Discover 2010 Annual Report Download - page 41

new 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, qualification for the safe harbor with respect to the securitization of any other assets,
including student loans, 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 securitization 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 over a period
of a few months. Our average level of securitized borrowings was $17.2 billion for fiscal year 2010 and $22.7 billion
for fiscal year 2009. Early amortization events include, for example, insufficient cash flows in the securitized pool of
receivables to meet contractual requirements (also known as “excess spread”), 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 “Management’s Discussion and Analysis of Financial Condition and Results
of Operations – Liquidity and Capital Resources – Securitization Financing.” 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. The rating agencies may require us to take certain credit enhancement actions to
maintain the ratings of the securities issued out of our trusts, which we may not be able to complete. Downgrades in our
ratings or those of our trusts could materially adversely affect our cost of funds, access to capital and funding, and overall
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