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
March 31, 1997 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 X No _____
As of April 30, 1997, 19,225,000 shares of the Registrant's Common
Stock, par value $.01 per share, were outstanding.
METRIS COMPANIES INC.
FORM 10-Q
TABLE OF CONTENTS
March 31, 1997
Page
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets..........................3
Consolidated Statements of Income....................4
Consolidated Statements of Cash Flows................5
Notes to Consolidated Financial Statements...........6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations..........................................10
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K....................24
Signatures..........................................25
Item 1.
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands) (unaudited)
March 31, December 31,
1997 1996
Assets:
Cash and due from banks $ 13,942 $ 8,902
Federal funds sold 26,818 19,001
Short-term investments 86 4,179
Cash and cash equivalents 40,846 32,082
Credit card loans:
Loans held for securitization 61,778 14,164
Retained interests in loans securitized 229,265 201,165
Less: Allowance for loan losses 19,357 12,829
Net credit card loans 271,686 202,500
Premises and equipment, net 6,666 5,163
Accrued interest and fees receivable 3,349 2,942
Prepaid expenses and deferred charges 8,219 4,826
Deferred income taxes 40,748 31,528
Other assets 9,984 7,575
Total assets $ 381,498 $ 286,616
Liabilities:
Interest-bearing deposit from affiliate $ $ 1,000
Short-term borrowings 102,000 54,163
Accounts payable 25,798 15,583
Other payables due to credit card
securitizations, net 49,764 36,619
Current income taxes payable to FCI 13,228 1,460
Deferred income 28,376 23,183
Accrued expenses and other liabilities 15,876 15,890
Total liabilities 235,042 147,898
Stockholders' Equity:
Preferred stock, par value $.01 per share;
10,000,000 shares authorized, none issued
or outstanding
Common stock, par value $.01 per share;
100,000,000 shares authorized, 19,225,000
shares issued and outstanding 192 192
Paid-in capital 107,220 107,220
Retained earnings 39,044 31,306
Total stockholders' equity 146,456
138,718
Total liabilities and stockholders' equity $ 381,498 $ 286,616
See accompanying Notes to Consolidated Financial Statements.
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Income
(in thousands, except per share data) (unaudited)
Three Months Ended
March 31,
1997 1996
Interest Income:
Credit card loans $ 11,934 $ 5,356
Federal funds sold 306 318
Other 190 29
Total interest income 12,430 5,703
Interest Expense:
Deposit 7 12
Short-term borrowings 1,452 1,085
Total interest expense 1,459 1,097
Net Interest Income 10,971 4,606
Provision for loan losses 11,054 4,690
Net interest expense after provision for
loan losses (83) (84)
Other Operating Income:
Net extended service plan revenues 289 4,176
Net securitization and credit card
servicing income 26,533 13,438
Credit card fees, interchange and
other credit card income 7,602 3,124
Fee-based product revenues 11,824 4,628
46,248 25,366
Other Operating Expense:
Credit card account and other product
solicitation and marketing expense 7,721 7,538
Employee compensation 7,953 3,008
Data processing services and communications 5,011 2,292
Third party servicing expense 2,970 2,159
Warranty and debt waiver underwriting
and claims servicing expense 1,216 1,788
Credit card fraud losses 899 336
Other 7,813 1,892
33,583 19,013
Income Before Income Taxes 12,582 6,269
Income taxes 4,844 2,414
Net Income $ 7,738 $ 3,855
Earnings per share:
Primary $ .38 $ .23
Fully diluted $ .38 $ .23
Weighted-average common and common
equivalent shares (fully diluted) 20,173 16,476
See accompanying Notes to Consolidated Financial Statements.
METRIS COMPANIES INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(dollars in thousands) (unaudited)
Three Months Ended
March 31,
1997
1996
Operating Activities:
Net income $ 7,738 $ 3,855
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 11,054 4,690
Depreciation and amortization 2,382 1,583
Net amortization of gain on securitization
of credit card loans 1,039 1,835
Changes in operating assets and liabilities:
Accrued interest and fees receivable (407) 300
Other payables due to credit card
securitizations, net 11,947 4,646
Prepaid expenses and deferred charges (5,109) (3,343)
Deferred income taxes (9,220) (2,433)
Accounts payable and accrued expenses 10,201 (1,125)
Current income taxes payable to FCI 11,768 3,973
Deferred income 5,193 3,759
Other (2,614) (116)
Net cash provided by operating activities 43,972 17,624
Investing Activities:
Proceeds from sales of loans 125,000 64,000
Net loans originated or collected (165,436) (134,980)
Credit card portfolio acquisition (39,804)
Additions to premises and equipment (1,805) (564)
Net cash used in investing activities (82,045) (71,544)
Financing Activities:
Decrease in interest-bearing deposit (1,000)
Net increase in short-term borrowings 47,837 30,331
Net cash provided by financing activities 46,837 30,331
Net increase (decrease) in cash and cash equivalents 8,764 (23,589)
Cash and cash equivalents at beginning of period 32,082 34,743
Cash and cash equivalents at end of period $ 40,846 $ 11,154
See accompanying Notes to Consolidated Financial Statements.
METRIS COMPANIES INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(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, fee-based products and services, and extended service plans 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 the business
through the formation of MCI. 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, was
contributed to the Company from FCI and its subsidiaries. In October 1996,
the Company completed an initial public offering of its common stock.
The consolidated financial statements include an allocation of expenses
for data processing and information systems, audit, accounting, 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 that, 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 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 Corporation
("Fingerhut"), a wholly owned subsidiary of FCI, and a tax sharing agreement
with FCI. These agreements have terms ranging up to seven years. In
addition, the consolidated financial statements include an allocation of
interest expense for the Company's net borrowings from FCI during 1996.
All significant intercompany balances and transactions have been
eliminated in consolidation.
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 1996 annual report to shareholders and incorporated by
reference in the Company's annual report on Form 10-K. 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 - SIGNIFICANT ACCOUNTING POLICIES
Statements of Cash Flow
Cash paid for interest during the three months ended March 31, 1997 and
1996, was $1.5 million and $1.1 million, respectively. Cash paid for income
taxes for the same periods was $15.0 million and $9.6 million, respectively.
Earnings Per Share
Earnings per share is 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 that occurred during September 1996 (See Note 1)
had occurred at the beginning of the first period shown. The common
equivalent shares outstanding were calculated using the treasury stock
method, using the initial public offering price for the period prior to the
initial public offering. In addition, common equivalent shares outstanding
were calculated assuming that certain options were converted into shares of
the Company's common stock at the beginning of the first period shown.
In February 1997, the FASB issued Statement of Financial Accounting
Standards No. 128 (FAS 128), "Earnings Per Share." This Statement is
effective for financial statements issued for periods ending after December
15, 1997 and supersedes APB Opinion No. 15, "Earnings Per Share." The
Statement replaces the presentation of primary EPS with a presentation of
basic EPS. It also requires dual presentation of basic and diluted EPS on
the face of the income statement and requires companies to restate prior-
period EPS for all periods in which an income statement is presented.
The Company has reviewed this Statement and notes that it will affect
the computation and presentation of EPS. However, the Company has not
completed all of the detailed computations and analysis necessary to
determine the definitive impact on prior-period EPS as well as the
calculation of EPS going forward. The Company intends to adopt this
statement prospectively, in the fourth quarter of 1997, as early application
is not permitted.
Extended Service Plans
The Company coordinates the marketing activities for Fingerhut's sales
of extended service plans and reimburses Fingerhut for the cost of its
marketing media and other services utilized in the sales of extended service
plans, based on contracts sold and on media utilization costs as agreed to by
the Company and Fingerhut.
The Company began performing administrative services and retained the
claims risk for all extended service plans sold on or after January 1, 1997.
As a result, extended service plan revenues and the related expenses have
been deferred and will be recognized over the life of the related extended
service plan contracts. Prior to January 1, 1997 the Company contracted with
a third-party underwriter and claims administrator to service and absorb the
risk of loss for most claims. These claims servicing contract costs were
expensed as the service contracts were sold, net of the related cost of
anticipated service contract returns. In addition, the revenues related to
these contract sales were recognized immediately.
NOTE 3 - CREDIT CARD SECURITIZATIONS
The Company securitizes and sells a portion of its credit card loans to
both public and private investors through the Metris Master Trust (the
"Trust"). Credit card loans are transferred to the Trust, which issues
certificates representing undivided ownership interests in the Trust. The
Company also retains participation interests in the Trust (under "Retained
interests in loans securitized" on the consolidated balance sheets), in an
amount equal to the amount of the retained subordinated certificates of each
series held by MRI plus the amount equal to the loans in excess of the
principal balance of the certificates. 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 and 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.
In May 1997, the Metris Master Trust issued Series 1997-1 certificates
to third parties with a principal amount of $794.8 million, generating
proceeds of $792.2 million of which $667.7 million was used to reduce the
Class A Variable Funding Certificates issued under Series 1995-1. The Series
1997-1 certificates are scheduled to begin accumulating principal collections
in March 2001, however the accumulation period could potentially begin at a
later date. The expected final payment date of these certificates is in
April 2002.
NOTE 4 - ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses is as follows:
Three Months Ended
March 31,
(in thousands) 1997
1996
Balance at beginning of period $ 12,829 $ 3,679
Allowance related to assets acquired, net 806
Provision for loan losses 11,054 4,690
Loans charged-off 5,450 1,660
Recoveries 118 36
Net loan charge-offs 5,332 1,624
Balance at end of period $ 19,357 $ 6,745
NOTE 5 - 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.
The Company borrows under the Revolving Credit Facility to fund on-
balance sheet loans and for other general business purposes. At March 31,
1997 and December 31, 1996, the Company had outstanding borrowings of $102
million and $50 million, respectively, under the Revolving Credit Facility.
The interest rates on the Revolving Credit Facility borrowings at March 31,
1997 and December 31, 1996 were 6.6% and 5.9%, respectively. The Company had
outstanding borrowings from FCI of $4.2 million at a weighted average
interest rate of 7.1% at December 31, 1996.
NOTE 6 - SUBSEQUENT EVENTS
On April 30, 1997, the Company declared its first quarterly dividend in
the amount of $.01 per share, aggregating approximately $.2 million, payable
on May 15, 1997, to shareholders of record as of the close of business on May
13, 1997.
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.
General
The Company is an information-based direct marketer and provider of
consumer credit products, fee-based products and services and extended
service plans 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(R)and the
Direct Merchants Bank MasterCard and Visa(R). 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 and operating expenses
including employee compensation, account solicitation and marketing expenses,
and data processing and servicing expenses.
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, Fingerhut Corporation ("Fingerhut")
customers and other third party partners. 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 or paid to the Company's product partners, claims rates
and claims servicing costs for certain programs, and other operating
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, an affiliate. Extended service plan profitability is directly
affected 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.
Results of Operations
Net income for the three months ended March 31, 1997, was $7.7 million,
or $.38 per share, up 101% from $3.9 million, or $.23 per share for the first
quarter of 1996. The 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 to
$1.7 billion for the first quarter 1997 from $610 million for the first
quarter 1996, an increase of 181%.
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 funding for the Company. The effect on the Company's
consolidated financial statements from securitization is to remove credit
card loans sold with limited recourse from the consolidated 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 lender to servicer, with a corresponding change
in how revenues and expenses are reported in the income statement. For
securitized and sold credit card loans, amounts that otherwise would have
been recorded as net interest income, fee income and provision for loan
losses are instead reported in other operating income as net securitization
and credit card servicing income.
During the current quarter, the Company implemented Statement of
Financial Accounting Standards No. 125 (FAS 125) "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities". FAS
125 did not have a material effect on the consolidated financial statements.
Managed Loan Portfolio
The Company analyzes its financial performance on a managed loan
portfolio basis. To do so, the income statement and balance sheet are
adjusted to reverse the effects of securitization. The Company's discussion
of revenues, where applicable, and provision for loan losses includes
comparisons to amounts reported in the Company's consolidated 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 is not an asset of the Company, and, therefore,
is not shown on the Company's consolidated balance sheets. The following
tables summarize the Company's managed loan portfolio.
March 31,
1997 1996
Dollars in thousands
Period-end balances
Credit card loans:
Loans held for securitization $ 61,778 $ 71,539
Retained interests in loans securitized 229,265 92,880
Investors' interests in securitized loans 1,525,610 512,555
Total managed loan portfolio $1,816,653 $ 676,974
Three Months Ended
March 31,
1997 1996
Dollars in thousands
Average balances
Credit card loans:
Loans held for securitization $ 36,657 $ 22,280
Retained interests in loans securitized 217,455 90,176
Investors' interests in securitized loans 1,456,977 497,303
Total managed loan portfolio $1,711,089 $ 609,759
Impact of Credit Card Securitizations. The following table provides 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, as well
as selected financial information on both an owned and a managed loan
portfolio basis:
Three Months Ended
March 31,
1997 1996
Dollars in thousands
Statements of Income (owned basis)
Net interest income $ 10,971 $ 4,606
Provision for loan losses 11,054 4,690
Other operating income 46,248 25,366
Other operating expense 33,583 19,013
Income before income taxes $ 12,582 $ 6,269
Adjustments for Securitizations
Net interest income $ 47,452 $ 17,040
Provision for loan losses 45,168 10,278
Other operating income (2,284) (6,762)
Other operating expense
Income before income taxes $ $
Managed Statements of Income
Net interest income $ 58,423 $ 21,646
Provision for loan losses 56,222 14,968
Other operating income 43,964 18,604
Other operating expense 33,583 19,013
Income before income taxes $ 12,582 $ 6,269
Other Data:
Owned Basis
Average interest-earning assets $ 291,375 $ 138,488
Return on average assets 9.1% 8.3%
Return on average equity 21.9% 21.0%
Net interest margin (1) 15.3% 13.4%
Managed Basis
Average interest-earning assets $ 1,748,352 $ 635,790
Return on average assets 1.8% 2.3%
Return on average equity 21.9% 21.0%
Net interest margin (1) 13.6% 13.7%
(1) Net interest margin is equal to annualized net interest income divided
by average interest-earning assets.
Net Interest Income
Net interest income consists primarily of interest earned on the
Company's credit card loans less interest expense on borrowings to fund the
loans. Managed net interest income for the three months ended March 31, 1997,
was $58.4 million compared to $21.6 million for the same period in 1996. This
increase was primarily due to a $1.1 billion increase in average loans over
the comparable period in 1996.
The following table provides an analysis of interest income and expense,
net interest spread, net interest margin and average balance sheet data for
the three month periods ended March 31, 1997 and 1996:
Analysis of Average Balances, Interest and Average Yields and Rates
<TABLE>
Three Months Ended March 31,
1997 1996
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
Dollars in thousands
Owned Basis
Assets:
Interest-earning assets (1)
Federal funds sold $ 23,441 $ 306 5.3% $ 23,835 $ 318 5.4%
Short-term investments 13,822 190 5.6% 2,197 29 5.3%
Credit card loans 254,112 11,934 19.0% 112,456 5,356 19.2%
Total interest-earning
<S> <C> <C> <C> <C> <C> <C>
assets $ 291,375 $12,430 17.3% $ 138,488 $ 5,703 16.6%
Cash and due from banks 10,785 2,952
Accrued interest and fees 2,674 1,826
Other amounts due from
securitizations 27,218
Other assets 55,808 22,208
Allowance for loan losses (16,716) (5,161)
Total assets $ 343,926 $ 187,531
Liabilities and Equity:
Interest-bearing
liabilities:
Interest-bearing deposit $ 667 $ 7 4.6% $ 1,000 $ 12 4.8%
Short-term borrowings 83,078 1,452 7.1% 3,213 1,085 6.0%
Total 83,745 1,459 7.1% 74,213 1,097 5.9%
Other liabilities 116,857 39,560
Total liabilities 200,602 113,773
Stockholders'/division
equity 143,324 73,758
Total liabilities and
equity $ 343,926 $ 187,531
Net interest income and
interest margin (2) $10,971 15.3% $ 4,606 13.4%
Net interest rate
spread (3) 10.2% 10.7%
Managed Basis
Credit card loans $1,711,089 $80,350 19.0% $ 609,759 $29,377 19.4%
Total interest-earning
assets 1,748,352 80,846 18.8% 635,790 29,724 18.8%
Total interest-bearing
liabilities 1,540,721 22,423 5.9% 571,515 8,078 5.7%
Net interest income and
interest margin (2) 58,423 13.6% 21,646 13.7%
Net interest rate
spread (3) 12.9% 13.1%
</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 net interest rate spread is the annualized yield on average interest-
earning assets minus the funding rate on average interest-bearing
liabilities.
Other Operating Income
Three Months Ended
March 31,
1997 1996
Dollars in thousands
Other Operating Income:
Net extended service plan revenues $ 289 $ 4,176
Net securitization and credit card
servicing income 26,533 13,438
Credit card fees, interchange and
other credit card income 7,602 3,124
Fee-based product revenues 11,824 4,628
Total $ 46,248 $ 25,366
Other operating income contributes substantially to the Company's
results of operations, representing 79% of owned revenues for the three
months ended March 31, 1997. Fee-based product revenues, particularly from
debt waiver products, continue to provide an increasing percentage of other
operating income. 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 and
to customers of its partners.
The following definitions may be helpful when reading the discussion and
analysis of other operating income:
Net extended service plan revenues - Net extended service plan revenues
include revenues received from sales of extended service plans, net of a
provision for service plan returns. The Company began performing
administrative services and retained the claims risk for all extended service
plans sold on or after January 1, 1997. As a result, extended service plan
revenues are deferred and recognized over the life of the related extended
service plan contracts. Prior to January 1, 1997 the Company contracted with
a third-party underwriter and claims administrator to service and absorb the
risk of loss for most claims and the revenues related to these contract sales
were recognized immediately.
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, fee 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 trust, provision for loan losses,
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.
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 generated from total accounts, which
represents fees 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 debt waiver protection for unemployment,
disability, and death, card registration, third party insurance, shopping and
dining clubs, and revenues from targeted list programs.
Other operating income increased $20.9 million for the three months
ended March 31, 1997, over the comparable period in 1996, primarily due to
income generated from the growth in average securitized credit card loans.
Additionally, fee-based product revenues increased by $7.2 million because of
the Company's marketing efforts to cross-sell other products and services to
its customers. Specifically, debt waiver product revenue increased by $6.2
million as the Company continued to add new credit card customers with debt
waiver protection.
Net extended service plan revenues decreased by $3.9 million in the
first quarter of 1997 compared to the first quarter of 1996. This decrease
reflects that the Company assumed responsibility for claims processing and
underwriting on contracts sold on or after January 1, 1997. As a result, all
extended service plan revenues and the related expenses have been deferred
and will be recognized over the life of the related extended service plan
contracts. The extended service plan revenues before accounting deferrals
for the first quarter 1997 were consistent with the first quarter of 1996.
Other Operating Expense
Three Months Ended
March 31,
Dollars in thousands 1997 1996
Other Operating Expense:
Credit card account and other product
solicitation and marketing expense $ 7,721 $ 7,538
Employee compensation 7,953 3,008
Data processing services and
communications 5,011 2,292
Third party servicing expense 2,970 2,159
Warranty and debt waiver underwriting
and claims servicing expense 1,216 1,788
Credit card fraud losses 899 336
Other 7,813 1,892
Total $ 33,583 $ 19,013
Total other operating expenses for the three months ended March 31,
1997, increased $14.6 million over the comparable period in 1996, primarily
due to employee compensation, data processing services and communications,
and other expenses. Employee compensation increased due to staffing needs to
support the increase in credit card accounts and the internalization of
various credit card operating 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. The increase in other expenses is
primarily due to general growth in all three business lines and building an
infrastructure to support the growth.
Total other operating expenses include direct and allocated expenses
from Fingerhut Companies, Inc. ("FCI") for administrative services provided
to the Company under the Administrative Services Agreement. Additionally,
total other operating expenses reflect the retroactive effects of additional
intercompany agreements and contracts between the Company and FCI or its
subsidiaries (See Note 1 to the Consolidated Financial Statements).
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
ended March 31, 1997 and 1996, 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. The Company continues to
focus its resources on refining its credit underwriting standards for new
accounts, and on collections and post charge-off recovery efforts to minimize
losses from these negative industry trends. At March 31, 1997, 59% of
managed accounts and 47% 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.
These trends are reflected in the increase in the Company's net charge-
off ratio. For the quarter ended March 31, 1997, the Company's net charge-
off ratio stood at an annualized rate of 8.5% compared to 5.8% for the
quarter ended March 31, 1996. 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 year.
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 accounts.
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
March 31, % of March 31, % of
1997 Total 1996 Total
Dollars in thousands
Managed loan porfolio $1,816,653 100% $676,974 100%
Loans delinquent:
30 to 59 days 37,466 2.06% 9,677 1.43%
60 to 89 days 24,820 1.37% 5,879 0.87%
90 or more 46,418 2.55% 10,046 1.48%
Total $ 108,704 5.98% $25,602 3.78%
The above numbers reflect continued seasoning of the Company's managed
loan portfolio. The Company continues 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:
Three Months Ended
March 31,
1997 1996
Dollars in thousands
On-balance sheet portfolio:
Average loans outstanding $ 254,112 $ 112,456
Net charge-offs 5,332 1,624
Net charge-offs as a percentage
of average loans outstanding (1) 8.51% 5.81%
Managed loan portfolio:
Average loans outstanding $ 1,711,089 $ 609,759
Net charge-offs 35,888 8,761
Net charge-offs as a percentage
loans outstanding (1) 8.51% 5.78%
(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.
The provision for loan losses on an owned basis for the three months
ended March 31, 1997 and 1996, totaled $11.1 million and $4.7 million,
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
for the three month period ended March 31, 1997, as compared to the three
month period ended March 31, 1996, is primarily reflective of the overall
maturation of the portfolio and the increase in on-balance sheet loans
outstanding. 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
Three Months Ended
March 31,
Dollars in thousands 1997 1996
(Owned Basis)
Balance at beginning of period $ 12,829 $ 3,679
Allowance related to assets acquired, net 806
Provision for loan losses 11,054 4,690
Loans charged-off 5,450 1,660
Recoveries 118 36
Net loan charge-offs 5,332 1,624
Balance at end of period $ 19,357 $ 6,745
Ending allowance as a
percent of loans 6.65% 4.10%
Three Months Ended
March 31,
Dollars in thousands 1997 1996
(Managed Basis)
Balance at beginning of period $ 95,669 $ 22,219
Allowance related to assets acquired, net 806
Provision for loan losses 56,222 14,968
Loans charged-off 36,682 8,944
Recoveries 794 183
Net loan charge-offs 35,888 8,761
Balance at end of period $ 116,809 $ 28,426
Ending allowance as a
percent of loans 6.43% 4.20%
Derivatives Activities
The Company uses derivative financial instruments for the purpose of
managing its exposure to interest rate risks and 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 the Company'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 funding 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 and two-thirds 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.
In connection with the issuance of the Metris Master Trust Series 1997-1
certificates the Company entered into a five year agreement to synthetically
alter the fixed rate of the certificates to a floating rate. Total notional
amount of this swap transaction amounted to $722.5 million.
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
uses a variety of funding sources to establish a maturity pattern with 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 funding for the Company has been the
securitization of credit card loans. At March 31, 1997, the Company had
received cumulative net proceeds of approximately $1.5 billion from sales of
credit card loans, of which $20.0 million was deposited in an investor
reserve account held by the trustee of Metris Master Trust for the benefit of
the Trust's certificateholders. Cash generated from these transactions was
used to reduce short-term borrowings and to fund further credit card loan
growth.
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 to fund on-
balance sheet loans and for other general business purposes. At March 31,
1997 and December 31, 1996, the Company had outstanding borrowings of $102
million and $50 million, respectively, under the Revolving Credit Facility.
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 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 or its subsidiaries.
Such restrictions were not material to the operations of the Company at March
31, 1997 and December 31, 1996.
As the portfolio of credit card loans grows, or as the Trust
certificates amortize or are otherwise paid, the Company's funding needs will
increase accordingly. The Company believes that its asset securitization
program, together with the Revolving Credit Facility and other sources of
capital, will provide adequate liquidity to the Company for meeting its
anticipated cash needs, although no assurance can be given to that effect.
Capital Adequacy
Direct Merchants Bank is subject to certain capital adequacy guidelines
adopted by the Office of the Comptroller of Currency ("OCC") and the Federal
Reserve Board, and monitored by the Federal Deposit Insurance Corporation and
the OCC. At March 31, 1997 and December 31, 1996, Direct Merchants Bank
exceeded the minimum required capital levels and was considered a "well-
capitalized" depository institution under regulations of the OCC.
Newly Issued Pronouncements
Also in February 1997, the FASB issued Statement of Financial Accounting
Standards No. 129, "Disclosure of Information about Capital Structure," (FAS
129) which codifies existing disclosure requirements regarding capital
structure. FAS 129 will be required to be adopted at year-end 1997 and is
not expected to have a material impact on the corporation's current capital
structure disclosures.
Forward-Looking Statements
This quarterly report contains forward looking statements within the
meaning of Section 27A of the Securities Act of 1993, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. These statements
include statements regarding intent, belief or current expectations of the
Company and its management. Stockholders and prospective investors are
cautioned that any such forward-looking statements are not guarantees of
future performance and involve a number of risks and uncertainties that may
cause the Company's actual results to differ materially from the results
discussed in the forward-looking statements. Among the factors that could
cause actual results to differ materially from those indicated by such
forward-looking statements are the Company's limited operating history as a
stand-alone entity; the Company's ability to obtain third parties to provide
extended service plans; the Company's limited experience with respect to
originating and servicing credit card accounts, including limited
delinquency, default and loss experience; the lack of seasoning of its credit
card portfolio, which makes the predictability of delinquency and loss levels
more difficult; risks associated with unsecured credit transactions,
particularly to moderate income consumers; interest rate risks; dependence on
the securitization of the Company's credit card loans to fund operations;
general economic conditions affecting consumer income, which may increase
consumer bankruptcies, defaults and delinquencies; state and federal laws and
regulations, including consumer and debtor protection laws; and the highly
competitive industry in which the Company operates. Each of these factors is
more fully discussed in Exhibit 99 to this Form 10-Q. Reference to this
Cautionary Statement or Exhibit 99 in the context of a forward-looking
statement or statements shall be deemed to be a statement that any one or
more of these factors may cause actual results to differ materially from
those anticipated in such forward-looking statement or statements.
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
99 Cautionary Statement Regarding Forward Looking
Statements
(b) Reports on Form 8-K:
None
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: By:
/s/ Robert W. Oberrender
Chief Financial Officer
(Principal Financial Officer)
Date: By:
/s/ Jean C. Benson
Controller
(Principal Accounting Officer)
Exhibit 11
Metris Companies Inc. and Subsidiaries
Computation of Earnings Per Share
(in thousands, except share and per share data)
Quarters Ended March 31,
1997 1996
Primary:
Net Income $ 7,738 $ 3,855
Weighted average shares of common stock
outstanding (1) 19,225,000 15,966,667
Common stock equivalents (2) 944,109 497,261
Weighted average common and common
equivalent shares 20,169,109 16,463,928
Net income per share $ .38 $ .23
Fully Diluted:
Net income $ 7,738 $ 3,855
Weighted average shares of common
stock outstanding (1) 19,225,000 15,966,667
Common stock equivalents 947,808 509,521
Weighted average common and common
equivalent shares 20,172,808 16,476,188
Net income per share $ .38 $ .23
(1) Assume shares outstanding as if the Company reorganization had
occurred at the beginning of the periods shown.
Based on the treasury stock method using the average market price for primary
earnings per share and the higher of the average or year-end market price for
fully diluted earnings per share. Prior to October 25, 1996, the initial
public offering price of $16 was used.
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated financial statements of Metris Companies Inc. for the fiscal
quarter ended March 31, 1997 and is qualifed for its entirety by reference to
such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996
<PERIOD-END> MAR-31-1997 MAR-31-1996
<CASH> 13,942 3,233
<INT-BEARING-DEPOSITS> 0 0
<FED-FUNDS-SOLD> 26,818 5,040
<TRADING-ASSETS> 0 0
<INVESTMENTS-HELD-FOR-SALE> 0 0
<INVESTMENTS-CARRYING> 0 0
<INVESTMENTS-MARKET> 0 0
<LOANS> 291,043 164,419
<ALLOWANCE> 19,357 6,745
<TOTAL-ASSETS> 381,498 215,223
<DEPOSITS> 0 1,000
<SHORT-TERM> 102,000 93,813
<LIABILITIES-OTHER> 133,042 45,236
<LONG-TERM> 0 0
0 0
0 0
<COMMON> 192 0
<OTHER-SE> 146,264 75,173
<TOTAL-LIABILITIES-AND-EQUITY> 381,498 215,223
<INTEREST-LOAN> 11,934 5,356
<INTEREST-INVEST> 306 318
<INTEREST-OTHER> 190 29
<INTEREST-TOTAL> 12,430 5,703
<INTEREST-DEPOSIT> 7 12
<INTEREST-EXPENSE> 1,459 1,097
<INTEREST-INCOME-NET> 10,971 4,606
<LOAN-LOSSES> 11,054 4,690
<SECURITIES-GAINS> 0 0
<EXPENSE-OTHER> 33,583 19,013
<INCOME-PRETAX> 12,582 6,269
<INCOME-PRE-EXTRAORDINARY> 7,738 3,855
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 7,738 3,855
<EPS-PRIMARY> .38 .23
<EPS-DILUTED> .38 .23
<YIELD-ACTUAL> 17.3 16.6
<LOANS-NON> 0 0
<LOANS-PAST> 7,437 2,440
<LOANS-TROUBLED> 0 0
<LOANS-PROBLEM> 0 0
<ALLOWANCE-OPEN> 12,829 3,679
<CHARGE-OFFS> 5,450 1,660
<RECOVERIES> 118 36
<ALLOWANCE-CLOSE> 19,357 6,745
<ALLOWANCE-DOMESTIC> 19,357 6,745
<ALLOWANCE-FOREIGN> 0 0
<ALLOWANCE-UNALLOCATED> 0 0
</TABLE>
Exhibit 99
CAUTIONARY STATEMENT
REGARDING FORWARD-LOOKING STATEMENTS
Metris Companies Inc. ("Metris" or "the Company") desires to
take advantage of the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995 and is filing this
cautionary statement in connection with such safe harbor
legislation. The Company's Form 10-K, the Company's Annual
Report to Shareholders, any Form 10-Q or Form 8-K filed by the
Company or any other written or oral statements made by or on
behalf of the Company may also include forward-looking statements
which reflect the Company's current views with respect to future
events and financial performance. The words "believe," "expect,"
"anticipate," "intends," "estimate," "forecast," "project" and
similar expressions identify forward-looking statements.
The Company wishes to caution investors that any forward-
looking statements made by or on behalf of the Company are
subject to uncertainties and other factors that could cause
actual results to differ materially from such statements. These
uncertainties and other factors include, but are not limited to,
the factors listed below (many of which have been discussed in
the Company's prior filings with the Securities and Exchange
Commission). Though the Company has attempted to list
comprehensively these important factors, the Company wishes to
caution investors that other factors may in the future prove to
be important in affecting the Company's results of operations.
New factors emerge from time to time and it is not possible for
management to predict all of such factors, nor can it assess the
impact of each such factor on the business or the extent to which
any factor, or combination of factors, may cause actual results
to differ materially from those contained in any forward-looking
statements.
Investors are further cautioned not to place undue reliance
on such forward-looking statements as they speak only of the
Company's views as of the date the statement was made. The
Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new
information, future events or otherwise.
Dependence on Fingerhut
As of December 31, 1996, approximately 50% of the Company's
credit card accounts were customers of Fingerhut Corporation
("Fingerhut Customers"), accounting for approximately 51% of the
Company's managed loans, and Fingerhut Customers are currently
the Company's only customers for extended service plans.
Moreover, until the Company further develops its own database of
information based upon its experience as an independent, stand-
alone entity, its success in the credit card business will remain
largely dependent upon its exclusive rights to use information in
Fingerhut's proprietary database (the "Fingerhut Database"),
particularly with respect to the experience of Fingerhut
Corporation ("Fingerhut") with its customers. Similarly, until
the Company develops extended service plan marketing
relationships with other companies, its success in the extended
service plan business will remain largely dependent upon its
right to provide extended service plans to Fingerhut Customers
and the level of Fingerhut's sales of warrantable products.
Metris has entered into agreements with Fingerhut relating to (i)
credit cards issued to Fingerhut Customers, (ii) use of
information in the Fingerhut Database and (iii) marketing of
extended service plans to Fingerhut Customers. The loss of the
ability to use information from the Fingerhut Database or to
market to Fingerhut Customers would have a significant adverse
economic impact on the Company's results of operations and future
prospects. Significant adverse changes which materially affect
Fingerhut's ability to maintain its database or to continue its
catalog sales business would also have an adverse impact on the
Company.
Fingerhut Companies, Inc. ("FCI") is a guarantor of the
Company's bank revolving credit facility. Breaches of covenants
contained in the guaranty, including various financial covenants
of FCI, would be events of default under the facility. Upon the
occurrence of any such event the facility would be terminable at
the option of the lenders. Such events could have a material
adverse impact on the Company's financial condition and results
of operations. To the extent that the FCI guarantee contains
certain financial covenants and the cost of maintaining
availability and borrowing under the revolving credit facility is
based on FCI's credit rating, the Company will be dependent on
the financial strength and performance of FCI. FCI has been
impacted by the industry-wide increase in paper and postage
rates, which began in early 1995 and continued into 1996.
Primarily as a result such increases in paper and postage rates,
FCI's debt rating was downgraded in 1996 by Standard & Poor's.
FCI is currently rated BBB/Baa2 by Standard & Poor's and Moody's
Investors Service, respectively.
Lack of Prior Operating History as Stand-Alone Entity
FCI's financial services business, including Direct
Merchants Credit Card Bank, National Association ("Direct
Merchants Bank"), recently has been consolidated within Metris
and therefore has operated as a separate operating group for a
limited time. In addition, the Company's management team has
operated the Company as a stand-alone entity for a limited time.
A number of significant changes occurred in the funding and
operations of the Company in connection with the consummation of
the Company's initial public offering. These changes include the
establishment of the Company's revolving credit facility and its
own incentive compensation and stock option plans. These changes
may have a substantial impact on the financial position and
future results of operations of the Company. As a result, the
historical financial information included in the Company's Form
10-K, the Company's Annual Report to Shareholders, any Form 10-Q
or Form 8-K filed by the Company or any other written or oral
statements made by the Company, does not necessarily reflect the
financial position and results of operations of the Company in
the future or what the financial position and results of
operations of the Company would have been had it been operated as
a stand-alone entity during the periods presented. Because FCI
has guaranteed the Company's indebtedness, the Company's funding
costs will not increase in the short-term. FCI is contractually
committed to guarantee the Company's revolving credit facility
for the term of that facility, but if FCI no longer guaranteed
the Company's indebtedness, the Company's funding costs would
increase and the Company's earnings on a stand-alone basis would
be expected to be lower, all other things being equal.
Metris has entered into an Administrative Services
Agreement, under which subsidiaries of FCI have agreed to provide
a variety of administrative services to the Company on a
transitional basis. Following the termination of the
Administrative Services Agreement, the Company will be required
to provide or procure these administrative services without the
assistance previously provided by FCI. The impact of these and
other changes on the Company's operations cannot be fully
predicted.
Lack of Seasoning of Credit Card Portfolio
The average age of a credit card issuer's portfolio of
accounts is an indicator of the stability of delinquency and loss
levels of that portfolio; a portfolio of older accounts generally
behaves more predictably than a newly originated portfolio. Most
of the Company's credit card accounts were originated within the
last 18 months and over 30% were originated within the last six
months. As a result, there can be no assurance as to the levels
of delinquencies and losses, which may affect earnings through
net charge-offs that can be expected over time with respect to
the Company's portfolio. Until the accounts become more
seasoned, it is likely that the levels of such delinquencies and
losses will increase as the average age of the Company's accounts
increases. Any material increases in delinquencies and losses
above management's expectations would have a material adverse
impact on the Company's results of operations and financial
condition.
Ability to Sustain and Manage Growth
In order to meet its strategic objectives the Company must
continue to achieve growth in its credit card loan portfolio.
Continued growth in the Company's credit card loan portfolio
depends on (i) the Company's ability to attract new cardholders,
(ii) growth in both existing and new account balances, (iii) the
degree to which the Company loses accounts and account balances
to competing card issuers, (iv) levels of delinquencies and
losses (v) the availability of funding (including, but not
limited to, securitizations) on favorable terms and (vi) general
economic and other factors beyond the control of the Company.
The Company's growth is also dependent on the level of the
Company's marketing expenditures used to solicit new customers
and the number of responses the Company receives with respect to
solicitations for its consumer credit, fee-based and other
financial service products. Any increases in postal rates could
have a negative impact on the level and cost of' direct mail
marketing activities. No assurance can be given as to the future
growth in the Company's loan portfolio or its profitability.
Further growth of the Company will require employment and
training of new personnel, expansion of facilities, expansion of
management systems and access to additional capital. If the
Company is unable to manage its growth effectively, the Company's
profitability and its ability to achieve its strategic objectives
may be adversely affected.
Risks Related to Target Market
The Company targets its consumer credit products to moderate
income consumers. Lenders historically have not solicited this
market to the same extent as more affluent market segment
consumers. As a result, in addition to higher delinquency and
loss rates, there is less historical experience with respect to
the credit risk and performance of moderate income consumers.
There can be no assurance that the Company can successfully
target and evaluate the creditworthiness of moderate income
consumers so as to minimize the expected higher delinquencies and
losses or that the Company's risk-based pricing system can offset
the negative impacts the expected higher delinquency and loss
experience for this market segment has on overall profitability.
Nor can there be assurance that the Company can successfully
price its fee based products and manage claims and service costs.
Primary risks associated with unsecured lending, especially
to the Company's target market, which focus on moderate income
consumers, are that (i) delinquencies and credit losses will
increase because of future economic downturns, (ii) an increasing
number of customers will default on the payment of their
outstanding balances or seek protection under bankruptcy laws,
resulting in accounts being charged off as uncollectible, (iii)
fraud by cardholders and third parties will increase and (iv)
unfavorable changes in consumers' attitudes toward financing
purchases with debt or in cardholder payment behavior, such as
increases in discretionary repayment of account balances, will
result in diminished interest income. At December 31, 1996, the
Company's managed credit card loans 30 days or more delinquent
were 5.53% of managed loans compared to 3.95% at December 31,
1995. A portion of this increase is to be expected as the
Company's portfolio continues to season. Additionally, general
economic factors, such as the rate of inflation, unemployment
levels and interest rates may affect the Company's target market
customers more severely than other market segments.
Limited History of Credit Card Operations
The Company began originating and servicing credit card
accounts in March 1995, and thus has limited underwriting and
servicing experience, and limited delinquency, default and loss
experience with respect to its credit card accounts. Although
the Company has experienced substantial growth in credit card
loans outstanding, revenues and net earnings, there can be no
assurances that these rates of growth will be sustainable or
indicative of future results. In addition, the Company's results
of operations, financial condition and liquidity depend, to a
material extent, on its ability to manage its credit card
business and on the performance of the credit card loans
outstanding.
Interest Rate Risk
The Company's credit card accounts generally have finance
charges set at a variable rate with a spread above a designated
prime rate or other designated index. Although the Company
intends to manage its interest rate risk through asset and
liability management, as the interest rate environment fluctuates
the Company may be adversely affected by changes in its cost of
funds as well as in the relationship between the indices used in
the Company's securitizations and other funding and the indices
used to determine the finance charges on account balances.
Funding and Securitization Considerations
The Company depends heavily upon the securitization of its
credit card loans to fund its operations and to date has been
able to complete securitization transactions on terms that it
believes are favorable. There can be no assurance, however, that
the securitization market will continue to offer attractive
funding alternatives. In addition, the Company's ability to
securitize its assets depends on the continued availability of
credit enhancement on acceptable terms and the continued
favorable legal, regulatory, accounting and tax environment for
securitization transactions. While the Company does not at
present foresee any significant problems in any of these areas,
any such adverse change could force the Company to rely on other
potentially more expensive funding sources.
Adverse changes in the performance of the Company's
securitized assets, including increased delinquencies and losses,
could result in a downgrade or withdrawal of the ratings on the
outstanding certificates under the Company's securitization
transactions or cause early amortization of such certificates.
This could jeopardize the Company's ability to effect other
securitization transactions on acceptable terms, thereby
decreasing the Company's liquidity and forcing the Company to
rely on other funding sources to the extent available.
The Company is also dependent on its bank revolving credit
facility, which is guaranteed by FCI. In the event that FCI no
longer owns 51% or more of the Company or FCI breaches its
covenants, including various financial covenants contained in its
guarantee, the facility may be terminated by the lenders.
Regulation
The activities of Metris are subject to extensive regulation
under both federal and state laws and regulations. Such laws and
regulations significantly limit the activities in which the
Company and the Company's credit card subsidiary, Direct
Merchants Bank, will be permitted to engage. Numerous
legislative and regulatory proposals are advanced each year
which, if adopted, could adversely affect the Company's
profitability or limit the manner in which the Company conducts
its activities. Moreover, the Company's interactions with FCI
pursuant to certain intercompany agreements are constrained under
those agreements by the requirements of the Fair Credit Reporting
Act ("FCRA"). Failure to comply with such requirements could
result in termination of such agreements and/or the Company
and/or Fingerhut becoming a consumer reporting agency under the
FCRA. The FCRA imposes a number of complex and burdensome
regulatory requirements and restrictions on a consumer reporting
agency, including restrictions on the circumstances under which a
consumer reporting agency may furnish information to others.
Accordingly, if Fingerhut were to become a consumer reporting
agency, the FCRA would restrict the Company's access to the
Fingerhut Database. Similarly, if the Company were to become a
consumer reporting agency its ability to furnish information to
third parties would be restricted by the FCRA. Such restrictions
on the Company's ability to access the Fingerhut Database and/or
on the Company's ability to furnish information to third parties
could have a significant adverse economic impact on the Company's
results of operations and future prospects.
Direct Merchants Bank is also subject to regulation by the
Federal Reserve Board, the Federal Deposit Insurance Corporation
and the OCC. Such regulations include limitations on the nature
of the businesses Direct Merchants Bank may conduct.
Consumer and Debtor Protection Laws
Metris is subject to numerous federal and state consumer
protection laws that impose requirements related to offering and
extending credit. The United States Congress and the states may
enact laws and amendments to existing laws to further regulate the
credit card industry or to reduce finance charges or other fees or
charges applicable to credit card and other consumer revolving
loan accounts. Such laws, as well as any new laws or rulings
which may be adopted, may adversely affect the Company's ability
to collect on account balances or maintain previous levels of
periodic rate finance charges and other fees and charges with
respect to the accounts. Any failure by the Company to comply
with such legal requirements also could adversely affect its
ability to collect the full amount of the account balances.
Changes in federal and state bankruptcy and debtor relief laws
could adversely affect the Company if such changes result in,
among other things, additional administrative expenses and
accounts being written off as uncollectible.
Competition
As a marketer of consumer credit products, Metris faces
increasing competition from numerous providers of financial
services, many of which have greater resources than the Company.
In particular, the Company's credit card business competes with
national, regional and local bank card issuers as well as other
general purpose credit card issuers, such as American Express,
Discover Card and Diners Club. Over 6,000 issuers are affiliated
with MasterCard alone. Many general purpose credit card issuers
are substantially larger and have more seasoned credit card
portfolios than the Company and often compete for customers by
offering lower interest rates and/or fee levels. In general,
customers are attracted to credit card issuers largely on the
basis of price, credit limit and other product features and
customer loyalty is often limited.
As the Company attempts to expand its extended service plan
business to the customers of third-party retailers, it will
compete with manufacturers, financial institutions, insurance
companies and a number of independent administrators, many of
which have greater operating experience and financial resources
than the Company.
There are numerous competitors in the fee-based products and
services market, including insurance companies, financial services
institutions and other membership-based consumer services
providers, many of which are larger, better capitalized and more
experienced than the Company.
Control by FCI
FCI owns approximately 83% of the outstanding shares of the
Company's Common Stock. Through its ability to elect all the
directors of the Company, FCI effectively controls all matters
affecting the Company, including the adoption of amendments to the
Company's Amended and Restated Certificate of Incorporation (the
"Certificate of Incorporation"), any determination with respect to
the acquisition or disposition of Company assets, future issuances
of the Company's common stock, par value $.01 per share (the
"Common Stock") or other securities of the Company, the Company's
incurrence of debt, and any dividend payable on the Common Stock.
FCI has not made any decision regarding its future plans for
its ownership interest in the Company. There can be no assurance
that FCI will maintain its ownership interest in the Company or as
to the manner or timing of any disposition of Common Stock by FCI.
The Company's bank revolving credit agreement requires that FCI
hold at least 51% of the Common Stock.
Fingerhut Private Label Credit Cards
FCI has established a limited purpose credit card bank
affiliate ("Fingerhut National Bank"), which will issue Fingerhut
private label credit cards. Such cards could be used only to
purchase Fingerhut products and may compete with the Company's
credit cards with respect to such purchases. To the extent that a
Metris cardholder has a Fingerhut credit card or other private
label credit card, his or her use of or availability of credit
under a Metris credit card may be reduced.
The Company believes that FCI's plans to issue Fingerhut
private label credit cards will not have a material negative
effect on the Company. Fingerhut currently provides credit to its
customers for their purchases of Fingerhut products and services,
and private label credit cards would be an extension of the credit
options Fingerhut currently provides. Any Fingerhut private label
credit cards could be used only to purchase Fingerhut products and
services.
Potential Conflicts of Interest; Relationship with FCI
Corporate Opportunities
The relationship between the respective businesses of Metris
and FCI may give rise to certain conflicts of interest regarding
corporate opportunities. Because both the Company and FCI sell to
the same client base, use direct mail and provide credit, business
opportunities may arise that either could pursue. While Fingerhut
will be prohibited under the Co-Brand Credit Card Agreement
between Fingerhut and Metris from directly or indirectly issuing a
competing, general purpose credit card, it currently provides
closed-end, fixed payment installment contracts to its customers
and expects to also provide closed-end or revolving credit private
label credit cards issued by a bank affiliate to its customers in
the future for use in purchasing Fingerhut products and services.
As a result, and as is the case now, FCI and Metris expect that
Fingerhut customers who are also Metris cardholders will generally
continue to use Fingerhut credit for Fingerhut purchases and use
their Metris credit cards for other purposes. In addition,
Fingerhut presently offers various types of credit-related
insurance products in connection with the credit it extends to its
customers, and the bank affiliate will in the future offer such
products in connection with the private label credit cards it
issues. Metris does not, and cannot, offer these products in
connection with credit extended by Fingerhut or the bank affiliate
because such products can be offered only by an insurance company
or the lender. Therefore, FCI and Metris believe that these
products do not compete with, and have no material effect on,
Metris.
To address the potential for conflicts between the Company
and FCI, the Certificate of Incorporation contains detailed
provisions concerning the business activities in which the Company
is permitted to engage until the day after the third shareholder
meeting held after FCI owns less than 50% of the Company's voting
stock.
The relevant provisions are intended to permit Metris to
continue all activities in which it currently engages, and to
expand into certain related financial service products. These
provisions generally permit the Company to continue providing
consumer credit products, extended service plans, and fee-based
products and services, and a variety of other financial service
products and services, provided that the Company shall not offer
any closed-end installment or revolving credit loans to Fingerhut
Customers for the exclusive purchase of Fingerhut merchandise.
The Company may engage in any other business with the consent of
FCI or authorized by a majority vote of the shareholders. Because
these limitations may restrict the Company's ability to offer new
products or services, they may limit the Company's ability to
compete.
The Certificate of Incorporation provides that no
opportunity, transaction, agreement or other arrangement to which
FCI or an entity in which FCI has an interest, is a party, shall
be a corporate opportunity of the Company unless such opportunity,
transaction, agreement or other arrangement shall have been
initially offered to the Company before it is offered to FCI or
such other entity, and either (i) the Company has an enforceable
contractual interest in such opportunity, transaction, agreement
or other arrangement or (ii) the subject matter of such
opportunity, transaction, agreement or other arrangement is a
constituent element of an activity in which the Company is then
actively engaged. Even if the foregoing conditions were met, such
fact alone would not conclusively render such opportunity the
property of the Company. The intercompany agreements limit FCI's
ability to engage in the financial services business during the
terms of such agreements, except through its ownership of Common
Stock of the Company. The foregoing provisions of the Certificate
of Incorporation of the Company were determined by FCI after
consultation with management of the Company but were not the
result of arm's-length negotiations.
Other Potential Conflicts of Interest
Conflicts of interest may arise in the future between Metris
and FCI in a number of areas relating to their past and ongoing
relationships, including potential acquisitions of businesses or
properties, the election of new or additional directors,
dividends, incurrence of indebtedness, tax matters, financial
commitments, registration rights, administration of benefit plans,
service arrangements, issuances and sales of capital stock of the
Company and public policy matters. In addition, there are
overlapping directors and executive officers between the Company
and FCI. The Company has not instituted any formal plan or
arrangement to address potential conflicts of interest that may
arise between the Company and FCI. However, the directors intend
to exercise reasonable judgment and take such steps as they deem
necessary under all of the circumstances in resolving any specific
conflict of interest that may occur and will determine what, if
any, specific measures may be necessary or appropriate. There can
be no assurance that any conflicts will be resolved in favor of
the Company.
Metris and Fingerhut have entered into a number of agreements
for the purpose of defining the ongoing relationship between them.
Pursuant to these arrangements, Fingerhut will provide benefits to
the Company that it might not provide to a third party, and there
is no assurance that the terms and conditions of any future
arrangements between Fingerhut and the Company will be as
favorable to the Company as in effect now. In addition,
notwithstanding the Tax Sharing Agreement between the Company and
FCI, under ERISA and Federal income tax law each member of a
consolidated group (for Federal income tax and ERISA purposes) is
also jointly and severally liable for the Federal income tax
liability, funding and termination liabilities, certain benefit
plan taxes and certain other liabilities of each other member of
the consolidated group. Similar rules may apply under state
income tax laws.
Dependence on Key Personnel
The Company's management and operations are dependent upon
the skills and experience of a small number of senior management
and operating personnel including Ronald Zebeck, President and
Chief Executive Officer; Peter Michielutti, Senior Vice President,
Business Development; Douglas McCoy, Senior Vice President,
Operations; Robert Oberrender, Senior Vice President, Chief
Financial Officer; Douglas Scaliti, Vice President, Marketing; and
David Reak, Vice President, Credit Risk. The Company does not
have employment agreements with its executive officers and does
not maintain key-man life insurance on any executive officer. The
loss of the services of members of senior management could have an
adverse impact on the Company.
Extended Service Plan Underwriting
Historically, Metris has contracted with a third party to
perform services related to most of its extended service plans and
to underwrite the risks related to performance under those
extended service plans for a fee. The Company has terminated this
agreement for sales on and after January 1, 1997, and currently
administers the extended service plans internally. The Company
will retain the risks associated with performance under the
extended service plans entered into on or after January 1, 1997,
but will not assume any risks already transferred to the third
party. There can be no assurance that the Company will not
experience higher than anticipated costs in connection with the
internal administration and underwriting of these plans.
Anti-Takeover Provisions
The Company's Certificate of Incorporation and By-laws
contain restrictions that may discourage other persons from
attempting to acquire control of the Company, including, without
limitation, a Board of Directors that has staggered terms for its
members, certain notice and supermajority voting provisions, and
certain "fair price" provisions. These provisions do not become
effective until FCI and its affiliates collectively own
outstanding Common Stock representing less than 51% of all the
outstanding Common Stock. The Board of Directors has the
authorization to issue preferred stock in one or more series
without the specific approval of the holders of the Common Stock.
Also, only a majority of the Board of Directors may call a special
meeting of stockholders. If the ownership of the Common Stock
ceases to be concentrated in a single holder, in certain
circumstances, these devices may render more difficult or tend to
discourage a change of control of the Company or the removal of
incumbent management, which could reduce the market value of the
Common Stock.
