DFS 8.31.2011 10Q
Table of Contents

 
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 August 31, 2011
 
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  S    No  ¨
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  S    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  x
Accelerated filer  o
Non-accelerated filer  o (Do not check if a  smaller reporting company)    
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  S
As of September 23, 2011, there were 549,637,090 shares of the registrant’s Common Stock, par value $0.01 per share, outstanding.
 

Table of Contents

DISCOVER FINANCIAL SERVICES
Quarterly Report on Form 10-Q
for the quarterly period ended August 31, 2011
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® More® Card, Discover® MotivaSM Card, Discover® Open Road® Card, Discover® Network and Diners Club International®. All other trademarks, trade names and service marks included in this quarterly report on Form 10-Q are the property of their respective owners.
Table of Contents

Part I.
FINANCIAL INFORMATION

Item 1.
Financial Statements
DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Financial Condition
 
August 31,
2011
 
November 30,
2010
 
(unaudited)
(dollars in thousands,
except share amounts)
Assets
 
 
 
Cash and cash equivalents
$
3,957,525

 
$
5,098,733

Restricted cash
937,230

 
1,363,758

Other short-term investments
—

 
375,000

Investment securities:

 

Available-for-sale (amortized cost of $5,798,756 and $4,989,958 at August 31, 2011 and November 30, 2010, respectively)
5,899,080

 
5,002,579

Held-to-maturity (fair value of $51,189 and $70,195 at August 31, 2011 and November 30, 2010, respectively)
53,088

 
72,816

Total investment securities
5,952,168

 
5,075,395

Loan receivables:
 
 
 
Loans held for sale
738,382

 
788,101

Loan portfolio:
 
 
 
Credit card
46,177,673

 
45,156,994

Other
4,279,613

 
2,891,318

Purchased credit-impaired loans
2,886,783

 
—

Total loan portfolio
53,344,069

 
48,048,312

Total loan receivables
54,082,451

 
48,836,413

Allowance for loan losses
(2,273,058
)
 
(3,304,118
)
Net loan receivables
51,809,393

 
45,532,295

Premises and equipment, net
465,871

 
460,732

Goodwill
255,421

 
255,421

Intangible assets, net
189,298

 
188,973

Other assets
2,158,761

 
2,434,661

Total assets
$
65,725,667

 
$
60,784,968

Liabilities and Stockholders’ Equity
 
 
 
Deposits:
 
 
 
Interest-bearing deposit accounts
$
37,470,037

 
$
34,309,839

Non-interest bearing deposit accounts
116,847

 
103,544

Total deposits
37,586,884

 
34,413,383

Short-term borrowings
100,000

 
—

Long-term borrowings
17,718,200

 
17,705,728

Accrued expenses and other liabilities
2,314,667

 
2,209,011

Total liabilities
57,719,751

 
54,328,122

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

 

Stockholders’ Equity:
 
 
 
Common stock, par value $.01 per share; 2,000,000,000 shares authorized; 549,475,683 and 547,128,270 shares issued at August 31, 2011 and November 30, 2010, respectively
5,495

 
5,471

Additional paid-in capital
3,492,663

 
3,435,318

Retained earnings
4,763,180

 
3,126,488

Accumulated other comprehensive loss
(19,979
)
 
(82,548
)
Treasury stock, at cost; 11,278,326 and 2,446,506 shares at August 31, 2011 and November 30, 2010, respectively
(235,443
)
 
(27,883
)
Total stockholders’ equity
8,005,916

 
6,456,846

Total liabilities and stockholders’ equity
$
65,725,667

 
$
60,784,968


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 the Company.
 
August 31,
2011
 
November 30,
2010
 
(unaudited)
(dollars in thousands)
Assets
 
 
 
Restricted cash
$
937,230

 
$
1,363,758

Credit card loan receivables
33,978,980

 
34,452,989

Other loan receivables
2,876,923

 
—

Allowance for loan losses allocated to securitized loan receivables
(1,589,949
)
 
(2,431,399
)
Other assets
30,404

 
24,083

Liabilities
 
 
 
Long-term borrowings
$
15,260,509

 
$
14,919,400

Accrued interest payable
12,803

 
11,758

See Notes to Condensed Consolidated Financial Statements.

1
Table of Contents

DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Income

 
For the Three Months Ended
August 31,
 
For the Nine Months Ended
August 31,
 
2011
 
2010
 
2011
 
2010
 
(unaudited) (dollars in thousands, except per share amounts)
Interest income:
 
 
 
 
 
 
 
Credit card loans
$
1,423,496

 
$
1,455,907

 
$
4,243,803

 
$
4,423,654

Other loans
157,424

 
67,588

 
428,762

 
183,150

Investment securities
15,676

 
5,574

 
42,535

 
15,966

Other interest income
2,496

 
6,870

 
10,234

 
24,101

Total interest income
1,599,092

 
1,535,939

 
4,725,334

 
4,646,871

Interest expense:
 
 
 
 
 
 
 
Deposits
241,719

 
279,137

 
749,584

 
882,921

Short-term borrowings
33

 
—

 
116

 
—

Long-term borrowings
120,301

 
110,000

 
375,060

 
324,561

Total interest expense
362,053

 
389,137

 
1,124,760

 
1,207,482

Net interest income
1,237,039

 
1,146,802

 
3,600,574

 
3,439,389

Provision for loan losses
99,514

 
712,565

 
692,763

 
2,824,035

Net interest income after provision for loan losses
1,137,525

 
434,237

 
2,907,811

 
615,354

Other income:
 
 
 
 
 
 
 
Discount and interchange revenue, net
282,889

 
273,932

 
809,631

 
805,209

Fee product revenue
107,858

 
104,132

 
321,527

 
309,590

Loan fee income
84,243

 
92,465

 
250,596

 
267,483

Transaction processing revenue
43,931

 
40,184

 
131,792

 
109,570

Merchant fees
4,110

 
7,220

 
12,981

 
23,091

Gain (loss) on investments
(3,614
)
 
18,951

 
(3,622
)
 
19,131

Other income
32,546

 
27,260

 
135,526

 
88,790

Total other income
551,963

 
564,144

 
1,658,431

 
1,622,864

Other expense:
 
 
 
 
 
 
 
Employee compensation and benefits
241,881

 
204,210

 
684,782

 
602,510

Marketing and business development
133,398

 
130,532

 
393,244

 
313,175

Information processing and communications
63,547

 
62,357

 
194,852

 
190,862

Professional fees
106,042

 
85,289

 
301,122

 
239,169

Premises and equipment
18,063

 
17,722

 
53,268

 
53,273

Other expense
79,476

 
66,128

 
245,431

 
155,601

Total other expense
642,407

 
566,238

 
1,872,699

 
1,554,590

Income before income tax expense
1,047,081

 
432,143

 
2,693,543

 
683,628

Income tax expense
398,263

 
171,526

 
979,414

 
268,482

Net income
$
648,818

 
$
260,617

 
$
1,714,129

 
$
415,146

Net income allocated to common stockholders
$
641,772

 
$
258,194

 
$
1,694,636

 
$
321,613

Basic earnings per share
$
1.18

 
$
0.47

 
$
3.11

 
$
0.59

Diluted earnings per share
$
1.18

 
$
0.47

 
$
3.11

 
$
0.58

Dividends paid per share
$
0.06

 
$
0.02

 
$
0.14

 
$
0.06

See Notes to the Condensed Consolidated Financial Statements.

2
Table of Contents

DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Changes in Stockholders’ Equity


 
Preferred Stock
 
Common Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Treasury
Stock
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
(unaudited) (dollars and shares in thousands)
Balance at November 30, 2009
1,225

 
$
1,158,066

 
544,799
 
$
5,448

 
$
3,573,231

 
$
3,873,262

 
$
(154,818
)
 
$
(19,642
)
 
$
8,435,547

Adoption of ASC 810 (FASB Statement No. 167), net of tax
—

 
—

 
—

 
—

 
—

 
(1,411,117
)
 
78,561

 
—

 
(1,332,556
)
Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
—

 
—

 
—

 
—

 
—

 
415,146

 
—

 
—

 
415,146

Adjustments related to investment securities, net of tax
—

 
—

 
—

 
—

 
—

 
—

 
(6,276
)
 
—

 

Adjustments related to cash flow hedges, net of tax
—

 
—

 
—

 
—

 
—

 
—

 
158

 
—

 

Adjustments related to pension and postretirement benefits, net of tax
—

 
—

 
—

 
—

 
—

 
—

 
78

 
—

 


Other comprehensive loss
—

 
—

 
—

 
—

 
—

 
—

 
(6,040
)
 
—

 
(6,040
)
Total comprehensive income
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
409,106

Purchases of treasury stock
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(8,145
)
 
(8,145
)
Common stock issued under employee benefit plans
—

 
—

 
67

 
1

 
867

 
—

 
—

 
—

 
868

Common stock issued and stock-based compensation expense
—

 
—

 
2,125

 
21

 
29,402

 
—

 
—

 
—

 
29,423

Income tax deficiency on stock based compensation plans
—

 
—

 
—

 
—

 
(3,411
)
 
—

 
—

 
—

 
(3,411
)
Dividends paid—common stock
—

 
—

 
—

 
—

 
—

 
(32,923
)
 
—

 
—

 
(32,923
)
Accretion of preferred stock discount
—

 
66,492

 
—

 
—

 
—

 
(66,492
)
 
—

 
—

 
—

Dividends—preferred stock
—

 
—

 
—

 
—

 
—

 
(23,811
)
 
—

 
—

 
(23,811
)
Redemption of preferred stock
(1,225
)
 
(1,224,558
)
 
—

 
—

 
—

 
—

 
—

 
—

 
(1,224,558
)
Repurchase of stock warrant
—

 
—

 
—

 
—

 
(172,000
)
 
—

 
—

 
—

 
(172,000
)
Special dividend—Morgan Stanley
—

 
—

 
—

 
—

 
—

 
33,757

 
—

 
—

 
33,757

Balance at August 31, 2010
—

 
$
—

 
546,991
 
$
5,470

 
$
3,428,089

 
$
2,787,822

 
$
(82,297
)
 
$
(27,787
)
 
$
6,111,297

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Balance at November 30, 2010
—

 
—

 
547,128
 
5,471

 
3,435,318

 
3,126,488

 
(82,548
)
 
(27,883
)
 
6,456,846

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
—

 
—

 
—

 
—

 
—

 
1,714,129

 
—

 
—

 
1,714,129

Adjustments related to investment securities, net of tax
—

 
—

 
—

 
—

 
—

 
—

 
54,897

 
—

 

Adjustments related to cash flow hedges, net of tax
—

 
—

 
—

 
—

 
—

 
—

 
7,330

 
—

 

Adjustments related to pension and postretirement benefits, net of tax
—

 
—

 
—

 
—

 
—

 
—

 
342

 
—

 


Other comprehensive income
—

 
—

 
—

 
—

 
—

 
—

 
62,569

 
—

 
62,569

Total comprehensive income
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
1,776,698

Purchases of treasury stock
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(207,560
)
 
(207,560
)
Common stock issued under employee benefit plans
—

 
—

 
40

 
—

 
906

 
—

 
—

 
—

 
906

Common stock issued and stock based compensation expense
—

 
—

 
2,308

 
24

 
56,439

 
—

 
—

 
—

 
56,463

Dividends paid—common stock
—

 
—

 
—

 
—

 
—

 
(77,437
)
 
—

 
—

 
(77,437
)
Balance at August 31, 2011
—

 
$
—

 
549,476

 
$
5,495

 
$
3,492,663

 
$
4,763,180

 
$
(19,979
)
 
$
(235,443
)
 
$
8,005,916


Notes to the Condensed Consolidated Financial Statements.

3
Table of Contents

DISCOVER FINANCIAL SERVICES
Condensed Consolidated Statements of Cash Flows
 
For the Nine Months Ended
August 31,
 
2011
 
2010
 
(unaudited)

 
(dollars in thousands)
Cash flows from operating activities
 
 
 
Net income
$
1,714,129

 
$
415,146

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
692,763

 
2,824,035

Deferred income taxes
351,854

 
63,131

Depreciation and amortization on premises and equipment
66,274

 
68,130

Amortization of deferred revenues
(191,290
)
 
(137,492
)
Other depreciation and amortization
(35,346
)
 
57,947

Loss (gain) on investments
3,622

 
(19,131
)
Loss on premises and equipment
3,242

 
1,930

Loss (gain) on loans sold
28

 
(439
)
Stock-based compensation expense
33,690

 
29,554

Gain on purchase of business
(15,917
)
 
—

Net change in loans originated for sale
49,719

 
(118,557
)
Changes in assets and liabilities:

 

Decrease (increase) in other assets
32,339

 
(230,385
)
Increase (decrease) in accrued expenses and other liabilities
106,908

 
(247,107
)
Net cash provided by operating activities
2,812,015

 
2,706,762

Cash flows from investing activities
 
 
 
Maturities of other short-term investments
375,000

 
1,350,000

Purchases of other short-term investments
—

 
(375,000
)
Maturities and sales of available-for-sale investment securities
786,463

 
540,526

Purchases of available-for-sale investment securities
(1,627,215
)
 
(1,239,631
)
Maturities of held-to-maturity investment securities
17,466

 
19,779

Purchases of held-to-maturity investment securities
(550
)
 
(549
)
Proceeds from sale of loans held for investment
611

 
—

Net principal disbursed on loans held for investment
(3,074,805
)
 
(2,035,023
)
Purchase of loan receivables
(596,163
)
 
—

Purchase of business, net of cash acquired
(401,158
)
 
—

Purchase of other investment
(15,000
)
 
—

Decrease in restricted cash—special dividend escrow
—

 
643,311

Decrease in restricted cash—for securitization investors
623,794

 
547,064

Proceeds from sale of premises and equipment
13

 
146

Purchases of premises and equipment
(70,053
)
 
(29,538
)
Net cash used for investing activities
(3,981,597
)
 
(578,915
)
Cash flows from financing activities
 
 
 
Net increase in short-term borrowings
100,000

 
—

Proceeds from issuance of securitized debt
2,500,000

 
1,000,000

Maturities of securitized debt
(5,114,986
)
 
(8,560,528
)
Proceeds from issuance of other long-term borrowings
—

 
1,003,427

Maturities of other long-term borrowings
(345,048
)
 
(590,676
)
Proceeds from issuance of common stock
17,928

 
—

Purchases of treasury stock
(207,560
)
 
(8,145
)
Net increase in deposits
3,147,752

 
1,177,096

Proceeds from acquisition of deposits
—

 
976,627

Redemption of preferred stock
—

 
(1,224,558
)
Repurchase of warrant
—

 
(172,000
)
Dividend paid to Morgan Stanley
—

 
(775,000
)
Dividends paid on common and preferred stock
(69,712
)
 
(59,455
)
Excess tax benefits related to stock-based compensation
—

 
737

Net cash provided by (used for) financing activities
28,374

 
(7,232,475
)
Net decrease in cash and cash equivalents
(1,141,208
)
 
(5,104,628
)
Cash and cash equivalents, at beginning of period
5,098,733

 
13,020,719

Cash and cash equivalents, at end of period
$
3,957,525

 
$
7,916,091

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid during the period for:
 
 
 
Interest expense
$
1,045,370

 
$
1,125,181

Income taxes, net of income tax refunds
$
635,360

 
$
112,027

Non-cash transactions:
 
 
 
Assumption of SLC debt
$
2,921,372

 
$
—

Special dividend—Morgan Stanley
$
—

 
$
33,757


See Notes to the Condensed Consolidated Financial Statements.

4
Table of Contents

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 and therefore is subject to oversight, regulation and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). Through its Discover Bank subsidiary, a Delaware state-chartered bank, the Company offers its customers credit cards, student loans, personal loans and deposit products. Through its DFS Services LLC subsidiary and its subsidiaries, the Company operates the Discover Network, the PULSE Network (“PULSE”) and Diners Club International (“Diners Club”). The Discover Network is a payment card transaction processing network for Discover card-branded and third-party issued credit, debit and prepaid cards. 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 credit cards and/or provide card acceptance services.
The Company’s business segments are Direct Banking and Payment Services. The Direct Banking segment includes Discover card-branded credit cards issued to individuals and small businesses on the Discover Network and other consumer products and services, including personal loans, student loans, prepaid cards and other consumer lending and deposit products offered through the Company’s Discover Bank subsidiary. The Payment Services segment includes PULSE, Diners Club and the Company’s third-party issuing business, which includes credit, debit and prepaid cards issued on the Discover Network by third parties.
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 quarter. 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 2010 audited consolidated financial statements filed with the Company’s annual report on Form 10-K for the fiscal year ended November 30, 2010.
Recently Issued Accounting Pronouncements
    
In September 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") No. 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2011-08 is intended to simplify goodwill impairment testing by adding a qualitative review step to assess whether the required quantitative impairment analysis that exists today is necessary. Under the amended rule, a company will not be required to calculate the fair value of a business that contains recorded goodwill unless it concludes, based on the qualitative assessment, that it is more likely than not that the fair value of that business is less than its book value. If such a decline in fair value is deemed more likely than not to have occurred, then the quantitative goodwill impairment test that exists under current GAAP must be completed; otherwise, goodwill is deemed to be not impaired and no further testing is required until the next annual test date (or sooner if conditions or events before that date raise concerns of potential impairment in the business). The amended goodwill impairment guidance does not affect the manner in which a company estimates fair value. The new standard is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The Company has $255 million in goodwill, all of which is associated with its PULSE network. The value of that goodwill will not be affected by the adoption of this standard.

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU will require companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements. It eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity. The standard does not change the items which must be reported in other comprehensive income, how such items are measured or when they must be reclassified to net income. This standard is effective for interim and annual periods beginning after December 15, 2011. Because this ASU

5
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impacts presentation only, it will have no effect on the Company's financial condition, results of operations or cash flows.

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU is intended to result in convergence between U.S. GAAP and International Financial Reporting Standards (“IFRS”) requirements for measurement of and disclosures about fair value. The amendments are not expected to have a significant impact on companies applying U.S. GAAP. Key provisions of the amendment include: a prohibition on grouping financial instruments for purposes of determining fair value, except when an entity manages market and credit risks on the basis of the entity’s net exposure to the group; an extension of the prohibition against the use of a blockage factor to all fair value measurements (that prohibition currently applies only to financial instruments with quoted prices in active markets); and a requirement that for recurring Level 3 fair value measurements, entities disclose quantitative information about unobservable inputs, a description of the valuation process used and qualitative details about the sensitivity of the measurements. In addition, for items not carried at fair value but for which fair value is disclosed, entities will be required to disclose the level within the fair value hierarchy that applies to the fair value measurement disclosed. This ASU is effective for interim and annual periods beginning after December 15, 2011. The adoption of this ASU is not expected to have a significant impact on the Company’s fair value measurements, financial condition, results of operations or cash flows.

In April 2011, the FASB issued ASU No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. This ASU amends the sale accounting requirement concerning a transferor’s ability to repurchase transferred financial assets even in the event of default by the transferee, which typically is facilitated in a repurchase agreement by the presence of a collateral maintenance provision. Specifically, the level of cash collateral received by a transferor will no longer be relevant in determining whether a repurchase agreement constitutes a sale. As a result of this amendment, more repurchase agreements will be treated as secured financings rather than sales. This ASU is effective prospectively for new transfers and existing transactions that are modified in the first interim or annual period beginning on or after December 15, 2011. Because essentially all repurchase agreements entered into by the Company have historically been deemed to constitute secured financing transactions, this amendment is expected to have no impact on the Company’s characterization of such transactions and therefore is not expected to have any impact on the Company's financial condition, results of operations or cash flows.

In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310): A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This ASU is intended to clarify the FASB’s views on the conditions under which a loan modification should be deemed to be a troubled debt restructuring and could result in the determination that more loan modifications meet that definition. Loans which constitute troubled debt restructurings are considered impaired when calculating the allowance for loan losses and are subject to additional disclosures pursuant to ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, which becomes effective concurrent with ASU No. 2011-02. The amendment is effective for the first interim or annual period beginning after June 15, 2011 and must be applied retrospectively to loan modifications occurring on or after the beginning of the fiscal year of adoption. The Company has reviewed the loan modifications it makes in light of this guidance, and has determined that this amendment is not expected to result in any change to the characterization of the Company's current loan modification programs. The amendment is therefore not expected to impact the Company's financial condition, results of operations or cash flows. 

2.
Business Combinations
Acquisition of The Student Loan Corporation. On December 31, 2010, the Company acquired The Student Loan Corporation (“SLC”), which is now a wholly-owned subsidiary of Discover Bank and included in the Company’s Direct Banking segment. The Company acquired SLC’s ongoing private student loan business, which includes certain private student loans held in three securitization trusts and other assets, and assumed SLC’s asset-backed securitization debt incurred by those trusts and other liabilities. The acquired loans are considered to be purchased credit-impaired loans for accounting purposes, the details of which are discussed further in Note 4: Loan Receivables. The acquisition significantly increased the size of the Company’s private student loan portfolio. In addition, the acquisition has provided the Company with a developed student loan business platform, additional school relationships and SLC’s website. Since the acquisition date, the results of operations and cash flows of SLC have been included in the Company’s condensed consolidated results of operations and cash flows. Pro forma data is not provided as the impact of the SLC acquisition was not significant to the Company’s condensed consolidated results of operations or cash flows.

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Table of Contents

Net cash consideration paid. The following table provides a calculation of the amount paid by the Company for SLC based on the net assets of the SLC securitization trusts acquired after applying an 8.5% discount to the trust assets (the “Trust Certificate Purchase Price”) (dollars in millions):

 
Actual
 
Estimate at
Closing
December 31,
2010

 
 
Gross trust assets
$
3,977

 
$
3,993

Less: 8.5% discount
(338
)
 
(339
)
Net trust assets
3,639

 
3,654

Less: Principal amount of and accrued interest on trust debt
(3,193
)
 
(3,215
)
Trust Certificate Purchase Price
$
446

 
$
439


Although the Company paid SLC shareholders $600 million for the acquisition of SLC (“Aggregate Merger Consideration”), the Company received a purchase price adjustment from Citibank, N.A. (“Citibank”) equivalent to the amount by which the Aggregate Merger Consideration exceeded the value of the Trust Certificate Purchase Price. In addition, Citibank agreed to adjust the cash consideration paid by the Company to compensate it for (i) agreeing to commute certain insurance policies covering certain of the loans acquired and (ii) for the value of non-trust related liabilities assumed by the Company. The following table provides a summary of total consideration paid by Discover at the closing of the acquisition on December 31, 2010 and a summary of the consideration revised for post-closing adjustments (dollars in millions): 
 
Actual
 
Estimate at
Closing
December 31,
2010

 
 
Aggregate Merger Consideration
$
600

 
$
600

Less: Purchase price adjustment(1)
(154
)
 
(161
)
Trust Certificate Purchase Price
446

 
439

Less: Further adjustments provided for by Citibank
 
 
 
Cash received for consent to insurance commutation
(16
)
 
(16
)
Cash received related to reimbursable liabilities(1)
(29
)
 
(57
)
Net cash consideration paid(1)
$
401

 
$
366

______________
(1)
Based on the final SLC closing balance sheet, the Company accrued a $35 million liability, at the end of the first quarter of fiscal 2011, payable to Citibank for post-closing adjustments arising from a $7 million increase in the Trust Certificate Purchase Price and a $28 million reduction in reimbursable liabilities, which together resulted in the difference between the actual and estimated numbers shown. The accrued amount was paid to Citibank during the second quarter of 2011.
Net assets acquired. The Company acquired net assets (including $155 million of cash) with an aggregate fair value of $572 million in exchange for cash consideration of $556 million, resulting in the recognition of a bargain purchase gain of approximately $16 million. The bargain purchase gain primarily resulted from Citibank’s adjustment of the cash consideration to be paid by the Company in exchange for the Company’s consent to permit SLC to commute, immediately prior to the acquisition, certain student loan insurance policies covering loans in one of the three trusts. The bargain purchase gain is recorded in other income on the Company’s condensed consolidated statement of income. Adjustments to these amounts may occur during 2011, as the Company completes its final valuation analysis of assets acquired and liabilities assumed.

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The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of the SLC acquisition (dollars in thousands):

 
At December 31,
2010

Student loan receivables
$
3,050,784

Cash
155,347

Indemnification asset
101,127

Student relationships intangible
2,400

Trade name intangible
3,800

Total intangible assets
6,200

Other assets
218,514

Total assets acquired
3,531,972

Securitized debt
2,921,372

Other liabilities
38,178

Total liabilities assumed
2,959,550

Net assets acquired
$
572,422

The Company acquired $6.2 million in identifiable intangible assets. These intangible assets consist of student relationships and trade name intangibles. Acquired student relationships consist of those relationships in existence between SLC and the numerous students that carry student loan balances. This intangible asset is deemed to have a finite useful life of five years and will be amortized over this period. Trade name intangibles relate to trademarks, trade names and internet domains and content. This intangible asset is deemed to have an indefinite useful life and therefore is not subject to amortization.
The Company also recorded a $101 million indemnification asset at the acquisition date. This asset reflects the discounted present value of payments expected to be received under Citibank’s indemnification of student loan credit losses that would have been recoverable under certain student loan insurance policies which, as noted above, were commuted pursuant to an agreement entered into by SLC with the Company’s consent immediately prior to the acquisition. The indemnification pertains only to loans in one of the three SLC securitization trusts that the Company acquired, namely the SLC Private Student Loan Trust 2010-A (“SLC 2010-A”). The SLC 2010-A trust included loans with an aggregate outstanding principal balance of $1.2 billion at the time of acquisition; outstanding loans in that trust totaled $1.1 billion as of August 31, 2011. The initial value of the indemnification asset is based on the insured portion of expected credit losses reflected in the initial carrying value of the related loans. Under the terms of the indemnification agreement with Citibank, indemnification payments related to student loan credit losses are subject to an overall cap of $166.8 million, consistent with the terms of the insurance policies which the indemnification serves to replace.
The subsequent accounting for the indemnification asset will generally reflect the manner in which the indemnified loans are subsequently measured. The value of the indemnification asset will increase or decrease as expected credit losses on the purchased credit-impaired (“PCI”) student loans increase or decrease, respectively. An increase in expected losses on PCI student loans that results in the immediate recognition of an allowance for loan losses will result in an immediate increase in the indemnification asset. A decrease in expected losses that results in an immediate reversal of a previously recognized loan loss allowance will result in the immediate reduction of the indemnification asset. Recognition of an allowance for loan losses on PCI student loans is discussed in more detail within Note 4: Loan Receivables under “Purchased Credit-Impaired Loans.” To the extent that a decrease in expected losses results in a prospective increase in the accretable yield on PCI student loans rather than an immediate reduction of the loan loss allowance, the value of the indemnification asset will be adjusted prospectively through a reduction in the rate of amortization. Amortization and valuation adjustments to the indemnification asset are recorded through other income on the condensed consolidated statement of income.









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Table of Contents

3.
Investment Securities
 
The Company’s investment securities consist of the following (dollars in thousands):

 
August 31,
2011
 
November 30,
2010
U.S. Treasury securities
$
2,371,805

 
$
1,575,403

U.S. government agency securities
2,669,180

 
1,888,701

States and political subdivisions of states
39,670

 
51,774

Other securities:
 
 

Credit card asset-backed securities of other issuers
356,940

 
1,031,112

Corporate debt securities(1)
501,705

 
507,896

Residential mortgage-backed securities
7,344

 
9,800

Other debt and equity securities
5,524

 
10,709

Total other securities
871,513

 
1,559,517

Total investment securities
$
5,952,168

 
$
5,075,395

___________________________
 
(1)
Amount represents corporate debt obligations issued under the Temporary Liquidity Guarantee Program (TLGP) that are guaranteed by the Federal Deposit Insurance Corporation (FDIC).

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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 thousands): 

 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
At August 31, 2011
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S Treasury securities
$
2,322,042

 
$
49,213

 
$
—

 
$
2,371,255

U.S government agency securities
2,627,392

 
41,788

 
—

 
$
2,669,180

Credit card asset-backed securities of other issuers
348,606

 
8,335

 
(1
)
 
$
356,940

Corporate debt securities
500,716

 
989

 
—

 
$
501,705

Total available-for-sale investment securities
$
5,798,756

 
$
100,325

 
$
(1
)
 
$
5,899,080

Held-to-Maturity Investment Securities(2)
 
 
 
 
 
 
 
U.S. Treasury securities(3)
$
550

 
$
—

 
$
—

 
$
550

States and political subdivisions of states
39,670

 
219

 
(2,923
)
 
36,966

Residential mortgage-backed securities
7,344

 
805

 
—

 
8,149

Other debt securities(4)
5,524

 
—

 
—

 
5,524

Total held-to-maturity investment securities
$
53,088

 
$
1,024

 
$
(2,923
)
 
$
51,189

At November 30, 2010
 
 
 
 
 
 
 
Available-for-Sale Investment Securities(1)
 
 
 
 
 
 
 
U.S Treasury securities
$
1,576,094

 
$
344

 
$
(1,585
)
 
$
1,574,853

U.S government agency securities
1,888,909

 
1,090

 
(1,298
)
 
1,888,701

Credit card asset-backed securities of other issuers
1,017,183

 
13,983

 
(54
)
 
1,031,112

Corporate debt securities
507,757

 
241

 
(102
)
 
507,896

Equity securities
15

 
2

 
—

 
17

Total available-for-sale investment securities
$
4,989,958

 
$
15,660

 
$
(3,039
)
 
$
5,002,579

Held-to-Maturity Investment Securities(2)
 
 
 
 
 
 
 
U.S. Treasury securities(3)
$
550

 
$
—

 
$
—

 
$
550

States and political subdivisions of states
51,774

 
281

 
(3,771
)
 
48,284

Residential mortgage-backed securities
9,800

 
869

 
—

 
10,669

Other debt securities(4)
10,692

 
—

 
—

 
10,692

Total held-to-maturity investment securities
$
72,816

 
$
1,150

 
$
(3,771
)
 
$
70,195

_________________________
(1)
Available-for-sale investment securities are reported at fair value.
(2)
Held-to-maturity investment securities are reported at amortized cost.
(3)
Amount represents securities pledged as collateral to a government-related merchant for which transaction settlement occurs beyond the normal 24-hour period.
(4)
Included in other debt securities at August 31, 2011 and November 30, 2010 are commercial advances of $2.8 million and $7.9 million respectively related to the Company’s Community Reinvestment Act strategies.

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Table of Contents

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 as of August 31, 2011 and November 30, 2010 (dollars in thousands):

 
Number of
Securities
in a Loss
Position
 
Less than 12 months
 
More than 12 months
 
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
At August 31, 2011
 
 
 
 
 
 
 
 
 
Available-for-Sale Investment Securities
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
—

 
$
—

 
$
—

 
$
—

 
$
—

U.S. government agency securities
—

 
—

 
—

 
$
—

 
$
—

Credit card asset-backed securities of other issuers
1

 
4,126

 
1

 
$
—

 
$
—

Corporate debt securities
—

 
—

 
—

 
$
—

 
$
—

Held-to-Maturity Investment Securities
 
 
 
 
 
 
 
 
 
State and political subdivisions of states
4

 
$
6,084

 
$
1

 
$
21,538

 
$
2,922

At November 30, 2010
 
 
 
 
 
 
 
 
 
Available-for-Sale Investment Securities
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
17

 
$
1,262,670

 
$
1,585

 
$
—

 
$
—

U.S. government agency securities
18

 
$
1,181,148

 
$
1,298

 
$
—

 
$
—

Credit card asset-backed securities of other issuers
23

 
$
238,646

 
$
54

 
$
—

 
$
—

Corporate debt securities
5

 
$
230,441

 
$
102

 
$
—

 
$
—

Held-to-Maturity Investment Securities
 
 
 
 
 
 
 
 
 
State and political subdivisions of states
4

 
$
7,731

 
$
239

 
$
27,603

 
$
3,532


During the three and nine months ended August 31, 2011, the Company received $170.5 million and $803.9 million, respectively, of proceeds related to maturities or redemptions of investment securities, as compared to $159.7 million and $560.3 million for the three and nine months ended August 31, 2010, respectively. For the three and nine months ended August 31, 2011, approximately $165.0 million and $786.5 million, respectively, of these proceeds related to maturities of credit card asset-backed securities of other issuers. For the three and nine months ended August 31, 2010, approximately $75.2 million and $469.6 million, respectively, of these proceeds related to maturities of credit card asset-backed securities of other issuers.


The Company records unrealized gains and losses on its available-for-sale investment securities in other comprehensive income. For the three months ended August 31, 2011 and 2010, the Company recorded a net unrealized gain of $61.0 million ($38.2 million after tax) and a net unrealized loss of $13.6 million ($8.5 million after tax), respectively, in other comprehensive income. For the nine months ended August 31, 2011 and 2010, the Company recorded a net unrealized gain of $87.7 million ($54.9 million after tax) and a net unrealized loss of $9.9 million ($6.3 million after tax), respectively, in other comprehensive income. Additionally for the nine months ended August 31, 2010, the Company reversed an unrealized gain of $7.5 million ($4.7 million after tax) from other comprehensive income upon liquidation of the collateral supporting the Golden Key U.S. LLC investment.

At August 31, 2011 and November 30, 2010, the Company had $2.9 million and $3.5 million, respectively, of gross unrealized losses in a continuous loss position for more than 12 months on its held-to-maturity investment securities in states and political subdivisions of states. The Company believes the unrealized loss on these investments is the result of changes in interest rates subsequent to the Company’s acquisitions of these securities and that the reduction in value is temporary. The Company does not intend to sell these investments nor does it expect to be required to sell these investments before recovery of their amortized cost bases, but rather expects to collect all amounts due according to the contractual terms of these securities.
 

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Table of Contents

Maturities of available-for-sale debt securities and held-to-maturity debt securities at August 31, 2011 are provided in the table below (dollars in thousands): 

 
One Year
or
Less
 
After One
Year
Through
Five Years
 
After Five
Years
Through
Ten Years
 
After Ten
Years
 
Total
Available-for-sale—Amortized Cost (1)
 
 
 
 
 
 
 
 
 
U.S Treasury securities
$
590,462

 
$
1,731,580

 
$
—

 
$
—

 
$
2,322,042

U.S government agency securities
921,790

 
1,705,602

 
—

 
—

 
2,627,392

Credit card asset-backed securities of other issuers
191,269

 
157,337

 
—

 
—

 
348,606

Corporate debt securities
353,224

 
147,492

 
—

 
—

 
500,716

Total available-for-sale investment securities
$
2,056,745

 
$
3,742,011

 
$
—

 
$
—

 
$
5,798,756

Held-to-maturity—Amortized Cost (2)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
550

 
$
—

 
$
—

 
$
—

 
$
550

State and political subdivisions of states
—

 
2,085

 
3,375

 
34,210

 
39,670

Residential mortgage-backed securities
—

 
—

 
—

 
7,344

 
7,344

Other debt securities
275

 
2,641

 
153

 
2,455

 
5,524

Total held-to-maturity investment securities
$
825

 
$
4,726

 
$
3,528

 
$
44,009

 
$
53,088

Available-for-sale—Fair Values (1)
 
 
 
 
 
 
 
 
 
U.S Treasury securities
$
591,201

 
$
1,780,054

 
$
—

 
$
—

 
$
2,371,255

U.S government agency securities
922,717

 
1,746,463

 
—

 
—

 
2,669,180

Credit card asset-backed securities of other issuers
192,728

 
164,212

 
—

 
—

 
356,940

Corporate debt securities
353,547

 
148,158

 
—

 
—

 
501,705

Total available-for-sale investment securities
$
2,060,193

 
$
3,838,887

 
$
—

 
$
—

 
$
5,899,080

Held-to-maturity—Fair Values (2)
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
550

 
$
—

 
$
—

 
$
—

 
$
550

State and political subdivisions of states
—

 
2,125

 
3,549

 
31,292

 
36,966

Residential mortgage-backed securities
—

 
—

 
—

 
8,149

 
8,149

Other debt securities
275

 
2,641

 
153

 
2,455

 
5,524

Total held-to-maturity investment securities
$
825

 
$
4,766

 
$
3,702

 
$
41,896

 
$
51,189

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


12
Table of Contents

4.
Loan Receivables
The Company has three portfolio segments: credit card loans, other consumer loans and purchased credit-impaired (“PCI”) student loans acquired in the SLC transaction (See Note 2: Business Combinations). Within these portfolio segments, the Company has classes of receivables which are depicted in the table below (dollars in thousands): 
 
August 31,
2011
 
November 30,
2010
Loans held for sale(1)
$
738,382

 
$
788,101

Loan portfolio:
 
 
 
Credit card loans:
 
 
 
Discover card(2)
45,949,224

 
44,904,267

Discover business card
228,449

 
252,727

Total credit card loans
46,177,673

 
45,156,994

Other consumer loans:
 
 
 
Personal loans
2,439,330

 
1,877,633

Private student loans
1,828,493

 
999,322

Other
11,790

 
14,363

Total other consumer loans
4,279,613

 
2,891,318

PCI student loans(3)
2,886,783

 
—

Total loan portfolio
53,344,069

 
48,048,312

Total loan receivables
54,082,451

 
48,836,413

Allowance for loan losses
(2,273,058
)
 
(3,304,118
)
Net loan receivables
$
51,809,393

 
$
45,532,295

 ____________________________
(1)
Amount represents federal student loans. At August 31, 2011 and November 30, 2010, $463.9 million and $500.2 million of federal student loan receivables, respectively, were pledged as collateral against a long-term borrowing.
(2)
Amounts include $16.9 billion and $19.5 billion of underlying investors’ interest in trust debt at August 31, 2011 and November 30, 2010, respectively, and $17.0 billion and $14.9 billion in seller’s interest at August 31, 2011 and November 30, 2010, respectively. See Note 5: Credit Card and Student Loan Securitization Activities for further information.
(3)
Amount includes $2.9 billion of loans pledged as collateral against the notes issued from the SLC securitization trusts. See Note 5: Credit Card and Student Loan Securitization Activities. The remaining $9.9 million not pledged as collateral represents loans eligible for reimbursement through an indemnification claim. Discover Bank must purchase such loans from the trust before a claim may be filed.
Credit Quality Indicators. The Company regularly reviews its collection experience (including delinquencies and net charge-offs) in determining its allowance for loan losses. Credit card and closed-end consumer loan receivables are placed on nonaccrual status upon receipt of notification of the bankruptcy or death of a customer or suspected fraudulent activity on an account. In some cases of suspected fraudulent activity, loan receivables may resume accruing interest upon completion of the fraud investigation.

13
Table of Contents

Information related to the delinquencies and net charge-offs in the Company’s loan portfolio, which excludes loans held for sale, is shown below by each class of loan receivables except for PCI student loans, which is shown under the heading “Purchased Credit-Impaired Loans” (dollars in thousands): 

Delinquent and Non-Accruing Loans:
 
 
 
 
 
 
 
 
 
  
30-89 Days
Delinquent
 
90 or
More Days
Delinquent
 
Total Past
Due
 
90 or
More Days
Delinquent
and
Accruing
 
Total
Non-accruing(2)
At August 31, 2011
 
 
 
 
 
 
 
 
 
Credit card loans:
 
 
 
 
 
 
 
 
 
Discover card(1)
$
553,174

 
$
561,127

 
$
1,114,301

 
$
498,752

 
$
208,404

Discover business card
2,885

 
3,929

 
6,814

 
3,655

 
889

Total credit card loans
556,059

 
565,056

 
1,121,115

 
502,407

 
209,293

Other consumer loans:
 
 
 
 
 
 
 
 
 
Personal loans
14,170

 
6,446

 
20,616

 
5,814

 
3,527

Private student loans (excluding PCI)
12,415

 
2,150

 
14,565

 
2,150

 
—

Other(3)
438

 
2,199

 
2,637

 
—

 
2,426

Total other consumer loans (excluding PCI)
27,023

 
10,795

 
37,818

 
7,964

 
5,953

Total loan receivables (excluding PCI)(3)
$
583,082

 
$
575,851

 
$
1,158,933

 
$
510,371

 
$
215,246

At November 30, 2010
 
 
 
 
 
 
 
 
 
Total loan receivables(1)
$
908,306

 
$
993,618

 
$
1,901,924

 
$
853,757

 
$
325,900

______________________ 
(1)
Consumer credit card loans that are 90 or more days delinquent and accruing interest include $36.4 million and $35 million of loans accounted for as troubled debt restructurings at August 31, 2011 and November 30, 2010, respectively.
(2)
The Company estimates that the gross interest income that would have been recorded in accordance with the original terms of these loans was $10.6 million and $35.6 million for the three months and nine months ended August 31, 2011, 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. These amounts were estimated based on customers' current balances and most recent rates.
(3)
Amount also excludes federal student loans that are held for sale.

Net Charge-Offs:
For the Three Months Ended August 31, 2011
 
For the Nine Months Ended August 31, 2011
  
Net
Charge-offs
 
Net Charge-off
Rate
 
Net
Charge-offs
 
Net Charge-off
Rate
 
 
 
 
 
 
 
 
Credit card loans:
 
 
 
 
 
 
 
Discover card
$
436,242

 
3.84
%
 
$
1,651,311

 
4.91
%
Discover business card
3,506

 
6.01
%
 
14,937

 
8.26
%
Total credit card loans
439,748

 
3.85
%
 
1,666,248

 
4.93
%
Other consumer loans:
 
 
 
 
 
 
 
Personal loans
16,000

 
2.73
%
 
50,980

 
3.19
%
Private student loans (excluding PCI)
2,618

 
0.62
%
 
5,573

 
0.49
%
Other
410

 
13.41
%
 
1,022

 
10.35
%
Total other consumer loans (excluding PCI)
19,028

 
0.98
%
 
57,575

 
1.09
%
Net charge-offs as a percentage of total loans (excluding PCI)
$
458,776

 
3.63
%
 
$
1,723,823

 
4.64
%
Net charge-offs as a percentage of total loans (including PCI)
$
458,776

 
3.43
%
 
$
1,723,823

 
4.41
%

14
Table of Contents

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 a FICO score, relating to the customer’s broader credit performance. FICO scores are generally obtained at origination of the account and monthly or quarterly thereafter. The following table provides the most recent FICO scores available for the Company’s customers as of August 31, 2011, as a percentage of each class of loan receivables: 

 
Credit Risk Profile by FICO
Score
 
660 and Above
 
Less than 660
or No Score
Discover card
79%
 
21%
Discover business card
87%
 
13%
Private student loans (excluding PCI)
95%
 
5%
Personal loans
95%
 
5%
Allowance for Loan Losses. The Company maintains an allowance for loan losses at an appropriate level to absorb probable losses inherent in the loan portfolio. The Company considers the collectibility of all amounts contractually due on its loan receivables, including those components representing interest and fees. Accordingly, the allowance for loan losses represents the estimated uncollectible principal, interest and fee components of loan receivables. The allowance is evaluated monthly and is maintained through an adjustment to the provision for loan losses. Charge-offs of principal amounts of loans outstanding are deducted from the allowance and subsequent recoveries of such amounts increase the allowance. Charge-offs of loan balances representing unpaid interest and fees result in a reversal of interest and fee income, respectively, which is effectively a reclassification of provision for loan loss.
For its credit card loan receivables, the Company bases its allowance for loan losses on several analyses that help estimate incurred losses as of the balance sheet date. While the Company’s estimation process includes historical data and analysis, there is a significant amount of judgment applied in selecting inputs and analyzing the results produced by the models to determine the allowance. The Company uses a migration analysis to estimate the likelihood that a loan will progress through the various stages of delinquency. The loan balances used in the migration analysis represent all amounts contractually due and, as a result, the migration analysis captures principal, interest and fee components in estimating uncollectible accounts. The Company uses other analyses to estimate losses incurred on non-delinquent accounts. The considerations in these analyses include past performance, risk management techniques applied to various accounts, historical behavior of different account vintages, current economic conditions, recent trends in delinquencies, bankruptcy filings, account collection management, policy changes, account seasoning, loan volume and amounts, payment rates, and forecasting uncertainties. The Company does not identify individual loans for impairment, but instead estimates its allowance for credit card loan losses on a pooled basis, which includes loans that are delinquent and/or no longer accruing interest.
For its other consumer loans, the Company considers historical and forecasted estimates of incurred losses in estimating the related allowance for loan losses. The Company may also consider other factors, such as current economic conditions, recent trends in delinquencies and bankruptcy filings, account collection management, policy changes, account seasoning, loan volume and amounts, payment rates and forecasting uncertainties.

15
Table of Contents

The following table provides changes in the Company’s allowance for loan losses for the three and nine months ended August 31, 2011 and 2010 (dollars in thousands): 
 
For the Three Months Ended
August 31,
 
For the Nine Months Ended
August 31,
 
2011
 
2010
 
2011
 
2010
Balance at beginning of period
$
2,632,320

 
$
3,930,624

 
$
3,304,118

 
$
1,757,899

Additions:
 
 
 
 
 
 
 
Addition to allowance related to securitized receivables(1)
—

 
—

 
—

 
2,144,461

Provision for loan losses
99,514

 
712,565

 
692,763

 
2,824,035

Deductions:
 
 
 
 
 
 
 
Charge-offs:
 
 
 
 
 
 
 
Discover card
(584,534
)
 
(982,920
)
 
(2,085,452
)
 
(3,203,959
)
Discover business card
(4,416
)
 
(14,502
)
 
(17,672
)
 
(50,190
)
Total credit card loans
(588,950
)
 
(997,422
)
 
(2,103,124
)
 
(3,254,149
)
Personal loans
(16,458
)
 
(23,836
)
 
(52,438
)
 
(70,957
)
Federal student loans
—

 
(11
)
 
—

 
(308
)
Private student loans
(2,663
)
 
(660
)
 
(5,646
)
 
(1,264
)
Other
(411
)
 
(139
)
 
(1,025
)
 
(858
)
Total other consumer loans
(19,532
)
 
(24,646
)
 
(59,109
)
 
(73,387
)
Total charge-offs
(608,482
)
 
(1,022,068
)
 
(2,162,233
)
 
(3,327,536
)
Recoveries:
 
 
 
 
 
 
 
Discover card
148,292

 
121,255

 
434,141

 
341,337

Discover business card
910

 
875

 
2,735

 
2,516

Total credit card loans
149,202

 
122,130

 
436,876

 
343,853

Personal loans
458

 
421

 
1,458

 
942

Private student loans
45

 
14

 
73

 
22

Other
1

 
35

 
3

 
45

Total other consumer loans
504

 
470

 
1,534

 
1,009

Total recoveries
149,706

 
122,600

 
438,410

 
344,862

Net charge-offs
(458,776
)
 
(899,468
)
 
(1,723,823
)
 
(2,982,674
)
Balance at end of period
$
2,273,058

 
$
3,743,721

 
$
2,273,058

 
$
3,743,721

 ______________________
(1)
On December 1, 2009, upon adoption of FASB Statements No. 166 and 167, the Company recorded $2.1 billion allowance for loan losses related to newly consolidated and reclassified credit card loan receivables.
Net charge-offs of principal are recorded against the allowance for loan losses, as shown in the table above. Information regarding net charge-offs of interest and fee revenues on credit card and other consumer loans is as follows (dollars in thousands): 
 
For the Three Months Ended
August 31,
 
For the Nine Months Ended
August 31,