10-Q 1 dfs331201710q.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 March 31, 2017
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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth 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
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 April 28, 2017, there were 380,190,745 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 March 31, 2017
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
 
March 31,
2017
 
December 31,
2016
 
(unaudited)
(dollars in millions,
except share amounts)
Assets
 
 
 
Cash and cash equivalents
$
15,163

 
$
11,914

Restricted cash
1,100

 
95

Investment securities (includes $1,553 and $1,605 at fair value at March 31, 2017 and December 31, 2016, respectively)
1,718

 
1,757

Loan receivables
 
 
 
Loan receivables
75,853

 
77,254

Allowance for loan losses
(2,264
)
 
(2,167
)
Net loan receivables
73,589

 
75,087

Premises and equipment, net
750

 
734

Goodwill
255

 
255

Intangible assets, net
165

 
166

Other assets
2,055

 
2,300

Total assets
$
94,795

 
$
92,308

Liabilities and Stockholders’ Equity
 
 
 
Deposits
 
 
 
Interest-bearing deposit accounts
$
53,017

 
$
51,461

Non-interest bearing deposit accounts
505

 
531

Total deposits
53,522

 
51,992

Long-term borrowings
26,823

 
25,443

Accrued expenses and other liabilities
3,185

 
3,550

Total liabilities
83,530

 
80,985

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; 563,401,588 and 562,414,040 shares issued at March 31, 2017 and December 31, 2016, respectively
6

 
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 March 31, 2017 and December 31, 2016
560

 
560

Additional paid-in capital
3,979

 
3,962

Retained earnings
15,568

 
15,130

Accumulated other comprehensive loss
(155
)
 
(161
)
Treasury stock, at cost; 181,050,010 and 173,648,023 shares at March 31, 2017 and December 31, 2016, respectively
(8,693
)
 
(8,173
)
Total stockholders’ equity
11,265

 
11,323

Total liabilities and stockholders’ equity
$
94,795

 
$
92,308

 
 
 
 

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.
 
March 31,
2017
 
December 31,
2016
 
(unaudited)
(dollars in millions)
Assets
 
 
 
Restricted cash
$
1,100

 
$
95

Loan receivables
$
31,130

 
$
33,016

Allowance for loan losses allocated to securitized loan receivables
$
(976
)
 
$
(955
)
Other assets
$
5

 
$
4

Liabilities
 
 
 
Long-term borrowings
$
16,780

 
$
16,411

Accrued expenses and other liabilities
$
15

 
$
15

 
 
 
 

See Notes to the Condensed Consolidated Financial Statements.
1



DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Income
 
For the Three Months Ended March 31,
 
2017
 
2016
 
 (unaudited)
(dollars in millions, except per share amounts)
Interest income
 
 
 
Credit card loans
$
1,876

 
$
1,733

Other loans
367

 
326

Investment securities
7

 
11

Other interest income
28

 
14

Total interest income
2,278

 
2,084

Interest expense
 
 
 
Deposits
191

 
162

Long-term borrowings
195

 
172

Total interest expense
386

 
334

Net interest income
1,892

 
1,750

Provision for loan losses
586

 
424

Net interest income after provision for loan losses
1,306

 
1,326

Other income
 
 
 
Discount and interchange revenue, net
233

 
273

Protection products revenue
58

 
61

Loan fee income
89

 
80

Transaction processing revenue
39

 
36

Other income
28

 
24

Total other income
447

 
474

Other expense
 
 
 
Employee compensation and benefits
363

 
345

Marketing and business development
168

 
162

Information processing and communications
80

 
88

Professional fees
147

 
160

Premises and equipment
25

 
24

Other expense
102

 
107

Total other expense
885

 
886

Income before income tax expense
868

 
914

Income tax expense
304

 
339

Net income
$
564

 
$
575

Net income allocated to common stockholders
$
551

 
$
562

Basic earnings per common share
$
1.43

 
$
1.35

Diluted earnings per common share
$
1.43

 
$
1.35

Dividends declared per common share
$
0.30

 
$
0.28

 
 
 
 

See Notes to the Condensed Consolidated Financial Statements.
2



DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Comprehensive Income
 
For the Three Months Ended March 31,
 
2017
 
2016
 
 (unaudited)
(dollars in millions)
Net income
$
564

 
$
575

Other comprehensive income, net of taxes
 
 
 
Unrealized gain on available-for-sale investment securities, net of tax
1

 
14

Unrealized gain (loss) on cash flow hedges, net of tax
5

 
(26
)
Other comprehensive income (loss)
6

 
(12
)
Comprehensive income
$
570

 
$
563

 
 
 
 

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
 
Treasury
Stock
 
Total
Stockholders’
Equity
 
Preferred Stock
 
Common Stock
 
 
 
 
 
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
(unaudited)
(dollars in millions, shares in thousands)
Balance at December 31, 2015
575

 
$
560

 
560,679

 
$
5

 
$
3,885

 
$
13,250

 
$
(160
)
 
$
(6,265
)
 
$
11,275

Net income

 

 

 

 

 
575

 

 

 
575

Other comprehensive loss

 

 

 

 

 

 
(12
)
 

 
(12
)
Purchases of treasury stock

 

 

 

 

 

 

 
(423
)
 
(423
)
Common stock issued under employee benefit plans

 

 
21

 

 
1

 

 

 

 
1

Common stock issued and stock-based compensation expense

 

 
1,510

 

 
27

 

 

 

 
27

Dividends — common stock

 

 

 

 

 
(118
)
 

 

 
(118
)
Dividends — preferred stock

 

 

 

 

 
(9
)
 

 

 
(9
)
Balance at March 31, 2016
575

 
$
560

 
562,210

 
$
5

 
$
3,913

 
$
13,698

 
$
(172
)
 
$
(6,688
)
 
$
11,316

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
575

 
$
560

 
562,414

 
$
5

 
$
3,962

 
$
15,130

 
$
(161
)
 
$
(8,173
)
 
$
11,323

Net income

 

 

 

 

 
564

 

 

 
564

Other comprehensive income

 

 

 

 

 

 
6

 

 
6

Purchases of treasury stock

 

 

 

 

 

 

 
(520
)
 
(520
)
Common stock issued under employee benefit plans

 

 
20

 

 
1

 

 

 

 
1

Common stock issued and stock-based compensation expense

 

 
968

 
1

 
16

 

 

 

 
17

Dividends — common stock

 

 

 

 

 
(117
)
 

 

 
(117
)
Dividends — preferred stock

 

 

 

 

 
(9
)
 

 

 
(9
)
Balance at March 31, 2017
575

 
$
560

 
563,402

 
$
6

 
$
3,979

 
$
15,568

 
$
(155
)
 
$
(8,693
)
 
$
11,265

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

See Notes to the Condensed Consolidated Financial Statements.
4



DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Cash Flows
 
For the Three Months Ended March 31,
 
2017
 
2016
 
(unaudited)
(dollars in millions)
Cash flows from operating activities
 
 
 
Net income
$
564

 
$
575

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
586

 
424

Depreciation and amortization
93

 
84

Amortization of deferred revenues and accretion of accretable yield on acquired loans
(98
)
 
(98
)
Net loss investments and other assets
14

 
13

Other, net
11

 
4

Changes in assets and liabilities:
 
 
 
Decrease (increase) in other assets
181

 
(33
)
(Decrease) increase in accrued expenses and other liabilities
(338
)
 
189

Net cash provided by operating activities
1,013

 
1,158

 
 
 
 
Cash flows from investing activities
 
 
 
Maturities and sales of available-for-sale investment securities
52

 
158

Maturities of held-to-maturity investment securities
4

 
5

Purchases of held-to-maturity investment securities
(17
)
 
(16
)
Net principal repaid on loans originated for investment
1,010

 
1,793

Purchases of other investments
(14
)
 
(1
)
Increase in restricted cash
(1,005
)
 
(911
)
Purchases of premises and equipment
(47
)
 
(46
)
Net cash (used for) provided by investing activities
(17
)
 
982

 
 
 
 
Cash flows from financing activities
 
 
 
Proceeds from issuance of securitized debt
1,290

 
991

Maturities and repayment of securitized debt
(925
)
 
(980
)
Proceeds from issuance of other long-term borrowings
1,005

 
38

Proceeds from issuance of common stock
1

 
1

Purchases of treasury stock
(520
)
 
(423
)
Net increase in deposits
1,529

 
925

Dividends paid on common and preferred stock
(127
)
 
(129
)
Net cash provided by financing activities
2,253

 
423

Net increase in cash and cash equivalents
3,249

 
2,563

Cash and cash equivalents, at beginning of period
11,914

 
9,572

Cash and cash equivalents, at end of period
$
15,163

 
$
12,135

 
 
 
 


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 2016 audited consolidated financial statements filed with the Company’s annual report on Form 10-K for the year ended December 31, 2016.
Recently Issued Accounting Pronouncements
In January 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (“ASU”) 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The purpose of this ASU is to simplify the test for goodwill impairment by eliminating Step 2 of the current impairment test. Under the current rules, if the reporting unit’s carrying value exceeds its fair value (Step 1), goodwill impairment is measured as the difference between the carrying value of goodwill and its implied fair value. To compute the implied fair value of goodwill under Step 2, an entity has to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Under the new standard, the Company will perform its annual goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. The Company should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value;

6


however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendments in this ASU apply to the Company’s annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The amendments in this ASU apply on a prospective basis. All of the Company’s recorded goodwill is associated with its PULSE debit business. This ASU has no impact on cash flows, and its adoption is not expected to have any impact on the Company’s financial condition or results of operations because the estimated fair value of the PULSE reporting unit is well in excess of its carrying value. The Company has not elected to early adopt this amendment.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. Whereas restricted cash balances have traditionally been excluded from the statement of cash flows, this ASU requires restricted cash and restricted cash equivalents to be included within the beginning and ending totals of cash, cash equivalents and restricted cash presented on the statement of cash flows for all periods presented. Restricted cash and restricted cash equivalent inflows and outflows with external parties are required to be classified within the operating, investing, and/or financing activity sections of the statement of cash flows whereas transfers between cash and cash equivalents and restricted cash and restricted cash equivalents should no longer be presented on the statement of cash flows. ASU 2016-18 also requires the nature of the restrictions to be disclosed to help provide information about the sources and uses of these balances during a reporting period and a reconciliation of the cash, cash equivalents and restricted cash totals on the statement of cash flows to the related balance sheet line items when cash, cash equivalents, and restricted cash are presented in more than one line item on the balance sheet. The reconciliation can be presented either on the face of the statement of cash flows or in the notes to the financial statements and must be provided for each period that a balance sheet is presented. The ASU will become effective for the Company on January 1, 2018, with early adoption permitted, and is not expected to have a material impact to the Company’s statement of cash flows. The Company has not elected to early adopt this amendment.
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 of credit impairment 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. Updates to that estimate each period will be recorded through provision expense. 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 are expected to affect the Company’s allowance for loan losses as a result of: (1) the requirement to measure the allowance based on all losses expected to occur over the remaining life of the loans receivable rather than including only losses deemed to be related to a past event or current condition, and (2) the reclassification of the non-accretable credit adjustment, currently embedded in the Company’s purchased credit-impaired ("PCI") student loan portfolio, into the allowance for loan losses. The separate measurement guidance applicable today for loans modified in a troubled debt restructuring will also be affected. Both troubled debt restructurings and PCI assets, which the ASU refers to as purchased credit-deteriorated ("PCD") will still be subject to certain separate disclosure requirements. Measurement of credit impairment of available-for-sale debt securities will generally 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.
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 re-evaluated in subsequent periods and adjusted through provision expense as needed, 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 standard, initiating implementation efforts across the Company, and planning for loss modeling requirements consistent with lifetime expected loss estimates. The Company has also been involved in efforts to identify and resolve various implementation issues specific to the application of the standard to credit card receivables. Adoption of the standard could have a potentially material impact on how the Company records and reports its financial condition and results of operations, and on regulatory capital. The extent of the impact upon adoption

7


will likely depend on the characteristics of the Company's loan portfolio and economic conditions at that date, as well as forecasted conditions thereafter.
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 previous GAAP, such amounts generally were recorded directly to stockholders' equity. 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 permits certain elective changes associated with stock compensation accounting. For example, companies can elect to account for award forfeitures as they occur rather than using an estimated forfeiture rate 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. The Company adopted the ASU on its effective date of January 1, 2017. For the three months ended March 31, 2017, the effect on net income from excess tax benefits was $6 million, and basic and diluted earnings per share each increased by $0.016 per share. The Company elected to apply the change in presentation on the Condensed Consolidated Statement of Cash Flows on a prospective basis. The Company will continue to incorporate estimated forfeitures in the accrual of compensation expense and the Company has not changed its policy on statutory withholding requirements. The Company will continue to allow the employee to withhold up to the Company’s minimum statutory withholding requirements. This election had no impact on the Company's condensed consolidated financial statements.
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 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, discussed below. Based on its evaluations to date, management does not anticipate that this ASU will result in different conclusions regarding the Company's revenue arrangements that involve a principal-agent relationship, but any such changes that could occur would result only in classification differences on the statements of income with no impact on income before taxes, net income, financial condition or cash flows.
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 does not expect it to have a material impact on the condensed consolidated financial statements.
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

8


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 material 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. Management does not expect to present any restated prior period amounts when the standard becomes effective in 2018, because little if any change in timing or measurement of the Company’s revenue is expected to occur under the new standard.
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 investment securities consist of the following (dollars in millions):
 
March 31,
2017
 
December 31,
2016
U.S. Treasury securities(1)
$
673

 
$
674

States and political subdivisions of states
1

 
2

Residential mortgage-backed securities - Agency(2)
1,044

 
1,081

Total investment securities
$
1,718

 
$
1,757

 
 
 
 
(1)
Includes $59 million and $73 million of U.S. Treasury securities pledged as swap collateral as of March 31, 2017 and December 31, 2016, respectively.
(2)
Consists of residential mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae.

9


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 March 31, 2017
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S. Treasury securities
$
676

 
$

 
$
(3
)
 
$
673

Residential mortgage-backed securities - Agency
880

 
3

 
(3
)
 
880

Total available-for-sale investment securities
$
1,556

 
$
3

 
$
(6
)
 
$
1,553

Held-to-Maturity Investment Securities(2)
 
 
 
 
 
 
 
States and political subdivisions of states
$
1

 
$

 
$

 
$
1

Residential mortgage-backed securities - Agency(3)
164

 
1

 
(1
)
 
164

Total held-to-maturity investment securities
$
165

 
$
1

 
$
(1
)
 
$
165

 
 
 
 
 
 
 
 
At December 31, 2016
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S. Treasury securities
$
676

 
$

 
$
(2
)
 
$
674

Residential mortgage-backed securities - Agency
934

 
2

 
(5
)
 
931

Total available-for-sale investment securities
$
1,610

 
$
2

 
$
(7
)
 
$
1,605

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

 
$

 
$

 
$
2

Residential mortgage-backed securities - Agency(3) 
150

 
1

 
(1
)
 
150

Total held-to-maturity investment securities
$
152

 
$
1

 
$
(1
)
 
$
152

 
 
 
 
 
 
 
 
(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.
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
 
 
Fair
Value
 
Unrealized
Losses
At March 31, 2017
 
 
 
 
 
Available-for-Sale Investment Securities
 
 
 
 
 
U.S. Treasury securities
1

 
$
673

 
$
(3
)
Residential mortgage-backed securities - Agency
17

 
$
450

 
$
(3
)
Held-to-Maturity Investment Securities
 
 
 
 
 
Residential mortgage-backed securities - Agency
37

 
$
78

 
$
(1
)
 
 
 
 
 
 
At December 31, 2016
 
 
 
 
 
Available-for-Sale Investment Securities
 
 
 
 
 
U.S. Treasury securities
1

 
$
674

 
$
(2
)
Residential mortgage-backed securities - Agency
19

 
$
586

 
$
(5
)
Held-to-Maturity Investment Securities
 
 
 
 
 
Residential mortgage-backed securities - Agency
31

 
$
61

 
$
(1
)
 
 
 
 
 
 
There were no investment securities in a continuous unrealized loss position for more than 12 months at March 31, 2017 and December 31, 2016, respectively. There were no losses related to other-than-temporary impairments during the three months ended March 31, 2017 and 2016.

10


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 March 31,
 
2017
 
2016
Net unrealized gain recorded in other comprehensive income, before-tax
$
2

 
$
23

Net unrealized gain recorded in other comprehensive income, after-tax
$
1

 
$
14

 
 
 
 
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 March 31, 2017
 
 
 
 
 
 
 
 
 
Available-for-Sale Investment Securities—Amortized Cost
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$

 
$
676

 
$

 
$

 
$
676

Residential mortgage-backed securities - Agency

 
57

 
483

 
340

 
880

Total available-for-sale investment securities
$

 
$
733

 
$
483

 
$
340

 
$
1,556

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

 
$

 
$

 
$
1

 
$
1

Residential mortgage-backed securities - Agency

 

 

 
164

 
164

Total held-to-maturity investment securities
$

 
$

 
$

 
$
165

 
$
165

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

 
$
673

 
$

 
$

 
$
673

Residential mortgage-backed securities - Agency

 
57

 
483

 
340

 
880

Total available-for-sale investment securities
$

 
$
730

 
$
483

 
$
340

 
$
1,553

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

 
$

 
$

 
$
1

 
$
1

Residential mortgage-backed securities - Agency

 

 

 
164

 
164

Total held-to-maturity investment securities
$

 
$

 
$

 
$
165

 
$
165

 
 
 
 
 
 
 
 
 
 
Other Investments
As a part of the Company's community reinvestment initiatives, the Company has made equity investments in certain limited partnerships and limited liability companies that finance the construction and rehabilitation of affordable rental housing, as well as stimulate economic development in low to moderate income communities. These investments are accounted for using the equity method of accounting and are recorded within other assets. 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 March 31, 2017 and December 31, 2016, the Company had outstanding investments in these entities of $319 million and $326 million, respectively, and related contingent liabilities of $56 million and $64 million, respectively. Of the above outstanding equity investments, the Company had $270 million of investments related to affordable housing projects as of March 31, 2017 and December 31, 2016, which had $56 million and $64 million related contingent liabilities, respectively.

11


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):
 
March 31,
2017
 
December 31,
2016
Loan receivables
 
 
 
Credit card loans(1)
$
59,757

 
$
61,522

Other loans
 
 
 
Personal loans
6,663

 
6,481

Private student loans
6,689

 
6,393

Other
295

 
274

Total other loans
13,647

 
13,148

PCI loans(2)
2,449

 
2,584

Total loan receivables
75,853

 
77,254

Allowance for loan losses
(2,264
)
 
(2,167
)
Net loan receivables
$
73,589

 
$
75,087

 
 
 
 
(1)
Amounts include $21.3 billion and $20.8 billion underlying investors’ interest in trust debt at March 31, 2017 and December 31, 2016, respectively, and $8.5 billion and $10.8 billion in seller's interest at March 31, 2017 and December 31, 2016, respectively.
(2)
Amounts include $1.3 billion and $1.4 billion of loans pledged as collateral against the notes issued from the Student Loan Corporation ("SLC") securitization trusts at March 31, 2017 and December 31, 2016, respectively. See Note 5: Credit Card and Student Loan Securitization Activities for additional information.

12


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 March 31, 2017
 
 
 
 
 
 
 
 
 
Credit card loans(2)
$
617

 
$
616

 
$
1,233

 
$
557

 
$
201

Other loans
 
 
 
 


 
 
 
 
Personal loans(3)
54

 
20

 
74

 
19

 
10

Private student loans (excluding PCI)(4)
98

 
38

 
136

 
38

 

Other
1

 
1

 
2

 

 
9

Total other loans (excluding PCI)
153

 
59

 
212

 
57

 
19

Total loan receivables (excluding PCI)
$
770

 
$
675

 
$
1,445

 
$
614

 
$
220

 
 
 
 
 
 
 
 
 
 
At December 31, 2016
 
 
 
 
 
 
 
 
 
Credit card loans(2)
$
655

 
$
597

 
$
1,252

 
$
544

 
$
189

Other loans
 
 
 
 


 
 
 
 
Personal loans(3)
55

 
19

 
74

 
18

 
8

Private student loans (excluding PCI)(4)
106

 
35

 
141

 
35

 

Other
1

 
1

 
2

 

 
19

Total other loans (excluding PCI)
162

 
55

 
217

 
53

 
27

Total loan receivables (excluding PCI)
$
817

 
$
652

 
$
1,469

 
$
597

 
$
216

 
 
 
 
 
 
 
 
 
 
 
(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 the three months ended March 31, 2017 and 2016. 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 $66 million and $58 million of loans accounted for as troubled debt restructurings at March 31, 2017 and December 31, 2016, respectively.
(3)
Personal loans that are 90 or more days delinquent and accruing interest include $3 million and $2 million of loans accounted for as troubled debt restructurings at March 31, 2017 and December 31, 2016, respectively.
(4)
Private student loans that are 90 or more days delinquent and accruing interest include $4 million and $3 million of loans accounted for as troubled debt restructurings at March 31, 2017 and December 31, 2016.


13


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 March 31,
 
2017
 
2016
  
Net
Charge-offs
 
Net 
Charge-off
Rate
(1)
 
Net
Charge-offs
 
Net 
Charge-off
Rate
(1)
Credit card loans
$
422

 
2.84
%
 
$
326

 
2.34
%
Other loans
 
 
 
 
 
 
 
Personal loans
51

 
3.16
%
 
34

 
2.45
%
Private student loans (excluding PCI)
14

 
0.83
%
 
12

 
0.85
%
Other
2

 
3.45
%
 

 
%
Total other loans
67

 
2.02
%
 
46

 
1.59
%
Net charge-offs (excluding PCI)
$
489

 
2.69
%
 
$
372

 
2.21
%
Net charge-offs (including PCI)
$
489

 
2.60
%
 
$
372

 
2.11
%
 
 
 
 
 
 
 
 
(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 portion 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 March 31, 2017
 
 
 
Credit card loans
81
%
 
19
%
Personal loans
95
%
 
5
%
Private student loans (excluding PCI)(1)
95
%
 
5
%
 
 
 
 
At December 31, 2016
 
 
 
Credit card loans
82
%
 
18
%
Personal loans
96
%
 
4
%
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 and willing to make payments, the ability to temporarily suspend payments. Eligible borrowers have a lifetime cap on forbearance of 12 months. At March 31, 2017 and December 31, 2016, there were $25 million and $19 million, respectively, of private student loans, including PCI, in forbearance, representing 0.4% and 0.3%, respectively, of total student loans in repayment and forbearance.



14


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 March 31, 2017
 
Credit Card
 
Personal Loans
 
Student Loans(1)
 
Other
 
Total
Balance at beginning of period
$
1,790

 
$
200

 
$
158

 
$
19

 
$
2,167

Additions
 
 
 
 
 
 
 
 
 
Provision for loan losses
524

 
58

 
12

 
(8
)
 
586

Deductions
 
 
 
 
 
 
 
 
 
Charge-offs
(535
)
 
(57
)
 
(17
)
 
(2
)
 
(611
)
Recoveries
113

 
6

 
3

 

 
122

Net charge-offs
(422
)
 
(51
)
 
(14
)
 
(2
)
 
(489
)
Balance at end of period
$
1,892

 
$
207

 
$
156

 
$
9

 
$
2,264

 
 
 
 
 
 
 
 
 
 
 
For the Three Months Ended March 31, 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
362

 
44

 
17

 
1

 
424

Deductions
 
 
 
 
 
 
 
 
 
Charge-offs
(439
)
 
(39
)
 
(15
)
 

 
(493
)
Recoveries
113

 
5

 
3

 

 
121

Net charge-offs
(326
)
 
(34
)
 
(12
)
 

 
(372
)
Balance at end of period
$
1,590

 
$
165

 
$
148

 
$
18

 
$
1,921

 
 
 
 
 
 
 
 
 
 
(1)
Includes both PCI and non-PCI private student loans.
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 March 31,
 
2017
 
2016
Interest and fees accrued subsequently charged off, net of recoveries (recorded as a reduction of interest income)
$
84

 
$
69

Fees accrued subsequently charged off, net of recoveries (recorded as a reduction to other income)
$
22

 
$
17

 
 
 
 

15


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 March 31, 2017
 
 
 
 
 
 
 
 
 
Allowance for loans evaluated for impairment as
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment in accordance with ASC 450-20
$
1,717

 
$
184

 
$
103

 
$
3

 
$
2,007

Evaluated for impairment in accordance with
ASC 310-10-35(2)(3)
175

 
23

 
19

 
6

 
223

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

 

 
34

 

 
34

Total allowance for loan losses
$
1,892

 
$
207

 
$
156

 
$
9

 
$
2,264

Recorded investment in loans evaluated for impairment as
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment in accordance with ASC 450-20
$
58,630

 
$
6,576

 
$
6,588

 
$
250

 
$
72,044

Evaluated for impairment in accordance with
ASC 310-10-35(2)(3)
1,127

 
87

 
101

 
45

 
1,360

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

 

 
2,449

 

 
2,449

Total recorded investment
$
59,757

 
$
6,663

 
$
9,138

 
$
295

 
$
75,853

 
 
 
 
 
 
 
 
 
 
At December 31, 2016
 
 
 
 
 
 
 
 
 
Allowance for loans evaluated for impairment as
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment in accordance with ASC 450-20
$
1,623

 
$
179

 
$
105

 
$
3

 
$
1,910

Evaluated for impairment in accordance with
ASC 310-10-35(2)(3)
167

 
21

 
18

 
16

 
222

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

 

 
35

 

 
35

Total allowance for loan losses
$
1,790

 
$
200

 
$
158

 
$
19

 
$
2,167

Recorded investment in loans evaluated for impairment as
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment in accordance with ASC 450-20
$
60,437

 
$
6,400

 
$
6,307

 
$
219

 
$
73,363

Evaluated for impairment in accordance with
ASC 310-10-35(2)(3)
1,085

 
81

 
86

 
55

 
1,307

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

 

 
2,584

 

 
2,584

Total recorded investment
$
61,522

 
$
6,481

 
$
8,977

 
$
274

 
$
77,254

 
 
 
 
 
 
 
 
 
 
(1)
Includes both PCI and non-PCI private student loans.
(2)
Loan receivables evaluated for impairment in accordance with Accounting Standards Codification ("ASC") 310-10-35 include credit card loans, personal loans and student loans collectively evaluated for impairment in accordance with ASC Subtopic 310-40, Receivables, which consists of modified loans accounted for as troubled debt restructurings. Other loans are individually evaluated for impairment and generally do not represent troubled debt restructurings.
(3)
The unpaid principal balance of credit card loans was $973 million and $935 million at March 31, 2017 and December 31, 2016, respectively. The unpaid principal balance of personal loans was $86 million and $79 million at March 31, 2017 and December 31, 2016, respectively. The unpaid principal balance of student loans was $99 million and $84 million at March 31, 2017 and December 31, 2016, respectively. All loans accounted for as troubled debt restructurings have a related allowance for loan losses.
Troubled Debt Restructurings
The Company has internal loan modification programs that provide relief to credit card, personal loan and student loan borrowers who are experiencing financial hardship. The internal loan modification programs include both temporary and permanent programs which vary by product. External loan modification programs are also available for credit card and personal loans. Temporary and permanent modifications on credit card and personal loans, as well as temporary modifications on student loans and certain grants of student loan forbearance, result in the loans being considered individually impaired. In addition, loans that defaulted or graduated from modification programs or forbearance are considered to be individually impaired.
For credit card customers, the temporary hardship program primarily consists of a reduced minimum payment and an interest rate reduction, both lasting for a period no longer than 12 months. The permanent workout program involves changing the structure of the loan to a fixed payment loan with a maturity no longer than 60 months and reducing the interest rate on the loan. The permanent modification program does not normally provide for the forgiveness of unpaid principal, but

16


may allow for the reversal of certain unpaid interest or fee assessments. The Company also makes permanent loan modifications for customers who request financial assistance through external sources, such as a consumer credit counseling agency program. These loans typically receive a reduced interest rate but continue to be subject to the original minimum payment terms and do not normally include waiver of unpaid principal, interest or fees. Credit card loans included in temporary and permanent programs are accounted for as troubled debt restructurings.
For personal loan customers, in certain situations the Company offers various payment programs, including temporary and permanent programs. The temporary programs normally consist of a reduction of the minimum payment for a period of no longer than 12 months with the option of a final balloon payment required at the end of the loan term or an extension of the maturity date with the total term not exceeding nine years. Further, in certain circumstances the interest rate on the loan is reduced. The permanent program involves changing the terms of the loan in order to pay off the outstanding balance over a longer term and also in certain circumstances reducing the interest rate on the loan. Similar to the temporary programs, the total term may not exceed nine years. The Company also allows permanent loan modifications for customers who request financial assistance through external sources, similar to the credit card customers discussed above. Payments are modified based on the new terms agreed upon with the credit counseling agency. Personal loans included in temporary and permanent programs are accounted for as troubled debt restructurings.
To assist student loan borrowers who are experiencing temporary financial difficulties but are willing to resume making payments, the Company may offer hardship forbearance or programs that include payment deferral, temporary payment reduction, temporary interest rate reduction or extended terms. A modified loan typically meets the definition of a troubled debt restructuring based on the cumulative length of the concession period and an evaluation of the credit quality of the borrower, based on FICO scores. Prior to the third quarter of 2016, only a second forbearance when the borrower was 30 days or greater delinquent was considered a troubled debt restructuring. As a result, the student loan balances being accounted for as troubled debt restructurings increased, although it did not lead to significant changes in the balance of the overall allowance for loan losses.
The Company monitors borrower performance after using payment programs or forbearance and the Company believes the programs help to prevent defaults and are useful in assisting customers experiencing financial difficulties. The Company plans to continue to use payment programs and forbearance and, as a result, expects to have additional loans classified as troubled debt restructurings in the future.
Additional information about modified loans classified as troubled debt restructurings is shown below (dollars in millions):
 
Average recorded investment in loans
 
Interest income recognized during period loans were impaired(1)
 
Gross interest income that would have been recorded with original terms(2)
For the Three Months Ended March 31, 2017
 
 
 
 
 
Credit card loans(3)
$
1,108

 
$
25

 
$
20

Personal loans
$
84

 
$
2

 
$
1

Private student loans(4)
$
94

 
$
2

 
$

 
 
 
 
 
 
For the Three Months Ended March 31, 2016
 
 
 
 
 
Credit card loans(3)
$
1,021

 
$
20

 
$
20

Personal loans
$
69

 
$
2

 
$
1

Private student loans(4)
$
50

 
$
1

 
N/A

 
 
 
 
 
 
(1)
The Company does not separately track interest income on loans in modification programs. Amounts shown are estimated by applying an average interest rate to the average loans in the various modification programs.
(2)
The Company does not separately track the amount of additional gross interest income that would have been recorded if the loans in modification programs had not been restructured and interest had instead been recorded in accordance with the original terms. Amounts shown are estimated by applying the difference between the average interest rate earned on non-impaired loans and the average interest rate earned on loans in the modification programs to the average loans in the modification programs.
(3)
Includes credit card loans that were modified in troubled debt restructurings, but are no longer enrolled in a troubled debt restructuring program due to noncompliance with the terms of the modification or successful completion of a program. The average balance of credit card loans that were no longer enrolled in a troubled debt restructuring program was $311 million and $274 million, respectively, for the three months ended March 31, 2017 and 2016.
(4)
As a result of the updates implemented in the third quarter of 2016, some student loans accounted for as troubled debt restructurings have additional gross income that would have been recorded if the loans in modification programs had not been restructured and interest had instead been recorded in accordance with the original terms. For the three months ended March 31, 2017, the gross income that would have been recorded with original terms for student loans in modification programs was not material.

17


In order to evaluate the primary financial effects that resulted from credit card loans entering into a loan modification program during the three months ended March 31, 2017 and 2016, the Company quantified the amount by which interest and fees were reduced during the periods. During the three months ended March 31, 2017 and 2016, the Company forgave approximately $11 million and $9 million, respectively, of interest and fees as a result of accounts entering into a credit card loan modification program.
The following table provides information on loans that entered a loan modification program during the period (dollars in millions):
 
For the Three Months Ended March 31,
 
2017
 
2016
 
Number of Accounts
 
Balances
 
Number of Accounts
 
Balances
Accounts that entered a loan modification program during the period
 
 
 
 
 
 
 
Credit card loans
30,893

 
$
181

 
22,284

 
$
135

Personal loans
1,563

 
$
18

 
1,061

 
$
12

Private student loans
1,017

 
$
17

 
452

 
$
8

 
 
 
 
 
 
 
 
The following table presents the carrying value of loans that experienced a payment default during the period that had been modified in a troubled debt restructuring during the 15 months preceding the end of each period (dollars in millions):
 
For the Three Months Ended March 31,
 
2017
 
2016
 
Number of Accounts
 
Aggregated Outstanding Balances Upon Default
 
Number of Accounts
 
Aggregated Outstanding Balances Upon Default
Troubled debt restructurings that subsequently defaulted
 
 
 
 
 
 
 
Credit card loans(1)(2)
8,166

 
$
44

 
4,700

 
$
25

Personal loans(2)
307

 
$
4

 
158

 
$
2

Private student loans(3)
185

 
$
3

 
197

 
$
3

 
 
 
 
 
 
 
 
(1)
Terms revert back to the pre-modification terms for customers who default from a temporary program and charging privileges remain revoked in most cases.
(2)
For credit card loans and personal loans, a customer defaults from a modification program after two consecutive missed payments. The outstanding balance upon default is generally the loan balance at the end of the month prior to default.
(3)
For student loans, defaults have been defined as loans that are 60 or more days delinquent. The outstanding balance upon default is generally the loan balance at the end of the month prior to default.
Of the account balances that defaulted as shown above for the three months ended March 31, 2017 and 2016, approximately 38% and 37%, respectively, of the total balances were charged off at the end of the month in which they defaulted. For accounts that have defaulted from a loan modification program and have not been subsequently charged off, the balances are included in the allowance for loan loss analysis discussed above under "— Allowance for Loan Losses."
Purchased Credit-Impaired Loans
Purchased loans with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected are considered impaired at acquisition and are reported as PCI loans. The private student loans acquired in the SLC transaction, as well as the additional acquired private student loan portfolio comprise the Company’s only PCI loans at March 31, 2017 and December 31, 2016. Total PCI student loans had an outstanding balance of $2.6 billion and $2.7 billion, including accrued interest, and a related carrying amount of $2.4 billion and $2.6 billion as of March 31, 2017 and December 31, 2016, respectively.

18


The following table provides changes in accretable yield for the acquired loans during each period (dollars in millions):
 
For the Three Months Ended March 31,
 
2017
 
2016
Balance at beginning of period
$
796

 
$
965

Accretion into interest income
(41
)
 
(49
)
Balance at end of period
$
755

 
$
916

 
 
 
 
Periodically, the Company updates the estimate of cash flows expected to be collected based on management's latest expectations of future credit losses, borrower prepayments and certain other assumptions that affect cash flows. No provision expense was recorded during the three months ended March 31, 2017 and 2016. The allowance for PCI loan losses at March 31, 2017 and December 31, 2016 was $34 million and $35 million. For the three months ended March 31, 2017 and 2016, there were no changes in expected cash flow assumptions. Changes to accretable yield are recognized prospectively as an adjustment to yield over the remaining life of the pools.
At March 31, 2017, the 30 or more days delinquency and 90 or more days delinquency rates on PCI student loans (which include loans not yet in repayment) were 2.64% and 0.84%, respectively. At December 31, 2016, the 30 or more days delinquency and 90 or more days delinquency rates on PCI student loans (which include loans not yet in repayment) were 2.88% and 0.87%, respectively. These rates include private student loans that are greater than 120 days delinquent that are covered by an indemnification agreement or insurance arrangements through which the Company expects to recover a substantial portion of the loan. The net charge-off rate on PCI student loans was 0.53% and 0.43% for the three months ended March 31, 2017 and 2016, respectively.
5.
Credit Card and Student Loan Securitization Activities
Credit Card Securitization Activities
The Company accesses the term asset securitization market through the Discover Card Master Trust I (“DCMT”) and the Discover Card Execution Note Trust (“DCENT”), which are trusts into which credit card loan receivables are transferred (or, in the case of DCENT, into which beneficial interests in DCMT are transferred) and from which DCENT issues notes to investors.
The DCENT debt structure consists of four classes of securities (DiscoverSeries Class A, B, C and D notes), with the most senior class generally receiving a triple-A rating. In order to issue senior, higher rated classes of notes, it is necessary to obtain the appropriate amount of credit enhancement, generally through the issuance of junior, lower rated or more highly subordinated classes of notes. The subordinated classes are held by wholly-owned subsidiaries of Discover Bank. The Company is exposed to credit-related risk of loss associated with trust assets as of the balance sheet date through the retention of these subordinated interests. The estimated probable incurred loss is included in the allowance for loan losses estimate.
The Company’s credit card securitizations are accounted for as secured borrowings and the trusts and Discover Funding LLC are treated as consolidated subsidiaries of the Company. The Company’s retained interests in the assets of the trusts, consisting of investments in DCENT notes held by subsidiaries of Discover Bank, constitute intercompany positions which are eliminated in the preparation of the Company’s condensed consolidated statements of financial condition.
Upon transfer of credit card loan receivables to the trust, the receivables and certain cash flows derived from them become restricted for use in meeting obligations to the trusts’ creditors. Further, the transferred credit card loan receivables are owned by the trust and are not available to third-party creditors of the Company. The trusts have ownership of cash balances that also have restrictions, the amounts of which are reported in restricted cash. Investment of trust cash balances is limited to investments that are permitted under the governing documents of the trusts and which have maturities no later than the related date on which funds must be made available for distribution to trust investors. With the exception of the seller’s interest in trust receivables, the Company’s interests in trust assets are generally subordinate to the interests of third-party investors and, as such, may not be realized by the Company if needed to absorb deficiencies in cash flows that are allocated to the investors in the trusts’ debt.

19


The carrying values of these restricted assets, which are presented on the Company’s condensed consolidated statements of financial condition as relating to securitization activities, are shown in the table below (dollars in millions):
 
March 31,
2017
 
December 31,
2016
Restricted cash
$
1,025

 
$
23

 
 
 
 
Investors’ interests held by third-party investors
16,075

 
15,625

Investors’ interests held by wholly-owned subsidiaries of Discover Bank
5,231

 
5,189

Seller’s interest
8,507

 
10,812

Loan receivables(1)
29,813

 
31,626

Allowance for loan losses allocated to securitized loan receivables(1)
(950
)
 
(928
)
Net loan receivables
28,863

 
30,698

Other
5

 
4

Carrying value of assets of consolidated variable interest entities
$
29,893

 
$
30,725

 
 
 
 
(1)
The Company maintains its allowance for loan losses at an amount sufficient to absorb probable losses inherent in all loan receivables, which includes all loan receivables in the trusts. Therefore, credit risk associated with the transferred receivables is fully reflected on the Company’s balance sheet in accordance with GAAP.
The debt securities issued by the consolidated trusts are subject to credit, payment and interest rate risks on the transferred credit card loan receivables. To protect investors, the securitization structures include certain features that could result in earlier-than-expected repayment of the securities. The primary investor protection feature relates to the availability and adequacy of cash flows in the securitized pool of receivables to meet contractual requirements. Insufficient cash flows would trigger the early repayment of the securities. This is referred to as the “economic early amortization” feature.
Investors are allocated cash flows derived from activities related to the accounts comprising the securitized pool of receivables, the amounts of which reflect finance charges billed, certain fee assessments, allocations of merchant discount and interchange, and recoveries on charged-off accounts. From these cash flows, investors are reimbursed for charge-offs occurring within the securitized pool of receivables and receive a contractual rate of return and Discover Bank is paid a servicing fee as servicer. Any cash flows remaining in excess of these requirements are reported to investors as excess spread. An excess spread rate of less than 0% for a contractually specified period, generally a three-month average, would trigger an economic early amortization event. In such an event, the Company would be required to seek immediate sources of replacement funding. Apart from the restricted assets related to securitization activities, the investors and the securitization trusts have no recourse to the Company’s other assets or the Company's general credit for a shortage in cash flows.
Through its wholly-owned indirect subsidiary, Discover Funding LLC, the Company is required to maintain a contractual minimum level of receivables in the trust in excess of the face value of outstanding investors’ interests. This excess is referred to as the minimum seller’s interest. The required minimum seller’s interest in the pool of trust receivables, which is included in credit card loan receivables restricted for securitization investors, is set at approximately 7% in excess of the total investors’ interests (which includes interests held by third parties as well as those interests held by the Company). If the level of receivables in the trust was to fall below the required minimum, the Company would be required to add receivables from the unrestricted pool of receivables, which would increase the amount of credit card loan receivables restricted for securitization investors. A decline in the amount of the excess seller’s interest could occur if balance repayments and charge-offs exceeded new lending on the securitized accounts or as a result of changes in total outstanding investors’ interests. Seller's interest is impacted by seasonality as higher balance repayments tend to occur in the first calendar year quarter. If the Company could not add enough receivables to satisfy the requirement, an early amortization (or repayment) of investors’ interests would be triggered. The Company retains significant exposure to the performance of trust assets through holdings of the seller's interest and subordinated security classes of DCENT. The Company may elect to add receivables to the restricted pool of receivables subject to certain requirements. The Company also has the right to remove a random selection of accounts, which would serve to decrease the amount of credit card loan receivables restricted for securitization investors, subject to certain requirements including that the minimum seller's interest is still met. In the three months ended March 31, 2017, no accounts were added to or removed from those restricted for securitization investors.
In addition to performance measures associated with the transferred credit card loan receivables or the inability to add receivables to satisfy the seller's interest requirement, there are other events or conditions which could trigger an early amortization event, such as non-payment of principal at expected maturity. As of March 31, 2017, no economic or other early amortization events have occurred.

20


The table below provides information concerning investors’ interests and related excess spread (dollars in millions):  
At March 31, 2017
Investors’
Interests(1)
 
Number of Series
Outstanding
 
3-Month Rolling
Average Excess
Spread
Discover Card Execution Note Trust (DiscoverSeries notes)
$
21,306

 
37

 
12.73
%
 
 
 
 
 
 
(1)
Investors’ interests include third-party interests and subordinated interests held by wholly-owned subsidiaries of Discover Bank.
The Company continues to own and service the accounts that generate the loan receivables held by the trusts. Discover Bank receives servicing fees from the trusts based on a percentage of the monthly investor principal balance outstanding. Although the fee income to Discover Bank offsets the fee expense to the trusts and thus is eliminated in consolidation, failure to service the transferred loan receivables in accordance with contractual requirements could lead to a termination of the servicing rights and the loss of future servicing income, net of related expenses.
Student Loan Securitization Activities
The Company’s student loan securitizations are accounted for as secured borrowings and the trusts are treated as consolidated subsidiaries of the Company. Trust receivables underlying third-party investors’ interests are recorded in PCI loans and the related debt issued by the trusts is reported in long-term borrowings. The assets of the Company’s consolidated VIEs are restricted from being sold or pledged as collateral for other borrowings and the cash flows from these restricted assets may be used only to pay obligations of the trusts.
Currently there are three trusts from which securities were issued to investors. Principal payments on the long-term secured borrowings are made as cash is collected on the underlying loans that are used as collateral on the secured borrowings. The Company does not have access to cash collected by the securitization trusts until cash is released in accordance with the trust indenture agreements and, for certain securitizations, no cash will be released to the Company until all outstanding trust borrowings have been repaid. Similar to the credit card securitizations, the Company continues to own and service the accounts that generate the student loan receivables held by the trusts and receives servicing fees from the trusts based on either a percentage of the principal balance outstanding or a flat fee per borrower. Although the servicing fee income offsets the fee expense related to the trusts and thus is eliminated in consolidation, failure to service the transferred loan receivables in accordance with contractual requirements could lead to a termination of the servicing rights and the loss of future servicing income, net of related expenses.
Under terms of all the trust arrangements, the Company has the option, but not the obligation, to provide financial support to the trusts, but has never provided such support. A substantial portion of the credit risk associated with the securitized loans has been transferred to third parties under private credit insurance or indemnification arrangements.
The carrying values of these restricted assets, which are presented on the Company’s condensed consolidated statements of financial condition as relating to securitization activities, are shown in the table below (dollars in millions): 
 
March 31,
2017
 
December 31,
2016
Restricted cash
$
75

 
$
72

 
 
 
 
Student loan receivables(1)
1,317

 
1,390

Allowance for loan losses allocated to securitized loan receivables(1)
(26
)
 
(27
)
Net student loan receivables
1,291

 
1,363

Carrying value of assets of consolidated variable interest entities
$
1,366

 
$
1,435

 
 
 
 
(1)
The Company maintains its allowance for loan losses on PCI loans sufficient to absorb probable decreases in cash flows that were previously expected. Therefore, credit risk associated with the transferred receivables is fully reflected on the Company's balance sheet in accordance with GAAP.
6.
Deposits
The Company offers its deposit products to customers through two channels: (i) through direct marketing, internet origination and affinity relationships (“direct-to-consumer deposits”); and (ii) indirectly through contractual arrangements with securities brokerage firms (“brokered deposits”). Direct-to-consumer deposits include certificates of deposit, money market accounts, online savings and checking accounts and IRA certificates of deposit, while brokered deposits include certificates of deposit and sweep accounts.

21


The following table provides a summary of interest-bearing deposit accounts (dollars in millions):
 
March 31,
2017
 
December 31,
2016
Certificates of deposit in amounts less than $100,000
$
20,734

 
$
20,225

Certificates of deposit in amounts $100,000 or greater(1)
5,862

 
5,864

Savings deposits, including money market deposit accounts
26,421

 
25,372

Total interest-bearing deposits
$
53,017

 
$
51,461

 
 
 
 
(1)
Includes $1.4 billion in certificates of deposit greater than $250,000, the Federal Deposit Insurance Corporation ("FDIC") insurance limit, as of March 31, 2017 and December 31, 2016, respectively.
The following table summarizes certificates of deposit in amounts of $100,000 or greater by contractual maturity (dollars in millions):
Maturity Period