Description

(i am recommending investing in PVN coverts, both the 3.25% and 0%)

Business:
Through two wholly owned banking subsidiaries, Providian National Bank (PNB) and Providian Bank (PB), PVN provides credit card and consumer loans and deposit products in the United States.

Investment Thesis - I believe the PVN convert are longs because:
1) PVN is an ongoing concern, with assets highly likely to cover all liabilities
2) funding risk is highly manageable (i.e. continued access to ABS mkt)
3) regulatory issues being satisfied (deposits, new FFIEC guidelines, negative amortization, accrued finance charges, etc.)
4) mgmt team (CEO, Joe Saunders) has experience turning around troubled credit card cos.
5) in worst case scenario, PVN has assets to fund securitizations coming back on B/S
6) PVN repurchased $57m of 3.25% in open mkt in 9/01 (@$40/bond)

My research edge
met & spoke w/ company mgmt, competitors, regulators
spoke with ABS mkt dealers

PVN converts
1) 3.25% due 8/05: currently trading at $49.5, will get par ($100) in 3yrs (forget about the convert details, as its so far out of the money)
approx 32% IRR
2) 0% due 2/06 (put date): currently trading at $20, put for $55.21 cash in 2/06 (again forget about convert details)
approx 33% IRR


Liquidity Analysis
cash: $388 (3/02)
repo: $3,536 (3/02)
securites: $1,709 (3/02, all I-grade & govt)
net cash from sale of high risk loans: $1,200 (5/02, net of attrition)
inv in high risk loans: $200 (tranche C of sale bought by PVN)
liquid assets: $6.8bn at a minimum (i'm assuming $0 for tranch C)

net loans on B/S: $6,893 (let's analyze in greater detail later)
net inv in loans off B/S: $2,277 (due from securitizations - analyze later)
OCF for next 9mos: $1,000 (to be used to pay down deposits, per regulatory agreement)

total assets: $17bn

deposits: $14,425 (3/02, committed to $12.5bn by EOY for regulators)
MTNs: $202 (3/02, $3bn facility available only if I-grade)
3.25% conv: $345.3 (3/02, @ par)
0% conv: $552.07 (3/02, @ put price)
Trust Pref: $104 (3/02)

total liabilities: $15.6bn

preliminary conclusion is that both converts are covered by adequate liquidity; now, let's review the assumptions and margin of safety



Analysis of Assumtions & Margin of Safety
1) PVN will be CF positive for the next 9mos, and through 2005/2006
- PVN generated OCF of $564m in Q1/02, and $200m net of investing in perhaps PVN's most arduous quarter ever; PVN is expected to be OCF and FCF positive into the future - evidence is clear in the stabilization of charge off rates and in lower delinquencies - as PVN is prohibited from marketing to subprime, the quality of the asset portfolio should improve

2) on B/S loans are worth $6.9bn
- the current FICO breakdown is as follows: (29% <600, 64% 600-670, 7% >670); let's assume the following premiums if the portfolios were sold:
-20%, 0% and 4% (the 20% is the discount PVN sold its high risk junk to CCRT, SSB & GS; PVN's platinum portoflio was sold to JPM for 2%); using such liquidation type premiums, and assuming additional 6% of reserves ($400m), the on B/S portfolio is worth $6.1bn - if the premiums were to double (a more likely scenario), the portfolio is worth $6.5bn (assuming additional reserving)

3) the I/O strip (due from receivables) is worth $2.2bn
- using a similar analysis, the I/O strip is worth between $1.9 and $2.1b

4) securitizations will not come back on B/S
though the PVN Master Trust is private, it is possible to get excess spread #'s through the ABS mkt (currently excess spread #'s are >6% and have never dipped below 5%)

approximately $1.7bn in ABS paper was funded privately with 2 banks in 11/01 (in the midst of crisis) - PVN posted $500m collateral, or an extremly high 30% advance rate - PVN will likely re-access the ABS mkt via 144a or public - this will free up $150m or so of capital

should PVN not be able to access the ABS mkt (ABS dealers tell me this is highly unlikely), approx $2.2bn would need to be funded on B/S (incl increased reserves @ 15% charge off rate and capital charges @ 200% risk weight) - clearly this would be a negative, though PVN has the liquidity to do it

in any event, total liabilites from securitizations are approx $10.3bn versus securitized loans of $13.6bn - so there is adequate protection

5) regulators - the new FFIEC guidelines have already been satisfied (except for negative amortization which might require an additional charge of $250m - but it is unclear if this will pass)


Conclusion
there is a margin of safety on the converts, somewhere around 10-20% depending on one's calculations - should PVN not be able to access the ABS mkt, that margin of safety would disappear, but PVN would be able to fund such an event (and later sell the loans in an organized manner to regain liquidity) - most importantly, accessing the ABS mkt would likely lead to a credit rating upgrade

Catalyst

rating agency upgrade
positive earnings & funding guidance