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.

Arriving at their cubicles on the morning of Wednesday, April 3, employees of troubled credit card lender Providian Financial found their message lights ablaze.

When you work in a ho-hum, midlevel post for a company with more than $20 billion in assets, you do not expect to hear, "Hello, this is Joe Saunders," in the CEO's gravelly Chicago accent over your voice mail.

At least not without cringing.

Spokesman Alan Elias says new card designs, such as see-through Smart cards, can help give Providian a fresh image.
Brandon Fernandez
Spokesman Alan Elias says new card designs, such as see-through Smart cards, can help give Providian a fresh image.
Konrad Alt runs Providian's office of risk management and reputation.
Brandon Fernandez
Konrad Alt runs Providian's office of risk management and reputation.
New CEO Joe Saunders now emphasizes "decency" and "clarity."
New CEO Joe Saunders now emphasizes "decency" and "clarity."
Warren Wilcox, Providian's top marketing executive.
Brandon Fernandez
Warren Wilcox, Providian's top marketing executive.
Providian's world headquarters at  201 Mission St.
Providian's world headquarters at 201 Mission St.
Providian's world headquarters at  201 Mission St.
Providian's world headquarters at 201 Mission St.

Based on recent events, the odds that Saunders' message would bear good news were long. Saunders had come to Providian in November, after the previous CEO left in disgrace. Waves of layoffs have been besieging the company, which, during an improbable and mercurial rise to industry prominence, elevated the sneaky, slimy reputation of credit card lenders to new heights. Its marketing tactics were so suspect that it earned the largest federal fine ever slapped on a credit card provider. And this was a company whose honest business premise -- aggressively seeking out vulnerable customers with spotty or nonexistent credit histories (the so-called "subprime sector") -- basically involved exploiting the financially challenged.

The past eight months, however, have been a pretty good argument for the power of bad karma: After it was learned that accounting irregularities had concealed the company's business plan just long enough for top executives to dump their stock, most of Providian's leadership resigned. Subsequently, 10 percent of the company's workers were laid off. And Providian's stock, once worth more than $66, plummeted as low as $2 before bouncing back to its modest current price of around $7.

The message that morning, though, wasn't announcing more layoffs -- which Saunders has promised. Neither had the company been sold or folded.

The message contained a three-minute pep talk.

"I thought this might be a good time to talk about the kind of company we're trying to build," Saunders said. "It is easy to look good when we're giving out good news, but when we decline a customer's credit, when we call to collect a debt, when we have to let an employee go or terminate a business relationship, those are the key moments. And at those moments we will always remember decency because all of us know now how it feels to get bad news. If we can do that ... then people will say and we will know that this company believes in basic decency."

From topic one, "decency," Saunders moved to "clarity": "Our marketing will be clear so our customers know what they are buying, and our disclosures will be clear so that our investors know exactly how our business is doing ....

"Will we ever get to the point that everything is perfectly clear, or that we are conducting all of our activities with perfect decency? No," said Saunders, his tone suddenly flashing a wary knowingness worthy of Father Knows Best. "It is a great thing to work for a profitable company, but if you want to build a franchise with long-term value, making profits at the expense of core values is a fool's bargain.

"We will not be fools."

Not again, at least.

In its short history, Providian Financial has been an extremely profitable company rarely associated with the words "decency" and "clarity." Unless, of course, they followed the phrase "lack of." But that, says a batch of freshly imported executives, was then.

Today, even if Providian didn't want to change, with its losses still accelerating it doesn't have a choice. Staying in business requires, among other things, drastic adjustments in whom the company lends to and how it markets to them. "In essence," company spokesman Alan Elias says, "we're creating a new Providian."

But most startling of all, perhaps, is that the new company envisioned by Elias and his colleagues won't just be smaller and smarter.

The reincarnation of Providian, which had arguably the worst reputation in one of the most universally loathed industries, will be nicer. "We don't even use the word '"subprime' anymore," Elias says. "Because, to us, it's kind of like '"subhuman.'"

In retrospect, the rise of Providian looks nearly as dramatic and improbable as its fall. But the entire arc can be explained by the singular focus of the company's first chief executive.

Shailesh Mehta had a one-track mind, and that track was growth. When he joined the small subsidiary of Kentucky insurer Capital Holding in 1986, the company managed only about $414 million in outstanding balances. In a little more than a decade, its cards would be in one of every eight American wallets.

After taking over the company that would become Providian in 1989, Mehta had a singular goal and a revolutionary approach to achieve it. A masterful problem-solver with mathematics degrees from Case Western University (where he graduated first in his class) and the prestigious Indian Institute of Technology, Mehta eschewed traditional credit-scoring methods in favor of his own studies of customer behavior.

Mehta's ideal customer wasn't a frugal one. Providian wanted chargers who took on loads of debt and paid only the minimum amount each month, without defaulting. One much-written-about Providian method involved sending unsolicited checks to prospective customers that could be cashed instantly, and then paid back at a high interest rate. Anyone who took on the high-interest debt immediately would be accepted. Declining the checks probably signaled debt-wariness and, as such, could be cause for rejection.

A benefit for subprime lenders is the ability to charge the highest rates and fees on the market, to compensate for the risk of a loan defaulting. Customers with blemished credit don't have a lot of credit options, and they're willing to tolerate astronomical interest rates.

It was a dramatically successful recipe for growth: Within 10 years, the company was managing more than $14 billion in accounts, and it would double in size again during the two years that followed. Providian was swimming in money, and so were its executives. (Mehta's most garish display of wealth: moving his family into a 17,000-square-foot Hillsborough replica of the White House -- modeled by Hearst Castle architect Julia Morgan during the 1930s so that William Randolph Hearst's sons could entertain dignitaries.)

But little did anyone realize back then that the real secret to Providian's success was its timing. During the mid- to late 1990s, the nation experienced the longest period of sustained economic growth in its history, and few loans went bad. More Americans than ever were garnering credit, and many of those new customers were in the subprime market, which was paying off so handsomely that other companies -- particularly Capital One -- moved in on it. But none of the other companies was willing to go quite so far as Providian, which was doing a third of its lending to the subprime sector.

With all its growth success, however, the firm was developing problems on the service side. By 1999, Forbes reported, Providian's 10 million customers were generating nearly 50 percent more Better Business Bureau complaints than up-market rival MBNA's 35 million customers. By May 1999, the San Francisco district attorney had begun investigating whether Providian was deliberately overcharging and deceiving its customers.

Providian suddenly had an image problem. To deal with it, the company turned to Konrad Alt, a former official with the Senate Banking Committee and the Office of the Comptroller of the Currency (the federal agency that regulates banks), and Chris Lewis, also formerly of the OCC, to handle its broadly empowered public policy office.

Alt, who today heads Providian's 60-person department of risk management and reputation, is a trim man with a slender face and short hair who tells the story of his time at the company with a delicious deadpan.

"It's hard in the credit card industry," he says. "As a general rule, the public believes credit card lenders are sneaky, deceptive, and use small print. ... These things don't make it easier."

Essentially, the investigation launched by the San Francisco District Attorney's Office and, later, Alt's former employers at the OCC accused Providian of taking every negative industry stereotype to grotesque levels.

Among other things, Providian was alleged to have offered a "no annual fee" card that required customers to pay a $156 annual "credit protection fee." (Consumers could cancel the credit protection -- if they were willing to pay an annual fee.) Even if consumers wanted the costly credit protection -- which would supposedly pay a customer's bills for 18 months, interest free, if the person were hospitalized or became unemployed -- the company allegedly concealed the fact that the policy strangely wouldn't apply to "involuntary unemployment" (such as being fired or laid off) unless the consumer had paid three months of advance premiums. Nor would the protection -- insurance, essentially -- apply to hospitalization caused by a pre-existing condition. Unless, that is, the customer paid six months of premiums in advance and had an account that was current, not over-limit. Providian also yanked the insurance policy if the company found out that the customer had submitted more than a minimum payment on any of his other, non-Providian credit cards.

None of this, of course, was adequately disclosed during telemarketing calls, which investigators charged were based on scripts that deliberately withheld specifics from customers. All in all, Providian's name took a beating.

The investigation concluded in June 2000, when the company signed a "consent order" with the OCC, forbidding specific marketing behavior Providian was alleged to have engaged in. As part of the settlement, Providian paid out $300 million -- without admitting guilt. It was the single largest fine in the OCC's history.

Announcing the settlement, Comptroller of the Currency John D. Hawke Jr. said: "Consumers should not have to become detectives to find out the true terms and conditions of their credit card agreement. They should not discover after they receive their monthly statement that they have purchased a $156 credit protection policy that they neither want nor need. And if they are promised a promotional bonus for transferring credit balances, they should receive that bonus -- and not be told after the fact that the program requires a balance transfer of $10,000."

Looking back on the affair, Alt says flatly: "That was certainly a reputational challenge."

On Wall Street, however, the company escaped practically unscathed. Four months after paying the OCC penalty, its stock price hit an all-time high. So life went on at Providian, where growth rates continued to accelerate. The company's effort to improve its behavior earned it USA Today's Quality Cup award for customer service only a year after the investigation closed.

"When we won the Quality Cup, it was wonderful," Alt recalls, allowing himself a rare smile. "On the public relations front, I think we felt like we were finally coming out from under it."

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?

No matter how obvious the Enron comparison seems, don't mention it within earshot of Providian executives unless you're prepared -- or hoping -- to see them erupt.

"Let me explain that, because, frankly, it's a bunch of bullshit," says spokesman Alan Elias, the mere mention of the name turning his face from stern to sour, his tone from guarded optimism to righteous anger. "The mistake we made was an optics mistake, because we determined from a legal perspective that [the bankruptcy change] wasn't a material event [and therefore didn't have to be mentioned in government filings]. We didn't frankly take enough consideration of how the optics of it would look. Hindsight being 20/20, we should have communicated that more clearly to the street. ... But as far as some allegations of trying to hide this or that, it's bullshit."

Elias is sitting at a small conference table in one of the many Spartanly decorated offices on the executive floor of Providian's corporate headquarters at 201 Mission St. The main floor of the office is composed of cubicles with walls so high -- and so apparently sound absorbent -- that it's impossible to tell if anyone is actually working there. Lining the walls surrounding these cubes are the offices of top executives.

Because Elias' office doesn't have a conference table, he's borrowed the office of Warren Wilcox, Providian's marketing vice chairman, who worked with Saunders at Fleet. Today's meeting is supposed to give Elias an oppor- tunity to articulate Providian's survival strategy.

That plan was developed by Saunders' new management team -- consisting of two other recent Fleet expats -- which has the considerable task of cleaning up the mess Mehta left behind. All they have to do is plug the unfathomably large stream of losses, refill the company's drained coffers, and remake Providian as an up-market lender.

The first step was made shortly after Saunders arrived on Nov. 26, when the new CEO promptly sold $8.2 billion of the company's highest-quality accounts to J.P. Morgan Chase for $2.8 billion, money Providian needed to survive in the short-term. It also sold operations in the United Kingdom and Argentina.

The next step was far trickier: The company had to convince the OCC -- which can shut down banks -- that its business plan was viable enough to keep it alive. The OCC process involved a painstaking give-and-take, with the government agency and the bank negotiating the next three years of the company's life in excruciatingly minute detail.

The plan approved by regulators begins with an absolute ban on further lending to the subprime sector. It also mandates hiring freezes, layoffs, and tighter controls on the credit line increases the company once gave away like so much Halloween candy. In addition, Providian has had to reprice its riskiest loans. (That was bad news for its subprime customers, whose interest rates were hiked from 23.99 percent to 29.99 percent.)

And last, the company needs to stifle its losses. That means finding a taker for its massive subprime portfolio.

"I'm very skeptical there's anyone willing to buy it," says Matthew Park, a New York-based Thomas Weisel analyst. "Maybe if the discount is heavy enough."

The problem, everyone from Park to Providian agrees, is a credit card industry phenomenon called "account seasoning," which makes Providian's continued holding of the accounts the financial equivalent of palming a hand grenade. The theory of account seasoning, industry watchers say, is tied to the tendency of new credit card holders to be more diligent about paying off their bills on time. Accounts that will end up defaulting often won't offer a hint of that until at least six months have passed, and sometimes longer. Subprime accounts are always particularly sensitive to seasoning, but they are even more so in Providian's case.

That's because during the third quarter of 2001, when the company was scrambling to preserve a picture of growth for Wall Street, it began issuing cards to customers it would have previously rejected. That wave of accounts figures to be even more prone to drastic losses than the accounts that sank Providian in the first place, and that reckoning is drawing near. "When a company is growing, [seasoning] isn't that big a deal," Park says. "Once you stop growing, it can be like a rabid python in your system."

And Providian has stopped growing. Three months ago, Park says, it would have been nearly impossible for Providian to survive without dumping its subprime portfolio. With the economic picture looking up, however, things aren't so bleak. "Their numbers will be uglier with it, but they'll probably survive," he says. "If the recession were deeper, they would have suffered worse.

"There's no question they were lucky."

(The company's good fortune was evident Monday, when Providian announced it had sold $2.6 billion in higher-risk assets. Also evident was its urgent need to shed the subprime accounts: It took an after-tax loss of $240 million in the deal.)

Park, though, isn't the only analyst who sees the company's fortunes looking up. Even Charlotte Chamberlain, who called trusting Providian the biggest mistake of her career, recently upgraded her rating of the stock to "buy."

Of course, for Providian shares -- once worth more than $66 -- being a good buy at $7.60 hardly measures as a victory. The company still has major challenges in front of it, most significantly remaking itself as a more upscale lender, particularly in the so-called middle market, a notch above subprime and the most likely place for Providian to find success.

The problem facing the company in that market, however, is that those customers tend to have more credit choices, and Providian -- used to dealing with customers desperate for a bare-bones card with an enormous rate -- doesn't have many options to offer. Ideally, says Dawn Greiner, a marketing vice president, the company will eventually have 10 to 15 distinct products for customers in these more competitive markets. At the moment, it has five. Greiner's boss, Warren Wilcox, says the company is at least six months away from launching any new products.

Without providing specifics, executives say they'll try to use lower rates as a competitive tool in the meantime. And the card issuer with the formerly evil reputation has one other secret weapon: pretty pictures.

"I guess maybe before we were kind of vanilla," says Elias, who is fondling a deck of credit cards. "Now we're looking at new things we can do, whether it's the plastics themselves -- you may have seen our Smart cards, which are kind of see-through -- or the designs on the cards. We're testing a lot of plastics now that have geography designs on the cards."

Like a card shark revealing his hand, Elias sprawls his holdings on the conference table. A few of the cards are partially see-through; one bears a picture of the Brooklyn Bridge; another sports a fancily shot jalapeño pepper, an apparent nod to the Southwest. The Statue of Liberty adorns another.

Holding up the hot pepper card, Elias says, "This is a way for us to start to build a different image for the company."

There Providian goes again, getting all warm and fuzzy.

Warren Wilcox, Providian's vice chairman for planning and marketing, is one of those not-so-rare corporate creatures who have absolutely mastered the art of the clarifying hand gesture. To chat with Wilcox is to take in a series of points, boxes, roof-raises, and sweeps that subtly illuminate the company's strategy, not unlike Dana Carvey's imitation of the elder President Bush on Saturday Night Live.

From his 28th-floor office with a Bay Bridge view, Wilcox is talking about the shape of the company he joined in January, when he came over from Fleet with fellow executive Susan Gleason, Providian's new operations chief, to join Saunders. On the strategy side, he explains, using the phrase "go-forward basis" a little too often, the imperatives were clear: Providian needed to focus its energy on the middle market -- which it had worked in before -- and the prime market, a Fleet specialty.

What wasn't clear beforehand was whether the company had the will to pick itself up off the ground again. "There was disappointment and anger and frustration and a whole set of emotions," he recalls. "Those are absolutely logical in an environment where you had been successful, and then the wheels come off to some degree. ... But the question is, how do you react? You can say, '"The show's over,' and just go home. Or the other thing you can do is get your dander up a little bit. You can say, '"You know what? We shouldn't have let this happen, but we can be successful again,' get your dander up a little and take this thing forward. In general, it's that second type of reaction that I sensed here."

But while Wilcox wants you to know that the company was used to succeeding and is doggedly determined to succeed again, he also wants one other thing to be clear: This is a newer, nicer Providian.

Or at least it better be.

"Before, 90 percent of the emphasis was on grow, grow, grow, grow," he says. "Now, I think, we understand that, on the most fundamental level, we excel or fail based on one-on-one interactions with customers. That's the primary level. ... If we excel at that level, I think, ultimately, a better reputation will follow."

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