Discover 2011 Annual Report Download - page 151

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The maximum potential amount of future payments the Company could be required to make would be equal to the
current outstanding balances of third-party investor interests in credit card asset-backed securities plus the principal amount of
any other outstanding secured borrowings. The Company has recorded substantially all of the maximum potential amount of
future payments in long-term borrowings on the Company’s statement of financial condition. The Company has not recorded
any incremental contingent liability associated with its secured borrowing representations and warranties. Management
believes that the probability of having to replace, repurchase or sell assets pledged as collateral under secured borrowing
arrangements, including an early amortization event, is low.
Guarantees. The Company has obligations under certain guarantee arrangements, including contracts and
indemnification agreements, which contingently require the Company to make payments to the guaranteed party based on
changes in an underlying asset, liability or equity security of a guaranteed party, rate or index. Also included as guarantees are
contracts that contingently require the Company to make payments to a guaranteed party based on another entity’s failure to
perform under an agreement. The Company’s use of guarantees is disclosed below by type of guarantee.
Counterparty Settlement Guarantees. Diners Club and DFS Services LLC, on behalf of PULSE, have various
counterparty exposures, which are listed below.
•Merchant Guarantee. Diners Club has entered into contractual relationships with certain international merchants,
which generally include travel-related businesses, for the benefit of all Diners Club licensees. The licensees hold the
primary liability to settle the transactions of their customers with these merchants. However, Diners Club retains a
counterparty exposure if a licensee fails to meet its financial payment obligation to one of these merchants.
•ATM Guarantee. PULSE entered into contractual relationships with certain international ATM acquirers in which
DFS Services LLC retains counterparty exposure if an issuer fails to fulfill its settlement obligation.
The maximum potential amount of future payments related to such contingent obligations is dependent upon the
transaction volume processed between the time a counterparty defaults on its settlement and the time at which the Company
disables the settlement of any further transactions for the defaulting party, which could be up to one month depending on the
type of guarantee/counterparty. However, there is no limitation on the maximum amount the Company may be liable to pay.
The actual amount of the potential exposure cannot be quantified as the Company cannot determine whether particular
counterparties will fail to meet their settlement obligations. While the Company has some contractual remedies to offset these
counterparty settlement exposures (such as letters of credit or pledged deposits), in the event that all licensees and/or issuers
were to become unable to settle their transactions, the Company estimates its maximum potential counterparty exposures to
these settlement guarantees, based on historical transaction volume of up to one month, would be as follows:
Diners Club:
Merchant guarantee (in millions)
PULSE:
ATM guarantee (in thousands)
November 30,
2011
$ 255
$ 1,077
With regard to the counterparty settlement guarantees discussed above, the Company believes that the estimated
amounts of maximum potential future payments are not representative of the Company’s actual potential loss exposure given
Diners Club’s and PULSE’s insignificant historical losses from these counterparty exposures. As of November 30, 2011, the
Company had not recorded any contingent liability in the consolidated financial statements for these counterparty exposures,
and management believes that the probability of any payments under these arrangements is low.
The Company also retains counterparty exposure for the obligations of Diners Club licensees that participate in the
Citishare network, an electronic funds processing network. Through the Citishare network, Diners Club customers are able to
access certain ATMs directly connected to the Citishare network. The Company’s maximum potential future payment under this
counterparty exposure is limited to $15 million, subject to annual adjustment based on actual transaction experience. However,
as of November 30, 2011, the Company had not recorded any contingent liability in the consolidated financial statements
related to this counterparty exposure, and management believes that the probability of any payments under this arrangement is
low.
Merchant Chargeback Guarantees. The Company issues and permits third parties to issue payment 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 payment card customer and a merchant. The contingent liability arises if the disputed
transaction involves a merchant or merchant acquirer with whom the Discover Network has a direct relationship. If a dispute is
resolved in the customer’s favor, the Discover Network will credit or refund the disputed amount to the Discover Network card
issuer, who in turn credits its customer’s account. The Discover Network will then charge back the disputed amount of the
payment card transaction to the merchant or merchant acquirer, where permitted by the applicable agreement, to seek recovery
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