Discover 2011 Annual Report Download - page 74

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62
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 economic conditions deteriorate or other events adversely impact the assumptions used by management in these
valuations, we may be exposed to an impairment loss that, when recognized, could have a material impact on our consolidated
financial condition and results of operations. At November 30, 2011, there were no reporting units or intangible assets that were
at reasonable risk for failing the respective impairment evaluations.
Income Taxes
We are subject to the income tax laws of the jurisdictions where we have business operations, primarily the United
States, its states and municipalities. We must make judgments and interpretations about the application of these inherently
complex tax laws when determining the provision for income taxes and must also make estimates about when in the future
certain items will affect taxable income in the various taxing jurisdictions. Disputes over interpretations of the tax laws may be
settled with the taxing authority upon examination or audit. We regularly evaluate the likelihood of assessments in each of the
taxing jurisdictions resulting from current and subsequent years' examinations, and tax reserves are established as appropriate.
Changes in the estimate of income taxes can occur due to tax rate changes, interpretations of tax laws, the status and
resolution of examinations by the taxing authorities, and newly enacted laws and regulations that impact the relative merits of
tax positions taken. When such changes occur, the effect on our consolidated financial condition and results of operations can
be significant. See Note 17: Income Taxes to our consolidated financial statements for additional information about income
taxes.
Purchased Credit-Impaired Loans
The estimate of expected future cash flows on purchased credit-impaired ("PCI") loans determines the amount of yield
we can recognize in future periods and impacts whether a loan loss reserve must be established for these loans. We re-evaluate
the amount and timing of expected cash flows quarterly using updated loan portfolio characteristics as well as assumptions
regarding expected borrower default and prepayment behavior. Because estimates of expected future cash flows on PCI loans
involve assumptions and significant judgment, it is reasonably possible that others could derive different estimates than ours for
the same periods. In addition, changes in estimates from one period to the next can have a significant impact on our
consolidated financial condition and results of operations. A decrease in expected cash flows involving an increase in estimated
credit losses would result in an immediate charge to earnings for the recognition of a loan loss provision. Increases or decreases
in expected cash flows related solely to changes in estimated prepayments or to changes in variable interest rate indices would
result in prospective yield adjustments over the remaining life of the loans. An increase in expected cash flows due to a
reduction in expected credit losses would result first in the reversal of any previously established loan loss reserve on PCI loans
through an immediate credit to earnings and then, if needed, a prospective adjustment to yield over the remaining life of the
loans.
If management used a different estimate of expected borrower defaults, our consolidated statement of financial condition
and results of operations could have differed. For example, a 10% increase in the expected borrower default rate of each PCI
loan pool as of November 30, 2011 could have resulted in an impairment of up to $55 million. This impairment would have
been reflected as an increase in provision for loan losses and a decrease in the carrying value of the PCI loans. The accounting
and estimates used in our calculations are discussed further in Note 6: Loan Receivables to our consolidated financial
statements.
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