DFS 8.31.2012 10Q

 
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, 2012
 
o
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  S    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  S    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  x
Accelerated filer  o
Non-accelerated filer  o (Do not check if a  smaller reporting company)    
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  S
As of September 28, 2012, there were 504,775,854 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, 2012
TABLE OF CONTENTS
 
 
 
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® MotivaSM Card, Discover® Open Road® Card, Discover® Network and Diners Club International®. All other trademarks, trade names and service marks included in this quarterly report on Form 10-Q are the property of their respective owners.

Table of Contents

Part I.
FINANCIAL INFORMATION

Item 1.
Financial Statements
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Financial Condition
 
August 31,
2012
 
November 30,
2011
 
(unaudited)
(dollars in thousands,
except share amounts)
Assets
 
 
 
Cash and cash equivalents
$
6,237,610

 
$
2,849,843

Restricted cash
301,349

 
1,285,820

Other short-term investments
250

 
—

Investment securities:

 

Available-for-sale (amortized cost of $6,250,126 and $6,019,927 at August 31, 2012 and November 30, 2011, respectively)
6,377,502

 
6,107,831

Held-to-maturity (fair value of 92,268 and $96,042 at August 31, 2012 and November 30, 2011, respectively)
90,005

 
98,222

Total investment securities
6,467,507

 
6,206,053

Loan receivables:
 
 
 
Mortgage loans held for sale, measured at fair value
272,082

 
—

Student loans held for sale
—

 
714,180

Loan portfolio:
 
 
 
Credit card
48,124,468

 
46,638,625

Other
5,893,952

 
4,733,742

Purchased credit-impaired loans
4,867,010

 
5,250,388

Total loan portfolio
58,885,430

 
56,622,755

Total loan receivables
59,157,512

 
57,336,935

Allowance for loan losses
(1,687,664
)
 
(2,205,196
)
Net loan receivables
57,469,848

 
55,131,739

Premises and equipment, net
519,621

 
483,250

Goodwill
287,043

 
255,421

Intangible assets, net
192,181

 
188,018

Other assets
2,433,255

 
2,383,793

Total assets
$
73,908,664

 
$
68,783,937

Liabilities and Stockholders’ Equity
 
 
 
Deposits:
 
 
 
Interest-bearing deposit accounts
$
42,175,032

 
$
39,463,887

Non-interest bearing deposit accounts
143,280

 
113,575

Total deposits
42,318,312

 
39,577,462

Short-term borrowings
250,139

 
50,000

Long-term borrowings
19,246,113

 
18,287,178

Accrued expenses and other liabilities
2,948,187

 
2,627,086

Total liabilities
64,762,751

 
60,541,726

Commitments, contingencies and guarantees (Notes 9, 12, and 13)

 

Stockholders’ Equity:
 
 
 
Common stock, par value $.01 per share; 2,000,000,000 shares authorized; 552,572,624 and 549,748,783 shares issued at August 31, 2012 and November 30, 2011, respectively
5,526

 
5,497

Additional paid-in capital
3,570,371

 
3,507,754

Retained earnings
6,877,990

 
5,243,318

Accumulated other comprehensive loss
(31,326
)
 
(51,679
)
Treasury stock, at cost; 45,086,760 and 20,918,354 shares at August 31, 2012 and November 30, 2011, respectively
(1,276,648
)
 
(462,679
)
Total stockholders’ equity
9,145,913

 
8,242,211

Total liabilities and stockholders’ equity
$
73,908,664

 
$
68,783,937


The table below presents the carrying amounts of certain assets and liabilities of Discover Financial Services’ consolidated variable interest entities (VIEs) which are included in the condensed consolidated statements of financial condition above. The assets in the table below include those assets that can only be used to settle obligations of the consolidated VIEs. The liabilities in the table below include third party liabilities of consolidated VIEs only, and exclude intercompany balances that eliminate in consolidation. The liabilities also exclude amounts for which creditors have recourse to the general credit of Discover Financial Services.
 
August 31,
2012
 
November 30,
2011
 
(unaudited)
(dollars in thousands)
Assets
 
 
 
Restricted cash
$
295,439

 
$
1,274,175

Credit card loan receivables
33,517,582

 
33,815,860

Purchased credit-impaired loans
2,631,970

 
2,839,871

Allowance for loan losses allocated to securitized loan receivables
(1,074,058
)
 
(1,510,730
)
Other assets
33,638

 
33,724

Liabilities
 
 
 
Long-term borrowings
$
17,337,914

 
$
15,842,512

Accrued interest payable
13,906

 
13,184

See Notes to Condensed Consolidated Financial Statements.

1
Table of Contents

DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Income

 
For the Three Months Ended August 31,
 
For the Nine Months Ended August 31,
 
2012
 
2011
 
2012
 
2011
 
(unaudited)
 (dollars in thousands, except per share amounts)
Interest income:
 
 
 
 
 
 
 
Credit card loans
$
1,451,836

 
$
1,423,496

 
$
4,296,757

 
$
4,243,803

Other loans
217,433

 
157,424

 
630,313

 
428,762

Investment securities
21,371

 
15,676

 
58,869

 
42,535

Other interest income
4,329

 
2,496

 
11,207

 
10,234

Total interest income
1,694,969

 
1,599,092

 
4,997,146

 
4,725,334

Interest expense:
 
 
 
 
 
 
 
Deposits
204,982

 
241,719

 
650,213

 
749,584

Short-term borrowings
423

 
33

 
424

 
116

Long-term borrowings
119,905

 
120,301

 
368,472

 
375,060

Total interest expense
325,310

 
362,053

 
1,019,109

 
1,124,760

Net interest income
1,369,659

 
1,237,039

 
3,978,037

 
3,600,574

Provision for loan losses
126,288

 
99,514

 
510,401

 
692,763

Net interest income after provision for loan losses
1,243,371

 
1,137,525

 
3,467,636

 
2,907,811

Other income:
 
 
 
 
 
 
 
Discount and interchange revenue, net
265,531

 
282,889

 
795,166

 
809,631

Protection products revenue
104,201

 
107,858

 
310,256

 
321,527

Loan fee income
80,012

 
84,243

 
241,719

 
250,596

Transaction processing revenue
59,168

 
43,931

 
163,823

 
131,792

Merchant fees
4,426

 
4,110

 
11,654

 
12,981

Gain (loss) on investments
—

 
(3,614
)
 
28

 
(3,622
)
Other income
80,912

 
32,546

 
154,247

 
135,526

Total other income
594,250

 
551,963

 
1,676,893

 
1,658,431

Other expense:
 
 
 
 
 
 
 
Employee compensation and benefits
274,366

 
241,881

 
770,448

 
684,782

Marketing and business development
160,534

 
133,398

 
410,975

 
393,244

Information processing and communications
68,812

 
63,547

 
210,723

 
194,852

Professional fees
107,749

 
106,042

 
317,334

 
301,122

Premises and equipment
19,562

 
18,063

 
55,728

 
53,268

Other expense
194,884

 
79,476

 
486,194

 
245,431

Total other expense
825,907

 
642,407

 
2,251,402

 
1,872,699

Income before income tax expense
1,011,714

 
1,047,081

 
2,893,127

 
2,693,543

Income tax expense
385,028

 
398,263

 
1,098,844

 
979,414

Net income
$
626,686

 
$
648,818

 
$
1,794,283

 
$
1,714,129

Net income allocated to common stockholders
$
620,770

 
$
641,772

 
$
1,776,770

 
$
1,694,636

Basic earnings per share
$
1.21

 
$
1.18

 
$
3.39

 
$
3.11

Diluted earnings per share
$
1.21

 
$
1.18

 
$
3.39

 
$
3.11

Dividends paid per share
$
0.10

 
$
0.06

 
$
0.30

 
$
0.14

See Notes to the Condensed Consolidated Financial Statements.

2
Table of Contents

DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Comprehensive Income

 
For the Three Months Ended August 31,
 
For the Nine Months Ended August 31,
 
2012
 
2011
 
2012
 
2011
 
(unaudited)
 (dollars in thousands, except per share amounts)
Net income
$
626,686

 
$
648,818

 
$
1,794,283

 
$
1,714,129

Other comprehensive income, net of taxes
 
 
 
 
 
 
 
Unrealized gain on securities available for sale, net of tax
9,931

 
38,170

 
24,626

 
54,897

Unrealized (loss) gain on cash flow hedges, net of tax
(241
)
 
8,208

 
(2,497
)
 
7,330

Unrealized pension and post-retirement benefit gain (loss), net of tax
—

 
1

 
(1,776
)
 
342

Other comprehensive income
9,690

 
46,379

 
20,353

 
62,569

Comprehensive income
$
636,376

 
$
695,197

 
$
1,814,636

 
$
1,776,698




See Notes to the Condensed Consolidated Financial Statements.

3
Table of Contents

DISCOVER FINANCIAL SERVICES
Condensed Consolidated 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
 
 
 
 
 
 
(unaudited)
(dollars and shares in thousands)
Balance at November 30, 2010
 
547,128

 
$
5,471

 
$
3,435,318

 
$
3,126,488

 
$
(82,548
)
 
$
(27,883
)
 
$
6,456,846

Net income
 
—

 
—

 
—

 
1,714,129

 
—

 
—

 
1,714,129

Other comprehensive income
 
—

 
—

 
—

 
—

 
62,569

 
—

 
62,569

Purchases of treasury stock
 
—

 
—

 
—

 
—

 
—

 
(207,560
)
 
(207,560
)
Common stock issued under employee benefit plans
 
40

 
—

 
906

 
—

 
—

 
—

 
906

Common stock issued and stock-based compensation expense
 
2,308

 
24

 
56,439

 
—

 
—

 
—

 
56,463

Dividends—common stock
 
—

 
—

 
—

 
(77,437
)
 
—

 
—

 
(77,437
)
Balance at August 31, 2011
 
549,476

 
$
5,495

 
$
3,492,663

 
$
4,763,180

 
$
(19,979
)
 
$
(235,443
)
 
$
8,005,916

 
 
 
 
 
 
 
 
 
 
 
 
 
 


Balance at November 30, 2011
 
549,749

 
$
5,497

 
$
3,507,754

 
$
5,243,318

 
$
(51,679
)
 
$
(462,679
)
 
$
8,242,211

Net income
 
—

 
—

 
—

 
1,794,283

 
—

 
—

 
1,794,283

Other comprehensive income
 
—

 
—

 
—

 
—

 
20,353

 
—

 
20,353

Purchases of treasury stock
 
—

 
—

 
—

 
—

 
—

 
(813,969
)
 
(813,969
)
Common stock issued under employee benefit plans
 
41

 
—

 
1,323

 
—

 
—

 
—

 
1,323

Common stock issued and stock based compensation expense
 
2,783

 
29

 
61,294

 
—

 
—

 
—

 
61,323

Dividends—common stock
 
—

 
—

 
—

 
(159,611
)
 
—

 
—

 
(159,611
)
Balance at August 31, 2012
 
552,573

 
$
5,526

 
$
3,570,371

 
$
6,877,990

 
$
(31,326
)
 
$
(1,276,648
)
 
$
9,145,913


See Notes to the Condensed Consolidated Financial Statements.

4
Table of Contents

DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Cash Flows
 
For the Nine Months Ended
August 31,
 
2012
 
2011
 
(unaudited)
 
(dollars in thousands)
Cash flows from operating activities
 
 
 
Net income
$
1,794,283

 
$
1,714,129

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
510,401

 
692,763

Deferred income taxes
159,001

 
351,854

Depreciation and amortization on premises and equipment
70,931

 
66,274

Amortization of deferred revenues
(154,008
)
 
(191,290
)
Other depreciation and amortization
(102,927
)
 
(35,346
)
(Gain) loss on investments
(28
)
 
3,622

Loss on equity method and other investments
8,061

 
—

(Gain) loss on premises and equipment
(494
)
 
3,242

Loss on sale of other assets
314

 
—

(Gain) on origination and sale of loans
(48,541
)
 
(6,154
)
Stock-based compensation expense
36,108

 
33,690

(Gain) on purchase of business
—

 
(15,917
)
Proceeds from sale of mortgage loans originated for sale
550,815

 
—

Net principal disbursed on mortgage loans originated for sale
(782,677
)
 
—

Changes in assets and liabilities:

 

(Increase) decrease in other assets
(129,661
)
 
32,339

Increase in accrued expenses and other liabilities
247,626

 
106,908

Net cash provided by operating activities
2,159,204

 
2,756,114

Cash flows from investing activities
 
 
 
Maturities of other short-term investments
—

 
375,000

Purchases of other short-term investments
(250
)
 
—

Maturities and sales of available-for-sale investment securities
1,558,449

 
786,463

Purchases of available-for-sale investment securities
(1,708,935
)
 
(1,627,215
)
Maturities of held-to-maturity investment securities
9,101

 
17,466

Purchases of held-to-maturity investment securities
(51,285
)
 
(550
)
Proceeds from sale of student loans held for sale
270,020

 
21,859

Net principal disbursed on loans originated for investment
(2,532,687
)
 
(3,040,152
)
Purchase of loan receivables
(390,075
)
 
(596,163
)
Purchase of net assets of a business
(48,886
)
 
—

Purchase of business, net of cash acquired
—

 
(401,158
)
Purchase of other investments
(27,168
)
 
(15,000
)
Decrease in restricted cash
985,338

 
623,794

Proceeds from sale of premises and equipment
515

 
13

Purchases of premises and equipment
(104,685
)
 
(70,053
)
Net cash used for investing activities
(2,040,548
)
 
(3,925,696
)
Cash flows from financing activities
 
 
 
Net increase in short-term borrowings
200,139

 
100,000

Proceeds from issuance of securitized debt
5,099,617

 
2,500,000

Maturities and repayment of securitized debt
(3,648,040
)
 
(5,114,986
)
Repayment of long-term borrowings and bank notes
(12,681
)
 
(345,048
)
Premium paid on debt exchange
(114,493
)
 
—

Proceeds from issuance of common stock
16,231

 
17,928

Purchases of treasury stock
(813,896
)
 
(207,560
)
Net increase in deposits
2,701,115

 
3,147,752

Dividends paid on common stock
(158,881
)
 
(69,712
)
Net cash provided by financing activities
3,269,111

 
28,374

Net increase (decrease) in cash and cash equivalents
3,387,767

 
(1,141,208
)
Cash and cash equivalents, at beginning of period
2,849,843

 
5,098,733

Cash and cash equivalents, at end of period
$
6,237,610

 
$
3,957,525

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid during the period for:
 
 
 
Interest expense
$
898,126

 
$
1,045,370

Income taxes, net of income tax refunds
$
967,774

 
$
635,360

Non-cash transactions:
 
 
 
Initial fair value of contingent consideration to be paid for purchase of net assets of a business
$
8,541

 
$
—

Assumption of debt by buyer related to loans sold
$
424,993

 
$
—

Assumption of SLC debt
$
—

 
$
2,921,372


See Notes to the Condensed Consolidated Financial Statements.

5
Table of Contents

Notes to the Condensed Consolidated Financial Statements
(unaudited)
 
1.
Background and Basis of Presentation
Description of Business. Discover Financial Services (“DFS” or the “Company”) is a direct banking and payment services company. The Company is a bank holding company under the Bank Holding Company Act of 1956 as well as a financial holding company under the Gramm-Leach-Bliley Act and therefore is subject to oversight, regulation and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). Through its Discover Bank subsidiary, a Delaware state-chartered bank, the Company offers its customers credit card loans, private student loans, personal loans, and deposit products. Through its Discover Home Loans, Inc. subsidiary, the Company offers its customers home loans. The majority of the Direct Banking revenues relate to interest income earned on each of its loan products. Through its DFS Services LLC subsidiary and its subsidiaries, the Company operates the Discover Network, the PULSE Network (“PULSE”), and Diners Club International (“Diners Club”). The Discover Network is a payment card transaction processing network for Discover card-branded and third-party issued credit, debit and prepaid cards. PULSE operates an electronic funds transfer network, providing financial institutions issuing debit cards on the PULSE network with access to ATMs domestically and internationally, as well as point of sale terminals at retail locations throughout the U.S. for debit card transactions. Diners Club is a global payments network of licensees, which are generally financial institutions, that issue Diners Club branded credit cards and/or provide card acceptance services.
The Company’s business segments are Direct Banking and Payment Services. The Direct Banking segment includes consumer banking and lending products which includes Discover card-branded credit cards issued to individuals and small businesses on the Discover Network and other consumer products and services, including home loans, personal loans, private student loans, prepaid cards and other consumer lending and deposit products. The Payment Services segment includes PULSE, Diners Club and the Company’s third-party issuing business, which includes credit, debit and prepaid cards issued on the Discover Network by third parties.
Basis of Presentation. The accompanying condensed consolidated 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 financial statements. In the opinion of management, the financial statements reflect all adjustments which are necessary for a fair presentation 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 condensed consolidated financial statements and related disclosures. These estimates are based on information available as of the date of the condensed consolidated financial statements. The Company believes that the estimates used in the preparation of the condensed consolidated financial statements are reasonable. Actual results could differ from these estimates. These interim condensed consolidated financial statements should be read in conjunction with the Company’s 2011 audited consolidated financial statements filed with the Company’s annual report on Form 10-K for the fiscal year ended November 30, 2011.
Recently Issued Accounting Pronouncements. In July 2012, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") No. 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. ASU 2012-02 applies to long-lived intangible assets, other than goodwill, that are not subject to amortization on the basis that they have indefinite useful lives. This standard is intended to simplify impairment testing by adding a qualitative review step to assess whether the required quantitative impairment analysis that exists today is necessary. Under the new standard, a company will not be required to calculate the fair value of the intangible asset unless it concludes, based on the qualitative assessment, that it is more likely than not that the fair value of that asset is less than its book value. If such a decline in fair value is deemed more likely than not to have occurred, then the quantitative impairment test that exists under current GAAP must be completed; otherwise, the asset is deemed to be not impaired and no further testing is required until the next annual test date (or sooner if conditions or events before that date raise concerns of potential impairment of the asset). The amended impairment guidance does not affect the manner in which fair value is determined. The new guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The Company's non-amortizable intangibles consist of $155 million in acquired trade names and other assets associated with Diners Club. The value of those assets will not be affected by the adoption of this standard.

6
Table of Contents

In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. ASU 2011-11 adds certain additional disclosure requirements about financial instruments and derivatives instruments that are subject to netting arrangements. The Company has master netting arrangements pertaining to collateral posting requirements with its interest rate swap counterparties, as more fully discussed in Note 15: Derivatives and Hedging Activities. Additional details about these positions and how they are reported will be disclosed. The new disclosures are required for annual reporting periods beginning on or after January 1, 2013, and interim periods within those periods. Because this amendment impacts disclosures only, it will have no effect on the Company's financial condition, results of operations or cash flows.
In September 2011, the FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2011-08 is intended to simplify goodwill impairment testing by adding a qualitative review step to assess whether the required quantitative impairment analysis that exists today is necessary. Under the amended rule, a company will not be required to calculate the fair value of a business that contains recorded goodwill unless it concludes, based on the qualitative assessment, that it is more likely than not that the fair value of that business is less than its book value. If such a decline in fair value is deemed more likely than not to have occurred, then the quantitative goodwill impairment test that exists under current GAAP must be completed; otherwise, goodwill is deemed to be not impaired and no further testing is required until the next annual test date (or sooner if conditions or events before that date raise concerns of potential impairment in the business). The amended goodwill impairment guidance does not affect the manner in which a company estimates fair value. The new standard is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The Company has $287 million in goodwill, which is associated with its PULSE Network and Discover Home Loans, Inc. The value of that goodwill will not be affected by the adoption of this standard.
In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU will require companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements. It eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity. The standard does not change the items which must be reported in other comprehensive income, how such items are measured or when they must be reclassified to net income. The FASB subsequently deferred the effective date of certain provisions of this standard pertaining to the reclassification of items out of accumulated other comprehensive income, pending the issuance of further guidance on that matter. Because this ASU impacts presentation only, it had no effect on the Company's financial condition, results of operations or cash flows.
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU is intended to result in convergence between U.S. GAAP and International Financial Reporting Standards (“IFRS”) requirements for measurement of and disclosures about fair value. The amendments are not expected to have a significant impact on companies applying U.S. GAAP. Key provisions of the amendment include: a prohibition on grouping financial instruments for purposes of determining fair value, except when an entity manages market and credit risks on the basis of the entity’s net exposure to the group; an extension of the prohibition against the use of a blockage factor to all fair value measurements (that prohibition previously applied only to financial instruments with quoted prices in active markets); and a requirement that for recurring Level 3 fair value measurements, entities disclose quantitative information about unobservable inputs, a description of the valuation process used and qualitative details about the sensitivity of the measurements. In addition, for items not carried at fair value but for which fair value is disclosed, entities will be required to disclose the level within the fair value hierarchy that applies to the fair value measurement disclosed. The adoption of this ASU did not have a significant impact on the Company’s fair value measurements, financial condition, results of operations or cash flows.
In April 2011, the FASB issued ASU No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. This ASU amends the sale accounting requirement concerning a transferor’s ability to repurchase transferred financial assets even in the event of default by the transferee, which typically is facilitated in a repurchase agreement by the presence of a collateral maintenance provision. Specifically, the level of cash collateral received by a transferor will no longer be relevant in determining whether a repurchase agreement constitutes a sale. As a result of this amendment, more repurchase agreements will be treated as secured financings rather than sales. This ASU became effective for the Company on March 1, 2012. Because essentially all repurchase agreements entered into by the Company have historically been deemed to constitute secured financing transactions, this amendment did not have an impact on the Company’s characterization of such transactions or on the Company's financial condition, results of operations or cash flows.


7
Table of Contents

2.
Business Combinations
Acquisition of the net assets of the Home Loan Center, Inc. On June 6, 2012, through its Discover Home Loans, Inc. subsidiary, the Company acquired substantially all of the operating and related assets and certain liabilities of Home Loan Center, Inc. ("Home Loan Center"), a subsidiary of Tree.com, Inc., adding a residential mortgage lending component to the Company's direct banking business. In exchange for the net assets acquired, the Company paid an aggregate of $48.9 million, including payments made prior to the closing that were applied to the closing price. A portion of such amount is being held in escrow pending the Home Loan Center's ability to discharge certain contingent liabilities related to loans previously sold to secondary market investors. These contingent liabilities were not assumed by the Company. An additional $10.0 million of purchase price will be due from the Company on the first anniversary of the closing, subject to certain conditions being satisfied. The Company is finalizing its valuation analysis of assets acquired and liabilities assumed. The acquisition did not have a significant impact for the three or nine months ended August 31, 2012 on the Company's consolidated financial condition, results of operations or cash flows or on the Direct Banking reportable segment in which it is included.

Acquisition of The Student Loan Corporation. On December 31, 2010, the Company acquired The Student Loan Corporation (“SLC”), which is now a wholly-owned subsidiary of Discover Bank and included in the Company’s Direct Banking segment. The Company acquired SLC’s ongoing private student loan business, which includes certain private student loans held in three securitization trusts and other assets, and assumed SLC’s asset-backed securitization debt incurred by those trusts and other liabilities. The acquired loans are considered to be purchased credit-impaired ("PCI") loans for accounting purposes, the details of which are discussed further in Note 4: Loan Receivables. The acquisition significantly increased the size of the Company’s private student loan portfolio. In addition, the acquisition has provided the Company with a developed student loan business platform, additional school relationships and SLC’s website. Since the acquisition date, the results of operations and cash flows of SLC have been included in the Company’s condensed consolidated results of operations and cash flows. Pro forma data is not provided as the impact of the SLC acquisition was not significant to the Company’s condensed consolidated results of operations or cash flows.
Net cash consideration paid. The following table provides a calculation of the amount paid by the Company for SLC based on the net assets of the SLC securitization trusts acquired after applying an 8.5% discount to the trust assets (the “Trust Certificate Purchase Price”) (dollars in millions):

 
Actual
 
Gross trust assets
$
3,977

Less: 8.5% discount
(338
)
Net trust assets
3,639

Less: Principal amount of and accrued interest on trust debt
(3,193
)
Trust Certificate Purchase Price
$
446



8
Table of Contents

Although the Company paid SLC shareholders $600 million for the acquisition of SLC (“Aggregate Merger Consideration”), the Company received a purchase price adjustment from Citibank, N.A. (“Citibank”) equivalent to the amount by which the Aggregate Merger Consideration exceeded the value of the Trust Certificate Purchase Price. In addition, Citibank agreed to adjust the cash consideration paid by the Company to compensate it for (i) agreeing to commute certain insurance policies covering certain of the loans acquired and (ii) the value of non-trust related liabilities assumed by the Company. The following table provides a summary of total consideration paid by Discover including post-closing adjustments (dollars in millions): 
 
Actual
 
Aggregate Merger Consideration
$
600

Less: Purchase price adjustment
(154
)
Trust Certificate Purchase Price
446

Less: Further adjustments provided for by Citibank
 
Cash received for consent to insurance commutation
(16
)
Cash received related to reimbursable liabilities
(29
)
Net cash consideration paid
$
401


Net assets acquired. The Company acquired net assets (including $155 million of cash) with an aggregate fair value of $563 million in exchange for cash consideration of $556 million, resulting in the recognition of a bargain purchase gain of approximately $7 million. The bargain purchase gain primarily resulted from Citibank’s adjustment of the cash consideration to be paid by the Company in exchange for the Company’s consent to permit SLC to commute, immediately prior to the acquisition, certain student loan insurance policies covering loans in one of the three trusts. The bargain purchase gain is recorded in other income on the Company’s condensed consolidated statement of income. During the fourth quarter of 2011, the Company finalized its purchase accounting, which resulted in a decrease of $27 million in the indemnification asset and a $19 million increase in student loan receivables. In addition, there were immaterial changes made to the other assets purchased and liabilities assumed. These adjustments reflect the Company's finalized cash flow projections related to the student loans acquired. The offset to these adjustments resulted in a $9 million reduction in the originally estimated bargain purchase gain of $16 million.
The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of the SLC acquisition (dollars in thousands):

 
At December 31,
2010

Student loan receivables
$
3,070,042

Cash
155,347

Indemnification asset
74,571

Student relationships intangible
2,400

Trade name intangible
3,800

Total intangible assets
6,200

Other assets
217,441

Total assets acquired
3,523,601

Securitized debt
2,921,372

Other liabilities
38,889

Total liabilities assumed
2,960,261

Net assets acquired
$
563,340

The Company acquired $6.2 million in identifiable intangible assets. These intangible assets consist of student relationships and trade name intangibles. Acquired student relationships consist of those relationships in existence between SLC and the numerous students that carry student loan balances. This intangible asset is deemed to have a finite useful life of 5 years and will be amortized over this period. Trade name intangibles relate to trademarks, trade names and internet domains and content. This intangible asset is deemed to have an indefinite useful life and therefore is not subject to amortization.

9
Table of Contents

The Company also recorded a $75 million indemnification asset. This asset reflects the discounted present value of payments expected to be received under Citibank’s indemnification of student loan credit losses that would have been recoverable under certain student loan insurance policies which, as noted above, were commuted pursuant to an agreement entered into by SLC with the Company’s consent immediately prior to the acquisition. The indemnification pertains only to loans in one of the three SLC securitization trusts that the Company acquired, namely the SLC Private Student Loan Trust 2010-A (“SLC 2010-A”). The SLC 2010-A trust included loans with an aggregate outstanding principal balance of $1.2 billion at the time of acquisition; outstanding loans in that trust totaled $1 billion as of August 31, 2012. The initial value of the indemnification asset was based on the amount of projected credit losses expected to be reimbursed by Citibank. Under the terms of the indemnification agreement with Citibank, indemnification payments related to student loan credit losses are subject to an overall cap of $166.8 million, consistent with the terms of the insurance policies which the indemnification serves to replace.
The subsequent accounting for the indemnification asset will generally reflect the manner in which the indemnified loans are subsequently measured. The value of the indemnification asset will increase or decrease as expected credit losses on the PCI student loans increase or decrease, respectively. An increase in expected losses on PCI student loans that results in the immediate recognition of an allowance for loan losses will result in an immediate increase in the indemnification asset. A decrease in expected losses that results in an immediate reversal of a previously recognized loan loss allowance will result in the immediate reduction of the indemnification asset. Recognition of an allowance for loan losses on PCI student loans is discussed in more detail within Note 4: Loan Receivables under “Purchased Credit-Impaired Loans.” To the extent that a decrease in expected losses results in a prospective increase in the accretable yield on PCI student loans rather than an immediate reduction of the loan loss allowance, the value of the indemnification asset will be adjusted prospectively through a reduction in the rate of amortization. Amortization and valuation adjustments to the indemnification asset are recorded through other income on the condensed consolidated statement of income.

3.
Investments
The Company’s investment securities consist of the following (dollars in thousands):

 
August 31,
2012
 
November 30,
2011
U.S. Treasury securities
$
2,471,448

 
$
2,563,800

U.S. government agency securities
2,319,285

 
2,795,223

States and political subdivisions of states
35,242

 
40,936

Other securities:
 
 
 
Credit card asset-backed securities of other issuers
164,294

 
299,889

Corporate debt securities(1)
145,529

 
449,469

To-be-announced investment securities
—

 
50,254

Residential mortgage-backed securities - Agency (2)
1,331,709

 
6,482

Total other securities
1,641,532

 
806,094

Total investment securities
$
6,467,507

 
$
6,206,053

____________________
(1)
Amount represents corporate debt obligations issued under the Temporary Liquidity Guarantee Program (TLGP) that are guaranteed by the Federal Deposit Insurance Corporation (FDIC).
(2)
Consists of residential mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae.

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Table of Contents

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, 2012
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S. Treasury securities
$
2,417,773

 
$
53,125

 
$
—

 
$
2,470,898

U.S. government agency securities
2,267,348

 
51,937

 
—

 
2,319,285

Credit card asset-backed securities of other issuers
161,386

 
2,908

 
—

 
164,294

Corporate debt securities
145,396

 
133

 
—

 
145,529

Residential mortgage-backed securities - Agency
1,258,223

 
19,273

 
—

 
1,277,496

Total available-for-sale investment securities
$
6,250,126

 
$
127,376

 
$
—

 
$
6,377,502

Held-to-Maturity Investment Securities(2)
 
 
 
 
 
 
 
U.S. Treasury securities(3)
$
550

 
$
—

 
$
—

 
$
550

States and political subdivisions of states
35,242

 
234

 
(302
)
 
35,174

Residential mortgage-backed securities - Agency (4)  
54,213

 
2,331

 
—

 
56,544

Total held-to-maturity investment securities
$
90,005

 
$
2,565

 
$
(302
)
 
$
92,268

At November 30, 2011
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S. Treasury securities
$
2,516,008

 
$
47,242

 
$
—

 
$
2,563,250

U.S. government agency securities
2,762,265

 
34,166

 
(1,208
)
 
2,795,223

Credit card asset-backed securities of other issuers
293,231

 
6,658

 
—

 
299,889

Corporate debt securities
448,423

 
1,066

 
(20
)
 
449,469

Total available-for-sale investment securities
$
6,019,927

 
$
89,132

 
$
(1,228
)
 
$
6,107,831

Held-to-Maturity Investment Securities(2)
 
 
 
 
 
 
 
U.S. Treasury securities(3)
$
550

 
$
—

 
$
—

 
$
550

States and political subdivisions of states
40,936

 
197

 
(2,823
)
 
38,310

Residential mortgage-backed securities - Agency (4)  
6,482

 
650

 
—

 
7,132

To-be-announced investment securities
50,254

 
—

 
(204
)
 
50,050

Total held-to-maturity investment securities
$
98,222

 
$
847

 
$
(3,027
)
 
$
96,042

_________________________
(1)
Available-for-sale investment securities are reported at fair value.
(2)
Held-to-maturity investment securities are reported at amortized cost.
(3)
Amount represents securities pledged as collateral to a government-related merchant for which transaction settlement occurs beyond the normal 24-hour period.
(4)
Amounts represent residential mortgage-backed securities that were classified as held-to-maturity as they were entered into as a part of the Company's community reinvestment initiatives.

11
Table of Contents

The following table provides information about investment securities with aggregate gross unrealized losses and the length of time that individual investment securities have been in a continuous unrealized loss position as of August 31, 2012 and November 30, 2011 (dollars in thousands):

 
Number of
Securities
in a Loss
Position
 
Less than 12 months
 
More than 12 months
 
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
At August 31, 2012
 
 
 
 
 
 
 
 
 
Held-to-Maturity Investment Securities
 
 
 
 
 
 
 
 
 
State and political subdivisions of states
3

 
$
—

 
$
—

 
$
13,183

 
$
302

At November 30, 2011
 
 
 
 
 
 
 
 
 
Available-for-Sale Investment Securities
 
 
 
 
 
 
 
 
 
U.S. government agency securities
2

 
$
242,898

 
$
1,208

 
$
—

 
$
—

Corporate debt securities
3

 
$
100,041

 
$
20

 
$
—

 
$
—

Held-to-Maturity Investment Securities
 
 
 
 
 
 
 
 
 
State and political subdivisions of states
6

 
$
2,689

 
$
46

 
$
27,768

 
$
2,777

To-be-announced investment securities
2

 
$
50,050

 
$
204

 
$
—

 
$
—


During the three and nine months ended August 31, 2012, the Company received $473.7 million and $1.6 billion of proceeds related to maturities, redemptions, or liquidation of investment securities, as compared to $170.5 million and $803.9 million for the three and nine months ended August 31, 2011.
During the three and nine months ended August 31, 2012, and during the three months ended August 31, 2011, there were no sales of securities. During the nine months ended August 31, 2011, the Company received $161 thousand of proceeds and recorded $146 thousand of gross realized gains relating primarily to the sale of equity securities.
The Company records unrealized gains and losses on its available-for-sale investment securities in other comprehensive income. For the three and nine months ended August 31, 2012, the Company recorded net unrealized gains of $15.9 million ($9.9 million after tax) and $39.5 million ($24.6 million after tax), respectively, in other comprehensive income. For the three and nine months ended August 31, 2011, the Company recorded net unrealized gains of $61.0 million ($38.2 million after tax) and $87.7 million ($54.9 million after tax), respectively, in other comprehensive income.
At August 31, 2012 and November 30, 2011, the Company had $302 thousand and $2.8 million, respectively, of gross unrealized losses in a continuous loss position for more than 12 months on its held-to-maturity investment securities in states and political subdivisions of states. The Company believes the unrealized loss on these investments is the result of changes in interest rates subsequent to the Company’s acquisitions of these securities and that the reduction in value is temporary. The Company does not intend to sell these investments nor does it expect to be required to sell these investments before recovery of their amortized cost basis, as they were entered into as a part of the Company's community reinvestment initiatives. The Company expects to collect all amounts due according to the contractual terms of these securities.
 

12
Table of Contents

Contractual maturities of available-for-sale debt securities and held-to-maturity debt securities at August 31, 2012 are provided in the table below (dollars in thousands): 

 
One Year
or
Less
 
After One
Year
Through
Five Years
 
After Five
Years
Through
Ten Years
 
After Ten
Years
 
Total
Available-for-sale—Amortized Cost (1)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
175,393

 
$
2,242,380

 
$
—

 
$
—

 
$
2,417,773

U.S. government agency securities
567,952

 
1,699,396

 
—

 
—

 
2,267,348

Credit card asset-backed securities of other issuers
142,855

 
18,531

 
—

 
—

 
161,386

Corporate debt securities
145,396

 
—

 
—

 
—

 
145,396

Residential mortgage-backed securities - Agency
—

 
—

 
326,189

 
932,034

 
1,258,223

Total available-for-sale investment securities
$
1,031,596

 
$
3,960,307

 
$
326,189

 
$
932,034

 
$
6,250,126

Held-to-maturity—Amortized Cost (2)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
550

 
$
—

 
$
—

 
$
—

 
$
550

State and political subdivisions of states
1,385

 
3,285

 
—

 
30,572

 
35,242

Residential mortgage-backed securities - Agency(3)
—

 
—

 
—

 
54,213

 
54,213

Total held-to-maturity investment securities
$
1,935

 
$
3,285

 
$
—

 
$
84,785

 
$
90,005

Available-for-sale—Fair Values (1)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
175,949

 
$
2,294,949

 
$
—

 
$
—

 
$
2,470,898

U.S. government agency securities
570,147

 
1,749,138

 
—

 
—

 
2,319,285

Credit card asset-backed securities of other issuers
144,788

 
19,506

 
—

 
—

 
164,294

Corporate debt securities
145,529

 
—

 
—

 
—

 
145,529

Residential mortgage-backed securities - Agency
—

 
—

 
329,418

 
948,078

 
1,277,496

Total available-for-sale investment securities
$
1,036,413

 
$
4,063,593

 
$
329,418

 
$
948,078

 
$
6,377,502

Held-to-maturity—Fair Values (2)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
550

 
$
—

 
$
—

 
$
—

 
$
550

State and political subdivisions of states
1,387

 
3,350

 
—

 
30,437

 
35,174

Residential mortgage-backed securities - Agency(3)
—

 
—

 
—

 
56,544

 
56,544

Total held-to-maturity investment securities
$
1,937

 
$
3,350

 
$
—

 
$
86,981

 
$
92,268

____________________
(1)
Available-for-sale investment securities are reported at fair value.
(2)
Held-to-maturity investment securities are reported at amortized cost.
(3)
Amounts represent residential mortgage-backed securities that were classified as held-to-maturity as they were entered into as a part of the Company's community reinvestment initiatives.

Other Investments. As a part of the Company's community reinvestment initiatives, the Company has made equity investments in certain limited partnerships and limited liability companies that finance the construction and rehabilitation of affordable rental housing, as well as stimulate economic development in low to moderate income communities. These investments are accounted for using the equity method of accounting, and are recorded within other assets, and the related commitment for future investments is recorded in other liabilities within the statement of financial condition. The portion of each investment's operating results allocable to the Company is recorded in other expense within the condensed consolidated statement of income. The Company earns a return primarily through the receipt of tax credits allocated to the affordable housing projects and the community revitalization projects. These investments are not consolidated as the Company does not have a controlling financial interest in the entities. As of August 31, 2012 and November 30, 2011, the Company had outstanding investments of $194.8 million and $137.9 million, respectively, in these entities, and the related contingent liability was $52.6 million and $6.3 million, respectively.


13
Table of Contents

4.
Loan Receivables
The Company has three portfolio segments: credit card loans, other loans and PCI student loans acquired in the SLC transaction (See Note 2: Business Combinations) and in a separate portfolio acquisition from Citibank. Within these portfolio segments, the Company has classes of receivables which are depicted in the table below (dollars in thousands): 
 
August 31,
2012
 
November 30,
2011
Student loans held for sale(1)
$
—

 
$
714,180

Mortgage loans held for sale(2)
272,082

 
—

Loan portfolio:
 
 
 
Credit card loans:
 
 
 
Discover card(3)
47,915,177

 
46,419,544

Discover business card
209,291

 
219,081

Total credit card loans
48,124,468

 
46,638,625

Other loans:
 
 
 
Personal loans
3,114,408

 
2,648,051

Private student loans
2,752,715

 
2,069,001

Other
26,829

 
16,690

Total other loans
5,893,952

 
4,733,742

PCI student loans(4)
4,867,010

 
5,250,388

Total loan portfolio
58,885,430

 
56,622,755

Total loan receivables
59,157,512

 
57,336,935

Allowance for loan losses
(1,687,664
)
 
(2,205,196
)
Net loan receivables
$
57,469,848

 
$
55,131,739

 ____________________________
(1)
Amount represents federal student loans. At November 30, 2011, $446.6 million of federal student loan receivables were pledged as collateral against a long-term borrowing. During first quarter 2012, Discover Bank sold these loans and recorded a loss of $518 thousand. As a part of this transaction, the related borrowings were assumed by the purchaser.
(2)
All mortgage loans held for sale are pledged as collateral against the warehouse line of credit used to fund consumer residential loans. See Note 7: Borrowings.
(3)
Amounts include $19.9 billion and $18.5 billion underlying investors’ interest in trust debt at August 31, 2012 and November 30, 2011, respectively, and $13.6 billion and $15.4 billion in seller’s interest at August 31, 2012 and November 30, 2011, respectively. See Note 5: Credit Card and Student Loan Securitization Activities for further information.
(4)
Amounts include $2.6 billion and $2.8 billion of loans pledged as collateral against the notes issued from the SLC securitization trusts at August 31, 2012 and November 30, 2011, respectively. See Note 5: Credit Card and Student Loan Securitization Activities. Of the remaining $2.3 billion and $2.5 billion at August 31, 2012 and November 30, 2011, respectively, that were not pledged as collateral, approximately $14.7 million and $12.8 million represent loans eligible for reimbursement through an indemnification claim. Discover Bank must purchase such loans from the trust before a claim may be filed.

14
Table of Contents

Credit Quality Indicators. The Company regularly reviews its collection experience (including delinquencies and net charge-offs) in determining its allowance for loan losses. Credit card and closed-end consumer loan receivables are placed on nonaccrual status upon receipt of notification of the bankruptcy or death of a customer or suspected fraudulent activity on an account. Upon completion of the fraud investigation, loan receivables may resume accruing interest.
Information related to the delinquencies and net charge-offs in the Company’s loan portfolio, which excludes loans held for sale, is shown below by each class of loan receivables except for PCI student loans, which is shown under the heading “Purchased Credit-Impaired Loans” (dollars in thousands): 

Delinquent and Non-Accruing Loans:
 
 
 
 
 
 
 
 
 
  
30-89 Days
Delinquent
 
90 or
More Days
Delinquent
 
Total Past
Due
 
90 or
More Days
Delinquent
and
Accruing
 
Total
Non-accruing(2)
At August 31, 2012
 
 
 
 
 
 
 
 
 
Credit card loans:
 
 
 
 
 
 
 
 
 
Discover card(1)
$
441,545

 
$
424,514

 
$
866,059

 
$
374,035

 
$
179,716

Discover business card
1,803

 
2,483

 
4,286

 
2,377

 
489

Total credit card loans
443,348

 
426,997

 
870,345

 
376,412

 
180,205

Other loans:
 
 
 
 
 
 
 
 
 
Personal loans
16,395

 
6,784

 
23,179

 
6,021

 
4,229

Private student loans (excluding PCI)
29,314

 
5,876

 
35,190

 
4,832

 
1,237

Other
502

 
1,637

 
2,139

 
—

 
1,889

Total other loans (excluding PCI)
46,211

 
14,297

 
60,508

 
10,853

 
7,355

Total loan receivables (excluding PCI)
$
489,559

 
$
441,294

 
$
930,853

 
$
387,265

 
$
187,560

At November 30, 2011
 
 
 
 
 
 
 
 
 
Credit card loans:
 
 
 
 
 
 
 
 
 
Discover card(1)
$
554,354

 
$
556,126

 
$
1,110,480

 
$
498,305

 
$
200,208

Discover business card
2,823

 
3,548

 
6,371

 
3,335

 
860

Total credit card loans
557,177

 
559,674

 
1,116,851

 
501,640

 
201,068

Other loans:
 
 
 
 
 
 
 
 
 
Personal loans
15,604

 
7,362

 
22,966

 
6,636

 
3,628

Private student loans (excluding PCI)
10,073

 
2,992

 
13,065

 
2,883

 
125

Other
507

 
2,091

 
2,598

 
—

 
2,317

Total other loans (excluding PCI)
26,184

 
12,445

 
38,629

 
9,519

 
6,070

Total loan receivables (excluding PCI)
$
583,361

 
$
572,119

 
$
1,155,480

 
$
511,159

 
$
207,138

______________________ 
(1)
Consumer credit card loans that are 90 or more days delinquent and accruing interest include $31.8 million and $37.9 million of loans accounted for as troubled debt restructurings at August 31, 2012 and November 30, 2011, respectively.
(2)
The Company estimates that the gross interest income that would have been recorded in accordance with the original terms of these credit card loans was $7.8 million and $24.5 million for the three and nine months ended August 31, 2012, respectively. The Company does not separately track the amount of gross interest income that would have been recorded in accordance with the original terms of loans. These amounts were estimated based on customers' current balances and most recent rates.



    

15
Table of Contents

Net Charge-offs. The Company's net charge-offs include the principal amount of losses charged off less principal recoveries and exclude charged-off interest and fees, recoveries of interest and fees and fraud losses. Charged-off and recovered interest and fees are recorded in interest and loan fee income, respectively, which is effectively a reclassification of the loan loss provision, while fraud losses are recorded in other expense. Credit card loan receivables are charged off at the end of the month during which an account becomes 180 days contractually past due. Closed-end consumer loan receivables are generally charged off at the end of the month during which an account becomes 120 days contractually past due. Generally, customer bankruptcies and probate accounts are charged off at the end of the month 60 days following the receipt of notification of the bankruptcy or death but not later than the 180-day or 120-day contractual time frame.

Net Charge-Offs:
For the Three Months Ended August 31,
 
2012
 
2011
  
Net
Charge-offs
 
Net Charge-off
Rate
 
Net
Charge-offs
 
Net Charge-off
Rate
Credit card loans:
 
 
 
 
 
 
 
Discover card
$
285,345

 
2.42
 %
 
$
436,242

 
3.84
%
Discover business card
1,741

 
3.34
 %
 
3,506

 
6.01
%
Total credit card loans
287,086

 
2.43
 %
 
439,748

 
3.85
%
Other loans:
 
 
 
 
 
 
 
Personal loans
16,214

 
2.14
 %
 
16,000

 
2.73
%
Private student loans (excluding PCI)
4,674

 
0.73
 %
 
2,618

 
0.62
%
Other
(97
)
 
(0.26
)%
 
410

 
13.41
%
Total other loans (excluding PCI)
20,791

 
1.45
 %
 
19,028

 
0.98
%
Net charge-offs as a percentage of total loans (excluding PCI)
$
307,877

 
2.32
 %
 
$
458,776

 
3.63
%
Net charge-offs as a percentage of total loans (including PCI)
$
307,877

 
2.12
 %
 
$
458,776

 
3.43
%
 
 
 
 
 
 
 
 
 
For the Nine Months Ended August 31,
 
2012
 
2011
  
Net
Charge-offs
 
Net Charge-off
Rate
 
Net
Charge-offs
 
Net Charge-off
Rate
Credit card loans:
 
 
 
 
 
 
 
Discover card
$
960,403

 
2.76
 %
 
$
1,651,311

 
4.91
%
Discover business card
5,941

 
3.75
 %
 
14,937

 
8.26
%
Total credit card loans
966,344

 
2.76
 %
 
1,666,248

 
4.93
%
Other loans:
 
 
 
 
 
 
 
Personal loans
49,869

 
2.32
 %
 
50,980

 
3.19
%
Private student loans (excluding PCI)
11,650

 
0.64
 %
 
5,573

 
0.49
%
Other
70

 
0.14
 %
 
1,022

 
10.35
%
Total other loans (excluding PCI)
61,589

 
1.48
 %
 
57,575

 
1.09
%
Net charge-offs as a percentage of total loans (excluding PCI)
$
1,027,933

 
2.63
 %
 
$
1,723,823

 
4.64
%
Net charge-offs as a percentage of total loans (including PCI)
$
1,027,933

 
2.39
 %
 
$
1,723,823

 
4.41
%



16
Table of Contents

As part of credit risk management activities, on an ongoing basis the Company reviews information related to the performance of a customer’s account with the Company as well as information from credit bureaus, such as a FICO or other credit scores, relating to the customer’s broader credit performance. Credit scores are generally obtained at origination of the account and are refreshed monthly or quarterly thereafter to assist in predicting customer behavior.  Historically, the Company has noted that a significant proportion of delinquent accounts have FICO scores below 660. The following table provides FICO scores available for the Company’s customers as a percentage of each class of loan receivables: 
 
August 31, 2012
 
November 30, 2011
 
660 and Above
 
Less than 660
or No Score
 
660 and Above
 
Less than 660
or No Score
Discover card
83
%
 
17
%
 
81
%
 
19
%
Discover business card
91
%
 
9
%
 
89
%
 
11
%
Personal loans
97
%
 
3
%
 
97
%
 
3
%
Private student loans (excluding PCI)(1)
95
%
 
5
%
 
95
%
 
5
%
____________________ 
(1)
PCI loans are discussed under the heading "Purchased Credit-Impaired Loans."

For private student loans, additional credit risk management activities include monitoring the amount of loans in forbearance. Forbearance allows borrowers experiencing temporary financial difficulties and willing to make payments the ability to temporarily suspend payments. Eligible borrowers have a lifetime cap on forbearance of 12 months. At August 31, 2012 and November 30, 2011, there were $105.5 million and $75.9 million of loans in forbearance, respectively. In addition, at August 31, 2012 and November 30, 2011, there were 2.0% and 1.5% of private student loans in forbearance as a percentage of student loans in repayment and forbearance.
Allowance for Loan Losses. The Company maintains an allowance for loan losses at an appropriate level to absorb probable losses inherent in the loan portfolio. The Company considers the collectibility of all amounts contractually due on its loan receivables, including those components representing interest and fees. Accordingly, the allowance for loan losses represents the estimated uncollectible principal, interest and fee components of loan receivables. The allowance is evaluated monthly and is maintained through an adjustment to the provision for loan losses. Charge-offs of principal amounts of loans outstanding are deducted from the allowance and subsequent recoveries of such amounts increase the allowance. Charge-offs of loan balances representing unpaid interest and fees result in a reversal of interest and fee income, respectively, which is effectively a reclassification of provision for loan losses.
The Company bases its allowance for loan losses on several analyses that help estimate incurred losses as of the balance sheet date. While the Company’s estimation process includes historical data and analysis, there is a significant amount of judgment applied in selecting inputs and analyzing the results produced by the models to determine the allowance. The Company uses a migration analysis to estimate the likelihood that a loan will progress through the various stages of delinquency. The loan balances used in the migration analysis represent all amounts contractually due and, as a result, the migration analysis captures principal, interest and fee components in estimating uncollectible accounts. The Company uses other analyses to estimate losses incurred on non-delinquent accounts. The considerations in these analyses include past performance, risk management techniques applied to various accounts, historical behavior of different account vintages, current economic conditions, recent trends in delinquencies, bankruptcy filings, account collection management, policy changes, account seasoning, loan volume and amounts, payment rates, and forecasting uncertainties. The Company does not evaluate loans for impairment on an individual basis, but instead estimates its allowance for loan losses on a pooled basis, which includes loans that are delinquent and/or no longer accruing interest and/or certain loans that have defaulted from a loan modification program, as discussed below under the section entitled "Impaired Loans and Troubled Debt Restructurings."

17
Table of Contents

The following table provides changes in the Company’s allowance for loan losses for the three and nine months ended August 31, 2012 and 2011 (dollars in thousands): 
 
For the Three Months Ended August 31,
 
For the Nine Months Ended August 31,
 
2012
 
2011
 
2012
 
2011
Balance at beginning of period
$
1,869,253

 
$
2,632,320

 
$
2,205,196

 
$
3,304,118

Additions:
 
 
 
 
 
 
 
Provision for loan losses
126,288

 
99,514

 
510,401

 
692,763

Deductions:
 
 
 
 
 
 
 
Charge-offs:
 
 
 
 
 
 
 
Discover card
(428,935
)
 
(584,534
)
 
(1,400,273
)
 
(2,085,452
)
Discover business card
(2,623
)
 
(4,416
)
 
(8,540
)
 
(17,672
)
Total credit card loans
(431,558
)
 
(588,950
)
 
(1,408,813
)
 
(2,103,124
)
Personal loans
(17,341
)
 
(16,458
)
 
(52,474
)
 
(52,438
)
Private student loans
(4,793
)
 
(2,663
)
 
(11,956
)
 
(5,646
)
Other
(22
)
 
(411
)
 
(194
)
 
(1,025
)
Total other loans
(22,156
)
 
(19,532
)
 
(64,624
)
 
(59,109
)
Total charge-offs
(453,714
)
 
(608,482
)
 
(1,473,437
)
 
(2,162,233
)
Recoveries:
 
 
 
 
 
 
 
Discover card
143,590

 
148,292

 
439,870

 
434,141

Discover business card
882

 
910

 
2,599

 
2,735

Total credit card loans
144,472

 
149,202

 
442,469

 
436,876

Personal loans
1,127

 
458

 
2,605

 
1,458

Private student loans
119

 
45

 
306

 
73

Other
119

 
1

 
124

 
3

Total other loans
1,365

 
504

 
3,035

 
1,534

Total recoveries
145,837

 
149,706

 
445,504

 
438,410

Net charge-offs
(307,877
)
 
(458,776
)
 
(1,027,933
)
 
(1,723,823
)
Balance at end of period
$
1,687,664

 
$
2,273,058

 
$
1,687,664

 
$
2,273,058


Net charge-offs of principal are recorded against the allowance for loan losses, as shown in the table above. Information regarding net charge-offs of interest and fee revenues on credit card and other loans is as follows (dollars in thousands): 
 
For the Three Months Ended August 31,
 
For the Nine Months Ended August 31,
 
2012
 
2011
 
2012
 
2011
Interest accrued subsequently charged off, net of recoveries (recorded as a reduction of interest income)
$
76,942

 
$
128,329

 
$
272,345

 
$
480,044

Fees accrued subsequently charged off, net of recoveries (recorded as a reduction to other income)
$
14,845

 
$
22,807

 
$
52,503

 
$
86,762

 

18
Table of Contents

The following table provides additional detail of the Company’s allowance for loan losses and recorded investment in its loan portfolio (which excludes loans held for sale) by impairment methodology (dollars in thousands): 
 
Credit Card
 
Personal
Loans
 
Student
Loans
 
Other
Loans
 
Total
At August 31, 2012
 
 
 
 
 
 
 
 
 
Allowance for loans evaluated for impairment as:
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment(1)
$
1,331,282

 
$
92,069

 
$
65,203

 
$
783

 
$
1,489,337

Troubled debt restructurings(2)
190,981

 
4,287

 
3,059

 
—

 
198,327

Purchased credit-impaired(3)
—

 
—

 
—

 
—

 
—

Total allowance for loan losses
$
1,522,263

 
$
96,356

 
$
68,262

 
$
783

 
$
1,687,664

Recorded investment in loans evaluated for impairment as:
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment(1)
$
47,007,109

 
$
3,098,013

 
$
2,740,212

 
$
26,829

 
$
52,872,163