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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended March 31, 2003
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________ to __________
Commission file number: 001-12351
METRIS COMPANIES INC.
(Exact name of registrant as specified in its charter)
Delaware 41-1849591
(State of Incorporation) (I.R.S. Employer Identification No.)
10900 Wayzata Boulevard, Minnetonka, Minnesota 55305-1534
(Address of principal executive offices)
(952) 525-5020
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No _____
-----
As of April 30, 2003, 57,754,091 shares of the registrant's common stock, par
value $.01 per share, were outstanding.
METRIS COMPANIES INC.
FORM 10-Q
TABLE OF CONTENTS
-----------------
- --------------------------------------------------------------------------------
March 31, 2003
Page
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets..............................3
Consolidated Statements of Income........................4
Consolidated Statements of Changes in
Stockholders' Equity...............................5
Consolidated Statements of Cash Flows....................6
Notes to Consolidated Financial Statements...............7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations..............................................21
Item 3. Quantitative and Qualitative Disclosures
About Market Risk.......................................43
Item 4. Controls and Procedures ....................................44
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...........................................44
Item 2. Changes in Securities.......................................44
Item 3. Defaults Upon Senior Securities.............................44
Item 4. Submission of Matters to a Vote of Security Holders.........44
Item 5. Other Information...........................................44
Item 6. Exhibits and Reports on Form 8-K............................45
Signatures..................................................47
Part I. Financial Information
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands) (Unaudited)
March 31, December 31,
2003 2002
---------- ------------
Assets:
Cash and due from banks .................................................... $ 90,770 $ 62,813
Federal funds sold ......................................................... 102,300 88,000
Short-term investments ..................................................... 412,155 429,419
----------- -----------
Cash and cash equivalents .................................................. 605,225 580,232
----------- -----------
Retained interests in loans securitized .................................... 1,670,171 1,736,912
Less: Valuation allowance ................................................. 931,052 986,517
----------- -----------
Net retained interests in loans securitized ................................ 739,119 750,395
----------- -----------
Credit card loans .......................................................... 686,285 846,417
Less: Allowance for loan losses ........................................... 125,357 90,315
----------- -----------
Net credit card loans ...................................................... 560,928 756,102
----------- -----------
Property and equipment, net ................................................ 75,205 83,831
Purchased portfolio premium, net ........................................... 58,083 64,579
Other receivables due from credit card
securitizations, net .................................................... 276,134 184,220
Other assets ............................................................... 168,843 174,987
----------- -----------
Total assets .......................................................... $ 2,483,537 $ 2,594,346
=========== ===========
Liabilities:
Deposits ................................................................... $ 801,498 $ 892,754
Debt ....................................................................... 358,276 357,649
Accounts payable ........................................................... 50,480 53,589
Deferred income ............................................................ 138,207 159,267
Accrued expenses and other liabilities ..................................... 100,125 72,062
----------- -----------
Total liabilities ..................................................... 1,448,586 1,535,321
----------- -----------
Stockholders' Equity:
Convertible preferred stock - Series C, par
value $.01 per share; 10,000,000
shares authorized, 1,182,098 and 1,156,086
shares issued and outstanding, respectively ........................... 440,331 430,642
Common stock, par value $.01 per share;
300,000,000 shares authorized, 64,759,515
and 64,223,231 shares issued, respectively ............................ 648 642
Paid-in capital ............................................................ 228,702 227,376
Unearned compensation ...................................................... (448) --
Treasury stock - 7,055,300 shares .......................................... (58,308) (58,308)
Retained earnings .......................................................... 424,026 458,673
----------- -----------
Total stockholders' equity ............................................ 1,034,951 1,059,025
----------- -----------
Total liabilities and stockholders' equity ............................ $ 2,483,537 $ 2,594,346
=========== ===========
See accompanying Notes to Consolidated Financial Statements.
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Income
(In thousands, except earnings per-share data) (Unaudited)
Three Months Ended
March 31,
2003 2002
---- ----
Interest Income:
Credit card loans .............................................. $ 29,907 $ 88,526
Federal funds sold ............................................. 359 114
Other .......................................................... 1,895 1,204
--------- ---------
Total interest income .......................................... 32,161 89,844
--------- ---------
Deposit interest expense ....................................... 10,908 23,653
Other interest expense ......................................... 8,433 8,512
--------- ---------
Total interest expense ......................................... 19,341 32,165
--------- ---------
Net Interest Income ............................................ 12,820 57,679
Provision for loan losses ...................................... 44,786 111,876
--------- ---------
Net Interest Expense After Provision for Loan Losses............ (31,966) (54,197)
--------- ---------
Other Operating Income:
Net securitization and credit card servicing income............. 56,396 157,419
Credit card fees, interchange and other credit card income...... 21,757 61,000
Enhancement services revenues .................................. 93,684 94,996
--------- ---------
171,837 313,415
--------- ---------
Other Operating Expense:
Credit card account and other product solicitation and marketing
expenses................................................... 36,054 40,552
Employee compensation .......................................... 53,381 56,548
Data processing services and communications .................... 19,178 22,306
Enhancement services claims expense ............................ 13,022 11,207
Occupancy and equipment ........................................ 9,613 12,797
Purchased portfolio premium amortization ....................... 6,496 8,455
MasterCard/Visa assessment and fees ............................ 2,415 3,834
Credit card fraud losses ....................................... 940 2,228
Asset impairments, lease write-offs and severance............... 16,777 --
Other .......................................................... 19,639 16,461
--------- ---------
177,515 174,388
--------- ---------
Income (Loss) Before Income Taxes .............................. (37,644) 84,830
Income tax expense (benefit) ................................... (12,686) 32,490
--------- ---------
Net Income (Loss) .............................................. (24,958) 52,340
Convertible preferred stock dividends .......................... 9,689 9,188
--------- ---------
Net Income (Loss) Applicable to Common Stockholders............. $ (34,647) $ 43,152
========= =========
Earnings (Loss) per share:
Basic ..................................................... (0.61) 0.55
Diluted ................................................... (0.61) 0.54
Shares used to compute earnings (loss) per share:
Basic ..................................................... 57,257 96,032
Diluted ................................................... 57,257 96,973
Dividends declared per common share ............................ -- $ 0.01
See accompanying Notes to Consolidated Financial Statements.
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
(In thousands) (Unaudited)
Total
Number of Shares Preferred Common Paid-in Unearned Treasury Retained Stockholders'
Preferred Common Stock Stock Capital Compensation Stock Earnings Equity
-----------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2001 .... 1,058 63,419 $ 393,970 $ 642 $ 232,413 $ (4,980) $ (13,014) $ 532,924 $1,141,955
Net income ................. -- -- -- -- -- -- -- 52,340 52,340
Cash dividends ............. -- -- -- -- -- -- -- (938) (938)
Common stock repurchased ... -- (1,292) -- -- -- -- (17,582) -- (17,582)
Preferred dividends in
kind ................... 23 -- 8,864 -- -- -- -- (8,864) --
Issuance of common stock
under employee
benefit plans .......... -- 116 -- 1 1,822 -- -- -- 1,823
Amortization of
restricted stock ....... -- -- -- -- -- 404 -- -- 404
------ ------- --------- ------- ---------- -------- --------- --------- ----------
BALANCE AT MARCH 31, 2002 ....... 1,081 62,243 $ 402,834 $ 643 $ 234,235 $ (4,576) $ (30,596) $ 575,462 $1,178,002
====== ======= ========= ======= ========== ======== ========= ========= ==========
BALANCE AT DECEMBER 31, 2002 .... 1,156 57,168 $ 430,642 $ 642 $ 227,376 $ -- $ (58,308) $ 458,673 $1,059,025
Net loss ................... -- -- -- -- -- -- -- (24,958) (24,958)
Preferred dividends in
kind .................... 26 -- 9,689 -- -- -- -- (9,689) --
Issuance of common stock
under employee
benefit plans .......... -- 536 -- 3 792 -- -- -- 795
Deferred compensation
obligations............ -- -- -- 3 546 (549) -- -- --
Restricted stock
forfeitures............ -- -- -- -- (12) 12 -- -- --
Amortization of
restricted stock ...... -- -- -- -- -- 89 -- -- 89
------ ------- --------- ------- ---------- -------- --------- --------- ----------
BALANCE AT MARCH 31, 2003 ....... 1,182 57,704 $ 440,331 $ 648 $ 228,702 $ (448) $ (58,308) $ 424,026 $1,034,951
====== ======= ========= ======= ========== ======== ========= ========= ==========
See accompanying Notes to Consolidated Financial Statements.
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands) (Unaudited)
Three Months Ended
March 31,
2003 2002
---- ----
Operating Activities:
Net income (loss) ........................................................ $ (24,958) $ 52,340
Adjustments to reconcile net income (loss) to net
cash provided by (used in)operating activities:
Depreciation and amortization ............................................ 39,254 27,240
Provision for loan losses ................................................ 44,786 111,876
Retained interests valuation income ...................................... (56,920) (7,557)
Asset impairments, lease write-offs, and severance ....................... 16,777 --
Changes in operating assets and liabilities, net:
Other receivables due from credit
card securitizations ........................................ (99,401) (18,825)
Accounts payable and accrued expenses ............................ 12,336 (5,384)
Deferred income .................................................. (21,060) (10,503)
Other ............................................................ (15,946) 59,528
--------- ---------
Net cash provided by (used in) operating activities ...................... (105,132) 208,715
--------- ---------
Investing Activities:
Proceeds from transfers of portfolios to the Metris
Master Trust........................................................... 205,560 619,554
Net proceeds from sales and repayments of
securitized loans...................................................... (723,527) (292,037)
Net loans collected ...................................................... 738,427 33,017
Additions to premises and equipment ...................................... (501) (3,645)
--------- ---------
Net cash provided by investing activities ................................ 219,959 356,889
--------- ---------
Financing Activities:
Proceeds from issuance of debt ........................................... 627 26
Repayment of debt ........................................................ -- (292,000)
Net decrease in deposits ................................................. (91,256) (332,122)
Cash dividends paid ...................................................... -- (938)
Proceeds from issuance of common stock ................................... 795 1,823
Repurchase of common stock ............................................... -- (17,582)
--------- ---------
Net cash used in financing activities .................................... (89,834) (640,793)
--------- ---------
Net increase (decrease) in cash and cash
equivalents............................................................ 24,993 (75,189)
Cash and cash equivalents at beginning of period ......................... 580,232 488,086
--------- ---------
Cash and cash equivalents at end of period ............................... $ 605,225 $ 412,897
========= =========
Supplemental disclosures and cash flow information:
Cash paid (received) during the period for:
Interest ............................................................ $ 10,952 $ 34,261
Income taxes ........................................................ (32,042) (17,948)
Tax benefit from employee stock option
exercises.............................................................. -- 170
See accompanying Notes to Consolidated Financial Statements.
METRIS COMPANIES INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except as noted) (Unaudited)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Metris
Companies Inc. ("MCI") and its subsidiaries, including Direct Merchants Credit
Card Bank, N.A. ("Direct Merchants Bank" or "DMCCB" or the "Bank"), which 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.
We have eliminated all significant intercompany balances and transactions
in consolidation. We have reclassified certain prior-period amounts to conform
with the current period's presentation. 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". In the first quarter of 2003, we have reclassified these amounts
to "Net securitization and credit card servicing income."
Interim Financial Statements
We have prepared the unaudited interim consolidated financial statements
and related unaudited financial information in the footnotes in accordance with
accounting principles generally accepted in the United States of America and the
rules and regulations of the Securities and Exchange Commission ("SEC") for
interim financial statements. These interim financial statements reflect all
adjustments consisting of normal recurring accruals which, in the opinion of
management, are necessary to present fairly our consolidated financial position
and the results of our operations and our cash flows for the interim periods.
You should read these consolidated financial statements in conjunction with the
financial statements and the notes thereto contained in our Annual Report on
Form 10-K for the fiscal year ended December 31, 2002. The nature of our
business is such that the results of any interim period may not be indicative of
the results to be expected for the entire year.
Pervasiveness of Estimates
We have prepared the consolidated financial statements in accordance with
accounting principles generally accepted in the United States of America, which
require us to make estimates and assumptions that affect the reported amounts in
the consolidated financial statements and accompanying notes. The most
significant and subjective of these estimates is our determination of the
adequacy of the allowance for loan losses and our determination of the fair
value of retained interests from assets securitized. The significant factors
susceptible to future change that have an impact on these estimates include
default rates, net interest spreads, liquidity and overall economic conditions.
As a result, the actual losses in our loan portfolio and the fair value of our
retained interests as of March 31, 2003 and December 31, 2002 could materially
differ from these estimates.
Comprehensive Income
SFAS No. 130 "Reporting Comprehensive Income," does not apply to our
current financial results and therefore, net income equals comprehensive income.
NOTE 2 - EARNINGS PER SHARE
The following table presents the computation of basic and diluted weighted-
average shares used in the per-share calculations:
Three Months Ended
March 31,
2003 2002
---- ----
Net income (loss) ................................... $(24,958) $ 52,340
Convertible preferred stock dividends ............... 9,689 9,188
-------- --------
Net income (loss) applicable to common stockholders . $(34,647) $ 43,152
======== ========
Weighted-average common shares outstanding .......... 57,257 62,188
Adjustments for dilutive securities:
Assumed conversion of convertible preferred stock (1) -- 33,844
-------- --------
Basic common shares ................................. 57,257 96,032
Assumed exercise of outstanding stock options (1) ... -- 941
-------- --------
Diluted common shares ............................... 57,257 96,973
======== ========
(1) The earnings per share calculation for the period ended March 31, 2003
excludes the assumed conversion of the convertible preferred stock and the
outstanding stock options, as they are anti-dilutive.
NOTE 3 - Stock-Based Compensation Plans
We recognize compensation cost for stock-based employee compensation plans
based on the difference, if any, between the quoted market price of the stock on
the date of grant and the amount an employee must pay to acquire the stock. No
expense was reflected in net income related to stock options as all options
granted had an exercise price equal to the market value of the underlying common
stock on the date of grant. We recorded $0.1 million of amortization of deferred
compensation obligation, net of related tax benefit, in net income related to
restricted stock granted in the first quarter of 2003.
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. Under the fair value
method, our net earnings and earnings per share would have been recorded at the
pro forma amounts indicated below:
Three Months Ended March 31,
2003 2002
---- ----
Net income (loss), as reported ................. $ (24,958) $ 52,340
Deduct: Annual stock-based employee
compensation expense (benefit)
determined based on the fair value
for all awards, net of related tax
effects...................................... (7,897) 4,373
--------- ----------
Pro forma net income (loss) .................... (17,061) 47,967
========= ==========
Earnings (loss) per share:
Basic-as reported .............................. (0.61) 0.55
========= ==========
Basic-pro forma ................................ (0.47) 0.50
========= ==========
Diluted-as reported ............................ (0.61) 0.54
========= ==========
Diluted-pro forma .............................. (0.47) 0.49
========= ==========
Weighted-average assumptions in
option valuation:
Risk-free interest rates ........................ 1.5% 3.7%
Dividend yields ................................. -- 1.6%
Stock volatility factor ......................... 107.0% 92.9%
Expected life of options (in years) ............. 4.3 6.0
The above pro forma amounts may not be representative of the effects on reported
net earnings for future periods.
NOTE 4 - ACCOUNTING CHANGES
On January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible
Assets," which establishes accounting and reporting standards for goodwill and
other intangible assets. It requires enterprises to test these assets for
impairment upon adoption of SFAS 142 as well as on an annual basis, and reduce
the carrying amount of these assets if they are found to be impaired. Goodwill
and other intangible assets with an indefinite useful life will no longer be
amortized. Other intangible assets with an estimable useful life will continue
to be amortized over their useful lives. The adoption of the new standard did
not have a material impact on our financial statements.
On January 1, 2002, we adopted SFAS No. 144, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which
supersedes FASB Statement No. 121, and provides a single accounting model for
long-lived assets to be disposed of. The adoption of the new standard did not
have a material impact on our financial statements.
In July 2002, the Financial Accounting Standards Board ("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. The adoption of the new standard did not have
a material impact on our financial statements.
In January 2003, FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation-Transition and Disclosure", which amends SFAS No. 123, "Accounting
for Stock-Based Compensation". SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require more prominent and more
frequent disclosures in financial statements about the effects of stock-based
compensation. SFAS No. 148 requirements are effective for fiscal years ending
after December 15, 2002. There was not a material impact on our financial
statements upon adoption of SFAS No. 148.
In January 2003, the Federal Financial Institutions Examination Council
("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.
In January 2003, FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" in an effort to expand upon and strengthen existing
accounting guidance that addresses when a company should include in its
financial statements the assets, liabilities and activities of another entity.
FASB Interpretation No. 46 requires a variable interest entity to be
consolidated by a company, if that company is subject to a majority of the risk
of loss from the variable interest entity activities or entitled to receive a
majority of the entity's residual returns or both. The Interpretation also
requires disclosures about variable interest entities that the company is not
required to consolidate, but in which it has a significant variable interest.
The consolidation requirements of Interpretation No. 46 apply immediately to
variable interest entities created after January 31, 2003, and apply to existing
variable interest entities in the first fiscal year or interim period beginning
after June 15, 2003. Interpretation No. 46 provides a specific exemption for
entities qualifying as Qualified Special Purpose Entities as described in SFAS
No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities-a replacement of FASB Statement No. 125". All of
our non-consolidated entities are Qualified Special Purpose Entities under the
definition in SFAS No. 140. We do not expect the adoption of this Interpretation
to have a material impact on our financial statements.
In April 2003, FASB issued SFAS No. 149 "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is effective for contracts entered into or modified after
June 30, 2003. In addition, certain provisions relating to forward purchases or
sales of when-issued securities or other securities that do not yet exist,
should be applied to existing contracts as well as new contracts entered into
after June 30, 2003. We do not expect the adoption of SFAS No. 149 to have a
material impact on our financial statements.
NOTE 5 - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is as follows:
Three Months Ended
March 31,
2003 2002
---- ----
Balance at beginning of period ................ $ 90,315 $ 410,159
Allowance related to assets transferred to the
Metris Master Trust......................... (1,455) (21,443)
Provision for loan losses ..................... 44,786 111,876
Principal receivables charged-off ............. (8,681) (88,891)
Recoveries .................................... 392 5,213
--------- ---------
Net principal receivables charged off ......... (8,289) (83,678)
--------- ---------
Balance at end of period ...................... $ 125,357 $ 416,914
========= =========
Credit card loans greater than 30 days contractually past due for the
periods ended March 31, 2003 and March 31, 2002 were $56.4 million and $226.3
million, respectively.
NOTE 6 - RETAINED INTERESTS IN LOANS SECURITIZED
Activity in retained interests is as follows:
March 31, December 31,
--------- ------------
2003 Change 2002
---- ------ ----
Contractual retained interests. $ 937,476 $ (53,577) $ 991,053
Excess transferor's interests.. 75,815 29,355 46,460
Finance charge receivables .... 656,880 (42,519) 699,399
----------- ----------- -----------
Gross retained interests ...... $ 1,670,171 $ (66,741) $ 1,736,912
Valuation allowance ........... (931,052) 55,465 (986,517)
----------- ----------- -----------
Net retained interests ........ $ 739,119 $ (11,276) $ 750,395
=========== =========== ===========
March 31, December 31,
--------- ------------
2002 Change 2001
---- ------ ----
Contractual retained interests. $ 813,417 $ 36,008 $ 777,409
Excess transferor's interests.. 44,997 5,073 39,924
Finance charge receivables .... 569,268 47,423 521,845
----------- ----------- -----------
Gross retained interests ...... $ 1,427,682 $ 88,504 $ 1,339,178
Valuation allowance ........... (551,385) (13,886) (537,499)
----------- ----------- -----------
Net retained interests ........ $ 876,297 $ 74,618 $ 801,679
=========== =========== ===========
Activity in the valuation allowance on retained interests in loans
securitized is as follows:
Three Months Ended
March 31,
2003 2002
---- ----
Balance at beginning of period ..................... $ 986,517 $ 537,499
Transfers related to assets transferred to the
Metris Master Trust.............................. 1,455 21,443
Retained interests valuation income ................ (56,920) (7,557)
--------- ---------
Balance at end of period ........................... $ 931,052 $ 551,385
========= =========
NOTE 7 - SEGMENTS
We operate in two principal areas: consumer lending products and
enhancement services. Our consumer lending products are primarily unsecured and
secured credit cards, including the Direct Merchants Bank MasterCard(R) and
Visa(R). Our credit cardholders include customers obtained from third-party
lists and other customers for whom general credit bureau information is
available.
We market our enhancement services, including: (1) debt waiver protection
for unemployment, disability, death and family leave; (2) membership programs
such as card registration, purchase protection and other club memberships; and
(3) third-party insurance, directly to our credit card customers and customers
of third parties. We currently administer extended service plans issued through
a third party retailer. These plans are no longer being sold, and contracts
expire by first quarter, 2005. We continue to sell extended service plans for
homeowners through third party distribution partnerships as well as directly to
consumers.
We have presented the segment information reported below on a managed
basis. We use this basis to review segment performance and to make operating
decisions. In doing so, the income statement and balance sheet are adjusted to
reverse the effects of securitizations. Presentation on a managed basis is not
in conformity with accounting principles generally accepted in the United States
of America. The adjustments columns in the segment table include adjustments to
present the information on an owned basis as reported in the financial
statements of this quarterly report.
We do not allocate the expenses, assets and liabilities attributable to
corporate functions to the operating segments, such as employee compensation,
data processing services and communications, third-party servicing expenses, and
other expenses including occupancy, depreciation and amortization, professional
fees, and other general and administrative expenses. We include these expenses
in the reconciliation of the income before income taxes for the reported
segments to the consolidated total. We do not allocate capital expenditures for
leasehold improvements, capitalized software and furniture and equipment to
operating segments. There were no material operating assets located outside of
the United States for the periods presented.
Our enhancement services operating segment pays a fee to our consumer
lending products segment for successful marketing efforts to cardholders at a
rate similar to those paid to our other third parties. Our enhancement services
segment reports interest income and our consumer lending products segment
reports interest expense at our weighted-average borrowing rate for the excess
cash flow generated by the enhancement services segment and used by the consumer
lending products segment to fund the growth of cardholder balances.
Three Months Ended March 31,
2003
- ----
Consumer
Lending Enhancement Securitization Other
Products Services Adjustments(a) Adjustments(b) Consolidated
-------- -------- -------------- -------------- ------------
Interest income.. $ 485,229 $ 29 $ (453,068) $ (29) $ 32,161
Interest
expense ..... 64,011 -- (44,641) (29) 19,341
----------- ----------- ----------- ----------- -----------
Net interest
income ........ 421,218 29 (408,427) -- 12,820
Other operating
income......... 99,290 93,684 (21,137) -- 171,837
Total revenue ... 520,508 93,713 (429,564) -- 184,657
Income before
income taxes. 38,510(c) 51,345(c) -- (127,499) (37,644)
Total assets .... $ 9,976,427 $ 95,319 $(8,318,889) $ 730,680(d) $ 2,483,537
Three Months Ended March 31,
2002
- ----
Consumer
Lending Enhancement Securitization Other
Products Services Adjustments(a) Adjustments(b) Consolidated
-------- -------- -------------- -------------- ------------
Interest income.. $ 526,678 $ 2,328 $ (436,834) $ (2,328) $ 89,844
Interest
Expense ..... 90,732 -- (56,239) (2,328) 32,165
----------- ----------- ----------- ----------- -----------
Net interest
Income ...... 435,946 2,328 (380,595) -- 57,679
Other operating
income....... 130,763 94,996 87,656 -- 313,415
Total revenue ... 566,709 97,324 (292,939) -- 371,094
Income before
income taxes. 140,324(c) 64,907(c) -- (120,401) 84,830
Total assets .... $11,177,901 $ 151,429 $(8,223,360) $ 544,980(d) $ 3,650,950
(a) This column reflects adjustments to the Company's internal financial
statements, which are prepared on a managed basis, to eliminate investors'
interests in securitized loans.
(b) The other adjustments column includes: intercompany eliminations and
amounts not allocated to segments.
(c) Income before income taxes includes intercompany commissions paid by the
enhancement services segment to the consumer lending products segment for
successful marketing efforts to cardholders of $3.0 million for the three
months ended March 31, 2003 and $3.3 million for the three months ended March
31, 2002.
(d) Total assets include the assets attributable to corporate functions not
allocated to operating segments and the removal of investors' interests in
securitized loans to present total assets on an owned basis.
NOTE 8 - SUBSEQUENT EVENT
On May 1, 2003, we sold our Arizona facility for cash proceeds of $19.3
million, which approximated its carrying value.
NOTE 9 - SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS
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 non-guaranteeing subsidiaries
are not presented because we have determined that the subsidiaries financial
information would not be material to investors.
METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
March 31, 2003
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Assets:
Cash and cash equivalents ................ $ (1,538) $ 2,707 $ 604,056 $ -- $ 605,225
Net retained interests in
loans securitized ..................... 30,623 -- 708,496 -- 739,119
Net credit card loans .................... 4,770 -- 556,158 -- 560,928
Property and equipment, net .............. -- 50,139 25,066 -- 75,205
Purchased portfolio
premium, net........................... 117 -- 57,966 -- 58,083
Other receivables due from
credit card
securitizations, net................... 8 -- 276,126 -- 276,134
Other assets ............................. 27,850 40,743 168,401 (68,151) 168,843
Investment in subsidiaries ............... 1,434,917 1,418,412 -- (2,853,329) --
----------- ----------- ----------- ----------- -----------
Total assets ............................. $ 1,496,747 $ 1,512,001 $ 2,396,269 $(2,921,480) $ 2,483,537
=========== =========== =========== =========== ===========
Liabilities:
Deposits ................................. $ (1,000) $ -- $ 802,498 $ -- $ 801,498
Debt ..................................... 391,957 -- 9,319 (43,000) 358,276
Accounts payable ......................... 73 17,377 37,890 (4,860) 50,480
Deferred income .......................... -- 12,337 128,122 (2,252) 138,207
Accrued expenses and other
liabilities............................ 70,766 47,370 28 (18,039) 100,125
----------- ----------- ----------- ----------- -----------
Total liabilities ........................ 461,796 77,084 977,857 (68,151) 1,448,586
----------- ----------- ----------- ----------- -----------
Total stockholders' equity ............... 1,034,951 1,434,917 1,418,412 (2,853,329) 1,034,951
----------- ----------- ----------- ----------- -----------
Total liabilities and
stockholders' equity................... $ 1,496,747 $1,512,001 $ 2,396,269 $(2,921,480) $ 2,483,537
=========== =========== =========== =========== ===========
METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
December 31, 2002
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Assets:
Cash and cash equivalents ................ $ (3,795) $ 8,088 $ 575,939 $ -- $ 580,232
Net retained interests in
loans securitized ..................... -- -- 750,395 -- 750,395
Net credit card loans .................... 3,814 -- 752,288 -- 756,102
Property and equipment, net .............. -- 56,728 27,103 -- 83,831
Purchased portfolio premium, net.......... 129 -- 64,450 -- 64,579
Other receivables due from
credit card
securitizations, net................... 13 -- 184,207 -- 184,220
Other assets ............................. 10,098 45,865 180,153 (61,129) 174,987
Investment in subsidiaries ............... 1,606,930 1,578,574 -- (3,185,504) --
----------- ----------- ----------- ----------- -----------
Total assets ............................. $ 1,617,189 $ 1,689,255 $ 2,534,535 $(3,246,633) $ 2,594,346
=========== =========== =========== =========== ===========
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 .......................... -- 16,681 146,097 (3,511) 159,267
Accrued expenses and other
liabilities............................ 167,865 44,961 (132,260) (8,504) 72,062
----------- ----------- ----------- ----------- -----------
Total liabilities ........................ 558,164 82,325 955,961 (61,129) 1,535,321
----------- ----------- ----------- ----------- -----------
Total stockholders' equity ............... 1,059,025 1,606,930 1,578,574 (3,185,504) 1,059,025
----------- ----------- ----------- ----------- -----------
Total liabilities and
stockholders' equity................... $ 1,617,189 $ 1,689,255 $ 2,534,535 $(3,246,633) $ 2,594,346
=========== =========== =========== =========== ===========
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Three Months Ended March 31, 2003
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Net Interest Income
(Expense)............................ $ (8,706) $ (610) $ 22,136 $ -- $ 12,820
Provision for loan losses .............. 846 -- 43,776 164 44,786
--------- --------- --------- --------- ---------
Net Interest Expense After
Provision for Loan Losses ........... (9,552) (610) (21,640) (164) (31,966)
--------- --------- --------- --------- ---------
Other Operating Income:
Net securitization and
credit card servicing
income............................... (2,324) -- 59,399 (679) 56,396
Credit card fees,
interchange and other
credit card income................... 55 12,543 21,889 (12,730) 21,757
Enhancement services
revenues............................. -- 9,179 88,258 (3,753) 93,684
Intercompany allocations ............... 75 65,606 9,991 (75,672) --
--------- --------- --------- --------- ---------
(2,194) 87,328 179,537 (92,834) 171,837
--------- --------- --------- --------- ---------
Other Operating Expense:
Credit card account and
other product
solicitation and
marketing expenses................... -- 14,587 33,755 (12,288) 36,054
Employee compensation .................. -- 47,555 5,826 -- 53,381
Data processing services and
communications ...................... (1) (21,987) 44,651 (3,485) 19,178
Enhancement services claims
expense.............................. -- 109 12,913 -- 13,022
Occupancy and equipment ................ -- 9,888 (275) -- 9,613
Purchased portfolio premium
amortization .......................... 11 -- 7,697 (1,212) 6,496
MasterCard/Visa assessment
and fees............................. -- -- 2,415 -- 2,415
Credit card fraud losses ............... 1 -- 939 -- 940
Asset impairments, lease
write-offs and severance ............ -- 13,652 3,125 -- 16,777
Other .................................. 84 17,549 2,006 -- 19,639
Intercompany allocations ............... 11 25,626 50,035 (75,672) --
--------- --------- --------- --------- ---------
106 106,979 163,087 (92,657) 177,515
--------- --------- --------- --------- ---------
Loss Before Income Tax
Benefit and Equity in
Loss of Subsidiaries................. (11,852) (20,261) (5,190) (341) (37,644)
Income tax benefit ..................... (3,994) (6,828) (1,749) (115) (12,686)
Equity in loss of
subsidiaries......................... (17,100) (3,667) -- 20,767 --
--------- --------- --------- --------- ---------
Net Loss ............................... $ (24,958) $ (17,100) $ (3,441) $ 20,541 $ (24,958)
========= ========= ========= ========= =========
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Three Months Ended March 31, 2002
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Net Interest (Expense)
Income............................... $ (5,482) $ (1,173) $ 64,334 $ -- $ 57,679
Provision for loan losses .............. 65 -- 61,811 50,000 111,876
--------- --------- --------- --------- -----------
Net Interest Expense After
Provision for Loan Losses ........... (5,547) (1,173) 2,523 (50,000) (54,197)
--------- --------- --------- --------- -----------
Other Operating Income:
Net securitization and
credit card servicing
income............................... 35 -- 157,384 -- 157,419
Credit card fees,
interchange and other
credit card income................... 264 7,923 59,247 (6,434) 61,000
Enhancement services
revenues............................. -- 16,163 78,833 -- 94,996
Intercompany allocations ............... 30 53,073 9,661 (62,764) --
--------- --------- --------- --------- -----------
329 77,159 305,125 (69,198) 313,415
--------- --------- --------- --------- -----------
Other Operating Expense:
Credit card account and
other product
solicitation and
marketing expenses................... -- 2,660 37,892 -- 40,552
Employee compensation .................. 404 49,168 6,976 -- 56,548
Data processing services
and communications .................. 23 (19,562) 45,211 (3,366) 22,306
Enhancement services claims
expense.............................. -- 56 11,151 -- 11,207
Occupancy and equipment ................ -- 11,864 933 -- 12,797
Purchased portfolio premium
amortization .......................... -- -- 9,362 (907) 8,455
MasterCard/Visa assessment
and fees............................. -- -- 3,834 -- 3,834
Credit card fraud losses ............... (8) -- 2,236 -- 2,228
Other .................................. 43 14,484 3,894 (1,960) 16,461
Intercompany allocations ............... (509) 18,078 45,195 (62,764) --
--------- --------- --------- ---------- -----------
(47) 76,748 166,684 (68,997) 174,388
--------- --------- --------- ---------- -----------
(Loss) Income Before Income
Taxes and Equity in
(Loss) Income of
Subsidiaries ......................... (5,171) (762) 140,964 (50,201) 84,830
Income taxes ............................ (1,980) (292) 53,989 (19,227) 32,490
Equity in income of
subsidiaries.......................... 55,531 56,001 -- (111,532) --
--------- --------- --------- --------- -----------
Net Income .............................. $ 52,340 $ 55,531 $ 86,975 $(142,506) $ 52,340
========= ========= ========= ========== ===========
METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Three Months Ended March 31, 2003
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Operating Activities:
Net cash (used in) provided by
operating activities.................. $(136,555) $ (10,163) $ 21,046 $ 20,540 $(105,132)
--------- --------- --------- --------- ---------
Investing Activities:
Net proceeds from sales and
repayments of securitized loans....... (32,923) -- (485,044) -- (517,967)
Net loans (originated) collected ........ (1,802) -- 740,229 -- 738,427
Additions to property and equipment...... -- (466) (35) -- (501)
Investment in subsidiaries .............. 172,013 160,162 -- (332,175) --
--------- --------- --------- --------- ---------
Net cash provided by investing
activities............................ 137,288 159,696 255,150 (332,175) 219,959
--------- --------- --------- --------- ---------
Financing Activities:
Net increase (decrease) in debt ......... 729 -- (102) -- 627
Net decrease in deposits ................ -- -- (91,256) -- (91,256)
Proceeds from issuance of common
stock................................. 795 -- -- -- 795
Capital contributions ................... -- (154,914) (156,721) 311,635 --
--------- --------- --------- --------- ---------
Net cash (used in) provided by
financing activities.................. 1,524 (154,914) (248,079) 311,635 (89,834)
--------- --------- --------- --------- ---------
Net (decrease) increase in cash and
cash equivalents...................... 2,257 (5,381) 28,117 -- 24,993
Cash and cash equivalents at
beginning of period................... (3,795) 8,088 575,939 -- 580,232
--------- --------- --------- --------- ---------
Cash and cash equivalents at end of
period................................ $ (1,538) $ 2,707 $ 604,056 $ -- $ 605,225
========= ========= ========= ========= =========
METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Three Months Ended March 31, 2002
(Dollars in thousands)
Unaudited
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Operating Activities:
Net cash provided by operating
activities .......................... $ 67,354 $ 58,817 $ 225,051 $(142,507) $ 208,715
--------- --------- --------- --------- ---------
Investing Activities:
Net proceeds from sales and
repayments of securitized loans ..... -- -- 327,517 -- 327,517
Net loans (originated) collected ....... (7,873) -- 40,890 -- 33,017
Additions to property and equipment .... -- (3,631) (14) -- (3,645)
Investment in subsidiaries ............. (55,527) (54,716) -- 110,243 --
--------- --------- --------- --------- ---------
Net cash (used in) provided by
investing activities................. (63,400) (58,347) 368,393 110,243 356,889
--------- --------- --------- --------- ---------
Financing Activities:
Increase (decrease) in debt ............ 222 (102) (292,094) -- (291,974)
Decrease in deposits ................... -- -- (332,122) -- (332,122)
Cash dividends paid .................... (938) -- -- -- (938)
Proceeds from issuance of common
stock................................ 1,823 -- -- -- 1,823
Repurchase of common stock ............. (17,582) -- -- -- (17,582)
Capital contributions .................. -- (3) (32,261) 32,264 --
--------- --------- --------- --------- ---------
Net cash used in financing activities .. (16,475) (105) (656,477) 32,264 (640,793)
--------- --------- --------- --------- ---------
Net (decrease) increase in cash and
cash equivalents..................... (12,521) 365 (63,033) -- (75,189)
Cash and cash equivalents at
beginning of period.................. 17,613 1,505 468,968 -- 488,086
--------- --------- --------- --------- ---------
Cash and cash equivalents at end of
period............................... $ 5,092 $ 1,870 $ 405,935 $ -- $ 412,897
========= ========= ========= ========= =========
ITEM 2.
METRIS COMPANIES INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides information management
believes to be relevant to understanding the financial condition and results of
operations of Metris Companies Inc. ("MCI") and its subsidiaries, including
Direct Merchants Credit Card Bank, N.A. ("Direct Merchants Bank" or "DMCCB" or
the "Bank"), which may be referred to as "we," "us," "our" or the "Company." You
should read this discussion along with the following documents for a full
understanding of our financial condition and results of operations: Management's
Discussion and Analysis of Financial Condition and Results of Operations in our
Annual Report on Form 10-K for the fiscal year ended December 31, 2002; and our
Proxy Statement for the 2003 Annual Meeting of Stockholders. In addition, you
should read this discussion along with our Quarterly Report on Form 10-Q for the
period ended March 31, 2003, of which this commentary is a part, and the
condensed consolidated financial statements and related notes thereto.
Results of Operations
Net loss for the three months ended March 31, 2003 was $25.0 million, down
from net income of $52.3 million for the first quarter of 2002. Diluted loss per
share for the three months ended March 31, 2003 was $0.61 compared to diluted
earnings per share of $0.54 for the first quarter of 2002. The decrease in net
income is primarily due to a decrease in net interest income and other operating
income, partially offset by a decrease in the provision for loan losses.
Net interest income decreased from $57.7 million for the three months ended
March 31, 2002 to $12.8 million for the three months ended March 31, 2003. The
decrease is primarily due to a decrease in average interest-earning assets of
$1.4 billion and a 470 basis point reduction in net interest margin. The
decrease in average interest-earning assets is primarily due to the transfer of
$1.9 billion of receivables to the Metris Master Trust (the "Master Trust")
since March 31, 2002. The decrease in margin is primarily due to a $1.7 billion
reduction in average credit card loans, which has resulted in short-term, lower
yielding investments increasing to 47% of average interest-earning assets,
versus 11% in the first quarter of 2002.
The provision for loan losses was $44.8 million in the first quarter of
2003 compared to $111.9 million in the first quarter of 2002. The decrease is
primarily due to significantly lower credit card receivables. Lower credit card
loan balances, decreased net principal charge-offs, and recent delinquency
trends were all factors considered by management in determining the necessary
balance in the allowance for loan losses.
Other operating income decreased 45.2% to $171.8 million for the three
months ended March 31, 2003 from $313.4 million for the same period in 2002. Net
securitization and credit card servicing income, a component of other operating
income, decreased 64.2% to $56.4 million for the first quarter of 2003 from
$157.4 million for the same period in 2002, primarily due to a decrease in
excess spread as a result of an increased default rate on securitized
receivables. Credit card fees, interchange and other credit card income
decreased to $21.8 million for the three months ended March 31, 2003, compared
to $61.0 million for the same period in 2002. The decrease in credit card fees,
interchange and other credit card income is primarily due to the reduction of
our credit card portfolio. In addition, effective June 2002, 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.
Total other operating expenses for the three months ended March 31, 2003,
increased $3.1 million over the comparable period in 2002. During the first
quarter of 2003, we recorded approximately $12.0 million of write-downs of
excess property, equipment, and operating leases and another $4.8 million charge
for a workforce reduction. Credit card account and other product solicitation
and marketing expenses decreased $4.5 million for the three months ended March
31, 2003, largely due to fewer new credit card accounts partially offset by
increased enhancement services marketing. Employee compensation decreased $3.2
million for the three months ended March 31, 2003, due to decreased staffing
needs. Data processing services and communications decreased $3.1 million for
the three months ended March 31, 2003, primarily due to a reduction in our
credit card portfolio. Enhancement services claims expense increased $1.8
million for the three months ended March 31, 2003, primarily due to an increase
in interest forgiven claims on our debt waiver products, partially offset by a
decrease in warranty claims primarily due to the run-off of the ServiceEdge(R)
portfolio.
Critical Accounting Policies
The Company's most significant accounting policies are our determination of
the allowance for loan losses, valuation of retained interests and accounting
for deferred acquisition costs and revenue recognition on enhancement services
products.
Allowance for loan losses
We maintain an allowance for loan losses sufficient to absorb anticipated
probable loan losses inherent in the credit card loan portfolio as of the
balance sheet date. At the time of charge-off, all principal balances are
written off against the allowance and all fees and finance charges are netted
against the applicable income statement line item. The allowance is based on
management's consideration of all relevant factors including management's
assessment of applicable economic and seasonal trends.
We segment the loan portfolio into several individual liquidating pools
with similar credit risk and time since solicitation (vintage pools), and
estimate (based on historical experience and existing environmental conditions)
the dollar amount of principal, accrued finance charges and fees in each 30-day
delinquency bucket that will not be collected and, therefore, "roll" into the
next 30-day bucket and ultimately charge-off. We then aggregate these pools into
prime and 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 include higher risk segments, such as
our subprime accounts, 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 losses
and bankruptcy losses.
Additionally, in evaluating the adequacy of the loan loss reserves, we
consider several subjective factors which may be overlaid into the credit risk
roll-rate model in determining the necessary loan loss reserve, including:
o national and economic trends and business conditions, including the
condition of various market segments;
o changes in lending policies and procedures, including those for
underwriting, collection, charge-off and recovery, as well as in the
experience, ability and depth of lending management and staff;
o trends in volume and the product pricing of accounts, including any
concentrations of credit; and
o impacts from external factors - such as changes in competition, and
legal and regulatory requirements - on the level of estimated credit
losses in the current portfolio.
Significant changes in these factors could impact our financial projections
and thereby affect the adequacy of our allowance for loan losses.
Valuation of Retained Interests
We determine the fair value of the net retained interests in loans
securitized by calculating the present value of future expected cash flows using
management's best estimate of key assumptions including credit losses, gross
yield, interest expense, servicing fees, payment rates and a discount rate
commensurate with the risks involved. Our fair value analysis considers cash
flows associated with the current receivable balances as of the balance sheet
date. We assume no new sales or increases in outstanding receivables in
conjunction with the accounts in the portfolio. The significant assumptions are
applied to the existing receivable balance to determine the expected future cash
flows. Our funding costs are primarily variable based on the London Interbank
Offered Rate ("LIBOR"), and the income earned on our receivable balance is
substantially variable based on Prime. We assume a flat interest rate
environment and when interest rates change, we assume our assets and liabilities
will reprice in a consistent manner.
Our estimate of the assumptions considers several subjective factors,
including:
o national and economic trends and business conditions, including the
condition of various market segments;
o changes in lending policies and procedures, including those for
underwriting, collection, charge-off and recovery, as well as changes
in the experience, ability and depth of lending management and staff;
o trends in volume and the product pricing of accounts, including any
concentrations of credit; and
o impacts from external factors, such as changes in competition, and
legal and regulatory requirements.
Furthermore, we consider the impact of conduit/asset-backed transaction
enhancement levels and restrictions on the release of cash from the Master Trust
due to spread triggers (see pages 35-36 of this Report for further discussion)
on the timing of our cash receipts from the Master Trust. Significant changes in
these factors could impact our financial projections and thereby affect the
valuation of the retained interests.
The significant assumptions used for estimating the fair value of the
retained interests in loans securitized are as follows:
March 31, December 31,
--------- ------------
2003 2002
---- ----
Annual discount rate ........................ 20.0% 20.0%
Monthly payment rate ........................ 6.8% 6.8%
Gross yield (1) ............................. 21.5% 21.4%
Annual interest expense and servicing fees... 4.1% 4.3%
Annual gross principal default rate ......... 20.2% 19.9%
(1) Includes finance charges, late and overlimit fees and bad debt recoveries,
net of finance charge and fee charge-offs. Gross yield for purposes of our
valuation does not include interchange income, debt waiver fees, or cash
advance fees.
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 March 31, 2003 and
December 31, 2002 were $61.6 million and $73.2 million, respectively. If
deferred acquisition costs were to exceed forecasted future cash flows, we would
make an appropriate adjustment for impairment. The most significant assumption
used by the Company in determining the realizability of these deferred costs is
future revenues from our enhancement services products. A significant reduction
in revenues could have a material impact on the values of these balances.
Debt Waiver Products
Qualifying membership acquisition costs are deferred and charged to
expense as debt waiver product fees are recognized. We amortize these costs
using an accelerated methodology, which approximates our historical
cancellation experience for debt waiver products. Amortization of debt
waiver acquisition costs was $1.4 million for the three months ended March
31, 2003. All other debt waiver acquisition costs are expensed as incurred.
Deferred debt waiver acquisition costs were $2.6 million as of March 31,
2003 and December 31, 2002.
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 $20.5 million and $7.8
million for the three months ended March 31, 2003 and 2002, respectively.
All other membership acquisition costs are expensed as incurred. Deferred
membership acquisition costs were $56.5 million and $66.9 million as of
March 31, 2003 and December 31, 2002, respectively. The decline in deferred
membership acquisition costs is primarily due to declining enrollments
through the first quarter of 2003. In addition the reduction is a result of
the migration to more monthly bill products being sold and the termination
of our relationship with certain third-party partners.
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 $2.0 million and $3.1 million for the three
months ended March 31, 2003 and 2002, respectively. All other warranty
acquisition costs are expensed as incurred. Deferred warranty acquisition
costs amount to $2.2 million and $3.0 million as of March 31, 2003 and
December 31, 2002, respectively. The decline in deferred warranty
acquisition costs is primarily due to declining enrollments through the
first quarter of 2003. In addition the reduction is a result of the
migration to more monthly bill products being sold and the termination of
our relationship with certain third-party partners.
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.
Revenue is recognized in the month following the completion of the
cancellation period, which is one-month. 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. Revenues recorded for debt
waiver products are included in the consolidated statements of income under
"Enhancement services revenues" and were $50.2 million and $60.7 million
for the three months ended March 31, 2003 and 2002, respectively. Unearned
revenues and reserves for pending claims and incurred but not reported
claims are recorded in the consolidated balance sheets in "Deferred income"
and "Accrued expenses and other liabilities," respectively. Unearned
revenues as of March 31, 2003 were $15.5 million compared to $16.9 million
as of December 31, 2002. Reserves for pending and incurred but not reported
claims were $8.6 million as of March 31, 2003, compared to $8.2 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 March
31, 2003 on the membership program products were $17.9 million compared to
$22.0 million as of December 31, 2002. Cancellation reserves were $16.4
million
and $19.5 million as of March 31, 2003 and December 31, 2002, respectively.
Revenues recorded for membership products are included in the consolidated
statements of income under "Enhancement services revenues" and were $30.6
million and $17.1 million for the three months ended March 31, 2003 and
2002, respectively. Unearned revenues on membership program products are
recorded in the consolidated balance sheets in "Deferred income." Unearned
revenues as of March 31, 2003 were $99.5 million compared to $114.2 million
as of December 31, 2002. The decline in unearned revenue for our membership
products is primarily due to declining enrollments through the first
quarter of 2003. In addition the reduction is a result of the migration to
more monthly bill products being sold and the termination of our
relationship with certain third-party partners. Reserves for pending and
incurred but not reported claims, included in "Accrued expenses and other
liabilities," were $0.1 million as of March 31, 2003 and December 31, 2002.
Warranty Products
We coordinate the marketing activities for Direct Merchants Bank and
third-party sales of extended service plans. We perform administrative
services and retain the claims risk for all extended service plans sold. As
a result, we defer and recognize extended service plan revenues and the
incremental direct acquisition costs on an accelerated amortization method
over the life of the related extended service plan contracts beginning
after the expiration of any manufacturer's warranty coverage. A liability
is established and netted against the related receivable in the
consolidated balance sheets in "Other assets" from inception of the
extended service plan through the end of the cancellation period that
reflects our historical cancellation experience with these products. Gross
receivables as of March 31, 2003 on the warranty products were $2.5 million
compared to $3.8 million as of December 31, 2002. Cancellation reserves
were $2.9 million and $5.3 million as of March 31, 2003 and December 31,
2002, respectively. Revenues recorded for warranty products are included in
the consolidated statements of income under "Enhancement services revenues"
and were $10.0 million and $13.0 million for the three months ended March
31, 2003 and 2002, respectively. Unearned revenues on warranty products are
recorded in the consolidated balance sheets in "Deferred income." Unearned
revenues as of March 31, 2003 were $13.0 million compared to $17.6 million
as of December 31, 2002. The decline in unearned revenue for our warranty
products is primarily due to declining enrollments through the first
quarter of 2003. In addition the reduction is a result of the migration to
more monthly bill products being sold and the termination of our
relationship with certain third-party partners. Reserves for pending and
incurred but not reported claims, included in "Accrued expenses and other
liabilities," were $0.7 million as of March 31, 2003 and December 31, 2002.
Net Interest Income
Net interest income consists primarily of interest earned on our credit
card loans, less interest expense on borrowings to fund loans. Table 1 provides
an analysis of interest income and expense, net interest spread, net interest
margin and average balance sheet data for the three month periods ended March
31, 2003 and 2002.
Table 1: Analysis of Average Balances, Interest and Average Yields and Rates
(Dollars in thousands)
Three Months Ended March 31,
2003 2002
---------------------------------------------------------------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
Assets:
Interest-earning assets:
Federal funds sold ............ $ 117,654 $ 359 1.2% $ 28,431 $ 114 1.6%
Short-term investments ........ 539,335 1,895 1.4% 271,628 1,204 1.8%
Credit card loans ............. 751,674 29,907 16.1% 2,497,941 88,526 14.4%
----------- ----------- -------- ----------- ----------- ------
Total interest-earning assets.. $ 1,408,663 $ 32,161 9.3% $ 2,798,000 $ 89,844 13.0%
Other assets .................. 1,365,429 -- -- 1,569,516 -- --
Allowances for loan losses..... (106,909) -- -- (407,868) -- --
----------- -----------
Total assets .................. $ 2,667,183 -- -- $ 3,959,648 -- --
=========== ===========
Liabilities and Equity:
Interest-bearing liabilities:
Deposits ...................... $ 839,491 $ 10,908 5.3% $ 1,929,909 $ 23,653 5.0%
Debt .......................... 389,640 8,433 8.8% 451,480 8,512 7.6%
----------- ----------- -------- ----------- ----------- ------
Total interest-bearing
liabilities ................ $ 1,229,131 $ 19,341 6.4% $ 2,381,389 $ 32,165 5.5%
Other liabilities ............. 391,833 -- -- 423,889 -- --
----------- -----------
Total liabilities ............. 1,620,964 -- -- 2,805,278 -- --
Stockholders' equity .......... 1,046,219 -- -- 1,154,370 -- --
----------- -----------
Total liabilities and equity... $ 2,667,183 -- -- $ 3,959,648 -- --
=========== ===========
Net interest income and
interest margin (1) ........ -- $ 12,820 3.7% -- $ 57,679 8.4%
Net interest rate spread (2)... -- -- 2.9% -- -- 7.5%
Return on average assets ...... -- -- N/A -- -- 5.4%
Return on average total
equity ..................... -- -- N/A -- -- 18.4%
(1) We compute "net interest margin" by dividing annualized net interest income
by average total interest-earning assets.
(2) The "net interest rate spread" is the annualized yield on average
interest-earning assets minus the annualized funding rate on average
interest-bearing liabilities.
Net interest income decreased from $57.7 million for the three months ended
March 31, 2002 to $12.8 million for the three months ended March 31, 2003. The
decrease is primarily due to a decrease in average interest-earning assets of
$1.4 billion and a 470 basis point reduction in net interest margin. The
decrease in average interest-earning assets is primarily due to the transfer of
$1.9 billion of receivables to the Master Trust since March 31, 2002. The
decrease in margin is primarily due to a $1.7 billion reduction in average
credit card loans, which has resulted in short-term, lower yielding investments
increasing to 47% of average interest-earning assets, versus 11% in the first
quarter of 2002.
Other Operating Income
Other operating income contributed 93.1% and 84.5% of total revenues for
the three month periods ended March 31, 2003 and 2002, respectively. Other
operating income decreased $141.6 million for the three months ended March 31,
2003 over the comparable period in 2002.
Net securitization and credit card servicing income decreased $101.0
million to $56.4 million for the three months ended March 31, 2003 over the
comparable period in 2002. The decrease was primarily due to a decrease in
excess spread, as a result of an increased default rate on securitized
receivables.
Credit card fees, interchange and other credit card income decreased to
$21.8 million for the three months ended March 31, 2003, compared to $61.0
million for the same period in 2002. The decrease in credit card fees,
interchange and other credit card income is primarily due to the reduction of
our credit card portfolio. In addition, effective June 2002, 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.
Enhancement services revenues decreased by $1.3 million for the three
months ended March 31, 2003, compared to the three months ended March 31, 2002.
This decrease was primarily due to a decrease in receivables covered by our debt
waiver products, as well as a decrease in ServiceEdge(R) revenue due to the
run-off of the ServiceEdge(R) portfolio. These decreases were partially offset
by increased enrollments in existing membership products and enrollments from
new membership products.
Table 2: Enhancement Services Revenues and Active Memberships (In thousands)
Three Months Ended March 31,
Revenues 2003 2002
---- ----
Credit Protection Products.... $50,976 $61,683
Membership Program Products... 30,554 17,160
Warranty / Other ............. 12,154 16,153
-----------------------
Total ...................... $93,684 $94,996
=======================
March 31, December 31, March 31,
Active Memberships 2003 2002 2002
---- ---- ----
Credit Protection Products.... 827 905 1,080
Membership Program Products... 3,057 3,248 2,947
Warranty / Other ............. 815 941 1,560
---------------------------------------
Total ...................... 4,699 5,094 5,587
======================================
Other Operating Expense
Total other operating expenses for the three months ended March 31, 2003,
increased $3.1 million over the comparable period in 2002. During the first
quarter of 2003, we recorded approximately $12.0 million of write-downs of
excess property, equipment, and operating leases and another $4.8 million charge
for a workforce reduction. Credit card account and other product solicitation
and marketing expenses decreased $4.5 million for the three months ended March
31, 2003, largely due to fewer new credit card accounts partially offset by
increased enhancement services marketing. Employee compensation decreased $3.2
million for the three months ended March 31, 2003, due to decreased staffing
needs. Data processing services and communications decreased $3.1 million for
the three months ended March 31, 2003, primarily due to a reduction in our
credit card portfolio. Enhancement services claims expense increased $1.8
million for the three months ended March 31, 2003, primarily due to an increase
in interest forgiven claims on our debt waiver products, partially offset by a
decrease in warranty claims primarily due to the run-off of the ServiceEdge(R)
portfolio.
Asset Quality
Our delinquency and net loan charge-off rates at any point in time reflect,
among other factors, the credit risk of loans, the average age of our various
credit card account portfolios, the success of our collection and recovery
efforts, and general economic conditions. The average age of our credit card
portfolio affects the stability of delinquency and loss rates. In order to
minimize losses, we continue to focus our resources on refining our credit
underwriting standards for new accounts, and on collections and post charge-off
recovery efforts. At March 31, 2003, 58% of our outstanding receivables balance
were from credit card accounts that have been with us in excess of two years,
and 21% 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
It is our policy to accrue interest and fee income on all credit card
accounts, except in limited circumstances, until we charge-off the account. In
November 2002, we stopped billing late fees once an account became 120 days
contractually delinquent and in March 2003, we stopped billing overlimit fees
once an account became 120 days contractually delinquent. These changes will not
have a material effect on our financial results. 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. This is in accordance with
FFIEC guidance. Table 3 presents the delinquency trends of our credit card loan
portfolio.
Table 3: Loan Delinquency
(Dollars in thousands)
March 31, % of December 31, % of March 31, % of
2003 Total 2002 Total 2002 Total
---- ----- ---- ----- ---- -----
Loans outstanding .... $ 686,285 100% $ 846,417 100% $2,219,800 100%
Loans contractually
delinquent:
30 to 59 days ... 20,921 3.0% 1,673 0.2% 55,101 2.5%
60 to 89 days ... 18,390 2.7% 2,121 0.2% 38,023 1.7%
90 or more days.. 17,108 2.5% 4,082 0.5% 133,223 6.0%
---------- ----- ---------- ----- ---------- -----
Total ......... $ 56,419 8.2% $ 7,876 0.9% $ 226,347 10.2%
========== ===== ========== ===== ========== =====
The decrease in the delinquency rates as of March 31, 2003 and December 31,
2002 compared to March 31, 2002, 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 $5.5 million, representing 63.8% of
total gross charge-offs as of March 31, 2003 and $25.3 million, representing
28.5% of total gross charge-offs as of March 31, 2002. We charge-off accounts
that are identified as fraud losses no later than 90 days after the last
activity. We enter into forward flow agreements with third parties for the sale
of a majority of charged-off 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 4: Net Charge-offs
(Dollars in thousands) Three Months Ended
March 31,
---------
2003 2002
---- ----
Average credit card loans.... $ 751,674 $2,497,941
Net charge-offs ............. 8,289 83,678
Net charge-off ratio ........ 4.5% 13.6%
========== ==========
The decrease in the net charge-off ratios for the three months ended March
31, 2003 is primarily due to the sale of approximately $120 million delinquent
receivables during September and December 2002.
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. We also leverage forbearance programs and credit counseling services
for qualifying cardholders that are experiencing payment difficulties. These
programs include reduced interest rates, reduced or suspended fees and other
incentives to induce the customer to continue making payments. The amount of
customer receivables in debt forbearance programs was $35.3 million or 5% of
total credit card loans as of March 31, 2003, compared to $34.7 million or 4% of
total credit card loans as of December 31, 2002. All delinquent receivables in
debt forbearance programs are included in Table 3.
The provision for loan losses was $44.8 million for the three months ended
March 31, 2003, compared to a provision of $111.9 million for the three months
ended March 31, 2002. The decrease in the provision for loan losses in 2003
compared to 2002 is primarily due to lower credit card loan balances and
decreased net principal charge-offs due to the sale of delinquent receivables.
The allowance for loan losses was $125 million as of March 31, 2003, versus $90
million as of December 31, 2002. Our roll-rate models, including management
contingency, indicated our required allowance for loan losses was in the range
of $110 million to $125 million as of March 31, 2003, versus $75 million to $90
million as of December 31, 2002. The ratio of allowance for loan losses to
period-end credit card loans was 18.3% at March 31, 2003, compared to 10.7% at
December 31, 2002. The allowance for loan losses as a percentage of 30-day plus
receivables was 222.2% at March 31, 2003, compared to 1,146.7% at December 31,
2002.
We believe the allowance for loan losses is adequate to cover probable
future losses inherent in the loan portfolio under current conditions. However,
we cannot give assurance as to future credit losses that may be incurred in
connection with our loan portfolio, nor can we provide assurance that the
established allowance for loan losses will be sufficient to absorb future
losses.
Retained Interests Valuation
We record a valuation allowance to reduce the contractual value of the
retained interests in loans securitized to fair value. The following summarizes
our retained interests as of March 31, 2003, December 31, 2002, March 31, 2002
and December 31, 2001.
March 31, December 31,
--------- ------------
2003 Change 2002
---- ------ ----
Contractual retained interests ...... $ 937,476 $ (53,577) $ 991,053
Excess transferor's interests ....... 75,815 29,355 46,460
Finance charge receivables .......... 656,880 (42,519) 699,399
----------- ----------- -----------
Gross retained interests ............ $ 1,670,171 $ (66,741) $ 1,736,912
Valuation allowance ................. (931,052) 55,465 (986,517)
----------- ----------- -----------
Net retained interests .............. $ 739,119 $ (11,276) $ 750,395
=========== =========== ===========
March 31, December 31,
--------- ------------
2002 Change 2001
---- ------ ----
Contractual retained interests ...... $ 813,417 $ 36,008 $ 777,409
Excess transferor's interests ....... 44,997 5,073 39,924
Finance charge receivables .......... 569,268 47,423 521,845
----------- ----------- -----------
Gross retained interests ............ $ 1,427,682 $ 88,504 $ 1,339,178
Valuation allowance ................. (551,385) (13,886) (537,499)
----------- ----------- -----------
Net retained interests .............. $ 876,297 $ 74,618 $ 801,679
=========== =========== ===========
Gross retained interests in loans securitized decreased by $66.7 million
between December 31, 2002 and March 31, 2003, to $1.7 billion. The decrease
reflects $585 million reduction in loans in the Master Trust partially offset by
higher conduit enhancement levels. The $88.5 million increase in gross retained
interests during the three months ended March 31, 2002 was due to the sale of
approximately $635 million of receivables from Direct Merchants Bank to the
Master Trust during the three months ended March 31, 2002.
During the three months ended March 31, 2003, the valuation allowance
decreased by $55.5 million, of which $37.9 million was due to the decrease in
the gross retained interests and $17.6 million due to higher finance charge
yields resulting from repricing initiatives and a decrease in funding costs due
to lower projected LIBOR. During the three months ended March 31, 2002, the
valuation allowance increased $13.9 million, of which $35.5 million was due to
higher gross retained interests. This was partially offset by $21.6 million
decrease in the valuation allowance due to higher finance charge yields
resulting from repricing initiatives.
Balance Sheet Analysis
Cash and Cash Equivalents
Cash and cash equivalents increased $25.0 million to $605.2 million as of
March 31, 2003, compared to $580.2 million as of December 31, 2002. The increase
is primarily due to the transfer of $204.5 million of receivables from Direct
Merchants Bank to the Master Trust offset by a decrease in deposits.
Credit Card Loans
Credit card loans were $686.3 million as of March 31, 2003, compared to
$846.4 million as of December 31, 2002. The $160.1 million decrease is primarily
a result of the transfer of $204.5 million of receivables from Direct Merchants
Bank to the Master Trust.
Deposits
Deposits decreased $91.3 million to $801.5 million as of March 31, 2003,
from $892.8 million as of December 31, 2002. The decrease relates to a shift in
funding from CDs to off-balance sheet asset-backed securitizations.
Under an operating agreement with the Office of the Comptroller of the
Currency ("OCC"), 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.
Deferred Income
Deferred income decreased $21.1 million to $138.2 million as of March 31,
2003 compared to $159.3 million as of December 31, 2002. The decrease primarily
relates to declining enhancement services enrollments, decrease in covered
receivables under our debt waiver product, our migration from annual-billed to
monthly-billed enhancement service products and the run-off of the
ServiceEdge(R) portfolio.
Liquidity, Funding and Capital Resources
One of our primary financial goals is to maintain an adequate level of
liquidity through active management of assets and liabilities. Liquidity
management is a dynamic process, affected by changes in the characteristics of
our assets and liabilities and short- and long-term interest rates. We use a
variety of financing sources to manage liquidity, funding, and interest rate
risks. Table 5 summarizes our funding and liquidity as of March 31, 2003 and
December 31, 2002:
Table 5: Liquidity, Funding and Capital Resources
March 31, 2003 December 31, 2002
-------------- -----------------
DMCCB Other Consolidated DMCCB Other Consolidated
----- ----- ------------ ----- ----- ------------
Cash and due
from banks.......... $ 88,949 $ 1,821 $ 90,770 $ 58,399 $ 4,414 $ 62,813
Federal funds
sold................ 102,300 -- 102,300 88,000 -- 88,000
Short-term
investments......... 331,467 80,688 412,155 322,039 107,380 429,419
-------- -------- -------- -------- -------- --------
Total cash and
cash equivalents .... $522,716 82,509 $605,225 $468,438 $111,794 $580,232
======== ======== ======== ======== ======== ========
March 31, 2003 December 31, 2002
---------------- -----------------
Unused Unused
On-balance sheet funding Outstanding Capacity Outstanding Capacity
- ------------------------ ----------- -------- ----------- --------
Revolving credit line -
July 2003........................... $ -- $ -- $ -- $ 162,696
Term loan - June 2003.................. 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........................... 147,046 N/A 146,824 N/A
Thomas H. Lee Equity Fund IV, L.P. -
March 2004.......................... -- 125,000 -- --
Other.................................. 11,230 N/A 10,825 N/A
Deposits - various
maturities through
February 2007....................... 801,498 N/A 892,754 N/A
----------- ---------- ------------ ------------
Subtotal 1,159,774 125,000 1,250,403 162,696
Off-balance sheet funding
- -------------------------
Metris Master Trust:
Term asset backed
securitizations -
various maturities
through January 2009......... 7,610,000 -- 7,610,000 --
Bank conduits -
various maturities
through March 2004............... 708,890 684,000 1,177,957 422,043
Metris facility-March 2003............. -- -- 48,900 26,100
----------- ------------ ------------ ------------
Subtotal 8,318,890 684,000 8,836,857 448,143
----------- ------------ ------------ ------------
Total $ 9,478,664 $ 809,000 $ 10,087,260 $ 610,839
=========== ============ ============ ============
For the three months ended March 31, 2003 and 2002, we had net repayments
of approximately $518.0 million and net proceeds of approximately $327.5 million
respectively, from sales of credit card loans to the Master Trust and the Metris
facility referred to in the above table.
As of March 31, 2003 and December 31, 2002, we had $7.3 million 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
$689.6 million at March 31, 2003 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 March 31, 2003 and December 31, 2002 we were in compliance with
all financial covenants under our credit agreement.
Our contractual cash obligations during the next twelve months as of March
31, 2003 were as follows:
Long-term debt........ $101,310
Operating leases...... 13,639
Deposits ............. 328,956
--------
Total ................ $443,905
========
In addition to the contractual cash obligations, open-to-buy on credit card
accounts as of March 31, 2003 was $11.1 billion.
As of March 31, 2003, $1.9 billion of off-balance sheet funding in the
Master Trust is scheduled to amortize over the next twelve months. We base the
amortization amounts on estimated amortization periods, which are subject to
change based on the Master Trust performance.
The following table shows the annualized yields, defaults, costs and excess
spreads for the Master Trust on a cash basis:
Three Months Ended March 31,
(In thousands) 2003 2002
---- ----
--------------------------------------
Gross yield (1) .................... $657,781 27.71% $586,680 26.57%
Annual principal defaults .......... 508,200 21.41% 314,378 14.24%
-------- ----- -------- -----
Net portfolio yield ................ 149,581 6.30% 272,302 12.33%
Annual interest expense
and servicing fees............... 88,169 3.94% 106,302 4.75%
-------- ----- -------- -----
Net excess spread ................ $ 61,412 2.36% $166,000 7.58%
======== ===== ======== =====
(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.
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 the performance of the Master Trust, specifically the
average of net excess spread over a one to three-month period.
The cash restricted from release is limited to the amount of excess spread
generated in the Master Trust on a cash basis. During periods of lower excess
spreads, the required amount of 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 $457 million at
March 31, 2003 and $304 million at December 31, 2002. As of March 31, 2003,
$133.4 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 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. The $104.3 million increase in this restricted cash is a result of
approximately $61.4 million of net excess cash generated by the Master Trust
being restricted within the Master Trust and approximately $42.9 million that
was funded pursuant to the terms of our conduit warehouse facilities. We expect
all cash basis excess spread to be restricted from release to us until 2004.
On March 17, 2003 we obtained a $425 million extension through March 2004
of an $850 million conduit which was scheduled to mature in June of 2003. We
also secured a $425 million conduit through March 2004, which 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%. All of these conditions precedent to
funding in the conduits have been met.
On March 31, 2003, Thomas H. Lee Equity Fund IV, L.P. ("THL Fund IV")
committed to provide a term loan to the Company in an aggregate amount of $125
million as a backup financing facility, secured by assets of the Company. 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 17, 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.
The Internal Revenue Service ("IRS") has recently completed its examination
of the Company's tax returns through December 31, 1998. The IRS has proposed
adjustments to increase the Company's federal income tax by $42.9 million, plus
interest of more than $15 million, pertaining to the Company's treatment of
certain credit card fees as
original issue discount ("OID"). Although these fees are primarily reported as
income when billed for financial reporting purposes, we believe the fees
constitute OID and must be deferred and amortized over the life of the
underlying credit card 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.
During the next twelve months we have contractual cash obligations of $444
million, off-balance sheet funding scheduled to amortize of $1.9 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 receivables, maturing debt obligations and general
operating needs. During the next twelve months we intend to reduce outstanding
credit receivables in the Master Trust by approximately $1.6 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
and dividend or other capital restrictions.
The Federal Reserve Act imposes various legal limitations on the extent to
which banks can finance or otherwise supply funds to their affiliates. In
particular, Direct Merchants Bank is subject to certain restrictions on any
extensions of credit to or other covered transactions, such as certain purchases
of assets, with MCI and its affiliates. Such restrictions limit Direct Merchants
Bank's ability to lend to MCI and its affiliates. Additionally, Direct Merchants
Bank is limited in its ability to declare dividends to MCI in accordance with
the national bank dividend provisions.
Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the OCC. At March 31, 2003 and December 31, 2002, Direct Merchants
Bank's Tier 1 risk-based capital ratio, risk-based total capital ratio and Tier
1 leverage ratio exceeded the minimum required capital levels, and Direct
Merchants Bank was considered a "well-capitalized" depository institution under
regulations of the OCC, as illustrated in the following table.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, Direct Merchants Bank must meet specific capital guidelines
that involve quantitative measures of assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices.
Direct Merchants Bank's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require Direct Merchants Bank to maintain minimum amounts and ratios (set forth
in the following table) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 leverage
capital (as defined) to average assets (as defined). Failure to meet minimum
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material adverse effect on our financial statements.
Additional information about Direct Merchants Bank's actual capital amounts
and ratios are presented in the following table:
To be
Adequately To Be Well
Actual Capitalized Capitalized
------ ----------- -----------
As of March 31, 2003 Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital ......... $256,335 34.4% $ 59,683 8.0% $ 74,604 10.0%
(to risk-weighted
assets)
Tier 1 Capital ........ 245,580 32.9% 29,842 4.0% 44,762 6.0%
(to risk-weighted
assets)
Tier 1 Capital ........ 245,580 18.5% 53,226 4.0% 66,532 5.0%
(to average assets)
To be
Adequately To Be Well
Actual Capitalized Capitalized
------ ----------- -----------
As of December 31, 2002 Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital ......... $402,891 30.9% $104,465 8.0% $130,581 10.0%
(to risk-weighted
assets)
Tier 1 Capital ........ 385,658 29.5% 52,233 4.0% 78,349 6.0%
(to risk-weighted
assets)
Tier 1 Capital ........ 385,658 24.4% 63,219 4.0% 79,024 5.0%
(to average assets)
FFIEC guidelines indicate that an institution with a concentration in
subprime lending should hold one and one-half to three times the normal minimum
capital required. The OCC has regulatory authority to evaluate the safety and
soundness of Direct Merchants Bank under these more stringent guidelines. The
OCC has required Direct Merchants Bank, under the more stringent guidelines, to
maintain two times the normal minimum capital on those credit card loans that
qualify as subprime loans (FICO score of 660 and below) and maintain a minimum
capital ratio of 10%. Under these more stringent guidelines, Direct Merchants
Bank's total capital ratio as of March 31, 2003 was 22.7%.
Regulatory Matters
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. The OCC terminated
this formal agreement on March 18, 2003.
On March 18, 2003, we entered into an operating agreement with the OCC
designed to ensure that Direct Merchants Bank continues to operate in a safe and
sound manner.
The operating agreement requires, among other things, the following:
o 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 March 31, 2003, 59.1% of the Bank's credit card
receivables were subprime. The Bank will continue to sell credit card
receivables on a daily basis to MCI under the purchase agreement
currently in effect between MCI and the Bank.
o 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.
o 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.
o 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
potentially require MCI to make such capital infusions or provide Direct
Merchants Bank with financial assistance so as to permit Direct Merchants Bank
to meet its liquidity requirements.
The operating agreement required 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 these agreements Direct Merchants Bank declared and paid a
$155 million dividend to us.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which are subject to the "safe harbor" created by those sections.
Forward-looking statements include, without limitation: expressions of the
"belief," "anticipation," or "expectations" of management; 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, our high
liquidity requirement; factors that affect delinquency rates, credit loss rates
and charge-off rates of our credit card receivables; changes in the cost and/or
availability of funding to us due to changes in the deposit, credit card or
securitization markets; changes in the way we are perceived in such markets
and/or conditions relating to existing or future financing commitments; the
success and impact of our existing or modified strategic initiatives; the
effects of government policy and regulation, whether of general applicability or
specific to us, including restrictions and/or limitations relating to our
minimum capital requirements, deposit taking abilities, reserving methodologies,
dividend policies and payments, growth, and/or underwriting criteria; changes in
accounting rules, policies, practices and/or procedures; product development;
consumer loan portfolio growth; competition; legal and regulatory proceedings,
including the impact of ongoing litigation; interest rates; one-time charges;
extraordinary items; and general economic conditions.
These and other risks and uncertainties are discussed in "Legal
Proceedings" (page 44), "Management's Discussion and Analysis of Financial
Condition and Results of Operations" (pages 21-43) and "Quantitative and
Qualitative Disclosures About Market Risk" (pages 43-44). Although we have
attempted to list comprehensively the major risks and uncertainties, other
factors may in the future prove to be important in causing actual results to
differ materially from those contained in any forward-looking statement. Readers
are cautioned not to place undue reliance on any forward-looking statement,
which speaks only as of the date thereof. We undertake no obligation to update
any forward-looking statements, whether as a result of new information, future
events or otherwise.
Selected Operating Data - Managed Basis
In addition to analyzing the Company's performance on an owned basis, we
analyze the Company's financial performance on a managed loan portfolio basis.
On a managed basis, the balance sheets and income statements include other
investors' interests in securitized loans that are not assets of the Company,
thereby reversing the effects of sale accounting under SFAS No. 140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities." We believe this information is meaningful to the reader of the
financial statements. We service the receivables that have been securitized and
sold and own the right to the cash flows from those receivables sold in excess
of amounts owed to security holders.
The following information is not in conformity with accounting principles
generally accepted in the United States of America, however, we believe the
information is relevant to understanding the overall financial condition and
results of operations of the Company.
Table 6: Managed Loan Portfolio
(Dollars in thousands) March 31, % of December 31, % of March 31, % of
2003 Total 2002 Total 2002 Total
---- ----- ---- ----- ---- -----
Period-end balances:
Credit card loans ...................... $ 686,285 $ 846,417 $ 2,219,800
Retained interests and
investors' interests in
loans securitized....................... 9,989,060 10,573,769 9,651,042
----------- ----------- -----------
Managed ................................... $10,675,345 $11,420,186 $11,870,842
=========== =========== ===========
Loans contractually
delinquent:
Credit card loans ...................... 56,419 8.2% 7,876 0.9% 226,347 10.2%
Retained interests and
investors' interests in
loans securitized...................... 1,170,536 11.7% 1,252,073 11.8% 927,764 9.6%
----------- ----------- -----------
Managed ................................... $ 1,226,955 11.5% $ 1,259,949 11.0% $ 1,154,111 9.7%
=========== =========== ===========
Three Months Ended
March 31,
---------
2003 2002
---- ----
Average balances:
Credit card loans ............. $ 751,674 $ 2,497,941
Retained interests and
investors' interests in
loans securitized............. 10,405,396 9,546,574
----------- -----------
Managed ......................... $11,157,070 $12,044,515
=========== ===========
Net charge-offs:
Credit card loans ............. 8,289 4.5% 83,678 13.6%
Retained interests and
investors' interests in
loans securitized............ 486,486 19.0% 300,496 12.8%
----------- -----------
Managed ......................... $ 494,775 18.0% $ 384,174 12.9%
=========== ===========
The increase in the managed delinquency rates as of March 31, 2003 over
December 31, 2002 and March 31, 2002 primarily reflects various factors,
including 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 customers due to increased average outstanding balances, which
require higher monthly payments. This, along with a deteriorating economy, has
made our collections efforts more difficult, resulting in higher delinquencies.
Total managed loans decreased $744.8 million to $10.7 billion as of March
31, 2003, compared to $11.4 billion as of December 31, 2002. This was primarily
due to a reduction in credit lines, tighter underwriting standards implemented
in 2002 and lower new accounts. The amount of credit card receivables in debt
forbearance programs was $868.5 million or 8.1% of total managed loans as of
March 31, 2003, compared with $860.1 million or 7.5% of managed loans as of
December 31, 2002. All delinquent receivables in debt forbearance programs are
included in Table 6.
Managed net charge-offs increased $110.6 million for the three month ended
March 31, 2003 compared to the same period 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 $186.0 million, representing 35.7% of total
managed gross charge-offs as of March 31, 2003 and $152.6 million, representing
37.8% of total managed gross charge-offs as of March 31, 2002. In addition to
those bankrupt accounts that were charged-off, we received formal notification
of $86.2 million and $63.2 million of managed bankrupt accounts as of March 31,
2003 and 2002, respectively.
Net Interest Income
Table 7: Analysis of Average Balances, Interest and Average Yields and Rates
Three Months Ended
March 31,
2003 2002
--------------------------
(Dollars in thousands)
Average interest-earning
assets:
Owned .............................. $ 1,408,663 $ 2,798,000
Retained interests and
investors' interests in
loans securitized................. 10,405,396 9,546,574
----------- -----------
Managed ................................ $11,814,059 $12,344,574
=========== ===========
Net interest income:
Owned ............................... $ 12,820 $ 57,679
Retained interests and
investors' interests in
loans securitized................. 408,427 380,594
----------- -----------
Managed ................................ $ 421,247 $ 438,273
=========== ===========
Net interest margin (1):
Owned ............................... 3.7% 8.4%
Retained interests and
investors' interests in
loans securitized................. 15.9% 16.2%
Managed ................................ 14.5% 14.4%
(1) We compute net interest margin by dividing annualized net interest income
by average total interest-earning assets.
Managed net interest income for the three months ended March 31, 2003 was
$421.2 million, compared to $438.3 million for the same period in 2002. Net
interest income consists primarily of interest earned on our credit card loans
less interest expense on borrowing to fund the loans. The decrease is primarily
due to a $530.5 million decrease in managed average interest-earning assets.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
rates. Our principal market risk is due to changes in interest rates. This
affects us directly in our lending and borrowing activities, as well as
indirectly, as interest rates may impact the payment performance of our
cardholders.
To manage our direct risk to market interest rates, management actively
monitors the interest rates and the interest sensitive components of our owned
and managed balance sheet to minimize the impact that changes in interest rates
have on the fair value of assets, net income and cash flow. We seek to minimize
that impact primarily by matching asset and liability repricings.
Our primary managed assets are credit card loans, which are virtually all
priced at rates indexed to the variable Prime rate. We fund credit card loans
through a combination of cash flows from operations, asset securitizations, bank
loans, subsidiary bank deposits, long-term debt and equity issuances. Our
securitized loans are owned by the Master Trust and bank-sponsored single-seller
and multi-seller receivables conduits within the Master Trust, which have
committed funding primarily indexed to variable commercial paper rates and
LIBOR. Our $270 million bank credit facility consisted of a $170 million
revolving credit facility that was indexed to the Prime rate and a $100 million
term loan that is indexed to LIBOR. Effective March 17, 2003, the $170 million
revolving credit facility was terminated. The long-term debt is at fixed
interest rates. At March 31, 2003, none of the securities issued out of the
Master Trust and conduit funding of securitized receivables was funded with
fixed rate securities, compared to 8.8% at March 31, 2002.
In an interest rate environment with rates significantly above current
rates, the potential negative impact on earnings of higher interest expense is
partially mitigated by fixed rate funding and interest rate cap contracts.
The approach we use to quantify interest rate risk is a sensitivity
analysis, which we believe best reflects the risk inherent in our business. This
approach calculates the impact on net income from an instantaneous and sustained
change in interest rates of 200 basis points. Assuming that we take no
counteractive measures, as of March 31, 2003, a 200-basis-point increase in
interest rates affecting our floating rate financial instruments, including both
debt obligations and loans, would result in a decrease in net income of
approximately $29.4 million relative to a base case over the next 12 months,
compared to an approximate $11.0 million decrease as of December 31, 2002
relative to a base case over the next 12 months. A decrease of 200 basis points
would result in an increase in net income of approximately $43.0 million as of
March 31, 2003, and an increase of $55.0 million as of December 31, 2002.
The change in the 12 month sensitivity to both a 200 basis point increase
and decrease in the market interest rate is mainly due to an increase in loan
balances in the first quarter where the interest rate charged on customer loan
balances is below the floor rate and a continued decrease in the forecasted
future loan balances. You should not construe our use of this methodology to
quantify the market risk of financial instruments as an endorsement of its
accuracy or the accuracy of the related
assumptions. In addition, this methodology does not take into account the
indirect impact interest rates may have on the payment performance of our
cardholders, or the fact that LIBOR and Prime rates may not move in tandem in an
increasing or decreasing rate environment. The quantitative information about
market risk is necessarily limited because it does not take into account
operating transactions or other costs associated with managing immediate changes
in interest rates.
Item 4. Controls and Procedures
Within the 90-day period prior to the filing of this Report, an evaluation
was performed under the supervision and with the participation of the Company's
management, including the Chairman and Chief Executive Officer ("CEO") and the
Chief Financial Officer ("CFO"), of the effectiveness of the design and
operation of the Company's disclosure controls and procedures. Based on that
evaluation, the Company's management, including the CEO and CFO, have concluded
that the Company's disclosure controls and procedures are effective in ensuring
that information required to be disclosed in the reports it files under the
Securities Exchange Act of 1934 are recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms. There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect internal controls
subsequent to the evaluation date.
Part II. Other Information
Item 1. Legal Proceedings
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 an OCC Report of Examination until April 17, 2002. We believe the
lawsuit is without merit and defendants have moved for its dismissal.
In addition to the foregoing, we are a party to various legal proceedings
resulting from the ordinary business activities related to our operations.
Due to the uncertainties of litigation, we cannot assure you that we will
prevail on all claims made against us in the lawsuits that we currently fact or
that additional proceedings will not be brought.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
10.1 Operating Agreement, dated as of March 18, 2003, between MCI
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)).
10.2 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)).
10.3 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)).
10.4 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)).
10.5 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)).
11. Computation of Earnings Per Share.
99.1 Certification of Principal Executive Officer Pursuant to
Section 1350 of Chapter 63 of Title 18 of the United States
Code.
99.2 Certification of Principal Financial Officer Pursuant to
Section 1350 of Chapter 63 of Title 18 of the United States
Code.
(b) Reports on Form 8-K:
On January 23, 2003, we filed a Current Report on Form 8-K to report
that on January 22, 2003, Metris Companies Inc. issued a press release
announcing a workforce reduction.
On February 28, 2003, we filed a Current Report on Form 8-K to report
that on February 27, 2003, Metris Companies Inc. issued a press
release correcting a prior announcement regarding a payment of
dividends and clarifying that the dividend announced February 27,
2003, of $.01 per share payable March 31, 2003, would not be paid. The
Company determined
that the dividend could not be paid under the terms of its credit
agreement which prohibits the payment of dividends following a year in
which a loss was incurred.
On March 19, 2003, we filed a Current Report on Form 8-K to report
that: 1. Metris Receivables, Inc., our wholly owned subsidiary,
through the Metris Master Trust, entered into $850 million of 364-day
warehouse financing facilities with its bank groups. The availability
of funding under these facilities is subject to various conditions,
including a net reduction of receivables in the Metris Master Trust;
2. the termination of our $170 million revolving credit facility; and
3. Metris and its subsidiary, Direct Merchants Credit Card Bank, N.A.,
entered into an Operating Agreement and related agreements including a
Capital Assurance and Liquidity Maintenance Agreement, and a Liquidity
Reserve Deposit Agreement each dated March 18, 2003 with the Office of
the Comptroller of the Currency designed to ensure the ongoing safety
and soundness of the Bank's operations. The operating agreement
includes liquidity and capital maintenance provisions for the bank. By
entering into this new agreement, the bank was able to pay a dividend
in the amount of $155 million. The Bank's existing formal agreement
with the OCC, signed in April 2002, was also terminated.
On April 16, 2003, we filed a Current Report on Form 8-K to report the
submission of unaudited financial statements in a press release dated
April 16, 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
METRIS COMPANIES INC.
(Registrant)
Date: May 15, 2003 By: /s/ John A. Witham
-------------------
John A. Witham
Executive Vice President, Chief Financial Officer
Principal Financial Officer
Date: May 15, 2003 By: /s/ Mark P. Wagener
--------------------
Mark P. Wagener
Senior Vice President, Controller
Principal Accounting Officer
Certification
I, David D. Wesselink, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Metris Companies Inc.
"Registrant";
2. Based on my knowledge, this Quarterly Report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this Quarterly Report;
3. Based on my knowledge, the financial statements, and other financial
information included in this Quarterly Report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the Registrant as of, and for, the periods presented in this
Quarterly Report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this Quarterly
Report is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this Quarterly Report (the "Evaluation Date"); and
c) presented in this Quarterly Report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the Audit
Committee of the Registrant's Board of Directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officers and I have indicated in this
Quarterly Report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 15, 2003
/s/ David D. Wesselink
- ----------------------
David D. Wesselink
Chairman and Chief Executive Officer
(Principal Executive Officer)
Certification
I, John A. Witham, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Metris Companies Inc.
"Registrant";
2. Based on my knowledge, this Quarterly Report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this Quarterly Report;
3. Based on my knowledge, the financial statements, and other financial
information included in this Quarterly Report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the Registrant as of, and for, the periods presented in this
Quarterly Report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this Quarterly
Report is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this Quarterly Report (the "Evaluation Date"); and
c) presented in this Quarterly Report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the Audit
Committee of the Registrant's Board of Directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officers and I have indicated in this
Quarterly Report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 15, 2003
/s/ John A. Witham
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John A. Witham
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)