2500 Lake Cook Road (cid:129) Riverwoods, Illinois 60015 (cid:129) Discover.com/company
2014 ANNUAL REPORT
CONNECTING CUSTOMERS WITH THE FUTURE
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CONNECTING CUSTOMERS
WITH THE FUTURE
Board of Directors
The Leading Direct Bank
and Payments Partner
Direct Banking
Discover is one of the largest direct banks in
the United States, offering a broad array of
products, including credit cards, personal loans,
student loans, deposit products and home loans.
The Discover brand is known for rewards,
service and value. Across all direct banking
products, Discover seeks to help customers
meet their fi nancial needs and achieve brighter
fi nancial futures.
Executive Committee
Payment Services
PULSE is one of the nation’s leading ATM/debit
networks, while Diners Club International is
a global payments network. Our Network
Partners business provides payment transaction
processing and settlement services on the
Discover Network. In the payments industry,
Discover strives to be the most fl exible and
innovative partner in the United States and
around the world.
Mary K. Bush
President, Bush International
Gregory C. Case
Compensation and Leadership
Development Committee Chair;
President and CEO, Aon plc
Candace H. Duncan
Retired Managing Partner,
KPMG LLP
Primary Investor Contact
Investor Relations
Phone: 1(cid:129)224 (cid:129) 405 (cid:129) 4555
investorrelations@discover.com
Transfer Agent
Computershare
P.O. Box 30170
College Station, TX 77842
Phone: 1(cid:129) 866 (cid:129)258 (cid:129) 6590
Corporate Web site:
www.computershare.com/investor
Annual Shareholders’ Meeting
The 2015 Annual Meeting of Shareholders
of Discover Financial Services
Wednesday, April 29, 2015, at 9:00 AM CST
at the company’s headquarters at
2500 Lake Cook Road, Riverwoods, IL 60015
Michael H. Moskow
Risk Oversight Committee Chair;
Retired President and CEO,
Federal Reserve Bank of Chicago
Mark A. Thierer
Chairman and CEO,
Catamaran Corporation
Steven E. Cunningham
Senior Vice President,
Chief Risk Offi cer
Carlos M. Minetti
Executive Vice President,
President –Consumer Banking
Glenn P. Schneider
Executive Vice President,
Chief Information Offi cer
Harit Talwar
Executive Vice President,
President–U.S. Cards
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Discover Card
(cid:129) $56 billion in loans
Deposit Products
(cid:129) $29 billion in direct-to-consumer deposits
(cid:129) Leading cash rewards program
(cid:129) Money market accounts, certifi cates of deposit,
(cid:129) 1 in 4 U.S. households
savings accounts and checking accounts
Student Loans
(cid:129) $9 billion in private student loans
Home Loans
(cid:129) $3 billion of originations in 2014
(cid:129) Offered at more than 2,000 colleges
(cid:129) Conventional and FHA loans
(cid:129) Home equity loans
Personal Loans
(cid:129) $5 billion in loans
(cid:129) Debt consolidation and major purchases
Discover
Network
Pulse Debit
Network
Diners Club
International
(cid:129) $129 billion volume
(cid:129) 10+ network alliances
(cid:129) $166 billion volume
(cid:129) 3,700+ issuers
(cid:129) $27 billion volume
(cid:129) 80+ licensees
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To Our Shareholders:
Five years ago, we set our sights on becoming
the leading U.S. direct bank and a fl exible global
payments partner.
Our focus on that vision has allowed us to pursue
new opportunities and has led to consistently
strong performance across a number of key
metrics. Today, we are connecting more and
more customers with a brighter fi nancial future.
Over the last fi ve years, Discover has expanded
signifi cantly in direct banking. We now offer
credit cards, personal loans, private student
loans, home loans, deposit products and checking
accounts that help our customers achieve their
fi nancial goals.
We have grown to be the world’s third-
most-accepted network* by partnering with
fi nancial institutions, acquirers, processors
and other companies around the world to
leverage our Discover, PULSE and Diners Club
International networks.
*The Nilson Report, March 2014
David Nelms, Chairman & CEO
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Our Progress
Your company achieved strong fi nancial results in 2014.
Direct Banking Loans
$49.2 Bn
Direct-To-Consumer Deposits
$20.6 Bn
Total Network Volume
$248 Bn
Acceptance Locations
17 MM
ATM Locations
750K
Net Income
$0.8 Bn
Stock Price at Fiscal Year-End
$18.28
2010
2014
Highlights included:
$69.9 Bn
• Net income of $2.3 billion or $4.90 per diluted share
$28.8 Bn
$322 Bn
31 MM
• Return on equity of 21%
• Repurchase of 5% of our outstanding common stock
• Growth in total loans of 6%
• A net charge-off rate of 2.04%
• Network volume of $322 billion, including
$116 billion of Discover card volume
1.6 MM
We achieved these results primarily by focusing on
profi table growth in our U.S. credit card business, which
in turn has been built around our promise to provide
$2.3 Bn
cardmembers with “rewards, service and value.” We also
achieved meaningful growth in personal loans and private
student loans, while continuing to invest for the future
$65.49
across our direct banking and payments operations.
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Direct Banking Accomplishments
Credit card loan growth of 6% outpaced the industry average, driven in
part by the popularity of our fl agship Discover it card. One of our greatest
accomplishments of 2014 came when Discover received the highest customer
satisfaction ranking among U.S. credit card companies, tying for the top
ranking in the 2014 J.D. Power U.S. Credit Card Satisfaction StudySM—
a recognition bestowed upon us by our customers.
Discover pioneered cash rewards in the credit card industry, and today
Discover continues to innovate in ways that are important to customers. In
2014, we enhanced our Cashback Bonus rewards program by providing
customers with multiple redemption options with no minimum for redemption,
and with rewards that will never expire. We also launched Discover Deals,
which provides customers with opportunities to earn extra cash rewards and
to receive instant savings while shopping.
Also in 2014, Discover led the industry by providing free FICO® Credit
Scores to all eligible Discover cardmembers—online and on monthly
statements. Knowing and understanding their FICO Credit Scores can help
cardmembers achieve their personal goals and better prepare for the future.
Customer response has been overwhelmingly positive.
Of course, our growth in credit cards would be of no value to shareholders
were it not profi table growth. Accordingly, we have continued to focus on
leading-edge practices in credit risk management. As a result, we continue to
outperform most large competitors when it comes to credit quality.
We are leveraging our expertise in credit risk management across other
consumer lending products. In 2014, we grew personal loans by 19% and
private student loans by 4% (22% growth rate excluding purchased student
loans). We also made Discover Personal Loans more widely available to
the general public, and Discover Student Loans launched rewards for good
grades.
Discover.com/company
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Total Network Volume [Billions]
Direct Banking Loans [Billions]
Direct-To-Consumer Deposits [Billions]
$322
27
$310
27
$306
$280
29
29
$248
27
160
160
166
140
118
103
111
117
123
129
$69.9
5.3
8.5
$65.8
4.5
8.1
$61
3.6
7.8
$57.7
3.4
7.3
$49.2
3
1
45.2
47
49.6
53.2
56.1
$27.9 $28.4
$28.8
$26.2
12.2
13.1
14.2
13.8
13.7
15.3
12.4
16.6
$20.6
12.2
8.4
2010
2011
2012
2013
2014
2010
2011
2012
2013
2014
2010
2011
2012
2013
2014
Diners Club International
PULSE
Discover Network
Personal/Other*
Student
Credit card
*Includes other consumer loans and loans held for sale
Certifi cate of Deposits
Money Market/Savings/Checking
Net Principal Charge-Off Rate
Effi ciency Ratio
Net Income [Millions]
7.53%
3.97%
39.9%
39.4%
39.4%
36%
32.8%
$2,470
$2,345
$2,323
$2,227
2.29%
1.98%
2.04%
$765
2010
2011
2012
2013
2014
2010 2011
2012
2013
2014
2010
2011
2012
2013
2014
The effi ciency ratio is noninterest expense
divided by total revenue (net interest income
and noninterest income).
Diluted Earnings Per Share
of Common Stock
$4.96
$4.90
$4.46
$4.06
Return on Equity
Stock Price at Fiscal Year-End
30%
26%
24%
21%
$41.61
$65.49
$55.95
$1.22
12%
$23.82
$18.28
2010
2011
2012
2013
2014
2010
2011
2012
2013
2014
2010
2011
2012
2013
2014
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For Discover Home Loans and Discover Home Equity, 2014 was largely about
positioning for the future. Discover Cashback Checking exceeded 100,000
cross-sold accounts by year end, and we look forward to a broad market
launch in 2015.
Payments Accomplishments
In 2014, Discover achieved growth in dollar volume on our networks while
expanding acceptance to more than 31 million global merchant locations and
more than 1.6 million ATMs. In addition, our proprietary network continued
to be an integral component of card issuance by providing added branding,
acceptance and value for Discover cardmembers. We believe that owning
a proprietary, branded network contributes to the related card business,
and that it is no accident that the two U.S. credit card issuers with their own
networks have had stronger profi tability in terms of return on card assets than
most of their competitors.
Our accomplishments in payments in 2014 included:
• Launch of a new business-to-business payments platform with Ariba®, an
SAP company and a leading global business commerce network.
• The signing of agreements in Thailand and Cambodia that enhance the
presence we already have in Asia through UnionPay (China), JCB (Japan),
BC Card (Korea), RuPay (India) and others.
• Endorsement by the American Bankers Association (ABA) of Discover Debit,
a compelling alternative signature debit program.
Discover Debit and Pulse PIN debit are great products, but the U.S. debit
market is very challenging right now. Certain competitor actions have
adversely affected the marketplace, and Discover continues to aggressively
address these challenges head on.
Other challenges in payments included Diners Club in Europe and the loss
of a large third-party issuer in 2014. Longer term, we are excited about
Discover.com/company
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the many innovations and new players in the payments industry, and we
are well positioned to partner with established and emerging players in the
years ahead.
Connecting to the Future
In retail banking, the trend is increasingly toward use of direct channels
(online, mobile, phone and mail). According to the ABA, direct channels
are now preferred by 54% of customers, compared with only 21% who
prefer branches and 14% who prefer ATMs. Our unique business model
puts us in excellent position to better connect customers with this increasingly
direct future. As a bank and a network, Discover interacts on a daily basis
with consumers, merchants, acquirers, other fi nancial institutions and other
networks on a global scale.
Our industry tends to focus too much on transactions, but for consumers
it’s not always just a “transaction.” It’s often a broader “experience” that
can span months or years. The broader customer experience encompasses
many potential touch points—and many opportunities to add value—
including the customer’s research and discovery process, special offers
that they might receive, a wide variety of payment options, the decision to
fi nance the purchase or not, dealing with returns and disputes, rewards and
redemption offers, and the use of fi nancial management tools to monitor or
analyze their spending.
At Discover, we are continuously expanding the information on credit card
usage we provide—by sending two-way text messages to confi rm purchases,
for example. We also provide customers with tools to analyze their spending
habits, and we have a feedback loop that includes customer call listening,
complaint monitoring and the use of social media.
In addition, we focus on simplicity of interaction, ease of communication and
intuitive designs for our website and apps. As a result, the number of mobile
app users at Discover has doubled in the last two years—and half are now
mobile-only users. We also have many “fi rsts,” including being the fi rst major
card issuer to offer fi ngerprint login and pre-login account information.
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As we move forward, Discover will be guided by long-term principles,
including our focus on providing outstanding rewards, service and value
for our customers, and on being a fl exible partner in the payments industry.
Our plans for 2015 include the new Discover it Miles card, which we
launched in February. We will also continue to enhance and add new
Discover it features. In addition, we will focus on online and mobile banking
enhancements, including e-wallets, while simultaneously working to manage
credit risk and enhance operations.
In payments, our focus will be on using our proprietary network to enhance
the customer experience for our cardmembers. We will also continue to
leverage our capabilities in emerging payments and our relationships
with other global fi nancial institutions and organizations to grow global
acceptance and network volume. In addition, we will work to increase
penetration of the market for signature debit. And fi nally, as the payments
industry transitions to EMV technology in the United States in 2015, we will
carefully manage the transition for our customers and business partners.
Our Commitments to Each Other
We appreciate the loyalty our customers have shown to Discover over the
years, and we are committed to demonstrating that loyalty goes both ways.
That’s why we are so focused on connecting our customers with the future—
and doing our part to ensure that their fi nancial future is bright.
One of the keys to a brighter future is fi nancial literacy, and Discover has
been recognized for its efforts to bring fi nancial education to high school
classrooms. Our fl agship initiative is Pathway to Financial Success, a fi ve-
year, $10 million commitment to bring fi nancial education to our nation’s
high schools, and so far we have provided grants to more than 900 public
schools and districts covering all 50 states. As a result, Discover was named
“Organization of the Year – Corporate Leadership” by the Institute for
Financial Literacy.
Discover.com/company
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Pathway to Financial Success is just one aspect of our commitment to being
a good corporate citizen. Discover employees also volunteered more than
50,000 hours of time and we donated millions of dollars to thousands of
non-profi t organizations in 2014. I thank Discover employees for their
generous spirit and for their commitment to Discover, our customers and
our communities.
Finally, I want to recognize the Discover Board of Directors. Our Board
includes executives who have led major corporations, as well as individuals
with broad knowledge of the U.S. economy and fi nancial services. Discover
operates in a heavily regulated industry and our directors agree to serve
knowing that it will be a demanding job. Accordingly, I want to thank our
Board for its counsel and guidance as we seek to connect our customers—
and Discover—with the future.
David Nelms
Chairman and Chief Executive Offi cer
March 3, 2015
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VISION
To be the leading direct bank and payments partner.
MISSION
To help people spend smarter, manage
debt better and save more so they achieve
a brighter financial future.
VALUES
Doing the right thing
Innovation
Simplicity
Collaboration
Openness
Volunteerism
Enthusiasm
Respect
Discover.com/company
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the calendar year ended December 31, 2014
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
(State or other jurisdiction of incorporation or organization)
36-2517428
(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)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Common Stock, par value $0.01 per share
New York Stock Exchange
Depositary Shares, each representing 1/40th interest in a
share of Fixed Rate Non-Cumulative Perpetual Preferred
Stock, Series B, par value $0.01 per share
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes
No
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
No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files). Yes
No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
(Do not check if a smaller reporting company)
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes
No
The aggregate market value of the common equity held by non-affiliates of the registrant on the last business day of the registrant’s most recently
completed second fiscal quarter was approximately $28,651,886,813.
As of February 20, 2015, there were 447,239,938 shares of the registrant’s Common Stock, par value $0.01 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive proxy statement for its annual stockholders’ meeting to be held on April 29, 2015 are incorporated by reference
in Part III of this Form 10-K.
DISCOVER FINANCIAL SERVICES
Annual Report on Form 10-K for the calendar year ended December 31, 2014
TABLE OF CONTENTS
Part I
Item 1.
Business ................................................................................................................................
1
Item 1A.
Risk Factors ...........................................................................................................................
Item 1B.
Unresolved Staff Comments ....................................................................................................
Item 2.
Item 3.
Item 4.
Part II
Item 5.
Item 6.
Item 7.
Properties .............................................................................................................................
Legal Proceedings .................................................................................................................
Mine Safety Disclosures .........................................................................................................
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities .................................................................................................................
Selected Financial Data ..........................................................................................................
Management's Discussion and Analysis of Financial Condition and Results of Operations ...........
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk ......................................................
25
42
43
43
43
44
46
49
83
85
Item 8.
Item 9.
Financial Statements and Supplementary Data .........................................................................
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ..........
161
Item 9A.
Controls and Procedures ........................................................................................................
161
Item 9B.
Other Information ..................................................................................................................
162
Part III
Item 10.
Directors, Executive Officers and Corporate Governance ..........................................................
Item 11.
Executive Compensation ........................................................................................................
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters ..............................................................................................................................
Item 13.
Certain Relationships and Related Transactions, and Director Independence ...............................
Item 14.
Principal Accounting Fees and Services ...................................................................................
163
163
163
163
164
Part IV
Item 15.
Exhibits, Financial Statement Schedules ...................................................................................
165
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® 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 annual report on Form 10-K are the property of their respective owners.
Part I. | Item 1.
Business
Introduction
Discover Financial Services is a direct banking and payment services company. We were incorporated in
Delaware in 1960. We are 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 are subject to oversight, regulation and
examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). We provide direct
banking products and services and payment services through our subsidiaries. We offer our customers credit card
loans, private student loans, personal loans, home loans, home equity loans and deposit products. We had $70.0
billion in loan receivables and $28.8 billion in deposits issued through direct-to-consumer channels and affinity
relationships at December 31, 2014. We operate 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 ("POS") 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.
In December 2012, our board of directors approved a change in our fiscal year end from November 30 to
December 31 of each year. This fiscal year change was effective January 1, 2013. As a result of the change, we had a
one month transition period in December 2012. The audited results for the one month ended December 31, 2012 are
included in this report.
Available Information
We make available, free of charge through the investor relations page of our internet site www.discover.com, our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, Forms 3,
4 and 5 filed by or on behalf of directors and executive officers, and any amendments to those documents filed with or
furnished to the Securities and Exchange Commission (the "SEC") pursuant to the Securities Exchange Act of 1934.
These filings are available as soon as reasonably practicable after they are filed with or furnished to the SEC.
In addition, the following information is available on the investor relations page of our internet site: (i) our
Corporate Governance Policies; (ii) our Code of Ethics and Business Conduct; and (iii) the charters of the Audit,
Compensation and Leadership Development, Nominating and Governance, and Risk Oversight Committees of our
board of directors. These documents are also available in print without charge to any person who requests them by
writing or telephoning our principal executive offices: Discover Financial Services, Office of the Corporate Secretary,
2500 Lake Cook Road, Riverwoods, Illinois 60015, U.S.A., telephone number (224) 405-0900.
Operating Model
We manage our business activities in two segments: Direct Banking and Payment Services. Our Direct Banking
segment includes consumer banking and lending products, specifically Discover-branded credit cards issued to
individuals on the Discover Network and other consumer banking products and services, including private student
loans, personal loans, home loans, home equity loans, prepaid cards and other consumer lending and deposit
products. Our Payment Services segment includes PULSE, Diners Club and our Network Partners business, which
provides payment transaction processing and settlement services on the Discover Network.
We are principally engaged in providing products and services to customers in the United States, although the
royalty and licensee revenue we receive from Diners Club licensees is mainly derived from sources outside of the United
States. For quantitative information concerning our geographic distribution, see Note 4: Loan Receivables to our
consolidated financial statements.
Below are descriptions of the principal products and services of each of our reportable segments. For additional
financial information relating to our business and our operating segments, see Note 22: Segment Disclosures to our
consolidated financial statements.
-1-
Direct Banking
Set forth below are descriptions of our credit cards, student loans, personal loans, home loans, home equity loans
and deposit products. For additional information regarding the terms and conditions of these products, see "— Product
Terms and Conditions."
Credit Cards
We currently offer credit cards issued to consumers. Our credit card customers are permitted to "revolve" their
balances and repay their obligations over a period of time and at an interest rate set forth in their cardmember
agreements, which may be either fixed or variable. The interest that we earn on revolving credit card balances makes up
approximately 84% of our total interest income. We also charge customers other fees as specified in the cardmember
agreements. These fees may include fees for late payments, balance transfer transactions and cash advance transactions.
Our credit card customers' transactions in the U.S. are processed over the Discover Network. Where we have a
direct relationship with a merchant, which is the case with respect to our large merchants representing a majority of
Discover card sales volume, we receive discount and fee revenue from merchants. Discount and fee revenue is based on
pricing that is set forth in contractual agreements with each such merchant and is based on a number of factors including
industry practices, special marketing arrangements, competitive pricing levels and merchant size. Where we do not have
a direct relationship with a merchant, we receive acquirer interchange and assessment fees from the merchant acquirer
that settles transactions with the merchant. The amount of this fee is based on a standardized schedule and can vary
based on the type of merchant.
Most of our cards offer the Cashback Bonus rewards program, the costs of which we record as a reduction of
discount and interchange revenue. See "— Marketing — Rewards/Cashback Bonus" for further discussion of our
programs offered.
The following chart* shows the Discover card transaction cycle as processed on the Discover Network:
Student Loans
Our private student loans are available to students attending eligible non-profit four-year undergraduate and
graduate schools. We also offer certain post-graduate loans, including bar study and residency loans. We encourage
students to borrow responsibly and maximize grants, scholarships and other free financial aid before taking student
loans.
We currently offer fixed and variable rate private student loans originated by Discover Bank. We market our
student loans online and through direct mail and email to existing and potential customers. We also work with school
financial aid offices to create awareness of our products with students. Students can apply for our student loans online,
by phone, or by mail, and we have dedicated staff within our call centers to service student loans. We invite applicants
to apply with a creditworthy cosigner, which may improve the likelihood for loan approval and a lower interest rate.
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As part of the loan approval process, all of our student loans, except for bar study and residency loans, are
certified and disbursed through the school to ensure students do not borrow more than the cost of attendance less other
financial aid. Upon graduation, for variable loans originated before May 2014, students are generally eligible to receive
a graduation reward. Students may redeem their graduation reward as a credit to the balance of any of their Discover
student loans or as a direct deposit to a bank account. For all loans originated in May 2014 and after, students are
generally eligible to receive a reward for achieving a specified grade point average during the academic period
covered by the loan.
Personal Loans
Our personal loans are unsecured loans with fixed interest rates, terms and payments. These loans are primarily
intended to help customers consolidate existing debt, although they can be used for other reasons. We generally market
personal loans to our existing credit card customers through direct mail, statement inserts and email. We also market
personal loans to non-Discover customers through direct mail. Customers can submit applications via phone, online or
through the mail, and can service their accounts online or by phone.
Home Loans and Home Equity Loans
In 2012, we began offering home mortgage loans and related services to help consumers finance home purchases
and refinance existing home mortgages. We offer prime adjustable, fixed-rate conforming, jumbo, Federal Housing
Administration ("FHA") and U.S. Department of Veterans Affairs (“VA”) first lien loans to qualified applicants. We
generally market home loans to existing Discover customers through direct mail, email, statement envelopes and inserts,
and advertising on Discover websites. We also market home loans to non-Discover customers through direct mail,
internet advertising, including search engine marketing, display banners, internet lead aggregators, rate tables on
financial websites and social media. Consumers can apply for or obtain information about home loans by mail or
online, or they can speak directly to a dedicated mortgage banker over the phone. Loans are funded and closed using
proceeds principally from borrowings under a third-party warehouse line of credit. Substantially all funded loans and
the related loan servicing rights are sold to investors in the secondary market, generally within 30 days of funding. The
proceeds from such sales are used to repay borrowings under the warehouse line of credit. In addition to funding loans,
we offer escrow and title services to home loan customers. For more information regarding our warehouse line of credit,
see "Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital
Resources — Funding Sources — Short-Term Borrowings."
We offer closed-end home equity loans to help consumers improve their homes as well as payoff higher interest
debt. These loans are fixed term and rate loans that provide consumers the stability of a fixed payment on their
obligation while being secured against the equity in their homes. We market this product primarily to existing card
customers through a mix of direct mail, internet advertising and email. Non-Discover customers can obtain information
regarding Discover home equity products on our website and have the ability to apply by calling a personal banker.
Deposits
We obtain deposits from consumers directly or through affinity relationships ("direct-to-consumer deposits") and
through third-party securities brokerage firms that offer our deposits to their customers ("brokered deposits"). Our
deposit products include certificates of deposit, money market accounts, savings accounts, checking accounts and
Individual Retirement Arrangement ("IRA") certificates of deposit. We market our direct-to-consumer deposit products to
our existing customer base and other prospective customers through the use of our website, mobile platform, print
materials, affinity arrangements with third parties and internet advertising. Customers can apply for, fund, and service
their deposit accounts online or via phone, where we have a dedicated U.S. based staff within our call centers to service
deposit accounts. For more information regarding our deposit products, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations — Liquidity and Capital Resources — Funding Sources — Deposits."
Payment Services
Set forth below are descriptions of PULSE, Diners Club and our Network Partners business, which provides
payment transaction processing and settlement services on the Discover Network.
PULSE Network
Our PULSE network is one of the nation’s leading debit/ATM networks. PULSE links cardholders of more than
7,200 financial institutions with ATMs and POS terminals located throughout the United States. This includes more than
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3,700 financial institutions with which PULSE has direct relationships and approximately 3,400 additional financial
institutions through agreements PULSE has with other debit networks. PULSE also provides cash access at 1.6 million
ATMs in 130 countries.
PULSE's primary source of revenue is transaction fees charged for switching and settling ATM, personal
identification number ("PIN") POS debit and signature debit transactions initiated through the use of debit cards issued
by participating financial institutions. In addition, PULSE offers a variety of optional products and services that produce
income for the network, including signature debit transaction processing, debit card fraud detection and risk mitigation
services, and connections to other regional and national electronic funds transfer networks.
When a financial institution joins the PULSE network, debit cards issued by that institution are eligible to be
used at all of the ATMs and PIN POS debit terminals that participate in the PULSE network, and the PULSE mark can be
used on that institution's debit cards and ATMs. In addition, financial institution participants may sponsor merchants,
direct processors and independent sales organizations to participate in the PULSE PIN POS and ATM debit service. A
participating financial institution assumes liability for transactions initiated through the use of debit cards issued by that
institution, as well as for ensuring compliance with PULSE's operating rules and policies applicable to that institution's
debit cards, ATMs and, if applicable, sponsored merchants, direct processors and independent sales organizations.
When PULSE enters into a network-to-network agreement with another debit network, the other network's
participating financial institutions' debit cards can be used at terminals in the PULSE network. PULSE does not have a
direct relationship with these financial institutions and the other network bears the financial responsibility for
transactions of those financial institutions' cardholders and for ensuring compliance with PULSE's operating rules.
Diners Club
Our Diners Club business maintains an acceptance network in over 185 countries and territories through its
relationships with over 80 licensees, which are generally financial institutions. We generally do not directly issue Diners
Club cards to consumers, but grant our licensees the right to issue Diners Club branded cards and/or provide card
acceptance services. Our licensees pay us royalties for the right to use the Diners Club brand, which is our primary
source of Diners Club revenues. We also earn revenue from providing various support services to our Diners Club
licensees, including processing and settlement of cross border transactions. We also provide a centralized service
center and internet services to our licensees.
When Diners Club cardholders use their cards outside the host country or territory of the issuing licensee,
transactions are routed and settled over the Diners Club network through its centralized service center. In order to
increase merchant acceptance in certain targeted countries and territories, we work with merchant acquirers to offer
Diners Club and Discover acceptance to their merchants. These acquirers are granted licenses to market the Diners Club
brands to existing and new merchants. As we continue to work toward achieving full card acceptance across our
networks, Discover customers are using their cards at an increasing number of merchant and ATM locations that accept
Diners Club cards around the world. Diners Club cardholders with cards issued by licensees outside of North America
continue to use their cards on the Discover Network in North America and on the PULSE and Diners Club network
domestically and internationally.
Network Partners Business
We have agreements with a number of financial institutions, networks and commercial service providers for
issuance of products or processing of payments on Discover networks. We refer to these financial institutions, networks
and commercial service providers as "Network Partners." We may earn merchant discount and acquirer assessments
net of issuer fees paid, in addition to other fees, for processing transactions for Network Partners.
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The following chart* shows an example of Network Partners transaction cycle:
* * *
The discussion below provides additional detail concerning the supporting functions of our two segments. The
credit card, student loan, personal loan, home loan, home equity loan and deposit products issued through our Direct
Banking segment require significant consumer portfolio investments in risk management, marketing, customer service
and related technology, whereas the operation of our Payment Services business requires that we invest in the
technology to manage risk and service network partners, merchants and merchant acquirer relationships.
Credit Risk Management
Credit risk management is a critical component of our management and growth strategy. Credit risk refers to the
risk of loss arising from borrower default when borrowers are unable or unwilling to meet their financial obligations to
us. Our credit risk arising from consumer lending products is generally highly diversified across millions of accounts
without significant individual exposures. We manage credit risk primarily based on customer segments and product
types. See "— Risk Management" for more information regarding how we define and manage our credit and other
risks.
Account Acquisition (New Customers)
We acquire new credit card customers through direct mail, internet, media advertising, merchant or partner
relationships, or through unsolicited individual applications. We also acquire new student loan, personal loan and
home loan customers through similar channels. In all cases we have a rigorous process for screening applicants.
To identify credit-worthy prospective customers, our credit risk management and marketing teams use proprietary
analytical tools to match our product offerings with customer’s needs. We consider the prospective customer's financial
stability, as well as ability and willingness to pay.
We assess the creditworthiness of each consumer loan applicant through evaluating applicant’s credit
information provided by credit bureaus and information from other sources. The assessment is performed using our
credit scoring systems, both externally developed and proprietary. For our unsecured lending products, we also use
experienced credit underwriters to supplement our automated decision-making processes. For our home loan and home
equity products, experienced credit underwriters must review and approve each application.
Upon approval of a customer's application for one of our unsecured lending and home equity products, we
assign a specific annual percentage rate using an analytically driven pricing framework that simultaneously provides
competitive pricing for customers and seeks to maximize revenue on a risk-adjusted basis. For our credit card loans, we
also assign a credit line based on risk level and expected return.
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Portfolio Management (Existing Customers)
The revolving nature of our credit card loans requires that we regularly assess the credit risk exposure of such
accounts. This assessment uses the individual's Discover account performance information as well as information from
credit bureaus. We utilize statistical evaluation models to support the measurement and management of credit risk. At
the individual customer level, we use custom risk models together with generic industry models as an integral part of the
credit decision-making process. Depending on the duration of the customer's account, risk profile and other
performance metrics, the account may be subject to a range of account management treatments, including transaction
authorization limits and increases or decreases on credit limits. Our installment loans are billed according to an
amortization schedule that is calculated at the time of the disbursement of the loan and, in the case of deferred student
loans, at the time the loan enters repayment.
Customer Assistance
We provide our customers with a variety of tools to proactively manage their accounts, including electronic
payment reminders and a website dedicated to customer education, as further discussed under the heading "—
Customer Service." These tools are designed to limit a customer's risk of becoming delinquent. When a customer's
account becomes delinquent or is at risk of becoming delinquent, we employ a variety of strategies to assist customers
in becoming current on their accounts.
All monthly billing statements of accounts with past due amounts include a request for payment of such amounts.
Customer assistance personnel generally initiate contact with customers within 30 days after any portion of their
balance becomes past due. The nature and the timing of the initial contact, typically a personal call or letter, are
determined by a review of the customer's prior account activity and payment habits.
We reevaluate our collection efforts, and consider the implementation of other techniques, as a customer
becomes increasingly delinquent. We limit our exposure to delinquencies through controls within our process for
authorizing transactions and credit limits and criteria-based account suspension and revocation. In situations involving
customers with financial difficulties, we may enter into arrangements to extend or otherwise change payment schedules,
lower interest rates and/or waive fees to aid customers in becoming current on their obligations to us. For more
information see "Management's Discussion and Analysis of Financial Condition and Results of Operations — Loan
Quality — Modified and Restructured Loans."
Marketing
In addition to working with our credit risk management personnel on account acquisition and portfolio
management, our marketing group provides other key functions, including product development, management of our
Cashback Bonus and other rewards programs, protection product management, and brand and advertising
management.
Product Development
In order to attract and retain customers and merchants, we continue to develop new programs, features, and
benefits and market them through a variety of channels, including mail, phone and online. Targeted marketing efforts
may include balance transfer offers and reinforcement of our Cashback Bonus and other rewards programs. Through
the development of a large prospect database, use of credit bureau data and use of a customer contact strategy and
management system, we have been able to improve our modeling and customer engagement capabilities, which helps
optimize product, pricing and channel selection.
Rewards / Cashback Bonus
Our cardmembers use several card products that allow them to earn their rewards based on how they want to
use credit, as set forth below.
• Discover it card offers 5% Cashback Bonus in categories that change throughout the year up to a quarterly
•
maximum (signing up is required) and 1% Cashback Bonus on all other purchases, as well as other benefits.
The newly launched Discover it Miles card offers 1.5 miles for every dollar spent on purchases, no annual fee
and an annual credit of up to $30 for in-flight Wi-Fi charges.
• Discover it Chrome card offers 2% Cashback Bonus on gas and restaurants up to a quarterly maximum (no
sign up required) and 1% Cashback Bonus on all other purchases as well as other benefits.
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• Discover More card offers 5% Cashback Bonus in categories that change throughout the year up to a quarterly
maximum (signing up is required) and up to 1% Cashback Bonus* on all other purchases.
• Discover Open Road card offers 2% Cashback Bonus on the first $250 spent in combined gas and restaurant
purchases each billing period and up to 1% Cashback Bonus* on all other purchases.
• Miles by Discover customers receive two miles for every $1 on the first $3,000 spent in travel and restaurant
purchases each year, one mile for every $1 spent thereafter, and one mile for every $1 spent on all other
purchases.
Escape by Discover customers receive two miles for every $1 on all purchases. This card has a $60 annual fee.
•
• Discover Business card offers 5% Cashback Bonus on the first $2,000 spent in office supply purchases, 2%
Cashback Bonus on the first $2,000 spent in gas purchases each year and up to 1% Cashback Bonus* on all
other purchases.
* With Discover Deals, customers can shop at top merchants and earn additional Cashback Bonus or miles, a statement credit on their Discover account or
instant savings at checkout both online and in stores. Cashback Bonus can be redeemed for (i) merchant partner gift cards (starting at $20) that add $5 or
more to their reward, (ii) Discover gift cards (starting at $20, available through April 1, 2015), (iii) charitable donations to select charities (starting at 1 cent),
(iv) in the form of a statement credit (starting at 1 cent), or (v) electronic deposit to a bank account (starting at 1 cent). Miles can be redeemed for (i) partner
gift cards (starting at 1,000 miles), (ii) Discover gift cards (starting at 5,000 miles, available through April 1, 2015), (iii) cash in the form of statement credits
or direct deposits (starting at 2 miles), (iv) charitable donations to select charities (starting at 2 miles), or (v) for the Escape card only, travel credits starting at
10,000 miles.
Protection Products
We currently service and maintain existing enrollments of the protection products detailed below for our credit
card customers. Although we suspended new sales of these products to consumers at the end of 2012, we may resume
offering similar products in the future.
•
•
Identity Theft Protection. The most comprehensive identity theft monitoring product we offer includes an initial
credit report, credit bureau report monitoring at the three major credit bureaus, prompt alerts to key changes to
credit bureau files that help customers spot possible identity theft quickly, internet surveillance to monitor up to
20 credit and debit card numbers on suspicious websites, identity theft insurance up to $25,000 to cover
certain out-of-pocket expenses due to identity theft, and access to knowledgeable professionals who can
provide information about identity theft issues.
Payment Protection. This product allows customers to suspend their payments for up to two years, depending on
the qualifying event and product level, when certain qualifying life events occur. While on benefit, customers
have no minimum monthly payment, and are not charged interest, late fees or the fees for the product. This
product covers a variety of different events, such as unemployment, disability, natural disasters or other life
events, such as marriage or birth of a child. Depending on the product and availability under state laws,
outstanding balances up to $10,000 or $25,000, depending on product level are cancelled in the event of
death.
• Wallet Protection. This product offers one-call convenience if a customer's wallet is lost or stolen, including
requesting cancellation and replacement of the customer's credit and debit cards, monitoring the customer's
credit bureau reports at the three major credit bureaus for 180 days and alerting them to key changes to their
credit files, providing up to $100 to replace the customer's wallet or purse and, if needed, allowing the
customer up to a $1,000 cash advance on his or her Discover card account.
• Credit ScoreTracker. This product offers customers resources that help them understand and monitor their credit
scores. Credit ScoreTracker is specifically designed for score monitoring by alerting customers when their score
changes, allowing customers to set a target score, and providing resources to help customers understand the
factors that may be influencing their scores.
In addition to the protection products above, our credit card customers can purchase online service warranties
from our extended warranty provider to protect purchases of new electronics and appliances as well as certain other
purchases.
Brand and Advertising Management
We maintain a full-service marketing department charged with delivering integrated mass and direct
communications to foster customer engagement with our products and services. Our brand team utilizes consumer
insights and market intelligence to define our mass communication strategy, create multi-channel advertising messages
and develop marketing partnerships with sponsorship properties. This work is performed in house as well as with a
variety of external agencies and vendors.
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Customer Service
Our customers can contact our customer service personnel by calling 1-800-Discover. Our customers can also
manage their accounts online or through applications for certain mobile devices. Our internet and mobile solutions offer
a range of benefits, including:
• Online account services that allow customers to customize their accounts, choose how and when they pay their
bills, view annual account summaries that assist them with budgeting, research transaction details, initiate
transaction disputes and chat with or email a customer representative;
Email and mobile text reminders that help customers avoid fees, keep their accounts secure and track big
purchases or returns;
•
• Money management tools like the Spend Analyzer, Paydown Planner and Purchase Planner; and
• An online portal where customers automatically earn 5-20% Cashback Bonus when they shop at well-known
online merchants using their Discover card.
Our student loan, personal loan, home equity and deposit product customers can utilize our online account
services to manage their accounts, and to use interactive tools and calculators. For the home loan origination process,
we have an online portal for home loan customers to educate themselves on the home loan process, monitor the status
of their loans prior to funding, upload documents and e-sign initial loan documents.
Processing Services
Our processing services cover four functional areas: card personalization/embossing, print/mail, remittance
processing and document processing. Card personalization/embossing is responsible for the embossing and mailing of
plastic credit cards for new accounts, replacements and reissues, and gift cards. Print/mail specializes in statement and
letter printing and mailing for merchants and customers. Remittance processing, currently a function outsourced to third-
party vendors, handles account payments and check processing. Document processing handles hard-copy forms,
including new account applications.
Fraud Prevention
We monitor our customers' accounts to prevent, detect, investigate and resolve fraud. Our fraud prevention
processes are designed to protect the security of cards, applications and accounts in a manner consistent with our
customers' needs to easily acquire and use our products. Prevention systems monitor the authorization of application
information, verification of customer identity, sales, processing of convenience and balance transfer checks, and
electronic transactions.
Each credit card transaction is subject to screening, authorization and approval through a proprietary POS
decision system. We use a variety of techniques that help identify and halt fraudulent transactions, including adaptive
models, rules-based decision-making logic, report analysis, data integrity checks and manual account reviews. We
manage accounts identified by the fraud detection system through technology that integrates fraud prevention and
customer service. Strategies are subject to regular review and enhancement to enable us to respond quickly to changing
conditions as well as to protect our customers and our business from emerging fraud activity.
Product Terms and Conditions
Credit Cards
The terms and conditions governing our credit card products vary by product and change over time. Each credit
card customer enters into a cardmember agreement governing the terms and conditions of the customer's account.
Discover card's terms and conditions are generally uniform from state to state. The cardmember agreement permits us,
to the extent permitted by law, to change any term of the cardmember agreement, including any finance charge, rate or
fee, or add or delete any term of the cardmember agreement, with notice to the customer as required by law. The
customer has the right to opt out of certain changes of terms and pay their balance off under the original terms. Each
cardmember agreement provides that the account can be used for purchases, cash advances and balance transfers.
Each Discover card account is assigned a credit limit when the account is initially opened. Thereafter, individual credit
limits may be increased or decreased from time to time, at our discretion, based primarily on our evaluation of the
customer's creditworthiness. We offer various features and services with the Discover card accounts, including the
Cashback Bonus rewards programs described under “— Marketing — Rewards/Cashback Bonus.”
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All Discover card accounts generally have the same billing structure. We generally send a monthly billing
statement to each customer who has an outstanding debit or credit balance. Customers also can waive their right to
receive a physical copy of their bill, in which case they will receive email notifications of the availability of their billing
statement online. Discover card accounts are grouped into multiple billing cycles for operational purposes. Each billing
cycle has a separate billing date, on which we process and bill to customers all activity that occurred in the related
accounts during a period of approximately 28 to 32 days that ends on the billing date.
Discover card accounts are assessed periodic finance charges using fixed and/or variable interest rates. Certain
account balances, such as balance transfers, may accrue periodic finance charges at lower fixed rates for a specified
period of time. Variable rates are indexed to the highest prime rate published in The Wall Street Journal on the last
business day of the month. Periodic finance charges are calculated using the daily balance (including current
transactions) method, which results in daily compounding of periodic finance charges, subject to a grace period on new
purchases. The grace period essentially provides that periodic finance charges are not imposed on new purchases, or
any portion of a new purchase, that is paid by the due date on the customer's current billing statement if the customer
paid the balance on his or her previous billing statement in full by the due date on that statement. Neither cash
advances nor balance transfers are subject to a grace period.
Each customer with an outstanding debit balance on his or her Discover card account must generally make a
minimum payment each month. If a customer exceeds his or her credit limit as of the last day of the billing period, we
may include all or a portion of this excess amount in the customer's minimum monthly payment. A customer may pay
the total amount due at any time. We also may enter into arrangements with delinquent customers to extend or
otherwise change payment schedules, and to waive finance charges and/or fees, including re-aging accounts in
accordance with regulatory guidance.
In addition to periodic finance charges, we may impose other charges and fees on Discover card accounts,
including cash advance transaction fees, late fees where a customer has not made a minimum payment by the required
due date, balance transfer fees and returned payment fees. We also charge fees each time we decline to honor a
balance transfer check, cash advance check, or other promotional check due to such reasons as insufficient credit
availability, delinquency or default.
The Credit Card Accountability Responsibility and Disclosure Act of 2009 (the "CARD Act") required us to
review, every six months, certain interest rates that were increased on accounts since January 1, 2009 to determine
whether to reduce the interest rate based on the factors that prompted the increase or factors we currently consider in
determining interest rates applicable to similar new credit card accounts. The amount of any rate decrease must be
determined based upon our reasonable policies and procedures. Any reduced interest rate must be applied to the
account not later than 45 days after completion of the review.
Student Loans
The terms and conditions governing our student loans vary by product and are specified in the borrower's
promissory note and disclosures. Each borrower signs a promissory note and accepts the loan terms during the
application process. Student loans feature zero origination fees, fixed or variable interest rates, and potential rewards.
Student loans may include a deferment period, during which borrowers are not required to make payments while
enrolled in school at least half time. This period begins on the date the loan is first disbursed and ends six to nine
months after the borrower ceases to be enrolled in school at least half time. We also offer an optional "In-School
Payment" product that requires a student to make monthly payments while in school. The standard repayment period is
15 to 20 years, depending on the type of student loan. Borrowers can choose to receive electronic communications, in
which case they will receive email notifications of the availability of their monthly billing statements online. There is no
prepayment penalty, and borrowers may decide whether or not to apply any excess payments toward their next
monthly payments and advance their next due date.
We calculate interest on a daily basis on the outstanding principal loan balance until the loan is paid in full. The
interest rate will never be higher than the maximum allowed by law, as stated in the promissory note and disclosures.
The variable interest rate we offer, is equal to a variable index (e.g., based on the prime rate, London Interbank Offered
Rate ("LIBOR") or T-Bill) plus a fixed margin assigned to the loan during origination. Variable interest rates may adjust
quarterly if the index changes. We may impose other charges, including late charges when a customer has not made a
minimum payment by the required due date and a returned check charge. In certain circumstances, we may offer
borrower assistance programs including forbearance periods of up to 12 months over the life of the loan or short-term
payment reductions. We accrue interest when loans are in forbearance or in other payment assistance programs.
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Personal Loans
The terms and conditions governing personal loans are set at the time the loan is accepted and generally do not
change for the life of the loan. Personal loan account terms and conditions are generally uniform from state to state. All
personal loan accounts generally have the same billing structure. Customers receive monthly statements approximately
20 days prior to payment due dates. The statement provides detail on all transactions processed since the last statement
was generated, as well as a summary of the current amount due. Customers also can waive their right to receive
physical copies of their bills, in which case they will receive email notifications of the availability of their billing
statements online. Personal loan accounts are assessed periodic finance charges using simple interest. We may impose
other charges, including late charges when a customer has not made a minimum payment by the required due date
and a returned check charge. There is no prepayment penalty for repaying a personal loan balance in full prior to the
scheduled maturity date.
Home Loans and Home Equity Loans
We offer prime adjustable, fixed-rate conforming, jumbo, FHA and VA first lien home loans to qualified
applicants. The terms of the loan are set at closing. Substantially all funded loans and the related loan servicing rights
are sold to investors in the secondary market, generally within 30 days of funding.
Home equity loans are fixed-rate loans that carry a monthly payment over the term of the loan and are secured
by a first or second lien on a customer's home. The terms of the loan are set at closing. Customers are sent monthly
statements 20 days in advance of the payment due date. The statements provide the customer the allocation of any
payments made since the last billing date as well as the payment due on the next scheduled payment date. The
customer has the ability to view their account information as well as make payments online through the account center.
Customers are also subject to additional charges, including late fees and returned payment charges. The customer has
the ability to make larger than minimum payments on the loans and early payoffs are not subject to a prepayment
penalty.
Deposits
We offer four main types of deposit products directly to consumers on a national basis: certificates of deposit,
savings accounts, money market and checking accounts, though at the current time we are offering checking accounts
only to existing credit card or deposit customers. All of these deposits are FDIC insured to the maximum permitted by
law. Interest is compounded daily and credited to each account on a monthly basis, using the daily balance method.
We do not pay interest generally on checking account balances, but instead offer cashback rewards for certain
transactions. We offer a range of ownership options, including single, joint, trust and custodial. Deposit accounts may
be funded through electronic funds transfer, check or wire transfer. Customers may service their accounts through a
variety of convenient methods, including online at www.discoverbank.com, mobile and tablet device applications, and
by telephone.
Certificates of deposit are offered on a full range of tenors from three months through 10 years with interest rates
that are fixed for the full period. We provide automatic renewal along with options on reinvestment or disbursement of
interest. There are minimum balance requirements to open certificates of deposit and penalties for early withdrawals.
Money market accounts are transactional accounts with minimum balance requirements. Money market account funds
may be accessed through electronic funds transfer, checks, wire transfer and debit cards. Savings accounts may be
accessed through electronic funds transfer, wire transfer and official checks. Money market accounts and savings
accounts have limitations on withdrawal frequency, as required by law. Interest rates on money market accounts and
savings accounts are subject to change at any time. Fees apply to some transactions, and availability of funds varies
based on product and method of funding.
We also issue certificates of deposit through select contracted brokerage firms. All of these deposits are also FDIC
insured to the maximum allowed by law. All settlements occur through the Depository Trust Company. Tenors issued,
interest and commission rates are determined weekly with tenor issuances of five months to ten years. Simple interest is
applied to brokered certificates of deposit. At any given time, we may choose to not issue these certificates of deposit or
to issue only certain tenors in a given week. Early redemption of these certificates occurs only in the event of death or
adjudication of incompetence. We have also entered into several third-party agreements which provide structured
sweep deposit balances.
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Discover Network Operations
We support our merchants through a merchant acquiring model that includes direct relationships with large
merchants in the United States and arrangements with merchant acquirers for small- and mid-size merchants. In
addition to our U.S.-based merchant acceptance locations, Discover Network cards also are accepted at many
locations in Canada, Mexico, the Caribbean, China, Japan and a growing number of countries around the world on
the Diners Club network, or through reciprocal acceptance arrangements made with international payment networks
(i.e., network-to-network).
We maintain direct relationships with most of our largest merchant accounts, which enables us to benefit from
joint marketing programs and opportunities and to retain the entire discount revenue from the merchants. The terms of
our direct merchant relationships are governed by merchant services agreements. These agreements also are
accompanied by additional program documents that further define our network functionality and requirements,
including operating regulations, technical specifications and dispute rules. To enable ongoing improvements in our
network's functionality and in accordance with industry convention, we publish updates to our program documents on a
semi-annual basis. Discover card transaction volume was concentrated among our top 100 merchants in the 2014
calendar year with our largest merchant accounting for approximately 8% of total Discover card transaction volume.
In order to increase merchant acceptance, Discover Network services the majority of its small- and mid-size
merchant portfolios through third-party merchant acquirers to allow such acquirers to offer a comprehensive payments
processing package to such merchants. Merchants also can apply to our merchant acquirer partners directly to accept
Discover Network cards through the acquirers' integrated payments solutions. Merchant acquirers provide merchants
with consolidated servicing for Discover, Visa and MasterCard transactions, resulting in streamlined statements and
customer service for merchants, and reduced costs for us. These acquirer partners also perform credit evaluations and
screen applications against unacceptable business types and the Office of Foreign Asset Control Specifically Designated
Nationals list.
Discover Network operates systems and processes that seek to ensure data integrity, prevent fraud and ensure
compliance with our operating regulations. Our systems evaluate incoming transaction activity to identify abnormalities
that require investigation and fraud mitigation. Designated Discover Network personnel are responsible for validating
compliance with our operating regulations and law, including enforcing our data security standards and prohibitions
against illegal or otherwise unacceptable activities. Discover Network is a founding and current member of the Payment
Card Industry Security Standards Council, LLC, and is working to expand the adoption of the Council's security
standards globally for merchants and service providers that store, transmit or process cardholder data.
Technology
We provide technology systems processing through a combination of owned and hosted data centers and the use
of third-party vendors. These data centers support our payment networks, provide customers with access to their
accounts and manage transaction authorizations, among other functions. Discover Network works with a number of
vendors to maintain our connectivity in support of POS authorizations. This connectivity also enables merchants to
receive timely payment for their Discover Network card transactions.
Our approach to technology development and management involves both third-party and in-house resources. We
use third-party vendors for basic technology services (e.g., telecommunications, hardware and operating systems) as well
as for processing and other services for our direct banking and payment services businesses. We subject each vendor to
a formal approval process to ensure that the vendor can assist us in maintaining a cost-effective and reliable technology
platform. We use our in-house resources to build, maintain and oversee some of our technology systems. We believe
this approach enhances our operations and improves cost efficiencies.
Seasonality
In our credit card business, we experience fluctuations in transaction volumes and the level of loan receivables as
a result of higher seasonal consumer spending and payment patterns around the winter holidays, summer vacations
and back-to-school periods. In our student loan business, our loan disbursements peak at the beginning of a school's
academic semester or quarter. Although there is a seasonal impact to transaction volumes and the levels of credit card
and student loan receivables, seasonal trends have not caused significant fluctuations in our results of operations or
credit quality metrics between quarterly and annual periods.
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Revenues in our Diners Club business are generally higher in the first half of the year as a result of Diners Club's
tiered pricing system where licensees qualify for lower royalty rate tiers as cumulative volume grows during the course
of the year.
Competition
We compete with other consumer financial services providers and payment networks on the basis of a number of
factors, including brand, reputation, customer service, product offerings, incentives, pricing and other terms. Our credit
card business also competes on the basis of reward programs and merchant acceptance. We compete for accounts and
utilization with cards issued by other financial institutions (including American Express, Bank of America, JPMorgan
Chase and Citi) and, to a lesser extent, businesses that issue their own private label cards or otherwise extend credit to
their customers. In comparison to our largest credit card competitors, our strengths include cash rewards, conservative
portfolio management and strong customer service. Competition based on cash rewards programs, however, has
increased in recent years. Our student loan product competes for customers with Sallie Mae and Wells Fargo, as well
as other lenders that offer student loans. Our personal loan product competes for customers primarily with JPMorgan
Chase, Wells Fargo, Citi and peer to peer lenders. Our home loan product competes for customers primarily with
traditional lending institutions, namely Wells Fargo, Bank of America, JPMorgan Chase and Citi, which operate in
multiple distribution channels, including direct-to-consumer. Our home loan product also faces additional competition
from direct lending websites owned and operated by other online lenders that originate the bulk of their loans through
their websites or by phone. Our home equity product faces competition primarily from traditional branch lending
institutions like Wells Fargo, JP Morgan Chase, U.S. Bank and PNC.
Although our student and personal loan receivables have increased, our credit card receivables continue to
represent most of our receivables. The credit card business is highly competitive. Some of our competitors offer a wider
variety of financial products than we do, including automobile loans, which may currently position them better among
customers who prefer to use a single financial institution to meet all of their financial needs. Some of our competitors
enjoy greater financial resources, diversification and scale than we do, and are therefore able to invest more in
initiatives to attract and retain customers, such as advertising, targeted marketing, account acquisitions and pricing
offerings in interest rates, annual fees, reward programs and low-priced balance transfer programs. In addition, some
of our competitors have assets such as branch locations and co-brand relationships that may help them compete more
effectively. Another competitive factor in the credit card business is the increasing use of debit cards as an alternative to
credit cards for purchases.
Because most domestically-issued credit cards, other than those issued on the American Express network, are
issued on the Visa and MasterCard networks, most other card issuers benefit from the dominant market share of Visa
and MasterCard. The former exclusionary rules of Visa and MasterCard limited our ability to attract merchants and
credit and debit card issuers, contributing to Discover not being as widely accepted in the U.S. as Visa and
MasterCard. Merchant acceptance of the Discover card has increased in the past several years, both in the number of
merchants enabled for acceptance and the number of merchants actively accepting Discover. We continue to make
investments in expanding Discover and Diners Club acceptance in key international markets where an acceptance gap
exists.
In our payment services business, we compete with other networks for volume and to attract network partners to
issue credit, debit and prepaid cards on the Discover, PULSE and Diners Club networks. We generally compete on the
basis of customization of services and various pricing strategies, including incentives and rebates. We also compete on
the basis of issuer fees, fees paid to networks (including switch fees), merchant acceptance, network functionality,
customer perception of service quality, brand image, reputation and market share. The Diners Club and Discover
networks' primary competitors are Visa, MasterCard and American Express, and PULSE's network competitors include
Visa's Interlink, MasterCard's Maestro and First Data's STAR. American Express is a particularly strong competitor to
Diners Club as both cards target international business travelers. As the payments industry continues to evolve, we are
also facing increasing competition from new entrants to the market, such as online networks, telecom providers and
other alternative payment providers, which leverage new technologies and a customer's existing deposit and credit
card accounts and bank relationships to create payment or other fee-based solutions.
In our direct-to-consumer deposits business, we have acquisition and servicing capabilities similar to other direct
competitors, including USAA, Ally Bank, American Express, Capital One (360), Sallie Mae and Barclays. We also
compete with traditional banks and credit unions that source deposits through branch locations. We seek to differentiate
our deposit product offerings on the basis of brand reputation, convenience, customer service and value.
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For more information regarding the nature of and the risks we face in connection with the competitive
environment for our products and services, see "Risk Factors — Strategic Business Risk."
Intellectual Property
We use a variety of methods, such as trademarks, patents, copyrights and trade secrets, to protect our intellectual
property. We also place appropriate restrictions on our proprietary information to control access and prevent
unauthorized disclosures. Our Discover, PULSE and Diners Club brands are important assets, and we take steps to
protect the value of these assets and our reputation.
Employees
As of January 31, 2015, we employed approximately 14,676 individuals.
Risk Management
Our business exposes us to strategic (including reputational), credit, market, liquidity, operational, compliance
and legal risks. We use a comprehensive enterprise-wide risk management framework to identify, measure, monitor,
manage and report on risks we assume in conducting our activities. We seek financial returns commensurate with the
risks to which we are exposed.
Enterprise Risk Management Principles
Our enterprise risk management philosophy is expressed through five key principles that guide our approach to
risk management: comprehensiveness, accountability, independence, defined risk appetite and transparency.
Comprehensiveness
We seek to maintain a comprehensive framework for managing risk enterprise-wide, including policies, risk
management processes, monitoring and testing, and reporting. Our framework is designed to be comprehensive with
respect to our reporting segments and their control and support functions, and it extends across all risk types.
Accountability
We structure accountability across three lines of defense along the principles of risk management execution,
oversight and independent validation. As the first line of defense, our business units seek to proactively manage the
risks to which they are exposed as a result of their activities. Employees are expected to identify, report and correct
process weaknesses.
Independence
Our second and third lines of defense, which are comprised of risk and control functions, operate independent of
the business units. The second line of defense includes our corporate risk management ("CRM") department, which is
led by our Chief Risk Officer (“CRO”), who is appointed by our Board of Directors. The CRO is accountable for
providing an independent perspective on the risks to which we are exposed and how well management is identifying,
assessing and managing risk; and the capabilities we have to manage risk across the enterprise. Our internal audit
department, as the third line of defense, performs periodic, independent reviews and tests compliance with risk
management policies, procedures and standards across the Company.
Defined Risk Appetite
We operate within the risk appetite framework approved by our Board of Directors, which guides an acceptable
level of risk taking, considering desired financial returns and other objectives. To that end, limits and escalation
thresholds are set consistent with the risk appetite approved by our Board of Directors.
Transparency
We seek to provide transparency of exposures and outcomes, which is core to our risk culture and operating
style. We provide this risk transparency through our risk committee structure and standardized processes for escalating
issues and reporting. This is accomplished at several levels within the organization, including monthly meetings held by
our Risk Committee and quarterly reports to the Risk Oversight Committee of our Board of Directors, as well as regular
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reporting to our Risk subcommittees commensurate with the needs of our businesses. Further, the CRO is a member of
the Executive Committee.
Risk Management Roles and Responsibilities
Our governance structure is designed and will be adjusted as necessary to meet the continuous needs of the
business, and based on the principle that each line of business is responsible for managing risks inherent in its business
with appropriate independent oversight and assessment. Committees are in place to oversee the management of risks
across the Company. We seek to apply operating principles consistently to each committee. These operating principles
are detailed in committee charters, which are approved by our Risk Committee.
Board of Directors
Our Board of Directors is responsible for: (i) approval of certain risk management policies, (ii) approval of our
capital targets and risk appetite and associated limits, (iii) oversight of our strategic plan and (iv) appointment of our
CRO.
Risk Oversight Committee of our Board of Directors
Our Risk Oversight Committee of our Board of Directors is responsible for reviewing and approving the risk
management policies and overseeing the operations of our enterprise-wide risk management framework. Our Risk
Oversight Committee approves risk management policies, oversees the operation of policies and procedures, and
reviews reports from management on the status of and changes to risk exposures. In addition, our Risk Oversight
Committee is responsible for the oversight of capital planning, liquidity risk management and resolution planning
activities.
Risk Committee
Our Risk Committee is an executive management-level committee, that establishes a comprehensive risk
management program and provides a forum to review and discuss credit, market, liquidity, operational, compliance
and legal, and strategic risks across the Company and for each business unit. Risk Committee membership includes all
members of our Executive Committee. The Committee establishes policies and reviews effectiveness of procedures to
identify, measure, monitor, manage and report risk enterprise-wide, communicates risk appetite and philosophy, and
reviews aggregated risk exposures within the Company. The Committee provides periodic reports to our Risk Oversight
and Audit Committees.
Our Risk Committee has formed and designated a number of committees to assist it in carrying out its
responsibilities. These committees, made up of representatives from senior levels of management, escalate issues to our
Risk Committee as guided by escalation thresholds. These risk management committees include the Discover Bank Credit
Committee, Asset/Liability Management Committees (Discover Financial Services and Discover Bank), the Counterparty
Credit Committee, the New Initiatives Committee, the Operational Risk Committee, the Capital Planning Committee, and
the Compliance Committee.
Chief Executive Officer (“CEO”)
The CEO is ultimately responsible for risk management within our Company. In that capacity, the CEO oversees
the CRO, establishes a risk management culture throughout the Company and ensures that businesses operate in
accordance with this risk culture.
Business Unit Heads
Our executive committee members, as business unit heads, are responsible for managing risk in pursuit of their
strategic, financial and other business objectives, and ensuring their business units operate within established risk
appetite limits. They are also responsible for identifying risks and implementing appropriate controls; explicitly
considering risk when developing strategic plans, budgets and new products; and implementing appropriate risk
controls when pursuing business strategies and objectives. Senior executive officers also coordinate with our CRM
department to produce relevant, sufficient, accurate and timely risk reporting that is consistent with the processes and
methodology established by our CRM department. In addition, our business unit heads are responsible for ensuring that
sufficient financial resources and qualified personnel are deployed to manage the risks inherent in our business
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activities. Additionally, our business unit heads designate, in consultation with the CRO, a business risk officer to assist
with risk management responsibilities.
Business risk officers work in conjunction with the business unit head to implement a business risk management
program that satisfies business unit needs and adheres to corporate policy, standards and risk architecture.
Chief Risk Officer
Our CRO is a member of the Executive Committee and chairs our Risk Committee. In addition, the CRO has
oversight responsibility to establish the CRM function with capabilities to exercise its mandate across all risk categories.
Our CRO reports directly to our Risk Oversight Committee and administratively to the CEO. The CRO provides an
independent view on the key risks to which our Company is exposed to our Risk Committee, our Audit Committee, our
Risk Oversight Committee and our Board of Directors.
Corporate Risk Management
CRM is led by the CRO and supports business units by providing objective oversight of our risk profile to help
ensure that risks are managed, aggregated and reported to our Risk Committee, our Risk Oversight Committee and our
Audit Committee. CRM participates in our Risk Committee and sub-committee meetings to provide an enterprise-wide
perspective on risk, governance matters, policies and risk thresholds. CRM is comprised of operational, consumer credit,
counterparty credit, and market and liquidity risk oversight functions. In addition, CRM has enterprise risk management,
corporate compliance, third-party risk management, and risk and insurance management frameworks to manage
potential risk that might arise within these respective areas.
Law Department
Our law department plays a significant role in managing our legal risk, policy development and training, and in
collaborating with the business units to incorporate a commitment to compliance in our day-to-day activities. The law
department participates in meetings of our Risk Committee and the risk subcommittees in order to advise on legal and
regulatory matters.
Internal Audit Department
Our internal audit department performs periodic, independent reviews and testing of compliance with risk
management policies and standards across the Company, as well as assessments of the design and operating
effectiveness of these policies and standards. The internal audit department also validates that risk management controls
are functioning as intended by reviewing and evaluating the design and operating effectiveness of the CRM program
and processes, including the independence and effectiveness of the CRM function. The results of such reviews are
reported to our Audit Committee.
Risk Appetite and Strategic Limit Structure
Risk appetite is defined as the aggregate level in the type of risks we are willing to accept or avoid in order to
achieve our strategic objectives, reflecting and based on our risk management philosophy and current business model
that, in turn, influences our culture and operating style. The determination of risk appetite is directly linked to the
strategic and capital planning process and is consistent with our aspirations and mission statement. The expressions of
risk appetite also serve as tools to preclude business activities that are inconsistent with our long-term goals.
We segment our risk appetite expressions by type and cascading approval levels. Our Board of Directors
approves our risk appetite and strategic limit structure, our Risk Committee approves our tactical limits and escalation
triggers, and our risk sub-committees establish our execution-level limits.
Management and our CRM department monitor approved limits and escalation triggers to ensure that the
business is operating within the expressed risk appetite and limits. Risk limits are monitored and reported on to various
risk committees and our Board of Directors, as appropriate. Through ongoing monitoring of risk exposures,
management is able to identify appropriate risk response and mitigation strategies in order to react dynamically to
changing conditions.
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Risk Categories
We are exposed to a broad set of risks in the course of our business activities due to both internal and external
factors, which we segment into six major risk categories. The first five are defined to be broadly consistent with Federal
Reserve regulatory guidance and Basel: credit, market, liquidity, operational, and compliance/legal risk. We recognize
the sixth, strategic risk, as a separate risk category. We evaluate the potential impact of a risk event on the Company
by assessing the financial impact, the impact to our reputation, the legal and regulatory impact, and the client/customer
impact. In addition, we have established various policies to help govern these risks.
Credit Risk
Credit risk arises from the potential that a borrower or counterparty will fail to perform on an obligation. Our
credit risk includes consumer credit risk and counterparty credit risk. Consumer credit risk is primarily incurred by
Discover Bank through the issuance of (i) unsecured credit including credit cards, student loans and personal loans and
(ii) secured credit including secured credit cards, deposit secured loans and home equity loans. Discover Home Loans
incurs consumer credit risk through the issuance of residential first mortgage loans to consumers. Commercial credit risk
and residential first mortgage loans originated by Discover Bank are limited to certain Community Reinvestment Act
(“CRA”) compliance activities and the issuance of small business credit cards. Counterparty credit risk is incurred
through a number of activities including settlement, certain marketing programs, treasury and asset/liability
management, network incentive programs, vendor relationships and insurers.
The Discover Bank Credit Committee ensures the lending activities of the Bank comply with the Bank Credit Policy
and also identifies, measures, monitors and controls risk arising from consumer credit risk and commercial credit risk
associated with small business credit cards. Risks associated with CRA activities are overseen and monitored by the
CRA Committee of the Bank.
Our Counterparty Credit Committee is responsible for the enterprise-wide approach to counterparty credit risk
management through development of the Counterparty Credit Risk Management Policy and the associated oversight
framework for the identification, measurement, monitoring, managing and reporting of counterparty credit risk.
Market Risk
Market risk is the risk to our financial condition resulting from adverse movements in market rates or prices, such
as interest rates, foreign exchange rates, credit spreads or equity prices. We are exposed to various types of market
risk, in particular interest rate risk and other risks that arise through the management of our investment portfolio. The
Asset/Liability Management Policy governs the management of market risk.
Liquidity Risk
Liquidity risk is the risk that we will be unable to meet our obligations as they become due because of an inability
to liquidate assets or obtain adequate funding, or an inability to easily unwind or offset specific exposures without
significantly lowering market prices because of inadequate market depth or market disruptions. The Asset/Liability
Management Policy governs the management of liquidity risk.
Operational Risk
Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and
systems or from external events. Operational risk is inherent in all our businesses. Operational risk categories
incorporate all of the operational loss event-type categories set forth by the Basel Committee on Banking Supervision,
which include the following: (i) fraud (internal and external), (ii) employment practices and workplace safety, (iii) clients,
products and business practices, (iv) damage to physical assets, (v) business disruption and system failures, and (vi)
execution, delivery and process management.
Compliance and Legal Risk
Compliance risk is the operational risk of legal or regulatory sanctions, financial loss or damage to reputation
resulting from failure to comply with laws, regulations, rules, other regulatory requirements, or codes of conduct and
other standards of self-regulatory organizations applicable to us. Legal risk arises from the potential that unenforceable
contracts, lawsuits or adverse judgments can disrupt or otherwise negatively affect our operations or condition. These
risks are inherent in all of our businesses. Both compliance and legal risk are subsets of operational risk but are
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recognized together as a separate and complementary risk category by us given their importance and the specific
capabilities and resources we deploy to manage these risk types effectively.
Compliance and legal risk exposures are actively and primarily managed by our business units in conjunction
with our compliance and law departments. Our compliance program governs the management of compliance risk. Our
Risk Committee and Compliance Committee oversee our compliance and legal risk management. Our compliance and
law departments provide independent oversight for all of our compliance and legal risk management activities. Our law
department coordinates with our CRM and compliance departments in the management of compliance and legal risks
by reporting and escalating material incidents, participating in risk and control self-assessments, and monitoring and
reporting key risk indicators.
Strategic Risk
Strategic risk can arise from: adverse business decisions; improper implementation of decisions; and a failure to
anticipate and respond to industry changes, create and maintain a competitive business model, and attract and
profitably serve clients.
Our Executive Committee actively manages strategic risk through the development, implementation and oversight
of our business strategies, including the development of budgets and business plans. Our business units take on and are
accountable for managing strategic risk in pursuit of their objectives.
The New Initiative Policy and the Capital and Dividends Policy govern the management of strategic risk. In
addition, the assessment of strategic risk is an important consideration of various subcommittees of our Risk Committee
including the Discover Bank Credit Committee, our Asset and Liability Management Committee, our Capital Planning
Committee and our New Initiative Committee. Our CRM department also plays an important role in the management of
strategic risk by: (i) overseeing the objective setting and strategic planning processes from a risk perspective, to gain
comfort that strategic risks have been adequately considered in the setting of objectives and development of strategies;
(ii) providing an independent risk perspective to the new initiatives process; and (iii) assessing if there is effective
alignment of management's proposed long-term strategic objectives with the risk appetite limits approved by our Board
of Directors.
Capital Planning
Our capital planning and management framework encompasses forecasting capital levels, establishing capital
targets, monitoring capital adequacy against targets, maintaining appropriate contingency capital plans and identifying
strategic options to deploy excess capital.
Risk Management Review of Compensation
We believe in a pay for performance philosophy which considers performance across the company, business
segments and individual performance, as appropriate, and the long-term interests of our shareholders and the safety
and soundness of the Company. We design compensation to be competitive relative to our peers to attract, retain and
motivate our employees. In addition to being competitive in the markets in which we compete for talent and
encouraging employees to achieve objectives set out by our management, our compensation programs are designed to
balance an appropriate mix of compensation components to align the interests of employees with the long-term interests
of shareholders and the safety and soundness of the Company.
The design and administration of our compensation programs provide incentives that appropriately balance risk
and financial results in a manner that does not incentivize employees to take imprudent risks, is compatible with
effective controls and enterprise-wide risk management, and is supported by strong corporate governance, including
oversight by our Board of Directors and the Compensation and Leadership Development Committee of our Board of
Directors.
Supervision and Regulation
General
Our operations are subject to extensive regulation, supervision and examination under U.S. federal, state and
foreign laws and regulations. As a bank holding company under the Bank Holding Company Act of 1956 and a
financial holding company under the Gramm-Leach-Bliley Act, we are subject to the supervision, examination and
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regulation of the Federal Reserve. As a large provider of consumer financial services, we are subject to the supervision,
examination and regulation of the Consumer Financial Protection Bureau (the "CFPB").
We operate two banking subsidiaries, each of which is in the United States. Discover Bank, our main banking
subsidiary, offers credit card loans, student loans, personal loans and home equity loans as well as certificates of
deposit, savings and checking accounts and other types of deposit accounts. Discover Bank is chartered and regulated
by the Office of the Delaware State Bank Commissioner (the "Delaware Commissioner"), and is also regulated by the
Federal Deposit Insurance Corporation (the "FDIC"), which insures its deposits up to applicable limits and serves as the
bank's primary federal banking regulator. Our other bank, Bank of New Castle, is also chartered and regulated by the
Delaware Commissioner and insured and regulated by the FDIC.
Bank Holding Company Regulation
Permissible activities for a bank holding company include those activities that are so closely related to banking as
to be a proper incident thereto, such as consumer lending and other activities that have been approved by the Federal
Reserve by regulation or order. Certain servicing activities are also permissible for a bank holding company if
conducted for or on behalf of the bank holding company or any of its affiliates. Impermissible activities for bank holding
companies include activities that are related to commerce such as retail sales of nonfinancial products.
A financial holding company and the non-bank companies under its control are permitted to engage in activities
considered financial in nature, incidental to financial activities, or complementary to financial activities, if the Federal
Reserve determines that such activities pose no risk to the safety or soundness of depository institutions or the financial
system in general. Being a financial holding company under the Gramm-Leach-Bliley Act requires that the depository
institutions that we control meet certain criteria, including capital, management and Community Reinvestment Act
requirements. In addition, under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank
Act") we are required to meet certain capital and management criteria to maintain our status as a financial holding
company. Failure to meet the criteria for financial holding company status results in restrictions on new financial
activities or acquisitions and could require discontinuance of existing activities that are not generally permissible for
bank holding companies.
Federal Reserve regulations and the Federal Deposit Insurance Act (the "FDIA"), as amended by the Dodd-Frank
Act, require that bank holding companies serve as a source of strength to each subsidiary bank and commit resources
to support each subsidiary bank. This support may be required at times when a bank holding company may not be
able to provide such support without adversely affecting its ability to meet other obligations.
The Dodd-Frank Act addresses risks to the economy and the payments system, especially those posed by large
systemically significant financial firms. Bank holding companies with $50 billion or more in total consolidated assets,
including Discover, are considered systemically significant under the Dodd-Frank Act and are subject to heightened
prudential standards established by the Federal Reserve. Regulatory developments, findings and ratings could
negatively impact our business strategies or require us to: limit or change our business practices, restructure our
products in ways that we may not currently anticipate, limit our product offerings, invest more management time and
resources in compliance efforts, limit the fees we can charge for services, or limit our ability to pursue certain business
opportunities and obtain related required regulatory approvals. For additional information regarding bank regulatory
limitations on acquisitions and investments, see "— Acquisitions and Investments." See Note 19: Litigation and
Regulatory Matters to our consolidated financial statements for more information on recent matters affecting Discover.
Regulatory developments could also impact our strategies, the value of our assets, or otherwise adversely affect our
businesses. For more information regarding the regulatory environment and developments under the Dodd-Frank Act,
see "Management's Discussion and Analysis of Financial Condition and Results of Operations — Regulatory
Environment and Developments" and “Risk Factors."
Capital, Dividends and Share Repurchases
We, Discover Bank and Bank of New Castle are subject to capital adequacy guidelines adopted by federal
banking regulators, which include maintaining minimum capital and leverage ratios for capital adequacy and higher
ratios to be deemed "well-capitalized." As a bank holding company, we were required to maintain Tier 1 and total
capital equal to at least 4% and 8% of our total risk-weighted assets, respectively, prior to January 1, 2015. We were
also required to maintain a minimum "leverage ratio" (Tier 1 capital to adjusted total assets) of 4% to 5% prior to
January 1, 2015, depending upon criteria defined and assessed by the Federal Reserve. Further, under the Federal
Reserve's annual capital plan requirements, we are required to demonstrate that under stress scenarios we will maintain
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a Tier 1 common ratio (meaning the ratio of Tier 1 common capital to total risk-weighted assets) above 5%. At
December 31, 2014, Discover Financial Services met all requirements to be deemed "well-capitalized." For related
information regarding our bank subsidiaries, see "— FDIA" below.
Federal Reserve and FDIC final rules applicable to Discover Financial Services and Discover Bank, respectively,
include new minimum and "well-capitalized" risk-based capital and leverage ratios, effective January 1, 2015, and
refine the definition of what constitutes "capital" for purposes of calculating those ratios. The new minimum capital level
requirements applicable to Discover Financial Services and Discover Bank under the final rules, beginning January 1,
2015, are: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 risk-based capital ratio of 6% (increased
from 4%); (iii) a total risk-based capital ratio of 8% (unchanged); and (iv) a Tier 1 leverage ratio of 4% for all U.S.
banking institutions. The new capital level requirements to be “well-capitalized” under the final rules are: (i) a common
equity Tier 1 capital ratio of 6.5%; (ii) a Tier 1 risk-based capital ratio of 8%; (iii) a total risk-based capital ratio of 10%;
and (iv) a Tier 1 leverage ratio of 5%.
There are various federal and state law limitations on the extent to which our banking subsidiaries can provide
funds to us through dividends, loans or otherwise. These limitations include minimum regulatory capital requirements,
federal and state banking law requirements concerning the payment of dividends out of net profits or surplus, and
general federal and state regulatory oversight to prevent unsafe or unsound practices. In general, federal and
applicable state banking laws prohibit, without first obtaining regulatory approval, insured depository institutions, such
as our banking subsidiaries, from making dividend distributions if such distributions are not paid out of available
earnings or would cause the institution to fail to meet applicable capital adequacy standards. For more information, see
"— FDIA" below.
Additionally, we are required to submit an annual capital plan to the Federal Reserve that includes an assessment
of our expected uses and sources of capital over the nine quarter planning horizon. In January 2015, we submitted our
annual capital plan to the Federal Reserve under the Federal Reserve’s Comprehensive Capital Analysis and Review, or
CCAR, program, which included planned dividends and share repurchases over the nine quarter planning horizon.
Our ability to make capital distributions, including our ability to pay dividends or repurchase shares of our common
stock, will be subject to the Federal Reserve's review and non-objection of the actions that we proposed in our annual
capital plan. In addition, Discover Financial Services is required to publish company-run stress tests results in March
and September each year in accordance with Federal Reserve rules and Discover Bank is required to publish company-
run stress test results under FDIC rules. The dates for publication of stress test results by Discover Financial Services and
Discover Bank may differ after 2015 based on recently updated rules adopted by the Federal Reserve and the FDIC.
For more information, including additional conditions and limits on our ability to pay dividends and repurchase
our stock, see "Risk Factors — Credit, Market and Liquidity Risk — We may be limited in our ability to pay dividends
on and repurchase our stock" and "— We are a holding company and depend on payments from our subsidiaries,"
"Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital
Resources — Capital" and Note 17: Capital Adequacy to our consolidated financial statements.
FDIA
The FDIA imposes various requirements on insured depository institutions. For example, the FDIA requires,
among other things, the federal banking agencies to take "prompt corrective action" in respect of depository institutions
that do not meet minimum capital requirements. The FDIA sets forth the following five capital tiers: "well-capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." A
depository institution's capital tier will depend upon how its capital levels compare with various relevant capital
measures and certain other factors that are established by regulation. At December 31, 2014, Discover Bank and Bank
of New Castle met all applicable requirements to be deemed "well-capitalized." As noted above, recently-issued
Federal Reserve rules and additional future rulemaking, including with respect to implementation of Basel III, have
altered and in the future could further alter the capital adequacy framework for Discover.
The FDIA also prohibits any depository institution from making any capital distributions (including payment of a
dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be
"undercapitalized." "Undercapitalized" institutions are subject to growth limitations and are required to submit a capital
restoration plan. For a capital restoration plan to be acceptable, among other things, the depository institution's parent
holding company must guarantee that the institution will comply with the capital restoration plan.
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If a depository institution fails to submit an acceptable capital restoration plan, it is treated as if it is "significantly
undercapitalized." "Significantly undercapitalized" depository institutions may be subject to a number of requirements
and restrictions, including orders to sell sufficient voting stock to become "adequately capitalized," requirements to
reduce total assets, and cessation of receipt of deposits from correspondent banks. "Critically undercapitalized"
institutions are subject to the appointment of a receiver or conservator.
Each of our banking subsidiaries may also be held liable by the FDIC for any loss incurred, or reasonably
expected to be incurred, due to the default of the other U.S. banking subsidiary and for any assistance provided by the
FDIC to the other U.S. banking subsidiary that is in danger of default.
The FDIA prohibits insured banks from accepting brokered deposits or offering interest rates on any deposits
significantly higher than the prevailing rate in the bank's normal market area or nationally (depending upon where the
deposits are solicited), unless it is "well-capitalized," or it is "adequately capitalized" and receives a waiver from the
FDIC. A bank that is "adequately capitalized" and that accepts brokered deposits under a waiver from the FDIC may
not pay an interest rate on any such deposit in excess of 75 basis points over certain prevailing market rates. There are
no such restrictions under the FDIA on a bank that is "well-capitalized." As of December 31, 2014, Discover Bank and
Bank of New Castle each met the FDIC's definition of a "well-capitalized" institution for purposes of accepting brokered
deposits. An inability to accept brokered deposits in the future could materially adversely impact our funding costs and
liquidity. For more information, see “Risk Factors — Credit, Market and Liquidity Risk — An inability to accept or
maintain deposits in the future could materially adversely affect our liquidity position and our ability to fund our
business.”
The FDIA also affords FDIC-insured depository institutions, such as Discover Bank and Bank of New Castle, the
ability to "export" favorable interest rates permitted under the laws of the state where the bank is located. Discover
Bank and Bank of New Castle are both located in Delaware and, therefore, charge interest on loans to out-of-state
borrowers at rates permitted under Delaware law, regardless of the usury limitations imposed by the state laws of the
borrower's residence. Delaware law does not limit the amount of interest that may be charged on loans of the type
offered by Discover Bank or Bank of New Castle. This flexibility facilitates the current nationwide lending activities of
Discover Bank and Bank of New Castle.
The FDIA subjects Discover Bank to deposit insurance assessments. Under the Dodd-Frank Act, in order to bolster
the reserves of the Deposit Insurance Fund, the minimum reserve ratio set by the FDIC was increased to 1.35%. The
FDIC set a reserve ratio of 2%, 65 basis points above the statutory minimum. The FDIC also amended its deposit
insurance regulations with two changes. First, the FDIC implemented a provision of the Dodd-Frank Act that changed
the assessment base for deposit insurance premiums from one based on domestic deposits to one based on average
consolidated total assets minus average tangible equity. Second, the FDIC revised the risk-based assessment system for
all large insured depository institutions (generally, institutions with at least $10 billion in total assets, including Discover
Bank) to one based on a scorecard method. Further increases may occur in the future. The Dodd-Frank Act removed the
statutory cap for the reserve ratio, leaving the FDIC free to set a cap in the future.
Acquisitions and Investments
Since we are a bank holding company, and Discover Bank and Bank of New Castle are insured depository
institutions, we are subject to banking laws and regulations that limit the types of acquisitions and investments that we
can make. In addition, certain permitted acquisitions and investments that we seek to make are subject to the prior
review and approval of our banking regulators, including the Federal Reserve and FDIC. Our banking regulators have
broad discretion on whether to approve proposed acquisitions and investments. In deciding whether to approve a
proposed acquisition, federal bank regulators will consider, among other factors, the effect of the acquisition on
competition, our financial condition, and our future prospects, including current and projected capital ratios and levels;
the competence, experience, and integrity of our management and our record of compliance with laws and regulations;
the convenience and needs of the communities to be served, including our record of compliance under the Community
Reinvestment Act; and our effectiveness in combating money laundering. Therefore, results of supervisory activities of
the banking regulators, including examination results and ratings, can impact whether regulators approve proposed
acquisitions and investments. Supervisory actions related to anti-money laundering and related laws and regulations will
limit for a period of time our ability to enter into certain types of acquisitions and make certain types of investments. For
more information on recent matters affecting Discover, see Note 19: Litigation and Regulatory Matters to our
consolidated financial statements. For information on the challenging regulatory environment, see "Risk Factors."
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In addition, certain acquisitions of our voting stock may be subject to regulatory approval or notice under U.S.
federal or Delaware state law. Investors are responsible for ensuring that they do not, directly or indirectly, acquire
shares of our stock in excess of the amount that can be acquired without regulatory approval under the Change in Bank
Control Act, the Bank Holding Company Act and the Delaware Change in Bank Control provisions, which prohibit any
person or company from acquiring control of us without, in most cases, the prior written approval of each of the FDIC,
the Federal Reserve and the Delaware Commissioner.
Consumer Financial Services
The relationship between us and our U.S. customers is regulated extensively under federal and state consumer
protection laws. Federal laws include the Truth in Lending Act, the Equal Credit Opportunity Act, the Fair Credit
Reporting Act, the Gramm-Leach-Bliley Act, the CARD Act and the Dodd-Frank Act. These and other federal laws,
among other things, prohibit unfair, deceptive and abusive trade practices, require disclosures of the cost of credit,
provide substantive consumer rights, prohibit discrimination in credit transactions, regulate the use of credit report
information, provide financial privacy protections, require safe and sound banking operations, restrict our ability to
raise interest rates, and subject us to substantial regulatory oversight. The CFPB has rulemaking and interpretive
authority under the Dodd-Frank Act and other federal consumer financial services laws, as well as broad supervisory,
examination and enforcement authority over large providers of consumer financial products and services, such as
Discover. For more information, see "Management's Discussion and Analysis of Financial Condition and Results of
Operations — Regulatory Environment and Developments — Consumer Financial Services."
State and, in some cases, local laws also may regulate in these areas, as well as in the areas of collection
practices, and may provide other additional consumer protections. Moreover, our U.S. subsidiaries are subject to the
Servicemembers Civil Relief Act, which protects persons called to active military service and their dependents from
undue hardship resulting from their military service. The Servicemembers Civil Relief Act applies to all debts incurred
prior to the commencement of active duty (including credit card and other open-end debt) and limits the amount of
interest, including service and renewal charges and any other fees or charges (other than bona fide insurance) that is
related to the obligation or liability.
Violations of applicable consumer protection laws can result in significant potential liability in litigation by
customers, including civil monetary penalties, actual damages, restitution and attorneys' fees. Federal banking
regulators, as well as state attorneys general and other state and local consumer protection agencies, also may seek to
enforce consumer protection requirements and obtain these and other remedies. Further violations may cause federal
banking regulators to deny, or delay approval of, potential acquisitions and investments. See "— Acquisitions and
Investments."
We are subject to additional laws and regulations affecting mortgage lenders. We conduct our mortgage lending
business through two subsidiaries: Discover Bank (for our home equity loans) and Discover Home Loans, Inc. (for our
conventional refinances and purchase transactions), which is a state-licensed mortgage lender. Federal, state and, in
some instances, local laws regulate mortgage lending activities. These laws generally regulate the manner in which
lending and lending-related activities are marketed or made available, including advertising and other consumer
disclosures, payments for services and recordkeeping requirements. These laws include the Real Estate Settlement
Procedures Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Equal Credit Opportunity Act, the Fair
Housing Act, the Home Mortgage Disclosure Act and various state laws. State laws often restrict the amount of interest
and fees that may be charged by a mortgage lender, or otherwise regulate the manner in which mortgage lenders
operate or advertise. The CFPB has indicated that the mortgage industry is an area of supervisory focus and that it will
concentrate its examination and rulemaking efforts on the variety of mortgage-related topics required under the Dodd-
Frank Act, including the steering of consumers to less favorable products, discrimination, abusive or unfair lending
practices, predatory lending, origination disclosures, minimum mortgage underwriting standards, mortgage loan
origination compensation and servicing practices. The CFPB has published several final rules impacting the mortgage
industry. For more information, see “Management's Discussion and Analysis of Financial Condition and Results of
Operations — Regulatory Environment and Developments — Consumer Financial Services — Mortgage Lending.”
Payment Networks
We operate the Discover and PULSE networks, which deliver switching and settlement services to financial
institutions and other program participants for a variety of ATM, POS and other electronic banking transactions. These
operations are regulated by certain federal and state banking, privacy and data security laws. Moreover, the Discover
and PULSE networks are subject to examination under the oversight of the Federal Financial Institutions Examination
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Council, an interagency body composed of the federal bank regulators and the National Credit Union Association. In
addition, as our payments business has expanded globally through Diners Club, we are subject to government
regulation in countries in which our networks operate or our cards are used, either directly or indirectly through
regulation affecting Diners Club network licensees. Changes in existing federal, state or international regulation could
increase the cost or risk of providing network services, change the competitive environment, or otherwise materially
adversely affect our operations. The legal environment regarding privacy and data security is particularly dynamic, and
any unpermitted disclosure of confidential customer information could have a material adverse impact on our business,
including loss of consumer confidence.
The Dodd-Frank Act contains several provisions that are relevant to the business practices, network transaction
volume, revenue and prospects for future growth of PULSE, our debit card network business. The Dodd-Frank Act
requires that merchants control the routing of debit transactions, and that interchange fees received by certain payment
card issuers on debit card transactions be “reasonable and proportional” to the issuer's cost in connection with such
transactions, as determined by the Federal Reserve. The Dodd-Frank Act also requires the Federal Reserve to restrict
debit card networks and issuers from requiring debit card transactions to be processed solely on a single payment
network or two or more affiliated networks, or from requiring that transactions be routed over certain networks. For
information regarding related impacts on our debit card business, see “Management's Discussion and Analysis of
Financial Condition and Results of Operations — Regulatory Environment and Developments — Payment Networks.”
Money Laundering & Terrorist Financing Prevention Program
We maintain an enterprise-wide program designed to comply with all applicable anti-money laundering and
anti-terrorism laws and regulations, including the Bank Secrecy Act and the USA PATRIOT Act of 2001. This program
includes policies, procedures, training and other internal controls designed to mitigate the risk of money laundering or
terrorist financing posed by our products, services, customers and geographic locale. These controls include procedures
and processes to detect and report suspicious transactions, perform customer due diligence, and meet all recordkeeping
and reporting requirements related to particular transactions involving currency or monetary instruments. The program
is coordinated by a compliance officer and undergoes an annual independent audit to assess its effectiveness. Our
program is typically reviewed on an annual basis by federal banking regulators. In June 2014, Discover Bank entered
into a Consent Order with the FDIC to resolve matters related to the FDIC’s examination of Discover Bank’s anti-money
laundering and related compliance programs. In the Consent Order, Discover Bank agreed to, among other things,
enhance its anti-money laundering and related compliance programs. Also, the Federal Reserve notified us of its
intention to enter into a supervisory action with us to require enhancements to our enterprise-wide anti-money
laundering and related compliance programs. See Note 19: Litigation and Regulatory Matters to our consolidated
financial statements for more information. For additional information regarding bank regulatory limitations on
acquisitions and investments, see "— Acquisitions and Investments."
Sanctions Programs
We have a program designed to comply with applicable economic and trade sanctions programs, including
those administered and enforced by the U.S. Department of the Treasury's Office of Foreign Assets Control. These
sanctions are usually targeted against foreign countries, terrorists, international narcotics traffickers and those believed
to be involved in the proliferation of weapons of mass destruction. These regulations generally require either the
blocking of accounts or other property of specified entities or individuals, but they may also require the rejection of
certain transactions involving specified entities or individuals. We maintain policies, procedures and other internal
controls designed to comply with these sanctions programs.
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Executive Officers of the Registrant
Set forth below is information concerning our executive officers, each of whom is a member of our Executive
Committee.
Name
Age Position
David W. Nelms ......................... 54
Chairman and Chief Executive Officer
Roger C. Hochschild.................... 50
President and Chief Operating Officer
R. Mark Graf .............................. 50
Executive Vice President and Chief Financial Officer
Kathryn McNamara Corley.......... 55
Executive Vice President, General Counsel and Secretary
Steven E. Cunningham ................ 45
Senior Vice President and Chief Risk Officer
Carlos M. Minetti ........................ 52
Executive Vice President and President - Consumer Banking
Diane E. Offereins ...................... 57
Executive Vice President and President - Payment Services
James V. Panzarino .................... 62
Executive Vice President and President - Credit and Card Operations
R. Douglas Rose ......................... 46
Senior Vice President and Chief Human Resources Officer
Glenn P. Schneider ..................... 53
Executive Vice President and Chief Information Officer
Harit Talwar ............................... 54
Executive Vice President and President - U.S. Cards
David W. Nelms is our Chairman and Chief Executive Officer. He has held the role of Chief Executive Officer
since February 2004 and assumed the role of Chairman in January 2009. Mr. Nelms served as President and Chief
Operating Officer from 1998 to 2004. Prior to joining us, Mr. Nelms worked at MBNA America Bank from 1990 to
1998, most recently as Vice Chairman. Mr. Nelms holds a Bachelor's degree in Mechanical Engineering from the
University of Florida and an M.B.A. from Harvard Business School.
Roger C. Hochschild is our President and Chief Operating Officer. He has held this role since March 2004.
Mr. Hochschild was Executive Vice President, Chief Administrative Officer and Chief Strategic Officer (2001 to 2004)
and Executive Vice President, Chief Marketing Officer (1998 to 2001) of our former parent company Morgan Stanley.
Mr. Hochschild holds a Bachelor's degree in Economics from Georgetown University and an M.B.A. from the Amos
Tuck School at Dartmouth College.
R. Mark Graf is our Executive Vice President and Chief Financial Officer. He has held this role since April 2011.
He was also Chief Accounting Officer until December 2012. Prior to joining us, Mr. Graf was an investment advisor
with Aquiline Capital Partners, a private equity firm specializing in investments in the financial services industry. From
2006 to 2008, Mr. Graf was a partner at Barrett Ellman Stoddard Capital. Mr. Graf was Executive Vice President and
Chief Financial Officer for Fifth Third Bank from 2004 to 2006, after having served as its Treasurer from 2001 to 2004.
He holds a Bachelor's degree in Economics from the Wharton School of the University of Pennsylvania.
Kathryn McNamara Corley is our Executive Vice President, General Counsel and Secretary. She has held this
role since February 2008. Previously, she served as Senior Vice President, General Counsel and Secretary (1999 to
2008). Prior to becoming General Counsel, Ms. Corley was Managing Director for our former parent company
Morgan Stanley's global government and regulatory relations. Ms. Corley holds a Bachelor's degree in Political Science
from the University of Southern California and a J.D. from George Mason University School of Law.
Steven E. Cunningham is our Senior Vice President and Chief Risk Officer. He has held this role since May 2013.
In his role, he is also responsible for the Comprehensive Capital Analysis and Review and Resolution Planning program
offices. Previously, he served as Senior Vice President and Treasurer (2010 to 2013). Prior to joining us, Mr.
Cunningham was the Chief Financial Officer for Harley Davidson Financial Services from 2009 to 2010. From 2000 to
2009, he served in several financial and treasury roles with Capital One Financial, including Chief Financial Officer of
our banking and auto finance segments. From 1991 to 2000, Mr. Cunningham held numerous roles with the FDIC in
the Atlanta and Washington, D.C. offices. He holds a Bachelor's degree in Finance from the University of Alabama and
a M.B.A. from The George Washington University.
Carlos Minetti is our Executive Vice President and President - Consumer Banking. He has held this role since
February 2014. Previously, he served as Executive Vice President, President - Consumer Banking and Operations (2010
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to 2014), Executive Vice President, Cardmember Services and Consumer Banking (2006 to 2010), and Executive Vice
President, and Chief Risk Officer for Cardmember Services and Risk Management (2001 to 2006). Prior to joining us,
Mr. Minetti worked in card operations and risk management for American Express from 1987 to 2000, most recently
as Senior Vice President. Mr. Minetti holds a Bachelor's degree in Industrial Engineering from Texas A & M University
and an M.B.A. from the University of Chicago.
Diane E. Offereins is our Executive Vice President and President - Payment Services. She has held this role since
April 2010. Previously, she served as Executive Vice President, Payment Services (2008 to 2010) and Executive Vice
President and Chief Technology Officer (1998 to 2010). In 2006, she assumed leadership of the PULSE network. Prior
to joining us, Ms. Offereins worked at MBNA America Bank from 1993 to 1998, most recently as Senior Executive Vice
President. Ms. Offereins holds a Bachelor's degree in Accounting from Loyola University.
James V. Panzarino is our Executive Vice President and President - Credit and Card Operations. He has held this
role since December 2014. Previously, he served as Executive Vice President and Chief Credit and Card Operations
Officer (2014), Executive Vice President and Chief Credit Risk Officer (2009 to 2013), Senior Vice President and Chief
Credit Risk Officer (2006 to 2009), and Senior Vice President, Cardmember Assistance (2003 to 2006). Prior to joining
us, Mr. Panzarino was Vice President of External Collections and Recovery at American Express from 1998 to 2002.
Mr. Panzarino holds a Bachelor's degree in Business Management and Communication from Adelphi University.
R. Douglas Rose is our Senior Vice President and Chief Human Resources Officer. He has held this role since
April 2013. Prior to joining us, he served as Vice President, Human Resources at United Airlines from 2009 to 2013.
He was also Senior Vice President, Human Resources at Capital One and a Human Resources consultant for Hewitt
Associates. Mr. Rose holds a Bachelor's degree in Communications from the University of Pennsylvania and a Master's
degree from the University of Michigan.
Glenn P. Schneider is our Executive Vice President and Chief Information Officer. He has held this role since
January 2015. Previously, he served as Senior Vice President and Chief Information Officer (2008 to 2015), Senior
Vice President, Application Development (2003 to 2008), and Vice President, Marketing Applications (1998 to 2003).
Prior to joining us in 1993, Mr. Schneider worked for Kemper Financial Services as a Programmer. He holds a
Bachelor's degree in Economics/Computer Science with a minor in Statistics from Northern Illinois University.
Harit Talwar is our Executive Vice President and President - U.S. Cards. He has held this role since April 2010.
Previously, he served as Executive Vice President, Card Programs and Chief Marketing Officer (2008 to 2010),
Executive Vice President, Discover Network (2003 to 2008), and Managing Director for our international business
(2000 to 2003). Prior to joining us, Mr. Talwar held a number of positions at Citigroup from 1985 to 2000, most
recently as Country Head, Consumer Banking Division, Poland. Mr. Talwar holds a B.A. (Hons) degree in Economics
from Delhi University in India and an M.B.A. from the Indian Institute of Management, Ahmedabad.
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Item 1A. Risk Factors
You should carefully consider each of the following risks described below and all of the other information in this
annual report on Form 10-K in evaluating us. Our business, financial condition, cash flows and/or results of operations
could be materially adversely affected by any of these risks. The trading price of our common stock could decline due to
any of these risks. This annual report on Form 10-K also contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a
result of certain factors, including the risks faced by us described below and elsewhere in this annual report on Form
10-K. See “Special Note Regarding Forward-Looking Statements,” which immediately follows the risks below.
Current Economic and Regulatory Environment
Economic conditions have had and could have a material adverse effect on our business, results of operations and
financial condition.
As a provider of consumer financial services, our business, results of operations and financial condition are
subject to the United States and global economic environment. Although the economy has continued to improve
generally with respect to employment and housing market conditions, the improvement has not been at a rapid pace. A
customer's ability and willingness to repay us can be negatively impacted by economic conditions and other payment
obligations. We are experiencing a period of historical lows in our delinquency and charge-off rates and we expect
that these rates will be increasing over time. The over 30 days delinquency rate for total loan receivables was 1.66% at
December 31, 2014, up from 1.64% at December 31, 2013. The full-year net charge-off rate for total loan receivables
was 2.04% for the year ended December 31, 2014, up from 1.98% for the year ended December 31, 2013. We
expect increases in our allowance for loan losses in 2015, which will negatively impact our net income.
Economic conditions also can reduce the usage of credit cards in general and the average purchase amount of
transactions industry-wide, including our cards, which reduces interest income and transaction fees. We rely heavily on
interest income from our credit card business to generate earnings. Our interest income from credit card loans was
$6.4 billion for the year ended December 31, 2014, which was 75% of revenues (defined as interest income plus other
income), compared to $6.0 billion for the year ended December 31, 2013, which was 73% of revenues. Economic
conditions combined with a competitive marketplace could result in Discover being unable to grow loans, resulting in
reduced revenue from its core direct banking business.
Financial regulatory reform initiatives have and will continue to significantly impact the regulatory environment for
the financial services industry, which could adversely impact our business, results of operations and financial
condition.
The Dodd-Frank Act contains comprehensive provisions governing the practices and oversight of financial
institutions and other participants in the financial markets. The Dodd-Frank Act regulates large systemically significant
financial firms, including Discover, through a variety of measures, including increased capital and liquidity
requirements, limits on leverage and enhanced supervisory authority. Federal banking regulators have issued and
continue to propose new regulations and supervisory guidance under the Dodd-Frank Act and otherwise, and have
been increasing their examination and enforcement activities. We expect regulators to continue addressing concerns
through formal enforcement actions against financial institutions or non-public supervisory actions or findings.
The impact of the evolving regulatory environment on our business and operations depends upon a number of
factors including the supervisory priorities and actions of the Federal Reserve, the FDIC and the CFPB, the actions of our
competitors and other marketplace participants, and the behavior of consumers. Regulatory developments, findings and
ratings could negatively impact our business strategies or require us to: limit or change our business practices,
restructure our products in ways that we may not currently anticipate, limit our product offerings, invest more
management time and resources in compliance efforts, limit the fees we can charge for services, or limit our ability to
pursue certain business opportunities and obtain related required regulatory approvals. For additional information
regarding bank regulatory limitations on acquisitions and investments, see "Business — Supervision and Regulation —
Acquisitions and Investments." See Note 19: Litigation and Regulatory Matters to our consolidated financial statements
for more information on recent matters affecting Discover. Regulatory developments could also impact our strategies,
the value of our assets, or otherwise adversely affect our businesses.
Compliance expenditures have increased significantly for Discover and other financial services firms, and we
expect them to continue to increase as regulators remain focused on controls and operational processes. We may face
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additional compliance and regulatory risk to the extent that we enter into new business arrangements with third-party
service providers, alternative payment providers or other industry participants. The additional expense, time and
resources needed to comply with ongoing regulatory requirements may adversely impact our business and results of
operations.
For more information regarding the regulatory environment and developments potentially impacting Discover,
see "Management's Discussion and Analysis of Financial Condition and Results of Operations — Regulatory
Environment and Developments."
Strategic Business Risk
We face competition in the credit card market from other consumer financial services providers, and we may not be
able to compete effectively, which could result in fewer customers and lower account balances and could materially
adversely affect our financial condition, cash flows and results of operations.
The consumer financial services business is highly competitive. We compete with other consumer financial
services providers on the basis of a number of factors, including brand, reputation, customer service, product offerings,
incentives, pricing and other terms. Competition in credit cards is also based on merchant acceptance and the value
provided to the customer by rewards programs. Many credit card issuers have instituted rewards programs that are
similar to ours, and, in some cases, are more attractive to customers than our programs. These competitive factors affect
our ability to attract and retain customers, increase usage of our products and maximize the revenue generated by our
products. In addition, because most domestically-issued credit cards, other than those issued by American Express, are
issued on the Visa and MasterCard networks, most other card issuers benefit from the dominant position and marketing
and pricing power of Visa and MasterCard. The competitive marketplace, combined with slow economic growth, could
result in Discover being unable to grow loans, resulting in reduced revenue from its core direct banking business. If we
are unable to compete successfully, or if competing successfully requires us to take aggressive actions in response to
competitors' actions, our financial condition, cash flows and results of operations could be materially adversely affected.
We incur considerable expenses in competing with other consumer financial services providers, and many of our
competitors have greater financial resources than we do, which may place us at a competitive disadvantage and
negatively affect our financial results.
We incur considerable expenses in competing with other consumer financial services providers to attract and
retain customers and increase usage of our products. A substantial portion of these expenses relates to marketing
expenditures. We incurred expenses of $735 million and $717 million for the years ended December 31, 2014 and
2013, respectively, for marketing and business development. Our consumer financial services products compete
primarily on the basis of pricing, terms and service. Because of the highly competitive nature of the credit card issuing
business, a primary method of competition among credit card issuers, including us, has been to offer rewards
programs, low introductory interest rates, attractive standard purchase rates and balance transfer programs that offer a
favorable annual percentage rate or other financial incentives for a specified length of time on account balances
transferred from another credit card. In the fourth quarter of 2014, we incurred a $178 million charge to earnings to
enhance our rewards program by allowing easier redemption of rewards, which resulted in the elimination of our
current estimate of customer rewards forfeiture, a contra-liability account.
Competition is intense in the credit card industry, and customers may frequently switch credit cards or transfer
their balances to another card. We expect to continue to invest in initiatives to remain competitive in the consumer
financial services industry, including the launch of new cards and features, brand awareness initiatives, targeted
marketing, online and mobile enhancements, e-wallet participation, customer service improvements, credit risk
management and operations enhancements, and infrastructure efficiencies. There can be no assurance that any of the
expenses we incur or incentives we offer to attempt to acquire and maintain accounts and increase usage of our
products will be effective. In addition, to the extent that we offer new products, features or services to remain
competitive, we may be subject to increased operational or other risks.
Furthermore, many of our competitors are larger than we are, have greater financial resources than we do, have
more breadth in consumer banking products, and/or have lower funding and operating costs than we have and expect
to have, and have assets such as branch locations and co-brand relationships, that may be appealing to certain
customers. For example, larger credit card issuers, which have greater resources than we do, may be better positioned
to fund appealing rewards, marketing and advertising programs. We may be at a competitive disadvantage as a result
of the greater financial resources, diversification and scale of many of our competitors.
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Our expenses directly affect our earnings results. Many factors can influence the amount of our expenses, as well
as how quickly they may increase. Our ongoing investments in infrastructure, which may be necessary to maintain a
competitive business, integrate newly-acquired businesses, and establish scalable operations, increase our expenses. In
addition, as our business develops, changes or expands, additional expenses can arise as a result of a reevaluation of
business strategies, management of outsourced services, asset purchases, structural reorganization, compliance with
new laws or regulations or the integration of newly-acquired businesses. If we are unable to successfully manage our
expenses, our financial results will be negatively affected.
We face competition from other operators of payment networks and alternative payment providers, and we may not
be able to compete effectively, which could result in reduced transaction volume, limited merchant acceptance of our
cards, limited issuance of cards on our networks by third parties and materially reduced earnings from our payment
services business.
We face substantial and increasingly intense competition in the payments industry, both from traditional players
and new, emerging alternative payment providers. For example, we compete with other payment networks to attract
network partners to issue credit and debit cards and other card products on the Discover, PULSE and Diners Club
networks. Competition with other operators of payment networks is generally based on issuer fees, fees paid to
networks (including switch fees), merchant acceptance, network functionality and other economic terms. Competition is
also based on customer perception of service quality, brand image, reputation and market share. Further, we are facing
increased competition from alternative payment providers, who may create innovative network arrangements with our
primary competitors or other industry participants, which could adversely impact our costs, transaction volume and
ability to grow our business.
Many of our competitors are well established, larger than we are and/or have greater financial resources than
we do. These competitors have provided financial incentives to card issuers, such as large cash signing bonuses for new
programs, funding for and sponsorship of marketing programs and other bonuses. Visa and MasterCard each enjoy
greater merchant acceptance and broader global brand recognition than we do. Although we have made progress in
merchant acceptance, we have not achieved global market parity with Visa and MasterCard. In addition, Visa and
MasterCard have entered into long-term arrangements with many financial institutions that may have the effect of
discouraging those institutions from issuing credit cards on the Discover Network or issuing debit cards on the PULSE
network. Some of these arrangements are exclusive, or nearly exclusive, which further limits our ability to conduct
material amounts of business with these institutions. If we are unable to remain competitive on issuer fees and other
incentives, we may be unable to offer adequate pricing to network partners while maintaining sufficient net revenues.
We also face competition as merchants put pressure on transaction fees. Increasing merchant fees or acquirer
fees could adversely affect our effort to increase merchant acceptance of credit cards issued on the Discover Network
and may cause merchant acceptance to decrease. This, in turn, could adversely affect our ability to attract network
partners and our ability to maintain or grow revenues from our proprietary network. In addition, competitor's
settlements with merchants and related actions, including pricing pressures and/or surcharging, could negatively impact
our business practices. In response to the Dodd-Frank Act, competitor actions related to the structure of merchant and
acquirer fees and merchant and acquirer transaction routing strategies have adversely affected and are expected to
continue to adversely affect our PULSE network's business practices, network transaction volume, revenue and prospects
for future growth, and entry into new product markets. Visa has entered into arrangements with some merchants and
acquirers that has, and is expected to continue to have, the effect of discouraging those merchants and acquirers from
routing debit transactions to PULSE. In addition, the Dodd-Frank Act's network participation requirements and
competitor actions negatively impact PULSE’s ability to enter into exclusivity arrangements, which affects PULSE’s current
business practices and may materially adversely affect its network transaction volume and revenue. PULSE filed a
lawsuit against Visa in late 2014 with respect to these competitive concerns, which will significantly impact expenses for
the payment services segment. PULSE’s transaction processing revenue was $182 million and $192 million for the years
ended December 31, 2014 and 2013, respectively.
American Express is also a strong competitor, with international acceptance, high transaction fees and an
upscale brand image. Internationally, American Express competes in the same market segments as Diners Club. We
may face challenges in increasing international acceptance on our networks, particularly if third parties that we rely on
to issue Diners Club cards, increase card acceptance and market our brands do not perform to our expectations.
In addition, if we are unable to maintain sufficient network functionality to be competitive with other networks, or
if our competitors develop better data security solutions or more innovative products and services than we do, our
ability to retain and attract network partners and maintain or increase the revenues generated by our proprietary card
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issuing business or our PULSE business may be materially adversely affected. Additionally, competitors may develop
data security solutions which, as a consequence of the competitors' market power, we may be forced to use. As a result,
those competitors could subject us to adverse restrictions and our business may be adversely affected.
Our business depends upon relationships with issuers, merchant acquirers and licensees, which are generally
financial institutions. The economic and regulatory environment and increased consolidation in the financial services
industry decrease our opportunities for new business and may result in the termination of existing business relationships
if a business partner is acquired or goes out of business. In addition, as a result of this environment, financial institutions
may have decreased interest in engaging in new card issuance opportunities or expanding existing card issuance
relationships, which would inhibit our ability to grow our payment services business. We continue to face substantial
and intense competition in the payments industry, which impacts our revenue margins, transaction volume and business
strategies. Transaction processing volume declined in the third and fourth quarters due to a third-party issuer contract
related to our network partner business that was not renewed in 2014. Although this loss of volume was mostly
complete at the end of 2014, and we have added volume with our business-to-business payments arrangement, the
added volume is lower margin. Also, as previously disclosed, we expect to lose significant volume from a large PULSE
debit issuer beginning in 2015. The loss of these volumes significantly impacts our payment services volume and profits,
but does not impact our overall profitability.
If we are unsuccessful in maintaining our international network business and achieving meaningful global card
acceptance, we may be unable to grow our international network business.
We have made progress toward, but have not completed, achieving global card acceptance across the Diners
Club network, the Discover Network and PULSE since we acquired the Diners Club network and related assets in 2008.
This would allow Discover customers to use their cards at merchant and ATM locations that accept Diners Club cards
around the world and would allow Diners Club customers to use their cards on the Discover Network in North America
and on the PULSE network both domestically and internationally.
Our international network business depends upon the cooperation, support and continuous operation of the
network licensees that issue Diners Club cards and that maintain a merchant acceptance network. As is the case for
other card payment networks, our Diners Club network does not issue cards or determine the terms and conditions of
cards issued by the network licensees, with the exception of the Diners Club Italy issuing business, which we acquired in
2013. If we are unable to continue our relationships with network licensees or if the network licensees are unable to
continue their relationships with merchants, our ability to maintain or increase revenues and to remain competitive
would be adversely affected due to the potential deterioration in customer relationships and related demand that could
result. Further, if one or more licensees were to experience a significant impairment of their business or were to cease
doing business for economic, regulatory or other reasons, we would face the adverse effects of business interruption in
a particular market, including loss of volume, acceptance and revenue, and exposure to potential reputational risk.
Such conditions resulted in our acquisition of Diners Club Italy and financial assistance to our Slovenian licensee,
resulting in a charge to earnings of approximately $40 million in the second quarter of 2013. In the fourth quarter of
2014, we classified Diners Club Italy as held-for-sale, which resulted in an additional charge to earnings of
approximately $21 million. Our ability to sell Diners Club Italy is subject to uncertainty and complexity. Further,
Citigroup continues to own and operate network licensees generating a large share of the Diners Club network sales
volume. In 2014, Citigroup announced the potential sale of Diners Club Japan, the largest licensee in both volume and
revenue. In addition, other Diners Club licensees around the world face challenges as well. When these events occur,
we may deploy resources and incur expenses to support various transition activities in order to sustain network
acceptance. Interruption of network licensee relationships could have an adverse effect on the acceptance of Discover
cards when they are used on the Diners Club network outside of North America.
Also, as we have non-amortizable intangible assets that resulted from the purchase of Diners Club, if we are
unable to maintain or increase revenues due to the reasons described above, we may be exposed to an impairment
loss on the Diners Club acquisition that, when recognized, could have a material adverse impact on our consolidated
financial condition and results of operations. The long-term success of our international network business depends upon
achieving meaningful global card acceptance, which has included and may continue to include higher overall costs or
longer timeframes than anticipated.
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The success of our student loan strategy depends upon our ability to manage the risks of our student loan portfolio
and the student lending environment. If we fail to do so, we may be unable to sustain and grow our student loan
portfolio.
Our private student loan portfolio has grown from $1.0 billion at November 30, 2010 to $8.5 billion at
December 31, 2014. The long-term success of our student loan strategy depends upon our ability to manage the credit
risk, pricing, funding, operations and expenses of a larger student loan portfolio, as well as grow student loan
originations. Our student loan strategy is also impacted by external factors such as the overall economic environment, a
challenging regulatory environment for private student loans and a competitive marketplace. For more information on
the regulatory environment, see "Management's Discussion and Analysis of Financial Condition and Results of
Operations — Regulatory Environment and Developments — Consumer Financial Services — Private Student Loans"
and Note 19: Litigation and Regulatory Matters to our consolidated financial statements. Slow economic recovery
combined with government and regulatory focus on student lending and competitive factors, such as the need to offer
fixed interest rates, may present challenges to managing and growing our private student loan business in the future,
and could cause us to restructure our private student loan product in ways that we may not currently anticipate. In
addition, changes that adversely affect the private student loan market generally may negatively impact the profitability
and growth of our student loan portfolio.
The success of our home loans strategy depends upon our ability to market, originate and sell mortgage loans. If we
are unable to do so, our long-term strategy and overall success will be adversely affected.
The success of our home loans strategy depends upon our ability to generate mortgage loan origination volume.
Our origination volume is largely dependent on our ability to offer competitively priced, desirable loan products under
the Discover brand and our ability to attract qualified prospective borrowers. Our origination volumes are also affected
by certain external factors outside our control, including adverse economic conditions and reductions in refinance
volumes. This has put pressure on us to develop our purchase mortgage capability to replace some of the lost refinance
loan volume. Historically, direct-to-consumer businesses have been more successful in the refinance business and less
successful in the purchase market, and we face challenges in developing a scalable direct-to-consumer purchase
mortgage origination business. Overall economic conditions as well as an inability to attract customers in the purchase
market has led and may continue to lead to fewer loan originations than expected, which adversely affects our ability to
grow the business and results in reduced earnings. In the fourth quarter of 2014, our lack of progress in meeting these
challenges resulted in an approximately $27 million charge to earnings related to the impairment of goodwill realized
with the acquisition of our mortgage origination platform. We will continue to evaluate our home loans strategy.
Our success also depends upon relationships with financial intermediaries, including secondary market
purchasers, to which we sell eligible mortgages on a servicing-released basis, and our warehouse lender, which
provides funding from the time we fund a customer's mortgage until it is sold to a secondary market purchaser. The
secondary mortgage market, as well as the availability of mortgage financing, has experienced disruptions resulting
from reduced investor demand and/or increased investor yield requirements for mortgage loans and associated
mortgage servicing rights (including the government-sponsored enterprises Fannie Mae and Freddie Mac) and
mortgage-backed securities. Most of the market liquidity in the mortgage industry is provided, either directly or
indirectly, by government sponsored entities or government agencies. Any attempts to shift market liquidity to private
capital sources could impose risk to the mortgage industry to the extent that changes reduce the capacity of available
funding. If we are unable to sell our loans in the secondary market, sell servicing, or retain our warehouse facility, we
could incur additional credit risk and losses, and funding costs and liquidity could be adversely impacted.
The long-term success of our home loans strategy depends partly upon our ability to manage the expenses and
risks of offering home loan products. If we cannot execute a successful strategy, we may continue to experience losses
in this area. In addition, we may incur additional expenses and risks if we are unable to successfully address and
manage regulatory, counterparty and industry-related risks.
We may experience unanticipated losses as a result of mortgage loan repurchase and indemnification obligations
under agreements with secondary market purchasers.
We may be required to repurchase mortgage loans that have been sold to secondary market purchasers in the
event there are breaches of certain representations and warranties contained within the sales agreements, such as
improper underwriting, fraud, or other origination defects. We also may be required to indemnify certain purchasers
and others against losses they incur in the event of breaches of representations and warranties and in various other
circumstances, and the amount of such losses could exceed the repurchase amount of the related loans. In connection
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with the sale of loans to certain secondary market purchasers, we also expect to refund premiums paid by secondary
market purchasers in instances where the borrower prepays the loan within a specified period of time. We would need
to find alternative purchasers for, or arrange with a third party to service, any loans that we are unable to sell or are
required to repurchase.
Consequently, we are exposed to credit risk, and potentially funding risk, associated with sold loans due to the
risk we may be required to repurchase these loans. We establish reserves in our consolidated financial statements for
potential losses related to the risk of having to repurchase mortgage loans we have sold. The adequacy of the reserves
and the ultimate amount of losses incurred will depend on, among other things, the actual future mortgage loan
performance, the actual level of future repurchase and indemnification requests, the actual success rate of claimants,
actual recoveries on the collateral and macroeconomic conditions. Due to continued uncertainties relating to the credit
performance of mortgages, the reserves we establish may not be adequate and losses incurred could adversely affect
our financial condition and results of operations.
Acquisitions or strategic investments that we pursue may not be successful and could disrupt our business, harm our
financial condition or reduce our earnings.
In the past few years, Discover has been expanding its business beyond credit cards, both organically and
through acquisitions. We may consider or undertake additional strategic acquisitions of, or material investments in,
businesses, products, portfolios of loans or technologies in the future. We may not be able to identify suitable
acquisition or investment candidates, or even if we do identify suitable candidates, they may be difficult to finance,
expensive to fund and there is no guarantee that we can obtain any necessary regulatory approvals or complete the
transactions on terms that are favorable to us. We generally must receive federal regulatory approvals before we can
acquire a bank, bank holding company, deposits or certain assets or businesses. For additional information regarding
bank regulatory limitations on acquisitions and investments, see "Business — Supervision and Regulation — Acquisitions
and Investments."
To the extent we pay the purchase price of any acquisition or investment in cash, it may have an adverse effect
on our financial condition; similarly, if the purchase price is paid with our stock, it may be dilutive to our stockholders.
In addition, we may assume liabilities associated with a business acquisition or investment, including unrecorded
liabilities that are not discovered at the time of the transaction, and the repayment or settlement of those liabilities may
have an adverse effect on our financial condition.
We may not be able to successfully integrate the personnel, operations, businesses, products, or technologies of
an acquisition or investment. Integration may be particularly challenging if we enter into a line of business in which we
have limited experience and the business operates in a difficult legal, regulatory or competitive environment. We may
find that we do not have adequate operations or expertise to manage the new business. The integration of any
acquisition or investment may divert management's time and resources from our core business, which could impair our
relationships with our current employees, customers and strategic partners and disrupt our operations. Acquisitions and
investments also may not perform to our expectations for various reasons, including the loss of key personnel, customers
or vendors. If we fail to integrate acquisitions or investments or realize the expected benefits, we may lose the return on
these acquisitions or investments or incur additional transaction costs, and our business, reputation and financial
condition may be harmed as a result.
Credit, Market and Liquidity Risk
Our business depends on our ability to manage our credit risk, and failing to manage this risk successfully may
result in high charge-off rates, which would materially adversely affect our business, profitability and financial
condition.
We seek to grow our loan receivables while maintaining quality credit performance. Our success depends on our
ability to manage our credit risk while attracting new customers with profitable usage patterns. We select our
customers, manage their accounts and establish terms and credit limits using proprietary scoring models and other
analytical techniques that are designed to set terms and credit limits to appropriately compensate us for the credit risk
we accept, while encouraging customers to use their available credit. The models and approaches we use may not
accurately predict future charge-offs due to, among other things, inaccurate assumptions. While we continually seek to
improve our assumptions and models, we may make modifications that unintentionally cause them to be less predictive
or we may incorrectly interpret the data produced by these models in setting our credit policies.
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Our ability to manage credit risk and avoid high charge-off rates may be adversely affected by economic
conditions that may be difficult to predict as explained in our economic conditions risk factor at the beginning of this
section. The full-year net charge-off rate for total loan receivables was 2.04% in 2014, up from 1.98% in 2013. At
December 31, 2014 and 2013, $660 million, or 0.94%, and $634 million, or 0.96%, of our loan receivables were
non-performing (defined as loans over 90 days delinquent and accruing interest plus loans not accruing interest). We
are experiencing a period of historical lows in our delinquency and charge-off rates and we expect that these rates will
be increasing over time. There can be no assurance that our underwriting and portfolio management strategies will
permit us to avoid high charge-off levels, or that our allowance for loan losses will be sufficient to cover actual losses.
A customer's ability and willingness to repay us can be negatively impacted by increases in their payment
obligations to other lenders and by restricted availability of credit to consumers generally. Our collection operations
may not compete effectively to secure more of customers' diminished cash flow than our competitors. In addition, we
may fail to quickly identify customers who are likely to default on their payment obligations and reduce our exposure by
closing credit lines and restricting authorizations, which could adversely impact our financial condition and results of
operations. Our ability to manage credit risk also may be adversely affected by legal or regulatory changes (such as
restrictions on collections, bankruptcy laws, minimum payment regulations and re-age guidance), competitors' actions
and consumer behavior, as well as inadequate collections staffing, techniques and models.
We continue to expand our marketing of our personal, private student loan and home loan products, including
the launch of a new home equity loan product in late 2013. We have less experience in these areas as compared to
our traditional credit card lending business, and there can be no assurance that we will be able to grow these products
in accordance with our strategies, manage our credit and other risks associated with these products, or generate
sufficient revenue to cover our expenses in these markets. Our failure to manage our credit and other risks may
materially adversely affect our profitability and our ability to grow these products, limiting our ability to further diversify
our business.
Adverse market conditions or an inability to effectively manage our liquidity risk could negatively impact our ability
to meet our liquidity and funding needs, which could materially adversely impact our business operations and
overall financial condition.
We must effectively manage the liquidity risk to which we are exposed. We require liquidity in order to meet
cash requirements such as day-to-day operating expenses, extensions of credit on our consumer loans and required
payments of principal and interest on our borrowings. Our primary sources of liquidity and funding are payments on
our loan receivables, deposits, and proceeds from securitization transactions and securities offerings. We may maintain
too much liquidity, which can be costly and limit financial flexibility, or we may be too illiquid, which could result in
financial distress during a liquidity stress event. Our liquidity portfolio had a balance of approximately $10.8 billion as
of December 31, 2014, compared to $11.1 billion as of December 31, 2013. Our total contingent liquidity sources as
of December 31, 2014 amounted to $34.3 billion (consisting of $10.8 billion in our liquidity portfolio, $16.0 billion in
incremental Federal Reserve discount window capacity, and $7.5 billion of undrawn capacity in private securitizations),
compared to $32.6 billion at December 31, 2013.
In the event that our current sources of liquidity do not satisfy our needs, we would be required to seek additional
financing. The availability of additional financing will depend on a variety of factors such as market conditions, the
general availability of credit to the financial services industry, new regulatory restrictions and requirements, and our
credit ratings. Disruptions, uncertainty or volatility in the capital, credit or deposit markets, such as the volatility
experienced in the capital and credit markets during the financial crisis of 2007, may limit our ability to repay or
replace maturing liabilities in a timely manner. As such, we may be forced to delay raising funding or be forced to issue
or raise funding at undesirable terms and/or costs, which could decrease profitability and significantly reduce financial
flexibility. Regulations such as the liquidity coverage ratio (LCR), as part of the Basel III accord, may increase the cost of
funding and impact funding availability and are described more fully in "Management's Discussion and Analysis of
Financial Condition and Results of Operations — Regulatory Environment and Developments." Further, in disorderly
financial markets or for other reasons, it may be difficult or impossible to liquidate some of our investments to meet our
liquidity needs.
While market conditions have stabilized and, in many cases, improved, there can be no assurance that
significant disruption and volatility in the financial markets will not occur in the future. Likewise, adverse developments
with respect to financial institutions and other third parties with whom we maintain important financial relationships
could negatively impact our funding and liquidity. If we are unable to continue to fund our assets through deposits or
access capital markets on favorable terms, or if we experience an increase in our borrowing costs or otherwise fail to
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manage our liquidity effectively, our liquidity, operating results, financial results and condition may be materially
adversely affected.
An inability to accept or maintain deposits in the future could materially adversely affect our liquidity position and
our ability to fund our business.
We obtain deposits from consumers either directly or through affinity relationships and through third-party
securities brokerage firms that offer our deposits to their customers. We had $28.8 billion in deposits acquired directly
or through affinity relationships and $17.3 billion in deposits originated through securities brokerage firms as of
December 31, 2014, compared to $28.4 billion and $16.4 billion, respectively, as of December 31, 2013. Competition
from other financial services firms that use deposit funding and the rates and services we offer on our deposit products
may affect deposit renewal rates, costs or availability. Changes we make to the rates offered on our deposit products
may affect our profitability (through funding costs) and our liquidity (through volumes raised). In addition, our ability to
maintain existing or obtain additional deposits may be impacted by factors, including factors beyond our control, such
as: perceptions about our financial strength; quality of deposit servicing or online banking generally, which could
reduce the number of consumers choosing to make deposits with us; third parties continuing or entering into affinity
relationships with us; or third-party securities brokerage firms offering our deposit products.
Our ability to obtain deposit funding and offer competitive interest rates on deposits is also dependent on capital
levels of our bank subsidiaries. The FDIA in certain circumstances prohibits insured banks, such as our subsidiary
Discover Bank, from accepting brokered deposits (as defined in the FDIA) and applies other restrictions, such as a cap
on interest rates we may pay. See “Business — Supervision and Regulation” and Note 17: Capital Adequacy to our
consolidated financial statements for more information. As of December 31, 2014, we had brokered deposits (as
defined in the FDIA) of $17.3 billion. While Discover Bank met the FDIC's definition of “well-capitalized” as of
December 31, 2014, and has no restrictions regarding acceptance of brokered deposits or setting of interest rates,
there can be no assurance that it will continue to meet this definition. Additionally, our regulators can adjust the
requirements to be "well-capitalized" at any time and have authority to place limitations on our deposit businesses,
including the interest rate we pay on deposits.
If we are unable to securitize our receivables, it may have a material adverse effect on our liquidity, cost of funds
and overall financial condition.
We use the securitization of credit card receivables, which involves the transfer of receivables to a trust and the
issuance by the trust of beneficial interests to third-party investors, as a significant source of funding as well as for
contingent liquidity. Our average level of credit card securitized borrowings from third parties was $15.1 billion and
$14.3 billion for the years ended December 31, 2014 and 2013, respectively. Although the securitization market for
credit cards has been re-established since the financial crisis, there can be no assurance that there will not be future
disruptions in the market. Our ability to raise funding through the securitization market also depends, in part, on the
credit ratings of the securities we issue from our securitization trusts. If we are not able to satisfy rating agency
requirements to maintain the ratings of asset-backed securities issued by our trusts, it could limit our ability to access the
securitization markets. Additional factors affecting the extent to which we may securitize our credit card receivables in
the future include the overall credit quality of our receivables, the costs of securitizing our receivables, and the legal,
regulatory, accounting and tax requirements governing securitization transactions. For example, the Basel Committee
on Banking Supervision recently proposed changes to the rules for banks’ calculation of credit risk capital requirements
for exposures to securitization transactions. The timing and impact of these proposed rules are unclear at this time, but
they could impact the pricing and/or volume of our asset-backed securities issuances. A prolonged inability to
securitize our credit card receivables, or an increase in the costs of such issuances, may have a material adverse effect
on our liquidity, cost of funds and overall financial condition.
The occurrence of events that result in the early amortization of our existing credit card securitization transactions or
an inability to delay the accumulation of principal collections in our credit card securitization trusts would materially
adversely affect our liquidity.
Our liquidity would be materially adversely affected by the occurrence of events that could result in the early
amortization of our existing credit card securitization transactions. Our credit card securitizations are structured as
“revolving transactions” that do not distribute to securitization investors their share of monthly principal payments
received on the underlying receivables during the revolving period, and instead use those principal payments to fund
the purchase of new receivables. The occurrence of an “early amortization event” may result in termination of the
revolving periods of our securitization transactions, which would require us to repay the affected outstanding
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securitized borrowings out of principal collections without regard to the original payment schedule. Our average level
of credit card securitized borrowings from third parties was $15.1 billion and $14.3 billion for the years ended
December 31, 2014 and 2013, respectively. Early amortization events include, for example, insufficient cash flows in
the securitized pool of receivables to meet contractual requirements (i.e. excess spread less than zero) and certain
breaches of representations, warranties or covenants in the agreements relating to the securitization. For more
information on excess spread, see Note 5: Credit Card and Student Loan Securitization Activities to our consolidated
financial statements. An early amortization event would negatively impact our liquidity, and require us to rely on
alternative funding sources, which may or may not be available at the time. An early amortization event also could
impact our ability to access the undrawn conduit facilities that we maintain for contingent liquidity purposes.
Our credit card securitization structure includes a requirement that we accumulate principal collections into a
restricted account in the amount of scheduled maturities on a pro rata basis over the 12 months prior to a security's
maturity date. We have the option under our credit card securitization documents to shorten this accumulation period,
subject to the satisfaction of certain conditions, including reaffirmation from each of the rating agencies of the security's
required rating. Historically, we have exercised this option to shorten the accumulation period to one month prior to
maturity. If we were to determine that the payment rate on the underlying receivables would not support a one-month
accumulation period, or if one or more of the rating agencies were to require an accumulation period of longer than
one month, we would need to begin accumulating principal cash flows earlier than we have historically. A lengthening
of the accumulation period would negatively impact our liquidity, requiring management to implement mitigating
measures. During periods of significant maturity levels, absent management actions, the lengthening of the
accumulation period could materially adversely affect our financial condition.
A downgrade in the credit ratings of our securities could materially adversely affect our business and financial
condition.
We, along with Discover Bank, are regularly evaluated by the ratings agencies, and their ratings for our long-
term debt and other securities, including asset-backed securities issued by our securitization trusts, are based on a
number of factors that may change from time to time, including our financial strength as well as factors that may not be
within our control. Factors that affect our unsecured credit ratings include, but are not limited to, the macroeconomic
environment in which we operate and the credit ratings of the U.S. government, the credit quality and performance of
our assets, the amount and quality of our capital, the level and stability of our earnings, and the structure and amount
of our liquidity. In addition to these factors, the ratings of our asset-backed securities are also based on the quality of
the underlying receivables and the credit enhancement structure of the trusts. Downgrades in our ratings or those of our
trusts could materially adversely affect our cost of funds, access to capital and funding, and overall financial condition.
There can be no assurance that we will be able to maintain our current credit ratings or that our credit ratings will not
be lowered or withdrawn.
We may not be successful in managing the investments in our liquidity investment portfolio and investment
performance may deteriorate due to market fluctuations, which would adversely affect our business and financial
condition.
We must effectively manage the risks of the investments in our liquidity investment portfolio, which is comprised
of cash and cash equivalents and high-quality liquid investments. Our liquidity portfolio was $10.8 billion at
December 31, 2014. The value of our investments may be adversely affected by market fluctuations including changes
in interest rates, prices, prepayment rates, credit risk premiums and overall market liquidity. Also, investments backed
by collateral could be adversely impacted by changes in the value of the underlying collateral. In addition, economic
conditions may cause certain of the obligors, counterparties and underlying collateral on our investments to incur losses
of their own or default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other
reasons, thereby increasing our credit risk exposure to these investments. These risks could result in a decrease in the
value of our investments, which could negatively impact our financial condition. These risks could also restrict our
access to funding. While the securities in our investment portfolio are currently limited to obligations of high-quality
sovereign and government-sponsored issuers, we may choose to expand the range our investments over time, which
may result in greater fluctuations in market value. While we expect these investments to be readily convertible into cash
and do not believe they present a material increase to our risk profile or will have a material impact on our risk-based
capital ratios, they are subject to certain market fluctuations that may reduce the ability to fully convert them into cash.
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Changes in the level of interest rates could materially adversely affect our earnings.
Changes in interest rates cause our net interest income to increase or decrease, as certain of our assets and
liabilities carry interest rates that fluctuate with market benchmarks. External factors may cause interest rates to increase.
The inability of the Federal Reserve to adjust monetary policy in a timely manner after a prolonged period of injecting
liquidity into the economy as well as other market factors could result in a steep increase in domestic inflation and a
resulting need to rapidly increase interest rates. Tighter Federal Reserve monetary policy and rising interest rates would
increase the cost of borrowing for consumers, businesses and governments. Higher interest rates could negatively
impact Discover’s customers as total debt service payments would increase, impede Discover’s ability to grow its
consumer lending businesses, and increase the cost of funding, which would put Discover at a disadvantage as
compared to competitors that have less expensive funding sources.
Some of our consumer loan receivables bear interest at a fixed rate or do not earn interest, and we are not able
to increase the rate on those loans to offset any higher cost of funds, which could materially reduce earnings. At the
same time, our variable rate loan receivables, which are based on the prime market benchmark rate, may not change
at the same rate as our floating-rate borrowings or may be subject to a cap, subjecting us to basis risk. The majority of
our floating-rate borrowings and interest rate derivatives are generally based on the one-month LIBOR rate. If the one-
month LIBOR rate were to increase without a corresponding increase in the prime rate, our earnings would be
negatively impacted. While the majority of our existing certificates of deposit bear interest at fixed rates that do not
fluctuate with market benchmarks, we use derivative instruments to hedge the fixed rates associated with some of these
certificates of deposit. However, new deposit issuances are subject to fluctuations in interest rates. Moreover, although
certificates of deposit we issue directly to consumers are subject to early withdrawal penalties, these penalties may not
fully mitigate early withdrawal behavior in a rising interest rate environment.
Interest rates may also adversely impact our delinquency and charge-off rates. Many consumer lending products
bear interest rates that fluctuate with certain base lending rates published in the market, such as the prime rate and
LIBOR. As a result, higher interest rates often lead to higher payment requirements by consumers under obligations to us
and other lenders, which may reduce their ability to remain current on their obligations to us and thereby lead to loan
delinquencies and additions to our loan loss provision, which could materially adversely affect our earnings.
We continually monitor interest rates and have a number of tools, including the composition of our investments,
liability terms and interest rate derivatives, to manage our interest rate risk exposure. Changes in market assumptions
regarding future interest rates could significantly impact our interest rate risk strategy, our financial position and results
of operations. If our interest rate risk management strategies are not appropriately monitored or executed, these
activities may not effectively mitigate our interest rate sensitivity or have the desired impact on our results of operations
or financial condition. For information related to interest rate risk sensitivities, see "Quantitative and Qualitative
Disclosures About Market Risk."
We may be limited in our ability to pay dividends on and repurchase our stock.
In the year ended December 31, 2014, we increased our quarterly common stock dividend to $0.24 per share
and repurchased approximately 5% of our outstanding common stock under our share repurchase program. The
declaration and payment of future dividends, as well as the amount thereof, are subject to the discretion of our board of
directors and the Federal Reserve’s non-objection to our annual capital plan. The amount and size of any future
dividends and share repurchases will depend upon our results of operations, financial condition, capital levels, cash
requirements, future prospects, regulatory review and other factors as further described in "Business — Supervision and
Regulation — Capital, Dividends and Share Repurchases." Holders of our shares of common stock are subject to the
prior dividend rights of holders of our preferred stock or the depositary shares representing such preferred stock
outstanding, and if full dividends have not been declared and paid on all outstanding shares of our preferred stock in
any dividend period, no dividend may be declared or paid on or set aside for payment on our common stock. Banking
laws and regulations and our banking regulators may limit or prohibit our payment of dividends on or our repurchase
of our stock at any time. There can be no assurance that we will declare and pay any dividends on or repurchase our
stock in the future.
We are a holding company and depend on payments from our subsidiaries.
Discover Financial Services, our parent holding company, depends on dividends, distributions and other
payments from its subsidiaries, particularly Discover Bank, to fund dividend payments, share repurchases, payments on
its obligations, including debt obligations, and to provide funding and capital as needed to its operating subsidiaries.
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Banking laws and regulations and our banking regulators may limit or prohibit our transfer of funds freely, either to or
from our subsidiaries, at any time. These laws, regulations and rules may hinder our ability to access funds that we may
need to make payments on our obligations or otherwise achieve strategic objectives. For more information, see
"Business — Supervision and Regulation — Capital, Dividends and Share Repurchases."
Operational and Other Risk
Our framework and models for managing risks may not be effective in mitigating our risk of loss.
Our risk management framework seeks to identify and mitigate risk and appropriately balance risk and return.
We have established processes and procedures intended to identify, measure, monitor and report the types of risk to
which we are subject, including credit risk, market risk, liquidity risk, operational risk, compliance and legal risk, and
strategic risk. We seek to monitor and control our risk exposure through a framework of policies, procedures, limits and
reporting requirements.
Management of our risks in some cases depends upon the use of analytical and/or forecasting models. We use a
variety of models to manage and inform decision making with respect to customers, and for the measurement of risk
including credit, market and operational risks and for our finance and treasury functions. Models used by Discover can
vary in their complexity and are designed to identify, measure, and mitigate risks at various levels such as loan-level,
portfolio segments, entire portfolios and products. These models use a set of computational rules to generate numerical
estimates of uncertain values to be used for assessment of price, financial forecasts, and estimates of credit, interest rate,
market, and operational risk. All models carry some level of uncertainty that introduces risks in the estimates.
If the models that we use to mitigate risks are inadequate, we may incur increased losses. In addition, there may
be risks that exist, or that develop in the future, that we have not appropriately anticipated, identified or mitigated. If
our risk management framework and models do not effectively identify or mitigate our risks, we could suffer unexpected
losses and our financial condition and results of operations could be materially adversely affected.
If our security systems, or those of third parties, containing information about us, our customers or third parties with
which we do business, are compromised, our business could be disrupted and we may be subject to significant
financial exposure, liability and damage to our reputation.
Our direct banking and network operations rely heavily on the secure processing, storage and transmission of
confidential information about us, our customers and third parties with which we do business. Information security risks
for financial institutions have increased and continue to increase in part because of the proliferation of new
technologies, the use of the internet, mobile and telecommunications technologies to conduct financial transactions, and
the increased sophistication and activities of organized crime, activists, hackers, terrorist organizations, nation state
actors and other external parties. Those parties may also attempt to fraudulently induce employees, customers or other
users of our systems to disclose sensitive information in order to gain access to our data or that of our customers.
Our technologies, systems, networks and software, and those of other financial institutions, have been and are
likely to continue to be the target of increasingly frequent cyber-attacks, malicious code, computer viruses, denial of
service attacks, social engineering, other remote access attacks, and physical attacks that could result in unauthorized
access, misuse, loss or destruction of data (including confidential customer information), account takeovers,
unavailability of service or other events. These types of threats may derive from human error, fraud or malice on the
part of external or internal parties, or may result from accidental technological failure.
Despite our efforts to ensure the integrity of our systems through our information security and business continuity
programs, we may not be able to anticipate or to implement effective preventive measures against all security breaches
or events of these types, especially because the techniques used change frequently and quickly or are not recognized
until launched, and because:
•
•
Security attacks can originate from a wide variety of sources and geographic locations.
Because we rely on many third-party service providers and network participants, including merchants, a
security breach or cyber-attack affecting one of these third parties could impact us. For example, the
financial services industry has seen an increase in point-of-sale breaches at retail merchant locations, which
are remote attacks against the environment where retail transactions are authorized (especially card-present
purchases), resulting in potential exposure of personal and identifiable information impacting millions of
households. For additional information see the risk factor "— We rely on third parties to deliver services. If
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we face difficulties managing our relationships with third-party service providers, our revenue or results of
operations could be materially adversely affected."
•
Further, to access our products and services, our customers may use computers and mobile devices that are
beyond our security control systems.
We are subject to increasingly more risk related to security systems as we increase acceptance of the Discover
card internationally, expand our suite of online direct banking products, enhance our mobile payment technologies,
acquire new or outsource some of our business operations, expand our internal usage of web-based products and
applications, and otherwise attempt to keep pace with rapid technological changes in the financial services industry.
Our efforts to mitigate this risk increase our expenses. While we continue to invest in our cyber security defenses, if our
security systems or those of third parties are penetrated or circumvented such that the confidentiality, integrity and
availability of information about us, our customers, transactions processed on our networks or third parties with which
we do business is compromised, we could be subject to significant liability that may not be covered by insurance,
including significant legal and financial exposure, actions by our regulators, damage to our reputation, or a loss of
confidence in the security of our systems, products and services that could materially adversely affect our business. For
additional information on risks in this area, see the risk factors below regarding fraudulent activity, the introduction of
new products and services, the use of third parties for outsourcing, technology generally, and laws and regulations
addressing consumer privacy and data use and security.
If we cannot remain organizationally effective, we will be unable to address the opportunities and challenges
presented by our strategy and the increasingly dynamic and competitive economic and regulatory environment.
To remain organizationally effective, we must effectively empower, integrate and deploy our management and
operational resources and incorporate global and local business, regulatory and consumer perspectives into our
decisions and processes. In order to execute on our strategy to be the leading direct bank and payments partner, we
must develop and implement innovative and efficient technology solutions and marketing initiatives while effectively
managing legal, regulatory, compliance, security, operational and other risks as well as expenses. Examples include the
implementation of a broader rollout of our checking product, the expansion of our new core banking platform beyond
deposits, a strategy for our home loans platform, and a structure for a more competitive global network business. If we
fail to develop and implement these solutions, we may be unable to expand quickly and the results of our expansion
may be unsatisfactory. In addition, if we are unable to make decisions quickly, assess our opportunities and risks,
execute our strategy, and implement new governance, managerial and organizational processes as needed in this
increasingly dynamic and competitive economic and regulatory environment, our financial condition, results of
operations, relationships with our business partners, banking regulators, customers and shareholders, and ultimately
our prospects for achieving our long-term strategies, may be negatively impacted.
We may be unable to increase or sustain Discover card usage, which could impair growth in, or lead to diminishing,
average balances and total revenue.
A key element of our business strategy is to increase the usage of the Discover card by our customers, including
making it their primary card, and thereby increase our revenue from transaction and service fees and interest income.
However, our customers' use and payment patterns may change because of social, legal and economic factors, and
customers may decide to use debit cards or other payment products instead of credit cards, not increase card usage, or
pay their balances within the grace period to avoid finance charges. We face challenges from competing card products
in our attempts to increase credit card usage by our existing customers. Our ability to increase card usage also is
dependent on customer satisfaction, which may be adversely affected by factors outside of our control, including
competitors' actions and legislative/regulatory changes. Existing legal and regulatory restrictions limit pricing changes
that may impact an account throughout its lifecycle, which may reduce our capability to offer lower price promotions to
drive account usage and customer engagement. As part of our strategy to increase usage, we have been increasing the
number of merchants who accept cards issued on the Discover Network. If we are unable to continue increasing
merchant acceptance or fail to improve awareness of existing merchant acceptance of our cards, our ability to grow
usage of Discover cards may be hampered. As a result of these factors, we may be unable to increase or sustain credit
card usage, which could impair growth in or lead to diminishing average balances and total revenue.
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Our transaction volume is concentrated among large merchants, and a reduction in the number of large merchants
that accept cards on the Discover Network or PULSE network or the rates they pay could materially adversely affect
our business, financial condition, results of operations and cash flows.
Discover card transaction volume was concentrated among our top 100 merchants in 2014, with our largest
merchant accounting for approximately 8% of that transaction volume. Transaction volume on the PULSE network was
also concentrated among the top 100 merchants in 2014, with our largest merchant accounting for approximately 11%
of PULSE transaction volume. These merchants could seek to negotiate better pricing or other financial incentives by
conditioning their continued participation in the Discover Network and/or PULSE network on a change in the terms of
their economic participation. Loss of acceptance at our largest merchants would decrease transaction volume,
negatively impact our brand, and could cause customer attrition. In addition, some of our merchants, primarily our
remaining small and mid-size merchants, are not contractually committed to us for any period of time and may cease to
participate in the Discover Network at any time on short notice.
Actual or perceived limitations on acceptance of credit cards issued on the Discover Network or debit cards
issued on the PULSE network could adversely affect the use of Discover cards by existing customers and the
attractiveness of the Discover card to prospective customers. Also, we may have difficulty attracting and retaining
network partners if we are unable to add or retain acquirers or merchants who accept cards issued on the Discover or
PULSE networks. As a result of these factors, a reduction in the number of our merchants or the rates they pay could
materially adversely affect our business, financial condition, results of operations and cash flows.
Our business, financial condition and results of operations may be adversely affected by merchants’ increasing focus
on the fees charged by credit card and debit card networks.
Merchant acceptance and fees are critical to the success of both our card-issuing and payment processing
businesses. Merchants are concerned with the fees charged by credit card and debit card networks. They seek to
negotiate better pricing or other financial incentives as a condition of continued participation in the Discover Network
and PULSE network. During the past few years, merchants and their trade groups have filed numerous lawsuits against
Visa, MasterCard, American Express and their card-issuing banks, claiming that their practices toward merchants,
including issuer fees, violate federal antitrust laws. There can be no assurance that they will not in the future bring legal
proceedings against other credit card and debit card issuers and networks, including us. Merchants also may promote
forms of payment with lower fees, such as ACH-based payments, or seek to impose surcharges at the point of sale for
use of credit or debit cards. Merchant groups have also promoted federal and state legislation that would restrict issuer
practices or enhance the ability of merchants, individually or collectively, to negotiate more favorable fees. The
heightened focus by merchants on the fees charged by credit card and debit card networks, together with the Dodd-
Frank Act and recent U.S. Department of Justice settlements with Visa and MasterCard, which would allow merchants to
encourage customers to use other payment methods or cards and may increase merchant surcharging, could lead to
reduced transactions on, or merchant acceptance of, Discover Network or PULSE network cards or reduced fees, any of
which could adversely affect our business, financial condition and results of operations.
Political, economic or other instability in a country or geographic region, or other unforeseen or catastrophic events,
could adversely affect our international business activities and reduce our revenue.
Natural disasters or other catastrophic events, including terrorist attacks, may have a negative effect on our
business and infrastructure, including our information technology systems. Our Diners Club network, concentrated
primarily on serving the global travel industry, could be adversely affected by international conditions that may result in
a decline in consumer or business travel activity. Armed conflict, public health emergencies, natural disasters or
terrorism may have a significant negative effect on travel activity and related revenue. Although a regionalized event or
condition may primarily affect one of our network participants, it may also affect our overall network and card activity
and our resulting revenue. Overall network and card transaction activity may decline as a result of concerns about
safety or disease or may be limited because of economic conditions that result in spending on travel to decline. The
impact of such events and other catastrophes on the overall economy may also adversely affect our financial condition
or results of operations.
Fraudulent activity associated with our products or our networks could cause our brands to suffer reputational
damage, the use of our products to decrease and our fraud losses to be materially adversely affected.
We are subject to the risk of fraudulent activity associated with merchants, customers and other third parties
handling customer information. Our fraud losses have been increasing and we incurred losses of $134 million and
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$110 million for the years ended December 31, 2014 and 2013, respectively. Credit and debit card fraud, identity
theft and related crimes are prevalent and perpetrators are growing ever more sophisticated. Our resources and fraud
prevention tools may be insufficient to accurately predict and prevent fraud. The risk of fraud continues to increase for
the financial services industry in general. Additionally, our risk of fraud continues to increase as acceptance of the
Discover card grows internationally and we expand our direct banking business. Our financial condition, the level of
our fraud charge-offs and other results of operations could be materially adversely affected if fraudulent activity were to
significantly increase. High-profile fraudulent activity could negatively impact our brand and reputation. In addition,
significant increases in fraudulent activity could lead to regulatory intervention (such as mandatory card reissuance) and
reputational and financial damage to our brands, which could negatively impact the use of our cards and networks and
thereby have a material adverse effect on our business. Further, fraudulent activity may result in lower license fee
revenue from our Diners Club licensees.
The financial services and payment services industries are rapidly evolving, and we may be unsuccessful in
introducing new products or services on a large scale in response to these changes.
Technological changes continue to significantly impact the financial services and payment services industries,
such as continuing development of technologies in the areas of smart cards, radio frequency and proximity payment
devices, electronic commerce and mobile commerce, among others. For example, the industry migration to evolving
security (referred to as “EMV”) standards in 2015 will be a fundamental change in how payment transactions are
processed and how customers use their cards. There are significant risks in migrating to EMV standards, including
merchant acceptance, consumer adoption and technology issues, which may have adverse implications for both our
card-issuing and network businesses. The introduction of EMV standards requires changes to our payment systems to
permit interoperability among our networks, both domestically and globally. The U.S. payments industry is expected to
bring risks and opportunities in 2015 for both our card-issuing and payments businesses in EMV migration as well as
increasingly competitive mobile, e-wallet and tokenization solutions.
The effect of technological changes on our business is unpredictable. We depend, in part, on third parties for the
development of and access to new technologies. We expect that new services and technologies relating to the payments
business will continue to appear in the market, and these new services and technologies may be superior to, or render
obsolete, the technologies that we currently use in our products and services. Rapidly evolving technologies and new
entrants in mobile and emerging payments pose a risk to Discover both as a card issuer and to the payments business.
As a result, our future success may be dependent on our ability to identify and adapt to technological changes and
evolving industry standards and to provide payment solutions for our customers, merchants and financial institution
customers.
Difficulties or delays in the development, production, testing and marketing of new products or services may be
caused by a number of factors including, among other things, operational, capital and regulatory constraints. The
occurrence of such difficulties may affect the success of our products or services, and developing unsuccessful products
and services could result in financial losses as well as decreased capital availability. In addition, the new products and
services offered may not be attractive to consumers and merchant and financial institution customers. Also, success of a
new product or service may depend upon our ability to deliver it on a large scale, which may require a significant
capital investment that we may not be in a position to make. If we are unable to successfully introduce and maintain
new income-generating products and services while also managing our expenses, it may impact our ability to compete
effectively and materially adversely affect our business and earnings.
We rely on third parties to deliver services. If we face difficulties managing our relationships with third-party service
providers, our revenue or results of operations could be materially adversely affected.
We depend on third-party service providers for many aspects of the operation of our business. For example, we
depend on third parties for software and systems development, the timely transmission of information across our data
transportation network, and for other telecommunications, processing, remittance, technology-related and other services
in connection with our direct banking and payment services businesses. If a service provider fails to provide the services
that we require or expect, or fails to meet contractual requirements, such as service levels or compliance with applicable
laws, the failure could negatively impact our business by adversely affecting our ability to process customers'
transactions in a timely and accurate manner, otherwise hampering our ability to serve our customers, or subjecting us
to litigation and regulatory risk for poor vendor oversight. Such a failure could adversely affect the perception of the
reliability of our networks and services, and the quality of our brands, and could materially adversely affect our
revenues and/or our results of operations.
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We rely on technology to deliver services. If key technology platforms become obsolete, or if we experience
disruptions, including difficulties in our ability to process transactions, our revenue or results of operations could be
materially adversely affected.
Our ability to deliver services to our customers and run our business in compliance with applicable laws and
regulations may be affected by the functionality of our technology systems. The implementation of technology changes
and upgrades to maintain current and integrated systems may result in compliance issues and may, at least temporarily,
cause disruptions to our business, including, but not limited to, systems interruptions, transaction processing errors and
system conversion delays, all of which could have a negative impact on us. In addition, our transaction processing
systems and other operational systems may encounter service interruptions at any time due to system or software failure,
natural disaster or other reasons. Such services could be disrupted at any of our primary or back-up facilities or our
other owned or leased facilities. Third parties to whom we outsource the maintenance and development of certain
technological functionality may experience errors or disruptions that could adversely impact us and over which we may
have limited control. In addition, there is no assurance that we will be able to sustain our investment in new technology
to avoid obsolescence of critical systems and applications. A failure to maintain current technology, systems and
facilities or to control third-party risk, could cause disruptions in the operation of our business, which could materially
adversely affect our transaction volumes, revenues, reputation and/or our results of operations.
Merchant defaults may adversely affect our business, financial condition, cash flows and results of operations.
As an issuer and merchant acquirer in the United States on the Discover Network, and as a holder of certain
merchant agreements internationally for the Diners Club network, we may be contingently liable for certain disputed
credit card sales transactions that arise between customers and merchants. If a dispute is resolved in the customer's
favor, we will cause a credit or refund of the amount to be issued to the customer and charge back the transaction to
the merchant or merchant acquirer. If we are unable to collect this amount from the merchant or merchant acquirer, we
will bear the loss for the amount credited or refunded to the customer. Where the purchased product or service is not
provided until some later date following the purchase, such as an airline ticket, the likelihood of potential liability
increases. For the years ended December 31, 2014 and 2013 losses related to merchant chargebacks were not
material.
Our success is dependent, in part, upon our executive officers and other key employees. If we are unable to recruit,
retain and motivate key officers and employees to manage our business well, our business could be materially
adversely affected.
Our success depends, in large part, on our ability to retain, recruit and motivate key officers and employees to
manage our business. Our senior management team has significant industry experience and would be difficult to
replace. We believe we are in a critical period of competition in the financial services and payments industry. The
market for qualified individuals is highly competitive, and we may not be able to attract and retain qualified personnel
or candidates to replace or succeed members of our senior management team or other key personnel. We may be
subject to restrictions under future legislation or regulation limiting executive compensation. For example, the federal
banking agencies issued guidance on incentive compensation policies at banking organizations. These requirements
could negatively impact our ability to compete with other companies in recruiting and retaining key personnel and
could impact our ability to offer incentives that motivate our key personnel to perform. If we are unable to recruit, retain
and motivate key personnel to manage our business well, our business could be materially adversely affected.
Damage to our reputation could damage our business.
In recent years, financial services companies have experienced increased reputational risk as consumers protest
and regulators scrutinize business and compliance practices of such companies. Maintaining a positive reputation is
critical to attracting and retaining customers, investors and employees. Damage to our reputation can therefore cause
significant harm to our business and prospects. Harm to our reputation can arise from numerous sources, including,
among others, employee misconduct, litigation or regulatory outcomes, failing to deliver minimum standards of service
and quality, compliance failures, and the activities of customers, business partners and counterparties. Social media
also can cause harm to our reputation. By its very nature, social media can reach a wide audience in a very short
amount of time, which presents unique corporate communications challenges. Negative or ‘wrong’ type of publicity
generated through unexpected social media coverage can damage Discover’s reputation and brand. Negative publicity
regarding us, whether or not true, may result in customer attrition and other harm to our business prospects.
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We may be unsuccessful in promoting and protecting our brands or protecting our other intellectual property, or
third parties may allege that we are infringing their intellectual property rights.
The Discover, PULSE and Diners Club brands have substantial economic and goodwill value. Our success is
dependent on our ability to promote and protect these brands and our other intellectual property. Our ability to attract
and retain customers is highly dependent upon the external perception of our company and brands. Our brands are
licensed for use to business partners and network participants, some of whom have contractual obligations to promote
and develop our brands. For example, the Discover card brand is now being issued by certain Diners Club licensees in
their local markets. If our business partners do not adhere to contractual standards, engage in improper business
practices, or otherwise misappropriate, use or diminish the value of our brands or our other intellectual property, we
may suffer reputational and financial damage. If we will not be able to adequately protect ourselves, our overall
business success may be adversely affected. In addition, third parties may allege that our marketing, processes or
systems may infringe their intellectual property rights. Given the potential risks and uncertainties of such claims, our
business could be adversely affected by having to pay significant monetary damages or licensing fees, and we may
have to alter our business practices.
Laws, regulations, and supervisory guidance and practices, or the application thereof, may adversely affect our
business, financial condition and results of operations.
We must comply with an array of banking, consumer lending and payment services laws and regulations in all of
the jurisdictions in which we operate as described more fully in “Business — Supervision and Regulation” and
“Management’s Discussion and Analysis of Financial Condition and Results of Operations — Regulatory Environment
and Developments.” Regulatory developments, findings and ratings could negatively impact our business strategies or
require us to: limit or change our business practices, restructure our products in ways that we may not currently
anticipate, limit our product offerings, invest more management time and resources in compliance efforts, limit the fees
we can charge for services, or limit our ability to pursue certain business opportunities and obtain related required
regulatory approvals. For additional information regarding bank regulatory limitations on acquisitions and investments,
see "Business — Supervision and Regulation — Acquisitions and Investments." See Note 19: Litigation and Regulatory
Matters to our consolidated financial statements for more information on recent matters affecting Discover and the
second risk factor in this section regarding the regulatory environment for the businesses in which we engage.
In addition, we are subject to inquiries and enforcement actions from state attorney general offices and regulation
by the Federal Trade Commission, state banking regulators and the U.S. Department of Justice, as well as the SEC and
New York Stock Exchange in our capacity as a public company. We also are subject to the requirements of entities that
set and interpret the accounting standards (such as the FASB, the SEC, banking regulators and our independent
registered public accounting firm) who may add new requirements or change their interpretations on how standards
should be applied. A specific example of this is the proposed accounting standards update related to calculation of
loan loss reserves. In December 2012, the FASB issued an exposure draft containing a current expected credit loss
("CECL") model for lenders and financial institutions to evaluate impairment of loans and financial instruments. The
model as currently proposed requires evaluation of impairment based on an estimate of life of loan losses where the
previous evaluation required utilization of an incurred loss model. The FASB is continuing to deliberate and refine the
CECL model based on feedback received and a final standard is expected to be issued in 2015. While we continue to
evaluate the model and provisions in the exposure draft and both are subject to change, this and other guidance not
yet issued could potentially materially impact how we record and report our financial condition and results of
operations, or could have an impact on regulatory capital. We are also subject to anti-corruption laws and regulations,
including the U.S. Foreign Corrupt Practices Act and other laws, that prohibit the making or offering of improper
payments.
Failure to comply with laws, regulations and standards could lead to adverse consequences such as financial,
structural, reputational and operational penalties, including receivership, litigation exposure and fines (as described
further below). Failure to comply with anti-corruption and other laws can expose us and/or individual employees to
potentially severe criminal and civil penalties. Legislative and regulatory changes could impact the profitability of our
business activities, require us to limit or change our business practices or our product offerings, or expose us to
additional costs (including increased compliance costs). Significant changes in laws and regulations may have a more
adverse effect on our results of operations than on the results of our larger, more diversified competitors.
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Current and proposed laws and regulations addressing consumer privacy and data use and security could inhibit the
number of payment cards issued and increase our costs.
Legal or regulatory pronouncements relating to consumer privacy, data use and security affect our business. We
are subject to a number of laws concerning consumer privacy and data use and security. Due to recent consumer data
compromise events in the United States, which resulted in unauthorized access to payment card data of millions of
customers, these areas have become a focus of the executive administration, Congress, state legislators and banking
regulators. Developments in this area, such as new laws or regulations, could result in requirements on Discover and
other card issuers or networks that could increase costs or adversely affect the competitiveness of our credit card or
debit card products. See the discussion on recent security developments in “Management’s Discussion and Analysis of
Financial Condition and Results of Operations — Regulatory Environment and Developments — Payment Networks” for
more information. In addition, failure to comply with the privacy and data use and security laws and regulations to
which we are subject, including by reason of inadvertent disclosure of confidential information, could result in fines,
sanctions, penalties or other adverse consequences and loss of consumer confidence, which could materially adversely
affect our results of operations, overall business and reputation.
Litigation and regulatory actions could subject us to significant fines, penalties and/or requirements resulting in
increased expenses.
Businesses in the consumer banking and payment services industries have historically been subject to significant
legal actions, including class action lawsuits and commercial, shareholder and patent litigation. Many of these actions
have included claims for substantial compensatory, statutory or punitive damages. While we have historically relied on
our arbitration clause in agreements with customers to limit our exposure to consumer class action litigation, there can
be no assurance that we will continue to be successful in enforcing our arbitration clause in the future. Legal challenges
to the enforceability of these clauses have led most card issuers, and may cause us, to discontinue their use. There have
been bills pending in Congress to directly or indirectly prohibit the use of pre-dispute arbitration clauses in some or all
consumer banking products. Also, the Dodd-Frank Act authorized the CFPB to conduct a study on pre-dispute
arbitration clauses and, based on the study, potentially limit or ban arbitration clauses. A preliminary report on
arbitration agreements issued by the CFPB expressed concerns about these agreements that may signal the agency is
contemplating taking such steps. Further, we are involved in pending legal actions challenging the use of our arbitration
clause. In addition, we have been and may again be involved in various actions or proceedings brought by
governmental regulatory and enforcement agencies, which could harm our reputation, require us to change our
business activities and product offerings, or subject us to significant fines, penalties, customer restitution or other
requirements, resulting in increased expenses. For example, complying with the FDIC consent order related to our anti-
money laundering program causes us to incur significant expenses. See Note 19: Litigation and Regulatory Matters to
our consolidated financial statements for more information on current matters affecting Discover.
Special Note Regarding Forward-Looking Statements
This annual report on Form 10-K and materials we have filed or will file with the SEC (as well as information
included in our other written or oral statements) contain or will contain certain statements that are forward-looking
within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future
performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Actual outcomes and
results may differ materially from those expressed in, or implied by, our forward-looking statements. Words such as
“expects,” “anticipates,” “believes,” “estimates” and other similar expressions or future or conditional verbs such as
“will,” “should,” “would” and “could” are intended to identify such forward-looking statements. You should not rely
solely on the forward-looking statements and should consider all uncertainties and risks throughout this annual report
on Form 10-K, including those described under “Risk Factors.” The statements are only as of the date they are made,
and we undertake no obligation to update any forward-looking statement.
Possible events or factors that could cause results or performance to differ materially from those expressed in our
forward-looking statements include the following:
•
•
changes in economic variables, such as the availability of consumer credit, the housing market, energy costs,
the number and size of personal bankruptcy filings, the rate of unemployment, the levels of consumer
confidence and consumer debt, and investor sentiment;
the impact of current, pending and future legislation, regulation, supervisory guidance, and regulatory and
legal actions, including, but not limited to, those related to financial regulatory reform, consumer financial
services practices, anti-corruption and funding, capital and liquidity;
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•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
the actions and initiatives of current and potential competitors;
our ability to manage our expenses;
our ability to successfully achieve card acceptance across our networks and maintain relationships with
network participants;
our ability to sustain and grow our private student loan and mortgage loan products;
losses as a result of mortgage loan repurchase and indemnification obligations to secondary market
purchasers;
difficulty obtaining regulatory approval for, financing, closing, transitioning, integrating or managing the
expenses of acquisitions of or investments in new businesses, products or technologies;
our ability to manage our credit risk, market risk, liquidity risk, operational risk, compliance and legal risk,
and strategic risk;
the availability and cost of funding and capital;
access to deposit, securitization, equity, debt and credit markets;
the impact of rating agency actions;
the level and volatility of equity prices, commodity prices and interest rates, currency values, investments,
other market fluctuations and other market indices;
losses in our investment portfolio;
limits on our ability to pay dividends and repurchase our common stock;
limits on our ability to receive payments from our subsidiaries;
fraudulent activities or material security breaches of key systems;
our ability to remain organizationally effective;
our ability to increase or sustain Discover card usage or attract new customers;
our ability to maintain relationships with merchants;
the effect of political, economic and market conditions, geopolitical events and unforeseen or catastrophic
events;
our ability to introduce new products or services;
our ability to manage our relationships with third-party vendors;
our ability to maintain current technology and integrate new and acquired systems;
our ability to collect amounts for disputed transactions from merchants and merchant acquirers;
our ability to attract and retain employees;
our ability to protect our reputation and our intellectual property; and
new lawsuits, investigations or similar matters or unanticipated developments related to current matters.
We routinely evaluate and may pursue acquisitions of or investments in businesses, products, technologies, loan
portfolios or deposits, which may involve payment in cash or our debt or equity securities.
The foregoing review of important factors should not be construed as exclusive and should be read in conjunction
with the other cautionary statements that are included in this annual report on Form 10-K. These factors expressly
qualify all subsequent oral and written forward-looking statements attributable to us or persons acting on our behalf.
Except for any ongoing obligations to disclose material information as required under U.S. federal securities laws, we
do not have any intention or obligation to update forward-looking statements after we distribute this annual report on
Form 10-K, whether as a result of new information, future developments or otherwise.
Item 1B. Unresolved Staff Comments
None.
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Item 2.
Properties
We have ten principal properties located in nine states in the United States. As of January 31, 2015, we owned
four principal properties, which included our corporate headquarters, two call centers and a processing center, and we
leased six principal properties, which included two call centers, our PULSE headquarters, two Discover Home Loans
offices and a Student Loan Corporation office. The call centers, processing center and Student Loan Corporation offices
largely support our Direct Banking segment; the PULSE headquarters is used by our Payment Services segment; the
Discover Home Loans offices support our mortgage business; and our corporate headquarters is used by both our
Direct Banking and Payment Services segments. Each of our call centers and our processing center are operating at and
being utilized to a reasonable capacity. We believe our principal facilities are both suitable and adequate to meet our
current and projected needs. We also have ten leased offices, seven of which are located outside the United States, that
are used to support our Diners Club operations, and one leased office in China that supports our Direct Banking
segment.
Item 3.
Legal Proceedings
For a description of legal proceedings, see Note 19: Litigation and Regulatory Matters to our consolidated
financial statements.
Item 4. Mine Safety Disclosures
None.
-43-
Part II. | Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
Common Stock Market Prices and Dividends
Our common stock is traded on the New York Stock Exchange ("NYSE") (ticker symbol DFS). The approximate
number of record holders of our common stock as of February 20, 2014 was 59,338.
The following table sets forth the quarterly high and low sales prices of a share of our common stock as reported
by the NYSE and the cash dividends we declared per share of our common stock during the quarter indicated:
Quarter Ended:
March 31, 2013 ................................................................................................................. $
June 30, 2013 .................................................................................................................... $
September 30, 2013 ........................................................................................................... $
December 31, 2013 ............................................................................................................ $
Quarter Ended:
March 31, 2014 ................................................................................................................. $
June 30, 2014 .................................................................................................................... $
September 30, 2014 ........................................................................................................... $
December 31, 2014 ............................................................................................................ $
Stock Price
High
Low
Cash Dividends
Declared
45.38
49.71
53.36
56.20
60.00
62.62
65.98
66.75
$
$
$
$
$
$
$
$
37.24 $
42.12 $
46.93 $
48.40 $
51.63 $
54.35 $
59.00 $
60.15 $
—
0.20
0.20
0.20
0.20
0.24
0.24
0.24
In the second quarter of 2014, we increased our quarterly common stock dividend from $0.20 per share to
$0.24 per share and maintained a $0.24 per share dividend for each of the third and fourth quarters of 2014.
Although we expect to continue our policy of paying regular cash dividends, we cannot assure that we will do so in the
future. For more information, including conditions and limits on our ability to pay dividends, see "Business —
Supervision and Regulation — Capital, Dividends and Share Repurchases," "Risk Factors — Credit, Market and
Liquidity Risk — We may be limited in our ability to pay dividends on and repurchase our stock" and "— We are a
holding company and depend on payments from our subsidiaries," "Management's Discussion and Analysis of
Financial Condition and Results of Operations — Liquidity and Capital Resources — Capital" and Note 17: Capital
Adequacy to our consolidated financial statements.
-44-
Issuer Purchases of Equity Securities
The table below sets forth information regarding purchases of our common stock related to our share repurchase
program and employee transactions that were made by us or on our behalf during the most recent quarter:
Period
October 1-31, 2014
Total Number of
Shares
Purchased
Average Price
Paid Per Share
Total Number of
Shares Purchased as
Part of Publicly
Announced Plan or
Program(1)
Maximum Dollar
Value of Shares that
may yet be
purchased under the
Plans or Programs(1)
Repurchase program(1) ................................................................
2,406,623
Employee transactions(2) ..............................................................
1,338
November 1-30, 2014
Repurchase program(1) ................................................................
1,795,445
Employee transactions(2) ..............................................................
217
December 1-31, 2014
Repurchase program(1) ................................................................
2,036,490
Employee transactions(2) ..............................................................
2,534
Total
Repurchase program(1) ................................................................
6,238,558
Employee transactions(2) ..............................................................
4,089
$
$
$
$
$
$
$
$
63.22
63.53
64.76
63.59
64.43
63.10
64.06
63.27
2,406,623
$ 2,321,590,369
N/A
N/A
1,795,445
$ 2,205,316,932
N/A
N/A
2,036,490
$ 2,074,099,410
N/A
N/A
6,238,558
$ 2,074,099,410
N/A
N/A
(1) On April 16, 2014, our board of directors approved a share repurchase program authorizing the repurchase of up to $3.2 billion of our outstanding shares of
(2)
common stock. This program expires on April 15, 2016 and may be terminated at any time.
Reflects shares withheld (under the terms of grants under employee stock compensation plans) to offset tax withholding obligations that occur upon the delivery of
outstanding shares underlying restricted stock units or upon the exercise of stock options.
-45-
Stock Performance Graph
The following graph compares the cumulative total stockholder return (rounded to the nearest whole dollar) of
our common stock, the S&P 500 Stock Index and the S&P 500 Financials Index for the period from November 30,
2009 through December 31, 2014. The graph assumes an initial investment of $100 on November 30, 2009. The
cumulative returns include stock price appreciation and assume full reinvestment of dividends. This graph does not
forecast future performance of our common stock.
Discover
Financial
Services
S&P 500
Index
S&P 500
Financials
Index
November 30, 2009 ............................................................................................................ $
100.00
November 30, 2010 ............................................................................................................ $
118.33
November 30, 2011 ............................................................................................................ $
154.34
November 30, 2012 ............................................................................................................ $
271.65
December 31, 2012(1)
.......................................................................................................... $
251.34
December 31, 2013 ............................................................................................................. $
367.71
December 31, 2014 ............................................................................................................. $
432.61
$
$
$
$
$
$
$
100.00
107.75
113.81
129.26
130.17
168.70
187.92
$
$
$
$
$
$
$
100.00
98.54
87.53
107.40
112.29
149.58
169.18
(1)
In 2013, we changed fiscal years creating a one month transition period in December 2012.
Item 6.
Selected Financial Data
The following table presents our selected financial data and operating statistics. The statement of income data for
the calendar years ended December 31, 2014 and 2013, fiscal year ended November 30, 2012 and one month
ended December 31, 2012 and the statement of financial condition data as of December 31, 2014 and 2013 have
been derived from our audited consolidated financial statements included elsewhere in this annual report on Form 10-K.
The statement of financial condition data as of November 30, 2012, 2011 and 2010, and the statement of income data
for the fiscal years ended November 30, 2011 and 2010 have been derived from audited consolidated financial
statements not included elsewhere in this annual report on Form 10-K.
-46-
Discover Financial Services
Selected Financial Data
For the Calendar Years
Ended December 31,
For the Fiscal Years Ended
November 30,
2014
2013
2012
2011
2010
For the One
Month Ended
December 31,
2012
(dollars in millions, except per share amounts)
Statement of Income Data:
Interest income ............................................................ $
7,596
$
7,064
$
6,703
$
6,345
$
6,146
$
Interest expense ...........................................................
Net interest income ..................................................
Other income ..............................................................
Revenue net of interest expense .................................
Provision for loan losses ...............................................
Other expense .............................................................
Income before income tax expense ............................
Income tax expense .....................................................
1,134
6,462
2,015
8,477
1,443
3,340
3,694
1,371
Net income ............................................................. $
2,323
Net income allocated to common stockholders ............ $
2,270
$
$
1,146
5,918
2,306
8,224
1,086
3,194
3,944
1,474
2,470
2,414
1,331
5,372
2,281
7,653
848
3,052
3,753
1,408
2,345
2,318
1,485
4,860
2,205
7,065
1,013
2,541
3,511
1,284
2,227
2,202
1,583
4,563
2,095
6,658
3,207
2,182
1,269
504
765
668
$
$
$
$
$
$
Statement of Financial Condition Data (as of):
Loan receivables(1) ........................................................ $ 69,969
$ 65,771
$ 61,017
$ 57,670
$ 49,181
Total assets ................................................................. $ 83,126
$ 79,340
$ 75,283
$ 69,117
$ 61,130
Total stockholders' equity .............................................. $ 11,134
$ 10,809
Allowance for loan losses ............................................. $
1,746
$
1,648
$
$
9,778
1,725
$
$
8,242
2,205
$
$
6,457
3,304
Long-term borrowings .................................................. $ 22,544
$ 20,474
$ 19,729
$ 18,287
$ 17,706
Per Share of Common Stock:
Basic EPS from continuing operations ............................. $
Diluted EPS from continuing operations .......................... $
4.91
4.90
$
$
4.97
4.96
$
$
4.47
4.46
$
$
4.06
4.06
$
$
1.23
1.22
$
$
$
$
$
$
$
$
$
595
103
492
200
692
178
240
274
104
170
168
62,598
73,491
9,873
1,788
17,666
0.34
0.34
Weighted-average shares outstanding (000's) ................
462,115
485,492
518,428
541,813
544,058
497,881
Weighted-average shares outstanding (fully diluted)
(000's)
.......................................................................
463,412
486,861
519,620
542,626
548,760
498,994
Dividends declared per share of common stock ............... $
0.92
$
0.60
$
0.40
$
0.20
$
0.08
$
0.14
Common stock dividend payout ratio .............................
18.73%
12.07%
8.95%
4.92%
6.52%
41.48%
Ratios:
Return on average total equity .......................................
Return on average assets ..............................................
Average stockholders' equity to average total assets........
21%
3%
14%
24%
3%
14%
26%
3%
13%
30%
3%
12%
12%
1%
11%
21%
3%
14%
(1)
In 2011 we acquired $3.1 billion of student loan receivables acquired with the SLC acquisition in December 2010 and $2.4 billion of student loan receivables
acquired from Citibank, N.A. in September 2011.
-47-
Selected Financial Data (continued)
For the Calendar Years
Ended December 31,
For the Fiscal Years Ended
November 30,
2014
2013
2012
2011
2010
For the One
Month Ended
December 31,
2012
(dollars in millions)
Selected Statistics:
Total Loan Receivables
Loan receivables ......................................................... $ 69,969
$ 65,771
$ 61,017
$ 57,670
$ 49,181
Average loan receivables ............................................. $ 65,853
$ 61,820
$ 58,043
$ 53,260
$ 50,203
$
$
62,598
61,877
Interest yield ...............................................................
11.40%
11.28%
11.38%
11.78%
12.13%
11.21%
Net principal charge-off rate ........................................
Delinquency rate (over 30 days) ...................................
Delinquency rate (over 90 days) ...................................
2.04%
1.66%
0.78%
1.98%
1.64%
0.77%
2.29%
1.75%
0.83%
3.97%
2.29%
1.14%
7.53%
3.87%
2.02%
2.19%
1.69%
0.82%
Credit Card Loans
Credit card loan receivables ......................................... $ 56,128
$ 53,150
$ 49,642
$ 46,972
$ 45,502
Average credit card loan receivables ............................ $ 52,600
$ 49,816
$ 47,301
$ 45,522
$ 45,911
$
$
51,135
50,494
Interest yield ...............................................................
12.09%
12.00%
12.16%
12.42%
12.71%
11.92%
Net principal charge-off rate ........................................
Delinquency rate (over 30 days) ...................................
Delinquency rate (over 90 days) ...................................
2.27%
1.73%
0.85%
2.21%
1.72%
0.84%
2.62%
1.86%
0.91%
4.47%
2.38%
1.19%
8.02%
4.02%
2.11%
2.47%
1.79%
0.90%
Personal Loans
Personal loan receivables ............................................. $
5,007
Average personal loan receivables ................................ $
4,592
$
$
4,191
3,706
$
$
3,272
2,944
$
$
2,648
2,228
$
$
1,878
1,593
$
$
3,296
3,290
Interest yield ...............................................................
12.36%
12.52%
12.35%
11.94%
11.41%
12.43%
Net principal charge-off rate ........................................
Delinquency rate (over 30 days) ...................................
Delinquency rate (over 90 days) ...................................
2.04%
0.79%
0.22%
2.13%
0.70%
0.21%
2.33%
0.76%
0.23%
3.02%
0.87%
0.28%
5.72%
1.57%
0.57%
Private Student Loans (excluding PCI)
Private student loan receivables .................................... $
4,850
Average private student loan receivables ....................... $
4,450
$
$
3,969
3,561
$
$
3,000
2,557
$
$
2,069
1,637
$
$
999
827
$
$
Interest yield ...............................................................
Net principal charge-off rate ........................................
Delinquency rate (over 30 days) ...................................
Delinquency rate (over 90 days) ...................................
7.02%
1.29%
1.80%
0.52%
7.07%
1.30%
1.66%
0.46%
7.20%
0.73%
1.07%
0.27%
7.04%
0.48%
0.63%
0.14%
5.75%
0.33%
0.50%
0.14%
2.52%
0.77%
0.23%
3,072
3,021
7.22%
0.81%
1.22%
0.29%
-48-
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in
conjunction with our audited consolidated financial statements and related notes included elsewhere in this annual
report on Form 10-K. Some of the information contained in this discussion and analysis constitutes forward-looking
statements that involve risks and uncertainties. Actual results could differ materially from those discussed in these
forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to,
those discussed below and elsewhere in this annual report on Form 10-K particularly under “Risk Factors” and “Special
Note Regarding Forward-Looking Statements,” which immediately follows “Risk Factors.” Unless otherwise specified,
references to Notes to our consolidated financial statements are to the Notes to our audited consolidated financial
statements as of December 31, 2014 and 2013 and for calendar years ended December 31, 2014 and 2013, fiscal
year ended November 30, 2012 and one month ended December 31, 2012.
Introduction and Overview
Discover Financial Services is a direct banking and payment services company. We provide direct banking
products and services and payment services through our subsidiaries. We offer our customers credit card loans, private
student loans, personal loans, home loans, home equity loans and deposit products. We also operate 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.
Our primary revenues consist of interest income earned on loan receivables and fees earned from customers,
merchants and issuers. The primary expenses required to operate our business include funding costs (interest expense),
loan loss provisions, customer rewards, and expenses incurred to grow, manage and service our loan receivables and
networks. Our business activities are funded primarily through consumer deposits, securitization of loan receivables and
the issuance of unsecured debt.
Change in Fiscal Year
On December 3, 2012, our board of directors approved a change in our fiscal year end from November 30 to
December 31 of each year. This fiscal year change was effective January 1, 2013. As a result of the change, we had a
one month transition period in December 2012. The audited results for the one month ended December 31, 2012 is
included in this report.
2014 Highlights
• Net income was $2.3 billion, compared to $2.5 billion in the prior year.
•
Total loans grew $4.2 billion, or 6.4%, from the prior year to $70.0 billion.
• Credit card loans grew $3.0 billion, or 5.6%, to $56.1 billion and Discover card sales volume increased
5.1% from the prior year.
• Net charge-off rate for credit card loans increased 6 basis points from the prior year to 2.27% and the
delinquency rate for credit card loans over 30 days past due increased 1 basis point to 1.73%.
•
Payment Services transaction dollar volume for the segment was $202.3 billion, up 3% from the prior year.
• We incurred a $178 million charge to earnings to enhance our rewards program by allowing easier
redemption of rewards, which resulted in the elimination of our current estimate of customer rewards
forfeiture.
• Our capital market activities included issuances of approximately $5.0 billion in public credit card asset-
backed securities. Discover Bank issued $1.1 billion in senior bank notes and Discover Financial Services
issued $500 million of senior notes.
• We repurchased approximately 25 million shares, or 5%, of our outstanding common stock for $1.5 billion.
-49-
2013 and 2012 Highlights
• During the 2013 calendar year, our capital market activities included issuances of approximately $4.7
billion in public credit card asset-backed securities. Discover Bank issued $1.7 billion in senior bank notes.
• We repurchased approximately 27 million shares of common stock for $1.3 billion, reducing our number of
shares outstanding by 5% during the calendar year ended December 31, 2013.
• We began offering residential mortgage loans through Discover Home Loans following our June 2012
acquisition of substantially all of the operating and related assets of Home Loan Center, a subsidiary of
Tree.com, Inc.
• We repurchased 34 million shares, or approximately 6%, of our outstanding common stock for $1.2 billion
during the fiscal year ended November 30, 2012.
• During the 2012 fiscal year, our capital market activities included issuances of approximately $5.4 billion in
public credit card asset-backed securitizations and a $560 million preferred stock issuance. We also
completed two private debt exchange offers involving an aggregate $822 million of outstanding debt.
Outlook
The growth of our existing direct banking products remains a priority as we continue to enhance our offerings to
customers. We anticipate that investments in marketing and the fourth quarter 2014 changes we made to simplify and
ease reward redemption will contribute to new card account growth and wallet share gains with existing customers. We
are also targeting solid growth in our private student and personal loan portfolios, and are evaluating our home loans
strategy.
Revenue margin is expected to decline modestly in 2015. We expect this to be driven by net interest margin
compression, a continued decline in protection products revenue, an increased credit card rewards rate and challenges
in our payments business. The anticipated net interest margin compression is due to expected higher funding costs and
modest yield declines from growth in promotional balances, run-off of higher priced balances and higher interest
charge-offs.
While our credit quality remains relatively stable, we increased our allowance for loan losses in the fourth
quarter of 2014 due to seasoning of loan growth from recent years. We expect our provision levels to increase as a
result of continued seasoning of and growth in our loan portfolio.
We expect operating expenses to increase in 2015, primarily due to planned marketing, technology and
infrastructure investments, as well as increased legal, regulatory and compliance costs. Specifically, our anti-money
laundering program enhancements are expected to contribute to increased expenses.
We expect lower returns in our payment services segment in 2015 due to competitive challenges, the loss of
network relationships and increased expenses. We continue to face substantial and intense competition in the payments
industry, which impacts our revenue margins, transaction volume and business strategies. We anticipate a decline in
volume in 2015 as compared to prior year periods as a result of a previously disclosed third-party issuer contract
related to our Network Partners business that was not renewed in 2014 and the loss of volume from a large PULSE
debit issuer. The loss of volumes and increase in expenses is expected to significantly impact the financial results of our
payment services segment, but is not expected to significantly impact our overall profitability. Despite these continued
challenges in our payments business, we continue to leverage our network to support our card-issuing business.
Regulatory Environment and Developments
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") contains
comprehensive provisions governing the practices and oversight of financial institutions and other participants in the
financial markets. The Dodd-Frank Act regulates large systemically significant financial firms, including Discover,
through a variety of measures, including increased capital and liquidity requirements, limits on leverage and enhanced
supervisory authority. Federal banking regulators have implemented and continue to propose new regulations and
supervisory guidance under the Dodd-Frank Act and otherwise, and have been increasing their examination and
enforcement action activities. We expect regulators to continue taking formal enforcement actions against financial
institutions in addition to addressing concerns through non-public supervisory actions or findings.
-50-
The impact of the evolving regulatory environment on our business and operations depends upon a number of
factors including supervisory priorities and actions, the actions of our competitors and other marketplace participants
and the behavior of consumers. Regulatory developments, findings and ratings could negatively impact our business
strategies, require us to limit or change our business practices, limit our product offerings, invest more management
time and resources in compliance efforts, limit the fees we can charge for services, or limit our ability to pursue certain
business opportunities and obtain related required regulatory approvals. For additional information regarding bank
regulatory limitations on acquisitions and investments, see "Business — Supervision and Regulation — Acquisitions and
Investments." For more information on recent matters affecting Discover, see Note 19: Litigation and Regulatory Matters
to our consolidated financial statements. Regulatory developments could also impact our strategies, the value of our
assets, or otherwise adversely affect our businesses.
Compliance expenditures have increased significantly for Discover and other financial services firms, and we
expect them to continue to increase as regulators remain focused on controls and operational processes. We may face
additional compliance and regulatory risk to the extent that we enter into new business arrangements with third-party
service providers, alternative payment providers or other industry participants. The additional expense, time and
resources needed to comply with ongoing regulatory requirements may adversely impact our business and results of
operations.
The final rule implementing Section 619 of the Dodd-Frank Act, commonly referred to as the Volcker Rule, which
contains certain prohibitions and restrictions on the ability of “banking entities” to engage in proprietary trading and
sponsor or invest in “covered funds” became effective in April 2014, and banking entities must generally conform with
this rule by July 2015, subject to a one-year extension for certain investments in, and relationships with, legacy covered
funds. We do not engage in any of the activities that are prohibited by the final rule and, therefore, do not believe it
will have a material impact on our business.
Consumer Financial Services
The CFPB regulates consumer financial products and services, as well as certain financial services providers,
including Discover. The CFPB is authorized to prevent “unfair, deceptive or abusive acts or practices” and ensure
consistent enforcement of laws so that all consumers have access to markets for consumer financial products and
services that are fair, transparent and competitive. The CFPB has rulemaking and interpretive authority under the Dodd-
Frank Act and other federal consumer financial services laws, as well as broad supervisory, examination and
enforcement authority over large providers of consumer financial products and services, such as Discover. The CFPB
collects detailed account level information from us about credit cards, deposit accounts and other products, and is
authorized to collect fines and provide consumer restitution in the event of violations. Several of our products, including
credit cards, private student loans and home loans, are areas of focus by the CFPB. In addition, the CFPB has an online
complaint system that allows consumers to log public complaints with respect to the products we offer. The CFPB has
proposed making consumer narratives available to the public. The financial services industry is concerned that the
publication of detailed unverified consumer narratives could lead to reputational injury to consumer lenders. The CFPB's
analysis of account data and complaints could inform future decisions with respect to regulatory, enforcement or
examination focus, and influence consumers' attitudes about doing business with Discover.
Credit Cards
The CFPB has been focused recently on online credit card disclosures, the clarity and transparency of credit card
rewards and grace period disclosures, and debt collection practices. In September 2014, the CFPB issued guidance on
the marketing of credit card promotional interest rate offers that will require enhanced consumer disclosures. The CFPB
is currently collecting data about reward program marketing practices, which may result in additional guidance.
Further, the CFPB continues to collect data regarding consumers' experiences with debt collectors and plans to use the
data to help develop debt collection regulations. Courts and legislators have also been focused on the debt collection
practices of consumer financial services providers. The ultimate impact of the increased scrutiny of these areas is
uncertain at this time.
Private Student Loans
There continues to be significant legislative and regulatory focus on the private student loan market, including by
the CFPB and the FDIC. This regulatory focus has resulted in an increase in supervisory examinations of Discover related
to private student loans. The CFPB is currently investigating certain student loan servicing practices of Discover Bank.
See Note 19: Litigation and Regulatory Matters to our consolidated financial statements for more information. The
-51-
recent legislative and regulatory areas of focus include servicing practices with respect to assisting student borrowers
with economic hardships, refinancing of private student loans, the liability of student borrowers in the event of cosigner
death or bankruptcy, the standard for discharging student loans in bankruptcy, loan payment allocation, and
requirements related to borrower military service. In October 2014, the CFPB student loan ombudsman for the private
student loan market issued the 2014 annual report required by the Dodd-Frank Act, which referenced these issues and
others. The enactment of new legislation or the adoption of new regulations or guidance may increase the complexity
and expense of servicing student loans. Legislators and regulators may take additional actions that impact the student
loan market in the future, which could cause us to restructure our private student loan product in ways that we may not
currently anticipate.
Mortgage Lending
The CFPB has indicated that the mortgage industry is an area of supervisory focus and that it will concentrate its
examinations and rulemaking efforts on the variety of mortgage-related topics required under the Dodd-Frank Act
including steering consumers to less favorable products, discrimination, abusive or unfair lending practices, predatory
lending, origination disclosures, minimum mortgage underwriting standards, mortgage loan origination compensation
and servicing practices. The CFPB has published several final rules impacting the mortgage industry, including rules
related to ability-to-repay, mortgage servicing and integrated mortgage origination disclosures. Failure to comply with
the ability-to-repay rule could result in possible CFPB enforcement action and special statutory damages plus actual,
class action and attorney fee damages, all of which a borrower may claim in defense of a foreclosure action at any
time. The new integrated mortgage origination disclosures rule, effective August 2015, requires combining disclosures
currently provided under the Truth in Lending Act and the Real Estate Settlement Procedures Act, resulting in significant
effort by the mortgage industry to test and implement as well as process changes with third-party settlement agents. In
addition, congressional committees have approved legislation that could significantly affect the single family housing
finance market in the United States, including proposals to wind down the government-sponsored enterprises, Fannie
Mae and Freddie Mac, to which we currently sell our mortgages. It is uncertain what the ultimate impact of these
developments will be on our mortgage business.
In October 2014, the Federal Reserve, FDIC, SEC and other federal regulatory agencies adopted a final rule to
implement requirements under the Securities Exchange Act of 1934, as added under the Dodd-Frank Act, exempting
"qualified residential mortgages" from the requirement that the sponsor of an asset-backed securitization retain not less
than five percent of the credit risk of the underlying assets. Because most of the mortgages we offer are "qualified
residential mortgages" as defined in the exemption, we do not expect the final rule to impact the pricing and depth of
the secondary mortgage market to which we sell our mortgages.
Payment Networks
The Dodd-Frank Act contains several provisions impacting the debit card market, including network participation
requirements and interchange fee limitations. The changing debit card environment, including competitor actions related
to merchant and acquirer pricing and transaction routing strategies, has adversely affected and is expected to continue
to adversely affect our PULSE network's business practices, network transaction volume, revenue and prospects for
future growth. We continue to closely monitor competitor strategies in order to assess their impact on our business and
on competition in the marketplace. The U.S. Department of Justice is examining some of these competitor pricing
strategies. In addition, the Dodd-Frank Act's network participation requirements impact PULSE's ability to enter into
exclusivity arrangements, which affect PULSE's current business practices and may materially adversely affect its
network transaction volume and revenue.
Publicly-reported incidents regarding unauthorized access to consumer information held by major retailers and
others has prompted a renewed focus by Congress and state legislators to possibly enact legislation to address future
data security breaches. In October 2014, the President signed a new Executive Order which, among other things,
directs the government to take the lead in moving the market towards more secure payment systems, including
implementing a new policy to secure payments to and from the federal government by applying chip and PIN
technology to newly issued and existing government credit cards and debit cards, and upgrading retail payment card
terminals at federal agency facilities to accept chip and PIN-enabled cards. In January 2015, the President announced
legislative proposals and administration efforts with respect to privacy and cybersecurity, including a specific proposal
for a national data breach notification standard and a proposal designed to encourage the private sector to increase
the sharing of information related to cyber threats. All these developments could ultimately result in the imposition of
requirements on Discover or other card issuers or networks that could increase costs or adversely affect the
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competitiveness of our credit card or debit card products. It is too early to know if any new legislation will become law,
the final form any such legislation would take, or the impact such a law would have on Discover.
The final compromise text for the proposed European Union regulation of interchange fees assessed for card-
based payment transactions was released and endorsed by the European Union countries in January 2015. The
regulation remains subject to a vote by the full European Parliament and final approval by the Council anticipated in
April 2015. The regulation, if enacted, would reduce the fees that card issuers can receive for payment card
transactions. As such, the regulation would likely have significant impact across the industry and could impact our
Diners Club network. At this time, we are evaluating the scope and impact that the regulation would have on the
business practices and revenues of our Diners Club network participants in Europe.
Capital, Liquidity and Funding
Capital
Discover Financial Services and Discover Bank are subject to new regulatory capital requirements beginning in
January 2015 under final rules issued by the Federal Reserve and the FDIC to implement the provisions of the Basel III
regulatory capital reforms. The rules include significant changes to bank capital, leverage and liquidity requirements.
The rules require new risk-based capital and leverage ratios and refine the definition of what constitutes capital for
purposes of calculating those ratios. See "Business — Supervision and Regulation — Capital, Dividends and Share
Repurchases" for more information. In addition, the rules establish a capital conservation buffer above the new
regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and result in
higher required minimum ratios by up to 2.5%. The new capital conservation buffer requirement will be phased in
beginning in January 2016 and will be fully implemented in January 2019. A banking organization will be subject to
limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if its capital level falls
below any of the minimum capital requirements, including the buffer amount. Based on our current capital composition
and levels, we believe that we would be in compliance with the requirements as set forth in the final rules had they been
in effect prior to 2015.
The final rule implementing the Federal Reserve's amendments to the capital plan and stress test rules applicable
to bank holding companies with $50 billion or more in total consolidated assets, including Discover, became effective in
November 2014. The rule provides guidance with respect to the current capital plan and stress testing cycle. It also
modifies the start date of the capital plan and stress test cycles from October 1 of a calendar year to January 1 of the
following calendar year, with capital plans and stress testing results due April 5 instead of January 5, starting in 2016.
The final rule also clarifies the limitations that apply on capital distributions where a bank holding company has net
capital issuances that are less than the amount in that bank holding company's approved capital plan.
Liquidity
We are subject to the Federal Reserve's final rule implementing certain enhanced prudential standards under the
Dodd-Frank Act for large U.S. bank holding companies, including enhanced liquidity and risk management
requirements, which became effective beginning in January 2015. The final rule prescribes a broad range of qualitative
liquidity risk management practices.
Additionally, in September 2014, federal banking regulators published a final rule to implement the liquidity
coverage ratio as a new quantitative requirement designed to promote the short-term resilience of the liquidity risk
profile of large and internationally active banking organizations in the United States. The ratio requires covered banks
to maintain an amount of high-quality liquid assets sufficient to cover projected net cash outflows during a prospective
30-day calendar period under an acute, hypothetical liquidity stress scenario. We are subject to this new requirement
and will be required to maintain a liquidity ratio of 90% in 2016, which will increase to 100% in 2017. We believe our
liquidity management practices position us well to comply with this new standard when it becomes effective.
In October 2014, the Basel Committee on Banking Supervision issued the final standard for the Net Stable
Funding Ratio (“NSFR”). The NSFR is defined as the amount of available stable funding relative to the amount of
required stable funding. “Available stable funding” is defined as the portion of capital and liabilities expected to be
reliable over the time horizon considered by the NSFR, which extends to one year. This ratio should be equal to at least
100% on an ongoing basis. The NSFR limits overreliance on short-term wholesale funding, encourages better
assessment of funding risk across all on- and off-balance sheet items, and promotes funding stability. The rule is
expected to be fully implemented beginning in January 2018. At this time, the U.S. regulatory authorities are still
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assessing the NSFR. These new standards are subject to the Federal Reserve’s adaptation for U.S. banks, and their
terms may change before implementation.
Securitizations
In August 2014, the SEC adopted final rules for asset-backed securities offerings that will substantially change the
disclosure, reporting and offering process for public offerings of asset-backed securities, including those offered under
Discover Bank’s credit card securitization program. The new rules will change the disclosure and offering process for
credit card securitizations and the eligibility criteria for shelf registration statements. Among other changes, the final
rules will require a certification concerning the disclosure contained in the prospectus and the design of the
securitization at the time of each offering off the shelf and appointment of an asset representations reviewer to review
assets for compliance with related representations and warranties in the related underlying transaction agreements
when delinquency rates rise above a certain level and investors request such a review. Issuers of publicly offered asset-
backed securities must comply with these new rules no later than November 23, 2015. We do not believe these rules
will have a material impact on Discover Bank's securitization program.
In October 2014, the Federal Reserve, FDIC, SEC and other federal regulatory agencies adopted a final rule to
implement requirements under the Securities Exchange Act of 1934, as added by the Dodd-Frank Act, requiring the
sponsor of an asset-backed securitization to retain not less than five percent of the credit risk of the underlying assets.
Sponsors of asset-backed securitizations will be required to comply with the risk retention rules no later than December
24, 2016. We do not believe the risk retention rules will have a material impact on Discover Bank's securitization
program.
Results of Operations
The discussion below provides a summary of our results of operations for the calendar year ended December 31,
2014 compared to our results of operations for the calendar year ended December 31, 2013 and fiscal year ended
November 30, 2012. The discussion also provides information about our loan receivables as of December 31, 2014
compared to December 31, 2013 and December 31, 2012.
Segments
We manage our business activities in two segments: Direct Banking and Payment Services. In compiling the
segment results that follow, our Direct Banking segment bears all corporate overhead costs that are not specifically
associated with a particular segment and all costs associated with Discover Network marketing, servicing and
infrastructure, with the exception of an allocation of direct and incremental costs driven by our Payment Services
segment.
Direct Banking
Our 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 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, our credit card products generate
substantially all of our revenues related to discount and interchange, protection products and loan fee income.
Payment Services
Our Payment Services segment includes PULSE, an automated teller machine, debit and electronic funds transfer
network; Diners Club, a global payments network; and our Network Partners business, which provides payment
transaction processing and settlement services on the Discover Network. 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.
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The following table presents segment data (dollars in millions):
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
Direct Banking
Interest income
Credit card ........................................................................................ $
6,359
$
5,978
$
5,751
$
510
Private student loans ...........................................................................
PCI student loans ................................................................................
Personal loans ....................................................................................
Other ................................................................................................
Total interest income ........................................................................
Interest expense ......................................................................................
Net interest income .........................................................................
Provision for loan losses ..........................................................................
Other income .........................................................................................
Other expense ........................................................................................
Income before income tax expense ...................................................
Payment Services
Provision for loan losses ..........................................................................
Other income .........................................................................................
Other expense ........................................................................................
Income before income tax expense ...................................................
312
260
568
97
7,596
1,134
6,462
1,440
1,700
3,117
3,605
3
315
223
89
252
272
464
98
7,064
1,146
5,918
1,069
1,976
2,961
3,864
17
330
233
80
184
303
363
102
6,703
1,331
5,372
848
1,939
2,891
3,572
—
342
161
181
18
24
34
9
595
103
492
178
169
224
259
—
31
16
15
Total income before income tax expense ................................................... $
3,694
$
3,944
$
3,753
$
274
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The following table presents information on transaction volume (in millions):
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
Network Transaction Volume
PULSE Network ...................................................................................... $
165,851
$
159,805
$
159,944
$
14,133
Network Partners ....................................................................................
Diners Club(1)
.........................................................................................
Total Payment Services ........................................................................
Discover Network—Proprietary(2) .............................................................
9,446
26,970
202,267
119,471
9,808
26,867
196,480
113,791
8,754
28,644
197,342
109,014
Total Volume ...................................................................................... $
321,738
$
310,271
$
306,356
$
Transactions Processed on Networks
Discover Network ...................................................................................
PULSE Network ......................................................................................
Total ..................................................................................................
2,020
4,283
6,303
1,947
4,187
6,134
1,844
4,321
6,165
885
2,274
17,292
10,987
28,279
183
357
540
Credit Card Volume
Discover Card Volume(3) .......................................................................... $
125,111
Discover Card Sales Volume(4) ................................................................. $
115,518
$
$
118,594
109,957
$
$
114,213
105,454
$
$
11,384
10,657
(1) Diners Club volume is derived from data provided by licensees for Diners Club branded cards issued outside North America and is subject to subsequent revision or
amendment.
Represents gross proprietary sales volume on the Discover Network.
Represents Discover card activity related to net sales, balance transfers, cash advances and other activity.
Represents Discover card activity related to net sales.
(2)
(3)
(4)
Direct Banking
For the Year Ended December 31, 2014 compared to the Year Ended December 31, 2013
Our Direct Banking segment reported pretax income of $3.6 billion for the year ended December 31, 2014, as
compared to pretax income of $3.9 billion for the year ended December 31, 2013.
Loan receivables totaled $69.9 billion at December 31, 2014, which was up from $65.8 billion at December 31,
2013, due to growth in credit card loans and other loan portfolios partially offset by a decrease in purchased credit-
impaired ("PCI") student loan balances. The growth in credit card loans was due to growth in customers with revolving
balances partially offset by a higher net principal charge-off rate. The growth within the other loans portfolio was
primarily attributable to organic growth in personal and private student loans. Discover card sales volume was $115.5
billion for the year ended December 31, 2014, which was an increase of 5% as compared to the year ended December
31, 2013. This volume growth was driven primarily by continued growth in new accounts combined with lower
attrition.
Net interest margin increased for the year ended December 31, 2014 as compared to the year ended December
31, 2013. This was primarily driven by higher yields on total loan receivables combined with lower interest rates on
funding. The increase in loan receivable yields was driven by higher interest rates and growth in non-promotional
revolving balances, partially offset by decline in higher rate balances along with growth in credit card promotional
balances.
Interest income increased during the year ended December 31, 2014 as compared to the year ended December
31, 2013 primarily due to higher average balances of credit card loans, personal loans and private student loans
resulting from growth across these products. The increase was also attributable to higher yields on credit card loans and
PCI student loans, partially offset by a decrease in yield on personal loans along with a decrease in PCI student loan
balances.
Interest expense was relatively flat during the year ended December 31, 2014 as compared to the year ended
December 31, 2013, as lower interest expense on deposits attributable to lower yields was offset by higher interest
expense resulting from increase in borrowings.
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At December 31, 2014 and December 31, 2013, our delinquency rate for credit card loans over 30 days past
due was 1.73% and 1.72%, respectively. For the year ended December 31, 2014, our net charge-off rate on credit
cards remained relatively flat as compared to the year ended December 31, 2013. Recent loan growth has led to an
increase in reserves required to cover losses from loan seasoning. An increase in reserve requirements combined with
lower recoveries led to an increase in the provision for loan losses for the year ended December 31, 2014, as
compared to the year ended December 31, 2013. For a more detailed discussion on provision for loan losses, see "—
Loan Quality — Provision and Allowance for Loan Losses."
Total other income decreased for the year ended December 31, 2014 as compared to the year ended December
31, 2013 primarily due to a one-time charge to customer rewards costs resulting from the elimination of our current
estimate of customer rewards forfeiture of $178 million, which reduced discount and interchange revenue. Gain on sale
of mortgage loans also decreased, driven primarily by lower mortgage refinance volume due to increased mortgage
interest rates in 2013, as well as changes in product mix. The overall decrease in other income was also attributable to
a decrease in protection product revenue reflecting lower sales volume as we have stopped selling these products.
Total other expense increased for the year ended December 31, 2014 as compared to the year ended December
31, 2013. The increase was primarily due to higher employee compensation costs driven by growth in headcount,
along with higher professional fees related to technology and digital investments. Marketing and business development
costs, and information processing and communications costs also increased due to growth initiatives. The goodwill
impairment of $27 million related to the Discover Home Loans business also contributed to overall increase in total
other expenses. For more information, see Note 7: Goodwill and Intangible Assets to our consolidated financial
statements.
For the Calendar Year Ended December 31, 2013 compared to the Fiscal Year Ended November 30, 2012
Our Direct Banking segment reported pretax income of $3.9 billion for the calendar year ended December 31,
2013, as compared to pretax income of $3.6 billion for the fiscal year ended November 30, 2012.
Loan receivables totaled $65.8 billion at December 31, 2013, which was up from $62.6 billion at December 31,
2012, due to growth in credit card loans and other loan portfolios partially offset by a decrease in PCI loans balances.
The growth in credit card loans was due to growth in customers with revolving balances combined with a continued
improvement in the net principal charge-off rate. The growth within the other loans portfolio was primarily attributable
to organic growth in personal and private student loans. Discover card sales volume was $110.0 billion for the
calendar year ended December 31, 2013, which was an increase of 4% as compared to the fiscal year ended
November 30, 2012. This increase was driven primarily by continued growth in our active customer base combined
with seasonal promotional programs driving incremental sales.
Net interest margin increased for the calendar year ended December 31, 2013 as compared to the fiscal year
ended November 30, 2012. This was primarily driven by decreased funding costs and growth in loan receivables,
partially offset by lower yields on total loan receivables. The decrease in loan receivable yields was driven by growth in
credit card promotional balances and a decline in higher rate balances, partially offset by growth in non-promotional
revolving balances.
Interest income increased during the calendar year ended December 31, 2013 as compared to the fiscal year
ended November 30, 2012 primarily due to higher average balances of credit card loans, personal loans and private
student loans resulting from growth across these products combined with lower credit card loan interest charge-offs. The
increase in interest income from these products was partially offset by a decrease in yield on credit card loan
receivables along with a decrease in PCI student loan volume.
Interest expense declined during the calendar year ended December 31, 2013 as compared to the fiscal year
ended November 30, 2012 primarily due to lower funding costs resulting from maturities of higher interest borrowings
and deposits that were replaced with borrowings and deposits paying low interest rates.
At December 31, 2013, our delinquency rate for credit card loans over 30 days past due was 1.72% as
compared to 1.79% at December 31, 2012, reflective of continuing trends of strong credit performance. For the
calendar year ended December 31, 2013, our net charge-off rate on credit cards declined to 2.21%, as compared to
2.62% for the fiscal year ended November 30, 2012. An increase in reserve requirements partially offset by a decline
in the level of net charge-offs led to an increase in the provision for loan losses for the calendar year ended December
31, 2013, as compared to the fiscal year ended November 30, 2012. For a more detailed discussion on provision for
loan losses, see "— Loan Quality — Provision and Allowance for Loan Losses."
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Total other income increased for the calendar year ended December 31, 2013 as compared to the fiscal year
ended November 30, 2012 primarily due to an increase in discount and interchange revenue, which was driven by an
increase in sales volume. Gain on sale of mortgage loans also increased, reflecting a full year of activity for the
calendar year ended December 31, 2013 as compared to a partial year of activity for the fiscal year ended November
30, 2012, due to the acquisition and integration of assets of Home Loan Center in June of 2012. The overall increase in
other income was partially offset by a decrease in protection product revenue reflecting lower sales volume as we have
stopped selling these products. Loan fee income also decreased due to lower levels of delinquencies which resulted in a
lower level of loan fees being generated. Additionally, the increase was partially offset by decrease in refinance
mortgage loan volume due to increasing interest rates during 2013.
Total other expense increased for the calendar year ended December 31, 2013 as compared to the fiscal year
ended November 30, 2012 primarily due to an increase in employee compensation costs driven by increased
headcount. Marketing and business development costs also increased due to growth initiatives. Higher information
processing and communication expenses also contributed to the increase as a result of higher software maintenance,
licenses, and technology expenses due to growth initiatives. The overall expense increase was partially offset by legal
expenses associated with the consent order that Discover Bank entered into with the FDIC and CFPB, for which there
was no equivalent impact in 2013.
Payment Services
For the Year Ended December 31, 2014 compared to the Year Ended December 31, 2013
Our Payment Services segment reported pretax income of $89 million for the year ended December 31, 2014,
up $9 million as compared to the year ended December 31, 2013, primarily as the result of a decrease in loan losses
related to certain Diners Club licensee loans and other expense, partially offset by a decrease in other income. The
decrease in other expense was primarily due to non-recurring expenses incurred in 2013 related to our purchase of the
Diners Club Italy licensee and financial assistance to facilitate the purchase of the Slovenian licensee by a European
bank. The decrease in other expense was partially offset by a fair value adjustment of $21 million resulting from
recording Diners Club Italy as held-for-sale in 2014. The decrease in other income was primarily driven by a decrease
in transaction processing revenue reflecting the impact of merchant rerouting and lower rates.
Transaction dollar volume increased $5.8 billion for the year ended December 31, 2014 as compared to the
year ended December 31, 2013, primarily driven by a growth in PULSE network volume. The number of transactions
processed on the PULSE network increased slightly for the year ended December 31, 2014 as compared to the year
ended December 31, 2013.
We have been working with our European Diners Club licensees with regard to their ability to maintain financing
sufficient to support business operations. We may provide additional support in the future, including loans, facilitating
transfer of ownership, or acquiring assets or licenses, which may cause us to incur losses. The licensees that we
currently consider to be of concern accounted for approximately 4% of Diners Club revenue for the year ended
December 31, 2014. In addition, Diners Club has $151 million of non-amortizable intangible assets at December 31,
2014. While we determined that none of these intangibles are presently impaired, to the extent that we are unable to
maintain Diners Club revenues at appropriate levels, we may be exposed to a non-cash impairment loss on these assets
that, when recognized, could have a material adverse impact on our results of operations.
For the Calendar Year Ended December 31, 2013 compared to the Fiscal Year Ended November 30, 2012
Our Payment Services segment reported pretax income of $80 million for the calendar year ended December 31,
2013, down $101 million as compared to the fiscal year ended November 30, 2012, primarily as the result of an
increase in other expense and to a lesser extent a decrease in other income. The increase in other expense was
primarily due to an increase in expenses attributable to support of our Diners Club network and in employee
compensation reflecting an increase in headcount. The decrease in other income was primarily driven by a decrease in
transaction processing revenue reflecting the impact of merchant rerouting and lower rates.
Transaction dollar volume decreased $862 million for the calendar year ended December 31, 2013 as compared
to the fiscal year ended November 30, 2012, primarily driven by a reduction in Diners Club volume due to the impact
of currency exchange rates, partially offset by an increase in Network Partners volume.
As previously disclosed, we have been working with our European Diners Club licensees with regard to their
ability to maintain financing sufficient to support business operations. For example, we have provided loans to certain
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licensees that have an outstanding balance of approximately $36 million at December 31, 2013. We have undrawn
commitments to lend these licensees up to an additional $19 million as of December 31, 2013, subject to collateral
requirements stated in the individual agreements. During 2013, we acquired Diners Club Italy, which included $34
million of receivables, and we provided financial assistance to facilitate the purchase of our Slovenian licensee by a
European bank. These transactions resulted in a charge to earnings of approximately $40 million in the second quarter
of 2013. Additionally, we increased reserves by $15 million related to the loans to certain European Diners Club
licensees, discussed above, due to liquidity concerns. There were no similar acquisitions, asset write downs or
allowances in the prior year period.
Critical Accounting Estimates
In preparing our consolidated financial statements in conformity with accounting principles generally accepted in
the United States (“GAAP”), management must make judgments and use estimates and assumptions about the effects of
matters that are uncertain. For estimates that involve a high degree of judgment and subjectivity, it is possible that
different estimates could reasonably be derived for the same period. For estimates that are particularly sensitive to
changes in economic or market conditions, significant changes to the estimated amount from period to period are also
possible. Management believes the current assumptions and other considerations used to estimate amounts reflected in
our consolidated financial statements are appropriate. However, if actual experience differs from the assumptions and
other considerations used in estimating amounts in our consolidated financial statements, the resulting changes could
have a material effect on our consolidated results of operations and, in certain cases, could have a material effect on
our consolidated financial condition. Management has identified the estimates related to our allowance for loan losses,
the evaluation of goodwill and other non-amortizable intangible assets for potential impairment, the accrual of income
taxes, and estimates of future cash flows associated with PCI loans as critical accounting estimates. Historically,
management has considered the estimate of reward forfeitures to be a critical accounting estimate. In the fourth quarter
of 2014, management made a series of changes to the redemption elements of our customer rewards program
eliminating the forfeiture of rewards. These changes resulted in a one-time expense of $178 million due to the reversal
of our current estimate for customer rewards forfeiture, a contra-liability account. With elimination of the forfeiture
reward estimate, the determination of customer rewards cost no longer involves the use of a critical accounting estimate.
See "— Other Income" and Note 2: Summary of Significant Accounting Policies to our consolidated financial
statements for further details about customer rewards cost.
Allowance for Loan Losses
We base our allowance for loan losses on several analyses that help us estimate incurred losses as of the balance
sheet date. This estimate considers uncollectible principal, interest and fees reflected in the loan receivables. While our
estimation process includes historical data and analysis, there is a significant amount of judgment applied in selecting
inputs and analyzing the results produced to determine the allowance. We use a migration analysis to estimate the
likelihood that a loan will progress through the various stages of delinquency. Management also estimates loss
emergence by using other analyses to estimate losses incurred from non-delinquent accounts. The considerations in
these analyses include past and current loan performance, loan seasoning and growth, current risk management
practices, account collection strategies, economic conditions, bankruptcy filings, policy changes and forecasting
uncertainties. Given the same information, others may reach different reasonable estimates.
If management used different assumptions in estimating incurred net loan losses, the impact to the allowance for
loan losses could have a material effect on our consolidated financial condition and results of operations. For example,
a 10% change in management's estimate of incurred net loan losses could have resulted in a change of approximately
$175 million in the allowance for loan losses at December 31, 2014, with a corresponding change in the provision for
loan losses. See "— Loan Quality" and Note 2: Summary of Significant Accounting Policies to our consolidated
financial statements for further details about our allowance for loan losses.
Goodwill
We recognize goodwill when the purchase price of an acquired business exceeds the total of the fair values of
the acquired net assets. As required by GAAP, we test goodwill for impairment annually, or more often if indicators of
impairment exist. In evaluating goodwill for impairment, management must estimate the fair value of the reporting unit
(s) to which the goodwill relates. Because market data concerning acquisitions of comparable businesses typically are
not readily obtainable, other valuation techniques such as earnings multiples and cash flow models are used in
estimating the fair values of these reporting units. In applying these techniques, management considers historical results,
business forecasts, market and industry conditions and other factors. We may also consult independent valuation
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experts where needed in applying these valuation techniques. The valuation methodologies we use involve assumptions
about business performance, revenue and expense growth, capital expenditures, discount rates and other assumptions
that are judgmental in nature.
During the fourth quarter of 2013, we changed the date of its annual goodwill impairment test from June 1 to
October 1. This goodwill impairment test date change was applied prospectively beginning on October 1, 2013 and
had no effect on the consolidated financial statements.
At December 31, 2014, we had goodwill of $257 million. If economic conditions deteriorate or other events
adversely impact the assumptions used by management in these valuations, we may be exposed to an impairment loss
that, when recognized, could have a material impact on our consolidated financial condition and results of operations.
At December 31, 2014, based on the annual impairment testing performed, there was the recognition of an impairment
charge of $27 million related to the Discover Home Loans business. No other impairment was identified. See Note 7:
Goodwill and Intangible Assets to our consolidated financial statements for further details about goodwill and the
related impairment charge.
Other Non-amortizable Intangible Assets
We recognized certain other non-amortizable intangible assets in our acquisition of the Diners Club business. As
required by GAAP, we test other non-amortizable intangible assets for impairment annually, or more often if indicators
of impairment exist. Because market data concerning acquisitions of intangible assets is not readily available,
management evaluates non-amortizable intangible assets for potential impairment by estimating their fair values using
discounted cash flow models. In applying these techniques, management considers historical results, business forecasts,
market and industry conditions and other factors. We may also consult independent valuation experts where needed in
applying these valuation techniques. The valuation methodologies we use involve assumptions about business
performance, revenue and expense growth, discount rates and other assumptions that are judgmental in nature.
During the fourth quarter of 2013, we changed the date of its annual impairment test for non-amortizable
intangible assets from June 1 to October 1. No impairment charges were identified during the impairment tests
conducted at June 1, 2013 and October 1, 2013.
At December 31, 2014, we had non-amortizable intangibles of $176 million. If economic conditions deteriorate
or other events adversely impact the assumptions used by management in these valuations, we may be exposed to an
impairment loss that, when recognized, could have a material impact on our consolidated financial condition and
results of operations. At December 31, 2014, based on the annual impairment testing performed, there was no
impairment recorded on any non-amortizable intangible asset.
Income Taxes
We are subject to the income tax laws of the jurisdictions where we have business operations, primarily the
United States, its states and municipalities. We must make judgments and interpretations about the application of these
inherently complex tax laws when determining the provision for income taxes and must also make estimates about when
in the future certain items will affect taxable income in the various taxing jurisdictions. Disputes over interpretations of
the tax laws may be settled with the taxing authority upon examination or audit. We regularly evaluate the likelihood of
assessments in each of the taxing jurisdictions resulting from current and subsequent years' examinations, and tax
reserves are established as appropriate.
Changes in the estimate of income taxes can occur due to tax rate changes, interpretations of tax laws, the status
and resolution of examinations by the taxing authorities, and newly enacted laws and regulations that impact the
relative merits of tax positions taken. When such changes occur, the effect on our consolidated financial condition and
results of operations can be significant. See Note 15: Income Taxes to our consolidated financial statements for
additional information about income taxes.
Purchased Credit-Impaired Loans
The estimate of expected future cash flows on purchased credit-impaired loans determines the amount of interest
income we can recognize in future periods and impacts whether a loan loss reserve must be established for these loans.
We reevaluate, by pool, the amount and timing of expected cash flows quarterly using updated loan portfolio
characteristics as well as assumptions regarding expected borrower default and prepayment behavior. Because
estimates of expected future cash flows on PCI loans involve assumptions and significant judgment, it is reasonably
-60-
possible that others could derive different estimates than ours for the same periods. In addition, changes in estimates
from one period to the next can have a significant impact on our consolidated financial condition and results of
operations. A decrease in expected cash flows involving an increase in estimated credit losses would result in an
immediate charge to earnings for the recognition of a loan loss provision. Increases or decreases in expected cash flows
related solely to changes in estimated prepayments or to changes in variable interest rate indices would result in
prospective yield adjustments over the remaining life of the loans. An increase in expected cash flows due to a
reduction in expected credit losses would result first in the reversal of any previously established loan loss reserve on
PCI loans through an immediate credit to earnings and then, if needed, a prospective adjustment to yield over the
remaining life of the loans.
If management used a different estimate of expected borrower defaults, our consolidated statement of financial
condition and results of operations could have differed. For example, a 10% increase in the expected borrower default
rate of each PCI loan pool as of December 31, 2014 could have resulted in an additional impairment of up to $11
million. This impairment would have been reflected as an increase in provision for loan losses and a decrease in the
carrying value of the PCI loans. The accounting and estimates used in our calculations are discussed further in Note 4:
Loan Receivables to our consolidated financial statements.
Earnings Summary
The following table outlines changes in our consolidated statements of income for the periods presented (dollars
in millions):
For the Calendar Years
Ended December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
Calendar Year 2014 vs.
Calendar Year 2013
increase (decrease)
Calendar Year 2013
vs. Fiscal Year 2012
increase (decrease)
$
%
$
%
Interest income .................. $
7,596
$
7,064
$
6,703
$
595
$
Interest expense ................
Net interest income ........
Provision for loan losses .....
Net interest income after
provision for loan
losses .........................
Other income ....................
Other expense ..................
Income before income
tax expense ................
Income tax expense ...........
1,134
6,462
1,443
5,019
2,015
3,340
3,694
1,371
1,146
5,918
1,086
4,832
2,306
3,194
3,944
1,474
1,331
5,372
848
4,524
2,281
3,052
3,753
1,408
103
492
178
314
200
240
274
104
Net income ................... $
2,323
$
2,470
$
2,345
$
170
$
532
(12)
544
357
187
(291)
146
(250)
(103)
(147)
8 % $
361
(1)%
9 %
33 %
4 %
(13)%
5 %
(6)%
(7)%
(185)
546
238
308
25
142
191
66
(6)% $
125
5 %
(14)%
10 %
28 %
7 %
1 %
5 %
5 %
5 %
5 %
Net Interest Income
The tables that follow this section have been provided to supplement the discussion below and provide further
analysis of net interest income, net interest margin and the impact of rate and volume changes on net interest income.
Net interest income represents the difference between interest income earned on our interest-earning assets and the
interest expense incurred to finance those assets. We analyze net interest income in total by calculating net interest
margin (net interest income as a percentage of average total loan receivables) and net yield on interest-bearing assets
(net interest income as a percentage of average total interest-earning assets). We also separately consider the impact of
the level of loan receivables and the related interest yield and the impact of the cost of funds related to each of our
funding sources, along with the income generated by our liquidity portfolio, on net interest income.
Our interest-earning assets consist of: (i) cash and cash equivalents, primarily related to amounts on deposit with
the Federal Reserve, (ii) restricted cash, (iii) other short-term investments, (iv) investment securities and (v) loan
receivables. Our interest-bearing liabilities consist primarily of deposits, both direct-to-consumer and brokered, and
long-term borrowings, including amounts owed to securitization investors. Net interest income is influenced by the
following:
-61-
•
•
•
•
The level and composition of loan receivables, including the proportion of credit card loans to other loans, as
well as the proportion of loan receivables bearing interest at promotional rates as compared to standard
rates;
The credit performance of our loans, particularly with regard to charge-offs of finance charges, which reduce
interest income;
The terms of long-term borrowings and certificates of deposit upon initial offering, including maturity and
interest rate;
The level and composition of other interest-bearing assets and liabilities, including our liquidity portfolio;
• Changes in the interest rate environment, including the levels of interest rates and the relationships among
interest rate indices, such as the prime rate, the Federal Funds rate and the London Interbank Offered Rate
("LIBOR");
•
•
The effectiveness of interest rate swaps in our interest rate risk management program; and
The difference between the carrying amount and future cash flows expected to be collected on PCI loans.
For the Year Ended December 31, 2014 compared to the Year Ended December 31, 2013
Net interest margin increased for the year ended December 31, 2014 as compared to the year ended December
31, 2013 primarily driven by an increase in the yield on total loan receivables combined with lower interest rates on
funding. The increase in loan receivable yields was driven by higher interest rates and growth in non-promotional
revolving balances, partially offset by a decline in higher rate balances along with growth in credit card promotional
balances.
Interest income increased during the year ended December 31, 2014 as compared to the year ended December
31, 2013 primarily due to higher average balances of credit card loans, personal loans and private student loans
resulting from growth across these products. The increase was also attributable to higher yields on credit card loans and
PCI student loans, partially offset by a decrease in yield on personal loans along with a decrease in PCI student loan
balances.
Interest expense was relatively flat during the year ended December 31, 2014 as compared to the year ended
December 31, 2013, as lower interest expense on deposits attributable to lower yields was offset by higher interest
expense resulting from increase in borrowings.
For the Calendar Year Ended December 31, 2013 compared to the Fiscal Year Ended November 30, 2012
Net interest margin increased for the calendar year ended December 31, 2013 as compared to the fiscal year
ended November 30, 2012 primarily driven by decreased funding costs and growth in loan receivables, partially offset
by lower yields on loan receivables. The decrease in loan receivable yields was driven by growth in credit card
promotional balances and a decline in higher rate balances, partially offset by growth in customers with revolving
balances.
Interest income increased during the calendar year ended December 31, 2013 as compared to the fiscal year
ended November 30, 2012 primarily due to higher interest income from credit card loans, personal loans and private
student loans resulting from growth across these products combined with lower credit card loan interest charge-offs. The
increase in interest income from these products was partially offset by a decrease in yield on credit card loan
receivables along with a decrease in PCI student loan balances.
Interest expense declined during the calendar year ended December 31, 2013 as compared to the fiscal year
ended November 30, 2012 primarily due to the combination of deposits bearing higher interest rates maturing and
being replaced by deposits bearing lower interest rates and maturities of borrowings and certain asset-backed
securities.
-62-
Average Balance Sheet Analysis
(dollars in millions)
Calendar Years Ended December 31,
2014
2013
Fiscal Year Ended
November 30, 2012
One Month Ended
December 31, 2012
Average
Balance
Rate
Interest
Average
Balance
Rate
Interest
Average
Balance
Rate
Interest
Average
Balance
Rate
Interest
Assets
Interest-earning assets:
Cash and cash equivalents ............................ $ 7,228
0.25% $
18
$ 5,557
0.25% $
14
$
5,074
0.27% $
14
$ 2,704
0.25% $ —
Restricted cash .............................................
763
Investment securities ......................................
4,000
0.08%
1.67%
1
67
704
5,190
0.10%
1.42%
1
74
924
6,437
0.15%
1.24%
2
80
1,400
6,247
0.11%
1.34%
—
7
Loan receivables(1):
Credit card(2)(3) ......................................
52,600
12.09%
6,359
49,816
12.00%
5,978
47,301
12.16%
5,751
50,494
11.92%
510
Personal loans .......................................
4,592
12.36%
Federal student loans(4) ...........................
—
NM
Private student loans ..............................
4,450
PCI student loans ...................................
3,916
Mortgage loans held for sale ..................
Other ...................................................
118
177
7.02%
6.64%
3.92%
3.49%
568
—
312
260
5
6
3,706
12.52%
—
NM
3,561
4,434
216
87
7.07%
6.13%
3.47%
3.00%
464
—
252
272
7
2
2,944
12.35%
363
3,290
12.43%
121
2,557
4,998
96
26
1.64%
7.20%
6.06%
1.10%
11.98%
2
184
303
1
3
—
NM
3,021
4,724
310
38
7.22%
5.96%
3.05%
5.24%
Total loan receivables .......................
65,853
11.40%
7,510
61,820
11.28%
6,975
58,043
11.38%
6,607
61,877
11.21%
Total interest-earning assets .........
77,844
9.76%
7,596
73,271
9.64%
7,064
70,478
9.51%
6,703
72,228
9.73%
Allowance for loan losses ............................
(1,645)
Other assets ...............................................
4,279
Total assets ................................. $ 80,478
(1,639)
4,348
$ 75,980
(1,948)
4,032
$ 72,562
(1,725)
4,234
$ 74,737
Liabilities and Stockholders’ Equity
Interest-bearing liabilities:
Interest-bearing deposits:
Time deposits(5) ...................................... $ 26,627
Money market deposits(6) ........................
7,624
Other interest-bearing savings deposits ...
10,617
Total interest-bearing deposits(7).........
44,868
Borrowings:
Short-term borrowings ...........................
111
Securitized borrowings(5)(6)......................
16,686
Other long-term borrowings(5) .................
4,192
Total borrowings ..............................
20,989
1.66%
0.91%
0.96%
1.37%
1.59%
1.78%
5.28%
2.48%
443
$ 27,718
70
101
614
2
297
221
520
5,719
9,428
42,865
199
16,297
2,609
19,105
2.02%
0.87%
0.95%
1.63%
1.57%
1.74%
6.18%
2.35%
559
$ 27,033
50
89
5,413
8,638
698
41,084
3
284
161
448
89
16,979
2,017
19,085
2.61%
0.92%
1.03%
2.06%
1.32%
1.95%
7.62%
2.55%
706
$ 27,849
50
89
5,368
8,864
845
42,081
1
331
154
486
283
16,998
1,733
19,014
Total interest-bearing liabilities .....
65,857
1.72%
1,134
61,970
1.85%
1,146
60,169
2.21%
1,331
61,095
2.29%
0.88%
1.00%
1.84%
1.36%
1.80%
7.82%
2.34%
1.99%
Other liabilities and stockholders’ equity .........
14,621
Total liabilities and stockholders’
equity ...................................... $ 80,478
14,010
$ 75,980
12,393
$ 72,562
13,642
$ 74,737
35
—
18
24
1
—
588
595
54
4
7
65
—
26
12
38
103
Net interest income......................
$ 6,462
$ 5,918
$ 5,372
$
492
Net interest margin(8) ........................................
Net yield on interest-bearing assets(9) .................
Interest rate spread(10) .......................................
9.81%
8.30%
8.04%
9.57%
8.08%
7.79%
9.25%
7.62%
7.30%
9.39%
8.05%
7.74%
(1) Average balances of loan receivables include non-accruing loans, which are included in the yield calculations. If the non-accruing loan balances were excluded,
(2)
(3)
there would not be a material impact on the amounts reported above.
Interest income on credit card loans includes $192 million, $171 million, $179 million and $14 million of amortization of balance transfer fees for the calendar
years ended December 31, 2014 and 2013, fiscal year ended November 30, 2012 and one month ended December 31, 2012, respectively.
The calendar year ended December 31, 2013, fiscal year ended November 30, 2012 and one month ended December 31, 2012 include the impact of interest rate
swap agreements used to change a portion of certain floating-rate credit card loan receivables to fixed-rate.
Includes federal student loans held for sale.
Includes the impact of interest rate swap agreements used to change a portion of fixed-rate funding to floating-rate funding.
Includes the impact of interest rate swap agreements used to change a portion of floating-rate funding to fixed-rate funding.
Includes the impact of FDIC insurance premiums.
(4)
(5)
(6)
(7)
(8) Net interest margin represents net interest income as a percentage of average total loan receivables.
(9) Net yield on interest-bearing assets represents net interest income as a percentage of average total interest-earning assets.
(10) Interest rate spread represents the difference between the rate on total interest-earning assets and the rate on total interest-bearing liabilities.
-63-
Rate/Volume Variance Analysis(1)
(dollars in millions)
Calendar Year Ended December 31, 2014 vs.
Calendar Year Ended December 31, 2013
Calendar Year Ended December 31, 2013 vs.
Fiscal Year Ended November 30, 2012
Volume
Rate
Total
Volume
Rate
Total
Increase/(decrease) in net interest income due to changes in:
Interest-earning assets:
Cash and cash equivalents ..................... $
4
$
— $
4
$
1
$
(1) $
Restricted cash ......................................
Investment securities ..............................
Loan receivables:
Credit card .......................................
Personal loans ..................................
Federal student loans .........................
Private student loans ..........................
PCI student loans ...............................
Mortgage loans held for sale..............
Other ...............................................
Total loan receivables ....................
Total interest income ................
Interest-bearing liabilities:
Interest-bearing deposits:
Time deposits ...................................
Money market deposits ......................
Other interest-bearing savings
deposits .........................................
Total interest-bearing deposits ........
Borrowings:
Short-term borrowings .......................
Securitized borrowings ......................
Other long-term borrowings ...............
Total borrowings ...........................
Total interest expense .................
—
(19)
336
110
—
62
(33)
(3)
3
475
460
(21)
17
11
7
(1)
7
86
92
99
—
12
45
(6)
—
(2)
21
1
1
60
72
(95)
3
1
(91)
—
6
(26)
(20)
(111)
—
(7)
381
104
—
60
(12)
(2)
4
535
532
(116)
20
12
(84)
(1)
13
60
72
(12)
—
(17)
302
96
(2)
71
(34)
2
3
438
422
18
3
8
29
2
(13)
40
29
58
(1)
11
(75)
5
—
(3)
3
4
(4)
(70)
(61)
—
(34)
(33)
(67)
(243)
(165)
(147)
(3)
(8)
—
—
(176)
(147)
—
(1)
(6)
227
101
(2)
68
(31)
6
(1)
368
361
2
(47)
7
(38)
(185)
546
Net interest income .................... $
361
$
183
$
544
$
364
$
182
$
(1)
The rate/volume variance for each category has been allocated on a consistent basis between rate and volume variances between the calendar years ended
December 31, 2014 and 2013, and fiscal year ended November 30, 2012 based on the percentage of the rate or volume variance to the sum of the two absolute
variances.
-64-
Loan Quality
Loan receivables consist of the following (dollars in millions):
December 31,
November 30,
2014
2013
2012
2012
2011
2010
Student loans held for sale ......................... $
— $
— $
— $
— $
714
$
788
Loan portfolio:
Credit card loans ..................................
56,128
53,150
51,135
49,642
46,972
45,502
Other loans:
Personal loans ..................................
Private student loans ..........................
Mortgage loans held for sale..............
Other ...............................................
Total other loans ...........................
PCI loans(1) ...........................................
Total loan portfolio ........................
Total loan receivables ................
Allowance for loan losses ..........................
5,007
4,850
122
202
10,181
3,660
69,969
69,969
(1,746)
4,191
3,969
148
135
8,443
4,178
65,771
65,771
(1,648)
3,296
3,072
355
38
6,761
4,702
62,598
62,598
(1,788)
3,272
3,000
322
37
6,631
4,744
61,017
61,017
(1,725)
2,648
2,069
—
17
4,734
5,250
56,956
57,670
(2,205)
1,878
999
—
14
2,891
—
48,393
49,181
(3,304)
Net loan receivables .................. $
68,223
$
64,123
$
60,810
$
59,292
$
55,465
$
45,877
(1)
Represents purchased credit-impaired private student loans (see Note 4: Loan Receivables to our consolidated financial statements).
Provision and Allowance for Loan Losses
Provision for loan losses is the expense related to maintaining the allowance for loan losses at an appropriate
level to absorb the estimated probable losses in the loan portfolio at each period end date. Factors that influence the
provision for loan losses include:
•
The impact of general economic conditions on the consumer, including unemployment levels, bankruptcy
trends and interest rate movements;
• Changes in consumer spending and payment behaviors;
• Changes in our loan portfolio, including the overall mix of accounts, products and loan balances within the
portfolio and maturation of the loan portfolio;
•
•
•
The level and direction of historical and anticipated loan delinquencies and charge-offs;
The credit quality of the loan portfolio, which reflects, among other factors, our credit granting practices and
effectiveness of collection efforts; and
Regulatory changes or new regulatory guidance.
In calculating the allowance for loan losses, we estimate probable losses separately for segments of the loan
portfolio that have similar risk characteristics. We use a migration analysis to estimate the likelihood that a loan will
progress through the various stages of delinquency. We use other analyses to estimate losses incurred from non-
delinquent accounts which adds to the identification of loss emergence. We use these analyses together as a basis for
determining our allowance for loan losses.
The allowance for loan losses was $1.7 billion at December 31, 2014, which reflects a $98 million reserve build
over the amount of the allowance for loan losses at December 31, 2013. The reserve build, which primarily related to
credit card loan receivables, was due mainly to seasoning of the loan growth and lower recoveries. "Seasoning" refers
to the maturing of a loan portfolio as, in general, growing loan balances do not begin to show signs of credit
deterioration or default until they have been in repayment for some period of time. At December 31, 2013, the
allowance for loan losses was $1.6 billion, which reflected a $140 million reserve release over the amount of the
allowance for loan losses at December 31, 2012. The reserve release, which primarily related to credit card loan
receivables, was driven by continuing favorability in delinquencies resulting in lower charge-offs, both contractual and
bankruptcy, which resulted in lower estimated losses.
-65-
The provision for loan losses is the amount of expense realized after considering the level of net charge-offs in the
period and the required amount of allowance for loan losses at the balance sheet date. For the year ended December
31, 2014, the provision for loan losses increased by $357 million, or 33%, as compared to the year ended December
31, 2013. The increase was primarily due to increasing levels of net charge-offs combined with the reserve build
discussed above. For the calendar year ended December 31, 2013, the provision for loan losses increased by $238
million, or 28%, as compared to the fiscal year ended November 30, 2012. The increase was due to lower levels of
reserve releases during the calendar year ended December 31, 2013 as compared to the fiscal year ended November
30, 2012, partially offset by a decrease in net charge-offs. For the one month ended December 31, 2012, the provision
for loan losses was $178 million, which included a reserve build of $63 million. This reserve build was due to an
increase in the forecast for net charge-offs due to loan growth. For the fiscal year ended November 30, 2012, a
reduction in reserve requirements led to a decrease in the provisions for loan losses of $165 million or 16%.
At December 31, 2014, the level of the allowance related to personal loans and student loans increased as
compared to December 31, 2013 due to loan growth and continued seasoning of the portfolios. For student loans,
payments are not required while the borrower is still in school; therefore, this loan portfolio matures at a slower pace
than our other loan portfolios. The level of allowance related to other loans was unchanged for the period.
At December 31, 2013, the level of the allowance related to personal loans increased as compared to
December 31, 2012 due to loan growth and continued seasoning of the portfolio. The level of allowance attributable to
student loans for the same period increased, primarily due to a PCI student loan impairment recorded as a result of
revisions to credit loss assumptions for the underlying loans. In addition, the allowance related to student loans
increased due to growth and continued seasoning of the portfolio. The level of allowance related to other loans at
December 31, 2013 as compared to December 31, 2012 increased by $16 million driven primarily by provision
charges on a small number of loans to Diners Club licensees.
-66-
The following tables provide changes in our allowance for loan losses for the periods presented (dollars in
millions):
For the Calendar Year Ended December 31, 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 .................................................
1,259
102
Deductions:
Charge-offs ...................................................................
(1,636)
Recoveries .....................................................................
445
Net charge-offs ..........................................................
(1,191)
(105)
11
(94)
79
(62)
5
(57)
3
(3)
—
(3)
1,443
(1,806)
461
(1,345)
Balance at end of period .................................................... $
1,474
$
120
$
135
$
17
$
1,746
For the Calendar Year Ended December 31, 2013
Credit Card
Personal
Loans
Student Loans
Other
Total
Balance at beginning of period ........................................... $
1,613
$
99
$
75
$
1
$
1,788
Additions:
Provision for loan losses .................................................
893
Deductions:
Charge-offs ...................................................................
(1,604)
Recoveries .....................................................................
504
Net charge-offs ..........................................................
(1,100)
92
(86)
7
(79)
84
(48)
2
(46)
17
1,086
(1)
—
(1)
(1,739)
513
(1,226)
Balance at end of period .................................................... $
1,406
$
112
$
113
$
17
$
1,648
For the One Month Ended December 31, 2012
Credit Card
Personal
Loans
Student Loans
Other
Total
Balance at beginning of period ........................................... $
1,554
$
97
$
73
$
1
$
1,725
Additions:
Provision for loan losses .................................................
165
Deductions:
Charge-offs ...................................................................
Recoveries .....................................................................
Net charge-offs ..........................................................
(146)
40
(106)
9
(8)
1
(7)
4
(2)
—
(2)
—
—
—
—
178
(156)
41
(115)
Balance at end of period .................................................... $
1,613
$
99
$
75
$
1
$
1,788
-67-
The following tables provide changes in our allowance for loan losses for the periods presented (dollars in
millions):
For the Fiscal Year Ended November 30, 2012
Credit Card
Personal
Loans
Student Loans
Other
Total
Balance at beginning of period ........................................... $
2,070
$
82
$
53
$
— $
2,205
Additions:
Provision for loan losses .................................................
724
Deductions:
Charge-offs ...................................................................
(1,817)
Recoveries .....................................................................
577
Net charge-offs ..........................................................
(1,240)
84
(73)
4
(69)
39
(19)
—
(19)
1
—
—
—
848
(1,909)
581
(1,328)
Balance at end of period .................................................... $
1,554
$
97
$
73
$
1
$
1,725
For the Fiscal Year Ended November 30, 2011
Credit Card
Personal
Loans
Student Loans
Other
Total
Balance at beginning of period ........................................... $
3,209
$
76
$
18
$
1
$
3,304
Additions:
Provision for loan losses .................................................
897
Deductions:
Charge-offs ...................................................................
(2,615)
Recoveries .....................................................................
579
Net charge-offs ..........................................................
(2,036)
73
(69)
2
(67)
42
(7)
—
(7)
1
(2)
—
(2)
1,013
(2,693)
581
(2,112)
Balance at end of period .................................................... $
2,070
$
82
$
53
$
— $
2,205
For the Fiscal Year Ended November 30, 2010
Credit Card
Personal
Loans
Student Loans
Other
Total
Balance at beginning of period ........................................... $
1,648
$
95
$
14
$
1
$
1,758
Additions:
Addition to allowance related to securitized
receivables(1) ................................................................
Provision for loan losses .................................................
2,144
3,126
Deductions:
Charge-offs related to loans sold .....................................
(25)
Charge-offs ...................................................................
(4,154)
Recoveries .....................................................................
470
Net charge-offs ..........................................................
(3,684)
—
72
—
(92)
1
(91)
—
8
—
(4)
—
(4)
—
1
—
(1)
—
(1)
2,144
3,207
(25)
(4,251)
471
(3,780)
Balance at end of period .................................................... $
3,209
$
76
$
18
$
1
$
3,304
(1) On December 1, 2009, upon adoption of the Financial Accounting Standards Board (“FASB”) Statements No. 166 and 167, we recorded $2.1 billion allowance for
loan losses related to newly consolidated and reclassified credit card loan receivables.
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Net Charge-offs
Our net charge-offs include the principal amount of losses charged off less principal recoveries and exclude
charged-off and recovered 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 provision for
loan losses, 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.
The following table presents amounts and rates of net charge-offs of key loan products (dollars in millions):
For the Calendar Years Ended
December 31,
For the Fiscal Years Ended November 30,
2014
2013
2012
2011
2010
For the One
Month Ended
December 31,
2012
$
%
$
%
$
%
$
%
$
%
$
%
Credit card loans.......... $ 1,191
2.27% $ 1,100
2.21% $ 1,240
2.62% $ 2,036
4.47% $ 3,684
8.02% $ 106
2.47%
Personal loans .............. $
94
2.04% $
79
2.13% $
69
2.33% $
67
3.02% $
91
5.72% $
Private student loans
(excluding PCI(1))......... $
57
1.29% $
46
1.30% $
19
0.73% $
7
0.48% $
4
0.33% $
7
2
2.52%
0.81%
(1) Charge-offs for PCI loans did not result in a charge to earnings during any of the years presented and are therefore excluded from the calculation. See Note 4: Loan
Receivables to our consolidated financial statements for more information regarding the accounting for charge-offs on PCI loans.
While the net charge-off rate on our credit card loan receivables went to 2.27% from 2.21% for the year ended
December 31, 2014 as compared to the year ended December 31, 2013, we remain in a period of historical lows. The
net charge-off rate on our personal loan receivables declined by 9 basis points for the same period due to growth in the
personal loan portfolio as, in general, loans do not begin to show signs of credit deterioration or default for some
period of time after origination. The net charge-off rate on our private student loans excluding PCI loans was relatively
flat for the year ended December 31, 2014 as compared to year ended December 31, 2013.
The net charge-off rate on our credit card loan receivables decreased 41 basis points for the calendar year
ended December 31, 2013 as compared to the fiscal year ended November 30, 2012. The decrease in the net charge-
off rate for credit card loan receivables was driven by lower net charge-offs due to the continuing trend of low
delinquencies combined with higher receivables balances. The net charge-off rate on our personal loan receivables
declined by 20 basis points for the same period due to growth in the personal loan portfolio. The net charge-off rate on
our private student loans excluding PCI loans increased 57 basis points due to a larger portion of the portfolio entering
repayment.
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Delinquencies
Delinquencies are an indicator of credit quality at a point in time. A loan balance is considered delinquent when
contractual payments on the loan become 30 days past due.
The following table presents the amounts and delinquency rates of key loan products that are 30 and 90 days or
more delinquent, loan receivables that are not accruing interest, regardless of delinquency and restructured loans
(dollars in millions):
Calendar Years Ended
December 31,
Fiscal Years Ended November 30,
2014
2013
2012
2011
2010
One Month
Ended
December 31,
2012
$
%
$
%
$
%
$
%
$
%
$
%
Loans 30 days delinquent or
more:
Credit card loans ................ $ 971
1.73% $ 912
1.72% $ 925
1.86% $1,117
2.38% $1,831
4.02% $ 917
1.79%
Personal loans .................... $
40
0.79% $
29
0.70% $
25
0.76% $
22
0.87% $
29
1.57% $
26
0.77%
Private student loans
(excluding PCI(1)) ............... $
Loans 90 days delinquent or
more:
87
1.80% $
66
1.66% $
32
1.07% $
13
0.63% $
5
0.50% $
37
1.22%
Credit card loans ................ $ 480
0.85% $ 447
0.84% $ 451
0.91% $ 560
1.19% $ 958
2.11% $ 460
0.90%
Personal loans .................... $
11
0.22% $
8
0.21% $
Private student loans
(excluding PCI(1)) ............... $
25
0.52% $
18
0.46% $
8
8
0.23% $
0.27% $
7
3
0.28% $
11
0.57% $
0.14% $
1
0.14% $
8
9
0.23%
0.29%
Loans not accruing interest ...... $ 183
0.28% $ 200
0.33% $ 198
0.35% $ 207
0.40% $ 326
0.67% $ 192
0.33%
Restructured loans:
Credit card loans(2) ............. $1,037
1.85% $1,123
2.11% $1,332
2.68% $1,217
2.59% $ 305
0.67% $1,309
2.56%
Personal loans(3) ................. $
55
1.10% $
31
0.74% $
21
0.64% $
Private student loans
(excluding PCI(1))(4) ............ $
38
0.78% $
28
0.71% $
15
0.50% $
8
5
0.29% $ —
—% $
21
0.65%
0.26% $ —
—% $
16
0.53%
(1)
(2)
(3)
(4)
Excludes PCI loans which are accounted for on a pooled basis. Since a pool is accounted for as a single asset with a single composite interest rate and aggregate
expectation of cash flows, the past-due status of a pool, or that of the individual loans within a pool, is not meaningful. Because we are recognizing interest income
on a pool of loans, it is all considered to be performing.
Restructured loans include $44 million, $43 million, $54 million, $56 million, $38 million and $35 million at December 31, 2014, 2013 and 2012 and
November 30, 2012, 2011 and 2010, respectively, that are also included in loans over 90 days delinquent or more.
Restructured loans include $3 million, $2 million, $2 million and $1 million at December 31, 2014, 2013 and 2012 and November 30, 2012 respectively, that are
also included in loans over 90 days delinquent or more.
Restructured loans include $5 million, $3 million, $2 million and $2 million at December 31, 2014, 2013 and 2012 and November 30, 2012 respectively, that are
also included in loans over 90 days delinquent or more.
Credit card receivables 30-day and 90-day delinquency rates at December 31, 2014 were relatively flat as
compared to December 31, 2013. The 30-day delinquency rate for personal loans increased slightly for the same
period due to seasoning of the loan portfolio, while the 90-day delinquency rate remained relatively flat. The 30-day
and 90-day delinquency rates for private student loan balances at December 31, 2014 increased compared to the
prior year as a result of continued seasoning of the student loan portfolio.
Both credit card and personal loan receivables 30-day and 90-day delinquency rates at December 31, 2013
decreased slightly as compared to December 31, 2012 due to continuing favorable economic factors. The delinquency
rates for private student loan balances at December 31, 2013 increased as compared to December 31, 2012 due to
the seasoning of our loan portfolio as more loans have entered repayment.
The restructured credit card loan balance decreased at both December 31, 2014 as compared to December 31,
2013 and at December 31, 2013 as compared December 31, 2012 due to continued improvement in customer credit
performance. The restructured personal and private student loan balances increased at both December 31, 2014 as
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compared to December 31, 2013 and at December 31, 2013 as compared to December 31, 2012 as a result of
continued growth in and seasoning of these loan portfolios.
Maturities and Sensitivities of Loan Receivables to Changes in Interest Rates
Our loan portfolio had the following maturity distribution(1) (dollars in millions):
Due One
Year or
Less
Due After
One Year
Through
Five Years
Due After
Five Years
Total
At December 31, 2014
Credit card loans ........................................................................................ $
16,253
$
29,715
$
10,160
$
56,128
Personal loans ............................................................................................
1,352
Private student loans (excluding PCI) .............................................................
PCI loans ...................................................................................................
Mortgage loans held for sale .......................................................................
Other loans ................................................................................................
110
310
122
27
3,505
949
1,234
—
56
150
3,791
2,116
—
119
5,007
4,850
3,660
122
202
Total loan portfolio .................................................................................. $
18,174
$
35,459
$
16,336
$
69,969
(1)
Because of the uncertainty regarding loan repayment patterns, the above amounts have been calculated using contractually required minimum payments.
Historically, actual loan repayments have been higher than such minimum payments and, therefore, the above amounts may not necessarily be indicative of our
actual loan repayments.
At December 31, 2014, approximately $35.0 billion of our loan portfolio due after one year had interest rates
tied to an index and approximately $16.8 billion were fixed-rate loans.
Modified and Restructured Loans
We have loan modification programs that provide for temporary or permanent hardship relief for our credit card
loans to borrowers experiencing financial difficulties. 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
modification 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. We
also make loan modifications for customers who request financial assistance through external sources, such as a
consumer credit counseling agency program. These loans continue to be subject to the original minimum payment terms
and do not normally include waiver of unpaid principal, interest or fees. For additional information regarding the
accounting treatment for these loans as well as amounts recorded in the financial statements related to these loans, see
Note 4: Loan Receivables to our consolidated financial statements.
For student loan borrowers, in certain situations we offer hardship payment forbearance to borrowers who are
experiencing temporary financial difficulties and are willing to resume making payments. When a borrower is 30 or
more days delinquent and granted a second hardship forbearance period, we classify these loans as troubled debt
restructurings. In addition, we offer 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. 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. No loans have been in a temporary modification program for greater than 12
months.
For personal loan customers, in certain situations we offer 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 programs involve 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. We also allow loan modifications for customers
who request financial assistance through external sources, similar to our credit card customers discussed above.
Payments are modified based on the new terms agreed upon with the credit counseling agency. Personal loans included
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in temporary and permanent programs are accounted for as troubled debt restructurings. Beginning in first quarter of
2014, loan modifications through external sources are accounted for as troubled debt restructurings.
Borrower performance after using payment programs or forbearance is monitored and we believe the programs
help to prevent defaults and are useful in assisting customers experiencing financial difficulties. We plan to continue to
use payment programs and forbearance and, as a result, we expect to have additional loans classified as troubled debt
restructurings in the future.
Other Income
The following table presents the components of other income for the periods presented (dollars in millions):
For the Calendar Years
Ended December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
2014 Calendar Year vs.
2013 Calendar Year
(decrease) increase
2013 Calendar Year vs.
2012 Fiscal Year
increase (decrease)
$
%
$
%
Discount and interchange
revenue(1) ....................... $
979
$
1,126
$
1,035
$
Protection products ...........
Loan fee income ...............
Transaction processing
revenue ..........................
Gain on investments ..........
Gain on origination and
sale of mortgage loans ....
Other income ...................
314
334
182
4
81
121
350
320
192
5
144
169
409
325
218
26
105
163
82
33
29
18
2
17
19
$
(147)
(13)% $
(36)
14
(10)
(1)
(63)
(48)
(10)%
4 %
(5)%
(20)%
(44)%
(28)%
Total other income ........ $
2,015
$
2,306
$
2,281
$
200
$
(291)
(13)% $
91
(59)
(5)
(26)
(21)
39
6
25
9 %
(14)%
(2)%
(12)%
(81)%
37 %
4 %
1 %
(1) Net of rewards, including Cashback Bonus rewards, of $1.4 billion, $1.0 billion, $1.0 billion and $123 million for the calendar years ended December 31, 2014
and 2013, fiscal year ended November 30, 2012 and one month ended December 31, 2012, respectively. During the three months ended December 31, 2014, we
made certain changes to its customer rewards program, eliminating forfeitures. These changes resulted in a one-time expense of $178 million due to the reversal of
the estimate for customer rewards forfeiture, a contra-account to accrued expenses and other liabilities. Actual forfeitures resulted in additional discount and
interchange revenue and total other income of $36 million each for the calendar years ended December 31, 2014 and 2013 and $35 million and $3 million for the
fiscal year ended November 30, 2012 and one month ended December 31, 2012, respectively.
Discount and Interchange Revenue
Discount and interchange revenue includes discount revenue and acquirer interchange net of interchange paid to
network partners. We earn discount revenue from fees charged to merchants with whom we have entered into card
acceptance agreements for processing credit card purchase transactions. We earn acquirer interchange revenue from
merchant acquirers on all Discover Network card transactions and certain Diners Club transactions made by credit card
customers at merchants with whom merchant acquirers have entered into card acceptance agreements for processing
credit card purchase transactions. We incur an interchange cost to card issuing entities that have entered into
contractual arrangements to issue cards on the Discover Network and on certain transactions on the Diners Club
network. This cost is contractually established and is based on the card issuing organization's transaction volume and is
reported as a reduction to discount and interchange revenue. We offer our customers various reward programs,
including the Cashback Bonus reward program, pursuant to which we pay certain customers a percentage of their
purchase amounts based on the type and volume of the customer's purchases. Reward costs are recorded as a
reduction to discount and interchange revenue.
Discount and interchange revenue decreased for the year ended December 31, 2014 as compared to the year
ended December 31, 2013, driven primarily by the rewards redemption policy change. This increase in rewards was
partially offset by the increase in gross discount and interchange revenue, which was primarily attributable to higher
sales volume. Discount and interchange revenue increased for the calendar year ended December 31, 2013 as
compared to the fiscal year ended November 30, 2012, driven by higher sales volume.
-72-
Protection Products
We earn revenue related to fees received for providing ancillary products and services, including payment
protection and identity theft protection services, to customers. The amount of revenue recorded is generally based on
either a percentage of a customer's outstanding balance or a flat fee and is recognized as earned.
Protection product revenue decreased for the year ended December 31, 2014 as compared to the year ended
December 31, 2013, as well as for the calendar year ended December 31, 2013 as compared to the fiscal year ended
November 30, 2012. The decrease in protection product revenue reflects lower sales volume as we have stopped
selling these products.
Loan Fee Income
Loan fee income consists primarily of fees on credit card loans and includes late, cash advance and other
miscellaneous fees. Loan fee income increased slightly as compared to the year ended December 31, 2013 primarily
due to higher late fees and cash advance fees. Loan fee income decreased slightly for the calendar year ended
December 31, 2013 as compared to the fiscal year ended November 30, 2012 primarily due to lower volume of loan
fees being generated, partially offset by fewer late fee charge-offs as a result of decrease in credit card delinquency
rates.
Transaction Processing Revenue
Transaction processing revenue represents switch fees charged to financial institutions and merchants for
processing ATM, debit and point-of-sale transactions over the PULSE network, as well as various participation and
membership fees. Switch fees are charged on a per transaction basis. Transaction processing revenue decreased both
for the year ended December 31, 2014 as compared to the year ended December 31, 2013, and for the calendar year
ended December 31, 2013, as compared to the fiscal year ended November 30, 2012, reflecting the impact of
merchant rerouting and lower rates.
Gain on Investments
Gain on investments includes net realized gains on the sale of investments, net of any write-downs of investment
securities to fair value when the decline in fair value is considered other than temporary. Gain on investments for the
years ended December 31, 2014 and 2013 was mainly comprised of gains on the sales of U.S. Treasury and Agency
Securities. Gain on investment securities for the fiscal year ended November 30, 2012 was comprised almost entirely of
a gain of $26 million related to the liquidation of a minority interest in an equity investment.
Gain on Origination and Sale of Mortgage Loans
Gain on sale of mortgage loans consists of the net gain on the origination and sale of loans as well as the net
gain on the related interest rate lock commitments and the net gain or loss on forward delivery contracts. Revenue
related to mortgage banking operations declined for the year ended December 31, 2014 as compared to the year
ended December 31, 2013 primarily driven by an increase in mortgage interest rates that resulted in lower mortgage
refinance volume. Decline in revenue related to mortgage banking operation was also due to reduced margins in the
industry resulting from increased competitive pressure since the increase in mortgage rates. Gain on sale of mortgage
loans increased for the calendar year ended December 31, 2013 as compared to the fiscal year ended November 30,
2012, due to a full year of activity for the calendar year ended December 31, 2013 as compared to only a partial year
of activity for the fiscal year ended November 30, 2012. The increase was partially offset by decrease in refinance
mortgage loan volume due to increasing interest rates during 2013. The partial year of activity for the fiscal year ended
November 30, 2012 resulted from the acquisition and integration of the assets of Home Loan Center in June of 2012.
Other Income
Other income includes royalty revenues earned by Diners Club, merchant fees, revenue from the transition
services agreement related to the acquisition of SLC, revenue from merchants related to reward programs, revenues
from network partners and other miscellaneous revenue items.
Other income decreased for the year ended December 31, 2014 as compared to the year ended December 31,
2013 primarily due to certain merchant network fees that were reclassified out of other income to discount and
interchange revenue during 2014. Other income was relatively flat for the calendar year ended December 31, 2013 as
compared to the fiscal year ended November 30, 2012.
-73-
Other Expense
The following table represents the components of other expense for the periods presented (dollars in millions):
For the Calendar Years
Ended December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
2014 Calendar Year vs.
2013 Calendar Year
increase (decrease)
2013 Calendar Year vs.
2012 Fiscal Year
increase (decrease)
$
%
$
%
Employee compensation
and benefits ................... $
1,242
$
1,164
$
1,048
$
87
$
Marketing and business
development ...................
Information processing and
communications ..............
Professional fees ...............
Premises and equipment ....
Other expense ..................
735
346
450
92
475
717
333
410
82
488
603
289
432
76
604
51
25
34
8
35
78
18
13
40
10
(13)
7 % $
116
11 %
3 %
114
19 %
4 %
10 %
12 %
(3)%
44
(22)
6
(116)
15 %
(5)%
8 %
(19)%
5 %
Total other expense ....... $
3,340
$
3,194
$
3,052
$
240
$
146
5 % $
142
Total other expense increased $146 million for the year ended December 31, 2014 as compared to the year
ended December 31, 2013. The increase was primarily driven by higher employee compensation costs due to growth
in overall headcount along with higher professional fees due to consultant expenses related to technology and digital
investments. Higher marketing and business development expenses also contributed to the increase in other expense
mainly due to growth initiatives. The increase in total other expense was partially offset by a decrease in the other
expense line item, which primarily resulted from non-recurring expenses incurred in 2013 related to our purchase of the
Diners Club Italy Licensee and financial assistance to facilitate the purchase of the Slovenian licensee by a European
bank. The decrease in other expense line item was partially offset by the impairment of goodwill related to the Discover
Home Loans business along with fair value adjustment resulting from recording Diners Club Italy as held-for-sale.
Total other expense increased $142 million for the calendar year ended December 31, 2013 as compared to the
fiscal year ended November 30, 2012 primarily due to higher employee compensation costs driven by growth in
overall headcount along with a full year of operating activity of the Home Loan Center assets. Additionally, marketing
and business development costs increased due to growth initiatives. Higher information processing and communications
related expenses also contributed to the increase in other expense mainly related to increased software maintenance,
licenses and technology expenses due to growth initiatives. Other expense decreased primarily due to legal expenses
incurred in 2012 associated with the consent order that Discover Bank entered into with the FDIC and CFPB, for which
there was no equivalent impact in 2013.
Income Tax Expense
The following table reconciles our effective tax rate to the U.S. federal statutory income tax rate:
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
U.S. federal statutory income tax rate .......................................................
35.0%
35.0%
U.S. state, local and other income taxes, net of U.S. federal income tax
benefits ................................................................................................
Other ....................................................................................................
Effective income tax rate ......................................................................
2.8
(0.7)
37.1%
2.2
0.2
37.4%
35.0%
2.9
(0.4)
37.5%
35.0%
3.2
(0.1)
38.1%
Income tax expense decreased $103 million, or 7.0%, for the year ended December 31, 2014 as compared to
the year ended December 31, 2013, reflecting a decrease in pretax income. The effective tax rate decreased 0.3% for
the year ended December 31, 2014 from 37.4% for the year ended December 31, 2013 due to favorable adjustments
to unrecognized tax benefits and recognition of tax benefits attributable to prior year tax adjustments.
-74-
Income tax expense increased $66 million, or 4.7%, for the calendar year ended December 31, 2013 as
compared to the fiscal year ended November 30, 2012, reflecting an increase in pretax income. The effective tax rate
decreased 0.1% for the calendar year ended December 31, 2013 from 37.5% for the fiscal year ended November 30,
2012 as a result of a decrease in state income tax rates offset by the impact of the Diners Club Italy acquisition.
Liquidity and Capital Resources
Funding and Liquidity
We seek to maintain diversified funding sources and a strong liquidity profile in order to fund our business and
repay or refinance our maturing obligations. In addition, we seek to achieve an appropriate maturity profile and utilize
a cost-effective mix of funding sources. Our primary funding sources include deposits, sourced directly from consumers
or through brokers, term asset-backed securitizations, private asset-backed securitizations and short- and long-term
borrowings.
Funding Sources
Deposits
We offer deposit products to customers through two channels: (i) through direct marketing, internet origination
and affinity relationships (“direct-to-consumer deposits”); and (ii) indirectly through contractual arrangements with
securities brokerage firms (“brokered deposits”). Direct-to-consumer deposits include certificates of deposit, money
market accounts, online savings and checking accounts and IRA certificates of deposit, while brokered deposits include
certificates of deposit and sweep accounts.
At December 31, 2014, we had $28.8 billion of direct-to-consumer deposits and $17.3 billion of brokered
deposits. Maturities of our certificates of deposit range from 1 month to 10 years, with a weighted-average maturity of
22 months.
The following table summarizes deposits by contractual maturity as of the end of the current period (dollars in
millions):
Three
Months
or Less
Over Three
Months
Through Six
Months
Total
Over Six
Months
Through
Twelve
Months
Over Twelve
Months
Indeterminate
At December 31, 2014
Certificates of deposit in amounts less than
$100,000(1) ........................................... $
Certificates of deposit in amounts of
$100,000 to less than $250,000(1) ...........
Certificates of deposit in amounts of
$250,000(1)or greater .............................
Savings deposits, including money market
deposit accounts(2) ..................................
21,502
$
2,784
$
2,478
$
4,389
$
11,851
$
4,481
1,153
18,656
719
184
—
498
103
—
1,265
1,999
335
—
531
—
—
—
—
18,656
Total interest-bearing deposits ................ $
45,792
$
3,687
$
3,079
$
5,989
$
14,381
$
18,656
(1) $100,000 represents the basic insurance amount previously covered by the FDIC. Effective July 21, 2010, the basic insurance per depositor was permanently
increased to $250,000.
Represents deposits with no contractual maturity, except for structured sweep deposits associated with agreements entered into with third parties.
(2)
Credit Card Securitization Financing
We use the securitization of credit card receivables as an additional source of funding. We access the asset-
backed securitization market using the Discover Card Master Trust I ("DCMT") and the Discover Card Execution Note
Trust ("DCENT"), through which we issue DCENT DiscoverSeries notes both publicly and through private transactions.
We retain significant exposure to the performance of trust assets through holdings of the seller's interest and
subordinated security classes of DCENT.
The securitization structures include certain features designed to protect investors. The primary feature relates to
the availability and adequacy of cash flows in the securitized pool of receivables to meet contractual requirements, the
insufficiency of which triggers early repayment of the securities. We refer to this as "economic early amortization,"
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which is based on excess spread levels. Excess spread is the amount by which income received by a trust during a
collection period, including interest collections, fees and interchange, exceeds the fees and expenses of the trust during
such collection period, including interest expense, servicing fees and charged-off receivables. In the event of an
economic early amortization, which would occur if the excess spread fell below 0% on a three-month rolling average
basis, we would be required to repay the affected outstanding securitized borrowings using available collections
received by the trust (the period of ultimate repayment would be determined by the amount and timing of collections
received). An early amortization event would negatively impact our liquidity, and require us to utilize our available
non-securitization related contingent liquidity or rely on alternative funding sources, which may or may not be available
at the time. As of December 31, 2014, the DiscoverSeries three-month rolling average excess spread was 13.95%.
Another feature of our securitization structure is a reserve account funding requirement in which, in limited
circumstances, excess cash flows generated by the transferred loan receivables are held at the trust. This funding
requirement is triggered when DCENT’s three-month average excess spread rate decreases to below 4.50%, with
increasing funding requirements as excess spread levels decline below preset levels to 0%. See Note 5: Credit Card and
Student Loan Securitization Activities to our consolidated financial statements for additional information regarding the
structures of DCMT and DCENT and for tables providing information concerning investors’ interests and related excess
spread at December 31, 2014.
At December 31, 2014, we had $16.0 billion of outstanding public asset-backed securities and $5.8 billion of
outstanding asset-backed securities that had been issued to our wholly-owned subsidiaries.
The following table summarizes expected contractual maturities of the investors’ interests in credit card
securitizations excluding those that have been issued to our wholly-owned subsidiaries (dollars in millions):
At December 31, 2014
Scheduled maturities of long-term borrowings—owed to
credit card securitization investors ..................................... $
15,950
$
3,301
$
7,749
$
4,900
$
—
Total
Less Than
One Year
One Year
Through
Three Years
Four Years
Through
Five Years
After Five
Years
The triple-A rating of DCENT Class A Notes issued to date has been based, in part, on an FDIC rule which
created a safe harbor that provides that the FDIC, as conservator or receiver, will not, using its power to disaffirm or
repudiate contracts, seek to reclaim or recover assets transferred in connection with a securitization, or recharacterize
them as assets of the insured depository institution, provided such transfer satisfies the conditions for sale accounting
treatment under previous GAAP. Although the implementation of FASB Accounting Standards Codification ("ASC")
Topic 860, Transfers and Servicing), no longer qualified certain transfers of assets for sale accounting treatment, the
FDIC approved a final rule that preserved the safe-harbor treatment applicable to revolving trusts and master trusts,
including DCMT, so long as those trusts would have satisfied the original FDIC safe harbor if evaluated under GAAP
pertaining to transfers of financial assets in effect prior to December 1, 2009. Other legislative and regulatory
developments may, however, impact our ability and/or desire to issue asset-backed securities in the future. For
information on recent developments, see "— Regulatory Environment and Developments — Capital, Liquidity and
Funding — Securitizations."
Other Long-Term Borrowings—Student Loans
At December 31, 2014, we had $1.4 billion of remaining principal balance outstanding on securitized debt
assumed as part of the acquisition of Student Loan Corporation. Principal and interest payments on the underlying
student loans will reduce the balance of these secured borrowings over time.
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Corporate and Bank Debt
The following table provides a summary of Discover Financial Services (Parent Company) and Discover Bank
outstanding debt as of December 31, 2014 (dollars in millions):
Discover Financial Services Senior Notes
Discover Bank Senior Notes
Discover Bank Subordinated Notes
Principal Amount
Outstanding
$
$
400
78
322
500
500
1,800
Maturity
June 2017
$
July 2019
April 2022
Principal Amount
Outstanding
Maturity
Principal Amount
Outstanding
750
750
February 2018
August 2021
1,000
August 2023
$
$
200
500
700
Maturity
November 2019
April 2020
November 2022
400
March 2026
November 2024
$
2,900
Certain Discover Financial Services senior notes require us to offer to repurchase the notes at a price equal to
101% of their aggregate principal amount plus accrued and unpaid interest in the event of a change of control
involving us and a corresponding ratings downgrade to below investment grade. For more information on outstanding
notes, including weighted-average interest rates, see Note 9: Long-Term Borrowings to our consolidated financial
statements.
Short-Term Borrowings
We utilize a warehouse line of credit available up to $205 million as a form of short-term borrowings. This line
of credit is used for the sole purpose of funding consumer residential mortgage loans. The warehouse line of credit had
an outstanding balance of $113 million as of December 31, 2014. In addition, we may access short-term borrowings
through the Federal Funds market or through repurchase agreements. At December 31, 2014, there were no
outstanding balances under the Federal Funds market or repurchase agreements.
Additional Funding Sources
Private Asset-Backed Securitizations
We have access to committed undrawn capacity through privately placed asset-backed securitizations. At
December 31, 2014, we had total committed capacity of $7.5 billion, none of which was drawn.
Federal Reserve
Discover Bank has access to the Federal Reserve Bank of Philadelphia’s discount window. As of December 31,
2014, Discover Bank had $16 billion of available capacity through the discount window based on the amount and type
of assets pledged. We have no borrowings outstanding under the discount window as of December 31, 2014.
Funding Uses
Our primary uses of funds include the extensions of loans and credit, primarily through Discover Bank, the
purchase of investment securities for our liquidity portfolio, working capital and debt and capital service. We assess
funding uses and liquidity needs under both the normal course of business and hypothetical adverse environments,
considering primary uses of funding, such as on-balance sheet loans, and contingency uses of funding, such as the need
to post additional collateral for derivatives positions. In order to anticipate funding needs under adverse environments,
we maintain liquidity stress scenarios that assess the impact of a range of unusual business events, such as severe
economic recessions, financial market disruptions, adverse operational events and other forms of stress.
Credit Ratings
Our borrowing costs and capacity in certain funding markets, including securitizations and senior and
subordinated debt, may be affected by the credit ratings of DFS, Discover Bank and the securitization trusts.
Downgrades in these credit ratings could result in higher interest expense on our unsecured debt and asset
securitizations, as well as potentially higher fees related to borrowings under our lines of credit. In addition to increased
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funding costs, deterioration in credit ratings could reduce our borrowing capacity in the unsecured debt and asset
securitization capital markets.
We also have agreements with certain of our derivative counterparties that contain provisions that require DFS
and Discover Bank to maintain an investment grade credit rating from specified major credit rating agencies. Because
the credit rating of DFS did not meet the specified thresholds, we had posted $4 million of collateral with our
counterparties at December 31, 2014. Discover Bank's credit rating met specified thresholds set by its counterparties.
However, if Discover Bank’s credit rating were reduced by one ratings notch, Discover Bank would be required to post
additional collateral, which, as of December 31, 2014, would have been $97 million.
A credit rating is not a recommendation to buy, sell or hold securities, may be subject to revision or withdrawal
at any time by the assigning rating organization, and each rating should be evaluated independently of any other
rating. The credit ratings are summarized in the following table:
Moody’s
Investors
Service
Standard &
Poor’s
Fitch Ratings
Senior Unsecured Debt
Discover Financial Services ...............................................................................................
Discover Bank ..................................................................................................................
Outlook for Senior Unsecured Debt .......................................................................................
Ba1
Baa3
Stable
BBB-
BBB
Positive
BBB+
BBB+
Stable
Subordinated Debt
Discover Bank ..................................................................................................................
Ba1
BBB-
BBB
Discover Card Execution Note Trust
Class A(1)
.........................................................................................................................
Class B(1)
.........................................................................................................................
Class C(2)
.........................................................................................................................
Aaa(sf)
Aa1(sf)
N/A
AAA(sf)
AA+(sf)
N/A
AAAsf
AA-sf
N/A
(1) An “sf” in the rating denotes rating agency identification for structured finance product ratings.
(2) All Class C notes are currently held by subsidiaries of Discover Bank and, therefore, are not publicly rated.
Liquidity
We seek to ensure that we have adequate liquidity to sustain business operations, fund asset growth and satisfy
debt obligations under normal and stress conditions at the Discover Financial Services and Discover Bank entity levels
and on a consolidated basis. In addition to the funding sources discussed above, we also maintain high quality, liquid,
unencumbered assets in our investment portfolio.
We maintain a liquidity risk and funding management policy which outlines the overall framework and general
principles for managing the liquidity risk across our businesses. The policy is approved by the board of directors with
the implementation responsibilities delegated to the Asset and Liability Management Committee (the “ALCO”). We seek
to balance the trade-offs between maintaining too much liquidity, which may be costly, with having too little liquidity,
which could cause financial distress. Liquidity risk is centrally managed by the ALCO, which is chaired by our Treasurer
and has cross-functional membership. The ALCO monitors liquidity risk profile and determines any actions that may
need to be taken.
We employ a variety of metrics to monitor and manage liquidity. We developed liquidity early warning
indicators (“EWI”) to detect initial phases of liquidity stress events and a reporting and escalation process that is
designed to be consistent with regulatory guidance. The EWIs include both idiosyncratic and systemic measures, and
are monitored on a daily basis and reported to the ALCO regularly. An EWI breach triggers prompt review and
decision making by our senior management team, and in certain instances may lead to the convening of a senior-level
response team and activation of the contingency funding plan.
In addition, liquidity stress testing is conducted regularly and contingency funding planning is in place to address
potential liquidity shortfalls. We evaluate a range of stress scenarios including idiosyncratic and systemic events that
could impact funding sources and our ability to meet liquidity needs. These scenarios measure the liquidity position at
Discover Financial Services, Discover Bank and on a consolidated basis from daily to up to a two-year horizon by
analyzing the stress on liquidity versus the ability to generate contingent liquidity. We maintain contingent funding
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sources, including our liquidity portfolio, private securitizations with unused capacity and Federal Reserve discount
window capacity, which we could utilize to satisfy liquidity needs during such stress events. We expect to be able to
satisfy all maturing obligations and fund business operations during the next 12 months by utilizing the funding sources
that are currently available to us.
At December 31, 2014, our liquidity portfolio was comprised of cash and cash equivalents and high quality,
liquid and unencumbered investment securities. Cash and cash equivalents were primarily in the form of deposits with
the Federal Reserve. Investment securities primarily included debt obligations of the U.S. Treasury and U.S. government
agencies and residential mortgage-backed securities issued by U.S. government agencies. These investments are
considered highly liquid, and we have the ability to raise cash by utilizing repurchase agreements, pledging certain of
these investments to access the secured funding markets or selling them. The level and mix of our liquidity portfolio may
fluctuate based upon the level of expected maturities of our funding sources as well as operational requirements and
market conditions.
At December 31, 2014, our liquidity portfolio and undrawn credit facilities were $34.3 billion, which was $1.7
billion higher than the balance at December 31, 2013. During the calendar year ended December 31, 2014, the
average balance of our liquidity portfolio was $11.9 billion.
December 31,
2014
2013
(dollars in millions)
Liquidity portfolio
Cash and cash equivalents(1)
....................................................................................................................... $
6,921
$
Investment securities(2)
................................................................................................................................
Total liquidity portfolio ...........................................................................................................................
Undrawn credit facilities(3)
Private asset-backed securitizations .............................................................................................................
Federal Reserve discount window(4)
.............................................................................................................
Total undrawn credit facilities
.................................................................................................................
3,831
10,752
7,500
16,024
23,524
6,193
4,922
11,115
7,000
14,500
21,500
Total liquidity portfolio and undrawn credit facilities .............................................................................. $
34,276
$
32,615
(1) Cash-in-process is excluded from cash and cash equivalents for liquidity purposes.
(2)
Excludes $16 million of U.S. Treasury securities that have been pledged as swap collateral in lieu of cash as of December 31, 2014 and $9 million of U.S. Treasury
securities that have been pledged as swap collateral in lieu of cash as of December 31, 2013.
See " — Additional Funding Sources" for additional information.
Excludes $5 million of investments accounted for in the liquidity portfolio that were pledged to the Federal Reserve as of December 31, 2013.
(3)
(4)
Bank Holding Company Liquidity
The primary uses of funds at the bank holding company level include debt and capital service (interest and
dividend payments and return of principal) and capital management activity, which may include the periodic
repurchase of shares of our common stock. Our primary sources of funds at the bank holding company level include the
proceeds from the public issuance of unsecured debt and preferred stock, as well as dividends from our subsidiaries,
particularly Discover Bank. Under periods of stress or at the discretion of our regulators, the bank holding company
could lose access to one or both of those funding sources. In addition, federal statute and regulatory standards require
that bank holding companies retain sufficient liquidity in order to serve as a source of financial strength for their banks
and their banks' subsidiaries during periods of liquidity stress.
We utilize a measure called Number of Months of Pre-Funding to determine the length of time Discover Financial
Services can meet upcoming funding obligations including common and preferred dividend payments and debt service
obligations using existing cash resources. At December 31, 2014, Discover Financial Services has sufficient cash
resources to fund the dividend and debt service payments for at least the next 18 months, which exceeds current ALCO
and board limits.
We structure our debt maturity schedule to minimize the amount of debt maturing at the bank holding company
level within a short period of time. As of December 31, 2014, there is no upcoming debt maturity in 2015 or 2016 at
the bank holding company level. Our ALCO and board of directors regularly review our compliance with our liquidity
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limits as a bank holding company, which are established in accordance with the liquidity risk appetite articulated by
our board.
Capital
Our primary sources of capital are from the earnings generated by our businesses and common and preferred
stock issuances in the capital markets. We seek to manage capital to a level and composition sufficient to support the
risks of our businesses, meet regulatory requirements, meet rating agency targets and support future business growth.
Within these constraints, we are focused on deploying capital in a manner that provides attractive returns to our
stockholders. The level, composition and utilization of capital are influenced by changes in the economic environment,
strategic initiatives, and legislative and regulatory developments.
Under regulatory capital requirements adopted by the FDIC, the Federal Reserve and other bank regulatory
agencies, Discover Financial Services, along with Discover Bank, must maintain minimum levels of capital. Failure to
meet minimum capital requirements can result in the initiation of certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could limit our business activities and have a direct material
effect on our financial position and results. We must meet specific capital guidelines that involve quantitative measures
of assets and liabilities as calculated under regulatory accounting practices. Capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Our capital adequacy assessment also includes tax and accounting considerations in accordance with regulatory
guidance. We maintain a deferred tax asset on our balance sheet, and we include this asset when calculating our
regulatory capital levels. However, for regulatory capital purposes, deferred tax assets that are dependent on future
taxable income are currently limited to the lesser of: (i) the amount of deferred tax assets we expect to realize within one
year of the calendar quarter-end date, based on our projected future taxable income for that year; or (ii) 10% of the
amount of our Tier 1 capital. At December 31, 2014, no portion of our deferred tax asset was disallowed for
regulatory capital purposes.
At December 31, 2014, Discover Financial Services and Discover Bank met the requirements for "well-
capitalized" status, exceeding the regulatory minimums to which they were subject under the existing Basel I standards.
As discussed in “— Regulatory Environment and Developments — Capital, Liquidity and Funding,” we are
subject to a common equity Tier 1 capital ratio requirement as of January 1, 2015. We currently disclose our Tier 1
common capital ratio as calculated under Basel I for our bank holding company, which is a regulatory capital measure
widely used by investors, analysts, rating agencies and bank regulatory agencies to assess the capital position of
financial services companies. Since analysts and banking regulators may assess the quality and composition of our
capital adequacy using this ratio, we believe it is useful to provide investors the ability to assess our capital adequacy
on the same basis. Further, we believe that providing an estimate of capital position based on the Basel III final rules is
important to complement the existing capital ratios and for comparability to other financial institutions. As of
December 31, 2014, the Tier 1 common capital ratio calculated under Basel I and common equity Tier 1 capital ratio
calculated under Basel III are not formally defined by U.S. GAAP or codified in the federal banking regulations, as
such, they are considered to be non-GAAP financial measures. Other financial services companies may also disclose
these ratios and definitions may vary, so we advise users of this information to exercise caution in comparing these
ratios for different companies.
Our Tier 1 common capital ratio, as calculated under Basel I, decreased to 14.1% at December 31, 2014 from
14.3% at December 31, 2013. The decrease was driven by higher risk-weighted assets compared to the prior year.
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The following table provides a reconciliation of total common stockholders’ equity (a U.S. GAAP financial
measure) to our Tier 1 common capital calculated under Basel I (dollars in millions):
December 31,
2014
December 31,
2013
Total common stockholders’ equity .................................................................................................................. $
10,574
$
10,249
Less: Goodwill
..........................................................................................................................................
Less: Intangible assets, net
..........................................................................................................................
(257)
(176)
Tangible common equity ................................................................................................................................
10,141
Effect of certain items in accumulated other comprehensive income excluded from Tier 1 common capital ..........
138
Total Tier 1 common capital (Basel I)
............................................................................................................... $
10,279
Risk-weighted assets (Basel I)(1)
....................................................................................................................... $
72,889
(284)
(185)
9,780
69
9,849
68,649
$
$
Tier 1 common capital ratio (Basel I)
...............................................................................................................
14.1%
14.3%
(1) Under the banking agencies’ risk-based capital guidelines, assets and credit equivalent amounts of derivatives and off-balance sheet exposures are assigned to
broad risk categories. The aggregate dollar amount in each risk category is multiplied by the associated risk weight of the category. The resulting weighted values
are added together, along with the measure for market risk, resulting in our total risk-weighted assets.
The following table provides a reconciliation of common equity Tier 1 capital and risk-weighted assets calculated
under Basel III using the standardized approach to Tier 1 common capital and risk-weighted assets calculated under
Basel I (dollars in millions):
December 31,
2014
Total Tier 1 common capital (Basel I)
........................................................................................................................................ $
10,279
Add: Adjustments related to capital components(1)
.................................................................................................................
26
Common equity Tier 1 capital (Basel III Final Rule)
..................................................................................................................... $
10,305
Risk-weighted assets (Basel III Final Rule)(2)
................................................................................................................................ $
73,315
Common equity Tier 1 capital ratio (Basel III Final Rule)
.............................................................................................................
14.1%
(1) Adjustments related to capital components include: deferred tax liabilities related to intangible assets and deduction for deferred tax assets.
(2) Key differences under fully phased-in Basel III rules in the calculation of risk-weighted assets compared to Basel I include: higher risk weighting for past due loans
and unfunded commitments.
Current or future legislative or regulatory initiatives may require us to hold more capital in the future. Federal
Reserve and FDIC final rules applicable to Discover Financial Services and Discover Bank, respectively, include new
minimum and "well-capitalized" risk-based capital and leverage ratios, effective January 1, 2015, and refine the
definition of what constitutes "capital" for purposes of calculating those ratios. For additional information, see "—
Regulatory Environment and Developments — Capital, Liquidity and Funding."
Additionally, we are required to submit an annual capital plan to the Federal Reserve that includes an assessment
of our expected uses and sources of capital over the nine quarter planning horizon. In January 2015, we submitted our
annual capital plan to the Federal Reserve under the Federal Reserve’s Comprehensive Capital Analysis and Review, or
CCAR, program, which included planned dividends and share repurchases over the nine quarter planning horizon. In
March 2014, we received non-objection from the Federal Reserve with respect to our proposed capital actions through
March 31, 2015. Our ability to make capital distributions, including our ability to pay dividends or repurchase shares
of our common stock, will continue to be subject to the Federal Reserve’s review and non-objection of the actions that
we propose each year in our annual capital plan.
Also in March 2014, the Federal Reserve published the results of its annual supervisory stress tests for bank
holding companies with $50 billion or more in total consolidated assets, including Discover Financial Services. At that
same time, we published company-run stress test results for Discover Financial Services and Discover Bank. Discover
Financial Services is required to publish company-run stress tests results in March and September each year in
accordance with Federal Reserve rules and Discover Bank is required to publish company-run stress test results under
FDIC rules. We published our mid-year stress test results in September 2014. The dates for publication of stress test
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results by Discover Financial Services and Discover Bank may differ after 2015 based on recently updated rules
adopted by the Federal Reserve and the FDIC.
We recently declared a quarterly cash dividend on our common stock of $0.24 per share, payable on
February 19, 2015 to holders of record on February 5, 2015, which is consistent with the dividend amount that we
paid in each of the second, third and fourth quarters. We also recently declared a quarterly cash dividend on our
preferred stock of $16.25 per share, equal to $0.40625 per depositary share, payable on March 2, 2015 to holders of
record on February 13, 2015, which was the same amount paid on our preferred stock in each of the four quarters.
On April 16, 2014, our board of directors approved a two-year share repurchase program authorizing the
repurchase of up to $3.2 billion of our outstanding shares of common stock. The program expires on April 15, 2016,
and may be terminated at any time. This program replaced the prior $2.4 billion program, which had $1.0 billion of
remaining authorization. During the calendar year ended December 31, 2014, we repurchased approximately 25
million shares, or 5%, of our outstanding common stock for $1.5 billion. We expect to continue to make share
repurchases under our repurchase program from time to time based on market conditions and other factors, subject to
legal and regulatory requirements and restrictions. Share repurchases under the program may be made through a
variety of methods, including open market purchases, privately negotiated transactions or other purchases, including
block trades, accelerated share repurchase transactions, or any combination of such methods. Any share repurchases
after March 31, 2015 will be subject to receiving Federal Reserve non-objection with respect to our proposed capital
actions through June 30, 2016.
The amount and size of any future dividends and share repurchases will depend upon our results of operations,
financial condition, capital levels, cash requirements, future prospects and other factors. The declaration and payment
of future dividends, as well as the amount thereof, are subject to the discretion of our board of directors. Holders of our
shares of common stock are subject to the prior dividend rights of holders of our preferred stock or the depositary
shares representing such preferred stock outstanding, and if full dividends have not been declared and paid on all
outstanding shares of preferred stock in any dividend period, no dividend may be declared or paid or set aside for
payment on our common stock. In addition, as noted above, banking laws and regulations and our banking regulators
may limit our ability to pay dividends and make share repurchases, including limitations on the extent to which our
banking subsidiaries can provide funds to us through dividends, loans or otherwise. Further, also noted above, current
or future regulatory initiatives may require us to hold more capital in the future. There can be no assurance that we will
declare and pay any dividends or repurchase any shares of our common stock in the future. There can be no assurance
that we will declare and pay any dividends or repurchase any shares of our common stock in the future. For more
information, including conditions and limits on our ability to pay dividends and repurchase our stock, see "Business —
Supervision and Regulation — Capital, Dividends and Share Repurchases," "Risk Factors — Credit, Market and
Liquidity Risk — We may be limited in our ability to pay dividends on and repurchase our stock" and "— We are a
holding company and depend on payments from our subsidiaries" and Note 17: Capital Adequacy to our consolidated
financial statements.
Certain Off-Balance Sheet Arrangements
Guarantees
Guarantees are contracts or indemnification agreements that contingently require us to make payments to a
guaranteed party based on changes in an underlying asset, liability, or equity security of a guaranteed party, rate or
index. Also included in guarantees are contracts that contingently require the guarantor to make payments to a
guaranteed party based on another entity’s failure to perform under an agreement. Our guarantees relate to
transactions processed on the Discover Network and certain transactions processed by PULSE and Diners Club. See
Note 18: Commitments, Contingencies and Guarantees to our consolidated financial statements for further discussion
regarding our guarantees.
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Contractual Obligations and Contingent Liabilities and Commitments
In the normal course of business, we enter into various contractual obligations that may require future cash
payments. Contractual obligations include deposits, long-term borrowings, operating and capital lease obligations,
interest payments on fixed-rate debt, purchase obligations and other liabilities. Our future cash payments associated
with our contractual obligations are summarized below (dollars in millions):
Total
Less Than
One Year
Payments Due By Period
One Year
Through
Three Years
Four Years
Through Five
Years
More Than
Five Years
At December 31, 2014
Deposits(1)(2) ....................................................................... $
46,089
$
31,708
$
9,093
$
3,522
$
Borrowings(3) .....................................................................
22,543
3,301
8,156
5,928
Capital lease obligations ....................................................
Operating leases ...............................................................
1
111
Interest payments on fixed-rate debt ....................................
2,105
Purchase obligations(4) .......................................................
Other liabilities(5) ...............................................................
801
229
1
16
387
453
51
—
28
705
269
42
—
22
471
79
33
1,766
5,158
—
45
542
—
103
Total contractual obligations ............................................ $
71,879
$
35,917
$
18,293
$
10,055
$
7,614
(1) Deposits do not include interest payments because payment amounts and timing cannot be reasonably estimated as certain deposit accounts have early withdrawal
rights and the option to roll interest payments into the balance.
(2) Deposits due in less than one year include deposits with indeterminate maturities.
(3)
(4)
See Note 9: Long-Term Borrowings to our consolidated financial statements for further discussion. Total future payment of interest charges for the floating-rate notes
is estimated to be $714 million as of December 31, 2014, utilizing the current interest rates as of that date.
Purchase obligations for goods and services include payments under, among other things, consulting, outsourcing, data, advertising, sponsorship, software license,
telecommunications agreements and global acceptance contracts. Purchase obligations also include payments under rewards program agreements with merchants.
Purchase obligations at December 31, 2014 reflect the minimum purchase obligation under legally binding contracts with contract terms that are both fixed and
determinable. These amounts exclude obligations for goods and services that already have been incurred and are reflected on our consolidated statement of
financial condition.
(5) Other liabilities include our expected future contributions to our pension plan, the contingent liability associated with our equity method securities and a commitment
to purchase certain when-issued mortgage-backed securities under an agreement with the Delaware State Housing Authority as part of our community reinvestment
initiatives.
As of December 31, 2014 our consolidated statement of financial condition reflects a liability for unrecognized
tax benefits of $635 million, and approximately $135 million of accrued interest and penalties. Since the ultimate
amount and timing of any future cash settlements cannot be predicted with reasonable certainty, the estimated income
tax obligations about which there is uncertainty, as addressed in ASC Topic 740, Income Taxes (guidance formerly
provided by FASB Interpretation No. 48), have been excluded from the contractual obligations table. See Note 15:
Income Taxes to our consolidated financial statements for further information concerning our tax obligations.
We extend credit for consumer loans, primarily arising from agreements with customers for unused lines of credit
on certain credit cards, provided there is no violation of conditions established in the related agreement. At
December 31, 2014, our unused commitments were $169.2 billion. These commitments, substantially all of which we
can terminate at any time and which do not necessarily represent future cash requirements, are periodically reviewed
based on account usage, customer creditworthiness and loan qualification. In addition, in the ordinary course of
business, we guarantee payment on behalf of subsidiaries relating to contractual obligations with external parties. The
activities of the subsidiaries covered by any such guarantees are included in our consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk refers to the risk that a change in the level of one or more market prices, rates, indices, correlations or
other market factors will result in losses for a position or portfolio. We are exposed to market risk primarily from
changes in interest rates.
Interest Rate Risk
We borrow money from a variety of depositors and institutions in order to provide loans to our customers, as
well as invest in other assets and our business. These loans and other assets earn interest, which we use to pay interest
on the money borrowed. Our net interest income and, therefore, earnings, will be negatively affected if the interest rate
-83-
earned on assets increases at a slower pace than increases to the interest rate we owe on our borrowings. Changes in
interest rates and competitor responses to those changes may influence customer payment rates, loan balances or
deposit account activity. We may face higher-cost alternative sources of funding as a result, which has the potential to
decrease earnings.
Our interest rate risk management policies are designed to measure and manage the potential volatility of
earnings that may arise from changes in interest rates by having a financing portfolio that reflects the mix of variable
and fixed-rate assets. To the extent that asset and related financing repricing characteristics of a particular portfolio are
not matched effectively, we may utilize interest rate derivative contracts, such as swap agreements, to achieve our
objectives. Interest rate swap agreements effectively convert the underlying asset or liability from fixed to floating rate or
from floating to fixed rate. See Note 21: Derivatives and Hedging Activities to our consolidated financial statements for
information on our derivatives activity.
We use an interest rate sensitivity simulation to assess our interest rate risk exposure. For purposes of presenting
the possible earnings effect of a hypothetical, adverse change in interest rates over the 12-month period from our
reporting date, we assume that all interest rate sensitive assets and liabilities will be impacted by a hypothetical,
immediate 100 basis point increase in interest rates relative to market consensus expectations as of the beginning of the
period. The sensitivity is based upon the hypothetical assumption that all relevant types of interest rates that affect our
results would increase instantaneously, simultaneously and to the same degree.
Our interest rate sensitive assets include our variable rate loan receivables and the assets that make up our
liquidity portfolio. We have restrictions on our ability to mitigate interest rate risk by adjusting rates on existing balances
and competitive actions may restrict our ability to increase the rates that we charge to customers for new loans. At
December 31, 2014, the majority of our credit card and student loans were at variable rates. Assets with rates that are
fixed at period end but which will mature, or otherwise contractually reset to a market-based indexed rate or other
fixed rate prior to the end of the 12-month period, are considered to be rate sensitive. The latter category includes
certain revolving credit card loans that may be offered at below-market rates for an introductory period, such as
balance transfers and special promotional programs, after which the loans will contractually reprice in accordance with
our normal market-based pricing structure. For purposes of measuring rate sensitivity for such loans, only the effect of
the hypothetical 100 basis point change in the underlying market-based indexed rate has been considered. For assets
that have a fixed interest rate but which contractually will, or are assumed to, reset to a market-based indexed rate or
other fixed rate during the next 12 months, earnings sensitivity is measured from the expected repricing date. In
addition, for all interest rate sensitive assets, earnings sensitivity is calculated net of expected loan losses which for
purposes of this analysis are assumed to remain unchanged relative to our baseline expectations over the analysis
horizon.
Interest rate sensitive liabilities are assumed to be those for which the stated interest rate is not contractually fixed
for the next 12-month period. Thus, liabilities that vary with changes in a market-based index, such as Federal Funds or
LIBOR, which will reset before the end of the 12-month period, or liabilities whose rates are fixed at the fiscal period
end but which will mature and are assumed to be replaced with a market-based indexed rate prior to the end of the
12-month period, also are considered to be rate sensitive. For these fixed-rate liabilities, earnings sensitivity is measured
from the expected maturity date.
Assuming an immediate 100 basis point increase in the interest rates affecting all interest rate sensitive assets and
liabilities at December 31, 2014, we estimate that net interest income over the following 12-month period would
increase by approximately $167 million, or 2%. Assuming an immediate 100 basis point increase in the interest rates
affecting all interest rate sensitive assets and liabilities at December 31, 2013, we estimated that net interest income
over the following 12-month period would increase by approximately $136 million, or 2%. The increase in net interest
income sensitivity is due to actions we have taken to position our balance sheet for future rate increases, which included
swapping floating-rate borrowings to fixed-rate borrowings in the second and third quarters of 2014 calendar year.
We have not provided an estimate of any impact on net interest income of a decrease in interest rates as many of our
interest rate sensitive assets and liabilities are tied to interest rates that are already at or near their minimum levels (i.e.,
Prime and LIBOR) and, therefore, could not materially decrease further. Net interest income sensitivity requires
assumptions to be made regarding market conditions, consumer behavior, and the overall growth and composition of
the balance sheet. These assumptions are inherently uncertain and, as a result, actual earnings may differ from the
simulated earnings presented above. Our actual earnings are dependent on multiple factors including, but not limited
to, the direction and timing of changes in interest rates the movement of short-term vs. long-term rates, balance sheet
design, competitor actions which may affect pricing decisions in our loans and deposits, and strategic actions
undertaken by management.
-84-
Item 8.
Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Discover Financial Services
Riverwoods, IL
We have audited the internal control over financial reporting of Discover Financial Services (the “Company”) as of
December 31, 2014 based on criteria established in Internal Control — Integrated Framework (2013) issued by the
Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for
maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial
Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based
on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining
an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing
such other procedures as we considered necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the
company's principal executive and principal financial officers, or persons performing similar functions, and effected by
the company's board of directors, management, and other personnel to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over financial reporting includes those policies
and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on
the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or
improper management override of controls, material misstatements due to error or fraud may not be prevented or
detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial
reporting to future periods are subject to the risk that the controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2014, based on the criteria established in Internal Control — Integrated Framework (2013) issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the consolidated statement of financial condition, and related consolidated statements of income, comprehensive
income, changes in stockholders’ equity, and cash flows as of and for the year ended December 31, 2014 of the
Company and our report dated February 25, 2015 expressed an unqualified opinion on those financial statements.
Chicago, Illinois
February 25, 2015
-85-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Discover Financial Services
Riverwoods, IL
We have audited the accompanying consolidated statements of financial condition of Discover Financial Services (the
“Company”) as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive
income, changes in stockholders' equity, and cash flows for the calendar years ended December 31, 2014 and 2013,
the fiscal year ended November 30, 2012, and the one-month period ended December 31, 2012. These financial
statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of
Discover Financial Services at December 31, 2014 and 2013, and the results of their operations and their cash flows
for the calendar years ended December 31, 2014 and 2013, the fiscal year ended November 30, 2012, and the one-
month period ended December 31, 2012, in conformity with accounting principles generally accepted in the United
States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the Company's internal control over financial reporting as of December 31, 2014, based on the criteria
established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations
of the Treadway Commission and our report dated February 25, 2015 expressed an unqualified opinion on the
Company's internal control over financial reporting.
Chicago, Illinois
February 25, 2015
-86-
DISCOVER FINANCIAL SERVICES
Consolidated Statements of Financial Condition
December 31,
2014
2013
(dollars in millions,
except share amounts)
Assets
Cash and cash equivalents ............................................................................................................................. $
7,284
$
Restricted cash ..............................................................................................................................................
Investment securities (includes $3,847 and $4,931 at fair value at December 31, 2014 and 2013, respectively)....
Loan receivables:
Loan receivables (includes $122 and $148 at fair value at December 31, 2014 and 2013, respectively) ...........
Allowance for loan losses ...........................................................................................................................
Net loan receivables ...............................................................................................................................
Premises and equipment, net
..........................................................................................................................
Goodwill
......................................................................................................................................................
Intangible assets, net
.....................................................................................................................................
106
3,949
69,969
(1,746)
68,223
670
257
176
Other assets
.................................................................................................................................................
2,461
Total assets
....................................................................................................................................... $
83,126
$
6,554
182
4,991
65,771
(1,648)
64,123
654
284
185
2,367
79,340
Liabilities and Stockholders’ Equity
Deposits:
Interest-bearing deposit accounts ................................................................................................................ $
45,792
$
44,766
Non-interest bearing deposit accounts
........................................................................................................
Total deposits
........................................................................................................................................
Short-term borrowings ...................................................................................................................................
Long-term borrowings ....................................................................................................................................
Accrued expenses and other liabilities .............................................................................................................
Total liabilities
...................................................................................................................................
Commitments, contingencies and guarantees (Notes 15, 18, and 19)
Stockholders’ Equity:
Common stock, par value $0.01 per share; 2,000,000,000 shares authorized; 558,194,324 and 555,349,629
shares issued at December 31, 2014 and 2013, respectively ..........................................................................
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 December 31, 2014 and 2013, respectively .........
Additional paid-in capital
..............................................................................................................................
Retained earnings
.........................................................................................................................................
Accumulated other comprehensive loss
...........................................................................................................
Treasury stock, at cost; 109,006,038 and 83,105,578 shares at December 31, 2014 and 2013, respectively .......
Total stockholders’ equity ...................................................................................................................
297
46,089
113
22,544
3,246
71,992
5
560
3,790
11,467
(138)
(4,550)
11,134
Total liabilities and stockholders’ equity ............................................................................................... $
83,126
$
193
44,959
140
20,474
2,958
68,531
5
560
3,687
9,611
(68)
(2,986)
10,809
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 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.
Assets
Restricted cash .............................................................................................................................................. $
Loan receivables
........................................................................................................................................... $
Allowance for loan losses allocated to securitized loan receivables .................................................................... $
Other assets
................................................................................................................................................. $
Liabilities
Long-term borrowings .................................................................................................................................... $
Accrued expenses and other liabilities ............................................................................................................. $
See Notes to Consolidated Financial Statements.
-87-
December 31,
2014
2013
(dollars in millions)
102
32,304
$
$
(833) $
$
37
179
33,360
(861)
34
17,395
11
$
$
16,986
9
DISCOVER FINANCIAL SERVICES
Consolidated Statements of Income
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
(dollars in millions, except per share amounts)
510
78
7
—
595
65
—
38
103
492
178
314
82
33
29
18
2
17
19
Interest income:
Credit card loans ................................................................................ $
6,359
$
5,978
$
5,751
$
Other loans ........................................................................................
Investment securities ............................................................................
Other interest income ..........................................................................
1,151
67
19
997
74
15
856
80
16
Total interest income ........................................................................
7,596
7,064
6,703
Interest expense:
Deposits .............................................................................................
Short-term borrowings .........................................................................
Long-term borrowings .........................................................................
Total interest expense ......................................................................
Net interest income .....................................................................
Provision for loan losses ......................................................................
Net interest income after provision for loan losses ..........................
Other income:
Discount and interchange revenue, net ..................................................
Protection products revenue .................................................................
Loan fee income .................................................................................
Transaction processing revenue ............................................................
Gain on investments ............................................................................
Gain on origination and sale of mortgage loans ....................................
Other income .....................................................................................
Total other income ..........................................................................
Other expense:
614
2
518
1,134
6,462
1,443
5,019
979
314
334
182
4
81
121
2,015
698
3
445
1,146
5,918
1,086
4,832
845
1
485
1,331
5,372
848
4,524
1,126
1,035
350
320
192
5
144
169
409
325
218
26
105
163
2,306
2,281
200
Employee compensation and benefits ....................................................
1,242
1,164
1,048
Marketing and business development ....................................................
Information processing and communications ..........................................
Professional fees .................................................................................
Premises and equipment ......................................................................
Other expense ....................................................................................
Total other expense .........................................................................
Income before income tax expense ...............................................
Income tax expense ............................................................................
Net income ................................................................................. $
Net income allocated to common stockholders ............................... $
Basic earnings per common share ............................................................ $
Diluted earnings per common share ......................................................... $
735
346
450
92
475
3,340
3,694
1,371
2,323
2,270
4.91
4.90
$
$
$
$
717
333
410
82
488
3,194
3,944
1,474
2,470
2,414
4.97
4.96
$
$
$
$
603
289
432
76
604
3,052
3,753
1,408
2,345
2,318
4.47
4.46
$
$
$
$
87
51
25
34
8
35
240
274
104
170
168
0.34
0.34
See Notes to the Consolidated Financial Statements.
-88-
DISCOVER FINANCIAL SERVICES
Consolidated Statements of Comprehensive Income
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
(dollars in millions)
Net income ............................................................................................ $
2,323
$
2,470
$
2,345
$
170
Other comprehensive (loss) income, net of taxes
Unrealized gain (loss) on available-for-sale investment securities, net of
tax ..................................................................................................
Unrealized (loss) gain on cash flow hedges, net of tax ............................
Unrealized pension plan (loss) gain, net of tax .......................................
Foreign currency translation adjustments, net of tax ................................
Other comprehensive (loss) income ...................................................
4
(20)
(53)
(1)
(70)
(52)
10
45
1
4
19
(4)
(38)
—
(23)
(3)
—
6
—
3
Comprehensive income ................................................................ $
2,253
$
2,474
$
2,322
$
173
See Notes to the Consolidated Financial Statements.
-89-
DISCOVER FINANCIAL SERVICES
Consolidated Statements of Changes in Stockholders’ Equity
Preferred Stock
Common Stock
Shares
Amount
Shares
Amount
Additional
Paid-in
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
(Loss) Income
Treasury
Stock
Total
Stockholders’
Equity
(dollars in millions, shares in thousands)
Balance at November 30, 2011 ..
— $ — 549,749
$
$ 3,508
$ 5,243
$
(52) $ (462) $
Net income ................................
Other comprehensive loss ............
Purchases of treasury stock ..........
Common stock issued under
employee benefit plans ..............
Common stock issued and stock-
based compensation expense .....
Dividends — common stock
($0.40 per share) ......................
Dividends — preferred stock
($8.13 per share) ......................
Issuance of preferred stock, net of
issuance costs ...........................
Balance at November 30, 2012 ..
Net income ................................
Other comprehensive income .......
Purchases of treasury stock ..........
Common stock issued and stock-
based compensation expense .....
Dividends — common stock
($0.14 per share) ......................
Balance at December 31, 2012 ...
Net income ................................
Other comprehensive income .......
Purchases of treasury stock ..........
Common stock issued under
employee benefit plans ................
Common stock issued and stock-
based compensation expense .....
Dividends — common stock
($0.60 per share) ......................
Dividends — preferred stock
($65.00 per share) ....................
Balance at December 31, 2013 ...
Net income ................................
Other comprehensive loss ............
Purchases of treasury stock ..........
Common stock issued under
employee benefit plans ..............
Common stock issued and stock-
based compensation expense .....
Dividends — common stock
($0.92 per share) ......................
Dividends — preferred stock
($65.00 per share) ....................
Balance at December 31, 2014 ...
—
—
—
—
—
—
—
—
—
—
—
—
—
—
575
575
560
560
—
—
—
—
—
—
—
—
—
—
—
—
—
54
3,246
—
—
—
553,049
—
—
—
302
—
575
560
553,351
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
66
1,933
—
—
575
560
555,350
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
62
2,782
—
—
5
—
—
—
—
—
—
—
—
5
—
—
—
—
—
5
—
—
—
—
—
—
—
5
—
—
—
—
—
—
—
—
—
—
2
83
—
—
—
3,593
—
—
—
5
—
3,598
—
—
—
3
86
—
—
3,687
—
—
—
3
100
—
—
2,345
—
—
—
—
(210)
(5)
—
7,373
170
—
—
—
(71)
7,472
2,470
—
—
—
—
(294)
(37)
9,611
2,323
—
—
—
—
(430)
(37)
—
(23)
—
—
— (1,216)
—
—
—
—
—
—
—
—
—
—
(75)
(1,678)
—
3
—
—
—
—
—
(12)
—
—
(72)
(1,690)
—
4
—
—
8,242
2,345
(23)
(1,216)
2
83
(210)
(5)
560
9,778
170
3
(12)
5
(71)
9,873
2,470
4
— (1,296)
(1,296)
—
—
—
—
—
—
—
—
(68)
(2,986)
—
(70)
—
—
— (1,564)
—
—
—
—
—
—
—
—
3
86
(294)
(37)
10,809
2,323
(70)
(1,564)
3
100
(430)
(37)
575
$ 560
558,194
$
5
$ 3,790
$ 11,467
$
(138) $ (4,550) $
11,134
See Notes to the Consolidated Financial Statements.
-90-
DISCOVER FINANCIAL SERVICES
Consolidated Statements of Cash Flows
Cash flows from operating activities
Net income ......................................................................................................................... $
Adjustments to reconcile net income to net cash provided by operating activities:
2,323
$
2,470
$
2,345
$
170
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
(dollars in millions)
Provision for loan losses ..................................................................................................
Deferred income taxes .....................................................................................................
Depreciation and amortization on premises and equipment ................................................
Amortization of deferred revenues ....................................................................................
Other depreciation and amortization ................................................................................
Accretion of accretable yield on acquired loans .................................................................
Gain on investments ........................................................................................................
Loss on equity method and other investments .....................................................................
Loss on premises and equipment ......................................................................................
Gain on origination and sale of loans ...............................................................................
Stock-based compensation expense ..................................................................................
Elimination of credit card rewards program forfeitures .......................................................
Impairment of goodwill
...................................................................................................
Loss on Diners Club Italy business held for sale ..................................................................
Proceeds from sale of mortgage loans originated for sale ...................................................
Net principal disbursed on mortgage loans originated for sale ............................................
Changes in assets and liabilities:
Increase in other assets ...............................................................................................
Increase (decrease) in accrued expenses and other liabilities ..........................................
Net cash provided by operating activities ..................................................................................
Cash flows from investing activities
Maturities and sales of available-for-sale investment securities ............................................
Purchases of available-for-sale investment securities ...........................................................
Maturities of held-to-maturity investment securities .............................................................
Purchases of held-to-maturity investment securities .............................................................
Proceeds from sale of student loans held for sale ................................................................
Net principal disbursed on loans originated for investment .................................................
Purchases of loan receivables ...........................................................................................
Purchase of net assets of a business ..................................................................................
Purchases of other investments .........................................................................................
Proceeds from sale of other investments ............................................................................
Decrease (increase) in restricted cash ................................................................................
Proceeds from sale of premises and equipment ..................................................................
Purchases of premises and equipment ...............................................................................
Net cash (used for) provided by investing activities .....................................................................
Cash flows from financing activities
Net (decrease) increase in short-term borrowings ...............................................................
Proceeds from issuance of securitized debt ........................................................................
Maturities and repayment of securitized debt .....................................................................
Proceeds from issuance of other long-term borrowings .......................................................
Repayment of long-term borrowings and bank notes ..........................................................
Payment of contingent consideration for purchase of net assets of a business, at fair value.....
Premium paid on debt exchange ......................................................................................
Proceeds from issuance of common stock ..........................................................................
Purchases of treasury stock ..............................................................................................
Net increase in deposits ..................................................................................................
Proceeds from issuance of preferred stock .........................................................................
Dividends paid on common and preferred stock ................................................................
Net cash provided by (used for) financing activities ....................................................................
Net increase (decrease) in cash and cash equivalents .................................................................
Cash and cash equivalents, at beginning of period .....................................................................
Cash and cash equivalents, at end of period .............................................................................. $
1,443
(11)
126
(214)
243
(260)
(4)
29
—
(81)
60
178
27
21
2,811
(2,700)
(238)
73
3,826
1,460
(390)
10
(53)
—
(5,095)
—
—
(60)
—
76
—
(145)
(4,197)
(27)
5,049
(4,678)
1,646
—
—
—
5
(1,564)
1,137
—
(467)
1,101
730
6,554
7,284
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest expense .............................................................................................................. $
Income taxes, net of income tax refunds ............................................................................ $
933
1,388
Non-cash investing and financing transactions:
1,086
322
111
(193)
223
(272)
(5)
18
8
(144)
59
—
—
—
4,160
(3,805)
(252)
(269)
3,517
1,423
(325)
29
(2)
—
(3,915)
(136)
—
(114)
—
108
—
(231)
(3,163)
(231)
4,650
(3,638)
1,744
—
(9)
—
13
(1,296)
2,782
—
(399)
3,616
3,970
2,584
6,554
975
1,348
$
$
$
$
$
$
Initial fair value of contingent consideration paid for purchase of net assets of a business ...... $
Assumption of debt by buyer related to loans sold ............................................................. $
— $
— $
— $
— $
See Notes to the Consolidated Financial Statements.
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848
146
95
(204)
172
(303)
(26)
11
—
(104)
47
—
—
—
1,798
(2,021)
(112)
349
3,041
1,783
(1,816)
11
(51)
269
(4,085)
(490)
(49)
(65)
—
(1,057)
1
(144)
(5,693)
234
5,850
(3,752)
—
(13)
—
(291)
26
(1,216)
2,539
560
(209)
3,728
1,076
2,850
3,926
1,203
1,301
8
425
$
$
$
$
$
178
(12)
9
(16)
15
(24)
(2)
1
—
(17)
3
—
—
—
378
(392)
(68)
(1)
222
112
(132)
1
—
—
(1,599)
(27)
—
(4)
17
2,054
—
(13)
409
43
—
(2,066)
—
—
—
—
2
(12)
65
—
(5)
(1,973)
(1,342)
3,926
2,584
81
(1)
—
—
Notes to the Consolidated Financial Statements
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 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 also 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 consumer banking and lending products, specifically Discover-branded credit cards issued to individuals 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
provides payment transaction processing and settlement services on the Discover Network. 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.
Change in Fiscal Year End
On December 3, 2012, the Company's board of directors approved a change in the Company’s fiscal year end
from November 30 to December 31 of each year. This fiscal year change was effective January 1, 2013. As a result of
the change, the Company had a one month transition period in December 2012. The audited results for the one month
ended December 31, 2012 are included in this report.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting
principles generally accepted in the United States (“GAAP”). The preparation of financial statements in conformity with
GAAP requires the Company to make estimates and assumptions that affect the amounts reported in the consolidated
financial statements and related disclosures. These estimates are based on information available as of the date of the
consolidated financial statements. The Company believes that the estimates used in the preparation of the consolidated
financial statements are reasonable. Actual results could differ from these estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries.
The Company's policy is to consolidate all entities in which it owns more than 50% of the outstanding voting stock
unless it does not control the entity. However, the Company did not have a controlling voting interest in any entity other
than its wholly-owned subsidiaries in the periods presented in the accompanying consolidated financial statements.
It is also the Company's policy to consolidate any variable interest entity for which the Company is the primary
beneficiary, as defined by GAAP. On this basis, the Company consolidates the Discover Card Master Trust I and the
Discover Card Execution Note Trust as well as three student loan securitization trusts acquired in 2010. The Company is
deemed to be the primary beneficiary of each of these trusts since it is, for each, the trust servicer and the holder of both
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the residual interest and the majority of the most subordinated interests. Because of those involvements, the Company
has, for each trust, i) the power to direct the activities that most significantly impact the economic performance of the
trust, and ii) the obligation (or right) to absorb losses (or receive benefits) of the trust that could potentially be
significant. The Company has determined that it was not the primary beneficiary of any other variable interest entity
during the calendar years ended December 31, 2014 and 2013, fiscal year ended November 30, 2012 or one month
ended December 31, 2012.
For investments in any entities in which the Company owns 50% or less of the outstanding voting stock but in
which the Company has significant influence over operating and financial decisions, the Company applies the equity
method of accounting. The Company also applies the equity method to its investments in qualified affordable housing
projects and similar tax credit partnerships. In cases where the Company's equity investment is less than 20% and
significant influence does not exist, such investments are carried at cost.
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.
Summary of Significant Accounting Policies
Cash and Cash Equivalents
Cash and cash equivalents is defined by the Company as cash on deposit with banks, including time deposits
and other highly liquid investments, with maturities of 90 days or less when purchased. Cash and cash equivalents
included $846 million and $719 million of cash and due from banks and $6.4 billion and $5.8 billion of interest-
earning deposits in other banks at December 31, 2014 and 2013, respectively.
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Restricted Cash
Restricted cash includes cash for which the Company's ability to withdraw funds at any time is contractually
limited. Restricted cash is generally designated for specific purposes arising out of certain contractual or other
obligations.
Investment Securities
At December 31, 2014, investment securities consisted of U.S. Treasury and U.S. government agency obligations,
mortgage-backed securities issued by government agencies and debt instruments issued by states and political
subdivisions of states. Investment securities that the Company has the positive intent and ability to hold to maturity are
classified as held-to-maturity and are reported at amortized cost. All other investment securities are classified as
available-for-sale, as the Company does not hold investment securities for trading purposes. Available-for-sale
investment securities are reported at fair value with unrealized gains and losses, net of tax, reported as a component of
accumulated other comprehensive income included in stockholders' equity. The Company estimates the fair value of
available-for-sale investment securities as more fully discussed in Note 20: Fair Value Measurements and Disclosures.
The amortized cost for each held-to-maturity and available-for-sale investment security is adjusted for amortization of
premiums or accretion of discounts, as appropriate. Such amortization or accretion is included in interest income. The
Company evaluates its unrealized loss positions for other-than-temporary impairment in accordance with GAAP
applicable for investments in debt and equity securities. Realized gains and losses and the credit loss portion of other-
than-temporary impairments related to investment securities are determined at the individual security level and are
reported in other income.
Loan Receivables
Loan receivables consist of credit card receivables, other loans and purchased credit-impaired ("PCI") loans.
Loan receivables also include unamortized net deferred loan origination fees and costs (also see “— Significant
Revenue Recognition Accounting Policies — Loan Interest and Fee Income”). Credit card loan receivables are reported
at their principal amounts outstanding and include uncollected billed interest and fees and are reduced for unearned
revenue related to balance transfer fees (also see “— Significant Revenue Recognition Accounting Policies — Loan
Interest and Fee Income”). Other loans consist of student loans, personal loans, mortgage loans held for sale and other
loans and are reported at their principal amounts outstanding. With the exception of mortgages, the Company's loan
receivables are deemed to be held for investment at origination or acquisition because management has the intent and
ability to hold them for the foreseeable future.
Cash flows associated with loans that are originated or acquired with the intent to sell are included in cash flows
from operating activities. Cash flows associated with loans originated or acquired for investment are classified as cash
flows from investing activities, regardless of a subsequent change in intent.
Purchased Credit-Impaired Loans
PCI loans are loans acquired at prices which reflected a discount related to deterioration in individual loan credit
quality since origination. The Company's PCI loans are comprised entirely of acquired private student loans.
The PCI student loans were aggregated into pools based on common risk characteristics at the time of their
acquisition. Loans were grouped primarily on the basis of origination date as loans originated in a particular year
generally reflect the application of common origination strategies and/or underwriting criteria. Each pool is accounted
for as a single asset and each has a single composite interest rate, total contractual cash flows and total expected cash
flows.
Interest income on PCI loans is recognized on the basis of expected cash flows rather than contractual cash flows.
The total amount of interest income recognizable on a pool of PCI loans (i.e., its accretable yield) is the difference
between the carrying amount of the loan pool and the future cash flows expected to be collected without regard to
whether the expected cash flows represent principal or interest collections. Interest is recognized on an effective yield
basis over the life of the loan pool.
The initial estimates of the fair value of the PCI student loans included the impact of expected credit losses, and
therefore, no allowance for loan loss was recorded as of the purchase dates. The difference between contractually
required cash flows and cash flows expected to be collected, as measured at the acquisition dates, is not permitted to be
accreted. Charge-offs are absorbed by this non-accretable difference and do not result in a charge to earnings.
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The estimate of cash flows expected to be collected is evaluated each reporting period to ensure it reflects
management's latest expectations of future credit losses and borrower prepayments, and interest rates in effect in the
current period. To the extent expected credit losses increase after the acquisition dates, the Company will record an
allowance for loan losses through the provision for loan losses, which will reduce net income. Changes in expected
cash flows related to changes in prepayments or interest rate indices for variable rate loans generally are recorded
prospectively as adjustments to interest income.
To the extent that a significant increase in cash flows due to lower expected losses is deemed probable, the
Company will first reverse any previously established allowance for loan losses and then increase the amount of
remaining accretable yield. The increase to yield would be recognized prospectively over the remaining life of the loan
pool. An increase in the accretable yield would reduce the remaining non-accretable difference available to absorb
subsequent charge-offs. Disposals of loans, which may include sales of loans or receipt of payments in full from the
borrower or charge-offs, result in removal of the loans from their respective pools.
Delinquent Loans
The entire balance of an account is contractually past due if the minimum payment is not received by the
specified date on the customer's billing statement. Delinquency is reported on loans that are 30 days or more past due.
Credit card loans are charged off at the end of the month during which an account becomes 180 days past due.
Closed-end consumer loan receivables are charged off at the end of the month during which an account becomes 120
days contractually past due. 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 time
frame described above. Receivables associated with alleged or potential fraudulent transactions are adjusted to their
net realizable value upon receipt of notification of such fraud through a charge to other expense and are subsequently
written off at the end of the month 90 days following notification, but not later than the contractual 180-day or 120-day
time frame described above. The Company's charge-off policies are designed to comply with guidelines established by
the Federal Financial Institutions Examination Council (“FFIEC”).
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.
The practice of re-aging an account also may affect loan delinquencies and charge-offs. A re-age is intended to
assist delinquent customers who have experienced financial difficulties but who demonstrate both an ability and
willingness to repay. Accounts meeting specific criteria are re-aged when the Company and the customer agree on a
temporary repayment schedule that may include concessionary terms. With re-aging, the outstanding balance of a
delinquent account is returned to a current status. Customers may also qualify for a workout re-age when either a
longer term or permanent hardship exists. The Company's re-age practices are designed to comply with FFIEC
guidelines.
Allowance for Loan Losses
The Company maintains an allowance for loan losses at a level that is appropriate to absorb probable losses
inherent in the loan portfolio. The estimate of probable incurred losses considers uncollectible principal, interest and
fees reflected in the loan receivables. The allowance is evaluated monthly for appropriateness 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 of loan losses (also see “— Significant Revenue Recognition Accounting Policies
— Loan Interest and Fee Income”).
The Company calculates its allowance for loan losses by estimating probable losses separately for classes of the
loan portfolio with similar loan characteristics, which generally results in segmenting the portfolio by loan product type.
The Company bases its allowance for loan loss 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. For substantially all of its loan receivables, 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 and current loan performance,
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loan seasoning and growth, current risk management practices, account collection strategies, economic conditions,
bankruptcy filings, policy changes and forecasting uncertainties. For the majority of its portfolio, the Company 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 part of certain collection strategies, the Company may modify the terms of loans to customers experiencing
financial hardship. 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 accounted for as troubled debt
restructurings. With respect to student loans, the Company does not anticipate significant shortfalls in collections on the
contractual amounts due from 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.
Loan receivables, other than PCI loans, that have been modified under a troubled debt restructuring are
evaluated separately from the pools of receivables that are subject to the collective analyses described above. Loan
receivables modified in a troubled debt restructuring are recorded at their present values with impairment measured as
the difference between the loan balance and the discounted present value of cash flows expected to be collected.
Consistent with the Company's measurement of impairment of modified loans on a pooled basis, the discount rate used
for credit card loans in internal programs is the average current annual percentage rate applied to non-impaired credit
card loans, which approximates what would have applied to the pool of modified loans prior to impairment. The
discount rate used for credit card loans in external programs reflects a rate that is consistent with rates offered to
cardmembers not in a program that have similar risk characteristics. For student and personal loans, the discount rate
used is the average contractual rate prior to modification. Changes in the present value are recorded in the provision
for loan losses. All of the Company's troubled debt restructurings, which are evaluated collectively on an aggregated
(by loan type) basis, have a related allowance for loan losses.
Premises and Equipment, net
Premises and equipment, net, are stated at cost less accumulated depreciation and amortization, which is
computed using the straight-line method over the estimated useful lives of the assets. Buildings are depreciated over a
period of 39 years. The costs of leasehold improvements are capitalized and depreciated over the lesser of the
remaining term of the lease or the asset's estimated useful life, typically ten years. Furniture and fixtures are depreciated
over a period of five to ten years. Equipment is depreciated over three to ten years. Capitalized leases, consisting of
computers and processing equipment, are depreciated over three and six years, respectively. Maintenance and repairs
are immediately expensed, while the costs of improvements are capitalized.
Purchased software and capitalized costs related to internally developed software are amortized over their useful
lives of three to ten years. Costs incurred during the application development stage related to internally developed
software are capitalized. Costs are expensed as incurred during the preliminary project stage and post implementation
stage. Once the capitalization criteria as defined in GAAP have been met, external direct costs incurred for materials
and services used in developing or obtaining internal-use computer software and payroll and payroll-related costs for
employees who are directly associated with the internal-use computer software project (to the extent those employees
devoted time directly to the project) are capitalized. Amortization of capitalized costs begins when the software is ready
for its intended use. Capitalized software is included in premises and equipment, net in the Company's consolidated
statements of financial condition. See Note 6: Premises and Equipment for further information about the Company's
premises and equipment.
Goodwill
Goodwill is recorded as part of the Company's acquisitions of businesses when the purchase price exceeds the
fair value of the net tangible and separately identifiable intangible assets acquired. The Company's goodwill is not
amortized, but rather is subject to an impairment test at the reporting unit level annually as of October 1, or between
annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a
reporting unit below its carrying amount. The Company's reported goodwill relates to PULSE, acquired in 2005, and to
the Home Loan Center mortgage origination business acquired in 2012. The Company's goodwill impairment analysis
is a two-step test. In the first step, the fair value of the reporting unit is compared to its carrying value. If the fair value of
the reporting unit exceeds its carrying value including goodwill, goodwill is not impaired. If the carrying value including
goodwill exceeds its fair value, goodwill is potentially impaired and the second step of the test becomes necessary. In
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the second step, the implied fair value of goodwill is derived and compared to the carrying amount of goodwill. The
implied fair value of goodwill is the excess of the fair value of the reporting unit over the sum of the fair values of all
identifiable assets less the liabilities associated with the reporting unit. If the carrying value of goodwill allocated to the
reporting unit exceeds its implied fair value, an impairment charge is recorded for the excess. The Company conducted
its annual goodwill impairment test as of October 1, 2014, which resulted in the recognition of non-cash impairment
charge of $27 million during the three months ended December 31, 2014 related to the Discover Home Loans business.
The impairment charge was recorded in the other expense line as a component of total other expense in the
accompanying consolidated and combined statements of income and within the Direct Banking segment. See Note 7:
Goodwill and Intangible Assets for further details concerning the goodwill impairment charge.
During the fourth quarter of 2013, the Company changed the date of its annual goodwill impairment test from
June 1 to October 1. The change in goodwill impairment testing date is deemed a change in accounting principle
which management determined to be preferable under the circumstances. The change was made to better align with the
timing of its annual and long-term planning process, which is a significant element in the testing process. Due to the
change in the Company’s fiscal year end from November 30 to December 31, the change from June 1 to October 1
also enhances the ability of the Company to obtain carrying values for use in the testing process by using the beginning
of a fiscal quarter.
In connection with the change in date of the annual goodwill impairment test, the Company performed a
goodwill impairment test on October 1, 2013. This change did not delay, accelerate, or avoid a goodwill impairment
charge. The goodwill impairment tests on June 1, 2013 and October 1, 2013 were performed such that a period
greater than 12 months did not elapse between test dates. The change in the annual goodwill impairment testing date
was applied prospectively beginning on October 1, 2013 and had no effect on the consolidated financial statements.
This change was not applied retrospectively as it is impracticable to do so because retrospective application would have
required the application of significant estimates and assumptions without the use of hindsight.
Intangible Assets
The Company's identifiable intangible assets consist of both amortizable and non-amortizable intangible assets.
The Company's amortizable intangible assets consist primarily of acquired customer relationships and certain trade
name intangibles. All of the Company's amortizable intangible assets are carried at net book value and are amortized
over their estimated useful lives. The amortization periods approximate the periods over which the Company expects to
generate future net cash inflows from the use of these assets. The Company's policy is to amortize intangibles in a
manner that reflects the pattern in which the projected net cash inflows to the Company are expected to occur, where
such pattern can be reasonably determined, as opposed to the straight-line basis. This method of amortization typically
results in a greater portion of the intangible asset being amortized in the earlier years of its useful life.
All of the Company's amortizable intangible assets, as well as other amortizable or depreciable long-lived assets
such as premises and equipment, are subject to impairment testing when events or conditions indicate that the carrying
value of an asset may not be fully recoverable from future cash flows. A test for recoverability is done by comparing the
asset's carrying value to the sum of the undiscounted future net cash inflows expected to be generated from the use of
the asset over its remaining useful life. Impairment exists if the sum of the undiscounted expected future net cash inflows
is less than the carrying amount of the asset. Impairment would result in a write-down of the asset to its estimated fair
value. The estimated fair values of these assets are based on the discounted present value of the stream of future net
cash inflows expected to be derived over the remaining useful lives of the assets. If an impairment write-down is
recorded, the remaining useful life of the asset will be evaluated to determine whether revision of the remaining
amortization or depreciation period is appropriate.
The Company's non-amortizable intangible assets consist of the international transaction processing rights and
brand-related intangibles included in the acquisition of Diners Club as well as the trade names acquired in The Student
Loan Corporation acquisition. These assets are deemed to have indefinite useful lives and are therefore not subject to
amortization. All of the Company's non-amortizable intangible assets are subject to a test for impairment annually as of
October 1, or more frequently if events or changes in circumstances indicate that the asset might be impaired. As
required by GAAP, if the carrying value of a non-amortizable intangible asset is in excess of its fair value, the asset
must be written down to its fair value through the recognition of an impairment charge to earnings. No impairment
charges were identified during the impairment test conducted at October 1, 2014. In contrast to amortizable
intangibles, there is no test for recoverability associated with the impairment test for non-amortizable intangible assets.
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During the fourth quarter of 2013, the Company changed the date of its annual impairment test for non-
amortizable intangible assets from June 1 to October 1 to coincide with the change in the Company's goodwill
impairment test date. The Company performed impairment tests at June 1, 2013 and October 1, 2013, and as such a
period greater than 12 months did not elapse between test dates.
Stock-based Compensation
The Company measures the cost of employee services received in exchange for an award of stock-based
compensation based on the grant-date fair value of the award. The cost is recognized over the requisite service period,
except for awards granted to retirement-eligible employees, which are fully expensed on the grant date. No
compensation cost is recognized for awards that are subsequently forfeited.
Advertising Costs
The Company expenses television advertising costs in the period in which the advertising is first aired and all
other advertising costs as incurred. Advertising costs are recorded in marketing and business development and were
$194 million, $208 million, $172 million and $17 million for the calendar years ended December 31, 2014 and 2013,
fiscal year ended November 30, 2012 and one month ended December 31, 2012, respectively.
Income Taxes
Income tax expense is provided for using the asset and liability method, under which deferred tax assets and
liabilities are determined based on the temporary differences between the financial statement and income tax bases of
assets and liabilities using currently enacted tax rates. Deferred tax assets are recognized when their realization is
determined to be more likely than not. Uncertain tax positions are measured at the highest amount of tax benefit for
which realization is judged to be more likely than not. Tax benefits that do not meet these criteria are unrecognized tax
benefits. See Note 15: Income Taxes for more information about the Company's income taxes.
Financial Instruments Used for Asset and Liability Management
The Company utilizes derivative financial instruments to manage its various exposures to changes in fair value of
certain assets and liabilities, variability in future cash flows arising from changes in interest rates, or other types of
forecasted transactions, and changes in foreign exchange rates. All derivatives are carried at their estimated fair values
on the Company’s consolidated statements of financial condition. Derivatives having gross positive fair values, inclusive
of net accrued interest receipts or payments, are recorded in other assets. Derivatives with gross negative fair values,
inclusive of net accrued interest payments or receipts, are recorded in accrued expenses and other liabilities. The
methodologies used to estimate the fair values of these derivative financial instruments are described in Note 20: Fair
Value Measurements and Disclosures. Collateral receivable or payable amounts associated with derivatives are not
offset against the fair value of these derivatives, but are recorded separately in other assets or deposits, respectively.
Certain of these instruments are designated and qualify for hedge accounting. A hedge is deemed effective to the
extent that the change in fair value, cash flow, or net investment of the hedged item is offset by changes in the hedging
instrument. If the change in the hedging instrument is more or less than the change in fair value, cash flow, or net
investment of the hedged item, the difference is referred to as the ineffective portion of the hedge. Under cash flow
hedge accounting, the effective portion of the change in the fair value of these derivative instruments is recognized in
other comprehensive income. The change in fair value of these derivative instruments relating to the ineffective portion is
recognized immediately in other income. Amounts accumulated in other comprehensive income are reclassified to
earnings in the period during which the hedged items affect income. For a net investment hedge, the effective portion of
changes in the fair value of the derivatives is reported in other comprehensive income as part of the cumulative
translation adjustment. The ineffective portion of the change in fair value of the derivatives, if any, is recognized directly
in earnings. Amounts are reclassified out of accumulated other comprehensive income into earnings when the hedged
net investment is either sold or substantially liquidated. Under fair value hedge accounting, changes in both (i) the fair
values of the derivative instruments and (ii) the fair values of the hedged items relating to the risks being hedged,
including net differences, if any (i.e., ineffectiveness), are recorded in interest expense. Certain other derivatives are not
designated as hedges or do not qualify for hedge accounting; changes in the fair value of these derivatives are
recorded in other income. These transactions are discussed in more detail in Note 21: Derivatives and Hedging
Activities.
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Accumulated Other Comprehensive Income
The Company records unrealized gains and losses on available-for-sale securities, changes in the fair value of
cash flow hedges, and certain pension and foreign currency translation adjustments in other comprehensive income
("OCI") on an after-tax basis where applicable. Details of other comprehensive income, net of tax, are presented in the
statement of comprehensive income, and a rollforward of accumulated other comprehensive income ("AOCI") is
presented in the statement of changes in stockholders' equity and Note 13: Accumulated Other Comprehensive Income.
Significant Revenue Recognition Accounting Policies
Loan Interest and Fee Income
Interest on loans is comprised largely of interest on credit card loans and is recognized based upon the amount
of loans outstanding and their contractual interest rate. Interest on credit card loans is included in loan receivables when
billed to the customer. The Company accrues unbilled interest revenue each month from a customer's billing cycle date
to the end of the month. The Company applies an estimate of the percentage of loans that will revolve in the next cycle
in the estimation of the accrued unbilled portion of interest revenue that is included in accrued interest receivable on the
consolidated statements of financial condition. Interest on other loan receivables is accrued monthly in accordance with
their contractual terms and recorded in accrued interest receivable, which is included in other assets, in the consolidated
statements of financial condition. Interest related to purchased credit-impaired loans is discussed in Note 4: Loan
Receivables.
The Company recognizes fees (except annual fees, balance transfer fees and certain product fees) on loan
receivables in interest income or loan fee income as the fees are assessed. Annual fees, balance transfer fees and
certain product fees are recognized in interest income or loan fee income ratably over the periods to which they relate.
Balance transfer fees are accreted to interest income over the life of the related balance. As of December 31, 2014 and
2013, deferred revenues related to balance transfer fees, recorded as a reduction of loan receivables, were $40 million
and $37 million, respectively. Loan fee income consists of fees on credit card loans and includes annual, late, returned
check, cash advance and other miscellaneous fees and is reflected net of waivers and charge-offs.
Direct loan origination costs on credit card loans are deferred and amortized on a straight-line basis over a one
year period and recorded in interest income from credit card loans. Direct loan origination costs on other loan
receivables are deferred and amortized over the life of the loan using the interest method and are recorded in interest
income from other loans. As of December 31, 2014 and 2013, the remaining unamortized deferred costs related to
loan origination were $63 million and $43 million, respectively, and were recorded in loan receivables.
The Company accrues interest and fees on loan receivables until the loans are paid or charged off, except in
instances of customer bankruptcy, death or fraud, where no further interest and fee accruals occur following
notification. 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. Payments received on non-accrual loans are allocated according to the same payment hierarchy methodology
applied to loans that are accruing interest. When loan receivables are charged off, unpaid accrued interest and fees
are reversed against the income line items in which they were originally recorded in the consolidated statements of
income. Charge-offs and recoveries of amounts which relate to capitalized interest on student loans are treated as
principal charge-offs and recoveries, affecting the provision for loan losses rather than interest income. The Company
considers uncollectible interest and fee revenues in assessing the adequacy of the allowance for loan losses.
Interest income from loans individually evaluated for impairment, including loans accounted for as troubled debt
restructurings, is accounted for in the same manner as other accruing loans. Cash collections on these loans are
allocated according to the same payment hierarchy methodology applied to loans that are not in such programs.
Discount and Interchange Revenue
The Company earns discount revenue from fees charged to merchants with whom the Company has entered into
card acceptance agreements for processing credit card purchase transactions. The Company earns acquirer
interchange revenue from merchant acquirers on all Discover Network, Diners Club and PULSE transactions made by
credit and debit cardholders at merchants with whom merchant acquirers have entered into card acceptance
agreements for processing payment card transactions. The Company pays issuer interchange to network partners who
have entered into contractual arrangements to issue cards on the Company's networks as compensation for risk and
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other operating costs. The discount revenue or acquirer interchange is recognized as revenue, net of any associated
issuer interchange cost, at the time the transaction is captured.
Customer Rewards
The Company offers its customers various reward programs, including the Cashback Bonus reward program,
pursuant to which the Company pays certain customers a reward equal to a percentage of their credit card purchase
amounts based on the type and volume of the customer's purchases. The liability for customer rewards, which is
included in accrued expenses and other liabilities on the consolidated statements of financial condition, is recorded on
an individual customer basis and is accumulated as qualified customers earn rewards through their ongoing credit card
purchase activity or other defined actions. In the fourth quarter of 2014, the Company eliminated forfeiture of rewards,
which was communicated to its customers. This resulted in a one-time expense of $178 million due to the reversal of the
Company's current estimate for customer rewards forfeiture, a contra-liability account. Previously, in determining the
appropriate liability for customer rewards, the Company estimated forfeitures of rewards accumulated but not
redeemed based on historical account closure and charge-off experience, actual customer credit card purchase activity
and the terms of the rewards program. The Company recognizes customer rewards costs as a reduction of the related
revenue, if any. In instances where a reward is not associated with a revenue-generating transaction, such as when a
reward is given for opening an account, the reward cost is recorded as an operating expense. For the calendar years
ended December 31, 2014 and 2013, fiscal year ended November 30, 2012 and one month ended December 31,
2012, rewards costs, adjusted for estimated forfeitures, if any, amounted to $1.4 billion, $1.0 billion, $1.0 billion and
$123 million, respectively. At December 31, 2014 and 2013, the liability for customer rewards, adjusted for estimated
forfeitures, was $1.4 billion and $1.1 billion, respectively, which is included in accrued expenses and other liabilities on
the consolidated statements of financial condition.
Protection Products
The Company earns revenue related to fees received for marketing products or services that are ancillary to the
Company's credit card and personal loans to its customers, including payment protection products and identity theft
protection services. The amount of revenue recorded is based on the terms of the agreements and contracts with the
third parties that provide these services. The Company recognizes this income over the customer agreement or contract
period as earned.
Transaction Processing Revenue
Transaction processing revenue represents fees charged to financial institutions and merchant acquirers/
processors for processing ATM and debit point-of-sale transactions over the PULSE network and is recognized at the
time the transactions are processed. Transaction processing revenue also includes network participant revenue earned
by PULSE related to fees charged for maintenance, support, information processing and other services provided to
financial institutions, processors and other participants in the PULSE network. These revenues are recognized in the
period that the related transactions occur or services are rendered.
Royalty and Licensee Revenue
The Company earns revenue from licensing fees for granting the right to use the Diners Club brand and
processing fees for providing various services to Diners Club licensees, which are referred to together as royalty and
licensee revenue. Royalty revenue is recognized in the period that the cardholder volume used to calculate the royalty
fee is generated. Processing fees are recognized in the month that the services are provided. Royalty and licensee
revenue is included in other income on the consolidated statements of income.
Incentive Payments
The Company makes certain incentive payments under contractual arrangements with financial institutions, Diners
Club licensees, merchants, acquirers and certain other customers. These payments are generally classified as contra-
revenue unless a specifically identifiable benefit is received by the Company in consideration for the payment and the
fair value of such benefit can be reasonably estimated. If no such benefit is identified, then the entire payment is
classified as contra-revenue, and included in other income in the consolidated statements of income in the line item
where the related revenues are recorded. If the payment gives rise to an asset because it is expected to directly or
indirectly contribute to future net cash inflows, it is deferred and recognized over the expected benefit period. The
unamortized portion of the deferred incentive payments included in other assets on the consolidated statements of
financial condition was $22 million and $23 million at December 31, 2014 and 2013, respectively.
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3.
Investments
The Company’s investment securities consist of the following (dollars in millions):
December 31,
2014
2013
2012
November 30,
2012
U.S. Treasury securities(1) ........................................................................... $
1,330
$
2,058
$
2,460
$
U.S. government agency securities .............................................................
1,033
1,561
States and political subdivisions of states .....................................................
Other securities:
Credit card asset-backed securities of other issuers ...................................
Corporate debt securities(2) .....................................................................
Residential mortgage-backed securities - Agency(3) ...................................
Total other securities ..........................................................................
10
—
—
1,576
1,576
15
6
—
1,351
1,357
2,233
34
151
—
1,354
1,505
Total investment securities .............................................................. $
3,949
$
4,991
$
6,232
$
2,463
2,237
34
159
75
1,253
1,487
6,221
Includes $16 million and $9 million of U.S. Treasury securities pledged as swap collateral in lieu of cash as of December 31, 2014 and 2013, respectively.
(1)
(2) Amount represents corporate debt obligations issued under the Temporary Liquidity Guarantee Program (TLGP) that are guaranteed by the Federal Deposit Insurance
Corporation (FDIC).
(3) Consists of residential mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae.
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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 December 31, 2014
Available-for-Sale Investment Securities(1)
U.S. Treasury securities ............................................................................ $
1,317
$
U.S. government agency securities ............................................................
Residential mortgage-backed securities - Agency .......................................
1,021
1,473
Total available-for-sale investment securities .......................................... $
3,811
$
12
12
13
37
$
$
— $
—
(1)
(1) $
Held-to-Maturity Investment Securities(2)
U.S. Treasury securities(3)
......................................................................... $
1
$
— $
— $
States and political subdivisions of states ...................................................
Residential mortgage-backed securities - Agency(4) .....................................
10
91
Total held-to-maturity investment securities ............................................. $
102
$
At December 31, 2013
Available-for-Sale Investment Securities(1)
U.S. Treasury securities ............................................................................ $
2,030
$
U.S. government agency securities ............................................................
Credit card asset-backed securities of other issuers .....................................
Residential mortgage-backed securities - Agency .......................................
1,535
6
1,329
$
$
—
2
2
27
26
—
—
—
—
— $
104
— $
—
—
(22)
Total available-for-sale investment securities .......................................... $
4,900
$
53
$
(22) $
Held-to-Maturity Investment Securities(2)
U.S. Treasury securities(3)
......................................................................... $
1
$
— $
— $
States and political subdivisions of states ...................................................
Residential mortgage-backed securities - Agency(4) .....................................
Total held-to-maturity investment securities ............................................. $
15
44
60
—
—
(1)
(1)
$
— $
(2) $
1,329
1,033
1,485
3,847
1
10
93
2,057
1,561
6
1,307
4,931
1
14
43
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.
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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
December 31, 2014
Available-for-Sale Investment Securities
Residential mortgage-backed securities - Agency ..............
8
$
97
$
— $
225
$
(1)
December 31, 2013
Available-for-Sale Investment Securities
Residential mortgage-backed securities - Agency ..............
23
$
1,097
$
(20) $
48
$
Held-to-Maturity Investment Securities
State and political subdivisions of states ...........................
Residential mortgage-backed securities - Agency ..............
4
2
$
$
8
40
$
$
(1) $
(1) $
3
$
— $
(2)
—
—
There were no gains or losses related to other-than-temporary impairments during the calendar years ended
December 31, 2014 and 2013, the fiscal year ended November 30, 2012 or the one month ended December 31,
2012.
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 Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
Proceeds related to maturities or redemptions of investment securities .......... $
Proceeds from the sales of available-for-sale investment securities ............... $
Gains on sales of available-for-sale investment securities ............................ $
Net unrealized gains (losses) recorded in other comprehensive income,
before tax ............................................................................................ $
Net unrealized gains (losses) recorded in other comprehensive income,
after tax ............................................................................................... $
250
1,220
4
5
4
$
$
$
$
$
733
719
2
$
$
$
(82) $
(52) $
1,795
$
— $
— $
30
19
$
$
113
—
—
(5)
(3)
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Maturities and weighted-average yields of available-for-sale debt securities and held-to-maturity debt securities
are provided in the tables 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 December 31, 2014
Available-for-Sale—Amortized Cost
U.S. Treasury securities ................................................... $
716
$
601
$
— $
— $
U.S. government agency securities ...................................
Residential mortgage-backed securities - Agency ..............
525
—
496
—
—
493
—
980
Total available-for-sale investment securities ................. $
1,241
$
1,097
$
493
$
980
$
Held-to-Maturity—Amortized Cost
U.S. Treasury securities ................................................... $
1
$
— $
— $
— $
State and political subdivisions of states ...........................
Residential mortgage-backed securities - Agency ..............
—
—
—
—
—
—
10
91
1,317
1,021
1,473
3,811
1
10
91
Total held-to-maturity investment securities .................... $
1
$
— $
— $
101
$
102
Available-for-Sale—Fair Values
U.S. Treasury securities ................................................... $
721
$
608
$
— $
— $
U.S. government agency securities ...................................
Residential mortgage-backed securities - Agency ..............
530
—
503
—
—
495
—
990
Total available-for-sale investment securities ................. $
1,251
$
1,111
$
495
$
990
$
Held-to-Maturity—Fair Values
U.S. Treasury securities ................................................... $
1
$
— $
— $
— $
State and political subdivisions of states ...........................
Residential mortgage-backed securities - Agency ..............
—
—
—
—
—
—
10
93
1,329
1,033
1,485
3,847
1
10
93
Total held-to-maturity investment securities .................... $
1
$
— $
— $
103
$
104
At December 31, 2014
Available-for-Sale—Weighted-Average Yields(1)
U.S Treasury securities ....................................................
U.S government agency securities ....................................
Residential mortgage-backed securities - Agency ..............
Total available-for-sale investment securities .................
Held-to-Maturity—Weighted-Average Yields
U.S. Treasury securities ...................................................
State and political subdivisions of states ...........................
Residential mortgage-backed securities ............................
Total held-to-maturity investment securities ....................
One Year
or
Less
After One
Year
Through
Five Years
After Five
Years
Through
Ten Years
After Ten
Years
Total
1.52%
1.90%
—%
1.68%
0.07%
4.27%
—%
0.89%
1.37%
1.53%
—%
1.44%
—%
—%
—%
—%
—%
—%
1.53%
1.53%
—%
—%
—%
—%
—%
—%
2.05%
2.05%
—%
4.69%
2.80%
2.99%
1.45%
1.72%
1.88%
1.69%
0.07%
4.68%
2.80%
2.98%
(1)
The weighted-average yield for available-for-sale investment securities is calculated based on the amortized cost.
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The following table presents interest on investment securities (dollars in millions):
Taxable interest ...................................................................................... $
66
$
73
$
Tax exempt interest .................................................................................
1
1
Total income from investment securities ................................................. $
67
$
74
$
78
$
2
80
$
7
—
7
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
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 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 December 31, 2014
and 2013, the Company had outstanding investments in these entities of $325 million and $308 million, respectively,
and related contingent liabilities of $51 million and $52 million, respectively.
4.
Loan Receivables
The Company has three loan portfolio segments: credit card loans, other loans and PCI student loans.
The Company's classes of receivables within the three portfolio segments are depicted in the table below (dollars
in millions):
Loan receivables:
December 31,
2014
2013
Credit card loans(1)
.................................................................................................................................... $
56,128
$
53,150
Other loans:
Personal loans .......................................................................................................................................
Private student loans ..............................................................................................................................
Mortgage loans held for sale(2) ................................................................................................................
Other(3)
.................................................................................................................................................
Total other loans ................................................................................................................................
Purchased credit-impaired loans(4) ...............................................................................................................
Total loan receivables
........................................................................................................................
Allowance for loan losses
..............................................................................................................................
5,007
4,850
122
202
10,181
3,660
69,969
(1,746)
4,191
3,969
148
135
8,443
4,178
65,771
(1,648)
Net loan receivables
...................................................................................................................... $
68,223
$
64,123
(1) Amounts include $21.7 billion and $20.2 billion underlying investors’ interest in trust debt at December 31, 2014 and 2013, respectively, and $8.6 billion and
$10.9 billion in seller's interest at December 31, 2014 and 2013, respectively. See Note 5: Credit Card and Student Loan Securitization Activities for further
information.
Substantially all mortgage loans held for sale are pledged as collateral against the warehouse line of credit used to fund consumer residential loans.
(2)
(3) Other includes home equity loans.
(4) 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 December 31, 2014 and 2013, respectively. See Note 5: Credit Card and Student Loan Securitization Activities.
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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 mortgage loans held for sale and
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 December 31, 2014
Credit card loans(2) .......................................................... $
491
$
480
$
971
$
442
$
157
Other loans:
Personal loans(3) ...........................................................
Private student loans (excluding PCI)(4) ............................
Other .........................................................................
Total other loans (excluding PCI) ...............................
29
62
1
92
11
25
1
37
40
87
2
129
10
25
—
35
5
—
21
26
Total loan receivables (excluding PCI) .................... $
583
$
517
$
1,100
$
477
$
183
At December 31, 2013
Credit card loans(2) .......................................................... $
465
$
447
$
912
$
408
$
155
Other loans:
Personal loans(3) ...........................................................
Private student loans (excluding PCI)(4) ............................
Other .........................................................................
Total other loans (excluding PCI) ...............................
21
48
1
70
8
18
2
28
29
66
3
98
8
18
—
26
5
—
40
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
$27 million, $29 million, $32 million and $3 million for the calendar years ended December 31, 2014 and 2013, fiscal year ended November 30, 2012 and one
month ended December 31, 2012, respectively. The Company does not separately track the amount of gross interest income that would have been recorded in
accordance with the original terms of loans. 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 $43 million and $41 million of loans accounted for as troubled debt
(3)
(4)
restructurings at December 31, 2014 and 2013, respectively.
Personal loans that are 90 or more days delinquent and accruing interest include $3 million and $2 million of loans accounted for as troubled debt restructurings at
both December 31, 2014 and 2013, respectively.
Private student loans that are 90 or more days delinquent and accruing interest include $5 million and $3 million of loans accounted for as troubled debt
restructurings at December 31, 2014 and 2013, respectively.
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Net Charge-offs
Information related to the net charge-offs in the Company’s loan portfolio is shown below by each class of loan
receivables except for mortgage loans held for sale and PCI student loans, which is shown under the heading
“— Purchased Credit-Impaired Loans” (dollars in millions):
For the Calendar Years Ended December 31,
2014
2013
For the Fiscal Year
Ended November 30,
2012
For the One Month
Ended December 31,
2012
Net
Charge-
offs
Net
Charge-
off Rate
Net
Charge-
offs
Net
Charge-
off Rate
Net
Charge-
offs
Net
Charge-
off Rate
Net
Charge-
offs
Net
Charge-
off Rate
Credit card loans ....................................... $ 1,191
2.27% $ 1,100
2.21% $ 1,240
2.62% $
106
2.47%
Other loans:
Personal loans .......................................
Private student loans (excluding PCI) ........
Other ...................................................
94
57
3
Total other loans (excluding PCI) .........
154
2.04%
1.29%
0.76%
1.63%
79
46
1
126
2.13%
1.30%
1.96%
1.67%
69
19
—
88
2.33%
0.73%
0.10%
1.52%
7
2
—
9
2.52%
0.81%
—%
1.61%
Net charge-offs as a percentage of
total loans (excluding PCI) ............. $ 1,345
Net charge-offs as a percentage of
total loans (including PCI) ............. $ 1,345
2.17% $ 1,226
2.14% $ 1,328
2.50% $
115
2.37%
2.04% $ 1,226
1.98% $ 1,328
2.29% $
115
2.19%
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:
At December 31, 2014
Credit card loans
..........................................................................................................................................
Personal loans
..............................................................................................................................................
Private student loans (excluding PCI)(1)
.............................................................................................................
At December 31, 2013
Credit card loans
..........................................................................................................................................
Personal loans
..............................................................................................................................................
Private student loans (excluding PCI)(1)
.............................................................................................................
Credit Risk Profile by FICO
Score
660 and
Above
Less than 660
or No Score
83%
96%
96%
83%
97%
95%
17%
4%
4%
17%
3%
5%
(1)
PCI loans are discussed under the heading "— Purchased Credit-Impaired Loans."
For private student loans, additional credit risk management activities include monitoring the amount of loans in
forbearance. Forbearance allows borrowers experiencing temporary financial difficulties and willing to make payments
the ability to temporarily suspend payments. Eligible borrowers have a lifetime cap on forbearance of 12 months. At
December 31, 2014 and 2013, there were $49 million and $110 million of private student loans, including PCI, in
forbearance, respectively. In addition, at December 31, 2014 and 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 December 31,
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 due to the implementation of temporary reduced payment programs, which
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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 following tables provide changes in the Company’s allowance for loan losses for the periods presented
(dollars in millions):
For the Calendar Year Ended December 31, 2014
Credit Card
Personal
Loans
Student
Loans(1)
Other
Total
Balance at beginning of period ........................................... $
1,406
$
112
$
113
$
17
$
1,648
Additions:
Provision for loan losses .................................................
1,259
102
Deductions:
Charge-offs ...................................................................
(1,636)
Recoveries .....................................................................
445
Net charge-offs ..........................................................
(1,191)
(105)
11
(94)
79
(62)
5
(57)
3
(3)
—
(3)
1,443
(1,806)
461
(1,345)
Balance at end of period .................................................... $
1,474
$
120
$
135
$
17
$
1,746
For the Calendar Year Ended December 31, 2013
Credit Card
Personal
Loans
Student
Loans(1)
Other
Total
Balance at beginning of period ........................................... $
1,613
$
99
$
75
$
1
$
1,788
Additions:
Provision for loan losses .................................................
893
Deductions:
Charge-offs ...................................................................
(1,604)
Recoveries .....................................................................
504
Net charge-offs ..........................................................
(1,100)
92
(86)
7
(79)
84
(48)
2
(46)
17
1,086
(1)
—
(1)
(1,739)
513
(1,226)
Balance at end of period .................................................... $
1,406
$
112
$
113
$
17
$
1,648
For the One Month Ended December 31, 2012
Credit Card
Personal
Loans
Student
Loans(1)
Other
Total
Balance at beginning of period ........................................... $
1,554
$
97
$
73
$
1
$
1,725
Additions:
Provision for loan losses .................................................
165
Deductions:
Charge-offs ...................................................................
Recoveries .....................................................................
Net charge-offs ..........................................................
(146)
40
(106)
9
(8)
1
(7)
4
(2)
—
(2)
—
—
—
—
178
(156)
41
(115)
Balance at end of period .................................................... $
1,613
$
99
$
75
$
1
$
1,788
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The following tables provide changes in the Company’s allowance for loan losses for the periods presented
(dollars in millions):
For the Fiscal Year Ended November 30, 2012
Credit Card
Personal
Loans
Student
Loans(1)
Other
Total
Balance at beginning of period ........................................... $
2,070
$
82
$
53
$
— $
2,205
Additions:
Provision for loan losses .................................................
724
Deductions:
Charge-offs ...................................................................
(1,817)
Recoveries .....................................................................
577
Net charge-offs ..........................................................
(1,240)
84
(73)
4
(69)
39
(19)
—
(19)
1
—
—
—
848
(1,909)
581
(1,328)
Balance at end of period .................................................... $
1,554
$
97
$
73
$
1
$
1,725
(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 tables above.
Information regarding net charge-offs of interest and fee revenues on credit card and other loans is as follows (dollars
in millions):
Interest and fees accrued subsequently charged off, net of recoveries
(recorded as a reduction of interest income) ............................................ $
Fees accrued subsequently charged off, net of recoveries
(recorded as a reduction to other income) ............................................... $
283
69
$
$
280
59
$
$
345
67
$
$
26
5
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
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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 December 31, 2014
Allowance for loans evaluated for impairment as:
Collectively evaluated for impairment in accordance with ASC 450-20 ............... $ 1,314
$
114
$
Evaluated for impairment in accordance with ASC 310-10-35(1)(2) ......................
160
Acquired with deteriorated credit quality, evaluated in accordance with ASC
310-30 .......................................................................................................
—
6
—
96
11
28
Total allowance for loan losses .................................................................... $ 1,474
$
120
$
135
$
Recorded investment in loans evaluated for impairment as:
$
1
$ 1,525
16
—
17
193
28
$ 1,746
Collectively evaluated for impairment in accordance with ASC 450-20 ............... $ 55,091
$ 4,952
$ 4,812
$
142
$ 64,997
Evaluated for impairment in accordance with ASC 310-10-35(1)(2) ......................
1,037
Acquired with deteriorated credit quality, evaluated in accordance with ASC
310-30 .......................................................................................................
—
55
—
38
3,660
60
—
1,190
3,660
Total recorded investment
........................................................................... $ 56,128
$ 5,007
$ 8,510
$
202
$ 69,847
At December 31, 2013
Allowance for loans evaluated for impairment as:
Collectively evaluated for impairment in accordance with ASC 450-20 ............... $ 1,218
$
109
$
76
$
1
$ 1,404
Evaluated for impairment in accordance with ASC 310-10-35(1)(2) ......................
188
Acquired with deteriorated credit quality, evaluated in accordance with ASC
310-30 .......................................................................................................
—
3
—
9
28
Total allowance for loan losses .................................................................... $ 1,406
$
112
$
113
$
Recorded investment in loans evaluated for impairment as:
Collectively evaluated for impairment in accordance with ASC 450-20 ............... $ 52,027
$ 4,160
$ 3,941
$
Evaluated for impairment in accordance with ASC 310-10-35(1)(2) ......................
1,123
Acquired with deteriorated credit quality, evaluated in accordance with ASC
310-30 .......................................................................................................
—
31
—
28
4,178
16
—
17
56
79
—
216
28
$ 1,648
$ 60,184
1,261
4,178
Total recorded investment
........................................................................... $ 53,150
$ 4,191
$ 8,147
$
135
$ 65,623
(1)
(2)
(3)
(4)
Loan receivables evaluated for impairment in accordance with 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.
The unpaid principal balance of credit card loans was $878 million and $900 million at December 31, 2014 and 2013 respectively. The unpaid principal balance
of personal loans was $54 million and $31 million at December 31, 2014 and 2013, respectively. The unpaid principal balance of student loans was $37 million
and $26 million at December 31, 2014 and 2013, respectively. All loans accounted for as troubled debt restructurings have a related allowance for loan losses.
Includes both PCI and non-PCI private student loans.
Excludes mortgage loans held for sale. 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
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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.
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. 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. No loans
have been in a temporary modification program for greater than 12 months.
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. Beginning in first quarter of 2014, loan modifications through external sources 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.
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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 Calendar Year Ended December 31, 2014
Credit card loans
Modified credit card loans(3)
....................................................................................... $
Internal programs ...................................................................................................... $
External programs ..................................................................................................... $
Personal loans ............................................................................................................... $
Private student loans(4) .................................................................................................... $
For the Calendar Year Ended December 31, 2013
Credit card loans
Modified credit card loans(3)
....................................................................................... $
Internal programs ...................................................................................................... $
External programs ..................................................................................................... $
Personal loans ............................................................................................................... $
Private student loans(4) .................................................................................................... $
For the Fiscal Year Ended November 30, 2012
Credit card loans
Modified credit card loans(3)
....................................................................................... $
Internal programs ...................................................................................................... $
External programs ..................................................................................................... $
Personal loans ............................................................................................................... $
Private student loans(4) .................................................................................................... $
For the One Month Ended December 31, 2012
Credit card loans
Modified credit card loans(3)
....................................................................................... $
Internal programs ...................................................................................................... $
External programs ..................................................................................................... $
Personal loans ............................................................................................................... $
Private student loans(4) .................................................................................................... $
252
452
365
48
32
269
468
463
26
22
255
557
603
16
10
281
509
530
21
16
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
45
12
27
5
3
49
9
36
3
2
48
17
51
2
1
4
1
4
—
—
3
61
13
1
N/A
3
66
11
1
N/A
N/A
73
9
N/A
N/A
—
6
1
N/A
N/A
(1)
(2)
(3)
(4)
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.
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 credit card loans and the average interest rate earned on loans in the modification programs to the average loans in
the modification programs.
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.
Student loan customers who have been granted a forbearance or loan modification classified as a TDR have not been given interest rate reductions.
In order to evaluate the primary financial effects that resulted from credit card loans entering into a loan
modification program during the calendar years ended December 31, 2014 and 2013, fiscal year ended November
30, 2012 and one month ended December 31, 2012, the Company quantified the amount by which interest and fees
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were reduced during the periods. During the calendar years ended December 31, 2014 and 2013, fiscal year ended
November 30, 2012 and one month ended December 31, 2012, the Company forgave approximately $42 million,
$40 million, $44 million and $3 million, respectively, of interest and fees as a result of accounts entering into a credit
card loan modification program.
The following table provides information on loans that entered a loan modification program during the period
(dollars in millions):
For the Calendar Years Ended December 31,
2014
2013
For the Fiscal Year Ended
November 30, 2012
For the One Month
Ended December 31,
2012
Number of
Accounts
Balances
Number of
Accounts
Balances
Number of
Accounts
Balances
Number of
Accounts
Balances
Accounts that entered a loan
modification program during
the period:
Credit card:
Internal programs .............
48,041
External programs ............
32,443
Personal loans ......................
Private student loans .............
3,528
1,453
$
$
$
$
316
169
42
21
40,653
35,020
2,178
877
$
$
$
$
256
189
27
17
50,946
40,530
1,555
470
$
$
$
$
345
227
20
11
3,078
2,614
120
60
$
$
$
$
19
14
2
2
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 Calendar Years Ended December 31,
2014
2013
For the Fiscal Year Ended
November 30, 2012
For the One Month
Ended December 31,
2012
Aggregated
Outstanding
Balances
Upon
Default
Number
of
Accounts
Aggregated
Outstanding
Balances
Upon
Default
Number
of
Accounts
Aggregated
Outstanding
Balances
Upon
Default
Number
of
Accounts
Aggregated
Outstanding
Balances
Upon
Default
Number
of
Accounts
Troubled debt restructurings that
subsequently defaulted:
Credit card(1)(2):
Internal programs .............
10,195
External programs ............
7,363
Personal loans(2) ...................
433
Private student loans(3) ...........
1,155
$
$
$
$
62
30
5
18
9,186
8,481
284
628
$
$
$
$
57
36
3
12
15,703
8,543
343
172
$
$
$
$
106
40
4
4
945
722
22
42
$
$
$
$
6
3
—
1
(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.
(2) A customer defaults from a modification program after two consecutive missed payments.
(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 calendar years ended December 31, 2014 and
2013, fiscal year ended November 30, 2012 and one month ended December 31, 2012, approximately 35%, 40%,
46% and 39%, 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 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 private student loan portfolio
comprise the Company’s only PCI loans at December 31, 2014 and 2013. Total PCI student loans had an outstanding
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balance of $3.9 billion and $4.6 billion, including accrued interest, and a related carrying amount of $3.7 billion and
$4.2 billion, as of December 31, 2014 and 2013, respectively.
The following table provides changes in accretable yield for the acquired loans during each period (dollars in
millions):
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
Balance at beginning of period ................................................................ $
1,580
$
2,072
$
2,580
$
2,096
Accretion into interest income ..............................................................
Other changes in expected cash flows ..................................................
(260)
21
(272)
(220)
(303)
(181)
(24)
—
Balance at end of period ......................................................................... $
1,341
$
1,580
$
2,096
$
2,072
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 year ended December 31, 2014 as compared to the prior period when
the Company recorded a $28 million provision expense due to higher expected future losses for one of its pools. The
allowance for PCI loan losses at December 31, 2014 and December 31, 2013 was $28 million. Additionally, changes
to other cash flow assumptions resulted in an increase in accretable yield related to expected life of the loans for the
calendar year ended December 31, 2014 and a decrease in accretable yield for the calendar year ended December
31, 2013 and fiscal year ended November 30, 2012. There was no impact on accretable yield as a result of changes
in cash flow assumptions for the one month ended December 31, 2012. Changes to accretable yield are recognized
prospectively as an adjustment to yield over the remaining life of the pools.
At December 31, 2014, the 30 or more days delinquency and 90 or more days delinquency rates on PCI student
loans (which includes loans not yet in repayment) were 2.35% and 0.75%, respectively. At December 31, 2013, the 30
or more days delinquency and 90 or more days delinquency rates on PCI student loans (which includes loans not yet in
repayment) were 2.33% and 0.80%, 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 for the
calendar years ended December 31, 2014 and 2013, fiscal year ended November 30, 2012 and one month ended
December 31, 2012 was 0.64%, 1.36%, 1.41% and 1.53%, respectively.
Mortgage Loans Held for Sale
The following table provides a summary of the initial unpaid principal balance of mortgage loans sold during
each period, by type of loan (dollars in millions):
For the Calendar Years Ended December 31,
2014
2013
For the Fiscal Year Ended
November 30, 2012
For the One Month Ended
December 31, 2012
Amount
%
Amount
%
Amount
%
Amount
%
Conforming(1) .......... $
2,484
90.79% $
2,721
67.77% $
1,213
70.28% $
FHA(2) .....................
Jumbo(3) ..................
VA(4) ......................
212
34
6
7.75
1.24
0.22
1,290
4
—
32.13
0.10
—
513
—
—
29.72
—
—
218
145
—
—
60.06%
39.94
—
—
Total ...................... $
2,736
100.00% $
4,015
100.00% $
1,726
100.00% $
363
100.00%
(1) Conforming loans are loans that conform to Government Sponsored Enterprises guidelines.
(2)
FHA loans are loans that are insured by the Federal Housing Administration and are typically made to borrowers with low down payments. The initial loan amount
must be within certain limits.
Jumbo loans are loans with an initial amount larger than the limits set by a Government Sponsored Enterprise.
(3)
(4) VA loans are loans that are insured by and conform to the Department of Veteran Affairs guidelines.
-114-
Geographical Distribution of Loans
The Company originates credit card loans throughout the United States. The geographic distribution of the
Company's credit card loan receivables was as follows (dollars in millions):
December 31,
2014
2013
$
%
$
%
California .................................................................................................. $
Texas .........................................................................................................
New York ..................................................................................................
Florida .......................................................................................................
Illinois ........................................................................................................
Pennsylvania ..............................................................................................
Ohio .........................................................................................................
New Jersey ................................................................................................
Michigan ...................................................................................................
Georgia .....................................................................................................
4,776
4,557
3,929
3,287
3,114
2,989
2,449
2,113
1,634
1,630
8.5% $
8.1
7.0
5.9
5.5
5.3
4.4
3.8
2.9
2.9
4,548
4,299
3,649
3,064
2,998
2,823
2,324
2,002
1,575
1,546
Other States ...............................................................................................
25,650
45.7
24,322
Total credit card loans ............................................................................. $
56,128
100.0% $
53,150
8.5%
8.1
6.9
5.8
5.6
5.3
4.4
3.8
3.0
2.9
45.7
100.0%
The Company originates personal loans, student loans, other loans and PCI loans throughout the United States.
The table below does not include mortgage loans held for sale. The geographic distribution of personal, student, other
and PCI loan receivables was as follows (dollars in millions):
December 31,
2014
2013
$
%
$
%
New York .................................................................................................. $
California ..................................................................................................
Pennsylvania ..............................................................................................
Illinois ........................................................................................................
Texas .........................................................................................................
New Jersey ................................................................................................
Massachusetts ............................................................................................
Ohio .........................................................................................................
Florida .......................................................................................................
Michigan ...................................................................................................
1,738
1,267
1,004
794
742
687
550
540
538
512
12.7% $
9.2
7.3
5.8
5.4
5.0
4.0
3.9
3.9
3.7
1,679
1,167
939
696
637
630
508
481
479
482
Other States ...............................................................................................
5,347
39.1
4,775
Total other loans (including PCI loans) ....................................................... $
13,719
100.0% $
12,473
13.4%
9.4
7.5
5.6
5.1
5.1
4.1
3.9
3.8
3.9
38.2
100.0%
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.
-115-
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 this structure, 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 majority of which are held by wholly-owned
subsidiaries of Discover Bank. The previous DCMT structure consisted of Class A, triple-A rated certificates and Class B,
single-A rated certificates held by third parties. Credit enhancement was provided by the subordinated Class B
certificates, cash collateral accounts, and more subordinated Series 2009-CE certificates held by a wholly-owned
subsidiary of Discover Bank. The credit-related risk of loss associated with trust assets as of the balance sheet date to
which the Company is exposed through the retention of these subordinated interests is fully captured in the allowance
for loan losses recorded by the Company.
The Company’s credit card securitizations are accounted for as secured borrowings and the trusts 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 and previously outstanding DCMT certificates held by subsidiaries of Discover Bank,
constitute intercompany positions which are eliminated in the preparation of the Company’s consolidated statement 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
statement of financial condition as relating to securitization activities, are shown in the table below (dollars in millions):
December 31,
2014
2013
Cash collateral accounts
................................................................................................................................ $
— $
Collections and interest funding accounts .........................................................................................................
Restricted cash ..........................................................................................................................................
Investors’ interests held by third-party investors ................................................................................................
Investors’ interests held by wholly owned subsidiaries of Discover Bank ..............................................................
Seller’s interest
..............................................................................................................................................
16
16
15,950
5,789
8,596
Loan receivables(1)
.....................................................................................................................................
30,335
59
31
90
15,190
5,024
10,898
31,112
Allowance for loan losses allocated to securitized loan receivables(1) ..................................................................
(805)
(833)
Net loan receivables ..................................................................................................................................
29,530
30,279
Other
...........................................................................................................................................................
37
34
Carrying value of assets of consolidated variable interest entities .................................................................... $
29,583
$
30,403
(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.
The debt securities issued by the consolidated trusts are subject to credit, payment and interest rate risks on the
transferred credit card loan receivables. To protect investors, the securitization structures include certain features that
could result in earlier-than-expected repayment of the securities. The primary investor protection feature relates to the
availability and adequacy of cash flows in the securitized pool of receivables to meet contractual requirements.
Insufficient cash flows would trigger the early repayment of the securities. This is referred to as the “economic early
amortization” feature.
Investors are allocated cash flows derived from activities related to the accounts comprising the securitized pool
of receivables, the amounts of which reflect finance charges billed, certain fee assessments, allocations of merchant
discount and interchange, and recoveries on charged-off accounts. From these cash flows, investors are reimbursed for
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charge-offs occurring within the securitized pool of receivables and receive a contractual rate of return and Discover
Bank is paid a servicing fee as servicer. Any cash flows remaining in excess of these requirements are reported to
investors as excess spread. An excess spread rate of less than 0% for a contractually specified period, generally a three-
month average, would trigger an economic early amortization event. In such an event, the Company would be required
to seek immediate sources of replacement funding. Apart from the restricted assets related to securitization activities, the
investors and the securitization trusts have no recourse to the Company’s other assets or the Company's general credit
for a shortage in cash flows.
The Company is required to maintain a contractual minimum level of receivables in the trust in excess of the face
value of outstanding investors’ interests. This excess is referred to as the minimum seller’s interest requirement. The
required minimum seller’s interest in the pool of trust receivables, which is included in credit card loan receivables
restricted for securitization investors, is set at approximately 7% in excess of the total investors’ interests (which includes
interests held by third parties as well as those certificated interests held by the Company). If the level of receivables in
the trust was to fall below the required minimum, the Company would be required to add receivables from the
unrestricted pool of receivables, which would increase the amount of credit card loan receivables restricted for
securitization investors. A decline in the amount of the excess seller’s interest could occur if balance repayments and
charge-offs exceeded new lending on the securitized accounts or as a result of changes in total outstanding investors’
interests. Seller's interest is impacted by seasonality as higher balance repayments tend to occur in the first calendar
year quarter. If the Company could not add enough receivables to satisfy the requirement, an early amortization (or
repayment) of investors’ interests would be triggered. The Company retains significant exposure to the performance of
trust assets through holdings of the seller's interest and subordinated security classes of DCENT and previously DCMT.
In addition, the Company has the right to remove a random selection of accounts, which would serve to decrease the
amount of credit card loan receivables restricted for securitization investors, subject to certain requirements including
that the minimum seller's interest is still met.
Another feature of the Company’s credit card securitization structure that is designed to protect investors’ interests
from loss, which is applicable to the notes issued from DCENT, is a reserve account funding requirement in which
excess cash flows generated by the transferred loan receivables are held at the trust. This funding requirement is
triggered when DCENT’s three-month average excess spread rate decreases to below 4.5%, with increasing funding
requirements as excess spread levels decline below preset levels to 0%.
In addition to performance measures associated with the transferred credit card loan receivables or the inability
to add receivables to satisfy the seller's interest requirement, there are other events or conditions which could trigger an
early amortization event, such as non-payment of principal at expected maturity. As of December 31, 2014, no
economic or other early amortization events have occurred.
The table below provides information concerning investors’ interests and related excess spread at the end of the
current period (dollars in millions):
Investors’
Interests(1)
# of Series
Outstanding
3-Month Rolling
Average Excess
Spread
At December 31, 2014
Discover Card Execution Note Trust (DiscoverSeries notes) ................................................... $
21,739
39
13.95%
(1)
Investors’ interests include third-party interests and subordinated interests held by wholly-owned subsidiaries of Discover Bank.
The Company continues to own and service the accounts that generate the loan receivables held by the trusts.
Discover Bank receives servicing fees from the trusts based on a percentage of the monthly investor principal balance
outstanding. Although the fee income to Discover Bank offsets the fee expense to the trusts and thus is eliminated in
consolidation, failure to service the transferred loan receivables in accordance with contractual requirements could lead
to a termination of the servicing rights and the loss of future servicing income, net of related expenses.
Student Loan Securitization Activities
The Company’s student loan securitizations are accounted for as secured borrowings and the trusts are treated as
consolidated subsidiaries of the Company. Trust receivables underlying third-party investors’ interests are recorded in
purchased credit-impaired loans, and the related debt issued by the trusts is reported in long-term borrowings. The
assets of the Company’s consolidated VIEs are restricted from being sold or pledged as collateral for other borrowings
and the cash flows from these restricted assets may be used only to pay obligations of the trusts.
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Currently there are three trusts from which securities were issued to investors. Principal payments on the long-term
secured borrowings are made as cash is collected on the underlying loans that are used as collateral on the secured
borrowings. The Company does not have access to cash collected by the securitization trusts until cash is released in
accordance with the trust indenture agreements and, for certain securitizations, no cash will be released to the
Company until all outstanding trust borrowings have been repaid. Similar to the credit card securitizations, the
Company continues to own and service the accounts that generate the student loan receivables held by the trusts and
receives servicing fees from the trusts based on either a percentage of the principal balance outstanding or a flat fee per
borrower. Although the servicing fee income offsets the fee expense related to the trusts and thus is eliminated in
consolidation, failure to service the transferred loan receivables in accordance with contractual requirements could lead
to a termination of the servicing rights and the loss of future servicing income, net of related expenses.
Under terms of all the trust arrangements, the Company has the option, but not the obligation, to provide
financial support to the trusts, but has never provided such support. A substantial portion of the credit risk associated
with the securitized loans has been transferred to third parties under private credit insurance or indemnification
arrangements.
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):
December 31,
2014
2013
Restricted cash .............................................................................................................................................. $
86
$
89
Student loan receivables
................................................................................................................................
Allowance for loan losses allocated to securitized loan receivables(1) ..............................................................
Net student loan receivables ...........................................................................................................................
1,969
(28)
1,941
Carrying value of assets of consolidated variable interest entities .................................................................... $
2,027
$
2,248
(28)
2,220
2,309
(1)
The Company maintains its allowance for loan losses on purchased credit-impaired loans sufficient to absorb probable decreases in cash flows that were previously
expected. Therefore, credit risk associated with the transferred receivables is fully reflected on the Company’s balance sheet in accordance with GAAP.
6.
Premises and Equipment
A summary of premises and equipment, net is as follows (dollars in millions):
December 31,
2014
2013
Land ............................................................................................................................................................ $
43
$
Buildings and improvements ...........................................................................................................................
Capitalized equipment leases .........................................................................................................................
Furniture, fixtures and equipment
....................................................................................................................
Software ......................................................................................................................................................
Premises and equipment
............................................................................................................................
Less: Accumulated depreciation ......................................................................................................................
Less: Accumulated amortization of software .....................................................................................................
589
2
753
422
1,809
(905)
(234)
Premises and equipment, net
...................................................................................................................... $
670
$
43
547
2
735
391
1,718
(829)
(235)
654
Depreciation expense, which includes amortization of assets recorded under capital leases, was $78 million, $65
million, $63 million and $6 million for the calendar years ended December 31, 2014 and 2013, fiscal year ended
November 30, 2012 and one month ended December 31, 2012, respectively. Amortization expense on capitalized
software was $48 million, $41 million, $32 million and $3 million for the calendar years ended December 31, 2014
and 2013, fiscal year ended November 30, 2012 and one month ended December 31, 2012, respectively.
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7.
Goodwill and Intangible Assets
Goodwill
As of December 31, 2014 and 2013, the Company had goodwill of $257 million and $284 million, respectively.
In 2012, $31 million of goodwill was recorded in connection with its acquisition of substantially all of the operating and
related assets and certain liabilities of Home Loan Center, which was allocated to the Direct Banking segment. In 2013,
a $2 million adjustment was recorded to reduce goodwill as a result of the finalization of purchase accounting for this
acquisition. Additionally, the Company has goodwill of $255 million resulting from its previous acquisition of PULSE,
which was allocated to the Payment Services segment.
The Company conducted its annual goodwill impairment test as of October 1, 2014, which resulted in the
recognition of non-cash impairment charge of $27 million during the three months ended December 31, 2014 related
to the Discover Home Loans business based on its carrying values exceeding its fair values. The Company reduced its
fair value estimate as a result of a fourth quarter reevaluation of the forecasts due to continuing challenges faced in
developing a scalable direct-to-consumer purchase mortgage origination business. The impairment charge is recorded
in the other expense line as a component of total other expense in the accompanying consolidated and combined
statements of income and within the Direct Banking segment.
The fair value of the Discover Home Loans reporting unit was estimated using a discounted cash flow method that
incorporated the financial forecasts incorporating assumptions about the amount and timing of future cash flows,
discount rates and other factors that are inherently uncertain and judgmental in nature.
During the fourth quarter of 2013, the Company changed the date of its annual goodwill impairment test from
June 1 to October 1. Based on the annual goodwill impairment test on June 1, 2013, management concluded that there
was no impairment to goodwill. The additional impairment test performed on October 1, 2013 also resulted in
management's conclusion that there was no impairment to goodwill.
Intangible Assets
The Company's amortizable intangible assets resulted from various acquisitions. The May 2013 acquisition of
Diners Club Italy, which is part of the Payment Services segment, resulted in the recognition of amortizable intangible
assets primarily related to customer relationships. The June 2012 acquisition of Home Loan Center, which is part of the
Direct Banking segment, resulted in the recognition of amortizable intangible assets related to proprietary software,
non-compete agreements and marketing agreements. The December 2010 acquisition of SLC, which is part of the Direct
Banking segment, resulted in the recognition of an amortizable intangible asset relating to acquired customer
relationships. The 2005 acquisition of PULSE, which is part of the Payment Services segment, resulted in the recognition
of amortizable intangible assets relating to acquired customer relationships and trade name intangibles. Acquired
customer relationships for Diners Club Italy consist of those relationships in existence between Diners Club Italy and their
customers that have a Diners Club charge card as valued at the date of the acquisition. Acquired customer relationships
for SLC consist of those relationships in existence between SLC and the numerous students that carry student loan
balances, while for PULSE they consist of those relationships in existence between PULSE and the numerous financial
institutions that participate in its network, as valued at the date of the respective acquisition.
Non-amortizable intangible assets consist of trade name intangibles recognized in the acquisition of SLC, along
with international transaction processing rights and trade name intangibles recognized in the acquisition of Diners Club
in June 2008. The Company conducted its annual impairment test of intangible assets as of October 1, 2014 and no
impairment charges were identified. During the fourth quarter of 2013, the Company changed the date of its annual
impairment test for non-amortizable intangible assets from June 1 to October 1 to coincide with the change in the
Company's goodwill impairment test date. No impairment charges were identified during the impairment tests
conducted at June 1, 2013 and 2012 or October 1, 2013.
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The following table summarizes the Company's intangible assets (dollars in millions):
December 31,
2014
2013
Weighted-
Average
Amortization
Period
Gross
Carrying
Amount
Accumulated
Amortization
Net
Book Value
Gross
Carrying
Amount
Accumulated
Amortization
Net
Book Value
Amortizable intangible assets:
Customer relationships ..................
15.6 years
$
72
$
60
$
12
$
78
$
60
$
18
Trade name and other ...................
25 years
Proprietary software ......................
7 years
Non-compete agreements ..............
3 years
Marketing agreements and other....
N/A
Total amortizable intangible
assets .....................................
Non-amortizable intangible assets:
Trade names ................................
N/A
International transaction processing
rights .........................................
N/A
Total non-amortizable intangible
assets .....................................
8
6
2
—
88
132
23
155
Total intangible assets............
$
243
$
3
2
2
—
67
—
—
—
67
5
4
—
—
21
132
23
155
8
6
2
6
100
132
23
155
$
176
$
255
$
2
2
1
5
70
—
—
—
70
$
6
4
1
1
30
132
23
155
185
Amortization expense related to the Company's intangible assets was $10 million, $12 million, $11 million and
$1 million for the calendar years ended December 31, 2014 and 2013, fiscal year ended November 30, 2012 and
one month ended December 31, 2012, respectively.
The following table presents expected intangible asset amortization expense for the next five years based on
intangible assets at the end of the current period (dollars in millions):
Year
2015 .................................................................................................................................................................................... $
2016 .................................................................................................................................................................................... $
2017 .................................................................................................................................................................................... $
2018 .................................................................................................................................................................................... $
2019 .................................................................................................................................................................................... $
Amount
5
4
3
3
2
8.
Deposits
The Company offers its deposit products to customers through two channels: (i) through direct marketing, internet
origination and affinity relationships (“direct-to-consumer deposits”); and (ii) indirectly through contractual
arrangements with securities brokerage firms (“brokered deposits”). Direct-to-consumer deposits include certificates of
deposit, money market accounts, online savings and checking accounts and IRA certificates of deposit, while brokered
deposits include certificates of deposit and sweep accounts.
As of December 31, 2014 and 2013, the Company had $28.8 billion and $28.4 billion, respectively, of direct-
to-consumer deposits and approximately $17.3 billion and $16.4 billion, respectively, of brokered and other deposits.
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A summary of interest-bearing deposit accounts is as follows (dollars in millions):
December 31,
2014
2013
Certificates of deposit in amounts less than $100,000(1) .................................................................................... $
21,502
$
21,211
Certificates of deposit from amounts of $100,000(1) to less than $250,000(1) .......................................................
Certificates of deposit in amounts of $250,000(1) or greater ..............................................................................
4,481
1,153
4,860
1,180
Savings deposits, including money market deposit accounts ..............................................................................
18,656
17,515
Total interest-bearing deposits
.................................................................................................................... $
45,792
$
44,766
Average annual interest rate ..........................................................................................................................
1.29%
1.57%
(1) $100,000 represents the basic insurance amount previously covered by the FDIC. Effective July 21, 2010, the basic insurance per depositor was permanently
increased to $250,000.
At the end of the current period, certificates of deposit maturing over the next five years, and thereafter were as
follows (dollars in millions):
Year
Amount
2015 .................................................................................................................................................................................... $
12,755
2016 .................................................................................................................................................................................... $
2017 .................................................................................................................................................................................... $
2018 .................................................................................................................................................................................... $
2019 .................................................................................................................................................................................... $
Thereafter
.............................................................................................................................................................................. $
5,685
3,408
2,000
1,522
1,766
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9.
Long-Term Borrowings
Long-term borrowings consist of borrowings and capital leases having original maturities of one year or more.
The following table provides a summary of the Company’s long-term borrowings and weighted-average interest rates
on balances outstanding at period end (dollars in millions):
December 31, 2014
December 31,
2013
Maturity
Interest
Rate
Weighted-
Average
Interest Rate
Outstanding
Amount
Outstanding
Amount
Securitized Debt
Fixed-rate asset-backed securities(1) ..................................
2015-2019
1.76%
Floating-rate asset-backed securities(2)(3) ...........................
2015-2019
0.34-0.74%
1.76%
0.51%
$
8,950
$
7,000
5,554
9,640
Total Discover Card Master Trust I and Discover Card
Execution Note Trust .................................................
Floating-rate asset-backed securities(4)(5)(6)(7) .......................
2031-2042
0.49-4.25%
2.01%
Total SLC Private Student Loan Trusts ............................
Total Long-Term Borrowings - owed to securitization
investors ..............................................................
Discover Financial Services (Parent Company)
15,950
15,194
1,445
1,445
1,792
1,792
17,395
16,986
Fixed-rate senior notes(1) .................................................
2017-2024
3.85-10.25%
5.08%
1,558
1,045
Discover Bank
Senior bank notes ..........................................................
2018-2026
2.00-4.25%
Subordinated bank notes ................................................
2019-2020
7.00-8.70%
3.38%
7.49%
2,892
698
1,744
698
Capital lease obligations ....................................................
2016
4.51%
4.51%
1
1
Total long-term borrowings ..................................
$
22,544
$
20,474
(1)
The Company uses interest rate swaps to hedge portions of these long-term borrowings against changes in fair value attributable to changes in London Interbank
Offered Rate (“LIBOR”). Use of these interest rate swaps impacts carrying value of the debt. See Note 21: Derivatives and Hedging Activities.
(2) Discover Card Execution Note Trust floating-rate asset-backed securities include issuances with the following interest rate terms: 1-month LIBOR + 18 to 58 basis
(3)
(4)
(5)
(6)
(7)
points and 3-month LIBOR + 20 basis points.
The Company uses interest rate swaps to manage its exposure to changes in interest rates related to future cash flows resulting from interest payments on a portion of
these long-term borrowings. There is no impact on debt carrying value from use of these interest rate swaps. See Note 21: Derivatives and Hedging Activities.
SLC Private Student Loan Trusts floating-rate asset-backed securities include issuances with the following interest rate terms: 3-month LIBOR + 17 to 45 basis points,
Prime rate + 75 to 100 basis points and 1-month LIBOR + 350 basis points.
The Company acquired an interest rate swap related to the securitized debt assumed in the SLC transaction. The swap does not qualify for hedge accounting and has
no impact on debt carrying value. See Note 21: Derivatives and Hedging Activities.
Repayment of this debt is dependent upon the timing of principal and interest payments on the underlying student loans. The dates shown represent final maturity
dates.
Includes $348 million of senior notes maturing in 2031, $827 million of senior and subordinated notes maturing in 2036 and $270 million of senior notes maturing
in 2042 as of December 31, 2014.
-122-
Maturities
Long-term borrowings had the following maturities at the end of the current period (dollars in millions):
Year
Due in 2015 .......................................................................................................................................................................... $
Due in 2016 ..........................................................................................................................................................................
Due in 2017 ..........................................................................................................................................................................
Due in 2018 ..........................................................................................................................................................................
Due in 2019 ..........................................................................................................................................................................
Thereafter
..............................................................................................................................................................................
Amount
3,302
3,050
5,106
2,650
3,278
5,158
Total
................................................................................................................................................................................. $
22,544
The Company has access to committed undrawn capacity through private securitizations to support the funding of
its credit card loan receivables. As of December 31, 2014, the total commitment of secured credit facilities through
private providers was $7.5 billion, of which none had been used and was included in long-term borrowings at
December 31, 2014. Access to the unused portions of the secured credit facilities is subject to the terms of the
agreements with each of the providers which have various expirations in calendar years 2015 and 2016. Borrowings
outstanding under each facility bear interest at a margin above LIBOR or the asset-backed commercial paper costs of
each individual conduit provider. The terms of each agreement provide for a commitment fee to be paid on the unused
capacity, and include various affirmative and negative covenants, including performance metrics and legal
requirements similar to those required to issue any term securitization transaction.
10.
Stock-Based Compensation Plans
The Company has two stock-based compensation plans: the Discover Financial Services Omnibus Incentive Plan
and the Discover Financial Services Directors' Compensation Plan.
Omnibus Incentive Plan
The Discover Financial Services Omnibus Incentive Plan (“Omnibus Plan”), which is stockholder approved,
provides for the award of stock options, stock appreciation rights, restricted stock, restricted stock units (“RSUs”),
performance stock units (“PSUs”) and other stock-based and/or cash awards (collectively, “Awards”). Currently, the
Company does not have any stock appreciation rights or restricted stock outstanding. The total number of shares that
may be granted is 45 million shares, subject to adjustments for certain transactions as described in the Omnibus Plan
document. Shares granted under the Omnibus Plan may be the following: (i) authorized but unissued shares, and (ii)
treasury shares that the Company acquires in the open market, in private transactions or otherwise.
Directors' Compensation Plan
The Discover Financial Services Directors' Compensation Plan (the “Directors' Compensation Plan”), which is
stockholder approved, permits the grant of RSUs to non-employee directors. The total number of units available for
grant under the Directors' Compensation Plan equals the excess, if any, of (i) 1,000,000 shares over (ii) the sum of
(a) the number of shares subject to outstanding awards granted under the Directors' Compensation Plan and (b) the
number of shares previously issued pursuant to the Directors' Compensation Plan. Shares of stock that are issuable
pursuant to the awards granted under the Directors' Compensation Plan may be authorized but unissued shares,
treasury shares or shares that the Company acquires in the open market. Annual awards for eligible directors are
calculated by dividing $125,000 (increased to $130,000 effective May 7, 2014) by the fair market value of a share of
stock on the date of grant and are subject to a restriction period whereby 100% of such units shall vest on the one year
anniversary of the date of grant.
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Stock-Based Compensation
The following table details the compensation cost, net of forfeitures (dollars in millions):
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
RSUs ..................................................................................................... $
PSUs .....................................................................................................
Total stock-based compensation expense ............................................... $
33
27
60
$
$
31
28
59
$
$
29
18
47
$
$
Income tax benefit
.................................................................................. $
22
$
22
$
18
$
2
1
3
1
RSU Activity
The following table sets forth the activity related to vested and unvested RSUs:
RSUs at December 31, 2013 .................................................................................................
4,143,915
Granted ..........................................................................................................................
567,506
$
$
Conversions to common stock ............................................................................................
(1,305,318) $
Forfeited .........................................................................................................................
(43,705) $
Number of
Units
Weighted-
Average
Grant-Date
Fair Value
Aggregate
Intrinsic Value
(in millions)
27.38
$
232
54.01
24.22
41.34
RSUs at December 31, 2014 .................................................................................................
3,362,398
$
32.92
$
220
The following table sets forth the activity related to unvested RSUs:
Number of
Units
Weighted-
Average
Grant-Date
Fair Value
Unvested RSUs at December 31, 2013(1)
.........................................................................................................
2,497,620
Granted ...................................................................................................................................................
567,506
$
$
Vested ......................................................................................................................................................
(1,158,694) $
Forfeited ...................................................................................................................................................
(43,705) $
Unvested RSUs at December 31, 2014(1)
.........................................................................................................
1,862,727
$
28.52
54.01
26.12
41.34
37.48
(1)
Unvested RSUs represent awards where recipients have yet to satisfy either explicit vesting terms or retirement-eligibility requirements.
Compensation cost associated with restricted stock units is determined based on the number of units granted and
the fair value on the date of grant. The fair value is amortized on a straight-line basis, net of estimated forfeitures over
the requisite service period for each separately vesting tranche of the award. The requisite service period is generally
the vesting period.
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The following table summarizes the total intrinsic value of the RSUs converted to common stock and the total
grant-date fair value of RSUs vested (dollars in millions, except weighted-average grant-date fair value amounts):
Intrinsic value of RSUs converted to common stock ..................................... $
Grant-date fair value of RSUs vested ........................................................ $
72
30
Weighted-average grant-date fair value of RSUs granted ........................... $
54.01
$
$
$
63
27
42.14
$
$
$
49
28
25.64
$
$
$
—
—
41.23
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
As of December 31, 2014 and 2013, there was $24 million and $28 million, respectively, of total unrecognized
compensation cost related to non-vested RSUs. The cost is expected to be recognized over a total period of 2.8 years
and 2.1 years, respectively, and a weighted-average period of 2.3 years and 2.8 years, respectively.
PSU Activity
The following table sets forth the activity related to vested and unvested PSUs:
PSUs at December 31, 2013 .................................................................................................
1,897,867
Granted ..........................................................................................................................
384,626
$
$
Conversions to common stock ............................................................................................
(710,379) $
Forfeited .........................................................................................................................
(12,439) $
Number of
Units
Weighted-
Average
Grant-Date
Fair Value
Aggregate
Intrinsic Value
(in millions)
26.93
$
106
53.66
19.15
44.97
PSUs at December 31, 2014 .................................................................................................
1,559,675
$
36.92
$
102
The following table sets forth the activity related to unvested PSUs:
Unvested PSUs at December 31, 2013 ............................................................................................................
1,652,292
Granted ...................................................................................................................................................
384,626
$
$
Vested(1)
...................................................................................................................................................
(559,114) $
Forfeited ...................................................................................................................................................
(12,439) $
Unvested PSUs at December 31, 2014(2)(3)(4)
.....................................................................................................
1,465,365
$
27.77
53.66
19.15
44.97
37.71
Number of
Units
Weighted-
Average
Grant-Date
Fair Value
(1) Vested PSUs represent awards where recipients have satisfied retirement-eligibility requirements.
(2)
Includes 518,438 PSUs granted in fiscal year 2012 that are earned based on the Company's achievement of EPS during the two-year performance period ended
November 30, 2013 and are subject to the requisite service period which ended January 2, 2015.
Includes 567,424 PSUs granted in calendar year 2013 that are earned based on the Company's achievement of EPS during the three-year performance period
which ends December 31, 2015 and are subject to the requisite service period which ends February 1, 2016.
Includes 379,503 PSUs granted in calendar year 2014 that may be earned based on the Company's achievement of EPS during the three-year performance period
which ends December 31, 2016 and are subject to the requisite service period which ends February 1, 2017.
(3)
(4)
Compensation cost associated with PSUs is determined based on the number of instruments granted, the fair value
on the date of grant, and the performance factor. The fair value is amortized on a straight-line basis, net of estimated
forfeitures over the requisite service period. Each PSU is a restricted stock instrument that is subject to additional conditions
and constitutes a contingent and unsecured promise by the Company to pay shares of the Company's common stock on
the conversion date for the PSU contingent on the number of PSUs to be issued. PSUs granted in fiscal year 2012 pay up
to two shares per unit, whereas PSUs granted in calendar years 2013 and 2014 pay up to 1.5 shares per unit. Additionally,
PSUs granted in fiscal year 2012 have a performance period of two years and a vesting period of three years, whereas
PSUs granted in calendar years 2013 and 2014 have a performance period of three years and a vesting period of three
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years. The requisite service period of an award, having both performance and service conditions, is the longest of the
explicit, implicit and derived service periods.
As of December 31, 2014, there was $27 million of total unrecognized compensation cost related to non-vested
PSUs. The cost is expected to be recognized over a total period of 2.1 years, with a weighted-average period of 0.8
years. As of December 31, 2013, there was $34 million of total unrecognized compensation cost related to non-vested
PSUs. The cost is expected to be recognized over a total period of 2.1 years, with a weighted-average period of 0.8
years.
Stock Option Activity
Option awards are granted with an exercise price equal to the fair market value of one share of the Company's
common stock at the date of grant; these types of awards expire ten years from the grant date and may be subject to
restrictions on transfer, vesting requirements, which are set at the discretion of the Compensation and Leadership
Development Committee of the Company's board of directors, or cancellation under specified circumstances. Stock
awards also may be subject to similar restrictions determined at the time of grant under this plan. Certain option and
stock awards provide for accelerated vesting if there is a change in control or upon certain terminations (as defined in
the Omnibus Plan or the award certificate).
The following table sets forth the activity concerning stock option activity:
Number of
Units
Weighted-
Average
Exercise Price
Weighted-
Average
Remaining
Contractual
Term
(in years)
Aggregate
Intrinsic Value
(in millions)
Options outstanding at December 31, 2013 ..................................................
171,726
$
25.82
2.76 years
$
Granted(1) ...............................................................................................
— $
—
Exercised ...............................................................................................
(56,221) $
24.63
Expired ..................................................................................................
— $
—
Options outstanding at December 31, 2014 ..................................................
115,505
$
26.40
1.90 years
$
Vested and exercisable at December 31, 2014 ..............................................
115,505
$
26.40
1.90 years
$
5
5
5
(1) No stock options have been granted by the Company since its spin-off from Morgan Stanley.
Cash received from the exercise of stock options was $1 million and $7 million for the year ended December 31,
2014 and 2013, respectively, and the income tax benefit realized from the exercise of stock options was insignificant
for the year ended December 31, 2014 and $3 million for the year ended December 31, 2013.
The following table summarizes the total intrinsic value of options exercised and total fair value of options vested
(dollars in millions):
Intrinsic value of options exercised ............................................................ $
2
$
11
$
22
$
6
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
As of December 31, 2014 and 2013 there was no unrecognized compensation cost related to non-vested stock
options granted under the Company's Omnibus Plan, as all these options have vested.
The Company utilized the Black-Scholes pricing model to estimate the fair value of each option at its date of
grant. The fair value was amortized on a straight-line basis, net of estimated forfeitures, over the requisite service
periods of the awards, which is generally the vesting period. Use of a valuation model requires management to make
certain assumptions with respect to selected model inputs. Since all options were granted prior to the Company's spin-
off from Morgan Stanley, the expected option life of stock options and the expected dividend yield of stock were
determined based upon Morgan Stanley's historical experience. The expected stock price volatility was determined
based upon Morgan Stanley's historical stock price data over a time period similar to the expected option life. The risk-
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free interest rate was based on U.S. Treasury Strips with a remaining term equal to the expected life assumed at the
date of grant.
11.
Employee Benefit Plans
The Company sponsors the Discover Financial Services Pension Plan (the "Discover Pension Plan"), which is a
non-contributory defined benefit plan that is qualified under Section 401(a) of the Internal Revenue Code, for eligible
employees in the U.S. Effective December 31, 2008, the Discover Pension Plan was amended to discontinue the accrual
of future benefits. The Company also sponsors the Discover Financial Services 401(k) Plan (the “Discover 401(k) Plan”),
which is a defined contribution plan that is qualified under Section 401(a) of the Internal Revenue Code, for its eligible
U.S. employees.
Discover Pension Plan
The Discover Pension Plan generally provides retirement benefits that are based on each participant's years of
credited service prior to 2009 and on compensation specified in the Discover Pension Plan. The Company's policy is to
fund at least the amounts sufficient to meet minimum funding requirements under the Employee Retirement Income
Security Act of 1974, as amended.
Net Periodic Benefit Cost
Net periodic benefit cost expensed by the Company included the following components (dollars in millions):
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
Service cost, benefits earned during the period ..................................... $
— $
— $
— $
Interest cost on projected benefit obligation ...........................................
Expected return on plan assets .............................................................
Net amortization ................................................................................
Net periodic benefit cost
................................................................. $
22
(23)
3
2
$
21
(23)
5
3
$
21
(23)
3
1
$
—
2
(2)
—
—
Accumulated Other Comprehensive Income
Pretax amounts recognized in accumulated other comprehensive income that have not yet been recognized as
components of net periodic benefit cost consist of (dollars in millions):
Prior service credit
............................................................................................................................................................... $
Net loss
..............................................................................................................................................................................
Total
............................................................................................................................................................................... $
6
(266)
(260)
December 31,
2014
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Benefit Obligations and Funded Status
The following table provides a reconciliation of the changes in the benefit obligation and fair value of plan assets
as well as a summary of the Discover Pension Plan's funded status (dollars in millions):
For the Calendar Years Ended
December 31,
2014
2013
Reconciliation of benefit obligation:
Benefit obligation at beginning of year ........................................................................................................ $
452
$
Service cost
..............................................................................................................................................
Interest cost
..............................................................................................................................................
Employee contributions ..............................................................................................................................
Actuarial loss (gain)
..................................................................................................................................
Plan amendments ......................................................................................................................................
Benefits paid ............................................................................................................................................
Benefit obligation at end of year .............................................................................................................
Reconciliation of fair value of plan assets:
Fair value of plan assets at beginning of year ..............................................................................................
Actual return on plan assets .......................................................................................................................
Employer contributions ..............................................................................................................................
Employee contributions ..............................................................................................................................
Benefits paid ............................................................................................................................................
Fair value of plan assets at end of year ...................................................................................................
—
22
—
112
—
(16)
570
367
50
—
—
(16)
401
523
—
21
—
(78)
—
(14)
452
368
13
—
—
(14)
367
Unfunded status (recorded in accrued expenses and other liabilities) .......................................................... $
(169) $
(85)
Assumptions
The following table presents the assumptions used to determine the benefit obligation:
Discount rate ............................................................................................................................................
4.08%
4.93%
December 31,
2014
December 31,
2013
The following table presents the assumptions used to determine net periodic benefit cost:
Discount rate .....................................................................................
Expected long-term rate of return on plan assets ....................................
4.93%
6.50%
4.09%
6.75%
5.07%
6.75%
3.96%
6.75%
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
The expected long-term rate of return on plan assets was estimated by computing a weighted-average return of
the underlying long-term expected returns on the different asset classes, based on the target asset allocations. Asset
class return assumptions are created by integrating information on past capital market performance, current levels of
key economic indicators and the market insights of investment professionals. Individual asset classes are analyzed as
part of a larger system, acknowledging both the interaction between asset classes and the influence of larger
macroeconomic variables such as inflation and economic growth on the entire structure of capital markets. Medium and
long-term economic outlooks for the U.S. and other major industrial economies are forecast in order to understand the
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range of possible economic scenarios and evaluate their likelihood. Historical relationships between key economic
variables and asset class performance patterns are analyzed using empirical models. Finally, comprehensive asset class
performance projections are created by blending descriptive asset class characteristics with capital market insight and
the initial economic analyses. The expected long-term return on plan assets is a long-term assumption that generally is
expected to remain the same from one year to the next but is adjusted if there is a material change in the target asset
allocation and/or significant changes in fees and expenses paid by the Discover Pension Plan.
Discover Pension Plan Assets
The targeted asset allocation for 2015 by asset class is 45% and 55% for equity securities and fixed income
securities, respectively. The Discover Financial Services Retirement Plan Investment Committee (the “Investment
Committee”) determined the asset allocation targets for the Discover Pension Plan based on its assessment of business
and financial conditions, demographic and actuarial data, funding characteristics and related risk factors. Other
relevant factors, including industry practices and long-term historical and prospective capital market returns were
considered as well.
The Discover Pension Plan return objectives provide long-term measures for monitoring the investment
performance against growth in the pension obligations. The overall allocation is expected to help protect the Discover
Pension Plan's funded status while generating sufficiently stable real returns (net of inflation) to help cover current and
future benefit payments and to improve the Discover Pension Plan's funded status. Total Discover Pension Plan portfolio
performance is assessed by comparing actual returns with relevant benchmarks, such as the Standard & Poor's (“S&P”)
500 Index, the S&P 500 Total Return Index, the Russell 2000 Index and the MSCI All Country World Index.
Both the equity and fixed income portions of the asset allocation use a combination of active and passive
investment strategies and different investment styles. The fixed income asset allocation consists of longer duration fixed
income securities in order to help reduce plan exposure to interest rate variation and to better correlate assets with
obligations. The longer duration fixed income allocation is expected to help stabilize the funding status ratio over the
long term.
The asset mix of the Discover Pension Plan is reviewed by the Investment Committee on a regular basis. The asset
allocation strategy will change over time in response to changes in the Discover Pension Plan's funded status.
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Fair Value Measurements
The Discover Pension Plan’s assets are stated at fair value. Quoted market prices in active markets are the best
evidence of fair value and are used as the basis for the measurement, if available. If a quoted market price is not
available, the estimate of the fair value is based on the best information available in the circumstances. The table below
presents information about the Discover Pension Plan assets and indicates the level within the fair value hierarchy, as
defined by ASC 820, with which each item is associated. All of the Company's pension plan assets were categorized as
Level 2 assets within the fair value hierarchy as of the end of the current period. For a description of the fair value
hierarchy, see Note 20: Fair Value Measurements and Disclosures. (dollars in millions):
December 31, 2014
December 31, 2013
Amount
Net Asset
Allocation
Amount
Net Asset
Allocation
Assets
Registered Investment Company:
Domestic small/mid cap equity fund ......................................................... $
Emerging markets equity fund ..................................................................
Global low volatility equity fund ...............................................................
International core equity fund ...................................................................
Common Collective Trusts:
Domestic large cap equity fund ................................................................
Domestic fixed income fund .....................................................................
Long duration fixed income fund ...............................................................
Temporary investment fund ......................................................................
Total assets ......................................................................................... $
31
30
20
44
54
—
219
3
401
8% $
7
5
11
13
—
55
1
100% $
32
29
19
46
50
7
181
3
367
9%
8
5
13
13
2
49
1
100%
The investments that are categorized as Level 2 assets primarily consist of fixed income securities and common
collective trusts. The common collective trust investment vehicles are valued using the Net Asset Value (“NAV”) provided
by the administrator of the fund. The NAV is quoted on a private market that is not active; however, the unit price is
based on underlying investments that are traded on an active market. The fair value of the stable value product is
calculated as the present value of future cash flows.
There were no transfers between Levels 1 and 2 within the fair value hierarchy for the years ended December 31,
2014 and 2013.
Cash Flows
The Company does not expect to make any contributions to the Discover Pension Plan for 2015.
Expected benefit payments associated with the Discover Pension Plan for the next five years and in aggregate for
the years thereafter are as follows (dollars in millions):
2015 .................................................................................................................................................................................. $
2016 .................................................................................................................................................................................. $
2017 .................................................................................................................................................................................. $
2018 .................................................................................................................................................................................. $
2019 .................................................................................................................................................................................. $
13
14
15
16
17
Following five years thereafter
............................................................................................................................................... $
103
Discover 401(k) Plan
Under the Discover 401(k) Plan, eligible U.S. employees receive 401(k) matching contributions. Eligible
employees also receive fixed employer contributions. Certain eligible employees also received employer transition credit
contributions from January 1, 2009 through December 31, 2013. The pretax expense associated with the Company
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contributions for the calendar years ended December 31, 2014 and 2013, fiscal year ended November 30, 2012 and
one month ended December 31, 2012 was $52 million, $50 million, $42 million and $3 million respectively.
12.
Common and Preferred Stock
Preferred Stock
The Company has 575,000 shares of Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series B (the
"preferred stock"), outstanding with a par value of $0.01 per share that were issued on October 16, 2012. Each share
of preferred stock has a liquidation preference of $1,000 and is represented by 40 depositary shares. Net proceeds
received from the preferred stock issuance totaled approximately $560 million. The preferred stock is redeemable at the
Company's option, subject to regulatory approval, either (1) in whole or in part on any dividend payment date on or
after December 1, 2017 or (2) in whole but not in part, at any time within 90 days following a regulatory capital event
(as defined in the certificate of designations for the preferred stock), in each case at a redemption price equal to $1,000
per share of preferred stock plus declared and unpaid dividends. Any dividends declared on the preferred stock will be
payable quarterly in arrears at a rate of 6.50% per annum.
Stock Repurchase Program
On April 16, 2014, the Company's board of directors approved a share repurchase program authorizing the
repurchase of up to $3.2 billion of its outstanding shares of common stock. The program expires on April 15, 2016,
and may be terminated at any time. During the year ended December 31, 2014, the Company repurchased
24,796,614 shares for $1.5 billion.
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13. Accumulated Other Comprehensive Income
Changes in each component of AOCI were as follows (dollars in millions):
Unrealized
Gain (Loss) on
Available-for-
Sale Investment
Securities, Net
of Tax
Gain (Loss) on
Cash Flow
Hedges, Net of
Tax
Foreign
Currency
Translation
Adjustments,
Net of Tax(4)
Pension Plan
Loss Net of Tax
AOCI
Balance at November 30, 2011 .............................. $
55
$
7
$
— $
(114) $
Net unrealized gains on investment securities, net of
tax expense of $11(1) .............................................
Unrealized losses on cash flow hedges, net of tax
benefit of $2(2) ......................................................
Unrealized pension plan loss, net of tax benefit of
$25(3) ...................................................................
Balance at November 30, 2012 ..............................
Net unrealized losses on investment securities, net of
tax benefit of $2(1) .................................................
Unrealized pension plan gain, net of tax expense of
$4(3) .....................................................................
Balance at December 31, 2012 ...............................
Net change(5) ..........................................................
Balance at December 31, 2013 ...............................
Net change(5) ..........................................................
19
—
—
74
(3)
—
71
(52)
19
4
Balance at December 31, 2014 ............................... $
23
$
—
(4)
—
3
—
—
3
10
13
—
—
—
—
—
—
—
1
1
(20)
(7) $
(1)
— $
—
—
(38)
(152)
—
6
(146)
45
(101)
(53)
(154) $
(138)
(52)
19
(4)
(38)
(75)
(3)
6
(72)
4
(68)
(70)
(1)
(2)
(3)
(4)
(5)
Represents the difference between the fair value and amortized cost of available-for-sale investment securities.
Represents unrealized gains (losses) related to effective portion of cash flow hedges.
Reflects adjustments to the funded status of pension plan, which is the difference between the fair value of the plan assets and the projected benefit obligation.
Includes unrealized losses on hedge of net investment in foreign subsidiary, net of tax benefit and net gains on foreign currency translation adjustments.
In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other
Comprehensive Income. ASU 2013-02 requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the
respective line items in the consolidated statements of income if the amount being reclassified is required to be reclassified in its entirety to net income. For amounts
that are not required to be reclassified to net income in their entirety in the same reporting period, an entity is required to cross-reference other disclosures that
provide additional detail about those amounts. As the result, the Company has adjusted its AOCI presentation prospectively, as required, and therefore additional
table was included to present the required information for the current period and the presentation has changed from historical periods.
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The table below presents each component of OCI before reclassifications and amounts reclassified from AOCI for
each component of OCI before- and after-tax (dollars in millions):
Before Tax
Tax (Expense)
Benefit
Net of Tax
For the Calendar Year Ended December 31, 2014
Available-for-Sale Investment Securities:
Net unrealized holding gains arising during the period ....................................................... $
Amounts reclassified from accumulated other comprehensive income ....................................
Net change ................................................................................................................. $
9
$
(4)
5
$
Cash Flow Hedges:
Net unrealized losses arising during the period ................................................................... $
(69) $
Amounts reclassified from accumulated other comprehensive income ....................................
38
Net change ................................................................................................................. $
(31) $
Foreign Currency Translation Adjustments:
Net unrealized losses arising during the period ................................................................... $
Net change ................................................................................................................. $
Pension Plan:
Unrealized losses arising during the period ........................................................................ $
Net change ................................................................................................................. $
(1) $
(1) $
(84) $
(84) $
For the Calendar Year Ended December 31, 2013
Available-for-Sale Investment Securities:
Net unrealized holding losses arising during the period ....................................................... $
(80) $
Amounts reclassified from accumulated other comprehensive income ....................................
(2)
Net change ................................................................................................................. $
(82) $
Cash Flow Hedges:
Net unrealized gains arising during the period ................................................................... $
Amounts reclassified from accumulated other comprehensive income ....................................
Net change ................................................................................................................. $
Foreign Currency Translation Adjustments:
Net unrealized gains arising during the period ................................................................... $
Net change ................................................................................................................. $
Pension Plan:
Unrealized gains arising during the period ......................................................................... $
Net change ................................................................................................................. $
$
8
8
16
$
1
1
72
72
$
$
$
$
(3) $
2
(1) $
26
$
(15)
11
$
— $
— $
31
31
$
$
30
—
30
$
$
(3) $
(3)
(6) $
— $
— $
(27) $
(27) $
6
(2)
4
(43)
23
(20)
(1)
(1)
(53)
(53)
(50)
(2)
(52)
5
5
10
1
1
45
45
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14. Other Expense
Total other expense includes the following components (dollars in millions):
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
Postage ................................................................................................. $
84
$
86
$
Fraud losses ...........................................................................................
134
Supplies ................................................................................................
Credit-related inquiry fees .......................................................................
Litigation expense ...................................................................................
Incentive expense ...................................................................................
23
19
—
50
Other expense ........................................................................................
165
110
26
19
(12)
61
198
$
85
93
22
20
218
59
107
Total other expense ............................................................................. $
475
$
488
$
604
$
7
9
2
1
—
5
11
35
15.
Income Taxes
Income tax expense consisted of the following (dollars in millions):
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
Current:
U.S. federal ........................................................................................ $
1,215
$
1,065
$
1,113
$
U.S. state and local .............................................................................
Total ..............................................................................................
Deferred:
U.S. federal ........................................................................................
U.S. state and local .............................................................................
Total ..............................................................................................
167
1,382
(7)
(4)
(11)
87
1,152
295
27
322
149
1,262
136
10
146
Income tax expense ..................................................................... $
1,371
$
1,474
$
1,408
$
101
15
116
(11)
(1)
(12)
104
The following table reconciles the Company’s effective tax rate to the U.S. federal statutory income tax rate:
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
U.S. federal statutory income tax rate .......................................................
35.0%
35.0%
U.S. state, local and other income taxes, net of U.S. federal income tax
benefits ................................................................................................
Other ....................................................................................................
Effective income tax rate ......................................................................
2.8
(0.7)
37.1%
2.2
0.2
37.4%
35.0%
2.9
(0.4)
37.5%
35.0%
3.2
(0.1)
38.1%
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Deferred income taxes reflect the net tax effects of temporary differences between the financial reporting and tax
bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when such
differences are expected to reverse. Valuation allowances are provided to reduce deferred tax assets to an amount that
is more likely than not to be realized. The Company evaluates the likelihood of realizing its deferred tax assets by
estimating sources of future taxable income and the impact of tax planning strategies. Significant components of the
Company’s net deferred income taxes, which are included in other assets in the consolidated statements of financial
condition, were as follows (dollars in millions):
December 31,
2014
2013
Deferred tax assets:
Allowance for loan losses ........................................................................................................................... $
659
$
Customer fees and rewards ........................................................................................................................
Compensation and benefits ........................................................................................................................
State income taxes
....................................................................................................................................
Other
.......................................................................................................................................................
Total deferred tax assets before valuation allowance .................................................................................
Valuation allowance ..................................................................................................................................
Total deferred tax assets, net of valuation allowance .................................................................................
Deferred tax liabilities:
Debt exchange premium ............................................................................................................................
Depreciation and software amortization ......................................................................................................
Unearned income ......................................................................................................................................
Intangibles ................................................................................................................................................
Deferred loan acquisition costs ...................................................................................................................
Partnership investments ..............................................................................................................................
Other
.......................................................................................................................................................
212
123
75
77
1,146
(41)
1,105
(91)
(116)
(31)
(15)
(23)
(19)
(6)
Total deferred tax liabilities
....................................................................................................................
(301)
Net deferred tax assets ....................................................................................................................... $
804
$
627
212
87
65
72
1,063
(37)
1,026
(98)
(83)
(40)
(22)
(16)
—
(13)
(272)
754
Deferred taxes at December 31, 2014 included a valuation allowance of $41 million established primarily on
Diners Club Italy deferred taxes.
A reconciliation of beginning and ending unrecognized tax benefits is as follows (dollars in millions):
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
Balance at beginning of period ................................................................ $
629
$
575
$
507
$
573
Additions:
Current year tax positions ....................................................................
Prior year tax positions ........................................................................
Reductions:
Prior year tax positions ........................................................................
Settlements with taxing authorities ........................................................
Expired statute of limitations .................................................................
18
74
(80)
(4)
(2)
1
142
(69)
(18)
(2)
74
1
(5)
(2)
(2)
2
—
—
—
—
Balance at end of period(1) ....................................................................... $
635
$
629
$
573
$
575
(1) As of the calendar years ended December 31, 2014 and 2013, fiscal year ended November 30, 2012, and one month ended December 31, 2012, amounts
included $144 million, $142 million, $108 million and $109 million respectively, of unrecognized tax benefits, which, if recognized, would favorably affect the
effective tax rate.
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The Company recognizes accrued interest and penalties related to unrecognized tax benefits as a component of
income tax expense, consistent with its policy prior to the adoption of FASB Interpretation No. 48, codified as ASC
740-10-25. Interest and penalties related to unrecognized tax benefits increased by $17 million to $135 million for the
calendar year ended December 31, 2014, increased by $17 million to $118 million for the calendar year ended
December 31, 2013, increased by $20 million to $99 million for the fiscal year ended November 30, 2012 and
increased by $2 million to $101 million for the one month ended December 31, 2012. The changes primarily relate to
the revaluation of existing federal and state tax issues.
The Company is subject to examination by the Internal Revenue Service ("IRS") and the tax authorities in various
state and foreign tax jurisdictions. The tax years under examination vary by jurisdiction. The IRS is currently examining
2011 through 2012.
The Company is pursuing an administrative appeal of the IRS’s proposed assessment for the years 1999 through
2005. It is reasonably possible that a settlement of the IRS appeal of the years 1999 through 2005 and certain state
audits may be made within 12 months of the reporting date. In the second quarter of 2014, the IRS issued a Notice of
Proposed Adjustment for the years 2006 through June 30, 2007, which was accepted by the Company, resulting in the
recognition of previously unrecognized tax benefits for those years. At this time, as a result of this settlement, the
Company believes it is reasonably possible that a reduction of unrecognized tax benefits in the range of $90 million to
$335 million could be recognized. The Company is also pursuing an administrative appeal of the IRS’s proposed
assessment for the years 2008 through 2010.
The Company regularly assesses the likelihood of additional assessments or settlements in each of the taxing
jurisdictions resulting from these and subsequent years' examinations. The Company believes that its reserves are
sufficient to cover any tax, penalties and interest that could result from such examinations.
At December 31, 2014, the Company had net operating loss carryforwards of $107 million for foreign purposes
which do not expire.
16.
Earnings Per Share
The following table presents the calculation of basic and diluted earnings per share ("EPS") (in millions, except
per share amounts):
Numerator:
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
Net income ........................................................................................ $
2,323
$
2,470
$
2,345
$
Preferred stock dividends .....................................................................
Net income available to common stockholders ...................................
Income allocated to participating securities ............................................
(37)
2,286
(16)
(37)
2,433
(19)
(5)
2,340
(22)
Net income allocated to common stockholders ................................... $
2,270
$
2,414
$
2,318
$
Denominator:
Weighted-average shares of common stock outstanding .........................
Effect of dilutive common stock equivalents ............................................
Weighted-average shares of common stock outstanding and common
stock equivalents ...........................................................................
462
1
463
485
2
487
519
1
520
Basic earnings per common share ............................................................ $
Diluted earnings per common share ......................................................... $
4.91
4.90
$
$
4.97
4.96
$
$
4.47
4.46
$
$
170
—
170
(2)
168
498
1
499
0.34
0.34
Anti-dilutive securities were not material and had no impact on the computation of diluted EPS for any of the
calendar years ended December 31, 2014 and 2013, fiscal year ended November 30, 2012 and one month ended
December 31, 2012.
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17.
Capital Adequacy
The Company is subject to the capital adequacy guidelines of the Federal Reserve, and Discover Bank (the
“Bank”), the Company’s main banking subsidiary, is subject to various regulatory capital requirements as administered
by the Federal Deposit Insurance Corporation (the "FDIC"). Failure to meet minimum capital requirements can result in
the initiation of certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could
have a direct material effect on the financial position and results of the Company and the Bank. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet
specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items, as
calculated under regulatory guidelines. Capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings and other factors. Federal Reserve and FDIC final rules applicable to
the Company and the Bank, respectively, include new minimum and "well-capitalized" risk-based capital and leverage
ratios, effective January 1, 2015, and refine the definition of what constitutes "capital" for purposes of calculating these
ratios.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank
to maintain minimum amounts and ratios (as defined in the regulations) of total risk-based capital and Tier 1 capital to
risk-weighted assets, and of Tier 1 capital to average assets. As of December 31, 2014, the Company and the Bank
met all capital adequacy requirements to which they were subject.
Under regulatory capital requirements prior to 2015, the Company and the Bank must maintain minimum levels
of capital that are dependent upon the risk-weighted amount or average level of the financial institution’s assets,
specifically (a) 8% to 10% of total risk-based capital to risk-weighted assets (“total risk-based capital ratio”), (b) 4% to
6% of Tier 1 capital to risk-weighted assets (“Tier 1 risk-based capital ratio”) and (c) 4% to 5% of Tier 1 capital to
average assets (“Tier 1 leverage ratio”). To be categorized as “well-capitalized,” the Company and the Bank must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. As of
December 31, 2014, the Company and the Bank met the requirements for well-capitalized status and there have been
no conditions or events that management believes have changed the Company’s or the Bank’s category.
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The following table shows the actual capital amounts and ratios of the Company and comparisons of each to the
regulatory minimum and “well-capitalized” requirements (dollars in millions):
Actual
Minimum Capital
Requirements
Capital Requirements
To Be Classified as
Well-Capitalized
Amount
Ratio
Amount
Ratio
Amount
Ratio
December 31, 2014
Total capital (to risk-weighted assets)
Discover Financial Services .................... $
Discover Bank ...................................... $
12,418
11,040
Tier 1 capital (to risk-weighted assets)
Discover Financial Services .................... $
10,839
Discover Bank ...................................... $
9,470
Tier 1 capital (to average assets)
Discover Financial Services .................... $
10,839
Discover Bank ...................................... $
9,470
December 31, 2013
Total capital (to risk-weighted assets)
Discover Financial Services .................... $
Discover Bank ...................................... $
11,975
10,496
Tier 1 capital (to risk-weighted assets)
Discover Financial Services .................... $
10,409
Discover Bank ...................................... $
8,941
Tier 1 capital (to average assets)
Discover Financial Services .................... $
10,409
Discover Bank ...................................... $
8,941
17.0% $
15.3% $
14.9% $
13.1% $
13.2% $
11.7% $
17.4% $
15.5% $
15.2% $
13.2% $
13.4% $
11.6% $
5,831
5,767
2,916
2,884
3,288
3,252
5,492
5,428
2,746
2,714
3,116
3,077
8.0%
8.0%
4.0%
4.0%
4.0%
4.0%
8.0%
8.0%
4.0%
4.0%
4.0%
4.0%
$
$
$
$
$
$
$
$
$
$
$
$
7,289
7,209
4,373
4,326
4,111
4,066
6,865
6,785
4,119
4,071
3,895
3,847
10.0%
10.0%
6.0%
6.0%
5.0%
5.0%
10.0%
10.0%
6.0%
6.0%
5.0%
5.0%
The amount of dividends that a bank may pay in any year is subject to certain regulatory restrictions. Under the
current banking regulations, a bank may not pay dividends if such a payment would leave the bank inadequately
capitalized. In the calendar years ended December 31, 2014 and 2013 and fiscal year ended November 30, 2012,
Discover Bank paid dividends of $1.8 billion, $1.6 billion and $1.5 billion, respectively, to the Company. No dividends
were paid by Discover Bank during the one month ended December 31, 2012.
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18.
Commitments, Contingencies and Guarantees
Lease Commitments
The Company leases various office space and equipment under capital and non-cancelable operating leases
which expire at various dates through 2028. At the end of the current period, future minimum payments on leases with
original terms in excess of one year consist of the following (dollars in millions):
Capitalized
Leases
Operating
Leases
2015 ........................................................................................................................................................... $
1
$
2016 ...........................................................................................................................................................
2017 ...........................................................................................................................................................
2018 ...........................................................................................................................................................
2019 ...........................................................................................................................................................
Thereafter
.....................................................................................................................................................
—
—
—
—
—
16
15
13
12
10
45
Total minimum lease payments
...................................................................................................................
1
$
111
Less: Amount representing interest
..................................................................................................................
Present value of net minimum lease payments .............................................................................................. $
—
1
Occupancy lease agreements, in addition to base rentals, generally provide for rent and operating expense
escalations resulting from increased assessments for real estate taxes and other charges. Total rent expense under
operating lease agreements, which considers contractual escalations, was $16 million, $15 million, $18 million and $3
million for the calendar years ended December 31, 2014 and 2013, fiscal year ended November 30, 2012 and one
month ended December 31, 2012, respectively.
Unused Commitments to Extend Credit
At December 31, 2014, the Company had unused commitments to extend credit for loans of approximately
$169.2 billion. Such commitments arise primarily from agreements with customers for unused lines of credit on certain
credit cards and certain other loan products, provided there is no violation of conditions in the related agreements.
These commitments, substantially all of which the Company can terminate at any time and which do not necessarily
represent future cash requirements, are periodically reviewed based on account usage, customer creditworthiness and
loan qualification.
Securitizations Representations and Warranties
As part of the Company’s financing activities, the Company provides representations and warranties that certain
assets pledged as collateral in secured borrowing arrangements conform to specified guidelines. Due diligence is
performed by the Company which is intended to ensure that asset guideline qualifications are met. If the assets pledged
as collateral do not meet certain conforming guidelines, the Company may be required to replace, repurchase or sell
such assets. In its credit card securitization activities, the Company would replace nonconforming receivables through
the allocation of excess seller’s interest or from additional transfers from the unrestricted pool of receivables. If the
Company could not add enough receivables to satisfy the requirement, an early amortization (or repayment) of
investors’ interests would be triggered. In its student loan securitizations, the Company would generally repurchase the
loans from the trust at the outstanding principal amount plus interest.
The maximum potential amount of future payments the Company could be required to make would be equal to
the current outstanding balances of third-party investor interests in credit card asset-backed securities plus the principal
amount of any other outstanding secured borrowings. The Company has recorded substantially all of the maximum
potential amount of future payments in long-term borrowings on the Company’s statement of financial condition. The
Company has not recorded any incremental contingent liability associated with its secured borrowing representations
and warranties. Management believes that the probability of having to replace, repurchase or sell assets pledged as
collateral under secured borrowing arrangements, including an early amortization event, is low.
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Mortgage Loans Representations and Warranties
The Company sells loans it originates to investors on a servicing released basis and the risk of loss or default by
the borrower is generally transferred to the investor. However, the Company is required by these investors to make
certain representations and warranties relating to credit information, loan documentation and collateral. These
representations and warranties may extend through the contractual life of the mortgage loan. Subsequent to the sale, if
underwriting deficiencies, borrower fraud or documentation defects are discovered in individual mortgage loans, the
Company may be obligated to repurchase the respective mortgage loan or indemnify the investors for any losses from
borrower defaults if such deficiency or defect cannot be cured within the specified period following discovery. The
Company has established a repurchase reserve based on expected losses. At December 31, 2014, this amount was not
material and was included in accrued expenses and other liabilities on the consolidated statements of financial
condition. The related provision was included in other income on the consolidated statements of income.
Guarantees
The Company has obligations under certain guarantee arrangements, including contracts and indemnification
agreements, which contingently require the Company to make payments to the guaranteed party based on changes in
an underlying asset, liability or equity security of a guaranteed party, rate or index. Also included as guarantees are
contracts that contingently require the Company to make payments to a guaranteed party based on another entity’s
failure to perform under an agreement. The Company’s use of guarantees is disclosed below by type of guarantee.
Counterparty Settlement Guarantees
Diners Club and DFS Services LLC (on behalf of PULSE) have various counterparty exposures, which are listed
below.
• Merchant Guarantee. Diners Club has entered into contractual relationships with certain international
merchants, which generally include travel-related businesses, for the benefit of all Diners Club licensees. The
licensees hold the primary liability to settle the transactions of their customers with these merchants. However,
Diners Club retains a counterparty exposure if a licensee fails to meet its financial payment obligation to one
of these merchants.
• ATM Guarantee. PULSE entered into contractual relationships with certain international ATM acquirers in
which DFS Services LLC retains counterparty exposure if an issuer fails to fulfill its settlement obligation.
The maximum potential amount of future payments related to such contingent obligations is dependent upon the
transaction volume processed between the time a counterparty defaults on its settlement and the time at which the
Company disables the settlement of any further transactions for the defaulting party, which could be one month
depending on the type of guarantee/counterparty. However, there is no limitation on the maximum amount the
Company may be liable to pay. The actual amount of the potential exposure cannot be quantified as the Company
cannot determine whether particular counterparties will fail to meet their settlement obligations.
While the Company has some contractual remedies to offset these counterparty settlement exposures (such as
letters of credit or pledged deposits), in the event that all licensees and/or issuers were to become unable to settle their
transactions, the Company estimates its maximum potential counterparty exposures to these settlement guarantees,
based on historical transaction volume, would be as follows (dollars in millions):
Diners Club:
Merchant guarantee ........................................................................................................................................................... $
PULSE:
ATM guarantee .................................................................................................................................................................. $
96
1
December 31,
2014
With regard to the counterparty settlement guarantees discussed above, the Company believes that the estimated
amounts of maximum potential future payments are not representative of the Company’s actual potential loss exposure
given Diners Club’s and PULSE’s insignificant historical losses from these counterparty exposures. As of December 31,
2014, the Company had not recorded any contingent liability in the consolidated financial statements for these
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counterparty exposures, and management believes that the probability of any payments under these arrangements is
low.
The Company also retains counterparty exposure for the obligations of Diners Club licensees that participate in
the Citishare network, an electronic funds processing network. Through the Citishare network, Diners Club customers
are able to access certain ATMs directly connected to the Citishare network. The Company’s maximum potential future
payment under this counterparty exposure is limited to $15 million, subject to annual adjustment based on actual
transaction experience. However, as of December 31, 2014, the Company had not recorded any contingent liability in
the consolidated financial statements related to this counterparty exposure, and management believes that the
probability of any payments under this arrangement is low.
Merchant Chargeback Guarantees
The Company operates the Discover Network, issues payment cards and permits third parties to issue payment
cards. The Company is contingently liable for certain transactions processed on the Discover Network in the event of a
dispute between the payment card customer and a merchant. The contingent liability arises if the disputed transaction
involves a merchant or merchant acquirer with whom the Discover Network has a direct relationship. If a dispute is
resolved in the customer’s favor, the Discover Network will credit or refund the disputed amount to the Discover
Network card issuer, who in turn credits its customer’s account. The Discover Network will then charge back the
disputed amount of the payment card transaction to the merchant or merchant acquirer, where permitted by the
applicable agreement, to seek recovery of amounts already paid to the merchant for payment card transactions. If the
Discover Network is unable to collect the amount subject to dispute from the merchant or merchant acquirer (e.g., in the
event of merchant default or dissolution) or after expiration of the time period for chargebacks in the applicable
agreement, the Discover Network will bear the loss for the amount credited or refunded to the customer. In most
instances, a loss by the Discover Network is unlikely to arise in connection with payments on card transactions because
most products or services are delivered when purchased, and credits are issued by merchants on returned items in a
timely fashion, thus minimizing the likelihood of cardholder disputes with respect to amounts paid by the Discover
Network. However, where the product or service is not scheduled to be provided to the customer until a later date
following the purchase, the likelihood of a contingent payment obligation by the Discover Network increases. Losses
related to merchant chargebacks were not material for the calendar years ended December 31, 2014 and 2013, fiscal
year ended November 30, 2012 and one month ended December 31, 2012.
The maximum potential amount of obligations of the Discover Network arising as a result of such contingent
obligations is estimated to be the portion of the total Discover Network transaction volume processed to date for which
timely and valid disputes may be raised under applicable law and relevant issuer and customer agreements. There is no
limitation on the maximum amount the Company may be liable to pay to issuers. However, the Company believes that
such amount is not representative of the Company’s actual potential loss exposure based on the Company’s historical
experience. The actual amount of the potential exposure cannot be quantified as the Company cannot determine
whether the current or cumulative transaction volumes may include or result in disputed transactions.
The table below summarizes certain information regarding merchant chargeback guarantees (in millions):
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
Aggregate sales transaction volume(1) ....................................................... $
125,637
$
120,442
$
114,847
$
11,521
(1)
Represents period transactions processed on the Discover Network for which a potential liability exists that, in aggregate, can differ from credit card sales volume.
The Company did not record any contingent liability in the consolidated financial statements for merchant
chargeback guarantees on December 31, 2014 and 2013. The Company mitigates the risk of potential loss exposure
by withholding settlement from merchants, obtaining third-party guarantees, or obtaining escrow deposits or letters of
credit from certain merchant acquirers or merchants that are considered higher risk due to various factors such as time
delays in the delivery of products or services.
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The table below provides information regarding settlement withholdings and escrow deposits, which are
recorded in interest-bearing deposit accounts, and accrued expenses and other liabilities on the Company’s
consolidated statements of financial condition (dollars in millions):
Settlement withholdings and escrow deposits ................................................................................................... $
16
$
17
December 31,
2014
2013
19.
Litigation and Regulatory Matters
In the normal course of business, from time to time, the Company has been named as a defendant in various
legal actions, including arbitrations, class actions and other litigation, arising in connection with its activities. Certain of
the actual or threatened legal actions include claims for substantial compensatory and/or punitive damages or claims
for indeterminate amounts of damages. The Company contests liability and/or the amount of damages as appropriate
in each pending matter.
The Company has historically relied on the arbitration clause in its cardmember agreements, which has in some
instances limited the costs of, and the Company’s exposure to litigation, but there can be no assurance that the
Company will continue to be successful in enforcing its arbitration clause in the future. Legal challenges to the
enforceability of these clauses have led most card issuers, and may cause the Company, to discontinue their use. In
addition, bills are periodically introduced in Congress to directly or indirectly prohibit the use of pre-dispute arbitration
clauses, and the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") authorized the
Consumer Financial Protection Bureau (the "CFPB") to conduct a study on pre-dispute arbitration clauses and, based on
the study, potentially limit or ban arbitration clauses. A preliminary report on arbitration agreements issued by the CFPB
expressed concerns about these agreements that may signal the CFPB is contemplating taking such steps. Further, the
Company is involved in pending legal actions challenging its arbitration clause.
The Company is also involved, from time to time, in other reviews, investigations and proceedings (both formal
and informal) by governmental agencies regarding the Company’s business including, among other matters, consumer
regulatory, accounting, tax and other operational matters, some of which may result in significant adverse judgments,
settlements, fines, penalties, injunctions, decreases in regulatory ratings, customer restitution or other relief, which could
materially impact the Company's financial statements, increase its cost of operations, or limit its ability to execute its
business strategies and engage in certain business activities. For example, Discover Bank entered into a Consent Order
with the FDIC as described more fully below. Also, the Federal Reserve notified the Company of its intention to enter into
a supervisory action with the Company to require enhancements to the Company's enterprise-wide anti-money
laundering and related compliance programs. In addition, as previously disclosed, the CFPB issued a Civil Investigative
Demand to Discover Bank seeking documents and information regarding certain of Discover Bank’s student loan
servicing practices, which could lead to a supervisory action. The Company and Discover Bank are cooperating with
the Federal Reserve and the CFPB, respectively, on these matters. Supervisory actions generally can include demands for
civil money penalties, changes to certain business practices and customer restitution. Supervisory actions related to anti-
money laundering and related laws and regulations will limit for a period of time the Company's ability to enter into
certain types of acquisitions and make certain types of investments.
In accordance with applicable accounting guidance, the Company establishes an accrued liability for legal and
regulatory matters when those matters present loss contingencies which are both probable and estimable. Litigation
expense was not material for the calendar years ended December 31, 2014 and 2013 and one month ended
December 31, 2012. Litigation expense of $218 million was recognized for the fiscal year ended November 30, 2012.
There may be an exposure to loss in excess of any amounts accrued. The Company believes the estimate of the
aggregate range of reasonably possible losses (meaning those losses the likelihood of which is more than remote but
less than likely) in excess of the amounts that the Company has accrued for legal and regulatory proceedings is up to
$170 million. This estimated range of reasonably possible losses is based upon currently available information for those
proceedings in which the Company is involved, takes into account the Company’s best estimate of such losses for those
matters for which an estimate can be made, and does not represent the Company’s maximum potential loss exposure.
Various aspects of the legal proceedings underlying the estimated range will change from time to time and actual
results may vary significantly from the estimate.
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The Company’s estimated range above involves significant judgment, given the varying stages of the
proceedings, the existence of numerous yet to be resolved issues, the breadth of the claims (often spanning multiple
years and, in some cases, a wide range of business activities), unspecified damages and/or the novelty of the legal
issues presented. The outcome of pending matters could be material to the Company’s consolidated financial condition,
operating results and cash flows for a particular future period, depending on, among other things, the level of the
Company’s income for such period, and could adversely affect the Company’s reputation.
On July 5, 2012, the Antitrust Division of the United States Department of Justice (the “Division”) issued a Civil
Investigative Demand (“CID”) to the Company seeking information regarding an investigation related to potential
violations of Sections 1 and 2 of the Sherman Act, 15 U.S.C. §§1-2, by an unidentified party other than Discover. The
CID seeks documents, data and narrative responses to several interrogatories and document requests, related to the
debit card market. A CID is a request for information in the course of a civil investigation and does not constitute the
commencement of legal proceedings. The Division is permitted by statute to issue a CID to anyone whom it believes may
have information relevant to an investigation. The receipt of a CID does not presuppose that there is probable cause to
believe that a violation of the antitrust laws has occurred or that a formal complaint ultimately will be filed. The
Company is cooperating with the Division in connection with the CID.
On August 14, 2012, a purported shareholder, James Groen, filed a shareholder derivative action in the U.S.
District Court for the Northern District of Illinois (Groen v. Nelms et al.) against the Company’s board of directors,
certain current and former officers and directors and the Company as nominal defendant. On August 27, 2012, a
second purported shareholder, the Charter Township of Clinton Police and Fire Retirement System, filed a substantially
identical shareholder derivative action in the same court against the same parties (Charter Township of Clinton Police
and Fire Retirement System v. Nelms et al.). On September 25, 2012, the actions were consolidated, and on February
19, 2013, the plaintiffs filed an amended consolidated complaint. The consolidated complaint asserts claims against the
board of directors and certain current and former officers and directors for alleged breach of fiduciary duty, corporate
waste and unjust enrichment arising out of the Company’s alleged violations of the law in connection with the marketing
and sale of its protection products. The relief sought in the consolidated complaint includes changes to the Company’s
corporate governance procedures; unspecified damages, injunctive relief, restitution and disgorgement from the
individual defendants; and attorneys’ fees. On April 5, 2013, the defendants filed a motion to dismiss the amended
consolidated complaint, and on June 5, 2013, briefing on the motion to dismiss was completed. The motion to dismiss is
currently pending.
On June 13, 2014, Discover Bank entered into a Consent Order with the FDIC to resolve previously disclosed
matters related to the FDIC’s examination of Discover Bank’s anti-money laundering and related compliance programs.
In the Consent Order, Discover Bank agreed to, among other things, enhance its anti-money laundering and related
compliance programs. The order does not include civil money penalties.
On September 2, 2014, a purported shareholder, Steamfitters Local 449 Pension Fund, filed a shareholder
derivative action in the Circuit Court of the Nineteenth Judicial Circuit, Lake County, Illinois (Steamfitters Local 449
Pension Fund, derivatively on behalf of Discover Financial Services v. David W. Nelms, et al.) against the Company’s
board of directors and certain current and former officers and directors of the Company. The complaint asserts claims
for alleged breach of fiduciary duty, corporate waste and unjust enrichment arising out of the Company’s alleged
violations of the law in connection with the marketing and sale of protection products. The relief sought in the
consolidated complaint includes changes to the Company’s corporate governance procedures, unspecified damages,
restitution and disgorgement from the individual defendants, and attorneys’ fees. On September 25, 2014, the court
entered an order staying the case until 30 days after the U.S. District Court for the Northern District of Illinois enters an
order on defendants’ motion to dismiss the amended consolidated complaint in Groen v. Nelms et al. and Charter
Township of Clinton Police and Fire Retirement System v. Nelms et al. (as consolidated, the Groen and Charter
Township cases are now captioned: In re Discover Financial Services Derivative Litigation).
On September 3, 2014, a collective action lawsuit was filed against the Company by a former employee in the
U.S. District Court for the Northern District of Illinois (Pawel Holda, et al. v. Discover Financial Services). The plaintiff
alleges that the Company misclassified employees as being exempt from the Fair Labor Standards Act. The plaintiff
seeks to recover overtime pay on behalf of himself and other allegedly similarly situated employees together with
penalties, interest and attorney's fees. The Company will seek to vigorously defend against the claims asserted in this
matter. On January 6, 2015, the parties entered into a confidential settlement and release agreement for resolution of
this matter. On January 12, 2015, the court found that the parties’ settlement was fair and reasonable, and entered an
order dismissing the case with prejudice.
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On November 21, 2014, a patent infringement lawsuit was filed against the Company by Maxim Integrated
Products, Inc. in the United States District Court for the Western District of Texas (Maxim Integrated Products, Inc. v.
Discover Financial Services). The complaint asserts that the Company has infringed on three patents owned by Maxim
relating to various systems and methods for performing secure transactions using mobile devices and also involving
secure exchanges of information using mobile encryption and decryption. The plaintiff seeks unspecified damages for
alleged past infringement, an award of attorneys’ fees and expenses, and a permanent injunction. The Company will
seek to vigorously defend against the claims asserted in this matter.
20. Fair Value Measurements and Disclosures
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. ASC Topic 820, Fair Value Measurement, provides a
three-level hierarchy for classifying financial instruments, which is based on whether the inputs to the valuation
techniques used to measure the fair value of each financial instrument are observable or unobservable. It also requires
certain disclosures about those measurements. The three-level valuation hierarchy is as follows:
•
•
•
Level 1: Fair values determined by Level 1 inputs are defined as those that utilize quoted prices (unadjusted)
in active markets for identical assets or liabilities that the Company has the ability to access.
Level 2: Fair values determined by Level 2 inputs are those that utilize inputs other than quoted prices
included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs
include quoted prices for similar assets and liabilities in active or inactive markets, quoted prices for the
identical assets in an inactive market, and inputs other than quoted prices that are observable for the asset or
liability, such as interest rates and yield curves that are observable at commonly quoted intervals. The
Company evaluates factors such as the frequency of transactions, the size of the bid-ask spread and the
significance of adjustments made when considering transactions involving similar assets or liabilities to assess
the relevance of those observed prices. If relevant and observable prices are available, the fair values of the
related assets or liabilities would be classified as Level 2.
Level 3: Fair values determined by Level 3 inputs are those based on unobservable inputs, and include
situations where there is little, if any, market activity for the asset or liability being valued. In instances in
which the inputs used to measure fair value may fall into different levels of the fair value hierarchy, the level
in the fair value hierarchy within which the fair value measurement in its entirety is classified is based on the
lowest level input that is significant to the fair value measurement in its entirety. The Company may utilize
both observable and unobservable inputs in determining the fair values of financial instruments classified
within the Level 3 category.
The determination of classification of its financial instruments within the fair value hierarchy is performed at least
quarterly by the Company. For transfers in and out of the levels of the fair value hierarchy, the Company discloses the
fair value measurement based on the value immediately preceding the transfer.
The Company's assessment of the significance of a particular input to the fair value measurement in its entirety
requires judgment, and involves consideration of factors specific to the asset or liability. Furthermore, certain techniques
used to measure fair value involve some degree of judgment and, as a result, are not necessarily indicative of the
amounts the Company would realize in a current market exchange.
During the years ended December 31, 2014 and 2013, there were no changes to the Company's valuation
techniques that had, or are expected to have, a material impact on the Company's consolidated financial position or
results of operations.
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Assets and Liabilities Measured at Fair Value on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are as follows (dollars in millions):
Quoted Prices
in Active
Markets
for Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Balance at December 31, 2014
Assets
U.S. Treasury securities ................................................................................ $
1,329
$
— $
— $
U.S. government agency securities ...............................................................
Residential mortgage-backed securities - Agency ...........................................
1,033
—
—
1,485
—
—
Available-for-sale investment securities ...................................................... $
2,362
$
1,485
$
— $
1,329
1,033
1,485
3,847
Mortgage loans held for sale ....................................................................... $
— $
122
$
— $
122
Interest rate lock commitments ...................................................................... $
— $
— $
7
$
Forward delivery contracts ...........................................................................
Other derivative financial instruments ...........................................................
—
—
Derivative financial instruments ................................................................ $
— $
1
35
36
—
—
$
7
$
Liabilities
Forward delivery contracts ........................................................................... $
Other derivative financial instruments ...........................................................
Derivative financial instruments ................................................................ $
— $
—
— $
3
$
20
23
$
— $
—
— $
Balance at December 31, 2013
Assets
U.S. Treasury securities ................................................................................ $
2,057
$
— $
— $
U.S. government agency securities ...............................................................
Credit card asset-backed securities of other issuers .........................................
Residential mortgage-backed securities - Agency ...........................................
1,561
—
—
—
6
1,307
—
—
—
Available-for-sale investment securities ...................................................... $
3,618
$
1,313
$
— $
7
1
35
43
3
20
23
2,057
1,561
6
1,307
4,931
Mortgage loans held for sale ....................................................................... $
— $
148
$
— $
148
Interest rate lock commitments ...................................................................... $
— $
— $
4
$
Forward delivery contracts ...........................................................................
Other derivative financial instruments ...........................................................
—
—
Derivative financial instruments ................................................................ $
— $
Liabilities
Forward delivery contracts ........................................................................... $
Other derivative financial instruments ...........................................................
Derivative financial instruments ................................................................ $
— $
—
— $
5
70
75
1
6
7
$
$
$
—
—
4
$
— $
—
— $
4
5
70
79
1
6
7
-145-
There were no transfers between Levels 1 and 2 within the fair value hierarchy for the years ended December 31,
2014 and 2013.
Available-for-Sale Investment Securities
Investment securities classified as available-for-sale consist of U.S. Treasury and government agency securities,
residential mortgage-backed securities, and credit card asset-backed securities issued by other financial institutions. The
fair value estimates of investment securities classified as Level 1, consisting of U.S. Treasury and government agency
securities, are determined based on quoted market prices for the same or similar securities. The Company classifies all
other available-for-sale investment securities as Level 2, the fair value estimates of which are primarily obtained from
pricing services, where fair values are estimated using pricing models based on observable market inputs or recent
trades of similar securities. The fair value estimates of mortgage-backed and credit card asset-backed securities are
based on the best information available. This data may consist of observed market prices, broker quotes or discounted
cash flow models that incorporate assumptions such as benchmark yields, issuer spreads, prepayment speeds, credit
ratings and losses, the priority of which may vary based on availability of information.
The Company validates the fair value estimates provided by the pricing services primarily by comparison to
valuations obtained through other pricing sources. The Company evaluates pricing variances amongst different pricing
sources to ensure that the valuations utilized are reasonable. The Company also corroborates the reasonableness of the
fair value estimates with analysis of trends of significant inputs, such as market interest rate curves. The Company
further performs due diligence in understanding the procedures and techniques performed by the pricing services to
derive fair value estimates.
At December 31, 2014, amounts reported in residential mortgage-backed securities reflect government-rated
obligations issued by Fannie Mae, Freddie Mac and Ginnie Mae with a par value of $1.4 billion, a weighted-average
coupon of 2.81% and a weighted-average remaining maturity of four years.
Mortgage Loans Held for Sale and Related Derivative Instruments
The Company enters into commitments with consumers to originate mortgage loans at a specified interest rate,
known as interest rate lock commitments (“IRLCs”). The Company reports IRLCs as derivative instruments at fair value
with changes in fair value being recorded in other income. IRLCs and mortgage loans held for sale under certain loan
programs are hedged in aggregate using “to be announced mortgage-backed securities” (“TBA MBS”). IRLCs and
mortgage loans held for sale under loan programs that generally have lower volume are hedged on an individual loan
level using best-efforts forward delivery contracts.
Fair values for each of these instruments are determined using quantitative risk models. The Company has various
monitoring processes in place to validate these valuations, including valuations of Level 3 assets. Valuation results are
reviewed in comparison to expected results, recent activity and historical trends. Any significant or unusual fluctuations
in value are analyzed.
• Mortgage loans held for sale. Valuations of mortgage loans held for sale are based on the loan amount,
note rate, loan program, expected sale date of the loan and, most significantly, investor pricing tables
stratified by product, note rate and term, adjusted for current market conditions. Mortgage loans held for
sale are classified as Level 2 as the investor pricing tables used to value them are an observable input.
Impaired mortgage loans held for sale are classified as Level 3 as loss severity is an unobservable input used
in valuation. The Company recognizes interest income separately from changes in fair value.
•
Interest rate lock commitments. IRLCs for loans to be sold to investors using a mandatory or assignment of
trade method derive their base value from an underlying loan type with similar characteristics using the TBA
MBS market, which is actively quoted and easily validated through external sources. The data inputs used in
this valuation include, but are not limited to, loan type, underlying loan amount, note rate, loan program,
and commitment term. IRLCs for loans to be sold to investors on a best-efforts basis derive their base value
from the value of the underlying loans using investor pricing tables stratified by product, note rate and term,
adjusted for current market conditions. These valuations are adjusted at the loan level to consider the
servicing release premium and loan pricing adjustments specific to each loan. For all IRLCs, this base value is
then adjusted for the anticipated loan funding probability, or pull through rate. The anticipated loan funding
probability is an unobservable input based on historical experience, which results in classification of IRLCs as
Level 3.
-146-
•
Forward delivery contracts. Under the Company's risk management policy, the Company economically
hedges the changes in fair value of IRLCs and mortgage loans held for sale caused by changes in interest
rates by using TBA MBS and entering into best-efforts forward delivery contracts. These hedging instruments
are recorded at fair value with changes in fair value recorded in other income. TBA MBS used to hedge both
IRLCs and loans held for sale are valued based primarily on observable inputs related to characteristics of the
underlying MBS stratified by product, coupon and settlement date. Therefore, these derivatives are classified
as Level 2. Best-efforts forward delivery contracts are valued based on investor pricing tables, which are
observable inputs, stratified by product, note rate, and term, adjusted for current market conditions. An
anticipated loan funding probability is applied to value best-efforts contracts hedging IRLCs, which results in
the classification of these contracts as Level 3. The current base loan price and, for best-efforts contracts
hedging IRLCs, the anticipated loan funding probability, are the most significant assumptions affecting the
value of the best-efforts contracts. The best-efforts forward delivery contracts hedging loans held for sale are
classified as Level 2, so such contracts are transferred from Level 3 to Level 2 at the time the underlying loan
is originated. For the purposes of the tables below, the Company refers to TBA MBS and best-efforts forward
delivery contracts as forward delivery contracts.
Other Derivative Financial Instruments
The Company's other derivative financial instruments consist of interest rate swaps and foreign exchange forward
contracts. These instruments are classified as Level 2 as their fair values are estimated using proprietary pricing models,
containing certain assumptions based on readily observable market-based inputs, including interest rate curves, option
volatility and foreign currency forward and spot rates. In determining fair values, the pricing models use widely
accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative.
This analysis reflects the contractual terms of the derivatives, including the period to maturity and the observable market-
based inputs. The fair values of the interest rate swaps are determined using the market standard methodology of
netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or
receipts). The variable cash payments are based on an expectation of future interest rates derived from the observable
market interest rate curves. The Company considers collateral and master netting agreements that mitigate credit
exposure to counterparties in determining the counterparty credit risk valuation adjustment. The fair values of the
currency instruments are valued comparing the contracted forward exchange rate pertaining to the specific contract
maturities to the current market exchange rate.
The Company validates the fair value estimates of interest rate swaps primarily through comparison to the fair
value estimates computed by the counterparties to each of the derivative transactions. The Company evaluates pricing
variances amongst different pricing sources to ensure that the valuations utilized are reasonable. The Company also
corroborates the reasonableness of the fair value estimates with analysis of trends of significant inputs, such as market
interest rate curves. The Company performs due diligence in understanding the impact to any changes to the valuation
techniques performed by proprietary pricing models prior to implementation, working closely with the third-party
valuation service, and reviews the control objectives of the service at least annually. The Company corroborates the fair
value of foreign exchange forward contracts through independent calculation of the fair value estimates.
Assets and Liabilities under the Fair Value Option
The Company has elected to account for mortgage loans held for sale at fair value. Electing the fair value option
allows a better offset of the changes in fair values of the loans and the forward delivery contracts used to economically
hedge them without the burden of complying with the requirements for hedge accounting. At December 31, 2014 and
2013, the aggregate unpaid principal balance of loans held for sale for which the fair value option had been elected
was $117 million and $146 million, respectively. At December 31, 2014 and 2013, the same loans had a fair value of
$122 million and $148 million, respectively. For the years ended December 31, 2014 and 2013, $18 million, and $37
million of losses, respectively, from fair value adjustments on mortgage loans held for sale were recorded in other
revenue on the consolidated statements of income.
-147-
Level 3 Financial Instruments Only
Changes in Level 3 Assets and Liabilities Measure at Fair Value on a Recurring Basis
The following tables provide changes in the Company’s Level 3 assets and liabilities measured at fair value on a
recurring basis (dollars in millions).
For the Calendar Year Ended December 31, 2014
Balance at
December 31,
2013
Transfers
into
Level 3
Transfers
out of
Level 3
Total net
gains
included in
earnings
Purchases
Sales
Settlements
Transfers
of IRLCs to
closed
loans
Balance at
December 31,
2014
Interest rate lock
commitments ...... $
Forward delivery
contracts ............ $
Mortgage loans
held for sale ....... $
4
—
—
—
—
2
—
(1)
—
87
1
—
—
—
1
—
—
(3)
4
—
—
(88) $
— $
— $
7
—
—
For the Calendar Year Ended December 31, 2013
Balance at
December 31,
2012
Transfers
into
Level 3
Transfers
out of
Level 3
Total net
gains
included in
earnings
Purchases
Sales
Settlements
Transfers
of IRLCs to
closed
loans
Balance at
December 31,
2013
Interest rate lock
commitments ...... $
Forward delivery
contracts ............ $
Mortgage loans
held for sale ....... $
12
—
—
—
—
3
—
(3)
—
121
3
—
—
—
1
—
—
(3)
3
—
(1)
(132) $
— $
— $
4
—
—
Unobservable Inputs and Sensitivities
The following table presents information about significant unobservable inputs related to the Company's Level 3
financial assets and liabilities measured at fair value on a recurring and non-recurring basis at the end of the current
period (dollars in millions):
Fair Value
Valuation
Technique
Significant
Unobservable
Input
Ranges of Inputs
Low
High
Weighted
Average(1)
At December 31, 2014
Interest rate lock commitments ....... $
Quantitative risk
models
7
Loan funding
probability
13%
99%
61%
(1) Weighted averages are calculated using notional amounts for derivative instruments.
The anticipated loan funding probability represents the Company's expectation regarding the percentage of IRLCs
that will ultimately be funded. Generally, an increase in the anticipated loan funding probability would result in an
increase in the magnitude of fair value measurements.
Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis
The Company also has assets that under certain conditions are subject to measurement at fair value on a non-
recurring basis. These assets include those associated with acquired businesses, including goodwill and other intangible
assets. For these assets, measurement at fair value in periods subsequent to the initial recognition of the assets is
applicable if one or more of the assets is determined to be impaired. During the fourth quarter of 2014, the Company
determined that the fair value of goodwill associated with Discover Home Loans declined below its carrying value and
should be fully impaired. At December 31, 2014, the Company recorded an impairment charge of $27 million to other
expense, the amount required to adjust the asset’s value to zero.
-148-
Financial Instruments Measured at Other Than Fair Value
The following tables disclose the estimated fair value of the Company's financial assets and financial liabilities
that are not required to be carried at fair value (dollars in millions):
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Carrying
Value
Balance at December 31, 2014
Assets
U.S. Treasury securities ....................................................... $
1
$
— $
— $
1
$
States and political subdivisions of states ..............................
Residential mortgage-backed securities - Agency ..................
—
—
10
93
—
—
10
93
1
10
91
Held-to-maturity investment securities ............................... $
1
$
103
$
— $
104
$
102
Cash and cash equivalents ................................................. $
Restricted cash ................................................................... $
Net loan receivables(1) ........................................................ $
Accrued interest receivables ................................................ $
Liabilities
Deposits ........................................................................... $
Short-term borrowings ....................................................... $
Long-term borrowings - owed to securitization investors......... $
Other long-term borrowings ............................................... $
Accrued interest payables ................................................... $
7,284
106
$
$
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
7,284
106
69,316
$
69,316
618
$
— $
618
46,242
113
16,067
5,721
132
$
$
$
$
$
— $
— $
1,561
1
$
$
— $
46,242
113
17,628
5,722
132
$
$
$
$
$
$
$
$
$
Balance at December 31, 2013
Assets
U.S. Treasury securities ....................................................... $
1
$
— $
— $
1
$
States and political subdivisions of states ..............................
Residential mortgage-backed securities - Agency ..................
—
—
Held-to-maturity investment securities ............................... $
1
$
14
43
57
—
—
$
— $
14
43
58
Cash and cash equivalents ................................................. $
Restricted cash ................................................................... $
Net loan receivables(1) ........................................................ $
Accrued interest receivables ................................................ $
Liabilities
Deposits ........................................................................... $
Short-term borrowings ....................................................... $
Long-term borrowings - owed to securitization investors......... $
Other long-term borrowings ............................................... $
Accrued interest payables ................................................... $
6,554
182
$
$
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
6,554
182
64,968
$
64,968
556
$
— $
556
45,231
140
15,312
3,934
117
$
$
$
$
$
— $
— $
1,971
1
$
$
— $
45,231
140
17,283
3,935
117
$
$
$
$
$
$
$
$
$
$
7,284
106
68,101
618
46,089
113
17,395
5,149
132
1
15
44
60
6,554
182
63,975
556
44,959
140
16,986
3,488
117
(1) Net loan receivables exclude mortgage loans held for sale that are measured at fair value on a recurring basis.
The fair values of these financial assets and liabilities, which are not carried at fair value on the consolidated
statements of financial condition, were determined by applying the fair value provisions discussed herein. The use of
different assumptions or estimation techniques may have a material effect on these estimated fair value amounts. The
-149-
following describes the valuation techniques of these financial instruments measured at other than fair value.
Cash and Cash Equivalents
The carrying value of cash and cash equivalents approximates fair value due to the low level of risk these assets
present to the Company as well as the relatively liquid nature of these assets, particularly given their short maturities.
Restricted Cash
The carrying value of restricted cash approximates fair value due to the low level of risk these assets present to
the Company as well as the relatively liquid nature of these assets, particularly given their short maturities.
Held-to-Maturity Investment Securities
Held-to-maturity investment securities consist of residential mortgage-backed securities issued by agencies and
municipal bonds. The fair value of residential mortgage-backed securities included in the held-to-maturity portfolio is
estimated similarly to residential mortgage-backed securities carried at fair value on a recurring basis discussed herein.
Municipal bonds are valued based on quoted market prices for the same or similar securities.
Net Loan Receivables
The Company's loan receivables are comprised of credit card and installment loans, including the PCI student
loans. Fair value estimates are derived utilizing discounted cash flow analyses, the calculations of which are performed
on groupings of loan receivables that are similar in terms of loan type and characteristics. Inputs to the cash flow
analysis of each grouping consider recent prepayment and interest accrual trends and leverage forecasted loss
estimates. The expected future cash flows, derived through the cash flow analysis, of each grouping are discounted at
rates at which similar loans within each grouping could be originated under current market conditions. Significant
inputs to the fair value measurement of the loan portfolio are unobservable, and as such are classified as Level 3.
Accrued Interest Receivables
The carrying value of accrued interest receivable, which is included in other assets on the statements of financial
condition, approximates fair value as it is short term in nature and is due in less than one year.
Deposits
The carrying values of money market deposits, savings deposits and demand deposits approximate fair value
due to the potentially liquid nature of these deposits. For time deposits for which readily available market rates do not
exist, fair values are estimated by discounting expected future cash flows using market rates currently offered for
deposits with similar remaining maturities.
Short-Term Borrowings
The carrying values of short-term borrowings approximate fair value as they are short term in nature and have
maturities of less than one year.
Long-Term Borrowings - Owed to Securitization Investors
Fair values of long-term borrowings owed to credit card securitization investors are determined utilizing quoted
market prices of the same transactions and, as such, are classified as Level 2. Fair values of long-term borrowings owed
to student loan securitization investors are calculated by discounting cash flows using estimated assumptions including,
among other things, maturity and market discount rates. A portion of the difference between the carrying value and the
fair value of the long-term borrowings owed to student loan securitization investors relates to purchase accounting
adjustments recorded in connection with the December 2010 purchase of SLC. Significant inputs to these fair value
measurements are unobservable, and, as such, are classified as Level 3.
Other Long-Term Borrowings
Fair values of other long-term borrowings, consisting of subordinated and senior debt, are determined utilizing
current observable market prices for those transactions and, as such, are classified as Level 2. A portion of the
difference between the carrying value and the fair value of other long-term borrowings relates to the cash premiums
-150-
paid in connection with the 2012 fiscal year debt exchanges. The fair values of other long-term borrowings classified as
Level 3 consist of capital leases.
Accrued Interest Payables
The carrying value of the Company's accrued interest payable, which is included in other liabilities on the
statements of financial condition, approximates fair value as it is short term in nature and is payable in less than one
year.
21. Derivatives and Hedging Activities
The Company uses derivatives to manage its exposure to various financial risks. The Company does not enter
into derivatives for trading or speculative purposes. Certain derivatives used to manage the Company’s exposure to
interest rate movements and other identified risks are not designated as hedges and do not qualify for hedge
accounting.
Derivatives may give rise to counterparty credit risk, which generally is addressed through collateral
arrangements as described under the sub-heading "— Collateral Requirements and Credit-Risk Related Contingency
Features." The Company enters into derivative transactions with established dealers that meet minimum credit criteria
established by the Company. All counterparties must be pre-approved prior to engaging in any transaction with the
Company. Counterparties are monitored on a regular basis by the Company to ensure compliance with the Company’s
risk policies and limits. In determining the counterparty credit risk valuation adjustment for the fair values of derivatives,
the Company considers collateral and legally enforceable master netting agreements that mitigate credit exposure to
related counterparties.
All derivatives are recorded in other assets at their gross positive fair values and in accrued expenses and other
liabilities at their gross negative fair values. See Note 20: Fair Value Measurements and Disclosures for a description of
the valuation methodologies of derivatives. Cash collateral posted and held balances are recorded in other assets and
deposits, respectively, in the consolidated statement of financial condition. Collateral amounts recorded in the
consolidated statement of financial condition are based on the net collateral posted or held position for each applicable
legal entity's master netting arrangement with each counterparty.
Derivatives Designated as Hedges
Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows
arising from changes in interest rates, or other types of forecasted transactions, are considered cash flow hedges.
Derivatives designated and qualifying as a hedge of the exposure to fluctuations in foreign exchange rates on
investments in foreign entities are referred to as net investment hedges. Derivatives designated and qualifying as a
hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular
risk, such as interest rate risk, are considered fair value hedges.
Cash Flow Hedges
The Company uses interest rate swaps to manage its exposure to changes in interest rates related to future cash
flows resulting from interest payments on credit card securitized debt and deposits, and previously from interest receipts
on credit card loan receivables. The Company's outstanding cash flow hedges are for an initial maximum period of five
years for securitized debt and seven years for deposits. The derivatives are designated as hedges of the risk of changes
in cash flows on the Company’s LIBOR or Federal Funds rate-based interest payments, and qualify for hedge
accounting in accordance with ASC Topic 815, Derivatives and Hedging (“ASC 815”).
The effective portion of the change in the fair value of derivatives designated as cash flow hedges is recorded in
other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted
cash flows affect earnings. The ineffective portion of the change in fair value of the derivative, if any, is recognized
directly in earnings. Amounts reported in accumulated other comprehensive income related to derivatives at
December 31, 2014 will be reclassified to interest expense as interest payments are made on certain of the Company's
floating-rate securitized debt or deposits. During the next 12 months, the Company estimates it will reclassify $40
million of pretax losses to interest expense related to its derivatives designated as cash flow hedges.
-151-
Net Investment Hedges
The Company is exposed to fluctuations in foreign exchange rates on investments it holds in foreign entities with a
functional currency other than the U.S. dollar. The Company uses foreign exchange forward contracts to hedge its
exposure to changes in foreign exchange rates on its net investment in Diners Club Italy. Foreign exchange forward
contracts utilized by the Company involve fixing the U.S. dollar-euro exchange rate for delivery of a specified amount
of foreign currency on a specified date. These derivatives are designated as net investment hedges, with the effective
portion of changes in the fair value of the derivatives reported in other comprehensive income as part of the cumulative
translation adjustment. The ineffective portion of the change in fair value of the derivatives, if any, is recognized directly
in earnings. Amounts are reclassified out of accumulated other comprehensive income into earnings when the hedged
net investment is either sold or substantially liquidated.
Fair Value Hedges
The Company is exposed to changes in fair value of certain of its fixed-rate debt obligations due to changes in
interest rates. The Company uses interest rate swaps to manage its exposure to changes in fair value of certain fixed-
rate senior notes, securitized debt and interest-bearing brokered deposits attributable to changes in LIBOR, a
benchmark interest rate as defined by ASC 815. These interest rate swaps qualify as fair value hedges in accordance
with ASC 815. Changes in both (i) the fair values of the derivatives and (ii) the hedged fixed-rate senior notes,
securitized debt and interest-bearing brokered deposits relating to the risk being hedged are recorded in interest
expense. The changes generally provide substantial offset to one another, with any difference, or ineffectiveness
recorded in interest expense. Any basis differences between the fair value and the carrying amount of the hedged item
at the inception of the hedging relationship are amortized to interest expense.
Derivatives Not Designated as Hedges
Interest Rate Swaps
The Company may have, from time to time, interest rate swap agreements that are not designated as hedges. As
part of its acquisition of SLC, the Company also acquired an interest rate swap related to the securitized debt assumed
in the transaction. Such agreements are not speculative and are also used to manage interest rate risk but are not
designated for hedge accounting. Changes in the fair value of these contracts are recorded in other income.
Foreign Exchange Forward Contracts
The Company has foreign exchange forward contracts that are economic hedges and are not designated as
accounting hedges. The Company enters into foreign exchange forward contracts to manage foreign currency risk.
Changes in the fair value of these contracts are recorded in other income.
Forward Delivery Contracts
The Company economically hedges the changes in fair value of IRLCs and mortgage loans held for sale caused
by changes in interest rates by using TBA MBS and entering into best efforts forward delivery commitments. These
derivative instruments are recorded at fair value with changes in fair value recorded in other income.
Interest Rate Lock Commitments
The Company enters into commitments with consumers to originate residential mortgage loans at a specified
interest rate. The Company reports IRLCs that relate to the origination of mortgage loans that will be held for sale as
derivative instruments at fair value with changes in fair value recorded in other income.
-152-
The following table summarizes the fair value (including accrued interest) and outstanding notional amounts of
derivative instruments and related collateral balances (dollars in millions).
December 31, 2014
December 31, 2013
Number of
Outstanding
Derivative
Contracts
Notional
Amount
Derivative
Assets
Derivative
Liabilities
Notional
Amount
Derivative
Assets
Derivative
Liabilities
Derivatives designated as hedges:
Interest rate swaps - cash flow hedge.......... $
4,100
8
$
4
$
Interest rate swaps - fair value hedge.......... $
5,507
175
Foreign exchange forward contract - net
investment hedge(1) .................................. $
Derivatives not designated as hedges:
Foreign exchange forward contracts(2)......... $
Interest rate swap(3) ................................... $
Forward delivery contracts ......................... $
Interest rate lock commitments(3) ................. $
Total gross derivative assets/liabilities(4) ..........
Less: Collateral held/posted(5) ....................
Total net derivative assets/liabilities ................
7
53
359
761
406
1
9
1
331
1,681
31
—
—
—
1
7
43
(20)
$
23
$
18
2
$
$
2,650
$
7,138
— $
35
44
796
693
235
— $
— $
3
$
— $
23
(23)
—
$
18
52
—
—
—
5
4
79
(61)
$
18
$
—
6
—
—
—
1
—
7
(7)
—
(1)
(2)
(3)
(4)
The foreign exchange forward contract has a notional amount of EUR 6 million and EUR 26 million as of December 31, 2014 and December 31, 2013, respectively.
The foreign exchange forward contracts have notional amounts of EUR 27 million, GBP 8 million, SGD 1 million and CHF 8 million as of December 31, 2014 and
EUR 20 million and GBP 6 million, SGD 1 million and CHF 5 million as of December 31, 2013.
Interest rate swaps not designated as hedges and interest rate lock commitments do not have associated master netting arrangements.
In addition to the derivatives disclosed in the table, the Company enters into forward contracts to purchase when-issued mortgage-backed securities as part of its
community reinvestment initiatives. At December 31, 2014 the Company had one outstanding contract with a notional amount of $33 million and immaterial fair
value. At December 31, 2013 the Company one outstanding contract with a notional amount of $40 million and immaterial fair value.
(5) Collateral amounts, which consist of both cash and investment securities, are limited to the related derivative asset/liability balance and do not include excess
collateral received/pledged.
-153-
The following tables summarize the impact of the derivative instruments on income and other comprehensive
income, and indicates where within the consolidated financial statements such impact is reported for the period (dollars
in millions):
Amount of (Loss) Gain Recognized in Other Comprehensive Income
For the Calendar Years Ended
December 31,
Location
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
Derivatives designated as hedges:
Interest rate swaps—cash flow/net investment hedges:
Total (losses) gains recognized in other
comprehensive income after amounts reclassified
into earnings, pre-tax ........................................
Other
Comprehensive
Income
Total (losses) gains recognized in other
comprehensive income ...............................
$
$
(27) $
(27) $
13
13
$
$
(6) $
(6) $
(1)
(1)
Amount of Gain (Loss) Recognized in Income
For the Calendar Years Ended
December 31,
Location
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
Derivatives designated as hedges:
Interest rate swaps—cash flow hedges:
Amount reclassified from other comprehensive
income into income ...........................................
Interest Income
$
— $
4
$
7
$
Amount reclassified from other comprehensive
income into income ...........................................
Interest Expense
Total amount reclassified from other
comprehensive income into income ...................
Interest rate swaps—fair value hedges:
Interest expense - ineffectiveness ...........................
Interest expense - other ........................................
Gain (loss) on interest rate swaps .....................
Interest Expense
Interest expense - ineffectiveness ...........................
Interest expense - other ........................................
Gain (loss) on hedged item ..............................
Interest Expense
(38)
(38)
(13)
38
25
19
(2)
17
(12)
(8)
(46)
41
(5)
51
(6)
45
—
7
58
30
88
(52)
(6)
(58)
Total gains recognized in income ..................
$
4
$
32
$
37
$
Derivatives not designated as hedges:
Gain (loss) on forward contracts ........................... Other Income
$
5
$
(1) $
1
$
Loss on interest rate swaps ................................... Other Income
(Loss) gain on forward delivery contracts ............... Other Income
Gain on interest rate lock commitments ................. Other Income
(1)
(6)
87
(1)
4
121
(7)
(1)
110
Total gains on derivatives not designated as
hedges recognized in income .....................
$
85
$
123
$
103
$
1
—
1
(9)
3
(6)
10
(1)
9
4
(1)
—
2
17
18
-154-
Collateral Requirements and Credit-Risk Related Contingency Features
The Company has master netting arrangements and minimum collateral posting thresholds with its counterparties
for its fair value and cash flow hedge interest rate swaps, foreign exchange forward contracts and forward delivery
contracts. The Company has not sought a legal opinion in relation to the enforceability of its master netting
arrangements, and as such, does not report any of these positions on a net basis. Collateral is required by either the
Company or its subsidiaries or the counterparty depending on the net fair value position of these derivatives held with
that counterparty. The Company may also be required to post collateral with a counterparty for its fair value and cash
flow hedge interest rate swaps depending on the credit rating it or Discover Bank receives from specified major credit
rating agencies. Collateral receivable or payable amounts are not offset against the fair value of these derivatives, but
are recorded separately in other assets or deposits.
As of December 31, 2014, DFS had a right to reclaim $4 million of cash collateral that had been posted (net of
amounts required to be posted by the counterparty) because the credit rating of the Company did not meet specified
thresholds. At December 31, 2014, Discover Bank’s credit rating met specified thresholds set by its counterparties.
However, if Discover Bank’s credit rating is reduced by one ratings notch, Discover Bank would be required to post
additional collateral, which would have been $97 million as of December 31, 2014.
The Company also has agreements with certain of its derivative counterparties that contain a provision where if
the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been
accelerated by the lender, then the Company could also be declared in default on its derivative obligations.
22.
Segment Disclosures
The Company’s business activities are managed in two segments: Direct Banking and Payment Services.
• Direct Banking: 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 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.
•
Payment Services: 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. 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.
The business segment reporting provided to and used by the Company’s chief operating decision maker is
prepared using the following principles and allocation conventions:
•
The Company aggregates operating segments when determining reporting segments.
• Corporate overhead is not allocated between segments; all corporate overhead is included in the Direct
Banking segment.
•
•
•
•
Through its operation of the Discover Network, the Direct Banking segment incurs fixed marketing, servicing
and infrastructure costs that are not specifically allocated among the segments, with the exception of an
allocation of direct and incremental costs driven by the Company's Payment Services segment.
The assets of the Company are not allocated among the operating segments in the information reviewed by
the Company’s chief operating decision maker.
The revenues of each segment are derived from external sources. The segments do not earn revenue from
intercompany sources.
Income taxes are not specifically allocated between the operating segments in the information reviewed by
the Company’s chief operating decision maker.
-155-
The following table presents segment data for the period (dollars in millions):
Direct
Banking
Payment
Services
Total
For the Calendar Year Ended December 31, 2014
Interest income
Credit card ...................................................................................................................... $
6,359
$
— $
6,359
Private student loans .........................................................................................................
PCI student loans ..............................................................................................................
Personal loans .................................................................................................................
Other ..............................................................................................................................
Total interest income .....................................................................................................
Interest expense ...................................................................................................................
Net interest income .......................................................................................................
Provision for loan losses
.......................................................................................................
Other income ......................................................................................................................
Other expense .....................................................................................................................
312
260
568
97
7,596
1,134
6,462
1,440
1,700
3,117
—
—
—
—
—
—
—
3
315
223
Income before income tax expense ................................................................................. $
3,605
$
89
$
312
260
568
97
7,596
1,134
6,462
1,443
2,015
3,340
3,694
For the Calendar Year Ended December 31, 2013
Interest income
Credit card ...................................................................................................................... $
5,978
$
— $
5,978
Private student loans .........................................................................................................
PCI student loans ..............................................................................................................
Personal loans .................................................................................................................
Other ..............................................................................................................................
Total interest income .....................................................................................................
Interest expense ...................................................................................................................
Net interest income .......................................................................................................
Provision for loan losses
.......................................................................................................
Other income ......................................................................................................................
Other expense .....................................................................................................................
252
272
464
98
7,064
1,146
5,918
1,069
1,976
2,961
—
—
—
—
—
—
—
17
330
233
Income before income tax expense ................................................................................. $
3,864
$
80
$
252
272
464
98
7,064
1,146
5,918
1,086
2,306
3,194
3,944
-156-
The following table presents segment data for the period (dollars in millions):
Direct
Banking
Payment
Services
Total
For the Fiscal Year Ended November 30, 2012
Interest income
Credit card ...................................................................................................................... $
5,751
$
— $
5,751
Private student loans .........................................................................................................
PCI student loans ..............................................................................................................
Personal loans .................................................................................................................
Other ..............................................................................................................................
Total interest income .....................................................................................................
Interest expense ...................................................................................................................
Net interest income .......................................................................................................
Provision for loan losses
.......................................................................................................
Other income ......................................................................................................................
Other expense .....................................................................................................................
184
303
363
102
6,703
1,331
5,372
848
1,939
2,891
—
—
—
—
—
—
—
—
342
161
Income before income tax expense ................................................................................. $
3,572
$
181
$
184
303
363
102
6,703
1,331
5,372
848
2,281
3,052
3,753
For the One Month Ended December 31, 2012
Interest income
Credit card ...................................................................................................................... $
510
$
— $
510
Private student loans .........................................................................................................
PCI student loans ..............................................................................................................
Personal loans .................................................................................................................
Other ..............................................................................................................................
Total interest income .....................................................................................................
Interest expense ...................................................................................................................
Net interest income .......................................................................................................
Provision for loan losses
.......................................................................................................
Other income ......................................................................................................................
Other expense .....................................................................................................................
18
24
34
9
595
103
492
178
169
224
Income before income tax expense ................................................................................. $
259
$
—
—
—
—
—
—
—
—
31
16
15
$
18
24
34
9
595
103
492
178
200
240
274
23.
Related Party Transactions
In the ordinary course of business, the Company offers consumer financial products to its directors, executive
officers and certain members of their families. These products are offered on substantially the same terms as those
prevailing at the time for comparable transactions with unrelated parties, and these receivables are included in the loan
receivables in the Company's consolidated statements of financial condition. They were not material to the Company's
financial position or results of operations.
-157-
24.
Parent Company Condensed Financial Information
The following Parent Company financial statements are provided in accordance with SEC rules, which require
such disclosure when the restricted net assets of consolidated subsidiaries exceed 25% of consolidated net assets.
Discover Financial Services
(Parent Company Only)
Condensed Statements of Financial Condition
December 31,
2014
2013
(dollars in millions)
Assets:
Cash and cash equivalents ............................................................................................................................. $
79
$
Notes receivable from subsidiaries(1)
...............................................................................................................
Investments in subsidiaries
.............................................................................................................................
Other assets
.................................................................................................................................................
2,436
10,360
204
4
2,254
9,824
158
Total assets
............................................................................................................................................... $
13,079
$
12,240
Liabilities and Stockholders' Equity:
Non-interest bearing deposit accounts
............................................................................................................ $
Interest-bearing deposit accounts ....................................................................................................................
Total deposits
...........................................................................................................................................
Short-term borrowings from subsidiaries
.........................................................................................................
Other long-term borrowings ...........................................................................................................................
Accrued expenses and other liabilities .............................................................................................................
Total liabilities ...........................................................................................................................................
$
1
4
5
108
1,559
273
1,945
6
7
13
146
1,045
227
1,431
Stockholders' equity ......................................................................................................................................
11,134
10,809
Total liabilities and stockholders' equity ....................................................................................................... $
13,079
$
12,240
(1)
The Parent Company advanced $2.2 billion to Discover Bank as of December 31, 2014, which is included in notes receivables from subsidiaries. These funds are
available to the Parent for liquidity purposes.
-158-
Discover Financial Services
(Parent Company Only)
Condensed Statements of Income
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
(dollars in millions)
Interest income ....................................................................................... $
Interest expense ......................................................................................
Net interest expense ............................................................................
Dividends from subsidiaries .....................................................................
Total income (loss)
..............................................................................
$
18
86
(68)
$
22
84
(62)
1,860
1,792
1,600
1,538
Other expense
Employee compensation and benefits .......................................................
Professional fees .....................................................................................
Other(1) ..................................................................................................
Total other expense (benefit) ................................................................
Income (loss) before income tax benefit (expense) and equity in
undistributed net income of subsidiaries ..........................................
Income tax benefit (expense) ....................................................................
Equity in undistributed net income of subsidiaries .......................................
1
3
—
4
—
3
1
4
1,788
1,534
18
517
17
919
$
22
52
(30)
1,500
1,470
—
1
(171)
(170)
1,640
(54)
759
Net income .................................................................................... $
2,323
$
2,470
$
2,345
$
2
7
(5)
—
(5)
—
—
—
—
(5)
2
173
170
(1) During the 2012 fiscal year, the Company completed a private exchange offer, resulting in the exchange of $500 million outstanding aggregate principal amount of
subordinated debt issued by a subsidiary for the same aggregate principal amount of new senior notes issued by the Parent. A cash premium of $176 million was
paid by the subsidiary but is associated with the borrowings on the Parent financial statements.
-159-
Discover Financial Services
(Parent Company Only)
Condensed Statements of Cash Flows
For the Calendar Years Ended
December 31,
2014
2013
For the Fiscal
Year Ended
November 30,
2012
For the One
Month Ended
December 31,
2012
(dollars in millions)
Cash flows from operating activities
Net income ........................................................................................ $
2,323
$
2,470
$
2,345
$
170
Adjustments to reconcile net income to net cash provided by operating
activities:
Equity in undistributed net income of subsidiaries ...........................
(517)
(919)
Stock-based compensation expense ..............................................
Deferred income taxes .................................................................
Premium on debt issuance(1) .........................................................
Depreciation and amortization .....................................................
Changes in assets and liabilities:
(Increase) decrease in other assets ................................................
Increase (decrease) in other liabilities and accrued expenses ...........
60
(5)
—
21
(50)
32
59
(2)
—
19
(33)
29
Net cash provided by operating activities ..................................................
1,864
1,623
Cash flows from investing activities
Increase in investment in subsidiaries ................................................
(Increase) decrease in loans to subsidiaries ........................................
Net cash (used for) provided by investing activities ....................................
Cash flows from financing activities
Net (decrease) increase in short-term borrowings from subsidiaries .....
Proceeds from issuance of common stock ..........................................
Proceeds from issuance of preferred stock .........................................
Proceeds from issuance of long-term borrowings ................................
Proceeds from advances from subsidiaries .........................................
(35)
(182)
(217)
(38)
5
—
500
—
—
(29)
(29)
58
13
—
—
—
(759)
47
109
(176)
4
(16)
10
1,564
(196)
(520)
(716)
1
26
560
—
93
Purchases of treasury stock ..............................................................
(1,564)
(1,296)
(1,216)
Net (decrease) increase in deposits ...................................................
Premium paid on debt exchange ......................................................
Dividends paid on common and preferred stock .................................
Net cash used for financing activities ........................................................
Increase (decrease) in cash and cash equivalents .......................................
Cash and cash equivalents, at beginning of period ....................................
(8)
—
(467)
(1,572)
75
4
(7)
—
(399)
(1,631)
(37)
41
Cash and cash equivalents, at end of period ............................................. $
79
$
4
$
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest expense .............................................................................. $
Income taxes, net of income tax refunds ............................................ $
Non-cash investing and financing transactions:
Capital contribution to subsidiary(1) ................................................... $
Debt issuance, net of discount(1) ........................................................ $
66
65
$
$
— $
— $
65
$
(1) $
— $
— $
12
(115)
(209)
(848)
—
1
1
$
66
$
(65) $
499
$
(499) $
(173)
3
(1)
—
1
32
(15)
17
(1)
57
56
(6)
2
—
—
—
(12)
(12)
—
(5)
(33)
40
1
41
2
—
—
—
(1) During the 2012 fiscal year, the Company completed a private exchange offer, resulting in the exchange of $500 million outstanding aggregate principal amount of
subordinated debt issued by a subsidiary for the same aggregate principal amount of new senior notes issued by the Parent. A cash premium of $176 million was
paid by the subsidiary but is associated with the borrowings on the Parent financial statements.
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25.
Subsequent Events
The Company has evaluated events and transactions that have occurred subsequent to December 31, 2014 and
determined there were no subsequent events that would require recognition or disclosure in the consolidated financial
statements.
26. Quarterly Results
The following table provides unaudited quarterly results (dollars in millions, except per share data):
December 31,
2014
September 30,
2014
June 30,
2014
March 31,
2014
December 31,
2013
September 30,
2013
June 30,
2013
March 31,
2013
Interest income ...................... $
1,974
$
1,926
$ 1,863
$ 1,833
$
1,842
$
1,787
$ 1,727
$ 1,708
Interest expense ....................
Net interest income............
Provision for loan losses ........
Other income(1) .....................
Other expense ......................
Income before income tax
expense ..........................
Income tax expense ...............
Net income ....................... $
Net income allocated to
common stockholders(2) .... $
Basic earnings per common
share(2) ............................... $
Diluted earnings per common
share(2) ............................... $
302
1,672
288
274
270
1,638
1,589
1,563
273
1,569
278
297
298
1,509
1,430
1,410
457
365
932
648
244
404
392
0.87
0.87
$
$
$
$
354
552
827
360
583
797
272
515
784
1,009
1,015
1,022
365
644
630
1.37
1.37
$
$
$
$
371
644
630
1.35
1.35
$
$
$
$
391
631
618
1.31
1.31
$
$
$
$
354
560
838
937
335
602
588
1.24
1.23
$
$
$
$
333
553
783
946
353
593
579
1.20
1.20
$
$
$
$
240
611
820
981
379
602
588
1.20
1.20
159
582
753
1,080
407
673
659
1.33
1.33
$
$
$
$
(1) During the three months ended December 31, 2014, the Company made certain changes to its customer rewards program eliminating forfeitures. These changes
resulted in a one-time expense of $178 million due to the reversal of the estimate for customer rewards forfeiture, a contra-account to accrued expenses and other
liabilities.
Because the inputs to net income allocated to common stockholders and earnings per share are calculated using weighted averages for the quarter, the sum of all
four quarters may differ from the year to date amounts in the consolidated statements of income.
(2)
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and
Chief Financial Officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures (as
defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)),
which are designed to ensure that information required to be disclosed by us in the reports that we file or submit under
the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules
and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure
that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is
accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end
of the period covered by this report.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial
reporting (as such term is defined in Exchange Act Rule 13a-15(f) and 15d-15(f)) for the Company. Our internal control
over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and
the preparation of financial statements in accordance with generally accepted accounting principles. There are inherent
-161-
limitations to the effectiveness of any system of internal control over financial reporting. These limitations include the
possibility of human error, the circumvention or overriding of the system and reasonable resource constraints. Because
of its inherent limitations, our internal control over financial reporting may not prevent or detect misstatements.
Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions or that the degree of compliance with policies or procedures may
deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2014.
In making this assessment, management used the criteria set forth in Internal Control - Integrated Framework (2013)
issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on management's
assessments and those criteria, management has concluded that our internal control over financial reporting was
effective as of December 31, 2014.
The effectiveness of our internal control over financial reporting as of December 31, 2014 has been audited by
Deloitte & Touche LLP, an independent registered public accounting firm, and the firm's report on this matter is included
in Item 8 of this annual report on Form 10-K.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting (as such term is defined in Exchange
Act Rule 13a-15(f) and 15d-15(f)) that occurred during the period covered by this report that have materially affected,
or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
None.
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Part III. | Item 10.
Directors, Executive Officers and Corporate Governance
Information regarding our executive officers is included under the heading “Executive Officers of the Registrant”
in Item 1 of this annual report on Form 10-K. Information regarding our directors and corporate governance under the
following captions in our proxy statement for our annual meeting of stockholders to be held on April 29, 2015 ("Proxy
Statement") is incorporated by reference herein.
"Election of Directors - Information Concerning Nominees for Election as Directors"
"Other Matters - Section 16(a) Beneficial Ownership Reporting Compliance"
"Corporate Governance - Shareholder Recommendations for Director Candidates"
"Corporate Governance - Board Meetings and Committees"
Our Code of Ethics and Business Conduct applies to all directors, officers and employees, including our Chief
Executive Officer and our Chief Financial Officer. You can find our Code of Ethics and Business Conduct on our internet
site, www.discover.com. We will post any amendments to the Code of Ethics and Business Conduct, and any waivers
that are required to be disclosed by the rules of either the SEC or the New York Stock Exchange, on our internet site.
Item 11.
Executive Compensation
Information regarding executive compensation under the following captions in our Proxy Statement is
incorporated by reference herein.
"Executive and Director Compensation"
"Compensation Discussion and Analysis"
"2014 Executive Compensation”
"Compensation Committee Report”
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Information relating to the compensation plans under which our equity securities are authorized for issuance as of
December 31, 2014, is set forth in the table below.
Plan Category
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights(1)
Weighted-average
exercise price of
outstanding options,
warrants and rights
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a))
(a)
(b)
(c)
Equity compensation plans approved by security holders ........
Equity compensation plans not approved by security holders ...
Total ..............................................................................
5,037,578
N/A
5,037,578
26.40
N/A
26.40
26,952,590
N/A
26,952,590
(1)
Includes 3,362,398 vested and unvested restricted stock units and 1,559,675 vested and unvested performance stock units that can be converted to up to 2 shares
per each unit dependent on the performance factor.
Information related to the beneficial ownership of our common stock is presented under the caption “Beneficial
Ownership of Company Common Stock” in our Proxy Statement and is incorporated by reference herein.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information regarding certain relationships and related transactions, and director independence under the
following captions in our Proxy Statement is incorporated by reference herein.
-163-
"Other Matters - Certain Transactions"
"Corporate Governance - Director Independence"
Item 14. Principal Accounting Fees and Services
Information regarding principal accounting fees and services under the caption "Ratification of Appointment of
Independent Registered Public Accounting Firm" in our Proxy Statement is incorporated by reference herein.
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Part IV. | Item 15.
Exhibits, Financial Statement Schedules
(a) Documents filed as part of this Form 10-K:
1. Consolidated Financial Statements
The consolidated financial statements required to be filed in this annual report on Form 10-K are listed below and
appear on pages 85 through 161 herein.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firm ...........................................................................
85
Consolidated Statements of Financial Condition as of December 31, 2014 and 2013 ....................................
87
Consolidated Statements of Income for the calendar years ended December 31, 2014 and 2013, fiscal year
ended November 30, 2012 and one month ended December 31, 2012 .......................................................
Consolidated Statements of Comprehensive Income for the calendar years ended December 31, 2014 and
2013, fiscal year ended November 30, 2012 and one month ended December 31, 2012 .............................
Consolidated Statements of Changes in Stockholders' Equity for the calendar years ended December 31,
2014 and 2013, fiscal year ended November 30, 2012 and one month ended December 31, 2012..............
Consolidated Statements of Cash Flows for the calendar years ended December 31, 2014 and 2013, fiscal
year ended November 30, 2012 and one month ended December 31, 2012................................................
88
89
90
91
Notes to the Consolidated Financial Statements ...........................................................................................
92
2. Financial Statement Schedules
Separate financial statement schedules have been omitted either because they are not applicable or because the
required information is included in the consolidated financial statements.
3. Exhibits
See the Exhibit Index following the signature pages for a list of the exhibits being filed or furnished with or
incorporated by reference into this annual report on Form 10-K.
-165-
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Signature
Discover Financial Services
(Registrant)
By:
/s/ R. MARK GRAF
R. Mark Graf
Executive Vice President and Chief Financial Officer
Date: February 25, 2015
-166-
Power of Attorney
We, the undersigned, hereby severally constitute Kathryn McNamara Corley and D. Christopher Greene, and
each of them singly, our true and lawful attorneys with full power to them and each of them to sign for us, and in our
names in the capacities indicated below, any and all amendments to the annual report on Form 10-K filed with the
Securities and Exchange Commission, hereby ratifying and confirming our signatures as they may be signed by our
said attorneys to any and all amendments to said Annual Report on Form 10-K.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities indicated on February 25, 2015.
Signature
Title
/S/ DAVID W. NELMS
Chairman and Chief Executive Officer
David W. Nelms
/S/ R. MARK GRAF
Executive Vice President and Chief Financial Officer (Principal Financial Officer)
R. Mark Graf
/S/ EDWARD W. McGROGAN
Edward W. McGrogan
Vice President, Controller and Chief Accounting Officer (Principal Accounting
Officer)
/S/ LAWRENCE A. WEINBACH
Lead Director
Lawrence A. Weinbach
/S/ JEFFREY S. ARONIN
Director
Jeffrey S. Aronin
/S/ MARY K. BUSH
Director
Mary K. Bush
/S/ GREGORY C. CASE
Director
Gregory C. Case
/S/ CANDACE H. DUNCAN
Director
Candace H. Duncan
/S/ CYNTHIA A. GLASSMAN
Director
Cynthia A. Glassman
/S/ RICHARD H. LENNY
Director
Richard H. Lenny
/S/ THOMAS G. MAHERAS
Director
Thomas G. Maheras
/S/ MICHAEL H. MOSKOW
Director
Michael H. Moskow
/S/ MARK A. THIERER
Director
Mark A. Thierer
-167-
Exhibit
Number
2.1*
2.2*
2.3
3.1
3.2
3.3
3.4
4.1
4.2
4.3
4.4
4.5
4.6
Exhibit Index
Description
Separation and Distribution Agreement, dated as of June 29, 2007, between Morgan Stanley and
Discover Financial Services (filed as Exhibit 2.1 to Discover Financial Services' Current Report on Form 8-
K filed on July 5, 2007 and incorporated herein by reference thereto), as amended by the First
Amendment to the Separation and Distribution Agreement dated as of June 29, 2007 between Discover
Financial Services and Morgan Stanley, dated February 11, 2010 (filed as Exhibit 10.2 to Discover
Financial Services' Current Report on Form 8-K filed on February 12, 2010 and incorporated herein by
reference thereto).
Agreement for the Sale and Purchase of the Goldfish Credit Card Business, dated February 7, 2008,
among Discover Financial Services, Goldfish Bank Limited, Discover Bank, SCFC Receivables
Corporation, and Barclays Bank Plc (filed as Exhibit 2.1 to Discover Financial Services' Current Report on
Form 8-K filed on February 7, 2008 and incorporated herein by reference thereto), as amended and
restated by Amended and Restated Agreement for the Sale and Purchase of the Goldfish Credit Card
Business, dated March 31, 2008, among Discover Financial Services, Goldfish Bank Limited, Discover
Bank, SCFC Receivables Corporation, Barclays Bank PLC, and Barclays Group US Inc. (filed as Exhibit
2.1 to Discover Financial Services' Quarterly Report on Form 10-Q filed on April 14, 2008 and
incorporated herein by reference thereto).
Agreement and Plan of Merger by and among Discover Bank, Academy Acquisition Corp. and The
Student Loan Corporation dated as of September 17, 2010 (filed as Exhibit 2.3 to Discover Financial
Services' Annual Report on Form 10-K for the fiscal year ended November 30, 2010 filed on January
26, 2011 and incorporated by reference thereto).
Amended and Restated Certificate of Incorporation of Discover Financial Services (filed as Exhibit 3.1 to
Discover Financial Services' Quarterly Report on Form 10-Q filed on July 1, 2009 and incorporated
herein by reference thereto).
Amended and Restated By-Laws of Discover Financial Services (filed as Exhibit 3.1 to Discover Financial
Services' Current Report on Form 8-K filed on May 12, 2014 and incorporated herein by reference
thereto).
Certificate of Elimination of the Fixed Rate Cumulative Perpetual Preferred Stock, Series A, of Discover
Financial Services (filed as Exhibit 3.1 to Discover Financial Services' Quarterly Report on Form 10-Q
filed on June 26, 2012 and incorporated herein by reference thereto).
Certificate of Designations of Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series B (filed as
Exhibit 3.1 to Discover Financial Services' Current Report on Form 8-K filed on October 16, 2012 and
incorporated herein by reference thereto).
Senior Indenture, dated as of June 12, 2007, by and between Discover Financial Services and U.S. Bank,
National Association, as trustee (filed as Exhibit 4.1 to Discover Financial Services' Current Report on
Form 8-K filed on June 12, 2007 and incorporated herein by reference thereto).
Form of Subordinated Indenture (filed as Exhibit 4.2 to Discover Financial Services' Registration
Statement on Form S-3 filed on July 6, 2009 and incorporated herein by reference thereto).
Fiscal and Paying Agency Agreement, dated November 16, 2009, between Discover Bank, as issuer,
and U.S. Bank National Association, as fiscal and paying agent (filed as Exhibit 4.1 to Discover Financial
Services' Current Report on Form 8-K filed on November 16, 2009 and incorporated herein by reference
thereto).
Fiscal and Paying Agency Agreement, dated April 15, 2010, between Discover Bank, as issuer, and U.S.
Bank National Association, as fiscal and paying agent (filed as Exhibit 4.1 to Discover Financial Services'
Current Report on Form 8-K filed on April 16, 2010 and incorporated herein by reference thereto).
Deposit Agreement, dated October 16, 2012 (filed as Exhibit 4.1 to Discover Financial Services' Current
Report on Form 8-K filed on October 16, 2012 and incorporated herein by reference thereto).
Form of Certificate Representing the Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series B (filed
as Exhibit 4.2 to Discover Financial Services' Current Report on Form 8-K filed on October 16, 2012 and
incorporated herein by reference thereto).
-168-
Exhibit
Number
4.7
4.8
4.9
4.10
10.1
10.2
10.3
10.4
10.5
10.6
10.7
Description
Fiscal and Paying Agency Agreement between Discover Bank and U.S. Bank National Association dated
as of February 21, 2013 (filed as Exhibit 4.1 to Discover Financial Services' Current Report on Form 8-K
filed on February 21, 2013 and incorporated herein by reference thereto).
Fiscal and Paying Agency Agreement, dated as of August 8, 2013, between Discover Bank, as issuer,
and U.S. Bank National Association, as fiscal and paying agent (filed as Exhibit 4.1 to Discover Financial
Services' Current Report on Form 8-K filed on August 8, 2013 and incorporated herein by reference
thereto).
Fiscal and Paying Agency Agreement, dated as of March 13, 2014, between Discover Bank, as issuer,
and U.S. Bank National Association, as fiscal and paying agent (filed as Exhibit 4.1 to Discover Financial
Services' Current Report on Form 8-K filed on March 13, 2014 and incorporated herein by reference
thereto).
Fiscal and Paying Agency Agreement, dated as of August 7, 2014, between Discover Bank, as issuer,
and U.S. Bank National Association, as fiscal and paying agent (filed as Exhibit 4.1 to Discover Financial
Services' Current Report on Form 8-K filed on August 7, 2014 and incorporated herein by reference
thereto).
Other instruments defining the rights of holders of long-term debt securities of Discover Financial Services
and its subsidiaries are omitted pursuant to Section (b)(4)(iii)(A) of Item 601 of Regulation S-K. Discover
Financial Services agrees to furnish copies of these instruments to the SEC upon request.
Tax Sharing Agreement, dated as of June 30, 2007, between Morgan Stanley and Discover Financial
Services (filed as Exhibit 10.1 to Discover Financial Services' Current Report on Form 8-K filed on July 5,
2007 and incorporated herein by reference thereto).
U.S. Employee Matters Agreement, dated as of June 30, 2007, between Morgan Stanley and Discover
Financial Services (filed as Exhibit 10.2 to Discover Financial Services' Current Report on Form 8-K filed
on July 5, 2007 and incorporated herein by reference thereto).
Transition Services Agreement, dated as of June 30, 2007, between Morgan Stanley and Discover
Financial Services (filed as Exhibit 10.3 to Discover Financial Services' Current Report on Form 8-K filed
on July 5, 2007 and incorporated herein by reference thereto).
Transitional Trade Mark License Agreement, dated as of June 30, 2007, between Morgan Stanley & Co.
PLC and Goldfish Bank Limited (filed as Exhibit 10.4 to Discover Financial Services' Current Report on
Form 8-K filed on July 5, 2007 and incorporated herein by reference thereto).
Trust Agreement, dated as of July 2, 2007, between Discover Bank, as Beneficiary, and Wilmington Trust
Company, as Owner Trustee (filed as Exhibit 4.1 to Discover Bank's Current Report on Form 8-K filed on
July 2, 2007 and incorporated herein by reference thereto), as amended by the First Amendment to Trust
Agreement, between Discover Bank, as Beneficiary and Wilmington Trust Company, as Owner Trustee,
dated as of June 4, 2010 (filed as Exhibit 4.3 to Discover Bank's Current Report on Form 8-K filed on
June 4, 2010 and incorporated herein by reference thereto).
Second Amended and Restated Pooling and Servicing Agreement, between Discover Bank, as Master
Servicer, Servicer and Seller and U.S. Bank National Association, as Trustee, dated as of June 4, 2010
(filed as Exhibit 4.1 to Discover Bank's Current Report on Form 8-K filed on June 4, 2010 and
incorporated herein by reference thereto), as amended by the First Amendment to Second Amended and
Restated Pooling and Servicing Agreement, between Discover Bank, as Master Servicer, Servicer and
Seller and U.S. Bank National Association, as Trustee, dated as of October 18, 2011 (filed as Exhibit 4.1
to Discover Bank's Current Report on Form 8-K filed on October 19, 2011 and incorporated herein by
reference thereto) and the Second Amendment to Second Amended and Restated Pooling and Servicing
Agreement, between Discover Bank as Master Servicer, Servicer and Seller and U.S. Bank National
Association, as Trustee, dated as of October 3, 2014 (filed as Exhibit 4.1 to Discover Bank's Current
Report on Form 8-K filed on October 3, 2014 and incorporated herein by reference thereto).
Series Supplement for Series 2007-CC, dated as of July 26, 2007, between Discover Bank, as Master
Servicer, Servicer and Seller and U.S. Bank National Association, as Trustee (filed as Exhibit 4.3 to
Discover Bank's Current Report on Form 8-K filed on July 27, 2007 and incorporated herein by reference
thereto), as amended by the Amendment to Specified Series Supplements, between Discover Bank, as
Master Servicer, Servicer and Seller and U.S. Bank National Association, as Trustee, dated as of June 4,
2010 (filed as Exhibit 4.2 to Discover Bank's Current Report on Form 8-K filed on June 4, 2010 and
incorporated herein by reference thereto).
-169-
Exhibit
Number
10.8†
10.9†
10.10†
10.11†
10.12†
Description
Discover Financial Services Omnibus Incentive Plan (filed as an attachment to Discover Financial Services'
Proxy Statement on Schedule 14A filed on February 27, 2009 and incorporated herein by reference
thereto).
Amended Form of Restricted Stock Unit Award Under Discover Financial Services Omnibus Incentive Plan
(filed as Exhibit 10.6 to Discover Financial Services' Quarterly Report on Form 10-Q filed on July 12,
2007 and incorporated herein by reference thereto).
Directors' Compensation Plan of Discover Financial Services (filed as Exhibit 10.3 to Discover Financial
Services' Current Report on Form 8-K filed on June 19, 2007 and incorporated herein by reference
thereto), as amended and restated as of January 20, 2011 (filed as Exhibit A to the Discover Financial
Services' definitive proxy statement filed on February 18, 2011 and incorporated by reference thereto),
as further amended by Amendment No. 2, effective as of December 1, 2011.
Amended Form of Restricted Stock Unit Award Under Discover Financial Services Directors'
Compensation Plan (filed as Exhibit 10.7 to Discover Financial Services' Quarterly Report on Form 10-Q
filed on July 12, 2007 and incorporated herein by reference thereto).
Discover Financial Services Employee Stock Purchase Plan (filed as Exhibit 10.2 to Discover Financial
Services' Current Report on Form 8-K filed on June 19, 2007 and incorporated herein by reference
thereto) as amended by Amendment No. 1 to Discover Financial Services Employee Stock Purchase Plan
effective as of May 1, 2008 (filed as Exhibit 10.12 to Discover Financial Services' Annual Report on Form
10-K filed on January 28, 2009 and incorporated herein by reference thereto); Amendment No. 2 to
Discover Financial Services Employee Stock Purchase Plan, effective as of December 1, 2009 (filed as
Exhibit 10.2 to Discover Financial Services' Quarterly Report on Form 10-Q filed on April 9, 2010 and
incorporated herein by reference thereto); and Amendment No. 3 to Discover Financial Services
Employee Stock Purchase Plan (filed as Exhibit 10.3 to Discover Financial Services' Quarterly Report on
Form 10-Q filed on September 28, 2011 and incorporated herein by reference thereto).
10.13† Offer of Employment, dated as of January 8, 1999 (filed as Exhibit 10.2 to Discover Financial Services'
Current Report on Form 8-K filed on June 12, 2007 and incorporated herein by reference thereto).
10.14† Waiver of Change of Control Benefits, dated September 24, 2007 (filed as Exhibit 10.15 to Discover
Financial Services' Registration Statement on Form S-4 filed on November 27, 2007 and incorporated
herein by reference thereto).
10.15
10.16
10.17
10.18
10.19†
10.20
Collateral Certificate Transfer Agreement, dated as of July 26, 2007 between Discover Bank, as
Depositor and Discover Card Execution Note Trust (filed as Exhibit 4.4 to Discover Bank's Current Report
on Form 8-K filed on July 27, 2007 and incorporated herein by reference thereto).
Indenture, dated as of July 26, 2007, between Discover Card Execution Note Trust, as Issuer, and U.S.
Bank National Association, as Indenture Trustee (filed as Exhibit 4.5 to Discover Bank's Current Report on
Form 8-K filed on July 27, 2007 and incorporated herein by reference thereto), as amended by the First
Amendment to Indenture, between Discover Card Execution Note Trust, as Issuer, and U.S. Bank National
Association, as Indenture Trustee, dated as of June 4, 2010 (filed as Exhibit 4.4 to Discover Bank's
Current Report on Form 8-K filed on June 4, 2010 and incorporated herein by reference thereto).
Amended and Restated Indenture Supplement for the DiscoverSeries Notes, between Discover Card
Execution Note Trust, as Issuer, and U.S. Bank National Association, as Indenture Trustee, dated as of
June 4, 2010 (filed as Exhibit 4.5 to Discover Bank's Current Report on Form 8-K filed on June 4, 2010
and incorporated herein by reference thereto).
Omnibus Amendment to Indenture Supplement and Terms Documents, dated as of July 2, 2009, between
Discover Card Execution Note Trust, as Issuer, and U.S. Bank National Association, as Indenture Trustee
(filed as Exhibit 4.1 to Discover Bank's Current Report on Form 8-K filed on July 6, 2009 and
incorporated herein by reference thereto).
Discover Financial Services Change-in-Control Severance Policy Amended and Restated October 15,
2014 (filed as Exhibit 10.1 to Discover Financial Services' Current Report on Form 8-K filed on October
16, 2014 and incorporated by reference thereto).
Release and Settlement Agreement, executed as of October 27, 2008, by and among Discover Financial
Services, DFS Services, LLC, Discover Bank, and their Subsidiaries and Affiliates; MasterCard
Incorporated and MasterCard International Incorporated and their Affiliates; and Visa Inc. and its
Affiliates and Predecessors including Visa U.S.A. Inc. and Visa International Service Association (filed as
Exhibit 99.1 to Discover Financial Services' Current Report on Form 8-K filed on October 28, 2008).
-170-
Exhibit
Number
10.21†
10.22†
10.23
10.24
10.25†
10.26†
10.27
10.28
10.29
10.30
10.31
10.32
10.33
10.34
10.35
10.36
Description
2008 Year End Form of Restricted Stock Unit Award Under Discover Financial Services Omnibus
Incentive Plan (filed as Exhibit 10.21 to Discover Financial Services' Annual Report on Form 10-K filed on
January 28, 2009 and incorporated herein by reference thereto).
2008 Special Grant Form of Restricted Stock Unit Award Under Discover Financial Services Omnibus
Incentive Plan (filed as Exhibit 10.22 to Discover Financial Services' Annual Report on Form 10-K filed on
January 28, 2009 and incorporated herein by reference thereto).
Form of Waiver, executed by each of Discover Financial Services' senior executive officers and certain
other employees (filed as Exhibit 10.3 to Discover Financial Services' Current Report on Form 8-K filed on
March 13, 2009 and incorporated herein by reference thereto).
Form of Executive Compensation Agreement, dated March 13, 2009, executed by each of Discover
Financial Services' senior executive officers and certain other employees (filed as Exhibit 10.4 to Discover
Financial Services' Quarterly Report on Form 10-Q filed on April 8, 2009 and incorporated herein by
reference thereto).
Form of Share Award Agreement Under Discover Financial Services Amended and Restated 2007
Omnibus Incentive Plan (filed as Exhibit 10(a) to Discover Financial Services' Current Report on Form 8-K
filed on December 11, 2009 and incorporated herein by reference thereto).
Amendment to 2009 Year End Award Certificate for Restricted Stock Units Under Discover Financial
Services Amended and Restated 2007 Omnibus Incentive Plan, effective December 1, 2009 (filed as
Exhibit 10.1 to Discover Financial Services' Quarterly Report on Form 10-Q filed on April 9, 2010 and
incorporated herein by reference thereto).
Settlement Agreement and Mutual Release between Discover Financial Services and Morgan Stanley,
dated February 11, 2010 (filed as Exhibit 10.1 to Discover Financial Services' Current Report on Form 8-
K filed on February 12, 2010 and incorporated herein by reference thereto).
Purchase Price Adjustment Agreement by and among Citibank, N.A., The Student Loan Corporation and
Discover Bank, dated September 17, 2010 (filed as Exhibit 10.32 to Discover Financial Services' Annual
Report on Form 10-K filed on January 26, 2011 and incorporated by reference thereto).
Amendment to Purchase Price Adjustment Agreement by and among Citibank, N.A., The Student Loan
Corporation and Discover Bank, dated December 30, 2010 (filed as Exhibit 10.33 to Discover Financial
Services' Annual Report on Form 10-K filed on January 26, 2011 and incorporated by reference thereto).
Indemnification Agreement by and between Citibank, N.A. and Discover Bank, dated September 17,
2010 (filed as Exhibit 10.34 to Discover Financial Services' Annual Report on Form 10-K filed on
January 26, 2011 and incorporated by reference thereto).
First Amendment to Indemnification Agreement by and between Citibank, N.A. and Discover Bank, dated
December 30, 2010 (filed as Exhibit 10.35 to Discover Financial Services' Annual Report on Form 10-K
filed on January 26, 2011 and incorporated by reference thereto).
Form Award Certificate for Restricted Stock Units Under Discover Financial Services Amended and
Restated 2007 Omnibus Incentive Plan (filed as Exhibit 10.4 to Discover Financial Services' Quarterly
Report on Form 10-Q filed on April 8, 2011 and incorporated by reference thereto).
Form Award Certificate for Performance Stock Units Under Discover Financial Services Amended and
Restated 2007 Omnibus Incentive Plan (filed as Exhibit 10.5 to Discover Financial Services' Quarterly
Report on Form 10-Q filed on April 8, 2011 and incorporated by reference thereto).
Asset Purchase Agreement between Discover Bank and Citibank, N.A. dated August 31, 2011 (filed as
Exhibit 10.2 to Discover Financial Services' Quarterly Report on Form 10-Q filed on September 28, 2011
and incorporated by reference thereto).
Form 2012 Award Certificate for Restricted Stock Units Under Discover Financial Services Amended and
Restated 2007 Omnibus Incentive Plan (filed as Exhibit 10.1 to Discover Financial Services' Quarterly
Report on Form 10-Q filed on April 3, 2012 and incorporated by reference thereto).
Form 2012 Award Certificate for Performance Stock Units Under Discover Financial Services Amended
and Restated 2007 Omnibus Incentive Plan (filed as Exhibit 10.2 to Discover Financial Services'
Quarterly Report on Form 10-Q filed on April 3, 2012 and incorporated by reference thereto).
-171-
Exhibit
Number
10.37
10.38
10.39
10.40
10.41
10.42
10.43
10.44
11
12.1
21
23
24
31.1
31.2
32.1
Description
Form 2013 Award Certificate for Restricted Stock Units Under Discover Financial Services Amended and
Restated 2007 Omnibus Incentive Plan (filed as Exhibit 10.1 to Discover Financial Services' Quarterly
Report on Form 10-Q filed on April 30, 2013 and incorporated herein by reference thereto).
Form 2013 Award Certificate for Performance Stock Units Under Discover Financial Services Amended
and Restated 2007 Omnibus Incentive Plan (filed as Exhibit 10.2 to Discover Financial Services'
Quarterly Report on Form 10-Q filed on April 30, 2013 and incorporated herein by reference thereto).
Amendment No. 3 to the Directors' Compensation Plan of Discover Financial Services, effective as of July
1, 2013 (filed as Exhibit 10.1 to Discover Financial Services' Quarterly Report on Form 10-Q filed on
July 30, 2013 and incorporated herein by reference thereto).
Form of 2013 Special Award Certificate for Restricted Stock Units Under Discover Financial Services
Amended and Restated 2007 Omnibus Incentive Plan (filed as Exhibit 10.1 to Discover Financial
Services' Current Report on Form 8-K filed on December 26, 2013 and incorporated herein by reference
thereto).
Discover Financial Services Amended and Restated 2014 Omnibus Incentive Plan (filed as an attachment
to Discover Financial Services' Proxy Statement on Schedule 14A filed on March 19, 2014 and
incorporated herein by reference thereto).
Form 2014 Award Certificate for Restricted Stock Units Under Discover Financial Services Amended and
Restated 2007 Omnibus Incentive Plan (filed as Exhibit 10.1 to Discover Financial Services' Quarterly
Report on Form 10-Q filed on April 29, 2014 and incorporated herein by reference thereto).
Form 2014 Award Certificate for Performance Stock Units Under Discover Financial Services Amended
and Restated 2007 Omnibus Incentive Plan (filed as Exhibit 10.2 to Discover Financial Services'
Quarterly Report on Form 10-Q filed on April 29, 2014 and incorporated herein by reference thereto).
Amendment No. 4 to the Directors' Compensation Plan of Discover Financial Services, effective as of May
7, 2014 (filed as Exhibit 10.2 to Discover Financial Services' Quarterly Report on Form 10-Q filed on
August 1, 2014 and incorporated herein by reference thereto).
Statement Re: Computation of Per Share Earnings (the calculation of per share earnings is in Part II,
Item 8, Note 16: Earnings Per Share to the consolidated financial statements and is omitted in
accordance with Section (b)(11) of Item 601 of Regulation S-K).
Statement Re: Computation of Ratio of Earnings to Fixed Charges and Computation of Ratio of Earnings
to Fixed Charges and Preferred Stock Dividends.
Subsidiaries of the Registrant.
Consent of Independent Registered Public Accounting Firm.
Powers of Attorney (included on signature page).
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of
1934.
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of
1934.
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 1350 of Chapter
63 of Title 18 of the United States Code.
101.INS
XBRL Instance Document.
101.SCH XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
-172-
Exhibit
Number
101.PRE
Description
XBRL Taxonomy Extension Presentation Linkbase Document.
*
†
We agree to furnish supplementally to the Commission a copy of any omitted schedule or exhibit to such agreement upon the request of the Commission in
accordance with Item 601(b)(2) of Regulation S-K.
Management contract or compensatory plan or arrangement required to be filed as an exhibit to Form 10-K pursuant to Item 15(b) of this report.
-173-
Exhibit 12.1
DISCOVER FINANCIAL SERVICES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND COMPUTATION OF RATIO OF EARNINGS TO FIXED
CHARGES AND PREFERRED STOCK DIVIDENDS
(dollars in millions)
For the Calendar Years Ended
December 31,
For the Fiscal Years Ended November 30,
2014
2013
2012
2011
2010
For the One
Month Ended
December 31,
2012
Earnings:
Income before income tax expense ...................................... $
3,694
$
3,944
$
3,753
Losses from unconsolidated investees ...................................
29
18
12
Total earnings ................................................................... $
3,723
$
3,962
$
3,765
Fixed charges:(1)
Total interest expense ......................................................... $
1,134
$
1,146
$
1,331
Interest factor in rents .........................................................
5
5
6
Total fixed charges ............................................................ $
1,139
$
1,151
$
1,337
Combined fixed charges and preferred stock dividends:(1)
$
$
$
$
3,511
5
3,516
1,485
5
1,490
$
$
$
$
1,269
4
1,273
1,583
5
1,588
$
$
$
$
Total interest expense ......................................................... $
1,134
$
1,146
$
1,331
$
1,485
$
1,583
$
Interest factor in rents .........................................................
Preferred stock requirements ...............................................
Total combined fixed charges and preferred stock dividends . $
Earnings from before income tax expense and fixed charges . $
Earnings before income tax expense and combined fixed
charges and preferred stock dividends .............................. $
Ratio of earnings to fixed charges .......................................
Ratio of earnings to combined fixed charges and preferred
stock dividends ...............................................................
$
$
$
5
60
1,199
4,862
4,922
4.3
4.1
$
$
$
5
60
1,211
5,113
5,173
4.4
4.3
$
$
$
6
—
1,337
5,102
5,102
3.8
3.8
$
$
$
5
—
1,490
5,006
5,006
3.4
3.4
$
$
$
5
39
1,627
2,861
2,900
1.8
1.8
274
1
275
103
1
104
103
1
—
104
379
379
3.6
3.6
(1)
Fixed charges are the sum of interest expensed, amortized premiums, discounts and capitalized expenses related to indebtedness and an estimate of interest within
rental expense. Combined fixed charges and preferred stock requirements are the sum of interest expense, amortized premiums, discounts and capitalized expenses
related to indebtedness, an estimate of interest within rental expense and preference security dividend requirements.
DISCOVER FINANCIAL SERVICES
SUBSIDIARIES
Subsidiary
Exhibit 21
Jurisdiction of
Incorporation or
Formation
Italy
India
Bank of New Castle ....................................................................................................................... Delaware
Diners Club International Ltd. .......................................................................................................... New York
Diners Club Italia S.r.l. ...................................................................................................................
Diners Club Services Private Limited .................................................................................................
DINIT d.o.o. .................................................................................................................................. Slovenia
Discover Bank ................................................................................................................................ Delaware
Discover Community Development Corporation ................................................................................ Delaware
Discover Financial Services (Canada), Inc. ....................................................................................... Canada
Discover Financial Services (Hong Kong) Limited .............................................................................. Hong Kong
Discover Financial Services (UK) Limited .......................................................................................... England/Wales
Discover Financial Services Insurance Agency, Inc. ........................................................................... Delaware
Discover Global Employment Company Private Limited ..................................................................... Singapore
Discover Home Loans, Inc. .............................................................................................................. Delaware
Discover Information Technology (Shanghai) Limited ......................................................................... Shanghai
Discover Products Inc. .................................................................................................................... Utah
Discover Properties LLC .................................................................................................................. Delaware
Discover Services Corporation ........................................................................................................ Delaware
DFS Corporate Services LLC ............................................................................................................ Delaware
DFS Escrow, Inc. ............................................................................................................................ Delaware
DFS International Inc. ..................................................................................................................... Delaware
DFS Services LLC ............................................................................................................................ Delaware
GTC Insurance Agency, Inc. ............................................................................................................ Delaware
HLC Settlement Services, Inc. ........................................................................................................... California
PULSE Network LLC ........................................................................................................................ Delaware
The Student Loan Corporation ......................................................................................................... Delaware
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statement Nos. 333-173360, 333-150228, 333-144184,
333-144188, and 333-144189 on Form S-8 and No. 333-182440 on Form S-3 of our reports dated February 25,
2015, relating to the consolidated financial statements of Discover Financial Services, and the effectiveness of the
Company's internal control over financial reporting, appearing in this Annual Report on Form 10-K of Discover Financial
Services for the calendar year ended December 31, 2014.
Exhibit 23
Chicago, Illinois
February 25, 2015
Exhibit 31.1
I, David W. Nelms, certify that:
CERTIFICATION
1.
2.
3.
4.
I have reviewed this Annual Report on Form 10-K of Discover Financial Services (the “registrant”);
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly
present in all material respects the financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a)
b)
c)
d)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures
to be designed under our supervision, to ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
Designed such internal control over financial reporting, or caused such internal control over financial
reporting to be designed under our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this
report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
Disclosed in this report any change in the registrant's internal control over financial reporting that
occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the
case of an annual report) that has materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5.
The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a)
b)
All significant deficiencies and material weaknesses in the design or operation of internal control over
financial reporting which are reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant's internal control over financial reporting.
Date: February 25, 2015
/s/ DAVID W. NELMS
David W. Nelms
Chairman of the Board and
Chief Executive Officer
Exhibit 31.2
I, R. Mark Graf, certify that:
CERTIFICATION
1.
2.
3.
4.
I have reviewed this Annual Report on Form 10-K of Discover Financial Services (the “registrant”);
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly
present in all material respects the financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a)
b)
c)
d)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures
to be designed under our supervision, to ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
Designed such internal control over financial reporting, or caused such internal control over financial
reporting to be designed under our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this
report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
Disclosed in this report any change in the registrant's internal control over financial reporting that
occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the
case of an annual report) that has materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5.
The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a)
b)
All significant deficiencies and material weaknesses in the design or operation of internal control over
financial reporting which are reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant's internal control over financial reporting.
Date: February 25, 2015
/s/ R. MARK GRAF
R. Mark Graf
Executive Vice President and Chief
Financial Officer
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Discover Financial Services (the “Company”) on Form 10-K for the period
ended December 31, 2014, as filed with the Securities and Exchange Commission (the “Report”), each of David W.
Nelms, Chairman of the Board and Chief Executive Officer of the Company, and R. Mark Graf, Executive Vice
President and Chief Financial Officer of the Company, certifies, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1.
2.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange
Act of 1934; and
The information contained in the Report fairly presents, in all material respects, the financial condition
and results of operations of the Company.
Date: February 25, 2015
/s/ DAVID W. NELMS
David W. Nelms
Chairman of the Board and Chief
Executive Officer
Date: February 25, 2015
/s/ R. MARK GRAF
R. Mark Graf
Executive Vice President and Chief
Financial Officer
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This Annual Report contains forward-looking statements. You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date on which they are made, which refl ect
management’s estimates, projections, expectations or beliefs at that time, and which are subject to risks and uncertainties that may cause actual results to differ materially. For a discussion of certain risks
and uncertainties that may affect our future results, please see “Risk Factors,” “Special Note Regarding Forward-Looking Statements,” “Business—Competition,” “Business—Supervision and Regulation” and
“Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the accompanying Annual Report on Form 10-K for the year ended December 31, 2014.
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 ® More® Card, Discover it ®, Discover® Network and Diners Club International.® All other trademarks, trade names and service marks included in this Annual Report are the property of their
respective owners. FICO is a registered trademark of the Fair Isaac Corporation in the United States and other countries.
©2015 Discover Financial Services
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Board of Directors
David W. Nelms (1)
Chairman and
Chief Executive Offi cer,
Discover Financial Services
(1) Also on Executive Committee
Lawrence A. Weinbach
Lead Director, Nominating and
Governance Committee Chair;
Chairman, Great Western Products
Holdings LLC; Managing Director,
Yankee Hill Capital Management LLC
Jeffrey S. Aronin
Chairman and CEO,
Paragon Pharmaceuticals
and Marathon Pharmaceuticals
Cynthia A. Glassman
Audit Committee Chair;
Former Under Secretary for Economic
Affairs, U.S. Department of Commerce
Richard H. Lenny
Chairman, Information
Resources, Inc.
Thomas G. Maheras
Founding Partner,
Tegean Capital
Management, LLC
Executive Committee
Roger C. Hochschild
President and
Chief Operating Offi cer
R. Mark Graf
Executive Vice President and
Chief Financial Offi cer
Kelly McNamara Corley
Executive Vice President,
General Counsel and Secretary
Discover.com/company
Diane E. Offereins
Executive Vice President,
President–Payment Services
James V. Panzarino
Executive Vice President,
President–Credit and Card
Operations
R. Douglas Rose
Senior Vice President,
Chief Human Resources Offi cer
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Board of Directors
The Leading Direct Bank
and Payments Partner
Direct Banking
Discover is one of the largest direct banks in
the United States, offering a broad array of
products, including credit cards, personal loans,
student loans, deposit products and home loans.
The Discover brand is known for rewards,
service and value. Across all direct banking
products, Discover seeks to help customers
meet their fi nancial needs and achieve brighter
fi nancial futures.
PULSE is one of the nation’s leading ATM/debit
networks, while Diners Club International is
a global payments network. Our Network
Partners business provides payment transaction
processing and settlement services on the
Discover Network. In the payments industry,
Discover strives to be the most fl exible and
innovative partner in the United States and
around the world.
Executive Committee
Payment Services
CONNECTING CUSTOMERS
WITH THE FUTURE
Mary K. Bush
President, Bush International
Gregory C. Case
Compensation and Leadership
Development Committee Chair;
President and CEO, Aon plc
Candace H. Duncan
Retired Managing Partner,
KPMG LLP
Primary Investor Contact
Investor Relations
Phone: 1(cid:129)224 (cid:129) 405 (cid:129) 4555
investorrelations@discover.com
Transfer Agent
Computershare
P.O. Box 30170
College Station, TX 77842
Phone: 1(cid:129) 866 (cid:129)258 (cid:129) 6590
Corporate Web site:
www.computershare.com/investor
Annual Shareholders’ Meeting
The 2015 Annual Meeting of Shareholders
of Discover Financial Services
Wednesday, April 29, 2015, at 9:00 AM CST
at the company’s headquarters at
2500 Lake Cook Road, Riverwoods, IL 60015
Michael H. Moskow
Risk Oversight Committee Chair;
Retired President and CEO,
Federal Reserve Bank of Chicago
Mark A. Thierer
Chairman and CEO,
Catamaran Corporation
Steven E. Cunningham
Senior Vice President,
Chief Risk Offi cer
Carlos M. Minetti
Executive Vice President,
President –Consumer Banking
Glenn P. Schneider
Executive Vice President,
Chief Information Offi cer
Harit Talwar
Executive Vice President,
President–U.S. Cards
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2500 Lake Cook Road (cid:129) Riverwoods, Illinois 60015 (cid:129) Discover.com/company
2014 ANNUAL REPORT
CONNECTING CUSTOMERS WITH THE FUTURE
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