UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-Q/A
(Mark One)
[X] Quarterly Report amendment pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended March 31, 2003
or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________ to __________
Commission file number: 001-12351
METRIS COMPANIES INC.
(Exact name of Registrant as specified in its charter)
Delaware 41-1849591
(State of Incorporation) (I.R.S. Employer Identification No.)
10900 Wayzata Boulevard, Minnetonka, Minnesota 55305-1534
(Address of principal executive offices)
(952) 525-5020
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
As of April 30, 2003, 57,754,091 shares of the Registrant's common stock, par
value $.01 per share, were outstanding.
METRIS COMPANIES INC.
FORM 10-Q
TABLE OF CONTENTS
MARCH 31, 2003
Page
----
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets........................... 4
Consolidated Statements of Income..................... 5
Consolidated Statements of Changes in Stockholders'
Equity............................................ 6
Consolidated Statements of Cash Flows................. 7
Notes to Consolidated Financial Statements............ 8
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................. 29
ITEM 3. Quantitative and Qualitative Disclosures About
Market Risk........................................... N/A
ITEM 4. Controls and Procedures...................................... 52
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings............................................ N/A
ITEM 2. Changes in Securities........................................ N/A
ITEM 3. Defaults Upon Senior Securities.............................. N/A
ITEM 4. Submission of Matters to a Vote of Security Holders.......... N/A
ITEM 5. Other Information............................................ N/A
ITEM 6. Exhibits and Reports on Form 8-K............................. N/A
Signatures................................................... 55
2
EXPLANATORY NOTE
As previously disclosed, Metris Companies Inc. (the "Company") restated
its financial results for 1998 through 2002 and for the first three quarters of
2003. This restatement was made in connection with the Company's analysis of its
method of valuing "Retained interests in loans securitized."
This Amendment No. 1 to the Company's Quarterly Report on Form 10-Q for
the period ended March 31, 2003, initially filed with the Securities and
Exchange Commission ("SEC") on May 15, 2003 (the "Original 10-Q"), is being
filed to reflect restatements of the following financial statements:(a)
consolidated balance sheets as of December 31, 2002, and March 31, 2003; (b)
consolidated statements of income for the three-months ended March 31, 2003 and
2002; and (c) consolidated statements of cash flows for the three-months ended
March 31, 2003 and 2002. Included in these restatements, in addition to changes
made as a result of the Company's revised accounting policies and procedures
related to valuing its retained interests, are corrections to conform with
accounting principles generally accepted in the United States of America
("GAAP") related to securitization transaction costs, credit card solicitation
costs, interest rate caps and debt waiver revenue associated with credit card
receivables sold to the Metris Master Trust, as well as the transfer of
allowance for loan losses that was incorrectly classified as a valuation reserve
in "Retained interests in loans securitized" as of December 31, 2001. In
addition, we have restated certain other prior period amounts to conform with
the current period's presentation. For a more detailed description of the
restatements, see Note 2 to the accompanying unaudited consolidated financial
statements and "Restatements" in Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in this Quarterly Report
on Form 10-Q/A.
This Amendment No. 1 amends and restates Items 1, 2, and 4 of Part I
and Item 6 of Part II of the Original 10-Q. No other information in the Original
10-Q is amended. The foregoing items have been amended to reflect the
restatements and have not been updated to reflect other events occurring after
the filing of the Original 10-Q or to modify or update those disclosures
affected by subsequent events. Such matters have been or will be addressed in
the amended Quarterly Report on Form 10-Q/A for the quarter ended June 30, 2003,
filed concurrently herewith, the Quarterly Report on Form 10-Q for the quarter
ended September 30, 2003, filed on March 2, 2004, the current report on Form 8-K
filed on March 15, 2004, and any reports filed with the SEC subsequent to the
date of this filing.
We are concurrently filing an amended Annual Report on Form 10-K/A for
the year ended December 31, 2002, and amended Quarterly Reports on Form 10-Q/A
for the quarter ended June 30, 2003 and for the quarter ended September 30,
2003, containing restated financial statements for the relevant periods. We did
not amend our Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for
periods affected by the restatements that ended prior to December 31, 2002, and
therefore, the financial statements, auditors' reports and related financial
information for the affected periods contained in such reports should no longer
be relied upon.
3
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands)
MARCH 31,
2003 DECEMBER 31,
AS RESTATED 2002
(UNAUDITED) AS RESTATED
----------- -----------
ASSETS:
Cash and due from banks $ 90,770 $ 62,813
Federal funds sold 102,300 88,000
Short-term investments 342,934 429,419
----------- -----------
Cash and cash equivalents 536,004 580,232
----------- -----------
Liquidity reserve deposit 69,221 --
Credit card loans 686,285 846,417
Less: Allowance for loan losses 125,357 90,315
----------- -----------
Net credit card loans 560,928 756,102
----------- -----------
Retained interest in loans securitized 805,633 808,026
Property and equipment, net 75,205 83,831
Purchased portfolio premium, net 58,083 64,579
Other receivables due from credit card
securitizations, net 114,347 110,471
Other assets 203,761 187,151
----------- -----------
TOTAL ASSETS $ 2,423,182 $ 2,590,392
=========== ===========
LIABILITIES:
Deposits $ 801,498 $ 892,754
Debt 358,276 357,649
Accounts payable 50,480 53,589
Deferred income 123,570 143,148
Accrued expenses and other liabilities 116,631 88,579
----------- -----------
TOTAL LIABILITIES 1,450,455 1,535,719
----------- -----------
STOCKHOLDERS' EQUITY:
Convertible preferred stock - Series C, par
value $.01 per share; 10,000,000
shares authorized, 1,182,098 and 1,156,086
shares issued and outstanding, respectively 440,331 430,642
Common stock, par value $.01 per share;
300,000,000 shares authorized, 64,759,515
and 64,223,231 shares issued, respectively 648 642
Paid-in capital 228,702 227,376
Unearned compensation (448) --
Treasury stock - 7,055,300 shares (58,308) (58,308)
Retained earnings 361,802 454,321
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 972,727 1,054,673
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,423,182 $ 2,590,392
=========== ===========
See accompanying Notes to Consolidated Financial Statements.
4
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Income
(In thousands, except earnings per-share data) (Unaudited)
THREE MONTHS ENDED
MARCH 31,
------------------------
2003 2002
---- ----
AS RESTATED AS RESTATED
----------- -----------
INTEREST INCOME:
Credit card loans $ 29,907 $ 88,526
Federal funds sold 359 114
Other 1,895 1,204
--------- ---------
Total interest income 32,161 89,844
--------- ---------
Deposit interest expense 10,908 23,653
Other interest expense 8,433 8,512
--------- ---------
Total interest expense 19,341 32,165
--------- ---------
NET INTEREST INCOME 12,820 57,679
Provision for loan losses 44,786 61,876
--------- ---------
NET INTEREST EXPENSE AFTER PROVISION FOR LOAN LOSSES (31,966) (4,197)
--------- ---------
OTHER OPERATING INCOME:
Securitization (expense) income (37,970) 102,446
Servicing income on securitized / sold receivables 47,813 45,039
Credit card fees, interchange and other credit card income 26,319 75,659
Enhancement services revenues 43,509 34,274
--------- ---------
79,671 257,418
--------- ---------
OTHER OPERATING EXPENSE:
Credit card account and other product solicitation and marketing expenses 33,688 47,253
Employee compensation 53,381 56,548
Data processing services and communications 19,178 22,306
Credit protection claims expense 12,306 9,179
Occupancy and equipment 9,613 12,797
Purchased portfolio premium amortization 6,496 8,455
MasterCard/Visa assessment and fees 2,415 3,834
Credit card fraud losses 940 2,228
Asset impairments, lease write-offs and severance 16,777 --
Other 20,352 18,490
--------- ---------
175,146 181,090
--------- ---------
(LOSS) INCOME BEFORE INCOME TAXES (127,441) 72,131
Income tax (benefit) expense (44,611) 27,851
--------- ---------
NET (LOSS) INCOME (82,830) 44,280
Convertible preferred stock dividends 9,689 9,188
--------- ---------
NET (LOSS) INCOME APPLICABLE TO COMMON STOCKHOLDERS $ (92,519) $ 35,092
========= =========
(LOSS) EARNINGS PER SHARE:
Basic (1.62) 0.46
Diluted (1.62) 0.46
SHARES USED TO COMPUTE (LOSS) EARNINGS PER SHARE:
Basic 57,257 96,032
Diluted 57,257 96,973
DIVIDENDS DECLARED PER COMMON SHARE -- $ 0.01
See accompanying Notes to Consolidated Financial Statements.
5
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
(In thousands) (Unaudited)
TOTAL
NUMBER OF SHARES PREFERRED COMMON PAID-IN UNEARNED TREASURY RETAINED STOCKHOLDERS'
PREFERRED COMMON STOCK STOCK CAPITAL COMPENSATION STOCK EARNINGS EQUITY
BALANCE AT DECEMBER 31,
2001 AS PREVIOUSLY REPORTED 1,058 63,419 $393,970 $642 $232,413 $(4,980) $(13,014) $532,924 $ 1,141,955
Cumulative restatements to
prior periods, see Note 2 -- -- -- -- -- -- -- (36,619) (36,619)
----- ------ -------- ---- -------- ------- -------- -------- -----------
BALANCE AT DECEMBER 31,
2001 AS RESTATED 1,058 63,419 $393,970 $642 $232,413 $(4,980) $(13,014) $496,305 $ 1,105,336
Net income (as restated) -- -- -- -- -- -- -- 44,280 44,280
Cash dividends -- -- -- -- -- -- -- (938) (938)
Common stock repurchased -- (1,292) -- -- -- -- (17,582) -- (17,582)
Preferred dividends in kind 23 -- 8,864 -- -- -- -- (8,864) --
Issuance of common stock
under employee benefit
plans -- 116 -- 1 1,822 -- -- -- 1,823
Amortization of restricted
stock -- -- -- -- -- 404 -- 404
----- ------ -------- ---- -------- ------- -------- -------- -----------
BALANCE AT MARCH 31, 2002
AS RESTATED 1,081 62,243 $402,834 $643 $234,235 $(4,576) $(30,596) $530,783 $ 1,133,323
===== ====== ======== ==== ======== ======= ======== ======== ===========
BALANCE AT DECEMBER 31,
2002 AS PREVIOUSLY REPORTED 1,156 57,168 $430,642 $642 $227,376 $ -- $(58,308) $458,673 $ 1,059,025
Cumulative restatements to
prior periods, see Note 2 -- -- -- -- -- -- -- (4,352) (4,352)
BALANCE AT DECEMBER 31,
2002 AS RESTATED 1,156 57,168 $430,642 $642 $227,376 $ -- $(58,308) $454,321 $ 1,054,673
Net loss (as restated) -- -- -- -- -- -- -- (82,830) (82,830)
Preferred dividends in kind 26 -- 9,689 -- -- -- -- (9,689) --
Issuance of common stock
under employee benefit
plans -- 536 -- 3 792 -- -- -- 795
Deferred compensation
obligations -- -- -- 3 546 (549) -- -- --
Restricted stock forfeitures -- -- -- -- (12) 12 -- -- --
Amortization of restricted
stock -- -- -- -- -- 89 -- -- 89
----- ------ -------- ---- -------- ------- -------- -------- -----------
BALANCE AT MARCH 31, 2003
AS RESTATED 1,182 57,704 $440,331 $648 $228,702 $ (448) $(58,308) $361,802 $ 972,727
===== ====== ======== ==== ======== ======= ======== ======== ===========
See accompanying Notes to Consolidated Financial Statements.
6
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands) (Unaudited)
THREE MONTHS ENDED
MARCH 31,
2003 2002
AS RESTATED AS RESTATED
----------- -----------
OPERATING ACTIVITIES:
Net income (loss) $ (82,830) $ 44,280
Adjustments to reconcile net (loss) income to net
cash provided by (used in) operating activities:
Depreciation, amortization and accretion (36,420) (43,787)
Provision for loan losses 44,786 61,876
Loss from credit card securitization 66,209 39,087
Asset impairments, lease write-offs, and severance 16,777 --
Market loss on derivative financial instruments 3,710 9,272
Changes in operating assets and liabilities, net:
Liquidity Reserve deposit (69,221) --
Fair value of retained interests in loans
securitized 83,608 48,868
Spread accounts receivable (164,549) (30,224)
Other receivables due from credit
card securitizations, net (3,876) 9,439
Accounts payable and accrued expenses 12,325 (4,128)
Deferred income (19,578) (8,413)
Other (42,793) 50,338
--------- ---------
Net cash provided by (used in) operating activities (191,852) 176,608
--------- ---------
INVESTING ACTIVITIES:
Proceeds from transfers of portfolios to the Metris
Master Trust
205,560 619,554
Net cash from loan originations and principal
collections on loans receivable 32,399 (228,410)
Additions to property and equipment (501) (3,645)
--------- ---------
Net cash provided by investing activities 237,458 387,499
--------- ---------
FINANCING ACTIVITIES:
Proceeds from issuance of debt 627 26
Repayment of debt -- (292,000)
Net decrease in deposits (91,256) (332,122)
Cash dividends paid -- (938)
Proceeds from issuance of common stock 795 1,823
Repurchase of common stock -- (17,582)
--------- ---------
Net cash used in financing activities (89,834) (640,793)
--------- ---------
Net decrease in cash and cash equivalents (44,228) (76,686)
Cash and cash equivalents at beginning of period 580,232 381,639
--------- ---------
Cash and cash equivalents at end of period $ 536,004 $ 304,953
========= =========
SUPPLEMENTAL DISCLOSURES AND CASH FLOW INFORMATION:
Cash paid (received) during the period for:
Interest $ 19,959 $ 34,261
Income taxes (32,042) (17,948)
See accompanying Notes to Consolidated Financial Statements.
7
METRIS COMPANIES INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except as noted) (Unaudited)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Metris
Companies Inc. ("MCI") and its subsidiaries. MCI's principal subsidiaries are
Direct Merchants Credit Card Bank, National Association ("Direct Merchants Bank"
or the "Bank"), Metris Direct, Inc. and Metris Receivables, Inc. MCI and its
subsidiaries, as applicable, may be referred to as "we," "us," "our" or the
"Company." We are an information-based direct marketer of consumer lending
products and enhancement services.
All dollar amounts are presented as pre-tax amounts unless otherwise
noted. We have eliminated all significant intercompany balances and transactions
in consolidation.
INTERIM FINANCIAL STATEMENTS
We have prepared the unaudited interim consolidated financial
statements and related unaudited financial information in the footnotes in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") and the rules and regulations of the Securities and Exchange
Commission ("SEC") for interim financial statements. These interim financial
statements reflect all adjustments consisting of normal recurring accruals,
which, in the opinion of management, are necessary to present fairly our
consolidated financial position and the results of our operations and our cash
flows for the interim periods. You should read these consolidated financial
statements in conjunction with the financial statements and the notes thereto
contained in our Annual Report on Form 10-K/A for the fiscal year ended December
31, 2002, filed concurrently with this Quarterly Report on Form 10-Q/A. The
nature of our business is such that the results of any interim period may not be
indicative of the results to be expected for the entire year.
PERVASIVENESS OF ESTIMATES
We have prepared the consolidated financial statements in accordance
with GAAP, which require us to make estimates and assumptions that affect the
reported amounts in the consolidated financial statements and accompanying
notes. The most significant and subjective of these estimates is our
determination of the adequacy of the allowance for loan losses and our
determination of the fair value of "Retained interests in loans securitized."
The significant factors susceptible to future change that have an impact on
these estimates include default rates, net interest spreads, payment rates,
liquidity and the ability to finance future receivables activity and overall
economic conditions. As a result, the actual losses in our loan portfolio and
the fair value of our retained interests as of March 31, 2003 and December 31,
2002, could materially differ from these estimates. The accompanying unaudited
consolidated financial statements do not include an adjustment to the fair value
of retained interests that might result from the inability to finance future
receivables.
COMPREHENSIVE INCOME
SFAS No. 130 "Reporting Comprehensive Income," does not apply to our
current financial results and therefore, net income equals comprehensive income.
NOTE 2 - RESTATEMENTS
The consolidated statements of income and cash flows as presented for
the three-month periods ended March 31, 2003 and 2002, and the consolidated
balance sheets as of March 31, 2003 and December 31, 2002, have been restated to
reflect the following:
- The valuation model and related collateral assumptions used to estimate the
fair value of the Company's "Retained interests in loans securitized" did
not properly reflect the structure of the Metris Master Trust and related
series supplements. All periods presented have been restated to reflect the
changes in the valuation model and the related collateral
8
assumptions. These restatements impact "Retained interests in loans
securitized," "Other receivables due from credit card securitizations, net"
and "Securitization income."
- The Company's policy for recognizing transaction costs related to the
securitization of receivables through the Metris Master Trust or a conduit
was not in accordance with GAAP. Historically, these costs had been
capitalized and amortized over the estimated life of the new debt
securities. These costs are now allocated and recognized over the initial
and reinvestment periods of the respective debt securities or Metris Master
Trust financing unless the transaction results in a loss, in which case the
costs are expensed as incurred. All periods presented have been restated to
reflect the revised policy. This restatement impacts "Other assets" and
"Securitization income."
- The Company's policy for recognizing expenses related to credit card
solicitation costs was not in accordance with GAAP. Historically, the
Company had capitalized and expensed these costs over the estimated period
over which the new credit card accounts were established, approximately
three months. These costs are now expensed as incurred. All periods
presented have been restated to reflect the revised policy. This
restatement impacts "Other assets" and "Credit card account and other
product solicitation and marketing expenses."
- The Company corrected its accounting for interest rate caps purchased in
May of 2002 and forward to comply with SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended. These costs had been
deferred and amortized over the estimated life of the new debt securities.
These instruments are now recorded at fair value. Periods from May 2002
forward have been restated to reflect this correction. This restatement
impacts "Retained interests in loans securitized," "Other assets" and
"Securitization income."
- The Company historically recognized revenue in the month following
completion of the cancellation period, generally one month. Cash flows
related to debt waiver are now included in the valuation of the
interest-only strip receivable. All periods presented have been restated to
reflect the revised policy. This restatement impacts "Retained interests in
loans securitized," "Deferred revenue," "Enhancement services revenue," and
"Securitization income."
- At December 31, 2001 we had $50 million of "Allowance for loan losses"
classified as valuation reserve in our "Retained interests in loans
securitized." The valuation reserve was subsequently transferred to
"Allowance for loan losses" through "Provision for loan losses" during the
first quarter of 2002. We have restated the December 31, 2001 balance sheet
and 2001 income statement and March 31, 2002 income statement to reflect
this transfer occurring during the fourth quarter of 2001. This restatement
impacts "Allowance for loan losses," "Retained interests in loans
securitized," "Provision for loan losses" and "Securitization income."
The cumulative impact of the above restatements as of December 31, 2001 is a
$36.6 million decrease in retained earnings and consists of the following
adjustments:
Retained interests in loans securitized $ 4.6
Allowance for loan losses (50.0)
Transaction costs 6.6
Pre-paid costs (17.9)
Income tax 20.1
-----------
$ (36.6)
===========
In addition, we have restated certain prior-period amounts to conform with
the current period's presentation.
- In prior periods, we classified interest income, provision for loan
losses, and related credit card loan fees generated from retained
interests in loans securitized on the income statement as "Interest
income-credit card loans and retained interests in loans securitized,"
"Provision for loan losses" and "Credit card fees, interchange and
other credit card income." For all periods presented, these amounts are
now included in the estimation of the fair value of the interest-only
strip receivable and "Securitization income."
- In prior periods we classified spread accounts receivable in "Other
receivables due from credit card securitizations, net." For all periods
presented, we have reclassified our spread accounts receivable from
"Other receivables due from credit card securitizations, net" to
"Retained interests in loans securitized."
9
- In prior periods, we classified servicing income in "Net securitization
and credit card servicing income." For all periods presented, we have
reclassified these amounts to "Servicing income."
- In prior periods, income from our debt waiver product sold to customers
of Direct Merchants Bank with receivables held by Direct Merchants Bank
was included in "Enhancement services revenue." For all periods
presented we have reclassified this income to "Credit card fees,
interchange and other credit card income."
- We classified the liquidity reserve deposit established in March 2003
and other restricted cash deposits maintained at Direct Merchants Bank
as "Short-term investments." We have reclassified these items to
"Liquidity reserve deposit" for all periods presented.
- Revenue related to our membership club and warranty business for
current and prior periods is classified as "Enhancement services
revenue." Claims expense related to this business has been reclassified
as "Other" expenses for all periods presented.
- In addition to the tax effects of the pre-tax restatement amounts, the
restated presentation also reflects revised probable amounts of future
taxable and deductible temporary differences, resulting in a
reclassification of certain deferred income taxes to current income
taxes.
See Notes 3,4,6,7,8,9, 10, 11 and 12, all of which are impacted by these
changes.
The following tables present certain captions of the consolidated
financial statements, for all periods presented, which were affected by the
restatements.
MARCH 31,2003 DECEMBER 31,2002
------------- ----------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
-------- ----------- -------- -----------
BALANCE SHEETS:
ASSETS:
Short-term investments $ 412,155 $ 342,934 $ 429,419 $ 429,419
Liquidity reserve deposit -- 69,221 -- --
Retained interests in loans securitized 1,670,171 -- 1,736,912 --
Less: Valuation allowance 931,052 -- 986,517 --
Retained interests in loans securitized 739,119 805,633 750,395 808,026
Other receivables due from credit card securitizations, net 276,134 114,347 184,220 110,471
Other assets 168,843 203,761 174,987 187,151
LIABILITIES:
Deferred income $ 138,207 $ 123,570 $ 159,267 $ 143,148
Accrued expenses and other liabilities 100,125 116,631 72,062 88,579
STOCKHOLDERS' EQUITY
Retained earnings $ 424,026 $ 361,802 $ 458,673 $ 454,321
10
THREE-MONTHS ENDED THREE-MONTHS ENDED
MARCH 31, 2003 MARCH 31, 2002
-------------- --------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
-------- ----------- -------- -----------
STATEMENTS OF INCOME:
Provision for loan losses $ 44,786 $ 44,786 $ 111,876 $ 61,876
Net interest expense after provision for loan losses (31,966) (31,966) (54,197) (4,197)
Other operating income:
Securitization (expense) income -- (37,970) -- 102,446
Servicing income on securitized /
sold receivables -- 47,813 -- 45,039
Net securitization and credit card servicing income 56,396 -- 157,419 --
Credit card fees, interchange and
other credit card income 21,757 26,319 61,000 75,659
Enhancement services revenue 93,684 43,509 94,996 34,274
Other operating expenses:
Credit card account and other product solicitation and
marketing expenses 36,054 33,688 40,552 47,253
Enhancement services claims expense 13,022 -- 11,207 --
Credit protection claims expense -- 12,306 -- 9,179
Other 19,639 20,352 16,461 18,490
(Loss) Income Before Income Taxes (37,644) (127,441) 84,830 72,131
Income tax (benefit) expense (12,686) (44,611) 32,490 27,851
Net (loss) income (24,958) (82,830) 52,340 44,280
(Loss) earnings per share (0.61) (1.62) 0.55 0.46
Diluted (loss) earnings per share (0.61) (1.62) 0.54 0.46
11
THREE-MONTHS ENDED THREE-MONTHS ENDED
MARCH 31, 2003 MARCH 31, 2002
-------------- --------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
-------- ----------- -------- -----------
STATEMENTS OF CASH FLOWS:
Net (loss) income $ (24,958) $ (82,830) $ 52,340 $ 44,280
Depreciation, amortization and accretion 39,254 (36,420) 27,240 (43,787)
Provision for loan losses 44,786 44,786 111,876 61,876
Retained interests valuation income (56,920) -- (7,557) --
Loss from credit card securitizations -- 66,209 -- 39,087
Changes in fair value of retained interests in
loans securitized -- 83,608 -- 48,868
Market loss on derivative financial instruments -- 3,710 -- 9,272
Changes in operating assets and liabilities, net:
Liquidity reserve deposit -- (69,221) -- --
Other receivables due from credit card
securitizations, net (99,401) (3,876) (18,825) 9,439
Accounts payable and accrued expenses 12,336 12,325 (5,384) (4,128)
Deferred income (21,060) (19,578) (10,503) (8,413)
Spread accounts receivable -- (164,549) -- (30,224)
Other (15,946) (42,793) 59,528 50,338
Net cash (used in) provided by operating activities (105,132) (191,852) 208,715 176,608
Net use of cash from sales and repayments of
securitized loans (723,527) -- (292,037) --
Net loans collected 38,427 -- 33,017 --
Net cash from loan originations and principal
collections on loans receivable -- 32,399 -- (228,410)
Net cash provided by investing activities 219,959 237,458 356,889 387,499
Net increase (decrease) in cash and cash equivalents 24,993 (44,228) (75,189) (76,686)
Cash and cash equivalents at end of period 605,225 536,004 412,897 304,953
The following is a summary of the Company's revised accounting policies
related to retained interests:
Upon securitization, the Company removes the applicable credit card
loans from the balance sheet and recognizes the "Retained interests in
loans securitized" at their allocated carrying value in accordance with
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities-a replacement of FASB Statement No. 125"
("SFAS No. 140"). Credit card receivables are sold to the Metris Master
Trust at the inception of a securitization series. We also sell credit card
receivables to the Metris Master Trust on a daily basis to replenish
receivable balances that have decreased due to payments and charge-offs.
The difference between the allocated carrying value and the proceeds from
the assets sold is recorded as a gain or loss on sale and is included in
"Securitization (expense) income." At the same time, the Company recognizes
the "Retained interests in loans securitized."
The "Retained interests in loans securitized" are financial assets
measured at fair value consistent with trading securities in accordance
with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and includes the contractual retained interests, an
interest-only strip receivable, excess transferor's interests and spread
accounts receivable. The contractual retained interests consist of
non-interest bearing securities held by the Company. The interest-only
strip receivable represents the present value of the excess of the
estimated future interest and fee collections expected to be generated by
the
12
securitized loans over the period the securitized loans are projected to be
outstanding above the interest paid on investor certificates, credit
losses, contractual servicing fees, and other expenses. The excess
transferor's interests represent principal receivables held in the Metris
Master Trust above the contractual retained interests. Spread accounts
receivable represents restricted cash reserve accounts held by the Metris
Master Trust that can be used to fund payments due to securitization
investors and credit enhancers if cash flows are insufficient. Cash held in
spread accounts is released to us if certain conditions are met or a
securitization series terminates with amounts remaining in the spread
accounts. The fair value of the "Retained interests in loans securitized"
is determined through estimated cash flows discounted at rates that reflect
the level of subordination, the projected repayment term, and risk of the
securitized loans.
At least quarterly, the Company reviews its "Retained interests in
loans securitized" for changes in fair value and recognizes those changes
as "Securitization (expense) income." The changes in fair value reflect the
Company's revisions in the expected timing and amount of future cash flows.
The significant factors that affect the timing and amount of future cash
flows relate to the collateral assumptions, which include payment rate,
default rate, gross yield and discount rate.
The Company recognizes future cash flows associated with its retained
interests using the effective yield method in accordance with EITF 99-20
"Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets." Accordingly,
"Securitization (expense) income" includes discount accretion associated
with the contractual retained interests, the excess transferor's interests,
the interest-only strip receivable, spread accounts receivable as well as
the difference in the actual excess spread received as compared to the
estimated amount recorded related to the interest-only strip. Since the
Company's retained interests are trading securities, the impairment
provisions of EITF 99-20 are not applicable.
Up-front transaction costs related to securitizations are allocated and
recognized over the initial and reinvestment periods unless the transaction
results in a loss, in which case, the costs are expensed as incurred and
recorded as "Securitization (expense) income."
The Company services the receivables held by the Metris Master Trust,
and receives servicing fees based upon the principal receivables
outstanding. "Servicing income" is recognized when earned. We consider
these fees to be adequate compensation and as a result no servicing asset
or liability is recorded.
"Other receivables due from credit card securitizations, net" primarily
represents cash accumulated in the Metris Master Trust during a month,
which is released to Metris Receivables, Inc. the following month.
13
NOTE 3 - EARNINGS (LOSS) PER SHARE
The following table presents the computation of basic and diluted
weighted- average shares used in the per-share calculations:
THREE MONTHS ENDED
MARCH 31,
---------
2003 2002
---- ----
Net income (loss), as restated $(82,830) $ 44,280
Convertible preferred stock dividends 9,689 9,188
-------- --------
Net income (loss) applicable to common stockholders $(92,519) $ 35,092
======== ========
Weighted-average common shares outstanding 57,257 62,188
Adjustments for dilutive securities:
Assumed conversion of convertible preferred stock (1) -- 33,844
-------- --------
Basic common shares 57,257 96,032
Assumed exercise of outstanding stock options (1) -- 941
-------- --------
Diluted common shares 57,257 96,973
======== ========
(1) The earnings per share calculation for the period ended March 31, 2003
excludes the assumed conversion of the convertible preferred stock and
the outstanding stock options, as they are anti-dilutive.
14
NOTE 4 - STOCK-BASED COMPENSATION PLANS
We recognize compensation cost for stock-based employee compensation
plans based on the difference, if any, between the quoted market price of the
stock on the date of grant and the amount an employee must pay to acquire the
stock. No expense was reflected in net income related to stock options as all
options granted had an exercise price equal to the market value of the
underlying common stock on the date of grant. We recorded $0.1 million of
amortization of deferred compensation obligation, net of related tax benefit, in
net income related to restricted stock granted in the first quarter of 2003.
Pro forma information regarding net income and earnings per share has
been determined as if we accounted for our employee stock options under the fair
value method. The fair value of the options was estimated at the grant date
using a Black-Scholes option pricing model. The fair value of the options is
amortized to expense over the options' vesting periods. Under the fair value
method, our net earnings and earnings per share would have been recorded at the
pro forma amounts indicated below:
THREE MONTHS ENDED MARCH 31,
2003 2002
---- ----
Net (loss) income, as restated $ (82,830) $ 44,280
Deduct: Annual stock-based employee compensation expense
(benefit) determined based on the fair value for all
awards, net of related tax effects (7,897) 4,373
---------- ----------
Pro forma net (loss) income (74,933) 39,907
========== ==========
Earnings (loss) per share:
Basic-as reported (1.62) 0.46
========== ==========
Basic-pro forma (1.48) (0.42)
========== ==========
Diluted-as reported (1.62) 0.46
========== ==========
Diluted-pro forma (1.48) (0.41)
========== ==========
Weighted-average assumptions in option valuation:
Risk-free interest rates 1.5% 3.7%
Dividend yields -- 1.6%
Stock volatility factor 107.0% 92.9%
Expected life of options (in years) 4.3 6.0
The above pro forma amounts may not be representative of the effects on restated
net (loss) earnings for future periods.
NOTE 5 - ACCOUNTING CHANGES
In January 2003, FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation-Transition and Disclosure," which amends SFAS No. 123, "Accounting
for Stock-Based Compensation." SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require more prominent and more
frequent disclosures in financial statements about the effects of stock-based
compensation. SFAS No. 148 requirements are effective for fiscal years ending
after December 15, 2002. The adoption of SFAS No. 148 did not have a material
impact on our financial statements.
In January 2003, FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" in an effort to expand upon and strengthen existing
accounting guidance that addresses when a company should include in its
financial statements the assets, liabilities and
15
activities of another entity. FASB Interpretation No. 46 requires a variable
interest entity to be consolidated by a company, if that company is subject to a
majority of the risk of loss from the variable interest entity activities or
entitled to receive a majority of the entity's residual returns or both.
Interpretation No. 46 also requires disclosures about variable interest entities
that the company is not required to consolidate, but in which it has a
significant variable interest. The consolidation requirements of Interpretation
No. 46 apply immediately to variable interest entities created after January 31,
2003, and apply to existing variable interest entities in the first fiscal year
or interim period beginning after June 15, 2003. Interpretation No. 46 provides
a specific exemption for entities qualifying as Qualified Special Purpose
Entities as described in SFAS No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities-a replacement of FASB
Statement No. 125." All of our non-consolidated entities are Qualified Special
Purpose Entities under the definition in SFAS No. 140. We do not expect the
adoption of Interpretation No. 46 to have a material impact on our financial
statements.
In April 2003, FASB issued SFAS No. 149 "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is effective for contracts entered into or modified after
September 30, 2003. In addition, certain provisions relating to forward
purchases or sales of when-issued securities or other securities that do not yet
exist, should be applied to existing contracts as well as new contracts entered
into after September 30, 2003. We do not expect the adoption of SFAS No. 149 to
have a material impact on our financial statements.
NOTE 6 - LIQUIDITY RESERVE DEPOSIT
Direct Merchants Bank has established restricted deposits with
third-party depository banks for the purpose of supporting Direct Merchants
Bank's funding needs and to satisfy banking regulators' requirements under the
Operating Agreement, dated March 18, 2003, among Direct Merchants Bank, MCI and
the Office of the Comptroller of the Currency. These deposits are invested in
short term liquid investments. As of March 31, 2003, the balance of these
deposits was $69.2 million and is classified on the balance sheets as "Liquidity
reserve deposit."
NOTE 7 - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is as follows:
THREE MONTHS ENDED
MARCH 31,
---------
2003 2002
---- ----
Balance at beginning of period $ 90,315 $ 460,159
Allowance related to assets transferred to the Metris
Master Trust (1,455) (21,443)
Provision for loan losses 44,786 61,876
Principal receivables charged-off (8,681) (88,891)
Recoveries 392 5,213
--------- ---------
Net principal receivables charged off (8,289) (83,678)
--------- ---------
Balance at end of period $ 125,357 $ 416,914
========= =========
Credit card loans greater than 30 days contractually past due for the
periods ended March 31, 2003 and March 31, 2002 were $56.4 million and $226.3
million, respectively.
16
NOTE 8 - RETAINED INTERESTS IN LOANS SECURITIZED
Our credit card receivables are primarily funded through asset
securitizations. As part of the asset securitizations, credit card receivables
are transferred to the Metris Master Trust, a non-consolidated, qualifying
special purpose entity that issues asset backed securities representing
undivided interests in receivables held in the Metris Master Trust and the right
to receive future collections of principal, interest and fees related to those
receivables. The senior classes of these securities are sold to third party
investors. We retain subordinated interests in the securitized receivables,
including contractual retained interests, an interest-only strip receivable,
excess transferor's interests maintained above the contractual retained
interests, and spread accounts receivable. The components of these retained
interests are recorded at their fair value.
The following table shows the fair value of the components of the
"Retained interests in loans securitized" as of March 31, 2003 and December 31,
2002.
MARCH 31, DECEMBER 31,
2003 2002
---- ----
Contractual retained interests $627,997 $685,197
Excess transferor's interests 52,247 57,447
Interest-only strip receivable 1,531 13,882
Spread accounts receivable 123,858 51,500
-------- --------
Retained interests in loans securitized $805,633 $808,026
======== ========
The following table illustrates the significant assumptions used for
estimating the fair value of retained interests as of March 31, 2003 and
December 31, 2002.
MARCH 31, DECEMBER 31,
2003 2002
---- ----
Monthly payment rate 6.7% 6.7%
Gross yield (1) 26.0% 26.0%
Annual interest expense and servicing fees 4.0% 4.0%
Annual gross principal default rate 22.7% 21.7%
Discount rate:
Contractual retained interests 16.0% 16.0%
Excess transferor's interests 16.0% 16.0%
Interest-only strip receivable 30.0% 30.0%
Spread accounts receivable 15.0% 16.0%
(1)Includes expected cash flows from finance charges, late and overlimit fees,
debt waiver premiums and bad debt recoveries, net of finance charge and fee
charge-offs. Gross yield for purposes of estimating fair value does not include
interchange income, or cash advance fees.
(2) Beginning on March 31, 2003 the discount rate on spread account balances has
been reduced by interest income expected to be earned.
At March 31, 2003, the sensitivity of the current fair value of the
retained interests to immediate 10% and 20% adverse changes are as follows (in
millions):
ADVERSE IMPACT ON FAIR VALUE
----------------------------
10% ADVERSE CHANGE 20% ADVERSE CHANGE
------------------ ------------------
Annual discount rate $ 22.6 $ 44.3
Monthly payment rate 193.6 434.3
Gross yield 176.6 358.8
Annual interest expense and servicing fees 31.4 63.9
Annual gross principal default rate 145.5 287.4
17
\
As the sensitivity indicates, the value of the Company's retained
interests on its balance sheet, as well as reported earnings, could differ
significantly if different assumptions or conditions prevail.
NOTE 9 - SECURITIZATION INCOME
The following summarizes "Securitization (expense) income" for the
three month periods ended March 31, 2003 and 2002.
THREE-MONTHS ENDED
MARCH 31,
---------
2003 2002
---- ----
Loss on new securitization of receivables to
the Metris Master Trust $ (19,955) $ (25,070)
(Loss) gain on replenishment of receivables to
the Metris Master Trust (46,254) (14,017)
Discount accretion 75,674 71,027
Change in fair value (83,608) (48,868)
Interest-only revenue 58,436 135,082
Transaction and other costs (22,263) (15,708)
--------- ---------
Securitization (expense) income $ (37,970) $ 102,446
========= =========
NOTE 10 - INCOME TAXES
The components of the (benefit) provision for income taxes consisted of
the following:
THREE-MONTHS ENDED
MARCH, 31
---------
2003 2002
---- ----
Current:
Federal $ (1,991) $(26,428)
State 424 464
-------- --------
(1,567) (25,964)
-------- --------
Deferred:
Federal (41,843) 52,081
State (1,201) 1,734
-------- --------
(43,044) 53,815
-------- --------
Income tax (benefit) expense $(44,611) $ 27,851
======== ========
18
A reconciliation of our effective income tax rate compared to the
statutory federal income tax rate is as follows:
THREE-MONTHS ENDED
MARCH 31,
2003 2002
---- ----
Statutory federal income tax rate 35.0% 35.0%
State income taxes, net of federal
benefit 0.4 2.0
Other, net (0.4) 1.6
---- ----
Effective income tax rate 35.0% 38.6%
==== ====
Our deferred tax assets and liabilities are as follows:
MARCH 31, DECEMBER 31,
2003 2002
---- ----
Deferred income tax assets resulting from future
deductible and taxable temporary differences:
Allowance for loan losses and retained
interests fair value adjustments $196,909 $172,299
Deferred revenues 49,914 59,042
Other 67,581 68,143
-------- --------
Total deferred tax assets 314,404 299,484
Deferred income tax liabilities resulting from future
taxable and deductible temporary differences:
Accrued interest on credit card loans 198,505 207,984
Deferred marketing costs 24,217 35,689
Other 27,813 34,986
-------- --------
Total deferred tax liabilities 250,535 278,659
Net deferred tax assets $ 63,869 $ 20,825
======== ========
In addition to the tax effects of the pre-tax restatement amounts, the
restated presentation also reflects revised probable amounts of future taxable
and deductible temporary differences, resulting in a reclassification of certain
deferred income taxes to current income taxes. The effects of the reclass for
the year ended December 31, 2002 and three-months ended March 31, 2003 amounted
to an addition to deferred income taxes of $16.5 million. Such reclasses did not
result in any adjustment to net income.
The Internal Revenue Service ("IRS") has completed its examination of
the Company's tax returns through December 31, 1998. The IRS has proposed
adjustments to increase the Company's federal income tax by $42.9 million, plus
interest of more than $15 million, pertaining to the Company's treatment of
certain credit card fees as original issue discount ("OID"). Although these fees
are primarily reported as income when billed for financial reporting purposes,
we believe the fees constitute OID and must be deferred and amortized over the
life of the underlying credit card loans for tax purposes. Cumulatively through
March 31, 2003, the Company has deferred approximately $207.8 million in federal
income tax under the OID rules. Any assessment similar to what has been proposed
by the IRS may ultimately require the Company to pay the federal tax plus state
taxes and related interest.
The Company believes its treatment of these fees is appropriate and
continues to work with the IRS to resolve the proposed adjustments. The
Company's position on the treatment of credit card fees is consistent with that
of many other U.S. credit card issuers. We do not expect final settlement or
additional tax to be paid over the next twelve months. However, both the timing
and amount of the final resolution of this matter are uncertain.
19
NOTE 11 - SEGMENTS
We operate in two principal areas: consumer lending products and
enhancement services. Our consumer lending products are primarily unsecured and
secured credit cards, including the Direct Merchants Bank MasterCard(R) and
Visa(R). Our credit cardholders include customers obtained from third-party
lists and other customers for whom general credit bureau information is
available.
We market our enhancement services, including: (1) debt waiver
protection for unemployment, disability, death and family leave; (2) membership
programs such as card registration, purchase protection and other club
memberships; and (3) third-party insurance, directly to our credit card
customers and customers of third parties. We currently administer extended
service plans issued through a third party retailer. These plans are no longer
being sold, and contracts expire by first quarter, 2005. We continue to sell
extended service plans for homeowners through third party distribution
partnerships as well as directly to consumers.
We have presented the segment information reported below on a managed
basis. We use this basis to review segment performance and to make operating
decisions. In doing so, the income statement and balance sheet are adjusted to
reverse the effects of securitizations. Presentation on a managed basis is not
in conformity with accounting principles generally accepted in the United States
of America. The adjustments columns in the segment table include adjustments to
present the information on an owned basis as reported in the financial
statements of this quarterly report.
We do not allocate the expenses, assets and liabilities attributable to
corporate functions to the operating segments, such as employee compensation,
data processing services and communications, third-party servicing expenses, and
other expenses including occupancy, depreciation and amortization, professional
fees, and other general and administrative expenses. We include these expenses
in the reconciliation of the income before income taxes for the reported
segments to the consolidated total. We do not allocate capital expenditures for
leasehold improvements, capitalized software and furniture and equipment to
operating segments. There were no material operating assets located outside of
the United States for the periods presented.
Our enhancement services operating segment pays a fee to our consumer
lending products segment for successful marketing efforts to cardholders at a
rate similar to those paid to our other third parties. Our enhancement services
segment reports interest income and our consumer lending products segment
reports interest expense at our weighted-average borrowing rate for the excess
cash flow generated by the enhancement services segment and used by the consumer
lending products segment to fund the growth of cardholder balances.
20
THREE MONTHS ENDED MARCH 31,
2003
----
CONSUMER
LENDING ENHANCEMENT SECURITIZATION OTHER
PRODUCTS SERVICES ADJUSTMENTS(a) ADJUSTMENTS(b) CONSOLIDATED
-------- -------- -------------- -------------- ------------
Interest
income $ 485,259 $ 29 $ (453,098) $ (29) $ 32,161
Interest expense 64,011 -- (44,641) (29) 19,341
----------- ----------- ----------- ----------- -----------
Net interest
income 421,248 29 (408,457) -- 12,820
Other operating
income 88,142 93,684 (102,155) -- 79,671
Total revenue 509,390 93,713 (510,612) -- 92,491
Income before
income taxes (51,262)(c) 51,316(c) -- (127,495) (127,441)
Total assets $ 9,942,909 $ 60,068 $(8,318,889) $ 739,094(d) $ 2,423,182
21
THREE MONTHS ENDED MARCH 31,
2002
----
CONSUMER
LENDING ENHANCEMENT SECURITIZATION OTHER
PRODUCTS SERVICES ADJUSTMENTS(a) ADJUSTMENTS(b) CONSOLIDATED
-------- -------- -------------- -------------- ------------
Interest
income $ 526,678 $ 2,328 $ (436,834) $ (2,328) $ 89,844
Interest
expense 88,405 -- (53,912) (2,328) 32,165
----------- ----------- ----------- ----------- -----------
Net interest
income 438,273 2,328 (382,922) -- 57,679
Other operating
income 129,971 94,996 32,451 -- 257,418
Total revenue 568,244 97,324 (350,471) -- 315,097
Income before
income taxes 126,701(c) 65,833(c) -- (120,403) 72,131
Total assets $11,133,489 $ 110,471 $(8,231,616) $ 544,980(d) $ 3,557,324
(a) This column reflects adjustments to the Company's internal financial
statements, which are prepared on a managed basis, to eliminate investors'
interests in securitized loans.
(b) The other adjustments column includes: intercompany eliminations and amounts
not allocated to segments.
(c) Income before income taxes includes intercompany commissions paid by the
enhancement services segment to the consumer lending products segment for
successful marketing efforts to cardholders of $3.0 million for the three months
ended March 31, 2003 and $3.3 million for the three months ended March 31, 2002.
(d) Total assets include the assets attributable to corporate functions not
allocated to operating segments and the removal of investors' interests in
securitized loans to present total assets on an owned basis.
NOTE 12 - SUBSEQUENT EVENT
On May 1, 2003, we sold our Arizona facility for cash proceeds of $19.3
million, which approximated its carrying value.
NOTE 13 - SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS
We have various indirect subsidiaries which do not guarantee Company
debt. We have prepared condensed consolidating financial statements of the
Company, the Guarantor subsidiaries and the non-guarantor subsidiaries for
purposes of complying with SEC reporting requirements. Separate financial
statements of the guaranteeing subsidiaries and non-guaranteeing subsidiaries
are not presented because we have determined that the subsidiaries financial
information would not be material to investors.
22
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING BALANCE SHEETS
MARCH 31, 2003 (AS RESTATED)
(DOLLARS IN THOUSANDS)
UNAUDITED (AS RESTATED)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
---- ------------ ------------ ------------ ------------
ASSETS:
Cash and cash equivalents $ (1,538) $ 2,726 $ 534,816 $ -- $ 536,004
Liquidity reserve deposit -- -- 69,221 -- 69,221
Net credit card loans 4,770 -- 556,158 -- 560,928
Retained interest in loans securitized 22,937 -- 782,696 -- 805,633
Property and equipment, net -- 54,806 20,399 -- 75,205
Purchased portfolio premium, net 117 -- 57,966 -- 58,083
Other receivables due from credit card
securitizations, net 8 -- 114,339 -- 114,347
Other assets 30,603 63,199 148,228 (38,269) 203,761
Investment in subsidiaries 1,383,549 1,328,320 -- (2,711,869) --
----------- ----------- ----------- ----------- -----------
TOTAL ASSETS $ 1,440,446 $ 1,449,051 $ 2,283,823 $(2,750,138) $ 2,423,182
=========== =========== =========== =========== ===========
LIABILITIES:
Deposits $ (1,000) $ -- $ 802,498 $ -- $ 801,498
Debt 391,957 9,319 -- (43,000) 358,276
Accounts payable 73 17,377 37,890 (4,860) 50,480
Deferred income -- 12,337 113,485 (2,252) 123,570
Accrued expenses and other liabilities 76,689 26,469 1,630 11,843 116,631
----------- ----------- ----------- ----------- -----------
TOTAL LIABILITIES 467,719 65,502 955,503 (38,269) 1,450,455
----------- ----------- ----------- ----------- -----------
TOTAL STOCKHOLDERS' EQUITY 972,727 1,383,549 1,328,320 (2,711,869) 972,727
----------- ----------- ----------- ----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,440,446 $ 1,449,051 $ 2,283,823 $(2,750,138) $ 2,423,182
=========== =========== =========== =========== ===========
23
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING BALANCE SHEETS
DECEMBER 31, 2002 (AS RESTATED)
(DOLLARS IN THOUSANDS)
UNAUDITED
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
---- ------------ ------------ ------------ ------------
ASSETS:
Cash and cash equivalents $ (3,795) $ 8,109 $ 575,918 $ -- $ 580,232
Net credit card loans 3,813 -- 752,289 -- 756,102
Retained interests in loans securitized -- -- 808,026 -- 808,026
Property and equipment, net -- 63,395 20,436 -- 83,831
Purchased portfolio premium, net 128 -- 64,451 -- 64,579
Other receivables due from credit card
securitizations, net 13 -- 110,458 -- 110,471
Other assets 10,160 44,252 180,591 (47,852) 187,151
Investment in subsidiaries 1,594,352 1,549,307 -- (3,143,659) --
----------- ----------- ----------- ----------- -----------
TOTAL ASSETS $ 1,604,671 $ 1,665,063 $ 2,512,169 $(3,191,511) $ 2,590,392
=========== =========== =========== =========== ===========
LIABILITIES:
Deposits $ (1,000) $ -- $ 893,754 $ -- $ 892,754
Debt 391,228 9,421 -- (43,000) 357,649
Accounts payable 71 20,683 38,949 (6,114) 53,589
Deferred income -- 16,681 129,978 (3,511) 143,148
Accrued expenses and other liabilities 159,699 23,926 (99,819) 4,773 88,579
----------- ----------- ----------- ----------- -----------
TOTAL LIABILITIES 549,998 70,711 962,862 (47,852) 1,535,719
----------- ----------- ----------- ----------- -----------
TOTAL STOCKHOLDERS' EQUITY 1,054,673 1,594,352 1,549,307 (3,143,659) 1,054,673
----------- ----------- ----------- ----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$ 1,604,671 $ 1,665,063 $ 2,512,169 $(3,191,511) $ 2,590,392
=========== =========== =========== =========== ===========
24
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING STATEMENTS OF INCOME
THREE MONTHS ENDED MARCH 31, 2003 (AS RESTATED)
(DOLLARS IN THOUSANDS)
UNAUDITED (AS RESTATED)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
---- ------------ ------------ ------------ ------------
NET INTEREST INCOME (EXPENSE) $ (8,706) $ (818) $ 22,344 $ -- $ 12,820
Provision for loan losses 846 -- 43,776 164 44,786
--------- --------- --------- --------- ---------
NET INTEREST EXPENSE AFTER PROVISION FOR
LOAN LOSSES (9,552) (818) (21,432) (164) (31,966)
--------- --------- --------- --------- ---------
OTHER OPERATING INCOME:
Securitization income and servicing
income (10,011) -- 20,533 (679) 9,843
Credit card fees, interchange and other
credit card income 55 12,543 26,451 (12,730) 26,319
Income from discontinued operations -- 8,998 (8,998) -- --
Enhancement services revenues -- 181 47,081 (3,753) 43,509
Intercompany allocations 75 65,606 9,991 (75,672) --
--------- --------- --------- --------- ---------
(9,881) 87,328 95,058 (92,834) 79,671
--------- --------- --------- --------- ---------
OTHER OPERATING EXPENSE:
Credit card account and other product
solicitation and marketing expenses -- 12,222 33,754 (12,288) 33,688
Employee compensation -- 51,211 2,170 -- 53,381
Data processing services and
communications (1) (21,987) 44,651 (3,485) 19,178
Credit protection claims expense -- 109 12,197 -- 12,306
Occupancy and equipment -- -- 9,613 -- 9,613
Purchased portfolio premium
amortization 11 -- 7,697 (1,212) 6,496
MasterCard/Visa assessment and fees -- -- 2,415 -- 2,415
Credit card fraud losses 1 -- 939 -- 940
Asset impairments, lease write-offs and
severance -- -- 16,777 -- 16,777
Other 84 39,098 (18,830) -- 20,352
Intercompany allocations 11 25,626 50,035 (75,672) --
--------- --------- --------- --------- ---------
106 106,279 161,418 (92,657) 175,146
--------- --------- --------- --------- ---------
LOSS BEFORE INCOME TAX BENEFIT AND
EQUITY IN LOSS OF SUBSIDIARIES (19,539) (19,769) (87,792) (341) (127,441)
Income tax benefit (1,439) (8,120) (34,935) (117) (44,611)
Equity in loss of subsidiaries (64,730) (52,857) -- 117,587 --
--------- --------- --------- --------- ---------
NET LOSS $ (82,830) $ (64,506) $ (52,857) $ 117,363 $ (82,830)
========= ========= ========= ========= =========
25
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING STATEMENTS OF INCOME
THREE MONTHS ENDED MARCH 31, 2002 (AS RESTATED)
(DOLLARS IN THOUSANDS)
UNAUDITED (AS RESTATED)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
---- ------------ ------------ ------------ ------------
Net Interest (Expense) Income $ (5,482) $ (1,395) $ 64,556 $ -- $ 57,679
Provision for loan losses 65 -- 61,811 -- 61,876
--------- --------- --------- --------- ---------
Net Interest Expense After Provision for
Loan Losses (5,547) (1,395) 2,745 -- (4,197)
--------- --------- --------- --------- ---------
Other Operating Income:
Securitization income and servicing
income 35 -- 147,450 -- 147,485
Credit card fees, interchange and other
credit card income 264 7,923 73,906 (6,434) 75,659
Income from discontinued operations -- 15,889 (15,889) -- --
Enhancement services revenues -- 275 33,999 -- 34,274
Intercompany allocations 30 53,073 9,661 (62,764) --
--------- --------- --------- --------- ---------
329 77,160 249,127 (69,198) 257,418
--------- --------- --------- --------- ---------
OTHER OPERATING EXPENSE:
Credit card account and other product
solicitation and marketing expenses -- 2,660 44,593 -- 47,253
Employee compensation 404 49,168 6,976 -- 56,548
Data processing services and
communications 23 (19,562) 45,211 (3,366) 22,306
Credit protection claims expense -- 56 9,123 -- 9,179
Occupancy and equipment -- -- 12,797 -- 12,797
Purchased portfolio premium
amortization -- -- 9,362 (907) 8,455
MasterCard/Visa assessment and fees -- -- 3,834 -- 3,834
Credit card fraud losses (8) -- 2,236 -- 2,228
Other 44 26,309 (5,903) (1,960) 18,490
Intercompany allocations (509) 18,078 45,195 (62,764) --
--------- --------- --------- --------- ---------
(46) 76,709 173,424 (68,997) 181,090
--------- --------- --------- --------- ---------
(LOSS) INCOME BEFORE INCOME TAXES AND
EQUITY IN (LOSS) INCOME OF SUBSIDIARIES (5,172) (944) 78,448 (201) 72,131
Income taxes (1,989) (1,430) 31,270 -- 27,851
Equity in income of subsidiaries 47,463 47,178 -- (94,641) --
--------- --------- --------- --------- ---------
NET INCOME $ 44,280 $ 47,664 $ 47,178 $ (94,842) $ 44,280
========= ========= ========= ========= =========
26
METRIS COMPANIES INC.
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2003 (AS RESTATED)
(DOLLARS IN THOUSANDS)
UNAUDITED (AS RESTATED)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
---- ------------ ------------ ------------ ------------
OPERATING ACTIVITIES:
Net cash (used in) provided by operating
activities $(107,278) $ (78,724) $(123,213) $ 117,363 $(191,852)
--------- --------- --------- --------- ---------
INVESTING ACTIVITIES:
Proceeds from transfers of portfolios to
Metris Master Trust -- -- 205,560 -- 205,560
Net cash from loan originations and
principal collections on loans
receivable (34,727) -- 67,126 -- 32,399
Additions to property and equipment -- 1,534 (2,035) -- (501)
Investment in subsidiaries 142,738 218,206 70,846 (431,790) --
--------- --------- --------- --------- ---------
Net cash provided by investing activities 108,011 219,740 341,497 (431,790) 237,458
--------- --------- --------- --------- ---------
FINANCING ACTIVITIES:
Net increase (decrease) in debt 729 (102) -- -- 627
Net decrease in deposits -- -- (91,256) -- (91,256)
Proceeds from issuance of common stock 795 -- -- -- 795
Capital contributions -- (146,297) (168,130) 314,427 --
--------- --------- --------- --------- ---------
Net cash (used in) provided by financing
activities 1,524 (146,399) (259,386) 314,427 (89,834)
--------- --------- --------- --------- ---------
Net (decrease) increase in cash and cash
equivalents 2,257 (5,383) (41,102) -- (44,228)
Cash and cash equivalents at beginning
of period (3,795) 8,109 575,918 -- 580,232
--------- --------- --------- --------- ---------
Cash and cash equivalents at end of
period $ (1,538) $ 2,726 $ 534,816 $ -- $ 536,004
========= ========= ========= ========= =========
27
METRIS COMPANIES INC.
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2002 (AS RESTATED)
(DOLLARS IN THOUSANDS)
UNAUDITED (AS RESTATED)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
---- ------------ ------------ ------------ ------------
OPERATING ACTIVITIES:
Net cash provided by operating activities $ 124,353 $ 28,317 $ 118,780 $ (94,842) $ 176,608
--------- --------- --------- --------- ---------
INVESTING ACTIVITIES:
Proceeds from transfers of portfolios to
the Metris Master Trust -- -- 619,554 -- 619,554
Net cash from loan originations and
principal collections on loans
receivable (7,873) -- (220,537) -- (228,410)
Additions to property and equipment -- (3,328) (317) -- (3,645)
Investment in subsidiaries (112,527) (42,492) 24,361 130,658 --
--------- --------- --------- --------- ---------
Net cash (used in) provided by investing
activities (120,400) (45,820) 423,061 130,658 387,499
--------- --------- --------- --------- ---------
FINANCING ACTIVITIES:
Increase (decrease) in debt 222 (196) (292,000) -- (291,974)
Decrease in deposits -- -- (332,122) -- (332,122)
Cash dividends paid (938) -- -- -- (938)
Proceeds from issuance of common stock 1,823 -- -- -- 1,823
Repurchase of common stock (17,582) -- -- -- (17,582)
Capital contributions -- 18,064 17,752 (35,816) --
--------- --------- --------- --------- ---------
Net cash used in financing activities (16,475) 17,868 (606,370) (35,816) (640,793)
--------- --------- --------- --------- ---------
Net (decrease) increase in cash and cash
equivalents (12,522) 365 (64,529) -- (76,686)
Cash and cash equivalents at beginning
of period 17,614 1,505 362,520 -- 381,639
--------- --------- --------- --------- ---------
Cash and cash equivalents at end of
period $ 5,092 $ 1,870 $ 297,991 $ -- $ 304,953
========= ========= ========= ========= =========
28
ITEM 2.
METRIS COMPANIES INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides information management
believes to be relevant to understanding the financial condition and results of
operations of Metris Companies Inc. ("MCI") and its subsidiaries. MCI's
principal subsidiaries are Direct Merchants Credit Card Bank, National
Association ("Direct Merchants Bank" or the "Bank"), Metris Direct, Inc. and
Metris Receivables, Inc. MCI and its subsidiaries, as applicable, may be
referred to as "we," "us," "our" or the "Company." You should read this
discussion along with the following documents for a full understanding of our
financial condition and results of operations: Management's Discussion and
Analysis of Financial Condition and Results of Operations in our Annual Report
on Form 10-K/A for the fiscal year ended December 31, 2002, filed concurrently
with this Quarterly Report on Form 10-Q/A; and our Proxy Statement for the 2003
Annual Meeting of Stockholders. In addition, you should read this discussion
along with our condensed consolidated financial statements and related notes
thereto for the period ended March 31, 2003.
RESTATEMENTS
The consolidated statements of income as presented for the three-month
periods ended March 31, 2003 and 2002 and the consolidated balance sheets as of
March 31, 2003 and December 31, 2002 have been restated to reflect the
following:
- The valuation model and related collateral assumptions used to
estimate the fair value of the Company's "Retained interests in
loans securitized" did not properly reflect the structure of the
Metris Master Trust and related series supplements. All periods
presented have been restated to reflect the changes in the
valuation model and the related collateral assumptions. These
restatements impact "Retained interests in loans securitized,"
"Other receivables due from credit card securitizations, net" and
"Securitization income."
- The Company's policy for recognizing transaction costs related to
the securitization of receivables through the Metris Master Trust
or a conduit was not in accordance with GAAP. Historically, these
costs had been capitalized and amortized over the estimated life of
the new debt securities. These costs are now allocated and
recognized over the initial and reinvestment periods of the
respective debt securities or Metris Master Trust financing unless
the transaction results in a loss, in which case the costs are
expensed as incurred. All periods presented have been restated to
reflect the revised policy. These restatements impact "Other
assets" and "Securitization income."
- The Company's policy for recognizing expenses related to credit
card solicitation costs was not in accordance with GAAP.
Historically, the Company had capitalized and expensed these costs
over the estimated period over which the new credit card accounts
were established, approximately three months. These costs are now
expensed as incurred. All periods presented have been restated to
reflect the revised policy. This restatement impacts "Other assets"
and "Credit card account and other product solicitation and
marketing expenses."
- The Company corrected its accounting for interest rate caps
purchased in May of 2002 and forward to comply with SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities," as
amended, on January 1, 2001. These costs had been deferred and
amortized over the estimated life of the new debt securities. These
instruments are now recorded at fair value. Periods from May 2002
forward have been restated to reflect this correction. This
restatement impacts "Retained interests in loans securitized,"
"Other assets" and "Securitization income."
29
- The Company historically recognized revenue in the month following
completion of the cancellation period, generally one month. Cash
flows related to debt waiver are now included in the valuation of
the interest-only strip receivable. All periods presented have been
restated to reflect the revised policy. This restatement impacts
"Retained interests in loans securitized," "Deferred revenue,"
"Enhancement services revenue," and "Securitization income."
- At December 31, 2001 we had $50 million of "Allowance for loan
losses" classified as valuation reserve in our "Retained interests
in loans securitized." The valuation reserve was subsequently
transferred to "Allowance for loan losses" through "Provision for
loans losses" during the first quarter of 2002. We have restated
the December 31, 2001 balance sheet and 2001 income statement and
March 31, 2002 income statement to reflect this transfer occurring
during the fourth quarter of 2001. This restatement impacts
"Allowance for loan losses," "Retained interests in loans
securitized," "Provision for loan losses" and "Securitization
income."
In addition, we have restated certain prior-period amounts to conform
with the current period's presentation.
- In prior periods, we classified interest income, provision for loan
losses, and related credit card loan fees generated from retained
interests in loans securitized on the income statement as "Interest
income-credit card loans" and "Retained interests in loans
securitized," "Provision for loan losses" and "Credit card fees,
interchange and other credit card income." For all periods
presented, these amounts are now included in the estimation of the
fair value of the interest-only strip receivable and
"Securitization income."
- In prior periods we classified spread accounts receivable in "Other
receivables due from credit card securitizations, net." For all
periods presented, we have reclassified our spread accounts
receivable from "Other receivables due from credit card
securitizations, net" to "Retained interests in loans securitized."
- In prior periods, we classified servicing income in "Net
securitization and credit card servicing income." For all periods
presented, we have reclassified these amounts to "Servicing
income."
- In prior periods, income from our debt waiver product sold to
customers of Direct Merchants Bank with receivables held by Direct
Merchants Bank was included in "Enhancement services revenue." For
all periods presented we have reclassified this income to "Credit
card fees, interchange, and other credit card income."
- We classified the liquidity reserve deposit established in March
2003 and other restricted cash deposits maintained at Direct
Merchants Bank as "Short-term investments." We have reclassified
these items to "Liquidity reserve deposit" for all periods
presented.
- Revenue related to our membership club and warranty business for
current and prior periods is classified as "Enhancement services
revenue." Claims expense related to this business has been
reclassified as "Other" expenses for all periods presented.
- In addition to the tax effects of the pre-tax restatement amounts,
the restated presentation also reflects revised probable amounts of
future taxable and deductible temporary differences, resulting in a
reclassification of certain deferred income taxes to current income
taxes.
30
RESULTS OF OPERATIONS
Net loss for the three months ended March 31, 2003 was $82.8 million,
down from net income of $44.3 million for the first quarter of 2002. Diluted
loss per share for the three months ended March 31, 2003 was $(1.62) compared to
diluted earnings per share of $0.46 for the first quarter of 2002. The decrease
in net income is primarily due to a decrease in net interest income and other
operating income, partially offset by a decrease in the provision for loan
losses and other operating expense.
Net interest income decreased from $57.7 million for the three months
ended March 31, 2002 to $12.8 million for the three months ended March 31, 2003.
The decrease is primarily due to a decrease in average interest-earning assets
of $1.4 billion and a 460 basis point reduction in net interest margin. The
decrease in average interest-earning assets is primarily due to the transfer of
$1.9 billion of receivables to the Metris Master Trust (the "Master Trust")
since March 31, 2002. The decrease in margin is primarily due to a $1.7 billion
reduction in average credit card loans, which has resulted in short-term, lower
yielding investments increasing to 47% of average interest-earning assets,
versus 11% in the first quarter of 2002.
The provision for loan losses was $44.8 million in the first quarter of
2003 compared to $61.9 million in the first quarter of 2002. The decrease is
primarily due to significantly lower credit card receivables. Lower credit card
loan balances, decreased net principal charge-offs, and recent delinquency
trends were all factors considered by management in determining the necessary
balance in the allowance for loan losses.
Other operating income decreased 69.0% to $79.7 million for the three
months ended March 31, 2003 from $257.4 million for the same period in 2002.
Securitization income, a component of other operating income, decreased to an
expense of $38.0 million for the first quarter of 2003 from income of $102.4
million for the same period in 2002. The decrease was primarily due to a $76.6
million reduction in interest only revenue as a result of an increased default
rate on securitized receivables, a $32.2 million increase in loss on
replenishment of receivables for the Metris Master Trust, and $34.7 million of
additional change in market value losses booked in the first quarter of 2003.
Credit card fees, interchange and other credit card income decreased to $26.3
million for the three months ended March 31, 2003, compared to $75.7 million for
the same period in 2002. The decrease in credit card fees, interchange and other
credit card income is primarily due to the reduction of our credit card
portfolio. In addition, effective June 2002, we also amended the Master Trust
core transaction documents, which resulted in interchange income earned on
receivables held by the Master Trust being recorded as contribution to the
excess spread earned.
Total other operating expenses for the three months ended March 31,
2003, decreased $5.9 million over the comparable period in 2002. Credit card
account and other product solicitation and marketing expenses decreased $13.6
million for the three months ended March 31, 2003, largely due to fewer new
credit card accounts partially offset by increased enhancement services
marketing. Employee compensation decreased $3.2 million for the three months
ended March 31, 2003, due to decreased staffing needs. Data processing services
and communications decreased $3.1 million for the three months ended March 31,
2003, primarily due to a reduction in our credit card portfolio. These decreases
were partially offset by credit protection claims expense increases of $3.1
million for the three months ended March 31, 2003, primarily due to an increase
in interest forgiven claims on our debt waiver products, approximately $12.0
million of write-downs of excess property, equipment, and operating leases and a
$4.8 million charge for a workforce reduction were recorded in the first quarter
of 2003.
31
Net Interest Income
Net interest income consists primarily of interest earned on our credit
card loans, less interest expense on borrowings to fund loans. Table 1 provides
an analysis of interest income and expense, net interest spread, net interest
margin and average balance sheet data for the three month periods ended March
31, 2003 and 2002.
TABLE 1: ANALYSIS OF AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS AND RATES
(Dollars in thousands)
THREE MONTHS ENDED MARCH 31,
2003 2002
------------------------------------------------------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ---- ------- -------- ----
ASSETS:
Interest-earning assets:
Federal funds sold $ 117,654 $ 359 1.2% $ 28,431 $ 114 1.6%
Short-term investments 480,628 1,722 1.4% 271,628 1,204 1.8%
Liquidity Reserve Deposit 58,707 173 1.2% -- -- --
Credit card loans 751,674 29,907 16.1% 2,502,417 88,526 14.3%
----------- ----------- ------- ----------- ----------- ---------
Total interest-earning assets $ 1,408,663 $ 32,161 9.3% $ 2,802,476 $ 89,844 13.0%
Other assets 1,411,030 -- -- 1,518,227 -- --
Allowances for loan -- -- -- --
losses (106,909) -- -- (407,868)
----------- -----------
Total assets $ 2,712,784 -- -- $ 3,912,835 -- --
=========== ===========
LIABILITIES AND EQUITY:
Interest-bearing liabilities:
Deposits $ 839,491 $ 10,908 5.3% $ 1,929,909 $ 23,653 5.0%
Debt 389,640 8,433 8.8% 451,480 8,512 7.6%
----------- ----------- ------- ----------- ----------- ---------
Total interest-bearing
liabilities $ 1,229,131 $ 19,341 6.4% $ 2,381,389 $ 32,165 5.5%
Other liabilities 467,612 -- -- 399,416 -- --
----------- -----------
Total liabilities 1,696,743 -- -- 2,780,805 -- --
Stockholders' equity 1,016,041 -- -- 1,132,031 -- --
----------- -----------
Total liabilities and equity $ 2,712,784 -- -- $ 3,912,836 -- --
=========== ===========
Net interest income and
interest margin (1) -- $ 12,820 3.7% -- $ 57,679 8.3%
Net interest rate spread (2) -- -- 2.9% -- -- 7.5%
Return on average assets -- -- N/A -- -- 5.4%
Return on average total equity -- -- N/A -- -- 18.8%
(1) We compute "net interest margin" by dividing annualized net interest income
by average total interest-earning assets.
(2) The "net interest rate spread" is the annualized yield on average
interest-earning assets minus the annualized funding rate on average
interest-bearing liabilities.
Net interest income decreased from $57.7 million for the three months
ended March 31, 2002 to $12.8 million for the three months ended March 31, 2003.
The decrease is primarily due to a decrease in average interest-earning assets
of $1.4 billion and a 460 basis point reduction in net interest margin. The
decrease in average interest-earning assets is primarily due to the transfer of
$1.9 billion of receivables to the Master Trust since March 31, 2002. The
decrease in margin is primarily due to a $1.7 billion reduction in average
credit card loans, which has resulted in short-term, lower yielding investments
increasing to 47% of average interest-earning assets, versus 11% in the first
quarter of 2002.
32
OTHER OPERATING INCOME
Other operating income of $79.7 million for the quarter ended March 31,
2003 decreased by $177.7 million as compared to the same period in 2002.
Securitization expense of $38.0 million was $140.4 less than the securitization
income of $102.4 for the period ended March 31, 2002. Credit card fees,
interchange, and other credit card income was $49.3 million lower than the same
period in 2002. These negative variances were partially offset by a $9.2 million
increase in Enhancement services revenue.
"Securitization (expense) income" was ($38.0) million for the
three-months ended March 31, 2003, compared to $102.4 million for the same
period in 2002. The following table details "Securitization (expense) income"
for the three-month period ended March 31, 2003 and 2002.
TABLE 2: ANALYSIS OF SECURITIZATION (EXPENSE) INCOME
(DOLLARS IN THOUSANDS)
THREE-MONTHS ENDED
MARCH 31,
---------
2003 2002
---- ----
Loss on new securitization of receivables to
the Metris Master Trust $ (19,955) $ (25,070)
Loss on replenishment of receivables to
the Metris Master Trust (46,254) (14,017)
Discount accretion 75,674 71,027
Change in fair value (83,608) (48,868)
Interest-only revenue 58,436 135,082
Transaction and other costs (22,263) (15,708)
--------- ---------
Securitization income $ (37,970) $ 102,446
========= =========
The significant decrease in "Securitization income" in the first
quarter of 2003 compared to 2002 reflects a $76.6 million reduction in
interest-only revenue due to a 522 basis point decrease in average excess spread
in the Metris Master Trust during this period, partially offset by a $858.8
million increase in average principal receivables held in the Metris Master
Trust. In addition, net loss on securitization of receivables was $27.1 million
higher than the first quarter of 2002, and there was a $34.7 million increase in
fair value write-downs due primarily to changes in excess spreads, quarter over
quarter.
"Credit card fees, interchange, and other credit card income" was $26.3
million compared to $75.7 million for the three-months ended March 31, 2003, and
2002, respectively. The decrease for the three-month period is primarily due to
a decrease in average "Credit card loans" of $1.7 billion for the three-month
period. In addition, effective June 2002, we amended the Metris Master Trust
core transaction documents, which resulted in interchange income earned on
receivables held by the Metris Master Trust being recorded as contribution to
the excess spread earned.
33
Enhancement services revenues increased by $9.2 million for the
three-months ended March 31, 2003, compared to the three-months ended March 31,
2002. This increase was primarily due to increased enrollments in existing
membership products and enrollments from new membership products.
TABLE 3: ENHANCEMENT SERVICES REVENUES AND ACTIVE MEMBERSHIPS (In thousands)
Three Months Ended
March 31,
---------
2003 2002
---- ----
Revenues
Credit Protection Products $ 801 $ 961
Membership Program Products 30,554 17,160
Warranty / Other 12,154 16,153
------- -------
Total $43,509 $34,274
======= =======
Active Memberships
March 31, December 31, March 31,
2003 2002 2002
---- ---- ----
Credit Protection Products 827 905 1,080
Membership Program Products 3,057 3,248 2,947
Warranty / Other 815 941 1,560
----- ----- -----
Total 4,699 5,094 5,587
===== ===== =====
OTHER OPERATING EXPENSE
Total other operating expenses for the three months ended March 31,
2003, decreased $5.9 million over the comparable period in 2002. Credit card
account and other product solicitation and marketing expenses decreased $13.6
million for the three months ended March 31, 2003, largely due to fewer new
credit card accounts partially offset by increased enhancement services
marketing. Employee compensation decreased $3.2 million for the three months
ended March 31, 2003, due to decreased staffing needs. Data processing services
and communications decreased $3.1 million for the three months ended March 31,
2003, primarily due to a reduction in our credit card portfolio. These decreases
were partially offset by credit protection claims expense increases of $3.1
million for the three months ended March 31, 2003, primarily due to an increase
in interest forgiven claims on our debt waiver products, and approximately $12.0
million of write-downs of excess property, equipment, and operating leases and a
$4.8 million charge for a workforce reduction were recorded in the first quarter
of 2003.
ASSET QUALITY
Our delinquency and net loan charge-off rates at any point in time
reflect, among other factors, the credit risk of loans, the average age of our
various credit card account portfolios, the success of our collection and
recovery efforts, and general economic conditions. The average age of our credit
card portfolio affects the stability of delinquency and loss rates. In order to
minimize losses, we continue to focus our resources on refining our credit
underwriting standards for new accounts, and on collections and post charge-off
recovery efforts. At March 31, 2003, 58% of our outstanding receivables balance
were from credit card accounts that have been with us in excess of two years,
and 21% of outstanding receivables were with us in excess of four years.
34
We use credit line analyses, account management and customer
transaction authorization procedures to minimize loan losses. Our risk models
determine initial credit lines at the time of underwriting. We manage credit
lines on an ongoing basis and adjust them based on customer usage and payment
patterns. We continually monitor customer accounts and initiate appropriate
collection activities when an account is delinquent or overlimit.
Delinquencies
It is our policy to accrue interest and fee income on all credit card
accounts, except in limited circumstances, until we charge-off the account. In
November 2002, we stopped billing late fees once an account became 120 days
contractually delinquent and in March 2003, we stopped billing overlimit fees
once an account became 120 days contractually delinquent. These changes will not
have a material effect on our financial results. Past due accounts are re-aged
to current status only after we receive at least three minimum payments or the
equivalent cumulative amount. Accounts can only be re-aged to current status
once every twelve months and two times every five years. Accounts entering
long-term fixed payment forbearance programs ("workout re-age") may receive a
workout re-age upon entering the Debt Management Program. Workout re-ages can
only occur after receipt of at least three consecutive minimum monthly payments,
or the equivalent cumulative amount as defined by the Debt Management Program.
Workout re-ages can only occur once in five years. This is in accordance with
FFIEC guidance. Table 3 presents the delinquency trends of our credit card loan
portfolio.
TABLE 4: LOAN DELINQUENCY
(Dollars in thousands)
MARCH 31, % OF DECEMBER 31, % OF MARCH 31, % OF
2003 TOTAL 2002 TOTAL 2002 TOTAL
---- ----- ---- ----- ---- -----
Loans outstanding $ 686,285 100% $ 846,417 100% $ 2,219,800 100%
Loans contractually
delinquent:
30 to 59 days 20,921 3.0% 1,673 0.2% 55,101 2.5%
60 to 89 days 18,390 2.7% 2,121 0.2% 38,023 1.7%
90 or more days 17,108 2.5% 4,082 0.5% 133,223 6.0%
---------- --- ------------ --- ----------- ----
Total $ 56,419 8.2% $ 7,876 0.9% $ 226,347 10.2%
========== === ============ === =========== ====
The decrease in the delinquency rates as of March 31, 2003 and December
31, 2002 compared to March 31, 2002, primarily reflects the sale of
approximately $120 million delinquent receivables during September and December
2002.
Net Charge-Offs
Net charge-offs are the principal amount of losses from cardholders
unwilling or unable to make minimum payments, bankrupt cardholders and deceased
cardholders, less current period recoveries. Net charge-offs exclude accrued
finance charges and fees, which are charged-off against the applicable income
statement line item at the time of charge-off. We charge-off and take accounts
as a loss either within 60 days after formal notification of bankruptcy, at the
end of the month during which most unsecured accounts become contractually 180
days past due, at the end of the month during which unsecured accounts that have
entered into a credit counseling or other similar program and later become
contractually 120 days past due, or at the end of the month during which secured
accounts become contractually 120 days past due after first reducing the loss by
the secured deposit.
Charge-offs due to bankruptcies were $5.5 million, representing 63.8%
of total gross charge-offs as of March 31, 2003 and $25.3 million, representing
28.5% of total gross charge-offs as of March 31, 2002. We charge-off accounts
that are identified as fraud losses no later than 90 days after the last
activity. We enter into forward flow agreements with third parties for the sale
of a majority of charged-off accounts. We also refer charged-off accounts to our
recovery unit for coordination of collection efforts to recover the amounts
owed. When appropriate, we place accounts with external collection agencies or
attorneys.
35
TABLE 5: NET CHARGE-OFFS
(Dollars in thousands)
THREE MONTHS ENDED
MARCH 31,
---------
2003 2002
---- ----
Average credit card loans $ 751,674 $ 2,502,417
Net charge-offs 8,289 83,678
Net charge-off ratio 4.5% 13.4%
=========== ===========
The decrease in the net charge-off ratios for the three months ended
March 31, 2003 is primarily due to the sale of approximately $120 million
delinquent receivables during September and December 2002.
Provision and Allowance for Loan Losses
We record provisions for loan losses in amounts necessary to maintain
the allowance at a level sufficient to absorb anticipated probable loan losses
inherent in the existing loan portfolio as of the balance sheet date.
The economy has exhibited a significant slowdown over the last two
years. Some of the actions we are taking to mitigate this slowdown include
expanding our collections strategies to aggressively address any potential
delinquency increases. We also leverage forbearance programs and credit
counseling services for qualifying cardholders that are experiencing payment
difficulties. These programs include reduced interest rates, reduced or
suspended fees and other incentives to induce the customer to continue making
payments. The amount of customer receivables in debt forbearance programs was
$35.3 million or 5% of total credit card loans as of March 31, 2003, compared to
$34.7 million or 4% of total credit card loans as of December 31, 2002. All
delinquent receivables in debt forbearance programs are included in Table 4.
The provision for loan losses was $44.8 million for the three months
ended March 31, 2003, compared to a provision of $61.9 million for the three
months ended March 31, 2002. The decrease in the provision for loan losses in
2003 compared to 2002 is primarily due to lower credit card loan balances and
decreased net principal charge-offs due to the sale of delinquent receivables.
The allowance for loan losses was $125.4 million as of March 31, 2003, versus
$90.3 million as of December 31, 2002. Our roll-rate models, including
management contingency, indicated our required allowance for loan losses was in
the range of $110 million to $125 million as of March 31, 2003, versus $75
million to $90 million as of December 31, 2002. The ratio of allowance for loan
losses to period-end credit card loans was 18.3% at March 31, 2003, compared to
10.7% at December 31, 2002. The allowance for loan losses as a percentage of
30-day plus receivables was 222.2% at March 31, 2003, compared to 1,146.7% at
December 31, 2002.
We believe the allowance for loan losses is adequate to cover probable
future losses inherent in the loan portfolio under current conditions. However,
we cannot give assurance as to future credit losses that may be incurred in
connection with our loan portfolio, nor can we provide assurance that the
established allowance for loan losses will be sufficient to absorb future
losses.
Valuation of Retained Interests in Loans Securitized
Our credit card receivables are primarily funded through asset
securitizations. Upon securitization, the Company removes the applicable credit
card loans from the balance sheet and recognizes the "Retained interests in
loans securitized" at their allocated carrying value in accordance with SFAS No.
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities-a replacement of FASB Statement No. 125" ("SFAS
No. 140"). Credit card receivables are sold to the Metris Master Trust at the
inception of a securitization series. We also sell Credit card receivables to
the Metris Master Trust on a daily basis to replenish receivable balances that
have decreased due to payments and charge-offs. The difference between the
allocated carrying value and the proceeds from the assets sold
36
is recorded as a gain or loss on sale and is included in "Securitization
(expense) income." At the same time, the Company recognizes the "Retained
interests in loans securitized."
The "Retained interests in loans securitized" are financial assets
measured at fair value consistent with trading securities in accordance with
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and includes the contractual retained interests, an interest-only
strip receivable, excess transferor's interests and spread accounts receivable.
The contractual retained interests consist of non-interest bearing securities
held by the Company. The interest-only strip receivable represents the present
value of the excess of the estimated future interest and fee collections
expected to be generated by the securitized loans over the period the
securitized loans are projected to be outstanding above the interest paid on
investor certificates, credit losses, contractual servicing fees, and other
expenses. The excess transferor's interests represent principal receivables held
in the Metris Master Trust over the contractual retained interests. Spread
accounts receivable represents restricted cash reserve accounts held by the
Metris Master Trust that can be used to fund payments due to securitization
investors and credit enhancers if cash flows are insufficient. Cash held in
spread accounts is released to us if certain conditions are met or a
securitization series terminates with amounts remaining in the spread accounts.
The fair value of the "Retained interests in loans securitized" is determined
through estimated cash flows discounted at rates that reflect the level of
subordination, the projected repayment term, and the credit risk of the
securitized loans.
The following summarizes our "Retained interests in loans securitized"
as of March 31, 2003 and December 31, 2002.
TABLE 6: RETAINED INTERESTS IN LOANS SECURITIZED
(In thousands):
MARCH 31, DECEMBER 31,
2003 2002
---- ----
Contractual retained interests $ 627,997 $ 685,197
Excess transferor's interests 52,247 57,447
Interest-only strip receivable 1,531 13,882
Spread accounts receivable 123,858 51,500
---------- ------------
Retained interests in loans securitized $ 805,633 $ 808,026
========== ============
"Retained interests in loans securitized" decreased by $2.4 million
between December 31, 2002, and March 31, 2003, to $805.6 million. The decrease
is primarily due to a $57.2 million decrease in contractual retained interests
and a $12.4 million decrease in interest-only strip receivables offset by a
$72.4 million increase in spread accounts receivable.
The interest-only strip receivable decreased to $1.5 million as of
March 31, 2003, from $13.9 million as of December 31, 2002, due to lower
projected excess spreads from the receivables held in the Metris Master Trust.
The projected excess spreads have decreased primarily due to higher than
expected principal default rates. Spread accounts receivable increased over
December 31, 2002, as all excess spread earned on receivables held in the Metris
Master Trust is being restricted from release to the Company due to the
performance of the receivables. For more information on restricted cash see the
Liquidity, Funding and Capital Resources section of the Management Discussion
and Analysis on pages 29 through 52.
At least quarterly, the Company adjusts the valuation of the "Retained
interests in loans securitized" to reflect changes in the amount and expected
timing of future cash flows. The significant factors that affect the timing and
amount of cash flows relate to the collateral assumptions, which include payment
rate, default rate, gross yield and discount rate. These values can, and will,
vary as a result of changes in the amount and timing of the cash flows and the
underlying economic assumptions. The components of retained interests are
recorded at their fair value. (See Critical Accounting Policies on page 39 for
more information on the valuation of the retained interests). The significant
assumptions used for estimating the fair value of the "Retained interests in
loans securitized" are as follows:
37
TABLE 7: SIGNIFICANT ASSUMPTIONS USED FOR ESTIMATING THE FAIR VALUE OF RETAINED
INTERESTS
MARCH 31, DECEMBER 31,
2003 2002
---- ----
Monthly payment rate 6.7% 6.7%
Gross yield (1) 26.0% 26.0%
Annual interest expense and servicing fees 4.0% 4.0%
Annual gross principal default rate 22.7% 21.7%
Discount rate:
Contractual retained interests 16.0% 16.0%
Excess transferor's interests 16.0% 16.0%
Interest-only strip receivable 30.0% 30.0%
Spread accounts receivable (2) 15.0% 16.0%
(1)Includes expected cash flows from finance charges, late and overlimit fees,
debt waiver premiums and bad debt recoveries, net of finance charge and fee
charge-offs. Gross yield for purposes of estimating fair value does not include
interchange income, or cash advance fees.
(2) Beginning on March 31, 2003 the discount rate on spread account balances has
been reduced by interest income expected to be earned.
38
BALANCE SHEET ANALYSIS
Cash and Cash Equivalents
Cash and cash equivalents decreased $44.2 million to $536.0 million as
of March 31, 2003, compared to $580.2 million as of December 31, 2002. The
decrease is primarily due to the establishment of a Liquidity Reserve Deposit
required by the Company's Operating Agreement with the OCC as described on page
46.
Credit Card Loans
Credit card loans were $686.3 million as of March 31, 2003, compared to
$846.4 million as of December 31, 2002. The $160.1 million decrease is primarily
a result of the transfer of $204.5 million of receivables from Direct Merchants
Bank to the Master Trust.
Deposits
Deposits decreased $91.3 million to $801.5 million as of March 31,
2003, from $892.8 million as of December 31, 2002. The decrease relates to a
shift in funding from CDs to off-balance sheet asset-backed securitizations.
Under an operating agreement with the Office of the Comptroller of the
Currency ("OCC"), the Company has agreed to reduce receivables at Direct
Merchants Bank to no more than $550 million by December 31, 2003, and to zero by
December 31, 2004. As a result, we do not anticipate issuing jumbo CDs in the
foreseeable future.
Deferred Income
Deferred income decreased $19.5 million to $123.6 million as of March
31, 2003 compared to $143.1 million as of December 31, 2002. The decrease
primarily relates to declining enhancement services enrollments, our migration
from annual-billed to monthly-billed enhancement service products and the
run-off of the ServiceEdge(R) portfolio.
CRITICAL ACCOUNTING POLICIES
The Company's most significant accounting estimates are our
determination of the "Allowance for loan losses" and the valuation of "Retained
interests in loans securitized."
Allowance for Loan Losses
We maintain an "Allowance for loan losses" sufficient to absorb
probable loan losses inherent in the credit card loan portfolio as of the
balance sheet date. The "Allowance for loan losses" results in a reserve
approximating 18 months future charge-offs for subprime receivables and 13
months future charge-offs for prime receivables. At the time of charge-off, all
principal balances are written off against the allowance and all fees and
finance charges are netted against the applicable income statement line item.
The allowance is based on management's consideration of all relevant factors
including management's assessment of applicable economic and seasonal trends.
We segment the loan portfolio into several individual liquidating pools
with similar credit risk characteristics, and estimate (based on historical
experience for similar pools and existing environmental conditions) the dollar
amount of principal, accrued finance charges and fees that will charge-off. We
then aggregate these pools into prime and subprime portfolios based on the
prescribed FICO score cuts, credit counseling programs and various pools of
other receivables. We also isolate other potentially higher risk segments such
as accounts that are over their credit limit by more than 10%, accounts in
suspended status because of receiving benefits under our debt waiver program and
accounts of other programs as deemed necessary. We separately analyze the
reserve requirement on each of these groups or portfolios.
39
We continually evaluate the homogenous liquidating risk pools employing
a roll-rate model which uses historical delinquency levels and pay-down levels
(12 months of historical data, with influence given to the last six months'
performance to capture current economic and seasonal trends), loan seasoning and
other measures of asset quality to estimate charge-offs for both credit losses
and bankruptcy losses.
Additionally, in evaluating the adequacy of the loan loss reserves, we
consider several subjective factors which may be overlaid into the credit risk
roll-rate model in determining the necessary loan loss reserve, including:
- national and economic trends and business conditions,
including the condition of various market segments;
- changes in lending policies and procedures, including those
for underwriting, collection, charge-off and recovery, as well
as the experience, ability and depth of lending management and
staff;
- trends in volume and the product pricing of accounts,
including any concentrations of credit; and
- impacts from external factors - such as changes in
competition, and legal and regulatory requirements - on the
level of estimated credit losses in the current portfolio.
Significant changes in these factors could impact our financial
projections and thereby affect the adequacy of our "Allowance for loan losses."
Valuation of Retained Interests in Loans Securitized
The "Retained interests in loans securitized" on our balance sheet
associated with our securitization transactions includes contractual retained
interests, excess transferor's interests, interest-only strip receivable, and
spread accounts receivable. We determine the fair value of each component of the
"Retained interests in loans securitized" at the time a securitization
transaction or replenishment sale is completed using a discounted cash flow
valuation model and on a quarterly basis thereafter. Any change in the fair
value is recorded in "Securitization income."
The discounted cash flow valuation is limited to the receivables that
exist and have been sold to the Metris Master Trust. Therefore, the model
assumes current principal receivable balance at the balance sheet date amortizes
with no new sales, interchange fees or cash advances. The future cash flows are
modeled in accordance with the debt series' legal documents and are applied to
all series on a pro-rata basis. Excess fee income, finance charge and recovery
cash flows above contractual expense payments are first applied to meet spread
accounts receivable requirements then returned to us as part of the
interest-only strip receivable. We determine upper and lower valuation limits of
the "Retained interests in loans securitized" based on historical and forecasted
excess spreads. We then determine the best estimate within the range based on
historical trends (weighted heavily toward the low end of the range), adjusted
when appropriate, for portfolio forecast information.
The contractual retained interests represent the subordinated
securities held by us. There is no stated interest/coupon rate associated with
these securities and they are not rated. They are subordinate to all other
securities, except for the interest-only strip receivable we own and
accordingly, are repaid last. Their fair value is determined by discounting the
expected future cash flows using a discount rate commensurate with the risks of
the underlying assets and the expected timing based on the scheduled maturity
date for the underlying securitization. If these securities are recoverable
based on the Metris Master Trust forecasts, cash flows related to the entire
subordinated principal balance are used in determining their fair value.
Transferor's interests represent undivided interests in receivables
that are not pledged to support a specific security series or class and
represent our interest in the excess principal receivables held in the Metris
Master Trust. The fair value is determined in the same manner as the contractual
retained interests and is discounted based on twelve months to maturity. We have
subordinated our rights to the excess cash flows on the principal
40
receivables underlying the transferor's interest, thus they are included in the
value of the interest-only strip receivable. Spread accounts receivable balances
represent cash held by the Metris Master Trust trustee due to performance of the
Metris Master Trust and requisite reserves required by certain security series.
These balances earn interest and the change in fair value is determined in the
same manner as the contractual retained interests.
The interest-only strip receivable represents the contractual right to
receive from the Metris Master Trust interest and other fee revenue less certain
costs over the estimated life of the underlying debt securities. The fair value
is determined by discounting the expected future cash flows using a discount
rate commensurate with the risks of the underlying assets and the expected
timing of the amortization inherent in the retained interests valuation model.
We believe our discount rates are consistent with what other market place
participants would use to determine the fair value of these assets. The
valuation model assumes that we repurchase the outstanding principal receivables
at face value according to the clean up call provisions contained in the
respective security series' legal documents.
We use certain assumptions and estimates in determining the fair values
of "Retained interests in loans securitized." These assumptions and estimates
include estimated principal payments, credit losses, gross yield, interest
expense, fees, the timing of cash receipts, and discount rates commensurate with
the risks of the underlying assets. On a quarterly basis, we review and adjust
as appropriate the assumptions and estimates used in our model based on a
variety of internal and external factors, including national and economic trends
and business conditions, current lending policies, procedures and strategies,
historical trends and assumptions about future trends, competition and legal and
regulatory requirements. Significant estimates are required in determining these
factors and different judgments concerning these factors can result in a
material impact on our balance sheet and income statement. The accompanying
unaudited consolidated financial statements do not include an adjustment to the
fair value of retained interest that might result from the inability to finance
future receivables.
Revenue Recognition on Enhancement Services Products
Debt Waiver Products
Direct Merchants Bank offers various debt waiver products on
receivables it owns as well as securitized receivables. The Company's policy for
recognizing debt waiver revenue on receivables sold to the Metris Master Trust
was not in accordance GAAP. Historically, the Company recognized revenue in the
month following completion of the cancellation period, generally one month. Cash
flows related to debt waiver are now included in the valuation of the
interest-only strip receivable. All periods presented have been restated to
reflect the revised policy. Direct Merchants Bank incurs the related claims and
marketing expenses. A reserve is maintained for future death and finance charge
claims based on Direct Merchants Bank's historical experience with settlement of
such claims. Reserves for pending claims and incurred but not reported claims
are recorded in the consolidated balance sheets as "Accrued expenses and other
liabilities." Reserves for pending and incurred but not reported claims were
$8.6 million as of March 31, 2003, compared to $8.2 million as of December 31,
2002.
Membership Program Products
We bill membership fees for enhancement services products through
financial institutions, including Direct Merchants Bank, and other
cardholder-based institutions. We record these fees as deferred membership
income upon acceptance of membership and amortize them on a straight-line basis
for all annually billed products, and on an accelerated amortization method for
all monthly billed products over the membership period beginning after the
contractual cancellation period is complete. A liability is established and
netted against the related receivable in the consolidated balance sheets in
"Other assets" from inception of the membership through the end of the
cancellation period that reflects our historical cancellation experience with
these products. Gross receivables as of March 31, 2003 on the membership program
products were $17.9 million compared to $22.0 million as of December 31, 2002.
Cancellation reserves were $16.4 million and $19.5 million as of March 31, 2003
and December 31, 2002, respectively. Revenues recorded for membership products
are included in the consolidated statements of income under
41
"Enhancement services revenues" and were $30.6 million and $17.1 million for the
three months ended March 31, 2003 and 2002, respectively. Unearned revenues on
membership program products are recorded in the consolidated balance sheets in
"Deferred income." Unearned revenues as of March 31, 2003 were $99.5 million
compared to $114.2 million as of December 31, 2002. The decline in unearned
revenue for our membership products is primarily due to declining enrollments
through the first quarter of 2003. In addition the reduction is a result of the
migration to more monthly bill products being sold and the termination of our
relationship with certain third-party partners. Reserves for pending and
incurred but not reported claims, included in "Accrued expenses and other
liabilities," were $0.1 million as of March 31, 2003 and December 31, 2002.
Warranty Products
We coordinate the marketing activities for Direct Merchants Bank and
third-party sales of extended service plans. We perform administrative services
and retain the claims risk for all extended service plans sold. As a result, we
defer and recognize extended service plan revenues and the incremental direct
acquisition costs on an accelerated amortization method over the life of the
related extended service plan contracts beginning after the expiration of any
manufacturer's warranty coverage. A liability is established and netted against
the related receivable in the consolidated balance sheets in "Other assets" from
inception of the extended service plan through the end of the cancellation
period that reflects our historical cancellation experience with these products.
Gross receivables as of March 31, 2003 on the warranty products were $2.5
million compared to $3.8 million as of December 31, 2002. Cancellation reserves
were $2.9 million and $5.3 million as of March 31, 2003 and December 31, 2002,
respectively. Revenues recorded for warranty products are included in the
consolidated statements of income under "Enhancement services revenues" and were
$10.0 million and $13.0 million for the three months ended March 31, 2003 and
2002, respectively. Unearned revenues on warranty products are recorded in the
consolidated balance sheets in "Deferred income." Unearned revenues as of March
31, 2003 were $13.0 million compared to $17.6 million as of December 31, 2002.
The decline in unearned revenue for our warranty products is primarily due to
declining enrollments through the first quarter of 2003. In addition the
reduction is a result of the migration to more monthly bill products being sold
and the termination of our relationship with certain third-party partners.
Reserves for pending and incurred but not reported claims, included in "Accrued
expenses and other liabilities," were $0.7 million as of March 31, 2003 and
December 31, 2002.
Deferred Acquisition Costs on Enhancement Services Products
We defer qualifying acquisition costs associated with our enhancement
services products. These costs, which relate directly to membership
solicitations (direct response advertising costs), principally include postage,
printing, mailing telemarketing costs, and commissions paid to third parties.
The total amount of enhancement services deferred costs as of March 31, 2003 and
December 31, 2002 were $61.6 million and $73.2 million, respectively. If
deferred acquisition costs were to exceed forecasted future cash flows, we would
make an appropriate adjustment for impairment. The most significant assumption
used by the Company in determining the realizability of these deferred costs is
future revenues from our enhancement services products. A significant reduction
in revenues could have a material impact on the values of these balances.
Debt Waiver Products
Qualifying membership acquisition costs are deferred and charged to
expense as debt waiver product fees are recognized. We amortize these costs
using an accelerated methodology, which approximates our historical cancellation
experience for debt waiver products. Amortization of debt waiver acquisition
costs was $1.4 million for the three months ended March 31, 2003. All other debt
waiver acquisition costs are expensed as incurred. Deferred debt waiver
acquisition costs were $2.6 million as of March 31, 2003 and December 31, 2002.
42
Membership Program Products
Qualifying membership acquisition costs are deferred and charged to
expense as membership fees are recognized. We amortize all deferred costs on a
straight-line basis for all annually billed products, and on an accelerated
method for all monthly billed products, which approximates our historical
cancellation experience for membership program products. Amortization of
membership deferred costs was $20.5 million and $7.8 million for the three
months ended March 31, 2003 and 2002, respectively. All other membership
acquisition costs are expensed as incurred. Deferred membership acquisition
costs were $56.5 million and $66.9 million as of March 31, 2003 and December 31,
2002, respectively. The decline in deferred membership acquisition costs is
primarily due to declining enrollments through the first quarter of 2003. In
addition the reduction is a result of the migration to more monthly bill
products being sold and the termination of our relationship with certain
third-party partners.
Warranty Products
Qualifying warranty acquisition costs are deferred and charged to
expense as warranty product fees are recognized. Those incremental direct
acquisition costs, which are a result of a contract that is not consummated, are
charged to expense as incurred. A successful effort conversion percentage is
applied to these incremental direct acquisition costs, which approximates our
historical successful effort rate percentage in negotiating warranty products.
We amortize these deferred costs using an accelerated amortization methodology,
which approximates our historical cancellation experience following the
expiration of the manufacturer's contractual cancellation period for the
warranty products. Amortization of warranty acquisition costs were $2.0 million
and $3.1 million for the three months ended March 31, 2003 and 2002,
respectively. All other warranty acquisition costs are expensed as incurred.
Deferred warranty acquisition costs amount to $2.2 million and $3.0 million as
of March 31, 2003 and December 31, 2002, respectively. The decline in deferred
warranty acquisition costs is primarily due to declining enrollments through the
first quarter of 2003. In addition, the reduction is a result of the migration
to more monthly bill products being sold and the termination of our relationship
with certain third-party partners.
43
LIQUIDITY, FUNDING AND CAPITAL RESOURCES
One of our primary financial goals is to maintain an adequate level of
liquidity through active management of assets and liabilities. Liquidity
management is a dynamic process, affected by changes in the characteristics of
our assets and liabilities and short- and long-term interest rates. We use a
variety of financing sources to manage liquidity, funding, and interest rate
risks. Table 5 summarizes our funding and liquidity as of March 31, 2003 and
December 31, 2002:
TABLE 8: LIQUIDITY, FUNDING AND CAPITAL RESOURCES
MARCH 31, 2003 DECEMBER 31, 2002
-------------- -----------------
DMCCB OTHER CONSOLIDATED DMCCB OTHER CONSOLIDATED
---------- ----- ------------ ----- ----- ------------
Cash and due
from banks $ 88,949 $ 1,821 $ 90,770 $ 58,399 $ 4,414 $ 62,813
Federal funds
sold 102,300 -- 102,300 88,000 -- 88,000
Short-term
investments 262,246 80,688 342,934 322,039 107,380 429,419
--------- ---------- ------------ -------- --------- ------------
Total cash and
cash
equivalents $ 453,495 $ 82,509 $ 536,004 $ 468,438 $ 111,794 $ 580,232
========= ========== ============ ========= ========= ============
MARCH 31, 2003 DECEMBER 31, 2002
-------------- -----------------
UNUSED UNUSED
OUTSTANDING CAPACITY OUTSTANDING CAPACITY
----------- --------- ----------- ---------
ON-BALANCE SHEET FUNDING
Revolving credit line - July
2003 $ -- $ -- $ -- $ 162,696
Term loan - June 2003 100,000 N/A 100,000 N/A
10% senior notes - November
2004 100,000 N/A 100,000 N/A
10.125% senior notes -
July 2006 147,046 N/A 146,824 N/A
Thomas H. Lee Equity Fund IV,
L.P. - March 2004 -- 125,000 -- --
Other 11,230 N/A 10,825 N/A
Deposits - various maturities
through February 2007 801,498 N/A 892,754 N/A
----------- --------- ------------ ---------
Subtotal 1,159,774 125,000 1,250,403 162,696
OFF-BALANCE SHEET FUNDING
Metris Master Trust:
Term asset backed
securitizations -
various maturities
through January 2009 7,610,000 -- 7,610,000 --
Bank conduits -
various maturities
through March 2004 708,890 684,000 1,177,957 422,043
Metris facility - March 2003 -- -- 48,900 26,100
----------- --------- ------------ ---------
Subtotal 8,318,890 684,000 8,836,857 448,143
----------- --------- ------------ ---------
Total $ 9,478,664 $ 809,000 $ 10,087,260 $ 610,839
=========== ========= ============ =========
As of March 31, 2003 and December 31, 2002, we had $7.3 million of
letters of credit issued under our revolving line of credit. Under our credit
agreement, we need to maintain, among other items, minimum equity plus reserves
to managed assets of 10%, minimum three-month
44
average excess spread (on each individual series of securities issued under the
Master Trust) of 1%, minimum equity of $689.6 million at March 31, 2003 and a
ratio of equity plus allowance for loan losses and valuation allowance to
managed 90-day plus delinquencies of 2.25. Furthermore, the Company has pledged
certain assets as collateral on the credit agreement. As of March 31, 2003 and
December 31, 2002 we were in compliance with all financial covenants under our
credit agreement.
Our contractual cash obligations during the next twelve months as of
March 31, 2003 were as follows:
Long-term debt $ 101,310
Operating leases 13,639
Deposits 328,956
----------
Total $ 443,905
==========
In addition to the contractual cash obligations, open-to-buy on credit
card accounts as of March 31, 2003 was $11.1 billion.
As of March 31, 2003, $1.9 billion of off-balance sheet funding in the
Master Trust is scheduled to amortize over the next twelve months. We base the
amortization amounts on estimated amortization periods, which are subject to
change based on the Master Trust performance.
The following table shows the annualized yields, defaults, costs and
excess spreads for the Master Trust on a cash basis:
THREE MONTHS ENDED MARCH 31,
(In thousands) 2003 2002
---- ----
Gross yield (1) $ 657,781 27.71% $ 586,680 26.57%
Annual principal defaults 508,200 21.41% 314,378 14.24%
---------- ------ ---------- ------
Net portfolio yield 149,581 6.30% 272,302 12.33%
Annual interest expense and servicing fees
88,169 3.94% 106,302 4.75%
---------- ------ ---------- ------
Net excess spread $ 61,412 2.36% $ 166,000 7.58%
=========== ====== ========== ======
(1) Includes cash flows from finance charges, late, overlimit and cash
advance fees, bad debt recoveries, interchange income and debt waiver
fees, less finance charge and fee charge-offs.
The Master Trust and the associated off-balance sheet debt provide for
early amortization if certain events occur. These events are described in the
applicable prospectus of each securitization transaction. The significant events
are (i) one-month and three-month average excess spreads below certain levels,
(ii) negative transferor's interest within the Master Trust or (iii) failure to
obtain funding during an accumulation period for a maturing term asset-backed
securitization. In addition, there are various triggers within our
securitization agreements that, if broken, would restrict the release of cash to
us from the Master Trust. This restricted cash provides additional security to
the investors in the Master Trust. We reflect cash restricted from release in
the Master Trust as "Other receivables due from credit card securitizations,
net" in the consolidated balance sheet. The triggers are related to the
performance of the Master Trust, specifically the average of net excess spread
over a one-to three-month period.
The cash restricted from release is limited to the amount of excess
spread generated in the Master Trust on a cash basis. During periods of lower
excess spreads, the required amount of excess spread to be restricted in the
Master Trust may not be achieved. During those periods, all excess spread
normally released to MRI will be restricted from release. Once the maximum
required amount of cash is restricted from release or excess spreads improve,
cash can again be released from the spread accounts. Based on the performance of
our Master Trust, the amount of cash required to be restricted was $457 million
at March 31, 2003 and $304 million at December
45
31, 2002. As of March 31, 2003, $133.4 million has been restricted from release
in the Master Trust due to performance and $21.4 million has been restricted
from release in the Master Trust due to corporate debt ratings. As of December
31, 2002, $29.1 million has been restricted from release in the Master Trust due
to performance and $21.4 million has been restricted from release in the Master
Trust due to corporate debt ratings. The $104.3 million increase in this
restricted cash is a result of approximately $61.4 million of net excess cash
generated by the Master Trust being restricted within the Master Trust and
approximately $42.9 million that was funded pursuant to the terms of our conduit
warehouse facilities. We expect continued restrictions on the release of a
significant portion of our cash basis excess spread throughout 2004.
On March 17, 2003, we obtained a $425 million extension through March
2004 of an $850 million conduit which was scheduled to mature in June of 2003.
We also secured a $425 million conduit through March 2004, which will replace
conduits and warehouse facilities scheduled to mature during March through May
2003. Furthermore, these conduits will provide for the financing of a term
asset-backed securitization that is scheduled to mature in July 2003. The
availability of funding under these facilities is subject to various conditions,
including a net reduction of receivables in the Master Trust and a minimum
three-month average excess spread of 1%. All of these conditions precedent to
funding in the conduits have been met.
On March 31, 2003, Thomas H. Lee Equity Fund IV, L.P. ("THL Fund IV")
committed to provide a term loan to the Company in an aggregate amount of $125
million as a backup financing facility, secured by assets of the Company. The
backup facility carries an interest rate of 12% per annum plus an option to earn
an additional meaningful economic return based on the performance of the
Company's managed receivables through December 31, 2004. The backup facility
would be repayable in full on March 1, 2004. During the past fiscal year we had
in place a $270 million term loan and revolving credit facility. In connection
with the conduit transactions discussed above, all availability under the $170
million revolving portion of this facility was terminated as of March 17, 2003,
with the exception of $7.3 million of outstanding letters of credit. Term loans
of $100 million remain outstanding under the facility and mature on June 30,
2003. We may refinance these loans with the backup facility provided by THL Fund
IV. THL Fund IV's obligation to provide this facility is subject to a number of
conditions.
The Internal Revenue Service ("IRS") has completed its examination of
the Company's tax returns through December 31, 1998. The IRS has proposed
adjustments to increase the Company's federal income tax by $42.9 million, plus
interest of more than $15 million, pertaining to the Company's treatment of
certain credit card fees as original issue discount ("OID"). Although these fees
are primarily reported as income when billed for financial reporting purposes,
we believe the fees constitute OID and must be deferred and amortized over the
life of the underlying credit card loans for tax purposes. Cumulatively through
the three months ended March 31, 2003, the Company has deferred more than $207.8
million in federal income tax under the OID rules. An assessment similar to what
has been proposed by the IRS may ultimately require the Company to pay the
federal tax, state tax and related interest.
The Company believes its treatment of the fees is appropriate and
continues to work with the IRS to resolve the proposed adjustments. The
Company's position on the treatment of credit card fees is consistent with that
of many other U.S. credit card issuers. We do not expect final settlement or
additional tax to be paid. However, both the timing and amount of the final
resolution of this matter are uncertain.
During the next twelve months we have contractual cash obligations of
$444 million, off-balance sheet funding scheduled to amortize of $1.9 billion
and will require funding for a $610 million term asset-backed securitization
maturing in January 2004. In addition, we will need cash to fund new
receivables, for the reduction of credit card loans at Direct Merchants Bank to
no more than $550 million at December 31, 2003 (required under our operating
agreement) and for general operating needs. We have historically utilized a
variety of funding vehicles, as well as ongoing cash generated from operations,
to finance credit card receivables, maturing debt obligations and general
operating needs. During the next twelve months we intend to reduce outstanding
credit receivables in the Master Trust by approximately $1.6 billion through
lower credit card account acquisitions, attrition in the portfolio and third
party sales as necessary. This reduction in the size of the portfolio will
significantly reduce our need for additional bank conduits or the issuance of
new asset-backed securities. We believe we have
46
adequate liquidity for meeting anticipated cash needs, although no assurance can
be given to that effect.
CAPITAL ADEQUACY
In the normal course of business, Direct Merchants Bank enters into
agreements, or is subject to regulatory requirements, that result in cash, debt
and dividend or other capital restrictions.
The Federal Reserve Act imposes various legal limitations on the extent
to which banks can finance or otherwise supply funds to their affiliates. In
particular, Direct Merchants Bank is subject to certain restrictions on any
extensions of credit to or other covered transactions, such as certain purchases
of assets, with MCI and its affiliates. Such restrictions limit Direct Merchants
Bank's ability to lend to MCI and its affiliates. Additionally, Direct Merchants
Bank is limited in its ability to declare dividends to MCI in accordance with
the national bank dividend provisions.
Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the OCC. At March 31, 2003 and December 31, 2002, Direct Merchants
Bank's Tier 1 risk-based capital ratio, risk-based total capital ratio and Tier
1 leverage ratio exceeded the minimum required capital levels, and Direct
Merchants Bank was considered a "well-capitalized" depository institution under
regulations of the OCC, as illustrated in the following table.
Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, Direct Merchants Bank must meet specific capital
guidelines that involve quantitative measures of assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices.
Direct Merchants Bank's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors.
Quantitative measures established by regulation to ensure capital
adequacy require Direct Merchants Bank to maintain minimum amounts and ratios
(set forth in the following table) of total and Tier 1 capital (as defined in
the regulations) to risk-weighted assets (as defined), and of Tier 1 leverage
capital (as defined) to average assets (as defined). Failure to meet minimum
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material adverse effect on our financial statements.
Additional information about Direct Merchants Bank's actual capital
amounts and ratios are presented in the following table:
TO BE ADEQUATELY TO BE WELL
ACTUAL CAPITALIZED CAPITALIZED
------ ----------- -----------
As of March 31, 2003 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
Total Capital $256,335 34.4% $ 59,683 8.0% $ 74,604 10.0%
(to risk-weighted
assets)
Tier 1 Capital 245,580 32.9% 29,842 4.0% 44,762 6.0%
(to risk-weighted
assets)
Tier 1 Capital 245,580 18.5% 53,226 4.0% 66,532 5.0%
(to average assets)
47
TO BE ADEQUATELY TO BE WELL
ACTUAL CAPITALIZED CAPITALIZED
------ ----------- -----------
As of December 31, 2002 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
Total Capital $402,721 30.8% $140,516 8.0% $ 130,645 10.0%
(to risk-weighted
assets)
Tier 1 Capital 385,480 29.5% 52,258 4.0% 78,387 6.0%
(to risk-weighted
assets)
Tier 1 Capital 385,480 24.7% 62,381 4.0% 77,977 5.0%
(to average assets)
FFIEC guidelines indicate that an institution with a concentration in
subprime lending should hold one and one-half to three times the normal minimum
capital required. The OCC has regulatory authority to evaluate the safety and
soundness of Direct Merchants Bank under these more stringent guidelines. The
OCC has required Direct Merchants Bank, under the more stringent guidelines, to
maintain two times the normal minimum capital on those credit card loans that
qualify as subprime loans (FICO score of 660 and below) and maintain a minimum
capital ratio of 10%. Under these more stringent guidelines, Direct Merchants
Bank's total capital ratio as of March 31, 2003 was 22.7%.
48
REGULATORY MATTERS
On April 16, 2002, Direct Merchants Bank entered into an agreement with
the OCC intended to strengthen the safety and soundness of Direct Merchants
Bank's operations. The agreement formalized recommendations made and
requirements imposed by the OCC following an examination of Direct Merchants
Bank that resulted in a Report of Examination issued on April 4, 2002. The OCC
terminated this formal agreement on March 18, 2003.
On March 18, 2003, we entered into an operating agreement with the OCC
designed to ensure that Direct Merchants Bank continues to operate in a safe and
sound manner.
The operating agreement requires, among other things, the following:
- The Bank must reduce its on-balance-sheet credit card
receivables to no more than $550 million by December 31, 2003
and to zero by December 31, 2004. During the time the Bank is
reducing these receivables, the mix of subprime receivables
may not exceed 60% of all credit card receivables. As of March
31, 2003, 59.1% of the Bank's credit card receivables were
subprime. The Bank will continue to sell credit card
receivables on a daily basis to MCI under the purchase
agreement currently in effect between MCI and the Bank.
- The Bank must maintain minimum capital in the aggregate amount
of (i) liquid assets deposited pursuant to the Liquidity
Reserve Deposit Agreement discussed below; (ii) the capital
required as a result of the 200% risk-weight applied to
on-book subprime credit card receivables; and (iii) the
minimum capital required under Federal law for a "well
capitalized" institution for all remaining assets owned by the
Bank.
- The Bank must meet certain liquidity requirements, including
maintaining, on a daily basis, liquid assets of not less than
100% of the deposits and other liabilities coming due within
the next 30 days, maintaining marketable assets in an amount
equal to or in excess of the Bank's insured deposits,
maintaining cash and cash equivalents in excess of 46% of
outstanding CDs, and entering into the Liquidity Reserve
Deposit Agreement discussed below to support the Bank's credit
card receivables funding needs.
- The Bank is required, within 60 days from the date of the
operating agreement, to submit to the OCC a written strategic
plan establishing objectives for the Bank's overall risk
profile, earning performance, growth, balance sheet mix,
off-balance sheet activities, liability structure, capital
adequacy, product line development and marketing segments.
The terms of the operating agreement required Direct Merchants Bank and
MCI to enter into a Capital Assurance and Liquidity Maintenance Agreement
("CALMA") which also was executed on March 18, 2003. The effect of the CALMA is
to potentially require MCI to make such capital infusions or provide Direct
Merchants Bank with financial assistance so as to permit Direct Merchants Bank
to meet its liquidity requirements.
The operating agreement required Direct Merchants Bank, a third-party
depository bank and the OCC to execute a Liquidity Reserve Deposit Agreement
("LRDA") within 30 days of the effective date of the operating agreement.
If the OCC were to conclude that the Bank failed to implement any
provision of the agreement, the OCC could pursue various enforcement options.
Upon signing these agreements Direct Merchants Bank declared and paid a
$155 million dividend to us.
49
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which are subject to the "safe harbor" created by those sections.
Forward-looking statements include, without limitation: expressions of the
"belief," "anticipation," "intent," or "expectations" of management; statements
and information as to our strategies and objectives; return on equity; changes
in our managed loan portfolio; net interest margins; funding costs; liquidity;
cash flow; operating costs and marketing expenses; delinquencies and charge-offs
and industry comparisons or projections; statements as to industry trends or
future results of operations of the Company and its subsidiaries; and other
statements that are not historical fact. Forward-looking statements may be
identified by the use of terminology such as "may," "will," "believes," "does
not believe," "no reason to believe," "expects," "plans," "intends,"
"estimates," "anticipated," or "anticipates" and similar expressions, as they
relate to the Company or our management. Forward-looking statements are based on
certain assumptions by management and are subject to risks and uncertainties
that could cause actual results to differ materially from those in the
forward-looking statements.
These risks and uncertainties include, but are not limited to, our high
liquidity requirement; our higher delinquency rate, credit loss rates and
charge-off rates of our "Credit card loans;" the higher charge-off and
bankruptcy rates of the Company's target market of moderate-income consumers;
the success and impact of our existing or modified strategic initiatives; the
effect of the restatement of the Company's financial statements discussed
herein, risks associated with Direct Merchants Bank's ability to comply with its
agreement with regulators regarding the safety and soundness of its operations;
interest rate risks; risks associated with acquired portfolios; dependence on
the securitization markets and other funding sources to fund our business,
including the refinancing of existing indebtedness; the effects of the
previously announced SEC investigation, government policy and regulation,
whether of general applicability or specific to us, including restrictions
and/or limitations relating to our minimum capital requirements, reserving
methodologies, dividend policies and payments, growth, and/or underwriting
criteria; reduced funding availability and increased funding costs; privacy laws
that could result in lower revenue generated from fewer marketing campaigns
and/or penalties for non-compliance; and general economic conditions that can
have a negative impact on the performance of loans and marketing of credit
protection and other enhancement services.
These and other risks and uncertainties are discussed herein and in the
Original 10-Q in "Legal Proceedings" (page 48 of the Original 10-Q),
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" (pages 29 - 52 hereof) and "Quantitative and Qualitative Disclosures
About Market Risk" (pages 46-47 of the Original 10-Q). Although we have
attempted to list comprehensively the major risks and uncertainties, other
factors may in the future prove to be important in causing actual results to
differ materially from those contained in any forward-looking statement. Readers
are cautioned not to place undue reliance on any forward-looking statement,
which speaks only as of the date thereof. We undertake no obligation to update
any forward-looking statements, whether as a result of new information, future
events or otherwise.
SELECTED OPERATING DATA - MANAGED BASIS
In addition to analyzing the Company's performance on an owned basis,
we analyze the Company's financial performance on a managed loan portfolio
basis. On a managed basis, the balance sheets and income statements include
other investors' interests in securitized loans that are not assets of the
Company, thereby reversing the effects of sale accounting under SFAS No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities." We believe this information is meaningful to the reader of the
financial statements. We service the receivables that have been securitized and
sold and own the right to the cash flows from those receivables sold in excess
of amounts owed to security holders.
The following information is not in conformity with accounting
principles generally accepted in the United States of America, however, we
believe the information is relevant to understanding the overall financial
condition and results of operations of the Company.
50
TABLE 9: MANAGED LOAN PORTFOLIO
(DOLLARS IN THOUSANDS) MARCH 31, % OF DECEMBER 31, % OF MARCH 31, % OF
2003 TOTAL 2002 TOTAL 2002 TOTAL
---- ----- ---- ----- ---- -----
PERIOD-END BALANCES:
Credit card loans $ 686,285 $ 846,417 $ 2,219,800
Receivables held in the
Metris Master Trust 9,989,060 10,573,769 9,651,042
------------- ------------ -----------
Managed $ 10,675,345 $ 11,420,186 $11,870,842
============= ============ ===========
Loans contractually
delinquent:
Credit card loans 56,419 8.2% 7,876 0.9% 226,347 10.2%
Receivables held in the
Metris Master Trust 1,170,536 11.7% 1,252,073 11.8% 927,764 9.6%
------------- ------------ -----------
Managed $ 1,226,955 11.5% $ 1,259,949 11.0% $ 1,154,111 9.7%
============= ============ ===========
THREE MONTHS ENDED
MARCH 31,
---------
2003 2002
---- ----
AVERAGE BALANCES:
Credit card loans $ 751,674 $ 2,497,941
Receivables held in the Metris Master
Trust 10,405,396 9,546,574
------------- ------------
Managed $ 11,157,070 $ 12,044,515
============= ============
Net charge-offs:
Credit card loans 8,289 4.5% 83,678 13.6%
Receivables held in the Metris
Master Trust 486,486 19.0% 300,496 12.8%
------------- ------------
Managed $ 494,775 18.0% $ 384,174 12.9%
============= ============
The increase in the managed delinquency rates as of March 31, 2003 over
December 31, 2002 and March 31, 2002 primarily reflects various factors,
including declining receivables, a deterioration in the economy and the impact
of our 2001 credit line increase program. The credit line increase program added
pressure to our customers due to increased average outstanding balances, which
require higher monthly payments. This, along with a deteriorating economy, has
made our collections efforts more difficult, resulting in higher delinquencies.
Total managed loans decreased $744.8 million to $10.7 billion as of
March 31, 2003, compared to $11.4 billion as of December 31, 2002. This was
primarily due to a reduction in credit lines, tighter underwriting standards
implemented in 2002 and lower new accounts. The amount of credit card
receivables in debt forbearance programs was $868.5 million or 8.1% of total
managed loans as of March 31, 2003, compared with $860.1 million or 7.5% of
managed loans as of December 31, 2002. All delinquent receivables in debt
forbearance programs are included in Table 6(a).
Managed net charge-offs increased $110.6 million for the three month
ended March 31, 2003 compared to the same period in 2002 primarily due to the
impact of the 2001 credit line increase program and deterioration in the
economy.
We charge-off bankrupt accounts within 60 days of formal notification.
Charge-offs due to bankruptcies were $186.0 million, representing 35.7% of total
managed gross charge-offs as of March 31, 2003 and $152.6 million, representing
37.8% of total managed gross charge-offs as of March 31, 2002. In addition to
those bankrupt accounts that were charged-off, we received formal notification
of $86.2 million and $63.2 million of managed bankrupt accounts as of March 31,
2003 and 2002, respectively.
51
Net Interest Income
TABLE 10: ANALYSIS OF AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS AND RATES
THREE MONTHS ENDED
MARCH 31,
2003 2002
------------ -------------
(Dollars in thousands)
Average interest-earning assets:
Owned $ 1,408,663 $ 2,798,000
Receivables held in the Metris
Master Trust 10,405,396 9,546,574
------------ -------------
Managed $ 11,814,059 $ 12,344,574
============ =============
Net interest income:
Owned $ 12,820 $ 57,679
Receivables held in the Metris Master
Trust 408,427 380,594
------------ -------------
Managed $ 421,247 $ 438,273
============ =============
Net interest margin (1):
Owned 3.7% 8.4%
Receivables held in the Metris Master
Trust 15.9% 16.2%
Managed 14.5% 14.4%
(1) We compute net interest margin by dividing annualized net interest
income by average total interest-earning assets.
Managed net interest income for the three months ended March 31, 2003
was $421.2 million, compared to $438.3 million for the same period in 2002. Net
interest income consists primarily of interest earned on our credit card loans
less interest expense on borrowing to fund the loans. The decrease is primarily
due to a $530.5 million decrease in managed average interest-earning assets.
ITEM 4 CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company's
management, including the Chairman and Chief Executive Officer ("CEO") and the
Chief Financial Officer ("CFO"), we evaluated the effectiveness of the design
and operation of the Company's disclosure controls and procedures (as defined in
Rule 13a-14(c) or 15d-14(c) under the Exchange Act). Based on that evaluation,
the Company's management, including the CEO and CFO, have concluded that our
disclosure controls and procedures, as of March 31, 2003, were not effective in
ensuring that information required to be disclosed in the reports we file under
the Securities Exchange Act of 1934, as amended ("Exchange Act") are recorded,
processed, summarized and reported within the time periods specified in SEC
rules and forms.
On November 17, 2003, our external auditors, KPMG LLP, issued a
material weakness report noting a material weakness in our policies and
procedures for estimating the fair value of our "Retained interests in loans
securitized" and associated revenue recognition. During the past several months
we have taken steps to revise our valuation model and related policies,
procedures and assumptions to address the issues in the material weakness
report. During the period, the Company also identified and changed its
accounting policies to conform with accounting principles generally accepted in
the United States of America associated with the accounting for securitization
transaction costs, credit card solicitation costs, and debt waiver revenue
associated with receivables sold to the Metris Master Trust (See Note 2 of the
unaudited consolidated financial statements on page 9 for further discussion).
The Company, as of February 24, 2004 has re-evaluated the effectiveness
of the design of the Company's disclosure controls and procedures (as defined in
Rule 13a-14(c) or 15d-14(c) under the Exchange Act). Based on that evaluation,
the Company's management, including the CEO and CFO, has
52
concluded that the design of our disclosure controls and procedures is effective
in ensuring that information required to be disclosed in the reports we file
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in SEC rules and forms. The Company has not yet
evaluated (tested) the operating effectiveness of such controls.
PART II. OTHER INFORMATION
ITEM 1. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.1 Operating Agreement, dated as of March 18, 2003, between
MCI, Direct Merchants Bank and the Office of the Comptroller
of the Currency (incorporated by reference to Exhibit 99.2
to MCI's Current Report on Form 8-K dated March 19, 2003
(File No. 1-12351)).
10.2 Capital Assurance and Liquidity Maintenance Agreement, dated
as of March 18, 2003, between Direct Merchants Bank and MCI
(incorporated by reference to Exhibit 99.3 to MCI's Current
Report on Form 8-K dated March 19, 2003 (File No. 1-12351)).
10.3 Liquidity Reserve Deposit Agreement, dated as of March 18,
2003, among Direct Merchants Bank, JPMorgan Chase Bank, and
the Office of the Comptroller of the Currency (incorporated
by reference to Exhibit 99.4 to MCI's Current Report on Form
8-K dated March 19, 2003 (File No. 1-12351)).
10.4 Metris Companies Inc. Term Loan Commitment Letter dated
March 31, 2003 between Thomas H. Lee Partners, L.P. and
Metris Companies Inc. (incorporated by reference to Exhibit
10.15 to MCI's Annual Report on Form 10-K for the year ended
December 31, 2002 (File No. 1-12351)).
10.5 Amendment No. 2, dated as of March 17, 2003, to the Amended
and Restated Credit Agreement, among MCI; the Lenders from
time to time parties thereto; The Chase Manhattan Bank, as
Administrative Agent; Bank of America, N.A., as Syndication
Agent; Deutsche Bank AG, New York Branch, as
Co-Documentation Agent; U.S. Bank National Association, as
Co-Documentation Agent; and Barclays Bank PLC, as Co-Agent
(incorporated by reference to Exhibit 10.6 (b) to MCI's
Annual Report on Form 10-K for the year ended December 31,
2002 (File No. 1-12351)).
11. Computation of Earnings Per Share
31.1 Certification of Principal Executive Officer Pursuant to
Rule 13a-14(a)/15d-14(a).
31.2 Certification of Principal Financial Officer Pursuant to
Rule 13a-14(a)/15d 14(a).
32.1 Certification of Principal Executive Officer Pursuant to
Section 1350 of Chapter 63 of Title 18 of the United States
Code.
32.2 Certification of Principal Financial Officer Pursuant to
Section 1350 of Chapter 63 of Title 18 of the United States
Code.
(b) Reports on Form 8-K:
On January 23, 2003, we filed a Current Report on Form 8-K to
report that on January 22, 2003, Metris Companies Inc. issued a
press release announcing a workforce reduction.
On February 28, 2003, we filed a Current Report on Form 8-K to
report that on February 27, 2003, Metris Companies Inc. issued a
press release correcting a
53
prior announcement regarding a payment of dividends and
clarifying that the dividend announced February 27, 2003, of $.01
per share payable March 31, 2003, would not be paid. The Company
determined that the dividend could not be paid under the terms of
its credit agreement which prohibits the payment of dividends
following a year in which a loss was incurred.
On March 19, 2003, we filed a Current Report on Form 8-K to
report that: 1. Metris Receivables, Inc., our wholly owned
subsidiary, through the Metris Master Trust, entered into $850
million of 364-day warehouse financing facilities with its bank
groups. The availability of funding under these facilities is
subject to various conditions, including a net reduction of
receivables in the Metris Master Trust; 2. the termination of our
$170 million revolving credit facility; and 3. Metris and Direct
Merchants Bank entered into an Operating Agreement and related
agreements including a Capital Assurance and Liquidity
Maintenance Agreement, and a Liquidity Reserve Deposit Agreement
each dated March 18, 2003 with the Office of the Comptroller of
the Currency designed to ensure the ongoing safety and soundness
of the Bank's operations. The operating agreement includes
liquidity and capital maintenance provisions for the bank. By
entering into this new agreement, the Bank was able to pay a
dividend in the amount of $155 million. The Bank's existing
formal agreement with the OCC, signed in April 2002, was also
terminated.
On April 16, 2003, we filed a Current Report on Form 8-K to
report the submission of unaudited financial statements in a
press release dated April 16, 2003.
54
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
METRIS COMPANIES INC.
(Registrant)
Date: April 9, 2004 By: /s/ John A. Witham
------------------
John A. Witham
Executive Vice President and Chief Financial Officer
(Principal Financial Officer and Authorized
Officer of Registrant)
55