201 Mission Street
Company Perspectives:
Key to Providian's future success will be the implementation of a balanced business strategy focusing on the middle and prime portions of the credit spectrum. Leveraging core marketing and underwriting competencies, and our proprietary modeling and analytical skills, the Company plans to attract and retain creditworthy customers with products that meet their individual credit needs. We believe that this integrated strategy will enable us to tap into the best of both markets--while at the same time, creating a natural bridge to accommodate the upward migration of our middle market customers as they improve their credit histories and profiles. With a tightly disciplined effort, we believe we can compete successfully.
Providian Financial Corporation is one of the leading issuers of credit cards in the United States. As of late 2002, the company had more than 13 million customer accounts and $20 billion in managed receivables. During the 1990s, the company grew rapidly by aggressively targeting the subprime segment of the credit market (which includes higher risk customers with prior credit problems or limited credit history), while charging higher interest rates and imposing higher service charges. This strategy proved to be fatally flawed, and in the early 21st century, Providian launched a turnaround effort that included a new focus on the middle market and prime credit sectors.
Commonwealth Life Roots
The earliest roots of Providian Financial can be traced back to Commonwealth Life Insurance Company. When founded in 1904, Commonwealth Life was intended to serve as a catalyst to economic development in Kentucky and as a means to keep both business and capital within state borders. To emphasize this connection, the firm was named after the Commonwealth of Kentucky. It also adopted the state's motto, "United We Stand, Divided We Fall," and its seal. Two of the company's founders figured prominently in its early years. Colonel Joshua D. Powers, the firm's first president, was a lawyer, a state legislator, and founder of several corporations. Darwin W. Johnson joined the company as secretary-treasurer after working for several years in the tobacco business.
Initially, Commonwealth sold insurance only in Kentucky, specializing in ordinary life insurance and also inexpensive coverage for low-income workers. This latter type of insurance policy was called industrial, or weekly premium debit, insurance because the insurance agent collected the premiums in person, every week. Although these premiums were often paid in the form of chickens, eggs, or produce, the company's fortunes grew rapidly, leading to expansion into other states, including Alabama. Because of the concentration of blue-collar workers, urban areas offered the most lucrative marketing opportunities.
Over the next 20 years, Commonwealth's business experienced both peaks and valleys. Between 1914 and 1918, its life insurance sales increased, although death losses from World War I and an influenza epidemic depressed overall financial results. The postwar recession of 1921 did not affect the company's growing prosperity, which continued during the rest of the decade. The company sustained major losses due to the Great Depression, but rebounded by 1935 as a result of the intensified efforts of its field sales force.
During this period, the company was led by Darwin Johnson, who had succeeded an ailing Joshua Powers as president in 1922. Johnson's death in 1936 touched off a power struggle on the board of directors that ended in the election of Homer Ward Batson as the company's next president. When Batson took over, the company was experiencing serious financial problems. Although it appeared on the surface that the company was doing well, many of its loans were not guaranteed with sufficient collateral and others had little chance of ever being repaid. In addition, the company's practice of paying liberal dividends to shareholders, even during the Depression years, resulted in a critical shortage of funds. Batson immediately implemented a series of measures intended to increase the company's capital and place it on stronger financial footing. All officers were required to take a salary reduction; unnecessary lights were to be turned off, and clerks were expected to use pencils until they were too short to be held comfortably. The consolidation of several field offices, elimination of problem policies, and suspension of dividend payments for 1938 contributed to the company's economic recovery.
Not all of Batson's initiatives proceeded as smoothly. In 1936, he sent form letters to the recipients of several small loans to request full payment. One of these borrowers was James E. Dunne, the publisher of Dunne's Insurance Reports. In response, Dunne proceeded to circulate a scathing assessment of Commonwealth's financial condition among the subscribers of Dunne's Insurance Reports. He subsequently attempted to oust Batson as president and ruin the company. Commonwealth's management eventually ran a series of advertisements in local newspapers to restore public confidence in the company.
Dunne's allegations of mismanagement and insolvency later were brought before a Jefferson County grand jury, but the company successfully defended itself against the charges. To provide stronger control over Commonwealth's future financial operations, however, the state's insurance commissioner required the company to submit all loan applications for more than $20,000 to both the insurance commission of Kentucky and that of the state in which the loan was to be made.
With this incident behind it, Commonwealth turned its attention to the marketplace. It found that its existing industrial insurance benefits were no longer competitive and the methods by which premiums had been calculated were out of date. A revitalized product line introduced in 1941 boosted sales force morale and increased insurance sales. That same year, the board of directors elected Morton Boyd as president and Batson became honorary chairman. Boyd focused on expanding Commonwealth's insurance business through the agency sales force.
The onset of World War II restricted the availability of many goods and provided few alternatives for consumer spending. High employment levels increased the demand for life insurance, spending considered helpful to the war effort because of its anti-inflationary effects. With customer demand higher than ever, Commonwealth's sales force had difficulty covering the market because it competed with the military for manpower and supplies such as gasoline. The war also affected the nature of the company's insurance policies. New issues written by Commonwealth and other insurers excluded members of the military from receiving death benefits. Policyholders who had purchased insurance prior to entering the military were allowed to retain their coverage. This procedure cost the company a significant amount of money in wartime mortality claims. When the war ended, the company concentrated on improving sales efficiency and quality through better recruitment and training of agents. Blue collar unemployment drove the weekly premium insurance business down, but sales of ordinary insurance picked up the slack.
The company continued to grow during the rest of the 1940s. The insurance business was becoming increasingly competitive, with many firms using the success of a particular product in one state as a springboard to marketing in another location. Commonwealth watched with more than a casual interest as one of its competitors in Alabama, Liberty National Life Insurance Company, successfully marketed burial insurance policies that also provided for the funeral service to be handled by a funeral home owned by the company. To counteract a likely expansion of this program into Kentucky, Commonwealth designed a similar product based on a standard weekly premium policy. The Kentucky Funeral Directors' Association was contracted to handle the funeral arrangements so that Commonwealth did not have to directly enter the funeral business. The product was an instant success, with some agents writing as many as 100 policies in the first week.
Growth continued in the 1950s with only a minor disruption caused by the Korean War. Commonwealth embarked upon a program of aggressive expansion beyond Kentucky. In 1952, it developed a new concept in life insurance that enabled policyholders to pay their premiums through regular automatic withdrawals from their checking accounts. Although the company met with some initial resistance from bankers, other insurers became enamored with the simplicity of the concept. Their decisions to introduce similar versions of Commonwealth's Bank-O-Matic program eventually persuaded reluctant bank executives to lend their support.
By 1954, the Korean War had given way to a recession that forced Commonwealth to curtail its ambitious expansion plans and focus instead on maintaining its field sales force. When agent turnover started to increase in response to a drop in sales, the company invested heavily in recruitment and training of new sales personnel. As the economy recovered, competition in the life insurance market intensified and Commonwealth introduced a new family coverage policy.
In 1958, Boyd became chairman and was succeeded as president and chief executive by William H. Abell, who had previously served the company as general counsel and a member of the board. Under his leadership, the branch-agency system was restructured into a more efficient and unified organization, improvements were made in agents' retirement benefits, and several product innovations were launched.
Diversifying in the 1960s
As Commonwealth entered the 1960s, it became evident that weekly premium insurance was no longer a viable product. Social Security and increased wages for middle-class workers decreased need for the burial insurance benefits that had made the weekly premium concept so popular. The gradual loss of business in this area compelled Commonwealth to investigate new avenues of growth. In addition, competing life insurance companies that offered health and accident coverage were able to offer customers a more complete selection of insurance products, enabling them to attract sales personnel. Commonwealth initially considered entering the health and accident field, but, when it appeared that the federal government would be heavily guiding the nation's healthcare system, the company shifted its focus to automobile, fire, and casualty insurance.
The company originally intended to enter this market via acquisition, but ultimately developed the business internally as a subsidiary. By mid-1962, a pilot operation based in Louisville, Kentucky, began selling residential fire and homeowners insurance and individual automobile policies. Problems arose, ranging from computer billing errors to underwriting mistakes, and the new operation barely broke even. Nevertheless, Commonwealth gradually expanded its new products market beyond Kentucky.
Aggressive expansion into other states proved to be more difficult than originally anticipated because the company's contacts, particularly among local bankers, were not as strong as in its home state. It was at this time, however, that Commonwealth was offered the opportunity to acquire the Indiana-based Empire Life and Accident Insurance Company. Empire's chairman sought the merger to resolve an ongoing conflict between two of its executives who were also his sons-in-law. The companies joined forces on October 31, 1963, under the Commonwealth banner. This development gave Commonwealth a stronger position in Indiana, and added a significant number of black customers to its rolls. Since its early years, when advertising stressed that Commonwealth wrote "white lives only," Commonwealth had served only the white market. Kentucky funeral parlors were still segregated at this time, so with the Empire merger, the company was forced to begin handling black burial business in Kentucky, resulting in the formation of the Kentucky Bonded Funeral Company.
The state of Florida was identified as the company's next site for expansion. Commonwealth management believed that by targeting a southern state, the company would meet with less sales resistance than it had faced in Indiana. Florida was also especially attractive because of its projected growth in population and economy.
Commonwealth continued to experience problems in hiring additional general agents because of a lack of attractive sales incentives and a narrow product line. By the late 1960s, the Vietnam War had made this situation even worse. Despite a healthy economy, which enhanced the market potential for insurance, the lack of available staff to cover sales territories placed the company's expansion strategy on indefinite hold. This situation became more critical as the war intensified and the costs of developing the Florida market increased. Attempts to acquire other companies proved fruitless, because most candidates were reluctant to be part of Commonwealth.
Emergence of Capital Holding in 1969
After much consideration, the company embarked upon a plan to form a holding company. At first, this holding company would consist of the existing Commonwealth organization but, in time, would serve as an umbrella for acquired subsidiaries that would be permitted to operate autonomously. The new organization was incorporated in Delaware in 1969 as Capital Holding Corporation, a name considered appropriate regardless of the type of business the company purchased. William Abell, Commonwealth's president since 1958, assumed the same position in the holding company and became chairman after the 1969 acquisitions of National Trust Life Insurance Company and Peoples Life Insurance Company. The following year, Capital purchased First National Life Insurance Company. The operations and sales force of this New Orleans, Louisiana-based organization were later integrated with those of Commonwealth, paving the way for the company's entry into the Louisiana market.
Capital's gradual growth through acquisition created opportunities and provided the necessary resources to expand its product line and improve its competitive standing. It also benefited from such socioeconomic factors as the baby boom of the 1970s, a growing young adult market, and the increasing availability of disposable income. The company suffered, however, from weak management and a conservative board of directors that remained fixated on the outmoded method of selling life insurance door-to-door. By the latter half of the decade, Commonwealth instituted a training program to help its agents increase their return on collection calls by converting these customers into buyers of new insurance products.
Several new products were also introduced. One of these policies, the Capitalizer, represented a major departure from the company's traditional philosophy. Until this point, Commonwealth had sold policies with set premiums and had assumed the risk of changing interest and mortality rates and expenses. In contrast, the Capitalizer offered an adjustable premium that would vary according to future profits or losses in the company's investments or changes in its mortality experience. This feature enhanced the company's ability to compete with mutual funds, which had recently become popular.
Thomas C. Simons, who was hired away from another insurance company to become the company's chief executive officer in 1978, set out to make major changes in Commonwealth's marketing strategy. He believed that the company's strength was its ability to sell products to the middle-income bracket of the market. His goal was to find new ways to reach this market before larger insurers did.
Pursuing the Middle Class and Entering the Credit Card Market in the 1980s
In 1981, Capital acquired National Liberty Corporation, a holding company that sold health insurance to middle-class consumers by direct mail, telephone solicitation, and television commercials. In addition to providing Capital with a business that fit its existing operations, National Liberty offered an efficient marketing system with the capability to improve both sales productivity and customer service. One year later, Capital began selling insurance and other financial products at service centers within Kroger's retail food stores, capitalizing on a growing consumer trend toward one-stop shopping, and setting the stage for similar future strategies.
In 1984, Capital purchased San Francisco-based First Deposit Corporation from Parker Pen Corporation for $10 million. Parker's entry into financial services was similar to that of other nonbanking companies who had discovered that they could move into the banking business by buying a bank and then stripping it of its commercial loans or demand deposits--in the process forming what was known as a nonbank bank. In October 1981 Parker bought Tilton, New Hampshire-based Citizens National Bank, which had been founded in 1853 and chartered in 1865. The bank was stripped of its commercial lending operations and later renamed First Deposit National Bank. In November 1981 Parker purchased Redding Savings & Loan Association of California, which was renamed First Deposit Savings Bank. The two units were set up as subsidiaries of a San Francisco-based holding company called First Deposit Corporation. Leading Parker's drive into banking was Andrew S. Kahr, a financial entrepreneur who was most famous for creating the Cash Management Account, an innovative integrated-investment vehicle aimed at individuals that was introduced by Merrill Lynch & Co. in 1977. Kahr was president and CEO of First Deposit and continued in that role under the new ownership by Capital Holding. Among First Deposit's activities was the development of a credit card issuing operation. Kahr's first credit card was a Visa card that had no annual fee (which was unusual at the time) but that carried a high interest rate of 21.9 percent and that also required a person to borrow at least $1,000 as a cash advance in order to receive the card. Another unusual feature at the time was that only 2 percent of the balance had to be paid off each month. Given these various features the card was clearly aimed at the lower ends of the credit spectrum, and First Deposit continued to pursue the subprime market under Capital Holding.
In another 1984 development, Bank of America agreed to allow Capital to sell automobile, homeowners, and life insurance from specific bank branches in return for an office rental fee. By 1986, however, this venture still had not shown a profit and Capital terminated the project. Despite this setback, 1986 ended on a high note with the successful acquisition of Worldwide Underwriters Insurance Company, a direct-response marketer of automobile and homeowners insurance. In 1987, as it strengthened its hold on the moderate-income segment of the marketplace, the company sold its Georgia International Life Insurance Company subsidiary, which focused primarily on higher-income households.
Capital joined with four other insurance companies in 1988 to settle previous complaints lodged by Delaware's insurance commissioner. The companies were accused of collecting higher life insurance premiums from blacks, reflecting differences in life expectancy between the black and white populations. Although the insurers claimed that they had not sold such policies in more than 20 years and were unaware that race-based premiums were still being paid, they agreed to increase the death benefits for black beneficiaries who had overpaid on their policies.
Simons died in August 1988 and was succeeded as chairman and CEO of Capital Holding by Irving W. Bailey II. He had been with the company for ten years and had most recently served as president and chief operating officer. Bailey continued his predecessor's strategy of developing niche businesses, which, unlike life insurance, faced little price competition. Under Simons, the company had introduced such products as burial policies for people with annual incomes under $15,000, life insurance policies for people making between $15,000 and $25,000, and insurance policies specifically developed for veterans.
Soon after Bailey took over, Capital Holding launched a new "living payout" policy that supplemented other life insurance plans. Capital would pay insured people with terminal illnesses one-half of the total face value of their primary policies while they were still living. Upon their deaths, Capital Holding would recoup this amount from the primary insurance company. In 1989, Capital spent $156 million to purchase Southlife Holding Company, a Nashville, Tennessee-based insurer, to increase its market share in the home-service field.
Meanwhile, on the credit card front, Kahr had grown tired of managing a company, and in 1988 he sold his interest in First Deposit Corp. and turned over the reins to Shailesh J. Mehta (Kahr helped guide the company as a consultant through the year 2000). Born in Bombay, India, Mehta was a mathematical genius who had been hired away from Cleveland Trust Company. When he joined the company in 1986 at the age of 37, First Deposit had just $414 million in card balances. By the end of 1989, that figure was approaching $2 billion, and First Deposit had more than 600,000 credit card customers. Already, First Deposit was generating 10.6 percent of Capital Holding's pretax profits. Mehta and other executives at First Deposit, most of whom also had math and engineering backgrounds, developed sophisticated algorithms and databases to find particular types of potential customers for credit card solicitations. In particular, Mehta and his colleagues sought out heavy borrowers who were willing to make minimum monthly payments and who would tolerate high interest rates and fees--a formula for maximizing income and profits from a credit card operation. Although First Deposit became a leader in targeting the riskier subprime portion of the credit market, the reliance on mathematical models helped the firm identify people who might have had prior credit problems but who were still likely to repay their debts, thereby keeping the customer default level to a manageable level (though higher than the industry average).
Fast Credit Card Growth; Becoming Providian: Early to Mid-1990s
Capital Holding and its subsidiaries continued to grow in the early 1990s. In 1991 Durham Corp., a life insurer based in Raleigh, North Carolina, was acquired for $257 million. The fastest growth, however, continued to come from First Deposit, which by late 1993 ranked as the 14th largest bank credit card lender, with 1.5 million customer accounts and $4 billion in card balances. But First Deposit ranked first in profitability and had seen its profits balloon from $17 million in 1988 to $53 million in 1990 to $118 million in 1993. As a subsidiary of an insurance holding company, First Deposit was able to keep a relatively low profile despite its stunning growth and obvious ability to generate profits, but already criticism about its business practices was beginning to surface. Consumer advocates were critical, for example, of credit insurance products that First Deposit offered to its customers, contending that such insurance was either unnecessary or inferior to cheap life insurance policies or disability insurance. The company's credit cards were also chastised for their high interest rates and poorly disclosed fees. Meanwhile, First Deposit expanded into other areas of consumer lending, such as home-equity loans and secured credit cards. The latter, which required the posting of cash collateral in the form of a savings deposit (typically $200 to $300), were clearly aimed at the subprime sector of the credit market--consumers with no credit history or with credit problems. By 1994, the company had already become the nation's second largest issuer of secured cards, trailing only Citibank, with more than 250,000 such accounts.
In 1994 Capital Holding changed its name to Providian Corporation, and First Deposit was renamed Providian Bancorp, Inc. This was part of a drive to create a more integrated company. During 1994 the increasing importance of the banking unit became even clearer, as Providian Bancorp generated 40 percent of the overall operating profits of the corporation. Further evidence came in December of that year when Mehta was named president and COO of the holding company.
Jettisoning Insurance to Focus on Credit Cards in the Late 1990s
With the banking unit seeing its profits increase each year by more than 20 percent, while the insurance operations were experiencing little if any growth, Providian decided to stake its future on the former. In December 1996 the firm announced that it would sell its insurance operations to AEGON N.V., a Dutch financial services giant, in a $3.5 billion deal and spinoff to shareholders of the Providian Bancorp banking unit. In June 1997 the transaction was completed with Providian Bancorp emerging as a publicly traded, San Francisco-based company with the new name of Providian Financial Corporation. Mehta was named chairman and CEO of the company, while Bailey became vice-chairman of AEGON. Providian Financial began as the 12th largest U.S. credit card issuer, with about $8 billion in card balances, and the number one issuer of secured credit cards, with 750,000 cardholders.
Having severed its insurance roots, Providian moved quickly to expand its credit card holdings through acquisitions. During 1998 the company bought from First Union Corporation two separate blocks of credit card loans, each worth about $1.1 billion. Providian also bought another $350 million of receivables from Morgan Stanley Dean Witter & Company in 1998. In early 1999, as part of a drive into electronic commerce, Providian purchased GetSmart for $33 million. Based in Burlingame, California, GetSmart was an Internet service that matched consumers with loan products, including credit cards, mortgages, auto and student loans, debt consolidation, and business financing. By the end of 1999 Providian had grown its loan portfolio to $21 billion, making it the number eight credit card issuer in the country. There were now 12 million Providian cardholders.
Millennial Downfall and Attempt at Turnaround
The meteorically rising Providian Financial began to falter in mid-1999 when charges of unfair business practices started to proliferate. In conjunction with the San Francisco district attorney's office, the Office of the Comptroller of the Currency (OCC) launched an investigation of Providian. In June 2000 the OCC issued a report concluding that the company had "engaged in a pattern of misconduct in which it misled and deceived consumers in order to increase profits." The allegations against Providian included misleading consumers about the interest rates on their credit cards and promoting a "no annual fee" credit card that carried a mandatory $156 annual "credit protection fee." Providian agreed to repay consumers at least $300 million to settle the allegations in the largest ever OCC enforcement action. Providian, which admitted no wrongdoing, also agreed to pay the city and county of San Francisco a $5.5 million fine and was ordered to halt some of its marketing campaigns that had been deemed deceptive. Around this same time, the company, in response to mounting complaints from customers who claimed they had been charged late fees for payments that had been made on time, added a two-day grace period beyond the due date in which customers could pay a bill without incurring a late charge. Then in December 2000 Providian agreed to pay another $105 million to settle a number of consumer class-action lawsuits alleging deceptive marketing and sales practices.
Despite these setbacks, Providian remained a Wall Street darling, with its market capitalization skyrocketing 453 percent from 1997 to 2000. Late in 2000, the stock hit its all-time high of $66.72 per share. By that time, the company ranked as the number five credit card issuer in the nation, with $30 billion in card balances--one-third of which was attributable to subprime customers.
To maintain the company's spectacular growth, which had been fueled in large part by the interest and fee income garnered from Providian's subprime customers, Mehta began seeking out more and more subprime customers. The company lowered its standards, giving cards to customers who would previously have been rejected by Providian's sophisticated mathematical models. With the economy faltering and subprime customers among the first to feel the effects, consumer bankruptcies and subprime default rates began to rise. Charge-offs for uncollectable loans began to rise quickly, increasing from 7.6 percent in the fall of 2000 to 12.1 percent one year later. In August 2001 Providian revealed about $30 million in credit losses for the second quarter. During the third quarter, credit losses helped spark a 71 percent decline in net income from the previous year. During the second half of 2001, Wall Street finally discovered the extent of the company's problems and punished the stock price, which fell 92 percent from July to October--to less than $5.
On the day that the third-quarter earnings were announced, Mehta declared that he would resign from the company as soon as a replacement was brought on board. In November 2001 Joseph W. Saunders was named president and CEO, having most recently served as chairman and CEO of FleetBoston Financial Corporation's credit card business. Over the next year, Saunders led a wide-ranging turnaround effort. Part of the impetus for change came from federal regulators, who prohibited Providian from accepting new accounts from subprime customers and who limited that company's asset growth to 2.5 percent per quarter. Saunders subsequently announced that Providian planned to focus on the middle market and prime credit sectors. Instead of growing, Providian moved to slim down its loan portfolio, selling off its credit card businesses in the United Kingdom and Argentina, $8.2 billion of its best-quality credit card loans, and $2.4 billion of its high-risk subprime credit card accounts. The company also sold or shut down several call centers and offices. The cutbacks reduced the workforce from 13,000 to fewer than 7,000 by late 2002. In March 2002 Providian offered to pay $38 million to settle a securities fraud class-action lawsuit, but a slew of other suits had been filed charging that executives had misled investors about changes in its accounting for credit losses that were said to have taken place in 2001. These suits clouded the company's future, but the turnaround seemed to be proceeding apace, particularly given that there had been much speculation in late 2001 that the company would be sold or would be forced into bankruptcy. After posting a $481 million loss for the fourth quarter of 2001--as a result of more than $1 billion in special restructuring charges--Providian posted profits in both the first and second quarters of 2002. Nevertheless, the company was unlikely to return to the levels of growth and profitability attained in the late 1990s given the new focus on less risky--but also less profitable--customers.
Principal Subsidiaries: Providian National Bank; Providian Bank; Providian Bancorp Services.
Principal Competitors: Citigroup Inc.; Bank One Corporation; MBNA Corporation; J.P. Morgan Chase & Co.; Household International, Inc.; Bank of America Corporation; Capital One Financial Corporation.
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