Discover 2010 Annual Report Download - page 42

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ratings will not be lowered or withdrawn.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,
deteriorating 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 increase our
risk of loss. For example, during the fourth quarter 2010, we moved a portion of our liquidity investment portfolio into
approximately $4 billion of U.S. Treasury, U.S. government agency and corporate debt securities guaranteed by the FDIC
in order to pursue a higher return. 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 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. For example, 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.
Although our interest costs associated with existing certificates of deposit are fixed, new deposit issuances are subject to
fluctuations in interest rates.
Interest rates may also adversely impact our delinquency and charge-off rates. Many consumer lending products bear
interest rates that fluctuate with certain base lending rates published in the market, such as the prime rate and LIBOR. As
a result, higher interest rates often lead to higher payment requirements by consumers under obligations to us and other
lenders, which may reduce their ability to remain current on their obligations to us and thereby lead to loan delinquencies
and additions to our loan loss provision, which could materially adversely affect our earnings.
We regularly monitor interest rates and have entered into interest rate derivative agreements in an effort to manage
our interest rate risk exposure. Changes in market assumptions regarding future interest rates could significantly impact
the valuation of our derivative instruments and, accordingly, impact our financial position and results of operations. If our
hedging activities are not appropriately monitored or executed, these activities may not effectively mitigate our interest
rate sensitivity or have the desired impact on our results of operations or financial condition.
We have a credit facility that could restrict our operations.
We have a multi-year unsecured committed credit facility that currently has $2.4 billion available and contains
restrictions, covenants and events of default. See “Management’s Discussion and Analysis of Financial Condition and
Results of Operations – Liquidity and Capital Resources – Additional Funding Sources.” Although we currently have no
outstanding balances due under the facility, the terms of the facility impose certain restrictions and future indebtedness
may impose various additional restrictions and covenants on us (such as tangible net worth requirements) that could have
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