Discover 2009 Annual Report Download

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2009 ANNUAL REPORT

Table of contents

  • Page 1
    200 9 A n n u A l Re p o Rt

  • Page 2
    ... sales volume. Discover card transactions are processed on the Discover network. the Direct Banking segment also includes other consumer products and services, such as personal loans, student loans, prepaid cards and deposit products. ® Payment Services (FoRMeRlY tHIRD-pARtY pAYMentS) the payment...

  • Page 3
    DISCOVER CARD CONSUMER DEPOSITS CONSUMER LOANS PULSE DEBIT NETWORK DINERS CLUB INTERNATIONAL DISCOVER NETWORK

  • Page 4
    ... direct-to-consumer deposits • 24/7 customer service PULSE Debit Network • $109 billion volume • 4,400+ issuers Consumer Personal Loans • $1.4 billion in loans Consumer Student Loans • $1.9 billion in loans • On preferred lender list at more than 750 schools Diners Club International...

  • Page 5
    ..., we are not out of the woods yet. While we continue to manage through near-term challenges, Discover is also focused on the future. With our customers, shareholders and employees in mind, we plan to build on our strengths as we strive to become the leading direct banking and payments company.

  • Page 6
    ... credit card issuer. A 5% increase in volume on our Discover, PULSE and Diners Club International networks to $232 billion; pre-tax profit of more than $100 million from our Payments Services segment for the first time in our history. Direct-to-consumer deposit balances from our banking customers...

  • Page 7
    ...U.S. merchants where our customers made a purchase increased 6%. We also launched an international ATM network now consisting of 680,000 ATMs, and made great progress on global point-of-sale card acceptance across the Discover and Diners Club networks-a move that will eventually allow Discover cards...

  • Page 8
    ... Discover credit card with cash rewards and no annual fee. Certificates of deposit and money market accounts that provide some of the best rates and service in the industry. Personal loans structured to provide value to customers who want to consolidate and pay down debt. Student loans to help...

  • Page 9
    ... merchants who take Discover cards. We will also continue to work on international point-of-sale card acceptance between the Discover and Diners Club International networks. Over the long term, we believe we can achieve significant growth in global volume across the Discover, PULSE and Diners Club...

  • Page 10
    Our Vision To be the most rewarding relationship consumers and businesses have with a financial services company. Our Values Doing the right thing Innovation Simplicity Collaboration Openness Volunteerism Enthusiasm Respect

  • Page 11
    ... ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended November 30, 2009 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...

  • Page 12
    ... names and service marks that we use in conjunction with the operation of our business, including, but not limited to: Discover®, PULSE®, Cashback Bonus®, Discover® More® Card, Discover® MotivaSM Card, Discover® Open Road® Card, Discover® Network and Diners Club International®. All other...

  • Page 13
    ... deposit products. Our Payment Services segment includes PULSE, Diners Club and our thirdparty issuing business, which includes credit, debit and prepaid cards issued on the Discover Network by third parties. Available Information We are required to file annual, quarterly and current reports, proxy...

  • Page 14
    ... reportable segments. Direct Banking Our Direct Banking segment, formerly referred to as our U.S. Card segment, includes Discover card-branded credit cards issued to individuals and small businesses on the Discover Network and other consumer products and services, including personal loans, student...

  • Page 15
    ...of Financial Condition and Results of Operations - Liquidity and Capital Resources - Funding Sources - Deposits." Payment Services Our Payment Services segment, formerly referred to as our Third-Party Payments segment, includes PULSE, our ATM, debit and electronic funds transfer network; Diners Club...

  • Page 16
    ...and Diners Club customers to be able to use their cards on the Discover Network in North America and on the PULSE Network domestically and internationally. Third-Party Issuing Business We have agreements related to issuing credit, debit and prepaid cards with a number of other financial institutions...

  • Page 17
    ... line based on risk level, income and expected card usage, and assign specific annual percentage rates ("APRs") and terms for different customers and products. In determining the APR, we use an analytical pricing strategy that provides competitive pricing for customers and seeks to maximize revenue...

  • Page 18
    ... credit or direct deposit to a bank account starting at and in increments of $50. Customers have the opportunity to increase their reward, up to double the reward amount, when they redeem for a brand name gift card from over 100 merchant partners. Fee Products We market several fee-based products...

  • Page 19
    ...A listing of third-party providers offering customers auto, homeowner's and term life insurance as well as home warranty plans; and • ShopDiscover, an online portal where customers automatically earn 5-20% Cashback Bonus when they shop at wellknown online merchants using their Discover card. Brand...

  • Page 20
    ... payments and check processing. Document processing handles hard-copy forms, including product enrollments and new account applications. Discover Card Terms and Conditions The terms and conditions governing our credit card products vary by product and change over time. Each credit card customer...

  • Page 21
    ...charges on the average daily balance of a customer's card account for the current billing cycle. Terms and conditions may vary for other products, such as the Discover Business card. Discover Network Operations We support our growing base of merchants through a merchant acquiring model that includes...

  • Page 22
    ... and customer service for our 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...

  • Page 23
    ... and internationally. In our payment services business, we compete with other networks for volume and to attract third-party issuers to issue credit, debit and prepaid cards on the Discover, PULSE and Diners Club networks. We generally compete on the basis of customer service and pricing, including...

  • Page 24
    ...risk management committees include the Asset/Liability Management Committee, the Capital Planning Committee, the Counterparty Credit Committee, the Discover Bank Credit Committee, the Discover Bank Pricing Committee, the Network Steering Committee, the New Initiatives Committee, the Operational Risk...

  • Page 25
    ... risk. Consumer credit risk is primarily incurred by issuing credit cards and granting student loans and personal loans to consumers. Counterparty credit risk is incurred through a number of activities including settlement, certain marketing programs, treasury and asset/liability management, network...

  • Page 26
    ... practices and workplace safety; customer, products and business practices; technology; physical asset and data security; processing; financial and reporting; and external provider. Operational risk exposures are managed through a combination of business line management and enterprise-wide oversight...

  • Page 27
    ...model, and failure to attract and profitably serve customers. 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 and are accountable...

  • Page 28
    ... We operate two banking subsidiaries, each of which is in the United States. Discover Bank offers credit card loans, student loans and personal loans, as well as checking accounts, certificates of deposit and money market accounts. It does not offer commercial loans other than business credit cards...

  • Page 29
    ... 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. Investment in Discover Because Discover Bank and Bank of New Castle...

  • Page 30
    ... 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...

  • Page 31
    ...Chief Operating Officer Executive Vice President, Chief Financial Officer and Treasurer Executive Vice President, General Counsel and Secretary Executive Vice President, Cardmember Services and Consumer Banking Executive Vice President, Payment Services Executive Vice President and Chief Credit Risk...

  • Page 32
    ... as Executive Vice President, Card Programs and Chief Marketing Officer since December 2008. Prior thereto, he had been Executive Vice President, Discover Network since December 2003. From 2000 to 2003, Mr. Talwar was Managing Director for our international business. Mr. Talwar held a number of...

  • Page 33
    ...card loans was $2.8 billion for the 2009 fiscal year. Excluding settlement payments received from Visa, this was 59% of revenues (defined as net interest income plus other income). Deterioration in the global capital markets has led to concerns by market participants about the stability of financial...

  • Page 34
    ... and examination by the Federal Reserve, including scrutiny of our risk management program; business strategy, earnings, capital and cash flow; anti-money laundering program; and examination of our non-bank businesses, including Discover Network, PULSE and Diners Club, and their relationships -22-

  • Page 35
    ... 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 interchange fees, fees paid to networks (including switch fees), merchant acceptance, network functionality...

  • Page 36
    ...Discover customers to use their cards at merchant and ATM locations that accept Diners Club cards in a growing number of countries around the world and to allow Diners Club customers to use their cards on the Discover Network in North America and on the PULSE Network domestically and internationally...

  • Page 37
    ...numerous network partners for merchant acceptance for existing Diners Club customers. MasterCard's termination of cash access for Diners Club cardholders in the summer of 2009 limits the availability of cash access locations for Diners Club cardholders to ATMs available through our PULSE Network and...

  • Page 38
    ...such as market conditions, the general availability of credit to the financial services industry and our credit ratings. Disruptions, uncertainty or volatility in the capital, credit or deposit markets may limit our ability to replace maturing liabilities in a timely manner and satisfy other funding...

  • Page 39
    ...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 prohibits a bank, including our subsidiary Discover Bank, from accepting brokered deposits or offering interest rates on...

  • Page 40
    ... 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 in its entirety. Discover Bank currently maintains an investment grade...

  • Page 41
    ... an investment grade long-term debt rating could materially adversely affect the cost of funds, access to capital and funding, and overall financial condition of Discover Bank. There can be no assurance that Discover Bank will be able to maintain its current credit ratings or that its credit ratings...

  • Page 42
    ...the number of, or rates paid by, large merchants that accept cards on the Discover Network or PULSE Network 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 2009...

  • Page 43
    ... 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 to continued participation in the Discover Network and PULSE Network. During...

  • Page 44
    ... or transmitted by our customers or others. As we increase acceptance of the Discover card internationally, we may experience additional risks related to security systems. If our security systems or those of merchants, processors or other third-party service providers are compromised such that...

  • Page 45
    ...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...

  • Page 46
    ... 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...

  • Page 47
    ...as the SEC and New York Stock Exchange in our capacity as a public company. In addition, as our payments business has expanded globally through the acquisition of Diners Club, we are subject to government regulation in countries in which our networks operate or our cards are used, either directly or...

  • Page 48
    ...our business, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Legislative and Regulatory Developments." Current and proposed regulation addressing consumer privacy and data use and security could inhibit the number of payment cards issued and increase our...

  • Page 49
    ... achieve card acceptance across our networks and maintain relationships with network participants; • our ability to manage our credit risk, market risk, liquidity risk, operational risk, legal and compliance risk, and strategic risk; • the availability and cost of funding and capital; • access...

  • Page 50
    ... our Direct Banking and Payment Services segments. We also have five leased offices, four of which are located outside the United States, that are used to support our Diners Club operations and a leased office in Shanghai that supports our Direct Banking segment. Excluding the one processing center...

  • Page 51
    ... the outcome of such matters could be material to our operating results and cash flows for a particular future period, depending on, among other things, our level of income for such period. We filed a lawsuit captioned Discover Financial Services, Inc. v. Visa USA Inc., MasterCard Inc. et al. in...

  • Page 52
    ...several interrogatories and document requests, which focus on certain payment card network rules relating to merchant acceptance practices, including those that apply to merchants' ability to steer customers to payment forms preferred by merchants. A CID is a request for information in the course of...

  • Page 53
    ... to pay dividends on our common stock. For a description of these restrictions, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - U.S. Treasury Capital Purchase Program." In addition, as a result of applicable banking...

  • Page 54
    Issuer Purchases of Equity Securities The table below sets forth the information with respect to purchases of our common stock made by us or on our behalf during the fourth quarter of our year ended November 30, 2009: Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs...

  • Page 55
    ... financial condition of the Morgan Stanley subsidiaries that comprised its Discover segment. Prior to our spin-off, the Discover segment consisted of Discover Financial Services, a wholly-owned subsidiary of Morgan Stanley, and certain other subsidiaries and assets related to credit card operations...

  • Page 56
    ...in this annual report on Form 10-K. Included in the selected historical financial data are certain amounts and statistics reported on a managed basis. Our senior management evaluates business performance and allocates resources using financial data that is presented on a managed basis. Managed loans...

  • Page 57
    ... operations, net of tax(2) ...Net income(1)...Net income available to common stockholders ...Statement of Financial Condition Data (as of): Loan receivables ...Total assets ...Total stockholders' equity...Allowance for loan losses ...Long-term borrowings ...Total average interest-earning assets...

  • Page 58
    For the Years Ended November 30, 2009 Selected Statistics: Total Loan Receivables Loan receivables - owned...Average loan receivables - owned ...Owned interest yield...Owned net principal charge-off rate ...Owned delinquency rate (over 30 days) ...Owned delinquency rate (over 90 days) ...Loan ...

  • Page 59
    ... customers credit cards, other consumer loans and deposit products. Through our DFS Services LLC subsidiary and its subsidiaries, we operate the Discover Network, the PULSE Network and Diners Club. The Discover Network operates a credit card transaction processing network for Discover card-branded...

  • Page 60
    ...prices but also due to the economic environment generally. This decline in sales, along with a lower level of promotional rate offers, contributed to a decline in managed credit card loans, which was largely offset by $2 billion of growth in our personal and student loan products and a lower payment...

  • Page 61
    ... 30, 2008. Diners Club has network licensees, which are generally financial institutions, that issue Diners Club branded credit cards and/or provide card acceptance services in over 185 countries and territories. • We sold our U.K. credit card business ("Goldfish") to Barclays Bank PLC on March...

  • Page 62
    ... volume and market share for our payments business around the world. Accounting Treatment for Off-Balance Sheet Securitizations In June 2009, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assets...

  • Page 63
    ..., see "- GAAP to Managed Data Reconciliations." November 30, 2009 Actual Balance Sheet Assets Cash and cash equivalents...Restricted cash ...Investment securities...Loan receivables, gross ...Allowance for loan losses ...Loan receivables, net ...Amounts due from asset securitization ...Deferred tax...

  • Page 64
    ... be accounted for under the new accounting rules as secured borrowings rather than asset sales, the cash flows from these transactions will be presented as cash flows from financing activities rather than cash flows from operating or investing activities. Notwithstanding this accounting treatment...

  • Page 65
    ... fees and merchant rules established by the credit card networks, authority for merchants to provide discounts to customers who use certain types of credit or debit cards, and extending the provisions of the CARD Act to business cards. We currently offer both federal and private student loans...

  • Page 66
    ...a fund to pay for the costs financed by assessments on financial firms with more than $10 billion in assets), enhanced regulation of derivatives and asset-backed securities (e.g., requiring loan originators to retain at least 5% of the credit risk of securitized exposures), restrictions on executive...

  • Page 67
    ...-based deposit insurance assessment system could be changed to account for the risks posed by certain employee compensation programs. *** The remaining discussion provides a summary of our results of operations for the years ended November 30, 2009, 2008 and 2007, as well as our financial condition...

  • Page 68
    ... costs driven by our Payment Services segment. Direct Banking. Our Direct Banking segment includes Discover card-branded credit cards issued to individuals and small businesses on the Discover Network and other consumer products and services, including personal loans, student loans, prepaid cards...

  • Page 69
    ... 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 fee-based products. Represents...

  • Page 70
    ... a decrease in costs related to litigation. The managed loan balance of $51.1 billion at November 30, 2008 was up 6% from November 30, 2007. This increase in loans was attributable to lower customer payments, growth in personal and student loans during the year and a slight increase in credit card...

  • Page 71
    ... securities also are not reversed in a managed presentation. Managed loan data is relevant because we service the securitized and owned loans, and the related accounts, in the same manner without regard to ownership of the loans. Management believes it is useful for investors to consider the credit...

  • Page 72
    ... are impacted by asset securitization, and which are shown on a managed basis in this annual report, to the most directly comparable GAAP-basis financial measure: Reconciliation of GAAP to Managed Data For the Years Ended November 30, 2009 Loan Receivables Total Loans GAAP Basis ...Securitization...

  • Page 73
    ... loan fee revenues less certain costs, including loan losses on securitized loans and the contractual rate of interest paid to third-party investors in the securitization as well as a servicing fee from the trust over the life of the asset sold. In the absence of observable market prices, the fair...

  • Page 74
    ... on the same or similar investments given the current market for credit card asset-backed securities. If management used different assumptions in calculating the weighted average discount rate, the change could have a significant impact on our statement of financial condition and equity. For example...

  • Page 75
    ... and direct-to-consumer. Net interest income is influenced by the following: • The level and composition of interest-earning assets and liabilities, including the percentage of floating rate credit card loan receivables we own and the percentage of floating rate liabilities we owe; • Changes in...

  • Page 76
    ...growth in both personal and student loans, in addition to a 388 basis point increase in interest yield. The yield increased due to higher rates on newly issued personal loans. Interest income on cash and cash equivalents and other assets decreased $117.5 million from the year ended November 30, 2007...

  • Page 77
    ... of rate and volume changes for the years ended November 30 (dollars in thousands): Average Balance Sheet Analysis 2009 Average Balance Assets Interest-earning assets: Cash and cash equivalents ...Other short-term investments...Investment securities ...Loan receivables:(1) Credit card(2) ...Other...

  • Page 78
    Rate/Volume Variance Analysis(1) 2009 vs. 2008 Volume Increase/(decrease) in net interest income due to changes in: Interest-earning assets: Cash and cash equivalents ...Other short-term investments ...Investment securities ...Loan receivables: Credit card ...Other...Total loan receivables ...Other ...

  • Page 79
    ... in the securitization markets at that time. The following table provides changes in the Company's allowance for loan losses for the years presented (dollars in thousands): For the Years Ended November 30, 2009 Balance at beginning of year...Additions: Provision for loan losses ...Deductions: Charge...

  • Page 80
    .... The net charge-off rate is calculated by dividing net charge-offs for the period by the average loan receivables for the period. The following table presents amounts and rates of net charge-offs of loan receivables (dollars in thousands): For the Years Ended November 30, 2009 $ Credit card loans...

  • Page 81
    The net charge-off rate on our loan receivables increased 286 basis points and 119 basis points for the years ended November 30, 2009 and 2008, respectively, compared to November 30, 2008 and 2007. The net charge-off rate has steadily increased since the fourth quarter of 2008, reflecting the ...

  • Page 82
    ... (dollars in thousands): For the Years Ended November 30, 2009 Securitization income ...Loan fee income ...Discount and interchange revenue(1) ...Fee products ...Merchant fees ...Transaction processing revenue ...Loss on investment securities ...Antitrust litigation settlement...Other income...Total...

  • Page 83
    ... are used to pay investors in the transactions a contractual rate of return on their investment, to reimburse investors for losses of principal resulting from charged-off loans, net of recoveries, and to pay us a contractual fee for servicing the securitized loans. Any excess cash flows, referred to...

  • Page 84
    ...thousands): 2009 vs. 2008 increase (decrease) $ $(537,274) 671,779 134,505 (120,002) (522,947) (508,444) 61,303 $(447,141) For the Years Ended November 30, 2009 Interest income on securitized loans...Interest paid to investors in asset-backed securities...Net interest income ...Other fee revenue on...

  • Page 85
    ... interchange revenue from merchant acquirers on all Discover Network card 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...

  • Page 86
    ...as compared to the years ended November 30, 2008 and 2007, primarily related to an increase in the number of customers that purchased these products and services as well as higher balances upon which the fees are based. Merchant Fees To broaden merchant acceptance of Discover Network cards, we began...

  • Page 87
    ... sales of merchant portfolios and lower revenues from the referral of declined applications to third-party issuers. Other income increased $60.4 million in 2008, primarily due to the inclusion of Diners Club revenue and reporting an unrealized gain on interest rate swap agreements for the year ended...

  • Page 88
    ... notes of Discover Bank and a common stock offering resulting in approximately $534 million in net proceeds to us. Funding Sources Deposits. We offer deposit products, including certificates of deposit, money market accounts, online savings accounts and Individual Retirement Account ("IRA...

  • Page 89
    ... depository institution, provided such transfer meets the conditions for sale accounting treatment under GAAP. Pursuant to FASB guidance related to transfers of financial assets and consolidations, effective December 1, 2009, the transfer of assets made to the Discover Card Master Trust I ("DCMT...

  • Page 90
    ...we increased the size of the Class D (2009-1) note to further support the more senior DCENT securities. A wholly-owned subsidiary of Discover Bank owns the DCENT Class D (2009-1) note. • In the third quarter of 2009, we issued Series 2009-CE from DCMT to provide credit enhancement to DCMT investor...

  • Page 91
    ... investors' interests ...$14,134,204 12,759,358 $26,893,562 # of Series Outstanding 16 27 43 (1) Effective July 31, 2009, all DCMT certificates and all notes issued by DCENT include cash flows derived from merchant discount and interchange revenue earned by Discover card. 3-Month Rolling Average...

  • Page 92
    ... to committed undrawn funding capacity through privately placed asset-backed conduits to support credit card loan receivables funding requirements. At November 30, 2009, we had used $2.7 billion of capacity under these conduits, with $1.5 billion remaining capacity available to us. The original...

  • Page 93
    ... than 90 days and certain credit card asset-backed securities of other issuers. The level of our liquidity reserve may fluctuate based upon the level of expected maturities of our funding sources as well as operational requirements and market conditions. During 2009, we increased our liquidity...

  • Page 94
    ...a sale and issuance for cash by us, to persons other than us or our subsidiaries after March 13, 2009, of shares of perpetual preferred stock, common stock or a combination thereof, that in each case qualify as Tier 1 capital at the time of issuance under the applicable risk-based capital guidelines...

  • Page 95
    ... of operations, financial condition, capital levels, cash requirements, future prospects and other factors deemed relevant by our board of directors. Accordingly, there can be no assurance that we will declare and pay any dividends in the future. In addition, as a result of applicable banking law...

  • Page 96
    ...with customers for unused lines of credit on certain credit cards, provided there is no violation of conditions established in the related agreement. During 2009, our unused commitments were reduced by $35 billion to $172 billion at November 30, 2009, as part of our risk management strategies. These...

  • Page 97
    ... 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 credit card loans that may be offered at below-market rates for an introductory period, such as balance transfers and special...

  • Page 98
    ... the Public Company Accounting Oversight Board (United States), the consolidated statement of financial condition, and related consolidated statements of income, changes in stockholders' equity, and cash flows as of and for the year ended November 30, 2009 of the Company and our report dated January...

  • Page 99
    ... of financial condition of Discover Financial Services (the "Company") as of November 30, 2009 and 2008, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended November 30, 2009. These financial statements...

  • Page 100
    ... Statements of Financial Condition November 30, 2009 November 30, 2008 (dollars in thousands, except per share amounts) Assets Cash and cash equivalents...Restricted cash - special dividend escrow...Other short-term investments ...Investment securities: Available-for-sale (amortized cost of $2,743...

  • Page 101
    Discover Financial Services Consolidated Statements of Income For the Years Ended November 30, 2009 2008 2007 (dollars in thousands, except per share amounts) Interest income: Credit card loans ...Other loans...Investment securities ...Other interest income...Total interest income...Interest ...

  • Page 102
    ... of spin-off transaction on June 30, 2007, and distribution of Discover Financial Services common stock by Morgan Stanley ...Purchases of treasury stock ...Common stock issued and stock-based compensation expense...Capital contribution from Morgan Stanley ...Cash dividends paid to Morgan Stanley...

  • Page 103
    ...-term borrowings and bank notes...Purchases of treasury stock ...Net increase (decrease) in deposits ...Capital contributions from Morgan Stanley...Dividends paid to Morgan Stanley ...Dividends paid on common and preferred stock...Net cash provided by financing activities ...Effect of exchange rate...

  • Page 104
    ...retail locations throughout the U.S. for debit card transactions. Diners Club is a global payments network of licensees, which are generally financial institutions, that issue Diners Club branded credit cards and/or provide card acceptance services. The Company's business segments are Direct Banking...

  • Page 105
    ... this document. Statement No. 166 amends the accounting for transfers of financial assets and will impact the accounting for the Company's credit card asset securitization activities. Under Statement No. 166, the trusts used in the Company's securitization transactions will no longer be exempt from...

  • Page 106
    ... the fair value of plan assets and significant concentrations of risk. The FSP is effective for fiscal years ending after December 15, 2009. The application of this guidance will only affect disclosures and therefore will not impact the Company's financial condition, results of operations or cash...

  • Page 107
    ... at the individual security level and are reported in other income. Loans Held for Sale. Loans held for sale include the amount of credit card receivables necessary to support net new securitization transactions expected to take place in the next three months. Management believes its ability...

  • Page 108
    ... current economic conditions, recent trends in delinquencies and bankruptcy filings, account collection management, policy changes, account seasoning, loan volume and amounts, payment rates and forecasting uncertainties. The allowance for loan losses is applicable only to the Company's owned loan...

  • Page 109
    ... to the Company for performing the servicing. Cash flows associated with the securitization of credit card receivables that were originated for investment are included in cash flows from investing activities. Cash flows related to credit card receivables transferred to the trust during the term of...

  • Page 110
    ... 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 each year, or more often if conditions indicate...

  • Page 111
    ... by credit card customers at merchants with whom merchant acquirers have entered into card acceptance agreements for processing credit card purchase transactions. Issuer interchange is a fee paid to the card-issuing entity as compensation for risk and other operating costs. The Company pays issuer...

  • Page 112
    ... merchants for processing ATM, debit and point-of-sale transactions over the PULSE Network, as well as various participation and membership fees. Transaction processing revenue is recognized in the consolidated statements of income at the time the transaction is processed. Amounts paid to financial...

  • Page 113
    ... as the International Card segment, to Barclays Bank PLC. The aggregate sale price under the agreement was £35 million (equivalent to approximately $70 million), which was paid in cash at closing. The following table provides summary financial information for discontinued operations related to the...

  • Page 114
    ... and losses, and fair value of available-for-sale and held-to-maturity investment securities are as follows (dollars in thousands): Amortized Cost At November 30, 2009 Available-for-Sale Investment Securities(1) Certificated retained interests in DCENT ...Credit card asset-backed securities of other...

  • Page 115
    ... in thousands): Less than 12 months Fair Value At November 30, 2009 Available-for-Sale Investment Securities Certificated retained interests in DCENT...Credit card asset-backed securities of other issuers ...Held-to-Maturity Investment Securities ...Certificated retained interests in DCENT and...

  • Page 116
    ...gains and no gross realized losses, from the sale of credit card asset-backed securities of other issuers. There were no sales of available-for-sale securities during 2008 and 2007. For the years ended November 30, 2009, 2008 and 2007, the Company recorded net unrealized losses of $14.1 million, $79...

  • Page 117
    ...953,990 (1) (2) Available-for-sale investment securities are reported at fair value. Held-to-maturity investment securities are reported at amortized cost. One Year or Less Available-for-sale investment securities Certificated retained interests in DCENT ...Credit card asset-backed securities of...

  • Page 118
    ...interest in credit card securitizations at November 30, 2009 and 2008, respectively. See Note 6: Credit Card Securitization Activities for further information. The following table provides changes in the Company's allowance for credit card loan losses for the years ended November 30, 2009, 2008 and...

  • Page 119
    ... (1,882) 1,011 (871) $ 9,139 Information regarding net charge-offs of interest and fee revenues on credit card loans is as follows (dollars in thousands): For the Years Ended November 30, 2009 Interest and fees accrued subsequently charged off, net of recoveries (recorded as a reduction of interest...

  • Page 120
    6. Credit Card Securitization Activities The Company accesses the term asset securitization market through DCMT and DCENT, which are trusts into which credit card loan receivables generated in the Direct Banking segment, formerly referred to as the U.S. Card segment, are transferred (or, in the ...

  • Page 121
    ... at November 30, 2009 and 2008, respectively, were pledged as security against a long-term borrowing. See Note 12: Long-term borrowings. The Company's retained interests are subject to credit, payment and interest rate risks on the transferred credit card loan receivables. To protect investors, the...

  • Page 122
    ... securitization transactions, net of issuance discounts, as applicable. The following table summarizes certain cash flow information related to the securitized pool of loan receivables (dollars in millions): For the Years Ended November 30, 2009 Proceeds from third-party investors in new credit card...

  • Page 123
    Key estimates used in measuring the fair value of the interest-only strip receivable at the date of securitization that resulted from credit card securitizations completed were as follows: For the Years Ended November 30, 2009 Weighted average life (in months)...Payment rate (rate per month) ......

  • Page 124
    ...234 $ 1,083 For the Years Ended November 30, 2009 Average Loans: Managed credit card loans ...Less: Securitized credit card loans ...Owned credit card loans...Net Principal Charge-offs: Managed credit card loans ...Less: Securitized credit card loans ...Owned credit card loans...$48,855 24,588 $24...

  • Page 125
    ... card acceptance services for a network consisting of merchant and cash access locations in over 185 countries and territories. Diners Club does not issue cards or extend consumer credit in international markets. Diners Club is included in the Company's Payment Services segment, formerly referred...

  • Page 126
    ...amortizable intangible assets consist of international transaction processing rights and trade name intangibles recognized in the acquisition of Diners Club in June 2008. Acquired customer relationships consist of those relationships in existence between PULSE and the numerous financial institutions...

  • Page 127
    10. Deposits The Company offers its deposit products, including certificates of deposit, money market accounts, online savings accounts and Individual Retirement Account (IRA) certificates of deposit, to customers through two channels (i) directly through direct mail, internet origination and ...

  • Page 128
    ...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 thousands): November 30, 2009 Funding source Bank notes due...

  • Page 129
    ... Omnibus Plan may be authorized but unissued shares or treasury shares that the Company acquires in the open market, in private transactions or otherwise. Option awards are generally granted with an exercise price equal to the fair market value of one Discover share at the date of grant; these types...

  • Page 130
    ... Plan. The Company adopted the Discover Financial Services Employee Stock Purchase Plan ("ESPP") in connection with the Distribution, which became effective May 1, 2008. The ESPP allows eligible employees to purchase DFS common stock at a 5% discount from market value. The total number of shares...

  • Page 131
    ... interest rate was based on U.S. Treasury Strips with a remaining term equal to the expected life assumed at the date of grant. Restricted Stock Unit Activity. The following table sets forth the activity concerning vested and unvested RSUs during the year ended November 30, 2009. Number of Shares...

  • Page 132
    ...the Company changed the measurement date to November 30 effective for the fiscal year ended November 30, 2009. The Company also participates in an unfunded postretirement benefit plan that provides medical and life insurance for eligible U.S. retirees and their dependents. All information related to...

  • Page 133
    ... in thousands): Pension For the Years Ended November 30, 2009 Service cost, benefits earned during the period...Interest cost on projected benefit obligation ...Expected return on plan assets...Net amortization ...Net settlements and curtailments ...Net periodic benefit cost...$ 1,022 20,189 (24,107...

  • Page 134
    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 Company's funded status (dollars in thousands): Pension For the Years Ended November 30, 2009 Reconciliation of ...

  • Page 135
    ... target asset allocation, the fees and expenses paid by the plan or market conditions. The following table presents assumed health care cost trend rates used to determine the postretirement benefit obligations: For the Years Ended November 30, 2009 Health care cost trend rate assumed for next year...

  • Page 136
    ... variation and to better correlate assets with obligations. The longer duration fixed income allocation is expected to help stabilize plan contributions over the long term. The asset mix of the Qualified Plan is reviewed by the Discover Financial Services Retirement Plan Investment Committee (the...

  • Page 137
    ... for cash by the Company, to persons other than the Company or its subsidiaries after March 13, 2009, of shares of perpetual preferred stock, common stock or a combination thereof, that in each case qualify as Tier 1 capital at the time of issuance under the applicable risk-based capital guidelines...

  • Page 138
    ... (2) (3) (4) (5) Represents the difference between the fair value and amortized cost of available-for-sale investment securities. Represents translation gains and losses relating to the Company's Goldfish business resulting from the change in exchange rates, primarily of the British pound, and the...

  • Page 139
    ..., the Company recorded allocations of intercompany expense from Morgan Stanley for certain corporate functions such as treasury, financial control, human resources, internal audit, legal, investor relations and various other functions historically provided by Morgan Stanley. Where possible, these...

  • Page 140
    ... table reconciles the Company's effective tax rate to the U.S. federal statutory income tax rate: For the Years Ended November 30, 2009 U.S. federal statutory income tax rate ...U.S. state and local income taxes, net of U.S. federal income tax benefits...Valuation allowance - capital loss ...Non...

  • Page 141
    ...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 thousands): November 30, 2009 Deferred tax assets: Allowance for loan losses...

  • Page 142
    ...): For the Years Ended November 30, 2009 Numerator: Income from continuing operations ...Preferred stock dividends...Preferred stock accretion ...Income (loss) from discontinued operations, net of tax ...Net income available to common stockholders ...Denominator: Weighted average shares of common...

  • Page 143
    ...assets) Discover Financial Services ...Discover Bank ...Tier I capital (to risk-weighted assets) Discover Financial Services ...Discover Bank ...Tier I capital (to average assets) Discover Financial Services ...Discover Bank ...November 30, 2008: Total capital (to risk-weighted assets) Discover Bank...

  • Page 144
    .... Under the current banking regulations, a bank may not pay dividends if such a payment would leave the bank inadequately capitalized. In the year ended November 30, 2009, Discover Bank paid no dividends. During the years ended November 30, 2008 and 2007, Discover Bank paid dividends of $95...

  • Page 145
    ...payments under this arrangement is low. Merchant Chargeback Guarantees. The Company issues credit cards and owns and operates the Discover Network. The Company is contingently liable for certain transactions processed on the Discover Network in the event of a dispute between the credit card customer...

  • Page 146
    ..., and credits are issued by merchants on returned items in a timely fashion. However, where the product or service is not scheduled to be provided to the customer until some later date following the purchase, the likelihood of a contingent payment obligation by the Discover Network increases. The...

  • Page 147
    ... the antitrust laws and harmed competition and consumers by foreclosing the Company from offering credit and debit network services to banks. The Company executed an agreement to settle the lawsuit with MasterCard and Visa on October 27, 2008. The agreement became effective on November 4, 2008...

  • Page 148
    ... provides the estimated fair values of financial instruments (dollars in thousands): November 30, 2009 Carrying Value Financial Assets Cash and cash equivalents...Restricted cash ...Other short-term investments ...Investment securities: Available-for-sale...Held-to-maturity...Net loan receivables...

  • Page 149
    ... pools of similar loan types, characteristics and expected repayment terms. The fair values of the loans are estimated by discounting expected future cash flows using a rate at which similar loans could be made under current market conditions. Amounts due from asset securitization. Carrying values...

  • Page 150
    ... recorded changes in the fair values of these derivative contracts in other income. The table below presents the effect of the Company's derivatives on the consolidated statements of income for the year ended November 30, 2009 (dollars in thousands): For the Year Ended November 30, 2009 Location of...

  • Page 151
    ...issuances to related parties). The Federal Reserve's Term Asset-Backed Securities Loan Facility ("TALF") favorably impacted the issuance volumes of triple-A rated securities in 2009, however, primary market transactions for lower rated credit card assetbacked securities, specifically A-rated and BBB...

  • Page 152
    ... of other financial institutions and the Company's investment in asset-backed commercial paper notes of Golden Key U.S. LLC. The estimated fair value reported for the credit card asset-backed securities of other issuers reflects the low end of market indicative pricing based on a small number of...

  • Page 153
    ...branded credit cards issued to individuals and small businesses on the Discover Network and other consumer products and services, including personal loans, student loans, prepaid cards and other consumer lending and deposit products offered through the Company's Discover Bank subsidiary. • Payment...

  • Page 154
    ... revenue and loan fee revenues. Securitization income is reported in other income. The years ended November 30, 2009 and 2008 include $1.9 billion and $0.9 billion, respectively, of income related to the Visa and MasterCard antitrust litigation settlement, which is included in the Direct Banking...

  • Page 155
    ... Related Party Transactions In the ordinary course of business, the Company offers consumer loan 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...

  • Page 156
    ... registered securities to include separate annual financial statements. Discover Financial Services (Parent Company Only) Condensed Statements of Financial Condition November 30, 2009 Assets Cash and cash equivalents ...Interest-earning time deposits due from subsidiary ...Restricted cash ...Notes...

  • Page 157
    Discover Financial Services (Parent Company Only) Condensed Statements of Income For the Years Ended November 30, 2009 Interest income ...Interest expense ...Net interest income ...Dividends from subsidiaries ...Management fees from subsidiaries ...Antitrust litigation settlement...Other income ......

  • Page 158
    Discover Financial Services (Parent Company Only) Condensed Statements of Cash Flows For the Years Ended November 30, 2009 Cash flows from operating activities Net income ...Adjustments to reconcile net income to net cash provided by (used for) operating activities: Non-cash charges included in net ...

  • Page 159
    ..., which is the date of the filing of its consolidated financial statements with the SEC. At the time of the Company's 2007 spin-off from Morgan Stanley, the Company entered into an agreement with Morgan Stanley regarding the manner in which the antitrust case against Visa and MasterCard was to be...

  • Page 160
    ..., of income related to the Visa and MasterCard antitrust litigation settlement, which is included in the Direct Banking segment, formerly referred to as the U.S. Card segment. See Note 23: Litigation. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None...

  • Page 161
    ... registered public accounting firm, and the firm's report on this matter is included in Item 8 of this Report. Changes in Internal Control over Financial Reporting In preparation for management's report on internal control over financial reporting, we documented and tested the design and operating...

  • Page 162
    ... Owners and Management and Related Stockholder Matters. Information relating to compensation plans under which our equity securities are authorized for issuance as of November 30, 2009, is set forth in the table below. Equity Compensation Plan Information Number of securities to be issued upon...

  • Page 163
    ... in our Proxy Statement is incorporated by reference herein. • "Other Matters - Certain transactions" • "Corporate Governance - Director independence" Item 14. Principal Accountant Fees and Services Information regarding principal accounting fees and services under the caption "Ratification of...

  • Page 164
    ... FINANCIAL STATEMENTS Reports of Independent Registered Public Accounting Firm ...86 Consolidated Statements of Financial Condition as of November 30, 2009 and 2008 ...88 Consolidated Statements of Income for the years ended November 30, 2009, 2008 and 2007 ...89 Consolidated Statements of Changes...

  • Page 165
    ...(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. Discover Financial Services (Registrant) By: /S/ DAVID W. NELMS David W. Nelms Chairman and Chief Executive Officer Date: January 27, 2010...

  • Page 166
    ...and Chief Executive Officer Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer) Senior Vice President, Controller and Chief Accounting Officer (Principal Accounting Officer) Lead Director Director Director Director Director Director Director Director...

  • Page 167
    ... to Discover Financial Services' Current Report on Form 8-K filed on July 5, 2007 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...

  • Page 168
    ... Discover Bank, as Master Servicer, Servicer and Seller, and U.S. Bank, National Association, as Trustee (filed as Exhibit 4.2 to Discover Card Master Trust I's Current Report on Form 8-K dated as of October 29, 2004 (Exchange Act file number 0-23108) and incorporated herein by reference thereto...

  • Page 169
    ... 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). 2008 Year End Form of Restricted Stock Unit Award Under Discover Financial Services Omnibus Incentive Plan (filed as...

  • Page 170
    ... and Restated 2007 Omnibus Incentive Plan (filed as Exhibit 10(a) to Discover Financial Services' Current Report on Form 8K filed on December 11, 2009 and incorporated herein by reference thereto). Statement Re: Computation of Per Share Earnings (the calculation of per share earnings is in Part II...

  • Page 171
    ...DISCOVER FINANCIAL SERVICES COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES For the Years Ended November 30, 2009 Earnings: Income from continuing operations... as interest expensed, amortized premiums discounts and capitalized expenses related to indebtedness and interest within rental expense.

  • Page 172
    ... DISCOVER FINANCIAL SERVICES SUBSIDIARIES Subsidiary Jurisdiction of Incorporation or Formation Bank of New Castle ...Diners Club International Ltd...Discover Bank...Discover Card Limited ...Discover Community Development Corporation...Discover Financial Services (Canada), Inc...Discover Financial...

  • Page 173
    ... to Discover Financial Services' adoption of the accounting standard, Accounting for Uncertainty in Income Taxes, on December 1, 2007), and the effectiveness of internal control over financial reporting, appearing in this Annual Report on Form 10-K of Discover Financial Services for the year ended...

  • Page 174
    ...'s board of directors (or persons performing the equivalent functions): a) 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...

  • Page 175
    ...'s board of directors (or persons performing the equivalent functions): a) 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...

  • Page 176
    ... the Annual Report of Discover Financial Services (the "Company") on Form 10-K for the period ended November 30, 2009, as filed with the Securities and Exchange Commission (the "Report"), each of David W. Nelms, Chairman and Chief Executive Officer of the Company, and Roy A. Guthrie, Executive Vice...

  • Page 177
    ... local time at the company's headquarters at 2500 lake Cook Road, Riverwoods, Il 60015. Discover, Cashback Bonus, More, Motiva, open Road, pulSe, Diners Club International and the other trademarks, logos, and service marks used in this Annual Report are the trademarks of Discover Financial Services...

  • Page 178
    2500 l AK e C ooK R oAD , R IV eR WooD S, IllInoI S 60015 www.discoverfinancial.com Cert no. SCS-COC-00648