Credit analyst warns regulators may find more trouble at Provident

By Ronda Fears

Nashville, March 6 -Kathy Shanley, senior bond analyst at Gimme Credit, suspects bank regulators may find more trouble at Provident Financial Corp. so she forecasts more downside in the paper.

Provident (Baa3/BB+) revealed earlier this week that it will restate operating results for 1997 through 2002, resulting in a cumulative $70.3 million reduction in net income.

The problem involves errors in the accounting for nine auto lease financing transactions funded in 1997 through 1999, which were incorrectly classified as off-balance-sheet operating leases rather than on-balance-sheet financing leases.

"Over the past year Provident has labored to reduce its exposure to high-risk businesses such as subprime lending, structured finance, and aircraft leases. The restatement raises questions about whether all the risks have been identified, and is likely to attract the attention of federal bank and securities regulators," Shanley said in a report Thursday.

"We fear regulators may find other issues to probe besides the modeling error, and see additional downside risk."

Provident's explanation for the belated discovery of the errors is that its finance staff found the problem while they were installing a new financial model.

The transactions in question are securitizations, through which Provident sold ownership of vehicles then leased them back in a sale-leaseback arrangement. Upon review the auditors ruled that off-balance-sheet treatment was inappropriate.

"We warned investors to avoid Provident in 2000, when it first dropped its use of gain-on-sale accounting [in August 2000]," Shanley said.

"At the time we feared the bank's exposure to subprime loans and securitization-related assets put it at risk for a negative earnings surprise."

Provident's results are already challenged by credit quality concerns, she said.

Net of the restatement, it earned just $3 million in 2001 and $99 million in 2002, she noted, "providing a wafer thin cushion to cover problem loans."

The bank also cautioned results for 2003 will be about 20c per share, or about $10 million, below previous estimates.

"This estimate does not appear to factor in the risk of higher funding costs in the wake of rating agency downgrades," Shanley said.

"There may be more writedowns since the charge only covers the modeling error."

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