Discover 2009 Annual Report Download - page 40

Our ability to raise funding through the securitization market generally, through TALF or otherwise, depends on our
ratings. If we are not able to satisfy rating agency requirements, such as completing certain credit enhancement actions
as requested by the agencies, to maintain the ratings of asset-backed securities issued by our securitization trusts, it could
limit our ability to access the securitization markets. Additional factors affecting the extent to which we will 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. A
prolonged inability to securitize our receivables 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 securitization transactions or an inability
to delay the accumulation of principal collections in our 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 securitization transactions. Credit card securitizations are normally structured as “revolving
transactions” that do not distribute to securitization investors their share of monthly principal payments on the receivables
during the revolving period, and instead use those principal payments to fund the purchase of replacement receivables.
The occurrence of “early amortization events” may result in termination of the revolving periods of our securitization
transactions, which would require us to repay the affected outstanding securitized borrowings over a period of a few
months. Our average level of securitized borrowings, excluding retained issuances, was $22.6 billion and $26.9 billion
for the 2009 and 2008 fiscal years, respectively, and we recorded $1.9 billion and $2.4 billion, respectively, in
securitization income. Early amortization events include, for example, insufficient cash flows in the securitized pool of
receivables to meet contractual requirements (also known as “excess spread”), certain breaches of representations,
warranties or covenants in the agreements relating to the securitization and receivership or insolvency of Discover Bank.
For more information on excess spread, see “Management’s Discussion and Analysis of Financial Condition and Results
of Operations – Liquidity and Capital Resources – Securitization Financing.” 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.
Our 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 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, including our financial strength as well as factors that may not be within our control. We currently maintain an
investment grade long-term debt rating with Fitch Ratings (“Fitch”) (BBB with negative outlook) and Standard and Poor’s
Rating Service (“S&P”) (BBB- with stable outlook). In 2009, Moody’s Investors Service (“Moody’s”) downgraded our long-
term debt rating from Baa3 with negative outlook to Ba1 with negative outlook. Our current Ba1 rating from Moody’s is
below investment grade. Downgrades in our long-term debt ratings 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 in its entirety.
Discover Bank currently maintains an investment grade long-term debt rating with Fitch (BBB with negative outlook) and
S&P (BBB with stable outlook). Moody’s downgraded the long-term debt rating of Discover Bank in 2009 from Baa2 with
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