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| DFS > SEC Filings for DFS > Form 10-K on 25-Jan-2013 | All Recent SEC Filings |
25-Jan-2013
Annual Report
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our audited consolidated financial
statements and related notes included elsewhere in this annual report on
Form 10-K. Some of the information contained in this discussion and analysis
constitutes forward-looking statements that involve risks and uncertainties.
Actual results could differ materially from those discussed in these
forward-looking statements. Factors that could cause or contribute to these
differences include, but are not limited to, those discussed below and elsewhere
in this annual report on Form 10-K particularly under "Risk Factors" and
"Special Note Regarding Forward-Looking Statements," which immediately follows
"Risk Factors." Unless otherwise specified, references to Notes to our
consolidated financial statements are to the Notes to our audited consolidated
financial statements as of November 30, 2012 and 2011 and for the three-year
period ended November 30, 2012.
Introduction and Overview
Discover Financial Services is a direct banking and payment services company.
Through our Discover Bank subsidiary, we offer our customers credit card loans,
private student loans, personal loans and deposit products. Through our Discover
Home Loans, Inc. subsidiary, we offer our customers home loans. Through our DFS
Services LLC subsidiary and its subsidiaries, we operate the Discover Network,
the PULSE network ("PULSE") and Diners Club International ("Diners Club"). The
Discover Network is a payment card transaction processing network for Discover
card-branded and network partner credit, debit and prepaid cards. PULSE operates
an electronic funds transfer network, providing financial institutions issuing
debit cards on the PULSE network with access to ATMs domestically and
internationally, as well as point of sale terminals at retail locations
throughout the U.S. for debit card transactions. Diners Club is a global
payments network of licensees, which are generally financial institutions, that
issue Diners Club branded credit cards and/or provide card acceptance services.
Our primary revenues consist of interest income earned on loan receivables and
fees earned from customers, merchants and issuers. The primary expenses required
to operate our business include funding costs (interest expense), loan loss
provisions, customer rewards, and expenses incurred to grow, manage and service
our loan receivables and networks. Our business activities are funded primarily
through consumer deposits, securitization of loan receivables and the issuance
of unsecured debt.
Change in Fiscal Year
On December 3, 2012, our board of directors approved a change in our fiscal year
end from November 30 to December 31 of each year. The fiscal year change is
effective beginning with our 2013 fiscal year, which began on January 1, 2013
and will end on December 31, 2013. As a result of the change, we will have a
December 2012 fiscal month transition period, the results of which we will
separately report in our quarterly report on Form 10-Q for the quarter ending
March 31, 2013 and in our annual report on Form 10-K for the year ending
December 31, 2013.
Change in Accounting Principle Related to Off-Balance Sheet Securitizations
Beginning with the first quarter of 2010, we have included the trusts used in
our securitization activities in our consolidated financial results in
accordance with the Financial Accounting Standards Board ("FASB") Statement of
Financial Accounting Standards No. 166, Accounting for Transfers of Financial
Assets - an amendment of FASB Statement No. 140 ("Statement No. 166") (codified
under the FASB Accounting Standards Codification ("ASC") Section 860, Transfers
and Servicing) and Statement of Financial Accounting Standards No. 167,
Amendments to FASB Interpretations No. 46(R) ("Statement No. 167") (codified
under ASC Section 810, Consolidation), which were effective for us on
December 1, 2009, the beginning of our 2010 fiscal year.
Under Statement No. 166, the trusts used in our securitization transactions are
no longer exempt from consolidation. Statement No. 167 prescribes an ongoing
assessment of our involvement in the activities of the trusts and our rights or
obligations to receive benefits or absorb losses of the trusts that could be
potentially significant in order to determine whether those entities will be
required to be consolidated in our financial statements. Based on our
assessment, we concluded that we are the primary beneficiary of the Discover
Card Master Trust I ("DCMT") and the Discover Card Execution Note Trust
("DCENT") (the "trusts") and accordingly, we began consolidating the trusts on
December 1, 2009. Using the carrying amounts of the trust assets and liabilities
as prescribed by Statement No. 167, we recorded a $21.1 billion increase in
total assets, a $22.4 billion increase in total liabilities and a $1.3 billion
decrease in stockholders' equity (comprised of a $1.4 billion decrease in
retained earnings offset by an increase of $0.1 billion in accumulated other
comprehensive income). The significant adjustments to our statement of financial
condition upon adoption of Statements No. 166 and 167 are outlined below:
• Consolidation of $22.3 billion of securitized loan receivables and the
related debt issued from the trusts to third-party investors;
• Reclassification of $4.6 billion of certificated retained interests
classified as investment securities to loan receivables;
• Recording of a $2.1 billion allowance for loan losses, not previously
required under GAAP, for the newly consolidated and reclassified credit
card loan receivables;
• Derecognition of the remaining $0.1 billion value of the interest-only
strip receivable, net of tax, recorded in amounts due from asset
securitization and reclassification of the remaining $1.6 billion of
amounts due from asset securitization to restricted cash, loan
receivables and other assets; and
• Recording of net deferred tax assets of $0.8 billion, largely related
to establishing an allowance for loan losses on the newly consolidated
and reclassified credit card loan receivables.
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Beginning with the first quarter of 2010, our results of operations no longer
reflect securitization income, but instead report interest income, net
charge-offs and certain other income associated with all securitized loan
receivables and interest expense associated with debt issued from the trusts to
third-party investors in the same line items in our results of operations as
non-securitized credit card loan receivables and corporate debt. Additionally,
we no longer record initial gains on new securitization activity since
securitized credit card loans no longer receive sale accounting treatment. Also,
there are no gains or losses on the revaluation of the interest-only strip
receivable as that asset is not recognizable in a transaction accounted for as a
secured borrowing. Because our securitization transactions are being accounted
for under the new accounting rules as secured borrowings rather than asset
sales, the cash flows from these transactions are presented as cash flows from
financing activities rather than as cash flows from operating or investing
activities. Notwithstanding this accounting treatment, our securitizations are
structured to legally isolate the receivables from Discover Bank, and we would
not expect to be able to access the assets of our securitization trusts, even in
insolvency, receivership or conservatorship proceedings. We do, however,
continue to have the rights associated with our retained interests in the assets
of these trusts.
Reconciliations of GAAP to Non-GAAP As-Adjusted Data
To enable the reader to better understand our financial information by
reflecting period-over-period data on a consistent basis, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
this report presents our financial information as of and for the years ended
November 30, 2012, 2011 and 2010 and, where necessary, we have also provided
certain information as of and for the years ended November 30, 2009 and 2008 on
a non-GAAP as-adjusted basis. Management believes the non-GAAP as-adjusted
financial information is useful to investors as it aligns with the financial
information used in management's decision-making process and in evaluating the
business.
The non-GAAP as-adjusted amounts related to Statement No. 167 show how our
financial data would have been presented if the trusts used in our
securitization activities were consolidated into our financial statements for
historical periods prior to fiscal year 2010.
The following tables display a reconciliation between GAAP and non-GAAP
as-adjusted amounts that reflect the full impact the consolidation of our trusts
would have had if we had adopted Statement No. 167 retrospectively.
Loan Receivables Data and Reconciliation
As of and for the Year Ended
November 30,
2009 2008
Total Loan Receivables (dollars in millions)
Loan portfolio
GAAP $ 23,625 $ 25,217
Adjustments for Statement No. 167 27,229 25,878
Non-GAAP As-Adjusted $ 50,854 $ 51,095
Loan receivables
GAAP $ 23,625 $ 25,217
Adjustments for Statement No. 167 27,229 25,878
Non-GAAP As-Adjusted $ 50,854 $ 51,095
Allowance for loan losses (beginning of period)
GAAP $ 1,375 $ 760
Adjustments for Statement No. 167 1,379 971
Non-GAAP As-Adjusted $ 2,754 $ 1,731
Provision for loan losses
GAAP $ 2,362 $ 1,596
Adjustments for Statement No. 167 2,761 1,881
Non-GAAP As-Adjusted $ 5,123 $ 3,477
Charge-offs
GAAP $ (2,166 ) $ (1,147 )
Adjustments for Statement No. 167 (2,208 ) (1,714 )
Non-GAAP As-Adjusted $ (4,374 ) $ (2,861 )
Recoveries
GAAP $ 187 $ 166
Adjustments for Statement No. 167 212 241
Non-GAAP As-Adjusted $ 399 $ 407
Net charge-offs
GAAP $ (1,979 ) $ (981 )
Adjustments for Statement No. 167 (1,996 ) (1,473 )
Non-GAAP As-Adjusted $ (3,975 ) $ (2,454 )
Allowance for loan losses (end of period)
GAAP $ 1,758 $ 1,375
Adjustments for Statement No. 167 2,144 1,379
Non-GAAP As-Adjusted $ 3,902 $ 2,754
Net charge-offs %
GAAP 7.45 % 4.59 %
Adjustments for Statement No. 167 0.32 0.42
Non-GAAP As-Adjusted 7.77 % 5.01 %
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As of and for the Year Ended
November 30,
2009 2008
Total Loan Receivables (continued) (dollars in millions)
Loans not accruing interest
GAAP $ 190 $ 173
Adjustments for Statement No. 167 248 194
Non-GAAP As-Adjusted $ 438 $ 367
Delinquency rate (Over 30 Days)
GAAP 4.92 % 4.35 %
Adjustments for Statement No. 167 0.39 0.21
Non-GAAP As-Adjusted 5.31 % 4.56 %
Delinquency rate (Over 90 Days)
GAAP 2.58 % 2.06 %
Adjustments for Statement No. 167 0.20 0.11
Non-GAAP As-Adjusted 2.78 % 2.17 %
Delinquency rate (Loans not accruing interest)
GAAP 0.80 % 0.69 %
Adjustments for Statement No. 167 0.06 0.03
Non-GAAP As-Adjusted 0.86 % 0.72 %
Discover Card
Total Discover Card Loans
GAAP $ 19,826 $ 23,348
Adjustments for Statement No. 167 27,229 25,879
Non-GAAP As-Adjusted $ 47,055 $ 49,227
Total Credit Card Loans
Loan receivables
GAAP $ 20,230 $ 23,814
Adjustments for Statement No. 167 27,229 25,879
Non-GAAP As-Adjusted $ 47,459 $ 49,693
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As of and for the Year Ended
November 30,
2009 2008
(dollars in millions)
Total Credit Card Loans (continued)
Allowance for loan losses (beginning of period)
GAAP $ 1,318 $ 751
Adjustments for Statement No. 167 1,379 971
Non-GAAP As-Adjusted $ 2,697 $ 1,722
Charge-offs
GAAP $ (2,097 ) $ (1,139 )
Adjustments for Statement No. 167 (2,207 ) (1,714 )
Non-GAAP As-Adjusted $ (4,304 ) $ (2,853 )
Recoveries
GAAP $ 186 $ 166
Adjustments for Statement No. 167 212 240
Non-GAAP As-Adjusted $ 398 $ 406
Net charge-offs
GAAP $ (1,911 ) $ (973 )
Adjustments for Statement No. 167 (1,995 ) (1,474 )
Non-GAAP As-Adjusted $ (3,906 ) $ (2,447 )
Allowance for loan losses (end of period)
GAAP $ 1,647 $ 1,318
Adjustments for Statement No. 167 2,145 1,379
Non-GAAP As-Adjusted $ 3,792 $ 2,697
Net charge-offs %
GAAP 7.87 % 4.73 %
Adjustments for Statement No. 167 0.13 0.34
Non-GAAP As-Adjusted 8.00 % 5.07 %
Delinquencies (over 30 Days)
GAAP $ 1,117 $ 1,083
Adjustments for Statement No. 167 1,540 1,234
Non-GAAP As-Adjusted $ 2,657 $ 2,317
Delinquencies (over 90 Days)
GAAP $ 699 $ 594
Adjustments for Statement No. 167 694 509
Non-GAAP As-Adjusted $ 1,393 $ 1,103
Delinquency Rate (over 30 days)
GAAP 5.52 % 4.55 %
Adjustments for Statement No. 167 0.08 0.11
Non-GAAP As-Adjusted 5.60 % 4.66 %
Delinquency Rate (over 90 days)
GAAP 2.92 % 2.16 %
Adjustments for Statement No. 167 0.02 0.06
Non-GAAP As-Adjusted 2.94 % 2.22 %
Restructured loans (A)
GAAP $ 73 $ -
Adjustments for Statement No. 167 145 -
Non-GAAP As-Adjusted $ 218 $ -
Delinquency Rate (Restructured Loans) (A)
GAAP 0.31 % - %
Adjustments for Statement No. 167 0.15 -
Non-GAAP As-Adjusted 0.46 % - %
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(A) Data not available for the year ended November 30, 2008.
Average Balance Sheet Reconciliation
For the Year Ended November 30,
2009 2008
(dollars in millions)
Total average loan receivables
GAAP $ 26,553 $ 21,348
Adjustments for Statement No. 167 24,577 27,663
Non-GAAP As-Adjusted $ 51,130 $ 49,011
Total loans interest yield
GAAP 11.31 % 10.89 %
Adjustments for Statement No. 167 1.09 1.70
Non-GAAP As-Adjusted 12.40 % 12.59 %
Total average credit card loan receivables
GAAP $ 24,267 $ 20,567
Adjustments for Statement No. 167 24,577 27,663
Non-GAAP As-Adjusted $ 48,844 $ 48,230
Credit card interest yield
GAAP 11.69 % 10.92 %
Adjustments for Statement No. 167 0.94 1.71
Non-GAAP As-Adjusted 12.63 % 12.63 %
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2012 Highlights
• Net income was $2.3 billion compared to net income of $2.2 billion in 2011.
• Total loans and credit card loans each grew 6% while Discover card sales volume grew 5% from the prior year.
• Credit card loan delinquencies decreased over the prior year with a delinquency rate for loans over 30 days past due of 1.86%, compared to 2.38% at the end of fiscal 2011. Credit card net charge-offs decreased to 2.62%, compared to the prior year net charge-off rate of 4.47%.
• We began offering residential mortgage loans through Discover Home Loans following our acquisition in June of substantially all of the operating and related assets of Home Loan Center, a subsidiary of Tree.com, Inc.
• Payment Services continued to produce strong results with pretax income of $181 million, up 9% over the prior year. Transaction volume for the segment was $197 billion, an increase of 12% over the prior year.
• We repurchased 34 million shares, or approximately 6%, of our outstanding common stock for $1.2 billion.
• Our capital market activities included issuances of approximately $5.4 billion in public credit card asset-backed securitizations and a $560 million preferred stock issuance. We also completed two private debt exchange offers involving an aggregate $822 million of outstanding debt.
2011 and 2010 Highlights
• In December 2010, we acquired SLC, which added approximately $3.1 billion of
private student loans to our portfolio, and in September 2011, we acquired
approximately $2.4 billion of private student loans from Citi.
• Our revenues were unfavorably impacted in 2011 and 2010 by the implementation of certain provisions of the CARD Act, which included limitations on our ability to reprice accounts, the elimination of overlimit fees and a reduction in the amount of standard late fees.
• We settled our antitrust litigation with Visa and MasterCard for $2.75 billion in 2008. For the years ended November 30, 2009 and 2008, we received a total of $1.9 billion ($1.2 billion after tax) and $0.9 billion ($0.5 billion after tax), respectively, from Visa for its portion of the settlement. At the time of our spin-off, we entered into an agreement with Morgan Stanley to determine how proceeds from the litigation would be shared, among other things. In 2010, we paid Morgan Stanley a dividend of $775 million under an amendment to that agreement.
Recent Developments
• On December 3, 2012, we changed our fiscal year end from November 30 to
December 31. See " - Change in Fiscal Year" above for more information.
• On December 3, 2012, we paid a quarterly cash dividend on our outstanding 575,000 shares of 6.50% Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series B, in the amount of $8.13 per share. The dividend equaled $0.20325 per depositary share, representing a 1/40th interest in a share of the preferred stock. The dividend covered the period from the issuance of the stock on October 16, 2012 through November 30, 2012.
• On January 17, 2013, we paid a cash dividend of $0.14 per share of our common stock, which was an increase from the $0.10 per share dividend that we paid in the previous quarter.
• On January 23, 2013, we announced the declaration of the first full quarterly cash dividend on our preferred stock referenced above in the amount of $16.25 per share, equal to $.40625 per depositary share, to be paid on March 1, 2013 to holders of record on February 14, 2013.
Outlook
Credit performance continued to improve through 2012 as we reached historical
lows in net charge-off rates. Reserve releases contributed to our overall
profitability, but we do not expect to receive a similar benefit of reserve
releases in 2013. We believe investments in marketing contributed to our
receivables growth and, heading into 2013, we are focused on continuing this
trend through new account acquisitions and wallet share gains. We are also
targeting solid growth and strong returns in our private student and personal
loan portfolios. The expansion of our direct banking product offerings remains a
priority and we look forward to launching online checking in early 2013.
We anticipate further total yield compression in 2013 due to the continuing
effects of the CARD Act, an increase in promotional offers and expected growth
in private student loans, which tend to carry lower interest rates and have
lower principal charge-offs than our card receivables. We expect this yield
compression to be somewhat offset by continued funding cost improvements.
Funding costs are expected to continue to decline over the next year as we
benefit from the interest rate
environment and replace higher-priced time deposits with lower cost borrowings.
Net interest margin is expected to remain above our long-term target. As in
2012, we intend to continue to maintain a strong capital level while targeting
investments for future growth and returning capital to shareholders through our
share repurchase program and quarterly dividends.
In our payments business, we continue to explore opportunities to leverage our
network infrastructure. In August 2012, we entered into a service arrangement
with PayPal to utilize our network relationships to obtain access to the
point-of-sale at millions of retail locations of participating merchants, which
is targeted for launch in the second quarter of 2013. We also continue to invest
in global brand awareness and acceptance through support of our Diners Club
network and arrangements with other banks, networks and merchant acquirers. We
expect to see a decline in the rate of PULSE transaction volume growth in 2013
as a result of actions by competitors with regard to merchant and acquirer
pricing and transaction routing strategies.
We continue to monitor the political and economic situation in Europe and work
with our local Diners Club licensees with regard to their ability to maintain
financing sufficient to support business operations. The inability of certain
licensees to maintain operating financing could adversely impact our payment
services business. From time to time, we provide financial assistance to
licensees when we deem it beneficial to our global payments strategy. For
example, we have provided loans to certain licensees and we recently entered
into an agreement to purchase one of our licensees. Such arrangements may cause
us to incur financial losses.
Regulatory Environment and Developments
The Reform Act contains a comprehensive set of provisions designed to govern the
practices and oversight of financial institutions and other participants in the
financial markets. The Reform Act addresses risks to the economy and the
payments system posed by large systemically significant financial firms,
including us, through a variety of measures, including increased capital and
liquidity requirements, limits on leverage, and enhanced supervisory authority.
The Reform Act also established a new financial industry regulator, the CFPB,
and new requirements for debit card transactions, which impact our core
businesses. Additional legislative or regulatory action that may impact our
business may result from the multiple studies mandated under the Reform Act.
. . .
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