DISCOVER FINANCIAL SERVICES The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K. Some of the information contained in this discussion and analysis constitutes forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this annual report on Form 10-K particularly under "Risk Factors" and "Special Note Regarding Forward-Looking Statements," which immediately follows "Risk Factors." Unless otherwise specified, references to Notes to our consolidated financial statements are to the Notes to our audited consolidated financial statements as ofDecember 31, 2019 and 2018 and for years endedDecember 31, 2019 , 2018 and 2017. Introduction and OverviewDiscover Financial Services ("DFS") is a direct banking and payment services company. We provide direct banking products and services and payment services through our subsidiaries. We offer our customers credit card loans, private student loans, personal loans, home equity loans and deposit products. We also operate the Discover Network, the PULSE network ("PULSE") andDiners Club International ("Diners Club "). The Discover Network processes transactions for Discover-branded credit and debit cards and provides payment transaction processing and settlement services. PULSE operates an electronic funds transfer network, providing financial institutions issuing debit cards on the PULSE network with access to ATMs domestically and internationally, as well as merchant acceptance throughout theU.S. for debit card transactions.Diners Club is a global payments network of licensees, which are generally financial institutions, that issueDiners Club branded 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), loan 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. 2019 Highlights The highlights below compare results as of and for the year endedDecember 31, 2019 against results for the year endedDecember 31, 2018 . • Net income was$3.0 billion , or$9.08 per diluted share, compared to$2.7
billion, or
• Total loans grew
• Credit card loans grew
• The total net charge-off rate increased 11 basis points to 3.17%.
• The net charge-off rate for credit card loans increased 17 basis points
to 3.43% and the delinquency rate for credit card loans over 30 days past
due increased 19 basis points to 2.62%.
• Direct-to-consumer deposits grew
• Payment Services transaction volume for the segment was
Outlook
The outlook below provides our expectations for our business, reflective of our
assumption that the
organic loan growth and execution of our capital plan.
• Our marketing strategy is focused on adding new accounts to achieve
continued loan growth. For credit cards, we are also focused on
increasing utilization with existing customers.
• Total expenses are expected to increase reflecting continued investment
in brand awareness and technological capabilities.
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• We will continue to pursue payments volume growth and leverage our
network to support our card-issuing business.
• We expect the total net charge-off rate to increase primarily due to the
seasoning of recent loan growth.
• Adoption of the current expected credit loss ("CECL") approach willincrease the allowance for loan losses. Going forward, the seasonality of
our business will likely impact quarterly reserve changes and could
increase volatility from one quarter to the next.
Regulatory Environment and Developments Policymakers continue to develop, implement and execute on regulatory, supervisory and enforcement priorities. The impact of the evolving regulatory environment on our business and operations depends upon a number of factors, including the actions of policymakers at the federal and state levels, our competitors, and consumers. For more information on how the regulatory and supervisory environment, ongoing enforcement actions and findings, and changes to laws and regulations could impact our strategies, the value of our assets, or otherwise adversely affect our business see "Risk Factors - Current Economic and Regulatory Environment." For more information on recent matters affecting us, see Note 19: Litigation and Regulatory Matters to our consolidated financial statements. Federal banking regulators continue to propose and implement new regulations and supervisory guidance, and modify their examination and enforcement priorities. InMay 2018 , the President signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act, which is intended to promote economic growth, provide tailored regulatory relief for smaller and less complex financial institutions, and enhance consumer protections. Among other provisions, the law raised the asset threshold for automatically designating a bank holding company as "systemically important" from$50 billion to$250 billion so that bank holding companies with assets below$250 billion are no longer automatically subject to enhanced prudential standards pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), which created a framework for regulation of large financial firms, including Discover. InOctober 2019 , the federal banking regulators approved final rules that will tailor existing regulatory requirements related to capital, liquidity and enhanced prudential standards to an institution's risk and complexity profile for banking institutions with total consolidated assets of$100 billion or more. Under the final rules, Discover is categorized as a Category IV institution and therefore subject to the least stringent requirements for bank holding companies with at least$100 billion in assets. Among other things, Discover will be subject to supervisory stress tests every other year rather than annually, will no longer be subject to regulations requiring submission of company-run capital stress tests and will no longer be subject to the liquidity coverage ratio. Discover will however still be required to submit annual capital plans to theFederal Reserve and will remain subject to other core components of the enhanced prudential standards rules, such as risk management and risk committee requirements and liquidity risk management regulations. The final rules took effect onDecember 31, 2019 . The final rules did not address other aspects of theFederal Reserve's capital plan rule or the Comprehensive Capital Analysis and Review ("CCAR") framework. These requirements, including the previously proposed "stress capital buffer" framework, are expected to be addressed in a forthcoming rulemaking from theFederal Reserve . We have been notified that we are subject to the CCAR quantitative process in 2020. Policymakers at the federal and state levels are increasingly focused on measures to enhance data security and data breach incident response requirements. Furthermore, regulations and legislation at various levels of government have been proposed and enacted to augment data privacy standards. For example, the California Consumer Privacy Act ("CCPA") creates a broad set of privacy rights and remedies modeled in part on theEuropean Union's General Data Protection Regulation. The CCPA went into effect onJanuary 1, 2020 , and proposed regulations have yet to be finalized. The original proponent of the CCPA recently launched a 2020 California ballot initiative with the goal of expanding the rights and remedies created by the CCPA, while protecting the new law from future legislative amendments. While it is too early to determine the full impact of these developments, they may result in the imposition of requirements on Discover and other providers of consumer financial services or networks that could adversely affect our businesses. Banking Current Expected Credit Loss InJune 2016 , theFinancial Accounting Standards Board issued Accounting Standards Update No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which is -47-
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effective for us onJanuary 1, 2020 . The standard alters accounting principles generally accepted inthe United States ("GAAP") by replacing the incurred loss model with the CECL approach. The CECL approach requires our allowance for loan losses to be based on an estimate of all expected credit losses over the remaining contractual term of all of the loans, as opposed to an estimate of incurred losses as of the balance sheet date. Refer to Note 1: Background and Basis of Presentation to our consolidated financial statements for details on the impact of adoption onJanuary 1, 2020 . InDecember 2018 , federal banking agencies adopted a joint final rule that will, among other things, give bank holding companies and banks, including Discover and its bank subsidiaries, the option to phase in the regulatory capital impacts of implementing CECL over a three-year transition period. Additionally, notwithstanding theJanuary 1, 2020 effective date, theFederal Reserve announced that it will not incorporate CECL into its supervisory stress tests until at least 2022 to reduce uncertainty, allow for better capital planning at affected firms and allow theFederal Reserve to gather additional information on the impact of CECL; however, banking institutions subject to Dodd-Frank Act company-run stress test requirements are required to incorporate CECL into their internal stress testing processes beginning in 2020. We anticipate thatDFS andDiscover Bank will continue to meet requirements to be "well-capitalized" upon adoption of the standard. For more information on CECL, see Note 1: Background and Basis of Presentation to our consolidated financial statements. LIBOR OnJuly 27, 2017 , theUK Financial Conduct Authority announced that it would no longer encourage or compel banks to continue to contribute quotes and maintain the London Interbank Offered Rate ("LIBOR") after 2021. LIBOR is commonly used as a benchmark to determine interest rates for financial instruments, such as floating-rate asset-backed securities issued byDiscover Card Execution Note Trust , and certain financial products, including some of our floating-rate student loans. A cross-functional team is overseeing and managing our transition away from the use of LIBOR. This team monitors developments associated with LIBOR alternatives and evolving industry and marketplace norms and conventions for LIBOR indexed instruments, evaluates the impact that the inability to determine LIBOR after 2021 will have on us, and facilitates the operational changes associated with the use of alternative benchmark rates.Consumer Financial Services The Consumer Financial Protection Bureau (the "CFPB") regulates consumer financial products and services, and examines certain providers of consumer financial products and services, including Discover. TheCFPB's authority includes preventing "unfair, deceptive or abusive acts or practices" and ensuring that consumer have access to fair, transparent and competitive financial products and services. TheCFPB has rulemaking, supervision and enforcement powers with respect to federal consumer protection laws. Historically, theCFPB's policy priorities focused on several financial products of the type we offer (e.g. credit cards and student loans). In addition, theCFPB is required by statute to undertake certain actions including its bi-annual review of the consumer credit card market. The current CFPB Director has indicated that theCFPB will focus on the prevention of harm, establishing valid metrics for success, and creating a level playing field for all financial institutions. Additionally, with regards to theCFPB's rulemaking and enforcement activities, the Director has outlined a framework that seeks to foster a more transparent rulemaking process that incorporates a robust cost benefit analysis, applies supervisory practices consistently, and ensures that due process is a critical component of enforcement activity. Payment Networks The Dodd-Frank Act contains several provisions impacting the debit card market, including network participation requirements and interchange fee limitations. The changing debit card environment, including competitor actions related to merchant and acquirer pricing and transaction routing strategies, has adversely affected, and is expected to continue to adversely affect, our PULSE network's business practices, network transaction volume, revenue and prospects for future growth. We continue to closely monitor competitor pricing and technology development strategies in order to assess their impact on our business and on competition in the marketplace. Following an inquiry by theU.S. Department of Justice into some of these competitor pricing strategies, PULSE filed a lawsuit againstVisa in late 2014 with respect to these competitive concerns. The Court granted summary judgment in favor ofVisa inAugust 2018 . PULSE filed an appeal onJanuary 17, 2019 andVisa filed their response to the appeal onApril 5, 2019 .The Fifth Circuit Court of Appeals held a hearing on the appealOctober 9, 2019 .Visa also faces ongoing merchant litigation as it relates to the underlying anticompetitive behavior that is the subject of PULSE's case againstVisa . In addition, the Dodd-Frank Act's network participation requirements impact PULSE's ability to enter into exclusivity arrangements, which affects PULSE's current business practices and may materially adversely affect its network transaction volume and revenue. -48-
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Results of Operations The discussion below provides a summary of our results of operations and information about our loan receivables as of and for the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 . Refer to our annual report on Form 10-K for the year endedDecember 31, 2018 for discussion of our results of operations and loan receivables information as of and for the year endedDecember 31, 2018 compared to the year endedDecember 31, 2017 . Segments We manage our business activities in two segments, Direct Banking and Payment Services, based on the products and services provided. For a detailed description of the operations of each segment, as well as the allocation conventions used in our business segment reporting, see Note 22: Segment Disclosures to our consolidated financial statements. The following table presents segment data (dollars in millions): For the Years Ended December 31, 2019 2018 2017 Direct Banking Interest income Credit card$ 9,690 $ 8,835 $ 7,907 Private student loans 698 614 523 PCI student loans 119 139 159 Personal loans 983 935 860 Other 502 369 199 Total interest income 11,992 10,892 9,648 Interest expense 2,530 2,139 1,648 Net interest income 9,462 8,753 8,000 Provision for loan losses 3,233 3,035 2,586 Other income 1,648 1,645 1,607 Other expense 4,231 3,918 3,629 Income before income tax expense 3,646 3,445 3,392 Payment Services Net interest income 1 1 - Provision for loan losses (2 ) - (7 ) Other income 348 310 290 Other expense 162 159 152 Income before income tax expense 189 152 145 Total income before income tax expense$ 3,835 $ 3,597 $ 3,537 -49-
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The following table presents information on transaction volume (in millions):
For the Years Ended December 31,
2019 2018 2017
Network Transaction Volume
PULSE Network $ 192,067 $ 179,792 $ 157,128
Network Partners 25,368 18,948 14,213
Diners Club(1) 33,967 33,877 31,544
Total Payment Services 251,402 232,617 202,885
Discover Network-Proprietary(2) 151,243 143,865 133,044
Total Volume $ 402,645 $ 376,482 $ 335,929
Transactions Processed on Networks
Discover Network 2,717 2,469 2,240
PULSE Network 4,788 4,364 3,856
Total 7,505 6,833 6,096
Credit Card Volume
Discover Card Volume(3) $ 160,283 $ 152,826 $ 141,858
Discover Card Sales Volume(4) $ 146,183 $ 139,031 $ 128,806 (1)
branded cards issued outside
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.
Direct Banking Our Direct Banking segment reported pretax income of$3.6 billion for the year endedDecember 31, 2019 as compared to$3.4 billion for the year endedDecember 31, 2018 . Net interest income increased for the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 primarily driven by loan growth and higher yields on credit card loans, partially offset by higher funding costs. Interest income increased over the prior year due to continued loan growth and yield expansion resulting from higher average market rates and changes in portfolio mix. Interest expense increased compared to the prior year due to a larger funding base and higher average market rates. For the year endedDecember 31, 2019 , the provision for loan losses increased as compared to the year endedDecember 31, 2018 primarily due to higher levels of net charge-offs, slightly offset by lower reserve builds. For a detailed discussion on provision for loan losses, see "- Loan Quality - Provision and Allowance for Loan Losses." Other income for the Direct Banking segment was relatively flat for the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 . Other expense increased for the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 primarily due to higher employee compensation and benefits, professional fees, and information processing and communications. Employee compensation and benefits increased as a result of higher average salaries. The increase in professional fees was primarily driven by higher collection fees resulting from increased recoveries, as well as investments in technological capabilities. Information processing and communications was higher due to continued investment in infrastructure and analytic capabilities. Discover card sales volume was$146.2 billion for the year endedDecember 31, 2019 , which was an increase of 5.1% as compared to the year endedDecember 31, 2018 . This volume growth was primarily driven by higher consumer spending. -50-
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Payment Services Our Payment Services segment reported pretax income of$189 million for the year endedDecember 31, 2019 as compared to pretax income of$152 million for the year endedDecember 31, 2018 . The increase in segment pretax income was primarily due to higher transaction volume across multiple channels. Critical Accounting Estimates In preparing our consolidated financial statements in conformity with 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 loan losses, the evaluation of goodwill for potential impairment and the accrual of income taxes as critical accounting estimates. Allowance for Loan Losses We base our allowance for loan losses on several analyses that help us estimate incurred losses as of the balance sheet date. In deriving this estimate, we consider the collectibility of principal, interest and fees associated with our loan receivables. While our estimation process includes historical data and analysis, there is a significant amount of judgment applied in selecting inputs and analyzing the results produced to determine the allowance. We use a migration analysis to estimate the likelihood that a loan will progress through the various stages of delinquency. Management also estimates loss emergence by using other analyses to estimate losses incurred from non-delinquent accounts. The considerations in these analyses include past and current loan performance, loan seasoning and growth, current risk management practices, account collection strategies, economic conditions, bankruptcy filings, policy changes and forecasting uncertainties. Given the same information, others may reach different reasonable estimates. If management used different assumptions in estimating incurred net loan losses, the impact to the allowance for loan losses could have a material effect on our consolidated financial condition and results of operations. For example, a 10% change in management's estimate of incurred net loan losses could have resulted in a change of approximately$338 million in the allowance for loan losses atDecember 31, 2019 , with a corresponding change in the provision for loan losses. See "- Loan Quality" and Note 2: Summary of Significant Accounting Policies to our consolidated financial statements for further details about our allowance for loan losses.Goodwill We recognize goodwill when the purchase price of an acquired business exceeds the total of the fair values of the acquired net assets. As required by GAAP, we test goodwill for impairment annually, or more often if indicators of impairment exist. In evaluating goodwill for impairment, management must estimate the fair value of the reporting unit(s) to which the goodwill relates. Because market data concerning acquisitions of comparable businesses typically are not readily obtainable, other valuation techniques such as earnings multiples and cash flow models are used in estimating the fair values of these reporting units. In applying these techniques, management considers historical results, business forecasts, market and industry conditions and other factors. We may also consult independent valuation experts where needed in applying these valuation techniques. The valuation methodologies we use involve assumptions about business performance, revenue and expense growth, capital expenditures, discount rates and other assumptions that are judgmental in nature. -51-
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AtDecember 31, 2019 , we reported goodwill of$255 million associated with our PULSE network. The estimated fair value of the PULSE reporting unit was more than six times its carrying value as ofOctober 1, 2019 , and there are no present conditions that we believe would cause the fair value of this reporting unit to fall below its carrying value. However, competitive pressures leading to significant declines in revenue, significant increases in the cost of equity, deteriorating economic conditions, or other events adversely impacting the assumptions used by management in the valuation, could cause the fair value of the reporting unit or the associated goodwill to decline in the future, which could result in an impairment loss. AtDecember 31, 2019 , based on the annual impairment testing performed, there was no impairment identified. See Note 7:Goodwill and Intangible Assets to our consolidated financial statements for further details about goodwill and the related impairment testing. Income Taxes We are subject to the income tax laws of the jurisdictions where we have business operations, primarilythe United States , its states and municipalities. We must make judgments and interpretations about the application of these inherently complex tax laws when determining the provision for income taxes and must also make estimates about when in the future certain items will affect taxable income in the various taxing jurisdictions. Disputes over interpretations of the tax laws may be settled with the taxing authority upon examination or audit. We regularly evaluate the likelihood of assessments in each of the taxing jurisdictions resulting from current and subsequent years' examinations, and tax reserves are established as appropriate. Changes in the estimate of income taxes can occur due to tax rate changes, interpretations of tax laws, the status and resolution of examinations by the taxing authorities, and newly enacted laws and regulations that impact the relative merits of tax positions taken. When such changes occur, such as the recent rate change enacted with the Tax Cuts and Jobs Act of 2017, the effect on our consolidated financial condition and results of operations can be significant. See Note 15: Income Taxes to our consolidated financial statements for additional information about income taxes. Earnings Summary The following table outlines changes in our consolidated statements of income (dollars in millions): 2019 vs. 2018 2018 vs. 2017 For the Years Ended December 31, Increase Increase (Decrease) 2019 2018 2017 $ % $ %
Interest income
13 %
Interest expense 2,530 2,139 1,648 391 18 % 491 30 %
Net interest income 9,463 8,754 8,000 709 8 % 754 9 %
Provision for loan
losses 3,231 3,035 2,579 196 6 % 456 18 %
Net interest income
after provision for loan
losses 6,232 5,719 5,421 513 9 % 298 5 %
Other income 1,996 1,955 1,897 41 2 % 58 3 %
Other expense 4,393 4,077 3,781 316 8 % 296 8 %
Income before income tax
expense 3,835 3,597 3,537 238 7 % 60 2 %
Income tax expense 878 855 1,438 23 3 % (583 ) (41 )%
Net income $ 2,957 $ 2,742 $ 2,099 $ 215 8 % $ 643 31 %
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Net Interest Income 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 theFederal 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. Net interest income is influenced by the following: • 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 ofinterest rates and the relationships among interest rate indices, such as
the prime rate, the Federal Funds rate, interest rate on excess reserves
and LIBOR;
• The effectiveness of interest rate swaps in our interest rate risk
management program; and
• The difference between the carrying amount and future cash flows expected
to be collected on purchased credit-impaired ("PCI") loans.
Net interest income increased for the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 primarily driven by loan growth and higher yields on credit card loans, partially offset by higher funding costs. Interest income increased over the prior year due to continued loan growth and yield expansion resulting from higher average market rates and changes in portfolio mix. Interest expense increased compared to the prior year due to a larger funding base and higher average market rates. -53-
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Average Balance Sheet Analysis
(dollars in millions)
For the Years Ended December 31,
2019 2018 2017
Average Average
Average Balance Yield/Rate Interest Balance Yield/Rate Interest Balance Yield/Rate Interest
Assets
Interest-earning assets
Cash and cash equivalents $ 9,667 2.27 % $ 219 $ 14,494 1.93 % $ 280 $ 13,300 1.11 % $ 148
Restricted cash 620 2.24 % 14 633 1.85 % 12 625 0.97 % 6
Other short-term investments 754 2.66 % 20 - - % - - - % -
Investment securities 7,603 2.35 % 179 1,910 2.08 % 40 1,667 1.60 % 27
Loan receivables(1)
Credit card(2) 72,740 13.32 % 9,690 67,953 13.00 % 8,835 62,079 12.74 % 7,907
Personal loans 7,522 13.07 % 983 7,423 12.60 % 936 7,020 12.25 % 860
Private student loans 8,124 8.59 % 698 7,441 8.25 % 614 6,764 7.72 % 522
PCI student loans 1,435 8.29 % 119 1,846 7.54 % 139 2,326 6.84 % 159
Other 1,065 6.63 % 71 593 6.28 % 37 336 5.56 % 19
Total loan receivables 90,886 12.72 % 11,561 85,256 12.39 % 10,561 78,525 12.06 % 9,467 Total interest-earning assets
109,530 10.95 % 11,993 102,293 10.65 % 10,893 94,117 10.25 % 9,648
Allowance for loan losses (3,167 ) (2,776 ) (2,335 )
Other assets 4,627 4,324 4,189
Total assets $ 110,990 $ 103,841 $ 95,971
Liabilities and Stockholders'
Equity
Interest-bearing liabilities
Interest-bearing deposits
Time deposits(3) $ 33,870 2.57 % 869 $ 31,236 2.22 % 695 $ 27,123 1.91 % 519
Money market deposits(4) 7,069 2.09 % 148 6,798 1.81 % 123 6,799 1.29 % 88
Other interest-bearing savings deposits 28,209 2.02 % 570 23,886 1.76 % 420 20,155 1.18 % 239 Total interest-bearing deposits(5) 69,148 2.30 % 1,587 61,920 2.00 % 1,238 54,077 1.56 % 846 Borrowings Short-term borrowings 1 2.33 % - 2 2.07 % - 2 1.10 % - Securitized borrowings(3)(4) 14,572 2.92 %
425 16,218 2.67 % 433 16,746 2.26 %
379
Other long-term borrowings(3) 11,060 4.68 % 518 10,231 4.57 % 468 9,767 4.33 % 423 Total borrowings 25,633 3.68 % 943 26,451 3.41 % 901 26,515 3.02 % 802 Total interest-bearing liabilities 94,781 2.67 % 2,530 88,371 2.42 % 2,139 80,592 2.04 % 1,648 Other liabilities and stockholders' equity 16,209 15,470 15,379 Total liabilities and stockholders' equity$ 110,990 $ 103,841 $ 95,971 Net interest income$ 9,463 $ 8,754 $ 8,000 Net interest margin(6) 10.41 % 10.27 % 10.19 % Net yield on interest-earning assets(7) 8.64 % 8.56 % 8.50 % Interest rate spread(8) 8.28 % 8.23 % 8.21 %
(1) Average balances of loan receivables include non-accruing loans, which are
included in the yield calculations. 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
(3) Includes the impact of interest rate swap agreements used to change a portion
of fixed-rate funding to floating-rate funding.
(4) Includes the impact of interest rate swap agreements used to change a portion
of floating-rate funding to fixed-rate funding.
(5) Includes the impact of
insurance premiums and Large Institution Surcharge. As of
(6) Net interest margin represents net interest income as a percentage of average
total loan receivables.
(7) Net yield on interest-earning assets represents net interest income as a
percentage of average total interest-earning assets.
(8) Interest rate spread represents the difference between the rate on total
interest-earning assets and the rate on total interest-bearing liabilities.
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Rate/Volume Variance Analysis(1) (dollars in millions) Year EndedDecember 31, 2019 vs.
Year Ended
Year Ended December 31, 2018 Year Ended
Volume Rate Total Volume Rate Total
(Decrease)/Increase in net interest income due to
changes in
Interest-earning
assets
Cash and cash
equivalents $ (104 ) $ 43 $ (61 ) $ 15 $ 117 $ 132
Restricted cash - 2 2 - 6 6
Other short-term
investments 20 - 20 - - -
Investment securities 133 6 139 4 9 13
Loan receivables
Credit card 634 221 855 763 165 928
Personal loans 12 35 47 51 25 76
Private student loans 58 26 84 54 38 92
PCI student loans (33 ) 13 (20 ) (35 ) 15 (20 )
Other 31 3 34 15 3 18
Total loan receivables 702 298 1,000 848 246 1,094
Total interest income 751 349 1,100 867 378 1,245
Interest-bearing
liabilities
Interest-bearing
deposits
Time deposits 61 113 174 85 91 176
Money market deposits 5 20 25 - 35 35
Other interest-bearing
savings deposits 83 67 150 49 132 181
Total interest-bearing
deposits 149 200 349 134 258 392
Borrowings
Securitized borrowings (46 ) 38 (8 ) (13 ) 67 54
Other long-term
borrowings 38 12 50 21 24 45
Total borrowings (8 ) 50 42 8 91 99
Total interest expense 141 250 391 142 349 491
Net interest income $ 610 $ 99 $ 709 $ 725 $ 29 $ 754 (1) The rate/volume variance for each category has been allocated on a consistent
basis between rate and volume variances between the years ended
2019, 2018 and 2017 based on the percentage of the rate or volume variance to
the sum of the two absolute variances.
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Loan Quality
Loan receivables consist of the following (dollars in millions):
December 31,
2019 2018 2017 2016 2015
Credit card loans $ 77,181 $ 72,876 $ 67,291 $ 61,522 $ 57,896
Other loans
Personal loans 7,687 7,454 7,374 6,481 5,490
Private student loans 8,402 7,728 7,076 6,393 5,647
Other 1,373 817 423 274 236
Total other loans 17,462 15,999 14,873 13,148 11,373
PCI loans(1) 1,251 1,637 2,084 2,584 3,116
Total loan receivables 95,894 90,512 84,248 77,254 72,385Allowance for loan losses (3,383 ) (3,041 ) (2,621 ) (2,167 )
(1,869 )
Net loan receivables $ 92,511 $ 87,471 $ 81,627 $ 75,087 $ 70,516 (1) Represents PCI private student loans. See Note 4: Loan Receivables to our
consolidated financial statements for more information regarding PCI loans.
Provision and Allowance for Loan Losses
Provision for loan losses is the expense related to maintaining the allowance
for loan losses at an appropriate level to absorb the estimated probable losses
in the loan portfolio at each period end date. While establishing the estimate
for probable losses requires significant management judgment, the factors that
influence the provision for loan losses include:
• The impact of general economic conditions on the consumer, including
national and regional conditions, unemployment levels, bankruptcy trends
and interest rate movements;
• Changes in consumer spending, payment and credit utilization behaviors;
• Changes in our loan portfolio, including the overall mix of accounts,
products and loan balances within the portfolio and maturation of the
loan portfolio;
• The level and direction of historical and anticipated loan delinquencies
and charge-offs;
• The credit quality of the loan portfolio, which reflects, among otherfactors, our credit granting practices and effectiveness of collection
efforts; and
• Regulatory changes or new regulatory guidance.
In determining the allowance for loan losses, we estimate probable losses separately for segments of the loan portfolio that have similar risk characteristics. We use a migration analysis to estimate the likelihood that a loan will progress through the various stages of delinquency. We use other analyses to estimate losses incurred from non-delinquent accounts, which adds to the identification of loss emergence. We use these analyses together as a basis for determining our allowance for loan losses. The provision for loan 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 loan losses at the balance sheet date. For the year endedDecember 31, 2019 , the provision for loan losses increased by$196 million , or 6%, as compared to the year endedDecember 31, 2018 primarily due to higher levels of net charge-offs, slightly offset by lower reserve builds. The allowance for loan losses was$3.4 billion atDecember 31, 2019 , which reflects a$342 million reserve build over the amount of the allowance for loan losses atDecember 31, 2018 . The reserve build, which primarily related to credit card loans, was because of seasoning of continued loan growth and to a lesser extent supply-driven credit normalization. -56-
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The following tables provide changes in our allowance for loan losses (dollars in millions):
For the Year Ended December 31, 2019
Student
Credit Card Personal Loans Loans(1) Other Total
Balance at beginning of period $ 2,528 $ 338 $ 169 $ 6 $ 3,041
Additions
Provision for loan losses 2,849 332 51 (1 ) 3,231
Deductions
Charge-offs (3,165 ) (369 ) (82 ) (1 ) (3,617 )
Recoveries 671 47 13 - 731
Net charge-offs (2,494 ) (322 ) (69 ) (1 ) (2,886 )
Other(2) - - (3 ) - (3 )
Balance at end of period $ 2,883 $ 348 $ 148 $ 4 $ 3,383
For the Year Ended December 31, 2018
Student
Credit Card Personal Loans Loans(1) Other Total
Balance at beginning of period $ 2,147 $ 301 $ 162 $ 11 $ 2,621
Additions
Provision for loan losses 2,594 345 95 1 3,035
Deductions
Charge-offs (2,734 ) (345 ) (97 ) (6 ) (3,182 )
Recoveries 521 37 12 - 570
Net charge-offs (2,213 ) (308 ) (85 ) (6 ) (2,612 )
Other(2) - - (3 ) - (3 )
Balance at end of period $ 2,528 $ 338 $ 169 $ 6 $ 3,041
For the Year Ended December 31, 2017
Student
Credit Card Personal Loans Loans(1) Other Total
Balance at beginning of period $ 1,790 $ 200 $ 158 $ 19 $ 2,167
Additions
Provision for loan losses 2,159 332 93 (5 ) 2,579
Deductions
Charge-offs (2,263 ) (258 ) (94 ) (3 ) (2,618 )
Recoveries 461 27 11 - 499
Net charge-offs (1,802 ) (231 ) (83 ) (3 ) (2,119 )
Other(2) - - (6 ) - (6 )
Balance at end of period $ 2,147 $ 301 $ 162 $ 11 $ 2,621 (1) Includes both PCI and non-PCI private student loans. (2) Net change in reserves on PCI pools having no remaining non-accretable difference.
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The following tables provide changes in our allowance for loan losses (dollars in millions):
For the Year Ended December 31, 2016
Student
Credit Card Personal Loans Loans(1) Other Total
Balance at beginning of period $ 1,554 $ 155 $ 143 $ 17 $ 1,869
Additions
Provision for loan losses 1,579 196 82 2 1,859
Deductions
Charge-offs (1,786 ) (172 ) (76 ) - (2,034 )
Recoveries 443 21 9 - 473
Net charge-offs (1,343 ) (151 ) (67 ) - (1,561 )
Balance at end of period $ 1,790 $ 200 $ 158 $ 19 $ 2,167
For the Year Ended December 31, 2015
Student
Credit Card Personal Loans Loans(1) Other Total
Balance at beginning of period $ 1,474 $ 120 $ 135 $ 17 $ 1,746
Additions
Provision for loan losses 1,300 147 64 1 1,512
Deductions
Charge-offs (1,660 ) (129 ) (65 ) (1 ) (1,855 )
Recoveries 440 17 9 - 466
Net charge-offs (1,220 ) (112 ) (56 ) (1 ) (1,389 )
Balance at end of period $ 1,554 $ 155 $ 143 $ 17 $ 1,869 (1) Includes both PCI and non-PCI private student loans.
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 loan 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):
For the Years Ended December 31,
2019 2018 2017 2016 2015
$ % $ % $ % $ % $ %
Credit card loans $ 2,494 3.43 % $ 2,213 3.26 % $ 1,802 2.91 % $ 1,343 2.34 % $ 1,220 2.22 %
Personal loans $ 322 4.28 % $ 308 4.15 % $ 231 3.30 % $ 151 2.55 % $ 112 2.15 %
Private student loans
(excluding PCI(1)) $ 69 0.85 % $ 85 1.14 % $ 83 1.21 % $ 67 1.10 % $ 56 1.07 %
(1) See Note 4: Loan Receivables to our consolidated financial statements for
information regarding the accounting for charge-offs on PCI loans.
The net charge-off rates on our credit card and personal loans increased for the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 as a result of seasoning of continued loan growth and supply-driven credit normalization. Net charge-offs on our private student loans decreased for the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 due to more effective collection strategies. -58-
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Delinquencies
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,
loan receivables that are not accruing interest regardless of delinquency, and restructured loans (dollars in millions):
Years Ended December 31,
2019 2018 2017 2016 2015
$ % $ % $ % $ % $ %
Loans 30 or more days
delinquent
Credit card loans $ 2,019 2.62 % $ 1,772 2.43 % $ 1,532 2.28 % $ 1,252 2.04 % $ 995 1.72 %
Personal loans $ 105 1.37 % $ 119 1.60 % $ 103 1.40 % $ 74 1.12 % $ 49 0.89 %
Private student loans
(excluding PCI
loans(1)) $ 145 1.72 % $ 155 2.00 % $ 167 2.35 % $ 141 2.22 % $ 108 1.91 %
Loans 90 or more days
delinquent
Credit card loans(2) $ 1,020 1.32 % $ 887 1.22 % $ 751 1.12 % $ 597 0.97 % $ 490 0.85 %
Personal loans(3) $ 31 0.40 % $ 35 0.47 % $ 30 0.41 % $ 19 0.29 % $ 15 0.27 %
Private student loans
(excluding PCI
loans(1))(4) $ 36 0.42 % $ 38 0.49 % $ 33 0.47 % $ 35 0.55 % $ 24 0.43 %
Loans not accruing
interest $ 266 0.28 % $ 302 0.34 % $ 233 0.28 % $ 216 0.29 % $ 224 0.32 %
Restructured loans
Credit card loans
Currently enrolled $ 2,108 2.73 % $ 1,649 2.26 % $ 926 1.38 % $ 781 1.27 % $ 746 1.29 %
No longer enrolled 1,254 1.62 599 0.82 390 0.58 304 0.49 273 0.47
Total credit card
loans(2) $ 3,362 4.35 % $ 2,248 3.08 % $ 1,316 1.96 % $ 1,085 1.76 % $ 1,019 1.76 %
Personal loans(3) $ 208 2.71 % $ 152 2.04 % $ 111 1.51 % $ 81 1.25 % $ 68 1.24 %
Private student loans
(excluding PCI
loans(1))(4) $ 269 3.20 % $ 182 2.36 % $ 137 1.94 % $ 86 1.35 % $ 48 0.85 %
(1) Excludes PCI loans, which are accounted for on a pooled basis. Since a pool
is accounted for as a single asset with a single composite interest rate and
aggregate expectation of cash flows, the past-due status of a pool, or that
of the individual loans within a pool, is not meaningful. Because we are
recognizing interest income on a pool of loans, it is all considered to be
performing.
(2) Restructured credit card loans include
million,
and 2015, respectively, which are also included in loans 90 or more days
delinquent.
(3) Restructured personal loans include
million and
respectively, which are also included in loans 90 or more days delinquent.
(4) Restructured private student loans include
million,
2015, respectively, which are also included in loans 90 or more days
delinquent.
The 30-day and 90-day delinquency rates for credit card loans atDecember 31, 2019 increased as compared toDecember 31, 2018 primarily due to seasoning of continued loan growth and supply-driven credit normalization. The 30-day and 90-day delinquency rates for personal loans decreased atDecember 31, 2019 compared toDecember 31, 2018 as a result of improved underwriting and more effective collection strategies. The 30-day and 90-day delinquency rates for student loans decreased atDecember 31, 2019 compared toDecember 31, 2018 due to more effective collection strategies. The restructured credit card, personal and private student loan balances increased atDecember 31, 2019 as compared toDecember 31, 2018 due to seasoning of continued loan growth and improved awareness of programs available to assist borrowers having difficulties meeting payment obligations. To provide additional clarity with respect to credit card loans classified as troubled debt restructurings, the table above now discloses the balance of those loans currently enrolled or no longer enrolled in a loan modification program. We believe loan modification programs are useful in assisting customers experiencing financial difficulties and help to prevent defaults. Of the$1,254 million of credit card loans that had been modified and are classified as troubled debt restructurings but for which the borrowers -59-
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are no longer enrolled in a loan modification program atDecember 31, 2019 ,$1,038 million represents balances associated with borrowers that successfully completed the program. We plan to continue to use loan modification programs as a means to provide relief to customers experiencing temporary financial difficulties. See Note 4: Loan Receivables to our consolidated financial statements for further description of our use of loan modifications to provide relief to customers experiencing financial hardship. Modified and Restructured Loans For information regarding modified and restructured loans, see "- Delinquencies" and Note 4: Loan Receivables to our consolidated financial statements. Maturities and Sensitivities of Loan Receivables to Changes in Interest Rates Our loan portfolio had the following maturity distribution(1) (dollars in millions): Due After Due One One Year Year or Through Due After At December 31, 2019 Less Five Years
Five Years Total
Credit card loans $ 23,147 $ 41,052 $ 12,982 $ 77,181
Personal loans 2,157 5,236 294 7,687
Private student loans (excluding PCI) 209 1,885 6,308 8,402
PCI loans 141 418 692 1,251
Other loans 50 247 1,076 1,373
Total loan portfolio $ 25,704 $ 48,838 $ 21,352 $ 95,894 (1) Because of the uncertainty regarding loan repayment patterns, the above
amounts have been calculated using contractually required minimum payments.
Historically, actual loan repayments have been higher than such minimum
payments and, therefore, the above amounts may not necessarily be indicative
of our actual loan repayments.
AtDecember 31, 2019 , approximately$42.4 billion of our loan portfolio due after one year had interest rates tied to an index and approximately$27.8 billion were fixed-rate loans. Other Income The following table presents the components of other income (dollars in millions): 2019 vs. 2018 2018 vs. 2017 For the Years Ended December 31, (Decrease) Increase Increase (Decrease) 2019 2018 2017 $ % $ %
Discount and interchange
revenue, net(1)
(1 )% $ 22 2 %
Protection products
revenue 194 204 223 (10 ) (5 )% (19 ) (9 )%
Loan fee income 449 402 363 47 12 % 39 11 %
Transaction processing
revenue 197 178 167 19 11 % 11 7 %
Other income 90 97 92 (7 ) (7 )% 5 5 %
Total other income $ 1,996 $ 1,955 $ 1,897 $ 41 2 % $ 58 3 %
(1) Net of rewards, including Cashback Bonus rewards, of
billion and
2017, respectively.
Total other income increased$41 million for the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 , which was primarily driven by higher loan fee income and transaction processing revenue. Loan fee income was higher as a result of an increase in late fees. The increase in transaction processing revenue was due to greater transaction volume on the PULSE network. Net discount and interchange revenue was relatively flat for the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 with offsetting increases in gross discount and interchange revenue and rewards, both of which were primarily the result of higher sales volume. -60-
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Other Expense
The following table represents the components of other expense (dollars in millions):
2019 vs. 2018 2018 vs. 2017
For the Years Ended December 31, Increase Increase
2019 2018 2017 $ % $ %
Employee compensation
and benefits $ 1,738 $ 1,627 $ 1,512 $ 111 7 % $ 115 8 %
Marketing and business
development 883 857 776 26 3 % 81 10 %
Information processing
and communications 409 350 315 59 17 % 35 11 %
Professional fees 753 672 655 81 12 % 17 3 %
Premises and equipment 107 102 99 5 5 % 3 3 %
Other expense 503 469 424 34 7 % 45 11 %
Total other expense $ 4,393 $ 4,077 $ 3,781 $ 316 8 % $ 296 8 %
Total other expense increased $316 million for the year ended December 31, 2019
as compared to the year ended December 31, 2018 . The increase was primarily
driven by higher employee compensation and benefits, professional fees, and
information processing and communications. Employee compensation and benefits
increased as a result of higher average salaries. The increase in professional
fees was primarily driven by higher collection fees resulting from increased
recoveries, as well as investments in technological capabilities. Information
processing and communications was higher due to continued investment in
infrastructure and analytic capabilities.
Income Tax Expense
The following table reconciles our effective tax rate to the U.S. federal statutory income tax rate:
For the Years Ended December 31,
2019 2018 2017
U.S. federal statutory income tax rate 21.0 % 21.0 % 35.0 %
U.S. state, local and other income taxes, net of
U.S. federal income tax benefits 3.5 3.6 3.1
Revaluation of net deferred tax assets and other
investments due to tax reform(1) - - 5.1
Tax credits (1.4 ) (1.3 ) (1.3 )
Other (0.2 ) 0.5 (1.2 )
Effective income tax rate 22.9 % 23.8 % 40.7 %
Income tax expense $ 878 $ 855 $ 1,438 (1) See Note 3: Investments - Other Investments to our consolidated financial
statements for a description of these investments.
For the year endedDecember 31, 2019 , income tax expense increased$23 million , or 2.7%, and the effective income tax rate decreased 0.9 percentage points as compared to the year endedDecember 31, 2018 . The increase in income tax expense was primarily driven by increased pretax income. The effective tax rate decreased primarily due to the resolution of certain tax matters. Liquidity and Capital Resources Funding and Liquidity We seek to maintain stable, diversified and cost-effective funding sources and a strong liquidity profile in order to fund our business and repay or refinance our maturing obligations under both 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 contingent 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 liquidity portfolio comprised of highly liquid, unencumbered assets, including cash and cash equivalents and investment securities, and borrowing capacity through -61-
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private term asset-backed securitizations. In addition, we have unused borrowing capacity with theFederal Reserve discount window, which provides another source of contingent liquidity. Funding Sources Deposits We offer deposit products to customers through two channels: (i) through direct marketing, internet origination and affinity relationships ("direct-to-consumer deposits"); and (ii) indirectly through contractual arrangements with securities brokerage firms ("brokered deposits"). Direct-to-consumer deposits include online savings accounts, certificates of deposit, money market accounts, IRA certificates of deposit and checking accounts, while brokered deposits include certificates of deposit and sweep accounts. AtDecember 31, 2019 , we had$54.4 billion of direct-to-consumer deposits and$18.3 billion of brokered and other deposits. Credit Card Securitization Financing We securitize credit card receivables as a source of funding. We access the asset-backed securitization market using the Discover CardMaster Trust I ("DCMT") and theDiscover Card Execution Note Trust ("DCENT"), through which we issue DCENT DiscoverSeries notes in both public and private transactions. From time to time, we may add credit card receivables to these trusts to create sufficient funding capacity for future securitizations while managing seller's interest. We retain significant exposure to the performance of trust assets through holdings of the seller's interest and subordinated security classes of DCENT. 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 by a trust during a collection period, including interest collections, fees and interchange, exceeds the fees and expenses of the trust 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 the affected outstanding securitized borrowings using available collections received by the trust; the period of ultimate repayment would be determined by the amount and timing of collections received. 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. As ofDecember 31, 2019 , the DiscoverSeries three-month rolling average excess spread was 13.44%. We may elect to add receivables to the restricted pool of receivables, subject to certain requirements. Through our wholly-owned indirect subsidiary,Discover Funding LLC , we are required to maintain a contractual minimum level of receivables in the trust in excess of the face value of outstanding investors' interests. This excess is referred to as the minimum seller's interest. The required minimum seller's interest in the pool of trust receivables, which is included in credit card loan receivables restricted for securitization investors, is set at 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 the trust 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 loan 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 is impacted by seasonality as higher 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. No accounts were added to those restricted for securitization investors for the year endedDecember 31, 2019 . AtDecember 31, 2019 , we had$14.1 billion of outstanding public asset-backed securities and$4.8 billion of outstanding subordinated asset-backed securities that had been issued to our wholly-owned subsidiaries. -62-
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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):
One Year Four Years
Less Than Through Through After Five
At December 31, 2019 Total One Year Three Years Five Years Years
Scheduled maturities of
long-term borrowings - owed to
credit card securitization
investors $ 14,124 $ 3,498 $ 7,841 $ 2,785 $ -
The triple-A rating of DCENT Class A Notes issued to date has been based, in
part, on an FDIC rule, which created a safe harbor that provides that the FDIC ,
as conservator or receiver, will not, using its power to disaffirm or repudiate
contracts, seek to reclaim or recover assets transferred in connection with a
securitization, or recharacterize them as assets of the insured depository
institution, provided such transfer satisfies the conditions for sale accounting
treatment under previous GAAP. Although the implementation of the 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 . Other legislative and regulatory developments
may, however, impact our ability and/or desire to issue asset-backed securities
in the future.
Other Long-Term Borrowings-Student Loans
At December 31, 2019 , $161 million of remaining principal balance was
outstanding on securitized debt assumed as part of our acquisition of The
Student Loan Corporation . Principal and interest payments on the underlying
student loans will reduce the balance of these secured borrowings over time.
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):
Principal Amount
At December 31, 2019 Outstanding
$ 3,422
$ 344
6,850
1,000
CertainDiscover Financial Services senior notes require us to offer to repurchase the notes at a price equal to 101% of their aggregate principal amount plus accrued and unpaid interest in the event of a change of control involving us and a corresponding ratings downgrade to below investment grade. 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 aFederal Reserve account. Funds borrowed in the repo market are short-term, collateralized loans, usually secured with highly-rated investment securities such asU.S. Treasury bills or notes, or federal agency mortgage bonds or debentures. AtDecember 31, 2019 , there were no outstanding balances in the federal funds market or repurchase agreements. Additional Funding Sources Private Asset-Backed Securitizations We have access to committed borrowing capacity through privately placed asset-backed securitizations. AtDecember 31, 2019 , we had total committed capacity of$6.0 billion ,$500 million of which was drawn. While we -63-
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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 potential contingency funding needs. We also seek to ensure the stability and reliability of these securitizations by staggering their maturity dates, renewing them approximately one year prior to their scheduled maturity dates and periodically drawing them for operational testing purposes and seasonal funding needs.Federal Reserve Discover Bank has access to theFederal Reserve Bank of Philadelphia's discount window. As ofDecember 31, 2019 ,Discover Bank had$34.2 billion of available borrowing capacity through the discount window based on the amount and type of assets pledged, primarily consumer loans. We have no borrowings outstanding under the discount window and reserve this capacity as a source of contingent liquidity. Funding Uses Our primary uses of funds include the extensions of loans and credit, primarily throughDiscover Bank , the purchase of investment securities for our liquidity portfolio, working capital, and debt and capital service. 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 contingent uses of funding, such as the need to post additional collateral for derivatives positions. In order to anticipate funding needs under stress, we conduct liquidity stress tests to assess the impact of idiosyncratic, systemic and hybrid (idiosyncratic and systemic) scenarios with varying levels of liquidity risk reflecting a range of stress severity. 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 collateral enhancement requirements for both our public and private asset securitizations. In addition to increased funding costs, deterioration in credit ratings could reduce our borrowing capacity in the unsecured debt and asset securitization capital markets. We also maintain agreements with certain of our derivative counterparties that contain provisions that requireDFS andDiscover Bank to maintain an investment grade credit rating from specified major credit rating agencies. AtDecember 31, 2019 ,Discover Bank's credit rating met specified thresholds set by its counterparties. However, if its credit ratings were to fall below investment grade,Discover Bank would be required to post additional collateral, which, as ofDecember 31, 2019 , would have been$20 million . DFS (Parent Company) had no outstanding derivatives as ofDecember 31, 2019 , and therefore, no collateral was required. The table below reflects our current credit ratings and outlooks: Moody's Investors Standard Service & Poor's Fitch RatingsDiscover Financial Services Senior unsecured debt Baa3 BBB-
BBB+
Outlook forDiscover Financial Services senior unsecured debt Stable Stable StableDiscover Bank Senior unsecured debt Baa2 BBB BBB+
Outlook for
Stable
Subordinated debt Baa3 BBB-
BBB
Discover Card Execution Note Trust Class A(1) Aaa(sf) AAA(sf) AAA(sf)
(1) An "sf" in the rating denotes rating agency identification for structured
finance product ratings.
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A credit rating is not a recommendation to buy, sell or hold securities, may be subject to revision or withdrawal at any time by the assigning rating organization, and each rating should be evaluated independently of any other rating. 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 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 policy is approved by the Board of Directors with implementation responsibilities delegated to theAsset and Liability Management Committee (the "ALCO"). Additionally, we maintain a liquidity management framework document, which 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. Liquidity risk is centrally managed by the ALCO, which is chaired by our Treasurer and has cross-functional membership. The ALCO monitors the liquidity risk profiles ofDFS andDiscover 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 atDFS andDiscover 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 the initial phases of liquidity stress events and a reporting and escalation process that is designed to be consistent with regulatory guidance. The EWIs include both idiosyncratic and systemic measures, and are monitored on a daily basis 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 in accordance with 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 atDFS andDiscover Bank across a range of time horizons by comparing estimated contingency funding needs to available contingent liquidity. Our primary contingent liquidity sources include our liquidity portfolio and private securitizations with unused borrowing capacity. In addition, we have unused borrowing capacity with theFederal Reserve discount window, which provides an additional source of contingent liquidity. We seek to maintain sufficient liquidity to be able 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. AtDecember 31, 2019 , our liquidity portfolio is comprised of highly liquid, unencumbered assets, including cash and cash equivalents and investment securities. Cash and cash equivalents were primarily in the form of deposits with theFederal Reserve . Investment securities primarily included debt obligations of theU.S. Treasury and residential mortgage-backed securities issued byU.S. government housing agencies or government-sponsored enterprises. These investments 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 upon the size of our balance sheet as well as operational requirements, market conditions and interest rate risk management policies. For example, we have altered the composition of our liquidity portfolio to mitigate the potential volatility of earnings that may arise from changes in interest rates. -65-
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AtDecember 31, 2019 , our liquidity portfolio and undrawn credit facilities were$56.3 billion , which was$3.4 billion higher than the balance atDecember 31, 2018 . During the year endedDecember 31, 2019 , the average balance of our liquidity portfolio was$18.1 billion . December 31, 2019 2018 (dollars in millions) Liquidity portfolio Cash and cash equivalents(1)$ 6,406 $ 12,832 Investment securities(2) 10,202 3,091 Total liquidity portfolio 16,608 15,923 Private asset-backed securitizations(3) 5,500 5,500 Primary liquidity sources 22,108 21,423 Federal Reserve discount window(3) 34,220 31,486
Total liquidity portfolio and undrawn credit facilities
(1) Cash in the process of settlement and restricted cash are excluded from cash
and cash equivalents for liquidity purposes.
(2) Excludes
been pledged as swap collateral in lieu of cash as of
2018, 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, which include 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, particularlyDiscover 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 fromDiscover Bank to the bank holding company. We utilize a measure referred to as Number of Months of Pre-Funding to determine the length of timeDiscover Financial Services can meet upcoming funding obligations including common and preferred stock dividend payments and debt service obligations using existing cash resources. We structure our debt maturity schedule to minimize the amount of debt maturing within a short period of time. See Note 9: Long-Term Borrowings to our 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 the growth and risks of our businesses and to 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 theFederal Reserve and theFDIC , DFS, along withDiscover Bank , must maintain minimum levels of capital. 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 position and 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 the future implementation of CECL, may require us to hold more capital or adversely impact our capital level. We consider the potential impacts of these reforms in managing our capital position.Discover Financial Services andDiscover Bank are subject to regulatory capital requirements that became effectiveJanuary 2015 under final rules issued by theFederal Reserve and theFederal Deposit Insurance Corporation -66-
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to implement the provisions under the Basel Committee'sDecember 2010 framework ("Basel III rules"). The Basel III rules requireDiscover Financial Services andDiscover Bank to maintain minimum risk-based capital and leverage ratios and define what constitutes capital for purposes of calculating those ratios. Under Basel III rules for regulatory capital,DFS andDiscover Bank are classified as "Standardized Approach" entities, defined asU.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 . As ofJanuary 1, 2019 , thresholds within the Basel III rules are fully phased in with the exception of certain transition provisions that were frozen pursuant to regulation issued inNovember 2017 . Pursuant to a final rule issued inJuly 2019 , the transition provisions that were previously frozen will be replaced with new permanent thresholds as discussed below. For additional information regarding the risk-based capital and leverage ratios, see Note 17: Capital Adequacy to our consolidated financial statements. The Basel III rules also introduced a capital conservation buffer ("CCB") on top of the minimum risk-weighted asset ratios. The buffer is designed to absorb losses during periods of economic stress. The application of the buffer was subject to phase-in periods that endedDecember 31, 2019 . Then beginningJanuary 1, 2019 , the CCB effectively results in minimum regulatory capital ratios (including the CCB) of (i) Common Equity Tier 1 ("CET1") to risk-weighted assets of at least 7.0%, (ii) Tier 1 capital to risk-weighted assets of at least 8.5% and (iii) Total capital to risk-weighted assets of at least 10.5%. Banking institutions with a capital ratio below the required threshold will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. There is a proposal under regulatory review by theFederal Reserve that would effectively replace the CCB with a new buffer requirement for DFS that is linked to supervisory stress testing results (i.e., the Stress Capital Buffer), see "- Regulatory Environment and Developments." The Basel III rules provide for certain threshold-based deductions from and adjustments to CET1, to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15%. InJuly 2019 , federal banking regulators issued a final rule that, among other things, revises certain capital requirements for Standardized Approach banks by raising the 10% of CET1 deduction threshold for certain items to 25% and eliminates the 15% combined deduction threshold applying to these items. These changes will become effective for all Standardized Approach banking institutions inApril 2020 , although banks have the option to adopt early beginning onJanuary 1, 2020 . 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 transparency of capital requirements for banking organizations. We are required to make prescribed regulatory disclosures on a quarterly basis regarding our capital structure, capital adequacy, risk exposures and risk-weighted assets. The Pillar 3 disclosures are made publicly available on our website in a report called "Basel III Regulatory Capital Disclosures." AtDecember 31, 2019 ,DFS andDiscover Bank met the requirements for "well-capitalized" status under Regulation Y and the prompt corrective action rules, respectively, exceeding the regulatory minimums to which they were subject under the applicable rules. We disclose tangible common equity, which represents common equity less goodwill and intangibles. Management believes that common stockholders' equity excluding goodwill and intangibles is a meaningful measure to investors of our true net asset value. As ofDecember 31, 2019 , tangible common equity is not formally defined byU.S. GAAP or codified in the federal banking regulations and, as such, is considered to be a non-GAAP financial measure. Other financial services companies may also disclose this measure and definitions may vary, so we advise users of this information to exercise caution in comparing this measure for different companies. The following table provides a reconciliation of total common stockholders' equity (aU.S. GAAP financial measure) to tangible common equity (dollars in millions):
2019 2018
Total common stockholders' equity(1) $ 11,296 $ 10,567
Less: goodwill (255 ) (255 )
Less: intangible assets, net (155 ) (161 )
Tangible common equity $ 10,886 $ 10,151 (1) Total common stockholders' equity is calculated as total stockholders' equity
less preferred stock.
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Additionally, we are subject to regulatory requirements imposed by theFederal Reserve as part of its stress testing framework and CCAR program. Refer to "- Regulatory Environment and Developments" for more information. For the period betweenJuly 1, 2019 andJune 30, 2020 , theFederal Reserve pre-approved capital distributions up to a maximum amount for each Category IV bank, including Discover. TheFederal Reserve based these capital distribution limits on results from the 2018 supervisory stress test. Notwithstanding the pre-approval, we were still required to prepare a capital plan to be approved by our Board of Directors. This plan outlined our contemplated capital distributions for the period fromJuly 1, 2019 toJune 30, 2020 , which were within theFederal Reserve's pre-approved amount. After our Board of Directors approved our capital plan, we submitted our planned capital actions to theFederal Reserve inApril 2019 . Pursuant to that plan, we are returning capital to our shareholders by paying dividends on our common and preferred stock and repurchasing shares of our common stock. We recently declared a quarterly cash dividend on our common stock of$0.44 per share, payable onMarch 5, 2020 to holders of record onFebruary 20, 2020 , which is consistent with the amount paid in the third and fourth quarters of 2019. We also recently declared a semi-annual cash dividend on our preferred stock of$2,750 per share, equal to$27.50 per depositary share, payable onApril 30, 2020 to holders of record onApril 15, 2020 , which is consistent with the amount paid in the second and fourth quarters of 2019. OnJuly 18, 2019 , our Board of Directors approved a share repurchase program authorizing the repurchase of up to$2.2 billion of our outstanding shares of common stock. The program expires onSeptember 30, 2020 and may be terminated at any time. This program replaced the prior$3.0 billion share repurchase program, which had$1.2 billion of remaining authorization. During the year endedDecember 31, 2019 , we repurchased approximately 22 million shares, or 7%, of our outstanding common stock for$1.7 billion . We expect to continue to repurchase shares under our program from time to time based on market conditions and other factors, subject to legal and regulatory requirements and restrictions, including limitations from theFederal Reserve as described above. Share repurchases under the program may be made through a variety of methods, including open market purchases, privately negotiated transactions or other purchases, including block trades, accelerated share repurchase transactions, or any combination of such methods. The amount and size of any future dividends and share repurchases will depend upon our results of operations, financial condition, capital levels, cash requirements, future prospects and other factors, such as the implementation of CECL. The declaration and payment of future dividends, as well as 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, and if full dividends have not been declared and paid on all outstanding shares of preferred stock in any dividend period, no dividend may be declared or paid or set aside for payment on our common stock. 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 to which our banking subsidiaries can provide funds to us through dividends, loans or otherwise. Further, current or future regulatory reforms may require us to hold more capital or adversely impact our capital level. There can be no assurance that we will declare and pay any dividends or repurchase any shares of our common stock in the future. For more information, including conditions and limits on our ability to pay dividends and repurchase our stock, see "Business - Supervision and Regulation - Capital, Dividends and Share Repurchases," "Risk Factors - Credit, Market and Liquidity Risk - We may be limited in our ability to pay dividends on and repurchase our stock" and "- We are a holding company and depend on payments from our subsidiaries" and Note 17: Capital Adequacy to our consolidated financial statements. Certain Off-Balance Sheet Arrangements Guarantees Guarantees are contracts or indemnification agreements that contingently 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 contingently 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 byPULSE and Diners Club . See Note 18: Commitments, Contingencies and Guarantees to our consolidated financial statements for further discussion regarding our guarantees. -68-
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Contractual Obligations and Contingent Liabilities and Commitments
In the normal course of business, we enter into various contractual obligations that may require future cash payments.
Contractual obligations include deposits, long-term borrowings, operating lease obligations, interest payments on
fixed-rate debt, purchase obligations and other liabilities. Our future cash payments associated with our contractual
obligations are summarized below (dollars in millions):
Payments Due By Period
Four Years
Less Than One One Year Through Through Five More Than Five
At December 31, 2019 Total Year Three Years Years Years
Deposits(1)(2) $ 72,746 $ 57,341 $ 10,272 $ 3,222 $ 1,911
Borrowings(3) 25,701 5,247 9,329 5,884 5,241
Operating leases 128 14 27 28 59
Interest payments on fixed-rate
debt 2,648 614 922 576 536
Purchase obligations(4) 1,237 641 369 180 47
Other liabilities(5) 301 53 72 42 134
Total contractual obligations
20,991
(1) Deposits do not include interest payments because payment amounts and timing
cannot be reasonably estimated as certain deposit accounts have early
withdrawal rights and the option to roll interest payments into the balance.
(2) Deposits due in less than one year include deposits with indeterminate
maturities.
(3) See Note 9: Long-Term Borrowings to our consolidated financial statements for
further discussion. Total future payment of interest charges for the
floating-rate notes is estimated to be
utilizing the current interest rates as of that date.
(4) Purchase obligations for goods and services include payments under, among
other things, consulting, outsourcing, data, advertising, sponsorship,
software license, telecommunications agreements and global acceptance
contracts. Purchase obligations also include payments under rewards program
agreements with merchants. Purchase obligations at
the minimum purchase obligation under legally binding contracts with contract
terms that are both fixed and determinable. These amounts exclude obligations
for goods and services that already have been incurred and are reflected on
our consolidated statement of financial condition.
(5) Other liabilities include our expected benefit payments associated with our
pension plan, the contingent liability associated with our other investments
accounted for under the equity method and a commitment to purchase certain
when-issued mortgage-backed securities under an agreement with the
As ofDecember 31, 2019 our consolidated statement of financial condition reflects a liability for unrecognized tax benefits of$61 million and approximately$17 million of accrued interest and penalties. Since the ultimate amount and timing of any future cash settlements cannot be predicted with reasonable certainty, the estimated income tax obligations about which there is uncertainty have been excluded from the contractual obligations table. See Note 15: Income Taxes to our consolidated financial statements for further information concerning our tax obligations. We extend credit for consumer loans, primarily arising 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 established in the related agreement. AtDecember 31, 2019 , our unused credit arrangements were approximately$206.7 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 and loan qualification. In addition, 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. Item 7A. 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 a variety of depositors and institutions in order to provide loans to our customers, as well as invest in other assets and our business. These loans 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 -69-
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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, which may decrease 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 financing portfolio that reflects our mix of variable- and fixed-rate assets. 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 21: Derivatives and Hedging Activities to our 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-month period from our reporting date, we assume that all interest rate sensitive assets and liabilities will be impacted by a hypothetical, immediate 100 basis point change in interest rates relative to market consensus expectations as of the beginning of the period. The sensitivity is based upon 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 the assets that make up our liquidity portfolio. We have limitations on our ability to mitigate interest rate risk by adjusting rates on existing balances and competitive actions may limit our ability to increase the rates that we charge to customers for new loans. AtDecember 31, 2019 , the majority of our credit card and student loans charge variable rates. Assets with rates that are fixed at period end but which will mature, or otherwise contractually reset to a market-based indexed rate or other fixed rate prior to the end of the 12-month 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 that have a fixed interest rate but contractually will, or are 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 loan losses, which for purposes of this analysis, 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-month period. Thus, liabilities that vary with changes in a market-based index, such as the federal funds rate or London Interbank Offered Rate, which will reset before the end of the 12-month period, or liabilities whose rates are fixed 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 12-month period, 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 requires assumptions to be made regarding market conditions, consumer behavior, and the overall growth and composition of the balance sheet. These assumptions 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 versus long-term rates, balance sheet composition, competitor actions affecting pricing decisions in our loans and deposits, and strategic actions undertaken by management. 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): At December 31, 2019 At December 31, 2018 Basis point change $ % $ % +100 $ 12 0.12 % $ 192 2.01 % -100 $ (13 ) (0.13 )%$ (194 ) (2.03 )% -70-
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