Discover 2010 Annual Report Download - page 123

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 statement of financial condition as relating to securitization activities, are shown in the table
below (dollars in thousands):
November 30,
2010
Cash collateral accounts(1) ................................................................................................................................................................ $ 459,474
Collections and interest funding accounts ............................................................................................................................................ 904,284
Restricted cash – for securitization investors...................................................................................................................................... 1,363,758
Investors’ interests held by third-party investors .................................................................................................................................... 14,921,057
Investors’ interests held by wholly owned subsidiaries of Discover Bank.................................................................................................... 4,608,210
Seller’s interest................................................................................................................................................................................ 14,923,722
Loan receivables – restricted for securitization investors(2) ................................................................................................................... 34,452,989
Allowance for loan losses allocated to securitized loan receivables(2) ....................................................................................................... 2,431,399
Net loan receivables.................................................................................................................................................................. 32,021,590
Other ............................................................................................................................................................................................ 24,083
Carrying value of assets of consolidated variable interest entities...................................................................................................... $33,409,431
(1) Amount 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 statement of financial condition 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 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.
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