<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________________
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED 001-12351
September 30, 1996 Commission File Number
___________________________
METRIS COMPANIES INC.
(Exact name of registrant as specified in its charter)
Delaware 41-1849591
(State of Incorporation) (I.R.S. Employer Identification No.)
600 South Highway 169, Suite 1800, St. Louis Park, Minnesota 55426
(Address of principal executive offices)
(612) 525-5020
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes No X
----- -----
As of November 30, 1996, 19,225,000 shares of the Registrant's Common
----------
Stock, par value $.01 per share, were outstanding.
<PAGE>
METRIS COMPANIES INC.
FORM 10-Q
TABLE OF CONTENTS
------------------------------------------------------------
SEPTEMBER 30, 1996
Page
----
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets..........................3
Consolidated Statements of Income....................4
Consolidated Statements of Changes
in Stockholder's Equity............................5
Consolidated Statements of Cash Flows................6
Notes to Consolidated Financial Statements...........7
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations..........................................11
PART II. OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K....................29
Signatures..............................................30
2
<PAGE>
Item 1.
- - -------
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(DOLLARS IN THOUSANDS) (UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
ASSETS
Cash and due from banks $ 13,013 $ 4,185
Federal funds sold 14,653 29,144
Short-term investments 2 1,414
----------- -----------
Cash and cash equivalents 27,668 34,743
Credit card loans:
Loans held for securitization 4,193 15,337
Retained interests in loans securitized 149,884 79,727
Less: Allowance for loan losses 8,540 3,679
----------- -----------
Net credit card loans 145,537 91,385
Premises and equipment, net 3,902 1,476
Accrued interest and fees receivable 1,700 2,223
Other receivables due from credit card
securitizations, net 31,597
Prepaid expenses and deferred charges 3,993 4,517
Deferred income taxes 19,192 4,306
Other assets 6,217 4,181
----------- -----------
TOTAL ASSETS $ 208,209 $ 174,428
----------- -----------
----------- -----------
LIABILITIES
Interest-bearing deposit from affiliate $ 1,000 $ 1,000
Short-term borrowings 53,385 63,482
Accounts payable 15,434 21,334
Other payables due to credit card
securitizations, net 25,485
Current income taxes payable to FCI 2,290 5,178
Deferred income 15,057 10,087
Accrued expenses and other liabilities 9,544 2,029
----------- -----------
TOTAL LIABILITIES 122,195 103,110
----------- -----------
STOCKHOLDER'S EQUITY
Preferred Stock, par value $.01 per share;
authorized 10,000,000 shares, none issued
or outstanding
Common Stock, par value $.01; authorized
100,000,000 shares, issued and outstanding
15,966,667 shares 160
Paid-in/Contributed capital 59,868 60,028
Retained earnings 25,986 11,290
----------- -----------
TOTAL STOCKHOLDER'S/DIVISION EQUITY 86,014 71,318
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDER'S
EQUITY $ 208,209 $ 174,428
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
<PAGE>
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Income
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
INTEREST INCOME
Credit card loans $ 7,464 $ 2,245 $ 19,583 $ 3,616
Federal funds sold 208 249 644 292
Other 56 14 120 60
-------- --------- --------- --------
Total interest income 7,728 2,508 20,347 3,968
-------- --------- --------- --------
INTEREST EXPENSE
Deposit 12 13 36 24
Short-term borrowings 953 538 2,787 806
-------- --------- --------- --------
Total interest expense 965 551 2,823 830
-------- --------- --------- --------
NET INTEREST INCOME 6,763 1,957 17,524 3,138
Provision for loan losses 5,383 1,110 10,556 1,644
-------- --------- --------- --------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 1,380 847 6,968 1,494
-------- --------- --------- --------
OTHER OPERATING INCOME:
Net extended warranty revenues 5,174 4,603 13,789 11,290
Net securitization and credit
card servicing income 13,190 6,090 33,726 9,244
Credit card fees, interchange
5,184 2,011 17,262 6,716
and other credit card income
Fee-based product revenues 8,482 2,212 20,549 3,761
-------- --------- --------- --------
32,030 14,916 85,326 31,011
-------- --------- --------- --------
OTHER OPERATING EXPENSE:
Credit card account and other
product solicitation and
marketing expenses 4,438 3,218 20,898 12,556
Employee compensation 6,362 415 14,885 1,117
Data processing services and
communications 3,435 825 8,632 1,705
Third party servicing expenses 2,087 1,540 6,700 2,718
Warranty and debt waiver
underwriting and claims
servicing expenses
2,781 1,753 6,842 4,177
Credit card fraud losses 657 274 1,723 555
Other 4,216 1,158 8,718 2,958
-------- --------- --------- --------
23,976 9,183 68,398 25,786
-------- --------- --------- --------
INCOME BEFORE INCOME TAXES 9,434 6,580 23,896 6,719
Income taxes 3,632 2,533 9,200 2,587
-------- --------- --------- --------
NET INCOME $ 5,802 $ 4,047 $ 14,696 $ 4,132
-------- --------- --------- --------
-------- --------- --------- --------
EARNINGS PER COMMON SHARE
Primary $ .35 $ .25 $ .89 $ .25
-------- --------- --------- --------
Fully diluted $ .35 $ .25 $ .89 $ .25
-------- --------- --------- --------
4
<PAGE>
Weighted average common share
and common share equivalents
outstanding 16,507 16,311 16,486 16,270
-------- --------- --------- --------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
5
<PAGE>
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholder's Equity
(DOLLARS IN THOUSANDS) (UNAUDITED)
<TABLE>
<CAPTION>
TOTAL
PAID-IN/ STOCKHOLDER'S
COMMON CONTRIBUTED RETAINED /DIVISION
STOCK CAPITAL EARNINGS EQUITY
-------- ----------- -------- -------------
<S> <C> <C> <C> <C>
BALANCE, DECEMBER 31,1994 $ $ 28 $ 6,709 $ 6,737
Net income 4,132 4,132
Contributions from FCI 30,000 30,000
------- ------- -------- -------
BALANCE, SEPTEMBER 30, 1995 $ $30,028 $ 10,841 $40,869
------- ------- -------- -------
------- ------- -------- -------
BALANCE, DECEMBER 31, 1995 $ $60,028 $ 11,290 $71,318
Net income 14,696 14,696
Company reorganization 160 (160)
------- ------- -------- -------
BALANCE, SEPTEMBER 30, 1996 $ 160 $59,868 $ 25,986 $86,014
------- ------- -------- -------
------- ------- -------- -------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
6
<PAGE>
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(DOLLARS IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
1996 1995
---- ----
OPERATING ACTIVITIES
Net income $ 14,696 $ 4,132
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Provision for loan losses 10,556 1,644
Depreciation and amortization 5,260 1,248
(Gain)/Net amortization of gain on
securitization of credit card loans 2,803 (5,837)
Deferred income tax provision (19,194) 1,566
Changes in operating assets and liabilities:
Accrued interest and fees receivable 523 (351)
Other receivables due to/from credit card
securitizations, net 53,967 (11,810)
Prepaid expenses and deferred charges (3,686) (5,696)
Accounts payable and accrued expenses 1,615 8,660
Current income taxes payable to FCI (2,887) (803)
Deferred income 4,970 4,101
Other 1,777 (2,618)
---------- ---------
Net cash provided by (used in) operating
activities 70,400 (5,764)
---------- ---------
INVESTING ACTIVITIES
Proceeds from sales of loans 674,055 250,555
Net loans originated or collected (738,764) (283,609)
Credit card portfolio acquisition (15,469)
Net decrease in loans to FCI 9,375
Additions to premises and equipment (2,669) (471)
---------- ---------
Net cash used in investing activities (67,378) (39,619)
---------- ---------
FINANCING ACTIVITIES
Increase in interest-bearing deposit 1,000
Net (decrease) increase in short-term borrowings (10,097) 24,774
Capital contributions from FCI 30,000
---------- ---------
Net cash (used in) provided by financing
activities (10,097) 55,774
---------- ---------
Net (decrease) increase in cash and cash
equivalents (7,075) 10,391
Cash and cash equivalents at beginning of period 34,743 23
---------- ---------
Cash and cash equivalents at end of period $ 27,668 $ 10,414
---------- ---------
---------- ---------
See accompanying Notes to Consolidated Financial Statements.
7
<PAGE>
METRIS COMPANIES INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1996
(DOLLARS IN THOUSANDS) (UNAUDITED)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Metris
Companies Inc. ("MCI") and its subsidiaries (collectively, "the Company"). The
Company is an information-based direct marketer of consumer credit products,
extended service plans, and other fee-based products and services to moderate
income consumers. The Company's business is conducted through Metris Direct,
Inc., Direct Merchants Credit Card Bank, National Association ("Direct Merchants
Bank") and Metris Receivables, Inc. ("MRI") each a wholly-owned subsidiary of
MCI.
Prior to September 1996, the Company operated as a division of Fingerhut
Companies, Inc. ("FCI"). During September 1996, FCI reorganized this business
through the formation of MCI and a contribution of the stock of Metris Direct,
Inc., Direct Merchants Bank and MRI in addition to the assets, liabilities and
equity of certain portions of the retail extended service plan business of
Fingerhut Corporation ("Fingerhut"), a wholly-owned subsidiary of FCI, to MCI.
Subsequent to September 30, 1996, the Company completed an initial public
offering of its common stock (See Note 8).
In early 1995, the Company's need for cash to fund credit card loans and
for other general business purposes increased above the cash generated by its
other businesses and therefore, since early 1995, the Company has borrowed funds
or obtained capital from FCI to fund its ongoing operations. The consolidated
financial statements include an allocation of FCI interest expense for the net
borrowings of the Company from FCI. The financial statements also reflect a $60
million allocation of capital from FCI to the Company during 1995. This capital
contribution was made in installments at the beginning of each month throughout
1995, in order to maintain the Company's equity at a level sufficient to support
the growth in managed assets experienced by the Company during 1995 (generally
at a level approximating 10% of total managed assets at the end of each month).
The consolidated financial statements also include an allocation of
expenses for data processing and information systems, audit, certain accounting
and similar administrative functions, treasury, legal, human resources, customer
service and other administrative support historically provided by FCI and its
subsidiaries to the Company. Such expenses were based on the actual use of such
services or were based on other allocation methods which, in the opinion of
management, are reasonable. During 1996, FCI and the Company entered into an
administrative services agreement which covers such expense allocations and the
provision of future services using similar rates and allocation methods for
various terms, the latest of which
8
<PAGE>
expires at the end of 1998. The consolidated financial statements also reflect
the retroactive effects of intercompany agreements entered into during 1996
including co-brand credit card, database access, data sharing and extended
service plan agreements with Fingerhut, and a tax sharing agreement with FCI.
These agreements have terms ranging up to seven years.
9
<PAGE>
All significant intercompany balances and transactions have been eliminated
in preparation of these financial statements.
INTERIM FINANCIAL STATEMENTS
The unaudited interim consolidated financial statements and related
unaudited financial information in the footnotes have been prepared in
accordance with generally accepted accounting principles and the rules and
regulations of the Securities and Exchange Commission for interim financial
statements. Such interim financial statements reflect all adjustments,
consisting of normal recurring accruals, which in the opinion of management, are
necessary to present fairly the consolidated financial position of the Company,
and the results of its operations and its cash flows for the interim periods.
These consolidated financial statements should be read in conjunction with the
financial statements and the notes thereto contained in the Company's
Registration Statement on Form S-1 (File No. 333-10831), which became effective
October 24, 1996. The nature of the Company's 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
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles which require management to make
estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements as well as the reported amount of revenues
and expenses during the reporting periods. Actual results could differ from
these estimates.
NOTE 2 - CONSOLIDATED STATEMENTS OF CASH FLOW
Cash paid for interest during the nine months ended September 30, 1996 and
1995, was $2,823 and $830, respectively. Cash paid for income taxes for the
same period was $31,014 and $2,004, respectively.
NOTE 3 - EARNINGS PER SHARE
Earnings per common share are computed using net income applicable to
common stock and the weighted average number of common and common equivalent
shares outstanding, after giving retroactive effect to the shares outstanding as
if the Company reorganization during September, 1996 (See Note 1) had occurred
at the beginning of the respective periods shown. The common equivalent shares
outstanding were calculated based on the treasury stock method using the initial
public offering price. In addition, common equivalent shares outstanding were
calculated assuming the Chief Executive Officer's tandem option (See Note 7) was
converted into shares of the Company's common stock at the beginning of the
respective periods shown.
10
<PAGE>
NOTE 4 - CREDIT CARD SECURITIZATIONS
The Company securitizes and sells its credit card loans to both public and
private investors through the Metris Master Trust (the "Trust"). Although the
Company continues to service the underlying credit card accounts and maintains
the customer relationships, these transactions are treated as sales for
financial reporting purposes and the associated loans are not reflected on the
consolidated balance sheets. The Company has receivables from or payables to
the Trust as a result of securitizations including amounts deposited in an
investor reserve account held by the trustee for the benefit of the Trust's
certificateholders ("Investor Deposit"), the excess servicing asset, which
represents the net gain recorded at any point in time for loans sold under the
asset securitizations, net of recourse reserves for securitized loans and normal
and excess servicing fee receivables. The change in the "Other
receivables/payables due from/to credit card securitizations, net" on the
consolidated balance sheets of $57.1 million is primarily due to the increase in
recourse reserves for securitized loans due to the growth in the loan portfolio
and the decrease in the receivable from the trust for the Investor Deposit.
NOTE 5 - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Balance at beginning of period $ 5,303 $ 534 $ 3,679 $
Provision for loan losses 5,383 1,110 10,556 1,644
--------- --------- -------- ------
Loans charged-off 2,188 158 5,816 158
Recoveries 42 121
--------- --------- --------- ---------
Net loan charge-offs 2,146 158 5,695 158
--------- --------- --------- ---------
Balance at end of period $ 8,540 $ 1,486 $ 8,540 $ 1,486
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
NOTE 6 - SHORT TERM BORROWINGS
On September 16, 1996, the Company executed agreements for the following
credit facilities: (1) a $300 million, five-year revolving credit facility for
the Company (the "Revolving Credit Facility"), guaranteed by FCI; and (2)an
amendment to Series 1995-1 under the Metris Master Trust to (a) increase the
Class A Variable Funding Certificate to support a $400 million increase (to $1.2
billion, of which the Company may use up to $800 million) of the Fingerhut Owner
Trust Commercial Paper Program in which the Company participates; and (b) issue
$112.6 million of additional asset-backed certificates (the "Certificates") to
support the aforementioned increase in the Commercial Paper Program.
11
<PAGE>
The Company borrows under the Revolving Credit Facility and from FCI to
fund on-balance sheet loans and for other general business purposes. At
September 30, 1996, the Company had outstanding borrowings of $25.0 million
under the Revolving Credit Facility and outstanding borrowings from FCI of $28.4
million. At December 31, 1995, the Company had borrowed $63.5 million from FCI.
The interest rate on the Revolving Credit Facility borrowings at September 30,
1996 was 8.3%. The interest rates on the borrowings from FCI were 8.3% and 7.1%
at September 30, 1996 and December 31,1995, respectively.
NOTE 7 - STOCK OPTIONS
Effective March of 1994, FCI granted the Company's Chief Executive Officer
("CEO") a tandem option, which vests evenly over four years from the effective
date, for either (a) 55,000 shares of FCI's common stock at an exercise price of
$15.00 per share or (b) a 3.3% equity interest in the adjusted fair value of the
Company, as defined, that exceeds two times the estimated fair value of the
Company in March of 1994. The exercise of either option terminates the other
and if the CEO terminates his employment prior to the completion of the
Company's public offering of its stock, the entire vested obligation is to be
settled in cash. Subsequent to September 30, 1996, the initial public offering
of the Company's stock occurred (See Note 8) and the 3.3% equity interest was
converted into 656,075 options for shares of the Company's Common Stock with an
exercise price of $2.76 per share. Compensation expense related to these
options of $2.9 million and $4.7 million was recorded for the three and nine
month periods ended September 30, 1996, respectively.
In addition, at the time of the initial public offering (See Note 8) Metris
granted options to purchase an aggregate of 745,500 shares of common stock to
officers and employees of the Company and Fingerhut, members of the Board of
Directors, and others. Of these, 651,500 options were granted at an exercise
price of $16 and the balance were granted at a below-market exercise price per
share, for which expense of $.8 million was recorded for the three and nine
month periods ended September 30, 1996. All options granted to current officers
and directors of the Company and Fingerhut were at the initial offering price.
NOTE 8 - SUBSEQUENT EVENTS
In October, 1996, the Company completed an initial public offering of
3,258,333 shares of its common shares at $16 a share. The transaction reduced
the FCI ownership interest in the Company to approximately 83%. The Company
realized net cash proceeds of approximately $47.7 million from the sale of such
shares after underwriting discounts and commissions and estimated expenses of
the offering.
12
<PAGE>
METRIS COMPANIES INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 2.
The following discussion and analysis provides information that management
believes to be relevant to understanding the financial condition and results of
operations of Metris Companies Inc. and Subsidiaries (the "Company"). This
discussion should be read in conjunction with the consolidated financial
statements and the related notes thereto included under Item 1 and with the
Registration Statement on Form S-1 (File No. 333-10831), which became effective
October 24, 1996.
GENERAL
The Company is an information-based direct marketer and provider of
consumer credit products, extended service plans (warranties) and other fee-
based products and services to moderate income consumers.
CONSUMER CREDIT PRODUCTS
The Company's consumer credit products currently are unsecured and secured
credit cards, including the Fingerhut co-branded MasterCard-Registered
Trademark- and the Direct Merchants Bank MasterCard. The primary factors
affecting the profitability of consumer credit products are credit card account
and loan growth, interest spreads on loans, credit card usage, credit quality
(delinquencies and charge-offs), the level of solicitation and marketing
expenses, fraud losses, servicing and other administrative costs. The Company
generates interest and other income through finance charges assessed on
outstanding credit card loans, credit card fees (including annual membership,
cash advance, overlimit, past-due, and other credit card fee income) and
interchange income. The Company's primary related expenses are the costs of
funding its loans, provisions for loan losses, operating expenses (including
employee compensation, account solicitation and marketing expenses), and data
processing and servicing expenses.
EXTENDED SERVICE PLANS
The Company also provides extended service plans that extend warranty
service coverage beyond the manufacturer's warranty on selected products sold by
Fingerhut. Extended service plan profitability is directly impacted by the
response rates to product solicitation efforts, returns or cancel rates for the
underlying product, the retail sales price of the product on which an extended
service plan is sold, the cost of underwriting and claims servicing, and other
operating costs.
13
<PAGE>
FEE-BASED PRODUCTS AND SERVICES
The Company markets its fee-based products and services, including debt
waiver programs, card registration, third party insurance, and membership clubs,
to its credit card customers and to Fingerhut customers. Profitability for fee-
based products and services is affected by the response rates to product
solicitation efforts, the targeted solicitation plans and the commission rates
received from the Company's product partners, claims rates and claims servicing
costs for certain programs, and other operating expenses.
RESULTS OF OPERATIONS
Net income for the three months ended September 30, 1996, was $5.8 million,
or $.35 per share, an increase of $1.8 million over the net income of $4.0
million, or $.25 per share, for the same period in 1995. The 45% increase in
net income is the result of an increase in net interest income and other
operating income partially offset by increases in the provision for loan losses
and other operating expenses. These increases are largely attributable to the
growth in average managed loans from $248 million for the third quarter 1995 to
$1.2 billion for the third quarter 1996, an increase of 378%.
Net income for the nine months ended September 30, 1996, was $14.7
million, or $.89 per share, compared to $4.1 million, or $.25 per share, for
the comparable period in the prior year. The 259% increase in net income is the
result of a significant increase in net interest income, and other operating
income, primarily driven by a $14.8 million increase in debt waiver product
revenue, partially offset by increases in the provision for loan losses and
other operating expenses. These increases are largely attributable to the
growth in average managed loans from $112 million for the nine months ended
September 30, 1995 to $890 million for the nine months ended September 30, 1996,
an increase of 695%.
MANAGED LOAN PORTFOLIO AND THE IMPACT OF CREDIT CARD SECURITIZATIONS
SECURITIZATION
Securitizations of credit card loans have been and are expected to be a
major source of liquidity for the Company. The effect on the Company's financial
statements from securitization is to remove credit card loans sold with limited
recourse from the balance sheet and record a gain on sale for the difference
between the carrying value of the loans and the adjusted sales proceeds.
The securitization and sale of credit card loans changes the Company's
interest in such loans from that of a lender to that of a servicer. Accordingly,
there is a change in how revenue is reported in the income statement. For
securitized and sold credit card loans, amounts that
14
<PAGE>
otherwise would have been recorded as interest income, interest expense, fee
income and provision for loan losses are instead reported in other operating
income as net securitization and credit card servicing income.
15
<PAGE>
MANAGED LOAN PORTFOLIO
The Company analyzes its financial performance on a managed loan portfolio
basis. In order to do so, the income statement and balance sheet are adjusted to
reverse the effect of securitized loans. The Company's discussion of revenues,
where applicable, and provision for loan losses includes comparisons to amounts
reported in the Company's statements of income ("owned basis" or "on-balance
sheet") as well as on a managed basis.
The Company's managed loan portfolio is comprised of credit card loans held
for securitization, retained interests in loans securitized and the investors'
share of securitized credit card loans. The investors' share of securitized
credit card loans are not assets of the Company, and, therefore, are not shown
on the Company's consolidated balance sheets. The following tables summarize the
Company's managed loan portfolio.
<TABLE>
<CAPTION>
SEPTEMBER 30,
---------------------------
DOLLARS IN THOUSANDS 1996 1995
PERIOD-END BALANCES: ---- ----
Loans held for securitization $ 4,193 $ 3,698
Retained interests in loans
securitized 149,884 44,667
Investors' interests in
securitized loans 1,122,610 250,555
---------- --------
Total managed loan portfolio $1,276,687 $298,920
---------- --------
---------- --------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
1996 1995 1996 1995
----- ------ ------ ------
<S> <C> <C> <C> <C>
AVERAGE BALANCES:
Credit card loans:
Loans held for securitization $ 17,613 $ 8,811 $ 28,137 $ 6,261
Retained interests in loans
securitized 132,092 36,340 105,276 23,464
Investors' interests in
securitized loans 1,034,907 203,457 756,654 82,283
----------- ----------- ----------- -----------
Total managed loan portfolio $ 1,184,612 $ 248,608 $ 890,067 $ 112,008
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
16
<PAGE>
IMPACT OF CREDIT CARD SECURITIZATIONS. The following table provides selected
financial information on a managed loan portfolio as well as a summary of the
effects of credit card securitizations on selected line items of the Company's
income statements for each of the periods presented:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ----------------------
DOLLARS IN THOUSANDS 1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
STATEMENTS OF INCOME
(OWNED BASIS)
Net interest income $ 6,763 $ 1,957 $ 17,524 $ 3,138
Provision for loan losses 5,383 1,110 10,556 1,644
Other operating income 32,030 14,916 85,326 31,011
Other operating expense 23,976 9,183 68,398 25,786
----------- ----------- ----------- -----------
Income before income taxes $ 9,434 $ 6,580 $ 23,896 $ 6,719
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
ADJUSTMENTS FOR SECURITIZATIONS:
Net interest income $ 36,826 $ 6,839 $ 78,416 $ 8,681
Provision for loan losses 37,957 7,098 75,258 9,395
Other operating income 1,131 259 (3,158) 714
Other operating expense ----------- ----------- ----------- -----------
Income before income taxes $ $ $ $
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
MANAGED STATEMENTS OF INCOME
Net interest income $ 43,589 $ 8,796 $ 95,940 $ 11,819
Provision for loan losses 43,340 8,208 85,814 11,039
Other operating income 33,161 15,175 82,168 31,725
Other operating expense 23,976 9,183 68,398 25,786
----------- ----------- ----------- -----------
Income before income taxes $ 9,434 $ 6,580 $ 23,896 $ 6,719
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
OTHER DATA:
OWNED BASIS:
Average interest earning
assets $ 169,817 $ 63,403 $152,760 $ 37,914
Return on average assets 11.51% 17.58% 10.34% 10.48%
Return on average
stockholder's equity 27.13% 42.70% 25.00% 26.09%
Net interest margin (1) 15.84% 12.28% 15.32% 11.06%
MANAGED BASIS:
Average managed interest
earning assets $ 1,204,723 $266,861 $ 909,414 $120,196
Return on managed assets 1.87% 5.45% 2.07% 4.09%
Net interest margin (1) 14.39% 13.11% 14.09% 13.15%
</TABLE>
(1) Net interest margin is equal to annualized net interest income divided by
average interest-earning assets.
17
<PAGE>
NET INTEREST INCOME
Net interest income is interest earned primarily on the Company's credit
card loans less interest expense on borrowings to fund the loans. Net interest
income for the three months ended September 30, 1996, was $6.8 million compared
to $2.0 million for the same period in 1995, an increase of $4.8 million. This
increase was primarily due to a $105 million increase in average loans over the
comparable period in 1995. The average annualized yield on interest earning
assets increased from 15.7% for the three months ended September 30, 1995, to
18.1% for the three months ended September 30, 1996, primarily due to the
increase in average credit card loans to total interest-earnings assets. The
Company has used variable rate funding in its credit card securitization
transactions and in its short-term borrowings, or has swapped fixed rates on
such transactions to variable rates.
Net interest income for the nine months ended September 30, 1996, was $17.5
million compared to $3.1 million in the comparable period in 1995. The large
increase was predominately due to a $104 million increase in average loans over
the comparable period in 1995. The average annualized yield on interest earning
assets increased from 14.0% for the nine months ended September 30, 1995 to
17.8% for the nine months ended September 30, 1996, as a larger percentage of
credit card accounts revolved.
18
<PAGE>
The following table provides an analysis of interest income and expense,
net interest spread, net interest margin and average balance sheet data on an
owned basis for the three and nine month periods ended September 30, 1996, and
1995:
ANALYSIS OF AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS AND RATES ON AN OWNED
BASIS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------------
1996 1995
----------------------------------- ------------------------------------
DOLLARS IN THOUSANDS Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ----- ------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning
assets: (1)
Federal funds sold $ 15,720 $ 208 5.3% $ 17,256 $ 249 5.7%
Short-term investments 4,392 56 5.1% 996 14 5.5%
Credit card loans 149,705 7,464 19.8% 45,151 2,245 19.7%
------------ -------- ----- ------------ --------- -----
Total interest-earning
assets $ 169,817 $ 7,728 18.1% $ 63,403 $ 2,508 15.7%
------------ -------- ----- ------------ --------- -----
Cash and due from banks 8,632 2,062
Accrued interest and fees 1,905 688
Other amounts due from
securitizations 580 18,286
Other assets 27,047 7,992
Allowance for loan losses (7,478) (1,110)
------------- ------------
------------- ------------
Total assets $ 200,503 $ 91,321
------------- ------------
------------- ------------
LIABILITIES AND EQUITY:
Interest-bearing
liabilities:
Interest bearing deposit $ 1,000 $ 12 4.8% $ 1,000 $ 13 5.2%
Short term borrowings 53,175 953 7.1% 33,677 538 6.3%
------------ -------- ---- ------- ------ ----
Total 54,175 965 7.1% 34,677 $ 551 6.3%
-------- ---- ------ ----
Other liabilities 61,242 19,038
------------ -------
Total liabilities 115,417 53,715
Stockholder's Equity 85,086 37,606
------------ -------
Total Liabilities and
Equity $ 200,503 $91,321
------------- -------
------------- -------
Net interest income and
interest margin (2) $ 6,763 15.8% $ 1,957 12.3%
Net interest rate spread (3) 11.0% 9.4%
</TABLE>
(1) There were no taxable equivalent adjustments necessary for the periods
presented.
(2) Net interest margin is computed by dividing annualized net interest income
by average total interest-earning assets.
19
<PAGE>
(3) The interest rate spread is the annualized yield on annualized average
interest earning assets minus the funding rate on average interest-bearing
liabilities.
20
<PAGE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------------------------------------------
1996 1995
---------------------------------- ---------------------------------
DOLLARS IN Average Yield/ Average Yield/
THOUSANDS Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest-earning
assets: (1)
Federal funds sold $ 16,178 $ 644 5.3% $ 6,786 $ 292 5.8%
Short-term
investments 3,169 120 5.1% 1,403 60 5.7%
Credit card loans 133,413 19,583 19.6% 29,725 3,616 16.3%
--------- ------- ----- ------- ------- -----
Total interest
earning assets $ 152,760 $20,347 17.8% $37,914 $ 3,968 14.0%
--------- ------- ----- ------- ------- -----
Cash and due from
banks 5,009 1,027
Accrued interest
and fees 2,285 1,461
Other amounts due
from securitizations 11,187 8,177
Other assets 24,408 4,657
Allowance for loan
losses (5,878) (526)
--------- -------
Total assets $ 189,771 $52,710
--------- -------
--------- -------
LIABILITIES AND EQUITY:
Interest-bearing
liabilities:
Interest bearing deposit $ 1,000 $ 36 4.8% $ 599 $ 24 5.3%
Short term borrowings 60,052 2,787 6.2% 17,850 806 6.0%
--------- ------- ----- ------- ------- -----
Total 61,052 2,823 6.2% 18,449 830 6.0%
--------- ------- ----- ------- ------- -----
Other liabilities 50,198 13,086
Total liabilities 111,250 31,535
Stockholder's Equity 78,521 21,175
--------- -------
Total Liabilities and Equity
$ 189,771 $52,710
--------- -------
--------- -------
Net interest income and
interest margin (2) $17,524 15.3% $ 3,138 11.1%
Net interest rate spread
(3) 11.6% 8.0%
</TABLE>
(1) There were no taxable equivalent adjustments necessary for the periods
presented.
(2) Net interest margin is computed by dividing annualized net interest income
by average total interest-earning assets.
(3) The interest rate spread is the annualized yield on annualized average
interest earning assets minus the funding rate on average interest-bearing
liabilities.
21
<PAGE>
OTHER OPERATING INCOME
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
DOLLARS IN THOUSANDS 1996 1995 1996 1995
---- ---- ---- ----
OTHER OPERATING INCOME:
Net extended warranty revenues $ 5,174 $ 4,603 $13,789 $11,290
Net securitization and credit
card servicing income 13,190 6,090 33,726 9,244
Credit card fees, interchange
and other credit card income 5,184 2,011 17,262 6,716
Fee-based product revenues 8,482 2,212 20,549 3,761
------- ------- ------- -------
Total $32,030 $14,916 $85,326 $31,011
------- ------- ------- -------
------- ------- ------- -------
Other operating income contributes substantially to the Company's results
of operations, representing 81% of revenues for the nine months ended September
30, 1996. Fee-based product revenues continue to provide an increasing
percentage of other operating income, particularly from debt waiver products.
Debt waiver products and other fee-based product revenues are expected to
increase with growth in credit card accounts and as the Company continues to
offer other fee-based products to its customer base.
The following definitions may be helpful when reading the discussion of the
changes in other operating income found below for the periods presented:
NET EXTENDED WARRANTY REVENUES - Net extended warranty revenues include
revenues received from sales of extended service plans, net of a provision for
service plan returns, and deferred warranty revenues.
NET SECURITIZATION AND CREDIT CARD SERVICING INCOME - Due to the
securitization of credit card loans, activity from securitized account balances
normally reported as net interest income, other operating income, and provision
for loan losses is reported in net securitization and credit card servicing
income. Net securitization income is the excess of interest and fee income
earned over the related securitization trust expenses, including interest
payments to certificateholders in the trusts, charge-offs, servicing costs and
transaction expenses related to securitized loans. Credit card servicing income
is also included in this amount and represents fees paid to the Company from the
trust for servicing the securitized loans. Such fees generally approximate 2% of
average securitized loans on an annualized basis.
22
<PAGE>
CREDIT CARD FEES, INTERCHANGE AND OTHER CREDIT CARD INCOME - Credit card
fees include annual membership, cash advance, overlimit, past-due, and other
credit card fee income derived from on-balance sheet loans. Also included in
this amount is interchange income which represents fees that are payable by
merchants to the credit card issuer for sales transactions. This amount
presently represents about 1.4% of all net credit card purchases.
FEE-BASED PRODUCT REVENUES - Fee-based product revenues presently include
revenues from sales of third party insurance, programs such as debt waiver
protection for unemployment, disability, and death, card registration, shopping
and dining clubs, and revenues from targeted list programs.
Other operating income increased $17.1 million for the three months ended
September 30, 1996, over the comparable period in 1995, primarily due to income
generated from the growth in average securitized credit card loans.
Additionally, fee-based product revenues increased by $6.3 million as the
Company's marketing efforts to cross-sell other products and services to its and
Fingerhut's customer base were successful. Specifically, debt waiver product
revenue increased by $5.9 million as the Company continued to add new credit
card customers with debt waiver protection.
Other operating income increased by $54.3 million for the nine months ended
September 30, 1996 over the comparable period in the prior year, largely due to
income generated from the growth in average securitized credit card loans.
Other factors contributing to the increase were credit card fees, interchange
and other credit card income which increased by $10.5 million primarily due to a
$7.8 million increase in interchange income. In addition, fee-based product
revenues increased by $16.8 million as the Company's marketing efforts to
cross-sell other products and services to its customer base were successful.
Specifically, debt waiver product revenue increased by $14.8 million as the
Company continued to add new credit card customers with debt waiver protection.
23
<PAGE>
OTHER OPERATING EXPENSE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
DOLLARS IN THOUSANDS 1996 1995 1996 1995
---- ---- ---- ----
OTHER OPERATING EXPENSE:
Credit card account and other
product solicitation and
marketing expenses $ 4,438 $ 3,218 $20,898 $12,556
Employee compensation 6,362 415 14,885 1,117
Data processing services and
communications 3,435 825 8,632 1,705
Third party servicing expenses 2,087 1,540 6,700 2,718
Warranty and debt waiver
underwriting and claims
servicing expenses 2,781 1,753 6,842 4,177
Credit card fraud losses 657 274 1,723 555
Other 4,216 1,158 8,718 2,958
------- ------- ------- -------
Total $23,976 $ 9,183 $68,398 $25,786
------- ------- ------- -------
------- ------- ------- -------
Other operating expenses include direct and allocated expenses from FCI for
administrative services provided to the Company under the Administrative
Services Agreement (See Note 1 to the Consolidated Financial Statements).
Additionally, other operating expenses reflect the retroactive effects of
additional intercompany agreements and contracts between FCI and its
subsidiaries (See Note 1 to the Consolidated Financial Statements).
Other operating expenses for the three months ended September 30, 1996,
increased $14.8 million over the comparable period in 1995, primarily due to
employee compensation and data processing services and communications expense.
Employee compensation increased due to staffing needs to support the increase in
credit card accounts and the internalization of credit card collections and
other functions, and increased management incentive plan expenses. The increase
in data processing services and communications expense was largely due to the
increased number of credit card accounts, transaction volumes and loan balances.
24
<PAGE>
Other operating expenses for the nine months ended September 30, 1996,
increased $42.6 million over the comparable period in 1995, largely due to costs
incurred in the Company's business development activities. Credit card account
and other product solicitation and marketing expenses rose by $8.3 million over
the same period in the prior year. New credit card account solicitation programs
were implemented in the first nine months of 1996, increasing the number of
credit card accounts and loans outstanding. Additionally, increased solicitation
costs were incurred in efforts to increase the penetration of extended service
plan sales on warrantable products sold by Fingerhut and fee-based products sold
to the Company's customers. Also, other operating expenses increased due to
increases in data processing services and communications and third party
servicing expenses of $6.9 million and $4.0 million, respectively, over those
incurred for the nine months ended September 30, 1995. These cost increases were
largely due to the growth in credit card accounts, transaction volumes and loan
balances. Employee compensation also increased $13.8 million to $14.9 million
for the nine months ended September 30, 1996, due to increased staffing needs to
support the increase in credit card accounts, the internalization of credit card
collections and other functions, and increased management incentive plan
expenses.
INCOME TAXES
The Company's provision for income taxes includes both federal and state
income taxes. The Company's effective tax rate was 38.5% for the three months
and nine months ended September 30, 1996 and 1995, respectively.
ASSET QUALITY
The Company's 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
the Company's various credit card account portfolios, the success of the
Company's collection and recovery efforts, and general economic conditions. The
average age of the Company's credit card portfolio affects the stability of
delinquency and loss rates of the portfolio. Additionally, consistent with the
credit card industry, the Company has recently experienced a rise in bankruptcy
filings. The Company plans to continue to focus its resources on refining its
credit underwriting standards for new accounts, and to increase its focus on
collections and post charge-off recovery efforts to minimize losses from these
negative industry trends. At September 30, 1996, 77% of managed accounts and
67% of managed loans were less than 12 months old. Accordingly, the Company
believes that its loan portfolio will experience increased levels of delinquency
and loan losses as the average age of the Company's accounts increases.
25
<PAGE>
This trend is reflected in the increase in the Company's net charge-off
ratios. For the quarter ended September 30, 1996, the Company's net charge-off
ratio stood at an annualized rate of 5.70% compared to 1.39% for the quarter
ended September 30, 1995. The Company's charge-off ratio was 5.70% for the nine
months ended September 30, 1996, compared to .71% for the comparable period in
1995. The Company believes, consistent with its statistical models and other
credit analyses, that this rate will continue to fluctuate but generally rise
over the next twelve to eighteen months.
The Company's strategy for managing loan losses to maximize profitability
consists of credit line management and risk-based pricing so that an acceptable
profit margin is maintained based on the perceived risk of each credit card
account. Under this strategy, interest margins are established for each credit
card account based on its perceived risk profile. Loan losses are further
managed through the offering of credit lines which are generally lower than is
currently standard in the industry. Individual accounts and their related credit
lines are also continually managed using various marketing, credit and other
management processes in order to continue to maximize the profitability of each
account.
DELINQUENCIES
Delinquencies not only have the potential to impact earnings in the form of
net loan losses, but are also costly in terms of the personnel and resources
dedicated to resolving them. Delinquency levels are monitored on a managed
basis, since delinquency on either an owned or managed basis subjects the
Company to credit loss exposure. A credit card account is contractually
delinquent if the minimum payment is not received by the specified date on the
cardholder's statement. It is the Company's policy to continue to accrue
interest and fee income on all credit card accounts, except in limited
circumstances, until the account and all related loans, interest and other fees
are charged-off. The following table presents the delinquency trends of the
Company's credit card loan portfolio on a managed portfolio basis:
MANAGED LOAN DELINQUENCY
SEPTEMBER 30, % OF SEPTEMBER 30, % OF
1996 TOTAL 1995 TOTAL
------------- ----- ------------- -----
DOLLARS IN THOUSANDS
Managed loan
portfolio $1,276,687 100% $298,920 100%
Loans delinquent:
30 to 59 days 26,800 2.10% 5,142 1.72%
60 to 89 days 15,782 1.24% 3,039 1.02%
90 or more 23,195 1.81% 2,288 0.76%
---------- ----- -------- -----
Total $65,777 5.15% $10,469 3.50%
---------- ----- -------- -----
---------- ----- -------- -----
26
<PAGE>
The above numbers reflect industry trends and continued seasoning of the
Company's managed loan portfolio. The Company intends to continue to focus its
resources on its collection efforts to minimize the negative impact to net loan
losses that results from increased delinquency levels.
NET CHARGE-OFFS
Net charge-offs include the principal amount of losses from cardholders
unwilling or unable to pay their loan balance, as well as bankrupt and deceased
cardholders, less current period recoveries. Net charge-offs exclude accrued
finance charges and fees which are charged against the related income at the
time of charge-off. The following table presents the Company's net charge-offs
for the periods indicated as reported in the consolidated financial statements
and on a managed portfolio basis:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
DOLLARS IN THOUSANDS
ON-BALANCE SHEET PORTFOLIO:
Average loans outstanding $ 149,705 $ 45,150 $133,413 $ 29,725
Net charge-offs 2,146 158 5,695 158
Net charge-offs as a
percentage of average
loans outstanding (1) 5.70% 1.39% 5.70% .71%
----- ----- ----- -----
----- ----- ----- -----
MANAGED LOAN PORTFOLIO:
Average loans outstanding $ 1,184,612 $ 248,608 $890,067 $ 112,008
Net charge-offs 17,010 890 37,398 890
Net charge-offs as a
percentage of average
loans outstanding (1) 5.71% 1.42% 5.61% 1.06%
----- ----- ----- -----
----- ----- ----- -----
</TABLE>
(1) Annualized
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained for on-balance sheet loans. For
securitized loans, anticipated losses and related recourse reserves are
reflected in the calculations of net securitization and credit card servicing
income. Provisions for loan losses are made in amounts necessary to maintain the
allowance at a level estimated to be sufficient to absorb probable future losses
of principal and earned interest, net of recoveries, inherent in the existing
on-balance sheet loan portfolio.
27
<PAGE>
The provision for loan losses on an owned basis for the three and nine
months ended September 30, 1996, totaled $5.4 million and $10.6 million,
respectively. This compares to provisions of $1.1 million and $1.6 million for
the three and nine months ended September 30, 1995, respectively. The amount
and level of the provision for loan losses on an owned basis may vary from
period to period, depending on the amount of credit card loans sold and
securitized in a particular period. However, the increase from the nine month
period ended September 30, 1995, as compared to the nine month period ended
September 30, 1996, is primarily reflective of the large increase in on-balance
sheet loans outstanding and the overall maturation of the portfolio. The
following table presents the change in the Company's allowance for loan losses
and other ratios on both an owned and a managed portfolio basis for the periods
presented:
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
DOLLARS IN THOUSANDS 1996 1995 1996 1995
(OWNED BASIS) ---- ---- ---- ----
<S> <C> <C> <C> <C>
Balance at beginning of period $ 5,303 $ 534 $ 3,679 $
Provision for loan losses 5,383 1,110 10,556 1,644
-------- -------- -------- -------
Loans charged-off 2,188 158 5,816 158
Recoveries 42 121
-------- -------- -------- -------
Net loan charge-offs 2,146 158 5,695 158
-------- -------- -------- -------
Balance at end of period $ 8,540 $ 1,486 $ 8,540 $ 1,486
-------- -------- -------- -------
-------- -------- -------- -------
Ending allowance as a percent
of loans 5.54% 3.07% 5.54% 3.07%
-------- -------- -------- -------
-------- -------- -------- -------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- ------------------
DOLLARS IN THOUSANDS 1996 1995 1996 1995
(MANAGED BASIS) ---- ---- ---- ----
Balance at beginning of period $ 44,305 $ 2,831 22,219 $
Provision for loan losses 43,340 8,208 85,814 11,039
-------- -------- -------- --------
Loans charged-off 17,336 890 38,150 890
Recoveries 326 752
-------- -------- -------- --------
Net loan charge-offs 17,010 890 37,398 890
-------- -------- -------- --------
Balance at end of period $ 70,635 $ 10,149 $ 70,635 $ 10,149
-------- -------- -------- --------
-------- -------- -------- --------
Ending managed allowance as a
percent of loans 5.53% 3.40% 5.53% 3.40%
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
28
<PAGE>
DERIVATIVES ACTIVITIES
The Company utilizes derivative financial instruments for the purpose of
managing its exposure to interest rate risks. The Company has a number of
mechanisms in place to monitor and control both market and credit risk from
these derivatives activities. All derivatives strategies and transactions are
managed under a hedging policy approved by the Board of Directors of FCI that
details the use of such derivatives and the individuals authorized to execute
such transactions. In addition, all derivatives strategies must currently be
approved by FCI's senior management.
Under these policies, the Company has entered into interest rate cap and
swap agreements to hedge its economic exposure to fluctuating interest rates
associated with the floating and fixed rate certificates issued by the Metris
Master Trust. In connection with the issuance of the $512.6 million Metris
Master Trust Series 1995-1 variable rate certificates in May 1995, the Company
entered into an eight-year agreement capping the certificates' interest rate at
11.2%. Also, in connection with the issuance of additional Series 1995-1,
certificates related to the September, 1996, amendment of Series 1995-1, the
Company entered into additional six-year agreements capping the certificates'
interest rate at 11.2%. Additionally, FCI, on behalf of the Company, entered
into two interest rate swap agreements in April 1996 to synthetically alter the
fixed rate of the Metris Master Trust Series 1996-1 certificates to a floating
rate. Total notional amounts of these swap transactions amounted to $605.5
million. The Company receives the benefits and bears the obligations of these
swap transactions. The obligations of the Company and the counterparties under
these swap agreements are settled on a monthly basis.
Liquidity, Funding and Capital Resources
The Company's goal is to maintain an adequate level of liquidity, both
short-term and long-term, through active management of assets and liabilities.
Because the characteristics of the Company's assets and liabilities change,
liquidity management is a dynamic process affected by the pricing and maturity
of the Company's assets and liabilities. This process is also affected by
changes in the relationship between short-term and long-term interest rates.
Therefore, to facilitate liquidity management, the Company utilizes a variety of
funding sources to establish a maturity pattern that provides a mix of short-
term and long-term funds. These funding sources are available, or are committed
to the Company through programs established either by the Company or by FCI.
A significant source of liquidity for the Company has been the
securitization of credit card loans. During the year ended December 31, 1995,
and for the first nine months of 1996, the Company received net proceeds of over
$1.7 billion from sales of credit card loans. Cash
29
<PAGE>
generated from these transactions was used to reduce short-term borrowings and
to fund further credit card loan growth.
30
<PAGE>
The Company's liquidity needs and funding sources may change over time. On
September 16, 1996, the Company executed agreements for the following credit
facilities: (1) a $300 million, five-year revolving credit facility for the
Company (the "Revolving Credit Facility"), guaranteed by FCI; and (2)an
amendment to Series 1995-1 under the Metris Master Trust to (a) increase the
Class A Variable Funding Certificate to support a $400 million increase (to $1.2
billion, of which the Company may use up to $800 million) of the Fingerhut Owner
Trust Commercial Paper Program in which the Company participates; and (b) issue
$112.6 million of additional asset-backed certificates (the "Certificates") to
support the aforementioned increase in the Commercial Paper Program.
The Company borrows under the Revolving Credit Facility and from FCI to
fund on-balance sheet loans and for other general business purposes. At
September 30, 1996, the Company had outstanding borrowings of $25.0 million
under the Revolving Credit Facility and outstanding borrowings from FCI of $28.4
million. At December 31, 1995, the Company had borrowed $63.5 million from FCI.
The interest rate on the Revolving Credit Facility borrowings at September 30,
1996, was 8.3%. The interest rates on the borrowings from FCI were 8.3% and
7.1% at September 30, 1996 and December 31, 1995, respectively.
The Revolving Credit Facility is guaranteed by FCI and is further supported
by the pledge of the stock of certain subsidiaries of the Company and certain
accounts receivable and interests held therein by the Company. The Revolving
Credit Facility also has Alternate Base Rate ("ABR") and LIBOR borrowing
options. The interest rates paid on the Company's borrowings under this facility
in the future may differ from the comparable interest rates paid on the
historical borrowings from FCI. The Revolving Credit Facility contains certain
financial covenants standard for revolving credit facilities of this type
including minimum net worth, minimum equity to managed assets ratio, maximum
leverage and a limitation on indebtedness. In addition, the FCI guarantee
includes certain covenants including interest coverage, leverage and minimum net
worth for FCI.
The Federal Reserve Act imposes various legal limitations on the extent to
which banks that are members of the Federal Reserve System can finance or
otherwise supply funds to certain of their affiliates. In particular, Direct
Merchants Bank is subject to certain restrictions on any extensions of credit to
the Company or its subsidiaries. Additionally, Direct Merchants Bank is limited
in its ability to declare dividends to the Company. Therefore, Direct Merchants
Bank's investments in federal funds sold are generally not available for the
general liquidity needs of the Company and its other subsidiaries. Such
restrictions were not material to the operations of the Company at September 30,
1996, and December 31, 1995.
31
<PAGE>
As the Trust certificates amortize or are otherwise paid, the Company's
funding needs will increase accordingly. The Company believes that its asset
securitization transactions, together with the Revolving Credit Facility, will
provide adequate liquidity to the Company for meeting its on-going cash needs,
although no assurance can be given to that effect.
CAPITAL ADEQUACY
The Company has increased its capital position through retained earnings
and $60.0 million in capital contributions from FCI in 1995. In October, 1996,
the Company completed an initial public offering of its common shares and
received net proceeds of approximately $47.7 million after underwriting
discounts and commissions and estimated expenses of the offering.
Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the OCC and the Federal Reserve Board, and monitored by the FDIC and
the OCC. At September 30, 1996, and December 31, 1995, Direct Merchants Bank
exceeded the minimum required capital levels and was considered a "well-
capitalized" depository institution under regulations of the OCC.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") has issued Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation". This statement is effective for fiscal years beginning after
December 15, 1995, and requires that an employer's financial statements include
certain disclosures about stock-based employee compensation arrangements. SFAS
No. 123 also provides for an optional method for calculating stock-based
employee compensation cost based on the fair market value of the stock award at
the date of grant. The Company currently follows the provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", in
accounting for stock-based employee compensation arrangements. Under the
guidelines of Opinion 25, compensation cost for stock-based employee
compensation plans is recognized based on the difference, if any, between the
quoted market price of the stock on the date of grant and the amount an employee
must pay to acquire the stock. The Company currently plans to implement the
disclosure requirements of SFAS No. 123 in 1996, when applicable, and retain its
current accounting method for stock-based employee compensation.
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," which
establishes the accounting for certain financial asset transfers, including
securitization transactions, and will become effective for transactions entered
into on or after January 1, 1997.
32
<PAGE>
The Company has reviewed this statement and believes that it will affect
the classification and valuation of certain financial assets and liabilities on
its balance sheets relating to its current credit card securitization program,
including excess servicing assets, retained interests in loans securitized,
derivative financial instruments related to such financial assets and
liabilities, and other receivables due from credit card securitizations, net.
However, the Company has not completed all of the complex analyses and reviews
necessary to determine the definitive impact to its current accounting methods
for transfers and servicing of financial assets and extinguishments of
liabilities. The Company intends to adopt this statement prospectively when
required as no early or retroactive application is permitted.
33
<PAGE>
PART II. OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
11 Computation of Earnings per Share
27 Financial Data Schedule
(b) Reports on Form 8-K:
None
34
<PAGE>
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.
Date: December 9, 1996 By:
---------------- /s/ Robert W. Oberrender
-------------------------
Chief Financial Officer
(Principal Financial Officer)
Date: December 9, 1996 By:
----------------- /s/ Jean C. Benson
-------------------------
Controller
(Principal Accounting Officer)
35
<PAGE>
Exhibit 11
METRIS COMPANIES, INC.
Computation of Earnings Per Share
(In thousands of dollars, except per share data)
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
PRIMARY
Net income $ 5,802 $ 4,047 $ 14,696 $ 4,132
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
Weighted average shares of
common stock outstanding 15,966,667 15,966,667 15,966,667 15,966,667
Common stock equivalent (2) 540,676 344,154 519,036 303,602
----------- ----------- ------------ -----------
Weighted average shares of
common stock and common
stock equivalents 16,507,667 16,310,821 16,485,703 16,270,269
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
Net income per share of
common stock and common
stock equivalents $ .35 $ .25 $ .89 $ .25
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
FULLY DILUTED
Net income $ 5,802 $ 4,047 $ 14,696 $ 4,132
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
Weighted average shares of
common stock
outstanding (1) 15,966,667 15,966,667 15,966,667 15,966,667
Common stock equivalents (2) 547,259 356,415 547,259 356,415
----------- ----------- ------------ -----------
Weighted average share of
common stock and common
stock equivalents 16,513,926 16,323,082 16,513,926 16,302,082
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
Net income per share of
common stock and common
stock equivalents $ .35 $ .25 $ .89 $ .25
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
</TABLE>
(1) Assume shares outstanding as if the Company reorganization had occurred at
the beginning of the respective periods shown.
2
<PAGE>
(2) Based on the treasury stock method using the initial public offering price.
3
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated financial statements of Metris Companies Inc. for the fiscal
quarter ended September 30, 1996 and is qualified in its entirety by reference
to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1996
<CASH> 13,013
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 14,653
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 154,077
<ALLOWANCE> 8,540
<TOTAL-ASSETS> 208,209
<DEPOSITS> 1,000
<SHORT-TERM> 53,385
<LIABILITIES-OTHER> 67,810
<LONG-TERM> 0
0
0
<COMMON> 160
<OTHER-SE> 85,854
<TOTAL-LIABILITIES-AND-EQUITY> 208,209
<INTEREST-LOAN> 19,583
<INTEREST-INVEST> 644
<INTEREST-OTHER> 120
<INTEREST-TOTAL> 20,347
<INTEREST-DEPOSIT> 36
<INTEREST-EXPENSE> 2,823
<INTEREST-INCOME-NET> 17,524
<LOAN-LOSSES> 10,556
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 68,398
<INCOME-PRETAX> 23,896
<INCOME-PRE-EXTRAORDINARY> 14,696
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 14,696
<EPS-PRIMARY> 0.89
<EPS-DILUTED> 0.89
<YIELD-ACTUAL> 0.178
<LOANS-NON> 0
<LOANS-PAST> 2,789
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 3,679
<CHARGE-OFFS> 5,816
<RECOVERIES> 121
<ALLOWANCE-CLOSE> 8,540
<ALLOWANCE-DOMESTIC> 8,540
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
