Discover 2010 Annual Report Download - page 78

For the Year Ended November 30, 2009 compared to the Year Ended November 30, 2008
Our Payment Services segment reported pretax income of $107 million for the year ended November 30, 2009, up
$25 million as compared to the year ended November 30, 2008. Revenues were up $61 million mainly driven by
increased transaction volume on the PULSE network, along with lower incentive payments and higher fee revenue.
Expenses were also up $33 million including a higher level of international marketing investments, partially offset by the
impact of cost containment initiatives. Additionally, the increase in both revenues and expenses during 2009 is due to the
inclusion of Diners Club for the full year, as compared to half a year since its acquisition in June 2008.
Transaction dollar volume for the year ended November 30, 2009 was $141 billion, an increase of 13% compared to
the year ended November 30, 2008. The increase in transaction dollar volume was driven primarily by the inclusion of
Diners Club for the full year, as compared to a half a year in 2008, in addition to higher activity from new and existing
financial institutions on the PULSE network. These were partially offset by the loss of volume from one large financial
institution along with lower third-party issuer volume as a result of lower gasoline prices and lower overall spending.
Critical Accounting Estimates
In preparing our consolidated financial statements in conformity with GAAP, management must make judgments and
use estimates and assumptions about the effects of matters that are uncertain. For estimates that involve a high degree of
judgment and subjectivity, it is possible that different estimates could reasonably be derived for the same period. For
estimates that are particularly sensitive to changes in economic or market conditions, significant changes to the estimated
amount from period to period are also possible. Management believes the current assumptions and other considerations
used to estimate amounts reflected in our consolidated financial statements are appropriate. However, if actual
experience differs from the assumptions and other considerations used in estimating amounts in our consolidated
financial statements, the resulting changes could have a material effect on our consolidated results of operations and, in
certain cases, could have a material effect on our consolidated financial condition. Management has identified the
estimates related to our allowance for loan losses, the accrual of credit card customer rewards cost, the evaluation of
goodwill and other nonamortizable intangible assets for potential impairment and the accrual of income taxes as critical
accounting estimates.
Allowance for Loan Losses
We base our allowance for loan loss on several analyses that help us estimate incurred losses as of the balance sheet
date. While our estimation process includes historical data and analysis, there is a significant amount of judgment
applied in selecting inputs and analyzing the results produced to determine the allowance. We use a migration analysis
to estimate the likelihood that a loan will progress through the various stages of delinquency. The migration analysis
considers uncollectible principal, interest and fees reflected in the loan receivables. In the first quarter 2010, management
refined its ability to estimate loss emergence by using other analyses to estimate losses incurred from non-delinquent
accounts. The considerations in these analyses include past performance, risk management techniques applied to various
accounts, historical behavior of different account vintages, current economic conditions, recent trends in delinquencies,
bankruptcy filings, account collection management, policy changes, account seasoning, loan volume and amounts,
payment rates, and forecasting uncertainties. Given the same information, others may reach different reasonable
conclusions.
If management used different assumptions in estimating incurred net loan losses, the impact to the allowance for loan
losses could have a material effect on our consolidated financial condition and results of operations. For example, a 10%
change in management’s estimate of incurred net loan losses could have resulted in a change of approximately $330
million in the allowance for loan losses at November 30, 2010, with a corresponding change in the provision for loan
losses. See “ – Loan Quality” and Note 2: Summary of Significant Accounting Policies to our consolidated financial
statements for further details about our allowance for loan losses.
Customer Rewards Cost
We offer our customers various reward programs, including the Cashback Bonus reward program, pursuant to which
we offer certain customers a reward equal to a percentage of their purchase amounts based on the type and volume of
the customer’s purchases. The liability for customer rewards is included in accrued expenses and other liabilities on our
consolidated statements of financial condition. We compute our rewards liability on an individual customer basis and it is
accumulated as qualified customers make progress toward earning a reward through their ongoing purchase activity. The
liability is adjusted for expected forfeitures of accumulated rewards. We estimate forfeitures based on historical account
-67-