Discover 2011 Annual Report Download - page 129

117
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. 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 consolidated statement of
financial condition as relating to securitization activities, are shown in the table below (dollars in thousands):
Cash collateral accounts (1)
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
Loan receivables (2)
Allowance for loan losses allocated to securitized loan receivables (2)
Net loan receivables
Other
Carrying value of assets of consolidated variable interest entities
November 30,
2011
$ 187,105
977,195
1,164,300
13,294,739
5,157,536
15,363,585
33,815,860
(1,510,730)
32,305,130
26,506
$ 33,495,936
2010
$ 459,474
904,284
1,363,758
14,921,057
4,608,210
14,923,722
34,452,989
(2,431,399)
32,021,590
24,083
$ 33,409,431
(1) As of November 30, 2011 and 2010, the full amount was pledged as collateral against a long-term borrowing.
(2) 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 VIEs 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 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. If the Company could not add enough receivables to satisfy the
requirement, an early amortization (or repayment) of investors’ interests would be triggered. We retain significant exposure to
the performance of trust assets through holdings of the seller's interest and subordinated security classes of DCMT and
DCENT.
Table of Contents