Edgar Filing: Discover Financial Services

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended August 31, 2008

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001-33378

DISCOVER FINANCIAL SERVICES

(Exact name of registrant as specified in its charter)


Delaware		36-2517428
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

2500 Lake Cook Road Riverwoods, Illinois 60015		(224) 405-0900
(Address of principal executive offices, including zip code)		(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 ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer ¨		Accelerated filer ¨
Non-accelerated filer x (Do not check if a smaller reporting company)		Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes ¨ No x

As of September 30, 2008 there were 479,916,008 shares of the registrant’s Common Stock, par value $0.01 per share, outstanding.

DISCOVER FINANCIAL SERVICES

Quarterly Report on Form 10-Q

For the quarterly period ended August 31, 2008

TABLE OF CONTENTS


Part I. FINANCIAL INFORMATION		3
Item 1. Financial Statements		3
Consolidated Statements of Financial Condition		3
Consolidated and Combined Statements of Income		4
Consolidated and Combined Statements of Changes in Stockholders’ Equity		5
Consolidated and Combined Statements of Cash Flows		6
Notes to Consolidated and Combined Financial Statements		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		29
Item 3. Quantitative and Qualitative Disclosures About Market Risk		57
Item 4. Controls and Procedures		58

Part II. OTHER INFORMATION		59
Item 1. Legal Proceedings		59
Item 1A. Risk Factors		60
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		60
Item 3. Defaults Upon Senior Securities		60
Item 4. Submission of Matters to a Vote of Security Holders		60
Item 5. Other Information		60
Item 6. Exhibits		60

Except as otherwise indicated or unless the context otherwise requires, “Discover Financial Services,” “Discover,” “DFS,” “we,” “us,” “our,” and “the Company” refer to Discover Financial Services and its subsidiaries.

We own or have rights to use the trademarks, trade names and service marks that we use in conjunction with the operation of our business, including, but not limited to: Discover, PULSE, Cashback Bonus, Discover More Card, Discover Motiva Card, Discover Open Road Card, Discover Network and Diners Club International. All other trademarks, trade names and service marks included in this quarterly report are the property of their respective owners.

Part I.

FINANCIAL INFORMATION

Item 1.

Financial Statements

DISCOVER FINANCIAL SERVICES

Consolidated Statements of Financial Condition


	August 31, 2008			November 30, 2007
	(unaudited)
	(dollars in thousands, except per share amounts)
Assets
Cash and due from banks	$	780,731		$	362,697
Federal Funds sold		3,543,800			6,270,600
Interest-earning deposits		6,150,944			1,440,979
Commercial paper		—			11,191

Cash and cash equivalents		10,475,475			8,085,467
Investment securities:
Available-for-sale (amortized cost of $1,137,907 and $425,681 at August 31, 2008 and November 30, 2007, respectively)		1,096,934			420,837
Held-to-maturity (market value of $92,000 and $100,769 at August 31, 2008 and November 30, 2007, respectively)		101,821			104,602

Total investment securities		1,198,755			525,439
Loan receivables:
Loans held for sale		—			—
Loan portfolio:
Credit card		20,241,785			20,345,787
Commercial loans		446,900			234,136
Other consumer loans		1,078,798			251,194

Total loan portfolio		21,767,483			20,831,117

Total loan receivables		21,767,483			20,831,117
Allowance for loan losses		(959,769	)		(759,925	)

Net loan receivables		20,807,714			20,071,192
Accrued interest receivable		133,026			123,292
Amounts due from asset securitization		2,647,860			3,041,215
Premises and equipment, net		563,869			575,229
Goodwill		255,421			255,421
Intangible assets, net		54,161			59,769
Other assets		1,147,267			712,678
Assets of discontinued operations		34,267			3,926,403

Total assets	$	37,317,815		$	37,376,105

Liabilities and Stockholders’ Equity
Deposits:
Interest-bearing deposit accounts	$	26,878,293		$	24,643,517
Non-interest bearing deposit accounts		80,960			67,796

Total deposits		26,959,253			24,711,313
Short-term borrowings		—			250,000
Long-term borrowings		1,854,263			2,134,093
Accrued interest payable		252,004			264,965
Accrued expenses and other liabilities		2,251,530			1,317,842
Liabilities of discontinued operations		372			3,098,470

Total liabilities		31,317,422			31,776,683
Commitments, contingencies and guarantees (Note 11)
Stockholders’ Equity:
Preferred stock, par value $0.01 per share; 200,000,000 shares authorized; none issued or outstanding		—			—
Common stock, par value $0.01 per share; 2,000,000,000 shares authorized; 480,227,524 and 477,762,018 shares issued at August 31, 2008 and November 30, 2007, respectively		4,802			4,777
Additional paid-in capital		2,924,923			2,846,127
Retained earnings		3,116,818			2,717,905
Accumulated other comprehensive (loss) income		(38,983	)		32,032
Treasury stock, at cost; 463,133 and 73,795 shares at August 31, 2008 and November 30, 2007, respectively		(7,167	)		(1,419	)

Total stockholders’ equity		6,000,393			5,599,422

Total liabilities and stockholders’ equity	$	37,317,815		$	37,376,105

See Notes to Consolidated and Combined Financial Statements.

DISCOVER FINANCIAL SERVICES

Consolidated and Combined Statements of Income


	For the Three Months Ended August 31,						For the Nine Months Ended August 31,
	2008			2007			2008			2007
	(unaudited)
	(dollars in thousands, except per share amounts)
Interest income:
Consumer loans	$	596,131		$	558,177		$	1,662,057		$	1,630,365
Commercial loans		7,916			1,050			15,137			1,651
Federal Funds sold		16,527			74,424			83,868			155,134
Commercial paper		—			212			77			627
Investment securities		14,372			1,366			31,985			3,843
Deposits		31,551			—			88,227			—
Other interest income		15,195			39,635			75,206			133,106

Total interest income		681,692			674,864			1,956,557			1,924,726
Interest expense:
Deposits		286,861			275,768			889,101			730,955
Short-term borrowings		—			9,598			135			87,504
Long-term borrowings		18,782			31,758			69,096			53,894

Total interest expense		305,643			317,124			958,332			872,353

Net interest income		376,049			357,740			998,225			1,052,373
Provision for loan losses		364,838			145,827			881,439			437,701

Net interest income after provision for loan losses		11,211			211,913			116,786			614,672

Other income:
Securitization income		629,046			565,075			1,970,574			1,657,941
Loan fee income		56,514			86,665			198,611			246,009
Discount and interchange revenue		41,480			37,898			158,899			183,443
Insurance		48,762			41,204			143,717			125,635
Merchant fees		16,183			22,798			52,876			71,977
Transaction processing revenue		31,085			25,271			87,444			74,968
Loss on investments		(5,325	)		(4	)		(37,789	)		(4	)
Other income		57,376			25,140			121,225			64,213

Total other income		875,121			804,047			2,695,557			2,424,182
Other expense:
Employee compensation and benefits		222,426			210,541			658,086			641,155
Marketing and business development		137,928			153,786			411,519			420,287
Information processing and communications		76,675			83,779			234,400			245,019
Professional fees		82,775			88,111			237,839			267,029
Premises and equipment		20,274			19,962			59,718			60,094
Other expense		72,469			69,705			220,153			207,899

Total other expense		612,547			625,884			1,821,715			1,841,483

Income from continuing operations before income tax expense		273,785			390,076			990,628			1,197,371
Income tax expense		94,885			145,925			371,356			443,146

Income from continuing operations		178,900			244,151			619,272			754,225
Income (loss) from discontinued operations, net of tax		1,153			(41,911	)		(123,857	)		(109,111	)

Net income	$	180,053		$	202,240		$	495,415		$	645,114

Basic earnings per share:
Income from continuing operations	$	0.38		$	0.51		$	1.29		$	1.57
Income (loss) from discontinued operations, net of tax		—			(0.09	)		(0.26	)		(0.22	)

Net income	$	0.38		$	0.42		$	1.03		$	1.35

Diluted earnings per share:
Income from continuing operations	$	0.37		$	0.51		$	1.28		$	1.57
Income (loss) from discontinued operations, net of tax		—			(0.09	)		(0.25	)		(0.22	)

Net income	$	0.37		$	0.42		$	1.03		$	1.35

Dividends paid per share	$	0.06		$	—		$	0.18		$	—

See Notes to Consolidated and Combined Financial Statements.

DISCOVER FINANCIAL SERVICES

Consolidated and Combined Statements of Changes in Stockholders’ Equity


	Common Stock					Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Treasury Stock			Total Stockholders’ Equity
	Shares		Amount			Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Treasury Stock			Total Stockholders’ Equity
	(unaudited)
	(dollars and shares in thousands)
Balance at November 30, 2006	1		$	100		$	2,636,265		$	3,008,421		$	129,986		$	—		$	5,774,772
Comprehensive income:
Net income	—			—			—			645,114			—			—			645,114
Foreign currency translation (accumulated amount of $33,426 at August 31, 2007)	—			—			—			—			(96,558	)		—
Net unrealized losses on investment securities	—			—			—			—			(147	)		—
Other	—			—			—			—			31			—

Other comprehensive loss	—			—			—			—			(96,674	)		—			(96,674	)

Total comprehensive income	—			—			—			—			—			—			548,440
Consummation of spin-off transaction on June 30, 2007, and distribution of Discover Financial Services common stock by Morgan Stanley	526,233			5,162			(5,162	)		—			—			—			—
Common stock issued and stock-based compensation expense	93			1			15,240			—			—			—			15,241
Capital contribution from Morgan Stanley	—			—			178,829			—			—			—			178,829
Cash dividends paid to Morgan Stanley	—			—			—			(850,000	)		—			—			(850,000	)
Other	(48,999	)		(490	)		490			—			—			—			—

Balance at August 31, 2007	477,328		$	4,773		$	2,825,662		$	2,803,535		$	33,312		$	—		$	5,667,282

Balance at November 30, 2007	477,762		$	4,777		$	2,846,127		$	2,717,905		$	32,032		$	(1,419	)	$	5,599,422
Adoption of FASB Interpretation No. 48	—			—			—			(8,743	)		—			—			(8,743	)
Comprehensive income:
Net income	—			—			—			495,415			—			—			495,415
Foreign currency translation (accumulated amount of $0 at August 31, 2008)	—			—			—			—			(48,358	)		—
Net unrealized losses on investment securities	—			—			—			—			(22,657	)		—

Other comprehensive loss	—			—			—			—			(71,015	)		—			(71,015	)

Total comprehensive income	—			—			—			—			—			—			424,400
Purchases of treasury stock	—			—			—			—			—			(5,748	)		(5,748	)
Common stock issued under employee benefit plans	1,150			12			16,310			—			—			—			16,322
Common stock issued and stock-based compensation expense	1,316			13			62,621			—			—			—			62,634
Dividends	—			—			—			(87,759	)		—			—			(87,759	)
Other	—			—			(135	)		—			—			—			(135	)

Balance at August 31, 2008	480,228		$	4,802		$	2,924,923		$	3,116,818		$	(38,983	)	$	(7,167	)	$	6,000,393

See Notes to Consolidated and Combined Financial Statements.

DISCOVER FINANCIAL SERVICES

Consolidated and Combined Statements of Cash Flows


	For the Nine Months Ended August 31,
	2008			2007
	(unaudited)
	(dollars in thousands)
Cash flows from operating activities
Net income	$	495,415		$	645,114
Adjustments to reconcile net income to net cash provided by operating activities:
Gains on sale of mortgages and installment loans		—			(2,741	)
Net principal disbursed on loans originated for sale		—			(79,392	)
Proceeds from sales of loans originated for sale		—			80,083
Loss on sale of Goldfish business		153,073			—
Loss on investments		37,789			4
Stock-based compensation expense		78,956			15,241
Deferred income taxes		(86,833	)		(41,119	)
Depreciation and amortization on premises and equipment		81,000			92,120
Other depreciation and amortization		92,120			99,063
Provision for loan losses		901,450			610,249
Amortization of deferred revenues		(44,530	)		(13,921	)
Changes in assets and liabilities:
(Increase) decrease in amounts due from asset securitization		391,033			(205,453	)
(Increase) decrease in other assets		(129,387	)		(110,363	)
Increase (decrease) in accrued expenses and other liabilities		903,014			251,836

Net cash provided by operating activities		2,873,100			1,340,721
Cash flows from investing activities
Proceeds from the sale of Goldfish business		69,529			—
Payments for business and other acquisitions, net of cash acquired		(160,080	)		(5,000	)
Maturities of investment securities		34,726			6,303
Purchases of investment securities		(32,129	)		(26,432	)
Proceeds from securitization and sale of loans held for investment		5,562,195			6,193,090
Net principal disbursed on loans held for investment		(7,665,129	)		(5,779,790	)
Purchases of premises and equipment		(78,414	)		(87,269	)

Net cash (used for) provided by investing activities		(2,269,302	)		300,902
Cash flows from financing activities
Net (decrease) in short-term borrowings		(759,312	)		(3,812,494	)
Proceeds from issuance of long-term debt and bank notes		—			2,102,951
Repayment of long-term debt and bank notes		(279,009	)		(1,256,983	)
Purchases of treasury stock		(5,748	)		—
Net increase (decrease) in deposits		2,248,246			9,614,804
Capital contributions from Morgan Stanley		—			273,138
Dividends paid to Morgan Stanley		—			(850,000	)
Dividends paid		(87,759	)		—

Net cash provided by financing activities		1,116,418			6,071,416
Effect of exchange rate changes on cash and cash equivalents		(24,592	)		13,365

Net increase in cash and cash equivalents		1,695,624			7,726,404
Cash and cash equivalents, at beginning of period		8,787,095			874,357

Cash and cash equivalents, at end of period	$	10,482,719		$	8,600,761

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest expense	$	998,259		$	843,640

Income taxes, net of income tax refunds	$	233,062		$	185,690

Non-cash transactions:
Exchange of retained seller’s interest for certificated beneficial interests in DCENT	$	750,000		$	315,000

Capital contributions from Morgan Stanley	$	—		$	(94,309	)

See Notes to Consolidated and Combined Financial Statements.

Notes to Consolidated and Combined Financial Statements

(unaudited)

1.	Background and Basis of Presentation

Description of Business. Discover Financial Services (“DFS” or the “Company”) is a leading credit card issuer and electronic payment services company. The Company’s business segments include U.S. Card and Third-Party Payments. The U.S. Card segment includes Discover Card-branded credit cards issued to individuals and small businesses on Discover’s signature card network (the “Discover Network”) and other consumer products and services, including installment loans, prepaid cards and other consumer lending and deposit products offered through the Company’s Discover Bank subsidiary. The Third-Party Payments segment includes the PULSE Network (“PULSE”), an automated teller machine, debit and electronic funds transfer network; Diners Club International (“Diners Club”), a global payments network; and the Company’s third-party issuing business, which includes credit, debit and prepaid cards issued on the Discover Network by third parties.

On March 31, 2008, the Company sold its U.K. credit card business (“Goldfish”) to Barclays Bank PLC. This business represented substantially all of the Company’s International Card segment. The International Card segment is presented in discontinued operations in this report. See Note 2: Discontinued Operations for further details.

Distribution. On December 19, 2006, Morgan Stanley announced that its Board of Directors had authorized the spin-off of its Discover segment. On June 30, 2007, the Company was spun-off from Morgan Stanley through the distribution of DFS shares to holders of Morgan Stanley common stock (the “Distribution”). Prior to the Distribution, the Discover segment consisted of Discover Financial Services, a wholly-owned subsidiary of Morgan Stanley, as well as certain other subsidiaries and assets related to credit card operations in the United Kingdom, which are presented in discontinued operations, that were contributed to the Discover segment by Morgan Stanley in conjunction with the Distribution.

Basis of Presentation. The accompanying consolidated and combined financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated or combined financial statements. In the opinion of management, the financial statements reflect all adjustments which are necessary for a fair statement of the results for the quarter. All such adjustments are of a normal, recurring nature. The preparation of financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect the amounts reported in the consolidated and combined financial statements and related disclosures. Actual results could differ from these estimates. These interim consolidated and combined financial statements should be read in conjunction with the Company’s 2007 audited consolidated and combined financial statements filed with the Company’s annual report on Form 10-K for the year ended November 30, 2007.

The financial statements presented in this quarterly report for periods on or after the Distribution are presented on a consolidated basis and include the results of operations, financial condition and cash flows of the Company and its wholly-owned subsidiaries. The financial statements for the periods prior to the Distribution are presented on a combined basis and reflect the historical combined results of operations, financial condition and cash flows of the Morgan Stanley subsidiaries that comprised its Discover segment (as described above) for the periods presented. The combined statements of income for periods prior to the Distribution reflect intercompany expense allocations made to the Discover segment by Morgan Stanley for certain corporate functions such as treasury, financial control, human resources, internal audit, legal, investor relations and various other functions historically provided by Morgan Stanley. Where possible, these allocations were made on a specific identification basis. Otherwise, such expenses were allocated by Morgan Stanley based on relative percentages of headcount or some other basis depending on the nature of the cost that was allocated. These historical cost

allocations may not be indicative of costs the Company has incurred since the spin-off and will incur in the future to obtain these same services as an independent entity. See Note 14: Related Party Transactions for further information on expenses allocated by Morgan Stanley.

The historical financial results in the combined financial statements presented for periods prior to the Distribution may not be indicative of the results that would have been achieved had the Company operated as a separate, stand-alone entity during those periods. The combined financial statements presented for those periods do not reflect any changes that have occurred or may yet occur in the financing and operations of the Company as a result of the Distribution. The Company has a capital structure different from the capital structure in the combined financial statements for those periods and accordingly, interest expense is not necessarily indicative of the interest expense the Company would have incurred as a separate, independent company. However, management believes that the combined financial statements presented for periods prior to the Distribution include all adjustments necessary for a fair presentation of the business. All intercompany balances and transactions of the Company have been eliminated.

Recently Issued Accounting Pronouncements

In June 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“FSP EITF 03-6-1”), which addresses whether unvested equity-based awards are participating securities and, therefore, need to be included in the earnings allocation in computing earnings per share under the two-class method described in FASB Statement No. 128, Earnings per Share. FSP EITF 03-6-1 is effective for the Company beginning December 1, 2009 and cannot be adopted early. All prior period earnings per share data presented in financial statements that are issued after the effective date shall be adjusted retrospectively to conform to the new guidance. The adoption of FSP EITF 03-6-1 will not impact the Company’s financial condition, results of operations or cash flows.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities (“Statement No. 161”). The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial condition, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. Statement No. 161 will impact disclosures only and will not have an impact on the Company’s consolidated financial condition, results of operations or cash flows.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations (“Statement No. 141R”), which replaces Statement of Financial Accounting Standards No. 141, Business Combinations (“Statement No. 141”) issued in 2001. Whereas its predecessor applied only to business combinations in which control was obtained by transferring consideration, the revised standard applies to all transactions or other events in which one entity obtains control over another. Statement No. 141R defines the acquirer as the entity that obtains control over one or more other businesses and defines the acquisition date as the date the acquirer achieves control. Statement No. 141R requires the acquirer to recognize assets acquired, liabilities assumed and any noncontrolling interest in the acquiree at their respective fair values as of the acquisition date. The revised standard changes the treatment of acquisition-related costs, restructuring costs related to an acquisition that the acquirer expects but is not obligated to incur, contingent consideration associated with the purchase price and preacquisition contingencies associated with acquired assets and liabilities. Statement No. 141R retains the guidance in Statement No. 141 for identifying and recognizing intangible assets apart from goodwill. The revised standard applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company will apply the provisions of Statement No. 141R to any business acquisition which occurs on or after the date the standard becomes effective.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (“Statement No. 160”). Statement No. 160 will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. A noncontrolling interest (or minority interest) is the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. Statement No. 160 establishes accounting and reporting standards for noncontrolling interests and for the deconsolidation of a subsidiary, topics for which there had been limited authoritative guidance. Statement No. 160 clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements rather than a liability or a “mezzanine equity” item. Statement No. 160 is effective on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company does not currently have any subsidiaries that get deconsolidated or for which a noncontrolling interest exists. As such, the adoption of Statement No. 160 is not expected to have an impact on the Company’s consolidated financial condition, results of operations or cash flows.

In June 2007, the FASB’s Emerging Issues Task Force (“EITF”) ratified Issue No. 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards (“EITF 06-11”), which clarifies the accounting for income tax benefits related to dividends paid on stock-based awards. The issue is effective for awards declared in fiscal years beginning after December 15, 2007, and interim periods within those years. EITF 06-11 is not expected to have a material impact on the Company’s consolidated financial condition, results of operations or cash flows.

2.	Discontinued Operations

On February 7, 2008, the Company and Barclays Bank PLC entered into a definitive sale and purchase agreement relating to the sale of £129 million of net assets (equivalent to approximately $258 million) of the Company’s Goldfish business, previously reported as the International Card segment. The Company completed the sale of the Goldfish business to Barclays Bank PLC on March 31, 2008. The aggregate sale price under the agreement was £35 million (equivalent to approximately $70 million), which was paid in cash at closing.

The Company has reclassified the net assets of the Goldfish business to discontinued operations and restated prior periods for comparability. The Company recorded an after tax loss from discontinued operations of $123.9 million for the nine months ended August 31, 2008. The results for the nine months ended August 31, 2008 included a pretax loss on the sale of the business of $222.4 million ($153.1 million after tax), which included the write-down of $36.7 million of other intangibles that had previously been measured at fair value on a non-recurring basis, partially offset by pretax income of the Goldfish business of $48.4 million ($29.2 million after tax) which included gains from the sale of other assets.

Assets and liabilities of discontinued operations related to the sale of the Company’s Goldfish business are as follows (dollars in thousands):


	August 31, 2008		November 30, 2007
Assets:
Cash and cash equivalents	$	7,244	$	701,628
Loan receivables and other assets		27,023		3,224,775

Total assets		34,267		3,926,403

Liabilities:
Borrowings		—		2,925,426
Other liabilities		372		173,044

Total liabilities		372		3,098,470

Net assets	$	33,895	$	827,933

The following table provides summary financial information for discontinued operations related to the sale of the Company’s Goldfish business (dollars in thousands):


	For the Three Months Ended August 31,						For the Nine Months Ended August 31,
	2008			2007			2008			2007
Revenues⁽¹⁾	$	2,008		$	77,852		$	130,363		$	223,912

Income (loss) from discontinued operations	$	3,483		$	(60,863	)	$	48,395		$	(164,172	)
Loss on the sale of discontinued operations⁽²⁾		(1,598	)		—			(222,428	)		—

Pretax income (loss) from discontinued operations		1,885			(60,863	)		(174,033	)		(164,172	)
Income tax expense (benefit)⁽²⁾		732			(18,952	)		(50,176	)		(55,061	)

Income (loss) from discontinued operations, net of tax	$	1,153		$	(41,911	)	$	(123,857	)	$	(109,111	)

(1)	Revenues are the sum of net interest income and other income.

(2)	Loss on the sale of discontinued operations for the nine months ended August 31, 2008 includes a $27.1 realization of

cumulative foreign currency translation adjustments which were previously recorded net of tax. As a result, there is no tax impact

for the nine months ended August 31, 2008 related to the realization of cumulative foreign currency translation adjustments.

3.	Loan Receivables

Loan receivables consist of the following (dollars in thousands):


	August 31, 2008			November 30, 2007
Loans held for sale	$	—		$	—
Loan portfolio:
Credit card		20,241,785			20,345,787
Commercial loans		446,900			234,136

Total credit card, including consumer and commercial		20,688,685			20,579,923
Other consumer loans		1,078,798			251,194

Total loan portfolio		21,767,483			20,831,117

Total loan receivables		21,767,483			20,831,117
Allowance for loan losses		(959,769	)		(759,925	)

Net loan receivables	$	20,807,714		$	20,071,192

Net proceeds from loan sales are as follows (dollars in thousands):


	For the Three Months Ended August 31,				For the Nine Months Ended August 31,
	2008		2007		2008		2007
Net proceeds from credit card securitizations	$	1,167,393	$	898,850	$	5,562,195	$	6,193,090
Net proceeds from mortgage and installment loan sales		—		23,013		—		77,342

Total net proceeds from loan sales	$	1,167,393	$	921,863	$	5,562,195	$	6,270,432

Activity in the allowance for loan losses is as follows (dollars in thousands):


	For the Three Months Ended August 31,						For the Nine Months Ended August 31,
	2008			2007			2008			2007
Balance at beginning of period	$	846,775		$	644,701		$	759,925		$	703,917
Additions:
Provision for loan losses		364,838			145,827			881,439			437,701
Deductions:
Charge-offs		(292,395	)		(201,648	)		(807,036	)		(635,157	)
Recoveries		40,551			40,578			125,441			122,997

Net charge-offs		(251,844	)		(161,070	)		(681,595	)		(512,160	)

Balance at end of period	$	959,769		$	629,458		$	959,769		$	629,458

Information regarding net charge-offs of interest and fee revenues are as follows (dollars in thousands):


	For the Three Months Ended August 31,				For the Nine Months Ended August 31,
	2008		2007		2008		2007
Interest and fees accrued subsequently charged off, net of recoveries (recorded as a reduction of interest income)	$	63,544	$	39,345	$	182,670	$	129,485
Loan fees accrued subsequently charged off, net of recoveries (recorded as a reduction to loan fee income)	$	27,441	$	16,436	$	78,426	$	58,050

Information regarding loan receivables that are over 90 days delinquent and accruing interest and loan receivables that are not accruing interest is as follows (dollars in thousands):


	August 31, 2008		November 30, 2007
Loans over 90 days delinquent and accruing interest	$	329,037	$	271,227
Loans not accruing interest	$	115,877	$	102,286

4.	Investment Securities

The Company’s investment securities consist of the following (dollars in thousands):


	August 31, 2008		November 30, 2007
U.S. Treasury and other U.S. government agency obligations	$	17,341	$	23,160
States and political subdivisions of states		70,275		61,091
Certificated retained interests in DCENT		1,024,542		310,861
Asset-backed commercial paper notes		72,091		108,681
Other securities		14,506		21,646

Total investment securities	$	1,198,755	$	525,439

The amortized cost, gross unrealized gains and losses, and fair value of available-for-sale and held-to-maturity investment securities are as follows (dollars in thousands):


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
At August 31, 2008
Investment Securities—Available-for-Sale⁽¹⁾
Certificated retained interests in DCENT	$	1,065,000	$	—	$	(40,458	)	$	1,024,542
Asset-backed commercial paper notes		72,091		—		—			72,091
Other equity securities		816		—		(515	)		301

Total investment securities—available-for-sale	$	1,137,907	$	—	$	(40,973	)	$	1,096,934

Investment Securities—Held-to-Maturity⁽²⁾
U.S. Treasury and other U.S. government agency obligations	$	1,594	$	1	$	—		$	1,595
States and political subdivisions of states		70,275		502		(10,297	)		60,480
Mortgage-backed securities		15,747		42		(69	)		15,720
Other debt securities		14,205		—		—			14,205

Total investment securities—held-to-maturity	$	101,821	$	545	$	(10,366	)	$	92,000

At November 30, 2007
Investment Securities—Available for Sale⁽¹⁾
Certificated retained interests in DCENT	$	315,000	$	—	$	(4,139	)	$	310,861
Asset-backed commercial paper notes		108,681				—			108,681
Other equity securities		2,000		—		(705	)		1,295

Total investment securities—available-for-sale	$	425,681	$	—	$	(4,844	)	$	420,837

Investment Securities—Held-to-Maturity⁽²⁾
U.S. Treasury and other U.S. government agency obligations	$	5,930	$	3	$	—		$	5,933
States and political subdivisions of states		61,091		388		(4,379	)		57,100
Mortgage-backed securities		17,230		192		(37	)		17,385
Other debt securities		20,351		—		—			20,351

Total investment securities—held-to-maturity	$	104,602	$	583	$	(4,416	)	$	100,769

(1)	Available-for-sale investment securities are reported at fair value.

(2)	Held-to-maturity investment securities are reported at amortized cost.

Certificated retained interests in DCENT are certificated Class B and C notes issued by the Discover Card Execution Note Trust (“DCENT”), which the Company now holds as other retained beneficial interests. During the three and nine months ended August 31, 2008, the Company exchanged $165 million and $750 million, respectively, of its seller’s interest in the Discover Card Master Trust I for the issuance of certificated Class B and C notes which had the effect of reducing its seller’s interest, previously included in loan receivables. Fair values of the certificated Class B and C notes issued by DCENT are estimated utilizing market pricing data for investments with similar terms. Fair values of other investments are based on quoted market prices utilizing public information for similar transactions where available. For more information, see Note 12: Fair Value Disclosures. The changes in the fair value of available-for-sale investment securities are recorded in other comprehensive income. During the three and nine months ended August 31, 2008, the Company recorded $21.5 million and $36.1 million, respectively, of gross unrealized losses ($13.5 million and $22.7 million, respectively, net of tax) and no unrealized gains through other comprehensive income.

For the three and nine months ended August 31, 2008, the Company recorded a $5.3 million and $36.6 million other-than-temporary impairment, respectively, on its investment in the asset-backed commercial paper notes of Golden Key U.S. LLC, which invested in mortgage-backed securities. These notes had a principal amount of $120.1 million and, as of August 31, 2008, a market value of $72.1 million. These notes are no longer traded, and as such, fair value of the notes is determined utilizing a valuation analysis, reflecting an estimate of the market value of the assets held by the issuer. The notes were priced to yield 5.40%; however, the Company has not recorded any interest income or discount accretion on these notes. The Company continues to monitor the value of the investment. Future valuations may result in further impairment of the Company’s investment.

5.	Business Combinations

On June 30, 2008, the Company purchased Diners Club for $168 million in cash from Citibank, N.A. The Company acquired the Diners Club brand, trademarks, employees, and license agreements with 44 network participants that issue Diners Club cards and that maintain an acceptance network consisting of merchant and cash access locations in 185 countries worldwide. Diners Club licensees were not included in the acquisition. Under the terms of the purchase, Citibank agreed to remain a significant long-term international issuer on the Diners Club network. Discover is not issuing cards or extending consumer credit in international markets as a result of the transaction. Diners Club is included in the Company’s Third-Party Payments segment. Since the acquisition date, the results of operations and cash flows of Diners Club have been included in the Company’s consolidated results of operations and cash flows, although no pro forma data is provided as the impact of the Diners Club acquisition was not significant to the Company’s consolidated results of operations or cash flows.

The Company will account for its purchase of Diners Club using the purchase method under which the purchase price will be allocated to the assets acquired and the liabilities assumed based on their estimated fair values at the date of the acquisition. The Company allocated $20.0 million of the purchase price to tangible net assets acquired based on their fair values at June 30, 2008. However, the Company has not completed its valuation analysis of identified intangible assets acquired and therefore, has preliminarily recorded the remaining $151.6 million of excess purchase price and acquisition-related costs in other assets as of August 31, 2008. A final valuation analysis of Diners Club assets acquired and liabilities assumed as of June 30, 2008 is expected to be completed by the Company in the fourth quarter of 2008, at which time the purchase price allocation will be finalized and any remaining excess purchase price will be recorded in goodwill at that time.

6.	Deposits

The Company’s deposits consist of brokered and direct certificates of deposit, money market deposit accounts, and, to a lesser degree, deposits payable upon demand.

A summary of interest-bearing deposit accounts is as follows (dollars in thousands):


	August 31, 2008			November 30, 2007
Certificates of deposit in amounts less than $100,000	$	21,562,963		$	19,385,024
Certificates of deposit in amounts of $100,000 or greater		1,214,194			775,717
Savings deposits, including money market deposit accounts		4,101,136			4,482,776

Total interest-bearing deposit accounts	$	26,878,293		$	24,643,517

Average annual interest rate		4.77	%		5.18	%

Certificates of deposit had the following maturities at August 31, 2008 (dollars in thousands):


Fiscal Year Ended November 30,	Amount
2008	$	2,165,529
2009	$	6,700,524
2010	$	5,440,680
2011	$	2,465,141
2012	$	2,405,720
Thereafter⁽¹⁾	$	3,599,563

(1)

Includes certificates of deposit which may be called by the Company prior to their contractual maturity at specific intervals of time.

7.	Long-Term Borrowings

Long-term borrowings consist of borrowings and capital leases having original maturities of one year or more. The following table provides a summary of the outstanding amounts and general terms of the Company’s long-term borrowings (dollars in thousands):


	August 31, 2008				November 30, 2007
Funding source	Outstanding		Interest Rate		Outstanding		Interest Rate		Interest Rate Terms	Maturity
Bank notes	$	249,947	2.95	%	$	249,856	5.03	%	3-month LIBOR + 15 basis points	February 2009
Secured borrowings		801,053	3.21	%		1,080,063	5.67	%	Commercial paper rate + 50 basis points	December 2010⁽¹⁾
Unsecured borrowings:
Floating rate senior notes		400,000	3.31	%		400,000	6.23	%	3-month LIBOR + 53 basis points	June 2010
Fixed rate senior notes		399,283	6.45	%		399,222	6.45	%	6.45% fixed	June 2017

Total unsecured borrowings		799,283				799,222
Capital lease obligations		3,980	6.26	%		4,952	6.26	%	6.26% fixed	various

Total long-term borrowings	$	1,854,263			$	2,134,093

(1)	Repayment is dependent upon the available balances of the cash collateral accounts at the various maturities of underlying securitization transactions, with final maturity in December 2010.

The Company entered into a 59-month $2.5 billion unsecured credit agreement that became effective July 2, 2007. The credit agreement provides for a revolving credit commitment of up to $2.5 billion (of which the Company may borrow up to 30% and Discover Bank may borrow up to 100% of the total commitment). As of August 31, 2008, the Company had no outstanding balances due under the facility. The credit agreement provides for a commitment fee on the unused portion of the facility, which can range from 0.07% to 0.175% depending on the index debt ratings. Loans outstanding under the credit facility bear interest at a margin above the Federal Funds rate, LIBOR, the EURIBOR or the Euro Reference rate. The terms of the credit agreement include various affirmative and negative covenants, including financial covenants related to the maintenance of certain capitalization and tangible net worth levels, and certain double leverage, delinquency and tier 1 capital to managed loans ratios. The credit agreement also includes customary events of default with corresponding grace periods, including, without limitation, payment defaults, cross-defaults to other agreements evidencing indebtedness for borrowed money and bankruptcy-related defaults. The commitment may be terminated upon an event of default.

8.	Employee Benefit Plans

The Company sponsors defined benefit pension and other postretirement plans for its eligible U.S. employees. Net periodic benefit cost expensed by the Company includes the following components (dollars in thousands):


	Pension
	For the Three Months Ended August 31,						For the Nine Months Ended August 31,
	2008			2007			2008			2007
Service cost, benefits earned during the period	$	4,206		$	4,243		$	12,618		$	13,892
Interest cost on projected benefit obligation		4,998			4,675			14,994			14,577
Expected return on plan assets		(6,009	)		(5,987	)		(18,027	)		(16,934	)
Net amortization		(560	)		(431	)		(1,680	)		599

Net periodic benefit cost	$	2,635		$	2,500		$	7,905		$	12,134


	Postretirement
	For the Three Months Ended August 31,						For the Nine Months Ended August 31,
	2008			2007			2008			2007
Service cost, benefits earned during the period	$	269		$	274		$	807		$	822
Interest cost on projected benefit obligation		361			328			1,083			984
Net amortization		(116	)		(138	)		(348	)		(414	)

Net periodic benefit cost	$	514		$	464		$	1,542		$	1,392

9.	Income Taxes

Income tax expense from continuing operations consists of the following (dollars in thousands):


	For the Three Months Ended August 31,						For the Nine Months Ended August 31,
	2008			2007			2008			2007
Current:
U.S. federal	$	155,222		$	178,024		$	444,919		$	445,423
U.S. state and local		3,235			11,604			44,609			34,436
International		395			2			399			5

Total		158,852			189,630			489,927			479,864
Deferred:
U.S. federal		(59,012	)		(37,546	)		(108,426	)		(30,367	)
U.S. state and local		(4,955	)		(6,159	)		(10,145	)		(6,351	)

Total		(63,967	)		(43,705	)		(118,571	)		(36,718	)

Income tax expense	$	94,885		$	145,925		$	371,356		$	443,146

The following table reconciles the Company’s effective tax rate from continuing operations to the U.S. federal statutory income tax rate:


	For the Three Months Ended August 31,				For the Nine Months Ended August 31,
	2008		2007		2008		2007
U.S. federal statutory income tax rate	35.0	%	35.0	%	35.0	%	35.0	%
U.S. state and local income taxes, net of U.S. federal income tax benefits	3.4		1.8		3.2		1.8
State examinations and settlements	(3.9	)	—		(1.1	)	—
Non-deductible spin-off costs	—		1.4		—		0.4
Other	0.2		(0.8	)	0.4		(0.2	)

Effective income tax rate	34.7	%	37.4	%	37.5	%	37.0	%

The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (“FIN 48”) on December 1, 2007. As a result of adoption, the Company recorded an $8.7 million reduction to the December 1, 2007 balance of retained earnings.

The total amount of unrecognized tax benefits at the date of adoption on December 1, 2007 was $242.8 million, of which $51.8 million of unrecognized tax benefits would favorably affect the effective tax rate if recognized.

The Company continues to recognize accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense, consistent with its policy prior to the adoption of FIN 48. The accrued balance of interest and penalties related to unrecognized tax benefits at December 1, 2007 was $41.0 million.

The Company is under continuous examination by the IRS and the tax authorities for various states. The tax years under examination vary by jurisdiction; for example, the current IRS examination covers 1999 through 2005. The Company regularly assesses the likelihood of additional assessments in each of the taxing jurisdictions resulting from these and subsequent years’ examinations. A liability for unrecognized tax benefits has been established that the Company believes is adequate in relation to the potential for additional assessments. Once established, unrecognized tax benefits are adjusted only when there is more information available or when an event occurs necessitating a change. It is reasonably possible that the unrecognized tax benefit will significantly increase or decrease within the next twelve months. Based on current progress with the federal audit, it is not possible to quantify the impact such changes may have on the effective tax rate.

10.

Earnings Per Share

Basic earnings per share (“EPS”) is computed by dividing income available to common stockholders by the weighted average number of shares of common stock outstanding for the period. Diluted EPS reflects the assumed conversion of all dilutive securities. On June 30, 2007, the Distribution by Morgan Stanley was completed to the Morgan Stanley stockholders of one share of DFS common stock for every two shares of Morgan Stanley common stock held on June 18, 2007. As a result, on July 2, 2007, the Company had 477,235,927 shares of common stock outstanding and this number of shares is being utilized for the calculation of basic and diluted EPS for the periods prior to the date of Distribution.

The following table presents the calculation of basic and diluted EPS (dollars and shares in thousands, except per share amounts):


	For the Three Months Ended August 31,					For the Nine Months Ended August 31,
	2008		2007			2008			2007
Numerator:
Income from continuing operations	$	178,900	$	244,151		$	619,272		$	754,225
Income (loss) from discontinued operations, net of tax		1,153		(41,911	)		(123,857	)		(109,111	)

Net income	$	180,053	$	202,240		$	495,415		$	645,114

Denominator:
Weighted average shares of common stock outstanding		479,618		477,272			479,138			477,248
Effect of dilutive stock options and restricted stock units		4,510		2,799			4,187			1,030

Weighted average shares of common stock outstanding and common stock equivalents		484,128		480,071			483,325			478,278

Basic earnings per share:
Income from continuing operations	$	0.38	$	0.51		$	1.29		$	1.57
Income (loss) from discontinued operations, net of tax		—		(0.09	)		(0.26	)		(0.22	)

Net income	$	0.38	$	0.42		$	1.03		$	1.35

Diluted earnings per share:
Income from continuing operations	$	0.37	$	0.51		$	1.28		$	1.57
Income (loss) from discontinued operations, net of tax		—		(0.09	)		(0.25	)		(0.22	)

Net income	$	0.37	$	0.42		$	1.03		$	1.35

The following securities are considered anti-dilutive and therefore are excluded from the computation of diluted EPS (shares in thousands):


	For the Three Months Ended August 31,		For the Nine Months Ended August 31,
	2008	2007	2008	2007
Number of anti-dilutive securities (stock options and restricted stock units)	5,076	927	5,994	658

11.

Commitments, Contingencies and Guarantees

Lease commitments. The Company leases various office space and equipment under capital and non-cancelable operating leases which expire at various dates through 2018. At August 31, 2008, future minimum payments on leases with remaining terms in excess of one year, consist of the following (dollars in thousands):


	August 31, 2008
	Capitalized Leases		Operating Leases
2008	$	395	$	1,398
2009		1,579		5,881
2010		1,579		5,552
2011		790		4,508
2012		—		4,535
Thereafter		—		17,203

Total minimum lease payments		4,343	$	39,077

Less: amount representing interest		363

Present value of net minimum lease payments	$	3,980

Unused commitments to extend credit. At August 31, 2008, the Company had unused commitments to extend credit for consumer and commercial loans of approximately $213 billion. Such commitments arise primarily from agreements with customers for unused lines of credit on certain credit cards, provided there is no violation of conditions established in the related agreement. These commitments, substantially all of which the Company can terminate at any time and which do not necessarily represent future cash requirements, are periodically reviewed based on account usage and customer creditworthiness.

Guarantees. The Company has certain obligations under certain guarantee arrangements, including contracts and indemnification agreements that contingently require the Company to make payments to a guaranteed party based on changes in an underlying asset, liability or equity security of a guaranteed party, rate or index. Also included as guarantees are contracts that contingently require the Company to make payments to a guaranteed party based on another entity’s failure to perform under an agreement. The Company’s use of guarantees is disclosed below by type of guarantee.

Discontinued Operations. Under the sale and purchase agreement to sell the Company’s Goldfish business, the Company indemnified the purchasers of the Goldfish business, including Barclays Bank PLC, against certain liabilities and losses. Such indemnities are customary in sale and purchase transactions and are contingent upon the purchasers incurring liabilities or losses that are not otherwise recoverable from third parties. Indemnification obligations of the Company include those related to the enforceability and transferability of the Goldfish credit card receivables. The maximum potential payments by the Company under the enforceability and transferability indemnification obligations is £129 million, and Barclays Bank PLC must provide notice to the Company of any such claims within 12 months of the transaction closing date, March 31, 2008. At August 31, 2008, there were no material amounts recorded in the Company’s consolidated financial statements related to indemnification obligations under the agreement for the sale of the Goldfish business, and management believes that there is a low probability of any future material payments under these arrangements.

Securitized Asset Representations and Warranties. As part of the Company’s securitization activities, the Company provides representations and warranties that certain securitized assets conform to specified guidelines. The Company may be required to repurchase such assets or indemnify the purchaser against losses if the assets do not meet certain conforming guidelines. Due diligence is performed by the Company to ensure that asset guideline qualifications are met. The maximum potential amount of future payments the Company could be required to make would be equal to the current outstanding balances of all assets subject to such securitization activities. The Company has not recorded any contingent liability in the consolidated and combined financial statements for these representations and warranties, and management believes that the probability of any payments under these arrangements is low.

Diners Club. Diners Club has entered into contractual relationships with certain international merchants, which generally include travel-related businesses, for the benefit of all Diners Club licensees. The licensees hold the primary liability to settle the transactions of their cardmembers with these merchants. However, Diners Club retains a counterparty exposure if a licensee fails to meet its financial payment obligation to one of these merchants. While Diners Club has contractual remedies to offset this counterparty exposure, in the event that all licensees were to become unable to settle their transactions with these merchants, the Company estimates its maximum potential counterparty exposure to be approximately $600 million based on historical transaction volume with these merchants.

Additionally, Diners Club retains counterparty exposure if a licensee fails to settle amounts resulting from cardmember transactions processed in the territory of another licensee. While Diners Club has contractual remedies to offset this counterparty exposure, in the event all licensees were to become unable to settle their transactions with another licensee, the Company estimates its maximum potential counterparty exposure to be approximately $12 million based on historical transaction volume between licensees.

With regard to the two counterparty exposures discussed above, the Company believes that the estimated amounts of maximum potential future payments are not representative of the Company’s actual potential loss exposure given Diners Club’s insignificant historical losses with regard to these counterparty exposures. As of August 31, 2008, the Company has not recorded any contingent liability in the consolidated financial statements for these counterparty exposures, and management believes that the probability of any payments under these arrangements is low.

Merchant Chargeback Guarantees. The Company issues credit cards and owns and operates the Discover Network in the United States. The Company is contingently liable for certain transactions processed on the Discover Network in the event of a dispute between the cardholder and a merchant. The contingent liability arises if the disputed transaction involves a merchant or merchant acquirer with whom the Discover Network has a direct relationship. If a dispute is resolved in the cardholder’s favor, the Discover Network will credit or refund the disputed amount to the Discover Network card issuer, who in turn credits its cardholder’s account. The Discover Network will then charge back the transaction to the merchant or merchant acquirer. If the Discover Network is unable to collect the amount from the merchant or merchant acquirer, it will bear the loss for the amount credited or refunded to the cardholder. In most instances, a payment requirement by the Discover Network is unlikely to arise because most products or services are delivered when purchased, and credits are issued by merchants on returned items in a timely fashion. However, where the product or service is not scheduled to be provided to the cardholder until some later date following the purchase, the likelihood of payment by the Discover Network increases. The maximum potential amount of future payments related to these contingent liabilities is estimated to be the portion of the total Discover Network transaction volume processed to date for which timely and valid disputes may be raised under applicable law and relevant issuer and cardholder agreements. However, the Company believes that amount is not representative of the Company’s actual potential loss exposure based on the Company’s historical experience. The actual amount of the potential exposure cannot be quantified as the Company cannot determine whether the current or cumulative transaction volumes may include or result in disputed transactions.

The table below summarizes certain information regarding merchant chargeback guarantees from continuing operations:


	For the Three Months Ended August 31,				For the Nine Months Ended August 31,
	2008		2007		2008		2007
Losses related to merchant chargebacks (in thousands)	$	6,134	$	1,427	$	9,387	$	5,029
Aggregate transaction volume⁽¹⁾ (in millions)	$	25,897	$	24,382	$	74,731	$	70,086

(1)	Represents period transactions processed on Discover Network to which a potential liability exists, which, in aggregate, can differ from credit card sales volume.

As of August 31, 2008 and November 30, 2007, there were no material amounts recorded for merchant chargeback guarantees in the Company’s consolidated and combined statements of financial condition. The Company mitigates this risk by withholding settlement from merchants and merchant acquirers or obtaining escrow deposits from certain merchant acquirers or merchants that are considered higher risk due to various factors such as time delays in the delivery of products or services and certain merchant behavior.

The table below provides information regarding the settlement withholdings and escrow deposits (dollars in thousands):


	August 31, 2008		November 30, 2007
Settlement withholdings and escrow deposits	$	57,492	$	52,683

Settlement withholdings and escrow deposits are recorded in interest-bearing deposit accounts and accrued expenses and other liabilities on the Company’s consolidated statement of financial condition.

12.

Fair Value Disclosures

In accordance with Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments, the Company is required to disclose the fair value of financial instruments for which it is practical to estimate fair value.

The following table provides the estimated fair values of financial instruments (dollars in thousands):


	August 31, 2008				November 30, 2007
	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Financial Assets
Cash and cash equivalents	$	10,475,475	$	10,475,475	$	8,085,467	$	8,085,467
Investment securities:
Available-for-sale	$	1,096,934	$	1,096,934	$	420,837	$	420,837
Held-to-maturity	$	101,821	$	92,000	$	104,602	$	100,769
Net loan receivables	$	20,807,714	$	20,969,720	$	20,071,192	$	20,215,713
Amounts due from asset securitization	$	2,647,860	$	2,647,860	$	3,041,215	$	3,041,215
Other assets:
Derivative financial instruments	$	4,626	$	4,626	$	2,643	$	2,643

Financial Liabilities
Deposits	$	26,959,253	$	27,087,646	$	24,711,313	$	24,782,822
Short-term borrowings	$	—	$	—	$	250,000	$	250,000
Long-term borrowings	$	1,854,263	$	1,774,444	$	2,134,093	$	2,091,902
Accrued expenses and other liabilities:
Derivative financial instruments	$	2,130	$	2,130	$	19,532	$	19,532

The Company estimates the fair value of its financial instruments in accordance with Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“Statement No. 157”), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. If available, observable market prices are used for identical or comparable assets or liabilities. For instances in which observable market prices are not readily available, the Company estimates fair value using present value or other techniques appropriate for a particular financial instrument. These techniques involve some degree of judgment and as a result are not necessarily indicative of the amounts the Company would realize in a current market exchange. The use of different assumptions or estimation techniques may have a material effect on the estimated fair value amounts. The following is a summary of the techniques utilized by the Company to derive fair value estimates of its assets and liabilities.

Cash and cash equivalents. The carrying value of cash and cash equivalents approximates fair value due to maturities of less than three months.

Investment securities available-for-sale. Investment securities classified as available-for-sale are recorded at their fair values. Fair values of certificated retained interests in Class B and C notes issued by DCENT are estimated utilizing market pricing data for investments with similar terms. Fair values of other investments are based on quoted market prices utilizing public information for similar transactions where available.

Investment securities held-to-maturity. The estimated fair values of investment securities classified as held-to-maturity are based on quoted market prices utilizing public information for comparable transactions or estimated from market pricing data.

Net loan receivables. The Company’s loan receivables consist of loans held for sale and the loan portfolio, which includes loans to consumers and commercial loans. The carrying value of loans held for sale, which consists entirely of consumer loans, approximates fair value as a result of the short-term nature of these assets. To estimate the fair value of the remaining loan receivables, loans are aggregated into pools of similar loan types, characteristics and expected repayment terms. The fair values of the loans are estimated by discounting future cash flows using a rate at which similar loans could be made under current market conditions.

Amounts due from asset securitization. Carrying values of the portion of amounts due from asset securitization that are short-term in nature approximate their fair values. Fair values of the remaining assets recorded in amounts due from asset securitization reflect the present value of estimated future cash flows utilizing management's best estimate of key assumptions with regard to credit card receivable performance and interest rate environment projections.

Deposits. The carrying values of money market deposit, non-interest bearing deposits, interest-bearing demand deposits and savings accounts approximates fair value due to the liquid nature of these deposits. For time deposits for which readily available market rates do not exist, fair values are estimated by discounting future cash flows using market rates currently offered for deposits with similar remaining maturities.

Short-term borrowings. Short-term borrowings have original maturities of less than one year. As a result of their short-term nature, the carrying values of short-term borrowings approximate their fair values.

Long-term borrowings. Long-term borrowings include fixed and floating rate debt. The fair values of long-term borrowings having fixed rates are determined by discounting cash flows of future interest accruals at market rates currently offered for borrowings with similar remaining maturities or repricing terms. The carrying values of long-term borrowings having floating rates approximate their fair values due to their automatic ability to reprice with changes in the interest rate environment.

Derivative financial instruments. As part of its interest rate risk management program, the Company may enter into interest rate swap agreements with institutions that are established dealers and that maintain certain minimum credit criteria established by the Company. The values of these agreements are derived using models which use primarily market observable inputs such as interest yield curves, credit curves and option volatility, and are recorded in other assets at their gross positive fair values and accrued expenses and other liabilities at their gross negative fair values.

The table that follows summarizes the interest rate swap agreements outstanding (dollars in thousands):


	Notional Amount		Weighted Average Years to Maturity	Estimated Fair Value
August 31, 2008
Interest rate swap agreements	$	678,000	10.6
Gross positive fair value				$	4,626
Gross negative fair value					(2,130	)

Total interest rate swap agreements	$	678,000	10.6	$	2,496

November 30, 2007
Interest rate swap agreements	$	1,000,500	10.1
Gross positive fair value				$	2,643
Gross negative fair value					(10,112	)

Total interest rate swap agreements	$	1,000,500	10.1	$	(7,469	)

For the three months ended August 31, 2008 and 2007, other income included gains of $0.8 million and losses of $6.0 million, respectively, related to these interest rate swap agreements and for the nine months ended August 31, 2008 and 2007, other income included losses of $0.1 million and $21.9 million, respectively, related to these interest rate swap agreements. For each period, the amounts recorded in other income were related to the change in fair value of these contracts that did not qualify as fair value hedges. Interest expense includes amortization related to the fair value adjustment to interest-bearing deposits existing prior to de-designation and the basis adjustment existing on the hedged interest-bearing deposits relating to the risk being hedged. Interest expense also includes any ineffectiveness related to certain derivatives designated and qualifying as fair value hedges. For the three months ended August 31, 2008 and 2007, interest expense included $4.3 million and $1.1 million in contra-expense, respectively, related to these contracts. For the nine months ended August 31, 2008 and 2007, interest expense included $15.6 million in contra-expense and $1.0 million in expense, respectively, related to these contracts.

Other income also included gains and losses related to foreign currency exchange contracts. For the three months ended August 31, 2007, other income included losses of $4.1 million related to these contracts. For the nine months ended August 31, 2008 and 2007, other income included gains of $13.7 million and losses of $4.1 million, respectively, related to these contracts. At November 30, 2007, the Company had an outstanding foreign currency exchange contract with a notional amount of £226 million entered into during 2007 to economically hedge short-term funding provided to a U.K. subsidiary of the Company with a non-dollar currency denomination, the borrowing of which is eliminated in consolidation. The fair value of the contract was a negative $9.4 million at November 30, 2007, and was included in accrued expenses and other liabilities in the consolidated statements of financial condition. The Company had no outstanding foreign currency exchange contracts at August 31, 2008.

In accordance with Statement No. 157, the following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis at August 31, 2008, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In instances in which the inputs used to measure fair value may fall into different

levels of the fair value hierarchy, the level in the fair value hierarchy within which the fair value measurement in its entirety has been determined is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. Disclosures concerning assets and liabilities measured at fair value are as follows:

Assets and Liabilities Measured at Fair Value on a Recurring Basis at August 31, 2008

(dollars in thousands)


	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance at August 31, 2008
Assets
Investment securities—available-for-sale	$	301	$	1,024,542	$	72,091	$	1,096,934
Amounts due from asset securitization⁽¹⁾	$	—	$	—	$	1,715,797	$	1,715,797
Derivative financial instruments⁽²⁾	$	—	$	4,626	$	—	$	4,626
Liabilities
Derivative financial instruments⁽²⁾	$	—	$	2,130	$	—	$	2,130

(1)	Balances represent only the portion of amounts due from asset securitization measured at fair value.

(2)	The Company does not offset the fair value of derivative contracts with a negative fair value against the fair value of contracts with a positive fair value.

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis

(dollars in thousands)


	Balance at May 31, 2008		Total Realized and Unrealized Gains (Losses) Included in Income			Purchases, Sales, Other Settlements and Issuances, net			Net Transfers In and/or Out of Level 3		Balance at August 31, 2008
Assets
Amounts due from asset securitization⁽¹⁾	$	1,780,128	$	(32,780	)⁽²⁾	$	(31,551	)	$	—	$	1,715,797
Investment securities—available-for-sale	$	77,408	$	(5,317	)⁽³⁾	$	—		$	—	$	72,091

(1)	Balances represent only the portion of amounts due from asset securitization measured at fair value.

(2)	This unrealized loss is recorded in securitization income in the consolidated statement of income.

(3)	This unrealized loss is recorded in loss from investments in the consolidated statement of income.

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis

(dollars in thousands)


	Balance at November 30, 2007		Total Realized and Unrealized Gains (Losses) Included in Income			Purchases, Sales, Other Settlements and Issuances, net			Net Transfers In and/or Out of Level 3		Balance at August 31, 2008
Assets
Amounts due from asset securitization⁽¹⁾	$	2,029,220	$	(1,608	)⁽²⁾	$	(311,815	)	$	—	$	1,715,797
Investment securities—available-for-sale	$	—	$	(36,590	)⁽³⁾	$	—		$	108,681	$	72,091

(1)	Balances represent only the portion of amounts due from asset securitization measured at fair value.

(2)	This unrealized loss is recorded in securitization income in the consolidated statement of income.

(3)	This unrealized loss is recorded in the loss from investments in the consolidated statement of income.

Both observable and unobservable inputs may be used to determine the fair value of positions that the Company has classified within the Level 3 category. As a result, the unrealized gains and losses for assets and liabilities within the Level 3 category presented in the tables above may include changes in fair value that were attributable to both observable and unobservable inputs.

At August 31, 2008, the Company also had assets that under certain conditions would be subject to measurement at fair value on a non-recurring basis, which consisted of those associated with acquired businesses, including goodwill and other intangible assets. For these assets, measurement at fair value in periods subsequent to their initial recognition would be applicable if one or more of these assets was determined to be impaired; however, no impairment losses have occurred relative to any of these assets since they were initially recorded at acquisition. When and if recognition of these assets at their fair value is necessary, such measurements would be determined utilizing Level 3 inputs. For information on assets subject to measurement at fair value on a non-recurring basis relating to the Company’s Goldfish business, see Note 2: Discontinued Operations.

As of August 31, 2008, the Company has not made any fair value elections with respect to any of its eligible assets or liabilities as permitted under the provisions of Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities–Including an amendment of FASB Statement No. 115.

13.

Segment Disclosures

The Company’s business activities are managed in two segments: U.S. Card and Third-Party Payments.

•

U.S. Card. The U.S. Card segment includes Discover Card-branded credit cards issued to individuals and small businesses on the Discover Network and other consumer products and services, including installment loans, prepaid cards and other consumer lending and deposit products offered through the Company’s Discover Bank subsidiary.

•

Third-Party Payments. The Third-Party Payments segment includes PULSE, an automated teller machine, debit and electronic funds transfer network; Diners Club, a global payments network; and the Company’s third-party issuing business, which includes credit, debit and prepaid cards issued on the Discover Network by third parties.

On March 31, 2008, the Company sold its Goldfish business to Barclays Bank PLC. This business represented substantially all of the Company’s International Card segment. The International Card segment is presented in discontinued operations in this report. See Note 2: Discontinued Operations for further details.

The business segment reporting provided to and used by the Company’s chief operating decision maker is prepared using the following principles and allocation conventions:

•

Segment information is presented on a managed basis because management considers the performance of the entire managed loan portfolio in managing the business. A managed basis presentation, which is a non-GAAP presentation, involves reporting securitized loans with our owned loans in the managed basis statements of financial conditions and reporting the earnings on securitized loans in the same manner as the owned loans instead of as securitized income. The managed basis presentation generally reverses the effects of securitization transactions.

•

Other accounting policies applied to the operating segments are consistent with the accounting policies described in Note 2: Summary of Significant Accounting Policies to the audited consolidated and combined financial statements included in the Company’s annual report on Form 10-K for the year ended November 30, 2007.

•

Corporate overhead is not allocated between segments; all corporate overhead is included in the U.S. Card segment.

•

Through its operation of the Discover Network, the U.S Card segment incurs fixed marketing, servicing and infrastructure costs, which are not specifically allocated among the operating segments.

•

The assets of the Company are not allocated among the operating segments in the information reviewed by the Company’s chief operating decision maker.

•

Income taxes are not specifically allocated among the operating segments in the information reviewed by the Company’s chief operating decision maker.

The following table presents segment data on a managed basis and a reconciliation to a GAAP presentation (dollars in thousands):


	Managed Basis									GAAP Basis
For the Three Months Ended	U.S. Card		Third-Party Payments⁽¹⁾		Total		Securitization Adjustment⁽²⁾			Total
August 31, 2008
Interest income	$	1,637,588	$	662	$	1,638,250	$	(956,558	)	$	681,692
Interest expense		534,870		17		534,887		(229,244	)		305,643

Net interest income		1,102,718		645		1,103,363		(727,314	)		376,049
Provision for loan losses		754,028		—		754,028		(389,190	)		364,838
Other income		482,311		54,686		536,997		338,124			875,121
Other expense		585,760		26,787		612,547		—			612,547

Income from continuing operations before income tax expense		245,241	$	28,544	$	273,785	$	—		$	273,785

August 31, 2007
Interest income	$	1,626,214	$	594	$	1,626,808	$	(951,944	)	$	674,864
Interest expense		703,024		—		703,024		(385,900	)		317,124

Net interest income		923,190		594		923,784		(566,044	)		357,740
Provision for loan losses		418,349		—		418,349		(272,522	)		145,827
Other income		481,060		29,465		510,525		293,522			804,047
Other expense		605,264		20,620		625,884		—			625,884

Income from continuing operations before income tax expense	$	380,637	$	9,439	$	390,076	$	—		$	390,076

For the Nine Months Ended
August 31, 2008
Interest income	$	4,861,739	$	1,823	$	4,863,562	$	(2,907,005	)	$	1,956,557
Interest expense		1,754,450		19		1,754,469		(796,137	)		958,332

Net interest income		3,107,289		1,804		3,109,093		(2,110,868	)		998,225
Provision for loan losses		1,962,633		—		1,962,633		(1,081,194	)		881,439
Other income		1,539,796		126,087		1,665,883		1,029,674			2,695,557
Other expense		1,754,685		67,030		1,821,715		—			1,821,715

Income from continuing operations before income tax expense	$	929,767	$	60,861	$	990,628	$	—		$	990,628

August 31, 2007
Interest income	$	4,709,530	$	1,726	$	4,711,256	$	(2,786,530	)	$	1,924,726
Interest expense		1,990,471		19		1,990,490		(1,118,137	)		872,353

Net interest income		2,719,059		1,707		2,720,766		(1,668,393	)		1,052,373
Provision for loan losses		1,268,674		—		1,268,674		(830,973	)		437,701
Other income		1,497,367		89,395		1,586,762		837,420			2,424,182
Other expense		1,779,750		61,733		1,841,483		—			1,841,483

Income from continuing operations before income tax expense	$	1,168,002	$	29,369	$	1,197,371	$	—		$	1,197,371

(1)	Diners Club was acquired on June 30, 2008.

(2)

The Securitization Adjustment column presents the effect of loan securitizations by recharacterizing as securitization income the portions of the following items that relate to the securitized loans: interest income, interest expense, provision for loan losses, discount and interchange revenue and loan fee revenues. Securitization income is reported in other income.

14.

Related Party Transactions

Related Party Transactions with Morgan Stanley prior to the Distribution

Morgan Stanley ceased to be a related party to the Company effective upon the Distribution on June 30, 2007. Prior to the Distribution, Morgan Stanley provided a variety of products and services to the Company or on the Company’s behalf and the Company provided certain products and services to Morgan Stanley. Subsequent to the Distribution, certain arrangements with Morgan Stanley have continued in accordance with the Transition Services Agreement and other agreements by and between Morgan Stanley and the Company (see the Company’s annual report on Form 10-K for the year ended November 30, 2007). Transactions with Morgan Stanley subsequent to the Distribution are not isolated from those conducted with other unrelated third parties and are thus not included in the information provided below.

Information provided for the three and nine months ended August 31, 2007 only includes transactions with Morgan Stanley through the date of Distribution, June 30, 2007, as Morgan Stanley was not considered a related party subsequent to the Distribution. Amounts due from or to Morgan Stanley are not provided for November 30, 2007 or August 31, 2008, as Morgan Stanley was not a related party at either date.

The Company paid dividends to Morgan Stanley during the three and nine months ended August 31, 2008 of $350 million and $850 million, respectively. The following table summarizes amounts recorded in the consolidated and combined financial statements as a result of related party transactions with Morgan Stanley (dollars in thousands):


	For the Three Months Ended			For the Nine Months Ended
	August 31, 2007			August 31, 2007
Interest expense:
Federal Funds purchased	$	—		$	29,514
Short-term borrowings		31,963			113,201
Long-term borrowings		—			31,123
Amortization of brokerage commissions		2,333			16,223
Servicing and administrative fees		1,541			19,415

Other income:
Gain on the sale of mortgage loans		602			2,375
Rental income		417			3,056
Amortization of underwriting fees on credit card securitizations		(789	)		(5,640	)

Other expense:
Rent expense		466			2,965
Transaction processing related to consumer loans		341			2,845

The table below summarizes intercompany expense allocations by functional area⁽¹⁾ (dollars in thousands):


	For the Three Months Ended		For the Nine Months Ended
	August 31, 2007		August 31, 2007
Company IT	$	—	$	2,608
Company Management⁽²⁾		1,799		13,071
Finance		2,158		13,973
Legal and Compliance		1,025		7,021
Strategy, Administration and other		3,170		14,944

Total Morgan Stanley allocations	$	8,152	$	51,617

(1)

Allocations based on percentage of total expenses of each functional area versus line item specific allocations. Majority of allocations relates to compensation expense.

(2)

Represents allocations of Morgan Stanley senior management costs.

15.

Subsequent Events

On September 16, 2008, the Company’s board of directors declared a cash dividend of $0.06 per share. The cash dividend is payable on October 22, 2008, to stockholders of record at the close of business on October 1, 2008.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated and combined financial statements and related notes included elsewhere in this quarterly report. This quarterly report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are based upon the current beliefs and expectations of our management and are subject to significant risks and uncertainties. Actual results may differ materially from those set forth in the forward-looking statements. These forward-looking statements speak only as of the date of this quarterly report, and there is no undertaking to update or revise them as more information becomes available. The following factors, among others, could cause actual results to differ materially from those set forth in the forward-looking statements: the actions and initiatives of current and potential competitors; our ability to manage credit risks and securitize our receivables at acceptable rates and under sale accounting treatment; changes in economic variables, such as the availability of consumer credit, the housing market, energy costs, the number and size of personal bankruptcy filings, the rate of unemployment and the levels of consumer confidence and consumer debt; the level and volatility of equity prices, commodity prices and interest rates, currency values, investments, other market fluctuations and other market indices; the availability and cost of funding and capital; access to U.S. debt and deposit markets; losses in our investment portfolio; the ability to increase or sustain Discover Card usage or attract new cardmembers and introduce new products or services; our ability to attract new merchants and maintain relationships with current merchants; our ability to successfully integrate the Diners Club International network and maintain relationships with network participants; material security breaches of key systems; unforeseen and catastrophic events; our reputation; the potential effects of technological changes; the effect of political, economic and market conditions and geopolitical events; unanticipated developments relating to lawsuits, investigations or similar matters; the impact of current, pending and future legislation, regulation and regulatory and legal actions, including the Federal Reserve Board’s proposed amendments limiting or modifying certain credit card practices; our ability to attract and retain employees; the ability to protect our intellectual property; the impact of our separation from Morgan Stanley; the impact of any potential future acquisitions; investor sentiment; and the restrictions on our operations resulting from indebtedness incurred during our separation from Morgan Stanley. Additional factors that could cause our results to differ materially from those described below can be found under “Part I. Item 1A. Risk Factors” in our annual report on Form 10-K for the year ended November 30, 2007 and “Part II. Other Information — Item 1A. Risk Factors” in our quarterly report on Form 10-Q for the quarter ended May 31, 2008, filed with the SEC and available at the SEC's internet site (http://www.sec.gov).

Introduction and Overview

Discover Financial Services is a leading credit card issuer and electronic payment services company with one of the most recognized brands in U.S. financial services. We offer credit cards and prepaid cards as well as other financial products and services to qualified customers. We are also a leader in payment processing and related services for merchants and financial institutions. Our fiscal year ends on November 30 of each year.

We continue to increase acceptance of cards issued on our signature card network (the “Discover Network”) among small and mid-sized merchants in the United States through agreements with third-party acquirers. The purchase of Diners Club International (“Diners Club”), completed on June 30, 2008, provides us with another strong brand name and continues our progress toward increasing acceptance worldwide. As we achieve interoperability between Diners Club and the Discover Network over the next two to three years, we expect Discover Network cardholders to be able to use their cards at merchants that accept Diners Club cards around the world, and Diners Club cardholders to be able to use their cards on the Discover Network in North America. The results of Diners Club are included in the Third-Party Payments segment.

Our primary revenues come from interest income earned on loan receivables, securitization income derived from the transfer of credit card loan receivables to securitization trusts and subsequent issuance of beneficial interests through securitization transactions, and fees earned from cardmembers, merchants and issuers. The

primary expenses required to operate our business include funding costs (interest expense), loan losses, cardmember rewards, and expenses incurred to grow and service our loan receivables (e.g., compensation expense and marketing).

Our business activities are funded primarily through the process of asset securitization, the raising of consumer deposits, and both secured and unsecured debt. In a credit card securitization, loan receivables are first transferred to the securitization trust, from which beneficial interests are issued to investors. We continue to own and service the accounts that generate the securitized loans. The trusts utilized by us to facilitate asset securitization transactions are not our subsidiaries. These trusts are excluded from our consolidated and combined financial statements in accordance with accounting principles generally accepted in the United States (“GAAP”). Because our securitization activities qualify as sales under GAAP and accordingly are not treated as secured financing transactions, we remove credit card loan receivables equal to the amount of the investor interests in securitized loans from our consolidated statements of financial condition. As a result, asset securitizations have a significant effect on our consolidated and combined financial statements in that the portions of interest income, provision for loan losses and certain components of other income related to the securitized loans against which beneficial interests have been issued are no longer recorded in our consolidated and combined statements of income; however, they remain significant factors in determining the securitization income we receive on our retained beneficial interests in those transactions. See “—Accounting Treatment for Off-Balance Sheet Securitizations” below for information regarding proposed amendments to the accounting standards applicable to asset securitizations and see “—Outlook” below for a discussion of the current state of the securitization markets.

Our senior management evaluates business performance and allocates resources using financial data that is presented on a managed basis. Managed loans consist of our on-balance sheet loan portfolio, loans held for sale and loan receivables that have been securitized and against which beneficial interests have been issued. Owned loans, a subset of managed loans, refer to our on-balance sheet loan portfolio and loans held for sale and include the undivided seller’s interest we retain in our securitizations. A managed basis presentation, which is a non-GAAP presentation, involves reporting securitized loans with our owned loans in the managed basis statements of financial condition and reporting the earnings on securitized loans in the same manner as the owned loans instead of as securitization income. The managed basis presentation generally reverses the effects of securitization transactions; however, there are certain assets that arise from securitization transactions that are not reversed. Specifically, these assets are the cash collateral accounts that provide credit enhancement to the investors in the transactions and cardmember payments allocated to the securitized loans, both of which are held at the trusts. These assets also include the interest-only strip receivable, reflecting the estimated fair value of the excess cash flows allocated to securitized loans and retained certificated beneficial interests. Income derived from these assets representing interest earned on accounts at the trusts, changes in the fair value of the interest-only strip receivable and interest income on investment securities also are not reversed in a managed presentation.

Managed loan data is relevant because we service the securitized and owned loans, and the related accounts, in the same manner without regard to ownership of the loans. Therefore, management believes it is useful for investors to consider the credit performance of the entire managed loan portfolio to understand the quality of loan originations and the related credit risks inherent in the owned portfolio and retained interests in our securitizations.

Financial measures using managed data are non-GAAP financial measures. Whenever managed data is presented in this quarterly report, a reconciliation of the managed data to the most directly comparable GAAP-basis financial measure is provided. See “—GAAP to Managed Data Reconciliations.”

Third Quarter Highlights

•

During the third quarter of 2008, we experienced growth in revenues (net interest income plus other income) as a result of Discover Card volume, installment loan growth and strong transaction volume in

our payments business as compared to the third quarter of 2007. Managed loans grew to $50 billion, from $47 billion, reflecting growth in both credit card and installment loans. Card volume grew year over year as sales volumes and balance transfers grew 5% and 11%, respectively, over the prior year. Our payments business volume increased by 48% over the prior year to $35 billion, including a $5 billion volume contribution from Diners Club.

•

The consumer credit environment continues to be challenging. The managed net charge-off rate for the quarter was 5.20% and the managed over 30 days delinquency rate was 3.85% at the end of the period. The owned charge-off rate and owned over 30 days delinquency rate were 4.76% and 3.58%, respectively, for the quarter. Additionally, the loan loss reserve rate increased to 4.41% in the quarter compared to 3.28% in the third quarter of 2007.

•

We increased our liquidity reserve by $1.2 billion since May 31, 2008 to $9.6 billion. Growth in funding in the quarter was achieved primarily through our deposit gathering channels. Deposit balances grew by approximately $2.2 billion, with approximately half the growth coming from direct-to-consumer deposits. We also completed two securitization transactions resulting in proceeds of $1.2 billion during the quarter.

•

On June 30, 2008, we purchased Diners Club for $168 million in cash, expanding our credit and debit payments business globally. At the end of the quarter, Diners Club is consolidated into our statement of financial condition, and two months of its operating results are included in our consolidated statements of income.

Outlook

Our financial results continue to be adversely impacted by the challenging consumer credit environment and capital market conditions, which began with declines in the housing markets, rising unemployment and the write-down of mortgage-related securities, and spread to other financial instruments and the financial markets more generally. We believe deterioration in the consumer credit environment in the United States has been driven primarily by decreased availability of credit to consumers, rising unemployment levels, declining housing prices and rising energy costs. We recorded higher provision for loan losses this quarter as a result of higher charge-offs, owned loan growth and in anticipation of higher future charge-off rates. We have been experiencing a trend of a greater percent of delinquent accounts flowing into later stages of delinquency and eventually into charge- off. Although our underwriting and portfolio management strategies and geographic diversity are designed to manage exposure to credit losses, the delinquency trend and continued challenges in the consumer credit environment are likely to lead to a higher charge-off rate.

Deterioration in the capital markets, which has caused many financial institutions to seek additional capital, merge with larger and stronger financial institutions and, in some cases, fail, has led to concerns by market participants about the stability of financial markets generally and the strength of counterparties. We believe these concerns have resulted in a contraction of available credit, even for the most credit-worthy borrowers. Historically, we have used the asset-backed securities market as an important source of funding. The continued disruption in the capital markets has resulted in higher costs of and reduced access to asset-backed securitization funding. Due to recent market events, the public asset-backed securitization market has not been available at volumes and pricing levels that would be attractive to us. Our last public asset-backed securitization transaction was on June 18, 2008. It is difficult to predict if or when securitization markets will return to historical capacity and pricing levels.

Our response to the disruptions in the securitization markets has been and we anticipate will continue to be increased utilization of brokered and direct-to-consumer deposit channels. As of August 31, 2008, we had total deposits of $27.0 billion. Our use of deposit funding is dependent upon consumers choosing to deposit funds with our banking subsidiary, Discover Bank, and the willingness of third-party brokers to sell our deposits to their customers. Future market developments, as well as changes in consumer and market perceptions, could impact our ability to maintain and increase our deposit funding levels. An inability to obtain deposit funding in the future would materially adversely affect our liquidity position, financial condition and funding costs.

We have approximately $2.6 billion in public asset-backed securities maturing during the fourth quarter of 2008. As the downturn in execution levels in the capital markets is expected to continue, we anticipate that some or all of the fourth quarter maturities will be funded through our deposit channels. This shift will result in higher levels of owned loan receivables, a related increase in allowance for loan losses and a greater reduction in the value of the interest-only strip receivable. We also have $1.5 billion of unutilized commitments from third-party commercial paper asset-backed conduits for securitization funding, including a $750 million conduit facility established in the third quarter.

The interest rate environment remains a challenge to our business. Since August 31, 2008, LIBOR has moved to significantly higher levels. If LIBOR remains elevated during the fourth quarter, we will experience higher interest expense on our off-balance sheet borrowings resulting in a reduction in our securitization income and a decline in the value of our interest-only strip receivable.

Our payments business continues to be an area of opportunity for us. Our payments business grew its transaction volume in the third quarter, which we expect to continue throughout the rest of this year and into next year, as this business continues to benefit from new and existing relationships with financial institutions. The addition of Diners Club enhances our opportunities in the global payments business. However, we will begin to incur interoperability and integration costs associated with Diners Club and, therefore, do not expect Diners Club to contribute to future results at the same level as in the third quarter.

Accounting Treatment for Off-Balance Sheet Securitizations

The Financial Accounting Standards Board (“FASB”) has issued proposed amendments to Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, as amended (“Statement No. 140”), and FASB Interpretation No. 46R, Consolidation of Variable Interest Entities (“FIN 46R”). Under the proposed amendment to Statement No. 140, the concept of a qualifying special purpose entity (“QSPE”) has been eliminated. QSPEs are currently exempt from the consolidation provisions of FIN 46R and, as a result, amendments to that standard are being considered as well. Exposure Drafts for proposed amendments to each standard were issued on September 15, 2008, and each is subject to a 60-day public comment period. Based on comments it may receive and other considerations, the FASB may revise the amendments before issuing final guidance. The changes to these standards, if adopted as proposed, may make it more difficult for us to maintain or establish sale accounting treatment in connection with transfers of financial assets in securitization transactions and could result in consolidation of the securitization entities by us. This would have a significant impact on our consolidated financial statements. For example, the impact of the potential consolidation, if applied as of August 31, 2008, may require us to add approximately $27 billion of securitized receivables to our assets, add the related debt issued to third-party investors to our liabilities, and reclassify amounts due from securitization. As proposed, each amended standard would become effective for us on December 1, 2009. For a discussion of certain risks to us associated with the proposed amendments, see the discussion under “Part II. Other Information—Item 1A. Risk Factors” in our quarterly report on Form 10-Q for the quarter ended May 31, 2008. In addition, a new FASB Staff Position, which will require additional disclosures for securitization activities prior to the effective date of the amendments to Statement No. 140 and FIN 46R, is expected to be effective for us as early as December 1, 2008. On September 15, 2008, the federal banking agencies issued a joint press release stating that they are evaluating the potential impact that these proposals could have on banking organizations’ financial statements, regulatory capital, and other regulatory requirements.

Legislative and Regulatory Developments

The Federal Reserve Board has proposed significant amendments to regulations that would limit or modify certain credit card practices, including, but not limited to, restrictions on applying rate increases to existing balances, payment allocation and default pricing. The Federal Reserve Board has indicated it hopes to publish final rules by the end of the year. We do not know the content of the final amendments nor the resulting impact

from the amendments at this time. If the amendments are adopted as proposed, the amendments would have a material adverse effect on our results of operations. For a discussion of certain risks to us associated with the proposed amendments, see the discussion under “Part II. Other Information—Item 1A. Risk Factors” in our quarterly report on Form 10-Q for the quarter ended May 31, 2008. In September, the U.S. House of Representatives approved a bill that would impose restrictions similar to those proposed by the Federal Reserve Board, but Congress did not take final action on this legislation before adjourning.

The Federal Deposit Insurance Corporation has proposed amendments to the deposit insurance assessment rates. The proposed amendments are subject to a 30 day public comment period. If adopted as proposed, we would have to pay higher deposit insurance assessments.

* * *

The remaining discussion provides a summary of our results of operations for the three and nine months ended August 31, 2008 and 2007, as well as our financial condition at August 31, 2008 and November 30, 2007. All information and comparisons are based on continuing operations.

Segments

We manage our business activities in two segments: U.S. Card and Third-Party Payments. In compiling the segment results that follow, the U.S. Card segment bears all overhead costs that are not specifically associated with a particular segment and all costs associated with Discover Network marketing, servicing and infrastructure, with the exception of an allocation of direct and incremental costs driven by the Third-Party Payments segment.

Third-Party Payments. The Third-Party Payments segment includes the PULSE Network (“PULSE”), an automated teller machine, debit and electronic funds transfer network; Diners Club, a global payments network; and our third-party issuing business, which includes credit, debit and prepaid cards issued on the Discover Network by third parties.

The following table presents segment data on a managed basis and a reconciliation to a GAAP presentation (dollars in thousands):


	Managed Basis									GAAP Basis
For the Three Months Ended	U.S. Card		Third-Party Payments⁽¹⁾		Total		Securitization Adjustment⁽²⁾			Total
August 31, 2008
Interest income	$	1,637,588	$	662	$	1,638,250	$	(956,558	)	$	681,692
Interest expense		534,870		17		534,887		(229,244	)		305,643

Net interest income		1,102,718		645		1,103,363		(727,314	)		376,049
Provision for loan losses		754,028		—		754,028		(389,190	)		364,838
Other income		482,311		54,686		536,997		338,124			875,121
Other expense		585,760		26,787		612,547		—			612,547

Income from continuing operations before income tax expense	$	245,241	$	28,544	$	273,785	$	—		$	273,785

August 31, 2007
Interest income	$	1,626,214	$	594	$	1,626,808	$	(951,944	)	$	674,864
Interest expense		703,024		—		703,024		(385,900	)		317,124

Net interest income		923,190		594		923,784		(566,044	)		357,740
Provision for loan losses		418,349		—		418,349		(272,522	)		145,827
Other income		481,060		29,465		510,525		293,522			804,047
Other expense		605,264		20,620		625,884		—			625,884

Income from continuing operations before income tax expense	$	380,637	$	9,439	$	390,076	$	—		$	390,076

For the Nine Months Ended
August 31, 2008
Interest income	$	4,861,739	$	1,823	$	4,863,562	$	(2,907,005	)	$	1,956,557
Interest expense		1,754,450		19		1,754,469		(796,137	)		958,332

Net interest income		3,107,289		1,804		3,109,093		(2,110,868	)		998,225
Provision for loan losses		1,962,633		—		1,962,633		(1,081,194	)		881,439
Other income		1,539,796		126,087		1,665,883		1,029,674			2,695,557
Other expense		1,754,685		67,030		1,821,715		—			1,821,715

Income from continuing operations before income tax expense	$	929,767	$	60,861	$	990,628	$	—		$	990,628

August 31, 2007
Interest income	$	4,709,530	$	1,726	$	4,711,256	$	(2,786,530	)	$	1,924,726
Interest expense		1,990,471		19		1,990,490		(1,118,137	)		872,353

Net interest income		2,719,059		1,707		2,720,766		(1,668,393	)		1,052,373
Provision for loan losses		1,268,674		—		1,268,674		(830,973	)		437,701
Other income		1,497,367		89,395		1,586,762		837,420			2,424,182
Other expense		1,779,750		61,733		1,841,483		—			1,841,483

Income from continuing operations before income tax expense	$	1,168,002	$	29,369	$	1,197,371	$	—		$	1,197,371

(1)	Diners Club was acquired on June 30, 2008.

(2)

The segment discussions that follow for the three and nine months ended August 31, 2008 and 2007 are on a managed basis.

U.S. Card

The U.S. Card segment reported pretax income of $245.2 million for the three months ended August 31, 2008, down $135.4 million, or 36%, as compared to August 31, 2007. The decrease in pretax income was driven by higher provision for loan losses, which was partially offset by an increase in net interest income. Provision for loan losses increased $335.7 million, or 80%, as a result of higher net charge-offs and a higher reserve rate, each of which is reflective of current economic conditions and recent delinquency trends, as well as owned loan growth. Net interest income increased $179.5 million, or 19%, when compared to the same period in 2007, reflecting widening net interest margins benefiting from lower cost of funds as our borrowing costs declined as a result of the Federal Reserve’s interest rate reductions in the first half of 2008 and amortization of balance transfer fees previously recorded in loan fee income. Other expenses decreased $19.5 million, or 3%, due to lower marketing expenditures, lower depreciation expense on information technology equipment and lower legal fees during the three months ended August 31, 2008, partially offset by higher compensation expenses. Other income was relatively flat as an increase in discount and interchange revenue was offset by the inclusion of balance transfer fee amortization in interest income beginning in the third quarter of 2008.

The U.S. Card segment reported pretax income of $929.8 million for the nine months ended August 31, 2008, down $238.2 million, or 20%, as compared to August 31, 2007. The decrease in pretax income was driven by higher provision for loan losses, which was partially offset by increased net interest income. Provision for loan losses increased $694.0 million, or 55%, as a result of higher net charge-offs and a higher reserve rate, each of which is reflective of current economic conditions and recent delinquency trends, as well as owned loan growth. Net interest income increased $388.2 million, or 14%, as interest income benefited from higher average loan receivables as well as an increase in the level of interest-earning assets related to the liquidity reserve, partially offset by an increase in borrowings to support the asset growth. The lower interest rate environment drove down our cost of funds significantly, but was partially offset by lower interest income earned on our floating rate interest-earning assets. Other income increased $42.4 million, or 3%, due to an increase in discount and interchange revenue partially offset by the inclusion of balance transfer fee amortization in interest income beginning in the third quarter of 2008. Other expenses decreased $25.0 million, or 1%, due to lower legal fees partially offset by higher compensation expenses.

The managed loan balance of $50.4 billion at August 31, 2008 was up 6% from August 31, 2007. This increase in loans is attributable to increases in credit card sales, installment loans and balance transfers in addition to lower payment rates. The weakening economic environment adversely impacted cardmember delinquencies and charge-offs. The managed over 30 days delinquency rate for the segment, including non-credit card loans, was 3.85%, 69 basis points higher than last year, and the managed credit card over 30 days delinquency rate was 3.92%, up 76 basis points from last year. For the three months ended August 31, 2008, the managed segment and credit card charge-off rates were 5.20% and 5.28%, up 154 and 161 basis points from the three and nine months ended August 31, 2007, respectively. For the nine months ended August 31, 2008, the managed segment and credit card charge-off rates were 4.84% and 4.90%, up 101 and 107 basis points from the comparable prior year periods, respectively. Our loan growth combined with the deterioration in the credit environment led to a $113.0 million increase to our reserves over and above our net charge-offs for the quarter.

Third-Party Payments

The Third-Party Payments segment continues to produce solid results. Volume, revenues and pretax income all grew significantly in the third quarter of 2008 as compared to the third quarter of 2007. Our volumes continue to benefit from new issuers and increased volume from existing issuers. This increase in volume coupled with higher fee income and the inclusion of Diners Club results for July and August drove increases in revenues and pretax income.

The Third-Party Payments segment reported pretax income of $28.5 million for the three months ended August 31, 2008, up $19.1 million as compared to the three months ended August 31, 2007. The increase in pretax income was driven by increased revenues from transaction growth and an increase in fee revenue, as well as a $7.2 million contribution from Diners Club. Third-Party Payments volume was $35.3 billion, up 48% compared to last year, reflecting the impact of new issuers, increased volume from existing issuers and the addition of July and August Diners Club volume of $5.2 billion. Diners Club volume is derived from data provided by licensees for Diners Club-branded cards issued outside of North America and is subject to subsequent revision or amendment.

The Third-Party Payments segment reported pretax income of $60.9 million for the nine months ended August 31, 2008, up $31.5 million, as compared to August 31, 2007. The increase in pretax income was driven by increased revenues from transaction growth, $5.2 million in revenue related to two separate one-time contractual payments and an increase in fee revenue, as well as a $7.2 million contribution from Diners Club, partially offset by marketing and pricing incentives. Third-Party Payments volume was $91.1 billion, up 35% compared to last year, reflecting the impact of new issuers, increased volume from existing issuers and the addition of July and August Diners Club volume of $5.2 billion.

GAAP to Managed Data Reconciliations

Securitized loans against which beneficial interests have been issued to third parties are removed from our consolidated statements of financial condition. Instances in which we retain certificated beneficial interests in the securitization transactions result in a reduction to loan receivables of the amount of the retained interest and a corresponding increase in available-for-sale investment securities. The portions of interest income, provision for loan losses and certain components of other income related to the securitized loans against which beneficial interests have been issued are no longer recorded in our consolidated and combined statements of income; however, they remain significant factors in determining the securitization income we receive on our retained beneficial interests in those transactions. Management believes it is useful for investors to consider the credit performance of the entire managed loan portfolio to understand the quality of loan originations and the related credit risks inherent in the owned portfolio and retained interests in securitization. Loan receivables on a GAAP (or owned) basis and related performance measures, including yield, charge-offs and delinquencies can vary from those presented on a managed basis. Generally, loan receivables included in the securitization trusts are derived from accounts that are more seasoned, while owned loan receivables represent a greater concentration of newer accounts, occurring as a result of the degree to which receivables from newer accounts are added to the trusts. The seasoning of an account is measured by the age of the account relationship. In comparison to more seasoned accounts, loan receivables of newer accounts typically carry lower interest yields resulting from introductory offers to new cardmembers and lower charge-offs and delinquencies.

Beginning with “—Earnings Summary,” the discussion of GAAP results is presented on a consolidated and combined basis with any material differences between segment performance specifically identified. The table that follows provides a GAAP to managed data reconciliation of loan receivables and related statistics that are impacted by asset securitization:

Reconciliation of GAAP to Managed Data


	For the Three Months Ended August 31,						For the Nine Months Ended August 31,
	2008			2007			2008			2007
	(dollars in thousands)
Loan Receivables
Total Loans
GAAP Basis	$	21,767,483		$	19,170,450		$	21,767,483		$	19,170,450
Securitization Adjustment		28,659,822			28,273,657			28,659,822			28,273,657

Managed Basis	$	50,427,305		$	47,444,107		$	50,427,305		$	47,444,107

Average Total Loans
GAAP Basis	$	21,053,804		$	19,812,392		$	20,820,031		$	20,127,794
Securitization Adjustment		27,965,279			27,204,080			27,629,914			26,630,250

Managed Basis	$	49,019,083		$	47,016,472		$	48,449,945		$	46,758,044

Interest Yield
GAAP Basis		11.41	%		11.20	%		10.72	%		10.80	%
Securitization Adjustment		13.61	%		13.88	%		14.00	%		13.94	%
Managed Basis		12.67	%		12.75	%		12.59	%		12.59	%

Net Principal Charge-off Rate
GAAP Basis		4.76	%		3.23	%		4.36	%		3.39	%
Securitization Adjustment		5.54	%		3.97	%		5.21	%		4.16	%
Managed Basis		5.20	%		3.66	%		4.84	%		3.83	%

Delinquency Rate (over 30 days)
GAAP Basis		3.58	%		2.81	%		3.58	%		2.81	%
Securitization Adjustment		4.06	%		3.40	%		4.06	%		3.40	%
Managed Basis		3.85	%		3.16	%		3.85	%		3.16	%

Delinquency Rate (over 90 days)
GAAP Basis		1.73	%		1.31	%		1.73	%		1.31	%
Securitization Adjustment		2.00	%		1.60	%		2.00	%		1.60	%
Managed Basis		1.88	%		1.48	%		1.88	%		1.48	%
Credit Card Loans
Credit Card Loans
GAAP Basis	$	20,688,685		$	19,078,441		$	20,688,685		$	19,078,441
Securitization Adjustment		28,659,822			28,273,657			28,659,822			28,273,657

Managed Basis	$	49,348,507		$	47,352,098		$	49,348,507		$	47,352,098

Average Credit Card Loans
GAAP Basis	$	20,202,845		$	19,722,180		$	20,205,528		$	20,035,079
Securitization Adjustment		27,965,279			27,204,080			27,629,914			26,630,250

Managed Basis	$	48,168,124		$	46,926,260		$	47,835,442		$	46,665,329

Interest Yield
GAAP Basis		11.45	%		11.22	%		10.73	%		10.82	%
Securitization Adjustment		13.61	%		13.88	%		14.00	%		13.94	%
Managed Basis		12.70	%		12.76	%		12.62	%		12.60	%

Net Principal Charge-off Rate
GAAP Basis		4.92	%		3.24	%		4.47	%		3.40	%
Securitization Adjustment		5.54	%		3.97	%		5.21	%		4.16	%
Managed Basis		5.28	%		3.67	%		4.90	%		3.83	%

Delinquency Rate (over 30 days)
GAAP Basis		3.72	%		2.80	%		3.72	%		2.80	%
Securitization Adjustment		4.06	%		3.40	%		4.06	%		3.40	%
Managed Basis		3.92	%		3.16	%		3.92	%		3.16	%

Delinquency Rate (over 90 days)
GAAP Basis		1.81	%		1.31	%		1.81	%		1.31	%
Securitization Adjustment		2.00	%		1.60	%		2.00	%		1.60	%
Managed Basis		1.92	%		1.48	%		1.92	%		1.48	%

Critical Accounting Policies

In preparing the consolidated and combined financial statements in conformity with GAAP, management must make judgments and use estimates and assumptions about the effects of matters that are uncertain. For estimates that involve a high degree of judgment and subjectivity, it is possible that different estimates could reasonably be derived for the same period. For estimates that are particularly sensitive to changes in economic or market conditions, significant changes to the estimated amount from period to period are also possible. Management believes the current assumptions and other considerations used to estimate amounts reflected in the consolidated and combined financial statements are appropriate. However, if actual experience differs from the assumptions and other considerations used in estimating amounts in the consolidated and combined financial statements, the resulting changes could have a material adverse effect on our consolidated results of operations and, in certain cases, could have a material adverse effect on our consolidated financial condition. Management has identified the policies related to the estimation of the allowance for loan losses, the accounting for asset securitization transactions, interest income recognition, the accrual of cardmember rewards cost, the evaluation of goodwill for potential impairment and accrual of income taxes as critical accounting policies.

These critical accounting policies are discussed in greater detail in our annual report on Form 10-K for the year ended November 30, 2007. That discussion can be found within Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading Critical Accounting Policies. There have not been any material changes in the critical accounting policies from those discussed in our annual report on Form 10-K for the year ended November 30, 2007.

Earnings Summary

The following table outlines changes in the consolidated and combined statements of income for the periods presented (dollars in thousands):


	For the Three Months Ended August 31,				2008 vs. 2007 increase (decrease)					For the Nine Months Ended August 31,				2008 vs. 2007 increase (decrease)
	2008		2007		$			%		2008		2007		$			%
Interest income	$	681,692	$	674,864	$	6,828		1	%	$	1,956,557	$	1,924,726	$	31,831		2	%
Interest expense		305,643		317,124		(11,481	)	(4	%)		958,332		872,353		85,979		10	%

Net interest income		376,049		357,740		18,309		5	%		998,225		1,052,373		(54,148	)	(5	%)
Provision for loan losses		364,838		145,827		219,011		150	%		881,439		437,701		443,738		101	%

Net interest income after provision for loan losses		11,211		211,913		(200,702	)	(95	%)		116,786		614,672		(497,886	)	(81	%)
Other income		875,121		804,047		71,074		9	%		2,695,557		2,424,182		271,375		11	%
Other expense		612,547		625,884		(13,337	)	(2	%)		1,821,715		1,841,483		(19,768	)	(1	%)

Income from continuing operations before income tax expense		273,785		390,076		(116,291	)	(30	%)		990,628		1,197,371		(206,743	)	(17	%)
Income tax expense		94,885		145,925		(51,040	)	(35	%)		371,356		443,146		(71,790	)	(16	%)

Income from continuing operations	$	178,900	$	244,151	$	(65,251	)	(27	%)	$	619,272	$	754,225	$	(134,953)		(18	%)

Income from continuing operations for the three months ended August 31, 2008 was $178.9 million, down 27% compared to the three months ended August 31, 2007, driven by higher provision for loan losses partially offset by higher other income. Other income increased $71.1 million due to an increase in securitization income and other income, partially offset by lower loan fee income. The provision for loan losses increased reflecting higher net charge-offs as a result of the weakening economic environment.

Income from continuing operations for the nine months ended August 31, 2008 was $619.3 million, down 18% compared to the nine months ended August 31, 2007, driven by higher provision for loan losses and lower net interest income, partially offset by higher other income. Net interest income decreased $54.1 million due to

an increase in interest expense, partially offset by an increase in interest income. The provision for loan losses increased reflecting higher net charge-offs and a higher allowance for loan losses as a result of the weakening economic environment. Other income increased primarily due to higher securitization income which resulted from higher excess spread on securitized loans.

Net Interest Income

Net interest income represents the difference between interest income earned on interest-earning assets which we own and the interest expense incurred to finance those assets. Net interest margin represents interest income, net of interest expense, as a percentage of total interest-earning assets. Our interest-earning assets consist of loan receivables, our liquidity reserve which includes Federal Funds sold and money market mutual funds, certain retained interests in securitization transactions included in amounts due from asset securitization and investment securities. Interest-earning assets do not include investor interests in securitization transactions that have been transferred to third parties since they are not assets which we own. Similarly, interest income does not include the interest yield on the related loans. Our interest-bearing liabilities consist primarily of deposits, both brokered and direct. Net interest income is influenced by the following:

•

The level and composition of interest-earning assets and liabilities, including the percentage of floating rate credit card loan receivables we own and percentage of floating rate liabilities we owe;

•

Changes in the interest rate environment, including the levels of interest rates and the relationship between interest rate indices;

•

Credit performance of our loans, particularly with regard to charge-offs of finance charges which reduce interest income;

•

The terms of certificates of deposit upon initial offering, including maturity and interest rate; and

•

Effectiveness of interest rate swaps in our interest rate risk management program.

Net interest income increased $18.3 million, or 5%, during the three months ended August 31, 2008, as compared to the three months ended August 31, 2007, related to an $11.5 million decrease in interest expense and $6.8 million increase in interest income. During the three months ended August 31, 2008, our net interest income improved because of lower cost of funds and amortization of balance transfer fees previously included in loan fee income. But the lower interest rate environment also negatively impacted the return on our interest-earning assets and, therefore, our net interest margin, which decreased 45 basis points to 4.57% for the three months ended August 31, 2008 as compared to 5.02% for the three months ended August 31, 2007.

The decline in interest expense was due to a 79 basis point decrease in our cost of funds to 4.52%, reflecting the effect of the declining interest rate environment on our floating rate liabilities as well as lower issuance costs on new certificates of deposit. This was offset in part by a higher level of funding needed to support the growth of our interest-earning assets, specifically related to installment and credit card loan growth and a higher level of liquidity. The increase in interest income reflected this higher level of assets as well as the inclusion of $33.3 million of balance transfer fee amortization in interest income beginning in the third quarter of 2008, previously reported in loan fee income. This was partially offset by the impact of a lower interest rate environment on our floating rate assets, specifically amounts due from securitization, our liquidity reserve and a portion of loan receivables, 40% of which earned interest at floating rates for the three months ended August 31, 2008 as compared to 48% in the prior comparative period. Interest income was also adversely impacted by an increase in finance charge charge-offs related to the deteriorating credit performance of our loan receivables.

Net interest income decreased $54.1 million, or 5%, and net interest margin decreased 106 basis points to 4.09% during the nine months ended August 31, 2008, as compared to the nine months ended August 31, 2007, related to an $85.9 million increase in interest expense partially offset by a $31.8 million increase in interest income. During the nine months ended August 31, 2008, our net interest income declined because of a higher

level of borrowings and lower interest rates earned on our floating rate interest-earning assets, which also negatively impacted our net interest margin. However, these declines were partially offset by a lower cost of funds, interest earned on our loan installment products and the inclusion of balance transfer fee amortization in interest income.

The increase in interest expense was largely due to our higher average funding levels in 2008. Partially offsetting this increase in funding levels was the impact of a 52 basis point decrease to 4.73% in our cost of funds for the nine months ended August 31, 2008 as a result of the lower interest rate environment. Interest income increased due to the higher average liquidity reserve and installment loan growth as well as the inclusion of $33.3 million of balance transfer fee amortization in interest income beginning in the third quarter of 2008, previously reported in loan fee income. These increases were partially offset by higher finance charge charge-offs in addition to the impact of a lower interest rate environment on our floating rate assets, specifically our liquidity reserve, amounts due from securitization and loan receivables, 41% of which earned interest at floating rates for the nine months ended August 31, 2008 as compared to 54% in the prior comparative period.

Average Balance Sheet Analysis


	For the Three Months Ended
	August 31, 2008							August 31, 2007
	Average Balance			Rate		Interest		Average Balance			Rate		Interest
	(dollars in thousands)
Assets
Interest-earning assets:
Interest-earning deposits	$	5,555,331		2.26	%	$	31,551	$	—		—		$	—
Federal Funds sold		3,041,721		2.16	%		16,527		5,581,086		5.29	%		74,424
Commercial paper		—		—			—		15,622		5.38	%		212
Investment securities		1,062,374		5.38	%		14,372		99,009		5.47	%		1,366
Loans:⁽¹⁾
Credit cards⁽²⁾		20,202,845		11.45	%		581,417		19,722,180		11.22	%		557,814
Other consumer loans		850,959		10.58	%		22,630		90,212		6.21	%		1,413

Total loans		21,053,804		11.41	%		604,047		19,812,392		11.20	%		559,227
Other interest-earning assets		2,043,924		2.96	%		15,195		2,739,813		5.74	%		39,635

Total interest-earning assets		32,757,154		8.28	%		681,692		28,247,922		9.48	%		674,864
Allowance for loan losses		(859,279	)						(647,472	)
Other assets		3,069,261							2,687,810
Assets of discontinued operations		104,014							4,117,181

Total assets	$	35,071,150						$	34,405,441

Liabilities and Stockholders’ Equity
Interest-bearing liabilities:
Interest-bearing deposits:
Time deposits⁽³⁾	$	20,814,101		4.93	%		257,756	$	17,809,420		5.21	%		233,872
Money market deposits		4,193,590		2.75	%		29,027		3,114,087		5.31	%		41,672
Other interest-bearing deposits		36,538		0.85	%		78		27,766		3.20	%		224

Total interest-bearing deposits		25,044,229		4.56	%		286,861		20,951,273		5.22	%		275,768
Borrowings:
Short-term borrowings		(175	)	—			—		689,693		5.52	%		9,598
Long-term borrowings		1,861,695		4.01	%		18,782		2,064,251		6.10	%		31,758

Total borrowings		1,861,520		4.01	%		18,782		2,753,944		5.96	%		41,356

Total interest-bearing liabilities		26,905,749		4.52	%		305,643		23,705,217		5.31	%		317,124
Other liabilities and stockholders’ equity:
Liabilities of discontinued operations		8,428							2,964,220
Other liabilities and stockholders’ equity		8,156,973							7,736,004

Total other liabilities and stockholders’ equity		8,165,401							10,700,224

Total liabilities and stockholders’ equity	$	35,071,150						$	34,405,441

Net interest income						$	376,049						$	357,740

Net interest margin⁽⁴⁾				4.57	%						5.02	%
Interest rate spread⁽⁵⁾				3.76	%						4.17	%


	For the Nine Months Ended
	August 31, 2008							August 31, 2007
	Average Balance			Rate		Interest		Average Balance			Rate		Interest
	(dollars in thousands)
Assets
Interest-earning assets:
Interest-earning deposits	$	4,331,181		2.71	%	$	88,227	$	—		—		$	—
Federal Funds sold		3,792,038		2.94	%		83,868		3,896,393		5.30	%		155,134
Commercial paper		2,213		4.63	%		77		15,563		5.37	%		627
Investment securities		825,931		5.15	%		31,985		93,157		5.50	%		3,843
Loans:⁽¹⁾
Credit cards⁽²⁾		20,205,528		10.73	%		1,629,161		20,035,079		10.82	%		1,627,904
Other consumer loans		614,503		10.40	%		48,033		92,715		5.91	%		4,112

Total loans		20,820,031		10.72	%		1,677,194		20,127,794		10.80	%		1,632,016
Other interest-earning assets		2,718,728		3.68	%		75,206		3,070,102		5.78	%		133,106

Total interest-earning assets		32,490,122		8.01	%		1,956,557		27,203,009		9.43	%		1,924,726
Allowance for loan losses		(829,134	)						(661,947	)
Other assets		2,920,965							2,525,194
Assets of discontinued operations		1,756,000							3,582,878

Total assets	$	36,337,953						$	32,649,134

Liabilities and Stockholders’ Equity
Interest-bearing liabilities:
Interest-bearing deposits:
Time deposits⁽³⁾	$	20,566,987		5.04	%		778,918	$	15,232,558		5.14	%		588,043
Money market deposits		4,413,010		3.31	%		109,837		3,557,530		5.31	%		141,923
Other interest-bearing deposits		42,894		1.07	%		346		37,310		3.53	%		989

Total interest-bearing deposits		25,022,891		4.73	%		889,101		18,827,398		5.17	%		730,955
Borrowings:
Short-term borrowings		4,658		3.86	%		135		2,127,182		5.48	%		87,504
Long-term borrowings		1,946,686		4.72	%		69,096		1,187,208		6.05	%		53,894

Total borrowings		1,951,344		4.72	%		69,231		3,314,390		5.68	%		141,398

Total interest-bearing liabilities		26,974,235		4.73	%		958,332		22,141,788		5.25	%		872,353
Other liabilities and stockholders’ equity:
Liabilities of discontinued operations		1,288,822							2,686,940
Other liabilities and stockholders’ equity		8,074,896							7,820,406

Total other liabilities and stockholders’ equity		9,363,718							10,507,346

Total liabilities and stockholders’ equity	$	36,337,953						$	32,649,134

Net interest income						$	998,225						$	1,052,373

Net interest margin⁽⁴⁾				4.09	%						5.15	%
Interest rate spread⁽⁵⁾				3.29	%						4.18	%

(1)	Average balances of loan receivables include non-accruing loans and these loans are therefore included in the yield calculations. If these balances were excluded, there would not be a material impact on the amounts reported above.

(2)	Interest income on credit card loans includes $33.3 million of amortization of balance transfer fees for the three and nine months ended August 31, 2008.

(3)	Includes the impact of interest rate swap agreements used to change a portion of fixed rate funding to floating rate funding.

(4)	Net interest margin represents net interest income as a percentage of total interest-earning assets.

(5)	Interest rate spread represents the difference between the rate on total interest-earning assets and the rate on total interest-bearing liabilities.

Rate/Volume Variance Analysis⁽¹⁾


	For the Three Months Ended August 31, 2008 vs. August 31, 2007									For the Nine Months Ended August 31, 2008 vs. August 31, 2007
	Volume			Rate			Total			Volume			Rate			Total
	(dollars in thousands)
Increase (decrease) in net interest income due to changes in:
Interest-earning assets:
Interest-earning deposits	$	31,551		$	—		$	31,551		$	88,227		$	—		$	88,227
Federal Funds sold		(25,174	)		(32,723	)		(57,897	)		(4,046	)		(67,220	)		(71,266	)
Commercial paper		(106	)		(106	)		(212	)		(474	)		(76	)		(550	)
Investment securities		13,165			(159	)		13,006			28,553			(411	)		28,142
Loans:
Credit cards		12,876			10,727			23,603			19,142			(17,885	)		1,257
Other consumer loans		19,585			1,632			21,217			38,690			5,231			43,921

Total loans		32,461	&nb