Discover 2015 Annual Report Download - page 98

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December 31, 2015, our unused commitments were approximately $178.7 billion. These commitments, substantially all
of which we can terminate at any time and which do not necessarily represent future cash requirements, are
periodically reviewed based on account usage, customer creditworthiness and loan qualification. In addition, in the
ordinary course of business, we guarantee payment on behalf of subsidiaries relating to contractual obligations with
external parties. The activities of the subsidiaries covered by any such guarantees are included in our consolidated
financial statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk refers to the risk that a change in the level of one or more market prices, rates, indices, correlations or
other market factors will result in losses for a position or portfolio. We are exposed to market risk primarily from
changes in interest rates.
Interest Rate Risk
We borrow money from a variety of depositors and institutions in order to provide loans to our customers, as
well as invest in other assets and our business. These loans and other assets earn interest, which we use to pay interest
on the money borrowed. Our net interest income and, therefore, earnings, will be negatively affected if the interest rate
earned on assets increases at a slower pace than increases to the interest rate we owe on our borrowings. Changes in
interest rates and competitor responses to those changes may influence customer payment rates, loan balances or
deposit account activity. We may face higher-cost alternative sources of funding as a result, which has the potential to
decrease earnings.
Our interest rate risk management policies are designed to measure and manage the potential volatility of
earnings that may arise from changes in interest rates by having a financing portfolio that reflects the mix of variable
and fixed-rate assets. To the extent that asset and related financing repricing characteristics of a particular portfolio are
not matched effectively, we may utilize interest rate derivative contracts, such as swap agreements, to achieve our
objectives. Interest rate swap agreements effectively convert the underlying asset or liability from fixed to floating rate or
from floating to fixed rate. See Note 22: Derivatives and Hedging Activities to our consolidated financial statements for
information on our derivatives activity.
We use an interest rate sensitivity simulation to assess our interest rate risk exposure. For purposes of presenting
the possible earnings effect of a hypothetical, adverse change in interest rates over the 12-month period from our
reporting date, we assume that all interest rate sensitive assets and liabilities will be impacted by a hypothetical,
immediate 100 basis point increase in interest rates relative to market consensus expectations as of the beginning of the
period. The sensitivity is based upon the hypothetical assumption that all relevant types of interest rates that affect our
results would increase instantaneously, simultaneously and to the same degree.
Our interest rate sensitive assets include our variable rate loan receivables and the assets that make up our
liquidity portfolio. We have restrictions on our ability to mitigate interest rate risk by adjusting rates on existing balances
and competitive actions may restrict our ability to increase the rates that we charge to customers for new loans. At
December 31, 2015, the majority of our credit card and student loans were at variable rates. Assets with rates that are
fixed at period end but which will mature, or otherwise contractually reset to a market-based indexed rate or other
fixed rate prior to the end of the 12-month period, are considered to be rate sensitive. The latter category includes
certain revolving credit card loans that may be offered at below-market rates for an introductory period, such as
balance transfers and special promotional programs, after which the loans will contractually reprice in accordance with
our normal market-based pricing structure. For purposes of measuring rate sensitivity for such loans, only the effect of
the hypothetical 100 basis point change in the underlying market-based indexed rate has been considered. For assets
that have a fixed interest rate but which contractually will, or are assumed to, reset to a market-based indexed rate or
other fixed rate during the next 12 months, earnings sensitivity is measured from the expected repricing date. In
addition, for all interest rate sensitive assets, earnings sensitivity is calculated net of expected loan losses which for
purposes of this analysis are assumed to remain unchanged relative to our baseline expectations over the analysis
horizon.
Interest rate sensitive liabilities are assumed to be those for which the stated interest rate is not contractually fixed
for the next 12-month period. Thus, liabilities that vary with changes in a market-based index, such as Federal Funds or
LIBOR, which will reset before the end of the 12-month period, or liabilities whose rates are fixed at the fiscal period
end but which will mature and are assumed to be replaced with a market-based indexed rate prior to the end of the