Discover 2009 Annual Report Download - page 74

Valuation of Certificated Retained Interests in DCENT – Classified as Available-for-Sale Investment Securities
Certain of the subordinated beneficial interests we retain in our securitized assets, including Class B and Class C notes
issued by DCENT, are classified as available-for-sale investment securities and are carried on our consolidated statement
of financial condition at their estimated fair values. Changes in the fair values of these notes are recorded in other
comprehensive income within stockholders’ equity. The fair values of these securities are estimated utilizing discounted
cash flow models, where the interest and principal payments are discounted at assumed current market rates for the same
or comparable transactions. In performing these valuations, management makes certain assumptions about the credit
spreads and liquidity risk premiums that market participants would demand 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, a 10% decrease in the discount rate
could have resulted in a $14 million change in the value of the Class B and Class C notes classified as available-for-sale
investment securities as of November 30, 2009. However, as described in “Accounting Treatment for Off-Balance Sheet
Securitizations,” pursuant to new FASB guidance related to transfers of financial assets and consolidation, our securitized
loans will be consolidated in the Company’s financial statements effective December 1, 2009, at which time our
certificated retained interests in DCENT will be eliminated in our consolidated financial statements. See Note 4: Investment
Securities, Note 6: Credit Card Securitization Activities and Note 24: Fair Value Disclosures to our consolidated financial
statements for further discussion about the accounting for our certificated retained interests in DCENT.
Customer Rewards Cost
We offer our customers various reward programs, including the Cashback Bonus reward program, pursuant to which
we offer certain customers a reward equal to a percentage of their purchase amounts based on the type and volume of
the customer’s purchases. The liability for customer rewards is included in accrued expenses and other liabilities on our
consolidated statements of financial condition. We compute our rewards liability on an individual customer basis and it is
accumulated as qualified customers make progress toward earning a reward through their ongoing purchase activity. The
liability is adjusted for expected forfeitures of accumulated rewards. We estimate forfeitures based on historical account
closure and charge-off experience, actual customer purchase activity and the terms of the rewards programs. We
recognize reward costs for both owned loans and securitized loans as a reduction of discount and interchange revenue in
the consolidated statements of income.
If management used a different estimate of forfeitures, our consolidated statement of financial condition and results of
operations could have differed significantly. For example, a 100 basis point decrease in the estimated forfeiture rate as of
November 30, 2009, could have resulted in an increase in accrued expenses and other liabilities of approximately $9
million. The corresponding increase in rewards cost would have been reflected as a decrease in discount and interchange
revenue. See “– Other Income” and Note 2: Summary of Significant Accounting Policies to our consolidated financial
statements for further details about credit card rewards cost.
Goodwill and Other Nonamortizable Intangible Assets
We recognize goodwill when the purchase price of an acquired business exceeds the fair values of the acquired net
assets. In addition, we have recognized certain other nonamortizable intangible assets in our acquisition of the Diners
Club business. As required by GAAP, we test goodwill and other nonamortizable intangible assets for impairment
annually, or more often if indicators of impairment exist. In evaluating goodwill for impairment, management must
estimate the fair value of the business 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 businesses. Similarly, in evaluating the other
nonamortizable intangible assets for potential impairment, management estimates 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.
If the assumptions used by management in these valuations are inappropriate, we may be exposed to an impairment
loss that, when realized, could have a material impact on our consolidated financial condition and results of operations.
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