10-Q 1 dfs630201710q.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 June 30, 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 July 28, 2017, there were 372,351,948 shares of the registrant’s Common Stock, par value $0.01 per share, outstanding.
 



DISCOVER FINANCIAL SERVICES
Quarterly Report on Form 10-Q for the quarterly period ended June 30, 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
 
June 30,
2017
 
December 31,
2016
 
(unaudited)
(dollars in millions,
except share amounts)
Assets
 
 
 
Cash and cash equivalents
$
12,950

 
$
11,914

Restricted cash
93

 
95

Investment securities (includes $1,499 and $1,605 at fair value at June 30, 2017 and December 31, 2016, respectively)
1,679

 
1,757

Loan receivables
 
 
 
Loan receivables
77,997

 
77,254

Allowance for loan losses
(2,384
)
 
(2,167
)
Net loan receivables
75,613

 
75,087

Premises and equipment, net
774

 
734

Goodwill
255

 
255

Intangible assets, net
164

 
166

Other assets
2,229

 
2,300

Total assets
$
93,757

 
$
92,308

Liabilities and Stockholders’ Equity
 
 
 
Deposits
 
 
 
Interest-bearing deposit accounts
$
52,359

 
$
51,461

Non-interest bearing deposit accounts
505

 
531

Total deposits
52,864

 
51,992

Long-term borrowings
26,438

 
25,443

Accrued expenses and other liabilities
3,196

 
3,550

Total liabilities
82,498

 
80,985

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

 

Stockholders’ Equity:
 
 
 
Common stock, par value $0.01 per share; 2,000,000,000 shares authorized; 563,441,961 and 562,414,040 shares issued at June 30, 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 June 30, 2017 and December 31, 2016
560

 
560

Additional paid-in capital
3,997

 
3,962

Retained earnings
15,989

 
15,130

Accumulated other comprehensive loss
(150
)
 
(161
)
Treasury stock, at cost; 188,278,530 and 173,648,023 shares at June 30, 2017 and December 31, 2016, respectively
(9,143
)
 
(8,173
)
Total stockholders’ equity
11,259

 
11,323

Total liabilities and stockholders’ equity
$
93,757

 
$
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.
 
June 30,
2017
 
December 31,
2016
 
(unaudited)
(dollars in millions)
Assets
 
 
 
Restricted cash
$
93

 
$
95

Loan receivables
$
31,356

 
$
33,016

Allowance for loan losses allocated to securitized loan receivables
$
(995
)
 
$
(955
)
Other assets
$
5

 
$
4

Liabilities
 
 
 
Long-term borrowings
$
16,738

 
$
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 June 30,
 
For the Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
 (unaudited)
(dollars in millions, except per share amounts)
Interest income
 
 
 
 
 
 
 
Credit card loans
$
1,916

 
$
1,734

 
$
3,792

 
$
3,467

Other loans
379

 
331

 
746

 
657

Investment securities
7

 
10

 
14

 
21

Other interest income
36

 
15

 
64

 
29

Total interest income
2,338

 
2,090

 
4,616

 
4,174

Interest expense
 
 
 
 
 
 
 
Deposits
199

 
166

 
390

 
328

Long-term borrowings
201

 
173

 
396

 
345

Total interest expense
400

 
339

 
786

 
673

Net interest income
1,938

 
1,751

 
3,830

 
3,501

Provision for loan losses
640

 
412

 
1,226

 
836

Net interest income after provision for loan losses
1,298

 
1,339

 
2,604

 
2,665

Other income
 
 
 
 
 
 
 
Discount and interchange revenue, net
278

 
265

 
511

 
538

Protection products revenue
56

 
59

 
114

 
120

Loan fee income
83

 
79

 
172

 
159

Transaction processing revenue
42

 
39

 
81

 
75

Other income
22

 
23

 
50

 
47

Total other income
481

 
465

 
928

 
939

Other expense
 
 
 
 
 
 
 
Employee compensation and benefits
367

 
340

 
730

 
685

Marketing and business development
192

 
198

 
360

 
360

Information processing and communications
77

 
89

 
157

 
177

Professional fees
156

 
150

 
303

 
310

Premises and equipment
23

 
23

 
48

 
47

Other expense
97

 
106

 
199

 
213

Total other expense
912

 
906

 
1,797

 
1,792

Income before income tax expense
867

 
898

 
1,735

 
1,812

Income tax expense
321

 
282

 
625

 
621

Net income
$
546

 
$
616

 
$
1,110

 
$
1,191

Net income allocated to common stockholders
$
532

 
$
602

 
$
1,083

 
$
1,164

Basic earnings per common share
$
1.41

 
$
1.47

 
$
2.83

 
$
2.81

Diluted earnings per common share
$
1.40

 
$
1.47

 
$
2.83

 
$
2.81

Dividends declared per common share
$
0.30

 
$
0.30

 
$
0.60

 
$
0.58

 
 
 
 
 
 
 
 

See Notes to the Condensed Consolidated Financial Statements.
2



DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Comprehensive Income
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
 (unaudited)
(dollars in millions)
Net income
$
546

 
$
616

 
$
1,110

 
$
1,191

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

 
4

 
1

 
18

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

 
(6
)
 
10

 
(32
)
Other comprehensive income (loss)
5

 
(2
)
 
11

 
(14
)
Comprehensive income
$
551

 
$
614

 
$
1,121

 
$
1,177

 
 
 
 
 
 
 
 

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

 

 

 

 

 
1,191

 

 

 
1,191

Other comprehensive loss

 

 

 

 

 

 
(14
)
 

 
(14
)
Purchases of treasury stock

 

 

 

 

 

 

 
(849
)
 
(849
)
Common stock issued under employee benefit plans

 

 
45

 

 
2

 

 

 

 
2

Common stock issued and stock-based compensation expense

 

 
1,631

 

 
45

 

 

 

 
45

Dividends — common stock

 

 

 

 

 
(234
)
 

 

 
(234
)
Dividends — preferred stock

 

 

 

 

 
(19
)
 

 

 
(19
)
Balance at June 30, 2016
575

 
$
560

 
562,355

 
$
5

 
$
3,932

 
$
14,188

 
$
(174
)
 
$
(7,114
)
 
$
11,397

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
575

 
$
560

 
562,414

 
$
5

 
$
3,962

 
$
15,130

 
$
(161
)
 
$
(8,173
)
 
$
11,323

Net income

 

 

 

 

 
1,110

 

 

 
1,110

Other comprehensive income

 

 

 

 

 

 
11

 

 
11

Purchases of treasury stock

 

 

 

 

 

 

 
(970
)
 
(970
)
Common stock issued under employee benefit plans

 

 
40

 

 
3

 

 

 

 
3

Common stock issued and stock-based compensation expense

 

 
988

 
1

 
32

 

 

 

 
33

Dividends — common stock

 

 

 

 

 
(232
)
 

 

 
(232
)
Dividends — preferred stock

 

 

 

 

 
(19
)
 

 

 
(19
)
Balance at June 30, 2017
575

 
$
560

 
563,442

 
$
6

 
$
3,997

 
$
15,989

 
$
(150
)
 
$
(9,143
)
 
$
11,259

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

See Notes to the Condensed Consolidated Financial Statements.
4



DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Cash Flows
 
For the Six Months Ended June 30,
 
2017
 
2016
 
(unaudited)
(dollars in millions)
Cash flows from operating activities
 
 
 
Net income
$
1,110

 
$
1,191

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
1,226

 
836

Deferred income taxes
(46
)
 
121

Depreciation and amortization
188

 
176

Amortization of deferred revenues and accretion of accretable yield on acquired loans
(195
)
 
(198
)
Net loss investments and other assets
27

 
26

Other, net
33

 
39

Changes in assets and liabilities:
 
 
 
Decrease in other assets
3

 
89

Decrease in accrued expenses and other liabilities
(314
)
 
(464
)
Net cash provided by operating activities
2,032

 
1,816

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

 
(1,050
)
Maturities of available-for-sale investment securities
104

 
671

Maturities of held-to-maturity investment securities
7

 
9

Purchases of held-to-maturity investment securities
(36
)
 
(46
)
Net principal disbursed on loans originated for investment
(1,550
)
 
(83
)
Proceeds from returns of investment
14

 

Purchases of other investments
(23
)
 
(12
)
Increase in restricted cash
2

 
1

Purchases of premises and equipment
(103
)
 
(86
)
Net cash used for investing activities
(1,585
)
 
(596
)
 
 
 
 
Cash flows from financing activities
 
 
 
Proceeds from issuance of securitized debt
2,952

 
1,833

Maturities and repayment of securitized debt
(2,651
)
 
(1,966
)
Proceeds from issuance of other long-term borrowings
1,050

 
73

Maturities and repayment of other long-term borrowings
(401
)
 

Proceeds from issuance of common stock
2

 
5

Purchases of treasury stock
(970
)
 
(849
)
Net increase in deposits
858

 
983

Dividends paid on common and preferred stock
(251
)
 
(254
)
Net cash provided by (used for) financing activities
589

 
(175
)
Net increase in cash and cash equivalents
1,036

 
1,045

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

 
9,572

Cash and cash equivalents, at end of period
$
12,950

 
$
10,617

 
 
 
 


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. 2016-08, 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 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. The new revenue recognition model will become effective for the Company on January 1, 2018.
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. Management has followed the discussions of the FASB subsequent to the issuance of the ASU, 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

8


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.
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. 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. At this time, management does not anticipate a restatement of prior period amounts when the standard becomes effective.
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.
2.
Investments
The Company’s investment securities consist of the following (dollars in millions):
 
June 30,
2017
 
December 31,
2016
U.S. Treasury securities(1)
$
672

 
$
674

States and political subdivisions of states
1

 
2

Residential mortgage-backed securities - Agency(2)
1,006

 
1,081

Total investment securities
$
1,679

 
$
1,757

 
 
 
 
(1)
Includes $37 million and $73 million of U.S. Treasury securities pledged as swap collateral as of June 30, 2017 and December 31, 2016, respectively.
(2)
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 June 30, 2017
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S. Treasury securities
$
676

 
$

 
$
(4
)
 
$
672

Residential mortgage-backed securities - Agency
827

 
3

 
(3
)
 
827

Total available-for-sale investment securities
$
1,503

 
$
3

 
$
(7
)
 
$
1,499

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

 
$

 
$

 
$
1

Residential mortgage-backed securities - Agency(3)
179

 
1

 
(1
)
 
179

Total held-to-maturity investment securities
$
180

 
$
1

 
$
(1
)
 
$
180

 
 
 
 
 
 
 
 
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.

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 June 30, 2017
 
 
 
 
 
 
 
 
 
Available-for-Sale Investment Securities
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
1

 
$
672

 
$
(4
)
 
$

 
$

Residential mortgage-backed securities - Agency
15

 
$
376

 
$
(2
)
 
$
46

 
$
(1
)
Held-to-Maturity Investment Securities
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities - Agency
38

 
$
88

 
$
(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 losses related to other-than-temporary impairments during the three and six months ended June 30, 2017 and 2016.
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 June 30,
 
For the Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Net unrealized gain recorded in other comprehensive income, before-tax
$

 
$
6

 
$
2

 
$
29

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

 
$
4

 
$
1

 
$
18

 
 
 
 
 
 
 
 

10


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 June 30, 2017
 
 
 
 
 
 
 
 
 
Available-for-Sale Investment Securities—Amortized Cost
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$

 
$
676

 
$

 
$

 
$
676

Residential mortgage-backed securities - Agency

 
73

 
560

 
194

 
827

Total available-for-sale investment securities
$

 
$
749

 
$
560

 
$
194

 
$
1,503

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

 
$

 
$

 
$
1

 
$
1

Residential mortgage-backed securities - Agency

 

 

 
179

 
179

Total held-to-maturity investment securities
$

 
$

 
$

 
$
180

 
$
180

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

 
$
672

 
$

 
$

 
$
672

Residential mortgage-backed securities - Agency

 
73

 
559

 
195

 
827

Total available-for-sale investment securities
$

 
$
745

 
$
559

 
$
195

 
$
1,499

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

 
$

 
$

 
$
1

 
$
1

Residential mortgage-backed securities - Agency

 

 

 
179

 
179

Total held-to-maturity investment securities
$

 
$

 
$

 
$
180

 
$
180

 
 
 
 
 
 
 
 
 
 
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 June 30, 2017 and December 31, 2016, the Company had outstanding investments in these entities of $332 million and $326 million, respectively, and related contingent liabilities of $74 million and $64 million, respectively. Of the above outstanding equity investments, the Company had $290 million and $270 million of investments related to affordable housing projects as of June 30, 2017 and December 31, 2016, respectively, which had $74 million and $64 million related contingent liabilities, respectively.

11


3.
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):
 
June 30,
2017
 
December 31,
2016
Loan receivables
 
 
 
Credit card loans(1)
$
61,797

 
$
61,522

Other loans
 
 
 
Personal loans
6,955

 
6,481

Private student loans
6,594

 
6,393

Other
329

 
274

Total other loans
13,878

 
13,148

PCI loans(2)
2,322

 
2,584

Total loan receivables
77,997

 
77,254

Allowance for loan losses
(2,384
)
 
(2,167
)
Net loan receivables
$
75,613

 
$
75,087

 
 
 
 
(1)
Amounts include $21.2 billion and $20.8 billion underlying investors’ interest in trust debt at June 30, 2017 and December 31, 2016, respectively, and $8.9 billion and $10.8 billion in seller's interest at June 30, 2017 and December 31, 2016, respectively. See Note 4: Credit Card and Student Loan Securitization Activities for additional information.
(2)
Amounts include $1.2 billion and $1.4 billion of loans pledged as collateral against the notes issued from the Student Loan Corporation ("SLC") securitization trusts at June 30, 2017 and December 31, 2016, respectively. See Note 4: 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 June 30, 2017
 
 
 
 
 
 
 
 
 
Credit card loans(2)
$
634

 
$
603

 
$
1,237

 
$
540

 
$
206

Other loans
 
 
 
 


 
 
 
 
Personal loans(3)
57

 
21

 
78

 
20

 
10

Private student loans (excluding PCI)(4)
98

 
42

 
140

 
42

 

Other
1

 
1

 
2

 

 
10

Total other loans (excluding PCI)
156

 
64

 
220

 
62

 
20

Total loan receivables (excluding PCI)
$
790

 
$
667

 
$
1,457

 
$
602

 
$
226

 
 
 
 
 
 
 
 
 
 
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 $9 million and $7 million for the three months ended June 30, 2017 and 2016, respectively, and $17 million and $15 million for the six months ended June 30, 2017 and 2016, 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 $61 million and $58 million of loans accounted for as troubled debt restructurings at June 30, 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 June 30, 2017 and December 31, 2016, respectively.
(4)
Private student loans that are 90 or more days delinquent and accruing interest include $5 million and $3 million of loans accounted for as troubled debt restructurings at June 30, 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 June 30,
 
2017
 
2016
  
Net
Charge-offs
 
Net 
Charge-off
Rate
(1)
 
Net
Charge-offs
 
Net 
Charge-off
Rate
(1)
Credit card loans
$
445

 
2.94
%
 
$
334

 
2.39
%
Other loans
 
 
 
 
 
 
 
Personal loans
54

 
3.18
%
 
33

 
2.38
%
Private student loans (excluding PCI)
20

 
1.15
%
 
17

 
1.10
%
Other
1

 
0.30
%
 

 
%
Total other loans
75

 
2.14
%
 
50

 
1.68
%
Net charge-offs (excluding PCI)
$
520

 
2.79
%
 
$
384

 
2.27
%
Net charge-offs (including PCI)
$
520

 
2.71
%
 
$
384

 
2.18
%
 
 
 
 
 
 
 
For the Six Months Ended June 30,
 
2017
 
2016
  
Net
Charge-off
Dollars
 
Net 
Charge-off
Rate
(1)
 
Net
Charge-off
Dollars
 
Net 
Charge-off
Rate
(1)
Credit card loans
$
867

 
2.89
%
 
$
660

 
2.37
%
Other loans
 
 
 
 
 
 
 
Personal loans
105

 
3.17
%
 
67

 
2.41
%
Private student loans (excluding PCI)
34

 
0.99
%
 
29

 
0.98
%
Other
3

 
1.79
%
 

 
%
Total other loans
142

 
2.08
%
 
96

 
1.64
%
Net charge-offs (excluding PCI)
$
1,009

 
2.74
%
 
$
756

 
2.24
%
Net charge-offs (including PCI)
$
1,009

 
2.65
%
 
$
756

 
2.15
%
 
 
 
 
 
 
 
 
(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 June 30, 2017
 
 
 
Credit card loans
82
%
 
18
%
Personal loans
96
%
 
4
%
Private student loans (excluding PCI)(1)
96
%
 
4
%
 
 
 
 
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

14


ability to temporarily suspend payments. Eligible borrowers have a lifetime cap on forbearance of 12 months. At June 30, 2017 and December 31, 2016, there were $28 million and $19 million, respectively, of private student loans, including PCI, in forbearance, representing 0.5% and 0.3%, 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 June 30, 2017
 
Credit Card
 
Personal Loans
 
Student Loans(1)
 
Other
 
Total
Balance at beginning of period
$
1,892

 
$
207

 
$
156

 
$
9

 
$
2,264

Additions
 
 
 
 
 
 
 
 
 
Provision for loan losses
533

 
82

 
23

 
2

 
640

Deductions
 
 
 
 
 
 
 
 
 
Charge-offs
(561
)
 
(61
)
 
(22
)
 
(1
)
 
(645
)
Recoveries
116

 
7

 
2

 

 
125

Net charge-offs
(445
)
 
(54
)
 
(20
)
 
(1
)
 
(520
)
Balance at end of period
$
1,980

 
$
235

 
$
159

 
$
10

 
$
2,384

 
 
 
 
 
 
 
 
 
 
 
For the Three Months Ended June 30, 2016
 
Credit Card
 
Personal Loans
 
Student Loans(1)
 
Other
 
Total
Balance at beginning of period
$
1,590

 
$
165

 
$
148

 
$
18

 
$
1,921

Additions
 
 
 
 
 
 
 
 
 
Provision for loan losses
347

 
44

 
20

 
1

 
412

Deductions
 
 
 
 
 
 
 
 
 
Charge-offs
(448
)
 
(38
)
 
(19
)
 

 
(505
)
Recoveries
114

 
5

 
2

 

 
121

Net charge-offs
(334
)
 
(33
)
 
(17
)
 

 
(384
)
Balance at end of period
$
1,603

 
$
176

 
$
151

 
$
19

 
$
1,949

 
 
 
 
 
 
 
 
 
 
 
For the Six Months Ended June 30, 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
1,057

 
140

 
35

 
(6
)
 
1,226

Deductions
 
 
 
 
 
 
 
 
 
Charge-offs
(1,096
)
 
(118
)
 
(39
)
 
(3
)
 
(1,256
)
Recoveries
229

 
13

 
5

 

 
247

Net charge-offs
(867
)
 
(105
)
 
(34
)
 
(3
)
 
(1,009
)
Balance at end of period
$
1,980

 
$
235

 
$
159

 
$
10

 
$
2,384

 
 
 
 
 
 
 
 
 
 
 
For the Six Months Ended June 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
709

 
88

 
37

 
2

 
836

Deductions
 
 
 
 
 
 
 
 
 
Charge-offs
(887
)
 
(77
)
 
(34
)
 

 
(998
)
Recoveries
227

 
10

 
5

 

 
242

Net charge-offs
(660
)
 
(67
)
 
(29
)
 

 
(756
)
Balance at end of period
$
1,603

 
$
176

 
$
151

 
$
19

 
$
1,949

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

15


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 June 30,
 
For the Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Interest and fees accrued subsequently charged off, net of recoveries (recorded as a reduction of interest income)
$
87

 
$
67

 
$
171

 
$
136

Fees accrued subsequently charged off, net of recoveries (recorded as a reduction to other income)
$
23

 
$
17

 
$
45

 
$
34

 
 
 
 
 
 
 
 
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 June 30, 2017
 
 
 
 
 
 
 
 
 
Allowance for loans evaluated for impairment as
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment in accordance with ASC 450-20
$
1,789

 
$
210

 
$
106

 
$
3

 
$
2,108

Evaluated for impairment in accordance with
ASC 310-10-35(2)(3)
191

 
25

 
20

 
7

 
243

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

 

 
33

 

 
33

Total allowance for loan losses
$
1,980

 
$
235

 
$
159

 
$
10

 
$
2,384

Recorded investment in loans evaluated for impairment as
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment in accordance with ASC 450-20
$
60,649

 
$
6,863

 
$
6,479

 
$
283

 
$
74,274

Evaluated for impairment in accordance with
ASC 310-10-35(2)(3)
1,148

 
92

 
115

 
46

 
1,401

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

 

 
2,322

 

 
2,322

Total recorded investment
$
61,797

 
$
6,955

 
$
8,916

 
$
329

 
$
77,997

 
 
 
 
 
 
 
 
 
 
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