Document/ExhibitDescriptionPagesSize 1: 10-Q Quarterly Report HTML 3.87M
2: EX-3.1 Articles of Incorporation/Organization or Bylaws HTML 248K
3: EX-31.1 Certification -- §302 - SOA'02 HTML 34K
4: EX-31.2 Certification -- §302 - SOA'02 HTML 34K
5: EX-32.1 Certification -- §906 - SOA'02 HTML 32K
11: R1 Document and Entity Information HTML 82K
12: R2 Condensed Consolidated Statements of Financial HTML 127K
Condition
13: R3 Condensed Consolidated Statements of Financial HTML 55K
Condition (Parenthetical)
14: R4 Condensed Consolidated Statements of Income HTML 134K
15: R5 Condensed Consolidated Statements of Comprehensive HTML 56K
Income
16: R6 Condensed Consolidated Statements of Changes in HTML 123K
Stockholders' Equity
17: R7 Condensed Consolidated Statements of Changes in HTML 36K
Stockholders' Equity (Parenthetical)
18: R8 Condensed Consolidated Statements of Cash Flows HTML 128K
19: R9 Background and Basis of Presentation HTML 40K
20: R10 Investments HTML 143K
21: R11 Loan Receivables HTML 438K
22: R12 Credit Card and Private Student Loan HTML 57K
Securitization Activities
23: R13 Deposits HTML 40K
24: R14 Long-Term Borrowings HTML 79K
25: R15 Preferred Stock (Notes) HTML 53K
26: R16 Accumulated Other Comprehensive Income HTML 122K
27: R17 Income Taxes HTML 46K
28: R18 Earnings Per Share HTML 60K
29: R19 Capital Adequacy HTML 104K
30: R20 Commitments, Contingencies and Guarantees HTML 54K
31: R21 Litigation and Regulatory Matters HTML 43K
32: R22 Fair Value Measurements HTML 196K
33: R23 Derivatives and Hedging Activities HTML 152K
34: R24 Segment Disclosures HTML 122K
35: R25 Revenue from Contracts with Customers HTML 106K
36: R26 Immaterial Restatement of Prior Period Financial HTML 154K
Statements
37: R27 Subsequent Events HTML 32K
38: R28 Background and Basis of Presentation (Policies) HTML 37K
39: R29 Investments (Tables) HTML 141K
40: R30 Loan Receivables (Tables) HTML 445K
41: R31 Credit Card and Private Student Loan HTML 45K
Securitization Activities (Tables)
42: R32 Deposits (Tables) HTML 37K
43: R33 Long-Term Borrowings (Tables) HTML 78K
44: R34 Preferred Stock (Tables) HTML 57K
45: R35 Accumulated Other Comprehensive Income (Tables) HTML 123K
46: R36 Income Taxes (Tables) HTML 43K
47: R37 Earnings Per Share (Tables) HTML 59K
48: R38 Capital Adequacy (Tables) HTML 99K
49: R39 Commitments, Contingencies and Guarantees (Tables) HTML 41K
50: R40 Fair Value Measurements (Tables) HTML 185K
51: R41 Derivatives and Hedging Activities (Tables) HTML 146K
52: R42 Segment Disclosures (Tables) HTML 114K
53: R43 Revenue from Contracts with Customers (Tables) HTML 102K
54: R44 Immaterial Restatement of Prior Period Financial HTML 154K
Statements (Tables)
55: R45 Background and Basis of Presentation (Narrative) HTML 32K
(Details)
56: R46 Investments (Narrative) (Details) HTML 68K
57: R47 Investments (Schedule of Investment Securities) HTML 47K
(Details)
58: R48 Investments (Schedule of Amortized Cost, Gross HTML 67K
Unrealized Gains, Gross Unrealized Losses and Fair
Value) (Details)
59: R49 Investments (Schedule of Fair Value of Securities HTML 54K
in a Continuous Unrealized Loss Position for Less
Than 12 Months and More Than 12 Months) (Details)
60: R50 Investments (Schedule of Maturities of HTML 115K
Available-for-Sale Debt Securities and
Held-to-Maturity Debt Securities) (Details)
61: R51 Loan Receivables (Narrative) (Details) HTML 77K
62: R52 Loan Receivables (Schedule of Loan Receivables) HTML 79K
(Details)
63: R53 Loan Receivables (Schedule of Credit Risk Profile HTML 105K
by FICO Score and Origination Year) (Details)
64: R54 Loan Receivables (Schedule of Delinquent Loans by HTML 98K
Origination Year) (Details)
65: R55 Loan Receivables (Schedule of Changes in the HTML 86K
Allowance for Credit Losses) (Details)
66: R56 Loan Receivables (Schedule of Net Charge-offs of HTML 34K
Interest and Fee Revenues on Loan Receivables)
(Details)
67: R57 Loan Receivables (Schedule of Gross Principal HTML 62K
Charge-offs (Details)
68: R58 Loan Receivables (Schedule of Delinquent and HTML 99K
Non-Accruing Loans) (Details)
69: R59 Loan Receivables (Schedule of Loans That Entered a HTML 65K
Modification Program During the Period) (Details)
70: R60 Loan Receivables (Schedule of Loan Modification HTML 61K
Effects) (Details)
71: R61 Loan Receivables (Schedule of Delinquent Loans HTML 53K
Receivables Aging) (Details)
72: R62 Loan Receivables (Schedule of Financing HTML 39K
Receivable, Modified, Subsequent Default)
(Details)
73: R63 Loan Receivables (Schedule of Accounts that HTML 47K
Entered a Troubled Debt Restructuring Program)
(Details)
74: R64 Loan Receivables (Schedule of Troubled Debt HTML 52K
Restructurings That Subsequently Defaulted)
(Details)
75: R65 Credit Card and Private Student Loan HTML 37K
Securitization Activities (Narrative) (Details)
76: R66 Credit Card and Private Student Loan HTML 76K
Securitization Activities (Schedule of Restricted
Credit Card Securitized Assets) (Details)
77: R67 Deposits (Narrative) (Details) HTML 31K
78: R68 Deposits (Schedule of Certificates of Deposit HTML 44K
Maturities) (Details)
79: R69 Long-Term Borrowings (Narrative) (Details) HTML 50K
80: R70 Long-Term Borrowings (Schedule of Long-Term HTML 121K
Borrowings and Weighted Average Interest Rates)
(Details)
81: R71 Long-Term Borrowings (Schedule of Long-Term HTML 47K
Borrowings Maturities) (Details)
82: R72 Preferred Stock (Schedule of Stock by Class) HTML 90K
(Details)
83: R73 Accumulated Other Comprehensive Income (Schedule HTML 56K
of Changes in Accumulated Other Comprehensive
Income (Loss)) (Details)
84: R74 Accumulated Other Comprehensive Income (Schedule HTML 73K
of Other Comprehensive Income Before
Reclassifications and Amounts Reclassified from
AOCI) (Details)
85: R75 Income Taxes (Schedule of Effective Income Tax HTML 41K
Rate Calculation) (Details)
86: R76 Earnings Per Share (Schedule of Basic and Diluted HTML 81K
EPS ) (Details)
87: R77 Capital Adequacy (Schedule of Minimum and HTML 98K
Well-Capitalized Requirements) (Details)
88: R78 Commitments, Contingencies and Guarantees HTML 43K
(Narrative) (Details)
89: R79 Commitments, Contingencies and Guarantees HTML 36K
(Schedule of Maximum Potential Counterparty
Exposures Related to Settlement Guarantees and
Merchant Chargeback Guarantee) (Details)
90: R80 Litigation and Regulatory Matters (Narrative) HTML 53K
(Details)
91: R81 Fair Value Measurements (Narrative) (Details) HTML 42K
92: R82 Fair Value Measurements (Schedule of Assets and HTML 103K
Liabilities Measured at Fair Value on a Recurring
Basis) (Details)
93: R83 Fair Value Measurements (Schedule of Financial HTML 101K
Instruments Measured at Other Than Fair Value)
(Details)
94: R84 Derivatives and Hedging Activities (Narrative) HTML 38K
(Details)
95: R85 Derivatives and Hedging Activities (Schedule of HTML 101K
Fair Value and Outstanding Notional Amounts of
Derivative Instruments and Related Collateral
Balances) (Details)
96: R86 Derivatives and Hedging Activities Derivatives and HTML 38K
Hedging Activities (Schedule of Hedged Items in a
Fair Value Hedging Relationship) (Details)
97: R87 Derivatives and Hedging Activities (Schedule of HTML 68K
Impact of the Derivative Instruments on Income)
(Details)
98: R88 Segment Disclosures (Narrative) (Details) HTML 32K
99: R89 Segment Disclosures (Schedule of Segment HTML 92K
Disclosures) (Details)
100: R90 Revenue from Contracts with Customers (Schedule of HTML 80K
Revenue from Contracts with Customers
Disaggregated by Business Segment) (Details)
101: R91 Immaterial Restatement of Prior Period Financial HTML 165K
Statements (Details)
104: XML IDEA XML File -- Filing Summary XML 208K
102: XML XBRL Instance -- dfs-20230930_htm XML 5.67M
103: EXCEL IDEA Workbook of Financial Report Info XLSX 254K
7: EX-101.CAL XBRL Calculations -- dfs-20230930_cal XML 259K
8: EX-101.DEF XBRL Definitions -- dfs-20230930_def XML 1.16M
9: EX-101.LAB XBRL Labels -- dfs-20230930_lab XML 2.11M
10: EX-101.PRE XBRL Presentations -- dfs-20230930_pre XML 1.52M
6: EX-101.SCH XBRL Schema -- dfs-20230930 XSD 227K
105: JSON XBRL Instance as JSON Data -- MetaLinks 634± 1.00M
106: ZIP XBRL Zipped Folder -- 0001393612-23-000052-xbrl Zip 623K
(Exact name of registrant as specified in its charter)
iDelaware
(State
or other jurisdiction of incorporation or organization)
i36-2517428
(I.R.S. Employer Identification No.)
i2500 Lake Cook Road, iRiverwoods,
iIllinoisi60015
(Address of principal executive offices, including zip code)
(i224)
i405-0900
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act
Title of each class
Trading symbol(s)
Name of each exchange on which registered
iCommon
Stock, par value $0.01 per share
iDFS
iNew York Stock Exchange
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. iYes☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for
such shorter period that the registrant was required to submit such files). iYes☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer,""accelerated filer,""smaller reporting company," and "emerging growth
company" in Rule 12b-2 of the Exchange Act.
iLarge Accelerated Filer
☒
Accelerated Filer
☐
Non-accelerated Filer
☐
Smaller Reporting Company
i☐
Emerging
Growth Company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐ No ☒
As of October 20, 2023, there were i250,057,955 shares of the
registrant's Common Stock, par value $0.01 per share, outstanding.
DISCOVER FINANCIAL SERVICES
Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2023
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. See Glossary of Acronyms, located after Part I — Item 4, for terms and abbreviations used throughout the quarterly report.
We own or have rights to use the trademarks, trade names and service marks that we use in conjunction with the operation of our business, including, but not limited to Discover®, PULSE®, Cashback Bonus®, Discover Cashback Checking®, Discover it®,
Freeze it®, College Covered® and Diners Club International®. All other trademarks, trade names and service marks included in this quarterly report on Form 10-Q are the property of their respective owners.
Investment
securities (includes available-for-sale securities of $i13,079 and $i11,987 reported at fair value with associated amortized cost of $i13,447
and $i12,167 at September 30, 2023 and December 31, 2022, respectively)
i13,336
i12,208
Loan
receivables
Loan receivables
i122,676
i112,120
Allowance
for credit losses
(i8,665)
(i7,374)
Net
loan receivables
i114,011
i104,746
Premises and equipment,
net
i1,084
i1,003
Goodwill
i255
i255
Other
assets
i5,513
i4,597
Total assets
$
i143,432
$
i131,706
Liabilities
and Stockholders' Equity
Liabilities
Deposits
Interest-bearing deposit accounts
$
i102,638
$
i90,151
Non-interest
bearing deposit accounts
i1,381
i1,485
Total
deposits
i104,019
i91,636
Long-term
borrowings
i19,467
i20,108
Accrued
expenses and other liabilities
i5,710
i5,618
Total
liabilities
i129,196
i117,362
Commitments, contingencies and guarantees (Notes 9, 12 and
13)
i
i
Stockholders' Equity
Common stock, par value $ii0.01/
per share; ii2,000,000,000/ shares authorized; i570,780,616
and i569,689,007 shares issued at September 30, 2023 and December 31, 2022, respectively
i6
i6
Preferred
stock, par value $ii0.01/ per share; ii200,000,000/
shares authorized; iiii10,700///
shares issued and outstanding at September 30, 2023 and December 31, 2022, respectively
The
table below presents the carrying amounts of certain assets and liabilities of Discover Financial Services' consolidated variable interest entities ("VIEs"), which are included in the condensed consolidated statements of financial condition above. The assets in the table below include those assets that can only be used to settle obligations of the consolidated VIEs. The liabilities in the table below include third-party liabilities of consolidated VIEs only and exclude intercompany balances that eliminate in consolidation. The liabilities also exclude amounts for which creditors have recourse to the general credit of Discover Financial Services.
Notes to the Condensed Consolidated Financial Statements
(unaudited)
1. iBackground
and Basis of Presentation
Description of Business
Discover Financial Services ("DFS" or the "Company") is a digital banking and payment services company. The Company is a bank holding company under the Bank Holding Company Act of 1956 and a financial holding company under the Gramm-Leach-Bliley Act. Therefore, the Company is subject to oversight, regulation and examination by the Board of Governors of the Federal Reserve System (the "Federal Reserve"). The Company provides digital banking products and services and payment services through its subsidiaries.
The Company offers its customers credit card loans, private student loans, personal loans, home loans and deposit products. The Company also operates the Discover Network, the PULSE network ("PULSE") and Diners Club International ("Diners Club"), collectively known as the Discover Global Network. The Discover Network processes transactions for Discover-branded credit and debit cards and provides payment transaction processing and settlement services. PULSE operates an electronic funds transfer network, providing financial institutions issuing debit cards on the PULSE network with access to ATMs domestically and internationally, as well as merchant acceptance throughout the United States of America ("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 and charge cards and/or provide card acceptance services.
The Company manages its business activities in itwo segments, Digital Banking and Payment Services, based on the products and services provided. See Note 16: Segment Disclosures for a detailed description of each segment's operations and the allocation conventions used in business segment reporting.
Basis
of Presentation
iThe accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. ("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 necessary for the fair presentation of results for the interim period. All such adjustments
are of a normal, recurring nature.iThe 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 2022 audited consolidated financial statements filed with the Company's annual report on Form 10-K for the year ended December 31, 2022.
Immaterial Restatement of Prior Period Financial Statements
As reported in the second quarter of 2023, beginning in 2007, the Company incorrectly classified certain credit card accounts into its highest merchant and merchant acquirer pricing tier. The Company
determined the revenue impact of the incorrect card product classification was immaterial to the consolidated financial statements for all impacted prior periods. For comparative purposes, the Company has made these corrections to the consolidated financial statements for the prior periods presented in this Form 10-Q. Additionally, prior period amounts in the applicable notes to the consolidated financial statements have been corrected. The impacts of the misclassification and subsequent corrections are contained entirely within the Digital Banking segment. See Note 18: Immaterial Restatement of Prior Period Financial Statements for additional information and quantification of the prior period restatement impacts.
In March 2023, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2023-02, Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method. The ASU expands the use of the proportional amortization method of accounting for tax credit investments. Currently, the method is limited to Low Income Housing Tax Credit investments. Under the amended guidance, use of proportional amortization will be available to any qualifying tax credit investments, including but not limited to investments in New Markets Tax Credit and Renewable Energy Tax Credit programs. The amendments in the ASU are to be applied on a retrospective
or modified retrospective basis. The ASU is effective for the Company on January 1, 2024. Management does not expect the amendments to have a material impact on the Company’s consolidated financial statements.
2. iInvestments
i
The
Company's investment securities consist of the following (dollars in millions):
(1)Includes $i285 million and $i97 million of U.S. Treasury securities pledged as swap collateral as of September 30,
2023 and December 31, 2022, respectively.
(2)Consists of a security issued by the Federal Home Loan Bank.
(3)Consists of securities issued by Fannie Mae, Freddie Mac, or Ginnie Mae.
/
iThe amortized cost, gross unrealized gains and losses and fair value of available-for-sale
and held-to-maturity investment securities are as follows (dollars in millions):
(1)Available-for-sale
investment securities are reported at fair value.
(2)Held-to-maturity investment securities are reported at amortized cost.
(3)Amounts represent residential mortgage-backed securities ("RMBS") that were classified as held-to-maturity as they were entered into as a part of the Company's community reinvestment initiatives.
The Company invests in
U.S. Treasury obligations and securities issued by government agencies and government-sponsored enterprises of the U.S. ("U.S. GSEs"), which have long histories with no credit losses and are explicitly or implicitly guaranteed by the U.S. federal government. Therefore, management has concluded that there is no expectation of non-payment on its investment securities and does not record an allowance for credit losses on these investments. In addition, the Company does not have the intent to sell any available-for-sale securities in an unrealized loss position and does not believe it is more likely than not that it will be required to sell any such security before recovery of its amortized cost basis.
iThe
following table provides information about available-for-sale investment securities with aggregate gross unrealized losses and the length of time that individual investment securities have been in a continuous unrealized loss position (dollars in millions):
There
were iiiiiiiino///////
proceeds from sales or recognized gains or losses on available-for-sale securities during the three and nine months ended September 30, 2023 and 2022. See Note 8: Accumulated Other Comprehensive Income for unrealized gains and losses on available-for-sale securities during the three and nine months ended September 30, 2023 and 2022.
i
Maturities of available-for-sale debt securities and held-to-maturity
debt securities are provided in the following table (dollars in millions):
As a part of the Company's community reinvestment initiatives, the Company has made equity investments in certain limited partnerships and limited liability companies that finance the construction
and rehabilitation of affordable rental housing and stimulate economic development in low- to moderate-income communities. These investments are accounted for using the equity method of accounting and are recorded within other assets. The related commitment for future investments is recorded in accrued expenses and other liabilities within the condensed consolidated statements of financial condition. The portion of each investment's operating results allocable to the Company reduces the carrying value of the investments and is recorded in other expense within the condensed consolidated statements of income. The Company further reduces the carrying value of the investments by recognizing any amounts that are in excess of future net tax benefits in other expense. The
Company earns a return primarily through tax credits allocated to the affordable housing projects and the community revitalization projects. The Company does not consolidate these investments as the Company does not have a controlling financial interest in the investee entities. As of September 30, 2023 and December 31, 2022, the Company had outstanding investments in these entities of $i426
million and $i416 million, respectively, and related contingent liabilities for unconditional and legally binding delayed equity contributions of $i126 million and $i111
million, respectively. Of the above outstanding equity investments, the Company had $i395 million and $i375
million of investments related to affordable housing projects as of September 30, 2023 and December 31, 2022, respectively, which had $i120 million and $i100
million of related contingent liabilities for unconditional and legally binding delayed equity contributions, respectively.
The Company holds non-controlling equity positions in several payment services entities and third-party venture capital funds which invest in such entities. Most of the direct investments in such entities are not subject to equity method accounting because the Company does not have significant influence over the investee. The Company's investments in third-party venture capital funds represent limited partnership interests and are accounted for under the equity method. The common or preferred equity securities that the
Company holds typically do not have readily determinable fair values. As a result, these investments are carried at cost minus impairment, if any. As of September 30, 2023 and December 31, 2022, the carrying value of these investments, which are recorded within other assets on the Company's condensed consolidated statements of financial condition, was $i34
million and $i39 million, respectively.
The Company also holds non-controlling equity positions in payment services entities that have publicly traded stock and therefore have readily determinable fair values. As a result, these investments are carried at fair value based on the quoted share prices. As of September 30, 2023 and December 31,
2022, the carrying value of these investments, which are recorded within other assets on the Company's condensed consolidated statements of financial condition, was $ii39/
million and $i41 million, respectively. During the three and nine months ended September 30, 2023, the Company recognized a $i6
million net gain and an $i11 million net loss, respectively, on the condensed consolidated statements of income related to these investments. The Company recognized net losses of $i5 million
and $i212 million during the three and nine months ended September 30, 2022, respectively.
(1)Amounts
include carrying values of $i13.9 billion and $i13.5 billion underlying investors' interest in trust debt at September 30, 2023 and December 31, 2022, respectively, and $i10.9 billion
and $i12.2 billion in seller's interest at September 30, 2023 and December 31, 2022, respectively. See Note 4: Credit Card and Private Student Loan Securitization Activities for additional information.
(2)Unbilled accrued interest receivable on credit card loans, which is presented as part of other assets in the Company's condensed consolidated statements of financial condition, was $i663
million and $i611 million at September 30, 2023 and December 31, 2022, respectively.
(3)Accrued interest receivable on private student, personal and other loans, which is presented as part of other assets in the Company's condensed consolidated statements of financial condition, was $i573
million, $i62 million and $i18 million, respectively, at September 30, 2023 and $i468
million, $i49 million and $i11 million, respectively, at December 31, 2022.
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 and information from credit bureaus, such as FICO or other credit scores, relating to the customer's broader credit performance. The Company actively monitors key credit quality indicators, including FICO scores and delinquency status, for credit card, private student and personal loans. These indicators are important to understand the overall credit performance of the Company's customers and their ability to repay.
FICO scores are generally obtained at the origination of the account and are refreshed monthly or quarterly thereafter to assist in predicting customer behavior. Historically, the
Company has noted that accounts with FICO scores below 660 have larger delinquencies and credit losses than those with higher credit scores.
The following table provides the distribution of the amortized cost basis (excluding accrued interest receivable presented in other assets) by the most recent FICO scores available
for the Company's customers for credit card, private student and personal loan receivables (dollars in millions):
Delinquencies are an indicator of credit quality at a point in time. A loan balance is considered delinquent when contractual payments on the loan become i30
days past due.
i
The amortized cost basis (excluding accrued interest receivable presented in other assets) of delinquent loans in the Company's loan portfolio is shown below for credit card, private student and personal loan receivables (dollars in millions):
(1)Private
student loans may include a deferment period, during which borrowers are not required to make payments while enrolled in school at least half time as determined by the school. During a deferment period, these loans do not advance into delinquency.
(1)Excludes
a $i31 million and $i30 million adjustment of the liability for expected credit losses on unfunded commitments
for the three months ended September 30, 2023 and 2022, respectively, and $i6 million and $i1
million for the nine months ended September 30, 2023 and 2022, respectively, as the liability is recorded in accrued expenses and other liabilities in the Company's condensed consolidated statements of financial condition.
(2)Represents the adjustment to the allowance for credit losses as a result of the adoption of ASU No. 2022-02 on January 1, 2023, which eliminated the requirement to apply discounted cash flow measurements for certain troubled debt restructurings.
The allowance for credit losses was approximately $i8.7 billion at September 30, 2023, which reflects a $i601
millionbuildover June 30, 2023, and a $i1.3 billion build from December 31, 2022. Thebuildin the allowance for credit losses for the three and nine months ended September 30, 2023 was primarily
driven by loan growth, increasing delinquencies, and macroeconomic variables impacting household cash flows.
The allowance estimation process begins with a loss forecast that uses certain macroeconomic variables and multiple macroeconomic scenarios among its inputs. In estimating the allowance at September 30, 2023, the Company used a macroeconomic forecast that projected the following weighted average amounts: (i) unemployment rate ending 2023 at i3.8% and peaking at i4.2%
in the fourth quarter of 2024 and (ii) i2.02% growth rate in real gross domestic product in 2023.
In estimating expected credit losses, the Company considered the uncertainties associated with borrower behavior and payment trends, as well as recent and expected macroeconomic conditions, such as high consumer price inflation and the fiscal and monetary policy responses to that inflation. The Federal Reserve raised its federal funds rate target range substantially during 2022 and the first three quarters of 2023
in an effort to slow economic growth and reduce inflation. Although real GDP growth and labor market conditions have exceeded most economists’ expectations this year, restrictive monetary policy, as manifested in relatively high interest rates, typically precedes weaker consumer credit conditions caused by rising unemployment as economic growth slows. Credit performance in the Company's lending portfolios has evolved in line with its expectations this year, but may weaken if the economy fails to avert a recession in response to tighter credit conditions or other factors. The Company assessed the prospects for various macroeconomic outcomes in setting its allowance for credit losses.
The forecast period the
Company deemed to be reasonable and supportable was iiiiii18/////
months for all periods presented. The iiiiii18/////
months reasonable and supportable forecast period was deemed appropriate given the current economic conditions. For all periods presented, the Company determined that a reversion period of ii12/
months was appropriate for the same reason. The Company applied a weighted reversion method to provide a more reasonable transition to historical losses for all loan products for all periods presented.
The net charge-offs for credit card loans, private student loans and personal loans increased for the three and nine months ended September 30, 2023, when compared to the same periods in 2022, primarily due to portfolio seasoning.
i
Net
charge-offs of principal are recorded against the allowance for credit losses, as shown in the preceding table. Information regarding net charge-offs of interest and fee revenues on credit card and other loans is as follows (dollars in millions):
iGross principal charge-offs of the Company's loan portfolio are presented in the table below, on a year-to-date basis, for credit card, private student and personal loan receivables (dollars in millions):
The
amortized cost basis (excluding accrued interest receivable presented in other assets) of delinquent and non-accruing loans in the Company's loan portfolio is shown below for each class of loan receivables (dollars in millions):(1)
(1)The
payment status of both modified and unmodified loans is included in this table.
(2)The Company estimates that the gross interest income that would have been recorded under the original terms of non-accruing credit card loans was $i11 million and $i6
million for the three months ended September 30, 2023 and 2022, respectively, and $i29 million and $i17
million for the nine months ended September 30, 2023 and 2022, respectively. The Company does not separately track the amount of gross interest income that would have been recorded under the original terms of loans. Instead, the Company estimated this amount based on customers' current balances and most recent interest rates.
Loan Modifications to Borrowers Experiencing Financial Difficulty
The Company has internal loan modification programs that provide relief to credit card, private student and personal loan borrowers who are experiencing financial hardship. The internal loan modification programs include both temporary and permanent programs, which vary by product. External loan modification programs, through third party consumer credit counseling agencies, are also available for credit card and personal loans. Those programs feature interest rate reductions, payment delays, term extensions, or a combination thereof.
For credit card customers, the Company offers both
temporary and permanent hardship programs. The temporary hardship programs consist of an interest rate reduction lasting for a period no longer than i12 months. Charging privileges on these accounts are generally suspended while in the program. However, if the customer meets certain criteria, charging privileges may be reinstated following completion of the program.
The permanent modification program involves closing the account, changing the structure of the loan to a fixed payment loan with a maturity no longer than i72
months and reducing the interest rate on the loan. The permanent modification program does not typically provide for the forgiveness of unpaid principal, but may allow for the reversal of certain unpaid interest or fee assessments. The Company also makes permanent loan modifications for customers who request financial assistance through external sources, such as a consumer credit counseling agency program. These loans typically receive a reduced interest rate, typically continue to be subject to the original minimum payment terms and do not normally include waiver of unpaid principal, interest or fees.
To assist private student loan borrowers who are experiencing temporary financial difficulties but are willing to resume making payments, the Company may
offer a payment delay (in the form of hardship forbearance or a temporary payment reduction), or a temporary interest rate reduction. Typically programs are offered up to six consecutive months at one time with a lifetime usage cap, most commonly, of 12 months.
For personal loan customers, the Company offers various payment programs, including temporary and permanent programs, in certain situations. The temporary programs normally consist of reducing the minimum payment for no longer than i12
months and, in certain circumstances, the interest rate on the loan is reduced. The permanent programs involve extending the loan term and, in certain circumstances, reducing the interest rate on the loan. The total term of the loan, including modification, may not exceed inine years. The Company also allows permanent loan modifications for customers who request financial assistance through external sources, similar to the credit card customers discussed above. Payments are modified based on the new terms agreed upon with the credit counseling agency.
In
addition to the programs described above, the Company will in certain cases accept partial payment in full satisfaction of the outstanding receivable. This is a form of principal forgiveness also known as a settlement. The difference between the loan balance and the amount received in settlement is recorded as a charge-off.
The Company monitors borrower performance after using payment programs or forbearance. The Company believes the programs are useful in assisting customers experiencing financial difficulties and allowing them to make timely payments. In addition to helping customers with their credit needs, these programs are designed to maximize collections and ultimately
the Company’s profitability. The Company plans to continue to use payment programs to provide relief to customers experiencing financial difficulties.
ASU No. 2022-02, Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, became effective for the Company on January 1, 2023. The new guidance eliminated Subtopic 310-40, Troubled Debt Restructurings, and implemented enhanced disclosure requirements regarding loan modifications to borrowers experiencing financial difficulty. The new
disclosures are required to be applied on a prospective basis. There will be no comparative disclosures to prior periods until such time as both periods disclosed are subject to the new guidance.
The following table provides the period-end amortized cost basis, by modification
category, of loans to borrowers experiencing financial difficulty that entered a modification program during the period (dollars in millions). Some of the loans presented in the table below may no longer be enrolled in a program at period-end:
For the Three Months Ended September 30,
For the Nine Months Ended September 30,(1)
2023
2023
Credit
card loans(2)(3)
Interest rate reduction
$
i685
$
i1,712
Total
credit card loans(4)
$
i685
$
i1,712
%
of total class of financing receivables
i0.70
%
i1.76
%
Private
student loans(2)
Payment delay(5)
$
i12
$
i32
Interest
rate reduction and payment delay(5)
i28
i74
Total
private student loans(4)
$
i40
$
i106
%
of total class of financing receivables
i0.38
%
i1.01
%
Personal
loans(2)
Payment delay(5)
$
i4
$
i8
Term
extension(6)
i9
i24
Interest
rate reduction and payment delay(5)
i21
i48
Interest
rate reduction and term extension(6)
i9
i22
Total
personal loans(4)
$
i43
$
i102
%
of total class of financing receivables
i0.45
%
i1.07
%
(1)The
current quarter-to-date enrollment figures, when aggregated with previously disclosed quarter-to-date amounts, will not equal the year-to-date amounts in this table because all year-to-date enrollments are presented using the current period-end amortized cost basis.
(2) Accrued interest receivable (including unbilled accrued interest receivable for credit card loans) on modified loans to borrowers experiencing financial difficulty, which is presented as part of other assets in the Company's condensed consolidated statements of financial condition, was immaterial at September 30, 2023.
(3) Accounts that entered a credit card loan modification program include $i120 million
and $i302 million that were converted from revolving line-of-credit arrangements to term loans during the three and nine months ended September 30, 2023, respectively.
(4) For settlements, the amortized cost basis is zero at period-end and therefore there is no amount reported for principal forgiveness in the table above. See financial effects table below for principal forgiveness to borrowers experiencing financial difficulty.
(5) The
Company defines a payment delay as a temporary reduction in payments below the original contractually required payment amounts (e.g., interest only payments). The Company's credit card loan modification programs do not result in an other than insignificant delay in payment.
/
(6) The Company defines term extensions as only those modifications for which the maturity date is extended beyond the original contractual maturity date by virtue of a change in terms other than a payment delay as defined above. Modifications to credit card loans are not considered term extensions because
credit card loans do not have a fixed repayment term.
The only non-cancellable commitments the Company has to lend additional funds to borrowers experiencing financial difficulty relate to certain private student loans. As of September 30, 2023, the amount of such commitments associated with loans modified during the periods presented was immaterial.
The
following table provides information on the financial effects of loan modifications to borrowers experiencing financial difficulty, by modification type, made during the period (dollars in millions):
(1)
Represents the amount of interest and fees forgiven resulting from accounts entering into a credit card loan modification program and pre-charge off settlements. Interest and fees forgiven are reversed against the respective line items in the consolidated statements of income.
(2) For private student loan payment delays, the Company offers up to six consecutive months of delay and most commonly limits assistance to a life of loan maximum of 12 months. For personal loan payment delays, the Company limits this assistance to a life of loan maximum of 12 months.
/
Loan
receivables that have been modified are subject to the same requirements for the accrual of expected credit loss over their expected remaining lives as for unmodified loans. The allowance for credit losses incorporates modeling of historical loss data and thereby captures the higher risk associated with modified loans to borrowers experiencing financial difficulty based on their account attributes.
i
The following table presents the payment status and period-end amortized cost basis, by class of loan receivable, of loans that were modified on or after January
1, 2023 to borrowers experiencing financial difficulty (dollars in millions):(1)
(1) This
table includes any loan that entered a modification program during the period without regard to whether it remained in a modification program as of the reporting date.
/
i
The following table presents the defaulted amount and period-end amortized cost basis, by modification category, of loans that defaulted during the period and were modified on or after January
1, 2023 through the end of the reporting period to borrowers experiencing financial difficulty (dollars in millions):
(1)For
purposes of this disclosure, a loan is considered to be defaulted when it is 60 days or more delinquent at month end and has advanced two stages of delinquency subsequent to modification. Loans that entered a modification program in any stage of delinquency but did not experience a further payment default are included in the payment status table above but are not counted as defaulted for purposes of this disclosure.
The defaulted amounts and period-end amortized cost basis of private student
loans and personal loans modified on or after January 1, 2023 to borrowers experiencing financial difficulty which subsequently defaulted were immaterial for the three and nine months ended September 30, 2023.
Troubled Debt Restructurings (Prior to 2023)
Prior to the adoption of ASU 2022-02, the Company considered a modified loan in which a concession had been granted to the borrower to be a TDR based generally on the cumulative length of the concession period and credit quality of the borrower. Due to differences between the legacy TDR requirements and current loan modification disclosure requirements, information presented in the disclosures below is not directly comparable
to the disclosures under the current guidance.
To evaluate the primary financial effects that resulted from credit card loans entering into a TDR program during the three and nine months ended September 30, 2022, the Company quantified the amount by which interest and fees were reduced during the periods. During the three and nine months ended September 30, 2022, the Company forgave approximately $i7
million and $i20 million of interest and fees resulting from accounts entering into a credit card loan TDR program.
i
The
following table provides information on loans that entered a TDR program during the period (dollars in millions):
Accounts that entered a TDR program during the period
Credit card loans(1)
i63,803
$
i414
i167,655
$
i1,071
Private
student loans
i1,863
$
i36
i5,141
$
i96
Personal
loans
i1,799
$
i25
i4,561
$
i62
(1)Accounts
that entered a credit card TDR program include $i80 million and $i225 million that were converted from
revolving line-of-credit arrangements to term loans during the three and nine months ended September 30, 2022, respectively.
/i
The following table presents the carrying value of loans that experienced a default during the period that had been modified in a TDR during the 15 months preceding the end of
each period (dollars in millions):
(1)For
credit card loans that default from a temporary loan modification program, accounts revert back to the pre-modification terms and charging privileges remain suspended in most cases.
(2)For credit card loans and personal loans, a customer defaults from a loan modification program after either itwo consecutive missed payments or at charge-off, depending on the program. The outstanding balance upon default is generally the loan balance at the end of the month
prior to default.
/
(3)For student loans, a customer defaults from a loan modification after they are i60 or more days delinquent. The outstanding balance upon default is generally the loan balance at the end of the month prior to default.
Of the account balances that defaulted as shown above for the three months ended September
30, 2022, approximately i60%, and for the nine months ended September 30, 2022, approximately i62%, of the total balances were charged off at the end of the month in which they defaulted from a TDR program. For the three and nine
months ended September 30, 2022, for accounts that had defaulted from a TDR program and had not been subsequently charged off, the balances were included in the allowance for credit loss analysis.
4. iCredit
Card and Private Student Loan Securitization Activities
The Company's securitizations are accounted for as secured borrowings and the related trusts are treated as consolidated subsidiaries of the Company. For a description of the Company's principles of consolidation with respect to VIEs, see Note 1: Background and Basis of Presentation to the consolidated financial statements in the Company's annual report on Form 10-K for the year ended December 31,
2022.
Credit Card Securitization Activities
The Company accesses the term asset securitization market through Discover Card Master Trust I ("DCMT") and Discover Card Execution Note Trust ("DCENT"). Credit card loan receivables are transferred into DCMT and beneficial interests in DCMT are transferred into DCENT. DCENT issues debt securities to investors that are reported primarily in long-term borrowings.
The DCENT debt structure consists of ifour
classes of securities (DiscoverSeries Class A, B, C and D notes), with the most senior class generally receiving a triple-A rating. To issue senior, higher-rated classes of notes, it is necessary to obtain the appropriate amount of credit enhancement, generally through the issuance of junior, lower-rated or more highly subordinated classes of notes. Wholly-owned subsidiaries of Discover Bank hold the subordinated classes of notes. The Company is exposed to credit risk associated with trust receivables as of the balance sheet date through the retention of these subordinated interests. The estimate of expected credit losses on trust receivables is included in the allowance for credit losses estimate.
The
Company's retained interests in the trust's assets, consisting of investments in DCENT notes held by subsidiaries of Discover Bank, constitute intercompany positions that are eliminated in the preparation of the Company's condensed consolidated statements of financial condition.
Upon transfer of credit card loan receivables to the trust, the receivables and certain cash flows derived from them become restricted for use in meeting obligations to the trust's creditors. Further, the transferred credit card loan receivables are owned by the trust and are not available to the Company's third-party creditors. The trusts have ownership of cash balances, the amounts of
which are reported in restricted cash within the Company's condensed consolidated statements of financial condition. Except for the seller's interest in trust receivables, the Company's interests in trust assets are generally subordinate to the interests of third-party investors in trust debt and, as such, may not be realized by the Company if needed to absorb deficiencies in cash flows that are allocated to those investors. Apart from the restricted assets related to securitization activities, the investors and the securitization trusts have no recourse to the Company's other assets or the
Company's general credit for a shortage in cash flows.
i
The carrying values of these restricted assets, which are presented on the Company's condensed consolidated statements of financial condition as relating to securitization activities, are shown in the following table (dollars in millions):
Investors'
interests held by third-party investors
i10,975
i10,200
Investors'
interests held by wholly-owned subsidiaries of Discover Bank
i2,918
i3,341
Seller's
interest
i10,898
i12,220
Loan receivables(1)
i24,791
i25,761
Allowance
for credit losses allocated to securitized loan receivables(1)
(i1,129)
(i1,152)
Net
loan receivables
i23,662
i24,609
Other assets
i3
i2
Carrying
value of assets of consolidated variable interest entities
$
i23,696
$
i24,644
(1)The
Company maintains its allowance for credit losses at an amount equal to lifetime expected credit losses associated with all loan receivables, which includes all loan receivables in the trusts. Therefore, the credit risk associated with the transferred receivables is fully reflected on the Company's statements of financial condition in accordance with GAAP.
The debt securities issued by the consolidated
trusts are subject to credit, payment and interest rate risks on the transferred credit card loan receivables. To protect investors in the securities, there are certain features or triggering events that will cause an early amortization of the debt securities, including triggers related to the impact of the performance of the trust receivables on the availability and adequacy of cash flows to meet contractual requirements. As of September 30, 2023, no economic or other early amortization events have occurred.
The Company continues to own and service the accounts that generate the loan receivables held by the trusts. Discover Bank receives servicing fees from the trusts based on a percentage of the monthly investor principal balance outstanding. Although the fee income to Discover Bank offsets
the fee expense to the trusts and thus is eliminated in consolidation, failure to service the transferred loan receivables in accordance with contractual requirements could lead to a termination of the servicing rights and the loss of future servicing income, net of related expenses.
Private Student Loan Securitization Activities
The Company's private student loan trust receivables reported in loan receivables and the related debt issued by the trust reported in long-term borrowings were immaterial as of September 30, 2023 and December 31, 2022. The amounts are included, together with amounts related to the Company's
credit card securitizations, in the supplemental information about assets and liabilities of consolidated variable interest entities, which is presented with the Company's condensed consolidated statements of financial condition.
5. iDeposits
The Company obtains deposits
from consumers directly or through affinity relationships ("direct-to-consumer deposits"). Additionally, the Company obtains deposits through third-party securities brokerage firms that offer the Company's deposits to their customers ("brokered deposits"). Direct-to-consumer deposit products include savings accounts, certificates of deposit, money market accounts, IRA savings accounts, IRA certificates of deposit and checking accounts. Brokered deposit products include certificates of deposit and sweep accounts.
Customer deposits held with Discover Bank are currently insured for up to $250,000 per account holder through the Federal Deposit Insurance Corporation (“FDIC”). At September 30,
2023 and December 31, 2022, the Company had approximately $i5.9 billion and $i8.9 billion of uninsured deposits, respectively. The
decrease in uninsured deposits reported was primarily driven by leveraging technological capabilities, beginning in the first quarter of 2023, enabling improved application of deposit account ownership attributes in deriving this amount. The amounts of uninsured deposits above were estimated based on the same methodologies and assumptions used for Discover Bank’s regulatory reporting at each respective balance sheet date.
iThe following table summarizes certificates of deposits maturing over the remainder of this year, over each of the next four years and thereafter (dollars in millions):
Long-term borrowings consist of borrowings having original maturities of one year or more. The following table provides a summary of the Company's long-term borrowings
and weighted-average interest rates on outstanding balances (dollars in millions):
Total
Discover Card Master Trust I and Discover Card Execution Note Trust
i10,820
i10,175
Floating-rate
asset-backed security(3)(4)
2031
ii9.50/%
i9.50%
i69
i84
Total
private student loan securitization trust
i69
i84
Total
long-term borrowings - owed to securitization investors
i10,889
i10,259
Discover
Financial Services (Parent Company)
Fixed-rate senior notes
2024-2032
i3.75% - i6.70%
i4.68%
i3,335
i3,333
Fixed-rate
retail notes
2023-2031
i3.00% - i4.40%
i3.80%
i147
i154
Discover
Bank
Fixed-rate senior bank notes(1)
2024-2030
i2.45% - i4.65%
i3.53%
i3,548
i5,348
Fixed-rate
subordinated bank notes
2028
ii5.97/%
i5.97%
i500
i489
Fixed-rate
Federal Home Loan Bank advances
2030
i4.77% - i4.82%
i4.82%
i523
i—
Floating-rate
Federal Home Loan Bank advance(5)
2023
ii5.54/%
i5.54%
i525
i525
Total
long-term borrowings
$
i19,467
$
i20,108
(1)The
Company uses interest rate swaps to hedge portions of these long-term borrowings against changes in fair value attributable to changes in the applicable benchmark interest rates. The use of these interest rate swaps impacts the carrying value of the debt. See Note 15: Derivatives and Hedging Activities.
(2)DCENT floating-rate asset-backed securities include issuances with the following interest rate terms: i1-month Term SOFR + 0.11448% Tenor Spread Adjustment + 60 basis points as of September 30, 2023.
(3)The private
student loan securitization trust floating-rate asset-backed security includes an issuance with the following interest rate term: iPrime rate + 100 basis points as of September 30, 2023.
(4)Repayment of this debt is dependent upon the timing of principal and interest payments on the underlying private student loans. The date shown represents the final maturity date.
(5)The floating-rate Federal Home Loan Bank (“FHLB”) advance includes the following interest rate term: iSOFR
+ 23 basis points as of September 30, 2023.
/
iThe following table summarizes long-term borrowings maturing over the remainder of this year, over each of the next four years and thereafter (dollars in millions):
As a member of the FHLB of Chicago, the Company has access to both short- and long-term advance structures with maturities ranging from overnight to 30 years. As of September 30, 2023, the Company had total committed borrowing capacity of $i3.3
billion based on the amount and type of assets pledged, of which the outstanding balance was comprised of $i1.0 billion in long-term advances. As of December 31, 2022, the Company had total committed borrowing capacity of $i2.2
billion based on the amount and type of assets pledged, of which the outstanding balance was comprised solely of a $i525 million long-term advance. These advances are presented as short- or long-term borrowings on the condensed consolidated statements of financial condition as appropriate.
Additionally, the Company has access to committed borrowing capacity through private securitizations to support the funding of its credit card loan receivables. As of September 30,
2023 and December 31, 2022, the total commitment of secured credit facilities through private providers was $ii3.5/
billion, iinone/ of which was drawn. Access to the unused portions of the secured credit facilities is subject to the terms of the agreements with each of the providers.The
secured credit facilities have various expirations in 2025. Borrowings outstanding under each facility bear interest at a margin above the Term Secured Overnight Financing Rate ("SOFR") or the asset-backed commercial paper costs of each provider. The terms of each agreement provide for a commitment fee to be paid on the unused capacity and include various affirmative and negative covenants, including performance metrics and legal requirements similar to those required to issue any term securitization transaction.
7. iPreferred
Stock
i
The table below presents a summary of the Company's non-cumulative perpetual preferred stock that is outstanding at September 30, 2023 (dollars in millions, except per depositary share amounts):
Series
Description
Initial
Issuance Date
Liquidation Preference and Redemption Price per Depositary Share(1)
(1)Redeemable
at the redemption price plus declared and unpaid dividends.
(2)Issued as depositary shares, each representing 1/ii100/th
interest in a share of the corresponding series of preferred stock. Each preferred share has a par value of $ii0.01/.
(3)Redeemable
at the Company’s option, subject to regulatory approval, either (i) in whole or in part on any dividend payment date on or after iOctober 30, 2027, or (ii) in whole but not in part, at any time within i90
days following a regulatory capital treatment event (as defined in the certificate of designations for the Series C preferred stock).
(4)Any dividends declared are payable semi-annually in arrears at a rate of i5.500% per annum until iOctober
30, 2027. Thereafter, dividends declared will be payable quarterly in arrears at a floating rate equal to i3-month Term SOFR plus a spread of i3.338%
per annum.
(5)Redeemable at the Company’s option, subject to regulatory approval, either (i) in whole or in part during the three-month period prior to, and including, each reset date (as defined in the certificate of designations for the Series D preferred stock) or (ii) in whole but not in part, at any time within i90 days following a regulatory capital treatment event (as defined in the certificate of designations for the Series D Preferred Stock).
(6)Any
dividends declared are payable semi-annually in arrears at a rate of i6.125% per annum until September 23, 2025, after which the dividend rate will reset every i5 years to a fixed annual rate equal to the i5-year
Treasury plus a spread of i5.783%.
iThe following table presents each component of other comprehensive income ("OCI") before reclassifications and amounts reclassified from AOCI for each component of OCI before- and after-tax (dollars in millions):
The
Company is subject to examination by the Internal Revenue Service and tax authorities in various state, local and foreign tax jurisdictions. The Company's federal income tax filings are open to examinations for the tax years ended December 31, 2019 and forward. The Company regularly assesses the likelihood of additional assessments or settlements in each of the taxing jurisdictions. At this time, the potential change in unrecognized tax benefits is expected to be immaterial over the next 12 months. The Company believes that its reserves are sufficient to cover any tax, penalties and interest that would result from such examinations.
10. iEarnings
Per Share
iThe following table presents the calculation of basic and diluted earnings per share ("EPS") (dollars and shares in millions, except per share amounts):
Weighted-average
shares of common stock outstanding
i250
i273
i255
i279
Effect
of dilutive common stock equivalents
i—
i1
i—
i—
Weighted-average
shares of common stock outstanding and common stock equivalents
i250
i274
i255
i279
Basic
earnings per common share
$
i2.59
$
i3.57
$
i9.70
$
i11.70
Diluted
earnings per common share
$
i2.59
$
i3.56
$
i9.69
$
i11.69
/
Anti-dilutive
securities were not material and had no impact on the computation of diluted EPS for the three or nine months ended September 30, 2023 and 2022.
DFS is subject to the capital adequacy guidelines of the Federal Reserve. Discover Bank, the Company's banking subsidiary, is subject to various regulatory capital requirements as administered by the FDIC. Failure to meet minimum capital requirements can result in the initiation of certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could limit the Company's business activities and have a direct material effect on the financial condition and operating results of DFS and Discover Bank. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, DFS and Discover Bank must meet specific risk-based capital requirements and leverage ratios that involve quantitative
measures of assets, liabilities and certain off-balance sheet items, as calculated under regulatory guidelines. Capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
DFS and Discover Bank are subject to regulatory and capital rules issued by the Federal Reserve and FDIC, respectively, under the Basel Committee's December 2010 framework ("Basel III rules"). Under the Basel III rules, DFS and Discover Bank are classified as "standardized approach" entities. Standardized approach entities are defined as U.S. banking organizations with consolidated total assets over $50 billion but not exceeding $250 billion and consolidated total on-balance sheet foreign exposure less than $10 billion.
In accordance with the final rule on the impact of current expected credit losses ("CECL")
on regulatory capital, the Company has elected to phase in the impact over three years beginning in 2022. Accordingly, the Company's Common Equity Tier 1 ("CET1") capital ratios are higher than they otherwise would have been. The Company's CET1 capital ratios will continue to be favorably impacted by this election over the phase-in period, which ends December 31, 2024.
As of September 30, 2023 and December 31, 2022, DFS and Discover Bank met all Basel III minimum capital ratio requirements to which they were subject.
DFS and Discover Bank also met the requirements to be considered "well-capitalized" under Regulation Y and prompt corrective action rules, respectively. There have been no conditions or events that management believes have changed DFS' or Discover Bank's category. To be categorized as "well-capitalized", DFS and Discover Bank must maintain minimum capital ratios outlined in the table below.
The
following table shows the actual capital amounts and ratios of DFS and Discover Bank and comparisons of each to the regulatory minimum and "well-capitalized" requirements (dollars in millions):
Actual
Minimum
Capital Requirements
Capital Requirements To Be Classified as Well-Capitalized
(1)Capital
ratios are calculated based on the Basel III standardized approach rules, subject to applicable transition provisions, including CECL transition provisions.
(2)The Basel III rules do not establish well-capitalized thresholds for these measures for bank holding companies. Existing well-capitalized thresholds established in the Federal Reserve's Regulation Y have been included where available.
/
(3)Capital amounts and ratios have been updated to reflect the impact of the restatement described in Note 18: Immaterial Restatement of Prior Period Financial Statements.
In the normal course of business, the Company enters into a number of off-balance sheet commitments, transactions and obligations under guarantee arrangements that expose the Company to varying degrees of risk. The Company's
commitments, contingencies and guarantee relationships are described below.
Commitments
Unused Credit Arrangements
At September 30, 2023, the Company had unused credit arrangements for loans of approximately $i231.8 billion. Such arrangements arise primarily from agreements with customers
for unused lines of credit on certain credit cards and certain other loan products, provided there is no violation of conditions in the related agreements. These arrangements, substantially all of which the Company can terminate at any time and which do not necessarily represent future cash requirements, are periodically reviewed based on account usage, customer creditworthiness, loan qualification and the cost of capital. As the Company’s credit card loans are unconditionally cancellable, ino
liability for expected credit losses is required for unused lines of credit. For all other loans, the Company records a liability for expected credit losses for unfunded commitments, which is presented as part of accrued expenses and other liabilities in the consolidated statements of financial condition.
Contingencies
See Note 13: Litigation and Regulatory Matters for a description of potential liability arising from pending litigation or regulatory proceedings involving the Company.
Guarantees
The Company has obligations under certain guarantee
arrangements, including contracts, indemnification agreements and representations and warranties, which contingently require the Company to make payments to the guaranteed party based on changes in an underlying asset, liability or equity security of a guaranteed party, rate or index. Also included as guarantees are contracts that contingently require the Company to make payments to a guaranteed party based on another entity's failure to perform under an agreement. The Company's use of guarantees is disclosed below by type of guarantee.
Securitizations
Representations and Warranties
As part of the Company's financing activities, the Company provides representations and warranties that certain assets pledged as collateral in secured borrowing arrangements conform to specified guidelines. Due diligence is performed by the Company, which is intended to ensure that asset guideline qualifications are met. If the assets pledged as collateral do not meet certain conforming guidelines, the Company may be required to replace, repurchase or sell such assets. In its credit card securitization activities, the
Company would replace nonconforming receivables through the allocation of excess seller's interest or from additional transfers from the unrestricted pool of receivables. If the Company could not add enough receivables to satisfy the requirement, an early amortization (or repayment) of investors' interests would be triggered. In its student loan securitizations, the Company would generally repurchase the loans from the trust at the outstanding principal amount plus interest.
The maximum potential amount of future payments the Company could be required to make would be equal to the current outstanding balances of third-party investor interests in credit card asset-backed
securities and the principal amount of any private student loan secured borrowings, plus any unpaid interest for the corresponding secured borrowings. The Company has recorded substantially all of the maximum potential amount of future payments in long-term borrowings on the Company's condensed consolidated statements of financial condition. The Company has not recorded any incremental contingent liability associated with its secured borrowing representations and warranties. Management believes that the probability of having to replace, repurchase or sell assets pledged as collateral under secured borrowing arrangements, including an early amortization event, is low.
Diners Club and DFS Services LLC (on behalf of PULSE) have various counterparty exposures, which are listed below:
•Merchant Guarantee. Diners Club has entered into contractual relationships with certain international merchants, which generally include travel-related businesses, for the benefit of all Diners Club licensees. The licensees hold the primary liability to settle the transactions of their customers with these merchants. However, Diners Club retains a counterparty exposure if a licensee fails to meet its financial payment obligation to one of these merchants.
•ATM Guarantee. PULSE entered into contractual relationships with certain international
ATM acquirers in which DFS Services LLC retains counterparty exposure if an issuer fails to fulfill its settlement obligation.
•Global Network Alliance Guarantee. Discover Network, Diners Club and PULSE have entered into contractual relationships with certain international payment networks in which DFS Services LLC retains the counterparty exposure if a network fails to fulfill its settlement obligation.
The maximum potential amount of future payments related to such contingent obligations is dependent upon the transaction volume processed between the time a potential counterparty defaults on its settlement and the time at which the Company disables the settlement of any further transactions for the defaulting party. The
Company has some contractual remedies to offset these counterparty settlement exposures (such as letters of credit or pledged deposits), however, there is no limitation on the maximum amount the Company may be liable to pay.
The actual amount of the potential exposure cannot be quantified as the Company cannot determine whether particular counterparties will fail to meet their settlement obligations. In the event all licensees and/or issuers were to become unable to settle their transactions, the Company estimates its maximum potential counterparty exposures to these settlement guarantees would be approximately $i90
million as of September 30, 2023.
The Company believes that the estimated amounts of maximum potential future payments are not representative of the Company's actual potential loss exposure given Diners Club's and PULSE's insignificant historical losses from these counterparty exposures. As of September 30, 2023, the Company had inot
recorded any contingent liability in the condensed consolidated financial statements for these counterparty exposures and management believes that the probability of any payments under these arrangements is low.
Discover Network Merchant Chargeback Guarantees
The Company operates the Discover Network, issues payment cards and permits third parties to issue payment cards. The Company is contingently liable for certain transactions processed on the Discover Network in the event of a dispute between the payment card customer and a merchant. The contingent liability arises if the disputed transaction involves a merchant or merchant acquirer with whom the Discover Network has a direct relationship. If a dispute is
resolved in the customer's favor, the Discover Network will credit or refund the disputed amount to the Discover Network card issuer, who in turn credits its customer's account. The Discover Network will then charge back the disputed amount of the payment card transaction to the merchant or merchant acquirer, where permitted by the applicable agreement, to seek recovery of amounts already paid to the merchant for payment card transactions. If the Discover Network is unable to collect the amount subject to dispute from the merchant or merchant acquirer (e.g., in the event of merchant default or dissolution or after expiration of the time period for chargebacks in the applicable agreement), the Discover Network will bear the loss for the amount credited or refunded to the customer. In most instances, a loss by the Discover Network is unlikely to arise in connection with payments on card transactions because most products or services are delivered when purchased and credits
are issued by merchants on returned items in a timely fashion, thus minimizing the likelihood of cardholder disputes with respect to amounts paid by the Discover Network. However, where the product or service is not scheduled to be provided to the customer until a later date following the purchase, the likelihood of a contingent payment obligation by the Discover Network increases.Losses related to merchant chargebacks were not material for the three and nine months ended September 30, 2023 and 2022.
The maximum
potential amount of obligations of the Discover Network arising from such contingent obligations is estimated to be the portion of the total Discover Network transaction volume processed to date for which timely and valid disputes may be raised under applicable law and relevant issuer and customer agreements. There is no limitation on the maximum amount the Company may be liable to pay to issuers. However, the Company believes that such amount is not representative of the Company's actual potential loss exposure based on the Company's historical experience. The actual amount of the potential exposure cannot be quantified as the
Company cannot determine whether the current or cumulative transaction volumes may include or result in disputed transactions.
i
The following table summarizes certain information regarding merchant chargeback guarantees (dollars in millions):
(1)Represents
transactions processed on the Discover Network for which a potential liability exists that, in aggregate, can differ from credit card sales volume.
/
The Company did iino/t
record any contingent liability in the condensed consolidated financial statements for merchant chargeback guarantees as of September 30, 2023 and December 31, 2022. The Company mitigates the risk of potential loss exposure by withholding settlement from merchants, obtaining third-party guarantees, or obtaining escrow deposits or letters of credit from certain merchant acquirers or merchants that are considered a higher risk due to various factors such as time delays in the delivery of products or services. As of September 30, 2023 and December 31, 2022, the Company had escrow deposits and settlement
withholdings of $i10 million and $i11 million, respectively, which are recorded in interest-bearing deposit accounts and accrued expenses and other liabilities on the
Company's condensed consolidated statements of financial condition.
13. iLitigation and Regulatory Matters
In the normal course of business, from time to time, the Company has been named as a defendant in various legal actions, including arbitrations, class actions and other litigation, arising in connection with its activities. Certain of the actual
or threatened legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. The litigation process is not predictable and can lead to unexpected results. The Company contests liability and/or the amount of damages as appropriate in each pending matter.
The Company has historically offered its customers an arbitration clause in its customer agreements. The arbitration clause allows the Company and its customers to quickly and economically resolve disputes. Additionally, the arbitration clause has in some instances limited the costs of, and the
Company's exposure to, litigation. Future legal and regulatory challenges and prohibitions may cause the Company to discontinue its offering and use of such clauses. From time to time, the Company is involved in legal actions challenging its arbitration clause. Bills may be periodically introduced in Congress to directly or indirectly prohibit the use of pre-dispute arbitration clauses.
The Company is also involved, from time to time, in other reviews, investigations and proceedings (both formal and informal) by governmental agencies regarding the Company's business including, among
other matters, consumer regulatory, accounting, tax and other operational matters. The investigations and proceedings may result in significant adverse judgments, settlements, fines, penalties, injunctions, decreases in regulatory ratings, customer restitution or other relief. These outcomes could materially impact the Company's condensed consolidated financial statements, increase its cost of operations, or limit the Company's ability to execute its business strategies and engage in certain business activities. Certain subsidiaries of the Company are subject to consent orders with the Consumer Financial Protection Bureau
("CFPB") and FDIC, as described below. Pursuant to powers granted under federal banking laws, regulatory agencies have broad and sweeping discretion and may assess civil money penalties, require changes to certain business practices or require customer restitution at any time.
In accordance with applicable accounting guidance, the Company establishes an accrued liability for legal and regulatory matters when those matters present loss contingencies that are both probable and estimable. Litigation and regulatory settlement-related expenses were immaterial for the three and nine months ended September 30, 2023 and 2022.
There may be an exposure to loss in excess of any amounts accrued. The Company believes the estimate of the aggregate range of reasonably possible losses (meaning the likelihood of losses is more than remote but less than likely), in excess of the amounts that the Company has accrued for legal and regulatory proceedings, is up to $i230
million as of September 30, 2023. This estimated range of reasonably possible losses is based on currently available information for those proceedings in which the Company is involved and considers the Company's best estimate of such losses for those matters for which an estimate can be made. It does not represent the Company's maximum potential loss exposure. Various aspects of the legal proceedings underlying the estimated range will change from time to time and actual results may vary significantly from the estimate.
The Company's
estimated range noted above involves significant judgment, given the varying stages of the proceedings, the existence of numerous yet to be resolved issues, the breadth of the claims (often spanning multiple years and, in some cases, a wide range of business activities), unspecified damages and/or the novelty of the legal issues presented. The outcome of pending matters could adversely affect the Company's reputation and be material to the Company's condensed consolidated financial condition, operating results and cash flows for a particular future period, depending on, among other things, the level of the Company's income for such period.
In July 2015, the
Company announced that its subsidiaries, Discover Bank, The Student Loan Corporation and Discover Products Inc. (the "Discover Subsidiaries"), agreed to a consent order with the CFPB with respect to certain private student loan servicing practices (the “2015 Order”). The 2015 Order expired in July 2020. In December 2020, the Discover Subsidiaries agreed to a consent order (the “2020 Order”) with the CFPB resolving the agency’s investigation into Discover Bank’s compliance with the 2015 Order. In connection with the 2020 Order, Discover is required to implement a redress and compliance plan and must pay at least $i10 million
in consumer redress to consumers who may have been harmed and has paid a $i25 million civil money penalty to the CFPB.
On September 25, 2023, following the consent of the Board of Directors of Discover Bank, the FDIC issued a consent order (“consent order”) to Discover Bank. The consent order addresses shortcomings in Discover Bank’s compliance management system for consumer protection laws and related matters. As part of the consent order, Discover Bank has agreed to improve its consumer compliance
management system and enhance related corporate governance and enterprise risk management practices, and increase the level of Board oversight over such matters. Discover Bank has been taking significant steps to strengthen the organization’s compliance management system and address the other issues identified in the consent order. Management and the Board are committed to ensuring that all of the requirements of the consent order are met. The consent order does not contain any monetary penalties or fines.
On March 8, 2016, a class-action lawsuit was filed against the Company, other credit card networks, other issuing banks and EMVCo in the U.S. District Court for the Northern District of California (B&R Supermarket, Inc., d/b/a Milam's Market, et al. v. Visa, Inc. et al.) alleging a conspiracy
by defendants to shift fraud liability to merchants with the migration to the EMV security standard and chip technology. The plaintiffs assert joint and several liability among the defendants and seek unspecified damages, including treble damages, attorneys' fees, costs and injunctive relief. The Company filed its motion to compel arbitration, motion for summary judgment, and Daubert challenges on November 30, 2022, and awaits rulings. The Company is not in a position at this time to assess the likely outcome or its exposure, if any, with respect to this matter. However, the Company will seek to defend itself vigorously against all claims asserted by the plaintiffs.
Card
Product Misclassification
As reported in the second quarter of 2023, beginning in 2007, the Company incorrectly classified certain credit card accounts into its highest merchant and merchant acquirer pricing tier. The misclassification affected pricing for certain merchants and merchant acquirers, but not for cardholders. In the second quarter of 2023, the Company recorded a liability of $i365 million
within accrued expenses and other liabilities to provide refunds to merchants and merchant acquirers as a result of the card product misclassification. As of September 30, 2023, the balance of the liability was $i376 million, reflecting an additional $i11 million
for the estimated effect of the current price tiering on discount and interchange assessments for the third quarter. As of September 30, 2023, no disbursements had been made against this liability as the Company continues to develop its plan to provide refunds to merchants and merchant acquirers and engage in ongoing discussions about such plans with its regulators.
Management is taking actions to correct the card product misclassification going forward and to prepare a program to compensate affected merchants and merchant
acquirers. It is not possible to know with certainty the final amount of potential refunds at this time given differences in individual merchant agreements, changes in network terms and availability of historical data. Regulators may require refunds or other remediation that may result in other charges or an amount different than the Company’s current estimate.
The Company remains in discussions with its regulators regarding this matter. The Company expects these discussions will likely result in enforcement actions, which may include, among other remedies, monetary penalties, the amount of which cannot be estimated at this time.
In
addition, the Company and its subsidiaries have been named as defendants in various lawsuits, including putative class actions on behalf of affected merchants, a putative class action on behalf of shareholders and shareholder derivative actions. The Company also is cooperating with an SEC investigation into the card product misclassification matter.
14. iFair
Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Accounting Standards Codification ("ASC") Topic 820, Fair Value Measurement, provides a three-level hierarchy for classifying the inputs to valuation techniques used to measure fair value of financial instruments based on whether the inputs are observable or unobservable. It also requires certain disclosures about those measurements. The three-level valuation hierarchy is as follows:
•Level 1: Fair values determined by Level 1 inputs are defined as those that utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the
Company has the ability to access.
•Level 2: Fair values determined by Level 2 inputs are those that utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active or inactive markets, quoted prices for the identical assets in an inactive market and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. The Company evaluates factors such as the frequency of transactions, the size of the bid-ask spread and the significance of adjustments made when considering transactions involving similar assets or liabilities to assess
the relevance of those observed prices. If relevant and observable prices are available, the fair values of the related assets or liabilities would be classified as Level 2.
•Level 3: Fair values determined by Level 3 inputs are those based on unobservable inputs and include situations where there is little, if any, market activity for the asset or liability being valued. In instances where the inputs used to measure fair value may fall into different levels of the fair value hierarchy, the level in the fair value hierarchy in which the measurements are classified is based on the lowest level input that is significant to the fair value measurement in its entirety. Accordingly, the Company may utilize both observable and unobservable inputs in determining the fair values of financial instruments
classified within the Level 3 category.
The Company evaluates the classification of each fair value measurement within the hierarchy at least quarterly.
The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and involves consideration of factors specific to the asset or liability. Furthermore, certain techniques used to measure fair value involve some degree of judgment and, as a result, are not necessarily indicative of the amounts the Company would realize in a current market exchange.
Derivative financial instruments - fair value hedges(1)
$
i—
$
i2
$
i—
$
i2
.
(1)Derivative
instrument carrying values in an asset or liability position are presented as part of other assets or accrued expenses and other liabilities, respectively, in the Company's condensed consolidated statements of financial condition.
Investment securities classified as available-for-sale consist of U.S.
Treasury and U.S. GSE securities and RMBS. The fair value estimates of investment securities classified as Level 1, consisting of U.S. Treasury securities, are determined based on quoted market prices for the same securities. The fair value estimates of U.S. GSE securities and RMBS are classified as Level 2 and are valued by maximizing the use of relevant observable inputs, including quoted prices for similar securities, benchmark yield curves and market-corroborated inputs.
The Company validates the fair value estimates provided by pricing services primarily by comparing to valuations obtained through other pricing sources. The Company evaluates pricing variances among different pricing sources to ensure that the valuations utilized are reasonable. The
Company also corroborates the reasonableness of the fair value estimates with analysis of trends of significant inputs, such as market interest rate curves. The Company further performs due diligence in understanding the procedures and techniques performed by the pricing services to derive fair value estimates.
At September 30, 2023, amounts reported in RMBS reflect U.S. government agency and U.S. GSE obligations issued by Ginnie Mae, Fannie Mae and Freddie Mac with an aggregate par value of $i505
million, a weighted-average coupon of i4.08% and a weighted-average remaining maturity of ifour years.
Marketable Equity Securities
The
Company holds non-controlling equity positions in payment service entities that have actively traded stock and therefore have readily determinable fair values. The Company classifies these equity securities as Level 1, the fair value estimates of which are determined based on quoted share prices for the same securities.
Derivative Financial Instruments
The Company's derivative financial instruments consist of interest rate swaps and foreign exchange forward contracts. These instruments are classified as Level 2 as their fair values are estimated using proprietary pricing models, containing certain assumptions based
on readily observable market-based inputs, including interest rate curves, option volatility and foreign currency forward and spot rates. In determining fair values, the pricing models use widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity and the observable market-based inputs. The fair values of the interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments are based on an expectation of future interest rates derived from the observable market interest rate curves. The Company considers collateral and master netting agreements that mitigate
credit exposure to counterparties in determining the counterparty credit risk valuation adjustment. The fair values of the currency instruments are valued by comparing the contracted forward exchange rate pertaining to the specific contract maturities to the current market exchange rate.
The Company validates the fair value estimates of interest rate swaps primarily through comparison to the fair value estimates computed by the counterparties to each of the derivative transactions. The Company evaluates pricing variances among different pricing sources to ensure that the valuations utilized are reasonable. The
Company also corroborates the reasonableness of the fair value estimates with analysis of trends of significant inputs, such as market interest rate curves. The Company performs due diligence in understanding the impact of any changes to the valuation techniques performed by proprietary pricing models before implementation, working closely with the third-party valuation service and reviewing the service's control objectives at least annually. The Company corroborates the fair value of foreign exchange forward contracts through independent calculation of the fair value estimates.
Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis
The
Company also has assets that, under certain conditions, are subject to measurement at fair value on a non-recurring basis. These assets include those associated with acquired businesses, including goodwill. For these assets, measurement at fair value in periods subsequent to the initial recognition of the assets may be applicable whenever one is tested for impairment. iiNo/
impairments were recognized related to these assets during the three and nine months ended September 30, 2023 and 2022.
Financial Instruments Measured at Other Than Fair Value
i
The following tables disclose the estimated
fair value of the Company's financial assets and financial liabilities that are not required to be carried at fair value (dollars in millions):
Long-term
borrowings - owed to securitization investors
$
i—
$
i9,862
$
i84
$
i9,946
$
i10,259
Other
long-term borrowings
i—
i9,468
i—
i9,468
i9,849
Long-term
borrowings
$
i—
$
i19,330
$
i84
$
i19,414
$
i20,108
Carrying
value approximates fair value(1)
Accrued interest payables(2)
$
i—
$
i308
$
i—
$
i308
$
i308
(1)The
carrying values of these assets and liabilities approximate fair value due to their short-term nature.
(2)Accrued interest receivable and payable carrying values are presented as part of other assets and accrued expenses and other liabilities, respectively, in the Company's condensed consolidated statements of financial condition.
(3)Excludes deposits without contractually defined maturities for all periods presented.
The Company uses derivatives to manage its exposure to various financial risks. The Company does not enter into derivatives for trading or speculative purposes. Certain derivatives used to manage the
Company's exposure to foreign currency are not designated as hedges and do not qualify for hedge accounting.
Derivatives may give rise to counterparty credit risk, which generally is mitigated through collateral arrangements as described under the sub-heading "— Collateral Requirements and Credit-Risk Related Contingency Features."The Company enters into derivative transactions with established dealers that meet minimum credit criteria established by the Company. All counterparties must be pre-approved before engaging in any transaction with the Company. The Company regularly
monitors counterparties to ensure compliance with the Company's risk policies and limits. In determining the counterparty credit risk valuation adjustment for the fair values of derivatives, if any, the Company considers collateral and legally enforceable master netting agreements that mitigate credit exposure to related counterparties.
All derivatives are recorded in other assets at their gross positive fair values and in accrued expenses and other liabilities at their gross negative fair values. See Note 14: Fair Value Measurements for a description of the valuation methodologies used for derivatives. Cash collateral amounts associated with derivative positions that are cleared through an exchange are legally characterized as settlement of the derivative
positions. Such collateral amounts are reflected as offsets to the associated derivatives balances recorded in other assets or in accrued expenses and other liabilities. Other cash collateral posted and held balances are recorded in other assets and deposits, respectively, in the condensed consolidated statements of financial condition. Collateral amounts recorded in the condensed consolidated statements of financial condition are based on the net collateral posted or held position for each applicable legal entity's master netting arrangement with each counterparty.
Derivatives Designated as Hedges
Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows arising from changes in interest rates, or other types of forecasted transactions, are considered cash flow hedges. Derivatives designated and qualifying as a hedge of the exposure
to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges.
Cash Flow Hedges
The Company uses interest rate swaps to manage its exposure to variability in cash flows related to changes in interest rates on interest-earning assets and funding instruments. These interest rate swaps qualify for hedge accounting in accordance with ASC Topic 815, Derivatives and Hedging ("ASC 815"). At September 30, 2023 and December 31, 2022, the Company's outstanding cash
flow hedges primarily relate to interest receipts from credit card receivables and had an initial maximum period of ifour years and ithree years, respectively.
The change in the fair value of derivatives designated
as cash flow hedges is recorded in OCI and is subsequently reclassified into earnings in the period that the hedged forecasted cash flows affect earnings. Amounts reported in AOCI related to derivatives at September 30, 2023, will be reclassified to interest income and interest expense as interest receipts and payments are accrued on the Company's then outstanding credit card receivables and certain floating-rate debt, respectively. During the next 12 months, the Company estimates it will reclassify $i113
million into pretax earnings related to its cash flow hedges.
Fair Value Hedges
The Company is exposed to changes in the fair value of its fixed-rate debt obligations due to changes in interest rates. The Company uses interest rate swaps to manage its exposure to changes in the fair value of certain fixed-rate long-term borrowings, including securitized debt and bank notes, attributable to changes in the respective benchmark rates. These interest rate swaps qualify as fair value hedges in accordance with ASC 815. Changes in the fair values of both (i) the derivatives and (ii) the hedged long-term borrowings attributable to the interest-rate risk being hedged are recorded in interest expense. The changes generally
provide substantial offset to one another, with any difference recognized in interest expense.
The Company has foreign exchange forward contracts that are economic hedges and are not designated as accounting hedges. The
Company enters into foreign exchange forward contracts to manage foreign currency risk. Changes in the fair value of these contracts are recorded in other income on the condensed consolidated statements of income.
Derivatives Cleared Through an Exchange
Cash variation margin payments on derivatives cleared through an exchange are legally considered settlement payments and are accounted for with corresponding derivative positions as one unit of account and not presented separately as collateral. With settlement payments on derivative positions cleared through this exchange reflected as offsets to the associated derivative asset and liability balances, the fair values of derivative instruments and
collateral balances shown are generally reduced.
Derivatives Activity
i
The following table summarizes the fair value (including accrued interest) and outstanding notional amounts of derivative instruments and related collateral balances (dollars in millions):
(1)The
foreign exchange forward contracts have notional amounts of EUR ii6/
million, GBP ii6/ million, SGD ii1/
million, INR ii788/ million and AUD ii2/
million as of September 30, 2023 and December 31, 2022.
(2)In addition to the derivatives disclosed in the table, the Company enters into forward contracts to purchase when-issued mortgage-backed securities as part of its community reinvestment initiatives. At September 30, 2023, the Company had ino
outstanding contracts. At December 31, 2022, the Company had ione outstanding contract with a total notional amount of $i48
million and an immaterial fair value.
(3)Collateral amounts, which consist of cash and investment securities, are limited to the related derivative asset/liability balance and do not include excess collateral received/pledged.
/i
The following amounts were recorded on the statements of financial condition related to cumulative
basis adjustments for fair value hedges (dollars in millions):
Cumulative
Amount of Fair Value Hedging Adjustment (Decreasing) the Carrying Amount of Hedged Liabilities(1)
Carrying Amount of Hedged Liabilities
Cumulative Amount of Fair Value Hedging Adjustment (Decreasing) the Carrying Amount of Hedged Liabilities(1)
Long-term borrowings
$
i6,595
$
(i127)
$
i4,386
$
(i3)
(1)The
balance includes $i14 million and $i28 million of cumulative hedging
adjustments related to discontinued hedging relationships as of September 30, 2023 and December 31, 2022, respectively.
The
following table summarizes the impact of the derivative instruments on income and indicates where within the condensed consolidated financial statements such impact is reported (dollars in millions):
Location and Amount of (Losses) Gains Recognized on the Condensed Consolidated Statements of Income
Total
amounts of income and expense line items presented in the condensed consolidated statements of income, where the effects of fair value or cash flow hedges are recorded
$
(i225)
$
i3,726
$
i21
The
effects of cash flow and fair value hedging
Gains (losses) on fair value hedging relationships
Amounts reclassified from OCI into earnings
$
i2
$
(i31)
$
i—
Gains
(losses) on fair value hedging relationships
Total amounts of income and expense line items presented in the condensed consolidated statements of income, where the effects of fair value or cash flow hedges are recorded
$
(i168)
$
i2,783
$
i19
The
effects of cash flow and fair value hedging
Losses on cash flow hedging relationships
Amounts reclassified from OCI into earnings
$
(i1)
$
(i1)
$
i—
Gains
(losses) on fair value hedging relationships
Gains on hedged items
$
i3
$
i—
$
i—
Losses
on interest rate swaps
(i11)
i—
i—
Total
losses on fair value hedging relationships
$
(i8)
$
i—
$
i—
The
effects of derivatives not designated in hedging relationships
Total amounts of income and expense line items presented in the condensed consolidated statements of income, where the effects
of fair value or cash flow hedges are recorded
$
(i622)
$
i10,513
$
i71
The
effects of cash flow and fair value hedging
Gains (losses) on cash flow hedging relationships
Amounts reclassified from OCI into earnings
$
i6
$
(i56)
$
i—
Gains
(losses) on fair value hedging relationships
Total amounts of income and expense line items presented in the condensed consolidated statements of income, where the effects of fair value or cash flow hedges are recorded
$
(i416)
$
i7,475
$
i64
The
effects of cash flow and fair value hedging
Losses on cash flow hedging relationships
Amounts reclassified from OCI into earnings
$
(i3)
$
(i1)
$
i—
Gains
(losses) on fair value hedging relationships
Gains on hedged items
$
i72
$
i—
$
i—
Losses
on interest rate swaps
(i61)
i—
i—
Total
gains on fair value hedging relationships
$
i11
$
i—
$
i—
The
effects of derivatives not designated in hedging relationships
Gains on derivatives not designated as hedges
$
i—
$
i—
$
i2
For
the impact of the derivative instruments on OCI, see Note 8: Accumulated Other Comprehensive Income.
Collateral Requirements and Credit-Risk Related Contingency Features
The Company has master netting arrangements and minimum collateral posting thresholds with its counterparties for its fair value and cash flow hedge interest rate swaps and foreign exchange forward contracts. The Company has not sought a legal opinion in relation to the enforceability of its master netting arrangements and, as such, does not report any of these positions on a net basis.Collateral is required
by either the Company or its subsidiaries or the counterparty depending on the net fair value position of the derivatives held with that counterparty. These collateral receivable or payable amounts are generally not offset against the fair value of these derivatives but are recorded separately in other assets or deposits. Most of the Company's cash collateral amounts relate to positions cleared through an exchange and are reflected as offsets to the associated derivatives balances recorded in other assets and accrued expenses and other liabilities.
The Company also has agreements
with certain of its derivative counterparties that contain a provision under which the Company could be declared in default on any of its derivative obligations if the Company defaults on any of its indebtedness, including default where the lender has not accelerated repayment of the indebtedness.
The Company manages its business activities in itwo segments: Digital Banking and Payment Services.
•Digital Banking: The Digital Banking segment includes Discover-branded credit cards issued to individuals on the Discover Network and other consumer products and services, including private student loans, personal loans, home loans and other consumer lending and deposit products.
The majority of Digital Banking revenues relate to interest income earned on the segment's loan products. Additionally, the Company's credit card products generate substantially all revenues related to discount and interchange, protection products and loan fee income.
•Payment Services: The Payment Services segment includes PULSE, an automated teller machine, debit and electronic funds transfer network; Diners Club, a global payments network; and the Company's Network Partners business, which provides payment transaction processing and settlement services on the Discover Network. The majority of Payment Services revenues relate to transaction processing revenue from PULSE and royalty and licensee revenue from
Diners Club.
The business segment reporting provided to and used by the Company's chief operating decision-maker is prepared using the following principles and allocation conventions:
•The Company aggregates operating segments when determining reportable segments.
•Corporate overhead is not allocated between segments; all corporate overhead is included in the Digital Banking segment.
•Through its operation of the Discover Network, the Digital Banking segment incurs fixed marketing, servicing and infrastructure costs that are not specifically allocated among
the segments, except for an allocation of direct and incremental costs driven by the Company's Payment Services segment.
•The Company's assets are not allocated among the operating segments in the information reviewed by the Company's chief operating decision-maker.
•The revenues of each segment are derived from external sources. The segments do not earn revenue from intercompany sources.
•Income taxes are not specifically allocated between the operating segments in the information reviewed by the
Company's chief operating decision maker.
ASC Topic 606, Revenue from Contracts with Customers ("ASC 606"), generally applies to the sales of any good or service for which no other specific accounting guidance is provided. ASC 606 defines a principles-based model under which revenue from
a contract is allocated to the distinct performance obligations within the contract and recognized in income as each performance obligation is satisfied. The Company's revenue that is subject to this model includes discount and interchange, protection products fees, transaction processing revenue and certain amounts classified as other income.
i
The
following table presents revenue from contracts with customers disaggregated by business segment and reconciles revenue from contracts with customers to total other income (dollars in millions):
(1)Net
of rewards, including Cashback Bonus rewards, of $i787 million and $i811 million for the three months ended September 30, 2023 and 2022, respectively,
and $i2.3 billion and $i2.2 billion for the nine months ended September 30, 2023 and 2022. respectively.
(2)Excludes
$i3 million and $i13 million of deposit product fees that are reported within net interest income for the three and
nine months ended September 30, 2023, respectively. Deposit product fees were immaterial for the three and nine months ended September 30, 2022.
For a detailed description of the Company's significant revenue recognition accounting policies, see Note 2: Summary of Significant Accounting Policies to the consolidated financial statements in the Company's annual report on Form 10-K for the year ended December 31, 2022.
18. iImmaterial Restatement of Prior Period Financial Statements
As reported in the second quarter of 2023, beginning in 2007, the Company incorrectly classified certain credit card accounts into its highest merchant and merchant acquirer pricing tier. The card product classification impacts the pricing and charging of discount and interchange revenue, which is recorded within discount and interchange revenue, net, on the consolidated statements of income. The
Company determined the revenue impact of the incorrect card product classification was immaterial to the consolidated financial statements for all impacted prior periods. For comparative purposes, the Company has made these immaterial corrections to the recognition of discount and interchange revenue, as well as the related impacts to assets, liabilities and retained earnings in the prior periods presented in this Form 10-Q. Assets were impacted by adjustments to deferred tax assets, and liabilities were impacted by an adjustment to the liability for estimated refunds to merchants and merchant acquirers.
i
The
prior period impacts to the Company's consolidated statement of financial condition were as shown below (dollars in millions):
The
prior period impacts to the Company's consolidated statements of income and the related impacts to the consolidated statements of comprehensive income were as shown below (dollars in millions):
Adjustments
to reconcile net income to net cash provided by operating activities:
Deferred income taxes
$
(i314)
$
(i3)
$
(i317)
Changes
in assets and liabilities:
Increase in accrued expenses and liabilities
$
i312
$
i13
$
i325
Net
cash provided by operating activities
$
i4,965
$
i—
$
i4,965
19. iSubsequent
Events
The Company has evaluated events and transactions that have occurred subsequent to September 30, 2023, and determined that there were no subsequent events that would require recognition or disclosure in the condensed consolidated financial statements.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The
following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this quarterly report. This quarterly report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements, which speak to our expected business and financial performance, among other matters, contain words such as "believe,""expect,""anticipate,""intend,""plan,""aim,""will,""may,""should,""could,""would,""likely,""forecast," and similar expressions. Such statements are based on the current beliefs and expectations of our management and are subject to significant risks and uncertainties. Actual results may differ materially from those set forth in the forward-looking statements. These forward-looking
statements speak only as of the date of this quarterly report and there is no undertaking to update or revise them as more information becomes available.
The following factors, among others, could cause actual results to differ materially from those set forth in the forward-looking statements: changes in economic variables, such as the availability of consumer credit, the housing market, energy costs, the number and size of personal bankruptcy filings, the rate of unemployment, the levels of consumer confidence and consumer debt and investor sentiment; the impact of current, pending and future legislation, regulation, supervisory guidance and regulatory and legal actions, including, but not limited to, those related to accounting guidance, tax reform, financial regulatory reform, consumer financial services practices, anti-corruption and funding, capital and liquidity; the actions and initiatives of current and potential competitors;
our ability to manage our expenses; our ability to successfully achieve card acceptance across our networks and maintain relationships with network participants and merchants; our ability to sustain and grow our private student loan, personal loan and home loan products; difficulty obtaining regulatory approval for, financing, closing, transitioning, integrating or managing the expenses of acquisitions of or investments in new businesses, products or technologies; our ability to manage our credit risk, market risk, liquidity risk, operational risk, legal and compliance risk and strategic risk; the availability and cost of funding and capital; access to deposit, securitization, equity, debt and credit markets; the impact of rating agency actions; the level and volatility of equity prices, commodity prices and interest rates, currency values, investments, other market fluctuations and other market indices; losses in our investment portfolio; limits on our ability to pay
dividends and repurchase our common stock; limits on our ability to receive payments from our subsidiaries; fraudulent activities or material security breaches of our or others' key systems; our ability to remain organizationally effective; our ability to increase or sustain Discover card usage or attract new customers; our ability to maintain relationships with merchants; the effect of political, economic and market conditions, geopolitical events, climate change, pandemics and unforeseen or catastrophic events; our ability to introduce new products and services; our ability to manage our relationships with third-party vendors, as well as those with which we have no direct relationship such as our employees' internet service providers; our ability to maintain current technology and integrate new and acquired systems and technology; our ability to collect amounts for disputed
transactions from merchants and merchant acquirers; our ability to attract and retain employees; our ability to protect our reputation and our intellectual property; our ability to comply with regulatory requirements; and new lawsuits, investigations or similar matters or unanticipated developments related to current matters. We routinely evaluate and may pursue acquisitions of or investments in businesses, products, technologies, loan portfolios or deposits, which may involve payment in cash or our debt or equity securities.
Additional factors that could cause our results to differ materially from those described below can be found in this section of this quarterly report and in "Risk Factors,""Business," and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our annual report on Form 10-K for the year ended December
31, 2022, which is filed with the Securities and Exchange Commission ("SEC") and available at the SEC's internet site (https://www.sec.gov).
Discover Financial Services ("DFS") is a digital banking and payment services company. We provide digital banking products and services and payment services through our subsidiaries. We offer our customers credit card loans,
private student loans, personal loans, home loans and deposit products. We also operate the Discover Network, the PULSE network ("PULSE") and Diners Club International ("Diners Club"), collectively known as the Discover Global Network. The Discover Network processes transactions for Discover-branded credit and debit cards and provides payment transaction processing and settlement services. PULSE operates an electronic funds transfer network, providing financial institutions issuing debit cards on the PULSE network with access to ATMs domestically and internationally and merchant acceptance throughout the United States of America ("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 and charge cards and/or provide card acceptance services.
Our primary revenues consist of interest income
earned on loan receivables and fees earned from customers, financial institutions, merchants and issuers. The primary expenses required to operate our business include funding costs (interest expense), credit loss provisions, customer rewards and expenses incurred to grow, manage and service our loan receivables and networks. Our business activities are funded primarily through consumer deposits, securitization of loan receivables and the issuance of unsecured debt.
Quarter Highlights
The highlights below compare results as of and for the three months ended September 30, 2023, against results for the same period in the prior year.
•Net income was
$683 million, or $2.59 per diluted share, compared to net income of $1.0 billion, or $3.56 per diluted share, in the prior year.
•Total loans grew $17.8 billion, or 17%, to $122.7 billion.
•Credit card loans grew $13.8 billion, or 16%, to $97.4 billion.
•The net charge-off rate for credit card loans increased 211 basis points to 4.03% and the delinquency rate for credit card loans over 30 days past due increased 130 basis points to 3.41%.
•Direct-to-consumer deposits grew $15.0 billion, or 23%, to $81.2 billion.
•Payment Services transaction volume for the segment was $91.8 billion, up 9%.
Outlook
The
outlook below provides our current expectations for our financial results based on market conditions, the regulatory and legal environment and our business strategies.
•We expect continued loan growth driven by moderation in the payment rate, recent account growth and our current expectation of sales trends.
•Based on the current interest rate environment, net interest margin is expected to be relatively flat in comparison to 2022.
•We expect the total net charge-off rate to increase, in comparison to the prior year, driven by the seasoning of recent vintages with higher delinquencies.
•Total expenses are expected to increase, driven by investments in acquisition and brand, compliance and risk management
capabilities, technology and analytics. We remain committed to managing expenses while continuing to make investments in profitable long-term growth.
As a bank holding company, DFS is subject to mandatory supervisory stress tests every other year and is required to submit annual capital plans to the Federal Reserve based on
forward-looking internal analysis of income and capital levels under baseline and stressful conditions. DFS is also subject to capital buffer requirements, including the Stress Capital Buffer ("SCB"), which requires maintaining regulatory capital levels above a threshold based on the results of supervisory stress tests after accounting for planned dividend payments.
In January 2021, the Federal Reserve finalized regulatory amendments that made targeted changes to the capital planning, regulatory reporting and SCB requirements for firms subject to Category IV standards, including DFS, to be consistent with the Federal Reserve’s regulatory tailoring framework. The final rules generally align to instructions the Federal Reserve previously provided to Category IV firms regarding their respective capital plan submissions. The amended rules also provide Category IV firms with the option to submit to supervisory stress tests
during off years if they wish for the Federal Reserve to reset the stress test portion of their SCB requirement. The Federal Reserve also revised the scope of application of its existing regulatory guidance for capital planning to align with the tailoring framework. However, the timing and substance of any additional changes to existing guidance or new guidance are uncertain. Moreover, following the failure of two domestic banks during March 2023, members of Congress, the President of the United States and various bank regulatory authorities have made public statements indicating a desire for additional prudential regulation for Category IV firms like DFS.
In July 2023, the Federal Reserve, the Office of the Comptroller of the Currency ("OCC") and the Federal Deposit Insurance Corporation ("FDIC") issued a proposal to amend the risk-based capital framework, which includes replacing the current "advanced approach"
with a new expanded risk-based approach. In addition, the proposal introduces new standardized approaches for credit risk, operational risk and credit valuation adjustment risk, and would significantly revise risk-based capital requirements for all banking institutions with assets of $100 billion or more, including DFS. If adopted, the new requirements would be effective July 1, 2025 with a three-year transition period.
In August 2023, the Federal Reserve, the FDIC and the OCC (the “Agencies”) issued a proposal that would require banking institutions in Categories II through IV of the tailoring framework, including DFS, and their insured depository institution subsidiaries with $100 billion or more in assets such as Discover Bank, to have
minimum levels of outstanding long-term debt. Under the proposed rule, a covered banking institution would be required to have a minimum outstanding amount of eligible long-term debt that is at least 6% of the institution’s total risk-weighted assets, 2.5% of its total leverage exposure (if it is required to maintain a minimum supplementary leverage ratio) and 3.5% of its average total consolidated assets, whichever is greater. If adopted, banking institutions would have three years to comply with the new requirements, though the Agencies would retain the authority to accelerate or extend the transition period.
While we cannot currently predict the timing or substance of the finalization of these proposals or other regulatory changes, if any such change were adopted, it could present changes to some or all of the regulatory tailoring currently applicable to DFS, otherwise tighten the prudential
regulatory requirements that would apply to DFS and increase our expenses.
In June 2022, the Federal Reserve released results of the 2022 Comprehensive Capital Analysis and Review ("CCAR") exercise. Our capital levels demonstrated resiliency under stress, staying well above regulatory minimums. Based on these results, in August 2022, our new SCB was set at 2.5%, the lowest possible requirement. This new SCB was effective October 1, 2022, through September 30, 2023. In accordance with the capital plan rule amendments, we elected not to participate in the 2023 supervisory stress tests. Nevertheless, on April 5, 2023, we submitted to the Federal Reserve a capital plan based on a forward-looking internal assessment of income and capital under baseline and stressful conditions.
On July 27, 2023, the Federal Reserve disclosed that our SCB was unchanged at 2.5%, effective beginning October 1, 2023 through September 30, 2024.
In March 2021, the United Kingdom's Financial Conduct Authority ("FCA") announced that it would no longer encourage or compel banks to continue to contribute quotes and maintain the London Interbank Offered Rate ("LIBOR") after December
31, 2021, and the most commonly used U.S. dollar ("USD") LIBOR settings ceased to be published on a representative basis in July 2023.
On December 16, 2022, the Federal Reserve adopted a final rule, which became effective on February 27, 2023, implementing the Adjustable Interest Rate (LIBOR) Act ("LIBOR Act"), which provides a statutory framework to replace LIBOR with a benchmark rate based on the Secured Overnight Financing Rate ("SOFR") for contracts governed by U.S. law that do not have fallback provisions or that have fallback provisions resulting in a replacement rate based on LIBOR.
In connection with the transition, $1.8 billion of our LIBOR-based capital markets
securities transitioned to the corresponding tenor for Chicago Mercantile Exchange ("CME") Term SOFR Reference Rate plus the applicable tenor spread adjustment in a manner consistent with the LIBOR Act and the regulation implementing the LIBOR Act. Additionally, approximately $500 million of Discover Bank's subordinated notes not covered under the LIBOR Act reset in August 2023 consistent with their fallback provisions.
As of September 30, 2023, LIBOR-indexed variable-rate loans comprised approximately 33% of our private student loan portfolio and approximately 3% of our aggregate loan portfolio. These outstanding private student loans converted to a SOFR index in October 2023. As of November 2021, we no longer originate new variable-rate student loans indexed to LIBOR. Instead, new originations of such loans are indexed solely to 3-month term SOFR, as published by the
CME.
For additional information regarding the replacement of LIBOR and other benchmark rates, see "Management’s Discussion and Analysis of Financial Condition and Results of Operations — Regulatory Environment and Developments — Banking — London Interbank Offered Rate" in our annual report on Form 10-K for the year ended December 31, 2022.
Consumer Financial Services
The CFPB regulates consumer financial products and services and examines certain providers of consumer financial products and services, including Discover. The CFPB's authority includes rulemaking, supervisory and enforcement powers with respect to federal consumer protection laws; preventing "unfair, deceptive or abusive acts or practices" ("UDAAP") and ensuring that consumers have access to fair and transparent
financial products and services. Historically, the CFPB's policy priorities focused on several financial products of the type we offer (e.g., credit cards and other consumer lending products). In addition, the CFPB is required by statute to undertake certain actions including its biennial review of the consumer credit card market.
The CFPB’s priorities have continued to focus on, among other things, increased enforcement of existing consumer protection laws, with a particular focus on fees charged to consumers, UDAAP, fair lending, student lending and servicing, debt collection and credit reporting. Additionally, detection of repeat offenders, such as companies that violate a formal court or agency order, has also become a priority for the CFPB. Director Chopra, in March 2022, identified, as repeat offenders, several companies that have had multiple enforcement actions, including Discover. The CFPB has recently taken action
against financial institutions for violating prior enforcement actions. In December 2020, certain of our subsidiaries entered into a consent order with the CFPB regarding identified private student loan servicing practices. See Note 13: Litigation and Regulatory Matters to our condensed consolidated financial statements for more information.
On February 1, 2023, the CFPB proposed a rule to alter Regulation Z’s late fee standards that includes caps on fees for late payments, which could result in increased cardholder delinquencies and credit losses.
Enhanced regulatory requirements, potential supervisory findings, or enforcement actions and ratings could negatively impact our ability to implement certain consumer-focused enhancements to product
features and functionality and business strategies, limit or change our business practices, limit our consumer product offerings, cause us to invest more management time and resources in compliance efforts or limit our ability to obtain related required regulatory approvals. The additional expense, time and resources needed to comply with ongoing or new regulatory requirements may adversely impact the cost of and access to credit for consumers and results of business operations.
Policymakers at the federal and state levels remain focused on enhancing data security and data breach incident
response requirements. Furthermore, regulations and legislation at various levels of government continue to be proposed and enacted to augment consumer data privacy standards and require companies to assess and/or disclose cybersecurity metrics, risks, opportunities, policies and practice. At the federal level, Discover is subject to the Gramm-Leach-Bliley Act ("GLBA") and its implementing regulations and guidance, which regulate Discover's use and disclosure of our consumers' nonpublic personal information ("NPI"). At the state level, the California Consumer Privacy Act ("CCPA"), which became effective in 2020, created a broad set of privacy rights and remedies. The California Privacy Rights Act ("CPRA"), which became effective on January 1, 2023, amends the CCPA, enhancing consumer privacy protections and creating a new California Privacy Protection Agency ("CPPA"). A California court
recently issued an order delaying enforcement of the CPRA regulations from July 1, 2023, until March 29, 2024, although the CPPA may still decide to enforce the provisions of the CCPA, as amended. By the end of 2023, thirteen U.S. states will have passed comprehensive privacy laws, with five of those laws effective in California, Colorado, Connecticut, Utah and Virginia. These laws exempt either NPI or financial institutions subject to the GLBA from their scope, so the impact of these state privacy laws on several Discover businesses is limited. We continue to evaluate the impact of the CCPA, as well as other federal and state laws, on our businesses and other providers of consumer financial services, including laws regulating the capture and use of consumer biometrics. For more information on the impact to Discover of data security and privacy laws on regulation, see
"Supervision and Regulation" and "Risk Factors" to our consolidated financial statements in our annual report on Form 10-K for the year ended December 31, 2022.
Environmental, Social and Governance Matters
Environmental, social and governance ("ESG") issues, including climate change, human capital and governance practices, are a significant area of focus by U.S. federal, state and international lawmakers and regulatory agencies, as well as shareholders and other stakeholders. In recent months, there have been substantial legislative and regulatory developments on such issues, including proposed, issued or implemented legislation and rulemakings that would require companies to assess and/or disclose climate and other ESG metrics, risks, opportunities, policies and practice. For example, in March 2022, the Securities
and Exchange Commission proposed climate-related disclosure requirements. The potential impact to us of these legislative and regulatory developments is uncertain at this time, although we expect that the emerging legal and regulatory requirements on ESG issues will result in additional compliance and reporting costs to us.
We continue to monitor and assess the potential impact of these legislative and regulatory developments.
We manage our business
activities in two segments, Digital Banking and Payment Services, based on the products and services provided. For a detailed description of the operations of each segment, as well as the allocation conventions used in our business segment reporting, see Note 16: Segment Disclosures to our condensed consolidated financial statements.
The following table presents segment data (dollars in millions):
(1)Diners Club volume is derived from
data provided by licensees for Diners Club branded cards issued outside North America and is subject to subsequent revision or amendment.
(2)Represents gross Discover card sales volume on the Discover Network.
(3)Represents Discover card activity related to sales net of returns, balance transfers, cash advances and other activity.
(4)Represents Discover card activity related to sales net of returns.
Our
Digital Banking segment reported pretax income of $803 million and $3.1 billion, respectively, for the three and nine months ended September 30, 2023, as compared to $1.3 billion and $4.4 billion, respectively, for the three and nine months ended September 30, 2022.
Net interest income increased for the three and nine months ended September 30, 2023, as compared to the same periods in 2022, primarily driven by a higher yield on loans and a higher average level of loan receivables, partially offset by higher funding costs. Interest income increased for the three and nine months ended September 30, 2023, as compared to the same periods in 2022, primarily due to higher market rates and a higher average level of loan receivables. Interest
expense increased for the three and nine months ended September 30, 2023, as compared to the same periods in 2022, primarily due to higher funding costs driven by higher market rates and a larger funding base.
For the three and nine months ended September 30, 2023, the provision for credit losses increased as compared to the same periods in 2022, primarily driven by loan growth, increasing delinquencies, and macroeconomic variables impacting household cash flows. For a detailed discussion on provision for credit losses, see "— Loan Quality — Provision and Allowance for Credit Losses."
Total other income for the Digital Banking segment increased for the three months ended September 30, 2023, as compared to the same periods in 2022,
primarily due to increases in net discount and interchange revenue and loan fee income. The increase in net discount and interchange revenue was primarily driven by lower rewards due to lower promotional rewards. Loan fee income increased primarily due to a higher volume of late payments. Total other income increased for the nine months ended September 30, 2023, as compared to the same period in 2022, primarily due to increases in loan fee income and net discount and interchange revenue. Loan fee income increased primarily due to a higher volume of late payments. The increase in net discount and interchange revenue was partially offset by an increase in rewards, both of which were driven by higher sales volume.
Total other expense increased for the three months ended September 30, 2023, as compared to the same period in 2022,
primarily due to increases in professional fees, information processing and communications and employee compensation and benefits. Professional fees increased primarily due to increased consulting supporting consumer compliance initiatives. The increase in information processing and communications was driven primarily from investments in technology. The increase in employee compensation and benefits was driven primarily by higher headcount.
Total other expense increased for the nine months ended September 30, 2023, as compared to the same period in 2022, primarily due to increases in employee compensation and benefits, professional fees, marketing and business development and information processing and communications. The increase in employee compensation and benefits was driven primarily by higher headcount. Professional fees increased primarily due to increased consulting
supporting consumer compliance initiatives. The marketing and business development increase was due primarily from growth investments in consumer banking products. The increase in information processing and communications was driven primarily from software write-downs and investments in technology.
Discover card sales volume was $55.0 billion and $160.8 billion, respectively, for the three and nine months ended September 30, 2023, which was an increase of 0.3% and 3.7%, respectively, as compared to the same periods in 2022. Volume was relatively flat for the three months ended September 30, 2023. For the nine months ended September 30, 2023, the volume growth was primarily driven by higher consumer spending.
Payment Services
Our
Payment Services segment reported pretax income of $85 million and $202 million, respectively, for the three and nine months ended September 30, 2023, as compared to pretax income of $53 million and a pretax loss of $28 million, respectively, for the same periods in 2022. The increase in segment pretax income for the three months ended September 30, 2023, was driven primarily from an increase in transaction processing revenue in the current period and losses on equity investments in the prior period. Transaction processing revenue increased primarily from higher volume. The losses on equity investments in the prior period were the result of larger mark-to-market adjustments for equity investments measured at fair value.
The increase in segment pretax income for the nine months ended September
30, 2023, was primarily due to losses on equity investments in the prior period, which were the result of larger mark-to-market adjustments for equity investments measured at fair value.
In preparing our consolidated financial statements in conformity with accounting principles generally accepted in the U.S. ("GAAP"), management must make judgments and use estimates and assumptions about the effects of matters that are uncertain. For estimates that involve
a high degree of judgment and subjectivity, it is possible that different estimates could reasonably be derived for the same period. For estimates that are particularly sensitive to changes in economic or market conditions, significant changes to the estimated amount from period to period are also possible. Management believes the current assumptions and other considerations used to estimate amounts reflected in our consolidated financial statements are appropriate. However, if actual experience differs from the assumptions and other considerations used in estimating amounts in our consolidated financial statements, the resulting changes could have a material effect on our consolidated results of operations and, in certain cases, could have a material effect on our consolidated financial condition. Management has identified the estimates related to our allowance for credit losses as a critical accounting estimate.
Allowance
for Credit Losses
The allowance for credit losses was $8.7 billion at September 30, 2023, which reflects a $601 millionbuild from the amount of the allowance for credit losses at June 30, 2023. The allowance for credit losses represents management’s estimate of expected credit losses over the remaining expected life of our financial assets measured at amortized cost. Changes in the allowance for credit losses, and in the related provision for credit losses, can materially affect net income.
In estimating the expected credit losses, we use a combination of statistical models and qualitative analysis. There is a significant amount of judgment applied in selecting inputs and analyzing the results produced to estimate the allowance for credit
losses. For more information on these judgments and our accounting policies and methodologies used to determine the allowance for credit losses, see "Management's Discussion and Analysis of Financial Condition and Results of Operations — Loan Quality," Note 4: Loan Receivables and Note 2: Summary of Significant Accounting Policies to our consolidated financial statements in our annual report on Form 10-K for the year ended December 31, 2022.
One of the key assumptions requiring significant judgment in estimating the current expected credit losses ("CECL") on a quarterly basis is the determination of the macroeconomic forecasts used in the loss forecast models. For the reasonable and supportable loss forecast period, we consider forecasts of multiple economic scenarios that generally include a base scenario with one or more optimistic (upside) or pessimistic (downside)
scenarios. These scenarios comprise a variety of macroeconomic variables, including annualized gross domestic product growth and unemployment rate. The scenarios that are chosen each quarter and the amount of weighting given to each scenario depend on a variety of factors including recent economic events, leading economic indicators, views of internal and third-party economists and industry trends. Assumptions about the macroeconomic environment are inherently uncertain and, as a result, actual changes in the allowance for credit losses may be different from the simulated scenario presented below.
To demonstrate the sensitivity of the estimated credit losses to the macroeconomic scenarios, we measured the impact of altering the weighting of macroeconomic scenarios used in our loss forecast. Our allowance for credit losses would increase by approximately $587 million at September 30,
2023 if we applied 100% weight to the most adverse scenario in our sensitivity analysis to reflect continued inflationary pressures, including persistent supply-chain disruptions and the influence of geopolitical events, as well as high interest rates and reduced credit availability.
The sensitivity disclosed above is hypothetical. It is difficult to estimate how potential changes in any one factor or input, such as the weighting of macroeconomic forecasts, might affect the overall allowance for credit losses because we consider a variety of factors and inputs in estimating the allowance for credit losses. The macroeconomic scenarios used are constructed with interrelated projections of multiple economic variables and loss estimates are produced that consider the historical correlation of those economic variables with credit losses. The inputs in the macroeconomic scenarios may not change at the same rate and may not be
consistent across all geographies or product types, and changes in factors and inputs may be directionally inconsistent, such that improvement in one factor or input may offset deterioration in others. As a result, the sensitivity analysis above does not necessarily reflect the nature and extent of future changes in the allowance for credit losses. It is intended to provide insights into the impact of different judgments about the economy on our modeled loss estimates for the loan portfolio and does not imply any expectation of future losses. Furthermore, the hypothetical increase in our allowance for credit losses for loans does not incorporate the impact of management judgment for qualitative factors applied in the current allowance for credit losses, which may have a positive or negative effect on our actual financial condition and results of operations.
The overall economic environment directly impacts the macroeconomic variables that are used in the loss forecast models. If management used different assumptions about the economic environment in estimating expected credit losses, the impact to the allowance for credit losses could have a material effect on our consolidated financial condition and results of operations. In addition, if we experience significant instability in the economic environment, the uncertainty around the credit loss forecasts may increase, both due to the uncertainty of the economic forecasts and the challenges our models may have in incorporating them.
Earnings Summary
The following table outlines changes in our condensed consolidated
statements of income (dollars in millions):
The tables that follow this section have been provided to supplement the discussion below and provide further analysis of net interest income, net interest margin and the impact of rate and volume changes on net interest income. Net interest income represents the difference between interest income earned on our interest-earning assets and the interest expense incurred to finance those assets. We analyze net interest income in total by calculating net interest margin (net interest income as a percentage of average total loan receivables) and net yield on interest-earning assets (net interest income as a percentage of average total interest-earning assets). We also separately consider the impact of the level of loan receivables and the related interest yield and the impact of the cost of funds related to each of our funding sources, along with
the income generated by our liquidity portfolio, on net interest income.
Our interest-earning assets consist of: (i) cash and cash equivalents primarily related to amounts on deposit with the Federal Reserve Bank of Philadelphia, (ii) restricted cash, (iii) other short-term investments, (iv) investment securities and (v) loan receivables. Our interest-bearing liabilities consist primarily of deposits, both direct-to-consumer and brokered, and long-term borrowings, including amounts owed to securitization investors. The following factors influence net interest income:
•The level and composition of loan receivables, including the proportion of credit card loans to other loans, as well as the proportion of loan receivables bearing interest at promotional rates as compared to standard rates;
•The
credit performance of our loans, particularly with regard to charge-offs of finance charges, which reduce interest income;
•The terms of long-term borrowings and certificates of deposit upon initial offering, including maturity and interest rate;
•The interest rates necessary to attract and maintain direct-to-consumer deposits;
•The level and composition of other interest-earning assets, including our liquidity portfolio, and interest-bearing liabilities;
•Changes in the interest rate environment, including the levels of interest rates and the relationships among interest rate indices, such as the prime rate, the federal funds rate, the interest rate on reserve balances, LIBOR and SOFR; and
•The
effectiveness of interest rate swaps in our interest rate risk management program.
Net interest income increased for the three and nine months ended September 30, 2023, as compared to the same periods in 2022, primarily driven by a higher yield on loans and a higher average level of loan receivables, partially offset by higher funding costs. Interest income increased for the three and nine months ended September 30, 2023, as compared to the same periods in 2022, primarily due to higher market rates and a higher average level of loan receivables. Interest expense increased for the three and nine months ended September 30, 2023, as compared to the same periods in 2022, primarily due to higher funding costs driven by higher market rates and a larger funding base.
(1)Average
balances of loan receivables and yield calculations include non-accruing loans. If the non-accruing loan balances were excluded, there would not be a material impact on the amounts reported above.
(2)Interest income on credit card loans includes $121 million and $99 million of amortization of balance transfer fees for the three months ended September 30, 2023 and 2022, respectively, and $335 million and $261 million for the nine months ended September 30, 2023 and 2022, respectively.
(3)Includes the impact of interest rate swap agreements used to change a portion of floating-rate assets to fixed-rate assets for the three and nine months
ended September 30, 2023 and 2022.
(4)The return on average assets, based on net income, was 0.48% and 0.85% for the three months ended September 30, 2023 and 2022, respectively, and 1.88% and 3.00% for the nine months ended September 30, 2023 and 2022, respectively.
(5)Includes the impact of one terminated derivative formerly designated as a cash flow hedge for the three and nine months ended September 30, 2023 and 2022.
(6)Includes
the impact of interest rate swap agreements used to change a portion of fixed-rate funding to floating-rate funding for the three and nine months ended September 30, 2023 and 2022.
(7)Includes the impact of terminated derivatives formerly designated as fair value hedges for the three and nine months ended September 30, 2023 and 2022.
(8)Includes the impact of interest rate swap agreements used to change a portion of floating-rate funding to fixed-rate funding for the three and nine months ended September 30, 2023 and 2022.
(9)The
return on average stockholders' equity, based on net income, was 19% and 29% for the three months ended September 30, 2023 and 2022, respectively, and 24% and 33% for the nine months ended September 30, 2023 and 2022, respectively.
(10)Net interest margin represents net interest income as a percentage of average total loan receivables.
(11)Net yield on interest-earning assets represents net interest income as a percentage of average total interest-earning assets.
(12)Interest rate spread represents the difference between the rate on total interest-earning assets and the
rate on total interest-bearing liabilities.
Provision for credit
losses is the expense related to maintaining the allowance for credit losses at an appropriate level to absorb the estimate of credit losses anticipated over the remaining expected life of loan receivables at each period end date. In deriving the estimate of expected credit losses, we consider the collectability of principal, interest and fees associated with our loan receivables. We also consider expected recoveries of amounts that were either previously charged-off or are expected to be charged-off. Establishing the estimate for expected credit losses requires significant management judgment. The factors that influence the provision for credit losses include:
•Increases or decreases in outstanding loan balances, including:
•Changes in consumer spending, payment and credit utilization behaviors;
•The
level of new account and loan originations and loan maturities; and
•Changes in the overall mix of accounts and products within the portfolio;
•The credit quality of the loan portfolio, which reflects our credit granting practices and the effectiveness of collection efforts, among other factors;
•The impact of general economic conditions on the consumer, including national and regional conditions, unemployment levels, bankruptcy trends and interest rate movements;
•The level and direction of historical losses; and
•Regulatory changes or new regulatory guidance.
Refer to "Management's Discussion
and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates — Allowance for Credit Losses" and Note 3: Loan Receivables to our condensed consolidated financial statements for more details on how we estimate the allowance for credit losses.
(1)Excludes
a $31 million and $30 million adjustment of the liability for expected credit losses on unfunded commitments for the three months ended September 30, 2023 and 2022, respectively, and $6 million and $1 million for the nine months ended September 30, 2023 and 2022, respectively, as the liability is recorded in accrued expenses and other liabilities in our condensed consolidated statements of financial condition.
(2)Represents the adjustment to the allowance for credit losses as a result of the adoption of ASU No. 2022-02 on January 1, 2023.
The allowance for credit losses was approximately $8.7 billion at September 30,
2023, which reflects a $601 millionbuild over June 30, 2023, and a $1.3 billion build from December 31, 2022. Thebuildin the allowance for credit losses for the three and nine months ended September 30, 2023 was primarily driven by loan growth, increasing delinquencies, and macroeconomic variables impacting household cash flows.
The allowance estimation process begins
with a loss forecast that uses certain macroeconomic variables and multiple macroeconomic scenarios among its inputs. In estimating the allowance at September 30, 2023, we used a macroeconomic forecast that projected the following weighted average amounts: (i) unemployment rate ending 2023 at 3.8% and peaking at 4.2% in the fourth quarter of 2024 and (ii) 2.02% growth rate in real gross domestic product in 2023.
In estimating expected credit losses, we considered the uncertainties associated with borrower behavior and payment trends, as well as recent and expected macroeconomic conditions, such as high consumer price inflation and the fiscal and monetary policy responses to that inflation. The Federal Reserve raised its federal funds rate target range substantially during 2022 and the first three quarters of 2023 in an effort to slow economic growth and reduce inflation. Although
real GDP growth and labor market conditions have exceeded most economists’ expectations this year, restrictive monetary policy, as manifested in relatively high interest rates, typically precedes weaker consumer credit conditions caused by rising unemployment as economic growth slows. Credit performance in our lending portfolios has evolved in line with our expectations this year, but may weaken if the economy fails to avert a recession in response to tighter credit conditions or other factors. We assessed the prospects for various macroeconomic outcomes in setting our allowance for credit losses.
The forecast period we deemed to be reasonable and supportable was 18 months for all periods presented. The 18 months reasonable and supportable forecast period was deemed appropriate given the current economic conditions. For all periods presented, we determined that a reversion period of 12 months was appropriate for the same reason.
We applied a weighted reversion method to provide a more reasonable transition to historical losses for all loan products for all periods presented.
The provision for credit losses is the amount of expense realized after considering the level of net charge-offs in the period and the required amount of allowance for credit losses at the balance sheet date. For the three and nine months ended September 30, 2023, the provision for credit losses increasedby $928 million and $2.6 billion compared to the same periods in 2022, primarily driven by loan growth, increasing delinquencies, and macroeconomic variables impacting household cash flows.
Net Charge-offs
Our
net charge-offs include the principal amount of losses charged off less principal recoveries and exclude charged-off and recovered interest and fees and fraud losses. Charged-off and recovered interest and fees are recorded in interest income and loan fee income, respectively, which is effectively a reclassification of the provision for credit losses, while fraud losses are recorded in other expense.
The following table presents amounts and rates of net charge-offs of key loan products (dollars in millions):
The
net charge-offs and net charge-off rate for credit card loans, private student loans and personal loans increased for the three and nine months ended September 30, 2023, when compared to the same periods in 2022, primarily due to portfolio seasoning.
Delinquencies are an indicator of credit quality at a point in time. A loan balance is considered delinquent when contractual payments on the loan become 30 days past due.
The
following table presents the amounts and delinquency rates of key loan products that are 30 and 90 days or more delinquent, and loan receivables that are not accruing interest regardless of delinquency (dollars in millions):
The 30-day and 90-day delinquency rates for credit card loans, private student
loans and personal loans at September 30, 2023, increased compared to December 31, 2022, primarily driven by portfolio seasoning.
Modified and Restructured Loans
For information regarding modified and restructured loans, see Note 3: Loan Receivables to our condensed consolidated financial statements.
Other Income
The following table presents the components of other income (dollars in millions):
(1)Net
of rewards, including Cashback Bonus rewards, of $787 million and $811 million for the three months ended September 30, 2023 and 2022, respectively, and $2.3 billion and $2.2 billion for the nine months ended September 30, 2023 and 2022, respectively.
Total other income increased for the three months ended September 30, 2023, as compared to the same period in 2022, primarily due to increases in net discount and
interchange revenue and loan fee income. The increase in net discount and interchange revenue was primarily driven by lower rewards due to lower promotional rewards. Loan fee income increased primarily due to a higher volume of late payments.
Total other income increased for the nine months ended September 30, 2023, as compared to the same period in 2022, primarily due to smaller losses on equity investments and increases in loan fee income and net discount and interchange revenue. The smaller losses on equity investments were the result of smaller mark-to-market adjustments for equity investments measured at fair value. Loan fee income increased primarily due to a higher volume of late payments. The increase in net discount and interchange revenue was partially offset by an increase in rewards, both of which were driven by higher sales volume.
Other
Expense
The following table represents the components of other expense (dollars in millions):
Total
other expense increased for the three months ended September 30, 2023, as compared to the same period in 2022, primarily due to increases in professional fees, information processing and communications and employee compensation and benefits. Professional fees increased primarily due to increased consulting supporting consumer compliance initiatives. The increase in information processing and communications was driven primarily from investments in technology. The increase in employee compensation and benefits was driven primarily by higher headcount.
Total other expense increased for the nine months ended September 30, 2023, as compared to the same period in 2022, primarily due to increases in employee compensation and benefits, professional fees, marketing and business development and information processing and communications.
The increase in employee compensation and benefits was driven primarily by higher headcount. Professional fees increased primarily due to increased consulting supporting consumer compliance initiatives. The marketing and business development increase was due primarily from growth investments in consumer banking products. The increase in information processing and communications was driven primarily from software write-downs and investments in technology.
Income Tax Expense
The following table presents the calculation of the effective income tax rate (dollars in millions):
We seek to maintain stable, diversified and cost-effective funding sources and a strong liquidity profile to fund our business and repay or refinance our maturing obligations under normal operating conditions and periods of economic or financial stress. In managing our liquidity risk, we seek to maintain a prudent liability maturity profile and ready access to an ample store of primary and contingency liquidity sources. Our primary funding sources include direct-to-consumer and brokered deposits, public term asset-backed securitizations and other short-term and long-term borrowings. Our primary liquidity sources include a portfolio composed of
highly liquid, unencumbered assets, including cash and cash equivalents and investment securities, as well as secured borrowing capacity through private term asset-backed securitizations and Federal Home Loan Bank ("FHLB") advances. In addition, we have unused borrowing capacity at the Federal Reserve discount window, which provides another source of contingency liquidity.
Funding Sources
Deposits
We obtain deposits from consumers directly or through affinity relationships ("direct-to-consumer deposits"). Additionally, we obtain deposits through third-party securities brokerage firms that offer our deposits to their customers ("brokered deposits"). Direct-to-consumer deposit products include savings
accounts, certificates of deposit, money market accounts, IRA savings accounts, IRA certificates of deposit and checking accounts. We gather these deposits from retail customers of our bank, many of whom have more than one Discover product. These deposits originate from a large and diverse customer base, and therefore, the majority of these deposit account balances are insured according to the FDIC's insurance limits. Our cost of insuring these deposits is likely to rise as the FDIC recently stated it plans, as required by law, to charge banks a special assessment to cover the cost of losses to the Deposit Insurance Fund incurred after the failure of two domestic banks in March 2023. Brokered deposit products include certificates of deposit and sweep accounts. In accordance with the FDIC final rule on revisions to its brokered deposits regulation, we no longer categorize certain retail deposit products such as affinity deposits and deposits generated through certain
sweep deposit relationships as brokered for regulatory reporting purposes. At September 30, 2023, we had $81.2 billion of direct-to-consumer deposits and $22.8 billion of brokered deposits, of which there are $82.7 billion of deposit balances due in less than one year and $21.3 billion of deposit balances due in one year or thereafter.
Credit Card Securitization Financing
We securitize credit card receivables as a source of funding. We access the asset-backed securitization market using the Discover Card Master Trust I ("DCMT") and the Discover Card Execution Note Trust ("DCENT"). In connection with our securitization transactions, credit card receivables are transferred to DCMT. DCMT has issued a certificate representing the beneficial interest in its credit card receivables to DCENT. We issue DCENT DiscoverSeries notes
in public and private transactions, which are collateralized by the beneficial interest certificate held by DCENT. From time to time, we may add credit card receivables to DCMT to create sufficient funding capacity for future securitizations while managing seller's interest. We retain significant exposure to the performance of the securitized credit card receivables through holding the seller's interest and subordinated classes of DCENT DiscoverSeries notes. At September 30, 2023, we had $11.0 billion of outstanding public asset-backed securities and $2.9 billion of outstanding subordinated asset-backed securities that had been issued to our wholly-owned subsidiaries.
The securitization structures include certain features designed to protect investors. The primary feature relates to the
availability and adequacy of cash flows in the securitized pool of receivables to meet contractual requirements, the insufficiency of which triggers early repayment of the securities. We refer to this as "economic early amortization," which is based on excess spread levels. Excess spread is the amount by which income received with respect to the securitized credit card receivables during a collection period including interest collections, fees and interchange, exceeds the fees and expenses of DCENT during such collection period, including interest expense, servicing fees and charged-off receivables. In the event of an economic early amortization, which would occur if the excess spread fell below 0% on a three-month rolling average basis, we would be required to repay all outstanding securitized borrowings using available collections received with respect to the securitized credit card receivables. For the three months ended September
30, 2023, the DiscoverSeries three-month rolling average excess spread was 14.42%. The period of ultimate repayment would be determined by the amount and timing of collections received.
Through our wholly-owned indirect subsidiary, Discover Funding LLC, we are required to maintain an interest in a contractual minimum level of receivables in DCMT in excess of the face value of outstanding investors' interests. This minimum interest is referred to as the minimum seller's interest. The required minimum seller's interest in the pool of trust receivables is approximately 7% in excess of the total investors' interests, which includes interests held by third
parties as well as those interests held by us. If the level of receivables in DCMT were to fall below the required minimum, we would be required to add receivables from the unrestricted pool of receivables, which would increase the amount of credit card receivables restricted for securitization investors. A decline in the amount of the excess seller's interest could occur if balance repayments and charge-offs exceeded new lending on the securitized accounts or as a result of changes in total outstanding investors' interests. Seller's interest exhibits seasonality as higher receivable balance repayments tend to occur in the first calendar year quarter. If we could not add enough receivables to satisfy the minimum seller's interest requirement, an early amortization (or repayment) of investors' interests would be triggered.
An early amortization event would impair our liquidity and may require us to utilize our available non-securitization-related
contingent liquidity or rely on alternative funding sources, which may or may not be available at the time. We have several strategies we can deploy to prevent an early amortization event. For instance, we could add receivables to DCMT, which would reduce our available borrowing capacity at the Federal Reserve discount window. As of September 30, 2023, there were $24.8 billion of credit card receivables in the trust and no accounts were added to those restricted for securitization investors for the three and nine months ended September 30, 2023. Alternatively, we could employ structured discounting, which was used effectively in 2009 to bolster excess spread and mitigate early amortization risk.
The following table summarizes expected contractual maturities of the investors' interests in credit card securitizations, excluding
those that have been issued to our wholly-owned subsidiaries (dollars in millions):
Scheduled maturities of borrowings - owed to credit card securitization investors
$
10,820
$
2,475
$
8,345
The "AAA(sf)" and "Aaa(sf)" ratings of the DCENT DiscoverSeries Class A Notes
issued to date have been based, in part, on an FDIC rule, which created a safe harbor that provides that the FDIC, as conservator or receiver, will not use its power to disaffirm or repudiate contracts, seek to reclaim or recover assets transferred in connection with a securitization, or recharacterize assets transferred in connection with a securitization as assets of the insured depository institution, provided such transfer satisfies the conditions for sale accounting treatment under previous GAAP. Although the implementation of Financial Accounting Standards Board Accounting Standards Codification Topic 860, Transfers and Servicing, no longer qualified certain transfers of assets for sale accounting treatment, the FDIC approved a final rule that preserved the safe-harbor treatment applicable to revolving trusts and master trusts,
including DCMT, so long as those trusts would have satisfied the original FDIC safe harbor if evaluated under GAAP pertaining to transfers of financial assets in effect prior to December 2009. However, other legislative and regulatory developments may impact our ability or desire to issue asset-backed securities in the future.
Federal Home Loan Bank Advances
Discover Bank is a member bank of the FHLB of Chicago, one of 11 FHLBs that, along with the Office of Finance, compose the FHLB System. The FHLBs are government-sponsored enterprises of the U.S. ("U.S. GSEs") chartered to improve the availability of funds to support home ownership. As such, senior debt obligations of the FHLBs feature the same credit ratings as U.S. Treasury securities and are considered high-quality liquid assets for bank regulatory purposes. Consequently, the FHLBs benefit from consistent capital market
access during nearly all macroeconomic and financial market conditions and low funding costs, which they pass on to their member banks when they borrow advances. Thus, we consider FHLB advances a stable and reliable funding source for Discover Bank for short-term contingency liquidity and long-term asset-liability management.
As a member of the FHLB of Chicago, Discover Bank has access to short- and long-term advance structures with maturities ranging from overnight to 30 years. At September 30, 2023, we had total committed borrowing capacity of $3.3 billion based on the amount and type of assets pledged, of which $1.0 billion of long-term advances were outstanding with the FHLB of Chicago. Under certain stressed conditions, we could pledge our liquidity portfolio securities and borrow against them at a modest reduction to their value.
Other Long-Term Borrowings—Corporate and Bank Debt
The following table provides a summary of Discover Financial Services (Parent Company) and Discover Bank outstanding fixed-rate debt (dollars in millions):
Discover Bank fixed-rate senior bank notes, maturing 2024-2030
$
3,550
Discover Bank fixed-rate subordinated bank notes, maturing 2028
$
500
At September 30, 2023, $657 million of interest on our fixed-rate debt is due in less than one year and $1.5 billion of
interest is due in one year and thereafter. See Note 6: Long-Term Borrowings to our condensed consolidated financial statements for more information on the maturities of our long-term borrowings.
Short-Term Borrowings
As part of our regular funding strategy, we may, from time to time, borrow short-term funds in the federal funds market or the repurchase ("repo") market through repurchase agreements. Federal funds are short-term, unsecured loans between banks or other financial entities with a Federal Reserve account. Funds borrowed in the repo market are short-term, collateralized loans, usually secured with highly rated investment securities such as U.S. Treasury bills or notes, or mortgage bonds or debentures issued by government agencies or U.S. GSEs. At September 30, 2023, there were no outstanding balances in the federal
funds market or under repurchase agreements.
Additional Funding Sources
Private Asset-Backed Securitizations
We have access to committed borrowing capacity through privately placed asset-backed securitizations. While we may utilize funding from these private securitizations from time to time for normal business operations, their committed nature also makes them a reliable contingency funding source. Therefore, we reserve some undrawn capacity, informed by our liquidity stress test results, for any contingency funding needs.At September 30, 2023, we had a total committed capacity of $3.5 billion, none of which was drawn. We
seek to ensure the stability and reliability of these securitizations by staggering their maturity dates, renewing them well ahead of their scheduled maturity dates and periodically drawing them for operational tests and seasonal funding needs.
Federal Reserve
Discover Bank has access to the Federal Reserve Bank of Philadelphia's discount window. As of September 30, 2023, Discover Bank had $48.7 billion of available borrowing capacity through the discount window based on the amount and type of assets pledged, primarily consumer loans. We also have access to, and have tested our ability to borrow from, the Federal Reserve's Bank Term Funding Program ("BTFP"), which offers loans up to one year in length collateralized by U.S. Treasuries, U.S. agency securities and U.S. agency mortgage-backed securities. As of September 30,
2023, we have no borrowings outstanding under the discount window or the BTFP and reserve this capacity as a source of contingency liquidity.
Funding Uses
Our primary uses of funds include the extensions of loans and credit to customers, primarily through Discover Bank; the maintenance of sufficient working capital for routine operations; the service of our debt and capital obligations, including interest, principal and dividend payments; and the purchase of investment securities for our liquidity portfolio.
In addition to originating consumer loans to new customers, we also extend credit to existing customers, which primarily arises from agreements for unused lines of credit on certain credit cards and certain other
loan products, provided there is no violation of conditions established in the related agreement. At September 30, 2023, our unused credit arrangements were approximately $231.8 billion. These arrangements, substantially all of which we can terminate at any time and which do not necessarily represent future cash requirements, are periodically reviewed based on account usage, customer creditworthiness, loan qualification and the cost of capital.
In the normal course of business, we enter into various contracts for goods
and services, such as consulting, outsourcing, data, sponsorships, software licenses, telecommunications and global merchant acceptance, among other things. These contracts are legally binding and specify all significant terms, including any applicable fixed future cash payments.
As of September 30, 2023, we have debt obligations, common stock and preferred stock outstanding, for which we incur servicing costs. Refer to “— Funding Sources” and “— Capital” for more information related to our debt obligations and capital service, respectively, and the timing of expected payments.
We assess funding uses and liquidity needs under stressed and normal operating conditions, considering primary uses of funding, such as on-balance sheet loans
and contingency uses of funding, such as the need to post additional collateral for derivatives positions. To anticipate funding needs under stress, we conduct liquidity stress tests to assess the impact of idiosyncratic, systemic and hybrid (i.e., idiosyncratic and systemic) scenarios with varying levels of liquidity risk reflecting a range of stress severity. If we determine we have excess cash and cash equivalents above what is required for daily operations, we may invest in highly liquid, unencumbered assets that we expect to be able to convert to cash quickly and with little loss of value using the repo market or other secured borrowing or outright sales.
Guarantees
Guarantees are contracts
or indemnification agreements that may require us to make payments to a guaranteed party based on changes in an underlying asset, liability, or equity security of a guaranteed party, rate or index. Also included in guarantees are contracts that may require the guarantor to make payments to a guaranteed party based on another entity’s failure to perform under an agreement. Our guarantees relate to transactions processed on the Discover Network and certain transactions processed by PULSE and Diners Club. In the ordinary course of business, we guarantee payment on behalf of subsidiaries relating to contractual obligations with external parties. The activities of the subsidiaries covered by any such
guarantees are included in our consolidated financial statements. See Note 12: Commitments, Contingencies and Guarantees to our consolidated financial statements for further discussion regarding our guarantees.
Credit Ratings
Our borrowing costs and capacity in certain funding markets, including those for securitizations and unsecured senior and subordinated debt, may be affected by the credit ratings of DFS, Discover Bank and the securitization trusts. Downgrades in these credit ratings could result in higher interest expense on our unsecured debt and asset securitizations, as well as higher credit enhancement requirements for both our public and private asset securitizations. In addition to increased funding costs, deterioration in our credit ratings could reduce
our borrowing capacity in the unsecured debt and asset securitization capital markets.
During the third quarter of 2023, Moody's affirmed our credit ratings, but changed the rating outlook on our senior unsecured debt from "stable" to "negative" following our disclosure of the card product misclassification and the reaching of a consent order with the FDIC on matters related to our compliance management system. The table below reflects our current credit ratings and outlooks:
Moody’s
Investors Service
Standard & Poor's
Fitch Ratings
Discover Financial Services
Senior unsecured debt
Baa2
BBB-
BBB+
Outlook for Discover Financial Services senior unsecured debt
Negative
Stable
Stable
Discover
Bank
Senior unsecured debt
Baa1
BBB
BBB+
Outlook for Discover Bank senior unsecured debt
Negative
Stable
Stable
Subordinated debt
Baa1
BBB-
BBB
Discover
Card Execution Note Trust (DCENT)
Class A(1)
Aaa(sf)
AAA(sf)
AAA(sf)
(1)An "sf" in the rating denotes rating agency identification for structured finance product ratings.
A credit rating is not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the assigning rating organization. Each rating should be evaluated independently of any other rating. A credit rating outlook reflects an agency's opinion regarding the likely rating direction over the medium term, often a period of about a year, and indicates the agency's belief that the issuer's credit profile is consistent with its current rating level at that point in time.
Liquidity
We seek to ensure that we have adequate liquidity to sustain business operations, fund asset growth and satisfy debt obligations under stressed and normal operating conditions. In addition
to the funding sources discussed in the previous section, we also maintain highly liquid, unencumbered assets in our liquidity portfolio that we expect to be able to convert to cash quickly and with little loss of value using either the repo market or other secured borrowing or outright sales.
We maintain a liquidity risk and funding management policy, which outlines the overall framework and general principles we follow in managing liquidity risk across our business. The Board of Directors approves the policy and the Asset and Liability Management Committee (the "ALCO") is responsible for its implementation. Additionally, we maintain a liquidity management framework document that outlines the general strategies, objectives and principles we utilize to manage our liquidity position and the various liquidity risks inherent in our business model. We seek to balance the trade-offs between maintaining too much liquidity,
which may be costly, with having too little liquidity, which could cause financial distress. The ALCO, chaired by our Treasurer, has cross-functional membership and manages liquidity risk centrally. The ALCO monitors the liquidity risk profiles of DFS and Discover Bank and oversees any actions Corporate Treasury may take to ensure that we maintain ready access to our funding sources and sufficient liquidity to meet current and projected needs. In addition, the ALCO and our Board of Directors regularly review our compliance with our liquidity limits at DFS and Discover Bank, which are established in accordance with the liquidity risk appetite set by our Board of Directors.
We employ a variety of metrics to monitor and manage liquidity. We utilize early warning indicators ("EWIs") to detect emerging liquidity stress events and a reporting and escalation process designed to be consistent with regulatory guidance. The EWIs
include both idiosyncratic and systemic measures and are monitored daily and reported to the ALCO regularly. A warning from one or more of these indicators triggers prompt review and decision-making by our senior management team and, in certain instances, may lead to the convening of a senior-level response team and activation of our contingency funding plan.
In addition, we conduct liquidity stress tests regularly and ensure contingency funding is in place to address potential liquidity shortfalls. We evaluate a range of stress scenarios that are designed to follow regulatory requirements, including idiosyncratic, systemic and a combination of such events that could impact funding sources and our ability to meet liquidity needs. These scenarios measure the projected liquidity position at DFS and Discover Bank across a range of periods by comparing estimated contingency funding needs to available contingency liquidity.
Our
primary contingency liquidity sources include our liquidity portfolio securities, which we could sell, repo or borrow against, and private securitizations with unused borrowing capacity. In addition, we could borrow FHLB advances by pledging securities to the FHLB of Chicago. Moreover, we have unused borrowing capacity with the Federal Reserve discount window and BTFP, which provide additional sources of contingency liquidity. We seek to maintain sufficient liquidity to satisfy all maturing obligations and fund business operations for at least 12 months in a severe stress environment. In such an environment, we may also take actions to curtail the size of our balance sheet, which would reduce the need for funding and liquidity.
At September 30, 2023, our liquidity portfolio was composed of highly liquid, unencumbered assets, including cash and cash equivalents and investment
securities. Cash and cash equivalents were primarily deposits with the Federal Reserve. Investment securities primarily included debt obligations of the U.S. Treasury and U.S. GSEs and residential mortgage-backed securities issued by U.S. government agencies or U.S. GSEs. These investments, nearly all of which are classified as available-for-sale, are considered highly liquid and we expect to have the ability to raise cash by selling them, utilizing repurchase agreements or pledging certain of these investments to access secured funding. The size and composition of our liquidity portfolio may fluctuate based on the size of our balance sheet as well as operational requirements, market conditions and interest rate risk management objectives.
At September 30, 2023, our liquidity portfolio and undrawn credit facilities were $75.5 billion, which was $8.3 billion higher than the balance at December 31, 2022. Our liquidity portfolio and undrawn credit facilities grew primarily as a result of the additional borrowing capacity with the Federal Reserve. During the three and nine months ended September 30, 2023, the average balance of our liquidity portfolio was $20.9 billion and $20.6 billion, respectively. Our liquidity portfolio and undrawn facilities consist of the following (dollars in millions):
Total liquidity portfolio and undrawn credit facilities
$
75,546
$
67,278
(1)Cash in the process of settlement and restricted cash are excluded from cash and cash equivalents for liquidity purposes.
(2)Excludes
$285 million and $97 million of U.S. Treasury securities that have been pledged as swap collateral in lieu of cash as of September 30, 2023 and December 31, 2022, respectively.
(3)See "— Additional Funding Sources" for additional information.
Bank Holding Company Liquidity
The primary uses of funds at the unconsolidated DFS level include debt service obligations (interest payments and return of principal) and capital service and management activities, including dividend payments on capital instruments and the periodic repurchase of shares of our common stock. Our primary sources of funds at the bank holding company level include the proceeds from the issuance of unsecured debt and capital securities, as well
as dividends from our subsidiaries, notably Discover Bank. Under periods of idiosyncratic or systemic stress, the bank holding company could lose or experience impaired access to the capital markets. In addition, our regulators have the discretion to restrict dividend payments from Discover Bank to the bank holding company.
We utilize a measure referred to as Number of Months of Pre-Funding to determine the length of time DFS can meet upcoming funding obligations, including common and preferred stock dividend payments and debt service obligations using existing cash resources. In managing this metric, we structure our debt maturity schedule to manage prudently the amount of debt maturing within a short period. See Note 6: Long-Term Borrowings to our condensed consolidated financial statements for further information regarding our debt.
Capital
Our
primary sources of capital are the earnings generated by our businesses and the proceeds from issuances of capital securities. We seek to manage capital to a level and composition sufficient to support our businesses' growth, account for their risks, and meet regulatory requirements, rating agency targets and debt investor expectations. Within these constraints, we are focused on deploying capital in a manner that provides attractive returns to our stockholders. The level, composition and utilization of capital are influenced by changes in the economic environment, strategic initiatives and legislative and regulatory developments.
Under regulatory capital requirements adopted by the Federal Reserve and the FDIC, DFS, along with Discover Bank, must maintain minimum capital levels. Failure to meet minimum capital requirements can result in the initiation of certain mandatory and possibly additional discretionary actions by regulators
that, if undertaken, could limit our business activities and have a direct material effect on our financial condition and operating results. We must meet specific capital requirements that involve quantitative measures of assets, liabilities and certain off-balance sheet items, as calculated under regulatory guidance and regulations. Current or future legislative or regulatory reforms, such as those related to the adoption of the CECL accounting model or those related to the proposed revisions to the Basel Committee's December 2010 framework ("Basel III rules"), may require us to hold more capital and/or adversely impact our capital level. We consider the potential impacts of these reforms in managing our capital position.
DFS and Discover Bank are subject to regulatory capital rules issued by the Federal Reserve and the FDIC, respectively, under the Basel III rules. Under these rules, DFS and Discover Bank are classified as "standardized approach" entities as they are U.S. banking organizations with consolidated total assets over $50 billion but not exceeding $250 billion and consolidated total on-balance sheet foreign exposures less than $10 billion. The Basel III rules require DFS and Discover Bank to maintain minimum risk-based capital and leverage ratios and define what constitutes capital for purposes of calculating those ratios.
In accordance with the final rule on the impact of CECL on regulatory capital, we have elected to phase in the impact over three years, beginning in 2022. By electing this option, our Common Equity Tier 1 ("CET1") capital ratios are higher
than they otherwise would have been.The phase-in of the CECL accounting model decreased CET1 by $1.1 billion as of January 1, 2023. For additional information regarding the risk-based capital and leverage ratios, see Note 11: Capital Adequacy to our condensed consolidated financial statements.
On March 4, 2020, the Federal Reserve announced the SCB final rule, which imposes limitations on DFS' capital distributions if we do not maintain our risk-based capital ratios above stated regulatory minimum ratios based on the results of supervisory stress tests. Under this rule, DFS is required to assess whether our planned capital actions are consistent with the effective capital distribution limitations that will apply on a pro-forma basis throughout the planning horizon.
The
SCB requirement is institution-specific and is calculated as the greater of (i) 2.5% and (ii) the sum of (a) the difference between DFS' actual CET1 ratio at the beginning of the forecast and the projected minimum CET1 ratio based on the Federal Reserve's models in its nine-quarter Severely Adverse stress scenario, plus (b) the sum of the dollar amount of DFS' planned common stock dividend distributions for each of the fourth through seventh quarters of its nine-quarter capital planning horizon, expressed as a percentage of risk-weighted assets. For Category IV firms, including DFS, the Federal Reserve calculates each firm's SCB biennially in even-numbered calendar years, and did so in 2022. Based on the results of the 2022 CCAR exercise released by the Federal Reserve, our new SCB was set at 2.5%, the lowest possible requirement, effective October 1, 2022, through September
30, 2023. In odd-numbered years, each firm subject to Category IV standards that did not opt-in to such year's supervisory stress tests as part of the Federal Reserve's CCAR process receives an adjusted SCB requirement that is updated to reflect its planned common stock dividends per the firm's annual capital plan. On July 27, 2023, the Federal Reserve disclosed SCB requirements to firms subject to Category IV standards that did not opt-in to this year's stress test. Our SCB remains unchanged at 2.5%, effective beginning October 1, 2023 through September 30, 2024. See "— Regulatory Environment and Developments — Banking — Capital Standards and Stress Testing" for additional information.
At September 30, 2023, DFS and
Discover Bank met the requirements for "well-capitalized" status under the Federal Reserve's Regulation Y and the prompt corrective action rules and corresponding FDIC requirements, respectively, exceeding the regulatory minimums to which they were subject under the applicable rules.
Basel III rules also require disclosures relating to market discipline. This series of disclosures is commonly referred to as "Pillar 3." The objective is to increase the transparency of capital requirements for banking organizations. We are required to make prescribed regulatory disclosures quarterly regarding our capital structure, capital adequacy, risk exposures and risk-weighted assets. We make the Pillar 3 disclosures publicly available on our website in a report called "Basel III Regulatory Capital Disclosures."
We
disclose tangible common equity, which represents common equity less goodwill and intangibles. Management believes that common stockholders' equity excluding goodwill and intangibles is meaningful to investors as a measure of our true net asset value. At September 30, 2023, tangible common equity is considered to be a non-GAAP financial measure as it is not formally defined by GAAP or codified in the federal banking regulations. Other financial services companies may also disclose this measure and definitions may vary. We advise users of this information to exercise caution in comparing this measure among different companies.
Our
Board of Directors approved a new share repurchase program in April 2023. The new program authorized up to $2.7 billion of share repurchases through June 30, 2024, and replaced the prior $4.2 billion share repurchase program. If and when we repurchase our shares under the program, we may use various methods, including open market purchases, privately negotiated transactions or other purchases, including block trades, accelerated share repurchase transactions, or any combination of such methods. During the three months ended September 30, 2023, we did not repurchase any shares. During the nine months ended September 30, 2023, we repurchased approximately 18.1 million shares for approximately $1.9 billion.
The amount and size of any future dividends and share repurchases will depend
on our results of operations, financial condition, capital levels, cash requirements, future prospects, regulatory review and other factors. As reported in the second quarter of 2023,we have decided to pause share repurchases while an internal review of compliance, risk management and corporate governance is ongoing. See Note 13: Litigation and Regulatory Matters for additional information on the card product misclassification. The declaration and payment of future dividends and the amount thereof are subject to the discretion of our Board of Directors. Holders of our shares of common stock are subject to the prior dividend rights of holders of our preferred stock or the depositary shares representing such preferred stock outstanding. No dividend may be declared or paid or set aside for payment on our common stock if full dividends have not been declared and paid on all outstanding shares of preferred stock in any dividend
period. In addition, as noted above, banking laws and regulations and our banking regulators may limit our ability to pay dividends and make share repurchases, including limitations on the extent our banking subsidiary (Discover Bank) can provide funds to us through dividends, loans or otherwise. Further, current or future regulatory reforms, such as those that propose to alter the Basel III standards, may require us to hold more capital or could adversely impact our capital level. As a result, there can be no assurance that we will declare and pay any dividends or repurchase any shares of our common stock in the future.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk refers to the risk that a change in the level of one or more market prices, rates, indices, correlations or other market factors will result in losses for an investment position or portfolio. We are exposed to market risk primarily from changes in interest rates.
Interest Rate Risk
We borrow money from various depositors and institutions to provide loans to our customers and invest in other assets and our business. These loans to customers and other assets earn interest, which we use to pay interest on the money borrowed. Our net interest income and, therefore, earnings will be reduced if the interest rate earned on assets increases at a slower pace than the interest rate paid on our borrowings.
Changes in interest rates and our competitors' responses to those changes may influence customer payment rates, loan balances or deposit account activity. As a result, we may incur higher funding costs that could decrease our earnings.
Our interest rate risk management policies are designed to measure and manage the potential volatility of earnings that may arise from changes in interest rates by having a portfolio that reflects our mix of variable- and fixed-rate assets and liabilities. To the extent that the repricing characteristics of the assets and liabilities in a particular portfolio are not sufficiently matched, we may utilize interest rate derivative contracts, such as swap agreements, to achieve our objectives. Interest rate swap agreements effectively convert the underlying asset or liability from fixed- to floating-rate or
from floating- to fixed-rate. See Note 15: Derivatives and Hedging Activities to our condensed consolidated financial statements for information on our derivatives activity.
We use an interest rate sensitivity simulation to assess our interest rate risk exposure. For purposes of presenting the possible earnings effect of a hypothetical, adverse change in interest rates over the 12 months from our reporting date, we assume that all interest-rate-sensitive assets and liabilities are subject to a hypothetical, immediate 100 basis point change in interest rates relative to market consensus expectations as of the beginning of the period. The sensitivity simulation includes the hypothetical assumption that all relevant types of interest rates would change instantaneously, simultaneously and to the same degree.
Our interest-rate-sensitive assets include our variable-rate loan receivables and
certain assets in our liquidity portfolio. We have limitations on our ability to mitigate interest rate risk by adjusting rates on existing balances. Further, competitive actions may limit our ability to increase the rates that we charge to customers for new loans. At September 30, 2023, the majority of our credit card and private student loans charge variable rates. Fixed-rate assets that will mature or otherwise contractually reset to a market-based indexed rate or other fixed-rate prior to the end of the 12-month measurement period are considered to be rate sensitive. The latter category includes certain revolving credit card loans that may be offered at below-market rates for an introductory period, such as balance transfers and special promotional programs, after which the loans will contractually reprice in accordance with our normal market-based pricing structure. For assets with a fixed interest rate that contractually
will, or is assumed to, reset to a market-based indexed rate or other fixed rate during the next 12 months, earnings sensitivity is measured from the expected repricing date. In addition, for all interest rate sensitive assets, earnings sensitivity is calculated net of expected credit losses. For purposes of this analysis, expected credit losses are assumed to remain unchanged relative to our baseline expectations over the analysis horizon.
Interest-rate-sensitive liabilities are assumed to be those for which the stated interest rate is not contractually fixed for the next 12 months. Thus, liabilities that vary with changes in a market-based index, such as the federal funds rate or SOFR, which will reset before the end of the next 12 months, or liabilities that have fixed rates at the fiscal period end but will mature and are assumed to be replaced with a market-based indexed rate prior to the end of the next 12 months, are
also considered to be rate sensitive. For these fixed-rate liabilities, earnings sensitivity is measured from the expected maturity date.
Net interest income sensitivity simulations require assumptions regarding market conditions, consumer behavior and the growth and composition of our balance sheet. The degree by which our deposit rates change when benchmark interest rates change, our deposit “beta,” is one of the most significant of these assumptions. Assumptions about deposit beta and other matters are inherently uncertain and, as a result, actual earnings may differ from the simulated earnings presented below. Our actual earnings depend on multiple
factors including, but not limited to, the direction and timing of changes in interest rates, the movement of short-term interest rates relative to long-term rates, balance sheet composition, competitor actions affecting pricing decisions in our loans and deposits, the mix of promotional balances in our card portfolio, the level of interest charge-offs and recoveries, the influence of loan repayment rates on revolving balances and strategic actions undertaken by our management.
We have taken actions to bring our net interest income sensitivity closer to neutral as the Federal Reserve has slowed its pace of monetary policy tightening and the outlook for near-term U.S. economic growth may be weakening. The following table shows the impacts to net interest income over the following 12-month period that we estimate would result from an immediate and parallel change in interest rates affecting all interest rate sensitive assets and
liabilities (dollars in millions):
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")), which are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act
is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting (as such term is defined in Exchange Act Rule 13a-15(f) and 15d-15(f)) that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
See Note 13: Litigation and Regulatory Matters to our condensed consolidated financial statements for a description of legal proceedings.
Item 1A. Risk Factors
There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022.
Item
2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
The following table sets forth information regarding purchases of our common stock related to our share repurchase program and employee transactions made by us or on our behalf during the most recent quarter.
Period
Total
Number of Shares Purchased
Average Price Paid Per Share(3)
Total Number of Shares Purchased as Part of Publicly Announced Plan or Program(1)(4)
Maximum Dollar Value of Shares that may yet be purchased under the Plans or Programs(1)(4)
July 1 - 31, 2023
Repurchase
program(1)(4)
—
$
—
—
$
2,225,091,655
Employee transactions(2)
2,009
$
118.11
N/A
N/A
August
1 - 31, 2023
Repurchase program(1)(4)
—
$
—
—
$
2,225,091,655
Employee transactions(2)
36,754
$
104.49
N/A
N/A
September
1 - 30, 2023
Repurchase program(1)(4)
—
$
—
—
$
2,225,091,655
Employee transactions(2)
1,666
$
90.31
N/A
N/A
Total
Repurchase
program(1)(4)
—
$
—
—
$
2,225,091,655
Employee transactions(2)
40,429
$
104.59
N/A
N/A
(1)In
April 2023, our Board of Directors approved a new share repurchase program authorizing the purchase of up to $2.7 billion of our outstanding shares of common stock through June 30, 2024. This share repurchase authorization replaced our prior $4.2 billion share repurchase program.
(2)Reflects shares withheld (under the terms of grants under employee stock compensation plans) to offset tax withholding obligations that occur upon the delivery of outstanding shares underlying restricted stock units or upon the exercise of stock options.
(3)Average price paid per share excludes any excise tax.
(4)Share repurchases were suspended because of an ongoing internal review of compliance, risk management and corporate governance.
See "— Liquidity and Capital Resources — Capital" for additional information.
During the period covered by this report, none of the Company’s directors or executive officers has adopted or terminated a Rule 10b5-1 trading arrangement or a non-Rule 10b5-1 trading arrangement (each as defined in Item 408 of Regulation S-K under the Securities Exchange Act of 1934, as amended).
On October 26, 2023, the
Company's Board of Directors (the "Board") approved and adopted, effective immediately, amended and restated bylaws of the Company (the "Amended and Restated Bylaws") to: (i) revise provisions regarding adjournment and lists of stockholders entitled to vote at stockholder meetings in light of recent amendments to the Delaware General Corporation Law (the “DGCL”); (ii) update the Company’s bylaws in connection with the SEC rules relating to universal proxy cards (the “Universal Proxy Rules”), including
requiring stockholders providing notice pursuant to Rule 14a-19(b) under the Securities Exchange Act of 1934, as amended, to certify to the Company that they have complied with certain requirements under the Universal Proxy Rules no later than five business days prior to the applicable stockholder meeting; (iii) clarify certain representations and agreements that must be completed by proposing stockholders and proposed nominees, as applicable, in connection with a stockholder nomination; (iv) require any stockholder directly or indirectly soliciting proxies from other stockholders to use a proxy card color other than white; (v) shortened the period for which a proxy may validly be used from three years to eleven months; (vi) clarify that the power of the Board and the meeting chair to determine and address deficient nominations or proposals; and (vii) make certain other clarifications
and administrative, technical or conforming revisions.
The preceding summary of the Amended and Restated Bylaws does not purport to be complete and is qualified in its entirety by reference to the Amended and Restated Bylaws, a copy of which is included as Exhibit 3.1 to this report and incorporated herein by reference.
Immaterial Restatement of Prior Period Financial Statements
The following tables reflect the impacts
of the card product misclassification and subsequent restatements of certain prior period amounts reported on the Company's consolidated financial statements. See Note 18Immaterial Restatement of Prior Period Financial Statements to the Company's condensed consolidated financial statements for more information on the card product misclassification.
The prior period impacts to the Company's consolidated statements of financial condition were as follows (dollars in millions):
The
prior period impacts to the Company's consolidated statements of income and the related impacts to the consolidated statements of comprehensive income were as follows (dollars in millions):
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred
income taxes
$
327
$
(9)
$
318
$
(672)
$
(5)
$
(677)
Changes in assets and liabilities:
Increase
in accrued expenses and liabilities
$
410
$
36
$
446
$
136
$
21
$
157
Net cash provided by operating activities
$
6,019
$
—
$
6,019
$
6,196
$
—
$
6,196
The
following tables reflect the impacts of the card product misclassification and subsequent restatements of certain prior period amounts reported on the Parent Company's financial statements.
The prior period impacts to the Parent Company's condensed statement of financial condition were as follows (dollars in millions):
The prior period impacts to the Parent Company's condensed statements of income and the related impacts to the condensed statements of comprehensive income were as follows (dollars in millions):
Transition
Letter, dated as of August 13, 2023, between Discover Financial Services and Roger C. Hochschild (filed as Exhibit 10.1 to Discover Financial Services’ Current Report on Form 8-K filed on August 14, 2023, and incorporated herein by reference thereto).
Certification
of Chief Executive Officer and Chief Financial Officer pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code.
101
Interactive Data File — the following financial statements from Discover Financial Services Quarterly Report on Form 10-Q formatted in inline XBRL: (1) Condensed Consolidated Statements of Financial Condition, (2) Condensed Consolidated Statements of Income, (3) Condensed Consolidated Statements of Comprehensive Income, (4) Condensed Consolidated Statements of Changes in Stockholders' Equity, (5) Condensed Consolidated Statements of Cash Flows and (6) Notes to the Condensed Consolidated Financial Statements.
104
Cover
Page Interactive Data File — the cover page from Discover Financial Services Quarterly Report on Form 10-Q formatted in inline XBRL and contained in Exhibit 101.
Pursuant to the requirements of Section 13 or 15(d) 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.
Discover Financial Services (Registrant)
By:
/s/ JOHN T. GREENE
John
T. Greene Executive Vice President, Chief Financial Officer
