UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2002
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________ to __________
Commission file number: 001-12351
METRIS COMPANIES INC.
(Exact name of registrant as specified in its charter)
Delaware 41-1849591
(State of Incorporation) (I.R.S. Employer Identification No.)
10900 Wayzata Boulevard, Minnetonka, Minnesota 55305-1534
(Address of principal executive offices)
(952) 525-5020
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No _____
-----
As of October 31, 2002, 57,623,488 shares of the registrant's common stock, par
value $.01 per share, were outstanding.
METRIS COMPANIES INC.
FORM 10-Q
TABLE OF CONTENTS
--------------------------------------------------------------------------------
September 30, 2002
Page
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets..........................3
Consolidated Statements of Income....................4
Consolidated Statements of Changes in
Stockholders' Equity........................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 ..........................................23
Item 3. Quantitative and Qualitative Disclosures
About Market Risk....................................42
Item 4. Controls and Procedures.....................................43
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.......................................44
Item 2. Changes in Securities...................................45
Item 3. Defaults Upon Senior Securities.........................45
Item 4. Submission of Matters to a Vote of Security Holders.....45
Item 5. Other Information.......................................45
Item 6. Exhibits and Reports on Form 8-K........................45
Signatures ........................................46
Part I. Financial Information
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands, except per-share data) (Unaudited)
September 30, December 31,
2002 2001
------------- ------------
Assets:
Cash and due from banks ...................................................... $ 93,662 $ 109,812
Federal funds sold ........................................................... 116,000 243,772
Short-term investments ....................................................... 881,017 134,502
----------- -----------
Cash and cash equivalents .................................................... 1,090,679 488,086
----------- -----------
Retained interests in loans securitized ...................................... 1,581,886 1,263,655
Less: Valuation allowance ................................................... 929,585 537,499
----------- -----------
Net retained interests in loans securitized .................................. 652,301 726,156
----------- -----------
Credit card loans ............................................................ 753,414 2,746,656
Less: Allowance for loan losses ............................................. 120,968 410,159
----------- -----------
Net credit card loans ........................................................ 632,446 2,336,497
----------- -----------
Property and equipment, net .................................................. 102,489 114,913
Purchased portfolio premium, net ............................................. 71,369 94,793
Other receivables due from credit card
securitizations, net ...................................................... 123,211 179,868
Other assets ................................................................. 228,536 288,373
----------- -----------
Total assets ............................................................ $ 2,901,031 $ 4,228,686
=========== ===========
Liabilities:
Deposits ..................................................................... $ 1,099,229 $ 2,058,008
Debt ......................................................................... 356,118 647,904
Accounts payable ............................................................. 82,036 83,475
Deferred income .............................................................. 178,540 215,031
Accrued expenses and other liabilities ....................................... 70,996 82,313
----------- -----------
Total liabilities ....................................................... 1,786,919 3,086,731
----------- -----------
Stockholders' Equity:
Convertible preferred stock - Series C,
par value $.01 per share; 10,000,000
shares authorized, 1,130,647 and
1,057,638 shares issued and outstanding,
respectively ............................................................ 421,166 393,970
Common stock, par value $.01 per share;
300,000,000 shares authorized, 64,627,008 and
64,224,878 shares issued, respectively .................................. 646 642
Paid-in capital .............................................................. 236,058 232,413
Unearned compensation ........................................................ (4,589) (4,980)
Treasury stock - 6,553,300 and 806,300
shares, respectively .................................................... (56,731) (13,014)
Retained earnings ............................................................ 517,562 532,924
----------- -----------
Total stockholders' equity .............................................. 1,114,112 1,141,955
----------- -----------
Total liabilities and stockholders'
equity .............................................................. $ 2,901,031 $ 4,228,686
=========== ===========
See accompanying Notes to Consolidated Financial Statements.
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Income
(In thousands, except earnings per-share data) (Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----
Interest Income:
Credit card loans and retained
interests in loans securitized .......................... $ 108,508 $ 175,330 $ 395,481 $ 507,554
Federal funds sold ........................................... 145 364 369 3,004
Other ........................................................ 3,838 3,513 7,401 10,585
--------- --------- --------- ---------
Total interest income ........................................ 112,491 179,207 403,251 521,143
Deposit interest expense ..................................... 14,453 31,427 56,441 100,986
Other interest expense ....................................... 8,799 10,721 25,931 33,310
--------- --------- --------- ---------
Total interest expense ....................................... 23,252 42,148 82,372 134,296
--------- --------- --------- ---------
Net Interest Income .......................................... 89,239 137,059 320,879 386,847
Provision for loan losses .................................... 138,197 116,513 445,378 318,924
--------- --------- --------- ---------
Net Interest (Expense) Income After
Provision for Loan Losses .......................... (48,958) 20,546 (124,499) 67,923
--------- --------- --------- ---------
Other Operating Income:
Net securitization and credit card
servicing income ........................................ 81,552 119,485 255,338 326,289
Credit card fees, interchange and
other credit card income ................................ 41,350 77,527 162,546 215,196
Enhancement services revenues ................................ 99,617 86,168 290,262 247,332
--------- --------- --------- ---------
222,519 283,180 708,146 788,817
--------- --------- --------- ---------
Other Operating Expense:
Credit card account and other product
solicitation and marketing expenses ..................... 48,824 42,354 145,569 134,600
Employee compensation ........................................ 51,875 61,105 162,788 171,956
Data processing services and
communications ......................................... 20,054 23,095 63,155 67,615
Enhancement services claims expense .......................... 13,146 10,506 40,270 25,435
Credit card fraud losses ..................................... 1,981 2,575 7,162 7,426
Purchased portfolio premium
amortization ............................................ 7,232 7,132 23,430 22,378
Other ........................................................ 32,624 42,609 117,274 120,119
--------- --------- --------- ---------
175,736 189,376 559,648 549,529
--------- --------- --------- ---------
(Loss) Income Before Income Taxes and
Cumulative Effect of Accounting
Change .................................................. (2,175) 114,350 23,999 307,211
Income taxes ................................................. (848) 43,614 9,360 117,662
--------- --------- --------- ---------
(Loss) Income Before Cumulative Effect
of Accounting Change ................................... (1,327) 70,736 14,639 189,549
Cumulative effect of accounting change
(net of income taxes of $9,000) ........................ -- -- -- 14,499
--------- --------- --------- ---------
Net (Loss) Income ............................................ (1,327) 70,736 14,639 175,050
Convertible preferred stock
dividends-Series C ..................................... 9,605 8,788 28,187 25,784
--------- --------- --------- ---------
Net (Loss) Income Applicable to Common
Stockholders ........................................... $ (10,932) $ 61,948 $ (13,548) $ 149,266
========= ========= ========= =========
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----
(Loss) earnings per share:
Basic-(loss) income before
cumulative effect of accounting
change ................................................. $ (0.19) $ 0.72 $ (0.22) $ 1.94
Basic-cumulative effect of
accounting change ...................................... -- -- -- (0.15)
Basic-net (loss) income .................................... (0.19) 0.72 (0.22) 1.79
Diluted-(loss) income before
cumulative effect of accounting
change ................................................. (0.19) 0.70 (0.22) 1.90
Diluted-cumulative effect of
accounting change ...................................... -- -- -- (0.15)
Diluted-net (loss) income .................................. (0.19) 0.70 (0.22) 1.75
Shares used to compute earnings per
share:
Basic ...................................................... 58,311 98,846 60,653 97,731
Diluted .................................................... 58,311 101,026 60,653 99,808
Dividends declared per common share ............................. $ 0.010 $ 0.010 $ 0.030 $ 0.030
See accompanying Notes to Consolidated Financial Statements.
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
(In thousands) (Unaudited)
Total
Number of Shares Preferred Common Paid-in Unearned Treasury Retained Stockholders'
Preferred Common Stock Stock Capital Compensation Stock Earnings Equity
----------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2000 .. 968 62,243 $ 360,421 $ 622 $ 198,077 $ -- $ -- $ 324,433 $ 883,553
Net income ............... -- -- -- -- -- -- -- 175,050 175,050
Cash dividends ........... -- -- -- -- -- -- -- (2,798) (2,798)
Preferred dividends in
kind - Series C ...... 66 -- 24,880 -- -- -- -- (24,880) --
Issuance of common stock
under employee
benefit plans ........ -- 1,411 -- 14 26,115 -- -- -- 26,129
Deferred compensation
obligations .......... -- 422 -- 5 5,429 (7,127) -- -- (1,693)
Amortization of
restricted stock ..... -- -- -- -- -- 2,704 -- -- 2,704
-------- -------- --------- -------- --------- -------- --------- --------- -----------
BALANCE AT SEPTEMBER 30, 2001 . 1,034 64,076 $ 385,301 $ 641 $ 229,621 $ (4,423) $ -- $ 471,805 $ 1,082,945
======== ======== ========= ======== ========= ======== ========= ========= ===========
BALANCE AT DECEMBER 31, 2001 .. 1,058 63,419 $ 393,970 $ 642 $ 232,413 $ (4,980) $ (13,014) $ 532,924 $ 1,141,955
Net income ............... -- -- -- -- -- -- -- 14,639 14,639
Cash dividends ........... -- -- -- -- -- -- -- (2,805) (2,805)
Common stock repurchased -- (5,747) -- -- -- -- (43,717) -- (43,717)
Preferred dividends in
kind - Series C ...... 73 -- 27,196 -- -- -- -- (27,196) --
Issuance of common stock
under employee
benefit plans ........ -- 326 -- 3 2,678 -- -- -- 2,681
Deferred compensation
obligations .......... -- 76 -- 1 967 (968) -- -- --
Amortization of
restricted stock ..... -- -- -- -- -- 1,359 -- -- 1,359
-------- -------- --------- -------- --------- -------- --------- --------- -----------
BALANCE AT SEPTEMBER 30, 2002 . 1,131 58,074 $ 421,166 $ 646 $ 236,058 $ (4,589) $ (56,731) $ 517,562 $ 1,114,112
======== ======== ========= ======== ========= ======== ========= ========= ===========
See accompanying Notes to Consolidated Financial Statements.
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands) (Unaudited)
Nine Months Ended
September 30,
2002 2001
----------- -----------
Operating Activities:
Net income .................................................................. $ 14,639 $ 175,050
Adjustments to reconcile net income to net cash
provided by operating activities:
Cumulative effect of accounting change ................................. -- 14,499
Depreciation and amortization .......................................... 78,775 72,313
Provision for loan losses .............................................. 445,378 318,924
Retained interests valuation income .................................... (89,300) (40,966)
Loss on derivative financial instruments ............................... 16,835 3,968
Changes in operating assets and liabilities, net:
Other receivables due from credit card
securitizations ............................................... 39,822 (179)
Accounts payable and accrued expenses .............................. (12,756) 50,871
Deferred income .................................................... (36,491) (33,812)
Other .............................................................. 23,876 33,567
----------- -----------
Net cash provided by operating activities ................................... 480,778 594,235
----------- -----------
Investing Activities:
Net proceeds from sales and repayments of
securitized loans ...................................................... 163,155 791,794
Net loans collected (originated) ............................................ 1,258,673 (1,474,079)
Credit card portfolio acquisitions .......................................... -- (157,640)
Additions to property and equipment ......................................... (5,607) (6,506)
----------- -----------
Net cash provided by (used in) investing
activities ............................................................. 1,416,221 (846,431)
----------- -----------
Financing Activities:
(Decrease) increase in debt ................................................. (291,786) 95,405
(Decrease) increase in deposits ............................................. (958,779) 29,339
Cash dividends paid ......................................................... (2,805) (2,798)
Issuance of common stock .................................................... 2,681 24,436
Repurchase of common stock .................................................. (43,717) --
----------- -----------
Net cash (used in) provided by financing
activities ............................................................. (1,294,406) 146,382
----------- -----------
Net increase (decrease) in cash and cash equivalents ........................ 602,593 (105,814)
Cash and cash equivalents at beginning of period ............................ 488,086 521,440
----------- -----------
Cash and cash equivalents at end of period .................................. $ 1,090,679 $ 415,626
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid (received) during the period for:
Interest ............................................................... $ 87,025 $ 129,220
Income taxes ........................................................... (15,551) 25,801
Tax benefit from employee stock option
exercises .............................................................. 174 8,689
See accompanying Notes to Consolidated Financial Statements.
METRIS COMPANIES INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except as noted) (Unaudited)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Metris
Companies Inc. ("MCI") and its subsidiaries, including Direct Merchants Credit
Card Bank, N.A. ("Direct Merchants Bank"), which may be referred to as "we,"
"us," "our" and the "Company." We are an information-based direct marketer of
consumer lending products and enhancement services.
We have eliminated all significant intercompany balances and transactions
in consolidation. We have reclassified certain prior-period amounts to conform
with the current period's presentation.
Interim Financial Statements
We have prepared the unaudited interim consolidated financial statements
and related unaudited financial information in the footnotes in accordance with
accounting principles generally accepted in the United States of America and the
rules and regulations of the Securities and Exchange Commission ("SEC") for
interim financial statements. These interim financial statements reflect all
adjustments consisting of normal recurring accruals which, in the opinion of
management, are necessary to present fairly our consolidated financial position
and the results of our operations and our cash flows for the interim periods.
You should read these consolidated financial statements in conjunction with the
financial statements and the notes thereto contained in our Annual Report on
Form 10-K/A for the fiscal year ended December 31, 2001. The nature of our
business is such that the results of any interim period may not be indicative of
the results to be expected for the entire year.
Pervasiveness of Estimates
We have prepared the consolidated financial statements in accordance with
accounting principles generally accepted in the United States of America, which
require us to make estimates and assumptions that affect the reported amounts in
the consolidated financial statements and accompanying notes. The most
significant and subjective of these estimates is our determination of the
adequacy of the allowance for loan losses and our determination of the fair
value of retained interests from assets securitized. The significant factors
susceptible to future change that have an impact on these estimates include
default rates, net interest spreads, liquidity and overall economic conditions.
As a result, the actual losses in our loan portfolio and the fair value of our
retained interests as of September 30, 2002 and December 31, 2001 could
materially differ from these estimates.
NOTE 2 - EARNINGS PER SHARE
The following table presents the computation of basic and diluted weighted-
average shares used in the per-share calculations:
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
(In thousands)
(Loss) income before cumulative effect
of accounting change ................................. $ (1,327) $ 70,736 $ 14,639 $ 189,549
Preferred dividends - Series C ............................ 9,605 8,788 28,187 25,784
--------- --------- --------- ---------
Net (loss) income applicable to common
stockholders before cumulative effect
of accounting change ................................. (10,932) 61,948 (13,548) 163,765
Cumulative effect of accounting change,
net .................................................. -- -- -- 14,499
--------- --------- --------- ---------
Net (loss) income applicable to common
stockholders ......................................... $ (10,932) $ 61,948 $ (13,548) $ 149,266
========= ========= ========= =========
Weighted-average common shares
outstanding .......................................... 58,311 63,588 60,653 62,898
Adjustments for dilutive securities:
Assumed conversion of convertible
preferred stock (1) .................................. -- 35,258 -- 34,833
--------- --------- --------- ---------
Basic common shares ....................................... 58,311 98,846 60,653 97,731
Assumed exercise of outstanding stock
options (1) .......................................... -- 2,180 -- 2,077
--------- --------- --------- ---------
Diluted common shares ..................................... 58,311 101,026 60,653 99,808
========= ========= ========= =========
(1) In accordance with SFAS 128, the earnings per share calculations for the
three- and nine-month periods ended September 30, 2002 exclude the assumed
conversion of the convertible preferred stock and the outstanding stock options
as they are anti-dilutive.
NOTE 3 - ACCOUNTING CHANGES
On January 1, 2001, we adopted Statement of Financial Accounting Standards
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities," which establishes accounting and reporting standards for derivative
instruments. SFAS 133 requires enterprises to recognize all derivatives as
either assets or liabilities in the statement of financial position and to
measure those instruments at fair market value. As a result of the adoption of
SFAS 133, we marked our derivatives to market value and recognized a one-time,
non-cash, after-tax charge to earnings of $14.5 million. This one-time charge is
reflected as a "Cumulative effect of accounting change" in the consolidated
statements of income for the nine months ended September 30, 2001.
On January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible
Assets," which establishes accounting and reporting standards for goodwill and
other intangible assets. It requires enterprises to test these assets for
impairment upon adoption of SFAS 142 as well as on an annual basis, and reduce
the carrying amount of these assets if they are found to be impaired. Goodwill
and other intangible assets with an indefinite useful life will no longer be
amortized. Other intangible assets with an estimable useful life will continue
to be amortized over their useful lives. The adoption of the new standard did
not have a material impact on our financial statements.
On January 1, 2002, we adopted SFAS No. 144, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which
supersedes FASB Statement No. 121, and provides a single accounting model for
long-lived assets to be disposed of. The adoption of the new standard did not
have a material impact on our financial statements. In April 2002, the FASB
issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 62, Amendment
of FASB Statement No. 13, and Technical Corrections." SFAS 145 will require
gains and losses on extinguishments of debt to be classified as income or loss
from continuing operations rather than as extraordinary items as previously
required under SFAS 4. SFAS 145 also amends SFAS 13 to require certain
modifications to capital leases be treated as a sale-leaseback and modifies the
accounting for sub-leases when the original lessee remains a secondary obligor
or guarantor. Accordingly, most gains or losses from extinguishments of debt for
fiscal years beginning after May 15, 2002 shall not be reported as
extraordinary. Upon adoption, any gain or loss on extinguishment of debt
previously classified as an extraordinary item in prior periods presented must
be reclassified to conform with the provisions of SFAS 145. SFAS 145's amendment
and technical correction to SFAS 13 is effective for all transactions occurring
after May 15, 2002. We do not expect a material impact on our financial
statements upon adoption of SFAS 145.
In July 2002, FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities." The statement addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." SFAS 146 requires that a liability for a cost associated
with an exit or disposal activity be recognized when a liability is incurred.
Under Issue 94-3, a liability for an exit cost as generally defined in Issue
94-3 was recognized at the date of an entity's commitment to an exit plan. The
provisions of this Statement are effective for exit or disposal activities that
are initiated after December 31, 2002. We do not expect a material impact on our
financial statements upon adoption of SFAS 146.
NOTE 4 - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----
Balance at beginning of period . $ 275,279 $ 258,057 $ 410,159 $ 123,123
Allowance related to assets
acquired, net ................ -- 6,063 -- 6,063
Allowance transferred to the
retained interests valuation
allowance .................. (208,102) (37,059) (481,386) 3,733
Provision for loan losses ...... 138,197 116,513 445,378 318,924
Loans charged off (1) .......... (91,509) (72,602) (271,995) (190,231)
Recoveries ..................... 7,103 12,397 18,812 21,757
--------- --------- --------- ---------
Net loans charged off .......... (84,406) (60,205) (253,183) (168,474)
--------- --------- --------- ---------
Balance at end of period ....... $ 120,968 $ 283,369 $ 120,968 $ 283,369
========= ========= ========= =========
(1) Loans charged off for the three-month and nine-month periods ended September
30, 2002 include $41.5 million related to the sale of $47 million of
receivables.
As of September 30, 2002, we had $2.9 million in credit card loans
classified as non-accrual, compared to $1.3 million in credit card loans
classified as non-accrual as of December 31, 2001. As of September 30, 2001, we
had no credit card loans classified as non-accrual. Credit card loans
contractually 90 or more days past due and still accruing interest amounted to
$13.2 million as of September 30, 2002, $122.3 million as of December 31, 2001,
and $120.7 million as of September 30, 2001.
During the three- and nine-month periods ended September 30, 2002, we
transferred $208.1 million and $481.4 million of allowance for loan losses,
respectively, to the valuation allowance for retained interests in loans
securitized. This transfer was primarily due to the sale of approximately $2.3
billion of receivables from Direct Merchants Bank to the Metris Master Trust
("Master Trust") during the nine months ended September 30, 2002, causing a
decrease in the credit card portfolio and growth in gross retained interests.
During the three-month period ended September 30, 2001, we transferred $37.1
million of allowance for loan losses to the valuation allowance for retained
interests in loans securitized. This transfer was due to growth in gross
retained interests. During the nine month period ended September 30, 2001, we
transferred $3.7 million of valuation allowance for retained interests in loans
securitized to allowance for loan losses. This transfer was primarily due to the
maturity of a bank conduit that was accounted for as a sale under SFAS 140 in
the second quarter of 2001 partially offset by the sale of receivables from
Direct Merchants Bank to the Master Trust.
NOTE 5 - RETAINED INTERESTS IN LOANS SECURITIZED
Activity in retained interests is as follows:
September 30, December 31,
2002 Change 2001
---- ------ ----
Gross retained interests $ 1,581,886 $ 318,231 $ 1,263,655
Valuation allowance .... (929,585) (392,086) (537,499)
----------- ----------- -----------
Net retained interests . $ 652,301 $ (73,855) $ 726,156
=========== =========== ===========
September 30, December 31,
2001 Change 2000
---- ------ ----
Gross retained interests $ 1,228,154 $ (795,527) $ 2,023,681
Valuation allowance .... (596,153) 44,699 (640,852)
----------- ----------- -----------
Net retained interests . $ 632,001 $ (750,828) $ 1,382,829
=========== =========== ===========
Activity in the valuation allowance on retained interests in loans
securitized is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----
Balance at beginning of period . $ 744,205 $ 568,084 $ 537,499 $ 640,852
Transfers from the allowance for
loan losses .................. 208,102 37,059 481,386 (3,733)
Retained interests valuation
income ....................... (22,722) (8,990) (89,300) (40,966)
--------- --------- --------- ---------
Balance at end of period ....... $ 929,585 $ 596,153 $ 929,585 $ 596,153
========= ========= ========= =========
Gross retained interests in loans securitized increased $318.2 million to
$1.6 billion as of September 30, 2002, compared to $1.3 billion as of December
31, 2001. The increase is due to the sale of approximately $2.3 billion of
receivables from Direct Merchants Bank to the Master Trust during the nine
months ended September 30, 2002. The $795.5 million decrease in gross retained
interests during the nine months ended September 30, 2001 was due primarily to
the maturity of a securitization that was accounted for as a sale under SFAS
140. As a result, approximately $855 million of receivables that were classified
as retained interests in loans securitized as of December 31, 2000 were
classified as credit card loans as of September 30, 2001. During the nine months
ended September 30, 2002 the valuation allowance increased by $392.1 million due
primarily to the higher gross retained interests and narrowing excess spreads in
the Master Trust due to increasing default rates. The projected default rate
increased from 18% as of December 31, 2001 to 21% as of September 30, 2002. The
increase in the projected default rate is due to increased delinquencies in the
Master Trust caused by the overall deterioration in the economy and our 2001
credit line increase program which added pressure to some of our customers due
to increased average outstanding balances which require higher monthly payments.
The increase in the projected default rate accounted for an approximate $250
million increase in the valuation allowance. The $44.7 million decrease in the
valuation allowance during the nine months ended September 30, 2001 primarily
reflects lower gross retained interests.
NOTE 6 - SEGMENTS
We operate in two principal areas: consumer lending products and
enhancement services. Our consumer lending products are primarily unsecured
credit cards, including the Direct Merchants Bank MasterCard(R) and Visa(R). Our
credit card accountholders include consumers obtained from third-party lists and
other consumers for whom general credit bureau information is available.
We market our enhancement services, including (1) debt waiver protection
for unemployment, disability, and death; (2) membership programs such as card
registration, purchase protection and other club memberships; and (3)
third-party insurance, directly to our credit card accountholders and customers
of third parties. We currently administer our extended service plans sold
through a third-party retailer, and the customer pays the retailer directly. In
addition, we develop customized targeted mailing lists from information
contained in our databases for use by unaffiliated companies in their own
product solicitation efforts that do not directly compete with our efforts.
We have presented the segment information reported below on a managed
basis. We use this basis to review segment performance and to make operating
decisions. In doing so, the income statement and balance sheet are adjusted to
reverse the effects of securitizations. Presentation on a managed basis is not
in conformity with accounting principles generally accepted in the United States
of America. The adjustments columns in the segment table include adjustments to
present the information on an owned basis as reported in the financial
statements of this Quarterly Report.
We do not allocate the expenses, assets and liabilities attributable to
corporate functions to the operating segments, such as employee compensation,
data processing services and communications, third-party servicing expenses, and
other expenses including occupancy, depreciation and amortization, professional
fees, and other general and administrative expenses. We do not allocate capital
expenditures for leasehold improvements, capitalized software and furniture and
equipment to operating segments. There were no material operating assets located
outside of the United States for the periods presented.
Our enhancement services operating segment pays a fee to our consumer
lending products segment for successful marketing efforts to the consumer
lending products segment's credit card accountholders at a rate similar to those
paid to our other third parties. Our enhancement services segment reports
interest income and our consumer lending products segment reports interest
expense at our weighted-average borrowing rate for the excess cash flow
generated by the enhancement services segment that is used by the consumer
lending products segment to fund the growth of credit card accountholder
balances.
Three Months Ended September 30, 2002
-------------------------------------
Consumer
Lending Enhancement Securitization Other
Products Services Adjustments(a) Adjustments(b) Consolidated
-------- -------- -------------- -------------- ------------
Interest income . $ 534,340 $ 65 $ (421,849) $ (65) $ 112,491
Interest
expense ..... 80,069 -- (56,752) (65) 23,252
----------- ----------- ----------- ----------- -----------
Net interest
income ...... 454,271 65 (365,097) -- 89,239
Other revenue ... 139,539 99,617 (16,637) -- 222,519
Total revenue ... 593,810 99,682 (381,734) -- 311,758
Income before
income taxes . 51,744(c) 57,867(c) -- (111,786) (2,175)
Total assets .... $10,819,140 $ 135,201 $(9,243,689) $ 1,190,379(d) $ 2,901,031
Three Months Ended September 30, 2001
-------------------------------------
Consumer
Lending Enhancement Securitization Other
Products Services Adjustments(a) Adjustments(b) Consolidated
-------- -------- -------------- -------------- ------------
Interest income ... $ 514,818 $ 2,970 $ (335,611) $ (2,970) $ 179,207
Interest expense .. 122,539 -- (77,421) (2,970) 42,148
----------- ----------- ----------- ----------- -----------
Net interest
income ....... 392,279 2,970 (258,190) -- 137,059
Other revenue .... 155,875 86,168 41,137 -- 283,180
Total revenue .... 548,154 89,138 (217,053) -- 420,239
Income before
income taxes . 191,515(c) 56,776(c) -- (133,941) 114,350
Total assets ..... $10,583,562 $ 145,857 $(7,162,158) $ 509,959(d) $ 4,077,220
Nine Months Ended September 30, 2002
------------------------------------
Consumer
Lending Enhancement Securitization Other
Products Services Adjustments(a) Adjustments(b) Consolidated
-------- -------- -------------- -------------- ------------
Interest income ... $ 1,570,839 $ 2,442 $(1,167,588) $ (2,442) $ 403,251
Interest expense .. 251,797 -- (166,983) (2,442) 82,372
----------- ----------- ----------- ----------- -----------
Net interest
income ........ 1,319,042 2,442 (1,000,605) -- 320,879
Other revenue ..... 389,619 290,262 28,265 -- 708,146
Total revenue ..... 1,708,661 292,704 (972,340) -- 1,029,025
Income before
income taxes ... 213,295(c) 177,351(c) -- (366,647) 23,999
Total assets ...... $10,819,140 $ 135,201 $(9,243,689) $ 1,190,379(d) $ 2,901,031
Nine Months Ended September 30, 2001
------------------------------------
Consumer
Lending Enhancement Securitization Other
Products Services Adjustments(a) Adjustments(b) Consolidated
-------- -------- -------------- -------------- ------------
Interest income ........ $ 1,463,178 $ 9,792 $ (942,035) $ (9,792) $ 521,143
Interest expense ....... 395,830 -- (251,742) (9,792) 134,296
----------- ----------- ----------- ----------- -----------
Net interest
income ............. 1,067,348 9,792 (690,293) -- 386,847
Other revenue .......... 441,486 247,332 99,999 -- 788,817
Total revenue .......... 1,508,834 257,124 (590,294) -- 1,175,664
Income before
income taxes and
cumulative effect of
accounting change .. 522,766(c) 166,513(c) -- (382,068) 307,211
Total assets ........... $10,583,562 $ 145,857 $(7,162,158) $ 509,959(d) $ 4,077,220
(a) This column reflects adjustments to the Company's internal financial
statements, which are prepared on a managed basis, to eliminate investors'
interests in securitized loans.
(b) The other adjustments column includes: intercompany eliminations and amounts
not allocated to segments.
(c) Income before income taxes (and cumulative effect of accounting change)
includes intercompany commissions paid by the enhancement services segment to
the consumer lending products segment for successful marketing efforts to
consumer lending products credit card accountholders of $4.4 million for the
three months ended September 30, 2002, $2.6 million for the three months ended
September 30, 2001, $10.7 million for the nine months ended September 30, 2002
and $8.8 million for the nine months ended September 30, 2001.
(d) Total assets include the assets attributable to corporate functions not
allocated to operating segments and the removal of investors interests in
securitized loans to present total assets on an owned basis.
NOTE 7 - STOCKHOLDERS' EQUITY
On February 6, 2001, the Board of Directors authorized a stock repurchase
program of up to $200 million of our outstanding common stock over a period
ending December 31, 2002. For the nine months ended September 30, 2002,
5,747,000 common shares had been repurchased under the program for $43.7
million. Subsequent to September 30, 2002, we repurchased an additional 502,000
common shares for $1.6 million. The amount of common shares we can repurchase in
a calendar year is limited under various debt agreements. In 2002, the Company
may repurchase up to an additional $49 million of common shares.
The purpose of the Metris Companies Inc. stock repurchase program is to
purchase outstanding stock for later reissuance under its stock option and
employee benefit plans or potential acquisition opportunities. During the first
nine months of 2002 and 2001, the Company issued 326,000 and 1,411,000 shares of
common stock, respectively, under its employee benefit plans for net cash
proceeds of $2.7 million and $26.1 million, respectively.
NOTE 8 - SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS
We have various indirect subsidiaries which do not guarantee Company debt.
We have presented the following condensed consolidating financial statements of
the Company, the guarantor subsidiaries and the non-guarantor subsidiaries to
comply with SEC reporting requirements. We have not presented separate financial
statements of the guarantor and non-guarantor subsidiaries because management
has determined that the subsidiaries' financial statements would not be material
to investors.
METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
September 30, 2002
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Assets:
Cash and cash equivalents ................ $ 197,611 $ 1,982 $ 891,086 $ -- $ 1,090,679
Net retained interests in loans
securitized ........................... -- -- 652,301 -- 652,301
Net credit card loans .................... 2,121 -- 630,325 -- 632,446
Property and equipment, net .............. -- 68,656 33,833 -- 102,489
Purchased portfolio premium, net
248 -- 71,121 -- 71,369
Other receivables due from credit card
securitizations, net .................. 7 -- 123,204 -- 123,211
Other assets ............................. (14,613) 16,364 235,925 (9,140) 228,536
Investment in subsidiaries ............... 1,930,861 1,807,568 -- (3,738,429) --
----------- ----------- ----------- ----------- -----------
Total assets ............................. $ 2,116,235 $ 1,894,570 $ 2,637,795 $(3,747,569) $ 2,901,031
=========== =========== =========== =========== ===========
Liabilities:
Deposits ................................. $ (1,000) $ -- $ 1,100,229 $ -- $ 1,099,229
Debt ..................................... 346,597 -- 9,521 -- 356,118
Accounts payable ......................... 4,729 31,242 53,426 (7,361) 82,036
Deferred income .......................... 36 19,026 162,213 (2,735) 178,540
Accrued expenses and other
liabilities .......................... 651,761 (86,559) (495,162) 956 70,996
----------- ----------- ----------- ----------- -----------
Total liabilities ........................ 1,002,123 (36,291) 830,227 (9,140) 1,786,919
----------- ----------- ----------- ----------- -----------
Total stockholders' equity ............... 1,114,112 1,930,861 1,807,568 (3,738,429) 1,114,112
----------- ----------- ----------- ----------- -----------
Total liabilities and
stockholders' equity ................ $ 2,116,235 $ 1,894,570 $ 2,637,795 $(3,747,569) $ 2,901,031
=========== =========== =========== =========== ===========
METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
December 31, 2001
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Assets:
Cash and cash equivalents ................. $ 17,613 $ 1,505 $ 468,968 $ -- $ 488,086
Net retained interests in
loans securitized ...................... -- -- 726,156 -- 726,156
Credit card loans, net of
allowance .............................. 1,646 -- 2,334,851 -- 2,336,497
Property and equipment, net ............... -- 78,425 36,488 -- 114,913
Purchased portfolio premium ............... 248 -- 94,545 -- 94,793
Other receivables due from
credit card
securitizations, net ................... 34 644 179,190 -- 179,868
Other assets .............................. (21,776) 55,731 260,676 (6,258) 288,373
Investment in subsidiaries ................ 1,900,528 1,745,701 -- (3,646,229) --
----------- ----------- ----------- ----------- -----------
Total assets .............................. $ 1,898,293 $ 1,882,006 $ 4,100,874 $(3,652,487) $ 4,228,686
=========== =========== =========== =========== ===========
Liabilities:
Deposits .................................. $ (1,000) $ -- $ 2,059,008 $ -- $ 2,058,008
Debt ...................................... 345,924 171 301,809 -- 647,904
Accounts payable .......................... 3,070 15,461 68,073 (3,129) 83,475
Deferred income ........................... 3,270 30,615 184,275 (3,129) 215,031
Accrued expenses and other
liabilities ............................ 405,074 (64,769) (257,992) -- 82,313
----------- ----------- ----------- ----------- -----------
Total liabilities ......................... 756,338 (18,522) 2,355,173 (6,258) 3,086,731
----------- ----------- ----------- ----------- -----------
Total stockholders' equity ................ 1,141,955 1,900,528 1,745,701 (3,646,229) 1,141,955
----------- ----------- ----------- ----------- -----------
Total liabilities and
stockholders' equity ................... $ 1,898,293 $ 1,882,006 $ 4,100,874 $(3,652,487) $ 4,228,686
=========== =========== =========== =========== ===========
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Three Months Ended September 30, 2002
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Net Interest (Expense)
Income ................................. $ (10,526) $ 659 $ 99,106 $ -- $ 89,239
Provision for loan losses ................. 37 -- 133,535 4,625 138,197
--------- --------- --------- --------- ---------
Net Interest (Expense)
Income After Provision
for Loan Losses ........................ (10,563) 659 (34,429) (4,625) (48,958)
--------- --------- --------- --------- ---------
Other Operating Income:
Net securitization and
credit card servicing
income ................................. (2,903) -- 84,455 -- 81,552
Credit card fees,
interchange and other
credit card income ..................... 763 53,926 48,406 (61,745) 41,350
Enhancement services
revenues ............................... -- 8,208 91,409 -- 99,617
Intercompany allocations .................. 38 65,527 11,174 (76,739) --
--------- --------- --------- --------- ---------
(2,102) 127,661 235,444 (138,484) 222,519
--------- --------- --------- --------- ---------
Other Operating Expense:
Credit card account and
other product
solicitation and
marketing expenses ..................... 16 56,475 40,467 (48,134) 48,824
Employee compensation ..................... -- 46,278 5,597 -- 51,875
Data processing services
and communications ..................... 8 (24,642) 48,442 (3,754) 20,054
Enhancement services claims
expense ................................ -- 478 12,668 -- 13,146
Credit card fraud losses .................. 51 -- 1,930 -- 1,981
Purchased portfolio premium
amortization ............................. -- -- 7,925 (693) 7,232
Other ..................................... 38 26,890 6,899 (1,203) 32,624
Intercompany allocations .................. 16 25,554 51,169 (76,739) --
--------- --------- --------- --------- ---------
129 131,033 175,097 (130,523) 175,736
--------- --------- --------- --------- ---------
(Loss) Income Before Income Taxes and
Equity in Income of Subsidiaries ....... (12,794) (2,713) 25,918 (12,586) (2,175)
Income taxes .............................. (4,989) (1,058) 10,108 (4,909) (848)
Equity in income of
subsidiaries ........................... 6,478 8,133 -- (14,611) --
--------- --------- --------- --------- ---------
Net (Loss) Income ......................... $ (1,327) $ 6,478 $ 15,810 $ (22,288) $ (1,327)
========= ========= ========= ========= =========
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Three Months Ended September 30, 2001
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Net Interest Income
(Expense) .............................. $ 62,939 $ (1,962) $ 76,082 $ -- $ 137,059
Provision for loan losses ................. 874 -- 115,639 -- 116,513
--------- --------- --------- --------- ---------
Net Interest Expense After
Provision for Loan Losses .............. 62,065 (1,962) (39,557) -- 20,546
--------- --------- --------- --------- ---------
Other Operating Income:
Net securitization and
credit card servicing
income ................................. (3,774) -- 123,259 -- 119,485
Credit card fees,
interchange and other
credit card income ..................... 4,539 12,060 60,928 -- 77,527
Enhancement services
revenues ............................... -- 11,885 74,283 -- 86,168
Intercompany allocations .................. 11 121,492 (121,503) -- --
--------- --------- --------- --------- ---------
776 145,437 136,967 -- 283,180
--------- --------- --------- --------- ---------
Other Operating Expense:
Credit card account and
other product
solicitation and
marketing expenses ..................... -- (969) 43,323 -- 42,354
Employee compensation ..................... 356 54,023 6,726 -- 61,105
Data processing services
and communications ..................... -- (16,892) 39,987 -- 23,095
Enhancement services claims
expense ................................ -- 330 10,176 -- 10,506
Credit card fraud losses .................. 1 5 2,569 -- 2,575
Purchased portfolio premium
amortization ........................... -- -- 7,132 -- 7,132
Other ..................................... 37 39,784 2,788 -- 42,609
--------- --------- --------- --------- ---------
394 76,281 112,701 -- 189,376
--------- --------- --------- --------- ---------
Income (Loss) Before Income
Taxes and Equity in
Income of Subsidiaries ................. 62,447 67,194 (15,291) -- 114,350
Income taxes .............................. 23,918 27,653 (7,957) -- 43,614
Equity in income of
subsidiaries ........................... 32,207 (7,334) -- (24,873) --
--------- --------- --------- --------- ---------
Net Income (Loss) ...................... $ 70,736 $ 32,207 $ (7,334) $ (24,873) $ 70,736
========= ========= ========= ========= =========
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Nine Months Ended September 30, 2002
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Net Interest (Expense)
Income ............................. $ (19,025) $ (357) $ 340,261 $ -- $ 320,879
Provision for loan losses ............. (695) -- 391,448 54,625 445,378
--------- --------- --------- ---------- ---------
Net Interest (Expense)
Income After Provision
for Loan Losses .................... (18,330) (357) (51,187) (54,625) (124,499)
--------- --------- --------- ----------- ---------
Other Operating Income:
Net securitization and
credit card servicing
income ............................. (4,645) -- 259,983 -- 255,338
Credit card fees,
interchange and other
credit card income ................. 1,216 67,645 166,564 (72,879) 162,546
Enhancement services
revenues ........................... -- 27,034 263,228 -- 290,262
Intercompany allocations .............. 109 190,794 35,961 (226,864) --
--------- --------- --------- ---------- ----------
(3,320) 285,473 725,736 (299,743) 708,146
--------- --------- --------- ----------- ----------
Other Operating Expense:
Credit card account and
other product
solicitation and
marketing expenses ................. 16 63,729 130,012 (48,188) 145,569
Employee compensation ................. (1,101) 141,199 22,690 -- 162,788
Data processing services
and communications ................. 44 (68,013) 136,672 (5,548) 63,155
Enhancement services claims
expense ............................ -- 978 39,292 -- 40,270
Credit card fraud losses .............. 178 -- 6,984 -- 7,162
Purchased portfolio premium
amortization ......................... -- -- 25,855 (2,425) 23,430
Other ................................. (72) 101,499 25,239 (9,392) 117,274
Intercompany allocations .............. 62 67,142 159,660 (226,864) --
--------- --------- --------- ---------- ----------
(873) 306,534 546,404 (292,417) 559,648
--------- ---------- --------- ---------- ----------
(Loss) Income Before Income
Taxes and Equity in
Income of Subsidiaries ............. (20,777) (21,418) 128,145 (61,951) 23,999
Income taxes .......................... (8,103) (8,353) 49,977 (24,161) 9,360
Equity in income of
subsidiaries ....................... 27,313 40,378 -- (67,691) --
--------- --------- ---------- ---------- ----------
Net Income ............................ $ 14,639 $ 27,313 $ 78,168 $ (105,481) $ 14,639
========= ========= ========== =========== ==========
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Nine Months Ended September 30, 2001
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Net Interest Income
(Expense) .......................... $ 2,002 $ (5,554) $ 390,399 $ -- $ 386,847
Provision for loan losses ............. 2,091 -- 316,833 -- 318,924
--------- --------- --------- --------- -----------
Net Interest (Expense)
Income After Provision
for Loan Losses .................... (89) (5,554) 73,566 -- 67,923
--------- --------- --------- --------- -----------
Other Operating Income:
Net securitization and
credit card servicing
income ............................. 982 -- 325,307 -- 326,289
Credit card fees,
interchange and other
credit card income ................. 1,688 21,357 192,151 -- 215,196
Enhancement services
revenues ........................... -- 43,086 204,246 -- 247,332
Intercompany allocations .............. 11 121,492 (121,503) -- --
--------- --------- --------- --------- -----------
2,681 185,935 600,201 -- 788,817
--------- --------- --------- --------- -----------
Other Operating Expense:
Credit card account and
other product
solicitation and
marketing expenses ................. -- 9,515 125,085 -- 134,600
Employee compensation ................. 698 151,249 20,009 -- 171,956
Data processing services
and communications ................. 2 (69,824) 137,437 -- 67,615
Enhancement services claims
expense ............................ -- 820 24,615 -- 25,435
Credit card fraud losses .............. 1 5 7,420 -- 7,426
Purchased portfolio premium
amortization ......................... -- -- 22,378 -- 22,378
Other ................................. 127 84,071 35,921 -- 120,119
--------- --------- --------- --------- -----------
828 175,836 372,865 -- 549,529
--------- --------- --------- --------- -----------
Income Before Income Taxes,
Equity in Income of
Subsidiaries and
Cumulative Effect of
Accounting Change .................. 1,764 4,545 300,902 -- 307,211
Income taxes .......................... 676 1,743 115,243 -- 117,662
Equity in income of
subsidiaries ....................... 173,962 171,160 -- (345,122) --
--------- --------- -------- --------- ----------
Income Before Cumulative
Effect of Accounting
Change ............................. 175,050 173,962 185,659 (345,122) 189,549
Cumulative effect of
accounting change, net ............. -- -- 14,499 -- 14,499
--------- --------- --------- --------- ----------
Net Income ............................ $ 175,050 $ 173,962 $ 171,160 $(345,122) $ 175,050
========= ========= ========= ========= ==========
METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Nine Months Ended September 30, 2002
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Operating Activities:
Net cash provided by operating activities .... $ 253,279 $ 104,842 $ 211,303 $ (88,646) $ 480,778
----------- ----------- ----------- ----------- -----------
Investing Activities:
Net proceeds from sales and repayments of
securitized loans ......................... -- -- 163,155 -- 163,155
Net loans collected .......................... 220 -- 1,313,078 (54,625) 1,258,673
(Additions to) dispositions of property and
equipment ................................. -- (7,557) 1,950 -- (5,607)
Investment in subsidiaries ................... (30,333) (61,867) -- 92,200 --
----------- ----------- ----------- ----------- -----------
Net cash (used in) provided by investing
activities ................................ (30,113) (69,424) 1,478,183 37,575 1,416,221
----------- ----------- ----------- ----------- -----------
Financing Activities:
Net increase (decrease) in debt .............. 673 (171) (292,288) -- (291,786)
Net decrease in deposits ..................... -- -- (958,779) -- (958,779)
Cash dividends paid .......................... (2,805) -- -- -- (2,805)
Issuance of common stock ..................... 2,681 -- -- -- 2,681
Repurchase of common stock ................... (43,717) -- -- -- (43,717)
Capital contributions ........................ -- (34,770) (16,301) 51,071 --
----------- ----------- ----------- ----------- -----------
Net cash used in financing activities ........ (43,168) (34,941) (1,267,368) 51,071 (1,294,406)
----------- ----------- ----------- ----------- -----------
Net increase in cash and cash equivalents .... 179,998 477 422,118 -- 602,593
Cash and cash equivalents at beginning of
period .................................... 17,613 1,505 468,968 -- 488,086
----------- ----------- ----------- ----------- -----------
Cash and cash equivalents at end of period ... $ 197,611 $ 1,982 $ 891,086 $ -- $ 1,090,679
=========== =========== =========== =========== ===========
METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Nine Months Ended September 30, 2001
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
Operating Activities:
Net cash provided by operating activities ... $ 150,433 $ 174,266 $ 614,658 $ (345,122) $ 594,235
----------- ----------- ----------- ----------- -----------
Investing Activities:
Net proceeds from sales and repayments of
securitized loans ........................ 545 -- 791,249 -- 791,794
Net loans originated ........................ (3,948) -- (1,470,131) -- (1,474,079)
Credit card portfolio acquisition ........... -- -- (157,640) -- (157,640)
(Additions to) dispositions of property and
equipment ................................ -- (17,522) 11,016 -- (6,506)
Investment in subsidiaries .................. (227,107) (218,038) -- 445,145 --
----------- ----------- ----------- ----------- -----------
Net cash used in investing activities ....... (230,510) (235,560) (825,506) 445,145 (846,431)
----------- ----------- ----------- ----------- -----------
Financing Activities:
Net increase (decrease) in debt ............. 673 (6) 94,738 -- 95,405
Net increase in deposits .................... -- -- 29,339 -- 29,339
Cash dividends paid ......................... (2,798) -- -- -- (2,798)
Issuance of common stock .................... 24,436 -- -- -- 24,436
Capital contributions ....................... -- 53,145 46,878 (100,023) --
----------- ----------- ----------- ----------- -----------
Net cash provided by financing activities ... 22,311 53,139 170,955 (100,023) 146,382
----------- ----------- ----------- ----------- -----------
Net decrease in cash and cash equivalents ... (57,766) (8,155) (39,893) -- (105,814)
Cash and cash equivalents at beginning of
period ................................... 64,869 10,658 445,913 -- 521,440
----------- ----------- ----------- ----------- -----------
Cash and cash equivalents at end of period .. $ 7,103 $ 2,503 $ 406,020 $ -- $ 415,626
=========== =========== =========== =========== ===========
ITEM 2.
METRIS COMPANIES INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides information management
believes to be relevant to understanding the financial condition and results of
operations of Metris Companies Inc. ("MCI") and its subsidiaries, including
Direct Merchants Credit Card Bank, N.A. ("Direct Merchants Bank"), which may be
referred to as "we," "us," "our" and the "Company." You should read this
discussion along with the following documents for a full understanding of our
financial condition and results of operations: Management's Discussion and
Analysis of Financial Condition and Results of Operations in our Annual Report
on Form 10-K/A for the fiscal year ended December 31, 2001; and our Proxy
Statement for the 2002 Annual Meeting of Shareholders. In addition, you should
read this discussion along with our Quarterly Report on Form 10-Q for the period
ended September 30, 2002, of which this commentary is a part, and the condensed
consolidated financial statements and related notes thereto.
Results of Operations
Net loss for the three months ended September 30, 2002 was $1.3 million,
compared to net income of $70.7 million for the third quarter of 2001. Diluted
loss per share for the three months ended September 30, 2002 was $0.19 compared
to diluted earnings per share of $0.70 for the third quarter of 2001. The
decrease in net income is due primarily to an increase in provision for loan
losses, a decrease in net securitization and credit card servicing income and a
decrease in credit card fees, interchange and other income. The increase in the
provision for loan losses is due to the estimated loan loss allowance necessary
to absorb probable future loan losses inherent in the existing loan portfolio.
Increased net charge-offs, increased delinquency rates and the current economic
environment were some of the factors considered by management in determining the
necessary balance in the allowance for loan losses. The decrease in the net
securitization revenue relates to a decreased excess spread on securitized
receivables due primarily to an increased default rate. The decrease in credit
card fees, interchange and other income is primarily due to a $1.0 billion
reduction in average receivables during the quarter due to the transfer of
approximately $690 million receivables to the Metris Master Trust. In addition,
we also amended the Pooling and Servicing Agreement between the Metris Master
Trust and Direct Merchants Bank, which resulted in interchange income earned on
receivables held by the Metris Master Trust to be recorded as net securitization
revenue. Enhancement services revenue increased 16% to $99.6 million for the
third quarter of 2002 compared to the same period in 2001. This increase was due
primarily to an increase in receivables covered by our debt waiver product,
price increases on various debt waiver products, increased active enrollments in
various membership products and a shift from annual-billed products to
monthly-billed products, which have higher product prices and different
trial/cancel periods which impact the timing of revenues recognized.
Net income for the nine months ended September 30, 2002 was $14.6 million,
down from $175.1 million for the first nine months of 2001. Net income reported
for the nine-month period ended September 30, 2001 includes a $14.5 million
cumulative effect of accounting change described below. Without this item,
reported earnings would have been $189.5 million for the nine-month period ended
September 30, 2001. Diluted loss per share for the nine months ended September
30, 2002 was $0.22 compared to diluted earnings per share of $1.75 for the same
period in 2001. Without the impact of the cumulative effect of accounting
change, diluted earnings per share would have been $1.90 for the nine months
ended September 30, 2001. The $174.9 million decrease in income before
cumulative effect of accounting change primarily relates to a $71.0 million
reduction in net securitization and credit card servicing income, a $126.5
million increase in the provision for loan losses, a $52.7 million decrease in
credit card fees, interchange, and other credit card income, and a $10.1 million
increase in operating expenses. This was partially offset by enhancement
services revenue increasing 17% to $290.3 million for the nine months ended
September 30, 2002 compared to the same period in 2001.
On January 1, 2001, we adopted Statement of Financial Accounting Standards
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities," which establishes accounting and reporting standards for derivative
instruments. SFAS 133 requires enterprises to recognize all derivatives as
either assets or liabilities in the statement of financial position and to
measure those instruments at fair value. Prior to SFAS 133, we amortized the
costs of interest rate contracts on a straight-line basis over the expected life
of the contract. The adoption of SFAS 133 resulted in a one-time, non-cash,
after-tax charge to earnings of $14.5 million reflected as a "Cumulative effect
of accounting change" in the consolidated statements of income for the nine
months ended September 30, 2001.
Critical Accounting Policies
Our most significant accounting policies are our determination of the
allowance for loan losses, valuation of retained interests and accounting for
deferred revenues and costs.
Allowance for loan losses
We maintain an allowance for loan losses sufficient to cover anticipated
probable loan losses inherent in the credit card loan portfolio as of the
balance sheet date. The allowance is based on management's consideration of all
relevant factors including management's assessment of applicable economic and
seasonal trends. In addition, we have incorporated updated regulatory guidance
regarding analysis and documentation for the allowance for loan losses.
We segment the loan portfolio into several individual static pools with
similar credit risk and time since solicitation (vintage pools), and estimate
(based on historical experience and existing environmental conditions) the
dollar amount of principal, accrued finance charges and fees in each 30-day
delinquency bucket that will not be collected and, therefore, "roll" into the
next 30-day bucket and ultimately charge off. We then aggregate these pools into
prime and sub-prime portfolios based on the prescribed FICO score cuts and into
several other groups such as credit counseling and payment alternative
receivables. We also isolate individual pools subsequent to solicitation when
the credit risk associated with the pools include higher risk segments, such as
our partially secured card program, accounts that are over their credit limit by
more than 10%, accounts receiving benefits under our debt waiver program and
other programs as deemed necessary. We separately analyze the reserve
requirement on each of these groups or portfolios.
We continually evaluate the homogeneous static risk pools using a roll rate
model which uses historical delinquency levels and pay-down levels (12 months of
historical data, with significant influence given to last six months'
performance to capture current economic and seasonal trends), loan seasoning and
other measures of asset quality to estimate charge-offs for both credit loss and
bankruptcy losses.
We also consider several subjective factors which may be overlaid into the
credit risk roll-rate model in determining the necessary loan loss reserve,
including:
o national and economic trends and business conditions, including the
condition of various market segments;
o changes in lending policies and procedures, including those for
underwriting, collection, charge-off and recovery, as well as in the
experience, ability and depth of lending management and staff;
o trends in volume and the product pricing of accounts, including any
concentrations of credit; and
o impacts from external factors, such as changes in competition, and legal
and regulatory requirements, on the level of estimated credit losses in the
current portfolio.
Significant changes in these factors could impact our financial projections
and thereby affect the adequacy of our allowance for loan losses.
The loan loss allowance methodology and calculation was revised in the
first quarter of 2002. The significant changes reflected in this revised
methodology are as follows:
o reserving for twelve months (versus six months) of estimated losses on
the static pool of our core prime receivables; and
o establishing a judgmental reserve for accounts over their credit limit,
accounts under specific payment programs and accounts receiving benefits
under our debt waiver program (versus including these items in our roll
rate methodology).
Retained interest
The Company determines the fair value of the net retained interests by
calculating the present value of future expected cash flows using management's
best estimate of key assumptions including credit losses, weighted-average
spreads, payment rates and a discount rate commensurate with the risks involved.
For purposes of determining the value of the retained interests, we have
included only cash flows associated with the excess spread and principal
receivables included in the retained interests as of the balance sheet date. We
have not included certain expected finance charge receivable cashflows in our
calculation.
The significant assumptions used for estimating the fair value of the
retained interests in loans securitized are as follows:
September 30, December 31,
------------- ------------
2002 2001
---- ----
Annual discount rate (1) ............................. 15% 15%
Monthly payment rate ................................. 6% 7%
Weighted-average spread (2) .......................... 20% 20%
Annual principal, finance charge and fees default
rate .............................................. 21% 18%
(1) If we had included all expected finance charge receivable cash flows, our
effective discount rate would have ranged from 40% to 50%.
(2) Includes finance charges, late fees and overlimit fees, less
weighted-average cost of funds and 2% servicing fee.
Deferred acquisition costs
We defer direct credit card origination costs associated with successful
credit card solicitations that we incur in transactions with independent third
parties, and certain other costs that we incur in connection with loan
underwriting and the preparation and processing of loan documents. We also defer
qualifying acquisition costs associated with our enhancement services products.
These costs, which relate directly to membership solicitations (direct response
advertising costs), principally include postage, printing, mailings and
telemarketing costs. The total amount of deferred costs as of September 30, 2002
and December 31, 2001 were $91.9 million and $89.5 million, respectively. The
most significant assumption we used in determining the realizability of these
deferred costs is future revenues from our credit cards and enhancement services
products. A significant reduction in revenues could have a material impact on
the values of these balances.
Deferred revenue on Enhancement Services products
Direct Merchants Bank offers various debt waiver products to its credit
card accountholders. Revenue for such products is recognized in the month
following completion of the cancellation period, and reserves are provided for
pending claims based on Direct Merchants Bank's historical experience with
settlement of such claims. We record fees on membership programs as deferred
income upon acceptance of membership and amortize them on a straight-line basis
over the membership period beginning after the contractual cancellation period
is complete. We recognize all amortization related to the cancel period in the
first month following the cancel period. We defer and recognize extended service
plan revenues and the incremental direct acquisition costs on a straight-line
basis over the life of the related extended service plan contracts beginning
after the expiration of any manufacturers' warranty coverage. We record unearned
revenues and reserves for pending claims as "Deferred income" and "Accrued
expenses and other liabilities," respectively.
Net Interest Income
Net interest income consists primarily of interest earned on our credit
card loans and retained interests in loans securitized, less interest expense on
borrowings to fund loans. Table 1 provides an analysis of interest income and
expense, net interest spread, net interest margin and average balance sheet data
for the three- and nine-month periods ended September 30, 2002 and 2001.
Table 1: Analysis of Average Balances, Interest and Average Yields and Rates
(Dollars in thousands)
Three Months Ended September 30,
2002 2001
-------------------------------------------------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
Assets:
Interest-earning assets:
Federal funds sold ............ $ 33,108 $ 145 1.7% $ 39,735 $ 364 3.6%
Short-term investments ........ 877,792 3,838 1.7% 337,222 3,513 4.1%
Credit card loans and
retained interests in loans
securitized .................. 2,631,258 108,508 16.4% 3,650,294 175,330 19.1%
----------- ----------- ---- ----------- ----------- ----
Total interest-earning assets . $ 3,542,158 $ 112,491 12.6% $ 4,027,251 $ 179,207 17.7%
Other assets .................. 626,691 -- -- 772,649 -- --
Allowances for loan
losses and retained
interests valuation
allowance .................... (1,051,866) -- -- (875,606) -- --
----------- -----------
Total assets .................. $ 3,116,983 -- -- $ 3,924,294 -- --
=========== ===========
Liabilities and Equity:
Interest-bearing liabilities:
Deposits ...................... $ 1,214,548 $ 14,453 4.7% $ 2,148,610 $ 31,427 5.8%
Debt .......................... 356,306 8,799 9.8% 362,098 10,721 11.7%
----------- ----------- ---- ----------- ----------- ----
Total interest-bearing
liabilities ................ $ 1,570,854 $ 23,252 5.9% $ 2,510,708 $ 42,148 6.7%
Other liabilities ............. 432,145 -- -- 365,168 -- --
----------- -----------
Total liabilities ............. 2,002,999 -- -- 2,875,876 -- --
Stockholders' equity .......... 1,113,984 -- -- 1,048,418 -- --
----------- -----------
Total liabilities and equity .. $ 3,116,983 -- -- $ 3,924,294 -- --
=========== ===========
Net interest income and
interest margin (1) ........ -- $ 89,239 10.0% -- $ 137,059 13.5%
Net interest rate spread (2)... -- -- 6.7% -- -- 11.0%
Return on average assets ...... -- -- (0.2%) -- -- 7.2%
Return on average total
equity ..................... -- -- (0.5%) -- -- 26.8%
(1) We compute net interest margin by dividing annualized net interest income by
average total interest-earning assets.
(2) The net interest rate spread is the annualized yield on average
interest-earning assets minus the annualized funding rate on average
interest-bearing liabilities.
Net interest income decreased from $137.1 million for the three months
ended September 30, 2001 to $89.2 million for the three months ended September
30, 2002. The decrease is due to a decrease in average interest-earning assets
of $485 million and a 350 basis point reduction in net interest margin. The
decrease in net interest margin is due to a 510 basis point decrease in yield
partially offset by an 80 basis point decrease in cost of funds. The decrease in
yield is due to higher charge-offs and lower interest rates. The decrease in
cost of funds is due to lower interest rates.
Table 1: Analysis of Average Balances, Interest and Average Yields and Rates (cont'd)
(Dollars in thousands)
Nine Months Ended September 30,
2002 2001
----------------------------------------------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
Assets:
Interest-earning assets:
Federal funds sold ............ $ 29,937 $ 369 1.6% $ 77,984 $ 3,004 5.2%
Short-term investments ........ 544,574 7,401 1.8% 291,701 10,585 4.9%
Credit card loans and
retained interests in loans
securitized .................. 3,269,775 395,481 16.2% 3,491,472 507,554 19.4%
----------- ----------- ---- ----------- ----------- ----
Total interest-earning assets . $ 3,844,286 $ 403,251 14.0% $ 3,861,157 $ 521,143 18.1%
Other assets .................. 680,958 -- -- 803,437 -- --
Allowances for loan
losses and retained
interests valuation
allowance .................... (1,012,482) -- -- (821,635) -- --
----------- -----------
Total assets .................. $ 3,512,762 -- -- $ 3,842,959 -- --
=========== ===========
Liabilities and Equity:
Interest-bearing liabilities:
Deposits ...................... $ 1,551,566 $ 56,441 4.9% $ 2,113,702 $ 100,986 6.4%
Debt .......................... 387,811 25,931 8.9% 361,340 33,310 12.3%
----------- ----------- ---- ----------- ----------- ----
Total interest-bearing
liabilities ................ $ 1,939,377 $ 82,372 5.7% $ 2,475,042 $ 134,296 7.3%
Other liabilities ............. 431,081 -- -- 391,434 -- --
----------- -----------
Total liabilities ............. 2,370,458 -- -- 2,866,476 -- --
Stockholders' equity .......... 1,142,304 -- -- 976,483 -- --
----------- -----------
Total liabilities and equity .. $ 3,512,762 -- -- $ 3,842,959 -- --
=========== ===========
Net interest income and
interest margin (1) ........ -- $ 320,879 11.2% -- $ 386,847 13.4%
Net interest rate spread (2) .. -- -- 8.3% -- -- 10.8%
Return on average assets (3) .. -- -- 0.6% -- -- 6.6%
Return on average total
equity (3) ................. -- -- 1.7% -- -- 26.0%
(1) We compute net interest margin by dividing annualized net interest income by
average total interest-earning assets.
(2) The net interest rate spread is the annualized yield on average
interest-earning assets minus the annualized funding rate on average
interest-bearing liabilities.
(3) Amounts for the nine-month period ended September 30, 2001 are shown before
the cumulative effect of accounting change.
Net interest income decreased from $386.8 million for the nine months ended
September 30, 2001 to $320.9 million for the nine months ended September 30,
2002. The decrease is primarily due to a 220 basis point reduction in net
interest margin. The decrease in net interest margin is due to a 410 basis point
decrease in yield partially offset by a 160 basis point decrease in cost of
funds. The decrease in yield is due to higher charge-offs and lower interest
rates. The decrease in cost of funds is due to lower interest rates.
Other Operating Income
Other operating income decreased $60.7 million and $80.7 million for the
three- and nine-month periods ended September 30, 2002 compared to the same
periods in 2001. The decrease was primarily due to the decrease in net
securitization and credit card servicing income. Net securitization and credit
card servicing income for the three- and nine-month periods ended September 30,
2002 decreased $37.9 million and $71.0 million over the comparable periods in
2001, due to a decreased excess spread, as a result of an increased default rate
on securitized receivables, partially offset by retained interests valuation
income needed to record the retained interests at fair value.
Credit card fees, interchange and other credit card income decreased $36.2
million and $52.7 million for the three- and nine-month periods ended September
30, 2002 compared to the same periods in 2001. For the three months ended
September 30, 2002, credit card fees, interchange and other income decrease is
primarily due to a $1.0 billion reduction in average receivables due to the
transfer of approximately $690 billion receivables to the Metris Master Trust.
For the nine months ended September 30, 2002, credit card fees, interchange and
other income decrease is primarily due to the $221.7 million reduction in
average receivables due to the transfer of approximately $2.3 billion
receivables to the Metris Master Trust. In addition, we also amended the Pooling
and Servicing Agreement between the Metris Master Trust and Direct Merchants
Bank, which resulted in interchange income earned on receivables held by the
Metris Master Trust to be recorded as net securitization revenue. For the three
months ended September 30, 2002, $17.2 million of interchange revenue was
recorded as net securitization revenue. For the nine months ended September 30,
2002, $27.4 million of interchange revenue was recorded as net securitization
revenue.
Enhancement services revenues increased by $13.4 million and $42.9 million
for the three- and nine-month periods ended September 30, 2002. These increases
were due primarily to an increase in receivables covered by our debt waiver
product, price increases on various debt waiver products, increased active
enrollments in various membership products and a shift from annual-billed
products to monthly-billed products, which have higher product prices and
different trial/cancel periods which impact the timing of revenues recognized.
Table 2 presents the breakdown of
revenues and active enrollments for our enhancement services products:
Table 2: Enhancement Services (In Thousands)
Revenues
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
---- ---- ---- ----
Credit Protection ... $ 57,730 $ 52,253 $179,273 $147,759
Membership Products . 28,405 14,815 66,673 40,550
Warranty/Other ...... 13,482 19,100 44,316 59,023
-------- -------- -------- --------
Total ............... $ 99,617 $ 86,168 $290,262 $247,332
======== ======== ======== ========
Active Enrollments
September 30, December 31, September 30,
2002 2001 2001
---- ---- ----
Credit Protection ... 1,037 1,125 1,150
Membership Products . 3,327 2,856 2,739
Warranty/Other ...... 1,132 1,794 1,968
----------- ---------- ----------
Total ............... 5,496 5,775 5,857
=========== ========== ==========
Other Operating Expense
Total other operating expenses for the three-month period ended September
30, 2002 decreased $13.6 million from the comparable period in 2001. This
decrease is due primarily to a decrease in professional fees and compensation
expense, partially offset by higher marketing expenses.
Total other operating expenses for the nine-month period ended September
30, 2002 increased $10.1 million over the comparable period in 2001. Credit card
account and other product solicitation and marketing expenses increased $11.0
million to $145.6 million for the nine-month period ended September 30, 2002
compared to the same period in 2001, largely due to increased costs associated
with our marketing activity. Enhancement services claims expense increased $2.6
million for the three-month period ended September 30, 2002 from the comparable
period in 2001. For the nine-month period ended September 30, 2002, enhancement
services claims expenses increased $14.8 million from the same period in 2001.
The increase in enhancement services claims expenses primarily reflects higher
claims paid on death benefits, as well as an increase in our estimate of
unreported claims as of the balance sheet date, both of which reflects increases
in covered receivables. Included in other operating expenses for the nine-month
period ended September 30, 2002 is a charge of $10 million due to the write-down
of portfolios of charged-off loans purchased in 2001 and 2000. The book values
of these portfolios were $5.6 million as of September 31, 2002 and $20.1 million
as of December 31, 2001.
Asset Quality
Our delinquency and net loan charge-off rates at any point in time reflect,
among other factors, the credit risk of loans, the average age of our various
credit card account portfolios, the success of our collection and recovery
efforts, and general economic conditions. The average age of our credit card
account portfolio affects the stability of delinquency and loss rates. In order
to minimize losses, we continue to focus our resources on refining our credit
underwriting standards for new accounts, and on collections and post charge-off
recovery efforts. At September 30, 2002, 55% of our outstanding receivables
balance were from credit card accounts that have been with us in excess of two
years, and 24% of outstanding receivables were with us in excess of four years.
We use credit line analyses, account management and customer transaction
authorization procedures to minimize loan losses. Our risk models determine
initial credit lines at the time of solicitation. We manage credit lines on an
ongoing basis and adjust them based on customer usage and payment patterns. To
maximize profitability, we continually monitor customer accounts and initiate
appropriate collection activities when an account is delinquent or overlimit.
Delinquencies
Delinquencies not only have the potential to affect earnings in the form of
net loan losses, but they are also costly in terms of the personnel and other
resources dedicated to their resolution. It is our policy to continue to accrue
interest and fee income on all credit card accounts until we charge off the
credit card account, except in limited circumstances. We follow FFIEC (Federal
Financial Institutions Examination Council) guidelines by re-aging past due
accounts to current status only after receiving the equivalent of three minimum
payments or one lump sum equivalent. Furthermore, accounts can only be re-aged
to current once every twelve months and twice every 5 years.
Table 3 presents the delinquency trends of our credit card loan
portfolio.
Table 3: Loan Delinquency
(Dollars in thousands)
September 30, % of December 31, % of September 30, % of
2002 Total 2001 Total 2001 Total
---- ----- ---- ----- ---- -----
Loans outstanding ... $ 753,414 100% $2,746,656 100% $2,634,228 100%
Loans contractually
delinquent:
30 to 59 days .. 18,961 2.5% 87,603 3.2% 71,082 2.7%
60 to 89 days .. 14,010 1.9% 66,647 2.4% 55,679 2.1%
90 or more days. 14,351 1.9% 123,528 4.5% 120,708 4.6%
---------- ----- ---------- ----- ---------- -----
Total ........ $ 47,322 6.3% $ 277,778 10.1% $ 247,469 9.4%
========== ===== ========== ===== ========== =====
The 310-basis-point decrease in the delinquency rates over September 30,
2001 primarily reflects the sale of $47 million of revoked receivables. As a
result of the sale of the revoked receivables, 30 to 59 days contractually
delinquent loans would have been $20.5 million, 60 to 89 days contractually
delinquent loans would have been $19.5 million, and 90 or more days
contractually delinquent loans would have been $51.0 million. Excluding the sale
of delinquent receivables, the delinquency rate as of September 30, 2002 would
have been 11.4%. The increase in the adjusted delinquency rate reflects a
deterioration in the economy, seasoning in the loan portfolio and the impact of
our 2001 credit line increase program. The credit line increase program added
pressure to some of our customers due to increased average outstanding balances,
which require higher monthly payments. This, along with a deteriorating economy,
has put pressure on our collections efforts, resulting in higher delinquencies.
Net Charge-Offs
Net charge-offs are the principal amount of losses from credit card
accountholders unwilling or unable to make minimum payments, bankrupt credit
card accountholders and deceased credit card accountholders, less current period
recoveries. Net charge-offs exclude accrued finance charges and fees, which are
charged against the related income at the time of charge-off. The following
table presents our net principal charge-offs for the periods indicated as
reported in the consolidated financial statements.
Table 4: Net Charge-offs
(Dollars in thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----
Average credit card loans $ 871,014 $1,837,506 $1,462,911 $1,563,662
Net charge-offs ......... 84,406 60,205 253,183 168,474
Net charge-off ratio .... 38.4% 13.0% 23.1% 14.4%
========== ========== ========== ==========
Net charge-offs and the net charge-off ratio for the three- and nine-month
periods ended September 30, 2002 include $41.5 million related to the sale of
approximately $47 million of receivables. Excluding the impact of this
transaction, net charge-offs would have been $42.9 million for the three months
ended September 30, 2002 and $211.7 million for the nine months ended September
30, 2002, and the net charge-off ratio would have been 19.5% for the three
months ended September 30, 2002 and 19.3% for the nine months ended September
30, 2002.
The increase in the adjusted charge off ratios for the three- and
nine-month periods ended September 30, 2002 primarily reflects a decrease in
loan growth, sales of current and early stage delinquent accounts to the Master
Trust, deterioration in the economy and the 2001 credit line increase program.
Provision and Allowance for Loan Losses
We make provisions for loan losses in amounts necessary to maintain the
allowance at a level estimated to be sufficient to absorb probable future loan
losses, net of recoveries, inherent in the loan portfolio.
The economy has slowed down significantly over the last year, exacerbated
by the terrorist attacks on September 11, 2001. Also, our 2001 credit line
increase program added pressure to some of our customers, due to increased
average outstanding balances which require higher monthly payments. This, along
with a deteriorating economy, has made our collection efforts more difficult,
resulting in higher delinquencies. This changing environment has caused our
delinquencies and losses to increase from prior years' levels. Some of the
actions we are taking to mitigate this slowdown include expanding our
collections strategies to aggressively address any potential delinquency
increases and using our recovery staff to work on precharge-off receivables. We
are closely managing our contingent accountholder liability through extension
and contraction of credit lines. We also leverage debt forbearance programs and
credit counseling services for qualifying credit card accountholders that are
experiencing payment difficulties. These programs include reduced interest
rates, reduced or suspended fees and other incentives to induce the customer to
continue making payments. The amount of customer receivables in debt forbearance
programs was $42.3 million or 6% of credit card loans as of September 30, 2002,
compared with $129.9 million or 5% of credit card loans as of December 31, 2001.
All delinquent receivables in debt forbearance programs are included in Table 3.
The provision for loan losses was $138.2 million and $445.4 million for the
three- and nine-month periods ended September 30, 2002 compared to $116.5
million and $318.9 million for the same periods in 2001. These increases reflect
higher delinquency rates and the current economic environment.
The allowance for loan losses was $121 million as of September 30, 2002,
versus $410 million as of December 31, 2001. Our roll rate models, including
management contingency, indicated our required allowance for loan losses was in
the range of $110 million to $130 million as of September 30, 2002, versus $385
million to $415 million as of December 31, 2001. The ratio of allowance for loan
losses to period-end loans was 16.1% at September 30, 2002, compared to 14.9% at
December 31, 2001. The allowance for loan losses as a percentage of 30-day plus
receivables was 255.6% at September 30, 2002 compared to 147.7% at December 31,
2001. The decrease is due to the sale of $47 million of revoked receivables.
Retained Interests Valuation
We record a valuation allowance to reduce the contractual value of the
retained interests in loans securitized to fair value. The following summarizes
our retained interests as of September 30, 2002, December 31, 2001, September
30, 2001 and December 31, 2000.
September 30, December 31,
2002 Change 2001
---- ------ ----
Gross retained interests $ 1,581,886 $ 318,231 $ 1,263,655
Valuation allowance .... (929,585) (392,086) (537,499)
----------- ----------- -----------
Net retained interests . $ 652,301 $ (73,855) $ 726,156
=========== =========== ===========
September 30, December 31,
2001 Change 2000
---- ------ ----
Gross retained interests $ 1,228,154 $ (795,527) $ 2,023,681
Valuation allowance .... (596,153) 44,699 (640,852)
----------- ----------- -----------
Net retained interests . $ 632,001 $ (750,828) $ 1,382,829
=========== =========== ===========
Gross retained interests in loans securitized increased $318.2 million to
$1.6 billion as of September 30, 2002, compared to $1.3 billion as of December
31, 2001. The increase is due to the sale of approximately $2.3 billion of
receivables from Direct Merchants Bank to the Master Trust during the nine
months ended September 30, 2002. The $795.5 million decrease in gross retained
interests during the nine months ended September 30, 2001 was due primarily to
the maturity of a securitization that was accounted for as a sale under SFAS
140. As a result, approximately $855 million of receivables that were classified
as retained interests in loans securitized as of December 31, 2000 were
classified as credit card loans as of September 30, 2001. During the nine months
ended September 30, 2002 the valuation allowance increased by $392.1 million due
primarily to the higher gross retained interests and narrowing excess spreads in
the Master Trust due to increasing default rates. The projected default rate
increased from 18% as of December 31, 2001 to 21% as of September 30, 2002. The
increase in the projected default rate is due to increased delinquencies in the
Master Trust caused by the overall deterioration in the economy and our 2001
credit line increase program which added pressure to some of our customers due
to increased average outstanding balances which require higher monthly payments.
The increase in the projected default rate accounted for an approximate $250
million increase in the valuation allowance. The $44.7 million decrease in the
valuation allowance during the nine months ended September 30, 2001 primarily
reflects lower gross retained interests.
Balance Sheet Analysis
Cash and Cash Equivalents
Cash and cash equivalents were $1.1 billion as of September 30, 2002,
compared to $488.1 million as of December 31, 2001. The $602.6 million increase
is due to the transfer of assets from Direct Merchants Bank to the Master Trust,
which creates excess liquidity at Direct Merchants Bank, as well as the
Company's decision to maintain a high level of liquidity in the current economic
environment.
Credit Card Loans
Credit card loans were $753.4 million as of September 30, 2002, compared to
$2.7 billion as of December 31, 2001. The $2.0 billion decrease is primarily a
result of the transfer of $2.3 billion of receivables from Direct Merchants Bank
to the Master Trust.
Deposits
Deposits decreased $958.8 million to $1.1 billion as of September 30, 2002,
compared to $2.1 billion as of December 31, 2001. The decrease relates to a
shift in funding from deposits to off-balance sheet asset-backed
securitizations.
Debt
Debt decreased to $356.1 million as of September 30, 2002 from $647.9
million as of December 31, 2001 due to the paydown of a warehouse financing
arrangement entered into by Direct Merchants Bank in June 2001 that was
accounted for as a collateralized financing.
Deferred Income
Deferred income decreased $36.5 million to $178.5 million as of September
30, 2002 compared to $215.0 million as of December 31, 2001. The decrease
relates primarily to our shift from annual-billed to monthly-billed enhancement
services products and the run-off of deferred revenues associated with our
ServiceEdge(R) product sold to customers of Fingerhut.
Stockholders' Equity
Stockholders' equity was $1.1 billion as of September 30, 2002, a decrease
of $27.8 million from December 31, 2001. The decrease results from $43.7 million
of stock repurchases under our stock repurchase program in 2002 partially offset
by current year earnings.
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 short- and long-term
interest rates. We use a variety of financing sources to manage liquidity,
refunding, and interest rate risks. Table 5 summarizes our funding and liquidity
as of September 30, 2002 and December 31, 2001:
Table 5: Liquidity, Funding and Capital Resources
(Dollars in thousands)
September 30, 2002 December 31, 2001
------------------ -----------------
Unused Unused
On-balance sheet funding Outstanding Capacity Outstanding Capacity
------------------------ ----------- -------- ----------- --------
Bank conduit 2002 ........................ $ -- $ 100,000 $ 292,000 $ 108,000
Revolving credit line July 2003 .......... -- 170,000 -- 170,000
Term loan June 2003 ...................... 100,000 N/A 100,000 N/A
Senior notes 10% November 2004 ........... 100,000 N/A 100,000 N/A
Senior notes 10.125% July 2006 ........... 146,597 N/A 145,924 N/A
Other .................................... 9,521 N/A 9,980 N/A
Deposits ................................. 1,099,229 N/A 2,058,008 N/A
Equity ................................... 1,114,112 N/A 1,141,955 N/A
----------- ----------- ----------- -----------
Subtotal ............................ $ 2,569,459 $ 270,000 $ 3,847,867 $ 278,000
Off-balance sheet funding
-------------------------
Metris Master Trust (1)................... $ 9,223,689 $ 813,561 $ 7,880,342 $ 328,908
Metris facility .......................... 20,000 55,000 15,500 59,500
----------- ----------- ----------- -----------
Subtotal ............................ $ 9,243,689 $ 868,561 $ 7,895,842 $ 388,408
----------- ----------- ----------- -----------
Total ............................... $11,813,148 $ 1,138,561 $11,743,709 $ 666,408
=========== =========== =========== ===========
(1) On November 20, 2002, our 1997-2 asset-backed securitization transaction
will mature. The 1997-2 asset-backed securitization represents approximately
$655 million of funding in the above table. The $813 million of unused capacity
at the Master Trust may be reduced by approximately $655 million if no
asset-backed securitization transaction takes place prior to November 20, 2002.
Under our Credit Agreement, we need to maintain, among other items, minimum
equity to managed receivables of 5%, minimum equity plus reserves to managed
receivables of 10%, minimum three-month average excess spread (by asset-backed
securitization deal) of 1%, minimum equity of $685 million as of September 30,
2002 and a ratio of equity plus reserves to managed 90-day plus delinquencies of
2.25. As of September 30, 2002 and December 31, 2001, we were in compliance with
all financial covenants under our Credit Agreement.
The Master Trust and the associated securitized debt provide for early
amortization if certain events occur. These events are described in the
applicable prospectus of each securitization transaction. The most significant
events would be three consecutive months of less than zero percent excess spread
or negative transferor's interest within the Master Trust. In addition, there
are various triggers within our securitization agreements that, if broken, would
restrict the release of cash to us from the Master Trust. This restricted cash
would provide additional security to the investors of the Master Trust. The
triggers are related to the performance of the Master Trust, specifically the
amount of net excess spread over a one to three month period. As of September
30, 2002, we have not broken any triggers in our securitization agreements and,
therefore, no cash has been restricted.
Our equity as a percent of managed assets was 9.2% as of September 30, 2002
versus 9.4% as of December 31, 2001. We have historically retained cash flow
generated from earnings (versus declaring larger dividends) to provide
additional equity and liquidity to fund future receivables growth.
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 September 30, 2002 and December 31, 2001, Direct
Merchants Bank's Tier 1 risk-based capital ratio, risk-based total capital ratio
and Tier 1 leverage ratio exceeded the minimum required capital levels, and
Direct Merchants Bank was considered a "well-capitalized" depository institution
under regulations of the OCC, as illustrated in the following table.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, Direct Merchants Bank must meet specific capital guidelines
that involve quantitative measures of assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices.
Direct Merchants Bank's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require Direct Merchants Bank to maintain minimum amounts and ratios (set forth
in the following table) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 leverage
capital (as defined) to average assets (as defined). Failure to meet minimum
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material adverse effect on our financial statements.
Additional information about Direct Merchants Bank's actual capital amounts
and ratios are presented in the following table:
For Capital
Adequacy To Be Well
Actual Purposes Capitalized
------ -------- -----------
As of September 30, 2002 Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital ..... $395,017 27.0% $117,145 8.0% $146,431 10.0%
(to risk-weighted
assets)
Tier 1 Capital .... 375,448 25.6% 58,572 4.0% 87,859 6.0%
(to risk-weighted
assets)
Tier 1 Capital .... 375,448 25.3% 59,475 4.0% 74,344 5.0%
(to average assets)
For Capital
Adequacy To Be Well
Actual Purposes Capitalized
------ -------- -----------
As of December 31, 2001 Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital ..... $346,907 13.0% $213,733 8.0% $267,166 10.0%
(to risk-weighted
assets)
Tier 1 Capital .... 308,186 11.5% 106,867 4.0% 160,300 6.0%
(to risk-weighted
assets)
Tier 1 Capital .... 308,186 11.2% 110,573 4.0% 138,216 5.0%
(to average assets)
FFIEC guidelines indicate that an institution with a concentration in
subprime lending should hold one and one-half to three times the normal minimum
capital required. The OCC has regulatory authority to evaluate the safety and
soundness of Direct Merchants Bank under these more stringent guidelines. The
OCC has required Direct Merchants Bank, under the more stringent guidelines, to
maintain two times the normal minimum capital on those credit card loans that
qualify as subprime loans (FICO score of 660 and below) and maintain a minimum
capital ratio of 10%. Under these more stringent guidelines, Direct Merchants
Bank's total capital ratio as of September 30, 2002 was 20.9%.
Regulatory Matters
On April 16, 2002, Direct Merchants Bank entered into an agreement with the
OCC to strengthen the safety and soundness of Direct Merchants Bank's
operations. The agreement formalizes recommendations made and requirements
imposed by the OCC following an examination of Direct Merchants Bank that
covered the 15-month period ended December 31, 2001. On April 17, 2002, MCI
filed the agreement with the Securities and Exchange Commission as an exhibit to
and incorporated it by reference in a current report on Form 8-K. We filed an
amendment to that current report on Form 8-K on October 22, 2002.
Direct Merchants Bank intends to comply with all of the terms of the
agreement in a timely manner. Furthermore, we believe that as of the filing date
of this Quarterly Report, Direct Merchants Bank has complied with all of the
terms of the agreement. Direct Merchants Bank has implemented the plans for
which the OCC has posed no objection and is revising or planning to implement
all others, pending and in response to comments from the OCC.
If the OCC were to conclude that Direct Merchants Bank failed to implement
in a timely manner any provision of the agreement or that Direct Merchants Bank
otherwise violated the agreement, the OCC could pursue various enforcement
options. Under applicable provisions of the Federal Deposit Insurance Act, the
OCC may, among other things, pursue an order to cease and desist from any
further violations or take affirmative actions to correct conditions resulting
from violations or practices, place limitations on the activities of a bank that
in its opinion violated a written agreement, remove from office members of
management or the board of directors of a bank or prohibit further participation
by those persons in the bank's affairs, and assess civil money penalties. If any
of these events were to actually occur, we could not assure you that the event
would not have a material adverse effect on Direct Merchants Bank's operations
or capital position.
Forward-Looking Statements
This Quarterly Report contains some forward-looking statements.
Forward-looking statements give our current expectations of future events. You
will recognize these statements because they do not strictly relate to
historical or current facts. Such statements may use words such as "anticipate,"
"estimate," "expect," "project," "intend," "think," "believe" and other words or
terms of similar meaning in connection with any discussion of future performance
of the Company. For example, these include statements relating to future
actions, future performance of current or anticipated products, solicitation
efforts, expenses, the outcome of contingencies such as litigation, and the
impact of the capital markets on liquidity. From time to time, we also may
provide oral or written forward-looking statements in other material released to
the public.
Any or all of our forward-looking statements in this Report and in any
other public statements we make may turn out to be wrong. They can be affected
by inaccurate assumptions or by known or unknown risks and uncertainties. Many
factors, which can not be predicted with certainty, will be important in
determining future results. Among such factors are higher delinquency,
charge-off and bankruptcy rates of our target market of moderate-income
consumers, risks associated with Direct Merchants Bank's ability to comply with
its agreement with the OCC regarding the safety and soundness of its operations,
risks associated with our continuing ability to market our enhancement services
and maintain or expand on current levels in that business, interest rate risks,
risks associated with acquired portfolios, dependence on the securitization
markets and other funding sources, state and federal laws and regulations that
limit our business activities, product offerings and fees, privacy laws that
could result in lower marketing revenue and penalties for non-compliance, and
general economic conditions that can have a major impact on the performance of
loans. Each of these factors and others are more fully discussed under the
caption "Business--Risk Factors" contained in the Company's Annual Report on
Form 10-K/A for the year ended December 31, 2001. As a result of these factors,
we cannot guarantee any forward-looking statements. Actual future results may
vary materially. Also, please note that the factors we provide are those we
think could cause our actual results to differ materially from expected and
historical results. Other factors besides those listed here or in our 10-K/A for
the year ended December 31, 2001 could also adversely affect us.
We undertake no obligations to publicly update any forward-looking
statements, whether as a result of new information, future events or otherwise.
You are advised, however, to consult any further disclosure we make on related
subjects in our periodic filings with the Securities and Exchange Commission.
This discussion is provided to you as permitted by the Private Securities
Litigation Reform Act of 1995.
Selected Operating Data - Managed Basis
We analyze the Company's financial performance on a managed loan portfolio
basis. On a managed basis, the balance sheet and income statement includes other
investors' interests in securitized loans that are not assets of the Company,
thereby reversing the effects of sale accounting under SFAS 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
We believe this information is meaningful to the reader of the financial
statements. We service receivables that have been securitized and sold and own
the right to the cash flows from those sold receivables in excess of interest
payments due to security holders.
The following information is not in conformity with accounting principles
generally accepted in the Unites States of America, however we believe the
information is relevant to understanding the overall financial condition and
results of operations of the Company.
Table 6: Managed Loan Portfolio
(In thousands) September 30, % of December 31, % of September 30, % of
2002 Total 2001 Total 2001 Total
---- ----- ---- ----- ---- -----
Period-end balances:
Credit card loans ......... $ 753,414 $ 2,746,656 $ 2,634,228
Retained interests in
loans securitized ...... 1,581,886 1,263,655 1,228,154
Investors' interests in
securitized loans
accounted for as sales . 9,237,804 7,895,842 7,161,810
------------- ----------- ------------
Total managed loan
portfolio .............. $ 11,573,104 $11,906,153 $11,024,192
============= =========== ============
Loans contractually
delinquent:
30 to 59 days ........... 380,141 3.3% 375,887 3.1% 285,243 2.6%
60 to 89 days ........... 303,891 2.6% 274,278 2.3% 221,120 2.0%
90 or more days ......... 565,139 4.9% 473,003 4.0% 474,224 4.3%
------------- ------- ----------- -------- ----------- -------
Total ................. $ 1,249,171 10.8% $ 1,123,168 9.4% $ 980,587 8.9%
============= ======= =========== ======== =========== =======
Gross active accounts ........ 3,556 3,871 3,875
Gross active credit card accounts decreased 315,000 during the nine months
ended September 30, 2002. The decrease was due primarily to increased
charge-offs as well as lower account originations and portfolio acquisitions
compared with the nine months ended September 30, 2001.
Three Months Ended
September 30,
2002 2001
---- ----
Average balances:
Total managed loan portfolio .. $11,769,200 $ 10,642,787
Net charge-offs ............... 488,861 16.5% 286,248 10.7%
Nine Months Ended
September 30,
2002 2001
---- ----
Average balances:
Total managed loan portfolio .. $11,844,839 $ 9,968,227
Net charge-offs ............... 1,315,325 14.8% 799,734 0.7%
Net charge-offs and the net charge-off ratio for the three- and nine-month
periods ended September 30, 2002 include $41.5 million related to the sale of
approximately $47 million of receivables. Excluding the impact of this
transaction, net charge-offs would have been $447.3 million for the three months
ended September 30, 2002 and $1.3 billion for the nine months ended September
30, 2002, and the net charge-off ratio would have been 15.1% for the three
months ended September 30, 2002 and 14.4% for the nine months ended September
30, 2002.
Excluding the sale of the delinquent receivables, the delinquency rate as
of September 30, 2002 would have been 11.1%. The 220-basis-point increase in the
adjusted managed delinquency rates over September 30, 2001 primarily reflects
various factors, including a deterioration in the economy, seasoning in the loan
portfolio and the impact of our 2001 credit line increase program. The credit
line increase program added pressure to our customers due to increased average
outstanding balances, which require higher monthly payments. This, along with a
deteriorating economy, has made our collections efforts more difficult,
resulting in higher delinquencies. The increase in charge off ratios for the
three- and nine-month periods ended September 30, 2002 primarily reflects a slow
down in loan growth, deterioration in the economy and the 2001 credit line
increase program.
The amount of customer receivables in debt forbearance programs was $880.9
million or 8% of total managed loans as of September 30, 2002 compared with
$837.2 million or 7% of managed loans as of December 31, 2001. All delinquent
receivables in debt forbearance programs are included in Table 6.
Net Interest Income
Table 7: Analysis of Average Balances, Interest and Average Yields and Rates
(Dollars in thousands)
Three Months Ended September 30,
2002 2001
--------------------------------------------------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
Credit card loans ........... $11,769,200 $ 530,357 17.9% $10,642,787 $ 510,942 19.0%
Total interest-earning assets 12,680,100 534,340 16.7% 11,019,743 514,818 18.5%
Total interest-bearing
liabilities .............. 10,708,796 80,004 3.0% 9,503,201 119,569 5.0%
Net interest income and
interest margin (1) ...... -- $ 454,336 14.2% -- $ 395,249 14.2%
Net interest rate spread (2) -- -- 13.7% -- -- 13.5%
Return on average assets .... -- -- 0.0% -- -- 2.6%
Return on average total
equity ................... -- -- (0.5%) -- -- 26.8%
Nine Months Ended September 30,
2002 2001
--------------------------------------------- ---------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
Credit card loans ........... $11,844,839 $ 1,563,069 17.6% $ 9,968,227 $ 1,449,589 19.4%
Total interest-earning assets 12,419,426 1,570,839 16.9% 10,337,912 1,463,178 18.9%
Total interest-bearing
liabilities .............. 10,514,441 249,355 3.2% 8,951,797 386,038 5.8%
Net interest income and
interest margin (1) ...... -- $ 1,321,484 14.2% -- $ 1,077,140 13.9%
Net interest rate spread (2) -- -- 13.7% -- -- 13.1%
Return on average assets (3) -- -- 0.2% -- -- 2.5%
Return on average total
equity (3) ............... -- -- 1.7% -- -- 26.0%
(1) We compute net interest margin by dividing annualized net interest income by
average total interest-earning assets.
(2) The net interest rate spread is the annualized yield on average
interest-earning assets minus the annualized funding rate on average
interest-bearing liabilities.
(3) Amounts for the nine-month period ended September 30, 2001 are shown before
the cumulative effect of accounting change.
Net interest income consists primarily of interest earned on our credit
card loans less interest expense on borrowings to fund the loans. Managed net
interest income for the three months ended September 30, 2002 was $454.3
million, compared to $395.2 million for the same period in 2001. The increase is
due to an approximate $1.7 billion increase in average interest-earning assets.
For the nine months ended September 30, 2002, managed net interest income was
$1.3 billion compared to $1.1 billion for the same period in 2001. The increase
is due to a $2.1 billion increase in average interest-earning assets and a 30
basis point increase in net interest margin.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
rates. Our principal market risk is due to changes in interest rates. This
affects us directly in our lending and borrowing activities, as well as
indirectly, as interest rates may impact the payment performance of our credit
card accountholders.
To manage our direct risk to market interest rates, management actively
monitors the interest rates and the interest sensitive components of our owned
and managed balance sheet to minimize the impact changes in interest rates have
on the fair value of assets, net income and cash flow. We seek to minimize the
impact of changes in interest rates on us primarily by matching asset and
liability repricings.
Our primary managed assets are credit card loans, which are virtually all
priced at rates indexed to the variable Prime Rate. We fund credit card loans
through a combination of cash flows from operations, asset securitizations, bank
loans, subsidiary bank deposits, long-term debt and equity issuances. Our
securitized loans are owned by a trust and bank-sponsored single-seller and
multi-seller receivable conduits, which have committed funding primarily indexed
to variable commercial paper rates and LIBOR. The $270 million bank credit
facility has pricing that is also indexed to LIBOR and Prime Rate. The
subsidiary bank deposits and long-term debt are issued at fixed interest rates.
At September 30, 2002, none of the trust and conduit funding of securitized
receivables was funded with fixed rate securities.
In an interest rate environment with rates at or below current rates, 100%
of the securitization funding for the managed loan portfolio is indexed to
floating commercial paper and LIBOR rates. In an interest rate environment with
rates significantly above current rates, the potentially negative impact on
earnings of higher interest expense is partially mitigated by fixed rate funding
and interest rate cap contracts.
The approach we use to quantify interest rate risk is a sensitivity
analysis, which we believe best reflects the risk inherent in our business. This
approach calculates the impact on net income from an instantaneous and sustained
change in interest rates by 200 basis points. Assuming that we take no
counteractive measures, as of September 30, 2002, a 200 basis point increase in
interest rates affecting our floating rate financial instruments, including both
debt obligations and loans, would result in an increase in net income of
approximately $63 million relative to a base case over the next 12 months,
compared to an approximately $20 million increase as of December 31, 2001. A
decrease of 200 basis points would result in a reduction in net income of
approximately $26 million as of September 30, 2002, compared to a $2 million
reduction as of December 31, 2001. The increased sensitivity to interest rate
fluctuations as of September 30, 2002 is due to a repricing on our credit card
portfolio implemented in the first quarter of 2002. You should not construe our
use of this methodology to quantify the market risk of financial instruments as
an endorsement of its accuracy or the accuracy of the related assumptions. In
addition, this methodology does not take into account the indirect impact
interest rates may have on the payment performance of our credit card
accountholders. The quantitative information about market risk is necessarily
limited because it does not take into account operating transactions or other
costs associated with managing immediate changes in interest rates.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this Report, an evaluation
was performed under the supervision and with the participation of the Company's
management, including the Chairman and Chief Executive Officer ("CEO") and the
Vice Chairman (Principal Financial Officer), of the effectiveness of the design
and operation of the Company's disclosure controls and procedures. Based on that
evaluation, the Company's management, including the CEO and Vice Chairman, have
concluded that the Company's disclosure controls and procedures are effective in
ensuring that information required to be disclosed in the reports it files under
the Securities Exchange Act of 1934 are recorded, processed, summarized and
reported within the time periods specified in Securities and Exchange Commission
rules and forms. There have been no significant changes in the Company's
internal controls or in other factors that could significantly affect internal
controls subsequent to the evaluation date.
Part II. Other Information
Item 1. Legal Proceedings
We are a party to various legal proceedings resulting from the ordinary
business activities relating to our operations. In July 2000 an Amended
Complaint was filed in Hennepin County District Court in Minneapolis, Minnesota
against MCI and our subsidiaries Metris Direct, Inc. and Direct Merchants Bank.
The complaint seeks damages in unascertained amounts and purports to be a class
action complaint on behalf of all credit card accountholders who were issued a
credit card by Direct Merchants Bank and were allegedly assessed fees or charges
that the cardholder did not authorize. Specifically, the complaint alleges
violations of the Minnesota Prevention of Consumer Fraud Act, the Minnesota
Deceptive Trade Practices Act and breach of contract. A final settlement
approval hearing was held on May 30, 2002, and the Court signed the order
granting final approval of the settlement whereby we will pay approximately $5.6
million for attorneys' fees and costs incurred by attorneys for the plaintiffs
in separate lawsuits filed in Arizona, California and Minnesota in 2000 and
2001. Under the terms of the settlement we denied any wrongdoing or liability.
The time for filing an appeal expired on August 5, 2002, and no appeal was
filed. At this time, we are in the process of implementing the terms of the
settlement.
On May 3, 2001, Direct Merchants Bank entered into a consent order with the
OCC. The consent order required Direct Merchants Bank to pay approximately $3.2
million in restitution to approximately 62,000 credit card accountholders who
applied for and received a credit card in connection with a series of limited
test marketing campaigns from March 1999 to June 2000. Under the terms of the
consent order, Direct Merchants Bank made no admission or agreement on the
merits of the OCC's assertions. The restitution as required by the OCC consent
order was paid and is reflected in our December 31, 2001 financial statements.
We believe that Direct Merchants Bank's agreement with the OCC will not have a
material adverse effect on the financial position of MCI or Direct Merchants
Bank.
In May 2001, the OCC also indicated that it was considering whether to
assess civil money penalties against Direct Merchants Bank. On October 17, 2002,
the OCC notified Direct Merchants Bank that it will not assess civil money
penalties.
On April 16, 2002, Direct Merchants Bank entered into an agreement with the
OCC to strengthen the safety and soundness of Direct Merchants Bank's
operations. For further information, see "Regulatory Matters" on page 37 of this
Report.
On September 20 and 24, 2002, two identical securities lawsuits were filed
in the United States District Court in Minnesota. On October 29, 2002, a third
substantially identical lawsuit was filed in the United States District Court of
Minnesota. In all of these lawsuits, plaintiffs allege that the OCC initiated an
examination of Direct Merchants Bank and provided its Report of Examination
("ROE") on November 5, 2001. Plaintiffs claim that we knew as of November 5,
2001 that the ROE would lead to the April 16, 2002 formal agreement with the OCC
and would obligate Direct Merchants Bank to restructure parts of its operations.
Plaintiffs allege that we deliberately did not reveal the existence of the ROE
until April 17, 2002, and thereafter made false and misleading statements about
the impact that the formal agreement with the OCC would have on us. Plaintiffs
seek to represent a class consisting of all purchasers of Metris common stock
between November 5, 2001 and July 17, 2002. Plaintiffs allege violations of
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. We believe that
we have substantive legal defenses to these claims and intend to defend
ourselves vigorously. However, due to uncertainties of litigation, there can be
no assurance that the defense or resolution of these matters will not have a
material adverse effect on our financial position.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
11 Computation of Earnings Per Share.
99.1 Certification of Principal Executive Officer Pursuant to Section
1350 of Chapter 63 of Title 18 of the United States Code.
99.2 Certification of Principal Financial Officer Pursuant to Section
1350 of Chapter 63 of Title 18 of the United States Code.
(b) Reports on Form 8-K:
On October 18, 2002, we filed a Current Report on Form 8-K to report
the submission of unaudited financial statements in a press release
dated October 16, 2002.
On October 22, 2002, we filed an amendment to the Current Report on
Form 8-K we filed April 17, 2002 to report that our wholly-owned
subsidiary, Direct Merchants Credit Card Bank, N.A., had entered into
an agreement on April 16, 2002 with the Office of the Comptroller of
the Currency, the agency that regulates the Bank, to strengthen
certain aspects of the safety and soundness of the Bank's operations.
See Part 2, Item 1, "Legal Proceedings" on page 44.
On October 28, 2002, we filed a Current Report on Form 8-K to report
our entry into a Distribution and Management Agreement with Sumner
Harrington Ltd. with respect to our issuance and sale of up to
$150,000,000 aggregate principal amount of our Renewable Unsecured
Subordinated Notes to be issued under our previously filed
Registration Statement on Form S-3 (File No. 333-47066).
We also furnished information under Item 9 of Form 8-K pursuant to
Regulation FD during the third quarter ended September 30, 2002.
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: November 14, 2002 By: /s/ David D. Wesselink
-----------------------
David D. Wesselink
Vice Chairman
Principal Financial Officer
Date: November 14, 2002 By: /s/ Mark P. Wagener
--------------------
Mark P. Wagener
Senior Vice President, Controller
Principal Accounting Officer
Certification
I, Ronald N. Zebeck, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Metris Companies
Inc.;
2. Based on my knowledge, this Quarterly Report does not contain any untrue
statement of material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this Quarterly Report;2.
3. Based on my knowledge, the financial statements, and other financial
information included in this Quarterly Report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
Quarterly Report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this Quarterly Report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
Quarterly Report (the "Evaluation Date"); and
c) presented in this Quarterly Report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
Quarterly Report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002
/s/ Ronald N. Zebeck
--------------------
Ronald N. Zebeck
Chairman and Chief Executive Officer
(Principal Executive Officer)
Certification
I, David D. Wesselink, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Metris Companies
Inc.;
2. Based on my knowledge, this Quarterly Report does not contain any untrue
statement of material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this Quarterly Report;
3. Based on my knowledge, the financial statements, and other financial
information included in this Quarterly Report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
Quarterly Report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this Quarterly Report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
Quarterly Report (the "Evaluation Date"); and
c) presented in this Quarterly Report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
Quarterly Report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002
/s/ David D. Wesselink
----------------------
David D. Wesselink
Vice Chairman
(Principal Financial Officer)