UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-Q/A
[X] Quarterly Report amendment pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended June 30, 2003
or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________ to __________
Commission file number: 001-12351
METRIS COMPANIES INC.
(Exact name of Registrant as specified in its charter)
Delaware 41-1849591
(State of Incorporation) (I.R.S. Employer Identification No.)
10900 Wayzata Boulevard, Minnetonka, Minnesota 55305-1534
(Address of principal executive offices)
(952) 525-5020
(Registrant's telephone number)
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 [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
As of July 31, 2003, 57,798,577 shares of the registrant's common stock, par
value $.01 per share, were outstanding.
METRIS COMPANIES INC.
FORM 10-Q
TABLE OF CONTENTS
JUNE 30, 2003
Page
----
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets............................................................ 4
Consolidated Statements of Income...................................................... 5
Consolidated Statements of Changes in
Stockholders' Equity.......................................................... 6
Consolidated Statements of Cash Flows.................................................. 7
Notes to Consolidated Financial Statements............................................. 8
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ......................................... 32
ITEM 3. Quantitative and Qualitative Disclosures
About Market Risk..................................................................... N/A
ITEM 4. Controls and Procedures ...................................................................... 56
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings............................................................................. N/A
ITEM 2. Changes in Securities......................................................................... N/A
ITEM 3. Defaults Upon Senior Securities............................................................... N/A
ITEM 4. Submission of Matters to a Vote of Security Holders........................................... N/A
ITEM 5. Other Information............................................................................. N/A
ITEM 6. Exhibits and Reports on Form 8-K.............................................................. N/A
Signatures.................................................................................... 59
2
EXPLANATORY NOTE
As previously disclosed, Metris Companies Inc. (the "Company") has
determined that it will restate its financial results for 1998 through 2002 and
for the first three quarters of 2003. This determination was made in connection
with the Company's analysis of its method of valuing "Retained interests in
loans securitized."
This Amendment No. 1 to the Company's Quarterly Report on Form 10-Q for
the period ended June 30, 2003, initially filed with the Securities and Exchange
Commission ("SEC") on August 14, 2003 (the "Original 10-Q"), is being filed to
reflect restatements of the following financial statements:(a) consolidated
balance sheets as of December 31, 2002 and June 30, 2003; (b) consolidated
statements of income for the three and six-months ended June 30, 2003 and 2002
and (c) consolidated statements of cash flows for the three and six-months ended
June 30, 2003 and 2002. Included in these restatements, in addition to changes
made as a result of the Company's revised accounting policies and procedures
related to valuing its retained interests, are corrections to conform with
accounting principles generally accepted in the United States of America
("GAAP") related to securitization transaction costs, credit card solicitation
costs, interest rate caps and debt waiver revenue associated with credit card
receivables sold to the Metris Master Trust, as well as the transfer of
allowance for loan losses that was incorrectly classified as a valuation reserve
in "Retained interests in loans securitized" as of December 31, 2001. In
addition, we have restated certain other prior period amounts to conform with
the current period's presentation. For a more detailed description of the
restatements, see Note 2 to the accompanying unaudited consolidated financial
statements and "Restatements" in Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in this Quarterly Report
on Form 10-Q/A.
This Amendment No. 1 amends and restates Items 1, 2, and 4 of Part I
and Item 6 of Part II of the Original 10-Q. No other information in the Original
10-Q is amended hereby. The foregoing items have been amended to reflect the
restatements and have not been updated to reflect other events occurring after
the filing of the Original 10-Q or to modify or update those disclosures
affected by subsequent events. Such matters have been or will be addressed in
the Quarterly Report on Form 10-Q for the quarter ended September 30, 2003,
filed on March 2, 2004, the Current Report on Form 8-K filed on March 15, 2004
and any reports filed with the SEC subsequent to the date of this filing.
We are concurrently filing an amended Annual Report on Form 10-K/A for
the year ended December 31, 2002 and amended Quarterly Reports on Form 10-Q/A
for the quarter ended March 31, 2003 and for the quarter ended September 30,
2003, containing restated financial statements for the relevant periods. We did
not amend our Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for
periods affected by the restatements that ended prior to December 31, 2002, and,
therefore, the financial statements, auditors' reports and related financial
information for the affected periods contained in such reports should no longer
be relied upon.
3
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands)
JUNE 30,
2003 DECEMBER 31,
AS RESTATED 2002
(UNAUDITED) AS RESTATED
------------- -----------
ASSETS:
Cash and due from banks $ 86,518 $ 62,813
Federal funds sold 33,700 88,000
Short-term investments 266,373 429,419
------------- -----------
Cash and cash equivalents 386,591 580,232
------------- -----------
Liquidity reserve deposit 80,590 --
Credit card loans 632,913 846,417
Less: Allowance for loan losses 109,162 90,315
------------- -----------
Net credit card loans 523,751 756,102
------------- -----------
Retained interests in loans securitized 852,215 808,026
Property and equipment, net 51,510 83,831
Purchased portfolio premium, net 51,584 64,579
Other receivables due from credit card
securitizations, net 92,611 110,471
Other assets 207,397 187,151
------------- -----------
TOTAL ASSETS $ 2,246,249 $ 2,590,392
============= ===========
LIABILITIES:
Deposits $ 641,934 $ 892,754
Debt 383,237 357,649
Accounts payable 49,996 53,589
Deferred income 106,134 143,148
Accrued expenses and other liabilities 115,274 88,579
------------- -----------
TOTAL LIABILITIES 1,296,575 1,535,719
------------- -----------
STOCKHOLDERS' EQUITY:
Convertible preferred stock - Series C, par
value $.01 per share; 10,000,000
shares authorized, 1,208,695 and 1,156,086
shares issued and outstanding, respectively 450,239 430,642
Common stock, par value $.01 per share;
300,000,000 shares authorized, 64,853,877
and 64,223,231 shares issued, respectively 648 642
Paid-in capital 230,241 227,376
Unearned compensation (292) --
Treasury stock - 7,055,300 shares (58,308) (58,308)
Retained earnings 327,146 454,321
------------- -----------
TOTAL STOCKHOLDERS' EQUITY 949,674 1,054,673
------------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,246,249 $ 2,590,392
============= ===========
See accompanying Notes to Consolidated Financial Statements.
4
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Income
(In thousands, except per-share data) (Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
AS RESTATED AS RESTATED
----------- -----------
2003 2002 2003 2002
---- ---- ---- ----
INTEREST INCOME:
Credit card loans $ 29,713 $ 66,324 $ 59,620 $ 154,850
Federal funds sold 164 110 523 224
Other 1,555 2,358 3,450 3,562
-------------- --------------- --------------- ---------------
Total interest income 31,432 68,792 63,593 158,636
-------------- --------------- --------------- ---------------
Deposit interest expense 9,597 18,334 20,505 41,987
Other interest expense 9,119 8,621 17,552 17,133
-------------- --------------- --------------- ---------------
Total interest expense 18,716 26,955 38,057 59,120
-------------- --------------- --------------- ---------------
NET INTEREST INCOME 12,716 41,837 25,536 99,516
Provision for loan losses 30,033 90,601 74,819 152,477
-------------- --------------- --------------- ---------------
NET INTEREST EXPENSE AFTER
PROVISION FOR LOAN LOSSES (17,317) (48,764) (49,283) (52,961)
-------------- --------------- --------------- ---------------
OTHER OPERATING INCOME:
Securitization income (expense) 17,707 42,746 (20,263) 145,192
Servicing income on securitized / sold
receivables 45,335 47,528 93,148 92,567
Credit card fees, interchange and other
credit card income 23,460 40,538 49,779 116,197
Enhancement services revenue 39,690 36,744 83,199 71,018
-------------- --------------- --------------- ---------------
126,192 167,556 205,863 424,974
-------------- --------------- --------------- ---------------
OTHER OPERATING EXPENSE:
Credit card account and other product
solicitation and marketing expenses 32,032 45,624 65,720 92,877
Employee compensation 45,721 54,365 99,102 110,913
Data processing services and communications 17,034 20,795 36,212 43,101
Credit protection claims expense 7,646 13,632 19,952 22,811
Occupancy and equipment 8,924 12,291 18,537 25,088
Purchased portfolio premium amortization 6,499 7,743 12,995 16,198
MasterCard/Visa assessment and fees 2,231 3,583 4,646 7,417
Credit card fraud losses 1,069 2,953 2,009 5,181
Asset impairments, lease write-offs and
severance 6,011 9,523 22,788 9,523
Other 19,307 28,445 39,659 46,935
-------------- --------------- --------------- ---------------
146,474 198,954 321,620 380,044
-------------- --------------- --------------- ---------------
LOSS BEFORE INCOME TAXES (37,599) (80,162) (165,040) (8,031)
Income tax benefit (12,851) (30,040) (57,462) (2,189)
-------------- --------------- ---------------- ---------------
NET (LOSS) INCOME (24,748) (50,122) (107,578) (5,842)
Convertible preferred stock dividends 9,908 9,394 19,597 18,582
-------------- --------------- --------------- ---------------
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS $ (34,656) $ (59,516) $ (127,175) $ (24,424)
============== =============== =============== ===============
LOSS PER SHARE:
Basic $ (0.60) $ (0.97) $ (2.22) $ (0.39)
Diluted $ (0.60) $ (0.97) $ (2.22) $ (0.39)
SHARES USED TO COMPUTE LOSS PER SHARE:
Basic 57,462 61,503 57,360 61,844
Diluted 57,462 61,503 57,360 61,844
DIVIDENDS DECLARED PER COMMON SHARE -- $ 0.01 -- $ 0.02
See accompanying Notes to Consolidated Financial Statements.
5
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
(In thousands) (Unaudited)
NUMBER OF SHARES PREFERRED COMMON PAID-IN UNEARNED
PREFERRED COMMON STOCK STOCK CAPITAL COMPENSATION
----------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2001 AS
PREVIOUSLY REPORTED 1,058 63,419 $ 393,970 $ 642 $ 232,413 $ (4,980)
Cumulative restatements to
prior periods, see Note 2 -- -- -- -- -- --
---------- ---------- ------------- --------- ------------ -----------
BALANCE AT DECEMBER 31, 2001, AS RESTATED 1,058 63,419 $ 393,970 $ 642 $ 232,413 $ (4,980)
Net income (as restated) -- -- -- -- -- --
Cash dividends -- -- -- -- -- --
Common stock repurchased -- (2,720) -- -- -- --
Preferred dividends in kind 48 -- 17,928 -- -- --
Issuance of common stock
under employee benefit plans -- 161 -- 2 2,255 --
Deferred compensation obligations -- 76 -- 1 967 (968)
Amortization of restricted
stock -- -- -- -- -- 911
---------- ---------- ------------- --------- ------------ -----------
BALANCE AT JUNE 30, 2002,
AS RESTATED 1,106 60,936 $ 411,898 $ 645 $ 235,635 $ (5,037)
========== ========== ============= ========= ============ ===========
BALANCE AT DECEMBER 31, 2002 AS PREVIOUSLY
REPORTED 1,156 57,168 $ 430,642 $ 642 $ 227,376 $ --
Cumulative restatements to prior
periods, see Note 2 -- -- -- -- -- --
BALANCE AT DECEMBER 31, 2002, AS RESTATED 1,156 57,168 $ 430,642 $ 642 $ 227,376 $ --
Net loss (as restated) -- -- -- -- -- --
Preferred dividends in kind 53 -- 19,597 -- -- --
Issuance of common stock
under employee benefit
plans -- 352 -- 3 2,367 --
Deferred compensation
obligations -- 303 -- 3 546 (549)
Restricted stock forfeitures -- (24) -- -- (48) 46
Amortization of restricted
stock -- -- -- -- -- 211
---------- ---------- ------------- --------- ------------ -----------
BALANCE AT JUNE 30, 2003,
AS RESTATED 1,209 57,799 $ 450,239 $ 648 $ 230,241 $ (292)
========== ========== ============= ========= ============ ===========
TOTAL
TREASURY RETAINED STOCKHOLDERS'
STOCK EARNINGS EQUITY
-------------------------------------------
BALANCE AT DECEMBER 31, 2001 AS
PREVIOUSLY REPORTED $ (13,014) $ 532,924 $ 1,141,955
Cumulative restatements to
prior periods, see Note 2 -- (36,619) (36,619)
--------- ------------- ------------
BALANCE AT DECEMBER 31, 2001, AS RESTATED $ (13,014) $ 496,305 $ 1,105,336
Net income (as restated) -- (5,842) (5,842)
Cash dividends -- (1,892) (1,892)
Common stock repurchased (32,951) -- (32,951)
Preferred dividends in kind -- (17,928) --
Issuance of common stock under employee
benefit plans -- -- 2,257
Deferred compensation
obligations -- -- --
Amortization of restricted
stock -- -- 911
--------- ------------- ------------
BALANCE AT JUNE 30, 2002,
AS RESTATED $ (45,965) $ 470,643 $ 1,067,819
========= ============= ============
BALANCE AT DECEMBER 31, 2002 AS
PREVIOUSLY REPORTED $ (58,308) $ 458,673 $ 1,059,025
Cumulative restatements to prior
periods, see Note 2 -- (4,352) (4,352)
BALANCE AT DECEMBER 31, 2002, AS RESTATED $ (58,308) $ 454,321 $ 1,054,673
Net loss (as restated) -- (107,578) (107,578)
Preferred dividends in kind -- (19,597) --
Issuance of common stock
under employee benefit
plans -- -- 2,370
Deferred compensation obligations -- -- --
Restricted stock forfeitures -- -- (2)
Amortization of restricted
stock -- -- 211
--------- ------------- ------------
BALANCE AT JUNE 30, 2003,
AS RESTATED $ (58,308) $ 327,146 $ 949,674
========= ============= ============
See accompanying Notes to Consolidated Financial Statements.
6
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands) (Unaudited)
SIX MONTHS ENDED
JUNE 30,
--------
2003 2002
AS RESTATED AS RESTATED
----------- -----------
OPERATING ACTIVITIES:
Net loss $ (107,578) $ (5,842)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation, amortization, and accretion (81,545) (92,351)
Provision for loan losses 74,819 152,477
(Gain) loss from credit card securitization 123,982 20,695
Asset impairments, lease write-offs, and severance 22,788 9,523
Market loss on derivative financial instruments 8,161 12,248
Changes in operating assets and liabilities, net:
Liquidity Reserve deposit (80,590) --
Fair value of retained interests in loans
securitized 103,897 183,201
Spread accounts receivable (201,314) 29,491
Other receivables due from credit card securitizations,
net 17,860 27,888
Accounts payable and accrued expenses 4,473 43,459
Deferred income (37,014) (21,008)
Other (67,123) 1,759
----------- -----------
Net cash provided by (used in) operating activities (219,184) 361,540
----------- -----------
INVESTING ACTIVITIES:
Proceeds from transfers of portfolios to the Metris Master
Trust 315,065 1,486,993
Net cash from loan originations and principal collections on
loans receivable (84,739) (370,193)
Disposal of property and equipment 19,252 --
Additions to property and equipment (727) (3,538)
----------- -----------
Net cash provided by investing activities 248,851 1,113,262
----------- -----------
FINANCING ACTIVITIES:
Proceeds from issuance of debt 125,348 153
Repayment of debt (100,206) (292,000)
Net decrease in deposits (250,820) (736,147)
Cash dividends paid -- (1,892)
Proceeds from issuance of common stock 2,370 2,257
Repurchase of common stock -- (32,951)
----------- -----------
Net cash used in financing activities (223,308) (1,060,580)
----------- -----------
Net increase (decrease) in cash and cash equivalents (193,641) 414,222
Cash and cash equivalents at beginning of period 580,232 381,639
----------- -----------
Cash and cash equivalents at end of period $ 386,591 $ 795,861
=========== ===========
SUPPLEMENTAL DISCLOSURES AND CASH FLOW INFORMATION:
Cash paid (received) during the period for:
Interest $ 36,280 $ 61,345
Income taxes (31,846) (16,488)
See accompanying Notes to Consolidated Financial Statements.
7
METRIS COMPANIES INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except as noted) (Unaudited)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Metris
Companies Inc. ("MCI") and its subsidiaries. MCI's principal subsidiaries are
Direct Merchants Credit Card Bank, National Association ("Direct Merchants Bank"
or the "Bank"), Metris Direct, Inc. and Metris Receivables, Inc. MCI and its
subsidiaries, as applicable, may be referred to as "we," "us," "our" or the
"Company." We are an information-based direct marketer of consumer lending
products and enhancement services.
All dollar amounts are presented as pre-tax amounts unless otherwise
noted. We have eliminated all significant intercompany balances and transactions
in consolidation. In the second quarter of 2003, certain subsidiaries were
designated as guarantors which had previously been classified as non-guarantors.
The supplemental consolidating financial statements have been reclassified for
all periods presented.
INTERIM FINANCIAL STATEMENTS
We have prepared the unaudited interim consolidated financial
statements and related unaudited financial information in the footnotes in
accordance with accounting principles generally accepted in the United States of
America ("GAAP")and the rules and regulations of the Securities and Exchange
Commission ("SEC") for interim financial statements. These interim financial
statements reflect all adjustments consisting of normal recurring accruals
which, in the opinion of management, are necessary to present fairly our
consolidated financial position and the results of our operations and our cash
flows for the interim periods. You should read these consolidated financial
statements in conjunction with the financial statements and the notes thereto
contained in our Annual Report on Form 10-K/A for the fiscal year ended December
31, 2002, filed concurrently with this Quarterly Report on Form 10-Q/A. All
dollar amounts are presented as pre-tax amounts unless otherwise noted. We have
eliminated all significant intercompany balances and transactions in
consolidation. The nature of our business is such that the results of any
interim period may not be indicative of the results to be expected for the
entire year.
PERVASIVENESS OF ESTIMATES
We have prepared the consolidated financial statements in accordance
with GAAP, which require us to make estimates and assumptions that affect the
reported amounts in the consolidated financial statements and accompanying
notes. The most significant and subjective of these estimates is our
determination of the adequacy of the allowance for loan losses and our
determination of the "Fair value of retained interests in loans securitized."
The significant factors susceptible to future change that have an impact on
these estimates include default rates, payment rates, net interest spreads,
liquidity and the ability to finance future receivables activity, and overall
economic conditions. As a result, the actual losses in our loan portfolio and
the fair value of our retained interests as of June 30, 2003 and December 31,
2002 could materially differ from these estimates. The accompanying unaudited
consolidated financial statements do not include an adjustment to the fair value
of retained interests that might result from the inability to finance future
receivables.
COMPREHENSIVE INCOME
SFAS No. 130 "Reporting Comprehensive Income," does not apply to our
current financial results and therefore, net income equals comprehensive income.
8
NOTE 2 - RESTATEMENTS
The consolidated statements of income and cash flows as presented for
the three and six-month periods ended June 30, 2003 and 2002 and the
consolidated balance sheets as of June 30, 2003 and December 31, 2002 have been
restated to reflect the following:
- The valuation model and related collateral assumptions used to estimate the
fair value of the Company's "Retained interests in loans securitized" did
not properly reflect the structure of the Metris Master Trust and related
series supplements. All periods presented have been restated to reflect the
changes in the valuation model and the related collateral assumptions.
These restatements impact "Retained interests in loans securitized," "Other
receivables due from credit card securitizations, net" and "Securitization
income."
- The Company's policy for recognizing transaction costs related to the
securitization of receivables through the Metris Master Trust or a conduit
was not in accordance with GAAP. Historically, these costs had been
capitalized and amortized over the estimated life of the new debt
securities. These costs are now allocated and recognized over the initial
and reinvestment periods of the respective debt securities or Metris Master
Trust financing unless the transaction results in a loss, in which case the
costs are expensed as incurred. All periods presented have been restated to
reflect the revised policy. This restatement impacts "Other assets" and
"Securitization income."
- The Company's policy for recognizing expenses related to credit card
solicitation costs was not in accordance with GAAP. Historically, the
Company had capitalized and expensed these costs over the estimated period
over which the new credit card accounts were established, approximately
three months. These costs are now expensed as incurred. All periods
presented have been restated to reflect the revised policy. This
restatement impacts "Other assets" and "Credit card account and other
product solicitation and marketing expenses."
- The Company corrected its accounting for interest rate caps purchased in
May of 2002 and forward to comply with SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended. These costs had been
deferred and amortized over the estimated life of the new debt securities.
These instruments are now recorded at fair value. Periods from May 2002
forward have been restated to reflect this correction. This restatement
impacts "Retained interests in loans securitized," "Other assets" and
"Securitization income."
- The Company historically recognized revenue in the month following
completion of the cancellation period, generally one month. Cash flows
related to debt waiver are now included in the valuation of the
interest-only strip receivable. All periods presented have been restated to
reflect the revised policy. This restatement impacts "Retained interests in
loans securitized," "Deferred revenue," "Enhancement services revenue," and
"Securitization income."
- At December 31, 2001 we had $50 million of "Allowance for loan losses"
classified as valuation reserve in our "Retained interests in loans
securitized." The valuation reserve was transferred to "Allowance for loan
losses" through "Provision for loans losses" during the first quarter of
2002. We have restated the December 31, 2001 balance sheet and 2001 income
statement and June 30, 2002 income statement to reflect this transfer
occurring during the fourth quarter of 2001. This restatement impacts
"Allowance for loan losses," "Retained interests in loans securitized,"
"Provision for loan losses" and "Securitization income."
The cumulative impact of the above restatements as of December 31, 2001 is
a $36.6 million decrease in retained earnings and consists of the following
adjustments:
Retained interests in loans securitized $ 4.6
Allowance for loan losses (50.0)
Transaction costs 6.6
Pre-paid costs (17.9)
Income tax 20.1
------------
$ (36.6)
============
9
In addition, we have restated certain prior-period amounts to conform
with the current period's presentation.
- In prior periods, we classified interest income, provision for loan
losses, and related credit card loan fees generated from retained
interests in loans securitized on the income statement as "Interest
Income-Credit card loans and retained interests in loans securitized,"
"Provision for loan losses" and "Credit card fees, interchange and
other credit card income." For all periods presented, these amounts are
now included in the estimation of the fair value of the interest-only
strip receivable and "Securitization income."
- In prior periods we classified spread accounts receivable in "Other
receivables due from credit card securitizations, net." For all periods
presented, we have reclassified our spread accounts receivable from
"Other receivables due from credit card securitizations, net" to
"Retained interests in loans securitized."
- In prior periods, we classified servicing income in "Net securitization
and credit card servicing income." For all periods presented, we have
reclassified these amounts to "Servicing income."
- In prior periods, income from our debt waiver product sold to customers
of Direct Merchants Bank with receivables held by Direct Merchants Bank
was included in "Enhancement services revenue." For all periods
presented we have reclassified this income to "Credit card fees,
interchange and other credit card income."
- We classified the liquidity reserve deposit established in March 2003
and other restricted cash deposits maintained at Direct Merchants Bank
as "Short-term investments." We have reclassified these items to
"Liquidity reserve deposit" for all periods presented.
- Revenue related to our membership club and warranty business for
current and prior periods is classified as "Enhancement services
revenue." Claims expense related to this business has been reclassified
as "Other" expenses for all periods presented.
- In addition to the tax effects of the pre-tax restatement amounts, the
restated presentation also reflects revised probable amounts of future
taxable and deductible temporary differences, resulting in a
reclassification of certain deferred income taxes to current income
taxes.
See Notes 4,6,7,8,9, 10, 11 and 12, all of which are impacted by these changes.
10
The following tables present certain captions of the consolidated
financial statements, for all periods presented, which were affected by the
restatements.
JUNE 30,2003 DECEMBER 31,2002
------------ ----------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
-------- ----------- -------- -----------
BALANCE SHEETS:
ASSETS:
Short-term investments $ 346,963 $ 266,373 $ 429,419 $ 429,419
Liquidity reserve deposit -- 80,590 -- --
Retained interests in loans securitized 1,623,652 -- 1,736,912 --
Less: Valuation allowance 858,605 -- 986,517 --
Net retained interests in loans securitized 765,047 852,215 750,395 808,026
Other receivables due from credit card
securitizations, net 281,233 92,611 184,220 110,471
Other assets 167,783 207,397 174,987 187,151
LIABILITIES:
Deferred income $ 119,807 $ 106,134 $ 159,267 $ 143,148
Accrued expenses and other liabilities 92,173 115,274 72,062 88,579
STOCKHOLDERS' EQUITY
Retained earnings $ 398,414 $ 327,146 $ 458,673 $ 454,321
THREE-MONTHS ENDED THREE-MONTHS ENDED
JUNE 30,2003 JUNE 30,2002
------------ ------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
--------- ---------- ---------- ----------
STATEMENTS OF INCOME:
Other operating income:
Securitization income $ -- $ 17,707 $ -- $ 42,746
Servicing income on securitized/sold receivables -- 45,335 -- 47,528
Net securitization and credit card servicing income 31,110 -- 71,223 --
Credit card fees, interchange and other credit card income 20,146 23,460 32,759 40,538
Enhancement services revenue 84,954 39,690 95,649 36,744
Other operating expenses:
Credit card account and other product
Solicitation and marketing expenses 28,138 32,032 56,193 45,624
Enhancement services claims expense 8,087 -- 15,917 --
Credit protection claims expenses -- 7,646 -- 13,632
Other 18,866 19,307 26,161 28,445
Loss Before Income Taxes (23,686) (37,599) (58,656) (80,162)
Income tax benefit (7,982) (12,851) (22,282) (30,040)
Net loss (15,704) (24,748) (36,374) (50,122)
Loss per share (0.44) (0.60) (0.74) (0.97)
Diluted loss per share (0.44) (0.60) (0.74) (0.97)
11
SIX-MONTHS ENDED SIX-MONTHS ENDED
JUNE 30,2003 JUNE 30,2002
----------- -------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
--------- ----------- --------- -----------
STATEMENTS OF INCOME:
Provision for loan losses $ 74,819 $ 74,819 $ 202,477 $ 152,477
Net interest expense after provision for
loan losses (49,283) (49,283) (102,960) (52,961)
Other operating income:
Securitization (expense) income -- (20,263) -- 145,192
Servicing income on securitized/sold
receivables -- 93,148 -- 92,567
Net securitization and credit card
servicing income 87,506 -- 228,642 --
Credit card fees, interchange and
other credit card income 41,903 49,779 93,759 116,197
Enhancement services revenue 178,638 83,199 190,645 71,018
Other operating expenses:
Credit card account and other product
solicitation and marketing expenses 64,192 65,720 96,745 92,877
Enhancement services claims expense 21,109 -- 27,124 --
Credit protection claims expense -- 19,952 -- 22,811
Other 38,505 39,659 42,622 46,935
(Loss) Income Before Income Taxes (61,330) (165,040) 26,174 (8,031)
Income tax (benefit) expense (20,668) (57,462) 10,208 (2,189)
Net (loss) income (40,662) (107,578) 15,966 (5,842)
Loss per share (1.05) (2.22) (0.04) (0.39)
Diluted loss per share (1.05) (2.22) (0.04) (0.39)
12
SIX-MONTHS ENDED SIX-MONTHS ENDED
JUNE 30,2003 JUNE 30,2002
------------ ------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
----------- ----------- ----------- -----------
STATEMENTS OF CASH FLOWS:
Net (loss) income $ (40,662) $ (107,578) $ 15,966 $ (5,842)
Depreciation, amortization and accretion 67,518 (81,545) 52,374 (92,351)
Provision for loan losses 74,819 74,819 202,477 152,477
Retained interests valuation (income)
Expense (131,893) -- 38,126 --
Loss (gain) from credit card securitizations -- 123,982 -- 20,695
Changes in fair value of retained interests
in loans securitized -- 103,897 -- 183,201
Market loss on derivative financial instruments -- 8,161 -- 12,248
Changes in operating assets and liabilities, net:
Liquidity reserve deposit -- (80,590) -- --
Other receivables due from credit card
securitizations, net (104,500) 17,860 54,024 27,888
Accounts payable and accrued expenses (2,111) 4,473 43,770 43,459
Deferred income (39,460) (37,014) (17,045) (21,008)
Spread accounts receivable -- (201,314) -- 29,491
Other (29,477) (67,123) 36,398 1,759
Net cash (used in) provided by operating activities (182,978) (219,184) 435,613 361,540
Net use of cash from sales and repayments of
securitized loans (773,955) -- (785,856) --
Net loans collected 733,600 -- 337,903 --
Net cash from loan originations and principal
collections on loans receivable -- (84,739) -- (370,193)
Net cash provided by investing activities 293,235 248,851 1,035,502 1,113,262
Net increase (decrease) in cash and cash equivalents (113,051) (193,641) 410,535 414,222
Cash and cash equivalents at end of period 467,181 386,591 898,621 795,861
The following is a summary of the Company's revised accounting policies
related to retained interests:
Upon securitization, the Company removes the applicable credit card
loans from the balance sheet and recognizes the "Retained interests in
loans securitized" at their allocated carrying value in accordance with
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities-a replacement of FASB Statement No. 125"
("SFAS No. 140"). Credit card receivables are sold to the Metris Master
Trust at the inception of a securitization series. We also sell credit card
receivables to the Metris Master Trust to replenish receivable balances
that have decreased due to payments and charge-offs. The difference between
the allocated carrying value and the proceeds from the assets sold is
recorded as a gain or loss on sale and is included in "Securitization
(expense) income." At the same time, the Company recognizes the "Retained
interests in loans securitized."
13
The "Retained interests in loans securitized" are financial assets
measured at fair value consistent with trading securities in accordance
with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and includes the contractual retained interests, an
interest-only strip receivable, excess transferor's interests and spread
accounts receivable. The contractual retained interests consist of
non-interest bearing securities held by the Company. The interest-only
strip receivable represents the present value of the excess of the
estimated future interest and fee collections expected to be generated by
the securitized loans over the period the securitized loans are projected
to be outstanding above the interest paid on investor certificates, credit
losses, contractual servicing fees, and other expenses. The excess
transferor's interests represent principal receivables held in the Metris
Master Trust above the contractual retained interests. Spread accounts
receivable represents restricted cash reserve accounts held by the Metris
Master Trust that can be used to fund payments due to securitization
investors and credit enhancers if cash flows are insufficient. Cash held in
spread accounts is released to us if certain conditions are met or a
securitization series terminates with amounts remaining in the spread
accounts. The fair value of the "Retained interests in loans securitized"
is determined through estimated cash flows discounted at rates that reflect
the level of subordination, the projected repayment term, and risk of the
securitized loans.
At least quarterly, the Company reviews its "Retained interests in
loans securitized" for changes in fair value and recognizes those changes
as "Securitization (expense) income." The changes in fair value reflect the
Company's revisions in the expected timing and amount of future cash flows.
The significant factors that affect the timing and amount of future cash
flows relate to the collateral assumptions, which include payment rate,
default rate, gross yield and discount rate.
The Company recognizes future cash flows associated with its retained
interests using the effective yield method in accordance with EITF 99-20
"Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets." Accordingly,
"Securitization (expense) income" includes discount accretion associated
with the contractual retained interests, the excess transferor's interests,
the interest-only strip receivable, spread accounts receivable as well as
the difference in the actual excess spread received as compared to the
estimated amount recorded related to the interest-only strip. Since the
Company's retained interests are trading securities, the impairment
provisions of EITF 99-20 are not applicable.
Up-front transaction costs related to securitizations are allocated and
recognized over the initial and reinvestment periods unless the transaction
results in a loss, in which case, the costs are expensed as incurred and
recorded as "Securitization (expense) income."
The Company services the receivables held by the Metris Master Trust,
and receives annual servicing fees based upon the principal receivables
outstanding. "Servicing income" is recognized when earned. We consider
these fees to be adequate compensation and as a result no servicing asset
or liability is recorded.
"Other receivables due from credit card securitizations, net" primarily
represents cash accumulated in the Metris Master Trust during a month,
which is released to Metris Receivables, Inc. the following month.
NOTE 3 - EARNINGS (LOSS) PER SHARE
The earnings per share calculation for the three- and six-month periods
ended June 30, 2003 and 2002 excludes the assumed conversion of the convertible
preferred stock and the outstanding stock options, as they are anti-dilutive.
14
NOTE 4 - STOCK-BASED COMPENSATION PLANS
We recognize compensation cost for stock-based employee compensation
plans based on the difference, if any, between the quoted market price of the
stock on the date of grant and the amount an employee must pay to acquire the
stock. No expense was reflected in net income related to stock options as all
options granted had an exercise price equal to the market value of the
underlying common stock on the date of grant. We recorded $0.2 million of
amortization of deferred compensation obligation, net of related tax benefit, in
employee compensation related to restricted stock granted in 2003.
Pro forma information regarding net (loss) income and (loss) earnings
per share has been determined as if we accounted for our employee stock options
under the fair value method. The fair value of the options was estimated at the
grant date using a Black-Scholes option pricing model. The fair value of the
options is amortized to expense over the options' vesting periods. Under the
fair value method, our net (loss) earnings and (loss) earnings per share would
have been recorded at the pro forma amounts indicated below:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------ -------------------------------
2003 2002 2003 2002
---- ---- ---- ----
Net loss, as restated $ (24,748) $ (50,122) $ (107,578) $ (5,842)
Deduct: Annual stock-based employee
compensation expense (benefit)determined
based on the fair value for all awards, net
of related tax effects 3,003 8,631 (4,894) 13,004
------------- ------------- -------------- --------------
Pro forma net (loss) income $ (21,745) $ (41,491) $ (102,684) $ 7,162
============= ============= ============== ==============
Loss per share:
Basic-as restated (0.60) (0.97) (2.22) (0.39)
============= ============= ============== ==============
Basic-pro forma (0.66) (1.11) (2.13) (0.61)
============= ============= ============== ==============
Diluted-as restated (0.60) (0.97) (2.22) (0.39)
============= ============= ============== ==============
Diluted-pro forma (0.66) (1.11) (2.13) (0.61)
============= ============= ============== ==============
Weighted-average assumptions in option
valuation:
Risk-free interest rates 1.5% 3.7% 1.5% 3.7%
Dividend yields -- 1.6% -- 1.6%
Stock volatility factor 124.2% 92.9% 110.1% 92.9%
Expected life of options (in years) 2.7 6.0 4.2 6.0
The above pro forma amounts may not be representative of the effects on
reported net income for future periods.
NOTE 5 - ACCOUNTING CHANGES
In January 2003, FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation-Transition and Disclosure," which amends SFAS No. 123, "Accounting
for Stock-Based Compensation." SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require more prominent and more
frequent disclosures in financial statements about the effects of stock-based
compensation. SFAS No. 148 requirements are effective for fiscal years ending
after December 15, 2002. The adoption of SFAS No. 148 did not have a material
impact on our financial statements.
In January 2003, FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" in an effort to expand upon and strengthen existing
accounting guidance that addresses when a company should include in its
financial statements the assets, liabilities and activities of another entity.
FASB Interpretation No. 46 requires a variable interest entity to be
15
consolidated by a company, if that company is subject to a majority of the risk
of loss from the variable interest entity activities or entitled to receive a
majority of the entity's residual returns or both. The Interpretation also
requires disclosures about variable interest entities that the company is not
required to consolidate, but in which it has a significant variable interest.
The consolidation requirements of Interpretation No. 46 apply immediately to
variable interest entities created after January 31, 2003, and apply to existing
variable interest entities in the first fiscal year or interim period beginning
after June 15, 2003. Interpretation No. 46 provides a specific exemption for
entities qualifying as Qualified Special Purpose Entities as described in SFAS
No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities-a replacement of FASB Statement No. 125." All of
our non-consolidated entities are Qualified Special Purpose Entities under the
definition in SFAS No. 140. We do not expect the adoption of this Interpretation
to have a material impact on our financial statements.
In April 2003, FASB issued SFAS No. 149 "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is effective for contracts entered into or modified after
June 30, 2003. In addition, certain provisions relating to forward purchases or
sales of when-issued securities or other securities that do not yet exist,
should be applied to existing contracts as well as new contracts entered into
after June 30, 2003. We do not expect the adoption of SFAS No. 149 to have a
material impact on our financial statements.
In May 2003, FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This Statement
establishes standards for classification and measurement of certain instruments
with characteristics of both liabilities and equity. It requires that financial
instruments within its scope be classified as a liability (or asset in some
circumstances). Many of those instruments were classified as equity under
previous accounting guidance. The statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. The adoption of SFAS No. 150 does not have a material impact on our
financial statements at this time.
NOTE 6 - LIQUIDITY RESERVE DEPOSIT
Direct Merchants Bank has established restricted deposits with
third-party depository banks for the purpose of supporting Direct Merchants
Bank's funding needs and to satisfy banking regulators' requirements under the
Operating Agreement, dated March 18, 2003, among Direct Merchants Bank, MCI and
the Office of the Comptroller of the Currency. These deposits are invested in
short term liquid investments. As of June 30, 2003, the balance of these
deposits was $80.6 million and is classified on the balance sheets as "Liquidity
reserve deposit."
16
NOTE 7 - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
2003 2002 2003 2002
---- ---- ---- ----
Balance at beginning of period $ 125,357 $ 416,914 $ 90,315 $ 460,159
Allowance related to assets transferred
to the Metris Trust (2,526) (147,137) (3,981) (168,580)
Provision for loan losses 30,033 90,601 74,819 152,477
Principal receivables charged-off (44,789) (91,595) (53,470) (180,486)
Recoveries 1,087 6,496 1,479 11,709
--------- --------- --------- ---------
Net principal receivables charged off (43,702) (85,099) (51,991) (168,777)
--------- --------- --------- ---------
Balance at end of period $ 109,162 $ 275,279 $ 109,162 $ 275,279
========= ========= ========= =========
Credit card loans greater than 30 days contractually past due for
the periods ended June 30, 2003, December 31, 2002 and June 30, 2002 were $48.3
million, $7.9 and $148.9 million, respectively.
NOTE 8 - RETAINED INTERESTS IN LOANS SECURITIZED
Our credit card receivables are primarily funded through asset
securitizations. As part of the asset securitizations, credit card receivables
are transferred to the Metris Master Trust, a non-consolidated, qualifying
special purpose entity that issues asset backed securities representing
undivided interests in receivables held in the Metris Master Trust and the right
to receive future collections of principal, interest and fees related to those
receivables. The senior classes of these securities are sold to third party
investors. We retain subordinated interests in the securitized receivables,
including contractual retained interests, an interest-only strip receivable,
excess transferor's interests maintained above the contractual retained
interests, and spread accounts receivable. The components of these retained
interests are recorded at their fair value.
The following table shows the fair value of the components of the
"Retained interests in loans securitized" as of June 30, 2003 and December 31,
2002.
JUNE 30, DECEMBER 31,
2003 2002
---- ----
Contractual retained interests $ 620,943 $ 685,197
Excess transferor's interests 54,850 57,447
Interest-only strip receivable 766 13,882
Spread accounts receivable 175,656 51,500
------------------ ------------------
Retained interests in loans securitized $ 852,215 $ 808,026
================== ==================
17
The following table illustrates the significant assumptions used for
estimating the fair value of retained interests as of June 30, 2003 and December
31, 2002.
JUNE 30, DECEMBER 31,
2003 2002
---- ----
Monthly payment rate 6.7% 6.7%
Gross yield (1) 25.6% 26.0%
Annual interest expense and servicing fees 3.8% 4.0%
Annual gross principal default rate 22.6% 21.7%
Discount rate:
Contractual retained interests 16.0% 16.0%
Excess transferor's interests 16.0% 16.0%
Interest-only strip receivable 30.0% 30.0%
Spread accounts receivable (2) 15.0% 16.0%
(1) Includes expected cash flows from finance charges, late and
overlimit fees, debt waiver premiums and bad debt recoveries, net of
finance charge and fee charge-offs. Gross yield for purposes of
estimating fair value does not include interchange income, or cash
advance fees.
(2) Beginning on March 31, 2003 the discount rate on spread account
balances has been reduced by interest income expected to be earned.
At June 30, 2003, the sensitivity of the current fair value of the
retained interests to immediate 10% and 20% adverse changes are as follows (in
millions):
ADVERSE IMPACT ON FAIR VALUE
----------------------------
10% ADVERSE CHANGE 20% ADVERSE CHANGE
------------------ ------------------
Annual discount rate $ 22.2 $ 43.5
Monthly payment rate 184.0 410.0
Gross yield 166.7 338.4
Annual interest expense and servicing fees 28.1 56.9
Annual gross principal default rate 139.5 275.1
As the sensitivity indicates, the value of the Company's retained
interests on its balance sheet, as well as reported earnings, could differ
significantly if different assumptions or conditions prevail.
NOTE 9 - SECURITIZATION INCOME
The following summarizes "Securitization (expense) income" for the
three and six-month periods ended June 30, 2003 and 2002.
THREE-MONTHS ENDED SIX-MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
2003 2002 2003 2002
---- ---- ---- ----
Loss on new securitization of receivables to
the Metris Master Trust $ (12,244) $ (45,509) $ (32,199) $ (70,578)
(Loss) gain on replenishment of receivables
to the Metris Master Trust (45,529) 63,900 (91,783) 49,883
Discount accretion 78,812 73,698 154,486 144,726
Change in fair value (20,289) (134,333) (103,897) (183,201)
Interest-only revenue 32,243 96,926 90,679 232,008
Transaction and other costs (15,286) (11,936) (37,549) (27,646)
--------- --------- --------- ---------
Securitization (expense) income $ 17,707 $ 42,746 $ (20,263) $ 145,192
========= ========= ========= =========
18
NOTE 10 - INCOME TAX BENEFIT
The components of the (benefit) provision for income taxes consisted of
the following:
THREE-MONTHS ENDED SIX-MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
---- ---- ---- ----
Current:
Federal $ (34,699) $ 34,373 $ (36,690) $ 7,945
State (483) 1,191 (59) 1,655
--------------- ---------- --------------- --------------
(35,182) 35,564 (36,749) 9,600
--------------- ---------- ---------------- --------------
Deferred:
Federal 21,731 (63,165) (20,112) (11,084)
State 600 (2,439) (601) (705)
--------------- ---------- --------------- --------------
22,331 (65,604) (20,713) (11,789)
--------------- ---------- --------------- --------------
Income tax benefit $ (12,851) $ (30,040) $ (57,462) $ (2,189)
=============== ========== =============== ==============
A reconciliation of our effective income tax rate compared to the
statutory federal income tax rate is as follows:
THREE-MONTHS ENDED SIX-MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
---- ---- ---- ----
Statutory federal income tax rate 35.0% 35.0% 35.0% 35.0%
State income taxes, net of federal
benefit (0.2) 1.0 0.3 (7.7)
Other, net (0.6) 1.5 (0.5) 0.0
---- ---- ---- ----
Effective income tax rate 34.2% 37.5% 34.8% 27.3%
==== ==== ==== ====
Our deferred tax assets and liabilities are as follows:
JUNE 30, DECEMBER 31,
2003 2002
---- ----
Deferred income tax assets resulting from future
deductible and taxable temporary differences:
Allowance for loan losses and retained
Interests fair value adjustments $183,846 $172,299
Deferred revenues 44,626 59,042
Other 72,795 68,143
-------- --------
Total deferred tax assets 301,267 299,484
Deferred income tax liabilities resulting from
future taxable and deductible temporary
differences:
Accrued interest on credit card loans 207,130 207,984
Deferred marketing costs 24,864 35,689
Other 27,735 34,986
-------- --------
Total deferred tax liabilities 259,729 278,659
-------- --------
Net deferred tax assets $ 41,538 $ 20,825
======== ========
In addition to the tax effects of the pre-tax restatement amounts, the
restated presentation also reflects revised probable amounts of future taxable
and deductible temporary differences, resulting in a reclassification of certain
deferred income taxes to current income taxes. The effects of the reclass for
the year ended December 31, 2002 and six-months ended June 30, 2003 amounted to
an addition to deferred income taxes of $16.5 million. Such reclasses did not
result in any adjustment to net income.
19
The Internal Revenue Service ("IRS") has completed its examination of
the Company's tax returns through December 31, 1998. The IRS has proposed
adjustments to increase the Company's federal income tax by $42.9 million, plus
interest of more than $15 million, pertaining to the Company's treatment of
certain credit card fees as original issue discount ("OID"). Although these fees
are primarily reported as income when billed for financial reporting purposes,
we believe the fees constitute OID and must be deferred and amortized over the
life of the underlying credit card loans for tax purposes. Cumulatively through
June 30, 2003, the Company has deferred approximately $213.9 million in federal
income tax under the OID rules. Any assessment similar to what has been proposed
by the IRS may ultimately require the Company to pay the federal tax plus state
taxes and related interest.
The Company believes its treatment of these fees is appropriate and
continues to work with the IRS to resolve the proposed adjustments. The
Company's position on the treatment of credit card fees is consistent with that
of many other U.S. credit card issuers. We do not expect final settlement or
additional tax to be paid over the next twelve months. However, both the timing
and amount of the final resolution of this matter are uncertain.
NOTE 11 - SEGMENTS
We operate in two principal areas: consumer lending products and
enhancement services. Our consumer lending products are primarily unsecured and
secured credit cards, including the Direct Merchants Bank MasterCard(R) and
Visa(R). Our credit cardholders include customers obtained from third-party
lists and other customers for whom general credit bureau information is
available.
We market our enhancement services, including: (1) debt waiver
protection for unemployment, disability, death and family leave; (2) membership
programs such as card registration, purchase protection and other club
memberships; and (3) third-party insurance, directly to our credit card
customers and customers of third parties. We administer extended service plans
issued through a third party retailer, which are no longer being sold, and will
expire by first quarter, 2005. We sell extended service plans for homeowners
through third party distribution partnerships as well as directly to consumers.
On July 29, 2003, CPP Holdings Limited, a privately owned provider of
assistance products and services throughout Europe, and CPP US Operations Group
(collectively with CPP Holding Limited "CPP") purchased the membership and
warranty products and operations of the Company's enhancement services segment.
Further details are described in Footnote 8 "Subsequent Events." The Company
will retain the credit protection and insurance business, and CPP will become
the Company's preferred provider of membership and warranty products.
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 adjustment columns in the segment table include adjustments to
present the information on an owned basis as reported in the financial
statements of this quarterly report.
We do not allocate the expenses, assets and liabilities attributable to
corporate functions to the operating segments, such as employee compensation,
data processing services and communications, third-party servicing expenses, and
other expenses including occupancy, depreciation and amortization, professional
fees, and other general and administrative expenses. We include these expenses
in the reconciliation of the income before income taxes, for the reported
segments to the consolidated total. We do not allocate capital expenditures for
leasehold improvements, capitalized software and furniture and equipment to
operating segments. There were no material operating assets located outside of
the United States for the periods presented.
The enhancement services operating segment has paid fees to our
consumer lending products segment for successful marketing efforts to
cardholders at a rate similar to those paid to other third parties. The
enhancement services segment reports interest income and our consumer lending
20
products segment reports interest expense at our weighted-average borrowing rate
for the excess cash flow generated by the enhancement services segment and used
by the consumer lending products segment to fund the growth of cardholder
balances.
THREE MONTHS ENDED JUNE 30, 2003
CONSUMER
LENDING ENHANCEMENT SECURITIZATION OTHER
PRODUCTS SERVICES ADJUSTMENTS(a) ADJUSTMENTS(b) CONSOLIDATED
--------------- --------------- --------------- ---------------- -----------
Interest income $ 451,176 $ 34 $ (419,744) $ (34) $ 31,432
Interest
(expense) income (60,198) -- 41,448 34 (18,716)
--------------- --------------- --------------- ----------------- -----------
Net interest
income 390,978 34 (378,296) -- 12,716
Other operating
income 87,074 84,954 (45,836) -- 126,192
Total revenue 478,052 84,988 (424,132) -- 138,908
Income before
income taxes 8,988 (c) 58,703 (c) -- (105,290) (37,599)
Total assets $ 9,467,542 $ 50,431 $ (7,860,000) $ 588,276 (d) $ 2,246,249
THREE MONTHS ENDED JUNE 30, 2002
CONSUMER
LENDING ENHANCEMENT SECURITIZATION OTHER
PRODUCTS SERVICES ADJUSTMENTS(a) ADJUSTMENTS(b) CONSOLIDATED
------------ ------------ ------------ ------------ ------------
Interest income $ 509,821 $ 58 $ (441,029) $ (58) $ 68,792
Interest
(expense) income (80,946) -- 53,933 58 (26,955)
------------ ------------ ------------ ------------ ------------
Net interest
Income 428,875 58 (387,096) -- 41,837
Other operating
income 118,731 95,649 (46,824) -- 167,556
Total revenue 547,606 95,707 (433,920) -- 209,393
Income before
income taxes (3,261)(c) 57,556(c) -- (134,457) (80,162)
Total assets $ 10,947,147 $ 104,240 $ (8,936,263) $ 1,007,791(d) $ 3,122,915
21
SIX MONTHS ENDED JUNE 30, 2003
CONSUMER
LENDING ENHANCEMENT SECURITIZATION OTHER
PRODUCTS SERVICES ADJUSTMENTS(a) ADJUSTMENTS(b) CONSOLIDATED
--------------- --------------- ------------------ ---------------- ------------
Interest income $ 936,435 $ 63 $ (872,842) $ (63) $ 63,593
Interest
(expense) income (124,209) -- 86,089 63 (38,057)
--------------- --------------- ------------------ ---------------- ----------
Net interest
Income 812,226 63 (786,753) -- 25,536
Other operating
income 175,216 178,638 (147,991) -- 205,863
Total revenue 987,442 178,701 (934,744) -- 231,399
Income before
Income taxes (38,358) (c) 106,103 (c) -- (232,785) (165,040)
Total assets $ 9,467,542 $ 50,431 $ (7,860,000) $ 588,276 (d) $2,246,249
SIX MONTHS ENDED JUNE 30, 2002
CONSUMER
LENDING ENHANCEMENT SECURITIZATION OTHER
PRODUCTS SERVICES ADJUSTMENTS(a) ADJUSTMENTS(b) CONSOLIDATED
------------ ------------ ------------- ------------- ------------
Interest income $ 1,036,499 $ 2,386 $ (877,863) $ (2,386) $ 158,636
Interest
(expense) Income (169,351) -- 107,845 2,386 (59,120)
------------ ------------ ------------ ------------ ------------
Net interest
Income 867,148 2,386 (770,018) -- 99,516
Other operating
income 248,702 190,645 (14,373) -- 424,974
Total revenue 1,115,850 193,031 (784,391) -- 524,490
Income before
Income taxes 123,440 (c) 123,389 (c) -- (254,860) (8,031)
Total assets $ 10,947,147 $ 104,240 $ (8,936,263) $ 1,007,791 (d) $ 3,122,915
(a) This column reflects adjustments to the Company's internal financial
statements, which are prepared on a managed basis, to eliminate
investors' interests in securitized loans.
(b) The other adjustments column includes: intercompany eliminations and
amounts not allocated to segments.
(c) Income before income taxes includes intercompany commissions paid by
the enhancement services segment to the consumer lending products
segment for successful marketing efforts to cardholders of $3.1 million
for the three months ended June 30, 2003 and $3.0 million for the three
months ended June 30, 2002, $6.1 million for the six months ended June
30, 2003 and $6.3 million for the six months ended June 30, 2002.
(d) Total assets include the assets attributable to corporate functions not
allocated to operating segments and the removal of investors' interests
in securitized loans to present total assets on an owned basis.
22
NOTE 12 - SUBSEQUENT EVENTS
On July 29, 2003, we announced the sale of the membership and warranty
business of the Enhancement Services segment for proceeds of approximately $45.0
million. We will record a gain related to the sale in the third quarter of 2003.
In July of 2003, the Office of the Comptroller of the Currency ("OCC")
requested and Direct Merchants Bank agreed to eliminate federally insured
deposits at the Bank, or the risk thereof to the Federal Deposit Insurance
Corporation ("FDIC"), by September 30, 2003. We have received preliminary
proposals from financing sources, and we are working with our financial advisors
on a variety of options to achieve this goal, however, there can be no assurance
that we will be successful. These options may include additional conduit
financing or the sale of credit card receivables to third parties.
NOTE 13 - SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS
We have various indirect subsidiaries that do not guarantee Company
debt. We have prepared condensed consolidating financial statements of the
Company, the Guarantor subsidiaries and the non-guarantor subsidiaries for
purposes of complying with SEC reporting requirements. Separate financial
statements of the guaranteeing subsidiaries and non-guaranteeing subsidiaries
are not presented because we have determined that the subsidiaries' financial
information would not be material to investors. In the second quarter of 2003,
certain subsidiaries were designated as guarantors, which had previously been
classified as non-guarantors. The supplemental consolidating financial
statements have been reclassified for all periods presented.
23
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING BALANCE SHEETS
JUNE 30, 2003
(DOLLARS IN THOUSANDS)
UNAUDITED (AS RESTATED)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------ ------------ ------------
ASSETS:
Cash and cash equivalents $ (49) $ 1,234 $ 385,406 $ -- $ 386,591
Retained interests in loans
securitized 24,292 -- 827,923 -- 852,215
Liquidity reserve deposit -- -- 80,590 -- 80,590
Net credit card loans 8,393 -- 515,358 -- 523,751
Property and equipment, net -- 50,997 513 -- 51,510
Purchased portfolio premium,
net 107 -- 51,477 -- 51,584
Other receivables due from credit card
securitizations, net 7 -- 92,604 -- 92,611
Other assets 41,114 57,694 132,237 (23,648) 207,397
Investment in subsidiaries 1,348,741 918,107 -- (2,266,848) --
----------- ----------- ----------- ----------- -----------
TOTAL ASSETS $ 1,422,605 $ 1,028,032 $ 2,086,108 $(2,290,496) $ 2,246,249
=========== =========== =========== =========== ===========
LIABILITIES:
Deposits $ (1,000) $ -- $ 642,934 $ -- $ 641,934
Debt 417,023 9,214 -- (43,000) 383,237
Accounts payable 97 22,026 32,230 (4,357) 49,996
Deferred income -- 10,003 98,206 (2,075) 106,134
Accrued expenses and other
liabilities 56,811 (361,952) 394,631 25,784 115,274
----------- ----------- ----------- ----------- ------------
TOTAL LIABILITIES 472,931 (320,709) 1,168,001 (23,648) 1,296,575
----------- ----------- ----------- ----------- ------------
TOTAL STOCKHOLDERS' EQUITY 949,674 1,348,741 918,107 (2,266,848) 949,674
----------- ----------- ----------- ----------- ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 1,422,605 $ 1,028,032 $ 2,086,108 $(2,290,496) $ 2,246,249
=========== =========== =========== =========== ============
24
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING BALANCE SHEETS
DECEMBER 31, 2002 (AS RESTATED)
(DOLLARS IN THOUSANDS)
UNAUDITED
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
---------------- ---------------- ---------------- ----------------- ---------------
ASSETS:
Cash and cash equivalents $ (3,795) $ 8,109 $ 575,918 $ -- $ 580,232
Net credit card loans 3,813 -- 752,289 -- 756,102
Retained interests in loans
securitized -- -- 808,026 -- 808,026
Property and equipment, net -- 63,395 20,436 -- 83,831
Purchased portfolio premium, net 128 -- 64,451 -- 64,579
Other receivables due from credit card
securitizations, net 13 -- 110,458 -- 110,471
Other assets 10,160 44,252 180,591 (47,852) 187,151
Investment in subsidiaries 1,594,352 1,549,307 -- (3,143,659) --
---------------- ---------------- ---------------- ----------------- - --------------
TOTAL ASSETS $ 1,604,671 $ 1,665,063 $ 2,512,169 $ (3,191,511) $ 2,590,392
================ ================ ================ ================= ==============
LIABILITIES:
Deposits $ (1,000) $ -- $ 893,754 $ -- $ 892,754
Debt 391,228 9,421 -- (43,000) 357,649
Accounts payable 71 20,683 38,949 (6,114) 53,589
Deferred income -- 16,681 129,978 (3,511) 143,148
Accrued expenses and other
liabilities 159,699 23,926 (99,819) 4,773 88,579
---------------- ---------------- ---------------- ----------------- --------------
TOTAL LIABILITIES 549,998 70,711 962,862 (47,852) 1,535,719
---------------- ---------------- ---------------- ----------------- --------------
TOTAL STOCKHOLDERS' EQUITY 1,054,673 1,594,352 1,549,307 (3,143,659) 1,054,673
---------------- ---------------- ---------------- ----------------- --------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 1,604,671 $ 1,665,063 $ 2,512,169 $ (3,191,511) $ 2,590,392
================ ================ ================ ================= =============
25
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING STATEMENTS OF INCOME
THREE MONTHS ENDED JUNE 30, 2003
(DOLLARS IN THOUSANDS)
UNAUDITED (AS RESTATED)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------ ------------ ------------
NET INTEREST INCOME
(EXPENSE) $ (8,682) 915 20,483 -- 12,716
Provision for loan losses 540 -- 29,759 (266) 30,033
--------- --------- --------- --------- ---------
NET INTEREST INCOME
(EXPENSE) AFTER PROVISION FOR LOAN LOSSES (9,222) 915 (9,276) 266 (17,317)
--------- --------- --------- --------- ---------
OTHER OPERATING INCOME:
Securitization income (443) 19,510 (1,360) 17,707
Servicing income on
securitized / sold
receivables -- -- 45,335 -- 45,335
Credit card fees,
interchange and other
credit card income 1,036 19,004 21,476 (18,056) 23,460
Enhancement services
Revenues -- 7,100 34,856 (2,266) 39,690
Intercompany allocations 5,264 73,725 8,247 (87,236) --
--------- -------- --------- --------- ---------
5,857 99,829 129,424 (108,918) 126,192
--------- --------- --------- --------- ---------
OTHER OPERATING EXPENSE:
Credit card account and
other product solicitation and marketing
expenses -- 18,209 32,733 (18,910) 32,032
Employee compensation -- 41,860 3,861 -- 45,721
Data processing services and communications 5 (19,717) 39,062 (2,316) 17,034
Credit protection claims
expense -- (97) 7,743 -- 7,646
Occupancy and equipment -- -- 8,924 -- 8,924
Purchased portfolio premium
amortization 10 -- 7,621 (1,132) 6,499
MasterCard/Visa assessment
and fees -- -- 2,231 -- 2,231
Credit card fraud losses 10 -- 1,059 -- 1,069
Asset impairments, lease
write-offs and severance -- -- 6,011 -- 6,011
Other 5,258 25,342 (11,286) (7) 19,307
Intercompany allocations 24 27,420 59,792 (87,236) --
--------- --------- --------- --------- ---------
5,307 93,017 157,751 (109,601) 146,474
--------- --------- --------- --------- ---------
(LOSS) INCOME BEFORE INCOME TAXES AND EQUITY
IN LOSS OF SUBSIDIARIES (8,672) 7,727 (37,603) 949 (37,599)
Income tax (benefit)
Expense (2,846) 936 (11,267) 326 (12,851)
Equity in (loss) income of
subsidiaries (18,922) (26,336) -- 45,258 --
--------- --------- --------- --------- ---------
NET LOSS $ (24,748) $ (19,545) $ (26,336) $ 45,881 $ (24,748)
========= ========= ========= ========= =========
26
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING STATEMENTS OF INCOME
THREE MONTHS ENDED JUNE 30, 2002
(DOLLARS IN THOUSANDS)
UNAUDITED (AS RESTATED)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
---------------- ---------------- ---------------- ---------------- -----------
NET INTEREST (EXPENSE)
INCOME $ (3,018) $ (60) $ 44,915 $ -- $ 41,837
Provision for loan losses (798) -- 91,399 -- 90,601
---------------- ---------------- ---------------- ---------------- -----------
NET INTEREST EXPENSE AFTER PROVISION FOR
LOAN LOSSES (2,220) (60) (46,484) -- (48,764)
---------------- ---------------- ----------------- ---------------- -----------
OTHER OPERATING INCOME:
Securitization income (1,777) -- 44,523 42,746
Servicing income on
securitized / sold
receivables -- -- 47,528 -- 47,528
Credit card fees,
interchange and other
credit card income 189 5,796 39,253 (4,700) 40,538
Enhancement services
revenues -- 2,663 34,081 -- 36,744
Intercompany allocations 41 72,193 15,127 (87,361) --
---------------- ---------------- ---------------- ---------------- -----------
(1,547) 80,652 180,512 (92,061) 167,556
---------------- ---------------- ---------------- ---------------- -----------
OTHER OPERATING EXPENSE:
Credit card account and
other product solicitation
and marketing expenses -- 13,974 31,704 (54) 45,624
Employee compensation (1,505) 45,753 10,117 -- 54,365
Data processing services and
communications 13 (23,809) 43,018 1,573 20,795
Credit protection claims
expense -- -- 13,632 -- 13,632
Occupancy and equipment -- -- 12,291 -- 12,291
Purchased portfolio premium
amortization -- -- 8,568 (825) 7,743
MasterCard/Visa assessment
and fees -- -- 3,583 -- 3,583
Credit card fraud losses 135 -- 2,818 -- 2,953
Asset impairments, lease
write-offs and severance -- -- 9,523 -- 9,523
Other (154) 48,690 (13,862) (6,229) 28,445
Intercompany allocations 555 23,510 63,296 (87,361) --
---------------- ---------------- ---------------- ---------------- -----------
(956) 108,118 184,688 (92,896) 198,954
---------------- ---------------- ---------------- ---------------- -----------
(LOSS) BEFORE INCOME TAXES AND EQUITY IN
LOSS OF SUBSIDIARIES (2,811) (27,526) (50,660) 835 (80,162)
Income tax (benefit)
expense (747) (13,066) (16,446) 219 (30,040)
Equity in loss of
subsidiaries (48,058) (34,214) -- 82,272 --
---------------- --------------- ---------------- ---------------- -----------
NET LOSS $ (50,122) $ (48,674) $ (34,214) $ 82,888 $ (50,122)
================ =============== ================ ================ ===========
27
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING STATEMENTS OF INCOME
SIX MONTHS ENDED JUNE 30, 2003
(DOLLARS IN THOUSANDS)
UNAUDITED (AS RESTATED)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------ ------------ ------------
NET INTEREST INCOME
(EXPENSE) (17,388) 98 42,826 -- 25,536
Provision for loan losses 1,387 -- 73,534 (102) 74,819
--------- --------- --------- --------- ---------
NET INTEREST INCOME
(EXPENSE) AFTER PROVISION FOR LOAN LOSSES (18,775) 98 (30,708) 102 (49,283)
--------- --------- --------- --------- ---------
OTHER OPERATING INCOME:
Securitization income (10,454) -- (7,770) (2,039) (20,263)
Servicing income on
securitized / sold
receivables -- -- 93,148 -- 93,148
Credit card fees,
interchange and other
credit card income 1,091 31,547 47,926 (30,785) 49,779
Enhancement services
revenues -- 16,278 72,939 (6,018) 83,199
Intercompany allocations 5,340 139,332 18,237 (162,909) --
--------- --------- --------- --------- ---------
(4,023) 187,157 224,480 (201,751) 205,863
--------- --------- --------- --------- ---------
OTHER OPERATING EXPENSE:
Credit card account and
other product solicitation
and marketing expenses -- 30,430 66,489 (31,199) 65,720
Employee compensation -- 93,071 6,031 -- 99,102
Data processing services and
communications 4 (41,704) 83,713 (5,801) 36,212
Credit protection claims
expense -- -- 19,952 -- 19,952
Occupancy and equipment -- -- 18,537 -- 18,537
Purchased portfolio premium
amortization 21 -- 15,318 (2,344) 12,995
MasterCard/Visa assessment
and fees -- -- 4,646 -- 4,646
Credit card fraud losses 11 -- 1,998 -- 2,009
Asset impairments,
lease write-offs and severance -- -- 22,788 -- 22,788
Other 5,342 64,454 (30,130) (7) 39,659
Intercompany allocations 35 53,047 109,827 (162,909) --
--------- --------- --------- --------- ---------
5,413 199,298 319,169 (202,260) 321,620
--------- --------- --------- --------- ---------
LOSS BEFORE INCOME TAXES AND EQUITY IN LOSS
OF SUBSIDIARIES (28,211) (12,043) (125,397) 611 (165,040)
Income tax benefit (4,285) (7,184) (46,202) 209 (57,462)
Equity in loss of subsidiaries
(83,652) (79,195) -- 162,847 --
--------- --------- --------- --------- ---------
NET LOSS $(107,578) $ (84,054) $ (79,195) $ 163,249 $(107,578)
========= ========= ========= ========= =========
28
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING STATEMENTS OF INCOME
SIX MONTHS ENDED JUNE 30, 2002
(DOLLARS IN THOUSANDS)
UNAUDITED (AS RESTATED)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------ ------------ ------------
NET INTEREST (EXPENSE)
INCOME $ (8,498) $ (1,456) $ 109,470 $ -- $ 99,516
Provision for loan losses (732) -- 153,209 -- 152,477
--------- --------- --------- --------- ---------
NET INTEREST EXPENSE AFTER PROVISION FOR
LOAN LOSSES (7,766) (1,456) (43,739) -- (52,961)
--------- --------- --------- --------- ---------
OTHER OPERATING INCOME:
Securitization income (1,742) -- 146,934 -- 145,192
Servicing income on securitized / sold
receivables -- -- 92,567 -- 92,567
Credit card fees,
interchange and other credit card income 452 13,719 113,160 (11,134) 116,197
Enhancement services
revenues -- 18,825 52,193 -- 71,018
Intercompany allocations 71 125,267 24,787 (150,125) --
--------- --------- --------- --------- ---------
(1,219) 157,811 429,641 (161,259) 424,974
--------- --------- --------- --------- ---------
OTHER OPERATING EXPENSE:
Credit card account and
other product solicitation and marketing
expenses -- 16,634 76,297 (54) 92,877
Employee compensation (1,101) 94,921 17,093 -- 110,913
Data processing services and communications 36 (43,371) 88,230 (1,794) 43,101
Credit protection claims expense -- -- 22,811 -- 22,811
Occupancy and equipment -- -- 25,088 -- 25,088
Purchased portfolio premium
amortization -- -- 17,930 (1,732) 16,198
MasterCard/Visa assessment and fees -- -- 7,417 -- 7,417
Credit card fraud losses 127 -- 5,054 -- 5,181
Asset impairments, lease write-offs and
severance -- -- 9,523 -- 9,523
Other (110) 75,054 (19,821) (8,188) 46,935
Intercompany allocations 46 41,588 108,491 (150,125) --
--------- --------- --------- --------- ---------
(1,002) 184,826 358,113 (161,893) 380,044
--------- --------- --------- --------- ---------
(LOSS) INCOME BEFORE INCOME TAXES AND EQUITY
IN (LOSS) INCOME OF SUBSIDIARIES (7,983) (28,471) 27,789 634 (8,031)
Income tax (benefit)
expense (2,736) (14,497) 14,825 219 (2,189)
Equity in income of subsidiaries (595) 12,964 -- (12,369) --
---------- --------- --------- ---------- -----------
NET INCOME $ (5,842) $ (1,010) $ 12,964 $ (11,954) $ (5,842)
========== ========= ========= ========== ===========
29
METRIS COMPANIES INC.
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2003
(DOLLARS IN THOUSANDS)
UNAUDITED (AS RESTATED)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- ------------ ------------ ------------ ------------
OPERATING ACTIVITIES:
Net cash (used in) provided by operating
activities $(141,049) $ (84,492) $(156,892) $ 163,249 $(219,184)
--------- --------- --------- --------- ---------
INVESTING ACTIVITIES:
Proceeds from transfers of portfolios to the
Metris Master Trust -- -- 315,065 -- 315,065
Net cash from loan originations and
principal collections on loans receivable (41,582) -- (43,157) -- (84,739)
Additions to (disposals of) property and
equipment -- (1,259) 19,784 -- 18,525
Investment in subsidiaries 158,658 240,640 477,513 (876,811) --
--------- --------- --------- --------- ---------
Net cash provided by investing activities 117,076 239,381 769,205 (876,811) 248,851
--------- --------- --------- --------- ---------
FINANCING ACTIVITIES:
Net increase (decrease) in debt 25,349 (207) -- -- 25,142
Net decrease in deposits -- -- (250,820) -- (250,820)
Proceeds from issuance of common stock 2,370 -- -- -- 2,370
Capital contributions -- (161,557) (552,005) 713,562 --
--------- --------- --------- --------- ---------
Net cash (used in) provided by financing
activities 27,719 (161,764) (802,825) 713,562 (223,308)
--------- --------- --------- --------- ---------
Net (decrease) increase in cash and cash
equivalents 3,746 (6,875) (190,512) -- (193,641)
Cash and cash equivalents at beginning of
period (3,795) 8,109 575,918 -- 580,232
--------- --------- --------- --------- ---------
Cash and cash equivalents at end of period $ (49) $ 1,234 $ 385,406 $ -- $ 386,591
========= ========= ========= ========= =========
30
METRIS COMPANIES INC.
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2002
(DOLLARS IN THOUSANDS)
UNAUDITED (AS RESTATED)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
----------- ----------- ----------- ----------- -----------
OPERATING ACTIVITIES:
Net cash provided by
operating activities $ 123,696 $ 428 $ 249,370 $ (11,954) $ 361,540
----------- ----------- ----------- ----------- -----------
INVESTING ACTIVITIES:
Proceeds from transfers of portfolios to the
Metris Master Trust -- -- 1,486,993 -- 1,486,993
Net cash from loan originations and
principal collections on loans receivable 120 (370,313) -- (370,193)
Additions to (disposals of) property and
equipment -- (4,776) 1,238 -- (3,538)
Investment in subsidiaries 47,949 (16,588) (88,845) 57,484 --
----------- ----------- ----------- ----------- -----------
Net cash (used in) provided by investing
activities 48,069 (21,364) 1,029,073 57,484 1,113,262
----------- ----------- ----------- ----------- -----------
FINANCING ACTIVITIES:
Increase (decrease) in debt 446 (293) (292,000) -- (291,847)
Decrease in deposits -- -- (736,147) -- (736,147)
Cash dividends paid (1,892) -- -- -- (1,892)
Proceeds from issuance of
common stock 2,257 -- -- -- 2,257
Repurchase of common stock (32,951) -- -- -- (32,951)
Capital contributions -- 21,702 23,828 (45,530) --
----------- ----------- ----------- ----------- -----------
Net cash (used in) provided by financing
activities (32,140) 21,409 (1,004,319) (45,530) (1,060,580)
----------- ----------- ----------- ----------- -----------
Net increase in cash and cash equivalents 139,625 473 274,124 -- 414,222
Cash and cash equivalents at beginning of
period 17,614 1,505 362,520 -- 381,639
----------- ----------- ----------- ----------- -----------
Cash and cash equivalents at end of period $ 157,239 $ 1,978 $ 636,644 $ -- $ 795,861
=========== =========== =========== =========== ===========
31
ITEM 2.
METRIS COMPANIES INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides information management
believes to be relevant to understanding the financial condition and results of
operations of Metris Companies Inc. ("MCI") and its subsidiaries. MCI's
principal subsidiaries are Direct Merchants Credit Card Bank, National
Association ("Direct Merchants Bank" or "DMCCB" or the "Bank"), Metris Direct,
Inc. and Metris Receivables, Inc. MCI and its subsidiaries, as applicable, may
be referred to as "we," "us," "our" or the "Company." You should read this
discussion along with the following documents for a full understanding of our
financial condition and results of operations: Management's Discussion and
Analysis of Financial Condition and Results of Operations in our Annual Report
on Form 10-K/A for the fiscal year ended December 31, 2002, filed concurrently
with this Quarterly Report on Form 10-Q/A; and our Proxy Statement for the 2003
Annual Meeting of Stockholders. In addition, you should read this discussion
along with our condensed consolidated financial statements and related notes
thereto for the period ended June 30, 2003.
RESTATEMENTS
The consolidated statements of income as presented for the three and
six-month periods ended June 30, 2003 and 2002 and the consolidated balance
sheets as of June 30, 2003 and December 31, 2002 have been restated to reflect
the following:
- The valuation model and related collateral assumptions used to
estimate the fair value of the Company's "Retained interests
in loans securitized" did not properly reflect the structure
of the Metris Master Trust and related series supplements. All
periods presented have been restated to reflect the changes in
the valuation model and the related collateral assumptions.
These restatements impact "Retained interests in loans
securitized," "Other receivables due from credit card
securitizations, net" and "Securitization income."
- The Company's policy for recognizing transaction costs related
to the securitization of receivables through the Metris Master
Trust or a conduit was not in accordance with GAAP.
Historically, these costs had been capitalized and amortized
over the estimated life of the new debt securities. These
costs are now allocated and recognized over the initial and
reinvestment periods of the respective debt securities or
Metris Master Trust financing unless the transaction results
in a loss, in which case the costs are expensed as incurred.
All periods presented have been restated to reflect the
revised policy. These restatements impact "Other assets" and
"Securitization income."
- The Company's policy for recognizing expenses related to
credit card solicitation costs was not in accordance with
GAAP. Historically, the Company had capitalized and expensed
these costs over the estimated period over which the new
credit card accounts were established, approximately three
months. These costs are now expensed as incurred. All periods
presented have been restated to reflect the revised policy.
This restatement impacts "Other assets" and "Credit card
account and other product solicitation and marketing
expenses."
- The Company corrected its accounting for interest rate caps
purchased in May of 2002 and forward to comply with SFAS 133,
"Accounting for Derivative Instruments and Hedging
Activities," as amended, on January 1, 2001. These costs had
been deferred and amortized over the estimated life of the new
debt securities. These instruments are now recorded at fair
value. All periods presented have been restated to reflect
this correction. This restatement impacts "Retained interests
in loans securitized," "Other assets" and "Securitization
income."
32
- The Company historically recognized revenue in the month
following completion of the cancellation period, generally one
month. Cash flows related to debt waiver are now included in
the valuation of the interest-only strip receivable. All
periods presented have been restated to reflect the revised
policy. This restatement impacts "Retained interests in loans
securitized," "Deferred revenue," "Enhancement services
revenue," and "Securitization income."
- At December 31, 2001 we had $50 million of "Allowance for loan
losses" classified as valuation reserve in our "Retained
interests in loans securitized." The valuation reserve was
transferred to "Allowance for loan losses" through "Provision
for loans losses" during the first quarter of 2002. We have
restated the December 31, 2001 balance sheet and 2001 income
statement and June 30, 2002 income statement to reflect this
transfer occurring during the fourth quarter of 2001. This
restatement impacts "Allowance for loan losses," "Retained
interests in loans securitized," "Provision for loan losses"
and "Securitization income."
In addition, we have restated certain prior-period amounts to conform
with the current period's presentation.
- In prior periods, we classified interest income, provision for
loan losses, and related credit card loan fees generated from
retained interests in loans securitized on the income
statement as "Interest income-credit card loans and retained
interests in loans securitized," "Provision for loan losses"
and "Credit card fees, interchange and other credit card
income." For all periods presented, these amounts are now
included in the estimation of the fair value of the
interest-only strip receivable and "Securitization income."
- In prior periods we classified spread accounts receivable in
"Other receivables due from credit card securitizations, net."
For all periods presented, we have reclassified our spread
accounts receivable from "Other receivables due from credit
card securitizations, net" to "Retained interests in loans
securitized."
- In prior periods, we classified servicing income in "Net
securitization and credit card servicing income." For all
periods presented, we have reclassified these amounts to
"Servicing income."
- In prior periods, income from our debt waiver product sold to
customers of Direct Merchants Bank with receivables held by
Direct Merchants Bank was included in "Enhancement services
revenue." For all periods presented we have reclassified this
income to "Credit card fees, interchange and other credit card
income."
- In prior periods, we classified the liquidity reserve deposit
and other restricted cash deposits maintained at Direct
Merchants Bank as "Short-term investments." We have
reclassified these items to "Liquidity reserve deposit" for
all periods presented.
- Revenue related to our membership club and warranty business
for current and prior periods is classified as "Enhancement
services revenue." Claims expense related to this business has
been reclassified as "Other" expenses for all periods
presented.
- In addition to the tax effects of the pre-tax restatement
amounts, the restated presentation also reflects revised
probable amounts of future taxable and deductible temporary
differences, resulting in a reclassification of certain
deferred income taxes to current income taxes.
33
RESULTS OF OPERATIONS
Net loss for the three months ended June 30, 2003 was $24.7 million,
compared to a net loss of $50.1 million for the second quarter of 2002. Diluted
loss per share for the three months ended June 30, 2003 was ($0.60) compared to
a diluted loss per share of ($0.97) for the second quarter of 2002. The decrease
in net loss is primarily due to a $60.6 million decrease in the provision for
loan losses and a $52.5 million reduction in operating expense, partially offset
by a $29.1 million decrease in net interest income and a $41.4 million decrease
in other operating income. The provision for loan losses decreased 66.9% to
$30.0 million for the second quarter of 2003 from $90.6 million for the same
period in 2002. The decrease is primarily due to a $684 million decline in owned
credit card receivables and lower delinquency levels, partially offset by higher
charge-off rates. Total other operating expenses decreased to $146.5 million in
the second quarter of 2003 from $198.9 million for the same period in 2002.
During the second quarter of 2003, credit card account and other product
solicitation and marketing expenses decreased $13.6 million, largely due to a
decrease in credit card marketing expenditures and decreased enhancement
services marketing. Employee compensation decreased $8.6 million for the three
months ended June 30, 2003, due to lower staffing requirements. Credit
protection claims expense decreased $6.0 million for the three months ended June
30, 2003, due to a decrease in covered receivable balances on our debt waiver
products.
These improvements are partially offset by a decline in "Net interest
income" of $29.1 million and "Credit card fees, interchange and other credit
card income" of $17.1 million primarily due to a decrease in average
interest-earning assets of $1.1 billion. The decrease of $25.0 million in net
securitization revenue is primarily driven by a loss of $57.8 million on
securitization of receivables as compared to a gain of $18.4 million for the
same period last year. The increase in loss on replenishment for the three
months ended June 30, 2003 over the same period in the prior year is driven by
the prior year benefit of receivables purchased from the Bank at a net discount
of $91.7 million for the three months ended June 30, 2002 compared to $1.8
million for the three months ended June 30, 2003. Interest only revenue of $32.2
million for the three-months ended June 30, 2003 declined by $64.7 million from
$96.9 million for the three-months ended June 30, 2002 due to an increased
principal default rate offset by lower cost of funds. These negative variances
were partially offset by improvement in the magnitude of the market value
write-downs. Market-value write-downs were $20.3 million for the three-months
ended June 30, 2003 compared to $134.3 million for the three-months ended June
30, 2002. Market value write-downs decreased from $83.6 million for the
three-months ended March 31, 2003 to $20.3 million for the three-months ended
June 30, 2003.
Net loss for the six months ended June 30, 2003 was $107.6 million, up
from a net loss of $5.8 million for the first six months of 2002. Diluted loss
per share for the six months ended June 30, 2003 was ($2.22) compared to diluted
loss per share of ($0.39) for the six months ended June 30, 2002. The $101.8
million increase in net loss primarily relates to a $165.5 million change in
securitization income, a decrease of $74.0 million in net interest income and a
$66.4 million decrease in credit card fees, interchange and other credit card
income. These changes are partially offset by a $77.7 million decrease in
provision for loan losses and a $58.4 million decrease in operating expenses.
Net Interest Income
Net interest income consists primarily of interest earned on our credit
card loans, less interest expense on borrowings to fund loans. Table 1 provides
an analysis of interest income and expense, net interest spread, net interest
margin and average balance sheet data for the three- and six-month periods ended
June 30, 2003 and 2002.
34
TABLE 1: ANALYSIS OF AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS AND RATES
(Dollars in thousands)
THREE MONTHS ENDED JUNE 30,
2003 2002
---------------------------------------------- -------------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE
--------------- ------------ --------- --------------- ------------- ---------
ASSETS:
Interest-earning assets:
Federal funds sold $ 53,441 $ 164 1.2% $ 28,221 $ 110 1.6%
Short-term investments 364,826 1,337 1.5% 477,642 2,358 2.0%
Liquidity Reserve Deposit 83,786 218 1.0% -- -- --
Credit card loans 690,903 29,713 17.3% 1,742,833 66,324 15.3%
--------------- ------------ --------- --------------- ------------- ---------
Total interest-earning assets $ 1,192,956 $ 31,432 10.6% $ 2,248,696 $ 68,792 12.3%
Other assets 1,370,203 1,484,939
Allowances for loan
losses (130,106) (309,827)
--------------- ----------------
Total assets $ 2,433,053 $ 3,423,808
=============== ===============
LIABILITIES AND EQUITY:
Interest-bearing liabilities:
Deposits $ 729,021 $ 9,597 5.3% $ 1,518,104 $ 18,334 4.8%
Debt 359,378 9,119 10.2% 356,692 8,621 9.7%
--------------- ------------ --------- --------------- ------------- ---------
Total interest-bearing
liabilities $ 1,088,399 $ 18,716 6.9% $ 1,874,796 $ 26,955 5.8%
Other liabilities 238,500 419,222
--------------- ---------------
Total liabilities 1,326,899 2,294,018
Stockholders' equity 1,106,154 1,129,790
--------------- ---------------
Total liabilities and equity $ 2,433,053 $ 3,423,808
=============== ===============
Net interest income and
interest margin (1) $ 12,716 4.3% $ 41,837 7.5%
Net interest rate spread (2) 3.7% 6.5%
(1) We compute "net interest margin" by dividing annualized net interest income
by average total interest-earning assets.
(2) The "net interest rate spread" is the annualized yield on average
interest-earning assets minus the annualized funding rate on average
interest-bearing liabilities.
Net interest income decreased from $41.8 million for the three months
ended June 30, 2002 to $12.7 million for the three months ended June 30, 2003.
The decrease is primarily due to a decrease in average interest-earning assets
of $1.1 billion and a 170 basis point reduction in net interest margin. The
decrease in average interest-earning assets is primarily due to the transfer of
$1.0 billion of receivables to the Master Trust since June 30, 2002. The
decrease in margin is primarily due to a $1.0 billion reduction in average
credit card loans, which has resulted in short-term, lower yielding investments
increasing to 42% of average interest-earning assets, versus 23% in the second
quarter of 2002. In addition, we have experienced a 110 basis point increase in
our funding costs versus the second quarter of 2002.
35
TABLE 1: ANALYSIS OF AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS AND RATES
(CONT'D)
(Dollars in thousands)
SIX MONTHS ENDED JUNE 30,
2003 2002
------------------------------------------------ ---------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ---- ------- -------- ----
ASSETS:
Interest-earning assets:
Federal funds sold $ 85,370 $ 523 1.2% $ 28,326 $ 224 1.6%
Short-term investments 422,407 3,059 1.5% 375,204 3,562 1.9%
Liquidity Reserve Deposit 71,316 391 1.1% -- -- --
Credit card loans 721,121 59,620 16.7% 2,115,683 154,850 14.8%
----------------- ------------ --------- --------------- ------------- ---------
Total interest-earning assets $ 1,300,214 $ 63,593 9.9% $ 2,519,213 $ 158,636 12.7%
Other assets 1,392,723 1,551,933
Allowances for loan
losses (118,572) (358,577)
----------------- ---------------
Total assets $ 2,574,365 $ 3,712,569
================= ===============
LIABILITIES AND EQUITY:
Interest-bearing liabilities:
Deposits $ 783,951 $ 20,505 5.3% $ 1,722,869 $ 41,987 4.9%
Debt 374,425 17,552 9.5% 403,824 17,133 8.6%
----------------- ------------ --------- --------------- ------------- ---------
Total interest-bearing
liabilities $ 1,158,376 $ 38,057 6.6% $ 2,126,693 $ 59,120 5.6%
Other liabilities 354,643 429,177
----------------- ---------------
Total liabilities 1,513,019 2,555,870
Stockholders' equity 1,061,346 1,156,699
----------------- ---------------
Total liabilities and equity $ 2,574,365 $ 3,712,569
================= ===============
Net interest income and
interest margin (1) $ 25,536 4.0% $ 99,516 8.0%
Net interest rate spread (2) 3.2% 7.1%
(1) We compute "net interest margin" by dividing annualized net interest income
by average total interest-earning assets.
(2) The "net interest rate spread" is the annualized yield on average
interest-earning assets minus the annualized funding rate on average
interest-bearing liabilities.
Net interest income decreased from $99.5 million for the six months
ended June 30, 2002 to $25.5 million for the six months ended June 30, 2003. The
decrease is primarily due to a decrease in average interest-earning assets of
$1.2 billion and a 280 basis point reduction in net interest margin. The
decrease in average interest-earning assets is primarily due to the transfer of
$1.0 billion of receivables to the Master Trust since June 30, 2002. The
decrease in margin is primarily due to a $1.4 billion reduction in average
credit card loans, which has resulted in short-term, lower yielding investments
increasing to 45% of average interest-earning assets, versus 16% for the six
months ended June 30, 2002. In addition, we have experienced a 100 basis point
increase in our funding costs versus the same period in 2002.
36
OTHER OPERATING INCOME
Other operating income decreased $41.4 million and $219.1 million for
the three- and six-month periods ended June 30, 2003 compared to the same
periods in 2002. For the three-month period ended June 30, 2003, securitization
income decreased $25.0 million. As detailed below, the change was primarily due
to a $64.7 million decrease in interest-only revenue due to lower excess spreads
on securitized receivables caused by an increased default rate and attrition in
the Master Trust. In addition, loss on securitization was $57.8 million for the
period ended June 30, 2003 compared to gains of $18.4 million during the same
period last year. These changes were offset by a $114.0 million reduction in the
market value write-downs of $20.3 million for the three months ended June 30,
2003 compared to $134.3 million for the three months ended June 30, 2002. Credit
card receivables attrition in the Master Trust has caused a decrease in
servicing income of $2.2 million. For the six-month period ended June 30, 2003,
securitization income (expense) decreased $165.5 million primarily due to losses
on replenishment of receivables to the Metris Master Trust. Additionally,
interest-only revenue was negatively impacted by $141.3 million due to lower
excess spreads caused by increased default rates and attrition of securitized
receivables. These impacts were partially offset by a $38.4 million decrease in
loss on new securitization and a $79.3 million decrease in downward fair value
adjustments.
The following summarizes "Securitization (expense) income" for the
three and six-month periods ended June 30, 2003 and 2002.
TABLE 2: ANALYSIS OF SECURITIZATION (EXPENSE) INCOME
(DOLLARS IN THOUSANDS)
THREE-MONTHS ENDED SIX-MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
2003 2002 2003 2002
---- ---- ---- ----
Loss on new securitization of receivables to
the Metris Master Trust $ (12,244) $ (45,509) $ (32,199) $ (70,578)
(Loss) gain on replenishment of receivables to the Metris Master
Trust (45,529) 63,900 (91,783) 49,883
Discount accretion 78,812 73,698 154,486 144,726
Change in fair value (20,289) (134,333) (103,897) (183,201)
Interest-only revenue 32,243 96,926 90,679 232,008
Transaction and other costs (15,286) (11,936) (37,549) (27,646)
------------ ------------ ------------ ---------
Securitization (expense) income $ 17,707 $ 42,746 $ (20,263) $ 145,192
============ ============= ============ =========
Credit card fees, interchange and other credit card income decreased
$17.1 million and $66.4 million for the three- and six-month periods ended June
30, 2003 compared to the same periods in 2002. The decrease in credit card fees,
interchange and other credit card income, for both the three- and six-month
periods, is primarily due to a decrease in average owned credit card receivables
of $1.0 billion and $1.4 billion for the respective three- and six-month
periods. Partially offsetting this decline was an amendment to the core
transaction documents of the Master Trust agreement, effective June 2002,
resulting in interchange income earned on receivables held by the Master Trust
being recorded as contribution to the excess spread earned.
Enhancement services revenues increased by $2.9 million and $12.2
million for the three- and six-months ended June 30, 2003. This increase was
primarily due to increased enrollments in existing membership products and
enrollments from new membership products.
37
TABLE 3: ENHANCEMENT SERVICES REVENUES AND ACTIVE MEMBERSHIPS (In thousands)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------- --------
REVENUES 2003 2002 2003 2002
---- ---- ---- ----
Membership Program Products 28,609 21,108 59,163 38,268
Warranty / Other 11,081 15,636 24,036 32,750
-------------- -------------- -------------- --------------
Total $ 39,690 $ 36,744 $ 83,199 $ 71,018
============== ============== ============== ==============
JUNE 30, DECEMBER 31, JUNE 30,
------- ----------- --------
ACTIVE MEMBERSHIPS 2003 2002 2002
---- ---- ----
Credit Protection Products 773 905 1,056
Membership Program Products 2,823 3,248 3,085
Warranty / Other 686 941 1,346
----------- ----------- -----------
Total 4,282 5,094 5,487
=========== =========== ===========
OTHER OPERATING EXPENSE
Total other operating expenses for the three- and six-month periods
ended June 30, 2003, decreased $52.5 million and $58.4 million over the
comparable periods in 2002. Credit card account and other product solicitation
and marketing expenses decreased $13.6 million and $27.2 million over the
comparable periods in 2002, largely due to fewer new credit card accounts and
decreased enhancement services marketing expenses. Employee compensation
decreased $8.6 million and $11.8 million over comparable periods in 2002, due to
lower staffing requirements. Data processing services and communications
decreased $3.8 million and $6.9 million for the three- and six-month periods
ended June 30, 2003, primarily due to the reduction in our credit card
portfolio. Credit protection claims expense decreased $6.0 million and $2.9
million for the three- and six-month periods ended June 30, 2003, primarily due
to a decrease in receivable balances covered by our debt waiver products.
Occupancy and Equipment expenses decreased $3.4 million and $6.6 million over
comparable periods in 2002 due to decreased space requirements. Asset
impairments, lease write-offs and severance decreased $3.5 million and increased
$13.3 million for the three- and six-month periods ended June 30, 2003 to $6.0
million and $22.8 million from $9.5 million and $9.5 million for the same
periods in 2002. During the first quarter of 2003, we recorded approximately
$12.0 million of write-downs of excess property, equipment, and operating leases
and a $4.8 million charge for a workforce reduction. In the second quarter of
2003, we recorded an additional $0.9 million for a workforce reduction and wrote
off the unamortized portion of the commitment fee of $5.1 million related to a
backup financing facility entered into in March of 2003 with Thomas H. Lee
Equity Fund IV, L.P. The commitment was replaced in June 2003. In the second
quarter of 2002, a write-down of $10 million was taken for portfolios of
charged-off loans purchased in 2001 and 2000. Other expenses decreased $9.1
million and $7.3 million for the three- and six-month periods ended June 30,
2003, compared to comparable periods in 2002. The decreases were primarily due
to reductions in professional fees of $5.3 million and $1.5 million and travel
and entertainment of $1.2 million and $2.2 million for the three- and six-month
periods ended June 30, 2003, respectively.
38
ASSET QUALITY
Our delinquency and net loan charge-off rates at any point in time
reflect, among other factors, the credit risk of loans, the average age of our
various credit card account portfolios, the success of our collection and
recovery efforts, and general economic conditions. The average age of our credit
card portfolio affects the stability of delinquency and loss rates. In order to
minimize losses, we continue to focus our resources on refining our credit
underwriting standards for new accounts, and on collections and post charge-off
recovery efforts. At June 30, 2003, 47% of our outstanding receivables balance
were from credit card accounts that have been with us in excess of two years,
and 22% 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 underwriting. We manage credit
lines on an ongoing basis and adjust them based on customer usage and payment
patterns. We continually monitor customer accounts and initiate appropriate
collection activities when an account is delinquent or over-limit.
Delinquencies
It is our policy to accrue interest and fee income on all credit card
accounts, except in limited circumstances, until we charge-off the account. In
November 2002, we stopped billing late fees once an account became 120 days
contractually delinquent and in March 2003, we stopped billing overlimit fees
once an account became 120 days contractually delinquent. Past due accounts are
re-aged to current status only after we receive at least three minimum payments
or the equivalent cumulative amount. Accounts can only be re-aged to current
status once every twelve months and two times every five years. Accounts
entering long-term fixed payment forbearance programs may receive a workout
re-age upon entering the debt management program ("workout re-age"). Workout
re-ages can only occur after receipt of at least three consecutive minimum
monthly payments, or the equivalent cumulative amount, as defined by the debt
management program. Workout re-ages can only occur once in five years. This is
in accordance with FFIEC guidance. Table 3 presents the delinquency trends of
our credit card loan portfolio.
TABLE 4: LOAN DELINQUENCY
(Dollars in thousands)
JUNE 30, % OF DECEMBER 31, % OF JUNE 30, % OF
2003 TOTAL 2002 TOTAL 2002 TOTAL
---- ----- ---- ----- ---- -----
Loans outstanding $ 632,913 100% $ 846,417 100% $ 1,317,238 100%
Loans contractually
delinquent:
30 to 59 days 19,699 3.1% 1,673 0.2% 41,382 3.1%
60 to 89 days 17,668 2.8% 2,121 0.2% 35,161 2.7%
90 or more days 10,899 1.7% 4,082 0.5% 72,360 5.5%
------------------ --- ---------- --- ----------- ---
Total $ 48,266 7.6% $ 7,876 0.9% $ 148,903 11.3%
================== === ========== === =========== ====
The decrease in the delinquency rates as of June 30, 2003 and December
31, 2002 compared to June 30, 2002, primarily reflects the sale of approximately
$120 million delinquent receivables during September and December 2002 and an
additional sale of $29.1 million of delinquent receivables in July 2003. These
receivables were accounted for as held-for-sale as of June 30, 2003 and are
recorded at fair value in other assets.
39
Net Charge-Offs
Net charge-offs are the principal amount of losses from cardholders
unwilling or unable to make minimum payments, bankrupt cardholders and deceased
cardholders, less current period recoveries. Net charge-offs exclude accrued
finance charges and fees, which are charged-off against the applicable revenue
line item at the time of charge-off. We charge-off and take accounts as a loss
either 60 days after formal notification of bankruptcy, at the end of the month
during which most unsecured accounts become contractually 180 days past due, at
the end of the month during which unsecured accounts that have entered into a
credit counseling or other similar program and later become contractually 120
days past due, or at the end of the month during which secured accounts become
contractually 120 days past due after first reducing the loss by the secured
deposit.
Charge-offs due to bankruptcies were $6.8 million, representing 15.1%
of total gross charge-offs for the three-month period ended June 30, 2003 and
$16.6 million, representing 18.1% of total gross charge-offs for the three-month
period ended June 30, 2002. Charge-offs due to bankruptcies were $12.3 million,
representing 23.4% of total gross charge-offs for the six-month period ended
June 30, 2003 and $41.9 million, representing 23.2% of total gross charge-offs
for the six-month period ended June 30, 2002. We charge-off accounts that are
identified as fraud losses no later than 90 days after the last activity. We
enter into forward flow agreements with third parties for the sale of a majority
of charged-off credit card receivables. We also refer charged-off accounts to
our recovery unit for coordination of collection efforts to recover the amounts
owed. When appropriate, we place accounts with external collection agencies or
attorneys.
TABLE 5: NET CHARGE-OFFS
(Dollars in thousands)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
---- ---- ---- ----
Average credit card loans $ 690,903 $ 1,742,833 $ 721,121 $ 2,115,683
Net charge-offs 43,702 85,099 51,991 168,777
Net charge-off ratio 25.4% 19.6% 14.5% 16.1%
================= =========== ========= ===========
The increase in the net charge-off ratio for the three months ended
June 30, 2003 is primarily due to a $27.0 million charge-off related to the sale
of approximately $29.1 million of delinquent receivables in July 2003, which
were accounted for as held-for-sale as of June 30, 2003. The decrease in the
charge-off ratio for the six-month period ended June 30, 2003 is primarily due
to the sale of approximately $120.0 million of delinquent receivables in
September and December of 2002 which reduced the charge-offs required in the
first six months of 2003, offset by charge-offs related to the $29.1 million of
delinquent assets held-for-sale at June 30, 2003.
Provision and Allowance for Loan Losses
We record provisions for loan losses in amounts necessary to maintain
the allowance at a level sufficient to absorb anticipated probable loan losses
inherent in the existing loan portfolio as of the balance sheet date.
In order to mitigate credit losses, we have expanded our collections
strategies to aggressively address any potential delinquency increases. We also
leverage forbearance programs and credit counseling services for qualifying
cardholders that are experiencing payment difficulties. These programs include
reduced interest rates, reduced or suspended fees and other incentives to induce
the customer to continue making payments. The amount of customer receivables in
debt forbearance programs was $33.8 million or 5% of total credit card loans as
of June 30, 2003, compared to $34.7 million or 4% of total credit card loans as
of December 31, 2002. All delinquent receivables in debt forbearance programs
are included in Table 3.
40
The provision for loan losses was $30.0 million and $74.8 million for
the three- and six-month periods ended June 30, 2003, compared to a provision of
$90.6 million and $152.5 million for the same periods in 2002. The decrease in
the provision for loan losses in 2003 compared to 2002 is primarily due to lower
credit card loans. The allowance for loan losses was $109.2 million as of June
30, 2003, versus $90.3 million as of December 31, 2002. Our roll-rate models,
including management contingency, indicated our required allowance for loan
losses was in the range of $99 million to $109.2 million as of June 30, 2003,
versus $75 million to $90.3 million as of December 31, 2002. The ratio of
allowance for loan losses to period-end credit card loans was 17.2% at June 30,
2003, compared to 10.7% at December 31, 2002. The allowance for loan losses as a
percentage of 30-day plus receivables was 226.2% at June 30, 2003, compared to
1146.7% at December 31, 2002.
We believe the allowance for loan losses is adequate to cover probable
future losses inherent in the loan portfolio under current conditions. However,
we cannot give assurance as to future credit losses that may be incurred in
connection with our loan portfolio, nor can we provide assurance that the
established allowance for loan losses will be sufficient to absorb future
losses.
Valuation of Retained Interests in Loans Securitized
Our credit card receivables are primarily funded through asset securitizations.
Upon securitization, the Company removes the applicable credit card loans from
the balance sheet and recognizes the retained interests in loans securitized at
their allocated carrying value in accordance with SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities-a
replacement of FASB Statement No. 125" ("SFAS No. 140"). Assets are sold to the
Metris Master Trust at the inception of a securitization series. We also sell
receivables to the Metris Master Trust on a daily basis to replenish receivable
balances that have decreased due to payments and charge-offs. The difference
between the allocated carrying value and the proceeds from the assets sold is
recorded as a gain or loss on sale and is included in "Securitization (expense)
income." At the same time, the Company recognizes the "Retained interests in
loans securitized." The "Retained interests in loans securitized" are financial
assets measured at fair value consistent with trading securities in accordance
with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and includes the contractual retained interests, an interest-only
strip receivable, excess transferor's interests and spread accounts receivable.
The contractual retained interests consist of non-interest bearing securities
held by the Company. The interest-only strip receivable represents the present
value of the excess of the estimated future interest and fee collections
expected to be generated by the securitized loans over the period the
securitized loans are projected to be outstanding above the interest paid on
investor certificates, credit losses, contractual servicing fees, and other
expenses. The excess transferor's interests represent principal receivables held
in the Metris Master Trust over the contractual retained interests. Spread
accounts receivable represents restricted cash reserve accounts held by the
Metris Master Trust that can be used to fund payments due to securitization
investors and credit enhancers if cash flows are insufficient. Cash held in
spread accounts is released to us if certain conditions are met or a
securitization series terminates with amounts remaining in the spread accounts.
The fair value of the "Retained interests in loans securitized" is determined
through estimated cash flows discounted at rates that reflect the level of
subordination, the projected repayment term, and the credit risk of the
securitized loans.
41
The following summarizes our "Retained interests in loans securitized"
as of March 31, 2003 and December 31, 2002.
TABLE 6: RETAINED INTERESTS IN LOANS SECURITIZED
JUNE 30, DECEMBER 31,
(In thousands): 2003 2002
---- ----
Contractual retained interests $ 620,943 $ 685,197
Excess transferor's interests 54,850 57,447
Interest-only strip receivable 766 13,882
Spread accounts receivable 175,656 51,500
------------- ---------------
Retained interests in loans securitized $ 852,215 $ 808,026
============= ===============
"Retained interests in loans securitized" increased by $44.2 million
between December 31, 2002, and June 30, 2003, to $852.2 million. The increase is
primarily due to a $124.2 million increase in spread accounts receivable offset
by a $64.2 million decrease in contractual retained interests and a $13.1
million reduction in the interest-only strip receivable.
The interest-only strip receivable decreased to $0.8 million as of June
30, 2003, from $13.9 million as of December 31, 2002, due to lower projected
excess spreads from the receivables held in the Metris Master Trust. The
projected excess spreads have decreased primarily due to expected decreases in
yield and by expected increases in the principal default rates. Spread accounts
receivable increased over December 31, 2002, as all excess spread earned on
receivables held in the Metris Master Trust is being restricted from release to
the Company due to the performance of the receivables. For more information on
restricted cash see the Liquidity, Funding and Capital Resources section of the
Management Discussion and Analysis on pages 31 through 55.
At least quarterly, the Company adjusts the valuation of the "Retained
interests in loans securitized" to reflect changes in the amount and expected
timing of future cash flows. The significant factors that affect the timing and
amount of cash flows relate to the collateral assumptions, which include payment
rate, default rate, gross yield and discount rate. These values can, and will,
vary as a result of changes in the amount and timing of the cash flows and the
underlying economic assumptions. The components of retained interests are
recorded at their fair value. (See Critical Accounting Policies on page 43 for
more information on the valuation of the retained interests). The significant
assumptions used for estimating the fair value of the "Retained interests in
loans securitized" are as follows:
TABLE 7: SIGNIFICANT ASSUMPTIONS USED FOR ESTIMATING THE FAIR VALUE OF RETAINED
INTERESTS
JUNE 30, DECEMBER 31,
2003 2002
---- ----
Monthly payment rate 6.7% 6.7%
Gross yield (1) 25.6% 26.0%
Annual interest expense and servicing fees 3.8% 4.0%
Annual gross principal default rate 22.6% 21.7%
Discount rate:
Contractual retained interests 16.0% 16.0%
Excess transferor's interests 16.0% 16.0%
Interest-only strip receivable 30.0% 30.0%
Spread accounts receivable (2) 15.0% 16.0%
(1)Includes expected cash flows from finance charges, late and
overlimit fees, debt waiver premiums and bad debt recoveries, net of
finance charge and fee charge-offs. Gross yield for purposes of
estimating fair value does not include interchange income, or cash
advance fees.
(2) Beginning on March 31, 2003 the discount rate on spread account
balances has been reduced by interest income expected to be earned.
42
BALANCE SHEET ANALYSIS
Cash and Cash Equivalents
Cash and cash equivalents decreased $193.6 million to $386.6 million as
of June 30, 2003, compared to $580.2 million as of December 31, 2002. The
decrease is primarily due to the reduction in deposits of $250.9 million and the
establishment of a $80.6 million liquidity reserve required by the Company's
Operating Agreement with the OCC as described on page 52 offset by sales of
receivables from Direct Merchants Bank to the Master Trust.
Credit Card Loans
Credit card loans were $632.9 million as of June 30, 2003, compared to
$846.4 million as of December 31, 2002. The $213.5 million decrease is primarily
a result of the transfer of $319.6 million of receivables from Direct Merchants
Bank to the Master Trust.
Property and equipment
Property and equipment decreased to $51.5 million at June 30, 2003,
mainly due to the sale of our Arizona facility on May 1, 2003 for cash proceeds
of $19.3 million, which approximated its carrying value.
Deposits
Deposits decreased $250.9 million to $641.9 million as of June 30,
2003, from $892.8 million as of December 31, 2002. The decrease relates to a
shift in funding from certificates of deposit ("CDs") to off-balance sheet
asset-backed securitizations.
Deferred Income
Deferred income decreased $37.0 million to $106.1 million as of June
30, 2003 compared to $143.1 million as of December 31, 2002. The decrease
primarily relates to declining enhancement services enrollments,, our migration
from annual-billed to monthly-billed enhancement service products and the
expiration of the ServiceEdge(R) extended warranty contracts.
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 acquisition costs and revenue recognition on
enhancement services products.
Allowance for loan losses
We maintain an allowance for loan losses sufficient to absorb
anticipated probable loan losses inherent in the credit card loan portfolio as
of the balance sheet date. At the time of charge-off, all principal balances are
written off against the allowance and all fees and finance charges are netted
against the applicable income statement line item. The allowance is based on
management's consideration of all relevant factors including management's
assessment of applicable economic and seasonal trends.
We segment the loan portfolio into several individual liquidating pools
with similar credit risk characteristics, and estimate (based on historical
experience for similar pools and existing environmental conditions) the dollar
amount of principal, accrued finance charges and fees that will ultimately
charge-off. We then aggregate these pools into prime and subprime portfolios
based on the prescribed FICO score cuts, credit counseling and various pools of
other receivables. We also isolate other potentially higher risk segments such
as accounts that are over their credit limit by more than 10%, accounts in
suspended status under our debt waiver benefits and other programs as deemed
necessary. We separately analyze the reserve requirement on each of these groups
or portfolios.
43
We continually evaluate the homogenous liquidating risk pools using a
roll-rate model which uses historical delinquency levels and pay-down levels (12
months of historical data, with influence given to the last six months'
performance to capture current economic and seasonal trends), loan seasoning and
other measures of asset quality to estimate charge-offs for both credit losses
and bankruptcy losses.
Additionally, in evaluating the adequacy of the loan loss reserves, we
consider several subjective factors which may be overlaid into the credit risk
roll-rate model in determining the necessary loan loss reserve, including:
- national and economic trends and business conditions,
including the condition of various market segments;
- changes in lending policies and procedures, including those
for underwriting, collection, charge-off and recovery, as well
as in the experience, ability and depth of lending management
and staff;
- trends in volume and the product pricing of accounts,
including any concentrations of credit; and
- impacts from external factors - such as changes in
competition, and legal and regulatory requirements - on the
level of estimated credit losses in the current portfolio.
Significant changes in these factors could impact our financial
projections and thereby affect the adequacy of our allowance for loan losses.
Valuation of Retained Interests in Loans Securitized
The "Retained interests in loans securitized" on our balance sheet
associated with our securitization transactions includes contractual retained
interests, transferor's interests, interest-only strip receivable, and spread
accounts receivable. We determine the fair value of each component of the
"Retained interests in loans securitized" at the time a securitization
transaction or replenishment sale is completed using a discounted cash flow
valuation model and on a quarterly basis thereafter. Any change in the fair
value is recorded in "Securitization income."
The discounted cash flow valuation is limited to the receivables that
exist and have been sold to the Metris Master Trust. Therefore, the model
assumes current principal receivable balances amortize with no new sales,
interchange fees or cash advances. The future cash flows are modeled in
accordance with the debt series' legal documents and are applied to all series
on a pro-rata basis. Excess fee income, finance charge and recovery cash flows
above contractual expense payments are first applied to meet spread accounts
receivable requirements then returned to us as part of the interest-only strip
receivable. We determine upper and lower valuation limits of the "Retained
interests in loans securitized" based on historical and forecasted excess
spreads. We then determine the best estimate within the range based on
historical trends (weighted heavily toward the low end of the range), adjusted
when appropriate, for portfolio forecast information.
The contractual retained interests represent the subordinated
securities held by us. There is no stated interest/coupon rate associated with
these securities and they are not rated. They are subordinate to all other
securities, except for the interest-only strip receivable we own and
accordingly, are repaid last. Their fair value is determined by discounting the
expected future cash flows using a discount rate commensurate with the risks of
the underlying assets and the expected timing based on the scheduled maturity
date for the underlying securitization. If these securities are recoverable
based on the Metris Master Trust forecasts, cash flows related to the entire
subordinated principal balance are used in determining their fair value.
44
Transferor's interests represent undivided interests in receivables
that are not pledged to support a specific security series or class and
represent our interest in the excess principal receivables held in the Metris
Master Trust. The fair value is determined in the same manner as the contractual
retained interests and is discounted based on twelve months to maturity. We have
subordinated our rights to the excess cash flows on the principal receivables
underlying the transferor's interest, thus they are included in the value of the
interest-only strip receivable. Spread accounts receivable balances represent
cash held by the Metris Master Trust trustee due to Trust performance and
requisite reserves required by certain security series. These balances earn
interest and the change in fair value is determined in the same manner as the
contractual retained interests.
The interest-only strip receivable represents the contractual right to
receive from the Metris Master Trust interest and other fee revenue less certain
costs over the estimated life of the underlying debt securities. The fair value
is determined by discounting the expected future cash flows using a discount
rate commensurate with the risks of the underlying assets and the expected
timing of the amortization inherent in the retained interests valuation model.
We believe our discount rates are consistent with what other market place
participants would use to determine the fair value of these assets. The
valuation model assumes that we repurchase the outstanding principal receivables
at face value according to the clean up call provisions contained in the
respective security series' legal documents.
We use certain assumptions and estimates in determining the fair values
of "Retained interests in loans securitized." These assumptions and estimates
include estimated principal payments, credit losses, gross yield, interest
expense, fees, the timing of cash receipts, and discount rates commensurate with
the risks of the underlying assets. On a quarterly basis, we review and adjust
as appropriate the assumptions and estimates used in our model based on a
variety of internal and external factors, including national and economic trends
and business conditions, current lending policies, procedures and strategies,
historical trends and assumptions about future trends, competition and legal and
regulatory requirements. Significant estimates are required in determining these
factors and different judgments concerning these factors can result in a
material impact on our balance sheet and income statement. The accompanying
unaudited consolidated financial statements do not include an adjustment to the
fair value of retained interest that might result from the inability to finance
future receivables.
Revenue Recognition on Enhancement Services Products
Debt Waiver Products
Direct Merchants Bank offers various debt waiver products on receivables it
owns as well as securitized receivables. The Company's policy for recognizing
debt waiver revenue on receivables sold to the Metris Master Trust was not in
accordance with GAAP. Historically, the Company recognized revenue in the month
following completion of the cancellation period, generally one month. Cash flows
related to debt waiver are now included in the valuation of the interest-only
strip receivable. All periods presented have been restated to reflect the
revised policy. Direct Merchants Bank incurs the related claims and marketing
expenses. A reserve is maintained for future death and finance charge claims
based on Direct Merchants Bank's historical experience with settlement of such
claims. Reserves for pending claims and incurred but not reported claims are
recorded in the consolidated balance sheets in "Accrued expenses and other
liabilities." Reserves for pending and incurred but not reported claims were
$7.8 million as of June 30, 2003, compared to $8.2 million as of December 31,
2002.
45
Membership Program Products
We bill membership fees for enhancement services products through
financial institutions, including Direct Merchants Bank, and other
cardholder-based institutions. We record these fees as deferred membership
income upon acceptance of membership and amortize them on a straight-line basis
for all annually billed products, and on an accelerated amortization method for
all monthly billed products over the membership period beginning after the
contractual cancellation period is complete. A liability is established and
netted against the related receivable in the consolidated balance sheets in
"Other assets" from inception of the membership through the end of the
cancellation period that reflects our historical cancellation experience with
these products. Gross receivables as of June 30, 2003 on the membership program
products were $13.3 million compared to $22.0 million as of December 31, 2002.
Cancellation reserves were $11.3 million and $19.5 million as of June 30, 2003
and December 31, 2002, respectively. Revenues recorded for membership products
are included in the consolidated statements of income under "Enhancement
services revenues" and were $28.6 million and $21.1 million for the three months
ended June 30, 2003 and 2002, respectively. Revenues for membership products
were $59.2 million and $38.3 million for the six months ended June 30, 2003 and
2002, respectively. Unearned revenues on membership program products are
recorded in the consolidated balance sheets in "Deferred income." Unearned
revenues as of June 30, 2003 were $85.3 million compared to $114.2 million as of
December 31, 2002.
Warranty Products
We coordinate the marketing activities for Direct Merchants Bank and
third-party sales of extended service plans. We perform administrative services
and retain the claims risk for all extended service plans sold. As a result, we
defer and recognize extended service plan revenues and the incremental direct
acquisition costs on an accelerated amortization method over the life of the
related extended service plan contracts beginning after the expiration of any
manufacturer's warranty coverage. A liability is established and netted against
the related receivable in the consolidated balance sheets in "Other assets" from
inception of the extended service plan through the end of the cancellation
period that reflects our historical cancellation experience with these products.
Gross receivables as of June 30, 2003 on the warranty products were $3.3 million
compared to $3.8 million as of December 31, 2002. Cancellation reserves were
$3.0 million and $5.3 million as of June 30, 2003 and December 31, 2002,
respectively. Revenues recorded for warranty products are included in the
consolidated statements of income under "Enhancement services revenues" and were
$8.4 million and $12.0 million for the three months ended June 30, 2003 and
2002, respectively. Revenues for warranty were $18.4 million and $25.0 million
for the six months ended June 30, 2003 and 2002, respectively. Unearned revenues
on warranty products are recorded in the consolidated balance sheets in
"Deferred income." Unearned revenues as of June 30, 2003 were $10.4 million
compared to $17.6 million as of December 31, 2002. Reserves for pending and
incurred but not reported claims, included in "Accrued expenses and other
liabilities," were $0.4 and $0.7 million as of June 30, 2003 and December 31,
2002, respectively.
Deferred Acquisition Costs on Enhancement Services Products
We defer qualifying acquisition costs associated with our enhancement
services products. These costs, which relate directly to membership
solicitations (direct response advertising costs), principally include postage,
printing, mailing, telemarketing costs, and commissions paid to third parties.
The total amount of enhancement services deferred costs as of June 30, 2003 and
December 31, 2002 were $46.9 million and $73.2 million, respectively. If
deferred acquisition costs were to exceed forecasted future cash flows, we would
make an appropriate adjustment for impairment. The most significant assumption
used by the Company in determining the realizability of these deferred costs is
future revenues from our enhancement services products. A significant reduction
in revenues could have a material impact on the values of these balances.
46
Debt Waiver Products
Qualifying membership acquisition costs are deferred and charged to
expense as debt waiver product fees are recognized. We amortize these costs
using an accelerated methodology, which approximates our historical cancellation
experience for debt waiver products. Amortization of debt waiver acquisition
costs was $1.3 million and $2.7 million for the three- and six-month periods
ended June 30, 2003. All other debt waiver acquisition costs are expensed as
incurred. Deferred debt waiver acquisition costs were $2.3 million and $2.6
million as of June 30, 2003 and December 31, 2002, respectively, and were
classified as "Other assets" on the consolidated balance sheets.
Membership Program Products
Qualifying membership acquisition costs are deferred and charged to
expense as membership fees are recognized. We amortize all deferred costs on a
straight-line basis for all annually billed products, and on an accelerated
method for all monthly billed products, which approximates our historical
cancellation experience for membership program products. Amortization of
membership deferred costs was $13.3 million and $11.9 million for the three
months ended June 30, 2003 and 2002, respectively. Amortization of membership
deferred costs was $33.9 million and $19.7 million for the six months ended June
30, 2003 and 2002, respectively. All other membership acquisition costs are
expensed as incurred. Deferred membership acquisition costs were $42.8 million
and $66.9 million as of June 30, 2003 and December 31, 2002, respectively, and
were classified as "Other assets" on the consolidated balance sheets.
Warranty Products
Qualifying warranty acquisition costs are deferred and charged to
expense as warranty product fees are recognized. Those direct acquisition costs
that cannot be associated with a successful contract, are charged to expense as
incurred. A successful effort conversion percentage is applied to these
incremental direct acquisition costs, which approximates our historical
successful effort rate percentage in selling warranty products. We amortize
these deferred costs using an accelerated amortization methodology, which
approximates our historical cancellation experience following the expiration of
the manufacturer's contractual cancellation period for the warranty products.
Amortization of warranty acquisition costs were $0.8 million and $3.0 million
for the three months ended June 30, 2003 and 2002, respectively. Amortization of
warranty acquisition costs were $2.8 million and $6.1 million for the six months
ended June 30, 2003 and 2002, respectively. All other warranty acquisition costs
are expensed as incurred. Deferred warranty acquisition costs amount to $1.4
million and $3.0 million as of June 30, 2003 and December 31, 2002,
respectively, and were classified as "Other assets" on the consolidated balance
sheets.
47
LIQUIDITY, FUNDING AND CAPITAL RESOURCES
One of our primary financial goals is to maintain an adequate level of
liquidity through active management of assets and liabilities. Liquidity
management is a dynamic process, affected by changes in the characteristics of
our assets and liabilities and short- and long-term interest rates. We use a
variety of financing sources to manage liquidity, funding, and interest rate
risks. Table 5 summarizes our funding and liquidity as of June 30, 2003 and
December 31, 2002:
TABLE 8: LIQUIDITY, FUNDING AND CAPITAL RESOURCES
JUNE 30, 2003 DECEMBER 31, 2002
------------- -----------------
DMCCB OTHER CONSOLIDATED DMCCB OTHER CONSOLIDATED
--------------- --------------- ------------------ --------------- --------------- -----------
Cash and due from
banks $ 85,412 $ 1,106 $ 86,518 $ 58,399 $ 4,414 $ 62,813
Federal funds
sold 33,700 -- 33,700 88,000 -- 88,000
Short-term
investments 209,157 57,216 266,373 322,039 107,380 429,419
--------------- --------------- ------------------ --------------- --------------- -----------
Total cash and
cash
equivalents $ 328,269 $ 58,322 $ 386,591 $ 468,438 $ 111,794 $ 580,232
=============== =============== ================== =============== =============== ===========
JUNE 30, 2003 DECEMBER 31, 2002
------------- -----------------
UNUSED UNUSED
ON-BALANCE SHEET FUNDING OUTSTANDING CAPACITY OUTSTANDING CAPACITY
---------------- ----------------- --------------- ------------
Revolving credit line - July
2003 $ -- $ -- $ -- $ 162,696
Term loan - June 2003 -- N/A 100,000 N/A
10% senior notes - November 2004 100,000 N/A 100,000 N/A
10.125% senior notes -
July 2006 147,270 N/A 146,824 N/A
Term loan - June 2004 125,000 N/A -- --
Other 10,967 N/A 10,825 N/A
Deposits - various maturities through
February 2007 641,934 N/A 892,754 N/A
---------------- ----------------- --------------- ------------
Subtotal $ 1,025,171 $ -- $ 1,250,403 $ 162,696
OFF-BALANCE SHEET FUNDING
Master Trust:
Term asset backed
securitizations -
various maturities
through January 2009 7,010,000 -- 7,610,000 --
Conduits - maturing
March 2004 850,000 -- 1,177,957 422,043
Metris facility - March 2003 -- -- 48,900 26,100
---------------- ----------------- --------------- ------------
Subtotal 7,860,000 -- 8,836,857 448,143
---------------- ----------------- --------------- ------------
Total $ 8,885,171 $ -- $ 10,087,260 $ 610,839
================ ================= ================ ============
48
Our contractual cash obligations during the next twelve months as of
June 30, 2003 are as follows:
Long-term debt $ 126,167
Operating leases 13,019
Deposits 182,705
----------------
Total $ 321,891
================
In addition to the contractual cash obligations, open-to-buy on credit
card accounts as of June 30, 2003 was $10.1 billion.
As of June 30, 2003, $2.0 billion of off-balance sheet funding in the
Master Trust is scheduled to amortize over the next twelve months. We base the
amortization amounts on estimated amortization periods, which are subject to
change based on the Master Trust performance.
The following table shows the annualized yields, defaults, costs and
excess spreads for the Master Trust on a cash basis:
THREE MONTHS ENDED JUNE 30,
(In thousands) 2003 2002
---- ----
Gross yield (1) $ 608,762 26.86% $ 616,011 25.98%
Annual principal defaults 477,392 21.06% 373,257 15.74%
---------------- ----- ---------------- -----
Net portfolio yield 131,370 5.80% 242,754 10.24%
Annual interest expense and
servicing fees 83,575 3.86% 100,048 4.33%
---------------- ----- ---------------- -----
Net excess spread $ 47,795 1.94% $ 142,706 5.91%
================ ===== ================ =====
SIX MONTHS ENDED JUNE 30,
(In thousands) 2003 2002
---- ----
Gross yield (1) $ 1,266,543 27.29% $ 1,202,691 26.27%
Annual principal defaults 985,592 21.23% 687,636 15.02%
---------------- ----- --------------- -----
Net portfolio yield 280,951 6.06% 515,055 11.25%
Annual interest expense and servicing
fees 171,744 3.90% 206,350 4.54%
---------------- ---- --------------- -----
Net excess spread $ 109,207 2.16% $ 308,705 6.71%
================ ==== =============== =====
(1) Includes cash flows from finance charges, late, overlimit and cash
advance fees, bad debt recoveries, interchange income and debt waiver
fees, less finance charge and fee charge-offs.
The Master Trust and the associated off-balance sheet debt provide for
early amortization if certain events occur. These events are described in the
applicable series supplement of each securitization transaction. The significant
events are (i) three-month average excess spreads below levels between 0.0% and
1.0%, (ii) negative transferor's interest within the Master Trust or (iii)
failure to obtain funding during an accumulation period for a maturing term
asset-backed securitization. In addition, there are various triggers within our
securitization agreements that, if broken, would restrict the release of cash to
us from the Master Trust. This restricted cash provides additional security to
the investors in the Master Trust. We reflect cash restricted from release in
the Master Trust as "Other receivables due from credit card securitizations,
net" in the consolidated balance sheet. The restricted cash is discounted to
reflect the present value of the future cash release. The triggers are primarily
related to the performance of the Master Trust, in particular the average of net
excess spread over a one to three-month period.
The cash restricted from release is limited to the amount of excess
spread generated in the Master Trust on a cash basis. During periods of lower
excess spreads, the required amount of cash to be restricted in the Master Trust
may not be achieved. During those periods, all excess cash normally released to
Metris Receivables, Inc. ("MRI") will be restricted from release. Once the
maximum required amount of cash is restricted from release or excess spreads
improve, cash can again be released to us. Based on the performance of our
Master Trust, the amount of cash required to be restricted was $463 million at
June 30, 2003 and $304 million at December 31, 2002. As of June 30, 2003, $177.1
million has been restricted from release in the Master Trust due to performance,
$21.4 million has been restricted from release in the Master Trust due to
corporate
49
debt ratings at the inception of the securitization transactions and $15.9
million has been restricted from release in the Master Trust for maturity
reserves. As of December 31, 2002, $29.1 million had been restricted from
release in the Master Trust due to performance and $21.4 million had been
restricted from release in the Master Trust due to corporate debt ratings at the
inception of the securitization transactions. The $148.0 million increase in
this restricted cash is a result of approximately $109.2 million of net excess
cash generated by the Master Trust being restricted within the Master Trust and
approximately $38.8 million that was funded as additional enhancements. We
expect all cash basis excess spread to be restricted from release to us until at
least 2004.
On March 17, 2003 we obtained a $425 million extension through March
2004 of an $850 million conduit which was scheduled to mature in June of 2003.
We also secured a $425 million conduit through March 2004, which replaced
conduits and warehouse facilities that matured during March through May 2003.
Furthermore, these conduits provided for the financing of a term asset-backed
securitization that matured in July 2003. The continued availability of funding
under these facilities is subject to various conditions, including a minimum
three-month average excess spread of 1% and a commitment, no later than
September 30, 2003, for funding of a $610 million term asset backed
securitization that matures in January and February 2004. On June 26, 2003, we
paid approximately $4.3 million of prepaid interest and related fees to reduce
the interest rate on one of these financing facilities.
On March 31, 2003, Thomas H. Lee Equity Fund IV, L.P. ("THL Fund IV")
committed to provide a term loan to the Company in an aggregate amount of $125
million as a backup financing facility, secured by assets of the Company. On
June 27, 2003 the term loan commitment was terminated and replaced with a $125
million senior secured loan funded by a consortium of lenders. With the
termination of the THL Fund IV commitment, we wrote off $5.1 million of
capitalized commitment fees.
The $125 million term loan was issued pursuant to an Amended and
Restated Senior Secured Credit Agreement dated as of June 18, 2003 (the "Credit
Agreement"). The loan matures June 27, 2004 and carries a fixed interest rate of
12% plus a monthly performance interest payment, which is indexed to the monthly
excess spread in the Master Trust. The funds were used to pay off a $100 million
term loan that matured in June of 2003. The terms of the Credit Agreement, under
which the loan was issued, require mandatory prepayment of a portion of the
principal if the Company receives funds due to the sale of certain Company
assets. We were therefore required to make a $22.5 million principal repayment
from the proceeds of the sale of our membership and warranty business. We are
bound by certain covenants under the Credit Agreement as filed July 11, 2003 on
Form 8-K. As of June 30, 2003, we were in compliance with all covenants under
the Credit Agreement. In addition, under the agreement, Direct Merchants Bank
dividends paid to MCI are limited to Bank earnings not to exceed $20 million per
quarter.
The Internal Revenue Service ("IRS") has recently completed its
examination of the Company's tax returns through December 31, 1998. The IRS has
proposed adjustments to increase the Company's federal income tax by $42.9
million, plus interest of more than $15 million, pertaining to the Company's
treatment of certain credit card fees as original issue discount ("OID").
Although these fees are primarily reported as income when billed for financial
reporting purposes, we believe the fees constitute OID and must be deferred and
amortized over the life of the underlying credit card loans for tax purposes.
Cumulatively through the year ended June 30, 2003, the Company has deferred
approximately $213.9 million in federal income tax under the OID rules. Any
assessment similar to what has been proposed by the IRS may ultimately require
the Company to pay the federal tax, state tax and related interest.
The Company believes its treatment of the fees is appropriate and
continues to work with the IRS to resolve the proposed adjustments. The
Company's position on the treatment of credit card fees is consistent with that
of many other U.S. credit card issuers. We do not expect any additional tax to
be paid or settlement to be reached over the next twelve months. However, both
the timing and amount of the final resolution of this matter is uncertain.
In July of 2003, the OCC requested and Direct Merchants Bank agreed to
eliminate federally insured deposits at the Bank, or the risk thereof to the
FDIC, by September 30, 2003. The Bank estimates that it will have approximately
$565 million of insured deposits at September 30, 2003. The Bank also estimates
it will have approximately $375 million of unencumbered cash and
50
approximately $500 million of available gross receivables at September 30, 2003
to meet this obligation. We have received preliminary proposals from financing
sources, and we are working with our financial advisors on a variety of options
to achieve this goal. These options may include additional conduit financing or
the sale of credit card receivables to third parties.
During the next twelve months we have contractual cash obligations of
$322 million and off-balance sheet funding scheduled to amortize of $2.0
billion, which includes funding for a $610 million term asset-backed
securitization maturing in January and February 2004. In addition, we require
funding for approximately $565 million of deposits to be paid-off or defeased by
September 30, 2003. We have historically utilized a variety of funding vehicles,
as well as ongoing cash generated from operations, to finance credit card
receivables, maturing debt obligations and general operating needs. During the
next twelve months we intend to reduce outstanding credit card receivables in
the Master Trust through lower credit card account acquisitions, attrition in
the portfolio and third party sales as necessary. This reduction in the size of
the portfolio will significantly reduce our need for additional bank conduits or
the issuance of new asset-backed securities. We believe that we will be able to
obtain the requisite funding that will provide us with adequate liquidity to
meet anticipated cash needs, although no assurance can be given to that effect.
CAPITAL ADEQUACY
In the normal course of business, Direct Merchants Bank enters into
agreements, or is subject to regulatory requirements, that result in cash, debt
and dividend or other capital restrictions.
The Federal Reserve Act imposes various legal limitations on the extent
to which banks can finance or otherwise supply funds to their affiliates. In
particular, Direct Merchants Bank is subject to certain restrictions on any
extensions of credit to or other covered transactions, such as certain purchases
of assets, with MCI and its affiliates. Such restrictions limit Direct Merchants
Bank's ability to lend to MCI and its affiliates. Additionally, Direct Merchants
Bank is limited in its ability to declare dividends to MCI in accordance with
the national bank dividend provisions.
Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the OCC. At June 30, 2003 and December 31, 2002, Direct Merchants
Bank's Tier 1 risk-based capital ratio, risk-based total capital ratio and Tier
1 leverage ratio exceeded the minimum required capital levels, as illustrated in
the following table.
Additionally, the Bank must maintain minimum capital in the aggregate
amount of (i) liquid assets deposited pursuant to the Liquidity Reserve Deposit
Agreement discussed below; (ii) the capital required as a result of the 200%
risk-weight applied to on-book subprime credit card receivables; and (iii) the
minimum capital required under Federal law for a "well capitalized" institution
for all remaining assets owned by the Bank. Under these more stringent
guidelines, Direct Merchants Bank's total capital ratio as of June 30, 2003 was
17.2% and Direct Merchants Bank was considered a "well-capitalized" depository
institution under regulations of the OCC (including FFIEC subprime guidelines).
Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, Direct Merchants Bank must meet specific capital
guidelines that involve quantitative measures of assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices.
Direct Merchants Bank's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors.
Quantitative measures established by regulation to ensure capital
adequacy require Direct Merchants Bank to maintain minimum amounts and ratios
(set forth in the following table) of total and Tier 1 capital (as defined in
the regulations) to risk-weighted assets (as defined), and of Tier 1 leverage
capital (as defined) to average assets (as defined). Failure to meet minimum
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material adverse effect on our financial statements.
Additional information about Direct Merchants Bank's actual capital
amounts and ratios are presented in the following table:
51
TO BE
ADEQUATELY TO BE WELL
ACTUAL CAPITALIZED CAPITALIZED
------ ----------- -----------
AS OF JUNE 30, 2003 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
Total Capital $ 259,364 39.4% $ 52,614 8.0% $ 65,768 10.0%
(to risk-weighted
assets)
Tier 1 Capital 249,917 38.0% 26,307 4.0% 39,461 6.0%
(to risk-weighted
assets)
Tier 1 Capital 249,917 21.8% 45,841 4.0% 57,301 5.0%
(to average assets)
TO BE
ADEQUATELY TO BE WELL
ACTUAL CAPITALIZED CAPITALIZED
------ ----------- -----------
AS OF DECEMBER 31, 2002 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
Total Capital $ 402,721 30.8% $104,516 8.0% $130,645 10.0%
(to risk-weighted
assets)
Tier 1 Capital 385,480 29.5% 52,258 4.0% 78,387 6.0%
(to risk-weighted
assets)
Tier 1 Capital 385,480 24.7% 62,381 4.0% 77,977 5.0%
(to average assets)
REGULATORY MATTERS
On March 18, 2003, we entered into an operating agreement with the OCC
designed to ensure that Direct Merchants Bank continues to operate in a safe and
sound manner.
The operating agreement requires, among other things, the following:
- The Bank must reduce its on-balance-sheet credit card
receivables to no more than $550 million by December 31, 2003
and to zero by December 31, 2004. During the time the Bank is
reducing these receivables, the mix of subprime receivables
may not exceed 60% of all credit card receivables. As of June
30, 2003, 56.2% of the Bank's credit card receivables were
subprime. The Bank will continue to sell credit card
receivables on a daily basis to MCI under the purchase
agreement currently in effect between MCI and the Bank.
- The Bank must maintain minimum capital in the aggregate amount
of (i)liquid assets deposited pursuant to the Liquidity
Reserve Deposit Agreement discussed below; (ii) the capital
required as a result of the 200% risk-weight applied to
on-book subprime credit card receivables; and (iii) the
minimum capital required under Federal law for a "well
capitalized" institution for all remaining assets owned by the
Bank.
- The Bank must meet certain liquidity requirements, including
maintaining, on a daily basis, liquid assets of not less than
100% of the deposits and other liabilities coming due within
the next 30 days, maintaining marketable assets in an amount
equal to or in excess of the Bank's insured deposits,
maintaining cash and cash equivalents
52
in excess of 46% of outstanding CDs, and entering into the
Liquidity Reserve Deposit Agreement discussed below to support
the Bank's credit card receivables funding needs.
- The Bank is working with the OCC to develop a written
strategic plan establishing objectives for the Bank's overall
risk profile, earning performance, growth, balance sheet mix,
off-balance sheet activities, liability structure, capital
adequacy, product line development and marketing segments.
The terms of the operating agreement required Direct Merchants Bank and
MCI to enter into a Capital Assurance and Liquidity Maintenance Agreement
("CALMA") which also was executed on March 18, 2003. The effect of the CALMA is
to potentially require MCI to make such capital infusions or provide Direct
Merchants Bank with financial assistance so as to permit Direct Merchants Bank
to meet its liquidity requirements.
As required by the operating agreement, Direct Merchants Bank, a
third-party depository bank and the OCC executed a Liquidity Reserve Deposit
Agreement ("LRDA").
If the OCC were to conclude that the Bank failed to implement any
provision of the agreement, the OCC could pursue various enforcement options.
Upon signing these agreements Direct Merchants Bank declared and paid a
$155 million dividend to us. An additional dividend of $15.8 million was
declared and paid during the second quarter of 2003.
In July of 2003, the OCC requested and Direct Merchants Bank agreed to
eliminate federally insured deposits at the Bank, or the risk thereof to the
FDIC, by September 30, 2003. The Bank estimates that it will have approximately
$565 million of insured deposits at September 30, 2003. The Bank also estimates
it will have approximately $375 million of unencumbered cash and approximately
$500 million of available gross receivables at September 30, 2003 to meet this
obligation. We have received preliminary proposals from financing sources, and
we are working with our financial advisors on a variety of options to achieve
this goal. These options may include additional conduit financing or the sale of
credit card receivables to third parties. If we do not eliminate federally
insured deposits, or the risk thereof, by September 30, 2003, the OCC could
pursue various enforcement options.
On August 5, 2003, we received notification from the Securities and
Exchange Commission that we are the subject of a formal, nonpublic
investigation. We believe that this investigation relates primarily to the
Company's treatment of loan loss allowances in 2001 and subsequent years, the
Company's 2001 credit line increase program and other related matters.
The SEC specifically advised us that this is a fact-finding inquiry and
that it has not reached any conclusions related to this matter. We are
responding fully to the SEC in its investigation.
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which are subject to the "safe harbor" created by those sections.
Forward-looking statements include, without limitation: expressions of the
"belief," "anticipation," "intent," or "expectations" of management; statements
and information as to our strategies and objectives; return on equity; changes
in our managed loan portfolio; net interest margins; funding costs; liquidity;
cash flow; operating costs and marketing expenses; delinquencies and charge-offs
and industry comparisons or projections; statements as to industry trends or
future results of operations of the Company and its subsidiaries; and other
statements that are not historical fact. Forward-looking statements may be
identified by the use of terminology such as "may," "will," "believes," "does
not believe," "no reason to believe," "expects," "plans," "intends,"
"estimates," "anticipated," or "anticipates" and similar expressions, as they
relate to the Company or our management. Forward-looking statements are based on
certain assumptions by management and are subject to risks and uncertainties
that could cause actual results to differ materially from those in the
forward-looking statements.
53
These risks and uncertainties include, but are not limited to, our high
liquidity requirement; our higher delinquency rate, credit loss rates and
charge-off rates of our "Credit card loans;" the higher charge-off and
bankruptcy rates of the Company's target market of moderate-income consumers;
the success and impact of our existing or modified strategic initiatives; the
effect of the restatement of the Company's financial statements discussed
herein, risks associated with Direct Merchants Bank's ability to comply with its
agreement with regulators regarding the safety and soundness of its operations;
interest rate risks; risks associated with acquired portfolios; dependence on
the securitization markets and other funding sources to fund our business,
including the refinancing of existing indebtedness; the effects of the
previously announced SEC investigation, government policy and regulation,
whether of general applicability or specific to us, including restrictions
and/or limitations relating to our minimum capital requirements, reserving
methodologies, dividend policies and payments, growth, and/or underwriting
criteria; reduced funding availability and increased funding costs; privacy laws
that could result in lower revenue generated from fewer marketing campaigns
and/or penalties for non-compliance; and general economic conditions that can
have a negative impact on the performance of loans and marketing of credit
protection and other enhancement services.
These and other risks and uncertainties are discussed herein and in the
Original 10-Q in "Legal Proceedings" (page 48 of the Original 10-Q),
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" (pages 32-56 hereof) and "Quantitative and Qualitative Disclosures
About Market Risk" (pages 46-47 of the Original 10-Q). Although we have
attempted to list comprehensively the major risks and uncertainties, other
factors may in the future prove to be important in causing actual results to
differ materially from those contained in any forward-looking statement. Readers
are cautioned not to place undue reliance on any forward-looking statement,
which speaks only as of the date thereof. We undertake no obligation to update
any forward-looking statements, whether as a result of new information, future
events or otherwise.
SELECTED OPERATING DATA - MANAGED BASIS
In addition to analyzing the Company's performance on an owned basis,
we analyze the Company's financial performance on a managed loan portfolio
basis. On a managed basis, the balance sheets and income statements include
other investors' interests in securitized loans that are not assets of the
Company, thereby reversing the effects of sale accounting under SFAS No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities." We believe this information is meaningful to the reader of the
financial statements. We service the receivables that have been securitized and
sold and own the right to the cash flows from those receivables sold in excess
of amounts owed to security holders.
The following information is not in conformity with accounting
principles generally accepted in the United States of America, however, we
believe the information is relevant to understanding the overall financial
condition and results of operations of the Company.
54
TABLE 9: MANAGED LOAN PORTFOLIO
(Dollars in thousands) JUNE 30, % OF DECEMBER 31, % OF JUNE 30, % OF
2003 TOTAL 2002 TOTAL 2002 TOTAL
------ ----- ---- ----- ---- -----
PERIOD-END BALANCES:
Credit card loans $ 632,913 $ 846,417 $ 1,317,238
Receivables held in the Metris
Master Trust 9,483,652 10,573,769 10,477,057
------------------ ------------------- -----------------
Managed $ 10,116,565 $ 11,420,186 $ 11,794,295
================== =================== =================
Loans contractually delinquent:
Credit card loans 48,266 7.6% 7,876 0.9% 148,903 11.3%
Receivables held in the Metris
Master Trust 1,084,241 11.4% 1,252,073 11.8% 1,047,236 10.0%
------------------ ------------------- -----------------
Managed $ 1,132,507 11.2% $ 1,259,949 11.0% $ 1,196,139 10.1%
================== =================== =================
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
2003 2002 2003 2002
---- ---- ---- ----
AVERAGE BALANCES:
Credit card loans $ 690,903 $ 1,737,626 $ 721,121 $ 2,115,683
Receivables held in the
Metris Master Trust 9,771,210 10,163,087 10,086,551 9,856,534
----------------- ----------------- ----------------- -----------------
Managed $ 10,462,113 $ 11,900,713 $ 10,807,672 $ 11,972,217
================= ================= ================= =================
NET CHARGE-OFFS:
Credit card loans $ 43,702 25.4% $ 85,099 19.6% $ 51,991 14.6% $ 168,777 16.1%
Receivables held in the
Metris Master Trust 454,914 18.7% 356,688 14.1% 942,431 18.8% 657,687 13.5%
----------------- ----------------- ----------------- -----------------
Managed $ 498,616 19.1% $ 441,787 14.9% $ 994,422 18.6% $ 826,464 13.9%
================= ================= ================= =================
The increase in the managed delinquency rates as of June 30, 2003 over
December 31, 2002 and June 30, 2002 reflects various factors, including
declining receivable balances, a deterioration in the economy and the impact of
our 2001 credit line increase program. The credit line increase program added
pressure to our customers due to increased average outstanding balances, which
require higher monthly payments. This, along with a deteriorating economy, has
made our collections efforts more difficult, resulting in higher delinquencies.
Total managed loans decreased $1.3 billion to $10.1 billion as of June
30, 2003, compared to $11.4 billion as of December 31, 2002. This was primarily
due to a reduction in credit lines, tighter underwriting standards implemented
in 2002 and lower new accounts. The amount of credit card receivables in debt
forbearance programs was $856.0 million or 8.5% of total managed loans as of
June 30, 2003, compared with $860.1 million or 7.5% of managed loans as of
December 31, 2002. All delinquent receivables in debt forbearance programs are
included in Table 6.
Managed net charge-offs increased $56.8 million and $168.0 million for
the three- and six-month periods ended June 30, 2003 compared to the same
periods in 2002 primarily due to the impact of the 2001 credit line increase
program and deterioration in the economy.
We charge-off bankrupt accounts 60 days following formal notification.
Charge-offs due to bankruptcies were $181.2 million, representing 34.5% of total
managed gross charge-offs for the three months ended June 30, 2003 and $133.2
million, representing 25.3% of total managed gross charge-offs for the three
months ended June 30, 2002. Charge-offs due to bankruptcies were $367.2 million,
representing 35.1% of total managed gross charge-offs for the six months ended
June 30, 2003 and $285.8 million, representing 32.8% of total managed gross
charge-offs for the six months ended June 30, 2002. In addition to those
bankrupt accounts that were charged-off, we received formal notification of
$89.7 million and $103.3 million of managed bankrupt accounts as of June 30,
2003 and 2002, respectively.
55
Net Interest Income
TABLE 10: ANALYSIS OF AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS AND RATES
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
---- ---- ---- ----
(Dollars in thousands)
Average interest-earning assets:
Owned $ 1,192,956 $ 2,243,490 $ 1,300,214 $ 2,519,213
Receivables held in the Metris
Master Trust 9,771,210 10,163,201 10,086,551 9,856,591
----------------- ----------------- ----------------- -----------------
Managed $ 10,964,166 $ 12,406,691 $ 11,386,765 $ 12,375,804
================= ================= ================= =================
Net interest income:
Owned $ 12,717 $ 41,838 $ 25,537 $ 99,516
Receivables held in the Metris
Master Trust 378,324 387,036 786,751 767,631
----------------- ----------------- ----------------- -----------------
Managed $ 391,041 $ 428,874 $ 812,288 $ 867,147
================= ================= ================= ==================
Net interest margin (1):
Owned 4.3% 7.5% 4.0% 8.0%
Retained interests and
investors' interests in
loans securitized 15.5% 15.3% 15.7% 15.7%
Managed 14.3% 13.9% 14.4% 14.1%
(1) We compute net interest margin by dividing annualized net interest
income by average total interest-earning assets.
Managed net interest income decreased $37.8 million and $54.9 million
for the three- and six-month periods ended June 30, 2003, compared to the same
periods in 2002. Net interest income consists primarily of interest earned on
our credit card loans less interest expense on borrowing to fund the loans. The
decrease is primarily due to a $1.4 billion and $989.0 million decrease in
managed average interest-earning assets, for the three- and six-month periods
ended June 30, 2003, compared to the same periods in 2003.
ITEM 4 CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company's
management, including the Chairman and Chief Executive Officer ("CEO") and the
Chief Financial Officer ("CFO"), we evaluated the effectiveness of the design
and operation of the Company's disclosure controls and procedures (as defined in
Rule 13a-14(c) or 15d-14(c) under the Exchange Act). Based on that evaluation,
the Company's management, including the CEO and CFO, have concluded that our
disclosure controls and procedures, as of June 30, 2003, were not effective in
ensuring that information required to be disclosed in the reports we file under
the Securities Exchange Act of 1934, as amended ("Exchange Act") are recorded,
processed, summarized and reported within the time periods specified in SEC
rules and forms.
On November 17, 2003, our external auditors, KPMG LLP, issued a
material weakness report noting a material weakness in our policies and
procedures for estimating the fair value of our "Retained interests in loans
securitized" and associated revenue recognition. During the past several months
we have taken steps to revise our valuation model and related policies,
procedures and assumptions to address the issues in the material weakness
report. During the period, the Company also identified and changed its
accounting policies to conform with accounting principles generally accepted in
the United States of America associated with the accounting for securitization
transaction costs, credit card solicitation costs, and debt waiver revenue
associated with receivables sold to the Metris Master Trust (See Note 2 of the
unaudited consolidated financial statements on page 9 for further discussion).
56
The Company, as of February 24, 2004, has re-evaluated the
effectiveness of the design of the Company's disclosure controls and procedures
(as defined in Rule 13a-14(c) or 15d-14(c) under the Exchange Act). Based on
that evaluation, the Company's management, including the CEO and CFO, has
concluded that the design of our disclosure controls and procedures is effective
in ensuring that information required to be disclosed in the reports we file
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in SEC rules and forms. The Company has not yet
evaluated (tested) the operating effectiveness of such controls.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.1 Amended and Restated Senior Secured Credit
Agreement, dated as of June 18, 2003, among Metris
Companies Inc., the Lenders from time to time
parties thereto, Goldman Sachs Credit Partners L.P.
as Administrative Agent, and Deutsche Bank Trust
Companies America as Collateral Agent (Incorporated
by reference to Exhibit 10 to MCI's Current Report
on Form 8-K dated July 11, 2003 (File No.
[1-12351])).
10.2 First Amendment to the Amended and Restated Senior
Secured Credit Agreement and to credit Agreement
Reserve Securities Account Control Agreement, dated
as of July 29, 2003 among Metris Companies Inc.,
the Lenders from time to time parties to the Senior
Secured Credit Agreement, Goldman Sachs Credit
Partners L.P. as Administrative Agent, and Deutsche
Bank Trust Companies America As Collateral Agent.
(Previously filed as an exhibit to the Original
10-Q, which was filed with the Securities and
Exchange Commission on July 15, 2003).
10.3 Asset Purchase Agreement Dated July 29, 2003 by and
among Metris Companies Inc., Metris Direct, Inc.,
Metris Direct Services, Inc., Metris Travel
Services Inc., Metris Club Services, Inc., Metris
Warranty Services, Inc., and Metris Warranty
Services of Florida, Inc., CPP Holdings Limited and
CPP US Operations Group, LLC. (Previously filed as
an exhibit to the Original 10-Q, which was filed
with the Securities and Exchange Commission on July
15, 2003).
10.4 Transition Services Agreement dated July 29, 2003
by and among CPP Holdings Limited and CPP US
Operations Group, LLC and Metris Companies Inc. and
MES Insurance Agency, LLC. (Previously filed as an
exhibit to the Original 10-Q, which was filed with
the Securities and Exchange Commission on July 15,
2003).
10.5 Employee Leasing Agreement dated July 29, 2003, by
and between CPP Holdings Limited and CPP US
Operations Group, LLC and Metris Companies Inc.
(Previously filed as an exhibit to the Original
10-Q, which was filed with the Securities and
Exchange Commission on July 15, 2003).
11. Computation of Earnings Per Share
31.1 Certification of Principal Executive Officer
Pursuant to Rule 13a-14(a)/15d-14(a).
31.2 Certification of Principal Financial Officer
Pursuant to Rule 13a-14(a)/15d-14(a).
32.1 Certification of Principal Executive Officer
Pursuant to Section 1350 of Chapter 63 of Title 18
of the United States Code.
32.2 Certification of Principal Financial Officer
Pursuant to Section 1350 of Chapter 63 of Title 18
of the United States Code.
57
(b) Reports on Form 8-K:
On April 16, 2003, we filed a Current Report on Form 8-K to
report the submission of unaudited financial statements in a
press release dated April 16, 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
METRIS COMPANIES INC.
(Registrant)
Date: April 9, 2004 By: /s/John A. Witham
-------------
John A. Witham
Executive Vice President and Chief Financial Officer
(Principal Financial Officer and Authorized
Officer of Registrant)
59