Discover 2011 Annual Report Download - page 42

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in the securitized pool of receivables to meet contractual requirements (i.e. excess spread less than zero), 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 Note 7: Credit Card and Student Loan Securitization Activities to
our consolidated financial statements. 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 credit card 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 credit card 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. The credit ratings of the securities issued
by our securitization trusts are regularly evaluated by the rating agencies. The ratings of our asset-backed securities are based
on a number of factors, including the quality of the underlying receivables and the credit enhancement structure of the trusts.
Downgrades in our ratings or those of our trusts 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.
We may not be successful in managing the investments in our liquidity investment portfolio and investment performance
may deteriorate due to market fluctuations, which would adversely affect our business and financial condition.
We must effectively manage the risks of the investments in our liquidity investment portfolio, which is comprised of
cash and cash equivalents and high quality, liquid investments. Our investments may be adversely affected by market
fluctuations including changes in interest rates, prices, credit risk premiums and overall market liquidity. Also, investments
backed by collateral could be adversely impacted by changes in the value of the underlying collateral. In addition, continued
poor economic conditions may cause certain of the obligors, counterparties and underlying collateral on our investments to
incur losses of their own or default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other
reasons, thereby increasing our credit risk exposure to these investments. These risks could result in a decrease in the value of
our investments, which could negatively impact our financial condition. Further, in an effort to increase the rate of return on our
investment portfolio, we may choose new investments, which may result in greater fluctuations in market value. While we
expect these investments to be readily convertible into cash and do not believe they present a material increase to our risk
profile or will have a material impact on our risk-based capital ratios, they are subject to certain market fluctuations that may
reduce the ability to fully convert them into cash.
Changes in the level of interest rates could materially adversely affect our earnings.
Changes in interest rates cause our interest expense to increase or decrease, as certain of our debt instruments carry
interest rates that fluctuate with market benchmarks. If we are unable to pass any higher cost of funds to our customers, the
increase in interest expense could materially reduce earnings. Some of our consumer loan receivables bear interest at a fixed
rate or do not earn interest, and we may not be able to increase the rate on those loans to mitigate any higher cost of funds. At
the same time, our variable rate loan receivables, which are based on the prime market benchmark rate, may not change at the
same rate as our floating rate borrowings or may be subject to a cap, subjecting us to basis point risk. The majority of our
floating rate borrowings are asset securitizations, which are generally based on the 1-month LIBOR rate. If the prime rate were
to decrease without a decrease in the 1-month LIBOR rate, our earnings would be negatively impacted. In addition to asset
securitizations, we also utilize deposits as a significant source of funds. Our interest costs associated with existing certificates
of deposit are fixed and, therefore, we cannot decrease the rate we pay on these deposits to mitigate any higher cost of funds.
New deposit issuances are subject to fluctuations in interest rates.
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