PROVIDIAN FINANCIAL CORP - 10-Q Quarterly Report

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Providian Financial Corporation and Subsidiaries
Consolidated Statements of Financial Condition

(dollars in thousands, except per share data)	September 30, 2004			December 31, 2003
	(unaudited)
Assets
Cash and cash equivalents	$	293,060		$	544,554
Federal funds sold and securities purchased under resale agreements	1,322,042			3,235,189
Investment securities:
Available-for-sale, at market value (amortized cost of $2,854,461 at September 30, 2004 and $1,880,107 at December 31, 2003)	2,845,804			1,859,150

Loans receivable	7,306,507			6,280,957
Less allowance for credit losses	(633,531		)	(625,886		)
Loans receivable, net	6,672,976			5,655,071

Due from securitizations	2,429,534			2,377,963
Deferred taxes	—			224,505
Premises and equipment, net	60,668			84,198
Interest receivable	56,028			44,850
Other assets	234,659			249,867
Total assets	$	13,914,771		$	14,275,347

Liabilities
Deposits:
Non-interest bearing	$	46,324		$	63,016
Interest bearing	9,016,444			10,038,041
	9,062,768			10,101,057

Short-term borrowings	341,592			108,828
Long-term borrowings	1,112,903			1,163,521
Accrued expenses and other liabilities	767,748			576,492
Total liabilities	11,285,011			11,949,898

Shareholders’ Equity
Common stock, par value $0.01 per share (authorized: 800,000,000 shares; issued: September 30, 2004—293,333,063 shares; December 31, 2003—290,753,031 shares)	2,933			2,908
Retained earnings	2,647,390			2,350,446
Cumulative other comprehensive income	(5,237		)	(12,480		)
Common stock held in treasury—at cost (September 30, 2004—383,047 shares; December 31, 2003-305,871 shares)	(15,326		)	(15,425		)
Total shareholders’ equity	2,629,760			2,325,449
Total liabilities and shareholders’ equity	$	13,914,771		$	14,275,347

See Notes to Consolidated Financial Statements.

Providian Financial Corporation and Subsidiaries
Consolidated Statements of Income

	Three months ended September 30,						Nine months ended September 30,
(dollars in thousands, except per share data) (unaudited)	2004			2003			2004			2003

Interest Income
Loans	$	223,728		$	200,777		$	651,249		$	758,857
Federal funds sold and securities purchased under resale agreements	2,409			10,562			10,514			33,998
Other	37,280			24,445			91,022			86,800
Total interest income	263,417			235,784			752,785			879,655

Interest Expense
Deposits	102,941			139,470			324,583			453,845
Borrowings	16,433			15,437			51,506			36,774
Total interest expense	119,374			154,907			376,089			490,619

Net interest income	144,043			80,877			376,696			389,036

Provision for credit losses	161,351			98,732			432,220			492,551

Net interest loss after provision for credit losses	(17,308		)	(17,855		)	(55,524		)	(103,515		)

Non-Interest Income
Servicing and securitization	311,241			261,086			836,195			614,402
Credit product fee income	135,515			173,427			421,723			593,234
Other	(4,696		)	10,953			11,208			48,683
	442,060			445,466			1,269,126			1,256,319
Non-Interest Expense
Salaries and employee benefits	68,220			90,050			219,748			282,881
Solicitation and advertising	57,377			38,523			175,358			157,428
Occupancy, furniture, and equipment	23,537			31,571			71,776			91,661
Data processing and communication	27,741			31,064			81,839			94,531
Other	80,058			95,380			233,311			312,969
	256,933			286,588			782,032			939,470
Income before income taxes	167,819			141,023			431,570			213,334
Income tax expense	58,737			55,704			151,050			84,267
Net income	$	109,082		$	85,319		$	280,520		$	129,067

Earnings per common share—basic	$	0.38		$	0.30		$	0.97		$	0.45

Earnings per common share—assuming dilution	$	0.34		$	0.28		$	0.88		$	0.44

Weighted average common shares outstanding—basic (000)	289,263			287,620			288,605			286,783

Weighted average common shares outstanding— assuming dilution (000)	333,570			313,973			327,618			300,170

See Notes to Consolidated Financial Statements.

Providian Financial Corporation and Subsidiaries
Consolidated Statements of Changes in Shareholders’ Equity

(dollars in thousands) (unaudited)	Common Stock			Additional Paid-In Capital			Retained Earnings			Cumulative Other Comprehensive Income			Common Stock Held in Treasury			Total

Balance at December 31, 2002	$	2,909		$	—		$	2,202,960		$	9,888		$	(76,685	)	$	2,139,072
Comprehensive income:
Net income							129,067									129,067
Change in unrealized gain (loss) on securities, net of income tax benefit of $13,426										(20,564		)				(20,564		)
Total comprehensive income																108,503

Purchase of 459,693 common shares for treasury													(4,073		)	(4,073		)
Exercise of stock options and other awards				21,311			(51,307		)				34,740			4,744
Issuance of restricted and unrestricted stock less forfeited shares	(3		)	(26,234		)							29,690			3,453
Deferred compensation related to grant of restricted and unrestricted stock less amortization of $6,455				3,002												3,002
Net tax effect from employee stock plans				1,921												1,921
Balance at September 30, 2003	$	2,906		$	—		$	2,280,720		$	(10,676	)	$	(16,328	)	$	2,256,622

Balance at December 31, 2003	$	2,908		$	—		$	2,350,446		$	(12,480	)	$	(15,425	)	$	2,325,449
Comprehensive income:
Net income							280,520									280,520
Change in unrealized gain (loss) on securities, net of income tax expense of $5,057										7,243						7,243
Total comprehensive income																287,763

Purchase of 159,159 common shares for treasury													(2,239		)	(2,239		)
Exercise of stock options and other awards	10			(11,420		)	16,424						3,161			8,175
Issuance of restricted and unrestricted stock less forfeited shares	15			20,676									(823		)	19,868
Deferred compensation related to grant of restricted and unrestricted stock less amortization of $6,364				(13,504		)										(13,504		)
Net tax effect from employee stock plans				4,248												4,248
Balance at September 30, 2004	$	2,933		$	—		$	2,647,390		$	(5,237	)	$	(15,326	)	$	2,629,760

See Notes to Consolidated Financial Statements.

Providian Financial Corporation and Subsidiaries
Consolidated Statements of Cash Flows

	Nine months ended September 30,
(dollars in thousands) (unaudited)	2004			2003

Operating Activities
Net income	$	280,520		$	129,067
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses	432,220			492,551
Depreciation and amortization of premises and equipment	26,112			33,839
Amortization of net loan acquisition costs	15,867			16,560
Amortization of deferred compensation related to restricted and unrestricted stock	6,364			6,455
Decrease in deferred income tax benefit	219,448			276,366
(Increase) decrease in interest receivable	(11,178		)	17,411
Net increase in other assets	(530		)	(81,037		)
Net increase (decrease) in accrued expenses and other liabilities	199,568			(181,901		)
Net cash provided by operating activities	1,168,391			709,311

Investing Activities
Net cash (used for) from loan originations and principal collections on loans receivable	(1,375,743		)	1,427,173
Net decrease in securitized loans	(73,936		)	(1,382,586		)
Net proceeds from sale of Providian Master Trust	—			19,899
(Increase) decrease in due from securitizations	(51,571		)	545,159
Purchases of available-for-sale investment securities	(9,023,934		)	(3,109,596		)
Proceeds from maturities and sales of available-for-sale investment securities	8,049,580			3,468,339
Decrease (increase) in federal funds sold and securities purchased under resale agreements or similar arrangements	1,913,147			(244,824		)
Net purchases of premises and equipment	(3,157		)	(10,395		)
Net cash (used) provided by investing activities	(565,614		)	713,169

Financing Activities
Net decrease in deposits	(1,042,353		)	(1,464,679		)
Repayment of short-term borrowings	(108,828		)	(91,584		)
Proceeds from long-term borrowings	290,974			305,314
Purchase of treasury stock	(2,239		)	(4,073		)
Proceeds from exercise of stock options	8,175			4,744
Net cash used by financing activities	(854,271		)	(1,250,278		)

Net (Decrease) Increase in Cash and Cash Equivalents	(251,494		)	172,202
Cash and cash equivalents at beginning of period	544,554			344,277
Cash and cash equivalents at end of period	$	293,060		$	516,479

See Notes to Consolidated Financial Statements.

The following table reflects, for the three and nine months ended September 30, 2004 and 2003, the stock-based employee compensation costs arising out of the restricted and unrestricted stock programs that are included in reported net income. It also reflects on a pro forma basis the Company’s net income and earnings per common share with and without dilution, as if compensation costs for stock options had been recorded based on the fair value at the date of grant under the Company’s stock-based compensation plans, consistent with the provisions of SFAS No. 123. The pro forma compensation expense reflects the fair value of the stock options amortized to expense over the vesting period of the grant, which is generally three years.

Stock-Based Employee Compensation Cost and
Pro Forma Net Income and Earnings Per Common Share

	Three months ended September 30,				Nine months ended September 30,
(dollars in thousands, except per share data)	2004		2003		2004		2003
Restricted and unrestricted stock amortization, net-of-taxes, included in net income, as reported(1)	$	1,518	$	1,074	$	3,851	$	3,905
Net income, as reported	$	109,082	$	85,319	$	280,520	$	129,067
Deduct: Pro forma stock-based employee compensation expense determined under fair value method, net-of-taxes(2)(3)	3,424		4,876		12,718		18,585
Pro forma net income(1)	$	105,658	$	80,443	$	267,802	$	110,482
Net income per common share:
As reported—basic	$	0.38	$	0.30	$	0.97	$	0.45
As reported—assuming dilution(4)	$	0.34	$	0.28	$	0.88	$	0.44
Net income per common share:
Pro forma—basic	$	0.37	$	0.28	$	0.93	$	0.39
Pro forma—assuming dilution(4)	$	0.33	$	0.26	$	0.84	$	0.38

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

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

(3) The pro forma stock-based compensation expense for the three and nine months ended September 30, 2004 reflects the modification in the fourth quarter of 2003 of the methodology used in estimating expected volatility of the Company’s stock price. This modification resulted in the reduction of the pro forma stock-based compensation expense by $0.4 million, net-of-taxes, for the three months ended September 30, 2004 and $1.0 million, net-of-taxes, for the nine months ended September 30, 2004. See discussion below for further information regarding this modification.

(4) Amounts reflect the effect of adopting EITF Issue No. 04-8, “The Effect of Contingently Convertible Instruments on Diluted Earnings per Share” (“EITF 04-8”) in the third quarter of 2004. See discussion at Note 12 to Consolidated Financial Statements.

The fair values of the stock options granted under the Company’s stock incentive plans and the common stock offerings under the employee stock purchase plan were estimated at the grant date using the Black-Scholes option pricing model and based on assumptions for the risk-free weighted average interest rate, expected dividend yield, weighted average expected volatility, and the expected stock option life. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions, are fully transferable, and typically have shorter terms. In addition, the Black-Scholes option pricing model requires the input of subjective assumptions, including the option’s expected life and the expected price volatility of the underlying stock. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective model assumptions can materially affect the estimate, the Black-Scholes option pricing model may not provide a reliable measure of the fair value of the Company’s employee stock options.

Expected volatility represents management’s estimate of the Company’s stock price changes expected to occur over the estimated life of the stock options and stock offerings. Prior to the fourth quarter of 2003, expected volatility was estimated based upon the unadjusted historical volatility of the Company’s common stock over a fixed period. During the fourth quarter of 2003, the Company modified its methodology for estimating expected volatility. The modification was based on the Company’s assessment that historical volatility is not indicative of expected future experience because it does not reflect the significant changes in the Company’s business implemented in 2001 and 2002. The expected volatility is now estimated giving consideration to the expected life of stock options and actual historical volatility of the price of the Company’s common stock adjusted for unusual, company-specific fluctuations in the Company’s stock price. Management believes that the modified methodology provides a better indicator of the expected volatility. For options granted during the third quarter of 2004, the modified methodology had the effect of reducing volatility from 89% to 43% for the three months ended September 30, 2004 and from 90% to 46% for the nine months ended September 30, 2004. This resulted in an aggregate fair value reduction of $7.6 million, which was 41% lower than if expected volatility had been based on unadjusted historical volatility.

Note 3. Consolidation of Variable Interest Entities

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

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

Because the Company’s securitizations are structured using qualifying special-purpose entities, as defined in Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities—a Replacement of FASB Statement No. 125” (“SFAS No. 140”) and FIN 46, the Company’s securitization trusts are not required to be consolidated. In connection with its Series 2000-A securitization, the Company has an equity interest in a special-purpose entity that was acquired prior to February 1, 2003. The Company has determined that the entity is a VIE and that the Company is not the primary beneficiary, and therefore the entity does not meet the requirements for consolidation by the Company under FIN 46. As of September 30, 2004, the Company’s total investment in this entity was $43.3 million, which represents the Company’s maximum loss exposure, and the estimated total assets of the entity were approximately $803.5 million.

The Company has also completed its analysis of certain VIEs that are not special-purpose entities and that were acquired before February 1, 2003, primarily with respect to the Company’s limited partnership interests that qualify for credit under the Community Reinvestment Act. Based on its review, the Company has determined that these limited partnerships are VIEs and that the Company is not the primary beneficiary, and therefore these entities do not meet the requirements for consolidation by the Company under FIN 46. As of September 30, 2004, the Company’s total investment in limited partnerships, including those acquired after January 31, 2003, was $23.7 million, which, combined with $16.1 million of remaining contractual funding commitments under these investments, represents the Company’s maximum loss exposure, and the estimated total assets of these entities were approximately $271.4 million.

Note 4. Interest and Fee Income Recognition

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

The suppression impact on income includes adjustments to previous period estimates of uncollectible interest and fees. During the three and nine months ended September 30, 2004 and 2003, the amount of interest and fees not recognized as income as a result of the impact of the suppression methodology was as follows:

Suppression of Interest and Fee Income

	Three months ended September 30,				Nine months ended September 30,
(dollars in thousands)	2004		2003		2004		2003
Loan interest income	$	20,801	$	29,536	$	58,211	$	115,004
Credit product fee income	30,819		46,277		87,179		156,873
Servicing and securitization income	103,601		141,017		315,873		435,749
Total	$	155,221	$	216,830	$	461,263	$	707,626

Note 5. Investment Securities

The Company’s available-for-sale investment securities portfolio is composed of treasury obligations, government sponsored agency securities, mortgage-backed securities, commercial paper, and other securities consisting primarily of asset-backed securities. A significant portion of the portfolio, including all mortgage-backed securities, is either issued or backed by a government sponsored agency or a fully government guaranteed agency. The mortgage-backed securities are in the form of (a) fixed and floating rate collateralized mortgage obligations, (b) adjustable rate pass-through securities, and (c) fixed rate pass-through securities. All of the securities in the portfolio have an investment grade credit rating, with a large majority having an AAA/Aaa rating. Fluctuations in general market conditions will translate into fluctuations in the security’s price. Reductions in the value of these securities stem from changes in market conditions, not necessarily from any intrinsic value deterioration. The Company is able to hold those securities that currently have a loss on an ongoing basis without any detriment to the liquidity of the portfolio. At September 30, 2004, the Company had an unrealized loss of $4.3 million on investments with an amortized cost of $309.8 million that were in a sustained unrealized loss position for 12 months or more.

Summary of Available-for-Sale Investment Securities

	September 30, 2004										December 31, 2003
(dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses Less Than 12 Months		Gross Unrealized Losses 12 Months or Longer		Market Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Market Value
United States Treasury and federal agency bonds	$	941,496	$	—	$	4,267	$	—	$	937,229	$	118,098	$	109	$	184	$	118,023
Mortgage-backed securities	463,956		413		405		4,256		459,708		1,010,943		638		20,413		991,168
Commercial paper	984,503		—		578		—		983,925		699,487		—		382		699,105
Other	464,506		496		57		3		464,942		51,579		90		815		50,854
Total investment securities available-for-sale	$	2,854,461	$	909	$	5,307	$	4,259	$	2,845,804	$	1,880,107	$	837	$	21,794	$	1,859,150

During the three months ended September 30, 2004, investment securities with an amortized cost of $293.5 million were sold at a net realized loss of $8.4 million, which includes gross gains of $0.1 million and gross losses of $8.5 million. During the nine months ended September 30, 2004, investment securities with an amortized cost of $406.4 million were sold at a net realized loss of $8.9 million, which includes gross gains of $0.2 million and gross losses of $9.1 million. For the three months ended September 30, 2003, investment securities with an amortized cost of $358.0 million were sold at a gross realized loss of $1.5 million. For the nine months ended September 30, 2003, investment securities with an amortized cost of $1.30 billion were sold at a net realized gain of $8.5 million, which includes gross gains of $11.2 million and gross losses of $2.7 million. Realized gains and losses were calculated using the specific identification method.

Note 6. Loans Receivable

The Company has credit risk on loans to the extent that borrowers fail to repay amounts owed and such amounts are not recovered through collections procedures. At September 30, 2004, the Company had no significant regional domestic or foreign concentrations of credit risk.

Note 7. Securitization or Sale of Receivables

The Company periodically securitizes pools of its loans receivable and issues asset-backed securities in underwritten offerings and private placements through trusts that meet the requirements for sale treatment. At September 30, 2004 and December 31, 2003, the Company’s securitization program had $10.31 billion and $10.33 billion of securityholders’ interests outstanding, of which $8.85 billion and $8.92 billion were held by third parties. The Company retains the remaining interests in the loans receivable transferred in its securitizations and includes them on its statement of financial condition.

The Company’s securitization transactions create undivided interests in the pool of loans and establish securityholders’ interests (asset-backed securityholders’ certificates and notes), a seller’s interest, interest-only strips receivable, and spread accounts. Securityholders’ interests consist of various classes of investor interests ranked by seniority. The senior securityholders’ interests, which are supported by various forms of credit enhancement, are sold to third party investors. When the Company enters into a securitization transaction, it receives cash proceeds from the sale of securities to third parties, removes the securitized loans and related allowance for credit losses from its statement of financial condition, and records the retained interests in the transaction. The Company typically recognizes a net gain on sale from the securitization, due primarily to the release of the related allowance for credit losses and recognition of an interest-only strip receivable, which is partially offset by discounts recognized for the retained subordinated interests.

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

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

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

The following table presents key economic assumptions used in the initial measurement of the retained subordinated interests for securitizations entered into during the nine months ended September 30, 2004 and 2003.

Securitization Initial Measurement Assumptions

	September 30,
	2004		2003
Payment rate(1)	6.9	%	5.4	%
Expected net credit loss rate	15.0	%	18.4	%
Weighted average loans receivable life (in years)(2)	0.85		0.95
Discount rate(3)	6.5% – 20.0	%	3.2% – 20.0	%
Average interest rate margin for third party investors(4)	0.49	%	0.94	%

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

(2) The weighted average loans receivable life is calculated by multiplying the principal collections expected in each future period by the number of periods until the balance is paid, summing those products, and dividing by the initial principal balance.

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

(4) The interest rate paid to third party investors in a term securitization with a variable rate is based on this margin plus the London Interbank Offered Rate (LIBOR). The interest rate paid to third party investors in the Company’s three-year fixed rate term securitization is based on this margin plus the 2.98 year swap rate. The interest rate paid to conduit asset-backed investors that participate in the variable funding series is generally based on a commercial paper rate. The average interest rate margin decreased in the nine months ended September 30, 2004 as a result of more favorable pricing included in the term securitizations issued by the Company in the first three quarters of 2004.

After the initial sale, the Company’s securitizations impact its earnings through sales of retained interests, changes in the fair values of its retained interests, including the accretion of the retained interests’ discounts, the ongoing recognition of interest-only strips receivable, and the difference in the actual excess servicing received as compared to the amount estimated in calculating the related interest-only strips receivable. At least quarterly, the Company adjusts the valuations of the retained interests to reflect changes in the amount of the securitized loans outstanding and any changes to the initial assumptions, estimates, and discount rates. The Company also continues to refine the financial models used to obtain more accurate measures of the timing and amount of cash flows. These values can, and will, vary as a result of changes in the level and timing of the cash flows and the underlying economic assumptions. Changes in the estimated fair value of the retained interests are reported as a component of non-interest income—servicing and securitization on the Company’s statement of income.

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

The Company continues to service the accounts included in the pool of securitized loans and earns a monthly servicing fee, which is generally offset by the servicing costs it incurs. The contractual servicing fee is representative of a market rate and the Company therefore does not currently recognize a servicing asset or liability in connection with its securitizations.

After the initial fair value recognition, the Company evaluates its retained securityholders’ interests and recognizes changes in their fair market value in non-interest income—servicing and securitization. The fair market value changes reflect the Company’s changes to estimated cash flows and discount rates, including the impact of changes in the remaining term until repayment. As securityholders’ interests approach their expected final payment date, their fair values generally approach their face values and the discounts are accreted, with the amount of such accretion realized in non-interest income—servicing and securitization. The following table summarizes the retained subordinated securityholders’ interests in the Providian Gateway Master Trust as of September 30, 2004 and December 31, 2003.

Summary of Retained Subordinated Securityholders’ Interests
in the Providian Gateway Master Trust

(dollars in thousands)	September 30, 2004			December 31, 2003
Retained subordinated securityholders’ interests
Face value	$	1,459,247		$	1,411,738
Discount	(198,939		)	(235,422		)
Fair market value	$	1,260,308		$	1,176,316

Weighted average remaining term (months)	24			22

For the three months ended September 30, 2004 and 2003, the changes in net unrealized gains on retained subordinated securityholders’ interests included in earnings were $82.3 million and $83.6 million. For the nine months ended September 30, 2004 and 2003, the changes in net unrealized gains on retained subordinated securityholders’ interests included in earnings were $196.1 million and $173.6 million. These unrealized gains are recognized in non-interest income — servicing and securitization.

Valuations of retained subordinated securityholders’ interests, interest-only strips receivable, and spread accounts require the Company to use judgment in selecting discount rates, estimating future cash flows, assessing current economic conditions, and assuming the outcome of future events. Retained subordinated securityholders’ interests are discounted at rates that reflect the level of subordination, the projected repayment term, and the credit risk of the securitized loans. In valuing interest-only strips receivable, the Company estimates the interest and fees that will be collected on the securitized loans, credit losses, contractual servicing fees, and repayment trends of the securitized loans to project the amount of excess servicing to be received over the period the securitized loans are projected to be outstanding. Spread account valuations are determined through a discounted cash flow analysis based on projected repayments of spread account balances to the Company.

The key economic assumptions used in valuing retained interests and the sensitivity of the current fair value of residual cash flows to immediate 10% and 20% adverse changes in those assumptions at September 30, 2004 are presented in the following table.

Securitization Sensitivities

(dollars in thousands)	Discount Rate			Expected Net Credit Loss Rate			Payment Rate
Current assumptions	5.7-20.0		%	13.0		%	7.6		%
Impact on fair value of:
10% adverse change	$	(25,725	)	$	(89,641	)	$	(21,014	)
20% adverse change	$	(50,930	)	$	(177,904	)	$	(40,348	)

The adverse changes to these key economic assumptions are hypothetical and are presented in accordance with SFAS No. 140. As the figures above indicate, changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. In addition, the effect of changing one assumption on the fair value of the retained interests is computed without allowing any other assumption to change. In reality, changes in one assumption may be accompanied by changes in others. Furthermore, the sensitivities presented do not reflect actions that management might take to mitigate the impact of the adverse change. Accordingly, these sensitivities should be used with caution.

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

Securitization Cash Flows

	Nine months ended September 30,
(dollars in thousands)	2004			2003
Proceeds from new securitizations(1)	$	2,480,000		$	1,065,000
Proceeds from collections allocated to securityholders’ interests(1)	6,718,589			5,804,380
Servicing fees received	221,587			248,309
Net cash flows received on retained interests	742,861			404,578
Principal paid in respect of maturing securitizations(1)	(2,553,936		)	(2,447,800		)

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

Note 8. Commitments, Guarantees, and Contingencies

Loan Commitments. A loan commitment is an agreement to lend to a customer up to a prescribed maximum amount, subject to the customer’s compliance with the account agreement. The Company can reduce or cancel a credit card commitment by providing the required prior notice to the customer, or without notice if permitted by law. The unfunded commitment represents the total unused portion of the line of credit available to the customer. Customers have not borrowed, and the Company does not anticipate that all of its customers will borrow, the entire line of credit available to them at the same time. Therefore, the total unfunded commitment amounts do not necessarily represent future cash requirements. Total unfunded commitments at September 30, 2004 and December 31, 2003 were $26.62 billion and $20.34 billion.

Guarantees. In January 2003, the Company entered into a pledge agreement with an insurer with respect to certain obligations owing to the insurer in connection with two series of the Providian Gateway Master Trust. In exchange for the insurer agreeing to a reduction in the base rate used for calculating the excess spread early amortization event for those two series, the Company pledged $30.0 million held in a deposit account as security for the payment to the insurer of amounts owing to it in connection with these transactions. The pledge agreement remains in effect until the investor certificates and all amounts owing to the insurer with respect to the two series are paid. In accordance with the pledge agreement, the pledged collateral was reduced when one of the series was repaid in September 2003. The remaining amount of the pledged collateral at September 30, 2004 was $13.6 million. The remaining series related to the pledge has an expected final payment date in September 2005. The Company does not currently expect that performance under this pledge will be required.

In August 2002, the Company, through a wholly owned limited liability entity, sold its investment in an alternative energy plant. Through its interest in the limited liability entity, the Company had received certain tax credits and tax deductions. In connection with the sale of the plant to a third party, the Company guaranteed certain obligations of the limited liability entity under a purchase and sale agreement. The guarantee covers the limited liability entity’s obligation to indemnify the purchaser against losses arising out of a breach of the purchase and sale agreement and its failure to repurchase the assets if tax credits are not available to the purchaser. The Company’s guarantee is capped at the amount of payments made to the limited liability entity at the time of sale, plus the amounts of additional payments made, and contingent future payments that may be made, to the limited liability entity and its affiliates arising from fuel production from the plant. At September 30, 2004, the guaranteed amount was $21.4 million.

The Company enters into various agreements that contain general indemnification provisions, primarily in connection with asset sale agreements and service contracts, including the purchase and sale agreement referred to in the preceding paragraph. These provisions typically require the Company to make payments to other parties to indemnify them against losses that may be incurred due to actions taken by the Company prior to entering into the agreement or due to a breach of representations, warranties, and covenants made in connection with the agreement or possible changes in or interpretations of tax law. The Company cannot estimate the potential future impact of these indemnification provisions, since this would require an assessment of future claims that may be made against the Company. Based on historical experience, the Company does not currently expect the risk of loss under these indemnification provisions to have a material adverse effect on its financial condition or results of operations, but it cannot give any assurance that they will not have such an effect.

Litigation. The Company is subject to various pending and threatened legal actions, including actions arising in the ordinary course of business from the conduct of its activities. While the Company believes that it has substantive defenses and intends to defend the actions vigorously, it cannot predict the ultimate outcome or the potential future impact on the Company of such actions. The Company does not currently expect any of the actions affecting it to have a material adverse

effect on its financial condition or results of operations, but it cannot give any assurance that they will not have such an effect.

Note 9. Long-Term Borrowings

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

Summary of Long-Term Borrowings

(dollars in thousands)	September 30, 2004		December 31, 2003

3.25% convertible senior notes maturing in 2005(1)	$	—	$	343,302
Zero coupon convertible senior notes maturing in 2021(2)	455,646		442,310
4.00% convertible senior notes maturing in 2008	287,500		287,500
2.75% convertible cash to accreting senior notes maturing in 2016	277,200		—
9.525% junior subordinated deferrable interest debentures maturing in 2027	109,281		109,281
	1,129,627		1,182,393
Less unamortized issuance costs	16,724		18,872
Total long-term borrowings	$	1,112,903	$	1,163,521

(1) Amount at September 30, 2004 of $343.3 million is due in one year or less and has been classified as a short-term borrowing.

(2) Amounts include the accreted portion of a yield to maturity of 4.00% per year.

Convertible Senior Notes

3.25% Convertible Senior Notes. In August 2000, the Company issued $402.5 million of 3.25% convertible senior notes due August 15, 2005 with interest payable semiannually on February 15 and August 15 of each year, commencing on February 15, 2001. These notes are convertible at the option of the holders, at any time prior to their maturity or their redemption or repurchase by the Company, at the conversion rate of 14.4892 shares (split adjusted) of the Company’s common stock for each $1,000 of note principal (an initial conversion price of $69.02 per share of common stock). The Company will adjust the conversion rate if certain events occur, as specified in the related indenture supplement, such as the issuance of dividends payable in the Company’s common stock or the occurrence of a stock split or combination. The Company has the option to redeem these notes for cash on or after August 20, 2003. During 2001, the Company repurchased $59.2 million principal amount of the 3.25% convertible senior notes, resulting in a $20.5 million gain, which was recorded as part of non-interest income—other in the Company’s statement of income. There have been no additional repurchases since that time. Holders may require the Company to purchase their notes for cash following a change of control, as defined in the related indenture supplement.

Zero Coupon Convertible Senior Notes. In February 2001, the Company issued $884.0 million principal amount at maturity of zero coupon convertible senior notes due February 15, 2021. The Company accretes the principal amount of the notes at a rate that provides holders with an aggregate annual yield to maturity of 4.00% per year, computed on a semiannual bond equivalent basis. These notes are convertible, at the option of the holders, into shares of the Company’s common stock at a conversion rate of 6.2240 shares of common stock per note (an initial conversion price of $72.77 per share of common stock, based on the offering price of $452.89 per note), if specified conditions are met. These conditions include the satisfaction of a market price condition, such that the price of the Company’s common stock equals or exceeds 110% of the accreted conversion price for at least 20 trading days of the 30 trading days prior to conversion. At September 30, 2004, 110% of the accreted conversion price was $91.80 per share. Holders may surrender the notes for conversion at any time prior to maturity. However, except in certain specified circumstances, if the conditions for conversion into common stock have not been met, upon conversion holders will receive cash in lieu of common stock in an amount determined based on the formulas provided in the related indenture supplement. Conversion may also be settled in cash, common stock, or other property upon the occurrence of certain corporate events, as specified in the related indenture supplement. The Company will adjust the conversion rate if certain events occur, as specified in the related indenture supplement, such as the issuance of dividends payable in the Company’s common stock or the occurrence of a stock split or combination. The Company may redeem all or a portion of the convertible notes for cash on or after February 15, 2006. During 2001, the Company repurchased $12.5 million principal amount at maturity of the convertible notes, resulting in a $2.1 million gain, which was recorded as part of non-interest income—other in the Company’s statement of income. There have been no additional repurchases since that time. Holders may require the Company to purchase their notes on February 15, 2006 at a price per note of $552.07, on February 15, 2011 at a price per note of $672.97, and on February 15, 2016 at a price per note of $820.35. The Company has the option to settle these purchases in cash (at the then current accreted value of the notes) or common stock (at the then current market price of the Company’s common stock), or using a combination of both.

In addition, holders may require the Company to purchase their notes for cash following a change of control, as defined in the related indenture supplement, occurring on or before February 15, 2006.

4.00% Convertible Senior Notes. In May 2003, the Company issued $287.5 million of 4.00% convertible senior notes due May 15, 2008 with interest payable semiannually on May 15 and November 15 of each year, commencing on November 15, 2003. These notes are convertible at the option of the holders at the conversion rate of 76.8758 shares of the Company’s common stock for each $1,000 of note principal (an initial conversion price of $13.01 per share of common stock), if specified conditions are met. These conditions include the satisfaction of a market price condition, such that the price of the Company’s common stock exceeds $14.31 per share (110% of the conversion price) for at least 20 trading days of the last 30 trading days of the preceding calendar quarter; the satisfaction of a trading price condition, such that the trading price of the notes falls below a specified level; the occurrence of certain corporate events, as specified in the related indenture supplement; and the occurrence of a specified credit rating event, such that the ratings of the notes by certain rating agencies fall below specified levels. Conversion of the notes will be settled in shares of the Company’s common stock, except under certain circumstances related to the trading price condition, when conversion may be settled in cash, common stock, or a combination of both, and upon the occurrence of certain corporate events, as specified in the related indenture supplement, when conversion may be settled in cash, common stock, or other property. The Company will adjust the conversion rate if certain events occur, as specified in the related indenture supplement, such as the issuance of dividends payable in the Company’s common stock or the occurrence of a stock split or combination. In addition, contingent interest is required to be paid to holders if certain conditions are met. The Company may not redeem the notes prior to their maturity. Holders may require the Company to purchase their notes for cash following a fundamental change, such as a change in control of the Company, as defined in the related indenture supplement.

During the third quarter of 2004, the specified market price condition for conversion of the Company’s 4.00% convertible senior notes was satisfied, as the Company’s common stock price exceeded the conversion trigger price of $14.31 per share for at least 20 trading days of the last 30 trading days of the quarter. As a result, the 4.00% convertible senior notes are convertible during the fourth quarter of 2004.

2.75% Convertible Cash to Accreting Senior Notes. In March 2004, the Company issued $277.2 million of 2.75% convertible cash to accreting senior notes due March 15, 2016. After March 15, 2011, the Company will pay interest at a rate of 1.75% per year and will accrete the principal amount of the notes at a rate that provides holders with an aggregate annual yield to maturity of 2.75% per year, computed on a semiannual bond equivalent yield basis. The notes are convertible at the option of the holders at a conversion rate of 58.7941 shares of the Company’s common stock for each $1,000 of note principal (an initial conversion price of $17.01 per share of common stock) if specified conditions are met. These conditions include the satisfaction of a market price condition, such that the price of the Company’s common stock exceeds $20.41 per share (120% of the conversion price) for at least 20 trading days of the last 30 trading days of the preceding calendar quarter; the satisfaction of a trading price condition, such that the trading price of the notes falls below a specified level; the announcement of a redemption of the notes by the Company, in which event holders will have the option to convert their notes prior to redemption; the occurrence of a specified credit rating event, such that the ratings of the notes by certain rating agencies fall below specified levels; the occurrence of specified corporate distributions, as defined in the related indenture supplement; and the occurrence of a fundamental change, as defined in the related indenture supplement. Conversion of the notes will be settled in shares of the Company’s common stock, except under certain circumstances related to the trading price condition, when conversion may be settled in cash, common stock, or a combination of both, and upon the occurrence of certain corporate events, as specified in the related indenture supplement, when conversion may be settled in cash, common stock, or other property. The Company will adjust the conversion rate if certain events occur, as specified in the related indenture supplement, such as the issuance of dividends payable in the Company’s common stock or the occurrence of a stock split or combination. In addition, contingent interest is required to be paid to holders if certain conditions are met. If a fundamental change, such as a change in control of the Company, as defined in the related indenture supplement, occurs on or before March 15, 2011, the Company may also be required to purchase the notes for cash and pay an additional make whole premium payable in the Company’s common stock upon the repurchase or conversion of the notes in connection with the fundamental change. The Company has the option to redeem all or a portion of the notes for cash at any time on or after March 31, 2011. Holders may require the Company to purchase all or a portion of their notes for cash on March 15, 2011 or March 15, 2014.

The Company adopted the provisions of EITF 04-8 in the third quarter of 2004. See Note 12 to the Consolidated Financial Statements for further discussion.

Junior Subordinated Deferrable Interest Debentures

In 1997, through Providian Capital I, a wholly owned subsidiary statutory trust, the Company issued mandatorily redeemable preferred securities, which accumulate accrued distributions that are payable semiannually. The Company has the right to defer payment of interest on the preferred securities at any time and from time to time, for a period not exceeding 10 consecutive semiannual periods with respect to each deferral period, provided that no extension period may extend beyond the stated maturity. During any such extension period, the Company’s ability to pay dividends on its common stock would be restricted. The Company has the right to cause the redemption of the preferred securities on or after February 1, 2007, or earlier in the event of certain regulatory changes. The redemption price depends on several factors, including the date of the redemption, the present value of the principal and premium payable, and the accumulated but unpaid distributions on the preferred securities. The sole assets of Providian Capital I are $109.3 million in aggregate principal amount of the Company’s 9.525% junior subordinated deferrable interest debentures due February 1, 2027 and the right to reimbursement of expenses under a related expense agreement with the Company. The Company’s obligations under such debentures, together with its other obligations with respect to the preferred securities, constitute a full and unconditional guarantee. During 2001, the Company repurchased $6.7 million principal amount of the preferred securities and recorded a $3.1 million gain as part of non-interest income—other in the Company’s statement of income. There have been no additional repurchases since that time.

In accordance with FIN 46 (see Note 3 to Consolidated Financial Statements), the Company has determined that the Providian Capital I trust is a VIE and that the Company is not the primary beneficiary, as the Company would not absorb a majority of the trust’s expected losses if they were to occur. The Company adopted the provisions of FIN 46 with respect to the trust effective July 1, 2003. As a result, the Company deconsolidated the trust and no longer reports the preferred securities on its statement of financial condition. Effective July 1, 2003, the Company began reporting the related interest as interest expense and its equity in the earnings of the nonconsolidated trust as non-interest income—other. At September 30, 2004, the Company reported $109.3 million in junior subordinated deferrable interest debentures related to the preferred securities in long-term borrowings and the Company’s equity investment in the trust of $5.0 million in other assets.

Note 10. Income Taxes

The Company’s effective income tax rate was 35.0% for the three and nine months ended September 30, 2004, and 39.5% for the three and nine months ended September 30, 2003. The decrease in the rate is due to tax credits that the Company expects to utilize based on its estimate of 2004 taxable income. The tax credits are generated from an existing investment in a limited liability entity that operates an alternative energy plant. The Company was not able to utilize these credits in 2003.

Note 11. Cumulative Other Comprehensive Income

The components of cumulative other comprehensive income, net-of-taxes, for the nine months ended September 30, 2004 and 2003 are presented in the following table.

Cumulative Other Comprehensive Income Components

(dollars in thousands)	Unrealized Gain (Loss) on Securities			Cumulative Other Comprehensive Income
Balance at December 31, 2002	$	9,888		$	9,888
Other comprehensive income	(33,990		)	(33,990		)
Tax benefit	13,426			13,426
Balance at September 30, 2003	$	(10,676	)	$	(10,676	)

Balance at December 31, 2003	$	(12,480	)	$	(12,480	)
Other comprehensive income	12,300			12,300
Tax expense	(5,057		)	(5,057		)
Balance at September 30, 2004	$	(5,237	)	$	(5,237	)

Note 12. Earnings per Common Share

The following table sets forth the computation of both basic and diluted earnings per common share for the three and nine months ended September 30, 2004 and 2003.

Computation of Earnings Per Common Share

	Three months ended September 30,				Nine months ended September 30,
(dollars and number of shares in thousands, except per share data)	2004		2003		2004		2003

Income for computation of earnings per common share—basic	$	109,082	$	85,319	$	280,520	$	129,067
Interest on convertible senior notes, net-of-taxes(1)	2,893		1,739		7,665		2,396
Income for computation of earnings per common share—assuming dilution	$	111,975	$	87,058	$	288,185	$	131,463

Weighted average common shares outstanding—basic	289,263		287,620		288,605		286,783

Restricted stock issued– non-vested	1,402		1,244		948		1,720
Employee stock options	4,506		3,007		4,364		1,466
Convertible senior notes(1)	38,399		22,102		33,701		10,201
Dilutive potential common shares	44,307		26,353		39,013		13,387

Weighted average common shares outstanding—assuming dilution	333,570		313,973		327,618		300,170

Earnings per common share—basic	$	0.38	$	0.30	$	0.97	$	0.45
Earnings per common share—assuming dilution(1)	$	0.34	$	0.28	$	0.88	$	0.44

(1) Amounts related to convertible senior notes reflect the effect of adopting EITF 04-8 in the third quarter of 2004 (see discussion below). The adoption of EITF 04-8 had the effect of reducing the Company’s diluted earnings per common share by $0.01 for the three months ended September 30, 2004 and 2003, and by $0.06 and $0.01 for the nine months ended September 30, 2004 and 2003. The reduction of diluted earnings per common share for the three months ended September 30, 2004 of $0.01 is due to the dilutive effect of the Company’s 2.75% convertible notes. Irrespective of the Company’s adoption of EITF 04-8, diluted earnings per common share for the three months ended September 30, 2004 already included the dilutive effect of the Company’s 4.00% convertible notes, since the specified market price condition for conversion of those notes was satisfied during the third quarter of 2004.

The Company’s convertible senior notes consist of its zero coupon, 4.00%, and 2.75% notes, which are contingently convertible notes, and its 3.25% notes. See Note 9 to Consolidated Financial Statements for further discussion. During the third quarter of 2004 the Company elected to adopt the provisions of EITF 04-8, and as a result has included the dilutive effect of its contingently convertible notes in its diluted earnings per share calculation from the time of issuance of the notes, in accordance with the if-converted methodology under SFAS No. 128. As required by EITF 04-8, the Company has also restated its diluted earnings per share for prior periods.

The amounts presented above reflect the assumed conversions of the Company’s 2.75% and 4.00% convertible senior notes to common shares, the impact of which was partially offset by the add-back of related debt interest expense to net income in accordance with the if-converted methodology. The Company’s zero coupon and 3.25% convertible senior notes were excluded from the calculation for all periods presented above because the effect would have been antidilutive. The interest expense and dilutive potential common shares included in the diluted earnings per share calculations presented above are as follows:

	Three months ended September 30,				Nine months ended September 30,
(dollars and number of shares in thousands)	2004		2003		2004		2003
2.75% convertible senior notes
Interest on notes, net-of-taxes	$	1,154	$	—	$	2,447	$	—
Dilutive potential common shares	16,297		—		11,599		—
4.00% convertible senior notes
Interest on notes, net-of-taxes	$	1,739	$	1,739	$	5,218	$	2,396
Dilutive potential common shares	22,102		22,102		22,102		10,201

In addition, the FASB has issued an Exposure Draft, “Earnings per Share—an Amendment of FASB Statement No. 128,” which would require that contracts containing an option to settle in cash or stock be assumed to settle in stock for purposes of calculating diluted earnings per share. The Company’s zero coupon convertible senior notes provide such an option to the Company in the event that holders of the notes exercise certain rights to require the Company to repurchase their notes. See Note 9 to Consolidated Financial Statements for further discussion. If the Exposure Draft in its current proposed form becomes effective, it would impact the Company’s diluted earnings per share calculation for the nine months ended September 30, 2004 by requiring the inclusion of an additional 33,876,005 shares related to these notes, and would also require that the Company restate its diluted earnings per share for prior periods for purposes of comparability. The impact on diluted earnings per share would be partially offset by the add-back of related debt interest expense to net income under the if-converted method. The Company has the unilateral right to amend the indenture supplement governing the notes to eliminate the Company’s right to settle note repurchases in stock and would currently intend to pursue such an amendment in the event the proposal becomes effective. If the Company amends the indenture supplement, under the terms of the current Exposure Draft the Company would not be required to include the additional shares in its diluted earnings per share calculation.

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

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

Our Business

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

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

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

We seek to fund our assets through a diversified mix of sources and may vary the use of any one source over time. Our ability to fund existing and future customer loans is currently dependent on four primary sources: consumer deposits, securitizations, a portfolio of cash and liquid investment securities, and, to a lesser extent, debt. Securitization is a process in which we segregate a pool of customer loans by transferring them to a trust, which directly or through other special-purpose entities issues certificates or notes backed by the principal, interest, and fee cash flows generated by the pool of transferred loans. At the time the certificates or notes are issued, we receive cash proceeds from the portion sold to third parties.

Executive Overview

During the third quarter of 2004, we continued our efforts to strengthen our financial condition and build a productive and sustainable portfolio of customer accounts supported by an appropriately sized and efficient infrastructure. Building off our progress over the past two years, we focused on four key areas of our business:

• Further strengthening our balance sheet and managing our liquidity position;

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

• Further improving credit performance; and

• Increasing operational efficiency and further reducing our operating expenses.

Balance Sheet and Liquidity. Our primary goals in this area have been to maintain strong capital ratios and manage our liquidity portfolio in line with our growth expectations and PNB’s Capital Plan. During the third quarter of 2004, our liquidity position increased by $67.6 million, to $4.46 billion, while deposit levels moderately increased, ending the period at $9.06 billion. During the third quarter of 2004, we accessed the capital markets with the issuance of $650.0 million of three-year fixed rate Providian Gateway Owner Trust 2004-D asset-backed notes backed by a certificate issued by the Providian Gateway Master Trust and the issuance of $430.0 million of investor securities in a variable funding series with a two year revolving period. These two transactions, as well as the asset-backed issuances in the first six months of 2004, provided us with more favorable terms than our issuances of asset-backed securities in 2003 and 2002.

Our capital position strengthened during the quarter and at the end of the third quarter of 2004 was $2.63 billion. At September 30, 2004, our shareholders’ equity and allowance for credit losses, on a combined basis, were equal to 44.7% of our reported loans. PNB continued to maintain strong levels of capital ratios during the period, ending the quarter with a total risk-based capital ratio on a subprime basis of 18.94%.

Marketing. In the third quarter of 2004, we added approximately 538,000 gross new accounts, of which about 70% were originated through our proprietary marketing program. We generated managed net receivables growth of approximately $656 million during the third quarter as a result of strong balance generation from new account originations and continued stabilization of our older core loan portfolio. We continued to implement our growth strategy by focusing on our core “New Providian” marketing, which emphasizes delivery of products, services, and rewards specifically designed for mainstream American consumers, and entering into additional marketing arrangements with co-branding and affinity partners. We entered into several new marketing partnership arrangements during the third quarter of 2004, some of which are scheduled to launch over the remainder of 2004. The success of our “New Providian” and partnership marketing strategies will continue to be a critical factor in our future earnings.

Credit. During the third quarter of 2004, we continued to improve the credit mix of our loan portfolio by originating higher-quality loans receivable. We continued to benefit from the results of enhancements in our collections processes and changes in our portfolio management strategies. These actions, combined with the overall improvement in the economy, resulted in lower delinquencies and net credit losses in the third quarter as compared to the second quarter. Our net credit loss rates for the three months ended September 30, 2004 were 6.99% on a reported basis and 10.39% on a managed basis, compared to 9.10% and 12.53% for the three months ended June 30, 2004. Our 30+ day delinquency rates at September 30, 2004 were 4.61% on a reported basis and 6.27% on a managed basis, compared to 4.74% and 6.44% at June 30, 2004.

Operational Efficiency. In the third quarter of 2004, we continued to recognize the benefits of streamlining our organization, which included the recognition of charges associated with the consolidation of the San Antonio, Texas customer service operations. Further charges associated with this consolidation are expected in the fourth quarter of 2004. The resulting reduction in our infrastructure better aligns it with expected levels of customer accounts and delinquency volumes. Reflecting these efforts and other actions over the past year, non-interest expense for the nine months ended September 30, 2004 was $782.0 million compared to $939.5 million for the same period in 2003. Non-interest expense, excluding solicitation and advertising, was $606.7 million for the nine months ended September 30, 2004, a decrease of $175.4 million from the same period in 2003.

Other Key Factors. As indicated above in the discussion under “—Balance Sheet and Liquidity,” we continue to access the capital markets through securitization fundings. Securitizations have remained a primary source of funding for our business. Securitizations have an impact on our earnings, because we record a gain or loss on the initial sale of loans in a securitization transaction and we release the allowance for credit losses associated with the securitized loans. In addition, we retain certain interests in the securitized loans, and we recognize changes in the fair value of these retained interests in current earnings. These impacts can contribute to volatility in our earnings. We continue to work on ways to reduce the level of these retained interests, in order to reduce the volatility of our non-interest income—servicing and securitization from period to period. For example, during the second and third quarters of 2004, our earnings benefited from increases in the valuation of interest-only strips receivable recognized from increases in forecasted excess servicing, primarily due to lower forecasted credit losses. In 2003 and in the first nine months of 2004, our earnings benefited significantly from income recognized as a result of increases in the valuation of our retained interests caused by spread compression in the credit markets. In contrast, in 2002 the change in market discount rates had a negative impact on our earnings, due to decreases in the valuation of these interests. These fluctuations affect current period earnings; however, discounts previously recognized on retained securityholders’ interests will accrete through earnings over the duration of a securitization transaction, which may span a number of quarterly and annual reporting periods.

Overview of Critical Accounting Policies

Our significant accounting policies are described in Note 2 to our Consolidated Financial Statements, “Summary of Significant Accounting Policies” in our 2003 Annual Report. Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), which in some instances require us to use estimates and assumptions. GAAP also requires management to make judgments in valuing certain assets. Uncertainties are inherent in the use of estimates, assumptions, and judgments. The following is an overview of our application of accounting policies that require us to exercise significant judgment and reach conclusions about future events based on information currently available. Differences in judgment, and differences between our estimates and assumptions and subsequent events, could have a material impact on our reported financial condition and results of operations.

Securitization Accounting. We account for our securitization transactions under Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities—a Replacement of FASB Statement No. 125” (“SFAS No. 140”). Our securitizations involve the transfer of a pool of loans receivable to a securitization trust. The trust or other special-purpose entity through which asset-backed securities are issued

meets the criteria under SFAS No. 140 for a qualifying special-purpose entity that is not consolidated in our financial statements. When we enter into a securitization, we receive cash proceeds from the sale of securities to third parties, remove from our balance sheet the securitized loans allocated to securityholders’ interests and the related allowance for credit losses, and record our retained interests in the transaction. We typically recognize a net gain on sale from the securitization, due primarily to the release of the related allowance for credit losses and recognition of an interest-only strip receivable, which is partially offset by discounts recognized for the retained subordinated interests. We continue to service the securitized loans and we receive contractual servicing fees during the term of the transaction. Our retained interests are generally reported at fair value and changes in their fair value are recognized in current period earnings.

Our retained interests in the securitized loans consist of a seller’s interest, subordinated securityholders’ interests, interest-only strips receivable, and spread accounts. These retained interests are recorded on our balance sheet in loans receivable, interest receivable, and due from securitizations. The seller’s interest is composed of senior and subordinated components. The senior seller’s interest in our securitizations represents an undivided interest in the pool of loans receivable transferred to the securitization trust that are not allocated to the securityholders’ interests. We retain the senior seller’s interest, which includes principal, interest and fees receivable, and classify it as loans receivable with a related allowance for credit losses and interest receivable on our balance sheet. The seller’s interest subordinated component is the accrued interest receivable asset (“AIR”), which represents our interest in outstanding accrued interest and fees that are initially allocated to the securityholders’ interests. The AIR is recorded in due from securitizations on our balance sheet.

We estimate the fair value of our retained subordinated securityholders’ interests, interest-only strips receivable, and spread accounts using a discounted cash flow valuation methodology that incorporates the estimated repayment of these interests over time. Retained subordinated securityholders’ interests are discounted at rates that reflect the level of subordination, the projected repayment term, and the credit risk of the securitized loans. For interest-only strips receivable, we estimate the interest and fees that will be charged on the securitized loans, the interest payable to the securityholders, credit losses, contractual servicing fees, and repayment trends of the securitized loans to project the amount of excess servicing to be collected over the period the securitized loans are expected to be outstanding. For spread accounts, we estimate their fair value through a discounted cash flow analysis based on projected repayments of existing spread account balances, generally at the maturity of the securitization. The fair value of our retained subordinated securityholders’ interests and spread accounts generally vary with the movement in market rates for comparable investments. Historically, we have not incurred a loss of invested principal on assets held through their final payment date and our valuations do not reflect such a loss of principal. The fair values of our interest-only strips receivable vary primarily with changes in our forecast of excess servicing. Estimated excess servicing fluctuates based primarily on the expected performance of the securitized loans.

A variety of internal and external factors, including economic conditions, current account management strategies, and market perceptions regarding our performance can affect the expected net interest and fee income, coupon rates, net credit losses, and discount rates we use in our estimates. Changes in loan performance expectations can have a material impact on the projected cash flows and thus on our fair value estimates of our retained interests. Complex judgment is required in the selection and use of these factors. Results that differ from our projections can result in a material impact on our balance sheet and income statement. As an example of the sensitivity of one assumption, at September 30, 2004, a 10% increase in the discount rates used in valuing the cash flows from our retained subordinated interests would have resulted in a decrease in their fair value of approximately $25.7 million. The sensitivity of key assumptions used in valuing our retained subordinated interests is discussed in Note 7 to our Consolidated Financial Statements, “Securitization or Sale of Receivables.”

At the time of a securitization, we determine whether the retained subordinated securityholders’ interests should be treated as held for trading or available-for-sale. This judgment is based on our intent and plans with respect to holding or selling the assets, and can vary among different securitizations and different retained interests. Our existing retained subordinated securityholders’ interests are securities measured as investments held for trading. Changes to unrealized gains and losses on investments held for trading are included in current period earnings. Changes to unrealized gains and losses on available-for-sale assets are excluded from earnings and reported as a net amount in a separate component of shareholders’ equity, as other comprehensive income. If there is a determination that such available-for-sale assets have been permanently impaired, unrealized losses are reported as a reduction to servicing and securitization income. When realized, available-for-sale gains and losses are removed from other comprehensive income and included in earnings. Designation of these assets as held for trading can have a material impact on the timing of unrealized gains and losses recognized in earnings, but not on shareholders’ equity.

Allowance for Credit Losses. We maintain an allowance for credit losses at a level that, in management’s judgment, is adequate to absorb estimated credit losses inherent in the existing loans receivable on our balance sheet. The amount of the allowance is determined based on an analysis of historical quantitative risk factors that include customer risk scores, delinquency roll rates, principal credit loss rates, bankruptcies, and other customer characteristics. The risk scores used in determining the allowance measure a customer’s credit risk based on a combination of proprietary and external risk models. The delinquency roll rate measures the migration of loans receivable through the stages of delinquency. These factors are used to estimate the likelihood that a loan receivable will charge off. In evaluating the adequacy of this quantitative analysis, management also takes into consideration environmental credit risk factors affecting the portfolio’s credit performance and makes appropriate adjustments to the allowance. These factors primarily include such things as the impact of general economic conditions on a customer’s ability to pay, trends in loan portfolio volume, seasoning, geographic concentrations, and the impact of recent modifications to loan review and underwriting procedures on the credit quality of the loans receivable portfolio. We also validate the adequacy of the allowance by comparing coverage ratios to our actual loss experience and to that of other credit card lenders.

Establishing an allowance for credit losses that is adequate and not excessive requires significant judgment. We forecast multiple scenarios and use alternative methods to establish and test the adequacy of the allowance. The coverage ratios under these varying scenarios and methods create a range of reasonable outcomes from which we record our allowance. The use of estimates is inherent in our assessment of the adequacy of the allowance for credit losses, and significant differences in these estimates could affect the adequacy of the allowance for credit losses.

Different assumptions regarding estimated net credit losses could materially affect our financial position and results of operations. For example, a 10% increase in the projected net credit losses estimated at September 30, 2004 would have resulted in an increase of approximately $63.4 million in the allowance for credit losses and the provision for credit losses.

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

Consistent with our method of calculating the allowance for credit losses, we use multiple scenarios and alternative methods to establish a range of reasonable levels of estimated uncollectible interest and fees, from which we determine the suppressed amounts when we record estimated collectible interest and fee income. We utilize historical charge-offs, delinquency roll rates, bankruptcy rates, customer risk scores, and loans receivable balance composition data to calculate the estimated uncollectible portion of accrued interest and fees. The risk scores used in determining the estimated uncollectible interest and fees measure a customer’s credit risk based upon proprietary risk models. The delinquency roll rate measures the migration of loans receivable through the stages of delinquency.

Different assumptions regarding estimated uncollectible interest and fees could materially affect our financial position and results of operations. For example, a 10% increase in the projected uncollectible interest and fees estimated at September 30, 2004 would have resulted in decreases of approximately $2.9 million to interest income and $16.8 million to non-interest income.

Earnings Summary

The following discussion provides a summary of our earnings for the three and nine months ended September 30, 2004, compared to the three and nine months ended September 30, 2003. The significant components of our results of operations are covered in further detail in subsequent sections of this discussion.

Net income was $109.1 million, or $0.34 per diluted share, for the three months ended September 30, 2004, compared to $85.3 million, or $0.28 per diluted share, in the same period of 2003. Net income was $280.5 million, or $0.88 per diluted share, for the nine months ended September 30, 2004, compared to $129.1 million, or $0.44 per diluted share, in the same period of 2003. Earnings per diluted share amounts include the dilutive effects of our contingently convertible notes as a result of our adoption of EITF Issue No. 04-8, “The Effect of Contingently Convertible Instruments on Diluted Earnings per Share” (“EITF 04-8”), in the third quarter of 2004. See Note 12 to our Consolidated Financial Statements for further discussion.

For the three months ended September 30, 2004, net revenue (net interest income plus non-interest income) was $586.1 million, compared to $526.3 million for the three months ended September 30, 2003, an increase of $59.8 million. For the nine months ended September 30, 2004 and 2003, net revenue remained flat at $1.65 billion for both periods. The increase in net revenue for the third quarter of 2004 compared to the third quarter of 2003 was primarily due to an increase in net interest income.

Net interest income increased by $63.2 million for the three months ended September 30, 2004 compared to the same period in 2003, primarily due to an increase in loans receivable as we benefited from our strategies of generating growth in higher credit quality loans receivable and effectively managing our existing portfolio, and due to a decrease in interest expense resulting from lower average deposit levels and lower costs incurred to fund our deposits. Non-interest income for the third quarter of 2004 remained relatively flat compared to the third quarter of 2003 and included an increase in servicing and securitization income of $50.2 million, primarily resulting from increases in the fair value recognized for our retained subordinated securityholders’ interests and spread accounts due to an overall favorable change in market discount rates, and higher levels of interest-only strips receivable recognized due to increases in forecasted excess servicing associated with continuing improvements in delinquencies and credit losses. The increase in servicing and securitization income was offset by a decrease in credit product fee income of $37.9 million primarily due to our transition to higher-quality credit card account originations, and a decrease in non-interest income—other of $15.6 million due to losses associated with the sale of investment securities in the third quarter of 2004 and the inclusion of income in the third quarter of 2003 from operations that were subsequently sold.

Our provision for credit losses was $161.4 million for the quarter ended September 30, 2004, an increase of $62.6 million from the third quarter of 2003 provision of $98.7 million. For the nine months ended September 30, 2004, our provision for credit losses was $432.2 million, a decrease of $60.3 million from the nine months ended September 30, 2003 provision of $492.6 million. The increase in the provision for the third quarter of 2004 compared to the same period in 2003 is primarily a result of growth in our reported loans receivable during the most recent quarter. The decrease in the provision for the nine months ended September 30, 2004 and the reduction in our loan loss coverage ratio from 10.74% at September 30, 2003 to 8.67% at September 30, 2004 reflects the trend in our net credit losses resulting from changes in our loan mix due to higher-quality credit card account originations, improvements in the U.S. economy, and changes in our portfolio management and collections strategies and processes.

For the quarter ended September 30, 2004, non-interest expense decreased $29.7 million to $256.9 million, compared to $286.6 million for the quarter ended September 30, 2003. For the nine months ended September 30, 2004, non-interest expense decreased $157.4 million to $782.0 million, compared to $939.5 million for the nine months ended September 30, 2003. These year over year reductions are primarily due to lower personnel and related infrastructure costs associated with our workforce reductions and lower collection costs resulting from our lower delinquencies due to higher-quality account originations and the implementation of certain credit risk management operations strategies.

Net Interest Income

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

Reported net interest income for the three months ended September 30, 2004 was $144.0 million, compared to $80.9 million for the same period in 2003, an increase of $63.2 million. Reported net interest income for the nine months ended September 30, 2004 was $376.7 million, compared to $389.0 million for the same period in 2003, a decrease of $12.3 million. The increase in reported net interest income for the three months ended September 30, 2004 was primarily driven by the increase in our reported loans receivable during the quarter and the decrease in our interest expense on deposits. The decline in reported net interest income for the nine months ended September 30, 2004 reflects our continuing efforts to create a higher-quality loan portfolio, which resulted in decreases in the yield on outstanding loans receivable. The yield on our reported loans receivable decreased to 12.75% for the nine months ended September 30, 2004 from 15.16% for the nine months ended September 30, 2003, as the mix of our portfolio reflected a growing proportion of higher-quality accounts, which generally have lower annual percentage rates, including lower and longer introductory rates.

Partially offsetting the negative impact to our yield from the change in the mix of our loan portfolio was an increase in the level of interest income that we estimate will become collectible (i.e., a reduction of the suppressed amounts). For the three months ended September 30, 2004 and 2003, reported interest income was reduced by $20.8 million and $29.5 million due to the impact of the suppression methodology. For the nine months ended September 30, 2004 and 2003, reported interest income was reduced by $58.2 million and $115.0 million due to the impact of the suppression methodology. Under the suppression methodology, the interest accrued on loans that we estimate to be uncollectible is not recognized as interest income on our

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

The following tables provides an analysis of reported interest income, interest expense, net interest spread, and average balances for the three and nine months ended September 30, 2004 and 2003.

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

	Three months ended September 30,
	2004							2003
(dollars in thousands)	Average Balance			Income/ Expense		Yield/ Rate		Average Balance			Income/ Expense		Yield/ Rate
Assets
Interest-earning assets
Loans receivable	$	7,340,073		$	223,728	12.19	%	$	5,865,604		$	200,777	13.69	%
Interest-earning cash and cash equivalents	251,615			838		1.33	%	449,419			1,170		1.04	%
Federal funds sold	653,711			2,409		1.47	%	4,181,325			10,562		1.01	%
Investment securities	2,965,909			15,164		2.05	%	1,630,987			10,428		2.56	%
Other	669,608			21,278		12.71	%	741,165			12,847		6.93	%
Total interest-earning assets	11,880,916			$	263,417	8.87	%	12,868,500			$	235,784	7.33	%

Allowance for credit losses	(626,891		)					(680,230		)
Other assets	2,429,753							3,551,516

Total assets	$	13,683,778						$	15,739,786

Liabilities and Shareholders’ Equity
Interest-bearing liabilities
Deposits	$	8,939,423		$	102,941	4.61	%	$	11,642,410		$	139,470	4.79	%
Borrowings	1,481,751			16,433		4.44	%	1,254,656			15,437		4.92	%
Total interest-bearing liabilities	10,421,174			$	119,374	4.58	%	12,897,066			$	154,907	4.80	%

Other liabilities	699,034							644,423
Total liabilities	11,120,208							13,541,489

Shareholders’ equity	2,563,570							2,198,297

Total liabilities and shareholders’ equity	$	13,683,778						$	15,739,786

Net Interest Income and Spread				$	144,043	4.29	%				$	80,877	2.53	%

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

	Nine months ended September 30,
	2004							2003
(dollars in thousands)	Average Balance			Income/ Expense		Yield/ Rate		Average Balance			Income/ Expense		Yield/ Rate
Assets
Interest-earning assets
Loans receivable	$	6,810,019		$	651,249	12.75	%	$	6,675,001		$	758,857	15.16	%
Interest-earning cash and cash equivalents	399,679			3,025		1.01	%	336,533			2,692		1.07	%
Federal funds sold	1,269,272			10,514		1.10	%	3,985,187			33,998		1.14	%
Investment securities	2,627,125			38,983		1.98	%	1,723,657			39,606		3.06	%
Other	647,295			49,014		10.10	%	753,596			44,502		7.87	%
Total interest-earning assets	11,753,390			$	752,785	8.54	%	13,473,974			$	879,655	8.70	%

Allowance for credit losses	(625,079		)					(901,249		)
Other assets	2,474,093							3,576,949

Total assets	$	13,602,404						$	16,149,674

Liabilities and Shareholders’ Equity
Interest-bearing liabilities
Deposits	$	9,088,745		$	324,583	4.76	%	$	12,179,739		$	453,845	4.97	%
Borrowings	1,390,123			51,506		4.94	%	1,119,796			36,774		4.38	%
Total interest-bearing liabilities	10,478,868			$	376,089	4.79	%	13,299,535			$	490,619	4.92	%

Other liabilities	661,620							703,004
Total liabilities	11,140,488							14,002,539

Shareholders’ equity	2,461,916							2,147,135

Total liabilities and shareholders’ equity	$	13,602,404						$	16,149,674

Net Interest Income and Spread				$	376,696	3.75	%				$	389,036	3.78	%

Interest Volume and Rate Variance Analysis

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

Rate-Volume Variance Analysis

	Three months ended September 30,									Nine months ended September 30,
	2004 vs. 2003									2004 vs. 2003
(dollars in thousands)	Increase (Decrease)			Change due to (1)						Increase (Decrease)			Change due to (1)
				Volume			Rate						Volume			Rate

Interest Income
Loans receivable	$	22,951		$	46,622		$	(23,671	)	$	(107,608	)	$	15,091		$	(122,699	)
Federal funds sold	(8,153		)	(11,540		)	3,387			(23,484		)	(22,334		)	(1,150		)
Investments and other securities	12,835			5,204			7,631			4,222			9,926			(5,704		)
Total interest income	27,633			40,286			(12,653		)	(126,870		)	2,683			(129,553		)

Interest Expense
Interest-bearing deposits	(36,529		)	(31,440		)	(5,089		)	(129,262		)	(110,812		)	(18,450		)
Borrowings	996			2,604			(1,608		)	14,732			9,631			5,101
Total interest expense	(35,533		)	(28,836		)	(6,697		)	(114,530		)	(101,181		)	(13,349		)

Net Interest Income	$	63,166		$	69,122		$	(5,956	)	$	(12,340	)	$	103,864		$	(116,204	)

(1) The changes due to both volumes 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 interest expense are calculated independently for each line in the table.

Allowance and Provision for Credit Losses

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

We establish our allowance for credit losses by analyzing historical risk behavior and credit loss trends and reviewing current loss expectations that incorporate general economic conditions that may impact future losses. We segregate loans into general risk classifications for each product type. We combine quantitative factors (including customer risk scores, historical delinquency roll rates, historical credit loss rates, and other customer characteristics) with environmental credit risk factors to prepare comparative evaluations of the allowance for credit losses.

The environmental credit risk factors are consistent with applicable bank regulatory guidelines and reflect our assessment of general macroeconomic conditions, trends in loan portfolio volume and seasoning, geographic concentrations, and modifications to loan review and underwriting procedures, among other factors. We compare allowances established in prior periods with subsequent actual credit losses and perform a peer group comparative analysis of lagged loss rates to coverage ratios. We derive our coverage ratios by dividing the allowance for credit losses by the reported loans outstanding at period end.

Allowance for Credit Losses

	Three months ended September 30,						Nine months ended September 30,
(dollars in thousands)	2004			2003			2004			2003
Balance at beginning of period	$	600,479		$	701,488		$	625,886		$	1,012,461
Provision for credit losses	161,351			98,732			432,220			480,676
Fair value adjustment—loans held for securitization or sale(1)	—			—			—			11,875
Credit losses	(141,409		)	(206,654		)	(508,849		)	(847,629		)
Recoveries	13,110			50,416			84,274			158,205
Credit losses on loans held for securitization or sale(1)	—			—			—			(171,606		)
Balance at end of period	$	633,531		$	643,982		$	633,531		$	643,982

Reported loans receivable at period end	$	7,306,507		$	5,994,446

Coverage ratios at period end	8.67		%	10.74		%

(1) The 2003 fair value adjustment—loans held for securitization or sale of $11.9 million reflects an increase in the allowance for credit losses as a result of the mark to market of Providian Bank (“PB”) loans receivable reclassified as loans held for securitization or sale in the nine months ended September 30, 2003. The decrease in the allowance for credit losses of $171.6 million in the nine months ended September 30, 2003 represents the allowance for credit losses that, together with the par value of the PB loans receivable, was transferred to loans held for securitization or sale as part of the adjustment to the fair value of $667.1 million.

The decrease in the coverage ratio (the allowance for credit losses as a percentage of reported loans receivable) as of September 30, 2004 compared to September 30, 2003 reflects the trend in our net credit losses resulting from changes in our loan mix due to higher-quality account originations, improvements in the U.S. economy, and changes in our portfolio management and collections strategies and processes. As we continue to evaluate the allowance for credit losses in light of changes in asset quality, regulatory requirements, general economic trends, and the effect of our new marketing strategy, we may make adjustments that would result in further changes to the coverage ratio, which would impact our provision for credit losses.

Non-Interest Income

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

As of September 30, 2004 and 2003, the total principal amount of securitized loans outstanding was $10.31 billion and $10.62 billion. For the three months ended September 30, 2004, servicing and securitization income was $311.2 million, an increase of $50.2 million from $261.1 million in the third quarter of 2003. Servicing and securitization income for the three months ended September 30, 2004 includes a $32.9 million benefit from an increase in the fair value recognized for our retained subordinated securityholders’ interests and spread accounts due to favorable changes in market discount rates. Changes in market discount rates are generally due to factors not within the control of the Company, such as changes in the U.S. economy, the current interest rate environment, and credit spread levels. More specifically, the improvement in the discount rates during the third quarter of 2004 was due primarily to credit spread tightening in the debt capital markets. Additionally, servicing and securitization income increased during the third quarter of 2004 compared to the same period of 2003 due to increases in the valuation of our interest-only strips receivable resulting from increases in forecasted excess servicing, primarily due to lower forecasted credit losses. Partially offsetting the positive contributions to income described above, servicing and securitization income in the third quarter of 2004 included lower discount accretion related to decreased average retained subordinated securityholders’ interests and spread account balances as compared to the same period in 2003.

For the nine months ended September 30, 2004, servicing and securitization income was $836.2 million, an increase of $221.8 million from $614.4 million for the same period in 2003. The increase in servicing and securitization income for the nine months ended September 30, 2004 is due to factors similar to those described for the third quarter of 2004, including an overall favorable change in market discount rates for our retained securityholders’ interests and spread accounts, and recognition of higher levels of interest-only strips receivable, partially offset by lower discount accretion from retained subordinated securityholders’ interests and lower levels of spread account balances.

Under the suppression methodology, we do not recognize income associated with the interest and fees on securitized loans that we estimate to be uncollectible as servicing and securitization income on the income statement or as due from securitizations on the balance sheet. In addition, servicing and securitization income is reduced by the reversal of accrued interest and fees included in due from securitizations (to the extent not previously suppressed) when the principal amount of a securitized loan is charged off. For the three months ended September 30, 2004 and 2003, the amount of servicing and securitization income not recognized as a result of the impact of the suppression methodology was $103.6 million and $141.0 million. For the nine months ended September 30, 2004 and 2003, the amount of servicing and securitization income not recognized as a result of the impact of the suppression methodology was $315.9 million and $435.7 million.

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

For the three months ended September 30, 2004, credit product fee income was $135.5 million, a decrease from $173.4 million for the three months ended September 30, 2003. For the nine months ended September 30, 2004, credit product fee income was $421.7 million, a decrease from $593.2 million for the nine months ended September 30, 2003. These year over year decreases primarily reflect our transition to higher-quality credit card account originations, which resulted in lower late and overlimit fees and lower cardholder service product and annual membership fee revenue.

In accordance with GAAP, we capitalize direct loan origination costs associated with successful account acquisition efforts. We amortize capitalized loan origination costs over the customer privilege period (currently one year) for credit card loans, unless the loans are securitized, in which case we recognize the remaining costs as an expense upon securitization. Effective January 1, 2004, we began classifying capitalized loan origination costs as a reduction to credit product fee income. Previously, amortized loan origination costs were reported as non-interest expense—solicitation and advertising. This reclassification had no material impact on our income statement.

Under the suppression methodology, we do not recognize fees on loans that we estimate to be uncollectible as credit product fee income on our income statement or as loans receivable on our balance sheet. In addition, credit product fee income is reduced by the reversal of accrued fees included in loans receivable (to the extent not previously suppressed), when the principal amount of a loan is charged off. For the three months ended September 30, 2004 and 2003, the amount of credit product fee income not recognized as a result of the impact of the suppression methodology was $30.8 million and $46.3 million. For the nine months ended September 30, 2004 and 2003, the amount of credit product fee income not recognized as a result of the impact of the suppression methodology was $87.2 million and $156.9 million. The decreases in the amount of suppressed income for the three and nine months ended September 30, 2004 as compared to the three and nine months ended September 30, 2003 is in line with the decreases in credit product fee income as discussed above.

Other. Non-interest income—other was $(4.7) million and $11.0 million for the three months ended September 30, 2004 and 2003. For the nine months ended September 30, 2004 and 2003, non-interest income—other was $11.2 million and $48.7 million. These decreases are primarily a result of changes in realized gains and losses on investment securities and derivative instruments, partially offset by installment payments received from the sale of a limited partnership investment and income related to limited partnership investments accounted for under the equity method. Additionally, non-interest income—other decreased during the first nine months of 2004 compared to the same period in 2003 due to the inclusion in 2003 of income from operations that were subsequently sold.

Non-Interest Expense

Non-interest expense includes salary and employee benefits costs, solicitation and advertising costs, occupancy, furniture, and equipment costs, data processing and communication costs, and other non-interest expense. The following table presents non-interest expense for the three and nine months ended September 30, 2004 and 2003. Overall, the decrease in non-interest expense reflects our efforts to increase operational efficiency and align our operations with our loan portfolio levels.

Summary of Non-Interest Expense

	Three months ended September 30,				Nine months ended September 30,
(dollars in thousands)	2004		2003		2004		2003
Salaries and employee benefits	$	68,220	$	90,050	$	219,748	$	282,881
Solicitation and advertising	57,377		38,523		175,358		157,428
Occupancy, furniture, and equipment	23,537		31,571		71,776		91,661
Data processing and communication	27,741		31,064		81,839		94,531
Other	80,058		95,380		233,311		312,969
Total non-interest expense	$	256,933	$	286,588	$	782,032	$	939,470

Salary and employee benefits costs include staffing costs associated with marketing, customer service, collections, and administration. In the second half of 2003, as part of our strategy of enhancing operational efficiency, we entered into agreements to outsource certain information technology functions. These include agreements with Accenture, which provides the Company with technology application development and maintenance services, and Computer Sciences Corporation, which provides desktop, help desk, server, security administration, e-mail, and network infrastructure services. These outsourcing arrangements have reduced, and we expect that they will continue to result in reduced, salaries and employee benefits expense with a partial offsetting increase in other non-interest expense items during the remainder of 2004.

Solicitation and advertising costs include printing, postage, telemarketing, list processing, and credit bureau costs paid to third parties in connection with account solicitation efforts and also include costs incurred to promote our products. Advertising costs and the majority of solicitation expenses are expensed as incurred. Third quarter and year-to-date 2004 solicitation and advertising expense increased compared to the same periods in 2003, reflecting increases in our marketing and account solicitation activity and increased use of third party marketing service providers.

As discussed in “—Non-Interest Income—Credit Product Fee Income,” effective January 1, 2004, we began classifying capitalized loan origination costs as a reduction to non-interest income—credit product fee income. Prior to January 1, 2004, these costs were reported as non-interest expense—solicitation and advertising. This reclassification had no material impact on our income statement.

In connection with workforce reductions and the closure of facilities, we record charges related to employee severance, premises, equipment, and furniture lease expenses, fixed asset write-downs, and disposition costs. At September 30, 2004, we had accrued $9.1 million for remaining costs expected to be paid, primarily for premises, equipment, and furniture lease costs associated with property no longer in use. This amount included $2.5 million for costs associated with the closure of our facilities in Louisville, Kentucky in January 2004. In connection with the closure of our Louisville facilities, we also recognized $3.4 million of severance and fixed asset write-down expense during the first quarter of 2004. To consolidate our customer service operations and further enhance our operational efficiency, we began closing our facilities in San Antonio, Texas in the third quarter of 2004 and expect to complete the closure during the fourth quarter of 2004.

Non-interest expense—other includes operational expenses such as collection costs, fraud losses, and bankcard association assessments. For the three months ended September 30, 2004 and 2003, collection costs were $14.9 million and $26.0 million. For the nine months ended September 30, 2004 and 2003, collection costs were $54.7 million and $122.9 million. The year over year decreases in collection costs are primarily the result of our lower delinquencies due to higher-quality credit card account originations and the implementation of certain credit risk management operations strategies.

Income Taxes

We recognized income tax expense of $58.7 million and $55.7 million for the three months ended September 30, 2004 and 2003. For the nine months ended September 30, 2004 and 2003, we recognized income tax expense of $151.1 million and $84.3 million. Our effective income tax rates were 35.0% for the three and nine months ended September 30, 2004, and 39.5% for the three and nine months ended September 30, 2003. The decrease in the rate is due to tax credits that

we expect to utilize based on our estimate of 2004 taxable income. The tax credits are generated from an existing investment in a limited liability entity that operates an alternative energy plant. We were not able to utilize these credits in 2003.

Securitizations of Loans Receivable

We account for our securitization transactions under SFAS No. 140. Our securitizations involve the transfer of a pool of loans receivable to a securitization trust. The trust or other special-purpose entity through which asset-backed securities are issued meets the criteria for a qualifying special-purpose entity that is not consolidated in our financial statements.

The securitization transactions create undivided interests in the pool of loans and establish securityholders’ interests (asset-backed securityholders’ certificates and notes), a seller’s interest, interest-only strips receivable, and spread accounts. Securityholders’ interests consist of various classes of investor interests ranked by seniority. The senior securityholders’ interests, which are supported with various forms of credit enhancement, are sold to third party investors. When we enter into a securitization transaction, we receive cash proceeds from the sale of securities to third parties, remove the securitized loans and related allowance for credit losses from our balance sheet, and record the retained interests in the transaction. We typically recognize a net gain on sale from the securitization, due primarily to the release of the related allowance for credit losses and recognition of an interest-only strip receivable, which is partially offset by discounts recognized for the retained subordinated interests. See “—Overview of Critical Accounting Policies.”

During the three months ended September 30, 2004 and 2003, we securitized $1.31 billion and $406.5 million of loans receivable, which were offset by reductions in securitized loans of $1.08 billion and $868.9 million from the repayment of certain series and a reduction in the invested amount of the variable funding series. During the nine months ended September 30, 2004 and 2003, we securitized $3.03 billion and $1.50 billion of loans receivable, which were offset by reductions in securitized loans of $3.05 billion and $3.31 billion from the repayment of certain series and a reduction in the invested amount of the variable funding series. We typically recognize a net gain or loss from the initial sale of investor interests to third party investors from the recognition of a gain from the interest-only strip receivable, and the recognition of a loss from the discounts recognized on other retained interests. We recognized a total gain of $12.0 million and a total loss of $4.2 million related to our new securitizations during the three months ended September 30, 2004 and 2003. We recognized a total gain of $5.5 million and a total loss of $20.4 million related to our new securitizations during the nine months ended September 30, 2004 and 2003. These gains and losses exclude the benefit realized from the reduction to the allowance for credit losses recognized at the time of sale.

The total amounts of our securitized loans as of September 30, 2004 and December 31, 2003 were $10.31 billion and $10.33 billion. The following table presents the fair value (carrying value, net of any discounts) of our retained interests in the loans receivable transferred in our securitizations and reported in due from securitizations at September 30, 2004 and December 31, 2003.

Due from Securitizations

(dollars in thousands)	September 30, 2004		December 31, 2003
Retained subordinated securityholders’ interests	$	1,260,308	$	1,176,316
Interest-only strips receivable	429,731		228,856
Spread accounts	273,295		403,802
Accrued interest receivable	351,752		397,951
Other(1)	114,448		171,038
Total due from securitizations	$	2,429,534	$	2,377,963

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

Reconciliation of Selected Reported Earnings to Selected Managed Earnings

	Three months ended September 30,						Nine months ended September 30,
(dollars in thousands)	2004			2003			2004			2003

Adjusted and Risk Adjusted Margins:
Reported
Interest income from loans	$	223,728		$	200,777		$	651,249		$	758,857
Allocated interest expense	(73,749		)	(70,607		)	(217,906		)	(243,053		)
Credit product fee income	135,515			173,427			421,723			593,234
Net credit losses	(128,299		)	(156,238		)	(424,575		)	(689,424		)
Adjusted margin	157,195			147,359			430,491			419,614
Servicing and securitization income	311,241			261,086			836,195			614,402
Other non-interest income	(4,696		)	10,953			11,208			48,683
Risk adjusted margin	463,740			419,398			1,277,894			1,082,699

Securitization Adjustments
Interest income from loans	$	497,475		$	562,350		$	1,496,207		$	1,730,201
Allocated interest expense	(58,795		)	(67,973		)	(174,515		)	(210,266		)
Credit product fee income	135,070			132,231			386,821			385,021
Net credit losses	(325,506		)	(450,798		)	(1,134,207		)	(1,511,929		)
Servicing and securitization income	(239,497		)	(191,294		)	(573,215		)	(429,797		)

Managed
Interest income from loans	$	721,203		$	763,127		$	2,147,456		$	2,489,058
Allocated interest expense	(132,544		)	(138,580		)	(392,421		)	(453,319		)
Credit product fee income	270,585			305,658			808,544			978,255
Net credit losses	(453,805		)	(607,036		)	(1,558,782		)	(2,201,353		)
Adjusted margin	405,439			323,169			1,004,797			812,641
Servicing and securitization income	71,744			69,792			262,980			184,605
Other non-interest income	(4,696		)	10,953			11,208			48,683
Risk adjusted margin	$	472,487		$	403,914		$	1,278,985		$	1,045,929

Net Interest Income:
Reported
Interest income from loans	$	223,728		$	200,777		$	651,249		$	758,857
Interest income from investments	39,689			35,007			101,536			120,798
Interest expense	(119,374		)	(154,907		)	(376,089		)	(490,619		)
Net interest income	144,043			80,877			376,696			389,036

Securitization Adjustments
Interest income from loans	$	497,475		$	562,350		$	1,496,207		$	1,730,201
Interest income from investments	(19,921		)	(11,356		)	(45,085		)	(39,105		)
Interest expense	(47,621		)	(41,132		)	(130,522		)	(134,390		)

Managed
Interest income from loans	$	721,203		$	763,127		$	2,147,456		$	2,489,058
Interest income from investments	19,768			23,651			56,451			81,693
Interest expense	(166,995		)	(196,039		)	(506,611		)	(625,009		)
Net interest income	$	573,976		$	590,739		$	1,697,296		$	1,945,742

Reconciliation of Selected Reported Financial Data
to Selected Managed Financial Data

(dollars in thousands)	September 30, 2004				June 30, 2004				December 31, 2003			September 30, 2003

Selected Financial Data:
Reported
Period End:
Delinquent loans	$	336,716			$			326,011	$	417,131		$	430,351
Loans receivable(1)	7,306,507				6,883,942				6,281,403			5,994,446
Total assets	13,914,771				13,592,270				14,275,347			15,333,709

Three-Month Average:
Loans receivable(1)	$	7,340,073			$		6,610,851		$	5,934,473		$	5,865,604
Earning assets	11,880,916				11,551,217				12,368,033			12,868,500
Total assets	13,683,778				13,477,337				14,815,957			15,739,786

Securitization Adjustments
Period End:
Delinquent loans	$	785,312			$			784,147	$		1,156,096	$	1,210,767
Loans receivable	10,594,908				10,361,415				10,653,351			10,951,709
Total assets	8,849,081				8,660,783				8,923,017			8,449,990

Three-Month Average:
Loans receivable	$	10,129,209			$	10,167,072			$		10,732,942	$		11,025,838
Earning assets	10,129,209				10,167,072				10,732,942			11,025,838
Total assets	8,455,475				8,599,879				8,529,245			8,722,273

Managed
Period End:
Delinquent loans	$		1,122,028		$	1,110,158			$		1,573,227	$			1,641,118
Loans receivable(1)	17,901,415				17,245,357				16,934,754			16,946,155
Total assets	22,763,852				22,253,053				23,198,364			23,783,699

Three-Month Average:
Loans receivable(1)	$			17,469,282	$	16,777,923			$		16,667,415	$			16,891,442
Earning assets	22,010,125				21,718,289				23,100,975			23,894,338
Total assets	22,139,253				22,077,216				23,345,202			24,462,059

(1) Balances exclude market value adjustments related to the fair value of designated financial instruments.

Loan Performance Measures. We present key loan performance measures on a reported and a managed basis. Reported loans do not necessarily have the same income or credit characteristics as securitized loans and can perform differently over time. Although managed loan performance measures include both reported and securitized loans, the securitized loans will have a more significant impact on the managed loan performance numbers because our securitized receivables balance is substantially larger than our reported receivables balance. In addition, when loans are securitized, there is a potentially significant impact on reported loan performance as loans are removed from loans receivable on our balance sheet or reclassified to loans held for securitization or sale, while there is generally no significant impact on managed loan performance.

Loan Performance Statistics

	Three months ended September 30,				Nine months ended September 30,
	2004		2003		2004		2003

Reported
Net interest margin on average loans(1)	8.17	%	8.87	%	8.48	%	10.30	%
Net interest margin on average earning assets	4.85	%	2.51	%	4.27	%	3.85	%
Adjusted margin on average loans(2)	8.56	%	10.06	%	8.43	%	8.38	%
Risk adjusted margin on average loans(3)	25.27	%	28.61	%	25.02	%	21.63	%
Return on average assets	3.19	%	2.17	%	2.75	%	1.07	%

Managed
Net interest margin on average loans(4)	13.48	%	14.79	%	13.78	%	15.12	%
Net interest margin on average earning assets	10.43	%	9.89	%	10.32	%	10.48	%
Adjusted margin on average loans(5)	9.29	%	7.66	%	7.89	%	6.04	%
Risk adjusted margin on average loans (6)	10.82	%	9.57	%	10.04	%	7.77	%
Return on average assets	1.97	%	1.40	%	1.69	%	0.69	%

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

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

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

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

(5) Represents interest income, less interest expense and net credit losses, plus credit product fee income on managed average loans receivable, expressed as a percentage of managed average loans receivable. Interest expense is allocated to managed average loans receivable based on the ratio of managed average loans receivable to managed average earning assets.

(6) Represents interest income, less interest expense and net credit losses, plus non-interest income, expressed as a percentage of managed average loans receivable. Interest expense is allocated to managed average loans receivable based on the ratio of managed average loans receivable to managed average earning assets.

Net Interest Margin. Our reported net interest margin on average loans decreased to 8.17% for the third quarter of 2004, from 8.87% for the same period in 2003. Managed net interest margin on average loans decreased to 13.48% for the third quarter of 2004, from 14.79% for the same period in 2003. The yield on our reported loans receivable decreased to 12.19% for the third quarter of 2004, from 13.69% for the same period in 2003. The yield on managed loans receivable decreased to 16.51% for the third quarter of 2004, from 18.07% for the same period in 2003. The lower yields in the three months ended September 30, 2004 are primarily a result of our continuing efforts to generate a higher-quality loan portfolio by increasing the percentage of higher credit quality accounts, which generally have lower annual percentage rates, including lower and longer introductory rates.

Reported earning assets include consumer loans, interest-earning cash, federal funds sold and securities purchased under resale agreements, investment securities, spread accounts, and interest-only strips receivable. Managed earning assets include reported earning assets plus the loans receivable removed or reclassified from loans receivable on our balance sheet through our securitizations, less the retained interests from securitizations reported on our balance sheet. Net interest income expressed as a percentage of average earning assets is referred to as net interest margin on average earning assets. The reported net interest margin on average earning assets increased to 4.85% for the quarter ended September 30, 2004 from 2.51% for the quarter ended September 30, 2003. The managed net interest margin on average earning assets increased to 10.43% for the quarter ended September 30, 2004 from 9.89% for the quarter ended September 30, 2003. These increases reflect the impact of lower average earning assets and lower interest expense due to decreased levels of deposit funding as compared to the third quarter of 2003, and lower interest rates paid on deposits.

Adjusted Margin and Risk Adjusted Margin. One of the ways we measure loan portfolio profitability is by comparing the revenue generated by customer accounts with the related funding costs and risk of loss. Risk adjusted margin consists of interest income plus non-interest income (including non-interest income—servicing and securitization and non-interest income—other) less interest expense allocated to loans and net credit losses. Therefore, this measure includes fluctuations from changing retained interest fair values and non-recurring gains or losses included in non-interest income—other. To provide an ongoing measure of loan profitability that is not subject to such fluctuations, which we believe is a more meaningful measure for assessing our loan performance, we use adjusted margin. Adjusted margin excludes non-interest income—servicing and securitization and non-interest income—other and consists of interest income plus non-interest income—credit product fee income, less interest expense allocated to loans and net credit losses. Risk adjusted margin and adjusted margin are expressed in dollars or as a percentage of average loans receivable.

Reported adjusted margins for the quarter ended September 30, 2004 were $157.2 million and 8.56%, compared to $147.4 million and 10.06% for the quarter ended September 30, 2003. Reported adjusted margins for the nine months ended September 30, 2004 were $430.5 million and 8.43%, compared to $419.6 million and 8.38% for the nine months ended September 30, 2003. The adjusted margins for the three months ended September 30, 2004 decreased primarily due to lower fee income and lower yields on reported loans outstanding, partially offset by lower net credit losses during the period. The adjusted margins for the nine months ended September 30, 2004 increased primarily due to lower net credit losses, partially offset by lower yields and reduced fee income associated with our transition to higher-quality accounts.

Managed adjusted margins for the quarter ended September 30, 2004 were $405.4 million and 9.29%, compared to $323.2 million and 7.66% for the quarter ended September 30, 2003. Managed adjusted margins for the nine months ended September 30, 2004 were $1.00 billion and 7.89%, compared to $812.6 million and 6.04% for the nine months ended September 30, 2003. The increases in the managed adjusted margins are primarily due to a decrease in net credit losses, partially offset by lower average managed loans and lower yields and lower fee income associated with our transition to higher-quality accounts.

Asset Quality

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

We measure the credit performance of our portfolio of loans receivable through two key rates, the 30+ day delinquency rate and the net credit loss rate. The 30+ day delinquency rate on reported loans was 4.61% as of September 30, 2004, compared to 6.64% as of December 31, 2003 and 7.18% as of September 30, 2003. The 30+ day delinquency rate on managed loans was 6.27% as of September 30, 2004, compared to 9.29% as of December 31, 2003 and 9.68% as of September 30, 2003. The reported net credit loss rate was 6.99% for the quarter ended September 30, 2004, compared to 10.65% for the quarter ended September 30, 2003. The managed net credit loss rate was 10.39% for the quarter ended September 30, 2004, compared to 14.37% for the quarter ended September 30, 2003.

The improved performance over the past year in both our reported and managed 30+ day delinquency rates and our reported and managed net credit loss rates reflects the impact of higher-quality credit card account originations, revised credit line and pricing strategies for existing customers, new collection and credit policies and practices, and improving conditions in the U.S. economy.

Reported 30+ day delinquency rates are influenced by fluctuations in the composition of receivables transferred to our securitization trust and by the amount of the senior seller’s interest in the securitization trust from time to time. These amounts may increase or decrease as a result of account additions, increases or decreases in the balance of the pool of loans receivable transferred to the securitization trust, and increases or decreases in the level of securityholders’ interests due to new issuances and amortization or accumulation of outstanding series. (See “—Securitizations of Loans Receivable.”) For example, during a month in which we designate additional accounts to the securitization trust or reduce the amount of an outstanding series of securityholders’ interests, the amount of our senior seller’s interest will increase. This increase, which may continue until new securityholders’ interests are issued or the amount of loans receivable in the securitization trust declines, will generally also increase our reported 30+ day delinquency rate because we will have a larger undivided interest in the pool of loans receivable transferred to the securitization trust than before the increase and because the trust loans receivable currently have higher delinquency rates than our reported loans receivable. As a result, short-term fluctuations in the reported 30+ day delinquency rate are not necessarily a reliable indicator of trends in our asset quality.

Delinquent Loans

	September 30, 2004				December 31, 2003
(dollars in thousands)	Loans		% of Total Loans		Loans		% of Total Loans
Reported
Loans outstanding	$	7,306,507	100.00	%	$	6,281,403	100.00	%
Loans delinquent
30-59 days	$	109,195	1.49	%	$	128,467	2.05	%
60-89 days	79,558		1.09	%	94,916		1.51	%
90 or more days	147,963		2.03	%	193,748		3.08	%
Total loans delinquent	$	336,716	4.61	%	$	417,131	6.64	%

Securitized
Loans outstanding(1)	$	10,594,908			$	10,653,351
Loans delinquent
30-59 days	$	248,849			$	346,630
60-89 days	187,693				269,107
90 or more days	348,770				540,359
Total loans delinquent	$	785,312			$	1,156,096

Managed
Loans outstanding	$	17,901,415	100.00	%	$	16,934,754	100.00	%
Loans delinquent
30-59 days	$	358,044	2.00	%	$	475,097	2.81	%
60-89 days	267,251		1.49	%	364,023		2.15	%
90 or more days	496,733		2.78	%	734,107		4.33	%
Total loans delinquent	$	1,122,028	6.27	%	$	1,573,227	9.29	%

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

Reported net credit loss rates are influenced by fluctuations in the composition of receivables transferred to our securitization trust and by the amount of the senior seller’s interest in the securitization trust from time to time. These amounts may increase or decrease as a result of account additions, increases or decreases in the balance of the pool of loans receivable transferred to the securitization trust, and increases or decreases in the level of securityholders’ interests due to new issuances and amortization or accumulation of outstanding series. (See “—Securitizations of Loans Receivable.”) For example, during a month in which we designate additional accounts to the securitization trust or reduce the amount of an outstanding series of securityholders’ interests, the amount of our senior seller’s interest will increase. This increase, which may continue until new securityholders’ interests are issued or the amount of loans receivable in the securitization trust declines, will generally also increase our reported net credit loss rate because we will have a larger undivided interest in the pool of loans receivable transferred to the securitization trust than before the increase and because the trust loans receivable currently have higher net credit loss rates than our reported loans receivable. As a result, short-term fluctuations in the reported net credit loss rate are not necessarily a reliable indicator of trends in our asset quality.

Net Credit Losses

	Three months ended September 30,						Nine months ended September 30,
(dollars in thousands)	2004			2003			2004			2003

Reported
Average loans outstanding(1)	$	7,340,073		$	5,865,604		$	6,810,019		$	6,675,001
Net credit losses(2)	$	128,299		$	156,238		$	424,575		$	689,424
Net credit losses as a percentage of average loans outstanding	6.99		%	10.65		%	8.31		%	13.77		%

Securitized
Average loans outstanding(3)	$	10,129,209		$	11,025,838		$	10,175,728		$	11,278,086
Net credit losses	$	325,506		$	450,798		$	1,134,207		$	1,511,929

Managed
Average loans outstanding(1)	$	17,469,282		$	16,891,442		$	16,985,747		$	17,953,087
Net credit losses(2)	$	453,805		$	607,036		$	1,558,782		$	2,201,353
Net credit losses as a percentage of average loans outstanding	10.39		%	14.37		%	12.24		%	16.35		%

(1) The 2003 average loans outstanding include loans held for securitization or sale at par.

(2) The year to date 2003 net credit losses exclude estimated net credit losses on loans held for securitization or sale of
$171.6 million.

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

Interest Rate Sensitivity

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

Our assets and liabilities consist primarily of investments in interest-earning assets (loans receivable and investment securities), which are primarily funded by interest-bearing liabilities (deposits and borrowings). Our loans receivable accrue interest at rates that are either fixed or float at a spread above the prime rate. At September 30, 2004, 75.7% of our reported loans receivable and 75.8% of our managed loans receivable had interest rates that were floating. While our fixed rate credit card receivables have no stated maturity or repricing period, we generally have the right to adjust the rate charged after providing notice to the customer, subject to competitive and other pressures beyond our control. Interest rates on our liabilities are generally indexed to LIBOR or bear a fixed rate. This asset/liability structure exposes us to two types of interest rate risk: (a) repricing risk, which results from a mismatch between assets and liabilities that mature or reprice in specific periods; and (b) basis risk, which arises from changing spread relationships between indexes such as the prime rate and LIBOR.

The principal objective of our interest rate risk management activities is to monitor and control our exposure to adverse effects resulting from movements of interest rates over time. We generally seek to strike a balance between hedging net interest income and the present value of net interest income. To measure exposure to interest rate changes, we use multiple complementary measures of risk to net interest income under a number of scenarios and rate changes. We typically model the impact of rate changes on current net interest income over a three-year period and the impact on the present value of net interest income over a longer horizon. When estimated risk exposure exceeds our guidelines, we seek to mitigate the risk through the use of matching and hedging techniques as described below.

The following table illustrates the estimated effects on managed net interest income of positive and negative parallel shifts in interest rates as calculated at September 30, 2004, using our interest rate risk model and taking into consideration our current hedging activity as of September 30, 2004. Our analysis compares estimated managed net interest income over 12 months in a stable interest rate environment to scenarios in which interest rates rise and fall by 200 basis points.

The information shown below is presented on a consolidated managed asset/liability basis, which includes the interest rate sensitivity of net interest income from securitized loans and the impact of derivative instruments. We do not in the normal course of business derive comparable interest rate sensitivity of net interest income on a reported basis. In the opinion of management, such comparable projections on a reported basis would not provide a significant benefit in understanding our expected future performance. In addition, the projections below do not include the impact of interest rate changes on non-interest income. Non-interest income—servicing and securitization can be subject to significant impacts to the extent that interest rate changes affect the market discount rate assumptions used in valuing our retained interests in securitizations. Sensitivities of the current fair value of our retained interests to changes in key securitization assumptions, including the market discount rate, are presented in Note 7 of our Consolidated Financial Statements.

Estimated Effects of Interest Rate Changes

Change in Interest Rates	Percentage Change in Managed Net Interest Income
+ 200 basis points	3.1	%
– 200 basis points	(1.0	)%

Our interest rate risk model incorporates certain assumptions regarding our ability to reprice our fixed rate credit card loans without otherwise impacting customer behavior. The actual repricing sensitivity of these loans depends on how our customers and competitors respond to changes in market interest rates. As of September 30, 2004, we modeled the repricing behavior of our fixed rate credit card loans based on an amortization schedule which results in approximately 50% of the original balance being repriced by the 15th month. The repricing of certain other categories of assets and liabilities is subject to competitive and other pressures beyond our control. As a result, certain assets and liabilities assumed to mature or otherwise reprice within a certain period may in fact mature or reprice at different times and at different volumes. The table above should be viewed as our estimate, subject to these uncertainties, of the general effect of the indicated interest rate movements on our managed net interest income.

We generally seek to mitigate risks to earnings and capital arising from movements in interest rates. The main tools we use to manage our interest rate sensitivity are investment decisions, pricing decisions on our loans receivable, and, when deemed appropriate, derivatives, including interest rate swap and cap agreements. We do not trade our derivative positions or use derivatives to speculate on interest rate movements, and we believe our use of such instruments is prudent and consistent with industry standards.

Notional Amounts of Interest Rate Swap and Cap Agreements

	Three months ended September 30,					Nine months ended September 30,
(dollars in thousands)	2004			2003		2004			2003
Interest Rate Swap Agreements
Beginning balance	$	999,100		$	308,200	$	288,200		$	918,200
Additions	664,200			—		1,385,100			—
Maturities	(231,000		)	—		(241,000		)	(610,000		)
Ending balance	$	1,432,300		$	308,200	$	1,432,300		$	308,200

Interest Rate Cap Agreements
Beginning balance	$	—		$	—	$	—		$	3,000
Maturities	—			—		—			(3,000		)
Ending balance	$	—		$	—	$	—		$	—

Notional amounts of interest rate swaps outstanding on September 30, 2004 increased from September 30, 2003. As market conditions or our asset/liability mix change, we may increase or decrease the notional amounts of interest rate swaps and caps outstanding in order to manage our interest rate risk within prudent levels. As required by SFAS No. 133, we record the fair value of an interest rate derivative as an asset or liability (as appropriate) and offset that amount with a change in the value of the item being hedged.

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

Funding and Liquidity

We seek to fund our assets by diversifying our distribution channels and offering a variety of funding products, with the goal of generating funding at the lowest cost available to us while maintaining liquidity at appropriate levels and managing interest rate risk. The primary goal of our liquidity management is to provide funding to support our operations in varying business environments. We employ multiple strategies, including diversification of funding sources, dispersion of maturities, and maintenance of liquid investments and cash balances.

The following table reflects our debt ratings and those of PNB as of September 30, 2004. In September 2004, Standard & Poor’s upgraded its ratings outlook for our debt ratings and those of PNB from stable to positive.

Current Long-Term Senior Debt Ratings

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

(1) Positive outlook.

(2) Stable outlook.

During the third quarter of 2004, consistent with our Capital Plan, our liquidity position (federal funds sold and securities purchased under resale agreements, available-for-sale investment securities, and cash and cash equivalents) increased by approximately $67.6 million from $4.39 billion at June 30, 2004 to $4.46 billion at September 30, 2004. We expect our liquidity position to remain relatively stable over the remainder of 2004. Our liquidity position at September 30, 2004 was approximately 32% of our reported assets and 20% of our managed assets.

Under the capital assurances and liquidity maintenance agreement we entered into with PNB, we agreed to provide capital and liquidity support to it. Our agreement with PNB to provide capital and liquidity support exempts certain of our near-term cash obligations, including current interest obligations on our 3.25% convertible senior notes due August 15, 2005 and current payments on the 9.525% junior subordinated deferrable interest debentures due February 1, 2027. In addition, certain accrued deferred compensation, miscellaneous working capital needs not to exceed $25 million, and severance payments are generally exempt from the parent company’s obligations under the agreement. See “Regulatory Matters” in our 2003 Annual Report for a description of the capital assurances and liquidity maintenance agreement.

Our investment in subsidiaries as a percentage of our total equity, which is referred to as our “double leverage,” at September 30, 2004 was 125%. A double leverage ratio in excess of 100% indicates the degree to which an investment in subsidiaries has been funded with long-term borrowings and other liabilities of the parent company. The principal source of funds for us to make payments on our parent company debt securities and to meet our other obligations is our cash investments and dividends from PNB. However, PNB has agreed not to pay any dividends to us during the term of its regulatory agreement without first obtaining regulatory consent. There can be no assurance that such consent, if sought, could be obtained. In addition, if we are required to provide additional capital and liquidity support to PNB, our ability to service our parent company debt obligations would be further limited.

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

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

For the remainder of the year (October 1, 2004 through December 31, 2004), we have funding requirements for maturing deposits of $721.5 million, maturing securitizations of $671.1 million, and no maturing short-term or long-term debt. The $671.1 million of maturing securitizations represents the third party securityholders’ interests in a variable funding series that is scheduled to begin amortizing in November 2004. We expect to extend the revolving period of this series for a period of approximately 12 months. If not renewed, this series will begin to amortize during the fourth quarter of 2004. We anticipate that we will meet our funding requirements for the remainder of the year, along with any incremental asset growth in 2004, by extending the revolving period of this variable funding series, issuing new securitization series, utilizing our liquidity position, and accepting new deposits. We may also generate additional funding by issuing common stock, including issuances under a dividend reinvestment and direct stock purchase plan, or by issuing new debt securities. Although we have been successful in meeting our funding needs, future events or changes affecting us or the markets in which we obtain our funding could adversely affect our ability to fund our business.

Deposits. Deposits decreased to $9.06 billion as of September 30, 2004 from $10.10 billion as of December 31, 2003. Compared to the June 30, 2004 balance of $9.00 billion, deposits remained relatively flat for the third quarter of 2004. At September 30, 2004, PNB’s deposits were covered by cash, liquid investments, and a risk-adjusted amount of on-balance sheet loans, as contemplated by its Capital Plan. We plan to have PNB continue to maintain assets of sufficient quality on its balance sheet to fully cover its deposits. However, there can be no assurance that it will be successful in doing so.

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

Maturities of Deposits

	September 30, 2004						December 31, 2003
(dollars in thousands)	Direct Deposits		Brokered Deposits		Total Deposits		Direct Deposits		Brokered Deposits		Total Deposits
Three months or less	$	326,388	$	395,069	$	721,457	$	453,512	$	631,682	$	1,085,194
Over three months through one year(1)	916,906		1,497,632		2,414,538		1,052,329		1,350,211		2,402,540
Over one year through five years(2)	1,497,445		3,449,123		4,946,568		1,837,037		3,386,580		5,223,617
Over five years	1,158		527,782		528,940		322		708,152		708,474
Deposits without contractual maturity	451,265		—		451,265		681,232		—		681,232
Total deposits	$	3,193,162	$	5,869,606	$	9,062,768	$	4,024,432	$	6,076,625	$	10,101,057

(1) At September 30, 2004, maturities of total deposits over three months through one year by quarter were as follows: first quarter 2005: $982.6 million; second quarter 2005: $727.1 million; third quarter 2005: $704.9 million.

(2) At September 30, 2004, maturities of total deposits over one year through two years were $2.33 billion.

A bank that is below the well-capitalized levels as reported on its Call Reports is subject to ceilings on rates paid for deposits and restrictions on accepting brokered deposits. A bank that is adequately capitalized is restricted from accepting brokered deposits without a waiver from the Federal Deposit Insurance Corporation and may not pay a rate on its deposits that is more than 75 basis points higher than the prevailing rate in its market. As of September 30, 2004, capital ratios for PNB were above the well-capitalized levels on a Call Report basis. PNB has exceeded the well-capitalized level since March 31, 2002. Accordingly, the restrictions on deposit taking activities described above do not currently apply to PNB.

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

Among our outstanding securitizations, we have two variable funding series, one with a one-year revolving period that we expect to renew annually (Series 2002-A), and the other which has a two-year revolving period (Series 2004-C). Series 2004-C, which has a commitment amount of $500.0 million and an initial funded amount of $430.0 million, was issued in August 2004. Securitization funding under the two variable funding series represents investor interests held by third parties,

Unsecured Funding Facilities. The following table summarizes the amounts outstanding under our unsecured funding facilities as of September 30, 2004.

Summary of Unsecured Funding Facilities

	September 30, 2004
(dollars in thousands)	Effective/ Issue Date	Facility Amount(1)		Principal Outstanding(2)		Maturity
Providian Financial shelf registration(3)	6/98	$	632,445	$	1,020,346	Various
Junior subordinated deferrable interest debentures(4)	2/97	—		109,281		2/27

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

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

(3) Outstanding securities issued under the shelf registration consist of four issuances of convertible senior notes with earliest possible required principal payment dates beginning in August 2005, February 2006, May 2008, and March 2011. In addition, we may be required to redeem these notes prior to their maturity following a change of control or a fundamental change, as defined in the related indenture supplements. See Note 9 to our Consolidated Financial Statements for further discussion.

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

In March 2004, we issued $277.2 million of 2.75% convertible cash to accreting senior notes due March 15, 2016. The notes are convertible at the option of the holders at a conversion rate of 58.7941 shares of our common stock for each $1,000 of note principal (an initial conversion price of $17.01 per share of common stock) if specified conditions are met. The proceeds from this issuance are available for general corporate purposes, including the repurchase of outstanding debt obligations, capital contributions or extensions of credit to our banking subsidiary, investments in retained interests in the securitizations of our banking subsidiary, and other purposes consistent with PNB’s Capital Plan. After March 15, 2011, we will pay interest at a rate of 1.75% per year and will accrete the principal amount of the notes at a rate that provides holders with an aggregate annual yield to maturity of 2.75% per year, computed on a semiannual bond equivalent yield basis. In addition, contingent interest is required to be paid to holders if certain conditions are met. If a fundamental change, such as a change in control resulting from a change in the ownership of our common stock, as defined in the related indenture supplement, occurs on or before March 15, 2011, we may also be required to purchase the notes for cash and pay an additional make whole premium payable in our common stock upon the repurchase or conversion of the notes in connection with the fundamental change. We have the option to redeem all or a portion of the notes for cash at any time on or after March 31, 2011. Holders may require us to purchase all or a portion of their notes for cash on March 15, 2011 or March 15, 2014. These notes also represent an additional contractual obligation for us (see “Funding and Liquidity—Contractual Obligations” in our 2003 Annual Report for a discussion of our contractual obligations as of December 31, 2003). See Note 9 and Note 12 to our Consolidated Financial Statements for further discussion of the notes and our other outstanding long-term borrowings.

In May 2003, we issued $287.5 million of 4.00% convertible senior notes due May 15, 2008. These notes are convertible at the option of the holders at the conversion rate of 76.8758 shares of our common stock for each $1,000 of note principal (an initial conversion price of $13.01 per share of common stock) if specified conditions are met. See Note 9 to our Consolidated Financial Statements for further discussion. During the third quarter of 2004, the specified market price condition for conversion of the 4.00% notes was satisfied, as our common stock price exceeded the conversion trigger price of $14.31 per share for at least 20 trading days of the last 30 trading days of the quarter. As a result, the 4.00% notes are convertible during the fourth quarter of 2004.

Our Board of Directors has suspended the payment of quarterly cash dividends on our common stock. The principal source of funds for the payment of dividends on our common stock is dividends received from PNB. However, PNB has agreed not to pay any dividends to us during the term of its regulatory agreement without first obtaining prior regulatory consent. There can be no assurance that such consent, if sought, could be obtained. See “Regulatory Matters” in our 2003 Annual Report.

Investments. We maintain short-term liquidity through federal funds sold and securities purchased under resale agreements, available-for-sale investment securities, and cash and cash equivalents. We also maintain a portfolio of high-quality

investment securities, such as U.S. government and agency obligations, mortgage-backed securities, and commercial paper. Investment securities were $2.85 billion as of September 30, 2004 and $1.86 billion as of December 31, 2003. Federal funds sold and securities purchased under resale agreements decreased to $1.32 billion as of September 30, 2004 from $3.24 billion as of December 31, 2003.

Off-Balance Sheet Arrangements

Financial Commitments. Significant commitments at September 30, 2004 consisted of commitments to extend credit card loans, which represent the total unused portions of the lines of credit available to customers. These amounts do not necessarily represent future cash requirements as we do not anticipate that all of our customers will borrow the entire line of credit available to them at the same time. Further discussion of these commitments is included in Note 8 to our Consolidated Financial Statements.

Our securitizations represent off-balance sheet arrangements. We use qualifying special-purpose entities as defined by SFAS No. 140 for our securitizations and account for the transactions as sales. See “—Securitizations of Loans Receivable” and Note 7 to our Consolidated Financial Statements for further discussion.

We enter into derivative financial instruments to reduce the risk of interest rate fluctuations that may result from differences in repricing characteristics between interest-earning assets and interest-bearing liabilities. We use interest rate risk management instruments, including interest rate swap and cap agreements for this purpose. As of September 30, 2004, we had interest rate swap agreements with maturities ranging from 2005 to 2016, and we had no interest rate cap agreements. See “—Interest Rate Sensitivity” for further discussion.

Guarantees. In January 2003, we entered into a pledge agreement with an insurer with respect to certain obligations owing to the insurer in connection with two series of the Providian Gateway Master Trust. One of the series has since been repaid. The amount of the pledged collateral at September 30, 2004 was $13.6 million, which is held in a deposit account as security for the payment to the insurer of amounts owing to it in connection with the remaining series.

In August 2002, through a wholly owned limited liability entity, we sold our investment in an alternative energy plant and in connection with the sale, we guaranteed certain obligations of the limited liability entity under a purchase and sale agreement. The guarantee covers the limited liability entity’s obligation to indemnify the purchaser against losses arising out of a breach of the purchase and sale agreement and failure to repurchase the assets if tax credits are not available to the purchaser. Our guarantee is capped at the amount of payments made to the limited liability entity at the time of sale, plus the amounts of additional payments made, and contingent future payments that may be made, to the limited liability entity and its affiliates arising from fuel production from the plant. At September 30, 2004, the guaranteed amount was $21.4 million.

We also are parties to and from time to time enter into various agreements that contain general indemnification provisions, primarily in connection with asset sale agreements and service contracts, including the purchase and sale agreement referred to in the preceding paragraph. We cannot estimate the potential future impact of these indemnification provisions, since this would require an assessment of future claims that may be made against us. Based on historical experience, we do not currently expect the risk of loss under these indemnification provisions to have a material adverse effect on our financial condition or our results of operations, but we cannot give any assurance that they will not have such an effect.

See Note 8 to our Consolidated Financial Statements for further discussion of these guarantee obligations.

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

Capital Adequacy

We continue to manage our capital levels with the dual objectives of having sufficient capital to support the achievement of our business plan and to meet regulatory requirements. During the three months ended September 30, 2004, we continued to focus our capital planning on meeting or exceeding regulatory minimum levels of capital and supporting anticipated growth. Our regulatory minimum levels of capital are derived from two primary sources: capital adequacy regulations that apply generally to banks and the Capital Plan, which lays out capital goals for PNB.

The regulatory capital ratios are determined by comparing regulatory capital levels relative to total assets as measured using a specified approach. Risk weighted assets are derived by adjusting asset levels based on the relative levels of risk as specified in the capital adequacy regulations. Regulatory capital includes core capital (Tier 1 Capital), which consists primarily of shareholders’ equity, and total risk-based capital (Tier 1 Capital + Tier 2 Capital), which adds to core capital a portion of the allowance for credit losses. Based on these definitions of capital, the capital adequacy regulations establish the following capital categories: well capitalized; adequately capitalized; undercapitalized; significantly undercapitalized; and critically undercapitalized. The capital ratios that correspond to well capitalized and adequately capitalized regulatory capital levels are set forth in the following table, along with PNB’s ratios on a Call Report basis as of September 30, 2004.

Capital Adequacy Guidelines

Capital Ratio	Calculation	PNB Ratios		Well- Capitalized Ratios		Adequately Capitalized Ratios
Total risk-based	(Tier 1 + Tier 2)/Total risk-based assets	22.24	%	10	%	8	%
Tier 1	Tier 1/Total risk-based assets	19.95	%	6	%	4	%
Leverage	Tier 1/Adjusted average assets	25.73	%	5	%	4	%

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

In addition, PNB’s capital ratios reflect the application of banking regulations that, among other things, require the amount of credit-enhancing interest-only strips receivable that exceed 25% of Tier 1 Capital (concentration limit) to be deducted from Tier 1 Capital; and requiring “dollar-for-dollar” risk-based capital (as defined in the regulations) for certain residual interests not deducted from Tier 1 Capital. As of September 30, 2004, PNB’s interest-only strips receivable represented 13.03% of Tier 1 Capital, which is below the 25% concentration limit in the regulation. However, PNB does hold “dollar-for-dollar” risk-based capital against approximately $1.68 billion in residual interests from its securitizations, which include the accrued interest receivable (“AIR”) related to securitized loans.

Under its Capital Plan, PNB’s capital ratios, as determined under the regulatory guidance discussed above, are required to be adjusted to reflect the application of the Expanded Guidance for Subprime Lending Programs issued by the federal banking regulators (“Subprime Guidance”) to a portion of its reported credit card account loans (see PNB Capital Ratios table below). Application of the Subprime Guidance results in higher risk weightings than would otherwise be required by the regulations being assigned to accounts that fall within the scope of the guidance. Under the methodology utilized in the Capital Plan for determining risk weightings, PNB has segmented its standard and middle market portfolios into several categories according to their internal credit scores and historical and projected charge-off rates. As applied by PNB at September 30, 2004, this methodology resulted in a weighted average risk weighting of 139% against PNB’s reported standard and middle market segment loans receivable, which totaled approximately $4.28 billion on such date. These risk weightings are subject to change depending upon conditions of our loan portfolio and/or changes in regulatory guidance. Managed loans outstanding to customers in the standard and middle segments totaled approximately $14.86 billion as of September 30, 2004.

PNB’s Capital Plan sets capital ratio goals using the regulatory definitions described above. These include achieving by specified dates, and thereafter maintaining, 10% total risk-based capital as shown on PNB’s Call Reports and after application of the Subprime Guidance. PNB achieved all of its goals at or before the specified dates and has thereafter maintained capital ratios higher than the minimums specified. The following table summarizes PNB’s capital ratios and goals.

PNB Capital Ratios

			Actual
	Capital Plan Goals		September 30, 2004		December 31, 2003
Total risk-based capital ratio, as reported on PNB Call Report	10	%	22.24	%	21.27	%

Total risk-based capital ratio, after application of Subprime Guidance	10	%	18.94	%	16.98	%

PNB’s capital ratios remained relatively flat during the second and third quarters of 2004. June 30, 2004 total risk-based capital ratios were 22.36% on a Call Report basis and 18.86% after application of the Subprime Guidance.

PNB’s future capital ratios will depend on, among other things, the level of internally generated capital as well as the level of loan growth, changes in loan mix, and the level of retained subordinated interests related to our securitization activity. Growth in reported receivables, combined with changes in the levels and valuations of spread accounts and other retained subordinated interests related to our securitizations, may result in changes in PNB’s risk-based capital ratios as reported on its Call Report and after applying the Subprime Guidance. Subject to the ongoing review and continuing update of its Capital Plan and the potential impact of evolving regulatory standards, we expect that PNB will continue to achieve the capital goals in its Capital Plan. PNB will be updating its Capital Plan on a rolling two-year basis pursuant to the terms of PNB’s written agreement with its regulators. We expect the updated plan to be consistent with our strategic objectives of profitable receivables growth and improving credit quality, while continuing our focus on maintaining strong capital and liquidity.

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

Cautionary Statement Regarding Forward-Looking Information

This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, 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 to industry trends or future results of operations of the Company and our subsidiaries; and other statements that are not historical fact. Forward-looking statements are based on certain assumptions by management and are subject to risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. These risks and uncertainties include, but are not limited to, competitive pressures; factors that affect liquidity, delinquency rates, credit loss rates, and charge-off rates; general economic conditions; consumer loan portfolio growth; changes in the cost and/or availability of funding due to changes in the deposit, credit, or securitization markets; changes in the way we are perceived in such markets and/or conditions relating to existing or future financing commitments; the effect of government policy and regulation, whether of general applicability or specific to us, including restrictions and/or limitations relating to our minimum capital requirements, deposit-taking abilities, reserving methodologies, dividend policies and payments, growth, and/or underwriting criteria; year-end adjustments; 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 the impact of existing, modified, or new strategic initiatives. These and other risks and uncertainties are described in our 2003 Annual Report under the heading “Risk Factors,” and are also described in other parts of our 2003 Annual Report, including “Legal Proceedings” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Readers are cautioned not to place undue reliance on any forward-looking statement, which speaks only as of the date thereof. We undertake no obligation to update any forward-looking statements.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Following the announcement in October 2001 of our third quarter 2001 delinquency and credit loss experience, a number of lawsuits were filed against us and certain of our executive officers and/or directors. These included Rule 10b-5 securities class actions, shareholder derivative actions, and class actions relating to our 401(k) plan.

The Rule 10b-5 securities class actions were filed in the District Court for the Northern District of California. These consolidated actions (In re Providian Financial Securities Litigation) alleged that we and certain of our officers made false and misleading statements concerning our operations and prospects for the second and third quarters of 2001 in violation of federal securities laws. The class comprised those persons or entities who acquired our stock between June 6, 2001 and October 18, 2001. In July 2004, these actions were settled in principle on a classwide basis for $65 million to be funded by our insurance carriers, subject to finalization and court approval. The settlement received final approval from the court in September 2004, with approximately 14% of the settlement amount to cover the plaintiffs’ attorneys’ fees and costs. Our insurance carriers will fund the settlement amount, in addition to the attorneys’ fees that have been incurred by the Company for its own defense. However, those carriers insuring amounts above $50 million have reserved their rights to contest coverage, and these reservation of rights claims have not yet been resolved.

The shareholder derivative actions were filed in December 2001 and January 2002 in California state court in San Francisco. These actions generally seek redress against members of our Board of Directors and certain executive officers and allege breach of fiduciary duty, gross negligence, breach of contract, and violation of state insider trading law. These actions have also been settled in principle and would require a payment of $1 million in attorneys’ fees, which would be funded by our insurance carrier. The settlement must be approved by the Court.

The class actions relating to our 401(k) plan were settled in June 2003 on a classwide basis for $8.6 million, which was funded by our insurance carriers.

Beginning in 1999, we were named as a defendant in a number of legal proceedings relating to allegedly unfair and deceptive business practices by our banking subsidiaries in the marketing of cardholder service products and other practices. In June 2000, we reached settlements with the Comptroller, the San Francisco District Attorney, the California Attorney General, and the Connecticut Attorney General with respect to these consumer claims. In November 2001, settlement of the consumer class action and other lawsuits pending in state and federal court relating to such practices received final state court approval, and the federal court actions were dismissed in March 2002. In connection with these settlements, we agreed to make certain business practice changes and to pay restitution to affected customers. Approximately 6,400 class members opted out of participation in the class action settlement, approximately 80% of whom were represented by counsel in Mississippi and Alabama. We have settled the Mississippi and Alabama opt out cases on a global basis, and the individual actions filed by 60 of the class members were dismissed as part of this settlement. Settlement payments are being made during the third and fourth quarters of 2004 out of previously established reserves.

In February 2001, we were named as a defendant in a putative consumer class action suit entitled Ross v. Visa, U.S.A. Inc., et al., which was filed in the United States District Court for the Eastern District of Pennsylvania against Visa, MasterCard, and a number of credit card issuing banks. The suit alleges that uniform foreign currency surcharges allegedly imposed by the defendants are the result of a conspiracy in restraint of trade and violate the federal antitrust laws. The suit also alleges that the defendant banks violated the Truth-in-Lending Act by failing to separately identify these surcharges to their customers on their monthly statements. Similar lawsuits were subsequently filed in California and New York. In August 2001, the Federal Judicial Panel on Multidistrict Litigation transferred all of these cases to the Southern District of New York. In January 2002, plaintiffs filed an amended consolidated complaint, which the defendants moved to dismiss. In July 2003 the court granted the motion to dismiss the plaintiffs’ claim for actual damages under the Truth-in-Lending Act, and denied the motion to dismiss the plaintiffs’ antitrust claims. The plaintiffs’ motion for class certification was granted on October 15, 2004. The case remains in the discovery phase.

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

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

1997 and 2001 that were not eligible for the discounted rates. The allegations involve claims that such mailings were not eligible for bulk mail postage rates because requirements relating to the updating of mailing lists were not satisfied. If we were not entitled to receive the discounted rates, we could be subject to treble damages, penalties, and other relief. The Civil Division of the U.S. Department of Justice is working with the U.S. Postal Service to investigate these allegations and to determine whether to pursue the matter. We have received a subpoena from the U.S. Postal Service and have provided documents in response to the subpoena.

In early 2004 we received a demand in arbitration from Credigy Receivables alleging a breach of contract by our subsidiary, First Select, Inc., in connection with the sale of a portfolio of certain charged-off consumer credit card accounts. We settled this matter in the third quarter of 2004 and funded the settlement out of previously established reserves.

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

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

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

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The Company currently has no share repurchase programs in place. The following table sets forth information, on a monthly basis during the third quarter of 2004, regarding the Company’s acquisition of its Common Stock in connection with shares withheld to cover tax withholding requirements related to the vesting of restricted stock:

Period	Total Number of Shares Purchased	Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares That May Yet Be Purchased
July	105,723	14.74	N/A	N/A
August	—	—	N/A	N/A
September	1,192	15.28	N/A	N/A

Item 6. Exhibits

Exhibits Required by Item 601 of Regulation S-K.

Exhibit 10.1	Form of Restricted Stock Grant Agreement under the Providian Financial Corporation 2000 Stock Incentive Plan between the registrant and non-employee directors of the registrant.

Exhibit 10.2	Form of Non-Qualified Stock Option Award under the Providian Financial Corporation 2000 Stock Incentive Plan between the registrant and non-employee directors of the registrant.

Exhibit 10.3	Form of Restricted Stock Grant Agreement under the Providian Financial Corporation 2000 Stock Incentive Plan between the registrant and officers of the registrant.

Exhibit 10.4	Form of Non-Qualified Stock Option Award under the Providian Financial Corporation 2000 Stock Incentive Plan between the registrant and officers of the registrant.

Exhibit 12.1	Computation of Ratio of Earnings to Fixed Charges and Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividend Requirements.
	(For the nine months ended September 30, 2004, the ratio of earnings to fixed charges and the ratio of earnings to combined fixed charges and preferred stock dividend requirements, in each

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Delaware		94-2933952
(State or other Jurisdiction of Incorporation or Organization)		(IRS Employer Identification No.)

201 Mission Street, San Francisco, California 94105
(Address of Principal Executive Offices) (Zip Code)

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

Not Applicable
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

PART I.	FINANCIAL INFORMATION

	Item 1.	Financial Statements (unaudited):
		Consolidated Statements of Financial Condition
		Consolidated Statements of Income
		Consolidated Statements of Changes in Shareholders’ Equity
		Consolidated Statements of Cash Flows
		Notes to Consolidated Financial Statements

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

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk

	Item 4.	Controls and Procedures

PART II.	OTHER INFORMATION

	Item 1.	Legal Proceedings

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds

	Item 6.	Exhibits

SIGNATURES

EXHIBIT INDEX

	case excluding interest on deposits, was 8.93; and the ratio of earnings to fixed charges and the ratio of earnings to combined fixed charges and preferred stock dividend requirements, in each case including interest on deposits, was 2.14.)

Exhibit 31.1	Section 302 Certification of Chief Executive Officer.

Exhibit 31.2	Section 302 Certification of Chief Financial Officer.

Exhibit 32.1	Section 906 Certifications of Chief Executive Officer and Chief Financial Officer.

		Providian Financial Corporation
		(Registrant)

Date: November 9, 2004		/s/ Anthony F. Vuoto
		Anthony F. Vuoto
		Vice Chairman and Chief Financial Officer
		(Principal Financial Officer and Duly Authorized Signatory)

Date: November 9, 2004		/s/ Daniel Sanford
		Daniel Sanford
		Executive Vice President and Controller
		(Chief Accounting Officer and Duly Authorized Signatory)

Year	Amount Amortizing (dollars in thousands)
2004	$	—
2005	3,025,028
2006	3,105,530
2007	1,243,749
2008	373,711

Exhibit		Description

10.1		Form of Restricted Stock Grant Agreement under the Providian Financial Corporation 2000 Stock Incentive Plan between the registrant and non-employee directors of the registrant.

10.2		Form of Non-Qualified Stock Option Award under the Providian Financial Corporation 2000 Stock Incentive Plan between the registrant and non-employee directors of the registrant.

10.3		Form of Restricted Stock Grant Agreement under the Providian Financial Corporation 2000 Stock Incentive Plan between the registrant and officers of the registrant.

10.4		Form of Non-Qualified Stock Option Award under the Providian Financial Corporation 2000 Stock Incentive Plan between the registrant and officers of the registrant.

12.1		Computation of Ratio of Earnings to Fixed Charges and Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividend Requirements.

31.1		Section 302 Certification of Chief Executive Officer.

31.2		Section 302 Certification of Chief Financial Officer.

32.1		Section 906 Certifications of Chief Executive Officer and Chief Financial Officer.