10-Q 1 dfs930201610q.htm 10-Q Document
 
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 September 30, 2016
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 October 21, 2016, there were 394,398,659 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 September 30, 2016
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 Checking®, Discover it®, Freeze ItSM, 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
 
September 30,
2016
 
December 31,
2015
 
(unaudited)
(dollars in millions,
except share amounts)
Assets
 
 
 
Cash and cash equivalents
$
12,076

 
$
9,572

Restricted cash
947

 
99

Other short-term investments
850

 

Investment securities (includes $1,697 and $2,963 at fair value at September 30, 2016 and December 31, 2015, respectively)
1,855

 
3,084

Loan receivables
 
 
 
Loan receivables
73,551

 
72,385

Allowance for loan losses
(2,024
)
 
(1,869
)
Net loan receivables
71,527

 
70,516

Premises and equipment, net
722

 
693

Goodwill
255

 
255

Intangible assets, net
166

 
168

Other assets
2,143

 
2,412

Total assets
$
90,541

 
$
86,799

Liabilities and Stockholders’ Equity
 
 
 
Deposits
 
 
 
Interest-bearing deposit accounts
$
48,785

 
$
47,094

Non-interest bearing deposit accounts
460

 
437

Total deposits
49,245

 
47,531

Long-term borrowings
26,830

 
24,650

Accrued expenses and other liabilities
3,119

 
3,343

Total liabilities
79,194

 
75,524

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

 

Stockholders’ Equity:
 
 
 
Common stock, par value $0.01 per share; 2,000,000,000 shares authorized; 562,391,470 and 560,679,352 shares issued at September 30, 2016 and December 31, 2015, respectively
5

 
5

Preferred stock, par value $0.01 per share; 200,000,000 shares authorized; 575,000 shares issued and outstanding and aggregate liquidation preference of $575 at September 30, 2016 and December 31, 2015
560

 
560

Additional paid-in capital
3,946

 
3,885

Retained earnings
14,696

 
13,250

Accumulated other comprehensive loss
(165
)
 
(160
)
Treasury stock, at cost; 165,954,687 and 139,000,423 shares at September 30, 2016 and December 31, 2015, respectively
(7,695
)
 
(6,265
)
Total stockholders’ equity
11,347

 
11,275

Total liabilities and stockholders’ equity
$
90,541

 
$
86,799

 
 
 
 
Upon adoption of ASU 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, certain balances as of December 31, 2015 have been restated to reflect the classification of debt issuance costs as a direct deduction of the related liability. See Note 1: Background and Basis of Presentation for additional information.
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.
 
September 30,
2016
 
December 31,
2015
 
(unaudited)
(dollars in millions)
Assets
 
 
 
Restricted cash
$
947

 
$
99

Loan receivables
$
31,837

 
$
30,551

Allowance for loan losses allocated to securitized loan receivables
$
(904
)
 
$
(811
)
Other assets
$
5

 
$
5

Liabilities
 
 
 
Long-term borrowings
$
17,780

 
$
16,735

Accrued expenses and other liabilities
$
14

 
$
12

 
 
 
 

See Notes to the Condensed Consolidated Financial Statements.
1



DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Income
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
 (unaudited)
(dollars in millions, except per share amounts)
Interest income
 
 
 
 
 
 
 
Credit card loans
$
1,812

 
$
1,676

 
$
5,279

 
$
4,902

Other loans
347

 
314

 
1,004

 
926

Investment securities
9

 
11

 
30

 
36

Other interest income
16

 
7

 
45

 
20

Total interest income
2,184

 
2,008

 
6,358

 
5,884

Interest expense
 
 
 
 
 
 
 
Deposits
178

 
157

 
506

 
464

Short-term borrowings

 

 

 
1

Long-term borrowings
181

 
166

 
526

 
469

Total interest expense
359

 
323

 
1,032

 
934

Net interest income
1,825

 
1,685

 
5,326

 
4,950

Provision for loan losses
445

 
332

 
1,281

 
1,028

Net interest income after provision for loan losses
1,380

 
1,353

 
4,045

 
3,922

Other income
 
 
 
 
 
 
 
Discount and interchange revenue, net
263

 
288

 
801

 
854

Protection products revenue
60

 
62

 
180

 
201

Loan fee income
91

 
87

 
250

 
248

Transaction processing revenue
40

 
39

 
115

 
121

Gain on investments

 

 

 
8

Gain on origination and sale of mortgage loans

 
2

 

 
68

Other income
22

 
25

 
69

 
84

Total other income
476

 
503

 
1,415

 
1,584

Other expense
 
 
 
 
 
 
 
Employee compensation and benefits
342

 
337

 
1,027

 
994

Marketing and business development
195

 
168

 
555

 
549

Information processing and communications
81

 
84

 
258

 
262

Professional fees
143

 
160

 
453

 
440

Premises and equipment
25

 
24

 
72

 
71

Other expense
109

 
109

 
322

 
366

Total other expense
895

 
882

 
2,687

 
2,682

Income before income tax expense
961

 
974

 
2,773

 
2,824

Income tax expense
322

 
362

 
943

 
1,027

Net income
$
639

 
$
612

 
$
1,830

 
$
1,797

Net income allocated to common stockholders
$
625

 
$
599

 
$
1,789

 
$
1,758

Basic earnings per common share
$
1.56

 
$
1.38

 
$
4.37

 
$
3.99

Diluted earnings per common share
$
1.56

 
$
1.38

 
$
4.36

 
$
3.98

Dividends declared per common share
$
0.30

 
$
0.28

 
$
0.88

 
$
0.80

 
 
 
 
 
 
 
 

See Notes to the Condensed Consolidated Financial Statements.
2



DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Comprehensive Income
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
 (unaudited)
(dollars in millions)
Net income
$
639

 
$
612

 
$
1,830

 
$
1,797

Other comprehensive income (loss), net of taxes
 
 
 
 
 
 
 
Unrealized (loss) gain on available-for-sale investment securities, net of tax
(4
)
 
3

 
14

 
(7
)
Unrealized gain (loss) on cash flow hedges, net of tax
13

 
(22
)
 
(19
)
 
(34
)
Foreign currency translation adjustments, net of tax

 
(1
)
 

 
(1
)
Other comprehensive income (loss)
9

 
(20
)
 
(5
)
 
(42
)
Comprehensive income
$
648

 
$
592

 
$
1,825

 
$
1,755

 
 
 
 
 
 
 
 

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 (Loss) Income
 
Treasury
Stock
 
Total
Stockholders’
Equity
 
Preferred Stock
 
Common Stock
 
 
 
 
 
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
(unaudited)
(dollars in millions, shares in thousands)
Balance at December 31, 2014
575

 
$
560

 
558,194

 
$
5

 
$
3,790

 
$
11,467

 
$
(138
)
 
$
(4,550
)
 
$
11,134

Net income

 

 

 

 

 
1,797

 

 

 
1,797

Other comprehensive loss

 

 

 

 

 

 
(42
)
 

 
(42
)
Purchases of treasury stock

 

 

 

 

 

 

 
(1,280
)
 
(1,280
)
Common stock issued under employee benefit plans

 

 
61

 

 
3

 

 

 

 
3

Common stock issued and stock-based compensation expense

 

 
2,382

 

 
75

 

 

 

 
75

Dividends — common stock

 

 

 

 

 
(356
)
 

 

 
(356
)
Dividends — preferred stock

 

 

 

 

 
(28
)
 

 

 
(28
)
Balance at September 30, 2015
575

 
$
560

 
560,637

 
$
5

 
$
3,868

 
$
12,880

 
$
(180
)
 
$
(5,830
)
 
$
11,303

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
575

 
$
560

 
560,679

 
$
5

 
$
3,885

 
$
13,250

 
$
(160
)
 
$
(6,265
)
 
$
11,275

Net income

 

 

 

 

 
1,830

 

 

 
1,830

Other comprehensive loss

 

 

 

 

 

 
(5
)
 

 
(5
)
Purchases of treasury stock

 

 

 

 

 

 

 
(1,430
)
 
(1,430
)
Common stock issued under employee benefit plans

 

 
66

 

 
3

 

 

 

 
3

Common stock issued and stock-based compensation expense

 

 
1,646

 

 
58

 

 

 

 
58

Dividends — common stock

 

 

 

 

 
(356
)
 

 

 
(356
)
Dividends — preferred stock

 

 

 

 

 
(28
)
 

 

 
(28
)
Balance at September 30, 2016
575

 
$
560

 
562,391

 
$
5

 
$
3,946

 
$
14,696

 
$
(165
)
 
$
(7,695
)
 
$
11,347

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

See Notes to the Condensed Consolidated Financial Statements.
4



DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Cash Flows
 
For the Nine Months Ended September 30,
 
2016
 
2015
 
(unaudited)
(dollars in millions)
Cash flows from operating activities
 
 
 
Net income
$
1,830

 
$
1,797

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
1,281

 
1,028

Depreciation and amortization
262

 
291

Amortization of deferred revenues and accretion of accretable yield on acquired loans
(298
)
 
(329
)
Net loss (gain) on origination and sale of loans, investments and other assets
40

 
(39
)
Proceeds from sale of mortgage loans originated for sale

 
2,713

Net principal disbursed on mortgage loans originated for sale

 
(2,519
)
Other, net
119

 
18

Changes in assets and liabilities:
 
 
 
Decrease (increase) in other assets
104

 
(145
)
Decrease in accrued expenses and other liabilities
(205
)
 
(5
)
Net cash provided by operating activities
3,133

 
2,810

 
 
 
 
Cash flows from investing activities
 
 
 
Maturities of other short-term investments
200

 

Purchases of other short-term investments
(1,050
)
 

Maturities and sales of available-for-sale investment securities
1,279

 
1,330

Maturities of held-to-maturity investment securities
17

 
13

Purchases of held-to-maturity investment securities
(56
)
 
(36
)
Net principal disbursed on loans originated for investment
(1,990
)
 
(953
)
Purchases of other investments
(23
)
 
(32
)
(Increase) decrease in restricted cash
(848
)
 
8

Proceeds from sale of premises and equipment

 
1

Purchases of premises and equipment
(132
)
 
(119
)
Net cash (used for) provided by investing activities
(2,603
)
 
212

 
 
 
 
Cash flows from financing activities
 
 
 
Net decrease in short-term borrowings

 
(113
)
Proceeds from issuance of securitized debt
3,026

 
1,750

Maturities and repayment of securitized debt
(2,043
)
 
(3,303
)
Proceeds from issuance of other long-term borrowings
1,100

 
2,759

Proceeds from issuance of common stock
5

 
3

Purchases of treasury stock
(1,430
)
 
(1,280
)
Net increase in deposits
1,702

 
513

Dividends paid on common and preferred stock
(386
)
 
(385
)
Net cash provided by (used for) financing activities
1,974

 
(56
)
Net increase in cash and cash equivalents
2,504

 
2,966

Cash and cash equivalents, at beginning of period
9,572

 
7,284

Cash and cash equivalents, at end of period
$
12,076

 
$
10,250

 
 
 
 


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”). The Company provides direct banking products and services and payment services through its subsidiaries. The Company offers its customers credit card loans, private student loans, personal loans, home equity loans and deposit products. The Company also operates the Discover Network, the PULSE network (“PULSE”) and Diners Club International (“Diners Club”). The Discover Network processes transactions for Discover-branded credit cards and provides payment transaction processing and settlement services. 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 charge cards and/or provide card acceptance services.
The Company’s business segments are Direct Banking and Payment Services. The Direct Banking segment includes Discover-branded credit cards issued to individuals on the Discover Network and other consumer products and services, including private student loans, personal loans, home equity loans, 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, an automated teller machine, debit and electronic funds transfer network; Diners Club, a global payments network; and the Company’s Network Partners business, which provides payment transaction processing and settlement services on the Discover Network. The majority of Payment Services revenues relate to transaction processing revenue from PULSE and royalty and licensee revenue 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 2015 audited consolidated financial statements filed with the Company’s annual report on Form 10-K for the year ended December 31, 2015.
Change in Accounting Principle
In April 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2015-03, Interest—-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which makes the presentation of debt issuance costs consistent with that of debt discounts and premiums. This ASU requires that debt issuance costs related to a recognized liability be presented in the balance sheet as a direct deduction from the carrying amount of that liability. Before becoming effective for the Company on January 1, 2016, these costs were recorded as deferred charges presented in other assets on the consolidated statements of financial condition. The guidance requires retrospective application in the financial statements. As such, some balances as of December 31, 2015 have been restated to

6


reflect the classification of debt issuance costs as a direct deduction of a related liability. The impact of adopting this ASU was a reduction of other assets of $137 million, a reduction of long-term borrowings of $74 million and a reduction of deposits of $63 million at December 31, 2015. There was no impact to the consolidated statements of income.
Recently Issued Accounting Pronouncements
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU eliminates the incurred loss threshold for initial recognition in current GAAP and replaces it with the expected loss concept. For all loans carried at amortized cost, companies will be required to measure their allowance for loan losses based on management’s current estimate of all expected credit losses over the remaining contractual term of the assets. Because it eliminates the incurred loss trigger, the new accounting guidance will require companies, upon the origination of a loan, to record their estimate of all expected credit losses on that loan through an immediate charge to earnings. The estimate of loan losses must be based on historical experience, current conditions and reasonable and supportable forecasts. The ASU does not mandate the use of any specific method for estimating credit loss, permitting companies to use judgment in selecting the approach that is most appropriate in their circumstances.
The new rules also impact the specialized accounting requirements pertaining to purchased credit-impaired ("PCI") assets, which the ASU refers to as purchased credit-deteriorated (“PCD”) assets, that the Company applies today to the acquired portion of its student loan portfolio. PCD assets will be reported at their gross amount with a related allowance equal to the current estimate of expected losses. That allowance will then be adjusted on a periodic basis in accordance with the new standards. The separate measurement guidance applicable today for loans modified in a troubled debt restructuring (“TDR”) will also be affected. Both TDRs and PCD assets will still be subject to certain separate disclosure requirements. Measurement of credit impairment of available-for-sale debt securities will remain unchanged under the new rules, but any such impairment will be recorded through an allowance, rather than a direct write-down of the security, with an offsetting entry to provision expense in the income statement.
The ASU will become effective for the Company on January 1, 2020, with early adoption permitted no sooner than January 1, 2019. Upon adoption, a cumulative effect adjustment to retained earnings will be recorded as of the beginning of the first reporting period in which the guidance is effective in an amount necessary to adjust the allowance for loan losses to equal the current estimate of expected losses on financial assets held at that date. Additionally, upon adoption, the carrying value of PCD loans will be increased through an offsetting addition to the allowance for loan losses for the amount of expected credit losses on those loans, to be evaluated and adjusted on a periodic basis, and any non-credit premium or discount will be amortized or accreted to interest income from that point forward over the remaining life of PCD loans. Management is evaluating the ASU, and it could have a potentially significant impact on how the Company records and reports its financial condition and results of operations, and on regulatory capital.
In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This ASU requires excess tax benefits and tax deficiencies, which arise due to differences between the measure of compensation expense for GAAP accounting purposes and the amount deductible for tax purposes, to be recorded directly through the income statement as a component of income tax expense. Under current GAAP, these differences are generally recorded in additional paid-in capital and thus have no impact on net income today. The change in treatment of excess tax benefits and tax deficiencies will also impact the computation of diluted earnings per share, and the cash flows associated with those items will be classified as operating activities on the statement of cash flows. The ASU will permit certain elective changes associated with stock compensation accounting. For example, companies can elect to account for forfeitures of awards as they occur rather than projecting forfeitures in the accrual of compensation expense. In addition, the ASU increases the proportion of shares an employer is permitted (though not required) to withhold on behalf of an employee to satisfy the employee’s income tax burden on a share-based award without causing the award to become subject to liability accounting. This ASU will become effective for the Company on January 1, 2017. The impact to net income and earnings per share that will result from the treatment of excess tax benefits after adoption of ASU 2016-09 will depend on the difference between the market price of Company stock between the grant dates and subsequent vesting dates of share-based awards, and this impact could be positive or negative depending on how the Company’s stock price moves. If the Company elects to permit employees to request withholdings of shares in excess of the statutory minimum to cover personal tax liabilities, it will have no financial statement impact. The Company has not made any change concerning this practice at this time.
In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). The guidance in this ASU provides clarification on the principal versus agent concept in relation to revenue recognition guidance issued as part of ASU 2014-09, Revenue from

7


Contracts with Customers (Topic 606). Topic 606 requires a company to determine whether it is a principal or an agent in a transaction in which another party is involved in providing goods or services to a customer by evaluating the nature of its promise to the customer. ASU 2016-08 provides clarification for identifying the good, service or right being transferred in a revenue transaction and identifies the principal as the party that controls the good, service or right prior to its transfer to the customer. The ASU provides further clarity on how to evaluate control in this context. This guidance will become effective for the Company on January 1, 2018 and management is evaluating the impact of these changes as part of its overall evaluation of ASU 2014-09.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The guidance will require lessees to capitalize most leases on their balance sheet whereas under current GAAP only capital leases are recognized on the lessee’s balance sheet. Leases which today are identified as capital leases will generally be identified as financing leases under the new guidance but otherwise their accounting treatment will remain relatively unchanged. Leases identified today as operating leases will generally remain in that category under the new standard, but both a right-of-use asset and a liability for remaining lease payments will now be required to be recognized on the balance sheet for this type of lease. The manner in which expenses associated with all leases are reported on the income statement will remain mostly unchanged. Lessor accounting also remains substantially unchanged by the new standard. The new guidance will become effective for the Company on January 1, 2019, and management is in the process of evaluating its impact.
In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The ASU will have limited impact on the Company since it does not change the guidance for classifying and measuring investments in debt securities or loans. The standard requires entities to measure certain cost-method equity investments at fair value with changes in value recognized in net income. Equity investments that do not have readily determinable fair values will be carried at cost, less any impairment, plus or minus changes resulting from any observable price changes in orderly transactions for an identical or similar investment of the same issuer. This ASU requires public entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes and requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans) on the balance sheet or the accompanying notes to the financial statements. This ASU will become effective for the Company on January 1, 2018 and is not expected to have a material impact to the financial statements.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The guidance in this ASU supersedes existing revenue recognition requirements in Topic 605, Revenue Recognition, including an assortment of transaction-specific and industry-specific rules. This 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. Throughout 2015, management followed the discussions of the FASB and evaluated the conclusions published by its Transition Resource Group ("TRG"), specifically those pertaining to how the new revenue recognition rules should be interpreted for credit card arrangements, loyalty programs, and transaction processing arrangements. Those discussions support the conclusion that timing and measurement of fee revenues associated with the Company’s credit card arrangements and costs associated with the Company’s credit card reward programs will not be impacted by the new rules. The FASB TRG discussions and guidance also support the conclusion that the timing and measurement of revenue associated with the Company’s transaction processing services, including discount and interchange and other transaction processing fees, will remain substantially unchanged under the new accounting model. This conclusion covers the vast majority of the Company’s revenue that is within the scope of the new standard. While management continues to evaluate the remaining in-scope revenue items to determine what, if any, impact the rules will have on their accounting and reporting, no substantive impacts are expected. The new revenue recognition model will become effective for the Company on January 1, 2018. Upon adoption in 2018, the Company will record an adjustment, if needed, 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, 2018, without restating prior periods presented. Because little if any change in timing or measurement of the Company’s revenue is expected to occur under the new standard, management does not expect to present any restated prior period amounts when the standard becomes effective in 2018.

8


2.
Business Dispositions
On June 16, 2015, the Company announced the closing of the mortgage origination business it acquired in 2012, which was part of its Direct Banking segment. The disposition represented the exiting of an ancillary business and did not have a major impact on the Company’s operations.
3.
Investments
The Company’s other short-term investments and investment securities consist of the following (dollars in millions):
 
September 30,
2016
 
December 31,
2015
Certificates of deposit(1)
$
850

 
$

Total other short-term investments
$
850

 
$

 
 
 
 
U.S. Treasury securities(2)
$
678

 
$
1,273

U.S. government agency securities

 
494

States and political subdivisions of states
2

 
7

Residential mortgage-backed securities - Agency(3)
1,175

 
1,310

Total investment securities
$
1,855

 
$
3,084

 
 
 
 
(1)
Includes certificates of deposit with maturity dates greater than 90 days but less than one year at the time of acquisition.
(2)
Includes $86 million and $7 million of U.S. Treasury securities pledged as swap collateral in lieu of cash as of September 30, 2016 and December 31, 2015, respectively.
(3)
Consists of residential mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae.
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 September 30, 2016
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S. Treasury securities
$
676

 
$
2

 
$

 
$
678

Residential mortgage-backed securities - Agency
998

 
21

 

 
1,019

Total available-for-sale investment securities
$
1,674

 
$
23

 
$

 
$
1,697

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

 
$

 
$

 
$
2

Residential mortgage-backed securities - Agency(3)
156

 
4

 

 
160

Total held-to-maturity investment securities
$
158

 
$
4

 
$

 
$
162

 
 
 
 
 
 
 
 
At December 31, 2015
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S. Treasury securities
$
1,277

 
$
1

 
$
(6
)
 
$
1,272

U.S. government agency securities
492

 
2

 

 
494

Residential mortgage-backed securities - Agency
1,195

 
6

 
(4
)
 
1,197

Total available-for-sale investment securities
$
2,964

 
$
9

 
$
(10
)
 
$
2,963

Held-to-Maturity Investment Securities(2)
 
 
 
 
 
 
 
U.S. Treasury securities(4)
$
1

 
$

 
$

 
$
1

States and political subdivisions of states
7

 

 

 
7

Residential mortgage-backed securities - Agency(3) 
113

 
1

 

 
114

Total held-to-maturity investment securities
$
121

 
$
1

 
$

 
$
122

 
 
 
 
 
 
 
 
(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 initiatives.
(4)
At December 31, 2015, amount represents securities pledged as collateral to a government-related merchant for which transaction settlement occurs beyond the normal 24-hour period. Beginning in the third quarter of 2016, collateral is no longer required.

9


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 December 31, 2015
 
 
 
 
 
 
 
 
 
Available-for-Sale Investment Securities
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
1

 
$
670

 
$
(6
)
 
$

 
$

Residential mortgage-backed securities - Agency
15

 
$
486

 
$
(4
)
 
$

 
$

 
 
 
 
 
 
 
 
 
 
Aggregate gross unrealized losses were not material as of September 30, 2016. There were no losses related to other-than-temporary impairments during the three and nine months ended September 30, 2016 and 2015.
The following table provides information about 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 September 30,
 
For the Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Proceeds from the sales of available-for-sale investment securities
$

 
$

 
$

 
$
899

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

 
$

 
$

 
$
8

Net unrealized (loss) gain recorded in other comprehensive income, before-tax
$
(6
)
 
$
4

 
$
23

 
$
(12
)
Net unrealized (loss) gain recorded in other comprehensive income, after-tax
$
(4
)
 
$
3

 
$
14

 
$
(7
)
 
 
 
 
 
 
 
 
Maturities of available-for-sale debt securities and held-to-maturity debt securities 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 September 30, 2016
 
 
 
 
 
 
 
 
 
Available-for-Sale Investment Securities—Amortized Cost
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$

 
$
676

 
$

 
$

 
$
676

Residential mortgage-backed securities - Agency

 

 
309

 
689

 
998

Total available-for-sale investment securities
$

 
$
676

 
$
309

 
$
689

 
$
1,674

Held-to-Maturity Investment Securities—Amortized Cost
 
 
 
 
 
 
 
 
 
State and political subdivisions of states
$

 
$

 
$

 
$
2

 
$
2

Residential mortgage-backed securities - Agency

 

 

 
156

 
156

Total held-to-maturity investment securities
$

 
$

 
$

 
$
158

 
$
158

Available-for-Sale Investment Securities—Fair Values
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$

 
$
678

 
$

 
$

 
$
678

Residential mortgage-backed securities - Agency

 

 
315

 
704

 
1,019

Total available-for-sale investment securities
$

 
$
678

 
$
315

 
$
704

 
$
1,697

Held-to-Maturity Investment Securities—Fair Values
 
 
 
 
 
 
 
 
 
State and political subdivisions of states
$

 
$

 
$

 
$
2

 
$
2

Residential mortgage-backed securities - Agency

 

 

 
160

 
160

Total held-to-maturity investment securities
$

 
$

 
$

 
$
162

 
$
162

 
 
 
 
 
 
 
 
 
 
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

10


accounted for using the equity method of accounting and are recorded within other assets. The related commitment for future investments is recorded in accrued expenses and other liabilities within the condensed consolidated statements of financial condition. The portion of each investment's operating results allocable to the Company is recorded in other expense within the condensed consolidated statements 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 September 30, 2016 and December 31, 2015, the Company had outstanding investments in these entities of $298 million and $328 million, respectively, and related contingent liabilities of $45 million and $57 million, respectively. Of the above outstanding equity investments, the Company had $233 million and $238 million, respectively, of investments related to affordable housing projects, which had $45 million and $57 million related contingent liabilities as of September 30, 2016 and December 31, 2015, respectively.
4.
Loan Receivables
The Company has three loan portfolio segments: credit card loans, other loans and PCI loans.
The Company's classes of receivables within the three portfolio segments are depicted in the table below (dollars in millions):
 
September 30,
2016
 
December 31,
2015
Loan receivables
 
 
 
Credit card loans(1)
$
58,006

 
$
57,896

Other loans
 
 
 
Personal loans
6,273

 
5,490

Private student loans
6,287

 
5,647

Other
277

 
236

Total other loans
12,837

 
11,373

Purchased credit-impaired loans(2)
2,708

 
3,116

Total loan receivables
73,551

 
72,385

Allowance for loan losses
(2,024
)
 
(1,869
)
Net loan receivables
$
71,527

 
$
70,516

 
 
 
 
(1)
Amounts include $22.2 billion and $21.6 billion underlying investors’ interest in trust debt at September 30, 2016 and December 31, 2015, respectively, and $8.2 billion and $7.2 billion in seller's interest at September 30, 2016 and December 31, 2015, respectively. The increase in the seller's interest from December 31, 2015 to September 30, 2016 is due in part to the addition of randomly-selected accounts to the credit card loan receivables restricted for securitization investors in order to increase excess seller's interest and related securitization capacity. See Note 5: Credit Card and Student Loan Securitization Activities for further information.
(2)
Amounts include $1.5 billion and $1.7 billion of loans pledged as collateral against the notes issued from the Student Loan Corporation ("SLC") securitization trusts at September 30, 2016 and December 31, 2015, respectively. See Note 5: Credit Card and Student Loan Securitization Activities for additional information.

11


Credit Quality Indicators
The Company regularly reviews its collection experience (including delinquencies and net charge-offs) in determining its allowance for loan losses.
Information related to the delinquent and non-accruing loans in the Company’s loan portfolio 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 September 30, 2016
 
 
 
 
 
 
 
 
 
Credit card loans(2)
$
586

 
$
500

 
$
1,086

 
$
452

 
$
181

Other loans
 
 
 
 


 
 
 
 
Personal loans(3)
46

 
16

 
62

 
15

 
8

Private student loans (excluding PCI)(4)
89

 
28

 
117

 
28

 

Other
3

 
1

 
4

 

 
21

Total other loans (excluding PCI)
138

 
45

 
183

 
43

 
29

Total loan receivables (excluding PCI)
$
724

 
$
545

 
$
1,269

 
$
495

 
$
210

 
 
 
 
 
 
 
 
 
 
At December 31, 2015
 
 
 
 
 
 
 
 
 
Credit card loans(2)
$
505

 
$
490

 
$
995

 
$
422

 
$
198

Other loans
 
 
 
 


 
 
 
 
Personal loans(3)
34

 
15

 
49

 
13

 
6

Private student loans (excluding PCI)(4)
84

 
24

 
108

 
25

 

Other

 
1

 
1

 

 
20

Total other loans (excluding PCI)
118

 
40

 
158

 
38

 
26

Total loan receivables (excluding PCI)
$
623

 
$
530

 
$
1,153

 
$
460

 
$
224

 
 
 
 
 
 
 
 
 
 
 
(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 $8 million for both the three months ended September 30, 2016 and 2015, and $23 million and $21 million for the nine months ended September 30, 2016 and 2015, 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. This amount was estimated based on customers' current balances and most recent interest rates.
(2)
Credit card loans that are 90 or more days delinquent and accruing interest include $47 million and $42 million of loans accounted for as troubled debt restructurings at September 30, 2016 and December 31, 2015, respectively.
(3)
Personal loans that are 90 or more days delinquent and accruing interest include $2 million and $4 million of loans accounted for as troubled debt restructurings at September 30, 2016 and December 31, 2015, 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 September 30, 2016 and December 31, 2015.


12


Information related to the net charge-offs in the Company's loan portfolio 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 September 30,
 
2016
 
2015
  
Net
Charge-off
Dollars
 
Net 
Charge-off
Rate
(1)
 
Net
Charge-off
Dollars
 
Net 
Charge-off
Rate
(1)
Credit card loans
$
314

 
2.17
%
 
$
285

 
2.04
%
Other loans
 
 
 
 
 
 
 
Personal loans
41

 
2.63
%
 
26

 
1.99
%
Private student loans (excluding PCI)
15

 
1.02
%
 
13

 
0.94
%
Total other loans
56

 
1.79
%
 
39

 
1.44
%
Net charge-offs (excluding PCI)
$
370

 
2.10
%
 
$
324

 
1.94
%
Net charge-offs (including PCI)
$
370

 
2.02
%
 
$
324

 
1.85
%
 
 
 
 
 
 
 
For the Nine Months Ended September 30,
 
2016
 
2015
  
Net
Charge-off
Dollars
 
Net 
Charge-off
Rate
(1)
 
Net
Charge-off
Dollars
 
Net 
Charge-off
Rate
(1)
Credit card loans
$
974

 
2.30
%
 
$
911

 
2.24
%
Other loans
 
 
 
 
 
 
 
Personal loans
108

 
2.49
%
 
81

 
2.10
%
Private student loans (excluding PCI)
44

 
0.99
%
 
39

 
0.99
%
Total other loans
152

 
1.69
%
 
120

 
1.51
%
Net charge-offs (excluding PCI)
$
1,126

 
2.19
%
 
$
1,031

 
2.12
%
Net charge-offs (including PCI)
$
1,126

 
2.10
%
 
$
1,031

 
2.01
%
 
 
 
 
 
 
 
 
(1)
Net charge-off rate represents net charge-off dollars (annualized) divided by average loans for the reporting period.
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.
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 September 30, 2016
 
 
 
Credit card loans
82
%
 
18
%
Personal loans
96
%
 
4
%
Private student loans (excluding PCI)(1)
96
%
 
4
%
 
 
 
 
At December 31, 2015
 
 
 
Credit card loans
83
%
 
17
%
Personal loans
96
%
 
4
%
Private student loans (excluding PCI)(1)
96
%
 
4
%
 
 
 
 
(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

13


ability to temporarily suspend payments. Eligible borrowers have a lifetime cap on forbearance of 12 months. At September 30, 2016 and December 31, 2015, there were $23 million and $31 million, respectively, of private student loans, including PCI, in forbearance, representing 0.4% and 0.5%, respectively, of total student loans in repayment and forbearance.
Allowance for Loan Losses
The following tables provide changes in the Company’s allowance for loan losses (dollars in millions): 
 
For the Three Months Ended September 30, 2016
 
Credit Card
 
Personal Loans
 
Student Loans(1)
 
Other
 
Total
Balance at beginning of period
$
1,603

 
$
176

 
$
151

 
$
19

 
$
1,949

Additions
 
 
 
 
 
 
 
 
 
Provision for loan losses
372

 
51

 
21

 
1

 
445

Deductions
 
 
 
 
 
 
 
 
 
Charge-offs
(425
)
 
(46
)
 
(17
)
 

 
(488
)
Recoveries
111

 
5

 
2

 

 
118

Net charge-offs
(314
)
 
(41
)
 
(15
)
 

 
(370
)
Balance at end of period
$
1,661

 
$
186

 
$
157

 
$
20

 
$
2,024

 
 
 
 
 
 
 
 
 
 
 
For the Three Months Ended September 30, 2015
 
Credit Card
 
Personal Loans
 
Student Loans(1)
 
Other
 
Total
Balance at beginning of period
$
1,441

 
$
131

 
$
143

 
$
20

 
$
1,735

Additions
 
 
 
 
 
 
 
 
 
Provision for loan losses
303

 
30

 

 
(1
)
 
332

Deductions
 
 
 
 
 
 
 
 
 
Charge-offs
(394
)
 
(31
)
 
(15
)
 

 
(440
)
Recoveries
109

 
5

 
2

 

 
116

Net charge-offs
(285
)
 
(26
)
 
(13
)
 

 
(324
)
Balance at end of period
$
1,459

 
$
135

 
$
130

 
$
19

 
$
1,743

 
 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended September 30, 2016
 
Credit Card
 
Personal Loans
 
Student Loans(1)
 
Other
 
Total
Balance at beginning of period
$
1,554

 
$
155

 
$
143

 
$
17

 
$
1,869

Additions
 
 
 
 
 
 
 
 
 
Provision for loan losses
1,081

 
139

 
58

 
3

 
1,281

Deductions
 
 
 
 
 
 
 
 
 
Charge-offs
(1,312
)
 
(123
)
 
(51
)
 

 
(1,486
)
Recoveries
338

 
15

 
7

 

 
360

Net charge-offs
(974
)
 
(108
)
 
(44
)
 

 
(1,126
)
Balance at end of period
$
1,661

 
$
186

 
$
157

 
$
20

 
$
2,024

 
 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended September 30, 2015
 
Credit Card
 
Personal Loans
 
Student Loans(1)
 
Other
 
Total
Balance at beginning of period
$
1,474

 
$
120

 
$
135

 
$
17

 
$
1,746

Additions
 
 
 
 
 
 
 
 
 
Provision for loan losses
896

 
96

 
34

 
2

 
1,028

Deductions
 
 
 
 
 
 
 
 
 
Charge-offs
(1,245
)
 
(93
)
 
(45
)
 

 
(1,383
)
Recoveries
334

 
12

 
6

 

 
352

Net charge-offs
(911
)
 
(81
)
 
(39
)
 

 
(1,031
)
Balance at end of period
$
1,459

 
$
135

 
$
130

 
$
19

 
$
1,743

 
 
 
 
 
 
 
 
 
 
(1)
Includes both PCI and non-PCI private student loans.

14


Net charge-offs of principal are recorded against the allowance for loan losses, as shown in the preceding table. Information regarding net charge-offs of interest and fee revenues on credit card and other loans is as follows (dollars in millions): 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Interest and fees accrued subsequently charged off, net of recoveries (recorded as a reduction of interest income)
$
65

 
$
65

 
$
201

 
$
210

Fees accrued subsequently charged off, net of recoveries (recorded as a reduction to other income)
$
15

 
$
16

 
$
49

 
$
53

 
 
 
 
 
 
 
 
The following tables provide additional detail of the Company’s allowance for loan losses and recorded investment in its loan portfolio by impairment methodology (dollars in millions):
 
Credit Card
 
Personal
Loans
 
Student
Loans(1)
 
Other
Loans
 
Total
At September 30, 2016
 
 
 
 
 
 
 
 
 
Allowance for loans evaluated for impairment as
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment in accordance with ASC 450-20
$
1,502

 
$
169

 
$
103

 
$
3

 
$
1,777

Evaluated for impairment in accordance with
ASC 310-10-35(2)(3)
159

 
17

 
18

 
17

 
211

Acquired with deteriorated credit quality, evaluated in accordance with ASC 310-30

 

 
36

 

 
36

Total allowance for loan losses
$
1,661

 
$
186

 
$
157

 
$
20

 
$
2,024

Recorded investment in loans evaluated for impairment as
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment in accordance with ASC 450-20
$
56,960

 
$
6,197

 
$
6,216

 
$
219

 
$
69,592

Evaluated for impairment in accordance with
ASC 310-10-35(2)(3)
1,046

 
76

 
71

 
58

 
1,251

Acquired with deteriorated credit quality, evaluated in accordance with ASC 310-30

 

 
2,708

 

 
2,708

Total recorded investment
$
58,006

 
$
6,273

 
$
8,995

 
$
277

 
$
73,551

 
 
 
 
 
 
 
 
 
 
At December 31, 2015
 
 
 
 
 
 
 
 
 
Allowance for loans evaluated for impairment as
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment in accordance with ASC 450-20
$
1,394

 
$
140

 
$
92

 
$
1

 
$
1,627

Evaluated for impairment in accordance with
ASC 310-10-35(2)(3)
160

 
15

 
15

 
16

 
206

Acquired with deteriorated credit quality, evaluated in accordance with ASC 310-30