##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
   FORM 10-Q x
    
    Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934For the quarterly period ended September 30, 2004oro
    
    Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934For the transition period fromto
 Commission file number:                                             001-12351 METRIS COMPANIES INC.  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) Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes  x                              No o Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes  x                              No o As of October 31, 2004, 57,970,527 shares of the registrants common stock, par
value $.01 per share, were outstanding.




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METRIS COMPANIES INC. FORM 10-Q TABLE OF CONTENTS September 30, 2004 PagePART I. FINANCIAL INFORMATIONItem 1. Consolidated Financial Statements (unaudited):Consolidated Balance Sheets
    
    
    3Consolidated Statements of Income
    
    
    4Consolidated Statements of Changes in Stockholders Equity
    
    
    5Consolidated Statements of Cash Flows
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    24Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    45Item 4.Controls and Procedures
    
    
    46PART II. OTHER INFORMATIONItem 1.Legal Proceedings
    
    
    46Item 2. Unregistered Sale of Equity Securities and Use of Proceeds
    
    
    47Item 3.Defaults Upon Senior Securities
    
    
    47Item 4.Submission of Matters to a Vote of Security Holders
    
    
    47Item 5.Other Information
    
    
    48Item 6.Exhibits
    
    
    48Signatures
    
    
    49Certification of Principal Executive OfficerCertification of Principal Financial OfficerCertification of Principal Executive Officer to Section 1350Certification of Principal Financial Officer to Section 1350
  2




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Part I. Financial Information 
 ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS METRIS COMPANIES INC. AND SUBSIDIARIES 
 (In thousands, except per share data)
 September 30,2004
    
    December 31,(Unaudited)
    
    2003Assets:Cash and due from banks
    
    $
    23,683
    
    
    $
    32,076Federal funds sold
    
    
    49,395
    
    
    
    25,300Short-term investments
    
    
    330,452
    
    
    
    121,109Cash and cash equivalents
    
    
    403,530
    
    
    
    178,485Liquidity reserve deposit
    
    
    79,655
    
    
    
    80,158Credit card loans
    
    
    70,389
    
    
    
    128,615Less: Allowance for loan losses
    
    
    14,293
    
    
    
    45,492Net credit card loans
    
    
    56,096
    
    
    
    83,123Retained interests in loans securitized
    
    
    839,408
    
    
    
    836,901Property and equipment, net
    
    
    26,399
    
    
    
    33,680Purchased portfolio premium
    
    
    10,745
    
    
    
    17,561Other receivables due from credit card
securitizations, net
    
    
    74,941
    
    
    
    80,714Other assets
    
    
    62,724
    
    
    
    81,774Total assets
    
    $
    1,553,498
    
    
    $
    1,392,396Liabilities:Deposits
    
    $
    3,735
    
    
    $
    6,262Debt
    
    
    448,398
    
    
    
    350,448Accounts payable
    
    
    38,280
    
    
    
    32,397Deferred income
    
    
    12,181
    
    
    
    18,060Accrued expenses and other liabilities
    
    
    105,247
    
    
    
    76,036Total liabilities
    
    
    607,841
    
    
    
    483,203Stockholders Equity:Convertible preferred stock  par
value $.01 per share; 10,000,000
shares authorized, 1,350,931 and
1,263,699 shares issued and outstanding,
respectively
    
    
    503,222
    
    
    
    470,728Common stock, par value $.01 per share;
300,000,000 shares authorized, 65,099,618
and 64,862,314 shares issued,
respectively
    
    
    651
    
    
    
    649Paid-in capital
    
    
    233,042
    
    
    
    229,655Unearned compensation
    
    
    
    
    
    
    (27
    )Treasury stock  7,055,300 shares
    
    
    (58,308
    )
    
    
    (58,308
    )Retained earnings
    
    
    267,050
    
    
    
    266,496Total stockholders equity
    
    
    945,657
    
    
    
    909,193Total liabilities and stockholders equity
    
    $
    1,553,498
    
    
    $
    1,392,396
 See accompanying Notes to Consolidated Financial Statements. 3




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METRIS COMPANIES INC. AND SUBSIDIARIES 
 (In thousands, except earnings per-share data) (Unaudited)
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenues:Loss on new securitization of receivables to
the Metris Master Trust
    
    $
    
    
    
    $
    (23,015
    )
    
    $
    (91,886
    )
    
    $
    (55,214
    )Loss on replenishment of receivables to the
Metris Master Trust
    
    
    (21,972
    )
    
    
    (35,792
    )
    
    $
    (71,353
    )
    
    $
    (127,574
    )Discount accretion
    
    
    63,747
    
    
    
    85,549
    
    
    
    185,287
    
    
    
    240,035Interest-only revenue
    
    
    87,316
    
    
    
    60,694
    
    
    
    217,385
    
    
    
    151,374Change in fair value
    
    
    25,518
    
    
    
    33,564
    
    
    
    94,202
    
    
    
    (70,333
    )Transaction and other costs
    
    
    (6,634
    )
    
    
    (27,221
    )
    
    
    (91,018
    )
    
    
    (64,772
    )Securitization income
    
    
    147,975
    
    
    
    93,779
    
    
    
    242,617
    
    
    
    73,516Servicing income on securitized receivables
    
    
    32,496
    
    
    
    43,849
    
    
    
    102,580
    
    
    
    136,997Credit card loan and other interest income
    
    
    4,549
    
    
    
    24,656
    
    
    
    14,665
    
    
    
    88,249Credit card loan fees, interchange and other
income
    
    
    3,736
    
    
    
    17,934
    
    
    
    19,816
    
    
    
    67,713Enhancement services income
    
    
    5,692
    
    
    
    16,549
    
    
    
    20,148
    
    
    
    99,748Loss on sale of credit card loans
    
    
    
    
    
    
    (117,183
    )
    
    
    
    
    
    
    (117,183
    )Gain on sale of membership and warranty
business
    
    
    
    
    
    
    80,391
    
    
    
    
    
    
    
    80,391Total revenues
    
    
    194,448
    
    
    
    159,975
    
    
    
    399,826
    
    
    
    429,431Expenses:Interest expense
    
    
    14,056
    
    
    
    22,296
    
    
    
    46,701
    
    
    
    60,353Provision for loan losses
    
    
    1,408
    
    
    
    33,019
    
    
    
    (5,175
    )
    
    
    107,838Credit card account and other product
solicitation and marketing expenses
    
    
    17,190
    
    
    
    19,325
    
    
    
    48,848
    
    
    
    85,045Employee compensation
    
    
    31,554
    
    
    
    41,997
    
    
    
    106,222
    
    
    
    141,099Data processing services and communications
    
    
    12,203
    
    
    
    16,770
    
    
    
    42,452
    
    
    
    52,982Credit protection claims expense
    
    
    3,421
    
    
    
    6,585
    
    
    
    14,805
    
    
    
    26,537Occupancy and equipment
    
    
    5,442
    
    
    
    8,716
    
    
    
    17,827
    
    
    
    27,253Purchased portfolio premium amortization
    
    
    2,241
    
    
    
    8,107
    
    
    
    6,743
    
    
    
    21,102Asset impairments, lease write-offs and
severance
    
    
    1,242
    
    
    
    29,976
    
    
    
    4,515
    
    
    
    52,764Loss on sale of deposits
    
    
    
    
    
    
    32,963
    
    
    
    
    
    
    
    32,963Other
    
    
    20,502
    
    
    
    32,397
    
    
    
    63,837
    
    
    
    78,711Total expenses
    
    
    109,259
    
    
    
    252,151
    
    
    
    346,775
    
    
    
    686,647Income (loss) before income taxes
    
    
    85,189
    
    
    
    (92,176
    )
    
    
    53,051
    
    
    
    (257,216
    )Income tax expense (benefit)
    
    
    23,425
    
    
    
    (17,198
    )
    
    
    20,003
    
    
    
    (74,660
    )Net income (loss)
    
    
    61,764
    
    
    
    (74,978
    )
    
    
    33,048
    
    
    
    (182,556
    )Convertible preferred stock dividends
    
    
    11,073
    
    
    
    10,131
    
    
    
    32,494
    
    
    
    29,728Net income (loss) after preferred dividends
    
    $
    50,691
    
    
    $
    (85,109
    )
    
    $
    554
    
    
    $
    (212,284
    )Earnings (loss) per common share:BasicDistributed
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Undistributed
    
    
    0.49
    
    
    
    (1.48
    )
    
    
    0.01
    
    
    
    (3.70
    )Total Basic
    
    $
    0.49
    
    
    $
    (1.48
    )
    
    $
    0.01
    
    
    $
    (3.70
    )Total Diluted
    
    $
    0.48
    
    
    $
    (1.48
    )
    
    $
    0.01
    
    
    $
    (3.70
    )Shares used to compute earnings (loss)
per common share:Basic
    
    
    57,981
    
    
    
    57,546
    
    
    
    57,899
    
    
    
    57,426Diluted
    
    
    58,915
    
    
    
    57,546
    
    
    
    58,830
    
    
    
    57,426
 See accompanying Notes to Consolidated Financial Statements. 4




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METRIS COMPANIES INC. AND SUBSIDIARIES 
 (In thousands)
 TotalNumber of
    
    Shares
    
    Preferred
    
    Common
    
    Paid-in
    
    Unearned
    
    Treasury
    
    Retained
    
    StockholdersPreferred
    
    Common
    
    Stock
    
    Stock
    
    Capital
    
    Compensation
    
    Stock
    
    Earnings
    
    EquityBALANCE AT DECEMBER 31,
2002
    
    
    1,156
    
    
    
    57,168
    
    
    $
    430,642
    
    
    $
    642
    
    
    $
    227,376
    
    
    $
    
    
    
    $
    (58,308
    )
    
    $
    454,321
    
    
    $
    1,054,673Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (182,556
    )
    
    
    (182,556
    )Preferred dividends in kind
    
    
    80
    
    
    
    
    
    
    
    29,728
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (29,728
    )
    
    
    Issuance of common stock
under employee benefit
plans
    
    
    
    
    
    
    426
    
    
    
    
    
    
    
    4
    
    
    
    2,547
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,551Deferred compensation
obligation
    
    
    
    
    
    
    303
    
    
    
    
    
    
    
    3
    
    
    
    546
    
    
    
    (549
    )
    
    
    
    
    
    
    
    
    
    
    Restricted stock
forfeitures
    
    
    
    
    
    
    (41
    )
    
    
    
    
    
    
    
    
    
    
    (76
    )
    
    
    76
    
    
    
    
    
    
    
    
    
    
    
    Amortization of restricted
stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    315
    
    
    
    
    
    
    
    
    
    
    
    315BALANCE AT SEPTEMBER 30,
2003 (Unaudited)
    
    
    1,236
    
    
    
    57,856
    
    
    $
    460,370
    
    
    $
    649
    
    
    $
    230,393
    
    
    $
    (158
    )
    
    $
    (58,308
    )
    
    $
    242,037
    
    
    $
    874,983BALANCE AT DECEMBER 31,
2003
    
    
    1,264
    
    
    
    57,807
    
    
    $
    470,728
    
    
    $
    649
    
    
    $
    229,655
    
    
    $
    (27
    )
    
    $
    (58,308
    )
    
    $
    266,496
    
    
    $
    909,193Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33,048
    
    
    
    33,048Preferred dividends in kind
    
    
    87
    
    
    
    
    
    
    
    32,494
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (32,494
    )
    
    
    Issuance of common stock
under employee benefit
plans
    
    
    
    
    
    
    287
    
    
    
    
    
    
    
    2
    
    
    
    3,477
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,479Deferred compensation
obligation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (85
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (85
    )Restricted stock
forfeitures
    
    
    
    
    
    
    (50
    )
    
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    (1
    )Amortization of restricted
stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23
    
    
    
    
    
    
    
    
    
    
    
    23BALANCE AT SEPTEMBER 30,
2004 (Unaudited)
    
    
    1,351
    
    
    
    58,044
    
    
    $
    503,222
    
    
    $
    651
    
    
    $
    233,042
    
    
    $
    
    
    
    $
    (58,308
    )
    
    $
    267,050
    
    
    $
    945,657
 See accompanying Notes to Consolidated Financial Statements. 5




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METRIS COMPANIES INC. AND SUBSIDIARIES 
  (Dollars in thousands) (Unaudited)
 Nine Months EndedSeptember 30,2004
    
    2003Operating Activities:Net income (loss)
    
    $
    33,048
    
    
    $
    (182,556
    )Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:Depreciation, amortization, and accretion
    
    
    (157,845
    )
    
    
    (135,733
    )Provision for loan losses
    
    
    (5,175
    )
    
    
    107,838Loss from credit card securitizations
    
    
    163,239
    
    
    
    182,788Gain on sale of membership club and warranty business
    
    
    
    
    
    
    (80,391
    )Asset impairments, lease write-offs, and severance
    
    
    4,515
    
    
    
    52,764Loss on sale of deposits
    
    
    
    
    
    
    32,963Loss on sale
of credit card loans
    
    
    
    
    
    
    117,183Market loss on derivative financial instruments
    
    
    8,564
    
    
    
    6,169Changes in operating assets and liabilities, net:Liquidity Reserve deposit
    
    
    503
    
    
    
    (83,875
    )Fair value of retained interests in loans
securitized
    
    
    (94,202
    )
    
    
    70,333Spread accounts receivable
    
    
    207,520
    
    
    
    (242,290
    )Other receivables due from credit card securitizations
    
    
    5,773
    
    
    
    24,981Accounts payable and accrued expenses
    
    
    30,579
    
    
    
    (12,007
    )Deferred income
    
    
    (5,879
    )
    
    
    (37,568
    )Other
    
    
    16,310
    
    
    
    (19,305
    )Net cash provided by (used in) operating activities
    
    
    206,950
    
    
    
    (198,706
    )Investing Activities:Proceeds from transfers of portfolios to the Metris Master
Trust
    
    
    
    
    
    
    670,965Net cash from loan originations and principal collections on
loans receivable
    
    
    (89,993
    )
    
    
    (534,797
    )Proceeds from sales of credit card portfolios to third
parties
    
    
    27,870
    
    
    
    494,784Proceeds from sale of membership club and warranty business
    
    
    
    
    
    
    45,000Net (additions) disposals of property and equipment
    
    
    (1,984
    )
    
    
    24,613Net cash (used in) provided by investing activities
    
    
    (64,107
    )
    
    
    700,565Financing Activities:Proceeds from issuance of debt
    
    
    283,974
    
    
    
    125,606Repayment of debt
    
    
    (202,724
    )
    
    
    (132,417
    )Sale of deposits
    
    
    
    
    
    
    (559,282
    )Net decrease in deposits
    
    
    (2,527
    )
    
    
    (327,174
    )Premium paid and transaction costs on sale of deposits
    
    
    
    
    
    
    (32,963
    )Proceeds from issuance of common stock
    
    
    3,479
    
    
    
    2,551Net cash provided by (used in) financing activities
    
    
    82,202
    
    
    
    (923,679
    )Net increase (decrease) in cash and cash equivalents
    
    
    225,045
    
    
    
    (421,820
    )Cash and cash equivalents at beginning of period
    
    
    178,485
    
    
    
    580,232Cash and cash equivalents at end of period
    
    $
    403,530
    
    
    $
    158,412Supplemental disclosures and cash flow information:Cash paid (received) during the period for:Interest
    
    $
    36,945
    
    
    $
    59,395Income taxes
    
    
    (34,997
    )
    
    
    (78,131
    )Tax benefit from employee stock option exercises
    
    
    208
    
    
    
    1
 See accompanying Notes to Consolidated Financial Statements. 6




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METRIS COMPANIES INC. AND SUBSIDIARIES 
 (Dollars in thousands, except as noted) (Unaudited)
 NOTE 1  ORGANIZATION AND BASIS OF PRESENTATION The consolidated financial statements include the accounts of Metris
Companies Inc. (MCI) and its subsidiaries. MCIs principal subsidiaries are
Direct Merchants Credit Card Bank, National Association (Direct Merchants
Bank or the Bank), Metris Direct, Inc. and Metris Receivables, Inc. (MRI).
MCI and its subsidiaries, as applicable, may be referred to as we, us,
our or the Company. We are an information-based direct marketer of
consumer lending products. All dollar amounts are presented as pre-tax amounts unless otherwise
noted. We have eliminated all significant intercompany balances and
transactions in consolidation. During the first quarter of 2004 we reclassified financial statement line
items to more accurately reflect the continuing operations of our business. In
prior periods we classified interest income from credit card loans, federal
funds sold, and other as total interest income. For all periods presented,
total interest income is classified as Credit card loan and other interest
income. In prior periods we classified interest expense from deposits and
other as total interest expense. For all periods presented total interest
expense has been reclassified as Interest expense. Interim Financial Statements We have prepared the unaudited interim consolidated financial statements
and related unaudited financial information in the footnotes in accordance with
accounting principles generally accepted in the United States of America
(GAAP) and the rules and regulations of the Securities and Exchange
Commission (SEC) for interim financial statements. These interim financial
statements reflect all adjustments consisting of normal recurring accruals,
which, in the opinion of management, are necessary to present fairly our
consolidated financial position and the results of our operations and our cash
flows for the interim periods. You should read these consolidated financial
statements in conjunction with the financial statements and the notes thereto
contained in our Annual Report on Form 10-K/A for the fiscal year ended
December 31, 2003. The nature of our business is such that the results of any
interim period may not be indicative of the results to be expected for the
entire year. Pervasiveness of Estimates We have prepared the consolidated financial statements in accordance with
GAAP, which requires us to make estimates and assumptions that affect the
reported amounts in the consolidated financial statements and accompanying
notes. The most significant and subjective of these estimates are our
determination of the valuation of our Retained interests in loans securitized
and our determination of the Allowance for loan losses. The significant
factors susceptible to future change that have an impact on these estimates
include default rates, net interest spreads, payment rates, liquidity and the
ability to finance future receivables activity and overall economic conditions.
As a result, the fair value of our Retained interests in loans securitized
and the actual losses in our Credit card loan portfolio as of September 30,
2004 and December 31, 2003, could materially differ from these estimates. Comprehensive Income SFAS No. 130 Reporting Comprehensive Income,does not apply to our
current financial results and therefore, net income equals comprehensive
income. 7




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##### Table of Contents



NOTE 2  ACCOUNTING CHANGES In October, 2004, the Financial Accounting Standards Board (FASB)
concluded that Statement 123R, Share-Based Payment, which will require all
companies to measure and record in the income statement compensation cost for
all share-based payments (including employee stock options) at fair value,
would be effective for public companies for interim or annual periods beginning
after June 15, 2005. The FASB plans to issue the final statement on or around
December 15, 2004. We do not expect the adoption of Statement 123R will have a
material impact on our financial statements. In March 2004, the Emerging Issues Task Force (EITF) reached a consensus
on EITF Issue No. 03-6 Participating Securities and the two-class method under
FASB Statement 128, (the Consensus or EITF 03-6). The Consensus requires
net income to be reduced by the amount of dividends declared in the current
period for each class of stock and by the contractual amount of dividends or
other participation payments that are paid or accumulated for the current
period. Undistributed earnings for the period are allocated to participating
securities based on the contractual participation rights of the security to
share in those current earnings assuming all earnings for the period are
distributed. Our preferred shareholders have contractual participation rights
on a converted basis that are equivalent to those of common shareholders.
Therefore, we allocate undistributed earnings to preferred and common
shareholders based on their respective ownership percentage, on a converted
basis, as of the end of the period. The guidance in EITF 03-6 is effective for
fiscal periods (interim or annual) beginning after March 31, 2004. Companies
are required to restate prior period earnings per share amounts to conform to
the guidance in EITF 03-6 upon adoption. The following table presents basic and diluted earnings (loss) per share
using the two-class method for the first quarter of 2004 and the previous five
annual periods: Threemonthsended
    
    Twelve months endedMarch 31,
    
    December 31,2004
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999As Previously Reported:Basic earnings (loss) per share
    
    $
    0.47
    
    
    $
    (3.27
    )
    
    $
    (0.66
    )
    
    $
    1.64
    
    
    $
    2.08
    
    
    $
    1.50Diluted earnings (loss) per share
    
    $
    0.47
    
    
    $
    (3.27
    )
    
    $
    (0.66
    )
    
    $
    1.61
    
    
    $
    2.01
    
    
    $
    1.44As Restated:Basic Earnings (Loss) per ShareDistributed  Preferred(1)
    
    $
    8.38
    
    
    $
    32.78
    
    
    $
    34.00
    
    
    $
    33.99
    
    
    $
    33.79
    
    
    $
    147.43Undistributed  Preferred
    
    
    10.80
    
    
    
    
    
    
    
    
    
    
    
    43.19
    
    
    
    52.06
    
    
    
    Basic  Preferred
    
    $
    19.18
    
    
    $
    32.78
    
    
    $
    34.00
    
    
    $
    77.18
    
    
    $
    85.85
    
    
    $
    147.43Distributed  Common
    
    $
    
    
    
    $
    
    
    
    $
    0.04
    
    
    $
    0.04
    
    
    $
    0.03
    
    
    $
    0.02Undistributed  Common
    
    
    0.30
    
    
    
    (3.27
    )
    
    
    (0.70
    )
    
    
    1.25
    
    
    
    1.72
    
    
    
    (0.31
    )Basic  Common
    
    $
    0.30
    
    
    $
    (3.27
    )
    
    $
    (0.66
    )
    
    $
    1.29
    
    
    $
    1.75
    
    
    $
    (0.29
    )Diluted Earnings (Loss) per ShareDistributed  Common
    
    $
    
    
    
    $
    
    
    
    $
    0.04
    
    
    $
    0.04
    
    
    $
    0.03
    
    
    $
    0.02Undistributed  Common
    
    
    0.30
    
    
    
    (3.27
    )
    
    
    (0.70
    )
    
    
    1.21
    
    
    
    1.63
    
    
    
    (0.31
    )Diluted  Common
    
    $
    0.30
    
    
    $
    (3.27
    )
    
    $
    (0.66
    )
    
    $
    1.25
    
    
    $
    1.66
    
    
    $
    (0.29
    )
 (1) 1999 results include a one-time, non-cash, accounting adjustment of $101.6
million related to the conversion of Series B Preferred Stock, which is
included in distributed earnings to preferred shareholders. 8




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##### Table of Contents



NOTE 3  EARNINGS (LOSS) PER SHARE The following table presents the computation of earnings (loss) per share. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    61,764
    
    
    $
    (74,978
    )
    
    $
    33,048
    
    
    $
    (182,556
    )Convertible preferred stock dividends
    
    
    11,073
    
    
    
    10,131
    
    
    
    32,494
    
    
    
    29,728Net income (loss) after preferred
dividends
    
    $
    50,691
    
    
    $
    (85,109
    )
    
    $
    554
    
    
    $
    (212,284
    )Convertible preferred stock dividends
    
    $
    11,073
    
    
    $
    10,131
    
    
    $
    32,494
    
    
    $
    29,728Weighted average preferred shares
    
    
    1,321
    
    
    
    1,209
    
    
    
    1,293
    
    
    
    1,182Distributed earnings per share  Preferred
    
    $
    8.38
    
    
    $
    8.38
    
    
    $
    25.13
    
    
    $
    25.15Undistributed income (loss)
    
    $
    50,691
    
    
    $
    (85,109
    )
    
    $
    554
    
    
    $
    (212,284
    )Preferred ownership on a converted basis
    
    
    44
    %
    
    
    43
    %
    
    
    44
    %
    
    
    43
    %Preferred shareholders interest in
undistributed income (loss)(1)
    
    $
    22,304
    
    
    $
    
    
    
    $
    244
    
    
    $
    Weighted average preferred shares
    
    
    1,321
    
    
    
    1,209
    
    
    
    1,293
    
    
    
    1,182Undistributed earnings per share 
Preferred
    
    $
    16.88
    
    
    $
    
    
    
    $
    0.19
    
    
    $
    Undistributed income (loss)
    
    $
    50,691
    
    
    $
    (85,109
    )
    
    $
    554
    
    
    $
    (212,284
    )Common ownership
    
    
    56
    %
    
    
    57
    %
    
    
    56
    %
    
    
    57
    %Common shareholders interest in
undistributed income (loss)(1)
    
    $
    28,387
    
    
    $
    (85,109
    )
    
    $
    310
    
    
    $
    (212,284
    )Weighted average common shares outstanding
- Basic
    
    
    57,981
    
    
    
    57,546
    
    
    
    57,899
    
    
    
    57,426Common share equivalents(2)
    
    
    934
    
    
    
    
    
    
    
    931
    
    
    
    Shares used to compute earnings (loss) per
common share  Diluted
    
    
    58,915
    
    
    
    57,546
    
    
    
    58,830
    
    
    
    57,426Total basic earnings per share  Common
    
    $
    0.49
    
    
    $
    (1.48
    )
    
    $
    0.01
    
    
    $
    (3.70
    )Total diluted earnings per share 
Common
    
    $
    0.48
    
    
    $
    (1.48
    )
    
    $
    0.01
    
    
    $
    (3.70
    )
  (1) Preferred shareholders do not participate in any undistributed
losses with common shareholders.(2) For the three- and nine-month periods ended September 30, 2003
conversion of common share equivalents is not assumed because such
conversion would be anti-dilutive. NOTE 4  STOCK-BASED COMPENSATION PLANS We recognize compensation cost for stock-based employee compensation plans
based on the difference, if any, between the quoted market price of the stock
on the date of grant and the amount an employee must pay to acquire the stock.
No expense was reflected in net loss related to stock options as all options
granted had an exercise price equal to the market value of the underlying
common stock on the date of grant. For the three- and nine-month periods ended
September 30, 2004 we recorded $0 and $15 thousand, respectively, in
amortization of deferred compensation obligation, net of related tax benefit,
in Net income (loss) related to restricted stock. This compares to $50
thousand and $195 thousand for the comparable periods in 2003. During the nine
months ended 2004 we issued approximately 955,000 restricted stock units to
employees. The units vest over a four-year period with possible acceleration
of vesting if certain earning targets are met. Upon vesting each restricted
stock unit converts to one share of common stock that is distributable to the
employee. The fair value of the restricted stock units is expensed over the
expected vesting period and included in Employee compensation on the
consolidated statements of income and Accrued expenses and other liabilities
on the consolidated balance sheets. For the three- and nine-month periods ended
September 30, 2004, we recognized $551 thousand and $821 thousand, respectively
in expense related to restricted stock units, net of related tax benefit. 9




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##### Table of Contents



The following table provides pro forma net income (loss) and earnings
(loss) per share as if we accounted for our employee stock options under the
fair value method. The fair value of the options was estimated at the grant
date using a Black-Scholes option pricing model. The fair value of the
options is amortized to expense over the options vesting periods. Under the
fair value method, our Net income (loss) and Earnings (loss) per share
would have been recorded at the pro forma amounts indicated below: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income (loss) (as reported)
    
    $
    61,764
    
    
    $
    (74,978
    )
    
    $
    33,048
    
    
    $
    (182,556
    )Add: Stock-based employee compensation
expense included in reported net
income (loss), net of related tax
effects
    
    
    551
    
    
    
    50
    
    
    
    836
    
    
    
    195Deduct: Annual stock-based employee
compensation expense (benefit)
determined based on the fair value
for all awards, net of related tax
effects
    
    
    1,666
    
    
    
    (9,236
    )
    
    
    (3,212
    )
    
    
    (13,985
    )Pro forma net income (loss)
    
    $
    60,649
    
    
    $
    (65,692
    )
    
    $
    37,096
    
    
    $
    (168,376
    )Earnings (loss) per common share:Basic-as reported
    
    
    0.49
    
    
    
    (1.48
    )
    
    
    0.01
    
    
    
    (3.70
    )Basic-pro forma
    
    
    0.48
    
    
    
    (1.32
    )
    
    
    0.04
    
    
    
    (3.45
    )Diluted-as reported
    
    
    0.48
    
    
    
    (1.48
    )
    
    
    0.01
    
    
    
    (3.70
    )Diluted-pro forma
    
    
    0.47
    
    
    
    (1.32
    )
    
    
    0.04
    
    
    
    (3.45
    )Weighted-average assumptions in
option valuation:Risk-free interest rates
    
    
    3.0
    %
    
    
    1.8
    %
    
    
    3.0
    %
    
    
    1.5
    %Dividend yields
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock volatility factor
    
    
    127.4
    %
    
    
    128.4
    %
    
    
    128.0
    %
    
    
    111.4
    %Expected life of options (in years)
    
    
    2.7
    
    
    
    2.7
    
    
    
    2.7
    
    
    
    3.7
 The above pro forma amounts may not be representative of the effects on
reported net income for future periods. NOTE 5  LIQUIDITY RESERVE DEPOSIT Direct Merchants Bank has established restricted deposits with third-party
depository banks for the purpose of supporting Direct Merchants Banks funding
needs and to satisfy banking regulators requirements under the Modified
Operating Agreement, dated December 11, 2003, among Direct Merchants Bank, MCI,
and the Office of the Comptroller of the Currency (OCC). These deposits are
invested in short-term liquid investments. As of September 30, 2004, the
balance of these deposits was $79.7 million and is classified on the balance
sheets as Liquidity reserve deposit. 10




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##### Table of Contents



NOTE 6  ALLOWANCE FOR LOAN LOSSES The activity in the Allowance for loan losses is as follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Balance at beginning of period
    
    $
    15,375
    
    
    $
    109,162
    
    
    $
    45,492
    
    
    $
    90,315Allowance related to assets
transferred to the Metris Master Trust
    
    
    
    
    
    
    (32,784
    )
    
    
    
    
    
    
    (36,765
    )Allowance related to assets re-acquired
    
    
    1
    
    
    
    
    
    
    
    (8,289
    )
    
    
    Provision for loan losses
    
    
    1,408
    
    
    
    33,019
    
    
    
    (5,175
    )
    
    
    107,838Principal receivables charged-off
    
    
    (2,983
    )
    
    
    (68,454
    )
    
    
    (19,669
    )
    
    
    (121,924
    )Recoveries
    
    
    492
    
    
    
    1,459
    
    
    
    1,934
    
    
    
    2,938Net principal receivables charged off
    
    
    (2,491
    )
    
    
    (66,995
    )
    
    
    (17,735
    )
    
    
    (118,986
    )Balance at end of period
    
    $
    14,293
    
    
    $
    42,402
    
    
    $
    14,293
    
    
    $
    42,402
 Credit card loans greater than 30 days contractually past due for the
periods ended September 30, 2004, and December 31, 2003 were $8.8 million and
$20.3 million, respectively. NOTE 7  RETAINED INTERESTS IN LOANS SECURITIZED The following table shows the fair value of the components of the
Retained interests in loans securitized as of September 30, 2004 and December
31, 2003. September 30,
    
    December 31,2004
    
    2003Contractual retained interests
    
    $
    493,574
    
    
    $
    542,014Excess transferors interests
    
    
    158,307
    
    
    
    48,775Interest-only strip receivable
    
    
    73,075
    
    
    
    16,039Spread accounts receivable
    
    
    114,452
    
    
    
    230,073Retained interests in loans securitized
    
    $
    839,408
    
    
    $
    836,901
 The following table illustrates the significant assumptions used for
estimating the fair value of retained interests as of September 30, 2004 and
December 31, 2003. September 30,
    
    December 31,2004
    
    2003Monthly payment rate
    
    
    7.5
    %
    
    
    6.7
    %Gross yield (1)
    
    
    25.5
    %
    
    
    25.4
    %Annual interest expense and servicing fees
    
    
    4.7
    %
    
    
    4.2
    %Annual gross principal default rate
    
    
    18.6
    %
    
    
    20.7
    %Discount rate:Contractual retained interests
    
    
    16.0
    %
    
    
    16.0
    %Excess transferors interests
    
    
    16.0
    %
    
    
    16.0
    %Interest-only strip receivable
    
    
    30.0
    %
    
    
    30.0
    %Spread
accounts receivable (2)
    
    
    16.0
    %
    
    
    15.3
    %Weighted average months to maturity
    
    
    20.8
    
    
    
    24.5Weighted
average enhancement level(3)
    
    
    11.1
    %
    
    
    9.9
    %
  (1) Includes expected cash flows from finance charges, late and overlimit fees, debt waiver
premiums and bad debt recoveries, net of finance charge and fee charge-offs. Gross yield for
purposes of estimating fair value does not include interchange income or cash advance fees.(2) Interest earned on spread accounts receivable
is now calculated as a monthly cash flow in the valuation of the
spread reserve deposits using the current London Inter Bank Offered
Rate yield curve. As of December 31, 2003 the discount rate
applied to the spread reserve deposits was reduced to account for the
interest income earned.(3) Includes contractual retained interest and required minimum spread reserve deposits. 11




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##### Table of Contents



At September 30, 2004, the sensitivity of the current fair value of the
retained interests to immediate 10% and 20% adverse changes are as follows (in
millions): Adverse Impact on Fair Value10% adverse change
    
    20% adverse changeAnnual discount rate
    
    $
    21.0
    
    
    $
    41.3Monthly payment rate
    
    
    87.9
    
    
    
    222.1Gross yield
    
    
    89.9
    
    
    
    204.2Annual interest expense and servicing fees
    
    
    23.8
    
    
    
    45.6Annual gross principal default rate
    
    
    63.3
    
    
    
    135.2
 As the sensitivity chart indicates, the value of the Companys Retained
interests in loans securitized on its consolidated balance sheets, as well as
reported earnings related to those interests, could differ significantly if
different assumptions or conditions prevail. NOTE 8  CONVERTIBLE PREFERRED STOCK Affiliates of Thomas H. Lee Partners, L.P. (THL Partners), a
Boston-based investment firm, and THL Partners co-investors hold 100% of the
outstanding shares of our preferred stock. The preferred shareholders are
entitled to receive quarterly dividends payable in additional shares of
preferred stock (dividends in-kind). The annual dividend rate is 9% through
December 8, 2008 and 15% thereafter (except following a Change in Control
Triggering Event, as described below). Preferred shareholders are also
entitled to receive 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. The preferred shareholders may also receive, in
lieu of a dividend in-kind, dividends payable in cash, property or other
securities which are economically equivalent to a dividend in-kind if the Board
of Directors determines that paying dividends in-kind would be inadvisable and
the payment of such other dividend is approved by 80% of the Board of
Directors, which 80% must include a majority of the directors elected by the
preferred stock (or, if there are no such directors, must be approved by
holders of a majority of the preferred stock). So long as THL Partners or their affiliates own at least 25% of the
originally issued preferred stock (or any shares of common stock issued upon
conversion thereof), the holders of a majority of the shares of preferred stock
are entitled to elect four of eleven directors of the Companys Board of
Directors. So long as THL Partners or their affiliates own at least 10% but
less than 25% of the originally issued preferred stock (or any shares of common
stock issued upon conversion thereof), the holders of a majority of the shares
of preferred stock are entitled to elect one director. Preferred shareholders
have the right to vote on general corporate matters with common shareholders on
a converted basis. Each share of preferred stock is convertible into 30 shares of common
stock and, if converted before December 9, 2005, a premium amount guaranteeing
seven years of dividends at the 9% rate through December 9, 2005. The
preferred shareholders are able to convert at anytime, and the preferred shares
automatically convert into common shares after December 9, 2005 if the common
stock trades at a share price of $21.33 or more for 20 consecutive days. As of
September 30, 2004 the preferred stock is convertible into 45,053,541 common
shares, or approximately 43.7%, of the outstanding common stock on a converted
basis. Before December 9, 2008 all of the preferred stock may be redeemed by us
by paying 103% of the redemption price of $372.50 and any accrued dividends at
the time of redemption. Such redemption can only occur at a time when (i) the
common stock has traded at a share price of $21.33 or more for the most recent
20 consecutive trading days and (ii) the Company has an unsecured corporate
debt rating of at least Baa3 from Moodys and BBB- from Standard and Poors.
We also have the option to redeem the 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. 12




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##### Table of Contents



If a Change in Control were to occur, we are obligated to offer redemption
of the preferred stock for cash at 101% of the greater of (i) the as converted
value of the preferred stock or (ii) $372.50 per share of preferred stock plus
accrued and unpaid dividends payable at the rate of 9% per annum through
December 9, 2005 (such greater amount referred to as the Liquidation
Preference). THL Partners has the right, but is not obligated, to accept
redemption of the preferred stock. If an offer of redemption is not made, a
Change in Control Trigger Event occurs and, as a result, (i) additional shares
of preferred stock are issued to the holders of preferred stock such that the
total number of outstanding shares of preferred stock equal the Liquidation
Preference divided by $372.50, (ii) the preferred stock dividend rate increases
to 11.5% before December 9, 2008 and 15% thereafter and dividends are due
quarterly in cash, and (iii) the Company becomes subject to limitations on
indebtedness and the issuance of capital stock and we cannot pay any dividends
or make distributions on, redeem or purchase any classes of stock. If the
Company fails to comply with any of the changes in terms, the dividend rate
increases another 2% and THL Partners can require the Company to purchase the
preferred stock at 101% of the Liquidation Preference. NOTE 9  INCOME TAXES The components of the expense (benefit) for income taxes consisted of the
following: Three-Months Ended
    
    Nine-Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Current:Federal
    
    $
    2,842
    
    
    $
    (41,623
    )
    
    $
    3,342
    
    
    $
    (94,179
    )State
    
    
    238
    
    
    
    797
    
    
    
    386
    
    
    
    1483,080
    
    
    
    (40,826
    )
    
    
    3,728
    
    
    
    (94,031
    )Deferred:Federal
    
    
    19,953
    
    
    
    23,059
    
    
    
    15,992
    
    
    
    18,813State
    
    
    392
    
    
    
    569
    
    
    
    283
    
    
    
    55820,345
    
    
    
    23,628
    
    
    
    16,275
    
    
    
    19,371Income tax expense
(benefit)
    
    $
    23,425
    
    
    $
    (17,198
    )
    
    $
    20,003
    
    
    $
    (74,660
    )
 A reconciliation of our effective income tax rate compared to the
statutory federal income tax rate is as follows: Three-Months Ended
    
    Nine-Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Statutory federal income tax rate
    
    
    35.0
    %
    
    
    35.0
    %
    
    
    35.0
    %
    
    
    35.0
    %State income taxes, net of federal
benefit
    
    
    0.5
    
    
    
    (0.9
    )
    
    
    0.8
    
    
    
    (0.2
    )Valuation allowance
    
    
    (9.1
    )
    
    
    (14.5
    )
    
    
    
    
    
    
    (5.2
    )Other, net
    
    
    1.1
    
    
    
    (0.9
    )
    
    
    1.9
    
    
    
    (0.6
    )Effective income tax rate
    
    
    27.5
    %
    
    
    18.7
    %
    
    
    37.7
    %
    
    
    29.0
    %
 13




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##### Table of Contents



Our deferred tax assets and liabilities are as follows: September 30,
    
    December 31,2004
    
    2003Deferred income tax assets resulting from future
deductible and taxable temporary differences:Allowance for loan losses and retained
interests fair value adjustments
    
    $
    54,130
    
    
    $
    122,852Intangible amortization
    
    
    45,889
    
    
    
    30,343Net operating loss and credit carry forwards
    
    
    7,921
    
    
    
    28,200Other
    
    
    28,876
    
    
    
    32,369Valuation allowance
    
    
    (2,440
    )
    
    
    (2,427
    )Total deferred tax assets
    
    
    134,376
    
    
    
    211,337Deferred income tax liabilities resulting from
future taxable and deductible temporary
differences:Accrued interest on credit card loans
    
    
    139,579
    
    
    
    194,766Other
    
    
    13,889
    
    
    
    19,388Total deferred tax liabilities
    
    
    153,468
    
    
    
    214,154Net deferred tax liabilities
    
    $
    (19,092
    )
    
    $
    (2,817
    )
 During the third quarter of 2004, the Company reduced the portion of its
valuation allowance related to its net operating loss carry forwards by $7.7
million primarily as a result of current period earnings. The remaining valuation allowance primarily relates to alternative
minimum tax credit carry forwards. We believe, based on our expected reversals
of taxable temporary differences and, to a lesser degree, reliance on future
earnings, the remaining deferred tax assets are fully realizable. The
net deferred tax liability is included in Accrued expenses and
other liabilities on the consolidated balance sheets. NOTE 10  ASSET IMPAIRMENTS, LEASE WRITE-OFFS AND SEVERANCE Asset impairments, lease write-offs and severance for the three months
ended September 30, 2004 consists of charges related to severance and the
write-down of various operating leases. During the comparable period in 2003,
this amount included a $2.6 million charge related to workforce reductions,
approximately $5.4 million in write-downs of excess property, equipment, and
operating leases and a $22.0 million write-off of purchased portfolio premium
on Credit card loans sold during 2003. During the nine-month period ended
September 30, 2004 this amount also included other workforce reduction charges.
The nine months ended September 30, 2003 included an $8.3 million charge for
workforce reductions, $5.1 million for commitment fees, $17.4 million for
write-downs of excess property and equipment and a $22.0 million write-off of
purchased portfolio premium on Credit card loans sold during 2003. NOTE 11  SALE OF MEMBERSHIP CLUB AND WARRANTY BUSINESS On July 29, 2003, we sold our membership club and warranty business to CPP
Group, a privately-owned provider of assistance products and services
throughout Europe, for cash proceeds of $45 million. We recorded a gain on the
sale of $80.4 million. Included in the gain was the recognition of $82.7
million of Deferred income and the write-off of $36.6 million of deferred
costs. 14




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NOTE 12  SALE OF CREDIT CARD LOANS On
April 30, 2004 we sold approximately $38 million of
Credit Card Loans from Direct Merchants Bank. Proceeds
from the sale approximated the carrying value of those loans. On September 16, 2003, we sold approximately 160,000 credit card accounts
amounting to $590.9 million of Credit card loans to a third party for cash
proceeds of $488.3 million. The sale included $144.4 million of receivables
from Direct Merchants Bank and $446.5 million of receivables from Metris
Receivables, Inc. On November 13, 2003, we sold approximately 125,000 credit
card accounts amounting to $494.3 million of Credit card loans to a third
party for cash proceeds of $396.5 million. During the third quarter of 2003 we
recorded a loss on these sales of $117.2 million related to these transactions. NOTE 13  SALE OF DEPOSITS On September 30, 2003, we sold all of the brokered and retail jumbo
certificates of deposit issued by Direct Merchants Bank. The face value of the
Deposits sold was $559.3 million. We recorded a loss on that sale of $33.0
million. NOTE 14  SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS We have various subsidiaries that do not guarantee Company debt. We have
prepared condensed consolidating financial statements of the Company, the
guarantor subsidiaries and the non-guarantor subsidiaries for purposes of
complying with SEC reporting requirements. Separate financial statements of
the guaranteeing subsidiaries and non-guaranteeing subsidiaries are not
presented because we have determined that separate presentation of the
subsidiaries financial information would not be material to investors. 15




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METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
September 30, 2004(Dollars in thousands)
Unaudited MetrisCompanies
    
    Guarantor
    
    Non-GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedAssets:Cash and cash equivalents
    
    $
    85,278
    
    
    $
    759
    
    
    $
    317,493
    
    
    $
    
    
    
    $
    403,530Liquidity reserve deposit
    
    
    
    
    
    
    
    
    
    
    79,655
    
    
    
    
    
    
    
    79,655Net credit card loans
    
    
    101
    
    
    
    
    
    
    
    55,995
    
    
    
    
    
    
    
    56,096Retained interests in loans
securitized
    
    
    1,884
    
    
    
    
    
    
    
    830,585
    
    
    
    6,939
    
    
    
    839,408Property and equipment, net
    
    
    
    
    
    
    26,395
    
    
    
    4
    
    
    
    
    
    
    
    26,399Purchased portfolio premium
    
    
    
    
    
    
    
    
    
    
    10,745
    
    
    
    
    
    
    
    10,745Other receivables due from
credit card securitizations,
net
    
    
    4
    
    
    
    
    
    
    
    74,937
    
    
    
    
    
    
    
    74,941Other assets
    
    
    37,816
    
    
    
    24,086
    
    
    
    39,797
    
    
    
    (38,975
    )
    
    
    62,724Investment in subsidiaries
    
    
    1,309,017
    
    
    
    1,101,166
    
    
    
    
    
    
    
    (2,410,183
    )
    
    
    Total assets
    
    $
    1,434,100
    
    
    $
    1,152,406
    
    
    $
    1,409,211
    
    
    $
    (2,442,219
    )
    
    $
    1,553,498Liabilities:Deposits
    
    $
    (500
    )
    
    $
    
    
    
    $
    4,235
    
    
    $
    
    
    
    $
    3,735Debt
    
    
    504,029
    
    
    
    (200,118
    )
    
    
    187,487
    
    
    
    (43,000
    )
    
    
    448,398Accounts payable
    
    
    403
    
    
    
    21,361
    
    
    
    29,688
    
    
    
    (13,172
    )
    
    
    38,280Deferred income
    
    
    
    
    
    
    
    
    
    
    12,181
    
    
    
    
    
    
    
    12,181Accrued expenses and other
liabilities
    
    
    (15,489
    )
    
    
    22,146
    
    
    
    74,454
    
    
    
    24,136
    
    
    
    105,247Total liabilities
    
    
    488,443
    
    
    
    (156,611
    )
    
    
    308,045
    
    
    
    (32,036
    )
    
    
    607,841Total
stockholders
equity
    
    
    945,657
    
    
    
    1,309,017
    
    
    
    1,101,166
    
    
    
    (2,410,183
    )
    
    
    945,657Total
liabilities and
stockholders
equity
    
    $
    1,434,100
    
    
    $
    1,152,406
    
    
    $
    1,409,211
    
    
    $
    (2,442,219
    )
    
    $
    1,553,498
 16




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METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
December 31, 2003(Dollars in thousands)
Unaudited MetrisCompanies
    
    Guarantor
    
    Non-GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedAssets:Cash and cash equivalents
    
    $
    (1,081
    )
    
    $
    3,034
    
    
    $
    176,532
    
    
    $
    
    
    
    $
    178,485Liquidity reserve deposit
    
    
    
    
    
    
    
    
    
    
    80,158
    
    
    
    
    
    
    
    80,158Net credit card loans
    
    
    15,203
    
    
    
    
    
    
    
    67,920
    
    
    
    
    
    
    
    83,123Retained interests in loans
securitized
    
    
    
    
    
    
    
    
    
    
    822,900
    
    
    
    14,001
    
    
    
    836,901Property and equipment, net
    
    
    
    
    
    
    33,663
    
    
    
    17
    
    
    
    
    
    
    
    33,680Purchased portfolio premium
    
    
    80
    
    
    
    
    
    
    
    17,481
    
    
    
    
    
    
    
    17,561Other receivables due from
credit card securitizations,
net
    
    
    5
    
    
    
    
    
    
    
    80,709
    
    
    
    
    
    
    
    80,714Other assets
    
    
    21,242
    
    
    
    30,934
    
    
    
    54,917
    
    
    
    (25,319
    )
    
    
    81,774Investment in subsidiaries
    
    
    1,296,461
    
    
    
    878,810
    
    
    
    
    
    
    
    (2,175,271
    )
    
    
    Total assets
    
    $
    1,331,910
    
    
    $
    946,441
    
    
    $
    1,300,634
    
    
    $
    (2,186,589
    )
    
    $
    1,392,396Liabilities:Deposits
    
    $
    (1,000
    )
    
    $
    
    
    
    $
    7,262
    
    
    $
    
    
    
    $
    6,262Debt
    
    
    384,684
    
    
    
    (413,842
    )
    
    
    422,606
    
    
    
    (43,000
    )
    
    
    350,448Accounts payable
    
    
    489
    
    
    
    15,406
    
    
    
    16,805
    
    
    
    (303
    )
    
    
    32,397Deferred income
    
    
    
    
    
    
    
    
    
    
    18,060
    
    
    
    
    
    
    
    18,060Accrued expenses and other
liabilities
    
    
    38,544
    
    
    
    48,416
    
    
    
    (42,909
    )
    
    
    31,985
    
    
    
    76,036Total liabilities
    
    
    422,717
    
    
    
    (350,020
    )
    
    
    421,824
    
    
    
    (11,318
    )
    
    
    483,203Total
stockholders
equity
    
    
    909,193
    
    
    
    1,296,461
    
    
    
    878,810
    
    
    
    (2,175,271
    )
    
    
    909,193Total
liabilities and
stockholders
equity
    
    $
    1,331,910
    
    
    $
    946,441
    
    
    $
    1,300,634
    
    
    $
    (2,186,589
    )
    
    $
    1,392,396
 17




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METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Three Months Ended September 30, 2004(Dollars in thousands)
Unaudited Metris
    
    
    
    
    
    Non-Companies
    
    Guarantor
    
    GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedRevenues:Securitization income
    
    
    1,936
    
    
    
    
    
    
    
    145,164
    
    
    
    875
    
    
    
    147,975Servicing income on
securitized receivables
    
    
    
    
    
    
    
    
    
    
    32,496
    
    
    
    
    
    
    
    32,496Credit card loan and other
interest income
    
    
    305
    
    
    
    
    
    
    
    4,244
    
    
    
    
    
    
    
    4,549Credit card loan fees,
interchange and other
income
    
    
    541
    
    
    
    22,507
    
    
    
    2,960
    
    
    
    (22,272
    )
    
    
    3,736Enhancement services income
    
    
    
    
    
    
    58
    
    
    
    5,643
    
    
    
    (9
    )
    
    
    5,692Intercompany allocations
    
    
    145
    
    
    
    39,947
    
    
    
    226
    
    
    
    (40,318
    )
    
    
    Total revenues
    
    
    2,927
    
    
    
    62,512
    
    
    
    190,733
    
    
    
    (61,724
    )
    
    
    194,448Expenses:Interest expense
    
    
    14,418
    
    
    
    (2,080
    )
    
    
    1,718
    
    
    
    
    
    
    
    14,056Provision for loan losses
    
    
    18
    
    
    
    2
    
    
    
    1,388
    
    
    
    
    
    
    
    1,408Credit card account and
other product solicitation
and marketing expenses
    
    
    
    
    
    
    15,841
    
    
    
    20,721
    
    
    
    (19,372
    )
    
    
    17,190Employee compensation
    
    
    
    
    
    
    30,963
    
    
    
    591
    
    
    
    
    
    
    
    31,554Data processing services
and communications
    
    
    (9
    )
    
    
    (12,181
    )
    
    
    27,366
    
    
    
    (2,973
    )
    
    
    12,203Credit protection claims
expense
    
    
    
    
    
    
    
    
    
    
    3,421
    
    
    
    
    
    
    
    3,421Occupancy and equipment
    
    
    
    
    
    
    5,440
    
    
    
    2
    
    
    
    
    
    
    
    5,442Purchased portfolio
premium amortization
    
    
    
    
    
    
    
    
    
    
    (827
    )
    
    
    3,068
    
    
    
    2,241Asset impairments, lease
write-offs and severance
    
    
    
    
    
    
    1,242
    
    
    
    
    
    
    
    
    
    
    
    1,242Other
    
    
    1,037
    
    
    
    16,209
    
    
    
    3,256
    
    
    
    
    
    
    
    20,502Intercompany allocations
    
    
    47
    
    
    
    8,365
    
    
    
    31,906
    
    
    
    (40,318
    )
    
    
    Total expenses
    
    
    15,511
    
    
    
    63,801
    
    
    
    89,542
    
    
    
    (59,595
    )
    
    
    109,259(Loss) income before
income tax (benefit)
expense and equity in
income of subsidiaries
    
    
    (12,584
    )
    
    
    (1,289
    )
    
    
    101,191
    
    
    
    (2,129
    )
    
    
    85,189Income tax (benefit)
expense
    
    
    (14,160
    )
    
    
    9,920
    
    
    
    27,812
    
    
    
    (147
    )
    
    
    23,425Equity in income of
subsidiaries
    
    
    60,188
    
    
    
    73,379
    
    
    
    
    
    
    
    (133,567
    )
    
    
    Net income
    
    $
    61,764
    
    
    $
    62,170
    
    
    $
    73,379
    
    
    $
    (135,549
    )
    
    $
    61,764
 18




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Three Months Ended September 30, 2003(Dollars in thousands)
Unaudited Metris
    
    
    
    
    
    Non-Companies
    
    Guarantor
    
    GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedRevenues:Securitization income
    
    
    10,307
    
    
    
    
    
    
    
    82,816
    
    
    
    656
    
    
    
    93,779Servicing income on
securitized receivables
    
    
    
    
    
    
    
    
    
    
    43,849
    
    
    
    
    
    
    
    43,849Credit card loan and
other interest income
    
    
    552
    
    
    
    
    
    
    
    24,104
    
    
    
    
    
    
    
    24,656Credit card loan fees,
interchange and other
income
    
    
    721
    
    
    
    24,903
    
    
    
    26,802
    
    
    
    (34,492
    )
    
    
    17,934Enhancement services
income
    
    
    
    
    
    
    2,923
    
    
    
    14,737
    
    
    
    (1,111
    )
    
    
    16,549Loss on sale of credit
card loans
    
    
    
    
    
    
    
    
    
    
    (117,183
    )
    
    
    
    
    
    
    (117,183
    )Gain on sale of
membership and warranty
business
    
    
    (831
    )
    
    
    9,445
    
    
    
    59,339
    
    
    
    12,438
    
    
    
    80,391Intercompany allocations
    
    
    2,324
    
    
    
    52,687
    
    
    
    4,439
    
    
    
    (59,450
    )
    
    
    Total revenues
    
    
    13,073
    
    
    
    89,958
    
    
    
    138,903
    
    
    
    (81,959
    )
    
    
    159,975Expenses:Interest expense
    
    
    14,378
    
    
    
    (2,209
    )
    
    
    10,127
    
    
    
    
    
    
    
    22,296Provision for loan losses
    
    
    2,028
    
    
    
    
    
    
    
    30,991
    
    
    
    
    
    
    
    33,019Credit card account and
other product
solicitation and
marketing expenses
    
    
    
    
    
    
    13,855
    
    
    
    26,598
    
    
    
    (21,128
    )
    
    
    19,325Employee compensation
    
    
    
    
    
    
    40,118
    
    
    
    1,879
    
    
    
    
    
    
    
    41,997Data processing services
and communications
    
    
    7
    
    
    
    (19,609
    )
    
    
    40,905
    
    
    
    (4,533
    )
    
    
    16,770Credit protection claims
expense
    
    
    
    
    
    
    
    
    
    
    6,585
    
    
    
    
    
    
    
    6,585Occupancy and equipment
    
    
    
    
    
    
    8,660
    
    
    
    56
    
    
    
    
    
    
    
    8,716Purchased portfolio
premium amortization
    
    
    18
    
    
    
    
    
    
    
    9,383
    
    
    
    (1,294
    )
    
    
    8,107Asset impairments, lease
write-offs and severance
    
    
    
    
    
    
    7,046
    
    
    
    22,930
    
    
    
    
    
    
    
    29,976Loss on sale of deposits
    
    
    
    
    
    
    
    
    
    
    32,963
    
    
    
    
    
    
    
    32,963Other
    
    
    2,665
    
    
    
    16,587
    
    
    
    28,209
    
    
    
    (15,064
    )
    
    
    32,397Intercompany allocations
    
    
    26
    
    
    
    19,327
    
    
    
    40,096
    
    
    
    (59,449
    )
    
    
    Total expenses
    
    
    19,122
    
    
    
    83,775
    
    
    
    250,722
    
    
    
    (101,468
    )
    
    
    252,151(Loss) income before
income tax (benefit)
expense and equity in
loss of subsidiaries
    
    
    (6,049
    )
    
    
    6,183
    
    
    
    (111,819
    )
    
    
    19,509
    
    
    
    (92,176
    )Income tax (benefit)
expense
    
    
    (1,848
    )
    
    
    2,985
    
    
    
    (24,294
    )
    
    
    5,959
    
    
    
    (17,198
    )Equity in loss of
subsidiaries
    
    
    (70,776
    )
    
    
    (87,524
    )
    
    
    
    
    
    
    158,300
    
    
    
    Net loss
    
    $
    (74,977
    )
    
    $
    (84,326
    )
    
    $
    (87,525
    )
    
    $
    171,850
    
    
    $
    (74,978
    )
 19




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Nine Months Ended September 30, 2004(Dollars in thousands)
Unaudited Metris
    
    
    
    
    
    Non-Companies
    
    Guarantor
    
    GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedRevenues:Securitization income
    
    
    856
    
    
    
    
    
    
    
    239,503
    
    
    
    2,258
    
    
    
    242,617Servicing income on
securitized receivables
    
    
    
    
    
    
    
    
    
    
    102,580
    
    
    
    
    
    
    
    102,580Credit card loan and
other interest income
    
    
    712
    
    
    
    
    
    
    
    13,953
    
    
    
    
    
    
    
    14,665Credit card loan fees,
interchange and other
income
    
    
    2,989
    
    
    
    56,622
    
    
    
    16,126
    
    
    
    (55,921
    )
    
    
    19,816Enhancement services
income
    
    
    
    
    
    
    200
    
    
    
    19,974
    
    
    
    (26
    )
    
    
    20,148Intercompany allocations
    
    
    294
    
    
    
    118,757
    
    
    
    1,621
    
    
    
    (120,672
    )
    
    
    Total revenues
    
    
    4,851
    
    
    
    175,579
    
    
    
    393,757
    
    
    
    (174,361
    )
    
    
    399,826Expenses:Interest expense
    
    
    46,978
    
    
    
    (7,641
    )
    
    
    7,364
    
    
    
    
    
    
    
    46,701Provision for loan losses
    
    
    (1,270
    )
    
    
    
    
    
    
    (3,905
    )
    
    
    
    
    
    
    (5,175
    )Credit card account and
other product
solicitation and
marketing expenses
    
    
    105
    
    
    
    40,290
    
    
    
    55,302
    
    
    
    (46,849
    )
    
    
    48,848Employee compensation
    
    
    
    
    
    
    104,112
    
    
    
    2,110
    
    
    
    
    
    
    
    106,222Data processing services
and communications
    
    
    (4
    )
    
    
    (40,624
    )
    
    
    92,263
    
    
    
    (9,183
    )
    
    
    42,452Credit protection claims
expense
    
    
    
    
    
    
    
    
    
    
    14,805
    
    
    
    
    
    
    
    14,805Occupancy and equipment
    
    
    
    
    
    
    17,813
    
    
    
    14
    
    
    
    
    
    
    
    17,827Purchased portfolio
premium amortization
    
    
    7
    
    
    
    
    
    
    
    4,686
    
    
    
    2,050
    
    
    
    6,743Asset impairments, lease
write-offs and severance
    
    
    
    
    
    
    4,515
    
    
    
    
    
    
    
    
    
    
    
    4,515Other
    
    
    6,293
    
    
    
    47,068
    
    
    
    10,476
    
    
    
    
    
    
    
    63,837Intercompany allocations
    
    
    115
    
    
    
    28,835
    
    
    
    91,722
    
    
    
    (120,672
    )
    
    
    Total expenses
    
    
    52,224
    
    
    
    194,368
    
    
    
    274,837
    
    
    
    (174,654
    )
    
    
    346,775(Loss) income before
income tax (benefit)
expense and equity in
income of subsidiaries
    
    
    (47,373
    )
    
    
    (18,789
    )
    
    
    118,920
    
    
    
    293
    
    
    
    53,051Income tax (benefit)
expense
    
    
    (17,865
    )
    
    
    (8,992
    )
    
    
    46,749
    
    
    
    111
    
    
    
    20,003Equity in income of
subsidiaries
    
    
    62,556
    
    
    
    72,171
    
    
    
    
    
    
    
    (134,727
    )
    
    
    Net income
    
    $
    33,048
    
    
    $
    62,374
    
    
    $
    72,171
    
    
    $
    (134,545
    )
    
    $
    33,048
 20




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##### Table of Contents



METRIS COMPANIES INC. Supplemental Consolidating Statements of Income
Nine Months Ended September 30, 2003 (Dollars in thousands)
Unaudited
 Metris
    
    
    
    
    
    Non-Companies
    
    Guarantor
    
    GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedRevenues:Securitization income
    
    
    (147
    )
    
    
    
    
    
    
    75,046
    
    
    
    (1,383
    )
    
    
    73,516Servicing income on
securitized receivables
    
    
    
    
    
    
    
    
    
    
    136,997
    
    
    
    
    
    
    
    136,997Credit card loan and
other interest income
    
    
    1,548
    
    
    
    
    
    
    
    86,701
    
    
    
    
    
    
    
    88,249Credit card loan fees,
interchange and other
income
    
    
    1,811
    
    
    
    56,450
    
    
    
    74,729
    
    
    
    (65,277
    )
    
    
    67,713Enhancement services
income
    
    
    
    
    
    
    28,647
    
    
    
    78,230
    
    
    
    (7,129
    )
    
    
    99,748Loss on sale of credit
card loans
    
    
    
    
    
    
    
    
    
    
    (117,183
    )
    
    
    
    
    
    
    (117,183
    )Gain on sale of
membership and warranty
business
    
    
    (831
    )
    
    
    9,445
    
    
    
    59,339
    
    
    
    12,438
    
    
    
    80,391Intercompany allocations
    
    
    7,664
    
    
    
    192,018
    
    
    
    22,676
    
    
    
    (222,358
    )
    
    
    Total revenues
    
    
    10,045
    
    
    
    286,560
    
    
    
    416,535
    
    
    
    (283,709
    )
    
    
    429,431Expenses:Interest expense
    
    
    32,761
    
    
    
    (2,307
    )
    
    
    29,899
    
    
    
    
    
    
    
    60,353Provision for loan losses
    
    
    3,414
    
    
    
    
    
    
    
    104,526
    
    
    
    (102
    )
    
    
    107,838Credit card account and
other product
solicitation and
marketing expenses
    
    
    
    
    
    
    44,286
    
    
    
    93,086
    
    
    
    (52,327
    )
    
    
    85,045Employee compensation
    
    
    
    
    
    
    128,656
    
    
    
    12,443
    
    
    
    
    
    
    
    141,099Data processing services
and communications
    
    
    12
    
    
    
    (61,312
    )
    
    
    124,616
    
    
    
    (10,334
    )
    
    
    52,982Credit protection claims
expense
    
    
    
    
    
    
    
    
    
    
    26,537
    
    
    
    
    
    
    
    26,537Occupancy and equipment
    
    
    
    
    
    
    27,033
    
    
    
    220
    
    
    
    
    
    
    
    27,253Purchased portfolio
premium amortization
    
    
    39
    
    
    
    
    
    
    
    24,701
    
    
    
    (3,638
    )
    
    
    21,102Asset impairments, lease
write-offs and severance
    
    
    5,129
    
    
    
    23,573
    
    
    
    24,062
    
    
    
    
    
    
    
    52,764Loss on sale of deposits
    
    
    
    
    
    
    
    
    
    
    32,963
    
    
    
    
    
    
    
    32,963Other
    
    
    8,020
    
    
    
    46,140
    
    
    
    46,179
    
    
    
    (21,628
    )
    
    
    78,711Intercompany allocations
    
    
    61
    
    
    
    72,373
    
    
    
    149,924
    
    
    
    (222,358
    )
    
    
    Total expenses
    
    
    49,436
    
    
    
    278,442
    
    
    
    669,156
    
    
    
    (310,387
    )
    
    
    686,647(Loss)
income before income tax
(benefit) expense and
equity in loss of
subsidiaries
    
    
    (39,391
    )
    
    
    8,118
    
    
    
    (252,621
    )
    
    
    26,678
    
    
    
    (257,216
    )Income tax (benefit)
expense
    
    
    (13,111
    )
    
    
    654
    
    
    
    (71,083
    )
    
    
    8,880
    
    
    
    (74,660
    )Equity in loss of
subsidiaries
    
    
    (156,276
    )
    
    
    (172,095
    )
    
    
    
    
    
    
    328,371
    
    
    
    Net loss
    
    $
    (182,556
    )
    
    $
    (164,631
    )
    
    $
    (181,538
    )
    
    $
    346,169
    
    
    $
    (182,556
    )
 21




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Nine Months Ended September 30, 2004(Dollars in thousands)
Unaudited Metris
    
    
    
    
    
    Non-Companies
    
    Guarantor
    
    GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedOperating Activities:Net cash (used in)
provided by operating
activities
    
    $
    (24,081
    )
    
    $
    (14,012
    )
    
    $
    318,312
    
    
    $
    (73,269
    )
    
    $
    206,950Investing Activities:Net cash from loan
originations and
principal collections on
loans receivable
    
    
    16,372
    
    
    
    
    
    
    
    (117,260
    )
    
    
    10,895
    
    
    
    (89,993
    )Proceeds
from sales of credit card portfolios to third parties
    
    
    
    
    
    
    
    
    
    
    27,870
    
    
    
    
    
    
    
    27,870Net additions of property
and equipment
    
    
    
    
    
    
    (1,984
    )
    
    
    
    
    
    
    
    
    
    
    (1,984
    )Investment in subsidiaries
    
    
    (12,556
    )
    
    
    (222,356
    )
    
    
    
    
    
    
    234,912
    
    
    
    Net cash provided by
(used in) investing
activities
    
    
    3,816
    
    
    
    (224,340
    )
    
    
    (89,390
    )
    
    
    245,807
    
    
    
    (64,107
    )Financing Activities:Net increase (decrease)
in debt
    
    
    102,645
    
    
    
    213,724
    
    
    
    (235,119
    )
    
    
    
    
    
    
    81,250Net increase (decrease)
in deposits
    
    
    500
    
    
    
    
    
    
    
    (3,027
    )
    
    
    
    
    
    
    (2,527
    )Proceeds from issuance of
common stock
    
    
    3,479
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,479Capital contributions
    
    
    
    
    
    
    22,353
    
    
    
    150,185
    
    
    
    (172,538
    )
    
    
    Net cash provided by
(used in) financing
activities
    
    
    106,624
    
    
    
    236,077
    
    
    
    (87,961
    )
    
    
    (172,538
    )
    
    
    82,202Net increase (decrease)
in cash and cash
equivalents
    
    
    86,359
    
    
    
    (2,275
    )
    
    
    140,961
    
    
    
    
    
    
    
    225,045Cash and cash equivalents
at beginning of period
    
    
    (1,081
    )
    
    
    3,034
    
    
    
    176,532
    
    
    
    
    
    
    
    178,485Cash and cash equivalents
at end of period
    
    $
    85,278
    
    
    $
    759
    
    
    $
    317,493
    
    
    $
    
    
    
    $
    403,530
 22




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Nine Months Ended September 30, 2003(Dollars in thousands)
Unaudited (as restated) MetrisCompanies
    
    Guarantor
    
    Non-GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedOperating Activities:Net cash (used in)
provided by operating
activities
    
    $
    (213,561
    )
    
    $
    (537,441
    )
    
    $
    296,784
    
    
    $
    255,512
    
    
    $
    (198,706
    )Investing Activities:Proceeds from transfer of
portfolios to the Metris
Master Trust
    
    
    
    
    
    
    
    
    
    
    670,965
    
    
    
    
    
    
    
    670,965Net cash from loan
originations and
principal collections on loans receivable
    
    
    753
    
    
    
    
    
    
    
    (519,772
    )
    
    
    (15,778
    )
    
    
    (534,797
    )Proceeds from sales of
credit card
portfolios to third
parties
    
    
    
    
    
    
    
    
    
    
    494,784
    
    
    
    
    
    
    
    494,784Proceeds from sale of
membership and
warranty business
    
    
    
    
    
    
    8,100
    
    
    
    36,900
    
    
    
    
    
    
    
    45,000Net disposals of
property and
equipment
    
    
    
    
    
    
    4,403
    
    
    
    20,210
    
    
    
    
    
    
    
    24,613Investment in subsidiaries
    
    
    230,640
    
    
    
    707,909
    
    
    
    
    
    
    
    (938,549
    )
    
    
    Net cash provided by
investing activities
    
    
    231,393
    
    
    
    720,412
    
    
    
    703,087
    
    
    
    (954,327
    )
    
    
    700,565Financing Activities:Net increase (decrease)
in debt
    
    
    2,610
    
    
    
    (9,421
    )
    
    
    
    
    
    
    
    
    
    
    (6,811
    )Net decrease in deposits
    
    
    
    
    
    
    
    
    
    
    (886,456
    )
    
    
    
    
    
    
    (886,456
    )Premiums and transaction
costs on deposits sold
    
    
    
    
    
    
    
    
    
    
    (32,963
    )
    
    
    
    
    
    
    (32,963
    )Proceeds from issuance of
common stock
    
    
    2,551
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,551Capital contributions
    
    
    
    
    
    
    (181,352
    )
    
    
    (517,463
    )
    
    
    698,815
    
    
    
    Net cash provided by
(used in) financing
activities
    
    
    5,161
    
    
    
    (190,773
    )
    
    
    (1,436,882
    )
    
    
    698,815
    
    
    
    (923,679
    )Net increase (decrease)
in cash and cash
equivalents
    
    
    22,993
    
    
    
    (7,802
    )
    
    
    (437,011
    )
    
    
    
    
    
    
    (421,820
    )Cash and cash equivalents
at beginning of period
    
    
    (3,795
    )
    
    
    8,109
    
    
    
    575,918
    
    
    
    
    
    
    
    580,232Cash and cash equivalents
at end of period
    
    $
    19,198
    
    
    $
    307
    
    
    $
    138,907
    
    
    $
    
    
    
    $
    158,412
 23




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##### Table of Contents



ITEM 2. METRIS COMPANIES INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Business Overview The following discussion and analysis provides information management
believes to be relevant to understanding the financial condition and results of
operations of Metris Companies Inc. (MCI) and its subsidiaries. MCIs
principal subsidiaries are Direct Merchants Credit Card Bank, National
Association (Direct Merchants Bank or the Bank), Metris Direct, Inc. and
Metris Receivables, Inc. (MRI). MCI and its subsidiaries, as applicable, may
be referred to as we, us, our or the Company. For a full understanding
of our financial condition and results of operations, you should read this
discussion along with Managements Discussion and Analysis of Financial
Condition and Results of Operations in our Annual Report on Form 10-K/A for the
fiscal year ended December 31, 2003. In addition, you should read this
discussion along with our condensed consolidated financial statements and
related notes thereto for the period ended September 30, 2004 included herein. MCI was incorporated in Delaware on August 20, 1996, and completed an
initial public offering in October 1996. We provide financial products and
services to middle market consumers throughout the United States. Our consumer
lending products are primarily unsecured credit cards, including the Direct
Merchants Bank MasterCard® and Visa®. We also offer co-branded
credit cards through partnerships with other companies. Our credit cards
generate consumer loans through Direct Merchants Bank. These loans in turn
generate income and cash flow from principal, interest and fee payments. The
sales of our other consumer financial products, such as credit protection
products, generate additional cash flow. For the quarter ended September 30, 2004, the Company reported net income
of $61.8 million, compared to a net loss of $70.3 million for the second
quarter of 2004 and net loss of $75.0 million for the third quarter of 2003.
The increase in earnings is a result of no new securitization
transactions during the
quarter, lower overall operating expenses,
increased Interest-only revenues, which reflect higher excess spreads in our
Metris Master Trust and favorable valuation adjustments on the carrying value
of our retained interests in securitized loans. Our
quarterly Net income (loss) may fluctuate based on
several factors, including securitization activity. When
securitization transactions occur we incur Loss on new
securitization to the Metris Master Trust and increased
transaction costs. During the quarter ended September 30, 2004 we continued to see signs
of improving asset quality. As a result, the three-month average excess spread
in the Metris Master Trust for the quarter ended September 30, 2004 was 5.58%.
This excess spread is 175 basis points higher than the 3.83% reported for the
second quarter of 2004 and 288 basis points higher than the 2.70% reported for
the third quarter of 2003. The increase in the excess spread has been driven
primarily by improvements in credit losses. The average principal default rate
in the Metris Master Trust was 16.8% for the quarter ended September 30, 2004,
a decrease of 320 basis points over the comparable period in 2003. In
addition, delinquency rates in the Metris Master Trust were 9.7% as of
September 30, 2004 compared to 9.4% as of June 30, 2004 and 11.1% as of
September 30, 2003. The slight increase in delinquencies
from the second quarter of 2004 is consistent with normal seasonal trends we
have seen in eight of the past nine years. The Company has also continued to see improved performance in the early
stage delinquencies in the Metris Master Trust. As of September 30, 2004 the
percentage of receivables one to 29 days contractually delinquent has
been below 5% for seven consecutive months in the Metris Master Trust. We
believe this improvement has resulted from revisions in the base operating
strategies with which we manage our portfolio, significantly enhanced
collection efforts and improvements in the macro economy. We anticipate that
performance in the Metris Master Trust will fluctuate on a month-to-month
basis. While we anticipate overall long-term improvement in the performance of
the Metris Master Trust, we do expect fluctuations in both excess spread and
delinquencies, including an anticipated seasonal increase in delinquencies
during the fourth quarter of 2004. 24




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##### Table of Contents



The one-month London Inter Bank Offered Rate (LIBOR)(the index which
primarily drives our cost of funds) has increased from 1.12% at December 31,
2003 to 1.84% as of September 30, 2004. This increase, and potential future
increases, results in a higher cost of funds on securities issued out of the
Metris Master Trust, which is partially offset by higher yields on our credit
card portfolio. We believe that impacts to our
financial statements that result from increases in interest rates may be
mitigated by a variety of management strategies including, but not limited to,
interest rate caps, portfolio re-pricing or the issuance of fixed rate debt.
For further information on the impact to us resulting from changes in interest
rates, refer to Item 3 Quantitative and Qualitative Disclosures about Market
Risk on pages 45-46 of this Report. We continue to focus on strengthening the long-term operations of the
business. Improvements in losses, delinquencies and payment rates have been
driven by tighter underwriting on new account originations, tighter line
management on existing and new cardholders, better pricing on offerings and
improved collections initiatives. We have changed the Companys base
strategies in these areas over the past two years and we are beginning to see
the benefits in improved operating results. These improved operating results
and our strong cash position are enabling us to focus on growing our business. We have steadily increased our new account
originations throughout 2004. In the first half of 2004 we generated
approximately 150,000 new accounts and during the quarter ended September 30,
2004 we generated an additional 118,000 new accounts. We are comfortable
increasing our new account originations in part due to the continued strong
results we are experiencing in our 2003 campaigns. We continue to see a 33%
improvement in delinquencies in comparing our 2003 campaigns to our 2002
campaigns at the same point in time. We expect credit card originations in
2005 to continue to reflect the discipline exhibited in our 2003 and 2004
originations and anticipate these improved results will create a more reliable,
predictable, long-term receivables base. This new account growth will remain
focused on our traditional target market, the middle-market consumer. We will
continue to leverage our account origination strategies, increase our efforts
to penetrate the Hispanic customer segment, increase our partnership and
third-party marketing efforts and test additional products, channels and
incremental prospects. In January 2003, the Federal Financial Institutions Examination Council
(FFIEC) issued guidance with respect to account management, risk management
and loss allowance practices for institutions engaged in credit card lending.
The guidance provides requirements for certain operational and accounting
policies, which are designed to bring consistency in practice between
institutions engaged in credit card lending. The Company has developed an
implementation plan to address the account management aspects of this guidance.
As initial steps in the implementation of this guidance, during June and July
of 2004, we stopped billing late and overlimit fees on credit card accounts in
which the customers balance was 130% or more of their credit limit. We
continue testing alternative approaches to fully comply with the account
management guidance, the results of which will drive further steps to be
implemented in 2005 and 2006. We anticipate that the impact of fully
implementing the account management guidance will result in slightly lower
yields in the Metris Master Trust, which we expect will be partially offset by
lower default rates. Critical Accounting Estimates The Companys most critical accounting estimates are the valuation of our
Retained interests in loans securitized and our determination of the
Allowance for loan losses. Valuation of Retained Interests in Loans Securitized The Retained interests in loans securitized on our balance sheet
associated with our securitization transactions includes contractual retained
interests, excess transferors interest, interest-only strip receivable, and
spread accounts receivable. We determine the fair value of each component of
the Retained interests in loans securitized at the time a securitization
transaction or replenishment sale is completed using a discounted cash flow
valuation model and on a quarterly basis thereafter. Increases to the fair
value of each of the assets related to discount accretion are recorded in
Discount accretion. Any other change in the fair value is recorded in
Change in fair value. 25




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##### Table of Contents



The discounted cash flow valuation is limited to the receivables that
exist and have been sold to the Metris Master Trust. Therefore, the model
assumes the current principal receivable balance at the balance sheet date
amortizes with no new sales, interchange fees or cash advances. The future
cash flows are modeled in accordance with the debt series legal documents and
are applied to all series on a pro-rata basis. Finance charge and fee income
and recovery cash flows above contractual expense payments are first applied to
meet spread accounts receivable requirements then returned to us as part of the
interest-only strip receivable. We determine upper and lower valuation limits
of the Retained interests in loans securitized based on historical and
forecasted excess spreads. We then determine the best estimate within the range
based on historical trends (weighted heavily toward the low end of the range),
adjusted, when appropriate, for portfolio forecast information. The contractual retained interests represent subordinated securities held
by us. There is no stated interest/coupon rate associated with these
securities and they are not rated. They are subordinate to all other
securities, except for the interest-only strip receivable we own and
accordingly, are repaid last. Their fair value is determined by discounting
the expected future cash flows using a discount rate commensurate with the
risks of the underlying assets and the expected timing based on the scheduled
maturity date for the underlying securitization. If these securities are
recoverable based on the Metris Master Trust forecasts, cash flows related to
the entire subordinated principal balance are used in determining their fair
value. Transferors interest represents an undivided interest in receivables that
are not pledged to support a specific security series or class and represent
our interest in the excess principal receivables held in the Metris Master
Trust. The fair value is determined in the same manner as the contractual
retained interests and is discounted based on 12 months to maturity. We have
subordinated our rights to the excess cash flows on the receivables underlying
the transferors interest, thus they are included in the value of the
interest-only strip receivable. Spread account receivable balances represent
interest earning cash held by the Metris Master Trust trustee due to
performance of the Metris Master Trust and minimum spread reserve deposits
required by certain security series. Changes in fair value are determined in
the same manner as the contractual retained interests. The interest-only strip receivable represents the contractual right to
receive, from the Metris Master Trust, interest and other fee revenue less
certain costs over the estimated life of the underlying debt securities. The
fair value is determined by discounting the expected future cash flows using a
discount rate commensurate with the risks of the underlying assets and the
expected timing of the amortization inherent in the retained interests
valuation model. We believe our discount rates are consistent with what other
market place participants would use to determine the fair value of these
assets. The valuation model assumes that we repurchase the outstanding
principal receivables at face value according to the clean-up call provisions
contained in the respective security series legal documents. We use certain assumptions and estimates in determining the fair value of
Retained interests in loans securitized. These assumptions and estimates
include estimated principal payments, credit losses, gross yield, interest
expense, fees, the timing of cash receipts, and discount rates commensurate
with the risks of the underlying assets. On a quarterly basis, we review and
adjust, as appropriate, the assumptions and estimates used in our model based
on a variety of internal and external factors, including national and economic
trends and business conditions, current lending policies, procedures and
strategies, historical trends and assumptions about future trends, competition,
and legal and regulatory requirements. Significant estimates are required in
determining these factors and different judgments concerning these factors can
result in a material impact on our balance sheet and income statement. 26




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##### Table of Contents



Allowance for Loan Losses We maintain an Allowance for loan losses sufficient to absorb probable
loan losses inherent in the credit card loan portfolio as of the balance sheet
date. The Allowance for loan losses results in a reserve approximating 18
months of future charge-offs. At the time of charge-off, all principal balances are written off against the allowance and
all fees and finance charges are netted against the applicable income statement
line item. The allowance is based on managements consideration of all
relevant factors, including managements assessment of applicable economic and
seasonal trends. Historically, we segmented the loan portfolio into several individual
liquidating pools with similar credit risk characteristics, and estimated
(based on historical experience for similar pools and existing environmental
conditions) the dollar amount of principal, accrued finance charges and fees
that would charge-off. We then aggregated these pools into prime and subprime
portfolios based on the prescribed FICO score cuts, credit counseling programs,
and various pools of other receivables. We separately analyzed the reserve
requirement on each of these groups or portfolios. During the first quarter of
2004, we aggregated all liquidating pools into one segment, which is treated as
subprime loans for allowance determination purposes. We believe this was
appropriate due to the reduction in the loan portfolio and the fact that the
remaining loans had similar risk characteristics. We continually evaluate the liquidating pool employing a roll-rate model
which uses historical delinquency levels and pay-down levels (12 months of
historical data, with influence given to the last six months performance to
capture current economic and seasonal trends), loan seasoning, and other
measures of asset quality to estimate charge-offs for both credit losses and
bankruptcy losses. Additionally, in evaluating the adequacy of the loan loss reserves, we
consider several subjective factors that may be overlaid into the credit risk
roll-rate model in determining the necessary loan loss reserve. These factors
include, but are not limited to:  
    
    national and economic trends and business conditions, including the
condition of various market segments;
    
    changes in lending policies and procedures, including those for
underwriting, collection, charge-off and recovery, as well as the
experience, ability and depth of lending management and staff;
    
    trends in volume and the product pricing of accounts, including any
concentrations of credit; and
    
    impacts from external factors  such as changes in competition, and
legal and regulatory requirements  on the level of estimated credit
losses in the current portfolio. Significant changes in these factors could impact our financial
projections and thereby affect the adequacy of our Allowance for loan losses. Results of Operations Net income for the three months ended September 30, 2004 was $61.8
million, compared to a Net loss of $75.0 million for the third quarter of
2003. Diluted earnings per common share for the three months ended September
30, 2004 were $0.48, compared to a diluted loss per common share of $1.48 for
the third quarter of 2003. The increase in Net income from a Net loss is
primarily due to a $54.2 million increase in Securitization income, a
decrease in Total expenses of $142.9 million, and a Loss on sale of credit
card loans of $117.2 million recorded in the third quarter of 2003 partially
offset by a Gain on sale of membership and warranty business of $80.4 million
also recorded in the third quarter of 2003. 27




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##### Table of Contents



Net income for the nine months ended September 30, 2004 was $33.0
million, compared to a Net loss of $182.6 million for the comparable period
in 2003. Diluted earnings per common share for the nine months ended September
30, 2004 were $0.01 compared to a diluted loss per common share of $3.70 for
the comparable period in 2003. The increase in Net income from a Net loss
is due to a $169.1 million increase in Securitization income, a $339.9
million decrease in total expenses, and a Loss on sale of credit card loans of
$117.2 million recorded in the third quarter of 2003, partially offset by a
Gain on sale of membership and warranty business of $80.4 also recorded in
the third quarter of 2003, and a decrease in other operating revenues. The following table summarizes Securitization income for the three- and
nine-month periods ended September 30, 2004 and 2003. Table 1: Analysis of Securitization Income(In thousands) Three-Months Ended
    
    Nine-Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Loss on new securitization of
receivables to the Metris Master
Trust
    
    $
    
    
    
    $
    (23,015
    )
    
    $
    (91,886
    )
    
    $
    (55,214
    )Loss on replenishment of
receivables to the Metris Master
Trust
    
    
    (21,972
    )
    
    
    (35,792
    )
    
    
    (71,353
    )
    
    
    (127,574
    )Discount accretion
    
    
    63,747
    
    
    
    85,549
    
    
    
    185,287
    
    
    
    240,035Interest-only revenue
    
    
    87,316
    
    
    
    60,694
    
    
    
    217,385
    
    
    
    151,374Change in fair value
    
    
    25,518
    
    
    
    33,564
    
    
    
    94,202
    
    
    
    (70,333
    )Transaction and other costs
    
    
    (6,634
    )
    
    
    (27,221
    )
    
    
    (91,018
    )
    
    
    (64,772
    )Securitization income
    
    $
    147,975
    
    
    $
    93,779
    
    
    $
    242,617
    
    
    $
    73,516
 Securitization income was $148.0 million for the three months ended
September 30, 2004, compared to $93.8 million for the same period in 2003. The
increase is due to improvements in the Loss on new securitizations to the
Metris Master Trust of $23.0 million and Loss on replenishment of receivables
to the Metris Master Trust of $13.8 million, a $26.6 million increase in
Interest-only revenue and a $20.6 million reduction in Transaction and other
costs. These improvements were partially offset by a $21.8 million reduction
in Discount accretion and an $8.0 million decline in the Change in fair
value. There was no Loss on new securitization of receivables to the Metris
Master Trust for the three months ended September 30, 2004 because there were
no new transactions during the quarter. The $23.0 million Loss on new
securitization of receivables to the Metris Master Trust in the third quarter
of 2003 is due to the larger size and duration of transactions completed during
the period. Loss on replenishment of receivables to the Metris Master Trust
decreased from $35.8 million for the three months ended September 30, 2003 to
$22.0 million for the three months ended September 30, 2004 primarily due to
lower volumes of receivables sold into the Metris Master Trust and a decrease
in the weighted average months to maturity on the outstanding securitization
transactions. Interest-only revenue was $87.3 million for the three months
ended September 30, 2004, compared to $60.7 million for the three months ended
September 30, 2003. This increase was due to a 288 basis point increase in the
weighted average excess spread in the Metris Master Trust, partially offset by
a $2.2 billion decrease in average principal receivables. Transaction and
other costs were $6.6 million for the three months ended September 30, 2004
compared to $27.2 million for the three months ended September 30, 2003. The
higher transaction costs in 2003 are primarily due to up-front fees on the
securitization transactions closed during the period. 28




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These quarter over quarter improvements were partially offset by a
decrease in Discount accretion of $21.8 million and a decrease in the Change
in fair value of $8.0 million. The decreased Discount accretion was
primarily due to lower receivable balances and the resulting lower contractual
retained interest held in the Metris Master Trust and lower spread reserve
deposits due to improved trust performance. The Change in fair value for the
three months ended September 30, 2004 was $25.5 million. This resulted
primarily from a $12.7 million increase in the interest-only asset due to higher projected excess spreads
partially offset by attrition and a $12.4 million decrease in the discount
against spread accounts receivable due to restricted cash being released as a
result of improved excess spread. The Change in fair value for the three
months ended September 30, 2003 was $33.6 million. This resulted primarily
from a $27.5 million change in fair value of accrued interest receivable
pertaining to receivables sold during the quarter, and a $23.3 million fair
value increase reflecting the early pay-down of the variable funding conduits
resulting from attrition and receivables sold during the quarter, partially
offset by a $21.9 million increase in the discount against spread accounts
receivable due to additional excess spread cash flows being restricted from
release. Securitization income was $242.6 million for the nine months ended
September 30, 2004, compared to $73.5 million for the same period in 2003. The
increase is due to improvement in the Change in fair value of $164.5 million,
a $66.0 million increase in Interest-only revenue and a $56.2 million
reduction in the Loss on replenishment of receivables to the Metris Master
Trust. These improvements were partially offset by a $54.7 million decrease
in Discount accretion, a $36.7 million increase in Loss on new securitization
of receivables to the Metris Master Trust and a $26.2 million increase in
Transaction and other costs. The year-to-date 2004 Change in fair value of $94.2 million was due to a
$38.0 million fair value increase pertaining to the early pay-down of the
variable funding conduits, a $32.7 million increase in the interest-only asset
due to higher projected excess spreads (partially offset by receivable
attrition) and a $30.1 million increase due to the release of restricted cash
due to higher excess spreads. The Change in fair value for the nine months
ended September 30, 2003 was a $70.3 million loss. This resulted primarily
from a $63.7 million increase in the discount against spread accounts
receivable due to additional excess spread cash flows being restricted from
release, a $18.9 million decrease in fair value due to performance of the
Metris Master Trust, partially offset by a $27.5 million increase in fair value
of accrued interest receivable pertaining to receivables sold during the third
quarter. The $66.0 million increase in interest-only revenue was due to a 234
basis point increase in weighted average excess spread in the Metris Master
Trust, partially offset by a $2.3 billion decrease in average principal
receivables. The $56.2 million reduction in the Loss on replenishment of
receivables to the Metris Master Trust is due to lower volumes of receivables
sold into the Metris Master Trust, a decrease in the weighted average months to
maturity on the outstanding securitization transactions and higher projected
excess spreads. The decrease in Discount accretion for the nine months ended September
30, 2004 is primarily due to lower receivable balances and the resulting lower
contractual retained interest held in the Metris Master Trust and lower spread
reserve deposits due to improved Metris Master Trust performance. The increase
in Loss on new securitization of receivables to the Metris Master Trust for
the nine months ended September 30, 2004 is due to the larger size and longer
term of transactions completed in 2004. The $91.9 million Loss on new
securitization of receivables to the Metris Master Trust for the nine months
ended September 30, 2004 relates to $1.8 billion of new securitizations with an
average of 18 months to maturity compared to $1.3 billion of new
securitizations with an average of 12 months to maturity during the same period
in 2003. The higher Transaction and other costs were also due to the size of
the respective securitization transactions. In addition, transaction fees were
incurred related to a paired series in the first quarter of 2004, commitment
fees for MBIA insurance coverage on future asset-backed transactions and a
mark-to-market valuation adjustment on interest rate caps. Servicing income on securitized receivables decreased $11.4 million and
$34.4 million for the three- and nine-month periods ended September 30, 2004,
respectively, over the comparable periods of 2003. The reduction is due to
decreases of $2.2 billion and $2.3 billion in average principal receivables
held by the Metris Master Trust for the three- and nine-month periods ended
September 30, 2004, respectively. 29




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##### Table of Contents



Credit card loan and other interest income and Credit card loan fees,
interchange and other income, decreased $34.3 million and $121.5 million for
the three- and nine-month periods ended September 30, 2004, respectively,
compared to the same periods in 2003. These decreases resulted primarily from
reductions in average owned credit card loans of $440.1 million and $557.5
million for the three- and nine-month periods, respectively. Enhancement services income decreased $10.9 million and $79.6 million
for the three- and nine-month periods ended September 30, 2004, respectively,
over the comparable periods in 2003. These decreases resulted from the sale of
our membership club and warranty business in July 2003. Remaining Enhancement
services income is primarily commission revenue that Direct Merchants Bank
earns on membership club and warranty products sold to the Banks credit card
portfolio under a marketing agreement with the third-party purchaser and income
generated from certain products not sold to that purchaser. Total expenses were $109.3 million for the three-month period ended
September 30, 2004, which represents a $142.9 million decrease over the
comparable period in 2003. During the third quarter of 2004 there were $1.2
million in one-time charges compared to expenses of $62.9 million related to
the sale of our deposits and other one-time charges during the third quarter of
2003. Provision for loan losses was $1.4 million and $33.0 million for the
three months ended September 30, 2004 and 2003, respectively. This decrease is
due primarily to the reduction in owned credit card loans and slightly improved
credit quality. Interest expense, Credit card account and other product
solicitation and marketing expenses, Employee compensation, Data processing
services and communications, Credit protection claims expense, Occupancy
and equipment, Purchased portfolio premium amortization, and Other also
decreased an aggregate of $49.6 million as a result of the sale of the
membership club and warranty business and the significant reduction in credit
card operations over the past year. Total expenses for the nine-month period ended September 30, 2004 were
$346.8 million, compared to $686.6 million for the nine months ended September
30, 2003. This $339.8 million decrease is due primarily to a $113.0 million
reduction in the Provision for loan losses, a $48.2 million decrease in
one-time charges, and the $33.0 million loss recognized in the third quarter of
2003 related to the sale of the Companys portfolio of deposits. Interest
expense also decreased $13.7 million as a result of the sale of the Companys
portfolio of deposits in the third quarter of 2003. Credit card account and
other product solicitation and marketing expenses, Employee compensation,
Data processing services and communications, Credit protection claims
expense, Occupancy and equipment, Purchased portfolio premium
amortization, and Other also decreased an aggregate of $131.9 million as a
result of the sale of the membership club and warranty business and the
significant reduction in credit card operations over the past year. Retained Interests in Loans Securitized Our credit card receivables are primarily funded through asset
securitizations. As part of these asset securitizations, credit card
receivables are transferred to the Metris Master Trust, a non-consolidated,
qualifying special purpose entity that issues asset-backed securities
representing undivided interests in receivables held in the Metris Master Trust
and the right to receive future collections of principal, interest and fees
related to those receivables. The senior classes of these securities are sold
to third-party investors. We retain subordinated interests in the securitized
receivables, including contractual retained interests, an interest-only strip
receivable, excess transferors interest maintained above the contractual
retained interests and spread accounts receivable. Upon securitization, the Company removes the applicable credit card loans
from the balance sheet and recognizes the Retained interests in loans
securitized at their allocated carrying value in accordance with SFAS No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities-a replacement of FASB Statement No. 125(SFAS No. 140).
Assets are sold to the Metris Master Trust at the inception of a securitization
series. We also sell receivables to the Metris Master Trust on a daily basis
to replenish receivable balances that have decreased due to payments and
charge-offs. The difference between the allocated carrying value and the
proceeds from the assets sold is recorded as a gain or loss on sale and is
included in Securitization (expense) income. At the same time, the Company
recognizes the Retained interests in loans securitized. 30




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The Retained interests in loans securitized are financial assets
measured at fair value consistent with trading securities in accordance with
SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities,and include the contractual retained interests, an interest-only
strip receivable, excess transferors interests and spread accounts receivable.
The contractual retained interests consist of non-interest bearing securities
held by the Company. The interest-only strip receivable represents the present value
of the excess of the estimated future interest and fee collections expected to
be generated by the securitized loans over the period the securitized loans are
projected to be outstanding above the interest paid on investor certificates,
credit losses, contractual servicing fees, and other expenses. The excess
transferors interests represent principal receivables held in the Metris
Master Trust over the contractual retained interests. Spread accounts
receivable represents restricted cash reserve accounts held by the Metris
Master Trust that can be used to fund payments due to securitization investors
and credit enhancers if cash flows are insufficient. Cash held in spread
accounts is released to us if certain conditions are met or a securitization
series terminates with amounts remaining in the spread accounts. The fair value
of the Retained interests in loans securitized is determined through
estimated cash flows discounted at rates that reflect the level of
subordination, the projected repayment term, and the credit risk of the
securitized loans. The following table summarizes our Retained interests in loans
securitized as of September 30, 2004 and December 31, 2003. Table 2: Retained interests in loans securitized September 30,
    
    December 31,(In thousands):
    
    2004
    
    2003Contractual retained interests
    
    $
    493,574
    
    
    $
    542,014Excess transferors interests
    
    
    158,307
    
    
    
    48,775Interest-only strip receivable
    
    
    73,075
    
    
    
    16,039Spread accounts receivable
    
    
    114,452
    
    
    
    230,073Retained interests in loans securitized
    
    $
    839,408
    
    
    $
    836,901
 Retained interests in loans securitized increased $2.5 million between
December 31, 2003, and September 30, 2004, to $839.4 million. The increase was
primarily due to a $109.5 million increase in excess transferors interests and
a $57.0 million increase in the interest-only strip receivable, partially
offset by a $115.6 million decrease in spread accounts receivable and a $48.4
million decrease in contractual retained interests. Contractual retained interest decreased to $493.6 million as of September
30, 2004, from $542.0 million as of December 31, 2003. The $48.4 million
decrease is due to a $1.2 billion decrease in principal receivables held in the
Metris Master Trust, partially offset by an increase in the weighted average
enhancement level and a decrease in weighted average months to maturity on the
outstanding series in the Metris Master Trust. The excess transferors
interests increased to $158.3 million as of September 30, 2004, from $48.8
million as of December 31, 2003 due to pay-down of the variable funding
conduits. The interest-only strip receivable increased to $73.1 million as of
September 30, 2004, from $16.0 million as of December 31, 2003 due to higher
projected excess spreads from the receivables held in the Metris Master Trust,
partially offset by lower receivables. The projected excess spreads have
increased primarily due to a decrease in the projected principal default rates,
partially offset by a projected increase in funding costs. Spread accounts
receivable decreased $115.6 million compared to December 31, 2003 due to
reserve releases during the year resulting from improved excess spreads. For
more information on restricted cash see the Liquidity, Funding and Capital
Resources section on pages 37 through 40. 31




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At least quarterly, the Company adjusts the valuation of the Retained
interests in loans securitized to reflect changes in the amount and expected
timing of future cash flows. The significant factors that affect the timing and
amount of cash flows relate to the collateral assumptions, which include
payment rate, default rate, gross yield and discount rate. These values can,
and will, vary as a result of changes in the amount and timing of the cash
flows and the underlying economic assumptions. The components of retained
interests are recorded at their fair value. (See Critical Accounting
Estimates on pages 25-27 for
more information on the valuation of the retained interests). The significant
assumptions used for estimating the fair value of the Retained interests in
loans securitized are as follows: Table 3: Significant assumptions used for estimating the fair value of retained
interests September 30,
    
    December 31,2004
    
    2003Monthly payment rate
    
    
    7.5
    %
    
    
    6.7
    %Gross yield (1)
    
    
    25.5
    %
    
    
    25.4
    %Annual interest expense and servicing fees
    
    
    4.7
    %
    
    
    4.2
    %Annual gross principal default rate
    
    
    18.6
    %
    
    
    20.7
    %Discount rate:Contractual retained interests
    
    
    16.0
    %
    
    
    16.0
    %Excess transferors interests
    
    
    16.0
    %
    
    
    16.0
    %Interest-only strip receivable
    
    
    30.0
    %
    
    
    30.0
    %Spread accounts receivable
    
    
    16.0
    %
    
    
    15.3
    %Weighted average months to maturity
    
    
    20.8
    
    
    
    24.5Weighted average enhancement level(2)
    
    
    11.1
    %
    
    
    9.9
    %
  (1)Includes expected cash flows from finance charges, late and overlimit fees, debt waiver
premiums and bad debt recoveries, net of finance charge and fee charge-offs. Gross yield for
purposes of estimating fair value does not include interchange income, or cash advance fees.(2)Includes contractual retained interest and required minimum spread reserve deposits. During the third quarter of 2004 the Company made the following assumption
changes to the valuation of retained interests:  
    
    The discount associated with the variable conduits has been determined
assuming 19.2 months to maturity, which reflects the remaining life of
the conduit. Previously, the discount was determined assuming
24 months to maturity.
    
    Requisite deposits used to cover interest expense during the
accumulation period associated with the defeasance of maturing term
asset back securities are assumed to have a market value of zero.
Previously, the model estimated the amount of funds that would be
returned to the company, and discounted this amount at 15.25% to
determine the market value.
    
    Interest earned on spread accounts receivable is now calculated as a
monthly cash flow in the valuation of the spread reserve deposits using the current LIBOR yield curve.
Previously, the discount rate applied to the spread reserve deposits
was reduced to account for the interest income earned.
    
    The weighted average months to maturity used to determine the market
value of the contractual retained interest is based on a 365 day
calendar, versus a 360 day calendar in previous models. The impact of these changes in assumptions was a $6.9 million increase in
Securitization income during the third quarter of 2004. Management believes
these changes represent a change in estimate, which is reflected in
current period earnings. 32




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##### Table of Contents



Credit card receivables Our delinquency and net loan charge-off rates at any point in time
reflect, among other factors, the credit risk of loans, the average age of our
various credit card account portfolios, the success of our collection and
recovery efforts, and general economic conditions. The average age of our credit card portfolio affects the stability
of delinquency and loss rates. In order to minimize losses, we continue to
focus our resources on refining our credit underwriting standards for new
accounts, and on enhancing collection strategies. We use credit line analyses, account management, and customer transaction
authorization procedures to minimize loan losses. Our risk models determine
initial credit lines at the time of underwriting. We manage credit lines on an
ongoing basis and adjust them based on customer usage, payment patterns and
profitability. We continually monitor customer accounts and initiate
appropriate collection activities when an account is delinquent or overlimit.
We monitor customer authorization history, complete credit line analysis, and
refine account management strategies to mitigate long-term credit losses. It is our policy to accrue interest and fee income on all credit card
accounts, except in limited circumstances, until we charge-off the account. In
November 2002, we stopped billing late fees once an account became 120 days
contractually delinquent and in March 2003, we stopped billing overlimit fees
once an account became 120 days contractually delinquent. In June and July of
2004 we stopped billing late and overlimit fees on accounts with balances of
130 percent or more of their limit. Past due accounts are re-aged to current
status only after we receive at least three minimum payments or the equivalent
cumulative amount. Accounts can only be re-aged to current status once every
twelve months, and two times every five years. Accounts entering long-term
fixed payment forbearance programs may receive a re-age upon entering the debt
management program (workout re-age). Workout re-ages can only occur after
receipt of at least three consecutive minimum monthly payments, or the
equivalent cumulative amount as defined by the debt management program. In
accordance with FFIEC guidance, workout re-ages can only occur once in five
years. Table 4 presents the delinquency trends of our credit card loan
portfolio. Table 4: Loan Delinquency(Dollars in thousands) September 30,
    
    % of
    
    December 31,
    
    % of
    
    September 30,
    
    % of2004
    
    Total
    
    2003
    
    Total
    
    2003
    
    TotalLoans outstanding
    
    $
    70,389
    
    
    
    100
    %
    
    $
    128,615
    
    
    
    100
    %
    
    $
    110,922
    
    
    
    100
    %Loans contractually
delinquent:30 to 59 days
    
    
    2,445
    
    
    
    3.5
    %
    
    
    5,015
    
    
    
    3.9
    %
    
    
    3,461
    
    
    
    3.1
    %60 to 89 days
    
    
    1,857
    
    
    
    2.6
    %
    
    
    4,888
    
    
    
    3.8
    %
    
    
    3,811
    
    
    
    3.4
    %90 or more days
    
    
    4,487
    
    
    
    6.4
    %
    
    
    10,406
    
    
    
    8.1
    %
    
    
    9,474
    
    
    
    8.6
    %Total
    
    $
    8,789
    
    
    
    12.5
    %
    
    $
    20,309
    
    
    
    15.8
    %
    
    $
    16,746
    
    
    
    15.1
    %
 The decrease in the delinquency rates between December 31, 2003 and
September 30, 2004 primarily reflects the improvement in our collection efforts
and the run-off of poor quality loans within our owned portfolio. The low
delinquency rate as of September 30, 2003 is the result of the sale of $29.1
million in delinquent assets during June 2003. 33




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##### Table of Contents



Net charge-offs are the principal amount of losses from cardholders
unwilling or unable to make minimum payments, bankrupt cardholders, and
deceased cardholders, less current period recoveries. Net charge-offs exclude
accrued finance charges and fees, which are charged-off against the applicable
revenue line item at the time of charge-off. We charge-off and take accounts
as a loss within (i)60 days following formal notification of bankruptcy; (ii)
at the end of the month during which most unsecured accounts become
contractually 180 days past due; (iii) at the end of the month during which unsecured accounts that have entered
into a credit counseling or other similar debt forbearance program later become
contractually 120 days past due; or (iv) at the end of the month during which
secured accounts become contractually 120 days past due after first reducing
the loss by the secured deposit. Beginning in the fourth quarter of 2003, we
changed our policy for recognizing credit losses on accounts that enter into a
settlement payment arrangement. Under the new policy, the portion of the
balance that has been forgiven is charged-off upon entering into the settlement
arrangement with the customer. The previous policy recognized these losses
after the completion of the settlement arrangement. We charge-off accounts
that are identified as fraud losses no later than 90 days after discovery. We enter into agreements with third parties for the sale of a majority of
charged-off credit card receivables. We also refer charged-off accounts to our
recovery unit for coordination of collections efforts to recover the amounts
owed. When appropriate, we place accounts with external collection agencies or
attorneys. Charge-offs due to bankruptcies were $0.6 million, representing
18.7% of total gross charge-offs for the three-month period ended September 30,
2004, and $6.6 million, representing 9.7% of total gross charge-offs for the
three-month period ended September 30, 2003. Charge-offs due to bankruptcies
were $3.7 million, representing 18.7% of total gross charge-offs for the
nine-month period ended September 30, 2004 and $18.9 million, representing
15.5% of total gross charge-offs for the nine-month period ended September 30,
2003. Table 5 presents our net charge-offs for the periods indicated as
reported in the consolidated financial statements. Table 5: Net Charge-offs(Dollars in thousands) Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Average credit card loans
    
    $
    72,581
    
    
    $
    512,710
    
    
    $
    93,363
    
    
    $
    650,887Net charge-offs
    
    
    2,491
    
    
    
    66,995
    
    
    
    17,735
    
    
    
    118,986Net charge-off ratio
    
    
    13.6
    %
    
    
    51.8
    %
    
    
    25.4
    %
    
    
    24.4
    %
 The decrease in the net charge-off ratio for the three months ended
September 30, 2004 compared to the three months ended September 30, 2003, is
primarily related to charge-offs due to the sale of $39.9 million of 2-cycle
plus delinquent assets and the sale of $144.4 million of receivables from
Direct Merchants Bank in September of 2003. The difference between par value
and the amount received on receivables sold is reported as a charge-off in the
period of the sale. Allowance for Loan Losses We record provisions for loan losses in amounts necessary to maintain the
allowance at a level sufficient to absorb anticipated probable loan losses
inherent in the existing loan portfolio as of the balance sheet date. In order to mitigate credit losses, we have expanded our collections
strategies to aggressively address any potential delinquency increases. We
also leverage forbearance programs and credit counseling services for
qualifying cardholders that are experiencing payment difficulties. These
programs include reduced interest rates, reduced or suspended fees, and other
incentives to induce the customer to continue making payments. The amount of
customer receivables in debt forbearance programs was $3.8 million or 5.4% of
total Credit card loans as of September 30, 2004, compared to $6.2 million or
4.8% of total Credit card loans as of December 31, 2003. All delinquent
receivables in debt forbearance programs are included in Table 4. 34




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##### Table of Contents



The Allowance for loan losses was $14.3 million as of September 30,
2004, versus $45.5 million as of December 31, 2003. The ratio of Allowance for
loan losses to period-end Credit card loans was 20.3% at September 30, 2004,
compared to 35.4% at December 31, 2003. The Allowance for loan losses as a
percentage of 30-day plus receivables was 162.6% at September 30, 2004,
compared to 224.0% at December 31, 2003. The decrease reflects slightly
improved credit quality as well as the composition of the portfolio as of
September 30, 2004 versus December 31, 2003. We believe the Allowance for loan losses is adequate to
cover probable future losses inherent in the loan portfolio under current
conditions. Balance Sheet Analysis Cash and Cash Equivalents "Cash and cash equivalents increased $225.0 million to $403.5 million as
of September 30, 2004 compared to $178.5 million as of December 31, 2003. The
increase is primarily due to the release of restricted cash of
$142.0 million from the Metris
Master Trust as well as from net proceeds received from various funding
activities completed during the second quarter of 2004. Credit Card Loans Credit card loans were $70.4 million as of September 30, 2004, compared
to $128.6 million as of December 31, 2003. The $58.2 million decrease is
primarily a result of the sale of approximately $38 million of receivables from
Direct Merchants Bank to a third party and continued attrition of the owned
loan portfolio. Other Assets Other assets decreased from $81.8 million at December 31, 2003 to $62.7
million at September 30, 2004. This decrease resulted primarily from an $8.6
million decrease in the fair value of interest rate caps and a $8.4 million in
amortization of prepaid expenses. Debt Debt increased to $448.4 million at September 30, 2004 from $350.4
million at December 31, 2003. This $98.0 million increase resulted from the
closing of a $300 million term loan, partially offset by the pay-downs of $100
million in senior notes and a $101.7 million term loan in the second quarter of
2004. Accrued expenses and other liabilities Accrued expenses and other liabilities increased from $76.0 million at
December 31, 2003 to $105.2 million at September 30, 2004. This increase
resulted primarily from the receipt of a federal income tax refund during the
second quarter of 2004. Off Balance Sheet Arrangements Our operations are funded primarily through asset securitizations of our
credit card receivables. We rely heavily on this method of funding and any
negative effect on our ability to securitize assets would have a material
impact on our business. We securitize consumer loans in order to manage our
total cost of funds. 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
as sales under accounting principles generally accepted in the United States of
America and are removed from our balance sheet. We primarily securitize
receivables by selling the receivables to the Metris Master Trust, a
proprietary, non-consolidated trust, which issues securities through public and
private asset-backed securitizations or multi-seller commercial paper conduits. 35




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The Metris Master Trust was formed in May 1995 pursuant to a pooling and
servicing agreement, as amended. MRI, one of our special purpose entity
subsidiaries, transfers receivables in designated accounts to the Metris Master
Trust. The Metris Master Trust may, and does from time to time, issue
securities that represent undivided interests in the receivables in the Metris
Master Trust. These securities are issued by series and each series typically has multiple classes. Each series, or class within a series,
may have different terms. The different classes of an individual series are
structured to obtain specific debt ratings. As of September 30, 2004, 10
series of publicly and privately issued term asset-backed securities were
outstanding. MRI currently retains the most subordinated class of securities
in each series and all other classes are issued to nonaffiliated third parties.
These securities are interests in the Metris Master Trust only and are not
obligations of MRI, MCI, Direct Merchants Bank, or any other subsidiary of the
Company. The interest in the Metris Master Trust not represented by any series
of securities issued by the Metris Master Trust also belongs to MRI and is
referred to as the transferors interest. Generally, each series involves an initial reinvestment period, referred to as the revolving period,
in which principal payments on receivables allocated to such series are
returned to MRI and reinvested in new principal receivables arising in the
accounts. After the revolving period ends, if the series has not been
defeased, 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. As of September 30, 2004, the
Metris Master Trust did not have any series in an accumulation period or
controlled amortization period. The scheduled accumulation and amortization
periods are set forth in the agreements governing each series. However, all
series set forth certain events by which amortization can be accelerated,
referred to as early amortization. Reasons an early amortization could occur
include: (i) one or three-month average of portfolio collections, less
principal and finance charge charge-offs, financing costs and servicing costs,
drop below certain levels, (ii) negative transferors interest within the
Metris Master Trust or (iii) failure to obtain funding prior to an accumulation
period for a maturing term asset-backed securitization. New receivables in
designated accounts cannot be funded from a series that is in early
amortization. We currently do not have any series that are in early
amortization. In addition, there are various triggers within our securitization
agreements that, if broken, restrict the release of cash to us from the Metris
Master Trust. This restricted cash provides additional security to the
investors and / or credit enhancers in the Metris Master Trust. We reflect
cash restricted from release in the Metris Master Trust at its fair value as
spread accounts receivable, which is a component of Retained interests in
loans securitized in the consolidated balance sheet. The triggers are usually
related to the performance of the Metris Master Trust, such as the average of
net excess spread over a one to three-month period.
See further discussion of spread accounts receivable in the Liquidity, Funding
and Capital Resources section on page 37. On a monthly basis, each series is allocated its share of finance charge
and fee 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
reserve accounts of the Metris Master Trust as additional protection for future
losses. Once each of these obligations is fully met, remaining finance charge
collections, if any, are returned to us. Principal receivables held by the
Metris Master Trust were $6.3 billion and $7.5 billion as of September 30, 2004
and December 31, 2003, respectively. Revenues and expenses generated from the Metris Master Trust are found in
the Securitization income and Servicing income on securitized receivables
lines in the consolidated statements of income. Our interests retained in
credit card receivables sold to the Metris Master Trust are recorded at fair
value in Retained interests in loans securitized on the consolidated balance
sheets. Maintaining adequate liquidity in the Metris Master Trust is, and will
continue to be, at the forefront of our business objectives. Additional
information regarding asset securitization is set forth under Liquidity,
Funding, and Capital Resources below. 36




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Liquidity, Funding and Capital Resources One of our primary financial goals is to maintain an adequate level of
liquidity through active management of assets and liabilities. Liquidity
management is a dynamic process, affected by changes in the characteristics of
our assets and liabilities and short- and long-term interest rates. We use a
variety of financing sources to manage liquidity, funding and interest rate
risks. Table 6 summarizes our funding and liquidity as of September 30, 2004
and December 31, 2003: Table 6: Liquidity, Funding and Capital Resources September 30, 2004
    
    December 31, 2003(In thousands)
    
    DMCCB
    
    Other
    
    Consolidated
    
    DMCCB
    
    Other
    
    ConsolidatedCash and due from banks
    
    $
    23,649
    
    
    $
    34
    
    
    $
    23,683
    
    
    $
    29,399
    
    
    $
    2,677
    
    
    $
    32,076Federal funds sold
    
    
    49,395
    
    
    
    
    
    
    
    49,395
    
    
    
    25,300
    
    
    
    
    
    
    
    25,300Short-term investments
    
    
    100,086
    
    
    
    230,366
    
    
    
    330,452
    
    
    
    71,829
    
    
    
    49,280
    
    
    
    121,109Total cash and cash
equivalents
    
    $
    173,130
    
    
    $
    230,400
    
    
    $
    403,530
    
    
    $
    126,528
    
    
    $
    51,957
    
    
    $
    178,485
 September 30, 2004
    
    December 31, 2003Unused
    
    UnusedOutstanding
    
    Capacity
    
    Outstanding
    
    CapacityOn-balance sheet funding(In thousands)Term loan  June 2004
    
    
    
    
    
    
    N/A
    
    
    
    101,679
    
    
    
    N/A10% Senior Notes  November 2004
    
    
    
    
    
    
    N/A
    
    
    
    100,000
    
    
    
    N/A10.125% senior notes 
July 2006
    
    
    148,398
    
    
    
    N/A
    
    
    
    147,724
    
    
    
    N/ATerm loan  May 2007
    
    
    300,000
    
    
    
    N/A
    
    
    
    
    
    
    
    N/AOther
    
    
    
    
    
    
    N/A
    
    
    
    1,045
    
    
    
    N/ADeposits
    
    
    3,735
    
    
    
    N/A
    
    
    
    6,262
    
    
    
    N/ASubtotal
    
    $
    452,133
    
    
    $
    N/A
    
    
    $
    356,710
    
    
    
    N/AOff-balance sheet funding(In thousands)Master Trust:Term asset-backed
securitizations 
various maturities through January 2009
    
    
    4,950,000
    
    
    
    
    
    
    
    6,400,000
    
    
    
    Bank conduits  maturing
May 2006
    
    
    530,000
    
    
    
    670,000
    
    
    
    196,000
    
    
    
    654,000Amortizing term series 
matured in February 2004
    
    
    
    
    
    
    
    
    
    
    99,200
    
    
    
    Subtotal
    
    
    5,480,000
    
    
    
    670,000
    
    
    
    6,695,200
    
    
    
    654,000Total
    
    $
    5,932,133
    
    
    $
    670,000
    
    
    $
    7,051,910
    
    
    $
    654,000
 37




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##### Table of Contents



As of September 30, 2004 and December 31, 2003, we had $5.5 million and
$5.9 million, respectively, in letters of credit issued under a letter of
credit facility agreement. Metris obligations under such facility are cash
collateralized. Subject to certain exceptions, the $300 million Senior Secured
Credit Agreement (Credit Agreement) requires the Company to prepay portions
of the loan from net proceeds received from the issuance, in whatever form, of
debt or equity by the Company or any of its affiliates, any insurance
settlement or litigation award, and from any sale of assets (other than
excluded asset sales) by the Company in excess of $10,000,000 in any fiscal year. During the third quarter of 2004 we were
not required to make any principal repayments. We are bound by certain
covenants under the Credit Agreement. As of September 30, 2004, we were in
compliance with all covenants under the Credit Agreement. Furthermore, the
Company has pledged substantially all of its assets as collateral under the
Credit Agreement other than the assets of the Bank and Metris Receivables, Inc. As of September 30, 2004 our contractual cash obligations for the next
twelve months are as follows: Operating leases
    
    $
    8,581Deposits
    
    
    3,735Contractual purchase obligations
    
    
    64,234Total
    
    $
    76,550
 In addition to the contractual cash obligations, as of September 30, 2004
open-to-buy on credit card accounts was $6.9 billion. We have the following term asset-backed securitizations outstanding as of
September 30, 2004. AmountAsset-backed securitization
    
    (in thousands)
    
    Expected final payment date(s)Series 00-1
    
    $
    600,000
    
    
    February 22, 2005 and March 21, 2005Series 02-3
    
    
    900,000
    
    
    May 20, 2005Series 01-2
    
    
    750,000
    
    
    May 22, 2005 and June 20, 2005Series 00-3
    
    
    500,000
    
    
    October 20, 2005 and November 21, 2005Series 99-3
    
    
    300,000
    
    
    November 21, 2005Series 99-2
    
    
    500,000
    
    
    July 20, 2006Series 04-1
    
    
    200,000
    
    
    April 20, 2007Series 02-4
    
    
    600,000
    
    
    May 21, 2007Series 02-1
    
    
    300,000
    
    
    January 20, 2009 and February 20, 2009Series 02-2
    
    
    300,000
    
    
    January 20, 2009 and February 20, 2009Total
    
    $
    4,950,000
 Our term asset-backed securitizations require the accumulation of
principal cash payments received by the Metris Master Trust to fund the
repayment of these obligations at the time of maturity. Historically, the
Company achieved this by either obtaining a paired-series funding vehicle or
defeasing the maturing bonds with draw downs on existing conduit facilities or
other funding vehicles prior to the start of the accumulation period. Our receivable funding needs for the remainder of 2004 and 2005 will be
covered by portfolio attrition and future asset-backed securitizations. We have
a $1.5 billion MBIA commitment to provide insurance coverage on future
asset-backed security transactions, of which $300 million is currently
available. The remaining $1.2 billion of commitment becomes available as MBIA
insured term asset-backed securitizations mature in 2005. 38




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##### Table of Contents



The Metris Master Trust and the associated off-balance sheet debt provide
for early amortization if certain events occur. The significant events include
(i) one-month and three-month average excess spreads below certain levels, (ii)
negative transferors interest within the Metris Master Trust or (iii) failure
to obtain funding prior to an accumulation period for a maturing term
asset-backed securitization. In addition, there are various triggers within our
securitization agreements that, if broken, would restrict the release of cash
to us from the Metris Master Trust. The triggers are related to the
performance of the Metris Master Trust, generally the average of net excess
spread over a one- to three-month period. This restricted cash provides additional security to the investors and credit enhancers in the
Metris Master Trust. We reflect cash restricted from release in the Metris
Master Trust, at fair value, in Retained interests in loans securitized in
the consolidated balance sheet. The following table shows the weighted-average annualized yields,
defaults, costs and excess spreads for the Metris Master Trust on a cash basis: Three Months Ended September 30,(In thousands)
    
    2004
    
    2003Gross yield (1)
    
    $
    430,380
    
    
    
    26.49
    %
    
    $
    577,801
    
    
    
    26.38
    %Annual principal defaults
    
    
    272,706
    
    
    
    16.79
    %
    
    
    438,779
    
    
    
    20.03
    %Net portfolio yield
    
    
    157,674
    
    
    
    9.70
    
    
    
    139,022
    
    
    
    6.35
    %Annual interest expense and
servicing fees
    
    
    65,060
    
    
    
    4.12
    %
    
    
    76,252
    
    
    
    3.65
    %Net excess spread
    
    $
    92,614
    
    
    
    5.58
    %
    
    $
    62,770
    
    
    
    2.70
    %
 Nine Months Ended September 30,(In thousands)
    
    2004
    
    2003Gross yield (1)
    
    $
    1,380,746
    
    
    
    26.92
    %
    
    $
    1,844,344
    
    
    
    26.99
    %Annual principal defaults
    
    
    947,292
    
    
    
    18.47
    %
    
    
    1,424,371
    
    
    
    20.84
    %Net portfolio yield
    
    
    433,454
    
    
    
    8.45
    %
    
    
    419,973
    
    
    
    6.15
    %Annual interest expense and
servicing fees
    
    
    187,461
    
    
    
    3.81
    %
    
    
    247,996
    
    
    
    3.82
    %Net excess spread
    
    $
    245,993
    
    
    
    4.64
    %
    
    $
    171,977
    
    
    
    2.33
    %
 1) Includes cash flows from finance charges, late, overlimit and cash
advance fees, bad debt recoveries, interchange income and debt waiver
fees, less finance charge and fee charge-offs. The following table shows the principal receivables and delinquent
principal receivables in the Metris Master Trust: September 30,
    
    December 31,
    
    September 30,(Dollars in thousands)
    
    2004
    
    2003
    
    2003Principal receivables
    
    $
    6,304,711
    
    
    $
    7,489,568
    
    
    $
    8,297,5432-cycle plus delinquent
principal receivables
    
    
    514,011
    
    
    
    698,574
    
    
    
    767,224Principal delinquency ratio
    
    
    8.2
    %
    
    
    9.3
    %
    
    
    9.3
    %
 39




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##### Table of Contents



The cash restricted from release to us is limited to the amount of excess
spread generated in the Metris Master Trust on a cash basis. During periods of
lower excess spreads, the required amount of excess spread to be restricted in
the Metris Master Trust may not be achieved. During those periods, all excess
spread normally released to MRI will be restricted from release. Once the
maximum required amount of cash is restricted from release or excess spreads
improve, cash can again be released from the spread accounts. Based on the
performance of our Metris Master Trust, the amount of cash required to be
restricted was $152 million at September 30, 2004 and $294 million at December
31, 2003. As of September 30, 2004, $94.4 million had been restricted from
release in the Metris Master Trust due to performance, $13.2 million had been
restricted from release due to corporate debt ratings, and $44.7 million was restricted
from release for non-performance based reserves. As of December 31, 2003, $255.4 million had
been restricted from release in the Metris Master Trust due to performance,
$21.4 million had been restricted from release due to corporate debt ratings,
and $16.9 million was restricted from release for non-performance based reserves. In
addition, $12.2 million was restricted from release for defeasance of series
2001-1. The $161.0 million decrease in cash restricted from release due to
performance is due primarily to the improving excess spreads in the Metris
Master Trust. The $8.2 million decrease in cash restricted for corporate debt
ratings resulted from the defeasance of series 1999-1 during the first quarter
of 2004. On October 20, 2004 approximately $60.0 million in cash previously
restricted was released to us as a result of improved performance in the Metris
Master Trust. The Companys 1998 through 2002 federal income tax returns are under
examination by the Internal Revenue Service (IRS). Both the Company and the
IRS have proposed adjustments involving the tax treatment of certain credit
card fees as original issue discount (OID). These fees include late,
overlimit, interchange, cash advance and annual fees. Although these fees are
primarily reported as income when billed for financial reporting purposes, we
believe the fees create OID that should be deferred and amortized over the
remaining life of the underlying credit card loans for tax purposes. As of
September 30, 2004 and December 31, 2003, the Company had deferred cumulative
federal income tax related to this issue of approximately $139 million and $179
million, respectively. The decrease is primarily attributable to the decrease
in managed receivables. Our treatment of these fees is consistent with that of
many other United States credit card issuers. Furthermore, we believe our
treatment of these fees is appropriate based on relevant technical authority
and specific guidance issued by the IRS regarding late fees. However, the
timing and amount of any final resolution remain uncertain. We continue to
work with the IRS to resolve this matter and do not expect to pay any
incremental tax related to this issue in the next twelve months nor do we
expect the resolution of this matter to have a material adverse effect on
future earnings. Our senior unsecured debt is rated by Moodys Investor Services
(Moodys), Standard & Poors Rating Services (S&P) and Fitch, Inc.
(Fitch). Factors affecting the various ratings include the overall health of
the global/national economy, specific economic conditions impacting the
subprime consumer finance industry, and the overall financial performance of
the Company, including earnings, credit losses, delinquencies, excess spreads
in the Metris Master Trust, and our overall liquidity. Certain of our term
asset-backed securitizations allow for the release of restricted cash if our
corporate debt ratings go above certain levels. The table below illustrates
the current debt ratings of MCI: StandardMoody's
    
    & Poor's
    
    FitchMetris Companies Inc.Senior unsecured debt:Rating
    
    Caa2
    
    CCC
    
    
    B-Outlook
    
    Positive
    
    Stable
    
    Stable
 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. 40




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##### Table of Contents



The Federal Reserve Act imposes various legal limitations on the extent to
which banks can finance or otherwise supply funds to their affiliates. In
particular, Direct Merchants Bank is subject to certain restrictions on any
extensions of credit to, or other covered transactions, such as certain
purchases of assets, with MCI and its affiliates. Such restrictions limit
Direct Merchants Banks ability to lend to MCI and its affiliates.
Additionally, Direct Merchants Bank is limited in its ability to declare
dividends to MCI in accordance with the national bank dividend provisions. Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the OCC. At September 30, 2004 and December 31, 2003, 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, 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. Additional information about Direct Merchants Banks actual capital
amounts and ratios are presented in the following table: To BeAdequately
    
    To Be WellActual
    
    Capitalized
    
    CapitalizedAs of September 30, 2004
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    RatioTotal Capital
(to risk-weighted assets)
    
    $
    249,776
    
    
    
    140.3
    %
    
    $
    14,245
    
    
    
    8.0
    %
    
    $
    17,806
    
    
    
    10.0
    %Tier 1 Capital
(to risk-weighted assets)
    
    
    247,418
    
    
    
    139.0
    %
    
    
    7,122
    
    
    
    4.0
    %
    
    
    10,684
    
    
    
    6.0
    %Tier 1 Capital
(to average assets)
    
    
    247,418
    
    
    
    69.8
    %
    
    
    14,175
    
    
    
    4.0
    %
    
    
    17,719
    
    
    
    5.0
    %
 To BeAdequately
    
    To Be WellActual
    
    Capitalized
    
    CapitalizedAs of December 31, 2003
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    RatioTotal Capital
(to risk-weighted assets)
    
    $
    240,868
    
    
    
    140.0
    %
    
    $
    13,760
    
    
    
    8.0
    %
    
    $
    17,200
    
    
    
    10.0
    %Tier 1 Capital
(to risk-weighted assets)
    
    
    238,328
    
    
    
    138.6
    %
    
    
    6,880
    
    
    
    4.0
    %
    
    
    10,320
    
    
    
    6.0
    %Tier 1 Capital
(to average assets)
    
    
    238,328
    
    
    
    70.2
    %
    
    
    13,589
    
    
    
    4.0
    %
    
    
    16,987
    
    
    
    5.0
    %
 41




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##### Table of Contents



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. Direct Merchants Bank and MCI have entered into a Capital Assurance and
Liquidity Maintenance Agreement (CALMA) that requires MCI to make such
capital infusions or provide the Bank with financial assistance so as to permit
the Bank to meet its liquidity requirements. Direct Merchants Bank has also entered into a Liquidity Reserve Deposit
Agreement under which the Bank has established restricted deposits with
third-party depository banks for the purpose of supporting Direct Merchants Banks funding needs. These deposits
are invested in short-term liquid investments and are classified on the
consolidated balance sheets as the Liquidity reserve deposit. As of
September 30, 2004, the balance of the liquidity reserve deposit was $79.7
million. Finally, the Companys Modified Operating Agreement with the OCC requires,
among other things, that:  
    
    The Bank must maintain minimum capital at the dollar amount
reported on its September 30, 2003 Call Report ($213 million), unless
otherwise approved by the OCC. The Bank may continue to pay
dividends in accordance with applicable statutory and regulatory
requirements provided capital remains at the required level.
    
    The Bank must maintain liquid assets at the greater of $35 million or 100% of the average highest daily funding
requirement for managed receivables ($32.9 million at September
30, 2004).
    
    The Bank must comply with the terms of the Liquidity Reserve
Deposit Agreement and the CALMA.
    
    MCI must comply with the terms of the CALMA. The
Company believes it is currently in compliance with all of the terms of the
Modified Operating Agreement. If the OCC were to conclude that the Bank failed
to adhere to any provisions of the Modified Operating Agreement, the OCC could
pursue various enforcement options. If any of these options were to be pursued
by the OCC, it could have a material adverse effect on our operations or
capital position. Selected Operating Data  Managed Basis In addition to analyzing the Companys performance on an owned basis, we
analyze the Companys financial performance on a managed loan portfolio basis.
On a managed basis, the balance sheets and income statements include other
investors interests in securitized loans that are not assets of the Company,
thereby reversing the effects of sale accounting under SFAS No. 140. We
believe this information is meaningful to the reader of the financial
statements. We service the receivables that have been securitized and sold and
own the right to the cash flows from those receivables sold in excess of
amounts owed to security holders. The following information is not in conformity with accounting principles
generally accepted in the United States of America; however, we believe the
information is relevant to understanding the overall financial condition and
results of operations of the Company. 42




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##### Table of Contents



Table 7: Managed Loan Portfolio
(Dollars and accounts in thousands) Three Months EndedSeptember 30,
    
    December 31,
    
    September 30,2004
    
    2003
    
    2003Account originations:
    
    

118
    
    



76
    
    



117
 September 30,
    
    December 31,
    
    September 30,2004
    
    2003
    
    2003Period-end gross active accounts:Credit card loans
    
    
    60
    
    
    
    93
    
    
    
    111Receivables held by the Metris
Master Trust
    
    
    2,117
    
    
    
    2,389
    
    
    
    2,611Managed
    
    
    2,177
    
    
    
    2,482
    
    
    
    2,722Period-end balances:Credit card loans
    
    $
    70,389
    
    
    $
    128,615
    
    
    $
    110,922Receivables held in the
Metris Master Trust
    
    
    6,711,075
    
    
    
    8,003,216
    
    
    
    8,870,955Managed
    
    $
    6,781,464
    
    
    $
    8,131,831
    
    
    $
    8,981,877
 September 30,
    
    % of
    
    December 31,
    
    % of
    
    September 30,
    
    % of2004
    
    Total
    
    2003
    
    Total
    
    2003
    
    TotalLoans contractually delinquent:Credit card loans
    
    
    8,789
    
    
    
    12.5
    %
    
    
    20,309
    
    
    
    15.8
    %
    
    
    16,746
    
    
    
    15.1
    %Receivables held in the
Metris Master Trust
    
    
    648,418
    
    
    
    9.7
    %
    
    
    881,766
    
    
    
    11.0
    %
    
    
    980,930
    
    
    
    11.1
    %Managed
    
    $
    657,207
    
    
    
    9.7
    %
    
    $
    902,075
    
    
    
    11.1
    %
    
    $
    997,676
    
    
    
    11.1
    %
 Three Months Ended
    
    
    
    
    
    Nine Months EndedSeptember 30,
    
    
    
    
    
    September 30,2004
    
    
    
    
    
    2003
    
    
    
    
    
    2004
    
    
    
    
    
    2003Average balances:Credit card loans
    
    $
    72,581
    
    
    
    
    
    
    $
    512,710
    
    
    
    
    
    
    $
    93,363
    
    
    
    
    
    
    $
    650,887Receivables held in
the Metris Master
Trust
    
    
    6,892,481
    
    
    
    
    
    
    
    9,417,277
    
    
    
    
    
    
    
    7,311,173
    
    
    
    
    
    
    
    9,903,679Managed
    
    $
    6,965,062
    
    
    
    
    
    
    $
    9,929,987
    
    
    
    
    
    
    $
    7,404,536
    
    
    
    
    
    
    $
    10,554,566Net charge-offs:Credit card loans
    
    $
    2,490
    
    
    
    13.6
    %
    
    $
    66,995
    
    
    
    51.8
    %
    
    $
    17,735
    
    
    
    25.4
    %
    
    $
    118,986
    
    
    
    24.4
    %Receivables held in
the Metris Master
Trust
    
    
    253,782
    
    
    
    14.6
    %
    
    
    505,856
    
    
    
    21.3
    %
    
    
    888,952
    
    
    
    16.3
    %
    
    
    1,447,256
    
    
    
    19.5
    %Managed
    
    $
    256,272
    
    
    
    14.6
    %
    
    $
    572,851
    
    
    
    22.9
    %
    
    $
    906,687
    
    
    
    16.4
    %
    
    $
    1,566,242
    
    
    
    19.8
    %
 The decrease in the managed delinquency rates as of September 30, 2004
compared to December 31, 2003 and September 30, 2003 reflects various factors,
including improved credit quality in the Metris Master Trust, improved
collection initiatives and improvements in the macro economy. Total managed loans decreased $1.3 billion to $6.8 billion as of September
30, 2004, compared to $8.1 billion as of December 31, 2003. This was primarily
due to a reduction in credit lines, tighter underwriting standards and a
decrease in gross active accounts. The ending balance per managed gross active
account was $3,115 as of September 30, 2004 compared to $3,276 at December 31,
2003 and $3,300 at September 30, 2003. The amount of credit card receivables
in debt forbearance programs was $596.7 million or 8.8% of total managed loans
as of September 30, 2004, compared with $695.4 million or 8.6% of managed loans
as of December 31, 2003. All delinquent receivables in debt forbearance
programs are included in Table 7. 43




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##### Table of Contents



The managed net charge-off ratios were 14.6% and 16.4% for the three- and
nine-month periods ended September 30, 2004. This represents improvements of
830 and 340 basis points, respectively over the comparable periods in 2003.
These improvements resulted primarily from the improved credit quality in the
Metris Master Trust. The higher charge-off ratio in 2003 also resulted from
losses associated with asset sales in the third and fourth quarters of 2003. We charge-off bankrupt accounts 60 days following formal notification.
Charge-offs due to bankruptcies were $94.4 million, representing 26.0% of total
managed gross charge-offs for the three months ended September 30, 2004 and
$171.9 million, representing 28.6% of total managed gross charge-offs for the
three months ended September 30, 2003. Charge-offs due to bankruptcies were
$310.0 million, representing 24.3% of total managed gross charge-offs for the
nine months ended September 30, 2004 and $539.1 million, representing 32.7% of
total managed gross charge-offs for the nine months ended September 30, 2003.
In addition to those bankrupt accounts that were charged-off, we had received
formal notification of $49.7 million and $80.3 million of managed bankrupt
accounts that had not been charged-off as of September 30, 2004 and 2003,
respectively. Table 8: Equity Ratios September 30,
    
    December 31,
    
    September 30,(Dollars in thousands)
    
    2004
    
    2003
    
    2003Equity to managed assets:Total equity
    
    
    945,657
    
    
    
    909,193
    
    
    
    874,983Total managed assets
    
    
    7,042,176
    
    
    
    8,098,524
    
    
    
    8,793,233Ratio of equity to managed
assets
    
    
    13.4
    %
    
    
    11.2
    %
    
    
    10.0
    %Common shareholder book value:Common shareholder equity
    
    $
    442,435
    
    
    $
    438,465
    
    
    $
    414,613Common shares outstanding
    
    
    58,044
    
    
    
    57,807
    
    
    
    57,856Common shareholder book value
    
    $
    7.62
    
    
    $
    7.58
    
    
    $
    7.17Total shareholders equity
    
    $
    945,657
    
    
    $
    909,193
    
    
    $
    874,983Preferred securities on a
converted basis
    
    
    45,054
    
    
    
    42,616
    
    
    
    42,616Diluted shares outstanding
    
    
    103,098
    
    
    
    100,423
    
    
    
    100,472Total book value
    
    $
    9.17
    
    
    $
    9.05
    
    
    $
    8.71
 Forward-Looking Statements This Quarterly Report on Form 10-Q contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which are subject to the safe harbor created by those sections.
Forward-looking statements include, without limitation: expressions of the
belief, anticipation, intent, or expectations of management; statements
and information as to our strategies and objectives; return on equity; changes
in our managed loan portfolio; net interest margins; funding costs; liquidity;
cash flow; operating costs and marketing expenses; delinquencies and
charge-offs and industry comparisons or projections; statements as to industry
trends or future results of operations of the Company and its subsidiaries; and
other statements that are not historical fact. Forward-looking statements may
be identified by the use of terminology such as may, will, believes,
does not believe, no reason to believe, expects, plans, intends,
estimates, anticipated, or anticipates and similar expressions, as they
relate to the Company or our management. Forward-looking statements are based
on certain assumptions by management and are subject to risks and uncertainties
that could cause actual results to differ materially from those in the
forward-looking statements. 44




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##### Table of Contents



These risks and uncertainties include, but are not limited to, our high
liquidity requirement and our need to enter into financing transactions on a
regular basis; the risk of reduced funding availability and increased funding
costs; the higher delinquency and charge-off rates of our targeted
middle-market consumers as compared to higher income consumers; the risk that
certain events could result in early amortization (required repayment) of the
securities issued by the Metris Master Trust; the risk that the recent
improvement in our delinquency and charge-off rates may not continue; the risk
that Direct Merchants Banks regulators could impose additional restrictions
that could negatively impact our operations or financial condition, including
further restrictions or limitations relating to Direct Merchants Banks minimum
capital and credit loss reserves requirements and its ability to pay
distributions to us; risks associated with Direct Merchants Banks ability to
operate in accordance with its regulatory restrictions, including those in its
Modified Operating Agreement with the OCC; the risk that we could be required
to provide support to Direct Merchants Bank; risks associated with fluctuations
in the value of and income earned from our retained interests in
securitizations; interest rate risk, including the risk of adverse changes in
the interest rates on the funds we borrow and the amounts we loan to our credit
card customers; risks associated with the intense competition we face; the
effect of laws and regulations that apply to us, or adverse changes in those
laws or regulations, including, among others, laws and regulations that limit
the fees and charges that we are allowed to impose, regulate our practices for
collection and sharing of non-public customer information, govern the sale and
terms of products and services we offer and require that we obtain and maintain
licenses and qualifications; the risk that we may be adversely affected by
litigation involving us, by our ongoing SEC and OCC investigations or by the
Internal Revenue Services examination of our treatment of certain credit card
fees as original issue discount; the effects of our previous restatements of
our financial results; the impact of recent decisions in the antitrust
litigation involving MasterCard and Visa and other industry-wide risks
including, among others, the risk of fraud by cardholders and third parties and
the risk of decreased consumer acceptance of credit card products; and general
economic conditions that can have a negative impact on the performance of
credit card loans and the marketing of our credit protection, insurance and
other products. These risks are discussed in our Annual Report on Form 10-K/A for the year
ended December 31, 2003 in Item 1 of such report under the heading Risk
Factors. Certain of these and other risks and uncertainties also are
discussed herein in Legal Proceedings on page 46, Managements Discussion
and Analysis of Financial Condition and Results of Operations
on pages 24-45
hereof, and Quantitative and Qualitative Disclosures About Market Risk on
page 45 hereof. Other factors may in the future prove to be important in
causing actual results to differ materially from those contained in any
forward-looking statement. Readers are cautioned not to place undue reliance
on any forward-looking statement, which speaks only as of the date thereof. We
undertake no obligation to update any forward-looking statements, whether as a
result of new information, future events or otherwise. 
 ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the risk of loss from adverse changes in market prices and
rates. Our principal market risk is due to changes in interest rates. This
affects us directly in our lending and borrowing activities, as well as
indirectly, as interest rates may impact the payment performance of our
cardholders. To manage our direct risk to market interest rates, management actively
monitors the interest rates and the interest sensitive components of our
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 re-pricings. 45




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##### Table of Contents



Our primary assets are Credit card loans, and Retained interests in
loans securitized. Our receivables and receivables held by the Metris Master
Trust 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,
bank loans, long-term debt and equity issuances. Our securitized loans are
held by the Metris Master Trust and bank-sponsored multi-seller commercial
paper conduits and investors in term series securities within the Metris Master
Trust, which have committed funding primarily indexed to variable commercial
paper rates and LIBOR. The long-term debt includes $148.4 million at a fixed
interest rate and $300 million indexed to LIBOR. At September 30, 2004 and
2003, none of the securities issued out of the Metris Master Trust and conduit
funding of securitized receivables were funded with fixed rate securities. In an interest rate environment with rates significantly above current
rates, the potential negative impact on earnings of higher interest expense is
partially mitigated by fixed rate funding and interest rate cap contracts. The approach we use to quantify interest rate risk is a sensitivity
analysis, which we believe best reflects the risk inherent in our business.
This approach calculates the impact on net income from an instantaneous and
sustained change in interest rates of 200 basis points. In this analysis,
interest rates on our floating rate debt are not allowed to decrease below zero
percent. Assuming that we take no counteractive measures, as of September 30,
2004, a 200-basis-point increase in interest rates affecting our floating rate
financial instruments, including both debt obligations and receivables issued
or owned by us or the Metris Master Trust, would result in a decrease in
Income (loss) before income taxes of approximately $18.2 million relative to
a no interest-rate increase base case over the next 12 months, compared to an
approximate $14.6 million decrease as of September 30, 2003. A decrease of 200
basis points would result in an increase in Income (loss) before income taxes
of approximately $58.9 million as of September 30, 2004, compared to an
increase of $28.5 million as of September 30, 2003. The change in sensitivity for the 200 basis point increase is primarily
due to a smaller receivable base offset by a higher percentage of receivables
impacted by a rate increase. The change in sensitivity for the 200 basis point
decrease is due to a larger decrease from interest expense as well as replacing
$225 million of long-term fixed rate debt with $300 million of long-term debt indexed to
LIBOR. As LIBOR rates have increased, the impact on interest expense from
falling rates has increased since interest expense can fall further before
reaching zero percent. 
 ITEM 4 CONTROLS AND PROCEDURES Under the supervision and with the participation of the Companys
management, including the Chairman and Chief Executive Officer (CEO) and the
Chief Financial Officer (CFO), we evaluated the effectiveness of the design
and operation of the Companys disclosure controls and procedures (as defined
in Rule 13a-15(e) or 15d-15(e) under the Exchange Act). Based on that
evaluation, the Companys management, including the CEO and CFO, have concluded
that, as of September 30, 2004, our disclosure controls and procedures were
effective in ensuring that information required to be disclosed in the reports
we file under the Securities Exchange Act of 1934, as amended (Exchange Act)
is recorded, processed, summarized, and reported within the time periods
specified in SEC rules and forms. During the quarter ended September 30, 2004,
there were no changes in our internal controls over financial reporting (as
defined in Rule 13a-15(f) or 15d-15(f) under the Exchange Act) that have
materially affected, or are reasonably likely to materially affect, our
internal controls over financial reporting. 
 Part II. Other Information 
 Item 1. Legal Proceedings Reference is made to Part I, Item 3 of the Companys Annual Report on Form
10-K/A for the fiscal year ended December 31, 2003, which summarizes two
pending lawsuits involving the Company and certain of its officers and
directors, and Part I, Item 1 Regulatory
Investigations, which summarizes a pending OCC investigation. 46




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##### Table of Contents



On August 5, 2003, we received notification from the SEC that we are the
subject of a formal, nonpublic investigation. We believe that this
investigation initially related primarily to our treatment of the Allowance for loan losses
in 2001 and subsequent years, our 2001 credit line increase program and other
related matters. On December 9, 2003, we received notification that the scope
of the investigation was expanded to include matters related to our valuation of
Retained interests in loans securitized. The Company subsequently has
received additional SEC subpoenas and requests for information on related and other
financial accounting issues, as well as the above matters. The SEC has advised
us that this is a fact-finding inquiry and that it has not reached any
conclusions related to this matter. We are responding fully to the SEC in its
investigation. The SEC has informed us that it is reviewing the information and
documents that we have submitted. We anticipate that we will provide additional
information and documents to the SEC in the future. The SEC also has
interviewed
certain of our current and former executive officers and our directors in connection with its
investigation. At this time, we cannot predict how long the SEC investigation
will last or what the results of the investigation will be. If the SEC
determines that we or our officers and directors have violated federal
securities laws or the SECs rules and regulations, we could be subject to SEC
enforcement action, including potential fines and penalties, which could
materially adversely affect our results of operations or financial condition.
We cannot assure you the resolution of the SEC investigation will not necessitate
further amendments or restatements to our previously filed reports. We do not
believe, however, that we or our officers or directors have violated any such
laws, rules or regulations. The Company currently is not otherwise subject to any pending litigation
other than routine litigation arising in the ordinary course of business.
Although the ultimate outcome of these matters cannot be predicted, we believe,
based on information currently available, that the resolution of those legal
matters will not result in any material adverse effect on our results of
operations, financial condition or ability to operate our business. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None 
 Item 3. Defaults Upon Senior Securities None 
 Item 4. Submission of Matters to a Vote of Security Holders  (a)
    
    The Company held its annual meeting of stockholders on September 15, 2004 and the following matters were voted on at that meeting.(b)
    
    The directors listed below were elected at that meeting. 47




---



##### Table of Contents



(1)
    
    The holders of our Common Stock elected seven directors for a one-year term: Leo R. Breitman
    
    Edward B. SpenoJohn A. Cleary
    
    Frank D. TrestmanJerome J. Jenko
    
    David D. WesselinkDonald J. Sanders
  (2)
    
    The holders of our Series C Preferred Stock elected four directors for a one-year term: C. Hunter Boll
    
    David V. HarkinsThomas M. Hagerty
    
    Thomas H. Lee
  (c)
    
    Matters Voted Upon:  (1)
    
    The election of the following directors who will serve until their
successors are elected and qualified, or their earlier death or
resignation: Broker Non-Director
    
    For
    
    Against
    
    Withheld
    
    Abstentions
    
    VoteLeo R. Breitman
    
    
    48,903,757
    
    
    None
    
    
    4,478,031
    
    
    None
    
    NoneJohn A. Cleary
    
    
    48,209,062
    
    
    None
    
    
    5,172,725
    
    
    None
    
    NoneJerome J. Jenko
    
    
    48,898,516
    
    
    None
    
    
    4,483,271
    
    
    None
    
    NoneDonald J. Sanders
    
    
    48,904,879
    
    
    None
    
    
    4,476,908
    
    
    None
    
    NoneEdward B. Speno
    
    
    48,200,773
    
    
    None
    
    
    5,181,015
    
    
    None
    
    NoneFrank D. Trestman
    
    
    48,899,822
    
    
    None
    
    
    4,481,965
    
    
    None
    
    NoneDavid D. Wesselink
    
    
    48,914,805
    
    
    None
    
    
    4,466,982
    
    
    None
    
    NoneC. Hunter Boll
    
    
    43,756,847
    
    
    None
    
    None
    
    None
    
    NoneThomas M. Hagerty
    
    
    43,756,847
    
    
    None
    
    None
    
    None
    
    NoneDavid V. Harkins
    
    
    43,756,847
    
    
    None
    
    None
    
    None
    
    NoneThomas H. Lee
    
    
    43,756,847
    
    
    None
    
    None
    
    None
    
    None
  (2)
    
    The approval of the Metris Companies Inc. Annual Incentive Bonus
Plan for Designated Corporate Officers: Broker Non-For
    
    Against
    
    Withheld
    
    Abstentions
    
    Vote68,932,903
    
    
    5,143,768
    
    
    None
    
    
    1,436,164
    
    
    None
  (3)
    
    Ratification of the selection of KPMG LLP as independent
auditor of the Company for the fiscal year ending December 31, 2004: For
    
    Against
    
    Withheld
    
    Abstentions
    
    Vote96,799,238
    
    
    222,474
    
    
    None
    
    
    116,922
    
    
    None
 
 Item 5. Other Information None 
 Item 6.  Exhibits 31.1
    
    Certification of Principal Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a).31.2
    
    Certification of Principal Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a).32.1
    
    Certification of Principal Executive Officer Pursuant to Section
1350 of Chapter 63 of Title 18 of the United States Code.32.2
    
    Certification of Principal Financial Officer Pursuant to Section
1350 of Chapter 63 of Title 18 of the United States Code.
 48




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##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. METRIS COMPANIES INC.(Registrant)Date:
November 09, 2004
    
    By:
    
    /s/ William A. HoulihanWilliam A. HoulihanExecutive Vice President and Chief Financial Officer(Principal Financial
Officer and Duly AuthorizedOfficer of Registrant)
 49