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Provident Financial modelling problem

On 6th March 2003 Provident Financial Group of Cincinnati announced a restatement of its results for the five financial years from 1997 to 2002. Between 1997 and 1999 Provident created nine pools of car leases. Part of the financial restatement was because the leases were treated off balance sheet, rather than on balance sheet as was later thought to be appropriate. But there was also a significant restatement of earnings, because there was a mistake in the model that calculated the debt amortisation for the leases. It appears that the analysts who built the model used for the first pool “put in the wrong value, and they didn’t accrue enough interest expense over the deal term. The first model that was put together had the problem, and that got carried through the other eight,” according to the Chief Financial Officer, who also went on to say that he did not think other banks had made similar errors. “We made such a unique mistake here that I think it’s unlikely.”

It appears that the error was found when Provident introduced a new financial model that was tested against the original, and that the two models produced different results. They then went back and looked at the original model to see which one was correct. We don’t know that these were spreadsheet models, but it’s entirely possible. And the lack of testing may have led to earned income being overstated by $70 million over five years. Provident also faces a class action suit from investors.

If I am right, and the erroneous model was a spreadsheet (and from the fact that those who built it were referred as “analysts” rather than “programmers” or “developers” some sort of user-developed software seems likely), this is a classic example of a spreadsheet being built as a one-off and then reused without adequate controls. Later pools must have used a different spreadsheet, as they were not subject to the same restatement.

The CFO has more confidence than I do in the ability of other banks to avoid similar errors.

See the press release from Provident, and press coverage from the Cincinnati Post and New York Times.