10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the quarterly period ended March 31, 2016 |
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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)
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Delaware | | 36-2517428 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
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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.
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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 April 22, 2016, there were 412,225,311 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 March 31, 2016
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 Checking®, Discover it®, Freeze ItSM, 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.
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Part I. | FINANCIAL INFORMATION |
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Item 1. | Financial Statements |
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Financial Condition
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| | | | | | | |
| March 31,
2016 | | December 31,
2015 |
| (unaudited) (dollars in millions, except share amounts) |
Assets | | | |
Cash and cash equivalents | $ | 12,135 |
| | $ | 9,572 |
|
Restricted cash | 1,010 |
| | 99 |
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Investment securities (includes $2,824 and $2,963 at fair value at March 31, 2016 and December 31, 2015, respectively) | 2,956 |
| | 3,084 |
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Loan receivables | | | |
Loan receivables | 70,320 |
| | 72,385 |
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Allowance for loan losses | (1,921 | ) | | (1,869 | ) |
Net loan receivables | 68,399 |
| | 70,516 |
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Premises and equipment, net | 706 |
| | 693 |
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Goodwill | 255 |
| | 255 |
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Intangible assets, net | 167 |
| | 168 |
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Other assets | 2,465 |
| | 2,412 |
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Total assets | $ | 88,093 |
| | $ | 86,799 |
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Liabilities and Stockholders’ Equity | | | |
Deposits | | | |
Interest-bearing deposit accounts | $ | 48,055 |
| | $ | 47,094 |
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Non-interest bearing deposit accounts | 410 |
| | 437 |
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Total deposits | 48,465 |
| | 47,531 |
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Long-term borrowings | 24,752 |
| | 24,650 |
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Accrued expenses and other liabilities | 3,560 |
| | 3,343 |
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Total liabilities | 76,777 |
| | 75,524 |
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Commitments, contingencies and guarantees (Notes 9, 12 and 13) |
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Stockholders’ Equity: | | | |
Common stock, par value $0.01 per share; 2,000,000,000 shares authorized; 562,210,058 and 560,679,352 shares issued at March 31, 2016 and December 31, 2015, respectively | 5 |
| | 5 |
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Preferred stock, par value $0.01 per share; 200,000,000 shares authorized; 575,000 shares issued and outstanding and aggregate liquidation preference of $575 at March 31, 2016 and December 31, 2015 | 560 |
| | 560 |
|
Additional paid-in capital | 3,913 |
| | 3,885 |
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Retained earnings | 13,698 |
| | 13,250 |
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Accumulated other comprehensive loss | (172 | ) | | (160 | ) |
Treasury stock, at cost; 147,983,359 and 139,000,423 shares at March 31, 2016 and December 31, 2015, respectively | (6,688 | ) | | (6,265 | ) |
Total stockholders’ equity | 11,316 |
| | 11,275 |
|
Total liabilities and stockholders’ equity | $ | 88,093 |
| | $ | 86,799 |
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Upon adoption of ASU 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, certain balances as of December 31, 2015 have been restated to reflect the classification of debt issuance costs as a direct deduction of the related liability. See Note 1: Background and Basis of Presentation for additional information.
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. |
| | | | | | | |
| March 31,
2016 | | December 31,
2015 |
| (unaudited) (dollars in millions) |
Assets | | | |
Restricted cash | $ | 1,010 |
| | $ | 99 |
|
Loan receivables | $ | 28,761 |
| | $ | 30,551 |
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Allowance for loan losses allocated to securitized loan receivables | $ | (811 | ) | | $ | (811 | ) |
Other assets | $ | 6 |
| | $ | 5 |
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Liabilities | | | |
Long-term borrowings | $ | 16,779 |
| | $ | 16,735 |
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Accrued expenses and other liabilities | $ | 13 |
| | $ | 12 |
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| | | |
See Notes to the Condensed Consolidated Financial Statements.
1
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Income
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| | | | | | | |
| For the Three Months Ended March 31, |
| 2016 | | 2015 |
| (unaudited) (dollars in millions, except per share amounts) |
Interest income | | | |
Credit card loans | $ | 1,733 |
| | $ | 1,606 |
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Other loans | 326 |
| | 304 |
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Investment securities | 11 |
| | 13 |
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Other interest income | 14 |
| | 6 |
|
Total interest income | 2,084 |
| | 1,929 |
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Interest expense | | | |
Deposits | 162 |
| | 152 |
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Short-term borrowings | — |
| | 1 |
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Long-term borrowings | 172 |
| | 147 |
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Total interest expense | 334 |
| | 300 |
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Net interest income | 1,750 |
| | 1,629 |
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Provision for loan losses | 424 |
| | 390 |
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Net interest income after provision for loan losses | 1,326 |
| | 1,239 |
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Other income | | | |
Discount and interchange revenue, net | 273 |
| | 268 |
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Protection products revenue | 61 |
| | 71 |
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Loan fee income | 80 |
| | 81 |
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Transaction processing revenue | 36 |
| | 42 |
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Gain on investments | — |
| | 8 |
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Gain on origination and sale of mortgage loans | — |
| | 40 |
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Other income | 24 |
| | 32 |
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Total other income | 474 |
| | 542 |
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Other expense | | | |
Employee compensation and benefits | 345 |
| | 331 |
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Marketing and business development | 162 |
| | 182 |
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Information processing and communications | 88 |
| | 88 |
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Professional fees | 160 |
| | 127 |
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Premises and equipment | 24 |
| | 24 |
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Other expense | 107 |
| | 121 |
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Total other expense | 886 |
| | 873 |
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Income before income tax expense | 914 |
| | 908 |
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Income tax expense | 339 |
| | 322 |
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Net income | $ | 575 |
| | $ | 586 |
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Net income allocated to common stockholders | $ | 562 |
| | $ | 573 |
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Basic earnings per common share | $ | 1.35 |
| | $ | 1.28 |
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Diluted earnings per common share | $ | 1.35 |
| | $ | 1.28 |
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Dividends declared per common share | $ | 0.28 |
| | $ | 0.24 |
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See Notes to the Condensed Consolidated Financial Statements.
2
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Comprehensive Income
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| | | | | | | |
| For the Three Months Ended March 31, |
| 2016 | | 2015 |
| (unaudited) (dollars in millions) |
Net income | $ | 575 |
| | $ | 586 |
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Other comprehensive income (loss), net of taxes | | | |
Unrealized gain on available-for-sale investment securities, net of tax | 14 |
| | — |
|
Unrealized loss on cash flow hedges, net of tax | (26 | ) | | (23 | ) |
Other comprehensive loss | (12 | ) | | (23 | ) |
Comprehensive income | $ | 563 |
| | $ | 563 |
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See Notes to the Condensed Consolidated Financial Statements.
3
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Changes in Stockholders’ Equity
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| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | 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, 2014 | 575 |
| | $ | 560 |
| | 558,194 |
| | $ | 5 |
| | $ | 3,790 |
| | $ | 11,467 |
| | $ | (138 | ) | | $ | (4,550 | ) | | $ | 11,134 |
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Net income | — |
| | — |
| | — |
| | — |
| | — |
| | 586 |
| | — |
| | — |
| | 586 |
|
Other comprehensive loss | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (23 | ) | | — |
| | (23 | ) |
Purchases of treasury stock | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (420 | ) | | (420 | ) |
Common stock issued under employee benefit plans | — |
| | — |
| | 18 |
| | — |
| | 1 |
| | — |
| | — |
| | — |
| | 1 |
|
Common stock issued and stock-based compensation expense | — |
| | — |
| | 2,330 |
| | — |
| | 50 |
| | — |
| | — |
| | — |
| | 50 |
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Dividends — common stock | — |
| | — |
| | — |
| | — |
| | — |
| | (108 | ) | | — |
| | — |
| | (108 | ) |
Dividends — preferred stock | — |
| | — |
| | — |
| | — |
| | — |
| | (9 | ) | | — |
| | — |
| | (9 | ) |
Balance at March 31, 2015 | 575 |
| | $ | 560 |
| | 560,542 |
| | $ | 5 |
| | $ | 3,841 |
| | $ | 11,936 |
| | $ | (161 | ) | | $ | (4,970 | ) | | $ | 11,211 |
|
| | | | | | | | | | | | | | | | | |
Balance at December 31, 2015 | 575 |
| | $ | 560 |
| | 560,679 |
| | $ | 5 |
| | $ | 3,885 |
| | $ | 13,250 |
| | $ | (160 | ) | | $ | (6,265 | ) | | $ | 11,275 |
|
Net income | — |
| | — |
| | — |
| | — |
| | — |
| | 575 |
| | — |
| | — |
| | 575 |
|
Other comprehensive loss | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (12 | ) | | — |
| | (12 | ) |
Purchases of treasury stock | — |
| | — |
| | — |
| | — |
| |
| | — |
| | — |
| | (423 | ) | | (423 | ) |
Common stock issued under employee benefit plans | — |
| | — |
| | 21 |
| | — |
| | 1 |
| | — |
| | — |
| | — |
| | 1 |
|
Common stock issued and stock-based compensation expense | — |
| | — |
| | 1,510 |
| | — |
| | 27 |
| | — |
| | — |
| | — |
| | 27 |
|
Dividends — common stock | — |
| | — |
| | — |
| | — |
| | — |
| | (118 | ) | | — |
| | — |
| | (118 | ) |
Dividends — preferred stock | — |
| | — |
| | — |
| | — |
| | — |
| | (9 | ) | | — |
| | — |
| | (9 | ) |
Balance at March 31, 2016 | 575 |
| | $ | 560 |
| | 562,210 |
| | $ | 5 |
| | $ | 3,913 |
| | $ | 13,698 |
| | $ | (172 | ) | | $ | (6,688 | ) | | $ | 11,316 |
|
| | | | | | | | | | | | | | | | | |
See Notes to the Condensed Consolidated Financial Statements.
4
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Cash Flows |
| | | | | | | |
| For the Three Months Ended March 31, |
| 2016 | | 2015 |
| (unaudited) (dollars in millions) |
Cash flows from operating activities | | | |
Net income | $ | 575 |
| | $ | 586 |
|
Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Provision for loan losses | 424 |
| | 390 |
|
Depreciation and amortization | 84 |
| | 95 |
|
Amortization of deferred revenues and accretion of accretable yield on acquired loans | (98 | ) | | (113 | ) |
Net loss (gain) on origination and sale of loans, investments and other assets | 13 |
| | (36 | ) |
Proceeds from sale of mortgage loans originated for sale | — |
| | 1,083 |
|
Net principal disbursed on mortgage loans originated for sale | — |
| | (1,110 | ) |
Other, net | 4 |
| | (8 | ) |
Changes in assets and liabilities: | | | |
Increase in other assets | (33 | ) | | (40 | ) |
Increase in accrued expenses and other liabilities | 189 |
| | 216 |
|
Net cash provided by operating activities | 1,158 |
| | 1,063 |
|
| | | |
Cash flows from investing activities | | | |
Maturities and sales of available-for-sale investment securities | 158 |
| | 1,188 |
|
Maturities of held-to-maturity investment securities | 5 |
| | 2 |
|
Purchases of held-to-maturity investment securities | (16 | ) | | (17 | ) |
Net principal repaid on loans originated for investment | 1,793 |
| | 2,129 |
|
Purchases of other investments | (1 | ) | | (5 | ) |
Increase in restricted cash | (911 | ) | | (3 | ) |
Purchases of premises and equipment | (46 | ) | | (41 | ) |
Net cash provided by investing activities | 982 |
| | 3,253 |
|
| | | |
Cash flows from financing activities | | | |
Net increase in short-term borrowings | — |
| | 53 |
|
Proceeds from issuance of securitized debt | 991 |
| | 950 |
|
Maturities and repayment of securitized debt | (980 | ) | | (1,083 | ) |
Proceeds from issuance of other long-term borrowings | 38 |
| | 499 |
|
Proceeds from issuance of common stock | 1 |
| | 1 |
|
Purchases of treasury stock | (423 | ) | | (420 | ) |
Net increase in deposits | 925 |
| | 333 |
|
Dividends paid on common and preferred stock | (129 | ) | | (119 | ) |
Net cash provided by financing activities | 423 |
| | 214 |
|
Net increase in cash and cash equivalents | 2,563 |
| | 4,530 |
|
Cash and cash equivalents, at beginning of period | 9,572 |
| | 7,284 |
|
Cash and cash equivalents, at end of period | $ | 12,135 |
| | $ | 11,814 |
|
| | | |
See Notes to the Condensed Consolidated Financial Statements.
5
Notes to the Condensed Consolidated Financial Statements
(unaudited)
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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”). The Company provides direct banking products and services and payment services through its subsidiaries. The Company offers its customers credit card loans, private student loans, personal loans, home equity loans and deposit products. The Company also operates the Discover Network, the PULSE network (“PULSE”) and Diners Club International (“Diners Club”). The Discover Network processes transactions for Discover-branded credit cards and provides payment transaction processing and settlement services. 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 charge cards and/or provide card acceptance services.
The Company’s business segments are Direct Banking and Payment Services. The Direct Banking segment includes Discover-branded credit cards issued to individuals on the Discover Network and other consumer products and services, including private student loans, personal loans, home equity loans, 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, an automated teller machine, debit and electronic funds transfer network; Diners Club, a global payments network; and the Company’s Network Partners business, which provides payment transaction processing and settlement services on the Discover Network. 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 2015 audited consolidated financial statements filed with the Company’s annual report on Form 10-K for the year ended December 31, 2015.
Change in Accounting Principle
In April 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2015-03, Interest—-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which makes the presentation of debt issuance costs consistent with that of debt discounts and premiums. This ASU requires that debt issuance costs related to a recognized liability be presented in the balance sheet as a direct deduction from the carrying amount of that liability. Before becoming effective for the Company on January 1, 2016, these costs were recorded as deferred charges presented in other assets on the consolidated statements of financial condition. The guidance requires retrospective application in the financial statements. As such, some balances as of December 31, 2015 have been restated to reflect the classification of debt issuance costs as a direct deduction of a related liability. The impact of adopting this ASU was a reduction of other assets of $137 million, a reduction of long-term borrowings of $74 million and a reduction of deposits of $63 million at December 31, 2015. There was no impact to the consolidated statements of income.
Recently Issued Accounting Pronouncements
In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This ASU requires excess tax benefits and tax deficiencies, which arise due to differences between the measure of compensation expense and the amount deductible for tax purposes, to be recorded directly through the income statement as a component of income tax expense. Under current GAAP, these differences are generally recorded in additional paid-in capital and thus have no impact on net income today. The change in treatment of excess tax benefits and tax deficiencies will also impact the computation of diluted earnings per share, and the cash flows associated with those items will be classified as operating activities on the statement of cash flows. The ASU will permit certain elective changes associated with stock compensation accounting. For example, companies can elect to account for forfeitures of awards as they occur rather than projecting forfeitures in the accrual of compensation expense. In addition, the ASU increases the proportion of shares an employer is permitted (though not required) to withhold on behalf of an employee to satisfy the employee’s income tax burden on a share-based award without causing the award to become subject to liability accounting. This ASU will become effective for the Company on January 1, 2017 and management is in the process of evaluating its impact. Upon adoption, the cumulative amounts associated with previous excess tax benefits will be reclassified from additional paid-in capital to retained earnings.
In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). The guidance in this ASU provides clarification on the principal versus agent concept in relation to revenue recognition guidance issued as part of ASU 2014-09, Revenue from Contracts with Customers (Topic 606). Topic 606 requires a company to determine whether it is a principal or an agent in a transaction in which another party is involved in providing goods or services to a customer by evaluating the nature of its promise to the customer. ASU 2016-08 provides clarification for identifying the good, service or right being transferred in a revenue transaction and identifies the principal as the party that controls the good, service or right prior to its transfer to the customer. The ASU provides further clarity on how to evaluate control in this context. This guidance will become effective for the Company on January 1, 2018 and management is evaluating the impact of these changes as part of its overall evaluation of ASU 2014-09.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The guidance will require lessees to capitalize most leases on their balance sheet whereas under current GAAP only capital leases are recognized on the lessee’s balance sheet. Leases which today are identified as capital leases will generally be identified as financing leases under the new guidance but otherwise their accounting treatment will remain relatively unchanged. Leases identified today as operating leases will generally remain in that category under the new standard, but both a right-of-use asset and a liability for remaining lease payments will now be required to be recognized on the balance sheet for this type of lease. The manner in which expenses associated with all leases are reported on the income statement will remain mostly unchanged. Lessor accounting also remains substantially unchanged by the new standard. The new guidance will become effective for the Company on January 1, 2019 and management is in the process of evaluating its impact.
In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The ASU will have limited impact on the Company since it does not change the guidance for classifying and measuring investments in debt securities or loans. The standard requires entities to measure certain cost-method equity investments at fair value with changes in value recognized in net income. Equity investments that do not have readily determinable fair values will be carried at cost, less any impairment, plus or minus changes resulting from any observable price changes in orderly transactions for an identical or similar investment of the same issuer. This ASU requires public entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes and requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans) on the balance sheet or the accompanying notes to the financial statements. This ASU will become effective for the Company on January 1, 2018 and is not expected to have a material impact to the financial statements.
In April 2015, the FASB issued ASU No. 2015-05, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. This ASU addresses whether a cloud computing arrangement contains a software license. Under this ASU a cloud computing arrangement contains a software license if the customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty and provided it is feasible for the customer to either host the software internally or with an external party unrelated to the original vendor. Upon meeting both of these criteria, a customer should account for the software license within a cloud computing arrangement in a manner consistent with the acquisition of other software licenses. This could potentially change the timing of expense recognition associated with the contract. If a cloud computing
arrangement does not meet both criteria, a customer will account for the arrangement entirely as a service contract. This ASU became effective for the Company on January 1, 2016. Management determined there were no existing contractual arrangements impacted by this ASU. The new guidance will be applied to any new contractual arrangements that meet the criteria discussed above.
In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. The guidance in this ASU was issued to improve targeted areas of the accounting rules for consolidation. This ASU changes the analysis companies will use to determine if certain types of legal entities should be consolidated. In addition, it modifies the determination of whether a limited liability entity should be evaluated as a variable interest entity ("VIE") or a voting interest entity and eliminates the presumption that a general partner should consolidate a limited partnership. The new amendment became effective for the Company on January 1, 2016. The amendments primarily triggered a review of the Company’s tax credit investments, which typically utilize limited liability entities. As a result of that review, management determined that its prior conclusions associated with the Company's tax credit investments continue to be appropriate.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The guidance in this ASU supersedes existing revenue recognition requirements in Topic 605, Revenue Recognition, including an assortment of transaction-specific and industry-specific rules. This 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. Throughout 2015, management followed the discussions of the FASB and its Transition Resource Group pertaining to credit card arrangements, loyalty programs, and transaction processing arrangements, and how the new revenue recognition rules should be interpreted for each. Based on those discussions, management is considering the comments made as part of those discussions in its ongoing evaluation of the new standard. Management expects to complete its evaluation of the impact of this amendment in 2016. The new revenue recognition model will become effective for the Company on January 1, 2018. Upon adoption in 2018, as appropriate, 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, 2018, without restating prior periods presented. Management has not yet determined which transition reporting option it will apply.
On June 16, 2015, the Company announced the closing of the mortgage origination business it acquired in 2012, which was part of its Direct Banking segment. The disposition represented the exiting of an ancillary business and did not have a major impact on the Company’s operations.
The Company’s investment securities consist of the following (dollars in millions): |
| | | | | | | |
| March 31,
2016 | | December 31,
2015 |
U.S. Treasury securities(1) | $ | 1,181 |
| | $ | 1,273 |
|
U.S. government agency securities | 492 |
| | 494 |
|
States and political subdivisions of states | 5 |
| | 7 |
|
Residential mortgage-backed securities - Agency(2) | 1,278 |
| | 1,310 |
|
Total investment securities | $ | 2,956 |
| | $ | 3,084 |
|
| | | |
| |
(1) | Includes $20 million and $7 million of U.S. Treasury securities pledged as swap collateral in lieu of cash as of March 31, 2016 and December 31, 2015, respectively. |
| |
(2) | Consists of residential mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae. |
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 March 31, 2016 | | | | | | | |
Available-for-Sale Investment Securities(1) | | | | | | | |
U.S. Treasury securities | $ | 1,177 |
| | $ | 3 |
| | $ | — |
| | $ | 1,180 |
|
U.S. government agency securities | 491 |
| | 1 |
| | — |
| | 492 |
|
Residential mortgage-backed securities - Agency | 1,134 |
| | 18 |
| | — |
| | 1,152 |
|
Total available-for-sale investment securities | $ | 2,802 |
| | $ | 22 |
| | $ | — |
| | $ | 2,824 |
|
Held-to-Maturity Investment Securities(2) | | | | | | | |
U.S. Treasury securities(3) | $ | 1 |
| | $ | — |
| | $ | — |
| | $ | 1 |
|
States and political subdivisions of states | 5 |
| | — |
| | — |
| | 5 |
|
Residential mortgage-backed securities - Agency(4) | 126 |
| | 3 |
| | — |
| | 129 |
|
Total held-to-maturity investment securities | $ | 132 |
| | $ | 3 |
| | $ | — |
| | $ | 135 |
|
| | | | | | | |
At December 31, 2015 | | | | | | | |
Available-for-Sale Investment Securities(1) | | | | | | | |
U.S. Treasury securities | $ | 1,277 |
| | $ | 1 |
| | $ | (6 | ) | | $ | 1,272 |
|
U.S. government agency securities | 492 |
| | 2 |
| | — |
| | 494 |
|
Residential mortgage-backed securities - Agency | 1,195 |
| | 6 |
| | (4 | ) | | 1,197 |
|
Total available-for-sale investment securities | $ | 2,964 |
| | $ | 9 |
| | $ | (10 | ) | | $ | 2,963 |
|
Held-to-Maturity Investment Securities(2) | | | | | | | |
U.S. Treasury securities(3) | $ | 1 |
| | $ | — |
| | $ | — |
| | $ | 1 |
|
States and political subdivisions of states | 7 |
| | — |
| | — |
| | 7 |
|
Residential mortgage-backed securities - Agency(4) | 113 |
| | 1 |
| | — |
| | 114 |
|
Total held-to-maturity investment securities | $ | 121 |
| | $ | 1 |
| | $ | — |
| | $ | 122 |
|
| | | | | | | |
| |
(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 December 31, 2015 | | | | | | | | | |
Available-for-Sale Investment Securities | | | | | | | | | |
U.S. Treasury securities | 1 |
| | $ | 670 |
| | $ | (6 | ) | | $ | — |
| | $ | — |
|
Residential mortgage-backed securities - Agency | 15 |
| | $ | 486 |
| | $ | (4 | ) | | $ | — |
| | $ | — |
|
| | | | | | | | | |
Aggregate gross unrealized losses were not material as of March 31, 2016. There were no losses related to other-than-temporary impairments during the three months ended March 31, 2016 and 2015.
The following table provides information about 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 March 31, |
| 2016 | | 2015 |
Proceeds from the sales of available-for-sale investment securities | $ | — |
| | $ | 899 |
|
Gain on sales of available-for-sale investment securities | $ | — |
| | $ | 8 |
|
Net unrealized gain recorded in other comprehensive income, before-tax | $ | 23 |
| | $ | — |
|
Net unrealized gain recorded in other comprehensive income, after-tax | $ | 14 |
| | $ | — |
|
| | | |
Maturities of available-for-sale debt securities and held-to-maturity debt securities 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 March 31, 2016 | | | | | | | | | |
Available-for-Sale Investment Securities—Amortized Cost | | | | | | | | | |
U.S. Treasury securities | $ | 500 |
| | $ | 677 |
| | $ | — |
| | $ | — |
| | $ | 1,177 |
|
U.S. government agency securities | 491 |
| | — |
| | — |
| | — |
| | 491 |
|
Residential mortgage-backed securities - Agency | — |
| | — |
| | 359 |
| | 775 |
| | 1,134 |
|
Total available-for-sale investment securities | $ | 991 |
| | $ | 677 |
| | $ | 359 |
| | $ | 775 |
| | $ | 2,802 |
|
Held-to-Maturity Investment Securities—Amortized Cost | | | | | | | | | |
U.S. Treasury securities | $ | 1 |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 1 |
|
State and political subdivisions of states | — |
| | — |
| | — |
| | 5 |
| | 5 |
|
Residential mortgage-backed securities - Agency | — |
| | — |
| | — |
| | 126 |
| | 126 |
|
Total held-to-maturity investment securities | $ | 1 |
| | $ | — |
| | $ | — |
| | $ | 131 |
| | $ | 132 |
|
Available-for-Sale Investment Securities—Fair Values | | | | | | | | | |
U.S. Treasury securities | $ | 501 |
| | $ | 679 |
| | $ | — |
| | $ | — |
| | $ | 1,180 |
|
U.S. government agency securities | 492 |
| | — |
| | — |
| | — |
| | 492 |
|
Residential mortgage-backed securities - Agency | — |
| | — |
| | 363 |
| | 789 |
| | 1,152 |
|
Total available-for-sale investment securities | $ | 993 |
| | $ | 679 |
| | $ | 363 |
| | $ | 789 |
| | $ | 2,824 |
|
Held-to-Maturity Investment Securities—Fair Values | | | | | | | | | |
U.S. Treasury securities | $ | 1 |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 1 |
|
State and political subdivisions of states | — |
| | — |
| | — |
| | 5 |
| | 5 |
|
Residential mortgage-backed securities - Agency | — |
| | — |
| | — |
| | 129 |
| | 129 |
|
Total held-to-maturity investment securities | $ | 1 |
| | $ | — |
| | $ | — |
| | $ | 134 |
| | $ | 135 |
|
| | | | | | | | | |
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. The related commitment for future investments is recorded in accrued expenses and other liabilities within the condensed consolidated statements of financial condition. The portion of each investment's operating results allocable to the Company is recorded in other expense within the condensed consolidated statements 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 March 31, 2016 and December 31, 2015, the Company had outstanding investments in these entities of $315 million and $328 million, respectively, and related contingent liabilities of $56 million and $57 million, respectively. Of the above outstanding equity investments, the Company had $233 million and $238 million, respectively, of investments related to affordable housing projects, which had $56 million and $57 million related contingent liabilities as of March 31, 2016 and December 31, 2015, respectively.
The Company has three loan portfolio segments: credit card loans, other loans and purchased credit-impaired ("PCI") loans.
The Company's classes of receivables within the three portfolio segments are depicted in the table below (dollars in millions): |
| | | | | | | |
| March 31,
2016 | | December 31,
2015 |
Loan receivables | | | |
Credit card loans(1) | $ | 55,620 |
| | $ | 57,896 |
|
Other loans | | | |
Personal loans | 5,534 |
| | 5,490 |
|
Private student loans | 5,949 |
| | 5,647 |
|
Other | 252 |
| | 236 |
|
Total other loans | 11,735 |
| | 11,373 |
|
Purchased credit-impaired loans(2) | 2,965 |
| | 3,116 |
|
Total loan receivables | 70,320 |
| | 72,385 |
|
Allowance for loan losses | (1,921 | ) | | (1,869 | ) |
Net loan receivables | $ | 68,399 |
| | $ | 70,516 |
|
| | | |
| |
(1) | Amounts include $20.9 billion and $21.6 billion underlying investors’ interest in trust debt at March 31, 2016 and December 31, 2015 and $6.2 billion and $7.2 billion in seller's interest at March 31, 2016 and December 31, 2015, respectively. See Note 5: Credit Card and Student Loan Securitization Activities for further information. |
| |
(2) | Amounts include $1.6 billion and $1.7 billion of loans pledged as collateral against the notes issued from the Student Loan Corporation ("SLC") securitization trusts at March 31, 2016 and December 31, 2015, respectively. See Note 5: Credit Card and Student Loan Securitization Activities. |
Credit Quality Indicators
The Company regularly reviews its collection experience (including delinquencies and net charge-offs) in determining its allowance for loan losses.
Information related to the delinquent and non-accruing loans in the Company’s loan portfolio 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 March 31, 2016 | | | | | | | | | |
Credit card loans(2) | $ | 454 |
| | $ | 480 |
| | $ | 934 |
| | $ | 427 |
| | $ | 190 |
|
Other loans | | | | |
|
| | | | |
Personal loans(3) | 40 |
| | 14 |
| | 54 |
| | 13 |
| | 6 |
|
Private student loans (excluding PCI)(4) | 78 |
| | 36 |
| | 114 |
| | 36 |
| | — |
|
Other | 2 |
| | 1 |
| | 3 |
| | — |
| | 20 |
|
Total other loans (excluding PCI) | 120 |
| | 51 |
| | 171 |
| | 49 |
| | 26 |
|
Total loan receivables (excluding PCI) | $ | 574 |
| | $ | 531 |
| | $ | 1,105 |
| | $ | 476 |
| | $ | 216 |
|
| | | | | | | | | |
At December 31, 2015 | | | | | | | | | |
Credit card loans(2) | $ | 505 |
| | $ | 490 |
| | $ | 995 |
| | $ | 422 |
| | $ | 198 |
|
Other loans | | | | |
|
| | | | |
Personal loans(3) | 34 |
| | 15 |
| | 49 |
| | 13 |
| | 6 |
|
Private student loans (excluding PCI)(4) | 84 |
| | 24 |
| | 108 |
| | 25 |
| | — |
|
Other | — |
| | 1 |
| | 1 |
| | — |
| | 20 |
|
Total other loans (excluding PCI) | 118 |
| | 40 |
| | 158 |
| | 38 |
| | 26 |
|
Total loan receivables (excluding PCI) | $ | 623 |
| | $ | 530 |
| | $ | 1,153 |
| | $ | 460 |
| | $ | 224 |
|
| | | | | | | | | |
| |
(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 $8 million and $7 million for the three months ended March 31, 2016 and 2015, 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. This amount was estimated based on customers' current balances and most recent interest rates. |
| |
(2) | Credit card loans that are 90 or more days delinquent and accruing interest include $44 million and $42 million of loans accounted for as troubled debt restructurings at March 31, 2016 and December 31, 2015, respectively. |
| |
(3) | Personal loans that are 90 or more days delinquent and accruing interest include $4 million of loans accounted for as troubled debt restructurings at March 31, 2016 and December 31, 2015. |
| |
(4) | Private student loans that are 90 or more days delinquent and accruing interest include $3 million of loans accounted for as troubled debt restructurings at March 31, 2016 and December 31, 2015. |
Information related to the net charge-offs in the Company's loan portfolio 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 March 31, |
| 2016 | | 2015 |
| Net
Charge-offs | | Net Charge-off
Rate | | Net
Charge-offs | | Net Charge-off
Rate |
Credit card loans | $ | 326 |
| | 2.34 | % | | $ | 319 |
| | 2.40 | % |
Other loans | | | | | | | |
Personal loans | 34 |
| | 2.45 | % | | 28 |
| | 2.22 | % |
Private student loans (excluding PCI) | 12 |
| | 0.85 | % | | 13 |
| | 1.03 | % |
Total other loans (excluding PCI) | 46 |
| | 1.59 | % | | 41 |
| | 1.58 | % |
Net charge-offs as a percentage of total loans (excluding PCI) | $ | 372 |
| | 2.21 | % | | $ | 360 |
| | 2.26 | % |
Net charge-offs as a percentage of total loans (including PCI) | $ | 372 |
| | 2.11 | % | | $ | 360 |
| | 2.14 | % |
| | | | | | | |
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.
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 March 31, 2016 | | | |
Credit card loans | 82 | % | | 18 | % |
Personal loans | 96 | % | | 4 | % |
Private student loans (excluding PCI)(1) | 96 | % | | 4 | % |
| | | |
At December 31, 2015 | | | |
Credit card loans | 83 | % | | 17 | % |
Personal loans | 96 | % | | 4 | % |
Private student loans (excluding PCI)(1) | 96 | % | | 4 | % |
| | | |
| |
(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 March 31, 2016 and December 31, 2015, there were $31 million of private student loans, including PCI, in forbearance, which represent 0.5% of total student loans in repayment and forbearance.
Allowance for Loan Losses
The following tables provide changes in the Company’s allowance for loan losses (dollars in millions): |
| | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended March 31, 2016 |
| Credit Card | | Personal Loans | | Student Loans(1) | | Other | | Total |
Balance at beginning of period | $ | 1,554 |
| | $ | 155 |
| | $ | 143 |
| | $ | 17 |
| | $ | 1,869 |
|
Additions | | | | | | | | | |
Provision for loan losses | 362 |
| | 44 |
| | 17 |
| | 1 |
| | 424 |
|
Deductions | | | | | | | | | |
Charge-offs | (439 | ) | | (39 | ) | | (15 | ) | | — |
| | (493 | ) |
Recoveries | 113 |
| | 5 |
| | 3 |
| | — |
| | 121 |
|
Net charge-offs | (326 | ) | | (34 | ) | | (12 | ) | | — |
| | (372 | ) |
Balance at end of period | $ | 1,590 |
| | $ | 165 |
| | $ | 148 |
| | $ | 18 |
| | $ | 1,921 |
|
| | | | | | | | | |
| For the Three Months Ended March 31, 2015 |
| Credit Card | | Personal Loans | | Student Loans(1) | | Other | | Total |
Balance at beginning of period | $ | 1,474 |
| | $ | 120 |
| | $ | 135 |
| | $ | 17 |
| | $ | 1,746 |
|
Additions | | | | | | | | | |
Provision for loan losses | 337 |
| | 31 |
| | 20 |
| | 2 |
| | 390 |
|
Deductions | | | | | | | | | |
Charge-offs | (428 | ) | | (31 | ) | | (15 | ) | | — |
| | (474 | ) |
Recoveries | 109 |
| | 3 |
| | 2 |
| | — |
| | 114 |
|
Net charge-offs | (319 | ) | | (28 | ) | | (13 | ) | | — |
| | (360 | ) |
Balance at end of period | $ | 1,492 |
| | $ | 123 |
| | $ | 142 |
| | $ | 19 |
| | $ | 1,776 |
|
| | | | | | | | | |
| |
(1) | Includes both PCI and non-PCI private student loans. |
Net charge-offs of principal are recorded against the allowance for loan losses, as shown in the preceding table. Information regarding net charge-offs of interest and fee revenues on credit card and other loans is as follows (dollars in millions): |
| | | | | | | |
| For the Three Months Ended March 31, |
| 2016 | | 2015 |
Interest and fees accrued subsequently charged off, net of recoveries (recorded as a reduction of interest income) | $ | 69 |
| | $ | 75 |
|
Fees accrued subsequently charged off, net of recoveries (recorded as a reduction to other income) | $ | 17 |
| | $ | 20 |
|
| | | |
The following tables provide additional detail of the Company’s allowance for loan losses and recorded investment in its loan portfolio by impairment methodology (dollars in millions): |
| | | | | | | | | | | | | | | | | | | |
| Credit Card | | Personal Loans | | Student Loans(3) | | Other Loans(4) | | Total |
At March 31, 2016 | | | | | | | | | |
Allowance for loans evaluated for impairment as | | | | | | | | | |
Collectively evaluated for impairment in accordance with ASC 450-20 | $ | 1,430 |
| | $ | 149 |
| | $ | 96 |
| | $ | 1 |
| | $ | 1,676 |
|
Evaluated for impairment in accordance with ASC 310-10-35(1)(2) | 160 |
| | 16 |
| | 16 |
| | 17 |
| | 209 |
|
Acquired with deteriorated credit quality, evaluated in accordance with ASC 310-30 | — |
| | — |
| | 36 |
| | — |
| | 36 |
|
Total allowance for loan losses | $ | 1,590 |
| | $ | 165 |
| | $ | 148 |
| | $ | 18 |
| | $ | 1,921 |
|
Recorded investment in loans evaluated for impairment as | | | | | | | | | |
Collectively evaluated for impairment in accordance with ASC 450-20 | $ | 54,600 |
| | $ | 5,464 |
| | $ | 5,896 |
| | $ | 194 |
| | $ | 66,154 |
|
Evaluated for impairment in accordance with ASC 310-10-35(1)(2) | 1,020 |
| | 70 |
| | 53 |
| | 58 |
| | 1,201 |
|
Acquired with deteriorated credit quality, evaluated in accordance with ASC 310-30 | — |
| | — |
| | 2,965 |
| | — |
| | 2,965 |
|
Total recorded investment | $ | 55,620 |
| | $ | 5,534 |
| | $ | 8,914 |
| | $ | 252 |
| | $ | 70,320 |
|
| | | | | | | | | |
At December 31, 2015 | | | | | | | | | |
Allowance for loans evaluated for impairment as | | | | | | | | | |
Collectively evaluated for impairment in accordance with ASC 450-20 | $ | 1,394 |
| | $ | 140 |
| | $ | 92 |
| | $ | 1 |
| | $ | 1,627 |
|
Evaluated for impairment in accordance with ASC 310-10-35(1)(2) | 160 |
| | 15 |
| | 15 |
| | 16 |
| | 206 |
|
Acquired with deteriorated credit quality, evaluated in accordance with ASC 310-30 | — |
| | — |
| | 36 |
| | — |
| | 36 |
|
Total allowance for loan losses | $ | 1,554 |
| | $ | 155 |
| | $ | 143 |
| | $ | 17 |
| | $ | 1,869 |
|
Recorded investment in loans evaluated for impairment as | | | | | | | | | |
Collectively evaluated for impairment in accordance with ASC 450-20 | $ | 56,877 |
| | $ | 5,422 |
| | $ | 5,599 |
| | $ | 179 |
| | $ | 68,077 |
|
Evaluated for impairment in accordance with ASC 310-10-35(1)(2) | 1,019 |
| | 68 |
| | 48 |
| | 57 |
| | 1,192 |
|
Acquired with deteriorated credit quality, evaluated in accordance with ASC 310-30 | — |
| | — |
| | 3,116 |
| | — |
| | 3,116 |
|
Total recorded investment | $ | 57,896 |
| | $ | 5,490 |
| | $ | 8,763 |
| | $ | 236 |
| | $ | 72,385 |
|
| | | | | | | | | |
| |
(1) | Loan receivables evaluated for impairment in accordance with Accounting Standards Codification ("ASC") 310-10-35 include credit card loans, personal loans and student loans collectively evaluated for impairment in accordance with ASC Subtopic 310-40, Receivables, which consists of modified loans accounted for as troubled debt restructurings. Other loans are individually evaluated for impairment and generally do not represent troubled debt restructurings. |
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(2) | The unpaid principal balance of credit card loans was $873 million and $869 million at March 31, 2016 and December 31, 2015, respectively. The unpaid principal balance of personal loans was $69 million and $67 million at March 31, 2016 and December 31, 2015, respectively. The unpaid principal balance of student loans was $52 million and $47 million at March 31, 2016 and December 31, 2015, respectively. All loans accounted for as troubled debt restructurings have a related allowance for loan losses. |
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(3) | Includes both PCI and non-PCI private student loans. |
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(4) | Certain other loans, including non-performing Diners Club licensee loans, are individually evaluated for impairment. |
Troubled Debt Restructurings
The Company has internal loan modification programs that provide relief to credit card, personal loan and student loan borrowers who are experiencing financial hardship. The internal loan modification programs include both temporary and permanent programs which vary by product. External loan modification programs are also available for credit card and personal loans. Temporary and permanent modifications on credit card and personal loans, as well as temporary modifications on student loans and certain grants of student loan forbearance, are considered to be individually impaired. In addition, loans that defaulted or graduated from modification programs or forbearance are considered to be individually impaired. As a result, the above mentioned loans are accounted for as troubled debt restructurings.
For credit card customers, the temporary hardship program primarily consists of a reduced minimum payment and an interest rate reduction, both lasting for a period no longer than 12 months. The permanent workout program involves
changing the structure of the loan to a fixed payment loan with a maturity no longer than 60 months and reducing the interest rate on the loan. The permanent modification program does not normally provide for the forgiveness of unpaid principal, but may allow for the reversal of certain unpaid interest or fee assessments. The Company also makes loan modifications for customers who request financial assistance through external sources, such as a consumer credit counseling agency program (referred to here as external programs). These loans typically receive a reduced interest rate but continue to be subject to the original minimum payment terms and do not normally include waiver of unpaid principal, interest or fees.
To assist student loan borrowers who are experiencing temporary financial difficulties but are willing to resume making payments, the Company may offer hardship forbearance periods of up to 12 months over the life of the loan. Forbearance provides borrowers a deferment in making payments, during which time loan interest continues to accrue at contractual rates. The Company does not anticipate significant shortfalls in the contractual amount due for borrowers using a first hardship forbearance period as the historical performance of these borrowers is not significantly different from the overall portfolio. However, when a borrower is 30 or more days delinquent and granted a second hardship forbearance period, the forbearance is considered a troubled debt restructuring. In addition, the Company offers temporary reduced payment programs, which normally consist of a reduction of the minimum payment for a period of no longer than 12 months each time the program is utilized by a borrower. When a student loan borrower is enrolled in a temporary reduced payment program for 12 months or fewer over the life of the loan, the modification is not considered a troubled debt restructuring. However, when enrollment is greater than 12 months over the life of the loan, the modification is considered a troubled debt restructuring.
For personal loan customers, in certain situations the Company offers various payment programs, including temporary and permanent programs. The temporary programs normally consist of a reduction of the minimum payment for a period of no longer than 12 months with the option of a final balloon payment required at the end of the loan term or an extension of the maturity date with the total term not exceeding nine years. Further, in certain circumstances the interest rate on the loan is reduced. The permanent program involves changing the terms of the loan in order to pay off the outstanding balance over a longer term and also in certain circumstances reducing the interest rate on the loan. Similar to the temporary programs, the total term may not exceed nine years. The Company also allows loan modifications for customers who request financial assistance through external sources, similar to the credit card customers discussed above. Payments are modified based on the new terms agreed upon with the credit counseling agency. Personal loans included in temporary and permanent programs are accounted for as troubled debt restructurings.
The Company monitors borrower performance after using payment programs or forbearance and the Company believes the programs help to prevent defaults and are useful in assisting customers experiencing financial difficulties. The Company plans to continue to use payment programs and forbearance and, as a result, expects to have additional loans classified as troubled debt restructurings in the future.
Additional information about modified loans classified as troubled debt restructurings is shown below (dollars in millions): |
| | | | | | | | | | | |
| Average recorded investment in loans | | Interest income recognized during period loans were impaired(1) | | Gross interest income that would have been recorded with original terms(2) |
For the Three Months Ended March 31, 2016 | | | | | |
Credit card loans | | | | | |
Modified credit card loans(3) | $ | 274 |
| | $ | 12 |
| | $ | 1 |
|
Internal programs | $ | 464 |
| | $ | 3 |
| | $ | 16 |
|
External programs | $ | 283 |
| | $ | 5 |
| | $ | 3 |
|
Personal loans | $ | 69 |
| | $ | 2 |
| | $ | 1 |
|
Private student loans | $ | 50 |
| | $ | 1 |
| | N/A |
|
| | | | | |
For the Three Months Ended March 31, 2015 | | | | | |
Credit card loans | | | | | |
Modified credit card loans(3) | $ | 255 |
| | $ | 11 |
| | $ | 1 |
|
Internal programs | $ | 452 |
| | $ | 3 |
| | $ | 15 |
|
External programs | $ | 323 |
| | $ | 6 |
| | $ | 3 |
|
Personal loans | $ | 57 |
| | $ | 2 |
| | $ | 1 |
|
Private student loans | $ | 40 |
| | $ | 1 |
| | N/A |
|
| | | | | |
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(1) | The Company does not separately track interest income on loans in modification programs. Amounts shown are estimated by applying an average interest rate to the average loans in the various modification programs. |
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(2) | The Company does not separately track the amount of gross interest income that would have been recorded if the loans in modification programs had not been restructured and interest had instead been recorded in accordance with the original terms. Amounts shown are estimated by applying the difference between the average interest rate earned on non-impaired loans and the average interest rate earned on loans in the modification programs to the average loans in the modification programs. |
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(3) | This balance is considered impaired, but is excluded from the internal and external program amounts reflected in this table. Represents credit card loans that were modified in troubled debt restructurings, but are no longer enrolled in troubled debt restructuring program due to noncompliance with the terms of the modification or successful completion of a program. |
In order to evaluate the primary financial effects that resulted from credit card loans entering into a loan modification program during the three months ended March 31, 2016 and 2015, the Company quantified the amount by which interest and fees were reduced during the periods. During the three months ended March 31, 2016 and 2015, the Company forgave approximately $9 million and $11 million of interest and fees as a result of accounts entering into a credit card loan modification program, respectively.
The following table provides information on loans that entered a loan modification program during the period (dollars in millions): |
| | | | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2016 | | 2015 |
| Number of Accounts | | Balances | | Number of Accounts | | Balances |
Accounts that entered a loan modification program during the period | | | | | | | |
Credit card loans | | | | | | | |
Internal programs | 14,967 |
| | $ | 96 |
| | 13,243 |
| | $ | 86 |
|
External programs | 7,317 |
| | $ | 39 |
| | 7,617 |
| | $ | 39 |
|
Personal loans | 1,061 |
| | $ | 12 |
| | 986 |
| | $ | 12 |
|
Private student loans | 452 |
| | $ | 8 |
| | 469 |
| | $ | 7 |
|
| | | | | | | |
The following table presents the carrying value of loans that experienced a payment default during the period that had been modified in a troubled debt restructuring during the 15 months preceding the end of each period (dollars in millions): |
| | | | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2016 | | 2015 |
| Number of Accounts | | Aggregated Outstanding Balances Upon Default | | Number of Accounts | | Aggregated Outstanding Balances Upon Default |
Troubled debt restructurings that subsequently defaulted | | | | | | | |
Credit card loans | | | | | | | |
Internal programs(1)(2) | 3,001 |
| | $ | 18 |
| | 3,176 |
| | $ | 20 |
|
External programs(1)(2) | 1,699 |
| | $ | 7 |
| | 1,643 |
| | $ | 7 |
|
Personal loans(2) | 158 |
| | $ | 2 |
| | 151 |
| | $ | 2 |
|
Private student loans(3) | 197 |
| | $ | 3 |
| | 305 |
| | $ | 4 |
|
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(1) | The outstanding balance upon default is the loan balance at the end of the month prior to default. Terms revert back to the pre-modification terms for customers who default from a temporary program and charging privileges remain revoked in most cases. |
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(2) | A customer defaults from a modification program after two consecutive missed payments. |
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(3) | Student loan defaults have been defined as loans that are 60 or more days delinquent. |
Of the account balances that defaulted as shown above for the three months ended March 31, 2016 and 2015, approximately 37% and 43%, respectively, of the total balances were charged off at the end of the month in which they defaulted. For accounts that have defaulted from a loan modification program and have not been subsequently charged off, the balances are included in the allowance for loan loss analysis discussed above under "— Allowance for Loan Losses."
Purchased Credit-Impaired Loans
Purchased loans with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected are considered impaired at acquisition and are reported as PCI loans. The private student loans acquired in the SLC transaction, as well as the additional acquired private student loan portfolio comprise the Company’s only PCI loans at March 31, 2016 and December 31, 2015. Total PCI student loans had an outstanding balance of $3.2 billion and $3.3 billion, including accrued interest, and a related carrying amount of $3.0 billion and $3.1 billion as of March 31, 2016 and December 31, 2015, respectively.
The following table provides changes in accretable yield for the acquired loans during each period (dollars in millions): |
| | | | | | | |
| For the Three Months Ended March 31, |
| 2016 | | 2015 |
Balance at beginning of period | $ | 965 |
| | $ | 1,341 |
|
Accretion into interest income | (49 | ) | | (59 | ) |
Other changes in expected cash flows | — |
| | (101 | ) |
Balance at end of period | $ | 916 |
| | $ | 1,181 |
|
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Periodically, the Company updates the estimate of cash flows expected to be collected based on management's latest expectations of future credit losses, borrower prepayments and certain other assumptions that affect cash flows. No provision expense was recorded during the three months ended March 31, 2016 and 2015. The allowance for PCI loan losses at March 31, 2016 and December 31, 2015 was $36 million. For the three months ended March 31, 2016, there were no changes in other cash flow assumptions. For the three months ended March 31, 2015 changes in other cash flow assumptions resulted in a decrease in accretable yield primarily related to changes in borrower prepayment assumptions. Changes to accretable yield are recognized prospectively as an adjustment to yield over the remaining life of the pools.
At March 31, 2016, the 30 or more days delinquency and 90 or more days delinquency rates on PCI student loans (which include loans not yet in repayment) were 2.18% and 0.73%, respectively. At December 31, 2015, the 30 or more days delinquency and 90 or more days delinquency rates on PCI student loans (which include loans not yet in repayment) were 2.53% and 0.88%, respectively. These rates include private student loans that are greater than 120 days delinquent that are covered by an indemnification agreement or insurance arrangements through which the Company expects to recover a
substantial portion of the loan. The net charge-off rate on PCI student loans was 0.43% and 0.50% for the three months ended March 31, 2016 and 2015, respectively.
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5. | Credit Card and Student Loan Securitization Activities |
Credit Card Securitization Activities
The Company accesses the term asset securitization market through the Discover Card Master Trust I (“DCMT”) and the Discover Card Execution Note Trust (“DCENT”), which are trusts into which credit card loan receivables are transferred (or, in the case of DCENT, into which beneficial interests in DCMT are transferred) and from which DCENT issues notes to investors.
The DCENT debt structure consists of four classes of securities (DiscoverSeries Class A, B, C and D notes), with the most senior class generally receiving a triple-A rating. In order to issue senior, higher rated classes of notes, it is necessary to obtain the appropriate amount of credit enhancement, generally through the issuance of junior, lower rated or more highly subordinated classes of notes. The subordinated classes are held by wholly-owned subsidiaries of Discover Bank. The Company is exposed to credit-related risk of loss associated with trust assets as of the balance sheet date through the retention of these subordinated interests. The estimated probable incurred loss is included in the allowance for loan loss estimate.
The Company’s credit card securitizations are accounted for as secured borrowings and the trusts and Discover Funding LLC are treated as consolidated subsidiaries of the Company. The Company’s retained interests in the assets of the trusts, consisting of investments in DCENT notes held by subsidiaries of Discover Bank, constitute intercompany positions which are eliminated in the preparation of the Company’s condensed consolidated statements of financial condition.
Upon transfer of credit card loan receivables to the trust, the receivables and certain cash flows derived from them become restricted for use in meeting obligations to the trusts’ creditors. Further, the transferred credit card loan receivables are owned by the trust and are not available to third-party creditors of the Company. The trusts have ownership of cash balances that also have restrictions, the amounts of which are reported in restricted cash. Investment of trust cash balances is limited to investments that are permitted under the governing documents of the trusts and which have maturities no later than the related date on which funds must be made available for distribution to trust investors. With the exception of the seller’s interest in trust receivables, the Company’s interests in trust assets are generally subordinate to the interests of third-party investors and, as such, may not be realized by the Company if needed to absorb deficiencies in cash flows that are allocated to the investors in the trusts’ debt.
The carrying values of these restricted assets, which are presented on the Company’s condensed consolidated statements of financial condition as relating to securitization activities, are shown in the table below (dollars in millions): |
| | | | | | | |
| March 31,
2016 | | December 31,
2015 |
Restricted cash | $ | 921 |
| | $ | 19 |
|
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Investors’ interests held by third-party investors | 15,725 |
| | 15,625 |
|
Investors’ interests held by wholly-owned subsidiaries of Discover Bank | 5,199 |
| | 6,017 |
|
Seller’s interest | 6,241 |
| | 7,231 |
|
Loan receivables(1) | 27,165 |
| | 28,873 |
|
Allowance for loan losses allocated to securitized loan receivables(1) | (783 | ) | | (783 | ) |
Net loan receivables | 26,382 |
| | 28,090 |
|
Other(2) | 6 |
| | 5 |
|
Carrying value of assets of consolidated variable interest entities | $ | 27,309 |
| | $ | 28,114 |
|
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(1) | The Company maintains its allowance for loan losses at an amount sufficient to absorb probable losses inherent in all loan receivables, which includes all loan receivables in the trusts. Therefore, credit risk associated with the transferred receivables is fully reflected on the Company’s balance sheet in accordance with GAAP. |
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(2) | Upon adoption of ASU 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, certain balances as of December 31, 2015 have been restated to reflect the classification of debt issuance costs as a direct deduction of the related liability. See Note 1: Background and Basis of Presentation for additional information. |