10-Q 1 dfs531201210q.htm FORM 10-Q DFS 5.31.2012 10Q

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended May 31, 2012
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                    to 
                    
Commission File Number 001-33378
DISCOVER FINANCIAL SERVICES
(Exact name of registrant as specified in its charter)
 
Delaware
 
36-2517428
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
2500 Lake Cook Road,
Riverwoods, Illinois 60015
 
(224) 405-0900
(Address of principal executive offices, including zip code)
 
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  S    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  S    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  x
Accelerated filer  o
Non-accelerated filer  o (Do not check if a  smaller reporting company)    
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  S
As of June 22, 2012, there were 514,911,832 shares of the registrant’s Common Stock, par value $0.01 per share, outstanding.
 




DISCOVER FINANCIAL SERVICES
Quarterly Report on Form 10-Q
for the quarterly period ended May 31, 2012
TABLE OF CONTENTS
 
Except as otherwise indicated or unless the context otherwise requires, “Discover Financial Services,” “Discover,” “DFS,” “we,” “us,” “our,” and “the Company” refer to Discover Financial Services and its subsidiaries.
We own or have rights to use the trademarks, trade names and service marks that we use in conjunction with the operation of our business, including, but not limited to: Discover®, PULSE®, Cashback Bonus®, Discover® More® Card, Discover® MotivaSM Card, Discover® Open Road® Card, Discover® Network and Diners Club International®. All other trademarks, trade names and service marks included in this quarterly report on Form 10-Q are the property of their respective owners.



Part I.
FINANCIAL INFORMATION

Item 1.
Financial Statements
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Financial Condition
 
May 31,
2012
 
November 30,
2011
 
(unaudited)
(dollars in thousands,
except share amounts)
Assets
 
 
 
Cash and cash equivalents
$
5,112,069

 
$
2,849,843

Restricted cash
1,802,881

 
1,285,820

Other short-term investments
250

 

Investment securities:

 

Available-for-sale (amortized cost of $6,445,885 and $6,019,927 at May 31, 2012 and November 30, 2011, respectively)
6,557,344

 
6,107,831

Held-to-maturity (fair value of $96,042 and $96,042 at May 31, 2012 and November 30, 2011, respectively)
94,620

 
98,222

Total investment securities
6,651,964

 
6,206,053

Loan receivables:
 
 
 
Loans held for sale

 
714,180

Loan portfolio:
 
 
 
Credit card
46,610,407

 
46,638,625

Other
5,451,930

 
4,733,742

Purchased credit-impaired loans
4,995,320

 
5,250,388

Total loan portfolio
57,057,657

 
56,622,755

Total loan receivables
57,057,657

 
57,336,935

Allowance for loan losses
(1,869,253
)
 
(2,205,196
)
Net loan receivables
55,188,404

 
55,131,739

Premises and equipment, net
492,444

 
483,250

Goodwill
255,421

 
255,421

Intangible assets, net
184,501

 
188,018

Other assets
2,395,471

 
2,383,793

Total assets
$
72,083,405

 
$
68,783,937

Liabilities and Stockholders’ Equity
 
 
 
Deposits:
 
 
 
Interest-bearing deposit accounts
$
41,427,004

 
$
39,463,887

Non-interest bearing deposit accounts
124,282

 
113,575

Total deposits
41,551,286

 
39,577,462

Short-term borrowings

 
50,000

Long-term borrowings
19,023,907

 
18,287,178

Accrued expenses and other liabilities
2,609,354

 
2,627,086

Total liabilities
63,184,547

 
60,541,726

Commitments, contingencies and guarantees (Notes 9, 12, and 13)

 

Stockholders’ Equity:
 
 
 
Common stock, par value $.01 per share; 2,000,000,000 shares authorized; 552,287,795 and 549,748,783 shares issued at May 31, 2012 and November 30, 2011, respectively
5,523

 
5,497

Additional paid-in capital
3,555,104

 
3,507,754

Retained earnings
6,303,466

 
5,243,318

Accumulated other comprehensive loss
(41,016
)
 
(51,679
)
Treasury stock, at cost; 35,047,041 and 20,918,354 shares at May 31, 2012 and November 30, 2011, respectively
(924,219
)
 
(462,679
)
Total stockholders’ equity
8,898,858

 
8,242,211

Total liabilities and stockholders’ equity
$
72,083,405

 
$
68,783,937


The table below presents the carrying amounts of certain assets and liabilities of Discover Financial Services’ consolidated variable interest entities (VIEs) which are included in the condensed consolidated statements of financial condition above. The assets in the table below include those assets that can only be used to settle obligations of the consolidated VIEs. The liabilities in the table below include third party liabilities of consolidated VIEs only, and exclude intercompany balances that eliminate in consolidation. The liabilities also exclude amounts for which creditors have recourse to the general credit of Discover Financial Services.
 
May 31,
2012
 
November 30,
2011
 
(unaudited)
(dollars in thousands)
Assets
 
 
 
Restricted cash
$
1,801,881

 
$
1,274,175

Credit card loan receivables
32,983,831

 
33,815,860

Purchased credit-impaired loans
2,701,874

 
2,839,871

Allowance for loan losses allocated to securitized loan receivables
(1,223,653
)
 
(1,510,730
)
Other assets
30,783

 
33,724

Liabilities
 
 
 
Long-term borrowings
$
17,121,359

 
$
15,842,512

Accrued interest payable
14,269

 
13,184

See Notes to Condensed Consolidated Financial Statements.

1


DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Income

 
For the Three Months Ended
May 31,
 
For the Six Months Ended
May 31,
 
2012
 
2011
 
2012
 
2011
 
(unaudited)
 (dollars in thousands, except per share amounts)
Interest income:
 
 
 
 
 
 
 
Credit card loans
$
1,421,115

 
$
1,403,191

 
$
2,844,921

 
$
2,820,307

Other loans
210,043

 
151,802

 
412,880

 
271,338

Investment securities
19,987

 
14,644

 
37,498

 
26,859

Other interest income
4,473

 
3,641

 
6,878

 
7,738

Total interest income
1,655,618

 
1,573,278

 
3,302,177

 
3,126,242

Interest expense:
 
 
 
 
 
 
 
Deposits
216,458

 
251,170

 
445,231

 
507,865

Short-term borrowings

 
37

 
1

 
83

Long-term borrowings
124,081

 
128,772

 
248,567

 
254,759

Total interest expense
340,539

 
379,979

 
693,799

 
762,707

Net interest income
1,315,079

 
1,193,299

 
2,608,378

 
2,363,535

Provision for loan losses
232,584

 
175,540

 
384,113

 
593,249

Net interest income after provision for loan losses
1,082,495

 
1,017,759

 
2,224,265

 
1,770,286

Other income:
 
 
 
 
 
 
 
Discount and interchange revenue, net
265,324

 
265,826

 
529,635

 
526,742

Protection products revenue
101,194

 
105,116

 
206,055

 
213,669

Loan fee income
77,256

 
80,753

 
161,707

 
166,353

Transaction processing revenue
52,174

 
45,310

 
104,655

 
87,861

Merchant fees
3,523

 
4,216

 
7,228

 
8,871

Gain (loss) on investments
28

 
(149
)
 
28

 
(7
)
Other income
33,641

 
42,772

 
73,335

 
102,979

Total other income
533,140

 
543,844

 
1,082,643

 
1,106,468

Other expense:
 
 
 
 
 
 
 
Employee compensation and benefits
249,357

 
229,826

 
496,082

 
442,901

Marketing and business development
119,012

 
124,181

 
250,441

 
259,846

Information processing and communications
71,448

 
66,588

 
141,911

 
131,305

Professional fees
110,085

 
104,749

 
209,585

 
195,080

Premises and equipment
18,857

 
17,957

 
36,166

 
35,205

Other expense
179,709

 
91,843

 
291,310

 
165,955

Total other expense
748,468

 
635,144

 
1,425,495

 
1,230,292

Income before income tax expense
867,167

 
926,459

 
1,881,413

 
1,646,462

Income tax expense
330,576

 
326,040

 
713,816

 
581,151

Net income
$
536,591

 
$
600,419

 
$
1,167,597

 
$
1,065,311

Net income allocated to common stockholders
$
531,545

 
$
593,488

 
$
1,156,013

 
$
1,052,912

Basic earnings per share
$
1.01

 
$
1.09

 
$
2.19

 
$
1.93

Diluted earnings per share
$
1.00

 
$
1.09

 
$
2.18

 
$
1.93

Dividends paid per share
$
0.10

 
$
0.06

 
$
0.20

 
$
0.08

See Notes to the Condensed Consolidated Financial Statements.

2


DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Comprehensive Income

 
For the Three Months Ended
May 31,
 
For the Six Months Ended
May 31,
 
2012
 
2011
 
2012
 
2011
 
(unaudited)
 (dollars in thousands, except per share amounts)
Net income
$
536,591

 
$
600,419

 
$
1,167,597

 
$
1,065,311

Other comprehensive income, net of taxes
 
 
 
 
 
 
 
Unrealized gain on securities available for sale, net of tax
7,245

 
31,974

 
14,695

 
16,727

Unrealized (loss) gain on cash flow hedges, net of tax
(773
)
 
7,947

 
(2,256
)
 
(878
)
Unrealized pension and post-retirement benefit gain(loss), net of tax
1,116

 

 
(1,776
)
 
341

Other comprehensive income
7,588

 
39,921

 
10,663

 
16,190

Comprehensive income
$
544,179

 
$
640,340

 
$
1,178,260

 
$
1,081,501




See Notes to the Condensed Consolidated Financial Statements.

3


DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Changes in Stockholders’ Equity


 
 
Common Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Treasury
Stock
 
Total
Stockholders’
Equity
 
 
Shares
 
Amount
 
 
 
 
 
 
(unaudited)
(dollars and shares in thousands)
Balance at November 30, 2010
 
547,128

 
$
5,471

 
$
3,435,318

 
$
3,126,488

 
$
(82,548
)
 
$
(27,883
)
 
$
6,456,846

Net income
 

 

 

 
1,065,311

 

 

 
1,065,311

Other comprehensive income
 

 

 

 

 
16,190

 

 
16,190

Purchases of treasury stock
 

 

 

 

 

 
(5,098
)
 
(5,098
)
Common stock issued under employee benefit plans
 
26

 

 
547

 

 

 

 
547

Common stock issued and stock-based compensation expense
 
1,220

 
13

 
33,692

 

 

 

 
33,705

Dividends—common stock
 

 

 

 
(44,201
)
 

 

 
(44,201
)
Balance at May 31, 2011
 
548,374

 
$
5,484

 
$
3,469,557

 
$
4,147,598

 
$
(66,358
)
 
$
(32,981
)
 
$
7,523,300

 
 
 
 
 
 
 
 
 
 
 
 
 
 


Balance at November 30, 2011
 
549,749

 
$
5,497

 
$
3,507,754

 
$
5,243,318

 
$
(51,679
)
 
$
(462,679
)
 
$
8,242,211

Net income
 

 

 

 
1,167,597

 

 

 
1,167,597

Other comprehensive income
 

 

 

 

 
10,663

 

 
10,663

Purchases of treasury stock
 

 

 

 

 

 
(461,540
)
 
(461,540
)
Common stock issued under employee benefit plans
 
28

 

 
828

 

 

 

 
828

Common stock issued and stock based compensation expense
 
2,511

 
26

 
46,522

 

 

 

 
46,548

Dividends—common stock
 

 

 

 
(107,449
)
 

 

 
(107,449
)
Balance at May 31, 2012
 
552,288

 
$
5,523

 
$
3,555,104

 
$
6,303,466

 
$
(41,016
)
 
$
(924,219
)
 
$
8,898,858


See Notes to the Condensed Consolidated Financial Statements.

4


DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Cash Flows
 
For the Six Months Ended
May 31,
 
2012
 
2011
 
(unaudited)

 
(dollars in thousands)
Cash flows from operating activities
 
 
 
Net income
$
1,167,597

 
$
1,065,311

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
384,113

 
593,249

Deferred income taxes
125,654

 
206,679

Depreciation and amortization on premises and equipment
46,569

 
43,993

Amortization of deferred revenues
(102,040
)
 
(123,758
)
Other depreciation and amortization
(74,135
)
 
(53,502
)
(Gain) loss on investments
(28
)
 
7

Loss on equity method and other investments
4,854

 

(Gain) loss on premises and equipment
(494
)
 
123

Loss on sale of other assets
314

 

Loss (gain) on loans sold and held for sale
514

 
(6,085
)
Stock-based compensation expense
24,244

 
22,640

Gain on purchase of business

 
(15,917
)
Changes in assets and liabilities:

 

(Increase) decrease in other assets
(116,869
)
 
58,062

Increase in accrued expenses and other liabilities
42,479

 
427,637

Net cash provided by operating activities
1,502,772

 
2,218,439

Cash flows from investing activities
 
 
 
Maturities of other short-term investments

 
375,000

Purchases of other short-term investments
(250
)
 

Maturities and sales of available-for-sale investment securities
1,089,890

 
621,507

Purchases of available-for-sale investment securities
(1,535,059
)
 
(1,109,470
)
Maturities of held-to-maturity investment securities
3,985

 
11,886

Purchases of held-to-maturity investment securities
(50,736
)
 
(550
)
Proceeds from sale of loans held for sale
270,020

 
14,944

Net principal disbursed on loans originated for investment
(623,137
)
 
(1,242,036
)
Purchase of loan receivables
(282,249
)
 
(464,897
)
Purchase of business, net of cash acquired

 
(401,158
)
Purchase of other investments
(22,125
)
 

(Increase) decrease in restricted cash
(517,061
)
 
546,655

Proceeds from sale of premises and equipment
515

 
13

Purchases of premises and equipment
(55,995
)
 
(49,868
)
Net cash used for investing activities
(1,722,202
)
 
(1,697,974
)
Cash flows from financing activities
 
 
 
Net (decrease) increase in short-term borrowings
(50,000
)
 
100,000

Proceeds from issuance of securitized debt
1,999,773

 
1,500,000

Maturities and repayment of securitized debt
(743,776
)
 
(3,876,294
)
Repayment of long-term borrowings and bank notes
(12,681
)
 
(334,122
)
Premium paid on debt exchange
(114,493
)
 

Proceeds from issuance of common stock
14,602

 
7,153

Purchases of treasury stock
(461,467
)
 
(5,098
)
Net increase in deposits
1,956,685

 
802,624

Dividends paid on common stock
(106,987
)
 
(40,501
)
Net cash provided by (used for) financing activities
2,481,656

 
(1,846,238
)
Net decrease in cash and cash equivalents
2,262,226

 
(1,325,773
)
Cash and cash equivalents, at beginning of period
2,849,843

 
5,098,733

Cash and cash equivalents, at end of period
$
5,112,069

 
$
3,772,960

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid during the period for:
 
 
 
Interest expense
$
637,919

 
$
735,063

Income taxes, net of income tax refunds
$
651,999

 
$
377,076

Non-cash transactions:
 
 
 
Assumption of debt by buyer related to loans sold
$
424,993

 
$

Assumption of SLC debt
$

 
$
2,921,372


See Notes to the Condensed Consolidated Financial Statements.

5


Notes to the Condensed Consolidated Financial Statements
(unaudited)
 
1.
Background and Basis of Presentation
Description of Business. Discover Financial Services (“DFS” or the “Company”) is a direct banking and payment services company. The Company is a bank holding company under the Bank Holding Company Act of 1956 as well as a financial holding company under the Gramm-Leach-Bliley Act and therefore is subject to oversight, regulation and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). Through its Discover Bank subsidiary, a Delaware state-chartered bank, the Company offers its customers credit cards, student loans, personal loans and deposit products. Through its DFS Services LLC subsidiary and its subsidiaries, the Company operates 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 third-party issued 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.
The Company’s business segments are Direct Banking and Payment Services. The Direct Banking segment includes consumer banking and lending products which includes Discover card-branded credit cards issued to individuals and small businesses on the Discover Network and other consumer products and services, including personal loans, student loans, prepaid cards and other consumer lending and deposit products offered through the Company’s Discover Bank subsidiary. The Payment Services segment includes PULSE, Diners Club and the Company’s third-party issuing business, which includes credit, debit and prepaid cards issued on the Discover Network by third parties.
Basis of Presentation. The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated financial statements. In the opinion of management, the financial statements reflect all adjustments which are necessary for a fair presentation of the results for the quarter. All such adjustments are of a normal, recurring nature. The preparation of financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and related disclosures. These estimates are based on information available as of the date of the condensed consolidated financial statements. The Company believes that the estimates used in the preparation of the condensed consolidated financial statements are reasonable. Actual results could differ from these estimates. These interim condensed consolidated financial statements should be read in conjunction with the Company’s 2011 audited consolidated financial statements filed with the Company’s annual report on Form 10-K for the fiscal year ended November 30, 2011.
Recently Issued Accounting Pronouncements. In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. ASU 2011-11 adds certain additional disclosure requirements about financial instruments and derivatives instruments that are subject to netting arrangements. The Company has master netting arrangements pertaining to collateral posting requirements with its interest rate swap counterparties, as more fully discussed in Note 15: Derivatives and Hedging Activities. Additional details about these positions and how they are reported will be disclosed. The new disclosures are required for annual reporting periods beginning on or after January 1, 2013, and interim periods within those periods. Because this amendment impacts disclosures only, it will have no effect on the Company's financial condition, results of operations or cash flows.
In September 2011, the FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2011-08 is intended to simplify goodwill impairment testing by adding a qualitative review step to assess whether the required quantitative impairment analysis that exists today is necessary. Under the amended rule, a company will not be required to calculate the fair value of a business that contains recorded goodwill unless it concludes, based on the qualitative assessment, that it is more likely than not that the fair value of that business is less than its book value. If such a decline in fair value is deemed more likely than not to have occurred, then the quantitative goodwill impairment test that exists under current GAAP must be completed; otherwise, goodwill is deemed to be not impaired and no further testing is required until the next annual test date (or sooner if conditions or events before that date raise concerns of potential impairment in the business). The amended goodwill impairment guidance does not affect the manner in which a company estimates fair value. The new standard is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The Company has $255.4 million in goodwill, all of which is associated with its PULSE Network. The value of that goodwill will not be affected by the adoption of this standard.

6


In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU will require companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements. It eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity. The standard does not change the items which must be reported in other comprehensive income, how such items are measured or when they must be reclassified to net income. The standard is initially effective for the Company with this filing. The FASB subsequently deferred the effective date of certain provisions of this standard pertaining to the reclassification of items out of accumulated other comprehensive income, pending the issuance of further guidance on that matter. Because this ASU impacts presentation only, it has no effect on the Company's financial condition, results of operations or cash flows.
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU is intended to result in convergence between U.S. GAAP and International Financial Reporting Standards (“IFRS”) requirements for measurement of and disclosures about fair value. The amendments are not expected to have a significant impact on companies applying U.S. GAAP. Key provisions of the amendment include: a prohibition on grouping financial instruments for purposes of determining fair value, except when an entity manages market and credit risks on the basis of the entity’s net exposure to the group; an extension of the prohibition against the use of a blockage factor to all fair value measurements (that prohibition previously applied only to financial instruments with quoted prices in active markets); and a requirement that for recurring Level 3 fair value measurements, entities disclose quantitative information about unobservable inputs, a description of the valuation process used and qualitative details about the sensitivity of the measurements. In addition, for items not carried at fair value but for which fair value is disclosed, entities will be required to disclose the level within the fair value hierarchy that applies to the fair value measurement disclosed. This ASU is effective for the Company with this filing. The adoption of this ASU did not have a significant impact on the Company’s fair value measurements, financial condition, results of operations or cash flows.
In April 2011, the FASB issued ASU No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. This ASU amends the sale accounting requirement concerning a transferor’s ability to repurchase transferred financial assets even in the event of default by the transferee, which typically is facilitated in a repurchase agreement by the presence of a collateral maintenance provision. Specifically, the level of cash collateral received by a transferor will no longer be relevant in determining whether a repurchase agreement constitutes a sale. As a result of this amendment, more repurchase agreements will be treated as secured financings rather than sales. This ASU became effective for the Company on March 1, 2012. Because essentially all repurchase agreements entered into by the Company have historically been deemed to constitute secured financing transactions, this amendment is expected to have no impact on the Company’s characterization of such transactions and therefore is not expected to have any impact on the Company's financial condition, results of operations or cash flows.

2.
Business Combinations
Acquisition of The Student Loan Corporation. On December 31, 2010, the Company acquired The Student Loan Corporation (“SLC”), which is now a wholly-owned subsidiary of Discover Bank and included in the Company’s Direct Banking segment. The Company acquired SLC’s ongoing private student loan business, which includes certain private student loans held in three securitization trusts and other assets, and assumed SLC’s asset-backed securitization debt incurred by those trusts and other liabilities. The acquired loans are considered to be purchased credit-impaired ("PCI") loans for accounting purposes, the details of which are discussed further in Note 4: Loan Receivables. The acquisition significantly increased the size of the Company’s private student loan portfolio. In addition, the acquisition has provided the Company with a developed student loan business platform, additional school relationships and SLC’s website. Since the acquisition date, the results of operations and cash flows of SLC have been included in the Company’s condensed consolidated results of operations and cash flows. Pro forma data is not provided as the impact of the SLC acquisition was not significant to the Company’s condensed consolidated results of operations or cash flows.

7


Net cash consideration paid. The following table provides a calculation of the amount paid by the Company for SLC based on the net assets of the SLC securitization trusts acquired after applying an 8.5% discount to the trust assets (the “Trust Certificate Purchase Price”) (dollars in millions):

 
Actual
 
Gross trust assets
$
3,977

Less: 8.5% discount
(338
)
Net trust assets
3,639

Less: Principal amount of and accrued interest on trust debt
(3,193
)
Trust Certificate Purchase Price
$
446


Although the Company paid SLC shareholders $600 million for the acquisition of SLC (“Aggregate Merger Consideration”), the Company received a purchase price adjustment from Citibank, N.A. (“Citibank”) equivalent to the amount by which the Aggregate Merger Consideration exceeded the value of the Trust Certificate Purchase Price. In addition, Citibank agreed to adjust the cash consideration paid by the Company to compensate it for (i) agreeing to commute certain insurance policies covering certain of the loans acquired and (ii) the value of non-trust related liabilities assumed by the Company. The following table provides a summary of total consideration paid by Discover including post-closing adjustments (dollars in millions): 
 
Actual
 
Aggregate Merger Consideration
$
600

Less: Purchase price adjustment
(154
)
Trust Certificate Purchase Price
446

Less: Further adjustments provided for by Citibank
 
Cash received for consent to insurance commutation
(16
)
Cash received related to reimbursable liabilities
(29
)
Net cash consideration paid
$
401


Net assets acquired. The Company acquired net assets (including $155 million of cash) with an aggregate fair value of $563 million in exchange for cash consideration of $556 million, resulting in the recognition of a bargain purchase gain of approximately $7 million. The bargain purchase gain primarily resulted from Citibank’s adjustment of the cash consideration to be paid by the Company in exchange for the Company’s consent to permit SLC to commute, immediately prior to the acquisition, certain student loan insurance policies covering loans in one of the three trusts. The bargain purchase gain is recorded in other income on the Company’s condensed consolidated statement of income. During the fourth quarter of 2011, the Company finalized its purchase accounting, which resulted in a decrease of $27 million in the indemnification asset and a $19 million increase in student loan receivables. In addition, there were immaterial changes made to the other assets purchased and liabilities assumed. These adjustments reflect the Company's finalized cash flow projections related to the student loans acquired. The offset to these adjustments resulted in a $9 million reduction in the originally estimated bargain purchase gain of $16 million.

8


The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of the SLC acquisition (dollars in thousands):

 
At December 31,
2010

Student loan receivables
$
3,070,042

Cash
155,347

Indemnification asset
74,571

Student relationships intangible
2,400

Trade name intangible
3,800

Total intangible assets
6,200

Other assets
217,441

Total assets acquired
3,523,601

Securitized debt
2,921,372

Other liabilities
38,889

Total liabilities assumed
2,960,261

Net assets acquired
$
563,340

The Company acquired $6.2 million in identifiable intangible assets. These intangible assets consist of student relationships and trade name intangibles. Acquired student relationships consist of those relationships in existence between SLC and the numerous students that carry student loan balances. This intangible asset is deemed to have a finite useful life of five years and will be amortized over this period. Trade name intangibles relate to trademarks, trade names and internet domains and content. This intangible asset is deemed to have an indefinite useful life and therefore is not subject to amortization.
The Company also recorded a $75 million indemnification asset. This asset reflects the discounted present value of payments expected to be received under Citibank’s indemnification of student loan credit losses that would have been recoverable under certain student loan insurance policies which, as noted above, were commuted pursuant to an agreement entered into by SLC with the Company’s consent immediately prior to the acquisition. The indemnification pertains only to loans in one of the three SLC securitization trusts that the Company acquired, namely the SLC Private Student Loan Trust 2010-A (“SLC 2010-A”). The SLC 2010-A trust included loans with an aggregate outstanding principal balance of $1.2 billion at the time of acquisition; outstanding loans in that trust totaled $1.1 billion as of May 31, 2012. The initial value of the indemnification asset was based on the amount of projected credit losses expected to be reimbursed by Citibank. Under the terms of the indemnification agreement with Citibank, indemnification payments related to student loan credit losses are subject to an overall cap of $166.8 million, consistent with the terms of the insurance policies which the indemnification serves to replace.
The subsequent accounting for the indemnification asset will generally reflect the manner in which the indemnified loans are subsequently measured. The value of the indemnification asset will increase or decrease as expected credit losses on the PCI student loans increase or decrease, respectively. An increase in expected losses on PCI student loans that results in the immediate recognition of an allowance for loan losses will result in an immediate increase in the indemnification asset. A decrease in expected losses that results in an immediate reversal of a previously recognized loan loss allowance will result in the immediate reduction of the indemnification asset. Recognition of an allowance for loan losses on PCI student loans is discussed in more detail within Note 4: Loan Receivables under “Purchased Credit-Impaired Loans.” To the extent that a decrease in expected losses results in a prospective increase in the accretable yield on PCI student loans rather than an immediate reduction of the loan loss allowance, the value of the indemnification asset will be adjusted prospectively through a reduction in the rate of amortization. Amortization and valuation adjustments to the indemnification asset are recorded through other income on the condensed consolidated statement of income.









9


3.
Investments
The Company’s investment securities consist of the following (dollars in thousands):

 
May 31,
2012
 
November 30,
2011
U.S. Treasury securities
$
2,661,307

 
$
2,563,800

U.S. government agency securities
2,467,241

 
2,795,223

States and political subdivisions of states
38,841

 
40,936

Other securities:
 
 
 
Credit card asset-backed securities of other issuers
180,263

 
299,889

Corporate debt securities(1)
221,337

 
449,469

To-be-announced investment securities

 
50,254

Residential mortgage-backed securities - Agency (2)
1,082,975

 
6,482

Total other securities
1,484,575

 
806,094

Total investment securities
$
6,651,964

 
$
6,206,053

____________________
(1)
Amount represents corporate debt obligations issued under the Temporary Liquidity Guarantee Program (TLGP) that are guaranteed by the Federal Deposit Insurance Corporation (FDIC).
(2)
Consists of residential mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae.

10


The amortized cost, gross unrealized gains and losses, and fair value of available-for-sale and held-to-maturity investment securities are as follows (dollars in thousands): 

 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
At May 31, 2012
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S. Treasury securities
$
2,609,613

 
$
51,207

 
$
(63
)
 
$
2,660,757

U.S. government agency securities
2,421,354

 
45,887

 

 
2,467,241

Credit card asset-backed securities of other issuers
176,223

 
4,040

 

 
180,263

Corporate debt securities
221,029

 
308

 

 
221,337

Residential mortgage-backed securities - Agency
1,017,666

 
10,080

 

 
1,027,746

Total available-for-sale investment securities
$
6,445,885

 
$
111,522

 
$
(63
)
 
$
6,557,344

Held-to-Maturity Investment Securities(2)
 
 
 
 
 
 
 
U.S. Treasury securities(3)
$
550

 
$

 
$

 
$
550

States and political subdivisions of states
38,841

 
172

 
(626
)
 
38,387

Residential mortgage-backed securities - Agency (4)  
55,229

 
1,876

 

 
57,105

Total held-to-maturity investment securities
$
94,620

 
$
2,048

 
$
(626
)
 
$
96,042

At November 30, 2011
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S. Treasury securities
$
2,516,008

 
$
47,242

 
$

 
$
2,563,250

U.S. government agency securities
2,762,265

 
34,166

 
(1,208
)
 
2,795,223

Credit card asset-backed securities of other issuers
293,231

 
6,658

 

 
299,889

Corporate debt securities
448,423

 
1,066

 
(20
)
 
449,469

Total available-for-sale investment securities
$
6,019,927

 
$
89,132

 
$
(1,228
)
 
$
6,107,831

Held-to-Maturity Investment Securities(2)
 
 
 
 
 
 
 
U.S. Treasury securities(3)
$
550

 
$

 
$

 
$
550

States and political subdivisions of states
40,936

 
197

 
(2,823
)
 
38,310

Residential mortgage-backed securities - Agency (4)  
6,482

 
650

 

 
7,132

To-be-announced investment securities
50,254

 

 
(204
)
 
50,050

Total held-to-maturity investment securities
$
98,222

 
$
847

 
$
(3,027
)
 
$
96,042

_________________________
(1)
Available-for-sale investment securities are reported at fair value.
(2)
Held-to-maturity investment securities are reported at amortized cost.
(3)
Amount represents securities pledged as collateral to a government-related merchant for which transaction settlement occurs beyond the normal 24-hour period.
(4)
Amounts represent residential mortgage-backed securities that were classified as held-to-maturity as they were entered into as a part of the Company's community reinvestment initiatives.

11


The following table provides information about investment securities with aggregate gross unrealized losses and the length of time that individual investment securities have been in a continuous unrealized loss position as of May 31, 2012 and November 30, 2011 (dollars in thousands):

 
Number of
Securities
in a Loss
Position
 
Less than 12 months
 
More than 12 months
 
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
At May 31, 2012
 
 
 
 
 
 
 
 
 
Available-for-Sale Investment Securities
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
1

 
$
99,785

 
$
63

 
$

 
$

Held-to-Maturity Investment Securities
 
 
 
 
 
 
 
 
 
State and political subdivisions of states
3

 
$
1,730

 
$
20

 
$
12,504

 
$
606

At November 30, 2011
 
 
 
 
 
 
 
 
 
Available-for-Sale Investment Securities
 
 
 
 
 
 
 
 
 
U.S. government agency securities
2

 
$
242,898

 
$
1,208

 
$

 
$

Corporate debt securities
3

 
$
100,041

 
$
20

 
$

 
$

Held-to-Maturity Investment Securities
 
 
 
 
 
 
 
 
 
State and political subdivisions of states
6

 
$
2,689

 
$
46

 
$
27,768

 
$
2,777

To-be-announced investment securities
2

 
$
50,050

 
$
204

 
$

 
$


During the three and six months ended May 31, 2012, the Company received $599.7 million and $1.1 billion of proceeds related to maturities, redemptions, or liquidation of investment securities, as compared to $291.4 million and $633.4 million for the three and six months ended May 31, 2011.
During the three and six months ended May 31, 2012, and during the three months ended May 31, 2011, there were no sales of securities. During the six months ended May 31, 2011, the Company received $161 thousand of proceeds and recorded $146 thousand of gross realized gains relating primarily to the sale of equity securities.
The Company records unrealized gains and losses on its available-for-sale investment securities in other comprehensive income. For the three and six months ended May 31, 2012, the Company recorded net unrealized gains of $11.6 million ($7.2 million after tax) and $23.6 million ($14.7 million after tax), respectively, in other comprehensive income. For the three and six months ended May 31, 2011, the Company recorded net unrealized gains of $51.1 million ($32.0 million after tax) and $26.7 million ($16.7 million after tax), respectively, in other comprehensive income.
At May 31, 2012 and November 30, 2011, the Company had $606 thousand and $2.8 million, respectively, of gross unrealized losses in a continuous loss position for more than 12 months on its held-to-maturity investment securities in states and political subdivisions of states. The Company believes the unrealized loss on these investments is the result of changes in interest rates subsequent to the Company’s acquisitions of these securities and that the reduction in value is temporary. The Company does not intend to sell these investments nor does it expect to be required to sell these investments before recovery of their amortized cost basis, as they were entered into as a part of the Company's community reinvestment initiatives. The Company expects to collect all amounts due according to the contractual terms of these securities.
 

12


Contractual maturities of available-for-sale debt securities and held-to-maturity debt securities at May 31, 2012 are provided in the table below (dollars in thousands): 

 
One Year
or
Less
 
After One
Year
Through
Five Years
 
After Five
Years
Through
Ten Years
 
After Ten
Years
 
Total
Available-for-sale—Amortized Cost (1)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
263,776

 
$
2,345,837

 
$

 
$

 
$
2,609,613

U.S. government agency securities
447,232

 
1,974,122

 

 

 
2,421,354

Credit card asset-backed securities of other issuers
122,237

 
53,986

 

 

 
176,223

Corporate debt securities
221,029

 

 

 

 
221,029

Residential mortgage-backed securities - Agency

 

 
345,109

 
672,557

 
1,017,666

Total available-for-sale investment securities
$
1,054,274

 
$
4,373,945

 
$
345,109

 
$
672,557

 
$
6,445,885

Held-to-maturity—Amortized Cost (2)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
550

 
$

 
$

 
$

 
$
550

State and political subdivisions of states
680

 
2,470

 
2,425

 
33,266

 
38,841

Residential mortgage-backed securities - Agency(3)

 

 

 
55,229

 
55,229

Total held-to-maturity investment securities
$
1,230

 
$
2,470

 
$
2,425

 
$
88,495

 
$
94,620

Available-for-sale—Fair Values (1)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
264,040

 
$
2,396,717

 
$

 
$

 
$
2,660,757

U.S. government agency securities
448,385

 
2,018,856

 

 

 
2,467,241

Credit card asset-backed securities of other issuers
124,255

 
56,008

 

 

 
180,263

Corporate debt securities
221,337

 

 

 

 
221,337

Residential mortgage-backed securities - Agency

 

 
347,108

 
680,638

 
1,027,746

Total available-for-sale investment securities
$
1,058,017

 
$
4,471,581

 
$
347,108

 
$
680,638

 
$
6,557,344

Held-to-maturity—Fair Values (2)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
550

 
$

 
$

 
$

 
$
550

State and political subdivisions of states
681

 
2,451

 
2,542

 
32,713

 
38,387

Residential mortgage-backed securities - Agency(3)

 

 

 
57,105

 
57,105

Total held-to-maturity investment securities
$
1,231

 
$
2,451

 
$
2,542

 
$
89,818

 
$
96,042

____________________
(1)
Available-for-sale investment securities are reported at fair value.
(2)
Held-to-maturity investment securities are reported at amortized cost.
(3)
Amounts represent residential mortgage-backed securities that were classified as held-to-maturity as they were entered into as a part of the Company's Community Reinvestment Act initiatives.

Other Investments. As a part of the Company's community reinvestment initiatives, the Company has made equity investments in certain limited partnerships and limited liability companies that finance the construction and rehabilitation of affordable rental housing, as well as stimulate economic development in low to moderate income communities. These investments are accounted for using the equity method of accounting, and are recorded within other assets, and the related commitment for future investments is recorded in other liabilities within the statement of financial condition. The portion of each investment's operating results allocable to the Company is recorded in other expense within the statement of income. The Company earns a return primarily through the receipt of tax credits allocated to the affordable housing projects and the community revitalization projects. These investments are not consolidated as the Company does not have a controlling financial interest in the entities. As of May 31, 2012 and November 30, 2011, the Company had outstanding investments of $158.8 million and $137.9 million, respectively, in these entities, and the related contingent liability was $14.9 million and $6.3 million, respectively.


13


4.
Loan Receivables
The Company has three portfolio segments: credit card loans, other loans and PCI student loans acquired in the SLC transaction (See Note 2: Business Combinations) and in a separate portfolio acquisition from Citibank. Within these portfolio segments, the Company has classes of receivables which are depicted in the table below (dollars in thousands): 
 
May 31,
2012
 
November 30,
2011
Loans held for sale(1)
$

 
$
714,180

Loan portfolio:
 
 
 
Credit card loans:
 
 
 
Discover card(2)
46,400,847

 
46,419,544

Discover business card
209,560

 
219,081

Total credit card loans
46,610,407

 
46,638,625

Other loans:
 
 
 
Personal loans
2,916,171

 
2,648,051

Private student loans
2,509,158

 
2,069,001

Other
26,601

 
16,690

Total other loans
5,451,930

 
4,733,742

PCI student loans(3)
4,995,320

 
5,250,388

Total loan portfolio
57,057,657

 
56,622,755

Total loan receivables
57,057,657

 
57,336,935

Allowance for loan losses
(1,869,253
)
 
(2,205,196
)
Net loan receivables
$
55,188,404

 
$
55,131,739

 ____________________________
(1)
Amount represents federal student loans. At November 30, 2011, $446.6 million of federal student loan receivables were pledged as collateral against a long-term borrowing. During first quarter 2012, Discover Bank sold these loans and recorded a loss of $518 thousand. As a part of this transaction, the related borrowings were assumed by the purchaser.
(2)
Amounts include $20.3 billion and $18.5 billion underlying investors’ interest in trust debt at May 31, 2012 and November 30, 2011, respectively, and $12.7 billion and $15.4 billion in seller’s interest at May 31, 2012 and November 30, 2011, respectively. See Note 5: Credit Card and Student Loan Securitization Activities for further information.
(3)
Amounts include $2.7 billion and $2.8 billion of loans pledged as collateral against the notes issued from the SLC securitization trusts at May 31, 2012 and November 30, 2011, respectively. See Note 5: Credit Card and Student Loan Securitization Activities. Of the remaining $2.3 billion and $2.5 billion at May 31, 2012 and November 30, 2011, respectively, that were not pledged as collateral, approximately $14.2 million and $12.8 million represent loans eligible for reimbursement through an indemnification claim. Discover Bank must purchase such loans from the trust before a claim may be filed.
Credit Quality Indicators. The Company regularly reviews its collection experience (including delinquencies and net charge-offs) in determining its allowance for loan losses. Credit card and closed-end consumer loan receivables are placed on nonaccrual status upon receipt of notification of the bankruptcy or death of a customer or suspected fraudulent activity on an account. Upon completion of the fraud investigation, loan receivables may resume accruing interest.

14


Information related to the delinquencies and net charge-offs in the Company’s loan portfolio, which excludes loans held for sale, is shown below by each class of loan receivables except for PCI student loans, which is shown under the heading “Purchased Credit-Impaired Loans” (dollars in thousands): 

Delinquent and Non-Accruing Loans:
 
 
 
 
 
 
 
 
 
  
30-89 Days
Delinquent
 
90 or
More Days
Delinquent
 
Total Past
Due
 
90 or
More Days
Delinquent
and
Accruing
 
Total
Non-accruing(2)
At May 31, 2012
 
 
 
 
 
 
 
 
 
Credit card loans:
 
 
 
 
 
 
 
 
 
Discover card(1)
$
428,513

 
$
456,373

 
$
884,886

 
$
401,966

 
$
186,091

Discover business card
2,091

 
2,986

 
5,077

 
2,770

 
625

Total credit card loans
430,604

 
459,359

 
889,963

 
404,736

 
186,716

Other loans:
 
 
 
 
 
 
 
 
 
Personal loans
14,933

 
8,014

 
22,947

 
7,277

 
3,445

Private student loans (excluding PCI)
20,683

 
4,980

 
25,663

 
4,290

 
924

Other
288

 
1,489

 
1,777

 

 
1,753

Total other loans (excluding PCI)
35,904

 
14,483

 
50,387

 
11,567

 
6,122

Total loan receivables (excluding PCI)
$
466,508

 
$
473,842

 
$
940,350

 
$
416,303

 
$
192,838

At November 30, 2011
 
 
 
 
 
 
 
 
 
Credit card loans:
 
 
 
 
 
 
 
 
 
Discover card(1)
$
554,354

 
$
556,126

 
$
1,110,480

 
$
498,305

 
$
200,208

Discover business card
2,823

 
3,548

 
6,371

 
3,335

 
860

Total credit card loans
557,177

 
559,674

 
1,116,851

 
501,640

 
201,068

Other loans:
 
 
 
 
 
 
 
 
 
Personal loans
15,604

 
7,362

 
22,966

 
6,636

 
3,628

Private student loans (excluding PCI)
10,073

 
2,992

 
13,065

 
2,883

 
125

Other
507

 
2,091

 
2,598

 

 
2,317

Total other loans (excluding PCI)
26,184

 
12,445

 
38,629

 
9,519

 
6,070

Total loan receivables (excluding PCI)(3)
$
583,361

 
$
572,119

 
$
1,155,480

 
$
511,159

 
$
207,138

______________________ 
(1)
Consumer credit card loans that are 90 or more days delinquent and accruing interest include $35.3 million and $37.9 million of loans accounted for as troubled debt restructurings at May 31, 2012 and November 30, 2011, respectively.
(2)
The Company estimates that the gross interest income that would have been recorded in accordance with the original terms of these credit card loans was $8.3 million and $16.7 million for the three and six months ended May 31, 2012, respectively. The Company does not separately track the amount of gross interest income that would have been recorded in accordance with the original terms of loans. These amounts were estimated based on customers' current balances and most recent rates.
(3)
At November 30, 2011, amounts also exclude federal student loans that were held for sale.


    

15


Net Charge-offs. The Company's net charge-offs include the principal amount of losses charged off less principal recoveries and exclude charged-off interest and fees, recoveries of interest and fees and fraud losses. Charged-off and recovered interest and fees are recorded in interest and loan fee income, respectively, which is effectively a reclassification of the loan loss provision, while fraud losses are recorded in other expense. Credit card loan receivables are charged off at the end of the month during which an account becomes 180 days contractually past due. Closed-end consumer loan receivables are generally charged off at the end of the month during which an account becomes 120 days contractually past due. Generally, customer bankruptcies and probate accounts are charged off at the end of the month 60 days following the receipt of notification of the bankruptcy or death but not later than the 180-day or 120-day contractual time frame. 

Net Charge-Offs:
For the Three Months Ended May 31,
 
2012
 
2011
  
Net
Charge-offs
 
Net Charge-off
Rate
 
Net
Charge-offs
 
Net Charge-off
Rate
Credit card loans:
 
 
 
 
 
 
 
Discover card
$
319,691

 
2.79
%
 
$
553,827

 
4.99
%
Discover business card
1,864

 
3.53
%
 
4,896

 
8.22
%
Total credit card loans
321,555

 
2.79
%
 
558,723

 
5.01
%
Other loans:
 
 
 
 
 
 
 
Personal loans
16,065

 
2.24
%
 
15,347

 
2.88
%
Private student loans (excluding PCI)
4,187

 
0.67
%
 
2,030

 
0.51
%
Other
115

 
1.72
%
 
579

 
17.33
%
Total other loans (excluding PCI)
20,367

 
1.51
%
 
17,956

 
1.59
%
Net charge-offs as a percentage of total loans (excluding PCI)
$
341,922

 
2.66
%
 
$
576,679

 
4.69
%
Net charge-offs as a percentage of total loans (including PCI)
$
341,922

 
2.42
%
 
$
576,679

 
4.42
%
 
 
 
 
 
 
 
 
 
For the Six Months Ended May 31,
 
2012
 
2011
  
Net
Charge-offs
 
Net Charge-off
Rate
 
Net
Charge-offs
 
Net Charge-off
Rate
Credit card loans:
 
 
 
 
 
 
 
Discover card
$
675,058

 
2.93
%
 
$
1,215,070

 
5.46
%
Discover business card
4,200

 
3.95
%
 
11,429

 
9.33
%
Total credit card loans
679,258

 
2.93
%
 
1,226,499

 
5.48
%
Other loans:
 
 
 
 
 
 
 
Personal loans
33,655

 
2.41
%
 
34,981

 
3.46
%
Private student loans (excluding PCI)
6,976

 
0.59
%
 
2,954

 
0.41
%
Other
167

 
1.44
%
 
613

 
8.98
%
Total other loans (excluding PCI)
40,798

 
1.50
%
 
38,548

 
1.82
%
Net charge-offs as a percentage of total loans (excluding PCI)
$
720,056

 
2.78
%
 
$
1,265,047

 
5.17
%
Net charge-offs as a percentage of total loans (including PCI)
$
720,056

 
2.53
%
 
$
1,265,047

 
4.92
%



16


As part of credit risk management activities, on an ongoing basis the Company reviews information related to the performance of a customer’s account with the Company as well as information from credit bureaus, such as a FICO or other credit scores, relating to the customer’s broader credit performance. Credit scores are generally obtained at origination of the account and are refreshed monthly or quarterly thereafter to assist us in predicting customer behavior.  Historically, the Company has noted that a significant proportion of delinquent accounts have FICO scores below 660. The following table provides FICO scores available for the Company’s customers as a percentage of each class of loan receivables: 
 
May 31, 2012
 
November 30, 2011
 
660 and Above
 
Less than 660
or No Score
 
660 and Above
 
Less than 660
or No Score
Discover card
82
%
 
18
%
 
81
%
 
19
%
Discover business card
90
%
 
10
%
 
89
%
 
11
%
Personal loans
97
%
 
3
%
 
97
%
 
3
%
Private student loans (excluding PCI)(1)
95
%
 
5
%
 
95
%
 
5
%
____________________ 
(1)
PCI loans are discussed under the heading "Purchased Credit-Impaired Loans."

For private student loans, additional credit risk management activities include monitoring the amount of loans in forbearance. Forbearance allows borrowers experiencing temporary financial difficulties and willing to make payments the ability to temporarily suspend payments. Eligible borrowers have a lifetime cap on forbearance of 12 months. At May 31, 2012 and November 30, 2011, there were $84.5 million and $75.9 million of loans in forbearance, respectively. In addition, at May 31, 2012 and November 30, 2011, there were 1.7% and 1.5% of private student loans in forbearance as a percentage of student loans in repayment and forbearance.
Allowance for Loan Losses. The Company maintains an allowance for loan losses at an appropriate level to absorb probable losses inherent in the loan portfolio. The Company considers the collectibility of all amounts contractually due on its loan receivables, including those components representing interest and fees. Accordingly, the allowance for loan losses represents the estimated uncollectible principal, interest and fee components of loan receivables. The allowance is evaluated monthly and is maintained through an adjustment to the provision for loan losses. Charge-offs of principal amounts of loans outstanding are deducted from the allowance and subsequent recoveries of such amounts increase the allowance. Charge-offs of loan balances representing unpaid interest and fees result in a reversal of interest and fee income, respectively, which is effectively a reclassification of provision for loan losses.
The Company bases its allowance for loan losses on several analyses that help estimate incurred losses as of the balance sheet date. While the Company’s estimation process includes historical data and analysis, there is a significant amount of judgment applied in selecting inputs and analyzing the results produced by the models to determine the allowance. The Company uses a migration analysis to estimate the likelihood that a loan will progress through the various stages of delinquency. The loan balances used in the migration analysis represent all amounts contractually due and, as a result, the migration analysis captures principal, interest and fee components in estimating uncollectible accounts. The Company uses other analyses to estimate losses incurred on 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. The Company does not evaluate loans for impairment on an individual basis, but instead estimates its allowance for loan losses on a pooled basis, which includes loans that are delinquent and/or no longer accruing interest and/or defaulted from a loan modification program, as discussed below under the section entitled "Impaired Loans and Troubled Debt Restructurings."

17


The following table provides changes in the Company’s allowance for loan losses for the three and six months ended May 31, 2012 and 2011 (dollars in thousands): 
 
For the Three Months Ended
May 31,
 
For the Six Months Ended
May 31,
 
2012
 
2011
 
2012
 
2011
Balance at beginning of period
$
1,978,591

 
$
3,033,459

 
$
2,205,196

 
$
3,304,118

Additions:
 
 
 
 
 
 
 
Provision for loan losses
232,584

 
175,540

 
384,113

 
593,249

Deductions:
 
 
 
 
 
 
 
Charge-offs:
 
 
 
 
 
 
 
Discover card
(474,233
)
 
(708,287
)
 
(971,338
)
 
(1,500,919
)
Discover business card
(2,807
)
 
(5,869
)
 
(5,917
)
 
(13,255
)
Total credit card loans
(477,040
)
 
(714,156
)
 
(977,255
)
 
(1,514,174
)
Personal loans
(16,905
)
 
(15,931
)
 
(35,133
)
 
(35,981
)
Private student loans
(4,296
)
 
(2,044
)
 
(7,163
)
 
(2,983
)
Other
(120
)
 
(580
)
 
(172
)
 
(615
)
Total other loans
(21,321
)
 
(18,555
)
 
(42,468
)
 
(39,579
)
Total charge-offs
(498,361
)
 
(732,711
)
 
(1,019,723
)
 
(1,553,753
)
Recoveries:
 
 
 
 
 
 
 
Discover card
154,542

 
154,460

 
296,280

 
285,849

Discover business card
943

 
973

 
1,717

 
1,826

Total credit card loans
155,485

 
155,433

 
297,997

 
287,675

Personal loans
840

 
584

 
1,478

 
1,000

Private student loans
109

 
14

 
187

 
29

Other
5

 
1

 
5

 
2

Total other loans
954

 
599

 
1,670

 
1,031

Total recoveries
156,439

 
156,032

 
299,667

 
288,706

Net charge-offs
(341,922
)
 
(576,679
)
 
(720,056
)
 
(1,265,047
)
Balance at end of period
$
1,869,253

 
$
2,632,320

 
$
1,869,253

 
$
2,632,320


Net charge-offs of principal are recorded against the allowance for loan losses, as shown in the table above. Information regarding net charge-offs of interest and fee revenues on credit card and other loans is as follows (dollars in thousands): 
 
For the Three Months Ended
May 31,
 
For the Six Months Ended
May 31,
 
2012
 
2011
 
2012
 
2011
Interest accrued subsequently charged off, net of recoveries (recorded as a reduction of interest income)
$
92,035

 
$
163,494

 
$
195,403

 
$
351,715

Fees accrued subsequently charged off, net of recoveries (recorded as a reduction to other income)
$
17,825

 
$
28,584

 
$
37,658

 
$
63,954

 

18


The following table provides additional detail of the Company’s allowance for loan losses and recorded investment in its loan portfolio (which excludes loans held for sale) by impairment methodology (dollars in thousands): 
 
Credit Card
 
Personal
Loans
 
Student
Loans
 
Other
Loans
 
Total
At May 31, 2012
 
 
 
 
 
 
 
 
 
Allowance for loans evaluated for impairment as:
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment(1)
$
1,515,403

 
$
86,373

 
$
63,003

 
$
213

 
$
1,664,992

Troubled debt restructurings(2)
197,257

 
4,574

 
2,430

 

 
204,261

Purchased credit-impaired(3)

 

 

 

 

Total allowance for loan losses
$
1,712,660

 
$
90,947

 
$
65,433

 
$
213

 
$
1,869,253

Recorded investment in loans evaluated for impairment as:
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment(1)
$
45,445,166

 
$
2,901,686

 
$
2,499,526

 
$
26,601

 
$
50,872,979

Troubled debt restructurings(2)
1,165,241

 
14,485

 
9,632

 

 
1,189,358

Purchased credit-impaired(3)

 

 
4,995,320

 

 
4,995,320

Total recorded investment
$
46,610,407

 
$
2,916,171

 
$
7,504,478

 
$
26,601