##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
   FORM 10-Q (Mark One) þ
    
    Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the quarterly period ended March 31, 2005 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
(State of Incorporation)
    
    41-1849591
(I.R.S. Employer Identification No.)
 10900 Wayzata Boulevard, Minnetonka, Minnesota 55305-1534
(Address of principal executive offices) (952) 525-5020
(Registrants telephone number) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ                                         No o Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). Yes þ                                         No o As of April 30, 2005, 58,182,708 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, 2005 PagePART I. FINANCIAL INFORMATIONItem 1.Consolidated Financial Statements:Consolidated Balance Sheets
    
    
    4Consolidated Statements of Income
    
    
    5Consolidated Statements of Changes in Stockholders Equity
    
    
    6Consolidated Statements of Cash Flows
    
    
    7Notes to Consolidated Financial Statements
    
    
    8Item 2.Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    21Item 3.Quantitative and Qualitative Disclosures About Market Risk
    
    
    39Item 4.Controls and Procedures
    
    
    40PART II. OTHER INFORMATIONItem 1.Legal Proceedings
    
    
    40Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    40Item 3.Defaults Upon Senior Securities
    
    
    40Item 4.Submission of Matters to a Vote of Security Holders
    
    
    40Item 5.Other Information
    
    
    41Item 6.Exhibits
    
    
    41Signatures
    
    
    43Certification of Principal Executive OfficerCertification of Principal Financial OfficerCertification of Principal Executive OfficerCertification of Principal Financial Officer
  2




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Forward-Looking Statements This Quarterly Report on Form 10-Q contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, which are subject to the safe harbor created by those sections.
Forward-looking statements include, without limitation: expressions of the belief,
anticipation, intent, or expectations of management; statements and information as to our
strategies and objectives; return on equity; changes in our managed loan portfolio; net interest
margins; funding costs; liquidity; cash flow; operating costs and marketing expenses; delinquencies
and charge-offs and industry comparisons or projections; statements as to industry trends or future
results of operations of the Company and its subsidiaries; and other statements that are not
historical fact. Forward-looking statements may be identified by the use of terminology such as
may, will, believes, does not believe, no reason to believe, expects, plans,
intends, estimates, anticipated, or anticipates and similar expressions, as they relate to
the Company or our management. Forward-looking statements are based on certain assumptions by
management and are subject to risks and uncertainties that could cause actual results to differ
materially from those in the forward-looking statements. These risks and uncertainties include, but are not limited to: the potential impact of any
failure to operate in accordance with OCC directives, including those included in our Modified
Operating Agreement; the ability of regulators to impose restrictions on Direct Merchants Bank that
could negatively impact our operations or financial results; the risk that failure to comply with
applicable laws and regulations, and adverse changes in those laws or regulations, could have a
negative impact on our financial results and could adversely affect our ability to conduct our
business in a profitable manner; the fact that we are the subject of an SEC investigation; that the
occurrence of certain events could result in early amortization (required repayment) of the
securities issued by the Metris Master Trust and also cause all amounts outstanding under our
existing senior notes to become due and payable; that our target consumers generally have higher
default rates and may be impacted more by general economic and social factors than lower default
consumers; that we require a high degree of liquidity to operate our business, and an inability to
access funding at the times and in the amounts that we need could adversely affect our ability to
operate or our financial results; that we are the subject of an Internal Revenue Service
examination; that changes in the interest rates on the funds we borrow and the amounts we loan to
our credit card customers could adversely affect our financial results; the fact that we face
intense competition; the fact that our financial results could be negatively impacted by
fluctuations in our interests in our securitizations; the fact that our restatements of financial
results have had, and may in the future continue to have, adverse effects on us; the risk that
disputes affecting MasterCard and Visa could negatively impact our operations and financial
results; and the fact that we are exposed to other industry-wide risks that could adversely affect
our financial performance. These risks are discussed in our Annual Report on Form 10-K for the year ended December 31,
2004 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 40, Managements
Discussion and Analysis of Financial Condition and Results of
Operations on pages 21 - 39 hereof,
and Quantitative and Qualitative Disclosures About Market Risk on page 39 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. 3




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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 31,2005
    
    
    December 31,(Unaudited)
    
    
    2004AssetsCash and due from banks
    
    $
    19,772
    
    
    $
    25,198Federal funds sold
    
    
    46,150
    
    
    
    22,450Short-term investments
    
    
    241,316
    
    
    
    43,070Cash and cash equivalents
    
    
    307,238
    
    
    
    90,718Available for sale securities
    
    
    
    
    
    
    306,409Liquidity reserve deposit
    
    
    63,977
    
    
    
    79,746Credit card loans
    
    
    61,956
    
    
    
    68,230Less: Allowance for loan losses
    
    
    9,830
    
    
    
    12,409Net credit card loans
    
    
    52,126
    
    
    
    55,821Retained interests in loans securitized
    
    
    865,576
    
    
    
    784,135Property and equipment, net
    
    
    23,293
    
    
    
    24,135Other receivables due from credit card
securitizations, net
    
    
    86,841
    
    
    
    68,021Other assets
    
    
    62,706
    
    
    
    72,494Total assets
    
    $
    1,461,757
    
    
    $
    1,481,479LiabilitiesDebt
    
    $
    324,231
    
    
    $
    373,624Accounts payable
    
    
    25,190
    
    
    
    37,619Accrued expenses and other liabilities
    
    
    137,014
    
    
    
    122,934Total liabilities
    
    
    486,435
    
    
    
    534,177Stockholders EquityConvertible preferred stock, par value $.01 per share;
10,000,000 shares authorized, 1,412,407 and 1,381,327
shares issued and outstanding, respectively
    
    
    526,122
    
    
    
    514,545Common stock, par value $.01 per share;
300,000,000 shares authorized, 65,225,015 and
65,182,416 issued, respectively
    
    
    652
    
    
    
    652Paid-in capital
    
    
    234,428
    
    
    
    233,989Treasury stock  7,055,300 shares
    
    
    (58,308
    )
    
    
    (58,308
    )Retained earnings
    
    
    272,428
    
    
    
    256,424Total stockholders equity
    
    
    975,322
    
    
    
    947,302Total liabilities and stockholders equity
    
    $
    1,461,757
    
    
    $
    1,481,479
 4




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METRIS COMPANIES INC. AND SUBSIDIARIES 
  (In thousands, except per share data) (Unaudited)
 Three Months EndedMarch 31,2005
    
    
    2004RevenuesLoss on new securitizations of receivables to the
Metris Master Trust
    
    $
    (29,161
    )
    
    $
    (1,246
    )Loss on replenishement of receivables to
the Metris Master Trust
    
    
    (11,497
    )
    
    
    (23,927
    )Discount accretion
    
    
    61,329
    
    
    
    59,970Interest-only revenue
    
    
    88,885
    
    
    
    74,932Change in fair value of retained interests in loans
securitized
    
    
    5,112
    
    
    
    47,965Transaction and other costs
    
    
    (6,612
    )
    
    
    (38,709
    )Securitization income
    
    
    108,056
    
    
    
    118,985Servicing income on securitized receivables
    
    
    29,420
    
    
    
    36,237Credit card loan and other interest income
    
    
    4,948
    
    
    
    5,106Credit card loan fees, interchange and other income
    
    
    2,780
    
    
    
    10,816Enhancement services income
    
    
    3,465
    
    
    
    7,480Gain on sale of membership club and warranty business
    
    
    1,800
    
    
    
    Total revenues
    
    
    150,469
    
    
    
    178,624ExpensesInterest expense
    
    
    11,381
    
    
    
    13,931Benefit for loan losses
    
    
    (948
    )
    
    
    (6,092
    )Marketing
    
    
    19,147
    
    
    
    15,932Employee compensation
    
    
    36,509
    
    
    
    38,945Data processing services and communications
    
    
    12,000
    
    
    
    16,472Credit protection claims expense
    
    
    5,413
    
    
    
    6,348Occupancy and equipment
    
    
    4,893
    
    
    
    6,401Other
    
    
    19,759
    
    
    
    22,375Total expenses
    
    
    108,154
    
    
    
    114,312Income before income taxes
    
    
    42,315
    
    
    
    64,312Income tax expense
    
    
    14,734
    
    
    
    22,702Net income
    
    
    27,581
    
    
    
    41,610Convertible preferred stock dividends
    
    
    11,577
    
    
    
    10,591Net income after preferred dividends
    
    $
    16,004
    
    
    $
    31,019Earnings per shareDistributed
    
    $
    
    
    
    $
    Undistributed
    
    
    0.15
    
    
    
    0.30Total Basic
    
    $
    0.15
    
    
    $
    0.30Total Diluted
    
    $
    0.15
    
    
    $
    0.30Shares used to compute earnings per shareBasic
    
    
    58,146
    
    
    
    57,791Diluted
    
    
    58,953
    
    
    
    58,318
 See accompanying Notes to Consoldiated Financial Statements. 5




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METRIS COMPANIES INC. AND SUBSIDIARIES 
  (In thousands) (Unaudited)
 Convertible
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    TotalNumber of Shares
    
    
    Preferred
    
    
    Common
    
    
    Paid - In
    
    
    Unearned
    
    
    Treasury
    
    
    Retained
    
    
    StockholdersPreferred
    
    
    Common
    
    
    Stock
    
    
    Stock
    
    
    Capital
    
    
    Compensation
    
    
    Stock
    
    
    Earnings
    
    
    EquityBalance at December 31, 2003
    
    
    1,264
    
    
    
    57,807
    
    
    $
    470,728
    
    
    $
    649
    
    
    $
    229,655
    
    
    $
    (27
    )
    
    $
    (58,308
    )
    
    $
    266,496
    
    
    $
    909,193Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    41,610
    
    
    
    41,610Convertible preferred stock dividends
    
    
    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
    
    
    $
    952,812Balance at December 31, 2004
    
    
    1,381
    
    
    
    58,127
    
    
    $
    514,545
    
    
    $
    652
    
    
    $
    233,989
    
    
    $
    
    
    
    $
    (58,308
    )
    
    $
    256,424
    
    
    $
    947,302Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27,581
    
    
    
    27,581Convertible preferred stock dividends
    
    
    31
    
    
    
    
    
    
    
    11,577
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,577
    )
    
    
    Issuance of common stock under
employee benefit plans
    
    
    
    
    
    
    43
    
    
    
    
    
    
    
    
    
    
    
    439
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    439Balance at March 31, 2005
    
    
    1,412
    
    
    
    58,170
    
    
    $
    526,122
    
    
    $
    652
    
    
    $
    234,428
    
    
    $
    
    
    
    $
    (58,308
    )
    
    $
    272,428
    
    
    $
    975,322
 See accompanying Notes to Consolidated Financial Statements. 6




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METRIS COMPANIES INC. AND SUBSIDIARIES 
  (In thousands) (Unaudited)
 Three Months EndedMarch 31,2005
    
    
    2004Operating ActivitiesNet income
    
    $
    27,581
    
    
    $
    41,610Adjustments to reconcile net income to net
cash provided by operating activities:Depreciation, amortization and accretion
    
    
    (53,154
    )
    
    
    (47,602
    )Benefit for loan losses
    
    
    (948
    )
    
    
    (6,092
    )Loss on credit card securitizations
    
    
    40,658
    
    
    
    25,173Gain of sale of membership club and warranty business
    
    
    (1,800
    )
    
    
    Market loss on derivative financial instruments
    
    
    328
    
    
    
    4,791Changes in operating assets and liabilities, net:Liquidity reserve deposit
    
    
    15,769
    
    
    
    17,352Fair value of retained interest in loans securitized
    
    
    (5,112
    )
    
    
    (47,965
    )Spread accounts receivable
    
    
    (23,218
    )
    
    
    97,154Other receivables due from credit card securitizations, net
    
    
    (18,820
    )
    
    
    (11,061
    )Accounts payable
    
    
    (12,429
    )
    
    
    23,419Accrued expenses and other liabilities
    
    
    14,375
    
    
    
    14,141Other
    
    
    5,850
    
    
    
    6,382Net cash (used in) provided by operating activities
    
    
    (10,920
    )
    
    
    117,302Investing ActivitiesProceeds from sales of available for sale securities
    
    
    837,155
    
    
    
    352,079Purchases of available for sale securities
    
    
    (530,746
    )
    
    
    (455,579
    )Net loans originated or collected
    
    
    379,402
    
    
    
    497,281Net sales and repayments of securitized loans
    
    
    (407,200
    )
    
    
    (465,200
    )Net additions to property and equipment
    
    
    (1,486
    )
    
    
    (851
    )Net cash provided by (used in) investing activities
    
    
    277,125
    
    
    
    (72,270
    )Financing ActivitiesRepayment of debt
    
    
    (50,000
    )
    
    
    (7,394
    )Proceeds from issuance of common stock
    
    
    315
    
    
    
    422Net cash used in financing activities
    
    
    (49,685
    )
    
    
    (6,972
    )Net increase in cash and cash equivalents
    
    
    216,520
    
    
    
    38,060Cash and cash equivalents at beginning of period
    
    
    90,718
    
    
    
    130,510Cash and cash equivalents at end of period
    
    $
    307,238
    
    
    $
    168,570Supplemental disclosures and cash flow informationCash paid (received) during the period for:Interest
    
    $
    14,843
    
    
    $
    11,576Income taxes
    
    
    1
    
    
    
    (249
    )
 See accompanying Notes to
Consolidated Financial Statements. 7




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METRIS COMPANIES INC. AND SUBSIDIARIES 
  (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 Bank), Metris Direct, Inc., and Metris Receivables, Inc.
(MRI). MCI and its subsidiaries, as applicable, may be referred to as we, us, our or the
Company. We are an information-based direct marketer of consumer lending products. All dollar amounts are presented as pre-tax amounts unless otherwise noted. We have
eliminated all intercompany balances and transactions in consolidation. During
the first quarter of 2005, we reclassified certain financial statement line items to
reflect the continuing operations of our business. In prior periods, we classified purchased
portfolio premium as an individual line item in Total assets. For all periods presented,
purchased portfolio premium is classified as Other assets on the consolidated balance sheets.
In prior periods, we classified deposits and deferred income as individual line items in Total
liabilities. For all periods presented, deposits and deferred income are classified as Accrued
expenses and other liabilities. In prior periods, we classified purchased portfolio premium
amortization and asset impairments, lease write-offs and severance as individual line items in
Total expenses. For all periods presented, purchased portfolio premium amortization and asset
impairments, lease write-offs and severance are classified as Other expenses on the consolidated
statements of income. Interim Financial Statements We have prepared the unaudited interim consolidated financial statements and related unaudited
financial information in the footnotes in accordance with accounting principles generally accepted
in the United States of America (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 consolidated financial statements and the notes
thereto contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2004.
The nature of our business, including the timing of asset-backed securitization transactions and
seasonal payment patterns, 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. The significant
factors susceptible to future change that have an impact on this estimate include default rates,
net interest spreads, payment rates, liquidity and the ability to finance future receivables
activity and overall economic conditions. As a result, the fair value of our Retained interests
in loans securitized as of March 31, 2005 and December 31, 2004, could materially differ from
these estimates. Comprehensive Income During the three months ended March 31, 2005 and 2004, we did not have any other comprehensive
income as defined by Statement of Financial Accounting Standards (SFAS) No. 130 Reporting
Comprehensive Income. As such, net income equals comprehensive income for all periods presented. 8




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NOTE 2  EARNINGS PER SHARE We calculate earnings per share in accordance with Emerging Issues Task
Force Issue
No. 03-6 Participating Securities and the two-class method under FASB Statement 128. This method
requires net income to be reduced by the amount of dividends declared in the current period for
each class of stock and by the contractual amount of dividends or other participation payments that
are paid or accumulated for the current period. Undistributed earnings for the period are
allocated to participating securities based on the contractual participation rights of the security
to share in those current earnings assuming all earnings for the period are distributed. Our
preferred stockholders have contractual participation rights on a converted basis that are
equivalent to those of common stockholders. Therefore, we allocate undistributed earnings to
preferred and common stockholders based on their respective ownership percentage, on a converted
basis, as of the end of the period. The following table presents the computation of earnings per share. Three Months EndedMarch 31,(In thousands, except per share data)
    
    2005
    
    
    2004Net income
    
    $
    27,581
    
    
    $
    41,610Convertible preferred stock dividends
    
    
    11,577
    
    
    
    10,591Net income after preferred dividends
    
    $
    16,004
    
    
    $
    31,019Convertible preferred stock dividends
    
    $
    11,577
    
    
    $
    10,591Weighted average preferred shares
    
    
    1,381
    
    
    
    1,264Distributed earnings per share - Preferred
    
    $
    8.38
    
    
    $
    8.38Undistributed income
    
    
    16,004
    
    
    $
    31,019Preferred ownership on a converted basis
    
    
    44
    %
    
    
    44
    %Preferred shareholders interest in undistributed income
    
    $
    7,042
    
    
    $
    13,648Weighted average preferred shares
    
    
    1,381
    
    
    
    1,264Undistributed earnings per share - Preferred
    
    $
    5.10
    
    
    $
    10.80Undistributed income
    
    $
    16,004
    
    
    $
    31,019Common owenership
    
    
    56
    %
    
    
    56
    %Common shareholder interest in undistributed income
    
    $
    8,962
    
    
    $
    17,371Weighted average common shares outstanding - Basic
    
    
    58,146
    
    
    
    57,791Common share equivalents
    
    
    807
    
    
    
    527Shares used to compute earnings per common share - Diluted
    
    
    58,953
    
    
    
    58,318Total basic earnings per share - Common
    
    
    0.15
    
    
    
    0.30Total diluted earning per share - Common
    
    
    0.15
    
    
    
    0.30
 9




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NOTE 3  SHARE-BASED COMPENSATION PLANS We recognize compensation expense for share-based employee compensation plans based on the
difference, if any, between the quoted market price of the stock on the measurement date and the
amount an employee must pay to acquire the stock. No expense has been recorded related to stock
options as all options granted had an exercise price equal to the market value of the underlying
common stock on the measurement date. During the three months ended March 31, 2005, we issued
approximately 570,000 restricted stock units to employees. The units vest over a one to eight year
period if certain earnings targets are met, or in some cases, if a change of control occurs. If
certain earnings targets are not met, the restricted stock units are cancelled. Upon vesting, each
restricted stock unit converts to one share of common stock that is distributable to the employee.
The fair value of the restricted stock units is expensed over the expected vesting period and
included in Employee compensation on the consolidated statements of income and Accrued expenses
and other liabilities on the consolidated balance sheets. We recognized approximately $1.0
million and $0 in expense related to restricted stock units, net of related tax benefit, for the
quarters ended March 31, 2005 and 2004, respectively. The following
table provides pro forma net income and earnings per share as if we accounted
for our equity compensation instruments under the fair value method.
The fair value of these instruments
was estimated at the grant date using a Black-Scholes option pricing
model. The fair value of  these instruments 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: Three Months EndedMarch 31,(In thousands, except per share data)
    
    2005
    
    
    2004Net income
    
    $
    27,581
    
    
    $
    41,610Add: Share-based employee compensation
expense (benefit) included in reported net income,
net of related tax effects
    
    
    954
    
    
    
    (8
    )Deduct:
Annual share-based employee
compensation expense (benefit) determined
based on the fair value for all awards, net of
related tax effects
    
    
    1,129
    
    
    
    (1,462
    )Pro forma net income
    
    $
    27,406
    
    
    $
    43,064Earnings per share:Basic-as reported
    
    $
    0.15
    
    
    $
    0.30Basic-pro forma
    
    $
    0.15
    
    
    $
    0.31Diluted-as reported
    
    $
    0.15
    
    
    $
    0.30Diluted-pro forma
    
    $
    0.15
    
    
    $
    0.31Weighted-average assumptions in option
valuation:Risk-free interest rates
    
    
    4.0
    %
    
    
    2.1
    %Stock volatility factor
    
    
    114.5
    %
    
    
    129.6
    %Expected life of options (in years)
    
    
    2.7
    
    
    
    2.7
 The above pro forma amounts may not be representative of the effects on net earnings for
future periods. 10




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NOTE 4  AVAILABLE FOR SALE SECURITIES Our Available for sale securities portfolio consists solely of investments in AA/Aa2 or
higher rated auction rate securities. Auction rate securities are term debt and/or equity
securities earning income at a rate that is frequently reset to reflect current market conditions
via an auction. The following table shows the fair value and cost of term debt and equity auction
rate securities outstanding at March 31, 2005 and December 31, 2004, respectively. Equity
securities available for sale are those auction rate securities with perpetual maturity dates. Fair Value and Cost of Available for SaleSecurities Oustanding as ofMarch 31,
    
    
    December 31,(In thousands)
    
    2005
    
    
    2004Debt SecuritiesLegal Final Maturity DateLess than 1 year
    
    $
    
    
    
    $
    10,0001 year - 5 years
    
    
    
    
    
    
    10,0005 years - 10 years
    
    
    
    
    
    
    Over 10 years
    
    
    
    
    
    
    24,420Total Debt Securities
    
    
    
    
    
    
    44,420Equity Securities
    
    
    
    
    
    
    261,989Total Available for Sale Securities
    
    $
    
    
    
    $
    306,409
 During the first quarter of 2005, we liquidated our portfolio of Available for sale
securities at par and invested the proceeds primarily in Short-term investments. Actual
maturities of our available for sale debt securities will vary from their legal final maturity
because on each reset date we buy and sell securities at par. As of December 31, 2004, reset dates
ranged from two to 31 days. At all times we invest in securities with reset dates of 90 days or
less. Due to the frequency with which the yields on these securities reset, cost approximates fair
market value and there is no resulting other comprehensive income. NOTE 5 - ALLOWANCE FOR LOAN LOSSES The activity in the Allowance for loan losses is as follows: Three Months EndedMarch 31,(In thousands)
    
    2005
    
    
    2004Balance at beginning of period
    
    $
    12,409
    
    
    $
    45,492Allowance related to assets re-acquired
    
    
    
    
    
    
    1,945Benefit for loan losses
    
    
    (948
    )
    
    
    (6,092
    )Principal receivables charged-off
    
    
    (2,811
    )
    
    
    (22,671
    )Recoveries
    
    
    1,180
    
    
    
    271Net principal receivables charged-off
    
    
    (1,631
    )
    
    
    (22,400
    )Balance at end of period
    
    $
    9,830
    
    
    $
    18,945
 Credit card loans greater than 30 days contractually past due for the periods ended March
31, 2005 and 2004, were $6.2 million and $11.1 million, respectively. On April 30, 2004, we sold approximately $38 million of Credit card loans from Direct Merchants Bank, which had a carrying value of $27.7 million, to a third party. Proceeds from the
sale were approximately $27.9 million. Included in principal receivables charged-off for the period ended March 31, 2004, is the impact of these loans being transferred to held for sale. 11




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NOTE 6  RETAINED INTERESTS IN LOANS SECURITIZED The following table shows the fair value of the components of the Retained interests in
loans securitized as of March 31, 2005 and December 31, 2004, respectively. March 31,
    
    
    December 31,(In thousands)
    
    2005
    
    
    2004Contractual retained interests
    
    $
    516,983
    
    
    $
    537,945Excess transferors interest
    
    
    180,886
    
    
    
    105,237Interest-only strip receivable
    
    
    83,460
    
    
    
    82,672Spread accounts receivable
    
    
    84,247
    
    
    
    58,281Retained interests in loans securitized
    
    $
    865,576
    
    
    $
    784,135
 The significant assumptions used in estimating the fair value of Retained interests in loans
securitized as of March 31, 2005 and December 31, 2004, are as follows. March 31,
    
    
    December 31,2005
    
    
    2004Monthly payment rate
    
    
    7.7
    %
    
    
    7.6
    %Gross yield (1)
    
    
    26.3
    %
    
    
    25.9
    %Annual interest expense and servicing fees
    
    
    5.4
    %
    
    
    5.0
    %Annual gross principal default rate
    
    
    18.2
    %
    
    
    18.4
    %Discount rate:Contractual retained interests
    
    
    15.0
    %
    
    
    16.0
    %Excess transferors interest
    
    
    15.0
    %
    
    
    16.0
    %Interest-only strip receivable
    
    
    30.0
    %
    
    
    30.0
    %Spread accounts receivable
    
    
    15.0
    %
    
    
    16.0
    %Weighted average months to maturity
    
    
    18.7
    
    
    
    20.1Weighted average enhancement level (2)
    
    
    12.5
    %
    
    
    12.1
    %Gross receivables held in the Metris Master Trust,
net of discount(3)
    
    
    92.8
    %
    
    
    92.3
    %
   (1)
 (2) Includes contractual retained interest and required minimum spread
reserve deposits. (3)Represents the ratio of Retained interests in loans securitized plus the
off-balance sheet receivables to gross receivables in the Metris Master Trust plus the gross
spread accounts receivable. At March 31, 2005, the sensitivity of the current fair value of the Retained interests in
loans securitized to immediate 10% and 20% adverse changes are as follows: Adverse Impact on Fair Value(In millions)
    
    10% Adverse Change
    
    
    20% Adverse ChangeAnnual discount rate
    
    $
    18.9
    
    
    $
    37.2Monthly principal payment rate
    
    
    3.1
    
    
    
    6.5Annual gross yield
    
    
    88.5
    
    
    
    195.9Annual interest expense and servicing fees
    
    
    28.1
    
    
    
    54.5Annual gross principal default rate
    
    
    59.6
    
    
    
    121.9
 As the sensitivity indicates, the value of the Companys Retained interests in loans
securitized on its consolidated balance sheets, as well as the potential impact to reported
earnings, could differ significantly if different assumptions were applied or different conditions
prevailed. 12




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NOTE 7  CONVERTIBLE PREFERRED STOCK Investors in a Thomas H. Lee Partners, L.P. (THL Partners) fund hold 100% of the outstanding
shares of our preferred stock. In general, the preferred stockholders are entitled to receive
quarterly dividends payable in additional shares of preferred stock (dividends in-kind). The
annual dividend rate is 9% through December 8, 2008, and 15% thereafter (except following a Change
in Control Triggering Event, as described below). Preferred stockholders are also entitled to
receive cash dividends paid on our common stock based on the number of shares of common stock into
which the preferred stock would convert on the record date of the dividend. The preferred
stockholders may also receive, in lieu of a dividend in-kind, dividends payable in cash, property
or other securities equivalent to a dividend in-kind if approved by 80% of the MCI Board of
Directors, which must include a majority of the directors elected by the preferred stockholders. So long as THL Partners or their affiliates own at least 25% of the originally issued
preferred stock (or any shares of common stock issued upon conversion thereof), the holders of a
majority of the shares of preferred stock are entitled to elect four of 11 directors of the MCIs
Board of Directors. So long as THL Partners or their affiliates own at least 10% but less than 25%

of the originally issued preferred stock (or any shares of common stock issued upon conversion
thereof), the holders of a majority of the shares of preferred stock are entitled to elect one
director of MCIs Board of Directors. Preferred stockholders have the right to vote on general
corporate matters with common stockholders on a converted basis. Each share of preferred stock is convertible into 30 shares of common stock and, if converted
before December 9, 2005, a premium amount guaranteeing dividends at the 9% rate through December 9,
2005. The preferred stockholders are able to convert at any time, and the preferred shares
automatically convert into common shares after December 9, 2005, if the common stock trades at a
share price of $21.33 or more for 20 consecutive days. As of March 31, 2005, the preferred stock
is convertible into 45,053,541 common shares, or approximately 43.7% of the outstanding common
stock on a converted basis. Before December 9, 2008, all of the preferred stock may be redeemed by paying 103% of the
redemption price of $372.50 per share and any accrued dividends at the time of redemption, but only
when (i) the common stock has traded at a share price of $21.33 or more for the most recent 20
consecutive trading days, and (ii) MCI has an unsecured corporate debt rating of at least Baa3 from
Moodys and BBB- from S&P. After December 9, 2008, we also have the option to redeem the preferred
stock without restriction, and without a premium, at $372.50 per share and any accrued dividends. If a Change in Control were to occur, we are obligated to offer redemption of the preferred
stock for cash at 101% of the greater of (i) the as-converted value of the preferred stock, or (ii)
$372.50 per share of preferred stock plus accrued and unpaid dividends payable at the rate of 9%
per annum through December 9, 2005 (such greater amount referred to as the Liquidation
Preference). THL Partners has the right, but is not obligated, to accept redemption of the
preferred stock. If an offer of redemption is not made, a Change in Control Trigger Event occurs
and, as a result, (i) additional shares of preferred stock are issued to the holders of preferred
stock such that the total number of outstanding shares of preferred stock equal the Liquidation
Preference divided by $372.50, (ii) the preferred stock dividend rate increases to 11.5% before
December 9, 2008, and 15% thereafter, and are due quarterly in cash, and (iii) MCI becomes subject
to limitations on indebtedness, the issuance of capital stock and we cannot pay any dividends or
make distributions on stock. If MCI fails to comply with any of the changes in terms, the dividend
rate increases another 2% and THL Partners can require the Company to purchase the preferred stock
at 101% of the Liquidation Preference. 13




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##### Table of Contents



NOTE 8  SUBSEQUENT EVENTS On April 6, 2005, the Company issued $544 million in series 2005-1 asset-backed securities
from the Metris Master Trust. On April 7, 2005, the Modified Operating Agreement entered into by MCI, Direct Merchants Bank
and the Office of the Comptroller of the Currency (OCC) was amended to reduce the minimum amount
of capital required to be held by Direct Merchants Bank from $213 million to $100 million. As a
result of the change to the Banks minimum capital requirements, the OCC approved a permanent
capital reduction of $130 million concurrent with the transfer of approximately $57 million in
remaining eligible credit card receivables from the Bank to MCI, which occurred on May 2, 2005.
MCI subsequently sold the majority of those receivables to the Metris Master Trust. The permanent
capital reduction was completed on May 6, 2005. Since
March 31, 2005, the Company has used proceeds
from existing Short-term investments and the permanent capital reduction to make optional
prepayments totaling $225 million on its senior-secured credit agreement due May 2007, resulting in
a total of approximately $18 million in costs and charges. As a result of the prepayments, MCI
paid off, in full, its remaining obligations owed under its $300 million senior secured credit
agreement effectively terminating the credit agreement. The impact from the issuance of series 2005-1 and the debt prepayments will be reflected in
the second quarter of 2005. NOTE 9  SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS The Senior Notes due 2006 are unconditionally guaranteed on a senior basis, jointly and
severally, by Metris Direct, Inc., magnUS Services, Inc., Metris Card Services, LLC and Metris
Credit Card Services, Inc. (the Guarantors). Any subsidiaries we form in the future may provide
a guarantee of this indebtedness. The guarantee is an unsecured obligation of the Guarantors and
ranks equally with all existing and future unsubordinated indebtedness. We also have various
indirect subsidiaries, which do not guarantee MCIs debt. We have prepared condensed consolidating
financial statements, which detail the Guarantor subsidiaries and the non-guarantor subsidiaries
for purposes of complying with SEC reporting requirements. Separate financial statements of the
Guarantor subsidiaries and the non-guarantor 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, 2005(In thousands) (Unaudited) Metris
    
    
    Guarantor
    
    
    Non-GuarantorCompanies Inc.
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedAssetsCash and due from banks
    
    $
    (2,260
    )
    
    $
    7
    
    
    $
    22,025
    
    
    $
    
    
    
    $
    19,772Federal funds sold
    
    
    
    
    
    
    
    
    
    
    46,150
    
    
    
    
    
    
    
    46,150Short-term investments
    
    
    73,062
    
    
    
    
    
    
    
    168,254
    
    
    
    
    
    
    
    241,316Cash and cash equivalents
    
    
    70,802
    
    
    
    7
    
    
    
    236,429
    
    
    
    
    
    
    
    307,238Liquidity reserve deposit
    
    
    
    
    
    
    
    
    
    
    63,977
    
    
    
    
    
    
    
    63,977Net credit card loans
    
    
    110
    
    
    
    
    
    
    
    52,016
    
    
    
    
    
    
    
    52,126Retained interest in loans
securitized
    
    
    5,313
    
    
    
    
    
    
    
    860,263
    
    
    
    
    
    
    
    865,576Property and equipment, net
    
    
    
    
    
    
    23,293
    
    
    
    
    
    
    
    
    
    
    
    23,293Other receivables due from
credit card
securitizations, net
    
    
    2
    
    
    
    
    
    
    
    86,839
    
    
    
    
    
    
    
    86,841Other assets
    
    
    31,218
    
    
    
    27,094
    
    
    
    56,710
    
    
    
    (52,316
    )
    
    
    62,706Investments in subsidiaries
    
    
    1,321,968
    
    
    
    1,132,237
    
    
    
    753
    
    
    
    (2,454,958
    )
    
    
    Total assets
    
    $
    1,429,413
    
    
    $
    1,182,631
    
    
    $
    1,356,987
    
    
    $
    (2,507,274
    )
    
    $
    1,461,757LiabilitiesDebt
    
    $
    465,205
    
    
    $
    (211,286
    )
    
    $
    113,312
    
    
    $
    (43,000
    )
    
    $
    324,231Accounts payable
    
    
    764
    
    
    
    16,434
    
    
    
    20,732
    
    
    
    (12,740
    )
    
    
    25,190Accrued expenses and other
liabilities
    
    
    (11,878
    )
    
    
    14,119
    
    
    
    127,304
    
    
    
    7,469
    
    
    
    137,014Total liabilities
    
    
    454,091
    
    
    
    (180,733
    )
    
    
    261,348
    
    
    
    (48,271
    )
    
    
    486,435Total stockholders equity
    
    
    975,322
    
    
    
    1,363,364
    
    
    
    1,095,639
    
    
    
    (2,459,003
    )
    
    
    975,322Total liabilities and
stockholders equity
    
    $
    1,429,413
    
    
    $
    1,182,631
    
    
    $
    1,356,987
    
    
    $
    (2,507,274
    )
    
    $
    1,461,757
 15




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METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
December 31, 2004(In thousands) Metris
    
    
    Guarantor
    
    
    Non-GuarantorCompanies Inc.
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedAssetsCash and due from banks
    
    $
    (1,102
    )
    
    $
    (178
    )
    
    $
    26,478
    
    
    $
    
    
    
    $
    25,198Federal funds sold
    
    
    
    
    
    
    
    
    
    
    22,450
    
    
    
    
    
    
    
    22,450Short-term investments
    
    
    6,065
    
    
    
    
    
    
    
    37,005
    
    
    
    
    
    
    
    43,070Cash and cash equivalents
    
    
    4,963
    
    
    
    (178
    )
    
    
    85,933
    
    
    
    
    
    
    
    90,718Available for sale securities
    
    
    50,000
    
    
    
    
    
    
    
    256,409
    
    
    
    
    
    
    
    306,409Liquidity reserve deposit
    
    
    
    
    
    
    
    
    
    
    79,746
    
    
    
    
    
    
    
    79,746Net credit card loans
    
    
    99
    
    
    
    
    
    
    
    55,722
    
    
    
    
    
    
    
    55,821Retained interest in loans
securitized
    
    
    8,686
    
    
    
    
    
    
    
    775,449
    
    
    
    
    
    
    
    784,135Property and equipment, net
    
    
    
    
    
    
    24,135
    
    
    
    
    
    
    
    
    
    
    
    24,135Other recievables due from
credit card
securitizations, net
    
    
    4
    
    
    
    
    
    
    
    68,017
    
    
    
    
    
    
    
    68,021Other assets
    
    
    34,117
    
    
    
    29,541
    
    
    
    54,830
    
    
    
    (45,994
    )
    
    
    72,494Investments in subsidiaries
    
    
    1,302,122
    
    
    
    1,110,022
    
    
    
    782
    
    
    
    (2,412,926
    )
    
    
    Total assets
    
    $
    1,399,991
    
    
    $
    1,163,520
    
    
    $
    1,376,888
    
    
    $
    (2,458,920
    )
    
    $
    1,481,479LiabilitiesDebt
    
    $
    462,282
    
    
    $
    (213,993
    )
    
    $
    168,335
    
    
    $
    (43,000
    )
    
    $
    373,624Accounts payable
    
    
    1,598
    
    
    
    21,761
    
    
    
    28,493
    
    
    
    (14,233
    )
    
    
    37,619Accrued expenses and otherliabilities
    
    
    (11,191
    )
    
    
    14,743
    
    
    
    104,285
    
    
    
    15,097
    
    
    
    122,934Total liabilities
    
    
    452,689
    
    
    
    (177,489
    )
    
    
    301,113
    
    
    
    (42,136
    )
    
    
    534,177Total stockholders equity
    
    
    947,302
    
    
    
    1,341,009
    
    
    
    1,075,775
    
    
    
    (2,416,784
    )
    
    
    947,302Total liabilities and
stockholders equity
    
    $
    1,399,991
    
    
    $
    1,163,520
    
    
    $
    1,376,888
    
    
    $
    (2,458,920
    )
    
    $
    1,481,479
 16




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Three Months Ended March 31, 2005(In thousands) (Unaudited) Metris
    
    
    Guarantor
    
    
    Non-GuarantorCompanies Inc.
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedRevenuesSecuritization income
    
    $
    2,955
    
    
    $
    
    
    
    $
    81,327
    
    
    $
    23,774
    
    
    $
    108,056Servicing income on securitized
receivables
    
    
    (59
    )
    
    
    
    
    
    
    29,479
    
    
    
    
    
    
    
    29,420Credit card loan and other interest
income
    
    
    350
    
    
    
    
    
    
    
    4,598
    
    
    
    
    
    
    
    4,948Credit card loan fees, interchange and
other income
    
    
    113
    
    
    
    28,429
    
    
    
    26,857
    
    
    
    (52,619
    )
    
    
    2,780Enhancement services income
    
    
    
    
    
    
    70
    
    
    
    3,414
    
    
    
    (19
    )
    
    
    3,465Gain on sale of membership club and
warranty business
    
    
    
    
    
    
    
    
    
    
    1,800
    
    
    
    
    
    
    
    1,800Intercompany allocations
    
    
    76
    
    
    
    36,984
    
    
    
    1,246
    
    
    
    (38,306
    )
    
    
    Total revenues
    
    
    3,435
    
    
    
    65,483
    
    
    
    148,721
    
    
    
    (67,170
    )
    
    
    150,469ExpensesInterest expense
    
    
    12,529
    
    
    
    (2,098
    )
    
    
    950
    
    
    
    
    
    
    
    11,381Provision (benefit) for loan losses
    
    
    62
    
    
    
    
    
    
    
    (1,010
    )
    
    
    
    
    
    
    (948
    )Marketing expenses
    
    
    
    
    
    
    17,054
    
    
    
    27,464
    
    
    
    (25,371
    )
    
    
    19,147Employee compensation
    
    
    
    
    
    
    35,270
    
    
    
    1,239
    
    
    
    
    
    
    
    36,509Data processing services and
communications
    
    
    11
    
    
    
    (11,212
    )
    
    
    26,083
    
    
    
    (2,882
    )
    
    
    12,000Credit protection claims expense
    
    
    
    
    
    
    
    
    
    
    5,413
    
    
    
    
    
    
    
    5,413Occupancy and equipment
    
    
    
    
    
    
    4,893
    
    
    
    
    
    
    
    
    
    
    
    4,893Other
    
    
    1,939
    
    
    
    12,138
    
    
    
    6,010
    
    
    
    (328
    )
    
    
    19,759Intercompany allocations
    
    
    40
    
    
    
    10,778
    
    
    
    27,488
    
    
    
    (38,306
    )
    
    
    Total expenses
    
    
    14,581
    
    
    
    66,823
    
    
    
    93,637
    
    
    
    (66,887
    )
    
    
    108,154(Loss) income before income
tax (benefit) expense and equity in
income of subsidiaries
    
    
    (11,146
    )
    
    
    (1,340
    )
    
    
    55,084
    
    
    
    (283
    )
    
    
    42,315Income tax (benefit) expense
    
    
    (3,881
    )
    
    
    (1,478
    )
    
    
    20,192
    
    
    
    (99
    )
    
    
    14,734Equity in income of subsidiaries
    
    
    34,846
    
    
    
    34,892
    
    
    
    
    
    
    
    (69,738
    )
    
    
    Net income
    
    $
    27,581
    
    
    $
    35,030
    
    
    $
    34,892
    
    
    $
    (69,922
    )
    
    $
    27,581
 17




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Three Months Ended March 31, 2004(In thousands) (Unaudited) Metris
    
    
    Guarantor
    
    
    Non-GuarantorCompanies Inc.
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedRevenuesSecuritization income
    
    $
    5
    
    
    $
    
    
    
    $
    87,257
    
    
    $
    31,723
    
    
    $
    118,985Servicing income on securitized
receivables
    
    
    (48
    )
    
    
    
    
    
    
    36,285
    
    
    
    
    
    
    
    36,237Credit card loan and other interest
income
    
    
    122
    
    
    
    
    
    
    
    4,984
    
    
    
    
    
    
    
    5,106Credit card loan fees, interchange and
other income
    
    
    1,227
    
    
    
    14,863
    
    
    
    40,163
    
    
    
    (45,437
    )
    
    
    10,816Enhancement services income
    
    
    
    
    
    
    113
    
    
    
    7,378
    
    
    
    (11
    )
    
    
    7,480Intercompany allocations
    
    
    316
    
    
    
    40,894
    
    
    
    753
    
    
    
    (41,963
    )
    
    
    Total revenues
    
    
    1,622
    
    
    
    55,870
    
    
    
    176,820
    
    
    
    (55,688
    )
    
    
    178,624ExpensesInterest expense
    
    
    13,955
    
    
    
    (2,578
    )
    
    
    2,554
    
    
    
    
    
    
    
    13,931Benefit for loan losses
    
    
    (1,317
    )
    
    
    
    
    
    
    (4,775
    )
    
    
    
    
    
    
    (6,092
    )Marketing expenses
    
    
    105
    
    
    
    11,492
    
    
    
    15,526
    
    
    
    (11,191
    )
    
    
    15,932Employee compensation
    
    
    
    
    
    
    38,019
    
    
    
    926
    
    
    
    
    
    
    
    38,945Data processing services and
communications
    
    
    5
    
    
    
    (15,738
    )
    
    
    35,427
    
    
    
    (3,222
    )
    
    
    16,472Credit protection claims expense
    
    
    
    
    
    
    
    
    
    
    6,348
    
    
    
    
    
    
    
    6,348Occupancy and equipment
    
    
    
    
    
    
    6,397
    
    
    
    4
    
    
    
    
    
    
    
    6,401Other
    
    
    407
    
    
    
    16,318
    
    
    
    6,356
    
    
    
    (706
    )
    
    
    22,375Intercompany allocations
    
    
    31
    
    
    
    11,413
    
    
    
    30,515
    
    
    
    (41,959
    )
    
    
    Total expenses
    
    
    13,186
    
    
    
    65,323
    
    
    
    92,881
    
    
    
    (57,078
    )
    
    
    114,312(Loss) income before income
tax (benefit) expense and equity in
income 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 of subsidiaries
    
    
    49,092
    
    
    
    52,789
    
    
    
    
    
    
    
    (101,881
    )
    
    
    Net income
    
    $
    41,610
    
    
    $
    48,193
    
    
    $
    52,789
    
    
    $
    (100,982
    )
    
    $
    41,610
 18




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Three Months Ended March 31, 2005(In thousands) (Unaudited) Metris
    
    
    Guarantor
    
    
    Non-GuarantorCompanies Inc.
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedOperating ActivitiesNet cash provided by (used in) operating
activities
    
    $
    29,112
    
    
    $
    (1,038
    )
    
    $
    (4,152
    )
    
    $
    (34,842
    )
    
    $
    (10,920
    )Investing ActivitiesProceeds from sales of available for
sale securities
    
    
    169,352
    
    
    
    
    
    
    
    667,803
    
    
    
    
    
    
    
    837,155Purchases of available for sale
securities
    
    
    (119,352
    )
    
    
    
    
    
    
    (411,394
    )
    
    
    
    
    
    
    (530,746
    )Net loans originated or collected
    
    
    3,942
    
    
    
    
    
    
    
    375,460
    
    
    
    
    
    
    
    379,402Net sales and repayments
of securitized loans
    
    
    
    
    
    
    
    
    
    
    (407,200
    )
    
    
    
    
    
    
    (407,200
    )Net additions to property and equipment
    
    
    
    
    
    
    (1,486
    )
    
    
    
    
    
    
    
    
    
    
    (1,486
    )Investment in subsidiaries
    
    
    (19,846
    )
    
    
    (22,215
    )
    
    
    28
    
    
    
    42,033
    
    
    
    Net cash provided by (used in) investing
activities
    
    
    34,096
    
    
    
    (23,701
    )
    
    
    224,697
    
    
    
    42,033
    
    
    
    277,125Financing ActivitiesNet increase (decrease) in debt
    
    
    2,316
    
    
    
    2,707
    
    
    
    (55,023
    )
    
    
    
    
    
    
    (50,000
    )Proceeds from issuance of common stock
    
    
    315
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    315Capital contributions
    
    
    
    
    
    
    22,217
    
    
    
    (15,026
    )
    
    
    (7,191
    )
    
    
    Net cash
provided by (used in) financing
activities
    
    
    2,631
    
    
    
    24,924
    
    
    
    (70,049
    )
    
    
    (7,191
    )
    
    
    (49,685
    )Net increase in cash and
cash equivalents
    
    
    65,839
    
    
    
    185
    
    
    
    150,496
    
    
    
    
    
    
    
    216,520Cash and cash equivalents at beginning
of period
    
    
    4,963
    
    
    
    (178
    )
    
    
    85,933
    
    
    
    
    
    
    
    90,718Cash and cash equivalents at end
of period
    
    $
    70,802
    
    
    $
    7
    
    
    $
    236,429
    
    
    $
    
    
    
    $
    307,238
 19




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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) Metris
    
    
    Guarantor
    
    
    Non-GuarantorCompanies Inc.
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedOperating ActivitiesNet cash provided by (used in) operating
activities
    
    $
    42,813
    
    
    $
    (7,231
    )
    
    $
    131,077
    
    
    $
    (49,357
    )
    
    $
    117,302Investing ActivitiesProceeds from sales of available for
sale securities
    
    
    
    
    
    
    
    
    
    
    352,079
    
    
    
    
    
    
    
    352,079Purchases of available for sale
securities
    
    
    
    
    
    
    
    
    
    
    (455,579
    )
    
    
    
    
    
    
    (455,579
    )Net loans originated or collected
    
    
    16,271
    
    
    
    
    
    
    
    479,846
    
    
    
    1,164
    
    
    
    497,281Net sales and repayments
of securitized loans
    
    
    
    
    
    
    
    
    
    
    (465,200
    )
    
    
    
    
    
    
    (465,200
    )Net additions to property and equipment
    
    
    
    
    
    
    (851
    )
    
    
    
    
    
    
    
    
    
    
    (851
    )Investment in subsidiaries
    
    
    (38,590
    )
    
    
    (43,186
    )
    
    
    
    
    
    
    81,776
    
    
    
    Net cash used in investing
activities
    
    
    (22,319
    )
    
    
    (44,037
    )
    
    
    (88,854
    )
    
    
    82,940
    
    
    
    (72,270
    )Financing ActivitiesNet (decrease) increase in debt
    
    
    (9,625
    )
    
    
    5,786
    
    
    
    (3,555
    )
    
    
    
    
    
    
    (7,394
    )Proceeds from issuance of common stock
    
    
    422
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    422Capital contributions
    
    
    
    
    
    
    43,186
    
    
    
    (9,603
    )
    
    
    (33,583
    )
    
    
    Net cash (used in) provided by financing
activities
    
    
    (9,203
    )
    
    
    48,972
    
    
    
    (13,158
    )
    
    
    (33,583
    )
    
    
    (6,972
    )Net increase (decrease) in cash and
cash equivalents
    
    
    11,291
    
    
    
    (2,296
    )
    
    
    29,065
    
    
    
    
    
    
    
    38,060Cash and cash equivalents at beginning
of period
    
    
    (1,081
    )
    
    
    3,034
    
    
    
    128,557
    
    
    
    
    
    
    
    130,510Cash and cash equivalents at end
of period
    
    $
    10,210
    
    
    $
    738
    
    
    $
    157,622
    
    
    $
    
    
    
    $
    168,570
 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 Bank), Metris Direct, Inc. and Metris Receivables, Inc.
(MRI). MCI and its subsidiaries, as applicable, may be referred to as we, us, our or the
Company. You should read this discussion along with Managements Discussion and Analysis of
Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year
ended December 31, 2004, filed with the Securities and Exchange Commission on March 11, 2005, for a
full understanding of our financial condition and results of operations. In addition, you should
read this discussion along with our consolidated financial statements and related notes thereto for
the period ended March 31, 2005, included herein. MCI was incorporated in Delaware on August 20, 1996, and completed an initial public offering
in October 1996. We provide financial products and services to middle market consumers throughout
the United States. MCI and its subsidiaries are information-based marketers of consumer lending
products throughout the United States. Our consumer lending products are primarily unsecured
credit cards, including the Direct Merchants Bank MasterCard® and Visa®credit cards. 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 earnings may fluctuate based on several factors, including the timing of asset-backed
securitization transactions and seasonal payment patterns. When securitization transactions occur
we incur Loss on new securitizations of receivables to the Metris Master Trust and increased
transaction costs. We incur losses on new securitizations due to the impact from our required
enhancement levels, the discount rate applied to cash flows and the assumed duration over which
those cash flows are discounted. During the first quarter of 2005, we saw continued signs of improving asset quality. The
three-month average excess spread in the Metris Master Trust for the quarter ended March 31, 2005,
was 6.47%. This excess spread is 161-basis-points higher than the 4.86% reported for the fourth
quarter of 2004, and 186-basis-points higher than the 4.61% reported for the first quarter of 2004.
The three-month average excess spread for the quarter ended March 31, 2005 includes an incremental
28-basis-points of yield due to recoveries resulting from sales of certain charged-off receivables,
including cease and desist, efforts exhausted and dismissed bankruptcies. Sales of these types of
charged-off receivables are not conducted on a regular monthly basis, but are conducted
periodically depending on market pricing. The remainder of the improvement in the excess spread
has been driven primarily by improvements in the overall credit quality of the portfolio. The
reported two-cycle plus delinquency rate in the Metris Master Trust decreased to 8.3% as of March
31, 2005, compared to 9.2% as of December 31, 2004, and 10.5% as of March 31, 2004. The average
principal default rate in the Metris Master Trust was 17.1% for the quarter ended March 31, 2005,
compared to 19.3% for the comparable period in 2004. We have also continued to see improved
performance in the early-stage delinquencies in the Metris Master Trust. As of March 31, 2005, the
first-cycle delinquency rate in the Metris Master Trust was 4.09%, compared to 4.40% as of December
31, 2004, and 4.38% as of March 31, 2004. We believe this improvement has resulted from revisions
to the operating strategies with which we manage our portfolio, significantly enhanced collection
efforts and improvements in the economy. The one-month London Interbank Offered Rate (LIBOR), the index which primarily drives our
cost of funds, increased to 2.87% as of March 31, 2005 from 2.40% at December 31, 2004. This
increase, and potential future increases, will result in a higher cost of funds on securities
issued out of the Metris Master Trust, which is partially offset by higher yields on our credit
card portfolio. We believe that impacts to our financial statements that result from increases in
interest rates may be mitigated by a variety of management strategies, including, but not limited
to, interest rate caps, portfolio re-pricing or the issuance of fixed rate debt. For further
information on the impact to us resulting from changes in interest rates, refer to Item 3 -
Quantitative and Qualitative Disclosures about Market Riskon page 39 of this Report. 21




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##### Table of Contents



In February 2005, we announced the defeasance of the $900 million series 2002-3 asset-backed
securities from the Metris Master Trust. Series 2002-3 was defeased through the use of our conduit
facility and was scheduled to mature in May 2005. The Company also issued $52.8 million of
asset-backed securities from the Metris Secured Note Trust 2004-2 during January of 2005. These
asset-backed securities are set to mature on October 20, 2006, and were rated Ba2/BB+ by Moodys
Investors Service, Inc. and Fitch Inc., respectively. Proceeds from the issuance were used to make
an optional $50 million prepayment on the Companys Senior Notes due 2006. We expensed
approximately $2.0 million in costs and charges related to the prepayment. During the first
quarter of 2005, the Company also reduced its conduit capacity from $1.2 billion to $1.0 billion.
Our receivable funding needs for 2005 and 2006 will be covered by future asset-backed securities
issuances and further portfolio attrition. We have $1.1 billion in remaining commitment from MBIA
Insurance Corporation (MBIA) to provide insurance coverage on future asset-backed securities
transactions, of which $800 million currently is available. The remaining $300 million of
commitment will become available to us when series 1999-3 matures. On April 6, 2005, the Company issued $544 million in series 2005-1 asset-backed securities
from the Metris Master Trust. On April 7, 2005, the Modified Operating Agreement entered into by MCI, Direct Merchants Bank
and the Office of the Comptroller of the Currency (OCC) was amended to reduce the minimum amount
of capital required to be held by Direct Merchants Bank from $213 million to $100 million. As a
result of the change to the Banks minimum capital requirements, the OCC approved a permanent
capital reduction of $130 million concurrent with the transfer
of approximately $57 million in
remaining eligible credit card receivables from the Bank to MCI, which occurred on May 2, 2005.
MCI subsequently sold the majority of those receivables to the Metris Master Trust. The permanent
capital reduction was completed on May 6, 2005. Since
March 31, 2005, the Company has used proceeds
from existing Short-term investments and the permanent capital reduction to make optional
prepayments totaling $225 million on its senior-secured credit agreement due May 2007, resulting in
a total of approximately $18 million in costs and charges. As a result of the prepayments, MCI
paid off, in full, its remaining obligations owed under its $300 million senior secured credit
agreement effectively terminating the credit agreement. The impact from the issuance of series 2005-1 and the debt prepayments will be reflected in
the second quarter of 2005. We continue to focus on strengthening the long-term operations of our business. Improvements
in losses, delinquencies and payment rates have been driven by tighter underwriting on new credit
card account originations, tighter credit line management on existing and new credit card accounts,
better pricing on offerings and improved collections initiatives. These improved results and our
stronger cash position are enabling us to focus on growing our business. During the quarter ended
March 31, 2005, we generated approximately 163,000 new accounts compared to 58,000 new accounts for
the same period in 2004. We are increasing our new account originations due to the continued
strong results we are experiencing in our 2003 vintages, our improved liquidity position and the
improved performance of the Metris Master Trust. We have experienced an improvement in
delinquencies in comparing our 2004 and 2003 vintages to our 2002 vintages at the same point in
time. Credit card originations in 2005 continue to reflect the discipline exhibited in our 2003
and 2004 originations and we expect these improved results will create a more reliable, predictable
and long-term receivables base. Our new account growth will remain focused on our traditional
target market, the middle-market consumer. We plan to continue to leverage our account origination
strategies, increase our efforts to penetrate the Hispanic customer segment, increase our
partnership and third-party marketing efforts and test additional products, channels and
incremental prospects. In January 2003, the Federal Financial Institutions Examination Council (FFIEC) issued
guidance with respect to various account management practices for institutions engaged in credit
card lending. The guidance provides requirements for certain operational and accounting policies,
which are designed to bring consistency in practice between institutions engaged in credit card
lending. We began implementing the guidance and believe we are now in compliance with most
aspects. In addition, we developed and have been executing against a multi-phased approach to
address the remaining aspects of this guidance, including receivable amortization. We expect to utilize various methods to ensure reasonable receivable amortization of our
accounts, including but not limited to: limiting consecutive fee billings; implementing a fee
billing cap; reducing customers interest rates; and increasing the required minimum payment due.
The impact of fully implementing the account management guidance, while not expected to be
significant, is unknown at this time. 22




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##### Table of Contents



Critical Accounting Estimates The Companys most critical accounting estimate is the valuation of our Retained interests
in loans securitized on our consolidated balance sheets associated with our securitization
transactions including contractual retained interests, excess transferors interest, interest-only
strip receivable and spread accounts receivable. We determine the fair value of each component of
the Retained interests in loans securitized at the time a securitization transaction or
replenishment sale is completed using a discounted cash flow valuation model and on a quarterly
basis thereafter. Increases to the fair value of each of the assets related to discount accretion
are recorded in Discount accretion. Any other change in the fair value is recorded in Change
in fair value of retained interests in loans securitized. 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 as of the balance sheet date amortizes with no new sales, interchange fees or cash
advances. The future cash flows are modeled in accordance with the Companys debt series legal
documents and are applied to all series on a pro-rata basis. The valuation model assumes that we
repurchase the outstanding principal receivables within each series at face value according to the
clean-up call provisions contained in the respective security series legal documents. The contractual retained interests represent subordinated securities held by us. There is no
stated interest or coupon rate associated with these securities and they are not rated. They are
subordinate to all other securities and, accordingly, are repaid last. Their fair value is
determined by discounting the expected future cash flows using a discount rate commensurate with
the risks of the underlying assets and the expected timing based on the scheduled maturity date
for the underlying securitization. If these securities are recoverable based on the Metris Master
Trust forecasts, cash flows related to the entire subordinated principal balance are used in
determining their fair value. Transferors interest represents an undivided interest in receivables that are not pledged to
support a specific security series or class, and represent our interest in the excess principal
receivables held in the Metris Master Trust. The fair value is determined in the same manner as
the contractual retained interests and is discounted based on 12 months-to-maturity. We have
subordinated our rights to the excess cash flows on the receivables underlying the transferors
interest, thus they are included in the value of the interest-only strip receivable. Spread account receivable balances represent interest-earning cash held by the Metris Master
Trust Trustee due to performance of the Metris Master Trust and minimum spread reserve deposits
required by certain security series. 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. The
expected future cash flows include the release of the spread account receivable balance on the
scheduled maturity date and estimated interest earned on the cash balances. The interest-only strip receivable represents the contractual right to receive excess spread
cash flows (portfolio collections, less principal charge-offs, financing costs and servicing
costs) from customer receivables over the estimated life of the amortizing receivables. The fair
value is determined by discounting the expected future cash flows using a discount rate
commensurate with the risks of the underlying assets based on the expected timing of cash flows in
the retained interests valuation model. Within the model, future excess spread cash flows are
first applied to meet spread accounts receivable requirements in accordance with the debt series
legal documents. When the spread accounts receivable requirements are met, cash is returned to us
and is valued as the interest-only strip receivable. We determine upper and lower valuation
limits of the interest-only strip receivable based on historical and forecasted excess spreads,
excluding interchange and cash advance fee collections. We then determine the best estimate
within the range, which has historically been weighted toward the low end of the range. We use certain assumptions and estimates in determining the fair value of Retained interests
in loans securitized. These assumptions and estimates include estimated principal payments,
credit losses, gross yield, interest expense, fees, the timing of cash receipts and discount rates
commensurate with the risks of the underlying assets. On a quarterly basis, we review and adjust,
as appropriate, the assumptions and estimates used in our model based on a variety of internal and
external factors, including national and economic trends and business conditions, current lending
policies, procedures and strategies, historical trends and assumptions about future trends,
competition and legal and regulatory requirements. Significant estimates are required in
determining these factors and different judgments concerning these factors can result in a
material impact on our consolidated balance sheets and statements of income. 23




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##### Table of Contents



Results of Operations Net income for the quarter ended March 31, 2005, was $27.6 million, a $14.0 million or 33.7%
decrease from net income of $41.6 million for the quarter ended March 31, 2004. The decrease in
net income is primarily due to a decrease in Securitization income, Servicing income on
securitized receivables and Credit card loan fees, interchange and other income, partially
offset by a reduction in operating expenses. Securitization income was $108.1 million for the quarter ended March 31, 2005,
compared to $119.0 million for the comparable period in 2004. The following table details
Securitization income for the quarters ended March 31, 2005 and 2004, respectively. Table 1: Analysis of Securitization Income Three Months EndedMarch 31,(In thousands)
    
    2005
    
    
    2004Loss on new securitizations of receivables to the
Metris Master Trust:Defeasance of maturing ABS series into conduit
    
    $
    (34,525
    )(1)
    
    $
    Amortizing term series financing
    
    
    
    
    
    
    (1,246
    )(3)Issuance of BB bonds
    
    
    5,364
    (2)
    
    
    (29,161
    )
    
    
    (1,246
    )Loss on replenishment of receivables to the Metris
Master Trust
    
    
    (11,497
    )
    
    
    (23,927
    )Discount accretion
    
    
    61,329
    
    
    
    59,970Interest-only revenue:Gross yield
    
    
    414,405
    
    
    
    486,792Principal defaults
    
    
    (249,571
    )
    
    
    (348,090
    )Interest expense and servicing fees
    
    
    (75,949
    )
    
    
    (63,770
    )88,885
    
    
    
    74,932Change in fair value of retained interests in loans securitized
    
    
    5,112
    
    
    
    47,965Transaction and other costs
    
    
    (6,612
    )
    
    
    (38,709
    )Securitization income
    
    $
    108,056
    
    
    $
    118,985
   (1)
    
    Loss represents $204 million of contractual retained interests (18.5% required subordination) discounted at 16% for 15 months and a $33 million
spread account receivable discounted at 16% for 15 months, partially offset by the present value of future 15 months assumed excess spread discounted at 30%.(2)
    
    Gain represents the reversal of the remaining discount (16% over 21 months) on $53 million of contractual retained interests, partially offset by a
$7 million interest reserve account discounted at 16% for 21 months and increased interest expense on $53 million of BB bonds discounted monthly at 30%.(3)
    
    Loss represents the discount on $113 million of contractual retained interests (18.5% required subordination) at 16% for one month, partially offset
by the present value of future one month assumed excess spread discounted at 30%. Loss on replenishment of receivables to the Metris Master Trust was $11.5 million for the
quarter ended March 31, 2005, a decrease of $12.4 million or 51.9% from $23.9 million for the
quarter ended March 31, 2004. The improvement was primarily due to an $11.5 million decrease
resulting from higher assumed excess spreads and a $3.1 million decrease due to a reduction in the
weighted average months-to-maturity on the outstanding securitization transactions, partially
offset by a $3.3 million increase due to an increase in the weighted average enhancement level on
the outstanding securitization transactions. Discount accretion was $61.3 million for the quarter ended March 31, 2005, a $1.3 million or
2.2% increase from $60.0 million for the quarter ended March 31, 2004. The increase was primarily
due to higher excess transferors interest and interest-only asset balances, partially offset by
lower contractual retained interest held in the Metris Master Trust and lower spread reserve
deposits primarily due to attrition and improved Metris Master Trust performance. 24




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##### Table of Contents



Interest-only revenue was $88.9 million for the quarter ended March 31, 2005, a $14.0
million or 18.7% increase from $74.9 million for the quarter ended March 31, 2004. The increase was
primarily due to a 186-basis-point increase in the three-month average excess spread in the Metris
Master Trust, partially offset by a $1.3 billion decrease in average principal receivables. Change in fair value of retained interests in loans securitized was income of $5.1 million
for the quarter ended March 31, 2005, a $42.9 million or 89.4% decrease from $48.0 million for the
quarter ended March 31, 2004. The decrease in the Change in fair value of retained interests in
loans securitized from the quarter ended March 31, 2004 was primarily due to a $42.3 million
decrease in the change in fair market value related to the change in conduit borrowings and
receivable attrition, and an $8.6 million decrease due to lower levels of trapped excess spread
released. These decreases were partially offset by a $10.3 million increase in Change in fair
value of retained interests in loans securitized due to the reduction of the discount rate for
contractual retained interest, transferor and restricted cash from 16.0% to 15.0%. The discount
rates were reduced to reflect a decrease in the overall risk of the assets in the Metris Master
Trust. Indicators of the reduced level of risk in the portfolio include improvements in credit
quality and excess spreads and improved access to the securitization markets. Transaction and other costs were $6.6 million for the quarter ended March 31, 2005, a $32.1
million or 82.9% decrease from $38.7 million for the quarter ended March 31, 2004. The decrease is
primarily due to a reduction in financing activity during the first quarter of 2005 over the
comparable period in 2004. Servicing income on securitized receivables was $29.4 million for the quarter ended March
31, 2005, a $6.8 million or 18.8% decrease from $36.2 million for the quarter ended March 31, 2004.
This reflects a $1.3 billion decrease in average principal receivables held by the Metris Master
Trust between the two periods. Credit card loan and other interest income was $4.9 million for the quarter ended March 31,
2005, a $0.2 million or 3.9% decrease from $5.1 million for the quarter ended March 31, 2004. This
decrease was due to a reduction in average owned credit loans of $61.4 million, partially offset by
an increase in interest income as a result of the rising interest rate environment. Credit card loan fees, interchange and other income, was $2.8 million for the quarter ended
March 31, 2005, an $8.0 million or 74.1% decrease from $10.8 million for the quarter ended March
31, 2004. The decrease resulted from the reduction in average owned credit card loans of $61.4
million quarter over quarter and a $4.0 million reduction in servicing income on receivables sold
to third parties. Enhancement services income was $3.5 million for the quarter ended March 31, 2005, a $4.0
million or 53.3% decrease from $7.5 million for the quarter ended March 31, 2004. The $4.0 million
decrease resulted primarily from the declining number of memberships following the sale of our
membership club and warranty business in 2003. Gain on sale of membership club and warranty business was $1.8 million for the quarter ended
March 31, 2005. This revenue resulted from the recognition of the remaining deferred portion of
the gain due to the expiration of our obligations under a temporary servicing agreement with the
purchaser. Interest expense was $11.4 million for the quarter ended March 31, 2005, a $2.5 million or
18.0% decrease from $13.9 million for the quarter ended March 31, 2004. This decrease resulted
primarily from the $50.0 million prepayment on our Senior Notes due 2006 and the $75.0 million in
prepayments on our $300 million Term Loan subsequent to the quarter ended March 31, 2004, partially
offset by higher interest rates on our $300 million Term Loan. Marketing expenses were $19.1 million for the quarter ended March 31, 2005, a $3.2 million
or 20.1% increase from $15.9 million for the quarter ended March 31, 2004. The increase was
primarily due to increased account marketing. We booked approximately 163,000 accounts in the
first quarter of 2005 compared to 58,000 for the quarter ended March 31, 2004. Employee compensation was $36.5 million for the quarter ended March 31, 2005, a $2.4 million
or 6.2% decrease from $38.9 million for the quarter ended March 31, 2004. This decrease resulted
from a reduction in the number of employees required to service fewer gross active accounts,
partially offset by an increase in performance based compensation. Data processing services and communications, Credit protection claims expense and
Occupancy and equipment totaled $22.3 million for the quarter ended March 31, 2005, a $6.9
million or 23.6% decrease from $29.2 million for the quarter ended March 31, 2004. This decrease
resulted primarily from a reduction in gross active accounts between the two periods. 25




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##### Table of Contents



Other expenses were $19.8 million for the quarter ended March 31, 2005, a $2.6 million or
11.6% decrease from $22.4 million for the quarter ended March 31, 2004. The following table
illustrates the components of Other expenses for the quarters ended March 31, 2005 and 2004,
respectively. Table 2: Other Expenses Three Months EndedMarch 31,(In thousands)
    
    2005
    
    
    2004MasterCard/Visa assessment and fees
    
    $
    1,677
    
    
    $
    1,809Credit card fraud losses
    
    
    533
    
    
    
    510Legal fees
    
    
    861
    
    
    
    219Collection and risk management
    
    
    3,091
    
    
    
    4,094Other professional fees
    
    
    4,581
    
    
    
    5,402Purchased portfolio premium amortization
    
    
    1,709
    
    
    
    2,397Asset impairment, lease write-offs and severance
    
    
    35
    
    
    
    1,461General and administrative expenses
    
    
    4,674
    
    
    
    6,483Other
    
    
    2,598
    
    
    
    Total other expenses
    
    $
    19,759
    
    
    $
    22,375
 The other component of Other expenses for the quarter ended March 31, 2005, is primarily
comprised of expenses related to the $50 million debt prepayment made during the first quarter of
2005, including a prepayment penalty and the write-off of capitalized debt costs. Retained Interests in Loans Securitized Our credit card receivables are primarily funded through asset-backed securitizations. Upon
securitization, we remove the applicable Credit card loans from our consolidated balance sheets
and recognize 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). We
sell some assets to the Metris Master Trust at the inception of a securitization series. We also
sell receivables to the Metris Master Trust on a daily basis to replenish principal 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 on our consolidated statements of income. At the same time,
we recognize Retained interests in loans securitized on our consolidated balance sheets. These
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 our contractual retained interests, an interest-only
strip receivable, excess transferors interests and spread accounts receivable. The contractual
retained interests consist of non-interest bearing securities held by us. 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 such loans are
assumed to be outstanding over the interest paid on investor certificates, credit losses,
contractual servicing fees and other expenses. The excess transferors interests represent
principal receivables held in the Metris Master Trust in excess of the contractual retained
interests. Spread accounts receivable represent restricted cash reserve accounts held by the
Metris Master Trust that can be used to fund payments due 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
related 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 assumed repayment term and the credit risk of the securitized loans. The following table summarizes our Retained interests in loans securitized as of March 31,
2005, and December 31, 2004, respectively. 26




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##### Table of Contents



Table 3: Retained interest in loans securitized March 31,
    
    
    December 31,(In thousands)
    
    2005
    
    
    2004Contractual retained interests
    
    $
    516,983
    
    
    $
    537,945Excess transferors interest
    
    
    180,886
    
    
    
    105,237Interest-only strip receivable
    
    
    83,460
    
    
    
    82,672Spread accounts receivable
    
    
    84,247
    
    
    
    58,281Retained interests in loans securitized
    
    $
    865,576
    
    
    $
    784,135
 The contractual retained interests were $517.0 million as of March 31, 2005, a $20.9 million
or 3.9% decrease from $537.9 million as of December 31, 2004. The decrease resulted from a $364.0
million reduction in principal receivables in the Metris Master Trust, partially offset by a slight
increase in the weighted average enhancement level and a 1.4 month decrease in the weighted average
months-to-maturity on the outstanding series in the Metris Master Trust. The excess transferors interests were $180.9 million as of March 31, 2005, a $75.7 million or
72.0% increase from $105.2 million as of December 31, 2004, due primarily to the pay-down of our
variable funding conduits. The interest-only strip receivable was $83.5 million as of March 31, 2005, a $0.8 million or
1.0% increase from $82.7 million as of December 31, 2004. The increase is due to higher assumed
excess spreads from receivables held in the Metris Master Trust, partially offset by a $364.0
million reduction in principal receivables. The assumed excess spread has increased from 2.58% at
December 31, 2004 to 2.68% at March 31, 2005 primarily due to a decrease in the assumed principal
default rates, partially offset by net yield compression resulting from an assumed increase in
interest rates. Spread accounts receivable were $84.2 million as of March 31, 2005, a $25.9 million or 44.4%
increase from $58.3 million as of December 31, 2004. The increase is due to a newly required
minimum spread reserve deposit associated with the defeasance of the Series 2002-3 asset-backed
securitization into our conduit and the establishment of an interest reserve related to the
issuance of BB bonds on Series 2004-2, partially offset by a release of required minimum spread
reserve deposits related to conduit pay-downs. For more information on restricted cash, see the
Off Balance Sheet Arrangementssection of Managements Discussion and Analysis of Financial
Condition and Results of Operationson pages 31-33. At least quarterly, we adjust our 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 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 discount rates used to estimate the fair value of the retained interest assets are
commensurate with the risk associated with the underlying expected future cash flows. Indicators
of the level of risk inherent in the portfolio include delinquency and loss rates and expectations
surrounding interest rates. Other factors that would impact the risk assessment include changes to
our corporate capital structure, corporate ratings or securitization enhancement levels. Changes
in expectations as to the level of risk related to future cash flows may result in changes to the
discount rate assumption. (See Critical Accounting Estimateson page 23 for more information on the
valuation of the Retained interests in loans securitized.) 27




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The significant assumptions we use in estimating the fair value of the Retained interests in
loans securitized are as follows: March 31,
    
    
    December 31,2005
    
    
    2004Monthly payment rate
    
    
    7.7
    %
    
    
    7.6
    %Gross yield (1)
    
    
    26.3
    %
    
    
    25.9
    %Annual interest expense and servicing fees
    
    
    5.4
    %
    
    
    5.0
    %Annual gross principal default rate
    
    
    18.2
    %
    
    
    18.4
    %Discount rate:Contractual retained interests
    
    
    15.0
    %
    
    
    16.0
    %Excess transferors interest
    
    
    15.0
    %
    
    
    16.0
    %Interest-only strip receivable
    
    
    30.0
    %
    
    
    30.0
    %Spread accounts receivable
    
    
    15.0
    %
    
    
    16.0
    %Weighted average months to maturity
    
    
    18.7
    
    
    
    20.1Weighted average enhancement level (2)
    
    
    12.5
    %
    
    
    12.1
    %Gross receivables held in the Metris Master Trust,
net of discount(3)
    
    
    92.8
    %
    
    
    92.3
    %
   (1)
    
    Includes expected cash flows from finance charges, late and overlimit
fees, debt waiver premiums and bad debt recoveries. Gross yield for purposes of
estimating fair value does not include cash flows from interchange income or cash
advance fees.(2)
    
    Includes contractual retained interest and required minimum spread
reserve deposits.(3)
    
    Represents the ratio of Retained interests in loans securitized plus
the off-balance sheet receivables to gross receivables in the Metris Master Trust
plus the gross spread accounts receivable. Effective March 31, 2005, we reduced the discount rate applied to the contractual retained
interests, excess transferors interest and spread accounts receivable from 16.0% to 15.0%. The
discount rates were reduced to reflect a decrease in the overall risk of the assets in the Metris
Master Trust. Indicators of the reduced level of risk in the portfolio include improvements in
credit quality and excess spreads and improved
access to the securitization markets. The impact of the decrease in the discount rate was an
incremental $10.3 million of revenue included in the Change in fair value of retained interests in
loans securitized on the consolidated statements of income for the quarter ended March 31, 2005. 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 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
credit card accounts and on collection efforts. We also use credit line assignment, customer transaction authorization controls and account
management strategies to minimize loan losses. Our internal 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, risk profile and payment patterns. We continually monitor customer
accounts and initiate appropriate collection activities when an account is delinquent or overlimit. 28




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##### Table of Contents



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. We do not bill or accrue late and
overlimit fees on accounts greater than 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 12 months and two
times every five years. Accounts entering long-term fixed payment debt management programs may
receive a re-age upon entering the debt management program (workout re-age.) Workout re-ages can
only occur after receipt of at least three consecutive minimum monthly payments, or the equivalent
cumulative amount, as defined by the debt management program. Workout re-ages can only occur once
in five years, in accordance with FFIEC guidelines. Table 5 presents the delinquency trends of our
owned credit card loan portfolio as of the dates specified below. Table 5: Loan Delinquency March 31,
    
    
    % of
    
    
    December 31,
    
    
    % of
    
    
    March 31,
    
    
    % of2005
    
    
    Total
    
    
    2004
    
    
    Total
    
    
    2004
    
    
    Total(Dollars in thousands)Loans outstanding
    
    $
    61,956
    
    
    
    100
    %
    
    $
    68,230
    
    
    
    100
    %
    
    $
    74,085
    
    
    
    100
    %Loans contractually delinquent:30 to 59 days
    
    
    1,339
    
    
    
    2.1
    %
    
    
    1,750
    
    
    
    2.6
    %
    
    
    2,543
    
    
    
    3.4
    %60 to 89 days
    
    
    1,414
    
    
    
    2.3
    %
    
    
    1,722
    
    
    
    2.5
    %
    
    
    2,336
    
    
    
    3.2
    %90 or more days
    
    
    3,452
    
    
    
    5.6
    %
    
    
    4,309
    
    
    
    6.3
    %
    
    
    6,200
    
    
    
    8.4
    %Total
    
    $
    6,205
    
    
    
    10.0
    %
    
    $
    7,781
    
    
    
    11.4
    %
    
    $
    11,079
    
    
    
    15.0
    %
 The decrease in the delinquency rate as of March 31, 2005 compared to both December 31, 2004
and March 31, 2004 is a result of overall improved credit quality. 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 (i) within 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 programs and later become contractually 120 days past due; (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; or (v) within 120 days of notification of the death of a cardholder. In the owned portfolio, charge-offs due to bankruptcies were $0.6 million, representing 14.6%
of total gross charge-offs for the three months ended March 31, 2005, and $2.4 million,
representing 10.5% of total gross charge-offs for the three months ended March 31, 2004. Table 6
presents our net charge-offs for the periods indicated as reported in the consolidated financial
statements. We enter into forward-flow agreements with third parties for the sale of a majority of
charged-off accounts. When appropriate, we place accounts with external collection agencies or
attorneys. 29




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##### Table of Contents



Table 6 presents our owned net charge-offs for the periods indicated as reported in the
consolidated financial statements: Table 6: Net Charge-offs Three Months EndedMarch 31,(Dollars in thousands)
    
    2005
    
    
    2004Average credit card loans
    
    $
    65,571
    
    
    $
    126,957Net charge-offs
    
    
    1,631
    
    
    
    22,400Net charge-off ratio (annualized)
    
    
    10.1
    %
    
    
    71.0
    %
 The decrease in the net charge-off ratios between the quarter ended March 31, 2005 and 2004 is
due primarily to the impact of the transfer of approximately $38 million in Credit card loans to
loans held for sale during the quarter ended March 31, 2004 and a slight improvement in the credit
quality of the remaining Credit card loans. We also take accounts as a loss when they are identified as fraud losses no later than 90 days
from discovery. These charge-offs are included in Other expenses on the consolidated statements
of income. Provision and Allowance for Loan Losses We record provision (benefit) 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. We believe the Allowance for loan losses is adequate to
cover probable future losses inherent in the loan portfolio under current conditions. However, we
cannot give assurance as to future credit losses that may be incurred in connection with our loan
portfolio, nor can we provide assurance that the established Allowance for loan losses will be
sufficient to absorb all potential future losses. We leverage debt management 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 owned receivables in debt management programs was $3.3 million or 5.3% of total Credit
card loans as of March 31, 2005, compared to $3.5 million or 5.1% of total Credit card loans as
of December 31, 2004. All delinquent receivables in debt forbearance programs are included in
Table 5. Balance Sheet Analysis Cash and Cash Equivalentsand Available for Sale Securities Cash and cash equivalents and Available for sale securities were $307.2 million as of
March 31, 2005, a decrease of $89.9 million or 22.6% from $397.1 million as of December 31, 2004.
This decrease resulted primarily from the $50.0 million optional prepayment of our Senior Notes due
2006 and a $23.2 million increase in cash restricted from release due primarily to additional
enhancement required on new asset-backed securities transactions. Other Receivables Due from Credit Card Securitizations, Net Other receivables due from credit card securitizations, net were $86.8 million as of March
31, 2005, an increase of $18.8 million or 27.6% from $68.0 million as of December 31, 2004. The

increase is primarily due to continuing favorable excess spreads in the Metris Master Trust. 30




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##### Table of Contents



Other Assets Other assets were $62.7 million as of March 31, 2005, a decrease of $9.8 million or 13.5%
from $72.5 million at December 31, 2004. This decrease resulted primarily from amortization of
certain prepaid costs of $2.9 million, receipt of a $1.5 million receivable from the third party
purchaser of our membership club and warranty business and a $4.0 million reduction in previously
deferred balances resulting from the termination of our obligations under a temporary servicing
agreement with that third party purchaser. Debt Debt was $324.2 million as of March 31, 2005, a decrease of $49.4 million or 13.2% from
$373.6 million at December 31, 2004. This decrease resulted primarily from the $50.0 million
prepayment on our Senior Notes due 2006. Accounts Payable Accounts payable were $25.2 million as of March 31, 2005, a decrease of $12.4 million or
33.0% from $37.6 million at December 31, 2004. The decrease resulted primarily from the timing of
payments for various marketing and operational expenses. Accrued Expenses and Other Liabilities Accrued expenses and other liabilities were $137.0 million at March 31, 2005, an increase of
$14.1 million or 11.5% from $122.9 million at December 31, 2004. The increase was due primarily to
a $14.7 million increase in current taxes payable. Off Balance Sheet Arrangements Our operations are funded primarily through asset-backed securitizations of principal
receivables on credit card accounts. Our securitizations involve selling pools of both current and
future principal receivable balances on credit card accounts. We retain the servicing of the
receivables, and we also currently maintain a qualified back-up servicer. Our securitizations are
treated as sales under GAAP and the receivables are removed from our consolidated balance sheets
(except for any retained interests in the securitization). We primarily securitize receivables by
selling them to the Metris Master Trust, a proprietary, non-consolidated trust, 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. 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,
2005, 11 series of publicly and privately issued securities were outstanding. MRI currently
retains the most subordinated class of securities in each series, and all other classes are issued
to non-affiliated 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, which is followed by a
controlled amortization period wherein investors are repaid their invested amount. Currently,
the Metris Master Trust does not have any series in an accumulation period or controlled
amortization period. The scheduled accumulation and amortization periods are set forth in the
securitization agreements governing each series. However, all series set forth certain events by
which amortization can be accelerated, referred to as early amortization. Reasons 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, would drop below
levels between 0.0% and 1.0%; (ii) negative transferors interest within the Metris Master Trust,
or; (iii) failure to obtain funding during an accumulation period for a maturing series. New
receivables in designated accounts cannot be funded from a series that is in early amortization.
We do not currently have any series that are in early amortization. 31




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##### Table of Contents



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 include cash
restricted from release in the Metris Master Trust at its fair value within Retained interests in
loans securitized on our consolidated balance sheets. The triggers are usually related to the
performance of the Metris Master Trust, specifically the average excess spread over a one- to
three-month period. The cash restricted from release is limited to the amount of excess spread generated in the
Metris Master Trust on a cash basis. During periods of lower excess spreads, the maximum amount of
cash required to be restricted in the Metris Master Trust may not be generated. During those
periods, all excess cash normally released to MRI will be restricted from release. Once the
maximum amount of cash required to be restricted is restricted from release or excess spreads
improve, cash can again be released to MRI. Table 7 presents the cash restricted from release as of
March 31, 2005 and December 31, 2004, respectively. Table 7: Cash Restricted from Release March 31,
    
    
    December 31,(In thousands)
    
    2005
    
    
    2004Cash restricted due to performance
    
    $
    35,059
    
    
    $
    36,367Cash restricted due to corporate debt ratings
    
    
    13,187
    
    
    
    13,187Other non-performance based cash restricted
    
    
    62,296
    
    
    
    37,770Total cash restricted
    
    $
    110,542
    
    
    $
    87,324
 The $1.3 million decrease in cash restricted due to performance from December 31, 2004 to
March 31, 2005, is primarily due to improving excess spreads in the Metris Master Trust. The $24.5
million increase in other cash restricted due to non-performance between March 31, 2005 and
December 31, 2004 is due to the additional enhancement required on new asset-backed securities
transactions. The following table generally illustrates the maximum amount of cash (as a percentage of
outstanding securitized principal receivables) that could be held by the Metris Master Trust
Trustee as additional collateral if the one-month and three-month average excess spread of the
Metris Master Trust were within various ranges: Table 8: Maximum Cash Restricted in the Metris Master Trust Cash Basis Net
    
    MaximumExcess Spread
    
    Restrictedgreater than 5.5%
    
    
    5.0% - 5.5%
    
    
    0.5% - 1.0
    %4.5% - 5.0%
    
    
    0.5% - 1.5
    %4.0% - 4.5%
    
    
    1.0% - 2.0
    %3.5% - 4.0%
    
    
    1.0% - 3.0
    %3.0% - 3.5%
    
    
    1.0% - 4.0
    %less than 3.0%
    
    
    4.5% - 5.0
    %
 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 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 $5.8 billion and $6.1
billion as of March 31, 2005 and December 31, 2004. 32




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##### Table of Contents



The following table shows the average annualized yields, defaults, costs and excess spreads
for the Metris Master Trust on a cash basis: Table 9: Weighted Average Annualized Yields, Defaults, Costs and Excess Spreads Quarter Ended March 31,2005
    
    
    2004Gross yield(1)
    
    
    28.73
    %
    
    
    27.46
    %Annual principal defaults
    
    
    17.08
    %
    
    
    19.26
    %Net portfolio yield
    
    
    11.65
    %
    
    
    8.20
    %Annual interest expense and
servicing fees
    
    
    5.18
    %
    
    
    3.59
    %Net excess spread
    
    
    6.47
    %
    
    
    4.61
    %
   (1)
    
    Includes cash flows from finance charges, late, overlimit, debt
waiver and cash advance fees, bad debt recoveries and interchange income. The following table shows gross and principal receivables and delinquent gross and principal
receivables in the Metris Master Trust: March 31,
    
    
    December 31,
    
    
    March 31,2005
    
    
    2004
    
    
    2004(Dollars in thousands)Gross receivables
    
    $
    6,050,712
    
    
    $
    6,443,919
    
    
    $
    7,396,229Principal receivables
    
    $
    5,753,684
    
    
    $
    6,117,669
    
    
    $
    6,995,4782-cycle plus delinquent gross
receivables
    
    $
    504,840
    
    
    $
    593,819
    
    
    $
    773,5922-cycle plus delinquent principal
receivables
    
    $
    400,164
    
    
    $
    470,442
    
    
    $
    610,470Gross delinquency ratio
    
    
    8.3
    %
    
    
    9.2
    %
    
    
    10.5
    %Principal delinquency ratio
    
    
    7.0
    %
    
    
    7.7
    %
    
    
    8.7
    %
 Revenues and expenses generated from the Metris Master Trust are reported in Securitization
income and Servicing income on securitized receivables 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. Additional information regarding off-balance sheet arrangements is set forth under Liquidity,
Funding and Capital Resourcesbelow. Additional information regarding the accounting for our
Retained interests in loans securitized can be found under Critical Accounting Estimateson page
23 of this Report. Liquidity, Funding and Capital Resources One of our primary financial goals is to maintain an adequate level of liquidity through
active management of our 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 11 summarizes our funding and liquidity as of
March 31, 2005 and December 31, 2004. 33




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##### Table of Contents



Table 11: Liquidity, Funding and Capital Resources March 31, 2005
    
    
    
    
    
    
    
    
    
    
    December 31, 2004MCI and non-bank
    
    
    
    
    
    
    
    
    
    
    MCI and non-bankDMCCB
    
    
    subsidiaries

    
    
    Consolidated
    
    
    DMCCB
    
    
    subsidiaries
    
    
    Consolidated(In thousands)Cash and due from banks
    
    $
    20,846
    
    
    $
    (1,074
    )
    
    $
    19,772
    
    
    $
    25,340
    
    
    $
    (142
    )
    
    $
    25,198Federal funds sold
    
    
    46,150
    
    
    
    
    
    
    
    46,150
    
    
    
    22,450
    
    
    
    
    
    
    
    22,450Short-term investments
    
    
    116,215
    
    
    
    125,101
    
    
    
    241,316
    
    
    
    12,599
    
    
    
    30,471
    
    
    
    43,070Available for sale securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    107,138
    
    
    
    199,271
    
    
    
    306,409Total liquid assets
    
    $
    183,211
    
    
    $
    124,027
    
    
    $
    307,238
    
    
    $
    167,527
    
    
    $
    229,600
    
    
    $
    397,127
 The following tables detail our outstanding on- and off-balance sheet funding as of March 31,
2005 and December 31, 2004, including any unused capacity as of those dates. Table 12: Outstanding On- and Off-Balance Sheet Funding March 31, 2005
    
    
    December 31, 2004(In thousands)
    
    Outstanding
    
    
    Unused Capacity
    
    
    Outstanding
    
    
    Unused CapacityOn-balance sheet funding10.125% senior notes  July 2006
    
    
    99,231
    
    
    
    N/A
    
    
    
    148,624
    
    
    
    N/ATerm loan  May 2007
    
    
    225,000
    
    
    
    N/A
    
    
    
    225,000
    
    
    
    N/ASubtotal
    
    
    324,231
    
    
    
    N/A
    
    
    
    373,624
    
    
    
    N/AOff-balance sheet fundingMetris Master Trust:Term asset-backed securitizations
with various
maturities through
February 2009
    
    
    4,102,800
    
    
    
    
    
    
    
    4,950,000
    
    
    
    Conduits  maturing April 2006
    
    
    800,000
    
    
    
    200,000
    
    
    
    360,000
    
    
    
    840,000Subtotal
    
    
    4,902,800
    
    
    
    200,000
    
    
    
    5,310,000
    
    
    
    840,000Total
    
    $
    5,227,031
    
    
    $
    200,000
    
    
    $
    5,683,624
    
    
    $
    840,000
 The decrease in our unused capacity between December 31, 2004 and March 31, 2005, resulted
primarily from the defeasance of the $900 million series 2002-3. Following the issuance of series
2005-1 on April 6, 2005, unused conduit capacity increased to $850 million as of April 30, 2005. We have the following term asset-backed securitizations outstanding as of March 31, 2005: Table 13: Outstanding Asset-Backed Securitizations (Dollars in thousands)Asset-backed securitization
    
    Amount
    
    
    Expected final payment date(s)Series 2000-3
    
    
    500,000
    
    
    October 20, 2005 and November 21, 2005Series 1999-3
    
    
    300,000
    
    
    November 21, 2005Series 2001-2
    
    
    750,000
    
    
    May 22, 2006 and June 20, 2006Series 1999-2
    
    
    500,000
    
    
    July 20, 2006Series 2004-2
    
    
    652,800
    
    
    October 20, 2006Series 2004-1
    
    
    200,000
    
    
    April 20, 2007Series 2002-4
    
    
    600,000
    
    
    May 21, 2007Series 2002-1
    
    
    300,000
    
    
    January 20, 2009 and February 20, 2009Series 2002-2
    
    
    300,000
    
    
    January 20, 2009 and February 20, 2009Total
    
    $
    4,102,800
 34




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##### Table of Contents



Our term asset-backed securitizations require the accumulation of principal cash payments
received by the Metris Master Trust to fund the repayment of these obligations at the time of
maturity. We typically achieve this by either obtaining a paired series funding vehicle or
defeasing the maturing bonds with draw downs on existing conduit facilities or other funding
vehicles prior to the start of the accumulation period. As of March 31, 2005 and December 31, 2004, we had $4.7 million and $5.5 million in letters of
credit issued under a letter of credit facility agreement. We have pledged investments equal to
110% collateral against our letters of credit, which are classified in Other assets on the
consolidated balance sheets. Effective April 21, 2005, the collateral pledged against our letters
of credit was reduced to 100%. As of March 31, 2005 our contractual cash obligations over the next twelve months are as
follows: Table 14: Contractual Cash Obligations (In thousands)Operating leases
    
    $
    7,904Deposits
    
    
    2,621Contractual purchase obligations
    
    
    47,303Total
    
    $
    57,828
 In addition to contractual cash obligations, open-to-buy on credit card accounts as of March
31, 2005, was $6.6 billion. While these amounts represent the total lines of credit available to
our customers, we have not experienced, and do not anticipate, that all of our customers will
exercise their entire available credit line at any given point in time. We also have the right to
increase, reduce, cancel, alter or amend the terms for those available lines of credit at any time. In February 2005, we announced the defeasance of the $900 million series 2002-3 asset-backed
securities from the Metris Master Trust. Series 2002-3 was defeased through the use of our conduit
facility and was scheduled to mature in May 2005. The Company also issued $52.8 million of
asset-backed securities from the Metris Secured Note Trust 2004-2 during January of 2005. These
asset-backed securities are set to mature on October 20, 2006 and were rated Ba2/BB+ by Moodys
Investors Service, Inc. and Fitch Inc., respectively. Proceeds from the issuance were used to make
an optional $50 million prepayment on the Companys Senior Notes due 2006. During the first
quarter of 2005, the Company also reduced its conduit capacity from $1.2 billion to $1.0 billion.
Our receivable funding needs for 2005 and 2006 will be covered by future asset-back securities
issuances and further portfolio attrition. We have $1.1 billion in remaining commitment from MBIA
Insurance Corporation (MBIA) to provide insurance coverage on future asset-backed securities
transactions, of which $800 million currently is available. The remaining $300 million of
commitment will become available to us when series 1999-3 matures. Subsequent to March 31, 2005, the Company issued $544 million in series 2005-1 asset-backed
securities from the Metris Master Trust. In addition, the Company made optional prepayments
totaling $225 million on its senior-secured credit agreement due May 2007, resulting in
approximately $17.9 million in costs and charges. The impact of these transactions will be
reflected in the second quarter of 2005. The Companys 1998 through 2002 federal income tax returns are under examination by the
Internal Revenue Service (IRS). The IRS is considering adjustments involving the Companys tax
treatment of certain credit card fees as original issue discount (OID). The Company has also
proposed OID-related adjustments in the form of refund claims for some of these years. The fees at
issue include late, overlimit, interchange, cash advance and annual fees. Although these fees are
primarily reported as income when billed for financial reporting purposes, we believe the fees
create OID that should be deferred and amortized over the remaining life of the underlying credit
card loans for tax purposes. As of March 31, 2005, and December 31, 2004, the Company had deferred
cumulative federal income tax related to this issue of approximately $107 million and $129 million,
respectively. Our treatment of these fees is consistent with that of many other United States
credit card issuers. Furthermore, we believe our treatment of these fees is appropriate based on
relevant technical authority and specific guidance issued by the IRS regarding late fees. However,
the timing and amount of any final resolution remain uncertain. We continue to work with the IRS
to resolve this matter and do not expect to pay any incremental tax related to this issue in the
next 12 months, nor do we expect the resolution of this matter to have a material adverse effect on
future earnings. 35




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##### Table of Contents



Our secured and unsecured debt is rated by Moodys, Standard & Poors Rating Services (S&P)
and 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 our
overall financial performance, including earnings, credit losses, delinquencies, excess spreads in
the Metris Master Trust and our overall liquidity. Certain of our term asset-backed securitizations
require the restriction of cash if our corporate debt ratings go below certain levels. The
following illustrates the current debt ratings of MCI: Moodys
    
    S & P
    
    FitchSenior unsecured debt
    
    B3
    
    CCC
    
    B -
 Capital Adequacy The following table shows our capital ratios for the periods ended March 31, 2005 and December
31, 2004, respectively. Table 15: Capital Ratios March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands, except per share amounts)Equity to managed assets:Total equity
    
    
    975,322
    
    
    
    947,302Total managed assets
    
    
    6,364,558
    
    
    
    6,791,478Ratio of equity to managed
assets
    
    
    15.3
    %
    
    
    13.9
    %Common stockholder book value:Common stockholders equity
    
    $
    449,200
    
    
    $
    432,757Common shares outstanding
    
    
    58,170
    
    
    
    58,127Common stockholders book value
    
    $
    7.72
    
    
    $
    7.45Total stockholders equity
    
    $
    975,322
    
    
    $
    947,302Preferred securities on a converted
basis
    
    
    45,054
    
    
    
    45,054Total shares
outstanding on a converted basis
    
    
    103,224
    
    
    
    103,181Total book value
    
    $
    9.45
    
    
    $
    9.18
 In the normal course of business, Direct Merchants Bank enters into agreements, or is subject
to regulatory requirements, that result in cash, debt, dividend or other capital restrictions.
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 also entered into a Liquidity Reserve Deposit Agreement (LRDA) under which the Bank has
established restricted deposits with third-party depository institutions for the purpose of
supporting Direct Merchants Banks funding needs. These deposits are invested in short-term liquid
assets and are classified on the consolidated balance sheets as the Liquidity reserve deposit.
As of March 31, 2005 and December 31, 2004, the balance in the liquidity reserve accounts was $64.0
million and $79.7 million, respectively. MCI and Direct Merchants Bank have a Modified Operating Agreement with the OCC, which was
amended on April 7, 2005 and requires, among other things:  
    The Bank must maintain minimum capital of $100 million, unless otherwise
approved by the OCC.
    The Bank may continue to pay dividends in accordance with applicable statutory
and regulatory requirements provided capital remains at the required level.
    The Bank must maintain liquid assets at the greater of $35 million or 100% of
the average highest daily funding requirement for managed receivables ($33.3 million at
March 31, 2005). 36




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##### Table of Contents




    The Bank must comply with the terms of the LRDA and the CALMA.
    MCI must comply with the CALMA. The Company believes it is currently in compliance with all of the terms of the Modified
Operating Agreement, as amended. 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 those options were to be pursued by the OCC, it could have a material adverse effect on
our operations or capital position. On April 7, 2005, the Modified Operating Agreement entered into by MCI, Direct Merchants Bank
and OCC was amended to reduce the minimum amount of capital required to be held by Direct Merchants
Bank from $213 million to $100 million. As a result of the change to the Banks minimum capital
requirements, the OCC approved a permanent capital reduction of $130 million concurrent with the
transfer of approximately $57 million in remaining eligible credit card receivables from the Bank
to MCI, which occurred on May 2, 2005. MCI subsequently sold the majority of those receivables to
the Metris Master Trust. The permanent capital reduction was completed on May 6, 2005. Since
March 31, 2005 the Company has used proceeds from existing Short-term investments and the permanent
capital reduction to make optional prepayments totaling $225 million on its senior-secured credit
agreement due May 2007, resulting in approximately $18 million in costs and charges. As a result of the prepayments, MCI paid off, in full, its remaining
obligations owed under its $300 million senior secured credit agreement effectively terminating the
credit agreement. Direct Merchants Bank is subject
to certain capital adequacy guidelines issued by the OCC.
Quantitative measures established by regulation to ensure capital adequacy require Direct Merchants
Bank to maintain minimum amounts and ratios (set forth in Table 16) of total and Tier 1 capital
(as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 leverage capital
(as defined) to average assets (as defined). Failure to meet minimum capital requirements can
result in certain mandatory, and possibly additional discretionary actions, by regulators that, if
undertaken, could have a direct material adverse effect on our financial condition. Furthermore,
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. At both March 31, 2005 and
December 31, 2004, 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. Additional information about Direct Merchants Banks actual capital amounts and ratios are
presented in the following table: Table 16: Direct Merchants Banks Actual Capital Amounts and Ratios To Be Adequately
    
    
    To Be Well(Dollars in thousands)
    
    Actual
    
    
    Capitalized
    
    
    CapitalizedAs of March 31, 2005
    
    Amount
    
    
    Ratio
    
    
    Amount
    
    
    Ratio
    
    
    Amount
    
    
    RatioTotal
capital (to risk-weighted assets)
    
    $
    245,572
    
    
    
    125.9
    %
    
    $
    15,601
    
    
    
    8.0
    %
    
    $
    19,501
    
    
    
    10.0
    %Tier 1
capital (to risk-weighted assets)
    
    
    243,051
    
    
    
    124.6
    %
    
    
    7,801
    
    
    
    4.0
    %
    
    
    11,701
    
    
    
    6.0
    %Tier 1
capital (to average assets)
    
    
    243,051
    
    
    
    71.1
    %
    
    
    13,676
    
    
    
    4.0
    %
    
    
    17,095
    
    
    
    5.0
    %
 To Be Adequately
    
    
    To Be WellActual
    
    
    Capitalized
    
    
    CapitalizedAs of December 31, 2004
    
    Amount
    
    
    Ratio
    
    
    Amount
    
    
    Ratio
    
    
    Amount
    
    
    RatioTotal
capital (to risk-weighted assets)
    
    $
    247,382
    
    
    
    113.6
    %
    
    $
    17,417
    
    
    
    8.0
    %
    
    $
    21,771
    
    
    
    10.0
    %Tier 1
capital (to risk-weighted assets)
    
    
    244,555
    
    
    
    112.3
    %
    
    
    8,709
    
    
    
    4.0
    %
    
    
    13,063
    
    
    
    6.0
    %Tier 1
capital (to average assets)
    
    
    244,555
    
    
    
    70.5
    %
    
    
    13,875
    
    
    
    4.0
    %
    
    
    17,344
    
    
    
    5.0
    %
 37




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##### Table of Contents



Selected Operating Data
 Managed Basis In addition to analyzing the Companys performance on an owned basis, we analyze the Companys
financial performance on a managed loan portfolio basis. On a managed basis, the balance sheets
and income statements include other investors interests in securitized loans that are not assets
of the Company, thereby reversing the effects of sale accounting under SFAS No. 140.We believe
this information is meaningful to the reader of the financial statements. We service the
receivables that have been securitized and sold and own the right to the cash flows from those
receivables sold in excess of amounts owed to security holders. The following information is not in conformity with accounting principles generally accepted
in the United States of America, however, we believe the information is relevant to understanding
the overall financial condition and results of operations of the Company. Table 17: Managed Loan Portfolio Three Months EndedMarch 31,
    
    
    
    
    
    
    December 31,
    
    
    
    
    
    
    March 31,2005
    
    
    
    
    
    
    2004
    
    
    
    
    
    
    2004(Dollars and accounts in thousands)Account originations:Partner
    
    
    34
    
    
    
    
    
    
    
    42
    
    
    
    
    
    
    
    9Non-partner
    
    
    129
    
    
    
    
    
    
    
    166
    
    
    
    
    
    
    
    49Total account originations
    
    
    163
    
    
    
    
    
    
    
    208
    
    
    
    
    
    
    
    58Period EndedMarch 31,
    
    
    
    
    
    December 31,
    
    
    
    
    
    March 31,Gross active accounts:
    
    
    2005
    
    
    
    
    
    
    
    2005
    
    
    
    
    
    
    
    2005Historical vintages(1)
    
    
    1,555
    
    
    
    
    
    
    
    1,678
    
    
    
    
    
    
    
    2,112New vintages (1)
    
    
    613
    
    
    
    
    
    
    
    499
    
    
    
    
    
    
    
    2392,168
    
    
    
    
    
    
    
    2,177
    
    
    
    
    
    
    
    2,351Period-end loans:Historical vintages(1)
    
    $
    5,261,812
    
    
    
    
    
    
    $
    5,787,904
    
    
    
    
    
    
    $
    7,142,451New vintages (1)
    
    
    908,165
    
    
    
    
    
    
    
    792,316
    
    
    
    
    
    
    
    393,550$
    6,169,977
    
    
    
    
    
    
    $
    6,580,220
    
    
    
    
    
    
    $
    7,536,001Period-end balances:Credit card loans
    
    $
    61,956
    
    
    
    
    
    
    $
    68,230
    
    
    
    
    
    
    $
    74,085Receivables held by the Metris Master Trust
    
    
    6,108,021
    
    
    
    
    
    
    
    6,511,990
    
    
    
    
    
    
    
    7,461,916Managed
    
    $
    6,169,977
    
    
    
    
    
    
    $
    6,580,220
    
    
    
    
    
    
    $
    7,536,001% of
    
    
    
    
    
    
    % of
    
    
    
    
    
    % ofTotal
    
    
    
    
    
    
    Total
    
    
    
    
    
    TotalLoans contractually delinquent:Credit card loans
    
    
    6,205
    
    
    
    10.0
    %
    
    
    7,781
    
    
    
    11.4
    %
    
    
    11,079
    
    
    
    15.0
    %Receivables held by the Metris Master Trust
    
    
    504,840
    
    
    
    8.3
    %
    
    
    593,819
    
    
    
    9.1
    %
    
    
    773,592
    
    
    
    10.4
    %Managed
    
    $
    511,045
    
    
    
    8.3
    %
    
    $
    601,600
    
    
    
    9.1
    %
    
    $
    784,671
    
    
    
    10.4
    %
   (1)
    
    New vintages include credit card account originations between 2003 and 2005. Historical vintages include credit card account
originations and portfolio purchases prior to 2003. The decrease in the managed delinquency rates as of March 31, 2005 compared to December 31,
2004 and March 31, 2004, 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. 38




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Table 17: Continued Three Months EndedMarch 31,2005
    
    
    
    
    
    
    2004(Dollars in thousands)Average balances:Credit card loans
    
    $
    65,571
    
    
    
    
    
    
    $
    126,957Receivables held by the Metris Master Trust
    
    
    6,346,605
    
    
    
    
    
    
    
    7,787,351Managed
    
    $
    6,412,176
    
    
    
    
    
    
    $
    7,914,308Net charge-offs:Credit card loans
    
    $
    1,631
    
    
    
    10.1
    %
    
    $
    22,400
    
    
    
    71.0
    %Receivables held by the Metris Master Trust
    
    
    227,592
    
    
    
    14.5
    %
    
    
    327,607
    
    
    
    16.9
    %Managed
    
    $
    229,223
    
    
    
    14.5
    %
    
    $
    350,007
    
    
    
    17.8
    %
 The managed net charge-off ratio was 14.5% for the three-month period ended March 31, 2005,
compared to 15.5% for the prior quarter and 17.8% for the quarter ended March 31,2004. This
represents improvements of 330-basis-points over the comparable period in 2004. These improvements
resulted primarily from the improved credit quality in the Metris Master Trust. We charge-off bankrupt accounts within 60 days of formal notification. Charge-offs due to
bankruptcies were $82.4 million or 25.1% of total managed gross charge-offs for the quarter ended
March 31, 2005, and $107.7 million or 22.2% of total managed gross charge-offs for the quarter
ended March 31, 2004. In addition to those bankrupt accounts that were charged-off, we received
formal notification of $43.6 million and $58.5 million of managed bankrupt accounts that had not
been charged-off as of March 31, 2005 and 2004, respectively. Total managed loans decreased $410.2 million to $6.2 billion as of March 31, 2005, compared to
$6.6 billion and $7.5 billion as of December 31, 2004 and March 31, 2004, respectively. The
reduction in credit cards loans from December 31, 2004 to March 31, 2005, is a result of typical
seasonal trends. The decrease in credit card loans from March 31, 2004 to March 31, 2005, resulted
from the charging-off of higher balance historical vintage receivables, which are being replaced
with new vintage lower balance receivables. The amount of credit card receivables in debt
management programs was $507.6 million or 8.2% of total managed loans as of March 31, 2005,
compared with $540.3 million or 8.2% of managed loans as of December 31, 2004. All delinquent
receivables in debt management programs are included in Table 17. 
 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 consolidated balance sheets and 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. Our primary assets are Credit card loans and Retained interests in loans securitized. The
majority of our owned receivables and the receivables held by the Metris Master Trust are 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 issued by the Metris Master Trust, which have committed funding
primarily indexed to variable commercial paper rates and LIBOR. Long-term debt includes
approximately $100 million at a fixed interest rate and approximately $225 million indexed to
LIBOR. At March 31, 2005 and 2004, none of the securities issued out of the Metris Master Trust
and conduit funding of securitized receivables were funded with fixed rate securities. 39




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In an interest rate environment with rates significantly above current rates, we partially
mitigate the negative impact on earnings from higher interest expense by entering into interest
rate cap contracts and, to a lesser extent, through fixed rate funding. The approach we use to quantify interest rate risk is a sensitivity analysis that we believe
best reflects the risk inherent in our business. This approach calculates the impact on net income
before income taxes 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 0%. Assuming that we take no counteractive measures, as of March 31, 2005, 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 Iincome before
income taxes of approximately $22.0 million over the next 12 months relative to a base case,
compared to an approximate $14.0 million decrease as of March 31, 2004. A decrease of
200-basis-points would result in an increase in Income before income taxes of approximately $18.5
million as of March 31, 2005, compared to an increase of $35.3 million as of March 31, 2004. The change in sensitivity for the 200-basis-point increase is primarily due to a smaller
receivable base and a higher percentage of receivables impacted by a rate increase. The change in
sensitivity for the 200-basis-point decrease is due to a larger decrease from interest expense due
to the prepayment of long-term debt indexed to LIBOR in 2005. As LIBOR rates have increased, the
impact on interest costs from falling rates has increased since interest costs can fall further
before hitting 0%. 
 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) as of March 31, 2005. Based on
that evaluation, our management, including the CEO and CFO, have concluded that, as of March 31,
2005, our disclosure controls and procedures were effective. During the quarter ended March 31,
2005, there were no changes in our internal controls over financial reporting (as defined in Rule
13a-15(f) or 15d-15(f) under the Exchange Act) that have materially affected, or are reasonably
likely to materially affect, our internal controls over financial reporting. 
 Part II. Other Information 
 Item 1. Legal Proceedings Reference is made to Part I, Item 3 of the Companys Annual Report on Form 10-K for the fiscal
year ended December 31, 2004, which summarizes two pending lawsuits involving the Company and
certain of its officers and directors. Reference also is made to Part I, Item 1 Business  Regulatory Investigations, of the
Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2004, which summarizes
the SEC investigation, 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. Because at this time we are unable to
estimate damages that may result from the resolution of the matters outlined above, there can be no
assurance that defense or resolution of these matters will not have a material adverse effect on
our financial position. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None 
 Item 3. Defaults Upon Senior Securities None 
 Item 4. Submission of Matters to a Vote of Security Holders No matter was submitted to a vote of security holders during the quarter ended March 31, 2005. 40




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Item 5. Other Information On May 6, 2005, MCI made optional prepayments totaling $150 million on obligations due
May 2007 under its $300 million senior secured credit agreement, entered into with the
lenders party thereto and Deutsche Bank Trust Companies America, as Administrative Agent
and Collateral Agent, paying off in full its remaining obligations and effectively
terminating the credit agreement. The prepayments resulted in approximately $11.4
million in costs and charges. 
 Item 6. Exhibits Exhibits Charter Documents:  3.1
    Amended and Restated Certificate of Incorporation of the
(incorporated by reference to Exhibit 3.1 to the Companys Registration Statement
on Form 8-A12B dated April 26, 1999 (File No. 1-12351)).  (a)
    Certificate of Amendment to the Amended and Restated
Certificate of Incorporation of the Company dated June 4, 2003 (incorporated by
reference to Exhibit 3.1 to the Companys Report on Form 10-K dated April 12,
2004 (File No. 1-12351)).(b)
    Certificate of Amendment to the Amended and Restated
Certificate of Incorporation of the Company dated September 19, 2000
(incorporated by reference to Exhibit 3.3 to the Companys Registration
Statement on Form S-3 dated September 29, 2000. (File No. 1-12351)).(c)
    Certificate of Amendment to the Amended and Restated
Certificate of Incorporation of the Company dated March 24, 1999 (incorporated
by reference to Exhibit 3.1 to the Companys Registration Statement on Form
8-A12B dated April 26, 1999. (File No. 1-12351)).  3.2
    Amended and Restated Bylaws of the Company (incorporated by reference
to Exhibit 3.1 to the Companys Quarterly Report on Form 10-Q for the period ended
June 30, 1999 (File No. 1-12351)). Instruments Defining Rights:  4.1
    Certificate of Designation of Series C Perpetual Preferred Stock
(incorporated by reference to Exhibit 4.2 of MCIs Current Report on Form 8-K
dated December 22, 1998 (File No. 1-12351)).  (a)
    Amended Certificate of Designation of Series C Perpetual
Convertible Preferred Stock (incorporated by reference to Exhibit 3.3 to MCIs
Registration Statement on Form S-3 (File No. 333-82007)).  4.3
    Certificate of Designation of Series D Junior Participating
Convertible Preferred Stock (incorporated by reference to Exhibit 4.3 of MCIs
Current Report on Form 8-K dated December 22, 1998 (File No. 1-12351)).4.4
    Registration Rights Agreement, dated as of December 9, 1998, between
MCI and the Investors named therein (incorporated by reference to Exhibit 10.3 to
MCIs Current Report on Form 8-K dated December 22, 1998 (File No. 1-12351)).4.5
    Form of common stock certificate of MCI (incorporated by reference to
Exhibit 4.3 to MCIs Registration Statement on Form S-8 (File No. 333-91917)).4.6
    Indenture, dated as of July 13, 1999, by and among MCI, Metris
Direct, Inc. and The Bank of New York, including Form of 10 1/8% Senior Notes due
2006 and Form of Guarantee (incorporated by reference to Exhibit 4.1 to MCIs
Registration Statement on Form S-4 (File No. 333-86695)). 41




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##### Table of Contents



(a)
    First Supplemental Indenture, dated as of February 28, 2000,
among MCI, the Guarantors named therein and The Bank of New York, (incorporated
by reference to Exhibit 4.1 to MCIs Quarterly Report on Form 10-Q for the
period ended March 31, 2000 (File No. 1-12351)).(b)
    Second Supplemental Indenture, dated as of February 2, 2001,
among MCI, the Guarantors named therein and The Bank of New York (incorporated
by reference to Exhibit 4.7(b) to MCIs Annual Report on Form 10-K for the year
ended December 31, 2001 (File No. 1-12351)).(c)
    Agreement of Resignation, Appointment and Acceptance, dated as
of February 20, 2002, among MCI, The Bank of New York, as Prior Trustee, and US
Bank National Association, as Successor Trustee (incorporated by reference to
Exhibit 4.7(c) to MCIs Annual Report on Form 10-K for the year ended December
31, 2002 (File No. 1-12351)).  4.8
    Exchange and Registration Rights Agreement, dated as of July 13,
1999, by and among MCI, Bear, Stearns & Co. Inc., Chase Securities Inc., Salomon
Smith Barney Inc. and Barclays Capital Inc., relating to the new notes
(incorporated by reference to Exhibit 4.2 to MCIs Registration Statement on Form
S-4 (File No. 333-86695)). Material Contracts:  10.1
    Second Amendment dated as of March 1, 2005 to the Senior Secured
Credit Agreement dated as of May 6, 2004, among Metris Companies Inc., the lenders
from time to time parties thereto, and Deutsche Bank Trust Companies America as
Administrative Agent and as Collateral Agent (Incorporated by reference to Exhibit
10.14 (b) to MCIs Annual Report on Form 10-K for the year ended December 31,
2004, filed with the SEC on March 11, 2005 (File No. 1-12351)).  10.2
    Amendment effective as of April 7, 2005 to the Modified Operating
Agreement between Direct Merchants Credit Card Bank, National Association and the
Office of the Comptroller of the Currency effective as of December 11, 2003
(Incorporated by reference to Exhibit 99.1 to MCIs Current Report on Form 8-K
filed with the SEC on April 11, 2005 (File No. 1-12351)). Certifications:  31.1
    Certification of Principal Executive Officer Pursuant to Rule
13a-14(a)/15d-14(a).31.2
    Certification of Principal Financial Officer Pursuant to Rule
13a-14(a)/15d 14(a).32.1
    Certification of Principal Executive Officer Pursuant to Section
1350 of Chapter 63 of Title 18 of the United States Code.32.2
    Certification of Principal Financial Officer Pursuant to Section
1350 of Chapter 63 of Title 18 of the United States Code. 42




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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 9, 2005
    
    
    
    By:
    
    /s/ William A. HoulihanWilliam A. HoulihanExecutive Vice President and Chief Financial Officer(Principal Financial Officer and AuthorizedOfficer of Registrant)
 43