Discover 2015 Annual Report Download - page 129

-113-
necessary to obtain the appropriate amount of credit enhancement, generally through the issuance of junior, lower
rated or more highly subordinated classes of notes. The subordinated class are held by wholly-owned subsidiaries of
Discover Bank. The company is exposed to credit-related risk of loss associated with trust assets as of the balance sheet
date through the retention of these subordinated interests. The probable loss is included in the Company's allowance for
loan loss estimate.
The Company’s credit card securitizations are accounted for as secured borrowings and the trusts and Discover
Funding LLC are treated as consolidated subsidiaries of the Company. The Company’s retained interests in the assets of
the trusts, consisting of investments in DCENT notes and previously outstanding DCMT certificates held by subsidiaries
of Discover Bank, constitute intercompany positions which are eliminated in the preparation of the Company’s
consolidated statements of financial condition.
Upon transfer of credit card loan receivables to the trust, the receivables and certain cash flows derived from
them become restricted for use in meeting obligations to the trusts’ creditors. Further, the transferred credit card loan
receivables are owned by the trust and are not available to third-party creditors of the Company. The trusts have
ownership of cash balances that also have restrictions, the amounts of which are reported in restricted cash. Investment
of trust 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 consolidated statements of
financial condition as relating to securitization activities, are shown in the table below (dollars in millions):
December 31,
2015 2014
Restricted cash .............................................................................................................................................. $ 19 $ 16
Investors’ interests held by third-party investors ................................................................................................ 15,625 15,950
Investors’ interests held by wholly-owned subsidiaries of Discover Bank .............................................................. 6,017 5,789
Seller’s interest .............................................................................................................................................. 7,231 8,596
Loan receivables(1) ..................................................................................................................................... 28,873 30,335
Allowance for loan losses allocated to securitized loan receivables(1) .................................................................. (783) (805)
Net loan receivables .................................................................................................................................. 28,090 29,530
Other ........................................................................................................................................................... 34 37
Carrying value of assets of consolidated variable interest entities .................................................................... $ 28,143 $ 29,583
(1) 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 balance sheet in accordance with GAAP.
The debt securities issued by the consolidated trusts 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 the Company's general credit
for a shortage in cash flows.