10-Q 1 dfs630201410q.htm 10-Q DFS 6.30.2014 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 June 30, 2014
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  x    No  o
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  x    No  o
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  o    No  x
As of July 28, 2014, there were 461,904,399 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 June 30, 2014
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 Cashback CheckingSM, Discover® More® Card, Discover it®, 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
 
June 30,
2014
 
December 31,
2013
 
(unaudited)
(dollars in millions,
except share amounts)
Assets
 
 
 
Cash and cash equivalents
$
6,879

 
$
6,554

Restricted cash
305

 
182

Investment securities:
 
 
 
Available-for-sale (amortized cost of $3,952 and $4,900 at June 30, 2014 and December 31, 2013, respectively)
4,000

 
4,931

Held-to-maturity (fair value of $71 and $58 at June 30, 2014 and December 31, 2013, respectively)
70

 
60

Total investment securities
4,070

 
4,991

Loan receivables:
 
 
 
Mortgage loans held for sale, measured at fair value
129

 
148

Loan portfolio:
 
 
 
Credit card
52,742

 
53,150

Other
9,089

 
8,295

Purchased credit-impaired loans
3,915

 
4,178

Total loan portfolio
65,746

 
65,623

Total loan receivables
65,875

 
65,771

Allowance for loan losses
(1,614
)
 
(1,648
)
Net loan receivables
64,261

 
64,123

Premises and equipment, net
665

 
654

Goodwill
284

 
284

Intangible assets, net
179

 
185

Other assets
2,294

 
2,367

Total assets
$
78,937

 
$
79,340

Liabilities and Stockholders’ Equity
 
 
 
Deposits:
 
 
 
Interest-bearing deposit accounts
$
44,245

 
$
44,766

Non-interest bearing deposit accounts
200

 
193

Total deposits
44,445

 
44,959

Short-term borrowings
120

 
140

Long-term borrowings
20,057

 
20,474

Accrued expenses and other liabilities
2,934

 
2,958

Total liabilities
67,556

 
68,531

Commitments, contingencies and guarantees (Notes 8, 11, and 12)

 

Stockholders’ Equity:
 
 
 
Common stock, par value $0.01 per share; 2,000,000,000 shares authorized; 558,095,924 and 555,349,629 shares issued at June 30, 2014 and December 31, 2013, respectively
5

 
5

Preferred stock, par value $0.01 per share; 200,000,000 shares authorized; 575,000 shares issued or outstanding and aggregate liquidation preference of $575 at June 30, 2014 and December 31, 2013
560

 
560

Additional paid-in capital
3,758

 
3,687

Retained earnings
10,659

 
9,611

Accumulated other comprehensive loss
(72
)
 
(68
)
Treasury stock, at cost; 92,793,813 and 83,105,578 shares at June 30, 2014 and December 31, 2013, respectively
(3,529
)
 
(2,986
)
Total stockholders’ equity
11,381

 
10,809

Total liabilities and stockholders’ equity
$
78,937

 
$
79,340

 
 
 
 
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.
 
June 30,
2014
 
December 31,
2013
 
(unaudited)
(dollars in millions)
Assets
 
 
 
Restricted cash
$
301

 
$
179

Credit card loan receivables
$
29,715

 
$
31,112

Purchased credit-impaired loans
$
2,106

 
$
2,248

Allowance for loan losses allocated to securitized loan receivables
$
(804
)
 
$
(861
)
Other assets
$
37

 
$
34

Liabilities
 
 
 
Long-term borrowings
$
16,165

 
$
16,986

Accrued interest payable
$
9

 
$
9

 
 
 
 

See Notes to the Condensed Consolidated Financial Statements.
1



DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Income
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
 (unaudited)
(dollars in millions, except per share amounts)
Interest income:
 
 
 
 
 
 
 
Credit card loans
$
1,560

 
$
1,463

 
$
3,097

 
$
2,914

Other loans
282

 
241

 
557

 
475

Investment securities
17

 
19

 
33

 
39

Other interest income
4

 
4

 
9

 
7

Total interest income
1,863

 
1,727

 
3,696

 
3,435

Interest expense:
 
 
 
 
 
 
 
Deposits
151

 
184

 
304

 
370

Short-term borrowings

 
1

 
1

 
2

Long-term borrowings
123

 
112

 
239

 
223

Total interest expense
274

 
297

 
544

 
595

Net interest income
1,589

 
1,430

 
3,152

 
2,840

Provision for loan losses
360

 
240

 
632

 
399

Net interest income after provision for loan losses
1,229

 
1,190

 
2,520

 
2,441

Other income:
 
 
 
 
 
 
 
Discount and interchange revenue, net
327

 
308

 
581

 
571

Protection products revenue
78

 
88

 
161

 
176

Loan fee income
80

 
76

 
163

 
157

Transaction processing revenue
46

 
47

 
90

 
100

Gain on investments

 

 
4

 
3

Gain on origination and sale of mortgage loans
22

 
51

 
38

 
102

Other income
30

 
41

 
61

 
84

Total other income
583

 
611

 
1,098

 
1,193

Other expense:
 
 
 
 
 
 
 
Employee compensation and benefits
301

 
285

 
608

 
575

Marketing and business development
168

 
185

 
337

 
354

Information processing and communications
87

 
85

 
171

 
163

Professional fees
112

 
101

 
211

 
205

Premises and equipment
22

 
20

 
45

 
39

Other expense
107

 
144

 
209

 
237

Total other expense
797

 
820

 
1,581

 
1,573

Income before income tax expense
1,015

 
981

 
2,037

 
2,061

Income tax expense
371

 
379

 
762

 
786

Net income
$
644

 
$
602

 
$
1,275

 
$
1,275

Net income allocated to common stockholders
$
630

 
$
588

 
$
1,248

 
$
1,247

Basic earnings per common share
$
1.35

 
$
1.20

 
$
2.66

 
$
2.53

Diluted earnings per common share
$
1.35

 
$
1.20

 
$
2.66

 
$
2.52

Dividends declared per common share
$
0.24

 
$
0.20

 
$
0.44

 
$
0.20

 
 
 
 
 
 
 
 

See Notes to the Condensed Consolidated Financial Statements.
2



DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Comprehensive Income
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
 
 (unaudited)
(dollars in millions)
Net income
$
644

 
$
602

 
$
1,275

 
$
1,275

Other comprehensive income (loss), net of taxes
 
 
 
 
 
 
 
Unrealized gain (loss) on securities available for sale, net of tax
8

 
(31
)
 
10

 
(42
)
Unrealized (loss) gain on cash flow hedges, net of tax
(10
)
 
8

 
(14
)
 
7

Other comprehensive loss
(2
)
 
(23
)
 
(4
)
 
(35
)
Comprehensive income
$
642

 
$
579

 
$
1,271

 
$
1,240

 
 
 
 
 
 
 
 

See Notes to the Condensed Consolidated Financial Statements.
3



DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Changes in Stockholders’ Equity
 
 
 
 
 
 
 
 
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Treasury
Stock
 
Total
Stockholders’
Equity
 
Preferred Stock
 
Common Stock
 
 
 
 
 
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
(unaudited)
(dollars in millions, shares in thousands)
Balance at December 31, 2012
575

 
$
560

 
553,351

 
$
5

 
$
3,598

 
$
7,472

 
$
(72
)
 
$
(1,690
)
 
$
9,873

Net income

 

 

 

 

 
1,275

 

 

 
1,275

Other comprehensive loss

 

 

 

 

 

 
(35
)
 

 
(35
)
Purchases of treasury stock

 

 

 

 

 

 

 
(599
)
 
(599
)
Common stock issued under employee benefit plans

 

 
36

 

 
2

 

 

 

 
2

Common stock issued and stock-based compensation expense

 

 
1,607

 

 
50

 

 

 

 
50

Dividends — common stock

 

 

 

 

 
(99
)
 

 

 
(99
)
Dividends — preferred stock

 

 

 

 

 
(19
)
 

 

 
(19
)
Balance at June 30, 2013
575

 
$
560

 
554,994

 
$
5

 
$
3,650

 
$
8,629

 
$
(107
)
 
$
(2,289
)
 
$
10,448

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2013
575

 
$
560

 
555,350

 
$
5

 
$
3,687

 
$
9,611

 
$
(68
)
 
$
(2,986
)
 
$
10,809

Net income

 

 

 

 

 
1,275

 

 

 
1,275

Other comprehensive loss

 

 

 

 

 

 
(4
)
 

 
(4
)
Purchases of treasury stock

 

 

 

 

 

 

 
(543
)
 
(543
)
Common stock issued under employee benefit plans

 

 
30

 

 
2

 

 

 

 
2

Common stock issued and stock-based compensation expense

 

 
2,716

 

 
69

 

 

 

 
69

Dividends — common stock

 

 

 

 

 
(208
)
 

 

 
(208
)
Dividends — preferred stock

 

 

 

 

 
(19
)
 

 

 
(19
)
Balance at June 30, 2014
575

 
$
560

 
558,096

 
$
5

 
$
3,758

 
$
10,659

 
$
(72
)
 
$
(3,529
)
 
$
11,381

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

See Notes to the Condensed Consolidated Financial Statements.
4



DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Cash Flows
 
For the Six Months Ended June 30,
 
2014
 
2013
 
(unaudited)
(dollars in millions)
Cash flows from operating activities
 
 
 
Net income
$
1,275

 
$
1,275

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
632

 
399

Deferred income taxes
48

 
163

Depreciation and amortization on premises and equipment
61

 
56

Amortization of deferred revenues
(105
)
 
(94
)
Other depreciation and amortization
120

 
107

Accretion of accretable yield on acquired loans
(134
)
 
(139
)
Gain on investments
(4
)
 
(3
)
Loss on equity method and other investments
12

 
8

Gain on origination and sale of loans
(38
)
 
(102
)
Stock-based compensation expense
32

 
31

Proceeds from sale of mortgage loans originated for sale
1,162

 
2,618

Net principal disbursed on mortgage loans originated for sale
(1,103
)
 
(2,445
)
Changes in assets and liabilities:
 
 
 
Increase in other assets
(70
)
 
(86
)
(Decrease) increase in accrued expenses and other liabilities
(117
)
 
299

Net cash provided by operating activities
1,771

 
2,087

 
 
 
 
Cash flows from investing activities
 
 
 
Maturities and sales of available-for-sale investment securities
1,331

 
1,280

Purchases of available-for-sale investment securities
(244
)
 
(89
)
Maturities of held-to-maturity investment securities
8

 
17

Purchases of held-to-maturity investment securities
(18
)
 
(1
)
Net principal (disbursed) repaid on loans originated for investment
(545
)
 
578

Purchases of loan receivables

 
(136
)
Purchases of other investments
(34
)
 
(53
)
Increase in restricted cash
(123
)
 
(247
)
Purchases of premises and equipment
(73
)
 
(117
)
Net cash provided by investing activities
302

 
1,232

 
 
 
 
Cash flows from financing activities
 
 
 
Net decrease in short-term borrowings
(20
)
 
(109
)
Proceeds from issuance of securitized debt
2,650

 
2,700

Maturities and repayment of securitized debt
(3,492
)
 
(3,103
)
Proceeds from issuance of other long-term borrowings
399

 
750

Payment of contingent consideration for purchase of net assets of a business, at fair value

 
(9
)
Proceeds from issuance of common stock
2

 
7

Purchases of treasury stock
(543
)
 
(601
)
Net (decrease) increase in deposits
(516
)
 
393

Dividends paid on common and preferred stock
(228
)
 
(187
)
Net cash used for financing activities
(1,748
)
 
(159
)
Net increase in cash and cash equivalents
325

 
3,160

Cash and cash equivalents, at beginning of period
6,554

 
2,584

Cash and cash equivalents, at end of period
$
6,879

 
$
5,744

 
 
 
 

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 card loans, private student loans, personal loans, home equity loans and deposit products. Through its Discover Home Loans, Inc. subsidiary, the Company offers its customers home loans. 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 branded credit cards and credit, debit and prepaid cards, issued by third parties, which the Company refers to as network partners. 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 that issue Diners Club branded charge 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, specifically Discover branded credit cards issued to individuals and small businesses on the Discover Network and other consumer products and services, including private student loans, personal loans, home loans, home equity loans, prepaid cards and other consumer lending and deposit products. The majority of Direct Banking revenues relate to interest income earned on the segment's loan products. Additionally, the Company's credit card products generate substantially all revenues related to discount and interchange, protection products and loan fee income.
The Payment Services segment includes PULSE, Diners Club and the Company’s network partners business, which includes credit, debit and prepaid cards issued on the Discover Network by third parties. This segment also includes the business operations of Diners Club Italy, which primarily consist of issuing Diners Club charge cards. The majority of Payment Services revenues relate to transaction processing revenue from PULSE and royalty and licensee revenue (included in other income) from Diners Club.
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 interim period. 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 2013 audited consolidated financial statements filed with the Company’s annual report on Form 10-K for the calendar year ended December 31, 2013.
Recently Issued Accounting Pronouncements.
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). The guidance in this update supersedes existing revenue recognition requirements in Topic 605, Revenue Recognition, including an assortment of transaction-specific and industry-specific rules. The ASU establishes a principles-based model under which revenue from a contract is allocated to the distinct performance obligations within the contract and recognized in income as each performance obligation is satisfied. ASU Topic 606 does not apply to rights or obligations associated with financial instruments (for example, interest income from loans or investments, or interest expense on debt), and therefore the Company’s net interest income should not be affected. The Company’s revenue from discount and interchange, protection products, transaction processing, and certain fees are within the scope of these rules. Management has not yet completed its evaluation of the impact, if any, of the new guidance on these revenues. The new revenue recognition model will become effective for the Company on January 1, 2017. Upon adoption in 2017, the Company will record an adjustment to retained earnings as of the beginning of the year of initial application, which can be either the earliest comparative period presented, with all periods presented under the new rules, or January 1, 2017, without restating prior periods presented. Management has not yet determined which transition reporting option it will apply.
In January 2014, the FASB issued ASU No. 2014-01, Investments-Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects. This standard will permit a reporting entity to make an accounting policy election to account for investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under this new method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). This treatment will replace the effective yield method currently permitted for certain investments of this kind. The Company has not historically utilized the effective yield method, and as a result, implementation of this ASU will not impact the Company’s accounting for its investments in qualified affordable housing projects unless a subsequent election is made to apply it. In addition to establishing the conditions under which the proportional amortization method can be used, the ASU calls for additional disclosures that will enable the reader to understand the nature of the investment and the effect of its measurement and related tax credits on the company’s financial position and results of operations. The new guidance is effective for annual reporting periods beginning after December 15, 2014 and interim periods within those periods, with early adoption permitted. The standard will require additional disclosure about the nature of the Company's affordable housing investments, but unless the Company subsequently decides to elect the new accounting model, the new guidance will have no effect on the Company’s financial condition, results of operations or cash flows.
2.
Investments
The Company’s investment securities consist of the following (dollars in millions):
 
June 30,
2014
 
December 31,
2013
U.S. Treasury securities(1)
$
1,341

 
$
2,058

U.S. government agency securities
1,043

 
1,561

States and political subdivisions of states
10

 
15

Other securities:
 
 
 
Credit card asset-backed securities of other issuers

 
6

Residential mortgage-backed securities - Agency(2)
1,676

 
1,351

Total other securities
1,676

 
1,357

Total investment securities
$
4,070

 
$
4,991

 
 
 
 
(1)
Includes $6 million and $9 million of U.S. Treasury securities that have been pledged as swap collateral in lieu of cash as of June 30, 2014 and December 31, 2013, respectively.
(2)
Consists of residential mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae.

6


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 millions):
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
At June 30, 2014
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S. Treasury securities
$
1,319

 
$
21

 
$

 
$
1,340

U.S. government agency securities
1,024

 
19

 

 
1,043

Residential mortgage-backed securities - Agency
1,609

 
11

 
(3
)
 
1,617

Total available-for-sale investment securities
$
3,952

 
$
51

 
$
(3
)
 
$
4,000

Held-to-Maturity Investment Securities(2)
 
 
 
 
 
 
 
U.S. Treasury securities(3)
$
1

 
$

 
$

 
$
1

States and political subdivisions of states
10

 

 

 
10

Residential mortgage-backed securities - Agency(4)  
59

 
1

 

 
60

Total held-to-maturity investment securities
$
70

 
$
1

 
$

 
$
71

 
 
 
 
 
 
 
 
At December 31, 2013
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S. Treasury securities
$
2,030

 
$
27

 
$

 
$
2,057

U.S. government agency securities
1,535

 
26

 

 
1,561

Credit card asset-backed securities of other issuers
6

 

 

 
6

Residential mortgage-backed securities - Agency
1,329

 

 
(22
)
 
1,307

Total available-for-sale investment securities
$
4,900

 
$
53

 
$
(22
)
 
$
4,931

Held-to-Maturity Investment Securities(2)
 
 
 
 
 
 
 
U.S. Treasury securities(3)
$
1

 
$

 
$

 
$
1

States and political subdivisions of states
15

 

 
(1
)
 
14

Residential mortgage-backed securities - Agency(4)  
44

 

 
(1
)
 
43

Total held-to-maturity investment securities
$
60

 
$

 
$
(2
)
 
$
58

 
 
 
 
 
 
 
 
(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.
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 (dollars in millions):
 
Number of
Securities
in a Loss
Position
 
Less than 12 months
 
More than 12 months
 
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
At June 30, 2014
 
 
 
 
 
 
 
 
 
Available-for-Sale Investment Securities
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities - Agency
11

 
$
55

 
$

 
$
503

 
$
(3
)
 
 
 
 
 
 
 
 
 
 
At December 31, 2013
 
 
 
 
 
 
 
 
 
Available-for-Sale Investment Securities
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities - Agency
23

 
$
1,097

 
$
(20
)
 
$
48

 
$
(2
)
Held-to-Maturity Investment Securities
 
 
 
 
 
 
 
 
 
State and political subdivisions of states
4

 
$
8

 
$
(1
)
 
$
3

 
$

Residential mortgage-backed securities - Agency
2

 
$
40

 
$
(1
)
 
$

 
$

 
 
 
 
 
 
 
 
 
 

7


The Company records gains and losses on investment securities in other income when investments are sold or liquidated, when the Company believes an investment is other than temporarily impaired prior to the disposal of the investment, or in certain other circumstances. Gains and losses on sales of available-for-sale investment securities are calculated using the specific identification method and were recorded entirely in earnings. The Company recognized gains on sales of available-for-sale investment securities in other comprehensive income. There were no gains or losses related to other-than-temporary impairments during the three and six months ended June 30, 2014 and 2013, respectively.
The following table provides information about proceeds related to maturities and redemptions of investment securities and proceeds from sales, recognized gains and losses, and net unrealized gains and losses on available-for-sale securities (dollars in millions):
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Proceeds related to maturities or redemptions of investment securities
$
59

 
$
269

 
$
119

 
$
578

Proceeds from the sales of available-for-sale investment securities, comprised of U.S. Treasury securities and U.S. government agency securities
$

 
$

 
$
1,220

 
$
719

Gains on sales of available-for-sale investment securities
$

 
$

 
$
4

 
$
2

Net unrealized gains (losses) recorded in other comprehensive income, before-tax
$
13

 
$
(51
)
 
$
16

 
$
(67
)
Net unrealized gains (losses) recorded in other comprehensive income, after-tax
$
8

 
$
(31
)
 
$
10

 
$
(42
)
 
 
 
 
 
 
 
 
Maturities of available-for-sale debt securities and held-to-maturity debt securities at the end of the period are provided in the table below (dollars in millions):
 
One Year
or
Less
 
After One
Year
Through
Five Years
 
After Five
Years
Through
Ten Years
 
After Ten
Years
 
Total
At June 30, 2014
 
 
 
 
 
 
 
 
 
Available-for-Sale—Amortized Cost(1)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
367

 
$
952

 
$

 
$

 
$
1,319

U.S. government agency securities
102

 
922

 

 

 
1,024

Residential mortgage-backed securities - Agency

 

 
548

 
1,061

 
1,609

Total available-for-sale investment securities
$
469

 
$
1,874

 
$
548

 
$
1,061

 
$
3,952

Held-to-Maturity—Amortized Cost(2)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
1

 
$

 
$

 
$

 
$
1

State and political subdivisions of states

 

 

 
10

 
10

Residential mortgage-backed securities - Agency

 

 

 
59

 
59

Total held-to-maturity investment securities
$
1

 
$

 
$

 
$
69

 
$
70

Available-for-Sale—Fair Values(1)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
371

 
$
969

 
$

 
$

 
$
1,340

U.S. government agency securities
102

 
941

 

 

 
1,043

Residential mortgage-backed securities - Agency

 

 
550

 
1,067

 
1,617

Total available-for-sale investment securities
$
473

 
$
1,910

 
$
550

 
$
1,067

 
$
4,000

Held-to-Maturity—Fair Values(2)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
1

 
$

 
$

 
$

 
$
1

State and political subdivisions of states

 

 

 
10

 
10

Residential mortgage-backed securities - Agency

 

 

 
60

 
60

Total held-to-maturity investment securities
$
1

 
$

 
$

 
$
70

 
$
71

 
 
 
 
 
 
 
 
 
 
(1)
Available-for-sale investment securities are reported at fair value.
(2)
Held-to-maturity investment securities are reported at amortized cost.
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

8


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 accrued expenses and 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 condensed consolidated 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 June 30, 2014 and December 31, 2013, the Company had outstanding investments in these entities of $309 million and $308 million, respectively, and related contingent liabilities of $37 million and $52 million, respectively.
3.
Loan Receivables
The Company has three portfolio segments: credit card loans, other loans and purchased credit-impaired ("PCI") student loans.
The Company's classes of receivables within the three portfolio segments are depicted in the table below (dollars in millions):
 
June 30,
2014
 
December 31,
2013
Mortgage loans held for sale(1)
$
129

 
$
148

Loan portfolio:
 
 
 
Credit card loans:
 
 
 
Discover card(2)
52,542

 
52,952

Discover business card
200

 
198

Total credit card loans
52,742

 
53,150

Other loans:
 
 
 
Personal loans
4,579

 
4,191

Private student loans
4,336

 
3,969

Other
174

 
135

Total other loans
9,089

 
8,295

Purchased credit-impaired loans(3)
3,915

 
4,178

Total loan portfolio
65,746

 
65,623

Total loan receivables
65,875

 
65,771

Allowance for loan losses
(1,614
)
 
(1,648
)
Net loan receivables
$
64,261

 
$
64,123

 
 
 
 
(1)
Substantially all mortgage loans held for sale are pledged as collateral against the warehouse line of credit used to fund consumer residential loans.
(2)
Amounts include $20.0 billion and $20.2 billion underlying investors’ interest in trust debt at June 30, 2014 and December 31, 2013, respectively, and $9.7 billion and $10.9 billion in seller's interest at June 30, 2014 and December 31, 2013, respectively. See Note 4: Credit Card and Student Loan Securitization Activities for further information.
(3)
Amounts include $2.1 billion and $2.2 billion of loans pledged as collateral against the notes issued from the Student Loan Corporation ("SLC") securitization trusts at June 30, 2014 and December 31, 2013. See Note 4: Credit Card and Student Loan Securitization Activities. Of the remaining $1.8 billion and $2.0 billion at June 30, 2014 and December 31, 2013, respectively, that were not pledged as collateral, approximately $22 million for each period represents 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, non-fraudulent credit card and closed-end consumer loan receivables may resume accruing interest.

9


Information related to the delinquent and non-accruing loans 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 millions):
  
30-89 Days
Delinquent
 
90 or
More Days
Delinquent
 
Total Past
Due
 
90 or
More Days
Delinquent
and
Accruing
 
Total
Non-accruing(1)
At June 30, 2014
 
 
 
 
 
 
 
 
 
Credit card loans:
 
 
 
 
 
 
 
 
 
Discover card(2)
$
439

 
$
418

 
$
857

 
$
379

 
$
165

Discover business card
1

 
2

 
3

 
1

 
1

Total credit card loans
440

 
420

 
860

 
380

 
166

Other loans:
 
 
 
 
 
 
 
 
 
Personal loans(3)
22

 
8

 
30

 
8

 
5

Private student loans (excluding PCI)(4)
51

 
21

 
72

 
21

 

Other

 
2

 
2

 

 
27

Total other loans (excluding PCI)
73

 
31

 
104

 
29

 
32

Total loan receivables (excluding PCI)
$
513

 
$
451

 
$
964

 
$
409

 
$
198

 
 
 
 
 
 
 
 
 
 
At December 31, 2013
 
 
 
 
 
 
 
 
 
Credit card loans:
 
 
 
 
 
 
 
 
 
Discover card(2)
$
464

 
$
445

 
$
909

 
$
406

 
$
154

Discover business card
1

 
2

 
3

 
2

 
1

Total credit card loans
465

 
447

 
912

 
408

 
155

Other loans:
 
 
 
 
 
 
 
 
 
Personal loans(3)
21

 
8

 
29

 
8

 
5

Private student loans (excluding PCI)(4)
48

 
18

 
66

 
18

 

Other
1

 
2

 
3

 

 
40

Total other loans (excluding PCI)
70

 
28

 
98

 
26

 
45

Total loan receivables (excluding PCI)
$
535

 
$
475

 
$
1,010

 
$
434

 
$
200

 
 
 
 
 
 
 
 
 
 
 
(1)
The Company estimates that the gross interest income that would have been recorded in accordance with the original terms of non-accruing credit card loans was $6 million and $7 million for the three months ended June 30, 2014 and 2013, respectively, and was $13 million and $15 million for the six months ended June 30, 2014 and 2013, respectively. The Company does not separately systematically compute the amount of gross interest income that would have been recorded in accordance with the original terms of loans. This amount was estimated based on customers' quarterly average balances and rates prior to non-accrual status.
(2)
Consumer credit card loans that are 90 or more days delinquent and accruing interest include $37 million and $41 million of loans accounted for as troubled debt restructurings at June 30, 2014 and December 31, 2013, respectively.
(3)
Personal loans that are 90 or more days delinquent and accruing interest include $1 million and $2 million of loans accounted for as troubled debt restructurings at June 30, 2014 and December 31, 2013, respectively.
(4)
Private student loans that are 90 or more days delinquent and accruing interest include $3 million of loans accounted for as troubled debt restructurings at June 30, 2014 and December 31, 2013.

10


Net Charge-offs
The Company's net charge-offs include the principal amount of loans 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 income 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. Personal loans and private student loans, which are 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.
Information related to the 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 millions):
 
For the Three Months Ended June 30,
 
2014
 
2013
  
Net
Charge-offs
 
Net 
Charge-off
Rate
 
Net
Charge-offs
 
Net 
Charge-off
Rate
Credit card loans:
 
 
 
 
 
 
 
Discover card
$
299

 
2.33
%
 
$
284

 
2.34
%
Discover business card
1

 
1.68
%
 
2

 
2.14
%
Total credit card loans
300

 
2.33
%
 
286

 
2.34
%
Other loans:
 
 
 
 
 
 
 
Personal loans
22

 
1.95
%
 
19

 
2.24
%
Private student loans (excluding PCI)
14

 
1.30
%
 
13

 
1.58
%
Other
1

 
0.90
%
 

 
%
Total other loans (excluding PCI)
37

 
1.59
%
 
32

 
1.83
%
Net charge-offs as a percentage of total loans (excluding PCI)
$
337

 
2.22
%
 
$
318

 
2.27
%
Net charge-offs as a percentage of total loans (including PCI)
$
337

 
2.08
%
 
$
318

 
2.10
%
 
 
 
 
 
 
 
For the Six Months Ended June 30,
 
2014
 
2013
  
Net
Charge-offs
 
Net 
Charge-off
Rate
 
Net
Charge-offs
 
Net 
Charge-off
Rate
Credit card loans:
 
 
 
 
 
 
 
Discover card
$
592

 
2.33
%
 
$
570

 
2.35
%
Discover business card
2

 
1.72
%
 
3

 
2.40
%
Total credit card loans
594

 
2.32
%
 
573

 
2.35
%
Other loans:
 
 
 
 
 
 
 
Personal loans
43

 
2.01
%
 
38

 
2.27
%
Private student loans (excluding PCI)
28

 
1.31
%
 
20

 
1.21
%
Other
1

 
1.07
%
 

 
%
Total other loans (excluding PCI)
72

 
1.63
%
 
58

 
1.67
%
Net charge-offs as a percentage of total loans (excluding PCI)
$
666

 
2.22
%
 
$
631

 
2.26
%
Net charge-offs as a percentage of total loans (including PCI)
$
666

 
2.08
%
 
$
631

 
2.09
%
 
 
 
 
 
 
 
 
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 FICO or other credit scores, relating to the customer’s broader credit performance. FICO scores are generally obtained at origination of the account and are refreshed monthly or quarterly thereafter to assist in predicting customer behavior. Historically, the Company has noted that a significant proportion of delinquent accounts have FICO scores below 660.

11


 The following table provides the most recent FICO scores available for the Company’s customers as a percentage of each class of loan receivables:
 
Credit Risk Profile
by FICO Score
 
660 and 
Above
 
Less than 660
or No Score
At June 30, 2014
 
 
 
Discover card
83
%
 
17
%
Discover business card
93
%
 
7
%
Personal loans
97
%
 
3
%
Private student loans (excluding PCI)(1)
96
%
 
4
%
 
 
 
 
At December 31, 2013
 
 
 
Discover card
83
%
 
17
%
Discover business card
92
%
 
8
%
Personal loans
97
%
 
3
%
Private student loans (excluding PCI)(1)
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, but still willing to make payments, the ability to temporarily suspend payments. Eligible borrowers have a lifetime cap on forbearance of 12 months. At June 30, 2014 and December 31, 2013, there were $52 million and $110 million of private student loans, including PCI, in forbearance, respectively. In addition, at June 30, 2014 and December 31, 2013, there were 0.9% and 1.9% of private student loans in forbearance as a percentage of student loans in repayment and forbearance, respectively. At June 30, 2014, the dollar amount of loans in forbearance and loans in forbearance as a percentage of private student loans in repayment and forbearance were lower when compared to December 31, 2013 due the implementation of temporary reduced payment programs, which normally consist of a reduction of the minimum payment for a period of no longer than 12 months at a time. Loans in these programs are not considered to be in 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 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, 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 primarily estimates its allowance for loan losses on a pooled basis, which includes loans that are delinquent and/or no longer accruing interest and/or certain loans that have defaulted from a loan modification program, as discussed below under the section entitled "— Troubled Debt Restructurings." Certain other loans, including non-performing Diners Club licensee loans, are individually evaluated for impairment.

12


The following tables provide changes in the Company’s allowance for loan losses (dollars in millions): 
 
For the Three Months Ended June 30, 2014
 
Credit Card
 
Personal Loans
 
Student Loans
 
Other
 
Total
Balance at beginning of period
$
1,342

 
$
109

 
$
122

 
$
18

 
$
1,591

Additions:
 
 
 
 
 
 
 
 
 
Provision for loan losses
317

 
22

 
20

 
1

 
360

Deductions:
 
 
 
 
 
 
 
 
 
Charge-offs
(415
)
 
(24
)
 
(15
)
 
(1
)
 
(455
)
Recoveries
115

 
2

 
1

 

 
118

Net charge-offs
(300
)
 
(22
)
 
(14
)
 
(1
)
 
(337
)
Balance at end of period
$
1,359

 
$
109

 
$
128

 
$
18

 
$
1,614

 
 
 
 
 
 
 
 
 
 
 
For the Three Months Ended June 30, 2013
 
Credit Card
 
Personal Loans
 
Student Loans
 
Other
 
Total
Balance at beginning of period
$
1,453

 
$
97

 
$
83

 
$
1

 
$
1,634

Additions:
 
 
 
 
 
 
 
 
 
Provision for loan losses
193

 
20

 
12

 
15

 
240

Deductions:
 
 
 
 
 
 
 
 
 
Charge-offs
(417
)
 
(22
)
 
(14
)
 

 
(453
)
Recoveries
131

 
3

 
1

 

 
135

Net charge-offs
(286
)
 
(19
)
 
(13
)
 

 
(318
)
Balance at end of period
$
1,360

 
$
98

 
$
82

 
$
16

 
$
1,556

 
 
 
 
 
 
 
 
 
 
 
For the Six Months Ended June 30, 2014
 
Credit Card
 
Personal Loans
 
Student Loans
 
Other
 
Total
Balance at beginning of period
$
1,406

 
$
112

 
$
113

 
$
17

 
$
1,648

Additions:
 
 
 
 
 
 
 
 
 
Provision for loan losses
547

 
40

 
43

 
2

 
632

Deductions:
 
 
 
 
 
 
 
 
 
Charge-offs
(823
)
 
(48
)
 
(30
)
 
(1
)
 
(902
)
Recoveries
229

 
5

 
2

 

 
236

Net charge-offs
(594
)
 
(43
)
 
(28
)
 
(1
)
 
(666
)
Balance at end of period
$
1,359

 
$
109

 
$
128

 
$
18

 
$
1,614

 
 
 
 
 
 
 
 
 
 
 
For the Six Months Ended June 30, 2013
 
Credit Card
 
Personal Loans
 
Student Loans
 
Other
 
Total
Balance at beginning of period
$
1,613

 
$
99

 
$
75

 
$
1

 
$
1,788

Additions:
 
 
 
 
 
 
 
 
 
Provision for loan losses
320

 
37

 
27