Discover 2009 Annual Report Download - page 137

Discover 401(k) Awards. Eligible U.S. employees of the Company receive 401(k) matching contributions and, effective
January 1, 2009, also receive fixed employer contributions and, if eligible, certain transition credit employer
contributions under the Discover 401(k) Plan. Prior to the Distribution, eligible U.S. employees of Discover participated in
the Morgan Stanley 401(k) Plan, which included 401(k) matching contributions to eligible employees. The pretax expense
associated with the 401(k) match for the years ended November 30, 2009, 2008 and 2007 was $33.7 million, $15.4
million, and $17.0 million, respectively. The expense for the year ended November 30, 2009 also included fixed
employer contributions and employer transition credit contributions.
15. Common and Preferred Stock
During the year ended November 30, 2009, the Company raised approximately $534 million in capital through the
issuance of 60,054,055 shares of common stock, par value of $0.01, at a public offering price of $9.25 per share
($8.89 per share net of underwriter discounts and commissions). This included 6,000,000 shares sold pursuant to the
over-allotment option granted to the underwriters.
On March 13, 2009, the Company issued and sold to the United States Department of the Treasury (the “U.S.
Treasury”) under the CPP (i) 1,224,558 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series
A (the “senior preferred stock”) and (ii) a ten-year warrant to purchase 20,500,413 shares of the Company’s common
stock, par value $0.01 per share, for an aggregate purchase price of $1.225 billion. The senior preferred stock, which
qualifies as Tier 1 capital, has a per share liquidation preference of $1,000, and pays a cumulative dividend rate of
5% per year for the first five years and a rate of 9% per year beginning May 15, 2014. The warrant has a 10-year term
and was immediately exercisable upon issuance, with an exercise price, subject to anti-dilution adjustments, equal to
$8.96 per share of common stock. Of the aggregate amount of $1.225 billion received, approximately $1.15 billion was
attributable to the senior preferred stock and approximately $75 million was attributable to the warrant, based on the
relative fair values of these instruments on the date of issuance. The Company used a discounted cash flow analysis to
determine the fair value of the senior preferred stock, which included the following key assumptions: (i) a discount rate of
15%, (ii) a dividend rate for the first five years of 5% and (iii) a dividend rate after five years of 9%. The Company used a
binomial lattice model to determine the fair value of the warrant, which included the following key assumptions:
(i) volatility of 50%, (ii) an exercise price of $8.96, (iii) a dividend yield of 2.57% and (iv) the ten-year risk-free rate of
3.5%. The resulting fair values of the preferred stock and stock warrants were used to allocate the aggregate purchase
price of $1.225 billion on a pro rata basis. The Company used the effective interest rate method to amortize the discount
and the senior preferred stock.
As the senior preferred stock was initially valued at $1.15 billion, the difference between the initial value and the par
value of the stock will be accreted over a period of five years through a reduction to retained earnings on an effective
yield basis. While this accretion does not impact net income, it, along with the dividends, reduces the amount of net
income available to common stockholders, and thus reduces both basic and diluted earnings per share.
The senior preferred stock is generally non-voting, other than class voting rights on certain matters that could adversely
affect the right of the holders of the stock. The senior preferred stock terms provide that the stock may not be redeemed
prior to May 15, 2012 unless the Company has received aggregate gross proceeds from one or more qualified equity
offerings (as described below) of at least $306 million. In such a case, the Company may redeem the senior preferred
stock, in whole or in part, subject to the approval of the Federal Reserve, upon notice, up to a maximum amount equal to
the aggregate net cash proceeds received by the Company from such qualified equity offerings. A “qualified equity
offering” is a sale and issuance 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 of the Federal Reserve.
On or after May 15, 2012, the senior preferred stock may be redeemed by the Company at any time, in whole or in
part, subject to the approval of the Federal Reserve and notice requirements.
However, pursuant to a letter agreement between the Company and the U.S. Treasury, the Company is permitted, after
obtaining the approval of the Federal Reserve, to redeem the senior preferred stock at any time, and when such senior
preferred stock is redeemed, the U.S. Treasury is required to liquidate the warrant, all in accordance with The American
Recovery and Reinvestment Act of 2009, as it may be amended from time to time, and any rules and regulations
thereunder. The U.S. Treasury may transfer the senior preferred stock to a third party at any time.
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