UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-Q/A
AMENDMENT NO. 1
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended March 31, 2002
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, 2002, 62,257,143 shares of the registrant's common stock, par
value $.01 per share, were outstanding.
METRIS COMPANIES INC.
FORM 10-Q
TABLE OF CONTENTS
-----------------
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March 31, 2002
Page
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets.......................3
Consolidated Statements of Income.................4
Consolidated Statements of Changes in
Stockholders' Equity.....................5
Consolidated Statements of Cash Flows.............6
Notes to Consolidated Financial Statement.........7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations.......................................19
Item 3. Quantitative and Qualitative Disclosures
About Market Risk................................36
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................37
Item 2. Changes in Securities........................................37
Item 3. Defaults Upon Senior Securities..............................37
Item 4. Submission of Matters to a Vote of Security Holders..........37
Item 5. Other Information............................................38
Item 6. Exhibits and Reports on Form 8-K........................38
Signatures..............................................39
2
Part I. Financial Information
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands, except per-share data) (Unaudited)
March 31, December 31,
2002 2001
---- ----
Assets:
Cash and due from banks .................................................... $ 108,597 $ 109,812
Federal funds sold ......................................................... 183,809 243,772
Short-term investments ..................................................... 120,491 134,502
----------- -----------
Cash and cash equivalents .................................................. 412,897 488,086
----------- -----------
Retained interests in loans securitized .................................... 1,338,437 1,263,655
Less: Valuation allowance ................................................. 551,385 537,499
----------- -----------
Net retained interests in loans securitized ................................ 787,052 726,156
----------- -----------
Credit card loans .......................................................... 2,210,847 2,746,656
Less: Allowance for loan losses ........................................... 416,914 410,159
----------- -----------
Net credit card loans ...................................................... 1,793,933 2,336,497
----------- -----------
Property and equipment, net ................................................ 111,695 114,913
Deferred tax asset ......................................................... -- 32,167
Purchased portfolio premium, net ........................................... 86,338 94,793
Other receivables due from credit card
securitizations, net .................................................... 190,816 179,868
Other assets ............................................................... 268,219 256,206
----------- -----------
Total assets .......................................................... $ 3,650,950 $ 4,228,686
=========== ===========
Liabilities:
Deposits ................................................................... $ 1,725,886 $ 2,058,008
Debt ....................................................................... 355,930 647,904
Accounts payable ........................................................... 103,011 83,475
Deferred income ............................................................ 204,528 215,031
Deferred tax liability ..................................................... 26,200 --
Accrued expenses and other liabilities ..................................... 57,393 82,313
----------- -----------
Total liabilities ..................................................... 2,472,948 3,086,731
----------- -----------
Stockholders' Equity:
Convertible preferred stock - Series C, par
value $.01 per share; 10,000,000
shares authorized, 1,081,435 and 1,057,638
shares issued and outstanding, respectively ........................... 402,834 393,970
Common stock, par value $.01 per share;
300,000,000 shares authorized, 64,341,570
and 64,224,878 shares issued, respectively ............................ 643 642
Paid-in capital ............................................................ 234,235 232,413
Unearned compensation ...................................................... (4,576) (4,980)
Treasury stock - 2,098,400 and 806,300 shares,
respectively........................................................... (30,596) (13,014)
Retained earnings .......................................................... 575,462 532,924
----------- -----------
Total stockholders' equity ............................................ 1,178,002 1,141,955
----------- -----------
Total liabilities and stockholders' equity ............................ $ 3,650,950 $ 4,228,686
=========== ===========
See accompanying Notes to Consolidated Financial Statements.
3
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Income
(In thousands, except earnings per-share data) (Unaudited)
Three Months Ended
March 31,
2002 2001
Interest Income:
Credit card loans and retained interests in loans securitized..... $ 152,214 $ 163,522
Federal funds sold ............................................... 114 2,311
Other ............................................................ 1,204 3,896
--------- ---------
Total interest income ............................................ 153,532 169,729
Deposit interest expense ......................................... 23,653 36,623
Other interest expense ........................................... 8,512 11,212
--------- ---------
Total interest expense ........................................... 32,165 47,835
--------- ---------
Net Interest Income .............................................. 121,367 121,894
Provision for loan losses ........................................ 154,370 87,729
--------- ---------
Net Interest (Expense) Income After Provision for Loan Losses..... (33,003) 34,165
--------- ---------
Other Operating Income:
Net securitization and credit card servicing income............... 124,118 87,092
Credit card fees, interchange and other credit card income........ 73,107 62,832
Enhancement services revenues .................................... 94,996 78,264
--------- ---------
292,221 228,188
--------- ---------
Other Operating Expense:
Credit card account and other product solicitation and marketing
expenses...................................................... 40,552 40,765
Employee compensation ............................................ 56,548 54,736
Data processing services and communications ...................... 22,306 22,379
Enhancement services claims expense .............................. 11,207 6,679
Credit card fraud losses ......................................... 2,228 2,651
Purchased portfolio premium amortization ......................... 8,455 7,828
Other ............................................................ 33,092 36,185
--------- ---------
174,388 171,223
--------- ---------
Income Before Income Taxes and Cumulative Effect of Accounting
Change........................................................ 84,830 91,130
Income taxes ..................................................... 32,490 35,085
--------- ---------
Income Before Cumulative Effect of Accounting Change.............. 52,340 56,045
Cumulative effect of accounting change (net of income taxes of
$9,000)....................................................... -- 14,499
--------- ---------
Net Income ....................................................... 52,340 41,546
Convertible preferred stock dividends-Series C ................... 9,188 8,403
--------- ---------
Net Income Applicable to Common Stockholders ..................... $ 43,152 $ 33,143
========= =========
Earnings per share:
Basic-income before cumulative effect of accounting change .. $ 0.55 $ 0.58
Basic-cumulative effect of accounting change ................ -- (0.15)
Basic-net income ............................................ 0.55 0.43
Diluted-income before cumulative effect of accounting change. 0.54 0.57
Diluted-cumulative effect of accounting change .............. -- (0.15)
Diluted-net income .......................................... 0.54 0.42
Shares used to compute earnings per share:
Basic ....................................................... 96,032 96,660
Diluted ..................................................... 96,973 98,445
Dividends declared per common share .............................. $ 0.01 $ 0.01
See accompanying Notes to Consolidated Financial Statements.
4
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, 2000 968 62,243 $ 360,421 $ 622 $ 198,077 $ -- $ -- $ 324,433 $ 883,553
Net income ............. -- -- -- -- -- -- -- 41,546 41,546
Cash dividends ......... -- -- -- -- -- -- -- (916) (916)
Preferred dividends in
kind - Series C .... 21 -- 8,109 -- -- -- -- (8,109) --
Issuance of common stock
under employee
benefit plans ...... -- 662 -- 7 9,029 (4,241) -- -- 4,795
----------- ----------- --------- --------- --------- ----------- -------- --------- ----------
BALANCE AT MARCH 31, 2001 ... 989 62,905 $ 368,530 $ 629 $ 207,106 $ (4,241) $ -- $ 356,954 $ 928,978
=========== =========== ========= ========= ========= =========== ======== ========= ==========
BALANCE AT DECEMBER 31, 2001 1,058 63,419 $ 393,970 $ 642 $ 232,413 $ (4,980) $(13,014) $ 532,924 $1,141,955
Net income ............. -- -- -- -- -- -- -- 52,340 52,340
Cash dividends ......... -- -- -- -- -- -- -- (938) (938)
Common stock repurchased -- (1,292) -- -- -- -- (17,582) -- (17,582)
Preferred dividends in
kind - Series C .... 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 ... 1,081 62,243 $ 402,834 $ 643 $ 234,235 $ (4,576) $(30,596) $ 575,462 $1,178,002
=========== =========== ========= ========= ========= =========== ======== ========= ==========
See accompanying Notes to Consolidated Financial Statements.
5
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands) (Unaudited)
Three Months Ended
March 31,
2002 2001
--------- ----------
Operating Activities:
Net income ........................................... $ 52,340 $ 41,546
Adjustments to reconcile net income to net cash
provided by operating activities:
Cumulative effect of accounting change .......... -- 14,499
Depreciation and amortization ................... 27,240 18,176
Provision for loan losses ....................... 154,370 87,729
Retained interests valuation expense (income).... (50,051) (16,797)
Loss on derivative financial instruments ........ 9,272 3,710
Changes in operating assets and liabilities, net:
Deferred income taxes ....................... 58,367 (3,994)
Other receivables due from credit card
securitizations ........................ (20,220) 7,982
Accounts payable and accrued expenses ....... (5,384) 37,815
Deferred income ............................. (10,503) (23,128)
Other ....................................... (23,531) (15,345)
--------- ---------
Net cash provided by operating activities ............ 191,900 152,193
--------- ---------
Investing Activities:
Net proceeds from sales and repayments of
securitized loans................................. (10,845) 132,719
Net loans originated or collected .................... 388,194 (290,920)
Additions to property and equipment .................. (3,645) (2,867)
--------- ---------
Net cash provided by (used in) investing activities .. 373,704 (161,068)
--------- ---------
Financing Activities:
(Decrease) increase in debt .......................... (291,974) 134
Decrease in deposits ................................. (332,122) (31,810)
Cash dividends paid .................................. (938) (916)
Issuance of common stock ............................. 1,823 9,036
Repurchase of common stock ........................... (17,582) --
--------- ---------
Net cash used in financing activities ................ (640,793) (23,556)
--------- ---------
Net decrease in cash and cash equivalents ............ (75,189) (32,431)
Cash and cash equivalents at beginning of period ..... 488,086 521,440
--------- ---------
Cash and cash equivalents at end of period ........... $ 412,897 $ 489,009
========= =========
Supplemental disclosures and cash flow
information:
Cash paid during the period for:
Interest ........................................ $ 34,261 $ 42,090
Income taxes .................................... (17,948) (7,831)
Tax benefit from employee stock option
exercises........................................ 170 743
See accompanying Notes to Consolidated Financial Statements.
6
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, including Direct Merchants Credit
Card Bank, N.A. ("Direct Merchants Bank"), which may be referred to as "we,"
"us," "our" and the "Company." We are an information-based direct marketer of
consumer lending products and enhancement services.
We have eliminated all significant intercompany balances and transactions
in consolidation. We have reclassified certain prior-period amounts to conform
with the current period's presentation. We have eliminated all significant
intercompany balances and transactions in consolidation. We have reclassified
certain prior-period amounts to conform with the current period's presentation.
Included in these reclassifications is a change to our consolidated statements
of cash flows to reflect the provision for loan losses and retained interests
valuation expense as an adjustment to operating activities, versus the net
change in the allowance for loan losses. The impact was an increase to cash flow
provided by operating activities and a decrease to cash flow provided by
investing activities by $83.7 million for the three months ended March 31, 2002.
The impact of this change was an increase to cash flow provided by operating
activities and an increase to cash flow used by investing activities by $48.1
million for the three months ended March 31, 2001. These changes had no impact
to the "Net change in cash and cash equivalents" on the consolidated statements
of cash flows.
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 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, 2001. 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
accounting principles generally accepted in the United States of America, 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 from assets securitized. The significant factors
susceptible to future change that have an impact on these estimates include
default rates, net interest spreads, liquidity 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, 2002 and December 31, 2001 could materially
differ from these estimates.
7
NOTE 2 - EARNINGS 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,
2002 2001
---- ----
(In thousands)
Income before cumulative effect of accounting change ......... $52,340 $56,045
Preferred dividends - Series C ............................... 9,188 8,403
------- -------
Net income applicable to common stockholders before cumulative
effect of accounting change ............................. 43,152 47,642
Cumulative effect of accounting change, net .................. -- 14,499
------- -------
Net income applicable to common stockholders ................. $43,152 $33,143
======= =======
Weighted-average common shares outstanding ................... 62,188 62,303
Adjustments for dilutive securities:
Assumed conversion of convertible preferred stock ............ 33,844 34,357
------- -------
Basic common shares .......................................... 96,032 96,660
Assumed exercise of outstanding stock options ................ 941 1,785
------- -------
Diluted common shares ........................................ 96,973 98,445
======= =======
NOTE 3 - ACCOUNTING CHANGES
On January 1, 2001, we adopted Statement of Financial Accounting Standards
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities," which establishes accounting and reporting standards for derivative
instruments. SFAS 133 requires enterprises to recognize all derivatives as
either assets or liabilities in the statement of financial position and to
measure those instruments at fair market value. As a result of the adoption of
SFAS 133, we marked our derivatives to market value and recognized a one-time,
non-cash, after-tax charge to earnings of $14.5 million. This one-time charge is
reflected as a "Cumulative effect of accounting change" in the consolidated
statements of income for the three months ended March 31, 2001.
On January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible
Assets," which establishes accounting and reporting standards for goodwill and
other intangible assets. It requires enterprises to test these assets for
impairment upon adoption of SFAS 142 as well as on an annual basis, and reduce
the carrying amount of these assets if they are found to be impaired. Goodwill
and other intangible assets with an indefinite useful life will no longer be
amortized. Other intangible assets with an estimable useful life will continue
to be amortized over their useful lives. The adoption of the new standard did
not have a material impact on our financial statements.
On January 1, 2002, we adopted SFAS No. 144, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which
supersedes FASB Statement No. 121, and provides a single accounting model for
long-lived assets to be disposed of. The adoption of the new standard did not
have a material impact on our financial statements.
8
NOTE 4 - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is as follows:
Three Months Ended
March 31,
2002 2001
---- ----
Balance at beginning of period ............... $ 410,159 $ 123,123
Allowance transferred to the retained
interests valuation allowance............ (63,937) (19,206)
Provision for loan losses .................... 154,370 87,729
Loans charged off ............................ (88,891) (52,616)
Recoveries ................................... 5,213 4,507
--------- ---------
Net loans charged off ........................ (83,678) (48,109)
--------- ---------
Balance at end of period ..................... $ 416,914 $ 143,537
========= =========
As of March 31, 2002, we had $8.4 million in credit card loans classified
as non-accrual, compared to $1.3 million of credit card loans classified as
non-accrual as of December 31, 2001. Credit card loans contractually 90 or more
days past due and still accruing interest amounted to $124.8 million, $122.3
million and $80.7 million as of March 31, 2002, December 31, 2001 and March 31,
2001, respectively.
During the three-month period ended March 31, 2002, we transferred $63.9
million of allowance for loan losses to the valuation allowance for retained
interests in loans securitized. The transfers are due to the sale of
approximately $610 million of receivables from Direct Merchants Bank to the
Metris Master Trust ("Master Trust") and growth in the retained interests during
the first quarter of 2002. During the three-month period ended March 31, 2001,
we transferred $19.2 million of allowance for loan losses to the valuation
allowance for retained interests in loans securitized. This transfer was due to
a decrease in the credit card portfolio and growth in gross retained interests.
NOTE 5 - RETAINED INTERESTS IN LOANS SECURITIZED
Activity in the retained interests is as follows:
March 31, December 31,
2002 Change 2001
---- ------ ----
Gross retained interests . $ 1,338,437 $ 74,782 $ 1,263,655
Valuation allowance ...... (551,385) (13,886) (537,499)
----------- ----------- -----------
Net retained interests.... $ 787,052 $ 60,896 $ 726,156
=========== =========== ===========
March 31, December 31,
2001 Change 2000
---- ------ ----
Gross retained interests . $ 1,910,168 $ (113,513) $ 2,023,681
Valuation allowance ...... (643,261) (2,409) (640,852)
----------- ----------- -----------
Net retained interests.... $ 1,266,907 $ (115,922) $ 1,382,829
=========== =========== ===========
9
Activity in the valuation allowance on retained interests in loans
securitized is as follows:
Three Months Ended
March 31,
2002 2001
---- ----
Balance at beginning of period ........... $ 537,499 $ 640,852
Transfers from the allowance
for loan losses ........................ 63,937 19,206
Retained interests
valuation expense (income) ............. (50,051) (16,797)
--------- ---------
Balance at end of period ................. $ 551,385 $ 643,261
========= =========
NOTE 6 - SEGMENTS
We operate in two principal areas: consumer lending products and
enhancement services. Our consumer lending products are primarily unsecured
credit cards, including the Direct Merchants Bank MasterCard(R) and Visa(R). Our
credit card accountholders 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, and death; (2) membership programs such as card
registration, purchase protection and other club memberships; and (3)
third-party insurance, directly to our credit card accountholders and customers
of third parties. We currently administer our extended service plans sold
through a third-party retailer, and the customer pays the retailer directly. In
addition, we develop customized targeted mailing lists from information
contained in our databases for use by unaffiliated companies in their own
product solicitation efforts that do not directly compete with our efforts.
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 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 the consumer
lending products segment's accountholders 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 that is used by the consumer lending products
segment to fund the growth of accountholder balances.
10
Three Months Ended March 31,
2002
----
Consumer
Lending Enhancement Securitization Other
Products Services Adjustments(a) Adjustments(b) Consolidated
-------- -------- -------------- -------------- ------------
Interest income. $ 526,678 $ 2,328 $ (373,146) (2,328) $ 153,532
Interest
expense .... 90,732 -- (56,239) (2,328) 32,165
----------- ----------- ----------- --------- -----------
Net interest
income ..... 435,946 2,328 (316,907) -- 121,367
Other revenue .. 130,763 94,996 66,462 -- 292,221
Total revenue .. 566,709 97,324 (250,445) -- 413,588
Income before
income taxes. 140,324(c) 64,907(c) -- (120,401) 84,830
Total assets .... $11,177,901 $ 151,429 $(8,223,360) $544,980 (d) $ 3,650,950
Three Months Ended March 31,
2001
----
Consumer
Lending Enhancement Securitization Other
Products Services Adjustments(a) Adjustments(b) Consolidated
-------- -------- -------------- -------------- ------------
Interest income. $ 466,820 $ 3,620 $ (297,091) (3,620) $ 169,729
Interest
expense .... 143,930 -- (92,475) (3,620) 47,835
----------- ----------- ----------- ----------- -----------
Net interest
income ..... 322,890 3,620 (204,616) -- 121,894
Other revenue .. 125,371 78,264 24,553 -- 228,188
Total revenue .. 448,261 81,884 (180,063) -- 350,082
Income before
income taxes. 157,580(c) 54,678(c) -- (121,128) 91,130
Total assets .... $ 9,181,949 $ 138,599 $(6,170,284) $ 614,197 (d) $ 3,764,461
(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 (and cumulative effect of accounting change)
includes intercompany commissions paid by the enhancement services segment
to the consumer lending products segment for successful marketing efforts
to consumer lending products accountholders of $3.3 million for the three
months ended March 31, 2002 and $3.2 million for the three months ended
March 31, 2001.
(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.
11
NOTE 7 - SHAREHOLDERS' EQUITY
On February 6, 2001, the Board of Directors authorized a share repurchase
program of up to $200 million of our outstanding common stock over a period
ending December 31, 2002. The amount of common stock we can repurchase in a
calendar year is limited under its various debt agreements. For the three months
ended March 31, 2002, 1,292,100 common shares had been repurchased under the
program for $17.6 million. In 2002, we may repurchase up to an additional $77
million of common stock.
The purpose of the Metris Companies Inc. stock repurchase program is to
purchase outstanding stock for later reissuance under our stock option and
employee benefit plans or potential acquisition opportunities. During the first
quarter of 2002 and 2001, the Company issued 116,000 and 662,000 shares of
common stock, respectively, under its employee benefit plans for net cash
proceeds of $1.8 million and $4.8 million, respectively.
NOTE 8 - SUBSEQUENT EVENT
On April 16, 2002, Direct Merchants Bank entered into an agreement with the
Office of the Comptroller of the Currency ("OCC") to strengthen the safety and
soundness of Direct Merchants Bank's operations. The agreement formalizes
recommendations made and requirements imposed by the OCC following an
examination of Direct Merchants Bank that covered the 15-month period ended
December 31, 2001. On April 17, 2002, Metris Companies Inc. filed the agreement
with the Securities and Exchange Commission as an exhibit to a current report on
Form 8-K. We filed an amendment to that current report on Form 8-K on October
22, 2002.
NOTE 9 - SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS
We have various indirect subsidiaries which do not guarantee company debt.
We have presented the following condensed consolidating financial statements of
the Company, the guarantor subsidiaries and the non-guarantor subsidiaries to
comply with SEC reporting requirements. We have not presented separate financial
statements of the guarantor and non-guarantor subsidiaries because management
has determined that the subsidiaries' financial statements would not be material
to investors.
12
METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
March 31, 2002
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Assets:
Cash and cash equivalents ................ $ 5,092 $ 1,870 $ 405,935 $ -- $ 412,897
Net retained interests in
loans securitized ..................... -- -- 787,052 -- 787,052
Credit card loans, net of allowance ...... 9,451 -- 1,784,482 -- 1,793,933
Property and equipment, net .............. -- 76,032 35,663 -- 111,695
Purchased portfolio premium .............. 248 -- 86,090 -- 86,338
Other receivables due from credit card
securitizations, net.................. 7 -- 190,809 -- 190,816
Other assets ............................. 9,866 52,204 211,987 (5,838) 268,219
Investment in subsidiaries ............... 1,956,055 1,778,331 -- (3,734,386) --
----------- ----------- ----------- ----------- -----------
Total assets ............................. $ 1,980,719 $ 1,908,437 $ 3,502,018 $(3,740,224) $ 3,650,950
=========== =========== =========== =========== ===========
Liabilities:
Deposits ................................. $ (1,000) $ -- $ 1,726,886 $ -- $ 1,725,886
Debt ..................................... 346,146 69 9,715 -- 355,930
Accounts payable ......................... 4,362 11,807 89,761 (2,919) 103,011
Deferred income .......................... 804 25,897 180,746 (2,919) 204,528
Deferred tax liability ................... 4,795 (7,207) 28,612 -- 26,200
Accrued expenses and other
liabilities........................... 447,610 (78,184) (312,033) -- 57,393
----------- ----------- ----------- ----------- -----------
Total liabilities ........................ 802,717 (47,618) 1,723,687 (5,838) 2,472,948
----------- ----------- ----------- ----------- -----------
Total stockholders' equity ............... 1,178,002 1,956,055 1,778,331 (3,734,386) 1,178,002
----------- ----------- ----------- ----------- -----------
Total liabilities and
stockholders' equity.................. $ 1,980,719 $ 1,908,437 $ 3,502,018 $(3,740,224) $ 3,650,950
=========== =========== =========== =========== ===========
13
METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
December 31, 2001
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Assets:
Cash and cash equivalents ............ $ 17,613 $ 1,505 $ 468,968 $ -- $ 488,086
Net retained interests in loans
securitized ....................... -- -- 726,156 -- 726,156
Credit card loans, net of allowance .. 1,646 -- 2,334,851 -- 2,336,497
Property and equipment, net .......... -- 78,425 36,488 -- 114,913
Deferred income taxes ................ (31,921) 4,937 59,151 -- 32,167
Purchased portfolio premium .......... 248 -- 94,545 -- 94,793
Other receivables due from credit card
securitizations, net .............. 34 644 179,190 -- 179,868
Other assets ......................... 10,145 50,794 201,525 (6,258) 256,206
Investment in subsidiaries ........... 1,900,528 1,745,701 -- (3,646,229) --
----------- ----------- ----------- ----------- -----------
Total assets ......................... $ 1,898,293 $ 1,882,006 $ 4,100,874 $(3,652,487) $ 4,228,686
=========== =========== =========== =========== ===========
Liabilities:
Deposits ............................. $ (1,000) $ -- $ 2,059,008 $ -- $ 2,058,008
Debt ................................. 345,924 171 301,809 -- 647,904
Accounts payable ..................... 3,070 15,461 68,073 (3,129) 83,475
Deferred income ...................... 3,270 30,615 184,275 (3,129) 215,031
Accrued expenses and other
liabilities ...................... 405,074 (64,769) (257,992) -- 82,313
----------- ----------- ----------- ----------- -----------
Total liabilities .................... 756,338 (18,522) 2,355,173 (6,258) 3,086,731
----------- ----------- ----------- ----------- -----------
Total stockholders' equity ........... 1,141,955 1,900,528 1,745,701 (3,646,229) 1,141,955
----------- ----------- ----------- ----------- -----------
Total liabilities and
stockholders' equity ............. $ 1,898,293 $ 1,882,006 $ 4,100,874 $(3,652,487) $ 4,228,686
=========== =========== =========== =========== ===========
14
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Three Months Ended March 31, 2002
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Net Interest (Expense)
Income ........................... $ (5,482) $ (1,173) $ 128,022 $ -- $121,367
Provision for loan losses ............ 65 -- 104,305 50,000 154,370
--------- --------- --------- --------- --------
Net Interest Expense
After Provision
for Loan Losses................... (5,547) (1,173) 23,717 (50,000) (33,003)
Other Operating Income:
Net securitization and
credit card servicing
income............................ 2,378 -- 121,740 -- 124,118
Credit card fees,
interchange and other
credit card income................ (2,079) 7,923 131,709 (64,446) 73,107
Enhancement services
revenues.......................... -- 16,163 78,833 -- 94,996
Intercompany allocations ............. 30 53,073 9,661 (62,764) --
--------- --------- --------- --------- --------
329 77,159 341,943 (127,210) 292,221
--------- --------- --------- --------- --------
Other Operating Expense:
Credit card account and
other product
solicitation and
marketing expenses................ -- 3,229 37,323 -- 40,552
Employee compensation ................ 404 49,168 6,976 -- 56,548
Data processing services
and communications ............... 23 (19,562) 45,211 (3,366) 22,306
Enhancement services claims
expense........................... -- (513) 11,720 -- 11,207
Credit card fraud losses ............. (8) -- 2,236 -- 2,228
Purchased portfolio premium
amortization ..................... -- -- 10,444 (1,989) 8,455
Other ................................ 43 26,348 8,661 (1,960) 33,092
Intercompany allocations ............. (509) 18,078 45,195 (62,764) --
--------- --------- --------- --------- ---------
(47) 76,748 167,766 (70,079) 174,388
--------- --------- --------- --------- ---------
(Loss) Income Before Income
Taxes and Equity in
Income of Subsidiaries............ (5,171) (762) 197,894 (107,131) 84,830
Income taxes ......................... (1,980) (292) 75,793 (41,031) 32,490
Equity in income of
subsidiaries...................... 55,531 122,101 -- (177,632) --
--------- --------- --------- --------- ---------
Net Income ........................... $ 52,340 $ 121,631 $ 122,101 $(243,732) $ 52,340
========= ========= ========= ========= =========
15
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Three Months Ended March 31, 2001
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Net Interest (Expense)
Income ........................... $ (35,551) $ (1,430) $ 158,875 $ -- $ 121,894
Provision for loan losses ............ 204 -- 87,525 -- 87,729
--------- --------- --------- --------- ---------
Net Interest (Expense) Income After
Provision for Loan Losses.......... (35,755) (1,430) 71,350 -- 34,165
Other Operating Income:
Net securitization and
credit card servicing
income............................ 2,378 -- 84,714 -- 87,092
Credit card fees, interchange and other
credit card income................ (1,289) (6,788) 71,111 (202) 62,832
Enhancement services
revenues.......................... -- 17,118 61,146 -- 78,264
--------- --------- --------- --------- ---------
1,089 10,330 216,971 (202) 228,188
--------- --------- --------- --------- ---------
Other Operating Expense:
Credit card account and
other product
solicitation and
marketing expenses................ -- 6,120 34,645 -- 40,765
Employee compensation ................ -- 43,411 11,325 -- 54,736
Data processing services and
communications ................... -- (30,533) 52,912 -- 22,379
Enhancement services claims
expense........................... -- 167 6,512 -- 6,679
Credit card fraud losses ............. -- -- 2,651 -- 2,651
Purchased portfolio premium
amortization ........................ -- -- 7,828 -- 7,828
Other ................................ 38 18,462 17,685 -- 36,185
--------- --------- --------- --------- ---------
38 37,627 133,558 -- 171,223
--------- --------- --------- --------- ---------
(Loss) Income Before Income
Taxes, Equity in Income
of Subsidiaries and
Cumulative Effect of
Accounting Change................. (34,704) (28,727) 154,763 (202) 91,130
Income taxes ......................... (13,361) (11,970) 60,494 (78) 35,085
Equity in income of
subsidiaries...................... 62,889 79,770 -- (142,659) --
--------- --------- --------- --------- --------
Income Before Cumulative
Effect of Accounting
Change............................ 41,546 63,013 94,269 (142,783) 56,045
Cumulative effect of
accounting change, net ........... -- -- 14,499 -- 14,499
--------- --------- --------- --------- ---------
Net Income ........................... $ 41,546 $ 63,013 $ 79,770 $(142,783) $ 41,546
========= ========= ========= ========= =========
16
METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Three Months Ended March 31, 2002
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
Operating Activities:
Net cash provided by operating
activities ....................... $ 67,286 $ 36,732 $ 199,414 $(111,532) $ 191,900
--------- --------- --------- --------- ---------
Investing Activities:
Net proceeds from sales and
repayments of securitized loans .. -- -- (10,845) -- (10,845)
Net loans originated or collected .... (7,805) -- 395,999 -- 388,194
Additions to property and equipment .. -- (3,631) (14) -- (3,645)
Investment in subsidiaries ........... (55,527) (32,630) -- 88,157 --
--------- --------- --------- --------- ---------
Net cash (used in) provided by
investing activities.............. (63,332) (36,261) 385,140 88,157 373,704
--------- --------- --------- --------- ---------
Financing Activities:
Increase (decrease) in debt .......... 222 (102) (292,094) -- (291,974)
Decrease in deposits ................. -- -- (332,122) -- (332,122)
Cash dividends paid .................. (938) -- -- -- (938)
Issuance of common stock ............. 1,823 -- -- -- 1,823
Repurchase of common stock ........... (17,582) -- -- -- (17,582)
Capital contributions ................ -- (4) (23,371) 23,375 --
--------- --------- --------- --------- ---------
Net cash used in financing activities. (16,475) (106) (647,587) 23,375 (640,793)
--------- --------- --------- --------- ---------
Net (decrease) increase in cash and
cash equivalents.................. (12,521) 365 (63,033) -- (75,189)
Cash and cash equivalents at
beginning of period............... 17,613 1,505 468,968 -- 488,086
--------- --------- --------- --------- ---------
Cash and cash equivalents at end of
period............................ $ 5,092 $ 1,870 $ 405,935 $ -- $ 412,897
========= ========= ========= ========= =========
17
METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Three Months Ended March 31, 2001
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Operating Activities:
Net cash (used in) provided by
operating activities.............. $ (7,013) $ 86,318 $ 215,422 $(142,534) $ 152,193
--------- --------- --------- --------- ---------
Investing Activities:
Net proceeds from sales and
repayments of securitized loans... 1,487 4 131,228 -- 132,719
Net loans originated or collected .... (12,157) -- (278,763) -- (290,920)
Dispositions of (additions to)
property and equipment............ -- 4,271 (7,138) -- (2,867)
Investment in subsidiaries ........... (63,034) (94,322) -- 157,356 --
--------- --------- --------- --------- ---------
Net cash used in investing activities. (73,704) (90,047) (154,673) 157,356 (161,068)
--------- --------- --------- --------- ---------
Financing Activities:
Increase (decrease) in debt .......... 222 (3) (85) -- 134
Decrease in deposits ................. -- -- (31,810) -- (31,810)
Cash dividends paid .................. (916) -- -- -- (916)
Issuance of common stock ............. 9,036 -- -- -- 9,036
Capital contributions ................ -- 145 14,677 (14,822) --
--------- --------- --------- --------- ---------
Net cash provided by (used in)
financing activities.............. 8,342 142 (17,218) (14,822) (23,556)
--------- --------- --------- --------- ---------
Net (decrease) increase in cash and
cash equivalents.................. (72,375) (3,587) 43,531 -- (32,431)
Cash and cash equivalents at
beginning of period............... 64,869 10,658 445,913 -- 521,440
--------- --------- --------- --------- ---------
Cash and cash equivalents at end of
period............................ $ (7,506) $ 7,071 $ 489,444 $ -- $ 489,009
========= ========= ========= ========= =========
18
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, including
Direct Merchants Credit Card Bank, N.A. ("Direct Merchants Bank"), which may be
referred to as "we," "us," "our" and 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, 2001; and our Proxy
Statement for the 2002 Annual Meeting of Shareholders. In addition, you should
read this discussion along with our Quarterly Report on Form 10-Q/A for the
period ended March 31, 2002, of which this commentary is a part, and the
condensed consolidated financial statements and related notes thereto.
Results of Operations
Net income for the three months ended March 31, 2002 was $52.3 million, up
from $41.5 million for the first quarter of 2001. Net income reported for the
three months ended March 31, 2001 includes $14.5 million of a cumulative effect
of accounting change described below. Without this item, reported earnings would
have been $56.0 million for the three months ended March 31, 2001. Diluted
earnings per share for the three months ended March 31, 2002 was $0.54 compared
to $0.42 per share for the first quarter of 2001. Without the impact of the
cumulative effect of accounting change, diluted earnings per share would have
been $0.57 for the three months ended March 31, 2001. The $3.7 million reduction
in income before the cumulative effect of accounting change is primarily due to
an increase in provision for loan losses, partially offset by increases in other
operating income. The increase in the provision relates to the estimated
required balance in the allowance for loan losses to cover future charge-offs
inherent in our credit card loan portfolio as of March 31, 2002. Higher credit
card loan balances, increased net charge-offs, increased delinquency rates and
the current economic environment were some of the factors considered by
management in determining the necessary balance in the allowance for loan
losses. Other operating income increased 28% to $292.2 million for the three
months ended March 31, 2002 from $228.2 million for the same period in 2001. Net
securitization and credit card servicing income, a component of other operating
income, increased 43% to $124.1 for the first quarter of 2002 from $87.1 million
for the same period in 2001, primarily due to the $2.1 billion increase in
securitized receivables and lower costs of funds offset by increased
charge-offs. Enhancement services revenue also increased 21% to $95.0 million
for the first quarter of 2002 compared to the same period in 2001. These
increases were primarily due to the growth in total credit card accounts, an
increase in outstanding receivables in the managed credit card loan portfolio,
development of new third-party relationships and the creation of new products.
On January 1, 2001, we adopted Statement of Financial Accounting Standards
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities," which establishes accounting and reporting standards for derivative
instruments. SFAS 133 requires enterprises to recognize all derivatives as
either assets or liabilities in the statement of financial position and to
measure those instruments at fair value. Prior to SFAS 133, we amortized the
costs of interest rate contracts on a straight-line basis over the expected life
of the contract. The adoption of SFAS 133 resulted in a one-time, non-cash,
after-tax charge to earnings of $14.5 million reflected as a
19
"Cumulative effect of accounting change" in the consolidated statements of
income for the three months ended March 31, 2001.
Critical Accounting Policies
The Company's most significant accounting policies are our determination of
the allowance for loan losses, valuation of retained interests and accounting
for deferred origination costs.
Allowance for loan losses
We maintain an allowance for loan losses sufficient to cover anticipated
probable loan losses inherent in the credit card loan portfolio as of the
balance sheet date. The allowance is based on management's consideration of all
relevant factors including management's assessment of applicable economic and
seasonal trends. In addition, we have incorporated updated regulatory guidance
regarding analysis and documentation for the allowance for loan losses.
We segment the loan portfolio into several individual static pools with
similar credit risk and time since solicitation (vintage pools), and estimate
(based on historical experience and existing environmental conditions) the
dollar amount of principal, accrued finance charges and fees in each 30-day
delinquency bucket that will not be collected and, therefore, "roll" into the
next 30-day bucket and ultimately charge off. We then aggregate these pools into
prime and sub-prime portfolios based on the prescribed FICO score cuts and into
several other groups such as credit counseling and payment alternative
receivables. We also isolate individual pools subsequent to solicitation when
the credit risk associated with the pools include higher risk segments, such as
our partially secured card program, accounts that are over their credit limit by
more than 10%, accounts receiving benefits under our debt waiver program and
other programs as deemed necessary. We separately analyze the reserve
requirement on each of these groups or portfolios.
We continually evaluate the homogenous static risk pools using a roll rate
model which uses historical delinquency levels and pay-down levels (12 months of
historical data, with significant influence given to 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 loss 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:
o national and economic trends and business conditions, including the
condition of various market segments;
o 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;
o trends in volume and the product pricing of accounts, including any
concentrations of credit; and
o 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.
20
The loan loss allowance methodology and calculation was revised in the
first quarter of 2002. The significant changes reflected in this revised
methodology are as follows:
o reserving for twelve months (versus six months) of estimated losses on the
static pool of our core prime receivables; and
o establishing a judgmental reserve for accounts over their credit limit,
accounts under specific payment programs and accounts receiving benefits
under our debt waiver program (versus including these items in our roll
rate methodology).
Retained interests
The Company determines the fair value of the net retained interests by
calculating the present value of future expected cash flows using management's
best estimate of key assumptions including credit losses, weighted-average
spreads, payment rates and a discount rate commensurate with the risks involved.
For purposes of determining the value of the retained interests, we have
included only cash flows associated with the excess spread and principal
receivables included in the retained interests as of the balance sheet date. We
have not included certain expected finance charge receivable cash flows in our
calculation.
The significant assumptions used for estimating the fair value of the
retained interest in loans securitized are as follows:
March 31, December 31,
2002 2001
---- ----
Annual discount rate (1) ........................... 15% 15%
Monthly payment rate ............................... 6% 7%
Weighted-average spread (2) ........................ 21% 20%
Annual principal, finance charge and
fees default rate.............................. 19% 18%
(1) If we had included all expected finance charge receivable cash flows, our
effective discount rate would have ranged from 35% to 45%.
(2) Includes finance charges, late fees and overlimit fees, less
weighted-average cost of funds and 2% servicing fee.
Deferred acquisition costs
We defer direct credit card origination costs associated with successful
credit card solicitations that we incur in transactions with independent third
parties, and certain other costs that we incur in connection with loan
underwriting and the preparation and processing of loan documents. We also 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, mailings and
telemarketing costs. The total amount of deferred costs as of March 31, 2002 and
December 31, 2001 were $89.3 million and $89.5 million, respectively. The most
significant assumption we used in determining the realizability of these
deferred costs is future revenues from our credit cards and enhancement services
products. A significant reduction in revenues could have a material impact on
the values of these balances.
21
Deferred revenue on Enhancement Services products
Direct Merchants Bank offers various debt waiver products to its credit
card accountholders. Revenue for such products is recognized in the month
following completion of the cancellation period, and reserves are provided for
pending claims based on Direct Merchants Bank's historical experience with
settlement of such claims. Unearned revenues and reserves for pending claims are
recorded as "Deferred income" and "Accrued expenses and other liabilities,"
respectively. We record fees on membership programs as deferred income upon
acceptance of membership and amortize them on a straight-line basis over the
membership period beginning after the contractual cancellation period is
complete. We defer and recognize extended service plan revenues and the
incremental direct acquisition costs on a straight-line basis over the life of
the related extended service plan contracts beginning after the expiration of
any manufacturers' warranty coverage.
22
Net interest income consists primarily of interest earned on our credit
card loans and retained interests in loans securitized, 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, 2002 and 2001.
Table 1: Analysis of Average Balances, Interest and Average Yields and Rates
(Dollars in thousands)
Three Months Ended March 31,
2002 2001
------------------------------------------------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
Assets:
Interest-earning assets:
Federal funds sold ............ $ 28,431 $ 114 1.6% $ 164,574 $ 2,311 5.7%
Short-term investments ........ 271,628 1,204 1.8% 280,379 3,896 5.6%
Credit card loans and
retained interests in loans
securitized .................. 3,887,955 152,214 15.9% 3,343,477 163,522 19.8%
----------- ----------- ---- ----------- ----------- ----
Total interest-earning assets $ 4,188,014 $ 153,532 14.9% $ 3,788,430 $ 169,729 18.2%
Other assets .................. 759,353 -- -- 806,136 -- --
Allowances for loan
losses and retained interests
valuation allowance .......... (988,054) -- -- (781,211 ) -- --
----------- -----------
Total assets .................. $ 3,959,313 -- -- $ 3,813,355 -- --
=========== ===========
Liabilities and Equity:
Interest-bearing liabilities:
Deposits ...................... $ 1,930,007 $ 23,653 5.0% $ 2,130,414 $ 36,623 7.0%
Debt .......................... 356,019 8,512 9.7% 360,999 11,212 12.6%
----------- ----------- ---- ----------- ----------- ----
Total interest-bearing
liabilities ................ $ 2,286,026 $ 32,165 5.7% $ 2,491,413 $ 47,835 7.8%
Other liabilities ............. 519,185 -- -- 412,839 -- --
----------- -----------
Total liabilities ............. 2,805,211 -- -- 2,904,252 -- --
Stockholders' equity .......... 1,154,102 -- -- 909,103 -- --
----------- -----------
Total liabilities and equity... $ 3,959,313 -- -- $ 3,813,355 -- --
=========== ===========
Net interest income and
interest margin (1) ........ -- $ 121,367 11.8% -- $ 121,894 13.0%
Net interest rate spread (2) -- -- 9.2% -- -- 10.4%
Return on average assets ...... -- -- 5.4% -- -- 6.0%
Return on average total
equity ..................... -- -- 18.4% -- -- 25.0%
(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 $0.6 million to $121.4 million for the
quarter ended March 31, 2002 from $122.0 million for the quarter ended March 31,
2001. The decrease primarily relates to a decrease in the yield on credit card
loans and retained interests in loans securitized from 19.8% to 15.9%, partially
offset by a rate decrease on interest-bearing liabilities from 7.8% for the
three months ended March 31, 2001 to 5.7% for the three months ended March 31,
2002.
23
Other Operating Income
Other operating income contributes substantially to our results of
operations, representing 71% and 65% of total revenues for the three-month
periods ended March 31, 2002 and 2001, respectively.
Other operating income increased $64.0 million for the three months ended
March 31, 2002 over the comparable period in 2001. This increase is due to the
$37.0 million increase in net securitization and credit card servicing income.
The increase in net securitization and credit card servicing income was
primarily due to the change in the retained interests valuation expense needed
to record the retained interests at fair value. The retained interests valuation
expense decreased $33.3 million for the three months ended March 31, 2002 versus
the three months ended March 31, 2001.
Credit card fees, interchange and other credit card income increased $10.3
million to $73.1 million for the three months ended March 31, 2002 over the
comparable period in 2001 due to the growth in loans in the credit card
portfolio and retained interests partially offset by increased finance charge
and fee charge-offs. Average credit card loans and retained interests increased
to $3.9 billion for the three months ended March 31, 2002, compared to $3.3
billion for the same period in 2001.
Enhancement services revenues increased by $16.7 million for the three
months ended March 31, 2002, compared to the three months ended March 31, 2001.
This increase reflects higher credit protection revenue due to increased covered
receivables and higher sales of our debt waiver products, as well as the
increase in membership program revenues resulting from additional product offers
to third-party cardholders.
Other Operating Expense
Total other operating expenses for the three months ended March 31, 2002
increased $3.2 million over the comparable period in 2001, largely due to costs
associated with the growth of our business activities. Employee compensation
increased $1.8 million for the three month ended March 31, 2002 due to increased
staffing needs. Enhancement services claims expense increased $4.5 million for
the three months ended March 31, 2002 due to growth in debt waiver covered
receivables. Other expenses decreased $3.1 million for the three months ended
March 31, 2002 due to decreased professional fees, related legal expenses and
insurance reimbursements.
24
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
account 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, 2002, 55% of our outstanding receivables balance
were from credit card accounts that have been with us in excess of two years,
and 33% of outstanding receivables were with us in excess of four years.
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 solicitation. We manage credit lines on an
ongoing basis and adjust them based on customer usage and payment patterns. To
maximize profitability, we continually monitor customer accounts and initiate
appropriate collection activities when an account is delinquent or overlimit.
Delinquencies
Delinquencies not only have the potential to affect earnings in the form of
net loan losses, but they are also costly in terms of the personnel and other
resources dedicated to their resolution. It is our policy to continue to accrue
interest and fee income on all credit card accounts until we charge off the
account, except in limited circumstances. FFIEC (Federal Financial Institutions
Examination Council) guidelines with respect to credit card issuers permit the
re-aging of past due accounts to current status only after receiving the
equivalent of three minimum payments or one lump sum equivalent. Furthermore,
accounts can only be re-aged to current status once every twelve months and
twice every five years. Table 2 presents the delinquency trends of our credit
card loan portfolio.
Table 2: Loan Delinquency
(Dollars in thousands)
March 31, % of December 31, % of March 31, % of
2002 Total 2001 Total 2001 Total
---- ----- ---- ----- ---- -----
Loans outstanding ... $2,210,847 100% $2,746,656 100% $1,402,808 100%
Loans contractually
delinquent:
30 to 59 days .. 55,101 2.5% 87,603 3.2% 50,078 3.6%
60 to 89 days .. 38,023 1.7% 66,647 2.4% 40,843 2.9%
90 or more days. 133,223 6.0% 123,528 4.5% 80,733 5.7%
---------- ---------- ---------- ---------- ---------- ----------
Total ....... $ 226,347 10.2% $ 277,778 10.1% $ 171,654 12.2%
========== ========== ========== ========== ========== ==========
The 200-basis-point decrease in the delinquency rates over March 31, 2001
reflects the run-off of our partially secured credit card portfolio.
25
Net Charge-Offs
Net charge-offs are the principal amount of losses from credit card
accountholders unwilling or unable to make minimum payments, bankrupt credit
card accountholders and deceased credit card accountholders, less current period
recoveries. Net charge-offs exclude accrued finance charges and fees, which are
charged against the related income at the time of charge-off. The following
table presents our net principal charge-offs for the periods indicated as
reported in the consolidated financial statements.
Table 3: Net Charge-offs
(Dollars in thousands) Three Months Ended
March 31,
2002 2001
---- ----
Average credit card loans .......... $2,052,596 $1,298,748
Net charge-offs .................... 83,678 48,109
Net charge-off ratio ............... 16.5% 15.0%
========== ==========
The increase in the net charge off ratios for the three months ended March
31, 2002 primarily reflects a decrease in the loan growth, a deterioration in
the economy and the impact of the 2001 credit line increase program.
Provision and Allowance for Loan Losses
We make provisions for loan losses in amounts necessary to maintain the
allowance at a level estimated to be sufficient to absorb probable future loan
losses, net of recoveries, inherent in the loan portfolio.
The economy has slowed down significantly over the last year, exacerbated
by the terrorist attacks on September 11, 2001. Also, our 2001 credit line
increase program added pressure to some of our customers, due to increased
average outstanding balances which require higher monthly payments. This, along
with a deteriorating economy, has made our collection efforts more difficult,
resulting in higher delinquencies. This changing environment has caused our
delinquencies and losses to increase from prior years' levels. Some of the
actions we are taking to mitigate this slowdown include expanding our
collections strategies to aggressively address any potential delinquency
increases and using our recovery staff to work on precharge-off receivables. We
also leverage debt forbearance programs and credit counseling services for
qualifying credit card accountholders 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
$108.5 million or 5% of credit card loans as of March 31, 2002, compared with
$129.9 million or 5% of credit card loans as of December 31, 2001. All
delinquent receivables in debt forbearance programs are included in Table 2.
The provision for loan losses was $154.4 million for the three months ended
March 31, 2002, compared to $87.7 million for the three months ended March 31,
2001. The ratio of allowance for loan losses to period-end loans was 18.9% at
March 31, 2002, compared to 14.9% at December 31, 2001. The allowance for loan
losses as a percentage of 30-day plus receivables was 184.2% at March 31, 2002
and 147.7% at December 31, 2001.
26
Retained Interest Valuation
We record a valuation allowance to reduce the contractual value of the
retained interests in loans securitized to fair value. The following summarizes
our retained interests as of March 31, 2002, December 31, 2001, March 31, 2001
and December 31, 2000.
March 31, December 31,
2002 Change 2001
---- ------ ----
Gross retained interests ..... $ 1,338,437 $ 74,782 $ 1,263,655
Valuation allowance .......... (551,385) (13,886) (537,499)
----------- ----------- -----------
Net retained interests........ $ 787,052 $ 60,896 $ 726,156
=========== =========== ===========
March 31, December 31,
2001 Change 2000
---- ------ ----
Gross retained interests ..... $ 1,910,168 $ (113,513) $ 2,023,681
Valuation allowance .......... (643,261) (2,409) (640,852)
----------- ----------- -----------
Net retained interests........ $ 1,266,907 $ (115,922) $ 1,382,829
=========== =========== ===========
Gross retained interests in loans securitized increased by $74.8 million
between December 31, 2001 and March 31, 2002, to $1.3 billion. The increase is
due to the sale of approximately $610 million of receivables from Direct
Merchants Bank to the Master Trust during the three months ended March 31, 2002.
During the three months ended March 31, 2002, the valuation allowance increased
by $13.9 million, primarily due to the higher gross retained interests and a
higher projected default rate partially offset by an increase in the projected
weighted-average spread. The projected default rate increased from 18% as of
December 31, 2001 to 19% as of March 31, 2002. The increase in the projected
default rate was due to increased delinquencies in the Master Trust and the
overall deterioration in the economy. The increase in the projected default rate
caused an appproximate $30 million increase in the valuation allowance. The
projected weighted-average spread increased from 20% as of December 31, 2001 to
21% as of March 31, 2002. The increase in the projected weighted-average spread
is due to lower costs of funds and the impact of interest rate floors on credit
card accounts.
27
Balance Sheet Analysis
Credit Card Loans
Credit card loans were $2.2 billion as of March 31, 2002, compared to $2.7
billion as of December 31, 2001. The $0.5 billion decrease is primarily a result
of the transfer of $610 million of receivables from Direct Merchants Bank to the
Metris Master Trust.
Deferred Tax Asset/Liability
Total deferred tax asset/liability decreased to a net liability of $26.2
million as of March 31, 2002 from a net tax asset of $32.2 million as of
December 31, 2001. The decrease in net asset/liability is the result of various
timing differences between accounting principles generally accepted in the
United States of America and tax accounting.
Debt
Debt decreased to $355.9 million as of March 31, 2002 from $647.9 million
as of December 31, 2001 due to the paydown of a warehouse financing arrangement
entered into by Direct Merchants Bank in June 2001 that was accounted for as a
collateralized financing.
Deferred Income
Deferred income decreased $10.5 million to $204.5 million as of March 31,
2002 compared to $215.0 million as of December 31, 2001. The decrease primarily
relates to our migration from annual-billed to monthly-billed products.
Stockholders' Equity
Stockholders' equity was $1.2 billion as of March 31, 2002, an increase of
$36.0 million over December 31, 2001 stockholders' equity of $1.1 billion. The
increase results from net income of $52.3 million and $1.8 million stock
issuances under employee benefit plans offset by cash dividends of $0.9 million
and $17.6 million of stock repurchases under our stock repurchase program.
28
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. Because the
pricing and maturity characteristics of our assets and liabilities change,
liquidity management is a dynamic process, affected by changes in short- and
long-term interest rates. We use a variety of financing sources to manage
liquidity, refunding, and interest rate risks. Table 4 summarizes our funding
and liquidity as of March 31, 2002 and December 31, 2001:
Table 4: Liquidity, Funding and Capital Resources
(Dollars in thousands)
March 31, 2002 December 31, 2001
-------------- -----------------
Unused Unused
On-balance sheet funding Outstanding Capacity Outstanding Capacity
------------------------ ----------- -------- ----------- --------
Bank conduit 2002 ........ $ -- $ 400,000 $ 292,000 $ 108,000
Revolving credit line 2003 -- 170,000 -- 170,000
Term loan 2003 ........... 100,000 N/A 100,000 N/A
Senior notes 10% 2004 .... 100,000 N/A 100,000 N/A
Senior notes 10.125% 2006 146,146 N/A 145,924 N/A
Other .................... 9,784 N/A 9,980 N/A
Deposits ................. 1,725,886 N/A 2,058,008 N/A
Equity ................... 1,178,002 N/A 1,141,955 N/A
----------- ----------- ---------- ----------------
Subtotal ............ $ 3,259,818 $ 570,000 $3,847,867 $ 278,000
Off-balance sheet funding
Metris Master Trust $ 8,223,360 $ 585,890 $ 7,880,342 $ 328,908
Metris facility ... -- 75,000 15,500 59,500
Various conduits .. -- 850,000 -- --
----------- ----------- ----------- -----------
Subtotal ..... $ 8,223,360 $ 1,510,890 $ 7,895,842 $ 388,408
----------- ----------- ----------- -----------
Total ........ $11,483,178 $ 2,080,890 $11,743,709 $ 666,408
=========== =========== =========== ===========
Under our revolving line of credit agreement, we need to maintain, among
other items, minimum equity plus reserves to managed assets of 10%, minimum
three-month average excess spread (by asset-backed securitization deal) of 1%,
minimum equity of $684 million and a ratio of equity plus reserves to managed
90-day plus delinquencies of 2.25. As of March 31, 2002 and December 31, 2001,
we were in compliance with all financial covenants under our credit agreements.
The Master Trust and the associated securitized debt provide for early
amortization if certain events occur. These events are described in the
applicable prospectus of each securitization transaction. The most significant
events would be three consecutive months of less than zero percent excess spread
or negative transferor's interest within the Master Trust. 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
would provide additional security to the investors of the Master Trust. The
triggers are related to the performance of the Master Trust, specifically the
amount of net excess spread over a one to three month period. As of March 31,
2002, we have not broken any triggers in our securitization agreements and,
therefore, no cash has been restricted.
29
Our equity as a percent of managed assets was 9.9% as of March 31, 2002
versus 9.4% as of December 31, 2001. We have historically retained cash flow
generated from earnings (versus declaring larger dividends) to provide
additional equity and liquidity to fund future receivables growth. In addition,
stock incentive plans provide us with a source of equity and liquidity.
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, 2002 and December 31, 2001, 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.
30
Additional information about Direct Merchants Bank's actual capital amounts
and ratios are presented in the following table:
For Capital
Adequacy To Be Well
Actual Purposes Capitalized
As of March 31, 2002 Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital....... $390,623 18.8% $166,273 8.0% $207,841 10.0%
(to risk-weighted
assets)
Tier 1 Capital...... 359,825 17.3% 83,136 4.0% 124,705 6.0%
(to risk-weighted
assets)
Tier 1 Capital...... 359,825 14.1% 102,357 4.0% 127,947 5.0%
(to average assets)
For Capital
Adequacy To Be Well
Actual Purposes Capitalized
As of December 31, 2001 Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital ........ $346,907 13.0% $213,733 8.0% $267,166 10.0%
(to risk-weighted
assets)
Tier 1 Capital ....... 308,186 11.5% 106,867 4.0% 160,300 6.0%
(to risk-weighted
assets)
Tier 1 Capital ....... 308,186 11.2% 110,573 4.0% 138,216 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, 2002 was 12.0%.
31
Regulatory Matters
On April 16, 2002, Direct Merchants Bank entered into an agreement with the
Office of the Comptroller of the Currency ("OCC") to strengthen the safety and
soundness of Direct Merchants Bank's operations. The agreement formalizes
recommendations made and requirements imposed by the OCC following an
examination of Direct Merchants Bank that covered the 15-month period ended
December 31, 2001. On April 17, 2002, MCI filed the agreement with the
Securities and Exchange Commission as an exhibit to and incorporated by
reference in a current report on Form 8-K. We filed an amendment to that current
report on Form 8-K on October 22, 2002.
Direct Merchants Bank intends to comply with all of the terms of the
agreement in a timely manner. Furthermore, we believe that as of the filing date
of this amended Quarterly Report, Direct Merchants Bank has complied with all of
the terms of the agreement, including with respect to the updating, development,
adoption and delivery in a timely matter of its Strategic Plan, Capital Plan,
Contingency Funding Plan and various other written action plans. Direct
Merchants Bank has implemented the plans for which the OCC has posed no
objection and is revising or planning to implement all others, pending and in
response to comments from the OCC.
If the OCC were to conclude that Direct Merchants Bank failed to implement
in a timely manner any provision of the agreement or that Direct Merchants Bank
otherwise violated the agreement, the OCC could pursue various enforcement
options. Under applicable provisions of the Federal Deposit Insurance Act, the
OCC may, among other things, pursue an order to cease and desist from any
further violations or take affirmative actions to correct conditions resulting
from violations or practices, place limitations on the activities of a bank that
in its opinion violated a written agreement, remove from office members of
management or the board of directors of a bank or prohibit further participation
by those persons in the bank's affairs, and assess civil money penalties. If any
of these events were to actually occur, we could not assure you that the event
would not have a material adverse affect on Direct Merchants Bank's operations
or capital position.
32
Forward-Looking Statements
This Quarterly Report contains some forward-looking statements.
Forward-looking statements give our current expectations of future events. You
will recognize these statements because they do not strictly relate to
historical or current facts. Such statements may use words such as "anticipate,"
"estimate," "expect," "project," "intend," "think," "believe" and other words or
terms of similar meaning in connection with any discussion of future performance
of the Company. For example, these include statements relating to future
actions, future performance of current or anticipated products, solicitation
efforts, expenses, the outcome of contingencies such as litigation, and the
impact of the capital markets on liquidity. From time to time, we also may
provide oral or written forward-looking statements in other material released to
the public.
Any or all of our forward-looking statements in this Report and in any
other public statements we make may turn out to be wrong. They can be affected
by inaccurate assumptions or by known or unknown risks and uncertainties. Many
factors, which can not be predicted with certainty, will be important in
determining future results. Among such factors are higher delinquency,
charge-off and bankruptcy rates of our target market of moderate-income
consumers, risks associated with Direct Merchants Bank's ability to comply with
its agreement with regulators regarding the safety and soundness of its
operations, risks associated with our continuing ability to market our
enhancement services and maintain or expand on current levels in that business,
interest rate risks, risks associated with acquired portfolios, dependence on
the securitization markets and other funding sources, state and federal laws and
regulations that limit our business activities, product offerings and fees,
privacy laws that could result in lower marketing revenue and penalties for
non-compliance, and general economic conditions that can have a major impact on
the performance of loans. Each of these factors and others are more fully
discussed under the caption "Business--Risk Factors" contained in the Company's
Annual Report on Form 10-K/A for the year ended December 31, 2001. As a result
of these factors, we cannot guarantee any forward-looking statements. Actual
future results may vary materially. Also, please note that the factors we
provide are those we think could cause our actual results to differ materially
from expected and historical results. Other factors besides those listed here or
in our 10-K/A for the year ended December 31, 2001 could also adversely affect
us.
We undertake no obligations to publicly update any forward-looking
statements, whether as a result of new information, future events or otherwise.
You are advised, however, to consult any further disclosure we make on related
subjects in our periodic filings with the Securities and Exchange Commission.
This discussion is provided to you as permitted by the Private Securities
Litigation Reform Act of 1995.
33
Selected Operating Data - Managed Basis
We analyze the Company's financial performance on a managed loan portfolio
basis. On a managed basis, the balance sheet and income statement includes other
investors' interests in securitized loans that are not assets of the Company,
thereby reversing the effects of sale accounting under SFAS 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 receivables that have been securitized and sold and own
the right to the cash flows from those sold receivables in excess of interest
payments due 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.
Table 5: Managed Loan Portfolio
(Dollars in thousands) March 31, % of December 31, % of March 31, % of
2002 Total 2001 Total 2001 Total
---- ----- ---- ----- ---- -----
Period-end balances:
Credit card loans ......... $ 2,210,847 $ 2,746,656 $1,402,808
Retained interests in loans
securitized ........... 1,338,437 1,263,655 1,910,168
Investors' interests in
securitized loans
accounted for as sales. 8,223,360 7,895,842 6,170,416
------------ ----------- ----------
Total managed loan portfolio . $11,772,644 $11,906,153 $9,483,392
=========== =========== ==========
Loans contractually
delinquent:
30 to 59 days ........... 316,638 2.7% 375,887 3.1% 229,368 2.4%
60 to 89 days ........... 256,776 2.2% 274,278 2.3% 178,898 1.9%
90 or more days ......... 580,697 4.9% 473,003 4.0% 390,402 4.1%
----------- ------------ ----------- ------------- ---------- ------------
Total ................. $ 1,154,111 9.8% $ 1,123,168 9.4% $ 798,668 8.4%
=========== ============= =========== ============= ========== ============
Three Months Ended
March 31,
2002 2001
---- ----
Average balances:
Credit card loans ......... $ 2,052,596 $ 1,298,748
Retained interes0s in loans
securitized ........... 1,835,359 2,044,729
Investors' interests in
securitized loans
accounted for as sales. 8,074,887 6,050,624
------------------- -----------------
Total managed loan portfolio.. $ 11,962,842 $ 9,394,101
=================== =================
Net charge offs................ $ 384,174 13.0% $ 244,969 10.6%
=================== ========= ================= ========
34
The 140-basis-point increase in the managed delinquency rates over March
31, 2001 primarily reflects various factors, including a deterioration in the
economy, seasoning in the loan portfolio and the impact of our 2001 credit line
increase program. The credit line increase program added pressure to some of 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. The
increase in charge off ratios for the three-month period ended March 31, 2002
primarily reflects a slow down in loan growth, deterioration in the economy and
the 2001 credit line increase program.
The amount of customer receivables in forbearance programs was $775.1
million or 7% of total managed loans as of March 31, 2002 compared with $837.0
million or 7% of managed loans as of December 31, 2001. All delinquent
receivables in forbearance programs are included in Table 5.
Net Interest Income
Table 6: Analysis of Average Balances, Interest and Average Yields and Rates
Three Months Ended March 31,
2002 2001
------------------------------------------------------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(Dollars in thousands)
Credit card loans ............. $11,962,842 $ 525,360 17.8% $ 9,394,101 $ 460,613 19.9%
Total interest-earning assets.. 12,262,900 526,678 17.4% 9,839,055 466,820 19.2%
Total interest-bearing
liabilities ................ 10,360,913 88,404 3.5% 8,542,037 140,310 6.7%
Net interest income and
interest margin (1) ........ -- $ 438,274 14.5% -- $ 326,510 13.5%
Net interest rate spread (2)... -- -- 13.9% -- -- 12.5%
Return on average assets ...... -- -- 1.8% -- -- 2.3%
Return on average total
equity ..................... -- -- 18.4% -- -- 25.0%
(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 consists primarily of interest earned on our credit
card loans, less interest expense on borrowings to fund the loans. Managed net
interest income for the three months ended March 31, 2002 was $438.3 million
compared to $326.5 million for the same period in 2001. The increase in net
interest income is primarily due to a $2.4 billion increase in managed average
interest-earning assets and increases in net interest margin to 14.5% for the
three months ended March 31, 2002, compared to 13.5% for the same period in
2001. The managed net interest margin increase is primarily due to lower cost of
funds offset by lower portfolio yield.
35
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
rates. Our principal market risk is due to changes in interest rates. This
affects us directly in our lending and borrowing activities, as well as
indirectly, as interest rates may impact the payment performance of our
cardholders.
To manage our direct risk to market interest rates, management actively
monitors the interest rates and the interest sensitive components of our owned
and managed balance sheet to minimize the impact changes in interest rates have
on the fair value of assets, net income and cash flow. We seek to minimize the
impact of changes in interest rates on us primarily by matching asset and
liability repricings.
Our primary managed assets are credit card loans, which are virtually all
priced at rates indexed to the variable Prime Rate. We fund credit card loans
through a combination of cash flows from operations, asset securitizations, bank
loans, subsidiary bank deposits, long-term debt and equity issuances. Our
securitized loans are owned by a trust and bank-sponsored single-seller and
multi-seller receivable conduits, which have committed funding primarily indexed
to variable commercial paper rates and LIBOR. The $270 million bank credit
facility has pricing that is also indexed to LIBOR and Prime Rate. The
subsidiary bank deposits and long-term debt are issued at fixed interest rates.
At March 31, 2002 approximately 8.8% of the trust and conduit funding of
securitized receivables was funded with fixed rate securities. As of April 22,
2002, we had no fixed rate trust or conduit funding of securitized receivables.
In an interest rate environment with rates at or below current rates, 91.2%
of the securitization funding for the managed loan portfolio is indexed to
floating commercial paper and LIBOR rates. In an interest rate environment with
rates significantly above current rates, the potentially negative impact on
earnings of higher interest expense is mitigated by fixed rate funding and
interest rate cap contracts.
The approach we use to quantify interest rate risk is a sensitivity
analysis, which we believe best reflects the risk inherent in our business. This
approach calculates the impact on net income from an instantaneous and sustained
change in interest rates by 200 basis points. Assuming that we take no
counteractive measures, as of March 31, 2002, a 200 basis point increase in
interest rates affecting our floating rate financial instruments, including both
debt obligations and loans, will result in an increase in net income of
approximately $78 million relative to a base case over the next 12 months
compared to an approximate $20 million increase as of December 31, 2001. A
decrease of 200 basis points will result in a reduction in net income of
approximately $59 million as of March 31, 2002, compared to a $2 million
reduction as of December 31, 2001. The increased sensitivity to interest rate
fluctuation as of March 31, 2002 is due to a repricing on our credit card
portfolio implemented in first quarter of 2002. You should not construe our use
of this methodology to quantify the market risk of financial instruments as an
endorsement of its accuracy or the accuracy of the related assumptions. In
addition, this methodology does not take into account the indirect impact
interest rates may have on the payment performance of our cardholders. The
quantitative information about market risk is necessarily limited because it
does not take into account operating transactions or other costs associated with
managing immediate changes in interest rates.
36
Part II. Other Information
Item 1. Legal Proceedings
We are a party to various legal proceedings resulting from the ordinary
business activities relating to our operations. In July 2000 an Amended
Complaint was filed in Hennepin County District Court in Minneapolis, Minnesota
against MCI and our subsidiaries Metris Direct, Inc. and Direct Merchants Bank.
The complaint seeks damages in unascertained amounts and purports to be a class
action complaint on behalf of all credit card accountholders who were issued a
credit card by Direct Merchants Bank and were allegedly assessed fees or charges
that the cardholder did not authorize. Specifically, the complaint alleges
violations of the Minnesota Prevention of Consumer Fraud Act, the Minnesota
Deceptive Trade Practices Act and breach of contract. A final settlement
approval hearing was held on May 30, 2002, and the Court signed the order
granting final approval of the settlement whereby we will pay approximately $5.6
million for attorneys' fees and costs incurred by attorneys for the plaintiffs
in separate lawsuits filed in Arizona, California and Minnesota in 2000 and
2001. Under the terms of the settlement we denied any wrongdoing or liability.
The time for filing an appeal expired on August 5, 2002, and no appeal was
filed. At this time, we are in the process of implementing the terms of the
settlement.
On May 3, 2001, Direct Merchants Bank entered into a consent order with
the OCC. The consent order required Direct Merchants Bank to pay approximately
$3.2 million in restitution to approximately 62,000 credit card accountholders
who applied for and received a credit card in connection with a series of
limited test marketing campaigns from March 1999 to June 2000. Under the terms
of the consent order, Direct Merchants Bank made no admission or agreement on
the merits of the OCC's assertions. The restitution as required by the OCC
consent order was paid and is reflected in our December 31, 2001 financial
statements. We believe that Direct Merchants Bank's agreement with the OCC will
not have a material adverse affect on the financial position of MCI or Direct
Merchants Bank.
In May 2001, the OCC also indicated that it was considering whether to
assess civil money penalties against Direct Merchants Bank. On October 17, 2002,
the OCC notified Direct Merchants Bank that it will not assess civil money
penalties.
On April 16, 2002, Direct Merchants Bank entered into an agreement with
the OCC to strengthen the safety and soundness of Direct Merchants Bank's
operations. For further information, see "Regulatory Matters" on page 32 of this
Report.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
37
Item 5. Other Information
Not applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
11 Computation of Earnings Per Share.
99.1 Agreement between Direct Merchants Credit Card Bank, N.A. and the
Office of the Comptroller of the Currency, dated April 16, 2002
(incorporated by reference to Exhibit 99.1 to the Company's Current
Report on Form 8-K dated April 17, 2002 (File No. 1-12351)).
99.2 Certification of Principal Executive Officer Pursuant to Section
1350 of Chapter 63 of Title 18 of the United States Code.
99.3 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 April 17, 2002, we filed a Current Report on
Form 8-K to report that our wholly-owned subsidiary, Direct Merchants
Credit Card Bank, N.A., had entered into an agreement on April 16,
2002 with the Office of the Comptroller of the Currency, the agency
that regulates the Bank, to strengthen certain aspects of the safety
and soundness of the Bank's operations. We filed an amendment to that
current report on Form 8-K on October 22, 2002. See "Regulatory
Matters" on page 32 of this report.
38
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: October 22, 2002 By: /s/ David D. Wesselink
-----------------------
David D. Wesselink
Vice Chairman
Principal Financial Officer
Date: October 22, 2002 By: /s/ Mark P. Wagener
--------------------
Mark P. Wagener
Senior Vice President, Controller
Principal Accounting Officer
39
Certifications
I, Ronald N. Zebeck, certify that:
1. I have reviewed this amended Quarterly Report on Form 10-Q/A of Metris
Companies Inc.;
2. Based on my knowledge, this amended Quarterly Report does not contain any
untrue statement of material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this amended Quarterly Report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this amended Quarterly Report, fairly present in
all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in this
amended Quarterly Report.
Date: October 22, 2002
/s/ Ronald N. Zebeck
--------------------
Ronald N. Zebeck
Chairman and Chief Executive Officer
(Principal Executive Officer)
I, David D. Wesselink, certify that:
4. I have reviewed this amended Quarterly Report on Form 10-Q/A of Metris
Companies Inc.;
5. Based on my knowledge, this amended Quarterly Report does not contain any
untrue statement of material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this amended Quarterly Report; and
6. Based on my knowledge, the financial statements, and other financial
information included in this amended Quarterly Report, fairly present in
all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in this
amended Quarterly Report.
Date: October 22, 2002
/s/ David D. Wesselink
----------------------
David D. Wesselink
Vice Chairman
(Principal Financial Officer)
40