UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM 10-K/A
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended 001-12351
DECEMBER 31, 2002 Commission file number
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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)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.01 Par Value New York Stock Exchange, Inc.
---------------------------- ----------------------------
Title of Each Class Name of Each Exchange
On Which Registered
Securities registered pursuant to Section 12(g) of the Act: None
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 and (2) has been subject to such filing requirements for
the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of June 28, 2002 was approximately $493,557,434 based upon the
closing price of $8.31 on the New York Stock Exchange on that date.
As of March 14, 2003, 57,657,924 shares of the Registrant's Common Stock were
outstanding and the aggregate market value of common stock held by
non-affiliates of the Registrant on that date was approximately $76,887,744
based upon the closing price of $1.37 on the New York Stock Exchange on March
14, 2003.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Proxy Statement for the Annual Meeting of Stockholders
of Metris Companies Inc. held on May 6, 2003, were filed with the Securities and
Exchange Commission ("SEC") within 120 days after December 31, 2002, and are
incorporated by reference in Part III.
1
EXPLANATORY NOTE
As previously disclosed, Metris Companies Inc. (the "Company") has
restated its financial results for 1998 through 2002 and for the first three
quarters of 2003. The determination was made to restate these financial
statements in connection with the Company's analysis of its method of valuing
"Retained interests in loans securitized."
This Amendment No. 1 to the Company's Annual Report on Form 10-K for
the year ended December 31, 2002, initially filed with the Securities and
Exchange Commission ("SEC") on March 31, 2003 (the "Original 10-K"), is being
filed to reflect restatements of the following financial statements: (a)
consolidated balance sheets as of December 31, 2002 and December 31, 2001; (b)
consolidated statements of income for the years ended December 31, 2002, 2001
and 2000; and (c) consolidated statements of cash flows for years ended December
31, 2002, 2001 and 2000. Included in these restatements, in addition to changes
made as a result of the Company's revised accounting policies and procedures
related to valuing its retained interests, are corrections to conform with
accounting principles generally accepted in the United States of America
("GAAP") related to securitization transaction costs, credit card solicitation
costs, interest rate caps and debt waiver revenue associated with credit card
receivables sold to the Metris Master Trust, as well as the transfer of
allowance for loan losses that was incorrectly classified as a valuation reserve
in "Retained interests in loans securitized" as of December 31, 2001. In
addition, we have restated certain other prior period amounts to conform with
the current period's presentation. For a more detailed description of the
restatements, see Note 2 to the accompanying audited consolidated financial
statements and "Restatements" in Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in this Annual Report on
Form 10-K.
This Amendment No. 1 amends and restates Items 6, 7 and 8 of Part II,
Item 14 of Part III and Item 15 of Part IV of the Original 10-K and no other
information in the Original 10-K is amended hereby. The foregoing items have
been amended to reflect the restatements and have not been updated to reflect
other events occurring after the filing of the Original 10-K or to modify or
update those disclosures affected by subsequent events. Such matters have been
or will be addressed in the amended Quarterly Reports on Form 10-Q/A for the
quarters ended March 31, 2003 and June 30, 2003, filed concurrently here with,
the Quarterly Report on Form 10-Q for the quarter ended September 30, 2003 filed
on March 2, 2004, the Current Report on Form 8-K filed on March 15, 2004 and any
reports filed with the SEC subsequent to the date of this filing.
We are concurrently filing amended Quarterly Reports on Form 10-Q/A for
the quarters ended March 31, 2003, June 30, 2003, and September 30, 2003
containing restated financial statements for the relevant periods. We did not
amend our Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for
periods affected by the restatements that ended prior to December 31, 2002, and
the financial statements, auditors' reports and related financial information
for the affected periods contained in such reports should no longer be relied
upon.
2
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................... N/A
Item 2. Properties.................................................. N/A
Item 3. Legal Proceedings........................................... N/A
Item 4. Submission of Matters to a Vote of Security Holders......... N/A
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters............................................... N/A
Item 6. Selected Financial Data..................................... 4
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................... 6
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk................................................. N/A
Item 8. Financial Statements and Supplementary Data................. 40
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................... N/A
PART III
Item 10. Directors and Executive Officers of the Registrant......... N/A
Item 11. Executive Compensation..................................... N/A
Item 12. Security Ownership of Certain Beneficial
Owners and Management............................................. N/A
Item 13. Certain Relationships and Related Transactions............. N/A
Item 14. Controls and Procedures.................................... 105
PART IV
Item 15. Exhibits, Financial Statement Schedules
and Reports on Form 8-K........................................... 105
Signatures.......................................................... 107
Exhibit Index 109
3
PART I
ITEM 6. TABLE 1: SELECTED FINANCIAL DATA (AS RESTATED)
YEAR ENDED DECEMBER 31,
FOUR-YEAR
(in thousands, except EPS, dividends COMPOUND
and stock prices) 2002 2001 2000 1999 1998 GROWTH RATE
----------- ----------- ----------- ----------- ----------- -----------
INCOME STATEMENT DATA:
Net interest income $ 125,886 $ 202,861 $ (12,608) $ 27,428 $ (28,416) N/A
Provision for loan losses 219,804 461,106 164,800 122,322 -- N/A
Other operating income 835,421 1,273,444 1,080,270 794,857 363,483 23.1
Other operating expense 741,220 727,284 599,139 437,984 227,161 34.4
----------- ----------- ----------- ----------- ----------- ---------
Tax rate (1) 659.7% 39.5% 38.6% 48.1% 38.2%
Net income (loss) $ (1,584) $ 160,029 $ 185,902 $ 109,555 $ 66,691 N/A
----------- ----------- ----------- ----------- ----------- ---------
PER COMMON SHARE STATISTICS:
Earnings (Loss) per share - diluted $ (0.66) $ 1.61 $ 2.01 $ 1.44 $ 1.09 N/A
Stock price 2.47 25.71 26.31 23.79 16.77 (38.1)%
Dividends paid 0.040 0.040 0.033 0.017 0.013
Book value per common share
equivalent(2) 11.53 12.00 9.68 7.38 5.85 18.5
Shares outstanding (year-end) 57,168 63,419 62,243 57,919 57,779
Shares used to compute earnings
(loss) per share (diluted) 59,782 99,366 92,582 76,324 59,905
----------- ----------- ----------- ----------- ----------- ---------
SELECTED OPERATING DATA:
Year-end credit card loans $ 846,417 $ 2,756,763 $ 1,184,269 $ 150,200 $ 5,871
Year-end assets 2,590,392 4,165,975 3,738,307 2,041,862 928,326 28.7%
Average credit card loans 1,305,127 1,709,989 614,991 78,036 8,791
Average interest-earning assets 1,889,768 2,060,191 838,468 1,485,094 729,299 26.9
Average assets 3,334,850 3,903,846 2,826,653 193,926 51,729 183.4
Average total equity 1,116,578 1,011,573 759,653 564,288 313,237 37.4
Year-end deposits 892,754 2,058,008 2,106,199 775,381 --
Year-end debt 357,649 647,904 356,066 345,012 310,896 3.6
Year-end preferred stock 430,642 393,970 360,421 329,729 201,100 21.0
Return on average assets N/A 4.1% 6.6% 56.5% 128.9%
Return on average total equity N/A 15.8% 24.5% 19.4% 21.3%
Net interest margin 6.7% 9.8% (1.5)% 1.9% (3.9)% N/A
Allowance for loan losses $ 90,315 $ 460,159 $ 123,123 $ 12,175 $ --
Allowance for loan losses as a
percent of 30-day plus delinquent
receivables 1,146.7% 165.7% 138.1% 351.1% --
Delinquency ratio (3) 0.9% 10.1% 7.5% 2.3% --
Allowance for loan losses as a
percent of credit card loans 10.7% 16.7% 10.4% 8.1% --
Net charge-off ratio (4) 24.9% 12.3% 9.7% 52.7% --
4
TABLE 1: SELECTED FINANCIAL DATA (CONTINUED)
YEAR ENDED DECEMBER 31,
FOUR-YEAR
COMPOUND
2002 2001 2000 1999 1998 GROWTH RATE
---------- ---------- ---------- ---------- ---------- ----------
SELECTED ENHANCEMENT SERVICES DATA:
Revenue:
Membership products $ 92,919 $ 57,186 $ 75,981 $ 31,858 $ 13,301 62.6
Warranty/other 60,597 84,736 45,578 33,494 17,086 37.2
---------- ---------- ---------- ---------- ----------
Total revenue $ 153,516 $ 141,922 $ 121,559 $ 65,352 $ 30,387 49.9
---------- ---------- ---------- ---------- ----------
Deferred Revenue:
Membership products 114,184 130,922 159,481 89,812 44,201 26.8
Warranty/other 18,377 38,211 28,999 32,206 24,541 (7.0)
---------- ---------- ---------- ---------- ----------
Year-end deferred revenue $ 132,561 $ 169,133 $ 188,480 $ 122,018 $ 68,742 17.8
---------- ---------- ---------- ---------- ----------
Year-end deferred acquisition costs $ 48,647 $ 42,091 $ 37,149 $ 24,482 $ 21,746 22.3
Total enrollments 3,292 3,475 4,809 3,294 2,441 7.8
Third-party enrollments 1,825 1,398 1,675 1,336 1,316 8.5
Active members 5,094 5,775 6,067 4,902 3,619 8.9
(1) 1999 results include a permanent nondeductible tax difference of $50.8
million due to the extinguishment of the Series B Preferred Stock and 12%
Senior Notes, and the cancellation of warrants in June 1999 with the
issuance of its Series C Preferred Stock.
(2) "Book value" is calculated assuming conversion of preferred stock.
(3) "Delinquency ratio" represents credit card loans that were at least 30 days
contractually past due at year-end as a percentage of year-end owned credit
card loans. The decrease in delinquencies as of December 31, 2002 versus
December 31, 2001 primarily reflects the sale of approximately $120 million
delinquent receivables during September and December 2002.
(4) "Net charge-off ratio" reflects actual principal amounts charged-off, less
recoveries, as a percentage of average credit card loans. The net charge-off
ratio also includes a $101.5 million charge-off of loans transferred to
"held for sale."
5
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The consolidated statements of income for the years ended December 31,
2002, 2001 and 2000 and the consolidated balance sheets as of December 31, 2002
and 2001 have been restated. See Note 2 - restatements on page XX for further
discussion.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Net loss applicable to common stockholders for the year ended December
31, 2002 was $39.6 million, or ($.66) per diluted share, down from net income
applicable to common stockholders of $125.3 million, or $1.61 per diluted share
in 2001. The decrease in net income is primarily due to a $326.9 million
reduction in securitization income from 2001, caused by a 205 basis point
reduction in excess spread due to higher default rates in the Metris Master
Trust (Metris Master Trust or Master Trust). The annual principal default rate
in the Master Trust during 2002 was 16.4% compared to 13.2% in 2001.
Net interest income decreased from $202.9 million for the year ended
December 31, 2001 to $125.9 million for year ended December 31, 2002. The
decrease is due to a decrease in average interest-earning assets of $170.4
million and a 310 basis point reduction in net interest margin. The decrease in
margin is primarily due to a 390 basis point decrease in yield on credit card
loans resulting from a $404.9 million reduction in average credit card loans and
a 50 basis point reduction in the prime rate during the past year. Additionally,
there was a shift in the mix of assets from higher yielding credit card loans to
lower yielding investments. For the year ended December 31, 2002, 69.1% of our
average interest-earning assets were in credit card loans, compared to 83.0% for
the year ended December 31, 2001.
The provision for loan losses was $219.8 million in 2002 compared to
$461.1 million in 2001. The decrease relates to the estimated required balance
in the allowance for loan losses to cover probable losses inherent in our loan
portfolio under current conditions. The size of the credit card loan portfolio,
net principal charge-offs, recent delinquency and collection trends, and current
economic conditions were factors considered by management in determining the
necessary balance in the allowance for loan losses. Average credit card loans
decreased to $1.3 billion in 2002 from $1.7 billion in 2001. The net principal
charge-off rate was 24.9% in 2002 compared to 12.3% in 2001. The increase in the
net principal charge-off rate is partially due to the sale of approximately $120
million of delinquent receivables in 2002. The sale resulted in a charge-off of
$101.5 million. The weak economic environment and the effects of the Company's
2001 credit line increase program on the severity of credit losses also
adversely affected the net charge-off rate.
Other operating income decreased $438.0 million, or 34%, to $835.4
million for the year ended December 31, 2002. This decrease was primarily due to
a $326.9 million decrease in securitization income to $323.5 million in 2002.
The decrease in securitization income was primarily due to an unfavorable change
in the market value adjustment of $370.1 million and a reduction of $58.5
million in interest-only revenue based on the performance of the underlying
assets. These changes were partially offset by an increase of $63.4 million in
gains on asset replenishment and an $83.7 million increase in discount accretion
income. Servicing income on securitized/sold receivables of $195.2 million
increased $36.1 million over 2001. The increase in servicing income was due to
the increase in securitized credit card receivables due to the transfer of
approximately $2.3 billion of receivables from Direct Merchants Bank to the
Master Trust. Credit card fees, interchange and other credit card income
decreased to $163.2 million in 2002, compared to $322.0 million in 2001. The
decrease in credit card fees, interchange and other credit card income is due to
the reduction of our owned credit
6
card portfolio. In addition, we also amended the Master Trust core transaction
documents, which resulted in interchange income earned on receivables held by
the Master Trust to be recorded as contribution to the excess spread earned,
effective May 2002. In 2002, $44.3 million of interchange income was earned by
the Master Trust. Enhancement services revenue increased 8.2% to $153.5 million
due primarily to increased active enrollments in various membership products.
These increases were partially offset by a decrease in ServiceEdge(R) revenue
due to the run-off of the ServiceEdge(R) portfolio and a decrease in
PurchaseShield(R) revenue due to decreased enrollments.
Other operating expenses increased to $741.2 million in 2002, compared
to $727.3 million in 2001. This increase was primarily due to $27.7 million of
asset impairments and lease write-offs and a $14.1 million increase in credit
protection claims expense, partially offset by $14.6 million in lower employee
compensation expenses. During 2002, we recorded approximately $17.1 million of
write-downs of excess property, equipment, operating leases, and the pending
sale of our Arizona building, approximately $7 million of marketing and
origination costs on our retail note program and a $10.6 million write-down of
portfolios of charged-off loans purchased in 2001 and 2000.
CRITICAL ACCOUNTING POLICIES
The Company's accounting policies are identified on pages 55-63 of this
Report, the most significant of which are our determination of the allowance for
loan losses, valuation of retained interests in loans securitized, and
accounting for deferred acquisition costs and deferred revenue on enhancement
services products.
Allowance for loan losses
We maintain an allowance for loan losses sufficient to absorb
anticipated probable loan losses inherent in the credit card loan portfolio as
of the balance sheet date. At the time of charge-off, all principal balances are
written off against the allowance and all fees and finance charges are netted
against the applicable income statement line item. The allowance is based on
management's consideration of all relevant factors, including management's
assessment of applicable economic and seasonal trends.
We segment the loan portfolio into several individual liquidating pools
with similar credit risk and time since solicitation (vintage pools), and
estimate (based on historical experience and existing economic 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 subprime 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 includes higher risk segments, such as
our secured card program, accounts that are over their credit limit by more than
10% and other programs as deemed necessary. We separately analyze the reserve
requirement on each of these groups or portfolios. The impact on the allowance
for loan losses for accounts in suspended status under our debt waiver benefits
is included in the vintage pool roll-rate analysis.
We continually evaluate the homogenous liquidating risk pools using a
roll-rate model which uses historical delinquency levels and pay-down levels (12
months of historical data, with influence given to the last six months'
performance to capture current economic and seasonal trends), loan seasoning and
other measures of asset quality to estimate charge-offs for both credit loss and
bankruptcy losses.
7
Additionally, in evaluating the adequacy of the loan loss reserves, we
consider several subjective factors which may be overlaid into the credit risk
roll-rate model in determining the necessary loan loss reserve, including:
- national and economic trends and business conditions,
including the condition of various market segments;
- changes in lending policies and procedures, including those
for underwriting, collection, charge-off and recovery, as well
as changes in the experience, ability and depth of lending
management and staff;
- trends in volume and the product pricing of accounts,
including any concentrations of credit; and
- impacts from external factors - such as, changes in
competition, and legal and regulatory requirements - on the
level of estimated credit losses in the current portfolio.
Significant changes in these factors could impact our financial
projections and thereby affect the adequacy of our allowance for loan losses.
Valuation of Retained Interests in Loans Securitized
The "Retained interests in loans securitized" on our balance sheet
associated with our securitization transactions includes contractual retained
interests, transferor's interests, interest-only strip receivable, and spread
accounts receivable. We determine the fair value of each component of the
"Retained interests in loans securitized" at the time a securitization
transaction or replenishment sale is completed using a discounted cash flow
valuation model and on a quarterly basis thereafter. Any change in the fair
value is recorded in "Securitization income."
The discounted cash flow valuation is limited to the receivables that
exist and have been sold to the Metris Master Trust. Therefore, the model
assumes current principal receivable balances amortize with no new sales,
interchange fees or cash advances. The future cash flows are modeled in
accordance with the debt series' legal documents and are applied to all series
on a pro-rata basis. Excess fee income, finance charge and recovery cash flows
above contractual expense payments are first applied to meet spread accounts
receivable requirements then returned to us as part of the interest-only strip
receivable. We determine upper and lower valuation limits of the "Retained
interests in loans securitized" based on historical and forecasted excess
spreads. We then determine the best estimate within the range based on
historical trends (weighted heavily toward the low end of the range), adjusted
when appropriate, for portfolio forecast information.
The contractual retained interests represent the subordinated
securities held by us. There is no stated interest/coupon rate associated with
these securities and they are not rated. They are subordinate to all other
securities, except for the interest-only strip receivable we own and
accordingly, are repaid last. Their fair value is determined by discounting the
expected future cash flows using a discount rate commensurate with the risks of
the underlying assets and the expected timing based on the scheduled maturity
date for the underlying securitization. If these securities are recoverable
based on the Metris Master Trust forecasts, cash flows related to the entire
subordinated principal balance are used in determining their fair value.
Transferor's interests represent undivided interests in receivables
that are not pledged to support a specific security series or class and
represent our interest in the excess principal receivables held in the Metris
Master Trust. The fair value is determined in the same manner as the contractual
retained interests and is discounted based on twelve months to maturity. We have
subordinated our rights to the excess cash
8
flows on the principal receivables underlying the transferor's interest, thus
they are included in the value of the interest-only strip receivable. Spread
accounts receivable balances represent cash held by the Metris Master Trust
trustee due to Trust performance and requisite reserves required by certain
security series. These balances earn interest and the change in fair value is
determined in the same manner as the contractual retained interests.
The interest-only strip receivable represents the contractual right to
receive from the Metris Master Trust interest and other fee revenue less certain
costs over the estimated life of the underlying debt securities. The fair value
is determined by discounting the expected future cash flows using a discount
rate commensurate with the risks of the underlying assets and the expected
timing of the amortization inherent in the retained interest valuation model. We
believe our discount rates are consistent with what other market place
participants would use to determine the fair value of these assets. The
valuation model assumes that we repurchase the outstanding principal receivables
at face value according to the clean up call provisions contained in the
respective security series' legal documents.
We use certain assumptions and estimates in determining the fair values
of "Retained interests in loans securitized." These assumptions and estimates
include estimated principal payments, credit losses, gross yield, interest
expense, fees, the timing of cash receipts, and discount rates commensurate with
the risks of the underlying assets. On a quarterly basis, we review and adjust
as appropriate the assumptions and estimates used in our model based on a
variety of internal and external factors, including national and economic trends
and business conditions, current lending policies, procedures and strategies,
historical trends and assumptions about future trends, competition and legal and
regulatory requirements. Significant estimates are required in determining these
factors and different judgments concerning these factors can result in a
material impact on our balance sheet and income statement. The accompanying
unaudited consolidated financial statements do not include an adjustment to the
fair value of retained interest that might result from the inability to finance
future receivables.
Deferred Acquisition Costs on Enhancement Services Products
We defer qualifying acquisition costs associated with our enhancement
services products. These costs, which relate directly to membership
solicitations (direct response advertising costs), principally include postage,
printing, mailing telemarketing costs, and commissions paid to third parties.
The total amount of enhancement services deferred costs as of December 31, 2002
and 2001 were $73.2 million and $79.4 million, respectively. If deferred
acquisition costs were to exceed forecasted future cash flows, we would make an
appropriate adjustment for impairment. The most significant assumption used by
the Company in determining the realizability of these deferred costs is future
revenues from our enhancement services products. A significant reduction in
revenues could have a material impact on the values of these balances.
Debt Waiver Products
Qualifying membership acquisition costs are deferred and charged to
expense as debt waiver product fees are recognized. We amortize these costs
using an accelerated methodology, which approximates our historical cancellation
experience for debt waiver products. Amortization of debt waiver acquisition
costs was $3.7 million for the year ended December 31, 2002. All other debt
waiver acquisition costs are expensed as incurred. Deferred debt waiver
acquisition costs were $2.6 million as of December 31, 2002.
9
Membership Program Products
Qualifying membership acquisition costs are deferred and charged to expense as
membership fees are recognized. We amortize all deferred costs on a
straight-line basis for all annually billed products, and on an accelerated
method for all monthly billed products, which approximates our historical
cancellation experience for membership program products. Amortization of
membership deferred costs was $55.4 million, $28.0 million and $19.8 million for
the years ended December 31, 2002, 2001 and 2000, respectively. All other
membership acquisition costs are expensed as incurred. Deferred membership
acquisition costs were $66.9 million and $66.7 million as of December 31, 2002
and 2001, respectively.
Warranty Products
Qualifying warranty acquisition costs are deferred and charged to
expense as warranty product fees are recognized. Those incremental direct
acquisition costs, which are a result of a contract that is not consummated, are
charged to expense as incurred. A successful effort conversion percentage is
applied to these incremental direct acquisition costs, which approximates our
historical successful effort rate percentage in negotiating warranty products.
We amortize these deferred costs using an accelerated amortization methodology,
which approximates our historical cancellation experience following the
expiration of the manufacturer's contractual cancellation period for the
warranty products. Amortization of warranty acquisition costs were $12.8
million, $15.9 million, and $10.4 million for the years ended December 31, 2002,
2001, and 2000, respectively. All other warranty acquisition costs are expensed
as incurred. Deferred warranty acquisition costs amount to $3.0 million and
$12.7 million as of December 31, 2002 and 2001, respectively.
Revenue Recognition on Enhancement Services Products
Debt Waiver Products
Direct Merchants Bank offers various debt waiver products on receivables it owns
as well as securitized receivables. Direct Merchants Bank records deferred
revenue when the debt waiver customer is billed. For customers whose accounts
are funded on balance sheet, revenue is recognized in the month following the
completion of the of the cancellation period, which is one month. Cash flows
related to debt waiver on receivables sold to the Metris Master Trust are
included in the valuation of the interest-only strip receivable. Direct
Merchants Bank incurs the related claims and marketing expenses. A reserve is
maintained for future death and finance charge claims based on Direct Merchants
Bank's historical experience with settlement of such claims. Reserves for
pending claims and incurred but not reported claims are recorded in the
consolidated balance sheets in "accrued expenses and other liabilities."
Reserves for pending and incurred but not reported claims were $8.2 million as
of December 31, 2002, compared to $5.2 million as of December 31, 2001.
Membership Program Products
We bill membership fees for enhancement services products through financial
institutions, including Direct Merchants Bank, and other cardholder-based
institutions. We record these fees as deferred membership income upon acceptance
of membership and amortize them on a straight-line basis for all annually billed
products, and on an accelerated amortization method for all monthly billed
products over the membership period beginning after the contractual cancellation
period is complete. A liability is established and netted against the related
receivable in the consolidated balance sheets in "other assets" from inception
of the membership through the end of the cancellation period that reflects our
historical cancellation experience with these
10
products. Gross receivables as of December 31, 2002 on the membership program
products were $22.0 million compared to $38.7 million as of December 31, 2001.
Cancellation reserves were $19.5 million and $29.6 million for the years ended
December 31, 2002 and 2001, respectively. Revenues recorded for membership
products are included in the statements of income under "enhancement services
revenues" and were $92.9 million, $57.2 million and $76.0 million for the years
ended December 31, 2002, 2001 and 2000, respectively. Unearned revenues on
membership program products are recorded in the consolidated balance sheets in
"deferred income." Unearned revenues as of December 31, 2002 were $114.2 million
compared to $130.9 million as of December 31, 2001. Reserves for pending and
incurred but not reported claims, included in "accrued expenses and other
liabilities," were $0.1 million as of December 31, 2002, compared to $0.2
million as of December 31, 2001.
Warranty Products
We coordinate the marketing activities for Direct Merchants Bank and
third-party sales of extended service plans. We perform administrative services
and retain the claims risk for all extended service plans sold. As a result, we
defer and recognize extended service plan revenues and the incremental direct
acquisition costs on an accelerated amortization method over the life of the
related extended service plan contracts beginning after the expiration of any
manufacturer's warranty coverage. A liability is established and netted against
the related receivable in the consolidated balance sheets in "other assets" from
inception of the extended service plan through the end of the cancellation
period that reflects our historical cancellation experience with these products.
Gross receivables as of December 31, 2002 on the warranty products were $3.8
million compared to $7.0 million as of December 31, 2001. Cancellation reserves
were $5.3 million and $6.2 million for the years ended December 31, 2002 and
2001, respectively. Unearned revenues on warranty products are recorded in the
consolidated balance sheets in "deferred income. " Unearned revenues as of
December 31, 2002 were $17.6 million compared to $33.8 million as of December
31, 2001. Reserves for pending and incurred but reported claims, included in
"accrued expenses and other liabilities," were $0.7 million as of December 31,
2002, compared to $0.5 million as of December 31, 2001.
11
NET INTEREST INCOME
Net interest income consists primarily of interest earned on our credit
card loans, less interest expense on borrowings to fund loans. Table 2 provides
an analysis of interest income and expense, net interest spread, net interest
margin and average balance sheet data for the years ended December 31, 2002,
2001 and 2000.
TABLE 2: ANALYSIS OF AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS AND RATES
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------
2002 2001
---- ----
(Dollars in thousands) Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
----------- ----------- ----------- ----------- ----------- -----------
ASSETS:
Interest-earning assets:
Federal funds sold $ 23,750 $ 403 1.7% $ 63,981 $ 3,115 4.9%
Short-term investments 560,891 10,121 1.8% 286,221 12,373 4.3%
Credit card loans 1,305,127 218,878 16.8% 1,709,989 353,650 20.7%
----------- ----------- ----------- -----------
Total interest-earning assets $ 1,889,768 $ 229,402 12.1% $ 2,060,191 $ 369,138 17.9%
Other assets 1,696,174 -- -- 2,089,242 -- --
Allowance for loan losses (251,092) -- -- (245,587) -- --
----------- -----------
Total assets $ 3,334,850 -- -- $ 3,903,846 -- --
=========== ===========
LIABILITIES AND EQUITY:
Interest-bearing liabilities:
Deposits $ 1,406,022 $ 68,740 4.9% $ 2,110,967 $ 127,916 6.1%
Debt 380,728 34,776 9.1% 379,159 38,361 10.1%
----------- ----------- ----------- -----------
Total interest-bearing
liabilities $ 1,786,750 $ 103,516 5.8% $ 2,490,126 $ 166,277 6.7%
Other liabilities 431,522 -- -- 402,147 -- --
----------- ----------
Total liabilities 2,218,272 -- -- 2,892,273 -- --
Stockholders' equity 1,116,578 -- -- 1,011,573 -- --
----------- ----------
Total liabilities and equity $ 3,334,850 -- -- $ 3,903,846 -- --
=========== ===========
Net interest income and
interest margin (1) -- $ 125,886 6.7% -- $202,861 9.8%
Net interest rate spread (2) -- -- 6.3% -- -- 11.2%
Return on average assets N/A 4.1%
Return on average total
equity N/A 15.8%
(1) We compute "net interest margin" by dividing net interest income by
average total interest-earning assets.
(2) The "net interest rate spread" is the yield on average interest-earning
assets minus the funding rate on average interest-bearing liabilities.
12
TABLE 2: ANALYSIS OF AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS AND RATES
(CONTINUED)
YEAR ENDED DECEMBER 31,
2000
Table changes ------------------------------------------
(Dollars in thousands) Average Yield/
Balance Interest Rate
----------- ----------- -----------
ASSETS:
Interest-earning assets:
Federal funds sold $ 144,780 $ 9,139 6.3%
Short-term investments 78,697 4,710 6.0%
Credit card loans 614,991 106,549 17.3%
----------- -----------
Total interest-earning assets $ 838,468 $ 120,398 14.4%
Other assets 2,068,537 -- --
Allowance for loan losses (80,352) -- --
-----------
Total assets $ 2,826,653 -- --
===========
LIABILITIES AND EQUITY:
Interest-bearing liabilities:
Deposits $ 1,317,718 $ 89,560 6.8%
Debt 354,204 43,446 12.3%
----------- -----------
Total interest-bearing liabilities $ 1,671,922 $ 133,006 8.0%
Other liabilities 395,078 -- --
-----------
Total liabilities 2,067,000 -- --
Stockholders' equity 759,653 -- --
-----------
Total liabilities and equity $ 2,826,653 -- --
===========
Net interest income and interest
margin (1) -- $ (12,608) (1.5)%
Net interest rate spread (2) -- -- 6.4%
Return on average assets 6.6%
Return on average total
equity 24.5%
Net interest income decreased from $202.9 million for the year ended
December 31, 2001 to $125.9 million for year ended December 31, 2002. The
decrease is due to a decrease in average interest-earning assets of $170.4
million and a 310 basis point reduction in net interest margin. The decrease in
margin is primarily due to a 390-basis-point decrease in yield on credit card
loans resulting from a $404.9 million reduction in average credit card loans and
retained interests in securitized loans, and a 50-basis-point reduction in the
Prime rate during the past year. As of December 31, 2002, 69.1% of our
interest-earning assets were in credit card loans compared to 83.0% as of
December 31, 2001.
Risk-Based Pricing
Net interest income is affected by changes in the average interest rate
earned on interest-earning assets and the average interest rate paid on
interest-bearing liabilities, in addition to changes in the volume of
interest-earning assets and interest-bearing liabilities. Table 3 presents the
effects of changes in average volume and interest rates on individual financial
statement line items on an owned basis.
13
TABLE 3: CHANGES IN NET INTEREST INCOME
Update table YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
2002 VS. 2001 2001 VS. 2000
--------------------------------------------------------------------------
INCREASE CHANGE DUE TO INCREASE CHANGE DUE TO
(Dollars in thousands) (DECREASE) VOLUME RATE (DECREASE) VOLUME RATE
--------- --------- --------- --------- --------- ---------
INTEREST INCOME:
Federal funds sold $ (2,712) $ (1,959) $ (753) $ (6,024) $ (5,100) $ (924)
Short-term investments (2,252) 11,874 (14,126) 7,663 12,420 (4,757)
Credit card loans (134,772) (83,731) (51,041) 247,101 189,712 57,389
--------- --------- --------- --------- --------- ---------
Total interest income (139,736) (73,816) (65,920) 248,740 197,032 51,708
Deposit interest
expense (59,176) (42,717) (16,459) 38,356 53,914 (15,558)
Other interest expense (3,585) 159 (3,744) (5,085) 3,061 (8,146)
--------- --------- --------- --------- --------- ---------
Total interest expense (62,761) (42,558) (20,203) 33,271 56,975 (23,704)
--------- --------- --------- --------- --------- ---------
Net interest income $ (76,975) $ (31,258) $ (45,717) $ 215,469 $ 140,057 $ 75,412
========= ========= ========= ========= ========= =========
CREDIT CARD RECEIVABLES
Our delinquency and net loan charge-off rates at any point in time
reflect, among other factors, the credit risk of loans, the average age of our
various credit card account portfolios, the success of our collection and
recovery efforts, and general economic conditions. The average age of our credit
card portfolio affects the stability of delinquency and loss rates. In order to
minimize losses, we continue to focus our resources on refining our credit
underwriting standards for new accounts, and on collections and post charge-off
recovery efforts. At December 31, 2002, 49.5% of our outstanding receivables
balance was from accounts that have been with us in excess of two years, and
22.0% of outstanding receivables were with us in excess of four years.
We use credit line analyses, account management and customer
transaction authorization procedures to minimize loan losses. Our risk models
determine initial credit lines at the time of underwriting. We manage credit
lines on an ongoing basis and adjust them based on customer usage and payment
patterns. We continually monitor customer accounts and initiate appropriate
collection activities when an account is delinquent or overlimit.
Delinquencies
Delinquencies not only have the potential to affect earnings in the
form of net loan losses, but they also are 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, except in limited
circumstances, until we charge-off the account. Beginning in November 2002, we
stopped billing late fees once an account became 120 days contractually
delinquent. Past due accounts are re-aged to current status only after we
receive at least three minimum payments or the equivalent cumulative amount.
Accounts can only be re-aged to current status once every twelve months and two
times every five years. Accounts entering long-term fixed payment forbearance
programs ("workout re-age") may receive a workout re-age upon entering the Debt
Management Program. Workout re-ages can only occur after receipt of at least
three consecutive minimum monthly payments, or the equivalent cumulative amount
as defined by the Debt Management Program. Workout re-ages can only occur once
in five years. Table 4 presents the delinquency trends of our credit card loan
portfolio.
14
TABLE 4: LOAN DELINQUENCY
DECEMBER 31, % OF DECEMBER 31, % OF DECEMBER 31, % OF
2002 TOTAL 2001 TOTAL 2000 TOTAL
---------- ---------- ----------- ---------- ----------- ----------
(Dollars in
thousands)
Loan portfolio $ 846,417 100% $2,756,763 100% $1,184,269 100%
Loans contractually
delinquent:
30 to 59 days 1,673 0.2% 87,603 3.2% 27,837 2.3%
60 to 89 days 2,121 0.2% 66,647 2.4% 22,074 1.9%
90 or more days 4,082 0.5% 123,528 4.5% 39,257 3.3%
---------- ---------- ---------- ---------- ---------- ----------
Total $ 7,876 0.9% $ 277,778 10.1% $ 89,168 7.5%
========== ========== ========== ========== ========== ==========
The decrease in delinquencies as of December 31, 2002 versus December
31, 2001 primarily reflects the sale of approximately $120 million delinquent
receivables during September and December 2002.
Net charge-offs
Net charge-offs are the principal amount of losses from cardholders
unwilling or unable to make minimum payments, bankrupt cardholders and deceased
cardholders, less current period recoveries. Net charge-offs exclude accrued
finance charges and fees, which are charged-off against the applicable income
statement line item at the time of charge-off. We charge-off and take accounts
as a loss either within 60 days after formal notification of bankruptcy, at the
end of the month during which most unsecured accounts become contractually 180
days past due, at the end of the month during which unsecured accounts that have
entered into a credit counseling or other similar program and later become
contractually 120 days past due, or at the end of the month during which secured
accounts become contractually 120 days past due after first reducing the loss by
the secured deposit.
Charge-offs due to bankruptcies were $61.5 million, representing 17.8%
of total gross charge-offs as of December 31, 2002 and $76.3 million,
representing 27.8% of total gross charge-offs as of December 31, 2001. We
charge-off accounts that are identified as fraud losses no later than 90 days
after the last activity. We enter into forward flow agreements with third
parties for the sale of a majority of charged-off accounts. We also refer
charged-off accounts to our recovery unit for coordination of collection efforts
to recover the amounts owed. When appropriate, we place accounts with external
collection agencies or attorneys.
Table 5 presents our net charge-offs for the periods indicated as
reported in the consolidated financial statements:
TABLE 5: NET CHARGE-OFFS
YEAR ENDED DECEMBER 31,
--------------------------------------
2002 2001 2000
---- ---- ----
(Dollars in thousands)
Average credit card loans
outstanding $1,305,127 $1,709,989 $ 614,991
Net charge-offs 325,351 209,779 59,679
Net charge-off ratio 24.9% 12.3% 9.7%
========== ========== ==========
Net charge-offs for the year ended December 31, 2002 increased $115.6
million over the year ended December 31, 2001. The increase is due to a $101.5
million charge-
15
off for receivables that were sold during the year. The net charge-off ratio
increased from 12.3% to 24.9% due to the sale of the delinquent receivables, the
weak economic environment and the impact of the Company's 2001 credit line
increase program on the severity of credit losses.
Provision and Allowance for Loan Losses
We record provisions for loan losses in amounts necessary to maintain
the allowance at a level sufficient to absorb anticipated probable loan losses
inherent in the existing loan portfolio as of the balance sheet date.
The economy has exhibited a significant slowdown over the last two
years. Some of the actions we are taking to mitigate this slowdown include
expanding our collections strategies to aggressively address any potential
delinquency increases and utilizing our recovery staff to work on precharge-off
receivables. We also leverage forbearance programs and credit counseling
services for qualifying cardholders that are experiencing payment difficulties.
These programs include reduced interest rates, reduced or suspended fees and
other incentives to induce the customer to continue making payments. The amount
of customer receivables in Debt Management Programs was $34.7 million or 4.1% of
total credit card loans as of December 31, 2002, compared to $129.9 million or
5% of total credit card loans as of December 31, 2001.
The provision for loan losses for the year ended December 31, 2002,
totaled $219.8 million compared to a provision of $461.1 million in 2001. The
decrease in the provision for loan losses in 2002 compared to 2001 reflects the
decrease in credit card loans due to the transfer of approximately $2.3 billion
of receivables from Direct Merchants Bank to the Master Trust.
The allowance for loan losses was $90.3 million as of December 31,
2002, compared to $460.2 million as of December 31, 2001. In our previously
filed 2002 Form 10-K, our "Allowance for Loan Losses" was $410.2 million at
December 31, 2001 since we had $50 million of "Allowance for loan losses"
classified as valuation reserve in our "Retained interests in loans
securitized." The valuation reserve was transferred to "Allowance for loan
losses" through "Provision for loans losses" during the first quarter of 2002.
We have restated the December 31, 2001 balance sheet and 2001 income statement
to reflect this transfer occurring during the fourth quarter of 2001.
Our roll-rate models, including management contingency, indicated our
required allowance for loan losses was in the range of $75 million to $90
million as of December 31, 2002, compared to $410 million to $460 million as of
December 31, 2001. The ratio of allowance for loan losses to period-end credit
card loans was 10.7% at December 31, 2002, compared to 16.7% at December 31,
2001. The allowance for loan losses as a percentage of 30-day plus receivables
was 1,146.7% at December 31, 2002, compared to 165.7% at December 31, 2001. The
increase in the allowance as a percentage of credit card loans and the increase
in allowance as a percentage of 30-day plus receivables is primarily due to the
sale of approximately $120 million of delinquent receivables during 2002.
We believe the allowance for loan losses is adequate to cover probable
future losses inherent in the loan portfolio under current conditions. However,
we cannot give assurance as to future credit losses that may be incurred in
connection with our loan portfolio, nor can we provide assurance that the
established allowance for loan losses will be sufficient to absorb future
losses.
16
Valuation of Retained Interests in Loans Securitized
Our credit card receivables are primarily funded through asset
securitizations. Upon securitization, the Company removes the applicable credit
card loans from the balance sheet and recognizes the retained interests in loans
securitized at their allocated carrying value in accordance with SFAS No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities-a replacement of FASB Statement No. 125" ("SFAS No. 140"). Credit
card receivables are sold to the Metris Master Trust at the inception of a
securitization series. We also sell receivables to the Metris Master Trust on a
daily basis to replenish receivable balances that have decreased due to payments
and charge-offs. The difference between the allocated carrying value and the
proceeds from the assets sold is recorded as a gain or loss on sale and is
included in "Securitization (expense) income." At the same time, the Company
recognizes the "Retained interests in loans securitized."
The "Retained interests in loans securitized" are financial assets
measured at fair value consistent with trading securities in accordance with
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and includes the contractual retained interests, an interest-only
strip receivable, excess transferor's interests and spread accounts receivable.
The contractual retained interests consist of non-interest bearing securities
held by the Company.
The interest-only strip receivable represents the present value of the
excess of the estimated future interest and fee collections expected to be
generated by the securitized loans over the period the securitized loans are
projected to be outstanding above the interest paid on investor certificates,
credit losses, contractual servicing fees, and other expenses. The excess
transferor's interests represent principal receivables held in the Metris Master
Trust over the contractual retained interests. Spread accounts receivable
represents restricted cash reserve accounts held by the Metris Master Trust that
can be used to fund payments due to securitization investors and credit
enhancers if cash flows are insufficient. Cash held in spread accounts is
released to us if certain conditions are met or a securitization series
terminates with amounts remaining in the spread accounts. The fair value of the
"Retained interests in loans securitized" is determined through estimated cash
flows discounted at rates that reflect the level of subordination, the projected
repayment term, and the credit risk of the securitized loans.
The following summarizes our "Retained interests in loans securitized"
as of December 31, 2002 and December 31, 2001.
TABLE 6: RETAINED INTERESTS IN LOANS SECURITIZED
(In thousands): DECEMBER 31, DECEMBER 31,
2002 2001
---- ----
Contractual retained interests $ 685,197 $ 571,715
Excess transferor's interests 57,447 30,836
Interest-only strip receivable 13,882 214,707
Spread accounts receivable 51,500 42,301
---------- ----------
Retained interests in loans securitized $ 808,026 $ 859,559
========== ==========
"Retained interests in loans securitized" decreased by $51.5 million
between December 31, 2001, and December 31, 2002, to $808.0 million. The
decrease is primarily due to a decrease of $200.8 million in interest-only strip
receivable offset by a $113.5 million increase in contractual retained
interests, a $26.6 million increase in excess transferor's interests, and a $9.2
million increase in spread accounts receivable.
17
The increase in the contractual retained interests is primarily due to
a $1.3 billion increase in securitized receivables from December 31, 2001 to
December 31, 2002. The interest-only strip receivable decreased to $13.9 million
as of December 31, 2002, from $214.7 million as of December 31, 2001, due to
lower projected excess spreads from the receivables held in the Metris Master
Trust. The projected excess spreads have decreased primarily due to higher
expected principal default rates partially offset by lower cost of funds. Spread
accounts receivable increased over December 31, 2001, as excess spread earned on
receivables held in the Metris Master Trust is being restricted from release to
the Company due to the performance of the receivables. For more information on
restricted cash see the Liquidity, Funding and Capital Resources section of the
Management Discussion and Analysis on pages 22 through 29.
At least quarterly, the Company adjusts the valuation of the "Retained interests
in loans securitized" to reflect changes in the amount and expected timing of
future cash flows. The significant factors that affect the timing and amount of
cash flows relate to the collateral assumptions, which include payment rate,
default rate, gross yield and discount rate. These values can, and will, vary as
a result of changes in the amount and timing of the cash flows and the
underlying economic assumptions. The components of retained interests are
recorded at their fair value. The significant assumptions used for estimating
the fair value of the retained interests in loans securitized are as follows:
DECEMBER 31, DECEMBER 31,
2002 2001
---- ----
Monthly payment rate 6.7% 6.3%
Gross yield (1) 26.0% 25.4%
Annual interest expense and servicing fees 4.0% 5.5%
Annual gross principal default rate 21.7% 16.6%
Discount rate (2):
Contractual retained interests 16.0% 12.0%
Excess transferor's interests 16.0% 12.0%
Interest-only strip receivable 30.0% 25.0%
Spread accounts receivable 16.0% 12.0%
(1) Includes expected cash flows from finance charges, late and overlimit fees,
debt waiver premiums and bad debt recoveries, net of finance charge and fee
charge-offs. Gross yield for purposes of estimating fair value does not include
interchange income, or cash advance fees.
(2) The discount rates used in the retained interest valuation take into
consideration the uncertainty inherent in the portfolio. The deterioration in
credit quality and overall performance of the Metris Master Trust in 2002 create
a higher risk to future cash flows. Based on the increased risk in the
portfolio, the discount rates were increased during 2002.
18
At December 31, 2002, the sensitivity of the current fair value of the
retained interests to immediate 10% and 20% adverse changes are as follows (in
millions):
ADVERSE IMPACT ON FAIR VALUE
----------------------------
10% ADVERSE 20% ADVERSE
CHANGE CHANGE
----------- -----------
Annual discount rate $ 24.3 $ 47.4
Monthly payment rate 183.7 425.5
Gross yield 172.1 362.1
Annual interest expense and servicing fees 26.0 59.6
Annual gross principal default rate 135.6 278.5
As the sensitivity indicates, the value of the Company's retained
interests on its balance sheet, as well as reported earnings, could differ
significantly if different assumptions or conditions prevail.
OTHER OPERATING INCOME
Other operating income contributed 87% and 86% of total revenues for
both of the years ended December 31, 2002 and 2001, respectively. Other
operating income decreased $438.0 million for the year ended December 31, 2002
over 2001.
Securitization income decreased $326.9 million to $323.5 million in
2002. The decrease was primarily due to a decrease in fair value adjustments of
$370.1 million and a decrease in interest-only revenue of $58.5 million, both of
which are primarily due to deteriorating performance in the Metris Master Trust
and the increase in discount rates noted on page 20. In addition, transaction
and other costs increased by $35.2 million during the year. These changes were
partially offset by decreases in net losses on securitization of $53.4 million
and an $83.7 million increase in accretion income due to the change in discount
rates. The following summarizes "Securitization income" for the years ended
December 31, 2002, December 31, 2001 and December 31, 2000.
DECEMBER 31,
2002 2001 2000
---------- ---------- ----------
Loss on new securitization of receivables to the
Metris Master Trust $ (70,578) $ (60,574) $ (52,406)
(Loss) gain on replenishment of receivables to
the Metris Master Trust 28,706 (34,672) (24,816)
Discount accretion 305,327 221,670 279,500
Change in fair value (342,080) 28,069 (97,946)
Interest-only revenue 452,268 510,806 566,690
Transaction and other costs (50,126) (14,899) (26,565)
---------- ---------- ----------
Securitization income $ 323,517 $ 650,400 $ 644,457
========== ========== ==========
Credit card fees, interchange and other credit card income was $163.2
million in 2002, a decrease of $158.8 million from 2001. The decrease is
primarily due to the reduction in average credit card receivables due to the
transfer of approximately $2.3 billion of receivables to the Master Trust during
2002. In addition, we amended the Master Trust core transaction documents, which
resulted in interchange income earned on
19
receivables held by the Master Trust to be recorded as securitization income,
effective May 2002. In 2002, $44.3 million of interchange income was earned by
the Master Trust.
Enhancement services revenues increased by $11.6 million for the year
ended December 31, 2002. The increase was primarily due to increased active
enrollments in various membership products. These increases were partially
offset by a decrease in ServiceEdge(R) revenue due to the run-off of the
ServiceEdge(R) portfolio, and a decrease in PurchaseShield(R) revenue due to
decreased enrollments. Table 7 presents the breakdown of revenues and active
memberships for our enhancement services products.
TABLE 7: ENHANCEMENT SERVICES REVENUES AND ACTIVE MEMBERSHIPS (Dollars in
thousands)
Year Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Revenues
Membership Program Products $ 92,919 $ 57,186 $ 75,981
Warranty / Other 60,597 84,736 45,578
-------- -------- --------
Total $153,516 $141,922 $121,559
======== ======== ========
Year Ended December 31,
------------------------
2002 2001 2000
------ ------ ------
Active Memberships
Membership Program Products 3,248 2,856 3,335
Warranty / Other 1,846 2,919 2,732
------ ------ ------
Total 5,094 5,775 6,067
====== ====== ======
OTHER OPERATING EXPENSE
Total other operating expenses for the year ended December 31, 2002
increased $13.9 million over 2001. Credit card account and other product
solicitation and marketing expenses decreased $14.7 million over 2001. Credit
protection claims expense increased $14.1 million, reflecting higher claims paid
on debt waiver death benefits and interest forgiven, as well as an increase in
our estimate of unreported claims as of the balance sheet date. As of December
31, 2002, we had a debt waiver total covered balance of $2.4 billion, compared
to $2.8 billion as of December 31, 2001. Employee compensation decreased $14.6
million for the year ended December 31, 2002, due to decreased staffing needs
and fringe benefits. Other expenses increased $10.5 million.
During 2002, we recorded approximately $17.1 million of write-downs of
excess property, equipment, operating leases, and the pending sale of our
Arizona building. In addition, we recorded a $10.6 million write-down on
portfolios of charged-off loans purchased in 2001 and 2000. The book value of
these portfolios was $3.4 million as of December 31, 2002, compared to $20.1
million as of December 31, 2001.
DERIVATIVE ACTIVITIES
We use derivative financial instruments for the purpose of managing our
exposure to interest rate risks.
MRI enters into interest rate cap transactions related to each
asset-backed securitization transaction. MRI assigns all of its right, title,
and interest under the interest rate cap agreement to the Trustee of the Metris
Master Trust for the benefit of the holders of securities issued by the Metris
Master Trust. The purpose of the interest rate cap is to effectively limit the
interest exposure of the Metris Master Trust for each individual series to a
maximum based upon the LIBOR rate.
20
The interest rate caps do not meet the criteria for hedge accounting
treatment. The change in the fair value of the caps is included in the
consolidated income statement under "Securitization Income." For the year ended
December 31, 2002 we recognized expense of $22.6 million from the mark-to-market
adjustments on the interest rate caps. For the year ended December 31, 2001,
excluding the cumulative effect of accounting change, we recognized income of
$10.1 million from the mark-to-market adjustments on interest rate caps.
We entered into interest rate swap transactions through Direct
Merchants Bank. The swaps were used to convert a portion of the fixed rate
certificates of deposit ("CDs") to variable rate CDs, and thus hedge the fair
market value of the CDs. The CDs expose us to variability in the fair value in
rising or declining interest rate environments. By converting the fixed payment
to a variable payment, the interest rate swaps reduce the variability of the
fair market value of the CDs. As of December 31, 2002, there were no interest
rate swaps outstanding. As of December 31, 2001, there was one swap outstanding
with a fair value of $3.3 million.
As of the adoption of SFAS No. 133 or their inception, all swaps were
designated as fair value hedges. Changes in the value of the swaps are
recognized in income, in the period in which the change in value occurred. In
addition, changes in the value of the CDs, to the extent they are attributable
to the risk being hedged, are simultaneously recognized in income. Any
difference between the fair value change in the swaps versus the fair value
change in the related hedged CDs was considered to be the "ineffective" portion
of the hedge. The ineffective portion of the swap is recorded as an increase or
decrease in income.
During 2002 and 2001, all swaps were sold. At the date of sale, the
swap and the related CDs were valued, and a gain or loss was recognized for the
difference between the change in fair value of the swap and the change in fair
value of the CDs. The cumulative amount recorded as an adjustment to the value
of the CDs is being amortized over the life of the CDs as an adjustment to
interest expense. Additionally, $3.5 million was recognized as income in 2001
related to the ineffective portion of the swaps.
The adoption of SFAS No. 133, resulted in a one-time, non-cash,
after-tax charge to earnings of $14.2 million, reflected as a "Cumulative effect
of accounting change" in the consolidated statements of income for the year
ended December 31, 2001.
BALANCE SHEET ANALYSIS
Cash and Cash Equivalents
Cash and cash equivalents increased $198.6 million to $580.2 million as
of December 31, 2002, compared to $381.6 million as of December 31, 2001. The
increase is due to the transfer of assets from Direct Merchants Bank to the
Master Trust, which created excess cash at Direct Merchants Bank.
Credit Card Loans
Credit card loans were $846.4 million as of December 31, 2002 compared
to $2.76 billion as of December 31, 2001. The $1.9 billion decrease is primarily
a result of the transfer of $2.3 billion of receivables from Direct Merchants
Bank to the Master Trust.
21
Deposits
Deposits decreased $1.2 billion to $892.8 million as of December 31,
2002, from $2.1 billion as of December 31, 2001. The decrease relates to a shift
in funding from CDs to off-balance sheet asset-backed securitizations.
Under the OCC operating agreement, the Company has agreed to reduce
receivables at Direct Merchants Bank to no more than $550 million by December
31, 2003, and to zero by December 31, 2004. As a result, we do not anticipate
issuing certificates of deposit in the foreseeable future.
Debt
Debt decreased from $647.9 million in 2001 to $357.6 million in 2002
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 to $143.1 million as of December 31, 2002,
compared to $188.7 million as of December 31, 2001. The decrease primarily
relates to a shift from annual-billed to monthly-billed enhancement services
products and the run-off of deferred revenues associated with our ServiceEdge(R)
product.
Stockholders' Equity
Stockholders' equity was $1.1 billion as of December 31, 2002, a
decrease of $50.7 million from December 31, 2001. The decrease primarily results
from a net loss of $39.6 million, cash dividends of $3.7 million and $45.3
million of stock repurchases under our stock repurchase program, partially
offset by an increase of $36.7 million in convertible preferred stock, $3.0
million of stock issuances under employee benefit plans, and the forfeiture of
$4.8 million of restricted stock.
LIQUIDITY, FUNDING AND CAPITAL RESOURCES
One of our primary financial goals is to maintain an adequate level of
liquidity through active management of assets and liabilities. Liquidity
management is a dynamic process, affected by changes in the characteristics of
our assets and liabilities and short- and long-term interest rates. We use a
variety of financing sources to manage liquidity, funding, and interest rate
risks. Table 9 summarizes our funding and liquidity as of December 31, 2002 and
2001:
TABLE 9: LIQUIDITY, FUNDING AND CAPITAL RESOURCES
DECEMBER 31, 2002 DECEMBER 31, 2001
----------------- -----------------
DMCCB OTHER CONSOLIDATED DMCCB OTHER CONSOLIDATED
---------- ---------- ------------ ---------- ---------- ------------
Cash and due from
banks $ 58,399 $ 4,414 $ 62,813 $ 106,479 $ 3,333 $ 109,812
Federal funds sold 88,000 -- 88,000 243,772 -- 243,772
Short-term investments 322,039 107,380 429,419 50 28,005 28,055
---------- ---------- ---------- ---------- ---------- ----------
Total cash and cash
equivalents $ 468,438 $ 111,794 $ 580,232 $ 350,301 $ 31,338 $ 381,639
========== ========== ========== ========== ========== ==========
22
DECEMBER 31, 2002 DECEMBER 31, 2001
----------------- -----------------
ON-BALANCE SHEET FUNDING UNUSED UNUSED
OUTSTANDING CAPACITY OUTSTANDING CAPACITY
----------- ----------- ----------- -----------
Bank conduit - June 2003 $ -- $ -- $ 292,000 $ 108,000
Revolving credit line -July 2003 -- 162,696 -- 164,746
Term loan - June 2003 100,000 N/A 100,000 N/A
10% senior notes - November 2004 100,000 N/A 100,000 N/A
10.125% senior notes -
July 2006 146,824 N/A 145,924 N/A
Other 10,825 N/A 9,980 N/A
Deposits - various maturities through
February 2007 892,754 N/A 2,058,008 N/A
----------- ----------- ----------- -----------
Subtotal 1,250,403 162,696 2,705,912 272,746
OFF-BALANCE SHEET FUNDING
Metris Master Trust:
Term asset back securitizations
- various maturities through January
2009 7,610,000 -- 7,459,250 --
Bank conduits - various maturities
through June 2003 1,177,957 422,043 421,093 328,908
Metris facility-March 2003 48,900 26,100 15,500 59,500
----------- ----------- ----------- -----------
Subtotal 8,836,857 448,143 7,895,843 388,408
----------- ----------- ----------- -----------
Total $10,087,260 $ 610,839 $10,601,755 $ 661,154
=========== =========== =========== ===========
During 2002 and 2001, we had net proceeds of approximately $0.9 billion
and $1.8 billion, respectively, from sales of credit card loans to the Master
Trust and the Metris facility referred to in the above table. We used cash
generated from these transactions to reduce borrowings and to fund the credit
card loan portfolio.
As of December 31, 2002 and 2001, we had $7.3 million and $5.3 million,
respectively, of letters of credit issued under our revolving line of credit.
Under our credit agreement, we need to maintain, among other items, minimum
equity plus reserves to managed assets of 10%, minimum three-month average
excess spread (on each individual series of securities issued under the Master
Trust) of 1%, minimum equity of $685 million at December 31, 2002 and a ratio of
equity plus allowance for loan losses and valuation allowance to managed 90-day
plus delinquencies of 2.25. Furthermore, the Company has pledged certain assets
as collateral on the credit agreement. As of December 31, 2002, and 2001 we were
in compliance with all financial covenants under our credit agreement.
23
Our contractual cash obligations as of December 31, 2002 were as
follows:
LESS THAN ONE TO FOUR TO OVER FIVE
ONE YEAR THREE YEARS FIVE YEARS YEARS TOTAL
----------- ----------- ----------- ----------- -----------
Long-term debt $ 101,031 $ 109,530 $ 146,921 $ 167 $ 357,649
Operating leases 14,851 20,634 15,656 26,998 78,139
Deposits 388,965 256,277 247,512 -- 892,754
Open-to-buy on credit
card accounts -- -- -- -- 12,009,893
----------- ----------- ----------- ----------- -----------
Total $ 504,847 $ 386,441 $ 410,089 $ 27,165 $13,338,435
=========== =========== =========== =========== ===========
The following table presents the amounts, as of December 31, 2002, of
off-balance sheet funding in the Master Trust and the Metris facility scheduled
to amortize in future years. We base the amortization amounts on estimated
amortization periods, which are subject to change based on the Master Trust and
Metris facility performance:
(In thousands)
2003 $ 1,826,857
2004 2,260,000
2005 2,300,000
2006 1,250,000
2007 600,000
Thereafter 600,000
-----------
Total $ 8,836,857
===========
The following table shows the annualized yields, defaults, costs and
excess spreads for the Master Trust on a cash basis:
Year Ended December 31,
-----------------------------------------------------------------------------
(In thousands) 2002 2001 2000
----------------------- ----------------------- -----------------------
Gross yield (1) $2,564,009 26.46% $2,035,113 27.58% $1,528,056 27.22%
Annual principal defaults 1,587,095 16.38% 972,348 13.18% 632,763 11.27%
---------- ---------- ---------- ---------- ---------- ----------
Net portfolio yield 976,914 10.08% 1,062,765 14.40% 895,293 15.95%
Annual interest expense and
servicing fees 406,826 4.35% 451,061 6.62% 470,634 8.90%
---------- ---------- ---------- ---------- ---------- ----------
Net excess spread (2) $ 570,088 5.73% $ 611,704 7.78% $ 424,659 7.05%
========== ========== ========== ========== ========== ==========
(1) Includes finance charges, late, overlimit and cash advance fees, bad
debt recoveries, interchange income and debt waiver fees, less finance
charge and fee charge-offs.
(2) The net excess spread on a cash basis for the Master Trust was 2.24%
for the month ended February 28, 2003. The three-month average net
excess spread on a cash basis was 1.91% as of February 28, 2003.
The Master Trust and the associated off-balance sheet debt provide for
early amortization if certain events occur. These events are described in the
applicable prospectus of each securitization transaction. The significant events
are (i) one-month and three-month average excess spreads below certain levels,
(ii) negative transferor's interest within the Master Trust or (iii) failure to
obtain funding during an accumulation period for a maturing term asset-backed
securitization. In addition, there are various triggers within our
securitization agreements that, if broken, would restrict the release of cash to
us from the Master Trust. This restricted cash provides additional security to
the investors in the Master Trust. We reflect cash restricted from release in
the Master Trust as "other receivables due from credit card securitizations,
net" in the consolidated balance sheet. The triggers are related to
24
the performance of the Master Trust, specifically the average of net excess
spread over a one to three-month period.
The following table illustrates the maximum amount of cash (as a
percentage of outstanding securitized principal receivables) that could be held
by the Master Trust as additional collateral if the one-month and three-month
average excess spread of the Master Trust was within various ranges:
Cash Basis Net Maximum
Excess Spread Restricted
----------------- -----------
Greater than 5.5% --
5.1% - 5.5% 0.5% - 1.0%
4.6% - 5.0% 0.5% - 1.5%
4.1% - 4.5% 2.0% - 2.5%
3.6% - 4.0% 2.5% - 3.0%
3.1% - 3.5% 2.5% - 4.0%
Less than 3.0% 4.0% - 5.0%
The cash restricted from release is limited to the amount of excess
spread generated in the Master Trust on a cash basis. During periods of lower
excess spreads, the required amount of excess spread to be restricted in the
Master Trust may not be achieved. During those periods, all excess spread
normally released to MRI will be restricted from release. Once the maximum
required amount of cash is restricted from release or excess spreads improve,
cash can again be released from the spread accounts. Based on the performance of
our Master Trust, the amount of cash required to be restricted was $304 million
at December 31, 2002 and $455 million at February 28, 2003. As of December 31,
2002, $29.1 million has been restricted from release in the Master Trust due to
performance and $21.4 million has been restricted from release in the Master
Trust due to corporate debt ratings. As of February 28, 2003, $62.1 million has
been restricted from release in the Master Trust due to performance and $21.4
million has been restricted from release in the Master Trust due to corporate
debt ratings (see page 27 for discussion of corporate debt ratings). We expect
all cash basis excess spread to be restricted from release to us until 2004.
In the past, Direct Merchants Bank has issued jumbo CDs of $100,000 or
more. As of December 31, 2002 and 2001, $0.9 billion and $2.1 billion of CDs
were outstanding with original maturities ranging from six months to five years.
These CDs pay fixed interest rates ranging from 1.1% to 7.6% and 2.4% to 7.6% at
December 31, 2002 and 2001, respectively. Under the OCC operating agreement, the
Company has agreed to reduce receivables at Direct Merchants Bank to no more
than $550 million by December 31, 2003, and to zero by December 31, 2004. As a
result, we do not anticipate issuing jumbo CDs in the foreseeable future.
The weighted-average interest rate on outstanding funding as of
December 31, 2002 and 2001 was as follows:
DECEMBER 31, 2002 DECEMBER 31, 2001
----------------- -----------------
Bank conduit-2003 -- 2.4%
Term loan-2003 4.7% 5.4%
Senior notes-2004 10.0% 10.0%
Senior notes-2006 11.4% 11.5%
Other 8.7% 8.9%
Deposits 5.1% 5.1%
Master Trust 2.1% 3.0%
Metris facility 1.9% 2.3%
25
The 70 basis point decrease in the weighted-average interest rate on
the term loan and the 90 basis point decrease in the weighted-average interest
rate on the Master Trust were primarily due to the decrease in LIBOR, which is
the base rate for these funding vehicles, and the maturity of the 1997-1
asset-backed securitization, which had fixed rate funding at 6.9%, in April
2002. As the base rate, LIBOR decreased from 1.9% as of December 31, 2001, to
1.4% as of December 31, 2002.
The Company has $430.6 million of Series C Perpetual Convertible
Preferred Stock outstanding which is held by affiliates of Thomas H. Lee
Partners, L.P. (formerly, Thomas H. Lee Company) ("THL Partners"), a private
equity firm, and is convertible into common shares at a conversion price of
$12.42 per common share subject to adjustment in certain circumstances. The
Series C Preferred Stock has a 9% dividend payable in additional shares of
Series C Preferred Stock and will also receive any cash dividends paid on the
Company's common stock on a converted basis. One share of Series C Preferred
Stock is convertible into 30 shares of common stock, plus a premium amount
designed to guarantee a portion of seven years' worth of dividends at a 9%
annual rate. For conversions in 2002, the premium amount would be equal to
approximately 54.4% of those future dividends. Assuming conversion of the Series
C Preferred Stock into common stock, THL Partners would own approximately 40.5%
of the Company on a diluted basis at December 31, 2002. So long as affiliates of
THL Partners own at least 25% of the originally issued Series C Preferred Stock
(or any shares of Common Stock issued upon conversion thereof), the holders of a
majority of the then-outstanding shares of the Series C Preferred Stock are
entitled to elect four members to MCI's Board of Directors. The Series C
Preferred Stock may be redeemed by us in certain circumstances by paying 103% of
the redemption price of $372.50 and all accrued dividends at the time of
redemption. We also have the option to redeem the Series C Preferred Stock after
December 9, 2008, without restriction by paying the redemption price of $372.50
and all accrued dividends at the time of redemption.
The Internal Revenue Service ("IRS") has recently completed its
examination of the Company's tax returns through December 31, 1998. The IRS has
proposed adjustments to increase the Company's federal income tax by $42.9
million, plus interest of more than $14 million, pertaining to the Company's
treatment of certain credit card fees as original issue discount ("OID").
Although these fees are primarily reported as income when billed for financial
reporting purposes, we believe the fees constitute OID and must be deferred and
amortized over the life of the underlying credit card receivables for tax
purposes. Cumulatively through the year ended December 31, 2002, the Company has
deferred more than $212 million in federal income tax under the OID rules.
The Company believes its treatment of the fees is appropriate and
continues to work with the IRS to resolve the proposed adjustments. The
Company's position on the treatment of credit card fees is consistent with that
of many other U.S. credit card issuers. We do not expect any additional tax to
be paid or settlement to be reached over the next twelve months. However, both
the timing and amount of the final resolution of this matter is uncertain.
The Federal Reserve Act imposes various legal limitations on the extent
to which banks that are members of the Federal Reserve System can finance or
otherwise supply funds to certain of their affiliates. In particular, Direct
Merchants Bank is subject to certain restrictions on any extensions of credit to
MCI or its subsidiaries. Additionally, Direct Merchants Bank is limited in its
ability to declare dividends to MCI or its subsidiaries. Therefore, Direct
Merchants Bank's investments in federal funds sold are generally not available
for the general liquidity needs of the Company or its subsidiaries.
Since the later part of 2002, our corporate debt ratings, the Master
Trust ratings and the ratings of Direct Merchants Bank have been downgraded.
These
26
downgrades reflect the losses we experienced in 2002, as well as deteriorating
performance in the Master Trust. These downgrades and any future downgrades will
have a negative effect on our ability to obtain funding. In addition, access to
funding may be at a higher cost and on terms less favorable to us than those
previously available as a result of the deterioration in our financial
performance and asset quality.
Our deposits and secured/unsecured debt are rated by Moody's Investor
Services ("Moody's"), Standard & Poor's Rating Services ("S&P") and Fitch, Inc.
("Fitch"). Factors affecting the various ratings include the overall health of
the global/national economy, specific economic conditions impacting the subprime
consumer finance industry, and the overall financial performance of the Company,
including earnings, credit losses, delinquencies, excess spreads in the Master
Trust and our overall liquidity. Furthermore, certain of our term asset-backed
securitizations require the restriction of cash if our corporate debt ratings go
below certain levels. The table below illustrates the current debt ratings of
MCI and Direct Merchants Bank:
STANDARD
MOODY'S & POOR'S FITCH
------- -------- -----
METRIS COMPANIES INC.
Senior unsecured debt B3 CCC+ CCC
Credit facility B2 B- CCC
DIRECT MERCHANTS BANK Ba2
Short-term deposits B
Long-term deposits Ba1 B
Moody's, S&P and Fitch have a "negative outlook" for us and our debt
ratings. The rating agencies cited concerns about our funding and liquidity
challenges, earnings and asset quality.
During the first quarter of 2003, we continue to experience pressure on
our liquidity position. As part of our commitment to meet the goals under our
strategic plan, management is implementing measures to maintain strong levels of
liquidity.
On March 17, 2003 we obtained a $425 million extension through March
2004 of an $850 million conduit which was scheduled to mature in June of 2003.
We also secured a $425 million conduit through March 2004, which will replace
conduits and warehouse facilities scheduled to mature during March through May
2003. Furthermore, these conduits will provide for the financing of a term
asset-backed securitization that is scheduled to mature in July 2003. The
availability of funding under these facilities is subject to various conditions,
including a net reduction of receivables in the Master Trust and a minimum
three-month average excess spread of 1%. In connection with the transactions, we
also terminated our $170 million revolving line of credit.
On March 18, 2003 the Company and Direct Merchants Bank entered into an
operating agreement with the OCC. The operating agreement requires, among other
things, the following:
- The Bank must reduce its on-balance-sheet credit card
receivables to no more than $550 million by December 31, 2003
and to zero by December 31, 2004. During the time the Bank is
reducing these receivables, the mix of subprime receivables
may not exceed 60% of all credit card receivables. As of
December 31, 2002, 52.9% of the Bank's credit card portfolio
was subprime. The Bank will continue to sell credit card
receivables on a daily basis to MCI under the purchase
agreement currently in effect between MCI and the Bank.
27
- The Bank must maintain minimum capital in the aggregate amount
of (i)liquid assets deposited pursuant to the Liquidity
Reserve Deposit Agreement discussed below; (ii) the capital
required as a result of the 200% risk-weight applied to
on-book subprime credit card receivables; and (iii) the
minimum capital required under Federal law for a "well
capitalized" institution for all remaining assets owned by the
Bank.
- The Bank must meet certain liquidity requirements, including
maintaining, on a daily basis, liquid assets of not less than
100% of the deposits and other liabilities coming due within
the next 30 days, maintaining marketable assets in an amount
equal to or in excess of the Bank's insured deposits,
maintaining cash and cash equivalents in excess of 46% of
outstanding CDs and entering into the Liquidity Reserve
Deposit Agreement discussed below to support the Bank's credit
card receivables funding needs.
- The terms of the operating agreement required Direct Merchants
Bank and MCI to enter into a Capital Assurance and Liquidity
Maintenance Agreement ("CALMA") which also was executed on
March 18, 2003. The effect of the CALMA is to require MCI to
make such capital infusions or provide Direct Merchants Bank
with financial assistance so as to permit Direct Merchants
Bank to meet its liquidity requirements.
- The operating agreement requires Direct Merchants Bank, a
third-party depository bank and the OCC to execute a Liquidity
Reserve Deposit Agreement ("LRDA") within 30 days of the
effective date of the operating agreement.
Upon entering into the operating agreement, Direct Merchants Bank
declared and paid a dividend of $155 million to us on March 19, 2003.
Furthermore, the agreement allows Direct Merchants Bank to declare and pay
future dividends, provided such dividends are in compliance with OCC
regulations.
During the past fiscal year, we had in place a $270 million term loan
and revolving credit facility. In connection with the conduit transactions
discussed above, all availability under the $170 million revolving portion of
this facility was terminated as of March 18, 2003, with the exception of the
$7.3 million of outstanding letters of credit. Term loans of $100 million remain
outstanding under the facility and mature on June 30, 2003. In order to
refinance the facility in part, on March 31, 2003, THL Fund IV committed to
provide a term loan to the Company in an aggregate amount of $125 million as a
backup financing facility, secured by assets of the Company. The backup facility
carries an interest rate of 12% per annum plus an option to earn an additional
meaningful economic return based on the performance of the Company's managed
receivables through December 31, 2004. The backup facility would be repayable in
full on March 1, 2004. THL Fund IV's obligation to loan funds to the Company is
subject to a number of conditions, including the requirement that the Company
receive an opinion or opinions satisfactory to THL Fund IV that the new credit
facility is fair, from a financial point of view to the Company and to the
holders of the Company's outstanding notes. There can be no assurance that these
conditions will be met.
As previously noted, during 2003 we have contractual cash obligations
of $505 million, off-balance sheet funding scheduled to amortize of $1.8 billion
and will require funding for a $610 million term asset-backed securitization
maturing in January 2004. In addition, we will need cash to fund new
receivables, for the reduction of credit card loans at Direct Merchants Bank to
no more than $550 million at December 31, 2003 (required under our operating
agreement) and for general operating needs. We have historically utilized a
variety of funding vehicles, as well as ongoing cash generated from operations,
to finance credit card receivable growth, maturing debt obligations and general
operating needs. During the next year we intend to shrink the size of the
28
credit receivables in the Master Trust by approximately $2.1 billion through
lower credit card account acquisitions, attrition in the portfolio and third
party sales as necessary. This reduction in the size of the portfolio will
significantly reduce our need for additional bank conduits or the issuance of
new asset-backed securities. We believe we have adequate liquidity for meeting
anticipated cash needs, although no assurance can be given to that effect.
CAPITAL ADEQUACY
In the normal course of business, Direct Merchants Bank enters into
agreements, or is subject to regulatory requirements, that result in cash, debt,
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 pay dividends to us in accordance with the
national bank dividend provisions.
Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the OCC. At December 31, 2002 and 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 table below.
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.
29
Additional information about Direct Merchants Bank's actual capital
amounts and ratios are presented in the following table:
TO BE
ADEQUATELY TO BE WELL
ACTUAL CAPITALIZED CAPITALIZED
---------------- -------------------- ------------------
As of December 31, 2002 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
--------- ----- ---------- ----- --------- -----
Total capital $ 402,721 30.8% $ 104,516 8.0% $ 130,645 10.0%
(to risk-weighted
assets)
Tier 1 capital 385,480 29.5% 52,258 4.0% 78,387 6.0%
(to risk-weighted
assets)
Tier 1 capital 385,480 24.7% 62,381 4.0% 77,977 5.0%
(to average assets)
TO BE
ADEQUATELY TO BE WELL
ACTUAL CAPITALIZED CAPITALIZED
---------------- -------------------- ------------------
As of December 31, 2001 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
--------- ----- ---------- ----- --------- -----
Total capital $ 334,468 13.1% $ 204,533 8.0% $ 255,666 10.0%
(to risk-weighted
assets)
Tier 1 capital 297,167 11.6% 102,266 4.0% 153,400 6.0%
(to risk-weighted
assets)
Tier 1 capital 297,167 10.8% 109,921 4.0% 137,401 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, 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
guidelines, Direct Merchants Bank's total capital ratio as of December 31, 2002
was 22.8%.
NEWLY ISSUED PRONOUNCEMENTS
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 the adoption of SFAS No. 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
30
lives. The adoption of the 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 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 No. 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 No. 4. SFAS No. 145
also amends SFAS No. 13 to require that 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 No. 145. SFAS No. 145's amendment and technical correction to SFAS No. 13
is effective for all transactions occurring after May 15, 2002. There was not a
material impact on our financial statements upon adoption of SFAS No. 145.
In July 2002, FASB issued SFAS No. 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 No. 146 requires that a liability for
a cost associated with an exit or disposal activity be recognized when a
liability is incurred. Under Issue No. 94-3, a liability for an exit cost as
generally defined in Issue No. 94-3 was recognized at the date of an entity's
commitment to an exit plan. The provisions of SFAS No. 146 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
No. 146.
In November 2002, FASB issued Interpretation No. 45, "Guarantors
Accounting for Guarantees". The Interpretation requires certain guarantees to be
recognized and initially measured at fair value. The interpretation applies to
contracts or indemnification agreements that contingently require the guarantor
to make payments to the guaranteed party based on changes in an underlying that
is related to an asset, liability, or an equity security of the guaranteed
party. The requirements of Interpretation No. 45 are effective for financial
statements ending after December 15, 2002. The initial recognition and initial
measurement provisions of the Interpretation are applied, on a prospective basis
only, to guarantees issued after December 31, 2002, irrespective of the
guarantor's fiscal year-end. There was not a material impact on our financial
statements upon adoption of Interpretation No. 45.
In December 2002, FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities". In an effort to expand upon and strengthen existing
accounting guidance that addresses when a company should include in its
financial statements the assets, liabilities and activities of another entity.
FASB Interpretation No. 46 requires a variable interest entity to be
consolidated by a company, if that company is subject to a majority of the risk
of loss from the variable interest entity activities or entitled to receive a
majority of the entity's residual returns or both. The Interpretation also
requires disclosures about variable
31
interest entities that the company is not required to consolidate, but in which
it has a significant variable interest. The consolidation requirements of
Interpretation No. 46 apply immediately to variable interest entities created
after January 31, 2003, and apply to existing variable interest entities in the
first fiscal year or interim period beginning after June 15, 2003.
Interpretation No. 46 provides a specific exemption for entities qualifying as
Qualified Special Purpose Entities as described in SFAS No. 140. All of our
non-consolidated entities are Qualified Special Purpose Entities under the
definition in SFAS No. 140. We do not expect the adoption of this Interpretation
to have a material impact on our financial statements.
In December 2002, the FFIEC issued guidance on the accounting treatment
of Accrued Interest Receivables ("AIR") related to credit card securitizations.
AIR typically consists of a seller's retained interest in the investor's portion
of the accrued and billed fees and finance charges and the right to finance
charges accrued but not yet billed. The guidance requires AIR to be recorded on
the balance sheet as a retained beneficial interest. Accordingly, we
reclassified accrued but unbilled finance charges on our balance sheet from
"other receivables due from securitizations, net" and "other assets" to
"retained interests in loans securitized".
In January 2003, FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation-Transition and Disclosure", which amends FASB Statement No. 123,
"Accounting for Stock-Based Compensation". SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require more prominent and
more frequent disclosures in financial statements about the effects of
stock-based compensation. SFAS No. 148 requirements are effective for fiscal
years ending after December 15, 2002. There was not a material impact on our
financial statements upon adoption of SFAS No. 148.
In January 2003, the FFIEC issued guidance with respect to account
management, risk management, and loss allowance practices for institutions
engaged in credit card lending. The guidance provides requirements for certain
operational and accounting policies which are designed to bring consistency in
practice between institutions. At this time we are reviewing the impact of the
guidance and there can be no assurance that adoption of the guidance will not
have a material adverse effect on our financial condition.
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K/A contains certain forward - looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which are subject to the "safe harbor" created by those sections.
Forward-looking statements include, without limitations: expressions of the
"belief," "anticipation," "intent," or "expectations" of management; statements
and information as to our strategies and objectives; return on equity; changes
in our managed loan portfolio; net interest margins; funding costs; liquidity;
cash flow; operating costs and marketing expenses; delinquencies and charge-offs
and industry comparisons or projections; statements as to industry trends or
future results of operations of the Company and its subsidiaries; and other
statements that are no historical fact. Forward-looking statements may be
identified by the use or terminology such as "may," "will," "believes," "does
not believe," no reason to believe," expects," "plans," "intends," "estimates,"
"anticipated," or "anticipates" and similar expressions, as they relate to the
Company or our management. Forward-looking statements are based on certain
assumptions by management and are subject to risks and uncertainties that could
cause actual results to differ materially from those in the forward-looking
statements.
32
These risks and uncertainties include, but are not limited to, our high
liquidity requirement; our higher delinquency rate, credit loss rates and
charge-off rates of our "Credit card loans; "the higher charge-off and
bankruptcy rates of the Company's target market of moderate-income consumers;
the success and impact of our existing or modified strategic initiatives; the
effect of the restatement of the Company's financial statements discussed
herein, risks associated with Direct Merchants Bank's ability to comply with its
agreement with regulators regarding the safety and soundness of its operations;
interest rate risks; risks associated with acquired portfolios; dependence on
the securitization markets and other funding sources to fund our business,
including the refinancing of existing indebtedness; the effects of the
previously announced SEC investigation, government policy and regulation,
whether of general applicability or specific to us, including restrictions
and/or limitations relating to our minimum capital requirements, reserving
methodologies, dividend policies and payment, growth, and/or underwriting
criteria; reduced funding availability and increased funding costs; privacy laws
that could result in lower revenue generated from fewer marketing campaigns and
/or penalties for non-compliance; and general economic conditions that can have
a negative impact on the performance of loans and marketing of credit protection
and other enhancement services.
These and other risks and uncertainties are described herein and in the
original 10-K, including under the heading "Risk Factors" (pages 26-34 of the
original 10-K), and are also discussed in other parts of this Report, including
"Legal Proceedings" (page 35 of the original 10-K) and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" (pages 6-39
hereof). Although we have attempted to list comprehensively the major risks and
uncertainties, other factors may in the future prove to be important in causing
actual results to differ materially from those contained in any forward-looking
statement. Readers are cautioned not to place undue reliance on any
forward-looking statement, which speaks only as of the date thereof. We
undertake no obligation to update any forward-looking statements, whether as a
result of new information, future events or otherwise.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Net income applicable to common stockholders for the year ended
December 31, 2001 was $125.3 million, or $1.61 per diluted share, down from net
income applicable to common stockholders of $154.3 million, or $2.01 per diluted
share in 2000. The decrease in net income results from increases in provision
for loan losses and other operating expense partially offset by increases in net
interest income and other operating income.
The provision for loan losses was $461.1 million in 2001 compared to
$164.8 million in 2000. The increase relates to the estimated required balance
in the allowance for loan losses to cover probable inherent in our loan
portfolio under current conditions. Increased credit card loans, increased net
principal charge-offs, recent delinquency and collection trends, and current
economic conditions were factors considered by management in determining the
necessary balance in the allowance for loan losses. The net principal charge-off
rate was 12.3% in 2001 compared to 9.7% in 2000. The delinquency ratio was 10.1%
in 2001 compared to 7.5% in 2000.
Other operating income increased $193.2 million, or 18%, to $1.3
billion for the year ended December 31, 2001. This increase was comprised of an
increase in credit card fees, interchange and other credit card income of $136.6
million, an increase in servicing income of $30.3 million, an increase in
enhancement services revenues of $20.4 million, and an increase in
securitization income of $5.9 million. The servicing income increase was caused
by an increase of approximately $1.2 billion in average securitized receivables.
The remaining increases were primarily due to the growth in total credit card
accounts, an increase in outstanding receivables in the securitized
33
credit card loan portfolio, development of new third-party relationships and the
creation of new products.
Other operating expenses increased to $727.3 million in 2001, compared
to $599.1 million in 2000. This increase was primarily due to continued
investments in our infrastructure in order to service the growth in our credit
card loan portfolio, an increase in overall marketing expenditures and increased
amortization on purchased portfolio premiums.
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 No. 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 No. 133 resulted in a one-time, non-cash,
after-tax charge to earnings of $14.2 million reflected as a "Cumulative effect
of accounting change" in the consolidated statements of income for the year
ended December 31, 2001.
During the quarter ended March 31, 2000 we adopted Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements," for our
debt waiver products. This change resulted in a one-time, non-cash net charge to
earnings of $0.5 million, which is reflected as a "Cumulative effect of
accounting change" in the consolidated statements of income for the year ended
December 31, 2000. Because we have applied the provisions of this SAB to our
membership programs since 1998, before the SEC formalized its guidance, we did
not have to adjust our enhancement services revenues.
34
SELECTED OPERATING DATA - MANAGED BASIS
In addition to analyzing the Company's performance on an owned basis,
we analyze the Company's financial performance on a managed loan portfolio
basis. On a managed basis, the balance sheets and income statements include
other investors' interests in securitized loans that are not assets of the
Company, thereby reversing the effects of sale accounting under SFAS No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities. " We believe this information is meaningful to the reader of the
financial statements. We service the receivables that have been securitized and
sold and own the right to the cash flows from those receivables sold in excess
of amounts owed to security holders.
The following information is not in conformity with accounting
principles generally accepted in the United States of America, however, we
believe the information is relevant to understanding the overall financial
condition and results of operations of the Company.
TABLE 10: SELECTED OPERATING DATA - MANAGED BASIS
YEAR ENDED DECEMBER 31,
FOUR-YEAR COMPOUND
(Dollars in thousands) 2002 2001 2000 1999 1998 GROWTH RATE
------------ ------------ ------------ ------------ ------------ ------------------
SELECTED OPERATING DATA:
Total credit card accounts 3,929 4,929 4,464 3,680 2,972 7.2
Year-end loans $ 11,420,186 $ 11,991,784 $ 9,345,631 $ 7,343,272 $ 5,359,905 20.8
Year-end assets 11,431,203 12,124,528 9,806,249 7,563,394 5,503,862 20.1
Average loans 11,850,927 10,419,280 8,081,638 6,053,811 4,034,038 30.9
Average interest-earning assets 12,435,568 10,769,482 8,305,115 6,190,267 4,073,792 32.2
Average assets 11,972,958 10,656,156 8,332,500 6,269,760 4,159,171 30.3
Return on average assets N/A 2.3% 2.3% 1.0% 1.4%
Equity to managed assets 9.3% 9.4% 9.0% 8.2% 7.9%
Net interest margin (1) 14.3% 13.9% 12.9% 13.4% 12.4%
Delinquency ratio (2) 11.0% 9.4% 8.2% 7.6% 6.8%
Net charge-off ratio (3) 15.5% 10.9% 9.6% 9.0% 10.0%
(1) Includes MCI's actual cost of funds plus all costs associated with
asset securitizations, including the interest expense paid to
certificate holders and amortization of the discount and fees.
(2) Delinquency ratio represents credit card loans that were at least 30
days contractually past due at year-end as a percentage of year-end
managed loans.
(3) Net charge-off ratio reflects actual principal amounts charged-off,
less recoveries, as a percentage of average managed credit card loans.
37
TABLE 11: MANAGED LOAN PORTFOLIO
DECEMBER 31,
(Dollars in
thousands)
% OF % OF % OF
2002 TOTAL 2001 TOTAL 2000 TOTAL
------------------- ------- -------------------- ------- ------------------ -----
Credit card loans $ 846,417 $ 2,756,763 $ 1,184,269
Receivables held in
the Metris
Master Trust 10,573,769 9,235,021 8,161,362
Total managed loan
portfolio $ 11,420,186 $ 11,991,784 $ 9,345,631
=================== ==================== ==================
Loans contractually
Delinquent:
30 to 59 days 359,223 3.1% 375,887 3.1% 228,238 2.4%
60 to 89 days 285,448 2.5% 274,278 2.3% 173,531 1.9%
90 or more days 615,278 5.4% 473,003 4.0% 365,963 3.9%
------------------- ------- -------------------- ------- ------------------ -----
Total $ 1,259,949 11.0% $ 1,123,168 9.4% $ 767,732 8.2%
=================== ======= ==================== ======= ================== =====
AVERAGE BALANCES:
Credit card loans $ 1,305,127 $ 1,709,989 $ 614,991
Receivables held in the Metris
Master Trust 10,545,800 8,709,291 7,466,647
------------------- -------------------- ------------------
Total managed loan portfolio $ 11,850,927 $ 10,419,280 $ 8,081,638
=================== ==================== ==================
Net charge-offs $ 1,840,786 15.5% $ 1,140,151 10.9% $ 778,921 9.6%
=================== ======= ==================== ======= ================== =====
The 160-basis-point increase during 2002 in the managed delinquency
rates over 2001 primarily reflects declining receivables, a deterioration in the
economy and the impact of our 2001 credit line increase program. The credit line
increase program added pressure to our cardholders due to increased average
outstanding balances, which require higher monthly payments. This, along with a
deteriorating economy, has made collection efforts more difficult, resulting in
higher delinquencies.
Managed net charge-offs increased $700.6 million in 2002 primarily due
to the impact of the 2001 credit line increase program and deterioration in the
economy.
We charge-off bankrupt accounts within 60 days of formal notification.
Charge-offs due to bankruptcies were $654.5 million, representing 33.7% of total
managed gross charge-offs as of December 31, 2002 and $455.0 million,
representing 36.0% of total managed gross charge-offs as of December 31, 2001.
In addition to those bankrupt accounts that were charged-off, we received formal
notification of $106.3 million and $58.7 million of managed bankrupt accounts as
of December 31, 2002 and 2001, respectively.
Total managed loans decreased $571.6 million to $11.4 billion as of
December 31, 2002, compared to $12.0 billion as of December 31, 2001. This was
primarily due to a reduction in credit lines and tighter underwriting standards
implemented in 2002. The amount of credit card receivables in debt forbearance
programs was $860.1 million or 7.5% of total managed loans as of December 31,
2002, compared with $837.2 million or 7.0% of managed loans as of December 31,
2001. All delinquent receivables in debt forbearance programs are included in
Table 11.
38
TABLE 12: ANALYSIS OF AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS AND RATES
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------
2002 2001
(Dollars in thousands) Average ------------ Yield/ Average ------------ Yield/
Balance Interest Rate Balance Interest Rate
------------ ------------ ------ ------------ ------------ ------
MANAGED BASIS
Credit card loans $ 11,850,927 $ 2,089,070 17.6% $ 10,419,280 $ 1,957,913 18.8%
Total interest-earning
assets 12,435,568 2,099,595 16.9% 10,769,482 1,973,400 18.3%
Total interest-bearing
liabilities 10,420,532 321,981 3.1% 9,234,217 480,465 5.2%
Net interest income and
interest margin (1) -- 1,777,614 14.3% -- 1,492,935 13.9%
Net interest
rate spread (2) -- -- 13.8% -- -- 13.1%
YEAR ENDED DECEMBER 31,
----------------------------------------
2000
Average ------------ Yield/
(Dollars in thousands) Balance Interest Rate
------------ ------------ ------
MANAGED BASIS
Credit card loans $ 8,081,638 $ 1,582,503 19.6%
Total interest-earnings assets 8,305,115 1,596,352 19.2%
Total interest-bearing liabilities 7,209,068 521,477 7.2%
Net interest income and
interest margin (1) -- 1,074,875 12.9%
Net interest rate spread (2) -- -- 12.0%
(1) We compute "net interest margin" by dividing net interest income by
average total interest-earning assets.
(2) The "net interest rate spread" is the yield on average interest-earning
assets minus the funding rate on average interest-bearing liabilities.
Managed net interest income for the year ended December 31, 2002 was
$1.8 billion, compared to $1.5 billion for the same period in 2001. Net interest
income consists primarily of interest earned on our credit card loans less
interest expense on borrowing to fund the loans. The increase is due to a $1.7
billion increase in average interest-earning assets and a 40-basis-point
increase in net interest margin.
39
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
METRIS COMPANIES INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
DECEMBER 31,
----------------------------------------------
2002 2001
(AS RESTATED) (AS RESTATED)
--------------------- -------------------
ASSETS:
Cash and due from banks $ 62,813 $ 109,812
Federal funds sold 88,000 243,772
Short-term investments 429,419 28,055
--------------------- -------------------
Cash and cash equivalents 580,232 381,639
--------------------- -------------------
Credit card loans 846,417 2,756,763
Less: Allowance for loan losses 90,315 460,159
--------------------- -------------------
Net credit card loans 756,102 2,296,604
--------------------- -------------------
Retained interests in loans securitized 808,026 859,559
Property and equipment, net 83,831 114,913
Purchased portfolio premium, net 64,579 94,793
Other receivables due from credit card
securitizations, net 110,471 139,833
Other assets 187,151 278,634
--------------------- -------------------
TOTAL ASSETS $ 2,590,392 $ 4,165,975
===================== ===================
LIABILITIES:
Deposits $ 892,754 $ 2,058,008
Debt 357,649 647,904
Accounts payable 53,589 83,475
Deferred income 143,148 188,735
Accrued expenses and other liabilities 88,579 82,517
--------------------- -------------------
TOTAL LIABILITIES 1,535,719 3,060,639
--------------------- -------------------
STOCKHOLDERS' EQUITY:
Convertible preferred stock - Series C, par value $.01 per share; 10,000,000
shares authorized, 1,156,086 and 1,057,638 shares issued and outstanding 430,642 393,970
Common stock, par value $.01 per share; 300,000,000 shares authorized,
64,223,231 and 64,224,878 shares issued 642 642
Paid-in capital 227,376 232,413
Unearned compensation -- (4,980)
Treasury stock - 7,055,300 and 806,300 shares (58,308) (13,014)
Retained earnings 454,321 496,305
--------------------- -------------------
TOTAL STOCKHOLDERS' EQUITY 1,054,673 1,105,336
--------------------- -------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,590,392 $ 4,165,975
===================== ===================
See accompanying Notes to Consolidated Financial Statements.
40
METRIS COMPANIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
YEAR ENDED DECEMBER 31,
--------------------------------------------
2002 2001 2000
(AS RESTATED) (AS RESTATED) (AS RESTATED)
------------ ------------ ------------
INTEREST INCOME:
Finance charge income $ 218,878 $ 353,650 $ 106,549
Federal funds sold 403 3,115 9,139
Other 10,121 12,373 4,710
------------ ------------ ------------
Total interest income 229,402 369,138 120,398
------------ ------------ ------------
Deposit interest expense 68,740 127,916 89,560
Other interest expense 34,776 38,361 43,446
------------ ------------ ------------
Total interest expense 103,516 166,277 133,006
------------ ------------ ------------
NET INTEREST INCOME (EXPENSE) 125,886 202,861 (12,608)
Provision for loan losses 219,804 461,106 164,800
------------ ------------ ------------
NET INTEREST EXPENSE
AFTER PROVISION FOR LOAN LOSSES (93,918) (258,245) (177,408)
------------ ------------ ------------
OTHER OPERATING INCOME:
Securitization income 323,517 650,400 644,457
Servicing income on securitized / sold
receivables 195,214 159,074 128,823
Credit card fees, interchange and
other credit card income 163,174 322,048 185,431
Enhancement services revenues 153,516 141,922 121,559
------------ ------------ ------------
835,421 1,273,444 1,080,270
------------ ------------ ------------
OTHER OPERATING EXPENSE:
Credit card account and other product
solicitation and marketing expenses 173,269 188,009 149,205
Employee compensation 210,826 225,463 178,592
Data processing services and
communications 83,874 90,222 86,166
Credit protection claims expense 44,550 30,457 20,811
Credit card fraud losses 8,647 9,068 8,886
Purchased portfolio premium
amortization 30,220 30,277 19,275
Occupancy and equipment 48,013 47,572 35,563
Mastercard/Visa assessment and fees 13,869 16,522 14,712
Asset impairments and lease write-offs 27,736 -- --
Other 100,216 89,694 85,929
------------ ------------ ------------
741,220 727,284 599,139
------------ ------------ ------------
INCOME BEFORE INCOME TAXES AND
CUMULATIVE EFFECT OF ACCOUNTING CHANGES 283 287,915 303,723
Income tax expense 1,867 113,660 117,305
------------ ------------ ------------
(LOSS) INCOME BEFORE CUMULATIVE EFFECT
OF ACCOUNTING CHANGES (1,584) 174,255 186,418
Cumulative effect of accounting
changes (net of income taxes of $9,273
and $320) -- 14,226 516
------------ ------------ ------------
NET (LOSS) INCOME (1,584) 160,029 185,902
Convertible preferred stock
dividends 38,009 34,771 31,622
------------ ------------ ------------
NET (LOSS) INCOME APPLICABLE TO
COMMON STOCKHOLDERS $ (39,593) $ 125,258 $ 154,280
============ ============ ============
See accompanying Notes to Consolidated Financial Statements.
41
YEAR ENDED DECEMBER 31,
--------------------------------------------
2002 2001 2000
AS RESTATED AS RESTATED AS RESTATED
------------ ------------ ------------
EARNINGS (LOSS) PER SHARE:
Basic - income (loss) before
cumulative effect of accounting
changes $ (0.66) $ 1.79 $ 2.09
Basic - cumulative effect of
accounting changes -- (0.15) (0.01)
------------ ------------ ------------
Basic-net income (loss) (0.66) 1.64 2.08
============ ============ ============
Diluted - income (loss) before
cumulative effect of accounting
changes (0.66) 1.75 2.02
Diluted-cumulative effect of
accounting changes -- (0.14) (0.01)
------------ ------------ ------------
Diluted-net income(loss) (0.66) 1.61 2.01
============ ============ ============
SHARES USED TO COMPUTE EARNINGS
(LOSS) PER SHARE:
Basic 59,782 97,641 89,234
Diluted 59,782 99,366 92,582
DIVIDENDS DECLARED AND PAID PER
COMMON SHARE $ 0.040 $ 0.040 $ 0.033
See accompanying Notes to Consolidated Financial Statements.
42
METRIS COMPANIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(DOLLARS AND SHARES IN THOUSANDS)
NUMBER OF SHARES TOTAL
OUTSTANDING PREFERRED COMMON PAID-IN UNEARNED TREASURY RETAINED STOCKHOLDERS'
PREFERRED COMMON STOCK STOCK CAPITAL COMPENSATION STOCK EARNINGS EQUITY
BALANCE AT DECEMBER 31,
1999 AS PREVIOUSLY REPORTED 885 57,919 $329,729 $386 $130,772 $ -- $ -- $162,914 $ 623,801
Cumulative restatements to
prior periods, see Note 2 -- -- -- -- -- -- -- 58,395 58,395
----- ------ -------- ---- -------- ------- -------- -------- ----------
BALANCE AT DECEMBER 31,
1999, AS RESTATED 885 57,919 $329,729 $386 $130,772 $ -- $ -- $221,309 $ 682,196
===== ====== ======== ==== ======== ======= ======== ======== ==========
Net income (as restated) -- -- -- -- -- -- -- 185,902 185,902
Cash dividends -- -- -- -- -- -- -- (2,942) (2,942)
June 2000 three-for-
two stock split -- -- -- 201 (201) -- -- -- --
Preferred dividends in
kind 83 -- 30,692 -- -- -- -- (30,692) --
Issuance of common stock
under employee
benefit plans -- 4,324 -- 35 67,506 -- -- -- 67,541
----- ------ -------- ---- -------- ------- -------- -------- ----------
BALANCE, DECEMBER 31, 2000
AS RESTATED 968 62,243 $360,421 $622 $198,077 $ -- $ -- $373,577 $ 932,697
===== ====== ======== ==== ======== ======= ======== ======== ==========
Net income (as restated) -- -- -- -- -- -- -- 160,029 160,029
Cash dividends -- -- -- -- -- -- -- (3,752) (3,752)
Common stock repurchased -- (806) -- -- -- -- (13,014) -- (13,014)
Preferred dividends in
kind 90 -- 33,549 -- -- -- -- (33,549) --
Issuance of common stock
under employee
benefit plans -- 1,518 -- 15 27,927 -- -- -- 27,942
Deferred compensation -- 464 -- 5 6,409 (8,108) -- -- (1,694)
Amortization of
restricted stock -- -- -- -- -- 3,128 -- -- 3,128
----- ------ -------- ---- -------- ------- -------- -------- ----------
BALANCE, DECEMBER 31, 2001
AS RESTATED 1,058 63,419 $393,970 $642 $232,413 $(4,980) $(13,014) $496,305 $1,105,336
===== ====== ======== ==== ======== ======= ======== ======== ==========
Net loss (as restated) -- -- -- -- -- -- -- (1,584) (1,584)
Cash dividends -- -- -- -- -- -- -- (3,728) (3,728)
Common stock repurchased -- (6,249) -- -- -- -- (45,294) -- (45,294)
Preferred dividends in
kind 98 -- 36,672 -- -- -- -- (36,672) --
Issuance of common stock
under employee
benefit plans -- 462 -- 4 2,975 -- -- -- 2,979
Deferred compensation -- 76 -- 1 967 (968) -- -- --
Amortization of
restricted stock -- -- -- -- -- 1,808 -- -- 1,808
Forfeiture of
restricted stock -- (540) -- (5) (8,979) 4,140 -- -- (4,844)
----- ------ -------- ---- -------- ======= -------- -------- ----------
BALANCE, DECEMBER 31, 2002
AS RESTATED 1,156 57,168 $430,642 $642 $227,376 $ -- $(58,308) $454,321 $1,054,673
===== ====== ======== ==== ======== ======= ======== ======== ==========
See accompanying Notes to Consolidated Financial Statements.
43
METRIS COMPANIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------------------------
2002 2001 2000
AS RESTATED AS RESTATED AS RESTATED
----------- ----------- -----------
OPERATING ACTIVITIES:
Net income (loss) $ (1,584) $ 160,029 $ 185,902
Adjustments to reconcile net income (loss)
to net cash provided by operating
activities:
Cumulative effect of accounting changes -- 14,226 516
Depreciation, amortization and accretion (175,314) (125,096) (203,244)
Provision for loan losses 219,804 461,106 164,800
(Gain) loss from credit card securitization (41,872) 95,246 77,222
Asset impairments, lease write-offs, and severance 27,736 -- --
Market loss (gain) on derivative financial instruments 22,562 (10,128) --
Changes in operating assets and liabilities, net:
Fair value of retained interests in loans
securitized 342,080 (28,069) 97,946
Spread accounts receivable (39,785) 6,570 79,964
Other receivables due from credit
card securitizations 29,362 (132,177) (14,995)
Accounts payable and accrued expenses (27,163) 32,370 37,623
Deferred income (45,587) (23,306) 61,367
Other (1,728) 26,990 116,529
----------- ----------- -----------
Net cash provided by operating activities 308,511 477,761 603,630
----------- ----------- -----------
INVESTING ACTIVITIES:
Proceeds from transfers of portfolios to the Metris Master Trust 2,087,097 553,180 --
Net cash from loan originations and principal collections on loans
receivable (704,614) (1,127,389) (1,361,227)
Proceeds from sales of credit card portfolios
to third parties 16,278 -- --
Credit card portfolio acquisitions -- (290,774) (195,597)
Additions to premises and equipment (6,159) (5,708) (85,007)
----------- ----------- -----------
Net cash provided by (used in) investing
activities 1,392,602 (870,691) (1,641,831)
----------- ----------- -----------
FINANCING ACTIVITIES:
Proceeds from issuance of debt 51,745 387,000 11,054
Repayment of debt (342,000) (95,162) --
Net (decrease) increase in deposits (1,165,254) (48,191) 1,330,818
Cash dividends paid (3,728) (3,752) (2,942)
Increase in common equity 2,011 26,248 26,278
Repurchase of common stock (45,294) (13,014) --
----------- ----------- -----------
Net cash provided by (used in) financing
activities (1,502,520) 253,129 1,365,208
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 198,593 (139,801) 327,007
Cash and cash equivalents at beginning of year 381,639 521,440 194,433
----------- ----------- -----------
Cash and cash equivalents at end of year $ 580,232 $ 381,639 $ 521,440
=========== =========== ===========
See accompanying Notes to Consolidated Financial Statements.
44
YEAR ENDED DECEMBER 31,
-----------------------------
2002 2001 2000
---- ---- ----
SUPPLEMENTAL DISCLOSURES AND CASH FLOW INFORMATION:
Cash paid (received) during the year for:
Interest $106,394 $165,241 $81,724
Income taxes (32,996) 25,718 75,384
Tax benefit from employee stock option exercises 174 8,989 31,174
See accompanying Notes to Consolidated Financial Statements.
45
METRIS COMPANIES INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT AS NOTED)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Metris
Companies Inc. ("MCI") and its subsidiaries. MCI's principal subsidiaries are
Direct Merchants Credit Card Bank, National Association ("Direct Merchants Bank"
or the "Bank"), Metris Direct, Inc. and Metris Receivables, Inc. MCI and its
subsidiaries, as applicable, may be referred to as "we," "us," "our" or the
"Company." We are an information-based direct marketer of consumer lending
products and enhancement services, primarily to moderate-income consumers. We
issue credit cards through our wholly owned subsidiary, Direct Merchants Bank,
the 11th largest bankcard issuer in the United States. We also offer consumer
products through our enhancement services business unit, including credit
protection, third-party insurance, warranty products, and membership program
products, and list syndication products.
All dollar amounts are presented as pre-tax amounts unless otherwise
noted. We have eliminated all significant intercompany balances and transactions
in consolidation. We have reclassified certain prior-year amounts to conform
with the current year's presentation.
PERVASIVENESS OF ESTIMATES
We have prepared the consolidated financial statements in accordance
with accounting principles generally accepted in the United States of America
("GAAP"), which require us to make estimates and assumptions that affect the
reported amounts in the consolidated financial statements and accompanying
notes. The most significant and subjective of these estimates are our
determination of the adequacy of the allowance for loan losses, which is
discussed under Note 3, and our determination of the fair value of retained
interests in loans securitized, which is discussed under note 4. The significant
factors susceptible to future change that have an impact on these estimates
include default rates, net interest spreads, payment rates, liquidity and the
ability to finance future receivables activity, and overall economic conditions.
As a result, the actual losses in our loan portfolio and the fair value of our
retained interests as of December 31, 2002 and 2001 could materially differ from
these estimates.
NOTE 2 - RESTATEMENTS
The consolidated statements of income as presented for the periods
ended December 31, 2002, 2001 and 2000 and the consolidated balance sheets as of
December 31, 2002 and December 31, 2001 have been restated to reflect the
following:
- The valuation model and related collateral assumptions used to estimate
the fair value of the Company's "Retained interests in loans
securitized" did not properly reflect the structure of the Metris
Master Trust and related series supplements. All periods presented have
been restated to reflect the changes in the valuation model and the
related collateral assumptions. These restatements impact "Retained
interests in loans securitized," "Other receivables due from credit
card securitizations, net" and "Securitization income."
46
- The Company's policy for recognizing transaction costs related to the
securitization of receivables through the Metris Master Trust or a
conduit was not in accordance with GAAP. Historically, these costs had
been capitalized and amortized over the estimated life of the new debt
securities. These costs are now allocated and recognized over the
initial and reinvestment periods of the respective debt securities or
Metris Master Trust financing unless the transaction results in a loss,
in which case the costs are expensed as incurred. All periods presented
have been restated to reflect the revised policy. This restatement
impacts "Other assets" and "Securitization income."
- The Company's policy for recognizing expenses related to credit card
solicitation costs was not in accordance with GAAP. Historically, the
Company had capitalized and expensed these costs over the estimated
period over which the new credit card accounts were established,
approximately three months. These costs are now expensed as incurred.
All periods presented have been restated to reflect the revised policy.
This restatement impacts "Other assets" and "Credit card account and
other product solicitation and marketing expenses."
- The Company corrected its accounting for interest rate caps purchased
in May of 2002 and forward to comply with SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended, on January
1, 2001. These costs had been deferred and amortized over the estimated
life of the new debt securities. These instruments are now recorded at
fair value. All periods presented have been restated to reflect this
correction. This restatement impacts "Retained interests in loans
securitized," "Other assets" and "Securitization income."
- The Company historically recognized revenue in the month following
completion of the cancellation period, generally one month. Cash
flows related to debt waiver are now included in the valuation of
the interest-only strip receivable. All periods presented have been
restated to reflect the revised policy. This restatement impacts
"Retained interests in loans securitized," "Deferred revenue,"
"Enhancement services revenue," and "Securitization income."
- At December 31, 2001 we had $50 million of "Allowance for loan losses"
classified as valuation reserve in our "Retained interests in loans
securitized." The valuation reserve was transferred to "Allowance for
loan losses" through "Provision for loans losses" during the first
quarter of 2002. We have restated the December 31, 2001 balance sheet
and 2001 income statement and March 31, 2002 income statement to
reflect this transfer occurring during the fourth quarter of 2001. This
restatement impacts "Allowance for loan losses," "Retained interests in
loans securitized," "Provision for loan losses" and "Securitization
income."
47
In addition, we have restated certain prior-period amounts to conform
with the current period's presentation.
The cumulative impact of the above restatements as of December 31, 1999 is a
$58.4 million increase to retained earnings and consists of the following
adjustments:
Retained interests in loans securitized $ 79.4
Transaction costs 12.2
Tax (33.2)
------
Total $ 58.4
======
- In prior periods, we classified interest income, provision for loan
losses, and related credit card loan fees generated from retained
interests in loans securitized on the income statement as "Interest
Income-Credit card loans and retained interests in loans securitized,"
"Provision for loan losses" and "Credit card fees, interchange and
other credit card income." For all periods presented, these amounts are
now included in the estimation of the fair value of the interest-only
strip receivable and "Securitization income."
- In prior periods we classified spread accounts receivable in "Other
receivables due from credit card securitizations, net." For all periods
presented, we have reclassified our spread accounts receivable from
"Other receivables due from credit card securitizations, net" to
"Retained interests in loans securitized."
- In prior periods, we classified servicing income in "Net securitization
and credit card servicing income." For all periods presented, we have
reclassified these amounts to "Servicing income."
- In prior periods, income from our debt waiver product sold to customers
of Direct Merchants Bank with receivables held by Direct Merchants Bank
was included in "Enhancement services revenue." For all periods
presented we have reclassified this income to "Credit card fees,
interchange and other credit card income."
- Revenue related to the membership club and warranty business for
current and prior periods is classified as "Enhancement services
revenue." Claims expense related to the sold business has been
reclassified as "Other" expenses for all periods presented.
- In addition to the tax effects of the pre-tax restatement amounts, the
restated presentation also reflects revised probable amounts of future
taxable and deductible temporary differences, resulting in a
reclassification of certain deferred income taxes to current income
taxes. The effects of the reclass for each of the years ended December
31, 2000 through 2002 amounted to a reduction (addition) to deferred
income taxes of $23.8 million, $1.0 million, and ($16.5) million,
respectively. Such reclasses did not result in any adjustment to net
income.
See Notes 3,4,5,6,7,14,19,20 and 21, all of which are impacted by these
changes.
48
The following tables present certain captions of the consolidated
financial statements, for all periods presented, which were affected by the
restatements.
DECEMBER 31, 2002
--------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
----------- -----------
BALANCE SHEETS:
ASSETS:
Retained interests in loans securitized $1,736,912 $ --
Less: Valuation allowance 986,517 --
Net retained interests in loans securitized 750,395 808,026
Other receivables due from credit card securitizations, net 184,220 110,471
Other assets 174,987 187,151
LIABILITIES:
Deferred income $ 159,267 $ 143,148
Accrued expenses and other liabilities 72,062 88,579
STOCKHOLDERS' EQUITY
Retained earnings $ 458,673 $ 454,321
DECEMBER 31, 2001
--------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
----------- -----------
BALANCE SHEETS:
ASSETS:
Short-term investments $ 134,502 $ 28,055
Cash and cash equivalents 488,086 381,639
Allowance for credit card loan losses (410,159) (460,159)
Retained interests in loans securitized 1,339,178 --
Less: Valuation allowance 537,499 --
Net retained interests in loans securitized 801,679 859,559
Other receivables due from credit card securitizations, net 114,456 139,833
Other assets 268,155 278,634
LIABILITIES:
Deferred income $ 215,031 $ 188,735
Accrued expenses and other liabilities 82,313 82,517
STOCKHOLDERS' EQUITY
Retained earnings $ 532,924 $ 496,305
49
DECEMBER 31, 2002
--------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
----------- -----------
STATEMENTS OF INCOME:
Provision for loan losses $ 573,478 $ 219,804
Net interest expense after provision
for loan losses (149,635) (93,918)
Other operating income:
Securitization income -- 323,517
Servicing income on securitized/sold
receivables -- 195,214
Net securitization and credit card
servicing income 271,348 --
Credit card fees, interchange and other
credit card income 202,664 163,174
Enhancement services revenue 392,827 153,516
Other operating expenses:
Credit card account and other product
solicitation and marketing expenses 190,259 173,269
Enhancement services claims expenses 51,542 --
Credit protection claims expense -- 44,550
Other 93,221 100,216
(Loss) Income Before Income Taxes (49,781) 283
Income tax (benefit) expense (15,930) 1,867
Net (loss) (33,851) (1,584)
Loss per share (1.20) (0.66)
Diluted loss per share (1.20) (0.66)
50
DECEMBER 31, 2001 DECEMBER 31, 2000
------------------------- -------------------------
AS AS
STATEMENTS OF INCOME: PREVIOUSLY AS PREVIOUSLY AS
REPORTED RESTATED REPORTED RESTATED
---------- -------- ---------- --------
Finance charge income $ -- $353,650 $ -- $106,549
Credit card loans and
retained interests
in loans securitized 681,503 -- 490,929 --
Net interest income (expense) 549,145 202,861 388,234 (12,608)
Provision for loan
losses 549,145 461,106 388,234 164,800
Other operating income:
Net securitization and
credit card servicing
income 517,399 -- 444,254 --
Securitization income -- 650,400 -- 644,457
Servicing income on
securitized / sold
receivables -- 159,074 -- 128,823
Credit card fees, interchange and
other credit card income 296,926 322,048 223,333 185,431
Enhancement services revenue 340,132 141,922 266,200 121,559
Other operating expenses:
Credit card account and other product
solicitation and marketing expenses 174,883 188,009 144,481 149,205
Credit protection claims expense -- 30,457 -- 20,811
Enhancement services claims expense 35,628 -- 26,431 --
Other 84,519 89,694 80,308 85,929
Income before income taxes 412,868 287,915 322,911 303,723
Income tax expense 161,577 113,660 124,320 117,305
Net income 245,792 160,029 195,153 185,902
Earnings per share 2.52 1.64 2.19 2.08
Diluted earnings per share 2.47 1.61 2.11 2.01
51
DECEMBER 31, 2002
--------------------------------
AS
PREVIOUSLY AS
STATEMENTS OF CASH FLOWS: REPORTED RESTATED
----------- -----------
Net loss $ (33,851) $ (1,584)
Depreciation, amortization and accretion 130,013 (175,314)
(Gain) loss from credit card securitizations -- (41,873)
Retained interests valuation income (118,953) --
Market loss on derivative financial instruments -- 22,562
Changes in operating assets and liabilities, net:
Fair value of retained interests in loans
securitized -- 342,080
Spread accounts receivable -- (39,785)
Other receivables due from credit card
securitizations, net (23,680) 29,362
Accounts payable and accrued expenses (43,476) (27,163)
Deferred income (55,764) (45,487)
Other 43,871 (1,727)
Net cash provided by operating activities 499,374 308,511
Net use of cash from sales and repayments of
securitized loans (1,145,947) --
Net cash collected from loan originations and
principal collections on loans receivable -- (704,614)
Net loans collected 211,458 --
Net cash provided by investing activities 1,162,727 1,392,602
52
DECEMBER 31, 2001
-------------------------------
AS
PREVIOUSLY AS
STATEMENTS OF CASH FLOWS: REPORTED RESTATED
----------- -----------
Net income $ 245,792 $ 160,029
Cumulative effect of accounting changes 14,499 14,226
Depreciation, amortization and accretion 106,703 (125,096)
Provision for loan losses 549,145 461,106
(Gain) loss from credit card securitizations -- 95,246
Retained interests valuation income (131,992) --
Market gain on derivative financial instruments -- (10,128)
Changes in operating assets and liabilities, net:
Fair value of retained interests in loans
securitized -- (28,069)
Spread accounts receivable -- 6,570
Other receivables due from credit card
securitizations, net (5,583) (132,177)
Accounts payable and accrued expenses 6,446 32,370
Deferred income (20,476) (23,306)
Other 45,878 26,990
Net cash provided by operating activities 810,412 477,761
Net use of cash from sales and repayments of
securitized loans 1,272,438 --
Net loans collected (2,617,045) --
Net cash from loan originations and principal
collections on loans receivable -- (1,127,389)
Additions to property and equipment (5,706) (5,708)
Net cash (used in) provided by investing
activities (1,087,907) (870,691)
Proceeds from issuance of common stock 17,260 26,248
Net cash used in financing activities 244,141 253,129
53
DECEMBER 31, 2000
------------------------------
AS
PREVIOUSLY AS
STATEMENTS OF CASH FLOWS: REPORTED RESTATED
----------- -----------
Net income $ 195,153 $ 185,902
Depreciation, amortization and accretion 76,256 (203,244)
Provision for loan losses 388,234 164,800
Retained interests valuation income (104,710) --
(Gain) loss from credit card securitizations -- 77,222
Changes in operating assets and liabilities, net:
Fair value of retained interests in loans
securitized -- 97,946
Spread accounts receivable -- 79,964
Other receivables due from credit card
securitizations, net 55,240 (14,995)
Accounts payable and accrued expenses 45,877 37,623
Deferred income 60,403 61,367
Other (53,058) 116,529
Net cash provided by operating activities 666,833 603,630
Net cash from loan originations and principal
collections on loans receivable (1,976,341) (1,361,227)
Net cash (used in) investing activities (1,705,034) (1,641,831)
In addition, the restatements will have the following impact on the
previously reported annual information for the year ended December 31:
BASIC (LOSS) EARNINGS DILUTED (LOSS) EARNINGS
NET (LOSS) INCOME PER SHARE PER SHARE
----------------- --------- ---------
AS AS AS
PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS
REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED
-------- -------- -------- -------- -------- --------
2002 (33,851) (1,584) (1.20) (0.66) (1.20) (0.66)
2001 245,792 160,029 2.52 1.64 2.47 1.61
2000 195,152 185,902 2.19 2.08 2.11 2.01
1999 64,555 109,555 (1.07) 1.50 (1.07) 1.44
1998 57,348 66,691 0.97 1.14 0.94 1.09
54
NOTE 3 - SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of the significant accounting and reporting
policies used in preparing the consolidated financial statements.
FEDERAL FUNDS SOLD AND SHORT-TERM INVESTMENTS
Federal funds sold are short-term loans made to banks through the
Federal Reserve System. It is our policy to make such loans only to banks that
are considered to be in compliance with their regulatory capital requirements.
Short-term investments are investments in money market mutual funds, Treasuries,
other Government Agency Obligations, and commercial paper with maturities less
than three months. We invest in certain certificates of deposit and Housing
Bonds in order to meet our obligations under the Community Reinvestment Act, and
fulfill the credit needs of our local community.
CREDIT CARD LOANS
Credit card loans presented on our consolidated balance sheet are
receivables from cardholders that we have not sold via securitizations or
third-party conduit warehousing arrangements, and are recorded at the amount
outstanding plus related deferred acquisition costs and net of related deferred
revenue. Interest income on credit card loans is earned and accrued based on the
amount of the loans outstanding. Accrued interest and fees which have been
billed to the cardholder but not yet received are classified on the consolidated
balance sheet with the related credit card loans. Accrued interest which has not
yet been billed to the cardholder is estimated and classified on the
consolidated balance sheet in "Other assets." Interest income and fees are
generally recognized until a loan is charged-off. Upon charge-off, any unpaid
principal is applied to the allowance for loan losses and any unpaid finance
charges and fees are netted against the applicable income statement line items.
Beginning in November 2002, we stopped late fee billings after an account
becomes 120 days contractually delinquent.
When we decide to sell a portion of our credit card loans, the loans
are specifically identified and transferred to the held-for-sale account. The
loans are transferred into the account at the lower of cost or fair value at the
date the decision to sell is made. Any reduction in the loans' value is
reflected as a charge-off of the recorded investment in the loan with a
corresponding reduction in the allowance for loan losses. All deferred costs and
fees are written off upon the decision to sell. At the time of sale we record
the difference between the carrying value and sales price as an increase or
decrease in the provision for loan losses. Any portfolio premium would also be
written off unless we retain ownership of the cardholder account. To the extent
that the loans' carrying value at the time of transfer does not reflect fair
value, an additional provision for loan losses is recorded. Any loans in the
held-for-sale account are revalued to the lower of cost or fair value at each
subsequent reporting date. We had no loans in the held-for-sale account as of
December 31, 2002 and 2001.
55
ALLOWANCE FOR LOAN LOSSES
We maintain an allowance for loan losses sufficient to absorb
anticipated probable loan losses inherent in the credit card loan portfolio,
including accrued finance charges and fees, 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 liquidating pools
with similar credit risk characteristics, and estimate (based on historical
experience for similar pools and existing environmental conditions) the dollar
amount of principal, accrued finance charges and fees that will ultimately
charge-off. We then aggregate these pools into prime and subprime portfolios
based on the prescribed FICO score cuts, credit counseling and various pools of
other receivables. We also isolate other potentially higher risk segments such
as accounts that are over their credit limit by more than 10%, accounts in
suspended status under our debt waiver benefits and other programs as deemed
necessary. We separately analyze the reserve requirement on each of these groups
or portfolios.
We continually evaluate the homogenous liquidating risk pools using a
roll rate model which uses historical delinquency levels and pay-down levels (12
months of historical data, with influence given to the last six months'
performance to capture current economic and seasonal trends), loan seasoning and
other measures of asset quality to estimate charge-offs for both credit loss and
bankruptcy losses.
Additionally, in evaluating the adequacy of the loan loss reserves, we
consider several subjective factors which may be overlaid into the credit risk
roll-rate model in determining the necessary loan loss reserve, including:
- national and economic trends and business conditions,
including the condition of various market segments;
- changes in lending policies and procedures, including those
for underwriting, collection, charge-off and recovery, as well
as in the experience, ability and depth of lending management
and staff;
- trends in volume and the product pricing of accounts,
including any concentrations of credit; and
- impacts from external factors, such as changes in competition,
and legal and regulatory requirements, on the level of
estimated credit losses in the current portfolio.
Significant changes in these factors could impact our financial
projections and thereby affect the adequacy of our allowance for loan losses.
Various regulatory agencies, as an integral part of their examination
process, periodically review our allowance for loan losses maintained at Direct
Merchants Bank. Such agencies may require that we recognize additions to the
allowance based on their judgment on information available to them at the time
of their examination. In our opinion, the allowance for loan losses is adequate
to cover probable losses inherent in the loan portfolio under current
conditions.
We charge-off unsecured credit card accounts at the end of the month
during which the loan becomes contractually 180 days past due except as follows.
We charge-off all secured credit card accounts and accounts which enter into
credit
56
counseling or other similar programs and later become delinquent at the end of
the month during which the loan becomes contractually 120 days past due after
first reducing the loss by the security deposit. Bankrupt accounts are
charged-off within 60 days of formal notification of bankruptcy. Accounts of
deceased accountholders without a surviving, contractually liable individual, or
an estate large enough to pay the debt in full are charged-off immediately upon
notification.
SECURITIZATION, RETAINED INTERESTS IN LOANS SECURITIZED, AND SECURITIZATION
INCOME
Upon securitization, the Company removes the applicable credit card
loans from the balance sheet and recognizes the "Retained interests in loans
securitized" at their allocated carrying value in accordance with SFAS No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities-a replacement of FASB Statement No. 125" ("SFAS No. 140"). Credit
card receivables are sold to the Metris Master Trust at the inception of a
securitization series. We also sell credit card receivables to the Metris Master
Trust to replenish receivable balances that have decreased due to payments and
charge-offs. The difference between the allocated carrying value and the
proceeds from the assets sold is recorded as a gain or loss on sale and is
included in "Securitization income." At the same time, the Company recognizes
the "Retained interests in loans securitized."
The "Retained interests in loans securitized" are financial assets
measured at fair value consistent with trading securities in accordance with
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and includes the contractual retained interests, an interest-only
strip receivable, excess transferor's interests and spread accounts receivable.
The contractual retained interests consist of non-interest bearing securities
held by the Company. The interest-only strip receivable represents the present
value of the excess of the estimated future interest and fee collections
expected to be generated by the securitized loans over the period the
securitized loans are projected to be outstanding above the interest paid on
investor certificates, credit losses, contractual servicing fees, and other
expenses. The excess transferor's interests represent principal receivables held
in the Metris Master Trust above the contractual retained interests. Spread
accounts receivable represents restricted cash reserve accounts held by the
Metris Master Trust that can be used to fund payments due to securitization
investors and credit enhancers if cash flows are insufficient. Cash held in
spread accounts is released to us if certain conditions are met or a
securitization series terminates with amounts remaining in the spread accounts.
The fair value of the "Retained interests in loans securitized" is determined
through estimated cash flows discounted at rates that reflect the level of
subordination, the projected repayment term, and risk of the securitized loans.
At least quarterly, the Company reviews its "Retained interests in
loans securitized" for changes in fair value and recognizes those changes as
"Securitization income." The changes in fair value reflect the Company's
revisions in the expected timing and amount of future cash flows. The
significant factors that affect the timing and amount of future cash flows
relate to the collateral assumptions, which include payment rate, default rate,
gross yield and discount rate.
The Company recognizes future cash flows associated with its retained
interests using the effective yield method in accordance with EITF 99-20
"Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets." Accordingly,
"Securitization income" includes discount accretion associated with the
contractual retained interests, the excess transferor's interests, the
57
interest-only strip receivable, spread accounts receivable as well as the
difference in the actual excess spread received as compared to the estimated
amount recorded related to the interest-only strip. Since the Company's retained
interests are trading securities, the impairment provisions of EITF 99-20 are
not applicable.
Up-front transaction costs related to securitizations are allocated and
recognized over the initial and reinvestment periods unless the transaction
results in a loss, in which case, the costs are expensed as incurred and
recorded as "Securitization income."
The Company services the receivables held by the Metris Master Trust,
and receives annual servicing fees based upon the principal receivables
outstanding. "Servicing income" is recognized when earned. We consider these
fees to be adequate compensation and as a result no servicing asset or liability
is recorded.
"Other receivables due from credit card securitizations, net" primarily
represents cash accumulated in the Metris Master Trust during a month, which is
released to Metris Receivables, Inc. the following month.
SERVICING INCOME
During 2003, 2002, and 2001, we sold credit card loan receivables in
securitization transactions. In those securitizations, we retained servicing
responsibilities and subordinated interests. We receive annual servicing fees of
two percent of the outstanding principal balance. Revenue from these servicing
responsibilities is recognized when earned and recorded in the consolidated
income statements as "Servicing income on securitized/sold receivables."
CREDIT CARD FEES AND ORIGINATION COSTS
Credit card fees include annual membership, late payment, overlimit,
returned check, cash advance transaction and other miscellaneous fees. We assess
these fees according to the terms of the related cardholder agreements and,
except for annual membership fees, we recognize the fees as revenue when charged
to the cardholder's account.
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.
These deferred credit card origination costs and cardholders annual membership
fees are netted and amortized to interest income on a straight-line basis over
the cardholder's privilege period, generally 12 months. These net deferred fees
are included in credit card loans. If deferred direct credit card acquisition
costs were to exceed forecasted future cash flows, we would make an appropriate
adjustment for impairment. All other costs of credit card solicitation are
expensed as incurred.
CREDIT CARD FRAUD LOSSES
We experience credit card fraud losses from the unauthorized use of
credit cards. We expense these fraudulent transactions when identified, through
the establishment of a reserve for the transactions. We charge-off these amounts
no later than 90 days from discovery, after all attempts to recover the amounts
from these transactions, including charge backs to merchants and claims against
cardholders, are exhausted.
DEBT ISSUANCE COSTS
Debt issuance costs (upfront fees) are the costs related to issuing new
debt securities. We capitalize these costs and amortize them to expense over the
term of the new debt security.
PROPERTY AND EQUIPMENT
We record property and equipment at cost and depreciate them on a
straight-line basis over their estimated economic useful lives, which range from
one to 25 years. We capitalize software developed for internal use that
represents major enhancements or replacements of operating and management
information systems. We begin amortization of such capitalized software when the
systems are fully developed and ready for implementation. We expense repair and
maintenance costs as incurred. We review property and equipment for impairment
whenever events or changes in circumstances indicate that the carrying amount of
58
an asset may not be recoverable. Any impairment is recorded as other operating
expenses. Upon the decision to sell property and equipment, we adjust the
carrying value to the lower of cost or market and transfer the assets to a held
for sale account. No depreciation is recognized on held for sale assets.
PURCHASED PORTFOLIO PREMIUM
The purchased portfolio premium represents the excess of amounts paid
for portfolio acquisitions over the related credit card loan balances net of
reserves and discounts. The premium is amortized over the estimated account
life, generally seven years, based on the expected account attrition. The
recoverability of the premium is evaluated quarterly. Such evaluation is based
on undiscounted cash flow projections.
ENHANCEMENT SERVICES
Debt Waiver Products
Direct Merchants Bank offers various debt waiver products on
receivables it owns as well as securitized receivables. Direct Merchants Banks
records deferred revenue when the debt waiver customer is billed. For customers
whose accounts are funded on balance sheet, revenue is recognized in the month
following the completion of the of the cancellation period, which is one month.
Cash flows related to debt waiver on receivables sold to the Metris Master Trust
are included in the valuation of the interest-only strip receivable. Direct
Merchants Bank incurs the related claims and marketing expenses. A reserve is
maintained for future death and finance charge claims based on Direct Merchants
Bank's historical experience with settlement of such claims. Reserves for
pending claims and incurred but not reported claims are recorded in the
consolidated balance sheets in "accrued expenses and other liabilities."
Reserves for pending and incurred but not reported claims were $8.2 million as
of December 31, 2002, compared to $5.2 million as of December 31, 2001.
During the quarter ended March 31, 2000, we adopted Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements," for our
debt waiver products. This change resulted in a one-time, non-cash net charge to
earnings of $3.4 million, which is reflected as a "Cumulative effect of
accounting change" in the consolidated statements of income for the year ended
December 31, 2000.
Qualifying membership acquisition costs are deferred and charged to
expense as debt waiver product fees are recognized. We amortize these costs
using an accelerated methodology, which approximates our historical cancellation
experience for the debt waiver products. Amortization of debt waiver acquisition
costs was $3.7 million for the year ended December 31, 2002. All other debt
waiver acquisition costs are expensed as incurred. Deferred debt waiver
acquisition costs were $2.6 million as of December 31, 2002.
Membership Program Products
We bill membership fees for enhancement services products through
financial institutions, including Direct Merchants Bank, and other
cardholder-based institutions. We record these fees as deferred membership
income upon acceptance of membership and amortize them on a straight-line basis
for all annually billed products, and on an accelerated amortization method for
all monthly billed products over the membership period beginning after the
contractual cancellation period is complete. A liability is established and
netted against the related receivable in the consolidated balance sheets in
"other assets" from inception of the membership through the end of the
cancellation period that reflects our historical cancellation experience with
these products. Gross receivables as of
59
December 31, 2002 on the membership program products were $22.0 million compared
to $38.7 million as of December 31, 2001. Cancellation reserves were $19.5
million and $29.6 million for the years ended December 31, 2002 and 2001,
respectively. Revenues recorded for membership products are included in the
statements of income under "enhancement services revenues" and were $92.9
million, $57.2 million and $76.0 million for the years ended December 31, 2002,
2001 and 2000, respectively. Unearned revenues on membership program products
are recorded in the consolidated balance sheets in "deferred income." Unearned
revenues as of December 31, 2002 were $114.2 million compared to $130.9 million
as of December 31, 2001. Reserves for pending and incurred but not reported
claims, included in "accrued expenses and other liabilities," were $0.1 million
as of December 31, 2002, compared to $0.2 million as of December 31, 2001.
Qualifying membership acquisition costs are deferred and charged to
expense as membership fees are recognized. We amortize all deferred costs on a
straight-line basis for all annually billed products, and on an accelerated
method for all monthly billed products, which approximates our historical
cancellation experience for the membership program products. Amortization of
membership deferred costs was $55.4 million, $28.0 million and $19.8 million for
the years ended December 31, 2002, 2001 and 2000, respectively. All other
membership acquisition costs are expensed as incurred. Deferred membership
acquisition costs were $66.9 million and $66.7 million as of December 31, 2002
and 2001, respectively.
Warranty Products
We coordinate the marketing activities for Direct Merchants Bank and
third-party sales of extended service plans. We perform administrative services
and retain the claims risk for all extended service plans sold. As a result, we
defer and recognize extended service plan revenues and the incremental direct
acquisition costs on an accelerated amortization method over the life of the
related extended service plan contracts beginning after the expiration of any
manufacturer's warranty coverage. A liability is established and netted against
the related receivable in the consolidated balance sheets in "other assets" from
inception of the extended service plan through the end of the cancellation
period that reflects our historical cancellation experience with these products.
Gross receivables as of December 31, 2002 on the warranty products were $3.8
million compared to $7.0 million as of December 31, 2001. Cancellation reserves
were $5.3 million and $6.2 million for the years ended December 31, 2002 and
2001, respectively. Unearned revenues on warranty products are recorded in the
consolidated balance sheets in "deferred income". Unearned revenues as of
December 31, 2002 were $17.6 million compared to $33.8 million as of December
31, 2001. Reserves for pending and incurred but not reported claims, included in
"accrued expenses and other liabilities," were $0.7 million as of December 31,
2002, compared to $0.5 million as of December 31, 2001.
Qualifying warranty acquisition costs are deferred and charged to
expense as warranty product fees are recognized. Those incremental direct
acquisition costs, which are a result of a contract that is not consummated, are
charged to expense as incurred. A successful effort conversion percentage is
applied to these incremental direct acquisition costs, which approximates our
historical successful effort rate percentage in negotiating warranty products.
We amortize these deferred costs using an accelerated amortization methodology,
which approximates our historical cancellation experience following the
expiration of the manufacturer's contractual cancellation period for the
warranty products. Amortization of warranty acquisition costs amount to $12.8
million, $15.9 million, and $10.4 million for the years ended December 31, 2002,
2001, and 2000, respectively. All other warranty acquisition costs are expensed
as
60
incurred. Deferred warranty acquisition costs amount to $3.0 million and $12.7
million as of December 31, 2002 and 2001, respectively.
We discontinue the billing of enhancement services products to Direct
Merchants Bank customers that are more than 60 days past due (except for debt
waiver which bills customers until 120 days past due) or over their credit
limit. The impact of uncollectible fees associated with enhancement service
products is included in determining the adequacy of the allowance for loan
losses.
INTEREST RATE RISK MANAGEMENT CONTRACTS
We enter into a variety of interest rate risk management contracts such
as interest rate swap, floor and cap agreements with highly rated counterparties
in order to hedge our interest rate exposure on securitized loans and deposits.
We account for these contracts in accordance with SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by SFAS 138. We
recognize all derivatives as either assets or liabilities on the balance sheet
and measure those instruments at fair value. The change in fair value of the
derivatives is recognized currently in earnings unless specific hedge accounting
criteria are met. If the derivative qualifies as a hedge, the accounting
treatment for the change in fair value varies based on the type of risk being
hedged. The monthly interest rate differential to be paid or received on these
contracts is accrued and included in "Net securitization and credit card
servicing income" or "Deposit interest expense," as appropriate, on the
consolidated statements of income. Interest payable or receivable under these
contracts is classified under "Other receivables due from credit card
securitization, net" or "Other assets," as appropriate on the consolidated
balance sheets.
INCOME TAXES
Deferred taxes are based on the temporary differences between the
financial statement and the tax bases of assets and liabilities that will result
in future taxable or deductible amounts. The deferred taxes are based on the
enacted rate that is expected to apply when the temporary differences reverse. A
valuation allowance is recognized if it is more likely than not that all or some
portion of the deferred tax asset will not be realized.
61
EARNINGS PER SHARE
The following table presents the computation of basic and diluted
weighted-average shares used in the per-share calculations:
YEAR ENDED DECEMBER 31,
------------------------------------
2002 2001 2000
(In thousands) --------- --------- ---------
Income (loss) before cumulative effect of accounting changes $ (1,584) $ 174,255 $ 186,418
Preferred dividends 38,009 34,771 31,622
--------- --------- ---------
Net income (loss) applicable to common stockholders before
cumulative effect of accounting changes (39,593) 139,484 154,796
Cumulative effect of accounting changes, net -- 14,226 516
--------- --------- ---------
Net income (loss) applicable to common stockholders $ (39,593) $ 125,258 $ 154,280
========= ========= =========
Weighted average common shares outstanding 59,782 62,962 60,070
Adjustment for:
Assumed conversion of convertible preferred stock(1) -- 34,679 29,164
--------- --------- ---------
Basic common shares 59,782 97,641 89,234
Assumed exercise of outstanding stock options(1) -- 1,725 3,348
--------- --------- ---------
Diluted common shares 59,782 99,366 92,582
========= ========= =========
(1) The earnings per share calculation for the year ended December 31, 2002
excludes the assumed conversion of the convertible preferred stock and
the outstanding stock options, as they are anti-dilutive.
62
STOCK-BASED COMPENSATION PLANS
We recognize compensation cost for stock-based employee compensation
plans based on the difference, if any, between the quoted market price of the
stock on the date of grant and the amount an employee must pay to acquire the
stock.
Pro forma information regarding net income and earnings per share has
been determined as if we accounted for our employee stock options under the fair
value method. The fair value of the options was estimated at the grant date
using a Black-Scholes option-pricing model. The fair value of the options is
amortized to expense over the options' vesting periods. Our net earnings and
earnings per share would have been reduced to the pro forma amounts indicated
below:
YEAR ENDED DECEMBER 31,
--------------------------------------------
2002 2001 2000
---------- ----------- -----------
Net income (loss), as reported $ (1,584) $ 160,029 $ 185,902
Deduct: Annual stock-based compensation expense
based on the fair value for all awards, net of
related tax effects 18,141 16,847 15,071
---------- ----------- -----------
Pro forma net income (loss) (19,725) 143,182 170,831
========== =========== ===========
Earnings (loss) per share:
Basic-as reported (0.66) 1.64 2.08
========== =========== ===========
Basic-pro forma (0.97) 1.47 2.25
========== =========== ===========
Diluted-as reported (0.66) 1.61 2.01
========== =========== ===========
Diluted-pro forma (0.97) 1.44 2.17
========== =========== ===========
Weighted-average assumptions in option valuation:
Risk-free interest rates 3.7% 4.9% 6.4%
Dividend yields 1.6% 0.2% 0.1%
Stock volatility factor 92.9% 52.2% 58.4%
Expected life of options (in years) 6.0 6.0 6.0
The above pro forma amounts may not be representative of the effects on reported
net earnings for future years.
COMPREHENSIVE INCOME
SFAS No. 130 "Reporting Comprehensive Income," does not apply to our
current financial results and therefore, net income equals comprehensive income.
NOTE 4 - RETAINED INTERESTS IN LOANS SECURITIZED
Our credit card receivables are primarily funded through asset
securitizations. As part of the asset securitizations, credit card receivables
are transferred to the Metris Master Trust, a non-consolidated, qualifying
special purpose entity that issues asset backed securities representing
undivided interests in receivables held in the Metris Master Trust and the right
to receive future collections of principal, interest and fees related to those
receivables. The senior classes of these securities are sold to third party
investors. We retain subordinated interests in the securitized receivables,
including contractual retained interests, an interest-only strip receivable,
excess transferor's interests maintained above the contractual retained
interests, and spread accounts receivable. The components of these retained
interests are recorded at their fair value.
63
The following table shows the fair value of the components of the
"Retained interests in loans securitized" as of December 31, 2002 and December
31, 2001:
DECEMBER 31, DECEMBER 31,
2002 2001
------------ ------------
Contractual retained interests $685,197 $571,715
Excess transferor's interests 57,447 30,836
Interest-only strip receivable 13,882 214,707
Spread accounts receivable 51,500 42,301
-------- --------
Retained interests in loans securitized $808,026 $859,559
======== ========
The following table illustrates the significant assumptions used for
estimating the fair value of retained interests as of December 31, 2002 and
December 31, 2001:
DECEMBER 31 DECEMBER 31,
2002 2001
----------- ------------
Monthly payment rate 6.7% 6.3%
Gross yield (1) 26.0% 25.4%
Annual interest expense and servicing fees 4.0% 5.5%
Annual gross principal default rate 21.7% 16.6%
Discount rate (2):
Contractual retained interests 16.0% 12.0%
Excess transferor's interests 16.0% 12.0%
Interest-only strip receivable 30.0% 25.0%
Spread accounts receivable 16.0% 12.0%
(1)Includes expected cash flows from finance charges, late and overlimit fees,
debt waiver premiums and bad debt recoveries, net of finance charge and fee
charge-offs. Gross yield for purposes of estimating fair value does not include
interchange income, or cash advance fees.
(2) The discount rates used in the retained interest valuation take into
consideration the uncertainty inherent in the portfolio. The deterioratin in
credit quality and overall performance of the Metris Master Trust in 2002 create
a higher risk to future cash flows. Based on the increased risk in the
portfolio, the discount rates were increased over 2002.
At December 31, 2002, the sensitivity of the current fair value of the
retained interests to immediate 10% and 20% adverse changes are as follows (in
millions):
ADVERSE IMPACT ON FAIR VALUE
----------------------------
10% ADVERSE 20% ADVERSE
CHANGE CHANGE
----------- -----------
Annual discount rate $ 24.3 $ 47.4
Monthly payment rate 183.7 425.5
Gross yield 172.1 362.1
Annual interest expense and servicing fees 26.0 59.6
Annual gross principal default rate 135.6 278.5
As the sensitivity indicates, the value of the Company's retained
interests on its balance sheet, as well as reported earnings, could differ
significantly if different assumptions or conditions prevail.
64
The actual rates for loans securitized are as follows:
DECEMBER 31, DECEMBER 31,
2002 2001
------------ ------------
Annual gross principal default rate 16.4% 13.2%
Monthly payment rate 6.6% 6.6%
Gross yield (1) 26.5% 27.6%
(1) Includes finance charges, late and overlimit fees, debt waiver premiums,
interchange income, cash advance fees and bad debt recoveries, net of
finance charge and fee charge-offs.
NOTE 5 - SECURITIZATION INCOME
The following summarizes "Securitization income" for the years ended
December 31, 2002, December 31, 2001 and December 31, 2000.
DECEMBER 31,
2002 2001 2000
--------- --------- ---------
Loss on new securitization of receivables
to the Metris Master Trust $ (70,578) $ (60,574) $ (52,406)
(Loss) gain on replenishment of receivables
to the Metris Master Trust 28,706 (34,672) (24,816)
Discount accretion 305,327 221,670 279,500
Change in fair value (342,080) 28,069 (97,946)
Interest-only revenue 452,268 510,806 566,690
Transaction and other costs (50,126) (14,899) (26,565)
--------- --------- ---------
Securitization income $ 323,517 $ 650,400 $ 644,457
========= ========= =========
65
NOTE 6 - SECURITIZATION ACTIVITY
During 2002 and 2001, we sold credit card loan receivables in
securitization transactions. In those securitizations, we retained servicing
responsibilities and subordinated interests. We receive annual servicing fees of
two percent of the outstanding principal balance. Our subordinated interests
give us rights to future cash flows arising in the Master Trust after the
investors in the Master Trust have received their invested amount and interest
thereon. The investors and related securitization trusts have no recourse to our
assets. Because our retained interests are subordinate to investors' interests,
their value is subject to credit and interest rate risk associated with the
transferred financial assets.
Securitization activity for the years ended December 31, 2002 and 2001,
is as follows:
2002 2001
------------ ------------
Credit card loans $ 846,417 $ 2,756,763
Receivables held in the Metris Master Trust 10,573,769 9,235,021
------------ ------------
Total managed loans $ 11,420,186 $ 11,991,784
============ ============
Managed loans more than 30-days contractually
delinquent $ 1,259,949 $ 1,123,168
Managed loans charged-off, net of recoveries 1,840,786 1,140,151
YEAR ENDED DECEMBER 31,
2002 2001
------------ ------------
Cash flow to/from the Company:
Proceeds from transfers of portfolios to the Master Trust $ 2,087,097 $ 553,180
Net proceeds from sales and repayments of securitized loans (1,145,947) 1,272,438
Proceeds from principal receivables collections reinvested
in revolving credit card securitizations 5,490,499 4,181,887
Servicing fees received 192,325 147,518
Cash flows received from net excess spread 570,088 611,704
------------ -----------
Total $ 7,194,062 $ 6,766,727
============ ===========
66
NOTE 7 - ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses is as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------
2002 2001 2000
--------- --------- ---------
Balance at beginning of year $ 460,159 $ 123,123 $ 12,175
Allowance related to assets acquired -- 14,106 5,827
Allowance related to assets transferred to/from the Master Trust (264,297) 71,603 --
Provision for loan losses 219,804 461,106 164,800
Principal receivables charged-off (1) (345,785) (235,197) (61,684)
Recoveries 20,434 25,418 2,005
--------- --------- ---------
Net loans charged-off (325,351) (209,779) (59,679)
--------- --------- ---------
Balance at end of year $ 90,315 $ 460,159 $ 123,123
========= ========= =========
(1) Principal receivables charged-off for the year ended December 31, 2002
include a $101.5 million charge-off related to the sales of delinquent
receivables in September and December 2002.
Credit card loans greater than 30 days contractually past due for the
years ended December 31, 2002, 2001 and 2000 were $7.9 million, $277.8 million,
and $89.2 million, respectively.
NOTE 8 - PROPERTY AND EQUIPMENT
The carrying value of property and equipment is as follows:
AT DECEMBER 31,
--------------------
2002 2001
-------- --------
Furniture and equipment $ 40,870 $ 48,707
Computer software and equipment 71,640 65,407
Buildings and land 24,143 28,031
Leasehold improvements 16,389 18,561
-------- --------
Total $153,042 $160,706
Less: Accumulated depreciation and amortization 69,211 45,793
-------- --------
Balance at end of year $ 83,831 $114,913
======== ========
Depreciation and amortization expense for the years ended
December 31, 2002, 2001 and 2000, was $25.6 million, $24.7 million and $16.0
million, respectively.
In 2002, furniture and equipment was written down by $5.1 million due
to excess capacity. Subsequent to year-end we entered into a letter of intent to
sell our interest in an Arizona facility, as well as related furniture and
equipment. The transaction is expected to result in a loss of approximately $5.7
million, which reflects the write-down of the building and furniture and
equipment to the sales price. Accordingly, we have classified the land,
building, improvements and equipment as held for sale and halted applicable
depreciation.
67
NOTE 9 - PURCHASED PORTFOLIO PREMIUM
The carrying value of the purchased portfolio premium was $64.6 million
and $94.8 million as of December 31, 2002 and 2001, net of accumulated
amortization of $124.2 million and $94.0 million, respectively. Amortization
expense for the years ended December 31, 2002, 2001 and 2000, was $30.2 million,
$30.3 million, and $19.3 million, respectively. The purchased portfolio premium
is analyzed for impairment using the undiscounted cash flow method. As of
December 31, 2002 and 2001 the purchased portfolio premium was not impaired.
NOTE 10 - PORTFOLIO ACQUISITIONS AND SALES
In 2001, Direct Merchants Bank purchased two credit card portfolios
that consisted of approximately 170,000 active accounts and approximately $290
million in receivables. There were no portfolio acquisitions during 2002.
During 2002, we sold two portfolios of delinquent accounts
approximating $120 million in receivables. Upon the decision to sell, $101.5
million of receivables were charged-off.
NOTE 11 - CONVERTIBLE PREFERRED STOCK
Affiliates of Thomas H. Lee Partners, L.P. ("THL Partners"), a
Boston-based investment firm, and its predecessor, Thomas H. Lee Company, hold
100% of the outstanding shares of our Series C Perpetual Convertible Preferred
Stock. The Series C Preferred Stock has a 9% dividend payable in additional
shares of Series C Preferred Stock and also receives any cash dividends paid on
our common stock based on the number of shares of common stock into which the
Preferred Stock would convert on the record date of the dividend. Each share of
Series C Preferred Stock is convertible into 30 shares of common stock plus - if
converted at the option of the holder before January 1, 2004 - a premium amount
designed to guarantee a portion of seven years worth of dividends at the 9%
annual rate. The premium amount would have been equal to 41.0% of those future
dividends for conversions in 2001 and would be 54.4% of those dividends in 2002.
The Series C Preferred Stock is normally fully convertible into common
stock. This would mean that upon conversion of their Preferred Stock, our
Preferred Stockholders could have received 38,977,613 shares, or approximately
40.5%, outstanding common stock on a diluted basis as of December 31, 2002.
However, the indenture that governs our 10% Senior Notes due 2004 requires us to
offer to purchase those notes in the event that such a conversion would result
in a shareholder or group (within the meaning of Rules 13d-3 and 13d-5 of the
Securities Exchange Act of 1934) obtaining 35% or more of our outstanding voting
stock. Therefore, we included a provision in the terms of our Series C Preferred
Stock that sets the maximum percentage of outstanding voting stock that any
shareholder or group, such as the affiliates of THL Partners, could obtain while
any of our 10% Notes remain outstanding at 34.9%. Accordingly, as of December
31, 2002, the Series C Preferred Stock could have been converted into 30,647,631
shares, or 34.9%, of our common stock on a diluted basis, with the excess Series
C Preferred Stock converting into 8,329,982 shares of nonvoting Series D
Preferred Stock. The Series D Preferred Stock automatically converts into common
stock on a share-for-share basis at the time that the conversion will not exceed
the ownership limitations described above. The terms of our Series D Preferred
Stock are essentially the same as the terms of our common stock, except that
- the Series D Preferred Stock has a liquidation preference of $.01 per
share, and
68
- is non-voting, except as required by law to preserve the powers,
preferences or other rights of that class of stock.
So long as they or their affiliates own at least 25% of the originally
issued Series C Preferred Stock (or any shares of common stock issued upon
conversion thereof), the holders of a majority of the shares of Series C
Preferred Stock are entitled to elect four of 11 directors of the Board. So long
as they or their affiliates: (a) own any shares of Series C Preferred Stock (or
any shares of common stock issued upon conversion thereof); and (b) are entitled
to elect four directors, the Thomas H. Lee Equity Fund IV, L.P., which owns
approximately 85% of our outstanding Series C Preferred Stock, has the right to
appoint one of the four directors. So long as they or their affiliates own at
least 10% but less than 25% of the originally issued Series C Preferred Stock
(or any shares of common stock issued upon conversion thereof), the holders of a
majority of the shares of Series C Preferred Stock are entitled to elect one
director. The four directors who have been elected by the holders of our Series
C Preferred Stock are all affiliates of THL Partners and, through such
affiliation as well as actual ownership of Series C Preferred Stock, may be
deemed to be the beneficial owners of approximately 97% of the common stock that
would be issued upon conversion of our Series C and D Preferred Stock, both
individually and in the aggregate.
The Series C Preferred Stock may be redeemed by us in certain
circumstances by paying 103% of the redemption price of $372.50 and any accrued
dividends at the time of redemption. We also have the option to redeem the
Series C Preferred Stock after December 9, 2008, without restriction by paying
the redemption price of $372.50 and any accrued dividends at the time of
redemption.
NOTE 12 - STOCK OPTIONS
We offer the Metris Companies Inc. Long-Term Incentive and Stock Option
Plan, which permits a variety of stock-based grants and awards and gives us
flexibility in tailoring our long-term compensation programs. In 2002, the Board
of Directors recommended, and the shareholders approved, an increase in the
number of shares reserved for issuance under the plan to 19.0 million shares of
common stock for awards of stock options or other stock-based awards, subject to
adjustment in certain circumstances. As of December 31, 2002, 2.3 million shares
were available for grant. We do not provide loans to employees for the purchase
of stock or the exercise of stock options.
The MCI Compensation Committee has the authority to determine the
exercise prices, vesting dates or conditions, expiration dates and other
material conditions upon which options or awards may be exercised, except that
the option price for Incentive Stock Options ("ISOs") may not be less than 100%
of the fair market value of the common stock on the date of grant (and not less
than 110% of the fair market value in the case of an ISO granted to any employee
owning more than 10% of the common stock) and the terms of nonqualified stock
options may not exceed 15 years from the date of grant (not more than ten years
for ISOs and five years for ISOs granted to any employee owning more than 10% of
the common stock). Full- or part-time employees, consultants or independent
contractors are eligible to receive nonqualified options and awards. Only full-
or part-time employees are eligible to receive ISOs. Our stock options expire
ten years from the date of grant and vest over periods ranging from one to six
years with some options vesting at 25% to 33.3% per year.
During 2002, 2001 and 2000, we granted 2.1 million, 2.7 million and 4.2
million options, respectively, to officers and employees.
69
We also issue restricted stock grants under the stock option plan to
our executive officers. As of December 31, 2002, no shares had been granted to
any executive officer except our former Chairman and Chief Executive Officer.
The restricted stock has a five-year cliff vesting period. A total of 76,041
shares were issued in 2002 and 72,558 shares of restricted stock were granted in
2001, with an approximate aggregate market value in 2002 and 2001 of $1.0
million and $1.8 million respectively, at the time of the grants. Restricted
stock vests on the fifth anniversary of the date of grant provided the employee
remains employed though that DATE. As of the date restricted stock is granted,
deferred compensation is recorded as a reduction of equity for the fair value of
the shares granted. The deferred compensation is amortized to compensation
expense on a straight-line basis over the vesting period.
Upon our termination of our former Chairman and Chief Executive Officer
in December 2002, he forfeited all the restricted stock previously granted to
him. All previously recognized expense was reversed and the related deferred
compensation was added back to stockholders' equity. The amount of compensation
reversed in 2002 that had been recognized in previous years was $3.0 million.
We also offer the Metris Companies Inc. Non-Employee Director Stock
Option Plan which provides up to 750,000 shares of common stock for awards of
options, subject to adjustments in certain circumstances. During 2002, 2001 and
2000, we granted 100,000, 89,000 and 82,500 options, respectively. At December
31, 2002, 186,000 shares were available for grant.
Information regarding our stock option plans for 2002, 2001 and 2000,
is as follows:
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------
2002 2001 2000
---------------------- --------------------- ---------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- --------- ---------- --------- ---------- ---------
Options outstanding, beginning of
year 10,604,136 $19.73 9,907,062 $ 17.67 10,129,614 $ 9.72
Options exercised 49,899 13.67 1,383,358 11.81 4,212,537 5.46
Options granted 2,180,885 12.09 2,832,838 25.01 4,348,685 24.78
Options canceled/
forfeited 1,005,678 11.45 752,406 27.06 358,700 22.64
---------- ---------- ----------
Options outstanding,
end of year 11,729,444 19.05 10,604,136 19.73 9,907,062 17.67
========== ========== ==========
Weighted-average fair value of
options granted during the year -- 8.19 -- $ 13.57 -- $ 14.55
70
The following table summarizes information about stock options
outstanding at December 31, 2002:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- ----------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
NUMBER REMAINING AVERAGE NUMBER AVERAGE
OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICE AT 12/31/02 LIFE PRICE AT 12/31/02 PRICE
-------------- ----------- ----------- --------- ----------- ---------
$ 2.25-$16.77 5,116,908 7.1 $12.29 2,718,261 $12.14
$17.10-$24.42 3,900,000 7.3 22.06 2,134,845 21.89
$24.67-$38.88 2,712,536 7.9 27.47 514,534 29.37
---------- --- ------ --------- ------
11,729,444 7.4 $19.05 5,367,640 $17.67
========== === ====== ========= ======
EMPLOYEE STOCK PURCHASE PLAN
We offer the Metris Companies Inc. Employee Stock Purchase Plan
("ESPP"), whereby eligible employees may authorize payroll deductions of the
lesser of up to 15% of their salary or $25,000 to purchase shares of our common
stock. Under the plan, shares of our common stock may be purchased at the end of
each monthly offering period at 85% of the lower of the fair market value on the
first or last day of the monthly offering period. Employees contributed $1.8
million and $2.2 million to purchase 374,166 and 111,967 shares of common stock
under the ESPP for 2002 and 2001, respectively. We are authorized to issue up to
2.5 million shares of common stock to employees under the plan, and as of
December 31, 2002, there were approximately 1.9 million shares available for
future issuance.
We offer certain employees the Non-Qualified Employees Stock Purchase
Plan ("NQ ESPP"). Eligible employees may purchase shares of our common stock at
100% of the fair market value of common shares on the last day of the monthly
offering period. Employees contributed $0.1 million and $0.2 million to purchase
27,946 and 9,886 shares of common stock under the NQ ESPP for 2002 and 2001,
respectively. We are authorized to issue up to 0.5 million shares of common
stock to employees under the plan, and as of December 31, 2002, there were
approximately 0.5 million shares available for future issuance.
MANAGEMENT STOCK PURCHASE PLANS
We provide a management stock purchase plan, whereby any employee who
is a Senior Vice President or higher, excluding corporate officers designated by
the Board of Directors, who participates in the Metris Management Incentive
Bonus Plan is eligible to participate. Participants may elect to defer up to 50%
of their bonus received under the Management Bonus Plan, which is credited to a
stock purchase account as restricted stock units. We will make a match of $1 for
every $3 contributed by the participant. The participant's contributions are
vested immediately and our matching contributions vest after three years. No
contributions were made to the plan in 2002. Employees contributed approximately
$1.0 million to purchase 73,722 restricted stock units under the plans for 2001.
The restricted stock units convert to common stock when distributed from the
plans. We are authorized to issue up to 450,000 shares of common stock to
employees under the plans, and as of December 31, 2002, approximately 243,578 of
the authorized shares were available for future issuance.
We provide an additional management stock purchase plan, whereby
officers designated by the board of directors, who participate in the Metris
Annual
71
Incentive Bonus Plan for Designated Corporate Officers are eligible to
participate. Participants may elect to defer up to 50% of their bonus received
under the Management Bonus Plan, which is credited to a stock purchase account
as restricted stock units. We will make a match of $1 for every $3 contributed
by the participant. The participant's contributions are vested immediately and
our matching contributions vest after three years. No contributions were made to
the plan in 2002. Employees contributed approximately $0.3 million to purchase
22,498 restricted stock units under the plans for 2001. The restricted stock
units convert to common stock when distributed from the plans. We are authorized
to issue up to 450,000 shares of common stock to employees under the plans, and
as of December 31, 2002, approximately 372,669 of the authorized shares were
available for future issuance.
NOTE 13 - EMPLOYEE BENEFIT PLANS
We offer a defined contribution plan that is intended to qualify under
section 401(k) of the Internal Revenue Code. The 401(k) Plan provides retirement
benefits for eligible employees. Eligible employees may elect to contribute to
the 401(k) Plan, and we match a portion of employee contributions and make
discretionary contributions based upon our financial performance. For the years
ended December 31, 2002, 2001 and 2000 we contributed $2.6 million, $2.0 million
and $1.4 million to the 401(k) Plan, respectively.
The Company also offered a Non-Qualified Deferred Compensation Plan for
a select group of management or highly compensated employees. The plan provides
saving and investment opportunities to those individuals who elect to defer a
portion of their salary. The Company matched a portion of the employee
contribution and made discretionary contributions based on the Company's
financial performance. We contributed $0.4 million and $0.3 million to the plan
for the years ended December 31, 2002 and 2001, respectively.
Subsequent to year-end, the Non-Qualified Deferred Compensation Plan
was discontinued and all vested balances were distributed to participants.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
Our Supplemental Executive Retirement Plan ("SERP") provides officers
and other members of senior management with supplemental retirement benefits in
excess of limits imposed on qualified plans by federal tax law. The SERP is an
account balance plan to which we will make annual contributions targeted to
provide 40%-60% of the average of the participant's final three years of salary
and bonus with us. These benefits will be paid in 15 annual installments
beginning the year after they become eligible to receive benefits. Participants
are eligible to receive benefits upon leaving our employment if they are at
least 65 years of age or at least age 55 with five years of plan participation,
if a change of control occurs or in the event of death. We recognized $0.9
million and $0.7 million of expense in 2002 and 2001, respectively, related to
the SERP. Our liability was $3.8 million and $3.1 million at December 31, 2002
and 2001, respectively, for future payments under this plan. We calculate this
expense and liability based on actuarial assumptions regarding years of
participation, future investment returns and participants continuing in the SERP
until age 65.
72
NOTE 14 - INCOME TAXES
The components of the provision for income taxes consisted of the
following:
YEAR ENDED DECEMBER 31,
------------------------------------
2002 2001 2000
---------- ---------- ----------
Current:
Federal $ (28,893) $ 63,865 $ 93,334
State 138 6,381 7,085
---------- ---------- ----------
(28,755) 70,246 100,419
Deferred
Federal 29,840 41,445 11,072
State 782 1,969 5,814
---------- ---------- ----------
30,622 43,414 16,886
---------- ---------- ----------
Total $ 1,867 $ 113,660 $ 117,305
========== ========== ==========
A reconciliation of our effective income tax rate compared to the
statutory federal income tax rate is as follows:
YEAR ENDED
DECEMBER 31,
------------------------
2002 2001 2000
----- ---- ----
Statutory federal income tax rate 35.0% 35.0% 35.0%
State income taxes, net of federal benefit 211.3 1.9 2.7
Other, net 413.4 2.6 0.9
----- ---- ----
Effective income tax rate 659.7% 39.5% 38.6%
===== ==== ====
The 2002 effective income tax rate is high relative to statutory rates
primarily due to the effect of nondeductible expenses, minimum state income
taxes and low pretax income.
Our deferred tax assets and liabilities are as follows:
AT DECEMBER 31,
---------------------
2002 2001
--------- --------
Deferred income tax assets resulting from future
deductible and taxable temporary differences:
Allowance for loan losses and retained interests
fair value adjustments $ 172,299 $221,405
Deferred revenues 59,042 72,944
Other 68,143 45,867
--------- --------
Total deferred tax assets 299,484 340,216
Deferred income tax liabilities resulting from future
taxable and deductible temporary differences:
Accrued interest on credit card loans 207,984 226,060
Deferred marketing costs 35,689 37,524
Other 34,986 25,185
--------- --------
Total deferred tax liabilities 278,659 288,769
--------- --------
Net deferred tax assets $ 20,825 $ 51,447
========= ========
We believe, based on our operating earnings in prior years, expected
reversal of taxable temporary differences, and to a lesser degree reliance on
expectations for operating earnings in future years, the deferred tax assets are
fully realizable.
73
In addition to the tax effects of the pre-tax restatement amounts, the
restated presentation also reflects revised probable amounts of future taxable
and deductible temporary differences, resulting in a reclassification of certain
deferred income taxes to current income taxes. The effects of the reclass for
each of the years ended December 31, 1998 through 2002 amounted to a reduction
(addition) to deferred income taxes of $15.1 million, $40.3 million, $23.8
million, $1.0 million, and ($16.5 million), respectively. Such reclasses did not
result in any adjustment to net income.
The Internal Revenue Service ("IRS") has completed its examination of
the Company's tax returns through December 31, 1998. The IRS has proposed
adjustments to increase the Company's federal income tax by $42.9 million, plus
interest of more than $14 million, pertaining to the Company's treatment of
certain credit card fees as original issue discount ("OID"). Although these fees
are primarily reported as income when billed for financial reporting purposes,
we believe the fees constitute OID and must be deferred and amortized over the
life of the underlying "Credit card loans" for tax purposes. Cumulatively
through December 31, 2002, the Company has deferred more than $212 million in
federal income tax under the OID rules. Any assessment similar to what has been
proposed by the IRS may ultimately require the Company to pay the federal tax
plus state taxes and related interest.
The Company believes its treatment of these fees is appropriate and
continues to work with the IRS to resolve the proposed adjustments. The
Company's position on the treatment of credit card fees is consistent with that
of many other U.S. credit card issuers. We do not expect final settlement or
additional tax to be paid over the next twelve months. However, both the timing
and amount of the final resolution of this matter are uncertain.
NOTE 15 - RELATED PARTY TRANSACTIONS
In the ordinary course of business, our executive officers may have
credit card loans issued by us. Pursuant to our policy, such loans are issued on
the same terms as those prevailing at the time for comparable loans with
unrelated persons and do not involve more than the normal risk of
collectibility.
On May 7, 1999 we entered into a loan agreement with our former
Chairman and Chief Executive Officer, Ronald N. Zebeck. The loan's original and
current principal balance is $5 million. The loan is unsecured and bears
interest at a rate of 6.25%. Mr. Zebeck was terminated effective December 15,
2002. The terms of the loan agreement provide that if he remained employed by us
until May 17, 2004, or if his employment by us is terminated before that date
due to (a) his death or disability, or (b) for any reason other than for cause,
we will pay him a bonus equal to (1) the amount of interest accrued on the loan,
plus (2) the gross-up amount of taxes relating to his receipt of the interest
amount. At the time of Mr. Zebeck's termination, we reserved the right to treat
his termination as for cause. Accordingly, whether Mr. Zebeck is entitled to the
bonus described in this paragraph will depend on the resolution of the basis for
his termination.
NOTE 16 - COMMITMENTS AND CONTINGENCIES
Commitments to extend credit to consumers represent the unused credit
limits on open credit card accounts. These commitments were $12.0 billion and
$15.7 billion as of December 31, 2002 and 2001, respectively. While these
amounts represent the total lines of credit available to our customers, we have
not experienced and do not anticipate that all of our customers will exercise
their entire available line at any given point in time. We also have the right
to
74
increase, reduce, cancel, alter or amend the terms of these available lines of
credit at any time.
We lease certain office facilities and equipment under various
cancelable and non-cancelable operating lease agreements that provide for the
payment of a proportionate share of property taxes, insurance and other
maintenance expenses. These leases also may include scheduled rent increases and
renewal options. Rental expense for these operating leases for the years ended
December 31, 2002, 2001, and 2000, was $23.8 million, $21.8 million and $18.1
million, respectively. In 2002, we recognized $6.4 million of expense due to
excess capacity related to certain operating leases.
Future minimum lease commitments at December 31, 2002, under cancelable
and non-cancelable operating leases are as follows:
2003 14,851
2004 11,382
2005 9,252
2006 7,850
2007 7,806
Thereafter 26,998
--------
Total minimum lease payments $ 78,139
========
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 its subsidiaries, Metris Direct Inc. and Direct Merchants Bank.
The complaint sought damages in unascertained amounts and purported to be a
class action complaint on behalf of all cardholders 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 alleged violations
of the Minnesota Prevention of Consumer Fraud Act, the Minnesota Deceptive Trade
Practices Act and breach of contract. A class action settlement was signed by
the Judge on May 30, 2002 and entered on June 4, 2002, 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. We recorded a $5.6 million accrual during 2001 to
reflect the proposed settlement. Under the terms of the settlement, we denied
any wrongdoing or liability. A final order approving the settlement was signed
by the judge on May 30, 2002, and entered on June 4, 2002. No appeal was filed.
We implemented the terms of settlement beginning September 4, 2002.
In September and October 2002, three shareholder lawsuits were filed in
the United States District Court for the District of Minnesota, naming MCI,
Ronald N. Zebeck and David Wesselink as defendants. Two of the lawsuits have
been dismissed. The plaintiff in the remaining lawsuit seeks to represent a
class of purchasers of MCI common stock between November 5, 2001 and July 17,
2002. The lawsuit seeks damages in an unspecified amount. The complaint alleges
that defendants violated the federal securities laws when MCI failed to disclose
the existence of the OCC Report of Examination ("ROE") until April 17, 2002.
Metris believes that the lawsuit is without merit and has moved for its
dismissal.
Our activities as a credit card lender are subject to regular review
and examination by federal regulators to assess compliance with various federal
consumer protection laws. Regulators are authorized to impose penalties for
violations of these laws and, in certain cases, to order us to pay restitution
to injured cardholders.
75
On May 3, 2001, Direct Merchants Bank entered into a consent order with
the OCC. The consent order required us to pay approximately $3.2 million in
restitution to approximately 62,000 credit card customers 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, we
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. In October 2002, the OCC advised
that Direct Merchants Bank is in full compliance with the consent order.
In May 2001, the OCC also indicated that it was considering whether or
not to pursue an assessment of civil money penalties and gave us the opportunity
to provide information to the OCC bearing on whether imposing a penalty would be
appropriate and the severity of any penalty. The statutory provisions pursuant
to which a civil money penalty could be assessed give the OCC broad discretion
in determining whether or not a penalty will be assessed and, if so, the amount
of the penalty. In October 2002, the OCC made a determination not to assess
civil money penalties.
On April 16, 2002, Direct Merchants Bank entered into an agreement with
the OCC intended to strengthen the safety and soundness of Direct Merchants
Bank's operations. The agreement formalized recommendations made and
requirements imposed by the OCC following an examination of Direct Merchants
Bank that resulted in a Report of Examination issued on April 4, 2002. On March
18, 2003, the OCC terminated the agreement.
NOTE 17 - CAPITAL REQUIREMENTS AND RESTRICTED PAYMENTS
In the normal course of business, we enter into agreements, or are
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 us and our affiliates. Such restrictions limit Direct Merchants
Bank's ability to lend to us and our affiliates. Additionally, Direct Merchants
Bank is limited in its ability to declare dividends to us and our affiliates in
accordance with the national bank dividend rules and the Formal Agreement.
Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the OCC. At December 31, 2002 and 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.
We are also bound by restrictions set forth in the indentures related
to the Senior Notes dated November 7, 1997, and July 15, 1999. Pursuant to those
indentures, we may not make dividend payments in the event of a default or if
all such restricted payments would exceed 25% of our aggregate cumulative net
income.
NOTE 18 - CONCENTRATIONS OF CREDIT RISK
A concentration of credit risk is defined as significant credit
exposure with an individual or group engaged in similar activities or affected
similarly by economic conditions. We are active in originating credit card loans
throughout
76
the United States, and no individual or group had a significant concentration of
credit risk at December 31, 2002 or 2001.
We target our consumer lending products primarily to moderate-income
consumers. Primary risks associated with lending to this market are that they
may be more sensitive to future economic downturn, which may make them more
likely to default on their obligations.
The banking regulators have issued guidelines to further segregate a
credit card issuer's loan portfolio between subprime loans (loans to consumers
who have a FICO credit score of 660 or less) and prime loans (loans to consumers
with FICO scores in excess of 660). The banking regulators deem subprime loans
to have higher credit risk. Subprime receivables were $447.3, million or 52.9%
of the credit card portfolio as of December 31, 2002, compared to $1.6 billion
or 59.2% of the credit card portfolio as of December 31, 2001.
NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS
We have estimated the fair value of our financial instruments in
accordance with SFAS No. 107, "Disclosures About Fair Value of Financial
Instruments." Financial instruments include both assets and liabilities, whether
or not recognized in our consolidated balance sheets, for which it is
practicable to estimate fair value. The fair value of an asset is the amount at
which the asset could be bought or sold in a current transaction between willing
parties, that is, other than in a forced or liquidation sale. Additionally,
certain intangible assets recorded on the consolidated balance sheets, such as
purchased credit card relationships, and other intangible assets not recorded on
the consolidated balance sheets (such as the value of the credit card
relationships for originated loans and the franchise values of our various lines
of business) are not considered financial instruments and, accordingly, are not
valued for purposes of this disclosure. Accordingly, the aggregate estimated
fair value amounts presented do not represent the entire underlying value of the
Company.
Quoted market prices generally are not available for all of our
financial instruments. Accordingly, in cases where quoted market prices are not
available, fair values were estimated using present value and other valuation
techniques that are significantly affected by the assumptions used, including
the discount rate and estimated future cash flows. These assumptions are based
on historical experience and assessments regarding the ultimate collectibility
of assets and related interest, and estimates of product lives and repricing
characteristics used in our asset/liability management process. These
assumptions involve uncertainties and matters of judgment, and therefore, cannot
be determined with precision. Thus, changes in these assumptions could
significantly affect the fair-value estimates.
A description of the methods and assumptions used to estimate the fair
value of each class of our financial instruments is as follows:
Cash and cash equivalents
The carrying amounts approximate fair value due to the short-term
nature of these instruments.
Net credit card loans
Credit card loans are originated with variable rates of interest that
adjust with changing market interest rates. Thus, the carrying value of the
credit card loans, less the allowance for loan losses, approximates fair value.
This valuation does not include the value that relates to estimated cash flows
77
generated from new loans from existing cardholders over the life of the
cardholder relationship. Accordingly, the aggregate fair value of the credit
card loans does not represent the underlying value of the established cardholder
relationships.
Retained interests and other securitization related assets
The fair value of the retained interests and other securitization
related assets are estimated by discounting the expected future cash flows from
the Master Trust and each of the conduits at rates which we believe to be
consistent with those that would be used by an independent third party. However,
because there is no active market for the retained interests, the fair values
presented may not be indicative of the value negotiated in an actual sale. The
future cash flows used to estimate fair value are limited to the securitized
receivables that exist at year end and do not reflect the value associated with
future receivables generated by accountholder activity.
Interest rate caps
We enter into interest rate cap transactions related to each series of
securities issued from the Metris Master Trust. We report these assets on the
consolidated balance sheets at market value.
Debt
We make short-term borrowings with variable rates of interest that
adjust with changing market interest rates. Thus, carrying value approximates
fair value.
We obtain the fair value of long-term debt from quoted market yields,
when available.
Deposits
The fair values for fixed rate certificates of deposit are estimated
based on quoted market prices of comparable instruments.
The estimated fair values of our financial instruments are summarized
as follows:
AT DECEMBER 31,
--------------------------------------------
2002 2001
-------------------- ----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- ---------- ----------
Cash and cash equivalents $580,232 $ 580,232 $ 381,639 $ 381,639
Credit card loans, net 756,102 756,102 2,296,604 2,296,604
Retained interests in loans securitized 808,026 808,026 859,559 859,559
Other receivables due from credit card
securitizations, net 110,471 110,471 139,833 139,833
Interest rate caps 12,711 12,711 27,321 27,321
Interest rate swap agreements -- -- 3,293 3,293
Debt 357,649 341,580 647,904 633,005
Deposits 892,754 911,141 2,058,008 2,067,697
78
NOTE 20 - DERIVATIVE FINANCIAL INSTRUMENTS
We use derivative financial instruments for the purpose of managing our
exposure to interest rate risks.
MRI enters into interest rate cap transactions related to each
asset-backed securitization transaction. MRI assigns all of its right, title,
and interest under the interest rate cap agreement to the Trustee of the Metris
Master Trust for the benefit of the holders of securities issued by the Metris
Master Trust. The purpose of the interest rate cap is to effectively limit the
interest exposure of the Metris Master Trust for each individual series to a
maximum based upon the LIBOR rate.
The interest rate caps do not meet the criteria for hedge accounting
treatment. The change in the fair value of the caps is included in the
consolidated income statement under "Securitization Income." For the year ended
December 31, 2002 we recognized expense of $22.6 million from the mark-to-market
adjustments on the interest rate caps. For the year ended December 31, 2001,
excluding the cumulative effect of accounting change, we recognized income of
$10.1 million from the mark-to-market adjustments on interest rate caps.
We entered into interest rate swap transactions through Direct
Merchants Bank. The swaps were used to convert a portion of the fixed rate
certificates of deposit ("CDs") to variable rate CDs, and thus hedge the fair
market value of the CDs. The CDs expose us to variability in the fair value in
rising or declining interest rate environments. By converting the fixed payment
to a variable payment, the interest rate swaps reduce the variability of the
fair market value of the CDs. As of December 31, 2002, there were no interest
rate swaps outstanding. As of December 31, 2001, there was one swap outstanding
with a fair value of $3.3 million.
As of the adoption of SFAS No. 133 or their inception, all swaps were
designated as fair value hedges. Changes in the value of the swaps are
recognized in income, in the period in which the change in value occurred. In
addition, changes in the value of the CDs, to the extent they are attributable
to the risk being hedged, are simultaneously recognized in income. Any
difference between the fair value change in the swaps versus the fair value
change in the related hedged CDs was considered to be the "ineffective" portion
of the hedge. The ineffective portion of the swap is recorded as an increase or
decrease in income.
During 2002 and 2001, all swaps were sold. At the date of sale, the
swap and the related CDs were valued, and a gain or loss was recognized for the
difference between the change in fair value of the swap and the change in fair
value of the CDs. The cumulative amount recorded as an adjustment to the value
of the CDs is being amortized over the life of the CDs as an adjustment to
interest expense. Additionally, $3.5 million was recognized as income in 2001
related to the ineffective portion of the swaps.
79
Prior to SFAS No. 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 No. 133 resulted in a one-time, non-cash, after-tax charge to
earnings of $14.2 million, reflected as a "Cumulative effect of accounting
change" in the consolidated statements of income for the year ended December 31,
2001.
NOTE 21 - SEGMENTS
We operate in two principal areas: consumer lending products and
enhancement services. Our consumer lending products are primarily unsecured and
secured credit cards, including the Direct Merchants Bank MasterCard(R) and
Visa(R). Our credit cardholders include customers obtained from third-party
lists and other consumers for whom general credit bureau information is
available.
We market our enhancement services products, including (1) debt waiver
protection for unemployment, disabilities, death and family leave; (2)
membership programs such as card registration, purchase protection and other
club memberships; and (3) third-party insurance, directly to our credit card
customers and customers of third parties. We currently issue and administer our
extended service plans sold through a third-party retailer, and the customer
pays the retailer directly.
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 elimination column in the segment table includes adjustments to
present the information on an owned basis as reported in the financial
statements of this Annual Report on Form 10-K/A.
We do not allocate the expenses, assets and liabilities attributable to
corporate functions to the operating segments, such as employee compensation,
data processing services and communications, third-party servicing expenses, and
other expenses including occupancy, depreciation and amortization, professional
fees, and other general and administrative expenses. We include these expenses
in the reconciliation of the income before income taxes, extraordinary loss and
cumulative effect of accounting changes for the reported segments to the
consolidated total. We do not allocate capital expenditures for leasehold
improvements, capitalized software and furniture and equipment to operating
segments. There were no operating assets located outside of the United States
for the periods presented.
Our enhancement services operating segment pays a fee to the consumer
lending products segment for successful marketing efforts to cardholders at a
rate similar to those paid to other third parties. Our enhancement services
segment reports interest income and the consumer lending products segment
reports interest expense at our weighted-average borrowing rate for the excess
cash flow generated by the enhancement services segment and used by the consumer
lending products segment to fund the growth of cardholder balances.
80
2002
-------------------------------------------------------------------------------
CONSUMER
LENDING ENHANCEMENT SECURITIZATION OTHER
PRODUCTS SERVICES ADJUSTMENTS (a) ADJUSTMENTS(b) CONSOLIDATED
----------- ----------- --------------- -------------- ------------
Interest income $ 2,099,595 $ 2,521 $ (1,870,193) $ (2,521) $ 229,402
Interest expense 321,982 -- (215,945) (2,521) 103,516
----------- ----------- -------------- ------------- ------------
Net interest
income 1,777,613 2,521 (1,654,248) -- 125,886
Other operating
income 517,266 384,050 (65,895) -- 835,421
----------- ----------- -------------- ------------- ------------
Total revenue 2,294,879 386,571 (1,720,143) -- 961,307
Income (loss)
before income
taxes and
cumulative
effect of
accounting
change 267,336(c) 240,709(c) -- (507,762) 283
Total assets $10,671,740 $ 74,829 $ (8,836,857) $ 680,680(d) $ 2,590,392
81
2001
-------------------------------------------------------------------------------
CONSUMER
LENDING ENHANCEMENT SECURITIZATION OTHER
PRODUCTS SERVICES ADJUSTMENTS (a) ADJUSTMENTS(b) CONSOLIDATED
----------- ----------- --------------- -------------- ------------
Interest income $ 1,973,401 $ 12,308 $ (1,604,263) $ (12,308) $ 369,138
Interest expense 480,463 -- (301,878) (12,308) 166,277
----------- ----------- -------------- ------------- ------------
Net interest
income 1,492,938 12,308 (1,302,385) -- 202,861
Other operating
income 608,322 340,133 324,989 -- 1,273,444
----------- ----------- -------------- ------------- ------------
Total revenue 2,101,260 352,441 (977,396) -- 1,476,305
Income before
income taxes
and cumulative
effect of
accounting
change 550,658(c) 231,837(c) -- (494,580) 287,915
Total assets $11,369,799 $ 111,114 $ (7,895,843) $ 580,905(d) $ 4,165,975
2000
-------------------------------------------------------------------------------
CONSUMER
LENDING ENHANCEMENT SECURITIZATION OTHER
PRODUCTS SERVICES ADJUSTMENTS (a) ADJUSTMENTS(b) CONSOLIDATED
----------- ----------- --------------- -------------- ------------
Interest income $ 1,596,353 $ 11,848 $ (1,475,955) $ (11,848) $ 120,398
Interest expense 521,477 -- (376,623) (11,848) 133,006
----------- ----------- -------------- ------------- ------------
Net interest
income 1,074,876 11,848 (1,099,332) -- (12,608)
Other operating
income 492,864 266,201 321,205 -- 1,080,270
----------- ----------- -------------- ------------- ------------
Total revenue 1,567,740 278,049 (778,127) -- 1,067,662
Income before
income taxes
and cumulative
effect of
accounting
change 539,914(c) 183,208(c) -- (419,399) 303,723
Total assets $ 9,050,108 $ 120,735 $ (6,070,224) $ 637,688(d) $ 3,738,307
(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 adjustments column includes: intercompany eliminations and amounts not
allocated to segments.
(c) Income before income taxes and cumulative effect of accounting changes,
includes intercompany commissions paid by the enhancement services segment to
the consumer lending products segment for successful marketing efforts to
82
cardholders of $2.4 million, $12.4 million and $18.3 million for 2002, 2001 and
2000, respectively.
(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 22 - STOCKHOLDERS' EQUITY
On February 6, 2001, the Company's Board of Directors authorized a
share repurchase program of up to $200 million of its outstanding common stock
over a period ending December 31, 2002. The amount of shares the Company can
repurchase in a calendar year is limited under its various debt agreements. In
2002, the Company was limited to repurchasing approximately $98.3 million of
shares. As of December 31, 2002, 7.1 million shares had been repurchased under
the program for $58.3 million.
During the years ended December 31, 2002 and December 31, 2001, we paid
cash dividends of $3.7 million. Under our credit facility agreement we can not
make dividend payments in an aggregate amount in any fiscal year that exceed 40%
of consolidated net income for the prior fiscal year.
Upon our termination of our former Chairman and Chief Executive Officer
in December 2002, he forfeited 540,029 shares of restricted stock. As a result,
$4.8 million of deferred compensation and common stock was added back to
stockholders' equity.
NOTE 23 - DEBT AND DEPOSITS
We have a warehouse financing facilities accounted for as
collateralized financings under SFAS No. 140 which is included in "Debt" on the
consolidated balance sheet. The financing conduits had a capacity of $100
million and $400 million as of December 31, 2002 and 2001, respectively, and a
variable interest rate based on LIBOR. As of December 31, 2002 and 2001, there
was zero and $292 million, respectively outstanding on the conduit. Subsequent
to year-end, all financing conduits were terminated.
Our credit facility consists of a $170 million revolving credit
facility which matures in July 2003, and a $100 million term loan which matures
in June 2003. At December 31, 2002 and 2001, we had outstanding borrowings of
$100 million under the term loan facility with weighted-average interest rates
of 4.7% and 5.4% respectively, and outstanding letters of credit of $7.3 million
and $5.3 million, respectively. At December 31, 2002, we were in compliance with
all financial covenants under these agreements.
As of December 31, 2002, we had $150 million of 10.125% Senior Notes
due 2006 outstanding. The carrying value of theses Senior Notes is $146.8
million as of December 31, 2002. These Senior Notes were issued at a discount of
$6.3 million to yield an effective interest rate of 11%. The Senior Notes due
2006 and credit facility are unconditionally guaranteed on a senior basis,
jointly and severally, by Metris Direct, Inc., magnUS Services, Inc. (formerly
Metris Recovery Services, Inc.), Metris Card Services, LLC and Metris Credit
Card Services, Inc. (the "Guarantors"). Any subsidiaries we form in the future
will provide a guarantee of this indebtedness. The guarantee is an unsecured
obligation of the Guarantors and ranks equally with all existing and future
unsubordinated indebtedness. We also have $100 million of 10% Senior Notes due
2004 outstanding with terms and conditions substantially similar to the Senior
Notes due 2006. We also have a $10.0 million 9.19% term loan due 2005 used to
83
fund Company equipment. As of December 31, 2002 and 2001 we were in compliance
with all financial covenants under our credit agreements.
Our debt outstanding as of December 31, 2002, matures as follows:
2003 $ 101,031
2004 100,979
2005 8,551
2006 146,841
2007 80
Thereafter 167
---------
Total debt outstanding $ 357,649
=========
Direct Merchants Bank has issued certificates of deposit of $100,000 or
more from 1999 to 2002. As of December 31, 2002 and 2001, $0.9 billion and $2.1
billion of CDs were outstanding with original maturities ranging from six months
to five years. These CDs pay fixed interest rates ranging from 1.1% to 7.6% and
2.4% to 7.6% at December 31, 2002 and 2001, respectively.
Our deposits outstanding as of December 31, 2002 and 2001, mature as
follows:
WEIGHTED- WEIGHTED-
AVERAGE AVERAGE
INTEREST INTEREST
2002 RATE 2001 RATE
---------- --------- ---------- ---------
Three months or less $ 97,822 4.9% $ 404,955 5.8%
Over three months
through twelve
months 291,143 4.8% 811,802 5.3%
Over one year through
three years 256,277 5.1% 567,897 5.2%
Over three years 247,512 5.3% 273,354 5.9%
---------- --- ---------- ---
Total deposits $ 892,754 5.1% $2,058,008 5.4%
========== === ========== ===
The Company, at the request of the OCC, has agreed to reduce
receivables at Direct Merchants Bank to no more than $550 million at December
31, 2003 and zero at December 31, 2004. As a result, we do not anticipate
issuing jumbo CDs in the foreseeable future.
We have various indirect subsidiaries which do not guarantee Company
debt. We have prepared condensed consolidating financial statements of the
Company, the Guarantor subsidiaries and the non-guarantor subsidiaries for
purposes of complying with SEC reporting requirements. Separate financial
statements of the guaranteeing subsidiaries and the non-guaranteeing
subsidiaries are not presented because we have determined that the subsidiaries
financial information would not be material to investors.
84
NOTE 24 - SUBSEQUENT EVENTS
On March 18, 2003, we entered into an operating agreement with the OCC
designed to ensure that Direct Merchants Bank continues to operate in a safe and
sound manner. This operating agreement formally terminates our April 16, 2002
agreement with the OCC, which is discussed in Footnote 14.
The operating agreement requires, among other things, the following:
- The Bank must reduce its on-balance-sheet credit card receivables
to no more than $550 million by December 31, 2003 and to zero by
December 31, 2004. During the time the Bank is reducing these
receivables, the mix of subprime receivables may not exceed 60% of
all credit card receivables. As of December 31, 2002, 52.9% of the
Bank's credit card portfolio was subprime. The Bank will continue
to sell credit card receivables on a daily basis to MCI under the
purchase agreement currently in effect between MCI and the Bank.
- The Bank must maintain minimum capital in the aggregate amount of
(i)liquid assets deposited pursuant to the Liquidity Reserve
Deposit Agreement discussed below; (ii) the capital required as a
result of the 200% risk-weight applied to on-book subprime credit
card receivables; and (iii) the minimum capital required under
Federal law for a "well capitalized" institution for all remaining
assets owned by the Bank.
- The Bank must meet certain liquidity requirements, including
maintaining, on a daily basis, liquid assets of not less than 100%
of the deposits and other liabilities coming due within the next
30 days, maintaining marketable assets in an amount equal to or in
excess of the Bank's insured deposits, maintaining cash and cash
equivalents in excess of 46% of outstanding CDs, and entering into
the Liquidity Reserve Deposit Agreement discussed below to support
the Bank's credit card receivables funding needs.
- The Bank is required, within 60 days from the date of the
operating agreement, to submit to the OCC a written strategic plan
establishing objectives for the Bank's overall risk profile,
earning performance, growth, balance sheet mix, off-balance sheet
activities, liability structure, capital adequacy, product line
development and marketing segments.
The terms of the operating agreement required Direct Merchants Bank and
MCI to enter into a Capital Assurance and Liquidity Maintenance Agreement
("CALMA") which also was executed on March 18, 2003. The effect of the CALMA is
to require MCI to make such capital infusions or provide Direct Merchants Bank
with financial assistance so as to permit Direct Merchants Bank to meet its
liquidity requirements.
The operating agreement requires Direct Merchants Bank, a third-party
depository bank and the OCC to execute a Liquidity Reserve Deposit Agreement
("LRDA") within 30 days of the effective date of the operating agreement.
If the OCC were to conclude that the Bank failed to implement any
provision of the agreement, the OCC could pursue various enforcement options.
Upon signing this agreement Direct Merchants Bank declared and paid a
$155 million dividend to us.
On March 17, 2003 we secured a $425 million extension through March
2004 of an $850 million conduit which was scheduled to mature in June of 2003.
We also
85
secured a $425 million conduit through March 2004, which will replace conduits
and warehouse facilities scheduled to mature during March through May 2003. The
availability of funding under these facilities is subject to various conditions,
including a net reduction of receivables in the Master Trust. Maturities of the
conduits can accelerate in certain instances, including if net excess spreads in
the Master Trust fall below certain levels. We also terminated our $170 million
revolving line of credit.
On March 31, 2003, THL Fund IV committed to provide a term loan to the
Company in an aggregate amount of $125 million as a backup financing facility,
secured by assets of the Company. The backup facility carries an interest rate
of 12% per annum plus an option to earn an additional meaningful economic return
based on the performance of the Company's managed receivables through December
31, 2004. The backup facility would be repayable in full on March 1, 2004.
During the past fiscal year we had in place a $270 million term loan and
revolving credit facility. In connection with the conduit transactions discussed
above, all availability under the $170 million revolving portion of this
facility was terminated as of March 18, 2003, with the exception of $7.3 million
of outstanding letters of credit. Term loans of $100 million remain outstanding
under the facility and mature on June 30, 2003. We may refinance these loans
with the backup facility provided by THL Fund IV. THL Fund IV's obligation to
provide this facility is subject to a number of conditions.
86
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING BALANCE SHEETS
DECEMBER 31, 2002
(DOLLARS IN THOUSANDS)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
ASSETS:
Cash and cash equivalents $ (3,795) $ 8,109 $ 575,918 $ -- $ 580,232
Net retained interests in
loans securitized -- -- 808,026 -- 808,026
Net credit card loans 3,813 -- 752,289 -- 756,102
Property and equipment,
net -- 63,395 20,436 -- 83,831
Purchased portfolio
premium 128 -- 64,451 -- 64,579
Other receivables due
from credit card
securitizations, net 13 -- 110,458 -- 110,471
Other assets 10,160 44,252 180,591 (47,852) 187,151
Investment in subsidiaries 1,594,352 1,549,307 -- (3,143,659) --
------------ ------------ ------------- ------------ ------------
TOTAL ASSETS $ 1,604,671 $ 1,665,063 $ 2,512,169 $ (3,191,511) $ 2,590,392
============ ============ ============= ============ ============
LIABILITIES:
Deposits $ (1,000) $ -- $ 893,754 $ -- $ 892,754
Debt 391,228 9,421 -- (43,000) 357,649
Accounts payable 71 20,683 38,949 (6,114) 53,589
Deferred income -- 16,681 129,978 (3,511) 143,148
Accrued expenses and
other liabilities 159,699 23,926 (99,819) 4,773 88,579
------------ ------------ ------------- ------------ ------------
TOTAL LIABILITIES 549,998 70,711 962,862 (47,852) 1,535,719
------------ ------------ ------------- ------------ ------------
TOTAL STOCKHOLDERS' EQUITY 1,054,673 1,594,352 1,549,307 (3,143,659) 1,054,673
------------ ------------ ------------- ------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 1,604,671 $ 1,665,063 $ 2,512,169 $ (3,191,511) $ 2,590,392
============ ============ ============= ============ ============
87
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING BALANCE SHEETS
DECEMBER 31, 2001
(DOLLARS IN THOUSANDS)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
ASSETS:
Cash and cash equivalents $ 17,614 $ 1,505 $ 362,520 $ -- $ 381,639
Net retained interests in
loans securitized -- -- 859,559 -- 859,559
Net credit card loans 1,656 -- 2,294,948 -- 2,296,604
Property and equipment,
net -- 89,101 25,812 -- 114,913
Purchased portfolio
premium 248 -- 94,545 -- 94,793
Other receivables due
from credit card
securitizations, net 34 644 139,155 -- 139,833
Other assets (3,521) 54,243 237,351 (9,439) 278,634
Investment in subsidiaries 1,845,622 1,694,115 -- (3,539,737) --
------------ ------------ ------------- ------------ ------------
TOTAL ASSETS $ 1,861,653 $ 1,839,608 $ 4,013,890 $ (3,549,176) $ 4,165,975
============ ============ ============= ============ ============
LIABILITIES:
Deposits $ (1,000) $ -- $ 2,059,008 $ -- $ 2,058,008
Debt 345,924 9,980 292,000 -- 647,904
Accounts payable 3,070 15,461 68,073 (3,129) 83,475
Deferred income 3,270 30,615 157,979 (3,129) 188,735
Accrued expenses and
other liabilities (51,404) 60,061 77,041 (3,181) 82,517
Intercompany allocations 456,457 (122,131) (334,326) -- --
------------ ------------ ------------- ------------ ------------
TOTAL LIABILITIES 756,317 (6,014) 2,319,775 (9,439) 3,060,639
------------ ------------ ------------- ------------ ------------
TOTAL STOCKHOLDERS' EQUITY 1,105,336 1,845,622 1,694,115 (3,539,737) 1,105,336
------------ ------------ ------------- ------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 1,861,653 $ 1,839,608 $ 4,013,890 $ (3,549,176) $ 4,165,975
============ ============ ============= ============ ============
88
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31, 2002
(DOLLARS IN THOUSANDS)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
NET INTEREST INCOME
(EXPENSE) $ (30,584) $ (389) $ 156,859 $ -- $ 125,886
Provision for loan losses (603) -- 220,305 102 219,804
------------ ------------ ------------- ------------ ------------
NET INTEREST INCOME
(EXPENSE) AFTER
PROVISION FOR LOAN
LOSSES (29,981) (389) (63,446) (102) (93,918)
------------ ------------ ------------- ------------ ------------
OTHER OPERATING INCOME:
Securitization income 3,168 -- 324,872 (4,523) 323,517
Servicing income on
securitized / sold
receivables -- -- 195,214 -- 195,214
Credit card fees,
interchange and other
credit card income 1,748 94,941 166,747 (100,262) 163,174
Enhancement services
revenues -- 58,664 154,519 (59,667) 153,516
Intercompany allocations 166 266,604 45,742 (312,512) --
------------ ------------ ------------- ------------ ------------
5,082 420,209 887,094 (476,964) 835,421
------------ ------------ ------------- ------------ ------------
OTHER OPERATING EXPENSE:
Credit card account and
other product
solicitation and
marketing expenses 16 112,249 181,196 (120,192) 173,269
Employee compensation (1,101) 183,701 28,226 -- 210,826
Data processing services
and communications 52 (92,080) 184,702 (8,800) 83,874
Credit protection claims
expense -- 1,334 43,216 -- 44,550
Credit card fraud losses 177 -- 8,470 -- 8,647
Purchased portfolio
premium amortization 119 -- 33,727 (3,626) 30,220
89
Occupancy and equipment -- -- 48,013 -- 48,013
Mastercard/Visa
assessment and fees -- -- 13,869 -- 13,869
Asset impairments and
lease write-offs -- -- 27,736 -- 27,736
Other 7,037 143,488 (40,918) (9,391) 100,216
Intercompany allocations 80 92,814 219,618 (312,512) --
------------ ------------ ------------- ------------ ------------
6,380 441,506 747,855 (454,521) 741,220
------------ ------------ ------------- ------------ ------------
INCOME (LOSS) BEFORE
INCOME TAXES, EQUITY
IN INCOME OF
SUBSIDIARIES AND
CUMULATIVE EFFECT OF
ACCOUNTING CHANGE (31,279) (21,686) 75,793 (22,545) 283
Income taxes (9,377) (20,107) 38,110 (6,759) 1,867
Equity in income of
subsidiaries 20,318 37,683 -- (58,001) --
------------ ------------ ------------- ------------ ------------
NET INCOME (LOSS) $ (1,584) $ 36,104 $ 37,683 $ (73,787) $ (1,584)
============ ============ ============= ============ ============
90
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31, 2001
(DOLLARS IN THOUSANDS)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
NET INTEREST INCOME
(EXPENSE) $ 8,579 $ (8,437) $ 202,719 $ -- $ 202,861
Provision for loan losses 1,393 -- 459,713 -- 461,106
------------ ------------ ------------- ------------ ------------
NET INTEREST INCOME
(EXPENSE) AFTER
PROVISION FOR LOAN
LOSSES 7,186 (8,437) (256,994) -- (258,245)
------------ ------------ ------------- ------------ ------------
OTHER OPERATING INCOME:
Securitization income 67 -- 650,333 -- 650,400
Servicing income on
securitized / sold
receivables -- -- 159,074 -- 159,074
Credit card fees,
interchange and other
credit card income 2,890 31,507 318,718 (31,067) 322,048
Enhancement services
revenues -- 57,836 84,086 -- 141,922
Intercompany allocations 152 229,643 34,807 (264,602) --
------------ ------------ ------------- ------------ ------------
3,109 318,986 1,247,018 (295,669) 1,273,444
------------ ------------ ------------- ------------ ------------
OTHER OPERATING EXPENSE:
Credit card account and
other product
solicitation and
marketing expenses -- 12,869 175,140 -- 188,009
Employee compensation 1,101 197,646 26,716 -- 225,463
Data processing services
and communications 3 (90,538) 198,876 (18,119) 90,222
Enhancement services
claims expense -- 877 29,580 -- 30,457
Credit card fraud losses 1 5 9,062 -- 9,068
91
Purchased portfolio
premium amortization -- -- 32,116 (1,839) 30,277
Occupancy and equipment -- -- 47,572 -- 47,572
Mastercard/Visa
assessment and fees -- -- 16,522 -- 16,522
Intercompany allocations 127 57,355 207,120 (264,602) --
Other (392) 127,304 (34,366) (2,852) 89,694
------------ ------------ ------------- ------------ ------------
840 305,518 708,338 (287,412) 727,284
------------ ------------ ------------- ------------ ------------
INCOME BEFORE INCOME
TAXES, EQUITY IN
INCOME OF
SUBSIDIARIES AND
CUMULATIVE EFFECT OF
ACCOUNTING CHANGE 9,455 5,031 281,686 (8,257) 287,915
Income taxes 3,646 1,168 111,875 (3,029) 113,660
Equity in income of
subsidiaries 154,220 155,585 -- (309,805) --
------------ ------------ ------------- ------------ ------------
INCOME BEFORE CUMULATIVE
EFFECT OF ACCOUNTING
CHANGE 160,029 159,448 169,811 (315,033) 174,255
Cumulative effect of
accounting change, net -- -- 14,226 -- 14,226
------------ ------------ ------------- ------------ ------------
NET INCOME $ 160,029 $ 159,448 $ 155,585 $ (315,033) $ 160,029
============ ============ ============= ============ ============
92
METRIS COMPANIES INC.
SUPPLEMENTAL CONSOLIDATING STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31, 2000
(DOLLARS IN THOUSANDS)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
NET INTEREST (EXPENSE)
INCOME $ (76,200) $ (5,102) $ 68,694 $ -- $ (12,608)
Provision for loan losses (12) -- 164,812 -- 164,800
------------ ------------ ------------- ------------ ------------
NET INTEREST (EXPENSE)
INCOME AFTER PROVISION
FOR LOAN LOSSES (76,188) (5,102) (96,118) -- (177,408)
------------ ------------ ------------- ------------ ------------
OTHER OPERATING INCOME:
Securitization income 3,536 -- 640,921 -- 644,457
Servicing income on
securitized / sold
receivables -- -- 128,823 -- 128,823
Credit card fees,
interchange and other
credit card income 504 633 184,294 -- 185,431
Enhancement services
revenues -- 54,747 66,812 -- 121,559
------------ ------------ ------------- ------------ ------------
4,040 55,380 1,020,850 -- 1,080,270
------------ ------------ ------------- ------------ ------------
OTHER OPERATING EXPENSE:
Credit card account and
other product
solicitation and
marketing expenses -- 21,690 127,515 -- 149,205
Employee compensation -- 147,567 31,025 -- 178,592
Data processing services
and communications -- (82,228) 168,394 -- 86,166
Credit protection claims
expense -- 1,354 19,457 -- 20,811
Credit card fraud losses 5 -- 8,881 -- 8,886
93
Purchased portfolio
premium amortization -- -- 19,275 -- 19,275
Occupancy and equipment -- -- 35,563 -- 35,563
Mastercard/Visa
assessment and fees -- -- 14,712 -- 14,712
Other (119) 57,267 28,781 -- 85,929
------------ ------------ ------------- ------------ ------------
(114) 145,650 453,603 -- 599,139
------------ ------------ ------------- ------------ ------------
INCOME (LOSS) BEFORE
INCOME TAXES, EQUITY
IN INCOME
OF SUBSIDIARIES AND
CUMULATIVE EFFECT OF
ACCOUNTING CHANGE (72,034) (95,372) 471,129 -- 303,723
Income taxes (27,767) (38,424) 183,496 -- 117,305
Equity in income of
subsidiaries 230,169 287,117 -- (517,286) --
------------ ------------ ------------- ------------ ------------
INCOME (LOSS) BEFORE
CUMULATIVE EFFECT OF
ACCOUNTING CHANGE 185,902 230,169 287,633 (517,286) 186,418
Cumulative effect of
accounting change, net -- -- 516 -- 516
------------ ------------ ------------- ------------ ------------
NET INCOME (LOSS) $ 185,902 $ 230,169 $ 287,117 $ (517,286) $ 185,902
============ ============ ============= ============ ============
94
METRIS COMPANIES INC.
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, 2002
(DOLLARS IN THOUSANDS)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
OPERATING ACTIVITIES:
Net cash provided by
operating activities $ 78,331 $ 51,110 $ 209,857 $ (30,787) $ 308,511
------------ ------------ ------------- ------------ ------------
INVESTING ACTIVITIES:
Net proceeds from
transfers of
portfolios to the
Metris Master Trust -- -- 2,087,097 -- 2,087,097
Net cash from loan
originations and
principal collections
on loans receivable (1,554) -- (703,060) -- (704,614)
Proceeds from sales of
credit card portfolios
to third parties -- -- 16,278 -- 16,278
Additions to property and
equipment -- (5,161) (998) -- (6,159)
Investment in subsidiaries (96,479) 248,588 243,969 (396,078) --
------------ ------------ ------------- ------------ ------------
Net cash provided by
(used in) investing
activities (98,033) 243,427 1,643,286 (396,078) 1,392,602
------------ ------------ ------------- ------------ ------------
FINANCING ACTIVITIES:
Net proceeds from
issuance (repayment)
of debt 45,304 (559) (292,000) (43,000) (290,255)
Net (decrease) increase
in deposits -- -- (1,165,254) -- (1,165,254)
Cash dividends paid (3,728) -- -- -- (3,728)
Net (decrease) increase
in common equity 2,011 -- -- -- 2,011
Repurchase of common stock (45,294) -- -- -- (45,294)
Capital contributions -- (287,374) (182,491) 469,865 --
------------ ------------ ------------- ------------ ------------
95
Net cash (used in)
provided by financing
activities (1,707) (287,933) (1,639,745) 426,865 (1,502,520)
------------ ------------ ------------- ------------ ------------
Net (decrease) increase
in cash and
cash equivalents (21,409) 6,604 213,398 -- 198,593
Cash and cash equivalents
at beginning of year 17,614 1,505 362,520 -- 381,639
------------ ------------ ------------- ------------ ------------
Cash and cash equivalents
at end of year $ (3,795) $ 8,109 $ 575,918 $ -- $ 580,232
============ ============ ============= ============ ============
96
METRIS COMPANIES INC.
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,2001
(DOLLARS IN THOUSANDS)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
OPERATING ACTIVITIES:
Net cash provided by
operating activities $ 161,612 $ 132,930 $ 498,252 $ (315,033) $ 477,761
------------ ------------ ------------- ------------ ------------
INVESTING ACTIVITIES:
Net proceeds from
transfers of
portfolios to the
Metris Master Trust -- -- 553,180 -- 553,180
Net cash flow from loan
originations and
principal collections
on loans receivable (503) -- (1,126,886) -- (1,127,389)
Credit card portfolio
acquisitions -- -- (290,774) -- (290,774)
Additions to property and
equipment -- (18,257) 12,549 -- (5,708)
Investment in subsidiaries (218,746) (170,922) 2,238 387,430 --
------------ ------------ ------------- ------------ ------------
Net cash provided by
(used in) investing
activities (219,249) (189,179) (849,693) 387,430 (870,691)
------------ ------------ ------------- ------------ ------------
FINANCING ACTIVITIES:
Net proceeds from
issuance (repayment)
of debt 900 (1,062) 292,000 -- 291,838
Net (decrease) increase
in deposits -- -- (48,191) -- (48,191)
Cash dividends paid (3,752) -- -- -- (3,752)
Net (decrease) increase
in common equity 26,248 -- -- -- 26,248
Repurchase of common stock (13,014) -- -- -- (13,014)
Capital contributions -- 48,156 24,241 (72,397) --
------------ ------------ ------------- ------------ ------------
Net cash (used in)
provided by financing
activities 10,382 47,094 268,050 (72,397) 253,129
------------ ------------ ------------- ------------ ------------
97
Net (decrease) increase
in cash and
cash equivalents (47,255) (9,155) (83,391) -- (139,801)
Cash and cash equivalents
at beginning of year 64,869 10,660 445,911 -- 521,440
------------ ------------ ------------- ------------ ------------
Cash and cash equivalents
at end of year $ 17,614 $ 1,505 $ 362,520 $ -- $ 381,639
============ ============ ============= ============ ============
98
METRIS COMPANIES INC.
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, 2000
(DOLLARS IN THOUSANDS)
METRIS
COMPANIES GUARANTOR NON-GUARANTOR
INC. SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------------ ------------ ------------- ------------ ------------
OPERATING ACTIVITIES:
Net cash provided by
operating activities $ 160,614 $ 283,108 $ 696,061 $ (536,153) $ 603,630
------------ ------------ ------------- ------------ ------------
INVESTING ACTIVITIES:
Net cash from loan
originations and
principal collections
on loans receivable (417) -- (1,360,810) -- (1,361,227)
Proceeds from sales of
credit card portfolios
to third parties -- -- -- -- --
Credit card portfolio
acquisitions -- -- (195,597) -- (195,597)
Additions to property and
equipment -- (54,552) (30,455) -- (85,007)
Investment in subsidiaries (336,303) (404,912) -- 741,215 --
------------ ------------ ------------- ------------ ------------
Net cash provided by
(used in) investing
activities (336,720) (459,464) (1,586,862) 741,215 (1,641,831)
------------ ------------ ------------- ------------ ------------
FINANCING ACTIVITIES:
Net proceeds from
issuance (repayment)
of debt 242,667 (47,376) (184,237) -- 11,054
Net (decrease) increase
in deposits -- -- 1,330,818 -- 1,330,818
Cash dividends paid (2,942) -- -- -- (2,942)
Net (decrease) increase
in common equity (42,369) 234,081 39,628 (205,062) 26,278
------------ ------------ ------------- ------------ ------------
Net cash (used in)
provided by financing
activities 197,356 186,705 1,186,209 (205,062) 1,365,208
Net (decrease) increase
in cash and
cash equivalents 21,250 10,349 295,408 -- 327,007
99
Cash and cash equivalents
at beginning of year 43,619 309 150,505 -- 194,433
------------ ------------ ------------- ------------ ------------
Cash and cash equivalents
at end of period $ 64,869 $ 10,658 $ 445,913 $ -- $ 521,440
============ ============ ============= ============ ============
100
METRIS COMPANIES INC. AND SUBSIDIARIES
SUMMARY OF CONSOLIDATED QUARTERLY FINANCIAL INFORMATION AND STOCK DATA
(Dollars in thousands, except per-share data) (unaudited)
2002
----
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
--------- --------- --------- ---------
SUMMARY OF OPERATIONS:
Interest income $ 39,350 $ 31,416 $ 68,792 $ 89,844
Interest expense 21,144 23,252 26,955 32,165
--------- --------- --------- ---------
Net Interest Income 18,206 8,164 41,837 57,679
Provision for loan
losses 40,987 26,340 90,601 61,876
Other Operating Income 147,480 262,967 167,556 257,418
Other Operating Expense(1) 186,636 174,540 198,954 181,090
--------- --------- --------- ---------
Income (Loss) Before
Income taxes (61,937) 70,251 (80,162) 72,131
Income taxes (21,145) 25,201 (30,040) 27,851
--------- --------- --------- ---------
Net Income (Loss) (40,792) 45,050 (50,122) 44,280
Preferred Stock Dividends 9,822 9,605 9,394 9,188
--------- --------- --------- ---------
Net Income (Loss)
Applicable to Common
Stockholders $ (50,614) $ 35,445 $ (59,516) $ 35,092
========= ========= ========= =========
PER COMMON SHARE:
Earnings (Loss) per Share:
Basic $ (0.88) $ 0.50 $ (0.97) $ 0.46
Diluted (0.88) 0.50 (0.97) 0.46
Shares used to Compute
EPS (000's):
Basic 57,199 89,574 61,503 96,032
Diluted 57,199 89,579 61,503 96,973
Cash Dividends: $ 0.010 $ 0.010 $ 0.010 $ 0.010
Market Prices:
High $ 4.70 $ 8.40 $ 22.75 $ 27.49
Low 1.45 1.61 7.39 12.35
Close 2.47 2.31 8.31 20.00
(1) Fourth quarter 2002, included approximately $17.1 million write-down of
excess property, equipment, operating leases, and pending sale of our
Arizona building and approximately $7 million of marketing and
origination costs on our retail note program. In addition, we recorded
a $1.1 million write-down of portfolios of charged-off loans purchased
in 2001 and 2000.
101
METRIS COMPANIES INC. AND SUBSIDIARIES
SUMMARY OF CONSOLIDATED QUARTERLY FINANCIAL INFORMATION AND STOCK DATA
(Dollars in thousands, except per-share data) (unaudited)
2001
--------
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
SUMMARY OF OPERATIONS:
Interest income $120,165 $114,330 $ 76,204 $ 58,439
Interest expense 31,983 42,147 44,313 47,834
-------- -------- -------- --------
Net Interest Income 88,182 72,183 31,891 10,605
Provision for loan
losses 252,011 78,514 89,715 40,866
Other Operating Income 358,520 317,938 305,419 291,567
Other Operating Expense 166,915 197,764 187,868 174,737
-------- -------- -------- --------
Income Before Income Taxes
and Cumulative Effect of
Accounting Change 27,776 113,843 59,727 86,569
Income taxes 17,611 45,613 22,740 27,696
-------- -------- -------- --------
Income Before Cumulative
Effect of Accounting
Change 10,165 68,230 36,987 58,873
Cumulative Effect of
Accounting Change
(Net of Income Taxes
of $8,727) -- -- -- 14,226
-------- -------- -------- --------
Net Income 10,165 68,230 36,987 44,647
Preferred Stock Dividends 8,986 8,789 8,593 8,403
-------- -------- -------- --------
Net Income Applicable to
Common Stockholders $ 1,179 $ 59,441 $ 28,394 $ 36,244
======== ======== ======== ========
PER COMMON SHARE:
Earnings per Share:
Basic (1) $ 0.02 $ 0.70 $ 0.38 $ 0.46
Diluted (1) 0.02 0.68 0.37 0.45
Shares used to Compute
EPS (000's):
Basic 63,154 97,731 97,633 96,660
Diluted 64,271 99,911 99,842 98,445
Cash Dividends: $ 0.010 $ 0.010 $ 0.010 $ 0.010
Market Prices:
High $ 28.10 $ 38.65 $ 33.71 $ 31.63
Low 15.10 20.00 20.13 20.32
Close 25.71 24.75 33.71 20.78
(1) Earnings per share for the first quarter reflects the $14.2 million
one-time, non-cash accounting impact from the adoption of SFAS 133.
STOCK DATA
Our common stock, which is traded under the symbol "MXT," has been
listed on the New York Stock Exchange since May 7, 1999. Prior to its listing on
the New York Stock Exchange, our common stock traded under the symbol "MTRS" on
the Nasdaq Stock Market since its initial public offering on October 25, 1996.
As of March 14, 2003, there were approximately 746 holders of record and
approximately 18,650 beneficial holders of our common stock.
102
MANAGEMENT'S REPORT ON CONSOLIDATED FINANCIAL STATEMENTS
AND INTERNAL CONTROL
The accompanying consolidated financial statements, related financial
data, and other information in this annual report were prepared by the
management of Metris Companies Inc. Management is responsible for the integrity
and objectivity of the data presented, including amounts that must necessarily
be based on judgments and estimates. The consolidated financial statements were
prepared in conformity with accounting principles generally accepted in the
United States of America.
Management of Metris Companies Inc. depends on its accounting systems
and internal control structures in meeting its responsibilities for reliable
consolidated financial statements. In management's opinion, these systems and
structures provide reasonable assurance that assets are safeguarded and that
transactions are properly recorded and executed in accordance with management's
authorizations. As an integral part of these systems and structures, the Company
employs a professional staff of internal auditors who conduct operational and
special audits and coordinate audit coverage with Company management and the
independent auditors.
The consolidated financial statements have been audited by the
Company's independent auditors, KPMG LLP, whose opinion appears separately.
Their opinion on the consolidated financial statements is based on auditing
procedures that include performing selected tests of transactions and records as
they deem appropriate. These auditing procedures are designed to provide
reasonable assurance that the consolidated financial statements are free of
material misstatement.
The Audit Committee of the Company's Board of Directors, composed
solely of outside directors, meets quarterly with the internal auditors, the
independent auditors and management to review the work of each and ensure that
each is properly discharging its responsibilities. The internal and independent
auditors have free access to the Audit Committee to discuss the results of their
audit work and their findings.
/s/ David D. Wesselink /s/ John A. Witham
----------------------------------- ----------------------------------
David D. Wesselink John A. Witham
Chairman and Executive Vice President and
Chief Executive Officer Chief Financial Officer
103
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Metris Companies Inc.:
We have audited the accompanying consolidated balance sheets of Metris
Companies Inc. and subsidiaries as of December 31, 2002 and 2001, and the
related consolidated statements of income, changes in stockholders' equity and
cash flows for each of the years in the three-year period ended December 31,
2002. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Metris
Companies Inc. and subsidiaries as of December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, the
Company has restated its consolidated financial statements;
As discussed in Note 20 to the consolidated financial statements, the
Company changed its method of accounting for derivative financial instruments in
2001. As discussed in Note 3 to the consolidated financial statements, the
Company changed its method of recognizing revenue for its debt waiver products
in 2000.
----------------------
KPMG LLP
Minneapolis, Minnesota
March 31, 2003, except for Note 2, which is dated April 9, 2004.
104
14. CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company's
management, including the Chairman and Chief Executive Officer ("CEO") and the
Chief Financial Officer ("CFO"), we evaluated the effectiveness of the design
and operation of the Company's disclosure controls and procedures (as defined in
Rule 13a-14(c) or 15d-14(c) under the Exchange Act). Based on that evaluation,
the Company's management, including the CEO and CFO, have concluded that our
disclosure controls and procedures , as of December 31, 2002, were not effective
in ensuring that information required to be disclosed in the reports we file
under the Securities Exchange Act of 1934, as amended ("Exchange Act") are
recorded, processed, summarized and reported within the time periods specified
in SEC rules and forms.
On November 17, 2003, our external auditors, KPMG LLP, issued a
material weakness report noting a material weakness in our policies and
procedures for estimating the fair value of our "Retained interests in loans
securitized" and associated revenue recognition. During the past several months
we have taken steps to revise our valuation model and related policies,
procedures and assumptions to address the issues in the material weakness
report. During the period, the Company also identified and changed its
accounting policies to conform with accounting principles generally accepted in
the United States of America associated with the accounting for securitization
transaction costs, credit card solicitation costs, and debt waiver revenue
associated with receivables sold to the Metris Master Trust (See Note 2 of the
unaudited consolidated financial statements on page XX for further discussion).
The Company, as of February 24, 2004, has re-evaluated the
effectiveness of the design of the Company's disclosure controls and procedures
(as defined in Rule 13a-14(c) or 15d-14(c) under the Exchange Act). Based on
that evaluation, the Company's management, including the CEO and CFO, has
concluded that the design of our disclosure controls and procedures is effective
in ensuring that information required to be disclosed in the reports we file
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in SEC rules and forms. The Company has not yet
evaluated (tested) the operating effectiveness of such controls.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are made part of this Report:
1. Consolidated Financial Statements - See Item 8 above.
2. Financial Statement Schedules
All schedules to the consolidated financial
statements normally required by Form 10-K are omitted
since they are either not applicable or the required
information is shown in the financial statements or
the notes thereto.
(b) Reports on Form 8-K: During the three months ended December
31, 2002, through the date of this Report, the Company filed
the following six Current Reports on Form 8-K:
105
Form 8-K filed October 18, 2002, relating to the Company's
third quarter 2002 financial results.
Form 8-K filed October 26, 2002, relating to the Company's
Renewable Unsecured Subordinated Notes.
Form 8-K filed December 18, 2002, relating to the termination
of the Company's former chairman and chief executive officer.
Form 8-K filed January 23, 2003, relating to the Company's
workforce reduction.
Form 8-K filed February 28, 2003, correcting the Company's
prior announcement regarding payment of a dividend.
Form 8-K filed March 19, 2003, relating to the Company's
funding agreements and operating agreement with the Office of
the Comptroller of the Currency.
(c) Exhibits: See Exhibit Index on page 109 of this Report.
106
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on the 9th day of April,
2004.
METRIS COMPANIES INC.
(Registrant)
By /s/ David D. Wesselink
-----------------------------
David D. Wesselink
Chairman and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of Metris Companies
Inc., the Registrant, and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
Principal executive officer: Chairman of the Board, April 9, 2004
Chief Executive Officer
/s/ David D. Wesselink
----------------------------------------
David D. Wesselink
Principal financial officer: Executive Vice President, April 9, 2004
Chief Financial Officer
/s/ John A. Witham
----------------------------------------
John A. Witham
Principal accounting officer: Senior Vice President, April 9, 2004
Controller
/s/ Mark P. Wagener
----------------------------------------
Mark P. Wagener
107
DIRECTORS:
/s/ Lee R. Anderson, Sr. Director April 9, 2004
----------------------------------------
Lee R. Anderson, Sr.
/s/ C. Hunter Boll Director April 9, 2004
----------------------------------------
C. Hunter Boll
/s/ John A. Cleary Director April 9, 2004
----------------------------------------
John A. Cleary
/s/ Thomas M. Hagerty Director April 9, 2004
----------------------------------------
Thomas M. Hagerty
/s/ David V. Harkins Director April 9, 2004
----------------------------------------
David V. Harkins
/s/ Walter M. Hoff Director April 9, 2004
----------------------------------------
Walter M. Hoff
/s/ Thomas H. Lee Director April 9, 2004
----------------------------------------
Thomas H. Lee
/s/ Edward B. Speno Director April 9, 2004
----------------------------------------
Edward B. Speno
/s/ Frank D. Trestman Director April 9, 2004
----------------------------------------
Frank D. Trestman
108
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
Charter Documents:
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to the Company's Registration
Statement on Form 8-A (File No. 1-12351)).
3.2 Amended and Restated Bylaws of the Company (incorporated by reference
to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the
period ended June 30, 1999 (File No. 1-12351)).
Instruments Defining Rights:
4.1 Indenture, dated as of November 7, 1997, among MCI, Metris Direct,
Inc., as Guarantor, and the First National Bank of Chicago, as Trustee,
including form of 10% Senior Note due 2004 and form of Guarantee by
Metris Direct, Inc. (incorporated by reference to Exhibit 4.a to MCI's
Registration Statement on Form S-4 (File No. 333-43771)).
(a) First Supplemental Indenture, dated as of June 25, 1999, among
MCI, the Guarantors named therein and the First National Bank
of Chicago (incorporated by reference to Exhibit 4.4 to MCI's
Registration Statement on Form S-4 (File No. 333-86695)).
(b) Second Supplemental Indenture, dated as of February 28, 2000,
among MCI, the Guarantors named therein and Bank One Trust
Company, N.A., as Trustee, successor in interest to the First
National Bank of Chicago (incorporated by reference to Exhibit
4.2 to MCI's Quarterly Report on Form 10-Q for the period
ended March 31, 2000 (File No. 1-12351)).
(c) Third Supplemental Indenture, dated as of January 2, 2001,
among MCI, the guarantors named therein and Bank One Trust
Company, N.A. (incorporated by reference to Exhibit 4.1(c) to
MCI's Annual Report on Form 10-K for the year ended December
31, 2001 (File No. 1-12351)).
(d) Agreement of Resignation, Appointment and Acceptance, dated as
of November 14, 2001, among MCI, Bank One Trust Company, N.A.,
as Prior Trustee, and US Bank National Association, as
Successor Trustee (incorporated by reference to Exhibit 4.1(d)
to MCI's Annual Report on Form 10-K for the year ended
December 31, 2001 (File No. 1-12351)).
4.2 Certificate of Designation of Series B Perpetual Preferred Stock
(incorporated by reference to Exhibit 4.1 of MCI's Current Report on
Form 8-K dated December 22, 1998 (File No. 1-12351)).
4.3 Certificate of Designation of Series C Perpetual Preferred Stock
(incorporated by reference to Exhibit 4.2 of MCI's Current Report on
Form 8-K dated December 22, 1998 (File No. 1-12351)).
(a) Amended Certificate of Designation of Series C Perpetual
Convertible Preferred Stock (incorporated by reference to
Exhibit 3.3 to MCI's Registration Statement on Form S-3 (File
No. 333-82007)).
109
4.4 Certificate of Designation of Series D Junior Participating
Convertible Preferred Stock (incorporated by reference to
Exhibit 4.3 of MCI's Current Report on Form 8-K dated December
22, 1998 (File No. 1-12351)).
4.5 Registration Rights Agreement, dated as of December 9, 1998,
between MCI and the Investors named therein (incorporated by
reference to Exhibit 10.3 to MCI's Current Report on Form 8-K
dated December 22, 1998 (File No. 1-12351)).
4.6 Form of common stock certificate of MCI (incorporated by
reference to Exhibit 4.3 to MCI's Registration Statement on
Form S-8 (File No. 333-91917)).
4.7 Indenture, dated as of July 13, 1999, by and among MCI, Metris
Direct, Inc. and The Bank of New York, including Form of 10
1/8% Senior Notes due 2006 and Form of Guarantee (incorporated
by reference to Exhibit 4.1 to MCI's Registration Statement on
Form S-4 (File No. 333-86695)).
(a) First Supplemental Indenture, dated as of February
28, 2000, among MCI, the Guarantors named therein and
The Bank of New York, (incorporated by reference to
Exhibit 4.1 to MCI's Quarterly Report on Form 10-Q
for the period ended March 31, 2000 (File No.
1-12351)).
(b) Second Supplemental Indenture, dated as of February
2, 2001, among MCI, the Guarantors named therein and
The Bank of New York (incorporated by reference to
Exhibit 4.7(b) to MCI's Annual Report on Form 10-K
for the year ended December 31, 2001 (File No.
1-12351)).
(c) Agreement of Resignation, Appointment and Acceptance,
dated as of February 20, 2002, among MCI, The Bank of
New York, as Prior Trustee, and US Bank National
Association, as Successor Trustee (incorporated by
reference to Exhibit 4.7(c) to MCI's Annual Report on
Form 10-K for the year ended December 31, 2002 (File
No. 1-12351)).
4.8 Exchange and Registration Rights Agreement, dated as of July 13, 1999,
by and among MCI, Bear, Stearns & Co. Inc., Chase Securities Inc.,
Salomon Smith Barney Inc. and Barclays Capital Inc., relating to the
new notes (incorporated by reference to Exhibit 4.2 to MCI's
Registration Statement on Form S-4 (File No. 333-86695)).
4.9 Base Indenture, dated as of October 25, 2002, between MCI and U.S. Bank
National Association, as Trustee (incorporated by reference to Exhibit
4.1 to MCI's Current Report on Form 8-K dated October 28, 2002 (File
No. 1-12351
(a) First Supplemental Indenture, dated as of October 25, 2002
between MCI and U.S. Bank National Association, as Trustee
(incorporated by reference to Exhibit 4.2 to MCI's Current
Report on Form 8-K dated October 28, 2002 (File No. 1-12351)).
110
Material Contracts
10.1 Second Amended and Restated Pooling and Servicing Agreement, dated as
of January 22, 2002, among Metris Receivables, Inc. ("MRI"), as
Transferor, Direct Merchants Credit Card Bank, National Association
("Direct Merchants Bank"), as Servicer, and U.S. Bank National
Association, as Trustee (incorporated by reference to Exhibit 4.3 to
MRI's Current Report on Form 8-K dated January 24, 2002 (File No.
0-23961)).
(a) Amendment No. 1 to the Second Amended and Restated Bank
Receivables Purchase Agreement, dated as of June 14, 2002,
between Metris Companies Inc., as Buyer, and Direct Merchants
Credit Card Bank, National Association, as Seller
(incorporated by reference to Exhibit 4.1 to MRI's Current
Report on Form 8-K dated June 18, 2002 (File No. 0-23961).
10.2 Second Amended and Restated Bank Receivables Purchase Agreement, dated
as of January 22, 2002, between Direct Merchants Bank and MCI
(incorporated by reference to Exhibit 4.1 to MRI's Current Report on
Form 8-K dated January 24, 2002 (File No. 0-23961)).
(a) Amendment No. 1 to the Second Amended and Restated Purchase
Agreement, dated as of June 14, 2002, between Metris
Receivables, Inc., as Buyer, and Metris Companies Inc., as
Seller (incorporated by reference to Exhibit 4.2 to MRI's
Current Report on Form 8-K dated June 18, 2002 (File No.
0-23961).
10.3 Second Amended and Restated Bank Receivables Purchase Agreement, dated
as of January 22, 2002, between MCI and MRI (incorporated by reference
to Exhibit 4.2 to MRI's Current Report on Form 8-K dated January 24,
2002 (File No. 0-23961)).
(a) Amendment No. 1 to the Metris Master Trust Second Amended and
Restated Pooling and Servicing Agreement, dated as of June 14,
2002, among Metris Receivables, Inc., as Transferor, Direct
Merchants Credit Card Bank, National Association, as Servicer,
and U.S. Bank National Association, as Trustee (incorporated
by reference to Exhibit 4.3 to MRI's Current Report on Form
8-K dated June 18, 2002 (File No. 0-23961).
10.4* Change of Control Severance Agreement, dated as of May 15, 1998, by and
between MCI and Ronald N. Zebeck and a schedule of executive officers
of the Company also having such an agreement with MCI, indicating the
differences from the version of agreement filed (as permitted by
Instruction 2 to Item 601 of Regulation S-K) (incorporated by reference
to Exhibit 10.2 to MCI's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1998 (File No. 1-12351)).
(a) Amendment to Ronald N. Zebeck's Change of Control Severance
Agreement, dated as of December 9, 1998 (incorporated by
reference to Exhibit 10.7(i) to MCI's Annual Report on Form
10-K for the year ended December 31, 1998 (File No. 1-12351)).
(b) Amended Schedule of Executive Officers with Change of Control
Severance Agreements (incorporated by reference to Exhibit
10.4(b) to MCI's Annual Report on Form 10-K for the year ended
December 31, 2001 (File No. 1-12351)).
111
10.5* Retention Agreement, dated May 17, 1999, between Ronald N. Zebeck and
MCI (incorporated by reference to Exhibit 10.2 to MCI's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1999 (File No.
1-12351)).
10.6 Amended and Restated Credit Agreement, dated as of July 21, 2000, among
MCI; the Lenders from time to time parties thereto; The Chase Manhattan
Bank, as Administrative Agent; Bank of America, N.A., as Syndicate
Agent; Deutsche Bank AG, New York Branch, as Co-Documentation Agent;
U.S. Bank National Association, as Co-Documentation Agent; and Barclays
Bank PLC, as Co-Agent (incorporated by reference to MCI's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2000 (File No.
1-12351)).
(a) Amendment No. 1, dated as of July 10, 2001, to the Amended and
Restated Credit Agreement, among MCI; the Lenders from time to
time parties thereto; The Chase Manhattan Bank, as
Administrative Agent; Bank of America, N.A., as Syndication
Agent; Deutsche Bank AG, New York Branch, as Co-Documentation
Agent; U.S. Bank National Association, as Co-Documentation
Agent; and Barclays Bank PLC, as Co-Agent (incorporated by
reference to Exhibit 10.6(a) to MCI's Annual Report on Form
10-K for the year ended December 31, 2001 (File No. 1-12351)).
(b) Amendment No. 2, dated as of March 17, 2003, to the Amended
and Restated Credit Agreement, among MCI; the Lenders from
time to time parties thereto; The Chase Manhattan Bank, as
Administrative Agent; Bank of America, N.A., as Syndication
Agent; Deutsche Bank AG, New York Branch, as Co-Documentation
Agent; U.S. Bank National Association, as Co-Documentation
Agent; and Barclays Bank PLC, as Co-Agent (incorporated by
reference to Exhibit 10.6 (b) to MCI's Annual Report on Form
10-K for the year ended December 31, 2002 (File No. 1-12351)).
10.7* MCI Non-Employee Director Stock Option Plan (incorporated by reference
to Exhibit 10.3 to MCI's Registration Statement on Form S-4/A (File No.
333-86695)).
10.8* MCI Management Stock Purchase Plan (incorporated by reference to
Exhibit 10.4 to MCI's Registration Statement on Form S-4/A (File No.
333-86695)).
10.9* MCI Amended and Restated Annual Incentive Bonus Plan for Designated
Corporate Officers (incorporated by reference to Exhibit 10.5 to MCI's
Registration Statement on Form S-4/A (File No. 333-86695)).
10.10* MCI Amended and Restated Long-Term Incentive and Stock Option Plan
(incorporated by reference to Exhibit 10.6 to MCI's Registration
Statement on Form S-4/A (File No. 333-86695)).
(a) Form of Non-Qualified Stock Option Agreement (incorporated by
reference to Exhibit 10.8 to MCI's Annual Report on Form 10-K
for the year ended December 31, 1998 (File No. 1-12351)).
(b) Form of Non-Qualified Performance Accelerated Stock Option
Agreement (incorporated by reference to Exhibit 10.10(b) to
MCI's Annual Report on Form 10-K for the year ended December
31, 2001 (File No. 1-12351)).
112
(c) Form of Restricted Stock Award Agreement (incorporated by
reference to Exhibit 10.10(c) to MCI's Annual Report on Form
10-K for the year ended December 31, 2001 (File No. 1-12351)).
10.11 Formal Agreement, dated as of April 16, 2002, between Direct Merchants
Bank and the Office of the Comptroller of the Currency (Incorporated by
reference to Exhibit 99.1 to MCI's Current Report on Form 8-K dated
April 17, 2002 (File No. 1-12351)).
10.12 Operating Agreement, dated as of March 18, 2003, between MCI, Direct
Merchants Bank and the Office of the Comptroller of the Currency
(Incorporated by reference to Exhibit 99.2 to MCI's Current Report on
Form 8-K dated March 19, 2003 (File No. 1-12351)).
10.13 Capital Assurance and Liquidity Maintenance Agreement, dated as of
March 18, 2003, between Direct Merchants Bank and MCI (Incorporated by
reference to Exhibit 99.3 to MCI's Current Report on Form 8-K dated
March 19, 2003 (File No. 1-12351)).
10.14 Liquidity Reserve Deposit Agreement, dated as of March 18, 2003, among
Direct Merchants Bank, JPMorgan Chase Bank, and the Office of the
Comptroller of the Currency (Incorporated by reference to Exhibit 99.4
to MCI's Current Report on Form 8-K dated March 19, 2003 (File No.
1-12351)).
10.15 Metris Companies Inc. Term Loan Commitment Letter dated March 31, 2003
between Thomas H. Lee Partners, L.P. and Metris Companies Inc.
(incorporated by reference to Exhibit 10.15 to MCI's Annual Report on
Form 10-K for the year ended December 31, 2002 (File No. 1-12351)).
Other Exhibits
11 Computation of Earnings Per Share.
12(a) Computation of Ratio of Earnings to Fixed Charges.
12(b) Computation of Ratio of Earnings to Fixed Charges and Preferred
Dividends.
21 Subsidiaries of MCI. (Previously filed on March 31, 2003 as an exhibit
to the original Form 10-K.)
23 Independent Auditors' Consent.
31.1 Certification of Principal Executive Officer Pursuant to Rule
13a-14(a)/15d-14(a).
31.2 Certification of Principal Financial Officer Pursuant to Rule
13a-14(a)/15d 14(a).
32.1 Certification of Principal Executive Officer Pursuant to Section 1350
of Chapter 63 of Title 18 of the United States Code.
32.2 Certification of Principal Financial Officer Pursuant to Section 1350
of Chapter 63 of Title 18 of the United States Code.
* Management contract or compensatory plan or arrangement required to be filed
as an exhibit pursuant to Item 14(c) of Form 10-K.
113