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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 _______________________ FORM 10-Q (Mark One) x
    
    Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the quarterly period ended March 31, 2004 or o
    
    Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
 For the transition period
from_______to_______
 Commission file number: 001-12351 METRIS COMPANIES INC.  Delaware
    
    41-1849591(State of Incorporation)
    
    (I.R.S. Employer Identification No.)
 10900 Wayzata Boulevard, Minnetonka, Minnesota 55305-1534
(Address of principal executive offices) (952) 525-5020
(Registrants telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No 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 April 30, 2004, 57,908,304 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 March 31, 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
    
    
    20Item 3.Quantitative and Qualitative Disclosures About Market Risk
    
    
    38Item 4.Controls and Procedures
    
    
    38PART II. OTHER INFORMATIONItem 1.Legal Proceedings
    
    
    39Item 2.Changes in Securities
    
    
    39Item 3.Defaults Upon Senior Securities
    
    
    39Item 4.Submission of Matters to a Vote of Security Holders
    
    
    39Item 5.Other Information
    
    
    39Item 6.Exhibits and Reports on Form 8-K
    
    
    39Signatures
    
    
    41Computation of Earnings Per ShareCertification of Principal Executive OfficerCertification of Principal Financial OfficerCertification of Principal Executive OfficerCertification of Principal Financial Officer
  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)
 March 31,2004
    
    December 31,(Unaudited)
    
    2003Assets:Cash and due from banks
    
    $
    28,829
    
    
    $
    32,076Federal funds sold
    
    
    50,300
    
    
    
    25,300Short-term investments
    
    
    240,916
    
    
    
    121,109Cash and cash equivalents
    
    
    320,045
    
    
    
    178,485Liquidity reserve deposit
    
    
    62,806
    
    
    
    80,158Loans held for sale
    
    
    27,671
    
    
    
    Credit card loans
    
    
    74,085
    
    
    
    128,615Less: Allowance for loan losses
    
    
    18,945
    
    
    
    45,492Net credit card loans
    
    
    55,140
    
    
    
    83,123Retained interests in loans securitized
    
    
    794,415
    
    
    
    836,901Property and equipment, net
    
    
    31,061
    
    
    
    33,680Purchased portfolio premium, net
    
    
    15,165
    
    
    
    17,561Other receivables due from credit card
securitizations, net
    
    
    91,775
    
    
    
    80,714Other assets
    
    
    69,788
    
    
    
    81,774Total assets
    
    $
    1,467,866
    
    
    $
    1,392,396Liabilities:Deposits
    
    $
    5,621
    
    
    $
    6,262Debt
    
    
    343,278
    
    
    
    350,448Accounts payable
    
    
    55,816
    
    
    
    32,397Deferred income
    
    
    16,223
    
    
    
    18,060Accrued expenses and other liabilities
    
    
    94,116
    
    
    
    76,036Total liabilities
    
    
    515,054
    
    
    
    483,203Stockholders Equity:Convertible preferred stock  Series C, par
value $.01 per share; 10,000,000 shares
authorized, 1,292,132 and 1,263,699 shares
issued and outstanding, respectively
    
    
    481,319
    
    
    
    470,728Common stock, par value $.01 per share;
300,000,000 shares authorized, 64,963,352 and
64,862,314 shares issued,
respectively
    
    
    650
    
    
    
    649Paid-in capital
    
    
    231,636
    
    
    
    229,655Unearned compensation
    
    
    
    
    
    
    (27
    )Treasury stock  7,055,300 shares
    
    
    (58,308
    )
    
    
    (58,308
    )Retained earnings
    
    
    297,515
    
    
    
    266,496Total stockholders equity
    
    
    952,812
    
    
    
    909,193Total liabilities and stockholders equity
    
    $
    1,467,866
    
    
    $
    1,392,396
 3




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See accompanying Notes to Consolidated Financial Statements. 4




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METRIS COMPANIES INC. AND SUBSIDIARIES 
 (In thousands, except earnings per-share data)
 Three-Months EndedMarch 31,2004
    
    2003Revenues:Securitization income (expense)
    
    $
    118,985
    
    
    $
    (37,970
    )Servicing income on securitized / sold receivables
    
    
    36,237
    
    
    
    47,813Credit card loan and other interest income
    
    
    5,106
    
    
    
    32,161Credit card loan fees, interchange and other income
    
    
    10,816
    

    
    
    26,319Enhancement services income
    
    
    7,480
    
    
    
    43,509Total Revenues
    
    
    178,624
    
    
    
    111,832Expenses:Interest expense
    
    
    13,931
    
    
    
    19,341Provision for loan losses
    
    
    (6,092
    )
    
    
    44,786Credit card account and other product solicitation
and marketing expenses
    
    
    15,932
    
    
    
    33,688Employee compensation
    
    
    38,945
    
    
    
    53,381Data processing services and communications
    
    
    16,472
    
    
    
    19,178Credit protection claims expense
    
    
    6,348
    
    
    
    12,306Occupancy and equipment
    
    
    6,401
    
    
    
    9,613Purchased portfolio premium amortization
    
    
    2,397
    
    
    
    6,496Asset impairments, lease write-offs and severance
    
    
    1,461
    
    
    
    16,777Other
    
    
    18,517
    
    
    
    23,707Total Expenses
    
    
    114,312
    
    
    
    239,273Income (Loss) Before Income Taxes
    
    
    64,312
    
    
    
    (127,441
    )Income tax expense (benefit)
    
    
    22,702
    
    
    
    (44,611
    )Net Income (loss)
    
    
    41,610
    
    
    
    (82,830
    )Convertible preferred stock dividends
    
    
    10,591
    
    
    
    9,689Net Income (Loss) Applicable to Common Stockholders
    
    $
    31,019
    
    
    $
    (92,519
    )Earnings (loss) per share:Basic
    
    
    0.47
    
    
    
    (1.62
    )Diluted
    
    
    0.47
    
    
    
    (1.62
    )Shares used to compute earnings (loss) per share:Basic
    
    
    88,855
    
    
    
    57,257Diluted
    
    
    89,382
    
    
    
    57,257
 See accompanying Notes to Consolidated Financial Statements. 5




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METRIS COMPANIES INC. AND SUBSIDIARIES 
 (In thousands) (Unaudited)
 Number 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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (82,830
    )
    
    
    (82,830
    )Preferred dividends in
kind
    
    
    26
    
    
    
    
    
    
    
    9,689
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,689
    )
    
    
    Issuance of common
stock under employee
benefit plans
    
    
    
    
    
    
    536
    
    
    
    
    
    
    
    3
    
    
    
    792
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    795Deferred
compensation
obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    546
    
    
    
    (549
    )
    
    
    
    
    
    
    
    
    
    
    Restricted stock
forfeitures
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    
    
    
    
    (12
    )
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    Amortization of
restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    89
    
    
    
    
    
    
    
    
    
    
    
    89BALANCE AT MARCH 31, 2003
    
    
    1,182
    
    
    
    57,704
    
    
    $
    440,331
    
    
    $
    648
    
    
    $
    228,702
    
    
    $
    (448
    )
    
    $
    (58,308
    )
    
    $
    361,802
    
    
    $
    972,727BALANCE AT DECEMBER 31,
2003
    
    
    1,264
    
    
    
    57,807
    
    
    $
    470,728
    
    
    $
    649
    
    
    $
    229,655
    
    
    $
    (27
    )
    
    $
    (58,308
    )
    
    $
    266,496
    
    
    $
    909,193Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    41,610
    
    
    
    41,610Preferred dividends in
kind
    
    
    28
    
    
    
    
    
    
    
    10,591
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,591
    )
    
    
    Issuance of common
stock under employee
benefit plans
    
    
    
    
    
    
    151
    
    
    
    
    
    
    
    1
    
    
    
    2,070
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,071Deferred
compensation
obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (85
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (85
    )Restricted stock
forfeitures
    
    
    
    
    
    
    (50
    )
    
    
    
    
    
    
    
    
    
    
    (4
    )
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    Amortization of
restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23
    
    
    
    
    
    
    
    
    
    
    
    23BALANCE AT MARCH 31, 2004
    
    
    1,292
    
    
    
    57,908
    
    
    $
    481,319
    
    
    $
    650
    
    
    $
    231,636
    
    
    $
    
    
    
    $
    (58,308
    )
    
    $
    297,515
    
    
    $
    952,812
 See accompanying Notes to Consolidated Financial Statements. 6




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METRIS COMPANIES INC. AND SUBSIDIARIES 
 (In thousands) (Unaudited)
 Three-Months EndedMarch 31,2004
    
    2003Operating Activities:Net income (loss)
    
    $
    41,610
    
    
    $
    (82,830
    )Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:Depreciation, amortization and accretion
    
    
    (47,773
    )
    
    
    (48,366
    )Provision for loan losses
    
    
    (6,092
    )
    
    
    44,786Loss from credit card securitization
    
    
    25,173
    
    
    
    66,209Asset impairments, lease write-offs and severance
    
    
    1,461
    
    
    
    16,777Market loss on derivative financial instruments
    
    
    4,791
    
    
    
    3,710Changes in operating assets and liabilities, net:Liquidity reserve deposit
    
    
    17,352
    
    
    
    (69,221
    )Fair value of retained interests in
loans securitized
    
    
    (47,965
    )
    
    
    83,608Spread accounts receivable
    
    
    153,331
    
    
    
    (164,549
    )Other receivables due from credit card
securitizations, net
    
    
    (11,061
    )
    
    
    (3,876
    )Accounts payable and accrued expenses
    
    
    40,038
    
    
    
    12,325Deferred income
    
    
    (1,837
    )
    
    
    (19,578
    )Other
    
    
    3,443
    
    
    
    (30,847
    )Net cash provided by (used in) operating activities
    
    
    172,471
    
    
    
    (191,852
    )Investing Activities:Proceeds from transfers of portfolios to the Metris
Master Trust
    
    
    
    
    
    
    205,560Net cash from loan originations and principal
collections on loans receivable
    
    
    (24,096
    )
    
    
    32,399Additions to property and equipment
    
    
    (851
    )
    
    
    (501
    )Net cash (used in) provided by investing activities
    
    
    (24,947
    )
    
    
    237,458Financing Activities:Proceeds from issuance of debt
    
    
    
    
    
    
    627Repayment of debt
    
    
    (7,394
    )
    
    
    Net decrease in deposits
    
    
    (641
    )
    
    
    (91,256
    )Proceeds from issuance of common stock
    
    
    2,071
    
    
    
    795Net cash used in financing activities
    
    
    (5,964
    )
    
    
    (89,834
    )Net increase (decrease) in cash and cash equivalents
    
    
    141,560
    
    
    
    (44,228
    )Cash and cash equivalents at beginning of period
    
    
    178,485
    
    
    
    580,232Cash and cash equivalents at end of period
    
    $
    320,045
    
    
    $
    536,004Supplemental disclosures and cash flow information:Cash paid (received) during the period for:Interest
    
    $
    11,576
    
    
    $
    19,959Income taxes
    
    
    (249
    )
    
    
    (32,042
    )
 See accompanying Notes to Consolidated Financial Statements. 7




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##### Table of Contents



METRIS COMPANIES INC. AND SUBSIDIARIES 
 (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. 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 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 require us to make estimates and assumptions that affect the
reported amounts in the consolidated financial statements and accompanying
notes. The most significant and subjective of these estimates is our
determination of the fair value of Retained interests in loans securitized
and the adequacy 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 actual losses in our Credit card loan portfolio and the fair
value of our Retained interests in loans securitized as of March 31, 2004 and
December 31, 2003, could materially differ from these estimates. The
accompanying unaudited consolidated financial statements do not include an
adjustment to the fair value of Retained interests in loans securitized that
might result from the inability to finance future receivables. Comprehensive Income SFAS No. 130 Reporting Comprehensive Income,does not apply to our
current financial results and therefore, net income equals comprehensive
income. 8




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NOTE 2  EARNINGS (LOSS) PER SHARE The following table presents the computation of basic and diluted
weighted- average shares used in the per-share calculations: Three-Months EndedMarch 31,2004
    
    2003Net income (loss)
    
    $
    41,610
    
    
    $
    (82,830
    )Convertible preferred stock dividends
    
    
    10,591
    
    
    
    9,689Net income (loss) applicable to common stockholders
    
    $
    31,019
    
    
    $
    (92,519
    )Weighted-average common shares outstanding
    
    
    57,791
    
    
    
    57,257Adjustments for dilutive securities:Assumed conversion of convertible preferred stock (1)(2)
    
    
    31,064
    
    
    
    Basic common shares
    
    
    88,855
    
    
    
    57,257Assumed exercise of outstanding stock options (1)
    
    
    527
    
    
    
    Diluted common shares
    
    
    89,382
    
    
    
    57,257
  (1)
    
    The earnings per share calculation for the period ended March 31, 2003
excludes the assumed conversion of the convertible preferred stock and the
outstanding stock options, as they are anti-dilutive.  (2)
    
    Due to provisions in our 10% Senior Notes due November 2004, a
stockholder or group cannot obtain 35% or more of our outstanding voting
stock. As of March 31, 2004, shares of Series C Preferred
Stock would be
convertible into approximately (a) 31 million shares of Common Stock, or
34.9% of our Common Stock on a diluted basis, and (b) 14 million shares of
non-voting Series D Preferred Stock. Upon extinguishment of the
debt, which is expected to occur in the second quarter of 2004, the
Series C Preferred Stock would be convertible into approximately 45 million
shares of voting common stock. NOTE 3  STOCK-BASED COMPENSATION PLANS We recognize compensation cost for stock-based employee compensation plans
based on the difference, if any, between the quoted market price of the stock
on the date of grant and the amount an employee must pay to acquire the stock.
No expense was reflected in Net income related to stock options as all
options granted had an exercise price equal to the market value of the
underlying common stock on the date of grant. During the first quarter of 2004
and 2003, we recorded $15,000 and $59,000, respectively, in amortization of
deferred compensation obligation, net of related tax benefit, in Net income
related to restricted stock granted. Pro forma information regarding Net income and Earnings per share has
been determined as if we accounted for our employee stock options under the
fair value method. The fair value of the options was estimated at the grant
date using a Black-Scholes option-pricing model. The fair value of the options
is amortized to expense over the options vesting periods. Under the fair value
method, our Net income and Earnings per share would have been recorded at
the pro forma amounts indicated below: 9




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Three-Months EndedMarch 31,2004
    
    2003Net income (loss)
    
    $
    41,610
    
    
    $
    (82,830
    )Add: Stock-based employee
compensation expense included in
reported net income (loss), net of
related tax effects
    
    
    15
    
    
    
    59Deduct: Annual stock-based
employee compensation benefit
determined based on the fair value
for all awards, net of related tax
effects
    
    
    (1,462
    )
    
    
    (7,838
    )Pro forma net income (loss)
    
    
    43,087
    
    
    
    (74,933
    )Earnings (loss) per share:Basic-as reported
    
    
    0.47
    
    
    
    (1.62
    )Basic-pro forma
    
    
    0.48
    
    
    
    (1.48
    )Diluted-as reported
    
    
    0.47
    
    
    
    (1.62
    )Diluted-pro forma
    
    
    0.48
    
    
    
    (1.48
    )Weighted-average assumptions in
option valuation:Risk-free interest rates
    
    
    2.1
    %
    
    
    1.5
    %Dividend yields
    
    
    
    
    
    
    Stock volatility factor
    
    
    129.6
    %
    
    
    107.0
    %Expected life of options (in years)
    
    
    2.7
    
    
    
    4.3
 The above pro forma amounts may not be representative of the effects
on
net earnings (loss) for future periods. NOTE 4  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 a Liquidity Reserve
Deposit Agreement, dated March 18, 2003, among Direct Merchants Bank, MCI, and
the Office of the Comptroller of the Currency. These deposits are invested in
short term liquid investments. As of March 31, 2004, the balance of these
deposits was $62.8 million and is classified on the consolidated balance sheets
as Liquidity reserve deposit. NOTE 5  LOANS HELD FOR SALE During the first quarter of 2004, the Company entered into negotiations to
sell a credit card loan portfolio. The portfolio is recorded at the lower of
cost or fair market value and is classified as Loans held for sale on the
consolidated balance sheets as of March 31, 2004. On April 30, 2004 the
Company closed on the sale of these receivables for net proceeds approximating
the March 31, 2004 carrying value. 10




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NOTE 6  ALLOWANCE FOR LOAN LOSSES The activity in the Allowance for loan losses is as follows: Three-Months EndedMarch 31,2004
    
    2003Balance at beginning of period
    
    $
    45,492
    
    
    $
    90,315Allowance related to assets
transferred to the Metris Master Trust
    
    
    
    
    
    
    (1,455
    )Allowance related to assets re-acquired
    
    
    1,945
    
    
    
    Provision for loan losses
    
    
    (6,092
    )
    
    
    44,786Principal receivables charged-off (1)
    
    
    (22,671
    )
    
    
    (8,681
    )Recoveries
    
    
    271
    
    
    
    392Net principal receivables charged off
    
    
    (22,400
    )
    
    
    (8,289
    )Balance at end of period
    
    $
    18,945
    
    
    $
    125,357
  (1)
    
    During the period ended March 31, 2004, principal receivables charged-off
includes the impact of approximately $38 million in Credit card loans
transferred to Loans held for sale. Credit card loans greater than 30 days contractually past due for the
periods ended March 31, 2004 and 2003 were $11.1 million and $56.4 million,
respectively. NOTE 7  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. The components of these
retained interests are recorded at their fair value. The following table shows the fair value of the components of the
Retained interests in loans securitized as of March 31, 2004 and December 31,
2003. March 31,
    
    December 31,2004
    
    2003Contractual retained interests
    
    $
    574,275
    
    
    $
    542,014Excess transferors interest
    
    
    32,031
    
    
    
    48,775Interest-only strip receivable
    
    
    26,652
    
    
    
    16,039Spread accounts receivable
    
    
    161,457
    
    
    
    230,073Retained interests in loans securitized
    
    $
    794,415
    
    
    $
    836,901
 The following table illustrates the significant assumptions used in
estimating the fair value of retained interests as of March 31, 2004 and
December 31, 2003. 11




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March 31,
    
    December 31,2004
    
    2003Monthly payment rate
    
    
    7.0
    %
    
    
    6.7
    %Gross yield (1)
    
    
    25.2
    %
    
    
    25.4
    %Annual interest expense and servicing fees
    
    
    4.0
    %
    
    
    4.2
    %Annual gross principal default rate
    
    
    20.4
    %
    
    
    20.7
    %Discount rate:Contractual retained interests
    
    
    16.0
    %
    
    
    16.0
    %Excess transferors interest
    
    
    16.0
    %
    
    
    16.0
    %Interest-only strip receivable
    
    
    30.0
    %
    
    
    30.0
    %Spread accounts receivable
    
    
    15.3
    %
    
    
    15.3
    %Weighted average months to maturity
    
    
    19.6
    
    
    
    24.5
 (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 cash flows from interchange income,
or cash advance fees. At March 31, 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
    
    $
    17.6
    
    
    $
    34.4Monthly payment rate
    
    
    121.3
    
    
    
    293.0Gross yield
    
    
    116.5
    
    
    
    254.6Annual interest expense and servicing fees
    
    
    18.0
    
    
    
    36.0Annual gross principal default rate
    
    
    87.5
    
    
    
    189.6
 As the sensitivity indicates, the value of the Companys Retained
interests in loans securitized on its balance sheet, as well as reported
earnings, could differ significantly if different assumptions or conditions
prevail. NOTE 8  SECURITIZATION INCOME (EXPENSE) The following summarizes Securitization income (expense) for the
three-month periods ended March 31, 2004 and 2003, respectively. Three-Months EndedMarch 31,2004
    
    2003Loss on new securitization of receivables
to the Metris Master Trust
    
    $
    (1,246
    )
    
    $
    (19,955
    )Loss on replenishment of receivables to
the Metris Master Trust
    
    
    (23,927
    )
    
    
    (46,254
    )Discount accretion
    
    
    59,970
    
    
    
    75,674Change in fair value
    
    
    47,965
    
    
    
    (83,608
    )Interest-only revenue
    
    
    74,932
    
    
    
    58,436Transaction and other costs
    
    
    (38,709
    )
    
    
    (22,263
    )Securitization income (expense)
    
    $
    118,985
    
    
    $
    (37,970
    )
 12




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NOTE 9  INCOME TAXES The components of the provision (benefit) for income taxes consisted of
the following: Three-Months EndedMarch, 312004
    
    2003Current:Federal
    
    $
    299
    
    
    $
    (1,991
    )State
    
    
    (126
    )
    
    
    424173
    
    
    
    (1,567
    )Deferred:Federal
    
    
    22,149
    
    
    
    (41,843
    )State
    
    
    380
    
    
    
    (1,201
    )22,529
    
    
    
    (43,044
    )Income tax expense (benefit)
    
    $
    22,702
    
    
    $
    (44,611
    )
 A reconciliation of our effective income tax rate compared to the
statutory federal income tax rate is as follows: Three-Months EndedMarch 31,2004
    
    2003Statutory federal income tax rate
    
    
    35.0
    %
    
    
    35.0
    %State income taxes, net of federal
Benefit
    
    
    0.3
    
    
    
    0.4Other, net
    
    
    
    
    
    
    (0.4
    )Effective income tax rate
    
    
    35.3
    %
    
    
    35.0
    %
 Our deferred tax assets and liabilities are as follows: March 31,
    
    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
    
    $
    86,185
    
    
    $
    122,852Intangible amortization
    
    
    33,609
    
    
    
    30,343Net operating loss and credit carry forwards
    
    
    23,605
    
    
    
    28,200Other
    
    
    32,411
    
    
    
    32,369Valuation allowance
    
    
    (2,427
    )
    
    
    (2,427
    )Total deferred tax assets
    
    
    173,383
    
    
    
    211,337Deferred income tax liabilities resulting
from future taxable and deductible temporary
differences:Accrued interest on credit card loans
    
    
    184,794
    
    
    
    194,766Other
    
    
    13,935
    
    
    
    19,388Total deferred tax liabilities
    
    
    198,729
    
    
    
    214,154Net deferred tax liabilities
    
    $
    (25,346
    )
    
    $
    (2,817
    )
 Since the Company remains in an alternative minimum tax position for the
first quarter of 2004, the valuation allowance related to the minimum tax
credit carryforward remains at March 31, 2004. We believe, based on our
operating earnings in the current year, expected reversals of taxable temporary
differences and, to a lesser degree, reliance on future earnings, the remaining
deferred tax assets are fully realizable. 13




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NOTE 10  ASSET IMPAIRMENT, LEASE WRITE-OFFS AND SEVERANCE Asset impairments, lease write-offs and severance for the three-months
ended March 31, 2004 include a $1.0 million charge for workforce reductions and
a $0.4 million charge related to write-downs of various operating leases.
During the comparable period in 2003, this line item included a $4.8 million
charge for workforce reductions and a $12.0 million charge for write-downs of
excess property and equipment. NOTE 11  SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS We have various indirect subsidiaries, which do not guarantee Company
debt. We have prepared condensed consolidating financial statements of the
Company, the guarantor subsidiaries and the non-guarantor subsidiaries for
purposes of complying with SEC reporting requirements. Separate financial
statements of the guaranteeing subsidiaries and non-guaranteeing subsidiaries
are not presented because we have determined that the subsidiaries financial
information would not be material to investors. 14




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METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
March 31, 2004(In thousands)
Unaudited MetrisCompanies
    
    Guarantor
    
    Non-GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedAssets:Cash and cash equivalents
    
    $
    10,210
    
    
    $
    738
    
    
    $
    309,097
    
    
    $
    
    
    
    $
    320,045Liquidity reserve deposit
    
    
    
    
    
    
    
    
    
    
    62,806
    
    
    
    
    
    
    
    62,806Loans held for sale
    
    
    
    
    
    
    
    
    
    
    27,671
    
    
    
    
    
    
    
    27,671Net credit card loans
    
    
    249
    
    
    
    
    
    
    
    54,891
    
    
    
    
    
    
    
    55,140Retained interests in
loans securitized
    
    
    
    
    
    
    
    
    
    
    781,578
    
    
    
    12,837
    
    
    
    794,415Property and equipment, net
    
    
    
    
    
    
    31,048
    
    
    
    13
    
    
    
    
    
    
    
    31,061Purchased portfolio
premium, net
    
    
    73
    
    
    
    
    
    
    
    15,092
    
    
    
    
    
    
    
    15,165Other receivables due from
credit card
securitizations, net
    
    
    4
    
    
    
    
    
    
    
    91,771
    
    
    
    
    
    
    
    91,775Other assets
    
    
    17,284
    
    
    
    30,327
    
    
    
    27,052
    
    
    
    (4,875
    )
    
    
    69,788Investment in subsidiaries
    
    
    1,335,051
    
    
    
    921,996
    
    
    
    
    
    
    
    (2,257,047
    )
    
    
    Total assets
    
    $
    1,362,871
    
    
    $
    984,109
    
    
    $
    1,369,971
    
    
    $
    (2,249,085
    )
    
    $
    1,467,866Liabilities:Deposits
    
    $
    (1,000
    )
    
    $
    
    
    
    $
    6,621
    
    
    $
    
    
    
    $
    5,621Debt
    
    
    375,283
    
    
    
    (408,056
    )
    
    
    419,051
    
    
    
    (43,000
    )
    
    
    343,278Accounts payable
    
    
    116
    
    
    
    15,870
    
    
    
    39,830
    
    
    
    
    
    
    
    55,816Deferred income
    
    
    
    
    
    
    
    
    
    
    16,223
    
    
    
    
    
    
    
    16,223Accrued expenses and other
liabilities
    
    
    35,660
    
    
    
    41,244
    
    
    
    (33,750
    )
    
    
    50,962
    
    
    
    94,116Total liabilities
    
    
    410,059
    
    
    
    (350,942
    )
    
    
    447,975
    
    
    
    7,962
    
    
    
    515,054Total stockholders equity
    
    
    952,812
    
    
    
    1,335,051
    
    
    
    921,996
    
    
    
    (2,257,047
    )
    
    
    952,812Total liabilities and
stockholders equity
    
    $
    1,362,871
    
    
    $
    984,109
    
    
    $
    1,369,971
    
    
    $
    (2,249,085
    )
    
    $
    1,467,866
 15




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METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
December 31, 2003(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, net
    
    
    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
 16




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METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Three-Months Ended March 31, 2004(In thousands)
Unaudited MetrisCompanies
    
    Guarantor
    
    Non-GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedRevenues:Securitization (expense)
income
    
    
    (43
    )
    
    
    
    
    
    
    118,351
    
    
    
    677
    
    
    
    118,985Servicing income on
securitized/sold
receivables
    
    
    
    
    
    
    
    
    
    
    36,237
    
    
    
    
    
    
    
    36,237Credit card loan and
other interest income
    
    
    122
    
    
    
    
    
    
    
    4,984
    
    
    
    
    
    
    
    5,106Credit card loan fees,
interchange and other
income
    
    
    1,227
    
    
    
    14,863
    
    
    
    9,117
    
    
    
    (14,391
    )
    
    
    10,816Enhancement services
income
    
    
    
    
    
    
    113
    
    
    
    7,378
    
    
    
    (11
    )
    
    
    7,480Intercompany allocations
    
    
    316
    
    
    
    40,894
    
    
    
    753
    
    
    
    (41,963
    )
    
    
    1,622
    
    
    
    55,870
    
    
    
    176,820
    
    
    
    (55,688
    )
    
    
    178,624Expenses:Interest expense
    
    
    13,955
    
    
    
    (2,578
    )
    
    
    2,554
    
    
    
    
    
    
    
    13,931Provision for loan losses
    
    
    (1,317
    )
    
    
    
    
    
    
    (4,775
    )
    
    
    
    
    
    
    (6,092
    )Credit card account and
other product
solicitation and
marketing expenses
    
    
    105
    
    
    
    11,492
    
    
    
    15,526
    
    
    
    (11,191
    )
    
    
    15,932Employee compensation
    
    
    
    
    
    
    39,042
    
    
    
    (97
    )
    
    
    
    
    
    
    38,945Data processing services
and communications
    
    
    5
    
    
    
    (15,738
    )
    
    
    35,427
    
    
    
    (3,222
    )
    
    
    16,472Credit protection claims
expense
    
    
    
    
    
    
    
    
    
    
    6,348
    
    
    
    
    
    
    
    6,348Occupancy and equipment
    
    
    
    
    
    
    
    
    
    
    6,401
    
    
    
    
    
    
    
    6,401Purchased portfolio
premium amortization
    
    
    7
    
    
    
    
    
    
    
    3,093
    
    
    
    (703
    )
    
    
    2,397Asset impairments, lease
write-offs and severance
    
    
    
    
    
    
    
    
    
    
    1,461
    
    
    
    
    
    
    
    1,461Other
    
    
    400
    
    
    
    21,691
    
    
    
    (3,574
    )
    
    
    
    
    
    
    18,517Intercompany allocations
    
    
    31
    
    
    
    11,414
    
    
    
    30,517
    
    
    
    (41,962
    )
    
    
    13,186
    
    
    
    65,323
    
    
    
    92,881
    
    
    
    (57,078
    )
    
    
    114,312(Loss) Income Before
Income Tax Benefit and
Equity in Income (Loss)
of Subsidiaries
    
    
    (11,564
    )
    
    
    (9,453
    )
    
    
    83,939
    
    
    
    1,390
    
    
    
    64,312Income tax (benefit)
expense
    
    
    (4,082
    )
    
    
    (4,857
    )
    
    
    31,150
    
    
    
    491
    
    
    
    22,702Equity in income (loss)
of subsidiaries
    
    
    49,092
    
    
    
    52,789
    
    
    
    
    
    
    
    (101,881
    )
    
    
    Net Income (Loss)
    
    $
    41,610
    
    
    $
    48,193
    
    
    $
    52,789
    
    
    $
    (100,982
    )
    
    $
    41,610
 17




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METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Three-Months Ended March 31, 2003(In thousands)
Unaudited MetrisCompanies
    
    Guarantor
    
    Non-GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedRevenues:Securitization expense
    
    $
    (10,011
    )
    
    
    
    
    
    
    (27,280
    )
    
    
    (679
    )
    
    
    (37,970
    )Servicing income on
securitized/sold
receivables
    
    
    
    
    
    
    
    
    
    
    47,813
    
    
    
    
    
    
    
    47,813Credit card loan and
other interest income
    
    
    471
    
    
    
    
    
    
    

    31,690
    
    
    
    
    
    
    
    32,161Credit card loan fees,
interchange and other
income
    
    
    55
    
    
    
    12,543
    
    
    
    26,451
    
    
    
    (12,730
    )
    
    
    26,319Enhancement services
income
    
    
    
    
    
    
    9,179
    
    
    
    38,083
    
    
    
    (3,753
    )
    
    
    43,509Intercompany allocations
    
    
    75
    
    
    
    65,606
    
    
    
    9,991
    
    
    
    (75,672
    )
    
    
    (9,410
    )
    
    
    87,328
    
    
    
    126,748
    
    
    
    (92,834
    )
    
    
    111,832Expenses:Interest expense
    
    
    9,177
    
    
    
    818
    
    
    
    9,346
    
    
    
    
    
    
    
    19,341Provision for loan losses
    
    
    846
    
    
    
    
    
    
    
    43,776
    
    
    
    164
    
    
    
    44,786Credit card account and
other product
solicitation and
marketing expenses
    
    
    
    
    
    
    12,222
    
    
    
    33,754
    
    
    
    (12,288
    )
    
    
    33,688Employee compensation
    
    
    
    
    
    
    51,211
    
    
    
    2,170
    
    
    
    
    
    
    
    53,381Data processing services
and communications
    
    
    (1
    )
    
    
    (21,987
    )
    
    
    44,651
    
    
    
    (3,485
    )
    
    
    19,178Credit protection claims
expense
    
    
    
    
    
    
    109
    
    
    
    12,197
    
    
    
    
    
    
    
    12,306Occupancy and equipment
    
    
    
    
    
    
    
    
    
    
    9,613
    
    
    
    
    
    
    
    9,613Purchased portfolio
premium amortization
    
    
    11
    
    
    
    
    
    
    
    7,697
    
    
    
    (1,212
    )
    
    
    6,496Asset impairments, lease
write-offs and severance
    
    
    
    
    
    
    
    
    
    
    16,777
    
    
    
    
    
    
    
    16,777Other
    
    
    85
    
    
    
    39,098
    
    
    
    (15,476
    )
    
    
    
    
    
    
    23,707Intercompany allocations
    
    
    11
    
    
    
    25,626
    
    
    
    50,035
    
    
    
    (75,672
    )
    
    
    10,129
    
    
    
    107,097
    
    
    
    214,540
    
    
    
    (92,493
    )
    
    
    239,273Loss Before Income Tax
Benefit and Equity in
Loss of Subsidiaries
    
    
    (19,539

    )
    
    
    (19,769
    )
    
    
    (87,792
    )
    
    
    (341
    )
    
    
    (127,441
    )Income tax benefit
    
    
    (1,439
    )
    
    
    (8,120
    )
    
    
    (34,935
    )
    
    
    (117
    )
    
    
    (44,611
    )Equity in (loss) income
of subsidiaries
    
    
    (64,730
    )
    
    
    (52,857
    )
    
    
    
    
    
    
    117,587
    
    
    
    Net Loss
    
    $
    (82,830
    )
    
    $
    (64,506
    )
    
    $
    (52,857
    )
    
    $
    117,363
    
    
    $
    (82,830
    )
 18




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Three-Months Ended March 31, 2004(In thousands)
Unaudited MetrisCompanies
    
    Guarantor
    
    Non-GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedOperating Activities:Net cash (used in)
provided by operating
activities
    
    $
    (49,933
    )
    
    $
    45,555
    
    
    $
    199,169
    
    
    $
    (22,320
    )
    
    $
    172,471Investing Activities:Net cash from loan
originations and
principal collections on
loans receivable
    
    
    16,271
    
    
    
    
    
    
    
    (61,254
    )
    
    
    20,887
    
    
    
    (24,096
    )Additions to property and
equipment
    
    
    
    
    
    
    (851
    )
    
    
    
    
    
    
    
    
    
    
    (851
    )Investment in subsidiaries
    
    
    61,271
    
    
    
    344,197
    
    
    
    (423,188
    )
    
    
    17,720
    
    
    
    Net cash provided by
(used in) investing
activities
    
    
    77,542
    
    
    
    343,346
    
    
    
    (484,442
    )
    
    
    38,607
    
    
    
    (24,947
    )Financing Activities:Net (decrease) increase
in debt
    
    
    (18,389
    )
    
    
    (408,056
    )
    
    
    419,051
    
    
    
    
    
    
    
    (7,394
    )Net decrease in deposits
    
    
    
    
    
    
    
    
    
    
    (641
    )
    
    
    
    
    
    
    (641
    )Proceeds from issuance of
common stock
    
    
    2,071
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,071Capital contributions
    
    
    
    
    
    
    16,859
    
    
    
    (572
    )
    
    
    (16,287
    )
    
    
    Net cash (used in)
provided by financing
activities
    
    
    (16,318
    )
    
    
    (391,197
    )
    
    
    417,838
    
    
    
    (16,287
    )
    
    
    (5,964
    )Net increase
(decrease)
in cash and cash
equivalents
    
    
    11,291
    
    
    
    (2,296
    )
    
    
    132,565
    
    
    
    
    
    
    
    141,560Cash and cash equivalents
at beginning of period
    
    
    (1,081
    )
    
    
    3,034
    
    
    
    176,532
    
    
    
    
    
    
    
    178,485Cash and cash equivalents
at end of period
    
    $
    10,210
    
    
    $
    738
    
    
    $
    309,097
    
    
    $
    
    
    
    $
    320,045
 19




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Three-Months Ended March 31, 2003(In thousands)
Unaudited MetrisCompanies
    
    Guarantor
    
    Non-GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedOperating Activities:Net cash (used in)
provided by operating
activities
    
    $
    (107,278
    )
    
    $
    (78,724
    )
    
    $
    (123,213
    )
    
    $
    117,363
    
    
    $
    (191,852
    )Investing Activities:Proceeds from transfers
of portfolios to Metris
Master Trust
    
    
    
    
    
    
    
    
    
    
    205,560
    
    
    
    
    
    
    
    205,560Net cash from loan
originations and
principal collections on
loans receivable
    
    
    (34,727
    )
    
    
    
    
    
    
    67,126
    
    
    
    
    
    
    
    32,399Additions to property and
equipment
    
    
    
    
    
    
    1,534
    
    
    
    (2,035
    )
    
    
    
    
    
    
    (501
    )Investment in subsidiaries
    
    
    142,738
    
    
    
    218,206
    
    
    
    70,846
    
    
    
    (431,790
    )
    
    
    Net cash provided by
(used in) investing
activities
    
    
    108,011
    
    
    
    219,740
    
    
    
    341,497
    
    
    
    (431,790
    )
    
    
    237,458Financing Activities:Net increase (decrease)
in debt
    
    
    729
    
    
    
    (102
    )
    
    
    
    
    
    
    
    
    
    
    627Net decrease in deposits
    
    
    
    
    
    
    
    
    
    
    (91,256
    )
    
    
    
    
    
    
    (91,256
    )Proceeds from issuance of
common stock
    
    
    795
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    795Capital contributions
    
    
    
    
    
    
    (146,297
    )
    
    
    (168,130
    )
    
    
    314,427
    
    
    
    Net cash provided by
(used in) financing
activities
    
    
    1,524
    
    
    
    (146,399
    )
    
    
    (259,386
    )
    
    
    314,427
    
    
    
    (89,834
    )Net increase (decrease)
in cash and cash
equivalents
    
    
    2,257
    
    
    
    (5,383
    )
    
    
    (41,102
    )
    
    
    
    
    
    
    (44,228
    )Cash and cash equivalents
at beginning of period
    
    
    (3,795
    )
    
    
    8,109
    
    
    
    575,918
    
    
    
    
    
    
    
    580,232Cash and cash equivalents
at end of period
    
    $
    (1,538
    )
    
    $
    2,726
    
    
    $
    534,816
    
    
    $
    
    
    
    $
    536,004
 20




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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. MCI and its subsidiaries, as applicable, may be
referred to as we, us, our or the Company. You should read this
discussion along with the following documents for a full understanding of our
financial condition and results of operations: Managements Discussion and
Analysis of Financial Condition and Results of Operations in our Annual Report
on Form 10-K/A for the fiscal year ended December 31, 2003, filed April 29,
2004. In addition, you should read this discussion along with our condensed
consolidated financial statements and related notes thereto for the period
ended March 31, 2004 on Form 10-Q. 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. Our target market is particularly susceptible to changes in the economy.
Over the past few years, the status of the economy in the United States has led
to increased unemployment rates, increased incidences of personal bankruptcy,
and decreased consumer confidence, all of which have challenged the Company and
the middle market consumer loan industry. In addition, in 2001, we implemented
a program to increase the credit lines to a large portion of our existing
customers, which put increased payment pressure on those customers. We
continue to experience the residual effects of the recent economic downturn and
the 2001 credit line increase program through the first quarter of 2004 as
evidenced by our high managed charge-off rates. However, we have begun to
experience improving asset quality as a result of actions taken over the past
five quarters to strengthen credit line management strategies, limit marketing
efforts to better credit quality consumers, tighten credit authorization
criteria and enhance collection strategies. The Metris Master Trust two-cycle
plus delinquency rates fell from their peak of 12.05% in November 2002 to
10.46% as of March 31, 2004. In addition, the Metris Master Trust three-month
average excess spread increased to 4.61% as of March 31, 2004 compared to 2.37%
for the first quarter of 2003 and 3.62% in the fourth quarter of 2003. We continue to evaluate and modify our marketing programs to improve the
overall credit quality of the managed portfolio. Beginning late in 2002 we
tested pricing and line assignments for new customers. These actions were in
response to a lower interest rate environment, increased competition in the
middle market sector, and overall tightening of our underwriting. The early
results of these initiatives indicate improved credit quality from our most
recent marketing campaigns. Our 58,111 new accounts booked in the first
quarter of 2004 continue to reflect our focus on the middle market segment,
which is our traditional target market. We would expect the target market of
future marketing efforts to be consistent with the first quarter of 2004. Our business requires a high degree of liquidity. Thus, ensuring
appropriate liquidity is at the forefront of our business objectives. We rely
heavily on the securitization of our consumer loans for funding, primarily by
selling the loans to the Metris Master Trust. As of March 31, 2004, our
funding needs for 2004, included $1.65 billion in maturing asset-backed
financing and conduits in the Metris Master Trust, $95.3 million outstanding on
our $125 million term loan due in June 2004, and $100 million of senior notes
due in November 2004. 21




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##### Table of Contents



Our strategies to meet these funding needs are portfolio attrition, new
conduit financing transactions, the renewal of some of these facilities, and
new securitizations. In April 2004, we announced the issuance of $200
million of three-year credit card asset-backed term securities. The proceeds
from this transaction were used to repay an outstanding paired-series, which
was due in May 2004. Also, in April 2004, we announced a two-year conduit
financing facility for $800 million, which was subsequently up-sized to $900
million, maturing in May 2006. This multi-series conduit financing will
act as a warehouse facility to allow maturing asset-backed security
transactions to be funded until we access the asset-backed markets.
Finally, in May 2004 we used cash on hand to pay off the
$95.3 million outstanding on our $125 million term loan due
June 2004 and closed on a $300 million term loan from a group of
investors that matures in May 2007. Part of the proceeds from this financing will be
used during the second quarter of 2004 to pay off the $100 million of senior notes. With these new transactions, we have completed our corporate funding
initiatives for 2004. Our receivable funding needs for the remainder of 2004
and 2005 will be covered by the $900 million conduit, portfolio attrition, and
future asset-backed securitizations. We have $1.5 billion of remaining
capacity in our MBIA commitment to provide insurance coverage on future
asset-backed security transactions. In January 2003, the FFIEC issued guidance with respect to account
management, risk management, and loss allowance practices for institutions
engaged in credit card lending. The guidance provides requirements for certain
operational and accounting policies, which are designed to bring consistency in
practice between institutions engaged in credit card lending. We continue
testing alternative approaches to comply with several aspects of this guidance,
the results of which are not expected until the second half of 2004. At this
time we are unable to provide assurance that the final implementation of any
new policies will not have a material adverse effect on our financial
condition. Critical Accounting
Estimates The Companys most critical accounting estimates are our determination of
the Allowance for loan losses and the valuation of our Retained interests in
loans securitized. 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 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 will 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 loan portfolio and the fact 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. 22




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##### Table of Contents



Additionally, in evaluating the adequacy of the loan loss reserves, we
consider several subjective factors which may be overlaid into the credit risk
roll-rate model in determining the necessary loan loss reserve, including:  
    
    national and economic trends and business conditions, including
the condition of various market segments;
    
    changes in lending policies and procedures, including those for
underwriting, collection, charge-off and recovery, as well as the
experience, ability and depth of lending management and staff;
    
    trends in volume and the product pricing of accounts, including
any concentrations of credit; and
    
    impacts from external factors  such as changes in competition,
and legal and regulatory requirements  on the level of estimated
credit losses in the current portfolio. Significant changes in these factors could impact our financial
projections and thereby affect the adequacy of our Allowance for loan losses. Valuation of Retained Interests in Loans Securitized The Retained interests in loans securitized on our balance sheet
associated with our securitization transactions includes contractual retained
interests, 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. Any change in the fair
value is recorded in Securitization income (expense). 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 the subordinated securities
held by us. There is no stated interest/coupon rate associated with these
securities and they are not rated. They are subordinate to all other
securities, except for the interest-only strip receivable we own and
accordingly, are repaid last. Their fair value is determined by discounting
the expected future cash flows using a discount rate commensurate with the
risks of the underlying assets and the expected timing based on the scheduled
maturity date for the underlying securitization. If these securities are
recoverable based on the Metris Master Trust forecasts, cash flows related to
the entire subordinated principal balance are used in determining their fair
value. Transferors 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 twelve 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 accounts receivable balances
represent cash held by the Metris Master Trust trustee due to performance of
the Metris Master Trust and requisite reserves required by certain security
series. These balances earn interest and the change in fair value is
determined in the same manner as the contractual retained interests. 23




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##### Table of Contents



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 values of
Retained interests in loans securitized. These assumptions and estimates
include estimated principal payments, credit losses, gross yield, interest
expense, fees, the timing of cash receipts, and discount rates commensurate
with the risks of the underlying assets. On a quarterly basis, we review and
adjust as appropriate the assumptions and estimates used in our model based on
a variety of internal and external factors, including national and economic
trends and business conditions, current lending policies, procedures and
strategies, historical trends and assumptions about future trends, competition
and legal and regulatory requirements. Significant estimates are required in
determining these factors and different judgments concerning these factors can
result in a material impact on our balance sheet and income statement. The
accompanying unaudited consolidated financial statements do not include an
adjustment to the fair value of retained interest that might result from the
inability to finance future receivables. Results of Operations Net income for the three-months ended March 31, 2004 was $41.6 million, up
from a net loss of $82.8 million for the first quarter of 2003. Diluted
earnings per share for the three-months ended March 31, 2004 were $0.47
compared to a diluted loss per share of $1.62 for the first quarter of 2003.
The increase in Net income (loss) is primarily due to an increase in
Securitization income, a decrease in the Provision for loan losses, and a
general reduction in operating expenses, partially offset by reductions in
Servicing income on securitized / sold receivables, Credit card loan and
other interest income, and Credit card loan fees, interchange and other
income. Total Revenues Total revenues were $178.6 million for the three-months ended March 31,
2004, a 59.7% increase over $111.8 million for the three-months ended March 31,
2003. Securitization income was $119.0 million for the three-months ended March
31, 2004, compared to Securitization expense of $38.0 million for the same
period in 2003. The following table details Securitization income (expense)
for the three-month period ended March 31, 2004 and 2003. Table 1: Analysis of Securitization Income (Expense)(Dollars in thousands) Three-Months EndedMarch 31,2004
    
    2003Loss on new securitization of
receivables to the Metris Master Trust
    
    $
    (1,246
    )
    
    $
    (19,955
    )Loss on replenishment of receivables to
the Metris Master Trust
    
    
    (23,927
    )
    
    
    (46,254
    )Discount accretion
    
    
    59,970
    
    
    
    75,674Change in fair value
    
    
    47,965
    
    
    
    (83,608
    )Interest-only revenue
    
    
    74,932
    
    
    
    58,436Transaction and other costs
    
    
    (38,709
    )
    
    
    (22,263
    )Securitization income
    
    $
    118,985
    
    
    $
    (37,970
    )
 24




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##### Table of Contents



The significant increase in Securitization income in the first quarter
of 2004 compared to 2003 is due to 1) fair value write-ups of $48.0 million for
the three-months ended March 31, 2004 compared to fair value write-downs of
$83.6 million for the three months ended
March 31, 2003. The $48 million mark-up was primarily due to a $22.1
million adjustment to the discount on retained receivables related to the
pay-off of the variable funding conduits, and a $20.3 million decrease in the
discount against spread accounts receivable due to reserve releases during the
quarter, 2) net loss on securitization of receivables was $1.2 million for the
three months ended March 31, 2004 compared to $20.0 million for the three
months ended March 31, 2003. The loss on new securitization in the first
quarter of 2004 pertains to the issuance of series 2004-A, which was a paired
series to defease the maturing series 1999-1. The loss on new securitization
of $1.2 million was significantly lower than the loss in the first quarter of
2003 primarily due to the short maturity of the paired series, 3) loss on
replenishment decreased $22.3 million primarily due to lower volumes of
receivables sold into the Metris Master Trust and a decrease in the weighted
average months to maturity across all outstanding series, and 4) interest-only
revenue increased $16.5 million primarily due to a 224 basis point increase in
average excess spread in the Metris Master Trust during this period, partially
offset by a $2.3 billion decrease in average principal receivables held in the
Metris Master Trust. These improvements were partially offset by a $15.7
million decrease in discount accretion and a $16.4 million increase in
transaction and other costs. Discount accretion decreased primarily due to
lower attrition on receivables held in the Metris Master Trust and a decrease
in the weighted average months to maturity on the outstanding series.
Transaction and other costs of $38.7 million for the three months ended March
31, 2004 is due to transaction fees on the 2004-A paired series, 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 / sold receivables decreased $11.6
million from $47.8 million in the first quarter of 2003 to $36.2 million in the
first quarter of 2004. The reduction in Servicing income on securitized /
sold receivables resulted from a decrease in average credit card loans held by
the Metris Master Trust of $2.7 billion between the two periods. Credit card loan and other interest income and Credit card loan fees,
interchange and other income, decreased in the aggregate from $58.5 million
for the quarter ended March 31, 2003 to $15.9 million for the same period in
2004. The $42.6 million decrease resulted primarily from a reduction in
average Credit card loans of $624.7 million between the two periods. Enhancement services revenue decreased from $43.5 million for the period
ended March 31, 2003 to $7.5 million for the same period in 2004. The $36.0
million decrease resulted from the sale of our membership club and warranty
business in July 2003. Remaining Enhancement services revenue is primarily
commission revenue that Direct Merchants Bank earns on membership club and
warranty products sold to the Banks credit card portfolio. Total Expenses Total Expenses for the three-month period ended March 31, 2004 decreased
$125.0 million over the comparable period in 2003. Included in this decrease
was a $5.4 million decrease in Interest expense to $13.9 million for the
three-months ended March 31, 2004, compared to $19.3 million over the
comparable period in 2003. The decrease is primarily due to the sale of $559.3
million of insured certificates of deposit on September 30, 2003, partially
offset by the increased borrowing rates on our outstanding debt. The Provision for loan losses decreased $50.9 million to ($6.1) million
for the three-months ended March 31, 2004, compared to $44.8 million over the
comparable period in 2003, reflecting the significant reduction in Credit card
loans during the past year, slightly improved credit quality in the owned loan
portfolio, and the reversal of approximately $3 million of allowance associated with
buyback provisions of third-party asset sales in the second half of 2004. 25




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##### Table of Contents



Credit card account and
other product solicitation and marketing expenses decreased $17.8 million to $15.9 million for the three-months ended March 31, 2004, compared to $33.7 million over the comparable period in 2003, resulting primarily from a shrinking of the credit card business and the sale of our membership club and warranty business. Employee compensation decreased $14.5 million to $38.9 million for the
three-months ended March 31, 2004, compared to $53.4 million over the
comparable period in 2003 due to workforce reductions subsequent to March 31,
2003 of 980 employees. Credit protection claims expense decreased $6.0 million to $6.3 million
for the three-months ended March 31, 2004, compared to $12.3 million over the
comparable period in 2003, largely due to a decrease in claims resulting from a
decrease in covered receivables. Asset impairments, lease write-offs and severance was $1.5 million for
the three-months ended March 31, 2004, a decrease of $15.3 million over the
comparable period in 2003. Special charges for the three-months ended March
31, 2004 include workforce reductions of $1.0 million and $0.4 million related
to further write-down of various operating leases. During the comparable period
in 2003, these charges included $12.0 million in write-downs of excess property
and equipment and a $4.8 million charge for a workforce reduction. Credit card receivables Our delinquency and net loan charge-off rates at any point in time
reflect, among other factors, the credit risk of loans, the average age of our
various credit card account portfolios, the success of our collection and
recovery efforts, and general economic conditions. The average age of our
credit card portfolio affects the stability of delinquency and loss rates. In
order to minimize losses, we continue to focus our resources on refining our
credit underwriting standards for new accounts, and on collections. We use credit line analyses, account management, and customer transaction
authorization procedures to minimize loan losses. Our risk models determine
initial credit lines at the time of underwriting. We manage credit lines on an
ongoing basis and adjust them based on customer usage and payment patterns. We
continually monitor customer accounts and initiate appropriate collection
activities when an account is delinquent or overlimit. We monitor customer
authorization history, complete credit line analysis, and refine account
management strategies to mitigate long-term credit losses. Delinquencies It is our policy to accrue interest and fee income on all credit card
accounts, except in limited circumstances, until we charge-off the account. In
November 2002, we stopped billing late fees once an account became 120 days
contractually delinquent and in March 2003, we stopped billing overlimit fees
once an account became 120 days contractually delinquent. 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 2 presents the
delinquency trends of our credit card loan portfolio. Table 2: Loan Delinquency  March 31,
    
    % of
    
    December 31,
    
    % of
    
    March 31,
    
    % of(Dollars in thousands)
    
    2004
    
    Total
    
    2003
    
    Total
    
    2003
    
    TotalLoans outstanding
    
    $
    74,085
    
    
    
    100
    %
    
    $
    128,615
    
    
    
    100
    %
    
    $
    686,285
    
    
    
    100
    %Loans contractually
delinquent:
 26




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##### Table of Contents



March 31,
    
    % of
    
    December 31,
    
    % of
    
    March 31,
    
    % of2004
    
    Total
    
    2003
    
    Total
    
    2003
    
    Total30 to 59 days
    
    
    2,543
    
    
    
    3.4
    %
    
    
    5,015
    
    
    
    3.9
    %
    
    
    20,921
    
    
    
    3.0
    %60 to 89 days
    
    
    2,336
    
    
    
    3.2
    %
    
    
    4,888
    
    
    
    3.8
    %
    
    
    18,390
    
    
    
    2.7
    %90 or more days
    
    
    6,200
    
    
    
    8.4
    %
    
    
    10,406
    
    
    
    8.1
    %
    
    
    17,108
    
    
    
    2.5
    %Total
    
    $
    11,079
    
    
    
    15.0
    %
    
    $
    20,309
    
    
    
    15.8
    %
    
    $
    56,419
    
    
    
    8.2
    %
 The decrease in the delinquency rate as of March 31, 2004 compared to
December 31, 2003 is a result of slightly improved credit quality. The
increase in the delinquency rate as of December 31, 2003 compared to March 31,
2003, resulted primarily from the sale of approximately $72.5 million
delinquent receivables during December 2002. Net Charge-Offs Net charge-offs are the principal amount of losses from cardholders
unwilling or unable to make minimum payments, bankrupt cardholders and deceased
cardholders, less current period recoveries. Net charge-offs exclude accrued
finance charges and fees, which are charged-off against the applicable 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
and 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 accounts. 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 $2.4 million, representing 10.5% of total
gross charge-offs as of March 31, 2004 and $5.5 million, representing 63.8% of
total gross charge-offs as of March 31, 2003. Table 3 presents our net
charge-offs for the periods indicated as reported in the consolidated financial
statements. Table 3: Net Charge-offs Three-Months EndedMarch 31,(Dollars in thousands)
    
    2004
    
    2003Average credit card loans
    
    $
    126,957
    
    
    $
    751,674Net charge-offs
    
    
    22,400
    
    
    
    8,289Net charge-off ratio (annualized)
    
    
    71.0
    %
    
    
    4.5
    %
 The increase in the net charge-off ratios for the three-months ended March
31, 2004 is due primarily to the impact of the transfer of approximately $38
million of loans to Loans held for sale during the quarter. The net
charge-off ratio for the three-months ended March 31, 2003 was impacted by the
sale of $72.5 million in delinquent receivables during the fourth quarter of
2002. Allowance for Loan Losses We record Provision 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. 27




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##### Table of Contents



In
order to mitigate credit losses, we have focused our collection
efforts 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 $4.4 million or 5.9% of total
credit card loans as of March 31, 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 2. The Allowance for loan losses was $18.9 million as of March 31, 2004,
versus $45.5 million as of December 31, 2003. Our roll-rate models indicated
our required allowance for loan losses was $19 million as of March 31, 2004,
versus $46 million as of December 31, 2003. The ratio of Allowance for loan
losses to period-end credit card loans was 25.6% at March 31, 2004, compared
to 35.4% at December 31, 2003. The allowance for loan losses as a percentage
of 30-day plus receivables was 171.0% at March 31, 2004, compared to 224.0% at
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. Retained Interests in Loans Securitized Our credit card receivables are primarily funded by asset securitizations
through the Metris Master Trust. Upon securitization, the Company removes the
applicable Credit card loans from the balance sheet and recognizes the
Retained interests in loans securitized at their allocated carrying value in
accordance with SFAS No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities-a replacement of FASB
Statement No. 125(SFAS No. 140). Credit card receivables may be sold to the
Metris Master Trust at the inception of a securitization series. We also sell
credit card 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 income (expense). At the same time, the Company
recognizes the Retained interests in loans securitized. The Retained interests in loans securitized are financial assets
measured at fair value consistent with trading securities in accordance with
SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities,and include the contractual retained interests, an interest-only
strip receivable, excess transferors interest, 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 interest represents 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 March 31, 2004 and December 31, 2003. Table 4: Retained interests in loans securitized March 31,
    
    December 31,(In thousands):
    
    2004
    
    2003Contractual retained interests
    
    $
    574,275
    
    
    $
    542,014
 28




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##### Table of Contents



March 31,
    
    December 31,2004
    
    2003Excess transferors interest
    
    
    32,031
    
    
    
    48,775Interest-only strip receivable
    
    
    26,652
    
    
    
    16,039Spread accounts receivable
    
    
    161,457
    
    
    
    230,073Retained interests in loans securitized
    
    $
    794,415
    
    
    $
    836,901
 Retained interests in loans securitized decreased by $42.5 million
between December 31, 2003 and March 31, 2004 to $794.4 million. The decrease
is primarily due to a $16.7 million decrease in excess transferors interest
and a $68.6 million decrease in spread accounts receivable, partially offset by
a $32.3 million increase in contractual retained interests and a $10.6 increase
in interest-only strip receivable. Contractual retained interests increased to $574.3 million as of March 31,
2004, from $542.0 million as of December 31, 2003. The $32.3 million increase
is due to the issuance of series 2004-A and a decrease in the weighted average
months to maturity on the outstanding series in the Metris Master Trust. The
interest-only strip receivable increased to $26.7 million as of March 31, 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. The projected
excess spreads have increased primarily due to a decrease in loss rates and
funding costs, partially offset by a decrease in finance charge yield. Spread
accounts receivable decreased $68.6 million over December 31, 2003 due to
reserve releases during the quarter. For more information on restricted cash
see the Liquidity, Funding and Capital Resources section of the Management
Discussion and Analysis on pages 30 through 33. 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 Policies
on page 31 for more information on the valuation of the Retained interests in
loans securitized). The significant assumptions used for estimating the fair
value of the Retained interests in loans securitized are as follows: Table 5: Significant assumptions used for estimating the fair value of retained
interests March 31,
    
    December 31,2004
    
    2003Monthly payment rate
    
    
    7.0
    %
    
    
    6.7
    %Gross yield (1)
    
    
    25.2
    %
    
    
    25.4
    %Annual interest expense and servicing fees
    
    
    4.0
    %
    
    
    4.2
    %Annual gross principal default rate
    
    
    20.4
    %
    
    
    20.7
    %Discount rate:Contractual retained interests
    
    
    16.0
    %
    
    
    16.0
    %Excess transferors interest
    
    
    16.0
    %
    
    
    16.0
    %Interest-only strip receivable
    
    
    30.0
    %
    
    
    30.0
    %Spread accounts receivable
    
    
    15.3
    %
    
    
    15.3
    %Weighted average months to maturity
    
    
    19.6
    
    
    
    24.5
  (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. Balance Sheet Analysis 29




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##### Table of Contents



Cash and Cash Equivalents Cash and cash equivalents increased $141.6 million to $320.0 million as of
March 31, 2004, compared to $178.5 million as of December 31, 2003. The
increase is primarily due to the release of approximately $119 million in
restricted cash from the Metris Master Trust. Loans Held for Sale and Credit Card Loans Credit card loans were $74.1 million as of March 31, 2004, compared to
$128.6 million as of December 31, 2003. The $54.5 million decrease is
primarily a result of approximately $38 million in Credit card loans
transferred to Loans held for sale as of March 31, 2004. 30




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##### Table of Contents



Other Assets Other assets decreased $12.0 million from $81.8 million at December 31,
2003 to $69.8 million at March 31, 2004. The decrease resulted primarily from
a $4.8 million fair value decrease in interest rate caps, and a $5.1 million
decrease in pre-paid expenses. Accounts Payable Accounts payable increased $23.4 million from $32.4 million at December
31, 2003 to $55.8 million at March 31, 2004. The increase resulted primarily
from amounts collected and owed on receivables sold to third parties. Accrued Expenses and Other Liabilities Accrued expenses and other liabilities increased from $76.0 million at
December 31, 2003 to $94.1 million at March 31, 2004. The $18.1 million
increase was primarily due to a $22.5 million increase in our deferred tax
liability. 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. The Metris Master Trust was formed in May 1995 pursuant to a pooling and
servicing agreement, as amended. Metris Receivables, Inc. (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 of securities. 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 March
31, 2004, 13 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 known as the
transferors interest. Generally, each series involves an initial reinvestment period, referred
to as the revolving period, in which principal payments on receivables
allocated to such series are returned to MRI and reinvested in new principal
receivables arising in the accounts. After the revolving period ends,
principal payments allocated to the series are then accumulated and used to
repay the investors. This period is referred to as the accumulation period,
and is followed by a controlled amortization period wherein investors are
repaid their invested amount. Currently, the Metris Master Trust does not have
any series in an accumulation period or controlled amortization period. The
scheduled accumulation and amortization periods are set forth in the 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 31




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##### Table of Contents



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, would restrict the release of cash to us from the
Metris Master Trust. This restricted cash provides additional security to the
investors 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, specifically the average of net excess
spread over a one to three-month period. 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 $7.0 billion and $7.5 billion as of March 31, 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 securitzed / sold
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. 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, and by the
capital markets. We use a variety of financing sources to manage liquidity,
funding, and interest rate risks. Table 6 summarizes our funding and liquidity
as of March 31, 2004 and December 31, 2003: Table 6: Liquidity, Funding and Capital Resources March 31, 2004
    
    December 31, 2003DMCCB
    
    Other
    
    Consolidated
    
    DMCCB
    
    Other
    
    ConsolidatedCash and due from
banks
    
    $
    28,591
    
    
    $
    238
    
    
    $
    28,829
    
    
    $
    29,399
    
    
    $
    2,677
    
    
    $
    32,076Federal funds sold
    
    
    50,300
    
    
    
    
    
    
    
    50,300
    
    
    
    25,300
    
    
    
    
    
    
    
    25,300Short-term
investments
    
    
    103,789
    
    
    
    137,127
    
    
    
    240,916
    
    
    
    71,829
    
    
    
    49,280
    
    
    
    121,109Total cash and cash
equivalents
    
    $
    182,680
    
    
    $
    137,365
    
    
    $
    320,045
    
    
    $
    126,528
    
    
    $
    51,957
    
    
    $
    178,485
 32




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##### Table of Contents



Table 6: Liquidity, Funding and Capital Resources (cont.) March 31, 2004
    
    December 31, 2003Unused
    
    
    
    
    
    UnusedOutstanding
    
    Capacity
    
    Outstanding
    
    CapacityOn-balance sheet funding10% senior notes  November 2004
    
    
    100,000
    
    
    
    N/A
    
    
    
    100,000
    
    
    
    N/A10.125% senior notes 
July 2006
    
    
    147,948
    
    
    
    N/A
    
    
    
    147,724
    
    
    
    N/ATerm loan  June 2004
    
    
    95,330
    
    
    
    N/A
    
    
    
    101,679
    
    
    
    N/AOther
    
    
    
    
    
    
    N/A
    
    
    
    1,045
    
    
    
    N/ADeposits
    
    
    5,621
    
    
    
    N/A
    
    
    
    6,262
    
    
    
    N/ASubtotal
    
    
    348,899
    
    
    
    N/A
    
    
    
    356,710
    
    
    
    N/AOff-balance sheet fundingMetris Master Trust:Term asset backed
securitizations 
various maturities through
January 2009
    
    
    5,900,000
    
    
    
    
    
    
    
    6,400,000
    
    
    
    Bank conduits 
various maturities
through
April 2004
    
    
    330,000
    
    
    
    
    
    
    
    196,000
    
    
    
    654,000Amortizing term series 
matured in February 2004
    
    
    
    
    
    
    
    
    
    
    99,200
    
    
    
    Subtotal
    
    
    6,230,000
    
    
    
    
    
    
    
    6,695,200
    
    
    
    654,000Total
    
    $
    6,578,899
    
    
    $
    
    
    
    $
    7,051,910
    
    
    $
    654,000
 As of March 31, 2004 and December 31, 2003, we had $5.9 million of letters
of credit issued under our revolving line of credit. Under our Credit
Agreement, we need to maintain, among other items, minimum equity plus reserves
to managed accounts receivable of 15%, a minimum three-month average excess
spread of 1% (on each individual series of securities issued under the Metris
Master Trust), minimum consolidated net worth of $750 million, and a ratio of
equity plus allowance for loan losses and discount on gross Retained interest
in loans securitized to managed 90-day plus delinquencies of 2.25.
Furthermore, the Company has pledged substantially all of its assets as
collateral on the Credit Agreement other than the assets of the Bank and Metris
Receivables, Inc. Our contractual cash obligations during the next twelve months as of March
31, 2004 were as follows: Long-term debt
    
    $
    195,330Operating leases
    
    
    10,419Deposits
    
    
    5,621Contractual purchase obligations
    
    
    61,494Total
    
    $
    272,864
 In addition to the contractual cash obligations, open-to-buy on credit
card accounts as of March 31, 2004 was $7.5 billion. 33




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##### Table of Contents



Our funding needs for 2004, as of March 31, 2004, included $1.65 billion
in maturing asset-backed financing and conduits in the Metris Master Trust,
$95.3 million outstanding on our $125 million term loan due in June 2004, and
$100 million of senior notes due in November 2004. Our strategies to meet these funding needs are portfolio attrition, new
conduit financing transactions, the renewal of some of these facilities, and
new securitizations. In April 2004, we announced the issuance of $200
million of three-year credit card asset-backed term securities. The proceeds
from this transaction were used to repay an outstanding paired-series, which
was due in May 2004. Also, in April 2004, we announced a two-year conduit
financing facility for $800 million, which was subsequently up-sized to $900
million, maturing in May 2006. This multi-series conduit financing will
act as a warehouse facility to allow maturing asset-backed security
transactions to be funded until we access the asset-backed markets.
Finally, in May 2004 we used cash on hand to pay off the
$95.3 million outstanding on our $125 million term loan due
June 2004 and closed on a $300 million term loan from a
group of investors that matures in May 2007. Part of the proceeds from this financing will
be used during the second quarter of 2004 to pay off the $100 million of senior notes. With these new transactions, we have completed our corporate funding
initiatives for 2004. Our receivable funding needs for the remainder of 2004
and 2005 will be covered by the $900 million conduit, portfolio attrition, and
future asset-backed securitizations. We have $1.5 billion of remaining
capacity in our MBIA commitment to provide insurance coverage on future
asset-backed security transactions. 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
Retained interests in loans securitized in the consolidated balance sheet. The following table shows the annualized yields, defaults, costs, and
excess spreads for the Metris Master Trust on a cash basis: Three-Months EndedMarch 31,
    
    December 31,
    
    March 31,(In thousands)
    
    2004
    
    2003
    
    2003Gross yield (1)
    
    $
    497,616
    
    
    
    27.46
    %
    
    $
    523,108
    
    
    
    26.39
    %
    
    $
    657,781
    
    
    
    27.71
    %Annual principal defaults
    
    
    348,984
    
    
    
    19.26
    %
    
    
    378,651
    
    
    
    19.10
    %
    
    
    508,200
    
    
    
    21.41
    %Net portfolio yield
    
    
    148,632
    
    
    
    8.20
    %
    
    
    144,457
    
    
    
    7.29
    %
    
    
    149,581
    
    
    
    6.30
    %Annual interest expense
and servicing fees
    
    
    62,764
    
    
    
    3.59
    %
    
    
    68,996
    
    
    
    3.67
    %
    
    
    88,169
    
    
    
    3.93
    %Net excess spread
    
    $
    85,868
    
    
    
    4.61
    %
    
    $
    75,461
    
    
    
    3.62
    %
    
    $
    61,412
    
    
    
    2.37
    %
  (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. 34




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##### Table of Contents



The following table shows the principal receivables and delinquent
principal receivables in the Metris Master Trust: March 31,
    
    December 31,
    
    March 31,(In thousands)
    
    2004
    
    2003
    
    2003Principal receivables
    
    $
    6,995,478
    
    
    
    
    
    
    $
    7,489,568
    
    
    
    
    
    
    $
    9,290,8392-cycle plus
delinquent principal
receivables
    
    
    610,470
    
    
    
    
    
    
    
    698,574
    
    
    
    
    
    
    
    930,281Principal
delinquency ratio
    
    
    8.7
    %
    
    
    
    
    
    
    9.3
    %
    
    
    
    
    
    
    10.0
    %
 The cash restricted from release 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 $188 million at March 31, 2004
and $294 million at December 31, 2003. As of March 31, 2004, $177.8 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 $14.2 million was restricted from release for maturity 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 maturity reserves. In addition, $12.2 million was restricted from
release for defeasance of the series 2001-1. The $77.6 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. We expect continued
restrictions on the release of a significant portion of our cash basis excess
spread throughout 2004. In December 2003, an Internal Revenue Service (IRS) examination team
submitted a request for a Technical Advice Memorandum (TAM) to its
Washington, D.C. National Office regarding certain aspects of the Companys
treatment of certain credit card fees as original issue discount (OID). With
this submission, the examination team has effectively withdrawn its 2002
proposed adjustment for tax returns filed through December 31, 1998. The
request for a TAM covers tax returns filed through December 31, 2001. Although
these fees are primarily reported as income when billed for financial reporting
purposes, we believe the fees constitute OID and should be deferred and
amortized over the remaining life of the underlying credit card loans for tax
purposes. Cumulatively as of December 31, 2001, the Company had deferred
approximately $210 million in federal income tax under the OID rules. An
assessment could ultimately require the Company to pay up to this amount of
federal tax plus state taxes and related interest. The rulings in the TAM and
the outcome of additional resolution activities for these years, if necessary,
will likely determine our tax treatment of credit card fees in subsequent
years. As of December 31, 2003, and March 31, 2004, the Company had deferred
cumulative federal income tax of approximately $179 million and $168 million,
respectively. We believe that our treatment of these fees is appropriate and
consistent with that of many other U.S. credit card issuers, and the
public guidance recently issued by the IRS regarding late fees.
However, the ultimate timing and amount of the final resolution
remain uncertain. We continue to work with the IRS to resolve this
matter and we do not expect any additional tax to be paid over the
next twelve months as a result of the examination activity. 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. Furthermore, certain of
our term asset-backed securitizations 35




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##### Table of Contents



require the restriction of cash if our
corporate debt ratings go below certain levels. The table below illustrates
the current debt ratings of MCI: StandardMoodys
    
    & Poors
    
    FitchMetris Companies Inc.Senior unsecured debt
    
    Caa2
    
    CCC-
    
    CCC
 Capital Adequacy In the normal course of business, Direct Merchants Bank enters into
agreements, or is subject to regulatory requirements, that result in cash, debt
and dividend or other capital restrictions. The Federal Reserve Act imposes various legal limitations on the extent to
which banks can finance or otherwise supply funds to their affiliates. In
particular, Direct Merchants Bank is subject to certain restrictions on any
extensions of credit to or other covered transactions, such as certain
purchases of assets, with MCI and its affiliates. Such restrictions limit
Direct
Merchants Banks ability to lend to MCI and its affiliates. Additionally,
Direct Merchants Bank is limited in its ability to declare dividends to MCI in
accordance with the National Bank Act dividend provisions. Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the OCC. At March 31, 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, and Direct
Merchants Bank was considered a well-capitalized depository institution under
regulations of the OCC, as illustrated in the following table. Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, Direct Merchants Bank must meet specific capital guidelines
that involve quantitative measures of assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices.
Direct Merchants Banks capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors. Quantitative measures established by regulation to ensure capital adequacy
require Direct Merchants Bank to maintain minimum amounts and ratios (set forth
in the following table) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 leverage
capital (as defined) to average assets (as defined in the regulations).
Failure to meet minimum capital requirements can initiate certain mandatory and
possibly additional discretionary actions by regulators that, if undertaken,
could have a direct material adverse effect on our financial statements. Additional information about Direct Merchants Banks actual capital
amounts and ratios are presented in the following table: To Be Adequately
    
    To Be WellActual
    
    Capitalized
    
    CapitalizedAs of March 31, 2004
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    RatioTotal Capital
    
    $
    252,827
    
    
    
    115.8
    %
    
    $
    17,460
    
    
    
    8.0
    %
    
    $
    21,825
    
    
    
    10.0
    %(to risk-weighted assets)
 36




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##### Table of Contents



To Be Adequately
    
    To Be WellActual
    
    Capitalized
    
    CapitalizedAs of March 31, 2004
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    RatioTier 1 Capital
    
    
    249,945
    
    
    
    114.5
    %
    
    
    8,730
    
    
    
    4.0
    %
    
    
    13,096
    
    
    
    6.0
    %(to risk-weighted assets)Tier 1 Capital
    
    
    249,945
    
    
    
    64.0
    %
    
    
    15,631
    
    
    
    4.0
    %
    
    
    19,539
    
    
    
    5.0
    %(to average assets)
 37




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##### Table of Contents



To Be Adequately
    
    To Be WellActual
    
    Capitalized
    
    CapitalizedAs of December 31, 2003
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    RatioTotal Capital
    
    $
    240,868
    
    
    
    140.0
    %
    
    $
    13,760
    
    
    
    8.0
    %
    
    $
    17,200
    
    
    
    10.0
    %(to risk-weighted assets)Tier 1 Capital
    
    
    238,328
    
    
    
    138.6
    %
    
    
    6,880
    
    
    
    4.0
    %
    
    
    10,320
    
    
    
    6.0
    %(to risk-weighted assets)Tier 1 Capital
    
    
    238,328
    
    
    
    70.2
    %
    
    
    13,589
    
    
    
    4.0
    %
    
    
    16,987
    
    
    
    5.0
    %(to average assets)
 FFIEC guidelines indicate that an institution with a concentration in
subprime lending should hold one and one-half to three times the normal minimum
capital required. 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 balance sheets as the Liquidity reserve
deposit. As of March 31, 2004, the balance of the liquidity reserve deposit
was $63 million. Finally, Direct Merchants Bank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, at a minimum, liquid assets of not less
than $35 million or 100% of the average highest daily funding
requirement for managed receivables.
    
    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 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. 38




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##### Table of Contents



The following information is not in conformity with accounting principles
generally accepted in the United States of America, however, we believe the
information is relevant to understanding the overall financial condition and
results of operations of the Company. Table 7: Managed Loan Portfolio March 31,
    
    % of
    
    December 31,
    
    % of
    
    March 31,
    
    % of(Dollars in thousands)
    
    2004
    
    Total
    
    2003
    
    Total
    
    2003
    
    TotalPeriod-end balances:Credit card loans
    
    $
    74,085
    
    
    
    
    
    
    $
    128,615
    
    
    
    
    
    
    $
    686,285Receivables held in the
Metris Master Trust
    
    
    7,461,916
    
    
    
    
    
    
    
    8,003,216
    
    
    
    
    
    
    
    9,989,060Managed
    
    $
    7,536,001
    
    
    
    
    
    
    $
    8,131,831
    
    
    
    
    
    
    $
    10,675,345Loans contractually
delinquent:Credit card loans
    
    
    11,079
    
    
    
    15.0
    %
    
    
    20,309
    
    
    
    15.8
    %
    
    
    56,419
    
    
    
    8.2
    %Receivables held in the
Metris Master Trust
    
    
    773,592
    
    
    
    10.4
    %
    
    
    881,767
    
    
    
    11.0
    %
    
    
    1,170,536
    
    
    
    11.7
    %Managed
    
    $
    784,671
    
    
    
    10.4
    %
    
    $
    902,076
    
    
    
    11.1
    %
    
    $
    1,226,955
    
    
    
    11.5
    %
 39




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##### Table of Contents



Three-Months EndedMarch 31,2004
    
    
    
    
    
    2003Average balances:Credit card loans
    
    $
    126,957
    
    
    
    
    
    
    $
    751,674Receivables held in the
Metris Master Trust
    
    
    7,787,351
    
    
    
    
    
    
    
    10,465,368Managed
    
    $
    7,914,308
    
    
    
    
    
    
    $
    11,217,042Net charge-offs:Credit card loans(1)
    
    
    22,400
    
    
    
    71.0
    %
    
    
    8,289
    
    
    
    4.5
    %Receivables held in the
Metris Master Trust
    
    
    327,607
    
    
    
    16.9
    %
    
    
    486,486
    
    
    
    19.0
    %Managed
    
    $
    350,007
    
    
    
    17.8
    %
    
    $
    494,775
    
    
    
    18.0
    %
  (1)
    
    Net charge-offs for the period ended March 31, 2004 include the
impact of a $38 million portfolio of credit card loans transferred to
Loans held for sale. The March 31, 2003 net charge-offs are
impacted by the sale of $72.5 million in delinquent credit card loans
during December, 2002. The decrease in the managed delinquency rates as of March 31, 2004 over
December 31, 2003 and March 31, 2003 primarily reflects an improvement in
credit quality in the Metris Master Trust. Management believes the improvement
in credit quality is more than seasonal and reflects the improvements we have
made in collections, account management, and new account underwriting. Total managed loans decreased $595.8 million to $7.5 billion as of March
31, 2004, compared to $8.1 and $10.7 billion as of December 31, 2003 and March
31, 2003, respectively. The reduction in credit cards loans from March 31,
2003 to March 31, 2004 is due in part to the sale of $1.1 billion in loans to
third-parties in September and November 2003. The remaining decrease between
March 31, 2004 and December and March 31, 2003 is a result of a reduction in
credit lines, tighter underwriting standards implemented in 2002, and fewer new
accounts. The amount of credit card receivables in debt forbearance programs
was $668.9 million or 9.0% of total managed loans as of March 31, 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. The managed net charge-off rate decreased 20 basis points for the
three-months ended March 31, 2004 compared to the same period in 2003 primarily
due to the improving credit quality in the Metris Master Trust. Charge-offs
due to bankruptcies were $107.7 million,
representing 22.2% of total managed gross charge-offs as of March 31, 2004
and $186.0 million, representing 35.7% of total managed gross charge-offs as of
March 31, 2003. In addition to those bankrupt accounts that were charged-off,
we received formal notification of $58.5 million and $86.2 million of managed
bankrupt accounts as of March 31, 2004 and 2003, respectively. 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 40




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##### Table of Contents



the use of terminology such as may, will, believes,
does not believe, no reason to believe, expects, plans, intends,
estimates, anticipated, or anticipates and similar expressions, as they
relate to the Company or our management. Forward-looking statements are based
on certain assumptions by management and are subject to risks and uncertainties
that could cause actual results to differ materially from those in the
forward-looking statements. These risks and uncertainties include, but are not limited to, our high
liquidity requirement 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 outcome of 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 39, Managements Discussion
and Analysis of Financial Condition and Results of Operations
on pages 20 - 37
hereof, and Quantitative and Qualitative Disclosures About Market Risk on
page 38 hereof. Although we have attempted to list comprehensively the major
risks and uncertainties, other factors may in the future prove to be important
in causing actual results to differ materially from those contained in any
forward-looking statement. Readers are cautioned not to
place undue reliance on any forward-looking statement, which speaks only
as of the date thereof. We undertake no obligation to update any
forward-looking statements, whether as a result of new information, future
events or otherwise. 
 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. 41




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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 is at fixed interest rates. At
March 31, 2004 and 2003, none of the securities issued out of the Metris Master
Trust and conduit funding of securitized receivables was 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 March 31,
2004, a 200-basis-point increase in interest rates affecting our floating rate
financial instruments, including both debt obligations and receivables, would
result in a decrease in net income of approximately $14.0 million relative to a
base case over the next 12 months, compared to an approximate $29.4 million
decrease of March 31, 2003 relative to a base case over the next 12 months. A
decrease of 200 basis points would result in an increase in Net income of
approximately $35.3 million as of March 31, 2004, and an increase of $43.0
million as of March 31, 2003. The change in sensitivity for the 200 basis point decrease is primarily
due to a smaller receivable base and the decreased impact on interest expense,
as interest expense cannot fall below zero. The change in sensitivity for the
200 basis point increase is primarily due to a smaller receivable base and a
higher percentage of receivables that will be impacted by a rate increase. 
 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 March 31, 2004, the design of 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 March
31, 2004, except as described below, 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. On November 17, 2003, our external auditors, KPMG LLP, issued a material
weakness report noting a material weakness in our policies and procedures for
estimating the fair value of our Retained interests in loans securitized and
associated revenue recognition. During the fourth quarter of 2003 and the
first quarter of 2004 we revised our valuation model and related policies,
procedures and assumptions to address the issues in the material weakness
report. During the period, the Company also identified and changed its
accounting policies to conform with accounting principles generally accepted in
the United States of America associated with the accounting for securitization
transaction costs, credit card solicitation costs, and debt waiver revenue
associated with receivables sold to the Metris Master Trust. The Company has not yet completed its evaluation (testing) of the
operating effectiveness of such controls. 42




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##### Table of Contents



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. Reference
is also made to Part I, Item 1, Business 
Regulatory Investigations of the
Companys Annual Report on Form 10-K/A for the fiscal year ended December 31,
2003, which summarizes the current SEC and OCC investigations, to
which we are currently subject. 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. Changes in Securities None 
 Item 3. Defaults Upon Senior Securities None 
 Item 4. Submission of Matters to a Vote of Security Holders No
matter was submitted to a vote of security holders during the quarter
ended March 31, 2004. 
 Item 5. Other Information None 
 Item 6. Exhibits and Reports on Form 8-K  (a)
    
    Exhibits  10.1
    
    Fifth Amendment to the Amended and Restated Senior
Secured Credit Agreement dated as of January 26, 2004, among
Metris Companies Inc., the Lenders from time to time parties to
the Senior Secured Credit Agreement, Deutsche Bank Trust
Companies America as Administrative Agent and Collateral Agent
(Incorporated by reference to Exhibit 10.5 to MCIs Report on Form 10-Q/A for the quarter ended September 30, 2003,
filed with the SEC on April 12, 2004 (File No. 1-12351)).11
    
    Computation of Earnings Per Share.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). 43




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##### Table of Contents



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.  (b)
    
    Reports on Form 8-K:On March 15, 2004, we filed a Current Report on Form 8-K to report
under Items 7, 9 and 12, the filing of a press release announcing (a)
financial results for our fourth quarter ended December 31, 2003, (b)
the receipt of a commitment from MBIA Insurance Corporation to
provide financial guaranty insurance policies to refinance a portion
of the Companys maturing asset-backed securitization transactions in
2004 and 2005, and (c) the late filing of our Annual Report on Form
10-K.On April 14, 2004, we filed a Current Report on Form 8-K to report
under Items 5 and 7, the filing of a press release announcing that
Metris Receivables, Inc., one of our wholly owned subsidiaries,
through the Metris Master Trust, has issued $200 million of
three-year credit card asset-backed term securities to institutional
investors.On April 19, 2004, we filed a Current Report on Form 8-K to report
under Items 7, 9 and 12, the filing of a press release announcing (a)
our results of operations for the first quarter of 2004, and (b)
entry into a definitive agreement to establish a two-year $800
million conduit facility for the purpose of financing credit card
receivables in the Metris Master Trust.On April 20, 2004, we filed a Current Report on Form 8-K to report
under Items 5 and 7, the filing of a press release announcing that we
were considering a private placement of Senior Secured Notes in an
aggregate principal amount of approximately $250 million. 44




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. METRIS COMPANIES INC.
(Registrant)Date: May 7, 2004
    
    By: /s/ John A. WithamJohn A. WithamExecutive Vice President and Chief Financial Officer(Principal Financial Officer and AuthorizedOfficer of Registrant)
 45