Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the quarterly period ended March 31, 2018 |
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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)
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Delaware | | 36-2517428 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
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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.
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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 Exchange Act). Yes o No x
As of April 27, 2018, there were 348,977,139 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, 2018
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, College Covered®, 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.
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Part I. | FINANCIAL INFORMATION |
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Item 1. | Financial Statements |
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Financial Condition
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| | | | | | | |
| March 31,
2018 | | December 31,
2017 |
| (unaudited) (dollars in millions, except share amounts) |
Assets | | | |
Cash and cash equivalents | $ | 17,011 |
| | $ | 13,306 |
|
Restricted cash | 87 |
| | 81 |
|
Investment securities (includes $1,340 and $1,395 at fair value at March 31, 2018 and December 31, 2017, respectively) | 1,543 |
| | 1,568 |
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Loan receivables | | | |
Loan receivables | 82,744 |
| | 84,248 |
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Allowance for loan losses | (2,736 | ) | | (2,621 | ) |
Net loan receivables | 80,008 |
| | 81,627 |
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Premises and equipment, net | 848 |
| | 825 |
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Goodwill | 255 |
| | 255 |
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Intangible assets, net | 162 |
| | 163 |
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Other assets | 2,053 |
| | 2,262 |
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Total assets | $ | 101,967 |
| | $ | 100,087 |
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Liabilities and Stockholders’ Equity | | | |
Deposits: | | | |
Interest-bearing deposit accounts | $ | 60,530 |
| | $ | 58,165 |
|
Non-interest bearing deposit accounts | 600 |
| | 599 |
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Total deposits | 61,130 |
| | 58,764 |
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Long-term borrowings | 26,244 |
| | 26,326 |
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Accrued expenses and other liabilities | 3,722 |
| | 4,105 |
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Total liabilities | 91,096 |
| | 89,195 |
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Commitments, contingencies and guarantees (Notes 8, 11 and 12) |
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Stockholders’ Equity: | | | |
Common stock, par value $0.01 per share; 2,000,000,000 shares authorized; 564,510,213 and 563,497,702 shares issued at March 31, 2018 and December 31, 2017, respectively | 6 |
| | 6 |
|
Preferred stock, par value $0.01 per share; 200,000,000 shares authorized; 5,700 shares issued and outstanding and aggregate liquidation preference of $570 at March 31, 2018 and December 31, 2017 | 563 |
| | 563 |
|
Additional paid-in capital | 4,068 |
| | 4,042 |
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Retained earnings | 17,211 |
| | 16,687 |
|
Accumulated other comprehensive loss | (139 | ) | | (152 | ) |
Treasury stock, at cost; 213,093,774 and 205,577,507 shares at March 31, 2018 and December 31, 2017, respectively | (10,838 | ) | | (10,254 | ) |
Total stockholders’ equity | 10,871 |
| | 10,892 |
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Total liabilities and stockholders’ equity | $ | 101,967 |
| | $ | 100,087 |
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| | | |
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.
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| | | | | | | |
| March 31,
2018 | | December 31,
2017 |
| (unaudited) (dollars in millions) |
Assets | | | |
Restricted cash | $ | 87 |
| | $ | 81 |
|
Loan receivables | $ | 29,894 |
| | $ | 31,781 |
|
Allowance for loan losses allocated to securitized loan receivables | $ | (1,006 | ) | | $ | (998 | ) |
Other assets | $ | 6 |
| | $ | 5 |
|
Liabilities | | | |
Long-term borrowings | $ | 16,385 |
| | $ | 16,536 |
|
Accrued expenses and other liabilities | $ | 17 |
| | $ | 16 |
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| | | |
See Notes to the Condensed Consolidated Financial Statements.
1
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Income
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| | | | | | | |
| For the Three Months Ended March 31, |
| 2018 | | 2017 |
| (unaudited) (dollars in millions, except per share amounts) |
Interest income | | | |
Credit card loans | $ | 2,090 |
| | $ | 1,876 |
|
Other loans | 417 |
| | 367 |
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Investment securities | 7 |
| | 7 |
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Other interest income | 55 |
| | 28 |
|
Total interest income | 2,569 |
| | 2,278 |
|
Interest expense | | | |
Deposits | 262 |
| | 191 |
|
Long-term borrowings | 207 |
| | 195 |
|
Total interest expense | 469 |
| | 386 |
|
Net interest income | 2,100 |
| | 1,892 |
|
Provision for loan losses | 751 |
| | 586 |
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Net interest income after provision for loan losses | 1,349 |
| | 1,306 |
|
Other income | | | |
Discount and interchange revenue, net | 254 |
| | 233 |
|
Protection products revenue | 53 |
| | 58 |
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Loan fee income | 96 |
| | 89 |
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Transaction processing revenue | 43 |
| | 39 |
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Other income | 29 |
| | 28 |
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Total other income | 475 |
| | 447 |
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Other expense | | | |
Employee compensation and benefits | 405 |
| | 363 |
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Marketing and business development | 185 |
| | 168 |
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Information processing and communications | 82 |
| | 80 |
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Professional fees | 155 |
| | 147 |
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Premises and equipment | 26 |
| | 25 |
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Other expense | 115 |
| | 102 |
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Total other expense | 968 |
| | 885 |
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Income before income tax expense | 856 |
| | 868 |
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Income tax expense | 190 |
| | 304 |
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Net income | $ | 666 |
| | $ | 564 |
|
Net income allocated to common stockholders | $ | 646 |
| | $ | 551 |
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Basic earnings per common share | $ | 1.82 |
| | $ | 1.43 |
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Diluted earnings per common share | $ | 1.82 |
| | $ | 1.43 |
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Dividends declared per common share | $ | 0.35 |
| | $ | 0.30 |
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| | | |
See Notes to the Condensed Consolidated Financial Statements.
2
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Comprehensive Income
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| | | | | | | |
| For the Three Months Ended March 31, |
| 2018 | | 2017 |
| (unaudited) (dollars in millions) |
Net income | $ | 666 |
| | $ | 564 |
|
Other comprehensive income, net of taxes | | | |
Unrealized (loss) gain on available-for-sale investment securities, net of tax | (7 | ) | | 1 |
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Unrealized gain on cash flow hedges, net of tax | 19 |
| | 5 |
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Unrealized pension and post-retirement plan gain, net of tax | 1 |
| | — |
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Other comprehensive income | 13 |
| | 6 |
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Comprehensive income | $ | 679 |
| | $ | 570 |
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| | | |
See Notes to the Condensed Consolidated Financial Statements.
3
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Changes in Stockholders’ Equity
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| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | 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, 2016 | 575 |
| | $ | 560 |
| | 562,414 |
| | $ | 5 |
| | $ | 3,962 |
| | $ | 15,130 |
| | $ | (161 | ) | | $ | (8,173 | ) | | $ | 11,323 |
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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 |
|
| | | | | | | | | | | | | | | | | |
Balance at December 31, 2017 | 6 |
| | $ | 563 |
| | 563,498 |
| | $ | 6 |
| | $ | 4,042 |
| | $ | 16,687 |
| | $ | (152 | ) | | $ | (10,254 | ) | | $ | 10,892 |
|
Net income | — |
| | — |
| | — |
| | — |
| | — |
| | 666 |
| | — |
| | — |
| | 666 |
|
Other comprehensive income | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 13 |
| | — |
| | 13 |
|
Purchases of treasury stock | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (584 | ) | | (584 | ) |
Common stock issued under employee benefit plans | — |
| | — |
| | 23 |
| | — |
| | 2 |
| | — |
| | — |
| | — |
| | 2 |
|
Common stock issued and stock-based compensation expense | — |
| | — |
| | 989 |
| | — |
| | 24 |
| | — |
| | — |
| | — |
| | 24 |
|
Dividends — common stock | — |
| | — |
| | — |
| | — |
| | — |
| | (126 | ) | | — |
| | — |
| | (126 | ) |
Dividends — preferred stock | — |
| | — |
| | — |
| | — |
| | — |
| | (16 | ) | | — |
| | — |
| | (16 | ) |
Balance at March 31, 2018 | 6 |
| | $ | 563 |
| | 564,510 |
| | $ | 6 |
| | $ | 4,068 |
| | $ | 17,211 |
| | $ | (139 | ) | | $ | (10,838 | ) | | $ | 10,871 |
|
| | | | | | | | | | | | | | | | | |
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, |
| 2018 | | 2017 |
| (unaudited) (dollars in millions) |
Cash flows from operating activities | | | |
Net income | $ | 666 |
| | $ | 564 |
|
Adjustments to reconcile net income to net cash provided by (used for) operating activities: | | | |
Provision for loan losses | 751 |
| | 586 |
|
Depreciation and amortization | 107 |
| | 93 |
|
Amortization of deferred revenues and accretion of accretable yield on acquired loans | (101 | ) | | (98 | ) |
Net loss on investments and other assets | 11 |
| | 14 |
|
Other, net | (96 | ) | | 11 |
|
Changes in assets and liabilities: | | | |
Decrease in other assets | 251 |
| | 181 |
|
Decrease in accrued expenses and other liabilities | (351 | ) | | (338 | ) |
Net cash provided by operating activities | 1,238 |
| | 1,013 |
|
| | | |
Cash flows from investing activities | | | |
Maturities of available-for-sale investment securities | 44 |
| | 52 |
|
Maturities of held-to-maturity investment securities | 4 |
| | 4 |
|
Purchases of held-to-maturity investment securities | (33 | ) | | (17 | ) |
Net principal disbursed on loans originated for investment | 959 |
| | 1,010 |
|
Purchases of other investments | — |
| | (14 | ) |
Purchases of premises and equipment | (58 | ) | | (47 | ) |
Net cash used for investing activities | 916 |
| | 988 |
|
| | | |
Cash flows from financing activities | | | |
Proceeds from issuance of securitized debt | 1,666 |
| | 1,290 |
|
Maturities and repayment of securitized debt | (1,794 | ) | | (925 | ) |
Proceeds from issuance of other long-term borrowings | 822 |
| | 1,005 |
|
Maturities and repayment of other long-term borrowings | (751 | ) | | — |
|
Proceeds from issuance of common stock | 2 |
| | 1 |
|
Purchases of treasury stock | (584 | ) | | (520 | ) |
Net increase in deposits | 2,338 |
| | 1,529 |
|
Dividends paid on common and preferred stock | (142 | ) | | (127 | ) |
Net cash provided by financing activities | 1,557 |
| | 2,253 |
|
Net increase in cash, cash equivalents and restricted cash | 3,711 |
| | 4,254 |
|
Cash, cash equivalents and restricted cash, at beginning of period | 13,387 |
| | 12,009 |
|
Cash, cash equivalents and restricted cash, at end of period | $ | 17,098 |
| | $ | 16,263 |
|
| | | |
Reconciliation of cash, cash equivalents and restricted cash: | | | |
Cash and cash equivalents | $ | 17,011 |
| | $ | 15,163 |
|
Restricted cash | 87 |
| | 1,100 |
|
Cash, cash equivalents and restricted cash, at end of period | $ | 17,098 |
| | $ | 16,263 |
|
| | | |
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 and debit 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 activities are managed in two segments, Direct Banking and Payment Services, based on the products and services provided. For a detailed description of the operations of each segment, as well as the allocation conventions used in business segment reporting, see Note 15: Segment Disclosures.
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 2017 audited consolidated financial statements filed with the Company’s annual report on Form 10-K for the year ended December 31, 2017.
Recently Issued Accounting Pronouncements
In February 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The ASU permits, but does not require, issuers to reclassify into retained earnings any tax effects that are stranded in accumulated other comprehensive income (“AOCI”) as a result of the change in the statutory federal tax rate enacted by the Tax Cuts and Jobs Act of 2017 (“TCJA”). Tax effects that are stranded in AOCI for other reasons, such as prior changes in tax law or changes in a valuation allowance, may not be reclassified directly through retained earnings. The guidance is effective for fiscal years beginning after December 15, 2018. The Company is permitted to early adopt the guidance in any interim or annual period and apply it either (1) in the period of adoption, or (2) retrospectively to each period in which the effect of the change in the federal corporate income tax rate is recognized. The Company has not elected to early adopt the ASU as of March 31, 2018. The reclassification of stranded tax effects from AOCI to retained earnings will not be material to the Company’s consolidated statements of financial condition and will have no impact on the Company’s cash flows or consolidated statements of income.
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The amendments of ASU 2017-12 are intended to improve the financial reporting of hedging relationships to better reflect the economic results of an entity’s risk management activities through changes to both the designation and measurement guidance for qualifying hedges and improvements to the presentation of hedge results. The amendments expand an entity’s ability to apply hedge accounting for both financial and non-financial risk components and
allow for a simplified approach for fair value hedging of interest rate risk. ASU 2017-12 eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in fair value of a hedging instrument to be presented in the same income statement line as the hedged item. Additionally, the standard simplifies the hedge documentation and effectiveness assessment requirements under the previous guidance and amends the disclosures about hedging activities.
The Company early adopted ASU 2017-12 effective January 1, 2018. Accordingly, the Company is no longer required to separately measure and immediately recognize ineffectiveness related to cash flow hedges. The Company has also elected to measure changes in the fair value of hedged items designated under certain existing fair value hedges transitioned at adoption using the benchmark rate component of the contractual rate cash flows. As a result, the Company recorded separate cumulative-effect adjustments to (a) AOCI with respect to cash flow hedges and (b) the basis adjustment for certain hedged items with respect to fair value hedges. This resulted in an immaterial adjustment to the opening balance of retained earnings as of January 1, 2018, and thus did not have a material impact to the Company’s financial statements.
In January 2017, the FASB issued ASU No. 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; 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 condensed consolidated 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 did not early adopt this standard, but is still evaluating whether it will prior to the 2020 effective date.
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 became effective for the Company on January 1, 2018 and did not have a material impact to the Company’s statement of cash flows.
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 replaces the incurred loss model with the current expected credit loss ("CECL") approach. For loans carried at amortized cost, the allowance for loan losses will be based on management’s current estimate of all expected credit losses over the remaining contractual term of the loans. Upon the origination of a loan, the Company will have to record its 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 CECL estimate is to be based on historical experience, current conditions and reasonable and supportable forecasts. No specific method for estimating credit loss is mandated, permitting companies to use judgment in selecting the approach that is most appropriate in their circumstances.
The CECL approach is expected to affect the Company’s allowance for loan losses as a result of: (1) encompassing expected losses, not simply those deemed to be already incurred, (2) extending the loss estimate period over the entire life of the loan, and (3) reclassification of the credit loss component of the purchased credit-impaired ("PCI") loan portfolio out of loan carrying value and into the allowance for loan losses. All loans carried at amortized cost, including PCI loans and loans modified in a troubled debt restructuring ("TDR") will be measured under the CECL approach. Existing specialized measurement guidance for PCI loans, which the ASU refers to as purchased credit-deteriorated ("PCD"), and TDRs will be eliminated, although certain separate disclosure guidance will be retained. 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 is effective beginning January 1, 2020, with early adoption permitted no sooner than January 1, 2019. Management is not considering early adoption at this time. On the date of adoption, the allowance for loan losses will be adjusted to the CECL estimate for loans held at that date with an offsetting adjustment to retained earnings. Additionally, the carrying value of PCD loans will be increased through an offsetting addition to the allowance for loan losses for the CECL estimate on those loans. The CECL allowance will be re-evaluated in subsequent periods and adjusted through provision expense as needed. The Company is actively engaged in cross-functional implementation efforts 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 has the potential to materially impact stockholders' equity and regulatory capital as well as the Company's financial condition and results of operations. The extent of the impact upon adoption 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, Principal versus Agent Considerations (Reporting Revenue Gross versus Net). This guidance became effective for the Company on January 1, 2018, along with ASU 2014-09, Revenue from Contracts with Customers (Topic 606), discussed below. This ASU did not result in a change to the accounting or reporting of the Company's revenue arrangements that involve a principal-agent relationship. Therefore, its adoption has had no impact on the Company's condensed consolidated financial condition, results of operations or cash flows. 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. 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.
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. This ASU became effective for the Company on January 1, 2018 and has not had a material impact to the financial statements. The ASU has had 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 are 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.
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 became effective for the Company on January 1, 2018. The model generally results in the same revenue recognition patterns as have historically been applied to the Company’s revenues that are subject to this guidance. The 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 have not been affected as a result of the adoption of Accounting Standards Codification ("ASC") 606. Accounting and reporting for the Company’s transaction processing services, including discount and interchange revenue and other transaction processing fees, remains substantially unchanged from treatments under GAAP in effect prior to 2018. As permitted by the ASU, management has elected to adopt this standard using a modified retrospective approach, which means that the cumulative effect of initially applying the standard is recognized at the date of initial application through an adjustment to beginning retained earnings, but no restatement of prior periods is made. Based on its evaluations, management has concluded that no adjustment to beginning retained earnings is required as of January 1, 2018, the date of adoption. See Note 16: Revenue from Contracts with Customers for additional information resulting from this standard.
The Company’s investment securities consist of the following (dollars in millions): |
| | | | | | | |
| March 31,
2018 | | December 31,
2017 |
U.S. Treasury securities(1) | $ | 672 |
| | $ | 672 |
|
States and political subdivisions of states | — |
| | 1 |
|
Residential mortgage-backed securities - Agency(2) | 871 |
| | 895 |
|
Total investment securities | $ | 1,543 |
| | $ | 1,568 |
|
| | | |
| |
(1) | Includes $38 million and $48 million of U.S. Treasury securities pledged as swap collateral as of March 31, 2018 and December 31, 2017, 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 March 31, 2018 | | | | | | | |
Available-for-Sale Investment Securities(1) | | | | | | | |
U.S. Treasury securities | $ | 675 |
| | $ | — |
| | $ | (3 | ) | | $ | 672 |
|
Residential mortgage-backed securities - Agency | 683 |
| | — |
| | (15 | ) | | 668 |
|
Total available-for-sale investment securities | $ | 1,358 |
| | $ | — |
| | $ | (18 | ) | | $ | 1,340 |
|
Held-to-Maturity Investment Securities(2) | | | | | | | |
Residential mortgage-backed securities - Agency(3) | $ | 203 |
| | $ | 1 |
| | $ | (4 | ) | | $ | 200 |
|
Total held-to-maturity investment securities | $ | 203 |
| | $ | 1 |
| | $ | (4 | ) | | $ | 200 |
|
| | | | | | | |
At December 31, 2017 | | | | | | | |
Available-for-Sale Investment Securities(1) | | | | | | | |
U.S. Treasury securities | $ | 675 |
| | $ | — |
| | $ | (3 | ) | | $ | 672 |
|
Residential mortgage-backed securities - Agency | 728 |
| | 1 |
| | (6 | ) | | 723 |
|
Total available-for-sale investment securities | $ | 1,403 |
| | $ | 1 |
| | $ | (9 | ) | | $ | 1,395 |
|
Held-to-Maturity Investment Securities(2) | | | | | | | |
States and political subdivisions of states | $ | 1 |
| | $ | — |
| | $ | — |
| | $ | 1 |
|
Residential mortgage-backed securities - Agency(3) | 172 |
| | 1 |
| | (1 | ) | | 172 |
|
Total held-to-maturity investment securities | $ | 173 |
| | $ | 1 |
| | $ | (1 | ) | | $ | 173 |
|
| | | | | | | |
| |
(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 | | More than 12 months |
| | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses |
At March 31, 2018 | | | | | | | | | |
Available-for-Sale Investment Securities | | | | | | | | | |
U.S. Treasury securities | 1 |
| | $ | — |
| | $ | — |
| | $ | 672 |
| | $ | (3 | ) |
Residential mortgage-backed securities - Agency | 31 |
| | $ | 546 |
| | $ | (10 | ) | | $ | 122 |
| | $ | (5 | ) |
Held-to-Maturity Investment Securities | | | | | | | | | |
Residential mortgage-backed securities - Agency | 80 |
| | $ | 125 |
| | $ | (2 | ) | | $ | 40 |
| | $ | (2 | ) |
| | | | | | | | | |
At December 31, 2017 | | | | | | | | | |
Available-for-Sale Investment Securities | | | | | | | | | |
U.S. Treasury securities | 1 |
| | $ | — |
| | $ | — |
| | $ | 672 |
| | $ | (3 | ) |
Residential mortgage-backed securities - Agency | 27 |
| | $ | 457 |
| | $ | (3 | ) | | $ | 132 |
| | $ | (3 | ) |
Held-to-Maturity Investment Securities | | | | | | | | | |
Residential mortgage-backed securities - Agency | 45 |
| | $ | 56 |
| | $ | — |
| | $ | 38 |
| | $ | (1 | ) |
| | | | | | | | | |
There were no losses related to other-than-temporary impairments and no proceeds from sales or recognized gains and losses on available-for-sale securities during the three months ended March 31, 2018 and 2017. See Note 7: Accumulated Other Comprehensive Income for unrealized gains and losses on available-for-sale securities during the three months ended March 31, 2018 and 2017.
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, 2018 | | | | | | | | | |
Available-for-Sale Investment Securities—Amortized Cost | | | | | | | | | |
U.S. Treasury securities | $ | 675 |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 675 |
|
Residential mortgage-backed securities - Agency(1) | — |
| | 78 |
| | 506 |
| | 99 |
| | 683 |
|
Total available-for-sale investment securities | $ | 675 |
| | $ | 78 |
| | $ | 506 |
| | $ | 99 |
| | $ | 1,358 |
|
Held-to-Maturity Investment Securities—Amortized Cost | | | | | | | | | |
Residential mortgage-backed securities - Agency(1) | $ | — |
| | $ | — |
| | $ | — |
| | $ | 203 |
| | $ | 203 |
|
Total held-to-maturity investment securities | $ | — |
| | $ | — |
| | $ | — |
| | $ | 203 |
| | $ | 203 |
|
Available-for-Sale Investment Securities—Fair Values | | | | | | | | | |
U.S. Treasury securities | $ | 672 |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 672 |
|
Residential mortgage-backed securities - Agency(1) | — |
| | 77 |
| | 493 |
| | 98 |
| | 668 |
|
Total available-for-sale investment securities | $ | 672 |
| | $ | 77 |
| | $ | 493 |
| | $ | 98 |
| | $ | 1,340 |
|
Held-to-Maturity Investment Securities—Fair Values | | | | | | | | | |
Residential mortgage-backed securities - Agency(1) | $ | — |
| | $ | — |
| | $ | — |
| | $ | 200 |
| | $ | 200 |
|
Total held-to-maturity investment securities | $ | — |
| | $ | — |
| | $ | — |
| | $ | 200 |
| | $ | 200 |
|
| | | | | | | | | |
| |
(1) | Maturities of residential mortgage-backed securities are reflective of the contractual maturities of the investment. |
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 reduces the carrying value of the investments by recognizing any amounts that are in excess of future net tax benefits in other expense. 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, 2018 and December 31, 2017, the Company had outstanding investments in these entities of $286 million and $297 million, respectively, and related contingent liabilities of $66 million. Of the above outstanding equity investments, the Company had $279 million and $288 million of investments related to affordable housing projects as of March 31, 2018 and December 31, 2017, respectively, which had $66 million related contingent liabilities.
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,
2018 | | December 31,
2017 |
Loan receivables | | | |
Credit card loans(1) | $ | 65,577 |
| | $ | 67,291 |
|
Other loans | | | |
Personal loans | 7,307 |
| | 7,374 |
|
Private student loans | 7,416 |
| | 7,076 |
|
Other | 488 |
| | 423 |
|
Total other loans | 15,211 |
| | 14,873 |
|
PCI loans(2) | 1,956 |
| | 2,084 |
|
Total loan receivables | 82,744 |
| | 84,248 |
|
Allowance for loan losses | (2,736 | ) | | (2,621 | ) |
Net loan receivables | $ | 80,008 |
| | $ | 81,627 |
|
| | | |
| |
(1) | Amounts include $21.1 billion and $21.2 billion underlying investors’ interest in trust debt at March 31, 2018 and December 31, 2017, respectively, and $8.1 billion and $9.9 billion in seller's interest at March 31, 2018 and December 31, 2017, respectively. See Note 4: Credit Card and Student Loan Securitization Activities for additional information. |
| |
(2) | Amounts include $712 million and $762 million of loans pledged as collateral against the notes issued from the Student Loan Corporation ("SLC") securitization trusts at March 31, 2018 and December 31, 2017, respectively. See Note 4: Credit Card and Student Loan Securitization Activities for additional information. |
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, 2018 | | | | | | | | | |
Credit card loans(2) | $ | 752 |
| | $ | 777 |
| | $ | 1,529 |
| | $ | 719 |
| | $ | 209 |
|
Other loans | | | | |
|
| | | | |
Personal loans(3) | 73 |
| | 28 |
| | 101 |
| | 26 |
| | 11 |
|
Private student loans (excluding PCI)(4) | 118 |
| | 49 |
| | 167 |
| | 48 |
| | 10 |
|
Other | 2 |
| | 1 |
| | 3 |
| | — |
| | 19 |
|
Total other loans (excluding PCI) | 193 |
| | 78 |
| | 271 |
| | 74 |
| | 40 |
|
Total loan receivables (excluding PCI) | $ | 945 |
| | $ | 855 |
| | $ | 1,800 |
| | $ | 793 |
| | $ | 249 |
|
| | | | | | | | | |
At December 31, 2017 | | | | | | | | | |
Credit card loans(2) | $ | 781 |
| | $ | 751 |
| | $ | 1,532 |
| | $ | 693 |
| | $ | 203 |
|
Other loans | | | | |
|
| | | | |
Personal loans(3) | 73 |
| | 30 |
| | 103 |
| | 28 |
| | 10 |
|
Private student loans (excluding PCI)(4) | 134 |
| | 33 |
| | 167 |
| | 33 |
| | 2 |
|
Other | 3 |
| | 1 |
| | 4 |
| | — |
| | 18 |
|
Total other loans (excluding PCI) | 210 |
| | 64 |
| | 274 |
| | 61 |
| | 30 |
|
Total loan receivables (excluding PCI) | $ | 991 |
| | $ | 815 |
| | $ | 1,806 |
| | $ | 754 |
| | $ | 233 |
|
| | | | | | | | | |
| |
(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 $8 million for the three months ended March 31, 2018 and 2017, 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 $83 million and $72 million of loans accounted for as TDRs at March 31, 2018 and December 31, 2017, respectively. |
| |
(3) | Personal loans that are 90 or more days delinquent and accruing interest include $4 million and $5 million of loans accounted for as TDRs at March 31, 2018 and December 31, 2017, respectively. |
| |
(4) | Private student loans that are 90 or more days delinquent and accruing interest include $7 million and $5 million of loans accounted for as TDRs at March 31, 2018 and December 31, 2017, respectively. |
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, |
| 2018 | | 2017 |
| Net
Charge-offs | | Net Charge-off
Rate(1) | | Net
Charge-offs | | Net Charge-off
Rate(1) |
Credit card loans | $ | 540 |
| | 3.32 | % | | $ | 422 |
| | 2.84 | % |
Other loans | | | | | | | |
Personal loans | 73 |
| | 4.03 | % | | 51 |
| | 3.16 | % |
Private student loans (excluding PCI) | 22 |
| | 1.17 | % | | 14 |
| | 0.83 | % |
Other | — |
| | — | % | | 2 |
| | 3.45 | % |
Total other loans | 95 |
| | 2.52 | % | | 67 |
| | 2.02 | % |
Net charge-offs (excluding PCI) | $ | 635 |
| | 3.17 | % | | $ | 489 |
| | 2.69 | % |
Net charge-offs (including PCI) | $ | 635 |
| | 3.09 | % | | $ | 489 |
| | 2.60 | % |
| | | | | | | |
| |
(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, 2018 | | | |
Credit card loans | 81 | % | | 19 | % |
Personal loans | 95 | % | | 5 | % |
Private student loans (excluding PCI)(1) | 95 | % | | 5 | % |
| | | |
At December 31, 2017 | | | |
Credit card loans | 82 | % | | 18 | % |
Personal loans | 95 | % | | 5 | % |
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, 2018 and December 31, 2017, there were $40 million and $29 million, respectively, of private student loans, including PCI, in forbearance, representing 0.7% and 0.5%, respectively, of total student loans in repayment and forbearance.
Allowance for Loan LossesThe following tables provide changes in the Company’s allowance for loan losses (dollars in millions): |
| | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended March 31, 2018 |
| Credit Card | | Personal Loans | | Student Loans(1) | | Other | | Total |
Balance at beginning of period | $ | 2,147 |
| | $ | 301 |
| | $ | 162 |
| | $ | 11 |
| | $ | 2,621 |
|
Additions | | | | | | | | | |
Provision for loan losses | 645 |
| | 73 |
| | 31 |
| | 2 |
| | 751 |
|
Deductions | | | | | | | | | |
Charge-offs | (663 | ) | | (81 | ) | | (25 | ) | | — |
| | (769 | ) |
Recoveries | 123 |
| | 8 |
| | 3 |
| | — |
| | 134 |
|
Net charge-offs | (540 | ) | | (73 | ) | | (22 | ) | | — |
| | (635 | ) |
Other(2) | — |
| | — |
| | (1 | ) | | — |
| | (1 | ) |
Balance at end of period | $ | 2,252 |
| | $ | 301 |
| | $ | 170 |
| | $ | 13 |
| | $ | 2,736 |
|
| | | | | | | | | |
| 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 |
|
| | | | | | | | | |
| |
(1) | Includes both PCI and non-PCI private student loans. |
| |
(2) | Net change in reserves on PCI pools having no remaining non-accretable difference. |
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, |
| 2018 | | 2017 |
Interest and fees accrued subsequently charged off, net of recoveries (recorded as a reduction of interest income) | $ | 109 |
| | $ | 84 |
|
Fees accrued subsequently charged off, net of recoveries (recorded as a reduction to other income) | $ | 27 |
| | $ | 22 |
|
| | | |
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, 2018 | | | | | | | | | |
Allowance for loans evaluated for impairment as | | | | | | | | | |
Collectively evaluated for impairment in accordance with ASC 450-20 | $ | 2,007 |
| | $ | 266 |
| | $ | 122 |
| | $ | 5 |
| | $ | 2,400 |
|
Evaluated for impairment in accordance with ASC 310-10-35(2)(3) | 245 |
| | 35 |
| | 21 |
| | 8 |
| | 309 |
|
Acquired with deteriorated credit quality, evaluated in accordance with ASC 310-30 | — |
| | — |
| | 27 |
| | — |
| | 27 |
|
Total allowance for loan losses | $ | 2,252 |
| | $ | 301 |
| | $ | 170 |
| | $ | 13 |
| | $ | 2,736 |
|
Recorded investment in loans evaluated for impairment as | | | | | | | | | |
Collectively evaluated for impairment in accordance with ASC 450-20 | $ | 64,054 |
| | $ | 7,186 |
| | $ | 7,271 |
| | $ | 435 |
| | $ | 78,946 |
|
Evaluated for impairment in accordance with ASC 310-10-35(2)(3) | 1,523 |
| | 121 |
| | 145 |
| | 53 |
| | 1,842 |
|
Acquired with deteriorated credit quality, evaluated in accordance with ASC 310-30 | — |
| | — |
| | 1,956 |
| | — |
| | 1,956 |
|
Total recorded investment | $ | 65,577 |
| | $ | 7,307 |
| | $ | 9,372 |
| | $ | 488 |
| | $ | 82,744 |
|
| | | | | | | | | |
At December 31, 2017 | | | | | | | | | |
Allowance for loans evaluated for impairment as | | | | | | | | | |
Collectively evaluated for impairment in accordance with ASC 450-20 | $ | 1,921 |
| | $ | 269 |
| | $ | 112 |
| | $ | 4 |
| | $ | 2,306 |
|
Evaluated for impairment in accordance with ASC 310-10-35(2)(3) | 226 |
| | 32 |
| | 21 |
| | 7 |
| | 286 |
|
Acquired with deteriorated credit quality, evaluated in accordance with ASC 310-30 | — |
| | — |
| | 29 |
| | — |
| | 29 |
|
Total allowance for loan losses | $ | 2,147 |
| | $ | 301 |
| | $ | 162 |
| | $ | 11 |
| | $ | 2,621 |
|
Recorded investment in loans evaluated for impairment as | | | | | | | | | |
Collectively evaluated for impairment in accordance with ASC 450-20 | $ | 65,975 |
| | $ | 7,263 |
| | $ | 6,939 |
| | $ | 370 |
| | $ | 80,547 |
|
Evaluated for impairment in accordance with ASC 310-10-35(2)(3) | 1,316 |
| | 111 |
| | 137 |
| | 53 |
| | 1,617 |
|
Acquired with deteriorated credit quality, evaluated in accordance with ASC 310-30 | — |
| | — |
| | 2,084 |
| | — |
| | 2,084 |
|
Total recorded investment | $ | 67,291 |
| | $ | 7,374 |
| | $ | 9,160 |
| | $ | 423 |
| | $ | 84,248 |
|
| | | | | | | | | |
| |
(1) | Includes both PCI and non-PCI private student loans. |
| |
(2) | Loan receivables evaluated for impairment in accordance with 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 TDRs. Other loans are individually evaluated for impairment and generally do not represent TDRs. |
| |
(3) | The unpaid principal balance of credit card loans was $1.3 billion and $1.1 billion at March 31, 2018 and December 31, 2017, respectively. The unpaid principal balance of personal loans was $121 million and $109 million at March 31, 2018 and December 31, 2017, respectively. The unpaid principal balance of student loans was $145 million and $135 million at March 31, 2018 and December 31, 2017, respectively. All loans accounted for as TDRs 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 may be experiencing financial hardship. The Company continually evaluates new programs to determine which of them meet the definition of a TDR. 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 Company offers temporary hardship programs consisting of an interest rate reduction and in some cases a reduced minimum payment, 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 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. Modified credit card loans that are deemed to meet the definition of TDRs includes loans in both temporary and permanent programs.
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 TDRs.
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 TDR based on the cumulative length of the concession period and an evaluation of the credit quality of the borrower, based on FICO scores.
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 TDRs in the future.
Additional information about modified loans classified as TDRs 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, 2018 | | | | | |
Credit card loans(3) | $ | 1,413 |
| | $ | 34 |
| | $ | 26 |
|
Personal loans | $ | 117 |
| | $ | 3 |
| | $ | 1 |
|
Private student loans | $ | 142 |
| | $ | 3 |
| | $ | — |
|
| | | | | |
For the Three Months Ended March 31, 2017 | | | | | |
Credit card loans(3) | $ | 1,108 |
| | $ | 25 |
| | $ | 20 |
|
Personal loans | $ | 84 |
| | $ | 2 |
| | $ | 1 |
|
Private student loans | $ | 94 |
| | $ | 2 |
| | $ | — |
|
| | | | | |
| |
(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 TDRs, but are no longer enrolled in a TDR program due to noncompliance with the terms of the modification or due to successful completion of a program after which charging privileges may be reinstated based on customer-level evaluation. The average balance of credit card loans that were no longer enrolled in a TDR program was $399 million and $311 million, respectively, for the three months ended March 31, 2018 and 2017. |
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, 2018 and 2017, the Company quantified the amount by which interest and fees were reduced during the periods. During the three months ended March 31, 2018 and 2017, the Company forgave approximately $12 million and $11 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, |
| 2018 | | 2017 |
| Number of Accounts | | Balances | | Number of Accounts | | Balances |
Accounts that entered a loan modification program during the period | | | | | | | |
Credit card loans | 60,055 |
| | $ | 380 |
| | 30,893 |
| | $ | 181 |
|
Personal loans | 2,128 |
| | $ | 29 |
| | 1,563 |
| | $ | 18 |
|
Private student loans | 906 |
| | $ | 16 |
| | 1,017 |
| | $ | 17 |
|
| | | | | | | |
The following table presents the carrying value of loans that experienced a payment default during the period that had been modified in a TDR during the 15 months preceding the end of each period (dollars in millions): |
| | | | | | | | | | | | | |
| For the Three Months Ended March 31, |
| 2018 | | 2017 |
| Number of Accounts | | Aggregated Outstanding Balances Upon Default | | Number of Accounts | | Aggregated Outstanding Balances Upon Default |
TDRs that subsequently defaulted | | | | | | | |
Credit card loans(1)(2) | 8,814 |
| | $ | 47 |
| | 8,166 |
| | $ | 44 |
|
Personal loans(2) | 575 |
| | $ | 8 |
| | 307 |
| | $ | 4 |
|
Private student loans(3) | 271 |
| | $ | 5 |
| | 185 |
| | $ | 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, 2018 and 2017, approximately 37% and 38%, 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, 2018 and December 31, 2017. Total PCI student loans had an outstanding balance of $2.0 billion and $2.2 billion, including accrued interest, and a related carrying amount of $2.0 billion and $2.1 billion as of March 31, 2018 and December 31, 2017, respectively.
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, |
| 2018 | | 2017 |
Balance at beginning of period | $ | 669 |
| | $ | 796 |
|
Accretion into interest income | (36 | ) | | (41 | ) |
Balance at end of period | $ | 633 |
| | $ | 755 |
|
| | | |
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, 2018 and 2017. The allowance for PCI loan losses at March 31, 2018 and December 31, 2017 was $27 million and $29 million, respectively. For the three months ended March 31, 2018 and 2017, there were no changes in 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, 2018, 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 2.92% and 0.83%, respectively. At December 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 3.24% and 0.93%, 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 0.99% and 0.53% for the three months ended March 31, 2018 and 2017, respectively.
| |
4. | Credit Card and Student Loan Securitization Activities |
The Company’s securitizations are accounted for as secured borrowings and the related trusts are treated as consolidated subsidiaries of the Company. For a description of the Company’s principles of consolidation with respect to VIEs, see Note 1: Background and Basis of Presentation of the Company’s annual report on Form 10-K for the year ended December 31, 2017.
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”). Credit card loan receivables are transferred into DCMT and beneficial interests in DCMT are transferred into DCENT. DCENT issues debt securities to investors that are reported in long-term borrowings.
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 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, the amounts of which are reported in restricted cash. 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. 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.
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,
2018 | | December 31,
2017 |
Restricted cash | $ | 29 |
| | $ | 26 |
|
| | | |
Investors’ interests held by third-party investors | 15,950 |
| | 16,025 |
|
Investors’ interests held by wholly-owned subsidiaries of Discover Bank | 5,126 |
| | 5,133 |
|
Seller’s interest | 8,106 |
| | 9,861 |
|
Loan receivables(1) | 29,182 |
| | 31,019 |
|
Allowance for loan losses allocated to securitized loan receivables(1) | (1,006 | ) | | (998 | ) |
Net loan receivables | 28,176 |
| | 30,021 |
|
Other | 6 |
| | 5 |
|
Carrying value of assets of consolidated variable interest entities | $ | 28,211 |
| | $ | 30,052 |
|
| | | |
| |
(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 in the securities, there are certain features or triggering events that could cause an early amortization of the debt securities, including triggers related to the impact of the performance of the trust receivables on the availability and adequacy of cash flows to meet contractual requirements. As of March 31, 2018, no economic or other early amortization events have occurred.
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
Student loan 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 trusts 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. With the exception of the trusts’ restricted assets, the trusts and investors have no recourse to the Company’s other assets or the Company's general credit for a shortage in cash flows.
Currently there are two 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. 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,
2018 | | December 31,
2017 |
Restricted cash | $ | 58 |
| | $ | 55 |
|
Student loan receivables | 712 |
| | 762 |
|
Carrying value of assets of consolidated variable interest entities | $ | 770 |
| | $ | 817 |
|
| | | |
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.
The following table provides a summary of interest-bearing deposit accounts (dollars in millions): |
| | | | | | | |
| March 31,
2018 | | December 31,
2017 |
Certificates of deposit in amounts less than $100,000 | $ | 24,063 |
| | $ | 23,768 |
|
Certificates of deposit in amounts $100,000 or greater(1) | 6,035 |
| | 5,984 |
|
Savings deposits, including money market deposit accounts | 30,432 |
| | 28,413 |
|
Total interest-bearing deposits | $ | 60,530 |
| | $ | 58,165 |
|
| | | |
| |
(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, 2018 and December 31, 2017. |
The following table summarizes certificates of deposit in amounts of $100,000 or greater by contractual maturity (dollars in millions): |
| | | |
Maturity Period | March 31, 2018 |
Three months or less | $ | 778 |
|
Over three months through six months | 830 |
|
Over six months through twelve months | 1,739 |
|
Over twelve months | 2,688 |
|
Total | $ | 6,035 |
|
| |