UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM 10-K/A
AMENDMENT NO. 1
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended 001-12351
December 31, 2001 Commission file number
--------------------
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)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.01 Par Value
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K/A or any amendment to
this Form 10-K/A.
As of March 15, 2002, 62,225,770 shares of the Registrant's Common Stock were
outstanding and the aggregate market value of common stock held by
non-affiliates of the Registrant on that date was approximately $1,448,927,016
based upon the closing price on the New York Stock Exchange on March 15, 2002.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Proxy Statement for the Annual Meeting of Shareholders
of Metris Companies Inc. held on May 7, 2002, which was filed with the
Securities and Exchange Commission within 120 days after December 31, 2001, are
incorporated by reference in Part III.
TABLE OF CONTENTS
PART I
Page
Item 1. Business.............................................................. 2
Item 2. Properties............................................................32
Item 3. Legal Proceedings.....................................................32
Item 4. Submission of Matters to a Vote of Security Holders...................33
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.........................................................33
Item 6. Selected Financial Data...............................................34
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.........................................36
Item 7A.Quantitative and Qualitative Disclosures
About Market Risk...........................................................50
Item 8. Financial Statements and Supplementary Data...........................62
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure........................................111
PART III
Item 10. Directors and Executive Officers of the Registrant..................111
Item 11. Executive Compensation..............................................111
Item 12. Security Ownership of Certain Beneficial
Owners and Management......................................................111
Item 13. Certain Relationships and Related Transactions......................111
PART IV
Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K....................................................112
Signatures...................................................................113
Exhibit Index................................................................116
PART I
Item 1. Business
Metris Companies Inc. ("MCI") and its subsidiaries, which may be referred
to as "we," "us," "our," and the "Company," is one of the nation's leading
providers of financial services products and services. The company issues credit
cards through its wholly owned subsidiary, Direct Merchants Credit Card Bank,
National Association ("Direct Merchants Bank"), the 10th largest bankcard issuer
in the United States. As a top-tier enhancement services company, MCI also
offers consumers a variety of products, including credit card protection and
insurance, extended service plans and membership clubs. Our credit card
customers and prospects include individuals for whom credit bureau information
is available ("external prospects") and persons identified through other
third-party sources including customer lists and databases. We market our
enhancement services, including debt waiver programs, membership clubs, extended
service plans and third-party insurance to our credit card customers, customers
of third parties and the broad market.
MCI was incorporated in Delaware on August 20, 1996, and completed an
initial public offering in October 1996. Our principal subsidiaries are Direct
Merchants Bank, Metris Direct, Inc. and Metris Receivables, Inc.
Business Segments
We measure performance and operate in two business segments:
o Consumer Lending Products, which are primarily unsecured and partially
secured credit cards issued by Direct Merchants Bank; and
o Enhancement Services, which include credit protection, membership clubs,
extended service plans and third-party insurance offered to our credit card
customers, customers of third parties and the broad market.
We generate income from our consumer lending products through:
o interest and other finance charges assessed on outstanding credit card
loans;
o credit card fees (including annual membership, cash advances, overlimit
fees, and late fees);
o interchange fees; and
o collections and sales on recovery assets.
The primary expenses of this business are:
o the costs of funding the loans;
o provisions for loan losses and operating expenses, including employee
compensation, account solicitation and marketing expenses; and
o data processing and servicing expenses.
2
Profitability is affected by:
o response and approval rates to solicitation efforts;
o loan growth;
o interest spreads on loans;
o credit card usage;
o credit quality (delinquencies and charge-offs);
o card cancellations; and
o fraud losses.
Our consumer lending business primarily targets moderate-income consumers
who we believe have historically been overlooked by other credit card companies.
We target and evaluate prospective customers in this market by using our
proprietary scoring techniques, together with information from credit bureaus
and other customer lists and databases, to determine a potential customer's
creditworthiness. We also use sophisticated modeling techniques to evaluate the
expected risk, responsiveness and profitability of each prospective customer and
to offer and price the products and services we believe to be appropriate for
each customer. (See more detailed discussion following under the caption
"Business Lines" on pages 5 through 18 of this Report.)
In addition to sales to third parties, the enhancement services business
derives benefits from our consumer lending business because we cross-sell these
services to our credit cardholders. Nonetheless, our two business segments are
different with respect to the factors that affect profitability, including how
income is generated and how expenses are incurred. These differences require us
to manage our operations separately.
We receive revenue from our enhancement services through fees for those
services.
Expenses include costs of:
o solicitation;
o underwriting and claims servicing expenses;
o fees paid to third parties; and
o other operating expenses.
The primary factors that affect profitability for this business are:
o response rates to solicitation efforts;
o returns or cancel rates;
o renewal rates; and
o claims rates.
3
Strategy
The principal components of our strategy are the following:
Identify and solicit additional external prospects for credit cards
We intend to continue adding credit card accounts through the use of our
own internally developed risk models. We have developed our own proprietary
credit risk modeling system. By incorporating individual credit information from
the major credit bureaus into this proprietary modeling system, we expect to
generate additional customer relationships from external prospects.
Use risk-based pricing
We determine the specific pricing for an individual's credit card offer
through the prospective customer's risk profile and expected responsiveness
prior to solicitation and continually monitor and adjust pricing as the
relationship continues, a practice known as "risk-based pricing." We believe the
use of risk-based pricing allows us to maximize the profitability of a customer
relationship.
Pursue acquisitions of credit card portfolios or businesses
We pursue acquisitions of credit card portfolios or businesses whose
customers fit our product and target market profile or which otherwise
strategically fit with our business.
Increase the number of third-party customers using our products and
services
We seek to access additional customers for our products and services by
establishing relationships with third parties. Our strategy is to continue to
use our proprietary risk, response and profitability models to solicit strategic
partners' customers for credit cards and to focus our cross-selling activities
in order to increase the volume of enhancement services products purchased by
these customers.
Sell multiple products and services to each customer
We intend to use interactions with our customers to sell additional
products, thereby leveraging our account acquisition costs and infrastructure.
Currently, we focus our efforts on selling enhancement services to our credit
card customers and customers of third parties.
Diversify product offerings to our customers
We segment markets to expand the success of our existing consumer lending
products and enhancement services. We analyze the data in our proprietary
database and the databases of others to determine the needs of our target
markets. Then we develop, test and effectively market these new products to our
target markets.
4
Business Lines
We operate through two businesses: consumer lending products and
enhancement services.
Consumer Lending Products
Products
Our consumer lending products are primarily unsecured and partially secured
credit cards, including the Direct Merchants Bank MasterCard(R) and Visa(R). We
offer co-branded credit cards and may also offer other consumer lending products
either directly or through alliances with other companies. At December 31, 2001,
we had approximately 4.9 million credit card accounts with approximately $11.9
billion in managed credit card receivables. According to the Nilson Report, at
December 31, 2001, we were the 9th largest MasterCard(R) issuer in the United
States based on the number of cards issued, and the 10th largest bankcard issuer
based on managed credit card loan balances.
Prospects
Our primary sources of prospects to solicit for credit card offers are
obtained from credit bureau queries and individuals in third-party customer
lists and databases. Currently, our most significant source is the leads
obtained from credit bureau inquiries.
Credit Scoring
We use internally and externally developed proprietary models to enhance
our evaluation of prospects. These models help segment prospects into narrower
ranges within each risk score provided by Fair, Isaac and Co. ("FICO"), allowing
us to better evaluate individual credit risk and to tailor our risk-based
pricing accordingly. We also use this segmentation to exclude certain
individuals from our marketing solicitations.
We generate external prospects from lists obtained from the major credit
bureaus based on criteria established by us as well as from other third-party
sources. We use proprietary models and additional analysis in conjunction with
the files obtained from credit bureaus to further segment prospects based upon
their likelihood of default.
We believe our methods are effective in further segmenting and evaluating
risk within risk score bands. We have and continue to use the results of our
analysis of prospects to adjust the proprietary models to determine the pricing
for various segments and to exclude certain segments from subsequent direct
marketing efforts. While we believe that the proprietary models and additional
analysis are valuable tools in analyzing relative risks, it is not possible to
accurately predict which consumers will default or the overall level of
defaults.
We believe that both the proprietary models and our internal credit score
give us a competitive advantage in evaluating the credit risk of moderate-income
consumers and thereby broaden our customer prospect base. After every marketing
campaign, we monitor the performance of the proprietary models and continually
re-evaluate the effectiveness of these models in segmenting credit risk,
resulting in further refinements to our selection criteria for prospects. Over
time, we believe that we will capture additional credit information on the
behavioral characteristics of prospects which will allow us to further increase
the effectiveness of our proprietary models.
5
Solicitation
Prospects for solicitation include both external prospects and customers of
third parties. We contact prospects on a nationwide basis primarily through
pre-screened direct mail, invitation to apply and telephone solicitations. We
receive responses to our solicitations, perform fraud screening, verify name and
address changes, and obtain any information which may be missing from the
application. We then make the credit decisions and approve, deny or begin the
exception processing. We process exceptions for, among other things, derogatory
credit bureau information and fraud warnings. Our credit analysts process
exception applications based on policies approved by our credit policy
committee.
Pricing
Through risk-based pricing, we price credit card offers based upon a
prospect's risk profile prior to solicitation or upon receipt of an application.
We evaluate a prospect to determine credit needs, credit risk and existing
credit availability, and then develop a customized offer that includes the most
appropriate product, brand, pricing and credit line. We have numerous pricing
structures on our credit card products. After credit card accounts are opened,
we periodically monitor customers' internal and external credit performance and
recalculate delinquency, profitability, attrition and bankruptcy predictors. As
customers evolve through the credit life cycle and are regularly rescored, the
lending relationship may evolve to include more or less restrictive pricing and
product configurations.
Age of Portfolio
The following tables set forth, as of December 31, 2001 and 2000, the
number of credit card accounts and the amount of outstanding loans based on the
age of the owned accounts. (Accounts in acquired portfolios are presented based
on when the account was originated with the previous issuer.)
(Dollars in thousands)
2001
Age Since Percentage of
Origination Number Percentage Loans Loans
----------- of Accounts of Accounts Outstanding Outstanding
----------- ----------- ----------- -----------
0-6 Months .......................... 419,586 21.2% $ 327,733 11.9%
7-12 Months ......................... 269,831 13.7% 478,649 17.4%
13-18 Months ........................ 297,057 15.0% 496,114 18.1%
19-24 Months ........................ 324,656 16.4% 534,486 19.5%
25-36 Months ........................ 145,054 7.3% 223,041 8.1%
37+ Months .......................... 521,171 26.4% 686,633 25.0%
--------- ----- ---------- -----
Total .......................... 1,977,355 100.0% $2,746,656 100.0%
========= ===== ========== =====
2000
Percentage of
Age Since Number Percentage Loans Loans
Origination of Accounts of Accounts Outstanding Outstanding
----------- ----------- ----------- ----------- -----------
0-6 Months .......................... 482,344 26.1% $ 184,238 15.6%
7-12 Months ......................... 456,199 24.7% 270,136 22.9%
13-18 Months ........................ 75,137 4.1% 39,460 3.4%
19-24 Months ........................ 17,763 1.0% 5,777 0.5%
25-36 Months ........................ 62,658 3.4% 48,681 4.1%
37+ Months .......................... 750,572 40.7% 630,911 53.5%
---------- ----- ---------- -----
Total .......................... 1,844,673 100.0% $1,179,203 100.0%
========== ===== ========== =====
6
The following tables set forth, as of December 31, 2001 and 2000, the
number of credit card accounts and the amount of outstanding loans based on the
age of the managed accounts (includes investors' interests in securitized
loans). (Accounts in acquired portfolios are presented based on when the account
was originated with the previous issuer.)
(Dollars in thousands)
2001
Percentage of
Age Since Number Percentage Loans Loans
Origination of Accounts of Accounts Outstanding Outstanding
----------- ----------- ----------- ----------- -----------
0-6 Months ......................... 587,942 11.9% $ 576,621 4.8%
7-12 Months ........................ 466,773 9.5% 756,112 6.4%
13-18 Months ....................... 552,678 11.2% 976,050 8.2%
19-24 Months ....................... 547,183 11.1% 1,160,980 9.8%
25-36 Months ....................... 613,626 12.5% 1,767,649 14.8%
37+ Months ......................... 2,161,177 43.8% 6,668,741 56.0%
---------- ----- ----------- -----
Total ......................... 4,929,379 100.0% $11,906,153 100.0%
========== ===== =========== =====
2000
Percentage of
Age Since Number Percentage Loans Loans
Origination of Accounts of Accounts Outstanding Outstanding
----------- ----------- ----------- ----------- -----------
0-6 Months ......................... 754,748 16.9% $ 626,709 6.8%
7-12 Months ........................ 700,055 15.7% 843,396 9.1%
13-18 Months ....................... 456,801 10.2% 819,667 8.8%
19-24 Months ....................... 252,058 5.6% 521,530 5.6%
25-36 Months ....................... 596,358 13.4% 1,672,647 18.0%
37+ Months ......................... 1,703,962 38.2% 4,789,159 51.7%
---------- ----- ---------- -----
Total ......................... 4,463,982 100.0% $9,273,108 100.0%
========= ===== ========== =====
7
Geographic Distribution
We solicit credit card customers on a national basis and, therefore,
maintain a geographically diversified portfolio. The following tables show the
distribution of managed accounts and amount of managed outstanding loans by
state, as of December 31, 2001 and 2000.
(Dollars in thousands)
2001 Percentage of
Number Percentage Loans Loans
State of Accounts of Accounts Outstanding Outstanding
----- ----------- ----------- ----------- -----------
California ......... 684,964 13.9% $ 1,487,384 12.5%
New York ........... 426,585 8.7% 1,001,146 8.4%
Texas .............. 407,072 8.3% 963,379 8.1%
Florida ............ 354,529 7.2% 866,722 7.3%
Illinois ........... 210,230 4.3% 493,124 4.1%
Ohio ............... 186,421 3.8% 483,621 4.1%
Pennsylvania ....... 161,812 3.3% 407,574 3.4%
New Jersey ......... 156,847 3.2% 354,337 3.0%
Michigan ........... 135,341 2.7% 338,404 2.8%
Georgia ............ 123,223 2.5% 320,815 2.7%
Virginia ........... 122,899 2.5% 313,126 2.6%
All others (1) ..... 1,959,456 39.6% 4,876,521 41.0%
--------- ----- ----------- -----
Total ......... 4,929,379 100.0% $11,906,153 100.0%
========= ===== =========== =====
2000 Percentage of
Number Percentage Loans Loans
State of Accounts of Accounts Outstanding Outstanding
----- ----------- ----------- ----------- -----------
California ......... 607,333 13.6% $1,170,856 12.6%
Texas .............. 382,037 8.6% 789,888 8.5%
New York ........... 373,952 8.4% 755,207 8.1%
Florida ............ 325,352 7.3% 690,960 7.5%
Ohio ............... 170,282 3.8% 375,759 4.1%
Illinois ........... 180,612 4.0% 371,976 4.0%
Pennsylvania ....... 142,140 3.2% 303,338 3.3%
Michigan ........... 120,718 2.7% 257,569 2.8%
New Jersey ......... 131,746 3.0% 254,643 2.7%
Georgia ............ 116,016 2.6% 250,599 2.7%
Virginia ........... 114,050 2.6% 245,829 2.7%
North Carolina ..... 109,858 2.5% 231,943 2.5%
All others (1) ..... 1,689,886 37.7% 3,574,541 38.5%
--------- ----- ---------- -----
Total ......... 4,463,982 100.0% $9,273,108 100.0%
========= ===== ========== =====
(1) No other state accounts for more than 2.5% of loans outstanding.
Credit Lines
Once we approve an account, we use automated screening and credit scoring
techniques to establish an initial credit line based on the individual's risk
profile. We may elect, at any time and without prior notice to a cardholder, to
prevent or restrict further credit card use by the cardholder, usually as a
result of poor payment
8
performance or our concern over the creditworthiness of the cardholder. We
manage credit lines based on the results of the behavioral scoring analysis, and
in accordance with our internally established criteria. These analytic models
automatically and regularly assign credit line increases and decreases to
individual customers, as well as determine the systematic collection steps to be
taken at the various stages of delinquency. We use these models to manage the
authorization of each transaction, as well as the collections strategies used
for non-delinquent accounts with balances above their assigned credit lines.
The following tables set forth information with respect to credit limit and
account balance ranges of our owned credit card loan portfolio, as of December
31, 2001 and 2000.
(Dollars in thousands)
2001 Percentage of
Number of Loans Loans Percentage
Credit Limit Range Accounts Outstanding Outstanding Open to Buy Utilized
------------------ -------- ----------- ----------- ----------- --------
$1,000 or Less . 285,573 $ 125,578 4.6% $ 65,236 65.8%
$1,001-$2,000 .. 300,827 253,301 9.2% 234,328 51.9%
$2,001-$3,500 .. 392,914 471,482 17.2% 664,365 41.5%
$3,501-$5,000 .. 330,690 506,166 18.4% 943,968 34.9%
$5,001-$10,000 . 511,596 930,876 33.9% 2,896,001 24.3%
Over $10,000 ... 155,755 459,253 16.7% 1,493,769 23.5%
---------- ---------- ----- ---------- -----
Total ..... 1,977,355 $2,746,656 100.0% $6,297,667 30.4%
========== ========== ===== ========== =====
2000 Percentage of
Number of Loans Loans Percentage
Credit Limit Range Accounts Outstanding Outstanding Open to Buy Utilized
------------------ -------- ----------- ----------- ----------- --------
$1,000 or Less . 478,380 $ 106,030 9.0% $ 75,326 58.5%
$1,001-$2,000 .. 261,838 119,426 10.1% 190,560 38.5%
$2,001-$3,500 .. 309,578 207,424 17.6% 490,915 29.7%
$3,501-$5,000 .. 217,586 177,141 15.0% 609,388 22.5%
$5,001-$10,000 . 420,298 364,862 31.0% 2,529,364 12.6%
Over $10,000 ... 156,993 204,320 17.3% 1,556,756 11.6%
---------- ---------- ----- ---------- -----
Total ..... 1,844,673 $1,179,203 100.0% $5,452,309 17.8%
========= ========== ===== ========== ====
2001
Percentage of
Account Number of Loans Loans Percentage
Balance Range Accounts Outstanding Outstanding Open to Buy Utilized
------------- -------- ----------- ----------- ----------- --------
Credit Balance . 23,973 $ (2,370) (0.1%) $ 79,986 (3.1%)
No Balance ..... 667,750 -- -- 3,548,784 --
$1,000 or Less . 542,734 251,743 9.2% 1,398,772 15.3%
$1,001-$2,000 .. 267,326 406,266 14.8% 474,256 46.1%
$2,001-$3,500 .. 231,103 644,837 23.5% 388,647 62.4%
$3,501-$5,000 .. 124,025 538,151 19.6% 211,318 71.8%
$5,001-$10,000 . 107,181 743,293 27.0% 183,097 80.2%
Over $10,000 ... 13,263 164,736 6.0% 12,807 92.8%
---------- ----------- ----- ----------- -----
Total ..... 1,977,355 $ 2,746,656 100.0% $ 6,297,667 30.4%
========== =========== ===== =========== =====
9
2000
Percentage of
Account Number of Loans Loans Percentage
Balance Range Accounts Outstanding Outstanding Open to Buy Utilized
------------- -------- ----------- ----------- ----------- --------
Credit Balance. 23,496 $ (1,164) (0.1%) $ 81,962 (1.4%)
No Balance .... 558,907 -- -- 3,263,100 --
$1,000 or Less. 660,218 157,506 13.4% 1,114,966 12.4%
$1,001-$2,000 . 230,537 177,258 15.0% 364,141 32.7%
$2,001-$3,500 . 185,463 259,997 22.1% 291,274 47.2%
$3,501-$5,000 . 86,095 188,517 16.0% 162,524 53.7%
$5,001-$10,000 86,319 310,644 26.3% 158,001 66.3%
Over $10,000 .. 13,638 86,445 7.3% 16,341 84.1%
--------------- ----------- ----------- ----- ----------- -----
Total .... 1,844,673 $ 1,179,203 100.0% $ 5,452,309 17.8%
=========== =========== ===== =========== =====
The following tables set forth information with respect to credit limit and
account balance ranges of our managed loan portfolio (includes investors'
interests in loans securitized), as of December 31, 2001 and 2000.
(Dollars in thousands)
2001 Percentage of
Number of Loans Loans Percentage
Credit Limit Range Accounts Outstanding Outstanding Open to Buy Utilized
------------------ -------- ----------- ----------- ----------- --------
$1,000 or Less. 480,909 $ 275,322 2.3% $ 102,657 72.8%
$1,001-$2,000 . 566,593 558,262 4.7% 396,326 58.5%
$2,001-$3,500 . 774,180 1,097,179 9.2% 1,123,276 49.4%
$3,501-$5,000 . 768,475 1,439,888 12.1% 1,882,893 43.3%
$5,001-$10,000. 1,585,518 4,508,918 37.9% 6,959,736 39.3%
Over $10,000 .. 753,704 4,026,584 33.8% 5,213,070 43.6%
--------------- ----------- ----------- ----- ----------- -----
Total .... 4,929,379 $11,906,153 100.0% $15,677,958 43.2%
=========== =========== ===== =========== =====
2000 Percentage of
Number of Loans Loans Percentage
Credit Limit Range Accounts Outstanding Outstanding Open to Buy Utilized
------------------ -------- ----------- ----------- ----------- --------
$1,000 or Less. 742,667 $ 386,865 4.2% $ 116,715 76.8%
$1,001-$2,000 . 614,746 673,919 7.2% 356,481 65.4%
$2,001-$3,500 . 804,028 1,323,157 14.3% 988,615 57.2%
$3,501-$5,000 . 731,754 1,698,768 18.3% 1,536,701 52.5%
$5,001-$10,000. 1,405,708 4,636,867 50.0% 5,872,441 44.1%
Over $10,000 .. 165,079 553,532 6.0% 1,986,399 21.8%
--------------- ----------- ----------- ----- ----------- -----
Total .... 4,463,982 $ 9,273,108 100.0% $10,857,352 46.1%
=========== =========== ===== =========== ====
10
(Dollars in thousands)
2001
Percentage of
Account Number of Loans Loans Percentage
Balance Range Accounts Outstanding Outstanding Open to Buy Utilized
------------- -------- ----------- ----------- ----------- --------
Credit Balance . 58,543 $ (5,782) (0.1%) $ 242,223 (2.4%)
No Balance ..... 1,256,609 -- -- 6,873,759 --
$1,000 or Less . 1,021,506 445,748 3.8% 3,399,472 11.6%
$1,001-$2,000 .. 602,868 895,632 7.5% 1,349,978 39.9%
$2,001-$3,500 .. 643,048 1,751,345 14.7% 1,382,679 55.9%
$3,501-$5,000 .. 464,559 1,962,426 16.5% 998,741 66.3%
$5,001-$10,000 . 728,695 5,063,594 42.5% 1,310,997 79.4%
Over $10,000 ... 153,551 1,793,190 15.1% 120,109 93.7%
------------ ------------ ----- ----------- -----
Total ..... 4,929,379 $ 11,906,153 100.0% $15,677,958 43.2%
============ ============ ===== =========== =====
2000
Percentage of
Account Number of Loans Loans Percentage
Balance Range Accounts Outstanding Outstanding Open to Buy Utilized
------------- -------- ----------- ----------- ----------- --------
Credit Balance. 60,809 $ (6,345) (0.1%) $ 208,754 (3.1%)
No Balance ..... 854,604 -- -- 4,926,960 --
$1,000 or Less. 1,232,581 571,426 6.2% 2,704,744 17.4%
$1,001-$2,000 .. 631,019 978,220 10.5% 1,016,205 49.0%
$2,001-$3,500 .. 673,321 1,890,114 20.4% 939,575 66.8%
$3,501-$5,000 .. 460,109 1,996,404 21.5% 579,606 77.5%
$5,001-$10,000.. 536,680 3,612,067 39.0% 459,380 88.7%
Over $10,000 ... 14,859 231,222 2.5% 22,128 91.3%
--------- ----------- ---- ----------- ----
Total .... 4,463,982 $ 9,273,108 100.0% $ 10,857,352 46.1%
============ =========== ===== ============ ====
Since the start of our Broker CD program in 1999 we have distributed, on a
random basis, organically generated customer accounts between the owned
portfolio and accounts included in the Master Trust with the goal of maintaining
a balanced funding mix between bank deposits/conduits and our Master Trust.
Also, acquired portfolios, as well as our partially secured card and partner
programs, were generally included in the owned credit card portfolio. As a
result, the age of our receivables on an owned basis is younger than on a
managed basis. On an owned basis, the percentage of accounts and percentage of
outstanding balances greater than two years since origination as of December 31,
2001 were 33.7% and 33.1% versus 56.3% and 70.8% on a managed basis. In 2000 the
percentage of accounts and percentage of outstanding balance on the owned
portfolio greater than two years since origination were 44.1% and 57.6% versus
51.6% and 69.7% on a managed basis.
As of December 31, 2001 on an owned basis, 16.7% of the outstanding
receivable balance relates to accountholders with credit limits in excess of
$10,000 as compared to 33.8% on a managed basis. On an owned portfolio basis,
50.6% was outstanding to accountholders with credit limits in excess of $5,000,
compared to 71.7% on a managed basis. As of December 31, 2000 on an owned basis,
17.3% of the outstanding receivable balance relates to accountholders with
credit limits in excess of $10,000 as compared to 6.0% on a managed basis. On an
owned basis 48.3% of the credit card portfolio was outstanding to accountholders
with credit limits in excess of $5,000, compared to 56.0% on a managed basis.
The difference in the distributions between the owned and managed portfolios
primarily reflects the generally younger accounts that are in the owned
portfolio.
11
The banking regulators have issued guidelines to further segregate a credit
card issuers loan portfolio between sub-prime loans (loans to consumers who have
a FICO credit score of 660 or less) and prime loans (loans to consumers with
FICO scores in excess of 660). The bank regulators deem sub-prime loans to have
higher credit risk, and therefore require higher levels of capital and allowance
for loan losses. Sub-prime receivables on an owned basis were $1.5 billion or
54% of the owned portfolio as of December 31, 2001, compared to $1.2 billion or
98% of the owned portfolio as of December 31, 2000. The amount of sub-prime
receivables on a managed basis was $6.9 billion or 58% of the managed portfolio
as of December 31, 2001, compared to $5.2 billion or 56% of the managed
portfolio as of December 31, 2000.
Overall, the Company believes that the credit quality in the owned credit
card portfolio is generally similar to the managed portfolio. Delinquent loans
for the owned portfolio were 10.1% and 7.6% as of December 31, 2001 and 2000,
versus 9.4% and 8.3% on a managed basis. Net principal charge-offs in the owned
credit card portfolio were 14.5% and 23.5% for the years ended December 31, 2001
and 2000, versus 11.0% and 9.7% on a managed basis. The higher level of
sub-prime loans on an owned basis as of December 31, 2000 reflects the Company's
partially secured card program, which was discontinued in early 2001. The higher
level of owned charge-offs in both 2001 and 2000 are also principally due to the
partially secured card program.
During 2000 and 2001, the Company completed an industry competitive
analysis which indicated that our credit limits to our customers were
significantly below those offered by our competitors to comparable customers.
The average account balance as of December 31, 2001 was $1,389 on an owned basis
and $2,415 on a managed basis, and the average account balance as of December
31, 2000 was $639 on an owned basis and $2,077 on a managed basis.
Servicing, Billing and Payment
We have established a relationship with First Data Resources, Inc. ("FDR")
for cardholder processing services. FDR is a subsidiary of First Data
Corporation, a provider of information processing and related services,
including cardholder processing (services for financial institutions which issue
credit cards to cardholders), and merchant processing (services for financial
institutions which make arrangements with merchants for the acceptance of credit
cards as methods of payment). FDR provides the following services for us:
o data processing;
o credit card reissuance;
o monthly statements; and
o interbank settlement.
Our processing services agreement with FDR expires in 2011. We handle the
following functions internally:
o applications processing; and
o back office support for mail inquiries and fraud management.
In addition, we handle most inbound customer service telephone calls for
our customer base.
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We generally assess periodic finance charges on an account if the
cardholder has not paid the balance in full from the previous billing cycle. We
base these finance charges on the average daily balance outstanding on the
account during the monthly billing cycle.
If we are not paid in full prior to the due date, which is generally 25
days after the statement cycle date and applicable grace period, we impose
finance charges on all purchases from the date of the transaction to the
statement cycle date. We also impose finance charges on each cash advance from
the day we make the advance until the cardholder pays the advance in full. We
apply finance charges to the average daily balance. We do not impose a finance
charge on purchases if cardholders pay the entire balance on the account by the
due date.
We assess an annual fee on some credit card accounts. We may waive the
annual fee, or a portion thereof, in connection with the solicitation of new
accounts depending on the credit terms offered, which we determined based on the
prospect's risk profile prior to solicitation, or when we determine a waiver to
be appropriate considering the account's overall profitability. In addition to
the annual fee, we charge accounts other fees, including:
o a late fee with respect to any unpaid monthly balance if we do not receive
the required minimum monthly payment by the due date;
o a cash advance fee for each cash advance;
o a fee with respect to each check submitted by a cardholder in payment of an
account, which the cardholder's bank does not honor;
o an overlimit charge if, at any time during the billing cycle, the total
amount owed exceeds the cardholder's credit line by an amount consistent
with the cardholder agreement; and
o card processing or application fees for some credit card offers.
Each cardholder is subject to an agreement governing the terms and
conditions of their account. Pursuant to the agreement, we reserve the right to
change or terminate certain terms, conditions, services and features of the
account (including periodic finance charges, late fees, returned check charges
and any other charges, or the minimum payment), subject to the conditions set
forth in the cardholder agreement.
FDR sends monthly billing statements to cardholders on our behalf. When we
establish an account, we assign a billing cycle to it. Each of these cycles has
a separate monthly billing date based on the business day of the calendar month
on which the cycle begins. Each month, we send a statement to all accounts with
an outstanding balance greater than $1. All cardholders with open accounts must
make a minimum monthly payment, generally the greater of: $15, 2.5% of the
outstanding balance, the finance charge or the balance of the account if the
balance is less than $15, plus any past due amount. If we do not receive the
minimum payment by the due date, we consider the account delinquent.
Most merchant transactions by cardholders are authorized online. The
remaining transactions generally are low dollar amounts, typically below $50.
All authorizations are handled through FDR's adaptive control and fraud
detection systems.
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Delinquency, Collections and Charge-offs
We consider an account delinquent if we do not receive a payment due within
25 days from the closing date of the statement. Once an account becomes
delinquent, the equivalent of three minimum payments must be received before we
re-age the account to current. We handle collections internally, and we
determine the appropriate collection action to take by using the adaptive
control system, which continually monitors all delinquent accounts. We close
accounts that become 60 days contractually delinquent, but do not necessarily
charge them off. We charge off and take accounts as a loss either:
o within 60 days after formal notification of bankruptcy;
o at the end of the month during which most unsecured accounts become
contractually 180 days past due; or
o 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 and at the end of the month during which
partially secured accounts become contractually 120 days past due.
We immediately reserve for and charge off accounts that we identify as
fraud losses no later than 90 days after the last activity. We 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. Periodically, we sell a portion of our charged-off
portfolio to third parties.
Asset Securitizations and Other Funding Vehicles
Our securitizations involve packaging and selling pools of both current and
future receivable balances on credit card accounts, in which we retain the
servicing of such receivables. Our securitizations are treated either as sales
or collateralized borrowing agreements under accounting principles generally
accepted in the United States of America. The securitized receivables accounted
for as sales are removed from our balance sheet and treated as managed loans.
We primarily securitize receivables by selling the receivables either to
our proprietary trust, the Metris Master Trust, or to bank-sponsored
single-seller and multi-seller commercial paper conduits.
The Metris Master Trust
The Metris Master Trust ("Master Trust") was formed in May 1995 pursuant to
a pooling and servicing agreement, as amended. Metris Receivables, Inc. ("MRI"),
one of our subsidiaries, transfers receivables in designated accounts to the
Master Trust in exchange for proceeds and an interest in the Master Trust. MRI
may then exchange portions of this interest for one or more series of securities
which it may then sell publicly or privately to third-party investors. The
securities each represent undivided interests in all of the receivables in the
Master Trust, and may be split into separate classes which have different terms.
The different classes of an individual series are structured to obtain specific
credit ratings. As of December 31, 2001, 15 series of publicly issued securities
were outstanding. We currently retain the most subordinated class of securities
in each series and sell all the other classes.
Generally, each series involves an initial reinvestment period, referred to
as the "revolving period," in which principal payments on receivables allocated
to such series
14
are returned to MRI and reinvested in new receivables arising in the accounts.
After the revolving period ends, principal payments allocated to the series are
then accumulated and used to repay the investors. This period is referred to as
the accumulation period, and is followed by a controlled amortization period
wherein investors are repaid their invested amount. Currently, the Master Trust
has two series in an accumulation period and no series in a controlled
amortization period. The scheduled accumulation and amortization periods are set
in the agreements governing each series. However, all series set forth certain
events by which accumulation and amortization can be accelerated, referred to as
"early amortization." Usually, this would occur if the portfolio collections,
less charge-offs for bad debt, financing costs and operational costs, drop below
zero. New receivables in designated accounts cannot be funded while a series is
in early amortization. We currently do not have any series that are in early
amortization.
On a monthly basis, each series is allocated its share of finance charge
collections, which are used to pay investors interest on their securities, pay
their share of servicing fees and reimburse investors for their share of losses
due to charge-offs. Amounts remaining may be deposited in cash accounts of the
Master Trust as additional protection for future losses. Once each of these
obligations is fully met, any remaining finance charge collections, if any, are
returned to us.
Bank-Sponsored Conduit Programs
We maintain flexibility in our current funding program by maintaining
primarily bank-sponsored commercial paper conduits. These conduits purchase an
interest in receivables arising in designated accounts. These transactions also
feature a revolving period in which principal payments on receivables allocated
to the conduits are returned to us and reinvested in new receivables. These
agreements also have early amortization triggers. Finance charge collections are
used to pay certain obligations, including servicing fees, interest on the
principal amount of the conduits investment in the applicable receivables, and
recouping charge-offs. After such allocation, remaining finance charge
collections, if any, are returned to us.
Additional information regarding asset securitization is set forth under
the caption "Liquidity, Funding and Capital Resources" on pages 51 through 55 of
this Report.
Bank-Sponsored Deposit Programs
Direct Merchants Credit Card Bank, N.A. initiated a jumbo certificate of
deposit (CD) program in March 1999. The CDs are issued in increments of $100,000
by FDIC registered investment brokers. The broker is responsible for marketing
through its retail sales force, customer service and information distribution,
customer record maintenance and tax reporting. The CDs offered have fixed
interest rates and original maturities ranging from 6 months to 5 years.
In May 2000, Direct Merchants Credit card Bank, N.A. began offering jumbo
CDs directly to investors via advertising in local and national newspapers, in
addition to posting rates on several websites. The direct program is run in
conjunction with the brokered program with similar terms.
Recovery Asset Collections and Sales
magnUS Services, Inc. ("magnUS"), our wholly-owned third-party collection
agency, services both pre- and post-charged-off debt from a variety of sources.
magnUS manages the Direct Merchants Bank charged off portfolio from initial
charge-off through account resolution, as well as working pre-determined
delinquent billing cycles, prior to an account being charged off. Additionally,
magnUS services charged-off debt from other
15
third parties and purchased portfolios. magnUS uses sophisticated modeling
techniques to target collection efforts toward customers with a high probability
of securing payment. Revenue is generated based on collection efforts through
contracted contingency rates with third parties. Revenue for purchased
portfolios is recognized through accretion accounting.
Enhancement Services
We market enhancement services in three principal lines of business:
Credit protection and insurance products, including:
o credit account protection benefits arising from death, unemployment,
disability or family leave; and
o third-party insurance offered directly to our credit card customers.
Membership products, including:
o membership benefit programs in categories such as credit bureau monitoring,
fraud prevention and resolution, travel, credit card purchase protection or
automotive assistance.
Warranty products, including:
o extended service plans for third party retail products; and
o warranties for home appliances, systems and electronics.
We currently market the following programs:
Credit Protection and Insurance Products
----------------------------------------
Credit protection and insurance products are sold exclusively to Direct
Merchants Bank credit card customers.
Account Protection PlusSM is a program that will waive the balance of a
customer's Direct Merchants Bank credit card account (up to the credit limit) in
the event of the cardholder's death. It further protects this account in the
event of involuntary unemployment, disability or the need to take a Family
Medical Leave Act leave of absence from employment. In these situations, the
customer's account is "frozen" with no payments due or interest accruing up to
the maximum period of time permissible for each event.
Account Benefit Plan is a program that will waive the balance of a
customer's Direct Merchants Bank credit card account (up to the credit limit) in
the event of the cardholder's death.
Credit Life Insurance offers our credit card customers traditional life
insurance benefits that will pay the balance of the Direct Merchants Bank credit
card account in the event of the cardholder's death. Additional coverage may be
available on a state-by-state basis that will pay the minimum payment due on the
covered account in the event of unemployment or disability. The insurance
benefits are offered by insurance companies that reinsure those policies with
ICOM Limited, our captive insurance subsidiary.
Syndicated Insurance Products. We cooperate with a variety of insurance
companies to sell their regulated products to Direct Merchants Bank customers.
These transactions may follow different constructs. In the simplest, the
insurance company pays us a fee for access to a select list of customers, the
opportunity to leverage
16
Direct Merchants Bank's name during solicitation and billing processes that we
support. When it is in our best interest, we acquire the marketing margin
associated with product sales. In this construct, our licensed insurance agency,
MES Insurance Agency, LLC, manages all customer solicitation and its expense in
exchange for commission. Lastly, in low risk products, our captive insurance
company, ICOM Limited, re-insures the risk of the policies sold. This may range
from a minority percentage to all risk of loss. In this situation, the
administrative costs of servicing these policies are borne by us.
Membership Products
-------------------
Membership products are sold to customers of Direct Merchants Bank,
customers of third-party partners, and directly to consumers.
DirectAlert(R) helps members monitor and review their credit report through
the following benefits:
o unlimited access to their credit report in easy to read paper or electronic
(online) formats;
o regular monitoring updates detailing changes in their credit bureau report;
o information about inquiries or new trade lines opened in their name; and
o access to expert information to assist with handling disputes.
Fraud Alert ServicesSM provides members with a comprehensive ability to
deal with the risks associated with the sudden loss of personal financial
information. Members receive personal computer firewall software to protect
their home computers from attacks by hackers. If credit cards or wallets are
lost or stolen, members can have all their issuers notified with a single call
and emergency cash or airline tickets can be delivered to travelers away from
home. Should any member become the victim of identity theft, experts will help
members resolve these issues by assisting with law enforcement officials, credit
bureaus and other necessary parties.
PurchaseShield(R) is a membership program that offers various levels of
purchase protection to its members. Eligible purchases made on members' credit
cards are protected with the following benefits:
o extended manufacturers warranty;
o sale price protection; and
o product return guarantee.
In addition, PurchaseShield(R) offers its members a household repair rebate
that can be used on certain in-home electro-mechanical item repairs. This
program is administered internally, and all revenues and expenses are our
responsibility.
RoadSaverSM provides members with emergency roadside assistance, an
automotive mechanic helpline, customized trip planning, and car buyer
information services. Members are covered regardless of the car in which they
are traveling, and a single RoadSaverSM membership covers all household family
members.
TripSaverSM gives members a broad array of travel benefits - access to a
full service travel agency, driving vacation packages, restaurant and
entertainment discounts, automotive maintenance rebates and other special travel
offers.
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Warranty Products
-----------------
Extended Service Plans. We issue and administer extended service plans that
provide warranty coverage beyond the manufacturer's warranty period. In general,
the extended service plans that we issue and administer provide customers with
the right to have their covered purchases repaired, replaced, or in certain
circumstances, the purchase price of the product refunded, within certain limits
that we determine. The extended service plans that we have historically sold
were to customers of Fingerhut, and with the likely conclusion of catalog sales
operations at Fingerhut, we anticipate these programs to be in run-off. We will
issue and administer the following programs over a period of up to three years
based upon the original term purchased by a consumer. We are responsible for all
claims made during this period.
ServiceEdge(R) is an extended service plan issued and administered by us
for consumer electronics and other electro-mechanical items. ServiceEdge(R)
customers have the right to have their purchases repaired or replaced in the
event of electrical or mechanical failure or defects in materials and
workmanship for covered events after the manufacturer's warranty expires.
Quality Furniture CareSM is our extended service plan program for
furniture. The services provided to Quality Furniture CareSM customers include
stain cleaning, structural defect or damage repair, or replacement if the
merchandise cannot be repaired.
Quality Jewelry CareSM is our extended service plan for jewelry. The
services provided to Quality Jewelry CareSM customers include repair, soldering,
ring sizing, prong re-tipping and cleaning.
Home Warranties offer consumers a bundled coverage of existing home
appliances, electronics, heating, ventilation, or air conditioning systems,
plumbing and electrical service. These are relatively common products that
protect the consumer beyond the usual manufacturer's warranty. We issue and
administer products that offer a variety of coverages. We are responsible for
all revenues and claims costs of these products. These products are marketed to
the customers of Direct Merchants Bank and our third party partners, as well as
to the broad market.
Home ServiceEdgeSM covers repairs for up to 11 major home appliances and
systems. It is targeted toward homeowners or consumers who have responsibility
for the upkeep of their kitchen and utility appliances, and home heating/cooling
systems. The plan will assist the customer in locating and arranging for repair
service for covered products. In the event that a covered product cannot be
fixed, we will pay a set dollar amount toward the replacement of the product.
Home ServiceEdgeSM offers several different coverage and price point options to
customers based upon their individual need.
Home Electronics Warranty covers common consumer home electronics,
principally audio-visual products. We have designed this product to appeal to a
broad spectrum of consumers, whether they are homeowners or renters.
Competition
As a marketer of consumer lending products, we compete with numerous
providers of financial services, many of which have greater resources than we
do. In particular, our credit card business competes with national, regional and
local bankcard issuers as well as other general purpose credit and debit card
issuers. In general, customers are attracted to credit card issuers largely on
the basis of price, credit limit and other product features; as a result,
customer loyalty is often limited. However, we believe
18
that our strategy of focusing on the moderate-income sector and our proprietary
prospect database, proprietary models and internal credit scores allow us to
compete effectively in the market for moderate-income cardholders. There are
numerous competitors in the enhancement services market, including insurance
companies, financial services institutions and other membership-based or
consumer-enhancement service providers.
Regulation
The Company and Direct Merchants Bank
Direct Merchants Bank is a limited purpose credit card bank chartered as a
national banking association. It is a member of the Federal Reserve System. Its
deposits are insured by the Bank Insurance Fund which is administered by the
Federal Deposit Insurance Corporation ("FDIC") and it is subject to
comprehensive regulation and periodic examination by the Office of the
Comptroller of the Currency ("OCC"), its primary regulator. It is also subject
to regulation by the FDIC, as a back-up regulator. Direct Merchants Bank is not
a "bank" as defined under the Bank Holding Company Act of 1956 ("BHCA"), as
amended, because it:
o engages only in credit card operations;
o does not accept demand deposits or deposits that the depositor may withdraw
by check or similar means for payment to third parties or others;
o does not accept any savings or time deposits of less than $100,000, except
for deposits pledged as collateral for extensions of credit;
o maintains only one office that accepts deposits; and
o does not engage in the business of making commercial loans.
If Direct Merchants Bank failed to meet the credit card bank criteria
described above, Direct Merchants Bank's status as an insured bank would make us
subject to the provisions of the BHCA. We believe that becoming a bank holding
company would limit our ability to pursue future opportunities.
The OCC, as our primary regulator, has established operating guidelines for
national banks. As part of their normal periodic examination process, the OCC
may, in its sole discretion, require banks to modify or stop current practices
based on their interpretation of those guidelines. Such changes to our current
or planned practices may have an impact on the capital, liquidity, earnings and
management of Direct Merchants Bank, which in turn may impact MCI.
The OCC, the Federal Reserve Board, the Federal Deposit Insurance
Corporation and the Office of Thrift Supervision are expanding previously issued
examination guidance for supervising subprime lending activities. This expanded
guidance includes expectations for the allowance for loan losses and regulatory
capital. Under the expanded guidance, the allowance for loan losses required for
subprime loans should be sufficient to absorb at least all estimated credit
losses on outstanding balances over the current operating cycle, typically 12
months. Each subprime lender is responsible for quantifying the amount of
capital needed to offset the additional risk in subprime lending activities, and
for fully documenting the methodology and analysis supporting the amounts
specified. Given the higher risk inherent in subprime lending programs,
examiners may expect that Direct Merchants Bank would hold capital against
subprime
19
portfolios in an amount that is one and one half to three times greater than
what is appropriate for non-subprime assets of a similar type.
Exportation of Interest Rates and Fees
Under current judicial interpretations of federal law, national banks such
as Direct Merchants Bank may charge interest at the rate allowed by the laws of
the state where the bank is located and may "export" those interest rates on
loans to borrowers in other states, without regard to the laws of such other
states.
The United States Supreme Court has held that national banks may also
impose late payment fees, overlimit fees, annual fees, cash advance fees and
membership fees allowed by the laws of the state where the national bank is
located on borrowers in other states, without regard to the laws of such other
states. The Supreme Court based its opinion largely on its deference to a
regulation adopted by the OCC that has been interpreted to permit national banks
to export interest rates. As a result, national banks such as Direct Merchants
Bank may export such fees.
Dividends and Transfers of Funds
There are various federal law limitations on the extent to which Direct
Merchants Bank can finance or otherwise supply funds to MCI and its affiliates
through dividends, loans or otherwise. These limitations include:
o minimum regulatory capital requirements;
o restrictions concerning the payment of dividends out of net profits or
surplus; and
o Sections 23A and 23B of the Federal Reserve Act governing transactions
between a bank and its affiliates.
In general, federal law prohibits a national bank such as Direct Merchants
Bank from making dividend distributions on common stock if the dividend would
exceed currently available undistributed profits. In addition, Direct Merchants
Bank must get OCC approval prior to paying a dividend, if such distribution
would exceed current year net income combined with retained earnings from the
prior two years. Direct Merchants Bank cannot make a dividend if the
distribution would cause it to fail to meet applicable capital adequacy
standards. Finally, although not a regulatory restriction, the terms of certain
debt agreements prohibit the payment of dividends in certain circumstances.
Capital Adequacy
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") requires the banking agencies to prescribe certain non-capital
standards for safety and soundness relating generally to operations and
management, asset quality and executive compensation. FDICIA also provides that
regulatory action may be taken against a bank that does not meet such standards.
The OCC has adopted regulations that define the five capital categories
(well-capitalized, adequately-capitalized, undercapitalized,
significantly-undercapitalized and critically-undercapitalized) identified by
FDICIA, using the total risk-based capital, Tier 1 risk-based capital and
leveraged capital ratios as the relevant capital measures. Such regulations
establish various degrees of corrective action to be taken when an institution
is considered undercapitalized. Under the regulations, a "well-capitalized"
institution must have a Tier 1 capital ratio of at least 6%, a total capital
ratio of at least 10% and a leverage ratio of at least 5% and not be subject to
20
a capital directive order. Under these guidelines, Direct Merchants Bank is
considered well-capitalized.
The OCC's risk-based capital standards explicitly consider a bank's
exposure to declines in the economic value of its capital due to changes in
interest rates when evaluating a bank's capital adequacy. Interest rate risk is
the exposure of a bank's current and future earnings and equity capital arising
from adverse movements in interest rates. The evaluation will be made as a part
of the institution's regular safety and soundness examination.
The FDICIA requires the FDIC to implement a system of risk-based premiums
for deposit insurance pursuant to which the premiums paid by a depository
institution will be based on the probability that the FDIC will incur a loss in
respect of such institution. The FDIC has adopted a system that imposes
insurance premiums based upon a matrix that takes into account a bank's capital
level and supervisory rating.
Under FDICIA, only "well-capitalized" and "adequately-capitalized" banks
may accept brokered deposits. Direct Merchants Bank may accept deposits as part
of its funding and began issuing certificates of deposit ("CDs") in the first
quarter of 1999. These CDs are issued through third-party registered deposit
brokers and directly to the public in increments of $100,000 or more.
Lending Activities
Direct Merchants Bank's activities as a credit card lender are also subject
to regulation under various federal consumer protection laws including the
Truth-in-Lending Act, the Equal Credit Opportunity Act, the Fair Credit
Reporting Act, the Community Reinvestment Act ("CRA") and the Soldiers' and
Sailors' Civil Relief Act. Regulators are authorized to impose penalties for
violations of these statutes and, in certain cases, to order Direct Merchants
Bank to pay restitution to injured cardholders. Cardholders may also bring
actions for certain alleged violations of such regulations. Federal and state
bankruptcy and debtor relief laws also affect Direct Merchants Bank's ability to
collect outstanding balances owed by cardholders who seek relief under these
statutes.
The OCC's CRA regulations subject limited purpose banks, including Direct
Merchants Bank, to a "community development" test for evaluating required CRA
compliance. The community development performance of a limited purpose bank is
evaluated pursuant to various criteria involving community development lending,
qualified investments and community development services.
Legislation
Congress has passed a financial services law that will require many of our
business groups to disclose our practices for collection and sharing of
non-public customer information. The regulations associated with this law could
require us to limit or substantially modify our enhancement services and credit
card marketing activities and practices with third-party companies in ways that
could adversely affect us if these changes result in limits on sharing
information. Furthermore, there is similar or related legislation currently
pending or under consideration at the federal and state level.
From time to time legislation has been proposed in Congress to limit
interest rates and fees that could be charged on credit card accounts or
otherwise restrict practices of credit card issuers. If this or similar
legislation is adopted, our ability to collect on account balances or maintain
previous levels of finance charges and other fees could be adversely affected.
21
Additionally, the U.S. Senate and House of Representatives have each passed
legislation that would amend the federal bankruptcy laws. This legislation, a
form of which is expected to be signed into law, is generally considered to be
favorable to the credit card industry. However, any changes to state debtor
relief and collection laws could adversely affect us if such changes result in,
among other things, accounts being charged off as uncollectible and additional
administrative expenses. Congress and the states may in the future consider
other legislation that would materially affect the credit card and related
enhancement services industries.
Consumer and Debtor Protection Laws
Various federal and state consumer protection laws limit our ability to
offer and extend credit. In addition, the U.S. Congress and the states may
decide to regulate further the credit card industry by enacting laws or
amendments to existing laws to reduce finance charges or other fees or charges
applicable to credit card and other consumer revolving loan accounts. These laws
may adversely affect our ability to collect on account balances or maintain
established levels of periodic rate finance charges and other fees and charges
with respect to the accounts. Similarly, Congress, the OCC and/or the states may
decide to further regulate our enhancement services.
Investment in the Company and Direct Merchants Bank
Certain acquisitions of capital stock may be subject to regulatory approval
or notice under federal law. Investors are responsible for insuring that they do
not directly or indirectly acquire shares of our capital stock in excess of the
amount that can be acquired without regulatory approval.
Interstate Taxation
Several states have passed legislation attempting to tax the income from
interstate financial activities, including credit cards, derived from accounts
held by their residents. We believe this legislation will not materially affect
us. Our belief is based upon current interpretations of the enforceability of
this legislation, prior court decisions and the volume of business in states
that have passed this legislation.
Licensing Requirements
Several state and local government regulators require our subsidiaries to
be licensed in order to offer our enhancement services insurance and warranty
products in these states. We are in the process of obtaining licenses for these
products in the remainder of states. Our captive insurance subsidiary, ICOM
Limited, is licensed in Bermuda under The Insurance Act of 1978 as a Class 2
Insurer. We are restricted from writing any long-term policies or pursuing any
unrelated business in excess of certain limits under Bermuda law.
Fair Credit Reporting Act
The Fair Credit Reporting Act ("FCRA") regulates consumer reporting
agencies. Under the FCRA, an entity risks becoming a consumer reporting agency
if it furnishes consumer reports to third parties. A consumer report is a
communication of information which bears on a consumer's creditworthiness,
credit capacity, credit standing or certain other characteristics and which is
collected or used or expected to be used to determine the consumer's eligibility
for credit, insurance, employment or certain other purposes. The FCRA explicitly
excludes from the definition of consumer report a report containing information
solely as to transactions or experiences between the consumer and the entity
making the report. An entity may share consumer reports with any of its
affiliates so long as that entity provides consumers with an appropriate
disclosure and an opportunity to opt out of such affiliate sharing.
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Our objective is to conduct our operations in a manner that would fall
outside the definition of consumer reporting agency under the FCRA. If we were
to become a consumer reporting agency, however, we would be subject to a number
of complex and burdensome regulatory requirements and restrictions. Such
restrictions could have a significant adverse economic impact on us.
Employees
As of December 31, 2001, we had over 4,000 employees located in Arizona,
Florida, Illinois, Maryland, Minnesota and Oklahoma. None of our employees are
represented by a collective bargaining agreement. We consider our relations with
our employees to be good.
Trademarks, Trade Names and Service Marks
MCI and its subsidiaries have registered and continue to register, when
appropriate, various trademarks, tradenames and service marks used in connection
with its business and for private label marketing of certain of its products. We
consider these trademarks and service marks to be readily identifiable with, and
valuable to, our business.
23
Executive Officers of the Registrant
The following table sets forth certain information concerning the persons
who currently serve as our executive officers. Each executive officer serves at
the discretion of our Board of Directors.
Name Age Position
Ronald N. Zebeck 47 Chairman and Chief Executive
Officer
David D. Wesselink 59 Vice Chairman
William R. Anderson 44 Executive Vice President,
Enhancement Services
Richard G. Evans 53 Executive Vice President,
General Counsel and Secretary
Patrick J. Fox 46 Executive Vice President, Business
Development; President, Direct
Merchants Bank
Joseph A. Hoffman 44 Executive Vice President, Consumer
Credit Card Marketing/Operations
Matthew S. Melius 36 Executive Vice President, Credit
Risk Management
Jon B. Mendel 50 Executive Vice President, Human
Resources
David R. Reak 43 Executive Vice President, Risk
Management/Recovery
Benson K. Woo 47 Chief Financial Officer
Dan N. Piteleski 51 Senior Vice President, Chief
Information Officer
John A. Witham 50 Senior Vice President, Finance
Ralph A. Than 41 Senior Vice President, Treasurer
Mark P. Wagener 41 Senior Vice President, Controller
Ronald N. Zebeck has been our Chairman and Chief Executive Officer since
May 2000 and previously served as President and Chief Executive Officer since
our incorporation in August 1996. Mr. Zebeck has been President of Metris
Direct, Inc. since March 1994 and has served as Chairman of the Board of Direct
Merchants Bank since August 1995. Prior to joining us, Mr. Zebeck was Managing
Director, GM Card Operations of General Motors Corporation from 1991 to 1993,
Vice President, Marketing and Strategic Planning of Advanta Corporation
(Colonial National Bank USA) from 1987 to 1991, Director of Strategic Planning
of TSO Financial (later Advanta Corporation) from 1986 to 1987, and held various
credit card and credit-related positions at Citibank affiliates from 1976 to
1986. Mr. Zebeck is also a director of MasterCard International, Inc.
24
David D. Wesselink has been Vice Chairman of the Company since September
2000. Mr. Wesselink previously held the position of Executive Vice President,
Chief Financial Officer from December 1998. Prior to joining us, Mr. Wesselink
was Senior Vice President and Chief Financial Officer of Advanta Corporation
from 1993 to 1998. Prior to Advanta Corporation, he held several positions at
Household Finance Corp. and Household International, Inc. from 1971 to 1993,
including Senior Vice President from 1986 to 1993 and Chief Financial Officer
from 1982 to 1993.
William R. Anderson has been Executive Vice President, Enhancement Services
since February 2002. Mr. Anderson previously served as Senior Vice President,
Enhancement Services from October 1999 to February 2002, and Senior Vice
President, E-Commerce from February 1999 to October 1999. Prior to joining us,
Mr. Anderson was Executive Vice President and Director of Marketing at Bank of
America from 1996 to 1999. Prior to Bank of America, Mr. Anderson was General
Director of U.S. Consumer Marketing at the GM Card operations at General Motors
Corporation.
Richard G. Evans has been Executive Vice President, General Counsel and
Secretary since June 2001. Prior to joining us, Mr. Evans was Executive Vice
President, General Counsel and Director of Green Tree Financial Corporation from
1985 to 1999. Prior to Green Tree, Mr. Evans served as Special Assistant
Attorney General for the State of Minnesota from 1974 to 1984.
Patrick J. Fox has been Executive Vice President, Business Development
since September 2000. Mr. Fox previously served as Senior Vice President,
Business Development from March 1998. Prior to joining us, Mr. Fox held
executive positions in the credit card group of Bank of America from 1994 to
March 1998, including Director of Product Management and Business Development.
Prior to Bank of America, Mr. Fox held various marketing and sales management
positions with Bank One, which he joined in 1992, Comerica Bank and Citibank.
Mr. Fox has been President of Direct Merchants Bank since March 2000.
Joseph A. Hoffman has been Executive Vice President, Consumer Credit Card
Marketing/Operations since October 1999. Mr. Hoffman previously served as Senior
Vice President, Consumer Credit Marketing from April 1998. Prior to joining us,
Mr. Hoffman was Vice President of Marketing at Advanta Corporation from June
1994 to April 1998, where he held a variety of positions including Director of
Brand Management and Affinity and Co-Brand Marketing. Before that, Mr. Hoffman
was Vice President, Area Director, in Citibank's Card Product Group, which he
joined in 1980. During his fourteen-year tenure with Citibank, Mr. Hoffman held
a variety of marketing and operations positions with Citibank's Bankcard and
Private Label businesses.
Matthew S. Melius has been Executive Vice President, Credit Risk Management
since January 2001. Mr. Melius previously served as Executive Vice President,
E-Commerce from September 2000, Senior Vice President, E-Commerce from January
2000, Senior Vice President, Portfolio Marketing from January 1998, Vice
President, Portfolio Marketing from January 1997, and Director, Portfolio
Marketing from September 1995. Prior to joining us, Mr. Melius was Director,
Customer Retention of First National Bank of Omaha in the Credit Card Division
from 1989 to 1995.
Jon B. Mendel has been Executive Vice President, Human Resources since May
1998. Prior to joining us, Mr. Mendel was Senior Vice President, Human Resources
at TCF Financial Corporation. Prior to TCF, Mr. Mendel held various positions at
the St. Paul Companies, including Vice President, Human Resources of the St.
Paul Fire and Marine Insurance Company.
David R. Reak has been Executive Vice President, Risk Management/Recovery
since October 1999. Mr. Reak previously served as Senior Vice President, Credit
Risk from November 1998. Mr. Reak was appointed Vice President, Credit Risk in
October 1996 and
25
previously served as Senior Director, Credit Risk of Metris Direct, Inc. from
December 1995 to October 1996. Prior to joining us, he held several positions at
American Express Travel Related Services Company, including Senior Manager,
Credit Risk Management Europe and Middle East from 1994 to December 1995, Senior
Manager, Credit Risk Management U.S. Consulting Group from 1992 to 1994, and
Project Manager, Credit Research and Analysis from 1990 to 1992.
Benson K. Woo has been Chief Financial Officer since September 2000. Mr.
Woo previously held the position of Senior Vice President, Finance from October
1999. Prior to joining us, Mr. Woo was Vice President and Chief Financial
Officer of York International Corporation from 1998 to 1999. Prior to York
International Corporation, he was Vice President and Treasurer of Case
Corporation from 1994 to 1998. Prior to that, he held several positions at
General Motors Corporation from 1979 to 1994, including Finance Director, GM
Credit Card Operations from 1992 to 1994.
Dan N. Piteleski has been Senior Vice President, Chief Information Officer
since April 2001. Prior to joining us, Mr. Piteleski was Vice President, Chief
Information Officer of H.B. Fuller Company from 1995. Prior to H.B. Fuller, he
was Vice President, Information Systems at Zenith Data Systems from 1992, and
Manager, Information Systems and Technology at Apple Computer from 1988.
John A. Witham has been Senior Vice President, Finance since June 2002. Mr.
Witham previously held the position of Executive Vice President, Chief Financial
Officer of Bracknell Corporation from November 2000. Prior to Bracknell, he
served as Executive Vice President, Chief Financial Officer of Arcadia Financial
Ltd. from 1994 to 2000. Prior to Arcadia, Mr. Witham served as Senior Vice
President, Finance of various operating units of PHH Corporation from 1985 to
1994.
Ralph A. Than has been Senior Vice President, Treasurer since May 2000.
Prior to joining us, Mr. Than was Vice President, Treasurer of CNH Capital
Corporation, the finance subsidiary of CNH Global N.V. from 1998 to 2000. Before
that, he was Group Controller of the Agricultural Systems Business Unit of Case
Corporation from 1997 to 1998.
Mark P. Wagener has been Senior Vice President, Controller since October
2001. Mr. Wagener previously served as Vice President, Assistant Controller from
June 2000. Prior to joining us, he held several positions at Norwest Corporation
(Wells Fargo & Company) from 1988 to 1999. Prior to Norwest, Mr. Wagener was an
audit manager at Arthur Andersen LLP from 1982 to 1987.
Our officers are elected by, and hold office at the will of, our Board of
Directors and do not serve a "term of office" as such.
Risk Factors
This Annual Report on Form 10-K/A contains certain forward-looking
statements and information relating to MCI that are based on the beliefs of our
management as well as assumptions made by, and information currently available
to, our management. These forward-looking statements involve risks and
uncertainties that could cause our actual results to differ materially from such
statements. You should not place undue reliance on these forward-looking
statements as they speak only of our views as of the date the statement was made
and are not a guarantee of future performance.
Forward-looking statements include statements and information as to our
strategies and objectives, growth in earnings per share, return on equity,
growth in our managed loan portfolio, net interest margins, funding costs,
operating costs and marketing expenses, delinquencies and charge-offs and
industry comparisons or projections.
26
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. These
statements reflect management's current views with respect to future events and
are subject to certain risks, uncertainties and assumptions.
The factors discussed below, among others, could cause our actual results
to differ materially from those expressed in any forward-looking statements.
Although we have attempted to list comprehensively these important factors, we
caution you that other factors may in the future prove to be important in
affecting our results of operations. New factors emerge from time to time and it
is not possible for us to predict all of these factors, nor can we assess the
impact of each such factor on the business or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those
contained in any forward-looking statement.
Our Target Market for Consumer Lending Products Has Higher Default and
Bankruptcy Rates
The primary risk associated with secured and unsecured lending to
moderate-income consumers is higher default rates than other income classes of
consumers, resulting in more accounts being charged off as uncollectible. In
addition, general economic factors, such as the rate of inflation, unemployment
levels and interest rates, may result in greater delinquencies and credit losses
among moderate-income consumers than among other income classes of consumers. A
recession or economic downturn may cause an increase in default rates and
delinquencies. We may be unable to successfully identify and evaluate the
creditworthiness of our target customers to minimize the expected higher
delinquencies and losses. We also cannot assure you that our risk-based pricing
system can offset the negative impact on profitability that the expected greater
delinquencies and losses may have.
We May Not be Able to Sustain and Manage Growth
In order to meet our strategic objectives, we plan to continue to expand
our credit card loan portfolio. Continued growth in this area depends largely
on:
o our ability to attract new cardholders;
o growth in both existing and new account balances;
o the degree to which we lose accounts and account balances to competing card
issuers;
o levels of delinquencies and losses;
o the availability of funding, including securitizations, on favorable terms;
o general economic and other factors such as the rate of inflation,
unemployment levels and interest rates, which are beyond our control;
o our ability to acquire and integrate portfolios; and
o stability and growth in management.
27
Our continued growth also depends on our ability to manage this growth
effectively. Factors that affect our ability to successfully manage growth
include:
o retaining and recruiting experienced management personnel;
o finding and adequately training new employees; o cost-effectively expanding
our facilities;
o growing and updating our management systems; and
o obtaining capital when needed.
We May Not be Able to Successfully Market Our Enhancement Services or Sign
Additional Marketing Alliances
We target our enhancement services to our credit card customers and
customers of third parties. Because of the variety of offers provided and the
diversity of the customers targeted, we are uncertain about how many customers
will respond to our offers for these enhancement services. We may experience
higher than anticipated costs in connection with the internal administration and
underwriting of these enhancement services and lower than anticipated response
or retention rates.
Furthermore, we may be unable to expand the enhancement services business
or maintain historical growth and stability levels if:
o we cannot successfully market credit cards to new customers;
o existing credit card customers close accounts voluntarily or involuntarily;
o existing enhancement services customers cancel their services;
o we cannot form marketing alliances with other third parties or existing
marketing alliances with third parties terminate; or
o new or restrictive federal or state regulations limit our ability to market
or sell enhancement services.
Our Profitability and Ability to Grow is Dependent on Our Funding Sources
Securitization Markets
As of December 31, 2001, 70% of our receivables were funded through the
securitization market. These markets could undergo disruptions which adversely
affected the ability of companies like us to raise money from these sources.
Factors impacting these markets include current economic conditions, the
financial condition of other institutions accessing these markets and
national/world events. Furthermore, our ability to securitize our receivables
depends on the legal, regulatory and tax environment for such transactions.
In addition, even if we are able to securitize our receivables consistent
with past practice, poor performance of our securitized receivables, including
increased delinquencies and credit losses, lower payment rates or a decrease in
excess spreads below certain thresholds could result in a downgrade or
withdrawal of the ratings on the outstanding securities issued in our
securitization transactions, cause early amortization of such securities or
result in higher required credit enhancement levels. As a result, poor
performance of our securitized receivables could divert significant
28
amounts of cash that would otherwise be available to us. This could jeopardize
our ability to complete other securitization transactions on acceptable terms,
decrease our liquidity and force us to rely on other potentially more expensive
funding sources, to the extent available. We cannot assure you that the
securitization market will continue to offer suitable funding alternatives.
Credit Facility
We rely on our credit facility to fund our operations and growth. If we
breach any of our covenants under our credit facility, including various
financial covenants, the lenders may terminate the facility. Disruptions in the
securitization market could negatively affect our ability to comply with these
covenants, and therefore our ability to borrow or replace this facility could be
adversely affected.
CD Program
Direct Merchants Bank issues certificates of deposit in increments of
$100,000 or more. We expect to use the proceeds of these deposits to fund our
operations and growth. In order to maintain our current level of access to the
certificate of deposit market, Direct Merchants Bank must maintain a
"well-capitalized" rating, as that rating is defined by the OCC. If it does not
do so, Direct Merchants Bank may be required to modify the program and may not
be able to accept additional deposits.
Other Funding Sources
We also expect to obtain financing by selling debt and equity securities.
Our ability to obtain such financing is dependent upon many factors, including
general market conditions. We cannot assure you that we will be able to obtain
this financing on favorable terms or at all. In addition, restrictions contained
in our debt agreements may adversely affect our ability to finance future
operations or capital needs or to engage in other business activities.
Our ability to obtain financing from the various sources available to us is
dependent upon many factors, including those outside of our control. In
addition, disruptions or unfavorable conditions related to one financing source
may negatively affect our ability to access other financing sources, or may
increase our financing costs.
We Require a High Degree of Liquidity to Operate Our Business
We depend on cash flows from operations, asset securitizations, bank loans,
subsidiary bank deposit programs, long-term debt and equity issuances to fund
our operations and growth. The loss or interruption of any of these sources of
funding could adversely affect our ability to operate.
Key elements of our strategy are dependent upon us having adequate
available cash. These cash needs include:
o funding receivable growth through marketing campaigns;
o additional credit enhancement in the case of poor performance of our
securitized assets;
o interest and principal payments under our securitizations, our credit
agreement, our existing senior notes and other indebtedness;
o ongoing operating expenses;
29
o maintenance of the "well-capitalized" status of our subsidiary, Direct
Merchants Bank, which is necessary to maintain the CD program;
o portfolio and business acquisitions;
o fees and expenses incurred in connection with the securitization of
receivables and the servicing of them; and
o tax payments due on receipt of excess cash flow from securitization trusts.
Given these cash needs, we anticipate that we will need to enter into
financing transactions on a regular basis. We cannot assure you that we will be
able to secure funds to support our cash needs on terms as favorable as past
transactions. Any adverse change in the funding sources we use could force us to
rely on other potentially more expensive funding sources, to the extent
available, and could have other adverse consequences. If any of our funding
sources become limited it may require us to use more expensive sources of
funding. Any material increase in our costs of financing beyond our expectations
could negatively impact us.
Interest Rate Fluctuations Impact the Yield on Our Assets and Funding
Expense
An increase or decrease in market interest rates could have a negative
impact on the net interest spread between the yield on our assets and our cost
of funding. A rise in market interest rates may indirectly impact the payment
performance of our customers. We try to minimize the impact of changes in market
interest rates on our cash flow, asset value and net income primarily by funding
variable-rate assets with variable-rate funding sources and by using interest
rate derivatives to match asset and liability repricings. However, changes in
market interest rates may have a negative impact on us.
We May Not be Able to Successfully Integrate Portfolio Acquisitions
As previously mentioned, our growth may depend on our ability to acquire
and successfully integrate new portfolios of credit card customers. Since our
risk-based pricing system depends on information regarding customers, limited or
unreliable historical information on customers within an acquired portfolio may
have an impact on our ability to successfully and profitably integrate that
portfolio. Our success also depends on whether the desirable customers of an
acquired portfolio close their accounts after transfer of the portfolio. A large
attrition rate would result in a lower borrowing base upon which to assess fees,
higher costs relating to closing accounts and less potential for marketing
enhancement services. In addition, if customers reduce their borrowings after
the transfer of accounts, the acquired portfolio may be less profitable than
originally expected.
Current and Proposed Regulation and Legislation Limit Our Business
Activities, Product Offerings and Fees Charged
Various federal and state laws and regulations significantly limit the
activities in which we and Direct Merchants Bank are permitted to engage. Such
laws and regulations, among other things, limit the fees and other charges that
we are allowed to charge, limit or prescribe certain other terms of our products
and services, require specified disclosures to consumers, govern the sale and
terms of products and services we offer and require that we maintain certain
licenses, qualifications, or capital requirements (see "Business - Regulation"
on pages 19 through 23 of this Report). In some cases, the precise application
of these statutes and regulations is not clear. In addition,
30
the regulatory framework at the state and federal level regarding some of our
enhancement services is evolving. The regulatory framework affects the design or
profitability of such products and our ability to sell certain products. In
addition, numerous legislative and regulatory proposals are advanced each year
which, if adopted, could adversely affect our profitability or further restrict
the manner in which we conduct our activities. The failure to comply with, or
adverse changes in, the laws or regulations to which our business is subject, or
adverse changes in the interpretation thereof, could adversely affect our
ability to collect our receivables and generate fees on the receivables which
could have a material adverse effect on our business.
The Impact of Existing, Pending and Possible Future Privacy Laws Could
Result in Lower Marketing Revenue and Penalties for Non-Compliance
Effective July 2001, the federal Gramm-Leach-Bliley Act requires many of
our business groups to disclose our practices for collection and sharing of
non-public customer information. Changes to this law, or enactment of new laws,
have required and could further require us to limit or substantially modify our
enhancement services and credit card marketing activities and practices with
third-party companies in ways that would most likely decrease our revenue from
that business. These initiatives could require us to end substantially all of
our marketing efforts with third parties and may even adversely affect the
ability of the subsidiary through which we issue our credit card products,
Direct Merchants Bank, to share information about its customers with other MCI
affiliates, particularly enhancement services. The curtailment of our marketing
efforts directed to our customer base and third-party customers would
significantly negatively impact our business.
The privacy laws require us to provide initial and continuing disclosures
regarding our information sharing practices. The laws also require us to monitor
these disclosures and customer responses so that we do not unlawfully disclose
information about a customer who has directed us not to do so. If we do not
adequately manage the requirements, we may face regulatory sanctions, including
fines, and consumer class action litigation.
Other Industry Risks Related to Consumer Lending Products and Enhancement
Services Could Negatively Impact Us
We face a number of risks associated with unsecured lending. These include
the risk that delinquencies and credit losses will increase because of future
economic downturns; the risk that an increasing number of customers will default
on the payment of their outstanding balances or seek protection under bankruptcy
laws; and the risk that fraud by cardholders and third parties will increase. We
also face the risk that increased criticism from consumer advocates and the
media could hurt consumer acceptance of our products, as well as the risk of
litigation, including class action litigation, challenging our product terms,
rates, disclosures, collections or other practices, under state and federal
consumer protection statutes and other laws.
Due to Intense Competition in Our Consumer Lending Products and Enhancement
Services Businesses, We May Not be Able to Compete Successfully
We face intense and increasing competition from numerous financial services
providers, many of which have greater resources than us. In particular, our
credit card business competes with national, regional and local bankcard
issuers, as well as other general purpose and private label credit card issuers.
There has been a recent increase in solicitations to moderate-income consumers,
as competitors have increasingly focused on this market. Customers are attracted
to credit card issuers largely on the basis of price, credit limit and other
product features; as a result, customer loyalty is often limited. According to
published reports, as of December 2001, the 20 largest issuers accounted for
approximately 90% (based on receivables outstanding) of the market for general
purpose credit cards. Many of these issuers are substantially larger, have more
seasoned credit card portfolios and often compete for customers by offering
lower
31
interest rates and/or fee levels than us. We cannot assure you that we will be
able to compete successfully in this environment.
We also face competition from numerous enhancement services providers,
including insurance companies, financial services institutions and other
membership-based or consumer services providers. As we continue to expand our
extended service plan business to the customers of third-party retailers, we
compete with manufacturers, financial institutions, insurance companies and a
number of independent administrators.
Item 2. Properties
We currently lease our principal executive office space in Minnetonka,
Minnesota, consisting of leases for approximately 300,000 and 19,000 square
feet. These leases expire in December 2011 and March 2005, respectively. We also
lease 15,000 square feet of warehouse space in Minnetonka, Minnesota, which
expires in October 2003. Direct Merchants Bank leases office space in
Scottsdale, Arizona, consisting of approximately 26,000 square feet. This lease
will terminate by advance notice in June 2002. In addition, Direct Merchants
Bank purchased a 130,000 square foot building in Scottsdale, Arizona in 1999.
This building serves as western regional headquarters for us and Direct
Merchants Bank's operation center. In addition, we lease facilities in Tulsa,
Oklahoma, White Marsh, Maryland, Jacksonville, Florida, Champaign, Illinois, and
Duluth, Minnesota, consisting of approximately 100,000, 115,000, 160,000, 15,000
and 20,000 square feet, respectively. These leases expire in December 2010,
September 2007, June 2005, March 2002 and September 2006, respectively. The
leased properties in Oklahoma, Maryland, Florida and Duluth, Minnesota support
our collections, customer service and back office operations. We also own our
Hispanic operations center in Orlando, Florida, which consists of approximately
25,000 square feet. We believe our facilities are suitable to our businesses and
that we will be able to lease or purchase additional facilities as needed.
Item 3. Legal Proceedings
We are a party to various legal proceedings resulting from the ordinary
business activities relating to our operations. In July 2000 an Amended
Complaint was filed in Hennepin County District Court in Minneapolis, Minnesota
against MCI and our subsidiaries Metris Direct, Inc. and Direct Merchants Bank.
The complaint seeks damages in unascertained amounts and purports to be a class
action complaint on behalf of all credit card accountholders who were issued a
credit card by Direct Merchants Bank and were allegedly assessed fees or charges
that the cardholder did not authorize. Specifically, the complaint alleges
violations of the Minnesota Prevention of Consumer Fraud Act, the Minnesota
Deceptive Trade Practices Act and breach of contract. A final settlement
approval hearing was held on May 30, 2002, and the Court signed the order
granting final approval of the settlement whereby we will pay approximately $5.6
million for attorneys' fees and costs incurred by attorneys for the plaintiffs
in separate lawsuits filed in Arizona, California and Minnesota in 2000 and
2001. Under the terms of the settlement we denied any wrongdoing or liability.
The time for filing an appeal expired on August 5, 2002, and no appeal was
filed. At this time, we are in the process of implementing the terms of the
settlement.
On April 16, 2002, Direct Merchants Bank entered into an agreement with the
Office of the Comptroller of the Currency ("OCC") to strengthen the safety and
soundness of Direct Merchants Bank's operations. The agreement formalizes
recommendations made and requirements imposed by the OCC following an
examination of Direct Merchants Bank that covered the 15-month period ended
December 31, 2001. On April 17, 2002, MCI filed the agreement with the
Securities and Exchange Commission as an exhibit to and incorporated it by
reference in a current report on Form 8-K. We filed an amendment to that current
report on Form 8-K on October 22, 2002.
32
On May 3, 2001, Direct Merchants Bank entered into a consent order with the
OCC. The consent order required Direct Merchants Bank to pay approximately $3.2
million in restitution to approximately 62,000 credit card accountholders who
applied for and received a credit card in connection with a series of limited
test marketing campaigns from March 1999 to June 2000. Under the terms of the
consent order, Direct Merchants Bank made no admission or agreement on the
merits of the OCC's assertions. The restitution as required by the OCC consent
order was paid and is reflected in our December 31, 2001 financial statements.
We believe that Direct Merchants Bank's agreement with the OCC will not have a
material adverse affect on the financial position of MCI or Direct Merchants
Bank.
In May 2001, the OCC also indicated that it was considering whether to
assess civil money penalties against Direct Merchants Bank. On October 17, 2002,
the OCC notified Direct Merchants Bank that it will not assess civil money
penalties.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders during the fourth
quarter of our fiscal year ended December 31, 2001.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The information required by Item 201 of Regulation S-K is set forth in the
"Summary of Consolidated Quarterly Financial Information and Stock Data" on
pages 106 and 107 of this Report.
33
Item 6. Table 1: Selected Financial Data
Year Ended December 31,
(In thousands, except EPS, dividends Four-Year
and stock prices) Compound
2001 2000 1999 1998 1997 Growth Rate
---- ---- ---- ---- ---- -----------
Income Statement Data:
Net interest income ................. $ 530,710 $ 371,772 $ 180,328 $ 82,698 $ 57,243 74.5%
Provision for loan losses ........... 549,145 388,234 174,800 77,770 43,989 88.0
Other operating income .............. 1,154,457 933,787 623,772 315,480 187,796 57.5
Other operating expense ............. 714,154 594,414 437,984 227,160 139,167 50.5
---------------------------------------------------------------------------------------------------------------
Income before income taxes, extra-
ordinary loss and cumulative
effect of accounting changes .... 421,868 322,911 191,316 93,248 61,883 61.6
Tax rate ............................ 38.3% 38.5% 39.7% 38.5% 38.5% --
Net income (1) ...................... $ 260,291 $ 198,591 $ 115,363 $ 57,348 $ 38,058 59.4
---------------------------------------------------------------------------------------------------------------
Per Common Share Statistics:
EPS - diluted (1) ................... $ 2.62 $ 2.15 $ 1.41 $ 0.94 $ 0.63 40.7
Stock price (year-end split
adjusted)........................ 25.71 26.31 23.79 16.77 11.42 22.5
Dividends paid (split adjusted) ..... 0.040 0.033 0.017 0.013 0.010 --
Book value per common share
equivalent (split adjusted)(2)... 12.00 9.68 7.38 5.85 3.05 40.8
Shares outstanding (year-end) ....... 63,419 62,243 57,919 57,779 57,675 --
Shares used to compute EPS (diluted). 99,366 92,582 76,324 59,905 60,715 --
---------------------------------------------------------------------------------------------------------------
Selected Operating Data:
Total accounts ..................... 4,929 4,464 3,680 2,972 2,293 21.1
Year-end credit card loans ......... $2,746,656 $1,179,203 $ 145,783 $ -- $ -- --
Year-end assets .................... 4,228,686 3,736,025 2,045,082 945,719 538,662 67.4
Average credit card loans .......... 1,709,989 614,991 20,505 -- -- --
Average interest-earning assets .... 3,955,328 2,707,769 1,303,528 636,133 403,375 77.0
Average assets ..................... 3,903,846 2,826,653 1,449,297 774,167 417,903 74.8
Average total equity ............... 1,011,573 759,633 542,050 219,835 158,180 59.0
Year-end deposits .................. 2,058,008 2,106,199 775,381 -- -- --
Year-end debt ...................... 647,904 356,066 345,012 310,896 244,000 27.7
Year-end preferred stock ........... 393,970 360,421 329,729 201,100 -- --
Return on average assets (1) ....... 6.7% 7.0% 8.0% 7.4% 9.1% --
Return on average total equity (1) . 25.7% 26.1% 21.3% 26.1% 24.1% --
Selected Enhancement Services Data:
Revenue:
Credit protection .................. $ 202,300 $ 149,421 $ 109,502 $ 73,773 $ 47,550 43.6
Membership products ................ 94,695 75,981 31,858 13,301 4,905 109.6
Warranty/other ..................... 43,137 40,798 33,731 22,049 12,077 37.5
---------------------------------------------------------------------------------------------------------------
Total revenue ...................... 340,132 266,200 175,091 109,123 64,532 51.5
---------------------------------------------------------------------------------------------------------------
Year-end deferred revenue .......... 185,132 199,796 127,541 72,866 35,461 51.2
34
Year-end deferred acquisition costs. 79,400 74,084 45,837 23,726 15,778 49.8
Total enrollments .................. 3,475 4,809 3,294 2,441 2,143 12.8
Third-party enrollments ............ 1,398 1,675 1,336 1,316 1,124 5.6
Active members ..................... 5,775 6,067 4,902 3,619 2,997 17.8
Net interest margin ................ 13.4% 13.7% 13.8% 13.0% 14.2% --
Loan loss reserves ................. $ 410,159 $ 123,123 $ 12,175 $ -- $ -- --
Reserves as a percent of 30-day plus
receivables (3)................. 147.7% 138.1% 351.1% -- -- --
Delinquency ratio (3)(4) ........... 10.1% 7.6% 2.4% -- -- --
Loan loss reserve ratio ............ 14.9% 10.4% 8.4% -- -- --
Net charge-off ratio (5) ........... 14.5% 23.5% 52.7% -- -- --
(1) Excluding the one-time, non-cash accounting impacts from the adoption of
SFAS 133 in January 2001 for our interest rate derivative instruments, the
adoption of Staff Accounting Bulletin No. 101 for our debt waiver products
in March 2000, and the extinguishment of the Series B Preferred Stock and
12% Senior Notes and the cancellation of warrants in June 1999.
(2) Book value is calculated assuming conversion of preferred stock.
(3) Figures as of December 31, 2001 reflect the adoption of FFIEC guidelines on
re-aging accounts effective January 1, 2001. Excluding the re-age impact
the delinquency ratio as of December 31, 2001 was 9.9%.
(4) Delinquency ratio represents credit card loans that were at least 30 days
contractually past due at year-end as a percentage of year-end owned credit
card loans.
(5) Net charge-off ratio reflects actual principal amounts charged off, less
recoveries, as a percentage of average credit card loans. The net
charge-off ratio at December 31, 2001 reflects an additional write-off of
$5.0 million resulting from a change in charge-off policy to 120 days from
180 days for accounts that enter into a credit counseling or similar
program and later become delinquent.
35
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Net income applicable to common stockholders for the year ended December
31, 2001 was $211.0 million, or $2.47 per diluted share, up from net income
applicable to common stockholders of $163.5 million, or $2.11 per diluted share
in 2000. The increase in net income results from an increase in net interest
income and other operating income partially offset by increases in the provision
for loan losses and other operating expenses.
The provision for loan losses was $549.1 million in 2001 compared to $388.2
million in 2000. The increase relates to the estimated required balance in the
allowance for loan losses to cover future charge-offs inherent in our loan
portfolio. Increased credit card loans, increased net principal charge-offs,
recent delinquency and collection trends, and current economic conditions were
factors considered by management in determining the necessary balance in the
allowance for loan losses. The net principal charge-off rate was 14.5% in 2001
compared to 23.5% in 2000. The decrease in the net principal charge-off rate is
due to run-off of our partially secured portfolio. The delinquency ratio was
10.1% in 2001 compared to 7.6% in 2000. Excluding the FFIEC guidelines on
re-aging accounts adopted January 1, 2001, which required us to report an
additional $6.5 million in receivables as delinquent as of December 31, 2001,
the delinquency ratio was 9.9% in 2001.
Other operating income increased $220.7 million, or 24%, to $1.1 billion
for the year ended December 31, 2001. This increase was primarily due to an
increase in net securitization and credit card servicing income of $73.1 million
to $517.4 million in 2001 caused by higher finance charge and fee income and
lower funding costs on our securitized loan portfolio. The increase in finance
charge and fee income is a result of growth in securitized loans. The average
investors' interests in loans securitized increased $1.2 billion to $6.7 billion
in 2001, compared to $5.5 billion in 2000. Enhancement services revenues
increased 28% to $340.1 million in 2001, up from $266.2 million in 2000. These
increases were primarily due to the growth in total credit card accounts, an
increase in outstanding receivables in the securitized credit card loan
portfolio, development of new third-party relationships and the creation of new
products.
Other operating expenses increased to $714.2 million in 2001, compared to
$594.4 million in 2000. This increase was primarily due to continued investments
in our infrastructure in order to service the growth in our credit card loan
portfolio, an increase in overall marketing expenditures and increased
amortization on purchased portfolio premiums. Our operating efficiency ratio
decreased to 31.1% in 2001 from 32.4% in 2000 due to increased economies of
scale and management cost saving initiatives begun in the latter part of 2001.
On January 1, 2001, we adopted Statement of Financial Accounting Standards
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities," which establishes accounting and reporting standards for derivative
instruments. SFAS 133 requires enterprises to recognize all derivatives as
either assets or liabilities in the statement of financial position and to
measure those instruments at fair value. Prior to SFAS 133, we amortized the
costs of interest rate contracts on a straight-line basis over the expected life
of the contract. The adoption of SFAS 133 resulted in a one-time, non-cash,
after-tax charge to earnings of $14.5 million reflected as a "Cumulative effect
of accounting change" in the consolidated statements of income for the year
ended December 31, 2001. During 2001, $1.2 million was recorded as a reduction
to interest expense and a $13.6 million gain was recognized as a result of
36
recording derivatives that did not qualify for hedge accounting treatment at
fair value and hedge ineffectiveness.
In September 2000, the Financial Accounting Standards Board issued SFAS
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," which replaces SFAS 125, and revises the
accounting standards and disclosure requirements for securitizations and
transfers of financial assets and collateral. It requires enterprises to
recognize, upon transfer of financial assets, the financial and servicing assets
it controls and the liabilities it has incurred, derecognize financial assets
when control has been surrendered, and derecognize liabilities when
extinguished. This statement is effective for transfers and servicing of
financial assets and extinguishment of liabilities occurring after March 31,
2001. The recognition and reclassification of collateral and additional
disclosures related to securitization transactions and collateral were effective
for fiscal years ending after December 15, 2000. The adoption of the new
standard did not have a material impact on our financial statements.
During the quarter ended March 31, 2000, we adopted Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements," for our
debt waiver products. This SAB formalized the accounting for services sold where
the right to a full refund exists, requiring all companies to defer recognition
of revenues until the cancellation period is complete. Previously, we recognized
half of the revenues in the month billed and half in the following month. We now
recognize all of the revenue the month following completion of the cancellation
period. This change resulted in a one-time, non-cash net charge to earnings of
$3.4 million, which is reflected as a "Cumulative effect of accounting change"
in the consolidated statements of income for the year ended December 31, 2000.
Because we have applied the provisions of this SAB to our membership programs
since 1998, before the SEC formalized its guidance, we did not have to adjust
our enhancement services revenues.
Critical Accounting Policies
The Company's accounting policies are identified on pages 68 through 76 of
this Report, the most significant of which is our determination of the allowance
for loan losses, valuation of retained interests and accounting for deferred
origination costs.
Allowance for loan losses
We maintain an allowance for loan losses sufficient to cover anticipated
probable loan losses inherent in the credit card loan portfolio as of the
balance sheet date. The allowance is based on management's consideration of all
relevant factors including management's assessment of applicable economic and
seasonal trends. In addition, we have incorporated updated regulatory guidance
regarding analysis and documentation for the allowance for loan losses.
We segment the loan portfolio into several individual static pools with
similar credit risk and time since solicitation (vintage pools), and estimate
(based on historical experience and existing environmental conditions) the
dollar amount of principal, accrued finance charges and fees in each 30-day
delinquency bucket that will not be collected and, therefore, "roll" into the
next 30-day bucket and ultimately charge off. We then aggregate these pools into
prime and sub-prime portfolios based on the prescribed FICO score cuts and into
several other groups such as credit counseling and payment alternative
receivables. We also isolate individual pools subsequent to solicitation when
the credit risk associated with the pools include higher risk segments, such as
our partially secured card program, accounts that are over their credit limit by
more than 10% and other programs as deemed necessary. We separately analyze the
reserve requirement on each of these groups or portfolios. The impact on
37
the allowance for loan losses for accounts in suspended status under our debt
waiver benefits is included in vintage pool roll rate analysis.
We continually evaluate the homogenous static risk pools using a roll rate
model which uses historical delinquency levels and pay-down levels (12 months of
historical data, with significant influence given to last six months'
performance to capture current economic and seasonal trends), loan seasoning and
other measures of asset quality to estimate charge-offs for both credit loss and
bankruptcy losses.
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 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.
Retained interests
The Company determines the fair value of the net retained interests by
calculating the present value of future expected cash flows using management's
best estimate of key assumptions including credit losses, weighted-average
spreads, payment rates and a discount rate commensurate with the risks involved.
For purposes of determining the value of the retained interests, we have
included only cash flows associated with the excess spread and principal
receivables included in the retained interests as of the balance sheet date. We
have not included certain expected finance charge receivable cash flows in our
calculation.
The significant assumptions used for estimating the fair value of the
retained interest in loans securitized are as follows:
At December 31,
2001 2000
--- ----
Annual discount rate (1) ......................... 15% 15%
Monthly payment rate ............................. 7% 7%
Weighted-average spread (2) ...................... 20% 16%
Annual principal, finance charge and fees
default rate .................................. 18% 16%
(1) If we had included all expected finance charge receivable cash flows, our
effective discount rate would have ranged from 35% to 45%.
(2) Includes finance charges, late fees and overlimit fees, less
weighted-average cost of funds and 2% servicing fee.
38
At December 31, 2001, the sensitivity of the current fair value of the
retained interests to immediate 10 percent changes are as follows:
Impact on Fair Value (in millions)
of a 10% Increase or Decrease
-----------------------------
Annual discount rate ........................... $ 15
Monthly payment rate ........................... 1
Weighted-average spread ........................ 164
Annual principal, finance charge and fees
default rate................................. 183
As the sensitivity indicates, the value of the Company's retained interests
on its balance sheet, as well as reported earnings, could differ significantly
if different assumptions or conditions would prevail.
Deferred acquisition costs
We defer direct credit card origination costs associated with successful
credit card solicitations that we incur in transactions with independent third
parties, and certain other costs that we incur in connection with loan
underwriting and the preparation and processing of loan documents. We also defer
qualifying acquisition costs associated with our enhancement services products.
These costs, which relate directly to membership solicitations (direct response
advertising costs), principally include postage, printing, mailings and
telemarketing costs. The total amount of deferred costs as of December 31, 2001
and 2000 were $89.5 million and $79.2 million, respectively. The most
significant assumption used by the Company in determining the realizability of
these deferred costs is future revenues from our credit cards and enhancement
services products. A significant reduction in revenues could have a material
impact on the values of these balances.
Deferred revenue on Enhancement Services Products
Direct Merchants Bank offers various debt waiver products to its credit
card customers. Revenue for such products is recognized in the month following
completion of the cancellation period, and reserves are provided for pending
claims based on Direct Merchants Bank's historical experience with settlement of
such claims. Unearned revenues and reserves for pending claims are recorded as
"Deferred income" and "Accrued expenses and other liabilities," respectively. We
record fees on membership programs as deferred income upon acceptance of
membership and amortize them on a straight-line basis over the membership period
beginning after the contractual cancellation period is complete. We defer and
recognize extended service plan revenues and the incremental direct acquisition
costs on a straight-line basis over the life of the related extended service
plan contracts beginning after the expiration of any manufacturers' warranty
coverage.
39
Net Interest Income
Net interest income consists primarily of interest earned on our credit
card loans and retained interests in loans securitized, less interest expense on
borrowings to fund loans. Table 2 provides an analysis of interest income and
expense, net interest spread, net interest margin and average balance sheet data
for the years ended December 31, 2001, 2000 and 1999.
Table 2: Analysis of Average Balances, Interest and Average Yields and Rates
Year Ended December 31,
-------------------------------------------------------------------------------------
2001 2000
---- ----
(Dollars in thousands) Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
Assets:
Interest-earning assets:
Federal funds sold ................. $ 63,981 $ 3,115 4.9% $ 144,780 $ 9,139 6.3%
Short-term investments ............. 286,221 12,372 4.3% 78,697 4,710 6.0%
Credit card loans and
retained interests in
loans securitized .............. 3,605,126 681,503 18.9% 2,484,292 490,929 19.8%
----------- ----------- ----------- -----------
Total interest-earning assets ...... $ 3,955,328 $ 696,990 17.6% $ 2,707,769 $ 504,778 18.6%
Other assets ....................... 796,511 -- -- 814,053 -- --
Allowance for loan losses and
retained interest valuation
allowance....................... (847,993) -- -- (695,169) -- --
----------- -----------
Total assets ....................... $ 3,903,846 -- -- $ 2,826,653 -- --
=========== ===========
Liabilities and Equity:
Interest-bearing liabilities:
Deposits ........................... $ 2,110,967 $ 127,918 6.1% $ 1,317,718 $ 89,560 6.8%
Debt ............................... 379,159 38,362 10.1% 354,204 43,446 12.3%
----------- ----------- ----------- -----------
Total interest-bearing
liabilities..................... $ 2,490,126 $ 166,280 6.7% $ 1,671,922 $ 133,006 7.9%
Other liabilities .................. 402,147 -- -- 395,098 -- --
----------- -----------
Total liabilities .................. 2,892,273 -- -- 2,067,020 -- --
Stockholders' equity ............... 1,011,573 -- -- 759,633 -- --
----------- -----------
Total liabilities and equity ....... $ 3,903,846 -- -- $ 2,826,653 -- --
=========== ===========
Net interest income and
interest margin (1)............. -- $ 530,710 13.4% -- $ 371,772 13.7%
Net interest rate spread (2) ....... -- -- 10.9% -- -- 10.7%
(1) We compute net interest margin by dividing net interest income by average
total interest-earning assets.
(2) The net interest rate spread is the yield on average interest-earning
assets minus the funding rate on average interest-bearing liabilities.
40
Table 2: Analysis of Average Balances, Interest and Average Yields and Rates
(continued)
Year Ended December 31,
---------------------------------------
1999
----
(Dollars in thousands) Average Yield/
Balance Interest Rate
------- -------- ----
Assets:
Interest-earning assets:
Federal funds sold ................................... $ 90,748 $ 4,477 4.9%
Short-term investments ............................... 45,708 2,298 5.0%
Credit card loans and retained
interests in loans securitized ................... 1,167,072 229,394 19.7%
----------- -----------
Total interest-earning assets ........................ $ 1,303,528 $ 236,169 18.1%
Other assets ......................................... 651,227 -- --
Allowance for loan losses and retained
interest valuation allowance ..................... (505,458) -- --
-----------
Total assets ......................................... $ 1,449,297 -- --
===========
Liabilities and Equity:
Interest-bearing liabilities:
Deposits ............................................. $ 328,035 $ 19,329 5.9%
Debt ................................................. 323,260 36,512 11.3%
----------- -----------
Total interest-bearing liabilities ................... $ 651,295 $ 55,841 8.6%
Other liabilities .................................... 255,952 -- --
-----------
Total liabilities .................................... 907,247 -- --
Stockholders' equity ................................. 542,050 -- --
-----------
Total liabilities and equity ......................... $ 1,449,297 -- --
===========
Net interest income and interest
margin (1) ....................................... -- $ 180,328 13.8%
Net interest rate spread (2) ......................... -- -- 9.5%
(1) We compute net interest margin by dividing net interest income by average
total interest-earning assets.
(2) The net interest rate spread is the yield on average interest-earning
assets minus the funding rate on average interest-bearing liabilities.
Net interest income for the year ended December 31, 2001 was $530.7
million, compared to $371.8 million in 2000, an increase of $158.9 million. This
increase was primarily due to a $1.1 billion increase in average loans and
retained interests over the comparable period in 2000 offset by a decrease in
net interest margins. The net interest margin decreased to 13.4% for the year
ended December 31, 2001, from 13.7% for the year ended December 31, 2000. The
decrease in net interest margin is primarily due to the fixed interest rates on
Direct Merchants Bank's certificates of deposit used to fund variable rate
credit card loans in a decreasing interest rate environment.
Net interest income is affected by changes in the average interest rate
earned on interest-earning assets and the average interest rate paid on
interest-bearing liabilities, in addition to changes in the volume of
interest-earning assets and interest-bearing liabilities. Table 3 presents the
effects of changes in average volume and interest rates on individual financial
statement line items on an owned basis.
41
Risk-Based Pricing
We price credit card offers based on a prospect's risk profile prior to
solicitation or upon receipt of a completed application. We evaluate a prospect
to determine credit needs, credit risk, and existing credit availability and
then develop a customized offer that includes the most appropriate product,
brand, pricing and credit line. After customers open credit card accounts, we
periodically monitor customers' internal and external credit performance and
periodically recalculate behavior, revenue, attrition and bankruptcy predictors.
We re-evaluate customers' risk profiles on a regular basis, and the lending
relationship can evolve to include more competitive (or more restrictive)
pricing and product configurations. In our analyses, we consider the overall
profitability of accounts, using both credit information and the profitability
from selling enhancement services to customers.
Table 3: Changes in Net Interest Income
Year Ended December 31, Year Ended December 31,
2001 vs. 2000 2000 vs. 1999
-----------------------------------------------------------------------
Increase Change due to* Change due to*
(Dollars in thousands) (Decrease) Volume Rate Increase Volume Rate
---------- ------- ---- -------- ------ ----
Interest Income:
Federal funds sold .............. $ (6,024) $ (4,273) $ (1,751) $ 4,662 $ 3,173 $ 1,489
Short-term investments .......... 7,662 8,564 (902) 2,412 1,909 503
Credit card loans and retained
interests in loans securitized
190,574 210,856 (20,282) 261,535 260,294 1,241
--------- --------- --------- --------- --------- ---------
Total interest income ........... 192,212 188,038 4,174 268,609 262,776 5,833
Deposit interest
expense ...................... 38,358 46,785 (8,427) 70,231 66,832 3,399
Other interest expense .......... (5,084) 3,423 (8,507) 6,934 3,653 3,281
--------- --------- --------- --------- --------- ---------
Total interest expense .......... 33,274 49,434 (16,160) 77,165 80,927 (3,762)
--------- --------- --------- --------- --------- ---------
Net interest income ............. $ 158,938 $ 138,604 $ 20,334 $ 191,444 $ 181,849 $ 9,595
========= ========= ========= ========= ========= =========
* The change in interest due to both volume and rates has been allocated in
proportion to the relationship of the absolute dollar amounts of the change in
each. We calculate changes in income and expense independently for each caption
in the analysis. The totals for the volume and rate columns are not the sum of
the individual lines.
42
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 December 31, 2001, 33% of our outstanding receivables
balance was from accounts that have been with us in excess of two years, and 22%
of outstanding receivables were with us in excess of four years.
We use credit line analyses, account management and customer transaction
authorization procedures to minimize loan losses. Our risk models determine
initial credit lines at the time of solicitation. We manage credit lines on an
ongoing basis and adjust them based on customer usage and payment patterns. To
maximize profitability, we continually monitor customer accounts and initiate
appropriate collection activities when an account is delinquent or overlimit.
Delinquencies
Delinquencies not only have the potential to affect earnings in the form of
net loan losses, but they are also costly in terms of the personnel and other
resources dedicated to their resolution. It is our policy to continue to accrue
interest and fee income on all credit card accounts, except in limited
circumstances, until we charge off the account. In 2001, we adopted the FFIEC
(Federal Financial Institutions Examination Council) guidelines with respect to
credit card issuers that permitted the re-aging of past due accounts to current
status only after receiving the equivalent of three minimum payments or one lump
sum equivalent. Furthermore, accounts can only be re-aged to current statue once
every twelve months and two times every 5 years. Prior to the implementation of
these guidelines, credit card issuers were allowed to re-age accounts after
receipt of only one minimum payment. The impact of the guidelines was an
increase delinquent receivables by $6.5 million as of December 31, 2001. Table 4
presents the delinquency trends of our credit card loan portfolio.
Table 4: Loan Delinquency
December 31, % of December 31, % of December 31, % of
2001 Total 2000 Total 1999 Total
---- ----- ---- ----- ---- -----
(Dollars in
thousands)
Loan Portfolio .... $2,746,656 100% $1,179,203 100% $ 145,783 100%
Loans contractually
Delinquent:
30 to 59 days .. 87,603 3.2% 27,837 2.4% 922 0.6%
60 to 89 days .. 66,647 2.4% 22,074 1.9% 818 0.6%
90 or more days 123,528 4.5% 39,257 3.3% 1,728 1.2%
---------- ---- ---------- ---- ---------- ---
Total ....... $ 277,778 10.1% $ 89,168 7.6% $ 3,468 2.4%
========== ==== ========== ==== ========== ===
The 250 basis point increase during 2001 in the delinquency rates over 2000
primarily reflects seasoning in the portfolio, a deterioration in the economy
and the adoption of FFIEC guidelines on re-aging accounts effective January 1,
2001, which required us to report an additional $6.5 million of receivables as
delinquent as of December 31, 2001. Without the impact of the FFIEC guidelines,
the delinquency ratio was 9.9% as of December 31, 2001.
43
Net charge-offs
Net charge-offs are the principal amount of losses from accountholders
unwilling or unable to make minimum payments, bankrupt accountholders and
deceased accountholders less current period recoveries. Net charge-offs exclude
accrued finance charges and fees which are charged against the related income at
the time of charge-off. During the quarter ended December 31, 2001 we changed
our charge-off policy to 120 days from 180 days for accounts that enter into a
credit counseling or similar program and later become delinquent. With the
concurrence of regulatory authorities we concluded that these accounts should be
treated as closed-end loans and charged off after 120 days under FFIEC policy.
This change resulted in an additional write-off of $5.0 million in 2001. During
the quarter ended March 31, 2000, we changed our policy for partially secured
card accounts to charge off accounts that are 120 days contractually delinquent
rather than 180 days. This change was made based on our experience that secured
card customers who are 120 days delinquent more closely resemble recovery
accounts.
Table 5 presents our net charge-offs for the periods indicated as reported
in the consolidated financial statements:
Table 5: Net Charge-offs
Year Ended December 31,
---------------------------------------
2001 2000 1999
(Dollars in thousands)
Average credit card loans
outstanding ................. $1,709,989 $ 614,991 $ 20,505
Net charge-offs ................. 247,576 144,540 10,797
Net charge-off ratio ............ 14.5% 23.5% 52.7%
========== ========== ===========
Provision and Allowance for Loan Losses
We make provisions for loan losses in amounts necessary to maintain the
allowance at a level estimated to be sufficient to absorb probable future loan
losses, net of recoveries, inherent in the existing loan portfolio.
The economy has slowed down significantly over the last year, exacerbated
by the terrorist attacks on September 11, 2001. This changing environment has
caused our delinquencies and losses to increase from prior years' levels. Some
of the actions we are taking to mitigate this slowdown include expanding our
collections strategies to aggressively address any potential delinquency
increases and utilizing our recovery staff to work on precharge-off receivables.
We also leverage forbearance programs and credit counseling services for
qualifying cardholders that are experiencing payment difficulties. These
programs include reduced interest rates, reduced or suspended fees and other
incentives to induce the customer to continue making payments. The amount of
customer receivables in forbearance programs was $129.9 million or 5% of total
credit card loans as of December 31, 2001. The amount of receivables in
forbearance programs decreased to $99.7 million as of February 28, 2002 as a
result of tighter approval standards in our programs.
For purposes of assessing the adequacy of loan loss reserves, we segment
the loan portfolio into several individual static pools with similar credit risk
and time since solicitation (vintage pools), and estimate (based on historical
experience and existing environmental conditions) the dollar amount of
principal, accrued finance charges and fees in each 30-day delinquency bucket
that will not be collected and, therefore, "roll" into the next 30-day bucket
and ultimately charge off. We then aggregate these
44
pools into prime and sub-prime portfolios based on the prescribed FICO score
cuts and into several other groups such as credit counseling and payment
alternative receivables. We also isolate individual pools subsequent to
solicitation when the credit risk associated with the pools include higher risk
segments, such as our partially secured card program, accounts that are over
their credit limit by more than 10% 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 vintage pool roll
rate analysis.
We continually evaluate the homogenous static risk pools using a roll rate
model which uses historical delinquency levels and pay-down levels (12 months of
historical data, with significant influence given to last six months'
performance to capture current economic and seasonal trends), loan seasoning and
other measures of asset quality to estimate charge-offs for both credit loss and
bankruptcy losses.
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.
Various regulatory agencies, as an integral part of their examination
process, periodically review our allowance for loan losses maintained at Direct
Merchants Bank (essentially those loans not sold via securitization or
third-party conduit financing relationships). Such agencies may require that we
recognize additions to the allowance based on their judgment about information
available to them at the time of their examination. In determining the allowance
for loan losses for credit card loans held by Direct Merchants Bank, we have
taken into consideration the Office of the Comptroller of the Currency ("OCC")
guidance for subprime lending programs. Under these guidelines, we are required
to maintain an allowance for loan losses of at least twelve months' future
charge-offs on all loans considered subprime (primarily those loans with a FICO
score of 660 or below or with damaged credit histories).
The provision for loan losses for the year ended December 31, 2001, totaled
$549.1 million compared to a provision of $388.2 million in 2000. The increase
in the provision for loan losses in 2001 compared to 2000 reflects the growth in
credit card loans, an increase in delinquencies and the current economic
environment.
The allowance for loan losses was $410 million as of December 31, 2001,
versus $123 million as of December 31, 2000. Our roll rate models indicated our
required allowance for loan losses was in the range of $380 million to $410
million as of December 31, 2001, versus $105 million to $115 million as of
December 31, 2000. The ratio of allowance for loan losses to period-end credit
card loans was 14.9% at December 31, 2001 compared to 10.4% at December 31,
2000. The allowance for loan losses as a percentage of 30-day plus receivables
was 147.7% at December 31, 2001 compared to 138.1% at December 31, 2000. The
increase in the allowance as a percentage of loans and as a percentage of 30-day
plus receivables reflects a deterioration in the economy and
45
the impact of seasoning in the loan portfolio, which has caused higher
delinquency levels in the loan portfolio.
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. During the past three years, annual net charge-offs have exceeded the
beginning allowance for loan losses. This is primarily attributable to the
following factors:
o the allowance for loan losses takes into consideration losses inherent in
the portfolio as of the balance sheet date and does not consider future
growth in the portfolio (i.e., new accounts generated after the balance
sheet date or new charges on existing accounts).
o the impact of acquisitions, which occur subsequent to the balance sheet
date.
o the impact of reclassifying retained interests in loans securitized to
credit card loans due to the maturing of bank conduits that were accounted
for as a sale under FAS 140.
Retained Interests Valuation
We determine the fair value of the retained interests by calculating the
present value of future expected cash flows using management's best estimate of
key assumptions, including credit losses, weighted-average spreads, payment
rates, and a discount rate commensurate with the risk involved.
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 December 31, 2001, 2000 and 1999:
Table 6: Retained Interests in Loans Securitized
Year Ended December 31,
2001 Change 2000 Change 1999
---- ------ ---- ------ ----
Gross retained interests. $ 1,263,655 $ (760,026) $ 2,023,681 $ 406,455 $ 1,617,226
Valuation allowance ..... (537,499) 103,353 (640,852) (33,999) (606,853)
----------- ----------- ----------- ----------- -----------
Net retained interests .. $ 726,156 $ (656,673) $ 1,382,829 $ 372,456 $ 1,010,373
=========== =========== =========== =========== ===========
Gross retained interests in loans securitized decreased $760.0 million to
$1.3 billion in 2001, compared to $2.0 billion in 2000. In 2001, a bank conduit
that was accounted for as a sale under SFAS 140 matured. As a result,
approximately $855 million of receivables that were classified as retained
interests in loans securitized as of December 31, 2000 were classified as credit
card loans in 2001. The decrease was offset by the retained interests on the
growth in receivables funded through the Master Trust. The $406.5 million
increase in gross retained interests during 2000 reflects growth in our overall
business, requiring increased funding in our Master Trust. During 2001, the
valuation allowance decreased by $103.4 million primarily due to the lower gross
retained interests and the widening of excess spreads seen in the Master Trust.
The projected weighted-average spread increased from 16% as of December 31, 2000
to 20% as of December 31, 2001. The increase in the projected weighted-average
spread was due to lower cost of funds and the impact of interest rate floors on
credit card accounts. The weighted-average spread less default rate was 2% as of
December 31, 2001, compared to zero as of December 31, 2000. The projected
default rate increased from 16% as of
46
December 31, 2000 to 18% as of December 31, 2001. The increase in the
projected default rate was due to increased delinquencies in the Master Trust
and the overall deterioration in the economy. The increase in the projected
default rate caused an approximate $170 million increase in the valuation
allowance, which was more than offset by the increase in the projected
weighted-average spread and the decrease in the gross retained interests. During
2000, we recorded a $34 million increase in the valuation allowance, which is
primarily due to increases in the gross retained interests.
Other Operating Income
Other operating income contributes substantially to our results of
operations, representing 69% and 72% of total revenues for the years ended
December 31, 2001 and 2000, respectively. Other operating income increased
$220.7 million for the year ended December 31, 2001 over 2000.
Net securitization and credit card servicing income increased $73.1 million
to $517.4 million in 2001. The increase was primarily due to an increase in
servicing revenue and the change in the retained interests valuation expense
needed to record the retained interests at fair value. Servicing revenue
increased approximately $30 million to $159 million for the year ended December
31, 2001 caused by an increase of approximately $1.2 billion in average
securitized receivables. The retained interests valuation expense decreased
$27.3 million for the year ended December 31, 2001 versus the year ended
December 31, 2000.
Credit card fees, interchange and other credit card income was $296.9
million in 2001, an increase of $73.6 million over 2000. The increase is
primarily the result of growth in our credit card portfolio and the retained
interests in loans securitized. Average credit card loans and retained interests
were $3.6 billion in 2001 and $2.5 billion in 2000.
Enhancement services revenues increased by $73.9 million for the year ended
December 31, 2001. This increase reflects higher credit protection revenue due
to increased receivables and higher sales of our debt waiver products, as well
as the increase in membership program revenues resulting from additional product
offers to third-party cardholders.
Other Operating Expense
Total other operating expenses for the year ended December 31, 2001
increased $119.7 million over 2000, largely due to costs associated with the
growth of our business activities. Employee compensation increased $46.9 million
for the year ended December 31, 2001, due to increased staffing needs. Credit
card account and other product solicitation and marketing expenses increased
$30.4 million over 2000, largely due to increased marketing efforts which
resulted in 1.2 million new credit card accounts and 3.5 million new enhancement
relationships during 2001.
Enhancement services claims expenses increased $9.2 million primarily
driven by increased debt waiver claims. Debt waiver claims expenses were $33.6
million in 2001 and $23.7 million in 2000. The $9.9 million increase relates to
increased balances covered by debt waiver. As of December 31, 2001 we had a debt
waiver total covered balance of $2.7 billion, compared to $2.1 billion as of
December 31, 2000.
Purchased portfolio premium amortization increased $11.0 million to $30.3
million in 2001 compared to $19.3 million in 2000. The increase relates to the
amortization of premiums recognized on portfolio purchases late in 2000 and
throughout 2001. Between August 25, 2000 and October 17, 2001, we purchased
three portfolios with a total receivables balance of $476 million and a premium
of $60.9 million.
47
Other expenses increased $18.0 million for the year primarily due to
increased rent and depreciation related to the necessary investments in
facilities and equipment to support and improve our business.
Derivative Activities
We use derivative financial instruments for the purpose of managing our
exposure to interest rate risks. We have a number of procedures in place to
monitor and control both market and credit risk from these derivative
activities. Our senior management approves all derivative strategies and
transactions.
During 2001 and 2000, we entered into interest rate cap and interest rate
swap transactions. We enter into interest rate caps through our subsidiary,
Metris Receivables, Inc. ("MRI") on behalf of Master Trust investors. Interest
rate caps are purchased on each of MRI's securitized debt issuances.
We entered into interest rate swap transactions through Direct Merchants
Bank. The swaps are used to effectively convert a portion of the fixed rate
certificates of deposit ("CDs") to variable rate CDs, and thus hedge the fair
market value of the CDs. The CDs expose us to variability in the fair value in
rising or declining interest rate environments. By converting the fixed payment
to a variable payment, the interest rate swaps effectively reduce the
variability of the fair market value of the CDs.
We account for these contracts in accordance with SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by SFAS 138. We
recognize all derivatives as either assets or liabilities on the balance sheet
and measure those instruments at fair value. The change in the fair value of the
derivatives are recognized currently in earnings unless specific hedge
accounting criteria are met. If the derivative qualifies as a hedge, the
accounting treatment for the change in fair value varies based on the type of
risk being hedged. The monthly interest rate differential to be paid or received
on these contracts is accrued and included in "Net securitization and credit
card servicing income" or "Deposit interest expense," as appropriate, on the
consolidated statements of income. Interest payable or receivable under these
contracts are classified under "Other receivables due from credit card
securitization, net" or "Other assets," as appropriate, on the consolidated
balance sheets.
The adoption of SFAS 133 resulted in a one-time, non-cash, after-tax charge
to earnings of $14.5 million reflected as a "Cumulative effect of accounting
change" in the consolidated statements of income for the year ended December 31,
2001. During 2001, $1.2 million was recorded as a reduction to interest expense
and a $13.6 million gain was recognized as a result of recording derivatives
that did not qualify for hedge accounting treatment at fair value and hedge
ineffectiveness.
48
Balance Sheet Analysis
Retained Interests in Loans Securitized
Retained interests in loans securitized decreased $760.0 million to $1.3
billion in 2001, compared to $2.0 billion in 2000. In 2001, a securitization
that was accounted for as a sale under SFAS 140 matured. As a result,
approximately $855 million of receivables that were classified as retained
interests in loans securitized as of December 31, 2000 were classified as credit
card loans in 2001. The decrease was offset by the required retained interests
on the growth in receivables funded through the Master Trust.
Credit Card Loans
Credit card loans were $2.7 billion as of December 31, 2001 compared to
$1.2 billion as of December 31, 2000. The $1.5 billion increase is a result of
the transfer of $855 million of receivables from retained interests in loans
securitized to credit card loans due to the maturity of the securitization
previously discussed, the purchase of two credit card portfolios with
approximately $290 million of receivables and organic growth through increased
marketing efforts.
Deferred Income Taxes
Total deferred tax assets, net of deferred tax liabilities, decreased from
$146.3 million as of December 31, 2000 to $32.2 million as of December 31, 2001.
The decrease in net assets resulted largely from a $99.3 million increase in
deferred tax liabilities, primarily related to accrued interest on credit card
loans.
Debt
Debt increased from $356.1 million in 2000 to $647.9 million in 2001 due to
a warehouse financing arrangement entered into by Direct Merchants Bank in June
2001 that was accounted for as a collateralized financing. As of December 31,
2001 $292.0 million was outstanding on the conduit and was used to fund credit
card loans.
Deferred Income
Deferred income decreased $20.5 million to $215.0 million as of December
31, 2001 compared to $235.5 million as of December 31, 2000. The decrease
primarily relates to our migration from annual billed to monthly billed products
and lower product sales.
Stockholders' Equity
Stockholders' equity was $1.1 billion as of December 31, 2001, an increase
of $258.4 million over December 31, 2000 stockholders' equity of $883.6 million.
The increase results from net income of $245.8 million and $27.9 million stock
issuances under employee benefit plans offset by cash dividends of $3.8 million
and $13.0 million of stock repurchases under our stock repurchase program.
49
Item 7a. 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, which have committed funding primarily
indexed to variable commercial paper rates and the London Interbank Offered Rate
("LIBOR"). Our $270 million bank credit facility consists of a $170 million
revolving credit facility that is indexed to prime rate and a $100 million term
loan that is indexed to LIBOR. The subsidiary bank deposits are issued at fixed
interest rates. The long-term debt is at fixed interest rates. At December 31,
2001, approximately 8.8% of the Master Trust and conduit funding of securitized
receivables was funded with fixed rate securities, compared to 11.9% at December
31, 2000.
In an interest rate environment with rates at or below current rates, at
December 31, 2001, 91.2% of the securitization funding for the managed loan
portfolio is indexed to floating commercial paper and LIBOR rates compared to
88.1% at December 31, 2000. In an interest rate environment with rates
significantly above current rates, the potentially negative impact on earnings
of higher interest expense is partially mitigated by fixed rate funding and
interest rate cap contracts.
The approach we use to quantify interest rate risk is a sensitivity
analysis, which we believe best reflects the risk inherent in our business. This
approach calculates the impact on net income from an instantaneous and sustained
change in interest rates by 200 basis points. Assuming that we take no
counteractive measures, as of December 31, 2001, a 200-basis-point increase in
interest rates affecting our floating rate financial instruments, including both
debt obligations and loans, would result in an increase in net income of
approximately $20 million relative to a base case over the next 12 months,
compared to an approximate $47 million increase as of December 31, 2000 relative
to a base case over the next 12 months. A decrease of 200 basis points would
result in a reduction in net income of approximately $2 million as of December
31, 2001 and $47 million as of December 31, 2000. The decrease in the
sensitivity to changes in interest rates year over year is due to the impact of
rate floors on our credit card receivables. 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.
50
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, refunding, and interest rate
risks. Table 7 summarizes our funding and liquidity as of December 31, 2001 and
2000:
Table 7: Liquidity, Funding and Capital Resources
(in thousands) December 31, 2001 December 31, 2000
----------------- -----------------
Unused Unused
On-balance sheet funding Outstanding Capacity Outstanding Capacity
------------------------ ----------- -------- ----------- --------
Bank conduit 2002 ........ $ 292,000 $ 108,000 $ -- $ --
Revolving credit line 2003 -- 170,000 -- 170,000
Term loan 2003 ........... 100,000 N/A 100,000 N/A
Senior notes 10% 2004 .... 100,000 N/A 100,000 N/A
Senior notes 10.125% 2006 145,924 N/A 145,024 N/A
Other .................... 9,980 N/A 11,042 N/A
Deposits ................. 2,058,008 N/A 2,106,199 N/A
Equity ................... 1,141,955 N/A 883,553 N/A
----------- ----------- ----------- -----------
Subtotal ............ $ 3,847,867 $ 278,000 $ 3,345,818 $ 170,000
Off-balance sheet funding
-------------------------
Metris Master Trust ...... $ 7,880,342 $ 328,908 $ 5,857,224 $ 344,991
Metris facility .......... 15,500 59,500 -- 75,000
Various conduits ......... -- -- 213,000 687,000
----------- ----------- ----------- -----------
Subtotal ............ $ 7,895,842 $ 388,408 $ 6,070,224 $ 1,106,991
----------- ----------- ----------- -----------
Total ............... $11,743,709 $ 666,408 $ 9,416,042 $ 1,276,991
=========== =========== =========== ===========
Subsequent to December 31, 2001, we issued $600 million of seven year, term
asset- backed securities out of the Master Trust, and we created an $850 million
bank-sponsored conduit facility for additional funding capacity. Total unused
capacity as of March 15, 2002 was $2.1 billion.
Under our revolving line of credit agreement, we need to maintain, among
other items, minimum equity plus reserves to managed assets of 10%, minimum
three-month average excess spread (by asset-backed securitization deal) of 1%,
minimum equity of $662 million and a ratio of equity plus reserves to managed
90-day plus delinquencies of 2.25. As of December 31, 2001 and 2000 we were in
compliance with all financial covenants under our credit agreements.
Our contractual cash obligations as of December 31, 2001 were as follows:
Less than One to Four to Over five
one year three years five years years Total
-------- ----------- ---------- ----- -----
Long-term debt ......... $ 292,497 $ 200,910 $ 154,479 $ 18 $ 647,904
Operating leases ....... 16,650 23,818 17,333 34,301 92,102
Certificates of deposit. 1,216,757 567,897 273,354 -- 2,058,008
Metris Master Trust .... 2,370,342 2,860,000 2,650,000 -- 7,880,342
Metris facility ........ 15,500 -- -- -- 15,500
Open to buy on credit
card accounts (1) .. -- -- -- -- 15,677,958
---------- ---------- ---------- ---------- -----------
Total .................. $3,911,746 $3,652,625 $3,095,166 $ 34,319 $26,371,814
========== ========== ========== ========== ===========
(1) See tables on pages 9 - 11 for further information.
51
As previously noted, we utilize a variety of funding vehicles, as well as
ongoing cash generated from operations, to finance receivables growth, maturing
debt obligations and general operating needs. During the next year we intend to
issue new asset back securities and increase the size of bank conduits to meet
the cash obligations noted above. For example, subsequent to year-end the
maturing long-term debt of $292,497, the Metris facility of $15,500 and a
portion of the Metris Master Trust was refinanced on January, 30, 2002 with
proceeds from the issuance of the $600 million, seven- year asset-backed
securities previously discussed. The remaining Metris Master Trust balances and
the certificates of deposit will be refinanced through the issuance of new
certificates of deposit, currently available conduit liquidity or by proceeds
from the sale of receivables to the asset-backed market.
The weighted-average interest rate on outstanding funding as of December
31, 2001 and 2000 was as follows:
December 31, 2001 December 31, 2000
----------------- -----------------
Bank conduit 2002 .. 2.4% --
Term loan 2003 ..... 5.4% 9.9%
Senior notes 2004 .. 10.0% 10.0%
Senior notes 2006 .. 11.5% 11.6%
Other .............. 8.9% 9.0%
Deposits ........... 5.1% 7.0%
Equity ............. -- --
Metris Master Trust. 3.0% 7.3%
Metris facility .... 2.3% --
Various conduits ... -- 7.6%
The 450-basis-point decrease in the weighted-average interest rate on the
term loan and the 430 basis point decrease in the weighted-average interest rate
on the Metris Master Trust was primarily due to the decrease in LIBOR, which is
the base rate for these funding vehicles. As the base rate, LIBOR decreased from
6.6% as of December 31, 2000 to 1.9% as of December 31, 2001.
During 2001 and 2000, we had net proceeds of approximately $1.8 billion and
$0.6 billion, respectively, from sales of credit card loans to the Master Trust
and conduits. We used cash generated from these transactions to reduce
borrowings and to fund credit card loan portfolio growth.
The following table presents the amounts, at December 31, 2001 of investor
principal in securitized receivables scheduled to amortize in future years. We
base the amortization amounts on estimated amortization periods, which are
subject to change based on the Master Trust and conduit performance:
(in thousands)
2002 ............................................ $ 2,385,842
2003 ............................................ 600,000
2004 ............................................ 2,260,000
2005 ............................................ 1,400,000
2006 ............................................ 1,250,000
---------------
Total securitized loans at December 31, 2001 .... $ 7,895,842
===============
52
The following table shows the annualized yields, defaults, costs and
excess spreads for the Master Trust on a cash basis:
(In thousands) 2001 2000 1999
------------------------------------------------------------------------------
Gross yield .............. $2,035,113 27.58% $1,528,056 27.22% $1,177,906 27.27%
Annual principal defaults. 972,348 13.18% 632,763 11.27% 483,921 11.20%
---------- ----- ---------- ----- ---------- -----
Net portfolio yield ...... 1,062,765 14.40% 895,293 15.95% 693,985 16.07%
Annual interest expense,
including
servicing fee ........ 451,061 6.62% 470,634 8.90% 339,004 8.06%
---------- ----- ---------- ----- ---------- -----
Net excess spread ........ $ 611,704 7.78% $ 424,659 7.05% $ 354,981 8.01%
========== ===== ========== ===== ========== =====
The Master Trust and the associated securitized debt provide for early
amortization if certain events occur. These events are described in the
applicable prospectus of each securitization transaction. The most significant
events would be three consecutive months of less than zero percent excess spread
or negative transferor's interest within the Master Trust. In addition, there
are various triggers within our securitization agreements that, if broken, would
restrict the release of cash to us from the Master Trust. This restricted cash
would provide additional security to the investors of the Master Trust. The
triggers are related to the performance of the Master Trust, specifically the
amount of net excess spread over a one to three month period. As of June 30,
2002 we have not broken any triggers in our securitization agreements and,
therefore, no cash has been restricted.
The following table illustrates the amount of cash that would be restricted
as additional collateral if the excess spread of the Master Trust was within
various ranges for a one to three month period:
(In thousands)
Net Excess Spread Restricted Cash
----------------- ---------------
greater than 5.5% $ -
5.1% - 5.5% 56,409
4.6% - 5.0% 79,669
4.1% - 4.5% 181,239
3.6% - 4.0% 227,759
3.1% - 3.5% 274,278
less than 3.0% 350,468
In December 2001, the excess spread on our 1997-1 asset-backed
securitization transaction, which had fixed-rate funding at 8.5%, dropped below
the 4.5% trigger, requiring $21.3 million in cash to be restricted by the Master
Trust subsequent to year-end.
Direct Merchants Bank issues certificates of deposit of $100,000 or more.
As of December 31, 2001 and 2000, $2.1 billion and $2.1 billion of CDs were
outstanding with original maturities ranging from six months to five years and
three months to five years, respectively. These CDs pay fixed interest rates
ranging from 2.4% to 7.6% and 5.4% to 7.6% at December 31, 2001 and 2000,
respectively.
53
The Company's deposits and secured/unsecured debt are rated by Moody's
Investor Services, Standard & Poor's Rating Services and Fitch, Inc. Factors
affecting the various ratings include the overall health of the global/national
economy, specific economic conditions impacting the subprime consumer finance
industry and the overall financial performance of the Company, including
earnings, credit losses, delinquencies, excess spreads in the Master Trust and
overall Company liquidity. The table below illustrates the debt ratings MCI and
Direct Merchants Bank as of December 31, 2001:
Standard
Moody's & Poor's Fitch
------- -------- -----
Metris Companies Inc.
Senior unsecured debt. Ba3 B+ BB
Credit facility ...... Ba3 BB- BB+
Direct Merchants Bank .. Ba1
Short-term deposits .. B
Long-term deposits ... BB+
Subsequent to December 31, 2001, both Standard & Poor's Rating Services and
Fitch, Inc. issued a negative outlook for the Company and its debt ratings,
citing the current economic conditions and the overall financial condition of
the consumer finance sector.
The Company has $394.0 million of Series C Perpetual Convertible Preferred
Stock outstanding which is held by affiliates of Thomas H. Lee Partners, L.P.
(formerly the Thomas H. Lee Company) ("THL Partners"), a private equity firm,
and is convertible into common shares at a conversion price of $12.42 per common
share subject to adjustment in certain circumstances. The Series C Preferred
Stock has a 9% dividend payable in additional shares of Series C Preferred Stock
and will also receive any cash dividends paid on the Company's common stock on a
converted basis. One share of Series C Preferred Stock is convertible into 30
shares of common stock, plus a premium amount designed to guarantee a portion of
seven years' worth of dividends at a 9% annual rate. For conversions in 2001,
the premium amount would be equal to approximately 41% of those future
dividends. Assuming conversion of the Series C Preferred Stock into common
stock, THL Partners would own approximately 35% of the Company on a diluted
basis at December 31, 2001. The Series C Preferred Stock entitles the holders to
elect four members to MCI's Board of Directors. The Series C Preferred may be
redeemed by us in certain circumstances by paying 103% of the redemption price
of $372.50 and any accrued dividends at the time of redemption. We also have the
option to redeem the Series C Preferred Stock after December 9, 2008, without
restriction by paying the redemption price of $372.50 and any accrued dividends
at the time of redemption.
The Federal Reserve Act imposes various legal limitations on the extent to
which banks that are members of the Federal Reserve System can finance or
otherwise supply funds to certain of their affiliates. In particular, Direct
Merchants Bank is subject to certain restrictions on any extensions of credit to
MCI or its subsidiaries. Additionally, Direct Merchants Bank is limited in its
ability to declare dividends to MCI or its subsidiaries. Therefore, Direct
Merchants Bank's investments in federal funds sold are generally not available
for the general liquidity needs of the Company or its subsidiaries. These
restrictions were not material to our operations at December 31, 2001 and 2000.
As the portfolio of credit card loans grows, or as the Master Trust and
commercial paper conduit fundings amortize, our funding needs will increase
accordingly. We believe that our cash flows from operations, asset
securitizations, including commercial paper conduits, bank loans, subsidiary
bank deposits, long-term debt and equity issuances will provide us with adequate
liquidity for meeting anticipated cash needs, although no assurance can be given
to that effect.
54
Our equity as a percent of managed assets was 9.4% as of December 31, 2001
versus 9.0% as of December 31, 2000. We have historically retained cash flow
generated from earnings (versus declaring larger dividends) to provide
additional equity and liquidity to fund future receivables growth and operating
expenditures. In addition, our stock incentive plans provide us with a source of
equity and liquidity.
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 us in accordance with the
national bank dividend provisions.
Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the OCC. At December 31, 2001 and 2000, Direct Merchants Bank's Tier
1 risk-based capital ratio, risk-based total capital ratio and Tier 1 leverage
ratio exceeded the minimum required capital levels, and Direct Merchants Bank
was considered a "well-capitalized" depository institution under regulations of
the OCC, as illustrated in the table below.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, Direct Merchants Bank must meet specific capital guidelines
that involve quantitative measures of assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices.
Direct Merchants Bank's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require Direct Merchants Bank to maintain minimum amounts and ratios (set forth
in the following table) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 leverage
capital (as defined) to average assets (as defined). Failure to meet minimum
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material adverse effect on our financial statements.
55
Additional information about Direct Merchants Bank's actual capital amounts
and ratios are presented in the following table:
For Capital
Adequacy To Be Well
Actual Purposes Capitalized
As of December 31, 2001 Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital ..... $346,907 13.0% $213,733 8.0% $267,166 10.0%
(to risk-weighted
assets)
Tier 1 Capital .... 308,186 11.5% 106,867 4.0% 160,300 6.0%
(to risk-weighted
assets)
Tier 1 Capital .... 308,186 11.2% 110,573 4.0% 138,216 5.0%
(to average assets)
For Capital
Adequacy To Be Well
Actual Purposes Capitalized
As of December 31, 2000 Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total Capital ...... $227,453 10.8% $167,255 8.0% $211,029 10.0%
(to risk-weighted
assets)
Tier 1 Capital ..... 199,882 9.5% 83,135 4.0% 125,271 6.0%
(to risk-weighted
assets)
Tier 1 Capital .... 199,882 9.3% 84,833 4.0% 106,121 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 guidelines, Direct Merchants Bank's total
capital ratio as of December 31, 2001 was 8.5%.
Subsequent to December 31, 2001, we sold approximately $610 million of
receivables from Direct Merchants Bank to MCI. After selling these assets,
Direct Merchants Bank's total capital ratio was 17.6% under normal capital
adequacy guidelines and 11.3% under subprime guidelines, which are above minimum
requirements.
56
Newly Issued Pronouncements
In July 2001, the Financial Accounting Standards Board issued 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.
SFAS 142 is effective for goodwill and intangible assets included on the balance
sheet for all fiscal years beginning after December 15, 2001. The adoption of
the new standard will not have a material impact on our financial statements.
In October 2001, the Financial Accounting Standards Board issued SFAS No.
144, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." The standard is effective for fiscal years beginning
after December 15, 2001. The new rules on asset impairment supersede FASB
Statement No. 121, and provide a single accounting model for long-lived assets
to be disposed of. The adoption of the new standard will not have a material
impact on our financial statements.
Forward-Looking Statements
This Annual Report on Form 10-K/A contains some forward-looking statements.
Forward-looking statements give our current expectations of future events. You
will recognize these statements because they do not strictly relate to
historical or current facts. Such statements may use words such as "anticipate,"
"estimate," "expect," "project," "intend," "think," "believe," and other words
or terms of similar meaning in connection with any discussion of future
performance of the Company. For example, these include statements relating to
future actions, future performance of current or anticipated products,
solicitation efforts, expenses, the outcome of contingencies such as litigation,
and the impact of the capital markets on liquidity. From time to time, we also
may provide oral or written forward-looking statements in other material
released to the public.
Any or all of our forward-looking statements in this Report and in any
other public statements we make may turn out to be wrong. They can be affected
by inaccurate assumptions or by known or unknown risks and uncertainties. Many
factors, which can not be predicted with certainty, will be important in
determining future results. Among such factors are higher default and bankruptcy
rates of our target market of moderate-income consumers, interest rate risks,
risks associated with acquired portfolios, dependence on the securitization
markets and other funding sources, state and federal laws and regulations that
limit our business activities, product offerings and fees, privacy laws that
could result in lower marketing revenue and penalties for non-compliance, and
general economic conditions that can have a major impact on the performance of
loans. Each of these factors and others are more fully discussed under the
caption "Business--Risk Factors" on pages 26 through 32 of this Report. As a
result of these factors, we cannot guarantee any forward-looking statements.
Actual future results may vary materially. Also, please note that the factors we
provide are those we think could cause our actual results to differ materially
from expected and historical results.
We undertake no obligations to publicly update any forward-looking
statements, whether as a result of new information, future events or otherwise.
You are advised, however, to consult any further disclosure we make on related
subjects in our periodic filings with the Securities and Exchange Commission.
This discussion is provided to you as permitted by the Private Securities
Litigation Reform Act of 1995.
57
Year Ended December 31, 2000, Compared to Year Ended December 31, 1999
Net income applicable to common stockholders for the year ended December
31, 2000, was $163.5 million, or $2.11 per diluted share, up from net loss
applicable to common stockholders of $61.6 million, or $1.07 per diluted share
for 1999. Net loss applicable to common stockholders for the year ended December
31, 1999, included a $152.4 million one-time, non-cash accounting impact from
the issuance of the Series C Perpetual Convertible Preferred Stock,
extinguishing the Series B Preferred Stock, the 12% Senior Notes, and the
ten-year warrants reported in the second quarter 1999. Income before these
extraordinary items for the year ended December 31, 1999, was $115.4 million, or
$1.41 per diluted share. The increase in net income results from an increase in
net interest income and other operating income partially offset by increases in
the provision for loan losses and other operating expenses. These increases are
largely attributable to the growth in average loans and active enhancement
members.
The provision for loan losses was $388.2 million in 2000, compared to
$174.8 million in 1999. The increase primarily reflects higher credit card loan
balances and the addition of new credit card portfolios as well as an increase
in net charge-offs. The reported net charge-off rate was 23.5% in 2000, compared
to 52.7% in 1999.
Other operating income increased $310.0 million, or 50%, to $933.8 million
for the year ended December 31, 2000. Net securitization and credit card
servicing income increased $125.4 million or 39% in 2000 from $318.9 million in
1999. Credit card fees, interchange fees and other credit card income, increased
to $223.3 million for 2000, up 72% over $129.8 million for 1999. In addition,
enhancement services revenues increased 52% to $266.2 million in 2000, up from
$175.1 million in 1999. These increases were primarily due to the growth in
total credit card and enhancement services accounts, an increase in outstanding
receivables in the managed credit card loan portfolio, development of new
third-party relationships and the creation of new products.
In December 1999, the Securities and Exchange Commission released SAB 101.
This SAB formalized the accounting for services sold with a full refund,
requiring all companies to defer recognition of service revenues until the
cancellation period is complete. We adopted this practice for membership
programs in 1998, before the official guidance was released. Due to the adoption
of this SAB, we recorded a cumulative effect of change in accounting principle
in the first quarter of 2000, with a net after-tax impact of $3.4 million. This
one-time, non-cash adjustment was to defer recognition of debt waiver revenue
until the cancellation period is complete, which is one month. Prior to this
change, we recognized one-half of the current period revenues in the month
billed.
Other operating expenses increased to $594.4 million in 2000, compared to
$438.0 million in 1999. This increase was due to continued investments in our
infrastructure in order to service the growth in our managed credit card loan
portfolio and our enhancement services members, as well as an increase in
overall marketing expenditures. Our operating efficiency ratio increased to
32.4% in 2000 from 31.9% in 1999, due to the investment in infrastructure and
marketing programs.
58
Selected Operating Data - Managed Basis
We analyze the Company's financial performance on a managed loan portfolio
basis. On a managed basis, the balance sheet and income statement includes other
investors' interests in securitized loans that are not assets of the Company,
thereby reversing the effects of sale accounting under SFAS 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities".
We believe this information is meaningful to the reader of the financial
statements. We service the receivables that have been securitized and sold and
own the right to the cash flows from those sold receivables in excess of
interest 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 8: Selected Operating Data
Managed Basis Year Ended December 31,
Four-Year
Compound
(In thousands) 2001 2000 1999 1998 1997 Growth Rate
---- ---- ---- ---- ---- -----------
Selected Operating Data:
Year-end loans ................. $ 11,906,153 $ 9,273,108 $ 7,281,322 $ 5,315,042 $ 3,546,936 35.4
Year-end assets ................ 12,124,528 9,806,249 7,563,394 5,503,862 3,604,972 35.4
Average loans .................. 10,349,217 8,021,437 6,003,791 4,000,467 2,294,893 45.7
Average interest-earning assets. 10,699,419 8,244,914 6,140,247 4,040,220 2,341,451 46.2
Average assets ................. 10,656,156 8,332,500 6,269,760 4,159,171 2,355,978 45.8
Return on average assets (1) ... 2.4% 2.4% 1.8% 1.4% 1.6% --
Equity to managed assets ....... 9.4% 9.0% 8.2% 7.9% 4.9% --
Net interest margin (2) ........ 14.0% 13.0% 13.5% 12.5% 13.1% --
Delinquency ratio (3) .......... 9.4% 8.3% 7.6% 6.8% 6.6% --
Net charge-off ratio (4) ....... 11.0% 9.7% 9.0% 10.1% 8.3% --
(1)Excluding the one-time, non-cash accounting impacts from the adoption of SFAS
133 in January 2001 for our interest rate derivative instruments, the
adoption of Staff Accounting Bulletin No. 101 for our debt waiver products in
March 2000, and the extinguishment of the Series B Preferred Stock and 12%
Senior Notes and the cancellation of warrants in June 1999.
(2)Includes MCI's actual cost of funds plus all costs associated with asset
securitizations, including the interest expense paid to certificate holders
and amortization of the discount and fees.
(3)Delinquency ratio represents credit card loans that were at least 30 days
contractually past due at year-end as a percentage of year-end managed loans.
Figures as of December 31, 2001 reflect the adoption of FFIEC guidelines on
re-aging accounts effective January 1, 2001. Excluding the re-age impact the
delinquency ratio as of December 31, 2001 was 9.1%.
(4)Net charge-off ratio reflects actual principal amounts charged off, less
recoveries, as a percentage of average managed credit card loans. The net
charge-off ratio at December 31, 2001 reflects an additional write-off of $34
million resulting from a change in charge-off policy to 120 days from 180
days for accounts that enter into a credit counseling or similar program and
later become delinquent.
59
Table 9: Managed Loan Portfolio
December 31,
% of % of % of
2001 Total 2000 Total 1999 Total
---- ----- ---- ----- ---- -----
Credit card loans .......... $ 2,746,656 $ 1,179,203 $ 145,783
Retained interests in
loans securitized ...... 1,263,655 2,023,681 1,617,226
Investors' interests
in securitized loans
accounted for as
sales................... 7,895,842 6,070,224 5,518,313
----------- ----------- -------------
Total managed loan
portfolio............... $11,906,153 $ 9,273,108 $ 7,281,322
=========== ========== =============
Loans contractually
Delinquent:
30 to 59 days ........... 375,887 3.1% 228,238 2.5% 168,882 2.3%
60 to 89 days ........... 274,278 2.3% 173,531 1.9% 117,740 1.6%
90 or more days ......... 473,003 4.0% 365,963 3.9% 270,092 3.7%
----------- ------------- ---------- ------------- ------------- ------------
Total ................ $ 1,123,168 9.4% $ 767,732 8.3% $ 556,714 7.6%
=========== ============= ========== ============= ============= ============
Average balances:
Credit card loans .......... $ 1,709,989 $ 614,991 $ 20,505
Retained interests in
loans securitized ...... 1,895,137 1,869,301 1,146,567
Investors' interests
in securitized loans
accounted for as
sales................... 6,744,091 5,537,145 4,836,719
----------- ----------- -------------
Total managed loan
portfolio............... $10,349,217 $8,021,437 $ 6,003,791
=========== ========== =============
Net charge-offs ............ $ 1,140,151 11.0% $ 778,921 9.7% $ 543,085 9.0%
=========== ============= ========== ============= ============= ============
The 110-basis-point increase during 2001 in the managed delinquency rates
over 2000 primarily reflects seasoning in the portfolio, a deterioration in the
economy and the adoption of FFIEC guidelines on re-aging accounts effective
January 1, 2001, which required us to report an additional $36.1 million of
receivables as delinquent as of December 31, 2001. Without the impact of the
FFIEC guidelines, the managed delinquency ratio was 9.1% as of December 31,
2001. We continue to focus our resources on collection efforts to minimize
delinquency levels.
Managed net charge-offs increased $361.2 million in 2001. We estimate that
approximately $225 million of the increase was due to growth in the portfolio,
approximately $100 million was the result of seasoning in the loan portfolio and
deterioration in the economy and $34 million was due to the change in our credit
policy to charge-off after 120 days accounts that enter into credit counseling
or similar program and later become delinquent.
Total managed loans increased $2.6 billion to $11.9 billion as of December
31, 2001, compared to $9.3 billion as of December 31, 2000. This was primarily
due to organic growth of the loan portfolio through increased marketing efforts,
the credit line increase program and the purchase of two new credit card
portfolios with approximately $290 million of receivables.
60
In June 2001, a securitization that was accounted for as a sale under SFAS
140 matured. As a result, approximately $855 million of receivables that were
classified as retained interests in loans securitized as of December 31, 2000
were classified as credit card loans as of December 31, 2001.
Table 10: Analysis of Average Balances, Interest and Average Yields and Rates
Year Ended December 31,
---------------------------------------------------------------------------------------
2001 2000
---- ----
(Dollars in thousands) Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
Managed Basis
Credit card loans ...................... $10,349,217 $ 1,957,913 18.9% $ 8,021,437 $1,582,503 19.7%
Total interest-earning assets .......... 10,699,419 1,973,400 18.4% 8,244,914 1,596,352 19.3%
Total interest-bearing
liabilities......................... 9,234,217 480,465 5.2% 7,209,068 521,477 7.2%
Net interest income and
interest margin (1)................. -- 1,492,935 14.0% -- 1,074,875 13.0%
Net interest rate spread (2) ........... -- -- 13.2% -- -- 12.1%
(1) We compute net interest margin by dividing net interest income by average
total interest-earning assets.
(2) The net interest rate spread is the yield on average interest-earning
assets minus the funding rate on average interest-bearing liabilities.
Table 10: Analysis of Average Balances, Interest and Average Yields and Rates
(continued)
Year Ended December 31,
-------------------------------------
1999
----
(Dollars in thousands) Average Yield/
Balance Interest Rate
------- -------- ----
Managed Basis
Credit card loans ............. $6,003,791 $1,156,888 19.3%
Total interest-earnings assets. 6,140,247 1,163,663 19.0%
Total interest-bearing
liabilities................ 5,488,015 335,417 6.1%
Net interest income and
Interest margin (1) ....... -- 828,246 13.5%
Net interest rate spread (2) .. -- -- 12.9%
(1) We compute net interest margin by dividing net interest income by average
total interest-earning assets.
(2) The net interest rate spread is the yield on average interest-earning
assets minus the funding rate on average interest-bearing liabilities.
Managed net interest income for the year ended December 31, 2001 was $1.5
billion, compared to $1.1 billion in 2000, an increase of $418.1 million. This
increase was primarily due to a $2.3 billion increase in average managed loans
over the comparable period in 2000 and an increase in net interest margins. The
net interest margin on managed interest-earning assets increased to 14.0% for
the year ended December 31, 2001, from 13.0% for the year ended December 31,
2000. The increase in net interest margin is primarily due to lower average cost
of funds. Cost of funds, primarily based on LIBOR rates, decreased to 5.2% in
2001 from 7.2% in 2000, partially offset by a decrease in portfolio yields to
18.9% in 2001 from 19.7% in 2000 because our credit card rates are based on the
prime lending rate. Portfolio yields did not decrease at the same level as our
cost of funds due to interest rate floors on some customer accounts as well as
repricing initiatives taken early in 2001 due to the general deterioration in
the economy and rising charge-off rates.
61
Item 8. Financial Statements and Supplementary Data
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands, except per-share data)
December 31,
2001 2000
---- ----
Assets:
Cash and due from banks .......................... $ 109,812 $ 84,938
Federal funds sold ............................... 243,772 367,937
Short-term investments ........................... 134,502 68,565
----------- ----------
Cash and cash equivalents ........................ 488,086 521,440
----------- ----------
Retained interests in loans securitized .......... 1,263,655 2,023,681
Less: Valuation allowance ........................ 537,499 640,852
----------- ----------
Net retained interests in loans securitized ...... 726,156 1,382,829
----------- ----------
Credit card loans ................................ 2,746,656 1,179,203
Less: Allowance for loan losses .................. 410,159 123,123
----------- ----------
Net credit card loans ............................ 2,336,497 1,056,080
----------- ----------
Property and equipment, net ...................... 114,913 128,395
Deferred income taxes ............................ 32,167 146,345
Purchased portfolio premium, net ................. 94,793 95,537
Other receivables due from credit card
securitizations, net........................... 179,868 186,694
Other assets ..................................... 256,206 218,705
----------- ----------
Total assets ............................... $ 4,228,686 $3,736,025
=========== ==========
Liabilities:
Deposits ......................................... $ 2,058,008 $2,106,199
Debt ............................................. 647,904 356,066
Accounts payable ................................. 83,475 83,473
Deferred income .................................. 215,031 235,507
Accrued expenses and other liabilities ........... 82,313 71,227
----------- ----------
Total liabilities ............................. 3,086,731 2,852,472
----------- ----------
Stockholders' Equity:
Convertible preferred stock - Series C, par value $.01 per share; 10,000,000
shares authorized, 1,057,638 and 967,573 shares
issued and outstanding......................... 393,970 360,421
Common stock, par value $.01 per share;
300,000,000 shares authorized, 64,224,878
and 62,242,787 shares issued................... 642 622
Paid-in capital .................................. 232,413 198,077
Unearned compensation ............................ (4,980) --
Treasury stock - 806,300 shares .................. (13,014) --
Retained earnings ................................ 532,924 324,433
----------- ----------
Total stockholders' equity .................... 1,141,955 883,553
----------- ----------
Total liabilities and stockholders' equity .... $ 4,228,686 $3,736,025
=========== ==========
See accompanying Notes to Consolidated Financial Statements.
62
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Income
(Dollars in thousands, except per-share data)
Year Ended December 31,
-----------------------
2001 2000 1999
---- ---- ----
Interest Income:
Credit card loans and retained
interests in loans securitized ..... $ 681,503 $ 490,929 $ 229,394
Federal funds sold ...................... 3,115 9,139 4,477
Other ................................... 12,372 4,710 2,298
----------- --------- ---------
Total interest income ................... 696,990 504,778 236,169
----------- --------- ---------
Deposit interest expense ................ 127,918 89,560 19,329
Other interest expense .................. 38,362 43,446 36,512
----------- --------- ---------
Total interest expense .................. 166,280 133,006 55,841
----------- --------- ---------
Net Interest Income ..................... 530,710 371,772 180,328
Provision for loan losses ............... 549,145 388,234 174,800
----------- --------- ---------
Net Interest (Expense) Income
After Provision for Loan Losses ... (18,435) (16,462) 5,528
----------- --------- ---------
Other Operating Income:
Net securitization and credit card
servicing income ................... 517,399 444,254 318,873
Credit card fees, interchange
and other credit card income ....... 296,926 223,333 129,808
Enhancement services revenues ........... 340,132 266,200 175,091
----------- --------- ---------
1,154,457 933,787 623,772
----------- --------- ---------
Other Operating Expense:
Credit card account and other product
solicitation and marketing expenses.
174,883 144,481 107,726
Employee compensation ................... 225,463 178,592 122,417
Data processing services and
communications...................... 90,222 86,166 65,970
Enhancement services claims expense ..... 35,628 26,431 21,091
Credit card fraud losses ................ 9,068 8,886 7,384
Purchased portfolio premium
Amortization ...................... 30,277 19,275 31,752
Other ................................... 148,613 130,583 81,644
----------- --------- ---------
714,154 594,414 437,984
----------- --------- ---------
Income Before Income Taxes,
Extraordinary Loss and Cumulative
Effect of Accounting
Changes ........................... 421,868 322,911 191,316
Income taxes ............................ 161,577 124,320 75,953
----------- --------- ---------
Income Before Extraordinary Loss and
Cumulative Effect of Accounting
Changes ........................... 260,291 198,591 115,363
Extraordinary loss from early
extinguishment of debt ............ -- -- 50,808
Cumulative effect of accounting changes
(net of income taxes of $9,000 and
$2,180)............................ 14,499 3,438 --
----------- --------- ---------
Net Income .............................. 245,792 195,153 64,555
Preferred stock dividends-Series B ...... -- -- 7,506
Convertible preferred stock
dividends-Series C ................ 34,771 31,624 17,080
Adjustment for the retirement of Series
B preferred stock.................. -- -- 101,615
----------- --------- ---------
Net Income (Loss) Applicable to
Common Stockholders .................. $ 211,021 $ 163,529 $ (61,646)
=========== ========= =========
63
Earnings per share:
Basic-income (loss) before
extraordinary loss and
cumulative effect of accounting
changes ........................ $ 2.67 $ 2.23 $ (0.19)
Basic-extraordinary loss ........... -- -- (0.88)
Basic-cumulative effect of
accounting changes ............. (0.15) (0.04) --
Basic-net income (loss) ............ 2.52 2.19 (1.07)
Diluted-income (loss) before
extraordinary loss and
cumulative effect of accounting
changes ........................ 2.62 2.15 (0.19)
Diluted-extraordinary loss ......... -- -- (0.88)
Diluted-cumulative effect of
accounting changes ............. (0.15) (0.04) --
Diluted-net income (loss) .......... 2.47 2.11 (1.07)
Shares used to compute earnings per share:
Basic ................................... 97,641 89,234 57,855
Diluted ................................. 99,366 92,582 57,855
Dividends declared per common share ..... $ 0.040 $ 0.033 $ 0.017
See accompanying Notes to Consolidated Financial Statements.
64
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
(Dollars and shares in thousands)
Number of Shares Total
Outstanding Preferred Common Paid-In Unearned Treasury Retained Stockholders'
Preferred Common Stock Stock Capital Compensation Stock Earnings Equity
--------- ------ ----- ----- ------- ------------ ----- -------- ------
BALANCE, DECEMBER 31, 1998 ... 540 57,779 $ 201,100 $193 $ 107,615 $ -- $ -- $ 124,074 $ 432,982
Net income .............. -- -- -- -- -- -- -- 64,555 64,555
Retirement of preferred
stock - Series B .... (560) -- (208,606) -- (101,615) -- -- -- (310,221)
Issuance of preferred
stock - Series C .... 840 -- 312,910 -- 122,369 -- -- -- 435,279
Cash dividends .......... -- -- -- -- -- -- -- (1,390) (1,390)
June 1999 two-for-one
stock split ......... -- -- -- 193 (193) -- -- -- --
Preferred dividends in
kind - Series B ..... 20 -- 7,506 -- -- -- -- (7,506) --
Preferred dividends in
kind - Series C ..... 45 -- 16,819 -- -- -- -- (16,819) --
Issuance of common
stock under employee
benefit plans ....... -- 140 -- -- 2,596 -- -- -- 2,596
------ ------- --------- ---- --------- ------- --------- --------- -----------
BALANCE, DECEMBER 31, 1999 ... 885 57,919 $ 329,729 $386 $ 130,772 $ -- $ -- $ 162,914 $ 623,801
====== ======= ========= ==== ========= ======= ========= ========= ===========
Net income .............. -- -- -- -- -- -- -- 195,153 195,153
Cash dividends .......... -- -- -- -- -- -- -- (2,942) (2,942)
June 2000 three-for-
two stock split ..... -- -- -- 201 (201) -- -- -- --
Preferred dividends in
kind - Series C ..... 83 -- 30,692 -- -- -- -- (30,692) --
Issuance of common stock
under employee
benefit plans ....... -- 4,324 -- 35 67,506 -- -- -- 67,541
------ ------- --------- ---- --------- ------- --------- --------- -----------
BALANCE, DECEMBER 31, 2000 ... 968 62,243 $ 360,421 $622 $ 198,077 $ -- $ -- $ 324,433 $ 883,553
====== ======= ========= ==== ========= ======= ========= ========= ===========
Net income .............. -- -- -- -- -- -- -- 245,792 245,792
Cash dividends .......... -- -- -- -- -- -- -- (3,752) (3,752)
Common stock repurchased. -- (806) -- -- -- -- (13,014) -- (13,014)
Preferred dividends in
kind - Series C ..... 90 -- 33,549 -- -- -- -- (33,549) --
Issuance of common stock
under employee
benefit plans ....... -- 1,518 -- 15 27,927 -- -- -- 27,942
Deferred compensation
obligations ......... -- 464 -- 5 6,409 (8,108) -- -- (1,694)
Amortization of
restricted stock .... -- -- -- -- -- 3,128 -- -- 3,128
------ ------- --------- ---- --------- ------- --------- --------- -----------
BALANCE, DECEMBER 31, 2001 ... 1,058 63,419 $ 393,970 $642 $ 232,413 $(4,980) $ (13,014) $ 532,924 $ 1,141,955
====== ======= ========= ==== ========= ======= ========= ========= ===========
See accompanying Notes to Consolidated Financial Statements.
65
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands)
Year Ended December 31,
-----------------------
2001 2000 1999
---- ---- ----
Operating Activities:
Net income .................................................................. $ 245,792 $ 195,153 $ 64,555
Adjustments to reconcile net income to net
cash provided by operating activities:
Extraordinary loss from early extinguishment
of debt................................................................... -- -- 50,808
Cumulative effect of accounting changes ..................................... 14,499 3,438 --
Depreciation and amortization ............................................... 106,703 76,256 75,341
Provision for loan losses ................................................... 549,145 388,234 174,800
Retained interests valuation expense (income)................................ (131,992) (104,710) 35,449
Gains on derivative financial instruments ................................... (10,129) -- --
Changes in operating assets and liabilities,
net:
Deferred income taxes ............................................... 114,178 39,268 (32,592)
Other receivables due from credit
card securitizations ........................................... (14,354) 47,904 (61,144)
Accounts payable and accrued expenses ............................... 6,446 45,877 65,337
Deferred income ..................................................... (20,476) 60,403 46,774
Other ............................................................... (62,507) (95,563) (106,940)
----------- ----------- -----------
Net cash provided by operating activities ................................... 797,305 656,260 312,388
----------- ----------- -----------
Investing Activities:
Net proceeds from sales and repayments of
securitized loans ........................................................ 1,854,257 690,621 1,138,291
Net loans originated or collected ........................................... (2,632,577) (2,104,478) (1,005,899)
Credit card portfolio acquisitions .......................................... (290,774) (195,597) (1,156,673)
Additions to premises and equipment ......................................... (5,706) (85,007) (41,724)
----------- ----------- -----------
Net cash used in investing activities ....................................... (1,074,800) (1,694,461) (1,066,005)
----------- ----------- -----------
Financing Activities:
Net increase in debt ........................................................ 291,838 11,054 134,116
Net (decrease) increase in deposits ......................................... (48,191) 1,330,818 775,381
Cash dividends paid ......................................................... (3,752) (2,942) (1,390)
Decrease in preferred equity ................................................ -- -- (124)
Increase in common equity ................................................... 17,260 26,278 2,720
Repurchase of common stock .................................................. (13,014) -- --
----------- ----------- -----------
Net cash provided by financing activities ................................... 244,141 1,365,208 910,703
----------- ----------- -----------
Net (decrease) increase in cash and cash
equivalents...............................................................
(33,354) 327,007 157,086
Cash and cash equivalents at beginning of
year...................................................................... 521,440 194,433 37,347
----------- ----------- -----------
Cash and cash equivalents at end of year .................................... $ 488,086 $ 521,440 $ 194,433
=========== =========== ===========
66
Supplemental disclosures and cash flow information: Cash paid during the year
for:
Interest ................................................................. $ 165,241 $ 81,724 $ 29,519
Income taxes ............................................................. 25,718 75,384 116,954
Tax benefit from employee stock option
exercises................................................................. 8,989 31,174 588
Non-cash conversion of Senior Notes:
Accrued expenses and other liabilities ................................. -- -- (4,250)
Debt ................................................................... -- -- (100,000)
Metris preferred stock ................................................. -- -- 104,250
See accompanying Notes to Consolidated Financial Statements.
67
METRIS COMPANIES INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands, except as noted)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Metris
Companies Inc. ("MCI") and its subsidiaries, including Direct Merchants Credit
Card Bank, National Association ("Direct Merchants Bank"), which may be referred
to as "we," "us," "our" and the "Company." We are an information-based direct
marketer of consumer lending products and enhancement services, primarily to
moderate-income consumers. We issue credit cards through our wholly owned
subsidiary, Direct Merchants Bank, the 10th largest bankcard issuer in the
United States. We also offer consumers products through our enhancement services
business unit, including credit card protection and insurance, extended service
plans and membership clubs.
We have eliminated all significant intercompany balances and transactions
in consolidation. We have reclassified certain prior-year amounts to conform
with the current year's presentation. Included in these reclassifications is a
change in our consolidated statement of cash flows to reflect the provision for
loan losses and retained interests valuation expense as an adjustment to
operating activities, versus the net change in the allowance for loan losses.
The impact was an increase to cash flow provided by operating activities and an
increase to cash flow used by investing activities by $233.5 million and $138.6
million for the years ended December 31, 2001 and 2000, respectively. The impact
of this change was a decrease to cash flow provided by operating activities and
a decrease to cash flow used by investing activities by $15.5 million for the
year ended December 31, 1999. These changes had no impact to the "Net change in
cash and cash equivalents" on the consolidated statements of cash flows.
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, which is discussed under note 2, and
our determination of the fair value of retained interests from assets
securitized, which is discussed under note 17. 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 December 31, 2001 and 2000 could materially differ from
these estimates.
68
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of the significant accounting and reporting
policies used in preparing the consolidated financial statements.
Federal Funds Sold and Short-term Investments
Federal funds sold are short-term loans made to banks through the Federal
Reserve System. It is our policy to make such loans only to banks that are
considered to be in compliance with their regulatory capital requirements.
Short-term investments are investments in money market mutual funds and
commercial paper with maturities less than three months.
Credit Card Loans
Credit card loans presented on our consolidated balance sheet are
receivables from consumers that we have not sold via securitizations or
third-party conduit warehousing arrangements, and are recorded at the principal
amount outstanding. We accrue and earn interest income on credit card loans
based on the principal amount of the loans outstanding using the effective-yield
method. Accrued interest and fees which have been billed to the customer but not
yet received are classified on the consolidated balance sheet with the related
credit card loans. Accrued interest which has not yet been billed to the
customer is estimated and classified on the consolidated balance sheet in "Other
assets." Interest income and fees are generally recognized until a loan is
charged off. A loan would be placed on non-accrual status prior to being
charged-off if the cardholder is placed in a credit counseling or similar
payment program, and as part of that program no interest or fees are being
charged. At that time, the interest and fee portion of the charged-off balance
is deducted from current period interest income and credit card fees.
Securitization, Retained Interests in Loans Securitized and Securitization
Income
We publicly and privately securitize a significant portion of our credit
card loans to investors through the Master Trust and third-party, single-seller
and multi-seller receivables conduits. We have recorded these transactions in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities." If the transaction qualifies as a sale under SFAS 140, we
remove the applicable credit card loans from the consolidated balance sheet. We
retain participating interests in the sold credit card loans under "Retained
interests in loans securitized" on the consolidated balance sheets. Our retained
interests in loans securitized are subordinate to the interests of investors in
the Master Trust and conduit portfolios. Retained interests include contractual
subordinated interests, excess transferor's interests and accrued finance
charges on securitized loans. SFAS 140 also requires us to initially measure the
related financial and servicing assets controlled and liabilities incurred at
fair value, if practicable, by allocating the previous carrying amount between
the assets sold, if any, and retained interests, if any, based on their relative
fair values at the date of the transfer.
69
We determine the fair value of retained interests by calculating the
present value of future expected cash flows estimated using management's best
estimate of key assumptions including credit losses, weighted-average spreads,
payment rate and discount rates commensurate with the risks involved.
Accounting for a securitization as a sale of credit card loans changes our
interest in such loans from lender to servicer and investor, with a
corresponding change in how revenue is reported in the consolidated statements
of income. Amounts that otherwise would have been recorded as interest income,
interest expense, fee income and provision for loan losses are instead reported
in other operating income as "Net securitization and credit card servicing
income." We have various receivables from the Master Trust or conduits and other
assets as a result of securitizations, including: amounts deposited in accounts
held by the Master Trust for the benefit of the Master Trust's security holders;
amounts due from interest rate caps and floors; accrued and unbilled finance
charges on the securitized receivables; servicing fee receivables and various
other receivables. These amounts are reported as "Other receivables due from
credit card securitizations, net" on the consolidated balance sheets.
Allowance for Loan Losses
We maintain an allowance for loan losses sufficient to cover anticipated
probable loan losses inherent in the credit card loan portfolio as of the
balance sheet date. The allowance is based on management's consideration of all
relevant factors including management's assessment of applicable economic and
seasonal trends. In addition, we have incorporated updated regulatory guidance
regarding analysis and documentation for the allowance for loan losses.
We segment the loan portfolio into several individual static pools with
similar credit risk and time since solicitation (vintage pools), and estimate
(based on historical experience and existing environmental conditions) the
dollar amount of principal, accrued finance charges and fees in each 30-day
delinquency bucket that will not be collected and, therefore, "roll" into the
next 30-day bucket and ultimately charge off. We then aggregate these pools into
prime and sub-prime portfolios based on the prescribed FICO score cuts and into
several other groups such as credit counseling and payment alternative
receivables. We also isolate individual pools subsequent to solicitation when
the credit risk associated with the pools include higher risk segments, such as
our partially secured card program, accounts that are over their credit limit by
more than 10% 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 vintage pool roll rate analysis.
We continually evaluate the homogenous static risk pools using a roll rate
model which uses historical delinquency levels and pay-down levels (12 months of
historical data, with significant influence given to last six months'
performance to capture current economic and seasonal
70
trends), loan seasoning and other measures of asset quality to estimate
charge-offs for both credit loss and bankruptcy losses.
Additionally, in evaluating the adequacy of the loan loss reserves, we
consider several subjective factors which may be overlaid into the credit risk
roll-rate model in determining the necessary loan loss reserve, including:
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.
Various regulatory agencies, as an integral part of their examination
process, periodically review our allowance for loan losses maintained at Direct
Merchants Bank (essentially those loans not sold via securitization or
third-party conduit financing relationships). Such agencies may require that we
recognize additions to the allowance based on their judgment on information
available to them at the time of their examination. In our opinion, the
allowance for loan losses is adequate to cover probable losses inherent in the
loan portfolio under current conditions.
We charge off most unsecured credit card accounts at the end of the month
during which the loan becomes contractually 180 days past due. We charge off all
partially secured credit card accounts and accounts which enter into credit
counseling or other similar programs and later become delinquent at the end of
the month during which the loan becomes contractually 120 days past due.
Bankrupt accounts are charged off upon formal notification of bankruptcy.
Accounts of deceased accountholders without a surviving, contractually liable
individual, or an estate large enough to pay the debt in full are charged off
immediately upon notification.
Property and Equipment
We state property and equipment and computer hardware and software at cost
and depreciate them on a straight-line basis over their estimated economic
useful lives, which range from one to twenty-five years. We capitalize software
developed for internal use that represents major enhancements or replacements of
operating and management information systems. We begin amortization of such
capitalized software when the systems are fully developed and ready for
implementation. We expense repair and maintenance costs as incurred.
71
Purchased Portfolio Premium
The purchased portfolio premium represents the excess of amounts paid for
portfolio acquisitions over the related credit card loan balances net of
reserves and discounts. The premium is amortized over the estimated account
life, generally seven years, using an effective-yield method. The recoverability
of the premium is evaluated if events or circumstances indicate a possible
inability to realize the carrying amount. Such evaluation is based on various
analyses, including undiscounted cash flow projections.
Enhancement Services
Debt Waiver Products
Direct Merchants Bank offers various debt waiver products on receivables
owned by the Bank as well as securitized receivables. The Bank records deferred
revenue when the debt waiver customer is billed. Revenue is recognized in the
month following the completion of the cancellation period, generally one month.
The Bank incurs the related claims and marketing expenses. A reserve is
maintained at the Bank 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 $198.2
million, $144.7 million and $106.0 million for the years ended December 31,
2001, 2000 and 1999, respectively. Unearned revenues and reserves for pending
claims are recorded in the consolidated balance sheets in "Deferred income" and
"Accrued expenses and other liabilities," respectively. Unearned revenues as of
December 31, 2001 were $20.4 million compared to $13.3 million as of December
31, 2000. Reserves for pending claims were $5.2 million as of December 31, 2001
and $4.0 million as of December 31, 2000.
During the quarter ended March 31, 2000 we adopted Staff Accounting
Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements," for our
debt waiver products. This SAB formalized the accounting for services sold where
the right to a full refund exists, requiring all companies to defer recognition
of revenues until the cancellation period is complete. Previously, we recognized
half of the revenues in the month billed and half in the following month. We now
recognize all of the revenue the month following completion of the cancellation
period. This change resulted in a one-time, non-cash net charge to earnings of
$3.4 million, which is reflected as a "Cumulative effect of accounting change"
in the consolidated statements of income for the year ended December 31, 2000.
Because we have applied the provisions of this SAB to our membership programs
since 1998, before the SEC formalized its guidance, we did not have to adjust
our enhancement services revenues.
Membership Programs
We generally 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
over the membership period beginning after the contractual cancellation period
is complete. Revenues recorded for
72
membership products are included in the statements of income under "Enhancement
services revenues" and were $94.7 million, $76.0 million and $31.9 million for
the years ended December 31, 2001, 2000 and 1999, respectively.
In accordance with the provisions of Statement of Position 93-7, "Reporting
on Advertising Costs," qualifying membership acquisition costs are deferred and
charged to expense as membership fees are recognized. These costs, which relate
directly to membership solicitations (direct response advertising costs),
principally include: postage, printing, mailings and telemarketing costs. We
amortize these costs on a straight-line basis as we realize revenues over the
membership period. Amortization of membership acquisition costs amounted to
$23.7 million, $14.9 million and $9.9 million for the years ended December 31,
2001, 2000 and 1999, respectively. If deferred membership acquisition costs were
to exceed forecasted future net revenues, we would make an appropriate
adjustment for impairment. All other membership acquisition costs are expensed
as incurred. Deferred membership acquisition costs amounted to $69.9 million and
$59.3 million as of December 31, 2001 and 2000, respectively.
Extended Service Plans
We coordinate the marketing activities for 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 a
straight-line basis over the life of the related extended service plan contracts
beginning after the expiration of any manufacturers' warranty coverage. The
provision for service contract returns charged against deferred income for the
years ended December 31, 2001, 2000 and 1999, amounted to $0.2 million, $3.0
million and $5.0 million, respectively.
We discontinue the billing of enhancement services products to customers
that are more than 60 days past due (except for debt waiver which bills
customers until 120 days past due) or over their credit limit. The impact of
uncollectible fees associated with enhancement service products is included in
determining the adequacy of the allowance for loan losses and the retained
interests valuation allowance.
Credit Card Fees and Origination Costs
Credit card fees include annual membership, late payment, overlimit,
returned check, cash advance transaction and other miscellaneous fees. We assess
these fees according to the terms of the related cardholder agreements and,
except for annual membership fees, are recognized as revenue when charged to the
cardholder's account.
We defer direct credit card origination costs associated with successful
credit card solicitations that we incur in transactions with independent third
parties, and certain other costs that we incur in connection with loan
underwriting and the preparation and processing of loan documents. These
deferred credit card origination costs and annual membership fees are amortized
on a straight-line basis over the cardholder's privilege period, generally 12
months. Net deferred fees
73
were $4.2 million and $13.1 million as of December 31, 2001 and 2000,
respectively.
Solicitation Expenses
We generally expense credit card account costs, including printing, credit
bureaus, list processing costs, telemarketing and postage, as incurred over the
two- to three-month period during which the related responses to such
solicitation are received.
Credit Card Fraud Losses
We experience credit card fraud losses from the unauthorized use of credit
cards. We expense these fraudulent transactions when identified, through the
establishment of a reserve for the transactions. We charge off these amounts
after 90 days, after all attempts to recover the amounts from these
transactions, including chargebacks to merchants and claims against cardholders,
are exhausted.
Interest Rate Risk Management Contracts
We enter into a variety of interest rate risk management contracts such as
interest rate swap, floor and cap agreements with highly rated counterparties in
order to hedge our interest rate exposure on securitized loans and deposits. We
account for these contracts in accordance with SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by SFAS 138. We
recognize all derivatives as either assets or liabilities on the balance sheet
and measure those instruments at fair value. The change in the fair value of the
derivatives are recognized currently in earnings unless specific hedge
accounting criteria are met. If the derivative qualifies as a hedge, the
accounting treatment for the change in fair value varies based on the type of
risk being hedged. The monthly interest rate differential to be paid or received
on these contracts is accrued and included in "Net securitization and credit
card servicing income" or "Deposit interest expense," as appropriate, on the
consolidated statements of income. Interest payable or receivable under these
contracts is classified under "Other receivables due from credit card
securitization, net" or "Other assets," as appropriate on the consolidated
balance sheets.
Debt Issuance Costs
Debt issuance costs are the costs related to issuing new debt securities
and establishing new securitizations under the Metris Master Trust ("Master
Trust") or conduits. We capitalize the costs as incurred and amortize them to
expense over the term of the new debt security.
Income Taxes
Deferred taxes are based on the temporary differences between the financial
statement and the tax bases of assets and liabilities that will result in future
taxable or deductible amounts. The deferred taxes are based on the enacted rate
that is expected to apply when the temporary differences reverse. A valuation
allowance is recognized if it is more likely than not that all or some portion
of the deferred tax asset will not be realized.
74
Earnings Per Share
The following table presents the computation of basic and diluted
weighted-average shares used in the per-share calculations:
Year Ended December 31,
-----------------------
2001 2000 1999
---- ---- ----
(In thousands)
Income before extraordinary loss and
cumulative effect of accounting
changes ................................ $260,291 $198,591 $ 115,363
Preferred dividends - Series B .............. -- -- 7,506
Preferred dividends - Series C .............. 34,771 31,624 17,080
Adjustment for the retirement of Series B
preferred stock ........................ -- -- 101,615
-------- -------- ---------
Net income (loss) applicable to common stockholders before extraordinary loss
and cumulative effect of accounting
changes ................................ 225,520 166,967 (10,838)
Extraordinary loss from the early
extinguishment of debt ................. -- -- 50,808
Cumulative effect of accounting changes, net. 14,499 3,438 --
-------- -------- ---------
Net income (loss) applicable to common
stockholders ........................... $211,021 $163,529 $ (61,646)
======== ======== =========
Weighted average common shares outstanding .. 62,962 60,070 57,855
Adjustments for dilutive securities:
Assumed conversion of convertible preferred
stock .................................. 34,679 29,164 --(1)
-------- -------- ---------
Basic common shares(2) ...................... 97,641 89,234 57,855
Assumed exercise of outstanding stock
options .................................. 1,725 3,348 --(1)
-------- -------- ---------
Diluted common shares ....................... 99,366 92,582 57,855
======== ======== =========
(1) For the year ended December 31, 1999, there were convertible preferred
stock and options outstanding to purchase 15.3 million and 3.2 million
common shares. These potential common shares have been excluded from the
computation of diluted earnings per share because their inclusion would
have been anti-dilutive.
(2) In accordance with EITF Topic No. D-95, we revised our computation of basic
earnings per common share. As required by Topic D-95, the dilutive effect
of our Series C Convertible Preferred Stock is included in the computation
of basic EPS, using the if-converted method. The Series C Convertible
Preferred Stock participates in dividends on an as-converted basis with our
common stock. For all periods presented, there is no impact to diluted
earnings per share. We restated the basic EPS amounts for the years ended
December 31, 2000 and 1999 to be consistent with the revised methodology.
Before the impact of Topic D-95, basic EPS would have been $3.35, $2.72 and
$(1.07) for the years ended December 31, 2001, 2000 and 1999, respectively.
75
Comprehensive Income
SFAS 130 "Reporting Comprehensive Income," does not apply to our current
financial results and therefore, net income equals comprehensive income.
NOTE 3 - SECURITIZATION ACTIVITY
During 2001 and 2000, we sold credit card loans in securitization
transactions. In those securitizations, we retained servicing responsibilities
and subordinated interests. We receive annual servicing fees approximating two
percent of the outstanding balance and rights to future cash flows arising after
the investors in the securitization trust have received the return for which
they contracted. The investors and the securitization trusts have no recourse to
our other assets for failure of debtors to pay when due. Our retained interests
are subordinate to investors' interests. Their value is subject to credit and
interest rate risks on the transferred financial assets.
Securitization activity for the years ended December 31, 2001 and 2000, is
as follows:
December 31,
2001 2000
---- ----
Credit card loans ............................ $ 2,746,656 $ 1,179,203
Retained interests in loans securitized ...... 1,263,655 2,023,681
Investors' interests in loans
securitized.............................. 7,895,842 6,070,224
-------------- -----------
Total managed loans .......................... 11,906,153 9,273,108
Managed loans more than 30-days
contractually delinquent................. 1,123,168 767,732
Managed loans charged off, net of
recoveries............................... 1,140,151 778,921
For the years ended December 31,
2001 2000
---- ----
Cash flow to/from the Company:
Net proceeds from sales and
repayments of securitized loans ...... $ 1,825,618 $ 551,911
Proceeds from collections reinvested
in previous credit card
securitizations....................... 4,181,887 3,858,146
Servicing fees received ................. 147,518 119,572
Other cash flows received on
retained interests ................... 565,918 401,557
-------------- -----------
Total ................................ $ 6,720,941 $ 4,931,186
============== ===========
76
NOTE 4 - ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses is as follows:
Year Ended December 31,
-----------------------
2001 2000 1999
---- ---- ----
Balance at beginning of year .............. $ 123,123 $ 12,175 --
Allowance related to assets acquired, net . 14,106 5,963 --
Allowance related to assets transferred
to the Master Trust.................... (28,639) (138,709) (151,828)
Provision for loan losses ................. 549,145 388,234 174,800
Loans charged off ......................... (275,057) (150,099) (10,797)
Recoveries ................................ 27,481 5,559 --
--------- --------- --------
Net loans charged off ..................... (247,576) (144,540) (10,797)
--------- --------- --------
Balance at end of year .................... $ 410,159 $ 123,123 $ 12,175
========= ========= ========
During 2001, 2000 and 1999, we transferred $28.6 million, $138.7 million
and $151.8 million of allowance for credit card loan losses to the valuation
allowance on our retained interests in loans securitized. These transfers relate
to asset sales between Direct Merchants Bank and the Master Trust, changes in
accounting treatment as a result of changes in our source of funding (i.e.
collateralized borrowing versus sales treatment under SFAS 140 and 125) and the
amount of allowance for loan losses and valuation allowance on the retained
interests determined through our roll rate analysis and fair value calculation.
NOTE 5 - RETAINED INTERESTS
Activity in retained interests is as follows:
Year Ended December 31,
2001 Change 2000 Change 1999
Gross retained interests. $ 1,263,655 $(760,026) $ 2,023,681 $ 406,455 $ 1,617,226
Valuation allowance ..... (537,499) 103,353 (640,852) (33,999) (606,853)
----------- --------- ----------- ----------- -----------
Net retained interests... $ 726,156 $(656,673) $ 1,382,829 $ 372,456 $ 1,010,373
=========== ========= =========== =========== ===========
Activity in the valuation for retained interests is as follows:
Year Ended December 31,
-----------------------
2001 2000 1999
---- ---- ----
Balance at beginning of year .............................. $ 640,852 $ 606,853 $393,283
Allowance related to assets acquired, net ................. -- -- 26,293
Allowance related to assets transferred
to the Master Trust .................................... 28,639 138,709 151,828
Retained interests valuation expense (income).............. (131,992) (104,710) 35,449
--------- --------- --------
Balance at end of year .................................... $ 537,499 $ 640,852 $606,853
========= ========= ========
77
NOTE 6 - PROPERTY AND EQUIPMENT
The carrying value of property and equipment is as follows:
At December 31,
2001 2000
---- ----
Furniture and equipment ....................... $ 46,865 $ 46,416
Computer software and equipment ............... 65,407 55,399
Construction in progress ...................... 1,842 6,842
Buildings and land ............................ 28,031 27,805
Leasehold improvements ........................ 18,561 18,537
-------- --------
Total ......................................... $160,706 $154,999
Less: Accumulated depreciation and
amortization............................... 45,793 26,604
-------- --------
Balance at end of year ........................ $114,913 $128,395
======== ========
Depreciation and amortization expense for the years ended December 31,
2001, 2000 and 1999, was $24.7 million, $16.0 million and $6.8 million,
respectively.
NOTE 7 - PURCHASED PORTFOLIO PREMIUM
The carrying value of the purchased portfolio premium was $94.8 million and
$95.5 million as of December 31, 2001 and 2000, net of accumulated amortization
of $94.0 million and $63.7 million, respectively. Amortization expense for the
years ended December 31, 2001, 2000 and 1999 was $30.3 million, $19.3 million,
and $31.8 million, respectively. The purchased portfolio premium is analyzed for
impairment using the undiscounted cash flow method. As of December 31, 2001 and
2000 the purchased portfolio premium was not impaired.
NOTE 8 - PORTFOLIO ACQUISITIONS
In 2001, Direct Merchants Bank purchased two credit card portfolios that
consisted of approximately 170,000 active accounts and approximately $290
million in receivables. In 2000, Direct Merchants Bank purchased one credit card
portfolio that had approximately 184,000 active accounts and approximately $186
million in receivables.
NOTE 9 - CONVERTIBLE PREFERRED STOCK
Affiliates of Thomas H. Lee Partners, L.P. ("THL Partners"), a Boston-based
investment firm, and its predecessor, Thomas H. Lee Company, hold 100% of the
outstanding shares of our Series C Perpetual Convertible Preferred Stock. The
Series C Preferred Stock has a 9% dividend payable in additional shares of
Series C Preferred Stock and also receives any cash dividends paid on our common
stock based on the number of shares of common stock into which the Preferred
Stock would convert on the record date of the dividend. Each share of Series C
Preferred Stock is convertible into 30 shares of common stock plus - if
converted at the option of the holder before January 1, 2004 - a premium amount
designed to guarantee a portion of seven years worth of dividends at the 9%
annual rate. The premium amount would have been equal to 41.0% of those future
78
dividends for conversions in 2001 and would be 54.4% of those dividends in 2002.
The Series C Preferred Stock is normally fully convertible into common
stock. This would mean that upon conversion of their Preferred Stock, our
Preferred Stockholders could have received 35,597,993 shares, or approximately
36.0%, of our outstanding common stock on a diluted basis as of December 31,
2001, and could receive 38,977,613 shares, or approximately 38.5%, of our
outstanding common stock on a diluted basis as of March 15, 2002. However, the
indenture that governs our 10% Senior Notes due 2004 requires us to offer to
purchase those notes in the event that such a conversion would result in a
shareholder or group (within the meaning of Rules 13d-3 and 13d-5 of the
Securities Exchange Act of 1934) obtaining 35% or more of our outstanding voting
stock. Therefore, we included a provision in the terms of our Series C Preferred
Stock that sets the maximum percentage of outstanding voting stock that any
shareholder or group, such as the affiliates of THL Partners, could obtain while
any of our 10% Notes remain outstanding at 34.9%. Accordingly, as of December,
2001, the Series C Preferred Stock could have been converted into 33,998,592
shares, or 34.9%, of our common stock on a diluted basis, with the excess Series
C Preferred Stock converting into 1,599,401 shares of nonvoting Series D
Preferred Stock. As of March 15, 2002, the Series C Preferred Stock could have
been converted into 33,359,130 shares - again, 34.9%, of our common stock on a
diluted basis - and 5,618,483 shares of Series D Preferred Stock. The Series D
Preferred Stock automatically converts into common stock on a share-for-share
basis at the time that the conversion will not exceed the ownership limitations
described above. The terms of our Series D Preferred Stock are essentially the
same as the terms of our common stock, except that
o the Series D Preferred Stock has a liquidation preference of $.01 per
share, and
o is non-voting, except as required by law to preserve the powers,
preferences or other rights of that class of stock.
So long as they or their affiliates own at least 25% of the originally
issued Series C Preferred Stock (or any shares of common stock issued upon
conversion thereof), the holders of a majority of the shares of Series C
Preferred Stock are entitled to elect four of eleven directors of the Board. So
long as they or their affiliates: (a) own any shares of Series C Preferred Stock
(or any shares of common stock issued upon conversion thereof); and (b) are
entitled to elect four directors, the Thomas H. Lee Equity Fund IV, L.P., which
owns approximately 85% of our outstanding Series C Preferred Stock, has the
right to appoint one of the four directors. So long as they or their affiliates
own at least 10% but less than 25% of the originally issued Series C Preferred
Stock (or any shares of common stock issued upon conversion thereof), the
holders of a majority of the shares of Series C Preferred Stock are entitled to
elect one director. The four directors who have been elected by the holders of
our Series C Preferred Stock are all affiliates of THL Partners and, through
such affiliation as well as actual ownership of Series C Preferred Stock, may be
deemed to be the beneficial owners of approximately 97% of the common stock that
would be issued upon conversion of our Series C and D Preferred Stock, both
individually and in the aggregate. Those directors - C. Hunter Boll, Thomas M.
Hagerty,
79
David V. Harkins and Thomas H. Lee - were first appointed to the Board of
Directors in June 1999 and re-elected for one-year terms in May of 2000, 2001
and 2002.
The Series C Preferred Stock may be redeemed by us in certain circumstances
by paying 103% of the redemption price of $372.50 and any accrued dividends at
the time of redemption. We also have the option to redeem the Series C Preferred
Stock after December 9, 2008, without restriction by paying the redemption price
of $372.50 and any accrued dividends at the time of redemption.
Prior to shareholder approval and the receipt of notice that there was no
regulatory objection to the Series C Preferred Stock investment, THL Partners
agreed to purchase $200 million in Series B Perpetual Preferred Stock and $100
million in 12% Senior Notes due 2006. We also issued THL Partners 7.5 million
ten-year warrants to purchase shares of our common stock.
On March 12, 1999, shareholders approved the conversion of the Series B
Preferred Stock and 12% Senior Notes into Series C Preferred Stock. On June 1,
1999, the Series B Preferred Stock and the 12% Senior Notes were extinguished,
and the warrants were canceled causing a one-time, non-cash accounting
adjustment. The excess of the fair value of the Series C Preferred Stock over
the carrying value of the Series B Preferred Stock and the 12% Senior Notes at
the time of the conversion was allocated to the 12% Senior Notes and the Series
B Preferred Stock based upon their initial fair values. To arrive at net income
applicable to common stockholders in the calculation of earnings per share, the
amount allocated to the 12% Senior Notes was recognized as an extraordinary loss
from the early extinguishment of debt in the amount of $50.8 million and the
amount allocated to the Series B Preferred Stock was recognized as a reduction
of net income applicable to common stockholders in the amount of $101.6 million.
The extraordinary loss attributable to the 12% Senior Notes is not recorded net
of taxes. These adjustments did not have an impact on total stockholders'
equity.
Other than the arrangements and transactions discussed in this Note 9 and
the payment of normal directors' fees (including equity-based compensation and
reimbursement of reasonable expenses to the four directors elected by the
holders of our Series C Preferred Stock), we have not engaged in any material
transactions with affiliates of THL Partners.
NOTE 10 - STOCK OPTIONS
We offer the Metris Companies Inc. Long-Term Incentive and Stock Option
Plan, which permits a variety of stock-based grants and awards and gives us
flexibility in tailoring our long-term compensation programs. In 2001, the Board
of Directors recommended, and the shareholders approved, an increase in the
number of shares reserved for issuance under the plan to 17.0 million shares of
common stock for awards of stock options or other stock-based awards, subject to
adjustment in certain circumstances. As of December 31, 2001, 1.3 million shares
were available for grant. We do not provide loans to employees for the purchase
of stock or the exercise of stock options.
80
The Compensation Committee has the authority to determine the exercise
prices, vesting dates or conditions, expiration dates and other material
conditions upon which options or awards may be exercised, except that the option
price for Incentive Stock Options ("ISOs") may not be less than 100% of the fair
market value of the common stock on the date of grant (and not less than 110% of
the fair market value in the case of an ISO granted to any employee owning more
than 10% of the common stock) and the terms of nonqualified stock options may
not exceed 15 years from the date of grant (not more than 10 years for ISOs and
five years for ISOs granted to any employee owning more than 10% of the common
stock). Full- or part-time employees, consultants or independent contractors are
eligible to receive nonqualified options and awards. Only full- or part-time
employees are eligible to receive ISOs.
During 2001, 2000 and 1999, we granted 2.7 million, 4.2 million and 2.7
million options, respectively, to officers and employees.
We also issue restricted stock grants under the stock option plan to our
executive officers. A total of 72,600 and 91,400 common shares were granted in
2001 and 2000, with an approximate aggregate market value of $1.8 million and
$2.3 million at the time of the grant, respectively. The market value of these
restricted shares at the date of grant is amortized into expense over a period
not less than the restriction period. We recognized expense of $1.4 million in
2001 and $1.1 million in 2000 for these restricted shares. If the restrictions
are removed, generally upon death, disability or retirement, the remaining
unamortized market value of the restricted shares is expensed. Previous to 2001,
restricted shares were unregistered, and therefore the related unearned
compensation was recorded in "Accrued expenses and other liabilities" on the
consolidated balance sheet. In 2001 restricted shares were registered and all
unearned compensation was recorded as part of stockholders' equity.
We also offer the Metris Companies Inc. Non-Employee Director Stock Option
Plan which provides up to 750,000 shares of common stock for awards of options,
subject to adjustments in certain circumstances. During 2001, 2000 and 1999, we
granted 75,000, 82,500 and 127,500 options, respectively. At December 31, 2001,
300,000 shares were available for grant.
We have adopted the disclosure-only provisions of SFAS No. 123 "Accounting
for Stock-Based Compensation." Accordingly, we continue to account for
stock-based compensation under the provisions of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees." Under the guidelines
of Opinion 25, compensation cost for stock-based employee compensation plans is
recognized 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.
Proforma information regarding net income and earnings per share is
required by SFAS 123 and has been determined as if we accounted for our employee
stock options under the fair value method of SFAS 123. The fair value of the
options was estimated at the grant date using a Black-Scholes option pricing
model. The fair value of the options is amortized to expense over the options'
vesting periods. Our net earnings and earnings
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per share would have been reduced to the pro forma amounts indicated below:
Year Ended December 31,
-----------------------
2001 2000 1999
---- ---- ----
Net income as reported .............. $245,792 $195,193 $ 64,555
Net income pro forma ................ 236,570 185,356 59,733
Diluted earnings (loss) per share
as reported................... 2.47 2.11 (1.07)
Diluted earnings (loss) per share
pro forma 2.38 2.00 (1.15)
Weighted-average assumptions in option valuation:
Risk-free interest rates ............ 4.90% 6.40% 5.30%
Dividend yields ..................... 0.20% 0.10% 0.10%
Stock volatility factor ............. 52.2% 58.4% 55.4%
Expected life of options (in
years) ........................ 6.0 6.0 6.0
The above pro forma amounts may not be representative of the effects on
reported net earnings for future years.
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Information regarding our stock option plans for 2001, 2000 and 1999, is as
follows:
Year Ended December 31,
2001 2000 1999
---- ---- ----
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Options outstanding,
beginning of year ............. 9,907,062 $17.67 10,129,614 $9.72 7,862,100 $8.56
Options exercised ................ 1,383,358 11.81 4,212,537 5.46 111,750 6.40
Options granted .................. 2,832,838 25.01 4,348,685 24.78 2,860,914 13.47
Options canceled/
forfeited ..................... 752,406 27.06 358,700 22.64 481,650 13.79
------------------------------------------------------------------------------------
Options outstanding,
end of year ................... 10,604,136 19.73 9,907,062 17.67 10,129,614 9.72
Weighted-average
fair value of
options granted
during the year................ -- 12.17 -- 13.47 -- 6.53
The following table summarizes information about stock options outstanding
at December 31, 2001:
Options Outstanding Options Exercisable
------------------- -------------------
Weighted-
Average Weighted- Weighted-
Number Remaining Average Number Average
Outstanding Contractual Exercise Exercisable Exercise
Exercise Price at 12/31/01 Life Price at 12/31/01 Price
-------------- ----------- ---- ----- ----------- -----
$ 0.00-$16.77 ............. 3,568,727 6.8 $10.57 2,389,133 $11.99
$17.10-$24.42 ............. 4,058,285 8.3 22.09 1,353,360 21.33
$24.67-$38.88 .............. 2,977,124 8.9 27.51 203,237 29.05
---------- --- ------ --------- ------
10,604,136 7.9 $19.73 3,945,730 $16.07
========== === ====== ========= ======
Employee Stock Purchase Plan
During the third quarter of 1999, we adopted the Metris Companies Inc.
Employee Stock Purchase Plan ("ESPP"), whereby eligible employees may authorize
payroll deductions of up to 15% of their salary to purchase shares of our common
stock. Under the plan, shares of our common stock may be purchased at the end of
each monthly offering period at 85% of the lower of the fair market value on the
first or last day of the monthly offering period. Employees contributed $2.3
million and $2.0 million to purchase 121,658 and 100,624 shares of common stock
under the ESPP for 2001 and 2000, respectively. We are authorized to issue up to
2.6 million shares of common stock to employees under the plan, and as of
December 31, 2001, there were approximately 2.3 million shares available for
future issuance.
83
Management Stock Purchase Plans
We provide management stock purchase plans, whereby any employee who is a
Senior Vice President or higher and who participates in the Metris Management
Incentive Bonus Plan is eligible to participate. Participants may elect to defer
up to 50% of their bonus received under the Management Bonus Plan, which is
credited to a stock purchase account as restricted stock units. We will make a
match of $1 for every $3 contributed by the participant. The participant's
contributions are vested immediately and our matching contributions vest after
three years (two years for contributions made for the year of adoption).
Employees contributed approximately $1.9 million to purchase 75,512 restricted
stock units under the plans for 2001. The restricted stock units convert to
common stock when distributed from the plans. We are authorized to issue up to
900,000 shares of common stock to employees under the plans, and as of December
31, 2001, approximately 770,000 of the authorized shares were available for
future issuance.
NOTE 11 - EMPLOYEE BENEFIT PLANS
We offer a defined contribution plan that is intended to qualify under
section 401(k) of the Internal Revenue Code. The 401(k) Plan provides retirement
benefits for eligible employees. Eligible employees may elect to contribute to
the 401(k) Plan, and we match a portion of employee contributions and make
discretionary contributions based upon our financial performance. For the years
ended December 31, 2001, 2000 and 1999, we contributed $2.0 million, $1.4
million and $1.8 million to the 401(k) Plan, respectively.
In 2000, the Company adopted a new Non-Qualified Deferred Compensation Plan
for a select group of management or highly compensated employees. These
employees are allowed to participate in the 401(k) Plan under the new Plan in
2001 and 2000, but were unable to participate in the 401(k) Plan under the
previous Non-Qualified Deferred Compensation Plan in 1998. There was no
Non-Qualified Preferred Compensation Plan in effect during 1999. The new Plan
provides saving and investment opportunities to those individuals who elect to
defer a portion of their salary. Participants in the prior Plan were allowed to
transfer their balances to the new Plan. The Company matches a portion of the
employee contribution and makes discretionary contributions based on the
Company's financial performance. We contributed $334.5 thousand and $296.5
thousand to the Plan for the years ended December 31, 2001 and 2000,
respectively.
Supplemental Executive Retirement Plan
Our funded Supplemental Executive Retirement Plan ("SERP") provides
officers and other members of senior management with supplemental retirement
benefits in excess of limits imposed on qualified plans by federal tax law. The
SERP is an account balance plan to which we will make annual contributions
targeted to provide 60% of the average of the participant's final five years of
salary and bonus with us. These benefits will be paid in 15 annual installments
beginning the year after they become eligible to receive benefits. Participants
are eligible to receive benefits upon leaving our employment if they are at
least 65 years of age or at least age 55 with five years of plan participation,
if a change of control occurs or in the event of death. We recognized $0.7
84
million and $0.9 million of expense in 2001 and 2000, respectively, related to
the SERP. Our liability was $3.1 million and $3.1 million at December 31, 2001
and 2000, respectively, for future payments under this plan. We calculate this
expense and liability based on actuarial assumptions regarding years of
participation, future investment returns and participants continuing in the SERP
until age 65.
NOTE 12 - INCOME TAXES
The components of the provision for income taxes consisted of the
following:
Year Ended December 31,
-----------------------
2001 2000 1999
---- ---- ----
Current:
Federal... $ 41,795 $ 77,185 $94,309
State .... 5,604 7,867 14,236
Deferred .... 114,178 39,268 (32,592)
-------- -------- -------
$161,577 $124,320 $75,953
======== ======== =======
A reconciliation of our effective income tax rate compared to the statutory
federal income tax rate is as follows:
Year Ended
December 31,
------------
2001 2000 1999
---- ---- ----
Statutory federal income tax rate ......... 35.0% 35.0% 35.0%
State income taxes, net of federal benefit. 1.5% 2.8% 3.2%
Other, net ................................ 1.8% 0.7% 1.5%
---- ---- ----
Effective income tax rate ................. 38.3% 38.5% 39.7%
==== ==== ====
Our deferred tax assets and liabilities are as follows:
At December 31,
2001 2000
---- ----
Deferred income tax assets resulting from
future deductible temporary differences:
Allowance for loan losses and retained interests
valuation allowance ......................... $ 210,271 $ 214,989
Deferred revenues .............................. 72,944 74,755
Other .......................................... 31,632 18,800
------------- -----------
Total deferred tax assets ......................... $ 314,847 $ 308,544
Deferred income tax liabilities resulting from future taxable temporary
differences:
Accrued interest on credit card loans ....... $ 213,899 $ 114,595
Deferred costs .............................. 37,524 30,701
Other ....................................... 31,257 16,903
------------- -----------
Total deferred tax liabilities ................. $ 282,680 $ 162,199
Net deferred tax assets ........................ $ 32,167 $ 146,345
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We believe, based on our history of operating earnings, expectations for
operating earnings in the future, and the expected reversal of taxable temporary
differences, earnings will be sufficient to fully utilize the deferred tax
assets.
NOTE 13 - RELATED PARTY TRANSACTIONS
In the ordinary course of business, our executive officers may have credit
card loans issued by us. Pursuant to our policy, such loans are issued on the
same terms as those prevailing at the time for comparable loans with unrelated
persons and do not involve more than the normal risk of collectibility.
NOTE 14 - COMMITMENTS AND CONTINGENCIES
Commitments to extend credit to consumers represent the unused credit
limits on open credit card accounts. These commitments amounted to $15.7
billion, $10.9 billion and $9.7 billion as of December 31, 2001, 2000 and 1999,
respectively. While these amounts represent the total lines of credit available
to our customers, we have not experienced and do not anticipate that all of our
customers will exercise their entire available line at any given point in time.
We also have the right to increase, reduce, cancel, alter or amend the terms of
these available lines of credit at any time.
We lease certain office facilities and equipment under various cancelable
and non-cancelable operating lease agreements that provide for the payment of a
proportionate share of property taxes, insurance and other maintenance expenses.
These leases also may include scheduled rent increases and renewal options.
Rental expense for these operating leases for the years ended December 31, 2001,
2000 and 1999, was $21.8 million, $18.1 million and $11.1 million, respectively.
Future minimum lease commitments at December 31, 2001, under cancelable and
non-cancelable operating leases are as follows:
2002 $16,650
2003 12,545
2004 11,273
2005 9,513
2006 7,820
Thereafter 34,301
-------
Total minimum lease payments $92,102
=======
We are a party to various legal proceedings resulting from the ordinary
business activities relating to our operations. In July 2000 an Amended
Complaint was filed in Hennepin County District Court in Minneapolis, Minnesota
against MCI and our subsidiaries Metris Direct, Inc. and Direct Merchants Bank.
The complaint seeks damages in unascertained amounts and purports to be a class
action complaint on behalf of all cardholders who were issued a credit card by
Direct Merchants Bank and were allegedly assessed fees or charges that the
cardholder did not authorize. Specifically, the complaint alleges violations of
the Minnesota Prevention of Consumer Fraud Act, the Minnesota Deceptive Trade
Practices Act and breach of contract.
86
Subsequent to year end, preliminary approval of a class action settlement
was signed by the Court whereby we will pay approximately $5.6 million for
attorneys' fees and costs incurred by attorneys for the plaintiffs in separate
lawsuits filed in Arizona, California and Minnesota in 2000 and 2001. Based on
negotiations with plantiffs council and our offer of a settlement in the amount
of $5.6 million, we recorded a $5.6 million accrual during the third quarter of
2001 to reflect the proposed settlement. Under the terms of the settlement,
which was approved by the court on May 30, 2002, we denied any wrongdoing or
liability.
Direct Merchants Bank's activities as a credit card lender are subject to
regular review and examination by federal regulators to assess compliance with
various federal consumer protection laws. Regulators are authorized to impose
penalties for violations of these laws and, in certain cases, to order Direct
Merchants Bank to pay restitution to injured cardholders.
On May 3, 2001, Direct Merchants Bank entered into a consent order with the
Office of the Comptroller of the Currency ("OCC"). The consent order required
Direct Merchants Bank to pay approximately $3.2 million in restitution to
approximately 62,000 credit card customers who applied for and received a credit
card in connection with a series of limited test marketing campaigns from March
1999 to June 2000. Under the terms of the consent order, Direct Merchants Bank
made no admission or agreement on the merits of the OCC's assertions. The
restitution as required by the OCC consent order was paid and is reflected in
our December 31, 2001 financial statements. We believe that the non-monetary
portion of Direct Merchants Bank's agreement with the OCC will not have a
material adverse effect on the financial position of MCI or Direct Merchants
Bank.
In May 2001, the OCC also indicated that it was considering whether or not
to pursue an assessment of civil money penalties and gave Direct Merchants Bank
the opportunity to provide information to the OCC bearing on whether imposing a
penalty would be appropriate and the severity of any penalty. The statutory
provisions pursuant to which a civil money penalty could be assessed give the
OCC broad discretion in determining whether or not a penalty will be assessed
and, if so, the amount of the penalty. Direct Merchants Bank, to date, has not
incurred nor paid any civil money penalties. We have not made an accrual for
civil money penalties because we believe the assessment of such penalties is not
probable nor is the amount reasonably estimated.
NOTE 15 - CAPITAL REQUIREMENTS AND RESTRICTED PAYMENTS
In the normal course of business, we enter into agreements, or are subject
to regulatory requirements, that result in cash, debt and dividend or other
capital restrictions.
The Federal Reserve Act imposes various legal limitations on the extent to
which banks can finance or otherwise supply funds to their affiliates. In
particular, Direct Merchants Bank is subject to certain restrictions on any
extensions of credit to or other covered transactions, such as certain purchases
of assets, with us and our affiliates. Such restrictions limit Direct Merchants
Bank's ability to lend to us and our affiliates. Additionally, Direct Merchants
Bank is limited in its ability
87
to declare dividends to us in accordance with the national bank dividend rules.
Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the OCC. At December 31, 2001 and 2000, Direct Merchants Bank's Tier
1 risk-based capital ratio, risk-based total capital ratio and Tier 1 leverage
ratio exceeded the minimum required capital levels, and Direct Merchants Bank
was considered a "well-capitalized" depository institution under regulations of
the OCC.
We are also bound by restrictions set forth in the indentures related to
the Senior Notes dated November 7, 1997, and July 15, 1999. Pursuant to those
indentures, we may not make dividend payments in the event of a default or if
all such restricted payments would exceed 25% of our aggregate cumulative net
income.
NOTE 16 - CONCENTRATIONS OF CREDIT RISK
A concentration of credit risk is defined as significant credit exposure
with an individual or group engaged in similar activities or affected similarly
by economic conditions. We are active in originating credit card loans
throughout the United States, and no individual or group had a significant
concentration of credit risk at December 31, 2001 or 2000. The following table
details the geographic distribution of our retained, sold and managed credit
card loans:
Owned Sold Managed
----- ---- -------
At December 31, 2001
--------------------
California ....... $ 500,991 $ 986,393 $ 1,487,384
New York ........ 337,213 663,933 1,001,146
Texas ........... 324,492 638,887 963,379
Florida ......... 291,935 574,787 866,722
Illinois ........ 166,097 327,027 493,124
Ohio ............ 162,897 320,724 483,621
Pennsylvania..... 137,282 270,292 407,574
All others ...... 2,089,404 4,113,799 6,203,203
---------- ---------- -----------
Total ........ $4,010,311 $7,895,842 $11,906,153
========== ========== ===========
Owned Sold Managed
----- ---- -------
At December 31, 2000
--------------------
California ....... $ 404,947 $ 765,909 $1,170,856
Texas ............ 273,187 516,701 789,888
New York ......... 261,192 494,015 755,207
Florida .......... 238,972 451,988 690,960
Ohio ............. 129,958 245,801 375,759
Illinois ......... 128,650 243,326 371,976
Pennsylvania ..... 104,911 198,427 303,338
All others ....... 1,661,067 3,154,057 4,815,124
---------- ---------- ----------
Total ......... $3,202,884 $6,070,224 $9,273,108
========== ========== ==========
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We target our consumer lending products primarily to moderate-income
consumers. Primary risks associated with lending to this market are that they
may be more sensitive to future economic downturn, which may make them more
likely to default on their obligations.
NOTE 17 - FAIR VALUE OF FINANCIAL INSTRUMENTS
We have estimated the fair value of our financial instruments in accordance
with SFAS No. 107, "Disclosures About Fair Value of Financial Instruments."
Financial instruments include both assets and liabilities, whether or not
recognized in our consolidated balance sheets, for which it is practicable to
estimate fair value. Additionally, certain intangible assets recorded on the
consolidated balance sheets, such as purchased credit card relationships, and
other intangible assets not recorded on the consolidated balance sheets (such as
the value of the credit card relationships for originated loans and the
franchise values of our various lines of business) are not considered financial
instruments and, accordingly, are not valued for purposes of this disclosure. We
believe there is substantial value associated with these assets based on current
market conditions, including the purchase and sale of these assets. Accordingly,
the aggregate estimated fair value amounts presented do not represent the entire
underlying value of the Company.
Quoted market prices generally are not available for all of our financial
instruments. Accordingly, in cases where quoted market prices are not available,
fair values were estimated using present value and other valuation techniques
that are significantly affected by the assumptions used, including the discount
rate and estimated future cash flows. These assumptions are based on historical
experience and assessments regarding the ultimate collectibility of assets and
related interest, and estimates of product lives and repricing characteristics
used in our asset/liability management process. These assumptions involve
uncertainties and matters of judgment, and therefore, cannot be determined with
precision. Thus, changes in these assumptions could significantly affect the
fair-value estimates.
A description of the methods and assumptions used to estimate the fair
value of each class of our financial instruments is as follows:
Cash and cash equivalents and accrued interest and fees receivable
The carrying amounts approximate fair value due to the short-term nature of
these instruments.
Net credit card loans and retained interests
Credit card loans are originated with variable rates of interest that
adjust with changing market interest rates. Thus, the carrying value of the
credit card loans, less the allowance for loan losses, approximates fair value.
This valuation does not include the value that relates to estimated cash flows
generated from new loans from existing accountholders over the life of the
accountholder relationship. Accordingly, the aggregate fair value of the credit
card loans does not represent the underlying value of the established
accountholder relationships.
89
The fair value of the retained interests are estimated by discounting the
expected future cash flows from the Master Trust and each of the conduits at
rates which we believe to be consistent with those that would be used by an
independent third party. However, because there is no active market for this,
the fair values presented may not be indicative of the value negotiated in an
actual sale. The future cash flows used to estimate fair value are limited to
the securitized receivables that exist at year end and do not reflect the value
associated with future receivables generated by accountholder activity.
Interest rate cap, floor and swap agreements
The fair values of interest rate cap, floor and swap agreements were
obtained from dealer quoted prices. These values generally represent the
estimated amounts we would receive or pay to terminate the agreements at the
reporting dates, taking into consideration current interest rates and the
current creditworthiness of the counterparties.
Other securitization assets
For other securitization assets, the carrying amount is a reasonable
estimate of the fair value, due to their short-term nature.
Debt
We make short-term borrowings with variable rates of interest that adjust
with changing market interest rates. Thus, carrying value approximates fair
value.
We obtain the fair value of long-term debt from quoted market yields, when
available.
Deposits
The fair value for fixed rate certificates of deposit are estimated based
on quoted market prices of comparable instruments.
90
The estimated fair values of our financial instruments are summarized as
follows:
At December 31,
---------------
2001 2000
---- ----
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Cash and cash equivalents ................ $ 488,086 $ 488,086 $ 521,440 $ 521,440
Accrued interest and fees
receivable............................. 38,657 38,657 30,531 30,531
Credit card loans, net ................... 2,336,497 2,336,497 1,056,080 1,056,080
Securitization assets:
Retained interest in
loans securitized,
net................................. 726,156 726,156 1,382,829 1,382,829
Interest rate cap
agreements.......................... 27,321 27,321 39,365 15,468
Other ................................. 152,547 152,547 147,329 147,329
Interest rate swap
agreements............................. 3,293 3,293 -- 2,716
Debt ..................................... 647,904 633,005 356,066 327,917
Deposits ................................. 2,058,008 2,067,697 2,106,199 2,109,690
For purposes of determining the fair value of the net retained interests,
we have included only cash flows associated with the excess spread and principal
receivables included in the retained interests as of the balance sheet date. We
have not included certain expected finance charge receivable cashflows in our
calculation. The significant assumptions used for estimating the fair value of
the retained interests in loans securitized are as follows:
At December 31,
2001 2000
---- ----
Annual discount rate (1)........................ 15% 15%
Monthly payment rate ........................... 7% 7%
Weighted-average spread (2) .................... 20% 16%
Annual principal, finance charge and fees
default rate................................. 18% 16%
(1) If we had included all expected finance charge receivable cash flows, our
effective discount rate would have ranged from 35% to 45%. (2) Includes finance
charges, late fees and overlimit fees, less weighted-average cost of funds and
2% servicing fee.
91
At December 31, 2001, the sensitivity of the current fair value of the
retained interests to immediate 10 percent and 20 percent adverse changes are as
follows (in millions):
Impact on Fair Value
10% adverse change 20% adverse change
------------------ ------------------
Annual discount rate (1) .......... $ 15 $ 29
Monthly payment rate .............. 1 1
Weighted-average spread (2)........ 164 322
Annual principal, finance charge
and fees default rate........... 183 359
The actual annual principal and finance charge default rates for loans
securitized are as follows:
Year ended December 31, 2001 .......... 15%
Year ended December 31, 2000 .......... 14%
We believe these sensitivity analyses may not accurately reflect the
potential impact on the asset values as they do not consider potential
offsetting positive impacts that would occur in the portfolio.
NOTE 18 - DERIVATIVE FINANCIAL INSTRUMENTS
We use derivative financial instruments for the purpose of managing our
exposure to interest rate risks. We have a number of procedures in place to
monitor and control both market and credit risk from these derivative
activities. Our senior management approves all derivative strategies and
transactions.
During 2001 and 2000, we entered into interest rate cap and interest rate
swap transactions. We enter into interest rate caps through our subsidiary,
Metris Receivables, Inc. ("MRI") on behalf of Master Trust investors. Interest
rate caps are purchased in connection with each of MRI's securitized debt
issuances. The interest rate caps do not meet the criteria for hedge accounting
treatment. The change in the fair value of the caps is included in the
consolidated income statement under "Net securitization and credit card income."
For the year ended December 31, 2001, excluding the cumulative effect of
accounting change, we recognized income of $10.1 million from the mark-to-market
adjustments on the interest rate caps.
We entered into interest rate swap transactions through Direct Merchants
Bank. The swaps are used to effectively convert the fixed rate certificates of
deposit to variable rate certificates of deposit, and thus hedge the fair market
value of the CDs. The CDs expose us to variability in the fair value in rising
or declining interest rate environments. By converting the fixed payment to a
variable payment, the interest rate swaps effectively reduce the variability of
the fair market value of the CDs.
As of January 1, 2001, we had two outstanding interest rate swap agreements
accounted for as hedges under SFAS 133 with a combined value of $2.7 million. In
February 2001, we entered into two additional swap agreements with no value as
of the inception date. As of the adoption of SFAS 133 or their inception, all
four swaps were designated as fair value
92
hedges. Changes in the value of the swaps are recognized in income, in the
period in which the change in value occurred. In addition, changes in the value
of the CDs, to the extent they are attributable to the risk being hedged, are
simultaneously recognized in income. Any difference between the fair value
change in the swaps versus the fair value change in the related hedged CDs was
considered to be the "ineffective" portion of the hedge. The ineffective portion
of the swap is recorded as an increase or decrease in income.
During 2001, three of four swaps were sold. At the date of sale, the swap
and the related CDs were valued, and a gain or loss was recognized for the
difference between the change in fair value of the swap and the change in fair
value of the CDs. The cumulative amount recorded as an adjustment to the value
of the CDs is being amortized over the life of the CDs as an adjustment to
interest expense. For the year ended December 31, 2001, approximately $1.2
million of CD valuation adjustments were recorded as an offset to interest
expense. The unamortized valuation adjustment as of December 31, 2001 was $2.8
million, which will be recognized as an offset to interest expense in 2002.
Additionally, $3.5 million was recognized as income in 2001 related to the
ineffective portion of the swaps.
Prior to SFAS 133, we amortized the costs of interest rate contracts on a
straight-line basis over the expected life of the contract. The adoption of SFAS
133 resulted in a one-time, non-cash, after-tax charge to earnings of $14.5
million, reflected as a "Cumulative effect of accounting change" in the
consolidated statements of income for the year ended December 31, 2001. As of
December 31, 2001, we had 13 interest rate caps valued at $27.3 million and one
interest rate swap valued at $3.3 million.
The notional amounts and weighted-average interest rate of interest rate
swap, cap and floor agreements purchased and sold during 2001 and 2000 are as
follows:
Weighted- Weighted-
Year Ended December 31, Average Average
(Dollars in thousands) Interest Interest
2001 Rate 2000 Rate
---- ---- ---- ----
Interest rate swap
agreements:
Beginning balance ... $ 249,000 7.0% $ -- --
Additions ........... 171,300 6.8% 249,000 7.0%
Terminations ........ 295,800 6.9% -- --
---------- ----------
Ending balance ...... $ 124,500 7.0% $ 249,000 7.0%
========== ==========
Interest rate caps:
Beginning balance ..... $5,119,628 9.2% $4,213,021 9.4%
Additions ........... 396,243 10.5% 1,260,774 8.5%
Terminations ........ 1,053,294 9.5% 354,167 9.1%
---------- ----------
Ending balance ...... $4,462,577 9.2% $5,119,628 9.2%
========== ==========
Interest rate floor:
Beginning balance ... $ -- -- $ 58,333 6.2%
Additions ........... -- -- -- --
Terminations ........ -- -- 58,333 6.2%
--------- ----------
Ending balance ...... $ -- -- $ -- --
========= ==========
93
NOTE 19 - SEGMENTS
We operate in two principal areas: consumer lending products and
enhancement services. Our consumer lending products are primarily unsecured and
partially secured credit cards, including the Direct Merchants Bank
MasterCard(R) and Visa(R). Our credit card accountholders 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 and death, (2) membership programs such as card
registration, purchase protection and other club memberships, and (3)
third-party insurance, directly to our credit card customers and customers of
third parties. We currently issue and administer our extended service plans sold
through a third-party retailer, and the customer pays the retailer directly.
We have presented the segment information reported below on a managed
basis. We use this basis to review segment performance and to make operating
decisions. In doing so, the income statement and balance sheet are adjusted to
reverse the effects of securitizations. Presentation on a managed basis is not
in conformity with accounting principles generally accepted in the United States
of America. The elimination column in the segment table includes adjustments to
present the information on an owned basis as reported in the financial
statements of this Annual Report on Form 10-K/A.
We do not allocate the expenses, assets and liabilities attributable to
corporate functions to the operating segments, such as employee compensation,
data processing services and communications, third-party servicing expenses, and
other expenses including occupancy, depreciation and amortization, professional
fees, and other general and administrative expenses. We include these expenses
in the reconciliation of the income before income taxes, extraordinary loss and
cumulative effect of accounting changes for the reported segments to the
consolidated total. We do not allocate capital expenditures for leasehold
improvements, capitalized software and furniture and equipment to operating
segments. There were no operating assets located outside of the United States
for the periods presented.
Our enhancement services operating segment pays a fee to the consumer
lending products segment for successful marketing efforts to cardholders at a
rate similar to those paid to our other third parties. Our enhancement services
segment reports interest income and the consumer lending products segment
reports interest expense at our weighted-average borrowing rate for the excess
cash flow generated by the enhancement services segment and used by the consumer
lending products segment to fund the growth of cardholder balances.
94
2001
----
Consumer
Lending Enhancement Securitization Other
Products Services Adjustments (a) Adjustments (b) Consolidated
-------- -------- --------------- --------------- ------------
Interest
income ...... $ 1,973,400 $ 12,308 $ (1,276,410) $ (12,308) $ 696,990
Interest
expense ..... 492,773 -- (314,185) (12,308) 166,280
----------- --------- ------------ ----------- ------------
Net interest
income ...... 1,480,627 12,308 (962,225) -- 530,710
Other revenue . 612,683 340,132 201,642 -- 1,154,457
Total revenue . 2,093,310 352,440 (760,583) -- 1,685,167
Income before
income taxes
and
cumulative
effect of
accounting
change..... 684,663(c) 231,780(c) -- (494,575) 421,868
Total assets .. $11,395,934 $ 138,420 $ (7,895,843) $ 590,175(d) $ 4,228,686
2000
----
Consumer
Lending Enhancement Securitization Other
Products Services Adjustments (a) Adjustments (b) Consolidated
-------- -------- --------------- --------------- ------------
Interest
income .... $1,596,352 $ 11,848 $(1,091,574) $ (11,848) $ 504,778
Interest
expense..... 533,325 -- (388,471) (11,848) 133,006
---------- --------- ----------- --------- -----------
Net interest
income ...... 1,063,027 11,848 (703,103) -- 371,772
Other revenue . 494,155 266,200 173,432 -- 933,787
Total revenue . 1,557,182 278,048 (529,671) -- 1,305,559
Income before
income taxes
and
cumulative
effect of
accounting
change ...... 560,772(c) 176,756(c) -- (414,617) 322,911
Total assets .. $9,013,828 $ 154,236 $(6,070,224) $ 638,185 (d) $ 3,736,025
95
1999
----
Consumer
Lending Enhancement Securitization Other
Products Services Adjustments (a) Adjustments (b) Consolidated
-------- -------- --------------- --------------- ------------
Interest
income ...... $1,163,663 $ 4,649 $ (927,494) $ (4,649) $ 236,169
Interest
expense..... 340,066 -- (279,576) (4,649) 55,841
---------- --------- ----------- --------- ---------
Net interest
income ....... 823,597 4,649 (647,918) -- 180,328
Other revenue .. 368,500 175,091 80,181 -- 623,772
Total revenue .. 1,192,097 179,740 (567,737) -- 804,100
Income before
income taxes
and
cumulative
effect of
accounting
change ...... 392,453(c) 100,646(c) -- (301,783) 191,316
Total assets ... $7,190,903 $ 116,106 $(5,518,312) $ 256,385 (d) $ 2,045,082
(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, extraordinary loss and cumulative effect of
accounting changes, includes intercompany commissions paid by the enhancement
services segment to the consumer lending products segment for successful
marketing efforts to consumer lending products cardholders of $12.4 million,
$18.3 million and $6.7 million for 2001, 2000 and 1999, respectively.
(d) Total assets include the assets attributable to corporate functions not
allocated to operating segments and the removal of investors' interests in
securitized loans to present total assets on an owned basis.
NOTE 20 - STOCKHOLDERS' EQUITY
On February 6, 2001, the Company's Board of Directors authorized a share
repurchase program of up to $200 million of its outstanding common stock over a
period ending December 31, 2002. The amount of shares the Company can repurchase
in a calendar year is limited under its various debt agreements. In 2001, the
Company was limited to repurchasing approximately $75 million of shares. As of
December 31, 2001, 0.8 million shares had been repurchased under the program for
$13.0 million. Subsequent to December 31, 2001, we repurchased an additional 1.2
million shares for $17.6 million.
96
NOTE 21 - DEBT AND DEPOSITS
A warehouse financing facility entered into in June 2001 has been accounted
for as a collateralized financing under SFAS 140 and included in "Debt" on the
consolidated balance sheet. The financing conduit has a capacity of $400 million
and a variable interest rate based on LIBOR. As of December 31, 2001, $292
million was outstanding on the conduit. During July 2000, we amended and
restated our credit facility. The amended credit facility consists of a $170
million revolving credit facility which matures in July 2003 and a $100 million
term loan which matures in June 2003. At December 31, 2001 and 2000, we had
outstanding borrowings of $100 million under the term loan facility with
weighted-average interest rates of 5.4% and 9.9%, respectively, and no
outstanding balance on the revolving credit facility at December 31, 2001 and
2000. At December 31, 2001, we were in compliance with all financial covenants
under these agreements.
As of December 31, 2001, we had $145.9 million of 10.125% Senior Notes due
2006 outstanding. These Senior Notes were issued at a discount of $6.3 million
to yield an effective interest rate of 11%. The Senior Notes due 2006 and credit
facility are unconditionally guaranteed on a senior basis, jointly and
severally, by Metris Direct, Inc., magnUS Services, Inc. (formerly Metris
Recovery Services, Inc.), Metris Card Services, LLC and Metris Credit Card
Services, Inc. ("Guarantors"), and all of our future subsidiaries that guarantee
any of our indebtedness. The guarantee is an unsecured obligation of the
Guarantors and ranks equally with all existing and future unsubordinated
indebtedness. We also have $100 million of 10% Senior Notes due 2004 outstanding
with terms and conditions substantially similar to the Senior Notes due 2006. We
have a $10.0 million 9.19% term loan due 2005 used to fund Company equipment.
Our debt outstanding as of December 31, 2001, matures as follows:
2002 $292,497
2003 100,434
2004 100,476
2005 8,543
2006 145,936
Thereafter 18
---------
Total debt outstanding $ 647,904
=========
Direct Merchants Bank issues certificates of deposit of $100,000 or more.
As of December 31, 2001 and 2000, $2.1 billion and $2.1 billion of CDs were
outstanding with original maturities ranging from six months to five years and
three months to five years, respectively. These CDs pay fixed interest rates
ranging from 2.4% to 7.6% and 5.4% to 7.6% at December 31, 2001 and 2000,
respectively.
97
Our CDs outstanding as of December 31, 2001 and 2000, mature as follows:
Weighted- Weighted-
Average Average
Interest Interest
2001 Rate 2000 Rate
---- ---- ---- ----
Three months or less . $ 404,955 5.8% $ 384,795 6.1%
Over three months
through twelve
months .......... 811,802 5.3% 1,214,288 6.6%
Over one year through
three years ..... 567,897 5.2% 467,652 7.7%
Over three years ..... 273,354 5.9% 39,464 7.4%
---------- --- ---------- ---
Total certificates of
deposits ....... . $2,058,008 5.4% $2,106,199 6.8%
========== === ========== ===
We have various indirect subsidiaries which do not guarantee Company debt.
We have prepared condensed consolidating financial statements of the Company,
the Guarantor subsidiaries and the non-guarantor subsidiaries for purposes of
complying with SEC reporting requirements. Separate financial statements of the
guaranteeing subsidiaries and the non-guaranteeing subsidiaries are not
presented because we have determined that the subsidiaries financial information
would not be material to investors.
98
METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
December 31, 2001
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Assets:
Cash and cash
equivalents............ $ 17,613 $ 1,505 $ 468,968 $ -- $ 488,086
Net retained
interests in loans
securitized............. -- -- 726,156 -- 726,156
Credit card loans ......... 1,646 -- 2,334,851 -- 2,336,497
Property and
equipment, net.......... -- 78,425 36,488 -- 114,913
Deferred income
taxes................... (31,921) 4,937 59,151 -- 32,167
Purchased portfolio
premium................. 248 -- 94,545 -- 94,793
Other receivables
due from
credit card
securitizations, net ... 34 644 179,190 -- 179,868
Other assets .............. 10,145 50,794 201,525 (6,258) 256,206
Investment in
subsidiaries............ 1,900,528 1,745,701 -- (3,646,229) --
----------- ----------- ----------- ----------- -----------
Total assets .............. $ 1,898,293 $ 1,882,006 $ 4,100,874 $(3,652,487) $ 4,228,686
----------- ----------- ----------- ----------- -----------
Liabilities:
Deposits .................. $ (1,000) $ -- $ 2,059,008 $ -- $ 2,058,008
Debt ...................... 345,924 171 301,809 -- 647,904
Accounts payable .......... 3,070 15,461 68,073 (3,129) 83,475
Deferred income ........... 3,270 30,615 184,275 (3,129) 215,031
Accrued expenses and
other liabilities ...... 405,074 (64,769) (257,992) -- 82,313
----------- ----------- ----------- ----------- -----------
Total liabilities ......... 756,338 (18,522) 2,355,173 (6,258) 3,086,731
----------- ----------- ----------- ----------- -----------
Total stockholders'
equity.................. 1,141,955 1,900,528 1,745,701 (3,646,229) 1,141,955
----------- ----------- ----------- ----------- -----------
Total liabilities
and stockholders'
equity.................. $ 1,898,293 $ 1,882,006 $ 4,100,874 $(3,652,487) $ 4,228,686
=========== =========== =========== =========== ===========
99
METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
December 31, 2000
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Assets:
Cash and cash
equivalents ...... $ 64,869 $ 10,658 $ 445,913 $ -- $ 521,440
Net retained
interests in loans
securitized ...... 311 -- 1,382,518 -- 1,382,829
Credit card loans ... 2,232 -- 1,053,848 -- 1,056,080
Property and
equipment, net ... -- 77,693 50,702 -- 128,395
Deferred income
taxes ............ (2,415) 17,104 131,656 -- 146,345
Purchased portfolio
premium .......... 248 -- 95,289 -- 95,537
Other receivables
due from credit
card
securitizations,
net .............. 14 84 186,596 -- 186,694
Other assets ........ 13,806 41,946 173,583 (10,630) 218,705
Investment in
subsidiaries ..... 1,588,918 1,442,295 -- (3,031,213) --
------------ ------------ ----------- ------------ ----------
Total assets ........ $ 1,667,983 $ 1,589,780 $3,520,105 $ (3,041,843) $3,736,025
------------ ------------ ----------- ------------ ----------
Liabilities:
Deposits ............ $ (1,000) $ -- $2,107,199 $ -- $2,106,199
Debt ................ 345,024 880 10,162 -- 356,066
Accounts payable .... 259 14,536 73,993 (5,315) 83,473
Deferred income ..... 12,718 49,934 178,170 (5,315) 235,507
Accrued expenses and
other liabilities 427,429 (64,488) (291,714) -- 71,227
------------ ------------ ----------- ------------ ----------
Total liabilities ... 784,430 862 2,077,810 (10,630) 2,852,472
------------ ------------ ----------- ------------ ----------
Total stockholders'
equity ........... 883,553 1,588,918 1,442,295 (3,031,213) 883,553
------------ ------------ ----------- ------------ ----------
Total liabilities
and stockholders'
equity ........... $ 1,667,983 $ 1,589,780 $ 3,520,105 $ (3,041,843) $3,736,025
============ ============ =========== ============ ==========
100
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Year Ended December 31, 2001
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Net Interest Income
(Expense) ....................... $ 8,583 $ (7,480) $ 529,607 $ -- $ 530,710
Provision for loan losses .......... 2,402 -- 546,743 -- 549,145
----------- ---------- ----------- ----------- -----------
Net Interest Income
(Expense) After Provision
for Loan Losses ................. 6,181 (7,480) (17,136) -- (18,435)
----------- ---------- ----------- ----------- -----------
Other Operating Income:
Net securitization and
credit card servicing
income .......................... 9,511 -- 507,888 -- 517,399
Credit card fees,
interchange and other
credit card income .............. (5,551) 31,508 270,969 -- 296,926
Enhancement services
revenues ............. -- 57,836 282,296 -- 340,132
Intercompany allocations ........... 153 229,642 (229,795) -- --
----------- ---------- ----------- ----------- -----------
4,113 318,986 831,358 -- 1,154,457
----------- ---------- ----------- ----------- -----------
Other Operating Expense:
Credit card account and
other product solicitation
and marketing expenses........... -- 12,642 162,241 -- 174,883
Employee compensation .............. 1,101 197,645 26,717 -- 225,463
Data processing services and
communications................... 3 (90,538) 180,757 -- 90,222
Warranty and debt waiver
underwriting and claims
servicing expense ............... -- 877 34,751 -- 35,628
Credit card fraud losses ........... 1 5 9,062 -- 9,068
Purchased portfolio
premium amortization ............. -- -- 30,277 -- 30,277
Other .............................. (393) 127,530 21,476 -- 148,613
Intercompany allocations ........... 127 57,355 (57,482) -- --
----------- ---------- ----------- ----------- -----------
839 305,516 407,799 -- 714,154
----------- ---------- ----------- ----------- -----------
Income Before Income Taxes,
Equity in Income of
Subsidiaries and Cumulative
Effect of Accounting Change ..... 9,455 5,990 406,423 -- 421,868
Income taxes ....................... 3,621 2,294 155,662 -- 161,577
Equity in income of
subsidiaries .................... 239,958 236,262 -- (476,220) --
----------- ---------- ----------- ----------- -----------
Income Before Cumulative
Effect of Accounting Change ..... 245,792 239,958 250,761 (476,220) 260,291
Cumulative effect of
accounting change, net ........... -- -- 14,499 -- 14,499
----------- ---------- ----------- ----------- -----------
Net Income .......................... $ 245,792 $ 239,958 $ 236,262 $ (476,220) $ 245,792
=========== ========== =========== =========== ===========
101
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Year Ended December 31, 2000
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Net Interest (Expense) Income ... $ (76,200) $ (4,685) $452,657 $ -- $371,772
Provision for loan losses ....... (4) -- 388,238 -- 388,234
--------- --------- -------- --------- --------
Net Interest (Expense) Income
After Provision for Loan
Losses ....................... (76,196) (4,685) 64,419 -- (16,462)
--------- --------- -------- --------- --------
Other Operating Income:
Net securitization and credit
card servicing income ........ 3,544 (3) 440,713 -- 444,254
Credit card fees, interchange
and other credit card
income ....................... 504 633 222,196 -- 223,333
Enhancement services revenues ... -- 54,747 211,453 -- 266,200
--------- --------- -------- --------- --------
4,048 55,377 874,362 -- 933,787
--------- --------- -------- --------- --------
Other Operating Expense:
Credit card account and other
product solicitation and
marketing expenses
-- 21,917 122,564 -- 144,481
Employee compensation ........... -- 147,567 31,025 -- 178,592
Data processing services and
communications
-- (82,227) 168,393 -- 86,166
Warranty and debt waiver
underwriting and claims
servicing expense ............ -- 1,353 25,078 -- 26,431
Credit card fraud losses ........ 5 -- 8,881 -- 8,886
Purchased portfolio premium
amortization ................. -- -- 19,275 -- 19,275
Other ........................... (119) 57,812 72,890 -- 130,583
--------- --------- -------- --------- --------
(114) 146,422 448,106 -- 594,414
--------- --------- -------- --------- --------
(Loss) Income Before
Income Taxes, Equity in Income
of Subsidiaries and
Cumulative Effect of
Accounting Change ............ (72,034) (95,730) 490,675 -- 322,911
Income taxes .................... (27,733) (38,485) 190,538 -- 124,320
Equity in income of
subsidiaries ................. 239,454 296,699 -- (536,153) --
--------- --------- -------- --------- --------
Income Before Cumulative
Effect of Accounting Change .. 195,153 239,454 300,137 (536,153) 198,591
Cumulative effect of
accounting change, net ....... -- -- 3,438 -- 3,438
--------- --------- -------- --------- --------
Net Income ...................... $ 195,153 $ 239,454 $296,699 $(536,153) $195,153
========= ========= ======== ========= ========
102
METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Year Ended December 31, 1999
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------ ------------
Net Interest (Expense) Income ... $ (39,529) $ (974) $ 220,831 $ -- $ 180,328
Provision for loan losses ....... 248 -- 174,552 -- 174,800
---------- --------- ----------- --------- ---------
Net Interest (Expense) Income
After Provision for Loan
Losses ....................... (39,777) (974) 46,279 -- 5,528
---------- --------- ----------- --------- ---------
Other Operating Income:
Net securitization and credit
card servicing income ........ 5,601 (4) 313,276 -- 318,873
Credit card fees, interchange
and other credit card
income ....................... 886 (4,088) 133,010 -- 129,808
Enhancement services revenues ... -- 51,341 123,750 -- 175,091
---------- --------- ----------- --------- ---------
6,487 47,249 570,036 -- 623,772
---------- --------- ----------- --------- ---------
Other Operating Expense:
Credit card account and other
product solicitation and
marketing expenses ........... -- 36,751 70,975 -- 107,726
Employee compensation -- 110,886 11,531 -- 122,417
Data processing services and
communications ............... -- (66,273) 132,243 -- 65,970
Warranty and debt waiver
underwriting and claims
servicing expense ............ -- 2,755 18,336 -- 21,091
Credit card fraud losses ........ 17 -- 7,367 -- 7,384
Purchased portfolio premium
amortization ................. -- -- 31,752 -- 31,752
Other ........................... 1,071 32,997 47,576 -- 81,644
---------- --------- ----------- --------- ---------
1,088 117,116 319,780 -- 437,984
---------- --------- ----------- --------- ---------
(Loss) Income Before Income
Taxes, Equity in Income
of Subsidiaries and
Extraordinary Loss ........... (34,378) (70,841) 296,535 -- 191,316
Income taxes .................... (13,647) (28,471) 118,071 -- 75,953
Equity in income of
subsidiaries ................. 136,094 178,464 -- (314,558) --
---------- --------- ----------- --------- ---------
Income Before Extraordinary
Loss ......................... 115,363 136,094 178,464 (314,558) 115,363
Extraordinary loss from the
early extinguishment of
debt ......................... 50,808 -- -- -- 50,808
---------- --------- ----------- --------- ---------
Net Income ...................... $ 64,555 $ 136,094 $ 178,464 $(314,558) $ 64,555
========== ========= =========== ========= =========
103
METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Year Ended December 31,
(Dollars in thousands)
2001
----
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Consolidated
-------------- ------------ ------------ ------------
Operating Activities:
Net cash provided by operating
activities .......................... $ 33,007 $ 339 $ 763,959 $ 797,305
-------- ----------- ----------- ------------
Investing Activities:
Net proceeds from sales and repayments
of securitized loans ................ -- -- 1,854,257 1,854,257
Net loans originated or collected ...... 1,131 -- (2,633,708) (2,632,577)
Credit card portfolio acquisitions ..... -- -- (290,774) (290,774)
(Additions to) dispositions of premises
and equipment ....................... -- (18,258) 12,552 (5,706)
-------- ----------- ----------- ------------
Net cash provided by (used in)
investing activities ................ 1,131 (18,258) (1,057,673) (1,074,800)
-------- ----------- ----------- ------------
Financing Activities:
Net (decrease) increase in debt ........ (10,243) 8,623 293,458 291,838
Net decrease in deposits ............... -- -- (48,191) (48,191)
Cash dividends paid .................... (3,752) -- -- (3,752)
Net (decrease) increase in equity ...... (54,385) 143 71,502 17,260
Repurchase of common stock ............. (13,014) -- -- (13,014)
-------- ----------- ----------- ------------
Net cash (used in) provided by
financing activities ................ (81,394) 8,766 316,769 244,141
-------- ----------- ----------- ------------
Net (decrease) increase in cash and
cash equivalents ..................... (47,256) (9,153) 23,055 (33,354)
Cash and cash equivalents at beginning
of year
64,869 10,658 445,913 521,440
-------- ----------- ----------- ------------
Cash and cash equivalents at end of year $ 17,613 $ 1,505 $ 468,968 $ 488,086
======== =========== =========== ============
2000
----
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Consolidated
-------------- ------------ ------------ ------------
Operating Activities:
Net cash (used in) provided by
operating activities ................ $ (78,840) $ (13,591) $ 748,691 $ 656,260
--------- ----------- ----------- -----------
Investing Activities:
Net proceeds from sales and repayments
of securitized loans ................ -- -- 690,621 690,621
Net loans originated or collected ...... (417) -- (2,104,061) (2,104,478)
Credit card portfolio acquisitions ..... -- -- (195,597) (195,597)
Additions to premises and equipment .... -- (54,552) (30,455) (85,007)
--------- ----------- ----------- -----------
Net cash used in investing activities .. (417) (54,552) (1,639,492) (1,694,461)
--------- ----------- ----------- -----------
Financing Activities:
Net increase (decrease) in debt ........ 242,667 (47,376) (184,237) 11,054
Net increase in deposits ............... -- -- 1,330,818 1,330,818
Cash dividends paid .................... (2,942) -- -- (2,942)
Net (decrease) increase in equity ...... (139,218) 125,868 39,628 26,278
--------- ----------- ----------- -----------
Net cash provided by financing
activities .......................... 100,507 78,492 1,186,209 1,365,208
--------- ----------- ----------- -----------
Net increase in cash and cash
equivalents ......................... 21,250 10,349 295,408 327,007
Cash and cash equivalents at beginning
of year ............................. 43,619 309 150,505 194,433
--------- ----------- ----------- -----------
Cash and cash equivalents at end of year $ 64,869 $ 10,658 $ 445,913 $ 521,440
========= =========== =========== ===========
104
METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Year Ended December 31, 1999
(Dollars in thousands)
Metris Guarantor Non-Guarantor
Companies Inc. Subsidiaries Subsidiaries Consolidated
-------------- ------------ ------------ ------------
Operating Activities:
Net cash (used in) provided by operating
activities .......................... $ (12,089) $ (19,710) $ 344,187 $ 312,388
--------- --------- ----------- -----------
Investing Activities:
Net proceeds from sales and repayments
of securitized loans ................ -- -- 1,138,291 1,138,291
Net loans originated or collected ...... (693) -- (1,005,206) (1,005,899)
Credit card portfolio acquisitions ..... -- -- (1,156,673) (1,156,673)
Additions to premises and equipment .... -- (20,944) (20,780) (41,724)
--------- --------- ----------- -----------
Net cash used in investing activities .. (693) (20,944) (1,044,368) (1,066,005)
--------- --------- ----------- -----------
Financing Activities:
Net increase (decrease) in debt ........ 351,658 (97,800) (119,742) 134,116
Net increase in deposits ............... -- -- 775,381 775,381
Cash dividends paid .................... (1,390) (804) 804 (1,390)
Net (decrease) increase in equity ...... (288,860) 139,723 151,733 2,596
--------- --------- ----------- -----------
Net cash provided by financing
activities .......................... 61,408 41,119 808,176 910,703
--------- --------- ----------- -----------
Net increase in cash and cash
equivalents ......................... 48,626 465 107,995 157,086
Cash and cash equivalents at beginning
of year ............................. (5,007) (156) 42,510 37,347
--------- --------- ----------- -----------
Cash and cash equivalents at end of year. $ 43,619 $ 309 $ 150,505 $ 194,433
========= ========= =========== ===========
105
Metris Companies Inc. and Subsidiaries
Summary of Consolidated Quarterly Financial Information and Stock Data
(Dollars in thousands, except per-share data) (unaudited)
2001
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Summary of Operations:
Interest Income .................... $ 175,847 $ 179,207 $ 172,207 $ 169,729
Interest Expense ................... 31,984 42,148 44,313 47,835
---------- --------- ---------- ---------
Net Interest Income ................ 143,863 137,059 127,894 121,894
Provision for Loan
Losses ........................ 230,221 116,513 114,682 87,729
Other Operating Income ............. 365,640 283,180 277,449 228,188
Other Operating Expense ............ 164,625 189,376 188,930 171,223
---------- --------- ---------- ---------
Income Before Income
Taxes and Cumulative
Effect of Accounting
Change ........................ 114,657 114,350 101,731 91,130
Income Taxes ....................... 43,915 43,614 38,963 35,085
---------- --------- ---------- ---------
Income Before Cumulative
Effect of Accounting
Change .......................... 70,742 70,736 62,768 56,045
Cumulative Effect of
Accounting Change
(Net of Income Taxes
of $9,000) .................... -- -- -- 14,499
---------- --------- ---------- ---------
Net Income ......................... 70,742 70,736 62,768 41,546
Preferred Stock Dividends .......... 8,987 8,788 8,593 8,403
---------- --------- ---------- ---------
Net Income Applicable to
Common Stockholders ............. $ 61,755 $ 61,948 $ 54,175 $ 33,143
========== ========= ========== =========
Per Common Share:
Earnings per Share:
Basic (1) ..................... $ 0.73 $ 0.72 $ 0.64 $ 0.43
Diluted (1) ................... 0.72 0.70 0.63 0.42
Shares used to Compute
EPS (000's):
Basic ......................... 97,610 98,846 97,633 96,660
Diluted ....................... 98,727 101,026 99,841 98,445
Cash Dividends ..................... $ 0.010 $ 0.010 $ 0.010 $ 0.010
Market Prices:
High .......................... $ 28.10 $ 38.65 $ 33.71 $ 31.63
Low ........................... 15.10 20.00 20.13 20.32
Close ......................... 25.71 24.75 33.71 20.78
(1) Earnings per share for the first quarter reflects the $14.5 million
one-time, non-cash accounting impact from the adoption of SFAS 133.
106
Metris Companies Inc. and Subsidiaries
Summary of Consolidated Quarterly Financial Information and Stock Data
(Dollars in thousands, except per-share data) (unaudited)
2000
----
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Summary of Operations:
Interest Income .................... $ 156,378 $ 134,840 $ 115,759 $ 97,801
Interest Expense ................... 44,722 35,394 28,782 24,108
--------- ---------- -------- ---------
Net Interest Income ................ 111,656 99,446 86,977 73,693
Provision for Loan
Losses ........................ 91,290 110,936 98,215 87,793
Other Operating Income ............. 214,663 239,629 238,023 241,472
Other Operating Expense ............ 156,475 149,649 148,167 140,123
--------- ---------- -------- ---------
Income Before Income
Taxes and Cumulative
Effect of Accounting
Change ........................ 78,554 78,490 78,618 87,249
Income Taxes ....................... 29,999 30,130 30,338 33,853
--------- ---------- -------- ---------
Income Before Cumulative
Effect of Accounting
Change .......................... 48,555 48,360 48,280 53,396
Cumulative Effect of
Accounting Change
(Net of Income Taxes
of $2,180) .................... -- -- -- 3,438
--------- ---------- -------- ---------
Net Income ......................... 48,555 48,360 48,280 49,958
Preferred Stock Dividends .......... 8,220 8,036 7,770 7,598
--------- ---------- -------- ---------
Net Income Applicable to
Common Stockholders ............. $ 40,335 $ 40,324 $ 40,510 $ 42,360
========= ========== ======== =========
Per Common Share:
Earnings per Share:
Basic (1) ..................... $ 0.53 $ 0.54 $ 0.55 $ 0.57
Diluted (1) ................... 0.51 0.52 0.53 0.55
Shares used to Compute
EPS (000's):
Basic ......................... 91,314 90,457 88,002 87,126
Diluted ....................... 93,731 93,444 91,568 90,658
Cash Dividends ..................... $ 0.010 $ 0.010 $ 0.007 $ 0.006
Market Prices:
High .......................... $ 42.25 $ 42.56 $ 29.81 $ 26.71
Low ........................... 22.81 25.13 22.00 14.83
Close ......................... 26.31 39.50 25.14 25.92
(1) Earnings per share for the first quarter reflects the $3.4 million one-time,
non-cash accounting impact from the adoption of SAB 101 for our debt waiver
products.
107
Stock Data
The Company's common stock, which is traded under the symbol "MXT," has
been listed on the New York Stock Exchange since May 7, 1999. Prior to its
listing on the New York Stock Exchange, the Company's common stock traded under
the symbol "MTRS" on the Nasdaq Stock Market since the initial public offering
on October 25, 1996. As of March 15, 2002, there were approximately 350 holders
of record and approximately 16,000 beneficial holders of the Company's common
stock.
108
MANAGEMENT'S REPORT ON CONSOLIDATED FINANCIAL STATEMENTS
AND INTERNAL CONTROL
The accompanying consolidated financial statements, related financial data,
and other information in this annual report were prepared by the management of
Metris Companies Inc. Management is responsible for the integrity and
objectivity of the data presented, including amounts that must necessarily be
based on judgments and estimates. The consolidated financial statements were
prepared in conformity with accounting principles generally accepted in the
United States of America.
Management of Metris Companies Inc. depends on its accounting systems and
internal control structures in meeting its responsibilities for reliable
consolidated financial statements. In management's opinion, these systems and
structures provide reasonable assurance that assets are safeguarded and that
transactions are properly recorded and executed in accordance with management's
authorizations. As an integral part of these systems and structures, the Company
employs a professional staff of internal auditors who conduct operational and
special audits and coordinate audit coverage with Company management and the
independent auditors.
The consolidated financial statements have been audited by the Company's
independent auditors, KPMG LLP, whose independent professional opinion appears
separately. Their opinion on the consolidated financial statements is based on
auditing procedures that include performing selected tests of transactions and
records as they deem appropriate. These auditing procedures are designed to
provide reasonable assurance that the consolidated financial statements are free
of material misstatement.
The Audit Committee of the Board of Directors, composed solely of outside
directors, meets quarterly with the internal auditors, the independent auditors
and management to review the work of each and ensure that each is properly
discharging its responsibilities. The internal and independent auditors have
free access to the Audit Committee to discuss the results of their audit work
and their findings.
/s/ Ronald N. Zebeck /s/ David D. Wesselink
------------------------------- -----------------------------
Ronald N. Zebeck David D. Wesselink
Chairman and Vice Chairman
Chief Executive Officer Principal Financial Officer
109
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Metris Companies Inc.:
We have audited the accompanying consolidated balance sheets of Metris
Companies Inc. and subsidiaries as of December 31, 2001 and 2000, and the
related consolidated statements of income, changes in stockholders' equity and
cash flows for each of the years in the three-year period ended December 31,
2001. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Metris
Companies Inc. and subsidiaries as of December 31, 2001 and 2000, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America.
As discussed in Note 18 to the consolidated financial statements, the
Company changed its method of accounting for derivative financial instruments in
2001. As discussed in Note 2 to the consolidated financial statements, the
Company changed its method of recognizing revenue for its debt waiver products
in 2000.
/s/ KPMG LLP
------------------
KPMG LLP
Minneapolis, Minnesota
January 16, 2002
110
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by this item with respect to directors is set
forth under "Proposal One: Election of Directors," in the Company's Proxy
Statement for the Annual Meeting of Shareholders held on May 7, 2002, which was
filed within 120 days of December 31, 2001 and is incorporated herein by
reference. The information required by this item with respect to executive
officers is, pursuant to instruction 3 of Item 401(b) of Regulation S-K, set
forth in Part I of this Form 10-K/A under "Executive Officers of the
Registrant." The information required by this item with respect to reports
required to be filed under Section 16(a) of the Securities Exchange Act of 1934
is set forth under "Section 16(a) Beneficial Ownership Reporting Compliance" in
the Proxy Statement and is incorporated herein by reference.
Item 11. Executive Compensation
The information required by this item is set forth under "Compensation
Tables and Compensation Matters" in the Proxy Statement and is incorporated
herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is set forth under "Company Stock
Owned by Officers and Directors" and "Persons Owning More Than Five Percent of
Company's Common Stock" in the Proxy Statement and is incorporated herein by
reference.
Item 13. Certain Relationships and Related Transactions
The information required by this item is set forth under "Corporate
Governance" in the Proxy Statement and is incorporated herein by reference.
With the exception of the information incorporated by reference in Items
10-13, the Proxy Statement is not to be deemed filed as part of this Form
10-K/A.
111
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are made part of this Report:
1. Consolidated Financial Statements - See Item 8 above.
2. Financial Statement Schedules
All schedules to the consolidated financial statements normally
required by Form 10-K are omitted since they are either not
applicable or the required information is shown in the financial
statements or the notes thereto.
(b) Reports on Form 8-K: None
(c) Exhibits: See Exhibit Index on page 116 of this Report.
112
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized on the 22nd day of
October, 2002.
METRIS COMPANIES INC.
(Registrant)
By /s/ Ronald N. Zebeck
----------------------------
Ronald N. Zebeck
Chairman and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of Metris Companies
Inc., the Registrant, and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
Principal executive Chairman and October 22, 2002
officer and director: Chief Executive Officer
/s/ Ronald N. Zebeck
-------------------------------
Ronald N. Zebeck
Principal financial officer: Vice Chairman October 22, 2002
/s/ David D. Wesselink
-------------------------------
David D. Wesselink
Principal accounting officer: Senior Vice President, October 22, 2002
Controller
/s/ Mark P. Wagener
-------------------------------
Mark P. Wagener
113
Certifications
I, Ronald N. Zebeck, certify that:
1. I have reviewed this amended Annual Report on Form 10-K/A of Metris
Companies Inc.;
2. Based on my knowledge, this amended Annual Report does not contain any
untrue statement of material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this amended Annual Report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this amended Annual 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
amended Annual Report.
Date: October 22, 2002
/s/ Ronald N. Zebeck
--------------------
Ronald N. Zebeck
Chairman and Chief Executive Officer
(Principal Executive Officer)
I, David D. Wesselink, certify that:
4. I have reviewed this amended Annual Report on Form 10-K/A of Metris
Companies Inc.;
5. Based on my knowledge, this amended Annual Report does not contain any
untrue statement of material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this amended Annual Report; and
6. Based on my knowledge, the financial statements, and other financial
information included in this amended Annual 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
amended Annual Report.
Date: October 22, 2002
/s/ David D. Wesselink
----------------------
David D. Wesselink
Vice Chairman
(Principal Financial Officer)
114
Directors:
/s/ Lee R. Anderson, Sr. Director October 22, 2002
---------------------------
Lee R. Anderson, Sr.
/s/ C. Hunter Boll Director October 22, 2002
---------------------------
C. Hunter Boll
/s/ John A. Cleary Director October 22, 2002
---------------------------
John A. Cleary
/s/ Thomas M. Hagerty Director October 22, 2002
---------------------------
Thomas M. Hagerty
/s/ David V. Harkins Director October 22, 2002
---------------------------
David V. Harkins
/s/ Walter M. Hoff Director October 22, 2002
---------------------------
Walter M. Hoff
/s/ Thomas H. Lee Director October 22, 2002
---------------------------
Thomas H. Lee
/s/ Derek V. Smith Director October 22, 2002
---------------------------
Derek V. Smith
/s/ Edward B. Speno Director October 22, 2002
---------------------------
Edward B. Speno
/s/ Frank D. Trestman Director October 22, 2002
---------------------------
Frank D. Trestman
115
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
------ ----------------------
Charter Documents:
-----------------
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to the Company's Registration
Statement on Form 8-A (File No. 1-12351)).
3.2 Amended and Restated Bylaws of the Company (incorporated by reference to
Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the period
ended June 30, 1999 (File No. 1-12351)).
Instruments Defining Rights:
---------------------------
4.1 Indenture, dated as of November 7, 1997, among MCI, Metris Direct, Inc., as
Guarantor, and the First National Bank of Chicago, as Trustee, including
form of 10% Senior Note due 2004 and form of Guarantee by Metris Direct,
Inc. (incorporated by reference to Exhibit 4.a to MCI's Registration
Statement on Form S-4 (File No. 333-43771)).
(a) First Supplemental Indenture, dated as of June 25, 1999, among MCI,
the Guarantors named therein and the First National Bank of Chicago
(incorporated by reference to Exhibit 4.4 to MCI's Registration
Statement on Form S-4 (File No. 333-86695)).
(b) Second Supplemental Indenture, dated as of February 28, 2000, among
MCI, the Guarantors named therein and Bank One Trust Company, N.A., as
Trustee, successor in interest to the First National Bank of Chicago
(incorporated by reference to Exhibit 4.2 to MCI's Quarterly Report on
Form 10-Q for the period ended March 31, 2000 (File No. 1-12351)).
(c) Third Supplemental Indenture, dated as of January 2, 2001, among MCI,
the guarantors named therein and Bank One Trust Company, N.A.
(incorporated by reference to Exhibit 4.1(c) to MCI's Annual Report on
Form 10-K for the year ended December 31, 2001 (File No. 1-12351)).
(d) Agreement of Resignation, Appointment and Acceptance, dated as of
November 14, 2001, among MCI, Bank One Trust Company, N.A., as Prior
Trustee, and US Bank National Association, as Successor Trustee
(incorporated by reference to Exhibit 4.1(d) to MCI's Annual Report on
Form 10-K for the year ended December 31, 2001 (File No. 1-12351)).
4.2 Certificate of Designation of Series B Perpetual Preferred Stock
(incorporated by reference to Exhibit 4.1 of MCI's
116
Current Report on Form 8-K dated December 22, 1998 (File No. 1-12351)).
4.3 Certificate of Designation of Series C Perpetual Preferred Stock
(incorporated by reference to Exhibit 4.2 of MCI's Current Report on Form
8-K dated December 22, 1998 (File No. 1-12351)).
(a) Amended Certificate of Designation of Series C Perpetual Convertible
Preferred Stock (incorporated by reference to Exhibit 3.3 to MCI's
Registration Statement on Form S-3 (File No. 333-82007)).
4.4 Certificate of Designation of Series D Junior Participating Convertible
Preferred Stock (incorporated by reference to Exhibit 4.3 of MCI's Current
Report on Form 8-K dated December 22, 1998 (File No. 1-12351)).
4.5 Registration Rights Agreement, dated as of December 9, 1998, between MCI
and the Investors named therein (incorporated by reference to Exhibit 10.3
to MCI's Current Report on Form 8-K dated December 22, 1998 (File No.
1-12351)).
4.6 Form of common stock certificate of MCI (incorporated by reference to
Exhibit 4.3 to MCI's Registration Statement on Form S-8 (File No.
333-91917)).
4.7 Indenture, dated as of July 13, 1999, by and among MCI, Metris Direct, Inc.
and The Bank of New York, including Form of 10 1/8% Senior Notes due 2006
and Form of Guarantee (incorporated by reference to Exhibit 4.1 to MCI's
Registration Statement on Form S-4 (File No. 333-86695)).
(a) First Supplemental Indenture, dated as of February 28, 2000, among
MCI, the Guarantors named therein and The Bank of New York,
(incorporated by reference to Exhibit 4.1 to MCI's Quarterly Report on
Form 10-Q for the period ended March 31, 2000 (File No. 1-12351)).
(b) Second Supplemental Indenture, dated as of February 2, 2001, among
MCI, the Guarantors named therein and The Bank of New York
(incorporated by reference to Exhibit 4.7(b) to MCI's Annual Report on
Form 10-K for the year ended December 31, 2001 (File No. 1-12351)).
4.8 Exchange and Registration Rights Agreement, dated as of July 13, 1999, by
and among MCI, Bear, Stearns & Co. Inc., Chase Securities Inc., Salomon
Smith Barney Inc. and Barclays Capital Inc., relating to the new notes
(incorporated by reference to Exhibit 4.2 to MCI's Registration Statement
on Form S-4 (File No. 333-86695)).
117
Material Contracts
------------------
10.1 Second Amended and Restated Pooling and Servicing Agreement, dated as of
January 22, 2002, among Metris Receivables, Inc. ("MRI"), as Transferor,
Direct Merchants Credit Card Bank, National Association ("Direct Merchants
Bank"), as Servicer, and U.S. Bank National Association, as Trustee
(incorporated by reference to Exhibit 4.3 to MRI's Current Report on Form
8-K dated January 24, 2002 (File No. 0-23961)).
10.2 Second Amended and Restated Bank Receivables Purchase Agreement, dated as
of January 22, 2002, between Direct Merchants Bank and MCI (incorporated by
reference to Exhibit 4.1 to MRI's Current Report on Form 8-K dated January
24, 2002 (File No. 0-23961)).
10.3 Second Amended and Restated Bank Receivables Purchase Agreement, dated as
of January 22, 2002, between MCI and MRI (incorporated by reference to
Exhibit 4.2 to MRI's Current Report on Form 8-K dated January 24, 2002
(File No. 0-23961)).
10.4* Change of Control Severance Agreement, dated as of May 15, 1998, by and
between MCI and Ronald N. Zebeck and a schedule of executive officers of
the Company also having such an agreement with MCI, indicating the
differences from the version of agreement filed (as permitted by
Instruction 2 to Item 601 of Regulation S-K) (incorporated by reference to
Exhibit 10.2 to MCI's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1998 (File No. 1-12351)).
(a) Amendment to Ronald N. Zebeck's Change of Control Severance Agreement,
dated as of December 9, 1998 (incorporated by reference to Exhibit
10.7(i) to MCI's Annual Report on Form 10-K for the year ended
December 31, 1998 (File No. 1-12351)).
(b) Amended Schedule of Executive Officers with Change of Control
Severance Agreements (incorporated by reference to Exhibit 10.4(b) to
MCI's Annual Report on Form 10-K for the year ended December 31, 2001
(File No. 1-12351)).
10.5* Retention Agreement, dated May 17, 1999, between Ronald N. Zebeck and MCI
(incorporated by reference to Exhibit 10.2 to MCI's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1999 (File No. 1-12351)).
10.6 Amended and Restated Credit Agreement, dated as of July 21, 2000, among
MCI; the Lenders from time to time parties thereto; The Chase Manhattan
Bank, as Administrative Agent; Bank of America, N.A., as Syndicate Agent;
Deutsche Bank AG, New York Branch, as Co-Documentation Agent; U.S. Bank
National Association, as Co-Documentation Agent; and Barclays Bank PLC, as
Co-Agent (incorporated by reference to MCI's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2000 (File No. 1-12351)).
118
(a) Amendment No. 1, dated as of July 10, 2001, to the Amended and
Restated Credit Agreement, among MCI; the Lenders from time to time
parties thereto; The Chase Manhattan Bank, as Administrative Agent;
Bank of America, N.A., as Syndication Agent; Deutsche Bank AG, New
York Branch, as Co-Documentation Agent; U.S. Bank National
Association, as Co-Documentation Agent; and Barclays Bank PLC, as
Co-Agent (incorporated by reference to Exhibit 10.6(a) to MCI's Annual
Report on Form 10-K for the year ended December 31, 2001 (File No.
1-12351)).
10.7* MCI Non-Employee Director Stock Option Plan (incorporated by reference to
Exhibit 10.3 to MCI's Registration Statement on Form S-4/A (File No.
333-86695)).
10.8* MCI Management Stock Purchase Plan (incorporated by reference to Exhibit
10.4 to MCI's Registration Statement on Form S-4/A (File No. 333-86695)).
10.9* MCI Amended and Restated Annual Incentive Bonus Plan for Designated
Corporate Officers (incorporated by reference to Exhibit 10.5 to MCI's
Registration Statement on Form S-4/A (File No. 333-86695)).
10.10* MCI Amended and Restated Long-Term Incentive and Stock Option Plan
(incorporated by reference to Exhibit 10.6 to MCI's Registration Statement
on Form S-4/A (File No. 333-86695)).
(a) Form of Non-Qualified Stock Option Agreement (incorporated by
reference to Exhibit 10.8 to MCI's Annual Report on Form 10-K for the
year ended December 31, 1998 (File No. 1-12351)).
(b) Form of Non-Qualified Performance Accelerated Stock Option Agreement
(incorporated by reference to Exhibit 10.10(b) to MCI's Annual Report
on Form 10-K for the year ended December 31, 2001 (File No. 1-12351)).
(c) Form of Restricted Stock Award Agreement (incorporated by reference to
Exhibit 10.10(c) to MCI's Annual Report on Form 10-K for the year
ended December 31, 2001 (File No. 1-12351)).
10.11 Transfer and Administration Agreement, dated June 15, 2001, among Direct
Merchants Bank, as transferor, Variable Funding Capital Corporation, as a
conduit investor, First Union National Bank, as a committed investor and as
liquidity agent, and First Union Securities Inc., as deal agent
(incorporated by reference to Exhibit 10.11 to MCI's Annual Report on Form
10-K for the year ended December 31, 2001 (File No. 1-12351)).
119
Other Exhibits
--------------
11 Computation of Earnings Per Share.
12 (a) Computation of Ratio of Earnings to Fixed Charges.
12 (b) Computation of Ratio of Earnings to Fixed Charges and Preferred
Dividends.
21 Subsidiaries of MCI.
23 Independent Auditors' Consent.
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.
* Management contract or compensatory plan or arrangement required to be filed
as an exhibit pursuant to Item 14(c) of Form 10-K.
120