Discover 2008 Annual Report Download

Download and view the complete annual report

Please find the complete 2008 Discover annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.

Page out of 168

  • 1
  • 2
  • 3
  • 4
  • 5
  • 6
  • 7
  • 8
  • 9
  • 10
  • 11
  • 12
  • 13
  • 14
  • 15
  • 16
  • 17
  • 18
  • 19
  • 20
  • 21
  • 22
  • 23
  • 24
  • 25
  • 26
  • 27
  • 28
  • 29
  • 30
  • 31
  • 32
  • 33
  • 34
  • 35
  • 36
  • 37
  • 38
  • 39
  • 40
  • 41
  • 42
  • 43
  • 44
  • 45
  • 46
  • 47
  • 48
  • 49
  • 50
  • 51
  • 52
  • 53
  • 54
  • 55
  • 56
  • 57
  • 58
  • 59
  • 60
  • 61
  • 62
  • 63
  • 64
  • 65
  • 66
  • 67
  • 68
  • 69
  • 70
  • 71
  • 72
  • 73
  • 74
  • 75
  • 76
  • 77
  • 78
  • 79
  • 80
  • 81
  • 82
  • 83
  • 84
  • 85
  • 86
  • 87
  • 88
  • 89
  • 90
  • 91
  • 92
  • 93
  • 94
  • 95
  • 96
  • 97
  • 98
  • 99
  • 100
  • 101
  • 102
  • 103
  • 104
  • 105
  • 106
  • 107
  • 108
  • 109
  • 110
  • 111
  • 112
  • 113
  • 114
  • 115
  • 116
  • 117
  • 118
  • 119
  • 120
  • 121
  • 122
  • 123
  • 124
  • 125
  • 126
  • 127
  • 128
  • 129
  • 130
  • 131
  • 132
  • 133
  • 134
  • 135
  • 136
  • 137
  • 138
  • 139
  • 140
  • 141
  • 142
  • 143
  • 144
  • 145
  • 146
  • 147
  • 148
  • 149
  • 150
  • 151
  • 152
  • 153
  • 154
  • 155
  • 156
  • 157
  • 158
  • 159
  • 160
  • 161
  • 162
  • 163
  • 164
  • 165
  • 166
  • 167
  • 168

R
E
W
A
R
D
S
S
E
R
V
I
C
E
P
E
O
P
L
E
V
A
L
U
E
S
R
E
L
A
T
I
O
N
S
H
I
P
S
FOCUSED
2008 ANNUAL REPORT
DISCOVER FINANCIAL SERVICES 2008 ANNUAL REPORT

Table of contents

  • Page 1
    F R E L A T I O N S H I P S S E R V I C E V A L U E S R E W A R D S DIS COVER FINANCIAL S ERVICES 2008 ANNUAL REP O RT P E O P L E D 2008 A NNUAL REPORT

  • Page 2
    ...of PULSE, one of the nation's leading ATM/debit networks; Diners Club International, a global payments network; and our third-party issuing business, which includes credit, debit and prepaid cards issued by third parties on Discover Network. $102 billion volume 30+ issuers Leading cash rewards...

  • Page 3
    ... share from the first payment of our Visa/MasterCard settlement, discussed on page 38). Discover Card sales volume totaled $92 billion, and total managed loans reached $51 billion, up 6% year-over-year. Our full-year managed net charge-off rate was 5%, below the average of other major credit card...

  • Page 4
    ... number of strategic moves in 2008 with an eye toward the future: • We sold our U.K. credit card issuing business, which significantly • • • • reduced our funding and earnings risk and improved our capital ratios. We acquired Diners Club International, which has an acceptance network...

  • Page 5
    ... growing consumer deposits business, will enable us to increase our on-balance sheet loans. In connection with participating in the Capital Purchase Program, Discover expects to become a bank holding company. We are also beginning to implement the comprehensive new rules on credit card practices and...

  • Page 6
    ...in our first 18 months as a stand-alone public company. The experience of Discover's strong and independent Board of Directors is of significant value to the company. With their counsel, we will continue to focus on helping customers and our company manage through the current economic downturn and...

  • Page 7
    ... fiscal year ended November 30, 2008 ' 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 (State or...

  • Page 8
    ... 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...

  • Page 9
    ...services, including personal loans, student loans, prepaid cards, and deposit products offered through our subsidiary, Discover Bank. Our Third-Party Payments segment includes: (1) the PULSE Network ("PULSE"), an automated teller machine (ATM), debit and electronic funds transfer network; (2) Diners...

  • Page 10
    ... services, including personal and student loans and deposit products offered through our subsidiary, Discover Bank. Credit Cards We issue Discover Cards through our wholly-owned subsidiary, Discover Bank. We use the term "cardmember" to refer to the owner of a credit, debit or prepaid account issued...

  • Page 11
    ... fees, cash or balance transfer transactions, authorizations, disputes or other specifics. Installment Loans In addition to credit cards, we offer installment loan products, including personal loans and student loans. We offer our installment loan products to existing cardmembers as well as to new...

  • Page 12
    ... of Operations - Liquidity and Capital Resources - Funding Sources - Deposits." Third-Party Payments Our payments business includes the PULSE Network, Diners Club International, and our third-party issuing business, which includes credit, debit and prepaid cards issued on the Discover Network by...

  • Page 13
    ...litigation, we signed agreements related to issuing credit, debit and prepaid cards with GE Money (to issue Wal-Mart and SAM'S CLUB Discover Network cards), HSBC and a number of other financial institutions for issuance of card products on the Discover Network. We earn merchant discount and acquirer...

  • Page 14
    ... dedicated service. The Discover Motiva Card, launched in March 2007, provides cardmembers with a full month's interest as a reward each time they make six consecutive on-time payments. In 2007, we launched personal loan and student loan products. In 2008, we added a new section to our website where...

  • Page 15
    ... a statement credit, direct deposit, partner gift card or charitable donation. Cardmembers have the opportunity to increase their reward, up to double the reward amount when they redeem for a brand name gift card from over 100 merchant partners. Fee Products We market several fee-based products to...

  • Page 16
    ... models and data integrity checks to manage fraud and credit risks. Strategies are subject to regular review and enhancement to enable us to respond quickly to changing credit conditions as well as to protect our cardmembers and the business from emerging fraud activity. Proactive Account Management...

  • Page 17
    ... to service and operate cardmember credit accounts, including new account solicitation, application processing, new account fulfillment, transaction authorization and processing, cardmember billing, payment processing, cardmember service and collection of delinquent accounts. We also work closely...

  • Page 18
    ... time. Variable rates are indexed to the highest prime rate published in The Wall Street Journal on the last business day of the month. Additional Consumer Card Terms. Each cardmember with an outstanding debit balance in his or her consumer Discover Card account must generally make a minimum payment...

  • Page 19
    ... due date, overlimit fees for balances that exceed a cardmember's credit limit as of the close of the cardmember's monthly billing cycle, balance transfer fees, returned payment fees, pay-by-phone fees, and fees for each time we decline to honor a balance transfer check, cash advance check, or...

  • Page 20
    ...." In our third-party payments business, we compete with other networks for volume and to attract third-party issuers to issue credit, debit and prepaid cards on the Discover and PULSE Networks. Diners Club and Discover Network's primary competitors are Visa, MasterCard and American Express, and...

  • Page 21
    ...Our business, financial condition and results of operations could be adversely affected by new regulations to which we are or will become subject as a result of becoming a bank holding company." Permissible activities for a bank holding company include those activities that are so closely related to...

  • Page 22
    ... Reserve as a bank holding company, as long as the activities of Bank of New Castle are limited to credit card operations. Discover currently expects to register as a bank holding company in connection with participating in the United States Treasury's Capital Purchase Program. Regardless of whether...

  • Page 23
    ... that accepts brokered deposits under a waiver from the FDIC may not pay an interest rate on any deposit in excess of 75 basis points over certain prevailing market rates. There are no such restrictions on a bank that is well-capitalized. As of November 30, 2008, Discover Bank and Bank of New Castle...

  • Page 24
    ... implementing some of the changes required by the rules prior to the effective date. The credit card practices addressed by the rules include, but are not limited to, restrictions on the application of rate increases to existing and new balances, payment allocation, default pricing and two-cycle...

  • Page 25
    ... regulation in countries in which our networks operate or our cards are used, either directly or indirectly through regulation affecting Diners Club network licensees. Changes in existing federal, state or international regulation could increase the cost or risk of providing network services, change...

  • Page 26
    ... as Executive Vice President, Card Programs and Chief Marketing Officer since December 2008. Prior thereto, he had been Executive Vice President, Discover Network since December 2003. From 2000 to 2003, Mr. Talwar was Managing Director for Discover's international business. Mr. Talwar held a number...

  • Page 27
    ... funding and the trading price of our common stock. The continued economic downturn, recent financial market events and other conditions beyond our control have adversely affected unemployment rates, consumer spending, consumer indebtedness, availability of consumer credit, asset values, investments...

  • Page 28
    ... examination by the Federal Reserve, including scrutiny of our risk management program; business strategy, earnings, capital and cash flow; anti-money laundering program; and examination of our non-bank subsidiaries, including Discover Network, PULSE and Diners Club, and their relationships with 20

  • Page 29
    ... our financial condition, cash flows and results of operations. The credit card issuing business is highly competitive. We compete with other credit card issuers on the basis of a number of factors, including: merchant acceptance, products and services, incentives and reward programs, brand, network...

  • Page 30
    ... issuers to issue credit and debit cards and other card products on the Discover, PULSE and Diners Club networks. Competition with other operators of payment networks is generally based on issuer interchange fees, switch fees, fees paid to networks, merchant acceptance, network functionality and...

  • Page 31
    ... our business, profitability and financial condition. Our success depends on our ability to manage our credit risk while attracting new cardmembers with profitable usage patterns. We select our cardmembers, manage their accounts and establish terms and credit limits using proprietary scoring models...

  • Page 32
    ... their cards at merchant and ATM locations that accept Diners Club cards around the world and to allow Diners Club cardholders to use their cards on the Discover Network in North America and to access cash through the PULSE Network. The success of our acquisition of Diners Club in the immediate term...

  • Page 33
    ... on capital levels of our bank subsidiaries. The FDIA prohibits a bank, including our subsidiaries Discover Bank and Bank of New Castle, from accepting brokered deposits or offering interest rates on any deposits significantly higher than the prevailing rate in its normal market area or nationally...

  • Page 34
    ... issued by the trust. A downgrade in the credit ratings of our securities could materially adversely affect our business and financial condition. While we, along with Discover Bank, have continued to maintain investment grade credit ratings from the major rating agencies, Moody's recently changed...

  • Page 35
    ... may also change because of changes in the assumptions used to estimate their fair value, such as market interest rates and other conditions, increases in bankruptcy or charge-off rates, changes in payment rates and changes in the interpretation and application of accounting rules relating to such...

  • Page 36
    ...the number of, or rates paid by, large merchants that accept cards on the Discover Network or PULSE Network could materially adversely affect our business, financial condition, results of operations and cash flows. Discover Card transaction volume was concentrated among our top 100 merchants in 2008...

  • Page 37
    ...success of both our card issuing and payment processing businesses. Merchants are concerned with the fees charged by credit card companies. They seek to negotiate better pricing or other financial incentives as a condition to continued participation in the Discover Network. During the past few years...

  • Page 38
    ... may impose additional restrictions on issuing banks, merchants or merchant acquirers that materially adversely affect our networks, or the Discover Card issuing business. Visa and MasterCard aggressively seek to protect their networks from competition and have used their rules and policies to...

  • Page 39
    ...financial condition, cash flows and results of operations. As an issuer and merchant acquirer in the United States on the Discover Network, and as a holder of certain merchant agreements internationally for the Diners Club network, we may be contingently liable for certain disputed credit card sales...

  • Page 40
    ... SEC and New York Stock Exchange ("NYSE") in our capacity as a public company. In addition, as our payments business has expanded globally through the acquisition of Diners Club, we are subject to government regulation in countries in which our networks operate or our cards are used, either directly...

  • Page 41
    ...in which our cards are used. Current and proposed regulation addressing consumer privacy and data use and security could inhibit the number of payment cards issued and increase our costs. Regulatory pronouncements relating to consumer privacy, data use and security affect our business. In the United...

  • Page 42
    ... are considering similar legislation. Regulation of privacy, data use and security may cause an increase in the costs to issue payment cards and/ or may decrease the number of our cards that we or third parties issue. New regulations in these areas may also increase our costs to comply with such...

  • Page 43
    ... in a 50% or greater change, by vote or by value, in our stock ownership during the four-year period beginning on the date that begins two years before the distribution date, unless it is established that the transaction is not pursuant to a plan or series of transactions related to the distribution...

  • Page 44
    ... of shares of preferred stock and warrants to the U.S. Treasury under the Capital Purchase Program; access to U.S. debt and deposit markets; losses in our investment portfolio; the ability to increase or sustain Discover Card usage or attract new cardmembers and introduce new products or services...

  • Page 45
    ... PULSE headquarters is used by our Third-Party Payments segment and our corporate headquarters is used by both our U.S Card and ThirdParty Payments segments. All of our call centers and processing centers are operating at and being utilized to a reasonable capacity. We believe our current principal...

  • Page 46
    ...fiscal quarters in 2009, Visa agreed to pay us an amount equal to 5% of each quarter's total combined transaction sales volume for Company payment cards, including payment cards issued by the Company and payment cards issued by third parties on the Discover, PULSE and Diners Club networks, up to the...

  • Page 47
    ...several interrogatories and document requests, which focus on certain payment card network rules relating to merchant acceptance practices, including those that apply to merchants' ability to steer customers to payment forms preferred by merchants. A CID is a request for information in the course of...

  • Page 48
    ... Shares Purchased as Part of Publicly Announced Plans or Programs(1) Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs Period Total Number of Shares Purchased(2) Average Price Paid per Share September 1 - 30, 2008 Repurchase program(1) ...Employee transactions...

  • Page 49
    ... stockholder return (rounded to the nearest whole dollar) of our common stock, the S&P 500 Stock Index and the S&P 500 Financials Index for the period from July 2, 2007 through November 30, 2008. The graph assumes an initial investment of $100 on July 2, 2007, the date we began "regular way" trading...

  • Page 50
    ...year period ended November 30, 2008 and the statement of financial condition data as of November 30, 2008 and 2007 have been derived from our audited consolidated and combined financial statements included elsewhere in this annual report on Form 10-K. The statement of income data for the years ended...

  • Page 51
    ...(2) ...Net income ...Statement of Financial Condition Data (as of): Loan receivables ...Total assets ...Total stockholders' equity ...Allowance for loan losses ...Long-term borrowings ...Total average interest-earning assets ...Total average interest-bearing liabilities ...Per Share of Common Stock...

  • Page 52
    ...Credit card loan receivables-managed ...Average credit card loan receivables-managed ...Managed interest yield ...Managed net principal charge-off rate ...Managed delinquency rate (over 30 days) ...Managed delinquency rate (over 90 days) ... For the Years Ended November 30, 2007 2006 2005 (dollars...

  • Page 53
    ... incurred to grow, manage and service our loan receivables. Our business activities are funded primarily through the process of asset securitization, the raising of consumer deposits, and both secured and unsecured debt. In a credit card securitization, loan receivables are first transferred to the...

  • Page 54
    ... Payments segment in comparison to 2007. Transaction volume in this segment increased 36% over the prior year to $125.1 billion, including a $12.7 billion volume contribution from Diners Club. We sold our U.K. credit card business ("Goldfish") to Barclays Bank PLC on March 31, 2008. This business...

  • Page 55
    ... execution levels in the capital markets is expected to continue, we anticipate that all of the 2009 maturities will be funded with deposits, as was done in the fourth quarter of 2008. This shift will result in higher levels of owned loan receivables with related increases in the allowance for loan...

  • Page 56
    ...use their cards at merchant and ATM locations that accept Diners Club cards around the world, and Diners Club cardholders to use their cards on the Discover Network in North America. We also expect to achieve interoperability between the Diners Club network and the PULSE Network to allow Diners Club...

  • Page 57
    ... operations could be adversely affected by new regulations to which we are and will become subject as a result of becoming a bank holding company." Accounting Treatment for Off-Balance Sheet Securitizations The Financial Accounting Standards Board ("FASB") has issued proposed amendments to Statement...

  • Page 58
    ..., student loans, prepaid cards and other consumer lending and deposit products offered through our Discover Bank subsidiary. Third-Party Payments. The Third-Party Payments segment includes the PULSE Network ("PULSE"), an automated teller machine, debit and electronic funds transfer network; Diners...

  • Page 59
    ... Managed Basis Third-Party U.S. Card Payments(1) GAAP Basis Total Securitization Adjustment(2) Total For the Years Ended November 30, 2008 Interest income ...Interest expense ...Net interest income ...Provision for loan losses ...Other income(3) ...Other expense ...Income from continuing operations...

  • Page 60
    ... the Years Ended November 30, 2007 2006 2008 Volume PULSE Network ...Third-Party Issuers ...Diners Club International(1) ...Total Third-Party Payments ...Discover Network - Proprietary ...Total Volume ...Credit Card Volume ...Credit Card Sales Volume ...Transactions Processed on Networks Discover...

  • Page 61
    .... This increase in loans is attributable to lower cardmember payments, growth in our installment loans during the year and a slight increase in credit card volume, up 2% in 2008, largely due to higher gasoline prices. This increase was partially offset by lower balance transfer activity in 2008. The...

  • Page 62
    ...the loan receivables and related statistics that are impacted by asset securitization, and which are shown on a managed basis in this annual report on Form 10-K, to the most directly comparable GAAP-basis financial measure: Reconciliation of GAAP to Managed Data For the Years Ended November 30, 2008...

  • Page 63
    For the Years Ended November 30, 2008 2007 2006 (dollars in thousands) Delinquency Rate (over 30 days) GAAP Basis ...Securitization Adjustment ...Managed Basis ...Delinquency Rate (over 90 days) GAAP Basis ...Securitization Adjustment ...Managed Basis ...Credit Card Loans Credit Card Loans GAAP ...

  • Page 64
    ... fee revenues less certain costs, including loan losses on securitized loans and the contractual rate of interest paid to third-party investors in the securitization as well as a servicing fee from the trust over the life of the asset sold. In the absence of observable market prices, the fair value...

  • Page 65
    ... Note 4: Investment Securities, Note 6: Credit Card Securitization Activities and Note 23: Fair Value Disclosures to the consolidated and combined financial statements for further discussion about the accounting for our certificated retained interests in DCENT. Cardmember Rewards Cost We offer our...

  • Page 66
    ... combined statement of income for the periods presented (dollars in thousands): For the Years Ended November 30, 2008 2007 2006 2008 vs. 2007 increase (decrease) $ % 2007 vs. 2006 increase (decrease) $ % Interest income ...Interest expense ...Net interest income ...Provision for loan losses ...Net...

  • Page 67
    ... During the year ended November 30, 2008, our net interest income improved largely because the lower cost of funds more than offset the increased levels of borrowings to support higher average interest-earning assets, including a higher average liquidity reserve which generally earns a lower rate of...

  • Page 68
    ... of deposit issued at lower, historical rates. Interest income increased due to a higher level of Federal Funds sold, which was significantly greater in comparison to the prior year as a result of the establishment of our liquidity reserve, as well as growth in average credit card loan receivables...

  • Page 69
    ... reported above. (2) Interest income on credit card loans includes $70.1 million of amortization of balance transfer fees for the year ended November 30 2008. (3) Includes the impact of interest rate swap agreements used to change a portion of fixed-rate funding to floating-rate funding. (4) Net...

  • Page 70
    ...Analysis(1) 2008 vs. 2007 Rate 2007 vs. 2006 Rate Total Volume Increase/(decrease) in net interest income due to changes in: Interest-earning assets: Interest-earning deposits in other banks ...Federal Funds sold ...Commercial paper ...Investment securities ...Loan receivables: Credit card ...Other...

  • Page 71
    ... contractual time frame. The net charge-off rate is calculated by dividing net charge-offs for the period by the average loan receivables for the period. The following table presents amounts and rates of net charge-offs of loan receivables (dollars in thousands): 2008 $ % $ 2007 For the Years Ended...

  • Page 72
    ...any point in time. Loan balances are considered delinquent when contractual payments on the loan become 30 days past due. Loan receivables are placed on non-accrual status upon receipt of notification of the bankruptcy or death of a cardmember, as part of certain collection management processes, and...

  • Page 73
    ...the percentage of income per transaction and, over time, operating expenses as we no longer incur costs to acquire and service small and mid-sized merchants. The lower cost per transaction is generally expected to be offset by increased volume due to broader acceptance. Gains on the sale of merchant...

  • Page 74
    ... to new securitization transactions. These cash flows are used to pay investors in the transactions a contractual fixed or floating rate of return on their investment, to reimburse investors for losses of principal resulting from charged-off loans, net of recoveries, and to pay us a contractual fee...

  • Page 75
    ... spread (dollars in thousands): 2008 vs. 2007 increase (decrease) $ % 2007 vs. 2006 increase (decrease) $ % For the Years Ended November 30, 2008 2007 2006 Interest income on securitized loans ...Interest paid to investors in asset-backed securities ...Net interest income ...Other fee revenue on...

  • Page 76
    ... paid to third-party issuers in the United States. We earn discount revenue from fees charged to merchants with whom we have entered into card acceptance agreements for processing cardholder purchase transactions and acquirer interchange revenue from merchant acquirers on all Discover Network card...

  • Page 77
    ...-party merchant acquirers, this revenue will decrease along with associated costs. Transaction Processing Revenue Transaction processing revenue represents switch fees charged to financial institutions and merchants for processing ATM, debit and point-of-sale transactions over the PULSE Network, as...

  • Page 78
    ... presented (dollars in thousands): For the Years Ended November 30, 2007 2008 vs. 2007 increase (decrease) $ % 2007 vs. 2006 increase (decrease) $ % 2008 2006 Employee compensation and benefits ...Marketing and business development ...Information processing and communications ...Professional fees...

  • Page 79
    ...designed to optimize our credit ratings and provide that our bank capitalization levels are sufficient to allow for cost-effective access to debt and deposit markets, thus providing sufficient liquidity to fund our business over both the short and long term. Our liquidity and funding risk management...

  • Page 80
    ... senior unsecured rating from Moody's Investors Service and a BBB long-term rating from Fitch Ratings. Moody's Investors Service recently changed its outlook for the credit ratings of Discover Financial Services and Discover Bank from "Stable" to "Negative". A security rating is not a recommendation...

  • Page 81
    ... the level of capital necessary to support our business based on our managed loan receivables, goodwill and other intangible assets, taking into account, among other things, regulatory requirements, rating agency guidelines and internally managed requirements to sustain growth. Equity increased to...

  • Page 82
    ... DCENT. Our available-for-sale investment securities also include $85.8 million of investments made in highly rated third-party credit card asset-backed securities. As of November 30, 2008, the weighted average life of all of our available-for-sale investment securities was approximately 2 years. 74

  • Page 83
    ...-sale investment securities for accounting purposes. In the future, we may purchase additional subordinated notes to maintain our triple-A rated note issuance capacity. As of November 30, 2008, cash collateral accounts providing credit enhancement for the securitization transactions of Discover Card...

  • Page 84
    ..., which place deposits with their customers; and, increasingly, (2) products offered directly to consumers through direct mail, internet origination and affinity relationships, including certificates of deposit and money market accounts. We currently utilize six of the largest securities brokerage...

  • Page 85
    ... of 84 days. This allowed Discover Bank to obtain funding at a lower interest rate than alternatives existing at that time. The following table identifies the balances and weighted average interest rates on short-term borrowings outstanding at and for the years ended (dollars in thousands): November...

  • Page 86
    ... Financial Services may borrow up to 30% and Discover Bank may borrow up to 100% of the total commitment). We anticipate that the facility will support general liquidity needs and may be drawn to meet short-term funding needs from time to time. At November 30, 2008, we had no outstanding balances...

  • Page 87
    ... 2008 include deposits, long-term borrowings, operating and capital lease obligations and purchase obligations. Our future cash payments associated with our contractual obligations as of November 30, 2008 are summarized below (dollars in thousands): Payments Due By Period One Year Four Years Through...

  • Page 88
    ... deposits and certain investment securities. Portions of our credit card loan receivables have fixed interest rates, although we currently have the right, with notice to cardmembers, to subsequently reprice these receivables to a new interest rate unless the account has been closed or the cardmember...

  • Page 89
    ... the Public Company Accounting Oversight Board (United States), the consolidated statement of financial condition, and related consolidated statements of income, changes in stockholders' equity, and cash flows as of and for the year ended November 30, 2008 of the Company and our report dated January...

  • Page 90
    ... of financial condition of Discover Financial Services (the "Company") as of November 30, 2008 and 2007, and the related consolidated and combined statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended November 30, 2008. These financial...

  • Page 91
    ... Statements of Financial Condition November 30, November 30, 2007 2008 (dollars in thousands, except per share amounts) Assets Cash and due from banks ...Federal Funds sold ...Interest-earning deposits ...Commercial paper ...Cash and cash equivalents ...Investment securities: Available-for-sale...

  • Page 92
    Discover Financial Services Consolidated and Combined Statements of Income For the Years Ended November 30, 2008 2007 2006 (dollars in thousands, except per share amounts) Interest income: Credit card loans ...Other loans ...Federal Funds sold ...Commercial paper ...Investment securities ......

  • Page 93
    ... business ...Net unrealized losses on investment securities, net of tax ...- Amortization of losses related to pension and postretirement benefits, net of tax ...Other comprehensive loss ...Total comprehensive income ...Purchases of treasury stock ...Common stock issued under employee benefit plans...

  • Page 94
    ... for investing activities ...Cash flows from financing activities Net (decrease) increase in short-term borrowings ...Proceeds from issuance of long-term debt and bank notes ...Repayment of long-term debt and bank notes ...Purchases of treasury stock ...Net increase (decrease) in deposits ...Capital...

  • Page 95
    ... and Diners Club International ("Diners Club"). Discover Bank is a Delaware state-chartered bank that offers its customers a variety of credit card, other consumer loan and deposit products. PULSE operates an electronic funds transfer network, providing financial institutions issuing debit cards on...

  • Page 96
    ...the Company as cash on hand and on deposit with banks, including time deposits and other highly liquid investments with maturities of 90 days or less when purchased. Investment Securities. Investment securities consist of certificated retained beneficial interests in the Discover Card Execution Note...

  • Page 97
    ... market given current market conditions, scheduled maturities of outstanding asset-backed securities, management's targeted mix of funding sources used, and the relative availability of the Company's other funding sources. The amount of credit card receivables classified as held for sale...

  • Page 98
    ... balance of an account is contractually past due if the minimum payment is not received by the specified date on the cardmember's billing statement. Delinquency is reported on loans that are 30 or more days past due. Credit card loans are charged off at the end of the month during which an account...

  • Page 99
    ... were originated for investment are included in cash flows from investing activities. Cash flows related to credit card receivables transferred to the trust during the term of a securitization in order to maintain a constant level of investor interest in receivables are classified as operating cash...

  • Page 100
    ... of businesses when the purchase price exceeds the fair value of the net tangible and separately identifiable intangible assets acquired. The Company's goodwill is not amortized, but rather is subject to an impairment test at the reporting unit level each year, or more often if conditions indicate...

  • Page 101
    ... earnings as the fees are assessed. Annual fees, balance transfer fees and certain product fees are recognized in revenue ratably over the periods to which they relate. Loan fee income consists of fees on credit card loans and includes annual, late, overlimit, returned check, cash advance and other...

  • Page 102
    ... all Discover Network card transactions made by cardholders at merchants with whom merchant acquirers have entered into card acceptance agreements for processing cardholder purchase transactions. Issuer interchange is a fee paid to the card issuing entity as compensation for risk and other operating...

  • Page 103
    ... to the sale of the Company's Goldfish business, the financial statements of the Company's consolidated and combined foreign subsidiaries were translated into U.S. dollars in accordance with GAAP. Assets and liabilities were translated using the exchange rate in effect at each year-end; income and...

  • Page 104
    ... the Fair Value of a Financial Asset When the Market for That Asset Is Not Active ("FSP FAS 157-3"). This FSP clarifies the application of Statement No. 157 in an inactive market. The FASB also issued a joint press release with the Office of the Chief Accountant of the SEC on September 30, 2008 that...

  • Page 105
    ... date of the Company's fiscal year-end statement of financial position will be effective for the Company's fiscal year ending November 30, 2009. The change in measurement date is not expected to have a material impact on the Company's consolidated financial condition, results of operations or cash...

  • Page 106
    ... the International Card segment, to Barclays Bank PLC. The aggregate sale price under the agreement was £35 million (equivalent to approximately $70 million), which was paid in cash at closing. Assets and liabilities of discontinued operations related to the sale of the Company's Goldfish business...

  • Page 107
    ...-sale and held-to-maturity investment securities are as follows (dollars in thousands): Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value At November 30, 2008 Available-for-Sale Investment Securities(1) Certificated retained interests in DCENT ...$1,065,000 Credit card asset...

  • Page 108
    ... its seller's interest, a component of loan receivables. For more information on the fair value calculations of these investment securities, see Note 23: Fair Value Disclosures. During the years ended November 30, 2008 and 2007, the Company recorded $79.1 million and $4.1 million, respectively...

  • Page 109
    ... 30, 2008 and 2007 (dollars in thousands): Less than 12 months Fair Unrealized Value Losses More than 12 months Fair Unrealized Value Losses At November 30, 2008 Available-for-Sale Investment Securities Certificated retained interests in DCENT ...$705,549 Credit card asset-backed securities of...

  • Page 110
    ... government agency obligations ...State and political subdivisions of states ...Mortgage-backed securities ...Other debt securities ...Total held-to-maturity investment securities ...Available-for-sale-Fair Values(1) Certificated retained interests in DCENT ...Credit card asset-backed securities of...

  • Page 111
    ... 30, 2008 November 30, 2007 Credit card loans: Discover Card(1) ...Discover Business Card ...Total credit card loans ...Other consumer loans: Personal loans ...Student loans ...Other ...Total other consumer loans ...Total loan receivables ...Allowance for loan losses ...Net loan receivables...

  • Page 112
    ...sale. Loans held for sale include the amount of credit card receivables necessary to support net new securitization transactions expected to take place in the next three months. Although there was no balance at November 30, 2008 and 2007, there were loans classified as held for sale at various times...

  • Page 113
    ... financial statements in accordance with GAAP. The Company's securitization activities generally qualify as sales under GAAP and accordingly are not treated as secured financing transactions. As such, credit card loan receivables equal to the amount of the investor interests in transferred loan...

  • Page 114
    ... of future servicing fees. The following table summarizes the Company's retained interests in credit card securitizations (dollars in thousands): November 30, 2008 2007 Available-for-sale investment securities ...Loan receivables (seller's interest)(1) ...Amounts due from asset securitization: Cash...

  • Page 115
    ... transactions, net of issuance discounts, as applicable. The following table summarizes certain cash flows information related to the securitized pool of loan receivables (dollars in millions): For the Years Ended November 30, 2008 2007 2006 Proceeds from third-party investors in new credit card...

  • Page 116
    ...managed credit card loans, including securitized loans (dollars in millions): November 30, 2008 Loans Outstanding Loans Delinquent For the Year Ended November 30, 2008 Net Average Principal Loans Charge-offs Managed credit card loans ...Less: Securitized credit card loans ...Owned credit card loans...

  • Page 117
    ... acceptance network consisting of merchant and cash access locations in 185 countries. Discover is not issuing cards or extending consumer credit in international markets as a result of the transaction. Diners Club is included in the Company's Third-Party Payments segment. Since the acquisition date...

  • Page 118
    ... summarizes the fair values of the assets acquired and liabilities assumed at the date of the Diners Club acquisition (dollars in thousands): At June 30, 2008 Trade name intangibles ...International transaction processing rights ...Total intangible assets ...Other assets ...Total assets acquired...

  • Page 119
    ... next five years based on intangible assets at November 30, 2008 (dollars in thousands): Year Amount 2009 2010 2011 2012 2013 10. Deposits ... $7,683 $6,662 $6,576 $5,742 $4,770 The Company's deposits consist of brokered and direct certificates of deposits, money market deposit accounts, and, to...

  • Page 120
    ... Federal Funds purchased and other short-term borrowings with original maturities less than one year. The following table identifies the balances and weighted average interest rates on short-term borrowings outstanding at period end (dollars in thousands): November 30, 2008 Weighted Average Interest...

  • Page 121
    ...summary of the Company's long-term borrowings and weighted average interest rates on balances outstanding at period end (dollars in thousands): November 30, 2008 Interest Outstanding Rate November 30, 2007 Interest Outstanding Rate Interest Rate Terms Funding source Maturity Bank notes ...Secured...

  • Page 122
    ... under the Omnibus Plan may be authorized but unissued shares or treasury shares that the Company acquires in the open market, in private transactions or otherwise. Option awards are generally granted with an exercise price equal to the fair market value of one Discover share at the date of grant...

  • Page 123
    ... cost, net of forfeitures, related to each of the above plans, as well as those costs (in thousands) allocated by Morgan Stanley prior to the Distribution: For the Years Ended November 30, 2008 2007 2006 (1) Restricted stock units ...Stock options ...Employee stock purchase plan ...Total stock...

  • Page 124
    ...-average period of 0.32 years. The Company utilizes the Black-Scholes pricing model to estimate the fair value of each option as of its date of grant. The fair value is amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. Use...

  • Page 125
    ... 30, 2008, there was $52.9 million of total unrecognized compensation cost related to non-vested RSUs. The cost is expected to be recognized over a total period of 3.9 years and a weighted-average period of 1.2 years. 14. Employee Benefit Plans The Company sponsors the Discover Financial Services...

  • Page 126
    ...dollars in thousands): Pension For the Years Ended November 30, 2008 2007 2006 Postretirement For the Years Ended November 30, 2008 2007 2006 Service cost, benefits earned during the period ...Interest cost on projected benefit obligation ...Expected return on plan assets ...Net amortization ...Net...

  • Page 127
    ...service credit (cost) ...Net (loss) gain ...Total ... $ 27 (17) $ 10 $ 3 147 $150 Benefit Obligations and Funded Status. The following table provides a reconciliation of the changes in the benefit obligation and fair value of plan assets as well as a summary of the Company's funded status (dollars...

  • Page 128
    ... were used. The expected long-term return on plan assets is a long-term assumption that generally is expected to remain the same from one year to the next but is adjusted when there is a significant change in the target asset allocation, the fees and expenses paid by the plan or market conditions...

  • Page 129
    ...asset allocation targets for the Qualified Plan based on its assessment of business and financial conditions, demographic and actuarial data, funding characteristics and related risk factors. Other relevant factors, including industry practices and long-term historical and prospective capital market...

  • Page 130
    ... with the plan's risk and return objectives. In addition, any investment in derivatives must meet the following conditions: • Derivatives may be used only if the vehicle is deemed by the investment manager to be more attractive than a similar direct investment in the underlying cash market; or if...

  • Page 131
    ... the fair value and amortized cost of available-for-sale investment securities. Represents translation gains and losses relating to the Company's Goldfish business resulting from the change in exchange rates, primarily of the British pound, and the related tax effects. Represents additional minimum...

  • Page 132
    ... of which are shown in the table below: For the Years Ended November 30, 2007 2006 Employee compensation and benefits ...Marketing and business development ...Information processing and communications ...Professional fees ...Premises and equipment ...Other ...Total Morgan Stanley allocations ...124...

  • Page 133
    ... tax expense consisted of the following (dollars in thousands): For the Years Ended November 30, 2008 2007 2006 Current: U.S. federal ...U.S. state and local(1) ...International ...Total ...Deferred: U.S. federal ...U.S. state and local ...International ...Total ...Income tax expense ... $ 820,180...

  • Page 134
    ... other assets in the consolidated statements of financial condition, were as follows (dollars in thousands): November 30, 2008 2007 Deferred tax assets: Allowance for loan losses ...Compensation and benefits ...Goodwill ...State income taxes ...Unrealized gains/losses ...Cardmember fees and rewards...

  • Page 135
    ... months. Based on current progress with the federal audit, it is not possible to quantify the impact such changes may have on the effective tax rate. 19. Earnings Per Share Basic earnings per share ("EPS") is computed by dividing income available to common stockholders by the weighted average number...

  • Page 136
    ...) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes that, as of November 30, 2008, both Discover Bank and Bank of New Castle met all capital adequacy requirements to...

  • Page 137
    .... Under the current banking regulations, a bank may not pay dividends if such a payment would leave the bank inadequately capitalized. In the years ended November 30, 2008, 2007 and 2006, Discover Bank paid dividends from retained earnings to its parent, Discover Financial Services, of $95...

  • Page 138
    ...within 12 months of the transaction closing date, March 31, 2008. At November 30, 2008, there were no material amounts recorded in the Company's consolidated financial statements related to indemnification obligations under the agreement for the sale of the Goldfish business, and management believes...

  • Page 139
    ..., and management believes that the probability of any payments under these arrangements is low. Merchant Chargeback Guarantees. The Company issues credit cards and owns and operates the Discover Network in the United States. The Company is contingently liable for certain transactions processed on...

  • Page 140
    ... (1) Represents period transactions processed on Discover Network to which a potential liability exists which, in aggregate, can differ from credit card sales volume. The amount of the liability related to the Company's cardmember merchant guarantee was not material at November 30, 2008 and 2007...

  • Page 141
    ... fiscal quarters in 2009, Visa agreed to pay the Company an amount equal to 5% of each quarter's total combined transaction sales volume for Company payment cards, including those issued by the Company and those issued by third parties on the Discover, PULSE and Diners Club networks, up to a maximum...

  • Page 142
    ... investment securities. The estimated fair values of investment securities classified as held-to-maturity are based on quoted market prices utilizing public information for the same or comparable transactions or information estimated through market pricing data. Net loan receivables. The Company...

  • Page 143
    ... years ended November 30, 2008, 2007 and 2006, certain of the Company's outstanding derivative financial instruments were designated to hedge interest-bearing deposits and qualified as fair value hedges under the long haul method in accordance with Statement No. 133. Accordingly, changes in the fair...

  • Page 144
    ... Level 3 of the fair value hierarchy. During the year ended November 30, 2008, the Company transferred certain available-for-sale investment securities into the Level 3 classification from Level 2. The largest portion of the assets transferred relate to the Company's retained certificated interests...

  • Page 145
    ...personal loans, student loans, prepaid cards and other consumer lending and deposit products offered through the Company's Discover Bank subsidiary. Third-Party Payments. The Third-Party Payments segment includes PULSE, an automated teller machine, debit and electronic funds transfer network; Diners...

  • Page 146
    ...the Company's owned loans in the managed basis statements of financial condition and reporting the earnings on securitized loans in the same manner as the owned loans instead of as securitized income. The managed basis presentation generally reverses the effects of securitization transactions. Other...

  • Page 147
    ... Related Party Transactions In the ordinary course of business, the Company offers consumer loan products to its directors, executive officers and certain members of their families. These products are offered on substantially the same terms as those prevailing at the time for comparable transactions...

  • Page 148
    ... securities to include separate annual financial statements. Discover Financial Services (Parent Company Only) Condensed Statements of Financial Condition November 30, 2008 2007 (dollars in thousands) Assets Cash and due from banks ...Federal Funds sold ...Interest-earning deposits ...Interest...

  • Page 149
    Discover Financial Services (Parent Company Only) Condensed Statements of Income For the Years Ended November 30, 2008 2007 2006 (dollars in thousands) Interest income ...Interest expense ...Net interest income ...Dividends from subsidiaries ...Management fees from subsidiaries ...Antitrust ...

  • Page 150
    ... long-term debt and bank notes ...Maturity of long-term borrowings ...Purchases of treasury stock ...Net (decrease) increase in deposits ...Capital contributions from Morgan Stanley ...Dividends paid to Morgan Stanley ...Dividends paid ...Net cash used for financing activities ...Increase (decrease...

  • Page 151
    ... Capital Purchase Program (the "Program"), subject to standard closing conditions. The Company expects to issue and sell to the U.S. Treasury shares of preferred stock and warrants to purchase shares of common stock of the Company in accordance with the terms of the Program for an aggregate purchase...

  • Page 152
    ... registered public accounting firm, and the firm's report on this matter is included in Item 8 of this Report. Changes in Internal Control over Financial Reporting In preparation for management's report on internal control over financial reporting, we documented and tested the design and operating...

  • Page 153
    ... Analysis" "Compensation Committee Report" "2008 Executive Compensation" Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. Information relating to compensation plans under which Discover Financial Services equity securities are authorized for issuance...

  • Page 154
    ... Reports of Independent Registered Public Accounting Firm ...Consolidated Statements of Financial Condition as of November 30, 2008 and 2007 ...Consolidated and Combined Statements of Income for the years ended November 30, 2008, 2007 and 2006 ...Consolidated and Combined Statements of Changes...

  • Page 155
    ... of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on January 28, 2009. Discover Financial Services Registrant By: /S/ DAVID W. NELMS David W. Nelms Chairman and Chief Executive Officer Power...

  • Page 156
    [THIS PAGE INTENTIONALLY LEFT BLANK]

  • Page 157
    ... the Sale and Purchase of the Goldfish Credit Card Business, dated February 7, 2008, among Discover Financial Services, Goldfish Bank Limited, Discover Bank, SCFC Receivables Corporation, and Barclays Bank Plc (filed as Exhibit 2.1 to Discover Financial Services' Current Report on Form 8-K filed on...

  • Page 158
    ... Employee Stock Purchase Plan effective as of May 1, 2008. Credit Agreement, dated as of June 6, 2007, among Discover Financial Services, Discover Bank, the subsidiary borrowers from time to time party thereto, the lenders party thereto and JPMorgan Chase Bank, N.A., as Administrative Agent (filed...

  • Page 159
    ..., between Discover Card Execution Note Trust, as Issuer, and U.S. Bank National Association, as Indenture Trustee (filed as Exhibit 4.6 to Discover Bank's Current Report on Form 8-K filed on July 27, 2007 and incorporated herein by reference thereto). Discover Financial Services Change-in-Control...

  • Page 160
    [THIS PAGE INTENTIONALLY LEFT BLANK]

  • Page 161
    ... of Incorporation or Formation Bank of New Castle ...Diners Club International Ltd...Discover Bank ...Discover Card Limited ...Discover Community Development Corporation ...Discover Financial Services (Canada), Inc...Discover Financial Services (Cayman) Limited ...Discover Financial Services (Hong...

  • Page 162
    ... Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on December 1, 2007), and the effectiveness of internal control over financial reporting, appearing in this Annual Report on Form 10-K of Discover Financial Services for the year ended November 30, 2008...

  • Page 163
    ...'s board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process...

  • Page 164
    ...'s board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process...

  • Page 165
    ...of Discover Financial Services (the "Company") on Form 10-K for the period ended November 30, 2008, as filed with the Securities and Exchange Commission (the "Report"), each of David W. Nelms, Chairman and Chief Executive Officer of the Company, and Roy A. Guthrie, Executive Vice President and Chief...

  • Page 166
    [THIS PAGE INTENTIONALLY LEFT BLANK]

  • Page 167
    ... Executive Vice President Payment Services James V. Panzarino Senior Vice President Chief Credit Risk Officer Harit Talwar Executive Vice President Card Programs and Chief Marketing Officer Primary Investor Contact Investor Relations Phone: 1-224-405-4555 [email protected] Transfer...

  • Page 168
    2500 Lake Cook Road Riverwoods, IL 60015 www.discoverfinancial.com ©2009 Discover Financial Services Cert no. SCS-COC-00648