitization income, or credit product fee income onthe income statement and are not included in loans receivable, interestreceivable, or due from securitizations on the balance sheet. In connectionwith its securitizations, the Company recognizes a portion of the interest andfee income relating to the securitized loans receivable in servicing andsecuritization income. Under the suppression methodology, the Company analyzesprojected credit loss rates, delinquency status, and historical loss experienceto estimate the suppressed amounts.

 

During the second quarterof 2002, due to continuing high levels of customer bankruptcies and the impactof such bankruptcies on the collectibility of finance charges and fees, theCompany began to include in its estimate of uncollectible finance charges andfees an amount expected to charge off due to customer bankruptcies, regardlessof delinquency status. The additional estimated amounts associated withcustomer bankruptcies were included in the suppressed amounts. Prior to thesecond quarter of 2002, the estimates focused on delinquency roll rates (thepercentage of customers whose delinquency status worsens from month to month)and the Company did not include separate amounts for loans expected to chargeoff due to bankruptcy.

 

When the principal amountof a loan is charged off, the accrued finance charges and fees included in theloan balance are reversed against previously recognized suppressed amounts andincome. During the first quarter of 2003 and 2002, the impact on the Company'sreported finance charge and fee income and servicing and securitization incomeof suppressing estimated uncollectible finance charges and fees and thedifference between estimated uncollectible and actual uncollectible amountsduring the quarter was as follows:

 

**Estimated Uncollectible and Uncollected Finance Charges andFees**

 

|                          |   | **Three  months ended March 31,** |   |
|-------------------------------|--------|-----------------------------------|--------|
| **(dollars  in millions)**    |   | **2003**                          |   | **2002** |   |
|                          |   |                              |   |   |   |
| Finance charges               |   | $                                 | 46.8   |   | $ | 75.6 |   |
| Fees                          |   | 59.0                              |   | 122.0 |   |
| Servicing and  securitization |   | 141.2                             |   | 159.0 |   |
| Total                         |   | $                                 | 247.0  |   | $ | 356.6 |   |

 

 

In the fourth quarter of2002, the Company adopted regulatory guidance provided by the federal bankingagencies (the “AIR guidance”) under which it treats only principal receivablesas being removed from its balance sheet when the Company securitizes its loansreceivable. At the time of the securitization, the outstanding accrued financecharges and fees that are allocated to the certificateholders’ interests isclassified as an accrued interest receivable asset, or “AIR.” Finance chargeand fee suppressions related to the AIR of $183.8 million at March 31, 2003 and$217.9 million at December 31, 2002 are reflected in due from securitizationson the balance sheet.

 

**Note 5. Investment Securities**

 

# **Summary of Investment Securities**

 
|                                            |   | **March 31, 2003**  |      | **December 31, 2002**        |   |
|-------------------------------------------------|--------|---------------------|-----------|------------------------------|--------|
| **(dollars in thousands)**                      |   | **Amortized  Cost** |      | **Gross  Unrealized  Gains** |   | **Gross  Unrealized  Losses** |   | **Fair  Value** |   | **Amortized  Cost** |   | **Fair  Value** |   |
|                                            |   |                |      |                         |   |   |   |   |   |   |   |   |   |
| **Investment  Securities Available-for-Sale**   |   |                |      |                         |   |   |   |   |   |   |   |   |   |
| United States Treasury and Federal agency bonds |   | $                   | 521,945   |                         | $      | — |   | $ | 1,471 |   | $ | 520,474 |   | $ | 622,144 |   | $ | 622,081 |   |
| Mortgage-backed securities                      |   | 1,172,362           |      | 853                          |   | 336 |   | 1,172,879 |   | 974,002 |   | 982,023 |   |
| Equity securities                               |   | 25,420              |      | —                       |   | — |   | 25,420 |   | 25,420 |   | 25,420 |   |
| Other                                           |   | 130,332             |      | 662                          |   | 13 |   | 130,981 |   | 218,288 |   | 227,083 |   |
| Total securities available-for-sale             |   | $                   | 1,850,059 |                         | $      | 1,515 |   | $ | 1,820 |   | $ | 1,849,754 |   | $ | 1,839,854 |   | $ | 1,856,607 |   |

 

During the quarter ended March 31, 2003, the Companysold investment securities with an amortized cost of $300.6 million at a grossrealized gain of $9.6 million. No investment securities were sold during thequarter ended March 31, 2002. The Company calculates realized gains and lossesusing the specific identification method. There were no investment securitiespledged by the Company at March 31, 2003 or December 31, 2002.

 

9

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**Note6.  Loans Receivable and Allowance forCredit Losses**

 

The Company has creditrisk on loans to the extent that borrowers fail to repay amounts owed and suchamounts are not recovered through collection procedures.  At March 31, 2003, the Company had nosignificant regional domestic or foreign concentrations of credit risk.

 

The activity in the allowance for credit losses forthe three months ended March 31, 2003 and 2002 is as follows:

 

**Changes in the Allowance for Credit Losses**

 
|                                              |   | **Three  months ended March 31,** |      |
|---------------------------------------------------|--------|-----------------------------------|-----------|
| **(dollars  in thousands)**                       |   | **2003**                          |      | **2002** |   |
| Balance at  beginning of period                   |   | $                                 | 1,012,461 |   | $ | 1,932,833 |   |
| Provision for  credit losses                      |   | 261,815                           |      | 491,849 |   |
| Fair value  adjustment - loans available-for-sale |   | —                            |      | 388,230 |   |
| Credit losses                                     |   | (341,338                          | )         | (451,030 | ) |
| Recoveries                                        |   | 45,264                            |      | 37,795 |   |
| Credit losses on  higher risk loans sold          |   | —                            |      | (985,943 | ) |
| Balance at end  of period                         |   | $                                 | 978,202   |   | $ | 1,413,734 |   |

 

At March 31, 2002, theCompany reported $2.65 billion of higher risk loans, at fair value, as loansheld for securitization or sale, after reducing the net book value of the loansto fair value by adding $388.2 million to the allowance for credit lossesrelated to these loans. The loan balances and related allowance of $985.9million were then transferred to loans held for securitization or sale,resulting in a new cost basis for the loans, until they were sold in June 2002.

 

**Note7.  Securitization or Sale ofReceivables**

 

The Company periodically securitizes pools of its loans receivable andissues asset-backed securities in underwritten offerings and privateplacements. During the first quarter of 2003 and 2002, the Company securitized$1.09 billion and $257.7 million of loans receivable. The Companyrecognized net losses of $16.2 million and $6.5 million in the firstquarter of 2003 and 2002 from the initial sale to third party investors and therecognition of retained interests on securitizations. After the initial sale,the Company’s securitizations impact its earnings through changes in the fairvalues of its retained interests, including the accretion of the discounts onretained interests, the ongoing recognition of interest-only strips receivable,and the difference in the actual excess servicing received as compared to theamount estimated in the related interest-only strip receivable. In addition tothe initial losses on securitization and the subsequent impact of changes inthe fair value of retained interests, securitization activity during the firstquarter of 2003 impacted earnings through an increase to the allowance forcredit losses reflecting the increase in loans receivable that resulted fromthe amortization of certain securitizations, partially offset by a decrease tothe allowance resulting from new securitizations during the quarter.

 

The total amount of securitized loans as of March 31, 2003 andDecember 31, 2002 was $10.98 billion and $12.33 billion. Due fromsecuritizations was $3.02 billion as of March 31, 2003, and$3.72 billion as of December 31, 2002. At March 31, 2003 andDecember 31, 2002, the primary components of due from securitizations wereretained subordinated certificateholders’ interests, which were$1.67 billion and $2.06 billion; interest-only strips receivable,which were $277.5 million and $257.4 million; and spread accounts,which were $475.2 million and $467.0 million. After adopting the AIRguidance in the fourth quarter of 2002, the Company included an AIR of $417.5million and $488.1 million in due from securitizations at March 31, 2003and December 31, 2002.

 

The retained subordinated certificateholders’ interests represent debtsecurities and are classified as trading securities. They are reported at fairvalue under SFAS No. 115, “Accounting for Certain Investments in Debt andEquity Securities,” and are included on the Company’s balance sheet in due fromsecuritizations. The retained subordinated certificateholders’ interests consistprimarily of non-interest bearing beneficial interests that are repaid upon thematurity of the securitization transaction. Upon origination of asecuritization, the Company recognizes these assets at their allocated carryingvalue in accordance with SFAS No. 140. The allocated carrying value isless than the face value of the certificate, and the difference is recorded asa reduction to servicing and securitization income. At the same time, theCompany recognizes the fair value of these assets. The Company determines fairvalue through estimated cash flows discounted at rates that reflect the levelof subordination, the projected repayment term, and the credit risk of thesecuritized loans.

 

10

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Adjustments to record the allocated carrying value of new retainedsubordinated certificateholders’ interests during the first quarter of 2003 and2002 reduced reported servicing and securitization income by $84.2 millionand $18.4 million. These adjustments were partially offset by increasestotaling $61.4 million and $5.6 million from the allocated carryingvalue to the fair value upon issuance. The increases from allocated carryingvalue to fair value are included in the unrealized gains on retained certificateholders’interests until sale or maturity.

 

Subsequent to the initial fair value recognition, the Company evaluatesits retained subordinated certificateholders’ interests and recognizes changesin their fair market value in servicing and securitization income. The fairmarket value changes reflect the Company’s revisions in expected future cashflows and discount rates, including the risk and the life of the underlyingreceivables and the term of the certificateholders’ interests. Ascertificateholders’ interests approach maturity, their fair values generallyapproach their face value and the discounts are accreted, with the amount ofsuch accretion realized in servicing and securitization income. The followingtable summarizes the retained subordinated certificateholders’ interests in theProvidian Gateway Master Trust as of March 31, 2003 and December 31, 2002.

 

**Providian Gateway Master Trust**

# **Summary of Retained Subordinated Certificateholders’ Interests**

 

| **(dollars in millions)**                                |   | **March 31,  2003** |    | **December 31,  2002** |   |
|----------------------------------------------------------|--------|---------------------|---------|------------------------|--------|
| Retained subordinated certificateholders’ interests |   |                |    |                   |   |
| Face value                                               |   | $                   | 2,056.9 |                   | $      | 2,499.1 |   |
| Discount                                                 |   | (391.8              | )       | (441.9                 | )      |
| Fair market value                                        |   | 1,665.1             |    | 2,057.2                |   |
| Weighted average remaining term (months)                 |   | 19.0                |    | 17.3                   |   |
|                                                          |        |                     |         |                        |        |  |  |

 

For the quarter endedMarch 31, 2003, the change in net unrealized gains on retained subordinatedcertificateholders’ interests designated as trading securities was $118.6million. These unrealized gains are recognized in servicing and securitizationincome.

 

The Company’s valuations of retained subordinated certificateholders’interests, the AIR, interest-only strips receivable, and spread accountsrequire it to use its judgment in selecting discount rates, estimating futurecash flows, assessing current economic conditions, and assuming the outcome offuture events. Retained subordinated certificateholders’ interests arediscounted at rates that reflect the level of subordination, the projectedrepayment term, and the credit risk of the securitized loans. In valuinginterest-only strips receivable, the Company estimates the finance charges thatwill be collected on the securitized loans, credit losses, contractualservicing fees, and repayment trends of the securitized loans to project theamount of excess servicing to be received over the period the securitized loanswill be outstanding. The spread accounts are recorded at fair value through adiscounted cash flow analysis based on projected repayments from the spreadaccount balances to the Company.

 

At least quarterly, the Company adjusts these valuations of the retainedinterests to reflect changes in the amount of the securitized loans outstandingand any changes to the initial assumptions and estimates. The Company alsocontinues to refine the financial models used to update measures of the timingand amount of expected future cash flows. These values can, and will, vary as aresult of changes in the level and timing of the cash flows and the underlyingeconomic assumptions. Changes in the estimated fair value of the retained interestsare reported as a component of non-interest income, servicing andsecuritizations on the Company’s income statement.

 

The table below presents key economic assumptions used in the initialmeasurement of the retained subordinated interests for securitizations enteredinto during the quarters ended March 31, 2003 and 2002.

 

11

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**SecuritizationKey Assumptions**

 

|                                                       |   | **March 31,** |   |
|------------------------------------------------------------|--------|---------------|--------|
|                                                       |   | **2003**      |   | **2002** |   |
| Payment rate(1)                                            |   | 5.2           | %      | 6.3 | % |
| Expected net credit losses (annual rate)                   |   | 18.6          | %      | 17.2 | % |
| Weighted average life (in years)(2)                        |   | 1.0           |   | 1.13 |   |
| Discount rate(3)                                           |   | 6.3%-20.0     | %      | 8.2%-20.0 | % |
| Average interest rate margin for third party  investors(4) |   | 0.86          | %      | 0.43 | % |

 

----

(1)          Thepayment rate is derived from principal collections for the month divided by theaggregate amount of principal loan receivables at the beginning of the month.This rate is a weighted average of forecasted monthly rates. In the fourthquarter of 2002, the Company began utilizing a payment rate based on principalonly rather than total collections. The Company believes a principal paymentrate more accurately measures the projected outstanding loan balances allocatedto the certificateholders’ interests.

(2)          Theweighted average life is calculated by multiplying the principal collectionsexpected in each future period by the number of periods until the balance ispaid, summing those products, and dividing by the initial principal balance.

(3)          Discountrate assumptions vary based on the relative risk of the securitized cash flows.

(4)          Theinterest rate paid to third party investors is a variable rate based on thismargin plus the London Interbank Offered Rate (LIBOR).

 

The key economic assumptions used in valuing retained subordinatedinterests and the sensitivity of the current fair value of residual cash flowsto immediate 10% and 20% adverse changes in those assumptions at March 31,2003 are presented below.  Thesesensitivities are hypothetical and should be used with caution.

 

**Securitization Sensitivities**
| **(dollars  in millions)** |   | **Discount  Rate** |   | **Expected  Net Credit  Losses** |   | **Payment  Rate** |   |
|----------------------------|--------|--------------------|--------|----------------------------------|--------|-------------------|--------|
| Current  assumptions       |   | 6.3%-20.0          | %      | 18.6                             | %      | 5.2               | %      |
| Impact on fair  value of:  |   |               |   |                             |   |              |   |
| 10% adverse  change        |   | $                  | (48.4  | )                                | $      | (132.9            | )      | $ | (12.5 | ) |
| 20% adverse  change        |   | $                  | (94.2  | )                                | $      | (229.5            | )      | $ | (24.1 | ) |

 

 

The adverse changes to these key economic assumptionsare hypothetical and are presented in accordance with SFAS No. 140. As thefigures above indicate, changes in fair value based on a 10% variation inassumptions generally cannot be extrapolated because the relationship of thechange in assumption to the change in fair value may not be linear. Inaddition, the effect of changing one assumption on the fair value of theretained subordinated interest is computed without allowing any otherassumption to change. In reality, changes in one assumption may result inchanges in others (for example, increases in market interest rates may resultin lower payments and increased credit losses). Furthermore, the sensitivitiespresented do not reflect actions that management might take to mitigate theimpact of the adverse change.

 

12

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The table belowsummarizes certain cash flows from and paid in respect of securitizations:

 

**Securitization Cash Flows**
|                                                                            |   | **Quarter  ended March 31,** |   |
|---------------------------------------------------------------------------------|--------|-----------------------------------|--------|
| **(dollars  in millions)**                                                      |   | **2003**                          |   | **2002** |   |
|                                                                            |   |                              |   |   |   |
| Proceeds from  new securitizations(1)                                           |   | $                                 | 815.0  |   | $ | 195.3 |   |
| Proceeds from  collections reinvested in revolving period of securitizations(1) |   | 2,155.9                           |   | 3,009.8 |   |
| Servicing fees  received                                                        |   | 86.6                              |   | 111.5 |   |
| Net cash flows  received on retained interests                                  |   | 157.3                             |   | 80.4 |   |
| Principal paid  in respect of maturing securitizations(1)                       |   | (1,722.8                          | )      | (906.9 | ) |
|                                                                                 |        |                                   |        |  |  |  |  |

----

| (1) |   | Cash flows received or paid with respect to third  party certificateholders' interests. |
|-----|--------|-----------------------------------------------------------------------------------------|

 

 

**Note 8.  Guarantees and Contingencies**

 

*Guarantees*

 

In January 2003, the Companyentered into a pledge agreement with an insurer with respect to certainobligations owing to the insurer in connection with two series of the ProvidianGateway Master Trust. In exchange for the insurer agreeing to a reduction inthe base rate used for the purpose of calculating the excess spread earlyamortization event for those two series, the Company pledged $30.0 million heldin a deposit account as security for the payment to the insurer of amountsowing to it in connection with these transactions. The pledge will continue ineffect until the investor certificates and all amounts owing to the insurerwith respect to the two series are paid. However, the pledge agreement callsfor the pledged collateral to be reduced upon the payment of one of the series,which has an expected final payment date of September 15, 2003. The otherseries has an expected final payment date of September 15, 2005.

 

The Company does not currentlyexpect that performance under the guarantee described above will be required.

 

*Litigation*

 

The Company is subject to various pending andthreatened legal actions, including actions arising in the ordinary course ofbusiness from the conduct of its activities. While the Company believes that ithas substantive defenses and intends to defend the actions vigorously, itcannot predict the ultimate outcome or the potential future impact on theCompany of such actions. The Company does not presently expect any of theactions affecting it to have a material adverse effect on its financialcondition or results of operations, but it cannot give any assurance that theywill not have such an effect.

 

**Note9.  Asset Sales**

 

In February 2002, the Companysold its interests in the Providian Master Trust, which primarily consisted of$1.4 billion of loans receivable and $472 million of retained subordinatedinterests held by PNB. As of the date of sale, the Providian Master Trustcontained nearly $8 billion of loans receivable arising from approximately 3.3million active credit card accounts. This transaction resulted in cash proceedsof approximately $2.8 billion and a first quarter 2002 gain of approximately$401.9 million, which was included in non-interest income.

 

**Note 10.  Discontinued Operations**

 

Pursuant to SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” the Company reclassified thebalances relating to its United Kingdom and Argentina operations on itsconsolidated financial statements to reflect the expected disposition of theseoperations. The revenues, costs and expenses, and cash flows of theseoperations have been segregated in the Company’s consolidated statements ofincome and consolidated statements of cash flows for all periods presented andhave been separately reported as “discontinued operations.”

 

Sales of our discontinued operations in the UnitedKingdom and Argentina were finalized during the second quarter of 2002. Noresults from discontinued operations were reported in the first quarter of2003. The Company reported a $3.2 million gain from discontinuedoperations (net of $2.1 million in related taxes) for the three monthsended March 31, 2002.

 

13

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**Note11.  Cumulative Other Comprehensive Income**

 

The components of cumulative other comprehensiveincome, net of related taxes, for the three months ended March 31, 2003and 2002 are as follows:

 

**Cumulative Other Comprehensive Income Components**

 
| **(dollars  in thousands)**   |   | **Unrealized  Gain (Loss)  on Securities** |   | **Foreign  Currency  Translation** |   | **Cumulative  Other  Comprehensive  Income** |   |
|-------------------------------|--------|--------------------------------------------|--------|------------------------------------|--------|----------------------------------------------|--------|
| Balance at  December 31, 2001 |   | $                                          | 10,878 |                               | $      | (1,071                                       | )      | $ | 9,807 |   |
| Other  comprehensive income   |   | (8,164                                     | )      | (42,018                            | )      | (50,182                                      | )      |
| Tax benefit                   |   | 3,225                                      |   | 16,597                             |   | 19,822                                       |   |
| Balance at March  31, 2002    |   | $                                          | 5,939  |                               | $      | (26,492                                      | )      | $ | (20,553 | ) |
|                          |   |                                       |   |                               |   |                                         |   |   |   |   |
| Balance at  December 31, 2002 |   | $                                          | 9,888  |                               | $      | —                                       |   | $ | 9,888 |   |
| Other  comprehensive income   |   | (16,762                                    | )      | —                             |   | (16,762                                      | )      |
| Tax benefit                   |   | 6,621                                      |   | —                             |   | 6,621                                        |   |
| Balance at March  31, 2003    |   | $                                          | (253   | )                                  | $      | —                                       |   | $ | (253 | ) |

 

14

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**Note 12.  Earnings per Common Share**

 

The following table sets forth the computation of boththe basic and diluted earnings per common share:

 

**Computation of Earnings per Common Share**
|                                                                  |   | **Three  months ended March 31,** |   |
|-----------------------------------------------------------------------|--------|----------------------------------------|--------|
| **(in  thousands, except per share data)**                            |   | **2003**                               |   | **2002** |   |
| **Basic**                                                             |   |                                   |   |   |   |
| Income from  continuing operations                                    |   | $                                      | 4,700  |   | $ | 6,835 |   |
| Discontinued  operations, net of taxes                                |   | —                                 |   | 3,184 |   |
| Net income  available to common shareholders                          |   | $                                      | 4,700  |   | $ | 10,019 |   |
| Weighted average  common shares outstanding                           |   | 286,187                                |   | 283,893 |   |
| Earnings per  common share                                            |   |                                   |   |   |   |
| Income from  continuing operations                                    |   | $                                      | 0.02   |   | $ | 0.02 |   |
| Discontinued  operations, net of taxes                                |   | —                                 |   | 0.01 |   |
| Net income per  common share                                          |   | $                                      | 0.02   |   | $ | 0.03 |   |
|                                                                  |   |                                   |   |   |   |
| **Diluted**                                                           |   |                                   |   |   |   |
| Income from  continuing operations                                    |   | $                                      | 4,700  |   | $ | 6,835 |   |
| Plus: Income  impact of assumed conversions                           |   |                                   |   |   |   |
| Interest on  convertible senior notes, net of taxes(1)                |   | —                                 |   | — |   |
| Income from  continuing operations with assumed conversions           |   | 4,700                                  |   | 6,835 |   |
| Discontinued  operations, net of taxes                                |   | —                                 |   | 3,184 |   |
| Net income  available to common shareholders with assumed conversions |   | $                                      | 4,700  |   | $ | 10,019 |   |
| Weighted average  common shares outstanding                           |   | 286,187                                |   | 283,893 |   |
| Plus:  Incremental shares from assumed conversions                    |   |                                   |   |   |   |
| Restricted stock  issued-non vested                                   |   | 3,824                                  |   | 4,512 |   |
| Employee stock  options                                               |   | 418                                    |   | 135 |   |
| Convertible  senior notes(1)                                          |   | —                                 |   | — |   |
| Dilutive  potential common shares                                     |   | 4,242                                  |   | 4,647 |   |
| Adjusted  weighted average common shares                              |   | 290,429                                |   | 288,540 |   |
| Earnings per  common share:                                           |   |                                   |   |   |   |
| Income from  continuing operations                                    |   | $                                      | 0.02   |   | $ | 0.02 |   |
| Discontinued  operations, net of taxes                                |   | —                                 |   | 0.01 |   |
| Net income per  common share                                          |   | $                                      | 0.02   |   | $ | 0.03 |   |

 

----

(1)          For the quarters ended March 31, 2003 and 2002, there were no assumedconversions or interest expense add-backs because the effect would beantidilutive.

 

15

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**Item 2.  Managem****ent’s Discussion and Analysis of Financial Conditionand Results of Operations.**

 

This discussion is intended to further the reader’sunderstanding of the consolidated financial condition and results of operationsof our company. It should be read in conjunction with our historical financialstatements included in this quarterly report and with the information in ourAnnual Report on Form 10-K for the year ended December 31, 2002 (the“2002 Annual Report”). Our historical financial statements may not beindicative of our future performance. 

 

*OurBusiness*

 

Through our banking subsidiaries, we provide creditcard and deposit products to customers throughout the United States. Ourlending and deposit taking activities are conducted primarily through ProvidianNational Bank (“PNB”) and Providian Bank (“PB”). We market consumer loans anddeposits using distribution channels such as mail, telephone, and the Internet.

 

We generate income primarily through finance chargesassessed on outstanding loan balances, fees paid by customers related toaccount usage and performance (such as late, overlimit, cash advance,processing, and annual membership fees), and from the sale of variouscardholder service products. We receive interchange fees from bankcardassociations based on the purchase activity of our credit card customers. Inaddition, we earn income on our investments held for liquidity purposes,servicing fees, and excess servicing on securitized loans.

 

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

 

We seek to fund our assets through a diversified mixof funding sources. However, our ability to fund existing and future customerloans is currently dependent on four primary sources: customer deposits,securitizations, a portfolio of cash and liquid investment securities, and, toa lesser extent, debt. Securitization is a process in which we segregate a poolof customer loans by transferring them to a trust or other special purposeentity, which issues certificates backed by the principal, interest, and feecash flows generated by the pool of loans. At the time the certificates areissued, we receive cash proceeds, remove from our balance sheet the portion ofthe loans receivable associated with the certificates (sold to third parties orretained by us), including the related credit loss allowance, and recognizecertain retained subordinated interests, generally at fair value.

 

*AccountingPolicies*

 

Our financial statements are prepared in accordancewith accounting principles generally accepted in the United States (“GAAP”),which in some instances require us to use estimates and assumptions. Complexjudgments are also required for the valuation of certain of our assets.Uncertainties are inherent in these matters. Our most significant accountingpolicies are described in our 2002 Annual Report under “Management’s Discussionand Analysis of Financial Condition and Results of Operations” and underNote 2 to Consolidated Financial Statements, and include our policies forsecuritization, allowances for credit losses, finance charge and feerecognition and interest rate derivatives. These accounting policies are fundamentalto understanding our discussion and analysis of financial condition and resultsof operations and have not changed from those discussed in the 2002 AnnualReport.  Our application of accountingpolicies requires us to exercise significant judgment and reach conclusionsabout future events based upon information currently available. Differences injudgment, differences between our judgments and the actual events and outcomesthat unfold, and changes in underlying factors and assumptions, could have amaterial impact on our earnings.

 

*EarningsSummary*

 

The following discussion provides a summary of ourearnings for the three month period ended March 31, 2003, compared to the threemonth period ended March 31, 2002. In 2001 we announced our intention todiscontinue, and in the second quarter of 2002 we completed the sale of, ouroperations in the United Kingdom and Argentina. The significant components ofour results of operations are covered in further detail in subsequent sectionsof this discussion.

 

For the three months ended March 31, 2003,reported total net revenue (net interest income plus non-interest income) was$597.9 million, compared to $1,438.5 million for the three months ended March31, 2002. The decrease was primarily driven by a reduction in loans receivabledue to credit losses and asset dispositions in 2002. In addition, non-interestincome for the quarter ended March 31, 2002 included the gain on the sale ofour interests in the Providian Master Trust.

 

16

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Our provision for credit losses was $261.8 million forthe quarter ended March 31, 2003, a decrease of $618.3 million from the firstquarter of 2002. In the first quarter of 2002, the provision for credit lossesincluded an increase of $388.2 million to recognize the fair value of higherrisk loans to be sold in the subsequent period. In addition, the first quarter2003 provision reflects a lower reported loans receivable balance, the improveddelinquency performance of our loans receivable resulting from certain newportfolio management and collections strategies and policies and higher qualitycredit card account originations.

 

For the quarter ended March 31, 2003,non-interest expense decreased $218.8 million to $328.3 million, comparedto $547.1 million for the quarter ended March 31, 2002. Thisreduction is primarily due to lower personnel and related infrastructure costsassociated with our workforce reductions and reduced levels of solicitation andadvertising expenses as we transitioned to our new marketing strategy.

 

In the first quarter of 2002, we sold our interests inthe Providian Master Trust, which primarily consisted of $1.4 billion ofloans receivable and $472 million of retained subordinated interests heldby PNB. As of the date of sale, the Providian Master Trust contained nearly$8 billion of loans receivable arising from approximately 3.3 millionactive credit card accounts. When the sale was completed in the first quarterof 2002, we received cash proceeds of approximately $2.8 billion andrecognized a gain of approximately $401.9 million.

 

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

 

The following table provides an analysis of reportedinterest income, interest expense, net interest spread, and average balancesfor the three months ended March 31, 2003 and 2002.  Average earning assets representinterest-earning consumer loan portfolios and investments held for liquiditypurposes.

 

**Statement of Average Balances, Income and Expense, Yields andRates**
|                               |   | **Three  months ended March 31,** |       |
|------------------------------------|--------|-----------------------------------|------------|
|                               |   | **2003**                          |       | **2002** |   |
| **(dollars  in thousands)**        |   | **Average  Balance**              |       | **Income/  Expense** |   | **Yield/  Rate** |   | **Average  Balance** |   | **Income/  Expense** |   | **Yield/  Rate** |   |
| **Assets**                         |   |                              |       |   |   |   |   |   |   |   |   |   |   |
| Interest-earnings assets           |   |                              |       |   |   |   |   |   |   |   |   |   |   |
| Consumer loans                     |   | $                                 | 7,500,339  |   | $ | 310,340 |   | 16.55 | % | $ | 11,757,911 |   | $ | 488,085 |   | 16.60 | % |
| Interest-earning cash              |   | 212,151                           |       | 563 |   | 1.06 | % | 1,577,703 |   | 7,093 |   | 1.80 | % |
| Federal funds sold                 |   | 3,219,077                         |       | 9,826 |   | 1.22 | % | 1,280,120 |   | 5,609 |   | 1.75 | % |
| Investment securities              |   | 1,839,188                         |       | 14,827 |   | 3.22 | % | 1,390,302 |   | 17,645 |   | 5.08 | % |
| Other                              |   | 833,216                           |       | 16,643 |   | 7.99 | % | 421,298 |   | 13,903 |   | 13.20 | % |
| Total interest-earning assets      |   | 13,603,971                        |       | $ | 352,199 |   | 10.36 | % | 16,427,334 |   | $ | 532,335 |   | 12.96 | % |
|                               |   |                              |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for credit losses        |   | (1,104,594                        | )          |   |   |   |   | (1,969,281 | ) |   |   |   |   |
| Other assets                       |   | 4,018,847                         |       |   |   |   |   | 4,816,994 |   |   |   |   |   |
|                               |   |                              |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                       |   | $                                 | 16,518,224 |   |   |   |   |   | $ | 19,275,047 |   |   |   |   |   |
|                               |   |                              |       |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and Equity**        |   |                              |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities       |   |                              |       |   |   |   |   |   |   |   |   |   |   |
| Deposits                           |   | $                                 | 12,531,225 |   | $ | 161,222 |   | 5.15 | % | $ | 14,752,470 |   | $ | 195,303 |   | 5.30 | % |
| Borrowings                         |   | 942,036                           |       | 10,623 |   | 4.51 | % | 1,055,507 |   | 11,752 |   | 4.45 | % |
| Total interest-bearing liabilities |   | 13,473,261                        |       | $ | 171,845 |   | 5.10 | % | 15,807,977 |   | $ | 207,055 |   | 5.24 | % |
|                               |   |                              |       |   |   |   |   |   |   |   |   |   |   |
| Other liabilities                  |   | 852,962                           |       |   |   |   |   | 1,400,412 |   |   |   |   |   |
| Total liabilities                  |   | 14,326,223                        |       |   |   |   |   | 17,208,389 |   |   |   |   |   |
|                               |   |                              |       |   |   |   |   |   |   |   |   |   |   |
| Capital securities                 |   | 104,332                           |       |   |   |   |   | 104,332 |   |   |   |   |   |
|                               |   |                              |       |   |   |   |   |   |   |   |   |   |   |
| Equity                             |   | 2,087,669                         |       |   |   |   |   | 1,962,326 |   |   |   |   |   |
|                               |   |                              |       |   |   |   |   |   |   |   |   |   |   |
| Total liabilities and equity       |   | $                                 | 16,518,224 |   |   |   |   |   | $ | 19,275,047 |   |   |   |   |   |
|                               |   |                              |       |   |   |   |   |   |   |   |   |   |   |
| **Net  Interest Spread**           |   |                              |       |   |   | 5.26 | % |   |   |   |   | 7.72 | % |

 

17

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*InterestVolume And Rate Variance Analysis*

 

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 alsoaffected by changes in the volume of interest-earning assets andinterest-bearing liabilities. The following table sets forth the dollar amountof the increase (decrease) in reported interest income and expense resultingfrom changes in volumes and rates.

 

**Rate-Volume Variance Analysis**

 
|                       |   | **Three  months ended March 31,** |     |
|----------------------------|--------|-----------------------------------|----------|
|                       |   | **2003 vs. 2002**                 |     |
|                       |   | **Change due to (1)**             |     |
| **(dollars in thousands)** |   | **Increase  (Decrease)**          |     | **Volume** |   | **Rate** |   |
| **Interest Income**        |   |                              |     |   |   |   |   |
| Consumer loans             |   | $                                 | (177,745 | ) | $ | (176,278 | ) | $ | (1,467 | ) |
| Federal funds  sold        |   | 4,217                             |     | 6,341 |   | (2,124 | ) |
| Other securities           |   | (6,608                            | )        | 10,081 |   | (16,689 | ) |
| Total interest  income     |   | (180,136                          | )        | (159,856 | ) | (20,280 | ) |
|                       |   |                              |     |   |   |   |   |
| **Interest Expense**       |   |                              |     |   |   |   |   |
| Deposits                   |   | (34,081                           | )        | (28,689 | ) | (5,392 | ) |
| Borrowings                 |   | (1,129                            | )        | (1,284 | ) | 155 |   |
| Total interest  expense    |   | (35,210                           | )        | (29,973 | ) | (5,237 | ) |
|                       |   |                              |     |   |   |   |   |
| Net interest  income       |   | $                                 | (144,926 | ) | $ | (129,883 | ) | $ | (15,043 | ) |

----

| (1) |   | The changes due to both volume and rates have been  allocated in proportion to the relationship of the absolute dollar amounts of  the change in each. The changes in interest income and expense are calculated  independently for each line in the table. |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

*NetInterest Income*

 

Net interest income is interest earned from loansreceivable and our investment portfolios less interest expense on deposits andborrowings.

 

Reported net interest income for the three monthsended March 31, 2003 was $180.4 million, compared to$325.3 million for the same period in 2002, a decrease of$144.9 million. This decrease is primarily due to a $4.26 billion decreasein average reported loans receivable. Our average investments in federal fundssold and investment securities increased $2.39 billion compared to the firstquarter of 2002; however, the yield on these investments declined by 153 basispoints.

 

Interest expense declined from $207.1 million in firstquarter of 2002 to $171.8 million in the first quarter of 2003.  This decrease was primarily attributable toa decrease in the amount of deposits outstanding.

 

*Allowanceand Provision for Credit Losses*

 

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

 

We establish our allowance for credit losses byanalyzing historical credit loss trends and reviewing current loss expectationsthat incorporate general economic conditions that may impact future losses. Wesegregate loans by product type into general risk classifications for each marketsegment. We combine quantitative factors (including historical delinquency rollrates, historical credit loss rates, customer characteristics, such as riskscores, and other data) with environmental credit risk factors to preparecomparative evaluations of the allowance for credit losses.

 

18

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The environmental credit risk factors are consistentwith applicable bank regulatory guidelines and reflect our assessment ofgeneral macroeconomic conditions, trends in loan portfolio volume andseasoning, geographic concentrations, and recent modifications to loan reviewand underwriting procedures, among other factors. We compare allowancesestablished in prior periods with subsequent actual credit losses and perform apeer group comparative analysis of lagged loss rates to coverage ratios.Coverage ratios are derived by dividing the allowance for credit losses by theloans outstanding at period end.

 

**Allowance for Credit Losses**
|                                                 |   | **Three  months ended March 31,** |      |
|------------------------------------------------------|--------|-----------------------------------|-----------|
| **(dollars  in thousands)**                          |   | **2003**                          |      | **2002** |   |
| Balance at  beginning of period                      |   | $                                 | 1,012,461 |   | $ | 1,932,833 |   |
| Provision for  credit losses                         |   | 261,815                           |      | 491,849 |   |
| Fair value  adjustment - loans available-for-sale(1) |   | —                            |      | 388,230 |   |
| Credit losses                                        |   | (341,338                          | )         | (451,030 | ) |
| Recoveries                                           |   | 45,264                            |      | 37,795 |   |
| Credit losses on  higher risk loans sold(1)          |   | —                            |      | (985,943 | ) |
| Balance at end  of period                            |   | $                                 | 978,202   |   | $ | 1,413,734 |   |
| Reported loan  balance(2)                            |   | $                                 | 7,145,816 |   | $ | 8,288,825 |   |
| Coverage ratio                                       |   | 13.69                             | %         | 17.06 | % |

----

| (1) |   | At March 31, 2002, the Company reported $2.65  billion of higher risk loans, at fair value, as loans held for securitization  or sale, after reducing the net book value of the loans to fair value by  adding $388.2 million to the allowance for credit losses related to these  loans. The loan balances and related allowance of $985.9 million were then  transferred to loans held for securitization or sale, resulting in a new cost  basis for the loans, until they were sold in June 2002. |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | The March 31, 2003 and March 31, 2002 balances exclude  market value adjustments of $0.8 million and $17.9 million related to the  fair value of designated financial instruments.                                                                                                                                                                                                                                                                                                                    |

 

The decrease in the allowance for credit losses as apercentage of reported loans and as a dollar amount as of March 31, 2003 comparedto March 31, 2002 reflects the inherent trend in net credit losses afteradjusting our loan mix for the impact of recent higher quality credit cardaccount originations and changes in portfolio management strategies and for thesale of a portfolio of higher risk loans, partially offset by the sale of ourinterests in the Providian Master Trust. The decrease in the dollar amount alsoreflects the effect of adopting the AIR guidance in the fourth quarter of 2002(see “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations—The Impact of Securitizations” in our 2002 Annual Report). As wecontinue to evaluate the allowance for credit losses in light of changes inasset quality, regulatory requirements, general economic trends, and the effectof our new marketing strategy, we may further adjust the amount of theallowance, which would result in a change to the ratio of the allowance forcredit losses to reported loans.

 

*Non-InterestIncome*

 

*Servicingand Securitization Income.   *Servicingand securitization income relates primarily to securitized loans. It includesservicing fees, primarily relating to loans receivable transferred in oursecuritizations, excess servicing income, and gains or losses from thesecuritization of financial assets (see “Management’s Discussion and Analysisof Financial Condition and Results of Operations —The Impact ofSecuritizations” in our 2002 Annual Report). Because excess servicing income on securitized loans essentiallyrepresents a recharacterization of net interest income and credit product feeincome less credit losses and servicing expense, it can vary based on the samefactors that affect those items.

 

As of March 31, 2003 and 2002, securitized loansoutstanding were $10.98 billion and $12.23 billion. For the three months endedMarch 31, 2003, servicing and securitization income was$190.6 million, a decrease of $129.8 million from $320.4 millionin the first quarter of 2002. This decrease was primarily attributable to lowerservicing fees and excess servicing due to lower average securitized loansoutstanding in the first quarter of 2003.

 

*CreditProduct Fee Income.   *Creditproduct fee income includes performance fees (late, overlimit and returnedcheck charges), annual membership fees and cash advance fees, all of which aregenerally recorded as fees receivable. Credit product fee income also includesrevenue from cardholder service products, which are generally recorded as feerevenue if billed monthly and as customer purchases if billed annually orsemi-annually. Cardholder service product and annual membership revenue arerecognized ratably over the customer privilege period. Credit product feeincome also includes interchange fees received from bankcard associations.

 

19

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For the three months ended March 31, 2003, creditproduct fee income was $200.2 million, a decrease from $344.9 millionfor the three months ended March 31, 2002. This decrease reflects lower averageloans receivable, which resulted in lower late, overlimit, and interchange feesand lower cardholder service product and annual membership revenue. Inaddition, the decrease in credit product fee income reflects lower late andoverlimit fee income associated with our transition to higher quality creditcard account originations.

 

*Other*.  In the first quarter of 2002, non-interestincome—other included the gain on the sale of our interests in the ProvidianMaster Trust.

 

*Non-InterestExpense*

 

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. The following table presents non-interest expense for thethree months ended March 31, 2003 and 2002. Overall, the decrease innon-interest expense reflects our efforts to align our operations with thelower size of our loans receivable portfolio and reduced levels ofsolicitations as we transitioned to our new marketing strategy.

 

**Summary of Non-Interest Expense**

 
|                                 |   | **Three  months ended March 31,** |    |
|--------------------------------------|--------|-----------------------------------|---------|
| **(dollars  in thousands)**          |   | **2003**                          |    | **2002** |   |
| Salaries and  employee benefits      |   | $                                 | 96,975  |   | $ | 165,018 |   |
| Loan  solicitation and advertising   |   | 65,378                            |    | 108,682 |   |
| Occupancy,  furniture, and equipment |   | 28,683                            |    | 53,232 |   |
| Data processing  and communication   |   | 30,670                            |    | 49,286 |   |
| Other                                |   | 106,602                           |    | 170,866 |   |
| Total  non-interest expense          |   | $                                 | 328,308 |   | $ | 547,084 |   |

 

Salary and benefit costs include staffing costsassociated with marketing, customer service, collections, and administration.

 

Loan solicitation and advertising costs includeprinting, postage, telemarketing, list processing, and credit bureau costs paidto third parties in connection with account solicitation efforts, and alsoinclude costs incurred to promote our products. Advertising costs and themajority of solicitation expenses are expensed as incurred. In accordance withGAAP, we capitalize only the direct loan origination costs associated withsuccessful account acquisition efforts, after they are reduced by up-frontprocessing fees. We amortize capitalized loan origination costs over thecustomer privilege period (currently one year) for credit card loans, unlessthe loans are securitized, in which case we recognize the remaining costs as anexpense upon securitization. For the three months ended March 31, 2003 and2002, we amortized loan origination costs of $5.2 million and$14.7 million. For the three months ended March 31, 2003 and 2002,total loan solicitation and advertising costs, including amortized loanorigination costs, were $65.4 million and $108.7 million. Thisdecrease in loan solicitation and advertising costs reflects a reduction in thevolume of solicitations as we changed our marketing strategy and began testingnew product offerings.

 

Other non-interest expense includes operationalexpenses such as collection costs, fraud losses, and bankcard associationassessments.

 

In addition, in the first quarter of 2002 we recordeda $16.7 million charge in connection with workforce reductions and a$15.1 million charge related to the planned sale of higher riskreceivables. In connection with the closure of several of our facilities, werecognized additional charges related to premises, equipment and furniturelease expenses, fixed asset write-downs, and disposition costs in the third andfourth quarters of 2002. At March 31, 2003, we had $25.6 million accrued forremaining costs expected to be paid, primarily for premises, equipment andfurniture lease costs associated with property no longer in use.

 

*IncomeTaxes*

 

We recognized income tax expense from continuingoperations of $3.1 million and $4.5 million for the three months endedMarch 31, 2003 and 2002. Our effective tax rate was 39.5% for the three monthsended March 31, 2003 and 2002.

 

20

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*TheImpact of Securitizations*

 

We account for our securitization transactions underSFAS No. 140, “Accounting for Transfers and Servicing of Financial Assetsand Extinguishments of Liabilities.” Our securitizations involve the transferof a pool of loans receivable to a trust. The trust meets the criteria underSFAS No. 140 for a qualifying special purpose entity that is notconsolidated in our financial statements.

 

The structure of the transaction creates undividedinterests in the pool of loans and establishes certificateholders’ interests, aseller’s interest, and other retained interests, including an interest-onlystrip receivable and, in some cases, spread accounts. Certificateholders’interests consist of one or more classes of senior investor interests, whichare typically sold to third party investors, and one or more series ofsubordinated investor interests. We receive the proceeds from the sale to thirdparty investors and account for the transfer of loans receivable as a saleunder GAAP. We typically recognize a gain on sale from the securitization, dueprimarily to the release of the related allowance for credit losses and therecognition of an interest-only strip receivable, which is partially offset bydiscounts taken for the retained subordinated certificateholders’ interests.See “Management’s Discussion and Analysis of Financial Condition and Results ofOperations —The Impact of Securitizations” in our 2002 Annual Report.

 

During the first quarter of 2003 and 2002, wesecuritized $1.09 billion and $257.7 million of loans receivable. Werecognized losses of $16.2 million and $6.5 million in the first quarterof 2003 and 2002 from the initial sale to third party investors and therecognition of our retained interests on securitizations. In addition to the initial losses onsecuritization and the subsequent impact of changes in the fair value ofretained interests, the Company’s earnings in the first quarter of 2003 wereaffected by an increase to the allowance for credit losses due to an increasein loans receivable that resulted from the amortization of certainsecuritizations. This increase in loans receivable was partially offsetby new securitizations during the first quarter that had the effect of reducingour reported loans receivable. After theinitial sale, our securitizations impact our earnings through changes in thefair values of our retained interests, including the accretion of the discountson retained interests, the ongoing recognition of interest-only stripsreceivable, and the difference in the actual excess servicing received ascompared to the amount estimated in the related interest-only strip receivable.

 

The total amount of securitized loans as ofMarch 31, 2003 and December 31, 2002 was $10.98 billion and$12.23 billion. In February 2002, we sold our interests in theProvidian Master Trust, which included securitized loans of $6.56 billion.Due from securitizations was $3.02 billion as of March 31, 2003 and$3.72 billion as of December 31, 2002. At March 31, 2003 and December31, 2002, the primary components of due from securitizations were retainedsubordinated certificateholders’ interests, which were $1.67 billion and$2.06 billion; interest-only strips receivable, which were $277.5 millionand $257.4 million; and spread accounts, which were $475.2 millionand $467.0 million. After adopting the AIR guidance in the fourth quarterof 2002, we included an AIR of $417.5 million and $488.1 million in duefrom securitizations at March 31, 2003 and December 31, 2002.

 

*Non-GAAPManaged Financial Information*

 

Loans that have been securitized and sold to thirdparty investors are not considered to be our assets under GAAP and thereforeare not shown on our balance sheet. However, the interests we retain in thesecuritized loan pools create financial exposure to the current and expectedcash flows of the securitized loans (see “—The Impact of Securitizations”).Although the loans sold are not on our balance sheet, their performance canaffect some or all of our retained interests as well as our results ofoperations and our financial position. In addition, we continue to servicethese loans.

 

Because of this continued exposure and involvement, weuse managed financial information to evaluate our historical performance,assess our current condition, and plan our future operations. We believe thatmanaged financial information supplements our GAAP information and is helpfulto the reader’s understanding of our consolidated financial condition andresults of operations. “Reported” financial information refers to GAAPfinancial information. “Managed” financial information is derived by adjustingthe reported financial information to add back securitized loan balances andthe related finance charge and fee income, credit losses, and net interestcosts.

 

*LoanPerformance Measures.   *Wepresent key loan performance measures on a reported and a managed basis.  Reported loans do not necessarily have thesame income or credit characteristics as securitized loans and will likelyperform differently over time. Although managed loan performance measuresinclude both reported and securitized loans, the securitized loans will have amore significant impact on the managed loan performance numbers if oursecuritized receivables balance is substantially larger than the reportedreceivables balance. In addition, when loans are securitized, there is apotentially significant impact on reported loan performance as loans areremoved or reclassified from loans receivable on our balance sheet, while thereis generally no significant impact on managed loan performance.

 

21

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**Key Loan Performance Financial Data and Statistics**

 
|                                           |   | **Three  months ended March 31,** |       |
|------------------------------------------------|--------|-----------------------------------|------------|
| **(dollars  in thousands)**                    |   | **2003**                          |       | **2002** |   |
|                                           |   |                              |       |   |   |
| **Financial  Data**                            |   |                              |       |   |   |
|                                           |   |                              |       |   |   |
| Reported interest income from loans            |   | $                                 | 310,340    |   | $ | 488,085 |   |
| Securitized interest income from loans         |   | 585,996                           |       | 738,866 |   |
| Total managed interest income from loans       |   | $                                 | 896,336    |   | $ | 1,226,951 |   |
|                                           |   |                              |       |   |   |
| Reported interest income investments           |   | $                                 | 41,859     |   | $ | 44,250 |   |
| Securitization adjustment(1)                   |   | (13,010                           | )          | (13,539 | ) |
| Total managed  interest income investments     |   | $                                 | 28,849     |   | $ | 30,711 |   |
|                                           |   |                              |       |   |   |
| Reported interest expense                      |   | $                                 | 171,845    |   | $ | 207,055 |   |
| Securitized interest expense                   |   | 47,853                            |       | 88,270 |   |
| Total managed interest expense                 |   | $                                 | 219,698    |   | $ | 295,325 |   |
|                                           |   |                              |       |   |   |
| Reported net  interest income                  |   | $                                 | 180,354    |   | $ | 325,280 |   |
| Securitized net interest income                |   | 525,133                           |       | 637,057 |   |
| Managed net  interest income                   |   | $                                 | 705,487    |   | $ | 962,337 |   |
|                                           |   |                              |       |   |   |
| Reported  non-interest income                  |   | $                                 | 417,538    |   | $ | 1,113,180 |   |
| Securitized non-interest income                |   | 13,336                            |       | (34,040 | ) |
| Managed  non-interest income                   |   | $                                 | 430,874    |   | $ | 1,079,140 |   |
|                                           |   |                              | ** ** |   | ** ** |
| Reported average  loans outstanding            |   | $                                 | 7,500,339  |   | $ | 11,757,911 |   |
| Securitized average loans                      |   | 11,452,028                        |       | 15,245,763 |   |
| Managed average  loans outstanding             |   | $                                 | 18,952,367 |   | $ | 27,003,674 |   |
|                                           |   |                              |       |   |   |
| Reported average  earning assets               |   | $                                 | 13,603,971 |   | $ | 16,427,334 |   |
| Securitized average earning assets             |   | 11,452,028                        |       | 15,245,763 |   |
| Managed average  earning assets                |   | $                                 | 25,055,999 |   | $ | 31,673,097 |   |
|                                           |   |                              |       |   |   |
| **Loan  Performance Statistics**               |   |                              |       |   |   |
|                                           |   |                              |       |   |   |
| Reported                                       |   |                              |       |   |   |
| Net interest  margin on average loans(2)       |   | 11.50                             | %          | 11.56 | % |
| Net interest  margin on average earning assets |   | 5.30                              | %          | 7.92 | % |
| Risk adjusted  margin                          |   | 17.98                             | %          | 35.39 | % |
| Return on  average earning assets              |   | 0.14                              | %          | 0.24 | % |
|                                           |   |                              |       |   |   |
| Managed                                        |   |                              |       |   |   |
| Net interest  margin on average loans(3)       |   | 15.41                             | %          | 14.45 | % |
| Net interest  margin on average earning assets |   | 11.26                             | %          | 12.15 | % |
| Risk adjusted  margin                          |   | 6.89                              | %          | 15.38 | % |
| Return on  average earning assets              |   | 0.08                              | %          | 0.13 | % |

 

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(1)          In accordance with GAAP,the Company recognizes a portion of its non-interest income attributable to itsretained beneficial interests in securitized loans as interest income. On amanaged basis, this reported interest income is reclassified back tonon-interest income.

(2)          Represents interestincome recognized on reported average loans receivable, expressed as apercentage of reported average loans receivable, less interest expense ondeposits and borrowings, expressed as a percentage of reported average earningsassets.

(3)          Represents interestincome recognized on managed average loans receivable, expressed as apercentage of managed average loans receivable, less interest expense ondeposits and borrowings, including the interest costs payable to securitizationinvestors, expressed as a percentage of managed average earning assets.

 

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*NetInterest Income and Margin*.    Net interest income is interest earned from loans receivableand our investment portfolios less interest expense on deposits and borrowings.Reported net interest income for the three months ended March 31, 2003 was$180.4 million, compared to $325.3 million for the same period in2002, a decrease of $144.9 million. For the three months endedMarch 31, 2003, managed net interest income decreased to$705.5 million from $962.3 million for the first quarter of 2002. Ourreported net interest margin on average loans decreased to 11.50% for the firstquarter of 2003, from 11.56% for the same period in 2002. Managed net interestmargin on average loans increased to 15.41% for the first quarter of 2003, from14.45% for the same period in 2002. The yield on our reported loans receivabledecreased to 16.55% in the first quarter of 2003 from 16.60% in the firstquarter of 2002, while the yield on our managed loans receivable increased to18.92% in the first quarter of 2003 from 18.17% in the first quarter of 2002.The higher yield on our managed loans in the first quarter of 2003 reflects theimpact from the sale, in February 2002, of our interests in the lower yieldaccounts included in the Providian Master Trust.

 

Reported earning assetsprimarily include consumer loans, interest-earning cash, federal funds sold,and investment securities. Managed earning assets include reported earningassets plus the loans receivable removed or reclassified from loans receivableon our balance sheet through our securitizations, less the retained interestsfrom securitizations reported on our statement of financial condition. Netinterest income may be expressed as a percentage of average earning assets, inwhich case it is referred to as net interest margin on average earning assets.  The reported net interest margin on averageearning assets declined from 7.92% for the quarter ended March 31, 2002 to5.30% for the quarter ended March 31, 2003. The managed net interestmargin on average earning assets declined from 12.15% for the quarter endedMarch 31, 2002 to 11.26% for the quarter ended March 31, 2003. Thesedecreases reflect our efforts to strengthen our liquidity during 2002 byselling certain loans receivable and other assets and maintaining largepositions in cash and other liquid investments at lower yields.

 

*RiskAdjusted Margin.*    Weuse risk adjusted margin as a measure of loan portfolio profitability,consistent with our goal of matching the revenue generated by customer accountswith the risks undertaken. Risk adjusted margin is risk adjusted revenue (totalinterest income on loans plus non-interest income, less interest expenseallocated to loans, and less net credit losses) expressed as a percentage ofaverage loans outstanding. Managed risk adjusted revenue includes reportedrisk adjusted revenue plus the net interest income, non-interest income and netcredit losses related to the securitized consumer loans. Reported risk adjustedrevenue and risk adjusted margin for the quarter ended March 31, 2003 were$337.1 million and 17.98%, compared to $1.04 billion and 35.39% for thequarter ended March 31, 2002. Managed risk adjusted revenue and riskadjusted margin for the quarter ended March 31, 2003 were$326.5 million and 6.89%, compared to $1.04 billion and 15.38% forthe quarter ended March 31, 2002. The decrease in managed risk adjustedrevenue is primarily the result of lower net interest income and non-interestincome due to decreased managed loan balances resulting from the sales of ourinterests in the Providian Master Trust and a portfolio of higher risk loans,higher credit losses in the first quarter of 2003, and the inclusion innon-interest income in the first quarter of 2002 of the $401.9 million gain onthe sale of our interests in the Providian Master Trust. The decrease inmanaged risk adjusted margin is primarily the result of the lower risk adjustedrevenue and an increase in the managed net credit loss rate from 15.05% to17.61% due to the deterioration in the credit quality of our loans and weaknessin the economy, partially offset by a reduction in the interest paid todepositors and securitization investors.

 

*AssetQuality*

 

Our delinquencies and net credit losses reflect, amongother factors, the credit quality of our loans, the average age of our loansreceivable (generally referred to as “seasoning”), the success of ourcollection efforts, and general economic conditions. Initially, credit qualityis primarily determined by the characteristics of the targeted market segmentand the underwriting criteria utilized in the credit approval process. After anaccount is opened, account management efforts, seasoning, and demographic andeconomic conditions will affect credit quality.

 

We historically focused on three market segments: thestandard market segment (higher risk and generally underserved customers whomight not ordinarily qualify for credit cards, including customers with pastcredit problems or limited credit history); the middle market segment(customers whose credit is typically superior to the standard market segmentbut inferior to platinum and prime market segment customers); and the platinummarket segment (customers with generally good credit history).

 

In 2001 we changed our marketing strategies withinboth the new account acquisition and portfolio management functions with thegoal of creating a higher quality loan portfolio with more stable earnings andlower, less volatile credit loss rates. In October 2001, we discontinuedall new account marketing to the standard segment. In mid-2002, we introduced abalanced strategy of originating new loans across the broad middle to primemarket segments and more recently refined our strategy to focus on parts of themarket that we expect to be most profitable. Under our new programs, weselectively recruit higher quality customers from these most attractive partsof the market.

 

23

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Consistent with the changes in our strategy for newaccount acquisitions, we altered our marketing approaches for current customers.We also tightened credit line increase qualification criteria in all segments,and selectively re-priced loans that exhibited increased risk levels. Tostrengthen and extend our relationships with our best customers, we selectivelyprovide product upgrades, improve pricing, and increase credit lines whenappropriate.

 

We recognize credit losses on accounts determined tobe uncollectible by charging off the outstanding principal balances, asdescribed in our 2002 Annual Report under “Management’s Discussion and Analysisof Financial Condition and Results of Operations —Overview of CriticalAccounting Policies” and under Note 2 to Consolidated Financial Statements. Atthe time a loan is charged off, any accrued and unpaid finance charge and feeincome is removed from our loan balances but is maintained on the customer’srecord in the event of a future recovery. After a loan is charged off, wecontinue collection activity to the extent legally permissible. Any collectionson, and proceeds from the sale of, charged off loans are recognized asrecoveries and are offset against current period charged off balances todetermine net credit losses.

 

During the third quarter of 2002, we undertook astrategic review of our risk management and collections operations. As aresult, we initiated a series of changes to our operating strategies andpolicies. The most significant outcome of our review was the adoption of adelinquency lifecycle strategy for the management of delinquent accounts. InOctober 2002, we began to implement this strategy in combination withevent-driven approaches, consumer counseling, and consumer debt managementeducation. Under the delinquency lifecycle approach, we prioritize collectionsto focus on delinquency status, with attention to customer events within eachstage of delinquency. We believe that this facilitates management and collectoraccountability for, and ownership of, collection results.

 

We also reviewed our operational policies andprocedures in light of regulatory guidance and industry practice, and madechanges within those parameters where necessary or appropriate. As a result ofthe review, we implemented certain changes in 2002 that impacted ourrecognition of principal charge-offs, our procedures for investigating fraudlosses, and our recognition of charge-offs for accounts of deceased customers.

 

In February 2003, we modified our loan re-agingpractices. If a customer makes a partial payment that qualifies under ourstandards and applicable regulatory requirements, we re-age the related accountfrom delinquency status to current status. We re-age qualifying accounts notmore than once in any 12-month period, but not more than twice within60 months, in accordance with guidance provided by the Federal FinancialInstitutions Examination Council. Previously, our practice was to re-agequalifying accounts not more than once in any 30-month period and not more thantwice within 60 months. The impact of implementing this change was adecrease in the February 2003 reported 30+ day delinquency rate from 9.73%to 9.59%.

 

We expect that these changes will result inperformance improvements over the long term. Our continued review of riskmanagement and collections operations could lead to further modifications inthe future.

 

In January 2003, the Office of the Comptroller ofthe Currency and the Federal Deposit Insurance Corporation (“FDIC”), incoordination with the Federal Financial Institutions Examination Council,issued new guidance to the industry on credit card account management and lossallowance practices. We believe our practices are already in compliance withmost aspects of the guidance, and expect to achieve full compliance during thecourse of 2003 without material impact to our business model. However, we canprovide no assurance that our banking regulators will agree with our assessmentof our compliance with the guidance, nor can we estimate what costs, if any,might result from any direction provided by our banking regulators.

 

*Delinquencies.  * An account is contractually delinquent if theminimum payment is not received by the next billing date. Accountholders maycure account delinquencies by making a partial payment that qualifies under ourre-aging practices and applicable regulatory requirements. The 30+ daydelinquency rate on reported loans was 8.76% as of March 31, 2003,compared to 10.00% as of December 31, 2002 and 8.32% as of March 31, 2002.The 30+ day delinquency rate on managed loans was 10.31% as of March 31,2003, compared to 11.11% as of December 31, 2002 and 10.22% as of March31, 2002. The decreases from the fourth quarter of 2002 in both our reportedand managed 30+ day delinquency rates reflect the new collection and creditstrategies, policies and practices implemented in the latter part of 2002,existing portfolio management actions that emphasize a higher quality loanportfolio, and higher quality credit card account originations.

 

24

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**Delinquent Loans**

 
|                        |   | **March 31,  2003** |       | **December  31, 2002** |   |
|-----------------------------|--------|---------------------|------------|------------------------|--------|
| **(dollars  in thousands)** |   | **Loans**           |       | **% of  Total Loans**  |   | **Loans** |   | **% of  Total Loans** |   |
| **Reported**                |   |                |       |                   |   |   |   |   |   |
| Loans  outstanding(1) (2)   |   | $                   | 7,145,817  |                   | 100.00 | % | $ | 6,899,849 |   | 100.00 | % |
| Loans delinquent            |   |                |       |                   |   |   |   |   |   |
| 30 — 59 days           |   | $                   | 173,449    |                   | 2.43   | % | $ | 205,605 |   | 2.98 | % |
| 60 — 89 days           |   | 136,652             |       | 1.91                   | %      | 147,057 |   | 2.13 | % |
| 90 or more days             |   | 315,630             |       | 4.42                   | %      | 336,979 |   | 4.89 | % |
| Total loans  delinquent     |   | $                   | 625,731    |                   | 8.76   | % | $ | 689,641 |   | 10.00 | % |
|                        |   |                |       |                   |   |   |   |   |   |
| **Securitized**             |   |                |       |                   |   |   |   |   |   |
| Loans  outstanding(3)       |   | $                   | 11,323,170 |                   |   |   | $ | 12,719,752 |   |   |   |
| Loans delinquent            |   |                |       |                   |   |   |   |   |   |
| 30 — 59 days           |   | $                   | 353,358    |                   |   |   | $ | 460,295 |   |   |   |
| 60 — 89 days           |   | 283,102             |       |                   |   | 335,700 |   |   |   |
| 90 or more days             |   | 642,045             |       |                   |   | 694,129 |   |   |   |
| Total loans  delinquent     |   | $                   | 1,278,505  |                   |   |   | $ | 1,490,124 |   |   |   |
|                        |   |                |       |                   |   |   |   |   |   |
| **Managed**                 |   |                |       |                   |   |   |   |   |   |
| Loans outstanding(1)        |   | $                   | 18,468,987 |                   | 100.00 | % | $ | 19,619,601 |   | 100.00 | % |
| Loans delinquent            |   |                |       |                   |   |   |   |   |   |
| 30 — 59 days           |   | $                   | 526,807    |                   | 2.85   | % | $ | 665,900 |   | 3.39 | % |
| 60 — 89 days           |   | 419,754             |       | 2.27                   | %      | 482,757 |   | 2.46 | % |
| 90 or more days             |   | 957,675             |       | 5.19                   | %      | 1,031,108 |   | 5.26 | % |
| Total loans  delinquent     |   | $                   | 1,904,236  |                   | 10.31  | % | $ | 2,179,765 |   | 11.11 |   |

 

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(1)          The March 31, 2003 andMarch 31, 2002 balances exclude market value adjustments of $0.8 million and$17.9 million related to the fair value of designated financial instruments.

(2)          Effective December 2002,the Company adopted the federal banking agencies’ accrued interest receivable,or AIR, guidance, resulting in a reclassification of a portion of accruedinterest receivable from reported loans receivable to due from securitizationsduring the first quarter of 2003 and the fourth quarter of 2002.

(3)          Excludes the seller’sinterest in the loans receivable transferred in securitizations. The seniorseller’s interest is an undivided interestin the loans transferred to the securitization trust and is included inreported loans receivable.

 

*NetCredit Losses.   *Netcredit losses for consumer loans represent the principal amount of charged offloan balances (including charged off bankrupt and deceased customer accounts)less current period recoveries. Net credit losses include purchases, includingcertain financed cardholder service product sales and cash advances, andexclude accrued finance charges and fees and fraud losses. Recoveries includecollections on previously charged off accounts and the proceeds from the saleof charged off receivables. The amount of charged off receivables sold willvary from period to period and is influenced by charge off trends, marketconditions, and credit loss performance targets for the period in question.Fraud losses (losses due to the unauthorized use of credit cards, includingcredit cards obtained through fraudulent applications) are not included incredit losses and are charged to non-interest expense after an investigationperiod of up to 90 days (up to 60 days prior to November 2002).

 

Credit loss rates are derived by dividing net creditlosses by average loans receivable balances for a specified period. While netcredit losses exclude all accrued finance charges and fees charged off, loansreceivable balances include accrued finance charge and fee balances estimatedto be collectible. The reported net credit loss rate was 15.79% for the quarterended March 31, 2003, compared to 14.04% for the quarter endedMarch 31, 2002.

 

Managed net credit losses include reported net creditlosses plus charged off amounts less recoveries (including proceeds from thesale of charged off receivables) related to securitized loan amounts. Themanaged net credit loss rate was 17.61% for the quarter ended March 31,2003, compared to 15.05% for the quarter ended March 31, 2002.

 

The increases in the reported and managed net creditloss rates primarily reflect the higher concentration of our customers in thestandard and middle market segments resulting from the sale of our interests inthe Providian Master Trust in 2002. In the fourth quarter of 2002, the initialimpact of the collections initiatives described above showed improvements tolate stage collections and recovery performance. While, as expected, the netcredit loss rate was higher in the first quarter of 2003, we believe thatexpansion of the collections initiatives, coupled with underwritingenhancements and improving new

 

25

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account vintage performance for newer accounts, will have anincreasingly positive impact on the net credit loss rate during the remainderof 2003.

 

**Net Credit Losses**

 
|                                                            |   | **Three  months ended March 31,** |       |
|-----------------------------------------------------------------|--------|-----------------------------------|------------|
| **(dollars  in thousands)**                                     |   | **2003**                          |       | **2002** |   |
| **Reported**                                                    |   |                              |       |   |   |
| Average loans  outstanding(1)                                   |   | $                                 | 7,500,339  |   | $ | 11,769,464 |   |
| Net credit  losses(2)                                           |   | $                                 | 296,074    |   | $ | 413,235 |   |
| Net credit  losses as a percentage of average loans outstanding |   | 15.79                             | %          | 14.04 | % |
|                                                            |   |                              |       |   |   |
| **Securitized**                                                 |   |                              |       |   |   |
| Average loans  outstanding                                      |   | $                                 | 11,452,028 |   | $ | 15,245,763 |   |
| Net credit  losses                                              |   | $                                 | 538,468    |   | $ | 603,017 |   |
|                                                            |   |                              |       |   |   |
| **Managed**                                                     |   |                              |       |   |   |
| Average loans  outstanding(1)                                   |   | $                                 | 18,952,367 |   | $ | 27,015,227 |   |
| Net credit  losses(2)                                           |   | $                                 | 834,542    |   | $ | 1,016,252 |   |
| Net credit  losses as a percentage of average loans outstanding |   | 17.61                             | %          | 15.05 | % |

 

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(1)          The 2002 average loansoutstanding include loans held for securitization or sale at par.

(2)          The 2002 net creditlosses exclude the fair value adjustment on loans held for securitization orsale.

 

Reported and managed net credit losses do not includean adjustment for estimated credit losses in the amount of $985.9 million,which was made to reflect the fair value of a portfolio of $2.65 billionof higher risk loans held for sale or securitization at March 31, 2002.Prior to April 1, 2002, credit losses realized on these higher risk loanswere included in our reported and managed credit losses.

 

*InterestRate Sensitivity*

 

Interest rate sensitivity refers to the change inearnings or value resulting from fluctuations in interest rates. Our earningsare subject to risk to the extent that there is a difference between the amountof interest-earning assets and the amount of interest-bearing liabilities thatmature or reprice in a specific period. Even if earnings could be perfectlyhedged, a change in the level of interest rates will change the present valueof the hedged earnings stream.

 

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). Our receivables accrue finance charges at rates that areeither fixed or float at a spread above the prime rate. While our fixed ratecredit card receivables have no stated maturity or repricing period, wegenerally have the right to adjust the rate charged after providing notice tothe customer. Interest rates on our liabilities are generally indexed to LIBORor bear a fixed rate until maturity. This asset/liability structure exposes usto two types of interest rate risk: (a) repricing risk, which results froma mismatch between assets and liabilities that mature or reprice in specificperiods; and (b) basis risk, which arises from changing spreadrelationships between indexes such as the prime rate and LIBOR.

 

The principal objective of our interest rate riskmanagement activities is to monitor and control our exposure to adverse effectsresulting from movements of interest rates over time. We measure and manageinterest rate risk individually for each banking subsidiary and on a consolidatedbasis. We generally seek to strike a balance between hedging earnings andhedging the present value of earnings. To measure exposure to interest ratechanges, we use multiple complementary measures of risk to current earnings andthe present value of earnings under a number of scenarios and rate changes. Wetypically model the impact of rate changes on current earnings over athree-year period and the impact on the present value of earnings over a longerhorizon. When estimated risk exposure exceeds our guidelines, we seek tomitigate the risk through the use of matching and hedging techniques asdescribed below.

 

The table below illustrates the estimated effects ofpositive and negative parallel shifts in interest rates as calculated atMarch 31, 2003, using our interest rate risk model and taking intoconsideration our current hedging activity as of March 31, 2003.

 

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**Estimated Effects of Interest Rate Changes**

 
| **Change in  Interest Rates [increase (decrease)]** |   | **Percentage  Change in  Managed Net Interest Income(1)** |   |
|-----------------------------------------------------|--------|--------------------------------------------------------------------------|--------|
| 2.0%                                                |   | 3.4                                                                      | %      |
| (2.0)%                                              |   | (2.0                                                                     | )%     |

 

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(1)          The information shown ispresented on a consolidated managed asset/liability basis, giving effect toderivatives, securitizations and related funding. It compares managed netinterest income over twelve months in a stable interest rate environment toscenarios in which interest rates rise and fall by 200 basis points. We do notin the normal course of business derive comparable interest rate sensitivity ofnet interest income on a reported basis. Developing such a projection would beunreasonably burdensome, and, in the opinion of management, such comparableprojections on a reported basis would not provide a significant benefit inunderstanding our expected future performance.

 

Our interest rate risk model incorporates certainassumptions regarding our ability to reprice our fixed rate credit card loanswithout otherwise impacting customer behavior. The actual repricing sensitivityof these loans depends on how our customers and competitors respond to changesin market interest rates. As of March 31, 2003, we modeled the repricingmaturity of our fixed rate credit card loans based on an average maturity of15 months. The repricing of certain other categories of assets andliabilities is subject to competitive and other pressures beyond our control.As a result, certain assets and liabilities assumed to mature or otherwisereprice within a certain period may in fact mature or reprice at differenttimes and at different volumes. The table above should be viewed as our bestestimate, subject to these uncertainties, of the general effect of theindicated interest rate movements on our managed net interest income.

 

We generally seek to mitigate the risk arising fromchanges to earnings and value associated with interest rate movement bymatching the modeled repricing characteristics of assets and liabilities. Whenmatching the repricing characteristics of assets and liabilities is notpossible or efficient, we generally seek to hedge the risk by using derivativefinancial instruments, including interest rate swap and cap agreements. We donot trade derivatives or use derivatives to speculate on interest ratemovements, and we believe our use of such instruments is prudent and consistentwith industry standards.

 

**Notional Amounts of Interest Rate Swap and Cap Agreements**
|                               |   | **Three  months ended March 31,** |    |
|------------------------------------|--------|-----------------------------------|---------|
| **(dollars  in thousands)**        |   | **2003**                          |    | **2002** |   |
| **Interest  Rate Swap Agreements** |   |                              |    |   |   |
| Beginning  balance                 |   | $                                 | 918,200 |   | $ | 1,293,200 |   |
| Additions                          |   | —                            |    | — |   |
| Maturities                         |   | 100,000                           |    | 65,000 |   |
| Ending balance                     |   | $                                 | 818,200 |   | $ | 1,228,200 |   |
|                               |   |                              |    |   |   |
| **Interest Rate Cap Agreements**   |   |                              |    |   |   |
| Beginning  balance                 |   | $                                 | 3,000   |   | $ | 7,883 |   |
| Additions                          |   | —                            |    | — |   |
| Maturities                         |   | —                            |    | 1,869 |   |
| Ending balance                     |   | $                                 | 3,000   |   | $ | 6,014 |   |

 

Notional amounts of interest rate swaps and capsoutstanding on March 31, 2003 decreased from March 31, 2002,primarily as the need for hedging declined in conjunction with a decrease inour fixed rate loans. As market conditions or our asset/liability mix change,we may increase or decrease the notional amounts of interest rate swaps andcaps outstanding in order to manage our interest rate risk within prudentlevels.

 

We manage credit risk arising from derivativetransactions through an ongoing credit review, approval, and monitoringprocess. Credit risk for these derivative transactions is defined as the riskthat a loss will occur as the result of a derivative counterparty defaulting ona contract when the contract is in a favorable economic position to us. We mayenter into master netting, market settlement, or collateralization agreementswith derivative counterparties to reduce this risk.

 

In 2002 we completed the sale of our operations in theUnited Kingdom and Argentina. At March 31, 2003, our foreign currencyexposure had been reduced to small cash balances in British pounds sterling.

 

27

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*Fundingand Liquidity*

 

We seek to fund our assets through a diversified mixof funding products designed to appeal to a broad range of investors, with thegoal of generating funding at the lowest cost available to us while maintainingliquidity at prudent levels and managing interest rate risk. The primary goalof our 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.

 

Our debt ratings and those of PNB were downgraded in2001 and 2002. These downgrades have had and, together with any futuredowngrades, may continue to have a negative effect on our ability to obtainfunding and on the cost and terms of the funding that is available. Accordingly,our access to funding has been and may continue to be more limited, at a highercost and on terms less favorable than previously available to us.

 

**Current Long-Term Senior Debt Ratings**
|                             |   | **Standard  &  Poor’s(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)          Stableoutlook.

 

During the first quarter of 2003, our liquidityposition (federal funds sold and securities purchased under resale agreements,available-for-sale investment securities, and cash and cash equivalents)increased by approximately $763.9 million from December 31, 2002 to end thequarter at $6.57 billion. This increase was primarily attributable to assetattrition and receipt of a tax refund, partially offset by a decrease infunding from securitizations. In accordance with the Capital Plans that ourbanking subsidiaries have entered into with their regulators, we expect tocontinue to maintain significant levels of liquidity.

 

In addition, under the capital assurances andliquidity maintenance agreements we entered into with our banking subsidiaries,we have agreed to provide liquidity support to them. Our agreements with ourbanking subsidiaries to provide capital and liquidity support exempt certain ofour near-term cash obligations, including current interest obligations on our3.25% convertible senior notes due August 15, 2005 and current payments on theProvidian Capital I 9.525% capital securities. In addition, certain accrueddeferred compensation, miscellaneous working capital needs not to exceed $25million, and severance payments are generally exempt from the parent company’sobligations under the agreements. See “Regulatory Matters” in our 2002 AnnualReport for a description of our capital assurances and liquidity maintenanceagreements.

 

Our investment in subsidiaries as a percentage of ourtotal equity, which is referred to as our “double leverage,” at March 31, 2003was 132%. A double leverage ratio in excess of 100% indicates the degree towhich an investment in subsidiaries has been funded with long-term borrowingsand other liabilities of the parent company. The principal source of funds forus to make payments on our parent company debt securities and to meet our otherobligations is our cash investments and dividends from our bankingsubsidiaries. However, our banking subsidiaries have agreed not to pay anydividends to us during the term of their regulatory agreements without firstobtaining regulatory consent. They do not currently have any plans to seek suchconsent. In addition, if we are required to provide additional capital andliquidity support to our banking subsidiaries, our ability to service our debtobligations would be further limited.

 

*FundingSources and Maturities.   *Weseek to fund our assets by diversifying our distribution channels and offeringa variety of funding products. However, our ability to fund existing and futurecustomer loans is currently dependent on four primary sources: customerdeposits, securitizations, a portfolio of cash and liquid investmentsecurities, and, to a lesser extent, debt.

 

We offer maturity terms for our funding products thatrange up to 30 years. Actual maturity distributions depend on several factors,including expected asset duration, investor demand, relative costs, shape ofthe yield curve, and anticipated issuances in the securitization and capitalmarkets. We seek to maintain a balanced distribution of maturities and avoidundue concentration in any one period. We monitor existing funding maturitiesand loan growth projections to prudently manage liquidity levels.

 

28

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For the remainder of the year (April 1, 2003through December 31, 2003), we have funding requirements for maturingdeposits of $2.40 billion, maturing securitizations of $2.48 billion, and nomaturing debt. We anticipate that we will meet these funding requirements,along with any incremental asset growth, with securitization issuances, ourliquidity position, and new deposits. However, given the downgrades in ourcredit ratings and the 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. We maygenerate additional funding by issuing common stock through a dividendreinvestment and direct stock purchase plan or by issuing new debt securities.

 

*Deposits   *Deposits decreased to$12.59 billion as of March 31, 2003 from $12.71 billion as of December 31,2002. During 2003, we anticipate that our deposit issuances will provide asubstantial source of funding. Consistent with our Capital Plans, however, weexpect to continue to work with our banking subsidiaries’ regulators to improvethe quality of the assets that we hold on our balance sheet that are funded bydeposits as we also continue to work to reduce our overall level of reliance ondeposit funding.

 

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

 

**Maturitiesof Deposits**

** **
|                                   |   | **March 31,  2003**  |      | **December  31, 2002** |   |
|----------------------------------------|--------|----------------------|-----------|------------------------|--------|
| **(dollars  in thousands)**            |   | **Direct  Deposits** |      | **Brokered  Deposits** |   | **Total  Deposits** |   | **Direct  Deposits** |   | **Brokered  Deposits** |   | **Total  Deposits** |   |
| Three months or  less                  |   | $                    | 361,573   |                   | $      | 307,534 |   | $ | 669,107 |   | $ | 536,010 |   | $ | 605,389 |   | $ | 1,141,399 |   |
| Over three  months through one year(1) |   | 1,388,573            |      | 1,460,373              |   | 2,848,946 |   | 1,290,023 |   | 1,119,965 |   | 2,409,988 |   |
| Over one year  through five years(2)   |   | 2,518,355            |      | 4,290,301              |   | 6,808,656 |   | 2,506,801 |   | 4,192,418 |   | 6,699,219 |   |
| Over five years                        |   | 559                  |      | 1,256,126              |   | 1,256,685 |   | 43,623 |   | 1,383,717 |   | 1,427,340 |   |
| Deposits without  contractual maturity |   | 1,009,319            |      | —                 |   | 1,009,319 |   | 1,030,369 |   | — |   | 1,030,369 |   |
| Total Deposits                         |   | $                    | 5,278,379 |                   | $      | 7,314,334 |   | $ | 12,592,713 |   | $ | 5,406,826 |   | $ | 7,301,489 |   | $ | 12,708,315 |   |

 

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(1)          Maturities of depositsover three months through one year by quarter is as follows: third quarter2003: $758.4 million; fourth quarter2003: $977.4 million; firstquarter 2004: $1.11 billion.

(2)          Maturities of depositsover one year through two years, $3.08 billion.

 

A bank that is below the “well capitalized” levels asreported on its Call Reports is subject to ceilings on rates paid for deposits(limited to not more than 75 basis points higher than the prevailing rate inits market) and is restricted from accepting brokered deposits without a waiverfrom the FDIC. As of March 31, 2003, capital ratios for both PNB and PB wereabove the “well capitalized” levels on a Call Report basis. PB has exceeded the“well-capitalized” level since December 31, 2001; PNB, since March 31, 2002.Accordingly, the restrictions on deposit taking activities described above donot currently apply to PNB or PB and will not apply to them so long as theyremain “well capitalized” on a Call Report basis.

 

*Securitizations   *We securitize loans inorder to diversify funding sources and to obtain efficient all-in cost offunds, including the cost of capital. We seek a range of maturity terms in oursecuritizations.

 

Securitizations may utilize variable funding seriesthat renew annually if the relevant conditions for such renewal are satisfied.In the fourth quarter of 2002, we completed a variable funding seriessecuritization in our Providian Gateway Master Trust, which was funded in theamount of $1.09 billion of investor interests purchased by third parties. Inthe first quarter of 2003, we funded additional investor interests of $815.0million under this variable funding series. Also in the first quarter of 2003,$1.72 billion of investor interests relating to other series were repaid.

 

Securitized funding under variable funding seriesrepresenting investor interests held by third parties totaled $1.90 billion asof March 31, 2003 and $2.81 billion as of December 31, 2002. If the outstandingvariable funding series are not renewed, based on current projections andamounts outstanding as of March 31, 2003, these variable funding series areexpected to amortize or otherwise become payable during the fourth quarter of2003.

 

Term securitizations are issued with expectedmaturities of one year or more. Our term securitizations are expected toamortize over the periods indicated below, based on current projections andamounts outstanding as of March 31, 2003.

 

29

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**Amortization of Term Securitizations**

 

| **Year** |   | **Amount  Amortizing  (dollars in millions)** |   |
|----------|--------|-----------------------------------------------|--------|
| 2003 (1) |   | $                                             | 575    |   |
| 2004     |   | 2,002                                         |   |
| 2005     |   | 2,554                                         |   |
| 2006     |   | 1,029                                         |   |
| 2007     |   | 619                                           |   |
| 2008     |   | 246                                           |   |
|          |        |                                               |        |  |

 

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(1)          This amount is expected to amortize in the third quarter of 2003.

 

Given the deterioration in our financial performanceand asset quality since our third quarter 2001 earnings announcement, there hasbeen increased pressure on our ability to attract deposits, borrow funds fromother sources, and issue additional asset-backed securities as existing fundingamortizes.

 

The amount funded in our spreadaccounts will change from time to time, depending on securitization amounts andmaturities and the performance of the securitized loans.  At the end of the first quarter of 2003, thespread accounts had been fully funded to their required levels, which thentotaled $667 million.  As a result ofthe excess servicing of certain series of the Providian Gateway Master Trustfalling below specified levels, we expect total spread account fundingrequirements to increase to approximately $725 million by the end of the secondquarter of 2003.

 

*Unsecured Funding Facilities.*

 

**Summary of Unsecured Funding Facilities**

** **
|                                          |   | **March 31,  2003**        |   |
|-----------------------------------------------|--------|----------------------------|--------|
| **(dollars  in thousands)**                   |   | **Effective/  Issue Date** |   | **Facility  Amount (1)** |   | **Outstanding** |   | **Maturity** |   |
| Senior and  subordinated bank note program(2) |   | 2/98                       |   | $ | — |   | $ | 108,811 |   | 2/04 |   |
| Providian  Financial shelf registration(3)    |   | 6/98                       |   | 1,197,145 |   | 772,667 |   | 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)          Remaining facilityamount of $2.97 billion currently not available as a result of condition thatnew note issuances are not permitted unless debt of bank issuer is ratedinvestment grade. Bank notes currently outstanding under this program are allsenior bank notes.

(3)          Outstanding securitiesissued under the shelf registration consist of two convertible debt offeringswith earliest possible required principal payment dates beginning inAugust 2005 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 isavailable only for debt that is rated investment grade at the time of issuanceand is therefore not currently available to PNB. There can be no assurance thatPNB will be able to successfully utilize this program in the future.

 

The principal source of funds for payment of dividendson our common stock is dividends received from our banking subsidiaries.However, our banking subsidiaries have agreed not to pay any dividends to usduring the term of their regulatory agreements without first obtaining priorregulatory consent. See “Regulatory Matters” in our 2002 Annual Report. Ourbanking subsidiaries do not currently have any plans to seek such consent. Inaddition, our board of directors has suspended for an indefinite period thepayment of quarterly cash dividends on our common stock.

 

*Investments   *We maintain short-termliquidity through federal funds sold and securities purchased under resaleagreements, available-for-sale investment securities, and cash and cashequivalents. We also maintain a portfolio of high-quality investmentsecurities, such as U.S. government and agency obligations, mortgage-backedsecurities, and commercial paper. Investment securities decreased to $1.85billion as of March 31, 2003 from $1.86 billion as of December 31, 2002.Federal funds sold and securities purchased under resale agreements increasedto $4.23 billion as of March 31, 2003 from $3.60 billion as of December 31,2002.

 

30

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*CapitalAdequacy*

 

Each of our banking subsidiaries is subject to capitaladequacy guidelines as defined by its primary federal regulator. Core capital(Tier 1) consists principally of shareholders’ equity less goodwill. Totalrisk-based capital (Tier 1 + Tier 2) includes a portion of theallowance for credit losses and other capital components. Based on theseclassifications of capital, the capital adequacy regulations establish threecapital adequacy ratios that are used to measure whether a financialinstitution is “well capitalized” or “adequately capitalized. “ See “RegulatoryMatters—Our Capital Plans” and “Regulatory Matters—Supervision and RegulationGenerally—Capital Requirements” in our 2002 Annual Report.

 

**Capital Adequacy Guidelines**

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

 

**CapitalRatios(Call Report Basis)**

** **

| **Capital  Ratios as of March 31, 2003** |   | **Providian  National  Bank** |   | **Providian  Bank** |   |
|------------------------------------------|--------|-------------------------------|--------|---------------------|--------|
| Total risk-based                         |   | 14.60                         | %      | 20.50               | %      |
| Tier 1                                   |   | 12.69                         | %      | 19.00               | %      |
| Leverage                                 |   | 17.79                         | %      | 8.99                | %      |

 

Pursuant to the Capital Plans, our bankingsubsidiaries’ capital is also evaluated under the Expanded Guidance forSubprime Lending Programs (“Subprime Guidance”). Application of the SubprimeGuidance results in a higher overall risk weighting on the loan portfolio as awhole than would otherwise be required by the regulations. Under themethodology utilized under the Capital Plans for determining risk weightings,our banking subsidiaries have segmented their standard and middle market loanportfolios into several categories according to their internal credit scoresand historical and projected charge-off rates. As applied by the banks as ofMarch 31, 2003, this methodology resulted in weighted average riskweightings against reported standard and middle segment loans of 160% at PNBand 164% at PB. On a combined basis, the banks’ weighted average risk weightingon a Subprime Guidance basis was approximately 161% against reported standardand middle segment loans of approximately $5.18 billion as ofMarch 31, 2003. Such risk weightings are subject to change depending uponconditions in our loan portfolio and/or changes in regulatory guidance. Managedloans outstanding to customers in the standard and middle segments, on acombined basis, totaled approximately $16.50 billion as of March 31,2003. See “Regulatory Matters—Our Capital Plans” and “RegulatoryMatters—Supervision and Regulation Generally—Capital Requirements” in our 2002Annual Report.

 

PNB and PB have each met their commitments in theCapital Plans to achieve and maintain total risk-based capital ratiosassociated with “adequately capitalized” status after applying the SubprimeGuidance risk weightings. As of March 31, 2003, PNB’s and PB’s capitalratios exceeded the requirements for “well capitalized” status after applyingthe Subprime Guidance risk weightings. PNB has committed to achieve byJune 30, 2003 capital ratios associated with “well capitalized” statusafter applying the Subprime Guidance risk weightings and excluding from thecalculation the effect of adopting the AIR guidance, and to achieve byJune 30, 2004 capital ratios associated with “well capitalized” statusafter applying the Subprime Guidance risk weightings and including in thecalculation the effect of adopting the AIR guidance. As of March 31, 2003, PNB’stotal risk based capital ratio after applying the Subprime Guidance riskweightings and excluding the effect of the AIR guidance was 12.99%. PB is notaffected by the AIR guidance and has committed to achieve by June 30, 2003capital ratios associated with “well capitalized” status after applying theSubprime Guidance risk weightings.

 

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**Capital Ratios(Applying Subprime Guidance)**

| **Capital  Ratios as of March 31, 2003** |   | **Providian  National  Bank  (including AIR)** |   | **Providian  Bank** |   |
|------------------------------------------|--------|------------------------------------------------|--------|---------------------|--------|
| Total risk-based                         |   | 11.24                                          | %      | 12.42               | %      |
| Tier 1                                   |   | 9.66                                           | %      | 11.03               | %      |
| Leverage                                 |   | 17.79                                          | %      | 8.99                | %      |

 

Future capital ratios will depend on the level ofinternally generated capital as well as the level of loan growth, changes inloan mix, and the level of retained subordinated interests related to oursecuritization activity. Growth in reported receivables, combined with thegrowth in spread accounts and other retained subordinated interests relating toour securitizations, may result in the fluctuation of the banks’ risk-basedcapital ratios, as reported in their Call Reports and after applying theSubprime Guidance. However, with the substantial completion of our strategicasset dispositions and other strategic initiatives, as well as the generationof internal capital through the recognition of net income, and subject toongoing review and update of our Capital Plans and the potential impact ofevolving regulatory standards, we expect that our banking subsidiaries will beable to achieve the capital goals in their Capital Plans as required.

 

The capital requirements and classifications of ourbanking subsidiaries are subject to qualitative judgments by their regulatorswith respect to components, risk weightings, and other factors. The bankingregulators have the authority to require us to adhere to higher capitalrequirements. This would necessitate increasing capital ratios by variousmeans, including asset sales or equity issuances. In addition, the strategicinitiatives that we have taken, and any that we may take in the future, couldhave an impact on 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 thelow-level recourse rule, applies to transactions accounted for as sales underGAAP in which a bank contractually limits its risk of loss or recourse exposureto less than the full effective minimum risk-based capital requirement for theassets transferred. Low-level recourse transactions arise when a banksecuritizes assets and uses contractual cash flows, retained subordinatedinterests, or other assets as credit enhancements. Accordingly, our bankingsubsidiaries are required to hold risk-based capital equivalent to the maximumrecourse exposure on the assets transferred, not to exceed the amount ofrisk-based capital that would be required if the low-level recourse rule didnot 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 final rule was effective January 1, 2002 for any transactioncovered under the rule that settled on or after the effective date. Our bankingsubsidiaries elected early adoption of the residual interest rule, effectiveJanuary 1, 2002, as to transactions entered into before that date.

 

The residual interest rule adds new standards for thetreatment of retained interests related to securitizations, including aconcentration limit for credit-enhancing interest-only strips. This rule isintended to result in more consistent regulatory capital treatment for certaintransactions involving similar risk, and capital requirements that more closelyreflect a banking organization’s relative exposure to credit risk.Specifically, the final rule amended capital standards by: providing a moreconsistent risk-based capital treatment for recourse obligations and directcredit substitutes; applying a ratings-based approach that sets capitalrequirements for positions in securitized transactions; deducting from Tier 1capital the amount of credit-enhancing interest-only strips receivable thatexceeds 25% of Tier 1 capital (concentration limit); and requiring “dollar-for-dollar”risk-based capital for certain residual interests not deducted from Tier 1capital (dollar-for-dollar capital requirement). As of March 31, 2003,PNB’s interest-only strips receivable represented 11% of its Tier 1 capital,which is below the 25% concentration limit, and PB had no interest-only stripsreceivable.

 

On May 17, 2002, the federal banking agenciesissued clarifying guidance on the regulatory capital treatment of AIR relatedto credit card securitizations. The guidance defined the AIR asset as asubordinated retained interest that requires “dollar-for-dollar” risk-basedcapital. On December 4, 2002, the agencies also provided guidance on theaccounting for the AIR asset. We adopted the guidance for the capital treatmentand accounting of the AIR in the fourth quarter of 2002.

 

32

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*CautionaryStatement Regarding Forward-Looking Information*

 

This report contains certain forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended, which are subject to the “safe harbor” created by those sections.Forward-looking statements include, without limitation: expressions of the“belief,” “anticipation,” or “expectations” of management; statements as toindustry trends or future results of operations of our company and oursubsidiaries; and other statements that are not historical fact.Forward-looking statements are based on certain assumptions by management andare subject to risks and uncertainties that could cause actual results todiffer materially from those in the forward-looking statements. These risks anduncertainties include, but are not limited to, competitive pressures; factorsthat affect liquidity, delinquency rates, credit loss rates and charge-offrates; general economic conditions; consumer loan portfolio growth; changes inthe cost and/or availability of funding due to changes in the deposit, creditor securitization markets; changes in the way we are perceived in such marketsand/or conditions relating to existing or future financing commitments; theeffect of government policy and regulation, whether of general applicability orspecific to us, including restrictions and/or limitations relating to ourminimum capital requirements, deposit taking abilities, reservingmethodologies, dividend policies and payments, growth, and/or underwritingcriteria; changes in accounting rules, policies, practices and/or procedures;the success of product development efforts; legal and regulatory proceedings,including the impact of ongoing litigation; interest rates; one-time charges;extraordinary items; the ability to recruit or replace key personnel; and theimpact of existing, modified, or new strategic initiatives. These and otherrisks and uncertainties are described in our 2002 Annual Report under theheading “Risk Factors,” and are also described in other parts of our 2002Annual Report, including “Legal Proceedings” and “Management’s Discussion andAnalysis of Financial Condition and Results of Operations.” Readers arecautioned not to place undue reliance on any forward-looking statement, whichspeaks only as of the date thereof. We undertake no obligation to update anyforward-looking statements.

 

**Item 3.  Quantitative and****Qualitative Disclosures About MarketRisk.**

 

Information concerning quantitative and qualitativedisclosures about market risk is provided under the caption “Interest RateSensitivity” under “Management’s Discussion and Analysis of Financial Conditionand Results of Operations.”

 

**Item 4.  Controls and P****rocedures.**

 

Within the 90 days prior to the filing date of thisreport, the Company’s management, under the supervision and with theparticipation of the Company’s Chief Executive Officer and Chief FinancialOfficer, conducted an evaluation of the effectiveness of the design andoperation of the Company’s disclosure controls and procedures (as defined inExchange Act Rule 13a-14(c)).  The ChiefExecutive Officer and the Chief Financial Officer concluded that the Company’sdisclosure controls and procedures, which have been designed to ensure thatinformation required to be disclosed by the Company in the reports it filesunder the Exchange Act is recorded, processed, summarized and reported in atimely manner, are effective based on such evaluation.  There have been no significant changes ininternal controls or in other factors that could significantly affect internalcontrols subsequent to the date of such evaluation.

 

33

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**PARTII.  OTHER INFORM****ATION**

 

**Item 1.  Legal Proceedings.**

 

Following our third quarter earnings announcement in October 2001,a number of lawsuits were filed against us. These include Rule 10b-5 securitiesclass actions, two shareholder derivative actions, and class actions relatingto our 401(k) plan (the “401(k) Plan”).

 

The Rule 10b-5 securities class actions were filed in the DistrictCourt for the Northern District of California against us and certain of our executiveofficers and/or directors. These consolidated actions (In re ProvidianFinancial Securities Litigation) allege that we and certain of our officersmade false and misleading statements concerning our operations and prospectsfor the second and third quarters of 2001, in violation of federal securitieslaws. The actions define the putative class as those persons or entities whoacquired our stock between June 6 and October 18, 2001, and they seekdamages, interest, costs, and attorneys’ fees. Our motion to dismiss was deniedon December 4, 2002 and the case is moving into the discovery phase.

 

The shareholder derivative actions were filed in December 2001 andJanuary 2002 in California state court in San Francisco. These actionsgenerally seek redress against the members of our board of directors andcertain executive officers and allege breach of fiduciary duty, grossnegligence, breach of contract and violation of state insider trading law. Thecomplaints seek damages (in the name of the Company and to be awarded to theCompany), attorneys’ fees and other relief.

 

The class actions relating to the 401(k) Plan were filed beginning inDecember 2001 in the District Court for the Northern District ofCalifornia against us and/or certain of our executive officers and directors.The purported class comprises all persons who were participants orbeneficiaries of the Plan since July 17, 2001. These consolidated actions(In re Providian Financial ERISA Litigation) allege, among other things, thatthe defendants breached their fiduciary duties under the Employee RetirementIncome Security Act by encouraging participants to invest in our common stock,and restricting sales of the common stock held under the Plan, at a time whenthe common stock was an unsuitable Plan investment. The parties have agreed tosettle this litigation on a classwide basis for $8.6 million, which willbe funded by our insurance carriers. The settlement received preliminaryapproval from the court in April 2003.

 

Beginning in 1999, the Company was named as a defendant in a number oflegal proceedings relating to allegedly unfair and deceptive business practicesby our banking subsidiaries in the marketing of cardholder service products andother practices. In June 2000, the Company reached settlements with theComptroller, the San Francisco District Attorney, the California AttorneyGeneral, and the Connecticut Attorney General with respect to these consumerclaims. In December 2000, the Company announced that it had agreed tosettle the consumer class action and other lawsuits pending in state andfederal court relating to such practices. This settlement received final statecourt approval in November 2001 and the federal court actions weredismissed in March 2002. In connection with these settlements the Companyagreed to make certain business practice changes and to pay restitution toaffected customers. Approximately 6,400 class members opted out ofparticipation in the class action settlement and approximately 825 of thoseclass members have filed individual actions against the Company that arecurrently pending.

 

In February 2001, the Company was named as a defendant in aputative 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 EasternDistrict of Pennsylvania against Visa, MasterCard and a number of credit cardissuing banks. The suit alleges that uniform foreign currency surchargesallegedly imposed by the defendants are the result of a conspiracy in restraintof trade and violate the federal antitrust laws, and that the defendant banksfailed to separately identify these surcharges to their customers on theirmonthly statements in violation of the federal Truth-in-Lending Act. A numberof similar lawsuits have since been filed in California and New York. InAugust 2001, the Federal Judicial Panel on Multidistrict Litigationtransferred all of these cases to the Southern District of New York. InJanuary 2002, plaintiffs filed an amended consolidated complaint, which wemoved to dismiss in March 2002. The parties are awaiting a ruling by thecourt.

 

In July 2002, the Company was named as a defendant in a putative classaction suit entitled Shoars v. Providian Bancorp Services, Providian FinancialCorporation, et al., which was filed against the Company in California statecourt, alleging that our Paid Time Off (“PTO”) plan violates California LaborCode section 227.3 because the Company caps the payout of PTO benefits forterminated employees at 40 hours. We removed the case to federal court onthe grounds that federal ERISA law governs the PTO plan and therefore preemptsCalifornia law. The plaintiffs filed a motion to remand the case to statecourt, which we opposed. The federal court granted plaintiffs’ motion and thematter has been sent back to state court.

 

34

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Following the filing of a claim in arbitration, we continue to havesettlement discussions with our former Chief Executive Officer, Shailesh Mehta,concerning severance and other benefits alleged to be due underMr. Mehta’s employment agreement in connection with the termination of hisemployment in November 2001.

 

In addition, we are commonly subject to various other pending andthreatened legal actions arising in the ordinary course of business from theconduct of our activities. An informed assessment of the ultimate outcome orpotential liability associated with our pending lawsuits and other potentialclaims that could arise is not feasible at this time.

 

Due to the uncertainties of litigation, we can give noassurance that we will prevail on all claims made against us in the lawsuitsthat we currently face or that additional proceedings will not be brought.While we believe that we have substantive defenses in the actions and claimsdescribed above and intend to defend those actions and claims vigorously, wecannot predict their ultimate outcome or their potential future impact on us.We do not presently expect any of these matters to have a material adverseeffect on our business, financial condition or results of operations, but cangive no assurance that they will not have such an effect.

 

**Item 4.  Submission of Mat****ters to a Vote of Security Holders.**

 

(a)                                  The2003 Annual Meeting of Stockholders of the Company was held on May 1, 2003.

 

(b)                                 Thefollowing directors were elected at such meeting:

 

Richard D. Field

F. Warren McFarlan

Joseph W. Saunders

 

The following directors continued their term of officeafter such meeting:

 

James V. ElliottJ. David GrissomRobert J. HigginsRuth M. OwadesFrancesca Ruiz de LuzuriagaJane A. Truelove

 

(c)                                  Thefollowing matters were voted upon at such meeting:

 
| **Election  of Directors** |   | **Votes For** |   | **Votes  Withheld** |   |
|----------------------------|--------|---------------|--------|---------------------|--------|
|                       |   |          |   |                |   |
| Richard D. Field           |   | 244,557,391   |   | 18,865,212          |   |
| F. Warren  McFarlan        |   | 231,072,375   |   | 32,350,228          |   |
| Joseph W.  Saunders        |   | 245,826,731   |   | 17,595,872          |   |

 
| **Item**                                                                                                 |   | **Votes For** |   | **Votes  Against** |   | **Abstain** |   | **Broker   Non-Votes** |
|----------------------------------------------------------------------------------------------------------|--------|---------------|--------|--------------------|--------|-------------|--------|------------------------|
|                                                                                                     |   |          |   |               |   |        |   |                   |
| Ratification of  the selection of Ernst & Young LLP as independent auditors of the Company  for 2003 |   | 255,645,510   |   | 6,293,354          |   | 1,483,739   |   | —                 |
|                                                                                                     |   |          |   |               |   |        |   |                   |
| Stockholder  proposal relating to expensing of stock options                                             |   | 93,863,323    |   | 78,468,747         |   | 9,500,824   |   | 81,589,709             |

 

No other matter was voted upon at such meeting.

 

35

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**Item 6.  Exhibi****ts and Reports 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                                                                                                      |

 

(b)                                 Reportson Form 8-K.

 

The Company filed the following reports on Form 8-Kduring the first quarter of 2003:

 

The Company filed a report on Form 8-K (dated January15, 2003) on January 15, 2003 with respect to its managed net credit loss ratefor the month ended December 31, 2002 and its 30+ day managed delinquency rateas of December 31, 2002, including results from both reported and securitizedloans, including loans securitized in the Providian Gateway Master Trust.

 

The Company filed a report on Form 8-K (dated February13, 2003) on February 13, 2003 with respect to its managed net credit loss ratefor the month ended January 31, 2003 and its 30+ day managed delinquency rateas of January 31, 2003, including results from both reported and securitizedloans, including loans securitized in the Providian Gateway Master Trust.

 

The Company filed a report on Form 8-K (dated March17, 2003) on March 17, 2003 with respect to its managed net credit loss ratefor the month ended February 28, 2003 and its 30+ day managed delinquency rateas of February 28, 2003, including results from both reported and securitizedloans, including loans securitized in the Providian Gateway Master Trust.

 

(c)                                  Ratioof Earnings to Fixed Charges and Ratio of Earnings to Combined Fixed Chargesand Preferred Stock Dividend Requirements.

 
|                                                           |   | **Three  months  ended  March 31, 2003** |     | **Year ended December 31,** |     |
|----------------------------------------------------------------|--------|------------------------------------------|----------|-----------------------------|----------|
|                                                           |   |                                     | **2002** |                        | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|                                                           |   |                                     |     |                        |     |   |   |   |   |   |   |   |   |
| **Earning to Fixed Charges**                                   |   |                                     |     |                        |     |   |   |   |   |   |   |   |   |
| Excluding  interest on deposits                                |   | 1.57                                     |     | 3.83                        |     | 3.68 |   | 14.91 |   | 10.05 |   | 10.88 |   |
| Including  interest on deposits                                |   | 1.04                                     |     | 1.25                        |     | 1.24 |   | 2.27 |   | 3.03 |   | 2.93 |   |
|                                                           |   |                                     |     |                        |     |   |   |   |   |   |   |   |   |
| **Earnings to Combined Fixed Charges  and Preferred Stock(1)** |   |                                     |     |                        |     |   |   |   |   |   |   |   |   |
| Excluding  interest on deposits                                |   | 1.57                                     |     | 3.83                        |     | 3.68 |   | 14.91 |   | 10.05 |   | 10.88 |   |
| Including  interest on deposits                                |   | 1.04                                     |     | 1.25                        |     | 1.24 |   | 2.27 |   | 3.03 |   | 2.93 |   |

 

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(1)          Preferred stock dividendrequirements are adjusted 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:  May  15, 2003 |   | /s/ Anthony F. Vuoto                                                                                                       |   |
|                      |   | Anthony F. Vuoto  Vice Chairman and  Chief Financial Officer  (Principal Financial Officer and Duly  Authorized Signatory) |
|                      |   |                                                                                                                       |
| Date: May 15, 2003        |   | /s/ Daniel Sanford                                                                                                         |   |
|                      |   | Daniel Sanford  Executive Vice President and Controller  (Chief Accounting Officer and Duly  Authorized Signatory)         |

 

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**CERTIFICATION**

 

I, Joseph W. Saunders, the President and ChiefExecutive Officer of Providian Financial Corporation (the “Registrant”),certify that:

 

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

 

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 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 evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date: May 15, 2003 |                                  |
|--------------------|---------------------------------------|
|               |                                  |
|               | /s/ Joseph W. Saunders                |   |
|               | Joseph W. Saunders                    |
|               | President and Chief Executive Officer |

 

38

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**CERTIFICATION**

 

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

 

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

 

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 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 evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date: May 15, 2003 |                    |
|--------------------|-------------------------|
|               |                    |
|               | /s/ Anthony F. Vuoto    |   |
|               | Anthony F. Vuoto        |
|               | Chief Financial Officer |

 

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