got mangled Wednesday after reporting weak fourth-quarter financials and telling investors that, "with the concurrence of regulatory authorities," it has changed the way it recognizes bad loans.
The stock was down 10% in early afternoon trading. The market may be freaking after seeing what could be more evidence of regulatory intervention at Minnetonka, Minn.-based Metris. Last year the fast-growing lender had run-ins with the federal
Office of the Comptroller of the Currency and with the
New York attorney general regarding sales tactics.
The credit card lender, which targets borrowers with sullied credit histories, made 72 cents a share in the fourth quarter, 2 cents above the consensus estimate and up 46% from the year-ago quarter. But the impressive rise was made possible by skimping on the loan loss reserve, which serves as a cushion against bad loans.
Earnings also benefited from a big dip in operating expenses compared with the third quarter. Skeptics will wonder if the company kept costs out of the income statement by placing them on the balance sheet as assets. Possible evidence for that includes a sizable jump in the "other assets" line on the balance sheet.
Metris didn't immediately return a call seeking comment. Its stock was trading late Wednesday afternoon at $21.01, off 10.37% on the day.
Doing a 120, Not a 180
How did Metris change its bad loan accounting? It said it now recognizes certain past-due loans as a loss after 120 days of nonpayment, down from its original 180 days. This shift meant annualized bad loan losses, or chargeoffs, were equivalent to 11.8% of average loans in the fourth quarter. Without the change, this ratio would've been 10.9%.
The third-quarter chargeoff ratio was 10.7%, using the old 180-day method for certain loans. Metris' press release didn't say whether the regulators forced this change, but it did state that the company "had concluded" that 120 days was the appropriate term under federal banking guidelines. Why it hadn't concluded this before wasn't made clear.
Granted, a 1.1-percentage point increase in the chargeoff rate is hardly a cataclysmic outcome from a regulatory examination, but it's not clear that the feds have ended their probe. It's possible that the next change could be in the way the company accrues for fees on past-due loans. The company has recently reduced disclosure on this item.
The regulators may also be looking at the loan loss reserve. True, this increased by $68 million from the third quarter to remain at about 8% of the total loan portfolio, a conservatively high figure for a credit card lender.
But the reserve plunged as a percentage of past-due, or delinquent, loans. A drop in this indicator shows the company getting more relaxed about the outlook for credit losses, which is hard to justify when past-due loans are rising and the economy is sluggish.
The reserve was 85% of delinquencies in the fourth quarter, down from 100% in the year-ago period. The average ratio for the previous 12 quarters was 106%. If Metris decided to return the reserve to that level, it would mean adding $240 million to it, which would be equivalent to $148 million after taxes. If that sum were subtracted from fourth-quarter earnings, the company would have shown a loss of $71 million, or 71 cents a share.
The company got a 14-cent benefit from a sequential drop in compensation and "other" expense. Cost-cutting shouldn't be sniffed at. However, the other assets line of the balance sheet increased by $17 million, which may reflect the treatment of certain costs as assets (perhaps prepaid expenses), which would keep them out of the income statement.
Elsewhere, fees Metris charges its customers showed poor growth. This, too, may be the result of regulatory pressure. Credit insurance fees edged up 4% from the preceding period. Last year, the regulators demanded that Metris appoint a compliance officer who would regularly report to the OCC on the efforts to reform sales methods. This scrutiny may have led to a change in sales practices in the fee businesses.
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In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.