Rebuilding Credit

San Francisco's Providian Financial was once the most despised company in the credit card industry. Now, after a humbling fall, it just wants to be loved.

Inside the company, though, sentiments about the investigation lingered.

"I remember people being angry about it," says a former project manager. "But it was more like, '"Everybody else does this, and we just got caught.' There weren't really any denials."

Another former manager recalls the settlement becoming something of a fashionable punch line: "We'd be putting together marketing materials and joking about it," the former employee says. "It would be like, '"Blah, blah, blah, and you get a 400 percent interest rate with that.' We thought it was pretty funny, because, really, we were just worker bees. We knew we worked for a company everyone hated."

It was less funny in August 2001, though, when another group of employees playing around on the Yahoo! Finance Web site stumbled onto reports detailing their own executives' insider trading. The company's leaders were cashing out in a hurry. All told, between June and October, Providian's officers and directors sold more than 996,700 shares of stock, garnering over $48 million in return.

Unknown to the rest of its investors, Providian was in trouble. Its losses were far worse than they appeared, but they were being hidden by a change in the firm's accounting practices. The increase in credit losses first reported by the company in June (10.29 percent loss for the second quarter, up from 9.34 percent in the first) turned out to actually have been much worse (10.7 percent).

The difference in the reported and actual figures derived from a change in the way the company listed those bankruptcies. Historically, Providian had responded to bankruptcies by taking the defaulting accounts off the assets side of its balance sheets instantaneously, rather than opting for the less frequent listings that some of its competitors use. But during the second quarter of 2001, Providian began listing its bankruptcies monthly, without notifying investors.

This meant that about $30 million in bankruptcies occurring during the second quarter would not be reported until the third quarter. The shift, its executives say, was made for efficiency's sake, letting the company eliminate a few jobs. They added that Providian consulted its lawyers, who advised it not to list the change on its filings.

But there was another consequence: The timing of the shift -- and the decision not to notify Wall Street about it -- knocked just enough bankruptcies out of the second-quarter accounting picture to keep the company's loss rates within the guidelines the firm had always provided. In other words, a sick company appeared healthy.

Charlotte Chamberlain, an analyst with Jeffries and Company in Los Angeles, was concerned enough about the reported second-quarter losses to meet with Providian in person. She wanted to be sure all was well with the company before an August European trip, where she planned on recommending the stock to investors. She figured a face-to-face meeting with top executives would suffice for insurance. "I wanted to look the CFO in the eye and hear that June was an aberration," Chamberlain recalls. "Literally, 12 weeks later the thing was in free fall."

The public phase of that collapse started on Sept. 4, when the company finally announced the change in its accounting practices, and the impact that change had had on its earnings and loss rates. "Providian remains highly profitable," Mehta was quoted as saying in a press release.

A spurned Wall Street, though, was done listening, and the subsequent analyst reports seethed.

"The timing of the change and the poor disclosure surrounding it has further reduced management's credibility," one analyst noted.

"Questionable management credibility leads us to continue to avoid this stock," wrote another.

With analyst rage came greater scrutiny of Providian's business plan. And with that came the realization that June's numbers were less an aberration than an understatement. Providian's business was heavily invested in the theory that low-income or poor-credit customers would be able to make minimum payments. In a strong economy such as the one that had existed for all of Providian's subprime lending history, that's feasible. But when the economy dives as it did in the late summer of 2001, many of those subprime customers -- who accounted for nearly a third of Providian's business -- aren't able to pay.

How bad was it for Providian?

In the fourth quarter of 2001, Providian lost $395 million. Its stock, which hovered around $60 in early summer, collapsed to as low as $2 per share. By October, shareholders were filing class-action lawsuits in droves. And, on Oct. 18, Mehta announced that he would only serve as chief executive long enough for the company to replace him. (About a month later, Saunders was reportedly given a $2 million signing bonus to leave Fleet Credit Card Services and replace Mehta.) Layoffs that eventually hit 10 percent of the company's work force -- with more promised by Saunders -- began in November.

Providian was a disaster, and analysts like Chamberlain were left to second-guess themselves. "The biggest mistake of my career," she says. "This company basically pleaded no contest to lying to its own customers. What kind of hubris did I have to think that they'd lie to their customers, but they wouldn't lie to Wall Street?"


Hmmm, let's see: lying to Wall Street; spectacular capital losses; questionable accounting; shareholder lawsuits; high-profile business leaders resigning in disgrace; employees losing their jobs in droves. Sound familiar?

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