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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

Metris Companies Inc.

10900 Wayzata Boulevard, Minnetonka, Minnesota 55305-1534

(952) 525-5020

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

     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 þ          No o

     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 þ          No o

     The aggregate market value of the common Stock held by non-affiliates of the Registrant as of June 30, 2004 was approximately $499,229,238 based upon the last sales price of $8.69 on the New York Stock Exchange on that date.

     As of February 28, 2005, 58,164,100 shares of the Registrant’s Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

     Certain portions of the Proxy Statement for the Annual Meeting of Stockholders of Metris Companies Inc. to be held on May 11, 2005, which will be filed with the Securities and Exchange Commission (“SEC”) within 120 days after December 31, 2004, are incorporated by reference in Part III.

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FORWARD-LOOKING STATEMENTS

      This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. Forward-looking statements include, without limitation: expressions of the “belief,” “anticipation,” “intent,” or “expectations” of management; statements and information as to our strategies and objectives; statements as to industry trends or future results of operations of the Company and its subsidiaries; and other statements that are not historical fact. Forward-looking statements may be identified by the use of terminology such as “may,” “will,” “believes,” “does not believe,” “no reason to believe,” “expects,” “plans,” “intends,” “estimates,” “anticipated” or “anticipates” and similar expressions, as they relate to the Company or our management. Forward-looking statements are based on certain assumptions by management and are subject to risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements.

      These risks and uncertainties include, but are not limited to, risks associated with Direct Merchants Bank’s ability to comply with its agreements with regulators regarding the safety and soundness of its operations; the effect of government policy and regulation, whether of general applicability or specific to us, including restrictions and/or limitations relating to our minimum capital requirements, reserving

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      These and other risks and uncertainties are described under the heading “Risk Factors” in pages 21-27 of this Report, and are also discussed in other parts of this Report, including Legal Proceedings (pages 27-28), Management’s Discussion and Analysis of Financial Condition and Results of Operations (pages 30-56) and Quantitative and Qualitative Disclosures About Market Risk (page 56). 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, and are reminded that they are not guarantees of our future performance. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

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PART I

Overview

      Metris Companies Inc. (“MCI”) was incorporated in Delaware on August 20, 1996, and completed an initial public offering in October 1996. We are listed on the New York Stock Exchange under the symbol MXT. MCI’s principal subsidiaries are Direct Merchants Credit Card Bank, National Association (“Direct Merchants Bank” or “Bank”), Metris Direct, Inc. and Metris Receivables, Inc. (“MRI”). MCI and its subsidiaries are referred to in this report as “we,” “us,” “our,” and the “Company.”

      Our consumer lending products are primarily unsecured credit cards, including Direct Merchants Bank MasterCard® and Visa® credit cards. We also offer agent bank and co-branded credit cards through partnerships with other companies. Our credit cards generate consumer loans through Direct Merchants Bank. We also sell other consumer lending related products and services, such as credit protection products. We utilize our various legal entities as follows:

	•	Direct Merchants Bank owns all credit card accounts and sells receivables on accounts assigned to the Metris Master Trust on a daily basis to MCI.
	•	MCI sells receivables daily to MRI, one of our special purpose entity subsidiaries, which then sells them to our off balance sheet entity, the Metris Master Trust.
	•	The Metris Master Trust owns the receivables and finances them with borrowings under our conduit and asset-backed term securitizations.

      As of December 31, 2004, the Metris Master Trust had $6.5 billion in receivables and $5.3 billion of asset-backed securitization and conduit borrowings outstanding. MRI owns the “Retained interests in loans securitized” and “Other receivables due from securitizations, net” which totaled $852.2 million as of December 31, 2004. As of December 31, 2004, MCI had a $1.3 billion investment in subsidiaries, external “Debt” of $373.6 million, “Convertible preferred stock” of $514.5 million and “Total stockholders’ equity” of $947.3 million. The assets of Direct Merchants Bank were $336.2 million as of December 31, 2004, including $54.6 million in net credit card loans.

      Direct Merchants Bank engages only in credit card operations. It does not accept demand deposits or deposits that the depositor may withdraw by check or similar means for payment to third parties or others; it does not accept any savings or time deposits of less than $100,000, except for deposits pledged as collateral for extensions of credit; it maintains only one office that accepts deposits; and it does not engage in the business of making commercial loans. Therefore, it does not fall under the Bank Holding Company Act of 1956 (“BHCA”) as amended.

      We generate income from our consumer lending products through:

	•	excess spread (defined as portfolio yield collections, less principal charge-offs, financing costs and servicing costs) on credit card loans sold to the Metris Master Trust;
	•	servicing fees on securitized receivables;
	•	interest and other finance charges assessed on outstanding credit card loans that we own;
	•	interchange fees and credit card fees (including annual, cash advance, returned-check, credit protection products, overlimit and late fees) on outstanding credit card loans that we own; and
	•	commissions from third parties for marketing their products to our cardholders.

      The primary expenses of our business are:

	•	the costs of funding the loans;
	•	provisions for loan losses; and

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	•	operating expenses, including employee compensation, account solicitation, marketing, and data processing expenses.

      Profitability is affected by a number of factors, including:

	•	credit quality (delinquencies, bankruptcies and charge-offs);
	•	payment rates;
	•	yield earned on loans;
	•	cost of funds and related financing transaction costs;
	•	cash restricted from release from the Metris Master Trust;
	•	response and approval rates to our solicitation efforts;
	•	the size of our managed (owned and securitized) loan portfolios;
	•	credit card usage;
	•	credit card cancellations;
	•	fraud losses;
	•	cardholder servicing expenses; and
	•	operating expenses.

      In 2004, we had net income of $33.7 million, compared to a net loss of $147.7 million in 2003, and a net loss of $1.6 million in 2002. Over the past two years, we have focused on strengthening the long-term operations of our business. During this time period we have emphasized tighter underwriting on new account originations, stricter credit line management on existing and new credit card accounts, better pricing on offerings and improved collections infrastructure. We have begun to see improved operating results as evidenced by improvements in default rates, delinquencies and payment rates of our credit card accounts in 2004. These improved operating results and our stronger liquidity position are enabling us to focus on growing our business again. We steadily increased our new account originations throughout 2004. We are comfortable with increasing our new account originations, in part, due to the continued strong results we are experiencing in our 2003 and 2004 vintages. This new account growth will remain focused on our traditional target market, the middle-market consumer. We will continue to leverage our account origination strategies, increase our efforts to penetrate the Hispanic customer segment, increase our partnership and third-party marketing efforts, and test additional products, channels and incremental prospects.

Business Strategy and Marketing

          Products

      Our credit card products are primarily unsecured consumer credit cards, including the Direct Merchants Bank MasterCard® and Visa® credit cards. We also offer agent bank and co-branded credit cards through partnerships with other companies. At December 31, 2004, we had approximately 2.2 million gross active accounts with approximately $6.6 billion in managed credit card receivables. As of December 31, 2004, MCI was the 11^th largest bankcard issuer in the United States based on total managed receivables, according to the Nilson Report.

      When we refer to “managed” loans or other “managed” data, we are using information that includes the loan balances, delinquencies and credit losses related to securitized loans, and related finance charge and fee income, even though those balances, delinquencies, losses, charges and income are not on our financial statements as a result of the way in which we treat securitizations under accounting principles generally accepted in the United States of America (“GAAP”). Although securitized loans have been removed from our balance sheet, we retain interests in them that affect our financial performance.

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      In addition to consumer credit cards, we sell credit protection products through Direct Merchants Bank and insurance products through a third party provider. These products are sold to Direct Merchants Bank credit cardholders. Our Account Protection Plus^SM and Account Benefit Plan^SM are sold exclusively to Direct Merchants Bank credit cardholders. These products include the following:

      For a customer who has purchased this product, Direct Merchants Bank will waive the balance of the customer’s credit card account in the event of the cardholder’s death. The product further protects the credit card account in the event of involuntary unemployment, disability or the need to take an employer approved leave-of-absence. In these situations, the customer’s credit card account is “frozen” with no payments due or interest accruing up to the maximum period of time permissible for each event.

      For a customer who has purchased this product, Direct Merchants Bank will waive the balance of the customer’s credit card account in the event of the cardholder’s death.

      This product offers our credit cardholders traditional credit life insurance benefits that will pay the balance of the Direct Merchants Bank credit card account in the event of the cardholder’s death. Additional coverage may be available on a state-by-state basis that will pay the minimum payment due on the covered credit card account in the event of unemployment or disability. The insurance benefits are offered by insurance companies that re-insure those policies with ICOM Limited, our Bermuda captive insurance subsidiary.

     Other Insurance Products

      We cooperate with a variety of insurance companies to sell their regulated products to Direct Merchants Bank credit card customers. Our arrangements with these insurance companies generally follow one of two formats:

	•	The insurance company pays us a fee for access to a select list of Direct Merchants Bank cardholders. We provide support during the solicitation and billing process.
	•	Our licensed insurance agency subsidiary, MES Insurance Agency, LLC, manages the solicitation of customers for the third-party insurance products and may pay the expenses of that solicitation in exchange for a commission.

      With lower-risk products, ICOM Limited may reinsure all or a portion of the risk of the third-party insurance policies that are sold. In that situation, ICOM Limited bears the administrative costs of servicing the policies.

      Finally, we also have relationships with a variety of third-party partners that sell their products to Direct Merchants Bank customers. These relationships have various structures. In general, the partner pays us a fee to solicit a select list of cardholders and the opportunity to leverage Direct Merchants Bank’s name during the solicitation and billing processes, both of which we support.

Target Market

      We primarily target middle-market, creditworthy customers who are generally underserved and undermarketed by many large, prime and super-prime oriented credit card issuers. We originate new loans

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     Pricing

      Through risk-based pricing, we price credit card offers based on a prospect’s risk profile. We evaluate a prospect to determine credit needs, credit risk and existing credit availability, and then develop a customized offer that includes product, brand, pricing and credit line. We have numerous pricing structures for our credit card products. We continually test different pricing offers to prospects. The Company pursues strategies to ensure that the pricing offered to prospects is competitive in order to reduce adverse selection. For further information on portfolio yield please refer to Off Balance Sheet Arrangements on pages 43-45 of this Report.

      Each cardholder is subject to an agreement governing the terms and conditions of his or her credit card account (“cardholder agreement”). Pursuant to the cardholder agreement, we reserve the right to change or terminate certain terms, conditions, services and features of the account (including periodic finance charges, late fees, returned-check charges and any other charges, and the minimum payment), subject to the conditions set forth in the cardholder agreement.

      We generally assess periodic finance charges on an account if the cardholder has not paid the balance in full from the previous billing cycle. We base these finance charges on the average daily balance outstanding on the account during the monthly billing cycle.

      We do not impose a finance charge on purchases if the cardholder pays the entire balance on the account by the due date. If we are not paid in full prior to the due date, which is generally 20 to 25 days after the statement cycle date and applicable grace period, we impose finance charges on all purchases from the date the transaction posted to the cardholder’s account to the statement cycle date. We also impose finance charges on each cash advance from the day we make the advance until the cardholder pays the advance in full.

      We assess an annual fee on some credit card accounts. We may waive the annual fee, or a portion thereof, depending on the credit terms offered, which we determine based on the prospect’s risk profile prior to solicitation, or when we determine a waiver to be appropriate considering the account’s overall profitability. In addition to the annual fee, we charge other fees, including:

	•	a late fee with respect to any unpaid monthly balance if we do not receive the required minimum monthly payment by the due date and the account is less than or equal to 120 days contractually past due;
	•	a cash advance fee for most cash advances;
	•	a fee with respect to each check submitted by a cardholder in payment of an account that the cardholder’s bank does not honor; and
	•	an overlimit charge consistent with the cardholder agreement if, at any time during the billing cycle, the total amount owed exceeds the cardholder’s credit limit and the account is less than or equal to 120 days contractually past due.

      Late, overlimit and cash advance fees, represented approximately 16% of total billed fees and finance charges in 2004.

      Our customers and prospects are generally credit users. Over 90% of our existing customers carry a balance each month, generating finance charge billings. On average, our customers utilize approximately 50% of the credit lines assigned to them.

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      As of December 31, 2004, we had $68.2 million of owned credit card loans held primarily by Direct Merchants Bank, and $6.5 billion of credit card loans held in the Metris Master Trust, for a total of $6.6 billion in managed credit card loans. Currently, we assign all new eligible accounts to the Metris Master Trust shortly after the time of origination.

      The following tables set forth, as of December 31, 2004 and 2003, the number of managed credit card accounts and the amount of outstanding loans based on the age of the accounts. Accounts in acquired portfolios are presented based on when the account was originated by the previous credit card issuer.

      As of December 31, 2004, the percentage of accounts and percentage of outstanding balances greater than two years since origination were 75.4% and 86.7%, respectively on a managed basis, compared to 76.7% and 84.4% as of December 31, 2003.

Credit Process

      We use internally and externally developed models to supplement our evaluation of consumers. These models help segment prospects into unique credit groups within each FICO score range, allowing us to better evaluate individual credit risk and to tailor our product and pricing accordingly.

      We believe that our proprietary models give us a competitive advantage in evaluating the credit risk of middle-market consumers. We monitor the performance of the proprietary models and continually re-evaluate the effectiveness of these models in segmenting credit risk, which results in further refinements in our targeting and selection strategy. By monitoring each vintage pool we are able to optimize the use of

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      We process applications based on policies approved by the Bank’s credit policy committee. Upon receipt of an application for credit, we pull updated credit bureau reports, perform fraud screening, verify name and address changes and attempt to obtain information that may be missing. We then make a credit decision and approve, decline, or begin exception processing.

      When we approve a credit application, we use automated decisioning to determine credit worthiness and proprietary strategies to establish initial credit lines based upon the individual’s credit profile.

Portfolio Management

      After credit card accounts are opened, we regularly monitor customers’ internal and external credit performance and re-calculate credit risk, profitability and attrition scores.

      We manage credit lines based on the results of a behavioral scoring analysis, and in accordance with credit policies established by the Bank’s credit policy committee. These analytical models automatically and regularly assign credit line increases and decreases to individual customers, as well as determine the systematic collection steps to be taken while a credit card account is in delinquency. We use these models to manage the authorization of each transaction, as well as the collections strategies used for non-delinquent accounts with balances above their assigned credit lines. We may, at any time and without prior notice to a cardholder, prevent or restrict further credit card use by the cardholder, usually as a result of poor payment performance or our concern over the creditworthiness of the cardholder.

      Over the past three years we have taken steps to lower the credit lines of our existing cardholders. We have actively lowered customer credit lines by eliminating open-to-buy on higher-risk segments, closing and purging inactive accounts and reducing the number of customers eligible for credit line increases. This has limited customer spending and reduced our severity of credit loss. The average outstanding cardholder balance in our managed portfolio was approximately $3,000 and $3,300 as of December 31, 2004 and 2003, respectively. In addition to the actions we have taken to manage the credit lines of our existing account relationships, we have lowered the initial credit lines assigned to our new cardholders. Beginning in 2003, the majority of our new cardholders receive initial credit lines that were significantly lower than similar offers received in 2001 and 2002.

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      The following tables set forth information with respect to credit limit and account balance ranges of our managed loan portfolio as of December 31, 2004 and 2003.

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      As of December 31, 2004, on a managed basis, 25.5% of the outstanding receivable balances relate to cardholders with credit limits in excess of $10,000, compared to 27.5% as of December 31, 2003. On a managed basis, 69.0% of the receivable balance was outstanding to cardholders with credit limits in excess of $5,000 as of December 31, 2004, compared to 71.8% as of December 31, 2003. The decline in the percentage of accounts with credit limits above $5,000 and $10,000 is a result of higher balance, lower credit quality accounts charging off and these accounts being replaced with new accounts that have lower initial credit lines.

      The Federal Financial Institutions Examination Council (“FFIEC”) has issued guidelines to further segregate a credit card issuer’s loan portfolio between subprime loans and prime loans. The banking regulators deem subprime loans to have higher credit risk and therefore require higher levels of capital and allowance for loan losses. The amount of subprime receivables (defined as loans to consumers who have a FICO credit score of 660 or less) in our portfolio was $4.0 billion or 60.7% of the managed credit card portfolio as of December 31, 2004, compared to $4.9 billion or 61.2% of the managed credit card portfolio as of December 31, 2003.

Servicing, Billing and Payment

      We have established a relationship with First Data Resources, Inc. (“FDR”) for cardholder processing services. FDR is a subsidiary of First Data Corporation, a provider of information processing and related services, including cardholder processing (services for financial institutions that issue credit cards to consumers) and merchant processing (services for financial institutions that make arrangements with merchants for the acceptance of credit cards as methods of payment).

      FDR provides the following services to us:

	•	data processing;
	•	credit card reissuance;
	•	issuance of monthly statements to our credit cardholders;
	•	interbank settlements; and
	•	point-of-sale authorization referrals.

      We handle the following functions internally:

	•	applications processing; and
	•	back office support for mail inquiries and most fraud management.

      We handle inbound customer service telephone calls for our customer base. In addition, we process a portion of our customer payments, including all payments with exceptions. All other payments are processed by Remitco LLC. Prior to October 18, 2004, all other payments were processed by Household Credit Services.

      FDR sends monthly billing statements to Direct Merchants Bank cardholders on our behalf. When we establish an account, we assign a billing cycle to that account. Each cycle has a separate monthly billing date based on the business day of the calendar month on which the cycle begins. Each month we send a statement to all cardholders whose accounts have an outstanding balance greater than $1. Non charged-off account cardholders must make a minimum monthly payment, generally the greater of:

	•	$15;
	•	2.5% of the outstanding balance;
	•	the finance charge; or
	•	the balance of the account if the balance is less than $15;

      plus, in each case, any past-due amount.

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      Most merchant transactions by cardholders are authorized online. All authorizations are handled through FDR’s adaptive control and fraud detection systems.

      To monitor accounts and authorizations for potential fraudulent activity, we utilize a fraud detection system. This product scores authorizations based on a calculated fraud risk. Accounts suspected as fraud via the scoring model or rules-based queues are reviewed and may be blocked if activity cannot be verified with the cardholder. This process targets typical credit card fraud types, including lost and/ or stolen cards, non-receipt of cards, fraudulent applications, counterfeit card, account takeover, cardholder not present, and check kiting fraud.

Delinquency, Collections and Charge-offs

      We consider an account delinquent if we do not receive the minimum payment by the payment due date. 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 12 months and two times every five years. Accounts entering long-term fixed payment forbearance programs may receive a re-age upon entering the debt management program (“workout re-age”). Workout re-ages can only occur after receipt of at least three consecutive minimum monthly payments, or the equivalent cumulative amount as defined by the debt management program. Workout re-ages can only occur once in five years.

      We handle substantially all collections internally, and we determine the appropriate collection action to take by using FDR’s adaptive control system, which continually monitors all delinquent accounts. We close accounts that become 60 days contractually delinquent. We charge-off and take accounts as a loss either:

	•	within 60 days of formal notification of bankruptcy filing;
	•	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 debt management or other similar program become contractually 120 days past due;
	•	at the end of the month during which secured accounts become contractually 120 days past due;
	•	no later than 90 days from discovery of fraud losses; or
	•	within 120 days of notification of the death of a cardholder.

      We enter into forward-flow agreements with third parties for the sale of receivables on a majority of our charged-off accounts. When appropriate, we place accounts with external collection agencies or attorneys.

      As part of our overall portfolio management, we may periodically sell portfolios of delinquent credit card accounts. These transactions have a direct effect on our charge-off dollars and rates as any reduction in the loan’s value is reflected as a charge-off.

      In early 2003 we replaced a substantial portion of the collections management team, updated the technology used in our collections operations and initiated new training programs for all levels of collections personnel. We also implemented a new collections program that incorporates specific requirements for staffing, dialer strategies, and a new collections call model. In addition, reporting and performance standards were enhanced to ensure that management is held accountable for future performance. We believe these actions have contributed to the reduction in our default rates.

Funding and Liquidity

      We securitize consumer loans in order to fund our business. Our securitizations involve selling pools of both current and future receivable balances on credit card accounts. We retain the rights to service

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      The Metris Master Trust was formed in May 1995 pursuant to a pooling and servicing agreement, as amended. MRI, one of our special purpose entity subsidiaries, transfers receivables in designated accounts to the Metris Master Trust. The Metris Master Trust may, and does from time to time, issue securities that represent undivided interests in the receivables in the Metris Master Trust. These securities are issued by series, and each series typically has multiple classes. Each series, or class within a series, may have different terms. The different classes of an individual series are structured to obtain specific debt ratings. As of December 31, 2004, 12 series of publicly and privately issued securities were outstanding. MRI currently retains the most subordinated class of securities in each series, and all other classes are issued to nonaffiliated third parties. These securities are interests in the Metris Master Trust only and are not obligations of MRI, MCI, Direct Merchants Bank or any other subsidiary of the Company. The interest in the Metris Master Trust not represented by any series of securities issued by the Metris Master Trust also belongs to MRI and is known as the transferor’s interest.

      Generally each series involves an initial reinvestment period, referred to as the “revolving period,” in which principal payments on receivables allocated to that series are returned to MRI and reinvested in new principal receivables arising in the accounts. After the revolving period ends, principal payments allocated to the series are then accumulated and used to repay the investors. This period is referred to as the “accumulation period,” and is followed by a “controlled amortization period,” wherein investors are repaid their invested amount. Currently the Metris Master Trust does not have any series in an accumulation period or controlled amortization period. The scheduled accumulation and amortization periods are set forth in the securitization agreements governing each series. However, all series set forth certain events by which amortization can be accelerated, referred to as “early amortization.” Reasons an early amortization could occur include:

	•	the one- or three-month average of portfolio yield collections, less principal charge-offs, financing costs and servicing costs (“excess spread”) droping below levels below 1.0%;
	•	the existence of negative excess transferor’s interest within the Metris Master Trust; or
	•	the failure to obtain funding prior to an accumulation period for a maturing term asset-backed securitization.

      New receivables in designated accounts cannot be funded using principal payments allocated to a series that is in early amortization. We currently do not have, nor have we ever had, any series that is, or was, in early amortization.

      In addition, there are various triggers within our securitization agreements that, if broken, would restrict the release of cash to us from the Metris Master Trust. This restricted cash provides additional security to the investors in the securities issued by the Metris Master Trust. The triggers are usually related to the performance of the Metris Master Trust, specifically the average of excess spread over a one- to three-month period.

      On a monthly basis, each series is allocated its share of finance charge collections, which are used to pay investors interest on their securities, pay their share of servicing fees and reimburse investors for their share of losses due to charge-offs. Amounts remaining may be deposited in cash accounts of the Metris Master Trust as additional protection for future losses. Once each of these obligations is fully met, remaining finance charge and fee collections, if any, are returned to us.

      We ensure flexibility in our current funding program by maintaining bank-sponsored commercial paper conduits within the Metris Master Trust. These conduits purchase an interest in receivables arising

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      Additional information regarding asset securitization is set forth under Liquidity, Funding, and Capital Resources on pages 45-49 of this Report.

Competition

      As a marketer of consumer lending products, we compete with numerous providers of financial services. We compete with national, regional and local bankcard issuers, as well as other general-purpose credit and debit card issuers. In general, we believe customers are attracted to credit card products largely on the basis of price, credit limit and other product features; as a result, customer loyalty is often limited. However, we believe that our strategy of focusing on the middle-market sector, supported by our use of a proprietary prospect database, proprietary models and custom decision logic, allows us to compete effectively for middle-market consumers.

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      We solicit credit card customers on a national basis and, therefore, maintain a geographically diversified portfolio. The following tables show the distribution of managed accounts and amount of managed outstanding loans by state as of December 31, 2004 and 2003.

(1)	No other state accounts for more than 2.5% of managed loans outstanding.

Regulation

      Direct Merchants Bank is a limited purpose credit card bank chartered as a national banking association. It is a member of the Federal Reserve System. Its deposits are insured by the Bank Insurance Fund, which is administered by the Federal Deposit Insurance Corporation (“FDIC”), and it is subject to comprehensive regulation and periodic examination by the Office of the Comptroller of the Currency

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	•	engages only in credit card operations;
	•	does not accept demand deposits or deposits that the depositor may withdraw by check or similar means for payment to third parties or others;
	•	does not accept any savings or time deposits of less than $100,000, except for deposits pledged as collateral for extensions of credit;
	•	maintains only one office that accepts deposits; and
	•	does not engage in the business of making commercial loans.

      If Direct Merchants Bank failed to meet the credit card bank criteria described above, its status as an insured bank would make us subject to the provisions of the BHCA.

      Under current judicial interpretations of federal law, national banks such as Direct Merchants Bank may charge interest at the rate allowed by the laws of the state where the bank is located and may “export” those interest rates on loans to borrowers in other states without regard to the laws of those other states.

      The United States Supreme Court has held that national banks may also impose late payment fees, overlimit fees, annual fees, cash advance fees and membership fees allowed by the laws of the state where the national bank is located on borrowers in other states without regard to the laws of those other states. The Supreme Court based its opinion largely on its deference to a regulation adopted by the OCC that has been interpreted to permit national banks to export interest rates.

      The OCC establishes operating guidelines for national banks, to which Direct Merchants Bank is subject. On January 31, 2001, the OCC, Federal Reserve Board, FDIC and Office of Thrift Supervision jointly issued their “Expanded Guidance for Subprime Lending Programs,” which subjects subprime lending institutions to closer examination scrutiny in order to ensure that their programs have appropriate risk management controls and capital support. Under the expanded guidance, the allowance for loan losses required for subprime loans must be sufficient to absorb at least all estimated credit losses on outstanding balances over the current operating cycle. Each subprime lender is responsible for quantifying the amount of capital needed to offset the additional risk in subprime lending activities and for fully documenting the methodology and analysis supporting the amounts specified. As discussed below, the Bank is required to maintain capital levels in accordance with the Modified Operating Agreement that it and MCI have entered into with the OCC.

      In January 2003, the FFIEC issued guidance with respect to various account management 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 engaged in credit card lending. Beginning in 2003, we began implementing the guidance and believe we are now in compliance with most aspects. In addition, we developed and have been executing against a multi-phased approach to address the receivable amortization aspects of this guidance. We expect to utilize various methods to ensure reasonable receivable amortization of our accounts, including but not limited to: limiting consecutive fee billings; implementing a fee billing cap; reducing customer’s interest rates; and increasing the required minimum payment due. The impact of fully implementing the account management guidance, while not expected to be significant, is unknown at this time.

      The Bank and MCI have entered into a Capital Assurance and Liquidity Maintenance Agreement (“CALMA”). The CALMA requires MCI to make such capital infusions or provide the Bank with financial assistance so as to permit the Bank to meet its liquidity requirements. Direct Merchants Bank has entered into a Liquidity Reserve Deposit Agreement (“LRDA”) under which the Bank has established restricted deposits with third-party depository banks for the purpose of supporting the Bank’s funding needs. These deposits are invested in short-term liquid investments and are classified on the balance sheets

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      The Bank and MCI have a Modified Operating Agreement with the OCC that requires, among other things, that:

	•	The Bank must maintain minimum capital at the dollar amount reported on its September 30, 2003 Call Report ($213 million), unless otherwise approved by the OCC.
	•	The Bank may continue to pay dividends in accordance with applicable statutory and regulatory requirements, provided capital remains at the required level.
	•	The Bank must maintain liquid assets at the greater of $35 million or 100% of the average highest daily funding requirement for managed receivables ($31.5 million at December 31, 2004).
	•	The Bank must comply with the terms of the LRDA and CALMA.
	•	MCI must comply with the terms of the CALMA.

      We believe that the Bank and MCI are currently in compliance with all terms of the Modified Operating Agreement. If the OCC were to conclude that the Bank or MCI failed to adhere to any provisions of the Modified Operating Agreement, the OCC could pursue various enforcement options. If any of these options were to be pursued by the OCC, it could have a material adverse effect on our operations or capital position.

      There are various federal law limitations on the extent to which Direct Merchants Bank can finance or otherwise supply funds to MCI and its affiliates through dividends, loans or otherwise. These limitations include:

	•	minimum regulatory capital requirements;
	•	restrictions concerning the payment of dividends out of net profits or surplus; and
	•	Sections 23A and 23B of the Federal Reserve Act governing transactions between a bank and its affiliates.

      In general, federal law prohibits a national bank such as Direct Merchants Bank from making dividend distributions on common stock if the dividend would exceed currently available undistributed profits. In addition, a national bank such as Direct Merchants Bank must obtain OCC approval prior to paying a dividend if distribution would exceed current year net income combined with retained earnings from the prior two years. Due to the dividend paid by the Bank in March of 2003, Direct Merchants Bank was required to obtain prior approval from the OCC in order to pay dividends during the years ended December 31, 2004 and 2003. In addition, Direct Merchants Bank cannot pay a dividend if the distribution would cause it to fail to meet applicable capital adequacy standards. During the years ended December 31, 2004 and 2003, the Bank paid dividends in the amount of $66.0 million and $190.8 million, respectively. Subsequent to December 31, 2004, the Bank paid $15.0 million in dividends.

      The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) requires federal banking regulators to prescribe certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation. FDICIA also provides that regulatory action may be taken against a bank that does not meet such standards.

      The OCC has adopted regulations that define the five capital categories (well-capitalized, adequately-capitalized, undercapitalized, significantly-undercapitalized and critically-undercapitalized) identified by FDICIA, using the total risk-based capital, Tier 1 risk-based capital and leveraged capital ratios as the relevant capital measures. Such regulations establish various degrees of corrective action to be taken when

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      FDICIA requires the FDIC to implement a system of risk-based premiums for deposit insurance pursuant to which the premiums paid by a depository institution will be based on the probability that the FDIC will incur a loss relative to such institution. The FDIC has adopted a system that imposes insurance premiums based on a matrix that takes into account a bank’s capital level and supervisory rating.

      The Bank sold all insured certificates of deposit on September 30, 2003, and we do not anticipate that the Bank will issue certificates of deposit in the foreseeable future. As of December 31, 2004 all remaining deposits are related to our secured card product.

      As previously noted, the Modified Operating Agreement requires us to maintain a minimum of $213 million in capital at Direct Merchants Bank. We continue to work with the OCC to periodically re-evaluate minimum capital levels given our current performance and overall liquidity position. Any future reduction in minimum capital levels would require approval by the OCC.

      Direct Merchants Bank’s activities as a credit card lender also are subject to regulation under various federal consumer protection laws, including, but not limited to, the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Community Reinvestment Act (“CRA”) and the Service Member Civil Relief Act. Regulators are authorized to impose penalties for violations of these statutes and, in certain cases, to order Direct Merchants Bank to pay restitution to injured cardholders. Cardholders may also bring actions for certain alleged violations of these regulations. Federal and state bankruptcy and debtor relief laws also affect Direct Merchants Bank’s ability to collect outstanding balances owed by cardholders who seek relief under those statutes.

      The OCC’s CRA regulations subject limited purpose banks, including Direct Merchants Bank, to a “community development” test for evaluating required CRA compliance. The community development performance of a limited purpose bank is evaluated pursuant to various criteria involving community development lending, qualified investments and community development services.

      Congress has passed a financial services law that requires many of our business groups to disclose their practices for collection and sharing non-public customer information. Changes to this law, or enactment of new laws, could require us to limit or substantially modify our enhancement services and credit card marketing activities and practices with third-party companies in ways that could adversely affect us if these changes result in additional limits on sharing information. There is such legislation currently pending or under consideration at both the federal and state level.

      Additionally, Congress is considering legislation that would amend the federal bankruptcy laws. Prior legislation, which failed to be signed into law, was generally considered to be favorable to the credit card industry. However, future federal bankruptcy legislation or changes to state debtor relief and collection laws could adversely affect us if such changes result in, among other things, accounts being charged-off as uncollectible and increased administrative expenses. In addition, Congress and the states may in the future consider other legislation that would materially affect the credit card and related enhancement services industry.

      Various federal and state consumer protection laws limit our ability to offer and extend credit. In addition, Congress and the states may decide to further regulate the credit card industry by enacting new laws or amendments to existing laws to reduce finance charges or other fees or charges applicable to credit

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      Several states have passed legislation attempting to tax the income from interstate financial activities, including credit cards, derived from accounts held by their residents. We believe this legislation will not materially affect us. Our belief is based on current interpretations of the enforceability of this legislation, prior court decisions, and the volume of our business in states that have passed such legislation.

      Our captive insurance subsidiary, ICOM Limited, is licensed in Bermuda under The Insurance Act of 1978 as a Class 2 Insurer. We are restricted from writing any long-term policies or pursuing any unrelated business in excess of certain limits under Bermuda law.

      The Fair Credit Reporting Act (“FCRA”) regulates consumer reporting agencies. Under the FCRA, an entity risks becoming a consumer reporting agency if it furnishes consumer reports to third parties. A consumer report is a communication of information which bears on a consumer’s creditworthiness, credit capacity, credit standing or certain other characteristics, and which is collected or used or expected to be used to determine the consumer’s eligibility for credit, insurance, employment or certain other purposes. The FCRA explicitly excludes from the definition of “consumer report,” a report containing information solely as to transactions or experiences between the consumer and the entity making the report. An entity may share consumer reports with any of its affiliates so long as that entity provides consumers with an appropriate disclosure and an opportunity to opt out of such affiliate sharing.

      Our objective is to conduct our operations in a manner such that we fall outside the definition of a “consumer reporting agency” under the FCRA. If we were to become a consumer reporting agency, we would be subject to a number of complex and burdensome regulatory requirements and restrictions. Such restrictions could have a significant adverse economic impact on us.

      In late 2003, Congress passed significant changes to the FCRA. The FTC is primarily responsible for drafting and implementing new regulations for these changes, which affect credit reporting agencies, creditors and others. Numerous new requirements were imposed during 2004, and more are scheduled for 2005. These changes may affect Direct Merchants Bank’s credit selection, granting and other operational policies and procedures in the future.

Regulatory Investigations

      In August 2003, we received notification from the SEC that we are the subject of a formal, nonpublic investigation. We believe that this investigation initially related primarily to our treatment of the “Allowance for loan losses” in 2001 and subsequent years, our 2001 credit line increase program and other related matters. On December 9, 2003, we received notification that the scope of the investigation had been expanded to include matters related to our valuation of “Retained interests in loans securitized.” The Company subsequently received additional SEC subpoenas and requests for information on related and other financial accounting issues, as well as the above matters. The SEC has advised us that this is a fact-finding inquiry and that it has not reached any conclusions related to this matter. We have responded fully to the SEC in its investigation. The SEC has informed us that it is reviewing the information and documents that we have submitted. The SEC also has taken testimony from certain of our current and former officers and directors in connection with its investigation. At this time we cannot predict what the results of the investigation will be. If the SEC determines that we or our officers or directors have violated federal securities laws or the SEC’s rules and regulations, we could be subject to an SEC enforcement action, including potential fines and penalties, which could materially adversely affect our results of

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      In August 2003, we received correspondence indicating that we were the subject of an OCC investigation, together with a subpeona requiring us to produce certain documents. We understood that investigation to be related to executive compensation and reimbursement. In January 2005, we received notification from the OCC that the Order of Investigation had been terminated and there were no findings against MCI, the Bank or any of their current or former officers or directors.

Employees

      We have approximately 2,200 employees located in Arizona, Florida, Maryland, Minnesota and Oklahoma. None of our employees is represented by a collective bargaining agreement.

Trademarks, Trade Names and Service Marks

      We have registered and continue to register, when appropriate, various trademarks, tradenames and service marks used in connection with our business and for private label marketing of certain of our products. We consider these trademarks and service marks to be readily identifiable with, and valuable to, our business.

Executive Officers

      The following table sets forth certain information concerning the persons who currently serve as our executive officers. Each executive officer serves at the discretion of our Board of Directors.

      David D. Wesselink has been Chairman and Chief Executive Officer of the Company since December 2002. Mr. Wesselink previously was Vice Chairman of the Company from September 2000 to December 2002, and Executive Vice President and Chief Financial Officer of the Company from December 1998 to August 2000. Prior to joining the Company, Mr. Wesselink had been Senior Vice President and Chief Financial Officer of Advanta Corporation since 1993. Prior to Advanta Corporation, Mr. Wesselink held several positions at Household Finance Corp. and Household International, Inc. from 1971 to 1993, including Senior Vice President from 1986 to 1993, and Chief Financial Officer from 1982 to 1993. Mr. Wesselink also is a director of MasterCard Incorporated (U.S. Region Board), Saxon Capital, Inc., CFC International, Inc., American Financial Services Association and Central College.

      Richard G. Evans has been Executive Vice President, General Counsel and Secretary of the Company since June 2001. Prior to joining the Company, Mr. Evans was Executive Vice President, General Counsel

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      William A. Houlihan has been Executive Vice President and Chief Financial Officer of the Company since August 2004. Prior to joining the Company, Mr. Houlihan was Managing Director in the financial institutions investment banking group at JPMorgan Chase for one year. Prior to JPMorgan Chase, Mr. Houlihan spent three years as Executive Vice President and Chief Financial Officer at Hudson United Bancorp. Before joining Hudson United Bancorp, Mr. Houlihan held various investment banking positions at Keefe, Bruyette & Woods, Inc; Bear, Stearns & Co. Inc; and Goldman, Sachs & Company.

      Matthew S. Melius has been Executive Vice President, Operations, of the Company since January 2005. Mr. Melius has also served as President and Chief Executive Officer of Direct Merchants Bank since January 2003. Mr. Melius previously was Executive Vice President, Credit Risk Management, Collections, Credit Card Operations, Customer Service and Marketing from September 2003 to December 2004, Executive Vice President Credit Risk Management, Collections and Credit Card Operations from January 2003 to September 2003 and Executive Vice President, Credit Risk Management from January 2001 to December 2002. Prior to 2001, Mr. Melius was Executive Vice President, E-Commerce of the Company from January 2000 to December 2000; Senior Vice President, Portfolio Marketing from January 1999 to December 1999; and Vice President, Marketing from September 1995 to December 1998. Prior to that, Mr. Melius served seven years in the credit card division of First National Bank of Omaha, where he advanced from a management trainee to manager of the portfolio management department. In his role as manager of the portfolio management department he directed the account retention and portfolio profitability operations.

      Dan N. Piteleski has been Executive Vice President and Chief Information Officer of the Company since May 2002. Mr. Piteleski previously was Senior Vice President, Chief Information Officer of the Company from May 2001 to April 2002. Prior to joining the Company, Mr. Piteleski was Vice President, Chief Information Officer of H.B. Fuller Company for six years. Prior to H.B. Fuller, Mr. Piteleski served as Vice President, Information Systems at Zenith Data Systems for two and one-half years. Before Zenith, Mr. Piteleski was Manager, Information Systems and Technology at Apple Computer for four years. Mr. Piteleski has also worked in information systems at Equitable Resources Energy Company, Inc., and American Standard.

      Scott R. Fjellman has been Senior Vice President and Treasurer of the Company since January 2003. Mr. Fjellman previously was Vice President, Assistant Treasurer of the Company from April 2000 to December 2002. Prior to joining the Company, Mr. Fjellman was with Arcadia Financial Ltd. for eight years, most recently as Vice President of Securitization and Investor Relations. Before joining Arcadia Financial, Mr. Fjellman spent three years as an auditor with KPMG LLP.

      Jeffrey D. Grosklags has been Senior Vice President, Investor and Public Relations since October 2004. Mr. Grosklags previously was Senior Vice President, Credit Card Finance from September 2000 to September 2004. Prior to that Mr. Grosklags served in a variety of finance positions since 1995. Mr. Grosklags began his career with Deloitte & Touche where he worked for over three years as an auditor.

      Mark P. Wagener has been Senior Vice President and Controller of the Company since October 2001. Mr. Wagener previously was Vice President, Assistant Controller of the Company from June 2000 to September 2001. Prior to joining the Company, Mr. Wagener served for 13 years at Norwest Corporation (now Wells Fargo & Company) in various finance/accounting management positions, the last being Director of Corporate Planning and Analysis. Mr. Wagener began his career with Arthur Andersen & Co., where he worked for five years as an auditor.

      Our officers are elected by, and hold office at the will of, our Board of Directors and do not serve a “term of office” as such.

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Risk Factors

      The factors discussed below, among others, could cause our actual results to differ materially from those expressed in any forward-looking statements that we make in this Report. See Forward Looking Statements on pages 1-2 of this Report. Although we have attempted to list comprehensively these important factors, we caution that other factors may in the future prove to be important in affecting our results of operations. New factors emerge from time to time, and it is not possible for us to predict all of these factors, nor can we assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement.

      Direct Merchants Bank’s activities are regulated by the OCC. The OCC has imposed on the Bank the restrictions discussed under Business Regulation — MCI and Direct Merchants Bank and could increase the existing restrictions or impose new ones. New or more restrictive requirements could include, among others, restrictions relating to:

	•	minimum regulatory capital levels;
	•	extensions of credit;
	•	strategic acquisitions and asset growth;
	•	underwriting criteria, account management, account pricing, and accounting policies and practices;
	•	enhanced scrutiny and consent requirements relating to business plans and liquidity management
	•	submission of special periodic regulatory reports; and
	•	additional supervisory actions or sanctions under applicable Prompt Corrective Action guidelines and other applicable laws and regulations.

      The operations of our banking subsidiary, Direct Merchants Bank, and its activities as a credit card lender are subject to periodic review and examination by federal regulators to assess compliance with federal laws and regulations regarding the safety and soundness of financial institutions and federal consumer protection laws. These regulators have broad discretion to issue or revise regulations, and to issue guidance, that may significantly affect Direct Merchants Bank or the way the Bank or we conduct business. These regulators also are authorized to impose penalties for violations of the laws and regulations that they oversee, including, in certain cases, ordering Direct Merchants Bank to pay restitution to cardholders. Any new or more restrictive requirements could negatively impact our operations or financial results, limit our growth prospects, reduce our returns on capital or require us to raise additional capital.

      Various federal and state laws and regulations significantly limit the activities in which we and Direct Merchants Bank are permitted to engage. See Business — Regulation. Among other things, these laws and regulations:

	•	limit the fees and other charges that we are allowed to charge;
	•	limit or prescribe certain other terms of our products and services;

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	•	require specified disclosures to consumers, including disclosures regarding our practices for collection and sharing of non-public customer information;
	•	require us to treat non-public customer information in certain ways;
	•	govern the sale and terms of products and services we offer;
	•	require that we obtain and maintain licenses and qualifications; and
	•	impose capital requirements.

In some cases, the precise application of these statutes and regulations is not clear. Our failure to comply with applicable laws and regulations may result in regulatory action, negative publicity or consumer class action litigation. Moreover, numerous legislative and regulatory proposals that would impact aspects of our business are advanced each year, including proposals of revisions to federal bankruptcy laws. Changes in the laws and regulations to which our business is subject, including adoption of new legislation or revisions to the interpretation of existing laws and regulations, could adversely affect our ability to conduct our business in a profitable manner. Finally, changes in government fiscal or monetary policies, including changes in our rate of taxation, could also adversely affect our financial results.

      On August 5, 2003, we received notification from the SEC that we are the subject of a formal, nonpublic investigation. We believe that this investigation initially related primarily to our treatment of “Allowance for loan losses” in 2001 and subsequent years, our 2001 credit line increase program and other related matters. On December 9, 2003, we received notification that the scope of the investigation had been expanded to include matters related to our valuation of “Retained interests in loans securitized.” The Company subsequently received additional SEC subpoenas and requests for information on related and other financial accounting issues, as well as the above matters. The SEC also has taken testimony from certain of our current and former officers and our directors in connection with its investigation. We have responded fully to the SEC in its investigation. The SEC has informed us that it is reviewing the information and documents that we have submitted. The SEC has advised us that this is a fact-finding inquiry and that it has not reached any conclusions related to this matter. At this time we cannot predict what the results of the investigation will be.

      If the SEC determines that we or our officers and directors have violated federal securities laws or the SEC’s rules and regulations, we could be subject to SEC enforcement action, including potential fines and penalties, which could materially adversely affect our results of operations or financial condition. We cannot provide assurance the resolution of the SEC investigation will not necessitate further amendments or restatements to our previously filed reports. We do not believe, however, that we or our officers or directors have violated any such laws, rules or regulations.

      We face the risk of litigation, including class action lawsuits, challenging our product terms, rates, disclosures, collections and/or other practices, under state and federal consumer protection statutes and other laws, as well as actions relating to federal securities laws. In particular, state attorneys general and other government prosecutors have shown an increased interest in the enforcement of consumer protection laws, including laws relating to subprime lending, predatory lending practices and privacy. See Legal Proceedings on pages 27-28 for a discussion of legal actions to which we are currently subject. All litigation involves litigation costs, both in terms of money and diversion of management’s time and attention. In addition, litigation may result in orders that require us to change specific business practices or adopt business practices different from our competitors, pay settlement costs and damages and, in some cases, penalties. Any or all of these could negatively affect our business and financial results.

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      Under our regulatory framework and the CALMA, we could be required to contribute capital or otherwise provide support to Direct Merchants Bank in order to maintain or meet the Bank’s capital and liquidity needs. If we had to do this, it could limit our ability to expend funds at the MCI level or require us to engage in capital raising activities that could adversely affect our financial results and/or stock price for a variety of reasons, including dilution to existing equity holders.

      Certain events, such as a deterioration in the performance of our securitized receivables, deterioration in our financial condition, breaches of representations, warranties or covenants that we make in the documentation relating to our securitizations, or defaults under our other credit arrangements, could result in early amortization (required repayment) of the principal amount of the securities issued by the Metris Master Trust. Early amortization also would cause a default under our credit agreement that could, in turn, lead to a default with respect to our existing senior notes, potentially resulting in all amounts due under those arrangements also becoming due and payable.

      The primary risk associated with secured and unsecured lending to middle-market consumers is that default rates for those consumers are higher than those for lower default consumers. This results in more accounts being charged-off as uncollectable than would be the case with lower default consumers. If we are not successful in evaluating the creditworthiness of our target customers or in applying our risk-based pricing system, we could experience greater levels of delinquencies and losses. In addition, general economic and social factors, such as the rate of inflation, unemployment levels, interest rates and the effects of periods of war, may have a greater impact on consumers in our target market than on those with higher incomes. Accordingly, any general worsening of economic or social conditions may have a disproportionate effect on our target consumers and, thus, on our delinquency and charge-off rates. This, in turn, could:

	•	cause purchasers of securities issued by the Metris Master Trust to require even higher credit enhancement levels for future securities issued by the Metris Master Trust, which could divert significant amounts of cash that would otherwise be available to us;
	•	jeopardize our ability to complete future securitization transactions on acceptable terms or at all, thereby decreasing our liquidity and forcing us to rely on other potentially more expensive funding sources, to the extent available; and
	•	cause early amortization (required repayment) of outstanding securities issued by the Metris Master Trust, with the potential results noted above.

      Key elements of our strategy depend on us having adequate available cash, and we therefore require a high degree of liquidity to operate our business (see Management’s Discussion and Analysis of

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	•	funding new receivables;
	•	making interest and principal payments under our credit agreement, existing senior notes and other indebtedness;
	•	refinancing maturing series of asset-backed securities issued by the Metris Master Trust;
	•	providing credit enhancement with respect to asset-backed securities issued by the Metris Master Trust;
	•	covering fees and expenses incurred in connection with the securitization of receivables; and
	•	meeting other operating expenses.

      As a result of these activities, ensuring appropriate liquidity is an ongoing business objective. We rely heavily on the securitization of our consumer loans for funding, primarily by selling the loans to the Metris Master Trust.

      If we are unable to access funding at the times and in the amounts that we need, we would be required to scale back our business operations, could be unable to refinance maturing series of asset-backed securities issued by the Metris Master Trust, and could be unable to pay amounts due with respect to our credit agreement or our existing senior notes. Either an inability to refinance maturing series of securities issued by the Metris Master Trust or a default in payment when due of any amounts under our credit agreement or our existing senior notes would ultimately result in both an early amortization (required early repayment) of the asset-backed securities issued by the Metris Master Trust and an acceleration of all amounts due under our credit agreement and our existing senior notes. Even if we are successful in obtaining the funding that we need, an increase in the cost of that funding would negatively impact our financial results.

      The Company’s 1998 through 2002 federal income tax returns are under examination by the Internal Revenue Service (“IRS”). Both the Company and the IRS have proposed adjustments involving the tax treatment of certain credit card fees as original issue discount (“OID”). These fees include late, overlimit, interchange, cash advance and annual fees. Although these fees are primarily reported as income when billed for financial reporting purposes, we believe the fees create OID that should be deferred and amortized over the remaining life of the underlying credit card loans for tax purposes. As of December 31, 2004, and December 31, 2003, the Company had deferred cumulative federal income tax related to this issue of approximately $129 million and $179 million, respectively. The decrease is primarily attributable to the decrease in managed receivables. Our treatment of these fees is consistent with that of many other United States credit card issuers. Furthermore, we believe our treatment of these fees is appropriate based on relevant technical authority and specific guidance issued by the IRS regarding late fees. However, the timing and amount of any final resolution remain uncertain. We continue to work with the IRS to resolve this matter and do not expect to pay any incremental tax related to this issue in the next 12 months, nor do we expect the resolution of this matter to have a material adverse effect on future earnings.

      Like other financial institutions, we borrow money from institutional lenders that we then lend to our customers. We earn interest on the consumer loans we make and pay interest on the borrowings we use to fund those loans. Changes in these two interest rates affect the value of our assets and liabilities. Generally, our credit card loans are priced at rates indexed from the Prime rate. The interest we pay on our borrowings is based on indices over London Inter Bank Offered Rate (“LIBOR”). If the rate of

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      We manage these risks partly by changing the interest rates we charge on our credit card accounts. The success of repricing accounts to match an increase or decrease in our borrowing rates depends on the overall product mix of those accounts, the actual amount of accounts repriced, the rate at which we are originating new accounts, and our ability to retain accounts (and the related loan balances) after repricing. For example, if we increase the interest rate we charge on our credit card accounts and the cardholders close their accounts as a result, we may not be able to match our increased borrowing costs as quickly, if at all.

      Changes in interest rates also affect the balances our customers carry on their credit cards. When interest rates fall, there may be more low-rate product alternatives available to our customers. Consequently, their credit card balances may fall and prepayment and attrition rates may rise. We can mitigate this risk by reducing the interest rates we charge. However, these changes can reduce the overall yield on our portfolio. When interest rates rise, on the other hand, there are fewer low-rate alternatives available to our customers. Consequently, credit card balances may rise (or fall more slowly). In this circumstance, we may have to raise additional funds at higher interest rates to fund loans to our customers. We can mitigate the impact of this by increasing the interest rates we charge, although such changes may increase opportunities for our competitors to offer attractive products to our customers and consequently increase customer attrition from our portfolio.

      We face intense competition from numerous financial services providers, many of which have greater resources and name recognition than we do. Our credit card business competes with national, regional and local bankcard issuers, as well as other general purpose and private label credit card issuers. Some of these issuers are substantially larger and often compete for customers by offering lower interest rates and/ or fee levels than we do. Our credit card lending products also compete with other financial products such as home equity loans and other line of credit products. Moreover, the federal Gramm-Leach-Bliley Act, which permits the affiliation of commercial banks, securities firms and insurance companies, may increase the number of competitors in the banking industry and the level of competition for banking products, including credit cards.

      In addition, there has been continued focus on solicitations to middle-market consumers as competitors have continued to focus on this market. Our competitors may take actions such as offering lower interest rates and fees, higher credit lines, and incentives to customers to use their credit cards and/ or transfer existing balances to their credit cards. We believe customers are attracted to credit card products largely on the basis of price, credit limit and other product features, and customer loyalty is often limited, these and other competitive practices could result in the loss of existing customers, reductions in account balances, a slowdown in account and balance growth, increased customer acquisition costs and reductions in the levels of finance charges and fees that we charge.

      We retain interests in the assets included in securitizations, including retained subordinated interests, spread accounts and other residual interests. The value of and income earned from these interests will vary over time as a result of many factors not within our control, including the performance of the securitized loans, interest paid to the holders of asset-backed securities, and transaction expenses. The performance of the loans included in our securitizations is subject to risks and uncertainties, including, among others, increased delinquencies and credit losses, economic downturns and social factors, interest rate fluctuations, changes in government policies and regulations, competition, expenses, dependence upon third-party vendors, fluctuations in accounts and account balances, and industry risks. Since we are required to reflect

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      In 2004, we restated our financial results for 1998 through 2002, and for the first three quarters of 2003, in connection with our analysis of our method of valuing “Retained interests in loans securitized.” Included in these restatements, in addition to changes made as a result of our revised accounting policies and procedures related to valuing our retained interests, are corrections to conform with 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 addition. We also restated certain other prior period amounts to conform with the current period’s presentation. For a more detailed description of the restatements, see Amendment No. 1 to our Annual Report on Form 10-K for the year ended December 31, 2002. These restatements resulted in our making late filings with the SEC and may have harmed our reputation with investors and possibly customers. These restatements and their effects may have additional adverse effects on us in the future.

      We are a member of MasterCard International Incorporated (“MasterCard”) and Visa U.S.A. Inc. (“Visa”). MasterCard® and Visa® are membership organizations composed of financial institutions that issue MasterCard or Visa cards. The outcome of pending or future disputes involving these organizations could, if adversely decided, affect our operations or result in an increase in the fees we must pay as a member. In particular, in October 1998, the U.S. Department of Justice filed a complaint against MasterCard, Visa and Visa International, Inc., asserting that duality (the overlapping ownership and control of both the MasterCard and Visa associations by the same group of banks) restrains competition in violation of the antitrust laws, and challenging the rules adopted by both MasterCard and Visa that restrict member banks from joining American Express, Discover/ Novus or other competing networks. The case was tried in the summer of 2000 and the trial court announced its decision in October 2001. The trial court ruled in the associations’ favor on the duality claim, but against the associations on the competing networks claim. In September 2003, the Second Circuit Court of Appeals affirmed the decision of the District Court. Visa and MasterCard’s petition for rehearing was denied in January 2004. Visa and MasterCard appealed to the U.S. Supreme Court, but their petition was denied on October 4, 2004. Following the decision, on October 4, 2004, Discover filed an antitrust suit against MasterCard and Visa seeking unspecified damages for their alleged anticompetitive behavior. We cannot predict the final outcome of this or any similar future litigation, its effect on the competitive environment in the credit card industry, or its effect on credit card issuers such as Direct Merchants Bank.

      We face many industry-wide risks that could negatively affect our financial performance. For example, all businesses in the credit card industry face the risk of fraud by cardholders and third parties, as well as the risk that increased criticism from consumer advocates and the media could hurt consumer acceptance of our products. In addition, like all businesses in the financial services industry, we face risks related to:

	•	rapidly changing technologies, including in particular technological challenges in the developing online credit card and financial services market;
	•	the possibility that system disruptions and failures may interrupt or delay our ability to provide services to our customers;
	•	potential claims relating to the proprietary nature of widely used technology, such as “smart cards” and call center technology; and

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	•	the ability to provide and safeguard the secure transmission of confidential information over the Internet in the face of security breaches, acts of vandalism and developments in computer capabilities that could result in a compromise or breach of the technology used to protect customer transaction data.

Available Information

      You can find additional information regarding our executive officers and Board of Directors in the Proxy Statement relating to our 2005 Annual Meeting of Stockholders. In addition, we periodically file reports and other information with the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934. You can read and copy this information at SEC offices in Washington, D.C., New York City, and Chicago; obtain copies of this information by mail from the Public Reference Section of the SEC, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549, at prescribed rates; obtain copies from the SEC’s website (http://www.sec.gov); inspect information at the offices of the New York Stock Exchange, Inc., 20 Broad Street, New York, New York, 10005; request copies of documents by calling our Investor Relations Department at (952) 525-5074; or visit our website.

      Our Internet website is http://www.metriscompanies.com. We make available, free of charge, through the Investor Relations portion of our website, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

      We lease our principal executive office space in Minnetonka, Minnesota, currently consisting of approximately 174,000 square feet. That lease expires in December 2011. During 2004, we entered into a binding agreement with our landlord, effective October 1, 2004, to release us from our remaining rent obligation on approximately 126,000 square feet of office space at our Minnetonka headquarters.

      Direct Merchants Bank leases 56,000 square feet in Phoenix, Arizona, which serves as the Bank’s operation center. That lease expires in 2009. We also are party to a sublease agreement to rent 7,500 square feet in Scottsdale, Arizona, to support our Data Center, which is currently set to expire on July 31, 2006. In addition, we lease facilities in Tulsa, Oklahoma; White Marsh, Maryland; Jacksonville, Florida; and Duluth, Minnesota, consisting of approximately 100,000, 100,000, 99,000 and 20,000 square feet, respectively. These leases expire in December 2010, September 2007, May 2005 and September 2006, respectively. We have entered into sublease agreements for approximately 20,000 square feet of our lease obligation in Florida. We have entered into sublease agreements for approximately 50,000 square feet of our lease obligation in Maryland. The leased properties in Oklahoma, Maryland, Florida and Duluth support our collections, customer service and back office operations. We also own our operations center in Orlando, Florida, which consists of approximately 45,000 square feet. We believe our facilities are suitable to our businesses and that we will be able to lease or purchase additional facilities as needed.

      In September 2002, a shareholder lawsuit was filed in the United States District Court for the District of Minnesota, naming MCI, Ronald N. Zebeck and David D. Wesselink as defendants. The plaintiffs 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, among other things, that defendants violated the federal securities laws when MCI failed to timely disclose the resulting impact of an OCC Report of Examination. The lawsuit is currently in the pre-trial discovery phase. We believe the lawsuit is without merit and are vigorously defending against the claim.

      In January 2004, a complaint was filed in Hennepin County District Court in Minneapolis, Minnesota, against MCI, certain members of its Board of Directors and a number of other entities, by Ronald N. Zebeck, MCI’s former Chairman and Chief Executive Officer. The complaint alleges breach of contract,

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      In addition to the foregoing, we are a party to various legal proceedings resulting from the ordinary business activities relating to our operations.

      For a discussion of current regulatory investigations to which we are subject, see Regulatory Investigation under Item 1 on page 18-19.

      Because at this time we are unable to estimate damages that may result from the resolution of the matters outlined above, there can be no assurance that defense or resolution of these matters will not have a material adverse affect on our financial position.

      No matter was submitted to a vote of security holders during the fourth quarter of our fiscal year ended December 31, 2004.

PART II

      The information required by Item 201 of Regulation S-K is set forth in the Summary of Consolidated Quarterly Financial Information and Stock Data on pages 94-95 of this Report.

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