Discover 2011 Annual Report Download - page 41

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definition. For a comparison of Discover Bank's capital ratios to the “well-capitalized” capital requirements, see Note 19:
Capital Adequacy to our consolidated financial statements. Additionally, our regulators can adjust the requirements to be "well-
capitalized" at any time and have authority to place limitations on our deposit businesses, including the interest rate we pay on
deposits.
If we are unable to securitize our receivables, it may have a material adverse effect on our liquidity, cost of funds and
overall financial condition.
Historically, we have used the securitization of credit card receivables, which involves the transfer of receivables to a
trust and the issuance by the trust of beneficial interests to third-party investors, as a significant source of funding. Our average
level of securitized borrowings from third parties was $13.5 billion for fiscal year 2011 and $17.2 billion for fiscal year 2010.
Securitization markets experienced a significant drop in liquidity in 2007 and remain disrupted for some asset classes. The
securitization market for credit cards, however, has been re-established, although still not fully at terms or volumes that are
similar to pre-2007 levels.
The Reform Act imposes a number of significant changes related to asset-backed securities that may impact our ability
and desire to securitize our receivables. For example, the Reform Act nullified Rule 436(g) of the Securities Act of 1933 (the
“Securities Act”) effective immediately, which subjects the rating agencies to “expert liability” under Section 11 of the
Securities Act for misstatements or omissions of material facts in connection with credit ratings contained in registration
statements. In response to this measure, the major credit rating agencies issued statements indicating that they would be
unwilling to provide issuers with consent to use credit ratings in their registration statements. In order to provide a transition
period, the SEC issued a “no-action” letter in July 2010 allowing issuers to omit credit ratings from registration statements until
January 24, 2011. In November 2010, the SEC issued a second letter extending this no-action period indefinitely. Failure to
ultimately resolve this issue could impact the market for registered asset-backed securities.
The SEC has also proposed revised rules for asset-backed securities offerings that, if adopted, would substantially
change the disclosure, reporting and offering process for public and private offerings of asset-backed securities. Recent
legislative proposals have affected the timing and final form of these proposals, as the SEC has sought additional comment
from market participants. Significant changes to the disclosure requirements or registration process for securitizations could
make them more expensive, making securitization less attractive as a funding source.
The ability of issuers of asset-backed securities to obtain necessary credit ratings for their issuances has been based, in
part, on qualification under the FDIC's safe harbor rule for assets transferred in securitizations. The FDIC issued a final rule for
its securitization safe harbor which requires issuers to comply with a new set of requirements in order to qualify for the safe
harbor. Issuances out of our existing credit card securitization trusts are “grandfathered” under the new FDIC final rule.
However, preserving this grandfathered status imposes certain restrictions on our trusts. In the event that we would not be able
to meet such restrictions, we would need to create new trusts to securitize our receivables. Qualification for the safe harbor
with respect to any new trust that we may create to securitize our assets would require us to satisfy the requirements of the
FDIC's new final rule.
Our ability to raise funding through the securitization market also depends, in part, on the credit ratings of the securities
we issue from our securitization trusts. If we are not able to satisfy rating agency requirements to maintain the ratings of asset-
backed securities issued by our 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 credit card securitization transactions or an
inability to delay the accumulation of principal collections in our credit card 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 credit card 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 out of principal
collections without regard to the original payment schedule. Our average level of securitized borrowings was $13.5 billion for
fiscal year 2011 and $17.2 billion for fiscal year 2010. Early amortization events include, for example, insufficient cash flows
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