DFS 9.30.2014 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 September 30, 2014
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  x    No  o
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  x    No  o
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  o    No  x
As of October 24, 2014, there were 453,479,765 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 September 30, 2014
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 Cashback CheckingSM, Discover® More® Card, Discover it®, 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
 
September 30,
2014
 
December 31,
2013
 
(unaudited)
(dollars in millions,
except share amounts)
Assets
 
 
 
Cash and cash equivalents
$
7,382

 
$
6,554

Restricted cash
103

 
182

Investment securities:
 
 
 
Available-for-sale (amortized cost of $3,881 and $4,900 at September 30, 2014 and December 31, 2013, respectively)
3,913

 
4,931

Held-to-maturity (fair value of $82 and $58 at September 30, 2014 and December 31, 2013, respectively)
82

 
60

Total investment securities
3,995

 
4,991

Loan receivables:
 
 
 
Mortgage loans held for sale, measured at fair value
148

 
148

Loan portfolio:
 
 
 
Credit card
53,699

 
53,150

Other
9,731

 
8,295

Purchased credit-impaired loans
3,788

 
4,178

Total loan portfolio
67,218

 
65,623

Total loan receivables
67,366

 
65,771

Allowance for loan losses
(1,644
)
 
(1,648
)
Net loan receivables
65,722

 
64,123

Premises and equipment, net
661

 
654

Goodwill
284

 
284

Intangible assets, net
177

 
185

Other assets
2,272

 
2,367

Total assets
$
80,596

 
$
79,340

Liabilities and Stockholders’ Equity
 
 
 
Deposits:
 
 
 
Interest-bearing deposit accounts
$
45,177

 
$
44,766

Non-interest bearing deposit accounts
205

 
193

Total deposits
45,382

 
44,959

Short-term borrowings
139

 
140

Long-term borrowings
20,918

 
20,474

Accrued expenses and other liabilities
2,856

 
2,958

Total liabilities
69,295

 
68,531

Commitments, contingencies and guarantees (Notes 8, 11 and 12)

 

Stockholders’ Equity:
 
 
 
Common stock, par value $0.01 per share; 2,000,000,000 shares authorized; 558,160,815 and 555,349,629 shares issued at September 30, 2014 and December 31, 2013, respectively
5

 
5

Preferred stock, par value $0.01 per share; 200,000,000 shares authorized; 575,000 shares issued or outstanding and aggregate liquidation preference of $575 at September 30, 2014 and December 31, 2013
560

 
560

Additional paid-in capital
3,775

 
3,687

Retained earnings
11,182

 
9,611

Accumulated other comprehensive loss
(70
)
 
(68
)
Treasury stock, at cost; 102,763,441 and 83,105,578 shares at September 30, 2014 and December 31, 2013, respectively
(4,151
)
 
(2,986
)
Total stockholders’ equity
11,301

 
10,809

Total liabilities and stockholders’ equity
$
80,596

 
$
79,340

 
 
 
 
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.
 
September 30,
2014
 
December 31,
2013
 
(unaudited)
(dollars in millions)
Assets
 
 
 
Restricted cash
$
100

 
$
179

Credit card loan receivables
$
29,505

 
$
31,112

Purchased credit-impaired loans
$
2,038

 
$
2,248

Allowance for loan losses allocated to securitized loan receivables
$
(800
)
 
$
(861
)
Other assets
$
37

 
$
34

Liabilities
 
 
 
Long-term borrowings
$
16,276

 
$
16,986

Accrued interest payable
$
10

 
$
9

 
 
 
 

See Notes to the Condensed Consolidated Financial Statements.
1

Table of Contents

DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Income
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
 
 (unaudited)
(dollars in millions, except per share amounts)
Interest income:
 
 
 
 
 
 
 
Credit card loans
$
1,613

 
$
1,513

 
$
4,710

 
$
4,427

Other loans
291

 
255

 
848

 
730

Investment securities
17

 
16

 
50

 
55

Other interest income
5

 
3

 
14

 
10

Total interest income
1,926

 
1,787

 
5,622

 
5,222

Interest expense:
 
 
 
 
 
 
 
Deposits
153

 
169

 
457

 
539

Short-term borrowings
—

 
1

 
1

 
3

Long-term borrowings
135

 
108

 
374

 
331

Total interest expense
288

 
278

 
832

 
873

Net interest income
1,638

 
1,509

 
4,790

 
4,349

Provision for loan losses
354

 
333

 
986

 
732

Net interest income after provision for loan losses
1,284

 
1,176

 
3,804

 
3,617

Other income:
 
 
 
 
 
 
 
Discount and interchange revenue, net
295

 
276

 
876

 
847

Protection products revenue
78

 
90

 
239

 
266

Loan fee income
85

 
78

 
248

 
235

Transaction processing revenue
46

 
46

 
136

 
146

Gain on investments
—

 
—

 
4

 
3

Gain on origination and sale of mortgage loans
19

 
25

 
57

 
127

Other income
29

 
38

 
90

 
122

Total other income
552

 
553

 
1,650

 
1,746

Other expense:
 
 
 
 
 
 
 
Employee compensation and benefits
320

 
292

 
928

 
867

Marketing and business development
182

 
174

 
519

 
528

Information processing and communications
87

 
81

 
258

 
244

Professional fees
111

 
97

 
322

 
302

Premises and equipment
23

 
21

 
68

 
60

Other expense
104

 
118

 
313

 
355

Total other expense
827

 
783

 
2,408

 
2,356

Income before income tax expense
1,009

 
946

 
3,046

 
3,007

Income tax expense
365

 
353

 
1,127

 
1,139

Net income
$
644

 
$
593

 
$
1,919

 
$
1,868

Net income allocated to common stockholders
$
630

 
$
579

 
$
1,878

 
$
1,826

Basic earnings per common share
$
1.37

 
$
1.20

 
$
4.03

 
$
3.73

Diluted earnings per common share
$
1.37

 
$
1.20

 
$
4.02

 
$
3.72

Dividends declared per common share
$
0.24

 
$
0.20

 
$
0.68

 
$
0.40

 
 
 
 
 
 
 
 

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 September 30,
 
For the Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
 
 (unaudited)
(dollars in millions)
Net income
$
644

 
$
593

 
$
1,919

 
$
1,868

Other comprehensive income (loss), net of taxes
 
 
 
 
 
 
 
Unrealized (loss) gain on securities available for sale, net of tax
(9
)
 
4

 
1

 
(38
)
Unrealized gain (loss) on cash flow hedges, net of tax
12

 
(7
)
 
(2
)
 
—

Foreign currency translation adjustments, net of tax
(1
)
 
1

 
(1
)
 
1

Other comprehensive income (loss)
2

 
(2
)
 
(2
)
 
(37
)
Comprehensive income
$
646

 
$
591

 
$
1,917

 
$
1,831

 
 
 
 
 
 
 
 

See Notes to the Condensed Consolidated Financial Statements.
3

Table of Contents

DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Changes in Stockholders’ Equity
 
 
 
 
 
 
 
 
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Treasury
Stock
 
Total
Stockholders’
Equity
 
Preferred Stock
 
Common Stock
 
 
 
 
 
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
(unaudited)
(dollars in millions, shares in thousands)
Balance at December 31, 2012
575

 
$
560

 
553,351

 
$
5

 
$
3,598

 
$
7,472

 
$
(72
)
 
$
(1,690
)
 
$
9,873

Net income
—

 
—

 
—

 
—

 
—

 
1,868

 
—

 
—

 
1,868

Other comprehensive loss
—

 
—

 
—

 
—

 
—

 
—

 
(37
)
 
—

 
(37
)
Purchases of treasury stock
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(950
)
 
(950
)
Common stock issued under employee benefit plans
—

 
—

 
51

 
—

 
2

 
—

 
—

 
—

 
2

Common stock issued and stock-based compensation expense
—

 
—

 
1,875

 
—

 
71

 
—

 
—

 
—

 
71

Dividends — common stock
—

 
—

 
—

 
—

 
—

 
(197
)
 
—

 
—

 
(197
)
Dividends — preferred stock
—

 
—

 
—

 
—

 
—

 
(28
)
 
—

 
—

 
(28
)
Balance at September 30, 2013
575

 
$
560

 
555,277

 
$
5

 
$
3,671

 
$
9,115

 
$
(109
)
 
$
(2,640
)
 
$
10,602

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2013
575

 
$
560

 
555,350

 
$
5

 
$
3,687

 
$
9,611

 
$
(68
)
 
$
(2,986
)
 
$
10,809

Net income
—

 
—

 
—

 
—

 
—

 
1,919

 
—

 
—

 
1,919

Other comprehensive loss
—

 
—

 
—

 
—

 
—

 
—

 
(2
)
 
—

 
(2
)
Purchases of treasury stock
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(1,165
)
 
(1,165
)
Common stock issued under employee benefit plans
—

 
—

 
45

 
—

 
3

 
—

 
—

 
—

 
3

Common stock issued and stock-based compensation expense
—

 
—

 
2,766

 
—

 
85

 
—

 
—

 
—

 
85

Dividends — common stock
—

 
—

 
—

 
—

 
—

 
(320
)
 
—

 
—

 
(320
)
Dividends — preferred stock
—

 
—

 
—

 
—

 
—

 
(28
)
 
—

 
—

 
(28
)
Balance at September 30, 2014
575

 
$
560

 
558,161

 
$
5

 
$
3,775

 
$
11,182

 
$
(70
)
 
$
(4,151
)
 
$
11,301

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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 September 30,
 
2014
 
2013
 
(unaudited)
(dollars in millions)
Cash flows from operating activities
 
 
 
Net income
$
1,919

 
$
1,868

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
986

 
732

Deferred income taxes
76

 
154

Depreciation and amortization on premises and equipment
93

 
83

Amortization of deferred revenues
(160
)
 
(143
)
Other depreciation and amortization
181

 
164

Accretion of accretable yield on acquired loans
(198
)
 
(205
)
Gain on investments
(4
)
 
(3
)
Loss on equity method and other investments
19

 
13

Gain on origination and sale of loans
(57
)
 
(127
)
Stock-based compensation expense
46

 
45

Proceeds from sale of mortgage loans originated for sale
1,962

 
3,553

Net principal disbursed on mortgage loans originated for sale
(1,903
)
 
(3,201
)
Changes in assets and liabilities:
 
 
 
Increase in other assets
(94
)
 
(112
)
Decrease in accrued expenses and other liabilities
(40
)
 
(286
)
Net cash provided by operating activities
2,826

 
2,535

 
 
 
 
Cash flows from investing activities
 
 
 
Maturities and sales of available-for-sale investment securities
1,395

 
1,364

Purchases of available-for-sale investment securities
(390
)
 
(258
)
Maturities of held-to-maturity investment securities
9

 
27

Purchases of held-to-maturity investment securities
(31
)
 
(1
)
Net principal disbursed on loans originated for investment
(2,243
)
 
(752
)
Purchases of loan receivables
—

 
(136
)
Purchases of other investments
(42
)
 
(76
)
Decrease in restricted cash
79

 
107

Purchases of premises and equipment
(102
)
 
(177
)
Net cash (used for) provided by investing activities
(1,325
)
 
98

 
 
 
 
Cash flows from financing activities
 
 
 
Net decrease in short-term borrowings
(1
)
 
(246
)
Proceeds from issuance of securitized debt
3,849

 
3,250

Maturities and repayment of securitized debt
(4,590
)
 
(3,537
)
Proceeds from issuance of other long-term borrowings
1,147

 
1,248

Payment of contingent consideration for purchase of net assets of a business, at fair value
—

 
(9
)
Proceeds from issuance of common stock
4

 
12

Purchases of treasury stock
(1,165
)
 
(950
)
Net increase in deposits
431

 
932

Dividends paid on common and preferred stock
(348
)
 
(294
)
Net cash (used for) provided by financing activities
(673
)
 
406

Net increase in cash and cash equivalents
828

 
3,039

Cash and cash equivalents, at beginning of period
6,554

 
2,584

Cash and cash equivalents, at end of period
$
7,382

 
$
5,623

 
 
 
 

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, home equity loans and deposit products. Through its Discover Home Loans, Inc. subsidiary, the Company offers its customers home loans. 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 transaction processing network for Discover branded credit cards and credit, debit and prepaid cards, issued by third parties, which the Company refers to as network partners. 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 that issue Diners Club branded charge 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, specifically Discover branded credit cards issued to individuals and small businesses on the Discover Network and other consumer products and services, including private student loans, personal loans, home loans, home equity loans, prepaid cards and other consumer lending and deposit products. The majority of Direct Banking revenues relate to interest income earned on the segment's loan products. Additionally, the Company's credit card products generate substantially all revenues related to discount and interchange, protection products and loan fee income.
The Payment Services segment includes PULSE, Diners Club and the Company’s network partners business, which includes credit, debit and prepaid cards issued on the Discover Network by third parties. This segment also includes the business operations of Diners Club Italy, which primarily consist of issuing Diners Club charge cards. The majority of Payment Services revenues relate to transaction processing revenue from PULSE and royalty and licensee revenue (included in other income) from Diners Club.
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 interim period. 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 2013 audited consolidated financial statements filed with the Company’s annual report on Form 10-K for the calendar year ended December 31, 2013.
Recently Issued Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). The guidance in this update supersedes existing revenue recognition requirements in Topic 605, Revenue Recognition, including an assortment of transaction-specific and industry-specific rules. The ASU establishes a principles-based model under which revenue from a contract is allocated to the distinct performance obligations within the contract and recognized in income as each performance obligation is satisfied. ASU Topic 606 does not apply to rights or obligations associated with financial instruments (for example, interest income from loans or investments, or interest expense on debt), and therefore the Company’s net interest income should not be affected. The Company’s revenue from discount and interchange, protection products, transaction processing and certain fees are within the scope of these rules. Management has not yet completed its evaluation of the impact, if any, of the new guidance on these revenues. The new revenue recognition model will become effective for the Company on January 1, 2017. Upon adoption in 2017, the Company will record an adjustment to retained earnings as of the beginning of the year of initial application, which can be either the earliest comparative period presented, with all periods presented under the new rules, or January 1, 2017, without restating prior periods presented. Management has not yet determined which transition reporting option it will apply.
In January 2014, the FASB issued ASU No. 2014-01, Investments-Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects. This standard will permit a reporting entity to make an accounting policy election to account for investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under this new method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). This treatment will replace the effective yield method currently permitted for certain investments of this kind. The Company has not historically utilized the effective yield method, and as a result, implementation of this ASU will not impact the Company’s accounting for its investments in qualified affordable housing projects unless a subsequent election is made to apply it. In addition to establishing the conditions under which the proportional amortization method can be used, the ASU calls for additional disclosures that will enable the reader to understand the nature of the investment and the effect of its measurement and related tax credits on the company’s financial position and results of operations. The new guidance is effective for annual reporting periods beginning after December 15, 2014 and interim periods within those periods, with early adoption permitted. The standard will require additional disclosure about the nature of the Company's affordable housing investments, but unless the Company subsequently elects to apply the proportional amortization model, the new guidance will have no effect on the Company’s financial condition, results of operations or cash flows.
2.
Investments
The Company’s investment securities consist of the following (dollars in millions):
 
September 30,
2014
 
December 31,
2013
U.S. Treasury securities(1)
$
1,335

 
$
2,058

U.S. government agency securities
1,038

 
1,561

States and political subdivisions of states
10

 
15

Other securities:
 
 
 
Credit card asset-backed securities of other issuers
—

 
6

Residential mortgage-backed securities - Agency(2)
1,612

 
1,351

Total other securities
1,612

 
1,357

Total investment securities
$
3,995

 
$
4,991

 
 
 
 
(1)
Includes $15 million and $9 million of U.S. Treasury securities that have been pledged as swap collateral in lieu of cash as of September 30, 2014 and December 31, 2013, respectively.
(2)
Consists of residential mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae.

6
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 millions):
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
At September 30, 2014
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S. Treasury securities
$
1,318

 
$
16

 
$
—

 
$
1,334

U.S. government agency securities
1,022

 
16

 
—

 
1,038

Residential mortgage-backed securities - Agency
1,541

 
6

 
(6
)
 
1,541

Total available-for-sale investment securities
$
3,881

 
$
38

 
$
(6
)
 
$
3,913

Held-to-Maturity Investment Securities(2)
 
 
 
 
 
 
 
U.S. Treasury securities(3)
$
1

 
$
—

 
$
—

 
$
1

States and political subdivisions of states
10

 
—

 
—

 
10

Residential mortgage-backed securities - Agency(4)
71

 
—

 
—

 
71

Total held-to-maturity investment securities
$
82

 
$
—

 
$
—

 
$
82

 
 
 
 
 
 
 
 
At December 31, 2013
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S. Treasury securities
$
2,030

 
$
27

 
$
—

 
$
2,057

U.S. government agency securities
1,535

 
26

 
—

 
1,561

Credit card asset-backed securities of other issuers
6

 
—

 
—

 
6

Residential mortgage-backed securities - Agency
1,329

 
—

 
(22
)
 
1,307

Total available-for-sale investment securities
$
4,900

 
$
53

 
$
(22
)
 
$
4,931

Held-to-Maturity Investment Securities(2)
 
 
 
 
 
 
 
U.S. Treasury securities(3)
$
1

 
$
—

 
$
—

 
$
1

States and political subdivisions of states
15

 
—

 
(1
)
 
14

Residential mortgage-backed securities - Agency(4) 
44

 
—

 
(1
)
 
43

Total held-to-maturity investment securities
$
60

 
$
—

 
$
(2
)
 
$
58

 
 
 
 
 
 
 
 
(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.
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 (dollars in millions):
 
Number of
Securities
in a Loss
Position
 
Less than 12 months
 
More than 12 months
 
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
At September 30, 2014
 
 
 
 
 
 
 
 
 
Available-for-Sale Investment Securities
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities - Agency
16

 
$
370

 
$
(1
)
 
$
480

 
$
(5
)
 
 
 
 
 
 
 
 
 
 
At December 31, 2013
 
 
 
 
 
 
 
 
 
Available-for-Sale Investment Securities
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities - Agency
23

 
$
1,097

 
$
(20
)
 
$
48

 
$
(2
)
Held-to-Maturity Investment Securities
 
 
 
 
 
 
 
 
 
State and political subdivisions of states
4

 
$
8

 
$
(1
)
 
$
3

 
$
—

Residential mortgage-backed securities - Agency
2

 
$
40

 
$
(1
)
 
$
—

 
$
—

 
 
 
 
 
 
 
 
 
 

7
Table of Contents

The Company records gains and losses on investment securities in other income when investments are sold or liquidated, when the Company believes an investment is other than temporarily impaired prior to the disposal of the investment, or in certain other circumstances. Gains and losses on sales of available-for-sale investment securities are calculated using the specific identification method and are recorded entirely in earnings. The Company records unrealized gains and losses on its available-for-sale investment securities in other comprehensive income. Other-than-temporary impairment for investments is calculated using the specific identification method. No gains or losses related to other-than-temporary impairments were recorded during the three and nine months ended September 30, 2014 and 2013.
The following table provides information about proceeds related to maturities and redemptions of investment securities and proceeds from sales, recognized gains and losses and net unrealized gains and losses on available-for-sale securities (dollars in millions):
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Proceeds related to maturities or redemptions of investment securities
$
65

 
$
94

 
$
184

 
$
672

Proceeds from the sales of available-for-sale investment securities, comprised of U.S. Treasury securities and U.S. government agency securities
$
—

 
$
—

 
$
1,220

 
$
719

Gains on sales of available-for-sale investment securities
$
—

 
$
—

 
$
4

 
$
2

Net unrealized (losses) gains recorded in other comprehensive income, before-tax
$
(15
)
 
$
6

 
$
1

 
$
(61
)
Net unrealized (losses) gains recorded in other comprehensive income, after-tax
$
(9
)
 
$
4

 
$
1

 
$
(38
)
 
 
 
 
 
 
 
 
Maturities of available-for-sale debt securities and held-to-maturity debt securities at the end of the period are provided in the table below (dollars in millions):
 
One Year
or
Less
 
After One
Year
Through
Five Years
 
After Five
Years
Through
Ten Years
 
After Ten
Years
 
Total
At September 30, 2014
 
 
 
 
 
 
 
 
 
Available-for-Sale—Amortized Cost(1)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
567

 
$
751

 
$
—

 
$
—

 
$
1,318

U.S. government agency securities
401

 
621

 
—

 
—

 
1,022

Residential mortgage-backed securities - Agency
—

 
—

 
520

 
1,021

 
1,541

Total available-for-sale investment securities
$
968

 
$
1,372

 
$
520

 
$
1,021

 
$
3,881

Held-to-Maturity—Amortized Cost(2)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
1

 
$
—

 
$
—

 
$
—

 
$
1

State and political subdivisions of states
—

 
—

 
—

 
10

 
10

Residential mortgage-backed securities - Agency
—

 
—

 
—

 
71

 
71

Total held-to-maturity investment securities
$
1

 
$
—

 
$
—

 
$
81

 
$
82

Available-for-Sale—Fair Values(1)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
571

 
$
763

 
$
—

 
$
—

 
$
1,334

U.S. government agency securities
406

 
632

 
—

 
—

 
1,038

Residential mortgage-backed securities - Agency
—

 
—

 
519

 
1,022

 
1,541

Total available-for-sale investment securities
$
977

 
$
1,395

 
$
519

 
$
1,022

 
$
3,913

Held-to-Maturity—Fair Values(2)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
1

 
$
—

 
$
—

 
$
—

 
$
1

State and political subdivisions of states
—

 
—

 
—

 
10

 
10

Residential mortgage-backed securities - Agency
—

 
—

 
—

 
71

 
71

Total held-to-maturity investment securities
$
1

 
$
—

 
$
—

 
$
81

 
$
82

 
 
 
 
 
 
 
 
 
 
(1)
Available-for-sale investment securities are reported at fair value.
(2)
Held-to-maturity investment securities are reported at amortized cost.

8
Table of Contents

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 accrued expenses and 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 September 30, 2014 and December 31, 2013, the Company had outstanding investments in these entities of $317 million and $308 million, respectively, and related contingent liabilities of $44 million and $52 million, respectively.
3.
Loan Receivables
The Company has three loan portfolio segments: credit card loans, other loans and purchased credit-impaired ("PCI") student loans, as well as mortgage loans held for sale.
The Company's classes of receivables within the three portfolio segments are depicted in the table below (dollars in millions):
 
September 30,
2014
 
December 31,
2013
Mortgage loans held for sale(1)
$
148

 
$
148

Loan portfolio:
 
 
 
Credit card loans:
 
 
 
Discover card(2)
53,503

 
52,952

Discover business card
196

 
198

Total credit card loans
53,699

 
53,150

Other loans:
 
 
 
Personal loans
4,830

 
4,191

Private student loans
4,706

 
3,969

Other
195

 
135

Total other loans
9,731

 
8,295

Purchased credit-impaired loans(3)
3,788

 
4,178

Total loan portfolio
67,218

 
65,623

Total loan receivables
67,366

 
65,771

Allowance for loan losses
(1,644
)
 
(1,648
)
Net loan receivables
$
65,722

 
$
64,123

 
 
 
 
(1)
Substantially all mortgage loans held for sale are pledged as collateral against the warehouse line of credit used to fund consumer residential loans.
(2)
Amounts include $20.2 billion underlying investors’ interest in trust debt at September 30, 2014 and December 31, 2013, and $9.3 billion and $10.9 billion in seller's interest at September 30, 2014 and December 31, 2013, respectively. See Note 4: Credit Card and Student Loan Securitization Activities for further information.
(3)
Amounts include $2.0 billion and $2.2 billion of loans pledged as collateral against the notes issued from the Student Loan Corporation ("SLC") securitization trusts at September 30, 2014 and December 31, 2013. See Note 4: Credit Card and Student Loan Securitization Activities. Of the remaining $1.8 billion and $2.0 billion at September 30, 2014 and December 31, 2013, respectively, that were not pledged as collateral, approximately $23 million and $22 million, respectively, represents loans eligible for reimbursement through an indemnification claim. Discover Bank must purchase such loans from the trust before a claim may be filed.
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 non-accrual 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, non-fraudulent credit card and closed-end consumer loan receivables may resume accruing interest.

9
Table of Contents

Information related to the delinquent and non-accruing loans 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 millions):
  
30-89 Days
Delinquent
 
90 or
More Days
Delinquent
 
Total Past
Due
 
90 or
More Days
Delinquent
and
Accruing
 
Total
Non-accruing(1)
At September 30, 2014
 
 
 
 
 
 
 
 
 
Credit card loans:
 
 
 
 
 
 
 
 
 
Discover card(2)
$
479

 
$
439

 
$
918

 
$
401

 
$
164

Discover business card
1

 
1

 
2

 
1

 
1

Total credit card loans
480

 
440

 
920

 
402

 
165

Other loans:
 
 
 
 
 
 
 
 
 
Personal loans(3)
26

 
10

 
36

 
9

 
5

Private student loans (excluding PCI)(4)
61

 
24

 
85

 
24

 
—

Other
—

 
2

 
2

 
—

 
24

Total other loans (excluding PCI)
87

 
36

 
123

 
33

 
29

Total loan receivables (excluding PCI)
$
567

 
$
476

 
$
1,043

 
$
435

 
$
194

 
 
 
 
 
 
 
 
 
 
At December 31, 2013
 
 
 
 
 
 
 
 
 
Credit card loans:
 
 
 
 
 
 
 
 
 
Discover card(2)
$
464

 
$
445

 
$
909

 
$
406

 
$
154

Discover business card
1

 
2

 
3

 
2

 
1

Total credit card loans
465

 
447

 
912

 
408

 
155

Other loans:
 
 
 
 
 
 
 
 
 
Personal loans(3)
21

 
8

 
29

 
8

 
5

Private student loans (excluding PCI)(4)
48

 
18

 
66

 
18

 
—

Other
1

 
2

 
3

 
—

 
40

Total other loans (excluding PCI)
70

 
28

 
98

 
26

 
45

Total loan receivables (excluding PCI)
$
535

 
$
475

 
$
1,010

 
$
434

 
$
200

 
 
 
 
 
 
 
 
 
 
 
(1)
The Company estimates that the gross interest income that would have been recorded in accordance with the original terms of non-accruing credit card loans was $7 million for the three months ended September 30, 2014 and 2013 and was $20 million and $22 million for the nine months ended September 30, 2014 and 2013, respectively. The Company does not separately systematically compute the amount of gross interest income that would have been recorded in accordance with the original terms of loans. This amount was estimated based on customers' quarterly average balances and rates prior to non-accrual status.
(2)
Consumer credit card loans that are 90 or more days delinquent and accruing interest include $40 million and $41 million of loans accounted for as troubled debt restructurings at September 30, 2014 and December 31, 2013, respectively.
(3)
Personal loans that are 90 or more days delinquent and accruing interest include $2 million of loans accounted for as troubled debt restructurings at September 30, 2014 and December 31, 2013.
(4)
Private student loans that are 90 or more days delinquent and accruing interest include $4 million and $3 million of loans accounted for as troubled debt restructurings at September 30, 2014 and December 31, 2013, respectively.

10
Table of Contents

Net Charge-offs
The Company's net charge-offs include the principal amount of loans 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 income 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. Personal loans and private student loans, which are 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.
Information related to the 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 millions):
 
For the Three Months Ended September 30,
 
2014
 
2013
  
Net
Charge-offs
 
Net 
Charge-off
Rate
 
Net
Charge-offs
 
Net 
Charge-off
Rate
Credit card loans:
 
 
 
 
 
 
 
Discover card
$
288

 
2.16
%
 
$
257

 
2.05
%
Discover business card
1

 
1.82
%
 
1

 
2.12
%
Total credit card loans
289

 
2.16
%
 
258

 
2.05
%
Other loans:
 
 
 
 
 
 
 
Personal loans
23

 
1.92
%
 
20

 
2.01
%
Private student loans (excluding PCI)
12

 
1.14
%
 
12

 
1.33
%
Other
—

 
0.60
%
 
1

 
2.35
%
Total other loans (excluding PCI)
35

 
1.50
%
 
33

 
1.65
%
Net charge-offs as a percentage of total loans (excluding PCI)
$
324

 
2.06
%
 
$
291

 
2.00
%
Net charge-offs as a percentage of total loans (including PCI)
$
324

 
1.94
%
 
$
291

 
1.86
%
 
 
 
 
 
 
 
For the Nine Months Ended September 30,
 
2014
 
2013
  
Net
Charge-offs
 
Net 
Charge-off
Rate
 
Net
Charge-offs
 
Net 
Charge-off
Rate
Credit card loans:
 
 
 
 
 
 
 
Discover card
$
880

 
2.27
%
 
$
827

 
2.25
%
Discover business card
3

 
1.75
%
 
4

 
2.31
%
Total credit card loans
883

 
2.27
%
 
831

 
2.25
%
Other loans:
 
 
 
 
 
 
 
Personal loans
66

 
1.98
%
 
58

 
2.18
%
Private student loans (excluding PCI)
40

 
1.25
%
 
32

 
1.25
%
Other
1

 
0.88
%
 
1

 
1.72
%
Total other loans (excluding PCI)
107

 
1.58
%
 
91

 
1.66
%
Net charge-offs as a percentage of total loans (excluding PCI)
$
990

 
2.16
%
 
$
922

 
2.17
%
Net charge-offs as a percentage of total loans (including PCI)
$
990

 
2.03
%
 
$
922

 
2.01
%
 
 
 
 
 
 
 
 
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 FICO or other credit scores, relating to the customer’s broader credit performance. FICO 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.

11
Table of Contents

 The following table provides the most recent FICO scores available for the Company’s customers as a percentage of each class of loan receivables:
 
Credit Risk Profile
by FICO Score
 
660 and 
Above
 
Less than 660
or No Score
At September 30, 2014
 
 
 
Discover card
83
%
 
17
%
Discover business card
92
%
 
8
%
Personal loans
97
%
 
3
%
Private student loans (excluding PCI)(1)
95
%
 
5
%
 
 
 
 
At December 31, 2013
 
 
 
Discover card
83
%
 
17
%
Discover business card
92
%
 
8
%
Personal loans
97
%
 
3
%
Private student loans (excluding PCI)(1)
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, but still willing to make payments, the ability to temporarily suspend payments. Eligible borrowers have a lifetime cap on forbearance of 12 months. At September 30, 2014 and December 31, 2013, there were $44 million and $110 million of private student loans, including PCI, in forbearance, respectively. In addition, at September 30, 2014 and December 31, 2013, there were 0.8% and 1.9% of private student loans in forbearance as a percentage of student loans in repayment and forbearance, respectively. At September 30, 2014, the dollar amount of loans in forbearance and loans in forbearance as a percentage of private student loans in repayment and forbearance were lower when compared to December 31, 2013 due to the implementation of temporary reduced payment programs, which normally consist of a reduction of the minimum payment for a period of no longer than 12 months at a time. Loans in these programs are not considered to be in 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 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, 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 primarily 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 "— Troubled Debt Restructurings." Certain other loans, including non-performing Diners Club licensee loans, are individually evaluated for impairment.

12
Table of Contents

The following tables provide changes in the Company’s allowance for loan losses (dollars in millions): 
 
For the Three Months Ended September 30, 2014
 
Credit Card
 
Personal Loans
 
Student Loans
 
Other
 
Total
Balance at beginning of period
$
1,359

 
$
109

 
$
128

 
$
18

 
$
1,614

Additions:
 
 
 
 
 
 
 
 
 
Provision for loan losses
318

 
22

 
16

 
(2
)
 
354

Deductions:
 
 
 
 
 
 
 
 
 
Charge-offs
(400
)
 
(26
)
 
(14
)
 
—

 
(440
)
Recoveries
111

 
3

 
2

 
—

 
116

Net charge-offs
(289
)
 
(23
)
 
(12
)
 
—

 
(324
)
Balance at end of period
$
1,388

 
$
108

 
$
132

 
$
16

 
$
1,644

 
 
 
 
 
 
 
 
 
 
 
For the Three Months Ended September 30, 2013
 
Credit Card
 
Personal Loans
 
Student Loans
 
Other
 
Total
Balance at beginning of period
$
1,360

 
$
98

 
$
82

 
$
16

 
$
1,556

Additions:
 
 
 
 
 
 
 
 
 
Provision for loan losses
291

 
28

 
14

 
—

 
333

Deductions:
 
 
 
 
 
 
 
 
 
Charge-offs
(381
)
 
(21
)
 
(13
)
 
(1
)
 
(416
)
Recoveries
123

 
1

 
1

 
—

 
125

Net charge-offs
(258
)
 
(20
)
 
(12
)
 
(1
)
 
(291
)
Balance at end of period
$
1,393

 
$
106

 
$
84

 
$
15

 
$
1,598

 
 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended September 30, 2014
 
Credit Card
 
Personal Loans
 
Student Loans
 
Other
 
Total
Balance at beginning of period
$
1,406

 
$
112

 
$
113

 
$
17

 
$
1,648

Additions:
 
 
 
 
 
 
 
 
 
Provision for loan losses
865

 
62

 
59

 
—

 
986

Deductions:
 
 
 
 
 
 
 
 
 
Charge-offs
(1,223
)
 
(74
)
 
(44
)
 
(1
)
 
(1,342
)
Recoveries
340

 
8

 
4

 
—

 
352

Net charge-offs
(883
)
 
(66
)
 
(40
)
 
(1
)
 
(990
)
Balance at end of period
$
1,388

 
$
108

 
$
132

 
$
16

 
$
1,644

 
 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended September 30, 2013
 
Credit Card
 
Personal Loans
 
Student Loans
 
Other
 
Total
Balance at beginning of period
$
1,613

 
$
99

 
$
75

 
$
1