##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
   FORM 10-Q  [X]
    
    Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934For the quarterly period ended June 30, 2004or[   ]
    
    Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934For the transition period from  to Commission file number: 001-12351 METRIS COMPANIES INC.  Delaware
    
    41-1849591(State of Incorporation)
    
    (I.R.S. Employer Identification No.)
 10900 Wayzata Boulevard, Minnetonka, Minnesota 55305-1534
(Address of principal executive offices) (952) 525-5020
(Registrants telephone number) Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X]  No
[   ] Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X]  No
[   ] As of July 31, 2004, 57,965,743 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 June 30, 2004 PagePART I. FINANCIAL INFORMATIONItem 1.Consolidated Financial Statements (unaudited):Consolidated Balance Sheets
    
    
    3Consolidated Statements of Income
    
    
    4Consolidated Statements of Changes in
Stockholders Equity
    
    
    5Consolidated Statements of Cash Flows
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2.Managements Discussion and Analysis of
Financial Condition and Results of
Operations
    
    
    22Item 3.Quantitative and Qualitative Disclosures
About Market Risk
    
    
    40Item 4.Controls and Procedures
    
    
    41PART II. OTHER INFORMATIONItem 1.Legal Proceedings
    
    
    41Item 2. Changes in Securities
    
    
    41Item 3.Defaults Upon Senior Securities
    
    
    42Item 4.Submission of Matters to a Vote of Security Holders
    
    
    42Item 5.Other Information
    
    
    42Item 6.Exhibits and Reports on Form 8-K
    
    
    42Signatures
    
    
    44Certification of Principal Executive OfficerCertification of Principal Financial OfficerCertification of Principal Executive OfficerCertification of Principal Financial Officer
 2




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##### Table of Contents



Part I. Financial Information 
 ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS METRIS COMPANIES INC. AND SUBSIDIARIES 
 (In thousands, except per share data)
 June 30,2004
    
    December 31,(Unaudited)
    
    2003Assets:Cash and due from banks
    
    $
    26,364
    
    
    $
    32,076Federal funds sold
    
    
    29,700
    
    
    
    25,300Short-term investments
    
    
    345,165
    
    
    
    121,109Cash and cash equivalents
    
    
    401,229
    
    
    
    178,485Liquidity reserve deposit
    
    
    74,863
    
    
    
    80,158Credit card loans
    
    
    72,491
    
    
    
    128,615Less: Allowance for loan losses
    
    
    15,375
    
    
    
    45,492Net credit card loans
    
    
    57,116
    
    
    
    83,123Retained interests in loans securitized
    
    
    761,613
    
    
    
    836,901Property and equipment, net
    
    
    28,527
    
    
    
    33,680Purchased portfolio premium
    
    
    12,987
    
    
    
    17,561Other receivables due from credit card
securitizations, net
    
    
    75,773
    
    
    
    80,714Other assets
    
    
    68,482
    
    
    
    81,774Total assets
    
    $
    1,480,590
    
    
    $
    1,392,396Liabilities:Deposits
    
    $
    4,572
    
    
    $
    6,262Debt
    
    
    448,172
    
    
    
    350,448Accounts payable
    
    
    34,197
    
    
    
    32,397Deferred income
    
    
    14,258
    
    
    
    18,060Accrued expenses and other liabilities
    
    
    96,645
    
    
    
    76,036Total liabilities
    
    
    597,844
    
    
    
    483,203Stockholders Equity:Convertible preferred stock  Series C, par
Value $.01 per share; 10,000,000
Shares authorized, 1,321,204 and
1,263,699 shares issued and outstanding,
respectively
    
    
    492,149
    
    
    
    470,728Common stock, par value $.01 per share;
300,000,000 shares authorized, 65,012,591
and 64,862,314 shares issued,
respectively
    
    
    650
    
    
    
    649Paid-in capital
    
    
    231,896
    
    
    
    229,655Unearned compensation
    
    
    
    
    
    
    (27
    )Treasury stock  7,055,300 shares
    
    
    (58,308
    )
    
    
    (58,308
    )Retained earnings
    
    
    216,359
    
    
    
    266,496Total stockholders equity
    
    
    882,746
    
    
    
    909,193Total liabilities and stockholders equity
    
    $
    1,480,590
    
    
    $
    1,392,396
 See accompanying Notes to Consolidated Financial Statements. 3




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METRIS COMPANIES INC. AND SUBSIDIARIES 
 (In thousands, except earnings per-share data)
(Unaudited)
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenues:Securitization (expense) income
    
    $
    (24,343
    )
    
    $
    17,707
    
    
    $
    94,642
    
    
    $
    (20,263
    )Servicing income on securitized receivables
    
    
    33,847
    
    
    
    45,335
    
    
    
    70,084
    
    
    
    93,148Credit card loan and other interest income
    
    
    5,010
    
    
    
    31,432
    
    
    
    10,116
    
    
    
    63,593Credit card loan fees, interchange and
other income
    
    
    5,264
    
    
    
    23,460
    
    
    
    16,080
    
    
    
    49,779Enhancement services income
    
    
    6,976
    
    
    
    39,690
    
    
    
    14,456
    
    
    
    83,199Total revenues
    
    
    26,754
    
    
    
    157,624
    
    
    
    205,378
    
    
    
    269,456Expenses:Interest expense
    
    
    18,714
    
    
    
    18,716
    
    
    
    32,645
    
    
    
    38,057Provision for loan losses
    
    
    (491
    )
    
    
    30,033
    
    
    
    (6,583
    )
    
    
    74,819Credit card account and other product
solicitation and marketing expenses
    
    
    15,726
    
    
    
    32,032
    
    
    
    31,658
    
    
    
    65,720Employee compensation
    
    
    35,723
    
    
    
    45,721
    
    
    
    74,668
    
    
    
    99,102Data processing services and communications
    
    
    13,777
    
    
    
    17,034
    
    
    
    30,249
    
    
    
    36,212Credit protection claims expense
    
    
    5,036
    
    
    
    7,646
    
    
    
    11,384
    
    
    
    19,952Occupancy and equipment
    
    
    5,984
    
    
    
    8,924
    
    
    
    12,385
    
    
    
    18,537Purchased portfolio premium amortization
    
    
    2,105
    
    
    
    6,499
    
    
    
    4,502
    
    
    
    12,995Asset impairments, lease write-offs and
severance
    
    
    1,812
    
    
    
    6,011
    
    
    
    3,273
    
    
    
    22,788Other
    
    
    24,818
    
    
    
    22,607
    
    
    
    43,335
    
    
    
    46,314Total expenses
    
    
    123,204
    
    

    
    195,223
    
    
    
    237,516
    
    
    
    434,496Loss Before Income Taxes
    
    
    (96,450
    )
    
    
    (37,599
    )
    
    
    (32,138
    )
    
    
    (165,040
    )Income tax benefit
    
    
    (26,124
    )
    
    
    (12,851
    )
    
    
    (3,422
    )
    
    
    (57,462
    )Net Loss
    
    
    (70,326
    )
    
    
    (24,748
    )
    
    
    (28,716
    )
    
    
    (107,578
    )Convertible preferred stock dividends
    
    
    10,830
    
    
    
    9,908
    
    
    
    21,421
    
    
    
    19,597Net Loss Applicable to Common Stockholders
    
    $
    (81,156
    )
    
    $
    (34,656
    )
    
    $
    (50,137
    )
    
    $
    (127,175
    )Income (Loss) per share:BasicDistributed
 Preferred
    
    $
    8.38
    
    
    $
    8.38
    
    
    $
    16.76
    
    
    $
    16.76Undistributed  Preferred
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Basic  Preferred
    
    $
    8.38
    
    
    $
    8.38
    
    
    $
    16.76
    
    
    $
    16.76Distributed  Common
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Undistributed  Common
    
    
    (1.40
    )
    
    
    (0.60
    )
    
    
    (0.87
    )
    
    
    (2.22
    )Basic  Common
    
    $
    (1.40
    )
    
    $
    (0.60
    )
    
    $
    (0.87
    )
    
    $
    (2.22
    )DilutedDistributed  Common
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Undistributed  Common
    
    $
    (1.40
    )
    
    $
    (0.60
    )
    
    $
    (0.87
    )
    
    $
    (2.22
    )Diluted  Common
    
    $
    (1.40
    )
    
    $
    (0.60
    )
    
    $
    (0.87
    )
    
    $
    (2.22
    )Shares used to compute income (loss)
per share:Basic  Preferred
    
    
    1,292
    
    
    
    1,182
    
    
    
    1,278
    
    
    
    1,169Basic  Common
    
    
    57,924
    
    
    
    57,462
    
    
    
    57,857
    
    
    
    57,360Diluted  Common
    
    
    57,924
    
    
    
    57,462
    
    
    
    57,857
    
    
    
    57,360
 See accompanying Notes to Consolidated Financial Statements. 4




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METRIS COMPANIES INC. AND SUBSIDIARIES 
 (In thousands) (Unaudited)
 TotalNumber of
    
    Shares
    
    Preferred
    
    Common
    
    Paid-in
    
    Unearned
    
    Treasury
    
    Retained
    
    StockholdersPreferred
    
    Common
    
    Stock
    
    Stock
    
    Capital
    
    Compensation
    
    Stock
    
    Earnings
    
    EquityBALANCE AT DECEMBER 31,
2002
    
    
    1,156
    
    
    
    57,168
    
    
    $
    430,642
    
    
    $
    642
    
    
    $
    227,376
    
    
    $
    
    
    
    $
    (58,308
    )
    
    $
    454,321
    
    
    $
    1,054,673Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (107,578
    )
    
    
    (107,578
    )Preferred dividends in kind
    
    
    53
    
    
    
    
    
    
    
    19,597
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (19,597
    )
    
    
    Issuance of common stock
under employee benefit
plans
    
    
    
    
    
    
    352
    
    
    
    
    
    
    
    3
    
    
    
    2,367
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,370Deferred compensation
obligation
    
    
    
    
    
    
    303
    
    
    
    
    
    
    
    3
    
    
    
    546
    
    
    
    (549
    )
    
    
    
    
    
    
    
    
    
    
    Restricted stock
forfeitures
    
    
    
    
    
    
    (24
    )
    
    
    
    
    
    
    
    
    
    
    (48
    )
    
    
    46
    
    
    
    
    
    
    
    
    
    
    
    (2
    )Amortization of restricted
stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    211
    
    
    
    
    
    
    
    
    
    
    
    211BALANCE AT JUNE 30, 2003,
    
    
    1,209
    
    
    
    57,799
    
    
    $
    450,239
    
    
    $
    648
    
    
    $
    230,241
    
    
    $
    (292
    )
    
    $
    (58,308
    )
    
    $
    327,146
    
    
    $
    949,674BALANCE AT DECEMBER 31,
2003
    
    
    1,264
    
    
    
    57,807
    
    
    $
    470,728
    
    
    $
    649
    
    
    $
    229,655
    
    
    $
    (27
    )
    
    $
    (58,308
    )
    
    $
    266,496
    
    
    $
    909,193Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (28,716
    )
    
    
    (28,716
    )Preferred dividends in kind
    
    
    57
    
    
    
    
    
    
    
    21,421
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21,421
    )
    
    
    Issuance of common stock
under employee benefit
plans
    
    
    
    
    
    
    200
    
    
    
    
    
    
    
    1
    
    
    
    2,331
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,332Deferred compensation
obligation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (85
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (85
    )Restricted stock
forfeitures
    
    
    
    
    
    
    (50
    )
    
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    (1
    )Amortization of restricted
stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23
    
    
    
    
    
    
    
    
    
    
    
    23BALANCE AT JUNE 30, 2004,
    
    
    1,321
    
    
    
    57,957
    
    
    $
    492,149
    
    
    $
    650
    
    
    $
    231,896
    
    
    $
    
    
    
    $
    (58,308
    )
    
    $
    216,359
    
    
    $
    882,746
 See accompanying Notes to Consolidated Financial Statements. 5




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METRIS COMPANIES INC. AND SUBSIDIARIES 
 (Dollars in thousands) (Unaudited)
 Six Months EndedJune 30,2004
    
    2003Operating Activities:Net loss
    
    $
    (28,716
    )
    
    $
    (107,578
    )Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:Depreciation, amortization, and accretion
    
    
    (100,583
    )
    
    
    (81,545
    )Provision for loan losses
    
    
    (6,583
    )
    
    
    74,819Loss from credit card securitization
    
    
    141,267
    
    
    
    123,982Asset impairments, lease write-offs, and severance
    
    
    3,273
    
    
    
    22,788Market loss on derivative financial instruments
    
    
    7,572
    
    
    
    8,161Changes in operating assets and liabilities, net:Liquidity Reserve deposit
    
    
    5,295
    
    
    
    (80,590
    )Fair value of retained interests in loans
securitized
    
    
    (68,683
    )
    
    
    103,897Spread accounts receivable
    
    
    163,728
    
    
    
    (201,314
    )Other receivables due from credit card securitizations
    
    
    4,941
    
    
    
    17,860Accounts payable and accrued expenses
    
    
    19,136
    
    
    
    4,473Deferred income
    
    
    (3,802
    )
    
    
    (37,014
    )Other
    
    
    13,808
    
    
    
    (67,123
    )Net cash provided by (used in) operating activities
    
    
    150,653
    
    
    
    (219,184
    )Investing Activities:Proceeds
from transfers of portfolios to the Metris Master Trust
    
    
    
    
    
    
    315,065Net cash from loan originations and principal collections on
loans receivable
    
    
    (11,873
    )
    
    
    (84,739
    )Net disposals of property and equipment
    
    
    2,072
    
    
    
    18,525Net cash (used in) provided by investing activities
    
    
    (9,801
    )
    
    
    248,851Financing Activities:Proceeds from issuance of debt
    
    
    283,974
    
    
    
    125,348Repayment of debt
    
    
    (202,724
    )
    
    
    (100,206
    )Net decrease in deposits
    
    
    (1,690
    )
    
    
    (250,820
    )Proceeds from issuance of common stock
    
    
    2,332
    
    
    
    2,370Net cash provided by (used in) financing activities
    
    
    81,892
    
    
    
    (223,308
    )Net increase (decrease) in cash and cash equivalents
    
    
    222,744
    
    
    
    (193,641
    )Cash and cash equivalents at beginning of period
    
    
    178,485
    
    
    
    580,232Cash and cash equivalents at end of period
    
    $
    401,229
    
    
    $
    386,591Supplemental disclosures and cash flow information:Cash paid (received) during the period for:Interest
    
    $
    21,064
    
    
    $
    36,280Income taxes
    
    
    (35,820
    )
    
    
    (31,846
    )
 See accompanying Notes to Consolidated Financial Statements. 6




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




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NOTE 2  ACCOUNTING CHANGES In
March 2004, the Emerging Issues Task Force (EITF) reached a consensus
on EITF Issue No. 03-6 Participating Securities and the two-class method under
FASB Statement 128, (the Consensus or EITF 03-6). The Consensus requires
net income to be reduced by the amount of dividends declared in the current
period for each class of stock and by the contractual amount of dividends or
other participation payments that are paid or accumulated for the current
period. Undistributed earnings for the period are allocated to participating
securities based on the contractual participation rights of the security to
share in those current earnings assuming all earnings for the period are
distributed. Our Series C preferred shareholders have contractual
participation rights on a converted basis that are equivalent to those of
common shareholders. Therefore, we allocate undistributed earnings to
preferred and common shareholders based on their respective ownership
percentage on a converted basis as of the end of the period. The guidance in
EITF 03-6 is effective for fiscal periods (interim or annual) beginning after
March 31, 2004. Companies are required to restate prior period earnings per
share amounts to conform to the guidance in EITF 03-6 upon adoption. The following table presents basic and diluted earnings (loss) per share
using the two-class method for the first quarter of 2004 and the previous five
annual periods: Threemonthsended
    
    Twelve months endedMarch 31,
    
    December 31,2004
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999As Previously Reported:Basic earnings (loss) per share
    
    $
    0.47
    
    
    $
    (3.27
    )
    
    $
    (0.66
    )
    
    $
    1.64
    
    
    $
    2.08
    
    
    $
    1.50Diluted earnings (loss) per share
    
    $
    0.47
    
    
    $
    (3.27
    )
    
    $
    (0.66
    )
    
    $
    1.61
    
    
    $
    2.01
    
    
    $
    1.44As Restated:Basic Earnings (Loss) per ShareDistributed
 Preferred(1)
    
    $
    8.38
    
    
    $
    32.78
    
    
    $
    34.00
    
    
    $
    33.99
    
    
    $
    33.79
    
    
    $
    147.43Undistributed  Preferred
    
    
    10.80
    
    
    
    
    
    
    
    
    
    
    
    43.19
    
    
    
    52.06
    
    
    
    Basic  Preferred
    
    $
    19.18
    
    
    $
    32.78
    
    
    $
    34.00
    
    
    $
    77.18
    
    
    $
    85.85
    
    
    $
    147.43Distributed  Common
    
    $
    
    
    
    $
    
    
    
    $
    0.04
    
    
    $
    0.04
    
    
    $
    0.03
    
    
    $
    0.02Undistributed  Common
    
    
    0.30
    
    
    
    (3.27
    )
    
    
    (0.70
    )
    
    
    1.25
    
    
    
    1.72
    
    
    
    (0.31
    )Basic  Common
    
    $
    0.30
    
    
    $
    (3.27
    )
    
    $
    (0.66
    )
    
    $
    1.29
    
    
    $
    1.75
    
    
    $
    (0.29
    )Diluted Earnings (Loss) per ShareDistributed  Common
    
    $
    
    
    
    $
    
    
    
    $
    0.04
    
    
    $
    0.04
    
    
    $
    0.03
    
    
    $
    0.02Undistributed  Common
    
    
    0.30
    
    
    
    (3.27
    )
    
    
    (0.70
    )
    
    
    1.21
    
    
    
    1.63
    
    
    
    (0.31
    )Diluted  Common
    
    $
    0.30
    
    
    $
    (3.27
    )
    
    $
    (0.66
    )
    
    $
    1.25
    
    
    $
    1.66
    
    
    $
    (0.29
    )
  (1)
    
    1999 results include a one-time, non-cash amount of $101.6 million related to the conversion of
Series B Preferred Stock, which is included in distributed
earnings to preferred shareholders. NOTE 3  LOSS PER SHARE During the quarter ended June 30, 2004 we adopted the Consensus which
requires the use of the two-class method for computing earnings (loss) per
share, and requires affected companies to retroactively restate earnings per
share previously reported. The following table presents the computation of basic earnings per share.
The dilutive earnings per share calculations for the three- and six-month
periods ended June 30, 2004 and 2003 are equal to the basic earnings per share
calculations because any conversion of preferred shares, stock options, or
restricted stock units to common shares would be anti-dilutive. Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net loss
    
    $
    (70,326
    )
    
    $
    (24,748
    )
    
    $
    (28,716
    )
    
    $
    (107,578
    )Convertible preferred stock dividends
    
    
    10,830
    
    
    
    9,908
    
    
    
    21,421
    
    
    
    19,597Net loss applicable to common stockholders
    
    $
    (81,156
    )
    
    $
    (34,656
    )
    
    $
    (50,137
    )
    
    $
    (127,175
    )
 8




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##### Table of Contents



Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Distributed preferred earnings
    
    $
    10,830
    
    
    $
    9,908
    
    
    $
    21,421
    
    
    $
    19,597Weighted average preferred shares
    
    
    1,292
    
    
    
    1,182
    
    
    
    1,278
    
    
    
    1,169Distributed
earnings per share  Preferred
    
    $
    8.38
    
    
    $
    8.38
    
    
    $
    16.76
    
    
    $
    16.76Undistributed loss
    
    $
    (81,156
    )
    
    $
    (34,656
    )
    
    $
    (50,137
    )
    
    $
    (127,175
    )Preferred ownership on converted basis
    
    
    44
    %
    
    
    42
    %
    
    
    44
    %
    
    
    42
    %Preferred shareholders interest in
undistributed loss(1)
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Weighted average preferred shares
    
    
    1,292
    
    
    
    1,182
    
    
    
    1,278
    
    
    
    1,169Undistributed loss per share  Preferred
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Distributed common earnings
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Weighted average common shares
    
    
    57,924
    
    
    
    57,462
    
    
    
    57,857
    
    
    
    57,360Distributed
earnings per share  Common
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Undistributed loss
    
    $
    (81,156
    )
    
    $
    (34,656
    )
    
    $
    (50,137
    )
    
    $
    (127,175
    )Common ownership
    
    
    56
    %
    
    
    58
    %
    
    
    56
    %
    
    
    58
    %Common shareholders interest in
undistributed loss(1)
    
    $
    (81,156
    )
    
    $
    (34,656
    )
    
    $
    (50,137
    )
    
    $
    (127,175
    )Weighted average common shares
    
    
    57,924
    
    
    
    57,462
    
    
    
    57,857
    
    
    
    57,360Undistributed loss per share  Common
    
    $
    (1.40
    )
    
    $
    (0.60
    )
    
    $
    (0.87
    )
    
    $
    (2.22
    )
  (1)
    
    Preferred shareholders do not participate in any undistributed
losses with common shareholders. NOTE 4  STOCK-BASED COMPENSATION PLANS We recognize compensation cost for stock-based employee compensation plans
based on the difference, if any, between the quoted market price of the stock
on the date of grant and the amount an employee must pay to acquire the stock.
No expense was reflected in net loss related to stock options as all options
granted had an exercise price equal to the market value of the underlying
common stock on the date of grant. For the three- and six-month periods ended
June 30, 2004 we recorded $0 and $15 thousand, respectively, in amortization of
deferred compensation obligation, net of related tax benefit, in Net loss
related to restricted stock. This compares to $78 thousand and $0.1 million
for the comparable periods in 2003. In May 2004 we issued approximately
855,000 restricted stock units to employees. The units vest over a four-year
period with possible acceleration of vesting if certain earning targets are
met. Upon vesting each restricted stock unit converts to one share of common
stock that is distributed to the employee. The fair value of the restricted
stock units as of the grant date was approximately $6.0 million. The fair
value will be expensed and accrued over the expected vesting period and
included in Employee compensation on the consolidated statements of income
and Accrued expenses and other liabilities on the consolidated balance
sheets. For the quarter ended June 30, 2004, we expensed and accrued $0.4
million related to restricted stock units. Pro forma information regarding net loss and loss per share has been
determined as if we accounted for our employee stock options under the fair
value method. The fair value of the options was estimated at the grant date
using a Black-Scholes option pricing model. The fair value of the options is
amortized to expense over the options vesting periods. Under the fair value
method, our net loss and loss per share would have been recorded at the pro
forma amounts indicated below: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net loss
    
    $
    (70,326
    )
    
    $
    (24,748
    )
    
    $
    (28,716
    )
    
    $
    (107,578
    )Add: Stock-based employee compensation
Expense included in reported net
loss, net of related tax effects
    
    
    293
    
    
    
    105
    
    
    
    304
    
    
    
    145Deduct: Annual stock-based employee
compensation benefit determined based
on the fair value for all awards, net
of related tax effects
    
    
    (3,417
    )
    
    
    3,108
    
    
    
    (4,883
    )
    
    
    (4,749
    )
 9




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##### Table of Contents



Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Pro forma net loss
    
    $
    (66,616
    )
    
    $
    (27,751
    )
    
    $
    (23,529
    )
    
    $
    (102,684
    )Loss per share:Basic-as reported
    
    
    (1.40
    )
    
    
    (0.60
    )
    
    
    (0.87
    )
    
    
    (2.22
    )Basic-pro forma
    
    
    (1.34
    )
    
    
    (0.66
    )
    
    
    (0.78
    )
    
    
    (2.13
    )Diluted-as reported
    
    
    (1.40
    )
    
    
    (0.60
    )
    
    
    (0.87
    )
    
    
    (2.22
    )Diluted-pro forma
    
    
    (1.34
    )
    
    
    (0.66
    )
    
    
    (0.78
    )
    
    
    (2.13
    )Weighted-average assumptions in
option valuation:Risk-free interest rates
    
    
    3.2
    %
    
    
    1.5
    %
    
    
    3.2
    %
    
    
    1.5
    %Dividend yields
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock volatility factor
    
    
    129.1
    %
    
    
    124.2
    %
    
    
    129.1
    %
    
    
    110.1
    %Expected life of options (in years)
    
    
    2.7
    
    
    
    2.7
    
    
    
    2.7
    
    
    
    4.2
 The above pro forma amounts may not be representative of the effects on
reported net income for future periods. NOTE 5  LIQUIDITY RESERVE DEPOSIT Direct Merchants Bank has established restricted deposits with third-party
depository banks for the purpose of supporting Direct Merchants Banks funding
needs and to satisfy banking regulators requirements under the Modified
Operating Agreement, dated December 11, 2003, among Direct Merchants Bank, MCI,
and the Office of the Comptroller of the Currency (OCC). These deposits are invested
in short-term liquid investments. As of June 30, 2004, the balance of these
deposits was $74.9 million and is classified on the balance sheets as
Liquidity reserve deposit. NOTE 6  ALLOWANCE FOR LOAN LOSSES The activity in the Allowance for loan losses is as follows: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Balance at beginning of period
    
    $
    18,945
    
    
    $
    125,357
    
    
    $
    45,492
    
    
    $
    90,315Allowance related to assets
transferred to the Metris Master Trust
    
    
    
    
    
    
    (2,526
    )
    
    
    
    
    
    
    (3,981
    )Allowance related to assets re-acquired
    
    
    
    
    
    
    
    
    
    
    1,945
    
    
    
    Provision for loan losses
    
    
    (491
    )
    
    
    30,033
    
    
    
    (6,583
    )
    
    
    74,819Principal receivables charged-off
    
    
    (4,250
    )
    
    
    (44,789
    )
    
    
    (26,921
    )
    
    
    (53,470
    )Recoveries
    
    
    1,171
    
    
    
    1,087
    
    
    
    1,442
    
    
    
    1,479Net principal receivables charged off
    
    
    (3,079
    )
    
    
    (43,702
    )
    
    
    (25,479
    )
    
    
    (51,991
    )Balance at end of period
    
    $
    15,375
    
    
    $
    109,162
    
    
    $
    15,375
    
    
    $
    109,162
 Credit card loans greater than 30 days contractually past due for the
periods ended June 30, 2004, and December 31, 2003 were $9.3 million and $20.3
million, respectively. NOTE 7  RETAINED INTERESTS IN LOANS SECURITIZED Our credit card receivables are primarily funded through asset
securitizations. As part of these asset securitizations, credit card
receivables are transferred to the Metris Master Trust, a non-consolidated,
qualifying special purpose entity that issues asset-backed securities
representing undivided interests in receivables held in the Metris Master Trust
and the right to receive future collections of principal, interest, and fees
related to those receivables. The senior classes of these securities are sold
to third-party investors. We retain subordinated interests in the securitized
receivables, including contractual retained interests, an interest-only strip
receivable, excess transferors interest maintained above the contractual
retained interests, and spread accounts receivable. The components of these
retained interests are recorded at their fair value. 10




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##### Table of Contents



The following table shows the fair value of the components of the
Retained interests in loans securitized as of June 30, 2004 and December 31,
2003. June 30,
    
    December 31,2004
    
    2003Contractual retained interests
    
    $
    525,085
    
    
    $
    542,014Excess transferors interests
    
    
    52,255
    
    
    
    48,775Interest-only strip receivable
    
    
    47,290
    
    
    
    16,039Spread accounts receivable
    
    
    136,983
    
    
    
    230,073Retained interests in loans securitized
    
    $
    761,613
    
    
    $
    836,901
 The following table illustrates the significant assumptions used for
estimating the fair value of retained interests as of June 30, 2004 and
December 31, 2003. June 30,
    
    December 31,2004
    
    2003Monthly payment rate
    
    
    7.3
    %
    
    
    6.7
    %Gross yield
(1)
    
    
    25.7
    %
    
    
    25.4
    %Annual interest expense and servicing fees
    
    
    4.8
    %
    
    
    4.2
    %Annual gross principal default rate
    
    
    19.5
    %
    
    
    20.7
    %Discount rate:Contractual retained interests
    
    
    16.0
    %
    
    
    16.0
    %Excess transferors interests
    
    
    16.0
    %
    
    
    16.0
    %Interest-only strip receivable
    
    
    30.0
    %
    
    
    30.0
    %Spread accounts receivable
    
    
    15.3
    %
    
    
    15.3
    %Weighted average months to maturity
    
    
    24.4
    
    
    
    24.5
 (1)  Includes expected cash flows from finance charges, late and overlimit fees, debt waiver
premiums and bad debt recoveries, net of finance charge and fee charge-offs. Gross yield for
purposes of estimating fair value does not include interchange income or cash advance fees. At June 30, 2004, the sensitivity of the current fair value of the
retained interests to immediate 10% and 20% adverse changes are as follows (in
millions): 11




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##### Table of Contents



Adverse Impact on Fair Value10% adverse change
    
    20% adverse changeAnnual discount rate
    
    $
    22.3
    
    
    $
    43.7Monthly payment rate
    
    
    99.8
    
    
    
    247.6Gross yield
    
    
    101.6
    
    
    
    227.0Annual interest expense and servicing fees
    
    
    24.9
    
    
    
    49.0Annual gross principal default rate
    
    
    69.4
    
    
    
    153.4
 As the sensitivity indicates, the value of the Companys Retained
interests in loans securitized on its consolidated balance sheets, as well as
reported earnings, could differ significantly if different assumptions or
conditions prevail. NOTE 8  SECURITIZATION INCOME The following summarizes Securitization (expense) income for the three-
and six-month periods ended June 30, 2004 and 2003. Three-Months Ended
    
    Six-Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Loss on new securitization of receivables
to the Metris Master Trust
    
    $
    (90,640
    )
    
    $
    (12,244
    )
    
    $
    (91,886
    )
    
    $
    (32,199
    )Loss on replenishment of receivables to
the Metris Master Trust
    
    
    (25,454
    )
    
    
    (45,529
    )
    
    
    (49,381
    )
    
    
    (91,783
    )Discount accretion
    
    
    61,570
    
    
    
    78,812
    
    
    
    121,540
    
    
    
    154,486Change in fair value
    
    
    20,718
    
    
    
    (20,289
    )
    
    
    68,683
    
    
    
    (103,897
    )Interest-only revenue
    
    
    55,137
    
    
    
    32,243
    
    
    
    130,069
    
    
    
    90,679Transaction and other costs
    
    
    (45,674
    )
    
    
    (15,286
    )
    
    
    (84,383
    )
    
    
    (37,549
    )Securitization (expense) income
    
    $
    (24,343
    )
    
    $
    17,707
    
    
    $
    94,642
    
    
    $
    (20,263
    )
 NOTE 9  INCOME TAXES The components of the benefit for income taxes consisted of the following: Three-Months Ended
    
    Six-Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Current:Federal
    
    $
    201
    
    
    $
    (34,699
    )
    
    $
    500
    
    
    $
    (36,690
    )State
    
    
    274
    
    
    
    (483
    )
    
    
    148
    
    
    
    (59
    )475
    
    
    
    (35,182
    )
    
    
    648
    
    
    
    (36,749
    )Deferred:Federal
    
    
    (26,110
    )
    
    
    21,731
    
    
    
    (3,961
    )
    
    
    (20,112
    )State
    
    
    (489
    )
    
    
    600
    
    
    
    (109
    )
    
    
    (601
    )(26,559
    )
    
    
    22,331
    
    
    
    (4,070
    )
    
    
    (20,713
    )Income tax benefit
    
    $
    (26,124
    )
    
    $
    (12,851
    )
    
    $
    (3,422
    )
    
    $
    (57,462
    )
 A reconciliation of our effective income tax rate compared to the
statutory federal income tax rate is as follows: 12




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##### Table of Contents



Three-Months Ended
    
    Six-Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Statutory federal income tax rate
    
    
    35.0
    %
    
    
    35.0
    %
    
    
    35.0
    %
    
    
    35.0
    %State income taxes, net of federal
Benefit
    
    
    0.1
    
    
    
    (0.2
    )
    
    
    (0.1
    )
    
    
    0.3Valuation allowance
    
    
    (8.0
    )
    
    
    
    
    
    
    (24.1
    )
    
    
    Other, net
    
    
    
    
    
    
    (0.6
    )
    
    
    (0.2
    )
    
    
    (0.5
    )Effective income tax rate
    
    
    27.1
    %
    
    
    34.2
    %
    
    
    10.6
    %
    
    
    34.8
    %
 Our deferred tax assets and liabilities are as follows: June 30,
    
    December 31,2004
    
    2003Deferred income tax assets resulting from future
deductible and taxable temporary differences:Allowance for loan losses and retained
interests fair value adjustments
    
    $
    85,491
    
    
    $
    122,852Intangible amortization
    
    
    46,835
    
    
    
    30,343Net operating loss and credit carry forwards
    
    
    14,362
    
    
    
    28,200Other
    
    
    29,461
    
    
    
    32,369Valuation allowance
    
    
    (10,168
    )
    
    
    (2,427
    )Total deferred tax assets
    
    
    165,981
    
    
    
    211,337Deferred income tax liabilities resulting from
future taxable and deductible temporary
differences:Accrued interest on credit card loans
    
    
    153,746
    
    
    
    194,766Other
    
    
    10,982
    
    
    
    19,388Total deferred tax liabilities
    
    
    164,728
    
    
    
    214,154Net deferred tax assets
    
    $
    1,253
    
    
    $
    (2,817
    )
 During the second quarter of 2004, the Company recorded a $7.7 million
valuation allowance against its deferred tax assets due to uncertainties
related to their realization. We believe, based on our expected reversals of
taxable temporary differences and, to a lesser degree, reliance on future
earnings, the remaining deferred tax assets are fully realizable. NOTE 10  ASSET IMPAIRMENTS, LEASE WRITE-OFFS AND SEVERANCE Asset impairments, lease write-offs and severance for the three-months
ended June 30, 2004 consists of charges related to workforce reductions.
During the comparable period in 2003, this amount included a $5.1 million
charge for commitment fees and $0.9 million related to workforce reductions.
During the six-month period ended June 30, 2004 this amount included a $0.4
million charge related to write-downs of various operating leases and $2.8
million in workforce reduction charges. The comparable period in 2003 included
a $5.7 million charge for workforce reductions, $5.1 million for commitment
fees, and $12.0 million for write-downs of excess property and equipment. NOTE 11  SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS We have various subsidiaries that do not guarantee Company debt. We have
prepared condensed consolidating financial statements of the Company, the
guarantor subsidiaries and the non-guarantor subsidiaries for purposes of
complying with SEC reporting requirements. Separate financial statements of
the guaranteeing subsidiaries and non-guaranteeing subsidiaries are not
presented because we have determined that the subsidiaries financial
information would not be material to investors. 13




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Consolidating Balance Sheets
June 30, 2004(Dollars in thousands)
Unaudited MetrisCompanies
    
    Guarantor
    
    Non-GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedAssets:Cash and cash equivalents
    
    $
    75,577
    
    
    $
    2,489
    
    
    $
    323,163
    
    
    $
    
    
    
    $
    401,229Liquidity reserve deposit
    
    
    
    
    
    
    
    
    
    
    74,863
    
    
    
    
    
    
    
    74,863Net credit card loans
    
    
    60
    
    
    
    
    
    
    
    57,056
    
    
    
    
    
    
    
    57,116Retained interests in loans
securitized
    
    
    5,979
    
    
    
    
    
    
    
    744,076
    
    
    
    11,558
    
    
    
    761,613Property and equipment, net
    
    
    
    
    
    
    28,519
    
    
    
    8
    
    
    
    
    
    
    
    28,527Purchased portfolio premium
    
    
    
    
    
    
    
    
    
    
    12,987
    
    
    
    
    
    
    
    12,987Other receivables due from
credit card securitizations,
net
    
    
    3
    
    
    
    
    
    
    
    75,770
    
    
    
    
    
    
    
    75,773Other assets
    
    
    37,834
    
    
    
    25,782
    
    
    
    61,251
    
    
    
    (56,385
    )
    
    
    68,482Investment in subsidiaries
    
    
    1,268,328
    
    
    
    849,268
    
    
    
    
    
    
    
    (2,117,596
    )
    
    
    Total assets
    
    $
    1,387,781
    
    
    $
    906,058
    
    
    $
    1,349,174
    
    
    $
    (2,162,423
    )
    
    $
    1,480,590Liabilities:Deposits
    
    $
    (500
    )
    
    $
    
    
    
    $
    5,072
    
    
    $
    
    
    
    $
    4,572Debt
    
    
    499,107
    
    
    
    (395,304
    )
    
    
    387,369
    
    
    
    (43,000
    )
    
    
    448,172Accounts payable
    
    
    678
    
    
    
    13,963
    
    
    
    19,556
    
    
    
    
    
    
    
    34,197Deferred income
    
    
    
    
    
    
    
    
    
    
    14,258
    
    
    
    
    
    
    
    14,258Accrued expenses and other
liabilities
    
    
    5,750
    
    
    
    19,071
    
    
    
    73,651
    
    
    
    (1,827
    )
    
    
    96,645Total liabilities
    
    
    505,035
    
    
    
    (362,270
    )
    
    
    499,906
    
    
    
    (44,827
    )
    
    
    597,844Total
stockholders
equity
    
    
    882,746
    
    
    
    1,268,328
    
    
    
    849,268
    
    
    
    (2,117,596
    )
    
    
    882,746Total
liabilities and
stockholders
equity
    
    $
    1,387,781
    
    
    $
    906,058
    
    
    $
    1,349,174
    
    
    $
    (2,162,423
    )
    
    $
    1,480,590
 14




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##### Table of Contents



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




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Three Months Ended June 30, 2004(Dollars in thousands)
Unaudited Metris
    
    
    
    
    
    Non-Companies
    
    Guarantor
    
    GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedRevenues:Securitization (expense)
income
    
    
    (1,036
    )
    
    
    
    
    
    
    (24,012
    )
    
    
    705
    
    
    
    (24,343
    )Servicing income on
securitized receivables
    
    
    
    
    
    
    
    
    
    
    33,847
    
    
    
    
    
    
    
    33,847Credit card loan and other
interest income
    
    
    284
    
    
    
    
    
    
    
    4,726
    
    
    
    
    
    
    

    5,010Credit card loan fees,
interchange and other
income
    
    
    1,222
    
    
    
    19,252
    
    
    
    4,048
    
    
    
    (19,258
    )
    
    
    5,264Enhancement services income
    
    
    
    
    
    
    27
    
    
    
    6,955
    
    
    
    (6
    )
    
    
    6,976Intercompany allocations
    
    
    (166
    )
    
    
    37,915
    
    
    
    643
    
    
    
    (38,392
    )
    
    
    Total revenues
    
    
    304
    
    
    
    57,194
    
    
    
    26,207
    
    
    
    (56,951
    )
    
    
    26,754Expenses:Interest expense
    
    
    18,606
    
    
    
    (2,983
    )
    
    
    3,091
    
    
    
    
    
    
    
    18,714Provision for loan losses
    
    
    29
    
    
    
    (2
    )
    
    
    (518
    )
    
    
    
    
    
    
    (491
    )Credit card account and
other product solicitation

and marketing expenses
    
    
    
    
    
    
    12,951
    
    
    
    19,061
    
    
    
    (16,286
    )
    
    
    15,726Employee compensation
    
    
    
    
    
    
    36,721
    
    
    
    (998
    )
    
    
    
    
    
    
    35,723Data processing services
and communications
    
    
    
    
    
    
    (12,705
    )
    
    
    29,470
    
    
    
    (2,988
    )
    
    
    13,777Credit protection claims
expense
    
    
    
    
    
    
    
    
    
    
    5,036
    
    
    
    
    
    
    
    5,036Occupancy and equipment
    
    
    
    
    
    
    
    
    
    
    5,984
    
    
    
    
    
    
    
    5,984Purchased portfolio premium
amortization
    
    
    
    
    
    
    
    
    
    
    2,420
    
    
    
    (315
    )
    
    
    2,105Asset impairments, lease
write-offs and severance
    
    
    
    
    
    
    
    
    
    
    1,812
    
    
    
    
    
    
    
    1,812Other
    
    
    4,856
    
    
    
    22,206
    
    
    
    (2,244
    )
    
    
    
    
    
    
    24,818Intercompany allocations
    
    
    37
    
    
    
    9,058
    
    
    
    29,297
    
    
    
    (38,392
    )
    
    
    Total expenses
    
    
    23,528
    
    
    
    65,246
    
    
    
    92,411
    
    
    
    (57,981
    )
    
    
    123,204(Loss) Income Before Income
Tax Expense (Benefit) and
Equity in Income (Loss) of
Subsidiaries
    
    
    (23,224
    )
    
    
    (8,052
    )
    
    
    (66,204
    )
    
    
    1,030
    
    
    
    (96,450
    )Income tax expense (benefit)
    
    
    377
    
    
    
    (14,055
    )
    
    
    (12,213
    )
    
    
    (233
    )
    
    
    (26,124
    )Equity in (loss) income of
subsidiaries
    
    
    (46,725
    )
    
    
    (53,991
    )
    
    
    
    
    
    
    100,716
    
    
    
    Net (Loss) Income
    
    $
    (70,326
    )
    
    $
    (47,988
    )
    
    $
    (53,991
    )
    
    $
    101,979
    
    
    $
    (70,326
    )
 16




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Three Months Ended June 30, 2003(Dollars in thousands)
Unaudited MetrisCompanies
    
    Guarantor
    
    Non-GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedRevenues:Securitization (expense)
income
    
    
    (443
    )
    
    
    
    
    
    
    19,510
    
    
    
    (1,360
    )
    
    
    17,707Servicing income on
securitized receivables
    
    
    
    
    
    
    
    
    
    
    45,335
    
    
    
    
    
    
    
    45,335Credit card loan and
other interest income
    
    
    524
    
    
    
    
    
    
    
    30,908
    
    
    
    
    
    
    
    31,432Credit card loan fees,
interchange and other
income
    
    
    1,036
    
    
    
    19,004
    
    
    
    21,476
    
    
    
    (18,056
    )
    
    
    23,460Enhancement services
income
    
    
    
    
    
    
    7,100
    
    
    
    34,856
    
    
    
    (2,266
    )
    
    
    39,690Intercompany allocations
    
    
    5,264
    
    
    
    73,725
    
    
    
    8,247
    
    
    
    (87,236
    )
    
    
    Total revenues
    
    
    6,381
    
    
    
    99,829
    
    
    
    160,332
    
    
    
    (108,918
    )
    
    
    157,624Expenses:Interest expense
    
    
    9,206
    
    
    
    (915
    )
    
    
    10,425
    
    
    
    
    
    
    
    18,716Provision for loan losses
    
    
    540
    
    
    
    
    
    
    
    29,759
    
    
    
    (266
    )
    
    
    30,033Credit card account and
other product
solicitation and
marketing expenses
    
    
    
    
    
    
    18,209
    
    
    
    32,733
    
    
    
    (18,910
    )
    
    
    32,032Employee compensation
    
    
    
    
    
    
    41,860
    
    
    
    3,861
    
    
    
    
    
    
    
    45,721Data processing services
and communications
    
    
    5
    
    
    
    (19,717
    )
    
    
    39,062
    
    
    
    (2,316
    )
    
    
    17,034Credit protection claims
expense
    
    
    
    
    
    
    (97
    )
    
    
    7,743
    
    
    
    
    
    
    
    7,646Occupancy and equipment
    
    
    
    
    
    
    
    
    
    
    8,924
    
    
    
    
    
    
    
    8,924Purchased portfolio
premium amortization
    
    
    10
    
    
    
    
    
    
    
    7,621
    
    
    
    (1,132
    )
    
    
    6,499Asset impairments, lease
write-offs and severance
    
    
    
    
    
    
    
    
    
    
    6,011
    
    
    
    
    
    
    
    6,011Other
    
    
    5,268
    
    
    
    25,342
    
    
    
    (7,996
    )
    
    
    (7
    )
    
    
    22,607Intercompany allocations
    
    
    24
    
    
    
    27,420
    
    
    
    59,792
    
    
    
    (87,236
    )
    
    
    Total expenses
    
    
    15,053
    
    
    
    92,102
    
    
    
    197,935
    
    
    
    (109,867
    )
    
    
    195,223(Loss) Income Before
Income Tax (Benefit)
Expense and Equity in
(Loss) Income of
Subsidiaries
    
    
    (8,672
    )
    
    
    7,727
    
    
    
    (37,603
    )
    
    
    949
    
    
    
    (37,599
    )Income tax (benefit)
expense
    
    
    (2,846
    )
    
    
    936
    
    
    
    (11,267
    )
    
    
    326
    
    
    
    (12,851
    )Equity in (loss) income
of subsidiaries
    
    
    (18,922
    )
    
    
    (26,336
    )
    
    
    
    
    
    
    45,258
    
    
    
    Net (Loss) Income
    
    $
    (24,748
    )
    
    $
    (19,545
    )
    
    $
    (26,336
    )
    
    $
    45,881
    
    
    $
    (24,748
    )
 17




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Six Months Ended June 30, 2004(Dollars in thousands)
Unaudited MetrisCompanies
    
    Guarantor
    
    Non-GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedRevenues:Securitization (expense)
income
    
    
    (1,079
    )
    
    
    
    
    
    
    94,338
    
    
    
    1,383
    
    
    
    94,642Servicing income on
securitized receivables
    
    
    
    
    
    
    
    
    
    
    70,084
    
    
    
    
    
    
    
    70,084Credit card loan and
other interest income
    
    
    407
    
    
    
    
    
    
    
    9,709
    
    
    
    
    
    
    
    10,116Credit card loan fees,
interchange and other
income
    
    
    2,449
    
    
    
    34,115
    
    
    
    13,165
    
    
    
    (33,649
    )
    
    
    16,080Enhancement services
income
    
    
    
    
    
    
    141
    
    
    
    14,333
    
    
    
    (18
    )
    
    
    14,456Intercompany allocations
    
    
    149
    
    
    
    78,810
    
    
    
    1,395
    
    
    
    (80,354
    )
    
    
    Total revenues
    
    
    1,926
    
    
    
    113,066
    
    
    
    203,024
    
    
    
    (112,638
    )
    
    
    205,378Expenses:Interest expense
    
    
    32,561
    
    
    
    (5,561
    )
    
    
    5,645
    
    
    
    
    
    
    
    32,645Provision for loan losses
    
    
    (1,288
    )
    
    
    (1
    )
    
    
    (5,294
    )
    
    
    
    
    
    
    (6,583
    )Credit card account and
other product
solicitation and
marketing expenses
    
    
    
    
    
    
    24,262
    
    
    
    34,873
    
    
    
    (27,477
    )
    
    
    31,658Employee compensation
    
    
    
    
    
    
    75,763
    
    
    
    (1,095
    )
    
    
    
    
    
    
    74,668Data processing services
and communications
    
    
    5
    
    
    
    (28,443
    )
    
    
    64,897
    
    
    
    (6,210
    )
    

    
    30,249Credit protection claims
expense
    
    
    
    
    
    
    
    
    
    
    11,384
    
    
    
    
    
    
    
    11,384Occupancy and equipment
    
    
    
    
    
    
    
    
    
    
    12,385
    
    
    
    
    
    
    
    12,385Purchased portfolio
premium amortization
    
    
    7
    
    
    
    
    
    
    
    5,513
    
    
    
    (1,018
    )
    
    
    4,502Asset impairments, lease
write-offs and severance
    
    
    
    
    
    
    
    
    
    
    3,273
    
    
    
    
    
    
    
    3,273Other
    
    
    5,361
    
    
    
    44,076
    
    
    
    (6,102
    )
    
    
    
    
    
    
    43,335Intercompany allocations
    
    
    68
    
    
    
    20,471
    
    
    
    59,815
    
    
    
    (80,354
    )
    
    
    Total expenses
    
    
    36,714
    
    
    
    130,567
    
    
    
    185,294
    
    
    
    (115,059
    )
    
    
    237,516(Loss) Income Before
Income Tax (Benefit)
Expense and Equity in
Income (Loss) of
Subsidiaries
    
    
    (34,788
    )
    
    
    (17,501
    )
    
    
    17,730
    
    
    
    2,421
    
    
    
    (32,138
    )Income tax (benefit)
expense
    
    
    (3,705
    )
    
    
    (18,912
    )
    
    
    18,937
    
    
    
    258
    
    
    
    (3,422
    )Equity in income (loss)
of subsidiaries
    
    
    2,367
    
    
    
    (1,207
    )
    
    
    
    
    
    
    (1,160
    )
    
    
    Net (Loss) Income
    
    $
    (28,716
    )
    
    $
    204
    
    
    $
    (1,207
    )
    
    $
    1,003
    
    
    $
    (28,716
    )
 18




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Consolidating Statements of Income
Six Months Ended June 30, 2003(Dollars in thousands)
Unaudited MetrisCompanies
    
    Guarantor
    
    Non-GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedRevenues:Securitization (expense)
income
    
    
    (10,454
    )
    
    
    
    
    
    
    (7,770
    )
    
    
    (2,039
    )
    
    
    (20,263
    )Servicing income on
securitized receivables
    
    
    
    
    
    
    
    
    
    
    93,148
    
    
    
    
    
    
    
    93,148Credit card loan and
other interest income
    
    
    995
    
    
    
    
    
    
    
    62,598
    
    
    
    
    
    
    
    63,593Credit card loan fees,
interchange and other
income
    
    
    1,091
    
    
    
    31,547
    
    
    
    47,926
    
    
    
    (30,785
    )
    
    
    49,779Enhancement services
income
    
    
    
    
    
    
    16,278
    
    
    
    72,939
    
    
    
    (6,018
    )
    
    
    83,199Intercompany allocations
    
    
    5,340
    
    
    
    139,332
    
    
    
    18,237
    
    
    
    (162,909
    )
    
    
    Total revenues
    
    
    (3,028
    )
    
    
    187,157
    
    
    
    287,078
    
    
    
    (201,751
    )
    
    
    269,456Expenses:Interest expense
    
    
    18,383
    
    
    
    (98
    )
    
    
    19,772
    
    
    
    
    
    
    
    38,057Provision for loan losses
    
    
    1,387
    
    
    
    
    
    
    
    73,534
    
    
    
    (102
    )
    
    
    74,819Credit card account and
other product
solicitation and
marketing expenses
    
    
    
    
    
    
    30,430
    
    
    
    66,489
    
    
    
    (31,199
    )
    
    
    65,720Employee compensation
    
    
    
    
    
    
    93,071
    
    
    
    6,031
    
    
    
    
    
    
    
    99,102Data processing services
and communications
    
    
    4
    
    
    
    (41,704
    )
    
    
    83,713
    
    
    
    (5,801
    )
    
    
    36,212Credit protection claims
expense
    
    
    
    
    
    
    
    
    
    
    19,952
    
    
    
    
    
    
    
    19,952Occupancy and equipment
    
    
    
    
    
    
    
    
    
    
    18,537
    
    
    
    
    
    
    
    18,537Purchased portfolio
premium amortization
    
    
    21
    
    
    
    
    
    
    
    15,318
    
    
    
    (2,344
    )
    
    
    12,995Asset impairments, lease
write-offs and severance
    
    
    
    
    
    
    
    
    
    
    22,788
    
    
    
    
    
    
    
    22,788Other
    
    
    5,353
    
    
    
    64,454
    
    
    
    (23,486
    )
    
    
    (7
    )
    
    
    46,314Intercompany allocations
    
    
    35
    
    
    
    53,047
    
    
    
    109,827
    
    
    
    (162,909
    )
    
    
    Total expenses
    
    
    25,183
    
    
    
    199,200
    
    
    
    412,475
    
    
    
    (202,362
    )
    
    
    434,496(Loss) Income Before
Income Tax (Benefit)
Expense and Equity in
(Loss) Income of
Subsidiaries
    
    
    (28,211
    )
    
    
    (12,043
    )
    
    
    (125,397
    )
    
    
    611
    
    
    
    (165,040
    )Income tax (benefit)
expense
    
    
    (4,285
    )
    
    
    (7,184
    )
    
    
    (46,202
    )
    
    
    209
    
    
    
    (57,462
    )Equity in (loss) income
of subsidiaries
    
    
    (83,652
    )
    
    
    (79,195
    )
    
    
    
    
    
    
    162,847
    
    
    
    Net (Loss) Income
    
    $
    (107,578
    )
    
    $
    (84,054
    )
    
    $
    (79,195
    )
    
    $
    163,249
    
    
    $
    (107,578
    )
 19




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Six Months Ended June 30, 2004(Dollars in thousands)
Unaudited MetrisCompanies
    
    Guarantor
    
    Non-GuarantorInc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedOperating Activities:Net cash (used in)
provided by operating
activities
    
    $
    (60,752
    )
    
    $
    (423,869
    )
    
    $
    617,454
    
    
    $
    17,820
    
    
    $
    150,653Investing Activities:Net cash from loan
originations and
principal collections on
loans receivable
    
    
    16,431
    
    
    
    
    
    
    
    (24,948
    )
    
    
    (3,356
    )
    
    
    (11,873
    )Net additions to
(disposals of) property
and equipment
    
    
    
    
    
    
    2,068
    
    
    
    5
    
    
    
    (1
    )
    
    
    2,072Investment in subsidiaries
    
    
    36,897
    
    
    
    410,250
    
    
    
    (423,255
    )
    
    
    (23,892
    )
    
    
    Net cash provided by
(used in) investing
activities
    
    
    53,328
    
    
    
    412,318
    
    
    
    (448,198
    )
    
    
    (27,249
    )
    
    
    (9,801
    )Financing Activities:Net increase in debt
    
    
    81,250
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    81,250Net decrease in deposits
    
    
    500
    
    
    
    
    
    
    
    (2,190
    )
    
    
    
    
    
    
    (1,690
    )Proceeds from issuance of
common stock
    
    
    2,332
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,332Capital contributions
    
    
    
    
    
    
    11,006
    
    
    
    (20,435
    )
    
    
    9,429
    
    
    
    Net cash (used in)
provided by financing
activities
    
    
    84,082
    
    
    
    11,006
    
    
    
    (22,625
    )
    
    
    9,429
    
    
    
    81,892Net (decrease) increase
in cash and cash
equivalents
    
    
    76,658
    
    
    
    (545
    )
    
    
    146,631
    
    
    
    
    
    
    
    222,744Cash and cash equivalents
at beginning of period
    
    
    (1,081
    )
    
    
    3,034
    
    
    
    176,532
    
    
    
    
    
    
    
    178,485Cash and cash equivalents
at end of period
    
    $
    75,577
    
    
    $
    2,489
    
    
    $
    323,163
    
    
    $
    
    
    
    $
    401,229
 20




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##### Table of Contents



METRIS COMPANIES INC.
Supplemental Condensed Consolidating Statements of Cash Flows
Six Months Ended June 30, 2003(Dollars in thousands)
Unaudited (as restated) Metris
    
    Guarantor
    
    Non-GuarantorCompanies Inc.
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedOperating Activities:Net cash (used in)
provided by operating
activities
    
    $
    (141,049
    )
    
    $
    (84,492
    )
    
    $
    (156,892
    )
    
    $
    163,249
    
    
    $
    (219,184
    )Investing Activities:Proceeds from transfers
of portfolios to the
Metris Master Trust
    
    
    
    
    
    
    
    
    
    
    315,065
    
    
    
    
    
    
    
    315,065Net cash from loan
originations and
principal collections on
loans receivable
    
    
    (41,582
    )
    
    
    
    
    
    
    (43,157
    )
    
    
    
    
    
    
    (84,739
    )Net (Disposals of)
additions to property and
equipment
    
    
    
    
    
    
    (1,259
    )
    
    
    19,784
    
    
    
    
    
    
    
    18,525Investment in subsidiaries
    
    
    158,658
    
    
    
    240,640
    
    
    
    477,513
    
    
    
    (876,811
    )
    
    
    Net cash provided by
(used in) investing
activities
    
    
    117,076
    
    
    
    239,381
    
    
    
    769,205
    
    
    
    (876,811
    )
    
    
    248,851Financing Activities:Net increase (decrease)
in debt
    
    
    25,349
    
    
    
    (207
    )
    
    
    
    
    
    
    
    
    
    
    25,142Net decrease in deposits
    
    
    
    
    
    
    
    
    
    
    (250,820
    )
    
    
    
    
    
    
    (250,820
    )Proceeds from issuance of
common stock
    
    
    2,370
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,370Capital contributions
    
    
    
    
    
    
    (161,557
    )
    
    
    (552,005
    )
    
    
    713,562
    
    
    
    Net cash provided by
(used in) financing
activities
    
    
    27,719
    
    
    
    (161,764
    )
    
    
    (802,825
    )
    
    
    713,562
    
    
    
    (223,308
    )Net increase (decrease)
in cash and cash
equivalents
    
    
    3,746
    
    
    
    (6,875
    )
    
    
    (190,512
    )
    
    
    
    
    
    
    (193,641
    )Cash and cash equivalents
at beginning of period
    
    
    (3,795
    )
    
    
    8,109
    
    
    
    575,918
    
    
    
    
    
    
    
    580,232Cash and cash equivalents
at end of period
    
    $
    (49
    )
    
    $
    1,234
    
    
    $
    385,406
    
    
    $
    
    
    
    $
    386,591
 21




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##### Table of Contents



ITEM 2. METRIS COMPANIES INC. AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Business Overview The following discussion and analysis provides information management
believes to be relevant to understanding the financial condition and results of
operations of Metris Companies Inc. (MCI) and its subsidiaries. MCIs
principal subsidiaries are Direct Merchants Credit Card Bank, National
Association (Direct Merchants Bank or the Bank), Metris Direct, Inc. and
Metris Receivables, Inc. (MRI). MCI and its subsidiaries, as applicable, may
be referred to as we, us, our or the Company. For a full understanding
of our financial condition and results of operations, you should read this
discussion along with Managements Discussion and Analysis of Financial
Condition and Results of Operations in our Annual Report on Form 10-K/A for the
fiscal year ended December 31, 2003. In addition, you should read this
discussion along with our condensed consolidated financial statements and
related notes thereto for the period ended June 30, 2004 included herein. MCI was incorporated in Delaware on August 20, 1996, and completed an
initial public offering in October 1996. We provide financial products and
services to middle market consumers throughout the United States. Our consumer
lending products are primarily unsecured credit cards, including the Direct
Merchants Bank MasterCard® and Visa®. We also offer co-branded
credit cards through partnerships with other companies. Our credit cards
generate consumer loans through Direct Merchants Bank. These loans in turn
generate income and cash flow from principal, interest and fee payments. The
sales of our other consumer financial products, such as credit protection
products, generate additional cash flow. In 2001, we implemented a program to increase the credit lines to a large
portion of our existing customers. Shortly thereafter the United States
experienced an economic downturn. Our target market was severely impacted by
the economic downturn as unemployment and bankruptcy rates worsened. With the
increased payment pressure caused by the credit line increases, coupled with
the economic downturn, our customer default rates increased. We continue to
experience the residual effects of the past economic downturn and the 2001
credit line increase program through the second quarter of 2004 as evidenced by
our high managed charge-off rates. However, we have begun to experience
improving asset quality as a result of actions taken over the past six quarters
to strengthen credit line management strategies, limit marketing efforts to
better credit quality consumers, tighten credit authorization criteria, and
enhance collection strategies. The reported Metris Master Trust two-cycle plus
delinquency rates fell from their peak of 12.05% in November 2002 to 9.49% as
of June 30, 2004. In addition, the Metris Master Trust three-month average
excess spread was 3.83% as of June 30, 2004 compared to 4.61% for the first
quarter of 2004, and 1.93% in the second quarter of 2003. The decrease in the
three-month average excess spread between the first and second quarters of 2004
reflects the impact of seasonal payments on the Metris Master Trust yield. We continue to evaluate and modify our marketing programs to improve the
overall credit quality of the managed portfolio. Beginning late in 2002 we
tested pricing and line assignments for new customers. These actions were in
response to a lower interest rate environment, increased competition in the
middle market sector, and overall tightening of our underwriting. The early
results of these initiatives indicate improved credit quality from our most
recent marketing campaigns. Our 154,000 new accounts booked in the first half
of 2004 continue to reflect our focus on the middle market segment. Our
account marketing is following a disciplined process with regard to pricing,
line assignments and risk characteristics to achieve desired returns. We
expect the target market of future marketing efforts to be consistent with the
first half of 2004. Our business requires a high degree of liquidity. Thus, ensuring
appropriate liquidity is at the forefront of our business objectives. We rely
heavily on the securitization of our consumer loans for funding, primarily by
selling the loans to the Metris Master Trust. During the quarter ended June
30, 2004, we completed several funding transactions that will allow us to
continue focusing on improving our overall business performance (see the
Liquidity, Funding and Capital Resources section on pages 33-36 for further
discussion). 22




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##### Table of Contents



In April 2004 we announced the issuance of $200 million of three-year
credit card asset-backed term securities. The proceeds from this transaction
were used to repay an outstanding paired-series, which was due in May 2004.
During the quarter we also increased our conduit capacity to $1.2 billion. This
facility is a two-year conduit financing facility, maturing in May 2006. We
utilized this conduit during the quarter to defease maturing asset-backed
securitization (ABS) series 2001-3 and 2001-4 totaling $1.15 billion. Also,
in May 2004, we paid off the $95.3 million outstanding on our $125 million term
loan due June 2004. Finally, in May 2004, we closed on a $300 million term
loan that matures in May 2007. The proceeds of the loan were used in part to
repay the Companys $100 million 10% Senior Notes due in November 2004. The
balance of the proceeds from the loan will be used by the Company for general
corporate purposes. With these new transactions we have completed our corporate funding
initiatives for 2004. Our receivable funding needs for the remainder of 2004
and 2005 will be covered by portfolio attrition and future asset-backed
securitizations. We have $1.5 billion of capacity in a MBIA commitment to
provide insurance coverage on future asset-backed security transactions, of
which $300 million is currently available. In January 2003, the FFIEC issued guidance with respect to account
management, risk management, and loss allowance practices for institutions
engaged in credit card lending. The guidance provides requirements for certain
operational and accounting policies, which are designed to bring consistency in
practice between institutions engaged in credit card lending. The Company has
developed an implementation plan to address the account management aspects of
this guidance. As initial steps in the implementation of this guidance, during
June and July of 2004 we stopped billing late and overlimit fees on credit card
accounts in which the customers balance was 130 percent or more of their
credit limit. We continue testing alternative approaches to fully comply with
the account management guidance, the results of which are not expected until
later this year. We anticipate that the impact of fully implementing the
account management guidance will result in slightly lower yields in the Metris
Master Trust, which we expect will be partially offset by lower default rates. Critical Accounting Estimates The Companys most critical accounting estimates are our determination of
the Allowance for loan losses and the valuation of our Retained interests in
loans securitized. Allowance for Loan Losses We maintain an Allowance for loan losses sufficient to absorb probable
loan losses inherent in the credit card loan portfolio as of the balance sheet
date. The Allowance for loan losses results in a reserve approximating 18
months future charge-offs. At the time of charge-off, all principal balances
are written off against the allowance and all fees and finance charges are
netted against the applicable income statement line item. The allowance is
based on managements consideration of all relevant factors, including
managements assessment of applicable economic and seasonal trends. Historically, we segmented the loan portfolio into several individual
liquidating pools with similar credit risk characteristics, and estimated
(based on historical experience for similar pools and existing environmental
conditions) the dollar amount of principal, accrued finance charges and fees
that would charge-off. We then aggregated these pools into prime and subprime
portfolios based on the prescribed FICO score cuts, credit counseling programs,
and various pools of other receivables. We separately analyzed the reserve
requirement on each of these groups or portfolios. During the first quarter of
2004, we aggregated all liquidating pools into one segment, which is treated as
subprime loans for allowance determination purposes. We believe this was
appropriate due to the reduction in the loan portfolio and the fact the
remaining loans had similar risk characteristics. We continually evaluate the liquidating pool employing a roll-rate model
which uses historical delinquency levels and pay-down levels (12 months of
historical data, with influence given to the last six months performance to
capture current economic and seasonal trends), loan seasoning, and other
measures of asset quality to estimate charge-offs for both credit losses and
bankruptcy losses. 23




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##### Table of Contents



Additionally, in evaluating the adequacy of the loan loss reserves, we
consider several subjective factors that may be overlaid into the credit risk
roll-rate model in determining the necessary loan loss reserve. These factors
include:  
    
    national and economic trends and business conditions, including the
condition of various market segments;  
    
    changes in lending policies and procedures, including those for
underwriting, collection, charge-off and recovery, as well as the
experience, ability and depth of lending management and staff;  
    
    trends in volume and the product pricing of accounts, including any
concentrations of credit; and  
    
    impacts from external factors  such as changes in competition, and
legal and regulatory requirements  on the level of estimated credit
losses in the current portfolio. Significant changes in these factors could impact our financial
projections and thereby affect the adequacy of our Allowance for loan losses. Valuation of Retained Interests in Loans Securitized The Retained interests in loans securitized on our balance sheet
associated with our securitization transactions includes contractual retained
interests, excess transferors interest, interest-only strip receivable, and
spread accounts receivable. We determine the fair value of each component of
the Retained interests in loans securitized at the time a securitization
transaction or replenishment sale is completed using a discounted cash flow
valuation model and on a quarterly basis thereafter. Any change in the fair
value is recorded in Securitization (expense) income. The discounted cash flow valuation is limited to the receivables that
exist and have been sold to the Metris Master Trust. Therefore, the model
assumes the current principal receivable balance at the balance sheet date
amortizes with no new sales, interchange fees or cash advances. The future
cash flows are modeled in accordance with the debt series legal documents and
are applied to all series on a pro-rata basis. Finance charge and fee income
and recovery cash flows above contractual expense payments are first applied to
meet spread accounts receivable requirements then returned to us as part of the
interest-only strip receivable. We determine upper and lower valuation limits
of the Retained interests in loans securitized based on historical and
forecasted excess spreads. We then determine the best estimate within the range
based on historical trends (weighted heavily toward the low end of the range),
adjusted when appropriate, for portfolio forecast information. The contractual retained interests represent subordinated securities held
by us. There is no stated interest/coupon rate associated with these
securities and they are not rated. They are subordinate to all other
securities, except for the interest-only strip receivable we own and
accordingly, are repaid last. Their fair value is determined by discounting
the expected future cash flows using a discount rate commensurate with the
risks of the underlying assets and the expected timing based on the scheduled
maturity date for the underlying securitization. If these securities are
recoverable based on the Metris Master Trust forecasts, cash flows related to
the entire subordinated principal balance are used in determining their fair
value. Transferors interest represents an undivided interest in receivables that
are not pledged to support a specific security series or class and represent
our interest in the excess principal receivables held in the Metris Master
Trust. The fair value is determined in the same manner as the contractual
retained interests and is discounted based on twelve months to maturity. We
have subordinated our rights to the excess cash flows on the receivables
underlying the transferors interest, thus they are included in the value of
the interest-only strip receivable. Spread accounts receivable balances
represents interest earning cash held by the Metris Master Trust trustee due to
performance of the Metris Master Trust and requisite reserves required by
certain security series. Changes in fair value are determined in the same
manner as the contractual retained interests. 24




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##### Table of Contents



The interest-only strip receivable represents the contractual right to
receive, from the Metris Master Trust, interest and other fee revenue less
certain costs over the estimated life of the underlying debt securities. The
fair value is determined by discounting the expected future cash flows using a
discount rate commensurate with the risks of the underlying assets and the
expected timing of the amortization inherent in the retained interests
valuation model. We believe our discount rates are consistent with what other
market place participants would use to determine the fair value of these
assets. The valuation model assumes that we repurchase the outstanding
principal receivables at face value according to the clean up call provisions
contained in the respective security series legal documents. We use certain assumptions and estimates in determining the fair values of
Retained interests in loans securitized. These assumptions and estimates
include estimated principal payments, credit losses, gross yield, interest
expense, fees, the timing of cash receipts, and discount rates commensurate
with the risks of the underlying assets. On a quarterly basis, we review and
adjust, as appropriate, the assumptions and estimates used in our model based
on a variety of internal and external factors, including national and economic
trends and business conditions, current lending policies, procedures and
strategies, historical trends and assumptions about future trends, competition,
and legal and regulatory requirements. Significant estimates are required in
determining these factors and different judgments concerning these factors can
result in a material impact on our balance sheet and income statement. Results of Operations Net loss for the three months ended June 30, 2004 was $70.3 million,
compared to a Net loss of $24.7 million for the second quarter of 2003.
Diluted loss per share for the three months ended June 30, 2004 was $1.40,
compared to a diluted loss per share of $0.60 for the second quarter of 2003.
The increase in the Net loss is primarily due to a $42.1 million decrease in
Securitization income, a decrease of $11.5 million in Servicing income on
securitized receivables, a $26.4 million decrease in Credit card loan and
other interest income, an $18.2 million decrease in Credit card loan fees,
interchange and other income, and a $32.7 million decrease in Enhancement
services income, partially offset by a decrease in Total expenses of $72.0
million. Net loss for the six months ended June 30, 2004 was $28.7 million,
compared to a Net loss of $107.6 million for the comparable period in 2003.
Diluted loss per share for the six months ended June 30, 2004 was $.87 compared
to a diluted loss per share of $2.22 for the comparable period in 2003. The
decrease in the Net loss is primarily due to a $114.9 million increase in
Securitization income, and a $197.0 million decrease in total expenses,
partially offset by a decrease of $23.1 million in Servicing income on
securitized receivables, a $53.5 million decrease in Credit card loan and
other interest income, a $33.7 million decrease in Credit card loan fees,
interchange and other income, and a $68.7 million decrease in Enhancement
services income. The following table summarizes Securitization (expense) income for the
three- and six-month periods ended June 30, 2004 and 2003. Table 1: Analysis of Securitization (Expense) Income(In thousands) Three-Months Ended
    
    Six-Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Loss on new securitization of receivables
to the Metris Master Trust
    
    $
    (90,640
    )
    
    $
    (12,244
    )
    
    $
    (91,886
    )
    
    $
    (32,199
    )Loss on replenishment of receivables to
the Metris Master Trust
    
    
    (25,454
    )
    
    
    (45,529
    )
    
    
    (49,381
    )
    
    
    (91,783
    )Discount accretion
    
    
    61,570
    
    
    
    78,812
    
    
    
    121,540
    
    
    
    154,486Change in fair value
    
    
    20,718
    
    
    
    (20,289
    )
    
    
    68,683
    
    
    
    (103,897
    )Interest-only revenue
    
    
    55,137
    
    
    
    32,243
    
    
    
    130,069
    
    
    
    90,679Transaction and other costs
    
    
    (45,674
    )
    
    
    (15,286
    )
    
    
    (84,383
    )
    
    
    (37,549
    )Securitization (expense) income
    
    $
    (24,343
    )
    
    $
    17,707
    
    
    $
    94,642
    
    
    $
    (20,263
    )
 25




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##### Table of Contents



Securitization (expense) income was an expense of $24.3 million for the
three-months ended June 30, 2004, compared to income of $17.7 million for the
same period in 2003. The decrease is primarily due to losses on new
securitizations of $90.6 million for the three months ended June 30, 2004,
compared to losses on new securitizations of $12.2 million for the three months
ended June 30, 2003. The $90.6 million loss on new securitizations in the
second quarter of 2004 relates to the defeasance of two series totaling $1.15
billion and the issuance of a $200 million ABS transaction during the quarter.
The $90.6 million loss was significantly higher than the loss in the second
quarter of 2003 which relates to the defeasance of $300 million in maturing
securitizations into a one-year conduit. In addition, transaction and other
costs were $45.7 million for the three months ended June 30, 2004 compared to
$15.3 million for the three months ended June 30, 2003. The higher transaction
costs are primarily due to fees on a $1.2 billion two-year financing conduit
that was closed in the second quarter of 2004 and are reflective of the larger
facility size and longer term compared to the financing conduits that were
established in the second quarter of 2003. Finally, accretion income decreased
$17.2 million, primarily due to lower receivable balances and resulting
contractual retained interests held in the Metris Master Trust. These decreases were partially offset by an improvement in the change in
fair value of $41.0 million, a $22.9 increase in interest-only revenue, and a
$20.1 million reduction in the loss on replenishment of receivables. The second
quarter change in fair value of $20.7 million was primarily due to a $14.2
million fair value increase reflecting the early pay-down of the variable
funding conduits resulting from attrition, and a $10.8 million fair value
increase in the interest-only asset due to higher projected excess spreads.
Interest-only revenue increased $22.9 million due to a 190 basis point increase
in average excess spread in the Metris Master Trust, partially offset by a $2.3
billion decrease in average principal receivables. Loss on replenishment of
receivables decreased $20.1 million primarily due to lower volumes of
receivables sold into the Metris Master Trust and a decrease in the
weighted-average months to maturity across all outstanding series. Securitization (expense) income was income of $94.6 million for the
six-months ended June 30, 2004, compared to expense of $20.3 million for the
same period in 2003. The increase is due to improvement in the change in fair
value of $172.6 million, a $42.4 million reduction in the loss on replenishment
of receivables, and a $39.4 million increase in interest-only revenue,
partially offset by a $59.7 million increase in loss on new securitization, a
$46.8 million increase in transaction and other costs, and a $32.9 million
decrease in accretion income. The year-to-date 2004 change in fair value of
$68.7 million was primarily due to a $36.3 million fair value increase
reflecting the early pay-down of the variable funding conduits resulting from
attrition, a $20.0 million fair value increase in the interest-only asset due
to higher projected excess spreads, and a $17.6 million decrease in the
discount against spread accounts receivable due to reserve releases resulting
from improved excess spread. The $42.4 million reduction in the loss on
replenishment of receivables is due to lower volumes of receivables sold into
the Metris Master Trust, a decrease in the weighted average months to
maturity across all outstanding series, and higher projected excess
spreads. The $39.4 million increase in
interest-only revenue is due to a 206 basis point increase in average excess
spread in the Metris Master Trust, partially offset by a $2.3 billion decrease
in average principal receivables. These increases were partially offset by a $91.9 million loss on new
securitizations for the six months ended June 30, 2004, which was significantly
higher than the $32.2 million loss for the six months ended June 30, 2003. The
$91.9 million loss on new securitizations in 2004 relates to a total of $1.8
billion of new securitizations compared to $0.7 billion of new securitizations
during the same period in 2003. Transaction and other costs were $84.4 million
for the six months ended June 30, 2004 compared to $37.5 million for the same
period in 2003. The higher transaction costs were primarily due to fees on a
$1.2 billion two-year financing conduit that was closed in 2004, which are
reflective of a larger facility size and longer term compared to the financing
conduits that were established in 2003. In addition, transaction fees were
incurred related to a paired series in the first quarter of 2004, commitment
fees for MBIA insurance coverage on future asset-backed transactions, and a
mark-to-market valuation adjustment on interest rate caps. Finally, the
accretion income decreased $32.9 million due to lower attrition on receivables
held in the Metris Master Trust and a decrease in the weighted average months
to maturity across all outstanding series. 26




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##### Table of Contents



Servicing income on securitized receivables decreased $11.5 million and
$23.1 million for the three- and six-month periods ended June 30, 2004,
respectively, over the same periods of 2003. The reduction is due to a
decrease of $2.3 billion in average principal receivables held by the Metris
Master Trust. Credit card loan and other interest income decreased $26.4 million from
the second quarter of 2003, and Credit card loan fees, interchange and other
income, decreased $18.2 million from the second quarter of 2003, primarily due
to a $610.1 million decrease in average owned credit card loans. For the
six-month period ended June 30, 2004 Credit card loan and other interest
income decreased $53.5 million, and Credit card loan fees, interchange and
other income, decreased $33.7 million. These decreases resulted from a $617.3
million decrease in average owned credit card loans. Enhancement services income decreased $32.7 million and $68.7 million
for the three- and six-month periods ended June 30, 2004, respectively, over
the comparable periods in 2003. These decreases resulted from the sale of our
membership club and warranty business in July 2003. Remaining Enhancement
services income is primarily commission revenue that Direct Merchants Bank
earns on membership club and warranty products sold to the Banks credit card
portfolio under a marketing agreement with the third-party purchaser and the
run-off of certain products not sold. Total expenses were $123.2 million and $237.5 million for the three- and
six-month periods ended June 30, 2004, respectively. This represents decreases
of $72.0 million and $197.0 million from the three- and six-month periods ended
June 30, 2003, respectively. Provision for loan losses expense decreased
$30.5 million and $81.4 million for the three- and six-month periods,
respectively. This decrease reflects the significant reduction in credit card
loans during the past year and slightly improved credit quality. Interest
expense for the three- and six-month periods ended June 30, 2003 is comprised
primarily of interest incurred on our Deposits that were sold in the third
quarter of 2003. For the three-and six-month periods ended June 30, 2004,
Interest expense is comprised primarily of interest incurred related to the
term debt. The remaining $41.5 million and $115.6 million reduction in
expenses for the three- and six-month periods primarily reflects the sale of
the Companys membership club and warranty business and the significant
reduction in credit card operations during the past year. Asset impairments, lease write-offs and severance were $1.8 million and
$3.3 million for the three- and six-month periods ended June 30, 2004 and
include severance charges associated with the first and second quarter
workforce reductions, as well as expenses resulting from the write-down of
various operating leases. Credit card receivables Our delinquency and net loan charge-off rates at any point in time
reflect, among other factors, the credit risk of loans, the average age of our
various credit card account portfolios, the success of our collection and
recovery efforts, and general economic conditions. The average age of our
credit card portfolio affects the stability of delinquency and loss rates. In
order to minimize losses, we continue to focus our resources on refining our
credit underwriting standards for new accounts, and on enhancing collection
strategies. We use credit line analyses, account management, and customer transaction
authorization procedures to minimize loan losses. Our risk models determine
initial credit lines at the time of underwriting. We manage credit lines on an
ongoing basis and adjust them based on customer usage and payment patterns. We
continually monitor customer accounts and initiate appropriate collection
activities when an account is delinquent or overlimit. We monitor customer
authorization history, complete credit line analysis, and refine account
management strategies to mitigate long-term credit losses. It is our policy to accrue interest and fee income on all credit card
accounts, except in limited circumstances, until we charge-off the account. In
November 2002, we stopped billing late fees once an account became 120 days
contractually delinquent and in March 2003, we stopped billing overlimit fees
once an account became 120 days contractually delinquent. In June and July of
2004 we stopped billing late and overlimit fees on accounts with balances of 27




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130 percent or more of their limit. Past due accounts are re-aged to current
status only after we receive at least three minimum payments or the equivalent
cumulative amount. Accounts can only be re-aged to current status once every
twelve months, and two times every five years. Accounts entering long-term
fixed payment forbearance programs may receive a re-age upon entering the debt
management program (workout re-age). Workout re-ages can only occur after
receipt of at least three consecutive minimum monthly payments, or the
equivalent cumulative amount as defined by the debt management program. In
accordance with FFIEC guidance, workout re-ages can only occur once in five
years. Table 2 presents the delinquency trends of our credit card loan
portfolio. Table 2: Loan Delinquency(Dollars in thousands) June 30,
    
    % of
    
    December 31,
    
    % of
    
    June 30,
    
    % of2004
    
    Total
    
    2003
    
    Total
    
    2003
    
    TotalLoans outstanding
    
    $
    72,491
    
    
    
    100
    %
    
    $
    128,615
    
    
    
    100
    %
    
    $
    632,913
    
    
    
    100
    %Loans contractually
delinquent:30 to 59 days
    
    
    2,448
    
    
    
    3.4
    %
    
    
    5,015
    
    
    
    3.9
    %
    
    
    19,699
    
    
    
    3.1
    %60 to 89 days
    
    
    2,007
    
    
    
    2.8
    %
    
    
    4,888
    
    
    
    3.8
    %
    
    
    17,668
    
    
    
    2.8
    %90 or more days
    
    
    4,866
    
    
    
    6.7
    %
    
    
    10,406
    
    
    
    8.1
    %
    
    
    10,899
    
    
    
    1.7
    %Total
    
    $
    9,321
    
    
    
    12.9
    %
    
    $
    20,309
    
    
    
    15.8
    %
    
    $
    48,266
    
    
    
    7.6
    %
 The decrease in the delinquency rates between December 31, 2003 and June
30, 2004 primarily reflects the improvement in our collection efforts and the
run-off of poor quality loans within our owned portfolio. The low delinquency
rate as of June 30, 2003 is the result of the sale of $29.1 million on
delinquent assets in June 2003. Net charge-offs are the principal amount of losses from cardholders
unwilling or unable to make minimum payments, bankrupt cardholders, and
deceased cardholders, less current period recoveries. Net charge-offs exclude
accrued finance charges and fees, which are charged-off against the applicable
revenue line item at the time of charge-off. We charge-off and take accounts
as a loss within (i)60 days following formal notification of bankruptcy; (ii)
at the end of the month during which most unsecured accounts become
contractually 180 days past due; (iii) at the end of the month during which
unsecured accounts that have entered into a credit counseling or other similar
debt forbearance program later become contractually 120 days past due; or (iv)
at the end of the month during which secured accounts become contractually 120
days past due after first reducing the loss by the secured deposit. Beginning
in the fourth quarter of 2003, we changed our policy for recognizing credit
losses on accounts that enter into a settlement payment arrangement. Under the
new policy, the portion of the balance that has been forgiven is charged-off
upon entering into the settlement arrangement with the customer. The previous
policy recognized these losses after the completion of the settlement
arrangement. We charge-off accounts that are identified as fraud losses no
later than 90 days after discovery. We enter into agreements with third parties for the sale of a majority of
charged-off credit card receivables. We also refer charged-off accounts to our
recovery unit for coordination of collections efforts to recover the amounts
owed. When appropriate, we place accounts with external collection agencies or
attorneys. Charge-offs due to bankruptcies were $0.7 million, representing
17.6% of total gross charge-offs for the three-month period ended June 30, 2004
and $6.8 million, representing 15.1% of total gross charge-offs for the
three-month period ended June 30, 2003. Charge-offs due to bankruptcies were
$3.1 million, representing 18.7% of total gross charge-offs for the six-month
period ended June 30, 2004 and $12.3 million, representing 23.4% of total gross
charge-offs for the six-month period ended June 30, 2003. Table 3 presents our
net charge-offs for the periods indicated as reported in the consolidated
financial statements. 28




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Table 3: Net Charge-offs(Dollars in thousands) Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Average credit card loans
    
    $
    80,779
    
    
    $
    690,903
    
    
    $
    103,868
    
    
    $
    721,121Net charge-offs
    
    
    3,080
    
    
    
    43,702
    
    
    
    15,245
    
    
    
    51,991Net charge-off ratio
    
    
    15.3
    %
    
    
    25.4
    %
    
    
    29.4
    %
    
    
    14.5
    %
 The decrease in the net charge-off ratio for the three months ended June
30, 2004 compared to the three months ended June 30, 2003, is primarily due to
a $27.0 million charge-off related to the sale of approximately $29.1 million
of delinquent receivables in June 2003. Allowance for Loan Losses We record provisions for loan losses in amounts necessary to maintain the
allowance at a level sufficient to absorb anticipated probable loan losses
inherent in the existing loan portfolio as of the balance sheet date. In order to mitigate credit losses, we have expanded our collections
strategies to aggressively address any potential delinquency increases. We
also leverage forbearance programs and credit counseling services for
qualifying cardholders that are experiencing payment difficulties. These
programs include reduced interest rates, reduced or suspended fees, and other
incentives to induce the customer to continue making payments. The amount of
customer receivables in debt forbearance programs was $6.0 million or 8.3% of
total Credit card loans as of June 30, 2004, compared to $6.2 million or 4.8%
of total Credit card loans as of December 31, 2003. All delinquent
receivables in debt forbearance programs are included in Table 2. The Allowance for loan losses was $15.4 million as of June 30, 2004,
versus $45.5 million as of December 31, 2003. The ratio of Allowance for loan
losses to period-end Credit card loans was 21.2% at June 30, 2004, compared
to 35.4% at December 31, 2003. The Allowance for loan losses as a percentage
of 30-day plus receivables was 165.0% at June 30, 2004, compared to 224.0% at
December 31, 2003. We believe the Allowance for loan losses is adequate to
cover probable future losses inherent in the loan portfolio under current
conditions. Retained Interests in Loans Securitized Our credit card receivables are primarily funded through asset
securitizations. Upon securitization, the Company removes the applicable credit
card loans from the balance sheet and recognizes the Retained interests in
loans securitized at their allocated carrying value in accordance with SFAS
No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities-a replacement of FASB Statement No. 125(SFAS
No. 140). Assets are sold to the Metris Master Trust at the inception of a
securitization series. We also sell receivables to the Metris Master Trust on
a daily basis to replenish receivable balances that have decreased due to
payments and charge-offs. The difference between the allocated carrying value
and the proceeds from the assets sold is recorded as a gain or loss on sale and
is included in Securitization (expense) income. At the same time, the Company
recognizes the Retained interests in loans securitized. The Retained interests in loans securitized are financial assets
measured at fair value consistent with trading securities in accordance with
SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities,and include the contractual retained interests, an interest-only
strip receivable, excess transferors interests and spread accounts receivable.
The contractual retained interests consist of non-interest bearing securities
held by the Company. The interest-only strip receivable represents the present
value of the excess of the estimated future interest and fee collections
expected to be generated by the securitized loans over the period the
securitized loans are projected to be outstanding above the interest paid on
investor certificates, credit losses, contractual servicing fees, and other
expenses. The excess transferors interests represent principal receivables
held in the Metris Master Trust over the contractual retained interests.
Spread accounts receivable represents restricted cash reserve accounts held by
the Metris Master Trust that can be used to fund payments due to 29




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securitization investors and credit enhancers if cash flows are
insufficient. Cash held in spread accounts is released to us if certain
conditions are met or a securitization series terminates with amounts remaining
in the spread accounts. The fair value of the Retained interests in loans
securitized is determined through estimated cash flows discounted at rates
that reflect the level of subordination, the projected repayment term, and the
credit risk of the securitized loans. The following table summarizes our Retained interests in loans
securitized as of June 30, 2004 and December 31, 2003. Table 4: Retained interests in loans securitized June 30,
    
    December 31,(In thousands):
    
    2004
    
    2003Contractual retained interests
    
    $
    525,085
    
    
    $
    542,014Excess transferors interests
    
    
    52,255
    
    
    
    48,775Interest-only strip receivable
    
    
    47,290
    
    
    
    16,039Spread accounts receivable
    
    
    136,983
    
    
    
    230,073Retained interests in loans securitized
    
    $
    761,613
    
    
    $
    836,901
 Retained interests in loans securitized decreased by $75.3 million
between December 31, 2003, and June 30, 2004, to $761.6 million. The decrease
is primarily due to a $93.1 million decrease in spread accounts receivable and
a $16.9 million decrease in contractual retained interests partially offset by
a $31.3 million increase in interest-only strip receivable and a $3.5 million
increase in excess transferors interests. Contractual retained interest decreased to $525.1 million as of June 30,
2004, from $542.0 million as of December 31, 2003. The $16.9 million decrease
is due to a $0.9 billion decrease in principal receivables held in the Metris
Master Trust, partially offset by an increase in the weighted average
enhancement level on the outstanding series in the Metris Master Trust. The
interest-only strip receivable increased to $47.3 million as of June 30, 2004,
from $16.0 million as of December 31, 2003, primarily due to higher projected
excess spreads from the receivables held in the Metris Master Trust. The
projected excess spreads have increased primarily due to a projected increase
in yield and a projected decrease in the principal default rates, partially
offset by a projected increase in funding costs. Spread accounts receivable
decreased $93.1 million compared to December 31, 2003 due to reserve releases
during the quarter. For more information on restricted cash see the
Liquidity, Funding and Capital Resources section of the Management
Discussion and Analysis on pages 33 through 36. At least quarterly, the Company adjusts the valuation of the Retained
interests in loans securitized to reflect changes in the amount and expected
timing of future cash flows. The significant factors that affect the timing and
amount of cash flows relate to the collateral assumptions, which include
payment rate, default rate, gross yield and discount rate. These values can,
and will, vary as a result of changes in the amount and timing of the cash
flows and the underlying economic assumptions. The components of retained
interests are recorded at their fair value. (See Critical Accounting Estimates
on pages 23-25 for more information on the valuation of the retained
interests). The significant assumptions used for estimating the fair value of
the Retained interests in loans securitized are as follows: 30




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##### Table of Contents



Table 5: Significant assumptions used for estimating the fair value of retained
interests June 30,
    
    December 31,2004
    
    2003Monthly payment rate
    
    
    7.3
    %
    
    
    6.7
    %Gross yield
(1)
    
    
    25.7
    %
    
    
    25.4
    %Annual interest expense and servicing fees
    
    
    4.8
    %
    
    
    4.2
    %Annual gross principal default rate
    
    
    19.5
    %
    
    
    20.7
    %Discount rate:Contractual retained interests
    
    
    16.0
    %
    
    
    16.0
    %Excess transferors interests
    
    
    16.0
    %
    
    
    16.0
    %Interest-only strip receivable
    
    
    30.0
    %
    
    
    30.0
    %Spread accounts receivable
    
    
    15.3
    %
    
    
    15.3
    %Weighted average months to maturity
    
    
    24.4
    
    
    
    24.5
  (1)Includes expected cash flows from finance charges, late and overlimit fees, debt waiver
premiums and bad debt recoveries, net of finance charge and fee charge-offs. Gross yield for
purposes of estimating fair value does not include interchange income, or cash advance fees. Balance Sheet Analysis Cash and Cash Equivalents Cash and cash equivalents increased $222.7 million to $401.2 million as
of June 30, 2004, compared to $178.5 million as of December 31, 2003. The
increase is primarily due to net proceeds received from various funding
activities during the second quarter of 2004 as well as from the release of
cash previously restricted due to improved performance in the Metris Master
Trust. Credit Card Loans Credit card loans were $72.5 million as of June 30, 2004, compared to
$128.6 million as of December 31, 2003. The $56.1 million decrease is
primarily a result of the sale of approximately $38 million of receivables from
Direct Merchants Bank to a third party. Other Assets Other assets decreased from $81.8 million at December 31, 2003 to $68.5
million at June 30, 2004. This decrease resulted primarily from a $7.6 million
fair value decrease in interest rate caps and a $5.7 million reduction in
pre-paid expenses and other assets. Debt Debt increased to $448.2 million at June 30, 2004 from $350.5 million at
December 31, 2003. This $97.7 million increase resulted from the closing of a
$300 million term loan due in May 2007, partially offset by the pay-down of
$100 million in senior notes due in November 2004 and the pay-down of $101.7
million term loan due in June 2004. Accrued expenses and other liabilities Accrued expenses and other liabilities increased from $76.0 million at
December 31, 2003 to $96.6 million at June 30, 2004. This increase resulted
primarily from the receipt of a federal income tax refund during the quarter. 31




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Off Balance Sheet Arrangements Our operations are funded primarily through asset securitizations of our
credit card receivables. We rely heavily on this method of funding and any
negative effect on our ability to securitize assets would have a material
impact on our business. We securitize consumer loans in order to manage our
total cost of funds. Our securitizations involve packaging and selling pools of
both current and future receivable balances on credit card accounts, in which
we retain the servicing of such receivables. Our securitizations are treated
as sales under accounting principles generally accepted in the United States of
America and are removed from our balance sheet. We primarily securitize
receivables by selling the receivables to the Metris Master Trust, a
proprietary, non-consolidated trust, which issues securities through public and
private asset-backed securitizations or multi-seller commercial paper conduits. The Metris Master Trust was formed in May 1995 pursuant to a pooling and
servicing agreement, as amended. MRI, one of our special purpose entity
subsidiaries, transfers receivables in designated accounts to the Metris Master
Trust. The Metris Master Trust may, and does from time to time, issue
securities that represent undivided interests in the receivables in the Metris
Master Trust. These securities are issued by series and each series typically
has multiple classes. Each series, or class within a series, may have
different terms. The different classes of an individual series are structured
to obtain specific debt ratings. As of June 30, 2004, 11 series of publicly
and privately issued term asset-backed securities were outstanding. MRI
currently retains the most subordinated class of securities in each series and
all other classes are issued to nonaffiliated third parties. These securities
are interests in the Metris Master Trust only and are not obligations of MRI,
MCI, Direct Merchants Bank, or any other subsidiary of the Company. The
interest in the Metris Master Trust not represented by any series of securities
issued by the Metris Master Trust also belongs to MRI and is known as the
transferors interest. Generally, each series involves an initial reinvestment period, referred
to as the revolving period, in which principal payments on receivables
allocated to such series are returned to MRI and reinvested in new principal
receivables arising in the accounts. After the revolving period ends, if the
series has not been defeased, principal payments allocated to the series are
then accumulated and used to repay the investors. This period is referred to
as the accumulation period, and is followed by a controlled amortization
period wherein investors are repaid their invested amount. Currently, the
Metris Master Trust does not have any series in an accumulation period or
controlled amortization period. The scheduled accumulation and amortization
periods are set forth in the agreements governing each series. However, all
series set forth certain events by which amortization can be accelerated,
referred to as early amortization. Reasons an early amortization could occur
include: (i) one or three-month average of portfolio collections, less
principal and finance charge charge-offs, financing costs and servicing costs,
drop below certain levels, (ii) negative transferors interest within the
Metris Master Trust or (iii) failure to obtain funding prior to an accumulation
period for a maturing term asset-backed securitization. New receivables in
designated accounts cannot be funded from a series that is in early
amortization. We currently do not have any series that are in early
amortization. In addition, there are various triggers within our securitization
agreements that, if broken, would restrict the release of cash to us from the
Metris Master Trust. This restricted cash provides additional security to the
investors and / or credit enhancers in the Metris Master Trust. We reflect
cash restricted from release in the Metris Master Trust at its fair value as
spread accounts receivable, which is a component of Retained interests in
loans securitized in the consolidated balance sheet. The triggers are usually
related to the performance of the Metris Master Trust, such as the average of
net excess spread over a one to three-month period.
See further discussion of spread accounts receivable in the Liquidity, Funding
and Capital Resources section on page 35. On a monthly basis, each series is allocated its share of finance charge
and fee collections, which are used to pay investors interest on their
securities, pay their share of servicing fees and reimburse investors for their
share of losses due to charge-offs. Amounts remaining may be deposited in cash
reserve accounts of the Metris Master Trust as additional protection for future
losses. Once each of these obligations is fully met, remaining finance 32




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##### Table of Contents



charge collections, if any, are returned to us. Principal receivables held by
the Metris Master Trust were $6.6 billion and $7.5 billion as of June 30, 2004
and December 31, 2003, respectively. Revenues and expenses generated from the Metris Master Trust are found in
the Securitization (expense) income and Servicing income on securitized
receivables lines in the consolidated statements of income. Our interests
retained in credit card receivables sold to the Metris Master Trust are
recorded at fair value in Retained interests in loans securitized on the
consolidated balance sheets. Maintaining adequate liquidity in the Metris Master Trust is, and will
continue to be, at the forefront of our business objectives. Additional
information regarding asset securitization is set forth under Liquidity,
Funding, and Capital Resources below. Liquidity, Funding and Capital Resources One of our primary financial goals is to maintain an adequate level of
liquidity through active management of assets and liabilities. Liquidity
management is a dynamic process, affected by changes in the characteristics of
our assets and liabilities and short- and long-term interest rates. We use a
variety of financing sources to manage liquidity, funding, and interest rate
risks. Table 6 summarizes our funding and liquidity as of June 30, 2004 and
December 31, 2003: Table 6: Liquidity, Funding and Capital Resources June 30, 2004
    
    December 31, 2003(In thousands)
    
    DMCCB
    
    Other
    
    Consolidated
    
    DMCCB
    
    Other
    
    ConsolidatedCash and due from banks
    
    $
    24,557
    
    
    $
    1,807
    
    
    $
    26,364
    
    
    $
    29,399
    
    
    $
    2,677
    
    
    $
    32,076Federal funds sold
    
    
    29,700
    
    
    
    
    
    
    
    29,700
    
    
    
    25,300
    
    
    
    
    
    
    
    25,300Short-term investments
    
    
    112,273
    
    
    
    232,892
    
    
    
    345,165
    
    
    
    71,829
    
    
    
    49,280
    
    
    
    121,109Total cash and cash
equivalents
    
    $
    166,530
    
    
    $
    234,699
    
    
    $
    401,229
    
    
    $
    126,528
    
    
    $
    51,957
    
    
    $
    178,485
 June 30, 2004
    
    December 31, 2003Unused
    
    
    
    
    
    UnusedOutstanding
    
    Capacity
    
    Outstanding
    
    CapacityOn-balance
sheet funding(In thousands)Term loan  June 2004
    
    
    
    
    
    
    N/A
    
    
    
    101,679
    
    
    
    N/A10% Senior Notes  November 2004
    
    
    
    
    
    
    N/A
    
    
    
    100,000
    
    
    
    N/A10.125% senior notes 
July 2006
    
    
    148,172
    
    
    
    N/A
    
    
    
    147,724
    
    
    
    N/ATerm loan  May 2007
    
    
    300,000
    
    
    
    N/A
    
    
    
    
    
    
    
    N/AOther
    
    
    
    
    
    
    N/A
    
    
    
    1,045
    
    
    
    N/ADeposits
    
    
    4,572
    
    
    
    N/A
    
    
    
    6,262
    
    
    
    N/ASubtotal
    
    $
    452,744
    
    
    $
    N/A
    
    
    $
    356,710
    
    
    
    N/A
 33




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##### Table of Contents



June 30, 2004
    
    December 31, 2003Unused
    
    
    
    
    
    UnusedOutstanding
    
    Capacity
    
    Outstanding
    
    CapacityOff-balance
sheet funding(In thousands)Master Trust:Term asset backed
securitizations  various
maturities through January 2009
    
    
    4,950,000
    
    
    
    
    
    
    
    6,400,000
    
    
    
    Bank conduits  maturing
May 2006
    
    
    860,000
    
    
    
    340,000
    
    
    
    196,000
    
    
    
    654,000Amortizing term series 
matured in February 2004
    
    
    
    
    
    
    
    
    
    
    99,200
    
    
    
    Subtotal
    
    
    5,810,000
    
    
    
    340,000
    
    
    
    6,695,200
    
    
    
    654,000Total
    
    $
    6,262,744
    
    
    $
    340,000
    
    
    $
    7,051,910
    
    
    $
    654,000
 As of June 30, 2004 and December 31, 2003, we had $5.8 and $5.9 million,
respectively, in letters of credit issued under a letter of credit facility
agreement. Metris obligations under such facility are cash collateralized.
The $300 million senior secured loan was issued pursuant to a Senior Secured
Credit Agreement dated May 6, 2004 (Credit Agreement). The loan matures May
6, 2007, and carries a floating annual interest rate equal to the Adjusted
London Interbank Offered Rate (LIBOR) for the applicable interest period plus
9.50%. The proceeds of the loan were used in part to repay the Companys $100
million 10% Senior Notes due in November 2004 (together with accrued and unpaid
interest and prepayment premium due thereon) and to pay fees and transaction
expenses related to the loan. The balance of the proceeds from the loan will
be used by the Company for general corporate purposes. Subject to certain
exceptions, the Credit Agreement requires the Company to prepay portions of the
loan from net proceeds received from the issuance, in whatever form, of debt or
equity by the Company or any of its affiliates, any insurance settlement or
litigation award, and from any sale of assets (other than excluded asset sales)
by the Company in excess of $10,000,000 in any fiscal year. During the second
quarter of 2004, we were not required to make any principal repayments from the
proceeds of asset sales. We are bound by certain covenants under the Credit
Agreement. As of June 30, 2004, we were in compliance with all covenants under
the Credit Agreement. Furthermore, the Company has pledged substantially all
of its assets as collateral under the Credit Agreement other than the assets of
the Bank and Metris Receivables, Inc. As of June 30, 2004 our contractual cash obligations for the next twelve
months are as follows: Operating leases
    
    $
    9,708Deposits
    
    
    4,572Contractual purchase obligations
    
    
    59,802Total
    
    $
    74,082
 In addition to the contractual cash obligations, as of June 30, 2004
open-to-buy on credit card accounts was $7.3 billion. In April 2004 we announced the issuance of $200 million of three-year
credit card asset-backed term securities. The proceeds from this transaction
were used to repay an outstanding paired-series, which was due in May 2004.
During the quarter we also increased our conduit capacity to $1.2 billion. This
facility is a two-year conduit financing facility, maturing in May 2006. We
utilized this conduit during the quarter to defease maturing ABS series 2001-3
and 2001-4 totaling $1.15 billion. Also, in May 2004, we paid off the $95.3
million outstanding on our $125 million term loan due June 2004. Also, as
noted above, we closed on a $300 million term loan that matures in May 2007. With these new transactions we have completed our corporate funding
initiatives for 2004. Our receivable funding needs for the remainder of 2004
and 2005 will be covered by portfolio attrition and future asset-backed
securitizations. We have $1.5 billion of capacity in a MBIA commitment to
provide insurance coverage on future asset-backed security transactions, of
which $300 million is currently available. 34




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##### Table of Contents



The Metris Master Trust and the associated off-balance sheet debt provide
for early amortization if certain events occur. The significant events include
(i) one-month and three-month average excess spreads below certain levels, (ii)
negative transferors interest within the Metris Master Trust or (iii) failure
to obtain funding prior to an accumulation period for a maturing term
asset-backed securitization. In addition, there are various triggers within our
securitization agreements that, if broken, would restrict the release of cash
to us from the Metris Master Trust. The triggers are related to the
performance of the Metris Master Trust, generally the average of net excess
spread over a one-to three-month period. This restricted cash provides
additional security to the investors and credit enhancers in the Metris Master
Trust. We reflect cash restricted from release in the Metris Master Trust in
Retained interests in loans securitized in the consolidated balance sheet. The following table shows the annualized yields, defaults, costs and
excess spreads for the Master Trust on a cash basis: Three Months Ended June 30,(In thousands)
    
    2004
    
    2003Gross yield (1)
    
    $
    452,753
    
    
    
    26.75
    %
    
    $
    608,762
    
    
    
    26.86
    %Annual principal defaults
    
    
    325,602
    
    
    
    19.24
    %
    
    
    477,392
    
    
    
    21.06
    %Net portfolio yield
    
    
    127,151
    
    
    
    7.51
    %
    
    
    131,370
    
    
    
    5.80
    %Annual interest expense and
servicing fees
    
    
    59,637
    
    
    
    3.68
    %
    
    
    83,575
    
    
    
    3.87
    %Net excess spread
    
    $
    67,514
    
    
    
    3.83
    %
    
    $
    47,795
    
    
    
    1.93
    %
 Six Months Ended June 30,(In thousands)
    
    2004
    
    2003Gross yield (1)
    
    $
    950,368
    
    
    
    27.12
    %
    
    $
    1,266,543
    
    
    
    27.29
    %Annual principal defaults
    
    
    674,586
    
    
    
    19.25
    %
    
    
    985,592
    
    
    
    21.23
    %Net portfolio yield
    
    
    275,782
    
    
    
    7.87
    %
    
    
    280,951
    
    
    
    6.06
    %Annual interest expense and
servicing fees
    
    
    122,401
    
    
    
    3.65
    %
    
    
    171,744
    
    
    
    3.90
    %Net excess spread
    
    $
    153,381
    
    
    
    4.22
    %
    
    $
    109,207
    
    
    
    2.16
    %
  (1)
    
    Includes cash flows from finance charges, late, overlimit and cash
advance fees, bad debt recoveries, interchange income and debt waiver
fees, less finance charge and fee charge-offs. The following table shows the principal receivables and delinquent
principal receivables in the Metris Master Trust: June 30,
    
    December 31,
    
    June 30,(Dollars in thousands)
    
    2004
    
    2003
    
    2003Principal receivables
    
    $
    6,580,659
    
    
    $
    7,489,568
    
    
    $
    8,816,8912-cycle plus delinquent
principal receivables
    
    
    519,084
    
    
    
    698,574
    
    
    
    867,496Principal delinquency ratio
    
    
    7.9
    %
    
    
    9.3
    %
    
    
    9.8
    %
 The cash restricted from release to us is limited to the amount of excess
spread generated in the Metris Master Trust on a cash basis. During periods of
lower excess spreads, the required amount of excess spread to be restricted in
the Metris Master Trust may not be achieved. During those periods, all excess
spread normally released to MRI will be restricted from release. Once the
maximum required amount of cash is restricted from release or excess spreads
improve, cash can again be released from the spread accounts. Based on the
performance of our Metris Master Trust, the amount of cash required to be
restricted was $193 million at June 30, 2004 and $294 million at December 31,
2003. As of June 30, 2004, $164.3 million had been restricted from release in
the Metris Master Trust due to performance, $13.2 million had been restricted
from release due to corporate debt ratings, and $15.1 million was restricted
from release for maturity reserves. As of December 31, 2003, $255.4 million had
been restricted from release in the Metris Master Trust due to performance,
$21.4 million had been restricted from release due to corporate debt ratings,
and $16.9 million was restricted from release for maturity reserves. In
addition, $12.2 million was restricted from release for defeasance of the
ABS series 2001-1. The $91.1 million decrease in cash restricted from release due
to performance is due primarily to the improving excess spreads in the Metris
Master Trust. The $8.2 million decrease in cash restricted for 35




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##### Table of Contents



corporate debt ratings resulted from the defeasance of series 1999-1 during the
first quarter of 2004. We expect the restricted cash requirements to continue
to decline throughout 2004 with the expectation of continued improvement in
monthly excess spreads. In December 2003, an Internal Revenue Service (IRS) examination team
submitted a request for a Technical Advice Memorandum (TAM) to its
Washington, D.C. National Office regarding certain aspects of the Companys
treatment of certain credit card fees as original issue discount (OID). With
this submission, the examination team has effectively withdrawn its 2002
proposed adjustment for tax returns filed through December 31, 1998. The
request for a TAM covers tax returns filed through December 31, 2001. Although
these fees are primarily reported as income when billed for financial reporting
purposes, we believe the fees create OID that should be deferred and amortized
over the remaining life of the underlying credit card loans for tax purposes.
Cumulatively as of December 31, 2001, the Company had deferred approximately
$210 million in federal income tax under the OID rules. An assessment could
ultimately require the Company to pay up to this amount of federal tax plus
state taxes and related interest. The rulings in the TAM and the outcome of additional resolution activities
for these years, if necessary, will likely determine our tax treatment of
credit card fees in subsequent years. As of June 30, 2004 and December 31,
2003, the Company had deferred cumulative federal income tax of approximately
$154 million and $179 million, respectively. The IRS recently extended its
examination to include the tax return filed for the year ended December 31,
2002. We believe that our treatment of these fees is appropriate and
consistent with that of many other U.S. credit card issuers and public guidance
issued by the IRS regarding late fees. However, the ultimate timing and amount
of the final resolution remain uncertain. We continue to work with the IRS to
resolve this matter and do not expect any incremental tax to be paid over the
next twelve months as a result of the examination activity. We do not expect
the resolution of this matter to have a material adverse effect on future
earnings. Our senior unsecured debt is rated by Moodys Investor Services
(Moodys), Standard & Poors Rating Services (S&P) and Fitch, Inc.
(Fitch). Factors affecting the various ratings include the overall health of
the global/national economy, specific economic conditions impacting the
subprime consumer finance industry, and the overall financial performance of
the Company, including earnings, credit losses, delinquencies, excess spreads
in the Metris Master Trust, and our overall liquidity. Furthermore, certain of
our term asset-backed securitizations require the restriction of cash if our
corporate debt ratings go below certain levels. The table below illustrates
the current debt ratings of MCI: StandardMoodys
    
    & Poors
    
    FitchMetris Companies Inc.Senior unsecured debt
    
    Caa2
    
    CCC
    
    CCC
 Capital Adequacy In the normal course of business, Direct Merchants Bank enters into
agreements, or is subject to regulatory requirements, that result in cash,
debt, and dividend or other capital restrictions. The Federal Reserve Act imposes various legal limitations on the extent to
which banks can finance or otherwise supply funds to their affiliates. In
particular, Direct Merchants Bank is subject to certain restrictions on any
extensions of credit to, or other covered transactions, such as certain
purchases of assets, with MCI and its affiliates. Such restrictions limit
Direct Merchants Banks ability to lend to MCI and its affiliates.
Additionally, Direct Merchants Bank is limited in its ability to declare
dividends to MCI in accordance with the national bank dividend provisions. Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the OCC. At June 30, 2004 and December 31, 2003, Direct Merchants
Banks Tier 1 risk-based capital ratio, risk-based total capital ratio, and
Tier 1 leverage ratio exceeded the minimum required capital levels, as
illustrated in the table below. 36




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##### Table of Contents



Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, Direct Merchants Bank must meet specific capital guidelines
that involve quantitative measures of assets, liabilities, and certain
off-balance-sheet items, as calculated under regulatory accounting practices.
Direct Merchants Banks capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors. Quantitative measures established by regulation to ensure capital adequacy
require Direct Merchants Bank to maintain minimum amounts and ratios (set forth
in the following table) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 leverage
capital (as defined) to average assets (as defined). Failure to meet minimum
capital requirements can initiate certain mandatory, and possibly additional
discretionary actions, by regulators that, if undertaken, could have a direct
material adverse effect on our financial statements. Additional information about Direct Merchants Banks actual capital
amounts and ratios are presented in the following table: To BeAdequately
    
    To Be WellActual
    
    Capitalized
    
    CapitalizedAs of June 30, 2004
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    RatioTotal Capital
    
    $
    251,365
    
    
    
    127.5
    %
    
    $
    15,768
    
    
    
    8.0
    %
    
    $
    19,710
    
    
    
    10.0
    %(to risk-weighted assets)Tier 1 Capital
    
    
    248,763
    
    
    
    126.2
    %
    
    
    7,884
    
    
    
    4.0
    %
    
    
    11,826
    
    
    
    6.0
    %(to risk-weighted assets)Tier 1 Capital
    
    
    248,763
    
    
    
    70.8
    %
    
    
    14,049
    
    
    
    4.0
    %
    
    
    17,562
    
    
    
    5.0
    %(to average assets)
 To BeAdequately
    
    To Be WellActual
    
    Capitalized
    
    CapitalizedAs of December 31, 2003
    
    Amount
    
    Ratio
    
    Amount
    
    Ratio
    
    Amount
    
    RatioTotal Capital
    
    $
    240,868
    
    
    
    140.0
    %
    
    $
    13,760
    
    
    
    8.0
    %
    
    $
    17,200
    
    
    
    10.0
    %(to risk-weighted assets)Tier 1 Capital
    
    
    238,328
    
    
    
    138.6
    %
    
    
    6,880
    
    
    
    4.0
    %
    
    
    10,320
    
    
    
    6.0
    %(to risk-weighted assets)Tier 1 Capital
    
    
    238,328
    
    
    
    70.2
    %
    
    
    13,589
    
    
    
    4.0
    %
    
    
    16,987
    
    
    
    5.0
    %(to average assets)
 FFIEC guidelines indicate that an institution with a concentration in
subprime lending should hold one and one-half to three times the normal minimum
capital required. Direct Merchants Bank and MCI have entered into a Capital Assurance and
Liquidity Maintenance Agreement (CALMA) that requires MCI to make such
capital infusions or provide the Bank with financial assistance so as to permit
the Bank to meet its liquidity requirements. Direct Merchants Bank has also entered into a Liquidity Reserve Deposit
Agreement under which the Bank has established restricted deposits with
third-party depository banks for the purpose of supporting Direct Merchants
Banks funding needs. These deposits are invested in short-term liquid
investments and are classified on the consolidated balance sheets as the 37




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##### Table of Contents



Liquidity reserve deposit. As of June 30, 2004, the balance of the liquidity
reserve deposit was $74.9 million. Finally,
the Companys Modified Operating Agreement with the OCC
requires, among other things, that:  
    
    The Bank must maintain minimum capital at the dollar amount
reported on its September 30, 2003 Call Report ($213 million), unless
otherwise approved by the OCC. The Bank may continue to pay
dividends in accordance with applicable statutory and regulatory
requirements provided capital remains at the required level.  
    
    The Bank must maintain, at a minimum, liquid assets of not less
than $35 million or 100% of the average highest daily funding
requirement for managed receivables.  
    
    The Bank must comply with the terms of the Liquidity Reserve
Deposit Agreement and the CALMA.  
    
    MCI must comply with the terms of the CALMA If the OCC were to conclude that the Bank failed to adhere to any
provisions of the Modified Operating Agreement, the OCC could pursue various
enforcement options. If any of these options were to be pursued by the OCC, it
could have a material adverse effect on our operations or capital position. Selected Operating Data  Managed Basis In addition to analyzing the Companys performance on an owned basis, we
analyze the Companys financial performance on a managed loan portfolio basis.
On a managed basis, the balance sheets and income statements include other
investors interests in securitized loans that are not assets of the Company,
thereby reversing the effects of sale accounting under SFAS No. 140. We
believe this information is meaningful to the reader of the financial
statements. We service the receivables that have been securitized and sold and
own the right to the cash flows from those receivables sold in excess of
amounts owed to security holders. The following information is not in conformity with accounting principles
generally accepted in the United States of America; however, we believe the
information is relevant to understanding the overall financial condition and
results of operations of the Company. Table 7: Managed Loan Portfolio June 30,
    
    % of
    
    December 31,
    
    % of
    
    June 30,
    
    % of(Dollars and accounts in thousands)
    
    2004
    
    Total
    
    2003
    
    Total
    
    2003
    
    TotalPeriod-end gross active accounts:Credit card loans
    
    
    76
    
    
    
    
    
    
    
    107
    
    
    
    
    
    
    
    429Receivables held by the Metris
Master Trust
    
    
    2,163
    
    
    
    
    
    
    
    2,375
    
    
    
    
    
    
    
    2,609Managed
    
    
    2,239
    
    
    
    
    
    
    
    2,482
    
    
    
    
    
    
    
    3,038Period-end balances:Credit card loans
    
    $
    72,491
    
    
    
    
    
    
    $
    128,615
    
    
    
    
    
    
    $
    632,913Receivables held in the Metris
Master Trust
    
    
    7,010,664
    
    
    
    
    
    
    
    8,003,216
    
    
    
    
    
    
    
    9,472,725Managed
    
    $
    7,083,155
    
    
    
    
    
    
    $
    8,131,831
    
    
    
    
    
    
    $
    10,105,638Loans contractually delinquent:Credit card loans
    
    
    9,321
    
    
    
    12.9
    %
    
    
    20,309
    
    
    
    15.8
    %
    
    
    48,266
    
    
    
    7.6
    %Receivables held in the Metris Master Trust
    
    
    658,650
    
    
    
    9.4
    %
    
    
    881,766
    
    
    
    11.0
    %
    
    
    1,084,241
    
    
    
    11.4
    %Managed
    
    $
    667,971
    
    
    
    9.4
    %
    
    $
    902,075
    
    
    
    11.1
    %
    
    $
    1,132,507
    
    
    
    11.2
    %
 38




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##### Table of Contents



Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    
    
    
    
    2003
    
    
    
    
    
    2004
    
    
    
    
    
    2003Average balances:Credit card loans
    
    $
    80,779
    
    
    
    
    
    
    $
    690,903
    
    
    
    
    
    
    $
    103,868
    
    
    
    
    
    
    $
    721,121Receivables held in
the Metris Master
Trust
    
    
    7,258,288
    
    
    
    
    
    
    
    9,839,911
    
    
    
    
    
    
    
    7,522,820
    
    
    
    
    
    
    
    10,150,911Managed
    
    $
    7,339,067
    
    
    
    
    
    
    $
    10,530,814
    
    
    
    
    
    
    $
    7,626,688
    
    
    
    
    
    
    $
    10,872,032Net charge-offs:Credit card loans
    
    $
    3,080
    
    
    
    15.3
    %
    
    $
    43,702
    
    
    
    25.4
    %
    
    $
    15,245
    
    
    
    29.5
    %
    
    $
    51,991
    
    
    
    14.5
    %Receivables held in
the Metris Master
Trust
    
    
    307,563
    
    
    
    17.0
    %
    
    
    454,914
    
    
    
    18.7
    %
    
    
    635,170
    
    
    
    17.0
    %
    
    
    941,399
    
    
    
    18.8
    %Managed
    
    $
    310,643
    
    
    
    17.0
    %
    
    $
    498,616
    
    
    
    19.1
    %
    
    $
    650,415
    
    
    
    17.2
    %
    
    $
    993,390
    
    
    
    18.6
    %
 The decrease in the managed delinquency rates as of June 30, 2004 over
December 31, 2003 and June 30, 2003 reflects various factors, including
improved credit quality in the Metris Master Trust and overall the reduction in
portfolio size. Total managed loans decreased $1.0 billion to $7.1 billion as of June 30,
2004, compared to $8.1 billion as of December 31, 2003. This was primarily due
to a reduction in credit lines, tighter underwriting standards, and fewer new
accounts. The amount of credit card receivables in debt forbearance programs
was $648.6 million or 9.2% of total managed loans as of June 30, 2004, compared
with $695.4 million or 8.6% of managed loans as of December 31, 2003. All
delinquent receivables in debt forbearance programs are included in Table 7. Managed net charge-offs decreased $188.0 million and $343.0 million for
the three- and six-month periods ended June 30, 2004 compared to the same
periods in 2003, primarily due to improved credit quality in the Metris Master
Trust and a reduction in the overall size of the managed portfolio. We charge-off bankrupt accounts 60 days following formal notification.
Charge-offs due to bankruptcies were $107.8 million, representing 24.8% of
total managed gross charge-offs for the three months ended June 30, 2004 and
$181.2 million, representing 34.5% of total managed gross charge-offs for the
three months ended June 30, 2003. Charge-offs due to bankruptcies were $215.6
million, representing 23.7% of total managed gross charge-offs for the six
months ended June 30, 2004 and $367.2 million, representing 35.1% of total
managed gross charge-offs for the six months ended June 30, 2003. In addition
to those bankrupt accounts that were charged-off, we received formal
notification of $51.3 million and $89.7 million of managed bankrupt accounts as
of June 30, 2004 and 2003, respectively. Forward-Looking Statements This Quarterly Report on Form 10-Q contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which are subject to the safe harbor created by those sections.
Forward-looking statements include, without limitation: expressions of the
belief, anticipation, intent, or expectations of management; statements
and information as to our strategies and objectives; return on equity; changes
in our managed loan portfolio; net interest margins; funding costs; liquidity;
cash flow; operating costs and marketing expenses; delinquencies and
charge-offs and industry comparisons or projections; statements as to industry
trends or future results of operations of the Company and its subsidiaries; and
other statements that are not historical fact. Forward-looking statements may
be identified by the use of terminology such as may, will, believes,
does not believe, no reason to believe, expects, plans, intends,
estimates, anticipated, or anticipates and similar expressions, as they
relate to the Company or our management. Forward-looking statements are based
on certain assumptions by management and are subject to risks and uncertainties
that could cause actual results to differ materially from those in the
forward-looking statements. These risks and uncertainties include, but are not limited to, our high
liquidity requirement and our need to enter into financing transactions on a
regular basis; the risk of 39




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##### Table of Contents



reduced funding availability and increased funding costs; the higher
delinquency and charge-off rates of our targeted middle-market consumers as
compared to higher income consumers; the risk that certain events could result
in early amortization (required repayment) of the securities issued by the
Metris Master Trust; the risk that the recent improvement in our delinquency
and charge-off rates may not continue; the risk that Direct Merchants Banks
regulators could impose additional restrictions that could negatively impact
our operations or financial condition, including further restrictions or
limitations relating to Direct Merchants Banks minimum capital and credit loss
reserves requirements and its ability to pay distributions to us; risks
associated with Direct Merchants Banks ability to operate in accordance with
its regulatory restrictions, including those in its Modified Operating
Agreement with the OCC; the risk that we could be required to provide support
to Direct Merchants Bank; risks associated with fluctuations in the value of
and income earned from our retained interests in securitizations; interest rate
risk, including the risk of adverse changes in the interest rates on the funds
we borrow and the amounts we loan to our credit card customers; risks
associated with the intense competition we face; the effect of laws and
regulations that apply to us, or adverse changes in those laws or regulations,
including, among others, laws and regulations that limit the fees and charges
that we are allowed to impose, regulate our practices for collection and
sharing of non-public customer information, govern the sale and terms of
products and services we offer and require that we obtain and maintain licenses
and qualifications; the risk that we may be adversely affected by litigation
involving us, by our ongoing SEC and OCC investigations or by the Internal
Revenue Services examination of our treatment of certain credit card fees as
original issue discount; the effects of our previous restatements of our
financial results; the outcome of antitrust litigation involving MasterCard and
Visa and other industry-wide risks including, among others, the risk of fraud
by cardholders and third parties and the risk of decreased consumer acceptance
of credit card products; and general economic conditions that can have a
negative impact on the performance of credit card loans and the marketing of
our credit protection, insurance and other products. These risks are discussed in our Annual Report on Form 10-K/A for the year
ended December 31, 2003 in Item 1 of such report under the heading Risk
Factors. Certain of these and other risks and uncertainties also are
discussed herein in Legal Proceedings on page 41, Managements Discussion
and Analysis of Financial Condition and Results of Operations on pages 22  40
hereof, and Quantitative and Qualitative Disclosures About Market Risk on
page 40 hereof. Although we have attempted to list comprehensively the major
risks and uncertainties, other factors may in the future prove to be important
in causing actual results to differ materially from those contained in any
forward-looking statement. Readers are cautioned not to place undue reliance
on any forward-looking statement, which speaks only as of the date thereof. We
undertake no obligation to update any forward-looking statements, whether as a
result of new information, future events or otherwise. 
 ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the risk of loss from adverse changes in market prices and
rates. Our principal market risk is due to changes in interest rates. This
affects us directly in our lending and borrowing activities, as well as
indirectly, as interest rates may impact the payment performance of our
cardholders. To manage our direct risk to market interest rates, management actively
monitors the interest rates and the interest sensitive components of our
balance sheet to minimize the impact that changes in interest rates have on the
fair value of assets, net income and cash flow. We seek to minimize that
impact primarily by matching asset and liability re-pricings. Our primary assets are Credit card loans, and Retained interests in
loans securitized. Our receivables and receivables held by the Metris Master
Trust are virtually all priced at rates indexed to the variable Prime Rate. We
fund Credit card loans through a combination of cash flows from operations,
bank loans, long-term debt and equity issuances. Our securitized loans are
held by the Metris Master Trust and bank-sponsored multi-seller commercial
paper conduits and investors in term series securities within the Metris Master
Trust, which have committed funding primarily indexed to variable commercial
paper rates and LIBOR. The long-term debt includes $150 million at a fixed
interest rate and $300 million indexed to LIBOR. At June 30, 2004 and 2003,
none of the securities issued out of the Metris 40




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Master Trust and conduit funding of securitized receivables was funded
with fixed rate securities. In an interest rate environment with rates significantly above current
rates, the potential negative impact on earnings of higher interest expense is
partially mitigated by fixed rate funding and interest rate cap contracts. The approach we use to quantify interest rate risk is a sensitivity
analysis, which we believe best reflects the risk inherent in our business.
This approach calculates the impact on net income from an instantaneous and
sustained change in interest rates of 200 basis points. In this analysis,
interest rates on our floating rate debt are not allowed to decrease below zero
percent. Assuming that we take no counteractive measures, as of June 30, 2004,
a 200-basis-point increase in interest rates affecting our floating rate
financial instruments, including both debt obligations and receivables, would
result in a decrease in net income of approximately $22.7 million relative to a
base case over the next 12 months, compared to an approximate $24.1 million
decrease as of June 30, 2003 relative to a base case over the next 12 months. A
decrease of 200 basis points would result in an increase in Net income of
approximately $37.2 million as of June 30, 2004, compared to an increase of
$35.6 million as of June 30, 2003. The change in sensitivity for the 200 basis point decrease is primarily
due to replacing $225 million of long-term fixed rate debt with $300 million of
long-term debt indexed to LIBOR, as well as a smaller receivable base. The
change in sensitivity for the 200 basis point increase is primarily due to
replacing $225 million of long-term fixed rate debt with $300 million of
long-term debt indexed to LIBOR, a smaller receivable base, and a higher
percentage of receivables that will be impacted by a rate increase. 
 ITEM 4 CONTROLS AND PROCEDURES Under the supervision and with the participation of the Companys
management, including the Chairman and Chief Executive Officer (CEO) and the
Interim Chief Financial Officer (CFO), we evaluated the effectiveness of the design
and operation of the Companys disclosure controls and procedures (as defined
in Rule 13a-15(e) or 15d-15(e) under the Exchange Act). Based on that
evaluation, the Companys management, including the CEO and CFO, have concluded
that, as of June 30, 2004, our disclosure controls and procedures were
effective in ensuring that information required to be disclosed in the reports
we file under the Securities Exchange Act of 1934, as amended (Exchange Act)
is recorded, processed, summarized, and reported within the time periods
specified in SEC rules and forms. During the quarter ended June 30, 2004, there
were no changes in our internal controls over financial reporting (as defined
in Rule 13a-15(f) or 15d-15(f) under the Exchange Act) that have materially
affected, or are reasonably likely to materially affect, our internal controls
over financial reporting. 
 Part II. Other Information 
 Item 1. Legal Proceedings Reference is made to Part I, Item 3 of the Companys Annual Report on Form
10-K/A for the fiscal year ended December 31, 2003, which summarizes two
pending lawsuits involving the Company and certain of its officers and
directors. Reference is also made to Part I, Item 1, Business  Regulatory
Investigations of the Companys Annual Report on Form 10-K/A for the fiscal
year ended December 31, 2003, which summarizes the SEC and OCC investigations
to which we are currently subject. The Company currently is not otherwise subject to any pending litigation
other than routine litigation arising in the ordinary course of business.
Although the ultimate outcome of these matters cannot be predicted, we believe,
based on information currently available, that the resolution of those legal
matters will not result in any material adverse effect on our results of
operations, financial condition or ability to operate our business. 
 Item 2. Changes in Securities 41




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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 June 30, 2004. 
 Item 5. Other Information None 
 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits:  10.1
    
    Senior Secured Credit Agreement, dated as of May 6,
2004, among Metris Companies Inc. as Borrower, the Lenders from
time to time parties thereto, and Deutsche Bank Trust Company
Americas as Administrative Agent and Collateral Agent,
including the exhibits thereto. Incorporated by reference to
Exhibit 10 to MCIs Current Report on Form 8-K dated May 11,
2004 (File No. 1-12351)).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. (b) Reports on Form 8-K:  On April 14, 2004, we filed a Current Report on Form 8-K to report
under Items 5 and 7, the filing of a press release announcing that
Metris Receivables, Inc., one of our wholly owned subsidiaries,
through the Metris Master Trust, has issued $200 million of
three-year credit card asset-backed term securities to institutional
investors.On April 19, 2004, we filed a Current Report on Form 8-K to report
under Items 7, 9 and 12, the filing of a press release announcing (a)
our results of operations for the first quarter of 2004, and (b)
entry into a definitive agreement to establish a two-year $800
million conduit facility for the purpose of financing credit card
receivables in the Metris Master Trust.On April 20, 2004, we filed a Current Report on Form 8-K to report
under Items 5 and 7, the filing of a press release announcing that we
were considering a private placement of Senior Secured Notes in an
aggregate principal amount of approximately $250 million. 42




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On May 10, 2004, we filed a Current Report on Form 8-K to report
under Items 5 and 7, the filing of a press release announcing (a)
that Metris had entered into a new credit facility providing for a
three-year $300 million secured term loan, the proceeds of which were
used to pay off the Companys 10% Senior Notes due in November 2004
and for other general corporate purposes, and (b) Metris defeased the
$650 million series 2001-3 asset-backed securities from the Metris
Master Trust, which was scheduled to mature in August and September
2004.On May 11, 2004, we filed a Current Report on Form 8-K to report
under Items 5 and 7, the filing of the Senior Secured Credit
Agreement dated as of May 6, 2004 among Metris as Borrower, the
parties identified therein as lenders to the Company, and Deutsche
Bank Trust Company Americas as Administrative Agent and Collateral
Agent for the Lenders.On June 30, 2004, we filed a Current Report on Form 8-K to report
under Items 5 and 7, the filing of a press release announcing Metris
Receivables, Inc., a wholly-owned Metris subsidiary, had defeased the
$500 million Series 2001-4 asset backed securitization from the
Metris Master Trust, which was scheduled to mature in September and
October 2004.On August 5, 2004, we filed a Current Report on Form 8-K to
report under Items 5 and 7, the filing of a press release announcing
the resignation of Chief Financial Officer John A. Whitham. We also
announced that William A. Houlihan will join the Company as Executive
Vice President and CFO effective August 9, 2004. 43




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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: August 09, 2004
    
    By:
    
    /s/ Mark P. WagenerMark P. WagenerSenior Vice President,
Controller andInterim Chief Financial Officer(Principal Financial Officer and AuthorizedOfficer of Registrant)
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Index to Exhibits  10.1
    
    Senior Secured Credit Agreement, dated as of May 6,
2004, among Metris Companies Inc. as Borrower, the Lenders from time
to time parties thereto. Incorporated by reference to Exhibit 10
to MCIs Current Report on Form 8-K dated May 11, 2004
(File No. 1-12351)).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.