Discover 2010 Annual Report Download - page 145

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:
For the Year Ended
November 30,
2010
Diners Club:
Merchant guarantee (in millions).............................................................................................................................................. $224
PULSE:
ATM guarantee (in thousands) ................................................................................................................................................ $910
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,
2010, 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, 2010, 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 credit 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 credit 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 transaction to the merchant or
merchant acquirer. If the Discover Network is unable to collect the amount from the merchant or merchant acquirer, it will
bear the loss for the amount credited or refunded to the customer. In most instances, a payment obligation by the Discover
Network is unlikely to arise because most products or services are delivered when purchased, and credits are issued by
-134-